Tuesday, February 16, 2010

Returns on Human Capital

The term Human Capital originated with Theodore Schultz, a Nobel Prize winning economist in1979, interested in the plight of the world’s underdeveloped countries. He argued correctly that traditional approach to economic concepts and the styles of people management originating in the West, most notably the US, ignored, avoided or questioned the value of people merely because it did not have a way of quantifying their contribution. It is customary for every organization to claim that people are their most invaluable assets. Unfortunately, only a few lend credence and live fully up to such a lofty to such a claim. The great irony today is that, in spite of several publications and research pointing to the value of human capital, in times of poor economic performance, it is the employees who get laid off or outsourced and it is the budgets set aside for knowledge creation and skill building that gets axed. Why?

After the recent worldwide economic set back, the Global Airlines industry is undergoing a very painful process of readjustment arising out of lost traffic, high fuel prices, hyper competition and bargain hunting internet savvy youthful passengers.

While 29 Airlines are reported to have disappeared during 2008, it is projected that only about 20 Airlines will stay profitably afloat by 2020. At a time when several of these Airlines are reporting losses and looking for government subsidy, Singapore Airlines stands out as a citadel of managerial excellence.

They not only did not lay off their staff, they stayed profitable. the only differentiator was in the way they motivated their people during turbulent times to generate a value that was 2.2 times the salary they earned. ( See table across: Value added 5570.8/Wage bill 2545.9)

A few Indian companies also measure the contribution of their human capital. Even if they do not, there are two numbers in the balance sheet that will tell all that the Stakeholders need to know.

  • PAT ( Profit After Tax) and
  • FTE ( Full Time Employees on the rolls of the company)

Each employee at Infosys earned 12,000 US Dollars as Profits After Taxes in 2005 ( We can look at the latest numbers) while many of the others were earning progressively lower going down to as little as US $ 3000. With wage bills assuming 50% of the revenues for IT companies, the question relating to how much of the high wages earned by IT professionals is justified, can easily be answered. Similarly, the board may also question the quantum of value created by the management before according their approval for the wages and bonus payable to them.

How often would Board members pose such troublesome and inconvenient questions? They may do so if they demand such numbers to be provided to them and do the homework necessary before sitting at the board meeting. They may question the levels of productivity, people who may be kept or under utilized, departments that are of ornamental value, investment in services and facilities that do not earn any value and question the excessive layers of management.

The managements will always be under pressure from the employee associations and unions to pay more wages citing reasons of work stoppage or employee attrition. By giving away more to the employees within , the top management has much less left to keep as reserves for replacing obsolete equipment, invest in R& D for future, pay taxes, interest on borrowings and declare as dividends.

Unless the Board of directors and the top management is willing to hold their people accountable for justifying the salary and wages they demand and demonstrate adequacy of returns to enjoy the privileges, they run the risk of killing the golden goose prematurely. If everyone is keen to take out more than what they put in, there will be very little value add. Investors will lose faith, employees will feel insecure and lenders will demand higher premiums on the money they put out making the company uncompetitive in the market place.

The trustees of the board earn their trust when they take the trouble of doing the homework in advance and cautioning the management before bad decisions are taken; to do so later on would be to invite a heavy cost and lost reputation.

As is often said in the army, it is better to sweat in peace than bleed in war.

Management is about making difficult choices in an intelligent way.

If managers do not find it convenient to decide, they may have to live with the decisions the markets take on their behalf.


1 comment:

  1. Sir does Human capital follow a NORMAL CURVE ???

    What is considered as Human resource...THE CONTRIBUTION they bring to the company or the knowledge & know how they possess ??

    1) Experience is the most valuable asset a person can have....but what if there is no possibility of UPDATION....Older people find it difficult to adjust to radically changing BUSINESS ENVIRONMENT (Particularly IT)

    2)Is there any costing method to actually value HUMAN RESOURCE on REAL TIME basis !!!!
    The lev Shewatz model finds the NPV Of future earnings of the employees in an organization....but isnt that just a rough estimation & does it consider ATTRITION ???

    3)Sir aren't People divided into SKILLED....Semi Skilled....not skilled FOR A PARTICULAR jobs....& usually The "not skilled" people are LAYED OFF....

    4)Some times Cohesive Motivation (Fear) is also required to get the BEST OUT OF some must be made examples....

    5)Business Comes 1st (Survival of the fittest)!!!!!

    I am sorry if my comments r rude...but thats the way i 1 wants to hurt some 1 with purpose & Intent.....ITS NOT PERSONAL...ITS SIMPLY BUSINESS !!!!!