The Accounting and Cultural Factors Behind Neglected Investment In Employees
Most of us who are “managed” as employees spend a great deal of our time trying to understand why we see our organizations making decisions that just don’t seem to make sense. Those of us who study management spend a great deal of time telling employers why they should manage better. Yet over and over we see that they do not, that practices we might see as “pennywise and pound foolish,” short-sighted decisions that end up costing us more in the long-run rule the day.
We see these in the form of layoffs that then lead to rehiring soon after, chasing expensive outside talent rather than developing our own, resistance to empowering employees in decisions, and so forth.
Training in the US has declined to the point that by some measures, the average employee now gets about half a day per year, and the average 50 year-old has already worked for 12 different employers.Even now in a period of tight labor markets throughout the developed economies where hiring and retention is difficult, only about one-third of FTSE companies have any targets or financial incentives for executives tied to employee-related outcomes. Yet they acknowledge that those issues are their biggest problems.[1]
What we don’t spend much time doing is trying to figure out why they don’t do the right thing, why we have moved in this direction. In the US in particular we are inclined to blame the problem on the power of Chief Financial Officers and the general belief that they just don’t understand the value of people.
A better explanation begins with the fact that the system that governs businesses in particular is accounting and the principles used to determine how you are performing, who is winning and losing. Indian Accounting Standards are similar to accounting standards elsewhere – Generally Accepted Accounting Standards (GAAP) in the US arguably being most prominent – in that because they are based around notions of physical and financial capital, they have a hard time getting their hands around human capital. As many people have pointed out, employees and human capital are typically seen as costs rather than assets, which means that laying off employees means dropping costs rather than the reality that we are also dumping assets. It means that training and employee development can’t be seen as investments. They are only costs. The biggest distortions we are seeing in the US now arise from the fact that financial performance in the form of revenue or profits are reported on a “per employee” basis. So cutting your headcount by using non-employees or even outsourcing tasks makes the company appear much more valuable.
Perhaps the most unusual adaptation to financial accounting in corporations is the notion of “headcount budgets,” in addition to financial budgets. When a company sets up a project, it allocates a budget to it – spend no more than this much – but it also says, don’t hire or use more than this many employees to in the process. Spend as much of that budget on temps and contractors as you want as long as you don’t use more than this many employees even if using more employees is better and cheaper.
Therefore, we don’t invest much in our employees, we don’t give as much concern to retaining them, and we don’t spend much time trying to manage them carefully.
Accounting and finance are not the only factors pushing us to make strange management decisions that do not make sense, though. The long-running battle between different views about people and employees – are they just rational agents as economics and engineering typically assumes or are they complex characters as psychology discovered – continues to rage 50 years after we thought the more complex view had won. The resurgence sees optimization as the goal in management – using as few employees as possible, managing them with incentives, and popping them in and out of organizations as if they were components being assembled off the shelf.
Some of this is because of the resurgence of engineers in CEO roles whose training and orientation is toward optimization thinking. This has been driven by the new world of tech start-ups first by the Silicon Valley titans who founded companies like Microsoft, Apple, and Google. They were themselves engineers with no management experience or knowledge or saw themselves that way. The decline of management development especially in multi-national companies that had taught new hire managers about people issues and transferred those lessons elsewhere is another factor.
We can see this now in two prominent business trends that rewrite earlier principles. Lean production borrowed from Japanese management and applied around the world to great effect involved pushing decision making down to front line employees. Now, however, lean means simply trying to operate with as few fixed costs as possible, and that includes employees because of the assumption that employees as the biggest “fixed cost” even though layoffs prove otherwise. The decision making that employees had made on issues like designing how tasks were performed is being taken back by engineers and software. Why, despite the enormous success of lean production? Because of the assumption that sophisticated optimization approaches just have to be better.
The other change is the transformation of the term “agile” from another employee empowerment practice for project work that cut planning and also pushed decisions even on product design down to teams to something about being able to move quickly. In practice, that means a company that can scale itself up and down, drop this operation and start a new one fast. Hiring and laying off is the preferred method for doing so but using contractors and non-employees is part of the package as well. Managing employees carefully and developing them is, of course, a waste when they will simply have to gone soon.
Why is getting in and out of markets fast the priority as opposed to running existing operations well? One answer is the short-run orientation of executives, which reflects the short-run orientation of their investors. But the alternative of executing mergers and acquisitions and divestitures, cutting new deals, and restructuring operations is also much more glamorous and gets executives far more attention than the time-consuming task of keeping existing operations running effectively. That requires a lot more attention from leaders who have to shape the culture, motivate employees and provide them direction, and so forth.
Indian companies have arguably been advantaged as compared to their western counterparts by paying less attention to investors and their short-run focus. The task of managing workforces where skills are in short supply, where unions and labor regulations are more powerful, and where the social purpose of companies is more prominent may have kept them from ignoring the management of the workforce. But these corporate trends have a tendency to move around the world through multi-national practices, advice from global consulting firms, and the business press. They can be difficult to resist. Doing so starts with evidence that good employee management matters: turnover is costly, training employees improves performance, internal promotion is cheaper and better, and focusing on running employees well pays off well with much lower risk than the more glamorous world of big deals.
[1] CIPD and the High Pay Centre. 2020. CEO Pay and the Workforce. London. December.
