Is there any Dividend in Human Capital?

Transformation of Asset to Capital

Have you ever wonder what is the material cost of the last purchase? Whether it is a pair
of jean or shoe, it is common that the material cost is less than 20% or in some less than
10% of the price you paid.

Have you overpaid something? Probably no, welcome to the knowledge economy! A
declining material cost and escalating service cost economy!

It is an economy where the main value driver is our intellectual property. The ability for
anyone to explore the competitive cost advantage globally, enable many to enjoy its cost
leadership as a strategy. This common strategy has diminished effect, and differentiation
through the intellectual ability is the next right strategy to adopt.

It is in this economy that the growth in service sector overtaking the material sector as the
main driving force to emphasize on human resources. It is also a natural transition from
labour, personnel, human resources, human resource development to human capital being
evolved over the years, even the subject matter (People) remains the same!

It is also interesting to note that many organization regards its employee as the greatest
asset; it is by this term, I suppose human resources is being conferred with the “asset”
status. Asset in business is associated with income or wealth creation capabilities. It is
therefore fair to relate the employee in the same context as asset.

We have upgraded it further with reference like human capital that deals with the
ownership aspect in an organization. Capital in business is associated with the risk and
reward in ownership. It is a very interesting paradigm shift of the employee from a
participatory role to effective ownership role in the business. Common reference like
‘human capital shareholder’ emerges from this evolution.

This evolution in human capital drawn our attention; as it is very common today that the
intangible assets like trademark, branding or intellectual property deals a lot with people
than any material or processes. There are many companies today that the intangible assets
support most of its market capitalization in comparison to its value in tangible assets.

Human capital definitely adds considerable weight to this valuation process. Although the
process of evaluating human capital is varied and not perfect today, one cannot deny its
existence and influence in the business!

Human Capital & Wage System

In the development of the flexible wage system in Singapore, there was no specific
reference to human capital; however in its formulation there is considerable parallel in
concept to human capital where it advocates the flexibility of the wage system that agile
to the economic condition of the business.

Page 1 of 7
Is there any Dividend in Human Capital?

In the flexible wage system application, it provided for the downward wage adjustment to
cope with the economic downturn, operates in a similar manner like the draw down of the
capital reserve to sustain the business in hope for recovery.

During the SARS crisis, the flexible wage system was put to test. The drawback then was
the quantum provided for the downward adjustment was merely too low to make an
impact on its effect; and there was also no defined terms on how it can be applied. Instead
most employers resolved to measures like extended unpaid leave to lighten the payroll
cost to withstand the sudden dip in business caused by the crisis. Thankfully SARS was a
temporary crisis and its recovery was less than a year.

As we agree that human capital is key to any organization. The challenge next is how can
the organizational behavior, strategic planning or management be reasonably related with
definite term that is easily understood by everyone?

One of my experiences to address this challenge is to link the wage cost, which is an
integral part of human capital to Key Performance Indicators (KPI) that used in the
organization to determine its correlation.

For hospitality industry, KPI like Earning Before Interest, Tax, Depreciation and
Amortization (EBITDA) and Labour Covers are some of the very good indicators that
can be considered to adopt in its application to human capital.

a. EBITDA –

It is suitable to the industry as almost every employee is capable of affecting the

EBITDA to a certain extent. However other matter (within the ITDA) like gearing
that has an immediate impact to the interest expense is often beyond the influence
of every employee; in some cases even the management company has no
influence over it! It is therefore a fair indicator that covers as complete on the
operational aspect of its business other than the ITDA.

It is also an indicator that used to assess the “fitness” of an organization to

determine its profitability threshold.

b. Labour Covers –

It is the ratio of Gross Operating Revenue over Labour Cost. It can also be
regarded as the multiplier to the revenue creation by the employee (labour cost).
The higher the labour cover, the higher is the revenue creation capabilities of its
employee.

It is also an indicator that used to assess the “balance” of the wage cost in relation
to revenue.

Page 2 of 7
Is there any Dividend in Human Capital?

It is the next KPI to be considered only when the KPI on EBITDA had first been
qualified. What it means is if the profitability has reached the threshold, it tests
further whether the wage cost “imbalance” worsens the profitability situation or
the wage cost is not a major contributing factor to the worsening profitability.

The linkages of the wage system to the two KPIs above are by no mean exhaustive; it is
merely an illustration on the potential development in the research of human capital. In
this illustration, you may find that KPI applied leans toward financial consideration.

In the consideration of an appropriate KPI and its inter correlation with your business,
there are many other KPI like balance scorecard, EVA, employee performance rating,
employee survey or customer quality audit that can also serve as effective linkage to the
human capital.

In the selection, one has also to consider factors like consistency, ease of interpretation,
subjectivity judgment, employee buy in, confidentiality, timeliness, statistical bias,
distortion due to policy change, accuracy and other that will impact the long term
implementation of the system.

Application of Wage System in Human Capital

One of the earlier applications of wage system closely related to human capital is
employee share option plan (ESOP).

ESOP is essentially an allocation of equity to the employee at a discounted rate; it allows

the employee to participate in the capital appreciation of the trading share of the company
as well as the dividend distribution from its reserve. It engages employee as the
shareholder of the company to seek loyalty and participation beyond the salary they
receive.

It is also common to note many successful startup businesses made its pioneering
employees millionaire that would otherwise impossible with the single compensation of a
paycheck.

However ESOP involves equity participation that some employees may not subscribe and
therefore not be able to benefit from it. Besides ESOP also carries the same inherent risk
with any equity that there is no guarantee benefit that the share will trade above the offer
price or guarantee dividend payment.

In the development of the current model used in the later illustration, it was based on the
primary consideration on the flexibility of wage cost that can response to any sudden
change in the financial result of the business. It was one developed along the time horizon
in its application where the wage cost can be adjusted to the substantial changes in
financial result. It provides for short term remedy in a downturn and long term reward in
a recovery.

Page 3 of 7
Is there any Dividend in Human Capital?

In comparison to equity capital, the application operates similar to equity where the
reserve will be drawn to defence in a crisis and dividend will be distributed to reward the
shareholder under ordinary business condition.

a. Monthly Variable Cost (MVC)

In any crisis situation, timeliness and urgency is key to survival. The MVC that
forms part of the regular wage cost is drawn in a similar manner as equity reserve
to fight with the crisis in the interest to save job instead of loss job that otherwise
would happen had it not been implemented. Its primary objective is to outlast the
crisis as long as it takes and promotes teamwork among the employees.

For example, if the regular wage of an employee is $1,000 per month and MVC is
10%; in a crisis situation, the MVC can be drawn down from the wage cost up to
a maximum of $100 (ie 10%) to keep the business operating cost low. The
affected employee will be paid $900 instead of $1,000 under such a situation.

The MVC operates in tandem with the KPI and its adjustment is monthly
provided the criteria set is met. It is also time specific where the adjustment can
be lagged behind the result of the KPI, as to how far its lag depend very much on
the severity of the crisis and the consideration of other factors that were operating.

In the context of equity capital, reserve was accumulated over the profitable years
and a company will only draw down from its reserve to counter against any loss.
For MVC, the accumulation of the MVC ties with the length of service and rate of
pay, the differences with equity reserve are

a. Virtual Reserve
MVC is a virtual reserve to draw when the qualifying criteria are met.
There is no accumulation required to set aside from the monthly pay
package to build the reserve like equity capital.

b. No effect
Under ordinary business condition, MVC causes no loss to the employee,
as the monthly payment would be the same except that it forms a separate
component of the total pay package.

b. Annual Variable Cost (AVC)

In a normal or exceptional good operating condition, reward must be provided to
recognize the employee contribution to the business. It is especially so in a
recovery situation.

The AVC that is based on the regular wage is paid on a escalating rate subject to a
maximum set, in a similar manner like dividend, to reward the employees.

For example, if the regular wage of an employee is $1,000 per month and AVC is

Page 4 of 7
Is there any Dividend in Human Capital?

1.5 month. The AVC payment would be $1,500 (ie 1.5 month).
AVC also operates in tandem with the KPI under the varying operating result. It is
an annual payment that serves to reward the upside of the business gain.

In its application, it operates same like a dividend payment from equity capital.
Through the operation of virtual human capital reserve, it integrates very neatly
with MVC. The higher the MVC setting, the higher would be the AVC expected
to reciprocate by the employer to reward the employee through its participation in
the system.

c. Illustration

The following illustrates each point on the chart

a. Minimum Monthly EBITDA

MVC will be activated when it reaches the minimum monthly EBITDA set and the
other qualifying KPI of labour cover is also met. The adjustment of MVC
commences as long as the qualifying criteria stipulating the critical business
condition prevail.

b. Lower Annual EBITDA

It set the lower annual EBITDA limit when the employee will qualify for AVC
payment.

c. Target Annual EBITDA

Page 5 of 7
Is there any Dividend in Human Capital?

It set the target annual EBITDA when the target AVC will be paid.

d. Upper Annual EBITDA

It set the upper annual EBITDA limit when AVC will be capped at the maximum.

e. Maximum MVC
It set the maximum MVC to draw from the human capital reserve.

f. Target AVC
It set the target AVC when target annual EBITDA is met. It forms the bf gradient
line when variable AVC from 0 to target AVC is determined.

g. Upper AVC
It set the upper AVC limit when the upper annual EBITDA is met. It forms the fg
gradient line when variable from target AVC to upper AVC is determined.

Guiding Principles of Flexible Wage System in Human Capital

The illustrated system is and may perceive it as rigid in its consideration for application.

The primary learning we achieved was it set the expectation in an open and transparent
manner to bridge good industrial relationship. Besides it also provides an effective
remedy and reward system that was lacking prior to its implementation.

As with any system, there would be imperfection and the challenge to validate it with the
dynamic business environment and conditions. It is along with this overriding
consideration that it must be guided by principles rather than mechanical application in
order to serve us well.

In the development of the above system, lengthy deliberation was dedicated to set the
guiding principles prior to any consideration on the setting of KPI and threshold. The
guiding principles are

1. To be responsive to various situational needs in crisis

2. To be fair and equitable to all parties
3. To promote tripartite relationship and team cohesiveness
4. To be as complete as feasible in coverage in definitive terms and less specific
in quantifiable terms to avoid misunderstanding
5. To function as effective remedy to withstand the crisis and extend operational
functionality to outlast the crisis
6. It is time relevant. The wage adjustment must take place in a timely and
responsive fashion in accordance with agreed-upon trigger points lest the
flexibility in the new wage structure be negated by time-consuming negotiations;
7. To have common application of key performance indicators in every situation
8. All parties mutually consider its application in a critical financial situation at
the property level, to avert any imminent loss of jobs.

Page 6 of 7
Is there any Dividend in Human Capital?

These guiding principles set the values, boundaries, definitions and considerations with
the primary objective to structure a flexible wage system that can response to the
dynamic in business, social and economic environment.

Next Phase of Human Capital Development

We had commenced the journey to link human capital with wage system to structure one
that we learnt from the last valuable experience in SARS. In its operation, we would
definitely face with certain imperfection and need further refinement along its way.

It is my humble belief that we can take it along with other comparable applications to
develop it to the next higher level where it serves us as an effective tool with no lesser
importance than the utilization of other resources in business.

It is common today that 80% of a nation GDP is contributed by service, and wage cost is
undoubtedly a single largest component cost in the service. Human capital definitely has
an increasing role to optimize its output, to differentiate and provide continue growth to
any organization.

I look forward to the first annual general meeting with the human capital shareholder!

Page 7 of 7