Modeling Employee Contribution
Many measurable factors within the work environment have an impact on, or can be related to, employee asset value. Unicru has coined the term Incremental Employee Contribution, or IEC Model, as a label for the model that has been developed to help organizations address key questions that relate to the value of their employees, and to examine alternative interventions aimed at optimizing the asset value of their employee pool. To date, the IEC model has been used successfully to examine relationships among length of service, time to competency, productivity, the value of retention, employee asset value, and, ultimately, employee profitability.
Developing a meaningful framework relating Human Capital to outcomes relevant to an organization on a financial performance basis requires an asset model applicable to that Human Capital. The key concept is the development of an understanding of employees as an asset rather than as an expense.
To illustrate, let’s describe a simplified employee asset model applicable to many environments in the service and manufacturing sectors in which employees are paid hourly with a well-defined and understandable set of tasks in their job description. Their role is understood, and their productivity can be measured directly or indirectly. We also have an estimate of the cost of acquisition. This information, including a few assumptions, allows us to build a simple but fairly robust model.
The foundation of the employee asset model, as with any asset-based model, includes the following important concepts:
An employee asset is acquired at some definable (though not necessarily measurable) cost.
An employee asset has a measurable life cycle from acquisition to departure. Some employees may return to the same firm several times during their career.
An employee asset engaged in a process requires inputs in the form of cash or value flows and provides a series of cash or value flows over time in return.
In addition, there are some unique aspects to employee assets that prevent us from simply adapting a fixed asset modeling methodology. Some of these differences include the following:
The value of an employee asset changes over its lifecycle in ways far more complex than those of typical fixed assets.
Employees must generally learn the processes in which they are engaged.
Interactions between employees, their managers, and other aspects of the organization have a profound effect on the value of a particular employee.
Post–employee acquisition investments in employee assets (training, promotions, and incentives) have a larger relative effect on the value and performance than can be described in the typical fixed asset model.
One way to model employee value is to utilize some of the components and methodologies found in the typical decision support tools used in conventional financial modeling. Two commonly used models are:
Net Present Value (NPV) Analysis. Related to cash flow analysis, this approach views the cost of acquiring an asset, with inflows and outflows of value supporting the ongoing engagement of that asset in the processes essential to the operation of the organization. Of interest to the valuation of employee assets is the idea of an asset value lifecycle and a methodology that properly accounts for the time value of money. An investment today in today’s dollars is offset over time by returns obtained in the future. These returns must be discounted to today’s value.
Temporal Break-Even Analysis. Unit production break-even analysis is a basic principle taught in Finance 101. The idea is to determine how many units of a product, given a known variable cost to produce each unit and known overhead or fixed costs, must be produced to attain break-even status. This unit volume break-even analysis approach observes fixed and variable costs related to a process, operation, or asset life cycle and determines at what volume profitability is attained within a given set of constraints including the cost of capital. Temporal break-even recasts the analysis from a volume basis to one related to time; that is, the time when a process becomes profitable. In this case, the time span we will examine is the employee life cycle. How long must employees be retained before the costs of their acquisition, training, salary, and benefits are paid off? While it sounds simple on paper, the actual practice of making this determination is complex in all but the simplest job categories.