Corporations around the world face a systematic and sustained squeeze on profitability. This squeeze comes from two different directions simultaneously – customers and talent.
Our performance measurement systems are woefully unprepared for this squeeze – indeed, the squeeze is occurring precisely because most managers are not measuring the levers that count for sustained profitability. We are saddled with accounting and measurement systems that measure last century’s drivers of profitability, not the drivers of twenty-first century profitability.
The need for new performance metrics
We all know about the growing power of customers, and I have written here about two new forms of performance measurement that will be required to respond to this growing power – return on attention (ROA) and return on information (ROI). Few, if any, companies measure these new dimensions of performance.
Even fewer executives are focused on the growing power of talent. Sure, just like all executives talk about how they are customer-focused, executives are quite comfortable giving speeches about how they value and develop talent within their companies. But, what do they measure?
In terms of customers, how many companies have identified the 20% of their customer base that generates 80% of their profits? And how many companies could tell you the turnover rate among this 20% of their customer base?
Similarly, most companies now have reasonably well established development programs for their top executive ranks, but how many systematically measure talent development throughout their organization? I certainly don’t mean counting the number of training programs or even participants in training programs or any other activity based measurement. I am talking about systematic measurement of results of talent development efforts. In this context, I suggest another performance measure that will become critical to corporate performance – return on skills (ROS). (A more accurate label would be “return on talent”, but unfortunately I can’t energize executives around increasing ROT. Besides, I like the symmetry with the new measures of ROA and ROI mentioned earlier.)
What doesn’t get measured usually gets wasted, leading to an even more severe squeeze on profitability. And that is certainly the case with talent in most Western companies. There’s a reason that Dilbert and “The Office” attract such a large and appreciative audience – talent throughout our organizations confront obstacles at every turn rather than operating in institutional environments that leverage and develop talent as a precious asset.
Perhaps this will soon change. The bellweather for change surely must be the simultaneous publication of articles in the McKinsey Quarterly and Harvard Business Review exploring new metrics for performance regarding talent development. Unfortunately, the articles also reveal some of the deep challenges in moving to new measurement approaches.
As is often the case, it starts with definitions. What is talent? For most Western companies, the term is often confined to senior executives or, in more expansive discussions, might include highly educated employees like “quants” in stock trading or physicians in medical care. It rarely includes all employees.
For me, talent is ultimately about the ability to deliver superior value through one’s activities, whether it is the janitor or the CEO. There are no caps to talent - no matter how good people are at what they do, there are infinite opportunities to deliver even more value. Talent is ultimately a function of human capital, intellectual capital, social capital and structural capital working together to amplify the value that can be delivered – again, whether we are talking about janitors or CEOs. Talent to some degree is about an individual’s knowledge and skills, but it ultimately hinges on the ability of the individual to leverage the resources of others as well – that is why social capital and structural capital is so critical to talent.
Talent is by definition scarce, as Azim Premji, the head of Wipro, recently reminded me. At another level, though, talent is becoming even scarcer relative to growing demand. And people with talent are acquiring more bargaining power than ever, strengthening their ability to capture the value of their talent for themselves. The growing power of talent and the growing power of customers are intimately related as I noted here. I have written about the broader dynamics of talent scarcity here.
Aggregate ROS performance metrics
Lowell Bryan, in his McKinsey Quarterly article, “The New Metrics of Corporate Performance: Profit per Employee” (registration required) focuses on the growing importance of talent. As the title suggests, he proposes that executives focus on “profit per employee” as a key metric of performance, observing that
. . . it’s time to recognize that financial performance increasingly comes from returns on talent, not on capital. . . . This shift in perspective would have far-reaching implications – for measuring performance, for evaluating executives, even for the way analysts measure corporate value. Only if executives begin to look at performance in this new way will they change internal measurements of performance and thus motivate managers to make better economic decisions, particularly about spending on intangibles.
As Lowell points out, profits per employee as a measure has the strong virtue of simplicity. It also makes it very easy to compare performance across public companies. But, as Lowell indirectly acknowledges, it also has some drawbacks. For example, companies can potentially increase profits per employee through automation and through outsourcing – initiatives that have little, if anything, to do with increasing the talent of the remaining employees.
Of course, there is nothing wrong with these initiatives if they enhance overall profitability net of the cost of capital. Automation, outsourcing and other cost reducing initiatives have largely driven the performance of large American companies over the past couple of decades. But, here’s the problem. These are diminishing returns initiatives over time – cost reduction has a logical limit. In contrast, talent development has some very powerful increasing returns dynamics – the more rapidly a firm develops talent, the more readily it can develop the next wave of talent. Unfortunately, Lowell’s measure cannot differentiate between people reduction measures and talent development measures.
One modest enhancement would help. As I keep stressing, snapshots of performance are much less helpful, and often seriously misleading, relative to trajectories of performance. By focusing on growth of profits per employee over time we might at least start to see whether this growth diminishes over time (reflecting the diminishing returns of people reduction measures) or whether it accelerates over time (suggesting real impact in terms of talent development). It would also help to better assess competitive dynamics – it provides a measure of relative pace of talent development, alerting executives to companies that may be increasing profits per employee at a more rapid rate.
Granular ROS performance metrics
The article in Harvard Business Review, “Maximizing Your Return on People” (purchase unfortunately required), takes a very different tack. Rejecting more conventional HR measures such as employee turnover rates or total hours of training provided, it proposes a complex scorecard of performance measures. These performance measures cover a broad range of categories, ranging from leadership practices to learning capacity, and they rely heavily on surveys and subjective assessments of performance. As a result, these measures cannot be used from the outside to compare performance across companies – they require access to employees who will complete the surveys. I also yearn for some more quantifiable measures that can help to benchmark performance more objectively.
While this approach helps to capture some of the qualitative dimensions of talent development, I worry that it creates too much complexity. I am a strong believer in the philosophy of “closely watched numbers” – being very selective about the performance measures that matter on the belief that too many measures dilute focus. The authors do point out that the HR measures that matter the most will differ across and even within organizations, and will change over time, so there is an opportunity to focus on the sub-set of measures most relevant to performance.
In reflecting on both the McKinsey Quarterly article and the HBR article, I am also struck by how enterprise-centric these perspectives are. There is little recognition in either article that much of the potential for talent development hinges upon building effective networks of relationships far beyond the walls of the enterprise, as JSB and I suggested in The Only Sustainable Edge. Of course, Lowell will reply that his measure of profits per employee indirectly captures this dimension along with everything else that contributes to return on skills. That is both the strength and vulnerability of his measure – it captures everything but offers little assistance in highlighting the specific drivers of return on skills.
These two articles provide reassuring evidence that increasing attention will be paid to performance measures related to return on skills. At the same time, these articles highlight that we are still at the earliest stages of identifying and developing appropriate measures for a critical dimension of corporate performance.
Some key ROS performance metrics
So, in the interim, what would I suggest as some early measures of drivers of return on skills? Here are a few key numbers:
- Annual growth in profits per employee over a five year period, with particular attention to acceleration or deceleration patterns and pace of growth relative to key competitors
- Improvement in relevant output metrics for pivotal jobs – the job categories that have the greatest impact on overall corporate profitability and growth (e.g., utilization rates for refinery capacity to assess the talent of capacity planners)
- Attrition rates over time for the top 20% of performers in all functions of the company
- Qualitative assessment by the lead customers in your market and top performing suppliers of your industry of your firm’s ability to help accelerate their (not your) talent development. (Not serving the lead customers or working with the top performing suppliers in your industry? Well, that’s a warning sign.)
Bottom line: Success in increasingly challenging global markets will require much more focus on talent-centric and customer-centric performance measures. We are all familiar with ROS, ROA and ROI measures, but they need to take on a fundamentally different meaning as we confront a growing squeeze for more powerful customers and talent. We are only beginning to understand the implications of this shift.