Why are effective managers always interested in their return on investments? Why do they want to know who in the company is driving return on investments? Why should they care about measuring return on investments in Talent? What is the correlation between Talent and return on investments?
In this chapter, I introduce the concept of return on Talent (ROT). For decades, organizations have used key metrics like ROI (return on investments) and ROA (return on assets) to determine value. But, in the future, more organizations will use the measurement of ROT. Current business measurement equations merely measure the use of financial capital, but ROT measures the return on human capital. To calculate ROT, you simply divide a valuation for the knowledge generated and applied by your investment in Talent.
Before we talk about calculating ROT, let us talk about the two key components of ROT: (1) knowledge generated and applied and (2) investment in Talent.
Knowledge may be described as the “hidden” assets of an organization. Knowledge measurement relates to several factors that directly relate to business success—factors such as sales growth, profit growth, EPS growth, innovation growth, customer satisfaction, service quality, customer loyalty, customer retention, employee retention, new product development, product defect reduction, product failure rates, resources utilization rate, learning rate, number of patents and trademarks, and copyrights or new brands. By monitoring these factors, organizations can measure their knowledge assets and evaluate performance. By measuring knowledge accurately, management can better manage Talents. Proper valuation of knowledge helps an organization to know the ROT, which reflects the profitability of the investment in Talent.
Putting a price tag on knowledge generated helps a manager to quantify results. Talents generate knowledge, which is one of the greatest assets in the global economy. True knowledge brings creativity and innovation and adds value to the company. Knowledge has become a key production factor, like raw material, buildings, and machinery. Companies that measure the knowledge generated and applied by their Talents can make their investments in Talent more profitable. Companies cannot improve what they don’t measure.
If you have talented people, knowledge generated is just one component. The most important contribution that Talents can make is in the area of knowledge applied. If knowledge is not applied, then the company loses most of the market value of that knowledge. So, whatever knowledge a talented person generates and applies during the year divided by how much I invest in that person gives me the ROT value. If certain talented people generate many innovative ideas but never implement any of them, they fail to generate any ROT value because the return for the company is nothing.
Knowledge generated increases with its effective deployment. Knowledge becomes an asset when it is captured and utilized effectively. Unless knowledge is effectively utilized or applied, it cannot generate any yield or ROI. For example, theories of physics have no value unless they can be applied for the benefit of society. Similarly, within the organization, generating knowledge doesn’t add much value unless it is used in effective strategy formulation. Knowledge assets, like money or equipment, are worth cultivating only in the context of strategy. You can’t define and manage intellectual assets unless you know what you are trying to do with them.
Without investment in Talent, an organization becomes stagnant. Organizations invest in technology, machines, and people. But in the twenty-first century, the most valuable investment is the investment in talented people. Management must invest in the right people, whose capability must match the needs.
Finding the right people is not only more difficult today but also more costly. Every company needs Talents in critical positions to operate successfully. If an organization can make the right investments in the right people, the organization will grow vigorously. Organizations cannot keep their top Talents without spending top dollars on them. Top Talents want top rewards: It is not just monetary, it also can be peer recognition.
Managers of Talent need to reward the right things. After you define the power of the knowledge generated, you can reward the Talent appropriately. Some managers become jealous of the Talent working for them, and so they shower rewards on the people who solve immediate problems (firefighters). If you manage the knowledge generation in a company, you have to make sure that the person who comes up with the brilliant ideas gets rewarded. You put a value on an idea and a higher value on ideas that are ultimately applied—and become a new reality. For example, right now we are using the Pentium IV or Pentium V processor. Eventually the Pentium VII processor will come out. Who is coming up with that technology? Talents at Intel who generate the next generation of chips should be recognized and rewarded. I am not talking about rewarding them the next day. Some applications of knowledge may take at least one or two years. But as soon as the knowledge is applied and the corporation gains market share, management must reward the Talent who made the innovation possible. Too often top executives and firefighters get all the social recognition and financial rewards.
Managers need a reliable tool for measuring return on Talent so they reward the right people. Imagine that over a three-year period, a Talent saves you $1 million, and your investment in her is minimal. About twenty people work with her, and these twenty people represent your Talent group or innovation function. Later, when they are doing something that saves you $100 million, they need to be recognized and rewarded more. But they likely won’t be unless their manager measures the ROT value of this Talent pool.
Decreasing investment in Talent is usually a mistake. Such cutbacks bring about losses. To decrease the investment in Talent, senior managers must evaluate their expenditures on Talent regularly and consistently and learn about different areas in order to make wise strategic decisions on their investment in Talent.
To avoid creating an accounting nightmare, don’t calculate ROT on every person, only on top Talent, maybe only about one thousand to two thousand people out of twenty thousand, consistent with XYZ analysis that X people make up 5 to 10 percent of the population but contribute 60 to 70 percent of the value. These people are the top Talents. Often middle managers are not necessarily talented, but several talented people report to them. Now, if you are trying to measure return on Talent, these middle managers won’t care. It is essential that you explain to the managers, “We will invest more in our talented people.”
Managers should use the ROT value to determine compensation. Compensation should be based on some balance between individual and team performance and contribution. So, your investment in one individual Talent might be as high as $250,000 a year. Suppose the investment in a CEO is about $5 million a year, but the board should keep her because of her intellectual contribution. As long as the CEO’s return on investment is high (as measured in her company’s profitability), she will continue to make $5 million a year, and no one will care because everyone wins.
Investment in Talent is critical, but Talent has to show results. You cannot invest more just because Talents ask for more. What energy level are they showing? What results are they getting? If you know that certain people represent the future of the company, invest more in them. Some Talents may complain, but you have to look at their performance objectively. If they come up with a compelling business case that shows the company will gain more for more investment, invest more in them. If you don’t invest more, the Talent team might shut down the whole organization. ROT scores help you to invest the right amount in the right Talent at the right time.
You might double your investment in a talented team if you believe in its game plan. That’s one of the keys to managing Talent. Most managers want to keep their investment small. In a downturn economy, they want to take away investment. They want to be very cautious. They don’t want to invest more in Talent. But, they often overdo their cost cutting.
You can generate higher ROT values by increasing the numerator (knowledge generated and applied) or by decreasing the denominator (investment in Talent). Return on Talent is a function of knowledge and communication. A Talent generates more knowledge when all ideas and information can flow easily and multidirectionally.
ROT measures the payback from investment in people. ROT shows whether managers are hiring the right people and how effectively they use them to achieve business success. ROT can be a quantitative or qualitative measurement, based on management’s viewpoint. Are managers getting the maximum payback every hour of the day on their investment? If managers want to see quantitative results, they must put a price tag on knowledge generated and results achieved.
Effective managers use ROT measurements to make their investments in Talent more profitable. ROT measurements help them to monitor performance, forecast opportunity, and determine the profitability of their investment in Talent. To make their investment more profitable, managers must constantly measure ROT, continuously improve ROT, and reshuffle Talents.
Companies that constantly improve ROT grow at a fast rate. Management can monitor the performances of individuals as well as teams. If knowledge assets are increased, then all other related factors like production and sales will increase as well. So corporations should try to improve ROT continuously to sustain growth.
High ROT leads to creative workforces, innovations, smooth processes, continuous product improvements, and improved communications. It helps management to be flexible, to capitalize on opportunities, and to keep pace with the changing climate. Talented people influence those around them, and their knowledge is shared over time. If managers expect them to achieve their maximum performance, and maximum return, they must not place them in routine jobs.
Talents create ideas and knowledge that may lead to tangible outcomes that can readily be measured and translated into monetary values. They also create ideas and knowledge that are intangible but are judged to have enormous value. What is intangible knowledge, and how is it measured? We call the things we can’t measure in monetary terms “intangible.” In the spirit of the definition of ROT, knowledge not yet applied is intangible. Only applied knowledge is tangible and measurable, as the phrase implies by its wording: knowledge generated and applied. The first challenge is to calculate ROTs for tangible, applied knowledge. The second challenge, which is obviously much more difficult, is to calculate ROTs for intangible knowledge generated. However, some form of measurement of intangible knowledge must be devised to enable a corporation to understand and properly determine the value of Talent.
The basic calculations of return on Talent focus on one Talent or one team at a time. In order to properly attribute financial changes to the right people, it is important to define all activities in terms of projects with a defined scope and a beginning, middle, and end.
Projects are a big deal. First, they are the means of getting things done. Lists of action items have never caused anybody to take action. Projects do. Projects require establishing goals and objectives, plans to achieve them, milestones. Monies and staff need to be allocated to projects. When these things are achieved, the corporation has a chance that some action will actually be taken. Without projects, there may be no ROT.
Second, projects provide a means of tracking a specific investment and the returns generated by that investment. Tracking is difficult in accounting systems that use general funds and allocations of monies in and out of the general funds. Activity-based costing (ABC) accounting simplifies the process of tracking costs and returns related to a given project.
Return on Talent (ROT) needs to be put in a form suitable for calculating meaningful measures. Net dollars realized from knowledge generated and applied are defined as the gross dollars realized minus the cost of generating and applying the dollars. Gross dollars realized may reference revenues, cost savings, or cost avoidance.
Net (knowledge generated and applied) is defined as project value minus project expenses.
For ROT calculations, project expenses should include all costs directly related to a project except the fully burdened salaries of Talent(s), fully burdened salaries of other team members if any, and all other expenses.
Following are three examples of how to calculate ROT numerators.
Investment in Talent is the total of all costs directly related to the fully burdened salaries of Talent and other team members. During the first six months, a Talent spent money on the idea project using the idea seeding fund to buy laboratory equipment and materials. She also spent her time on a product development program. She documented progress in a laboratory book every day. The documentation was sufficient for the patent attorneys to write the patent with minimal additional help.
Project expenses included:
Knowledge generated and applied has two distinct elements: (1) knowledge generated and (2) knowledge applied. Some estimate of the intangible value of the knowledge generated, the technology, and the patent might be assumed for accounting purposes, as might be the case if you were applying for a loan. However, its real value is not known until the knowledge is applied. In this example, the application was to sell patent rights to another company. The tangible value placed on knowledge generated and applied is the sales price.
The patent was issued in the United States in eighteen months and in the European Union nine months later. Shortly after the U.S. patent was issued, a Fortune 100 company approached the company expressing interest in the patent. After the normal bickering and negotiations, the company bought the U.S. rights for $1,000,000 and the EU rights for $500,000 contingent and payable upon EU issuing the patent.
A relatively new hire, Janet, who had not yet learned to keep her head down and not make waves, became frustrated about the amount of time she was spending working with the finance department to reconcile differences between time cards (not time clocks) and project charges. Both had several signatures verifying the correctness of the submissions. The human resources group was tracking them to prevent overtime violations that had caused problems before.
She decided to talk to some of the managers and supervisors signing off on the submissions. She immediately discovered that no one wanted to talk to her. She continued to push until she found two people who would talk to her. They both explained that they did not pay much attention to those things. Others had already reviewed and signed off on their correctness. Furthermore, they were terribly time consuming. There was one project time sheet and time card for each of the five hundred employees in the department. And they were submitted every week. Human resources was involved in an effort to avoid a repeat of overtime violations that had caused problems last year.
The two people whom Janet had gotten to talk with her were managers. One told her that he would change inputs from his subordinates to balance the times reported on the project time sheets with project plans. The other manager had just transferred from the quality office. She told Janet a related story concerning time card errors. He suggested that time cards should have only one, or at most two, signatures—one by the person doing the work and the other, if management insisted, by his or her direct supervisor. His analogy was the old notion that “if more than one is in charge, no one is in charge.” He reasoned that if more than one person signed the card, everyone would assume that all was well and sign the card without ever checking it. In other words, if more than one person was responsible, then no one would assume responsibility.
Janet was appalled at the waste and excited about the opportunity. But her boss was not at all enthusiastic about her unassigned and unapproved initiatives. He advised Janet that she was in over her head and would damage her career if she persisted. She and her finance partner reduced the visibility of their pursuits but persisted.
They observed that they were doing the same kind of reconciliation that the other signatories were doing. They decided to determine how long it took them to do their reconciliation and to assume that all others in the chain were spending similar amounts of time creating errors in changing times to agree with planned time allocations. They determined that they were each spending four hours a week doing what they believed was non-value-added work. Worse, it wasn’t even honest. Managers were moving times charged to projects that had time available, not necessarily to the ones that people had actually worked on. The employee didn’t need to submit anything because it was ignored anyway. They assumed, for lack of data, that each of the six people who signed the time cards and the project reporting sheets spent about four hours per week for a total of twenty-four hours per week. And that was for just one of twenty departments. If all departments were requiring similar times, the total would be 480 hours per week—the equivalent of twelve professionals who could be doing value-added work.
This was too big to let go. Janet and her finance partner prepared a white paper explaining their findings. They even proposed a three-part solution: (1) Eliminate time cards for professionals and make the managers responsible for preventing overtime violations; (2) use the project reporting sheet for both work time and allocation of time between projects; and (3) have only the individual doing the work and his or her boss sign the project reporting sheet. They collaborated in allocating the times recorded.
Janet’s boss reluctantly agreed to take the proposal to his boss. The finance boss resisted. He did not think the proposal would do anything other than make people mad.
Janet and her boss teamed to champion the proposal up through the management ranks in human resources. Eventually, the proposal was accepted and implemented. The savings were projected to be 7.5 work years at $40,000 fully burdened salary for an annual savings of $300,000.
Janet and her finance partner each received a bonus of $30,000 to be paid out over three years. The money was the tangible portion of their idea, which for so long seemed as if it would die without a hearing and remain an intangible idea. An unexpected additional benefit soon emerged. More people at even higher levels of management were beginning to suggest ideas for improvement. Some of the ideas helped improve the performance of the organization.
How much did the ideas improve the performance, and how much improvement was due to other factors such as a strong economy? No one knew.
Janet’s original idea caused many things to happen. She felt that she was at least partially responsible for the excitement. But no one else seemed to remember what she did that triggered so much activity. Her intangible contributions went unnoticed. Indeed, her original recognition was forgotten until the vice president of human resources offered an out-of-the-box idea: to treat recruits like customers to be coddled rather than potential employees to be interrogated.
Janet and her partner estimated that they spent three months total work time—forty-five days each. Their salaries averaged about $60,000 per year each. So, for this period, the investment in both Talents was [$60,000 × 2] / 12] × 3 = $30,000.
Now, in this scenario, ROT value is based on a team rather than on individuals. Sometimes ROT value does not have to be calculated for individual Talent if multiple Talents are involved.
Calculating intangible knowledge is a big challenge. But we face it in everyday life. Think about how easy it is for a mathematics teacher to score a student compared with a literature teacher scoring a student. A mathematics teacher scores a student’s problem based on either right or wrong. But a literature teacher scores based on her feelings and the writing style of an essay; and that does not necessarily mean that the essay is right or wrong. This leads us to think about the value of intangible knowledge generated, which most managers often ignore.
Mr. HR Idea made a suggestion to Mr. Director, a boss who was getting bad reviews for poor performance and poor management style. He was a bottom line–oriented, command-and-control-style manager. He had been through the corporate management style training twice. Still, he just couldn’t behave as people wanted him to behave. He couldn’t shake his twenty-year military background. Everybody loved him in social settings. But in the work setting, where he had heavyweight authority, he was indeed authoritative. Mr. HR Idea suggested that the boss think about “Talent as customer and boss as supplier” of goods and services that meet the needs and wants of all his employees. He went on to suggest that the boss take a customer service class to learn some of the specific techniques that service people use to keep customers happy.
That simple suggestion had immediate effects on Mr. Director. He could follow disciplined prescriptions about how to behave. He did that for twenty years in the service. He was tentative at first, but some rapid positive reinforcement from his subordinates and his peers gave him ever-increasing confidence. He soon discovered that listening for understanding made a big difference and was fun. He learned a lot about what went on in the organization. After a few years, his employees voted him the “year’s best manager”—not most improved, but the best. He glowed for the remainder of his working life.
How much was this intangible knowledge passed on to Mr. Director worth? Who knows? Probably millions of dollars! But it is so intangible. Mr. HR Idea wasn’t voted “best” anything. He did not expect and did not receive any recognition.
To transform intangible ideas into tangible knowledge generated and applied, we need a way to measure intangible knowledge assets. Here is a seven-step process: (1) Determine what the knowledge or idea generated is; (2) identify the source or originator of the idea; (3) track the path of the idea from the source through all potential applications; (4) identify at least one application; (5) identify one or more persons pursuing the application; (6) determine how to measure the financial benefits of the idea; and (7) determine the financial value.
Don’t worry about the details of the formula. Some ideas take only hours to generate and communicate, such as Mr. HR Idea’s idea about regarding employees as customers. The transformation in behaviors was, of course, an application, but it was still intangible. The benefits in organizational financial performance need to be measured or, if not financial, some metric such as employee satisfaction or reduced turnover. Examine the metrics the organization uses to evaluate year-over-year performance, such as internal or external revenues, internal or external customer satisfaction, productivity, patents generated, widgets invented, services provided, and any others.
Determine the return in whatever metrics you can find to use. Financials are preferable, but alternatives are better than no measurement.
Tangible knowledge generated and applied: Both the ROT ratio and the net value of the applied knowledge are important. High ROT ratios do not by themselves accurately reflect value to the company or the value of the Talent. A low ROT with a very large applied knowledge value is more significant than a high ROT with a small knowledge applied value. The magnitude of the applied knowledge value is $1,415,000, and the ROT ratio is 18.86 for example 1. Both are large, making it clear that the value to the company is large.
Tangible and intangible knowledge generated and applied: In contrast to example 1, the knowledge applied and the ROT are both a modest $150,000 and 10, respectively. Clearly, the first example provides significantly more value to the corporation. Applied knowledge value and ROT are important indicators for judging contribution.
Intangible knowledge generated and applied: The intangible value of the change in Mr. Director’s behavior was judged by the CEO to be worth millions, whether you can actually calculate the benefits or not. We don’t need to quantify it. Mr. HR Idea’s initiative made a big difference. We need more of them. On second thought, it might be an interesting exercise to try to turn what appears to be a very intangible value into a quantified tangible value by deploying the seven-step process.
To optimize ROT, place Talent in positions where they can generate a lot of revenue and focus their activities by defining projects that can be tracked through multiple year-end closings. If talented people are not working in positions where they can generate knowledge and create wealth for the company, they are misplaced. People establish their own brand on their own expertise, and their knowledge, skill, or information should be leveraged exponentially.
Corporations rarely think about leveraging their technical Talent. They don’t know which knowledge can be leveraged. Defining ROTs of Talent projects and summing all of the projects in the corporation will help managers gain the knowledge they need to make informed decisions about investments. It will also help them appreciate the value of Talents by developing an objective database that demonstrates that 60 to 70 percent of the value is indeed generated by 5 to 10 percent of the people—the X people in an XYZ analysis. Segmenting work by projects will also help determine which 5 to 10 percent of the people are generating and applying knowledge of high value.