National Data Centre Capacity Building training course, 2012 at the CTBTO, Vienna, Austria (Source: Wikimedia Commons)
Ideas for Leaders #464

Training Knowledge Workers Pays Off for SMEs

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Key Concept

While previous studies have researched the return of investment in training for corporations, much of this research focused on manufacturing employees. New research based in India focuses specifically on knowledge companies in the SME sector, and shows that the return on training is not only significant, but also increases with the size of the firm.

Idea Summary

Given the pace of technological change, universities have difficulty teaching students the applied knowledge they will need in the workplace. The gap between education and real-world knowledge is only exacerbated the longer the employee has been out of college. In knowledge firms, therefore, the onus of maintaining a workforce equipped with the latest knowledge and skills falls on the firms’ training functions.

In order to help knowledge companies determine the value of training, two researchers from the Indian School of Business, joined by colleagues from the University of Minnesota and the University of Connecticut, undertook a study focused on the return on investment in training in Indian information technology services firms.

India accounts for 50% of information technology services in the world. The Indian information technology services industry, however, is uniquely structured. Just five of the largest firms represent 50% of revenues in the industry, with the remaining 50% divided by a large number small to medium enterprises (SMEs).

The training costs of the top five companies, who maintain fully staffed and fully equipped in-house training facilities, were radically different from the training functions of the SMEs, who depended in large part on outside contractors. Putting aside the five megafirms at the top of the industry, whose cost structures were not representative of most companies, the researchers focused on these SMEs. Eventually, they would focus on three years of data from a representative set of 32 firms.

One of the first conclusions pulled from the data is that return on employees is not linear. In the early stages of a new business, adding employees translates into more revenues and more profits. However, the equation soon changes as the company scales up. Although more employees lead to more revenues, the profits decrease because of the increasing cost per employee associated with recruiting and managing a larger workforce. There are thus diseconomies of scale related to hiring more people.

Using econometric measures to calculate the return on training per employee reveals that revenues increase with spending on training. On average, $1 of training leads to an increase in revenues of $4.67 per employee. Investment in training thus mitigates the diseconomies of scale associated with hiring more workers.

The data revealed that this mitigating effect is even greater with larger firms, since the return on training increases with the size of the workforce. A representative company with 200 employees (about the 25th percentile in terms of size) showed a return on training of $1.82 per $1.00 spent. In contrast, a company with more than 500 employees received a return on of $4.67 while a firm with 1600 (in the 95th percentile of size) benefitted from an astounding $13.91 return on training for every $1.00 spent!

Business Application

Despite what many executives believe, every new employee does not, in knowledge industries, generate revenues that cover the cost of hiring and managing that employee.

However, the more you spend on training knowledge workers, the more return you will receive — and the closer to achieving the linear return on employees (that is, a 100% return through increased revenues on the cost of each new employee). The largest firms will find the path to a linear return the easiest as the return on training is significantly larger.

The derivations in the research shows that the training budget should always be less that one-half of the total HR budget, and the wage budget should always be correspondingly more than half of the total HR budget. However, the data also shows that the allocation of the budget between training and wages increases in favor of training as the total budget allocated to HR (wages and training) increases.

The bottom line: training your knowledge workers is not inevitable; it is also profitable. The more employees you have, the better return you are receiving on your training expenditures.

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Authors

Institutions

Source

Idea conceived

  • September 2014

Idea posted

  • December 2014

DOI number

10.13007/464

Subject

Real Time Analytics