Getting to Grips with Intellectual Capital
Intangible assets, such as knowledge and customer relationships, are more than ever the core assets that drive business success in today's challenging business climate. One of the main problems is that their very intangibility makes them difficult to measure. Unlike tangible resources where 1+1=2, the nature of intellectual capital is such that 1+1 could equal 5. Different combinations may result in much higher value than the sum of individual elements. Similarly, when knowledge is transferred to another person or organisation, the originator has not lost it. These difficulties have led to a reluctance by the financial accounting community, which likes precision, to address the real need to measure the main sources of value for many companies.
Another difficulty is that of understanding the interaction between the different elements of intellectual capital and how they contribute to a firm's financial results, in both the short-term and long-term. The last few years has therefore seen an upsurge in interest in getting to grips with measuring intellectual capital - the difference between the book value of companies as measured by traditional financial measures, and the market value as expressed by share price.
The first methods to gain visibility have been those that categorise intellectual capital into its basic components.1 A typical categorisation is that of human capital (knowledge and expertise), structural capital (business processes, computer systems, organisational infrastructure) and customer capital (the value in ongoing business relationships). Some methods also separate out intellectual property, including patents, designs and copyrights. Another approach is to consider performance measurement systems, such as the balanced business scorecard and the EFQM (European Foundation for Quality Management) Excellence Model, and then introduce intellectual capital indicators into the relevant sections.
These methods are useful 'bottom up' approaches that help organizations gain wider appreciation of the elements of intellectual capital, and start the necessary processes behind their detailed assessment. They fail, however, to show the impact on financial results. This is where VAICTM comes in. Deceptively simple in its formula, it requires detailed analysis and comparison of company figures, not always reported in accounts, and generally not to the same principles. It too, considers different components of value - financial capital, human capital and structural capital - but additionally introduces an efficiency coefficient, that show how well a company converts its intellectual capital into value added (the difference between revenue and inputs excluding human resources).
VAICTM has now been applied across a range of firms, and for different countries, including Croatia. Applied on a time series of data, it indicates to business managers and to policy makers how well they are converting intellectual resources into financial wealth, and whether their conversion performance is improving or deteriorating. Ante Pulic and his colleagues at the Austrian Intellectual Capital Research centre who have developed, refined and applied VAICTM, have therefore added an essential 'top down' tool to 'bottom up' tools of the pioneers like Edvinsson, Sveiby and others.
The whole field of intellectual capital measurement and its management is still relatively new. Accountants, business managers and policy makers have still to grapple with its concepts and detailed application. VAICTM provides a helpful pointer to IC efficiency. It's a good place to start, before delving into the more detailed in-company assessments that the earlier methods address. Above all, it provides an essential link between intellectual capital and financial performance that should help to bring together the currently distinctive disciplines of finance and performance measurement.
1. These methods include the Skandia Navigator (developed by Leif Edvinnson and colleagues), and the Intangible Assets Monitor developed by Karl Erik Sveiby. The categorisation shown is normally attributed to a group that included Leif Edvinnson (then at Skandia), Gordon Petrash (Dow), Hubert Saint-Onge (CIBC), Charles Armstrong (S.A. Armstrong).
This article first appeared in Intellectual Capital: Efficiency in Croatian Economy, IBEC, Zagreb (November 2002).
© Copyright 2002. David J. Skyrme. All rights reserved.
Last updated: 29th March 2011