Measuring how 'human capital’ appreciates in value over time

Suppose you were a board member and your CEO announced at a board meeting that a major plant, one in which the company had invested hundreds of millions of dollars, was being disposed, resulting in a major charge to the company. How would you feel about his judgment? On the other hand, if these were human assets being disposed through layoffs, how would you feel? If you’re like most, ther...

04/15/2007


Suppose you were a board member and your CEO announced at a board meeting that a major plant, one in which the company had invested hundreds of millions of dollars, was being disposed, resulting in a major charge to the company. How would you feel about his judgment?

On the other hand, if these were human assets being disposed through layoffs, how would you feel?

If you’re like most, there seems to be a tendency to place a greater sense of loss on the disposal of fixed assets than there does on the 'disposal’ of people, perhaps because of the belief that a greater cost is eliminated with the people. Whether this is appropriate or not can vary with the business circumstance.

The value of human capital should be more fully accounted for when making these decisions. And, the accounting practices currently employed by most companies can have undue influence in driving the strategic decisions of many organizations. Fixed assets are treated as assets that depreciate over time. But, employees are treated as expenses, yet they appreciate over time with additional training and experience. The accounting of people should be such that their value as a corporate asset that appreciates over time is properly treated.

Many studies indicate that cost cutting through layoffs has a high risk and a low probability of success. David Stamps also observed that downsizing, in many cases, is driven by a short-sighted, bean-counting mentality rather than a strategic, long-term vision required to reshape a company into a smaller but healthier organization. Wall Street often rewards large layoffs with a jump in stock price; cost cutting must be good, since it will improve the bottom line.

However, the evidence suggests that cost cutting is a poor bet, no matter how it is presented (e.g., downsizing, right sizing, restructuring and so on). This is not to say that cost cutting never applies. Not all the companies studied suffered as a result of their cost cutting. Again, it may apply, for example, if you’re on the verge of collapse and have no choice to survive; if you’re a bloated bureaucracy and must do so to assure your longer-term success; or if you’re faced with intransigence in unions or employees and need to get people’s attention; in specifically targeted situations of obvious waste; or, finally, in a major market downturn or situation of global oversupply that severely depresses prices.

Parallels in cost analysis

There are direct parallels between the process of acquiring an employee (a human capital asset) and that of acquiring a fixed capital asset. In acquiring a fixed asset, the company first identifies a need and then writes a specification. Then it issues a request for quotation and invites interested suppliers to bid. After evaluating the bids, the company selects the supplier. The equipment is delivered and installed. The company trains its workforce on how to operate, troubleshoot and maintain the equipment. The equipment is started and production begins.

If all goes smoothly, after a period of time the asset will be fully functional, and the company will have met its need by applying capital in an effective manner (e.g., expanding capacity, solving a production problem, addressing an environmental requirement and so on).

Other considerations in the process include: