The Origins of the Human Capital Concept

by John Berry, Senior Consultant, Cutter Consortium

The business community concluded at some point that the words "employees," "workforce," and "personnel" were inadequate in describing workers' influence in shaping enterprise success. So a phrase was introduced into the lexicon of business and industry that more appropriately acknowledges the newfound importance of labor: "human capital."

It is believed that this concept came into existence in the 1950s and 1960s, when labor economists began to look at issues around workforce quality when businesses spent money on training and education [2]. Companies developed an expectation that improvements in workforce quality through training would improve productivity and earnings. Therefore, managers considered these expenditures investments. Thus, the concept of human capital emerged, despite the differences that exist between this kind of capital and the financial and physical variety.

Managers are well aware that generally accepted accounting principles (GAAP) fail to communicate the nuance in the value of employees to the organization and, therefore, cause missed opportunities in their proper management. However, there is an attitudinal shift in some companies that recognize that a much greater degree of sophistication is needed in the management of people as a critical factor of production in a company.

Several possible reasons loom for this attitudinal shift. Some argue that human capital is one of the few sources of competitive advantage left to companies. This is so because many traditional sources of advantage have evaporated. Consider the following [1]:

• Physical assets have lost much of their differentiating potential.

• The same has happened with financial capital. Today, it is abundant or at least easier to come by, when in earlier days, management struggled to acquire money needed to finance business objectives.

• Machines in and of themselves are not only useful but essential to the proper running of a company; in and of themselves, however, they do not confer any special advantage. The same is true for much, but not all, IT.

• Economies of scope and scale that huge multinationals have leveraged for advantage in the recent past are no longer differentiators. In many industries, bigness is an impediment as smaller competitors move more nimbly in a marketplace demanding agility and speed.

People, on the other hand, represent a vast wilderness for better management, and companies that succeed in this venture can land competitive advantages for two reasons: (1) human capital strategy is stable, persistent, and more enduring than other assets; and (2) it is not easily copied by competitors [1].

I welcome your comments on this issue of the Cutter Edge and encourage you to send your insights on the market in general to me at jberry@cutter.com.

-- John Berry, Senior Consultant, Cutter Consortium

References

1. Nalbantian, Haig R., Richard A. Guzzo, Dave Kieffer, and Jay Doherty. Play to Your Strengths: Managing Your Internal Labor Markets for Lasting Competitive Advantage. McGraw-Hill, 2003.

2. PriceWaterhouseCoopers. "Key Trends in Human Capital -- A Global Perspective 2006." March 2006, pp. 6, 16-17.