Want To Understand How Good A Workforce Is?
Human Capital Value Added (HCVA) reveals the true economic value each employee brings to a company—beyond their salary—and is a key metric for investors looking to gauge workforce effectiveness.
Over the past decade that I’ve worked in human capital consulting, I’ve become really interested in how workforce performance affects financial results for both public and private companies.
As a more regular part of No Work Left Behind, I’ll be sharing a little bit about the metrics and ratios that can help investors and managers understand how a company’s workforce is performing. This week, I’m focusing on Human Capital Value Added (HCVA), which shows the economic value each employee adds to a company, beyond just their salary.
At its core, HCVA isolates the value created by employees by subtracting operating costs (other than employee compensation) from revenue and dividing it by the total workforce. This creates a clear measure of the economic contribution each employee delivers to the bottom line.
While revenue-per-employee is a commonly used productivity metric, it lacks the nuance of HCVA. Revenue-per-employee simply divides total revenue by the number of employees, offering a general sense of productivity. However, it doesn’t account for the costs incurred to generate that revenue, particularly non-human capital expenses. HCVA, by contrast, adjusts for these factors, providing a more precise measure of the economic value employees generate above their compensation. For example, two companies with identical revenue-per-employee figures might have vastly different HCVA values if one operates with leaner non-HC expenses. This makes HCVA a more insightful tool for understanding workforce efficiency and effectiveness.
How to Calculate HCVA
Calculating HCVA involves a straightforward formula:
Identify Revenue: Begin with the total revenue generated by the company. This figure is often available in the company’s income statement.
Determine Operating Costs (Excluding Human Capital Costs): Extract operating costs from the income statement, excluding expenses directly tied to employee compensation (e.g., salaries, benefits, and payroll taxes). This separation ensures the focus remains on non-human capital costs, such as materials, utilities, and administrative overhead.
Calculate HC Costs Separately: Sum up all costs related to human capital, including wages, training, and benefits. While these are excluded from the numerator in the HCVA calculation, their inclusion elsewhere can provide additional insights into efficiency.
Obtain Workforce Numbers: Use the company’s reported total headcount. If headcount fluctuates significantly throughout the year, consider using an average to ensure accuracy.
Apply the Formula: Subtract the adjusted operating costs from revenue and divide the result by the total number of employees. The outcome represents the economic value each employee contributes beyond their compensation.
Example:
Imagine a company reports the following:
Total Revenue: $500 million
Operating Costs (excluding HC Costs): $350 million
Total Employees: 5,000
In this case, the company’s HCVA is $30,000, meaning each employee contributes $30,000 of economic value beyond their compensation.
Unlike metrics that broadly consider revenue or profitability, HCVA zeroes in on the workforce’s unique impact. By excluding human capital costs, it reveals how much value employees add relative to other operational inputs. This is particularly insightful in service-oriented industries where people—their skills, expertise, and creativity—are the primary drivers of success. For example, among two consulting firms with similar revenue and headcount, a higher HCVA suggests that one firm’s employees are either better utilized, more productive, or supported by more efficient operational structures. This can signal superior management practices or a competitive edge in workforce strategy.
A high HCVA indicates that employees are not just breaking even but are substantial contributors to economic value. It reflects efficient utilization of talent and suggests the company has optimized its workforce mix, streamlined operations, and fostered an environment where employees can thrive. On the flip side, a declining HCVA may signal overstaffing, poor workforce engagement, or operational inefficiencies. Rapid hiring without corresponding revenue growth could lead to a drop in HCVA, raising red flags for investors.
The context of HCVA varies significantly across sectors. Industries like technology and professional services, where human expertise is central, tend to exhibit higher HCVA ratios than capital-intensive industries such as manufacturing. Comparing HCVA across competitors within a sector helps investors identify leaders and laggards, offering insights into which companies most effectively leverage their human capital.
Firms in the top quartile of HCVA within their industries achieved average annualized stock returns 15% higher than their competitors.
Studies consistently show that companies with higher HCVA outperform their peers in total shareholder return (TSR). For example, a 2023 PwC study found that firms in the top quartile of HCVA within their industries achieved average annualized stock returns 15% higher than their competitors. High HCVA can signal future earnings potential and margin expansion, as companies with well-optimized human capital strategies sustain profitability even during downturns or wage inflation. Firms like Adobe and Microsoft, known for high HCVA, demonstrated strong margin resilience and outperformance during market turbulence in 2020. Similarly, Costco’s high HCVA, driven by its commitment to employee welfare, contributed to consistent profitability and stock stability during the COVID-19 pandemic.
Quantitative comparisons further emphasize HCVA’s significance. Companies with HCVA growth above 10% year-over-year reported earnings growth rates 1.5x higher than their peers. Over a five-year horizon, firms in the top decile of HCVA outperformed by 20% in TSR. High HCVA companies are often better equipped to weather economic shocks due to better employee engagement, lower turnover, and operational efficiency.
Integrating HCVA into valuation models can provide a forward-looking perspective. Rising HCVA may justify higher growth rates or EBITDA multiples, reflecting the effective use of human capital. For investors, HCVA offers a way to pinpoint companies that excel in harnessing their workforce’s potential, ensuring revenue growth isn’t solely driven by headcount expansion but also by enhancing the value derived from each employee.
Mergers and acquisitions also present opportunities to leverage HCVA. Acquirers can assess the target’s workforce efficiency and potential synergies, identifying opportunities to enhance efficiency post-acquisition. For instance, if the target has a significantly lower HCVA than the acquirer, it may indicate room for operational improvements.
A rough idea of HCVA for industry illustration purposes:
Sector variance highlights the wide application of HCVA. Technology companies like Apple and Google boast HCVA figures exceeding $1 million per employee, reflecting the high value generated by knowledge workers. Traditional manufacturing firms often report HCVA in the range of $50,000 to $100,000. A Deloitte study found that organizations investing at least 1.5% of revenue in employee development see, on average, a 20% higher HCVA compared to peers. Turnover rates also play a role: Companies with turnover below 10% reported HCVA figures nearly 15% higher than those with turnover exceeding 20%.
While HCVA is a powerful tool, it is not without limitations. The metric relies on accurate and granular data, which may not always be available, especially in smaller or less transparent companies. Additionally, HCVA should be used in conjunction with qualitative assessments, as factors like workforce morale, cultural alignment, and employee engagement—critical to long-term success—may not be immediately apparent from the numbers alone.
That said, I like the idea of using HCVA as a tool for gauging the effectiveness of a company’s leadership to draw efficiency and performance out of its workforce. Over time, a more productive organization should outperform its competitors.
What a weird and wonderful world,
