Human Resource Investment Considerations_Charles R. Greer

Several factors will be considered in the discussion of strategic human resource investment decisions. As noted earlier, these will include management’s values, views of risk, the economic rationale for investment in training, utility theory, and alternatives to human resou1rce investments. Investments in training are covered in this section because they are fundamental to the formation of human capital. Firms also invest in many other human resource practices with the expectation that there will be impacts on performance and financial returns.

Management Values

Fundamental values must be addressed in many human resource issues, particularly those involved in major strategic initiatives. When senior managers formulate and implement strategies, their values and philosophies are communicated to members of the organization through human resource policies and practices. For example, senior managers who are committed to the preservation of the organization’s human resources can manage the stress associated with major strategic events, through such measures as dealing with rumors and providing accurate information, so that misinformation does not have such a debilitating impact on employees. How an employee are treated following significant strategic events, such as a merger or acquisition, is a reflection of these values and communicates whether the organization views employees from an investment perspective. Those adopting an investment perspective seek to enhance the value of their human capital or, at the very least, prevent its depreciation.

Risk and Return on Investment

Although there are a number of important benefits to investments in human resources, such investments contain an element of risk. Investing in human resources is inherently more risky than investing in physical capital because the employer does not own the resource. Employees are free to leave, although contractual arrangements may limit their mobility. In order for investments in human resources to be attractive, the returns must be great enough to overcome the risks. Further, for some investments, such as cash outlays to maintain no-layoff policies, the benefits are not easily quantified and there are meaningful costs. Decision makers have to be prepared to trade off current costs for long-term strategic benefits, such as a more flexible, committed workforce and related positive aspects of the organizational culture to which such policies contribute.

Economic Rationale for Investment in Training

Because human resource investments frequently involve training, it is instructive to consider the difference between specific and general training. Nobel Laureate economist Gary Becker has written extensively on this subject. His distinction between specific and general training in human capital theory provides guidance for understanding when employers will provide training. The decision whether to invest in training and development depends, in part, on whether the education imparts skills that are specific to the employing organization (specific training) or are general and transferable to other employers (general training). Employers generally invest in or pay part of the cost of specific training because employees cannot readily transfer such skills to other employers. Employers recoup their investments after employees complete training by paying employees only part of the revenue derived from their increased productivity (marginal product). Conversely, conventional human capital theory predicts that employers will pay for none of the cost of general training because employees can transfer skills developed at employers’ expense to other employers. Accordingly, employers would rather hire an employee who has the requisite general skills. When employees having the requisite general skills cannot be hired, the employer must invest in general training without assurance that the unskilled employee will remain employed long enough after training for the employer to recoup the investment.

In reality, employers probably invest in general training more than the specific and general training rationale would suggest. A recent study has found the following:

Under certain conditions [use of employment contracts and retention of employees based on productivity] the firm may share the costs of and returns on investment in general human capital and pursue no lay-off policy. General human capital will have the same implications as firm-specific capital.

General training can be obtained in on-the-job training as well as in formal programs such as tuition reimbursement. It also can occur unintentionally simply as a byproduct of the work situation as employees learn work skills that are applicable to other employers. Employers may make general training investments in employees by paying a wage during training, which has been reduced by the training costs. Employers also can recoup some of their investments in general training because employees incur costs of mobility, such as the costs of finding new jobs and relocating. If the costs of mobility are high enough (moving expenses, realtors’ fees, psychological costs of moving children, etc.) the employer can pay a wage lower than the employee’s new general skills would warrant at other places of employment.

Labor economists also argue that employers are more reluctant to lay off employees in whom they have invested in specific training. (When employers pay part of the costs of general training, the firm also will be reluctant to lay off workers who have received this training.) Like general training, specific training can be obtained through formal programs. It also can be obtained through on-the-job experience, as much of what employees learn on the job tends to be of a specific nature. Employees who receive specific training from an employer receive a lower wage after training than their productivity would warrant because no other employers have use for these specific skills. Thus, it is likely that the employer will have invested more heavily in these employees and would not want to lose the investment.

To a certain extent, the distinction between general and specific training is misleading. There are probably few skills that have no transferability to other employers. Likewise, probably few skills are completely general. Further, employers do not seem to make clear distinctions between general and specific training. There are many considerations in layoff decisions in addition to the employer’s investment, such as equity, contractual obligations, and different business needs. Nonetheless, the concepts of specific and general training can provide insights on the conditions in which investments in human resources are more favorable.

Utility Theory

In considering investments in human resources in terms of hiring or development of current employees in order to pursue given strategies, there must be a method for evaluating the financial attractiveness of such investments. There must also be a method to be used in “selling” the investment to senior management. These tasks may be accomplished by determining the returns for such investments through cost– benefit analytical approaches such as utility analysis. Utility theory attempts to determine the economic value of human resource programs, activities, and procedures. As such, utility theory might be used to determine the dollar value of a selection test that enables an employer to identify and hire managers for a specific job whose productivity is higher than those hired without the test. The calculations of utility might involve several variables. For example, validity of the selection test would be a critical variable, in that it provides an indication of the predictive ability of the test. Additionally, the increased production, its contribution to profitability, and the standard deviation of the contribution, would be variables in the calculations. Finally, other variables might be included in the analysis, such as the cost of testing enough applicants to obtain a sufficient number having scores above the cut-off point.

Brian Becker and Mark Huselid’s study in a national retailing company provides another example of an application of utility theory. Becker and Huselid’s analysis explained return on sales for each store on the basis of the performance appraisals of the store supervisors. Their statistical analysis also controlled for differences in the supervisors’ educational levels and their commitment to the company. Their study demonstrated that better estimates of the standard deviation of the performance appraisal variable could be obtained through a model based on the use of accounting data (return on sales) rather than the more commonly used subjective approaches. This study helps to enhance the legitimacy of utility theory for applications in real business environments.

Outsourcing as an Alternative to Investment in Human Resources

As indicated earlier, investments in human resources should support the organization’s strategies. Unless there is the potential to build capabilities that provide an advantage over competition, cost considerations often lead to the rational decision to outsource through specialized service providers rather than invest in human resources. In general, strategic outsourcing is advocated where (1) world-class capabilities and a strategic advantage cannot be developed; (2) the resources devoted to services performed internally will be greater than those needed to outsource the service, and (3) excessive dependency on suppliers can be avoided. When an activity is performed internally at a higher cost, the misallocated resources will put the company at a disadvantage to its competitors.

Firms have been outsourcing human resource activities at a phenomenal rate. Furthermore, they have been outsourcing a wide range of activities. For example, firms routinely outsource the administration of 401(k) plans, executive search activities, payroll functions, employee assistance programs, human resource information systems, benefits administration, and outplacement. As a result of the demand for outsourcing, a whole new service industry of personnel service providers has been created, often by human resource executives who were downsized during the 1980s and early 1990s. Although many firms have been willing to outsource a wide range of their human resource activities, virtually all of them have retained the critical and sensitive functions of performance management, employee relations, and labor relations.

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Reference :

- Charles R. Greer (2003), Strategic Human Resource Management, (2nd ed.), Upper Saddle River, NJ: Pearson Prentice Hall.