Lecture 5

Intangible Capability through

People
Contents

1 Financial Capital & Intangible Capability

2 Accounting for Intangible Value

3 Evaluating Intangible Capability

4 Conclusion

2
Definition of an intangible asset

”an identifiable non-monetary asset without

physical substance”
Intangible Asset Issues
Characteristics
Two Main Characteristics:
(1) They lack physical existence.
(2) They are not financial instruments.

Normally classified as long-term asset.

Common types of intangibles:
Patents Trademarks or trade names
Copyrights Goodwill
Franchises or licenses
Valuation
Purchased Intangibles:
Recorded at cost.
Includes all costs necessary to make the intangible asset ready
for its intended use.

Internally Created Intangibles:

Generally expensed.
Only capitalize direct costs incurred in developing the
intangible, such as legal costs.
Financial Capital & Intangible
Capability
Market value of a firm

 A firm’smarket value is based largely on

two factors:
 financial capital; and
 intangible value
Financial Capital and Porter’s Value
Chain
 Fifty years ago, financial capital was
 the critical strategic resource for organizations
 Most management models developed at this
time
Conventional Models

Boston Consulting Group (BCG) matrix

 Boston Consulting Group (BCG) matrix, were
designed to help managers allocate capital to
decide which businesses to grow and which to
harvest
Porter’s value chain which describes
 how raw materials enter the organization;
 go through a series of processes
 that convert these materials into finished goods;
and
 how these goods are then provided to
customers
 ROI is an important and easy to use tool
 as both inputs and outputs have a defined financial
value
Recent Models

 Economic value added (EVA) suggests that

 a company should only fund a project if
▪ its return on financial capital is greater than the cost
of that capital
Criticism

 Financial capital is no longer

 the scarce resource that constrains growth.
 Globalcapital markets move money around
so quickly that
 having preferential access to capital no longer
brings competitive advantage.
 Many companies have
 more financial capital than they are able to use
Intangible Capability

 The components of intangible capability

can be separated out in several different
ways
 CIPD Model
Customer Capital and the Customer
Value Chain
 Customer capital
is the value of a
company’s franchise:
 its ongoing relationships with the people with
whom it does business, supported by its
branding and corporate reputation
 Thevalue provided by customer capital has
gained importance.
 key value chain becomes a customer-driven one
 Customer value chain is also basis of
 Bain & Company’s work on customer loyalty.
 Oneof their directors, Frederick Reichheld
(1996) noted that the average US company
now loses
 half its customers in five years,
 half its employees in four, and
 half its investors in less than one.
 Reichheld (1996):
 Profits are not at the heart of this new model.
They are critically important, of course, as an end
in themselves and because they are the source of
the incentives that keep employees, investors, and
customers loyal. But the course of all cash flow,
including the cash flow that eventually becomes
profit, is the rising spiral of value that springs
from the creation of superior value for customers.
 Together withEarl Sasser from Harvard,
Reichheld has estimated that
 a 5% increase in customer loyalty can produce
profit increases ranging from 25 to 85%
 They conclude that
 the quality of market share, measured in terms
of customer loyalty, deserves as much attention
as the quantity of that share (Reichheld and
Sasser, 1990)
 Reichheld (1996b) has shown that:
 given customer acquisition costs and the
additional value of repeat purchases and
referrals,
▪ a customer who stays with a company for 2 years
would generate $26 of profit
▪ whereas customers who stay for 10 and 20 years
would generate $760 and $2104 net profits
respectively.
Human, Organizational and Social
Capital

Human Capital.
 Human capital exists as a resource and a
capability,
 at individual and organizational levels.
 Individual human capital is acquired
 by attracting and selecting staff with the right
skills and experience.
 It can be developed through learning.
 Human capital can be converted into an
organizational resource by
 aligning people with the organization
 leveraging
Organizational Capital.
 Organizational or structural capital is the infrastructure
 that supports people to do their work.
 It includes elements like
 fitness of the
▪ organization structure,
▪ operational and management processes, procedures, routines,
▪ general use of information,
▪ IT systems and databases,
 existence of a knowledge centre,
 explicit knowledge and know-how
 Organizationalcapital has the advantage of
being fully owned by the company –
 it remains in place when the employees leave
and
 is therefore easier to manage and change than
human capital
Social Capital.
 Social or relational capital is an emergent
property arising from the organizational
system –
 the organization and the people working in the
organization.
 It provides the glue
 that holds organizations together.
 It is even less tangible than human capital
 It includes
 the network of relationships and
 features of social life within an organization,
 the knowledge tied up and shared in these
relationships,
 the ability to work together with other people in
value creation,
 the corporate culture, beliefs lived and
 values demonstrated by employees.
 Nahapiet and Ghoshal (1998) say:
 Social capital is owned jointly by the parties in a
relationship, and
 no one player has, or is capable of having
exclusive ownership rights.
The HCM Value Chain

 Human capital appreciate with use.

 Bartlett and Ghoshal (2002) calls it a
strategic resource as:
 surplus financial capital is chasing scarce
Human Capital:
▪ talented people and
▪ their knowledge
▪ the causal ambiguity of this scarce resource
Examples of Intangible Capability

 McKinsey’s 7S model basically consists of

different elements of human, org and social
capital:
 human capital = staff and skills;
 organizational capital = strategy, structure and
systems;
 social capital = superordinate goals and style.
Ulrich and Smallwood (2004)
identified 11 intangible capabilities
Customer capital
 Customer connectivity: building enduring
relationships or trust with targeted customers.
Human capital
 Talent: attracting, motivating and retaining
competent and committed people.
 Leadership: embedding leaders throughout
the organization.
Organizational capital
 Speed: making important changes rapidly.
 Accountability: demanding high performance
from employees.
 Learning: generating ideas with impact.
 Innovation: developing breakthrough
products and processes.
 Efficiency: managing costs.
 Social capital
 Shared mindset and coherent brand
identity: ensuring positive, consistent
perceptions of the company among employees
and customers.
 Collaboration: working effectively across
organizational boundaries.
 Strategic unity: articulating and sharing a
strategic viewpoint.
How an organization needs to pick
intangibles
 Collaboration if the business strategy is
about managing alliances.
 Learning if the strategy is about sharing
knowledge across global business.
 Talent if the employer is trying to grow in
new industries.
 Speed if the organization is trying to
compete on cycle time.
The Work Foundation’s five intangible
factors of production

Human capital
 Leadership: visible and accessible leadership
and management, combined with high
expectations from those in decision-making
roles.
Organization capital
 Structure: unique organizational structure
resulting from geography, size and history,
that enables continued success rather than
being a specific driver of that success.
 Process: a higher degree of informality and
continued dialogue supported by simple –
though not simplistic – processes that allow
faster decision-making.
Social capital
 Communication: openly sharing information between
peers and networks or managers that need timely and
accurate information in order to get the best job done.
 Culture and employee relations:
 a distrust of the status quo,
 valuing quality rather than quantity,
 a focus on the long term and on outcomes;
 a positive climate characterized by pride, innovation and
 strong interpersonal relations.
Accounting for Intangible
Value
The Value of Financial Valuation

 Today’s accounting systems were designed

 to report on tangible assets such as plant and
machinery.
 They cannot handle the intangibles
 The market can undervalue a company’s
intangibles.
 When this happens, companies are either led to
under-invest in their people or will be penalized
by the market
 Ernst& Young’s Measures that Matter
report (1997) demonstrates:
 To claim that tangible assets should be
measured and valued, while intangibles should
not – or could not – is like stating that ‘things’
are valuable, while ‘ideas’ are not.
Valuing Intangible Capability

 Thedifficulty in valuing intangibles

financially is that
 while costs are still fairly easy to identify,
 it is much harder to understand their benefits.
Valuing intangible value
Direct Valuation

 The benefit of direct valuation is that,

 like metrics, it gets attention.
 The disadvantage is that
 it can be very superficial
 all valuations rely on subjectivity and uncertainty
so they lack reliability.
 Thefact that market value is so much higher
than book value is often used to argue that
 intangibles have a financial value
Indirect Valuation

 Lev(2004) provides a methodology for

calculating intangible-driven earnings
 by subtracting from earnings the average
contribution of physical and financial assets in
the company’s industry.
 The value of intangible capital is then calculated
as the present value of the forecasted stream of
intangible-driven earnings
 The benefits of this approach are that it
provides a more valid calculation of overall
intangible value than market value.
 The disadvantage is that it is very sensitive
to interest rates and to assumptions that are
made in calculating discounting rates.
Creating value from intangibles

 Kaplan and Norton (2004b) note that

creating value from intangibles differs from
managing physical and financial assets in
four important ways:
 1. Value creation is indirect … Improvements in
intangible assets affect financial outcomes
through chains of cause-and-effect relationships.
 2 Value is contextual … The value of an intangible
asset depends on its alignment with the strategy
 3. Value is potential.
 The cost of investing in an intangible asset represents
a poor estimate of its value to the organization.
 Intangible assets … have potential value but not
market value …
 4. Assets are bundled
 Maximum value is created when all the
organization’s intangible assets are aligned with each
other, with the organization’s tangible assets, and
with the strategy.
Evaluating Intangible
Capability
Levels of Value

 Value of intangibles is contextual and

dependent upon alignment with an
organization’s strategy
 Scorecards provide a better approach
because
 they do not try to establish a hard link between
intangible value and a financial metric,
 but describe a potential relationship between
these elements
 As Kaplan and Norton (2004a) explain:
 It becomes clear that measuring the value of
intangible assets is really about estimating how
closely aligned those assets are to the company’s
strategy. If the company has a sound strategy
and if the intangible assets are aligned with that
strategy, then the assets will create value for the
organization.
3 levels: value for money, added value
and created value
 Value for money. Value for money refers to
basic, largely tangible value that may
represent
 increased efficiency;
 incremental improvements in effectiveness;
 meeting compliance requirements or other basic
standards.
 Added value.
 Added value represents capabilities required to
meet business needs.
 These capabilities
▪ can relate to major improvements in efficiency
▪ but are more likely to be about increased effectiveness
leading to growth, change and development
 Created value.
 Created value represents capabilities that offer
the potential
▪ to sustain and transform the way the business works
and
▪ to create new opportunities for competitive advantage.
Assignment

 Compare Best Practice with Best Fit

 Literature not older than 5 years
Thank you