When HR meets economics

A Deloitte study shows why HR leaders need to think like economists

The annual review meeting is on to fix the budget for the financial year. The marketing head quotes a figure and then makes a presentation justifying his demand. The finance head does the same; and so do the production head and the rest - except the human resources (HR) head. He quotes a figure, but says it's difficult to calculate the return on investment on HR budgets because quantifying what HR does (improving employee morale, for example) is almost impossible. Sounds familiar?

A Deloitte study released this month, however, shows why the HR head is completely off the mark, and why CEOs often shoot down the ideas of HR - not because they were not good or necessary, but because they did not have a proper business case. In many companies, 40 to 60 per cent of all variable costs are people cost, making it the highest variable budget expense. In such a situation, HR really has no choice but to prove its economic value. So it's no longer okay for HR leaders to think they know what's working. For, they have no option but to measure the efficiency and effectiveness of various HR programmes and prove it to the top leadership.

Today, an HR leader, says Deloitte, has to think like an economist - someone who studies and directs the allocation of finite resources. In the global economy, talent is one of those scarce resources.

Embracing that mindset is half the challenge. The other half is harnessing the applicable information. Companies are accustomed to following their own internal "leading indicators", but the economist-minded HR leader has to look outward as well. Macroeconomic indicators like the gross domestic product, employment shifts or public infrastructure spending are critical pointers to sound business decisions. By calibrating the finite talent investments their organisations are able to make, these leaders aim to make their workforces more responsive to the current and future needs of their organisations.

Ultimately, HR decisions are like many other business decisions: they involve both cause and effect - and supply and demand. As HR leaders focus on solving more complex business issues, they increase their alignment with the other business leaders in their organisation.

For example, mergers and acquisitions. It's increasingly common for the workforce value of a target organisation to be the chief reason for its acquisition. Economic data can help HR leaders find companies with people who offer hard-to-find skill sets. Which countries promote start-ups? Which countries have large populations of people with scarce skills? What countries are importing specialised talent the fastest? Which companies are gaining market share in innovative industries like biotech, based on their recent market performance? Thinking like an economist helps the HR leader find the talent value that can form the centrepiece of a deal.

People in leadership roles - in HR and everywhere else - have much of their time locked up by operational concerns. Thinking like an economist requires stepping back and taking the time to think about strategy. If talent is more important in addressing business issues, and talent is finite, how can it be allocated to generate more value for the business?

When hard numbers can explain or predict what's important to the business, leaders listen. Thinking about talent like an economist, Deloitte says, is not a dehumanising process. It doesn't mean reducing people to numbers. Rather, numbers can help leaders understand how to address the challenge of having the right people with the appropriate skills and competencies at the right place at the right time.

In short, experts say, HR departments have to get out of the mindset of defining their job profile as merely ensuring that the forms are filled out in triplicate; and to pull up people who forget to fill out some insignificant details. For, recent studies have shown that it is possible to establish a clear numerical relationship between good human capital management and enhanced financial performance. Consider, for example, a Hewitt research study, which shows that stocks of the best employers outperform comparable indices and industry performance metrics by over 15 per cent. The annual profit growth of the best employers is also 15 to 200 per cent higher than the industry.

To figure out how to go about measuring HR processes, here are two examples provided by Michigan Business School's professor Dave Ulrich. The first one is AT&T. Apart from tracking economic value added by measuring financial results such as cash flow, profitability and margins, and customer value added by doing continual surveys of both internal and external customers, AT&T leadership tracks people value added, which focuses on two processes - leadership and diversity. The data that tracks how employees perceive the leadership and diversity processes within their business are collected annually for each business unit or division. The scores are calculated as part of a manager's balanced scorecard and are used in calculating salary increases.

The other example is General Electric (GE). The company is concerned about two dimensions of managerial behaviour - performance and values. Performance dealt with the extent to which the manager accomplished financial objectives. And values dealt with the ways in which the manager behaved under the GE Leadership Effectiveness Survey. A manager is evaluated on both counts.

Examples like these show why HR leaders are completely wrong when they say HR development processes can't be quantified.