The Human Capital Make vs. Buy Decision

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    A recently published paper titled, “The Effect of HRM Practices and R&D Investment on Worker Productivity,” examines the “hiring conundrum,” is it better to develop internal staff or hire skilled workers from outside the company?

    The results will probably give heartburn to almost any manager who has fought to get training dollars to develop staff skills.

    This write-up on [email protected], which profiles one of the paper’s contributors, Wharton management professor Benjamin Campbell, provides a fairly detailed breakdown of the issues in the research. Although the topic isn’t outsourcing-specific, I suspect the conclusions pertain as much to hiring talent through a service provider as hiring talent on a permanent basis.

    According to the write-up, Dr. Campbell and his co-authors believe they have “statistically demonstrated when companies should hire from outside and when they should develop from within.”

    Want an easy answer? Then let’s cut to the quick:

    If a firm is faced with significant marketplace and technological changes, Campbell argues that it is "better off hiring workers from the outside labor market who have the skills it needs, rather than investing in developing those skills inside the firm."

    Of course, the definition of “significant” is a variable here, as are the human resources skills and systems at the company’s disposal. Overall, those companies with huge R&D expenses tend to be the same ones constantly facing significant marketplace and tech changes. Those companies fare better when they hire the talent they need than develop internally.

    But it’s not that easy. The report makes clear that companies also need to retain key experienced workers, because experience is also of value to tech firms to complement the newly hired skills.

    The report describes the “four most common HRM systems that firms set up as a result of the make-buy and retention decisions.”

    On one end is the “bureaucratic [internal labor markets] (ILM”, in which the earnings of new hires are similar, since everybody enters employment at basically the same level. The firm experiences a low separation rate.

    Then there’s the “Performance-based ILM,” in which initial earnings for new hires reflect skill requirements. After a couple of years, workers are selected for faster career development, depending on their performance, and compete for favored positions and higher earnings. This model, the report suggests, produces higher worker productivity in firms that have low R&D.

    “Spot Market (External Labor Markets)” firms “identify workers’ talent and skills, and hire and pay accordingly.” Here, the separation rate is higher than in ILMs.

    Last, there’s the Spot Market with Rewards, in which firms hire and pay workers in spot markets, but the processes for hiring and monitoring of worker performance are imperfect. “Firms must include performance rewards and tournament or wage-efficiency type incentives; thus variance of earnings increases over tenure. Earnings growth is higher than in spot market. [The] separation rate is higher than in [a] spot market [because of] bad matches (both at hire and in rewards) end.”

    This latter approach produces higher worker productivity in firms with high R&D.

    The research also suggests that a “‘surprising’ number of firms do the exact opposite of what would be best for their circumstances.

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