1. THE ECONOMIC VALUE OF HUMAN RESOURCES
Firms create value by either decreasing product/service costs or differenti- ating the product/service in a way that allows the firm to charge a premium price. Thus, the ultimate goal of any HR executive is to create value through the HR function. The first question that an HR executive must address is ‘How can the HR function aid in either decreasing costs or increasing revenues?’
Alcon Laboratories exemplifies the role of HR practices in directly decreasing costs. Trying to hold down the cost of health insurance, Alcon sought to encourage employees to take part in the less expensive Preferred Provider Organization (PPO) rather than the traditional fee-for-service type plans. Vice-president of HR, Jack Walters, noticed that many doctors who were part of the PPO were not the doctors being used by employ- ees. Thus, in negotiations, he asked MetLife to identify the doctors Alcon employees were using and recruit those doctors into the PPO. MetLife was able to bring most of those doctors into its PPO, and, as a result, Alcon’s health insurance costs increased at less than half of the industry average.
Increasing revenues, on the other hand, is a more distant goal to HR managers but one in which they can play an important role. For exam- ple, Federal Express (now FedEx) illustrates the value created by human resources. Federal Express managers stress that they are a ‘people-first’ organization. The corporate philosophy statement sums up their view of the source of competitive advantage: ‘People—Service—Profit’. Fred Smith, founder and CEO of the firm, says, ‘We discovered a long time ago that customer satisfaction really begins with employee satisfaction’ (Waterman 1994). In other words, the FedEx philosophy is that people are the primary link in the value chain, and thus, value is created by focusing first on employees.
How is this operationalized to create value? This emphasis on employee satisfaction is illustrated by FedEx’s annual attitude survey. Most organi- zations administer attitude surveys from time to time, and occasionally use the information gleaned from the surveys to address the most glaring organizational problems. At FedEx, however, the attitude survey forms part of the annual managerial evaluation and reward process. The survey addresses the atmosphere of an individual’s immediate work group, the immediate manager, the managers at levels higher in the organization, and the company’s atmosphere in general. Scores on the items covering the work group and the immediate manager form ‘the leadership index’. This index is used in two ways. If an individual manager receives low scores on the index from the employees reporting to him or her, that manager faces a year-long probation. During that time the manager is expected to improve the scores to an acceptable level or face some type of punitive action. Second, each year a goal is set for the company’s score on the leadership index. If the goal is not met, the top 300 managers in the firm do not receive any bonus, which usually is about 40 percent of base salary. By linking rewards and punishment to employee satisfaction levels, the firm ensures that employees are treated well. When they are treated well, they treat customers well—and this creates value.
FedEx’s philosophy has gained an increasing base of empirical support. For example, Schneider and Bowen (1985) hypothesized that HR prac- tices would be related to employee attitudes which would consequently be related to customer satisfaction. They found significant relationships between HR practices and customer reports of the quality of service they received in a sample of banks. Schlesinger and Zornitsky (1991) found that job satisfaction predicted employees’ perceptions of service quality as well as the discrepancy between employee and customer perceptions of quality. Ulrich et al. (1991) found significant relationships between the tenure of employees and customer satisfaction. Tornow and Wiley (1991) found that employee attitudes such as job satisfaction were related to measures of organizational performance. In addition, Schmit and Allscheid (1995) found that employees’ climate perceptions of management, supervisor, monetary, and service support were related to employee affect. Affect was related to service intentions, which was related to customer service. Empir- ical research thus supports the notions that employee satisfaction is linked to service quality and that HR practices are important determinants of employee satisfaction.
Finally, some HR practices can impact on both costs and revenues. Continental Airlines experienced a tremendous turnaround in which the HR function played a vital role. One of the frequently cited HR practices responsible for this turnaround was the on-time bonus, an incentive system in which each employee was paid a bonus of $65 for every month the airline was at the top of the industry in on-time performance (Boissueau 1995). While this may seem like it comes straight from any introductory textbook (Barlow 1996), its origin was not nearly so simple. In early 1995, after years of pay cuts or no pay raises, top management discovered that it again would be unable to give pay raises to employees. HR executives recognized that taking that message to the employees at a critical phase of the turnaround would destroy morale and greatly impede the cultural shift under way. HR executives along with line executives came up with the idea of the on-time bonus. This bonus resulted in Continental moving from last to first in the industry in on-time performance and consequently both decreased costs and increased revenues. On the cost side, the company paid out $51 million in bonuses in the next year but saved $75 million in lower passenger accommodation costs such as money for meals and hotel rooms associated with missed connections. On the revenue side, the bonus was instrumental in restoring employee morale and, thus, increasing customer satisfaction. In addition, because on-time performance is an important criterion for the higher revenue business traveler, this bonus had a strong impact on the firm’s revenues as they increased their share of the business traveler market.
2. RARITY OF HUMAN RESOURCES
The value of a firm’s human resources is a necessary but not sufficient criterion for competitive advantage. If the same characteristic of human resources is found in many competing firms, then that characteristic can- not be a source of competitive advantage for any one of them. Valuable but common characteristics of human resources provide only competitive parity, ensuring that a firm is not at a substantial competitive disadvantage because it does not possess that characteristic. Thus, an HR executive must examine how to develop and exploit rare characteristics of the firm’s human resources to gain competitive advantage.
For example, most firms view the labor pool for particular jobs as rel- atively homogeneous. Within any labor pool, however, differences exist across individuals in terms of their job-related skills and abilities. If the assumption exists across firms that the labor pool is homogeneous, there can be tremendous potential to exploit the rare characteristics of those employees for competitive advantage (Wright, McMahan, and McWilliams 1994).
For example, Nordstrom’s exists in the highly competitive retailing industry. This industry is usually characterized as having relatively low-skill requirements and high turnover for sales clerks. Nordstrom’s, however, has attempted to focus on individual salespersons as the key to its competitive advantage. It invests in attracting and retaining young, college-educated sales clerks who desire a career in retailing. It provides a highly incentive- based compensation system that allows Nordstrom’s salespersons to make as much as twice the industry average in pay. The Nordstrom’s culture encourages sales clerks to make heroic efforts to attend to customers’ needs, even to the point of changing a customer’s flat tire in the parking lot. The recruiting process, compensation practices, and culture at Nordstrom’s have helped the organization to maintain the highest sales per square foot of any retailer in the nation. Nordstrom’s has taken what is considered to be a relatively homogeneous labor pool and exploited the rare characteristics of its employees to gain a competitive advantage.
3. IMITABILITY OF HUMAN RESOURCES
Valuable and rare characteristics of a firm’s human resources can pro- vide above-normal profits for the firm in the short term; however, if other firms can imitate these characteristics, then over time the char- acteristics will provide no more than competitive parity. The HR exec- utive must attempt to develop and nurture characteristics of the firm’s human resources that cannot easily be imitated by competitors. This points to focusing on the importance of socially complex phenomena such as an organization’s unique history or culture in providing competitive advantage.
Every firm has a unique history that shapes and defines the present situ- ation. This history often provides a foundation for a competitive advantage which other firms find difficult or impossible to imitate. For example, a high-level executive at one of DuPont’s competitors observed that no matter what his firm did (including purchasing DuPont’s safety training programs), they were unable to match DuPont’s safety record. When asked to explain why, he stated: ‘When a firm starts out by making dynamite, something happens that just instils in employees’ minds the importance of safety.’ Thus, DuPont’s superior safety performance stems at least in part from its unique history that competitors would find impossible to imitate.
Southwest Airlines exemplifies the role that socially complex phenomena such as culture play in competitive advantage. According to the company’s top management, the firm’s success can be attributed to the ‘personality’ of the company; a culture of fun and trust that provides employees with both the desire and the discretion to do whatever it takes to meet the customers’ needs. The ‘fun’ airline uses an extensive selection process for hiring flight attendants who will project the fun image of the airline. Applicants must go through a casting call type exercise where they are interviewed by a panel that includes current flight attendants, managers, and customers. The applicants tell stories, such as their most embarrassing experience, in front of the panel and other applicants. Those who make it through the panel interview are then examined against a psychological profile that distinguished outstanding past flight attendants from those who were mediocre or worse.
In addition to the extensive selection process, employees are empow- ered to create an entertaining traveling environment by a strong orga- nizational culture that values customer satisfaction. Says Herb Kelleher, CEO:
We tell our people that we value inconsistency. By that I mean that we’re going to carry 20 million passengers this year and that I can’t foresee all of the situations that will arise at the stations across our system. So what we tell our people is, ‘Hey, we can’t anticipate all of these things, you handle them the best way possible. You make a judgment and use your discretion; we trust you’ll do the right thing. If we think you’ve done some thing erroneous, we’ll let you know—without criticism, without backbiting.’ (Quick 1992)
This extensive selection process and the strong organizational culture contribute to the differentiated service that has made Southwest Airlines the most financially successful airline over the past twenty years and has enabled it to continually be among the best in the industry for having the fewest customer complaints.
Seeing this financial success, competitors, such as Continental Airlines (Continental Lite) and United Airlines (United Express), attempted to compete with Southwest Airlines by providing low-cost service to a num- ber of destinations. Continental Lite ceased operations within a year, and United, while having survived, is still losing to Southwest in most mar- kets where they compete. Kelleher, who believes that Southwest’s superior performance has happened because its culture simply cannot be imitated, stated:
Maybe someone could equal the cost … possibly they could. And maybe some- one could equal the quality of service that goes along with that and consti- tutes great value, … possibly they could. But the one thing they would find it impossible to equal very easily is the spirit of our people and the attitude they manifest toward our customers. (Quick 1992)
In other words, the human resources of Southwest Airlines serve as a source of sustained competitive advantage because they create value, are rare, and are virtually impossible to imitate.
4. THE ORGANIZATION OF HUMAN RESOURCES
Finally, in order for any characteristic of a firm’s human resources to provide a source of sustained competitive advantage, the firm must be organized to exploit the resource. Organization requires having in place the systems and practices that allow HR characteristics to bear the fruit of their potential advantages.
For example, both General Motors (GM) and Ford historically have recruited assembly line workers from the same basic labor market. There is little evidence that the skill levels of Ford’s workers are significantly higher than those of GM workers. Ford, however, has been more successful at developing a cooperative, team-based culture than has GM. Both automak- ers set out to develop employee involvement programs during the late 1970s and early 1980s. Ford more successfully changed the culture and HR systems to allow for, and even value, employee participation in decision- making, relative to GM. Ford’s culture and HR systems allow for employees to participate in decision-making and to utilize cognitive skills that the GM systems have been less able to exploit (Templin 1992). In addition, as Ford moves toward hiring even more highly skilled employees through an extensive assessment process, its participative system will leave it poised to increase its relative advantages over GM (Templin 1994).
The question of organization focuses attention on systems, as opposed to single HR practices. Research on HR practices and firm performance seems to indicate that HR practices are most effective when they exist as a coherent system. Wright and Snell (1991) argued that Strategic Human Resource Management (HRM) required coordinated HR activities across the various subfunctions. Similarly, Wright and McMahan’s definition (1992) of Strategic HRM called for ‘horizontal integration’ of the vari- ous HR practices rather than viewing each in isolation. Lado and Wilson (1994) hypothesized that the more complex the HR system, the more likely it would be to serve as a source of sustainable competitive advantage. MacDuffie (1995), in a study of automobile manufacturing firms, found that performance was maximized when ‘bundles’ of HR practices were linked with participative work systems and flexible production systems. Wright et al. (1996) found that HR practices such as selection, appraisal, and compensation were unrelated to the financial performance of petro- chemical refineries alone, but that they were strongly positively related to performance among refineries that had highly participative work systems.
These research studies seem to indicate a need for HR functions to pay attention to the system of HR practices, rather than to focus on each in isolation.
Both quantitative and qualitative data gathered from an ongoing research study indicate that very few companies are spending much time and attention on coordinating each of the various HR subfunctions (e.g. staffing, compensation, training, and so on) with one another.1 Of thirteen firms in this study, only two have actively attended to achieving integration among the compensation, selection, training, and appraisal systems and processes. It appears that firms that do make such efforts have at least temporary advantages over their competitors.
Source: Barney Jay B., Clark Delwyn N. (2007), Resource-Based Theory: Creating and Sustaining Competitive Advantage, Oxford University Press; Illustrated edition.