Module 1 Case

Journal of Management Research Vol. 16, No. 3, July–Sept. 2016, pp. 177 –184

HR Metrics and the Financial Performance of a Firm A Case Based Approach

Arnob Sen and Shamima Haque

Abstract

HR metrics can be a meaningful measures of HR performance in the context of total organization. This article attempts to take a case-based approach to specifically highlight the linkage of HR efficiency metrics with some financial measures. The purpose of the paper is to focus on key HR metrics, taking examples from selected companies, indicating that when performance of HR system is measured and evaluated it may act as a positive reinforcing dimension in strategic value addition.

Keywords: HR metrics, Financial performance, Human capital

The nature and pace of the changing market conditions have rendered many of the traditional sources of competitive advantage less important and managers and scholars are in a search of new arenas for gaining advantage and profitability. In the current business environment of globalization and a demanding competitive paradigm, it is essential from a strategic management perspective to focus on the financial dimension of value associated with intangible assets to create sustainable long term advantages. The role of a skilled, motivated flexible workforce and other ‘people embodied skills that remain largely invisible’, has become more prominent (Hamel and Prahalad, 1994).

The most potent action HR managers can take to ensure their strategic contribution is to develop a measurement system that convincingly showcases HR’s impact on business performance. Becker,

Huselid & Ulrich (2001) has necessitated a new strategic approach. Instead of concentrating on a bottom-up perspective emphasizing compliance and traditional HR, the organization should move to a top-down perspective emphasizing the implementation of strategy. The need is to develop an innovative assessment system that measures HR’s contribution to firm profitability and shareholder value.

The key is to identify and measure the HR “deliverables” that support corporate strategy — and the HR systems that create those deliverables (Becker et al., 2001). When most of the HR functions are being outsourced, the HR professionals should think realistically on measures and processes of getting their contribution against the total organizational performance, visible in more smart terms.

With HR losing its strategic value over time, struggling to keep its place in the organizational architecture, this article intends to highlight how organizations should bring in HR metrics to explain the significance of HR as a core function, its relevance, its justification for not being outsourced, its financial impact and its contribution to the total organizational goals and directional strategy.

Arnob Sen (Corresponding Author) Shamima Haque School of Management Studies Techno India EM 4/1 Salt Lake, Sector V Kolkata – 700 091

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LITERATURE REVIEW The behavioral perspective describes how HR system creates new firm capabilities, while the resource based view emphasizes the attributes required for these capabilities to generate competitive advantage. Complementarities within the HR system, as well as the alignment of HR strategy with appropriate business goals provide a theoretical rationale for a positive link between HR and firm financial performance (Huselid & Becker, 1997). Ichniowski (1990), Huselid (1995), Huselid & Becker (1996) all support the conclusion that a high performance HR system has an economically meaningful effect on firm level measures of financial performance. Becker et al (2001) report that 35% improvement in firm’s HR system results in a 10-15% increase in market or book value. The HR system-firm performance relationship was indicated as significantly positive by Huselid & Becker in their 1997 study where they estimated that with one standard deviation improvement in HR system quality an associated increase in shareholder wealth of $41,000 per employee is possible.

Wright and Gardner (2000) have raised a particularly contradictory problematic question in the HR – firm performance relationship regarding pinpointing the causal direction. Theoretical and empirical examination of this relationship has assumed that the outcomes of firm performance are in some way influenced by HR practices. A “reverse causation” hypothesis would posit that as firms become more profitable, they invest in HR practices. These investments could stem from the belief that the practices will further increase performance, from the belief that HR practices reduce the risk of performance declines, or they could stem from a simple wealth distribution process. In line with this approach, a true causal model is that profits leads to HR practices rather than the opposite. In other words, increased productivity derived from human capital investments depends on the contribution of employees to a firm. Therefore, the higher the potential for employee contribution in a firm, the more likely it is that the firm will invest in human capital and that these investments will lead to

higher individual productivity and firm performance (Becker, 1976; Parnes, 1984).

Generally speaking there are three different kinds of metrics that organizations can collect in order to better understand and evaluate the impact of HR activities and to influence business strategy and business performance. They are efficiency, effectiveness, and impact (Boudreau and Ramstad, 2003). The efficiency metrics focuses on how well the HR function does its basic administrative tasks, whereas a potentially meaningful set of effectiveness metrics for the HR function concerns talent and talent management. Human capital metrics potentially can and often should influence the development and implementation of business strategies (Lawler III, Levenson and Boudreau, 2004). Finally, metrics having to do with developing and optimizing the capabilities and the core competencies of the organization can be collected in order to measure the impact of HR programs and practices (Lawler, 2003). Impact in this case means demonstrating a link between what HR does and tangible effects on the organization’s ability to gain and sustain competitive advantage. Overall, the results suggest that efficiency measures are most prevalent, effectiveness measures exist, but are far less prevalent, and measures of impact are rare (Lawler III et al., 2004).

The use of analytics in order to understand how HR practices and policies impact organizational performance is a powerful way for HR functions to add value to their organization. An organization should concentrate on few key human resource metrics, the choice of which should typically focus on those issues that an organization is attempting to correct. Researchers suggest a need to develop a standardized, universal set of adoptable action plans or key metrics that could drive the financial performance of a company based on the results of HR metrics (Barber 1999; Delery and Doty 1996; Fleetwood and Hesketh 2007).

FOCUS OF THE PAPER The highlight of the paper has been to develop a comprehensive understanding of relevant HR metrics that are essentially aligned with

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organizational goals taking a business partner perspective. Effective and efficient assessment processes enable HR leaders to take and influence decisions in a way that creates value and stimulates change and improvement. This article attempted to take a case-based approach to specifically highlight the linkage of HR efficiency metrics with some financial measures keeping an eye on the oil industry.

METHODOLOGY

Data The current study was conducted in a single industry, and the industry considered for the present study is oil industry. Within industry studies would help us identify the key competitive metrics that participants within the industry consider important, and to assess the unique strategies (both business and HR strategies) that firms engage in as a means of increasing their performance on those metrics. The unit of analysis for this study was the organization. Conducting the study at the corporate level provides a tremendous advantage in the assessment of financial performance because of the publicly available databases which provide such information. We have employed secondary data sources like annual reports, sustainability reports, financial statements and analysis reports & HR performance indicators.

For the study, 4 notable public sector organizations from the oil sector of India were selected, namely, Bharat Petroleum Corporation Ltd. (BPCL), Hindustan Petroleum Corporation Ltd. (HPCL), Indian Oil Corporation Ltd. (IOCL) & Oil India Ltd. (OIL). The annual reports and sustainability reports of these four organizations were collected from the company websites. The data for 5 consecutive years, starting from 2009-2010 to 2103-2014 was used for the present study to understand the relation between HR effectiveness and financial performance.

Measures

HR Metrics

The paper intends to measure few key HR

indicators to quantify the impact of HR:

Operating Income/Revenue per FTE: The number of rupees of revenue from operations generated per Full-Time Equivalent (FTE).

Profit per FTE: The number of rupees of profit generated per FTE, based on pre-tax profit. It is the profit created by employees who hold either revenue or non-revenue generating roles.

Human Capital Return on Investment: The rate of return for each rupee invested in employee pay and benefits, based on pre-tax profit.

Human Capital Value Added: It shows the operating profit per full time employee. This metric helps to identify to what extent the employees are adding value to the bottom line.

Labor Cost Operating Income/Revenue Ratio: The metric result can be translated as the amount of investment in employees required to generate each rupee of revenue.

Personnel Cost to Operating Income Cover: The total labor costs as a percentage of total expenses. This metrics indicates the percentage of total operating expenses that are spent on compensating employees.

Financial Measure

The financial measure considered in the present study include:

Return on long-term funds: The measure indicates the operating profit as a percentage of long term funds. The reason for using Return on long-term funds is that it considers operating profit. As the human resource of oil refinery is largely related with operations, operating profit is considered to be a better bridge between HR performance and profitability of the refinery.

Results Table 1 indicates six different HR metrics along with Operating Profit as a measure of financial performance calculated for BPCL for 5 consecutive years.

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Table 2 indicates the HR metrics for HPCL for 5 consecutive years.

Table 3 indicates the HR metrics and operating profit for IOCL for 5 consecutive years.

Table 4 indicates the HR metrics and operating profit for OIL for 5 consecutive years.

The graphical representation of the above Table 1, 2, 3 and 4 are indicated in Figure 1, 2, 3 and 4 respectively.

Table 1: HR Metrics for BPCL for 5 Consecutive Years

Year Operating Profit Human Human Labor Personnel Operating Income per FTE Capital Capital Cost Cost to Profit Factor Value ROI Operating Operating (Rs. Crore)

Added Income Income Ratio Cover

2009-10 8.64 0.17 0.54 3.53 0.15 0.02 3,484.56 2010-11 10.96 0.17 0.68 3.41 0.20 0.19 3,545.96 2011-12 15.86 0.14 0.87 5.16 0.17 0.01 3,866.85 2012-13 18.17 0.31 1.09 5.19 0.21 0.01 6,106.80

2013-14 19.67 0.45 1.37 6.10 0.22 0.01 8,086.22

Table 2: HR Metrics for HPCL for 5 Consecutive Years

Year Operating Profit Human Human Labor Personnel Operating Income per FTE Capital Capital Cost Cost to Profit Factor Value ROI Operating Operating (Rs. Crore)

Added Income Income Ratio Cover

2009-10 9.50 0.21 0.65 4.51 0.14 0.016 3,311.89 2010-11 11.84 0.19 0.68 3.81 0.18 0.016 3,323.07 2011-12 15.89 0.11 0.67 4.73 0.14 0.009 4,131.34 2012-13 18.78 0.12 0.68 2.95 0.23 0.013 4,261.66

2013-14 20.56 0.25 0.86 4.61 0.19 0.009 5,237.73

Table 3: HR Metrics for IOCL for 5 Consecutive Years

Year Operating Profit Human Human Labor Personnel Operating Income per FTE Capital Capital Cost Cost to Profit Factor Value ROI Operating Operating (Rs. Crore)

Added Income Income Ratio Cover

2009-10 7.84 0.39 0.77 5.12 0.17 0.024 15,098.73 2010-11 9.71 0.25 0.77 4.1 0.19 0.019 12,611.03 2011-12 11.64 0.33 1.00 6.87 0.15 0.014 18,442.62 2012-13 13.12 0.17 0.89 4.17 0.21 0.017 13,736.85 2013-14 14.00 0.24 1.08 5.53 0.20 0.015 15,702.23

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Figure 1

Table 4: HR Metrics for IOL for 5 Consecutive Years

Year Operating Profit Human Human Labor Personnel Operating Income per FTE Capital Capital Cost Cost to Profit Factor Value ROI Operating Operating (Rs. Crore)

Added Income Income Ratio Cover

2009-10 0.95 0.48 0.51 3.55 0.14 0.33 3,311.52 2010-11 1.35 0.55 0.91 6.36 0.14 0.33 3,799.36 2011-12 1.22 0.63 1.01 5.41 0.19 0.92 4,674.68 2012-13 1.23 0.65 1.06 6.53 0.16 0.92 4,614.71

2013-14 1.23 0.56 1.02 5.40 0.19 0.89 4,027.60

Table 5 Correlation and R-square between Human Capital ROI and Return on Long Term Funds of the Firms under Study

Company Correlation R square

BPCL 0.68127 46.41

HPCL 0.228111 5.2

IOCL 0.678968 46

OIL -0.001 0.0001

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Figure 2

Figure 3

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DISCUSSION If operating profit is considered as an after effect of human endeavor, all the ratios related to the work force, as considered in the present study, more or less have shown that they move in tandem with the operating profit. This necessarily affects the market capitalization of the company under consideration as operating profit is an important influencing factor for market value of share and hence the market capitalization. Ultimately what matters a lot to any company is the return on long- term funds. Correlation and R-square between Human Capital Return on Investment and Return on Long-term Funds have shown very strong positive correlation in three cases and a very weak negative correlation in case of one company. The probable explanation for the negative correlation might be changes in internal accounting policies. R- square in case of two companies support to the point that 46% of the variability in Return on Long-term funds can be explained by Human Capital ROI. Importance of Value Addition in understanding the growth of a company is huge. As it is often argued and proven, that in efficient markets, market absorbs all information and

accordingly value companies’; market capitalization is an easy and effective indicator for understanding the growth of a company. Importance of value addition as a factor affecting market capitalization cannot be over agreed and the Human Capital Value Added Factor considered in the paper proves to the point silently.

Market capitalization of all the four companies considered in the paper has improved considerably over the last five years and so has the Human Capital Value Added Factor, which ironically has not gained much importance. Operating income per full-time employee has improved over the number of years in all the cases and this proves that employees have contributed towards the growth of the company in an increased fashion but ironically Labor Cost Expenditure Ratio has either slipped in most of the cases or has remained flat. The pertinent question here is that, if this ratio improves will it lead to the improvement of profitability and market capitalization of the company? Improving market capitalization is in the best interest of the company as it is directly connected with the concept of wealth maximization goal of a company.

Figure 4

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CONCLUSION As intellectual capital has come to represent an increasing fraction of many firm’s total assets, the strategic role of HRM system has also become more critical. Organizations have an unprecedented opportunity to refocus their HRM systems as strategic assets (Becker et al, 1997).

Taking selected companies as cases, the paper attempted to indicate that when performance of

HR system is measured and evaluated it may act as a positive reinforcing dimension in strategic value addition that again can be financially visible and have maximum impact. Key HR metrics relevant to management issues, aligned to organizational priorities can provide meaningful strategically directional information which can be interpreted in financial terms and communicated in ways that meet the needs of managers at all levels in the organization and so can lead to effective action.

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