The Costing of Human Resources

Robert A. Loffreda

BUSINESS METRICS : No business runs effectively without cost accounting. Every manager is extremely aware of the need to control costs. Close attention is paid to the rising cost of materials, energy, distribution, marketing, sales, healthcare and so forth. Capital expenditures are amortized over time. Organizations manage to the metrics of their business.

COST VERSUS VALUE :   Have you ever actually dollarized the cost of a poor hiring decision versus the value of a good hiring decision? CEO's want the HR function to contribute to bottom-line results. Attempts have been made at human resource accounting. But this is the historical-cost approach typical of the accounting profession. As my associate George often says, "Accountants are the people who come in after the battle and shoot the wounded." This approach measures only the costs of employees. But what about the value of employees? It does not tell you how sound your investment was. To paraphrase Oscar Wilde, "An accountant may know the price of everything but not its value". (My apologies to accountants...I couldn't resist!)

THINK OF THE FREE AGENT IN SPORTS :   There is a certain logic to the idea that differences in pay among and within organizations (baseball teams), even within individual jobs (first baseman, pitchers, etc.), parallels predicted variations in productive output (we think this guy will hit .325 and drive in 125 runs) and the value of that output to the organization (he's going to put fans in the seats and help us get to the playoffs). Salaries can be a baseline from which to measure the relative value of individual job performance to the organization whether that individual be a manager or a left fielder. How much profit does your company make if the performance of every person in a given job category, (e.g. sales, customer service, engineering, management etc.) is average? How much if they are significantly above average? Significantly below average?  

THE ECONOMICS OF VARIABILITY : There are sizable differences in performance across individuals and potentially large gains in productivity can be realized when valid selection procedures are used to identify the best available talent. Nathan Myhrvold, former chief technology officer at Microsoft says," The top software developers are more productive than average developers, not by a factor of 10X; or 100X or even 1000X, but by a factor of 10,000X. The use of a valid selection procedure, whatever it may be, can tell you, in economic terms, the value of an above average employee. Without getting into some very complex calculations, many recent research efforts have shown that someone performing at the 85% contributes significantly more profitability than someone performing at the 50%. This seems simple and self-evident. However, most companies do not have an appreciation for the magnitude of the performance differential let alone its dollar value. And the dollar value of this differential increases as job complexity increases!!  For routine clerical work it is about 15% but for managerial/professional jobs it can be as high as 46%. Most sales jobs are 39%. Depending on the job, it can run into the hundreds of thousands of dollars. Consequently, organizations can significantly impact bottom line results by having a valid selection procedure in place that can identity those with high probabilities for performing at the 85th percentile or better.