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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Leonard Nakamura at the Philadelphia Federal Reserve used a number of approaches to arrive at some basic estimates of our national investment in intangibles. He actually made three calculations based on different sets of data to zero in on his estimates: expenditures, labor inputs, and corporate operating margins. The expenditure data focused on three types of investments for which data is available: research and development (R&D), advertising and software. For labor inputs, he looked at the “proportion of labor income going to workers whose occupations are creative—engineers, scientists, writers, artists, etc.” Nakamura then looked at the change in the proportion of cost of goods sold versus operating margins.

In Lev and Hand’s book Intangible Assets, he used these three numbers to triangulate an estimate that in the year 2000, investment in intangibles by American corporations was roughly $1 trillion. Assuming a useful life of intangibles of five to six years, he concluded that the equilibrium value of intangibles was roughly $5 – 6 trillion, roughly one third of the total valuation of U.S. corporations. This is a conservative estimate; Nakamura is quick to point out that there are many kinds of expenditures that were not included in his calculations due to lack of data.  Papers by Corrado, Hulten, and Sichel also came up with a $1 trillion number for 1999 which, they pointed out was about the same amount as investment in tangible assets. BusinessWeek recently reported on an update of the Corrado study still in process that will show $1.6 trillion in intangible investment in 2007, well in exces of the $1.2 trillion invested in tangibles that year.

The Stock Market

Another kind of data that gets used a lot to “quantify” intangibles is the valuation of public companies. The reason is the curious phenomenon that started in the late 1970s when the total stock market valuation of American corporations began to diverge in a big way from their tangible book value. Until the 1970’s, these two numbers (total corporate value and tangible book value) tracked each other pretty closely. This was logical because, as we have stated before, that industrial era business was dependent on what a company owned, which would be capitalized on its balance sheet. As computers and information technology enjoyed greater use, companies were able to create value for their customers that wasn’t associated with physical assets. This fact is the whole point of the knowledge factory discussion in the first section of this book.

In recent years, this intangible or off-balance sheet amount (the difference between total corporate value and tangible book value) ranged from roughly half to three quarters of the total stock market valuation of public companies. That means that up to 75% of the value of a company can not be associated with tangible productive assets. This is a very graphic way of illustrating the extent of the intangibles information gap. However, it can get confusing if you use this gap as a market “valuation” of intangibles. What does it mean when the market goes down—that all the loss in value is attributable to intangibles?

So comparing net book value of the company on the balance sheet value to total corporate value in the stock market does not give you any kind of hard data that you want to hang your hat on. But the fact remains that there is a big amount of corporate value that cannot be linked to underlying tangible assets. Businesspeople for the most part just ignore this gap.

Data from Mergers and Acquisitions

But no one can ignore the gap when there is a merger or an acquisition. This is the moment when traditional accounting and the reality of the knowledge economy come head to head. A good illustration of the extent of this gap was an Ernst & Young survey of 709 transactions in 2007 showed that on average, only 30% of the purchase price could be allocated to tangible assets. Another 23% of the price could be allocated to identifiable intangible assets such as brands, customer contracts, and technology. That left a whopping 47% in goodwill. Bottom line, this means that 70% of the average deal was intangible.

The huge goodwill is an indicator of the failure of the accounting system to provide helpful information on intangibles. Many would submit that it is, rather, just an indication that companies are overpaying. There is no data to refute this directly. However, the stock market still leaves a large intangible value. And we have seen that there has also been significant investment in intangibles. So there is some level of intangible value that is justified. We just cannot say exactly how much.

Given the information gap in the average company, it is not really that surprising that when two companies combine, the average merger fails to deliver the results expected at the closing of the deal. If you cannot even identify what you are buying going into the deal, how can you do a good job managing it after the deal closes? No one asks this question because the dilemma faced by merging companies is exactly like that faced by all companies—they have absolutely no idea what they have for intangibles….

Which begs the question, if organizations are spending so much money to build their intangible infrastructure, why don’t they even know what they have and what the total cost was? The information is there for the taking. Current accounting standards are confusing people to the point that they are ignoring their most important resource: their knowledge. Knowledge is a different kind of asset than a “tangible” asset. But it is an asset nevertheless. And one not to be ignored.

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

To leverage and build this knowledge, the management structure and approaches need to have room for the flow of information and innovation from the bottom up as well as the top down, from both the inside out and the outside in. Many innovation opportunities are created at the intersection between employee and/or organizational competencies and the needs of the marketplace. Opportunities can often only be detected at the employee or business unit level. Finding and exploiting these opportunities is the challenge of emergent strategies.

The role of a leader is different when trying to cultivate emergent strategies. The outside-in view of competitive strategy is not enough. Leaders also need to take an inside-out view of the corporate resources that create the ecosystem where innovative strategies will emerge and thrive. This innovation ecosystem is a place where smart people share their knowledge and, often in cooperation with customers or partners, create new opportunities for growth. The field of innovation is mainly focused on fomenting these emergent strategies. The innovation ecosystem is your intangible capital.

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

When people say that “all our assets walk out the door at night” they are showing their ignorance of structural capital. A really successful business has standardized processes and shared knowledge that stay in the company when people go home at night. Some, but far from all, structural knowledge can be protected legally and will become intellectual property. But, at this point, that distinction isn’t important. First you want to understand how structural capital is formed and managed.

Before we move forward, let us admit that structural capital, like so many of the terms used in intangibles management, has a branding problem. We can’t tell you how many consultants and businesspeople have told us, “We can’t use that phrase in front of my clients/managers,” fearing that they would draw blank stares. We use the phrase because it’s the phrase used in the literature and it is actually a nice description of what it is: knowledge that has been captured and becomes part of the organization. It is the infrastructure of the knowledge factory that is your intangible capital.

In our experience, businesspeople have no problem with the term when it is used to explain the potential within their organization. We recently had this kind of experience with a management team. We had been hired to help them think about how to scale their organization. They already had offices all across the country but they had only tapped a small portion of their potential market. We came up with a summary that showed that they had strong competencies and strong relationships. But the structural capital was weak. The General Manager got it immediately and asked us to do a structural capital gap analysis. Not only did he understand the concept, he packaged it for us as a new offering for our firm!

Once you understand the concept of structural capital, we think that you will embrace it too. Having said all that, our advice is to use a name that resonates with your individual organization. Choose one that works: structural knowledge, organizational knowledge, knowledge infrastructure, organizational capital or anything else that works. The important thing is to get beyond the name and get people in your organization to focus on the concept.

Because the truth is that structural capital is the Holy Grail of knowledge economy. It is the way that your organization captures knowledge and makes it re-usable. Remember what we said in Chapter 1 about how knowledge is an infinite asset? It is through structural capital that you can realize this promise and make your business scalable.

Watch in the coming days for discussion of the four basic forms of structural capital: culture, organizational knowledge, intellectual property (IP), and processes. Please know that there is a lot of overlap between these forms. Organizational knowledge, for example, can be converted to process and may even be protected as IP. We make the distinction mainly to be able to talk about specific characteristics of the individual forms even though all structural capital is, at its roots, captured knowledge of one form or another.

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

• Competencies
• Experience
• Longevity
• Attitude

Competencies

Competencies are a way of thinking about the knowledge behind your revenue streams and your value creation processes. Competencies are also one of the basic ways of understanding the knowledge contained in your human capital. When we work with companies, we try to get the management team to define the competencies needed at the corporate or group level. This kind of thinking can be pushed down to the level of each employee. The core competencies of an organization are related to its value creation processes. Please remember that there are also a separate set of competencies related to support services that are specific to the function such as accounting or information technology. These need to be understood but are apart from the core competencies associated with value creation that we examine here.

For example, project management is a core competency for a number of our client companies but this competency is matched by others that are unique to their specific businesses, to the kind of projects they manage. One has deep knowledge of the FDA requirements for software development. Another has a pool of expertise that includes master craftsmen that can do challenging custom jobs better than anyone else in their market. A third delivers help desk solutions for IT users around the country.

Competencies help you identify what is important in your employees’ work. They can be described pretty explicitly. They can be measured. They can be used as a basis for hiring and promotion. They are the right starting point for developing a clear picture of your employees as a productive asset, as part of your knowledge capital.

Experience

Another way of understanding the depth of knowledge represented by human capital is experience. Although years of work are not, in itself, a guarantee of a high level of knowledge, it is generally a good starting indicator. Of course, not every company understands this. Circuit City famously dismissed all their experienced salespeople the year before they went bankrupt to lower their average personnel costs.

Mixing types and levels of experience is a common way of developing balanced teams within an organization. One of the big fears of the aging workforce is that the experience and knowledge of Baby Boomers will be irrevocably lost as they retire. Meeting this challenge will require improved intangibles management that takes the kind of broad view of organizational knowledge such as that described in this book.

Longevity and Turnover

Longevity and turnover are related to experience as a way of framing human capital. In fact, they used to be critical metrics of the strength of a workforce. In today’s more mobile world where large amounts of an organization’s work may be done outside the normal employee base, these factors are less important. An employee’s choice to stay at a company is still a positive thing. But the dynamism of our economy has made it harder for companies and employees to stay in one place for their whole career. As such, an employee with decades of service to a single company is no longer the norm, nor a requirement for stability and growth.

Nevertheless, turnover can be an important factor in the formation of human capital. Examples of high-turnover jobs include bank tellers, caregivers, and call-center workers. In most organizations, these kinds of roles do not contribute to creation of a lot new knowledge capital because of the short average staff tenure. In fact, companies lose knowledge and incur considerable costs to keep a constant stream of new employees coming into the organization. There is something of a chicken-and-egg situation with high turnover jobs—which comes first: the tedium and pressure of the way the jobs are structured or the high turnover? Mitigating the tedium and empowering employees can be an antidote to the costs of high turnover.

Attitude

We all know without seeing research that a good attitude can make the difference between effective and ineffective employees. In case you have any doubt, we can cite research that compares the performance of the companies on Fortune’s list of the “100 Best Companies to Work for in America.” A study by Alex Edmans showed that the performance of these companies from 1984 to 2005 exceeded that of the overall market by 4%. Don’t ignore how your people feel about working in your organization.

We live in the knowledge era. Employees will always hold key parts of your organization’s knowledge in their heads. That makes employees more important than ever. The way to deal with this fact is to break down their role in your success. Understand it. Monitor it. Make the most of it.

Adapted from Intangible Capital: Putting Knowledge to Work in the 21st Century Organization

This importance is generally accepted. It is rare to meet a CEO who won’t tell you that his or her organization has the “best people” in the market. But this kind of statement is rarely challenged. Most businesspeople still don’t know how to see beyond the people and understand the employees and managers of an organization as knowledge assets—as human capital.

There are some that are critical of the label “human capital.” To them, it seems to smack of an attitude that people are just nameless cogs in an organization, exploited for their knowledge and experience. We don’t share that view. In fact, we like the term human capital because it is a graphic statement of the fact that people are indeed an asset of the organization. Assets require investment and maintenance. And they are a critical part of the productive capacity of the organization.

To us, this is the realization that matters—that your people are part of your productive capacity, now more so than ever. Because the future of your company depends on what you know rather than what you own. And what you know as an organization is intimately tied to the knowledge and experience of the people in your organization. In looking at human capital, it is helpful to distinguish between employees and managers. Both groups are employees but managers need a set of competencies that is distinct from those required for your value creation processes–I’ll look at each in the next couple posts.

Adapted from Intangible Capital: Putting Knowledge to Work in the 21st Century Organization

The raw materials of the knowledge era are knowledge-based intangibles. You may be nodding your head as you read this. But do you really know what it means? If not, you are not alone. Knowledge continues to be seen as an amorphous, misunderstood part of business. This widespread ignorance isn’t helped by the vocabulary. The word intangibles itself is troubling because its very definition implies that an intangible is invisible, untouchable, and unknowable. The word knowledge is also very general and lacks a specific connotation for business value creation. Yet knowledge is the core asset of this century.

Last week, I talked about how to get paid for knowledge because I wanted you to understand the central importance of knowledge to your business. It is not a “nice to have” luxury of upscale companies. Knowledge is a critical resource for every business from the most humble service and product companies to the highest of the high tech. You can probably think of a million examples of how your own workplace has changed in the last 10 to 20 years thanks to computers. But you may not have realized how the accumulated effect of all these changes has fundamentally altered your business.

What do this kind of computerization and the resulting growth of knowledge mean to your business? There are four basic types of knowledge assets that become the raw material for your value creation: human, relationship, structural and strategic capital. None of these are new categories of assets. People, customers, production processes and strategies have always been the building blocks of business. What has changed is that these knowledge intangibles have moved from a supporting to a star role in business models.

Even the future of manufacturing is dependent less on tangibles and more on intangibles such as a trained workforce, a culture that supports continuous improvement, a network that maximizes the quality and cost of your total production process and structural knowledge that ensures consistency as well as serving as a launch pad for innovation. Buying equipment is not the hard part—getting all the intangibles right is.

From Intangible Capital: Putting Knowledge to Work in the 21st Century Organization

Google’s search business is the simplest but most dramatic example of this. Their search business yields $20+ billion in advertising revenues each year. But the core product, the search itself, is free. This means that Google gives away huge amounts of value every day and still has managed to become one of the leading companies of the knowledge era thus far.

Another great example is the Grateful Dead. Long before the Internet and downloadable music, the Dead built a business model that was very different from other rock bands. They made their money from concert tickets and merchandise like tee shirts. They allowed people in their audiences to tape their performances—a practice strictly prohibited by other bands, who made most of their money from selling records. Along the way, the band developed a group of rabid fans, some of whom followed them from city to city. This strong community pioneered, in many ways, the approach taken today of countless business people using social media to create communities with and for their customers.

The open source movement is another example of the free versus paid dilemma. This approach is most common in the software market. Java and Linux are the two largest examples of software that is developed by a community and available to all at no charge. Yet there are plenty of vendors that make money selling hardware, services and related software to support the free and open product.

The open source approach is also being taken by selected hardware companies. An example that we have found very intriguing is Arduino, a company in Italy that put the designs of its simple electronic gadget on the web. You can use its designs and build as many of your own gadgets you want. The only restriction essentially is that you cannot use the Arduino brand. Users have used the designs to create projects as varied as a Wii controller for a remote control car, a breathalyzer microphone and a miniature pocket piano. The company benefits from the improvements to the base design shared by their community and gets much more attention than it would if it were just a small company selling electronic gadgets. And it does still make money from selling its own gadgets.

The free-versus-paid dynamic also creates a lot of conflict with traditional approaches to intellectual property. Our legal system affords protection to certain kinds of knowledge assets through patent, trademark ,and copyright systems. The ease of sharing and the open communication of the knowledge economy have created many threats to this system. Some, like the Pirate Party in Europe, advocate the elimination of this kind of property right. It is too hard to predict today where it will all end up. But we can tell you two things with certainty: You should find ways to share some of your knowledge for free and you will still have plenty of ways of making money.

From Intangible Capital: Putting Knowledge to Work in the 21st Century Organization

This is very obvious in an iPod, which is a highly innovative delivery system of an on-line music service. Apple broke ground in many ways when they created the iPod including:

• The physical design of the product itself
• The creation of an on-line delivery system for the music and content loaded on the product
• The licensing arrangements with key content providers to convince them to make their product available through Apple.

But it is also true for a company like Wal-Mart, which is known for the low cost of its merchandise. This cost advantage reflects its innovative:

• Retail information technology
• Supply chain management
• New efforts in energy use and impact

Time will tell whether Wal-Mart’s understanding of the business opportunity presented by energy/environmental sustainability will also broaden its perspective on community and employee stakeholder relations.

Even companies getting paid directly for knowledge products or services have a lot of their value embedded in their internal processes that are not even visible to the client. Think about the systems at UPS and Fedex. There are truck route planning systems, package tracking systems, air hub systems and many others that support the underlying service which is moving the package from one point to another. Customers of these companies are buying the quality and consistency that these systems ensure.

The truth is that a huge amount of the value of knowledge in most organizations is not isolated and individually identifiable—it exists as a system. The systems provide efficiency, quality, process improvement and innovation.

So, when thinking about how your own company gets paid for your knowledge, you have to consider this “bundled” value in addition to direct knowledge products.

From Intangible Capital: Putting Knowledge to Work in the 21st Century Organization

Your company already has extensive knowledge. The question is how you package this knowledge in a tangible form that has economic value. In order to understand your business as a knowledge business the best place to start is with your revenue line. What does it say there? What do the bills to your customers or clients say? Are you selling them a knowledge product, a physical product, a service, or the time of your employees?

In the coming days, I’ll be reviewing the different ways that your company can get paid for knowledge in greater detail. Hopefully, the discussion will help you think about how you do things today, how you could improve it, and maybe even new ways that you could get paid in the future.

Selling Knowledge Products

The first way of getting paid for what you know is to get paid directly through knowledge products. The simplest form of this kind of product is a written or spoken recording of knowledge. This includes books, articles, reports and white papers—all of which can be delivered in physical or electronic form. Speaking can be delivered directly as a one-time experience or recorded as a reusable product. Video is a more and more common delivery form for knowledge products. Many informational products are also bundled: providing a book, workbook and CD in one package. 

In these forms, knowledge is very much a commodity. The competition for it is often free content. The amount of free content is increasing every day thanks to the Internet. So to get paid for knowledge, your product needs to provide some kind of synthesis of a body of knowledge. Sometimes the knowledge is unique. Most of the time, the synthesis and the approach are the unique aspect. Take our book Intangible Capital for example. Much of what we are writing here is known. We didn’t identify the shift to the knowledge economy. But we have experienced together with our clients the implications of that shift to the challenges of running a business today. And we have come up with a series of steps that help companies “see” and manage this side of their business in a way that helps them grow and improve performance. Our contribution is to tie it all together and package the knowledge in a way that businesspeople can apply it to improve their own operations.

The same knowledge in our book can (and will) be delivered in different forms. Before taking on the project of this book, Mary took a course from Dianna Booher. Dianna has written 44 books in total in her two areas of interest: Christianity and business communications. A couple of years ago, Mary heard Dianna speak and was convinced to take her class when she heard Dianna explain the two dozen product offshoots she had sold for a single book including foreign language editions, electronic editions, workbooks, training manuals, laminated “tips” sheets sold at office supply stores, and recordings of programs, to name a few. Of course, that does not count the number of speeches and training sessions based on the book where she and her employees delivered a “live” version of the content. 

People like Dianna make a very good living selling synthesized knowledge. But selling a book is far from a guarantee of income. Each year in the U.S., over 150,000 new books are published by major U.S. publishers. Many more are published privately through on-demand vendors. Yet, the average book will sell just 500 copies.  Most of them will not make a profit. These kind of figures makes it tough on authors that want to make a living from their writing. It is not too different from the star system that dominates in the music business, although the Internet may change these dynamics over time.

Of course, many people write books as an adjunct to another business. Consultants write books to make their expertise tangible. Academics write books because publishing supports their career development. They are not alone. It is pretty common for businesses to give away knowledge products on the one hand to support their overall value and revenue creation model. Next up: Licensing and Secondary Sales

From Intangible Capital: Putting Knowledge to Work in the 21st Century Organization