20. A Primer on Intellectual Capital

To note, notwithstanding their agrarianist philosophy, the French physiocrats—such as François Quesnay (1694–1774) and Anne-Robert-Jacques Turgot (1727–1781)—who succeeded the mercantilists and immediately preceded the classical economists had identified entrepreneurship (or enterprise) to tally four factors. The prime advocate of a labor theory of value, Karl Marx (1818–1883), a German philosopher, sociologist, economic historian, journalist, and revolutionary, believed that all production belongs to labor because workers alone create value in society. Later schools, including the neoclassical economists, have continued to argue over which factor, including entrepreneurship, is the most important; proposed further distinctions of capital, e.g., fixed, working, and financial capital, as well as additions such as the state of technology and human capital; and, as we shall see, made intellectual capital the object of interest in sundry disciplines other than economics.

Human capital refers to the stock of knowledge, skills, and experience embodied in labor. (Some bring in health, values, behaviors, and motivation.) It is the sum total of attributes, in general cultivated by a worker through education and experience, that determine his or her value in the marketplace.

A brief account of the early days of the intellectual capital movement must cite the pioneering contribution of Hiroyuki Itami who brought out Mobilizing Invisible Assets in Japanese in 1980. In 1986, Karl-Erik Sveiby published the Know-How Company in Swedish. Chronologically, Brian Hall, David Teece, Leif Edvinsson, Hubert Saint-Onge, and Patrick Sullivan were other precursors of work on value creation, value extraction, and value reporting. The frequency and specificity of contributions to the field—theme might be a better word—have multiplied since its inception in the 1980s. (The dates suggest that managing intellectual capital was perhaps the first coherent theme that emerged under the discipline of knowledge management, even if collaboration between knowledge management and intellectual capital management researchers leaves something to be desired).

Knowledge equates with the meaningful links that, through experience or association, people make in their minds between data and information and their application in action in specific situations. It only becomes an asset if some useful order is created so it may be formalized, captured, and leveraged in actionable value propositions that accomplish something that could not be done before.

Value is (i) a fair return or equivalent in goods, services, or money for something exchanged; (ii) the monetary worth of something: market price; (iii) relative worth, utility, or importance; (iv) a numerical quantity that is assigned or is determined by calculation or measurement; and/or (v) something (as a principle or quality) intrinsically valuable or desirable.

The intangible (but, at the commonly cited rate of 80% of an organization's value, nonetheless very precious) assets that make up intellectual capital are not normally ascribed a value in an organization's balance sheet. (Put differently, they are roughly—but not exactly—the difference between the market and book value of its equity.) Yet, they are used to manufacture goods or provide services and are expected to create value (as well they do through, say, profit generation from products, services, or intellectual property; strategic positioning; acquiring the innovations of others when new personnel joins; customer loyalty; cost reductions; or improved productivity). The notion of intellectual capital provides a conceptual platform from which to view, analyze, and (hopefully) quantify them.

The steps involved in capitalizing return might involve, say, acquiring, developing, utilizing, and exploiting knowledge assets.

Although everyone agrees that intellectual capital underpins organizational performance, there is a regrettable—yet unavoidable—lack of consensus over definitions of it owing to the diversity of disciplinary and interdisciplinary views from which it is examined. Usefully, Marr (2005) elucidates economics, strategy, accounting, finance, reporting, marketing, human resource, information systems, legal, and intellectual property perspectives. The interdisciplinary views he brings to the subject are interfirm, public policy, knowledge-based, and epistemological.

Most models of intellectual capital assume a three-way distinction. However, they differ in the names and levels of aggregation. Structural capital is sometimes segregated into according to what has been formalized, e.g., business processes, and what has not, e.g., organizational culture. Pell-mell, and unmanageably so hence the usefulness of discriminating between them, the constituents of intellectual capital include competencies, experience, know-how, knowledge, skills; creativity, innovation; computer programs, databases, information systems, technologies; business processes, methodologies; designs, documents, drawings, publications; intra-organization and inter-organizational relationships; brands, trademarks, etc.

As you would expect, information flows and the perceptions they shape influence corporate reputation.

Formal and informal practices determine how business processes are handled and how work flows through an organization. They comprise, for example, virtual networks, tacit rules of behavior or workflows, and process manuals that lay out codified procedures and rules.

Intellectual property, very broadly, means the legal industrial property and copyright secured from the use of notable mental capacity in the artistic, industrial, literary, and scientific fields. To wit, creations of the mind such as inventions and scientific discoveries; literary and artistic works and their production, performance, and broadcast; and symbols, names, images, and designs can receive legal protection, for instance, by means of copyright and related rights, design rights, geographical indications, industrial designs and integrated circuits, patents, protection against unfair competition, trademarks, and trade secrets. It is no curiosity that explicit rights should be associated with intellectual property and not so readily with other forms of intellectual capital: the latter are frequently (though not always) a process, not an outcome, and are therefore more intangible. (In comparison, when patenting an intellectual property, the owner must make a full disclosure of characteristics by including a specification (description and claims), relevant drawings, prototypes, etc. that clearly define it.) For these reasons, intellectual property usually has a life, certainly in the case of patents, and can often be traded. (Then again, it does not necessarily provide competitive advantage.).

Without reporting systems, on what basis other than guesswork can one invest new capital into worthy, but intangibles-reliant, ventures?

In the first phase, the bulk of effort was expended on raising awareness of the potential of intellectual capital in creating and managing sustainable competitive advantage.

Robert Kaplan and David Norton introduced the Balanced Scorecard in 1992 to help organizations view themselves also from perspectives of learning and growth, business processes, and clients, in addition to finance, for each of which objectives, indicators, targets, and measures should be specified. (This said, the learning and growth perspective has been something of a black hole, with organizations plugging the gap with human resource-related measures, prompting Kaplan and Norton (2004) to posit in 2004 a new definition of intangible assets, viz., human capital, information capital, and organizational, that might have made more of existing classifications.) In 1995, Leif Edvinsson devised the Skandia Navigator, which embodies the same set of concerns as the scorecard but also considers what processes the organization has to nurture personnel. In 1997, Karl-Erik Sveiby devised the Intangible Assets Monitor, which invites application of growth, efficiency, and stability indicators across the accepted tripartite model; unlike the Balanced Scorecard, no financial targets are to be set. (At about the same time, Göran and Johan Roos advertised their proprietary Intellectual Capital Index providing a dynamic view of how intellectual stocks can change over time—by simplifying categories into indices, the index aims to predict returns as investment strategies shift).

Measurement, a quantitatively expressed reduction of uncertainty based on one or more observations, is at the end of the day more about the process of measuring than it is about hard numbers. When designing measurement systems, a rule of thumb is that it is better to be roughly right than precisely wrong. At appropriate levels of control, the common criteria used to improve effectiveness are (i) time, (ii) cost, (iii) resources, (iv) scope, (v) quality, and (vi) actions. It is critical to understand an organization's context; epistemology; and value creation, -extraction, and -reporting pathways if they are to serve as benchmarks.

In 2000 and 2003, the Ministry of Science, Technology, and Innovation in the Government of Denmark gave guidance on formulating intellectual capital statements to help organizations build up, develop, share, and anchor the knowledge that can make their products and services worth more. The four elements of the statements are (i) a knowledge narrative that expresses the ambition to increase the value a user receives from an organization's goods or services, (ii) a set of knowledge management challenges highlighting the knowledge resources that need to be strengthened through in-house development or by sourcing them externally, (iii) a set of initiatives that can be started to do something about the challenges, and (iv) a set of indicators that make it possible to follow up whether the initiatives have been launched or whether the challenges are being met (Danish Ministry of Science, Technology, and Innovation 2003). (The indicators suggested might measure effect, activities, and resource mix.).

This is so regardless of whether an organization is in the public or private sector.

This can only take place after an organization's critical intellectual capital has been marked out, conceivably also by means of knowledge audits. Then, because many types of intellectual assets are difficult to gauge directly, proxy measures can be used. Consider, for example, the budgets needed to operate (i) human capital—such as the costs of finding and recruiting talent, learning and development, etc.; (ii) relational capital—such as the outlays for promotion, marketing, branding, outsourcing, acquiring product or quality certifications, etc.; and (iii) structural capital—such as the internal and external expenditures for building processes, hiring process development consultants, developing software applications for internal systems, running knowledge management systems, investing in research and development, acquiring and documenting intellectual property rights, etc.