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Business Strategy, Human Resources, Labour Market Flexibility, and Competitive Advantage

Jonathan Michie, School of Management and Organizational Psychology Birkbeck, University of London j.michie@bbk.ac.uk and Maura Sheehan Graduate School of Management University of Dallas lkhelad@aol.com Abstract This paper contributes to the strategic human resource management literature by testing the three main approaches the universalistic, contingency and configurational against an original database. Specifically, we examine: (1) the relationship between HR and organizational performance, (2) the links between strategy, HR and the use of flexible employment contracts, and (3) the moderating effects of strategy on the links between HR, flexible labour, and organizational performance. Using original data collected from manufacturing and service sector companies, we find positive relationships between HR policies and practices and performance; that the relationship between HR and performance is dependent upon business strategy; and that companies pursuing an integrated approach to HR coupled with an innovator/quality-enhancer focus within their business strategy perform best. The use of externally flexible labour reduces the effectiveness of HR, especially for those pursuing an innovator/quality enhancer approach. We also find that HR is more likely to contribute to competitive success when introduced strategically as part of an integrated and coherent package, or bundle. Keywords: strategic human resource management, competitiveness, flexibility.

Acknowledgement This work was funded by The Leverhulme Trust (grant F/112/AL), the University of London Central Research Fund and the University of Dallas (Provosts summer stipend award) to whom we are grateful. We are indebted to Dr Sharon Milner and Elaine McDonald for research assistance. We have benefited from discussing these issues with a number of colleagues, including Professor David Guest, Dr Neil Conway, Dr Linda Trenberth and Professor Paul Teague. A number of colleagues were generous in supplying copies of their own questionnaires and details of their results, in particular Dr Peter Berg and Dr Eileen Appelbaum; Dr Sandra Black and Professor Lisa Lynch; Professor Ichniowski; Professor Steve Nickell; and Professor Paul Osterman. Patrick Burns, Director of Advocacy for The Work Foundation provided invaluable advice on the use of HR practices in UK firms. We are also grateful for comments received from Rebecca Gumbrell-McCormick and Klaus Nielsen.

INTRODUCTION A consensus has emerged on the positive relationship between the use of human resource policies and corporate performance (Appelbaum, et al., 2000; Becker and Gerhart, 1996; Guest et. al., 2000, 2003; Huselid and Becker, 1996; Huselid, 1995; Ichniowski et. al., 1997; 1994; MacDuffie, 1995; Osterman, 1999; 1994; Wood and Albanese, 1995; Wood and de Menezes, 1998; Wood, 1999). Debate remains over the nature and causes of these outcomes. It is generally agreed that a better understanding of the interaction between business strategy and HR will be key to explaining these empirical outcomes. In particular, it is argued that HR policies that are consistent with organizational strategy strategic human resource management (SHRM) - are more effective (Miles and Snow, 1984; Schuler and Jackson, 1987; Truss and Gratton, 1994; Delery and Doty, 1996). The literature on the link between strategy and HR remains underdeveloped empirically. Moreover, there is debate over the relevance of three main theoretical frameworks: universalistic, contingency and configurational. Labour market deregulation and flexibility are regarded as key determinants of national competitiveness and successful corporate performance. A growing body of research has examined the relationships between firms use of flexible employment contracts and HR practices, on the one hand, and corporate performance on the other hand (Michie and Sheehan, 2003; Storey, et al., 2002; Michie and Sheehan-Quinn, 2001; Arulampalam and Booth, 1998; Kleinknecht, 1998; Kleinknecht, et al., 1998). This area also remains underdeveloped both theoretically and empirically. To contribute to these literatures, this paper examines: (1) the effects of HR policy on organizational performance, (2) the links between strategy, HR and the use of flexible employment contracts, and (3) the moderating effects of strategy on the links between HR, flexible labour, and organizational performance. The following section provides a theoretical overview of the links between strategy, HR, labour market flexibility and performance; we then outline the hypotheses to be tested, describe the sample, the method of analysis and variables used; and then present our results and conclude.

THEORETICAL BACKGROUND The link between strategy and HR management Three theoretical perspectives dominate the SHRM literature: universalistic, contingency, and configurational. The universalistic perspective suggests there is a best practice approach to SHRM, with a set of HR policies to be identified which will improve performance (Osterman, 1999, 1994; Pfeffer, 1994, 1998; Deleroy and Doty, 1996). These best practice policies may be embodied in a variety of concrete and detailed HR techniques or practices; for example, there may be many techniques that will encourage sharing of information within an organization (Richardson and Thompson, 1999). The contingency approach argues that to be effective, an organizations HR policies must be consistent with other aspects of the organization. The organizations strategy is generally considered to be the primary contingency factor. Human resource policies and practices must be consistent with the organizations strategy (Miles and Snow, 1978, 1984). Business performance will be improved when the right fit between business strategy and HR is achieved. The configurational approach differs from the universalistic and contingency theories by being guided by a holistic approach to inquiry and assuming the systems assumption of equifinality. In general, configurational theories are concerned with how the pattern of multiple independent variables is related to a dependent variable rather than with how individual independent variables are related to the dependent variable (Delery and Doty, 1996: 804). Configurational SHRM is concerned with the pattern of planned human resource deployments and activities intended to enable an organization to achieve its goals (Wright and McMahan, 1992: 298). The configurational approach suggests that an organization must develop HR as a system so that both horizontal and vertical fit can be achieved.

Internal and External Fit


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Horizontal fit implies there must be internal consistency of the organizations HR practices as HR bundles or systems. Internal fit emphasises the interdependency between individual HR practices, with the use of one HR practice enhancing the effectiveness of others - a synergy between practices. Vertical fit refers to the consistency of the organizations HR system with other organizational characteristics such as the firms strategy. External fit suggests that HR practices must fit, or be congruent with, the firms policy choices outside the area of HR. The presence of these two fits implies that specific combinations of HR practices can be identified which improve performance, but these combinations will vary by organizational context (eg firm strategy). Different notions of fit underlie the three theoretical perspectives in the literature. The universalistic approach suggests that only internal fit matters, i.e., that best practice policies work in all contexts albeit with variation in terms of the actual HR techniques used. The contingency perspective suggests that to be effective an organisations HR practices must be consistent with other organisational factors primarily its strategy (i.e., that there should be external fit). The configurational perspective suggests that improved performance will only occur when vertical or external fit and horizontal or internal fit are implemented. Competitive Strategies Porter describes competitive advantage as the essence of competitive strategy and proposes three strategies that organizations can use to achieve this advantage: innovation, quality enhancement, and cost reduction. Schuler and Jackson (1987) link these three strategies with the associated behaviours of employees and HR practices that a firm should adopt. They argue that HR practices will prove effective only where the firm emphasizes the importance of either quality enhancement or innovation within its business strategy. In organizations pursuing a cost based strategy, the logical approach to HR strategy would be to emphasize numerical flexibility and wage cost minimization: In such a situation, the values and goals imbued within HR would be consistent with the organizations primary cost reduction
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goals (Hoque, 1999: 421). Labour Market Flexibility and Corporate Performance Labour market deregulation has been regarded as playing a key role in the drive for a competitive, flexible economy. On the one hand, the use of flexible work practices can result in savings on wage costs. Firstly, work may be hired and paid for only if there is work to be done (for example, during temporary production peaks). And secondly because flexible workers on average earn less than comparable tenured workers and are not entitled to the benefits tenured workers receive. In addition, the decisions to hire new workers is taken more easily if workers can be fired more flexibly under adverse circumstances. In this way, part of the entrepreneurial risk is shifted to employees thus making job creation easier (Kleinknecht, et al., 1997: 2). On the other hand it has been suggested that the sort of labour market deregulation pursued in Britain over the 1980s and 1990s may risk being detrimental to long-run economic performance by leading to a neglect or undervaluing of assets and processes such as training and innovative activity, which are vital to long-term development and economic progress (Michie and Wilkinson, 1995; Kitson and Michie, 1996). Research using the British Household Panel Survey 1991-95 that investigated the link between skills acquisition and labour market flexibility (proxied by employment status, contract type, and lack of union coverage) found that workers: ...on short-term employment contracts, who are working part-time, or are not covered by a union collective agreement, are significantly less likely to be involved in any work-related training to improve or increase their skills. These findings suggest that there is a trade-off between expanding the more marginal forms of employment, and expanding the proportion of the workforce getting work-related training. (Arulampalam and Booth, 1998: 521). In addition, if the time horizons of firms become shortened, the pursuit of what economists would characterise as 'efficiency gains' may come to
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dominate other sorts of gains to be had from innovation and technological progress. This becomes problematic if the pursuit of short-term efficiency gains reduces the potential of the system for economic progress (Kleinknecht, 1998; Michie and Prendergast, 1998). At the firm level there are three principal means of securing flexibility: numerical, functional, and wage or reward flexibility. Numerical flexibility is the ability of firms to vary the amount of labour employed, by making use of part-time, temporary and seasonal employees, short fixed-term contracts, agency labour, freelance work, and homework or outwork. The use of this type of labour is also commonly referred to as flexible employment contracts or contingent labour. Functional flexibility is the ability of firms to vary the amount and type of labour they use without resorting to the external labour market, and is accomplished primarily by having a labour force that is able to carry out a wide range of tasks that is, the ability to move workers from one task to another. Wage or reward flexibility is having payment systems in place that encourage and reward improved performance (for example, performancerelated pay). Since functional and reward flexibility are subsumed in HR policies and practices, the effects of using contingent labour, or flexible employment contracts, is the focus of our flexibility analysis. We expect to find a relationship between the type of competitive strategy a firm is pursuing and the use of flexible employment contracts. In other words, the use of flexible employment will be contingent upon the organizations competitive strategy. We expect firms that are pursuing a costbased strategy to be more likely to use flexible labour compared to firms pursuing an innovator/quality-enhancer approach. We found a significantly positive correlation between pursuing a cost-based strategy and the use of flexible labour contracts (r = 0.63 at the p<.01 level). In contrast, the correlation for innovators/quality enhancers and the use of flexible labour contracts is negative (r = -0.48 at the p <.01 level). In terms of outcomes, lower wages costs from the use of external labour may improve performance, at least in the short-run, in those firms pursuing a cost based strategy. In contrast, the use of such labour is likely to adversely affect performance for innovators/quality enhancers who rely on a well-trained and stable
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workforce to achieve their competitive objectives. HYPOTHESES TESTED The Universalistic Hypothesis The universalistic hypothesis posits that there will be a positive relationship between performance and HR policies. While there is debate over specific HR techniques, there is consensus about the general characteristics of the policies (Pfeffer, 1994; Delery and Doty, 1996). Pfeffer concludes there is a set of seven people management policies that seem to characterize most if not all of the systems producing profits through people (p. 64). We use a modified version of Delery and Dotys and Pfeffers recommended policies. We hypothesize: Hypothesis 1: There will be a positive relationship between performance and (a) the amount of effort and resources used to recruit the right people, (b) the use of internal career ladders, (c) formal training systems, (d) formal results-orientated appraisals, (e) performance-based compensation, (f) employment security, (g) employee voice and consultation, and (h) broadly defined jobs and decentralisation. Internal Fit The second hypothesis tests for internal fit in a universalistic context: Hypothesis 2: When the individual HR policies tested in Hypothesis 1 are combined to form an HR index, the positive relationship between HR and performance will increase, reflecting synergies associated with using the practices together i.e., there is universal internal fit. Contingency Hypothesis The sample establishments are split into three business strategy typologies: innovators/quality-enhancers, cost-reducers, and other. Following Hoque (1999), the measure of HR used within this part of the analysis is cumulative, with each establishment being ranked according to the extent to which they
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adopt HR practices; the maximum numbers of practices that could be adopted are 25 and the mean number of practices is 16.7 (Table 2). This variable attempts to examine the relationship between the extent to which HR practices have been adopted and performance. By splitting the sample by strategy typologies, and then regressing the aggregate HR variable on each of the dependent outcome variables, we assess the effectiveness of HR in the context of cost-reducer, innovators/quality-enhancers, and other business strategies. We also examine the interactions between HR and the use of flexible labour, on the one hand and strategy and performance, on the other. The contingency hypotheses tested are as follows: Hypothesis 3a: The effectiveness of HR on performance is contingent upon business strategy; Hypothesis 3b: The effect of external labour on performance is contingent upon business strategy. The interaction effects between HR and the use of flexible employment contracts will reduce the positive correlations between HR and performance for innovator/quality enhancer firms. Configurational Hypothesis The internal fit hypothesis is tested as follows: the sample having been split to perform the external fit tests described above is reclassified here to enable comparisons between business categories as follows: 1. low-HR cost reducer, using 10 or fewer HR practices: 28 establishments; 2. medium-HR cost reducer, more than 10 but fewer than 17 HR practices: 22 establishments; 3. high-HR cost-reducers, 17 or more HR practices: 11 establishments; 4. low-HR innovator/quality-enhancers, 10 or fewer HR practices: 25
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establishments; 5. medium-HR innovator/quality-enhancers, more than 10 but fewer than 17 HR practices: 68 establishments; 6. high-HR innovator/quality-enhancers, 17 or more HR practices: 83 establishments; 7. low-HR other, 10 or fewer HR practices: 31 establishments; 8. medium-HR other, more than 10 but fewer than 17 HR practices: 21 establishments; 9. high-HR other, 17 or more HR practices: 12 establishments. This series of dummy variables enables comparative analysis between the level of performance dependent on the approach taken to HR and business strategy. Category 6 is held constant which allows us to examine whether the high-HR innovator/quality-enhancer establishments outperform the other categories. Hypothesis 4: The level of performance is dependent on the approach taken to HR and to business strategy; high-HR innovator/qualityenhancers outperform the other categories within the sample. The final hypotheses examine the importance of introducing HR as a synergistic package of mutually supporting practices (i.e., external and internal fit are present). According to bundling theory, establishments that adopt a wide range of HR practices, and those introducing their HR practices as a coherent, institutionally supported synergistic package should outperform establishments within which HR has been introduced in an ad hoc manner. To test this, a trichotomous variable was constructed as follows:

(a) strategic HR establishments: above-average (17 or more) usage of HR, strategically integrated with each other: 141 (46.3%); (b) non-strategic HR establishments (17 or more) usage of HR practices, not strategically integrated: 53 (17.3%); (c) low-HR establishments (fewer than 17) usage of HR practices: 110 (36.5%). If a senior HR representative takes part in the companys overall strategic decision making and if the respondent reported that HR policies are deliberately integrated with each other, the establishment is categorized as having strategically integrated its HR practices. We also examine the relationship between strategic and non-strategic HR and the use of externally flexible labour. It is posited that a reliance on externally flexible labour will reduce some of the hypothesized positive effects of strategic alignment of HR on performance. Hypothesis 5a: Firms that introduce HR practices within an institutionally supported, coherent package outperform those that introduce similar numbers of HR practices in an ad hoc manner and not as part of an overall strategy. Hypothesis 5b: The use of flexible labour contracts will reduce the positive relationship between strategic HR and performance.

If the coupling of internal and external fit is important, the strategic HR establishments should outperform the other establishments within the sample. METHODS Sample and data collection
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We surveyed a stratified sample of publicly quoted UK manufacturing and service sector firms with more than 50 employees. Two dimensions were used to stratify the sample: organisation size and the primary sector of business activity. Five categories of organisation size were used those employing 50-99, 100-499, 500999, 10009999, and 10,000 or more. Thirteen sectors were identified (nine in manufacturing and four in services), using the 1992 UK Standard Industrial Classification (SIC) codes. The EXTEL database was used to identify all organisations with the above characteristics, which totalled 1280. Holding companies were removed which reduced the population to around 1000. A telephone survey of the selected companies was conducted as follows: The senior manager with HR responsibilities was faxed a briefing on the objectives of the survey and the expected length of the interview (around 30 minutes). Confidentiality emphasised. The person was then contacted to see if they would agree to the telephone interview and if agreeable, a date and time was set. These individuals were then faxed a glossary of HR terminology, with alternative or variant names of many of the practices, with examples relevant to both the manufacturing and service sectors. Interviews were conducted by telephone with the Director of Human Resources/Personnel/Employee Relations of each company in 78% of cases. Where this person was not available, an alternative senior person was interviewed. Most of the organisations in the sample were large and had more than one establishment/site. The interviewee was therefore asked to select the organisations most typical establishment/site that is, the site that most typified the organisations activities. In total 934 individuals were asked to complete the survey. Of these, 559 declined, 19 agreed but subsequently failed to complete the interview, and 362 interviews were completed successfully. As a result of missing data, 362 of the total number of responses were usable - a response rate of 39%. Control variables were included in the regressions, which should
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minimise possible survey response bias. Following Huselids (1995) approach to the same issue, we also used Heckmans (1979) procedure to generate an inverse Mills ratio that was included in the regression models for each dependent variable to control for selectivity bias. In each case, the relationship between the independent variables and the dependent variables remained broadly consistent with the results presented below. Measures (a) Control Variables. The following standard control variables were used: establishment size (see Appendix for details on the distribution), with dummies for establishments with up to 49 employees; 5099 employees; 100199 employees; 200499 employees; and 500 or more employees (the omitted category is establishments with less than 49 employees); the age of the establishment (Age); whether the establishment is UK or foreign owned (Foreign owned); two sector dummies: manufacturing (Manuf) and services (Serv) (see Appendix); and trade union recognition (20.1% of establishments). (b) Measures of Performance

In contrast to many other studies, we use objective, rather than subjective measures of performance. In addition, the data used in this analysis were collected at the establishment, rather than at the company level. The performance data are averaged over a three year period, which helps to reduce problems of simultaneity of one period explanatory variable measures. We use three measures of performance: percentage change in total sales (sales growth), percentage change in labour productivity, and percentage change in
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pre-tax profitability. To control for price movements, the variables were deflated by the producer price index for the sector in which the company belonged. To cater for the non-normal distribution of the data, we used the logarithm of the raw scores. To examine the representativeness of the establishment level data, confirmatory performance measures at the organizational level were obtained from the EXTEL database for the sample companies. For percentage change in total sales, the correlation between the two sources was 0.57 (p < .01); for percentage change in labour productivity, the correlation was 0.46 (p < .01); and for percentage change in pre-tax profitability, the correlation was 0.53 (p < .05). These results indicate that the data obtained at the establishment levels is correlated with performance at the organizational level (for further discussion, including that of the validity of self-report data in general, see Wall, et al., 2003). (c) Measures of Business Strategy

We build on Schuler and Jacksons (1987) business strategy typologies. The classifications are based on both subjective responses to questions on strategy and objective data. Companies were classified as having a cost based strategy if they reported that their strategy focussed on cost minimization/reduction or price competition/reduction and if they had a lower than average remuneration rate or if the proportion of their wage bill paid to permanent, full-time employees had declined over the past five years (16.8% of establishments). Firms were classified as having an innovator/quality based strategy if they reported that being innovative was the primary focus of their strategy and if they had introduced either a product or process innovation over the past three years (17.4% of establishments); and quality based if their strategy focussed on quality enhancement and if they had achieved a recognized quality award (48.2% of establishments). The latter strategies are combined (65.6% of establishments) for this analysis because of the similarities in terms of outcomes achieved. For example, all but one establishment that had introduced an innovation had also received a quality award. Seventeen percent of establishments did not meet any of these category specifications, and hence
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fall into the other category. (d) Measures of Labour Market Flexibility

In their analysis of the effect of labour market flexibility on firm growth and innovation, Kleinknecht et al. (1997) categorise flexibility into internal and external, similar to Beatsons (1995) definitions of flexibility at the intensive and extensive margins. The questions used in our survey on labour market flexibility adopt a similar approach, as indicated in Table 1. However, the variables associated with internal flexibility are grouped with HR practices (in particular, under broadly defined jobs). To make the analysis more manageable, only the aggregate indicator of external flexibility that is the number of employees that are externally flexible as a percentage of total employees is used. Insert Table 1 here (e) Measurement of HR Practices

Eight different HR practices were conceptualised and measured (see Table 2 for details of the individual techniques). The practices cover the areas of recruitment and selection, internal career opportunities, training, formal appraisals, performance based-pay, employment security, employee participation (voice) and consultation, and job design/internal employee flexibility. When testing the universalistic hypothesis the eight different practices are entered into the regression separately. When testing the contingency and configurational hypotheses, the measure of HR used is cumulative, with each establishment being ranked according to the extent to which they have adopted the 25 HR techniques presented in Table 2. Insert Table 2 here RESULTS The results from the testing of the hypotheses outlined above are presented in this section.
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Hypotheses 1 and 2: The Universalistic Hypothesis The means, standard deviations and correlations of HR practices, performance variables and the control variables were calculated, showing significant positive correlations between the HR practices, suggesting the practices are not independent of one another (full results available from the authors on request). Recruitment and selection, internal career opportunities, training, formal appraisals, and performance based compensation were all significantly correlated at the p<.01 level to all three of the performance measures; and employment security was significant with all of the measures between the p<.05 and p<.10 levels. Participation/voice and broadly defined jobs were both significantly correlated with profitability (at the p<.10 level) and participation/voice was significantly correlated to labour productivity (at the p<.10 level). These results support many of the relationships specified in Hypothesis 1. Insert Table 3 here These relationships are explored further in Table 3, which reports ordinary least squares (OLS) regressions (all results are corrected for heteroskedasticity) where Model 1 for each of the performance measures represents the restricted model (no HR practices). Model 2 enters each HR policy as individual explanatory variables. Each equation reached significance at conventional levels, and the control variables generally had the expected signs and significance levels. All of the HR policies have positive coefficients in relation to the three performance measures. With the exception of participation/voice and broadly defined jobs in relation to sales growth (positive but not significant), all of the other HR policies showed positive and significant coefficients. The HR policies explained 31.7%, 33.3% and 30.8% of the variance in sales growth, labour productivity, and profitability respectively (compared to 22.5%, 23.3% and 21.8% of the respective variances in the restricted model with no HR practices). These results are consistent with the correlation results and offer addition support for Hypothesis 1, that these policies are positively correlated with performance.
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To test for universal internal fit (Hypothesis 2), the HR practices are combined into an HR index as described above and the regressions are re-run and presented in Model 3. For each performance measure the HR index is positive and significant. Inclusion of the HR index in Model 3 accounted for an additional 11%, 14% and 12% of the sales growth, labour productivity and profitability variances respectively relative to Model 2. These results provide support for the hypothesis of universal internal fit. It suggests that there are indeed positive synergies associated with combing the individual practices. Hypothesis 3: Contingency Hypotheses Insert Table 4 here Table 4 reports strong links between strategy and the cumulative HR variable (Hypothesis 3a). Across the sample as a whole, and especially amongst the innovator/quality-enhancer firms, there is a strong positive and significant relationship between the HR index and all three performance measures. However, for the cost-reducer firms, the statistical significance of this relationship disappears for labour productivity and financial performance and becomes negative (although insignificantly so) for sales growth. For establishments in the other category, while the correlations between the HR index and performance measures are positive, none of the relationships are significant. The use of externally flexible labour is negatively and significantly correlated to sales growth and labour productivity for innovator/quality-enhancer firms. For cost-reducer and other firms this correlation is positive, but not significant, for all performance variables. When interacted with the HR index, the use of external labour reduces the positive correlation found between HR and the performance measures for all categories of firms and for all measures of performance. These results give support to the external fit hypothesis, that the effectiveness of HR is strongly dependent upon the business strategy pursued. As hypothesized, there is no evidence that the adoption of HR leads to improved
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performance where establishments emphasize cost control within their business strategies. In contrast, the evidence presented shows that where HR is coupled with strategies that emphasize quality-enhancement and innovation, performance is positively affected. The effect on performance of the use of external labour is also strongly contingent on the type of strategy being pursued (Hypothesis 3b). The negative correlation between pursuing an innovator/quality approach and the use of external labour, in addition to the nature of its interaction with the HR index in general, suggests that the use of this type of labour is a barrier to competitive success for these firms. This is not surprising. While external flexibility may include some examples of what might be termed high road practices, consistent with investing in HR for example where skilled employees choose to work on fixed-term contracts much of this type of labour flexibility will be of the low road, hire-and-fire type. Reliance on this type of externally flexible labour is usually associated with the sort of cost control that we found led to HR having no positive effect on performance. Moreover, since the use of external labour reduces the positive correlation between HR and performance, it is lowering the return associated with HR investment in terms of performance outcomes.

Hypothesis 4: Configurational Hypothesis Insert Table 5 The results in Tables 5 suggest that the high-HR innovator/qualityenhancers are the highest performing establishments in terms of all of the performance variables (Hypothesis 4). The negative signs on the HR-strategy coefficients show that establishments not following the high-HR innovator/quality enhancer approach perform less well than those establishments following this approach. The exception to this however appears in relation to sales growth, where high-HR cost reducers and high-HR other (where the signs are positive but not significant). This may reflect the fact that it is relatively easy for firms to increase sales compared to the other
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performance measures, but increased sales will not necessarily improve financial performance, especially if the price of the product or service is reduced in order to secure the increased volume. It is also important to recognize that where the internal and external fit does not hold, it is in the context of high HR usage which may thereby offset, at least in part, the potentially negative effects of cost based and ambiguous strategies. This final analysis examines whether establishments that appear to have introduced their HR practices as a strategically integrated package of mutually supporting practices outperform establishments that have introduced their practices in a more ad hoc manner (Hypothesis 5a). Insert Table 6 here The results in Table 6 show that strategic HR establishments outperform the Non-strategic HR establishments across all performance measures. A higher dependence on externally flexible labour weakens the positive correlations between strategic HR and all performance measures (Hypothesis 5b). These results suggest that, when firms introduce HR practices, the returns on HR are much greater where they are introduced as part of an institutionally supported and coherent package. CONCLUSION Investing in progressive HR practices can clearly pay dividends in terms of corporate performance. However, the results reported in this paper suggest that the degree to which this is true in statistical terms, the size and significance of the effect will vary according to a range of factors. One of these factors is the strategy that the firm adopts. Broadly, it may be pursuing a high road strategy of investing in progressive HR practices that will be expected to lead to a greater degree of commitment and motivation amongst the workforce, as well as to both an increased ability and greater opportunities to work more productively. Hence the HR investment will lead to improved productivity and profitability. Alternatively, the firm may choose a low road, cost-cutting strategy. This may include putting employees onto short-term contracts and/or part-time working,
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and accepting a greater degree of labour turnover. In this case we would not expect to find a high level of investment in HR. And if such HR practices were to be pursued, they would be unlikely to lead to significantly improved outcomes (although there is strong evidence of universalism, so investment in HR in general, especially in a number of policies, will have some positive effect on performance) .The effectiveness of HR policies and practices, therefore, will depend, in part at least, on the strategy being pursued. If a high road strategy is consciously chosen, then the costs of investing in HR practices can be expected to be recouped through improved performance. However, for this to happen requires the HR practices to lead not just to higher levels of commitment and motivation amongst staff, it is also necessary for this to be matched firstly by the skills to work more productively, and also by the opportunities to put those skills and motivation to good effect. For these three factors to be present motivation, skills and opportunities HR practices must be pursued as coherent packages, and combined with appropriate organizational design.

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Table 1. Labour Market Flexibility Variables


External Employment Flexibility Variables. Number of employees that are externally flexible as a percentage of total employees: a. Number of part-time employees as a percentage of total employees: b. Number of employees on temporary contracts as a percentage of total employees: Mean 22% 21% 19% Number of valid cases (n = 362) 354 362 361

c. Number of employees on fixed-term, casual, or seasonal contracts as a percentage of total employees: 28% 356 Note: The results for external flexibility are similar to those reported by the 1998 WERS survey. See Milward, et al., 2000, pp. 43-49.

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Table 2. HR Practices used in the Analysis


HR Practices A. Recruitment and Selection a. Use of at least one of the following selection methods: psychometric testing; personality/attitudinal tests; work sample; aptitude tests b. Trainability as a major selection criteria c. Use of realistic job previews during recruitment and selection B. Internal Career Opportunities a. Individuals have clear career paths within the organization b. Internal promotion the norm for appointments above the basic level c. Employees career aspirations are known to their immediate superiors d. Employees who desire promotion have more than one potential position they could be promoted to. C. Training a. Formal induction programme for new employees b. The majority (> 50%) of non-managerial employees received formal offthe-job training in the past 12 months c. Investor in People (IIP) Status D. Formal Appraisal a. Formal appraisal of the majority of non-managerial staff on a regular basis (at least annually) b. Performance appraisals are based primarily (more than 50% of responses) on objective, quantifiable measures. E. Performance Based Compensation a. A merit element in the pay of staff at all levels F. Employment Security a. It is very difficult to dismiss a permanent employee from this company c. Written policy of guaranteed job security or non-compulsory redundancies amongst permanent staff d. Written commitment to a goal of long-term employment security amongst permanent staff. G. Employee Voice and Consultation a. A system of regular, planned team briefings involving senior management during which time work stops b. Joint Consultative Committees (JCCs) c. Employees are encouraged to suggest improvements d. All staff are informed about the market position and competitive pressures faced by the establishment and/or company Mean 0.264 0.683 0.552 0.543 0.634 0.445 0.754 0.730 0.487 0.547 0.623 0.702 0.605 0.183 0.152 0.091 0.793 0.415 0.653 0.689 No. of valid cases (n = 362) 362 357 358 360 361 358 358 361 360 362 361 357 360 360 361 361 360 359 362 362 362

e. All staff are informed about the strategic objectives and 0.734 targets for the establishment and/or company
H. Broadly defined Jobs a. Harmonized terms and conditions between management and nonmanagement staff b. Redistribution of tasks amongst non-managerial employees over the past 3 years. c. Extent to which non-managerial employees have variety in their work (moderate-entirely) d. Work organized around team-working for the majority of employees 0.689 0.489 0.532 0.623

361 352 358 360

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Table 3. Results Testing for Universalism a,b


Variables Sales Growth Models 1 2 -0.05 -0.08 0.04 -0.05 -0.06 -0.07 0.05 -0.04 3 -0.05 -0.07 0.06 -0.05 Labour Productivity Models 1 2 3 1.32*** 1.16*** -0.09* -0.06 -0.04 0.03 -0.07 -0.05 -0.02 0.05 1.18*** -0.06 -0.05 -0.12** 0.03 0.19*** 0.04 Profitability Models 1 2 -0.03 -0.07 -0.08 0.04 -0.04 -0.06 -0.07 0.03 3 -0.02 -0.05 0.10* -0.06 0.12** 0.03 Constant 50-99 employees 100-199 employees 200+ employees Age Foreign-owned Union Recognistion HR practices: Recruitment and Selection Internal career opportunities Training Formal appraisal Performance based compensation Employment security Participation/voice Broadly defined jobs R
2

1.22*** 1.17*** 1.14***

1.40*** 1.36*** 1.32***

0.17*** 0.16*** 0.15** 0.18*** 0.17*** 0.18***

-0.15** -0.13** 0.22*** 0.20***

0.12** 0.11* 0.12** 0.11*

0.11* 0.09* 0.19*** 0.16*** 0.15** 0.13** 0.03 0.04 0.092* 0.252*** 0.130***

0.21*** 0.02 0.28*** 0.15** 0 .11* 0.15** 0.10* 0.10* 0.10* 0.262*** 0.159*** 0.233*** 0.333*** 0.492*** 362 362 362

0.13** 0.10* 0.16*** 0.11* 0.17*** 0.11* 0.11* 0.09* 0.09* 0.248*** 0.141*** 0.218*** 0.308*** 0.449*** 359 359 359

HR Index: R
2

Model R N

0.225*** 0.317*** 0.447*** 362 362 362

Note a: *p <.10; **p<.05; ***p<.01, one-tailed tests.

Note b: These statistics reflect the incremental variance accounted for by the HR policies and the HR index respectively, which are added to the complete specification of each model. The impact of HR on the dependent variable is underestimated by this statistic because the assumptions that the independent variables are orthogonal and have been entered on the basis of a clear causal ordering are not appropriate in the current study (see Huselid, 1995 for discussion of this issue). This caveat applies to all reported results.

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Table 4. Relationship between HR Practices, Labour Market Flexibility & Organizational Performance
Sales Growth:
Variables All firms Models 1 1.14*** -0.05 -0.07 0.15** 0.06 0.18*** -0.05 0.252*** Cost Reducers Models 1 1.23*** -0.08 -0.09* 0.11* 0.07 0.10* -0.06 - 0.066 Innovator/ Quality-enhancers 3 1.20*** -0.05 -0.08 0.11** 0.05 0.09* -0.09* -0.062 0.055 Models 1 1.15*** -0.03 -0.02 0.09* 0.05 0.10* -0.03 0.282*** 2 1.18*** -0.02 -0.03 0.10* 0.06 0.11* -0.04 0.265*** -0.154** 0.009 3 1.16*** -0.04 -0.03 0.11* 0.04 0.11* -0.02 0.241*** -0.132* Others Models 1 1.33*** -0.06 -0.08 0.10* 0.06 0.13* -0.06 0.083

Constant 50-99 employees 100-199 employees 200+ employees Age Foreign-owned Union Recognition HR Index: External labour 2 R HR Index* External labour 2 R Model R N
2

2 1.16*** -0.06 -0.08 0.14** 0.07 0.16*** -0.08 0.210*** -0.033 0.052

3 1.12*** -0.04 -0.07 0.12** 0.05 0.15** -0.06 0.173*** -0.021

2 1.22*** -0.08 -0.09* 0.10* 0.06 0.09* -0.07 - 0.064 0.064 0.082

2 1.30*** -0.07 -0.09* 0.08 0.05 0.09* -0.08 0.082 0.050 0.077

3 1.28*** -0.05 -0.06 0.08 0.04 0.12* -0.05 0.078 0.047

0.127** 0.052 0.447*** 362 0.479*** 362 0.531** 362 0.283*** 61 0.365*** 61

0.060 0.031 0.396*** 61 0.239*** 239 0.248*** 239

0.169*** 0.081 0.339*** 239 0.222*** 62 0.299*** 62

0.059 0.023 0.322*** 62

Labour Productivity:
22

Variables

All firms Models 1 1.18*** -0.06 -0.05 0.12** 0.03 0.19*** -0.04 0.262*** 2 1.13*** -0.05 -0.09* 0.15** 0.04 0.18*** -0.07 0.221*** -0.038 0.056 3 1.15*** -0.05 -0.07 0.13** 0.05 0.16** -0.07 0.183*** -0.030

Cost Reducers Models 1 1.36*** -0.06 -0.07 0.10* 0.05 0.09* -0.05 0.063 2 1.42*** -0.06 -0.08 0.11* 0.09* 0.10* -0.08 0.059 0.071 0.088 3 1.33*** -0.06 -0.08 0.12** 0.07 0.09* -0.07 0.058 0.064

Innovator/ Quality-enhancers Models 1 1.23*** -0.04 -0.05 0.06 0.07 0.09* -0.04 0.293*** 2 1.22*** -0.03 -0.04 0.09* 0.05 0.10* -0.05 0.279*** -0.112* 0.013 3 1.21*** -0.05 -0.05 0.10* 0.06 0.10* -0.03 0.267*** -0.093*

Others Models 1 1.55*** -0.09* -0.07 0.08 0.07 0.11* -0.05 0.076 2 1.53*** -0.06 -0.06 0.07 0.06 0.10* -0.06 0.069 0.054 0.081 3 1.52*** -0.07 -0.06 0.08 0.09* 0.12* -0.05 0.067 0.050

Constant 50-99 employees 100-199 employees 200+ employees Age Foreign-owned Union Recognition HR Index: External labour 2 R HR Index* External labour 2 R Model R N
2

0.145** 0.007 0.492*** 362 0.528*** 362 0.535*** 362 0.296*** 61 0.384*** 61

0.050 0.031 0.415*** 61 0.307*** 239 0.320*** 239

0.164*** 0.084 0.404*** 239 0.229*** 62 0.310*** 62

0.070 0.035 0.345*** 62

Profitability:
23

Variables

All firms Models 1 1.32*** -0.02 -0.05 0.10* 0.06 0.12** 0.03 0.248*** 2 1.30*** -0.03 -0.06 0.11** 0.05 0.13** 0.05 0.240*** -0.033 0.051 3 1.15*** -0.04 -0.05 0.11** 0.05 0.14** 0.04 0.183*** -0.027

Cost Reducers Models 1 1.40*** -0.05 -0.06 0.09* 0.06 0.09* -0.04 0.081 2 1.44*** -0.07 -0.09* 0.10* 0.11* 0.12* -0.07 0.079 0.073 0.079 3 1.39*** -0.06 -0.08 0.10** 0.08 0.10* -0.08 0.076 0.068

Innovator/ Quality-enhancers Models 1 1.62*** -0.03 -0.04 0.13** 0.06 0.10* 0.07 0.284*** 2 1.60*** -0.02 -0.04 0.12* 0.05 0.11* 0.06 0.279*** -0.112* 0.013 3 1.58*** -0.03 -0.05 0.15** 0.07 0.14** 0.05 0.260*** -0.100*

Others Models 1 1.58*** -0.10* -0.09* 0.06 0.05 0.09* -0.07 0.075 2 1.59*** -0.07 -0.08 0.09* 0.06 0.10* -0.05 0.072 0.053 0.078 3 1.55*** -0.06 -0.06 0.07 0.10* 0.13* -0.06 0.068 0.050

Constant 50-99 employees 100-199 employees 200+ employees Age Foreign-owned Union Recognition HR Index: External labour 2 R HR Index* External labour 2 R Model R N
2

0.129** 0.069 0.449*** 362 0.480*** 362 0.549*** 362 0.309*** 61 0.388*** 61

0.056 0.031 0.419*** 61 0.311*** 239 0.324*** 239

0.154** 0.093 0.417*** 239 0.233*** 62 0.311*** 62

0.062 0.035 0.346*** 62

Notes: See Table 3.

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Table 5. HR, Strategy, Flexibility, and Performance Outcomes


Variables Constant 50 99 employees 100 199 employees 200 + employees Age Foreign-owned Union Recognition Low-HR cost reducers Medium-HR cost reducers High-HR cost reducers Low-HR innovator/quality enhancers Medium-HR innovator/quality enhancers Low-HR others Medium-HR others High-HR others R N
2

Sales Growth 2.631*** -0.090* -0.071 0.113* 0.021 0.181*** -0.043 -0.193*** 0.062 -0.074 -0.060 -0.082 -0.120* -0.045 -0.081 0.225 362

Labour Productivity 2.89*** 0.086 0.062 0.153** -0.032 0.161*** 0.036 -0.212*** -0.170*** -0.056 -0.041 -0.081 -0. 173*** -0.050 -0.032 0.219 362

Financial Performance 2.78*** -0.104* -0.055 0.062 -0.021 0.123** -.062 -0.091* -0.079 -0.048 -0.162*** -0.092* -0.041 -0.061 -0.029 0.222 359

Notes: See Table 4. Omitted Category = High-HR innovators/quality-enhancers.

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Table 6. Internal Fit, Flexibility, and Performance Outcomes


Sales Growth Model 1 Constant 50 99 employees 100 199 employees 200+ employees Age Foreign-Owned Union Recognition Strategic HR Strategic HR * External flex Non-strategic HR Non-strategic HR * External flex R R N
2 2

Labour Productivity Model 1 3.98*** -0.05 -0.04 0.11* -0.04 0.15** -0.04 0.22*** Model 2 3.23*** -0.04 -0.06 -0.09* -0.03 .013** -.005 0.21*** 0.17*** 0.05 0.049 0.06 0.051 0.490*** 361 .541*** 361

Financial Performance Model 1 3.54*** -0.03 -0.05 0.13** 0.02 0.13** 0.05 0.18*** Model 2 3.58*** -0.04 -0.06 0.12** 0.03 0.14** 0.06 0.17*** 0.14* 0.081 0.077 0.05 0.043 .463*** 359 0.506*** 359

Model 2 3.22*** -0.04 -0.03 0.11* -0.04 0.12** -0.04 0.23*** 0.19***

3.22*** -0.03 -0.04 0.10* -0.03 0.11* -0.03 0.24***

0.07 0.03 0.060 0.488*** 361 0.548*** 361

Notes: See Table 4. Strategic HR = above average no. of HR practices used and establishment has a formal HR strategy. Non-strategic HR = above average no. of HR practices used but establishment does but have a formal HR strategy. Omitted category = below-average no. of HR practices used (low-HR).

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Appendix: Sample Details


Sample Establishments Count % Manufacturing: Establishment Size: Under 50 50 99 100 199 200 499 500+ Total Industrial Activity: Food and Drink Textiles and Clothing Wood, wood products, paper & printing Chemicals Metals and fabrication Industrial and Commercial Machinery Electronic and Electrical Equipment Transportation Equipment Other Manufacturing Total Services: Establishment Size: Under 50 50 99 100 199 200 499 500+ Total Industrial Activity: Hotels and Restaurants Wholesale and Retail Financial Other Business Services Total 46 14 18 16 31 36.8 11.2 14.4 12.8 24.8 41 46 51 62 42 242 33 23 45 2 30 31 29 14 16 242 16.9 19.0 21.1 25.6 17.4 100.0 13.6 9.5 18.6 8.7 12.4 12.8 12.0 5.8 6.6 100.0

125 100.0 31 39 23 32 125 24.8 31.2 18.4 25.6 100.0

Note: To preserve the robustness of the results, only two dummy variables dManuf and dServ are used in the estimations. Given the relatively small cell sample sizes for each industry, when the results were run using a higher degree of industry disaggregation, these coefficients were not significant. Foreign Ownership: 293 (80.2%) of the sample firms were UK owned and 72 (19.7%) were foreign owned.

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