Building Human Assets

Abstract

The added value created by corporate entities is increasingly dependent on intangible assets. Since human assets account for a significant proportion of company expenditure and company value, a company's real value must incorporate the value of its human assets. Through compensation management, investments, and by appealing to the minds and hearts of employees, a company's human assets can be built to become a significant source of competitive advantage. However, this is not without risk, as there are uncertainties posed by the dynamic nature of companies, markets, and employees. Carefully planned human resource initiatives can help reduce these uncertainties.

Overview

Every company has both hard assets and soft assets. Hard assets, also known as physical or tangible assets, include items such as buildings and machinery, and soft assets include intangible assets like human beings. Business success requires a combination of hard and soft assets.

Human assets consist of a company's employees and their value in terms of the quantity and quality of their knowledge, skills, abilities, competencies, talents, experience and attitudes. Another term for human assets is human capital.

The concept of human assets or human capital initially originated in the field of economics, where it was first used to explain the economic growth of countries. This concept has only in recent decades entered the field of management, thanks to the realization that a greater proportion of the added value created by corporate entities is not dependent on physical assets alone, but is increasingly dependent on other assets.

Companies make investments in human assets: They buy human assets by hiring employees, and they 'make' or 'build' human assets through training, job experience, and so on. A company's human assets are its main sources of 'competencies' and 'capabilities,' and as such, they constitute a valuable strategic asset which is necessary for creating and sustaining competitive advantage. As income generating assets, employees are a form of organizational wealth, with a potential for impacting shareholder value. The actions and professionalism of employees also have an affect on customer perceptions of a company. Given that human assets account for a significant proportion of company expenditure, it is surprising that managers tend to know less about their human assets than they do about other assets of their company.

Human Resource Accounting. Due to the vast significance of human assets, coupled with the recognition that human resources are assets with value, recommendations have been made for human assets to be incorporated into company accounts, a move which gives investors and all stakeholders a better valuation of a company. In response to these recommendations, academics and practitioners in the fields of economics, accounting, human resource management and general management, have been involved in striving to define, evaluate and measure human assets. Their efforts have led to the creation of a sub-field known as human asset accounting or human resource accounting, which is concerned with determining the value of the human resources employed in an organization, to that organization.

Apart from gaining a realistic appraisal of their corporate worth, companies that are able to place value on their human assets enjoy a myriad of additional benefits, including the measurement of the return on investments they make on their employees, and improved decision-making. In addition, valuing human assets helps companies to plan their future employment needs, and it also helps them to generate objective information for making projections for training and management development activities. Once they know the value of their human assets, human resource managers will be able to enlighten managers about the real value of lost skills, knowledge, and expertise. Both companies and investors will be able to understand the factors that drive corporate performance; and companies will be able to identify future sources of value in a competitive business environment. They will also be able to understand how investing in people creates value.

Methods for Determining Human Asset Value. There are several means of determining the value of human assets to an organization. These include the following:

• Economic Value: This approach defines the value of human assets as the present value of that portion of the future earnings of the company, attributed to human resources. Economic value can be calculated through the use of the Discounted Cash Flow model, which tries to predict the future earnings employees will generate, by discounting these cash flows to the present.
• Opportunity Costs: In this approach, the value of human assets is defined as their value (or worth) in their best alternative use.
• Value to the Undertaking: When a company has several cost centers (be they plants, divisions or departments) competing for a particular employee, the employee is assigned to the highest bidder, and the bid price denotes the value of the employee to the company and to the cost center.
• Total Contribution: This approach measures the performance of the company, and the contribution of its human assets to this performance.
• Historical Costs: This approach considers the costs of acquiring, developing, maintaining and utilizing personnel. Personnel expenses are treated as investments and the costs are treated as costs of long term assets, spread over the expected useful period of the investments. If an employee leaves the company before this period is over, the balance when he or she leaves is considered to be a loss.
• Replacement Costs: This involves calculating the estimated cost to the firm for replacing employees with other people of equivalent talents and experience. Like the historical cost approach, this approach also considers the costs of acquiring, developing, maintaining and utilizing the replacement employees.

In the area of human assets, as with all other assets, value determination must be an ongoing activity, since the value of people can appreciate or depreciate. This happens due to several factors: Firstly, people tend to move constantly within their company, as well as between companies. Secondly, the gain from employees is subject to change, as business conditions, technology, company conditions and individuals undergo change.

Further Insights

As they face the challenge of increasing global competition, human resource professionals must ensure that their company's human assets are adding as much value as possible to their products and services. Human resources professionals must build on their human assets by selectively hiring and attracting employees, and motivating them to stay with the company.

Job satisfaction is a key factor for motivating employees to stay in a company. There are five dimensions of job satisfaction: Compensation, supervision, coworkers, promotion, and the work itself.

Building Human Assets through Compensation Management. Pay satisfaction tends to decrease when employees perceive inequity or injustice of pay distribution within a company. Therefore, some employees may be more affected by pay differentials within a company than by pay differentials in the labor market. This creates opportunities for a company to increase job satisfaction through internal changes rather than by competing with other companies. Often, employees will not compare their pay across companies unless they encounter problems with their employers.

Companies are more likely to generate profit from their employees if they practice shared ownership initiatives such as profit-sharing, group incentives, and performance-based compensation. Shared ownership helps to bind employees to their company, and it also encourages employees to align their individual goals with those of the company, since their personal rewards will be linked with company performance.

Levels of Shared Ownership

• There are three levels of shared ownership, the first being at the organizational level. Shared ownership at this level can be effected through means such as stock ownership and profit sharing. The effectiveness of shared ownership at the organizational level is reduced in cases where there are low amounts of profit to be shared; where employees do not have much of a say in company matters, and; where employees can easily cash in their stock. Therefore, shared ownership at the organizational level works best when it is focused on senior, influential employees who have more of a say in decision-making, and who are less likely to dispose of their stock, since any such move might affect overall stock value.
• At the group level, shared ownership is appropriate in cases where production is team-based rather than individual-based, and it should be linked to group-level performance measurement. The smaller the group, the more effective the incentive.
• Shared ownership incentives at the individual level work best when there is ample information in the company to justify giving individual incentives to those whose effort will greatly influence company performance. In these cases, the individual rewards must be highly valued by the recipients.

Building Human Assets through Investments. Companies typically make four types of investments in order to build their stock of human assets. These are:

• Direct expenditures on education
• Direct expenditures on health
• Direct expenditures on internal migration
• On-the-job training

Employees require ample knowledge to enable them to direct their skills appropriately; and they cannot apply those skills if they are not in good health. Poor health leads to unavailability and undesirable attitudes, causing poor job performance.

Employees tend to be impacted strongly by the manner in which management satisfies their knowledge, skill and health needs. On-the-job training is an important success factor: Extensive training has been found to be a key characteristic of the most profitable companies. One may talk of two types of training:

• General training, whose costs are typically borne by employees
• Firm-specific training, whose costs are borne by a company or shared between the employee and the employer

The sharing of training costs is tantamount to an investment in the company on the part of an employee, and it often leads to increased job security for the employee.

Building Human Assets through the Minds & Hearts of Employees. Non-financial dimensions of job satisfaction can be put in place to create a congenial work climate that can be as satisfying as monetary compensation, with low need for maintenance, and low cost. Companies with the best human asset management practices share the following characteristics:

• A Belief in Value for Competitive Advantage: All employees try to ensure that every task adds value in achieving competitive advantage, for instance, by making sure that the work environments portray strongly shared values and as such, promote individual integration and greater employee commitment.
• Long-Term Commitment to a Core Strategy: Everyone in the company understands that success depends on long-term commitment to a core strategy. Any change introduced by management is considered very carefully before being implemented.
• Strong Culture: A strong, widely shared corporate culture and company systems are closely linked and managed for consistency and efficiency in the company.
• Constant and Extensive Two-Way Communication: Management believes that people have the ability to deal with all types of information, both good and bad. All available media are used, and all vital information—including financial and performance information—is shared with employees and other stakeholders.
• Partnering with Stakeholders: There is recognition of the need to partner with stakeholders, both within and outside the company; and there is a need to involve them in decision-making as well as in the design and implementation of new programs.
• A High Level of Collaboration: All functions and sections in the company enjoy a high level of collaboration and involvement, and they receive support to collaborate on new product development.
• Innovation and Risk: Such companies are not afraid to take risks or innovate, or even to make drastic changes—they realize that innovation and risk-taking are absolutely necessary in a volatile marketplace.
• Commitment to Continuous Improvement: Such companies have their systems and processes set up to actively encourage and gather new ideas from all sources.

Building Human Assets through Other Means. There are many other means by which companies can build their human assets, such as through interpersonal relations; a team-based work environment; the nature of the work itself, and; promotion among others. Interpersonal relationships play a large role in job satisfaction, since job satisfaction increases with employees' satisfaction with their coworkers. Companies can also decentralize to self-managed teams, thus creating a team-based work environment which can be maintained and nurtured through social activities.

Professionals, especially, have their job satisfaction closely linked to the nature of their work. Companies should therefore endeavor to motivate their professionals through creative job design. Promotion is another tool for enhancing job satisfaction. Companies can structure the career paths of individual employees, offering job assignments as rewards. Other non-financial sources of job satisfaction include employment security, and reduced status distinctions and barriers.

Making Human Assets a Source of Competitive Advantage. Companies cannot gain sustainable advantage simply by having talented employees: In order to have sustained competitive advantage, apart from using the typical financial, strategic, and technological means, companies must work on establishing their organizational capability, which is the ability to generate commitment from the human assets in the organization. Without commitment, there will be high employee turnover.

When companies set up systems of human resource practice that are difficult to replicate or imitate by their competitors, their employees are less likely to leave. They can seek to achieve this through their corporate culture, work climate, congenial interpersonal relations, and teamwork.

Creating Firm-Specific Employees. Companies should equip their human assets with a stock of special skills, knowledge, routines, and/or personal relationships that are unique to their organization, thus creating firm-specific employees. According to Kulkarni & Fiet (2007), a company and its specialized employees are mutually dependent on each other, and one of the ways in which a company can foster this mutual dependence, is through training. Companies that make firm-specific investments in training should share training costs and benefits with their employees. Employees who have received such firm-specific training would lose out if their job contracts are terminated, since their firm-specific skills would be less valuable to another company. As such, employees endowed with firm specificity have less incentive to leave their employers, and likewise, companies have less incentive to let them go. This applies most to senior management: Offstein (2006) proposes that the greater the capacity of the human assets in the top echelon, the greater the competitive advantage of that company.

General Human Assets. General human assets—those employees with general skills and knowledge—on the other hand, have the potential for high turnover, since their skills can be easily traded on competitive labor markets. Fortunately, though, even for general human assets, there are some means of alleviating turnover problems, such as increasing pay, making work challenging, and offering firm-specific compensation.

Firm-specific knowledge can be enhanced by creating unique equipment, processes, teams, and/or communication. Firm-specific promotion opportunities should also be put in place. Shared governance is also a valuable initiative—it increases employee participation and information sharing, thus increasing job satisfaction. Such strategies help to reduce—though not completely—the risk of employee turnover.

Issues

Risk & Risk Reduction. There are risks associated with building and investing in human assets: Like all other assets, their future value or future return can be uncertain. Companies, the market, and employees themselves, are all potential sources of uncertainties in the area of human assets. Through human resources practices, companies can help reduce the costs and/or reduce the uncertainties of human assets.

Uncertainty of Returns. As stated above, the value of human assets can depreciate or appreciate, and so too can the value they generate for the company. These types of human asset risks are termed uncertainties of returns. When faced by high levels of uncertainties of returns, companies can invest more in growth and learning opportunities, for instance; training for new skills and improved learning abilities. They can also increase selectivity when recruiting employees with broad-based skills; and they can also introduce skill-based pay. Such interventions will help lower and manage the risks of obsolete skills, as well as the demand for future skills.

Uncertainty of Human Assets. Companies can be responsible for causing uncertainties of human assets. For instance, a change in strategy can lead to changes in job responsibilities, and it can also lead to sudden demands for skills not possessed by employees. Uncertainties of combination are created by the risk of employees being wrongly matched to their job responsibilities, due to variations in demand and supply.

Uncertainty of Combination. Uncertainties of combination can be reduced through job rotation and team-based work. Through job rotation, employees develop multiple and flexible skills and behaviors by being rotated among different types of jobs. Team-based work achieves similar results by ensuring that employees move among temporary teams formed for particular projects or jobs.

Uncertainty of Cost. Uncertainties of costs are concerned with variations in the ratio of total expenditure on human assets to company revenues, caused by changes in company performance and remuneration. In such cases, variable compensation plans, performance-based incentive plans, and defined contribution pension plans, may be used to prevent and restore imbalances in the ratio of total expenditure on human assets to company revenues.

Market Changes. The market can also cause changes in business conditions, customer needs and competitor actions. These can lead to fluctuations in the supply and demand of suitable potential employees from both within and outside the company. External changes can also lead to skills obsolescence, as employees face a lack of present or future skills.

Employee Nature. Uncertainties are brought about by the nature of employees themselves, since a company does not have control over individuals: Unlike other assets, human assets have control over themselves. As such, individual employees make behavioral choices which are sometimes unpredictable. Employees may decrease their performance, making them less fitting for a particular job, thus causing a loss in productivity.

Uncertainty of Volume. The risk and reality of employee turnover leads to uncertainties of volume, counteracting efforts to build human assets, and as such, any company committed to building human assets must strive to reduce turnover. This can be done through the means discussed above, including offering highly competitive pay; employee stock options, participation programs, voice mechanisms like grievance procedures and suggestion schemes, attractive benefits packages, and flexible work arrangements. Those companies that have very critical uncertainties of volume should endeavor to alter their operating scales and timing, so that they utilize contingent, part-time and contractual employees when necessary.

Options. In order to be able to proactively manage uncertainties and respond immediately to change, companies must develop 'options,' which are investments in assets that provide the capability to respond to unplanned future changes, and to manage uncertainty. It is important, however, that every option, program or package that is developed to build human assets must fit in with company strategy; must be affordable to the company; and must be perceived as valuable by the employees.

Terms & Concepts

Competitive Advantage: A gain that a firm has over its competition, causing it to generate higher sales or margins and/or retain more customers than its competition.

Discounted Cash Flow Model: A model which tries to predict the future earnings employees will generate, by discounting the future cash flows to the present.

Firm-Specific Employees: Employees with a stock of special skills, knowledge, routines, and/or personal relationships that are unique to their company and not easily transferable to other companies.

General Human Capital: Employees with general skills and knowledge.

Hard Assets: The physical or tangible assets of a company.

Human Assets: Also known as human capital, human assets are a company's employees and their value in terms of the quantity and quality of their knowledge, skills, abilities, competencies, talents, experience and attitudes.

Options: Investments in assets that provide the capability to respond to unplanned future changes, and to manage uncertainty.

Organizational Capability: The ability to generate commitment from the human assets in an organization.

Performance-Based Compensation: Comparatively high compensation dependent on organizational performance.

Soft Assets: The intangible assets of a company.

Uncertainties of Combination: Uncertainties about employees and their job responsibilities being wrongly matched due to variations in demand and supply.

Uncertainties of Costs: Uncertainties regarding changes in company performance and changes in remuneration, and the resultant variations in the ratio of total expenditure on human assets to company revenues.

Uncertainties of Returns: Human asset risks concerning depreciation or appreciation in the value of human assets, and in the value they generate for a company.

Uncertainties of Volume: Uncertainties regarding employee turnover.

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Suggested Reading

Cherian, J., & Farouq, S. (2013). A review of human resource accounting and organizational performance. International Journal of Economics & Finance, 5(8), 74-83. Retrieved November 15, 2013, from EBSCO online database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=89867866&site=ehost-live

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Fitz-Enz, J. (1997). The 8 practices of exceptional companies: How great organizations make the most of their human assets. New York: American Management Association.

O'Reilly, C., & Pfeffer, J. (2000). Hidden value: How great companies achieve extraordinary results with ordinary people. Boston: Harvard Business School Press.

Pfeffer, J. (1994). Competitive advantage through people: Unleashing the power of the work force. Boston: Harvard Business School Press.