New theory explains how employee performance affects to business economics. You can use following tool to analyze your company’s business development potential
Excel tool includes absence, turnover, QWL-Lean and HRM-Performance maturity analyze.
Performance management’s aim is to identify, measure and develop organization performance in all levels and align it with strategic targets. But how to reliably analyze employee performance effect on business performance? This question is important when seeking competitive advantages through human capital productivity. New evidence-based science provides methods to master human capital performance analyze.
First there should be understanding how employees produce economic value. Staff is not only a cost. It is also an investment that may form a competitive advantage. The human resource competitive value is at the intangible human assets. Effective HR-management and HR-development is the key to success. Staff quality of working life (QWL) is a new index that defines employee performance. It is one of the most important HR-management scorecard.
The human capital production function is
R = K * L * TWh * (1 – Ax) * QWL
where R = Revenue [$]
K = Coefficient for effective working time revenue relation, HR business ratio [$/h]
L = Labor capacity in full-time equivalent [pcs]
TWh = Theoretical yearly working time [h]
QWL = quality of working life, indicating human capital intangible asset utilization (0-100%)
Ax = The auxiliary working time of the total theoretical working time (vacation, absence, family leave, orientation, training, HR practices, and HRD) [%]
(1 – Ax) = (100% – Ax) = Time available for actual work (time spent at work)
(1 – Ax) * QWL = Effective working time from the theoretical working time
Production monetary volume is the revenue, and the profit is the revenue minus operative costs. Operative profit (EBITDA) is calculated with following equation
EBITDA = Revenue – Variable Costs – Staff Costs – Other Fixed Costs
where EBITDA is Earnings Before Interest, Tax, Depreciation and Amortization
Next figure illustrates the human capital production function phenomenon at example SME. By improving the quality of working life the company makes 4 000 € more EBITDA per each employee. At the practical case studies we have achieved this level of profit increases.
Figure 1. Simplified presentation of Human Capital Production Function.
Quality of Working Life (QWL) determines the effective working time. The staff effective working time produces the revenue. The coefficient K describes the business area, tangible investments and business logic. QWL improvement requires HR-development time that goes to Auxiliary working time. Thus it reduces the time for work. When you do efficient HR-development you may increase the effective working time. Also, if absence and turnover is high the HR-development may reduce those. This way the annual Auxiliary working time may not increase, and you have good effect on profit.
Analyzing the Quality of Working Life
Critical scientists say that science connecting HRM to business performance is broken (e.g. Fleetwood and Hesketh 2010, Ehrhart et al. 2014). With over-simplification you will damage the reliability and HR-development effect to business performance. Fundamental mistake is to calculate staff inquiry results by using only statistical methods. Staff inquiry questions affect to human performance in different scale and phenomenon. Anxiety will only eat the performance. Creativity will boost the performance, but only if negative feelings are not taking the staff focus. New scientific method solves this problem – it is called the quality of working life index (QWL).
At Hertzberg’s (1958) motivation theory the human performance is hygiene factors multiplied by motivation factors. Hygiene factors cause distress, and motivation factors tend to increase the performance. I have created advanced human performance theory that includes three self-esteem categories which each has unique effect on performance. The self-esteem categories are:
- Physical and emotional safety (PE);
- Collaboration and identity (CI); and
- Objectives and creativity (OC).
Chosen categories and their effect on performance form the theory of QWL index. Theory is internationally verified scientifically. It is also important to know that QWL index have logical connection to customer satisfaction (see Kano 1984).
Figure 2. Self-esteem categories of QWL-index.
The QWL index is calculated using the following equation:
QWL = PE(x1) * ( ( CI(x2) + OC(x3) )/2 )
where QWL is calculated using the quality of working life index (0 … 1)
PE(x1) is the value of the function of physical and emotional safety
CI(x2) is the value of the function of collaboration and identity
OC(x3) is the value of the function of objectives and creativity
The functions of the self-esteem categories are adjusted so that the result is always between 0 and 100% (0 … 1). This way the QWL index is the scorecard for employee performance and human intangible assets utilization.
HR-development effect to business economic
HR-development may improve the profit in two ways: by cost savings and by business profit efficiency. By increasing the effective working time there is possible to make more revenue. More revenue with the same costs increases the profit, thus improves business profit efficiency. Absence and staff turnover cost savings are easy to measure and calculate. Better work efficiency is more difficult but possible. It needs the measurement and analyze of staff quality of working life (QWL). QWL improvement may reduce staff costs and increase work efficiency. You can analyze the effects by human capital production function and by utilizing the people analytics with employee performance.
Usually the possible staff cost savings are only one tenth of the profit increase potential from better work efficiency. For example company can gain 200 $/FTE from absence and turnover cost savings. But, with effective HR-development the profit will increase by 2 000 $/FTE. This is due to strategic HRM-Performance management that will increase the revenue and profit. Concentrating only to staff cost savings will not lead to revenue increase.
Human capital KPI
Human capital KPI consists multitude scorecards. There should be business scorecards, human performance indicators and operative metrics. Operative metrics are for alarms and also gives data for monetary analyze. For example, early intervention discussions starts latest when individual absence alarms. Fiscal analyze indicates that one absence day costs 300 € per day. When revenue produces more profit than the costs from overtime work then the absence is profitable to compensate.
One very good human capital productivity indicator is the HCROI index (Human Capital Return on Investment). It is the gross margin divided by staff costs. Gross margin is the same as sales margin which is revenue minus variable costs. Staff costs are part of fixed costs. It should include employees’ salary plus other staff costs. Staff size should be in Full-Time-Equivalent (FTE). Each FTE cost is Human Capital Cost Factor (HCCF). Important monetary staff performance scorecard is EBITDA divided by FTE. The operating profit (EBITDA) is revenue reduced by all operative costs.
Common human capital scorecards are the following:
- Human Capital Revenue Factor (HCRF): Revenue per employee (Revenue / FTE)
- Sales margin per employee: (Revenue – variable costs) / FTE
- Human Capital Return on Investment (HCROI): Sales margin / Staff costs
- Human Capital Value Added (HCVA): (Revenue – all costs + staff costs) / FTE
- Human Capital Cost Factor (HCCF): Staff costs / FTE
- EBITDA per employee: (Revenue – all costs) / FTE
Revenue per employee indicates the overall staff capacity to create revenue. HCROI is maybe the best purely economic human capital scorecard. It indicates very effectively the change in human capital productivity because positive issues increase the top-numerator and negative issues increase the low-numerator value. Also note that HCVA – HCCF = EBITDA per employee.
There are new so called new generation scorecards that combine business scorecards and human performance indicators. One of these scorecards are introduced by Robert Kaplan: Time-Driven-Activity-Based-Cost. This means the cost of one effective working hour. It can be calculated by the human capital production function:
TDABC = Staff costs / (L * TWh * (1 – Ax) * QWL)
As you can see there is also QWL index at this scorecard. TDABC tells how much one effective working hour costs. Using validated QWL index the accuracy is adequate. There are also one other essential new generation scorecard, which is called Human Resource Business Ratio. It is the same as K-coefficient at the human capital production function. This scorecard tells how much revenue one effective working hour produce:
HRBR = Revenue / (L * TWh * (1 – Ax) * QWL)
This scorecard indicates how competitive is the business strategy and the effect of tangible investments on technology and product development. It is important to know that HRBR is interrelated with QWL. This means that HRBR improvement tends to decrease QWL. Also when QWL is improved (especially objectives and creativity) there arise possibilities to improve HRBR.
Useful links for further studies:
HRM-P learning video: https://www.youtube.com/watch?v=wgPWbGXGXfs
HRM-P Strategic management: Scientific Research Open Access article
Public organizations human capital productivity: IRSPM Conference paper
Leadership DNA by game theoretic approach: Conference paper
HRM-P Artificial Intelligence simulation tool (Best Boss game): http://service.mekiwi.org/playgain/
QWL inquiry tool: https://vibecatch.com/
Ehrhart M. G., Schneider B. and Macey W. H. (2014). Organizational Climate and Culture, An introduction to Theory, Research and Practice. Routledge, New York, USA.
Fleetwood, S., & Hesketh, A. (2010). Explaining the performance of human resource management. Cambridge, United Kingdom: Cambridge University Press.
Herzberg, F., Mausner, B. and Snyderman, B., B. (1959). The motivation to work, Second edition, John Wiley & Sons, New York.
Kano N., Seraku N., Takahashi F., Tsuji S. (1984). Attractive Quality and Must-Be Quality. Hinshitsu: The Journal of the Japanese Society for Quality Control, 14(2), 39-48.
Kaplan, R. S., & Norton, D. P. (1996). The balanced scorecard: Translating strategy into action. Boston, MA: Harvard Business School Press.
Kaplan, R. S., & Norton, D. P. (2004). Strategy maps: Converting intangible assets into tangible outcomes. Boston, MA: Harvard Business School Press.
Kesti, M. and Syväjärvi, A. (2015) Human Capital Production Function in Strategic Management. Technology and Investment, 6, 12-21.
Kesti, M., Leinonen, J., and Syväjärvi, A. (2016). A Multidisciplinary Critical Approach to Measure and Analyze Human Capital Productivity. In Russ, M. (ed.). Quantitative Multidisciplinary Approaches in Human Capital and Asset Management (pp 1-317). Hershey, PA: IGI Global. (1-22)
Kesti, Marko Olavi, Jaana Leinonen and Terhi Kesti. (2017). “The Productive Leadership Game: From Theory to Game-Based Learning.” Public Sector Entrepreneurship and the Integration of Innovative Business Models. IGI Global, 2017. 238-260.
Adjunct Professor HRM-P, University of Lapland
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