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Business leaders should make human-capital decisions with the same scientific rigor they bring to finance and operations, says professor and author John Boudreau.
David McCann, CFO.com | US
January 14, 2011
"Our people are our most important asset." It's common today for business leaders to at least pay lip service to that sentiment. Yet many if not most leaders have only a vague notion of what that asset is worth, or how it can be deployed for optimal returns.
True, many human-resources departments have scorecards and databases that generate lots of reports on such things as turnover, performance distributions, and engagement. But what's usually missing is the application of metrics that finance executives hold dear — the HR equivalent of measures like net present value, internal rate of return, and economic value added, says John Boudreau, research director and professor at the University of Southern California's Marshall School of Business.
Boudreau, who will speak at the upcoming CFO Corporate Performance Management Conference in New York City, to be held January 30-February 1, places much of the blame for the lack of analytic rigor outside of HR, on top organizational leaders. To find out whether a project is worth undertaking, they typically use some variant of NPV. To learn which consumer groups are likely to be the most strategically important, they use some type of customer segmentation or lifetime profitability model. Yet, says Boudreau, "If I ask them what drives their employees' motivation, I get 15 answers in a room of 15 leaders. And most of them give what would be about a D-minus answer in my class on motivation theory. They'd never get away with that in the world of finance."
That's not to say that HR managers are blameless. In running a business, the best managers always seek to optimize a process so that it operates at maximum efficiency given an acceptable level of risk. But in the world of HR, "it's often more about how do we describe to the business leaders what we do — or how do we prove to them that what we're doing has value," says Boudreau.
In the CFO's world, investment risk is controlled through diversification, with a company's portfolio typically containing a variety of asset classes, such as stock, bonds, and cash. All are not likely to do well in a given time period, but collectively they should provide the optimal return-to-risk ratio. A similar approach ought to be applied to talent development, contends Boudreau, whose most recent book is Retooling HR: Using Proven Business Tools to Make Better Decisions About Talent (Harvard Business Press, 2010).
In the book, he uses the example of a company trying to decide how to allocate its talent resources in developing versus developed countries. The company may believe there is a 60% chance that business will grow quickly in the former, compared with a 40% likelihood of slower growth. Such a clear differentiation may dictate a decision made with tunnel vision. "Most HR systems tend to build talent for the most-frequent scenario without doing much mathematics," comments Boudreau.
According to portfolio theory, a better bet is to build talent in both areas in a ratio that optimizes risk and return. In this scenario, some of the resources that are allocated won't get used in the future, but the risk is hedged, says Boudreau.
While building for multiple scenarios may appear to be more expensive, investing in the most likely one will prove enormously costly if you're wrong. For that reason, companies often delay investing in talent until the future looks clearer. "It's the way business leaders often expect HR to work," says Boudreau, "even though in the investment world they understand the massive risk of that and how costly it is to move at the last minute."
Finance and operations executives understand that in order to run an efficient inventory system, sometimes it's necessary to buy a lot of product and run the risk of surpluses, and other times to hold off and risk shortages. Yet when Boudreau asks business leaders what is the right level of employee turnover, he says they almost always answer "as low as possible." They don't want any employee shortages, and they certainly don't want to carry extra workers.
But that would be like wanting a company with a traditional inventory system to fill orders immediately while never experiencing a shortage or holding extra inventory. Say that to an inventory operations engineer and he would say you can have two out of three (and probably think you don't know much about inventory management).
Nevertheless, an HR manager might tell you his job is to ensure that there is never an employee surplus or shortage and that all vacancies are filled immediately. That's the wrong answer, says Boudreau. "Making optimal decisions about talent means that you're not going to reduce turnover everywhere; you're going to reduce it where it pays off the most."
Managing turnover while optimizing talent also means putting top performers not in every job but only where they're needed — and filling other roles with "good-enough" performers, says Boudreau. That stance is rare in today's business world. "Top executives are almost always happy with the idea of having the best performer at every position," he says. "But that is in such direct contrast to the way they approach almost everything else." They don't, for example, think that the best computer technology should be on every person's desk, or that the best way to run manufacturing is to have every machine fully utilized. They know that trade-offs and diminishing returns must be factored in.
In a new book Boudreau is writing, he uses the example of airline pilots to illustrate the point. There is a massive upside to training pilots to the high standard of proficiency they need in the cockpit. But once they're at the standard, there is virtually no difference among them. And airline pilots are not, in fact, the world's best pilots. "To push up the envelope of performance, the Navy needs the best; United Airlines doesn't," says Boudreau.
Another area where HR would do well to adopt business metrics is the burgeoning practice of offering benefits packages customized for different employee groups — boomers, Gen Xers, millennials — or simply providing options: do you prefer more benefits or more direct pay? More health care or more pension funding?
Marketing typically uses what's called conjoint analysis to decide how to optimize offers for customer groups. The technique involves asking questions about preferences for specific packages of features: do you prefer more horsepower and fewer cupholders, or vice versa?
The parallel between consumer marketing and customizing benefits is quite apparent, says Boudreau. Yet while some benefits-consulting firms are pushing the use of conjoint analysis, overall it's not used much. "When you do that analysis, you get curves that are very similar to what you see in marketing that define the most efficient way to get bang for the buck," he says.
That analysis can enable HR managers to calculate such things as the most cost-effective combination of rewards to achieve a certain retention level, or the most efficient way to spend limited funds to get the best possible retention level. "That's very similar to marketing saying, 'We've got limited resources, so this is the feature to push on and these others we'll let be just good enough,'" says Boudreau.