Return on Human Capital is Coming to the US

Costco is famous for treating its employees well and developing and promoting from within instead of hiring externally. Nearly 20 years ago, The New York Times ran a piece titled “How Costco Became the Anti-Wal-Mart.”

Some Wall Street analysts assert that Mr. Sinegal is overly generous not only to Costco’s customers but to its workers as well.

Costco’s average pay, for example, is $17 an hour, 42 percent higher than its fiercest rival, Sam’s Club. And Costco’s health plan makes those at many other retailers look Scroogish. One analyst, Bill Dreher of Deutsche Bank, complained last year that at Costco “it’s better to be an employee or a customer than a shareholder.”

The company focuses on not just employees but pleasing other key stakeholders—customers, suppliers, and communities alongside shareholders, and investors have certainly done well. Costco has significantly outperformed the S&P 500 over just about any time period you consider (annualized):

  • 1 year: 64.39% vs. 25.27%
  • 5 years: 28.61% vs. 13.29%
  • 10 years: 24.82 vs. 10.86%
  • Since that article was published (July 17, 2005): 19.0% vs. 10.3%

Not much has changed since then: wages for hourly employees at Costco are $29 vs. $17 at Walmart/Sam’s Club and $19 at BJ’s Wholesale, and voluntary turnover at Costco is extraordinarily low at just 10.3%. The average US employee has been there over 9 years, worldwide more than 13,500 employees have been there more than 25 years, and the entire C-suite has a tenure of at least 22 years.

Not surprisingly, treating their employees well is expensive—in their latest 10-K they say “Compensation and benefits for employees is our largest expense after the cost of merchandise and is carefully monitored.” However, they do not publicly report what that compensation and benefits number is. They are basically saying trust us, this strategy has worked well in the past and it will continue to work well in the future, and don’t worry about the details.

We actually have no idea if they are being too generous, because we don’t know how much it costs and where that expense is relative to peers because none of them disclose the cost of salary and benefits.

That’s all about to change though, as this week the Financial Accounting Standards Board (FASB) voted to require quarterly disclosure of personnel costs, among other things, in line with international accounting standards (ISSB). Though the rule won’t go into effect until 2027, we anticipate many companies will start adopting these accounting practices much quicker.

Right now, only 17 companies in the S&P 100 report a dollar figure for compensation and benefits expense, and 10 of them are in the finance sector. This is a nice start as we can (for example) compare what Visa is spending compared to Mastercard and see how their investments in people are paying off. Similar to looking at returns on assets and invested capital, stakeholders can calculate figures such as return on human capital (ROHC – operating income/personnel expenses), which was 3.60 for Visa vs. 2.33 for Mastercard last year.

There have been great strides made with companies disclosing much more granular information about the makeup of their workforce and human capital performance KPIs, but even with best-in-class companies that is only part of the equation if we don’t know how much it costs.

This was one of the four metrics the SEC Investor Advisory Committee recommended be included in updated Human Capital rules this past September. With the political uncertainty and the threat of lawsuits hanging over the SEC, we don’t anticipate any movement on the proposed rule this year.

However, as companies begin to disclose the costs of their workforce, stakeholders will have better ways of benchmarking and analyzing how effective companies are at managing their people.

Additionally, this metric will allow investors to evaluate whether companies’ investment in their employees is worth it, compare outcomes of companies with different HCM strategies, and benchmark between sectors/industries.

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