Edge Perspectives with John Hagel

Wasting Talent

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.

Defining talent

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.

Innovation and Talent in the Indian IT Industry

NASSCOM, the Indian trade association for its rapidly growing IT enabled services industry, recently concluded its annual Leadership Forum, bringing together the leaders of this industry.  Although there was no official overarching theme defining the conference, it was clear that the big issue shaping most of the discussions involved the intersection of innovation and a growing scarcity of talent. In the process, though, I fear that the industry leaders are under-emphasizing some important opportunities.

I was privileged to be able to attend this conference and participate in a number of the panels and discussions. It was truly an energizing and inspiring experience, impressive in terms of the scope of the program, with over 100 speakers addressing a broad range of topics.

The Indian IT outsourcing industry has achieved substantial scale and very impressive growth. NASSCOM estimates that, for the financial year ending in March, the industry will grow to $31 billion in revenue, 32% over last year’s revenue.  The industry now employs 1.6 million people, driving much broader prosperity within India. According to Julio Quinteros, an analyst from Goldman Sachs, Indian IT services companies have rapidly grown shareholder value in sharp contrast to the more disappointing performance of established American IT services companies.

The most impressive thing about the conference was that, in spite of this enormous success, there was little if any complacency.  Instead, the leaders of the Indian IT services industry continued to show the same sense of urgency that has driven their success so far.

The competition for talent

Many of the discussions focused on the intensifying competition for talent within the IT services industry.  Continued growth of the industry hinges on the ability to access and develop talent.  Turnover rates are generally rising, especially in the business process outsourcing industry, further increasing the challenge of sustaining profitable growth. Wage rates are also rising as companies compete more aggressively to attract and retain the available talent. In the meantime, other countries such as the Philippines, Vietnam, China and the Eastern European countries are competing more effectively for IT outsourcing work.

Indian IT services firms are responding to these challenges on a number of fronts.  They continue to invest heavily in scaling their recruiting and training efforts, increasingly branching out and establishing facilities in second and third tier cities in India to reach a broader pool of talent.  In many cases, they are establishing development and operations centers in other low labor cost countries.

Indian firms are also investing in developing more value added services to generate more revenue per employee.  One of the hottest growth sectors for the Indian outsourcing industry is so-called “knowledge process outsourcing”, focusing on providing such high value services as financial research, clinical research and engineering services for product development programs.

More generally, these Indian firms are also focusing on tightening their operational performance to enhance profitability per employee and to become more responsive to increasing customer expectations.  McKinsey & Co. discussed a major report on “Operational Excellence: The Next Frontier in Offshoring” (executive summary available here) at the conference.  The report offered a framework for benchmarking operational performance and found a high dispersion of performance across Indian offshoring service companies. Offshoring service companies could do a much better job of absorbing increasing wage rates if they focus more aggressively on enhancing the productivity of their operations. One of the interesting sidelights in the report was the finding that third-party service providers generally outperform captive offshore facilities.

Innovation blowback opportunities

Another key theme emerging from the discussions at the conference involved the increasing need for innovation in the offshoring business.  Unfortunately, there did not appear to be any consistent definition of innovation so, at times, it was unclear what the exact nature of the opportunity is.  NASSCOM has announced a joint research effort with BCG on “Developing an Innovation Ecosystem for the Indian IT Industry”.  This effort in particular seems to be focused on identifying opportunities for the Indian IT industry to collaborate with other stakeholders in the Indian economy to address challenges in providing more cost-effective products and services to the Indian population.

This is a huge opportunity and has generally been under-emphasized by the IT services industry which historically has focused on overseas markets rather than the domestic market.  There are some notable exceptions to this.  Infosys, for example, has developed a strong partnership with ICICI Bank, one of the most innovative and successful banks in India.  ICICI Bank used the Finacle application software suite from Infosys to develop an extremely cost-effective and scalable operational platform.  This collaboration has helped ICICI Bank to grow rapidly, increasing its transaction volume by five-fold over a five year period.

This opportunity is particularly intriguing because it extends far beyond the domestic market, even though that is certainly attractive in its own right.  As JSB and I have written, there is an opportunity to pursue “innovation blowback” strategies, using the Indian market as a catalyst for breakthrough innovation in products and services that can then be used to support global attacker strategies designed to challenge incumbents in the more developed Western economies. In recent years, ICICI Bank has started to expand internationally, leveraging its innovative operational platforms to deliver more cost-effective services to customers in countries like the UK, Canada, Singapore and China. The Indian IT services industry could fuel enormous growth for the Indian economy by more aggressively supporting these innovation blowback strategies.

Fostering talent networks

But the biggest opportunity of all requires a different form of innovation.  It also requires a very different mindset for the leadership of the Indian IT service companies.

Rather than continuing to focus on attracting and retaining talent within their own companies, these firms could create enormous value by developing the management techniques required to mobilize and leverage specialized talent wherever it resides. This would require building scalable talent networks encompassing a broad range of smaller, more specialized companies. 

The Indian IT services companies have been very effective in building relationships with technology product companies on a global scale.  But when it comes to expanding their own IT services, they immediately focus inward.  If they don’t have the capability already in place, they may go out and acquire a smaller, more specialized company, but their instinct is to bring the capability in house.

As an alternative, these companies could take their emerging skills in partnering with technology product companies and apply them to building talent networks to mobilize and leverage large numbers of more specialized service providers.  The real power would be to master the techniques required to accelerate the development of talent across such a distributed network of partners, thus creating stronger incentives for partners to join the network.  Focusing on this challenge would create an opportunity to innovate in “Learning 2.0” capabilities, moving from traditional training programs to more distributed learning platforms and ecologies.

Ultimately, the opportunity would be to become leaders in the formation and orchestration of creation networks. This would require mastering open innovation management techniques to attract and mobilize talent, focus the innovation initiatives across multiple participants and accelerate commercialization and learning from these initiatives.

Even broader innovation opportunities

These efforts in turn would expose the Indian IT service companies to the challenges of coordinating activities across large networks of partners given existing IT architectures. By gaining firsthand experience in the limitations of these architectures, Indian IT service companies would be well-positioned to drive another wave of innovation in IT architectures.  In my talk on Web 2.0 at NASSCOM, I suggested that Indian IT service companies are natural candidates to define and deploy fundamentally new IT architectures that work from the “outside-in”. 

In contrast to traditional IT architectures that emerged in the center of the firm and imperfectly extend their reach beyond the boundaries of individual enterprises, we are in desperate need of IT architectures that start with the assumption that the task is to coordinate activities across hundreds, if not thousands of firms. By starting with this perspective, we would need to re-think the nature of transactions and define roles and governance processes accordingly. In fact, we would likely move from today’s transactional architectures to much more helpful relational architectures designed to support enduring and deepening relationships across individuals and institutions.

There’s no shortage of opportunities at both the product and process level to drive the growth of Indian IT services companies.  The sense of urgency that continues to pervade the leadership of these companies will serve them well in identifying and aggressively pursuing these opportunities.