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I was intrigued by some excellent set of papers on ROI in the marketing space in the last issue of Indian Management and decided to write on the trends and work being done in the global academic space in regard to Intellectual Capital the genesis for ROI in the intangible capital space.
Companies create value, and incur risk, by assembling unique combinations of assets. It is this portfolio that is called the business model, and it determines a company’s economic success.

Intelligence is ‘the faculty of adapting oneself to circumstances’ said Francis Binet and Henri Simon, the authors of the first IQ test (Wolf 1973). Intelligence is the operation of gathering information, an ability to comprehend; to understand and profit fromexperience or new information about specific and timely events; "they awaited news of the outcome". That which makes the human mind determine a course or choice of action, after sifting through alternatives, after evaluating risks or after predicting an outcome and that which has the power to create, destroy, add, delete, enhance or subsume.

The Economist defines Capital as the Money or wealth put to economic use, the life-blood of capitalism. Economists describe capital as one of the four essential ingredients of economic activity, the factors of production, along with land, labour and enterprise. Production processes that use a lot of capital relative to labour are capital intensive; those that use comparatively little capital are labour intensive.

Capital takes different forms,

· The new assets are traditionally thought to be intangible and not measurable

· The market is rewarding companies based on what type of assets they leverage

· Business design reflects how a company assembles tangible and intangible assets

· Therefore, a company’s asset portfolio is its key determinant of economic success

· Companies must adjust their asset portfolios to alter risk and reward

· New digital tools are necessary to adjust asset portfolios based on market signals

· Emphasis on People & their value significant

· Knowledge Economy is weightless

Let us look at what makes organizations derive capital value. Essentially through three formats:

1. Unique Assets: No other firm has exactly the same set of knowledge, skills, abilities, innovations, codified knowledge, patents, trade marks, copy rights and trade secrets. They are unique and difficult to duplicate and may require considerable time & resource to do so.

2. Differentiable Assets: includes assets such as manufacturing, distribution which while similar is different in some ways from those of competitors. They differ in size, shape, complexity, production rate and cost structure. Complementary business assets (innovations) are important to knowledge firms for generating & maintaining profits.

3. Generic Assets: Includes those not differentiable, such as cash, fixed assets, fixed capital and tangible assets. All of the assets are found in a balance sheet.

Some examples,

Sara Lee Corporation: Decreased its physical assets to convert to Brand Assets. Redefines business as being Brand Sponsor. Others being British Airways , Gap (Multiple brands – spreads positioning), plans life line for Gap, NIKE, Liz Claiborne (non Tariff Barriers – Makes China/ India 3rd world compliance),

Coca Cola: Single Product – Brand Leverage as its critical Intellectual Value creation and in contrast, PepsiCo, Multiple Products and takeovers.

Dell Computers: Eliminated Middlemen and passed on benefits to customers. On line buying. Optimizes value chain. Moves back office to India. Is more than a computer company?

AOL On Line: Used Scalability as its critical strategy - Technology enables assets and business models, to encompass more than just one product, physical location or customer.

IBM focused on intangible leadership. Louis Gerstner saw market value ultimate measure and created a turnaround through customer focus. Set personal standards of thorough, hardheaded, forceful, intense, competitive, focused and blunt/planned intervention.

Chrysler and clay raw casting for valve lifter became an example of vendor relationship – going out of business made to stay when company realized his value and the absence of an alternate vendor. Make clay instead of kitty litter. Moved into outsourcing unlike GM and FORD. Long term contracts. Supplier suggests metal to plastic castings. Supplier loses business but rewarded with other business.

Cisco – 1984 / 1993/ 2 Stanford professors family founders – Leonard Bosack – computer science / Sandy Lerner from business school create multi protocol routers to network computers – competition catches up, now to manage competition need for cash and technology advantage – capitalize on share price. Acquired Crescendo communications and 30 other high tech companies acquired.

GAP in uses stores, Internet and telephones for sales and distribution. Successful in differentiating market and product offerings by forming chains – banana republics and old navy.

Duracell – camera, video, hearing aid, play station, game boy, home security, to remote to any electrical DC system it could be a Duracell. The company’s channel assets are these products and services and Duracell continues to expand its market share by devising new ways to support these offerings as and when new products come into the market.

Williams Companies – From Business of Gas Pipe Line to running fiber optic cables – Sold to MCI worldwide.

J and J: 308 word ethics statement “ OUR CREDO”. The company’s belief in managing for the long term enables its managers to function with less fear of making mistakes.

Brands win through Starbucks Corporation that makes coffee available where people shop, travel, play and work.

And finally, USAA - 3.3 Million Customers, 98% in Top 40% satisfaction, 98% renew their policies every year. Privately held company - Maintains real time records, passionate about serving people, 22,400 employees special qualification for empathizing with army for uprooting, dangers of military life. 10 weeks of technical training, conflict resolution, relationship management, complaints handling, satisfaction measurement, need analysis. The leaders want to know through research what their employees think and feel. A best practice standard for hiring, training and directing employees.

The genesis,

John Kenneth Galbraith first published the term intellectual capital in 1969. He believed that intellectual capital meant more than just “intellect as pure intellect” but rather incorporated a degree of “intellectual action”.

Tobin’s Q compared the market value of an asset with its replacement cost. Tobin’s Q is a ratio of two stocks of value, a market valuation of a firm and the replacement value of its assets. It is a measure at a point in time and there is no rate of change component.

Market-To-Book-Ratio is the simplest measure of Intellectual Capital and is the difference between its market value and its book equity.

Economic Value Added (EVA) - EVAâ developed by Stern Stewart & Company that was also responsible for the MVA concept referred later. EVA deals with maximizing value at the adjusted performance and investment level.

Market Value Added (MVA) - Market Value Added (MVA), like EVA, also derives its origin in the concept of economic profit. One way of looking at MVA is to consider it the sum of initial capital invested and the economic profit or residual income or EVA accumulated over time. In simple terms, MVA represents the difference between the value of shareholders’ investment at a point in time and the amount of capital invested by shareholders up to that date. Put simply: MVA = Market value of the business – All of the capital invested in the business to date MVA = Market Value of Debt + Market Value of Equity - Total Adjusted Capital.

Value Based Management (VBM) is one of the systems by which the business strategy is executed and creates results. All elements of a knowledge solution must be effectively managed and leveraged. At an institutional level, the approach to implementing knowledge solutions recognizes and balances the interdependence of these critical elements and the intellectual platform essential towards creation of such cultures. Best run knowledge enterprises focuses on enabling the dominance of the intellect as a means towards the end, the end being the state of an intellectual enterprise.

Consulting organizations have nurtured such environments as a conscious competitive strategy. Value based management (VBM) is designed to create value in a company over the long-term.

Invisible Balance Sheet - Karl-Erik Sveiby produced an invisible balance sheet for Morgan & Banks. Against the three main categories of intellectual capital—external structure, internal structure, and competence—he chose indicators that illustrated growth/renewal, efficiency, and stability.

Calculated Intangible Value compares a company’s return on assets with a published Return-On-Assets for the industry. It defined the value of intangible assets as the company's ability to outperform an average competitor that has similar tangible assets. The method calculates first the return on assets for a particular company over a three-year period. The average for the industry is then ascertained.

Intellectual Capital Monitor - Thomas Stewart constructed the Intellectual Capital monitor that comprises one overall measurement (Market-To-Book-Ratio) and three indicators each for Human, Structural and Customer Capital.

The balanced scorecard (Kaplan and Norton) is a management system (not only a measurement system) that enables organizations to clarify their vision and strategy and translate them into action. It provides feedback around both the internal business processes and external outcomes in order to continuously improve strategic performance and results. When fully deployed, the balanced scorecard transforms strategic planning from an academic exercise into the nerve center of an enterprise.

Intangible Asset Register - The Konrad Group in Sweden developed the Intangible Asset Register. This performance measurement tool ignores the balance sheet and focuses on three-core dimensions; external & internal, and individual competence.

Return on Management - Paul Strassman advocated the use of a supplementary metric to the conventional Return-On-Investment, namely, Return-On-Management is a ratio that accounts for both Management-Value-Added and the real costs of management.

Customer Capital - Saint-Onge remodeled Skandia Work to separate customer capital from structural capital suggesting that the relationship is of absolute central importance to the company’s worth.

I C Multiplier and I C Rating - Leif Edvinsson has developed 1C Multiplier and 1C Rating as factors under the auspices of his company Intellectual Capital Sweden AB. The 1C Rating™ is based on data collected through comprehensive interviews with employees and other stakeholders and a rating is applied to each element of intellectual capital. The 1C Multiplier is the ratio of structural capital to human capital.

Skandia’s IC Navigator –Leif Edvinsson developed the IC Navigator at the Swedish financial services company Skandia. It incorporates the presumption that intellectual capital represents the difference between market and book value of the company.

Real Option Theory - Real Option Theory provides an approach which values the opportunities arising from intellectual capital. A real option is one that is based on non-financial assets and unlike a financial option the underlying asset is non-tradable.

Value Added Intellectual Coefficient - Ante Pulic of the Austrian intellectual Capital Research Centre argues that to create value added, we must effectively utilize the physical capital we have, as well as the intellectual potential. This concept narrows down intellectual capital to the employees only, i.e., not including structural capital.

Bontis - Bontis et at. (1999) Suggest that a process model can help create an IC measurement system and especially the selection of the right indicators. To do this, they refer to the 'value scheme', which describes the sources of company value coming from intellectual capital. Bontis and his colleagues believe that, once a company has a clear idea about its identity and strategy, it should use its long-term goals to identify two sets of variables: one set comprising its value-creating path (i.e. those IC categories that really drive company value creation); and the other set that can act as performance measurements.

Broker’s I C Audit - Annie Brooking (1996) - Brooking defines IC as the combined amalgam of these four components: market assets, human-centered assets, intellectual property assets and infrastructure assets. Market assets equal the potential an organization has due to market-related intangibles such as brands, customers, repeat business, backlog, distribution channels, contracts and agreements such as licensing and franchises.

Intellectual Capital Services’ IC-Index - Goran and Johan Roos of London-based Intellectual Capital Services created the IC-Index model. Johan and Goran Roos concluded that because it was so difficult to measure intellectual capital itself, the focus should be on measuring changes. To this end they developed a tool called the IC-Index. Their distinguishing concept is that it is the flows between components of intellectual capital and financial capital that matter. As they put it: "Balance sheets are still photographs. What drives an organization is the movie—each frame different from its predecessor. It's a dynamic where different kinds of capital growth feed into each other." What they call second-generation 1C, as opposed to the more simplistic formula of the first generation, is about carefully selected measures and the interaction between them. Roos and Roos recognize that financial and intellectual capital must be balanced—one is consumed to maintain the other.

Citation-weighted Patents - Schmookler and Scherer were two of the earliest researchers to use patent data in the economic analysis of technological change in the 1960s. The arrival of publicly available computerized patent information in the 1980s led to a second wave of econometric research using patent citations to increase the information content of the data. The distribution of the value of patented innovations is extremely skewed. A few patents are very valuable, but most are close to valueless. Therefore the number of patents held by a firm is not highly correlated to the sum of the value of those patents. A patent is a temporary legal monopoly granted to inventors for the commercial use of an invention.

Human Capital comprises all the skills, expertise and competencies of the company to react on market demands and customer needs including leadership and management issues and capabilities. Organisational Capital comprises the capabilities of a company, its infrastructure and organisational processes to produce products and services to the market. Market Capital represents the capabilities of a company to interact with the external interface like the customer, partners, and suppliers and other stakeholders. Innovation Capital refers to a company’s ability to innovate, improve and develop unutilized potential as well as generate long-term wealth.

Effectively, for now,

1. The Economic to Financial Cost Model School comprises of Tobin’s Q, market valuation models and strong economic theories as a foundation for effective valuation of enterprises and its assets. This school evaluated concepts like market capitalization, derived and created value and use of costing models applicable in the case of replacement. Intrinsic worth was perhaps best evaluated and discovered through this school. This school continues to be the most robust and researched based given the thinkers in this school falling back on economic theories to substantiate their perspective. The downside to this school has been a certain lack of willingness to innovate and to think outside the box.

2. The Business Valuation School comprises of EVA, MVA, VBM, Value Dynamics as techniques deployed to understand the economic indicators that are intrinsic/latent to the value of a firm and introduced concepts pertaining to use of capital and returns expected of capital deployed into business through a direct assignments of such capital into wealth generating activities. This school continued to believe that value can be realized from assets by its use while evaluating its cost of acquisition and comparing it costs associated with capital outflows versus costs associated with revenue out flows. This has largely been within the domain of business consulting and investment banking firms and has been extensively deployed for valuation, performance improvement and similar consulting interventions. This school continues to focus on shareholder value.

3. The Management Measurement School comprised of Balanced Scorecard, MBO, ROI, NPV, return of business management, business performance measures and to some extent dealt with tangible versus intangible assets, return on investment, accounting uses, performance measurement techniques, business and management audits including capturing goodwill.

4. The Intellectual Capital School has been large, substantive and considerable amount of direct work has and continues to take place. The school has espoused many definitions. At one end of the continuum are researchers who have worked on Intellectual Property, patent value, invisible balance sheet and at the other end are researchers who have evaluated a combination of process models, individual value models, structural and human capital models. The breadth of work is wide, so much so that, a reader could get quite lost in the myriad of indices, ratios, concepts and subtleties that one writer provides vis a vis another. The school has contributed through tools such as the IC navigator, IC Multiplier, Invisible Balance Sheet. This school continues to provide us considerable scope for further research and testing of hypothesis on the indices mentioned above. By its very definition this schools is tasked with the unenviable role of bringing together financial, structural, organization, customer, process and human capital components together and reach an acceptable valuation method.

And in summation,

In effect it is evident that with over 20 different types of methodologies, many building upon one another, quite a few frameworks have been experimented with, but not quite established in the Intellectual Capital Measurement scenario. Surely the absence of empirical evidence is glaring. And empirical works presented (Example – OECD Conference, Teece, Bontis, et. al) continue to experiment and explore new and innovative methodologies without the possibility of a prescriptive model emerging as a standard or a tool to follow.

While each of the models bring in an element of human capital measure none of them appear to be comprehensive enough to cover the labor potential aspects that HR schools of thought would like to see. For example, the implications on account of learning and training capability, value realized through performance on the job, potential demonstrated through special intellect or unique, research and original thinking, competencies and skill profiles essential to perform a job effectively. Or the traditional HC measures dealing with education, experience and productivity. Just as the resource-based models suggest the need to provide for deprecation to HC factors have also not been comprehensively addressed.

The commercial writers have surely not presented any working measurement model that can be understood and applied with a reasonable sense of clarity and definitiveness, needless to mention they lack empirical validity or the statistical rigor necessary to prove causal relationships.

This is apparent from the ever-increasing literature and application oriented models that are emerging particularly from business consultants and practicing managers who are seeking to establish commonplace causal relationship between intangible assets and market capitalization, albeit for influencing the share market. While literature survey does show significant thinking at the conceptual level, definitions, assumptions, approaches etc, there appears to be little agreement amongst the writers on a defined model for measurement.

That there are but a few from the academic world working on IC measurement is strikingly clear. In fact the need for economists to delve into this area of research is a crying need for the development and progress that is necessary to build upon an important area of the 21st century. That the works of academic researchers have confined their contribution primarily at the conceptual level demonstrates a level of cynicism that perhaps exists at the universities on the commercial concepts that are being deployed to measure IC. In any event human capital measurement tools have been least developed from a valuation perspective, more not so, from a labor understanding and utilization perspective.

Essentially questions to be addressed deal with causal relationship between firm performance and intellectual capital, drivers that can influence creation, development, deployment and utilization of IC resources and finally establishing a standard or a benchmark or an indices by which the measurement tends to follow a pattern that is internally consistent, reliable over time and valid to prove an hypothesis in varying situations.

There is a case to bring together learning from multiple fields namely, economics, finance and managerial learning’s from management and marketing. It may be wise to focus on the IC movement by dividing the 4 areas, namely, structural, customer, organizational and human capital dimensions into such 4 areas of independent research as against the current trend to combine all four into one combined valuation technique and thereby unable to do justice to any one of them comprehensively.

Intellect and Intellectual Capital at the Human Capital is surely the challenge of the new economic enterprises and has still some way to go.

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