Calculating the Actual return on

Investment
Capture
Cost of
HR
Program

Evaluation Planning Data Collection Data Analysis Reporting

Generate
Develop Develop Collect Data Collect Data Isolate Convert Calculate
objectives Evaluation During After Effects of Data to the Impact
of HR Plan & HR Program HR Program HR Monetary ROI Study
Program Baseline Data Implementation Implementation Program Value

1. Satisfaction / 3. Application / 5. ROI

Reaction Implementation
2. Learning 4. Busines Impact Identify
Intangible
Measures

6. Intangible
Benefits

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 Basic Issues
• Definition
• Annualized Values

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 ROI : Definitions
¾ The phrase return on investment in HR is often misused, sometimes
intentionally. In some situations, a broad definition for
¾ ROI includes any benefit from the program.
¾ In these situations, ROI is a vague concept in which even subjective
data linked to a program are included in the concept of the return.
¾ The return on investment has a more precise meaning and represents
an actual value developed by comparing program costs with benefits
¾ The two most common measures are the benefit/cost ratio and the ROI
formula.
¾ If HR programs are considered an investment, not an expense, then it
is appropriate to place the HR investment in the same funding
mechanism as other investments, such as the investment in equipment
and facilities.

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 Annualized Values
• Using annual values is becoming a generally accepted practice for
developing the ROI in many organizations. This approach is a
conservative way to develop the ROI, because many short-term HR
programs add value in the second or third year
• For long-term HR programs, annualized values are inappropriate, and
longer time frames need to be used. For example, in an ROI analysis of
a program to send employees to the USA to obtain MBA degrees, a
Singapore-based company used a seven-year time frame
• The program required two years for degree completion and then a five-
year impact, with post-program data used to develop the ROI.
However, for most programs that last anywhere from one day to one
month, first-year values are appropriate.

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Benefit/Cost Ratio

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 Benefit/Cost Ratio
Unfortunately, no standards exist as to what constitutes
an acceptable benefit/cost ratio. A standard should be
established within an organization, perhaps even for a
specific type of program. However, a 1: 1 ratio is
unacceptable for most programs, and some
organizations require a 1.25:1 ratio, where 1.25 times
the cost of the program is the benefit.

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ROI Formula

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 ROI Formula
An ROI for an HR investment of 50 percent means
that the cost were covered and an additional 50
percent of the costs were reported as “earning.”
For example, a cost $100 requires earning $150 in
order to bring a 50 percent return.

$150 - $100
ROI(%) = X 100 = 50%
$100

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ROI Formula

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ROI Formula

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 BCR/ROI Case Application
• Background Information
Retail Merchandise Coy (RMC) – a large, national store chain
located in most major USA markets – attempted to boost sales
by conducting an interactive selling skills program for sales
associates. The program, developed and delivered by an outside
vendor, represented a response to a clearly defined need to
increase the level of interaction between the sales associate and
the customer. The program consisted of two days of skills
training followed by three weeks of on-the-job application of
the skills.
The third day of the program was used for follow-up and
additional training. Three groups, representing the electronics
departments of three stores, initially received the training, as a
pilot implementation. A total of four participated.

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 ROI Analysis: RMC Case
• Post-program data collection was accomplished using three methods.
– First, the average weekly sales of each associate was monitored (business performance
monitoring of output data).
– Second, a follow-up questionnaire was distributed three months after the associates completed
the training to determine Level 3 success (actual application of the skills on the job).
– Third, Level 3 data were solicited in a follow-up session, which was conducted on the third day.
In this session, participants disclosed their success (or lack of success) with the application of
new skills.

• They also discussed techniques to overcome the barriers to program implementation.

This program used a control group to isolate the effects of training. Three additional
store locations were identified (control group) and compared with the three groups in the
pilot training (experimental group). The variables of store size, store location, and
customer traffic levels were used to match the two groups so that they could be as
identical as possible. The method to convert data to monetary values is a direct profit
contribution of the increased output. The actual profit obtained from an additional one
dollar of sales was readily available and used in the calculation.

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BCR and ROI Calculations:
Level 4

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BCR and ROI Calculations:
Level 5

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BCR and ROI Calculations:

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 BCR and ROI Calculations
$71,760
BCR = $32,984 = 2.2 : 1

And the return on investment became :

$71,760 - $32,984
ROI (%) = X 100 = 118%
$32,984

Thus, the program had an excellent return on investment

In its initial trial run after three months of on-the-job
Application of the skills

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 Other ROI Measures
• Payback Period
• Discounted Cash Flow
• Internal Rate of Return
• Utility Analysis

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 Payback Period
• Is a common methods for evaluating capital expenditures.
• For example, if the cost savings generated by an HR program remain constant
each year, the payback period is determined by dividing the total original cash
investment (development costs, outside program purchases, etc.) by the
amount of the expected annual or actual savings. The savings represent the net
savings after the program expenses are subtracted. To illustrate this
calculation, assume that an initial program cost is $100,000 with a three-year
useful life. The annual net savings from the program is expected to be
$40,000. Thus, the payback period becomes:

Total Investment
Payback Period = _____________________= 100,000 = 2.5 years
Annual Saving 40,000
The program will “payback” the original investment in 2.5 years. The
payback period is simple to use but has limitation of ignoring the time value of
money. It has not enjoyed widespread use in evaluating HR investments

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 Discounted Cash Flow
ƒ Discounted cash flow is a method of evaluating investment
opportunities in which certain values are assigned to the
timing of the proceeds from the investment. The
assumption, based on interest rates, is that a dollar earned
today is more valuable than a dollar earned a year from
now.
ƒ There are several ways of using the discounted cash flow
concept to evaluate capital expenditures. The most popular
one is probably the net present value of an investment.
This approach compares the savings, year by year,- with
the outflow of cash required by the investment. The
expected savings received each year is discounted by
selected interest rates.
ƒ The discounted cash flow method has the advantage of
ranking investments, but it becomes difficult to calculate.
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 Internal Rate of Return
• The internal rate of return (IRR) method determines the interest rate
required to make the present value of the cash flow equal zero.
• It represents the maximum rate of interest that could be paid if all
project funds were borrowed and the organization had to break even on
the projects.
• The IRR considers the time value of money and is unaffected by the
scale of the project. It can be used to rank alternatives and to make
accept/reject decisions when a minimum rate of return is specified.
• A major weakness of the IRR method is that it assumes all returns are
reinvested at the same internal rate of return. This can make an
investment alternative with a high rate of return look even better than it
really is and a project with a low rate of return look even worse.
• In practice, the IRR is rarely used to evaluate HR investments.

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 Utility Analysis
• Another interesting approach for developing the HR payoff
is utility analysis. Utility is a function of the duration of an
HR program's effect on employees' performance, the
number of employees affected, the validity of the HR
program, the value of the job for which HR initiative was
provided, and the total program cost.
• Utility analysis measures the economic contribution of a
program according to how much effect the program had in
identifying and modifying behaviour, hence the future
service contribution of employees. Schmidt, Hunter, and
Pearlman derived the following formula for assessing the
dollar value of a training program :
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 Utility Analysis
Formula :
Δ U = T X N X dt X Sdy – N X C
Where
ΔU = Monetary value of the training program
T = Duration in number of years of a training program’s effect on performance
N = Number of employees trained
dt = True difference in job performance between the average trained and the
average untrained employee in units of standard deviation
Sdy = Standard deviation of job performance of the untrained group in dollars
C = Cost of training per employee

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Utility Analysis

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ROI Issues : Complexity

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ROI Issues :
Caution When Using ROI
• The ROI process should be developed for programs for which a needs
assessment/analysis has been conducted.
• The ROI analysis should always include one or more strategies for isolating the
effects of the HR program.
• When making estimates, use the most reliable and credible sources
• Take a conservative approach when developing both benefits and costs
• Use caution when comparing the ROI on HR with other financial returns
• Involvement management in developing the return
• Approach sensitive and controversial issues with caution
• Teach others the methods for calculating the return
• Do not boast about a high return
• Do not try to use ROI for every programs

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