Monthly Archives: March 2016

HRM connection to Business Performance – Opening the black-box of HRM-P

HRM-Performance theory at learning video

In the following example I will illustrate the principle of human capital production function. Example analyze is from the case company of 400 employees (in Full-Time-Equivalent).  Each employee has the theoretical working time, which in this case is 2 000 hours per year. From this theoretical working time the auxiliary working time takes roughly 15%. Auxiliary working time (AX) includes vacation, absence, maternity leave, work orientation, staff training, HR-practices and HR-development.

When auxiliary working time is reduced from theoretical working time we get the time for work. During the time spend at work the intangible human assets have to be considered. Quality of Working Life (QWL) describes the utilizing degree of intangible human capital. If Quality of Working Life is at the level of 60%, then the effective working time share from the time for work is 60 % as well. Therefore the calculated effective working time is 85% times 0.6. Thus, 51% from theoretical working time is calculated to be effective.

Other working time can now be calculated and it is 85% – 51% = 34%. This other working time includes work planning, quality assurance, reporting, wasted working time due to errors, and fuss because poor motivation and engagement, and handling customer complaints.

With the effective working time the company makes the revenue. There is company specific coefficient (K), which determines how much revenue the company can make with one effective working hour. This example company makes 100 million dollars revenue. According the annual profit and loss calculation there are variable costs of 50 million dollars which is 50% from the revenue. Variable costs are materials and purchase services which are needed in making the revenue. Staff costs are 25 million dollars, and other fixed costs, like rents and licenses, are 15 million dollars. Finally, when all costs are reduced there will be operating profit, in this case 10 million dollars.


Figure. Human capital production function with example company initial data.

Management wants to improve company’s human capital productivity, and therefore invest some time to staff training and HR-practices. For simplicity, in this case we assume that this training and HR-practices time is already included at earlier year auxiliary working time, so the time for work remains the same.

When training and HR-practices are done properly, there will be positive effect at the Quality of Working Life. In practice we have recorded at case studies that 5 % improvement at QWL is possible and realistic objective at one year. In this case it means that the Quality of Working Life improves from 60 to 63%. Because QWL-index determines the Effective Working Time share, there will be equal 5% improvement at the Effective Working Time.

In growing business environment the company can utilize the K-factor in making more revenue. When revenue increases the variable costs are increased as well. Therefore $5M more revenue means in this case $2.5M dollars more variable costs. HR-development creates so called virtual talent capacity increase, which means that Human Resource capacity will increase without fixed costs raise. Improving intangible human assets effectively will enable more production capacity without fixed cost increase. Therefore only variable costs increase are reduced from Revenue and the rest $2.5M will improve the operating profit. As a conclusion, this company makes 6 250 dollars more profit for each employee.


Figure. Improving company productivity by HR-development.

Human capital production function mathematical equation goes like this:

Revenue = K x HR x TWh x (1-AX) x QWL
K = K-coefficient (Human Resource Business Ratio, $/h)
HR = human resource in full time equivalent (FTE)
TWh = theoretical yearly working time (h)
AX = auxiliary working time, this is the same as the time for work (%)
QWL = quality of working life index (%)

The operating profit, in financial terms Earnings before Interest, Taxes, Depreciation and Amortization, is revenue reduced by all costs.

The Human Resource Business Coefficient, shortly the K-factor, can be calculated from earlier year realization with following equation:


When case company data are inserted at the equation, there will be coefficient of 245.1 dollars per hour. This means that one effective working hour produce 245.1 dollars revenue. Company management can influence on K-factor by certain strategic innovations and my investing at product development and IC-technology. There is saying that management determines the profitability and leadership determines the productivity. At the Human Capital Production Function this means that management determines the K-factor and leadership the Quality of Working Life. Usually when K-factor is improved for example by strategic innovation there will be some reduce at the QWL, causing decline at organization productivity.

Determining the QWL-index is somewhat more complex than just measuring average results from the staff inquiry. This is due to the fact that those measured inquiry items have different scale and effect on performance. I will explain the validated scientific method for determining the QWL index later in coming blog post.

Marko Kesti
Dr. (admin.), M.Sc. (tech.)
Adjunct Professor, University of Lapland
+358 40 717 8006

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Kesti, M., Leinonen, J. and Syväjärvi, A. (2016). A Multidisciplinary Critical Approach to Measure and Analyze Human Capital Productivity. In Russ, M. (ed.). Quantitative Multidisciplinary Approaches in Human Capital and Asset Management (pp 1-317). Hershey, PA: IGI Global. (1-22). doi: 10.4018/978-1-4666-9652-5.

Kesti, M. and Syväjärvi, A. (2015) Human Capital Production Function in Strategic Management. Technology and Investment, 6, 12-21. doi: 10.4236/ti.2015.61002.

Kesti M. (2013). Human Capital Production Function, GSTF Journal on Business Review, Volume 3, Number 1, pages 22-32.