Thursday, 17 April 2008

The strategic impact of HR practices

One more of the things I discussed in my Singapore workshops was the need for HR to familiarise itself with research evidence showing a link between people management and business results.

I generally categorise research as focusing on overall or specific HR processes, or on particular ‘best practices’.

Overall / specific HR practices

The overall category includes the CIPD’s Future of Work research led by David Guest which has found that profits per employee increase with the number of people management practices in place.

Other academic and consultancy research has demonstrated similar links between individual HR processes. This includes Watson Wyatt’s Human Capital Index (HCI) that quantifies a company’s people management policies and practices and has been shown to link to, and inform, the company’s market value.

Watson Wyatt’s 1999 study used multiple regression analysis on data from 400 US and Canada based organisations to identify 30 key people management practices that were associated with a 30 per cent increase in market value. In 2000, similar research was conducted on 250 companies from sixteen countries across Europe and this found 19 key HR practices to be associated with a 26 per cent increase in market value. These studies only demonstrated correlation but in 2001, Watson Wyatt repeated their study with 500 North American companies and compared two different correlations for 51 companies that had participated in the 1999 and 2001 surveys. this showed that HR practices have a stronger impact on business performance than the other way around.

Watson Wyatt’s 2001 research identified forty three specific people management practices in five dimensions which in total were associated with a 47 per cent increase in market value. The practices were not just better or better funded programs but completely different practices from those used by lower performing organisations.

Particular best practices

The other category of research focuses on specific, universal perspective that assumes there is one best way of doing things, one set of practices and one way of performing them that if always followed will mean that any organisation can improve its performance.

A good example of this is that conducted by Jeffrey Pfeffer who reviewed financial outcomes in each of the top five companies in different industry sectors to identify seven basic dimensions these all had in common and that he believes characterize the people management processes that improve organisational performance:

1. Employment security
2. Selective hiring
3. Self-managed teams or teamworking
4. High pay contingent on company performance
5. Extensive training
6. Reduction of status differences
7. Sharing information.

Probably the most important research in this category is that conducted by Mark Huselid at Rutgers. Huselid calls his version of best practice a ‘high-performance work system’ (HPWS) and notes that an HPWS:

  • Links its selection and promotion decisions to validated competency models
  • Develops strategies that provide timely and effective support for the skills demanded by the firm’s strategy implementation
  • Enacts compensation and performance management policies that attract, retain and motivate high-performance employees.

Over the last decade, Huselid and his colleagues have used biannual large-scale surveys to study the relationship between HPWS and the performance of around 3000 publicly held companies in terms of sales revenue, shareholder value and profitability. A questionnaire sent to senior HR practitioners has been used to develop a High Performance HR Index and financial data has been gathered from subsequent years to ensure results demonstrate causation not just correlation. The research has found that the people management practices, outcomes and business results of high-performance and low-performance firms are all very different. Becker, Huselid and Ulrich explain:

‘They devote considerably more resources to recruiting and selection, they train with much greater vigor, they do a lot more performance management and tie compensation to it, they use teams to a much greater extent… and they are much less likely to be unionised. Indeed, the most striking attributes of these comparisons is not any one management practice – it is not recruiting or training or compensation. Rather, the differences are much more comprehensive – and systemic.’

HPWS firms employ roughly double the number of HR professionals per employee as other firms. In addition, their HR professionals are more likely to be rated positively in both their traditional and strategic roles. HPWS firms are also more likely to have developed a comprehensive measurement system for communicating nonfinancial information to employees.

HPWS firms are also likely to exhibit dramatically higher performance.

By correlating the High Performance Index with company’s financial performance, Huselid has found that if a company increases its Index score by one standard deviation (about fourteen per cent better) revenue is increased by to up to $42,000 per employee per year.

The graph from Huselid and Becker’s 1996 index demonstrates the extent to which a firm’s HR system is consistent with Huselid’s principles of a HPWS plotted against market value per employee. Two things are very noticeable. Firstly, the financial returns from HPWS are considerable. Secondly, the returns from investment are not linear – there appear to be three distinct phases of experience with improvements at both the low and the high end of the distribution giving rise to benefits that are nearly four times as great as changes within the larger middle ground of the distribution.

Huselid believes that the area of the graph between the lowest and the twentieth percentile ranking marks companies with poor people management practices. Improving these practices provides a quick and significant return so that ‘the HRM system creates value simply by getting out of the way’.

In the broad, middle range, from the twentieth to the sixtieth percentile, companies have already developed relatively good people management practices. Simply getting them even better has little marginal impact on firm performance. The approach does no damage but does not yet indicate a strategic approach to people management.

Finally, above the sixtieth percentile the payoffs begin to rise as quickly as it did below the twentieth percentile, but for different reasons. In this range, companies have comprehensive HR systems that are aligned with their company strategy and are internally consistent. It is in this third group that Huselid believes HR begins to emerge as a strategic asset (and in which I would argue, companies are treating their people as providers of human capital).

You can find more details and a critique of the various research in my book and I have also posted recently on more recent research on links between people management and business benefits.