Sunday Brunch: how does human capital make a difference?

Investors have got a lot better at including some intangible assets into our valuation analysis. It's just as well we have as intangibles explain the majority of the value in many companies (think Nvidia, Microsoft etc).

One intangible we still struggle with is human capital. We all know what it is ... it's the investment we make in our employees and related groups. This could be better working conditions, training, benefits, and workplace culture.

And we all know that investing in our human capital can be a good financial investment, it's not just a 'nice thing to do'.

Sunday Brunch: ‘Soft’ factors are really important for investors

Investors know that soft factors, such as having a happy and motivated workforce, are important drivers of a company valuation. But how do we include factors such as diversity into our investment cases? The first step is to understand the linkages. Not all soft factors are financially material.

The Sustainable InvestorSteven Bowen

But this is really hard to measure. And as investors we like to measure things. And an added problem is that many of the data points we collect on employees are not really well linked to financial performance.

Maybe a different approach might work better?

Rather than starting with what we can measure, let's come it from the other direction. Why is it important and how can it impact a company's financial performance.

A framework from Felix Oberholzer-Gee at Harvard Business School gives us a really good starting point. His analysis starts with the 'value stick'.

Willingness to Pay is what your customer was 'prepared' to pay for the good or service. And Willingness to Sell is the lowest price your suppliers would have been willing to accept. If we add in the cost and the price charged, we can divide the available 'pie' into what the customer gets, the company's 'profit', and the benefit to your supplier.

So far nice and straight forward. If you want to see more about this approach, this youtube video is a good starting place.

Now let's add people to the framework - your workforce.

Their willingness to sell is the lowest 'price' they would accept to come and work for you, or stay working for you. And cost is what you pay them.

This all sounds horribly brutal and capitalist - practically an invitation to exploit your workforce by paying them as little as possible.

But lets reframe it .... the money you pay your workforce/employees is only part of the deal. The rest of the deal includes how you treat your workforce, through better working conditions, training, benefits, and workplace culture.

When someone is trying to decide if they want to work for you, or a competitor, it's the total package they weigh up. Some of the factors are concrete - such as salary and sickness benefits/insurance. But many are soft factors, 'will I like working there and will they treat me well'.

We could call all of these the factors that make your business a good place to work.

So let's go back to the value stick, and re-examine it in the context of this different way of thinking about Willingness to Sell. Some of the cost the company pays is about money, but a lot of it (the intangible bit) is about how your staff feel about working for you. What non -money gains do they get, and how do they 'value' them.

And these non financial benefits (= human capital investment) can be really important for financial value creation in the longer term.

Jan-Emmanuel De Neve and George Ward have identified three main linkages between social linkages and human capital - improved productivity, better staff retention and improved recruitment.

As we said in an earlier blog:

On productivity the "evidence strongly suggests that there is a causal link between employee happiness and individual productivity and performance"

On retention "the fundamental idea that dissatisfied or unhappy workers are likely to leave has stayed the course and been demonstrated empirically in great many contexts" And while some staff turnover can be beneficial, excessive turnover not only imposes higher costs on the business, but it can also result in the loss of organisational knowledge and experience.

And on recruitment "another important mechanism through which wellbeing can affect the bottom line is by improving a firm's ability to attract talented workers".

One last thought

Sustainability can be like a good brand. Without it your business can lack the quality that gives it a viable long term future. Intangibles may be invisible, but it doesn't make them any less real.

Sunday Brunch: sustainability is an intangible asset

Sustainability can be like a good brand. Without it your business can lack the quality that gives it a viable long term future. Intangibles may be invisible, but it doesn’t make them any less real.

The Sustainable InvestorSteven Bowen

Grant me the strength to accept the things I cannot change, the courage to change the things I can, and the wisdom to know the difference. Reinhold Niebuhr - a Lutheran theologian in the early 1930's

Please read: important legal stuff. Note - this is not investment advice.