The 'At The Table Study': The Strategic Effectiveness Of Human Resources*
By by John Asencio, Chris Ellis and Myrna Hellerman who can be contacted at www.imakenews.com/sibson/
We’ve done a great job," said the self-congratulating senior executive team of a major corporation. "Just look at how we’ve cut overall per employee expenditures. Our benefit costs are the envy of the industry. We replaced most of our expensive training with e-learning and videos. We’ve streamlined performance management by getting the whole process on line. And, no one can criticize our variable pay plans—if employees don’t perform, they don’t get paid. Yes, we’ve got our employee spending under control." Management’s exuberance, however, contrasted sharply with the investment community’s "sell" recommendation and customers’ consistent evaluation of the company: "they’re hard to work with and they are our supplier of last resort."
As this major corporation continued its decline, its competitor was winning the hearts, minds, and pocketbooks of the investor and consumer communities. A clear contributing factor to the competitor’s’ success was a mindset around employee economics. The competitor managed employee related spending (i.e., using up money) in the context of investment (i.e., planful use of money to gain a future advantage/benefit). While the competitor’s absolute expenditure for employees was only slightly higher, it strategically allocated its expenses as investments to bring the greatest return to the business. Specifically, it invested in those elements of its rewards system that its analysis suggested would enhance the effort, commitment and results of its employees. The competitor measured success not just in terms of money spent (and saved) but also in terms of optimizing the return on its investment in employees.
Increasing the ROI of rewards is a goal of many organizations in today’s economic climate where productivity and revenue growth are paramount, but without the open checkbook of the prior decade. Based on research, organization experiences, and common sense, there are three key ingredients to achieving a greater return on rewards:
1. Develop a business-based total rewards strategy
2. Establish a robust set of people metrics
3. Take a disciplined approach to determining ROI
DEVELOP A BUSINESS-BASED TOTAL REWARDS STRATEGY
There are many facets of the total rewards system in an organization. In essence, anything provided by the employer that offered to employees in return for their membership, commitment, and contribution can be considered a reward. Based on our experiences, total rewards can be sufficiently defined using five elements, two of which are financial (compensation and benefits) and three of which are non-financial (affiliation, career, and work content), as shown below.
With this framework in mind, an investment in any of the elements represents an investment in the total rewards system of the company. This includes investments such as a new pay plan, benefits program, training course, or wellness facility. There are two primary ways an organization can increase the return on its total reward investment:
1. Align rewards with business strategy and talent requirements.
2. Make reward investments that are complementary and mutually reinforcing.
ALIGNING REWARDS WITH BUSINESS STRATEGY AND TALENT REQUIREMENTS
Many organizations today talk about aligning rewards with the business but in reality span a wide continuum in terms of actually achieving it. Companies that do this most effectively have clear and explicit alignment: they define in detail the critical strategic imperatives (e.g., grow revenue through new products) and than identify the organization capabilities (e.g., fast product development) and key talent segments (e.g., Product Engineers) required to execute the strategy successfully. In this way, organizations can best decide where and how to invest rewards based on the value of each talent segment. Some segments of employees will drive strategic competitive advantage (like in the example above), others will manage strategy execution, and still others will perform non-strategic, yet requisite tasks. Companies that are serious about achieving a high ROI on total rewards will differentiate their rewards investments accordingly, building a total rewards investment strategy based on directly aligning employee rewards with each segment’s impact on the organization (see figure 2).
While an effective reward strategy is closely aligned with business strategy, it also must represent a compelling a distinctive value proposition to employees. In other words, the strategy must also provide a foundation for reward programs and policies that people will find meaningful, valuable, and distinctive relative to the external marketplace for talent. Some organizations use the following simple process (in addition to other inputs) to gather this information: The current total rewards offering is clearly explained to all employees, who are then asked to distribute 100 points among the five Total Rewards Principles—compensation, benefits, career, work content and affiliation—to reflect their perception of how the company invests in each of the elements. Employees are then asked to distribute another 100 points as they believe the company should invest in each of the elements, reflecting perceived importance and value (See Figure 3).
Make reward investments that are complementary and mutually reinforcing
There are numerous studies that show how companies have measured the ROI of various reward programs. For example, gainsharing programs have been shown to increase worker productivity and work-life benefit plans have been linked to increases in employee retention. Clearly, it is critical for an organization to determine the best investment in a reward program for a particular talent segment. But companies that truly apply a total rewards perspective take this philosophy further and ask: how can the ROI of reward programs be further maximized when bundled together?
Recent research has shown that the concept of complementarity is important when assessing the impact of innovative human resource practices (Journal of Economic Perspectives, 2003). In particular, the return to implementing a bundle of mutually reinforcing human resource practices is greater than the return on the sum of non-reinforcing single initiatives. Like general HR practices, total reward programs should complement each other; the bundle of mutually reinforcing reward programs will exceed the return on the individual programs. This total rewards edge can be illustrated in such examples as:
A company with a strong affiliation, or employment brand, will leverage that brand value in the design and communication of its benefits plans, thereby enhancing the return on investment in those plans.
A company with a strong pay for performance philosophy will carry-over that same message to its career programs, linking development opportunities to employee performance and impact.
ESTABLISH A ROBUST SET OF PEOPLE METRICS
Interestingly, some organizations discuss the importance of increasing the return on rewards but do not have good people metrics to actually know if they are increasing the return or not. The set of metrics used to measure total rewards effectiveness will be unique to each company, and should be reflective of the company’s philosophy regarding the impact of human capital on business results. These chosen metrics set the stage for baseline measurements of the total reward system and can be used to determine the effectiveness of future investments in the total rewards offering.
It would not be unusual to begin with HR metrics that reflect the effectiveness of the HR function, such as "time required to fill an open position". But companies should avoid these types of metrics when it comes to measuring and optimizing ROI of rewards. The human capital metrics that matter are those that business leaders care about, involving productivity, cost, and retention. In developing a set of metrics—an HR Scorecard (Figure 4)—organizations should avoid searching for the perfect, fully controllable measures. Instead, metrics should reflect true value creation and impact.
TAKE A DISCIPLINED APPROACH TO DETERMINING ROI
Measuring the actual ROI of the total rewards offering in its entirety is very difficult for any organization because there simply is no existing baseline to measure impact against. A more productive approach involves measuring the ROI of changes made to the total rewards offering. This more practical approach to measurement will reveal whether specific investments in the offering have yielded the projected and desired returns to the business.
It is important to note that most ROI analyses will involve assumptions and calculations that require some degree of judgment. Taking a disciplined approach to determining ROI therefore does not involve a purely objective approach, which is often impossible, but rather a sensible, practical, and repeatable methodology that the organization consistently applies after every substantive investment or change it makes in its reward system.
The general approach to determining rewards ROI involves measuring both the cost and benefits of an investment, or bundle of investments, in one or more of the elements of the Total Rewards Framework (Figure 1). There are four basic steps to follow in determining return on investment:
1. Calculate baseline performance using your people metrics for the targeted population segment(s)
2. Calculate the cost of the investment
3. Calculate the change in baseline metrics
4. Determine the ROI
Specifically, the determination of the cost of investment in a new reward program or practice involves several activities, including:
>> Cost of development and implementation of the change (internal and external costs)
>> Cost of management of the change (delta between cost of managing the new practice versus old practice)
>> Cost of the change itself (the new practice might result in increase in compensation dollars, for example)
The determination of the impact/benefits of the investment involves several activities as well, including:
>> Change in key metrics associated with population segment impacted by the change. Example: Retention of high performers increased by 10%.
>> Other potential "intangible" benefits based on anecdotal evidence. Example: management perspective that "the quality of feedback as improved as a result of the investment in training and development."
>> Analysis of the impact of the reward investment in the key metrics relative to other changes that may or may not have impacted the key metrics. Example: employee satisfaction may not increase as much, for example, if the reward investment is implemented at the same time as a reduction-in-force.
The measurement and determination of rewards ROI will vary in difficulty by type of investment. For example, measuring the return of a leadership development intervention is more challenging than measuring the return of a new incentive program, which entails clear costs and benefits due to the nature of the program. More specifically, it is relatively easy to determine the cost of a new incentive program that links compensation directly to performance goals, as well as the benefits, since compensation cost is directly connected to improvements in key metrics, such as quality, productivity, or profitability, each having a clear relationship to financial impact.
ACHIEVING OPTIMAL ROI
In summary, optimizing total rewards ROI involves making the highest impact investments in the company’s total rewards offering. Achieving high impact involves investing in elements of the total rewards offering that are proven to be drivers of performance, satisfaction, or retention and that are consistent with the company’s total rewards strategy. Moreover, organizations should take care to make reward investments that are complementary and mutually reinforcing to achieve even higher levels of ROI.
Like most strategic endeavors, optimizing ROI is a process will never be perfect or fully objective; it requires a practical methodology and sound business judgment. It requires a good understanding of the impact of an investment, or set of investments, relative to the baseline metrics (and also relative to other potential investments). A thoughtful and rigorous approach to measuring and optimizing ROI will help a company ensure that it is allocating its rewards investment wisely and attracting, retaining, and engaging its talent in a manner that drives value for customers and shareholders.
*Reprinted with permission from The Segal Company. First published in Sibson's Perspectives(tm) magazine, Volume XII, Issue 1.
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