Desperately seeking Talent. It’s a common refrain among managers at high-tech companies.
The Wall Street Journal, March 1, 2000
Gloomy-looking employees carrying cardboard boxes filed out of Dell Corporation’s headquarters Thursday as the nation’s leading computer maker slashed 1,700 jobs.
The Houston Chronicle, Feb. 16, 2001
Layoffs are once again making headlines as CEOs and managers work to shore up declining business results by cutting costs. But not so long ago, a very different story filled the news with pitched battles waged over these same human resources.
What has happened to the frequently expressed mantra that employees are “our most valuable” assets? Were CEOs wrong? Should employees be the first assets overboard if a business begins to sink? Or are companies mortgaging their most valuable assets for short-term benefits? Do shareholders benefit from layoffs, or are they being shortchanged?
Understanding whether layoffs create or destroy shareholder value comes down to two simple questions:
1. Is the company capital-driven or employee-driven?
2. If it is employee-driven, are layoffs a case of divesting high-value human assets?
Answering these questions often exposes a fundamental weakness in many companies: Their systems for measuring performance are geared to the efficient use of capital, not people, and hark back to a time when more industries were capital-driven.
1. CAPITAL-DRIVEN OR HUMAN-RESOURCE DRIVEN?
The first challenge in determining whether the business is capital- or employee-driven may well be management inertia. Executives of most organizations are typically comfortable with current financial statements, performance measures and management processes. They aren’t likely to face pressure to adopt any new tools until a critical mass of companies does so.
In addition, financial reporting statements don’t easily lend themselves to a human-resource approach, and they are unlikely to change any time soon. In Canada and the U.S., employee costs are not detailed as separate line items (U.S. banks are an exception), and employee head count is infrequently detailed in segmented reporting.
However, if an executive team can get past these barriers, there is a new set of metrics that are intuitive, robust and more meaningful in assessing the human-resource driven businesses of today. The Boston Consulting Group has worked extensively with businesses in technology-driven industries such as software and pharmaceuticals. These businesses are characterized by high ratios of employee-to-capital costs. Executives in these industries need a new set of tools to help ensure that they are not knowingly disposing of their highest-value assets.
2. DETERMINING THE VALUE OF HUMAN ASSETS
In capital-intensive businesses, optimizing fixed and working capital is a critical lever for improving financial returns. Indeed, traditional measurement and reporting systems were developed because the efficient use of capital needed to be a fundamental goal. Although some technology-oriented businesses are extremely capital-intensive (as recent investments in next-generation mobile telecommunications licences in Europe amply show), others, such as software and pharmaceuticals, rely less on capital than on people. What these businesses need is a set of tools and metrics to help executives understand and manage the value of these assets.
For example, return on capital measures the productivity of capital investments. How useful is this measure for software businesses in which capital investments tend to be small and returns of more than 50 percent are common? For these and other people-intensive businesses, it is more important to know about employee productivity than capital productivity.
The Boston Consulting Group (BCG) has developed an approach called Workonomics. It is designed to answer the same basic questions about employee performance that traditional measurement and control systems answer about capital.
Traditional measures of employee productivity (for example, sales per employee and profit per employee) do not distinguish between contributions of employees and the contributions that should really be attributed to suppliers or to capital. As a result, it is difficult to compare employee productivity across businesses that use different levels of outsourcing or capital investment. However, Workonomics isolates employees’ contributions to productivity by removing extraneous factors.
For example, when making calculations using Workonomics, executives begin with sales per employee, then subtract all purchases from suppliers in order to adjust for differences in outsourcing. Once they have determined the value added per employee, they can make further adjustments for differing levels of capital investment by subtracting appropriate capital charges. Such calculations help executives form a more realistic picture of what their employees contribute to productivity, and how one group compares to another. In fact, comparisons of people can be every bit as accurate as comparisons involving capital. Perhaps more importantly, changes in shareholder value can be directly traced to changes in productivity as measured by Workonomics.
Identifying differences in productivity within an organization is the first step toward figuring out whether the value of the human assets is high or not. Further steps involve an analysis of why some parts of a company are more productive than others. Typically, the most critical variables are the capabilities of the workforce, the design of the organization, the work environment, how people are utilized, and how they are compensated and rewarded. Workonomics provides metrics and diagnostics for finetuning all of these factors.
For example, by quantifying the difference between the value that experienced employees can generate and what new recruits can produce (and by making similar comparisons between “stars” and average performers), executives can focus their efforts on divesting only low-value human assets, and retaining employees where they matter most. In good markets, attrition is unavoidable, but losing some employees is far costlier than losing others. In weaker markets, the temptation to look to layoffs for cost relief will always exist, but again, laying off some employees can be far costlier than the direct costs involved. Workonomics can help executives look beyond the direct consequences of attrition and see the indirect costs as well.
A simple example illustrates this point. Consider the role of experience in technical sales. Sales engineers with many years of experience frequently sell several times what inexperienced engineers sell, but companies do not always take this into account. Many technology companies, faced with declining sales, may make the simple, but mistaken, conclusion that if no one is buying, fewer salespeople are needed in the short term. Even if this company does the analysis to recognize the value of its human assets, the company may need to push further, and uncover differences within its organization, to avoid destroying shareholder value with misplaced layoffs.
For example, a BCG client may offer retirement packages for its more experienced and more expensive senior resources. As a result, a significant number of experienced sales engineers may leave and be replaced by junior people who, in a true value sense, cost more than they contribute.
The phenomenon is not limited to seniority. Another company we worked with encountered a different problem. Whereas it paid its software development managers well on average, it differentiated very little between what it paid the best and worst performers. This practice did not adequately reward superior managers, who had created vastly more value than average managers. In fact, at that company, a top-notch manager could cut three to nine months off the development time of a two-year project, saving several million dollars. Indiscriminate layoffs, done for the sake of short-term pressures, can hurt shareholder value in the future, as high-performers leave, and projects and their earnings are delayed or not realized at all. Only when executives consider the full cost of layoffs can they begin to calculate if, and where, they should divest human assets, and where they should focus on retention and delivering greater value from those same assets.
An executive working in technology over the past several years, and unaware of Workonomics, could easily get blindsided or even seduced by growth. Growth can certainly deliver higher levels of performance when performance is measured in capital terms. But this same growth can also mask declining productivity. When growth slows, as is the case now, the executive is left with a weaker, less productive organization with which to manage his or her way through the slowdown.
A Workonomics perspective keeps productivity in the forefront, alerting the executive to the need for an examination of the organization and potential investments in productivity improvement. If the output of a capital asset declines, managers can see this in a variety of ways, and invest in maintenance and upgrades to improve the output. If the productivity of the organization is declining, will the executive even be aware?
BEYOND THE ORGANIZATION: CUSTOMERS
So far, we’ve been focusing on the organization’s use of capital and human resources. But we should look beyond, outside the organization, to the customer.
Technology companies have recently introduced new practices into business operations. E-retailers have begun to look at their internal operations; they have also begun to implement measures to calculate the cost of acquiring and keeping customers. The telecom industry uses ARPU, or Average Revenue Per User, as a means of differentiating customers beyond simply how many of them subscribe to a given service.
As economies move away from the primary industries and more heavily into technology-driven areas, all three of these value systems—the classic capital-driven model, the human asset-based Workonomics model, and a customer-focused Custonomics view—must be integrated into a coherent system of shareholder-value management.
THE CHALLENGE FOR TECHNOLOGY EXECUTIVES
To create shareholder value and take full advantage of the opportunities before them, technology executives need to take a fresh look at their businesses and realize that in the parts that are people-intensive, capital-based measures may not provide the insights they need. The risks of not understanding employee performance and failing to set up differentiated rewards based on value creation are substantial.
Executives can avoid such problems by asking some basic questions:
- What kinds of business environments are we competing in? How important are people (as opposed to capital investment) to our success?
- If people make a significant difference, do we have people-oriented metrics in place to help us understand productivity and manage the business?
- In which parts of the company are employees most productive, and where do we receive the highest return from our investments in them? Do our current reward structures recognize employees who create value? Are these structures aligned with our business strategy?
- Which companies compete with us for talent? Are our current compensation and benefit systems fully competitive? Do they adequately reward the people who generate the most value?
The value of today’s technology-based businesses is driven by their intellectual capital, the quality of their service, and their ability to attract and retain the most productive employees. Executives who rely on intuitive methods for measuring the contributions of human capital put their companies at a competitive disadvantage. Knowing how to quantify the impact of people is essential to managing a successful technology business. It will become even more essential in the future.