Quality of Hire and Human Capital Measurement
The effective Management of Human Capital has become one of the key HR objectives for many organisations. With this desire for more effective management of Human Capital has also come a need to measure it more robustly.This article looks at how Human Capital is measured and asks if there is not a greater need for organisations to take into account Quality of Hire (by which we mean the success of the recruitment process in generating productive hires for a company) into the Human Capital calculations.
What is Human Capital Management
The term ‘Human Capital’ (HC) was first circulated in 1961 and is now generally used as an all-encompassing term for “the knowledge, skills, competencies and other attributes embodied in individuals or groups of individuals acquired during their life and used to produce goods, services or ideas in market circumstances.” (Flamholtz). It can be summed up in a formula devised by Consultant, Thomas Davenport:
Ability, knowledge, skill, talent + behaviour x effort x time = quality of labour (human capital)
Human Capital Management involves getting the right people, with the right skills, in the right position, at the right time, rewarding them with the right incentives to perform the right function in the right environment, to most effectively perform the work of the organisation. And it also involves training/developing the capital, and improving its output/productivity!
Human Capital and Profitability
There have been a large number of studies linking Human Capital to profitability – most recently The Sunday Times ‘100 Best Companies To Work For 2005’ with companies that feature in the top 100 consistently outperforming the rest of the FTSE all-share index. The graph below, produced by The Sunday Times, illustrates this point.
In the UK, a particularly well respected study of the link between HC practices and competitiveness and performance is regularly undertaken by Watson Wyatt, which uses the study to produce a HC Index (HCI). The Watson Wyatt HCI is an index from 0 to 100 awarded to surveyed company, based on the responses to a wide range of questions about the organisation’s human resource management practices, including pay, people development, communications and staffing. The research shows that five key HC practice dimensions are associated with a 90% increase in shareholder value:
- Clear Rewards and Accountability;
- Excellence in Recruitment and Retention;
- A Collegial, Flexible Workplace;
- Communications Integrity;
- Prudent Use of Resources.
As the report highlights, "the return to real-world economics after the bursting of the 'tech' bubble and unwinding of the 1990s' creative accounting, most businesses are fundamentally 'people businesses'. Increasingly, it is the quality of a company's people management that determines its real success or failure."
The link between Human Capital and profitability can be seen graphically in the model below (Guest et al)
(Interestingly the Watson Wyatt study also highlights three factors that can undermine financial performance:
- using contract workers to provide 'a disposable workforce'. According to the study, companies that have avoided the 'disposable worker' approach delivered up to 5.6% more shareholder value than average performing companies.
- avoiding developmental training which leads to a 5.2% increase in shareholder value
- avoiding excessive paternalism which leads to a 5.2% increase in shareholder value.
What aspects of HC have the biggest impact on performance and value?
As we have seen, the Watson Wyatt report highlights five areas of importance - Clear Rewards and Accountability; Excellence in Recruitment and Retention; a Collegial, Flexible Workplace; Communications Integrity; Prudent Use of Resources. The report quantifies the importance of the various factors thus:
Importance of Recruitment and Measurement
As we can see, effective recruitment has a positive impact on a company’s management of Human Capital. Conversely, poor recruitment will also have a significant impact and again this has been measured by a variety of surveys. For example, a study by Bernthal and Wellis showed that the cost of replacing an employee ranges from 29 to 46 percent of the person’s annual salary.
Despite its importance in HC calculations when it comes to measurement, Recruitment is one of the factors a company is least likely to measure – the table below, produced by the London Business School, highlights the most common indicators used in Human Capital Reporting.
In summary, the top 10 indicators of Human Capital Management used by FTSE companies seem to be:
Although many companies may put a lot of time and effort into recruiting, it would appear the effectiveness of this investment is not something that is measured. As you can see Recruitment does not even make it into the top 10. Only 4% of companies used any sort of recruitment measure with 1% using staff acquisition costs and payback analysis, graduate attraction, short-term tenure (3-12 months) respectively.
Why are companies not measuring Recruitment Effectiveness (Quality of Hire)?
Despite many companies huge spend on recruitment, it has always been a poorly measured metric, with very few companies even recording the source of the candidates to recruitment campaigns, let alone the quality of those hires. The reasons for this seem to fall into 4 groups:
No tradition of measurement – it simply has never been done, and once a hire is made little thought is given to future similar recruitment.
Difficulty of measurement – measuring quality of hire requires investment in time and processes which HR departments are often unwilling or unable to make. In addition, when it comes to HC measurement there are a number of measures, such as cost per hire, that are far easier to implement and assess.
Lack of pressure from senior management – senior management (non-HR) understand and rely on measures such as cost per hire or speed per hire which present simple if flawed metrics (see ‘who cares about cost per hire’ - http://www.workcomms.com/hottopics_whocares.asp).
The importance of measuring quality is underestimated – the messages from reports such as Watson Wyatt do not seem to have got through. Even if i t can be proved that effectively planned recruitment can add to the bottom line it still does not register on Boardroom or HR antennae.
The Solution – four ways to measure quality of hire
(A more detailed look at measuring cost per hire can be found at http://www.workcomms.com/hottopics_hire.asp) Despite perceptions Quality of Hire can be relatively easy to measure and below we have highlighted four ways it can be done.
Surveying line management
A straightforward measure of Quality of Hire is to ask the hiring manager how their expectations have been met. At its most fundamental, the question is simply, “would you hire this person again?” What we would suggest here is a structured questionnaire based on the agreed pre-hiring requirements:
Motivational fit for the job
Overall productivity
Knowledge and skills
Likelihood of the individual remaining in the organisation
Probability of being promoted after one year
There are lots of ways this can be done, but broadly they involve the use of rating scales: this is an interval scale providing a straightforward way of asking for attitudinal information that is easy and versatile to analyse, and that provides comparability over time. This approach is straightforward and its accuracy will be assured if the ‘quality criteria’ have been carefully and accurately thought out.
Performance Reviews
Many companies conduct performance reviews, often with formalised structures and procedures in place, which makes them suitable as a quality of hire metric. Also where performance reviews are tied in with compensation reviews (salary increases, promotions awards, bonuses etc) they can act as metrics to gauge the quality of employee.
Productivity
Productivity measures might include output per employee, sales revenue per employee, workload per employee etc, all of which can be used to measure quality. Obviously to use productivity as a measure, a company will need to set standards of productivity for the job roles and job families to be assesssed when establishing quality criteria, and these will vary from department to department and function to function. The benefit of this approach is that it introduces an empirical, relatively objective element to the analysis.
Turnover
This tends to be an appealing measure to many employers as it is relatively straightforward to measure and has some obvious logic to it: high turnover may indicate that there are issues with the quality of hires into the workforce. Conversely, high retention is considered to be a sign of quality hires. But to work, a company needs to distinguish between voluntary and involuntary turnover. Voluntary tunover is a very poor indicator of quality of hire. Someone who is an outstanding performer may be difficult to retain because they are more likely to be headhunted. Involuntary turnover is a better indicator, provided that turnover that occurs for a performance reason is isolated.
Screening and Assessment Tools
Many companies use screening tools such as behavioural and personality tests as part of their recruitment process. If validated these should provide another good guide to Quality of Hire. The theory being that, to join the company, candidates need to go through testing which selects only those with the competencies equating to ‘quality hires’, so the higher the score, the higher the quality of the candidate.
Conclusion
There is clearly a strong link between business performance and recruitment excellence. And recruitment excellence forms an important component of Human Capital Measurement as a whole. Many companies, however have been slow to measure Quality of Hire but in so doing are denying themselves access to a key business metric. The good news is that in reality Quality of Hire can, with a little planning and determination, be easily measured, and that as senior management start to look more closely at the impact of Human Capital on the ‘bottom line’ it should soon start moving up the HR and corporate agenda.
