Value Creation and Intellectual Capital

By Marcus Tarrant

Introduction

The concept of intellectual capital plays a crucial role in value creation at various stages of business development.  The concept seeks to explain value “beyond the balance sheet”, by exploring that “intangible” value which lies in the knowledge, relationships, creativity and capabilities of people and organisations.

Background

Accounting based management systems have long fallen short with respect to adequately describing and measuring value.  The value of an organisation is often greater than the sum of its tangible assets.  Intellectual capital theory provides a framework for the measurement and management of these “intangibles” which create such “additional” value.  Whilst this value is often described as “intangible”, it is often reflected very tangibly in the buying decisions of investors (stock valuations).  With the management of “Shareholder Value” underlying key decisions within corporations, it is important that the concept “Intellectual Capital” and its contribution to value is understood. 

This exploration of “Intellectual Capital” was led by Miss Anna Rylander and Dr Kate Andrews. 

Miss Rylander is a Senior Consultant for Intellectual Capital Services LTD in London UK and specialises in research and consulting on intangible assets. 

Dr Andrews is a registered psychologist who is the director of BDO Kendalls Knowledge Management Division, based in Brisbane.

Reading included:

Peppard, J. and Rylander A., (2001), Using an Intellectual Capital Perspective to Design and Implement a Growth Strategy: The case of APION, European Management Journal 2001

What is Intellectual Capital?

Intellectual Capital Defined

The concept was defined through a brainstorming approach.  The many thoughts and views provide a strong overview and boundary to the topic.

Intellectual Capital Is:

·         Intangible – in the sense that it has no physical presence

·         Special skills or knowledge gained by an organisation or individual

·         Transferable and applicable to practical applications

·         It is “everything that stays when the people go home”.

“The principal objective of the Intellectual Capital perspective is to create a framework that allows for describing all resources at a firm’s disposal and how they interact to create value.”[1]

Intellectual Capital was then further defined by its constituent parts, Human Capital, Organisational Capital, and Relationship Capital.  Hence to have a strong technical definition of Intellectual Capital, sub definitions are required.

Human Capital

This relates to the individuals within a corporation, and their capacity for value creation.  This is determined by competence, skills and intellectual agility.

Organisational Capital

This is often human capital that has been “institutionalised” into the way an organisation goes about its business.  It includes such elements as processes, systems, structures, brands, and intellectual property. 

Relationship Capital

There is a value to internal and external relationships.  Internal networks can influence the ability of an individual or division to achieve an outcome.  External relationships can enhance the ability of an organisation to obtain resources, sell products, or form alliances.

How can Intellectual Capital create value?

Does the creation of value from intellectual capital differ from that of traditional assets?

Intellectual resources have different characteristics to physical and monetary resources.  Because intellectual resources are co-dependent in creating value, the concept of diminishing returns does not apply.  For example, accounting theory dictates that the more use a capital item has, such as a machine, the less value that remains within that asset (hence the concept of depreciaton).  This is not necessarily the case with knowledge assets.  Take, for example, a knowledge bank – this database can be used over and over again, by the same or different people, and can continue delivering value at the same rate.  Hence intellectual resources need to be managed differently to physical assets.

Is value delivered through each component separately, or can it be an interaction of several components?

To illustrate how an interaction of the three types of intellectual capital may create value, it is best to use a hypothetical example. 

Imagine you work for a Large Management Consulting Firm, and are seeking to contact a colleague in another country to assist in solving a problem for a key client. The following illustrates the process you may use, highlighting how an interaction of Intellectual Capital components will increase the value that can be delivered.

The area you are working in is unfamiliar to you.  To obtain a quick understanding of the key issues in this area you look up the “knowledge bank” on the internet (Organisational Capital).  During your search on the subject you seek that Bryce Thomas in the UK has done a similar project to the one you are working on.  You give him a call and ask a series of specific questions (Extracting Human Capital).  You then deliver this gained value and knowledge to the client, and other members of your team (Relationship Capital).  In this example we have used all three types of Intellectual Capital to create and deliver value.  Each component has added to the capability, and process of creating value.  Without the “knowledge bank” you would not have located the individual with the knowledge to extract the Human Capital.  This simple example provides an overview of the compounding effect of these components.

Issues and Answers

How do we nurture and create Intellectual Capital?

Through understanding Intellectual Capital processes and flows it is possible to develop a conducive environment to its creation. 

Human Capital can be developed by placing emphasis on the value of employee knowledge.  This “Human Capital” can be purchased or developed internally by sponsoring knowledge creation and development activities.

Often the Organisational Capital flows from Human Capital.  The creation of new knowledge, systems processes etc, is embedded within the way the organisaiton goes about its business.  Whilst this process can be difficult to enforce, the value becomes locked within the organisation, and is likely to have a longer life span than it would if it remained within the individual.  Rewards etc can be offered for individuals contributing to “a knowledge network” or developing new business systems or processes.

Relationship Capital can be developed (internally) through things such as “team building activities” or management training camps.  By providing regular communication with a broad range of individuals within an organisation, internal networks can be fostered and encouraged.

Interaction of the components to create value can be fostered through a “promotion of skills and competencies” through internal communications and marketing.

How do we manage Intellectual Capital?

The stage of a business in its development lifecycle will determine the approach required to the management of Intellectual Capital.  A smaller organisation is characterised by an Intellectual Capital balance that is high in Human Capital, and low in terms of Organisational Capital.  This trend is generally reversed in large mature organisations.  Much of the knowledge needs to be institutionalised to enable access by the broad spectrum of staff. 

How do we communicate the value of Intellectual Capital to stakeholders?

Firstly the Intellectual Capital perspective has to have strong support throughout all levels of the organisation.  Unless this perspective is supported from the CEO down, it will gain little credibility with internal and external stakeholders.

The value of Intellectual Capital will often be ultimately reflected in the share price.  For example, a Premium Brand image enables that firm to charge a higher rate for a similar product.  This price premium often has a strong relationship to profitability which in turn affects the share price.

This issue is often not convincing stakeholders that Intellectual Capital has value, but rather how does that value relate to dollars.  The fact that the value of IC is situation dependent makes this even more difficult. 

For example, assume one develops a new technology the powers cars from water.  A that individual presents the technology to and oil company who buys it for $20m.  The oil company then  spends some money on further developing it, and utilises distribution channels to create further value.  This technology has projected future cash flows for Mobil of $2 billion per annum. 

This simple case illustrates both the value of the Intellectual Capital, and the dependence on a situation or environment.

How do we convert Intellectual Capital to $$$?

Through the creation of a conducive environment to the exploitation of Intellectual Capital, the full value can be realised.  An understanding of the processes and flow that create and move intellectual capital from one type to another can significantly enhance and organisations ability to develop and sell products

Summary

Whilst the accounting perspectives seeks to measure and look at cost, the Intellectual Capital framework seeks to more accurately describe value.  Through the three primary components (Human, Organisational and Relationship Capital), value can be developed and delivered.  Whilst this perspective is intangible in the physical sense, the value is often represented in a more tangible way by an organisations ability to obtain resources, conduct internal processes, and sell it products.