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Which HR Decisions Are Important?

In many organizations, human resource costs (recruitment, selection, compensation, training, and workforce administration) are the largest component of the firm’s operating expenses. In some service organizations these items constitute 70% to 80% of the firm’s total costs. Properly managing those costs is therefore critical to the success of any corporation. Other things equal, a 10% reduction in a firm’s HR costs can produce a huge increase in its bottom line profit. Still, of greater importance than managing workforce costs is creating workforce value. Firms do not become industry leaders because they have the lowest turnover rate, the smallest health insurance premiums, or the lowest cost per hire. Firms succeed because they create value for their customers. Firms succeed because they have a workforce that skillfully executes a value-creating business strategy. A firm’s objective must be to maximize the return on the investment (ROI) it makes in its workforce. The relationship between the ROI and HR costs can be summarized as: HR ROI = Workforce value / HR costs. Yes, other things equal, reducing HR costs in the denominator of this ratio produces an increase in ROI. Of course, increasing HR costs in the denominator of this ratio could also improve ROI. That would be the case when these additional HR expenditures result in even larger increases in workforce value.

Reducing inefficiencies in HR processes and increasing workforce value are both important. Increases in workforce value, however, are most likely to explain a firm’s level of success. Consider these two firms. Company A’s management and workforce are by far the most talented and engaged in the industry. Company B’s management and workforce are about average for the industry, but its cost per hire is much less than average. Which HR department is doing the better job? In which firm will more value be created for shareholders? The amount a firm can save by reducing inefficiencies in HR processes is usually insignificant compared to the amount it can gain by building a more talented and engaged work force. Of course if you can do both, you should. Several books have been written that focus on using financial tools to improve the efficiency of resource allocation within the HR department. This book discusses those issues but focuses on the financial understanding needed to align HR strategy with business strategy and create shareholder value.

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