We are in the midst of a transition. The development of human society over the past 200 years has seen the transition from a predominantly agricultural base to one that is primarily industrial. It is now entering a stage where the capacity to generate and apply knowledge is replacing capital as the driver of enterprise. Coupled with the increasing transfer of manufacture to places like China and India, Australia is in the throes of a significant restructure of our industrial base and economy. We are increasingly becoming a knowledge based society, and to compete globally will need to become more so.
It is suggested that a knowledge based society possesses the following key features:
- knowledge (in its many meanings) becomes increasingly important, becoming not only a production factor but also a commodity which can be traded. Knowledge is no longer power but also wealth;
- there is an on-going explosive growth in scientific knowledge with rapid advances made possible by information sciences;
- job specific knowledge increases and those in less intellectually demanding jobs need more knowledge to work effectively;
- knowledge multiplies at high rates forcing the more rapid transformation of society;
- the ready availability and use of information technology tools gives more people than before the ability to access more information than before, and;
- new basic practical skills are required in the society (ie. The ability to use information technology, fax, e-mail and other associated technologies).
A cursory evaluation of these features demonstrates that Australian society is becoming more and more knowledge based. Additionally, looking at your business enterprise and making a similar evaluation may well lead to the inevitable conclusion that, despite its investment in capitalised infrastructure, your enterprise is also becoming knowledge based. With time it will become even more so. How then does your enterprise (and you, incidentally) take advantage of the changing circumstances and maintain viability and profitability during such societal change? One way is by effectively managing and leveraging all your’s and your enterprise’s assets (including the knowledge assets) and by investing in the acquisition of knowledge that will provide benefit over the long term.
I suspect that when asked, “How much of your enterprise’s costs and benefits related to the delivery of products and services are associated with capturing, storing and processing information about your customers, service providers, infrastructure, operations?”, most would find it difficult to provide reasonable estimates of the true cost and the value added by these activities.
A business enterprise consists of three types of assets which, when appropriately used, can generate business success. These are its:
- Monetary Assets (net working capital);
- Tangible (Hard) Assets (anything valued with physical dimensions that is traditionally accounted for in the balance sheet), and;
- Intangible or Intellectual Assets (anything valued without physical dimension that is embedded in people (employees, customers, suppliers) or derived from processes, systems and culture associated with the enterprise. Along with goodwill and Intellectual Property, Research and Development is also recognised as an Intangible Asset.
Depending on the type of enterprise the ratio of the different assets will vary. For example: A bank might have the bulk of its assets as Monetary; a manufacturer as Tangible; a software company as Intangible. What might be the ratio be for yours?
NB: You (Yes! That’s You!) can also consider your life, and your passage through it, as a business enterprise. But more about you, Intellectual Capital and Intellectual Property at another time.
There will always be a component of any business enterprise’s assets which are Intangible. Businesses have always tried to organise knowledge; by writing handbooks; maintaining files; providing training and collecting data. However, management of this knowledge has, until recently, been an “ad hoc” affair. Increasingly business enterprises are improving their ability to manage and maximise the leverage of their Intangible Assets.
Most work diligently at improving their return on their Tangible Assets and one wonders just how much more gain there is in this area. Continuous improvement over time probably sees the efforts only result in diminishing returns as the Tangible Assets reach the limit of their performance capability and changing regulatory and operating environments place even greater pressure on achieving commercial returns. Perhaps it is now time to also examine options for recognising and optimising the returns on your Intangible Assets?
Intangible Assets are now being recognised as large contributors to market value and the renewal and effective deployment of Intangible Assets is emerging as a critical business enterprise competency. This leveraging of Intangible Assets is being seen as a way to develop and maintain competitive advantage.
Although most enterprises are well experienced in using the indicators that monitor the production of value by Tangible Assets there is a general lack of wherewithal to determine the value of Intangible Assets. It is likely that your Intangible Assets are considerably greater than what is often claimed since many enterprises are yet to define and estimate the value of all of their Intangible Assets. If you don’t evaluate, manage and leverage both your Tangible and Intangible Assets then the opportunity to benefit from the utilisation of all of your assets is being neglected. ‘How much of your operating costs, were spent in employing people?’ Can you say with confidence that you are maximising your return on this Intangible Asset component which, at least, can be measured in financial terms?
Intangible Assets are increasingly being referred to as Intellectual Capital and business enterprises are now beginning to focus on managing this capital more effectively, both in improving overall performance and in delivering competitive advantage. This is because Intellectual Capital is overtaking financial holdings, real estate, inventories and other Tangible Assets in reflecting the most valuable part of many enterprises. For example, in 2006, General Motors (symbolising the industrial era) with considerable Tangible Assets had a market capitalisation of around $US40 billion. Microsoft (symbolising the knowledge era) with few Tangible Assets had a market capitalisation of around $US70 billion. How things have changed. GM filed for bankruptcy in 2009 despite the tangibility of its assets and Microsoft remains solvent still.
There are moves internationally to require an Intellectual Capital supplement to be included in the annual reports of companies as a future reporting requirement. The development of reporting principles is ongoing in the European Economic Community as well as Japan and Australia.
The Australian Guiding Principles on Extended Performance Management were developed by the Society for Knowledge Economics. The Society was established in June 2005 following a mandate from the Australian Government Consultative Committee on Knowledge Capital and the Australian Government Information Management Office. The guiding Principles propose a framework for structuring an extended performance account that supplements traditional financial statements. The aim is to produce a one page account, which provides a summary of the value and performance of the enterprises knowledge intensive resources and activities relative to its strategic objectives.
Skandia, a Swedish company, already produces a supplement to its Annual Reports because it now recognises the value of its Intellectual Capital and evaluates its performance in this area in all of its businesses.
One of the major proponents of the value of Intellectual Capital management, Thomas A Stewart (1997) made the following remarks: “Systematic management of Intellectual Capital creates growth in shareholder value. This is accomplished, among other things,
through the continuous recycling and creative utilisation of shared knowledge and experience. This, in turn, requires the structuring and packaging of competencies with the help of technology, process descriptions, manuals, networks, and so on, to ensure that the
competence will remain with the company when the employees go home. Once packaged, these become part of the company’s structural capital–or more precisely, its organisational
capital. This creates the conditions for the rapid sharing of knowledge and sustained, collective knowledge growth. Lead times between learning and knowledge sharing are shortened systematically, human capital will also become more productive through
Intellectual Capital is knowledge that can be converted to profit. This definition encompasses inventions, ideas, general know-how, design approaches, computer programs, processes, and publications. There are three broad categories of Intellectual Capital:
- Human Capital, comprising the collective expertise, creative capability, leadership, entrepreneurial and managerial skills embodied by the employees of the enterprise;
- Structural Capital, comprising those technologies, methodologies and processes which enable the enterprise to function, that is, those elements which make up the way the enterprise works. They include: methodologies for assessing risk, management methods, databases of information on markets or customers, communication systems, know-how, copyright, patent and various design rights as well as Trade and Service Marks, and;
- Customer Capital, comprising the ongoing relationships with people or other enterprises to which your enterprise sells its products and services. These categories can be further subdivided, however three is sufficient to encapsulate all of the Intellectual Capital within an enterprise.
Knowledge about the Intellectual Capital residing in any enterprise represents a rich source of information which is of particular value in the following
- Validating the Organisation’s Ability to Achieve its Goals: It is relatively easy to determine whether strategic plans will succeed with respect to having appropriate Tangible Assets but there is also a need to ensure that the Intangible Assets are also appropriate. Do we have the appropriate people, business processes, information systems?
- Planning Research and Development: Provides information on the know-how in the organisation and whether it provides competitive advantage, identifies and aligns projects with strategic direction, identifies what additional know-how should be acquired; Supports identification of what Research & Development programmes should be funded to create the future knowledge needs; Supports
decisions on what part of Research & Development should be done “in-house”,
what could be outsourced, and what should be done collaboratively with competitors, suppliers and customers, and; Helps to determine what kinds of business relationships and alliances should be established with external providers of strategic knowledge and technology.
- Information for Re-engineering and Downsizing Programs: Supports decision making concerning human assets, what jobs or functions need to be replaced and minimises the loss of valuable capability and know-how; Defines what kinds of knowledge and talent prospective employees should command to support the organisations human capital development strategy, and; Identifies what processes are to be implemented to mobilise Intellectual Capital for developing capabilities essential to company strategy.
- Rationale for Organisational Education and Training Programs: Provides information related to what learning systems and environments should be created to build and renew human capital benefiting the individual as well as the enterprise, and; Supports decisions on what incentives and corporate culture are needed to foster and inspire efforts to enhance the Intellectual Capital of the enterprise.
- Assessing the Value of the Enterprise: The book value doesn’t truly reflect the value of an enterprise especially if a considerable amount of know-how is held (Eg. a software company). Information on the Intangible Assets provides additional information on the overall value of the organisation.
- Growing an Organisational Memory: Identifying where know-how and skills reside and ensuring that appropriate Intellectual Capacity is fully utilised and suitably captured reduces the costs of “reinventing the wheel” within an enterprise; Supports decisions on what sort of information infrastructure should be installed to best facilitate creation, storage and sharing of knowledge in order to support strategic and operational objectives, and; Helps to define what processes and systems should be established to safeguard Intellectual Capital and ensure its quality and reliability.
Intangible Asset valuation methods fall within three generally accepted valuation
approaches. The choice of approach is often determined by the required objective of the valuation and more than one approach may be used to obtain a valuation. There are currently 12 techniques which can be used to value Intangible Assets which fall within the valuation approaches of: Market Comparison which uses market activity comparisons involving like intangible assets to estimate a value; Income Capitalisation where value is determined by the capitalised value of income, cash flows or cost savings than can actually
or hypothetically be achieved by a market participant owning the asset, and; Cost Approach where value is determined by calculating the cost of replacing the asset with a similar asset or service capability. This latter approach is often used for internally generated intangible assets that have no identifiable income streams or other economic benefits.
Managing Intellectual Capital initially requires an identification and audit of existing Intellectual Capital, creating a system for collecting, storing and disseminating information about Intellectual Capital, assessing the value and relevance of existing
Intellectual Capital and what Intellectual Capital is needed for the future. A strategy for carrying this out might be as follows. Firstly, undertaking an Intellectual Capital audit which would include Best Practice and existing Intellectual Property audits as required to produce a status report on Intellectual Capital and recommendations for restructuring and/or building capability. This would like be followed by building an Intellectual Capital system and developing policy to support its identification, acquisition and utilisation to address the enterprises goals and maintain competitive advantage.
Ask yourself: ‘Has enough been done to maximise the value and benefits my enterprise derives from its Intellectual Capital?’ And after answering that one you might also care to ask yourself: ‘What am I doing to maximise the value of MY Intellectual Capital?’