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Human Capital Measurement

and Reporting:
A British Perspective

LONDON BUSINESS SCHOOL


MBA 2ND Year Project

Kee Foong
Richard Yorston

Supervisor: Ms Lynda Gratton


Client: Accounting for People

June 2003

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Contents

SUMMARY 3
1. INTRODUCTION 4
2. LITERATURE REVIEW 5
2.1. HUMAN CAPITAL 5
2.2. THE HUMAN CAPITAL LINK TO PROFITABILITY 9
2.3. HC MEASUREMENT EVOLUTION 12
2.4. WHY IS HC REPORTING IMPORTANT? 15
3. RESEARCH METHODOLOGY 21
4. RESEARCH RESULTS: 22
CURRENT HC MEASUREMENT AND REPORTING PRACTICES IN THE UK
4.1. INDICATORS USED 22
4.2. BENCHMARKS USED 26
4.3. HOW WAS MEASURING IMPLEMENTED? 28
4.4. QUALITY AND USEFULNESS OF MEASURES 29
4.5. OBSTACLES TO HC MEASUREMENT AND REPORTING 31
4.6. EXTERNAL REPORTING 33
4.7. HC MEASURES FOR INVESTORS 37
5. CONCLUSIONS 38
6. APPENDICES 40
APPENDIX 1: SEVEN STEPS TOMAKING HR A STRATEGIC ASSET 40
APPENDIX 2: QUESTIONNAIRE 41
APPENDIX 3: SURVEY 42
7. BIBLIOGRAPHY 47

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SUMMARY

Human Capital (HC) is increasingly recognised as a key competitive advantage for companies, as
well as a key indicator of a company’s success. This is partially the result of the move from a
manufacturing to a service economy. As such, it is important for organisations to measure and
report on HC management if they want to control, monitor and better invest in their ‘most
valuable asset’. This has become even more imperative with the growing body of evidence that
effective HC management is directly correlated to performance, competitiveness and ultimately,
shareholder value.

Designing the measures to evaluate HC management is the first step and requires linking the
indicator to a key performance driver that will be in line with the business strategy. Measuring
and reporting is a second step that can demand management commitment and resources yet will
produce invaluable insight to both external and internal audiences. The objective is to assist these
different stakeholders to make better decisions that will benefit the company.

This report looks at current practices on HC measurement and reporting by top FTSE companies
in the UK. The objective is to strengthen the evidence of a link between Human Capital and
profitability, therefore championing the business case for external reporting, and learn from
current experiences that will help to define a best practice. We look at what indicators and
benchmarks are used, how companies value their reporting, what are the current beliefs on
reporting externally and common pitfalls in measuring and reporting as well as opportunities for
implementation of standard measures.

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1. INTRODUCTION

There is a growing body of evidence that the quality of Human Capital Management (HCM) is an
important factor in a business's competitive advantage, and correlated with competitive
performance. This is especially so as we move to a services based economy, where knowledge is
a key differentiator (e.g. in consulting, investment banking and IT services), and where employee
costs can exceed 40% of corporate expense. Knowledge is also increasingly important in high-
value-added manufacturing-based businesses (pharmaceuticals, consumer electronics and
electrical machinery). However, very few companies are believed to offer significant HCM data
to shareholders in their annual reports. Many organisations say that 'people are our greatest
assets', but we don’t know how well they fare in investing in people.

As a result, in January 2003, British Industry Secretary Patricia Hewitt appointed the Accounting
for People Task Force to develop best practice guidance for companies on the external reporting
of HCM. The Task Force will also look at ways in which organisations can measure the quality
and the effectiveness of their HCM. It is a high-level group, chaired by Denise Kingsmill CBE,
with chief executives of top public companies among its members, along with leading
representatives from the management accountancy, academic and trades union fields.

The Task Force aims to change the current lack of reporting on HCM by producing practical
guidance that will go with the grain of corporate objectives and data practices. In order for the
Task Force to make its recommendations, it needs more evidence of the benefits on HC
measuring and reporting and more information on the relevant practices of the top companies in
the UK. For this we have conducted a survey to explore what is or is not being reported, and why.
We have also conducted a literature survey on HC and its link to profitability, and also the
measurement and reporting of HC.

The Task Force wishes to present its recommendations in Autumn 2003. The experience gathered
in UK, Europe and North America might help spark an international effort towards setting global
best practice guidance that would be auditable and comparable across companies, just as financial
measures are.

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2. LITERATURE REVIEW

2.1 Human Capital

Human Capital Management (HCM) is critical in order to create a high-performing work


environment. Companies need to manage HC through all the phases of an employee’s work life -
from recruitment to development to retention. HCM 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
organization. It also involves training/developing the capital, improving their output/productivity.
It is to maximise the organization’s HC (i.e. the accumulation of all the individual HC in the
organization). Strategic HCM is the transformation of how we employ, deploy, develop and
evaluate the workforce. It focuses on results, not processes.

The term ‘HC’ was first used by Nobel Laureate, Theodore W. Schultz, in the 1961 American
Economic Review Article, ‘Investment in HC.’ The term is now most frequently used to refer to a
combination of skills, experience and knowledge1. HC is 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.”2 HC makes an individual potentially productive and thus equips him or her to
earn income in exchange for labour.

1
Flamholtz, E.G. and Lacey, J.M., “Personnel Management, HC Theory, and Human Resource
Accounting”, Industrial Relations Monograph Series, No. 27, 1981:p.19
2
Westphalen, Sven-Age “Reporting on HC; Objectives and Trends” (1999) p.4

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Gary Becker, another Nobel Prize-winning economist includes personality, appearance,
reputation and credentials to the mix3. Thomas Davenport, a management consultant, has
combined several of these definitions to come up with his HC investment model below4:

Ability
Knowledge Human
+ Behaviour x Effort x Time = Capital
Skill
Talent Investment

Exhibit 1: Human Capital Investment model

The term capital is used figuratively to refer to what might probably be better described as
"quality of labour". The term was coined as an analogy between investing resources to increase
the stock of ordinary physical capital (e.g. computers) in order to increase the productivity of
labour and "investing" in the education or training of the labour force as an alternative means of
accomplishing the same general objective of higher productivity. In both sorts of "investment,"
investors incur costs in the present in the expectation of deriving extra benefits over a long period
of time in the future.

Adam Smith said, in the Wealth of Nations, that “When any expensive machine is erected, the
extraordinary work to be performed by it before it is worn out, it must be expected, will replace
the capital laid out upon it, with at least the ordinary profits. A man educated at the expense of
much labour and time to any of those employments which require extraordinary dexterity and
skill, may be compared to one of those expensive machines.”5

Economists increasingly argue that the accumulation of human as well as physical capital (plant
and machinery) is a crucial ingredient of economic growth, particularly in the new economy.

3
Becker, G.S., “HC: A Theoretical and Empirical Analysis with Special Reference to Education, 1993
4
Davenport, Thomas, “HC: What It Is and Why People Invest In It”, 1999, p.19
5
Smith, Adam, “Wealth of Nations”, 1973, p.103 (originally published in 1776)

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Unfortunately, detailed empirical analysis is rare, as there is no common measure of HC, even
within the same country over time, let alone for comparisons between countries.6Companies can
build HC through hiring, formal training and informal learning. Knowledge that is shared within
an organisation can either be tacit (what people know, but cannot readily express) or
explicit/codified (knowledge that is transmitted through formal systemic language). Tacit
knowledge can greatly enhance a company’s knowledge base, through synergies with explicit
knowledge. Sources of tacit and explicit knowledge are summarised in Exhibit 2.

Types of Knowledge Individual Group


__________________________________________________________________________________
Job skills Best practices
Explicit Design rules Stories
Procedures Work processes
_____________________________________________________________________
Intuition Rules of thumb
Tacit Know-how Traditions
Common sense Sources of information
Judgment Requirements for survival
Exhibit 2: Where to Find Tacit and Explicit Knowledge7

HC refers to things people have; but people have, are and do many things that do not translate
into economic value for themselves and the organizations they work for. There are 3 kinds of
resources that people possess which, collectively, constitute their individual HC. The same 3
resources but cumulated at the organizational level, constitute a company’s HC. An
organisation’s HC can be categorised into social capital, intellectual HC and emotional HC. 8 (See
Exhibit 3)

These 3 elements are highly interrelated and it is the combination, the feedback loops and the
connectivity that brings advantage. For example, Emotional Capital brings integrity to build the
relationships that underpin the creation of Social Capital. Social Capital helps develop Intellectual
Capital by accessing knowledge and skills outside the company and sharing knowledge within the
company. At the same time, they also create tensions and contradictions, e.g. relationships can
prevent necessary but unpleasant actions.

6
http://www.economist.com/research/Economics/alphabetic.cfm?TERM=HUMAN% 20CAPITAL
7
Davenport, Thomas, “HC: What It Is and Why People Invest In It”, 1999, p.149
(adapted from P.A. Galagan, The Search for Poetry of Work, Training and Development, Oct 1993, p.36)
8
Gratton, Lynda and Ghoshal, Sumantra “Competing on HC”, European Management Journal 2002 Fall

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Intellectual Social Emotional
Individual Knowledge, capacity to Who you know and how Self awareness, self
learn, skills and well you know them esteem and personal
expertise built over time. integrity that individuals
need to convert their
knowledge into action.

Organisational a. Accumulation of Structure, quality and a. The accumulation of


knowledge, skills and flexibility of the human individual self
expertise that all networks both a. inside awareness and self
members collectively and b. outside the esteem and b. the stock
possess and company. of pride, trust and
b. The knowledge and a. Internal: through inspiration which
expertise that may be recruitment of cohorts, together create a bias
owned or embedded in joint training in which for speed and action in
the organization (i.e. people get to know one rapidly evolving markets.
patents, IT based another, job rotation Related to how things
knowledge systems, through different get done within an
specialized processes of departments and organization: how
work). functions, long-term policies are carried into
employment and strong practice on a day-to-day
internal cultures, people basis.
build formal and informal
relationships that are
strongly related to the
way (how) things get
done in the co.
b. External: through
corporate account
management, strategic
alliances, relationship
marketing, supplier
partnerships.

Exhibit 3: Social, Intellectual and Emotional Capital at an Individual and Organisational


Levels

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2.2 The Human Capital Link to Profitability

There is a wealth of research that confirm the view that there are positive impacts of good
HCM on the performance of the company. Gratton has looked at selected high-performing
companies (Glaxo Wellcome, Hewlett-Packard) and made a simple causal model linking people
and the financial health of companies9.

Business People Individual Firm Financial


Goals Context Behaviour Performance Performance
& Attitudes

Kaplan & Norton have a similar model of value creation through HC, and have illustrated this
with an example10:

FINANCIAL Return on Capital Employed

__________________________________________________________

CUSTOMER Customer Loyalty

On-time Delivery

__________________________________________________________

INTERNAL/ BUSINESS Process Quality Process Cycle Time

PROCESS

__________________________________________________________

LEARNING & GROWTH Employee Skills

In fact, Kaplan and Norton have proposed a model that uses 7 steps to making human resources a
strategic asset (See Appendix 1).

9
Gratton, Lynda, “Living Strategy: Putting People at the Heart of Corporate Purpose”, 2000: p.10
10
Kaplan, Robert S. and Norton, David P., “The Balanced Scorecard” 1996:31

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Guest conducted a study on the link between HR strategy and financial performance for UK
companies for the “Future of Work” programme, and came up with the following model11:

Business strategy would determine to HR strategy and practices that would make HC more
effective, leading to higher quality of goods and services, and higher productivity, that would lead
to superior financial performance. This ties in well with Kaplan’s 7 Step framework mentioned
above and in Appendix 1.

The 1994 National Employer Survey (NES) conducted by the National Centre on the Educational
Quality if the Workforce (EQW) shows that investment in training brings more returns than
investment in capital. They conducted a telephone survey of approximately three thousand
establishments employing twenty workers or more. The results showed that increases in the
number years of worker schooling contribute proportionally more to productivity than increases
in either capital stock or work hours: a 10 per cent increase in education is associated with a 9 per
cent gain in productivity, while a 10 per cent increase in capital stock only resulted in a 3 per cent
gain in productivity. The difference is even more dramatic in the non-manufacturing (e.g. service)
sector. A 10 per cent increase in education, work hours, and capital stock correspond to
productivity gains in 11 per cent, 6 per cent, and 4 per cent, respectively.12 As the United
Kingdom moves from a manufacturing to a service-based economy, investment in HC (e.g.
training) becomes increasingly critical not just to the success of companies but to the
competitiveness of the entire economy.

11
http://www.esrc.ac.uk/ESRCContent/news/oct2.asp
12
National Center in the Educational Quality of the Workforce, “The Other Shoe: Education”s
Contribution to the Productivity if Establishments”. 1995:p.2

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Evidence also suggests that companies that measure intangibles like HC as well as financial
assets distinguish themselves by superior performances. Companies that regularly measure
performance in 6 categories (financial performance, operating efficiency, customer satisfaction,
employee performance, innovation and change, and community/environmental issues) excel in
three ways: identification as an industry leader over the prior three years (74 per cent of
measurement-managed companies versus 44 per cent of others), financial performance in the top
third of their industry (83 per cent versus 52 per cent), and self-reported success at major cultural
or operational change (97 per cent compared with 55 per cent). WM. Schiemann & Associates
concluded that a focus on employee measurement is the single biggest factor differentiating
successful firms from less successful ones.13 One of the reasons is that workers’ feelings about
their jobs and companies has a significant impact on their performance, and consequently, the
companies’ performance.

There are quantitative measures and qualitative measures. The quantitative measures tend towards
cost, capacity and time and tell us what happened. The qualitative measures focus on value and
human reactions and why it happened.

Like accounting and financial measures, HC measures are paramount and a starting point to HCM
and improvement. Measurement allows for the following:
- Communicate performance expectations.
- Know what is going on inside the organisation.
- Identify performance gaps that should be analysed and improved.
- Provide feedback comparing performance to a benchmark or industry standard.
- Recognise performance that should be rewarded.
- Support decisions regarding resource allocation, projections and schedules.

There is a consensus that through these metrics, the whole of the organisation can realise the
importance of what is or isn’t done in the human resource management area. It is also valuable
for the different stakeholders of the company to start to come to terms with some of these metrics
so that they realise the impact that HCM can have on company performance.

13
Lingle, J.H. and Schiemann, “From Balanced Scorecard to Strategic Gauges: Is Measurement Worth It?”,
Management Review, Mar.1996, pp. 58-60

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2.3 HC Measurement: Evolution

There have been many studies on ways to measure HC. For example, Brown suggests that a
simple HC index made up of four sub-metrics is better than crude measures like turnover,
education level, training attended and developmental plan objectives that most companies use.
The four sub-metrics in Brown’s index are Level in the company, Performance rating, Variety of
positions, Years in field/business. They are weighted so that the index will produce a score out of
100. The weighting will depend on the company’s specific situation, and the importance of
skill/competencies versus experience/performance. 14 The benefit of such a measure is that it is
simple. However, the disadvantage is that it is not an all-encompassing measure, and ignores
other possible inputs that might be important to particular companies or industries.

Such studies have led to the popularisation of the thought that HC should be recognised as a line
item in financial statements. Various studies have looked at how we can value human resources,
but these have lost acceptance in recent years. Such human resource accounting practices are
based on the concept of general economic theory, i.e. an individual’s value to an organisation is
the present value of future services that she/he is expected to provide during the period she/he is
anticipated to remain in the organisation15. A lot of value judgement lies in these (e.g. expected
length of service), and the recent rise in outsourcing coupled with frequent fluctuations in
employee size further complicates matters.

Monti-Belkaoui, et al, suggested that human resource valuation should be based on value-
addition, as it is a measure of wealth. Value-addition is defined as the increase in wealth
generated by the productive use of the firm’s resources before its allocation among shareholders,
bondholders, workers and the government. The Value-Added reporting became popular in the UK
with the publication of the Corporate Report in 1975, a discussion paper published by the
Accounting Standards Committee, which recommended, amongst other things, that a statement of
value added showing how the benefits of the efforts of an enterprise are shared by employees,
providers of capital, the government and reinvestment, be included in the external reporting16.
The statement of Value-Added provides a useful measure to help in gauging performance and

14
Brown, Mark Graham , “HC”s Measure for Measure”, Journal of Quality & Participation, Sep/Oct 99,
Vol. 22 Issue 5, pp.28-31
15
Flamholtz, Eric, “Human Resource Accounting: Advances in Concepts, Methods and Applications” (3rd.
Edition), 1999:p.160
16
Monti-Belkaoui, Janice & Riahi-Belkaoui, Ahmed, “Human Resource Valuation: A Guide to Strategies
and Techniques”, 1995

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activity. By relating key figures such as capital employed and employee costs, the value added
can be a significant indicator of performance.

One important consideration when using the VA statement is that the objective of the firm is not
necessarily to maximise value added. Management can make a wrong decision for example of
allocating spend to internal labour to produce a product that could be outsourced more
economically. This would increase the company VA but not the profits. Therefore the VA is a
useful information tool to report performance, but not the efficiency of the VA.

As more and more companies move to a business unit profit centre role, the human resources unit
can take on a similar role. If they were to do that, they need to measure HC in order to ascertain
the cost of investment in HC, and the returns from those investments. Measurement of best
investment in Human Capital (BIHC) also provides a framework for human resources to move
from a soft skill business, to a hard-skill measurement based one. ‘Best’ reflects comparative
analyses of the company’s current investment performance versus external standards,
‘Investment’ reflects the change in treating the money and effort spent on developing HC as an
investment rather than a cost, while ‘HC’ is the money and effort it takes to cultivate people and
their talents, reflecting the economic value of the knowledge, skills, experiences, creativity and
innovations of people in the company that enable the company to me productive and
competitive.17

Weiss suggests that we should not only include full-time employees as headcount, but also part-
time employees. For example, all employees spending more than 50% of their working time at a
company can be counted as a full employee, while those working less than 50% of the time can
be considered as one third of an employee. The whole process need not be micro-managed, and
some level of imprecision is acceptable.18 As for investments, this should include money that the
employee receives directly (e.g. salaries, stock options and bonuses), money paid to third parties
on behalf of employees (e.g. cellular phones, pensions, health care) and employee development
costs (e.g. search and resourcing costs, training, rewards and recognition costs).

17
Weiss, David, “High-Impact HR: Transforming Human Resources for Competitive Advantage”,
1999:p.228
18
Weiss, David, “High-Impact HR: Transforming Human Resources for Competitive Advantage”,
1999:p.235-238

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There are several theories behind HC. As Britain moves from an industrial manufacturing-based
economy to a service information-based one, HC is fast becoming more important than physical
assets. However, there is a strong reason why accounting measures may not be the best way to
measure and report human capital - Property rights. Companies do not own any individual’s
human capital, unlike inanimate assets/capital that are normally readily transferable from one
owner to another with minimal complications and transactions costs, at the organisation’s
discretion. HC is by definition inseparably embedded in a specific individual. HC itself cannot be
directly traded on the market - only its temporary services as reflected in the labour productivity
of the one individual who alone can own it. If an employee chooses to quit his or her job, then
any past investment the employer may have made to upgrade the employee's job skills is lost to
the firm from the minute the former employee walks out the door. Employers used to depend on
the “ownership” bond between employer and employee. However, in recent years, this bond has
been broken. This has given to another point of view on HC. Employees are seen more and more
as free agents; companies and organisations can only win their allegiance through retaining value
for value. In fact, employees can and should be treated more and more like investors.19 Although,
this looks at HC not as an organisation’s assets, but as its investors, it nonetheless reinforces the
importance of HC in today’s world. Additionally, the fact that there is no one universally
accepted way to financially account for human capital, has resulted in the current thought and
best practice of not using a strict accounting/valuation measure. Leading indicators (e.g. turnover,
employee productivity measures) are the preferred way now.

The Balanced Scorecard20 is another way that is proposed to measure HC. Becker et al argue that
HC is the foundation of value creation in new economy businesses (up to 85% of a corporation’s
value is based on intangibles), and propose an adaptation of the BSC that concentrates on HC
called the HR Scorecard21.

19
Davenport, Thomas, “HC: What It Is and Why People Invest In It”, 1999, p.13
20
Kaplan, Robert S. and Norton, David P., “The Balanced Scorecard – Measures that Drive Performance,”
Harvard Business Review 70, no.1, January-February 1992: 71-79
21
Becker, Brian, Huselid Mark, Ulrich, David, “The HR Scorecard: Linking People, Strategy, and
Performance”, 2001

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2.4 Why is HC Reporting Important?

"The fundamental objective of corporate reports is to communicate economic measurements of


and information about the resources and performance of the reporting entity useful to those
having reasonable rights to such information".22

In more recent times the Accounting Standards Board published its Statement of Principles for
Financial Reporting (Dec 1999) and the concept of usefulness was a significant feature in this
publication. As it is undeniable that human issues are useful for stakeholders to evaluate
companies, they should be reported.

The accounting standards setting authority have published standards relating to the operating and
financial review (OFR) of a company. As the profit and loss statement, balance sheet and cash
flow statement are a historical account of a company’s performance, the OFR provides
information that stakeholders can use to project the historical figures into the future. These
usually include the company’s vision and strategy, but should also include information on human
capital, and how it is being developed. After all, given the same physical assets, human capital
and other intangibles are what makes a company perform better or worse.

Another consideration when evaluating the need for improving the level of HC reporting in the
UK is the current trend in the nature of the businesses. Given that UK businesses are increasingly
becoming more service-based it is more important that the human resource is adequately
managed as the performance of the company relies even more on the employee performance. This
is explained in the Service Profit Chain based on research by Heskett, Sasser, and Schlesinger23,
where greater employee satisfaction leads to customer satisfaction, which increases sales.

People are the true agents in business. All assets and structures, whether tangible or intangible,
are the result of human actions. All depend ultimately on people for their continued existence.
Annual reports should include the usual visible assets and an “invisible” part that consists of
employee competence, internal and external structures. These “invisible assets” on an
organization’s balance sheet consists of employee competence, internal structure, and external
structure. Employee competence involves the capacity to act in a wide variety of situations to

22
UK Corporate Report 1975
23
James L. Heskett, W. Earl Sasser and Leonard A. Schlesinger , “Service Profit Chain: How Leading
Companies Link Profit and Growth to Loyalty, Satisfaction, and Value”, 1997.

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create both tangible and intangible assets. Some may not agree that employee competence is an
intangible asset. It is true that individual competence cannot be owned by anyone or anything
except the person who possesses it: employees are voluntary members of an organization.
Nevertheless, they should be included in the balance sheet of intangible assets because it is
impossible to conceive an organization without people and people tend to be loyal if they are
treated fairly and feel a sense of shared responsibility. Internal structure (e.g. patents, concepts,
models) is created by the employees and is generally owned by the organization. External
structure includes relationships with customers and suppliers. It also encompasses brand names,
trademarks and the company’s reputation or image24.

Companies may see HC reporting as both a positive opportunity and a negative risk. Although it
is beneficiary and professional to do so, generating information for better management, it also
threatens to expose activities that may be ineffective or counterproductive. Information may even
be considered sensitive when reporting externally. However, some leading human resources
professionals and academic researchers will coincide in that the value that can be added in this
field is enormous and deserves to be documented and demonstrated through reporting to make it
more effective and better known.

Most managers would agree that HCM has an impact on the company’s bottom line and that the
human resource is the most valuable possession the company has. The phrase “our people are our
best asset” has become a bit of a business cliché. According to our research among top FTSE
companies as well as similar studies carried out in the U.S. and Europe, today’s managers go
further by confirming that HC measurement and reporting can lead to improve the profitability
and competitiveness of the organisation.

At an aggregate level there is increasing evidence from both consultants and academics that HC
practices are linked with competitiveness and performance, measured through shareholder value.
Watson Wyatt LLP, an international HR consulting firm published studies25 carried out both in
North America and Europe showing the correlation between its HC Index (HCI™) and
shareholder value. The HCI is an index from 0 to 100 awarded to each surveyed company, based
on the responses to a wide range of questions about the organization’s human resource
management practices, including pay, people development, communications and staffing. The

24
Sveiby, Karl Erik, The New Organizational Wealth
25
Watson Wyatt, “The HC Index™: Linking HC and Shareholder Value”, Survey Report 1999, 2000,
2002.

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initial research for the HCI was conducted in the United States and Canada in 1999 among 400
publicly traded companies and was repeated in 2001 with 500 companies. This was extended to
Europe with 200 participating companies in 2000 and extended again in 2002 with 600
participating companies in 21 European countries and 500 companies in 12 countries across Asia-
Pacific. Specifically it shows that five key HC practice dimensions are associated with a 30%
increase in shareholder value:
• Clear Rewards and Accountability;
• Excellence in Recruitment and Retention;
• A Collegial, Flexible Workplace;
• Communications Integrity;
• Prudent Use of Resources.

A multiple regression analysis was conducted to find the relationship between the HCI and the
financial measures of the company’s value. The financial measures included company market
value, total returns to shareholders over a period of time and Tobin’s Q indicator (Market value of
a company divided by book value of company’s assets). This last indicator recognises that there is
an “intellectual capital” (R&D, trademarks, brands and HC) that adds to the physical capital of
tangible assets to create a higher market value. Therefore a company with a Tobin’s Q of 2 would
have a market value of twice as much as the book value of its assets.

The results in Europe as well as North America and Asia-Pacific show that those organisations
with a best HCM practices (e.g. high HCI) have a higher performance reflected in market value
and shareholder returns. Exhibits 4 and 5 show the aggregate results across a wide range of
companies surveyed.

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Exhibit 4: European Companies with higher HC Index create more value26

In times of economic downturn, where business opportunities are scarce and competitiveness is
critical, it becomes even more important to guard HRM practices. The following exhibit shows
the 2002 updated statistics for Europe.

Exhibit 5: Higher European HCI companies deliver more shareholder value. (Increase in
shareholder value over five years to 30 June 2002)27

80%

70%

60%

50%

40%

30%

20%

10%

0%
Low (0 to 25) Medium (26 to 75) High (76 to 100)
Company 2002 HCI scores

26
Figure taken from Watson Wyatt”s “The HC Index™ European Survey Report 2000” page 3.
27
Watson Wyatt”s “The HC Index™ European Survey Report 2002”.

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The main differences between the North American and European studies were legislative and
cultural factors reflected in a more ‘paternalistic’ environment in most European organisations,
which as seen in the last two rows of Table 1, has a negative impact on company performance.
The other difference is the more effective relationship with trade unions in Europe, which has a
positive impact on performance.
Table 1: HCI European Survey Report 2000
HCM practices with highest impact on market value

Impact on
market
value HC Management Practice
3.7% Integrated leadership
2.3% Use of knowledge workers
1.7% Stock ownership by employees
1.5% Recruiting excellence
1.5% Sharing information with employees
1.4% Consistent pan-European HR practices
1.2% Good union/management relations
1.0% Customer-focused environment
1.0% Ability for employees to manage self-manage
0.9% Employee Incentives
0.7% Intelligent use of contract workers
0.7% Getting employee feedback
0.6% Benefits
0.5% Pay
-2.7% Excessive Job security
-4.8% Unfocused retention

Another comprehensive academic study of the relationship between high-performance work


practices and overall firm performance is one carried out by Huselid28 showing that firms with
high-performance work practices reduce turnover and increase productivity. A one standard
deviation increase in the high-performance work practices was linked to $27,044 more in sales,
$18,641 more in market value and a $3,814 increase in profits per employee.

The value of investment in HC is also demonstrated by a company-level study, tracking the


employee/customer/profit relationship at Sears29, where a link was found between the employee’s
satisfaction (attitude towards the company and attitude towards the job) and employee turnover
and customer service. Specifically, it was found that a 5% increase in employee attitudes would
increase customer satisfaction by 1.3% and 0.5% in revenue growth.

When it comes to reporting, HR professionals and managers in general believe that the human
resource should be measured and reported. A study conducted by the Conference Board on

28
Huselid, M.A., “The Impact of HCM Practices on Turnover, Productivity and Corporate Financial
Performance” Academy of Management Journal, 38 1995, pp.635-672.
29
Rucci, Kirn and Quinn, “The Employee-Customer-Profit Chain at Sears”, Harvard Business Review,
January-February 1998.

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Fortune 500 companies and Europe 500 companies30 found that 86% respondents thought that HC
measurement improves the unit or company-wide bottom line. Other motivations for
measurement included:
- Steer HC resource allocation
- Win business cases for HC investment
- Track HC activities to develop HC predictions
- Link variable compensation to HC best practice
- Deliver HC information required by law
- Provide investors with info on HC performance

It is also useful to look at what other countries are doing with regards to HC reporting. Finnish
companies report on HR as an extra disclosure to company reports, so called personnel accounts.
However, personnel accounts are normally published only internally. The internal information
flow is naturally of great importance, but there are nevertheless some interested parties outside
the company, too. Important external stakeholders are, for instance, investors and creditors. The
main problem concerning external reporting is likely to be the lack of common definitions and
reporting routines. The forms of reported human resource information, as well as the used
indicators, are normally privately defined in every organisation, which, naturally, makes it
difficult to compare the companies with each other. Some industry-wide standards could help to
solve the problem.31

Financial markets shape the management decisions of publicly traded firms by rewarding or
punishing various behaviours through changes in valuation and access to capital. These decisions
are driven by the information available. Because of the lack of information on both the nature of
HC investments and the outcomes of such investments, stockholders, for example, do not provide
current rewards for these investments, even if they add value. Instead, investors focus on the
available indicators - which are primarily short-run measures, such as earnings. As such,
companies that make investments in education and training must do so in spite of pressure from
the investment community, rather than because of it.32

30
Stephen Gates, The Conference Board, “Value at Work: The Risks and Opportunities of Human
Measurement and Reporting”, 2002.
31
Eronen, Anne, “HC into the Company’s Balance Sheet?”, Series ETLA B133, Helsinki 1997,
http://www.etla.fi/english/research/publications/searchengine/pdf/abstract/b133eng.pdf
32
Bassi, Laurie J. and McMurrer, Daniel P., “Indicators of HC Investment and Outcomes from the
American Society for Training % Development”,
http://www.tu-harburg.de/aw1/newsletter/3/astd_us.pdf

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3. RESEARCH METHODOLOGY

The target respondents to our survey were top 250 ranked FTSE companies, as the objective was
to learn from experiences of organisations of significant economic size. The Task Force had
developed a set of key questions as a framework for its evidence-taking (Appendix 2). The task of
this particular project was to survey and interview a sample of the top 250 FTSE-listed companies
to seek their responses to all the relevant questions from the Key Questions list.

Initial research was done as to what the appropriate companies to contact were and the relevant
contact name. In general, HR managers of all the top ranked FTSE companies were contacted
either by email or by phone to participate in the research. In some cases, alumni from London
Business School working in top management positions of these companies were contacted to
participate. Initial impressions and information on the type of organisation and their experience
on HC reporting was obtained from first contacts. A significant number of the top 250 listed
companies (about 10%) were actually trust funds, that effectively only managed funds and not
people. Eleven companies contacted, that actually had HC reporting practices, agreed to take part
in a more detailed survey where they presented their use of indicators for HC management. A
further 5 companies agreed to meet one-on-one to discuss their experience and opinion on the use
of HC measures for external reporting in more detail.

A number of companies admitted that they were not actively measuring human capital but
planned to do so in the future or were in the process of designing a system that would allow them
to implement such measures.

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4. RESEARCH RESULTS:
CURRENT HC MEASUREMENT AND REPORTING PRACTICES IN THE UK

4.1 Indicators Used

Almost all companies in the FTSE 350 have a director or manager of HR or Personnel. Other title
names for similar positions are ‘Director for People’, ‘Employee Relations’ and ‘HR Planning’.
Some large Group Companies contacted do not have many employees in their head offices and
therefore usually have no involvement with Human Capital Management. They delegate this
function to the subsidiary to track HR management and so, obviously, there is no reporting of this
externally and no control in the parent company. In other cases the HR role is taken on by the
Company Secretary or the Finance Director.

Most HR departments measure and monitor their HR activities although with different degrees of
depth. As the main tasks undertaken by most HR departments are the contracting of personnel
and to some extent, managing employee relations, the most common measures used tend to be
related to these areas, such as turnover and employee satisfaction through surveys. A number of
companies also stated that their HC measurement systems are still not complete and that they are
in the process of identifying and defining the metrics they want to use.

Here we present a number of indicators used by those companies who were willing to share
information about their reporting practices, either internally or externally. For other companies,
these may serve as examples to consider, although they must first evaluate whether the measures
link to their own HR and business strategy.

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The indicators mentioned in our surveys are divided here into eight broad categories in order of
popularity:
Table 2: Most common indicators used in HC reporting
% of times
Indicators Mentioned
mentioned
TURNOVER/RETENTION/ABSENCE 19%
Employee Turnover 13%
Also mentioned: Turnover/length of service, Turnover costs, Retention, Turnover per new
grad vs. mature recruits.
Absentee statistics 6%
Also mentioned: Absence/sickness levels in %, costs, causes, trends, actions, per
business unit.

COMPETENCIES/TRAINING 17%
Performance reviews, appraisal completion 5%
Training per employee (days, spend, ROI) 4%
Staff with professional qualifications 1%
Competency ratings 1%
Mistakes 1%
Exam passes 1%
Quality of leadership based - 360 degree assessment 1%
Average educational level 1%

EMPLOYEE PRODUCTIVITY 16%


Profit per Employee 6%
Revenue per Employee 4%
Wealth Created per Employee 1%
Cost per Employee 1%
Productivity measures (e.g. activities per person per hour, etc.) 1%
Overtime 1%

WORKFORCE PROFILE 16%


Diversity 4%
Staff Headcount analysis 3%
Leadership talent pool (LTP) - Numbers by grade, global region, nationality, gender, etc. 1%
LTP - Numbers with senior executive potential aged<40 1%
LTP - Senior executive job cover over next 2 yrs 1%
Technical/specialist skill pools - Numbers by career stage and development potential 1%
Workforce demographics 1%
Average workforce age 1%
Average seniority 1%

EMPLOYEE ATTITUDE/ENGAGEMENT 12%


Employee Satisfaction (Surveys) 10%
Staff engagement Model 1%

EMPLOYEE COMPENSATION 8%
Remuneration analysis (reward analysis, Pay drift analysis, etc.) 5%
% of people with stock option plans 1%
% of people with variable compensation 1%

RECRUITMENT 4%
Staff acquisition costs and payback analysis 1%
Graduate attraction 1%
Short Term Tenure (3-12 months) - predictor of attraction strategy issues 1%

HEALTH AND SAFETY 3%


Employees health and safety statistics 3%

OTHER STATISTICS 6%
HR Staff / Employee 1%
Customer complaints and compliments 1%
Recourse to Fair Treatment Systems 1%
Recourse to Speak Out System 1%
Promoted persons 1%

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The most common measures used are about turnover, appraisal/performance review, employee
productivity and workforce profile. Also, many companies have internal surveys where they try
to gauge the workforce’s satisfaction and attitude towards the job and the company. A more
specific analysis on employee satisfaction comes from a review of the compensation and reward
system, an indicator of how fair the employee might view the reward to effort balance.

One of the important contributors to improving shareholder value identified in Watson Wyatt’s
report was recruitment excellence. Although many companies may put a lot of time and effort
into recruiting, it would appear from our survey that this area of HR management is not reported
enough with only a few companies measuring it. Recruiting excellence can be measured
according to time, quantity, quality, cost and strategic criteria. An effectively planned recruitment
that supports the business plan by placing the right people with ready-to-use skills in the right
roles will impact the company’s performance, making it critical to measure and report this area of
management, even though it may be difficult and time consuming.

Turnover and retention measures give important information to line managers on numbers and
reasons for employees leaving, which can help to anticipate future events. Our interviews provide
some examples. RAC have a notional cost per day of absence, so every business will know what
absence is costing it. The same happens with turnover where they have a notional cost per
percentage turnover. When focusing on these costs instead of cutting costs through layoffs, this
kind of information becomes very valuable.

Intuitively, higher turnover can generate higher recruitment and training costs, lower customer
satisfaction, produce more mistakes, increase workload and can be a symptom of low morale. A
study by Bernthal and Wellis33 showed that the cost of replacing an employee ranges from 29 to
46 percent of the person’s annual salary for a sample with 13% turnover. The report, based on
responses by 118 organizational members of the DDI HR Benchmark Group in 2000, found a
moderate but significant correlation between an employee's job satisfaction and intent to leave. It
is more valuable, therefore, to know the reasons behind the turnover rate. Some of the
respondents to our survey addressed this with leaver surveys and interviews.

Surveys on employee attitude and engagement are very important in gauging sentiment and
assessing organisational health. Rio Tinto provided one example of how these surveys can be

33
P. Bernthal and R. Wellis, “Retaining Talent: A Benchmarking Study” DDI, February 2001.

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used. They use surveys as a means of detecting poor organisational health, which can be reflected
in top-down decision making, lack of trust, lack of mentoring, absence of fair treatment systems
and lack of development in training programs. These tie in with other metrics such as declining
profits, examples of unethical behaviour and turnover to get an overall picture.

Compensation and payroll systems are usually among the most highly developed aspects of HC
management, especially as they are an integral part of financial control. Because of this, there is a
lot of analysis that can be done to help managers in their decisions. Companies interviewed use
this data to do pay drift analysis and evaluate reward systems. This information, complemented
with surveys, can be an important indicator of employee motivation. Furthermore, the payroll
data is used by some companies for payback analysis and understanding how much time it takes
to pay back initial attraction costs.

Measuring competencies through tests, performance reviews, surveys and analysing the
workforce’s educational levels were mentioned as indicators that assist in the design of training
programs. In some cases a ‘skills gap analysis’ is made at the beginning of the planning cycle to
then bridge the gaps with the appropriate training in line with the business needs. A second group
of indicators used have more to do with measuring the results, such as training hours, spend and
ROI. However, a distinction has to be made between ‘lag’ and ‘lead’ indicators as Rio Tinto
explains. Lag indicators such as average training hours per employee (i.e. ‘closing the door after
the horse has bolted’) can have little value in terms of driving behaviour, and therefore not
suitable for reporting. There is more value in measuring how effective the training is and not the
hours or spend accumulated, how the training plays out on employee satisfaction and impact on
the bottom line. Other companies recognised this and expressed their future intent in measuring
the impact/cost of learning and training, in order to understand its effectiveness and optimise
training costs.

HR professionals of a company can gain a lot of leverage by using basic productivity measures
like profit per employee, operating or employment costs per employee, revenue per employee,
activities per person per hour and wealth or value added by employee. Service companies that
rely heavily on employee performance to increase customer satisfaction find these measures
particularly relevant. The use of sophisticated software packages allows them to track
productivity of sales employees and reps and complement this information with other indicators
to address morale, training and relocation issues. The Royal Bank of Scotland use productivity

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indicators in their ‘Engagement Model’ to support decision-making rather than simply measuring
productivity to confirm past performance. They found that employee engagement and
productivity are directly correlated.

Workforce profile indicators tend to be measured by default in most companies and provide
useful information on age, diversity, length of service, leadership talent pools, etc. They can help
identify issues of diversity enhancement, succession planning, programme innovations and
training.

Other less common indicators that may have relevance to some companies’ business strategy are
health and safety indicators and such measures as customer satisfaction (especially relevant to
service businesses), and HR staff to employee ratio.

In summary, the top ten indicators used by the FTSE companies surveyed are as follows:

Employee Turnover 13%


Employee Satisfaction (surveys) 10%
Absentee statistics 6%
Profit per Fulltime Employee 6%
Performance reviews 5%
Remuneration Analysis 5%
Training per employee (days, spend, ROI) 4%
Employee Diversity 4%
Revenue per Employee 4%
Staff Headcount analysis 3%

4.2 Benchmarks Used

A number of companies gave us some insight into the type of benchmarks used to compare their
measures. Benchmarks are important for setting goals and understanding the real significance of
what each measure says. It improves the alignment of HC activities with strategy. It is important
to distinguish between external and internal benchmarks. External benchmarks can be valuable
when comparing the company’s performance to industry leaders or competitors. However, they
may not necessarily be linked to the strategic goals and therefore internally defined benchmarks
might be appropriate in these cases.

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The benchmarks surveyed were more readily available for the more popular indicators such as
turnover, absence statistics, profit and revenue per employee and remuneration.

Turnover benchmarks surveyed typically range from 10% to 30% although they can be as low as
5% in special cases. The larger concentration is between 10 and 15%. Some companies have
benchmarks for different cities or regions. For example, in one case the London staff turnover
benchmark was higher that for staff in other offices. In another case there was a different
benchmark per years of service, where the year-one turnover (25%) was higher than the total
turnover benchmark (12%). Different benchmarks are also defined per function.

Absentee statistics or paid sickness absence is less variable with benchmarks ranging between 3%
and 5%.

Revenue, cost and profit per employee benchmarks were also mentioned, although these will vary
across industries and according to the business strategies. However we present these benchmarks
as an example:
- Revenue per FTE £140,000
- Cost per FTE £86,000
- Profit per FTE £7,000
- Wealth Created per Employee £850

Other examples of benchmarks include remuneration and pay analysis:

- Average Remuneration £17,500


- Pay drift analysis34 +/-1%

Other benchmarks mentioned had to do with training and competency levels, such as staff with
professional qualifications (20%) and training days per employee per year (12 days) although
some these may not be of much help in shaping business performance (i.e. training days as
opposed to training results in competency levels).

Benchmarks come from either internal or external sources. External benchmarks are not defined
within the organisation and are usually chosen by a management consensus to ensure that they
apply within the company. Although external benchmarks can be of some relevance and match
standards to those of competitors, it is internally defined benchmarks that are more powerful

34
Pay-Drift analysis measures the difference between average pay settlements and average earnings.

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because they can be linked to business goals and strategies and really impact profitability.
Therefore, a recommended practice, as done by some companies interviewed, is to use a
combination of internal and external benchmarks that will set a complete frame of reference to
evaluate the indicators.

These are a list of benchmark sources mentioned by respondents:


• Budget
• Target improvement from previous year
• Internally set targets (with participation of different departments)
• Competitors
• Industry Norms
• Analyst presentations
• Saratoga Institute35

4.3 How was Measuring Implemented?

Respondents agree that the key indicators chosen should be linked to profitability, or rather, to the
HR strategy which is in turn is in line with the business strategy. Therefore, there should be logic
on how the company’s performance and shareholder value will be negatively or positively
affected if the indicator improves or worsens. It was also mentioned that the chosen key
indicators should be easily benchmarked (e.g. Revenue per Full-Time Employee) to get a clear
picture of how the company compares against competitors. They should also “talk” the same
language with other areas of the business (e.g. Finance).

Measures are usually chosen by common agreement across the organisation. It is important that
many departments participate, especially Finance and Senior Management to achieve buy-in to
the whole process. Some companies chose to use an external consultancy to come up with some
measures, and then liase with the finance team to select the ones to use out of those suggested by
the consultancy. In both cases, the input from different parts of the organisation makes it easier
for HR to implement the measuring process.

35
Saratoga Institute is a worldwide leading source of quantitative human performance and assessment data
and has identified more than 250 metrics for comparison within its database.
See http://www.saratogainstitute.com

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4.4 Quality and Usefulness of Measures

As demonstrated in a number of publications in the literature review, there is sufficient evidence


to show that there is a link between HC management and the company’s performance. Because
many managers at least intuitively believe this, they choose indicators and measures to assess this
capital and generate information that will help decision-making. The indicators chosen tend to be
those that are relevant and important to the company’s strategy and have a link to profitability.
Therefore, the indicators that are measured and reported are given quite a lot of importance and
are used as an internal management tool. According to our survey the majority of respondents
believes that this is the case with most indicators used as can be seen in Exhibit 6. Some
indicators may not be used extensively but produce relevant information, which may or may not
be reported.
Exhibit 6
How widely is each of these indicators used as an internal management tool?
70%

60%

50%

40%

30%

20%

10%

0%
To a great extent To some extent Not sure Not at all
% Response 62% 38% 0% 0%

HR managers responding to our survey agreed that the HCM indicators they use are associated
with company profitability and competitiveness to some or to a great extent.

Exhibit 7
To what extent are indicators associated with company
profitability/competitiveness?
70%

60%

50%

40%

30%

20%

10%

0%
To a great extent To some extent Not sure Not at all
% Response 62% 31% 2% 5%

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It was observed that the selection of indicators to be used tends to be kept simple, as most HR
managers, it would seem, don’t want to swamp the business with metrics. RAC explained that
they had first come up with 15 indicators in the designing phase, which was considered too much,
and then narrowed it down to a ‘vital’ few. Therefore, the ‘chosen few’ indicators that are
selected are usually measured and reported quite reliably and consistently as evidenced by the
survey responses.
Exhibit 8
How reliable do you think the measurement of each of these indicators is?
(1=Not reliable at all, 5=Very reliable)
50%

40%

30%

20%

Exhibit 9
10%

0%
1 5
2 3 4
Not at all Very reliable
% Response 0% 3% 10% 43% 44%

Exhibit 9
How consistent do you think the measurement of each of these indicators is?
(1=Not consistent at all, 5=Very consistent)
60%

50%

40%

30%

20%

10%

0%
1 5
2 3 4
Not at all Very consistent

% Response 0% 3% 4% 43% 49%

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From the survey it is clear that those few companies that decide to report on HC measures, choose
a few relevant and useful metrics that have a link to profitability and can be used as an internal
management tool and use them consistently and reliably.

4.5 Obstacles to Human Capital Measurement and Reporting

There is a big difference between reporting externally and internally. While many companies
measure their Human Capital to some extent, not many report it company-wide and very few
report externally through annual reports or other publications. Some managers can come to terms
with reporting internally to employees but not externally. The truth is that it not a common
practice to measure and report on HC either internally or externally and the reasons for not doing
so are pretty similar for both cases. Drawn from our survey and interviews with HR professionals
and similar research in North America36, we have put together a list of cited obstacles that make it
difficult to report.

Not something that can be shared externally: The main obstacle for reporting externally is that
the information reported could be sensitive and not something that can be shared externally. This
could be because the information may give important insight to competitors or potentially could
be negatively interpreted by external stakeholders such as financial analysts, unions, employees,
etc. Managers surveyed recognised that the data is not complicated to report, but is commercially
sensitive to report. They express concern that some of this information is about sources of
competitive advantage and thus would not be appropriate for external reporting.

Measurement not first priority for the Company: Other more important HR activities are viewed
as more important or critical. Especially in difficult times, other more urgent tasks can absorb all
of the HR department’s resources, such as downsizing or coping with employee relation
problems, etc. It is well known that most Human Resource departments deal mostly with
administrative issues regarding personnel. Indeed, in many companies contacted, the department
was called ‘Personnel Department’. As Human Resource Management is a company-wide
responsibility and not just the HR department’s job, other line managers may focus on the more
immediate priorities and not view HC measurement or even management as important or worth
any effort.

36
Stephen Gates, The Conference Board, “Value at Work: The Risks and Opportunities of Human
Measurement and Reporting”, 2002.

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Not enough time and resources: This ties in a little with the previous point on the priority of
HCM measurement and the following point on the lack of awareness of value in the exercise.
Therefore, if HR managers don’t give it enough importance, senior management will give it even
less importance and resources, leaving no time for measurement.

HR professionals unaware of value / No clear return on investment: Comments like “…it is not
considered that the formal establishment of indicators of performance would add any value”
summarise the thoughts of many managers. Maybe this is because reporting figures wouldn’t be
of any use to external stakeholders or because the figures don’t say anything. In other words,
there is no return seen on the investment and effort required in reporting. Also, some managers
mention that there wouldn’t be value in it until a standard definition for measurement is
established, which is our next point.

Lack of clear guidance and universal practice: A number of respondents to our survey mentioned
that it would be helpful if there were some sort of universal approach to reporting, defining
standards that would allow for valuable and meaningful comparisons. Because there is a current
absence of universal definition, the companies that are proactive enough to measure, do it ‘their
way’. Therefore, differences in criteria could be an issue when benchmarking. This could be
solved if some standards are put in place. Although it is recognised that there has to be room and
freedom for companies to take their own initiatives and adapt their metrics to their industry, there
are some standards that could be put in place to help ‘kick-off’ the practice.

Global and Group issues: Some of the companies interviewed were either a group holding of
many companies or were multinationals. While some of the Group companies did not have an HR
function in their headquarters and left the HR management to each subsidiary, the global
companies had offices in different countries, with some degree of autonomy in their Human
Resource management. In both cases there were issues with integrating the information in the
head office because of differences in requirements either across countries and businesses.

Little support from senior management/Low status of HR: Although thankfully this was not a
recurring theme, it was mentioned and can be an issue in some companies, therefore needs to be
considered. Also there may be cases where the HR professionals lack sufficient ROI knowledge
to be able to make a business case for the use of metrics to senior management. These companies

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that, for one reason or another, still haven’t given this area enough importance would probably
benefit most by a standard setting that would force them to fall in line.

Recapitulating, in order to overcome common obstacles that may hamper reporting, it would help
if there were some common guidance and standards in place to create an initial common core of
indicators, that would serve as a base for comparison and credibility. The approach should be not
too prescriptive, so as to leave some room for initiatives and variability in the relevance of some
metrics across industries. Although some of the information may be non-publishable, this is not
the case with every metric. Some indicators could be of great value if they were reported
externally because they would serve as a benchmark for all stakeholders to compare across
companies, boosting the importance of these measures and winning support for the HR cause.
Metrics that involve diagnostics on the intellectual capital of a company are an indicator of the
long-term health of the company and give better information to long term investors.

There should be a link between each indicator and a key performance driver so that the metrics
used are a valuable and credible diagnosis of the company’s performance and ultimate success of
the business strategy.

4.6 External Reporting

Companies were asked specifically about their experience or opinion on reporting their HC
measures externally. Firstly, they were asked if they reported any of their indicators externally at
all. The majority of indicators used by companies are not reported externally (76%), mainly for
the reasons expressed in the previous section. Exhibit 10

The 24% of indicators that are reported Does the indicator figure in external
reporting?
externally don’t necessarily go into the annual
report and accounts or other publications to the
Yes
investor community. By ‘externally’, some 24%
companies understand sharing the data with
other organisations such as FTSE for Good37 or
No
third party consultants that may be interested in 76%

Human Capital Management or advise

37
FTSE For Good index is a recognised measure of corporate social responsibility among firms listed on the
London Stock Exchange.

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investors. Very few indicators make it to the annual reports and therefore aren’t used or
considered by external stakeholders.

The indicators that are reported externally, are listed below:


• Diversity (gender, nationality) statistics.
• Health and safety statistics.
• Aggregate employee survey results:
o Joiner/leaver survey
o Satisfaction on pay and reward surveys
o Climate/workplace culture surveys
• Recourse to Fair Treatment Systems.
• Quality of leadership based - 360 degree assessment .
• Employee Headcount.
• Work overtime.
• Training spend.

It is worth noting that the indicators that are reported externally have little value to investors
because they are incomplete. Although they may be informative and interesting they do not
necessarily tell the story on the health of the organisation. For example, headcount, overtime and
training spend are useless unless there is a clear link explained on how each of these affect
profitability and competitiveness. Employee surveys and statistics on safety and diversity have to
be understood in terms of what impact do they have on shareholder value. A common core of
indicators that has a known and empirical impact on shareholder value would help educate
investors and external stakeholders.

The companies that do report externally mentioned a number of reasons why they thought human
capital reporting was beneficial:
• Demonstration of commitment to diversity and inclusiveness, health and safety and
respect for employees.
• Achieves buy-in and support from senior level.
• Improves confidence of stakeholders.
• Provides internal benchmarks on which to improve year to year.
• Facilitates prioritising of resources and efforts to improve performance.

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The majority of indicators however are not reported externally although some, it appears, could
become external indicators with a little bit more commitment. When asked if those indicators not
reported externally were difficult to publish, companies responded with mixed and extreme
views.
Exhibit 11
Of those indicators that are not reported externally, how complicated would it be to
report them externally? (1=Very straightforward,5=Very complicated)
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
1 5
2 3 4
Straightforw ard Very Complicated

% Response 39% 9% 13% 14% 25%

Some indicators are considered to be complicated to report externally but for a fair number it is
considered to be straightforward. The indicators that are considered complicated to report
externally are listed in Table 3. Those indicators considered straightforward to report externally
are listed in Table 4.

There is an overlap between some indicators in the two tables because some indicators such as
turnover, absence, survey results, profit per employee, employee costs and employee satisfaction
are considered simple to report by some companies and complicated by others.

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Table 3
Indicators considered complicated or very complicated to
report externally:
% appraisal completion
Customer complaints and compliments
Employee turnover ( voluntary leavers )
Employment costs - revenue ratio
Leadership talent pool (LTP) - Numbers by current grade,
global region, nationality, gender, estimated development
potential
LTP - Senior executive job cover over next 2 yrs
LTP - Numbers with senior executive potential aged<40
LTP - Resignations, mature recruits, new grad recruits
Mistakes
Pay drift analysis
Profit per employee
Staff Headcount analysis
Staff surveys Very complicated
Technical/specialist skill pools Complicated
Absence / Sickness levels
Employee satisfaction measures
Exam passes
Performance Ratings
Productivity measures (activities per person per hour, etc.)
Training ROI
Training Spend

Table 4
Indicators considered straightforward to report
externally:
Absence statistics
Average Remuneration
Employee Satisfaction
Employee Surveys
Employee Turnover
Cost per Employee
HR Staff per employee
Profit per Employee
Revenue per Employee
Wealth Created per Employee
Workforce profile
Staff with professional qualifications
Training days per employee

However there is a common group of indicators mentioned most commonly, considered


straightforward to report externally, which include employee turnover, absence levels, employee
satisfaction, revenue per employee and some forms of survey.

In general, HR managers agree that externally reported indicators would have to reflect the
particular values of the organisation and speak more generally about being a responsible

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employer. Among the most relevant ones, measures that reflect employee satisfaction were
suggested as the most appropriate to report externally because it is relevant to every business,
whatever the size of the workforce. Also, most people can relate to it.

4.7 HC measures for Investors

HR professionals tend to be pessimistic about the investors’ interest in HC data. They believe that
investors determine the company’s market value by its product, market strategy and results. They
are not too sure how investors would actually use HC measures and incorporate them into their
decision models. One manager explained that investors in the City do get talking to them about
these things when they make presentations, because most of them realize there are some very
simple principles that dictate which companies are successful. However, they don’t
systematically ask, in the way that they would ask about returns, cash flow, NPV on certain
projects.

Nevertheless, there is a growing interest from the investment community in HC issues.


Particularly, pension funds and social responsibility investors are some of the ones paying more
attention nowadays to social, environmental and ethical (SEE) criteria. In the UK, a social
responsibility index has emerged – FTSE for Good – that selects companies for eligibility based
on SEE criteria.

Recently, some events have encouraged pension funds to pay closer attention to HC reporting in
the UK. Legislation passed in 2000 requires all pension funds to declare whether they consider
SEE matters in making their investment decisions. According to a survey on the 500 largest UK
pension funds, 59% of funds are incorporating socially responsible investment (SRI) principles
into their investment process, either via the fund manager, or through engagement, or both. These
funds represent 78% of the assets surveyed38.

Pension funds and social responsibility investors may not be using HC metrics to adjust their
cash-flow valuations yet, but as evidence presented in the first part of this report on the link
between HC practices and shareholder value suggests, there should be a growing number of these
investors beginning to use the HC information, either directly or through SRI indexes, to screen
out companies that do not meet SEE criteria.

38
UK Social Investment Forum, Eugenie Mathieu, “Response of UK Pension Funds to the SRI Disclosure
Regulation”, October 2000. (http://www.uksif.org/Z/Z/Z/lib/2000/10/reprt-pf-discl/index.shtml)

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5. CONCLUSIONS

Although Human Capital is widely considered one of the most critical inputs in a company, and
the effective management of this resource has a positive impact on competitiveness and
profitability, very few British companies are actively measuring and reporting Human Capital. It
is common for HR departments to be engaged in more administrative tasks such as hiring or
downsizing and managing employee relations to some extent, while Accounting departments are
not trained and do not have the experience to measure and report on Human Capital. During
periods of boom and recession these tasks seem to take up more time, leaving little time for more
proactive management.

Academic research and managers’ intuitive knowledge coincide in that effective HC management
leads to improved profitability and competitiveness. Measuring and reporting on HC is however
less of a unanimous contemplation. Some companies have taken the initiative to measure
different aspects of their HC management, usually choosing popular indicators such as turnover,
employee satisfaction through surveys, absentee statistics and profit per employee. Although for
other companies currently not measuring, this kind of exercise is not the first priority, there is a
group going through the initial stages of defining their measurement system.

Currently, although indicators are used internally there is very little practice in reporting
indicators externally. Only a few respondents mentioned that they did this and these are usually
targeted at external consultants, employees and prospective applicants.

There are a number of obstacles cited for not reporting, such as “information too delicate to share
externally”, “company has set other priorities for HR”, “lack of time and resources”,
“unawareness of value in reporting” and “lack of clear guidance and universal practice”, among
others.

The benchmarks used for indicators vary across industry sectors. Employee turnover, for
example, can have higher rates in some sectors than in others. Clearly, there are certain measures
that are more appropriate for some sectors and some that are not.

According to most respondents, it would help to have a standard in place that would help kick-off
the initial practice of reporting and guide all companies into reporting a common set of metrics

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that would be then worth comparing. Unless measures are made compulsory, companies will
continue to follow their own initiatives and criteria, generating a whole variety of incomparable
indicators. Whatever the measures are, there is a consensus that these standards be kept simple.
Having too many measures can confuse and deter users. Also, indicators should measure what is
strategically important. The indicators should be linked to a key performance driver that is linked
to both the HR and business strategy and ultimately, shareholder value. ‘Lead’ and not ‘Lag’
indicators tend to be the most helpful ones in this sense.

As benchmarks can vary across industries it may be preferable to define different groups of HCM
measurement. Then companies can be broken down by industry or similar sectors (e.g.
Metals/Mining, Chemical/Plastics, Oil/Gas/Power, Pharmaceuticals, Engineering services, etc.)
and assigned to a group. Common metrics could then be assigned to each group.

The idea of implementing a single index such as the Watson Wyatt HC Index or something
similar may be an interesting alternative. It may be preferred to indicators as it preserves
confidentiality and is of easy interpretation, like the ranking in Fortune or like Credit Ratings.

As investors grow more interested in the HC and Corporate Social Responsibility issues and
research continues globally to assess the value of reporting, it seems there should be some
convergence soon towards a natural need for standard Human Capital indicators on the
companies’ reports.

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6. APPENDICES

Appendix 1: Seven Steps to Making HR a Strategic Asset

(excerpted from The HR Scorecard: Linking People, Strategy and Performance39)

Step 1: Clearly Define Business Strategy. Our focus on implementation assumes that a consensus strategy
exists and that it can be clearly described and communicated to the entire organization.

Step 2: Build a Business Case for Why and How HR Matters for Strategy Implementation. HR will
only become a strategic asset when both line managers and HR professionals assume a shared
responsibility for implementing strategy. For this to happen, both parties need to have a common
understanding that HR’s strategic value is linked to the extent to which it directly contributes to better
strategy execution.

Step 3: Build a Strategy Map Describing the Causal Flow of Strategy Implementation. A strategy map
takes what tends to be an externally focused vision in Step 1 and links it to an internal roadmap that
“show(s) how an organization plans to convert various assets into desired outcomes.”1 It is an essential part
of managing HR as a strategic asset because it provides the basis of aligning the HR Architecture with the
firm’s strategic drivers. It provides the organizational logic that transforms HR from a transaction and
operationally oriented function to an organizational asset with strategic impact.

Step 4. Link HR Architecture to Strategy Map. This may be the most important step in transforming HR to a
strategic asset. The term HR Deliverable is just a short-hand term for the outcomes of the HR Architecture
that directly drive successful strategy implementation. The question is where in the HR Architecture to
locate the HR Deliverables? Should we focus on employee performance and behaviors, or the drivers of
those behaviors? We believe those HR Deliverables should focus on employee performance behaviors
because they most directly influence the strategic goals of line managers.

Step 5: Design HR System in Alignment with HR Deliverables The strategic behaviors in the
Organization (HR Deliverables) are driven by competencies, motivation, work structure, strategic focus,
etc. Therefore, the HR system (recruiting, selection, compensation, rewards, career development, etc,) must
be focused on those behavioral drivers. The result is an HR system that is both externally aligned with the
requirements of the strategy map, and internally aligned among the various elements of the system.

Step 6: Design HR Strategic Measurement System (The HR Scorecard) Steps 1-5 lay the foundation for
managing HR as a strategic asset. Next the organization will need a measurement system that will not only
guide that management process, but also validate HR’s contribution to firm performance. We use the term
HR Scorecard because it is designed to extend the concepts of the Balanced Scorecard to an organizational
asset, in this case the HR Architecture. In other words, based on Steps 1-4 above, there is a very clear logic
that links the strategic results for the HR Architecture with the ultimate financial success of the
organization.

Step 7: Implement Management by Measurement. Managing HR as a strategic asset will be a


significant change initiative for most organizations. It will require a new perspective on HR, as well as
acceptance this new role, by both line managers and HR professionals. Senior line managers need to
understand that if the organization is going to reap the benefits making people “our most important asset”,
implementation of the HR Scorecard needs to be approached as a major change initiative. Ultimately the
success of this initiative will turn on whether the people in the organization who are charged with
implementing the firm’s strategy, understand the logic of the strategy’s execution, and their role in that
logic.

39
Robert S.Kaplan and David P. Norton, “Having Trouble with Your Strategy? Then Map It”, Harvard Business
Review, September-October 2000, p. 169

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Appendix 2: Questionnaire

Key Indicators Used for Human Capital Management Reporting

1) What makes the indicators your organisation uses ‘key’? (one example may be
linkage of management practice to corporate strategy, etc.)

2) Were they developed within a conceptual frame of reference related to key


businesses/management processes?

3) Were the indicators developed by the HR function alone or in conjunction with


others (example: finance or strategy colleagues)?

4) What (if any) indicators do you not currently use but think you could/should?
Why?

5) How important is it to link indicators with profitability?

6) Would there be value in the development of standardised measures for general


use/use across sector?

7) How was it decided which indicators to include in external reporting, if any?

8) Do you consider that there is a common core of indicators on which all companies
should report?

9) How have stakeholders responded to external reporting of Human Capital


measures?

10) Do different stakeholders attribute different priorities to different indicators?

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Appendix 3: Survey

SURVEY ON HUMAN CAPITAL MANAGEMENT REPORTING

Please complete the following information on the Company Profile:

Name of Company:

Industry sector:

Year Company was -


founded:

Number of employees: -

Frequency of Company -
Reporting:

1. Please list the key indicators of effective HCM that your organisation uses.
(Please fill in as many of the following boxes as possible)

(Example: Employee Turnover).

Indicator A:

Indicator B:

Indicator C:

Indicator D:

Indicator E:

Indicator F:

Indicator G:

Indicator H:

42 of 48
2. Please indicate any benchmark measures you use to assess each of these
indicators.

Example: Employee Turnover ___Benchmark: 10%

Indicator A Benchmark:

Indicator B Benchmark:

Indicator C Benchmark:

Indicator D Benchmark:

Indicator E Benchmark:

Indicator F Benchmark:

Indicator G Benchmark:

Indicator H Benchmark:

3. To what extent are each of these indicators associated with company profitability
or competitiveness?

To a
To some Not Not
Indicator A: great
extent at all sure
extent

To a
To some Not Not
Indicator B: great
extent at all sure
extent

To a
To some Not Not
Indicator C: great
extent at all sure
extent

To a
To some Not Not
Indicator D: great
extent at all sure
extent

To a
To some Not Not
Indicator E: great
extent at all sure
extent

To a
To some Not Not
Indicator F: great
extent at all sure
extent

To a
To some Not Not
Indicator G: great
extent at all sure
extent
43 of 48
4. How widely is each of these indicators used as an internal management tool?

To a To Not
Not
Indicator A: great some at
sure
extent extent all

To a To Not
Not
Indicator B: great some at
sure
extent extent all

To a To Not
Not
Indicator C: great some at
sure
extent extent all

To a To Not
Not
Indicator D: great some at
sure
extent extent all

To a To Not
Not
Indicator E: great some at
sure
extent extent all

To a To Not
Not
Indicator F: great some at
sure
extent extent all

To a To Not
Not
Indicator G: great some at
sure
extent extent all

To a To Not
Not
Indicator H: great some at
sure
extent extent all

5. How reliable do you think the measurement of each of these indicators is?
(1=Not reliable at all, 5=Very reliable)

Indicator A: 1 2 3 4 5

Indicator B: 1 2 3 4 5

Indicator C: 1 2 3 4 5

Indicator D: 1 2 3 4 5

Indicator E: 1 2 3 4 5

Indicator F: 1 2 3 4 5

Indicator G: 1 2 3 4 5
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Indicator A: 1 2 3 4 5

Indicator B: 1 2 3 4 5

Indicator C: 1 2 3 4 5

Indicator D: 1 2 3 4 5

Indicator E: 1 2 3 4 5

Indicator F: 1 2 3 4 5

Indicator G: 1 2 3 4 5

Indicator H: 1 2 3 4 5

7. Which (if any) of the indicators figure in the company's external reporting?

Indicator A:

Indicator B:

Indicator C:

Indicator D:

Indicator E:

Indicator F:

Indicator G:

Indicator H:

If external reporting occurs,


what benefits accrue from
this?

8. Of those indicators that are not reported externally, how complicated would it be
to report them externally?
(1=Very straightforward,5=Very complicated)

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Indicator A: 1 2 3 4 5

Indicator B: 1 2 3 4 5

Indicator C: 1 2 3 4 5

Indicator D: 1 2 3 4 5

Indicator E: 1 2 3 4 5

Indicator F: 1 2 3 4 5

Indicator G: 1 2 3 4 5

Indicator H: 1 2 3 4 5

9. Finally, if you do not report on any or all of these indicators, please identify those
factors which might prevent your doing so.

Not enough time

Not enough resources for


measurement

Little support from senior


management

Not something that can be


shared externally

Not viewed as important for


the Company

Other:
(Please specify)

Thank you.
If you would like to receive the aggregated results of this survey from the other FTSE
250 Companies, please give an email address where we can send it to:

Email:

This information will only be processed in accordance with the provisions of the Data
Protection Act 1998 and any other relevant legislation. No further information will be
sent to you unless required.

Submit Reset 46 of 48
7. BIBLIOGRAPHY

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American Society for Training & Development”,
http://www.tu-harburg.de/aw1/newsletter/3/astd_us.pdf

Bernthal, P. and Wellis, R., “Retaining Talent: A Benchmarking Study” DDI, February 2001

Becker, G.S., “Human Capital: A Theoretical and Empirical Analysis with Special Reference to
Education, 1993

Becker, Brian, Huselid Mark, Ulrich, David, “The HR Scorecard: Linking People, Strategy, and
Performance”, 2001

Brown, Mark Graham , “Human Capital”s Measure for Measure”, Journal of Quality &
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Davenport, Thomas, “Human Capital: What It Is and Why People Invest In It”, 1999

http://www.economist.com/research/Economics/alphabetic.cfm?TERM=HUMAN%
20CAPITAL

Eronen, Anne, “HC into the Company’s Balance Sheet?”, Series ETLA B133, Helsinki 1997,
http://www.etla.fi/english/research/publications/searchengine/pdf/abstract/b133eng.pdf

http://www.esrc.ac.uk/ESRCContent/news/oct2.asp

Flamholtz, E.G. and Lacey, J.M., “Personnel Management, HC Theory, and Human Resource
Accounting”, Industrial Relations Monograph Series, No. 27, 1981

Flamholtz, Eric, “Human Resource Accounting: Advances in Concepts, Methods and


Applications” (3rd. Edition), 1999

Galagan, P.A., The Search for Poetry of Work, Training and Development, Oct 1993

Gates, Stephen, The Conference Board, “Value at Work: The Risks and Opportunities of Human
Measurement and Reporting”, 2002

Gratton, Lynda and Ghoshal, Sumantra “Competing on HC”, European Management Journal
2002 Fall

Gratton, Lynda, “Living Strategy: Putting People at the Heart of Corporate Purpose”, 2000

Heskett, James L. , W. Earl Sasser and Leonard A. Schlesinger , “Service Profit Chain: How
Leading Companies Link Profit and Growth to Loyalty, Satisfaction, and Value”, 1997

Huselid, M.A., “The Impact of HCM Practices on Turnover, Productivity and Corporate
Financial Performance” Academy of Management Journal, 38 1995

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Kaplan, Robert S. and David P. Norton, “Having Trouble with Your Strategy? Then Map It”,
Harvard Business Review, September-October 2000

Kaplan, Robert S. and Norton, David P., “The Balanced Scorecard” 1996

Kaplan, Robert S. and Norton, David P., “The Balanced Scorecard – Measures that Drive
Performance,” Harvard Business Review 70, no.1, January-February 1992

Lingle, J.H. and Schiemann, “From Balanced Scorecard to Strategic Gauges: Is Measurement
Worth It?”, Management Review, Mar.1996

Monti-Belkaoui, Janice & Riahi-Belkaoui, Ahmed, “Human Resource Valuation: A Guide to


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UK Social Investment Forum, Eugenie Mathieu, “Response of UK Pension Funds to the SRI
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1999

Smith, Adam, “Wealth of Nations”, 1973, p.103 (originally published in 1776)

Sveiby, Karl Erik, The New Organizational Wealth

UK Corporate Report 1975

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