Improving Business Performance In The Age Of Human Capital
by Rowan Gibson
Building a competitive advantage today depends on building a unique set of organizational capabilities. This requires companies everywhere to rethink human capital and the role of HR, and to take a new, more strategic approach to Performance Improvement.
“Where is Michael Porter when you need him?” That’s the question posed recently by leading business thinker Gary Hamel in an article about modern competition. The question was not supposed to be a personal attack on Harvard Business School’s most noted academician. It was also not merely of passing interest. Instead, it was a landmark recognition that Porter’s famous notions of ‘competitive advantage’ - which have been at the cornerstone of corporate strategy for several decades - are no longer very useful in the new economic era.
Porter’s thesis was that companies should build a unique competitive advantage based on something that creates value for customers and that is difficult for competitors to imitate. So far so good. Except that, today, most traditional forms of competitiveness - cost, technology, distribution, manufacturing, product features - can all be quite easily copied. They are now merely tickets of entry to the marketplace. These variables no longer offer companies the basis for a sustainable competitive advantage. So what’s left? According to David Ulrich, professor at the University of Michigan’s School of Business, “the only competitive weapon left is organization.”
Building Organizational Capabilities
Today, the focus of competitive strategy is on building unique organizational capabilities. Companies are finding out that the only way they can win in the new economic era is by developing the kind of capabilities that meaningfully differentiate them from the rest. Capabilities that make them the fastest, or the most responsive, or the friendliest, or the most innovative, or the most flexible, or the most competent player in their field.
How does a company build these kind of capabilities? By bringing together a unique mix of resources, processes and values that makes it hard for rivals to match what they do. David Ulrich says, “Successful organizations will be those that are able to quickly turn their strategy into action; to manage processes intelligently and efficiently; to maximize employee contribution and commitment; and to create the conditions for seamless change.”
These are all ‘people’ issues. Which explains why companies are so intent today on strengthening their human capital. A groundbreaking study by McKinsey in 1997 introduced the business world to the notion of ‘talent wars’, and Mike Ruettgers, Executive Chairman of EMC Corporation explains why organizational talent is such a burning business priority. He says, “The one resource your competitors cannot duplicate - perhaps the only one - is the pool of managerial talent you create and cultivate.”
The Age Of Human Capital
For years, corporate chairmen have been talking about their people as their primary assets. Now they are waking up to the fact that it’s actually true. Over the last decade, the two other major forms of organizational capital - financial and structural - have proven to offer corporations no lasting hope for future security.
The financial fiascoes of recent years at companies like Enron, Global Crossing and Lernout & Hauspie - to name just a few - have revealed that blindly following the ‘cult of shareholder value’ is an unsustainable method for creating real wealth. Propping up the company’s earnings and share prices with activities like cost-cutting, mergers and acquisitions, buying back the company’s own shares or even dishonest accounting has often built nothing more than an empty house of cards. In the end, financial capital can prove to be completely worthless - literally wiped out on the stock market overnight.
Structural capital - in the form of facilities, warehouses, manufacturing plants etc. - is also worth less than ever before. In the new post-industrial era, the ‘book value’ of a company no longer has very much to do with its tangible assets. An analysis of today’s billion dollar acquisitions usually reveals that less than 10% of a company’s purchase price (in some cases as little as 3%) has anything to do with its buildings and equipment. The other 90% resides in intangible, intellectual assets.
Over the last two decades, many well-known companies have shifted their efforts away from manufacturing - by outsourcing to suppliers and lower-wage economies - while they concentrate instead on leveraging their know-how. Roughly 80% of General Electric’s revenue, for example, comes today from services. At IBM the figure is about 75%. And, these days, 90% of the people who work for ‘manufacturing’ companies - at least in the U.S: - actually perform white-collar service activities.
Clearly, then, the only form of organizational capital that has any lasting value in the new economic era is intellectual capital - human capital. It is as Winston Churchill put it many decades ago, “The empires of the future will be empires of the mind.”
A New Role For Human Resources
In the old days, business organizations - and the people within them - were considered to be an instrument of the company’s shareholders and their reason for existence was to implement a competitive strategy as efficiently and effectively as possible. This model is no longer appropriate. Today, the organization is the strategy. Its unique capabilities - based on the brains and the skills of its people - represent the company’s only enduring basis for competitive advantage.
This has obvious implications for the role of a company’s HR department. Rather than busying themselves merely with policies, regulations, hiring and firing, employee comfort, compensation and generic training initiatives, HR professionals should be striving to build and strengthen the unique set of organizational capabilities that give the company its competitive advantage - that help it to serve its customers in a meaningfully differentiated way.
The new model, therefore, is focused on improving the company’s business performance and shareholder value by understanding the true strategic value of human capital. It has to do with developing a more systemic view of the organization - a sense of connection and interaction between all of the various parts of the system - where the whole is much greater than the sum of its parts.
The role of Human Resources must be to help the company improve its business performance by improving its organizational performance - its human performance - in the context of the company’s unique strategic capabilities.
The concept of improving human performance is of course nothing new. In recent years, the popular Balanced Scorecard approach has helped to bring this issue to the fore. Originated by Robert S. Kaplan and David P. Norton, it offers a sustainable tool for strategy development and implementation which definitely integrates human capital as a part of the corporate strategy.
This thinking has helped to spark renewed interest in another people-focused approach which has essentially been around since the 1960s - Performance Improvement (PI). The benefit of this approach is that it encourages an understanding of the organization as a system of interdependent functions and people. PI gives organizations a systemic and comprehensive view of their whole institution, guiding them in addressing all the areas that enhance performance. This, instead of encouraging generic, panacea-type solutions, PI helps managers open their minds to all kinds of training and work environment initiatives that could potentially be used to enhance performance. And, of course, it provides a step-by-step process for implementing strategies and measuring the desired results. Used properly, Performance Improvement can help HR professionals and managers at all levels of the organization to assess and improve people’s individual capabilities in the context of their organization’s strategic performance needs. The metrics for performance improvement are therefore not whether some generic industry benchmark for quality or timeliness or productivity is being reached or surpassed, but whether the company’s strategic business model is actually being strengthened, creating added value for internal and external customers.
Gary Hamel and C.K. Prahalad make this point clear in their book Competing for the future: “Each employee must understand the nature of the linkage between his or her own job and the attainment of the goal”. They argue that every employee needs “a specific measure of their own performance that links individual achievement to the firm’s overall strategic intent.”
But just how widespread and effective is the use Performance Improvement in business today? There is very little data on the subject. However, companies in the United States seem to be far ahead in terms of the awareness and successful implementation of PI as a strategic initiative. Europe is once again lagging behind in this regard, which correlates with the similarly widening productivity gap that exists between these two economic regions. A recent study in Germany, conducted by AchieveGlobal and the University of Duisburg-Essen, revealed that only one in a hundred companies had implemented a comprehensive PI initiative throughout their firms, and only one third of German companies had actually heard of the Performance Improvement approach. It is worth noting that the European Commission’s “Competitiveness Report 2002” focuses on human capital development as one of the region’s key priorities for improving its economic performance compared with the United States.
And what about Asia? A recent survey entitled “From aspiration to achievement: Improving performance in the financial services industry”, conducted by PricewaterhouseCoopers and the Economist Intelligence Unit, uncovered similarly low levels of satisfaction among Asian executives with regard to their organisation’s performance and their abilities to deliver improvements in performance in a number of key business areas. The study, which was published in Hong Kong in December 2004, found that in Asia only 10% of financial sector executives interviewed said their organization had Key Performance Indicators (KPIs) in place to measure performance in key processes such as Customer Service, Product Development, HR, IT Management, Finance and Accounting, Procurement, Risk Management and Compliance, with 67% citing “no formal measures”. Peter Whalley, Assurance Partner of PricewaterhouseCoopers, says, “With regard to the Insurance sector in Hong Kong, the need has never been greater to implement performance improvement."
Obviously, what is required is more research on Performance Improvement in Europe, the USA and Asia in order to create a more conclusive picture about the implementation and effectiveness of these initiatives. What seems certain, however, is that there is huge potential for performance improvement in organizations all around the globe, and that HR needs to start playing an important new role in these organizations.
A New Mandate For Management
There are two main reasons for HR professionals to take this issue seriously: First, the increasingly strategic role of human capital and HR management due to the globalization of the economy. And second, today’s tough economic competition, which inevitably leads to the cutting of HR budgets unless HR can show that its initiatives will provide a measurable benefit.
Interestingly, the European research cited above revealed that HR was only involved in strategy development in 50% of the companies interviewed, while 88% of HR managers and 80% of general managers say that they recognize the importance of HR’s involvement in the process. A new orientation toward strategy, performance measurement and results would help to make HR’s initiatives - in areas like training, for example - much more effective. The European research showed that only 14 percent of the companies interviewed combine training activities with changes to the management systems in order to address specific gaps in performance. So they might, on the one hand, train their people on how to win new customers, but on the other hand their compensation system might not reward a salesperson’s acquisition activities. Dr. Margret Borchert, management professor at Germany’s Duisburg-Essen university, says; “German companies spend on average about 17 billion Euros a year on personnel training and education. There’s an increasing awareness, particularly in today’s tough competitive times, that these efforts should closely support the corporate strategy and focus on measurable results.”
Asian respondents generally echoed the views of their European counterparts. 62% considered that active involvement from senior management was a (top 3) critical success factor behind implementing successful Performance Improvement. 62% also pointed to the need for clear and measurable project milestones and benefits. The PwC study indicates that Performance Improvement initiatives depend on active leadership, and this is more than just communication to staff. “The goals or benefits of PI need to be ‘baked in’ from the start,” says Robert Ross, Global Risk Management Solutions Partner of PricewaterhouseCoopers. He concludes that “Senior management must identify realistic, tangible benefits and actively steer the process to ensure delivery. Performance cannot be optimized if it is not measured. This is true of the processes being improved and the people trying to improve them.” However, it is apparent that in many companies, there is too much focus on “doing projects”, with success being related to the completion of the project rather than any identification of improved performance.
In summary, executives seem on the whole to be quite clear on the criteria and conditions required for successful Performance Improvement, particularly the active involvement of the organization’s leadership and the need to set goals and milestones and measure benefits. However, it appears that these are in short supply when it comes to actually implementing sustained Performance Improvement initiatives.
The new mandate for management, therefore, is to recognize the strategic and economic value of building a unique set of organizational capabilities. This will focus the company on the development of human capital in a strategy- and result-oriented fashion. And it will reposition Human Resources as a crucial factor in achieving and sustaining a competitive advantage for the company in the future. By effectively implementing institution-wide Performance Improvement initiatives, business organizations - and perhaps even entire economic regions - will be able to unleash their full potential for successful wealth creation.
Article first published in Impact magazine in 2003. Updated in 2005 and reproduced with permission from author.
Rowan Gibson is founder and chairman of a company which helps organisations to rethink core strategies, and author of the international bestseller Rethinking the Future.
Copyright Rowan Gibson. All Rights Reserved.
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