Risk in the Real World
by Orlando D. Ashford | Human Resource Executive Online
Marsh & McLennan Cos.’ CHRO tells how a keen focus on the varieties of human capital risk — employee engagement, talent management and an aging workforce — are necessary for the success and survival of today’s HR executives, but especially important is the risk of CEO succession.
For many human resource executives, the shift to a global, knowledge-based economy has changed the game when it comes to identifying the real drivers of corporate success. We no longer view workers as interchangeable cogs in a matrix of assets, defined by the fixed capital of property, machines and their tangible products.
Instead, we recognize human capital as our primary asset, and we require a clear picture of how our workforces’ capabilities, performance and culture correlate to the bottom line. By now, we know that managing human capital risk — or any risk, for that matter — means identifying what is predictable and being able to respond quickly and effectively to what is unpredictable.
It’s a matter of having nimble structures and strategic vision, so we can cope with the threat or probability that an action or event will affect our organization’s ability to achieve our objectives. For HR leaders, that’s anything that threatens a firm’s ability to attract, develop and retain the key talent that drives business value.
Human capital, of course, is crucially different from structural capital in that it is owned by the individual — that is, individuals who can walk out the door and take their unique capital with them, unless their competencies, knowledge and skills are either tangibly recorded or somehow incorporated into an organization’s procedures and structures.
That’s a primary example of human capital risk — loss of key talent — but consider some others that often fly under the radar of human resource executive thinking:
1. Employee engagement.
The risk of insufficiently or poorly engaged employees can yield a direct hit to the bottom lines of organizations, taking a toll in terms of turnover, productivity and the company’s internal and external brands. Companies that fail to survey their human capital regularly, respond to substantial issues revealed by survey research and communicate effectively to the workforce are playing Russian roulette with their long-term success.
2. Hiring practices and talent management.
The risk of ineffective hiring practices, in which the right talent may be overlooked while the wrong talent takes its place, can be a major drain on corporate success. It can also have complicated sources — from outmoded or insufficient job descriptions to less-than-rigorous interviewing and background-screening processes.
Beyond hiring, talent-management failures — ranging from weak onboarding practices to poor training, limited development opportunities, stale performance management and a lack of mentoring — can compound the risk.
3. An aging workforce.
The risk of an aging workforce has become a global issue, as demographic realities in some of the most dynamic societies of the east and west — including those of the United States, Europe, China and India — point to an increasing dearth of younger workers to take the place of retiring employees whose experience and skill levels may be a key factor in driving business results.
As challenging and as variable as these risks can be, let’s also focus on a key human capital risk factor faced by virtually every organization: CEO succession.
Indeed, from personal experience as a human resource executive and in light of some recent research on the subject, I feel strongly that mitigating the risk posed by CEO-succession issues is a key component of sound HR strategy.
Inside CEO Succession
For example, the 2010 Survey on CEO Succession Planning, conducted by Stanford University, notes that the boards of most of the surveyed organizations agree that their single-most-important task is choosing the next CEO — but, on average, they spend only two hours per year on succession planning.
Furthermore, 69 percent of the 140 survey respondents think that a CEO successor needs to be “ready now,” but only 54 percent of them are grooming an executive for the position, while 39 percent say they have “zero” viable internal candidates.
And, not surprisingly, statistics tell us that only 50 percent of CEO successions are planned at all.
If we agree that CEO selection can have a profound impact on shareholder value, it’s clear that this is one of the most important — and least managed — of human capital risks.
Writing in a December 2008 Chief Executive magazine article entitled “The Cost of CEO Failures,” Nat Stoddard, chairman of Crenshaw Associates, a New York-based consulting firm specializing in career and transition management for senior executives, and Claire Wyckoff, a writer and editor who has held executive positions in both the corporate and nonprofit sectors, estimate the total cost of such failures — in terms of cash, inefficiencies and opportunities lost — is approximately $14 billion annually.
They write: “Leadership failure at the CEO level plays out in many directions: There are direct costs related to the individual’s compensation … [and] indirect costs, which result from errors in judgment, bad strategies, poor execution, opportunities foregone and the disruption to the organization caused by inconsistencies, lack of direction and, worst of all, loss of trust.”
Indeed, CEO succession has become a vital aspect of corporate governance — and thus a key focus of my role as chief human resource executive — at my organization, which is itself largely focused on both risk and human capital.
Marsh & McLennan Cos. Inc. is a global professional-services firm, the parent company of a number of the world’s leading risk experts and specialty consultants: risk and insurance services provider Marsh; risk and reinsurance intermediary Guy Carpenter; Mercer, the provider of HR consulting, investments and outsourcing services; and management consultancy Oliver Wyman. Together, we employ some 51,000 people worldwide, with annual revenues in excess of $10 billion.
As Marsh & McLennan has evolved over the decades, so has its commitment to a robust CEO succession plan, especially in the face of the inevitable challenges and changes that large, global companies must face.
As we began to understand the true costs of CEO turnover — in terms of hard costs, and the less quantifiable but very real impact “CEO churn” has on corporate culture and employee engagement — it became clear that we needed to take a more active approach to mitigating this key element of our human capital risk (indeed, through our work with clients, we had witnessed firsthand the negative impact of CEO and C-suite churn).
Since I joined the organization in 2008, one of our priorities has been to work closely with President and CEO Brian Duperreault and the board of directors to codify our approach to CEO succession.
From our perspective, nothing less than proactive management of CEO-succession risk would do, and so, through regular consultations with our CEO and board, the new Guidelines of Corporate Governance were adopted in September of 2010, spelling out the board’s belief that planning for CEO succession is one of its most important responsibilities.
The board is now required to approve and maintain a succession plan for the CEO, taking into account the recommendations of the directors and governance committee. This means that, at least annually, the CEO meets with the non-executive directors to discuss his or her potential successors and related issues. Afterward, the board may update its CEO succession plan as appropriate.
In addition, the CEO keeps in place, at all times, a confidential procedure for the timely and efficient transfer of his or her responsibilities in the event of an emergency or his or her sudden incapacitation or departure.
The CEO also periodically reviews with the non-executive directors the performance of other key members of the firm’s senior management, as well as any succession issues relating to those individuals. The board is responsible for determining that a satisfactory system is in place with regard to the education, development and orderly succession of senior management throughout the organization.
Risk Factors and HR’s Role
Given the direct and indirect correlation of CEO succession to shareholder value and costs, succession planning should be at the top of the enterprise-risk agenda. The role of the senior HR executive in this process is threefold, requiring:
1. A thorough, objective understanding of the company’s current CEO-succession plan; the CHRO should be analyzing and discussing the process with the CEO and, directly or indirectly, with the board of directors.
2. A clearly defined set of core CEO competencies against which to measure potential CEO candidates, and a one-, three- and five-year plan for developing internal talent. This is, of course, a basic tenet of talent management; however, the skills and accountabilities required of a CEO are vastly different than any other senior-leadership position at the firm.
3. HR’s championing of the notion of human capital risk — and CEO-succession planning, in particular — as fundamental to the overall enterprise-risk-management strategy of the firm.
The stakes are simply too high to treat CEO-succession planning as anything less than a strategic imperative.
As Marsh & McLennan Vice Chairman David Nadler, an expert on CEO succession and board planning, says, “A constant, collaborative process is crucial to ensuring a successful transition — and it must begin the first day a new CEO takes the helm.”
These prescriptions make such sense that we might expect them to exist within every large organization, yet it’s apparent that many companies do not face the risk of CEO succession with a proactive management approach.
And while managing CEO succession is something that must be driven from the top of any organization — there’s a distinct line of sight from the board to the C-suite, after all — not all examples of human capital risk management are as clearly defined.
Let’s consider another example of human capital risk, that of a technology manufacturing organization, a client of ours, that faced dramatic changes in its business environment.
In this case, the risk factors involved burgeoning competition from Asia and the seismic shift from the analog basis of the company’s products to digital technology.
Senior management recognized the need to change its organizational structure, so it created new units to sell new products and be more competitive with Asia and the world in general.
But management was slower to consider the workforce aspects of these changes — i.e., that a different business strategy required a different human capital strategy, especially considering that the future of its business was going to be digital, yet thousands of its workers still possessed only “analog” skills.
The company’s human capital risk was compounded by a compensation structure that tended to reward low performers in the older, analog lines of business.
And, not surprisingly, the company’s stock price had declined some 90 percent over a two-year period, as the market recognized the competitive disadvantage the company was at. Restoring the company to competitive health, therefore, required a keen focus on its human capital aspects.
The solution included an emphasis on compensation — analyzing reward practices, restructuring the compensation system to pay for performance and shifting the bulk of reward compensation to employees with proven positive impact on the company’s bottom line.
In hand with that, performance evaluations and metrics were changed to reflect the firm’s new business goals. This meant that, in addition to having to meet team goals, even low performers on high-performing teams had to meet individual goals as well. Finally, new training programs were instituted to migrate, wherever possible, employees with older, analog skills into digital skill sets.
The larger point of all this is that quantifying human capital risk and its business impact remains a challenge for many organizations, especially in an age of global business and increasing complexity.
It calls for a new mind-set, in which companies not only recognize the singular importance of human capital to business performance, but aggressively incorporate human capital risk as part of enterprise-risk management, correlating workforce performance with the bottom line through more rigorous data, analytics and metrics — such as internal-labor-market statistics and HR dashboards that enable management in new ways.
And, in the case of CEO succession, it’s vital that such a primary risk-management function be embedded in the corporate-governance structure itself.
For HR, the challenge is to make these correlations between human capital performance and business impact through education, effectiveness and evidence. It’s vital for HR leaders to carry the message that, in a global knowledge economy, human capital risk has emerged as one of the biggest potential threats to the value of the enterprise.
Just as the “war for talent” characterized previous decades of HR action, HR’s critical capability and value creator for the next decade will be managing the risks of global talent.
[About the Author: Orlando D. Ashford is senior vice president and chief HR and communications officer of New York-based Marsh and McLennan Cos. Inc. He serves as the lead employee advocate for 50,000 employees in more than 100 countries.]
Risk in the Real World