Chapter 16

The Human Capital Index

TYPES OF ORGANIZATIONS WHERE THIS METRIC IS APPROPRIATE

Any organization that has more than 100 employees and that spends at least 25 percent of its costs on salaries and benefits should have this measure and monitor it frequently. If you are a small company with 40 employees, everyone knows one another and managers have intimate knowledge of the strengths and weaknesses of each of their staff. In such a case a measure like this would be a waste of time, because with this small a staff it is possible to know everyone. A client of mine doubled in size over six years from about 900 employees to 2,000. The CEO was employee number three and in the old days knew every one of his employees, and many of them still work there. As the company grew and expanded locations, it became impossible for him to even learn the names of all the employees, not to mention their skills and abilities. He could rely on his managers to at least know all their staff members, but eventually they had too many people as well. Consequently, the organization worked to develop a human capital metric that would reveal areas of strength as well as gaps.

The other criterion for deciding whether you need a human capital metric is the skill level of your employees. One of my clients (Flagship in San Jose) is a janitorial and facilities maintenance firm. Even though they have over 1,000 employees and offices in different cities, most of their employees have rudimentary skills needed to perform cleaning and maintenance tasks. The president and owner, Dave, has a small team of managers and he knows their strengths and weaknesses well. I think Flagship could probably do just fine without tracking human capital as one of their key metrics. However, even a company like this might find a simple human capital metric useful. It might include head count versus plan, average seniority, absenteeism, and regret turnover. With over 100 employees it is probably useful for Dave and his human resources vice president to know when they are short-staffed or have too much absenteeism, and when the experience level dips too low.

HOW DOES THIS IMPACT PERFORMANCE?

If you had to pick one thing that most correlates to positive outcomes and business results, it’s having the right mix of talented people. Even one leader can make a massive difference in an organization’s success or failure. Think of Apple when Steve Jobs left or what GE would have become without Jack Welch. The value of a single leader is probably overrated, but a single individual can make a big difference. That brilliant scientist who has more patents than anyone in the company, or that frontline worker who solves every mechanical problem that arises in minutes can both have a huge impact on performance. Similarly, one really bad manager can have a major negative impact on many measures of performance. Even if you have people who are unhappy in their jobs, you can get good performance out of them. I saw a program on PBS recently about Henry Ford, and how once he redesigned jobs so that workers just did the same task over and over, he got more productivity out of them and made higher profits. He had to up workers’ pay to keep them from quitting the mind-numbing jobs, but they showed up every day and worked very hard. I can’t imagine that the employees were very happy or engaged in a monotonous job like that, but they were skilled and continued to crank out those Fords every day.

Losing a key employee or leader can have a devastating impact on an organization’s future performance. However, most organizations do not have human capital metrics that are sophisticated enough to show this. I’ve reviewed the human capital metrics of many big corporations and large government organizations and almost always find that they opt to measure what is easy to count versus what is important or really a measure of someone’s worth. Most organizations have a strong desire to track human capital, but the majority fail when trying to put together a meaningful and accurate analytic.

Mostly Worthless Human Capital Metrics

• Training hours. The logic here is that if we continue to invest in training and developing our employees, they will maintain their knowledge and skills at the highest level. But there are some big leaps in logic here. First of all, counting the number of butts sitting in chairs at a training session is not a measure of knowledge and skill acquisition. Rather, it is a measure of how many people sat in how many classrooms for how many hours. In the real world, even that metric is often inaccurate. The training sign-in sheet is usually passed around in the morning. Some people don’t come back after lunch because they have already signed in.

• Completion of “individual development plans.” Most large companies and nonprofit organizations have an annual process called individual development planning (IDP), during which an employee sits down with his or her boss and decides what knowledge and skills should be worked on for the following year. This is actually a good idea, but the execution is usually flawed. The product of most IDPs is a list of conferences or workshops the employee wants to attend. If the employee lists four courses and attends all four, the score on the IDP is 100 percent. What this number does not measure is whether the employee really learned a new skill or mastered a new subject or content.
• Certifications. Many fields require some form of certification—a piece of paper stating that the person holding it has attained competence in a particular field. For example, you can become a certified public accountant, registered nurse, certified financial planner, or certified welder. The problem with counting these certifications as a measure of competence is that they are not. There are countless incompetent people out there with pieces of paper saying they are certified, but most of these people passed certification tests that measured their ability to memorize rather than their ability to perform. If the certification test actually requires the person to perform job tasks (i.e., fly a plane), it is a good measure of competence, but passing most certification tests requires nothing more than memorizing a bunch of rules, facts, and principles. In other words, the tests assess specific knowledge but not skills. People study for the exams, pass them, and then mostly forget what they learned. Whether they become competent in their field depends a lot on experience, intelligence, and further training and mentoring. Certifications are like training hours—they’re easy to count, but they are not very revealing as a metric.

COST AND EFFORT TO MEASURE

The cost of collecting data on human capital metrics is typically low, but much of that determination is based on how much data you have today on your people. If you have fairly comprehensive databases on each of your employees, rolling up the measures into an analytic should not be much of an effort. Where the biggest time and expense usually comes is in designing the analytic in the first place. I worked with a big government R&D laboratory called the Engineer Research & Design Center (ERDC) in Vicksburg, Mississippi, to help them develop a human capital analytic. They had already done a lot of work on their own and decided to call in some outside help to get new ideas and facilitate the design process. Much of the discussion in the design meetings was objectivity of the metrics, the degree to which data would be accurately collected, and the extent to which the measures proposed would be good assessments of an individual’s value to the organization.

HOW DO I MEASURE IT?

Sadly, there is no uniform method or formula for tracking human capital or calculating the knowledge and skills of your workforce. All organizations acknowledge its importance, but there has been no agreement among human resource professionals about how to measure it. You would think that professional organizations of HR professionals would have gotten together to agree on this, and I am sure they have tried. The American Society for Training and Development cannot even get all companies to agree to measure training the same way. Coming up with a valid and acceptable metric for human capital is much more of a challenge, so each organization needs to develop a metric that best suits it. That said, it is likely to include a number of different variables for it to be valid. Sadly, just as with health and wellness, there is no single metric or ratio that can be tracked that provides a good measure of the human capital of an organization.

I have helped many organizations develop human capital metrics, and almost always what they end up with is a compromise between what they would like to measure and what is feasible. Not only is measuring human capital extremely difficult, but there is a lot of emotion surrounding it as well, because we are putting numbers onto people based on their value to the organization. It’s funny how most of my clients object to the equivalent of a credit score for human capital assigned to each employee, but none have a problem assigning vastly different compensation levels to different jobs. By doing so, you are assigning value based on the worth of the individual and the position. The problem is that high pay does not equate to high value all the time. I’m sure you all know a few highly paid executives or professionals who are idiots, and a few invaluable staff members who are way underpaid.

While I have seen lots of different good and bad approaches to measuring human capital, I can provide you with a description of what the ideal metric would contain, and you can use this as a benchmark to approximate in your own design. Some of the factors I discuss are fairly common; others are not, but they are no less important.

Traits

Companies like Marriott have defined key traits needed for each position in the company. For the job of housekeeper, attention to detail is an important trait. For the job of CFO, analytical ability is an important trait. As I mentioned earlier, traits are not competencies, behaviors, or skills. Traits are things that someone was born with or developed in childhood. For example, one of the traits that audio company Bose hires for is creativity. Many people are not creative. Instead of teaching creativity, Bose selects for it. In other words, they purposely recruit people from professions that require creativity to be successful. Bose hires a lot of musicians, painters, and individuals from other artistic or creative professions because their success in artistic fields is a good demonstration of their creativity. The most common way of assessing traits for new recruits is behavioral interviewing. If, for example, you were trying to determine if someone had the trait of paying attention to detail, you might ask a potential employee how they get ready for work in the morning. There will usually be marked differences in how a detail-oriented person will answer this question and how someone without this trait will answer it. Some traits can actually be measured better than others. Intelligence, analytical abilities, strength, flexibility, emotional intelligence, and other traits can be assessed using validated instruments. Other traits like charisma or leadership will be a lot harder to evaluate. Some traits can also be assessed based on past accomplishments. Looking at an artist’s portfolio of work and awards received is a better way to assess creativity than some behavioral interviewing question. Once you have identified the top three to six traits for each job, each person in that job gets assessed on the degree to which they possess high levels of the trait. The most simplistic assessment might be a high, medium, or low score. Assessment of traits is not a yes or no issue but a matter of degree. Other clients have assessed levels of traits in employees on a 1 to 10 scale.

Competencies: Knowledge, Skills, and Abilities

Competencies have to be defined for each job as well. I see lists of competencies defined in many organizations that are actually not competencies or skills, but a mixture of traits, behaviors, and skills. Generally, competencies are collections or groupings of individual skills and knowledge. An example of a broad area of competence required for a sales job might be determining customer needs. A specific skill under that area might be interviewing. Most organizations have competencies sorted into two groupings:

Relationships

All jobs have requirements for traits and competencies, but relationships are not important for all jobs, just most of them. The types of relationships that make someone valuable to an organization are relationships with:

• Peers or other professionals in the field
• Thought leaders or experts
• Customers
• Suppliers and vendors
• Partners
• Other employees

Three dimensions have to be considered here. First of all, the importance of relationships needs to be assigned for each position. Salespeople obviously would have this as an important job requirement, and so would executives, but relationships are important for lots of other job types as well. For example, a client just hired a doctor to head up its clinical quality area who is not only affiliated with a major university but has connections with many others doing research in the field of clinical quality and with leaders of key regulators and professional associations. The doctor was a great hire because of his many competencies but also because of his connections and relationships with key players in the field. The second factor that needs to be assessed is how many relationships the individual has. Both depth and breadth need to be assessed. Finally, the third dimension that needs to be assessed is the level of the individual with whom an employee has a relationship. I recall working with a CEO in an aircraft maintenance and repair company who happened to be close personal friends with the CEO of then Continental Airlines. The two had gone to college together and had worked together for years. This relationship made the CEO even more valuable to the company he ran and helped ensure that they kept Continental’s business. After Continental CEO Gordon Bethune retired before United bought the airline, the relationship lost a lot of importance, even though Bethune was still an influential figure in the airline business.

Only a few of my clients have attempted to quantify the level of relationships as a factor that gets assessed as part of a human capital analytic, but not one would consider it unimportant when looking at the value of an employee. For entry-level jobs it probably doesn’t matter, but for many higher level jobs it is a big part of what you are paying for when hiring a key manager from a competitor or another similar company. In fact, relationships are often a factor that distinguishes one job candidate from another and are a big factor in determining compensation. A recent pharmaceutical client paid big bucks to lure away the sales vice president from a competitor, in part because of the many relationships she had with important players and thought leaders in the industry. She hit the ground running as well and was extremely productive within a few weeks on the job.

Accomplishments

We all know people who accomplished a whole lot in the first 20 years of their career but just seem to be coasting now. We all know people who are brilliant and talented but haven’t done a whole lot in the last five years. Accomplishments are certainly an important part of what makes an employee valuable. I recall working with a vice president at Black & Decker who had patents for electric drills that he invented in his early career. However, that was 30 years ago. Part of assessing accomplishments is to look at the extent of the accomplishments and the recentness of them. A simple way to assess accomplishments is to just use overall performance review ratings. Bettis Laboratory, which designs nuclear propulsion systems for the navy, came up with a human capital metric wherein the human capital score of 0 to 100 was modified by the performance review score. So let’s say you have a highly skilled employee with the right traits, but this same person is only mediocre in her current job. She might have her competency score of 82 multiplied by .5 (mediocre performance), so she ends up with a human capital score of 41. Similarly, a new employee with few demonstrated competencies gets a human capital score of 15 that gets multiplied by 1.5 for high performance, and his 15 becomes 22.5, showing a higher worth because of his good performance. The weak link in this overall system is the level of subjectivity that went into the performance review. Another problem is that it only looked at the current year’s performance, so any past accomplishments were not considered. In spite of the flaws, it ended up being a practical metric that was not too hard to track and was more comprehensive than a measure that just looked at a person’s traits, relationships, and competencies as a way of assessing his or her value. A separate dimension or something else that might be considered part of an accomplishment rating is credentials. Credentials include education certificates or other pieces of papers that certify competence. These are usually required for most jobs, so this factor could be easily left off the human capital analytic since it would be assumed that everyone in the job has the required credentials. I’ve seen some organizations that want to give points for impressive degrees from impressive schools, but there is always debate about issues like comparing the value of an MBA from UCLA to one from Harvard or Notre Dame.

Position

The final factor that might be considered when constructing a human capital metric is the easiest and most objective to measure—the level of the person in the organization. A certain percentage of the human capital score is allocated to the level of the person on the org chart. The logic behind this is that higher-level people certainly get paid a lot more than lower-level people and so they should get a higher human capital score. Also, the impact of losing a high-level leader or technical professional is usually much greater as well. I worked with a hospital that did not have an HR vice president for a year while they were doing a search, so this created a big human capital gap in the workforce, particularly in the vice president position. Calculating position is simply a matter of assigning points to the various levels in your org chart. People at the top get the highest scores and those at the bottom get the lowest.

FORMULA AND FREQUENCY

The first step in constructing a good human capital analytic is to establish the requirements for each job in the organization. What this means is identifying the traits, competencies, credentials, and important relationships needed for each job. In addition to identifying competencies, the level of competency is also extremely important to document in the job description. There is a big difference between needing a basic understanding of a topic and being considered one of the leading experts on a topic, or having done something well thousands of times. If I am getting a knee replacement, I want the surgeon who has done hundreds of them, not the guy who took a course on joint replacement in med school but has never done one. Assuming that human capital requirements have been defined for each job, measurement involves assessing employees against the requirements to determine whether gaps exist. If the gaps are due to people not having the right traits for the job, this can only be addressed by selecting new people who do have the traits and moving the existing people out or at least into jobs they are better suited for. Gaps in competencies can be addressed with both hiring and development strategies.

A straw man human capital analytic looks like the one that follows. However, as with many of the metrics in this book, the submeasures and weights need to be agreed upon by your own organization based on the nature of the work you do, the availability of data, and how sophisticated you want to get.

Regardless of how you calculate the human capital analytic, there are two basic ways to make the gauge move: gaining or losing people through hiring and turnover, or developing them through training, mentoring, job assignments, or other factors.

VARIATIONS

A common variation I see is a human capital metric that also includes measures of key HR processes like recruiting, selection, training, leadership development, and managing performance. The human capital analytic at ERDC that I mentioned earlier is designed this way. Personally I think it clutters up the data too much. I would prefer to have different metrics that look at whether the organization had the right mix of people and another analytic that looked at how well HR processes were being performed. The folks at ERDC believed that the two were inseparable. We can’t say we are doing a good job selecting the right people if we have big gaps in our human resources. In other words, part of assessing HR processes is seeing how the processes lead to the organization having the right mix of talents and skills. This is something for you to think about and discuss. Another reason I like separating the two types of measures is that the CEO and other key executives need to monitor the human capital analytic that looks at gaps in the workforce. However, generally it is only the HR vice president who is responsible for the HR processes.

Another common variation is to include only an assessment of competencies in the human capital analytic and not to assess the values of traits, relationships, or accomplishments. This might be a good way to start constructing the metric, but I would not leave it at that.

A crude variation used by one military client is just to count the number of people in each job or trade (e.g., welders, pipefitters, mechanical engineers, etc.) and compare that number to the HR plan that spelled out the number of people needed in each job category. The only way to have a gap is if you are short of people. What I love about this is its simplicity. What I hate about it is that it says nothing about the real gaps in human capital that are caused by incompetent or barely competent people who happen to be in needed jobs. Some of the welders, for example, were barely competent, whereas others were so competent they could do the work of three guys. ERDC employed a more meaningful assessment by not just indicating how many of this and that specialty areas were needed in the workforce but also by indicating levels of competence that were needed:

• Entry-level
• Journeyman
• Expert

TARGETS AND BENCHMARKS

The overall target for the human capital index is that the organization has zero gaps. However, this is probably unrealistic, so a reasonable “green” zone might be 80 percent or above. In other words, if the organization has 80 percent of the talent it needs, it can probably achieve most of its other goals. What this does not take into account is gaps that could occur in the near future as the organization moves into new markets or fields. Consequently, the data from the human capital index needs to be drilled into for details, and the high-level analytic needs sensitive “warning lights” that light up when gaps appear in strategic or vital areas for the business.

BENEFITS OF DATA

The benefits of having an accurate measure of human capital are enormous. Having an assessment of the gaps in your workforce can enable the organization to:

• Target recruiting and selection to fill current and future gaps.
• Strategically assess the value of training on different topics.
• Evaluate the true value of each employee to the organization.
• Assess the impact of employee turnover.
• Integrate a number of key HR processes.
• Improve the integrity of succession planning.