Managing Intellectual Capital in Practice

Göran Roos, Stephen Pike, Lisa Fernstrom

• Publisher: Routledge
• Year: 2007
• ISBN:
  9781136383793
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This book is the essential guide for managers wishing to implement the benefits of Intellectual Capital thinking in their companies or divisions. It serves as an easily accessible introduction to the subject area for the novice, giving the gist of what it is about and how it has developed, but above all it gives hands-on instructions on how to incorporate intellectual capital thinking in everyday business and how to use the tools provided for the management and measurement of intangible resources. Throughout the main part of the book, three different cases in separate boxes run in parallel with the body text. These are introduced in chapter 2 and illustrate how the tools are to be used, depending on what type of company wishes to implement these ideas. The three case companies are characterised as a manufacturing company, an R&D organisation and a network company. Smaller case stories about well-known global companies are also interspersed throughout the book.

1 ________________________________

What is intellectual capital and why is it important?^*

Over the last ten years we have seen a rapidly growing interest in and understanding of the role that intellectual capital resources play in the workings of all organizational forms. Concomitantly, there has been a realization that organizations should be managed differently, including the use of new methods for performance measurement and disclosure.

In a recent survey conducted by the Economic Intelligence Unit for Accenture,¹ 94% of CEOs agreed that it is essential to understand and manage intellectual capital. Out of these, 50% stated that intellectual capital management is one of the three most important challenges for managers and 13% stated that it is the most important challenge.

The purpose of this book is to create a better understanding of intellectual capital and its management and to discuss how intellectual capital management can be applied in practice in organizations. Throughout, the reader will be provided with solid and grounded foundations, including tools and techniques, for crafting an organizational strategy that takes into account intellectual capital. Our discussions in later chapters will be illustrated with examples from different types of organizations: private sector, public sector and third sector.² Cases will be used to illustrate how intellectual capital thinking is applied.

WHY INTELLECTUAL CAPITAL?

Listed firms³

We have heard much about the new economy and its management challenges. Interestingly, the discussion has diminished somewhat since the dot.com bubble burst in 1999. It should not have. That unhappy event for many investors has masked a serious consideration of what is structurally new and different in developed economies generally. The United States economy in particular has changed radically. Stock market valuation underpinnings are seemingly irrevocably altered. There has been tremendous growth in expectations for the future earnings of U.S. companies.⁴ We have forms of enterprise that, first, employ new business models and second, grow and compete by leveraging different resource forms than those on which we have conventionally relied. The responsibility for managing shareholder wealth now has new implications for understanding what resources are to be managed, how, and what is to be communicated to whom, under what conditions and through what media.

In this and the following chapters we will outline:

• The changed nature of the U.S. economy in terms of its constituent companies,

• The unavoidable and profound importance of future value in the market valuation of equity,

• The new challenges that confront management in their quest to manage for value,

• The nature of intellectual capital and a broader understanding of the ways in which value is created in companies that predominantly rely on intellectual capital, and finally,

• A new basis for managing for shareholder value.

The economy has changed. We are used to hearing about the New York Stock Exchange (NYSE), Dow, and National Association of Securities Dealers Automated Quotation (Nasdaq) indices and their growth over the last several years. The predominant indices are the Dow Jones Industrial Average (“the Dow”), the S&P 500, and the Nasdaq–100. The S&P 500 is often regarded as the bellwether index of the U.S. economy.

The best illustration of the fundamental changes that have occurred to the U.S. economy is the growth of the number and importance of Nasdaq-listed companies in the S&P 500. Typically there had been few Nasdaq-listed companies in the S&P 500; less than 25 before 1993, accounting for less than 5% of the S&P 500’s equity market value. At the height of the dot.com boom in 1999, the then 47 Nasdaq-listed companies in the S&P 500 represented over 20.6% of its value. Even after the dot.com market implosion at the end of 1999, the number of Nasdaqlisted companies in the S&P continued to climb. At the end of 2003, 74 Nasdaq-listed companies were represented in the S&P 500, accounting for 16.7% of the index’s value. These new economy⁵ companies are among the U.S. economy’s prime shareholder value creators⁶ and include Microsoft, Cisco, Amazon, Yahoo!, Amgen, and eBay. eBay, a company with a market capitalization of close to $60 billion in September 2004, which joined the S&P 500 in late 2003, was formed in 1995 and only had its IPO in 1997, the latter event a mere seven years ago.

The new economy is broadly identified in Figures 1.1 and 1.2.⁷ These figures show a history of more than twenty years of the NYSE and Nasdaq exchanges by number of companies listed and their market value at year-end for the NYSE.

Figure 1.1 NYSE: market value of equities and number of listed firms, 1980–2003.

(Source: AssetEconomics LLP.)

Figure 1.2 Nasdaq: market value of equities and number of listed firms, 1980–2003.

(Source: AssetEconomics LLP.)

Broadly speaking, the NYSE is regarded as the home of the old economy, whereas the Nasdaq is regarded as the home of the new economy. As we might expect then, the asset backing of companies listed on each of these exchanges is quite different. Taking the S&P 500 as an example, the market-to-book value of Nasdaq‐listed nonfinancial companies in the S&P 500 is twice that of NYSE-listed companies in the index.

The S&P 500⁸ represented some 67.9% of the market value of equities in the United States⁹ out of the total 6,288 companies listed on the NYSE and Nasdaq at the end of 2003¹⁰. Nasdaq-listed companies are now a permanent feature of this bellwether index and many of these represent new forms of doing business, often relying on nontraditional business models and leveraging intellectual capital rather than strictly physical resources to create superior competitive advantage. The emergence and importance of the new economy in the United States is demonstrated by the number and value of Nasdaq-listed companies in the S&P 500, as shown in Figures 1.3 and 1.4. We will see that these companies are very important and represent a fundamental change in the make-up of the US economy.¹¹

Figure 1.3 Dollar and percentage value of Nasdaq-listed companies in the S&P 500.

(Source: AssetEconomics LLP.)

Figure 1.4 Number of NYSE versus Nasdaq-listed companies in the S&P 500.

(Source: AssetEconomics LLP.)

There have been extensive discussions about the new economy and its management. The economies in which businesses operate are in constant change. As a consequence, we cannot expect to excel managerially if we apply thinking developed for different economic dynamics than those in which we operate. This means that we constantly need to reappraise our mental models, our assumptions, and our practical approaches to managing organizations. To illustrate the point, we are not necessarily going to succeed by applying the tools and thinking developed for a manufacturing company assuming economies of scale to running a service organization grounded in economies of scope. Today’s world has a greater focus on services and intangibles than ever before and therefore requires much more sophisticated management of issues such as processes, brands, IP, relationships and competence.

Today all companies are trying to improve their value, whether monetary or nonmonetary in nature—many with mixed success. A contemporary example of the problems that require new approaches is outsourcing. A company that is outsourcing a manufacturing facility is actually exchanging a physical resource for a relational resource. If the organization does not change its management practices and strategy to take into account the differing economic behaviors of plant and equipment as compared to external relationships, it is highly likely that the expected economic benefits will either never be realized or that the (net present) value of these benefits is either negative or substantially smaller than expected. The responsibility for these failures lies equally with both parties in the outsourcing relationship. To illustrate this, we may examine how often either party in a potential outsourcing relationship has brought up the issue of required changes in management processes so as to extract maximum benefit from a relational resource (that is not owned nor controlled, follows network economic behavior, and is nonadditive in nature). We argue that failure to plan for and implement necessary changes in management practices will account for many of the stated occasions when the benefits of outsourcing have not been realized in accordance with original expectations.¹²

Good managers have always been able to manage their intellectual capital resources well, but they have usually relied on intuition and experience rather than explicit tools, and have been frequently frustrated in their endeavors to monitor the effectiveness and efficiency of value creation from these intellectual capital resources. This book aims to provide managers with tools that are as well grounded and tested as those available for management of classical monetary and physical resources.

Valuation of the firm

The importance of intellectual capital resources is not only illustrated by surveys of senior executives in many countries but is also inherent in the valuation of publicly listed companies on stock exchanges globally.

Finance theory was identifiably born in 1961. At that time, the valuation model for the firm was established in two parts: the value of “assetsin-place” and the value of growth opportunities. This distinction is central to the valuation of firm equity.

1. The present value of the uniform perpetual earnings on assets currently held, and

2. The present value of the opportunities the firm offers for making additional investments in real assets that will yield more than the “normal” market rate of return.¹³

Both present value calculations are made using the same “cost of capital” discount rate. Subsequently, a model known as the KBM model was developed^14,15 which separated the overall market value of a firm into the value of assets-in-place and the val...

Table of contents

• Cover
• Title
• Copyright
• Contents
• Foreword
• 1. What is intellectual capital and why is it important?*
• 2. How to identify the organizations’ intellectual capital resources*
• 3. Putting intellectual capital resources to value-creating use*
• 4. Valuing and measuring intellectual capital
• 5. Reporting on intellectual capital
• 6. Other applications of the intellectual capital approach
• Index