Human capital theory
Human Capital Production Function
HR-development may improve the profit in two ways: by cost savings and by business profit efficiency. By increasing the effective working time there is possible to make more revenue. More revenue with the same costs increases the profit, thus improves business profit efficiency. Absence and staff turnover cost savings are easy to measure and calculate. Better work efficiency is more difficult to analyze, however possible. It needs the measurement and analysis of staff quality of working life (QWL). QWL improvement may reduce staff costs and increase work efficiency. You can analyze the effects of human capital production function:
Revenue = K * HR * TWA * (1 – Ax) * QWL
EBITDA = Revenue – variable costs – Staff costs – Other fixed costs
K = business ratio, describing how much revenue one effective working hour makes
HR = staff size at full-time-equivalent
TWA = theoretical yearly working hours
Ax = Auxiliary working time (vacation, family leave, absence, training, HRM-practices)
QWL = Quality of Working Life index
EBITDA = operating profit
Quality of Working Life (QWL)
Quality of Working Life (QWL) determines the effective working time from the time spent at work. The staff effective working time produces revenue. New QWL theory is needed because traditional staff survey analytics are over-simplified, thus damaging the reliability of HR-performance analytics. The fundamental mistake is to calculate staff inquiry results by using statistical methods. The components of the staff inquiry affect human performance in different scales and phenomena. Anxiety will eat performance. Creativity will boost performance, but only if negative feelings and anxiety are not reducing human energy. The new scientific method solves this problem – it is called the quality of working life index (QWL).
The QWL index is calculated using the following equation:
QWL = PE(x1) * ( ( CI(x2) + OC(x3) )/2 )
where QWL is calculated using the quality of working life index (0 … 1)
PE(x1) is the value of the function of physical and emotional safety
CI(x2) is the value of the function of collaboration and identity
OC(x3) is the value of the function of objectives and creativity
The functions of the self-esteem categories are adjusted so that the result is always between 0 and 100% (0 … 1). This way the QWL index is the scorecard for employee performance and human intangible assets utilization.
Profit maximization bias - reason for performance failure
By demanding maximum profit, the superiors may think that they have to maximize team working time for making the profit rather than solving workplace problems. This will unleash the paradox of profit-maximizing bias – the more you force the profit the more likely it will not be achieved in the long run. Supervisors begin to maximize the ever-decreasing maximum and usually, it will take years to unlearn this harmful bias. Using a simulation learning game the supervisors can learn the sustainable way to improve profit and unlearn the possible profit maximum bias. Line-managers should foster their management skills in three main areas:
- Strategic leadership mind-set for prioritizing problem-solving and improving QWL
- Best leadership practice skills for performing management actions efficiency
- Situational leadership sensitivity with empathy and emotional intelligence
Human Capital Scorecards
Human capital KPI metrics consist of multitude scorecards. There should be business scorecards, human performance indicators (QWL), and operative metrics like absence and staff turnover. Operative metrics are for alarms and also gives data for monetary analysis. For example, a fiscal analysis may reveal that one absence day costs 350 € per day. When revenue produces more profit than costs from overtime work then the absence is profitable to compensate.
Common human capital scorecards are the following:
- Human Capital Revenue Factor (HCRF): Revenue per employee (Revenue / FTE)
- Sales margin per employee: (Revenue – variable costs) / FTE
- Human Capital Return on Investment (HCROI): Sales margin / Staff costs
- Human Capital Value Added (HCVA): (Revenue – all costs + staff costs) / FTE
- Human Capital Cost Factor (HCCF): Staff costs / FTE
- EBITDA per employee: (Revenue – all costs) / FTE
Staff costs are part of fixed costs. It should include employees’ salaries plus other staff costs. Staff size should be in Full-Time-Equivalent (FTE). Revenue per employee indicates the overall staff capacity to create revenue. HCROI is maybe the best purely economic human capital scorecard. It indicates very effectively the change in human capital productivity because positive issues increase the top-numerator and negative issues increase the low-numerator value. Also, note that HCVA – HCCF = EBITDA per employee.
There are new so-called new generation scorecards that combine business scorecards and human performance indicators. One of these scorecards is introduced by Robert Kaplan: Time-Driven-Activity-Based-Cost. This means the cost of one effective working hour – how much costs the effective hour that produces customer value. It can be calculated by the human capital production function:
TDABC = Staff costs / (L * TWh * (1 – Ax) * QWL)
As you can see there is also the QWL index at this scorecard. TDABC tells how much one effective working hour costs. Using validated QWL index the accuracy is adequate.
One new generation scorecard is the TDCV – how much one effective working hour produce customer value or how much the customer is willing to pay for one effective hour of work. It is the same as K-coefficient at the human capital production function, thus can be calculated with the following equation:
TDVC = Revenue / (L * TWh * (1 – Ax) * QWL)
This scorecard indicates how competitive is the business strategy and the effect of tangible investments on technology and product development.