Vienna Index™ Technical Questions
Have the Vienna Index formulas been validated?
The Vienna Index formulas have been developed in collaboration with and vetted by senior level human capital specialists, CFOs, private equity executives and investment bankers. Wharton MBAs and GE pedigree CFOs have carefully scrutinized the formulas and accepted, as credible the data used and the formulas themselves. In addition, the data source is a company’s financial system, the only auditable source of data in a company that is credible in the C-suite.
How are Human Capital Costs defined?
Human Capital Costs include three categories of cost:
- Employee Costs. These costs are pay, benefits and payroll taxes.
- Costs in Support of Employees. These are the variable costs a business incurs to support employees. These costs fall into the following categories: real estate or housing, communications, training & development, supplies, information technology, and transportation.
- Costs in Lieu of Employees. These are costs incurred in substitution of employees. These are costs associated with independent contractors and outsourcing. The test of whether the expense is a cost in lieu of employees is if the expense replaces an employee that otherwise would perform the function.
How are Financial Capital Costs defined?
Financial Capital Costs include:
- Depreciation or depletion
- Amortization, and
- Cost of Equity (expected return on shareholder equity)
How is Profit-driven Incentive Compensation defined?
Profit-driven Incentive Compensation (PdIC) is a subset of incentive compensation. According to WorldatWork, incentive compensation is defined as: “Variable rewards for performance or achievement of short-term or long-term goals designed to stimulate employee performance.” Therefore incentive compensation consists of variable compensation payments for a host of reasons that may or may not be linked to the profitability of the business.
PdIC, on the other hand, are those variable compensation payments that are directly and exclusively reflective of the profitability of the business enterprise.
To illustrate, variable compensation payments that are made because of achieving non-financial milestones or time vested equity compensation would not be viewed as PdIC. These are payments based on factors other than the profitability of the business. Conversely, cash bonuses, contributions to a profit-sharing plan or a 401k plan that are based on the profitability of the business are considered PdIC.
Can the Vienna Index measure the cause and effect of specific changes in human capital strategy?
The Vienna Index was designed to measure the effect of the total investment in human capital and all of the changes in human capital strategy. It was not intended to isolate the effect of any specific change in human capital strategy.
What should be the level of HCROI?
Like any other financial indicator, the level of HCROI should be a factor in your organization’s business plan for the year. Once you know your company’s HCROI you can plan to increase it by taking action to improve your organization’s performance, just as sales would take actions to improve revenue, or operations would take actions to streamline and improve processes thereby improving EBITDA.
Human Resources’ plans for increased HCROI should support the business’ financial goals. As an example, if you are measuring HCROI for several business units, a goal could be to move each business unit’s HCROI to that of the highest performing business unit, over time.
A separate question is: how does our HCROI compare to our peer group? As the Vienna Index database is built, this question will be answered.
Another question that may be asked by the CEO, Board member or investor is: what level of HCROI should we strive for? The answer to this question is the answer to the following question: what ROI, above the cost of capital, does our company expect to generate on its investments?
What should be the level of Productivity?
As with HCROI, the level of productivity should be a factor in your organization’s business plan for the year. Once you know your company’s Productivity you can plan to increase it by taking action to improve your organization’s performance, just as sales would take actions to improve revenue, or operations would take actions to streamline and improve processes thereby improving EBITDA.
Human Resources’ plans for increased Productivity should support the business’ financial goals. If you are measuring Productivity for several business units, a goal could be to move each business unit’s Productivity to that of the highest performing business unit, over time.
A separate question is: how does our company’s Productivity compare to our peer group? As the Vienna Index database is built, this question will be answered.
Another question that may be asked by the CEO, Board member or investor is: what level of Productivity should we strive for? The answer is the response to the following question: what level of Productivity will produce the desired level of HCROI? Thus the linkage between Productivity and HCROI.
Why are the Vienna Index formulas for ROI and Productivity better than “per employee” based measurements?
While several prominent organizations promote the use of “per employee” measures as a method to monitor how well the investment in people is performing, we at Vienna believe these measures to be incomplete, misleading and not credible in the C-suite for business planning purposes.
For instance, McKinsey and Co. regards “Profit per Employee” as a pretty good proxy for the return on intangibles. In its report, The Metrics Standard: Establishing Standards for 200 Core Human Capital Measures, The Corporate Leadership Council recommends the use of Operating Revenue per FTE as a broad measure of the productivity of the workforce. The Saratoga Institute also recommends (July 2008 Metric of the Month) the use of Profit per Regular FTE as a key metric to take a balanced approach to managing their workforce.
Here are the problems with “per employee” measures:
Definition of an employee. Who is an employee? There’s no universally accepted definition of an employee. This is no small problem. How do you define an employee with independent contractors, part-time or contingent employees, temporary employees, and outsourcing of jobs, projects and services. If a company decides to outsource selected activities, resulting in fewer employees, any per employee statistic will improve, but may not have improved overall productivity, profitability, or value of the business. It is also not uncommon for HR, Finance and Operations to define employees differently, further exasperating the validity of “per employee” as a credible denominator in these calculations. If a company replaces employees with machinery, per employee measures will improve, while ignoring the financial capital costs associated with the purchase of the machinery.
- Apples-to-apples comparisons. Companies want to establish a baseline and measure performance and progress over time and across business units. To credibly compare performance over time and among units, credible data is needed. Based on the above issues regarding the definition of an employee, it is not possible to have apples-to-apples comparisons using per employee numbers. Therefore, it is not possible to have apples-to-apples comparisons among business units over time or against peers using “per employee” formulas.
- Profit per employee is not an ROI measure! By definition, any ROI calculation needs to define and isolate an investment amount. Nowhere in the profit per employee formula has the “investment” been identified. As described above, if a company outsources jobs or replaces employees with machinery, the profit per employee statistics will improve, even if the underlying profitability of the company declines. As a result, this measure does not provide a clear line of sight, and/or may not correlate, to overall financial performance.
- Revenue per employee is a flawed Productivity measure. While Revenue, or some version of Revenue, is the proper numerator in a Productivity equation, use of “per employee” as the denominator is flawed for the reasons cited above. As with the ROI measure, this formulation can give misleading results for the same reasons.
- Per employee measures are not credible with the CFO. To be used in the C-suite or boardroom for business planning purposes, any measure must pass the CFO smell test. CFOs don’t trust per employee measures for the reasons mentioned above.