The issue of measuring the value of knowledge (and of knowledge management) remains one of the enduring challenges in KM. With the growing realization that financial measures "look backwards and at physical assets only", organizations need to get a grip on measuring what is perhaps their most valuable asset - knowledge. During the last few years several methods have emerged that specifically focus on the measurement of intellectual capital. This comprises the intangibles of the business that underpin future growth. It includes assets such as brands, customer relationships, patents, trademarks and, of course, knowledge. This briefing paper outlines some key issues and approaches in the measurement of knowledge and intellectual capital.

There is growing criticism that the traditional balance sheet does not take account of those intangible factors that largely determine a company's value and its growth prospects. The 'unreported' assets are on average 5-10 times those of the tangible assets. Furthermore several studies show that future growth is determined not by historical financial accounts but by factors such as management skills, innovation capability, brands and the collective know-how of the workforce. Consequently more organizations are starting to address the measurement and management of intangible assets such as knowledge. Those who do so cite several benefit:

• It more truly reflects the actual worth of the company
• The process of measurement gives insights into the drivers of sustainable performance
• Demands are growing for effective governance of intangibles, of which social and environmental reporting are already evident
• "What gets measured, gets managed" - it therefore focuses on protecting and growing those assets that reflect value
• It supports a corporate goal of enhancing shareholder value
• It provides more useful information to existing and potential investors.

Led by initiatives in Scandinavia, more organizations are now embarking on tackling the problem of intangible measurement. Our research [1] found over 30 different measurement methods, which we have grouped into four main approaches under the acronym ABBA.

The four approaches for measuring intangible - not mutually exclusive - are:

• Asset - valuing knowledge as an asset, potentially tradable
• Benefits - focusing on the benefits of a KM programme
• Baseline - assessing KM effectiveness as a basis for year-on-year comparison
• Aaction - focusing on performance measurement.

Whichever approach is adopted, a starting point it to divides intellectual capital into several categories. A typical classification is as follows:

1. Human Capital - that in the minds of individuals: knowledge, competences, experience, know-how etc.
2. Structural Capital - "that which is left after employees go home for the night": processes, information systems, databases etc.
3. Relationship (or Customer) Capital - customer relationships, brands, trademarks etc.

There are variants on such a classification. One is to separate out those assets protected by law - intellectual property. This includes trade-marks, patents, copyrights, licences. The point of classifying is to develop a set of measures that can be used to assess progress. Edvinsson and Malone, for example, report 90 measures in 5 groups developed by insurance company Skandia for its 'Navigator':

• Financial (20): income per employee, market value per employee etc.
• Customer (22): number of customer visits, satisfied customer index, lost customers
• Process (16): administrative error rate, IT expense per employee
• Renewal and Development (19): training per employee, R&D expense/administrative expense, satisfied employee index
• Human (13): leadership index, employee turnover, IT literacy.

This is part of a 'balanced score-card' that adds non-financial measures alongside financial measures as a tool for managers and a measure of overall performance. Our research shows that another balance is also important. This is the balance between indicators that represent inputs, processes and outputs - a feature not explicit in methods like the Skandia Navigator.

"If you're not keeping score, you're only practicing" says one commentator. To keep score you need to develop a measurement system using measures, such as those just listed, appropriate to each business unit. The last few years has seen a growth in the use of various measurement systems, such as:

• The balanced scorecard: developed by Kaplan and Norton. Designed to focus managers' attention to those factors that help the business strategy, it adds alongside financial measures, measures for customers, internal processes and innovation.
• Economic Value Added (EVA^TM) developed by Stern Stewart this is related to the return on capital employed. An associated measure is MVA (Market Value Added).

While playing an important part, critics of such measures argue that they are static measures and do not help managers identify the underlying cause and effect. The last few years has seen the development of new kinds of scorecard that are more directly helpful to understanding your intellectual capital. The ones we have identified as significant are:

• The Skandia Navigator (a kind of balanced scorecard) and its underlying value creation model.
• Karl Erik Sveiby's Intangible Assets Monitor - this divides intangible assets into external structure, internal structure and competence of people.
• The IC Index^@reg;, of Intellectual Capital Services - this combines value drivers in a distinction treee (hierarchy).
• The Inclusive Value Methodology of Professor Philip M'Pherson. This combines financial and non-financial hierarchies of value.
• IC Rating^® of Intellectual Capital Sweden - also a hierarchy but adds a risk factor.
• The Danish template developed in a 3-year in-depth project by the Danish Ministry of Industry.
• The VAIC^TM (Value Added Intellectual Coefficient) method from the Intellectual Capital Research Centre in Zagreb.

Each of these methods has some interesting characteristics, but unlike raw balanced scorecards, they variously help managers focus, not just on the components of value, but on trends, momentum, underlying factors, interactions and sensitivities to risk etc.

Companies that are applying such measures have found it gives them better understanding of the drivers of value and is improving management and growth of these vital assets. For example:

• Skandia AFS - use its Navigator and other tools to set management goals and drive the business forward. It published Intellectual Capital Supplements alongside its twice yearly financial reports from 1994-1999.
  
  
• Dow Chemical - has focussed specifically on understanding the value in their patent portfolio. Using the Technical Factor method of Arthur D. Little, alongside their own management model, they have generated over $125m new revenues from their patents.
  
  
• Austrian Research Centres, Seibersdorf - developed an IC report to provide better information to its stakeholders, that also revealed greater insights into its internal knowledge processes.
  
  
• Systematic Software Engineering, Denmark - its IC report helped raise the organization's profile, attracting more customers and highly skilled employees.

The measurement of intellectual capital is still relatively new, with only a smattering of pioneering companies widely using the newer measures. Our research has identified a number of steps that such companies go through before achieving visible business benefits:

• Developing a greater awareness and understanding of the role of knowledge and the nature of intellectual capital.
• Creating a common language that is more widely diffused within their company e.g. use of terms such as 'human capital'.
• Identifying illuminating indicators that are suitable and appropriate.
• Developing a measurement model, that brings these indicators into a coherent framework.
• Introducing measurement systems, including the accompanying management processes that guide and reward managers
• Using objective impartial consultants and surveys to carry out key aspects of the measurement process.
• Active communication and involvement of all those whose output is being measured.

Experience suggests that rushing into the details of measurement before understanding some fundamentals is counter-productive. One of the leading practitioners we interviewed put it succinctly:

"You need good mental models, before you can develop good management models."

The time is now ripe for organizations to develop that understanding and to develop new measures that will guide them more clearly to a prosperous future.

© Copyright. David J. Skyrme. First published 1997; latest revision October 2005. This material may be copied or distributed subject to the terms of our copyright conditions (no commercial gain; complete page copying etc.)

Material in this briefing was originally developed from research for the report Measuring the Value of Knowledge, David J. Skyrme, Business Intelligence (1998). Revisions to this Insight draw on content from an extensively expanded and updated edition of this report Measuring Knowledge and Intellectual Capital (2003) that compares and contrasts over 30 methods and provides considerable elaboration on the guidelines. It also considers KM assessment methods, measures of RoI (return on investment) of KM programmes and new holistic (sustainability) measures.

Measuring Knowledge and Intellectual Capital, David J. Skyrme, Business Intelligence (2003) is a 500 page report devoted specifically to the topic. It includes analysis, positioning, case examples and best practice guidelines.

Measuring The Value of Knowledge, David J. Skyrme - a Knowledge Briefing introducing the subject including an overview of different approaches, guidelines, pitfalls, and references to 40 different methods.

Making the Business Case for Knowledge Management, David J. Skyrme - a K-Guide giving a step-by-step guide to making the business case for investing in knowledge management.

The following books give their own perspectives on measuring intellectual capital:

Intellectual Capital: The New Wealth of Organizations, Thomas A. Stewart, Doubleday/Nicholas Brealy (1997) - a general overview, not specifically focused on measurement, though does contain an indicative example of a 'knowledge accounting' balance sheet.

The New Organizational Wealth: Managing and Measuring Intangible Assets, Karl Erik Sveiby, Berrett Koehler (1997) - describes his intangible assets monitor.

Intellectual Capital: Realizing Your Company's True Value by Finding Its Hidden Brainpower, Leif Edvinsson and Michael S. Malone, HarperBusiness (1997) - discusses the development of intellectual capital measurement at Skandia, and gives detailed itemization of measures used.

Intellectual Capital: Navigating in the New Business Landscape, Johan Roos, Göran Roos, Leif Edvinsson and Nicola Dragonetti, Macmillan (1997) - describes the Intellectual Capital Index.

Making Sense of Intellectual Capital, Daniel Andriessen, Elsevier Butterwroth-Heinemann (2004) - provides a good overview of the different methods as well as outlining his Weightless Wealth method.

Related articles on this website:

• Innovation in Intangible Performance Measures
• Models For Metrics: Are Yours Mechanical or Mental?

Go to Insights - List of Titles for full listing of other Insights on this Web site. See also Knowledge Management Resources.

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Management Insights are publications of David Skyrme Associates, who offers strategic consulting, presentations and workshops on many of these topics.

Additional coverage of these topics can be found in our free monthly briefing I³ UPDATE/ENTOVATION International News, various articles, publications and presentations.

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