The question “What value does HR add to an organization?” has always been difficult to answer. In this article, I will discuss the HR value chain. Not only helps this tool to show the added value of HR, it also constitutes an excellent framework for people analytics. In fact, it helps analyze how HR contributes to business outcomes.
The HR value chain in research
The HR value chain is a tool that shows how HR adds value to organizational goals.
Empirical evidence demonstrates the existence of positive relationships between HRM practices, HRM outcomes, and organizational outcomes.
For a more detailed review of literature on how HR practices impact business performance, click here.
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For example, investing in better employees (Generic Human Capital) and training people on the job (Unit-Specific Human Capital) lead to better service performance and, in the end, to higher unit effectiveness, as shown in the following model.
Each factor (circle) represents change (flow) in that construct over consecutive quarters. Values in parentheses are those for the receipts versus flow-through dependent variable. * p < .05. Based on Ployhart and colleagues, 2011.
This value chain illustrates how HR adds value to organizational goals. Hiring more qualified people and training them increases service performance. As a result of this growth, the unit is more effective – and profitable.
Interestingly, employee turnover influences this negatively. This is because essential knowledge and experience is lost when employees leave.
These findings justify the existence of HR policies like selection, performance management, and training. They add measurable value!
A meta-analysis by Crook and colleagues (2011) took the effects of 66 studies and investigated the impact of human capital on firm performance.
The researchers found that high-quality human capital contributes to firm performance through ‘operational performance’. This means that qualified and talented people make their departments perform better, which eventually causes the whole firm to perform better.
This model shows full mediation. The numbers are standardized path coefficients.
So why is HR still struggling to show its added value?
Partially, it’s because every organization is unique. What works in one organization doesn’t necessarily work in another.
The second reason is that it’s hard to show added value in a very practical way. The HR value chain solves this problem.
The HR value chain
So, what does the HR value chain look like?
It’s a three-step process that starts with HRM activities, followed by HRM outcomes and organizational objectives. It clearly depicts how HR activities lead to organizational goals.
HRM activities and processes: Efficiency metrics
On the left of the chain, we find the HRM activities. These are measured using the so-called efficiency metrics. Examples include:
- Cost of hire
- Time to hire/time to fill
- Learning and development budget
- Training time in days
- Time since last promotion
All these metrics measure HR processes and give information about how efficient the HR function is. It doesn’t say anything about how well HR is hitting its marks, a.k.a. HR effectiveness.
I like to refer to organizations who solely focus on HRM processes level 1 HR organizations. Their main focus is cost savings, reached by optimizing these efficiency metrics.
For example, if they can lower the cost of hire while keeping the time to hire metric stable, they are more efficient. This immediately shows the big weakness of these level 1 HR organizations: they focus on reducing HR cost – and thus approach HR as a cost-center instead of focusing on the value that HR adds.
In other words, HR efficiency says nothing about how HR contributes to the business.
HRM outcomes: Effectiveness metrics
In the second category, we observe the HRM outcomes. These are the outcomes that are traditionally seen as important HR KPIs. Examples include:
- Retention/employee turnover
- Absenteeism rate
- Individual performance
- Team performance
- Quality of hire
All these metrics provide information about how well the workforce is doing. This involves both HR and line management.
For example, when engagement is high, HR is more effective than when engagement is low. The same holds true for retention and (inversely) for employee absence.
Part of HR effectiveness is how well the intended HR practices are executed by managers. HR can do a stellar job but with bad managers, employees will be more absent and much more likely to leave!
It is important to realize that most of our HR activities are aimed at achieving positive HR outcomes. For example:
- We don’t want to spend too much time on bringing in new people, otherwise we will lose the best candidates, bringing our quality of hire metric down
- We are training our people to make them perform better and retain them
- We engage in wellness promotion in order to lower absence
- And so on
Level 2 HR organizations focus on HRM outcomes. They don’t focus on cost savings but on how they can reach their HR outcomes in a cost-efficient way.
The last category is organizational objectives. These are the strategic goals that the organization is trying to reach. Examples of metrics include:
- Market share
- Profit margins
- Market capitalization
- Customer satisfaction
- Customer loyalty
These are the kind of outcomes that add value to the business and make the business more viable in the long term.
Level 3 HR organizations focus on the business contribution they make with all of their people policies. These are truly strategic HR functions.
The HR value chain in practice
Let me give you an example about how these different levels of HR organizations think. Say we want to increase learning in the organization.
- A level 1 HR organization will allocate more L&D budget to employees, believing that better-trained employees will benefit the organization.
- A level 2 organization will allocate more L&D budget to employees and follow up by checking if these investments pay off. They test knowledge retention and check if the investments lead to better individual performance. If not, they will test and change training programs and/or training providers in order to optimize return.
- A level 3 organization does it the other way around. They know that the L&D spending was increased because the organization wanted to become more innovative and profitable. This organization will do all of the above and test how it impacts these two key performance indicators. They will only be satisfied when there’s a positive relationship between the L&D spending and the key performance indicators.
|Level 1 HR organization||Focus on cost-saving…||…through optimizing HR efficiency||Operational|
|Level 2 HR organization||Focus on HR results…||…through maximizing HR outcomes. Cost efficiency is secondary||Tactical|
|Level 3 HR organization||Focus on business results…||…through efficient and effective HR policies||Strategic|
The HR value chain and analytics
This is also where analytics comes in. HR serves the business and should follow the organizational objectives. All HR outcomes and activities that HR focuses on should lead to these business outcomes.
Analytics is a great tool to measure the effectiveness of the HR interventions aimed at reaching these business outcomes. This relates to the two models I included at the beginning of the article, which show the value that is added through HR practices. In this case by hiring the right people and training them on the job.
This kind of tangible analytics evidence connects what we do in HR to tangible financial business outcomes, proving once again the added value of HR.
To learn more about the HR value chain and how it can be used check out our Strategic HR Metrics course. In this course, you will learn how to create valuable strategic metrics and KPIs within HR.
If you are more interested in the analytics part of the value chain and want to learn how to leverage strategic analytics to add value to a business, have a look at our HR analytics lead course!