What Is Human Capital Management & Why Is It Important?
You’ve probably heard someone in a leadership position say, “Our employees are our greatest asset,” at one time or another.
While most of us would agree (I mean, who wouldn’t??), what does it actually mean when we refer to people as “assets”? Does this mean they have economic value like buildings, inventory, or equipment?
Renovations to a building will generally increase the building’s value, and inventory that sits on a shelf for months will generally decrease in value. But how do you measure the value of an intangible asset like an employee?
The practice of human capital management, or “HCM” for short, has become increasingly prevalent in the last few decades. This is for a couple of reasons.
One is that people recognize that an organization’s workforce is its greatest asset. The second is that, for many companies, the cost of their workforce is often their greatest expense.
As a result, HCM has become the driving force behind many new business practices, a growing abundance of human capital management software solutions, and an emphasis on the concept of human capital as a competitive advantage.
The goal of this article is to educate you on the essentials of what HCM is and why it’s important, using simple terminology and straightforward business concepts.
Maybe you’re an HR professional and want to educate yourself or your colleagues, or perhaps you’re the leader, owner, or founder of a startup or small business.
Either way, this will equip you with the basic fundamentals of HCM and enable you to get started on practicing it in your own organization.
- Definition of human capital and human capital management
- Examples of human capital activities and initiatives
- Difference between HCM and human resource management
- Elements of a human capital management system
- Importance of human capital management
What is Human Capital?
To understand HCM, let’s first take a step back and look at what “human capital” actually means.
Human capital is the economic value that comes from things like the worker’s experience, skills, knowledge, and abilities.
Human capital is an intangible asset, unlike tangible assets like buildings and equipment. However, both tangible and intangible assets have economic value.
Examples of other human capital assets that bring economic value include:
- The employee’s physical and mental health
- Personal values and beliefs
- Work ethic
- Education.
Human capital, like other forms of capital, can be measured and developed and delivers a return on investment (ROI).
While referring to human beings and employees as “capital” might seem harsh—and some joke about the similarity between the words “capital” and “cattle”—it can actually help an organization shift it's perspective and view employees as an asset that can increase in value.
Organizations that focus on activities such as learning and development initiatives, health and well-being programs, and specialized skills development. These bring rewards to both the individual employee and the organization.
So...
What is human capital management?
Human capital management, or “HCM” for short, is the collection of organizational practices related to the acquisition, management, and development of the human workforce—or human capital—within an organization.
The goal of HCM is to optimize and maximize the economic, or business, value of an organization’s human capital in order to gain a competitive advantage. Effective human capital management enables the organization to successfully pursue human capital initiatives.
What are human capital initiatives?
In his book, “Human Capital Management: Leveraging Your Workforce for a Competitive Advantage”, author Mark Salsbury writes, “human capital initiatives (HCIs) are large-scale goals or objectives an organization chooses to pursue that are heavily dependent and reliant on the people of the organization.”
Salsbury also points out that HCI’s are strategic, not tactical, and goes on to provide several examples, as follows:
- Improve performance culture
- Lean management / Six Sigma
- Integration of an acquisition or merger
- Build a global mindset
- Global talent acquisition/management
- New business model (often including reorganizations)
- Re-engineer a functional discipline (Sales, Marketing, etc.).
While this is a very useful list, many of these are large initiatives require significant time and resources and are only really applicable to larger, well-established organizations.
Certainly, most startups and early-stage companies aren’t concerning themselves with global or international human capital initiatives. For founders, CEOs, and leaders within these organizations, it’s important to note that HCI’s are relative to the size of the business.
Looking back at Salsbury’s definition, he talks about “large-scale goals or objectives”. Depending on what your business looks like, “large-scale” might be an initiative that affects all five employees in your organization.
Following are some examples of HCIs that you might find in a smaller organization:
- Create and deploy organizational vision and values
- Create new employee orientation and onboarding processes
- Raise investment funds to hire new software developers
- Create new business functions (e.g. HR) and hire the first-team employee
- Develop or purchase employee data management system
- Establish regular communication practices with employees.
As you can see, all of these HCIs require the people in the organization to make them happen, and will ultimately contribute in some way to the acquisition, management, and/or development of the organization’s human capital.
How is HCM different from Human Resources Management?
Human capital management and human resources management, or “HRM” for short, are closely tied to each other but are not the same thing.
HCM goals
The goal of effective HCM is to optimize and maximize the value and ROI of the human capital (employees) in an organization.
HRM goals
The goal of HRM, on the other hand, is to create and manage the systems, processes, and policies required to hire, train, retain, and enable employees to do their jobs.
HCM vs HRM
The Charter Institute for Personnel and Development in London offers a distinction between the two:
“Human capital management is comprehensive because it includes not only human resource (HR) practices, but also other work practices and people management strategies that increase organizational performance. The important distinction between human resource management and human capital management is that human capital extends well beyond the HR function to encompass the total people strategy of the organization. Human capital is owned by all of the business leaders and resides with everyone in the organization.”
Effective human capital management usually requires effective human resource management practices—talent management, workforce management, proper benefits administration, succession planning, etc.
As a result, HCM systems and activities are often managed by the organization’s Human Resources (HR) department. In organizations without a professional, dedicated HR team or individual, HCM often falls to a senior leader who is responsible for HR activities.
Here's a graphic that sums up how HCM and HRM are different:
What is a human capital management system?
A human capital management system is the collective business practices, HR processes, and technologies that enable an organization’s human capital to be acquired, managed, and developed in an organized manner, and on a large scale.
An HCM system takes a broad, organization-wide view of human capital. While individual managers, teams, and departments may have certain human capital management practices specific to them, in organizations with an established HCM system these practices are often guided by broader, organization-wide practices.
For example, new employees in an engineering team may receive training on certain team-specific software tools when they start, but that training would just be one element of a broader onboarding program that every new employee in the organization would go through.
Core Elements of A Human Capital Management System
These are the core elements required for a human capital management system. I've explained them in more detail below the graphic:
- Organizational vision and values: as with many organizational growth and development practices, developing an HCM system starts with defining and understanding your company’s purpose (vision) and core beliefs (values). These directly impact the workplace culture, how people behave, and the overall importance of the human capital in your organization.
Related read: 15 Vision Statement Examples & How To Write One - Strategic Goals and objectives: whether they’re quarterly or annual goals, or five-year BHAGs (Big Hairy Audacious Goals), your human capital initiatives will often be driven by your organization’s specific, measurable, and time-bound objectives. For example, a goal to “increase your annual employee engagement scores by X%” will drive specific HCIs that are managed within your human capital management system. This will, in turn, drive a specific set of practices to achieve those goals.
- HCM leadership team: like any system, HCM needs to be managed by people. Because of the far-reaching impact of human capital initiatives, the HCM team will typically be cross-functional, with leaders from across the organization. In organizations with a dedicated human resources function, the most senior leader in the HR department (e.g. Chief Human Resource Officer, VP of HR) will often drive HCM initiatives. In smaller organizations, this responsibility would fall to a senior executive (e.g. CEO, COO).
- Data management and support: successful HCM requires human capital data for decision-making—in order to manage, take action on, and measure the results of human capital initiatives. There are many types of employee-related data that can be captured, stored, and made available in workforce analytics, such as employee demographics; compensation and benefits; payroll; time and attendance; performance management; and skills training and development. This data can be managed using anything from an Excel spreadsheet to an enterprise-level HCM software solution, HRMS or HRIS.
These elements may sound huge, intimidating, and complex, but they don’t have to be. Any size of the company, from early-stage startup businesses to large, well-established ones, can create an HCM system.
For example, maybe your HCM system consists of an Excel spreadsheet for managing employee data and quarterly HCM team meetings where you review ongoing human capital initiatives.
The key is to start somewhere, even if it’s small, to build the rhythms and habits necessary for long-term human capital management success.
Why is human capital management important?
At this point you should hopefully have a better understanding of what human capital management is, but why does it matter? What is human capital management important?
Smart leaders are becoming increasingly aware of the importance of human capital management as a competitive advantage. The data shows that companies that focus on engagement, well-being, company culture, and employee development in their organization tend to outperform their competitors.
In an article by App Economy, they analyzed Glassdoor’s 2019 rankings of the "best places to work", which Glassdoor has been doing every year since 2009:
“Looking into the 20 best-ranked public companies over 10 years, 60% have beaten the S&P 500, and 91% had positive returns up to June 2019.” App Economy also noted that “the best places to work that trade publicly have more than doubled the returns of the S&P 500 over the last 10 years.”
The effective utilization and engagement of an organization’s human capital have also been proven to have a direct impact on a wide range of organizational KPIs (Key Performance Indicators), including productivity, employee turnover, product quality, work safety, and customer satisfaction.
The Gallup’s 2022 State of the Global Workplace report ties employee engagement—a feeling of being highly involved and enthusiastic about their work and workplace—to a wide variety of business outcomes and the overall performance of the workplace culture.
They reported that most employees are not engaged; worldwide, the percentage of adults who work full time for an employer and are engaged at work is just 21%.
Gallup also offers a number of compelling statistics that show how business units in the top quartile of global employee engagement perform versus those in the bottom quartile.
- Higher productivity: 41% lower absenteeism and 17% higher productivity
- Lower turnover: in organizations with high employee turnover, highly engaged business units achieve 24% lower turnover
- Better product quality: highly engaged business units experience 40% fewer quality incidents (defects).
- Better customer experience: highly engaged business units achieve 10% higher customer metrics and 20% higher sales.
Effective human capital management is critical for ensuring the health and success of your business and equips you to compete in an increasingly competitive world.
By making HCM a priority you will be able to attract, retain, and engage the talented, high-performing people you need to be successful, from finding the right talent, to onboarding and supporting the employee experience throughout the employee life cycle.
Toward better human capital management
The world of work is constantly evolving and, as we've seen from the examples above, organizations that prioritize human capital management perform better over time.
Now's the time to ask yourself how you're developing people in your organization and empowering them to succeed.
What people, management processes, and practices do you already have in place that will help get you on your way to building a human capital management system? Which ones are you missing and working on next?
Does your organization have a vision (purpose) and set of objectives that guide your approach to your people—your “human capital”? Could you benefit from an HCM solution?
Some further reading:
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