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High-Impact Human Capital Strategy
Addressing the 12 Major Challenges Today's Organizations Face
By Jack J. Phillips, Patricia Pulliam Phillips AMACOM
Copyright © 2015 Jack J. Phillips and Patricia Pulliam Phillips
All rights reserved.
ISBN: 978-0-8144-3607-3
CHAPTER 1
The Importance of Human Capital
The Journey to Show the Value
This introductory chapter examines the importance of human capital and introduces several arguments for why human capital should be a reigning priority. It begins by examining the role of people in organizations and then explores issues such as how human capital is (or is not) valued. The role of human capital in highly successful organizations is highlighted in lists such as Fortune's "100 Best Companies to Work For" and "Most Admired Companies." In almost all cases, logical arguments point toward the importance of the human part of the organization, which contributes most, if not all, of the organization's successes. The discussion emphasizes the value successful organizations place on their people and their reasons for doing so.
Are People Necessary?
The beginning point in the discussion about the importance of human capital is to think about the value people bring to an organization. This always brings up a question: Are people really necessary? Of course, in practice, we all realize that people are critical, but should the goal be to eliminate them or let someone else work with them? Is it possible to automate almost everything, as some companies attempt to do?
People Cause Problems
It's interesting to observe an automobile assembly line in a modern factory. There are no people to be seen — just expensive and impressive robots. Why would the company take this approach and replace humans with robots? Is it cheaper? Is it because of the problems employees create? Is it because of the difficulty in finding qualified workers? Maybe it's all these issues.
Some managers view the human aspect of organizations as an irritant, a burden, or perhaps a necessary evil. People cause most of the problems. It is the people who are dissatisfied, file grievances, have complaints, allege sexual harassment, get injured on the job, file workers compensation claims, go on strike, and create a host of other problems that not only take them out of service but take precious time and resources to resolve. Some executives have estimated that employee problems account for as much as 20 percent of the total cost of human capital investment. If the people could be removed, the problems would go away; there would be no complaints, charges, gripes, grievances, accidents, or work stoppages. For some executives, this would be Utopia, and they strive to achieve this scenario.
Technology Replaces People
The advancement of equipment, machines, and technology has enabled many organizations to automate parts of the job — and in some cases, all of the job. As technology evolves, is it possible to have a completely automated workplace? Is it possible to remove the human factor, at least for the most part? Consider something that would have been almost unheard of years ago: automated air travel. With available technology, airplanes could basically take off, fly to their destination, and land, completely automated. Much of the check-in, boarding, and logistics could be automated, as it is now to a certain extent. It may be possible for the entire process (from checking in to arriving at the desired destination) to be accomplished without any human interaction. To some, this seems like science fiction, but it could be a reality. Is this desired? Perhaps not. What happens if technology fails or there is a glitch in the automation? The dream becomes a nightmare. It may be impossible to remove the human factor in the short term, but this is a goal for many.
Automation Is Healthy
Regardless of your position on job automation, there are some jobs that should be eliminated; automation should be an essential and significant part of the strategy of deciding how much to invest in employees. Four types of jobs are ideal candidates for automation. First, the jobs that are considered very monotonous and boring should be eliminated. These jobs are routine and require little thought and concentration. Many assembly-line jobs fit into this category. If possible, these jobs should be automated; otherwise, the monotony leads to dissatisfaction, which leads to absenteeism, turnover, injuries, withdrawal, and sometimes even sickness. Employees can become sick solely because of the rote work they do.
Second, jobs that are highly dangerous should be automated. This is a critical issue in heavy industry, manufacturing, and mining — using technology to remove the employee factor so that injuries and deaths can be prevented. This is not only the cost-effective thing to do but the humane thing as well.
Third, transaction-based jobs should be automated. These jobs involve simple-step transactions that can be handled much more efficiently with technology. Consider the issue of booking an airline reservation — a very transaction-based process. A few years ago, it was all handled on the phone or face to face; now the majority of reservations are made on the Internet, thus eliminating many people who previously had to be involved in the process. Some airlines charge an additional fee when reservations are made via the phone, thus providing an incentive to reserve a seat via the Internet. The newer technology produces fewer errors and is quicker and less costly for the organization.
Fourth, jobs where it is difficult to recruit employees should be automated, if possible. Many organizations are automating processes, steps, and even entire functions. Consider the local service station and the job of fueling your automobile. Gone are the days when three attendants ran out to your car, filled the tank, checked the oil, washed the windshield, put air in the tires, and took your money. Today, the individual consumer is familiar with the gas pump. By following a few simple directions, the consumer fills the tank, pays with a credit card, and goes through an automatic car wash. These "modern" conveniences have enabled companies to provide more efficient delivery of their gasoline. If an attendant had to pump the gas and take the money, the associated cost would have to be passed onto the consumer — some estimate as much as 5–10 cents per gallon. This automation has eliminated jobs that are hard to fill and usually have high turnover. At the same time, there is increased efficiency and convenience. The hours of store operation are no longer a consideration; you can fuel your car at any time, any day of the week. Some service stations are open 24/7 with no people involved in the process.
People Are Still Necessary
With the previous discussion as a backdrop, several conclusions can be reached about the role of people in the workplace. First, minimizing the numbers is not necessarily a bad strategy. In the name of efficiency, employee welfare, and the desire to have motivating and challenging jobs, certain jobs need to be eliminated or minimized.
Second, human capital investment at some level is necessary. Even in a completely automated transaction, people are involved in making key decisions, solving problems, and ensuring that the processes work correctly. The investment still exists; it is just that it may be a smaller percentage of the operating expenses.
Third, in a highly automated workplace, people are still critical. Sometimes their skills are upgraded because of problems that arise when transactions, technology, or equipment fails. They are also needed to coordinate and implement the new technology in the first place. In an ideal situation, as jobs are eliminated, skills are upgraded so that the workforce is maintained or, in some cases, even grows. A firm that has both job creation (adding jobs) and significant automation (eliminating jobs) is adding tremendous value to the economy, which is the challenge of many organizations.
The Stock Market Mystery
When considering the value and importance of human capital, executives need to look no further than the stock market. Investors place a tremendous value on human capital in organizations. For example, consider San Diego–based QUALCOMM, a leader in developing and delivering innovative wireless communication products and services based on the company's CDMA (code division multiple access) digital technology. The company owns significant intellectual property applicable to products that implement any version of CDMA. QUALCOMM is included in the S&P 500 Index and is a Fortune 500 company traded on the NASDAQ stock market. QUALCOMM is a very profitable company, with revenues in 2013 of $44.9 billion and a net income of $6.9 billion.
QUALCOMM reported total assets (tangible) on its balance sheet of $45.5 billion; however, its market value is much higher. The stock price in 2014 was $75 per share, and the company had a market value of $120.9 billion. In essence, tangible assets represented only 37 percent of the market value, even though they included not only the current assets of cash, marketable securities, accounts receivable, and inventories but also property, plants, equipment, and even goodwill.
Thus investors see something in QUALCOMM that has a value much greater than the assets listed on the balance sheet. This "hidden value," as it is sometimes called, comes from the intangible assets, which now represent a major portion of the value of organizations, particularly those in knowledge industries, such as QUALCOMM. It is helpful to understand what makes up intangible assets; human capital is certainly a big part of it.
A Brief History of Valuing Human Capital
The concern for the value of human capital can be traced back many years, but this concern gained popularity in the late 1960s and early 1970s in the form of human resources accounting. Although interest diminished in the early 1980s, human resources accounting (HRA) enjoyed renewed emphasis in the late 1980s and continued strong throughout the 1990s. Human resources accounting was originally defined as a process designed to identify, measure, and communicate information about human resources in order to facilitate effective management within an organization. It was an extension of accounting principles — matching costs, revenues, and organizational data to communicate relevant information in financial terms. With HRA, employees are viewed as assets or investments for the organization. Methods of measuring these assets are similar to those of other assets; however, the process includes the concept of accounting for the condition of human capabilities and their value.
In the 1980s, organizations began developing case studies describing their application of HRA principles. For example, UpJohn used HRA to measure and forecast the return on investment in people. Even professional baseball teams began to use the concept to place a value on their talent. Three important questions placed HRA under scrutiny: Are human beings assets? What costs should be capitalized? What methods are most appropriate for establishing a value for employees with the eventual allocation of such values to expenses?
In 1986, Karl Erik Sveiby, manager and owner of a Swedish-based publishing company, published The Knowledge Company, a book that explains how to manage these intangible assets. It was one of the first books to focus on "intellectual capital," and it inspired other critical research in Europe. In Asia, the idea developed as firms attempted to show the value of their intangible assets. Japan's Hiroyuki Itami published an analysis of the performance of Japanese companies. His study concluded that much of the difference in the performance of firms comes from intangible assets. In 1991, Skandia AFS, an insurance firm in Sweden, organized the first known corporate Intellectual Capital Office, naming Lief Edvinsson its first vice president for intellectual capital. Edvinsson's mission was to learn how others were managing intellectual capital and using it to generate profits.
Major changes in the economy and organizations have created a tremendous interest in human capital. In the last century, the economy has moved from agricultural to industrial to knowledge-based, as shown in Figure 1.1.7 The knowledge era is perhaps the most far-reaching and explosive of the economic eras.
During the agricultural era, the focus of production was on land and how to make it more productive. During the industrial age, which dominated much of the first half of the twentieth century, the focus of production was on how efficiency and profits could be generated through the use of machinery. In the knowledge economy, the focus of production is on the human mind and how knowledge is used to build a more productive and efficient economy. Some researchers have labeled the knowledge economy as the talent economy, dominated by talent organizations.
Talent organizations are those that have no or few natural resources and very little physical capital. In 1963, for example, there were only a handful of companies that met this category, such as IBM, Eastman Kodak, Proctor & Gamble, and RCA. By 2013, more than half of the top fifty companies were talent based, including three of the four biggest: Apple, Microsoft, and Google. Truly, this knowledge-based or talent-based economy is where the value of human capital really shines.
When it comes to classifying intangible assets, there is no agreement on the specific categories; the assets are important and varied. A large technology company, such as QUALCOMM, has a market value far exceeding the actual book value that reflects its tangible assets. Important intangible categories make up this huge difference in value, and a big part of this is human capital.
The first step to understanding the issue is to clearly define the difference between tangible and intangible assets. As presented in Table 1.1, tangible assets are required for business operations and are readily visible, rigorously quantified, and represented as a line item on a balance sheet. Intangible assets are key to enjoying a competitive advantage in the knowledge era and are invisible, difficult to quantify, and not tracked through traditional accounting practices. With this distinction, it is easier to understand the different categorizations.
Intellectual capital was earlier defined as the intangible assets that could be converted to profit. This concept has created a tremendous interest in understanding the impact of the knowledge contribution of successful organizations. Although there are more than a dozen ways to classify intangible assets, some categories are common between the groupings; three variations are presented here. A widely accepted grouping is contained in Figure 1.2, where the enterprise is divided into tangible assets, intellectual capital, and financial capital.
In this arrangement, intellectual capital is divided into customer capital, human capital, and structural capital. Thomas Stewart, Leif Edvinsson, Hubert Saint-Onge, and many others support this division. Figure 1.3 shows the elements of intellectual capital offered by another researcher/practitioner in the field. This categorization includes research and development, intellectual assets, and knowledge, with knowledge being divided into tacit knowledge and codified knowledge.
Still another definition comes from Thomas Stewart, who suggests that human capital has three elements:
• Collective skills. These represent the talents of individuals, colleagues, and teams. This essentially reflects the capability to build on the skills of others.
• Communities of practice. Organizations are made up of communities, and these communities of professional practice have become a recognized part of business life. The nature of knowledge will require companies to foster communities where there is a high level of candor and where corporate doublespeak has no place.
• Social capital. What transforms workers into colleagues is social capital. It is the stock of active connections among people — the trust, mutual understanding, and shared values and behaviors that make cooperative action possible.
Whatever the definition, human capital is a significant part of intellectual capital, and intellectual capital is an important part of intangible assets. For organizations — especially knowledge-based organizations — intangible assets are often far greater than tangible assets. The bottom line is that we are in the knowledge era. Knowledge comes from humans — not machines, financial resources, or natural resources.
The Accounting Dilemma
One of the problems of attempting to place a value on human capital stems from accounting standards. Both financial accounting (which appears in annual reports) and management accounting (which enables managers to take action) are inadequate for current organizations. Although there has been much discussion, the general accepted accounting principles (GAAP) offered by the Financial Accounting Standards Board (FASB) are inadequate for placing a value on intangible assets, particularly human capital. Even Alan Greenspan, former chairman of the Federal Reserve Board, complained that accounting was not tracking investments of intellectual assets and that technology change has muddied the crucial distinction between capital assets and ordinary expenses. FASB indicates that accounting's fundamental purpose is to provide information that is useful in making rational investment, credit, and disposal decisions. That is not happening. If the books were communicating stories that investors found useful, then a company's market value would correlate with the value accountants place on it. The QUALCOMM example illustrates the tremendous difference between market value and book value.
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Excerpted from High-Impact Human Capital Strategy by Jack J. Phillips, Patricia Pulliam Phillips. Copyright © 2015 Jack J. Phillips and Patricia Pulliam Phillips. Excerpted by permission of AMACOM.
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