Appendix: Research and Results

THIS BOOK IS PREMISED on the view that a firm’s HR architecture has the potential to become a strategic asset with direct benefits for the bottom line. We argue that in addition to HR contribution to the overall quality of human capital, the basis of that strategic influence is through HR’s alignment with the firm’s strategy implementation process. Finally, we emphasize the importance of an appropriately focused measurement system to guide and evaluate this strategic HR role.

RESEARCH ON THE STRATEGIC IMPACT OF HR

Throughout the 1990s Mark Huselid and Brian Becker engaged in a program of research that had several defining features. First, it was premised on the importance of HR systems rather than individual HR practices. Second, it took as given that, for HR to be a strategic asset, those HR systems had to have a demonstrated influence on the measures that matter to CEOs, namely, firm profitability and shareholder value. By using measures of shareholder value, this research was also unique in that it focused on the level of the firm, as opposed to individual employees or work groups.

The foundation of this research effort has been an ongoing biannual survey of HR systems beginning in 1992 that targets a broad cross-section of publicly traded firms: firms with sales greater than $5 million and more than 100 employees. These data are then matched with publicly available information on financial performance. To date we have collected data on more than 2,800 respondents over the course of four surveys. While the response rate for these surveys was typical for such research, averaging nearly 20 percent, it’s clear from table A-1 that our respondents were representative of the major industry groups in our target population.

As our understanding of the strategic influence of HR developed, so did the breadth and complexity of our measures of the HR system. The initial 1992 survey (focusing on the 1991 HR system) was limited to the fundamental elements of a professional, developed HR system designed to develop and maintain a high-performance workforce. These thirteen items measured the percentage of the workforce, both exempt and nonexempt, that was covered by such policies as validated selection procedures, promotion from within, annual performance appraisals, merit-based promotions, incentive pay plans, hours of training, and information sharing systems.¹

This measure was broadened considerably for the 1994 and 1996 surveys, which were expanded to include the extent to which firms used different types of incentive compensation plans, the degree to which HR and business strategies were aligned, and how well the firm’s strategy was communicated and understood throughout the firm. In addition, we collected indicators on other characteristics that might complement a High-Performance Work System (HPWS). These included the professional competencies within the HR function as reflected in their effectiveness across different functional activities, as well as senior leadership styles that emphasize motivation and vision, rather than command and control. Finally, in the 1998 survey, we focused on how two other systems that support strategy implementation (knowledge management and business performance measurement) might also leverage the influence of the HR strategy.

Table A-1  Industry Distribution of Firm Population and

Research Sample

Each survey enabled us to construct an HPWS index that measures the extent to which a firm’s HR system is consistent with the principles of a high-performance HR strategy. These indices are additive measures across the elements of the HR system. Thus, over the broad middle range of the index, a firm can increase its index value in any number of ways, depending on its circumstances. However, we have found evidence that the benefits of these systems increase as a firm improves its system across the board. This is consistent with the importance of internal fit within a systems framework. While changing survey formats have allowed us to explore variations in this index, the core elements supporting an HR strategy that emphasizes employee performance have remained constant. They also show a consistent relationship with other organizational outcomes and systems that would be part of a high-performance culture.

Consistent with our themes that systems matter and that successful strategy implementation requires the support of various intellectual capital systems, we find that firms scoring higher on our HPWS index are also rated higher on their usage of knowledge management systems and Balanced Scorecard–style business performance systems. Senior management in these high-performance firms likewise adopts a philosophy that supports this approach by viewing the organization’s employees as a source of value creation. Finally, the firms in these two groups also differ on some objective benchmarks that we would anticipate to be related to the adoption of a High-Performance Work System. We find that firms in the high-performance group have much lower turnover rates and much lower levels of unionization. The average ratio of market to book value of equity is also more than twice as high in the group with High-Performance Work Systems.

Comprehensive Analysis of the Effects of
HR on Firm Performance

Estimating the effects of HR systems on firm performance by comparing experiences across hundreds of firms is challenging for many of the same reasons it is difficult to measure these effects within a single firm. In both cases, it is difficult to isolate the independent effects of HR on the firm’s financial performance given the multiple influences on firm performance at any point in time. In some respects, this is an easier task when comparing experiences across firms because, if one can measure those other influences, their impact on the HR-firm performance relationship can be controlled statistically. This is the approach we used in our research. We estimate the statistical relationship between a firm’s HR system and firm performance, for firms of the same size and asset class, in the same industry, with the same historical growth rate, investment in R&D, unionization rate, and risk profile (beta).²

These estimates have been calculated over four different national samples through the 1990s. In each instance, we find very powerful support for a positive relationship between a High-Performance Work System and firm financial performance. Table A-2 provides a representative illustration of the magnitude of these effects across several outcome measures of interest. As an indicator of the strategic impact of HR, we believe the best reflection of this influence is the effect on shareholder value, or market-to-book value. The first two columns in table A-2 reflect different approaches to measuring such an effect. They indicate that if the average firm were to improve its HR system by 33 percent (one standard deviation), shareholder value would increase by approximately 20 percent. Though we believe the ultimate test of HR as a strategic asset is its relationship with shareholder value, it is also clear that these HR systems have beneficial effects on accounting profits, employee productivity, and turnover as well.

Table A-2  Effects of One Standard Deviation Increase in 24-Item

HPWS Index^a

*** = p < .001, ** = p < .01, * = p < .05

a The model used to estimate these results includes as control variables: firm employment, percentage unionization, R&D expenses/sales, firm specific risk (beta), five-year percentage sales growth. When ln Market Value or Gross Rate of Return is the dependent variable, ln Book Value of the Plant and Equipment is an independent variable in the model.

Source: Brian E. Becker and Mark A. Huselid, “High Performance Work Systems and Firm Performance: A Synthesis of Research and Managerial Implications,” in Research in Personnel and Human Resources Management, vol. 16 (Greenwich, CT: JAI Press, 1998), 53–101.

The Evolution of a High-Performance Strategy

While we have described HR systems as if they exist on a simple continuum, their character is obviously more complex. For example, do firms systematically emphasize certain elements of an HR system, and does this kind of emphasis have any effect on firm performance? In other words, if we believe that different HR systems will have different effects on firm performance, we ought to see some evidence that there are systematically different approaches to how firms structure their HR systems. If different HR systems are indeed present in our data, the next question is whether these different approaches have different effects on firm performance. Or, perhaps there are simply different approaches to the same objective, and no single High-Performance Work System really exists. These results are briefly summarized in chapter 1.

To examine this question, we compared our sample of firms on forty characteristics. Twenty-four of these characteristics focused specifically on the HR system (selection, appraisal, development, compensation, communication, etc.). Another sixteen measured other characteristics of the firm that would be expected to facilitate the implementation of a High-Performance Work System. These included the ability of HR professionals to effectively manage different elements of the HR system, the alignment between the HR system and larger firm strategy, the clarity and communication of the firm’s mission, and the leadership style of the senior management. We describe these latter characteristics as implementation alignment.

Using a technique called cluster analysis, the firms in the sample were compared based on how they structured these forty characteristics into an overall HR strategy. This approach was appropriate, given our emphasis on the importance of systems. In effect, this type of analysis will indicate whether the firms in our sample can be categorized by the way in which they structure their HR architecture. We discovered four such systems, which are illustrated in figure A-1:

•  High-Performance Work Systems: Firms in this group score well above average on both the HR system and implementation alignment dimensions.

•  Compensation-Based Systems: Firms in this group score above average on the HR system index but below average on implementation alignment. We refer to this group as compensation-based because the only reason they score well on the HR system index is their very high ratings on the compensation dimensions.

•  Alignment Systems: These are an unusual set of firms. They are slightly above average on implementation alignment, but they score among the lowest on the HR system. These firms approach strategic HR from the top down but don’t finish the job. Senior managers say the right things, and HR is considered to be part of the strategic planning process, but managers have never made the investment in the infrastructure of a High-Performance Work System.

•  Personnel Systems: These firms are characterized by scores that are well below average on both the HR system and implementation alignment dimensions. Such organizations approach their HR systems in a very traditional way and appear to make no effort to exploit HR as a strategic asset.

Does it matter which HR architecture a firm adopts? Are there any differences in firm performance among these firms? The data show very clearly that there are. Controlling for other firm and industry characteristics, a firm pursuing a High-Performance strategy had a 65 percent higher market value (for a given book value) than a firm using either the Personnel or Alignment strategy. Firms using only the Compensation strategy had a 39 percent higher market value than similar firms using the Personnel strategy. There was no statistically significant difference between the experience of firms using the Alignment strategy and the Personnel strategies.

Figure A-1 Typologies of HR Architectures

MORE RECENT RESEARCH ON THE FINANCIAL IMPACT OF HRM

In this section, we highlight several key findings from the most recent survey by Mark Huselid and Brian Becker. These results are summarized in figure 2-5 in chapter 2 and describe a pattern of relationships among several intangible assets that are influenced by the HR architecture and strategically focused measurement systems.³

We can summarize the results of this study as follows:

•  Strategy implementation is more important than strategy content. A 35 percent improvement in the quality of strategy implementation, for the average firm, was associated with a 30 percent improvement in shareholder value. A similar improvement in the suitability of the strategy itself had no effect on firm performance.

•  Strategy implementation has three drivers: employee strategic focus, HR strategic alignment, and effective knowledge management. HR strategic alignment and the knowledge management system also drive employee strategic focus.

•  A balanced performance management system affects firm performance through its impact on employee strategic focus, which in turn drives effective strategy implementation.

In addition to the effects that drive the strategy implementation process, Becker and Huselid have focused specifically on the relationship between the High-Performance Work System described in chapters 1 and 2 and shareholder value in earlier studies. Our results indicate that for the average firm, a 35 percent improvement in our high-performance HR index is associated with just over a 20 percent increase in shareholder value. These findings are part of a larger research literature demonstrating HR’s impact on firm performance.⁴

We analyzed employee strategic focus as a response to three underlying management systems, looking specifically at the following relationships:

•   the extent to which a firm has aligned its HR system with the demands of the strategy implementation process;

•  the presence of a comprehensive knowledge management system that both generates and effectively distributes knowledge throughout the firm; and

•  the presence of a business performance measurement system that reflects both the leading and lagging indicators of successful strategy implementation.

Our data show that each of the three systems would have to be improved by 50 percent to realize the gains from employee strategic focus described earlier. In short, there are ample economic rewards associated with superior human capital management, but there are no quick fixes. Developing such an approach requires a systematic method and commitment to the long-run development of people.