Knowledge Based Capital:

The Role of Investments in Management Practices

Kathryn L. Shaw December 3, 2012

A Policy Framework for Knowledge-Based Capital OECD Directorate for Science, Technology and Industry

and MIT Center for Digital Business

What are the questions?

1. How have firms’ management practices changed over

time?

2. How much do managerial innovations raise

productivity, and why?

3. What policies encourage new investments?

Four Key Points

2

Key Point 1: “HR Technology Shocks” have

been sizable.

3

Flexible

Job

Assignment

Careful

Hiring

HRM

System

Incentive

Pay or Rewards

Teamwork

Training

Empowerment

Information

Sharing

Defining “HR Technology Shocks” as Innovative People Management

Practices (or HR Practices):

There have been innovations or “HR Technology shocks” in all areas.

These are comparable to the “IT Technology Shocks” we know. 4

The first round of HR innovations were teamwork.

Figure 1: HRM Practices in Large Firms, Teams

0

10

20

30

40

50

60

70

80

90

100

Teams 20% or More

Employees in

Teams

Self-Managed

Teams

20% or More

in Self-

Managed

Teams

More than

20% Given

Team-building

Skills

1987

1990

1993

1996

1999

Original data: see also Lawler, Mohrman, and Benson (2001), Shaw (2003a,b), Lazear and Shaw (2007). 5

The first round also included incentive pay.

Figure 2: HRM Practices in Large Firms,

Incentive Pay

0

10

20

30

40

50

60

70

80

90

100

Individual

Incentives

More than

20% of

Employees

Have

Individual

Incentives

Gainsharing More than

20% of

Employees

Have

Gainsharing

Skill-based

Pay

More than

20% of

Employees

Have Skilled

Based Pay

1987

1990

1993

1996

1999

See footnote to Figure 1. 6

The use of Performance pay is still rising, but hard

to measure because it comes in so many forms. .

7

The adoption of High Performance Work Practices varies

across countries.

Source: Thomas Bauer, ESWC, 2000.

Table 2: Indices of Involvement in HPWOs

Country Work System Skill Incentive HPWO

Index Index Index Index

Austria 0.602 0.012 0.028 0.214

Belgium 0.553 0.008 0.03 0.197

Denmark 0.617 0.016 0.018 0.217

Finland 0.57 0.01 0.066 0.215

France 0.548 0.008 0.06 0.205

Germany 0.522 0.008 0.032 0.187

Greece 0.477 0.006 0.019 0.167

Ireland 0.649 0.012 0.025 0.228

Italy 0.497 0.006 0.034 0.179

Luxembourg 0.596 0.013 0.04 0.216

Netherlands 0.66 0.013 0.041 0.238

Spain 0.488 0.016 0.022 0.176

Portugal 0.487 0.011 0.003 0.167

Sweden 0.57 0.01 0.062 0.214

UK 0.675 0.017 0.064 0.252

EU-15 0.562 0.011 0.042 0.205

8

0.2

.4.6

.81

1.2

Density

1 2 3 4 5

0.2

.4.6

.81

1.2

Density

1 2 3 4 5

0.2

.4.6

.81

1.2

Density

1 2 3 4 5

0.2

.4.6

.81

1.2

Density

1 2 3 4 5

Bloom and Van Rennen (2007) MANAGEMENT SCORES

France n=137 n=157

n=290 n=154 UK US

Germany

Bloom and VanReenen: Management Score by

Country

3.07

3.14

3.31

3.35US

Germany

UK

Typical UK managers?

Bad manufacturing management - a UK tradition?

“Efficient management is the single most significant factor

in the American productivity advantage”

[Marshall Plan Anglo-American productivity mission, 1947]

France

Denmark: similar time series trends.

Source: Tor Eriksson

11

HR Innovations occurred within narrowly defined small industries

(Proportion of Valve-Making Plants with New HRM Practices, UK and US)

Figure 3

Proportion of Plants with New HRM Practices (UK v. US)

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1980 1985 1990 1995 2000

Training (basic or technical) (UK) Training (basic or technical) (US)

Teams (UK) Teams (US)

Incentive Pay or Special Bonus (UK) Incentive Pay or Special Bonus (US)

Sources: Bartel, Ichniowski, Shaw (QJE, 2007)

Bartel, Ichniowski, Shaw and Correa (2008) 12

HR Innovations occurred within narrowly defined small industries (Proportion

of Valve-Making Plants with Computer-Aided Production Technologies, UK

and US)

Figure 1

Proportion of Plants with Computer-Aided Production

Technologies (UK v. US)

0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1.00

1980 1985 1990 1995 2000

First CNC Machine (UK) Autmated Inspection Sensors (UK)

3-D CAD (UK) FMS (UK)

First CNC Machine (US) Autmated Inspection Sensors (US)

3-D CAD (US) FMS (US)

Source: Bartel, Ichniowski, Shaw (QJE, 2007)

Bartel, Ichniowski, Shaw and Correa (2008)

13

Today’s HR Innovations are not measured.

Case study evidence shows that HR innovations are ongoing :

• There are HR innovations or are not IT based. One consulting firm estimates

the number of large firms with “training universities” has risen from 400 in 1993

to 2,000 in 2001 to 3,700 in 2010. These are Hamburger University

(McDonald’s), to Starbucks University, to Lockheed Martin’s Center for

Leadership opened in 2009.

• Software firms are producing valuable new HR/IT software, or upgrading their

product/processes software to focus more on people management.

14

Management-focused software firms and HR consulting firms

continue to grow.

Source: CompuStat Operating Revenue Data (Nov. 2012) .

•The IT management-focused firms, of SAP and Oracle, keep growing. Part

of this growth is absorbing other firms.

•The aim of innovative firms is to make people management part of

operations. Many firms have yet to do this.

15

0

5000

10000

15000

20000

25000

30000

35000

40000

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

Mill

ion

s (U

SD)

Annual Operating RevenueSAP ORCL PSFT. ORCL+PSFT.

*Source: CompuStat, WRDS (Nov. 2012)*Represents standardized revenue listings.

0

200

400

600

800

1000

1200

1400

0

2000

4000

6000

8000

10000

12000

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

Mill

ion

s (U

SD)

MER

CER

Mill

ion

s (U

SD)

HEW

ITT

Annual Operating Revenue

HEWITT MERCER

*Source: CompuStat, WRDS (Nov. 2012)*Represents standardized revenue listings.

Firms offering specific People Management Software grew – often quite

dramatically – during this decade.

Success Factors creates online software for companies to conduct performance

evaluation of workers’ productivity.

16

0

50

100

150

200

250

300

350

0

500

1000

1500

2000

2500

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

Mill

ion

s (U

SD)

Succ

ess

Fact

ors

Mill

ion

s (U

SD)

Sale

sFo

rce

.Co

m

Annual Operating RevenueSALESFORCE SUCCESSFACTORS

*Source: CompuStat, WRDS (Nov. 2012)*Represents standardized revenue listings.

Source: CompuStat Operating Revenue Data (Nov. 2012) .

Monster.com maintains a large percent of in-house company hiring websites worldwide.

The growth of LinkedIn and Facebook are likely increasing the

quality of job matches. 17

0

200

400

600

800

1000

1200

1400

1600

19

95

1996

19

97

1998

19

99

2000

20

01

2002

2003

20

04

2005

20

06

2007

20

08

2009

20

10

2011

Mill

ions

(U

SD)

Annual Operating RevenueMWW

*Source: CompuStat, WRDS (Nov. 2012)*Represents standardized revenue listings.

Source: CompuStat Operating Revenue Data (Nov. 2012) .

These figures show the growth of oDesk, a firm that matches contract workers to

companies. “Companies contracted” are the number of companies that use oDesk matching software to hire IT employees.

“Professionals contracted” are the number of workers hired for a contract IT job through the oDesk software.

Source; Calculations by Chris Stanton using confidential data from oDesk.com.

18

Key Point 2: Insider econometric studies

show companies can achieve big gains

from innovative HR practices, and the

studies show why.

19

HR Practices

Incentives

(selection)

Productivity

Incentives

(behavioral)

Teams

Peer Effects

Information

Technology

Lazear (2000)

Ichniowski, Shaw,

Prennushi (1997)

Bartel, Ichniowski,

Shaw (2007)

Bandiera,

Barankay, Rasul

(2009)

Hamilton,

Nickerson,

Owan (2003)

Mas and

Moretti (2009)

20

Key Point 3: The potential upside gains from

people management innovations are big.

21

Star workers are far more productive than low-performers in virtually

every occupation. The difference is rising.

• Teachers productivity is measured by student test scores. Teacher quality

differences explain 7% of the variance of test scores across students.

Run similar productivity regressions for other occupations:

• Call center productivity: individual worker quality explains from 32% of

the variance in productivity across workers.

• Agricultural fruit pickers: individual worker quality explains about 13% of

the variance in productivity across workers.

• Automobile windshield installers: individual worker quality explains 72%

of the variance in productivity across workers.

Key Point 3: The potential upside gains from people

management innovations are big.

22

The variance of pay is higher for high-skilled workers.

Source:. These data are for professionals hired to work on an individual contract basis for firms, as hired through the

oDesk internet job matching site.

Source; Calculations by Chris Stanton using confidential data from oDesk.com.

23

The value of bosses

• In a technology based service job, replacing a

low quality boss with a high quality boss raises

the productivity of his team by as much as

adding one team member. (Lazear, Shaw, and

Stanton, 2012)

24

The rising variance of pay.

• Over the last 25 years, the variance of pay rose

markedly in West Germany. The rising variance is due to

(Card, Hoening, Kline, 2012):

– Rising variance of pay across establishments.

– Higher quality workers employed by higher quality

firms.

There are high upside gains for workers if they are

matched to the right firms and have high human capital.

25

Key Point 4: There are policies that

encourage the adoption of new HR

technologies.

26

Competition proxies Dependent variable: Management

Import penetration

(SIC-3 industry,

1995-1999)

0.144

(0.040)

0.156

(0.084)

1 - Lerner index1

(SIC-3 industry except

firm itself, 1995-1999)

1.515

(0.683)

1.318

(0.637)

# of competitors

(Firm level,

2004)

0.142

(0.051)

0.145

(0.049)

Full controls2,3 No Yes No Yes No Yes

Bloom and VanReenen (2007): Competition and Management

Practices (in manufacturing)

1 Lerner index = (operating profit – capital costs)/sales ≈ rents

2 Includes 108 SIC-3 industry, country, firm-size, public and interview noise

(analyst, time, date, and manager characteristic) controls, = 732 obs

3 S.E.s in ( ) below, robust to heteroskedasticity, clustered by country-industry

Policy Options

• Market forces are increasing the adoption of innovative HR

practices.

• Further options:

– Encourage investments in computerized hardware and software. IT and HR are

complements.

– Increase competition. Innovative HR practices are correlated with industry

rankings of competition and import penetration.

– Lower labor market regulations. Innovative HR practices are more likely when

workers and firms form better matches.

28

Four Key Points

1. The “HR Technology Shocks” have been sizable.

2. Insider econometric evidence shows companies have achieved big

gains from innovative HR practices.

3. The potential upside gains from human resource management

innovations are big.

4. There are policies that encourage the adoption of new HR

technologies.

The combination of better management practices and technology

should be able to drive productivity gains for years to come, with the

management/HR practices being the main bottleneck to further

productivity gains, in my mind.”

CEO, for a firm selling HR/IT products to companies.

29