Within the past century, the economy has moved from agriculture to industry to a knowledge-based system focused on productivity—shifting from land to machines to the human mind. Managers, human resources professionals and accountants struggle to place value on human capital. The accounting function strives to apply its financially oriented principles to the human capital assets. Corporate decision-makers are challenged to determine how much to invest in human capital.
Can Human Capital Be Eliminated?
Some managers view the human aspect of organizations as an irritant, a burden or perhaps a necessary evil—the source of organizational problems. They see job dissatisfaction leading to grievances, complaints, absenteeism, injuries and a host of other issues that take employees out of service, reduce productiveness and consume organizational resources for resolution. Technological advances in equipment, machines and electronics have enabled organizations to automate many tasks. Some jobs—highly dangerous, boringly repetitious, simple-step transactional tasks or those with excessive turnover—should be eliminated or automated to the greatest extent possible.
Thinking in these directions about the role of humans in the workplace leads to several conclusions. First, minimizing the numbers can be a good thing—improving efficiency and employee welfare while providing more motivating and challenging jobs. Second, human capital investment at some level is necessary. Even in a completely automated transaction, humans are involved in decision-making and problem-solving. The investment still exists, but it might be a smaller percentage of operating expenses. Third, even in a highly automated workplace, people are still critical. Often 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 and significant automation is adding tremendous value to the economy—the challenge of many organizations.
Intangibles in the New Economy
Major changes in the economy, along with the proliferation of technology and automation, have driven increased interest in intangible assets. Tangible assets are required for business operations and are readily visible, rigorously quantified and represented as a line item on a balance sheet. Although they are invisible, difficult to quantify and not tracked through traditional accounting practices, intangible assets are critical to achieve and sustain a competitive advantage in the knowledge era. For organizations—including knowledge-based organizations—intangible assets are often far greater than tangible assets. The bottom line: This is the knowledge era, and knowledge comes from humans—not machines or financial or natural resources.
One of the problems with attempting to place a value on intangible assets stems from accounting standards: Financial accounting (which appears in annual reports) and management accounting (which enables managers to take action) are inadequate to the task. Although there has been much discussion, the generally accepted accounting principles (GAAP) offered by the Financial Accounting Standards Board (FASB) are inadequate for placing a value on intangible assets and, in particular, on human capital. Even Alan Greenspan, 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. The FASB indicates that accounting’s fundamental purpose is to provide information that is useful in making rational investment, credit and similar decisions. That is not happening.
Professor Baruch Lev, who specializes in valuing trademarks and patents, conducted a series of in-depth comparisons of corporate asset values (“book values”) and share prices. He concluded that the financial reporting methods used by nearly all corporations—the methods codified by the FASB and required of public companies by the Securities and Exchange Commission (SEC)—were giving “exactly the wrong impression” of the real comparative worth of the corporation. In growth industries, in particular, the accounting numbers consistently overstated the value of physical assets (like buildings and machinery) and consistently underestimated other assets, especially the intangibles. The debate will continue as the accounting profession tries to adjust to the new economy and as organizations continue to grapple with investment strategy.
As in almost every area, there are business superstars: organizations that are perceived as extraordinarily successful, based on their major accomplishments. One common superstar denominator is the recognition of the people factor. Executives at superstar organizations give recognition to the people who have demonstrated outstanding performance:
- QUALCOMM: With a distinguished reputation in technology innovation, QUALCOMM is a continuous learning organization dedicated to promoting the growth of its employees and the development of the surrounding community.
- General Electric: Jack Welch, former chairman and CEO of GE, transformed the company from an aging manufacturing bureaucracy into one of the world’s largest, most valuable global multi-nationals through the implementation of his conviction that behavior is driven by a fundamental core belief: The desire and ability of an organization to continuously learn from any source, anywhere, and to rapidly convert this learning into action is its ultimate competitive advantage.
- Honda: Having had a manufacturing presence in the United States for more than 40 years, Honda’s growth and expansion has a significant impact on the U.S. economy in terms of both dollars and numbers of employees. Much of Honda’s success turns on the company’s respect for individual employees.
- Southwest Airlines: Creating a culture of accountability and preserving and promoting the organization’s core values, known collectively as “SPIRIT,” Southwest has sustained growth and profitability when most airlines struggle to avoid bankruptcy.
- SAP: While some technology companies pin their potential on developing the latest, greatest techno-innovation, SAP, according to Les Hayman, chief officer of global human resources, knows that “you need a good strategy—not a brilliant one, but one you can execute. And you need a performance-driven culture and people who are emotionally engaged. If you have all those things, you’ll create the right product.”
Human Capital: The Competitive Advantage
Today’s organizations have access to many of the key success factors:
- Financial resources are available to almost any organization with a viable business model.
- Access to technology is equal. Any company in our information technology society can readily adapt technology to a given situation or business model.
- Businesses have access to customers. Having entry and access to a customer database is not necessarily a competitive advantage. Even a dominant player is not necessarily secure: Newspapers are laced with stories of small organizations taking on larger ones and succeeding.
What makes the difference, clearly, is the human capital of the organization. With relatively equal access to all the other resources, it is logical to conclude that the human resources are where a strategic advantage can be developed. However, even having capable human resources is no guarantee of success. What is important is the way those assets are managed to maximize the return on investment in the human capital of the organization.
Research and Lists
Jim Collins’ research, presented in “Built to Last,” co-authored with Jerry Porras, and in “Good to Great,” clearly demonstrates the importance of people in organizations’ longevity and greatness. “Built to Last” draws on a six-year project at the Stanford University Graduate School, in which the authors asked the fundamental question, “What makes the truly exceptional companies different from other companies?” The importance of people emerged as a dominant theme as these companies practice what they preach regarding the role of employees in the organization. The core ideologies of these visionary companies consistently highlight the importance of people and their contributions as the basis for companies that are built to last.
Collins’ “Good to Great” examines what makes companies move from being defined as “good” to being defined as “great.” In this work, Collins explores how good companies, mediocre companies and even bad companies are achieving greatness. The synthesis of the research in this book underscores the attributes of the truly great companies. The important ingredients are the quality of, and focus on, employees throughout the organizations, and the quality of leadership is the beginning point for these good-to-great organizations.
When the entire body of research is examined, what comes through is not the innovative products, the unique markets, the nature of the business or some other technological or resource advantage. The real advantage of these great companies is the people who make them great and then sustain that greatness over a long period of time.
Further evidence of the importance of people in the workplace is revealed by a variety of lists. Fortune magazine’s 100 Best Companies to Work For is the premier list that organizations strive to make. What employees themselves have to say about their workplace is the basis for inclusion on the list. Being on the list is so sought after that organizations are changing practices and philosophies in an attempt to make it.
Another important list, Fortune’s America’s Most Admired Companies, is unique because peer groups determine the ranking. From a human capital perspective, it is interesting that four of the eight key attributes focus directly on human capital: employee talent, quality of management, innovation and social responsibility. The other four are indirectly related. The key point is that investors and businesspeople admire companies who are placing important emphasis on the human capital aspects of their business.
Consider this significant observation at JP Morgan Chase, which proclaimed the importance of human capital in its annual report: “At 23 Wall Street stands a building that was once JP Morgan’s headquarters. In it is a vault (it is a bank building, after all). No money is stored there—it is a breakout room for the bank’s training center. There, in the knowledge and skills of its people as manifested in intellectual capital, is where the real wealth for JP Morgan Chase or any company can be found.”
The wealth of convincing, anecdotal and intuitive evidence of the importance and value of human capital and its contribution to an organization’s success continues to grow. The evidence supports the logical conclusion that investing in human capital is good. Although this should be convincing enough for most executives, the evidence does not necessarily amount to proof, and some executives need proof about the correlation between investing in human capital and subsequent performance. The next article in this series will summarize the research that shows the causal relationship between the investment in human capital and the success of the organization.
Jack J. Phillips, Ph.D., chairman of the ROI Institute, developed and pioneered the ROI process and has written more than 15 books on the subject. Jack can be reached at email@example.com.