A PROPOSED STRUCTURE FOR OBTAINING HUMAN RESOURCE INTANGIBLE VALUE IN RESTAURANT ORGANIZATIONS USING ECONOMIC VALUE ADDED
Kevin S. Murphy
James Madison University
Harrisonburg, Virginia, USA
ABSTRACT
Those restaurant companies that are able to deliver high performance human resource management, which will increase the intangible value of their human resources (employees) and create greater economic value added (EVA), will be the companies that can compete more effectively. The purpose of this paper is to begin the development of a model to demonstrate the EVA of an intangible human resource component. It is only when the restaurant industry engages in a paradigm shift and under goes a fundamental change in philosophy that it will be able to harvest the full potential of its employees intangible economic value (EVA).
Key Words: economic value added (EVA), human resource management, restaurants, intangible value
INTRODUCTION
One metric that demonstrates the current state of employment in the restaurant sector is, turnover rate. A 2001 study by People Report shows the annual hourly employee turnover rate at “concepts with average unit sales less than $2 million to be the highest at 152 percent, and those with volumes between $2 million and $4 million came in at 129 percent, while operations above $4 million, 116 percent”(Crecca, 2001). For the fast food segment of the restaurant industry the turnover rates are far worse reaching as high as 238 percent ( In a 1999 People Report survey of fifty companies in the hospitality industry, the median cost for losing a single hourly employee is $2,494. At the management level, the median cost is more than $24,000 (Pine, 2000). According to Jac Fitz-enz, director of the Saratoga Institute a human resource consultation firm, there are four costs associated with turnover (or lack of retention): termination, replacement, vacancy and productivity (2000). Fitz-enz estimates that the cost of employee turnover is “easily in excess of the equivalent of one year’s pay and benefits” and for some positions it is in the hundreds of thousands of dollars (p. 105). He observes that at Taco Bell the twenty percent of stores with the lowest employee turnover had twice the revenue and fifty-five percent higher profit then the stores in the top twenty percent of the turnover range.
If the food service industry could learn to view its employees from a new paradigm – that is as strategic human capital which possess intangible assets (knowledge, experience, skill, etc.) that are valuable to the firm – then in my opinion business performance would undoubtedly improve and the state of foodservice workers would be raised. The foodservice industry as a whole needs to break free of the current human resources paradigm of high turnover and low retention of employees, which is costing the industry billions in replacement costs, lost productivity, service quality, employee know how and experience (Pine, 2000). Gordon in 1991 paper on Industry Determinates Of Organizational Culture concluded that “ corporate cultures, consisting of widely shared assumptions and values, are, in part molded by the requirements of the industry in which they operate” (p. 410). The foodservice industry, and more specifically the restaurant segment, suffers from Gordon’s exact proposition that the industry norms shape the corporate culture/thinking of individual entities, when it comes to valuing employee retention and preventing turnover. The majority of the individual firms in the restaurant industry are stuck in a paradigm of giving to their employees as little as possible, because that’s “how the business makes money”. It is only when the restaurant industry engages in a paradigm shift and under goes a fundamental change in philosophy that it will be able to harvest the full potential of its employees intangible value.
LITERATURE REVIEW:
Baruch Lev, a professor at the Stern School of Business at New York University, author of several books and a leading authority on intangibles, was commissioned by The Brookings Institution to do a comprehensive study of intangibles in all aspects of business (2001). Dr. Lev wrote barely two pages on human resource intangibles and concluded, “the research on human resource expenditures (intangibles) is in its infancy and is seriously hampered by the absence of publicly disclosed corporate data on human resources” (p. 75). This is not to say that Professor Lev did an incomplete research job, it is just that the body of literature on human resource intangibles is very thin and it is difficult to draw any conclusions from the studies published thus far, especially with public companies not required by the Securities and Exchange Commission (SEC) to disclose significant financial information related to their employees. Steve Kerr of General Electric contends that while academic have made a number of significant contributions to the area of HR management systems that much of the finest work is being done by consultants and practitioners in the field (Hodgetts, 1996).
The Academy of Management Journal published in 1996 a Special Research Forum on Human Resource Management and Organizational Performance, which attempted to foster a better understanding of the role of human resource decisions in developing and maintaining firm performance and competitive strategy. Out of this forum several empirical studies of note, Huselid (1995), Delaney and Huselid (1996), Becker and Gerhart (1996), Becker and Huselid (1998), provided survey-based evidence of a positive link between human resource practices and market values. There is also ample published antidotal evidence on the value of human resource intangibles and contributions by consultants that claim to measure the ROI (return on investment) of human capital investments, but overall very little in the area of measuring the intangible value of a human resource activity such as training or retention exists.
Current theoretical approaches in business strategy have given a lift to the concept of human resources generating a sustainable competitive advantage (competitive method if you wish) (Becker and Gerhart, 1996). This is in step with the resource based view (RBV) of the firm, that businesses can develop sustained competitive advantage only by creating value that is rare and not easily imitated by the competition (de Charbert, 1998). The conventional sources of competitive advantage such as technology, natural resources, productivity improvements and low cost leadership, to mention a few, are known to create value. The resource based view is that these traditional types of competitive advantages are becoming increasingly scarce, hard to develop and easy to imitate, particularly in comparison to a well thought out employment systems such as Outback Steakhouses compensation package (Murphy, 2000). It is for this reason that HR strategies could become important sources of competitive advantage in the future, “the challenge for management will be creating value through people rather than using them as objects to add value” (Olsen and Zhao, 2002: 7)
Much of the research conducted on the link between firm performance and human resources has looked at individual approaches in this relationship – best practices (Becker and Gerhart, 1996). A best practices approach to human resource management involves the bench marking of human resource practice between one or more firms to determine the best approach to handle a particular HR practice. For example a company may compare benefits packages, training, compensation, labor relations or the selection process. The difficulty with this type of linkage between an individual HR practice and firm performance is that very few things operate in isolation as demonstrated by the results of Murphy’s compensation survey of Outback Steakhouse (2000). The resource-based view is that in order to create a sustainable competitive advantage and produce value for the firm that individual policies or practices produce the greatest results when they operate in tandem in a complex system that is not easily imitated (Barney, 1995).
The current status of theory on the value human resource intangibles is nearly non-existent or as Lev put it “in its infancy and is seriously hampered” (2001: 75). It may be such a complicated topic and filled with intervening variables that it does not get fully explored for sometime. However, there are some empirical studies that investigate the relationship between firm performance and HR systems that are worth describing as a foundation for my proposed theory.
A study by Dr Mark Huselid published in the Academy of Management Journal evaluated at length the links between of High Performance Work Practices systems and firm performance (1995). Specifically High Performance Work Practices as defined by U.S. Department of Labor include: “extensive recruitment, selection, and training procedures; formal information sharing, attitude assessment, job design, grievance procedures, and labor-management participation programs; and performance appraisal, promotion, and incentive compensation systems that recognize and reward employee merit have all been widely linked with valued firm-level outcomes” (1993: 641). Based on a national sample of nearly 1,000 firms, the results signify that these “practices have an economically and statistically significant impact on both intermediate worker outcomes (turnover and productivity) and short- and long-term measures of corporate financial performance” (Huselid, 1995: 635). Huselid’s study, found considerable support for the hypothesis that investments in such practices are associated with lower worker turnover and greater productivity and business fiscal performance across a wide range of sectors and organization sizes. “A one-standard-deviation increase in such practices is associated with a relative 7.05 percent decrease in turnover and, on a per employee basis, $27,044 more in sales and $18,641 and $3,814 more in market value and profits, respectively” (p. 659).
In a 1996 study on the impact of human resource management practices on perceptions of organizational performance Delaney and Huselid investigate 590 for-profit and nonprofit firms to determine if positive associations exist between human resource management (HRM) practices, (such as training and staffing selectivity), and perceptual firm performance measures. In general their findings suggest that progressive human resource management practices, (including selectivity in staffing, training, and incentive compensation), are positively related to perceptual measures of firm performance. The authors believe the improvement of reliable and valid measures of forward looking human resource practices and synergies remains a vital matter for researchers to explore.
BACKGROUND
The idea that individual worker performance has implications for business level results has been widespread among scholars and practitioners for many years (Huselid, 1995). Interest in this area has recently intensified as academics have begun to debate that, as a group, a company's employees can also provide a distinctive source of competitive advantage that is difficult for its competitors to imitate. An employment system that creates a distinct sustainable competitive advantage is an “intangible asset” because it is not carried on the balance sheet, as are traditional assets (plant and equipment). Bill Gates was quoted in an article in the London Business School’s Journal, Business Strategy Review “Our primary assets, which are software and our software development skills do not show up on the balance sheet at all” (1999). Intangible assets are now worth on average three times more than firm’s hard assets, according to the Harvard Business School’s Harvard Management Update Newsletter (Wagner, 2001). Microsoft for example, reported in 2000 that it had revenue of $23 billion, physical assets of $52 billion and a market capitalization (number of outstanding common stock shares times their price) of more than $423 billion. That leaves a spread between intangibles and tangible assets of eight fold.
“As innovation accelerates, it is increasingly difficult to measure the source of wealth. The three biggest measurement headaches are human capital, healthcare and computers”. (Rohwer, 1999: 263). Human capital is basically the ability of employees to generate economic output through the application of their education, knowledge and skills; it refers to employees’ know-how, capabilities, skills and expertise. “The best known indicator of human intellectual capital value is market to book value” (Dzinkowski, 2000: 93). The difficulty with this valuation is that there is no distinction as to what part of the intangible value is representative of human capital and what belongs to other intangibles (trademarks, etc). The other complex issue is that stock market valuations are so volatile and book value of assets does not always represent their true worth. On Friday July 26, 2002, in the midst of a severe stock market slide, Tyco International announced that it had hire Edward Breen, the former president of Motorola, to be its new CEO (Eisiner, 2002: C1). Tyco’s stock shot up 46% that day, worth $7.5 billion in market value, while at the same time Motorola’s stock declined $2.5 billion, a $10 billion swing due to the departure and arrival of one man. Wow! Is this a demonstration of the power and value of human capital intangibles… or just due to some wild market forces? Most likely the cause is a little of both.
RESEARCH QUESTION
Why should restaurant firms invest in human resources components (e.g. training, selection, retention, education and development) as sustainable competitive methods that have positive cash flow streams?
RESEARCH PURPOSE
The development of a framework to demonstrate the economic value added (EVA) of an intangible human resource component (e.g. personnel management; leadership/motivation; organizational behavior; labor relations). This paper will focus on the intangible constructs in personnel management and leave the other HRM components for future research.
HUMAN RESOURCE MANAGEMENT (HRM) CONSTRUCTS – INDEPENDENT
According to David Norton, co-developer of the balanced scorecard, the greatest anxiety today for business executives in the new economy is that “human capital is the foundation of value creation” and they don’t know how to create, measure, keep it or ultimately value it (Becker, Huselid & Ulrich, 2001:ix). Top level management realize that they are in a battle for talented employees, but they only seem to know how to manage their human capital like operating costs, something to be cut when the budget gets tight (Becker, Huselid & Ulrich, 2001). The intention of this paper is to propose the development of a model to demonstrate the economic value of common HRM intangible functions and to demonstrate why restaurant firms should invest in human resource management as a strategy to develop competitive methods that produce value for the firm? With this in mind the following HRM independent construct is proposed:
High Performance Work Practices/system: Particularly, extensive recruitment, selection, and training procedures; formal information sharing, attitude assessment, job design, grievance procedures, and labor-management participation programs; and performance appraisal, promotion, and incentive compensation systems that distinguish and compensate positive employee outcome have all been associated with valued business-level results (U.S. Department of Labor, 1993).
HUMAN RESOURCE MANAGEMENT (HRM) CONSTRUCTS – DEPENDENT
Intangible Economic Value Added: “The growth of intangible value and the drive to increase this value has not left HR unaffected. The most striking change in the new economy is the realization of the intangible economic value of Human Capital, and how that translates into fundamental business imperatives to attract, retain and develop that Human Capital” (McCormick, 2002:1). Intangible economic value is the potential and ability of employees to add additional value above and beyond the cost of the products and services they create while engaged in work activities or work related activities.
PROPOSITION
The intangible economic value of an organization’s human capital is a function of the quality of their human resource management’s high performance work practices system: This includes: extensive recruitment, selection, and training procedures; formal information sharing, attitude assessment, job design, grievance procedures, and labor-management participation programs; and performance appraisal, promotion, and incentive compensation systems that distinguish and compensate positive employee outcome.
INTANGIBLE ECONOMIC VALUE (DEPENDENT): Several possible measures are presented
Economic Value Added (EVA): Measures the true economic profit of a firm. The idea behind EVA is to identify which business practices best leverage their resources to generate returns and maximize shareholder value. “EVA is the financial performance measure that comes closer than any other to capturing the true economic profit of an enterprise, EVA also is the performance measure most directly linked to the creation of shareholder wealth over time (Stern Stewart & Co, 2002). EVA is net operating profit less a proper charge for the opportunity cost of all capital invested in an enterprise. “EVA is an estimate of true "economic" profit, or the amount by which earnings exceed or fall short of the required minimum rate of return that shareholders and lenders could get by investing in other securities of comparable risk.” The advantage of EVA is it precisely defines value in terms specific to an enterprise. The disadvantage in using EVA is it is complex to calculate and not widely used.
EVA = NOPAT – (capital x cost of capital ) NOPAT = net operating profit after taxes
HYPOTHESES
H1: As HRM recruitment practices (number of applicants per position) increase; the higher intangible economic value will be of an organization.
H1A: As HRM recruitment practices (dollars spent on recruitment) increase; the higher intangible economic value will be of an organization.
H1B: As HRM recruitment practices (number of employees involved in recruitment) increase; the higher intangible economic value will be of an organization.
H2: As HRM selection practices (percentage hired based on validated selection tests) increase; the higher intangible economic value will be of the organization.
H2A: As HRM selection practices (percentage of jobs filed from within) increase; the higher intangible economic value will be of the organization.
H3: Increased HRM training practices will diminish employee turnover and increase EVA.
H3A: Increased HRM training practices will increase productivity and increase EVA.
H4: Increased HRM development practices will increase productivity and increase EVA.
H4A: Increased HRM development practices will diminish employee turnover and increase EVA.
H5: The higher the employee retention rate of the firm, the greater intangible economic value of the organization.