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What is Human Capital?

definition

Human capital is an intangible asset made up of knowledge, experience, habits, creativity, and personality that helps a person or a workforce produce economic value.

🤔 Understanding human capital

Most businesses require capital to operate. You can’t buy raw materials or machinery without money. Just as businesses need capital to operate, they need human capital. Without a workforce that understands the business processes, knows how to research and improve those processes, and is capable of working together toward a common goal, the business cannot operate. Human capital includes all of a workforce’s or a person’s training, skills, creativity, and other intangibles that make them productive.

example

An example of human capital is the knowledge that a workforce has acquired through systematic or on-the-job training that they have received. Take a person who knows nothing about fixing computers and give them a job at a computer repair shop. As they learn more about replacing hard drives, building computers, or cleaning electronics, they are building human capital in the form of knowledge and experience, allowing them to produce more value through their labor.

Takeaway

Human capital is like a trained chef in a kitchen…

You can give anyone access to a fully stocked kitchen with all the food and tools they need, but not everyone will be able to make a three-course meal. You need a chef with training, knowledge, and experience to turn that food and those tools into an exceptional culinary experience.

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What is human capital?
What are the types of human capital?
What factors affect human capital?
How is human capital developed?
What are human capital investments?
What are the benefits of investing in human capital development?
How is human capital calculated?

What is human capital?

Human capital is the value of all of the intangibles that people bring to a business or organization. Human capital is made up of things like education, job training, institutional knowledge, creativity, and relationships between people. These are things that can’t be easily purchased or built. Contrast this with traditional capital, which is composed of money, buildings, raw materials, equipment, and other physical things.

Investment in human capital management is as important as traditional capital management when it comes to the success of a business and economic growth. If you give a group of untrained people access to a car factory, they wouldn’t be able to produce vehicles because they don’t know how. If they had the knowledge of how to run the factory, which is a type of human capital, they would be able to operate the machinery and build cars.

Although human capital isn’t something that can be easily bought or traded, companies can invest in human capital and build it over time. Taking time to invest in employee training and fostering a company culture that retains proficient workers and encourages creativity can help promote human capital.

What are the types of human capital?

There are two broad types of human capital: general and firm-specific.

General human capital will be valuable to many different employers. Specific human capital applies only to one particular business.

Some examples of general human capital are education, creativity, diligence, leadership ability, and problem-solving skills. These are things that can be used in all sorts of situations, and any employer will value them similarly.

Examples of firm-specific human capital include organizational knowledge and training with proprietary tools and equipment. While these things increase the value of an employee to one employer, they do not make that employee more valuable to another business. Knowledge of how to use a tool that is only used at business A doesn’t matter if the employee wants to find a job at business B or business C.

What factors affect human capital?

The building of human capital is affected by the culture of a society. People are influenced by their culture from a young age and may not notice how it affects them and their views. A culture can instill values of individual creativity or valuing the group over the self. Depending on the goals of a business, either of these values can be valuable in employees.

A society’s educational system also affects human capital. Schools that emphasize STEM (Science, Technology, Engineering, and Math) education impart knowledge that will be useful to tech and manufacturing businesses. Educational systems that emphasize the arts will produce workers that are ready to work for companies that focus on more creative work, such as graphic design.

The culture of a business is a significant factor in determining the human capital of its employees. If a company emphasizes employee retention and builds camaraderie between employees, that can help it develop and retain human capital.

In truth, almost everything in a society affects the development of human capital, and what types of human capital are developed.

How is human capital developed?

Businesses can develop human capital through formal education, on-the-job training, incentive systems, and fostering a company culture that emphasizes certain traits.

Businesses that offer formal training build human capital by imparting knowledge and skills to their employees that make them more productive workers. This type of education also lets companies build firm-specific human capital in their employees, such as organizational knowledge. This can be augmented with on-the-job training, which can teach workers how to accomplish tasks more quickly and effectively.

A business’s incentive systems play a role in the development of human capital as well. Companies that punish workers for deviating from the protocol will reduce their employees’ creativity and can affect their problem-solving skills but may augment their ability to learn and follow business processes. Similarly, businesses that reward innovation build a more creative workforce.

Many factors outside of a business impact a business’ human capital. For example, businesses hire employees out of high school or college, taking advantage of the human capital that public and private education builds. They can also benefit from human capital investments of their competitors by hiring employees away from other businesses after they’ve received training and professional development.

What are human capital investments?

The simplest type of human capital investment is training. Giving workers training on more complicated tasks helps them become more productive as they take on work that they could not accomplish in the past. Teaching them new, more efficient processes can also allow them to perform more of the same work in the same amount of time.

Fostering a company culture that will build the type of human capital that you want is another human capital investment. This can be done by organizing team building activities or changing the business’s incentive structure.

Businesses can also invest in human capital by helping improve employees’ lives outside of their work. Examples of this include providing economic assistance to workers who are moving and offering language classes to workers who need to improve their language skills. By making other aspects of workers’ lives easier, businesses can help them focus on work while they’re on-the-clock.

What are the benefits of investing in human capital development?

Investing in human capital development can increase the value of a business and its ability to produce revenue and profits. A trained workforce can produce more goods and can deliver those goods at a faster rate.

Investing in human capital also improves worker happiness. The Society of Human Resource Management found that 86% of workers state that employee development programs are an important part of their employee satisfaction. Providing this training not only improves output but helps retain high-performing employees. These training programs can also help with recruiting new employees who want access to workplace training.

An additional benefit of investing in human capital is its potential for compound growth. As a company builds a strong culture, that culture will reinforce itself and become stronger. When a company educates its workers, those workers will help educate incoming workers, producing even more human capital. If a company encourages creative problem solving, employees will continuously find new ways to accomplishing tasks that can save the business money or increase output.

How is human capital calculated?

Calculating human capital is difficult because it is made up of intangibles, such as company culture and worker knowledge. You won’t see the value of human capital on a balance sheet, and it isn’t an asset that the company can sell for cash (at least not directly).

One rough method of thinking about human capital quantitatively is to measure a company’s return on investment (ROI) on its investment in human capital. To do this, divide total company profits by the amount invested in human capital development. This can at least give you a benchmark to measure your investment’s ROI versus other firms in your industry.

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