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C H A P T E R 1 An Investment Perspective of Human Resource Management

Human Resources at Nordstrom How can a retailer gain a competitive advantage in a cut-throat marketplace? Middle- and high-end retailers generally locate in close proximity to each other and often carry similar—but not identical—merchandise. Consequently their sales and profit margins are usually in tandem. Nordstrom, however, has consis- tently produced above-industry-average profits and continues to be profitable when its competitors’ profits are falling or flat.

The key to Nordstrom’s success lies with the different way it manages its employees. Sales employees are known as “associates” and considered the orga- nization’s most valuable asset. The company’s success is rooted in its strategy of providing superlative customer service. Associates are encouraged to act as entrepreneurs and build strong personal relationships with customers, or “clients.” In fact, many clients shop only with a particular Nordstrom associate and call in advance to determine the associates’ schedules or to make appointments.

Nordstrom’s strategy involves a heavy investment in the organization’s sales force. Nordstrom provides associates with extensive training on merchandising and product lines and offers high compensation. Its commitment to its employ- ees is evident from the fact that the company’s organization chart is depicted inverse from that of a traditional retailer. Associates are at the highest level on the chart, followed by department and merchandise managers and, finally, executives. This depiction cements the organization’s philosophy that the customer is king. All efforts of senior-, middle-, and lower-level managers should support the efforts of the sales force.

L E A R N I N G O B J E C T I V E S

• Understand the sources of employee value

• Gain an appreciation of the importance of human capital and how it can be measured

• Understand how competitive advantage can be achieved through investment in employees

• Gain an appreciation of metrics, their measures, and their usefulness

• Understand the obstacles that prevent organizations from investing in their employees

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E ffective organizations are increasingly realizing that of the varied factors that contribute to perfor- mance, the human element is clearly the most critical. Regardless of the size or nature of an organi- zation, the activities it undertakes, and the environment in which it operates, its success is

determined by the decisions its employees make and the behaviors in which they engage. Managers at all levels in organizations are becoming increasingly aware that a critical source of competitive advantage often comes not from having the most ingenious product design or service, the best marketing strategy, state-of-the-art technology, or the most savvy financial management but from having the appropriate systems for attracting, motivating, and managing the organizations’ human resources (HR).

Adopting a strategic view of HR, in large part, involves considering employees as human “assets” and developing appropriate policies and programs as investments in these assets to increase their value to the organization and the marketplace. The characterization of employees as human assets can have a chilling effect on those who find the term derogatory because of its connotation that employees are to be considered “properly.” However, the characterization of employees as assets is fitting, considering what an asset actually is: something of value and worth. Effective organizations realize that their employees do have value, much as the organization’s physical and capital assets have value. Exhibit 1.1 illustrates some of the value employees bring to an organization.

Adopting an Investment Perspective The characterization of employees as human assets has important implications for the strategic management of HR in that it allows us to consider HR from an investment perspective. Physical and capital assets in organizations, such as plant, property, machinery, and technology, are

EXHIBIT 1.1 Sources of Employee Value

Decision Making Capabilities

Motivation

Commitment

Teamwork • Interpersonal skills • Leadership ability

Ability to Learn and Grow • Openness to new ideas • Acquisition of knowledge/skills

Technical Knowledge • Markets • Processes • Environment

• Customers

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acquired and subsequently managed most effectively by treating them as investments; the organiza- tion determines the optimal mix of high-performance, high-return assets to its strategic objectives. Analyses are made of the costs and benefits of certain expenditures, with judgments made concerning the riskiness and potential returns of such expenditures. Viewing HR from an investment perspective, much as physical assets are viewed, rather than as variable costs of production, allows an organization to determine how to best invest in its people. Furthermore, considering the risk and return on possi- ble expenditures related to acquiring or developing human assets allows an organization to consider how current expenditures can be best allocated to meet long-term performance goals.

In considering whether to undertake the expense of a new training program, for example, an organization needs to consider not only the out-of-pocket costs for the training but also the related opportunity costs, such as lost time on the job, and weigh these costs against the potential benefits of the training, such as enhanced performance, potential increased loyalty, and motiva- tion. The training also needs to be assessed relative to risk because the enhanced marketability of employees makes them more desirable to competitors. Similarly, in considering compensation pro- grams as an investment, an organization needs to consider what it is “investing” in when it pays someone (knowledge, commitment, new ideas, retention of employees from competitors). The potential return on the organization’s financial outlay in compensation will determine whether its compensation system is a viable investment strategy.

Taking an investment perspective toward HR/assets is critical considering that other physical assets, such as facilities, products and services, technologies, and markets, can be readily cloned or imitated by competitors.1 Human assets cannot be duplicated and therefore become the competitive advantage that an organization enjoys in its market(s). This is becoming increasingly important as the skills required for most jobs become less manual and more cerebral and knowledge-based in nature.2 Rapid and ongoing advances in technology have created a workplace where laborers are being replaced by knowledge workers. An organization’s “technology” is becoming more invested in people than in capital. Thought and decision making processes as well as skills in analyzing complex data are not “owned” by an organization but by individual employees. This is in stark contrast to traditional manufacturing organizations where the employer usually owns or leases the machinery and production processes, and duplication of the organiza- tion’s “capital” is restricted primarily by cost considerations.

Managing an organization’s employees as investments mandates the development of an appropriate and integrated approach to managing HR that is consistent with the organization’s strategy. As an example, consider an organization whose primary strategic objective involves innovation. An organization pursuing an innovation strategy cannot afford high levels of turnover within its ranks. It needs to retain employees and transfer among employees the new knowledge being developed in-house. It cannot afford to have its employees develop innovative products, services, and processes and then take this knowledge to a competitor for implementation. The significant investment

Managing Employees at United Parcel Service Although taking a strategic approach to HR management usually involves looking at employ- ees as assets and considering them as investments, this does not always mean that an organi- zation will adopt a “human relations” approach to HR. A few successful organizations still utilize principles of scientific management, where worker needs and interests are subordinate to efficiency. United Parcel Service (UPS) is a prime example of this. At UPS, all jobs from truck loaders to drivers to customer service representatives are designed around measures of efficiency. Wages are relatively high, but performance expectations are also high. This approach toward managing people is still “strategic” in nature because the systems for man- aging people are designed around the company’s strategic objectives of efficiency. Conse- quently, all employee training, performance management, compensation, and work design systems are developed to promote this strategic objective of efficiency.

Chapter 1 An Investment Perspective of Human Resource Management | 5

in research and development ends up having no return. Because the outcome of this expenditure (research and development) is knowledge that employees have developed, it is critical as part of the organization’s overall strategy for the organization to devise strategies to retain its employees and their knowledge bases until the “new knowledge” becomes “owned” by the organization itself (through diffusion throughout the organization) rather than by the employee.

This leads to a dilemma involving investing in human assets. An organization that does not invest in its employees may be less attractive to prospective employees and may have a more diffi- cult time retaining current employees; this causes inefficiency (downtime to recruit, hire, and train new employees) and a weakening of the organization’s competitive position. However, an organization that does invest in its people needs to ensure that these investments are not lost. Well-trained employees, for example, become more attractive in the marketplace, particularly to competitors who may be able to pay the employee more because they have not had to invest in the training that the employee has already received. Although an organization’s physical assets cannot “walk,” its human assets can, making the latter a much more risky investment. An organi- zation can certainly buy or sell its physical assets because it has “ownership” of them, but it does not own its human assets. Consequently, organizations need to develop strategies to ensure that employees stay on long enough for the organization to realize an acceptable return on its invest- ment relative to the employees’ acquired skills and knowledge, particularly when the organization has subsidized the acquisition. This requires the organization to determine the actual “value” of each employee. Valuation of human assets has implications for compensation, advancement opportunities, and retention strategies as well as how much should be invested in each area for each employee.

Valuation of Assets Five major kinds of assets or capital that organizations can leverage to aid in performance and add value to operations are financial assets/capital, physical assets/capital, market assets/capital, opera- tional assets/capital, and human assets/capital, as shown in Exhibit 1.2. Financial assets/capital include equity, securities and investments, and accounts receivable. Physical assets/capital include plant, land, equipment, and raw materials. Market assets/capital include goodwill, branding, customer loyalty, distribution networks, product lines and patents, trademarks, and copyrights. Operational assets/capital include management practices, the structure of work, and the use of technology. Human assets/capital include employee education levels, knowledge, skills, competen- cies, work habits and motivation, and relationships with coworkers, customers, suppliers, regula- tors, and lenders.

Financial and physical assets/capital are relatively easy to measure via accounting practices. Most of these assets are tangible and have some clear market value. Market and operational assets/capital are a bit more challenging to measure, but accounting practices have been developed that can place a general subjective value on such assets. Human assets/capital, however, are very difficult to measure; attempts to do so are at the forefront of current research being conducted in HR management.

A direct result of this difficulty in measuring human assets is that the valuation of current and future human assets is often ignored from consideration when organizations are facing eco- nomic and financial challenges. The media and financial markets usually respond favorably when decision makers announce restructurings or right-sizing initiatives, which reduce the size of the organization’s work force, allowing it to reduce short-term costs. Such actions, however, involve the loss of human assets, which have value to the organization, often without consideration of the longer-term impact of such losses on the organization’s ability to regain its position in the market- place. Effective management recognizes that the organization’s survival and renewal require the right size and mix of human capital and balances short-term needs to reduce or restructure costs with a clear strategy for the future. The key issue organizations face here is how to leverage the value of the organization’s human assets for the good of the organization in the immediate, short, and long-term.

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One model of employment that can provide valuable lessons in the valuation of and apprecia- tion for human assets is that utilized in India. Reading 1.1, “The India Way: Lessons for the U.S.,” illustrates how Indian organizations are able to integrate investing in their employees with their missions without compromising their commitment to either.

Understanding and Measuring Human Capital Given that employees and their collective skills, knowledge, and abilities represent a significant asset for organizations, a critical issue for organizations becomes measuring this value as well as its contribution to the organization’s bottom line. One of the first studies that successfully demon- strated this relationship was conducted by Huselid in the mid-1990s. This study identified what were called “high performance work systems” (HPWS) and demonstrated that integrated,

EXHIBIT 1.2 Types of Organizational Assets/Capital

Examples • equity • securities and investments • accounts receivable

• plant • land • equipment • raw materials

• goodwill • branding • customer loyalty • product line • distribution networks • patents, trademarks, copyrights

• management practices • structure of work • technology

• education • knowledge • skills • competencies • work habits and motivation • personal relationships

Ease of measurement

Easier

More di!cult

• Financial

• Physical

• Market

• Operational

• Human

Chapter 1 An Investment Perspective of Human Resource Management | 7

strategically focused HR practices were directly related to profitability and market value.3

A recent study by Watson Wyatt Worldwide found that the primary reason for organizational profitability is the effective management of human capital. This involves, in part, providing employees with rewards that are commensurate with their contributions and ensuring that investments in employees are not lost to competitors by actively managing employee retention.4

Another study found that effective, integrated management of human capital can result in up to a 47 percent increase in market value.5 A landmark study conducted by Becker, Huselid, and Ulrich that examined a variety of HR management quality indices found that the top 10 percent of organizations studied enjoyed a 391 percent return on investment (ROI) in the management of their human capital.6

Extending these findings, Dyer and Reeves attempted to define what can be called the HR “value chain.”7 They argued that performance could be measured via four different sets of out- comes: employee, organizational, financial and accounting, and market-based. More importantly, they proposed that these sets of outcomes had a sequential cause-and-effect relationship, as indi- cated in Exhibit 1.3. Each outcome fueled success in a subsequent outcome, establishing a causal link between HR practices and an organization’s market value.

Given this proven link between integrated and strategic HR practices and bottom-line perfor- mance, HR practitioners have been faced with the task of developing appropriate HR metrics, which specifically illustrate the value of HR practices and activities, particularly relative to accounting profits and market valuation of the organization. This task has proven to be far more complex than anticipated, given the difficulties of measuring human assets/capital. One study con- cluded that 90 percent of Fortune 500 organizations in the United States, Canada, and Europe evaluate their HR operations on the basis of three rather limited metrics: employee retention and turnover, corporate morale and employee satisfaction, and HR expense as a percentage of opera- tional expenses.8 Such “staffing metrics” simply document the extent to which HR performs tradi- tional job functions without necessarily illustrating how HR impacts company profits and shareholder value. Moreover, a focus on such staffing metrics involves a demonstration of how employees can be treated as expenses rather than as assets that can be managed, invested in, and leveraged for profit.

EXHIBIT 1.3 HR Value Chain

Employee Outcomes

• attitudes • behavior

Organizational Outcomes

• productivity • quality

Financial/ Accounting Outcomes

• expenses • revenues • pro!tability

Market- based

Outcomes

• stock price

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Senior HR executives in these organizations stressed that they lacked accurate and meaningful methods that measured performance, despite the fact that human assets/capital can account for as much as 80 percent of the value of an organization.9 One reason is that most accounting valuation methods stress the past and current value of assets. Much of the value of human assets/capital rests with the value of an organization and its ability to proactively meet challenges that lie ahead, relative to responsiveness to changing economic, political, and market conditions. As a result, valuation of human assets/capital and analysis of human capital investments can be value- laden, subjective, expensive—and, hence, ignored.

Given the complex nature of measuring human assets/capital and return on such invest- ments, where does an organization begin in assuming such an undertaking? One helpful model has been developed by Mercer, which can allow those concerned with measuring HR performance and documenting the value added by specific initiatives to demonstrate to senior management the value added and bottom-line impact.11 This model involves six steps: (1) identify a specific busi- ness problem that HR can impact; (2) calculate the actual cost of the problem to the organization; (3) choose a HR solution that addresses all or part of the problem; (4) calculate the cost of the solution; (5) 6 to 24 months after implementation, calculate the value of the improvement for the organization; and (6) calculate the specific ROI metric.

One caveat should be obvious from not only Mercer’s approach but also that currently being employed at Dow Chemical. Unlike the returns on other types of assets/capital, the ROI in human assets/capital are often not realized until some point in the future. Key decision makers need to be patient in waiting for these results, and HR also needs to subsequently take interim measures and provide status reports to senior management that illustrate preliminary beneficial results. HR needs to move away from mere data collection, however, and perform more comprehensive analysis of performance measures that relate to the critical metrics for which operating divisions are held accountable. Toward this end, HR needs to partner with chief financial officers to understand the language of investment and asset management. If HR continues to be seen as a cost center, it will be the primary target during cost-cutting opera- tions, given that labor is the primary cost incurred in the service- and information-intensive sectors that are fueling the growth in our economy. One study places the relative expenses for human capital as high as 70 percent of overall expenditures.12 Hence, the challenge for HR is to provide senior management with value-added human capital investments backed by solid and meaningful financial metrics.

Measuring Human Assets/Capital at Dow Chemical Dow Chemical has been a leader in forging the frontiers of measuring human capital. Dow has attempted to develop a reliable measure to help calculate each employee’s current and anticipated future contribution to the financial goals of the business. A pilot project is cur- rently being tested in a single business unit; it examines employee performance on project assignments by using two specific metrics: expected human capital return (EHCR) and actual human capital return (AHCR). EHCR involves a calculation of the break-even point of investment in an employee, above salary and additional outlays, such as recruiting and train- ing expenses. AHCR involves a calculation of the “value created” by the employee based on the projects he or she was worked on. This metric considers the skills and knowledge of each employee relative to the net present value of a specific project. The desired outcomes of these measures are assisting managers with matching employee talents and project needs, identify- ing employee development opportunities, and creating a more efficient and effective means for project team staffing. Although the program is still in the pilot stage, with validation studies in progress, Dow anticipates rolling out the metrics to other business units in the very near future.10

Chapter 1 An Investment Perspective of Human Resource Management | 9

HR Metrics Many CEOs openly acknowledge the importance of effective and strategic HR management in their organization’s success. Jack Welch noted in one of his last General Electric annual reports: “Develop- ing and motivating people is the most important part of my job. I spent one-third of my time on people. We invest $1 billion annually in training to make them better. I spend most of my time on the top 600 leaders in the company. This is how you create a culture.”13 One recent study of Fortune 100 annual reports found that 14 percent of such reports contained at least one quantitative measure of HR management, such as turnover rate, investment in training, percentage of pay that is variable, or results from an employee attitude survey.14 Despite this, Wall Street analysts still generally fail to acknowledge human capital in their assessment of the potential worth of a company’s stock or the effects which human capital measures can have on a company’s stock price.

Perhaps one reason for this lack of reporting of and respect for metrics related to human capital rests with the fact that there are no universally accepted metrics for the valuation of human capital or a standard format for measuring and reporting such data. Indeed, the Society for Human Resource Man- agement has identified a number of common metrics for measuring the performance and value of human capital, a number of which are presented in Exhibit 1.4. These are measures that can easily be translated into bottom-line measures of performance as well as compared to industry benchmarks. Exhibit 1.5 pro- vides examples of how five of these metrics that are often regarded as the most prominent measures of human capital management can be calculated and utilized. Nonetheless, stock analysts are more con- cerned with talking with operations, accounting, and finance heads rather than those in HR, as analysts usually have their training in, understand, and are most familiar and comfortable with these areas.

Moneyball and the Oakland Athletics The 2003 best-selling book, Moneyball, later made into a motion picture in 2011, chronicled the real-life application of HR metrics in major league baseball and their impact on perfor- mance. Starting with his appointment in 1998 as Oakland Athletics general manager, Billy Beane was forced to rethink how he selected players given the fact that his small-market team could not compete financially with big-market teams, such as those in New York and Boston, which consistently ended up signing the biggest name free agent players at hefty salaries. Beane looked beyond traditional statistical measures of player “value” such as batting average and home runs for position players and games won, earned run average and strikeouts for pitchers to seek out players that were generally undervalued. Beane and his statistician instead consid- ered alternative metrics, such as on-base percentage and average number of pitches required to complete an at-bat, and discovered that such metrics had a higher correlation with games won by a team. Applying these new metrics as part of an ongoing staffing plan, Beane’s cash-poor team qualified for the post-season from 2000 to 2003 with an average of 98 victories per season despite having one of the lowest payrolls in baseball. Soon, other teams were copying Beane’s approach and the Athletics lost their competitive advantage. Beane’s approach illustrates that the use of staffing metrics can translate into significant success for an organization. The key is selecting the appropriate metrics and analytical techniques, which may be different from those currently in use by the organization or standard within the industry.

Labor Supply Chain Management at Valero Energy San Antonio–based Valero Energy is a $70 billion energy-refining and marketing company that has reinvented its staffing function through the application of principles of supply chain man- agement. Conceptualizing the acquisition and management of talent as a supply chain, Valero scrapped its traditional staffing processes by which managers would request specific numbers of employees from HR who, in turn, would solicit referrals from employees and contact

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There are no “perfect” metrics, however, as the appropriate human capital metrics would depend on the organization or business unit’s strategy. Organizations concerned about minimizing costs might be most concerned with metrics related to turnover and revenue per employee. Orga- nizations pursuing a strategy of aggressive growth might rely on metrics such as time to fill, while those concerned with innovation might closely monitor training costs per employee. Divisions or subsidiaries within the same organization might use totally different metrics, dependent on their unit’s goals and strategies.

EXHIBIT 1.4 Common HR Metrics

Absence Rate

Cost per Hire

Health Care Costs per Employee

HR Expense Factor

Human Capital Return on Investment (ROI)

Human Capital Value Added

Labor Costs as a Percentage of Sales or Revenues

Profit per Employee

Revenue per Employee

Time to Fill

Training Investment Factor

Training Return on Investment (ROI)

Turnover Costs

Turnover Rate (Monthly/Annually)

Vacancy Costs

Vacancy Rate

Workers’ Compensation Cost per Employee

Workers’ Compensation Incident Rate

Workers’ Compensation Severity Rate

Yield Ratio

recruiters. After an analysis of data related to hiring sources, how long new employees remained employed, performance and productivity of new hires, and “fit” with the company culture, Valero gained a sense of how to recruit the best talent at the lowest cost.

Valero’s new staffing process involves forecasting three years in advance the demand for talent by both division and title. Five years of data were mined into a database, and a series of mathematical algorithms was developed for turnover trend analysis by location, position type, salary, tenure, and division. Another series of algorithms projected those trends forward for three years in line with anticipated workforce needs for future capital projects, updated systems, and anticipated new services. The result is the development of talent “pipelines,” which address specific future talent needs relative to the organization’s strategy and business model, allowing the development of related training and development programs and succession plans.15

Chapter 1 An Investment Perspective of Human Resource Management | 11

Factors Influencing How “Investment Oriented” an Organization Is Not all organizations realize that human assets can be strategically managed from an investment perspective. As shown in Exhibit 1.6, five major factors affect how “investment oriented” a com- pany is in its management of HR. The first of these is management values.16 Management may or may not have an appreciation of the value of its human assets relative to other capital assets, such as brand names, distribution channels, real estate, facilities and equipment, and information systems. The extent to which an organization can be characterized as investment-oriented may be revealed through answers to the following questions:

• Does the organization see its people as being central to its mission/strategy? • Do the company’s mission statement and strategic objectives, both company-wide and within

individual business units, espouse the value of or even mention human assets and their roles in achieving goals?

• More importantly, does the management philosophy of the organization encourage the devel- opment of any strategy to prevent the depreciation of its human assets or are they considered replicable and amortizable, like physical assets?

EXHIBIT 1.5 Calculation of Human Capital Measures

Measure Formula Value/Use

Human Capital ROI Revenue ! (operating expenses ! compensation " benefits costs) / compensation " benefits costs

Allows determination of return on human investments relative to productivity and profitability; represents pre-tax profit for amounts invested in employee pay and benefits after removal of capital expenses

Profit per Employee Revenue ! operating expenses / number of full-time equivalent (FTE) employees

Illustrates the value created by employees; provides a means of productivity and expense analysis

HR Expense Factor Total HR expense / total operating expenses

Illustrates the degree of leverage of human capital; provides a benchmark for overall expense analysis relative to targets or budgets

Human Capital Value Added

Revenue ! (operating expenses ! compensation " benefits costs) / total number of FTE employees

Shows the value of employee knowledge, skills, and performance and how human capital adds value to an organization

Turnover Rate Number of employee separations (during a given time period) / number of employees

Provides a measure of workplace retention efforts, which can impact direct costs, stability, profitability morale, and productivity; can be used as a measure of success for retention and reward programs

Sources: For a more complete list of metrics, formulas, and uses, see Society for Human Resource Management, HR Metrics Toolkit, published Nov. 15, 2007. Available at http://moss07.shrm.org/hrdisciplines/Pages/CMS_005910.aspx

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Senior management values and actions determine organizational investment in assets. It is critical to understand how the organization’s strategy mandates the investment in particular assets relative to others. Whether management values its people is a critical factor in its willingness to invest in them.

The second factor is attitude toward risk. The most fundamental lesson in financial manage- ment is that a trade-off exists between risk and return. Higher-risk investments are generally expected to have a greater potential return; lower-risk, safer investments are generally expected to have a more modest return. For example, in financial markets, bonds are considered less-risky investments than stocks but have a limited, fixed return. Stocks, on the other hand, are considered higher-risk investments but have no limit as to their potential return.

Both personal and institutional investment strategies can be highly conservative (risk averse) or pursue unlimited returns with reckless abandon. Investments in human assets are generally far more risky for an organization than investments in physical assets: Unlike physical assets, human assets are not owned by the organization. An organization with risk-averse management philosophies is far less likely to make significant investments in people. Other organizations see investments in employees as necessary for their success and develop strategies to minimize the potential risk of losing their investments. An organization can attempt to gain some “ownership” of employee services through long-term employment contracts or by offering employees financial incentives, such as stock-ownership programs, as well as additional professional development opportunities.

The third factor is the nature of the skills needed by employees. Certain organizations require employees to develop and utilize very specialized skills that might not be applicable in another organization; another employer might have employees utilize and develop skills that are highly marketable. For example, if an employer has a custom-made information system to handle administrative HR functions, employees using that system might not transfer those skills to another employer. However, if an employer uses a popular software program for which there is high demand for skilled employees among competitors, the investment in employees becomes more risky.

As a result, an organization that decides to provide its employees with specialized training in skills that can be utilized by others in the marketplace has a much stronger need to develop a strong retention strategy than an organization that teaches employees skills that are less market- able. Employees with skills demanded in the marketplace become more valuable and sought- after assets by companies that choose not to make expenditures or invest in training and skill development.

EXHIBIT 1.6 Factors Influencing an Organization’s Investment Orientation

Nature of Employee Skills

Utilitarianism

Availability of Outsourcing Attitude Toward Risk

Management Values

Chapter 1 An Investment Perspective of Human Resource Management | 13

The fourth factor affecting the investment orientation is the “utilitarian” mentality of the organi- zation. Organizations that take a utilitarian, or “bottom line,” perspective evaluate investments by using utility analysis, also known as cost-benefit analysis. Here, the costs of any investment are weighted against its benefits to determine whether the prospective investment is either profitable or, more com- monly, achieves the target rate of return the organization has set for its investments. A highly utilitar- ian approach attempts to quantify all costs and benefits. For example, rather than just considering direct cash expenditures, this approach would also consider the cost for the time involved to develop and administer an innovative performance measurement system (by considering how much people are being paid for the time involved in the process), the cost of having larger applicant pools (by consider- ing how much longer it would take to screen applicants), and the cost of employing more extensive employee selection procedures (again, by considering time and its monetary value).

The distinct problem many utilitarian organizations run into regarding investments in people involves the fact that many benefits of HR programs and policies are extremely difficult to quan- tify. If these programs and policies can be assessed quantitatively, subjectivity as to the actual value of the benefit may make consensus on the overall value difficult. This is especially true for pro- grams that attempt to enhance performance in service organizations. As an example, consider the customer service division of your local Internet service provider. Measures of effective service are not only difficult to assess objectively, but the organization may not be able to determine how much service is necessary to prevent customers from jumping to competitors and maintain their loyalty instead. Additional investments in service may not have any direct financial benefit.

Similarly, a government organization or public utility that attempts to develop a program to enhance efficiency may have a difficult time in finding the cost justifiable. Given that no market mechanisms exist for government agencies or legal monopolies, customers have no choice among competitors. Customers may complain to regulators or officials, but there may be no incentive or benefit for the organization to enhance its efficiency from an investment perspective. On a more basic level, a program that is designed to improve employee morale can have benefits that may be very difficult to measure and quantify. A utilitarian organization is likely to reject such “soft” programs that have no quantifiable return. Hence, the more utilitarian an organization, the more likely it is to see HR programs as investments, creating a challenge for those advocating for such HR programs to find a means to show their impact on the bottom line. Some very recent studies have begun to address this issue by attempting to establish a link between HR strategies and sys- tems and an organization’s financial performance. Initial results have shown a significant impact of HR systems on both market-based and accounting-based measures of performance.17

The final factor impacting an organization’s willingness to invest in its people is the availabil- ity of cost-effective outsourcing. An investment-oriented approach to managing an organization will attempt to determine whether its investments produce a sustainable competitive advantage over time. When specialists who may perform certain functions much more efficiently exist out- side an organization, any internal programs will be challenged and have to be evaluated relative to such a standard. This is true for virtually any organizational function, including customer ser- vice, accounting, manufacturing, and HR management functions.

The organization is further likely to invest its resources where key decision-makers perceive they will have the greatest potential return. This may result in few investments in people at the expense of investment in market and product development, physical expansion, or acquisition of new technology. As an example, employers in the fast-food industry, such as at McDonald’s, invest little in their people; they require minimal experience, provide little training, pay low wages, and expect high turnover because the supply of workers is excessive relative to demand. Organizations in this industry tend to invest much more in new product development, physical expansion, and marketing through competitive advertising.

HR professionals can be strong catalysts in influencing the extent to which an organization’s leaders truly understand the inherent value of its people. It has been argued that those in the HR profession have an ethical obligation and bear responsibility for leadership in this regard. Reading 1.2, “Strategic Human Resource Management as Ethical Stewardship,” describes these responsibilities of the profession and outlines the benefits of strategic HR for employees, employers, and the larger society.

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Conclusion Developing an effective strategy to manage an organization’s human assets requires considering employees as investments. Such an approach helps to ensure that HR practices and principles are clearly in sync with the organization’s overall strategy, forces the organization to invest in its best opportunities, and ensures that performance standards are met. As an example, employee stock- ownership programs attempt to strategically invest in the organization and its people by making employees owners of the company. Instead of having a conflict as to how profits should be allo- cated (bonuses to employees or reinvested in the business), both can be achieved simultaneously. In turn, this has the goal of gaining more commitment from employees and encouraging them to adopt a long-term focus toward the organization; this is often a shortcoming or deficiency of American organizations that are concerned with short-run indicators of performance. Employees who now intend to stay with the organization longer, given their vested ownership rights, provide organizations with an incentive to incur the short-term costs involved with investing in human assets for the long-term financial gains that can result from such investments.

An investment perspective of HR is often not adopted because it involves making a longer- term commitment to employees. Because employees can “walk” and because American organiza- tions are so infused with short-term measures of performance, investments in human assets, which tend to be longer-term investments, are often ignored. Organizations performing well finan- cially may feel no need to change their investment strategies. Those not doing well usually need a quick fix to turn things around and therefore ignore longer-term investments in people.

However, while investments in HR are longer term, once an organization gains a competitive advantage through its employees, the outcomes associated with the strategy are likely to be endur- ing and difficult to duplicate by competitors as such programs and values become more firmly entrenched in the organization’s culture. The commitment that an organization makes to its employees through its investments in them is often rewarded with the return of employees making a longer-term commitment to the organization. Although investments in human assets may be risky and the return may take a long time to materialize, investment in people continues to be the main source of sustainable competitive advantage for organizations.

Critical Thinking

1. Why do senior managers often fail to realize the value of human assets vis-à-vis other assets?

2. Why do line managers often fail to realize the value of human assets vis-à-vis other assets?

3. Why and how might a line or an operating manager value specific metrics related to the unit’s employees?

4. What can HR do to make senior and line managers take more of an investment approach to human assets?

5. Why is a competitive advantage based on a heavy investment in human assets more sustainable than investments in other types of assets?

6. Why can some organizations that fail to invest heavily in human assets still be financially successful? Why can some organizations that do invest heavily in human assets still be financially unsuccessful?

7. What challenges exist relative to the valuation of human assets and measuring human capital?

Reading 1.1

8. Upon what cultural factors does the “Indian Way” depend upon for its success? To what extent can organizations from your country and culture adopt successful Indian practices, what obstacles exist to full implementation, which of these obstacles can be overcome, and specifically how can they be overcome?

Reading 1.2

9. Explain the ethical steward and transformative leader role as applied to HR professionals. Specifically how does each contribute to the practice of strategic HR management?

Chapter 1 An Investment Perspective of Human Resource Management | 15

J. Arredondo