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Human and Intellectual Capital Best Practice

Managing Intellectual Capital

by Leif Edvinsson

Table of contents

Executive Summary

  • Intellectual capital is already gaining significantly in recognition and acceptance as a means of valuing and developing the key intangible assets of a business.

  • Surveys indicate that two-thirds of all US companies have started to look proactively for new ways to collect and report nonfinancial data, including intellectual capital.

  • At least a third of the current investment decisions by US companies are considered partly on the basis of intangibles. Statistics suggest that greater reliance on nonfinancial measures results in more accurate earnings forecasts.

Introduction

Intellectual capital (IC) is an offspring of the knowledge era. It is still in its formative phase, having first been formally recognized in 1991 when the large Swedish corporation, Skandia, started implementing a comprehensive set of innovative knowledge practices to account for its intangible assets. This pioneering initiative, championed by Jan Carendi and Bjorn Wolrath, resulted in Leif Edvinsson being appointed as the world’s first Director of Intellectual Capital (IC).

How will business assets be evaluated over the next decade—will they take account of those assets that are frequently and simultaneously both the most important and the most intangible? It is worth considering:

  • why just a handful of the millions of companies started since 1900 achieved solid growth for two decades, and why most of them failed within less than five years;

  • why managers try to achieve results by imposing financial goals and controls while knowing next to nothing about their company’s products, technologies, and customers;

  • how managers succeed without having any idea of the return on investments in network relationships, the costs of seeking information, or the state of their IC index.

Understanding Intellectual Capital

How Intellectual Capital Has Developed

The roots of the IC concept run deep. Norris Kronfeld and Arthur Rock wrote about it in an article featured in the November 1958 edition of The Analyst’s Journal. The economist John Kenneth Galbraith discussed the term “intellectual capital” in 1969, and Peter Drucker spoke about “knowledge workers” before that. Though systems for recording IC are now proliferating, the concept is still mysterious to most wage earners.

The Importance of Nonfinancial Measures

The importance of nonfinancial measures is self-evident. W. Edwards Deming, legendary creator of the quality circles concept, has criticized managers in the United States for spending over 97% of their time analyzing figures, and less than 3% on the intangibles that really matter. In other words, they spend 97% of their time trying to figure out 3% of what is going on.

Every third Nordic company now takes these “soft values” into account. The IC network plays its part in this global value evolution. We work with hundreds of consultants and researchers along two mainstream lines: we assist organizations that are installing IC routines, and we cultivate and improve our tools by developing IC ratings and using intellectual labs like the growing net of Future Centers.

Powerful institutions, like the US Federation of Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC) in Washington, are now endorsing supplementary accounts. The influential Brookings Institution explores the issue systematically. In Denmark a government proposal has made it a matter of legislation. When the international magazine Business Week ranks business schools, it features indicators of intellectual capital. Since present financial indicators just refer to the past, they create perilous gaps between the bottom line and long-term goals. They offer a frail groundwork for the strategies of leading-edge companies. Clearly, the key to future productivity is to recognize the interplay of psychological, sociological, and political values in entrepreneurship.

To the extent that customers get involved as co-producers, knowledge that used to be external and distant becomes ever more internal and intimate. Obviously, such changes cannot be handled by traditional accounting practices.

Monetary economies and accounting practices have provided mankind with efficient tools for complex social organization. The present challenge is to make them more multidimensional. Instead of being just black boxes, they could become compasses for charting the course toward tomorrow. The bottom line may be useful when a bank considers lending money to a company. It is not useful for running a company. Cash is only the beginning and the icon of the value-creating process. It is a wonderful enabler, but it can make us forget the reasons for doing something, for creating meaning.

It takes patience, perseverance, and painful re-examinations to make a vision like IC consistently operative. To date, it has been mainly the large and lucrative companies that have taken intangibles into account. Unfortunately, some of them seem to get it all wrong. Instead of using the indicators to advance employee competence or increase surplus and stockholder value, they often exploit them chiefly as seminar exercises for top management.

This is dangerous, since the emerging talent war has triggered a brain drain from large companies to small and medium-sized enterprises. Future business battles will be about ideas and non-traditional thinking, turned into knowledge innovations.

Certainly, figures cannot be faked as easily as words and symbols. Some people fear that before global standards are established, IC audits will open the gates for arbitrary, even fraudulent practices. Probably, yes. But in the absence of IC, vast areas of corporate reality remain in the dark, just visible to insiders. You might as well argue that IC is just what the doctor ordered to restore public confidence in the stock and securities markets.

A corporate rush to cut the brain’s lead times is the name of the competitive game now. One way to win is to start learning before new skills are required. To make qualified guesses, and invest in the supposed future. Buying such intellectual options will be a key strategy in the knowledge economy.

The internet now defies the established control of distribution channels and intellectual property. It undermines anyone whose status depends on privileged access to information. It leverages IC by offering extraordinary opportunities to start new businesses and see prompt returns. It is doing all that, and is likely do it much better and faster tomorrow. Maybe it is time to replace Adam Smith’s famous metaphor of the market—the invisible hand—and talk about the invisible brain.

Though stock market booms and busts distract attention from what is really happening, the industrial laws of gravity are being supplanted by rules dictated by knowledge. As the costs of copying and distributing products approach zero, old value chains will break or become obsolete.

There is much to be done before IC standards achieve the sophistication and reliability required to earn general respect. Nevertheless, they are already worth their weight in gold. As financial capital becomes ever more questioned and volatile, sustainable earnings capabilities and new wealth will tip the scales in favor of IC.

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Further reading

Books:

  • Cusumano, Michael A., and Constantinos C. Markides (eds). Strategic Thinking for the Next Economy. San Francisco, CA: Wiley, 2001.
  • Edvinsson, Leif. Corporate Longitude. Englewood Cliffs, NJ: FT Prentice Hall, 2002.
  • Marr, Bernard. Perspectives on Intellectual Capital: Multidisciplinary Insights into Management. Woburn, MA: Butterworth-Heinemann, 2005.
  • Stankosky, Michael. Creating the Discipline of Knowledge Management: The Latest in University Research. Woburn, MA: Butterworth-Heinemann, 2005.

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