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Talent Management Column

Managing Human Capital Risk

The potential for risk in human resources can negatively affect entire business organizations -- yet only half of organizations say they have a formal plan to assess such risks. It's up to HR leaders to better understand the risks and the potential costs they represent to the business.

Monday, October 10, 2011
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The topic of risk management has been around the business world for a long time. In some places, it was a synonym for safety -- figuring out how to reduce accidents and physical dangers. The topic got a new urgency after the 2008 financial crisis, when many companies realized they were exposed to huge financial risks of which they were unaware. Some companies were brought down by those risks.

And now the issue is coming to human resources.

Dictionary definitions of risk refer to danger, harm, or loss, and that may be why it has been associated with safety. The key aspect of risk, though, has to do with the possibility of harm.

What differentiates risk from uncertainty is that we can put some parameters around risk. We can estimate the chance of accidents or fires occurring even though such events are rare. Therefore we can estimate the costs we face from such risks. That's what underwriters do in creating insurance policies.

Uncertainty, in contrast, is something that is difficult to estimate, like trying to guess what certain presidential candidates will say when the microphone is on, which makes it hard to manage.

Human resource risk, then, is the chance that bad outcomes will occur in some aspect of HR. Those risks get attention when the bad outcomes threaten the overall organization and its goals. Then it becomes a business risk.

Employee turnover, an example of one type of HR risk, becomes a business risk when it could threaten the viability of the business. Business risk matters because it has the attention of everyone at the top of the organization.

A new report from the Conference Board, Managing Human Capital Risk: A Call for Partnership between Risk Management and Human Resources by Mary B. Young and Ellen S. Hexter, describes what companies are doing about managing human resource risk.

Among important human resource risks that affect business outcomes are class-action litigation and other compliance and regulatory issues, the loss of key employees and critical knowledge, talent-management gaps that make it difficult to get employees with needed skills, and individual employee behaviors that create liability issues (e.g., imprudent investment decisions or ethical scandals that damage brand value).  

Interestingly, the most important risk associated with human capital in a survey of HR and risk managers that was conducted as part of the study was a "shortage of critical skills within your company's workforce."

A 2007 study by the Economist Intelligence Unit reported that human capital risks were the most significant of all the risks facing business as measured by the possible consequences for business outcomes.

They are in the middle of the pack, according to the risk managers surveyed by the Conference Board -- no doubt because labor markets have cooled down in the interim period, reducing concerns about risks associated with turnover.

There is good news, however, in being on this list of risks in that the squeaky wheel gets the oil: Areas that are rated as having the potential for big risk are seen as more important, and the problems that cause those risks get more resources.

Nearly two-thirds (63 percent) of Conference Board respondents said that "the business" -- presumably not just HR -- participates in the assessment of human capital-related risks, and a small majority -- 52 percent -- say that the business has a formal process for assessing those risks.

That seems surprisingly high to me, and it could be because the sample here self-selected for interest in the topic.

The punch line of the study, at least for me, is that the enterprise-risk managers, who are the experts inside the organizations, ranked the ability to effectively manage these human capital risks 10th out of 11 possible types of business risks. That means we have a long way to go, but it also means there are opportunities to raise the profile of human resource issues by getting better at it.

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What does it mean to manage human capital risk effectively? We don't learn much from this study about how to do it, but it isn't hard to imagine what it might look like. The first step is to recognize what the risks are. That means more than recognizing HR problems. It means being able to tie business problems to them.

Human resource leaders have to take the lead and basically persuade others in the organization, especially the risk managers, as to what those business consequences are. That is not as easy as it may sound. Telling that story requires knowing the business well enough to identify the points of vulnerability.

Overall turnover, for example, may not put business goals at risk, but turnover of a few key individuals at a crucial point in the process might.

Once we understand the risks and the potential costs they represent, the management of that risk doesn't mean driving the probability of the bad outcome to zero. It means finding approaches that are cost-effective, where the value of risk reductions is worth the cost. That requires knowing one's function well, to know all the options for addressing a bad outcome.

For example, if the risk is that a key executive might leave, is it better to try to tie that executive in with stock options, to have a potential successor groomed to take her place, to rely on a search firm to find a replacement, or to buy insurance against the executive leaving?

How we think through those options systematically is a topic for next month.

Peter Cappelli is the George W. Taylor Professor of Management and director of the Center for Human Resources at The Wharton School. His latest book, with Bill Novelli, is Managing the Older Worker: How to Prepare for the New Organizational Order.

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