OBSERVER: Over our working lives, many things that were the stuff of science fiction have become reality - we now carry mobile communication devices, our businesses use machines to do work once done by people and we have easy access to up-to-date information on every conceivable subject.

However, the most fundamental of the "science fiction" staples remains a dream - the ability to see into the future

In the business world of 2002, we still rely heavily on the accountant's historical analysis of how our businesses have performed and marketing still spends a lot of time unpicking the experience of which campaigns actually succeeded. Would it not be more helpful if we had a better measure of how the business will perform in future?

Over the last three years, Watson Wyatt Worldwide has been carrying out a study called the Human Capital Index (HCI), which has identified significant correlations between effective people management and financial performance. The first study, carried out in North America in 1999, found that improvements in key human resources practices were associated with an increase of 30 per cent in market value among the participant companies.

The study was extended to Europe in 2000, when more than 250 responses were received from leading employers, including a sizeable portion of Europe's largest corporations.

The results of the European study identified 19 HR practices, covering five key dimensions, that were associated with a 26 per cent increase in market value.

Watson Wyatt defined increase in market value by matching the collected data on HR practices to objective financial measures of a company's value, such as total returns to shareholders and Tobins Q.

Tobins Q is the ratio of market value to the replacement value of physical assets.

It captures how the market values a business's intangible assets or intellectual capital ie. human, structural and customer capital.

The HCI proved that there is a significant correlation between the HR strategies being pursued by a company and the value of its intellectual capital and return to shareholders. This connection was independently appraised by academics and found to be statistically reliable.

Correlation is one thing - cause and effect is quite another. The unanswered question was whether effective people management drives positive financial results or whether successful companies simply have more resources to invest in HR programmes.

Seeking an answer to this question, Watson Wyatt carried out further research in 2001 and increased the HCI database to cover over 750 leading global companies.

This created the possibility of a longitudinal study of the relationship between the measure of Human Capital (the HCI) and financial performance.

To determine which way the relationship between HR practices and financial performance runs, Watson Wyatt compared two different correlations using HCI scores and financial data for 51 companies that participated in both the 1999 and 2001 HCI studies.

The first correlation was the degree to which human capital management is a "leading" indicator of future financial success and the second was the degree to which good human capital practices are simply a function of financial success, in other words a "lagging" indicator.

This analysis clearly demonstrated that HR practices are not only associated with business outcomes - they also create them. There was clear evidence supporting the view that the quality of people management is a leading indicator of financial performance for businesses.

It also confirmed superior human capital management as a leading, rather than lagging, indicator of improved financial performance.

Further analysis was carried out breaking the organisations into three categories as follows:

Organisations with low HCI scores averaged a 21 per cent five-year return;

Organisations with medium scores averaged 39 per cent;

Organisations with high HCI scores returned 64 per cent over five years.

In terms of its application, the HCI has developed into an effective business tool for senior management.

The age-old question of how HR contributes to the bottom line can now be addressed and terms such as return on capital employed can be used in connection with HR spend.

A proper business case can be put forward for HR initiatives, which will allow senior management to appraise them properly and the HR function to position itself as a serious business partner.

The data collected by Watson Wyatt is compelling and the HCI has proved a robust indicator of value in both rising and falling stock markets.

To strengthen both the results and the longitudinal study, Watson Wyatt are continuing to build the HCI database by extending their study to Asia Pacific and rolling out a second European study, which aims to include 200 Irish companies.

Mary Southwell is a Human Capital Consultant with Watson Wyatt