Measure Twice, Cut Once

One of the first things that you learn when doing DIY is to measure twice and cut once. My father, an ex-military man, used a different phrase with the same meaning; "time spent on reconnaissance is seldom wasted". Following either maxim will ensure that you save time, money and considerable amounts of frustration, take it from a bad carpenter! It is but a very simple step to take the "measure twice, cut once" philosphy and drop it into corporate life, especially when you are talking about reducing headcount in response to business performance figures.

In a recent BCG report, the authors of the report posited a new formula to relate the impact of people on profit; more specifically on EBIT. “At many companies, personnel costs exceed capital-related costs, which skews the relevance of traditional capital-oriented performance metrics such as return on capital. (...) Another approach...shifts the focus from capital to people and thereby provides a more accurate indication of the fundamentals of the business.”

The basic preposition is that employees are at the core of the value chain and therefore the key is to be able to quantitatively reflect the contribution per employee. Such a calculation requires both the Average Cost per Person employed (ACP) and the Value Added per Person (VAP).

We traditionally use the simple productivity metric of revenue per person as employees generate our revenue from our customers. However in order to generate revenue (R), employees need materials, represented by material costs (MC) and they use machines and other assets that are accounted for through depreciation (D). The employee adds value by leveraging those inputs. Thus the Value Added per Person (VAP) productivity metric recognises material costs and depreciation.

See the below for more detail.

R = Revenue
MC = Material Costs
D = Depreciation
PC = People Costs
P = Number of Staff

Value Added per Person (VAP) = (R-MC-D)/P
Average Cost per Person (ACP) = PC/P
Contribution per Person (CP) = VAP - ACP
EBITA = CP*P

Working Example:

Revenue = $300M
Material Costs = $120MDepreciation = $4M
People Costs = $145M
No. of Staff = 2400

Value Added per Person (VAP) = $73,333
Average Cost per Person (ACP) = $60,417
Contribution per Person (CP) = $12,917
EBITA = $31M

EBIT/EBITA can therefore be re-written as (VAP-ACP)*P. With this we could express the profitability of any company through three people oriented metrics, as the difference between productivity per employee (VAP) and the average personnel cost per employee (ACP) multiplied by the number of employees. The BCG equation links the control of HR performance with the key financial metric, making it, I feel, a powerful whole of company and BU metric for potential use and review by any company on a monthly and quarterly basis.

Sure, putting this in place may need you to do some tweaking to the formula and engagement with Finance to ensure it is appropriate to your specific company but as the authors conclude; “These new HR metrics are easy to calculate for companies or business units. Value added per person can be the starting point for understanding the productivity of business units and for adequately compensating value-added performance, as well as for controlling personnel costs and headcounts. The resulting insights into people performance will enable companies to make smarter and better-balanced decisions, especially if their goal is to cut costs wisely in times of crisis.”

Why not give it a go? You lose nothing by doing it and may be surprised how seriously your CEO or Business Unit Leader starts to take you when you show him/her the results.

All the best.

Jim