ARAB ACADEMY FOR SCIENCE & TECHNOLOGY

Intellectual Capital Measurement Tools

Mohamed Zaki Fareed 6/18/2012

Intellectual Capital Measurement Tools

Skandia is considered the first large company to have made a truly coherent effort at ensuring IC. Leif Edvinsson, the chief architect behind Skandias initiatives developed a dynamic and holistic IC reporting model called the Navigator with five areas of focus: financial, customer, process, renewal and development, and human capital. According to Skandias model the hidden factors of human and structural capital when added together comprise intellectual capital. Human Capital is defined as the combined knowledge, skill, innovativeness, and ability of the Companys individual employees to meet the task at hand. It also includes the companys values, culture, and philosophy. Human capital cannot be owned by the company. Structural Capital is the hardware, software, databases, organizational structure, patents, trademarks, and everything else of organizational capability that supports those employees productivity - in other words, everything that gets left behind at the office when employees go home. Structural capital also provides customer capital, the relationships developed with key customers. Unlike human capital, structural capital can be owned and thereby traded. Intellectual Capital equals the sum of human and structural capital. According to Edvinsson and Malone (1997), IC encompasses the applied experience, organizational technology, customer relationships and professional skills that provide Skandia with a competitive advantage in the market

The Skandia IC report uses up to 91 new IC metrics plus 73 (174 metrics) traditional metrics to measure the five areas of focus making up the Navigator model. Yet in trying to use their Experience to create a universal IC report, they still recommend 112 metrics. The following table summarizes some of these metrics: Financial Focus Revenues / employee ($) Revenues from new customers / total revenue ($) Profits resulting from new business operations ($) Days spent visiting customers (#) Ratio of sales contacts to sales closed (%) Number of customers gained versus lost (%) PCs / employee (#) IT capacity CPU (#) Processing time (#) Satisfied employee index (#) Training expense / administrative expense (%) Average age of patents (#) Managers with advanced degrees (%) Annual turnover of staff (%) Leadership index (%)

Customer Focus

Process Focus

Renewal and Development Focus Human Focus

The 112 indices use direct counts, dollar amounts, percentages and even survey results. Skandias model encourages direct counts to be compared with other direct counts to produce ratios or be transformed into money leaving only two types of measurement. Monetary measures are combined using a pre-determined weighting to produce an overall IC value (C) for the organization. Percentages, that can be considered measures of incompleteness, can be combined to produce the coefficient of IC efficiency (i) that captures the organizations velocity, position, and direction . An organizations IC represents a multiplicative function of the two sums, C and i. Organizational Intellectual Capital = i C 2) IC-INDEX The IC-Index is an example of second generation practices that attempt to consolidate all the different individual indicators into a single index, and to correlate the changes in intellectual capital with changes in the market. The notion of an IC-Index was first advanced by Goran Roos and his colleagues at Intellectual Capital Services Ltd. Roos et al. (1997) propose that the specific measurement of company IC forms, weightings, and indicators can be decided by knowing the companys strategy, characteristics of the particular business of the company, and its day-to-day operations.

To give an example, Roos et al. (1997) suggest that company strategy and those IC forms which help the company achieve its strategic goals should be the guiding factor in deciding which IC structural or human capital form to emphasize in an index. Moreover, the main consideration for selecting weights assigned the IC forms should be the relative importance each capital form has in the particular business of the company. 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. This second set is made up of key success factors (KSF) that can describe more than one company, and indicators which reflect a companys characteristics more closely. Information from the two steps are then to be joined leading to the creation of an IC system. Unfortunately, although the authors state that information from the two sets should be joined together to create the IC measurement system, they do not explain whether each category has its own measurement, and how such measures duplicate or offer unique variance from that contributed by the second set of KSF and indicators. 3) TECHNOLOGY BROKER Annie Brooking (1996) makes a practical contribution to IC measurement by offering three measurement models to help calculate the dollar value of IC as identified through the Technology Brokers IC audit. In Brooking definition IC consists of four components: 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. Human-centered assets are the collective expertise, creative and problem-solving capability, leadership, entrepreneurial and managerial skills embodied by employees of the organization. Intellectual property assets contain the legal mechanism for protecting many corporate assets, and infrastructure assets including know-how, trade secrets, copyright, patent and various design rights, trade and service marks. Infrastructure assets, equal those technologies, methodologies and processes which enable the organization to function including corporate culture, methodologies for assessing risk, methods of managing a sales force, financial structure, databases of information on the market or customers, and communication systems. The diagnostic process starts by having the organization answer twenty questions that make up the IC indicator. The results of this test suggest that the less a company is able to answer in the affirmative to the 20 questions, the more it needs to focus on strengthening its intellectual capital. Each component of Brookings IC model is then examined via a number of specific audit questionnaires that ask questions specific to those variables thought to contribute to that asset

category. For example, to identify the hidden value due to Market-Related intangibles, Brooking asks 15 Brand audit, 14 Customer audit, 7 Name audit, 5 Backlog audit, and 6 Collaboration audit questions. Intellectual Property intangible assets are identified by 9 Patent audit, 6 Copyright audit, 3 Design audit, and 4 Trade-Secret audit questions. Human-Centred hidden assets are identified by 5 audit questions about Employee Education, 5 Vocational audit, 12 Work-related Knowledge audit, 8 Occupational Assessment audit, 8 Work-related Competency audit, 10 Corporate Learning audit, and 3 Human-centred Asset Management audit questions. Lastly, Infrastructure hidden assets are evaluated by 6 Management Philosophy audit, 4 Corporate Culture audit, 31 Corporate Culture Collaboration audit, 7 Information Technology Systems audit, 6 Database audit, and 4 IT Manager audit questions. In total, the Technology Broker IC Audit is comprised of 178 questions. Once an organization completes its IC Technology Broker audit, Brooking offers three methods to calculate a dollar value for the IC identified by the audit. 4) INTANGIBLE ASSET MONITOR This model was developed by Karl-Erik Sveiby (1997) He foresees an intangible model as clearly understood as that of an organizations book value equal to tangible assets minus visible debt. Sveiby proposes a conceptual framework based on three families of intangible assets: External structure, (brands, customer and supplier relations) Internal structure, (the organization: management, legal structure, manual systems, attitudes, R&D, software) Individual competence, (education, experience). While efficiency of the internal structure or operational efficiency of an organization has historically been part of most traditional accounting measurement, the other two intangible assets in his model are not. Sveiby believes that the problem with using measures of these two assets is not that they are difficult to design; rather their outcomes seem difficult to interpret as they correlate with changes in business performance. Sveiby identifies three measurement indicators: growth and renewal i.e., change, efficiency, and stability for each of the three intangible assets. He recommends managers select one or two variables indicative of each indicator similar to those developed in the example of his Intangible Assets Monitor model shown below. SAMPLE MEASURES FOR INTANGIBLE ASSETS External Structure Internal Structure Growth & Renewal
organic volume growth growth in market share satisfied customers investments in IT time devoted to R&D attitude index of personnel toward managers, culture, customers

Competence of People
share of sales from competence enhancing customers growth in average professional experience

 Efficiency

quality index profit per customer sales per employee proportion of support staff sales per support staff

competence turnover change in added value per employee change in proportion of employee

The second step in designing a measurement system for intangible assets is to classify all employee groups within one of the two categories: professional and support staff. Professionals are those who plan, produce, process, or present the product or solutions, and who are all directly involved in client work. They are the only employees considered when assessing the third intangible asset: competence of personnel. All other employees whose work seeks to preserve, maintain, and develop the internal rather than external structure, those who work in accounting, administration, reception, etc., while essential to a firms long-term viability, contribute to an organizations internal structure and should be measured under that category. Where employees perform a variety of duties, the time spent working for clients is assigned professional, with the rest charged to the internal structure. Outside experts and suppliers are considered under the external structure as an important element in the external networks. Sveiby lists specific indices for each of his three growths and renewal, efficiency, and stability measurement indicators used to assess each category of intangible assets of a knowledge organization. To measure professional competence intangible assets, the indices include: Growth/renewal: number of years in the profession, education level, training and education costs, grading of executives, professional turnover, competence-enhancing customers Efficiency: proportion of professionals in the company, the leverage effect of professionals, value-added per professional Stability: average age, seniority, relative pay position, professional turnover rate To measure internal structure intangible assets, the indices include: Growth/renewal: investment in the internal structure, investment in information processing systems, customers contributing to internal structure Efficiency: proportion of support staff, sales per support person, values and attitude measurements Stability: age of the organization, support staff turnover, the rookie ratio To measure external structure intangible assets, the indices include: Growth/renewal: profitability per customer, organic growth Efficiency: the satisfied customer index, win/loss index, sales per customer Stability: proportion of big customers, age structure, devoted customers ratio, frequency of repeat orders

5) ECONOMIC VALUE ADDED (EVA) Economic Value Added (EVA) was introduced by Stern Stewart as a comprehensive performance measure that uses the variables of capital budgeting, financial planning, goal setting, performance measurement, shareholder communication, and incentive compensation to properly account for all ways in which corporate value can be added or lost. EVA is intended to offer improvements to the market value added (MVA) calculation. MVA represents the spread between the cash that a firms investors have put into the business since the startup of the company and the present value of the cash that they could get out of it by selling their shares. EVA only concentrates on changes in MVA occurring from new projects to account for the spread between market value and total capital. It accomplishes this by emphasizing maximizing incremental earnings over capital costs. To have a positive EVA, therefore, a companys rate of return on capital must exceed its required rate of return. Net sales - operating expenses - taxes - capital charges = EVA 6) CITATION-WEIGHTED PATENTS According to Bontis (1996), Dow Chemical has been at the forefront in using patents as proxies for practical IC measurement. Former Director of Intellectual Asset Management at Dow, Gordon Petrash, implemented a six-step process for managing intellectual assets that includes: Defining the role of knowledge in the business Assessing the competitions strategies and knowledge assets; Classifying the companys portfolio of knowledge assets; Evaluating the value of those assets to keep, develop, sell, or abandon; Investing in areas where gaps have been found; and Assembling the new knowledge portfolio and repeat ad infinitum. Citation-Weighted Patents is a technology factor is calculated based on the patents developed by a firm. Intellectual capital and its performance is measured based on the impact of research development efforts on a series of indices, such as number of patents and cost of patents to sales turnover, that describe the firms patents. A significant component of Dows initial management of intellectual assets has been its review of patent maintenance within R&D to create objective, major cost savings for the firm (Lynn, 1998). The Dow model estimates a technology factor to identify the impact of R&D efforts that lead to the creation of intellectual property and uses indicators such as R&D expense per sales dollar, number of patents, income per R&D expense, cost of patent maintenance per sales dollar, and project lie-cycle cost per sales dollar. Dow started with patents as an obvious and important example of intellectual assets in order to make IC visible to the organization.

Traditional accounting methods assign value to patents, but only in terms of the cost to obtain the patent, and not the cost of the R&D leading to the patent, nor the potential for marketability if put into production, nor any legal considerations about the patent. Objectively measuring and monitoring patents using multiple indicators within Dows technology factor, has made this intangible asset become meaningful. It also has the benefit of more thoroughly incorporating the bottom-line impact of R&D efforts. In addition, the Dow patent evaluation process can measure the internal operations that created the intellectual property, and can be benchmarked against other companies in the industry or compared to industry averages.

CONCLUSION
1) Scandia Navigator Scandia navigator IC components do not defer in definition of Human capital but when it comes to Structural capital it mixes organizational and relational capital together in addition to that it considers some components that can be listed in balance sheets like hardware. In Scandias model the third component it Intellectual capital that holds all Human Capital and Structural capital. The most confusing point regarding Skandia navigator it that Leif Edvinsson,is the chief architect behind Skandias, whos is referred to as the author of Organizational capital definition in managing intellectual capita in practice. 2) IC-INDEX The first point that worth to notice that it emphasizes on considering the company strategy as the major source in the value that the company intends to deliver. 3) TECHNOLOGY BROKER Technology broker the questionnaires covers the four major IC components. In technology broker human-centered assets is equivalent to human capital, where Intellectual property assets, infrastructure assets and market assets are equivalent to Organizational. Meanwhile it seems that technology broker is not considering relational capital in the definition of IC components, but we can see in market related questionnaire sample that they consider relational capital with customer, backlog related questions and collaboration. 4) INTANGIBLE ASSET MONITOR Intangible asset monitor could be the closest if not identical definition to IC components, it consists of external structure, internal structure and competence in the definition we can see that the external structure is as same relational capital, internal structure also is as same as organizational capital and individual competence is equivalent to human capital. 5) ECONOMIC VALUE ADDED (EVA) Economic value added if as financial indicator the does not reflect intellectual capital by any meaning. 6) CITATION-WEIGHTED PATENTS

This method is mainly concerned with patents which is part of organization capital therefore its main disadvantage is that it ignores the rest of intellectual capital components although they are major contributor to firms value creation process.