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Everyone believes good HR policies affect the bottom line. Southwest Airlines, GTE, and A.C. Nielsen can quantify it.
George Donnelly, CFO Magazine
March 1, 2000
Like most employees at Southwest Airlines, Libby Sartain is not prone to formality. Her title, after all, is vice president of people. The company ditched what it considers the slightly pompous human-resources name a long time ago. What it won't relinquish is its tight grip on its high-spirited, irreverent culture — a customer-focused environment credited with helping grow earnings by almost 10 percent last year, while most airlines experienced declines.
And although Sartain may maintain that Southwest doesn't "use sophisticated metrics" to measure its precious human capital, there is no denying that the company invests heavily in building it. For instance, to fill 4,200 job openings last year, the company interviewed nearly 80,000 people. Candidates undergo a rigorous interview process that can take as long as six weeks before they are hired. About 20 percent of new hires fail to make it through the training period. The payback: low turnover, high customer satisfaction, and, in Sartain's estimation, a self-monitoring culture of self-motivated employees. "We don't keep them if they don't fit into our culture," says Sartain. "A lot of people think we're just relaxed, loosey-goosey, but we have a lot of discipline."
Southwest CFO Gary Kelly believes investing in hiring is vital. "I do get asked on occasion by investors, 'Could you cut your costs in this area?'" he says. "But if you're not going to work hard to get people who are a good fit, it will hurt you. For example, we've never had a strike. What airline is even close to being able to say that? We explicitly believe there's a payback to that kind of investment." Another clear benefit: Southwest's turnover is about 9 percent, considerably lower than the average for its industry.
Success stories like Southwest's — it currently ranks sixth in Fortune magazine's list of most-admired companies — are drawing the envious curiosity of others. With the unemployment rate at an all-time low, high turnover is both costly and a competitive disadvantage.
And Wall Street is catching on. "When we do our quarterly calls, there are often questions about turnover: 'Have you had any turnover in senior management? Any turnover of your founding employees?' " says Ann Brady, CFO of Art Technology Group, an Internet software and service provider based in Cambridge, Massachusetts. "The analysts are smart enough to home in on it. They know that what's really driving revenue is people."
With research linking good human-capital practices to improved shareholder returns, companies are beginning to bring science to their recruiting practices, internal communications, training programs, and work environments. Some, like Southwest, define their core competencies for success and then hire for fit. A.C. Nielsen and Sears, Roebuck and Co. carefully survey their employees and link manager bonuses to employee satisfaction. GTE Corp. leverages technology to track a wide range of human capital measures that help pinpoint concerns, like churn (short-term turnover) within a business unit, before they become major problems.
Choose Your Measure
Traditionally, however, the department responsible for recruiting and communication — the human resources department — hasn't done much to endear itself to finance. Getting HR to track anything more than the most basic measures — its budget, the number of people hired, or the number trained — has often been a struggle. "You frequently see HR making a case for the HR department rather than creating strategic systems that allow the business to determine that it's getting better day by day," says John Boudreau, director of the Center for Advanced Human Resource Studies, at Cornell University.
The discipline is hampered by its legacy as a service provider. HR, says David White, CEO of Cambridge, Massachusetts-based Human Capital Technology, which customizes systems to track such areas as recruiting and performance measurement, is used to saying, " 'Let me please you,' as opposed to 'Let me measure you and act as a consultant to drive the organization forward.' " In addition, says Edward L. Gubman, a global practice leader at Hewitt Associates, HR sometimes hides behind the excuse that the measurement would be inexact and therefore not worth the effort.
Recent research, however, indicates that it is indeed worth the effort. A 1999 study by Watson Wyatt Worldwide, for example, surveyed companies on the quality of their human capital practices, creating a human capital index of 1 to 100. Companies reporting best practices in such areas as communications integrity and creation of a collegial, flexible workplace saw a 28 percent shareholder return in the first six months of 1999, versus a 12 percent return for companies in the two middle quartiles. The biggest driver? A strong recruiting function, says Bruce Pfau, author of Watson Wyatt's study. Companies benefit, he says, from having a "clear model for looking for whom they hire" and a "clear way of creating criteria against which individuals will be judged." Southwest clearly falls into that category with its selection process. Another example is Microsoft Corp., which rigorously trains its recruiters to screen the more than 3,000 résumés the company receives daily at its Internet site against specific job skill sets.
"We also evaluate whether a candidate is smart, passionate, interested in technology, and results-oriented," says Norman Tonina, senior director, finance development, at Microsoft. Hiring to fit Microsoft's intellectually challenging culture, he adds, is exhausting, but worthwhile. It has helped lead to a turnover rate that is "half the industry average," he claims. To foster these results, Microsoft and other highfliers, like Dell Computer Corp., track such recruitment metrics as cost per hire, time to fill, and offer-acceptance rate.
Of course, retaining employees once they are hired is equally important. And the evidence shows that retention is a complicated animal, driven by a host of factors, not simply compensation. In fact, competitiveness of rewards ranked third in Watson Wyatt's survey of what drives employee commitment — behind "trust in senior leadership" and the "chance to use [one's] skills." Consequently, it is routine for many companies to focus on keeping the talent they have, by slicing and dicing retention rates by unit, job title, performance rating, and years of service. Which measures work best, however, is a factor of industry, size, and strategy. And, ultimately, what is measured depends on "what you can affect," says Hewitt's Gubman.
One metric that can be affected is employee satisfaction. Just ask Robert Chrenc, CFO of A.C. Nielsen. According to Chrenc, the Stamford, Connecticut-based market-research firm was in bad shape at the time of its 1996 spin-off from Dun & Bradstreet, having lost hundreds of millions of dollars between 1993 and 1995. It was clear to Chrenc, after spending 28 years at Arthur Andersen LLP, with its orientation toward cultivating employees, that Nielsen had to shore up its human capital. To document just how low morale had sunk, the company began exploring employee attitudes through a 50-question survey. The news wasn't good: Only 42 percent of employees were satisfied with their jobs and the way the company was being run.
In response, Nielsen did something radical: It gave its employees a vote on part of the management team's bonus. Twenty-five percent of managers' bonuses are now based on the results of a survey of employee attitudes. Employee satisfaction has improved, hitting 63 percent in 1999. The company's goal is 70 percent, says Althea DeBrule, senior vice president of global human resources at Nielsen. "We want employees to tell us what we can do better," she says. "Once they tell us, we figure out if we accomplished what they told us to do" — and reward managers accordingly.
Because Nielsen's employees are happier, turnover dropped to 10.5 percent in 1999, a 50 percent decline. And, says Chrenc, the company's operating margins rose from 2 percent in 1996 to 8 percent in 1999. Employee satisfaction "does improve the bottom line. When you hire good people, train them well, and recognize them, that translates clearly to the clients." Nielsen's customer-satisfaction level last year in its North American unit was 72 percent, exactly the same as its employee-satisfaction level.
A Talent Inventory
In terms of shareholder value, just pleasing employees is not enough: Companies must nurture the best. A common method for identifying the most talented employees within a company is competency measurement.
The technique is not new. A recent Corporate Leadership Council study indicated that 77 percent of the Fortune 500 use some kind of competency-based system to evaluate employees. Competency measurement is a key building block for human capital management, says White of Human Capital Technology. A company should "inventory its desired set of competencies in light of its business strategy," he says, and then promote to match its ideal.
The idea is embraced at Nielsen, which tracks its high- potential employees, some 200 people out of a pool of 21,000. "We review their talent profiles, look at when they are scheduled to go on another assignment, and [then] track and measure how well they're doing," says DeBrule, adding that achievements are matched against company leadership standards and the specific competencies of the job.
Telecom giant GTE, in Irving, Texas, is assessing the skills and leadership potential of all its 120,000 employees. The results: specific metrics on several subsets of employees, including high-potential women and minorities, and the overall high-potential population.
GTE uses a ratio to compare how the placement of its best people into new assignments compares with that for the general employee population, explains Garrett Walker, human resources director. "The high-potential employees should be moving twice as often as the general population," he says.
This ratio is just 1 of 113 metrics GTE uses to measure human capital management. Others include employee attitudes; perceptions of HR service; cycle time to fill positions; cycle time to start; various training measures; HR cost measures, including head count of HR staff; turnover by unit; and churn. The result is a quarterly balanced scorecard that measures human capital management effectiveness and ties it to business results.
Too much of a good thing? On the contrary, says Walker: "Our executives have been extremely positive. They would like to have even more information." He adds that the scorecard, which was launched in the first quarter of last year, has ushered in a major cultural change in the HR department. "Early on, there was some fear of being measured on this," Walker says. "But now, we are compensated on the results of this scorecard, and that keeps our eye on the ball."
GTE's attention to human capital accounting allows it to quickly address major and minor personnel problems. For example, says Walker, the system allows GTE to monitor churn in its customer-service call center. "It costs us a tremendous amount of money to get [these employees] trained," says Walker. "And it's extremely important that we keep highly qualified people in those jobs. We want to get our return on investment."
With the information derived from its scorecard, GTE can quickly determine what kinds of call-center employees are turning over — the new recruits with 1 to 3 years of experience or employees with more than 10 years at GTE. Armed with that knowledge, says Walker, HR can identify the causes of defections and devise solutions "to stop the drain of talent."
Of course, remedying human capital problems isn't a guarantee that corporate performance will improve. Take the example of Sears, which has experienced problems in retail sales over the past couple of years and has suffered huge credit-card loan losses. In 1995, a study to assess whether Sears was a compelling place to work, shop, and invest determined that a force driving financial performance was employee satisfaction. For example, sales per square foot could rise as much as 17 percent when employees had responsive managers, access to training, and flexible working conditions.
Like A.C. Nielsen, Sears tied top-management bonuses to human capital results: one-third for employee satisfaction measures, one-third for customer-satisfaction measures, and one-third for increasing sales or earnings results. "The things we do to make Sears a compelling place to work" result in more satisfied customers, says Steven Kirn, vice president of innovation and organizational development.
For Sears, these efforts have not been enough to compensate for aggressive competition from discount chains, such as Target Corp. In the fourth quarter of 1999, Sears's same-store sales — a key measure of retail performance — increased only 2.4 percent at a time when many other competitors posted increases of 5 percent to 9 percent. Says Kirn, "If your business design is wrong, you can do all the cheerleading of employees you want; it isn't going to get you where you need to be."
Facing the Flaws
Not only are human capital efforts vulnerable to outside influences, but taken in isolation, the measures are also sometimes misleading. For example, GTE measures how long it takes to fill a position. But there's a cost to the company if it brings in the wrong people. At one business unit, the cycle time to fill a position dropped dramatically, but the cost of training went through the roof and customer satisfaction fell because the company churned employees.
Analysis revealed that the business unit had been hiring through temporary agencies and job banks, often finding applicants who were ready to start quickly but were harder to train and keep. It was a bad trade-off. "It made sense to accept a longer cycle time and more cost to ensure the right person was put in the job," says Walker.
Such insights attest to the benefits of measuring human capital. And they demand the attention of finance. Robert Kaplan, professor of accounting and leadership development at the Harvard Business School and co-author of The Balanced Scorecard, points out that interest in capturing human capital metrics "depends on how broadly the CFO interprets his or her mission. Some interpret it narrowly and say, 'We're in charge of only the things that have a dollar sign in front of them.' There are other CFOs who say, 'We're the best people in measurement, and our role in the organization is to make sure we can measure things.' If CFOs define their roles more generally as one of measurement, they can play a key role here."
Money Can't (Always) Buy You Love
Retaining employees isn't only about dollars and cents.
Retaining valuable employees is one of the main objectives of human capital measurement. But figuring out what makes employees stay — especially at technology firms — is complicated.
More than anything else, the highest-in-demand employees want to be where the action is. "People want to feel that they're working for a winning organization," says Thomas Flannery, director of the human capital service practice at Arthur Andersen LLP. "They want to feel they have the resources to do their job. When those things don't exist, companies are forced to [pay] more."
Creating that winning feeling at any firm — and especially at a dot-com company — is a constant struggle, even in today's booming economy. Employees are driven by an "emotional commitment: Do I feel valued, challenged, and capable of making a difference?" says Kirk Froggatt, vice president of human resources at Yahoo Inc. "And is the day-to-day experience energizing? Because if it isn't, I don't have to stay here, or anywhere, for that matter."
When people do leave, says Chris Carlton, vice president of human resources at Network Appliance Inc., a Sunnyvale, California, network data storage maker, it's often because "we haven't paid attention to them. They didn't feel valued from an ongoing stock perspective or from a work-environment perspective." A critical question for all senior managers, she says, is, "How do you make sure people are part of the community? It's the community that's going to keep them here."
Art Technology Group (ATG) is answering that question by paying attention to its culture, says Ann Brady, CFO of the Internet software and services provider, based in Cambridge, Massachusetts. "For the most part, decisions are made in a democratic setting," she notes. But ATG takes culture management one giant step further: Its vice president of organizational development, Brenda Sullivan, has been dubbed "the keeper of cool." "A large part of her job is to maintain the ATG cool," says Brady. "She surveys employees to keep on top of problems, identify conflicts, and resolve them."