Human Capital in 5-7 Minutes — Supplementary Lecture to Fully Understand Human Capital I

[Part 1.1: Basic Explanation]
Human Capital in 5-7 Minutes — Supplementary Lecture to Fully Understand Human Capital I

"Ito Report," "Yanagi Model"—you cannot talk about "human capital" without understanding these terms.
However, many people may not actually know their precise meanings or backgrounds.
This article serves as a "dictionary" and "supplementary lecture" to help you understand this series more deeply.

1. What is "Human Capital" in the first place?

Until now, people in management have been called "Human Resources." Resources are "things that decrease when used," and in management, they have been treated as "costs" to be reduced as much as possible.
In contrast, "Human Capital" views people as "capital that generates and amplifies value when invested in."
It is similar to the difference between fuel and solar panels. Fuel decreases when used and eventually hits zero. Solar panels, once invested in (installed), continue to generate energy for 20 to 30 years. Moreover, if you improve the performance of the panels (invest in education), you get more energy. This shift in thinking from "cost to investment" is the starting point of human capital management.

2. Why is "disclosure of human capital" being demanded around the world now?

Because the source of corporate value has shifted from factories and machinery (tangible assets) to data and ideas (intangible assets).
Toyota's value lies not in the "number of factories" but in the "brains of the people who devise production methods." However, the "value of those brains" is not listed anywhere on financial statements (P/L or B/S). Investors began to panic, saying, "Even if we look at the financial statements, we cannot see the true value of the company."
This led to a global wave:
· 2018: ISO 30414 (Guidelines for human capital reporting) announced
· 2020: U.S. SEC mandates human capital disclosure for listed companies
· 2023: Human capital disclosure in securities reports mandated in Japan as well

3. What is the Japanese guideline, the "Ito Report"?

It refers to the "Ito Report on Human Resources" compiled by a Ministry of Economy, Trade and Industry study group chaired by Professor Emeritus Kunio Ito of Hitotsubashi University.
· Ito Report 1.0 (September 2020): Presented the basic concept that "management strategy and human resource strategy must be linked"
· Ito Report 2.0 (May 2022): A practical guide that added specific actions on how to implement it
· Ito Report 3.0 (2024–): Focuses on dialogue with investors and linking it to corporate value enhancement

4. The "Yanagi Model" that proves the connection to corporate value

This is a concept proposed by Ryohei Yanagi, former CFO of Eisai (detailed in his book "ROESG Model," etc.). Investment in non-financial information such as ESG and human capital does not generate profits immediately today or tomorrow. However, the Yanagi Model empirically demonstrated, using actual data from Eisai, the causal relationship that "investment in human capital contributes to the improvement of PBR (Price-to-Book Ratio) with a time lag (delayed penetration effect) of 5 to 10 years."

5. The difference between "input" and "outcome"

It is easier to understand if you compare it to dieting.
· Input: "Paid 10,000 yen a month for the gym"
· Process (Activity): "Went to the gym 3 times a week"
· Output (Result): "Bench press weight increased by 10kg, and basal metabolism increased"
· Outcome (Value): "Weight dropped by 5kg, health checkup numbers normalized, and gained confidence"
Many of the human capital disclosures by Japanese companies today stop at "how much we spent on training (input)" and "what percentage took childcare leave (output)," and do not talk about "how corporate value improved (outcome)."

6. What is ROIC (Return on Invested Capital)? — The core metric of this series

The term "ROIC" appears frequently in this series. Let's grasp it here.
ROIC (Return on Invested Capital) = NOPAT ÷ Invested Capital
· NOPAT (Net Operating Profit After Tax): This means "pure business profit," which is the profit earned from the core business minus taxes. Since it does not include financial costs such as interest on borrowings, it is suitable for measuring a company's "profitability of the business itself."

· Invested Capital: This is the total amount of money invested for the business. Specifically, it is calculated as "interest-bearing debt + shareholders' equity" or "fixed assets + working capital (accounts receivable + inventory - accounts payable)."
Let's understand with an analogy. You open a ramen shop, borrow 5 million yen from a bank, and put in 5 million yen of your own funds. That is a total invested capital of 10 million yen. If the annual NOPAT is 1 million yen, ROIC = 1 million ÷ 10 million = 10%. This means "you are generating 1 million yen in annual business profit with an investment of 10 million yen."

Relationship with WACC — "The hurdle to overcome"
WACC (Weighted Average Cost of Capital) is the average cost a company incurs to raise funds. Think of it as the weighted average of interest to banks and the return expected by shareholders. If ROIC exceeds WACC, the company is "earning more profit than the cost of capital," meaning it is creating corporate value. Conversely, if ROIC < WACC, it means that the more the business continues, the more corporate value is being eroded.

Difference from ROE and ROA·
ROE (Return on Equity): Return on shareholders' equity. It is important from the shareholder's perspective, but it has the weakness that the number can be inflated simply by increasing borrowings (leverage).·
ROA (Return on Assets): Return on total assets. Since idle assets not used for business are also included in the denominator, it has the aspect of being difficult to accurately measure the actual efficiency of the business.·
ROIC: This is a metric that looks at how much "core business profit" is generated against "capital actually invested in the business." It is not affected by leverage and can most accurately measure the essential profitability of the business. That is why this series consistently asks, "How does human capital investment contribute to ROIC?"

7. What is "Quiet Quitting"?

This is a concept that will be covered in detail in the third installment, but let's define it here.
Quiet Quitting refers to a state where an employee does not actually submit a resignation letter but decides to "do only the minimum amount of work that matches their salary." It is a concept that spread on social media in the West around 2022, but in Japan, it is a phenomenon that has existed long before as "hanging-on employees."
According to a Gallup survey (State of the Global Workplace 2024), the percentage of "Engaged" employees in Japan is only 5%, the lowest level in the world. The vast majority of the rest are classified as "Not Engaged" or "Actively Disengaged." These 95% are the reserve army of "human liabilities" discussed in this series.

8. What is a "Causal Path"?

This is also a term that appears in the third installment.

In terms of meaning, it is a path diagram that specifically depicts "what route a certain measure follows to lead to the final result."

If you compare it to a car navigation system, when you enter 'I want to go from Osaka to Tokyo,' it displays a specific route: 'Meishin Expressway → Shin-Tomei Expressway → Shuto Expressway.'

This is a causal path. If you were told to 'just drive east' without a navigation system, you would end up lost on mountain roads, only wasting your gasoline.

Unlike capital investment, it is difficult to see 'how much return you get for how much you spend' when investing in human capital. Training expenses, recruitment costs, and welfare expenses—all of these simply disappear as costs on the P&L, and the returns do not appear directly on the financial statements.

That is precisely why the need arose to articulate 'which path this investment takes and which performance indicators it moves.' That is the causal path used in the context of human capital.

The Yanagi Model (4) gained attention because it demonstrated the causal path of 'human capital investment → 5-10 year lag → PBR improvement' using actual data, effectively converting 'invisible investment' into a 'visible path.'

Conversely, saying 'if we invest in human resources, corporate value should eventually rise' is just driving east without a navigation system.

In this series, the presence or absence of this causal path is used with the intention of highlighting the decisive turning point that separates 'human capital' from 'human liability.'