My husband is gets really annoyed that I don’t put clothes back in my cupboard after I have worn them. I tend to pile them up on the table in our bedroom until I create a high pyramid of creased outfits. I have struggled to change this habit so, as a last resort, my husband playfully implemented a fining system. If he sees clothes on the table, he fines me 50p.
I have started changing my behaviour because it is now being measured. Dumping clothes now has a monetary value and it’s starting to hurt my pocket in a big way.
The moral of the story is this – sometimes the best way to encourage a certain focus or behavior in an organisation, is to measure it and attach a value to it.
Companies want to make money and increase the bottom line. Organisations are also gradually realising that, in today’s global economy, talented people can give them their competitive edge. Very few companies have married these two concepts. How do you use your talent to make more money for your organisation?
One of the effective way to create wealth from people and entrench talent development into the fabric of the organisation is to measure it. Use metrics that make people accountable for it. But, how?
Lowell Bryan and Claudia Joyce from McKinsey have an interesting proposition in their book ‘Mobilizing Minds’. Their idea, which will take time to implement, is the best way to measure return on talent that I have come across so far.
Performance reporting from the past – talent doesn’t feature
If you flick through the annual reports of companies, you will notice there is endless information about capital and the way it’s managed in a business. Capital is the assets a company has which are used to generate more income. Generally these assets are tangible such as property, vehicles, plant and machinery and other equipment.
In any annual financial report, there is very little detail about the number of employees, the types of people the company employs and the way in which talent is used to make money. This is ironic because, in the 21st century organisation, it is generally no longer just capital that drives wealth creation – it is also people.
Most companies today have an organisational structure and design which was set up in an era when money was made by mobilizing physical labour and capital. Work was mainly factory based and required little thinking or problem solving. Now, in most cases, competitive advantage lies in the minds of people who are required to think, solve problems, build strategic relationships and apply their judgement.
It makes sense for the emphasis to move from return on capital to return on your talented ‘thinking intensive’ employees. If you want to get the best out of your talent, measure it and then report on it.
Generally accepted accounting principles don’t encourage reporting on talent
Financial reporting is currently based on generally accepted accounting principles (GAAP), which focus on accounting returns on capital. Companies use GAAP to prepare financial results for the external market. They generally use the same information to manage performance internally too.
Companies need a new way of reporting internally
The authors, Lowell Bryan and Claudia Joyce, say that net profit per employee should become the primary metric for internal performance. Management should still report to the market in accordance with the required accounting principles. However, globalisation and the new digital age demand a different financial measure to manage the economic benefit of talent internally.
‘If your organisation can harness mind power and boost the profits from each thinking employee’, say Bryan and Joyce, ‘then your organisation with be on the path to great success and competitive advantage in the 21st century world.’
The value of intangible capital – such as talented people – has increased. If companies focus on increasing economic returns from these assets, they can make the best use of their people and maximise the value of talent.
Net profit per employee
Net profit divided by total number of employees = Average net profit per employee
Profit per employee is the best reflection of performance because it measures returns on the people/talent which companies profess provides their competitive edge. It also reflects the average profit generated by each employee after the cost of salaries and wages has been fully expensed. Companies must increase profits relative to the number of people they employ.
Opportunities to increase profit per employee are unlimited. Talented people can produce real cash returns by turning their knowledge into intellectual property, strategic relationships, brands, patents or cutting edge software. On the other hand, the opportunity to improve returns on capital, other than employing more talented people to deploy that capital, is more limited.
This measurement will force companies to become more efficient and reduce internal complexity. In their book, Bryan and Joyce have proved that most companies have the opportunity to improve net profit per employee by simply structuring the organisation in an efficient, streamlined way. Surveys show that workers in ‘thinking-intensive’ jobs waste half a day to two days per week on unproductive emails, voicemails and meetings.
Bryan and Joyce say ‘Real wealth creation comes either from increasing profit per employee (without offsetting reductions in the numbers of employees or offsetting increases in capital intensity) or from increasing the number of employees earning such profits. Or from both’.
Return on capital
This measure should be used as a sense check rather than a metric to aspire to. Returns on capital should always exceed the cost of capital.
Show me some proof
Bryan and Joyce studied the 150 largest US companies by market capitalization in 1984. In 1984, they noticed:
- There were strong links between profits and number of employees
- The more employees these companies had, the lower the profits per employee
Then, they studied the 150 largest companies by market capitalization 20 years later, in 2004. The link between profit per employee and the number of employees disappeared.
To confirm their conclusion, Bryan and Joyce divided the 150 companies in 2004 into ‘thinking intensive’ and ‘physical labour intensive’ companies.
In the physical labour intensive companies, the link between profit per employee and total employees had not changed much in 20 years. However, profit per employee in the thinking intensive companies was much higher than in 1984. This means people in thinking intensive jobs are adding more value to the business 20 years later. Companies can create value and profit by mobilising their people’s minds.
Companies that are serious about managing talent and making more money should change their internal financial reporting systems to also focus on average net profit per employee. Talented staff is driving the economic engines of most 21st century organisations. The best way to see the fruits of talent management is to measure it.
Profit per employee will draw attention to unproductive, unnecessary complexities within companies and provide an incentive to streamline.
Talent should create wealth for you. The more talented people you have in your company, the more money you should make. Manage it by measuring it.