Kelly Kubicek is the Co-Founder and CEO of Fulcrum HR Consulting.
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Human capital is about the innate power workers have. It is about their knowledge, skills and insights, which can’t be sold or bought.
Scottish economist Adam Smith was one of the first to recognize that potential. Even though Smith didn’t use this exact phrase, he identified individuals' acquired and useful abilities as a fundamental source of wealth and economic progress of a country in The Wealth of Nations (1776). But Smith also reminded business leaders that they shouldn't invest in material capital without investing in people.
Two American economists—Gary Becker and Jacob Mincer—popularized the phrase human capital (HC) in the 1960s. They described it as a combination of knowledge, abilities, habits, personality and experience that everyone possesses and can put to productive use. To this day, human capital is still among the driving forces of business longevity and stability.
Human Capital In More Depth
Contrary to other assets, human capital is not finite, and its value grows when companies invest in it. Since it represents employees’ abilities, education, knowledge, health, ambition, etc., it has the potential to grow and create additional value. Despite being in a close relationship with human resources management (HRM), human capital management (HCM) is different. Professionals managing human capital should have organization design, capability management, competence management and knowledge management skills.
They should also be competent in career management and leadership development, as the goal is to improve people’s abilities and enable them to reach higher positions and results. That’s why HCM professionals invest in employee engagement and satisfaction. High-performing employees thrive on acknowledgment, requiring HCM professionals to be stellar in reward management.
Their responsibilities also include workforce analytics and succession planning. Even though both HRM and HCM professionals center their efforts around performance management, the latter focuses on the economic value of human capital.
HRM is all about people management. It leverages various strategies to recruit, train and retain talents. These professionals build an organizational culture and must handle compensation management, retention, recruitment, selection, wellness management, etc.
Human Capital Return On Investment (ROI)
Human capital ROI (HCROI) is a metric that represents the dollar value employees contributed compared to the resources employers spent on them, including compensations, benefits and training. This metric helps companies understand what elements help and hamper business productivity and performance. It can also be a good indicator of the value workers provide as groups and individuals. HCROI enables businesses to compare the number of hours employees worked to their productivity and impact on their revenues and profit.
Identifying ROI is a nuanced process when it comes to human capital and demands that companies attach a monetary value to an HC strategy or initiative. Moreover, it might be impossible to determine whether, for example, a well-being program or additional training directly impacted a revenue boost. Hence, many variables may influence the outcome, such as global events, market fluctuations or luck. But according to the ROI Institute, companies can use the same formula that evaluates other investments where the ROI is calculated as earnings divided by investment.
The ROI process model includes four stages: evaluation planning, data collection, data evaluation and reporting. The first steps are deciding the program goal and establishing an assessment plan. After that, companies should compile data during the program and after rolling it out. Data evaluation should identify program costs and isolate the program’s effects.
Why Should Companies Calculate Human Capital ROI?
The next step is to turn insights into monetary value and calculate ROI. This helps companies understand whether their initiatives and interventions benefited human capital and resulted in higher revenues and profits.
1. Evaluate The Effectiveness Of Human Capital Initiatives
Calculating the HCROI allows companies to evaluate the outcomes of their initiatives and ensure their decisions are data-driven and resources well-spent.
2. Show Concrete Results Of HC Strategies To The C-Suite
HCROI highlights the impact HC strategies had on business, allowing managers to get leadership buy-in. For instance, they can show concrete results of a learning program on finances.
3. Detect And Fill Human Capital Gaps
The data managers get by calculating the HCROI can help them determine their company’s strengths and weaknesses regarding human capital. As a result, they can understand how reducing or adding human capital will affect business.
4. Enhance HC Processes
HCROI insights and feedback are necessary to understand whether some human capital processes are inefficient and require improvements. For example, if a particular L&D initiative gives no positive results concerning revenues after three years, it’s likely time to eliminate it.
Investing In Human Capital For Business Performance
Investing in human capital tends to make people more productive. Moreover, employees become more eager to go the extra mile and continuously create value when they feel invested in and supported. That manifests in a positive cash flow, as workers’ effort and hard work ensure a company sells its products, services and goods, thus increasing customer satisfaction.
Employees carry out most of a company's strategies and drive profit. That makes them the critical element of a company’s performance. For instance, businesses with higher human capital orientation (e.g., more training, L&D programs, better equipment) typically perform better than their peers with no relevant HC strategies.
According to the latest McKinsey report on human capital, companies can improve their HC development and boost performance by understanding the potential in people, embracing job role mobility, and strengthening coaching and mentoring. That would also allow them to ensure a higher-performing organization while stabilizing cash flow.
Bottom Line
Companies that take time to enhance their human capital strategies and recognize employees as economic value-creators can boost their performance, productivity and cash flow. But they must also invest in HC and regularly calculate the HCROI to ensure their initiatives are effective.
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