Strategic HR, profitability and share price

Brett-Chulu34.jpg

RECENT research shows that having superior human resources (HR) capabilities resident in a business is related to superior profit growth, profit margin and share price growth.

The Human Capital Telescope with Brett Chulu

The research findings of a 2012 joint study by the Boston Consulting Group (BCG) and the World Federation of Personnel Management Associations (WFPMA) will be considered.

Poor HR suppresses profitability
Having poor HR practices is synonymous with suppressing business value. Here is a summary of the top six HR practices in terms of their relative impact on profit growth and profit margin.

Ranking first is recruitment. Companies with poor recruiting capabilities experienced growth in profits 3,5 times less than companies with superior recruitment capabilities.

In terms of profit margin, poor recruitment accounted for as much as two times underperformance relative to strong recruitment capabilities.

Ranking second are onboarding and talent retention practices. Onboarding refers to the system of integrating new employees into the company. If a company were to strengthen its onboarding and talent retention capabilities to reach world class standards, it would be expected to see a 2,5 fold improvement in profit growth.

Its profit margin would be expected to improve 1,9 times.

Ranking third is managing talent. Managing talent refers to how a company engages skilled employees to become consistent and committed business contributors.

If a company would hypothetically slacken its talent management capabilities, a 2,2 times slump in profit growth would be anticipated and a corresponding 2,1 times dip in profit margin would be expected.

Ranking fourth is employer branding. Employer branding is how a company uniquely positions itself in the minds and hearts of current and prospective employees by creatively combining financial and non-financial rewards as well as work practices to create an overall positive employment experience.

In terms of profit growth, companies with poor employer branding practices underperformed those with superior employer branding practices 2,4 times. Likewise, weak employer brands trailed by as much as 1,8 times when it came to profit margin.

Ranking fifth is performance management and rewards. A company with poor performance-reward management practices should expect profit growth 2,1 times less than its rivals with stronger performance-reward management practices. Similarly, a two times underperformance in profit margin is to be anticipated.

Ranking sixth is developing leadership. Companies good at developing leaders outperformed those poor at developing leaders in profit growth by a factor of 2,1. In the same vein, being poor at developing leaders accounted for a 1,8 times underperformance in profit margin performance.

Unfortunately, these findings are at the correlation level, meaning that they only show us that superior strategic HR practices are associated with superior business performance. Thus, from a practical point of view, until research advances to pinpoint the actual causal mechanisms, our best bet is strengthening HR capabilities in these six HR practices.

Poor HR suppresses share price
In addition to teasing out the statistical relationship between HR practices and profitability, the BCG-WFPMA study compared the difference in the share price performance of the 100 Best Companies To Work For and listed companies.

In this study, the share price performance of companies that consistently made it into the 100 Best Companies To Work For ranking was contrasted with that of S&P500 firms over a period of 10 years.

The results were astounding: companies that appeared in the 100 Best Companies To Work For list at least three times in the last 10 years, on average, experienced a 109% growth in share price as compared to just an average of 10% in S&P500 firms. That’s a 10-fold difference and just too significant to ignore.

Since companies that make it to the 100 Best Companies To Work For list have relatively superior HR practices and capabilities weaved into the fabric of their business practices, it means the absence of strategic HR capabilities in a firm should be a serious concern for investors. In the same vein, CEOs who are keen on creating value for shareholders cannot afford not to have strategic HR practices.

Unlike the strategic HR practices versus profitability correlation, we now know in part why strategic HR practices contribute to superior share price growth. From an independent research that was conducted by the Results Based Leadership Institute in the same year as the BCG-WFPMA study, that is, last year, it emerged that investors base 28,4% of their investment decisions on the quality of leadership.

It was found that investors do not have precise metrics for evaluating quality leadership. This means that those companies that are seen to be investing more in people-related practices are likely to be viewed positively by investors.

Here is a simple example to illustrate the decision pathway an equity investor may take.

A private equity investor interested in getting exposure to the Zimbabwean market will first look at attractive industries. The telecoms sector is one such attractive industry.

Next, the investor will study the historical performance (financial and operational) of companies in the telecoms sector.

Thus those telecoms companies with a strong history of operational and financial performance will receive higher valuation. Finally, the private equity investor will study all available information on the quality of leadership within these telecoms companies.

The obvious first port of call will be the profiles of board members and senior executives, where industry expertise, quality of personal networks, ethical records and evidence of relevant management experience and skills is scrutinised.

A savvy executive team that avails more information to the private equity investor on people-related practices such as those in the top six BCG-WFPMA research strengthens the investor’s perception that such a telecoms firm has superior leadership qualities.

For instance, if telecoms firm A and telecoms firm B rank equal in terms of historical performance as well as in the skills set and experience of senior executives, the telecoms firm that demonstrates, for instance, that it has better people-related practices should result in a higher price-earnings rating.

Reflect on it

Being a consistent best company to work for is associated with a 10-fold better share price performance than ordinary listed firms.
Chulu is a strategic HR consultant who is pioneering innovative strategic HR practices in both listed and unlisted companies. — brettchulu@consultant.com

Top