Chapter 14: Into the Future: A Boardroom Conversation

The CEO stood to speak.

“Ladies and gentlemen,” he said to the board, “I am pleased to report that in the past 12 months we successfully took control of our largest investment.”

He said it for effect. Having seen the presentations the previous year on workforce costs and talent strategies, they knew perfectly well what he was talking about.

“And this year,” he continued, “we will increase that investment to 40 percent of sales. Our results more than make the case for the increase. Indeed, our return on those investments grew last year at 15 percent while our actual labor costs dropped 3 percent.”

There were some nods around the table.

He smiled.

They were obviously very pleased.

In one year the CEO had taken the company from making people decisions with wishes, guesses, and hopes to making them with substantiated hard facts. Human capital no longer would be a curiosity on the board’s agenda; it would be a standing item.

He went on to report on the company’s progress:

“As you know, last year at this time we admitted to ourselves that we didn’t really know what we were getting for the $5 billion we spend each year on labor, recruiting, technical training, leadership development, performance management, information and knowledge sharing, and all the other things we do to build this huge asset.

“Let’s face it, we didn’t even know if employees’ experience in the firm over time created value for us. We didn’t know if giving employees more discretion in the way they work improves productivity or hurts it. We thought that pushing major operational decisions into the field made sense, but we weren’t certain. We only hoped that our 43 different incentive plans did what we thought they did. We weren’t sure whether we should expand our “university” or shut it down. The fact is, compared to what we knew about managing our financial assets, logistics, marketing—almost anything else—we were lost in the woods. Just admitting it was a major step forward.”

It was strangely emancipating to throw out the myths and uncertainty. For the first time he was really comfortable with all the previously soft and squishy people issues. They were no longer ephemeral. They were measurable, and their patterns told him how to make large and strategic decisions.

“The next step was to change the whole dialogue about workforce decision making. I started asking new questions,” he went on.

“My favorites are:

• Are we sure our human capital strategy is aligned with our business design? How do we know?

• What can we change—by cutting, reallocating, or increasing our investments—to manage people more effectively and to generate greater shareholder returns?

“And I always end by saying, ‘Prove it.’ Needless to say, some of those early conversations were awkward, but we began to think differently, and eventually we started acting differently. We moved from ad hoc hip-shooting to holistic decision making.

“We became convinced that getting serious answers to these questions would not only save money but actually create value for us—value in everything from customer service to net operating income. Perhaps just as important, we came to see that finding the right answers to these questions would provide us with a powerful competitive advantage because no one else was thinking this way. We would be the first mover, get a head start. Furthermore, we knew—unlike with marketing, technology, even products themselves—they couldn’t copy the advantage we would be building because it was inherently ours. What would they do: Try to reproduce our history, culture, leaders, and all of our management practices?

“So we set out to manage these human capital practices with the same rigor with which we manage our tangible assets. Knowing that ‘what gets measured gets managed,’ we first specified for ourselves which factors needed to be tracked. In most cases we already had the information; we just didn’t know it.”

At that point the CEO turned on the projector. Pointing to the Internal Labor Market (ILM) maps for the five major business units, he flagged the differences for the board.

“Among other things, we learned that we operate very different internal labor markets in our different lines of business. You can see that the sharply pointed pyramid form in these units means there’s ongoing and intense competition to capture one of the very few positions toward the top. The one with the bulge in the middle points to the reality of limited career growth beyond that point. In contrast, this rectangular map implies a less competitive structure in this group because there aren’t a limited number of seats at the top. Our preliminary assessment suggests that the respective structures are appropriate to the different groups’ business models. This means that one size fits all not only doesn’t apply to companies; it doesn’t even apply to all divisions. We really need to tailor our people management to these differences.

“I must say that when I was first introduced to these ILM maps, I thought they were interesting but wondered whether they were really that useful. What I came to realize was that in some ways they are merely symbols of a more complex system that can be analyzed in unprecedented ways.

“So, for instance, ILM modeling shows us the attributes of the managers who move through the organization most successfully. We discovered that all the MBAs we’ve been hiring from top schools don’t perform any better than do MBAs from second-tier schools. And we’re paying about 10 percent more to get the first-tier people.

“We also know if our managers are moving too slow or too fast. Or if they’re gaming the system. What might be even more interesting going forward is determining what kinds of managers most predictably develop high-potential people.”

He flipped off the projector. Not since last year’s governance discussion had he seen them so engaged. He was on a roll.

“These kinds of findings are reshaping how we think about many management techniques we’ve taken for granted. For example, we used to think about all employee turnover the same way; that is, anything more than 15 percent a year was bad. I used to rail at Marty about that all the time. I really wanted us to make the ‘100 Best Places to Work’ list, and I figured higher turnover would give us a black eye. Well, as they say, be careful what you wish for. Marty added turnover to his managers’ MBOs, and they dutifully hammered it—dropping it by half. Next thing you know, they’re doing a marvelous job at keeping their poor performers. Can you believe that? Needless to say, I’ve offered Marty a mea culpa, and we’ve put the teeth back in the performance management system.

“That experience emphasized that some turnover is good and necessary to run the business properly. More important, we now are positioned to have differentiated targets for turnover. We know if exits among our frontline customer-facing people—including our drivers—go above 10 percent, we will be hurt in both sales and customer turnover. Conversely, we know that our marketing people are rather easily replaced and that we shouldn’t be alarmed unless we go over 30 percent. What’s more, our turnover goals for managers now make sense. We can adjust our targets to reflect realities on the ground. Armed with our ILM models, we have a real handle on what it takes to retain top talent. We won’t penalize the Cambridge leadership because they’re still struggling with a tight labor market but we’ll stop giving a free ride to the folks in Toledo, where there are no other opportunities that would make any employee want to leave us. Last year those guys in Ohio were paid over $2 million for having a good record on retention. Right—we unwittingly rewarded them simply for being in a weak labor market. No more of that, I assure you.

“In the same way, we’ve learned that certain things we did in the past to save money were simply wrongheaded. If we increase the number of part-timers above 20 percent, our savings in fixed pay and benefits costs are quickly wiped out by a rapid erosion of overall productivity. They cost less per head, but we needed a whole lot more heads to get the job done. So we’re much less likely to be seduced by cost cutting than we were.

“Those kinds of discoveries have led us to rethink our staffing model and our propensity to lay off people in downturns. It’s clear that experience on the job in most sectors of this company cannot be replaced by new hires, no matter how talented they are. To avoid that trap we probably will put more leverage in the variable-pay program so that pay automatically ratchets down with slow business performance. In any case, the goal is to preserve our long-term investment in people.

“I’d have to say one of the unexpected outcomes of this measurement-based management is our ability to predict various scenarios. Of course, we’ve long done that with macroeconomic projections and sales forecasts. Now we can do the same thing with human capital. We have, in effect, a set of levers we can pull. We know that if we raise overtime 5 percent, we net an 8 percent productivity gain. We now have all of these various factors loaded in a software program along with the ILM data, and so we can do what-if simulations.

“So now we use the $8 million HRIS system for something other than mailing enrollment materials,” he said with a thin smile, knowing that his predecessor had been given a hard time for the delays and cost overruns in installing it.

He noticed the one or two predictable eye rolls and went on:

“All of this has been particularly helpful in planning our M&A activity. We better know what it takes to integrate an acquisition and what the implications will be for the careers of our existing employees as well as our labor costs. We take a keen interest nowadays in whether the target’s internal labor market matches the division we’ll be merging it with.

“Finally, I’ve found that Wall Street is really picking up on this line of thinking. In the most recent phone call, it was clear that our ability to specify the return on individual tactics such as larger spans of control and the management stock incentive plan really caught their attention. I could tell some of them thought it was smoke and mirrors, but the Goldman and Merrill guys got it. And Deborah What’s-her-name from Morgan Stanley glommed on to the fact that we’re going to shield our key people from layoffs. Those three in particular understood that something really different is going on here. It’s dawning on them that we really are now managing our people like we would any other major asset. I am positive that this is going to change the way analysts think about our organization.

“It won’t be long before somebody’s going to figure out that we are creating a large and increasingly measurable intangible value for shareholders. When that becomes clear, our logo is going to be on the cover of Business Week and our stock is going to surge.”

The meeting eventually moved to other topics.

During lunch the conversation turned back to the human capital strategy and the new metrics. Someone asked what the big “learnings” were from the last year. The CEO obviously had thought about it:

“There’s so much. In some ways, it’s shocking to think business has gone so long without cracking this measurement nut. But if I had to boil it down to several points, I’d say:

• We cannot make major strategic changes with the business model or the human capital strategy without considering all the essential factors in both the marketplace and within the organization itself.

• The way we choose to manage human capital strategy can be a source of unique and lasting competitive advantage.

• Determining how managers and employees actually behave is ultimately more important than simply listening to what they say (although having both perspectives is better).

• We must resist the temptation to manage primarily around cost. The focus needs to be on ROI.

• Specifically, we need to expect systems thinking, demand the right facts, and always—always—keep the focus on value creation. That’s the message I want to see permeate all parts of our company.

“Indeed, those three considerations are going to shape all of our major decisions in the future.”

After lunch they made their way back to the boardroom. Walking down the hall, someone overheard the CEO talking to the oldest board member:

“You know, Henry, a year or two from now I’ll stand up in front of an employee meeting and say, ‘People are our greatest asset,’ and you know what? They’ll believe it.”

Gentle laughter filled the hallway.

“No, seriously. They will know it’s true because they will have seen how we have changed how we run this business.”

As they turned the corner, the CEO put his arm around the board member’s shoulders.