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Human capital measurement: the centrality of people to knowledge-intensive organizations makes it important to measure the ROI on human capital. A new metric is designed to help.

Article Excerpt
The growing dissatisfaction with how R&D investments are accounted for in financial statements has led to a vigorous debate on the measurement and reporting of a wide range of intangibles--often called "intellectual capital"--including brands, company-specific knowledge and processes, and human capital practices (1). As a result, numerous disciplines have been drawn into the discussion, including finance, human resources, knowledge management, R&D, and general management.

Advocates of intangibles reporting find themselves in a quandary. Intuition suggests that investments in people from training and development, to traditional HR practices such as compensation and benefits, to fostering a particular type of culture--can and do improve operating results. But the difficulty of measuring the impact of people-related investments has stymied those responsible for them. An inability to draw a clear line from investment to business results places these programs first on the chopping block when cost-cutting is required, even if the short-term gain leads to more serious long-term problems. As a result, there has been a push to identify metrics that can reliably demonstrate how human capital investments generate long-term value for the organization.

Intellectual capital is often referred to as the "hidden value" of an organization. It is that hard-to-define property that everyone knows is worth a great deal but finds difficult to express in monetary terms. Leveraging value from intellectual capital can involve anything from the establishment of a more aggressive licensing policy for the company's under-utilized but patented technology (intellectual property) to more people-focused activities such as transferring best practices across the organization, creating communities of practice that encourage new forms of innovation, or eliciting tacit knowledge so that the real keys to successful performance are available to the organization at large.

Much has been written about how to unlock a company's hidden value. Yet an increasing body of knowledge that draws on human resource accounting, intellectual asset management, actuarial science, and finance and economic theory seeks to determine how much. Answering the question, "How much of this hidden value could be unlocked for an impact on our bottom line?" provides a basis for computing a return on investment in intellectual capital. This article will concentrate on one component of intellectual capital from which value can be extracted: human capital or more colloquially, people.

Human Capital Accounting

Human capital measurement grew out of a science developed in the 1960s called human resource accounting. Among the thinkers who established this new field are Rensis Likert, Theodore Schultz, and Eric Flamholtz. Flamholtz's book, Human Resource Accounting, first published in 1974 and now in its third edition, is a standard reference for those seeking to understand the topic (2). Flamholtz introduced the idea that employees contribute more to the organization than their salary and benefits. In fact, the replacement cost of employees could be many times their salary and benefits, depending on the skill level and extent of inter-organizational cooperation required to perform a job.

Some initial human resource accounting work was performed on behalf of a few forward-thinking organizations in the late 1970s but the movement then stalled. Why, if these ideas have been around for more than 40 years, have organizations been reluctant to adopt them? Primarily, for three reasons:

* First, associating this new science with financial accounting proved to be a double-edged sword. On the plus side, the link with financial accounting lent power and meaning to human resource (HR) accounting. Any approach that aspires to become part of the managerial decision-making tool kit must fit with financial accounting. On the minus side, the link with financial accounting saddled HR accounting with all of the former's drawbacks--a retrospective viewpoint, an overly strong focus on the concrete, and a false precision that equates sound measurement with an ability to count.

* Second, HR accounting required a data set that was not readily available in most organizations. Investing in the necessary infrastructure to produce the data proved too daunting.

* Finally, the return side of the equation was still not well-defined or easily understood. The additional precision that would be achieved around costs could not improve decision-making without an equally robust set of information about return.

The publication of Flamholtz's third edition and other HR measurement books, most notably Brian Becker's The HR Scorecard, signals the resurgence of interest in this topic. However, most of these new publications are targeted at HR professionals as a way of enhancing the relevance and the effectiveness...

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