How pre-packaged HR Analytics can accelerate the delivery of strategic advantage

10th June 2007

FSN White Paper

Contents

Introduction

What is Organisational Performance Management (OPM)?

What are the drivers of Organisational Performance Management?

The performance management culture

Legislative drivers

The challenge of HR Analytics

Meeting the challenge with COA People Analytics

Summary

Introduction

Since the mid-seventies the market valuations of listed companies have become increasingly detached from their underlying net assets. It seems that the value of large enterprises can no longer be measured purely in terms of physical assets or indeed using traditional financial measures of performance. So what accounts for this difference in valuation and why are physical assets less important?

Part of the answer lies in the significant structural changes that have taken place in Western economies over the last four decades, especially the decline in their industrial bases in favour of service industries. As such, businesses in the West are now less dependent on factories and more dependent on people. In the knowledge based economies that have emerged it seems that relationships, people, 'know-how' and intellectual property are more critical to value creation.

Nevertheless, it would be misleading to suggest that the vital role of people is confined to the services sector or just the private sector. Initiatives in government and a wide range of industries confirm that people are widely regarded as an organisation's most important asset. This is even reflected in the language that we use. "Human Resources" is increasingly referred to as "Human Capital", capturing compellingly the notion that people are indeed the wealth creators.

Yet people are not even mentioned in the balance sheet even though they are often the biggest single cost and no value is directly attributable to the workforce except the historic cost of wages and salaries reported in the profit and loss account. So how should the contribution of people to value creation be measured and is it possible to link people development with profit? It is these matters which are examined in this white paper.

What is Organisational Performance Management?

It is only in recent years that the science of performance management has reached maturity. In broad terms it links strategy to operational plans which are then monitored and analysed so that under or over-performance can be identified and management can take appropriate action in a timely fashion. The net experience gained in this cycle of planning, monitoring, analysing and taking action can then be used to inform and refine the strategy. As such, performance management is a 'closed loop' process which in 'learning organisations' plays an important part in a continuous cycle of performance improvement.

Organisational Performance Management (OPM) is just one component of overall performance management. It captures how group strategy affects the way that an organisation manages its people. For example, a company branching out into a novel product or service line may have to recruit new competencies or develop them internally. Measuring and monitoring the actions necessary to deliver this strategy and managing their success forms an essential part of organisational performance management.

But OPM should not be seen in isolation. Firstly, operational plans as noted earlier should be strategically aligned and secondly, Human Capital plans usually have implications for financial and other operation plans. For example, in the simple illustration given above an organisation might expect the delivery of new products to give rise to increased recruitment, training, development and IT costs in the short term. On the other hand in the fullness of time it could also expect increased revenue as the strategy is delivered and new products or services come on stream.

What are the drivers of Organisational Performance Management?

OPM is a rapidly developing discipline hastened by the onset of a growing performance management culture in the private and public sector together with increased regulation and government policy on reporting and disclosure.

The performance management culture

Historically, HR performance management has been the 'poor relation' in terms of group reporting processes and its contribution to profitability poorly understood. In all but the most enlightened organisations, the management of 'talent' has been left to HR departments often working in isolation. Few HR Directors are represented on the Boards of major companies and as a result many companies have not made the explicit link between HR management and overall financial performance. As such HR reporting has been left to languish within the HR function and its potential contribution has been undervalued.

Whilst headcount, starters and leavers, attrition rates and recruitment costs are regularly reported by the majority of organisations few if any go the extra mile to link these and other operational measures to strategy and broader performance management initiatives.

But the position is changing. New regulation such as the Companies Act 2006 (see below) makes the reporting of key performance measures about people mandatory for many companies and through the Directors' Report (a statutory requirement) brings HR reporting formally into the finance domain for the first time.

Furthermore, the growth of a performance management culture more generally is fuelling the demand for more helpful HR reporting as business managers increasingly recognise the value of non-financial measures in assessing value creation.

The challenge is there for all to see, namely; that the HR function takes charge of employee reporting or the finance function will step in to take its place.

Legislative drivers

The Companies Act 2006, contains a requirement for all companies to produce an Enhanced Business Review (EBR) within the traditional Directors' report. The main thrust of the EBR is to allow the 'members' of the company to assess whether the directors have been successful in their legal duty to "promote the success of the company" – in essence, whether the company has satisfactorily carried out its strategy.

"Success" is very broadly defined and, amongst other matters, the directors must have regard for the interests of the company's employees. In the case of quoted companies the Business Review must, "to the extent necessary for an understanding of the development, performance or position of the company's business", include the main trends and factors likely to affect the future development, performance and position of the company's business; and information about the company's employees. The latter has to include information about any policies of the company in relation to employees and the effectiveness of those policies.

In addition, the EBR must include an analysis using financial key performance indicators, and where appropriate, analysis using non-financial indicators, including information relating to employee matters. "Key performance indicators" are defined by the Act as "factors by reference to which the development, performance or position of the company's business can be measured effectively".

Whilst the legislation effectively mandates the production of employee KPIs (since few can argue that such disclosures do not add materially to an understanding of the business) the law is not prescriptive about the KPIs that should be disclosed. Furthermore, there are no supporting Accounting Standards which illustrate what KPIs are relevant or how they should be calculated and disclosed.

So companies are left to their own devices to determine what disclosures are appropriate. The difficulty is that although there is broad agreement about traditional financial KPIs there is little consensus around HR metrics and other non-financial KPIs.

The challenge of HR Analytics

One of the challenges of measuring HR performance is that in common with a number of other non-financial indicators organisations are generally not very good at it. A recent research report issued by Deloitte Touche Tohmatsu "In the Dark: What boards and executives don't know about the health of their businesses", quickly identified that although companies give themselves high marks in terms of their ability to track financial performance, with 87 percent describing their record as either excellent or good, only 29 percent similarly describe their ability to track non-financial performance as either excellent or good. Deloitte concludes that although companies are aware of the pitfalls of focusing exclusively on financial performance, the ability of executives to measure and monitor performance through non-financial measurements appears to be inadequate. Companies either do not have or are not sharing critical non-financial performance data, such as HR metrics, with their boards.

Furthermore, despite the overwhelming importance of employees to the future prospects of a company only 9 percent of the largest companies rated their measurement of employee commitment as excellent.

The problem with an over-dependency on strict financial ratios is that these traditional measures are generally regarded as 'lagging' indicators of performance. In other words, profit, EBITDA, and segmented revenue tell the reader what has happened in the past but provide little insight into the future. On the other hand, leading indicators as the name suggests, not only provide this insight but can also, if linked to financial plans, allow companies to forecast future financial performance with more confidence.

Employee measures or KPIs are an important example of non-financial indicators which can be harnessed to deliver greater insight into future performance. The difficulty facing many companies, is what measures are appropriate, which ones should be disclosed and how do they drive financial performance?

From a regulatory standpoint the general guidance is that measures disclosed externally should normally be the same measures used by management itself to drive the business. HR performance measures are important because they give shareholders an indication of the sustainability of the financial results. For many companies, people are their most valuable asset and if the workforce is stable and retainable then it suggests that financial performance is sustainable.

The doctrine behind most of the current legislation in this area is to put external stakeholders such as fund managers, trade unions, shareholders and other special interest groups as far as possible in the same position as management. Pragmatically, it seems helpful to use the same systems and processes for external HR reporting as internal reporting.

Deciding what KPIs to disclose can be daunting, particularly where there is insufficient history about how the measures have behaved over time. In the main, boards of management would normally only wish to disclose measures that they can feel confident in controlling and improving. A key question might be "Would we have been embarrassed if this HR measure had been disclosed last year?"

Another source of information is professional bodies and externally compiled benchmarks of HR performance. But these are fraught with difficulty. HR policies are so varied, even between organisations in the same sector that comparisons are often rendered inappropriate. For example, an ambitious organisation with an "up or out" culture that constantly encourages fresh talent may deliberately seek a high attrition rate whereas another organisation may value the store of experience built up through high staff retention.

Meeting the HR challenge with COA People Analytics

The challenge of striking an appropriate balance between leading and lagging indicators, financial and non-financial KPI's and assembling a coherent set of performance measures is familiar territory to CedarOpenAccounts (COA). With deep specialism in HR analytics, COA has developed a thorough knowledge of what drives HR effectiveness across a wide range of organisations in the public and private sector. Domain expertise on this scale is especially welcome against the backcloth of limited regulatory guidance and few sources of genuine expertise.

The task of creating a comprehensive framework for Organisational Performance Management is truly daunting and for some companies, the notion that a software house can provide this level of capability is a novel experience. But COA is one of a new breed of vendors that is packaging up its industry expertise not only in the form of a software package but also in the form of raw intellectual property (content) and support.

Essentially, COA People Analytics is not only a fully configured and functional software application but it is also imbued with the collective wisdom and experiences of a software house that has 'cut its teeth' at the sharp end of many HR implementations. This store of knowledge manifests itself as a comprehensive package of 'standard' HR performance measures covering the public and private sectors as well as more specialised HR metrics required by the government's "Best Value" initiative. Accompanying the metrics are a series of scorecards, pre-canned reports, charts and tables that allow management to measure, monitor and manage performance around, say, absence, employee satisfaction and recruitment.

Effectively, COA Analyser is a 'black boxed' or ready configured application which merely has to be populated with the relevant data from other applications, such as payroll, human resources, time recording, and project costing as appropriate. By pre-packaging all of this capability a user organisation is spared the effort of defining KPIs and establishing an application from scratch. This in turn translates into a smoother, less costly and more efficient implementation.

Pre-packaged KPIs helped Gateshead Council save £1.5m in absenteeism

Gateshead Council has earned a reputation for a modern, innovative approach to local government. It has been rated as an 'Excellent' council in three successive Government-sponsored Comprehensive Performance Assessments (CPA), and is the largest employer in the borough, with approximately 10,500 employees serving 190,000 residents.

"We needed a solution that would allow the HR team and individual managers to really understand the story behind the figures," said Jeff Dean, Head of Personnel Services at Gateshead Council. "We looked into developing an in-house solution but no one was confident that this would deliver on all of our needs or be flexible enough to work with us into the future."

Dean heard that COA People Analytics is designed to enable monitoring, analysis and reporting on pre-specified HR Key Performance Indicators (KPIs). People Analytics was implemented in late 2003 and by early 2004, the Council was using the system for early prompt information on how to react to employee absenteeism. The HR team was able to build a strong reporting procedure around the information available and from March 2004 to March 2005, Gateshead reduced sickness absenteeism by 1.8 days – the second highest drop of any authority in one single year nationwide. This is equivalent to £1.5 million in efficiency gains.

Crucially, COA People Analytics permits user organisations to establish and demonstrate value trees within the application which illustrate the hierarchy of KPIs and how they relate to expenditure and revenue generation. This makes it much easier for HR professionals to demonstrate the value that they bring to the organisation by linking initiatives to profit. Furthermore by illuminating the relationships between KPI's it is easier for line mangers to understand the interdependencies between KPIs in different areas of the business and to eliminate dysfunctional behaviour, for example, where conflicting KPIs encourage departments to maximise their results in a way that impairs overall performance.

A simple value tree shows how sickness days per FTE impacts on total revenue and revenue per FTE

 

A simple value tree shows how sickness days per FTE impacts on total revenue and revenue per FTE

Skandia is able to take a strategic view of people initiatives

With around 2,000 employees in such diverse places as Hong Kong , Cy prus , Ireland and the Isle of Man, as well as offices in the UK , Skandia's people management strategy and information gathering needs to be watertight.

With a diverse and growing workforce, Skandia HR faced a time-consuming and complex administrative burden in gathering information to generate the required management information for the business. Skandia wanted to produce a more effective scorecard which identified and tracked key performance indicators (KPIs) and allowed comparisons to be made between companies and divisions within the business as well as against its competitors.

Skandia chose to implement COA's People Analytics which is designed to enable point-in-time monitoring, analysis and reporting on specific HR KPIs. Skandia's need for a scorecard fitted well with the product and customisation was only needed in one area – that of employee costing, which analyses cost by employee cost centre.

"Instead of spending days collecting information for reports from Excel spreadsheets that are immediately out of date, our team can now obtain a snapshot view of every month's key data about people and generate reports about, for example, turnover, absenteeism, performance, equal opportunities and salary costs within two hours. And it's not simply a time saving, we are able to include far more detailed information in these reports or present it in many different ways for different audiences. This just wasn't possible previously," says Ann-Louise Hancock, Head of People Division, Skandia.

Management information is more credible and accurate. The technology has helped Skandia to look strategically at how the business is performing, to make informed decisions at all levels to identify and resolve issues before they become critical and also to plan for the future.

The technical solution behind COA People Analytics is based on the Cognos business intelligence suite which includes all of the web based reporting and a multi-dimensional data warehouse. This allows HR and finance professionals to examine different slices of performance through the organisation, drilling down into supporting detail when necessary.

COA Analyser also supports more intuitive methods of enquiry directly related to the value tree. The diagram above, for example, makes explicit the link between revenue generation and sickness days – a leading indicator of performance since absence translates directly into lost productivity or selling capacity in the short term and lost revenue in the future. In a single diagram it illustrates the strategic importance of minimising absence through sickness and the traffic lighting in the example shows how different departments contribute to the overall adverse performance.

Visualising the strategy and interdependencies in this way enables management at all levels of the organisation to better understand their scorecard, the metrics it contains and how their decision making affects corporate strategy. The ability to drill down through the metrics to lower levels of operational detail, for example down to individual employees allows management to expose poor performance masked by better performance higher up the organisational hierarchy.

The COA People Analytics application benefits from the pooled knowledge of public and private sector expertise. The result is a very comprehensive body of KPIs. Nevertheless, however compelling the application, measuring and monitoring KPIs is just the start of a performance management regime. Afterall, the main purpose of such an application is to generate actionable information that allows management to keep to its planned agenda.

Within the context of HR this can be more difficult in practice since many initiatives are very long term in nature. For example, succession planning and development of young talent can take place over many years and well beyond the horizon of operational scorecards.

People Analytics should be considered as part of a broader performance management regime linked to planning and financial reporting

 

HR Analytics should be considered as part of a broader performance management regime linked to planning and financial reporting

For this reason analytical applications in COA's Smart Business Suite are aligned with operational planning to ensure that short term initiatives are consistent with longer term strategic planning. Similarly, the financial implications captured in the value trees can be reflected in financial reporting and planning. In other words, People Analytics is a part of a much broader performance management capability that manages the consistency between short and long term objectives.

Summary

It is people, creativity, relationships and intellectual property that drive the success of the modern enterprise. As a result, private and public sector bodies both seek to maximise productivity, nurture and harness the talent within their organisations. But making the link between value creation and human capital is challenging.

Legislation and the growing 'performance culture' in government and commerce is concentrating minds on appropriate performance measures but there is little agreement on what KPIs should be reported or guidance from professional bodies and standards setters.

On the other hand, software houses that specialise in Organisational Performance Management are uniquely placed to help. For example, CedarOpenAccounts, with a long track record of implementing HR analytics can draw on a wealth of implementation experience to help fill the void. This capability has been codified and presented as a comprehensive pre-packaged set of HR performance metrics including 'leading' and 'lagging' KPIs suited to a wide range of government and private sector organisations.

But the metrics are also wrapped in a very functional web based application which allows for the rapid dissemination of reports and scorecards as well as providing broadly based capability to measure, monitor and manage performance.

Critically, COA People Analytics (as the product is called) provides 'value trees' that help to promote strategic alignment of HR initiatives by enabling users of the systems to visualise the interrelationships between KPIs and their impact on revenue, costs and profitability.

Nevertheless, HR Analytics should not be viewed in a vacuum. Tension between short and long term HR objectives mean that many initiatives, such as succession planning have to be planned over a considerable period. COA People Analytics meets this challenge in a shared processing environment which allows information to flow through to financial reporting and longer term plans.

By combining these elements in a broader performance management environment, organisations can prove the value of HR initiatives, plot their impact on the bottom line and forecast future performance with more certainty.

About FSN Publishing Limited

FSN Publishing Limited is an independent research, news and publishing organisation catering for the needs of the finance function. The report is written by Gary Simon , Group Publisher of FSN and Managing Editor of FSN Newswire. He is a graduate of London University , a Chartered Accountant and a Fellow of the British Computer Society with more than 23 years experience of implementing management and financial reporting systems. Formerly a partner in Deloitte for more than 16 years, he has led some of the most complex information management assignments for global enterprises in the private and public sector. His latest book, "Fast Close to the Max ® " will be available in the Spring 2007.

Gary.simon@fsn.co.uk

www.fsn.co.uk

Whilst every attempt has been made to ensure that the information in this document is accurate and complete some typographical errors or technical inaccuracies may exist. This report is of a general nature and not intended to be specific to a particular set of circumstances. FSN Publishing Limited and the author do not accept responsibility for any kind of loss resulting from the use of information contained in this document.

© FSN Publishing Limited. All rights reserved 2007.

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