How People Practices Affect Value

HealthCo learned the hard way that several of its key people practices were inadvertently destroying value, but its experience is not unique. Other companies have done the same thing, though not always through a myopic focus on costs. In many cases decision makers focus on value but implement practices that fail to optimize it. Our experience with First Tennessee National Corporation made that clear.

First Tennessee National Corporation is a nationwide financial services institution with a history dating back to 1864. With over 10,000 employees, it ranks among the 50 largest bank holding companies in the United States in asset size and market capitalization. Its goal is to provide “all things financial” to its customers.

When we first met the managers of that organization, we were struck by their intense dedication to understanding their customers and by their use of research methodologies. This bank routinely employed sophisticated tools of market analysis to understand customer needs and measure key indicators of customer response such as the number of new accounts, the size of accounts, customer retention, the “share of customer wallet” captured by the bank, and market share. For any specific time period managers knew where they stood on those measures and where trends were taking them.

The bank also was very clear about what set it apart from its rivals. Through extensive market research, it had identified customer service quality as the foundation of its competitive position. That was what accounted for its current success and differentiated it from the many other retail-oriented financial services companies against which it competed. Since service quality was dependent on interactions between customers and the bank’s many customer-facing employees, senior management naturally wanted to know more about its employees. Indeed, it wanted to understand its employees as well as it understood its customers. This is a great idea that most companies overlook.

By tapping both employee and business performance data and using statistical modeling techniques, the company was able to discern how business outcomes were driven by people practices and employee attributes. For example, it found that all else being equal, the locations with the longest-serving employees performed best in key customer and financial measures such as customer retention, growth of premium accounts, net earnings, and market share. No other factor came close to the importance of years of service. People who knew the bank’s products, procedures, and customers were demonstrably more effective in producing the customer satisfaction on which First Tennessee’s competitive position rested—and the business result that would satisfy shareholders. On the basis of that finding, the bank concluded that increasing the average years of service of customer-facing employees by just one year would have the following two effects on companywide revenue:

1. Revenue per customer would increase by 4 percent, or $15 million, per year.

2. Market share would expand by 2 percent, resulting in revenue gains of $25 million annually.

In addition to this $40 million revenue increase, eventual alterations in its people practices would reap another $20 million in savings from reduced turnover, greater operating efficiency, and lower payroll expenses.

With employee years of service being the key to higher revenue, the next step was to determine the effect of current people practices on longevity with the bank. Were those practices encouraging customer-facing employees to stick with the company or pushing them toward the exit? Company leaders, accustomed to making data-driven decisions in other areas, knew that credible information on that issue could not come from conventional human resources (HR) benchmarking or best-practice approaches because the bank’s environment was unique. Facts and solutions would have to be developed from within, and that was where the company’s leaders began looking.

Analyses based on several years of employee, financial, and customer data yielded three important facts. First, in an effort to expand its breadth of service offerings, the bank had been hiring new people with new skills and experiences in investment counseling, marketing, and information systems. Of course, the newcomers lacked the firm-specific know-how they would accumulate over time. In the meantime, every new person hired diluted the bank’s depth of firm-specific service and product knowledge. Second, because of the tight labor market at that time, outside hires were receiving top-dollar pay packages. That practice had the effect of tipping the rewards balance in favor of newer employees with general skills and against longer-service employees with the firm-specific and customer-specific knowledge that data had identified as the key drivers of value. In other words, direct experience with the bank’s products and customers and years of service in First Tennessee’s unique business environment didn’t matter a great deal when paychecks were handed out. Third, the bank’s incentive pay scheme left most customer-facing employees out in the cold. Pay for performance rewarded executives and commission-based salespeople but touched very few of the frontline people on whom the bank’s competitive strategy depended.

Not surprisingly, experienced employees, including a high percentage of top performers, were leaving the company at increasing rates. In effect, the company’s people practices were undermining the value of its human capital. Could the loss of customer value be far behind?

Recognizing the risk to its strategy, the bank moved quickly to realign its people practices with what it had identified as the key driver of customer service quality. That meant focusing on career development and rewards. Specifically, the bank took steps to do the following:

• Ensure that high performers had a clear path for growth (and long-term service)

• Extend pay-for-performance opportunities to more customer-facing employees

• Invest more in training to broaden the capabilities of the existing workforce

Most importantly, the company institutionalized ongoing measurement of its human assets and practices. Today it applies as much rigor to understanding workforce needs and characteristics as its marketing researchers apply to understanding customers, a claim few organizations can make.

Lessons

The First Tennessee case underscores two important lessons:

• Find the drivers of competitive advantage and then align people policies and practices with them.

• Be as diligent in understanding the workforce as you are in understanding the customers: What attracts them to your company? What encourages them to stay or leave? What produces the greatest and least value?