The Human Resource Equation: Cost versus Value

Firms feel increasingly compelled to invest significant resources into human capital in order to become successful and remain competitive. As the pressures of today's labor markets continue to intensify, the HR function is often perceived as a cost center within firms, although corporate rhetoric espousing that our people are our most important asset has remained conspicuously fashionable.

Wayne Cascio, a business professor at the University of Colorado, has examined the financial costs associated with employees. He argues that although firms recognize the financial value and benefit that people can bring into a firm, the unfortunate view that employees are costs to be cut, as opposed to assets to be developed, is still a widely held perspective. This view has seen the importance of accounting for the financial costs of employees become a vital part of the HR function and a newly found responsibility that firms owe to their respective investors.47

Labor costs can be extensive, especially in labor-intensive industries such as consulting firms, law firms, and universities. From a purely cost perspective, the people function often accounts for two-thirds or more of total operational expenses. Other factors, including cost per hire, wage-and-benefits' costs, cost per incident of absenteeism, and cost per incident of voluntary turnover are widely used metrics. On a more sobering note, there are immediate costs associated with the mismanagement of employees, including costs associated with lawsuits and costs associated with resolving industrial disputes. Thus, the role of HR has become linked to the accounting for such human-capital-related costs.48

An ongoing challenge for HR is to concentrate efforts on its people-investment approaches and steer away from models focusing primarily on the cost side of the equation.49 The focus ought to be on HR output as opposed to HR input. Cascio contends that one of the greatest challenges for modern-day HR is to advance from a compliance-driven HR model to a service model. More specifically, in the former, HR focuses primarily on complying with laws and regulations and the policing of management processes. In the latter, HR provides HR-related service to support line managers in their operations. Finally, a movement toward a decision-oriented model focusing on the utilization and deployment of talent has been observed, thereby surpassing the traditional compliance and service frameworks.50

Research shows that firms struggle with the concept of ROI in the context of the HR functions. This thinking applies to a variety of HR activities, including career management, T&D, and work-life balance practices. What is pivotal is the ability to capitalize on those practices that create the highest value for the firm and employees and to identify HR practices that contribute positively to business performance and overall business strategy.51

Although it might seem good business practice to keep operational costs low and to reduce costs at all levels, this approach may not prove to be successful. Cascio stresses the importance of identifying and developing pivotal talent within the firm thereby fostering human-capital investment and creating strategic value for the firm. For example, a purposeful focus on staffing, training, and compensation in a call center where employees take orders for merchandise can provide positive financial returns for the firm and all stakeholders.52

Cascio posits that research has consistently shown that core quality employees are critical to the survival, growth, and overall success of a firm, and generate benefits that outweigh their operational costs. Treating employees well and reducing employee turnover may have a positive side effect. In his Harvard Business Review article, Cascio argues that firms can learn from the U.S. retail industry where "shrinkage" (i.e., losses due to employee theft, fraud, and administrative errors) account for up to two percent of annual sales, which, in some cases, can constitute millions of lost dollars. Research shows that retailers with low employee turnover also have a tendency to have low shrinkage rates. U.S. retailer Costco, for instance, maintains labor pay rates that average 40 percent higher than those of its rivals, yet its shrinkage rate is a mere 0.2 percent, which is significantly lower than that of its closest competitors. Therefore, there appears to be value in ensuring competitive pay rates. Cascio concludes that in Costco's case the costs that it does not incur, in the form of reduced employee turnover and reduced shrinkage, clearly offsets its higher labor rates. Thus, it has been shown at Costco that labor costs as a percentage of sales per employee are lower than those of Sam's Club, its closest rival.53