Regular readers know that a recurring theme in this blog is the oft-forgotten "respect for people" pillar of lean manufacturing and the Toyota Production System. Companies and organizations will often attempt to implement the waste reduction aspects of lean, but will sabotage their efforts by not applying equal attention to developing and leveraging the knowledge and skills of their workers.
Traditional accounting practices and methods do not measure people, except as an hourly cost. The value of knowledge, creativity, and experience is no where to be found on the asset side of a balance sheet or the profit side of a P&L. This creates a propensity for the bizarre business decisions we often write about, such as Whirlpool laying off tens of thousands of years of knowledge and then paying to replace them with workers with a few days of experience. NCR was a similar example, and one company even had the ignorance to take such action under the guise of lean itself… at Christmas no less.
Last month Lowell Bryan wrote a McKinsey Quarterly article titled The New Metrics of Corporate Performance: Profit per Employee where he proposes some new business metrics focusing on the people side of an organization. As he puts it,
It’s time to recognize that financial performance increasingly comes from returns on talent, not on capital. This shift in perspective would have far-reaching implications – for measuring performance, for evaluating executives, even for the way analysts measure corporate value. Only if executives begin to look at performance in this new way will they change internal measurements of performance and thus motivate managers to make better economic decisions, particularly about spending on intangibles.
I had been thinking about this concept when our blogging friend John Hagel at Edge Perspectives penned an excellent post discussing the topic. As John points out specifically with regards to the McKinsey article and a "profits per employee" metric,
Profits per employee as a measure has the strong virtue of simplicity. It also makes it very easy to compare performance across public companies. But, as Lowell indirectly acknowledges, it also has some drawbacks. For example, companies can potentially increase profits per employee through automation and through outsourcing – initiatives that have little, if anything, to do with increasing the talent of the remaining employees.
Which is the exact problem I have with that particular metric… it doesn’t measure the contribution of talent itself. Automation and people reduction activities that would increase profits per employee have diminishing returns as you end up with fewer and fewer people to actually creatively identify and execute programs. John suggests a potential modification to that metric that could keep the business moving in the right direction:
In contrast, talent development has some very powerful increasing returns dynamics – the more rapidly a firm develops talent, the more readily it can develop the next wave of talent. Unfortunately, Lowell’s measure cannot differentiate between people reduction measures and talent development measures. As I keep stressing, snapshots of performance are much less helpful, and often seriously misleading, relative to trajectories of performance. By focusing on growth of profits per employee over time we might at least start to see whether this growth diminishes over time (reflecting the diminishing returns of people reduction measures) or whether it accelerates over time (suggesting real impact in terms of talent development).
So "GPE" – "growth of profits per employee" – might work. But does that really measure "talent?" Taking a step back, we need to define what "talent" is. John puts it this way, and I tend to agree:
For me, talent is ultimately about the ability to deliver superior value through one’s activities, whether it is the janitor or the CEO. There are no caps to talent – no matter how good people are at what they do, there are infinite opportunities to deliver even more value. Talent is ultimately a function of human capital, intellectual capital, social capital and structural capital working together to amplify the value that can be delivered – again, whether we are talking about janitors or CEOs. Talent to some degree is about an individual’s knowledge and skills, but it ultimately hinges on the ability of the individual to leverage the resources of others as well – that is why social capital and structural capital is so critical to talent.
How can you quantitatively measure "return on talent" or "return on skills?" There are probably indirect methods combining training programs, profit, attrition, and other attributes. However one characteristic of a good metric is that it allows relatively direct comparisons across organizations and even companies. When a wide variety of subcomponents are used to calculate a metric, this is often lost. I know of some companies that take a different indirect path by capitalizing training costs, thereby creating an expense when a trained individual is lost… either voluntarily or involuntarily (which is probably due to poor hiring, screening, and support methods).
When you take a step back and look at decisions such as Whirlpool’s from a long-term perspective, they seem pretty ridiculous even if they create favorability by traditional accounting standards. To avoid this in the future we need to figure out how to make the people side of business as important as the utilization of material assets.