C H A P T E R T E N
Human Resources Costs
Top management often asks important cost and investment questions. How much does the employee assistance program cost our organization'? Are we spending inore o n benefits than our competitors'? Are our payroll costs as a per- cent of operating expense higher than others in the industry'! How much has our new employee empowerment program cost us in the past two years'? Finding answers to these questions may not be easy in many organizations. Cost moni- toring and cost tracking have not always been a top priority among human resources, and consequently, cost data has not always been available or accurate.
The cost of maintaining an organization's human resources is increasing. As top executives stretch resources to fund H R programs, it is imperative that they know where the money is spent and for what purposes. This chapter explores the rationale for identifying, monitoring, and managing costs a s well as specific methods and techniques for classifying, allocating, and reporting those costs.
Although the methods must be tailored to the organization, several general prin- ciples and guidelines can be useful for any organization.
DEVELOPING C O S T S
Three broad categories of HR costs must be developed, monitored, and man- aged in the organization. The first group involves the direct cost of maintaining employees, and the largest component of this goes to direct salaries and benefits of employees. Unless these staffing costs are monitored and managed closely. the organization can become bloated. inefficient. and uncompetitive. Another impor-
H U M A N RESOURCES COSTS 2 3 tant cost is the cost of maintaining the HR function in the organization. This includes the direct cost for all the HR programs as well as HR department expense. HR department staffs have increased, and consequently, the costs of HR programs have increased. The use of outside services has grown dramatically.
resulting in increased cost. Finally. the third category is the cost savings that result from the implementation of many HR programs. These impact costs are the costs that are usually not tracked or monitored by HR, but often can represent the most important data to track.
Figure 10-1 shows the relationship of these cost items. The HR department costs are those costs that are associated with the programs and are applied to all employees. The employees represent the largest cost item in most organizations.
Program Impact Cost Savings
F I G U R E 1 0 - 1 . DYNAMICS O F H R COSTS
The implementation of H R programs should realize a cost savings, usually called an impact cost. For example, the HR department may initiate a program on absen- teeism prevention. The expenditures associated with the program are HR depart- ment costs which must be tracked and monitored. The program would have an impact on the overall employee cost because lower absenteeism would lower the payroll costs. Some organizations hire additional employees to cover excessive absenteeism. The amount of cost saved is calculated and reported as an impact cost, the cost of the reduced absenteeism. These three cost categories are covered in more detail in this chapter, although additional information on impact costs is covered in the next chapter.
Rationale for Developing Costs
Tracking and managing HR costs are important to an organization's success.
There are at least nine important reasons for monitoring HR costs. Collectively, they provide a convincing argument for developing a cost tracking system or tak- ing a renewed look at improving the present HR costing system. For some orga- nizations, all of these factors may not be applicable.
To determine the total HR expenditures. Every organization should know the approximate total HR expenditures. Although this appears to be funda- mental. many HR managers still do not know what the organization spends
252 HUMAN RESOURCE CONTRIBUTION
on HR. Total expenditures include costs such as salaries, employee benefits, facilities expense, and other general overhead. A few organizations calculate this expenditure and make comparisons with other organizations, although comparisons are difficult to achieve because of the different bases for cost calculations. Some organizations calculate HR costs in a variety of ways such as unit labor costs, and they set targets for cost performance. An effec- tive cost data collection system enables an organization to calculate the magnitude of total expenditures and helps top management answer two important questions:
W How much does the organization spend on its human resources?
W How much skoukd it spend on its human resources?
The answers to both questions are important.
W To determine the relative cost of each individual HR program. Thc H R department should know which programs are the most cost effective. Mon- itoring costs by program allows the HR staff to evaluate the relative cost of a program and determine how costs change. If a program costs more than in previous time periods. i t might be appropriate to re-evaluate its impact and overall success. It may be useful to compare specific components of costs to similar internal programs or programs in other organizations. The cost per participant for one program could be compared to the cost per participant for a similar program. Large differences may signal a problem, although there may be legitimate reasons for the differences. For example. it may be help- ful to know why recruiting a new programmer costs $2,000 more than recruiting a sales representative. Also, costs associated with items such as program development, program implementation, or other categories could be compared with other programs in the organization and may lead to the development of cost standards.
To predict future program costs. Historical costs provide a foundation for predicting future costs. Cost data from a previous program help develop standardized data to use in estimating the cost of new or proposed programs.
Sophisticated cost models provide the capacity to estimate or predict costs with a reasonable accuracy.
To calculate benefits versus costs for a specific program. Probably the most increasingly common and significant reason for collecting costs is to prepare data to use in a benefits-versus-costs comparison for a program.
Cost data takes on the same importance as the data that determines the eco- nomic benefits of a program. This approach views HR expenditures as investments, with a potential return.
H U M A N R E S O U R C E S C O S T S 253 To improve the efficiency of the HR department. Controlling costs is iiii
important management function. and H R should not be exempted froin this responsibility. H R managers must be able to monitor and control the costs o f developing and delivering program. Most H R departments have monthly bud- gets that project costs by various accounts and. i n some cases. by project or program. Cost reports that show how the depnnment is doing are tools to spot problem areas and take corrective action when necessary. Froni ;I practical mnniigement issue, the accumulation of cost data is ;I necessity. Some costs serve as efficiency nieasures for H R departments and ultimately help to evaluate the H R function. The cost per hire, cost per EAP participant. health care cost per employee, and cost per grievance are examples of measures that can serve as indices for tracking efficiency of various HR functions.
To evaluate alternatives to a proposed H R program. Realistic cost data provides management with data to estimate the cost of a proposed program.
The data can be used to evaluate the cost effectiveness of alternatives to ;I particular program. Consider an example involving the decision of whether to use an external eniployment agency or the internal recruiting capability.
A complete analysis of recruiting costs will reveal precisely the cost per hire for internal efforts. This cost can be compared with cost froin agencies o r other external sources. Of course. quality and policy decisions may enter thc process and may affect the ultimate decision. However. i t is important to obtain direct cost comparison and then factor i n the qualitative factors.
To plan and budget for next year’s operations. Another reason for track- ing HR costs is to prepare for next year’s operating budget. The operating budget usually includes all H R costs such as salaries and benefits. although those expenses may be charged to other departments. Collecting current costs is usually the first step in developing a budget. In recent years. the bud- geting process in many organizations has been more closely scrutinized and become more sophisticated. The days o f adding ;I percentage increase to last year’s budget is. for the most part. gone. H R departnicnts are asked to exani- ine their activities and prograins carefully when preparing the budget. A few departinents operate on a zero-brised budget i n which each activity must be justified during the budgeting process. This type of budget assumes no car- ryover expenses i n t o the next year based 0 1 1 the previoub year‘s activity. This process can be used ;IS the basis for setting priorities for next year’s efforts.
Proposed projects and their costs are reviewed by top nianagement. and their approval of specific projects lets the HR department focus on the most important efforts fo r the coming year.
To develop a marginal cast pricing system. H R expenditures are inipor.-
tant when de\,rloping nxirginnl cost pricing str;itegie\. I n orcler tor manage-
254 H U M A N R E S O U R C E C O N T R I B U T I O N
ment to consider a HR program involving new organizational strategies, they must be apprised of the cost for each strategy. Several organizations developed standard cost data that can easily fit into expansion plans, changes in procedures or policies, and changes in products or services. For example, calculating the costs of employee benefits as a percent of payroll costs is a standard cost item that allows organizations to quickly factor the investment in human resources into business decisions.
To integrate data into the human resource information systems. An HR department should collect cost data as part of existing databases for the human resources information system. These databases provide information on the contribution of human resource practices to the profitability of the organization.
In conclusion, these nine factors provide convincing rationale for collecting cost data. They clearly show why these data are necessary and why HR depart- ments should collect and monitor HR costs. However, in many organizations this type of data is either inaccurate or not available.'
General Considerations
Whether an organization is developing a new cost system or modifying an existing one, several factors about costs are worth considering. This helpful advice to HR professionals includes:
Collect costs even if they are not utilized in HR measurement and evalu- ation. Too often, an HR department will neglect to accurately collect and report costs because they will not be used directly in evaluation. Cost data rep- resent useful management tools and are necessary in an effective organization.
W Costs may not be precise. An accurate assessment of all costs associated with a program is almost impossible. With so many hidden costs and cost allocation schemes, it is difficult to develop a completely accurate picture of costs. A lack of precision should not discourage staff members from attempt- ing to monitor and collect costs. A reasonably accurate cost estimate is better than no cost estimate. If used in measuring the contribution. the costs are probably more accurate as the economic value of program benefits.
Use a practical approach in building a system. The HR department must define the purposes for developing a cost system before it is designed.
Tradeoffs in accuracy versus the feasibility of maintaining the system will be necessary. Also, the organization should not be burdened with additional paperwork, calculations, and other analyses that can become unproductive and may not add to the precision of cost data. A system is needed that is sim-
H U M A N R E S O U R C E S COSTS 255 ple yet accurate, easy to administer, and easy to understand by those who use it. Ifpossible. i t should be a part of current systems in use. Some account categories will be different. but the manner of collecting, compiling. storing.
and reporting data should be consistent with established practices within the organization.
Use caution when reporting cost data. Taken out of context and without proper explanations. cost data might be frightening 10 top management and disastrous for an HR manager. An example of the misuse of cost data comes from the U.S. General Accounting Office (GAO). The GAO examined the training provided to auditors of the Internal Revenue Service and conclud- ed that training cost the federal government as much as $6.5 billion in lost revenue.? The GAO calculated this figure by estimating the revenue that would have been brought in by experienced auditors who were taken off the job to train new employees. The GAO investigated the costs of training 1,103 new employees the IRS hired for five offices in the U.S. It figured that the lost revenue was $840 million from those offices. It arrived at the $6.5 billion figure by multiplying its figures to account for the 7,300 people the IRS hired nationwide during that time.
These costs, which were reported to the press, had one major tlaw. The GAO did not bother to calculate the long-term benefits of providing training to new employees who presumably could go back to the job and bring in even more revenue. They examined only the cost side of the ledger and not the benefits. The GAO report concluded that it is essential for the IRS to explore alternatives to its present training programs. The moral of this story:
If the costs of a program are reported, the benefits should be reported even if they are estimates; otherwise, a program can appear prohibitively expensive.
The effort to set up a cost system is extensive. Most organizations use a for- mal cost accounting system designed to accumulate cost by department, sec- tion, product line, and other categories. This type of system is usually adequate for collecting much of the cost data necessary for developing HR program costs. However, if a system is not in place. the effort to develop one is signifi- cant. and will usually involve input from the finance and accounting sections.
This substantial effort must be fully recognized at the beginning of the project.
EMPLOYEE C O S T S
Few organizations would survive without tracking direct employee costs, reported either as payroll, average unit labor costs, or total costs of employees.
This critical data must be used regularly to manage the organization efficiently.
Fully loaded costs of maintaining employees should be reported in meaningful
256 H U M A N R E S O U R C E C O N T R I B U T I O N
ways in order to make comparisons with other organizations, particularly those in the same industry. This section briefly outlines these major cost elements.
Direct Compensation
The largest portion of these costs are the wages and salaries paid directly to employees. They are tracked in every organization. Direct compensation also includes various incentives and bonuses, as well as deferred compensation. All of these costs must be included in the total direct payroll cost. Salaries and wages are usually available directly from the payroll system, while some bonuses.
incentives, and possibly deferred compensation may be stored on other systems.
Benefits
Few items connected with overall employee costs have increased as dramatical- ly as the cost of employee benefits. Benefit costs as a percent of payroll have risen steadily since their inception in the early 1920s and now hover around 40 percent.' Recently efforts have been made to contain health care and rising retirement plan costs. Still. these costs are significant and must be monitored, controlled. and min- aged. An important challenge to H R professionals is to determine exactly what should go into the cost component. Some benetits such as health plans, retirement plans. life insurance programs. and holidays. are clearly included. Other benefits are more difficult to lump in the total. Free parking. subsidized cafeteria. educa- tional progrunis, and credit union are sometimes omitted from benefit calculations, but should be included in total benefit costs. Also. to have an accurate estimate of the fully loaded costs, the cost of administering the benefits must be included.
These costs include the salaries and direct and indirect expenses of the benefits staff as well as costs for outside services related to benefits administration.
Several measures are available to compare benefit costs. The United States Chamber of Commerce, the International Foundation of Employee Benefits. and the Society of Human Resource Management (all based in the Washington, D.C.
area) offer national surveys of employee benefit costs. Also. in many areas, region- al surveys are available. One or more of these surveys can be used as a comparison so that the internal cost figure can be adjusted t o match the external number.
Direct and Indirect Support
In addition to salaries and benefits. direct expenses related to staffing are sig- nificant and should be included in the total employee cost. These include items such as the cost of maintaining an office o r workstation for the employee. the cost o f equipment such as tclephonc. calculator. computcr, fax niachinc. and niisccl-
H U M A N R E S O U R C E S C O S T S 257 laneous costs such as travel. direct office supplies. and office support. These fig- ures are easily tabulated but. unfortunately, are not monitored in a total amount in many organizations.
Indirect costs related to employment are also significant. and include the costs for support staff. division or corporate overhead. as well as cost of employee I:icilitics such a s break rooms and cafeterias. These costs should be calculated or estimated and included a s a percent of direct compensation to develop the fully I oaded cost b .
H R P R O G R A M C O S T S
There are two basic ways HR department costs can be classified and moni- tored. One is a cost accounting classification that contains expenditures such as labor, materials, supplies and travel. The other classification is by total program cost broken down into categories of the H R process such as program develop- ment. implementation, and monitoring. An effective system will monitor costs by account categories, but it will also include a method for accumulating costs by the H R process category. Many systems stop short of this second step. While the first grouping can sufficiently determine the total cost of an important item such as travel and consulting expenses, i t does not provide for program accountability or indicate areas in which costs might be excessive by relative comparisons of pro- grams. For example, the implementation costs of a productivity improvement program in one division should be compared t o the same cost category in anoth- er division.
Developing a Classification System
When developing an HR classification system. the following steps ensure that the system provides the information needed:
W Define which costs will be collected. A system of cost classithition may be subject to several interpretations. All relevant costs must be identified. Cost accounts should be clearly defined to reduce possible errors made in misclas- sifying costs. There should be little doubt where an item should be charged (i.e.. oftice supplies or duplication). Also. the various process categories should be clearly defined so that items can be properly grouped into those accounts.
H Assign the responsibility for developing the system. Because the imple- mentation of a costing system involves the input of others. responsibilities of each individual or department should be detailed to reduce delays in implemctitatioii and errors in the final product.