Human Capital ROI: What It Is, Why Use It and How to Calculate It
Multiple studies have shown that a company’s workforce is responsible for more than 90% of its Market Value through intangible assets such as patents, trademarks, intellectual property and innovation. And for most organizations, labor costs also are the single largest operating expense.
For these reasons, understanding and quantifying the impact of human capital value and risk on the business is critical as companies look to emerge from the COVID-19 pandemic. Human Capital ROI is a leading performance metric that can transform how to measure, manage and optimize workforce productivity.
We created this guide is a primer on Human Capital ROI to explain what it is, how to calculate it, and how to use it to make better talent management decisions.
What is Human Capital ROI?
Human Capital ROI is a cost-based metric that reflects the return on investment in people in terms of the incremental Revenue an organization would be able to generate from an additional $1 investment into the workforce.
For example, a 2.5 Human Capital ROI ratio means that for each additional $100,000 an organization invested into the workforce, it should expect this investment to be able to generate an additional $250,000 in revenue. HR can also use this metric to measure the ROI from recruiting, training and nurturing talent vs. other forms of investments.
Human Capital ROI is among three advanced productivity metrics that account for workforce costs in relation to company output (revenue/profit). The other two metrics are Return on Human Capital Investment (%) and Total Cost of Workforce (TCOW).
What’s Wrong with Traditional Measurements?
Traditional financial reporting contains minimal information on an organization’s talent management effectiveness and productivity in relation to revenue and profit. The recently released ISO #30414 Human Capital Reporting Standard addresses this deficiency with recommendations for disclosing certain advanced workforce productivity metrics. The U.S Securities and Exchange Commission Chairman has stated that he “would like to see more disclosure from public companies on how they think about human capital.”
Human Capital ROI solves the financial linkage challenge by quantifying overall changes in major expenses such as total labor costs to outputs such as revenue. The result is an output and input sensitive return on a series of cost-based workforce productivity metrics.
Finding from Our Workforce Productivity Study
HCMI’s early research and multi-industry study found that cost-based workforce productivity metrics predicted improvements and losses in overall market value. These findings held in the periods of recession, growth, and overall market stagnation.
In 2020, we conducted a follow-up study of the top 41 North American banks to exam the industry’s workforce productivity trends from past years. As shown below, there is a significant gap in Human Capital ROI between the top and bottom quartile banks. This gap grew over 33% in 2019.
Highlights of this study:
Labor costs are the single largest operating expense driving the cost-to-income-ratio (CIR) banking metric
Advanced metrics and measures used in the study link workforce investments to revenue and market value
Top 5 bank “winners” grew in market cap by $20.5 Billion per bank on average vs flat market value for the others
In 2019, the gap between the top and bottom quartile banks increased by 33%
Prior studies suggest talent management decisions before, during and after financial crises significantly impact the likelihood and speed of recovery from COVID-19
How to Calculate Human Capital ROI
3 Examples of Using Human Capital ROI to Make Better Workforce Decisions
Example 1: Use Human Capital ROI to track the impact of workforce investment decisions
Including Human Capital ROI in your HR reporting can help management visualize and track the impact of workforce investment decisions.
We recommend tracking historical Human Capital ROI trends as they are a good predictor of organizational performance and show the direction and the rate at which your productivity is improving or declining. Where the data allows, filtering productivity data down to the business line and job category level provides insights for more precise interventions.
Here are the top workforce questions you can answer using Human Capital ROI:
What is our workforce productivity? Is it higher than peers?
What is the marginal return of one dollar invested in the workforce?
Is the ROI on human capital higher than other investments?
Is workforce productivity increasing, decreasing or static?
How are we performing versus peers?
Example 2: Benchmarking your workforce performance against the industry average and similar peers
When you’re done calculating your Human Capital ROI, you’ll want to compare your numbers against industry benchmarks. This is a great way to evaluate your performance relative to peers before looking for possible interventions.
If your historical data and forecasts are close to industry benchmarks, you know that you are performing as well as other companies. If your score is well above or below the industry average, you may have differences in workforce strategies or the overall business performance. Comparing against specific peers with a similar business model, segment, size or geographical location can provide deeper insights.
An analytics tool like SOLVE can make this process quick and easy with data automation and pre-built industry benchmark data. Learn more about how you can benchmark your Human Capital ROI against peers.
Examples 3: Create your workforce productivity report and disclosure
Similar to how financial reports provide a snapshot of the financial health of your organization, Human Capital ROI along with Total Cost of Workforce and other advanced metrics provide a clear picture t with amazing details of your workforce costs, performance and distribution. Much of today’s talent management decision process is based on metrics and ratios. This type of report can be a tool for management to get timely and accurate information about workforce cost and productivity.
Human Capital ROI is also one of the recommended metrics in the ISO #30414 guideline. Even if getting certified might not be your organization's objective at the moment, it is a good idea to start familiarizing your team and management about this metric and evidence-based talent management in general.
Below is an example of our workforce impact statement: