The nature of human capital management
The Accounting for People Task Force report (2003) stated that HCM involves the systematic analysis, measurement and evaluation of how people policies and practices create value. The report emphasized that HCM should be regarded as an approach to people management that deals with it as a high-level strategic issue rather than a matter to be left to HR. However, Wright and McMahan (2011: 102) warned that human capital should not be treated as a form of capital owned and controlled by the firm: ‘To do so would miss the complexity of the construct and continue to ignore the “human” in strategic HRM.’
The defining characteristic of HCM is the use of metrics to guide an approach to managing people that regards them as assets and emphasizes that competitive advantage is achieved by strategic investments in those assets through employee engagement and retention, talent management and learning and development programmes. HCM relates HR strategy to business strategy. The concept of HCM is underpinned by the concept of human capital, as explained below.
The concept of human capital
Adam Smith, cited by Schultz (1981: 140), originated the idea of human capital (like so many other economic concepts) when he wrote that: ‘The acquired wealth of nations derives from the acquired abilities of people – their education, experience, skills and health.’ Individuals generate, retain and use knowledge and skill (human capital) and create intellectual capital. Their knowledge is enhanced by the interactions between them (social capital) and generates the institutionalized knowledge possessed by an organization (organizational capital). This concept of human capital is explained below.
Human capital defined
Human capital consists of the knowledge, skills and abilities of the people employed in an organization. As Wright and McMahan (2011: 101) explained:
Each individual in the organization has characteristics that comprise human capital. He/she also engages in the processing of information, interpretation and reaction to that information in making choices about how to feel and behave. The aggregation of human capital, we propose, constitutes the organization or unit’s ‘human capital’.
Human capital constitutes a key element of the market worth of a company. A research study conducted in 2003 by CFO Research Services estimated that the value of human capital represented over 36 per cent of total revenue in a typical organization.
The constituents of human capital
Human capital consists of intellectual, social and organizational capital.
The concept of human capital is associated with the overarching notion of intellectual capital, which is defined as the stocks and flows of knowledge available to an organization. These can be regarded as the intangible resources associated with people, which together with tangible resources (money and physical assets) comprise the market or total value of a business.
Social capital is another element of intellectual capital. It consists of the knowledge derived from networks of relationships within and outside the organization. Social capital has been defined by Putnam (1996: 66) as ‘the features of social life – networks, norms and trust – that enable participants to act together more effectively to pursue shared objectives’. It is important to take into account social capital considerations, that is, the ways in which knowledge is developed through interaction between people. Bontis et al (1999) commented that it is flows as well as stocks that matter. Intellectual capital develops and changes over time and a significant part is played in these processes by people acting together.
Organizational capital is the institutionalized knowledge possessed by an organization that is stored in databases, manuals, etc (Youndt, 2000). It is often called ‘structural capital’ (Edvinson and Malone, 1997), but the term ‘organizational capital’ is preferred by Youndt because, he argues, it conveys more clearly that this is the knowledge that the organization actually owns.
Approaches to people management raised by human capital theory
An approach to people management based on human capital theory involves obtaining answers to these questions:
- What are the key performance drivers that create value?
- What skills do we have?
- What skills do we need now and in the future to meet our strategic aims?
- How are we going to attract, develop and retain these skills?
- How can we develop a culture and environment in which organizational and individual learning takes place that meets both our needs and the needs of our employees?
- How can we provide for both the explicit and tacit knowledge created in our organization to be captured, recorded and used effectively?
Human capital theory helps to determine the impact of people on the business and their contribution to shareholder value. It demonstrates that HR practices produce value for money in terms of, for example, return on investment. It also provides guidance on future HR and business strategies and data that will inform strategies and practices designed to improve the effectiveness of people management in the organization.
Human capital measurement
The role of human capital measurement is to assess the impact of HRM practices and the contribution made by people to organizational performance. Human capital measurement is about finding links, correlations and, ideally, causation, between different sets of (HR) data, using statistical techniques.
The need for human capital measurement
Human capital measurement provides a basis for people management decision-making. It means identifying the people management drivers and modelling the effect of varying them. The recognized importance of achieving human capital advantage has led to an interest in the development of methods of measuring the value and impact of that capital for these reasons:
- People in organizations add value and there is a case for assessing this value to provide a basis for HR planning and for monitoring the effectiveness and impact of HR policies and practices.
- The process of identifying measures and collecting and analysing information relating to them will focus the attention of the organization on what needs to be done to find, keep, develop and make the best use of its human capital.
- Measurements can be used to monitor progress in achieving strategic HR goals and generally to evaluate the effectiveness of HR practices.
- You cannot manage unless you measure.
The need is to develop a framework within which reliable information can be collected and analysed such as added value per employee, productivity, and measures of employee behaviour (attrition and absenteeism rates, the frequency/severity rate of accidents, and cost savings resulting from suggestion schemes).
However, the Institute for Employment Studies (Hartley, 2005) emphasized that reporting on human capital is not simply about measurement. Measures on their own such as those resulting from benchmarking are not enough; they must be clearly linked to business performance. It was established by Scarborough and Elias (2002: x), on the basis of their research, that:
Measures are less important than the activity of measuring – of continuously developing and refining our understanding of the productive role of human capital within particular settings, by embedding such activities in management practices, and linking them to the business strategy of the firm