The Financial Value of Talent

Management

A thoroughly referenced research paper from 2002

Companies that want to grow and improve their

systems and processes must focus on the people
practices that allow or foster that growth and
improvement. The best practices are known. The
key variables (leadership competencies, experience,
skill, interest, rewards) that motivate people to
succeed have been identified and successfully put
into practice. Talent management is no longer a
cutting-edge field being solely tapped by pioneers. It
is a viable path toward improving organizational
performance.

Contents

• Increase Revenue
• Customer Satisfaction
• Improve Quality
• Increase Productivity
• Reduce Cost
• Reduce Cycle Time
• Increase Return to Shareholders & Market Capitalization
• Conclusion
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Integrated, strategically aligned human capital asset management systems have provided
significant economic benefits to companies that have embraced them as ongoing
processes instead of one-time events. Research done on the value of such systems to
companies consistently finds benefits in these seven critical economic areas: revenue,
customer satisfaction, quality, productivity, cost, cycle time, and market capitalization.
This research clearly shows that adopting and investing in best-practice talent
management systems results in bottom-line improvement in each of these key areas.

Increase Revenue

It was initially thought that companies that make more money were associated with better
talent management practices only because they could afford them (.19 correlation), but
the 2001 Watson Wyatt Human Capital Index Study showed that talent management
practices actually increase financial performance (.41 correlation).1

According to Watson Wyatt’s research2 15% of profit performance is driven by:

• Management participation
• Open management style
• Taking some risks, but not too many
• Top managers spending 20% of time with customers
• Around 20% of top management should be outsiders
• Management training is deemed important
• Top managers are effectively incentivized
• Succession planning is done
• A good appraisal system is in place
• Employees get feedback

In addition to supporting Becker and Huselid’s 1998 results, the 2001 Watson Wyatt
Human Capital Index study showed precisely which HR practices have an impact on the
bottom line. 49 specific HR practices across 6 dimensions played the greatest role in
creating shareholder value. The research quantified exactly how much an improvement in
each practice could be expected to increase a company’s market value. For example, a
company that makes a significant improvement (one standard deviation) in all of the
practices categorized under “Total Rewards and Accountability” should see its value
improve by 16.5 percent, and a significant improvement in 43 key HR practices is
associated with an increase of 47 percent in market value. Results included:

• 16.5% impact on company market value from total rewards and accountability
• 9% impact from a collegial, flexible workplace
• 7.9% impact from recruiting and retention excellence
• 7.1% impact from the integrity of communications
• 6.5% impact from the implementation of focused HR service technologies
• 33.9% loss from non-prudent use of resources
Careful inspection of all the data shows that for every available correlation calculated
over time, the relationship between past HR practices and future financial performance is
stronger than the relationship between past financial outcomes and future HR practices.
This is the first study to show that HR practices actually increase financial performance
(.41 correlation) instead of inferring that companies that make more money can afford
better HR practices (.19 correlation).3

Given companies of comparable size, those who’s CEOs exhibited more emotional
intelligence competencies showed better financial results as measured by both profit and
growth.4

The divisions of leaders with a critical mass of strengths in emotional intelligence

competencies outperformed revenue targets by a margin of 15-20 percent.5

Customer Satisfaction

Knowing and using the critical competencies associated with success creates results.

The 1998 Watson Wyatt study, Competencies and the Competitive Edge6, showed that
when an organization identifies and communicates the core competencies that it needs to
be successful in the present and the future, it has developed a powerful tool to help meet
its goals. Competencies define and communicate an organization’s strategy and help
employees to understand that strategy and achieve its goals. The many roles that
competencies can play in an organization include:

• Articulating what the organization values

• Providing a common language for employees and managers to describe value
creation
• Establishing a new paradigm for human capital management programs
(organizational levers)
• Focusing on the development of the individual instead of an organizational
structure
• Linking pay, promotions and growth directly to what the organization values to be
successful
• Guiding employees and managers to what is expected and how value is defined
even in times of dramatic change and restructuring

Competencies serve as a powerful communication vehicle to focus all members of the

organization on the skills and activities that will create both value and wealth.
Competency-based programs can make a difference to the bottom line. Analysis of the
financial data clearly shows that companies with competency- based programs perform
better in the marketplace. Such programs help focus the organization and all the
individuals in it on what they can do to add value to the organization.

Contributions are role-related rather than position-related. Adopting this view of

contribution to value will help organizations think differently about their human resource
and development programs. Organizations can focus on competencies needed for the
future and identify the roles that employees do and must play.

Programs that build employee commitment can bring great returns. Data from this and
other Watson Wyatt studies clearly demonstrate that both individual and organizational
performance increase when employees are committed to their companies. Ensuring that
organizational levers that build employee commitment are in place and working will
affect the bottom line. This was most notable when the competencies focused on
attributes and behaviors that promoted customer satisfaction.

Training is important, but it is no substitute for good management. A large majority of

the organizations participating in Watson Wyatt’s study7 identified training and
development as the driver of future corporate success. The high-performing companies
identified it slightly more often than the others.

Putting people first by adopting high performance management practices translates into
improved morale, more innovation, better customer service, higher productivity, greater
cost reduction, greater flexibility, and increased skills development.8

Improve Quality

Motor vehicle manufacturing firms implementing flexible production processes and

associated practices for managing people enjoyed 47 percent better quality and 43 percent
better productivity than firms relying on traditional mass-production approaches,
according to a worldwide study by Wharton School's John Paul MacDuffie.

Overall financial performance improved 3.8% per year for ten years when companies
stayed with traditional talent management practices, 6.8% when they realized they
needed to re-design their talent management practices, and 10.1% when they launched a
completely new talent management system

.9

Watson Wyatt’s 2002 European Human Capital Index study10 shows that 36 key human
capital variables (practices and policies) are associated with an almost 90% increase in
value.

Increase Productivity

Initial research11 on 740 companies’ HR practices found that those using high
performance work systems (HPWS are defined as integrated talent management
practices) had economically and statistically significantly higher levels of company
performance. One standard deviation of improvement on their bell curve of integrated
talent management systems was associated with changes in market value from $15,000 to
$60,000 per employee.
Employee productivity was calculated as the logarithm of net sales per employee using
gross rate of return on assets (GRATE), which is less sensitive to depreciation and other
non-cash transactions, and Tobin’s q, a future-oriented and risk-adjusted capital-market
measure of performance that reflects both current and anticipated profitability and often
mirrors the price that the market will pay for intangible assets (goodwill).

Further research that included three US surveys and the experience of more than 2,400
companies continued to show significant impact of systems that select, maintain, develop,
and reinforce employee performance on both market-based and accounting-based
measures of company performance (while statistically controlling for R&D investment,
industry market changes, capital improvements, sales growth trends, etc.). Moving from
the 60th percentile of integrated HPWS to the 80th percentile improved market valuation by
$20,000 per employee. This reflects both operational excellence and alignment with the
company’s strategy. When the elements are present, but not aligned with the company
strategy there is a 27% drop off in measured gains.12

Gallup Management Journal13 reported the following in 2001:

•19% of all employees are actively disengaged from their jobs

•55% of all employees are not engaged in their jobs and

•26% of all employees are engaged in their jobs

at a cost of $292-355 Billion per year to the US economy.

Great people management equals great shareholder value: European companies with the
best human capital management deliver around twice as much shareholder value as their
average competitors.14

Reduce Cost

ASTD and SHRM studied15 companies that are renowned for their ability to retain top
talent (Linbeck, Kennedy& Rossi, Zachary, Dow Chemical, Edward Jones, Great Plains,
Sears, and Southwest Airlines). One key finding was that all of these companies
implemented competency-based position profiles so that employees understood the skills
and abilities required to move into leadership positions.

You must also avoid wasting your money on bad human capital investments:

The 2001 Watson Wyatt Human Capital Index study16 showed precisely which HR
practices have an impact on the bottom line. 49 specific HR practices across 6
dimensions played the greatest role in creating shareholder value. Additionally, one
dimension, "Prudent Use of Resources" identifies six practices that diminish shareholder
value (e.g. training that is not connected to the business objectives and not evaluated for
ROI).
A new book17 shows how Microsoft, Intel, Nokia, Starbucks, Singapore Airlines and 20
other world-class organizations are luring and holding high-quality employees. One
senior executive said, "Microsoft has a market capitalization of $450 billion, the largest
in the world. If you add up every desk and chair, every computer, every building, every
piece of land, everything we own, including the $17 billion or so we have in the bank, it
comes to about $30 billion. If you then add in things like goodwill and other financial
assets, maybe you'll come up with another $70 billion, if you really struggle. But that
means that there is $350 billion more that people have given us credit for that is not there.
What is it? Well, it's the stuff in smart people's heads.“ With that knowledge Microsoft
has built and maintains a human capital management system very similar to Mundo
Strategies’ system to prevent employees from wanting to leave the company even as the
stock took a beating in the past few years.

Supervisors who received training in how to listen better and resolve employee problems
found that lost-time accidents were cut by 50 percent, formal grievances were reduced
from 15 to 3 per year, and productivity goals were exceeded.18

Retention is one of the more obvious areas that effective talent management practices can
affect.19 What attracts and retains high performers?

79% stay because of opportunities for advancement

69% stay because their job is redesigned

65% stay because they are learning new skills in their current job.

Why do high performers resign?

56% leave because they are dissatisfied with company management

56% leave due to inadequate opportunity for promotion

50% leave due to dissatisfaction with pay

Reduce Cycle Time

There is very little research into the impact of talent management practices on company
cycle time. One classic work20 on cycle time showed that steel mini-mills using a high-
commitment approach to management required 34 percent fewer labor hours to make a
ton of steel and had a 64 percent better scrap rate than mini-mills using a command and
control approach.

Increase Return to Shareholders & Market Capitalization

The five highest return to shareholders from 1972-1992 (Southwest Airlines Co.
21,775%, Wal-Mart Stores, Inc. 19,897%, Tyson Foods, Inc. 18,118%, Circuit City
Stores, Inc. 16,410%, and Plenum Publishing 15,689%) differentiated themselves from
their competitors and the market only through the way they managed their people during
the infancy of talent management.21

Whereas at the start of the 1990s studying its earnings and fixed assets and adding a
token amount for goodwill invariably gauged a company’s stock market valuation, by the
end of the decade a seismic shift had taken place. When accountants Ernst & Young22
came to look at the issue, they found that the largest slice of most companies' market
capitalization was held in intangibles - primarily, the talent, knowledge and teamwork of
its staff. In high-tech companies like Nokia, the percentage was as high as 95 per cent;
but even 'old economy' stalwarts like BP, despite its huge investments in oil platforms
and exploration equipment, notched up a significant 74 per cent.

The upshot was that even companies operating in the same sector with similar earnings
could experience widely differing stock valuations. Those ignoring the new emphasis on
'intangibles' invariably found themselves penalized by the markets.

Watson Wyatt23 also reported that a 26% increase in market value in 2000 was driven by
common talent management best practices:

• Use of knowledge and contract workers

• Recruiting excellence
• Consistent pan-European HR practices
• Good union-management relations
• Lack of hierarchy, clear leadership
• Teamwork and 360° feedback
• Customer-focused environment
• Remuneration
• Sharing information with employees

The difference between a non-strategic HR system and one that has removed the barriers
to performance are dramatic. Improving the relative sophistication of the HR system by
adopting best practices does not provide measurable value (20%-60% adoption of a
strategic HR system). Integrating the strategic elements of HR into the broader fabric of
the organization provides a significant improvement in shareholder value (60%-80%).

When HR systems have adopted best practices and aligned those systems with business
priorities and initiatives they return the greatest shareholder value (80%-100%).24

The five-year survival rates of initial public offering showed that firms whose talent
management practices scored in the top one-sixth of IPO firms had a 33 percent higher
probability of surviving than those in the lowest one-sixth. Firms in the upper one-sixth
in providing financial rewards to all employees, not just managers, had almost twice as
much chance of surviving for five years, according to research by Theresa Welbourne of
Cornell and Alice Andrews of Vanderbilt.
Conclusion

Companies that want to grow and improve their systems and processes must focus on the
people practices that allow or foster that growth and improvement. The best practices are
known. The key variables (leadership competencies, experience, skill, interest, rewards)
that motivate people to succeed have been identified and successfully put into practice.
Talent management is no longer a cutting-edge field being solely tapped by pioneers. It
is a viable path toward improving organizational performance. Organizations that don’t
want to be left behind must identify, adopt, and invest in talent management. The
alternatives are not very attractive.

[1] http://www.watsonwyatt.com/research/resrender.asp?id=W-488&page=1

[2] http://www.watsonwyatt.com

[3] http://www.watsonwyatt.com/research/resrender.asp?id=W-488&page=1

[4] Williams, D., "Leadership for the 21st Century," Life Insurance Leadership Study,
Boston: HayGroup, 1994.

[5] McClelland, D., "Identifying Competencies with Behavior- Event Interviews,"

Psychological Science, Vol. 9, No. 5, pages 331-340, 1998.

[6] http://www.watsonwyatt.com/research/resrender.asp?id=W-99&page=1

[7] http://www.watsonwyatt.com/research/resrender.asp?id=W-99&page=1

[8] Pfeffer, J. (1998). The Human Equation. Boston MA: Harvard Business School
Press.

[9] http://texascenter.ba.ttu.edu/CBI-HPS/subsnew.htm

[10] http://www.watsonwyatt.com/research/resrender.asp?id=hci2002&page=1

[11] Huselid, M. and Becker, B. (1995). High Performance Work Systems and Organizational
Performance. Paper presented at the 1995 Academy of Management annual conference, Vancouver, B.C.
[12] Huselid, M. and Becker, B. (1998). High Performance Work Systems, Intellectual
Capital, and The Creation of Shareholder Wealth. Working paper. School of
Management and Labor Relations, Rutgers University.

[13] http://gmj.gallup.com/press_room/release.asp?i=114

[14] http://www.watsonwyatt.com/research/resrender.asp?id=hci2002&page=1

[15] American Society for Training and Development and Society for Human Resource
Management (1999). Recruiting and Retaining Employees: Using training and
education in the war for talent. Alexandria, VA: ASTD.

[16] http://www.watsonwyatt.com/research/resrender.asp?id=W-488&page=1

[17] http://www.conference-board.org/knowledge/knowledgeBook.cfm?id=497&nav=hr

[18] Porras, J.I. & Anderson, B., "Improving Managerial Effectiveness Through
Modeling-Based Training," Organizational Dynamics, Vol. 9, pp. 60-77, 1981.

[19] “Strategic Rewards” by Watson Wyatt, 1999

[20] Commonly attributed to Jeffrey Arthur of Purdue.

[21] Pfeffer (1994). Competitive Advantage Through People, 1994.

[22] http://www.personneltoday.com/pt_archive/arch_details.asp?ID=15731&Source=1

[23] http://www.watsonwyatt.com

[24] Huselid, Mark and Becker, Brian (1995). High Performance Work Systems and
Organizational Performance. Paper presented at the 1995 Academy of Management
Annual Conference, Vancouver, BC.