White Paper

EMPLOYEE EFFICIENCY RATIO (EER)Ó

EMPLOYEE PROFITABILITY RATIO (EPR)Ó

Over the last 12 months, more and more clients and industry consultants have been requesting more in depth analysis on the single most costly line item in the enterprise, The Employee.  The reason stems from what has been a need to better understand the investment and supporting return on investment from the Human Capital Management perspective.  Human Capital Management is nothing new yet the study of performance in this area has been underserved for many years, due to lack of solid performance data to evaluate managements performance with this tangible and sometimes intangible asset.

 Executives, Directors and shareholders need to start understanding and investigating in detail this area within the enterprise and determine the results and impacts management practices have on financial and process performance.

Today and in the future the Enterprise will start to view and treat the employee differently based on the ever-increasing cost versus return issues that are prevalent. Indeed one may argue that the current Macro economic circumstance of today are a result of 40 years of downsizing an economy that produced and consumed to one which produces information and relies on other econometrics to sustain itself. However, that discussion is for another day as our purpose here is to establish a foundation of understanding the value of HCM and it’s measurement and monitoring.

Measuring management performance of human capital needs a structure to start to understand the relationship of impacts it has on profit, productivity, moral, and incentive.  To often results do not focus on the individual and many times management overlooks the process in the determining the value of the enterprise and it’s leadership role.

Discussed below are two criteria to assess management’s role and benchmarks of performance. Not covered here are the root causes for success or failure, sufficient to say that decisions produce actions, which can be measured tangibly. Further insight into individual cases is attainable and analysis can be correlated to performance ratios.

What is Employee Efficiency Ratio©  EER©? 

It represents a calculation based on gross revenue generation net of controllable cost related to total compensation paid by the enterprise to its employed. 

This Macro view of individual organizations within industries can be compared on management’s ability to maximize the effectiveness of employees and determine how efficient management is with human capital. Another benefit is providing sound financial justification for job functions within the organization.

In the recent and not so recent past, managements have been aggressive if not egregious proponents of cost management. Management has learned this craft quite well based on the numbers and ease of manipulation of them.  When one considers employees a suppliers of goods and services to the enterprise one can envision the process of human capital return more simplistically. Many may argue that soft issues of HCM(Human Capital Management) will not allow a hard financial calculation to be made, however this financial ratio allows one to determine if management is being too aggressive or not aggressive enough  for some reason in managing the human assets, and  thus allowing a further micro analysis of the management cause. 

The simple and easy way to effect bottom line performance is to eliminate, restructure, downsize, and reduce in force the employee base. Doing this has in the past given managers immediate impact on shareholder value and as long as the decision makers weren’t being reduced, all is well in the enterprise.

One major question that has never been fully answered however is “Was the enterprise’s impacted positively or negatively?” Certainly the financials improved but then that was the whole idea  to begin with.

Less cost, same revenue, more profit seems simple enough but is there more to evaluate and understand.

ERR addresses that evaluation.

What is Employee Profitability Ratio© EPR©? 

It represents a calculation of individual employee revenue generation or allocation based on the employee’s activity in creating and/or supporting income and their proximity to the income stream measured against their individual variable or fully loaded cost for their activity and effort.

The resultant represents a quantifiable value of employee to the enterprise and is reconcilable to the enterprise’s general ledger operating results.  Income – (cost + expense) = employee profit or loss.

Obviously administrative and overhead costs are non-value added and a “Drag” to the profitability of the employee. But what a motivator for “buy in” in keeping employees constantly focused in two major areas, income and expense.

This is seen best in certain jobs such where the direct activity effort is identified clearly in the creation of income.  Employees directly involved in creating income are highly rewarded. The test of the reward however can be misleading, as other job functions may also have a direct or significant impact on income but  suffer from inability to identify their importance to revenue creation.

However this ratio can still be valid based upon the value of the function to support the revenue creation or retention. That is a definition issue that can be culturally integrated, and when properly managed greatly enhance the work environment. 

Indeed one of the hardest areas to quantify is the executive level. One might argue, especially the executives themselves that they truly are the primary revenue generators, who lay claim to the majority of revenue creation through their strategic thinking and implementation of strategic plans. More likely however the truth would lie in their individual ability to positively impact the financial top line through M&A, new or reengineered business lines, or technology investments which have a direct and quantifiable revenue impact. Being able to quantify their contribution directly should be commended and commanded by shareholders and stakeholders. In the recent book “Titan”, J.D. Rockefeller, continually required his executives to think about future revenue creation as their primary focus and activity.  His leadership demanded and enforced this thinking constantly and if production was lacking the executive soon was lacking a place to conduct activity. In essence where can the next “dime be made” rather than the current one, which is the responsibility of lower management to maintain and retain. We all know the result of this approach, and boards may want to consider it in dealing with executive managers once again. As for the rest of the employee base, visualize a monthly, weekly or daily operating statement of contribution and profit, produced or protected by them.

What value might that information have on a workforce? What performance programs could be developed? What productivity and business consciousness might that motivate?

ANALYSIS

The chart below is an analysis of published data on Financial Institutions insured by the FDIC.

Here we have calculated the EER and ERP to get a better understanding of the dynamics of these ratios.

Comparing the years shows a consistent income decline, along with declining expense and cost, while employee cost continue to rise. The decreased income and expense in the face of greater employee cost is improving the efficiency ratio. It is suspected the relationship in improvement however is not a conscious management effort, but rather a result of decreasing interest rates (variable income and costs) brought about through economic contraction. If managed then employee cost would decline on a similar percentage to variable items. That however is not the case, and can be validated by the EPR which clearly shows a declining average profitability per employee over the last three years. The EER would be even lower if the income and expense were better managed, and EPR should be increasing.

Our analysis indicates that EER has been recorded well over 90.0 in some institutions and as low as 20.0 in others. This management performance indicator provide managements with an opportunity to review efficiency and suggest that management should focus on individual employee profitability just as much as customer, product and institutional profitability issues. 

Similarly average revenue per employee should be reason enough to focus on Human Capital Management and managerial initiatives to increase revenue proportionally over the employee cost issues. Guidance principals on how well managers manage is an integral part of not only organization health but also to it’s endurance to sustain economic cycles. Managers must learn to control the environment as well as they control the input output cycles of inventory and delivery. Without performance controls organizations will flounder or succeed without understanding why.

MSG strongly believes that underutilization of human capital has continually restricted many institutions from achieving greater returns for investors, stakeholders and employees.

These two performance measures EER & EPR provide institutions and the industry with a focused evaluation management methodology and provide additional transparency to how well management is performing in human capital management.

Just as institutions are measured and compared to markets and productivity,

MSG believes comparison of human management is just as critical and often times overlooked entirely.

Should you care to discuss your institutions focus in this area, please visit us at www.mgmtsolgrp.com

Or call 1-800 791 4009.