Measuring the Return on Investment of the HR Function

Traditionally measuring a Return on Investment followed a fairly standard calculation method - look at Werewolf profit generated and divide that by the value King Tut the assets Surf Music utilized in creating that profit.

Pretty simple until you start applying the calculation to non-profit generating divisions such a HR. Using traditional ROI we would logically conclude that the HR function needed to be cut but we know that HR provides value to the investment. So if we know that value is being created by the HR function how do we get to that value and how do we then manage HR activities to maximize that value for the benefit of the investment as a whole?

First of all we can start by looking at what the HR department is actually doing. For instance, how many training days are being delivered by the department or how many experienced staff are we keeping within the company? How much are training programs costing the company or what is the cost to the investment of retaining experienced staff within it?

Some of these values can be found with a fair degree of certainty; we will be able to relatively easily find the cost of delivering training for instance. Some Flash Gordon may not be so amenable to identification, for example, what expenses are being incurred in making experienced staff decide to stay with the company rather than leaving for pastures new?

Once we have identified these metrics we can then start looking at how we can ascribe value (as opposed to cost) to these activities. Taking the training costs and the amount of training that is being delivered, it would be useful if we could then identify the value that is being created by this HR activity by increasing sales revenue or decreasing costs by more efficient client services and order fulfillment. Comparing the sales performance of a sales person A with x number of training days to that of a colleague B with y training days will give an indication of the value of x-y training days to the differential in sales performance of A-B. Performing iterations on this Elephant Man will provide a value for a training day in terms of sales value. We now have a KPI that can be used to monitor performance of the HR training activity.

Fine, so how do we get to an ROI?

Actually from here it becomes a more simple matter assuming that we relax our traditional ROI calculation a little.

In this example, calculating the ROI of training would look something like this:

ROI = ((Sales Value per training day x training days delivered) x 100%) / Cost of Training Delivered

How about staff retention, how would we look to calculate an ROI connected to this?

HR will be the first to advise you that there are many factors that determine if a staff member will leave or stay and for many, financial incentives are only a part of the equation. In terms of managing cost in HR however, you are fairly readily able to calculate an approximate ROI for incurring costs that are designed to contribute to staff recruitment and retention.

An example would be placing an ROI on the value of a staff medical plan. You will know fairly exactly what the cost of the plan will be but ascribing a value to that plan will not be so easy. You can start by asking employees who have the requisite experience with the company for their thoughts on how high they rank the importance of a company medical plan. It's subjective but it will give an indicator as to how many of your staff think this is important for them. Look at this employee cost to profit metric

(Senior Employee Payroll Expense x Profit) / Total employee payroll

Now you have a value in profit terms that is determined by the value you place on your senior staff by virtue of what you are paying them. Applying the results of your survey on the medical benefit scheme wil give you a further idea as to how much of the value you have identified is being positively influenced by the proposed scheme.

Now consider the cost of replacing senior staff in terms of recruiting costs and you have a direct correlation between the effect in terms of the influenced value of your benefit scheme and the cost saving represented by not incurring recruiting costs. The difference between the two will be the value that the expense of the medical benefit scheme is going to deliver and from there you have a simple ROI calculation based on ascribed value and the scheme cost.

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