Does employee training lead to higher profits?

Republished with permission from Knowledge@Wharton, the online research and business analysis journal of the Wharton School of the University of Pennsylvania.

Does intensive internal training of employees lead to higher profits? In knowledge-based industries where the main asset is skilled professionals such as software engineers, the answer is yes, according to the research paper “Strategy, Human Capital Investments, Business Domain Capabilities, and Performance: A Study in the Global Software Services Industry,” by Joydeep Chatterjee, senior fellow at the Mack Institute for Innovation Management and professor of global strategic management at the University of Washington. But not all training yields equal benefits. Surprisingly, technological training such as those on computer languages did not boost project profits, the paper found. Rather, providing an employee training to raise their level of knowledge about clients’ industries did the trick.

In his paper, Chatterjee analyzed the relationship between training and profits at a leading Indian IT services company headquartered in Bangalore, using data from 347 software development projects staffed by more than 5,500 employees between 2005 and 2008. To fend off stiff competition from large U.S. firms such as IBM, Accenture and HP, which were opening offices in India and hiring local engineers, the company decided to invest heavily in employee training to upgrade their technical skills and industry-domain knowledge, which includes taking exams twice a year.

Chatterjee analyzed the company’s capability development efforts and concluded that “leveraging the general technological skills in combination with the business-domain skills enabled the focal firm to earn superior returns.” While employees do need good technical skills to accomplish project objectives, it is their knowledge of the customer’s industry domain that makes them add value to the endeavor.

Focus of the Research

My research in this paper examines how firms develop superior capabilities and move up the industry value chain in the global IT services industry. I sought to explore how, in doing so, firms expand their corporate scope and enhance their competitive position vis-a-vis their global rivals. I have four research papers in this broad area, one of which has just been accepted for publication at The Strategic Management Journal.

Key Takeaways

My paper that has just been accepted describes how firms develop superior capabilities due to specific human capital investments. The primary managerial implication of this research is that capability-seeking investments in developing general human capital through strategic learning, such as training and internal certifications, can enhance firm performance.

Although investing in general human capital is risky because employees are mobile, the company in this paper considered this a strategic necessity in order to thrive in the fast-paced IT services industry. We found that by leveraging general technological skills, in combination with business domain knowledge to address customers’ business problems, firms can earn and sustain higher profits.

This study also demonstrates how a company in a developing country responded to strong competitive challenge from global rivals possessing vastly superior capabilities — by upgrading the capabilities of its employees through internal development. In doing so, the firm was able to narrow the capability gap vis-a-vis its foreign peers, and expand its business globally.

Surprises

I studied the competitive dynamics between American and Indian software services firms using an event study methodology. I collected announcement information on foreign investments made by American and Indian firms in India and U.S. respectively.

While U.S. firms were investing in India to build large software delivery centers and access India’s rich talent pool of software engineers, some of the leading Indian firms made opposite investments in the U.S. to build client relationships and acquire business domain knowledge about their client’s industry — with the ultimate aim of offering high value-added business and technology consulting services and moving up the software services industry value chain.

“By leveraging general technological skills, in combination with business domain knowledge to address customers’ business problems, firms can earn and sustain higher profits.”

Indian firms were rushing to increase their business domain skills and client intimacy while western firms were rushing to reduce or rationalize their cost structures and remain competitive. So there is essentially a convergence of capability portfolios of firms in this industry, as several companies rush to offer end-to-end services to their customers and become a one-stop-shop spanning the entire software services industry value chain.

The own firm returns were positive. However, when I calculated the cross firm returns, I found that when U.S. firms invested in software development centers in India, the Indian firms were hit harder than their U.S. counterparts. Similarly, when Indian firms invested in the U.S. by acquiring boutique consulting firms, or by setting up business consulting units, the Indian rivals were hit harder relative to their U.S. counterparts.

Therefore, I was very surprised to find that the stock market penalized the Indian IT services firms significantly more than American IT services firms, when their rivals made capability-seeking moves to access complementary capabilities along the software industry value chain. This seems to suggest that firms that are already established in the high value-added segment of the industry value chain are being favored by the investors. These firms seem to enjoy some advantage over their rivals, who are established in the low value-added segment of the industry value chain.

“The firm was able to narrow the capability gap vis-a-vis its foreign peers, and expand its business globally.”

For example, when Indian firms are making a variety of investments, both organic and inorganic, to move up the industry value chain in the software services industry, the stock market views these attempts positively. But when rivals, both domestic and foreign, make complementary investments, the stock market penalizes the Indian firms significantly more, relative to the U.S. firms who are already established in the high-value-added segment.

This further suggests that there are strong mobility barriers in this industry — barriers that prevent or discourage Indian firms from moving up the industry value chain and offering high-end services such as business consulting [and other] services to global customers. More broadly, this research suggests that it is easier to move down the value chain, compared to moving up the value chain.

Practical Implications

In the paper that was just published, which used data on internal certification exams, I find that certification exams are beneficial for firms. So IT services firms should actually invest heavily in building business domain competency Twitter , in order to provide customized software solutions to their clients. This can be achieved organically through specialized training and certifications as evidenced in my published work.

Other Research

In another paper with a co-author, I conducted research on how software development firms exploited the onsite, offshore global service delivery model to achieve superior profits and expand their business. We studied how firms utilize the onsite, offshore teams distributed in different time zones, share knowledge, and how this impacts their performance. Our results suggest that it is very important to have some common understanding of business functions of their customers among team members, at both onsite and offshore locations.

“IT services firms should actually invest heavily in building business domain competency, in order to provide customized software solutions to their clients.”

We further find that too much of this overlap of common or shared knowledge is not beneficial for project performance. We found that shared knowledge follows an inverted “U” relationship with software development project performance. This inverted “U” relationship is amplified in smaller teams. That is, the inverted “U” relation becomes more prominent in small teams, or put another way, in large teams it is very important to have sufficient mutual knowledge to facilitate coordination among team members and the negative effects of higher shared knowledge are reduced.

To put all these results together, we can suggest that software development firms should design their product teams such that they have optimum amounts of shared knowledge between onsite and offshore teams. This can change depending on the coordination load or the level of difficulty faced to achieve optimal team coordination. For larger teams and for low onsite presence, the coordination load is higher. Therefore, for larger teams, they should have higher levels of shared knowledge and for low onsite presence, they should have higher levels of shared knowledge within the project team.

Publication does not imply endorsement of views by the World Economic Forum.

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Author: Joydeep Chatterjee is a senior fellow at the Mack Institute for Innovation Management and professor of global strategic management at the University of Washington.

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