Risk management and talent

When a company announces that its people are its most important asset, it sounds like a platitude, and eyes tend to glaze over. If a company were to say 'Our people are our greatest source of risk', it might attract more attention.

In reality, people are both. They are the primary source of value and the greatest source of risk in an organisation, and this becomes accentuated in high value service industries, characterised by considerable investments in intellectual capital and high levels of remuneration. For example, in the capital markets and investment banking sector, up to 65% of annual expenditure is people related.

Conventional management and accountancy display an historic bias towards managing assets that are owned by the company, and monitoring the costs that are more easily measured. The human assets hired by the company – their talent, knowledge and ways of working – receive less attention. They pass under the title 'intangible', which is something of a misnomer, given that they walk into the workplace every day, talk with each other and with customers; build skills, knowledge and experience and are generally responsible for delivering the promises made by executives to shareholders.

Traditional financial accounts do not encompass the value or the risk associated with employing high-value people. There is no record in the financial accounts headed 'cost of failed hires', or 'five-year return of effective leadership-development programme'. But the gains and losses from the human capital investments which companies make are felt directly on the bottom line.

Discussion of 'risk' in the management of talent is often restricted to discussions of litigation risk from the failure to observe employment laws or specific industry regulations. However, a comprehensive assessment of people-related risk would cover much more. Reputational risk, for example, would cover questionable deals and many other incidents that fall short of reaching tribunals and newspapers.

And the broader question of hidden risks from the failure to have the right people in the right place at the right time for the right cost and fully engaged can be considerable. High staff turnover, for example, has direct costs such as search fees, and indirect costs such as management time, but it can also lead to significant opportunity costs: lost business from empty seats, or missed opportunities to seize high margin deals in new markets.

If this more broadly defined people-related risk could be quantified, the amounts at stake would be so eye-wateringly high that it would compel managers to devote a large proportion of their time to it.

In the capital markets and investment banking sector, for example, the talent hired is of obvious importance. One significant risk is that a 'star' may leave, and be followed by his or her close colleagues and customers.

“A discrimination case could cost a company its reputation as well as money

Consider the view of a business manager quoted in a new IFR Market Intelligence report on talent management in capital markets and investment banking. He observes that business managers have not historically been held to account for all the costs which are identifiable people related risks. For instance, he says that even the banks have not truly quantified the cost to the business of losing people. It is much more than just a case of lost revenue. There is the management time in recruitment, and the ripple effects on morale. If a key person resigns, the person sitting next door thinks: ‘Should I be thinking of resigning too?’

This manager believes it is possible to quantify the losses and gains from people-related initiatives on a more rigorous basis, and early indications are that the number is 'scary', to use his word. He envisages a move towards performance-related shadow revenue shared between the business and the human resources function, related to the impact of high performance, integrated, recruitment, development and retention policies. In this way, all those responsible for people-related practices are exposed to the risk that they fail, helping to ensure stronger management of the overall human resource environment. There is a revenue impact line as well as a cost efficiency line.

Talent portfolio management

The concept of talent portfolio management involves taking an investment based strategic approach to the management of human assets. Just as certain capital markets activity involves the management of asset portfolios, one can conceive of a talent portfolio segmented into different human asset groups – for example front-office 'stars', their teams and people in key support roles. CEOs can be seen as chief talent officers/chief (people) investment officers, divisional managers (for example, fixed income, equity) as divisional portfolio managers, heads of lines of business (eg DCM, ECM, FIG) as business portfolio managers, human resource partners as portfolio analysts, and human resource specialists as people risk managers.

There is now a body of knowledge for human capital measures which can be used as part of a strategic approach to the management of human resources. The concept of talent portfolio management is to treat appropriate people as an investment, not a cost. It is a fundamental shift in perspective, implying an understanding of the organisation as a dynamic and complex system where the talent pool is segmented and each segment risk-managed by a business aware and business focused human resource department, equipped with appropriate systems and human capital related metrics.

The IFR report includes descriptions of statistical modelling that bears resemblance to other statistics-based models of risk. Exactly the same principles can be applied to people. If one has data on starters, leavers, promotions and bonuses, and on turnover of upper-quartile performers, for example, one can gauge the probability that a promotion or a bonus will help to retain a top performer. Once this is integrated into the management of the organisation, then approximate measures of return on investment for people-related initiatives can be made. For example, if it can be statistically demonstrated as probable that a bonus, promotion, leadership development or new assignment, will help to retain strong performers, the extra returns from this retention can be estimated and compared with the initial investment.

There are huge difficulties with modelling, because organisations are complex and dynamic. But meaningful measures can and have been developed. Moreover, there is a direct impact on company performance and share price arising from the internal dynamics of the human resource environment. Stock analysts are starting to look more seriously at indicators such as management strength, succession plans and employee engagement surveys, and some bank CEOs are sharing these as part of their quarterly analyst briefings. Organisations are increasingly building such measures into the management of their investment in talent.

The business manager quoted above indicates that the historic reticence to do this may actually be because the sums at stake are embarrassingly high, rather than hard to quantify. It may also be difficult to acknowledge just how large a proportion of company value has historically been put at risk through the lack of a strategic or systematic approach to talent management.

“If the more broadly defined people-related risk could be quantified, the amounts at stake would be eye-wateringly high

Progressive approach

It is likely that a progressive and strategic approach to talent management also engenders a climate in which individuals are less likely to be unsupervised, make serious errors, or take the employer to a tribunal. Thus, a focus on people related risks, outside of market and credit related risks, will allow organisations to satisfy their regulatory responsibilities.

The emphasis on a risk-based approach in the Financial Services Authority's N2 regulations puts the focus firmly upon vetting, competence and probity of individuals and teams. As PricewaterhouseCoopers noted in 2001, shortly after the regulations came into force: 'The arrival of N2 heralded a fundamental shift towards the importance of people management in firms' compliance and risk management strategies … Firms will need to look carefully at the following to ensure they remain compliant as well as competitive: the positioning of human resource management as part of corporate business planning; the relationship between human resource management, risk management and compliance, and the use of measurement in human resource management to show compliance.'

It is often supposed that compliance with regulations is a dead weight for employers. But if a strategic approach to talent that involves putting some measures on risks and returns, and which is geared towards commercial objectives, also helps to ensure compliance with FSA rules, this represents a significant opportunity for employers in the financial services industry to secure an effective 'win-win'.

At Citigroup, who are featured in the IFR report, risk management and people management are considered jointly, and there is a comprehensive range of performance measures. In part, this move came as a response to the Enron scandal.

Risk management is seen as a dimension of people management, and vice versa, says a senior human resource professional. He says that reputational risk is where people are not aligned with the organisation's goals in respect of their responsibilities or behaviour. Other risks could come from employee litigation – a discrimination case could cost the company its reputation as well as money.

The Royal Bank of Scotland has a human resources risk team, and produces a monthly people-related risk report. Morgan Stanley also produces a set of monthly risk reports for the bank's risk committee, while Lehman Brothers has hired a McKinsey consultant to work on people-related economic models.

One of the major challenges in this area is that responsibility is spread so wide within an organisation, while another is that risk is accentuated because of the highly mobile nature of people. All managers are, in part at least, responsible for the conduct and engagement of the talent in their teams, and do well to remember that these assets have legs.

Successful approaches to risk and talent management tend to involve leadership from the top of the organisation. Where a CEO sees him or herself as the chief talent officer/chief investment officer, responsible for the nurturing and performance of people within the organisation, that company is better positioned to maximise performance.