Intellectual Capital And Business Value - The Hidden Resource

What is intellectual capital and how is this "capital" used or converted into business value and profits? The IC of an organization comprises such intangible resources and assets that an organization can use to create value by converting it into new processes, products, and services. Though there is no solid consensus on what IC is, there is wide agreement on its definition. It is the knowledge, experience, and brainpower of employees as well as knowledge resources stored in an organization's databases, systems, processes, culture, and philosophy.

Business has always relied on its intangible resources, along with tangible and capital resources, to create value and achieve the organization's goals. Business performance and success depend on how well an organization manages its resources. Formerly, business resources comprised 80 percent of tangible and capital resources, with intangible assets making up around 20 percent. Gradually, this changed with intangible assets reaching 80 percent of the assets of most organizations by 1999. Though a widely declared observation, it is important to explain how the 80 percent is calculated.

The 80 percent figure is calculated by considering the divergence between the market and book values of an organization, known as market capitalization. Though market capitalization is not a phenomenon specific to the knowledge economy, it has escalated in the knowledge economy to reach unprecedented multiples of the book value. Market and book values are never identical, but in the knowledge economy staggering market capitalization figures sent many writers in search for the hidden resource that is creating such huge market values. So what does the book value communicate?

Book values of publicly traded companies mainly reflect the value of tangible and capital assets of the company. Sometimes the book value reflects some of the intangible assets of the company under the heading of goodwill. This is hardly an accurate reflection of the value of intangible assets as it is created to balance the books following an acquisition. The market value of the company reflects the value of a hidden resource that is recognized and valued by the market, including but not limited to the company's reputation, innovativeness, technological prowess, and brand equity. These and other attributes like a company's culture make up the intangible resources of a company. Market capitalization only reflects such resources that can create value (i.e., the company's intellectual capital).

To arrive at an approximation of the value of a company's IC, subtract the book value of a company the total of its tangible and capital resources from its market value. For example, Microsoft's book value (total assets minus total liabilities) on March 31, 2001, was $54.3 billion. This included $1.4 billion in goodwill and $277 million in intangible assets. Its market capitalization (number of outstanding shares multiplied by stock price), however, amounted to approx­imately $301 billion. Subtracting the net book value and that of reported intangible assets results in a staggering figure of $248.4 billion. If we agree that this is the value of Microsoft's intellectual capital, then it makes 82.4 percent of the company's total assets.

Carrying out similar calculations on other companies, it is noted that IC makes up around 80 percent of the Standard & Poor's (S&P) 500 companies, with an average market capitalization rate of 6.5. Of course, the 80 percent figure may be higher in high-tech industries or dot-coms where intellectual capital may reach over 90 percent of the corporate value. Think of Amazon, for example. One would think that this percentage would drop when it comes to more traditional or lowtech industries, but the best-performing companies in all industries show similar results. Ford's IC amounted to 83 percent of its total assets based on its market capitalization value of March 31, 2001.

Studying market capitalization rates by reference to industry in 1995, Sveiby found that industries heavily dependent on IC like companies in the pharmaceutical and business services industries are valued at multiples of their book value. In contrast, companies that mainly manage tangible assets like those in traditional manufacturing and real estate industries have market values that are close to their book values. Interestingly, the best-performing companies in any industry still display high market capitalization rates regardless of their industry. Sveiby compares two steel companies, Nucor and Bethlehem. He notes that though both companies have nearly the same annual revenue of $1.3 billion, Bethlehem is valued by the market close to its book value. Nucor, however, is valued by the market at around four times its book value. Sveiby attributes this to Nucor's mini mill technology and its "management approach that releases the competence of its employees" in short, its IC and its ability to effectively manage it.

In an economy where IC forms the majority of an organization's resources and assets, it is essential to develop ways to identify and manage it. According to IC theorists, intellectual capital is made up of three main components: human capital, customer capital, and structural capital. The first represents employee knowledge, competency, and brainpower. Customer capital represents relations with customers, suppliers, and distributors. Structural capital designates the organizational systems, culture, practices, and processes.