CorpComms Magazine

Open any annual report and the chances are that it will include the statement that people are the company's 'most important asset'. While some readers may dismiss this as a glib comment akin to a claim that the chairman is kind to animals, others believe it is a curiously misanthropic notion that has no place in the modern world. 

Indeed, there is a growing body of research that demonstrates how, taking the statement to its natural conclusion, human capital should be included on the balance sheet rather than being dismissed in three words. 

These studies indicate that it may be more accurate to describe a company as possessing two types of asset: human capital in the present - the people currently employed and their knowledge and ways of working - and the results of human capital invested in the past, such as technology, factories, intellectual property and money. Conventional accountancy only measures the latter category and converts it into the mechanistic language of assets, which often sidelines the people who make up the enterprise. 

Accountancy has been dominant in shaping formal reports, and its measures are now so familiar that it is tacitly assumed there is some commercial logic to this dominance. This may have been the case in the past, when assets such as technology and machinery were key to succeeding, but it is illogical to accept this status quo in the current environment, where human capital, defined as 'intangible assets', is so important. 

Even an energy giant like BP, with its massive investments in oil platforms and the like, is composed of around 75 percent 'intangible' assets. In a consultancy or investment bank, that figure rises to around 98 percent. 

So if only between 2 and 25 percent of a company's value consists of historically acquired assets, why does the reporting of these, and of financial transactions, take up 99 percent of the annual report? 

Soft sell

The practice of human capital reporting, aimed at accounting for the bulk of the company's real assets, is commonly dismissed as a 'soft' or pointless activity. Still, the conventional way of describing organisations does cause real problems. 

Two years ago, furniture retail group MFI introduced a new delivery system that centralised control, taking responsibility for despatching items away from individual stores. The company immediately hit problems because it had failed to conduct workforce planning or train delivery people in basic skills and customer service. There was poor communication between stores and delivery staff; as a result, when staff delivered the wrong items and the customer complained, staff would say: 'It's nothing to do with me - take it up with MFI.' 

Complaints flooded in, and the company adopted a rather evasive tone when dealing with them. At the height of the delivery problems, an MFI spokesman said: 'Margins are being negatively affected through the costs of remedial work with customers and the costs being incurred to address the ongoing systems issues.' But of course, the problems had nothing to do with 'systems' and everything to do with people. 

In July of this year, MFI's heavily loss-making high street operation was put up for sale, but many of the underlying reasons for the decline in the company's fortunes did not make it into the annual report or business news coverage. 

A human capital report provides an 'early warning signal', says Susanna Mitterer, chief executive of the UK branch of intellectual capital specialist Summit. 'Usually, a year before you see it in the financial figures, you can see increased staff turnover, or a reduction in morale, or problems with certain skills and competencies; customer satisfaction is down and the number of complaints is up.' 

Human capital reporting is established practice in Sweden, with analysts using intellectual capital reports to gauge the prospects for companies such as mobile phone giant Ericsson and computer consultancy TurnIT. 

Steve Langhorn is one of the few managers in the UK who has successfully implemented a human capital report. He set up and ran the process for different parts of the Whitbread Group, including David Lloyd Leisure. 'The first level is to have the data; the second is to turn the data into meaningful reports on turnover, absence and so on,' he says. 'The Holy Grail is the ability to predict differential or superior performance in a number of key areas.' 

At David Lloyd Leisure, for example, Langhorn's team was able to demonstrate that staff survey results on whether employees felt well qualified to do their job were predictive of improved customer satisfaction and member retention - key performance indicators for the company.

A Copernican shift

To call human capital reporting 'intangible' is arguably a misnomer. After all, people exist. It is accountancy that has generated intangible concepts. The direction in which the young science of human capital reporting (and some of the research that underpins it) is heading is toward a truly Copernican shift - a fundamental change in paradigm in which assets are considered subordinate to people, not the other way round. 

Rick Emslie, who co-founded the European branch of human capital specialist Saratoga in 1993, is now strategic HR adviser at consultancy Strata Intelligence. Emslie says that this paradigm shift is necessary, although it is unlikely to come about with a 'Eureka moment'. Rather, progress will come through a thousand pragmatic steps. 

'We have to wear away at the stone,' says Emslie. 'People are convinced by examples.' He believes that it is a common mistake of the human resources field to tend to wait for the 'perfect' set of comprehensive measures before promoting the practice. 

Supermarket group Tesco and the Royal Bank of Scotland have developed their own human capital measures, including employee surveys - though primarily for internal purposes. Both companies are committed to the practice and convinced that it has helped them become leaders in their respective fields. 

An absence of external measures 'leaves the investment community high and dry,' notes Emslie. It is certainly curious that investors are not pushing for the kind of transparency that might help them avoid another MFI. 

Emslie adds: 'There is not a single thing in the organisation that isn't done by an individual or initiated by an individual, but we are getting into areas where it's more of a challenge to measure what's going on.' 

People power

While quantifying this aspect of a company may be difficult, it is not impossible, Emslie says. 'The fact that we're stuck with the accounting system that we have doesn't prevent us from treating people as tangible assets. That can be done by demonstrating that when you do measure people activity, you are more likely to get improved results. You are then in a better position to go to the accounting standards boards and say that they have to make a fundamental change.' 

One innovation is the internal labour market model, developed by Haig Nalbantian and his colleagues at the New York office of Mercer HR. This sophisticated model maps the actual movements of people through the organisation and the links between performance and pay, and combines them with employee surveys to build up a three-dimensional picture of the organisation. This model has been used to inform strategic decisions that have eventually yielded returns of millions of dollars. 

Results like these are consistent with the research work of US thinkers such as Jeffrey Pfeffer and Mark Huselid, who believe that making employee motivation and development the first priority of business is the most reliable way to boost profits. Pfeffer, in his book The human equation, complains that while evidence to support this line of thinking accumulated throughout the 1990s, management theory and practice seem to have moved in the opposite direction. 

The irony here is that executives who most pride themselves on a rational, nononsense approach tend to display some Luddite instincts in overlooking the evidence that management research is generating and sticking to late Mediaeval measures. After all, conventional accountancy was developed by the Venetian mathematician Luca Pacioli in the 1490s. As Emslie points out, after 500 years of accountancy, people are still described only as a 'cost'. 

It is often said in business that the pace of change is relentless and accelerating, and this is certainly true. It is strange, however, that the world of company reports and accounts still appears to be anchored firmly in the past.

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