People Strategies 1

People Strategies By William Huckabee University of Phoenix FIN 711 September 15, 2008

People Strategies 2 People Strategies In all but a very few corporate entities, it is the leaders responsibility to coordinate and engage a firms assets in such a way as to produce superior performance and create a comparative advantage over competitors (Riahi-Belkaoui, 2003, p. 215). Many successfully lead companies are able to achieve these goals; however, there are many companies who have a difficult time even surviving. In fact, the most successful firms have one thing in common; they all employ skilled employees at all levels within the firm (Brigham and Ehrhardt, 2005, p.3). Typically, a firms success can be attributed to their ability to differentiate their product and service offerings through the employment of innovative human capital (Pfeffer and Veiga, 1999, p. 37). According to Pfeffer and Veiga, there is evidence that suggests a strong link between the management of people in an organization and the economic results achieved by the organization (p. 37). The authors suggest further that leaders who engage in high performance management practices have the ability to increase the firms shareholders wealth by as much as $41,000 per employee, or about 14 percent increase in the companys market value premium (p. 39). Nazari and Herreman (2007) support Pfeffer and Veiga (1999) and suggest further that there is a direct link in the relationship between the performance of a firms human capital and financial success (pp. 595-596). One firm, Northrop Grumman Corporation, is pursuing a strategy of investing in its human capital. In the firms 2007 Annual Report, the firm recognizes that its human capital is an asset of strategic importance (Northrop Grumman, 2007, p. 4). According to the firms top leaders, they are implementing a strategic initiative to create the best workplace and best workforce in the industry (Corporate Communications, August 2008: People Strategy Initiatives). In fact, the leadership stresses the importance of this asset to its shareholders and

People Strategies 3 their continuing investments in its human capital and technology to improve shareholder return (Northrop Grumman, 2007, p. 4). Northrop Grumman is a leading Aerospace & Defense company headquartered in Los Angeles, California. The firm employs nearly 120,600 employees, which are geographically dispersed over the Globe (Northrop Grumman, 2007, p. 10). The primary business of the company is information, electronics, and shipbuilding providing products and services to the Department of Defense, which is the companys primary customer and the source of a substantial portion of the companys profits (p. 12). The risk Northrop Grumman faces is associated with the nature of defense contracts. The risk is that the costs estimation of this type of contracts requires significant judgment and expertise and according to Northrop Grumman (2007), the cost growth associated with defense contracts is affected significantly by several key issues, which include 1) the unavailability of labor, 2) the productivity of labor, and 3) the nature and complexity of the work to be performed, among others (p. 13). As a result, it is important for leaders to determine the best solutions for attracting and retaining the necessary talent to be innovative and competitive in this industry; Northrop Grummans leadership has recognized this as a problem and is taking steps to mitigate this risk (Northrop Grumman, 2007, p. 4). The Aerospace & Defense Industry generated total sales of nearly $329.1 billion in 2007 (Datamonitor, 2008, p. 7). Also, the defense portion of the industry was the most lucrative during 2003 though 2007, which accounted for 81.7 percent of the market (p. 15). The primary reason for this level of lucrativeness in this sector was the increasing demand of the Global War on Terror (p. 15).

People Strategies 4 Also, spending in the United States accounted for nearly 51 percent of the Global Aerospace & Defense spending, and recent industry mergers and a forecasted deceleration in the industrys compounded annual growth rate to 1.2% during 2007 through 2012 will create problems for companies like Northrop Grumman (Datamonitor, 2008, p. 7). With the reducing growth rate, rivalry and competition will be fierce among the leading companies competing for and winning defense contracts (pp. 14-15). In order to survive in this tight industry, companies will be forced to use their human capital to create value through innovation to differentiate their products and services in order to gain new market share and to control the market share that these companies already maintain (p. 15). Finally, with an industry so tight and facing a deceleration of growth over the next four years, will Northrop Grummans People Strategy Initiatives create value for the companys shareholders? Methods Northrop Grummans financial statements were evaluated to determine the extent the companys value for a three-year period beginning in 2003. The result of this evaluation was used to determine the companys financial ratios and to construct charts to visually display the companys financial ratios. Next, a short list of questions was developed to determine the financial ramification of Northrop Grummans human capital problem. These questions were designed to obtain information from senior management about the companys employee attrition rate and the costs associated with attracting new employees. Finally, an attempt to use the Value Added Intellectual Coefficient (VAICTM) as defined by Shiu (2006) to value Northrop Grummans human capital efficiencies (pp. 356-365).

People Strategies 5 Financial Analysis Northrop Grummans financials look good with the exception of the anomalies associated with the firms turnover ratios. In fact, the firms leadership states that the company achieved record sales, operating margin, EPS, and cash flow from operations during 2007 (Northrop Grumman, 2007, p. 3). Figure 1 below describes the firms sales, net income, total assets, and total liabilities in millions of dollars. Figure 2 below describes the firms nearest competitors sales, net income, total assets, and total liabilities in millions of dollars. An inspection of the companys turnover ratios indicates that the firm is a little unstable in controlling the firms days receivables and days inventory. For instance, the firms days receivables had a significant drop in 2004 and then increased to the same levels in 2006, which indicates that the firm is having troubles collecting revenues from its customers. This can be indicative of poor human capital performance, poor product and/or service quality, and poor contract performance, which can all be associated with employee turnover. In fact, OConnell and Kung (2007) suggest that high turnover rates often results in inefficiencies associated with employees not having sufficient experience training new employees (p. 15). Also, according to the authors, errors made by overburden workers are associated with high turnover.

People Strategies 6

Figure 1: Northrop Grumman's financial snapshot.

Figure 2: Northrop Grumman's turnover ratios

In comparing Northrop Grummans financials with Lockheed Martins (2007), Lockheed has more stable sales, total assets, and total liability figures. This is indicative of more stability in the firms human capital (OConnell and Kung, 2007, p. 15). In fact, as described by Lockheed Martins financial in Figure 3 below, the company has increased net income from a negative $1, 046,000 in the seven year period to more than $3,000,000 (Lockheed Martin, 2007). Additionally, when comparing total asset, Northrop Grummans totals assets are well above its liabilities, which indicates that the firm is positioned well when it comes to its financial leverage.

People Strategies 7 Also, Northrop Grummans total liabilities is just a bit lower than Lockheed Martins, however, Lockheed Martins market share is about 2 percent larger than Northrop Grummans, which can account for the increased amount of liabilities (Datamonitor, 2008, p. 12).

Figure 3: Lockheed Martin's financial snapshot.

When looking at other financial indicators to determine the value of a firm, Lockheed Martin (2007) has been more stable over the same period, with steady increases/decreases but seem to normalize around 2004 (see Figure 4 below). By contrast, Northrop Grumman seems to have a problem stabilizing their financials (see Figure 2). For instance, Northrop Grummans key turnover ratios make significant increased and decreases but never really normalize during the evaluated period. This could be an indication of the risks associated with defense department contracts as stated earlier. Here, there could be problems in meeting contract deadlines based on problems associated with employee turnover or productivity, creating huge gaps in the days receivables as well as the accounts receivables turnover ratio.

People Strategies 8

Figure 4: Lockheed Martin's turnover ratios.

The financials for Northrop Grumman suggest a problem with the management of the firms human capital. As suggested earlier, there is evidence that suggests a strong link between the management of people in an organization and the economic results achieved by the organization, which is clearly evidenced here in Northrop Grummans financials (Pfeffer and Veiga, 1999, p. 37). Finally, even though the Northrop Grummans leadership suggest that the firm recognized record sales, operating margin, EPS, and cash flow from operations during 2007 (Northrop Grumman, 2007, p. 3), however, analyzing their financial a little deeper indicates that the company maybe having problems in other areas, such as employee turnover, which leads to product and service quality and productivity issues.

People Strategies 9 Leadership Questions On September 8, 2008, an email was sent to Northrop Grummans Corporate Vice President and Chief of Human Resources and Administrative Officer, Mr. Ian Ziskin, and posed the following questions to him in reference to the implementation of the companys People Strategy Initiatives (W. Huckabee, personal communication, September, 8 2008). The questions were designed to determine the costs associated with employee attrition and to determine Northrop Grummans employee turnover rate, which affects the quality of the companys products and services as well as estimating contracts for their customer. The questions were: 1. Do you feel that creating a change in the workplace and attracting the best workforce will add value to Northrop Grummans financial results? 2. If so, how do you think that this improvement can be measured? Can it be seen on the balance sheet? 3. How do you or others at Northrop Grumman account for the worth of our employees capabilities, or do you know? 4. What is Northrop Grummans employee turnover rate? Is this something that you measure? If so, what to you estimate the cost of employee turnover for Northrop Grumman to be? 5. How do you think that the People Strategy that is being implemented will affect the costs? In response to the above questions, Mr. Ziskin was very helpful in answering most of the questions. According to Mr. Ziskin, Northrop Grumman expects the People Strategy to enhance the companys financials by ensuring that the company is able to attract, develop, and retain the best workforce we can (I. Ziskin, personal communication, September 9, 2008). Also, he states

People Strategies 10 that retention especially, is key and that a lower attrition rate means a more stable and experienced workforce and lower cost[s] to hire and replace the [workforce] (I. Ziskin, personal communication, September 9, 2008). A stable work environment is the key to implementing any other programs to enhance the human capital assets of the firm. For instance, employment security is an important dimension and it is fundamental to the implementation of other high performance management practices, and according to Pfeffer and Veiga (1999), job security and the careful and consistent consideration of an employees skills and abilities are two important tools that can be used to improve productivity and reduce employee turnover (pp. 40-41). Mr Ziskin also stated that the Northrop Grummans attrition rate is 9 percent, but for those employees that have been with the firm less that three years, the attrition rate is about [18 percent] (I. Ziskin, personal communication, September 9, 2008). Furthermore, he puts the average cost of attrition per year at 150 percent of a persons salary, which averages out to be $100,000 per person for every person who [leaves the organization and needs to be replaced] (I. Ziskin, personal communication, September 9, 2008). Furthermore, Mr. Ziskin states that Northrop Grumman hires between 14,000 and 16,000 people each year which drives up operating costs dramatically (I. Ziskin, personal communication, September 9, 2008). Using these figures, that puts the Northrop Grummans costs between $1.4 and $1.6 million per year just to attract a competent workforce (I. Ziskin, personal communication, September 9, 2008). According to OConnell and Kung (2007), employee turnover is one of the most persistent problems organizations are facing and it is very costly, as evidenced with Northrop Grummans costs above (p. 14). Furthermore, the Bureau of Labor Statistics, as cited in OConnell and Kung (2007) suggests that replacing and employee costs a corporation in excess

People Strategies 11 of $13,000 in a typical industry, but the article also suggests that an information technology worker can cost a corporation as much as $20,000 per employee to replace (pp. 14-16). Also, Mr. Ziskin states that the firm does not maintain information related to the value of employees capabilities or capacities, so there is no revealing way for Northrop Grumman to determine what value the corporations human capital assets (I. Ziskin, personal communication, September 9, 2008). Finally, Mr. Ziskin stated that the People Strategy should help [the company] reduce the attrition rate and keep the best [qualified] people; [only] time will tell if we are right (I. Ziskin, personal communication, September 9, 2008). Value Added Intellectual Coefficient Shiu (2006) suggests that in a knowledge economy such as ours, there is a need to formulate alternative theories on accounting for, and determining the value of intellectual capital performance (p. 356). Furthermore, the authors suggest that accounting methods like the human resource accounting method, the intangible assets monitoring method, as well as eternal measures including market to book value and Tobins Q, among others (p. 356). Shiu, suggests that a new accounting tool, the Value Added Intellectual Coefficient (VAIC) is designed to help managers leverage a firms assets by providing a standardized and consistent measure for conducting a comparative analysis (p. 357). Furthermore, VAIC is a formula to designed to monitor the efficiency to the firms total resources broken down into it major components with a primary focus of value added and not on financial control (p. 358).

People Strategies 12 As mentioned above, VAIC is broken down into several components to determine the value of intellectual capital (Shiu, 2006, pp. 357-360). According to Shui (2006) these components are: 1. Capital employed efficiency (CEE), which is an indication of the total efficiency of the capital employed. 2. Human capital efficiency (HCE), which is an indication of the total efficiency produced by the human capital. 3. Structural capital efficiency (SCE), which is an indication of how efficient the structural capital is performing (p. 359). Written out the formula is: VAIC = CEE + HCE + SCE Table 1 below displays the components of VAIC, their mean, standard deviation, minimum, and maximum values for each component. The mean of the VAIC is 11.8641 with it minimum and maximum being .2123 and 1.9114 respectively. This suggests that Northrop Grumman creates $11.86 of value for every dollar of capital invested. The mean of the HCE is 9.3963, which suggests that the firm creates $9.39 of value for every dollar invested in human capital (Shui, 2006, p. 361). Moreover, the mean of the CEE is .79, which suggests that for every dollar of capital invested, the firm earns $0.79 in value added. This is significantly lower than the previous two ratios, which indicates the firm has a long way to go before recognizing an efficient return on their invested capital. Finally, the mean of the SCE is 1.6695, which indicates that the firm is recognizing a $1.66 return for every dollar invested in it structural capital. Although not as significant as the firms human capital efficiency, the firm is employing this asset fairly efficiently; there is room for lots of improvement, however.

People Strategies 13
Variable CEE HCE SCE VAIC N 7 7 7 7 Mean 0.7983 9.3963 1.6695 11.8641 Std Dev 0.0093 0.1390 0.0812 0.2132 Minimum 0.0093 0.1390 0.0812 0.2132 Maximum 0.1321 1.4796 0.3241 1.9114

Table 1: Descriptive statistics (table adapted from Shiu, 2006, p. 361).

Results As a result of investigating the components of the results the calculations of VAIC (Figure 5 below), there is a direct correlation of Northrop Grummans human capital efficiency and the total VAIC. This positive correlation indicates that if the firm continued to develop employee programs that it would have a positive impact on the firms financial outcomes. The firms capital employed efficiency in negatively correlated to the firms VAIC, which indicates that the firm in snot employing its invested capital sufficiently to improve their financial outcome. This suggests that the firms leadership should look for more efficient ways of investing it capital for adding value to the firms shareholders. The firms structural capital efficiency seems to be positively correlated with the firms VAIC. This indicates that the firms structural capital is employed efficiently; however, it is significantly lower than the firms human capital efficiency.

Figure 5: Northrop Grummans VAIC and its components.

People Strategies 14 Conclusion This paper set out to determine if Northrop Grummans People Strategy Initiatives was a viable strategy for growing the firms financial outcomes. An analysis of the firms financials for a seven-year period was conducted along with a strong competitor within the Aerospace & Defense industry. The results of the analysis indicates that there are some anomalies in the firms turnover ratios that could be associated with a large employee turnover ratio, which according to some authors is indicative of poor quality products and services, low productivity, and poor contract performance (OConnell and Kung, 2007, p. 14). Using the Value Added Intellectual Coefficient a It has been determined that the firms People Strategy is worth the time and money invested, however, with a $ $9.39 return on every dollar invested in human capital, the firm should look to other areas for improvement. For instance, the firms CEE is relatively low with a mean of the CEE is .79, suggesting that for every dollar of capital invested the firm is only earning $0.79 return in value added. Finally, it is my belief that the firms People Strategy Initiatives is a valid strategy for possible improvement of the companys turnover ratios, productivity, quality, and contract performance, but I also think that the firm should exert some effort in investigating the low CEE ratio to determine where the company can improve in this area of value, with a focus on better capital investment.

People Strategies 15 References Brigham, E., & Ehrhardt, M. (2005). Financial management; Theory and practice.(11th Ed.). United States: Thomson. Collis, D., & Montgomery, C. (2008). Competing on resources. Harvard Business Review, 86(7/8), pp. 140-150. Retrieved September 2, 2008, from EBSCOHost database. Datamonitor. (2008). Aerospace & defense in the United States, pp. 1-34. Retrieved September 2, 2008, from EBSCOHost database. Lockheed Martin. (2007). Investor relations. Retrieved September 9, 2008 from Lockheed Martins Corporate investors relations website. Http://www.lockheedmartin.com/investor.general_infromation/annual_reports.html. Nazari, J. & Herremans, I. (2007). Extended VAIC model: Measuring intellectual capital components. Journal of Intellectual Capital, 8(4), pp. 595-609. doi: 10.1108/14691930710830774 Northrop Grumman. (2007). Investor Relations. Retrieved September 9, 2008 from Northrop Grummans investor relations website. Http:// www.northropgrumman.com OConnell, M., & Kung, M. (2007). The cost of employee turnover. Industrial Management, pp. 14-19. Retrieved September 9, 2008, from EBSCOHost database. Pfeffer, J., & Veiga, J. (1999). Putting people first for success*. Academy of Management Executive, 13(2), pp. 37-48. Retrieved September 5, 2008, from EBSCOHost database. Riahi-Belkaoui, A. (2003). Intellectual capital and firm performance of US multinational firms. Journal of Intellectual Capital, 4(2), pp. 215-226. doi: 10.1108/1469193010472839

People Strategies 16 Shiu, H. (2006). The application of value added intellectual coefficient to measure corporate performance: Evidence from technological firms. International Journal of Management, 23(2), pp. 356-365. Retrieved September 9, 2008, from EBSCOHost database.