The first driver is the shift in the control of the means of production. In the industrial era, a company’s profits were driven by what it owned. Workers had to come to the employer to get access to the means of production. It gave companies a greater level of control over its workers. With the rise of the knowledge economy, however, the knowledge held by employees and, indeed, external stakeholders have become an important part of a corporation’s “means of production.” The knowledge factory relies on the unique contribution of human and relationship capital elements. This shift in the balance of power means that companies have to pay more attention to the interests and priorities of their stakeholders as “partners” in the success of the knowledge factory.

The second driver of the increased focus on reputation is the acceleration of communications. If you didn’t understand this before, you certainly do now given the events of wikileaks, Tunisia, and Egypt. Blogs, Twitter, Facebook and other social networks are just the latest developments in a society that had already developed 24-hour news. It is easier than ever before for anyone to get a message out. Sometimes all it takes is a blog post or a YouTube video by one disgruntled customer to go viral and threaten your reputation in an instant.

The third driver is an increased interest in sustainability and corporate social responsibility. Sustainability is an umbrella term for a number of related trends including corporate social responsibility and triple bottom line. CFO magazine defines sustainability as “the practice of publicizing a company’s environmental and social risks, responsibilities and opportunities…it can be thought of as an environmental-impact statement for the entire corporation, with ‘environment’ defined not only in terms of natural resources and climatological effects but also the economic and social impacts of labor practices, charitable endeavors and governance structures.”

The fourth and final driver is the lack of transparency of intangibles. There is a shocking lack of information available to internal and external stakeholders about the knowledge side of business. So when news does get out about a problem or a failure, then the reaction is swift and often very negative. If your stakeholders don’t understand how your business works and don’t receive periodic information beyond just the financials, then bad news is a warning to get out. The less your stakeholders understand about your business and the less you share about non-financial aspects of it, the more vulnerable you are to severe reactions to bad financial news.

You need to consider all four drivers as you think about managing your reputation. But we ask you to pay special attention to the last driver—intangibles reporting. You have a lot of control over your reputation—if you are getting the kind and quality of information to your stakeholders. And very few companies have developed good reporting on intangibles. That means that the 80% of corporate value that is driven by intangibles is invisible. Stakeholders can only guess at it unless you give them the information they need. This is really the goal of Intangible Capital. Helping you see, leverage and communicate about your intangibles. Because it will help you perform better AND because it will help you get the reputation you deserve.

Adapted from Intangible Capital: Putting Knowledge to Work in the 21st Century Organization by Mary Adams and Michael Oleksak.

In thinking about reputation, however, it is important to flip the perspective and see your company through the eyes of your people and your partners. As contributors to the knowledge factory, they are also stakeholders in its success. What do they think of the organization? Does it seem sustainable? Is it a place they want to be or to do business with?

There are countless factors influencing that judgment by your employees and stakeholders. For your employees, it’s about being a good place to work, about compensation and growth. For your customers, it’s about your product, your service, your pricing and how you stand up against the competition. For both, it’s about the quality of your structural capital, the amount of collective knowledge in your system, how you use what you know to create value.

Increasingly, it’s also about how you behave as a corporate citizen. Your environmental footprint, your social contributions, your fairness and transparency. The perspective that’s important here is the perspective of the employee and the stakeholder. It’s about what they think, not what you think. And whether what they think is enough of an incentive to stay connected to you.

There are also new categories of relationship capital that must be mentioned. These include stakeholders such as investors, bankers, neighbors, markets, and even society as a whole. Investors are interested in your financial results and your capacity to continue to produce results in the future. Bankers have a direct interest in the continuing success and viability of your business. Neighbors include the communities that live and work near your facilities or are affected by your product or services. Markets include your competitors and participants in markets related to yours. Society as a whole includes stakeholders that are interested in legal, environmental and systemic consequences of your organization’s actions. Each of these has varied interests. And any one of them can withdraw their support if they believe their interests are not being served.

What holds the whole thing together? Your reputation. Being a good (or good enough) employer. Being a good (or good enough) partner. Your stakeholders collectively create your reputation and they will make their stay-or-leave decisions based on that same reputation. That means that your reputation is your license to earn money in the future. Last year’s earnings tell you the financial bottom line but they don’t tell you whether you are in a good position for a repeat performance. For this, reputation is a much stronger indicator. As the sum total of your company’s value, your reputation will be set through the consensus of your stakeholders. And ultimately, your reputation becomes a leading indicator of your financial earnings. Which is more than enough reason for anyone (even those who view “shareholder value” as measured by short-term stock swings) to pay attention to intangibles and reputation.

Adapted from Intangible Capital: Putting Knowledge to Work in the 21st Century Organization by Mary Adams and Michael Oleksak.

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U.S. business culture is very much about results. Two of the ideas that best capture this perspective are the concepts of the “bottom line” and “shareholder value.” The bottom line is a financial calculation. As we have made clear throughout this book, the integrity of financial statements that are used to calculate the profit or loss of an enterprise is seriously compromised by their failure to address knowledge intangibles. Profit and cash flow are still important to the day-to-day survival of a business. But focusing on today’s bottom line without regard to tomorrow’s bottom line can lead you to make bad decisions: To outsource a function that should be a core competency. To fail to invest in an intangible that will preserve and protect a competitive advantage.

Peter Drucker put it this way in the Essential Drucker (p. 111):

Our traditional mind-set…has always somehow perceived business as buying cheap and selling dear. The new approach defines a business as the organization that adds value and creates wealth.

The question of value has actually been at the forefront of American business vocabulary for several decades. The “maximization of shareholder value” is a core doctrine that has rarely been subject to much question. Who could argue? It seems to be the most sensible idea there is; a corporation must measure itself by the value it builds for its shareholders. The problem has come in how this idea has been applied.

The principal metric used for evaluating a public company’s shareholder value is its stock price. Again, seemingly simple on the surface. But stock prices move minute to minute and day to day. This is an even shorter-term measure than is last year’s bottom line. Yet it is regularly used as a justification for strategic decisions, not to mention employee compensation schemes. Seen this way, the concept of shareholder value and the bottom line have been at the root of a lot of dangerous short-term thinking.

Many associate Jack Welch, former CEO of GE, with this concept, citing a speech Welch gave in 1981 entitled, “Growing Fast in a Slow-Growth Economy.” But in March, 2009 he denied that he ever intended to send a message that share price should be of paramount importance. He told the Financial Times that, “The idea that shareholder value is a strategy is insane…Shareholder value is a result, not a strategy…Your main constituencies are your employees, your customers and your products.” 

Then in September, 2009, the Aspen Institute released a paper signed by a group of 28 executives that included Warren Buffet (CEO, Berkshire Hathaway), Lou Gerstner (Retired CEO, IBM) and John Bogle (Founder, The Vanguard Group). The paper, entitled Overcoming Short-termism, opens by saying:

In recent years, boards, managers, shareholders with varying agendas and regulators, all, to one degree or another, have allowed short-term considerations to overwhelm the desirable long-term growth and sustainable profit objectives of the corporation…We believe that short-term objectives have eroded faith in corporations…Restoring that faith critically requires restoring a long-term focus…if not voluntarily, then by appropriate regulation. 

There are those that believe that in the long term, shareholders themselves will force a move away from a short-term perspective. The majority of public stock in the U.S. and the U.K. is now owned by small investors or by pension and investment plans–whose money comes from everyday citizens. In The New Capitalists: How Citizen Investors Are Reshaping the Corporate Agenda, Stephen Davis, Jon Lukomnik and David Pitt-Watson make the case that this change in ownership will drive increased corporate activism. These “citizen investors” are beginning to realize that they have a voice. And the voice is not focused on one company or another maximizing profits to the detriment of the economy as a whole. This voice is concerned with profits but also with long-term value creation and responsible corporate citizenship.

How will it happen? Probably when a lot of threads come together:

• changing business models to meet the new innovation design constraints of the 21st century
• changing attitudes about corporate obligations
• and, (if we have anything to do with it!!) the growing realization that corporate information is leaving out the intangible side of business.

Intangibles represent 80% of the value of the average corporation but these are mistakenly assumed to be non-financial assets without lasting value. The contrary is actually true. The enduring value in an organization is in its knowledge, its brand, its culture, its processes and its people. When we get these assets into the spotlight where they belong, it will change how decisions are made and businesspeople will be in a much better position to think long term.

Adapted from Intangible Capital: Putting Knowledge to Work in the 21st Century Organization by Mary Adams and Michael Oleksak.

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Triangulation is an approach used in a number of disciplines (including surveying and astronomy) using known points to plot out an unknown distance or space. With intangibles, you can use these three kinds of data—investment, assessment and indicators—to plot out the landscape of your intangibles and get comfortable with the future earnings potential of your business.

In this drawing, the starting point is the investment calculation for intangibles. Since it is a financial measurement, we show it intersecting with the calculation of earnings potential. But assessment and indicators are non-financial metrics. They shed light on the capacity of the intangibles through analysis (assessment) and direct measurement (indicators). That’s why they are shown as defining a different shape, although it is one that overlaps with the earnings potential. Triangulation of intangibles does not add up to an auditable number. But it does shed light on the critical intangible sources of value and future earnings potential of a company. And these measures provide much richer and more accurate information than the gut feel of a manager or an analyst that is in use today.
The exact measurement of intangibles is still in its infancy. Over time, our collective skills in this kind of analysis will improve. But if you use investment, assessment and indicators, you will be able to triangulate, to come up with an understanding of the health and workings of your organization’s intangibles. Most reporting solutions, in fact, use a combination of these metrics to help create a data set about intangibles.

An Example

One of the best generic examples of this approach was suggested by the PwC Corporate Reporting Group. It is a Value Analysis Statement that combines a several measurement approaches. The left-hand column includes 21 value-creating activities divided into six categories of value: innovation, brand, customer, human capital, supply chain and environmental/social. Then for each category, various data columns report:

• Historic cash flow from that activity
• Prospective cash flow indicator (an arrow up, level or down)
• Risk indicators (names the risks but does not measure)
• Non-financial indicators
• Historic trends for the non-financial indicators
• Objective for the non-financial indicators going forward

This is a sound approach from that combines the several kinds of intangibles data—investment, assessment and indicators—with financial results to give a richer picture of the drivers behind the numbers.

We are in the process of creating some scorecards like this for our clients. We’ll try to provide more examples soon.

Adapted from Intangible Capital: Putting Knowledge to Work in the 21st Century Organization by Mary Adams and Michael Oleksak.

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Most performance measurement systems being built today are being built without a basic understanding of the underlying intangible capital of the organization. Since IC represents 80% of the value of the average organization, this means that the integrity and utility of these performance measurement systems should be questioned. It all starts with an inventory of your intangibles.

We once had a client that had close to several million dollars of inventory in their warehouse. It was a service business and they used the products in the warehouse in client installations. So they viewed it as secondary to their business. And, believe it or not, they didn’t have an inventory system. Project managers would order materials under a job system so the cost got billed to the client. But the physical movement was tracked in people’s heads. The materials would show up. The warehouse manager would do his best to figure out what came in and which job it belonged to. But, it may not surprise you that they often lost materials and ended up double ordering, often paying express shipping rates to get the product in by the installation date. Sounds pretty dysfunctional?

These people knew their business in and out. But it honestly took them a long time to understand that there would be a significant return on the relatively low cost of developing an inventory system. You are probably thinking, “That’s not us. We would never do something that stupid.” Then we only have one question: Have you completed the inventory of your knowledge factory yet?

With good information, you will learn over time how much investment, for example, is needed to keep the quality and outlook of an intangible strong, how that intangible affects your overall profitability, and how its performance can be measured in the interim using indicators. This kind of holistic approach is still in its infancy.

Here are the steps for a performance measurement system that addresses the full range of your intangible assets:

1. Inventory – The first step to understanding the knowledge side of your business is to take an inventory of the competencies, relationships, brands, processes and intellectual property to which you have access. Identify your business recipe and model the business to show how your combine your unique intangible capital to create value for your customers and get paid. Update this list at least annually.
2. Investment – It makes a lot of sense to keep track of how much you are investing in the intangibles on your inventory. Knowing these numbers will help your management team and board make better decisions. It will also help other stakeholders understand your priorities. Over time, you will be able to use this data to learn more about the effectiveness of your investments. Set up your chart of accounts so that intangibles investments are easy to identify and generate a report on a quarterly or annual basis.
3. Assessment – Evaluate each of the intangibles on your inventory. Are they adequate for today’s needs? What about future needs? Where are you at risk?
4. Strategy – Armed with an understanding of your key intangibles and how they fit in your business model, you can make better decisions about what your priorities need to be for the coming year for your deliberate and emergent strategies.
5. Performance Measurement – Then—AND ONLY THEN—can you can design a performance measurement system that really gets at the roots of the knowledge side of your business (which in the average business today represents 80% of the total value). This kind of metric is monitored on an on-going basis or at least monthly.
6. Financial Results – Ultimately, your intangible assets and knowledge factory will lead to financial results (if they don’t go back to my posts on monetizing intangibles).
7. Start again at the beginning – Management information should be a way to learn and improve your operations. Ideally, you will have a continuous flow of a variety of information types and enough flexibility built into your system to allow for adaptation over time.

Over time, you will see the value of each of the kinds of measurement sources we have talked about thus far: investment, assessment, and indicators. There is a lot of potential for learning by comparing the three kinds of data points to triangulate an understanding of your knowledge assets, a concept I’ll discuss soon.

Adapted from Intangible Capital: Putting Knowledge to Work in the 21st Century Organization by Mary Adams and Michael Oleksak.

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The income statement is still the main tool we have to measure the profitability of an organization. It is the one place that all the financial flows come together—revenues, expenses and amortization of capital expenditures. But the income statement has been distorted by the rise of the knowledge economy. This has led to the rise of a new kind of reporting of the operating story, called the performance measurement system.

As organizations began to invest more heavily in intangibles beginning in the 1970’s and 80’s, this expense led to a gap between corporate value and the balance sheets (because these intangible investments are not eligible to be capitalized).

This investment also distorts the income statement. It is important to understand these because, while most businesspeople appreciate the distortions of the balance sheet caused by the shift to the knowledge era, few appreciate its affect on the income statement. Here are two big distortions:

1 – Understated Earnings

The first consequence of the rise of the knowledge economy on the income statement has been that earnings have been understated for the past thirty years. By a lot. If you have ever created or used an income statement you probably know the accountants’ definition of the income statement is that it contains revenues and expenses related to the current year’s operations. Revenues and expenses related to future periods have to be moved off the income statement because they would distort the operating story. Investment in building future value or infrastructure which is expected to be used over more than the current year should be excluded from the income statement. But that’s not the way that it has worked with intangibles. And organizations across the U.S. and across the globe have invested trillions of dollars in intangibles and “paid” for it through their current year earnings.

Of course, this situation is favorable because it lowers taxable income. Further, the cost of building intangibles infrastructure such as process and IT is not as concentrated as building a brick and mortar factory; it is often built up incrementally over the years. In fact, it is often advisable to spread spending over time to allow the organization to adjust and adapt itself to the changes that the automation of process often require.

There are those that will read this and say it was all for the better. It forced companies to be judicious in their spending and to ensure that they got return on their investment. It saved on taxes. It was the conservative approach to accounting, which would rather err on the side of understating revenue and overstating costs. You may see this picture and say, “We’ve done OK so far, why shake things up?” Why not leave well enough alone? The truth is that there have been real consequences of this distortion. Earnings that are diminished by intangibles investments put a company that is building for the future at a disadvantage. This is a point that is often lost in conversations about growth companies with high valuations. The business press always marvels at how the company can be worth so much if it is not making money (it’s not always the case that they are investing in intangibles but if there is a high valuation, investors understand something about the income statement beyond the short term profits).

2- The Lost Operating Story

Beyond the distortion of earnings, there has been a second significant problem in the income statement caused by the shift to a knowledge economy. Financials no longer tell the operating story of a company. Most people have gotten used to this fact and don’t really think about it. But it is a pretty big deal.

We learned as bankers to trace the full operating cycle of a company from the purchase of raw materials all the way to collection of the accounts receivable. By using simple calculations, we could compare current period revenue and costs (usually on a monthly basis) with different classes of assets to know whether the operations were staying in synch. These calculations included ratios for days of different kinds of inventory on hand, days of receivables and payables—which examined month to month and year to year told us the operating trends of the operation.

Behind the scenes, there was a whole other level of tracking called cost accounting. This was the marriage of accounting and engineering, enabling a manager to understand the cost of each step in a process, the use of overhead by different parts of the production process and other operating units. In sum, the financial system could be used to measure and track almost everything of import going on inside a company. Until the knowledge era came along.

This system falls down when the operations include information flows through and into knowledge assets. Think back to the models we showed you of knowledge factories in Chapter 3. Let’s talk about how you account for the functioning of these factories. Sometimes, there is a physical product involved—you already know how account for that. But even physical products have knowledge components. And knowledge flows in companies are much harder to track. The use of a process does not lower the “inventory” of knowledge contained in the process. In fact, as we have seen, use of knowledge can increase the knowledge by adapting to lessons learned during use. You can allocate the cost of human capital to the work they are doing. But you cannot account for the “use” of a relationship because it is not a financial asset. In order to tell the operating story of the knowledge factory, you need to move beyond financial measures.

Next time: intangibles and non-financial indicators

Adapted from Intangible Capital: Putting Knowledge to Work in the 21st Century Organization by Mary Adams and Michael Oleksak.

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Over time, many of these tools have been refined and evaluated for statistical significance. The idea is to use a series of questions that indicate what’s going on inside a person’s head, how they work and interact with others. Because the output is delivered in the same way for each assessment, they become comparable across individuals and/or teams. The knowledge gained through an assessment like this helps create a starting point for change and improvement.

An assessment of your knowledge factory is more complex than the analysis of a single person but many of the same principles apply.

IC Assessments generally use a consistent methodology for data gathering and reporting. The focus is what’s going on inside the “black box” of your knowledge factory, which can be as inscrutable and mysterious as what goes on inside a person’s head.

So if you want to create your own assessment, what are your choices? The main parameters are laid out below. This is a long post but I thought I should keep all these points covered below together:

• Scope
• Rating system
• Standard of measurement
• Perspectives
• Who should assess

If it is your first time, you can keep the process simple or you can jump in with both feet and create a more robust process that will be repeatable across your business units and/or across time. But do not try to take on too much at first. Here are some things to consider:

Scope

In theory, you could examine just one aspect of intangible capital, such as human, relationship or structural capital. In truth, many organizations already have scattered assessments of individual pieces of the overall IC pie. The truth is that you evaluate, measure, and assess intangibles all the time. Take your employees for example. You set goals for them and assess their performance. Or your customer relationships. Many companies have rankings or ratings of customers according to how well they fit your target profiles or how much potential you see in the relationship. Processes get assessed and audited too.

We advocate looking at all the pieces in the context of how they fit together to create your knowledge factory. It makes sense to periodically do an assessment of your entire organization. The one distinction that can be made is to look at the value creation system versus the support functions in the organization. If you have done the exercises in the previous chapters, you already have an inventory of your critical value creation assets. Pull out these inventories of competencies, processes, intellectual property, relationships and brands. Make sure you have all your critical assets listed. At first, you can limit yourselves to just value creation assets although, ultimately, you will want to expand your review to evaluate support services too.

Rating System

An assessment involves interviews or surveys of stakeholders. Interviews produce more information because the interviewer can ask follow-up questions. This can be extremely valuable for turning the data into actionable goals. But interviews are obviously much more time-consuming and expensive. Surveys can be a good substitute if they are designed well. In either case, the questions used for the assessment use a rating scale. We usually ask questions using a Likert scale such as, “on a scale from 1 to 10, how would you rate this asset…” But you can use a scale that seems most comfortable for the stakeholders involved. Letter grades (A, B, C, etc.), for example, are easy for people to envision but letters have to be converted to numbers if you want to compare averages or do any other calculations. The output of one of our assessments, for example, uses a letter system similar to bond ratings (AAA to D).

Standard of Measurement

As we said above, you already have a number of kinds of assessments within your organization. In theory, you could assemble all the different kinds of evaluations you have in one place but it would be something like trying to fit different pieces of different puzzles together. A cohesive picture might not emerge. Instead, what we advise is to do a comprehensive assessment of all of your knowledge assets at the same time, using the same measuring stick—your business recipe.

You may recall that business recipe is the fourth category of knowledge assets that make up intangible capital (the other three are human, relationship and structural knowledge capital).

Business recipe is your business opportunity and the strategy you use to exploit it. It basically explains how everything fits together and how it is supposed to work. If you have drawn or built a model of your knowledge factory, you probably have a good understanding of your business recipe. Why does this work as a measuring stick? Because the business recipe is the reason you have built your knowledge factory and your business. It will tell you very quickly if you have what it takes to deliver on your business recipe.

There are two ways to ask questions in relationship to business recipe. The first is to tie it directly to the company and its strategy. For example, if a CEO tells you that his/her organization has the best people in the market, you would be hard-pressed to agree or disagree. It would be too subjective. But if that same CEO were to tell you that the company needed five core competencies to deliver on its business recipe, then it would suddenly become a lot easier to evaluate. You just have to ask about the adequacy of each competency.

To use it as a standard of measurement, the interview needs to start with a statement of the organization’s business recipe. Then, questions can be asked using it for context. Sample questions would include:

• How would you rate the degree to which the functioning of its processes (or a specific process) helps the company deliver on its business recipe?
• How would you rate the functioning of the relationships (or a specific relationship) key to it business recipe?
• How would you rate the employees’ competencies (or a specific competency) that are key to its business recipe?

This kind of question uses the business recipe as a measuring stick. It is a great way to take an abstract concept, “do they have good people” and convert it into a specific, valuable assessment. We use this measuring stick for companies that are looking to increase the performance of your organization.

A second, simpler measuring stick derived from the business recipe is the company’s industry or peers. We use this measuring stick in a number of our assessments for helping companies build value and increase growth. In this case, rather than asking whether the assets are adequate to support the company’s strategy, you can ask how the performance/level of a specific intangible compares to that seen in the industry. Here the score would range from worst to below average, average, above average and best.

Three Perspectives

The questions above focus on the current performance of the intangibles. This is a good place to start. It is basically the perspective of a financial balance sheet—determining the condition of the company as of a certain date. And it will provide you with good strong data about the current status of intangibles. However, there is real value in a couple of other perspectives. In the IC Rating system, we use two additional kinds of questions, one that addresses the organization’s readiness for the future and another that addresses risks. Each of these rounds out the picture of the current adequacy of intangibles.

It is hard to ask stakeholders to predict the future. For this reason, we use questions that get at the organization’s efforts to “renew and develop” specific intangibles. This creates more specific feedback, especially in personal interviews. Here is a future-oriented version of the questions seen above:

• How would you rate the organization’s efforts to renew and develop the processes (or a specific process) key to its business recipe?
• How would you rate the organization’s efforts to renew and develop the relationships (or a specific relationship) key to it business recipe?
• How would you rate the organization’s efforts to renew and develop employee competencies (or a specific competency) key to its business recipe?

The final key perspective for the knowledge-era balance sheet is risk. If the components of intangible capital are considered as assets, then risk is the way to describe the corresponding liabilities. Weak assets or unresolved challenges can also be viewed as risk. In an assessment of intangible capital, questions about risk are usually pretty specific. Examples of these include:

• Assess how vulnerable the company is to individual customer defections
• Assess the probability that key employees leave the company within a year
• Assess the company’s system/process for quality appraisal according to how well it works

Risk management is often a separate function within an organization. However, like most corporate functions, it is more accustomed to working with tangibles than with intangibles. There is real potential for making a link between intangibles and risk management in areas such as process design and compliance as well as human capital management.

We saw the value of using the three perspectives—current, future and risk—in a rating we did of an organization a couple years ago. This organization was trying to adapt its strategy to changes in its market. When we tallied up the results of all the interviews, the ratings for the employees’ current competencies were the highest of all the components of its intangible capital. But when questions were asked about the renewal and development of those same competencies, the score was the lowest of all the intangible capital components. There were also risks highlighted in the same vein. The finding was that while the organization had great people that were well-suited to their current business recipe, they were not at all prepared for the change that the organization felt was inevitable. This was a very powerful finding. If we hadn’t asked the question from the different perspectives, we would have had a very skewed view of the strength of the intangible capital.

Who Should Assess?

If you are the leader of a business or a team, you may want to start off with a self assessment where you rate your knowledge assets based on your understanding of your business. This alone can be a powerful process for you. But, as with most data-gathering exercises, there would be greater value in consulting others. The next step, therefore, would be to do a self assessment as a team. The gold standard is to incorporate stakeholders of all kinds in the process. In our work, we prefer to use even more external than internal stakeholders and to get a variety of perspectives: managers, employees, industry experts, customers, partners and suppliers.

You may want to engage a third party to perform the interviews for you. This can help you avoid the bias of internal interviewers who may think they know the answer to a question or whose understanding of an answer is colored by their personal opinions. Actually, the starting point of almost any management consulting exercise is a diagnostic or assessment of the company. Depending on the purpose of the engagement and the experience of the consultant, this may or may not cover all the areas of knowledge assets. But, frankly, the knowledge intangibles are a frequent focus of diagnostics in one form or another. This is because every company has significant information gaps which they do not know how to fill.

Hiring a large consulting firm to dig around and figure things out what’s happening on an ad hoc basis is a common practice. While more widespread assessment will not eliminate the need for management consultants, it would probably mean fewer situations where a diagnostic or a custom assessment needs to be developed. That means that more resources can be applied to actually using the knowledge gained to effect change in the organization.

This is a way that corporate assessments could become a disruptive innovation in the management consulting market. A good standardized assessment can often identify the same set of issues as a full-scale custom project. There are several reasons for this.

1. An assessment can be viewed as a piece of structural capital, where the accumulated knowledge is built into the tool. It makes everyone that uses it as smart as the smartest person that designed it. The consulting team does not have to re-invent the wheel every time.
2. Assessments that rely on stakeholders with deep knowledge of the company have a leg up on situations where consultants have to get up to speed in order to make their own evaluation.
3. The use of external stakeholders brings an outside perspective which is one of the value propositions of consultants (“we can help you apply best practices from other companies…”)

Actually, the ultimate disruption would be an evolution of assessments to the point where stakeholders can collaboratively evaluate the strength of the company. At this point, there is no precedent for a social media solution that digs this deeply into a company’s operations. But it is possible from a technological point of view and could certainly be managed in or out of the public eye. This kind of social media solution may be the fulfillment of Umair Haque’s statement that capital is consensus.

Adapted from Intangible Capital: Putting Knowledge to Work in the 21st Century Organization by Mary Adams and Michael Oleksak.

Over time, many of these tools have been refined and evaluated for statistical significance. The idea is to use a series of questions that indicate what’s going on inside a person’s head, how they work and interact with others. Because the output is delivered in the same way for each assessment, they become comparable across individuals and/or teams. The knowledge gained through an assessment like this helps create a starting point for change and improvement.

An assessment of your knowledge factory is more complex than the analysis of a single person but many of the same principles apply. IC Assessments generally use a consistent methodology for data gathering and reporting. The focus is what’s going on inside the “black box” of your knowledge factory, which can be as inscrutable and mysterious as what goes on inside a person’s head.

So if you want to create your own assessment, what are your choices? The main parameters are laid out below. This is a long post but I thought I should keep all these points covered below together:

• Scope
• Rating system
• Standard of measurement
• Perspectives
• Who should assess

If it is your first time, you can keep the process simple or you can jump in with both feet and create a more robust process that will be repeatable across your business units and/or across time. But do not try to take on too much at first. Here are some things to consider:

Scope

In theory, you could examine just one aspect of intangible capital, such as human, relationship or structural capital. In truth, many organizations already have scattered assessments of individual pieces of the overall IC pie. The truth is that you evaluate, measure, and assess intangibles all the time. Take your employees for example. You set goals for them and assess their performance. Or your customer relationships. Many companies have rankings or ratings of customers according to how well they fit your target profiles or how much potential you see in the relationship. Processes get assessed and audited too.

IWe also advocate looking at all the pieces in the context of how they fit together to create your knowledge factory. It makes sense to periodically do an assessment of your entire organization. The one distinction that can be made is to look at the value creation system versus the support functions in the organization. If you have done the exercises in the previous chapters, you already have an inventory of your critical value creation assets. Pull out these inventories of competencies, processes, intellectual property, relationships and brands. Make sure you have all your critical assets listed. At first, you can limit yourselves to just value creation assets although, ultimately, you will want to expand your review to evaluate support services too.

Rating System

An assessment involves interviews or surveys of stakeholders. Interviews produce more information because the interviewer can ask follow-up questions. This can be extremely valuable for turning the data into actionable goals. But interviews are obviously much more time-consuming and expensive. Surveys can be a good substitute if they are designed well. In either case, the questions used for the assessment use a rating scale. We usually ask questions using a Likert scale such as, “on a scale from 1 to 10, how would you rate this asset…” But you can use a scale that seems most comfortable for the stakeholders involved. Letter grades (A, B, C, etc.), for example, are easy for people to envision but letters have to be converted to numbers if you want to compare averages or do any other calculations. The output of one of our assesssments, for example, uses a letter system similar to bond ratings (AAA to D).

Standard of Measurement

As we said above, you already have a number of kinds of assessments within your organization. In theory, you could assemble all the different kinds of evaluations you have in one place but it would be something like trying to fit different pieces of different puzzles together. A cohesive picture might not emerge. Instead, what we advise is to do a comprehensive assessment of all of your knowledge assets at the same time, using the same measuring stick—your business recipe.

You may recall that business recipe was the fourth category of knowledge assets that make up intangible capital. Business recipe is your business opportunity and the strategy you use to exploit it. It basically explains how everything fits together and how it is supposed to work. If you have drawn or built a model of your knowledge factory, you probably have a good understanding of your business recipe. Why does this work as a measuring stick? Because the business recipe is the reason you have built your knowledge factory and your business. It will tell you very quickly if you have what it takes to deliver on your business recipe.

There are two ways to ask questions in relationship to business recipe. The first is to tie it directly to the company and its strategy. For example, if a CEO tells you that his/her organization has the best people in the market, you would be hard-pressed to agree or disagree. It would be too subjective. But if that same CEO were to tell you that the company needed five core competencies to deliver on its business recipe, then it would suddenly become a lot easier to evaluate. You just have to ask about the adequacy of each competency.

To use it as a standard of measurement, the interview needs to start with a statement of the organization’s business recipe. Then, questions can be asked using it for context. Sample questions would include:

• How would you rate the degree to which the functioning of its processes (or a specific process) helps the company deliver on its business recipe?
• How would you rate the functioning of the relationships (or a specific relationship) key to it business recipe?
• How would you rate the employees’ competencies (or a specific competency) that are key to its business recipe?

This kind of question uses the business recipe as a measuring stick. It is a great way to take an abstract concept, “do they have good people” and convert it into a specific, valuable assessment. We use this measuring stick for companies that are looking to increase the performance of your organization.

A second, simpler measuring stick derived from the business recipe is the company’s industry or peers. We use this measuring stick in a number of our assessments for helping companies build value and increase growth. In this case, rather than asking whether the assets are adequate to support the company’s strategy, you can ask how the performance/level of a specific intangible compares to that seen in the industry. Here the score would range from worst to below average, average, above average and best.

Three Perspectives

The questions above focus on the current performance of the intangibles. This is a good place to start. It is basically the perspective of a financial balance sheet—determining the condition of the company as of a certain date. And it will provide you with good strong data about the current status of intangibles. However, there is real value in a couple of other perspectives. In the IC Rating system, we use two additional kinds of questions, one that addresses the organization’s readiness for the future and another that addresses risks. Each of these rounds out the picture of the current adequacy of intangibles.

It is hard to ask stakeholders to predict the future. For this reason, we use questions that get at the organization’s efforts to “renew and develop” specific intangibles. This creates more specific feedback, especially in personal interviews. Here is a future-oriented version of the questions seen above:

• How would you rate the organization’s efforts to renew and develop the processes (or a specific process) key to its business recipe?
• How would you rate the organization’s efforts to renew and develop the relationships (or a specific relationship) key to it business recipe?
• How would you rate the organization’s efforts to renew and develop employee competencies (or a specific competency) key to its business recipe?

The final key perspective for the knowledge-era balance sheet is risk. If the components of intangible capital are considered as assets, then risk is the way to describe the corresponding liabilities. Weak assets or unresolved challenges can also be viewed as risk. In an assessment of intangible capital, questions about risk are usually pretty specific. Examples of these include:

• Assess how vulnerable the company is to individual customer defections
• Assess the probability that key employees leave the company within a year
• Assess the company’s system/process for quality appraisal according to how well it works

Risk management is often a separate function within an organization. However, like most corporate functions, it is more accustomed to working with tangibles than with intangibles. There is real potential for making a link between intangibles and risk management in areas such as process design and compliance as well as human capital management.

We saw the value of using the three perspectives—current, future and risk—in a rating we did of an organization a couple years ago. This organization was trying to adapt its strategy to changes in its market. When we tallied up the results of all the interviews, the ratings for the employees’ current competencies were the highest of all the components of its intangible capital. But when questions were asked about the renewal and development of those same competencies, the score was the lowest of all the intangible capital components. There were also risks highlighted in the same vein. The finding was that while the organization had great people that were well-suited to their current business recipe, they were not at all prepared for the change that the organization felt was inevitable. This was a very powerful finding. If we hadn’t asked the question from the different perspectives, we would have had a very skewed view of the strength of the intangible capital.

Who Should Assess?

If you are the leader of a business or a team, you may want to start off with a self assessment where you rate your knowledge assets based on your understanding of your business. This alone can be a powerful process for you. But, as with most data-gathering exercises, there would be greater value in consulting others. The next step, therefore, would be to do a self assessment as a team. The gold standard is to incorporate stakeholders of all kinds in the process. In our work, we prefer to use even more external than internal stakeholders and to get a variety of perspectives: managers, employees, industry experts, customers, partners and suppliers.

You may want to engage a third party to perform the interviews for you. This can help you avoid the bias of internal interviewers who may think they know the answer to a question or whose understanding of an answer is colored by their personal opinions. Actually, the starting point of almost any management consulting exercise is a diagnostic or assessment of the company. Depending on the purpose of the engagement and the experience of the consultant, this may or may not cover all the areas of knowledge assets. But, frankly, the knowledge intangibles are a frequent focus of diagnostics in one form or another. This is because every company has significant information gaps which they do not know how to fill.

Hiring a large consulting firm to dig around and figure things out what’s happening on an ad hoc basis is a common practice. While more widespread assessment will not eliminate the need for management consultants, it would probably mean fewer situations where a diagnostic or a custom assessment needs to be developed. That means that more resources can be applied to actually using the knowledge gained to effect change in the organization.

This is a way that corporate assessments could become a disruptive innovation  in the management consulting market. A good standardized assessment can often identify the same set of issues as a full-scale custom project. There are several reasons for this.

• First, an assessment can be viewed as a piece of structural capital, where the accumulated knowledge is built into the tool. It makes everyone that uses it as smart as the smartest person that designed it. The consulting team does not have to re-invent the wheel every time.
• Second, assessments that rely on stakeholders with deep knowledge of the company have a leg up on situations where consultants have to get up to speed in order to make their own evaluation.
• Third, the use of external stakeholders brings an outside perspective which is one of the value propositions of consultants (“we can help you apply best practices from other companies…”)

Actually, the ultimate disruption would be an evolution of assessments to the point where stakeholders can collaboratively evaluate the strength of the company. At this point, there is no precedent for a social media solution that digs this deeply into a company’s operations. But it is possible from a technological point of view and could certainly be managed in or out of the public eye. This kind of social media solution may be the fulfillment of Umair Haque’s statement that capital is consensus.

Adapted from Intangible Capital: Putting Knowledge to Work in the 21st Century Organization by Mary Adams and Michael Oleksak.

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The first question asked how important each type of information was to the CEO’s ability to “make decisions about the long-term success and durability of your business.”

The second asked about the adequacy of the information the CEO currently receives.  The findings showed that this information was important to CEOs but there were wide gaps (ranging from 55 to 74%) between the importance and the availability of information types including:

• Information about customers and clients’ preferences and needs
• Information about the risks to which the business is exposed
• Benchmarking information on the performance of industry peers
• Information about brand and reputation
• Information about employees’ views and needs
• Financial forecasts and projections
• Information about the effectiveness of R&D processes
• Information about the supply chain

This kind of question is not easily answered through financial figures and numerical indicators (as is possible with the tangible side of business). Yet we all know this information is important—even without a survey like this. It’s past time to bridge these serious information gaps.

Adapted from Intangible Capital: Putting Knowledge to Work in the 21st Century Organization by Mary Adams and Michael Oleksak.

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First is the infinite value of knowledge. Selling or giving away knowledge does not decrease your “inventory” of knowledge as it does with a physical product. If you have 100 shirts in stock and make 100 sales, you have depleted your supply of shirts. If you sell a piece of software via a download, you do not have less software than before. In fact, the value of your software is going to increase because you will probably benefit from the lessons learned from the experience of your new users. The value of this software will continue to increase as long as the users are getting benefit from it and it remains attractive relative to other solutions to the customer’s problem. Your management information set should be able to tell you the potential of your knowledge.

Second is leverage. We have also shown that many kinds of knowledge are free or priced like commodities. Even patents (the most tangible of the intangibles) can have limited value when considered as stand-alone assets. The most valuable knowledge is that which is combined with technology and a sustaining ecosystem of knowledge assets—a knowledge factory. Leverage is created when knowledge assets are combined and become scalable and capable of creating significant growth with low incremental costs. Your management information set should help you understand these interrelationships.

Third is consensus. We recently quoted Umair Haque’s new definition of capitalism. In that post he also says, “Capital is consensus: Here’s a secret: capital isn’t just whatever bean counters and boardrooms decide it is. It’s what we — collectively, as global citizens — decide has value, because it impacts our productivity, well-being, and quality of life.”  The rules of behavior are changing for corporations. It is not enough to produce financial profits. The value of your organization is created by the consensus of your stakeholders. Your stakeholders will also look at your record as a steward of the environment and of your communities. The transparency of the Internet will only continue these trends. Your management information should help you understand the viewpoint of your stakeholders.

Fourth is capacity. There are no gauges on the side of your employees’ heads or your customers’ facilities. Your structural capital does not come with the warning that it will self destruct after 1,000 uses. Most structural capital has a theoretically infinite life. The potential for continued productivity of these assets is a more complex question because the useful life of structural capital is dependent on the market need, not the solution itself. Your management information set should help you understand the productivity, relevance, and outlook of the demand for your knowledge assets.

The bottom line is that financial measurement of intangibles is difficult. This is unpopular news for businesspeople, especially in the U.S., who have been raised on the “mother’s milk” of hard data. Many use this as an excuse to ignore nonfinancial knowledge assets. But ignoring intangibles is like finding oil bubbling up from the ground and walking away because there’s no immediate way of knowing the size of the oil deposit below your feet. Your company is like that. You are sitting atop a deep reservoir of knowledge that is almost certainly not being used to its full potential. You have no choice. You have to do something.

The answer is to learn how to measure your core intangible capital (which you will remember comprises 80% of the value of the average company today) in not only financial terms but also nonfinancial terms. Nonfinancial does not mean soft or unreliable. It means finding more sophisticated ways of measuring the health and financial potential of intangibles. We’ll show you how in our posts over the next few weeks.

Adapted from Intangible Capital: Putting Knowledge to Work in the 21st Century Organization by Mary Adams and Michael Oleksak.

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