WORKFORCEWORK WORKPLACE

Research insightNovember 2013

Resourceful assets?

in partnership with

Championing better work and working lives

The CIPD’s purpose is to champion better work and working lives by improving practices in people and organisation development, for the benefit of individuals, businesses, economies and society. Our research work plays a critical role – providing the content and credibility for us to drive practice, raise standards and offer advice, guidance and practical support to the profession. Our research also informs our advocacy and engagement with policy-makers and other opinion-formers on behalf of the profession we represent.

To increase our impact, in service of our purpose, we’re focusing our research agenda on three core themes: the future of work, the diverse and changing nature of the workforce, and the culture and organisation of the workplace.

About us

The CIPD is the professional body for HR and people development. We have over 130,000 members internationally – working in HR, learning and development, people management and consulting across private businesses and organisations in the public and voluntary sectors. We are an independent and not-for-profit organisation, guided in our work by the evidence and the front-line experience of our members.

About the author

This report was written by Dr Anthony Hesketh, Senior Lecturer at Lancaster University Management School.

WORKOur focus on work includes what work is and where, when and how work takes place, as well as trends and changes in skills and job needs, changing career patterns, global mobility, technological developments and new ways of working.

WORKPLACEOur focus on the workplace includes how organisations are evolving and adapting, understanding of culture, trust and engagement, and how people are best organised, developed, managed, motivated and rewarded to perform at their best.

WORKFORCEOur focus on the workforce includes demographics, generational shifts, attitudes and expectations, the

changing skills base and trends in learning and education.

Swimming with or against the tide?Recent research published by McKinsey (Bradley et al 2013) makes sobering reading for those executives who like to point to the profits of their business as an indicator of their talent. Examining the economic performance of 3,000 global companies over a five-year period (2007–11), McKinsey’s analysis revealed that those companies in the top quintile at the beginning of the analysis had only a 50:50 chance of remaining there five years later.

This does not mean that how well companies perform is serendipitous. On the contrary, wider forces are at work. Of those companies that bucked the global economic downturn and moved up into the top quintile, 90% did so on the back of an upturn in their industrial sectors. Only four companies making the move into the top ranks did so against a sector average of economic profit that was either flat or declining. Company boats, then, rise and fall in line with wider economic tides.

But dig a little deeper and interesting questions begin to emerge. The higher the tide of the industrial sector, the greater the variance in performance between companies. All boats rise (or fall), but some rise higher (or fall lower) than others. McKinsey estimates 40% of a company’s performance can be explained by the sector in which it is located. The remaining 60%, they enticingly suggest, can be attributed to the company’s effect.

The sustainability of this effect is certainly precarious. But McKinsey’s findings suggest the deck of cards is delicately tilted in favour of those executives with a greater understanding of what creates and drives the value of their companies. This is the point, then, at which the real executive craft begins.

McKinsey’s research identified a number of tough, complex and risky choices facing leaders over which markets and geographies to play in. This, in turn, requires an integrated understanding of a company’s proprietary advantage, reflected in its privileged assets and capabilities. The margin for error is tight but the pay-off for companies can certainly be worthwhile.

The question then turns on how can executives better understand the specific assets and distinctive capabilities their companies possess, align them and ultimately leverage performance? This brings us nicely to the driver underpinning the Valuing your Talent project.

Valuing your Talent (VyT)Executives have long recognised and understood Einstein’s observation that not everything that counts can be counted. Accountants refer to such items as intangible. But while formal convention enables accountants to monetise intangible assets such as goodwill on the balance sheet, these same conventions block us from quantifying the biggest intangible asset of all: our people.

’Only four companies making the move into the top ranks did so against a sector average of economic profit that was either flat or declining..’

Valuing your TalentResourceful assets?

Valuing your Talent 1

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This has not stopped many from trying, but after extensive academic research, consulting interventions and even a major government task force, agreement on how to quantify the value of our people still remains elusive.

However, in the present context of concern and expectation about corporate cultures, about how organisations operate, and how they develop and manage their increasingly diverse workforces and ways of working, we have to finally agree more consistent measures and frameworks that provide the visibility all stakeholders need.

To address this, the three professional bodies representing the HR and finance professions, and management – the CIPD, CIMA and CMI, together with the RSA are collaborating on a major research and engagement project called Valuing your Talent (VyT). The work, which is being supported and sponsored by the UK Commission for Employment and Skills, is designed to help employers understand how to measure the impact their people have on the performance of

their organisation and as a result make better people management and workforce investment decisions.

’A perfect storm of changes in

the accounting industry is

converging on human capital

issues.’

Second, we need to define much more clearly the basic people metrics to promote agreement and consistency in how such measures are used.

Third, building on these practices we will develop a broad framework against which executives, employees, the investment community and other wider stakeholders can assess how businesses of all kinds are developing their people and organisations to enable sustained and higher levels of performance.

First, we need to better understand how developing and managing people releases and drives value. For this we will explore existing best practice, drawing on a range of case studies across different sectors and sizes of organisation.

The VyT project, then, has three primary objectives

1 2 3

Three overarching principles are guiding our work:

• We are seeking to be highly collaborative, drawing on views from academia, accounting, business and employee representation groups.

• We want to be inclusive, drawing on innovative research methodologies to hear from recognised leaders in this area but also using, for example, social media technologies to tap into a wider base of views and opinions.

• We are emphatically non-proprietorial. What we create we will openly share in order to spread and promote best practice in the measurement of people management.

Valuing your Talent 3

Data collection is already underway. Our main recommendations and human capital framework will be launched in April 2014.

Where the numbers finish, the executive craft beginsOf course, it is not all about numbers. Many grate at the description of human resources as an asset ripe for greater exploitation. While the accounting profession is for the first time getting to grips with the notion of an asset as a resource, the HR profession has steadfastly defended the human element in HRM.

There is a large element of executives who do not require the accounting, academic or consulting industries to prove something that they already know to be true: good management makes a difference to how people perform.

It is for this reason that VyT is looking beyond the capitalisation of human resources to how we value our talent and our management practices as more art than science. Alongside the development of a raft of metrics we are investigating the craft of the human resource executive’s art. This in turn requires methodologies that utilise the narrative form to capture a company’s competitive intangibles.

Capitalisation certainly represents one avenue to credibility. An alternative view, however, presents the management of talent as a craft without which companies would lose the discretionary effort of their employees, which research has continuously demonstrated makes a material difference to business outcomes.

Our emerging findings suggest that there are four key themes underpinning the art of managing human resources.

Human Capital Reporting: is the time nigh?One of the defining hallmarks of modern business has been the rise of intangible value. Before Lehman’s collapse the gaping chasm between the book and market values of a company had reached record levels. An increasing element of this growing disparity between hard asset and intangible value was attributed to the distinctive capabilities of the people located in particular companies.

Such was the importance of this knowledge or human capital that an attempt was made to account for the value of people, hence the Kingsmill Report Accounting for people, commissioned in 2003 by the then Chancellor of the Exchequer, Gordon Brown.

’One of the defining hallmarks of modern business has been the rise of intangible value.’

Four key themes underpinning the art of managing human resources

Clarity Enablement Imperative Traction

Reaching an unambiguous understanding and statement of strategic intent and clearly communicating this to different stakeholders both within and without the company.

The establishment, negotiation and resourcing of that which enables the strategic intent of the company.

The underpinning rationale for the priority and sequencing of future major business activities.

Establishing progress on strategic imperatives with a clear connection between the maximised performance of talent with tangible business outcomes.

Kingsmill certainly raised the awareness of the financial value of people while at the same time highlighting an apparent vacuum in our ability to use conventional accounting techniques to estimate the value of an asset on which the typical company spends anything between 20–80% of its total operating costs.

A key recommendation, and one accepted by Brown, was the compulsory insertion into the Operating and Financial Review (OFR) of a company’s annual report, a specific section reporting the value of human capital. Millions of consulting dollars later, confusion over what to include and what not to include in reports, not to mention two postponements, followed by the eventual abandonment of the human capital element of the OFR, left the notion of accounting for the value of talent in tatters.

The reasons were largely technical. The Treasury remained unconvinced by (largely academic) research attempting to establish and measure the causal relationship between human resources and the financial performance of companies. The accounting profession pushed back against attributing a financial value to an asset that was largely intangible and could not be reliably identified or predicted. A stalemate resulted and has done so for the decade since Kingsmill.

But times have changed. Doing business in post-Lehman twenty-first century capitalism requires a greater level of responsibility and transparency in the wake of ever-increasing regulation. Where some regard tighter governance as the imposition of needlessly bureaucratic strictures, others see the need to shine a brighter light of granularity on the strategic direction, behaviour and especially on the reward of people.

This has been no better exemplified than in the ‘shareholder spring’ where the relationship between executive remuneration and performance was called into question by key stakeholders in business as many employees suffered pay freezes, or even pay cuts, to preserve their jobs. Ours is a very different economic, business and social context to that of Kingsmill’s. But other forces are propelling us forward to the need for a framework against which our talent or human capital can be better understood, harnessed and ultimately monetised.

Accounting for accounting?A perfect storm of changes in the accounting industry is converging on human capital issues. What is an enormously complex debate has major and potentially very practical ramifications for how we might value our talent in general, and for human capital reporting in particular. There are at least two developments of magnitude.

The first turns on the latest cycle of the re-evaluation of the financial reporting standards (IFRS) by the International Accounting Standards Board (IASB). Although an update of the conceptual framework underpinning the IFRS is relatively routine, the IASB is for the first time considering defining an asset in terms of it being, ‘a resource (rather than simply the inflow of economic benefits that the resource may generate)’ (IFRS, 2013: 1).

Clearly the ramifications for human resources are moot. Such an implication may not have been a deliberate one (we are in fact exploring this with the IASB as part of the research), but the resource genie is now out of the bottle.

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‘Doing business in post-Lehman

twenty-first century capitalism

requires a greater level of

responsibility and transparency

in the wake of ever-increasing

regulation.’

If, ‘an asset must be capable of producing economic benefits’, and ‘those economic benefits need not be certain [...] and has a cost or value that can be measured with reliability’ (IFRS, 2013: 2-3), the onus is now on the IASB to explain why the value of human resources cannot now appear on the balance sheet as an asset in its own right. The challenge for VYT, then, lies in providing a Human Capital Reporting framework that provides, ‘financial information… capable of making a difference in decisions [which] has predictive value, confirmatory value or both’ (IFRS, 2013b: A28, QC7).

A second development turns on the development of Integrated Reporting (or <IR>). This represents the coming together of businesses and investors to develop a new corporate reporting model for the future. This major undertaking has at its heart a process of reporting that, ‘is a concise communication about how an organisation’s strategy, governance, performance and prospects, in the context of its external environment, lead to the creation of value over the short, medium and long term’ (IIRC, 2013: 8).

Here again, at face value nothing appears to be out of the ordinary. The ultimate aim is to support the providers of capital in their deliberations over their financial capital allocation assessments. Significantly, the <IR> initiative identifies six capitals comprising the resources and relationships a company relies upon for its success (c.f. IIRC, 2013: 11).

These capitals are financial, manufactured, social and relationship, natural, and, critically for our purposes, human capital. The latter is defined as, ‘people’s competencies, capabilities and experience, and their motivations

to innovate’ (IIRC, 2013: 12) and a specific document discussing the capitals provides an extensive list of human capital metrics thought to be of use in company financial reporting (IIRC, 2013a: 21).

The <IR> initiative is essentially seeking to help companies to better illustrate to their investors those aspects of their capitals that are material in driving financial value. Clearly, with an added appetite for greater granularity and transparency in establishing that which is material in enabling organisations to realise their value, a second people-related genie – that of human capital – has now left the accounting bottle.

A question of balance?Both of these developments, then, present chief financial officers with a problem, and potential solution. The challenge lies in companies being able to capture the economic value of their human capital management as, ‘a matter [that] is material [and is of such relevance and importance that it could substantively influence the assessments of providers of financial capital with regard to the organisation’s ability to create value over the short, medium and long term’ (IIRC, 2013b: 2).

Were a human capital framework to achieve this status of materiality – and at this stage it is far from clear it might – companies would not just be able to demonstrate the materiality of human resources in creating value, but simultaneously offer the route through which the costs of employees could finally leave the profit and loss account and be fully capitalised as an asset on the balance sheet. Not only would our most important asset finally be attributed an economic value but the contribution of our people would at long last play a primary role in the financial

deliberations over the formulation of overarching strategy and accompanying business model.

We view the human capital framework we are devising as a developmental progression to real and tangible economic value through which companies at different points in their talent management cycles can progress. How far companies travel will be largely determined by the benefits and resources executives believe are material to them and to their wider stakeholders.

Reference BRADLEY, C., DAWSON, A. and SMIT, S. (2013). The strategic yardstick you can’t afford to ignore. Mckinsey Quarterly. October.

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Issued: November 2013 Reference: 6404 © Chartered Institute of Personnel and Development 2013

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