Return on People versus Return on Capital

Shareholders invest in companies. Companies invest in assets. Shareholders receive the returns generated by these assets.

These assets can be viewed as the well-known "factors of production" required to create wealth. The basis for wealth until the industrial revolution was land. The revolution changed the focus to capital goods and technology which served us well until about the 1980s.

We are now climbing steadily into the knowledge economy and the focus is shifting rapidly towards people as the creators of organizational wealth. It is also argued that talented people are becoming relatively more scarce than capital or technology. (More on this in future posts).

So whereas before, it made sense to consider "return on capital employed" where that capital was land, financial investments, or capital goods, there is an growing need to measure "return on people employed". As Lowell Bryan of McKinsey puts it, profit per employee.

But whereas it is relatively easy to assign profitability to individual capital goods (machinery), funds, and technology, it is not as easy to determine the profitability generated by each individual in an organization, critical though this knowledge is. Without it, we might be under-investing or over-investing in people. Human capital measurement is therefore critical for maximizing earnings.

Currently, the best way of measuring return on people investments is to do it on a profit centre by profit centre basis. That is, determine how much was invested in people within a given profit centres, and then try to determine how of the profit was due to investments in people as opposed to investments in other intangible assets, or in capital and technology.

In the coming weeks, this blog will examine approaches for teasing apart how much of the profit can be attributed to people as opposed to other assets.

As an aside, investments in people are not really classed as investments at all. They are expensed, probably because organizations cannot "own" people in the same way they own other assets. Organizations rent people and the profits generated by individual is the return on rent paid. Furthermore, it is argued that the disparity between a company's market value and its book value is due to its intangible assets, one of which are the people that it "rents".

More on this later.