Ingrid Selene
Principal, Communication at Work

Increasingly, executives are aware of the risks in not managing an organization's human capital well. An annual study by Aon in Australia found companies rated human resources as the number three risk concern in 2009/10 (previously rated the fourth, fifth or sixth risk)¹. However, research by Aon and others continues to find that people issues are not given the attention and priority of senior management that one would expect given these results.

Saratoga² concluded that there was no evidence to indicate that the role of HR was developing and becoming more strategic or more influential. McKinsey³ went even further, finding that the influence of HR departments was actually declining and they are not seen as making a valuable contribution. The majority of line managers don't regard HR as a strategic business partner (60%) and they say that HR lacks the capabilities to develop talent strategies aligned with business objectives (58%).

The low standing of HR functions may be partly due to the lack of success of many of the programs they've introduced. McKinsey found in interviews they conducted in 2006 with global CEOs, business unit leaders and HR professionals that companies' talent management programs weren't delivering results. The respondents attributed this to lack of time commitment by senior management (54%), lack of commitment by line managers to people development (52%) and lack of rigor in succession planning processes (39%) among other reasons⁴. 

Limited by lack of data

One of the reasons why HR departments have been limited in their capacity to address human capital risks is the lack of data, particularly metrics that measure effectiveness of programs and their impact on the business. In order to be accepted as a strategic business partner, and to gain support for investment in human capital, HR departments need to be able to measure the value of their contribution, not just costs or customer satisfaction^5,6.  

In a study of HR management in Australia, senior HR managers said that a poor understanding of the value of human resource management to the bottom line was the major factor limiting the function's input to strategic business decisions⁷. This may be attributed to the fact that only one in four (25%) said that the connections between the measurements used and organizational performance were clear⁸.

Furthermore, board directors and executives (73%) say that they're under increasing pressure to measure non-financial indicators of the long-term health of their organizations⁹. Employee commitment is described as one of the critical or important non-financial drivers of their organization's success by over nine in ten (92%) directors and executives. The greatest barrier to using non-financial performance measures are the tools – nearly six in ten (59%) say that they are inadequate. In particular, in a 2007 update of this study, employee commitment was cited most frequently as the area where senior management needed better quality information (58%) and where the quality of information provided to the board was most often rated as poor (29%)¹⁰.

The two most frequently used performance metrics in the area of employee commitment are retention (50%) and competitiveness of compensation and benefits (44%). Less than three in ten reported using other measures such as the quality of learning and development programs, the level of employee commitment or the quality of health and safety provisions¹¹.

One of the drivers of boards' increasing interest in non-financial measures is the need for better risk management in these areas. While the traditional areas of risk are generally regarded as being well managed, in other areas, such as human capital, executives do not think that they are very effective (only 32% rated their organization as effective)¹². This is despite the fact that human capital risks (e.g., skills shortages, succession issues, loss of key personnel) are rated as the most significant threats to their company's business operations (60% rating the risk as very high or high)¹³.

Applying a risk methodology to the management of human capital in an organization addresses these (and other) issues. As part of the risk assessment process, organizations will need to be able to measure the impact of their human capital risks, and to evaluate the benefits of various risk mitigation strategies. In addition, by including the risks associated with one of their major assets, human capital, in their other risk assessment processes, executives and boards will have a more complete view and understanding of the risks across the organization and their relative importance.). 

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Types of human capital risks

Human capital risks can be defined as events and employee behaviors that occur both within and outside the workplace that can affect employee productivity and/or otherwise affect the organization’s operational and financial results.

Human capital risks include:

One way to frame human capital risk and provide a structure for analyzing it is to use a model based on the employee life cycle. Aon has developed a life cycle model with six phases and has identified the human capital risks associated with each phase.

While this framework for understanding human capital risk implies a simplicity that belies the underlying complexity of these risks, it provides a useful overview and demonstrates the breadth of the issue.). 

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Implications of using a risk paradigm for human capital

Taking a risk approach to human capital is not just about putting a different label on familiar concepts such as turnover and absenteeism. It means looking at human capital from a new perspective, using a risk paradigm.

Having a structured, systematic approach to managing human capital risks will result in more accurate, comprehensive and effective management of these risks than relying on informal processes, intuition and subjective judgments. It means that assumptions and judgments are made explicit, and the biases of individuals counteracted by involving multiple, diverse people in the process and using data to support assessments. In addition, the risk methodology results in information being shared and knowledge gained and captured, which can improve both current management practices and aid knowledge transfer.

What does the risk approach entail, how is it different?

Key features of the risk approach include:

These are the components of a risk assessment methodology that will provide a comprehensive understanding of the key human capital risks in an organization at a particular point in time. It is important to also undertake regular reviews and reassessments as the risk environment for human capital is far from static. Furthermore, once an organization has a baseline risk assessment it can better assess the potential human capital risks arising from any major initiatives such as a merger, acquisition or other change project.

Applying a risk assessment process to human capital represents a major cultural shift for an organization. Traditionally, people issues have been the domain of the HR department; but in actual practice, the business units deal with individual, day-to-day people issues. HR is often seen as being responsible for administrative processes such as payroll, and not as a key contributor to business strategy.

Undertaking a human capital risk assessment needs to involve people from across the business, not just in HR, if it is to be of most value. One of the advantages of this is that this process can build understanding and create consensus. The process also forces a more strategic approach to HR. Another consequence will be the increased focus that is placed on quantitative HR data, including financial data demonstrating returns on HR investment.

Following this risk-based approach doesn't mean throwing out all the traditional concepts used by HR. But it will open up HR functions to the scrutiny of other areas of the business such as finance, risk management and legal. Ultimately, it should help to achieve a more rigorous, results-oriented approach to managing the people assets of the organization and thus, help to achieve the appropriate level of investment in this important asset.). 

Contact

For more information on Aon Consulting's Communications solutions, please contact Ingrid Selene, Principal, Communication at Work, at ingrid.selene@aon.com.au. 

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Notes: