Vous êtes sur la page 1sur 10

JOURNAL OF BUSINESS AND PSYCHOLOGY

Volume 14, No. 1, Fall 1999

ECONOMIC UTILITY OF TRAINING


PROGRAMS
Assa Birati
Bar-Ilan University

Aharon Tziner
Netanya Academic College

ABSTRACT: In economic terms, training projects represent a major outlay for


many corporations. In spite of the growing need to evaluate the cost-effective-
ness of training programs in organizations, such cost-benefit analyses are rarely
conducted. Moreover, the extant conceptual approaches and mathematical for-
mulas typically used for this purpose produce inaccurate estimates of the eco-
nomic utility of training programs for organizations.
An amended approach to this procedure is elaborated and its benefits dem-
onstrated. The proposed model regards any potential plan as an investment proj-
ect that should be evaluated in a similar way to the assessment of other invest-
ment options. Thus, it is recommended that a training project be considered only
if its potential real, post-tax rate of return exceeds the real, post-tax cost of
capital to the firm, subject to the unique features of investment in human capi-
tal. This process could improve the potential financial benefits to the firm, from
investment in training.

Global competition, technological advances, demographic shifts and


diversity in the work place are all exerting increasing pressure on orga-
nizations to improve the skills of their work force. In economic terms,
training represents a major outlay for American organizations (Car-
nevale, Gainer & Villet, 1990; Cascio, 1989, 1992; Noe, 1986), with an
estimated annual cost of 100 billion dollars in 1996 (Saks, Haccoun &
Laxer, 1996). However, only few studies have dealt with evaluating the
effectiveness of training (i.e., the level of success of a training program)

This paper was written when the second author was a visiting professor with the
School of Business Administration at Bar-Ilan University. Both authors have contributed
equally to this paper.
Address correspondence to Assa Birati, School of Business Management, Bar-Ilan
University, 52900 Ramat-Gan, Israel; email: birata@ashur.cc.biu.ac.il.

155 C 1999 Human Sciences Press, Inc.


156 JOURNAL OF BUSINESS AND PSYCHOLOGY

in a rigorous scientific manner (Tracey, Tannenbaum & Kavangh, 1995;


Tziner, Haccoun & Kadish, 1991).
Surprisingly enough, those methods that do attempt to determine
training effectiveness rely heavily on employee responses (Brinkerhoff,
1989; Tannebaum & Yukl, 1992). As Tannebaum and Yukl (1992) state,
reactions cannot serve as the sole criterion of effectiveness. Kraiger, Ford
and Salas (1993) suggest that learning may be evidenced by changes in
cognitive, affective, and skill capacities, so that an examination of training
effectiveness should target changes in all these areas.
Cognitive-based outcomes of the training process entail a meaning-
ful change in: (1) the level of declarative knowledge; (2) the acquisition
of meaningful structures for organizing knowledge; and (3) the develop-
ment of superior cognitive strategies. Affectively-based learning out-
comes refer to changes in stated attitudes and in motivation in the de-
sired direction, such as the trainee recognizing the value of the acquired
knowledge/skills, attraction toward the object of learning, increased self-
efficacy, and/or willingness to exert effort in order to implement the ac-
quired knowledge/skills (assuming these outcomes are attributable to
the training process). Skill-based outcomes involve the extent and auto-
maticity with which trained skills, attitudes and behaviors are exhibited
after training has been completed. Thus, if evaluation is conducted with
respect to cognitive, affective and skill-based outcomes, it is likely to
produce a more accurate estimate of whether training objectives have
been achieved (i.e., the training program has proved effective).
Instrumental as this approach may be to assessing training effective-
ness, it still does not tackle the issue of the cost-effectiveness of training
programs. Although there is a growing awareness of the importance of this
consideration in promoting sound management of human resources, sys-
tematic cost-benefit studies of training are hard to find. This may very well
be attributable to the lack of a sound conceptual and computational frame-
work.
Although Cohen (1985) addressed this problem, the conceptual model
and ensuing computational formula he advanced are unfortunately defi-
cient. In fact, his model contains only an incomplete measure of training
cost-effectiveness, incorporating solely: (1) the productive value of em-
ployee training less earnings paid after training; (2) the cost of training;
and (3) the length of time the trainee will continue working for the com-
pany after training is completed.
In addition, Cohen (1985) also ignores the following important con-
siderations:

(a) Relative profitability, i.e., the return on the training project as


compared with the cost of capital (money) to the employers. As
the cost of resources may differ substantially from one firm to
ASSA BIRATI AND AHARON TZINER 157

the next, the relative desirability of each training program must


be matched with the cost of money to the investing firm. Thus,
only projects whose rate of return exceeds the cost of money can
be considered profitable, and should be further evaluated,
(b) The tangible investment in training on the part of the employer,
including the following potential inflows that may reduce the
actual cost to the firm:
(1) participation in the training costs by employees, not re-
flected in their future (reduced) remunerations;
(2) participation in the training costs by an external authority
(local or federal government, unions, etc.);
(3) income tax considerations. It should be noted that training
cost is usually a tax deductible item. However, tax exempt
firms, such as not-for profit organizations or firms with
accumulated tax losses, will not enjoy this benefit.

Furthermore, in terms of the employer's benefit, Cohen's formula


ignores the following non-tangible variables which should also be an-
alyzed, estimated and quantified:

(a) the improvement in the cognitive, affective and skill capacities


of the trained employees after training, less the increase in the
workers' remuneration resulting from training. Cohen merely
equates benefit with the "productive value of the worker after
training . . .";
(b) the fact that employers known to invest in training may be more
attractive to future potential recruitees than non-training em-
ployers;
(c) the probable rise in morale in a training-oriented firm, as em-
ployees perceive such an employer to be committed to their ca-
reer enhancement (Staw, 1995).

Another important contribution to the measurement of the financial


desirability of employee training was made by Mathieu and Leonard, Jr.
(1987), who offer an advanced approach to the estimation of gains from
training. However, while their study capitalizes the expected future cash
flows from training, it does not compare the internal rate of return from
training with the cost of capital to the firm. Likewise, as indicated in our
presentation below, it does not take into consideration the relative prof-
itability of the investment in training as compared with the firm's other
investment opportunities.
These drawbacks have been addressed in our present approach.
However, before elaborating on its specifics, we would first like to con-
158 JOURNAL OF BUSINESS AND PSYCHOLOGY

sider the principle behind it, that is, the notion of capital budgeting pro-
cedure and its bearing upon training cost-effectiveness.

TRAINING PROGRAMS IN TERMS OF


THE CAPITAL BUDGET PROCESS

As mentioned above, training has long been recognized as a major


cost factor for many firms, requiring substantial resources. This being
the case, we might expect training to be treated like other investment
plans and be incorporated into the capital budget process of the com-
pany. The adoption of the capital budgeting procedure for the evaluation
of investment in training should apply to most economic entities, includ-
ing not-for profit organizations.1 This paper, however, deals only with
profit-seeking firms. Moreover, the evaluation of training projects should
consider the special features related to investment in human capital. In
particular, it should include an in-depth investigation into the specific risk
of investing in employees, as compared to most other types of investments.
For example, investment in other assets (whether tangible on non-tang-
ible) includes the transfer of ownership to the acquiring firm with a
relatively high degree of certainty that the firm will be able to utilize these
assets for a predetermined number of years. A trained employee, on the
other hand, may quit, so that the firm may lose some or all of its investment
in his or her training. This sort of uncertainty must be carefully evaluated,
and, insofar as possible, the expected loss should be deducted from the
projected benefits from the training program.
Additionally, in capital budgeting procedures, the first requirement
from any given potential investment is that it produces a real, post-tax
rate of return that will exceed the real post-tax cost of capital to the firm
at the time of the advanced stage of the investment planning. Assuming
that the firm is able to estimate its real, post-tax cost of capital, mea-
surement of the real, post-tax rate of return on training programs is
therefore the first step in evaluating their desirability.
To put this in formal terms, the principal requirement that must be
satisfied before considering any investment decision (and as we recom-
1
Levy and Sarnat (1994, p. 23) define the capital budgeting process as a multi-faceted
activity which includes:
The formation and articulation of long-term goals; searching for new and profitable
uses of investment funds; the preparation of engineering, marketing and financial
forecasts; the preparation of appropriation and control budget and the integration of
these budgets in the firm's information system; the evaluation of alternative projects;
and the post-audit of the performance of past projects.
The most important variables in the process relate to the estimation of the relative
profitability of the projects as compared with the cost of money and the other potential
investments available to the firm. These variables are considered in our paper.
ASSA BIRATI AND AHARON TZINER 159

mend, should training constitute an investment) is not merely the esti-


mated post-tax real rate of return on the potential investment (R), but
rather a comparison between the size of R and the estimated real post-
tax cost of capital (K). The result should also satisfy the condition that
R — K > 0 (not only in absolute terms but also relative to the firm's
other investment projects).
Assuming that the firm knows the value of K, we start our model
with the estimation of R.

A CONCEPTUAL MODEL FOR COMPUTING THE COST-


EFFECTIVENESS OF TRAINING

Rate of Return on Training Programs


In order to evaluate the rate of return on training investments, it is
advisable to estimate the cash outflows (for the investment) and cash
inflows (benefits provided by the investment) associated with the poten-
tial projects.
(a) Cash Outflows (C). Cohen (1985) lists the following as employers'
tangible cost of training:

1. Training costs
2. Earnings paid during training less positive production during
training (Table 1, p. 328).

We will denote Cohen's total costs factor (i.e., 1 + 2) by the letter H.


We suggest that the computation also include the following deduc-
tions (where relevant): (a) any cash participation by employees that is
not reflected in their reduced future wages (P), and; (b) training sub-
sidies offered to the employers by local or central government and/or
unions (E).
Another factor that should be considered in evaluating both the
costs and benefits of training relates to the tax standing of the entity.
This may have a crucial impact on the desirability of the planned invest-
ment. Effective income tax rates may differ by type of firm, by country,
and by specific location (as the income tax rates of different states and
cities are not identical). Furthermore, the tax standing for start-up firms
and entities with accumulated tax losses will most certainly be lower than
the rates imposed on profitable organizations. This factor may indeed be
critical for the final decision of whether or not to implement a given project.
Thus, assuming that the effective tax rates may differ among firms or even
for the same firm in different years, (Tt) will be the effective income-tax
rate for any particular firm in period t.
160 JOURNAL OF BUSINESS AND PSYCHOLOGY

We further assume that the net training costs (C), are made in cash
at the initial stage of the program.
The after-tax cash outflow for the cost of training is therefore:

(b) Cash Inflows From Training Benefits (B). Going back to Cohen's (1985)
formula, we find the following benefits to the employer from training:

1. Productive value of the worker after training, less earnings paid


after training.
2. Higher retention of workers in company (Table 1, p. 328).

In our opinion, Cohen's "productive value of the worker after train-


ing" does not represent the true benefit from training. For this variable
we suggest instead the economic value of the improvement in cognitive,
affective and skill-based capacities (Kraiger et al., 1993) as a result of
training, less the increased salary in the future of the worker as a result
of the newly-acquired capacities.
Therefore, to estimate the potential future cash inflow from training
(brought to present values), we propose the following list of benefits.2

1. The estimated economic value of the improvement in workers'


capacities attributable to training, less the increased remunera-
tion to the worker in each future period resulting from the train-
ing process (St);
2. As in Cohen's approach, the estimated cash savings from "higher
retention" (or lower voluntary turnover) of workers in firms that
provide training programs (Nt);
3. The estimated cash savings from improved performance by non-
trained employees resulting from improved morale in a training-
oriented entity (Mt).

From these benefits we must deduct the expected loss in the poten-
tial benefits incurred by trained employees quitting.
Thus the calculation of benefits from training produces (Bt), the es-
timated total annual real cash inflows resulting from a training pro-
gram:

2
This method recently developed by Tziner and Birati (1996) for assessing direct and
indirect costs of turnover may be adapted and used for the purpose of estimating the
economic value of these components.
ASSA BIRATI AND AHARON TZINER 161

where Bt is the present value of the cash inflow from the benefits in
period t, and St, Nt and Mt are the estimated future cash inflows result-
ing from improved performance, higher retention rate, and improved
morale, in period t, respectively.

THE INTERNAL RATE OF RETURN ON TRAINING INVESTMENTS

To arrive at the estimated rate of return on training investment, the


following calculation is needed.
We start with the assumption that all the post-tax estimated variables
were converted to their present value and are in real, inflation-adjusted
terms. R can then be calculated from equation (3), as follows:

where C and Bt are derived from equations (1) and (2), respectively, and
t is the period of the benefits.

DECIDING WHETHER TO APPROVE


A PROPOSED TRAINING PROGRAM

Once we have found the estimated internal rate of return on the


training program (R), it can be compared to the known estimate of the
cost of capital to the firm (K) to determine whether the project is profita-
ble.3 If R > K, this means that the real, post-tax return on the invest-
ment exceeds the real, post-tax cost of capital, resulting in a net real
profit to the entity.
If this requirement is met, then the relative profitability of the
training project should also be compared with all of the firm's other
investment options, an important requirement in the capital budgeting
process in general. As a matter of course, in any given period of time
the total resources available to the firm for investment are limited.
Thus, even profitable investment opportunities must be ranked accord-
ing to their relative potential contribution to the goals of the entity.
Only the highest ranked projects with acceptable operational risks
should then be approved, and this goes for training as well.
3
One way to deal with the risk associated with the projects is to adjust K, so that the
project with the higher risk factor will be compared with the higher cost of capital factor.
162 JOURNAL OF BUSINESS AND PSYCHOLOGY

CONCLUSIONS

In the current global economy, firms face increasingly fierce compe-


tition, compelling them more than ever before to continuously review
and enhance their level of efficiency. Common sense dictates that reduc-
ing operational costs while increasing cash flow is an effective business
strategy in response to threats to economic survival. This strategy has
led industrial firms to invest substantial resources and efforts in cutting
the costs of raw materials and production equipment, as well as in im-
proving and streamlining all spheres of company activities. While cost-
benefit analysis has commonly been employed to assess the economic
utility of these measures, cost-benefit studies on human resource devel-
opment programs are rare. Indeed, the measurement of costs and bene-
fits in this context is quite difficult (Lawler, Anderson & Buckles, 1995,
p. 677).
Employee training constitutes a major method for improving the
skills and knowledge of the work force. Nevertheless, in past decades
the literature on training has been dominated primarily by studies on
the effectiveness of various methods for shaping skills, attitudes and
behavior at work, and the enhancement of transfer of training to the
work milieu (Gist, Stevens & Bavetla, 1991; Saks, Haccoun & Laxer,
1996; Tziner, Haccoun & Kadish, 1991). Substantial attention has also
been focused on devising procedures and conceptual models for evaluat-
ing the effectiveness of training programs (Barling, Weber & Kelloway,
1996; Mathieu, Martineau & Tannenbaum, 1993; Saks, 1995; Tannen-
baum & Yukl, 1992). The analysis of the costs and benefits associated
with a training program (i.e., economic utility or efficiency analysis)
however, has received little attention. Mathieu and Cohen (1995), and
Leonard (1987) and Schmidt, Hunter and Pearlman (1982) are among
the few researchers who have addressed this issue.
Unfortunately, the approaches they have taken do not provide com-
prehensive estimation of training cost-effectiveness, as considerations of
paramount importance have not been taken into account. For instance,
the evaluation of the cash flows associated with a training program in
relation to the financial posture of the company has not been incorpo-
rated into their models of cost-benefit analysis. As we have shown here,
a particular time-adjusted comparison of cash outflow/cash inflow could
be more profitable for a company with a solid financial standing than for
one in a weaker financial position, as reflected in their cost of capital.
The approach elaborated in this paper, therefore, is likely to produce, in
a convenient form, more accurate information about the costs, benefits,
and profitability of various training programs and training methods. Or-
ganizational decision makers could use such information to better allo-
ASSA BIRATI AND AHARON TZINER 163

cate the limited financial resources available for investment and to im-
prove their training programs.
Similarly, our model could be used to determine for which employ-
ees, for what type of job, or in response to what kind of training needs, a
training program should be instituted, based on analysis of the economic
utility ensuing from the various alternatives. Likewise, decisions as to
what type of training methods and procedures to opt for could emanate
from the application of the present cost-benefit analysis approach. Hope-
fully, as the conceptual model we have advanced here provides a more
accurate estimate of the economic utility of training, it will become a
standard tool in the hands of organizational decision makers who must
determine whether to launch, or to discontinue, a particular training
program.
Nevertheless, we suggest that future researchers attempt to further
refine the estimation procedures of cash flow components resulting from
training. Also, empirical investigations should be conducted to examine
the extent to which the prospective advantages of our present approach
actually materialize in practice.

REFERENCES

Barling, J., Kelloway, E.K., & Weber, T. (1966). Effects of transformational leadership
training on attitudinal and financial outcomes: A field experiment. Journal of Applied
Psychology, 81, 827-832.
Brinkerhoff, R.O., (1989). Evaluating training programs in business and industry. San
Francisco: Jossey-Bass.
Cascio, W.F. (1989). Using utility analysis to assess training outcomes. In I.L. Goldstein
(Ed.), Training and development in organizations (pp. 63-88). San Francisco: Jossey-

Cascio, W. F. (1992). Managing human resources: Productivity, quality of work of profits.


New York: McGraw-Hill.
Carnevale, A.P., Gainer, L.J., & Villet, J. (1990). Training in America: The organization
and strategic role of training. San Francisco: Jossey-Bass.
Cohen, S.I. (1985). A cost-benefit analysis of industrial training. Economics of Education
Review, 4, 327-339.
Gist, M.E., Stevens, C.K., & Bavetta, A.G. (1991). Effects of self-efficacy and post-training
intervention on the acquisition and maintenance of complex interpersonal skills. Per-
sonnel Psychology, 44, 837-861.
Kraiger, K., Ford, J.K., & Salas, E. (1993). Application of cognitive, skill-based, and affec-
tive theories of learning outcomes to new methods of training evaluation. Journal of
Applied Psychology, 78, 311-328.
Lawler, J.J., Anderson, R.W., & Buckles, R.J. (1995). Human resource management and
organizational effectiveness. In G.R. Ferris, S.D. Rosen, & D.T. Barnum (Eds.), Hand-
book of human resource management. Cambridge, MA: Black well, pp. 630-649.
Levy, H., & Sarnat, M. (1994). Capital investment and financial decisions, 5th ed., En-
glewood Cliffs, NJ: Prentice-Hall.
Mathieu, J.E. & Leonard Jr., R.L. (1987). Applying utility concepts to a training program
in supervisory skills: A time based approach. Academy of Management Journal, 30,
316-335.
164 JOURNAL OF BUSINESS AND PSYCHOLOGY

Mathieu, J.E., Martineau, J.W., & Tannebaum, S.I. (1993). Individual and situational in-
fluences on the development of self-efficacy: Implications for training effectiveness.
Personnel Psychology, 46, 125-147.
Mincer, J. (1989). Job training: Costs, returns, and wage profiles. National Bureau of Eco-
nomic Research Working Paper, No. 3208, December 1989.
Noe, R.A. (1986). Trainees' attributes: Neglected influences on training effectiveness.
Academy of Management Review, 11, 736-749.
Saks, A.M. (1995). Longitudinal field investigation of the moderating and mediating ef-
fects of self-efficacy on the relationship between training and newcomer adjustment.
Journal of Applied Psychology, 80, 211-225.
Saks, A.M., Haccoun, R., & Laxer, D. (1996). Transfer training: A comparison of self-
management and relapse prevention interventions. Administrative Sciences Associa-
tion of Canada (ASAC) Proceedings, 17, 81-91.
Schmidt, F.L., Hunter, J.E., & Pearlman, K. (1982). Assessing the economic impact of per-
sonnel programs on work productivity. Personnel Psychology, 35, 333-347.
Staw, B.M. (1995). Psychological dimensions of organizational behavior (2nd ed.). En-
glewood Cliffs, NJ: Prentice Hall.
Tannenbaum, S.I., & Yukl, G. (1992). Training and development in work organizations.
Annual Review of Psychology, 43, 399-441.
Tracey, J.B., Tannenbaum, S.I., & Kavangh, M.J. (1995). Applying trained skills on the
job: The importance of the work environment. Journal of Applied Psychology, 80, 239-
252.
Tziner, A., & Birati, A. (1996). Assessing employee turnover costs: A revised approach.
Human Resource Management Review, 6, 113-122.
Tziner, A., Haccoun, R.R., & Kadish, A. (1991). Personal and situational characteristics
influencing the effectiveness of transfer of training improvement strategies. Journal
of Occupational Psychology, 64, 167-177.
Wexley, K.N., & Latham, G.P. (1991). Developing and training human resources in organi-
zation. New York: HarperCollins.