Pricing a company's human capital

Determining the future value of a company based purely on historical financial figures is no longer sufficient, and analysts must look at a company's human capital to get an accurate read on its prospects.

When it comes to determining the future value of a business, the work of analysts typically only considers a corporation's recent financial history. But research is pointing to the importance of reporting future-relevant information to analysts.

The knowledge-era is being analysed using industrial-era rules, says Loretta O'Donnell, associate dean of education at the Australian School of Business. Many accounting principles used today were developed following the industrial revolution when the economy was heavily based on industry. But with the rise of organisations such as Google, Apple, Microsoft, Qantas and a multitude of knowledge-intensive, service-based, human-capital-oriented industries, such measures are no longer enough.

One of the greatest indicators of future performance in a knowledge-based business is people management. While some thought-leading companies already communicate human capital management to markets, the standout question is whether analysts can understand the relevance of such data when it's put before them.

Take a knowledge-intensive company, such as energy supplier AGL, where human capital is the key asset. "How that asset is managed and developed and how its people work together over time is significant in terms of the financial markets being able to place a potential future value on that organisation," O'Donnell says. "If people are managed and developed well, then it is a sign of an organisation that has a level of confidence in its ability to manage its people."

While an organisation may manage its talent proficiently, the reporting of human capital data presents challenges. It takes courage because it opens the books to what's happening behind the rhetoric and "digs into the reality of the organisation", O'Donnell says. "The art of developing a strategy and executing a strategy is very complex and fraught and it is the human capital analysis of a business that really gets to the heart of an organisation's ability to execute on its strategy," she explains. That's why – beyond the retrospective profit-and-loss statements – it is such an important factor for determining the potential future value of a firm.

Adept organisations are releasing information that they know is increasingly interesting to financial markets even though it's not demanded by regulators, observes O'Donnell. "They do it because they are proud of the journey that they are on. They are clear and consistent in their human capital strategy," she says.

Who does it well?

David Leigh, chief executive of international talent management business SHL, finds it extraordinary that regulators insist every organisation has a financial audit, but no regulator has ever insisted that every organisation has an audit of their people. "I think shareholders and stakeholders will be considerably more interested in understanding the human capital profile of a particular company that they've invested in or have a relationship with if they are given the opportunity to digest insightful information on the topic," Leigh says.

Brian Bissaker, chief executive of Colonial First State, one of Australia's largest fund managers, agrees. "Around 70 per cent of what we do is managing people," he says. "If we get that right then it adds up to great shareholder value. More analysts are looking at the people management strategies and how good a communicator and strategy setter and feedback-loop-giver you are as a senior manager. There's a lot more emphasis being placed upon people management, particularly in service industries."

Consulting firm Deloitte is also considered a leader in talent management and human capital reporting. For several years, the firm has been recognised as a thought leader in the social media field, but that's partly due to the company's talent management strategies. Social media is used within the organisation to help staff get to know each other and share ideas, and has been used externally to communicate with people who would potentially like to enter the organisation.

"We use a lot of social media but in order to do so we need to be doing good things internally," says Alec Bashinsky, Deloitte's national partner for people and performance. "There's no point just branding a message and saying 'we're great'. The way we brand it is by talking about what we've done internally around engagement and driving performance, how we have developed our people and talent. We also use our employees for word of mouth. We run an employee referral program that last year filled 40 per cent of our vacancies."

Just as important as the use of social media and staff to spread the word about the business are reports to shareholders and other stakeholders, including the board. "There are two types of reporting that boards focus on these days," Bashinsky says. "The first is based on communicating externally about the people risk elements – that is, what an organisation is doing to protect its assets, such as workplace health and safety.

"The second form of reporting is around talent. Australian Bureau of Statistics' figures show that in 2015, for the first time in this country, we will have more jobs available in the market than we will have people to fill them. Talent in that equation is truly critical. I think shareholders are beginning to look more at the bench strength of a company. Do the businesses have the people to execute the roles and how good is their employee engagement?"

One problem is that analysts may not know how to interpret human capital management information. Bashinsky says it's a slow process but some progress is being made. As more companies provide such information, more analysts will begin to ask for it from other companies and will come to understand its importance and meaning, he predicts. "At the moment analysts aren't using human capital information enough," Bashinsky says. "It's going to take a bit more time for analysts to begin to recognise that such information is another critical measure of performance because it helps to illustrate what's happening with people in that organisation."

Do analysts understand?

Why should organisations report on human talent management issues if analysts have not been trained to understand their meaning? It's a sensible question to which there is not yet a satisfactory answer. Carol Royal, director of Masters of Technology and Innovation Management at the Australian School of Business, says the stockbrokers who write reports on companies and the fund managers who invest in businesses typically only look through the single lens of financial management.

"They rarely look at management in any detail," Royal says. "They take a bush lawyer approach to understanding management and management quality in companies, and they sometimes get it quite wrong. Then they wander off with all of these lag indicators of the previous quarterly period only to find that their forecasts are incorrect."

O'Donnell says financial market analysts, fund managers and stockbrokers are typically trained in very complex mathematical skills. Her research on human capital management with Royal reveals that in one Australian investment bank, 93 per cent of financial analysts had underpinning degrees in quantitative analytical tools. "That is understandable," she says. "They need to be able to look at the financial data and make predictions. But it is not sufficient to understand the way human capital has to be recruited, developed and created in contemporary, knowledge-intensive organisations. Part of our research is not only saying boards need to disclose more systematic human capital information to the markets, we also say financial markets need to know what questions to ask and how to digest the information." Universities and other educational institutions also need to reconsider the essential elements in the professional development of financial analysts and professional associations, insists O'Donnell.

Questions for analysts

Human capital systems that should be measured encompass leadership systems, governance, career planning and pathways, talent retention and creation, and remuneration. "Performance measurement for these areas really should be in place for an organisation to be sustainable," says Royal. "The rhetoric at the top needs to be matched with the practice throughout the organisation. When they are out of line, then you can't be managing effectively because the business is espousing one thing and doing something else."

Questions analysts should be asking to identify a more accurate future value of an organisation, O'Donnell says, are around leadership, culture, reward systems, succession planning and talent auditing. "If you want to put a value on Google as a company, you would need to understand that the organisation is driven by innovation, creativity and human capital," she says. "You would also need to understand that its success is not just down to a pipeline of new ideas and products coming through Google but also a pipeline of human capital talent that's driving those new ideas and innovations.

"The biotechnology industry, like IT, is very much a people-based industry. You can't look at a biotech company based on traditional accounting methods. Physical assets in the firm are not really relevant to the actual potential future value. So although financial analysts may be very well educated, in some cases they haven't been trained to ask the kinds of questions that are getting beyond the numbers to the real human capital heart of the organisation."

Analysts need not become psychologists, O'Donnell says. But they should request specific information from an organisation that goes beyond historical financial figures. "Look at contemporary organisations such as Google or AGL," she says. "If you look behind the financial statements and rhetoric and marketing publications you find people. Those people will make value or destroy value." A psychological profile of all the key people scattered around the organisation is not feasible. "We can't even look at the education of the CEO and make predictions based on that," says O'Donnell.

O'Donnell and Royal's research indicates what can be done by looking at the systems by which people are managed. How are they recruited into the organisation and subsequently trained and developed? How is knowledge managed around the organisation? What are the career plans in the organisation? Are the human capital systems appropriate and internally consistent? Do they complement each other? For instance, supermarket giant Woolworths does not always recruit the best and the brightest. At entry level, it recruits 16-year-old school leavers. "What they do well is invest money in high-potential school leavers and train them up to be very effective store managers and beyond. They are very generous with their training and development. Woolworths has a set of management systems that are internally consistent and consistent with its strategy," says Royal.

Bashinsky claims that when you know what you're looking for it's fairly clear when a business has the right mix of talent management skills, systems and processes. Small signs give away the fact that human capital management is in good hands.

"It's being demonstrated by the Commonwealth Bank in the fact that they promoted their new CEO from within," he says. "In many organisations they don't do enough around their people strategy. How many times do you see CEOs appointed from outside the organisation? It happens all the time. So when you're promoting from within, when you're confident you have the people on board to replace the weight-bearing roles – particularly the single most important role – you're demonstrating to analysts and shareholders that you have a solid plan in place, you have the necessary bench strength and succession planning."

This article was originally published in knowledge@Australian School of Business.