Employees are said to be one of the most valuable assets of a company. ROI is one of the most powerful business measures. Then why don’t we see any ROI applied to HR? Why instead of getting to the point and analyzing the financial impact of employees does HR continue to use indirect KPIs such as time to fill and cost to hire? They wish they could calculate ROI for these certain HR activities, but they simply don’t know how to do this.
As a result we see a lot of pointless KPIs for HR:
- Are you measuring cost to hire? Why? Do you want to minimize the hiring costs? You will still be able to find and hire the average employee, but forget about having talented people in your company! 
- Are you measuring turnover? I assume you want to keep turnover low, as high turnover means increased hiring and training costs. Congratulations, your company is trying to keep any employee without paying attention to his or her actual performance. 
The winning HR KPIs should take into account not just plain numbers, but the quality of a hire. Let me show you some examples:
- Time to fill. All you need is to have a talent hired in the shortest time. If HR brings someone to the company just to fill a position, you are losing your money.
- Cost to hire. You can be serious about cutting costs, but the question is what money will new hires earn for your company? It is worth investing more in finding and hiring talents!
- Training costs. The cost doesn’t matter. What matters is in what extent training will help employee to generate higher revenue for your company.
I could continue, but I think the idea is clear. All of your HR actions and KPIs should be aligned to the ultimate goal of the HR:
- Hire and keep talents that will help a company to earn more.
Employees are often called the most valuable investment of the company. Well, if they are an investment and you really want to make an informed decision about HR, then you need to know the ROI for this investment.
Whereas ROI (Return of Investment) formula is simple:
- ROI (%) = (Net profit / Investment) * 100
It is not so easy to apply it to HR. The problem is that we need to find out the value of “Investment” and “Net profit.”
Investment in the case of HR stands for the sum of all costs associated with an employee:
- Cost to hire
- Cost of training
- Workspace and equipment costs
- Cost to manage
- Compensation: salary + benefits
Net profit is supposed to show the benefit that an employee contributed to the organization. The question is how to measure these contributions.
Below I share some details about how to measure ROI for HR. When I am asked to formulate it in a short way, I say that it should be measurable “by design.” This approach was illustrated in another article where we talked about measuring ROI for marketing.
How to put a dollar value on a talent
This approach might work for positions where employees are involved in sales or where their results can be directly linked with sales. Take the profit from the deals that your sale person closed last year and you have his contribution in a dollar equivalent.
But actually, it is not so easy even with those who are on the sales front line as generating high profits doesn’t always mean executing the strategy of the company. In this case we are measuring success in a short-term perspective. For example, we don’t take into account how the behavior of an employee will affect a client’s lifetime value.
Another problem is that for some positions it is really hard to calculate a dollar value. What was the contribution of the software developer in the project? Well, we could give some estimation when the project is finished and is successful on the market. But what about projects that are still in development (no financial outcomes yet) or projects that failed because of other factors, not because of poor development?
Alternative to a dollar value
When it is hard or not possible to find a direct dollar value of an employee’s contribution we could come up with another approach. Here it is:
- First, we need to separate an employee’s contribution from the contribution of others.
- Second, we need to align the contribution of an employee with outcomes that a company wants to achieve.
- Finally, to be able to estimate results, the contribution of an employee should be quantified and measured.
In other words, an employee should help the company to execute the strategy and management should be able to track his results.
If we could do this, we could estimate the contribution of the talent into company’s performance on any stage of the project, even when it is not finished yet. Also, this approach would work for successful projects, as well as for failed ones.
Align actions with strategic objectives
We need to start with an ultimate objective of the company and go deeper in the details in order to understand what do we need to accomplish in each perspective of the business in order to achieve the desired objective.
The Balanced Scorecard framework suggests doing the analysis within four perspectives. We start with Finance (for example, the objective might be “improve profits”), then we move to Customers (what should we offer to customers to be able to improve profits), the next is Internal business perspective (what systems do we need to have to give customers what they want) and finally Education and Growth perspective (what should we learn to be able to build a business system that will satisfy customers’ needs and ensure future profits).
Business objectives can be scaled (cascaded) to a department, business unit or employee level. As a result any business objective, including business objectives of a single employee, can be linked with the major strategy of the company.
Sometimes the business objective is not clear. When it is not defined it is hard to align it with a business strategy. The best approach in this case would be to start with research and analysis. Once the scope of the problem and goals is clear, it is possible to synthesize a new objective and align it with a strategy.
Align action plan with KPI
An employee will be assigned a goal that is aligned with a company’s strategy (in other words, it is focused on outcomes that company wants to achieve). Also, this approach separates the contribution of an employee from contribution of others.
Now the goal is to find out the way to quantify the contribution of an employee. We need a good Key Performance Indicator (KPI) that could help us to estimate employee’s success in achieving expected results. That’s another tough task. I was already sharing our approach to designing winning KPIs, so there is no need to explain again how hard is to find a good KPI that will be result-oriented and it will be hard to “game” the system from the part of an employee.
Although the task is a difficult one, I believe that management could always come up with something useful. If not, how they supposed to manage this employee?
Calculating the ROI for an employee
By now we have the following results:
- The job of a talent employee is aligned with a strategy of the company and we know what he or she should do to help a company achieve wished for results.
- Management came up with some way to estimate employee’s progress or performance using a result-oriented KPI.
We could do a rough estimation of a dollar value of objective’s impact. To do this we need to understand to what extent the expected financial result will be driven by achievement of the current objective of an employee.
I would like to note the limitations of this approach: it will be a very subjective estimation, as even for the historical events it is hard to weigh all the drivers and factors correctly. In the business situation we won’t normally see any financial result yet. So the estimation will be rather the estimation of the expectation, not of an actual result.
Despite of the subjectivity of these estimations it worth calculating Talent’s ROI, here is a new formula:
- Talent ROI (%) = ((Dollar value of objective’s impact * Employee Progress according to the KPI, %) / Investment)) x 100
Using the Talent ROI formula
Now we could use this formula together with HR KPIs. Let’s take Cost to hire as an example and compare the old and new approaches.
- Calculate the Cost to hire KPI.
- Use benchmarking values from the company’s past experience or from other companies in industry.
- Minimize the cost to hire to make business cost effective.
Advantages: can be a signal that some of hiring methods are too expensive.
Disadvantages: although we are controlling hiring costs we don’t distinguish high-performing talents that deliver the end result and average employees. Using this KPI could even be damaging . The cost cutting strategy based on this KPI is short-term rather than long-term.
- Employee’s objective is aligned with company strategy and expected financial outcomes
- Dollar value of employee’s objective is estimated
- Result-oriented KPI is used to track employee’s progress
- Talent ROI can be calculated
Advantages: decision marking is based on classical financial measure – ROI calculated for a talent. Can be used with any HR actions such as hiring or training (it is an alternative to the cost to use hiring and training cost KPIs). Strategic decisions are based on long-term objectives and expected results.
Disadvantages: top management needs to invest time in formulating strategic objectives linked by cause-and-effect connection with each other. Objectives’ dollar value estimations are subject to a personal opinion of managers.
Example of calculating a Talent ROI
I’d like to show how one can get to use this approach in practice.
1. Strategy objective. We need to have a strategy objectives mapped with a cause-and-effect connection. I’ll reuse an example that I was writing about before.
In that case the major financial objective was “Increase Profits,” it was connected using a cause and effect link to “Improve customer engagement” objective within “Customers” perspective. “Improve customer engagement” objective in its turn was connected to “Focus marketing on customer’s benefits” (Business Systems perspective), which was finally linked to the objective named “Research customer’s engagement drivers” in Learning and Growth perspective.
2. Dollar value. Now we could estimate “Dollar value of objective’s impact.”
Our low level objective is “Research customer’s engagement drivers.” I could assume that if the drivers of employee engagement are implemented successfully we could expect a 20% growth in profits. In this example we have only one objective linked to “Improve customer engagement,” so we could tell that financial value of “Research customer’s engagement drivers” is equal to 20% growth in profits. For this example, let’s take 20% growth equal to $200,000.
3. KPI. We need to use some KPIs that will show us the progress of an employee in finding customer’s engagement drivers.
We could ask an employee to find and test engagement drivers with a control group of customers. For example, employee could come up with 3 engagement drivers and we could try improving them for a control group of customer to see what will happen with customer engagement. Depending on specific business it might be a long process, but this could be a good starting point for a KPI. The KPI is defined as “The number of successfully tested engagement drivers.”
4. Investment. What are costs associated with an employee?
For example, we want to hire an external consultant who has experience with conducting customer surveys in our niche. Our total investment in this case is $25,000.
5. ROI. Now we have all the data needed to calculate the ROI.
- Talent ROI (%) = ((Dollar value of objective’s impact * Employee Progress according to the KPI, %) / Investment)) x 100.
When employee will successfully finish the project (Employee Progress according to the KPI, % = 100%) his ROI will be:
- Talent ROI (%) = (($200,000 * 1) / $25,000)) x 100 = 800%
HR and Top Managers could use this figure when searching and hiring for a consultant who will do the research project.
Also, from this example it might look like that KPI is not so important, but it is a deceptive thought. Without a proper KPI we could not control the research process properly. For example, external consultant could come up with some factors that he thinks are drivers of customer engagement, but without testing them (as it is required by KPI), we won’t know if they are correct.
With “Talent ROI, %” company’s top manager and HR can make informed decisions taking in account financial impact of hiring and keeping a talent in a company. Measures and KPIs by themselves won’t make the difference; they should always be aligned with certain business objectives and action plan. The Balanced Scorecard is a good framework for this process. You will find our version of HR Balanced Scorecard that you can adapt to your needs here.
Have you tried calculating “Talent ROI?” Please, share your thoughts and experience in the comments.
- ^ “The Silliness of Measuring Cost Per Hire, and How it Can Reduce Your Strategic Impact”, Dr. John Sullivan, 2012. Ere.net Recruiting Community. http://www.ere.net/2012/08/06/the-silliness-of-measuring-cost-per-hire-and-how-it-can-reduce-your-strategic-impact/
- ^ “Learning from Apple’s HR strategy for turnover rate KPI”, Aleksey Savkin, 2013, BSC Designer, http://www.bscdesigner.com/apples-turnover-rate.htm
- ^ “Use Balanced Scorecard Template with BSC Designer”, Aleksey Savkin, 2013, BSC Designer. http://www.bscdesigner.com/webbsc_manual/use-balanced-scorecard-template.htm