The contemporary manager has a problem. It is no longer possible to touch or see the things that matter to business performance. A long-term shift from tangibles to intangibles is occurring in many industries. The focus is no longer mainly on cash, inventory, plant and equipment or land, which typically accounts for only about one-fifth of a firm’s value.

Instead, more slippery considerations such as vision, motivation, various types of explicit and implicit knowledge, customer and employee loyalty, and brands are the key determinants of an enterprise’s performance. In 1982, 60% of the value of the United States S&P 500 companies was accounted for by tangibles. By 1999, it had fallen to 16% (the figure remains below 20%). According to the consultancy firms Accenture and AssetEconomics, by mid-2003, $US7.6 trillion, or 58% of the value of the US stockmarket, was a valuation of the future potential of intangibles.

A 2003 survey by Accenture, AssetEconomics and the Economist Intelligence Unit of American companies found that half the executives listed the management of intangibles as one of their top three priorities. Yet only 5% said they had a robust system of measurement. One- third had no measurement in place, and 61% had measures that were either informal or unorganised. John Barton, principal of John Barton Associates, says companies have trouble developing the new ways of thinking required to understand and assess intangible assets. “What you see in company after company is that knowledge management is pushed back into IT.”

What is required is not a modification of the methods used to value tangibles but a radical departure. Intangible assets are considered to be elements such as innovation, knowledge (explicit and tacit), governance, organisational design, reputation, customer and employee loyalty, capabilities and brand strength. The way in which these are bought, sold and created, is different from tangible assets. For one thing, intangibles have a more uncertain value than is usually the case with tangible assets. Investing in knowledge generation, for instance, can lead nowhere or it can lead to high- value returns. The result of an investment in plant and equipment, by contrast, is comparatively predictable.

Some intangibles have completely different characteristics from tangibles. Knowledge, for instance, is usually not scarce in the way tangible assets are (because it is not lost to the owner when sold). Possessing knowledge is to some extent inevitable in a business, whereas owning a tangible asset is not. It is hard to imagine a business without knowledge, at least if it is to have any hope of staying in existence. Businesses cannot “own” knowledge, except to the extent that they can legally protect its fruits through patents and brand names. The push from the accountancy community to take a pessimistic view of intangibles on the balance sheet is at least half right.

The “snapshot” approach to valuation (the balance sheet is a snapshot of a business’s value at a moment in time) is not ideally suited to getting a grip on intangibles. What really matters is what income they will create, not what their resale value is (which means taking a close look at what customers will pay for in the future). For example, important staff members may create great value for an organisation, but they cannot be bought and sold in the way that, say, land can. Resale value is largely a meaningless measure for “human capital”.

The greatest challenge is in human-resources management. The term itself inspires little confidence (humans are in no meaningful sense “resources”). Yet if intangibles are to be managed well, much depends on the way people are managed. All intangibles gain value only because of what people do. Peter Aughton, chief executive of the consultancy Amerin and director of the Fred Emery Institute, says human-resource managers might do well to drop the title. “Human-resource managers often come through a background of the humanities, but somehow they lose their roots and try to run things as a machine. They get lost in bureaucracies and … the reward structure.” Barton says what is required is “360-degree stakeholder management” – not just training workers to be multi-skilled, but also to involve them in management. Without this, the necessary innovation and flexibility will not materialise.
One way to derive an assessment of intangibles is to use “future value analysis”. According to an article by John J. Ballow, Robert J. Thomas and Goran Roos in the Journal of Applied Corporate Finance, this is the difference between a company’s market capitalisation (the total value of its shares) and the “current value of daily operations”. The general rule of thumb, they say, is that capitalised current operating value equals 10 times the current earnings.
Future value is only a tentative indication of a company’s need to manage intangibles but, in combination with net tangible assets as a proportion of the share price, it does give an idea of a company’s position. Ballow, Thomas and Roos write that no US companies include accounting for intangibles in their annual reports. Only in Europe have there been serious attempts to improve the accounting for intangibles.

Source: BRW Magazine, by David James