STRATEGY

MEASUREMENT

MANAGEMENT ACCOUNTING GUIDELINE Impacting Future Value: How to Manage your Intellectual

By Bernard Marr

Published by The Society of Management Accountants of Canada,the American Institute of Certified Public Accountants and The Chartered Institute of Management Accountants. NOTICE TO READERS

The material contained in the Management Accounting Guideline Impacting Future Value: How to Manage your Intellectual Capital is designed to provide illustrative information with respect to the subject matter covered. It does not establish standards or preferred practices.This material has not been considered or acted upon by any senior or technical committees or the board of directors of either the AICPA, CIMA or CMA Canada and does not represent an official opinion or position of either the AICPA, CIMA or CMA Canada.

Copyright © 2008 by The Society of Management Accountants of Canada (CMA Canada),the American Institute of Certified Public Accountants,Inc. (AICPA) and The Chartered Institute of Management Accountants (CIMA). All Rights Reserved.

No part of this publication may be reproduced, stored in a retrieval system or transmitted, in any form or by any means, without the prior written consent of the publisher or a licence from The Canadian Licensing Agency (Access Copyright). For an Access Copyright Licence, visit www.accesscopyright.ca or call toll free to 1 800 893 5777.

ISBN: 1-55302-220-3 MANAGEMENT

IMPACTING FUTURE VALUE: HOW TO MANAGE YOUR INTELLECTUAL CAPITAL

INTRODUCTION managing intellectual capital.The success of leading companies such as Amazon, Intellectual capital helps to drive success Google, Microsoft, and Wal-Mart is and create value.Although physical and based on their intellectual capital. Physical financial assets remain important, assets such as distribution warehouses, intellectual capital elements such as the office buildings, and stores are important, right skills and , a respected but not as much as (for example) know- brand and a good corporate reputation, ledge about customers, technology, and strong relationships with key suppliers, markets. For example, the possession of customer and market such as Wal-Mart, with its huge store data, or a culture of set infrastructure, couldn’t perform as well enterprises apart. as it does without (a) the intelligence Growth, above-average earnings, and to build its stores at the right locations, sustainable competitive advantages are (b) the knowledge about consumers no longer driven by investing in physical to stock the right goods, and (c) its assets such as factories, offices, or expertise in inventory replenishment. machinery, but instead by investing in and Intellectual capital allows organizations to

CONTENTS EXECUTIVE SUMMARY Page INTRODUCTION 3 Success and future value creation in today’s ABOUT THIS MAG 4 economy depend on the ownership and WHAT IS INTELLECTUAL CAPITAL? 5 appropriate management of intellectual capital. Defining Intellectual Capital 5 Superior performance is no longer driven by FIVE STEPS TO SUCCESSFUL traditional physical assets, but instead primarily by INTELLECTUAL CAPITAL MANAGEMENT 7 intellectual capital.That term includes knowledge, 1. Identifying your Intellectual Capital 7 skills, brands, corporate reputation, relationships, 2. Mapping the Intellectual Capital Value Drivers 10 information and data, as well as processes, , 3. Measuring Intellectual Capital 14 trust, or an innovative organizational culture. 4. Managing Intellectual Capital 24 The importance of intellectual capital as an 5. Reporting Intellectual Capital 27 enabler of future performance is now generally CONCLUSION 29 accepted among executives across the world. USEFUL WEBSITES 29 Most organizations, however,still lack practical REFERENCES AND ENDNOTES 30 skills, tools, and techniques to identify, measure, and manage this vital performance driver.This management accounting guideline (MAG) addresses this lack by introducing five key steps for successfully managing intellectual capital, namely: (1) how to identify intellectual capital in your , (2) how to map its impact, (3) how to measure it, (4) how to manage it, and (5) how to report it. Practical and easy-to-apply tools and techniques are provided for each of these steps, to equip managers and accountants with the necessary skills to successfully manage the intellectual capital of their organizations.

3 MANAGEMENT

STRATEGY leverage their tangible resources.Without and market value (the value of a public company appropriate intellectual capital, physical assets are as measured by the share price times the number MEASUREMENT just that can yield, at best, average of shares issued). returns.1 Identifying and managing the right To positively impact future value, organizations intellectual capital is and will increasingly be the require a better understanding of intellectual key differentiator between successful, mediocre, capital and the latest tools available to identify, and failing enterprises. measure, and manage this important value driver. It is therefore not surprising that intellectual This MAG provides such understanding and out- capital has moved from the periphery to the core lines the latest tools that will equip managers and of modern businesses. Organizations that want to accountants with the necessary skills to better remain competitive in today’s world need tools manage intangibles to improve organizational and techniques to manage their intellectual performance and drive future value. In addition, capital. In fact, executives around the world have this MAG looks at the latest tools for external confirmed this in a recent survey by Accenture reporting of intellectual capital, to improve the and the Economist Intelligence Unit, which found external communication of the company’s value that most executives believe that intellectual to its shareholders and stakeholders. capital is absolutely critical for the future success 2 of their businesses. The same survey also finds ABOUT THIS MAG that most executives agree that their current approaches to measuring and managing intellectual This guideline is aimed at finance professionals and capital are either poor or non-existent. Other accountants in business who would like to better recent surveys, including one that surveyed understand how to manage intellectual capital. In 780 Chief Executive Officers and Chief Financial particular,it is for those who are responsible for Officers of the 5,000 largest companies in the implementing or improving the management, United States, and another involving 15 of the measurement, and reporting of intellectual capital world’s leading banks and financial services firms, in their organizations. It will also be useful to found that measuring and managing intangibles anyone looking for a general introduction and is the least developed in current performance an overview of the key ideas and challenges of measurement and management systems.3 A report measuring, managing, and reporting intangibles. from the Brookings Institution, an independent This guideline follows on from the CIMA report research and policy institute, outlined that the ‘Understanding Corporate Value: Managing and large and growing discrepancy between (a) the Reporting Intellectual Capital,’ published in 20036. importance of intangible assets to economic This earlier technical report provided an overview growth, and (b) our inability to clearly identify, of tools and approaches for managing and measure, and account for those assets is a serious reporting intellectual capital. However,the world problem for business managers, investors, and has moved on since 2003, and new tools and governments.4 Also, Intellectual capital is not standards have emerged. Also, this MAG provides only critical for commercial enterprises, but clearer guidance and practical tools to enable the increasingly it matters as well in government and reader to better measure, manage, and report not-for-profit organizations. Studies in government intellectual capital. organizations have found that intangibles such This MAG outlines five key steps for successfully as corporate reputation, , and managing intellectual capital. Each step contains relationships with key stakeholders are of vital a number of practical and easy-to-follow tools 5 importance. and techniques. Although all of these tools and The internal problem of identifying, measuring, techniques are rigorously grounded in the latest and managing intellectual capital also applies to research, they have been selected because of their external reporting, where there are growing practical relevance and easy application.The first frustrations with the inability of traditional step looks at how to identify intellectual capital financial reporting to account for and report on within an organization. Step two provides tools for intangibles.The increasing gap between (a) what assessing the strategic value of intellectual capital organizations report in their annual reports by visually mapping how it helps organizations to (mainly traditional physical and financial assets), accomplish their strategic objectives. Step three and (b) what actually matters the most (the discusses how to measure intellectual capital and intangibles) is reflected in the ever increasing provides tools and techniques to do so. Step four variance between book value (mainly traditional outlines how to use the resultant information to assets or liabilities recorded in the balance sheet) better manage intellectual capital in organizations. 4 IMPACTING FUTURE VALUE: HOW TO MANAGE YOUR INTELLECTUAL CAPITAL

It explores how to improve decision making, used as a template to ensure that all possible how to review the strategy, and how to assess the intangibles are identified. Debates about a risks associated with intellectual capital.The final potential overlap, or whether one intangible step discusses the reporting and disclosure of should be put into one category or another, intellectual capital, and provides guidance on how are therefore, at this point, not productive or to prepare such reports. Before discussing each of particularly useful.What is important is that the five intellectual capital management steps, we we identify all intangibles that matter to our provide a detailed definition of what intellectual organizations. capital is – to dispel a lot of confusion about the meaning of this term. Defining Intellectual Capital WHAT IS INTELLECTUAL CAPITAL?7 Together with physical and , intellectual capital is one of the three vital Before we can identify, measure, manage, and resources of organizations. Intellectual capital report on intellectual capital, we need to under- includes all non-tangible resources that (a) are stand what we mean by that term.The concept attributed to an organization, and (b) contribute of intellectual capital is often discussed, but not to the delivery of the organization’s value 8 always well defined. And a multitude of different proposition. Intangible resources can be split words have been used to describe the same or a into three components: human capital, structural similar concept. People tend to use terms such capital, and relational capital (see Figure 1). Each as assets, resources, or performance drivers; and of these is discussed further below. they often replace intellectual with words such as intangible, knowledge-based, or non-financial.Any Human Capital of these words (or a combination of them) can be found in the management literature. Also, The principal sub-components of an organization’s some disciplines (such as the financial accounting human capital are its workforce’s skill sets, depth and legal disciplines) have created quite narrow of expertise, and breadth of experience. Human definitions, such as ‘non-financial fixed assets that resources can be thought of as the living and do not have physical substance but are identifiable thinking part of intellectual capital resources.9 and controlled by the entity through custody and These can therefore walk out at night when legal rights,’ the definition found in accounting people leave; relational and structural capital on standards. Although narrow definitions like this the other hand remains with the organization are necessary to ensure consistency in balance even after people have left. Human capital includes sheets and other external reports, they are less the (a) skills and competencies of employees, useful in creating a broader understanding of (b) their know-how in certain fields that are intellectual capital.This is so because they exclude important to the success of the enterprise, and many commonly accepted intangibles, such as (c) their aptitudes and attitudes. Employee loyalty, customer relationships or knowledge and skills motivation, and flexibility will often be significant of employees, as they cannot be controlled by factors too, because a firm’s ‘expertise and the firm in an ‘accounting’ sense. All of this has experience pool’ is developed over time. A high led to some considerable confusion about what level of staff turnover may mean that a firm is intellectual capital is and is not. losing these important elements of intellectual capital. In this guideline, we will use the terms ‘intellectual capital’ and ‘intangibles’ interchangeably. It is Relational Capital important to stress that there is no generally right or wrong way to classify intellectual capital. For Relational capital includes all the relationships the purpose of this guideline, it is important to that exist between an organization and any provide as broad a classification as possible, to outside person or organization.These can include ensure that the reader gets a complete picture customers, intermediaries, employees, suppliers, of what intellectual capital encompasses.The key alliance partners, regulators, pressure groups, objective of this broad classification (defined communities, creditors, and investors. Relation- below) is to increase the general understanding ships tend to fall into two categories – those that of what intellectual capital is, and therefore to are formalized through, for example, contractual facilitate the identification of intellectual capital obligations with major customers, suppliers and within organizations.The classification should be partners, and those that are more informal. 5 MANAGEMENT

STRATEGY Figure 1: Classification of Intellectual Capital MEASUREMENT Physical Financial Capital Capital

Intellectual Capital

Human Capital Relational Capital Structural Capital • Knowledge and skills •Formal relationships • Organizational culture •Work-related experience • Informal relationships ➢ Corporate values • Competencies • Social networks ➢ •Vocational qualification • Partnerships ➢ Management philosophy •Employee engagement • Alliances •Processes and routines • Emotional intelligence • Brand image ➢ Formal processes • Entrepreneurial spirit •Trust ➢ Tacit / informal routines • Flexibility •Corporate reputation ➢ Management processes •Employee loyalty •Customer loyalty •Employee satisfaction • Customer engagement • ➢ • Education • Licensing agreements Brand names ➢ • • Distribution agreements Data and information ➢ •Joint ventures Codified knowledge ➢ Patents / ➢ Trade secrets

Although the former tended to be predominant in culture, organizational values, and management the past, today, the latter have a more important philosophies.They provide employees with a impact on how the enterprise is managed. In shared framework to interpret events, a frame- today’s integrated economy, with just-in-time work that encourages individuals to operate both supply chains, relationships with trading partners autonomously and as a team to achieve the and suppliers can be crucial. Brand image, company’s objectives.11 corporate reputation, and product/service Processes and Routines, which reflect shared reputation, which reflect the relationships organizational knowledge, can be important between organizations and their (current and organizational resources. Practices and routines potential) customers, also fall into this category. include internal practices and processes; these can be formal or informal (tacit) procedures and Structural Capital rules. Formalized routines can be reflected in Structural capital covers a broad range of vital process manuals that provide codified procedures elements. Foremost among these are usually and rules; informal routines include understood (a) the organization’s essential operating (but unstated) codes of behavior and workflows. processes, (b) how it is structured, (c) its policies, One example of a process that has become a information flows, and content of its , valuable strategic resource is Southwest Airlines’ (d) its leadership and management style, and airplane turnaround, which they have optimized (e) its culture, and (f) its incentive schemes.They to only last 25 minutes.This process, introduced as can, however,also include legally protected a necessary part of Southwest’s start-up as intangible resources. Structural capital can be a low-cost carrier,has today become a key sub-categorized into Culture, Practices and Routines, differentiator.12 and Intellectual Property. Intellectual property – owned or legally protected Organizational culture is fundamental to achieving intangible resources – is becoming increasingly organizational goals. Organizational culture important. Patents, copyrights, , brands, provides a common way of seeing things, sets the registered designs, trade secrets, content, decision-making pattern, and establishes the value and processes whose ownership is granted to the system.10 Cultural resources include corporate company by law have become a key element of 6 IMPACTING FUTURE VALUE: HOW TO MANAGE YOUR INTELLECTUAL CAPITAL

competition.13 Intellectual property is owned by Each of these five steps will be discussed in detail the organization and not its employees. It below.We will explain what each step involves, represents the tools and enablers that help to and provide a number of tools and techniques define and differentiate an organization’s unique designed to help the practicing manager to better offering to the markets in which it operates. manage the organization’s intellectual capital. Examples of intellectual property include symbols such as the McDonald’s Arches and the Nike Swoosh, or the patented 1. Identifying your Intellectual Capital ‘1-click’ buying option at Amazon.com.Coca-Cola, The first step, an inventory check, requires for example, made a conscious decision to keep identifying an organization’s intellectual capital. the formula for Coke a that it actively The categorization of intellectual capital outlined protects. Had they patented the formula instead, above can be used to facilitate a discussion about their protection would have run out many the current stock of intangibles. It can be used to years ago, most likely destroying its market share. create a template that informs people about the different categories of intellectual capital, and FIVE STEPS TO SUCCESSFUL prompts them to think about their organizations’ INTELLECTUAL CAPITAL different types of intangibles (see Figure 3). MANAGEMENT Intellectual capital can be identified through conducting interviews, facilitated workshops, or In this MAG, we will outline five key steps for via mail or online surveys. From experience, successfully managing intellectual capital (see face-to-face individual interviews or surveys work Figure 2).The first step is to identify an best, as they allow everyone to have a say, free of organization’s intellectual capital. Once this is the suppressing influence of stronger or more known, we need to assess its value. It is important dominant participants in workshops. to understand that not all intellectual capital is automatically valuable to an organization. It is only It is important to emphasize again that the valuable if it helps to deliver the organizational objective of this classification template is to objectives. In step two, we therefore assess the facilitate a discussion about as many different relevance of intellectual capital by mapping the resources (intellectual, physical, and financial strategy (with its intellectual value drivers) onto capital) as possible, to create the most realistic a strategic map.The third step is to extract picture of the existing resource architecture. meaningful management information from Individual responses from surveys or interviews measuring the performance of intellectual capital. can then be analyzed and compiled into a list of all In step four,this management information can the major resources. At this point, it is no longer then be used to analyze performance and to as important to use the categories introduced in develop management insights that inform Figure 1, as it is to present the individual resources organizational decision making and learning. Finally, in a language that is understood within the in step five, external reports can be produced to particular organization. Different organizations communicate the value of intellectual capital to tend to use organization-specific terminology to internal and external stakeholders. describe the same resources. It is always advisable Figure 2: Five-Step Intellectual Capital to use the organization’s commonly used language Management Model instead of the categories or examples provided in the template below. Using terminology such as ‘human capital’, for example, can cause misunder- 1. Identifing your intellectual capital standing or even cynicism, especially if this terminology is not commonly used within the organization. 2. Mapping the key value drivers Intellectual Capital Underpins Competencies 3. Measuring intellectual capital Even though most organizations possess a wide variety of intellectual capital, some will contribute 4. Managing intellectual capital more to delivery of their value proposition than others.This is because (a) the value of intellectual capital depends on an organization’s specific 5. Reporting intellectual capital strategy, and (b) intellectual capital dynamically interacts with and depends on other resources: 7 MANAGEMENT

STRATEGY Figure 3: Identifying Your Resource Stock (Source Marr, 2008)

MEASUREMENT Resource Category Examples of Sub-categories: Intellectual Capital elements with a significant presence in our organization: Human Capital Knowlege, education, technical knowledge and expertise, skills, know-how, attitudes, experience, motivation, flexibility, commitment, creativity, etc. Relational Capital Customer relationships, supplier relationships, reputation, image, trust, contractual relationships, informal relationships, alliances, relationships with regulators, partners, etc. Structural Capital Processes, tacit routines, , governance and management approaches, organizational culture, social capital, shared identity, patents, brand names, copyrights, trade secrets, codified information and knowledge, e.g., in databases or process manuals, etc. Property, plants, location of buildings, information and communication infrastructure, machines, equipment, natural resources, physical infrastructure, office design, etc. Financial Capital Cash, investments, bonds, loans, budget, etc.

• The value of intellectual capital depends on In turn, these allow an organization to perform its an organization’s specific strategy.For core activities to deliver its value proposition and example, the know-how of building engines strategic deliverables (see Figure 4). A core is essential for Honda, but of little value to a activity is an excellently performed internal financial services firm; likewise, the compe- activity that is central, not peripheral, to a tencies associated with creating light and company’s strategy, competitiveness, and value durable composite materials so essential for proposition. An organization should only have successful Formula One motor racing teams very few (usually between 2 and 5) core activities. is undoubtedly probably of little value to a telecommunications firm. Figure 4: Intellectual Capital • Intellectual Capital elements are not static – Underpins Capabilities and they dynamically interact with each other, Core Competencies and often depend on other resources for their value. For example, Amazon.com’s brand awareness and reputation, although critically important, would rapidly fade without its Value Proposition / efficient distribution network, well-designed Strategic Deliverables internal processes, and strong supplier relation- ships. It is therefore impossible to value a brand name without taking into account all other important factors, such as reputation, people, processes, etc. Cases such as the accounting Core Activites firm, Arthur Andersen,have shown how a brand name can disappear overnight if the supporting intangibles such as trust or reputation fall away. Often referred to as the interconnectedness of resource stocks, such Organizational relationships are extremely important to Resources (intangible and tangible) intangibles. This means, therefore, that individual intellectual capital resources interrelate with other intangible and tangible resources to form core competencies. 8 IMPACTING FUTURE VALUE: HOW TO MANAGE YOUR INTELLECTUAL CAPITAL

Figure 5: Assessing the Importance of Intellectual Capital

Identified Key Relative strengths of these resources Relative importance of these resources Resources Examples in our organization to delivering our value proposition 0 = not at all important 0 = not at all important 10 = vitally important 10 = vitally important Our specific subject 7 10 knowledge Our perceived 4 9 reputation Relationships with 4 6 key partners Our patent for X 9 2 Our brand X 8 7 Etc.

To understand the role and strategic importance include the two data sets (strengths and impor- of intellectual capital in any organization therefore tance), and to use different size bubbles to requires a clear understanding of the firm’s indicate any gaps. strategic direction and objectives. Figure 6 illustrates such a resource map, one created for a leading online retailing business14 Assessing the Strategic Value of Intellectual to understand the relative importance of its Capital resources to deliver the existing value proposition. The relative importance or strategic value of The value proposition of this well-known retailer intellectual capital can only be assessed in the was to become the world’s preferred source for a context of the existing organization.The questions particular type of goods by providing consumers to ask are: How important are our different not only with top level service, but also high intellectual capital resources to achieving our quality value-added information, excellent price, overall value proposition? Or,how strong are our simple transactions, and an enjoyable shopping existing resources and how can we utilize them experience. In this example, managers assessed more effectively? Independently assessing (a) the structural capital and human capital as the most importance of the different resources to delivery important intellectual capital value drivers of your value proposition, and (b) your resource (indicated by the biggest bubbles).This commercial strengths allows organizations to perform a gap enterprise places particular emphasis on its analysis.This lets you understand whether you knowledge of the market and its customers, plus its are building the appropriate intellectual capital processes and brand. Other important resources for your value proposition, or whether you are were its relationships, especially with its suppliers under- or over-investing in certain areas. and lenders, as the business is still in the growing phase and unprofitable.This map helped the This assessment is best done individually, either organization to understand the relative importance in interviews or by survey. Or it can be done in of its intellectual capital in order to allocate its a workshop setting.The easiest way to perform resources appropriately. the assessment is to use the list of key resources identified above, and then to add columns to As discussed in Figure 6, intellectual capital assess the relative strengths and the importance interacts with other resources to create a core of these resources to delivering the current competency, which in turn helps to deliver the strategy (see Figure 5). Conducting both assess- value proposition.This means that resource ments allows organizations to highlight any gaps. interdependencies can only be assessed in relation to the organization’s existing core competencies The results from the individual assessments can and value proposition. If you have defined your then be aggregated and displayed in a resource strategic deliverables and core activities, you can map. Such a map visually represents the relative then use the above resource list to understand strength or importance of the different resources how the resources combine to deliver your core (intangible and tangible). It is also possible to competencies and value proposition.15 9 MANAGEMENT

STRATEGY Figure 6: Visualizing the Relative Importance of Key Resources (Source Marr, 2006) MEASUREMENT

Organizational Key Resources

Physical Capital Relational Capital Financial Capital

Budget Distribution Network Supplier IT Relationships Infrastructure Lender Relationships

Process Brand Distribution Design Know How Know How Processes Patents Marketing Know How

Human Capital Structural Capital

Studies have found that organizational resources 2. Mapping the Intellectual Capital (especially intangibles) are interdependent and Value Drivers enhance each other in affecting organizational performance. For example, a strong brand name A value creation map is a visual representation might improve performance, but a strong brand of the organizational strategy. Mapping your key name combined with the right market knowledge value drivers into a visual map has two primary and customer service processes can improve functions.The first is to ensure that the strategy performance even more. As a consequence, with all its intellectual capital value drivers is organizations should attempt not only to integrated and coherent; the second is to enable (a) understand the direct effect of each organi- easy communication of the strategy and the role zational resource on performance, but also to and importance of intellectual capital in delivering (b) assess the interdependencies and their effects the strategy. A value creation map brings together on performance.16 For this purpose, you can use the three key elements of an organizational a matrix to rate how resource A depends on strategy, namely, its value proposition, its core resource B to deliver the core competency, until activities, and its enabling strategic elements or the all resource combinations are rated.The scale performance drivers: used for assessing the relationships could be • The value proposition (or output deliverables) between 0 and 5, with 0 indicating no relationship identifies an organization’s purpose and its and 5 indicating a very strong interdependency. roles and deliverables. It also identifies the Again, these matrices can be completed by key output stakeholders of the organization individuals and then aggregated. and the value delivered to them. It is mainly Applying these tools will allow organizations to derived from the analysis of the core gain a solid understanding of their intellectual purpose and the stakeholder requirements. capital infrastructure. In the next section we will Clarifying the value proposition allows discuss how to map this into an integrated picture organizations to put its intellectual capital of strategy. into a strategic context.

10 IMPACTING FUTURE VALUE: HOW TO MANAGE YOUR INTELLECTUAL CAPITAL

Figure 7: Value Creation Map Template (Source Marr, 2008)

Output Stakeholder Value Proposition / Output Deliverables

Core Activity 1 Core Activity 11 Core Activity 111

Human Relational Resources Structural Resources Resources e.g. Supplier e.g. Information e.g. Know How Relationships and Data

Physical Financial Resources Resources e.g.Technology e.g. Funding

Enabling Strategic Elements / Value Drivers

• The core activities are the vital few things an such shared understanding, an organization can organization has to excel at to deliver its then assess and manage its intellectual capital. value proposition.They essentially define How maps are portrayed can vary depending on (a) what an organization should focus on, preferences, levels of understanding, and available and (b) what differentiates it from others. data.The most basic display does not show any Core activities are directly linked to the cause-and-effect relationships or individual inter- organizational core competencies. dependencies between the enabling elements. • The enabling strategic elements (or value Placing all these elements in one box indicates drivers) are the other strategic elements the interdependence of these different enablers or objectives an organization requires to or value drivers and the fact that, as a bundle perform its core activities and to deliver its of enabling elements, they support the core value proposition.These enabling elements activities. or value drivers derive from the assessment of the organization’s resource architecture Value creation maps showing cause-and-effect 18 and intellectual capital. relationships (see the example in Figure 8) provide the most insight. Such maps indicate the These three components are then placed in most important cause-and-effect relationships relationship and displayed on one piece of paper between the different enablers. For example, to create a completely integrated and coherent better training builds up relevant knowledge, picture of the strategy. A value creation map which in turn improves customer service therefore visually represents an organization’s processes.This type of value creation map is unique strategy at a specific point in time. It truly operational, thus promoting a deep and 17 therefore has a limited life-span. As a conse- comprehensive understanding of the role and quence, the maps need to be regularly revised importance of intellectual capital. (usually annually), and no two value creation maps should be the same.The basic template Because a value creation map without cause- of a value creation map is shown in Figure 7. and-effect links is easier to create (because the detailed interdependencies do not have to be A value creation map (a) reflects a shared determined), there is a danger that intellectual understanding of strategy and the importance of capital elements may be added that don’t have a intellectual capital in the context of this strategy, real impact on performance. A value creation and (b) facilitates its communication. Based on 11 MANAGEMENT

STRATEGY Figure 8: Value Creation Map TT Club (Source Marr, 2006) MEASUREMENT

(1.1) Provision of Sustainable Financial Security Through Excellent and Customized Trusted Insurance Covers for the Global Transport Industry, together with Value Added Services

(2.2) Understanding (2.3) Building and (2.1) Claims Handling and Changing Client Maintaining Close Service Delivery Requirements & Relationships Underwriting Risk with Industry

Structure, Reputation as Relationships with Processes, Recognized Specialist in Transport Industry, with Systems Transport Industry re-insurers, and brokers

Capital Strength / Knowledge / Expertise Access to Re-Insurance

Customer Care Ethos

Recruiting,Training, Network / Global Developing, and Retaining Presence and Headquarter Good People in the City of London

map with cause-and-effect links displays the key companies, is a leading provider of insurance most important interdependencies between the and related risk management services for the different enablers, thus ensuring that each element international transport and logistics industry.The is clearly linked to the core activities and value TT Club has its global headquarters in the City proposition.This makes value creation maps easier of London, the central hub for insurance firms, to interpret and analyze, and makes possible the but has 20 office locations around the world. Its test and verification of assumed causal customers range from the world’s largest shipping relationships and interdependencies. lines, busiest ports, global freight forwarders, and cargo handling terminals, to smaller companies We therefore recommend that organizations operating in niche markets. Since its inception create value creation maps (preferably with cause- over 20 years ago, the TT Club has steadily grown and-effect links) that map the key relationships its premium income at an average rate of 10% per between the intellectual capital and the strategic annum. Customer loyalty has been an essential outputs of an organization. Such maps can be factor in this growth. Indeed, 90% of its customers created (preferably by a small task force) from renew their policies with the TT Club each year. the data collected in the first step of identifying the intellectual capital. A workshop with a wider Developing a value creation map (with cause-and- audience (usually the senior management team) effect links) was part of the TT Club’s strategic can then be conducted to discuss and finalize planning cycle. It wanted to better understand its the map. strategic value drivers, with an emphasis on the non-financial and intangible performance drivers. Case study:Thomas Miller Developing the value creation map involved a set of interviews with members of the senior manage- The Thomas Miller Group is a global insurance ment team, the CEO, and board members.The group that includes mutual insurance companies map was finalized in a facilitated one-day planning (known as Clubs).The TT Club, one of the Group’s 12 IMPACTING FUTURE VALUE: HOW TO MANAGE YOUR INTELLECTUAL CAPITAL workshop with the senior management team. Gulf region, Kosovo, and Afghanistan,and also The value creation map for the TT Club is shown maintains an RAF presence in Cyprus, Gibraltar, in Figure 8. Ascension Island, and the Falkland Islands. Its key peacetime responsibility is to maintain the The TT Club decided that its value proposition required readiness of its forces to support the was to provide sustainable financial security for requirement to operate as an expeditionary the global transport industry, by offering excellent air force. customized insurance covers and value-added services that customers trust.They identified The RAF has applied the value creation map to three core activities: (1) claims handling and cascade the overall strategy into the forces and delivery of services, such as risk assessments RAF stations across the UK. Based on interviews, and advice; (2) understanding the industry and a value creation map was created for different changing client demands and underwriting stations.The essential resources on which the requirements; (3) building and maintaining close station relied (e.g., people, equipment, runways, relationships with the industry, which gives the and buildings) were evident.There were also TT Club the status of an independent body several obvious core activities that needed little within the industry. thought.These included flight training, servicing of aircraft, and administrative support. However, These competencies are delivered through the the importance of maintaining fighting spirit and current structures, processes, and systems cohesion across the unit called for competency in supported by the reputation and recognition a number of intangible, but nonetheless essential, of the TT Club as a specialist member of the value drivers.The emerging picture was translated transport industry.These competencies are also into a value creation map that charted how the delivered through relationships not only within enabling strategic elements flowed to the core the transport industry, but also with re-insurers activities, then to the delivered output, all to and brokers. At the foundation of the value achieve the overall mission. creation map is the ability to recruit, train, develop, and retain good people who help to The goal was always to represent the essence of create the needed knowledge and expertise. a station on a single A4 page. In the RAF context, This knowledge and expertise together with the the resultant diagram was termed the Strategic strong customer care ethos, helps to shape the Map.The draft strategic maps were then subjected TT Club’s reputation in the industry. Knowledge to rigorous review during a presentation given and expertise also shapes the development of its to station commanders and their executives. processes, structures, and systems. Although there were differing views on the key interdependencies and the relative importance Another key enabler is capital strength and access of core activities, agreement was achieved on the to re-insurance, one of the strongest resources of map’s essential components. After the Strategic the TT Club. Access to re-insurance depends on a Map had been agreed upon in principle, an strong and dynamic relationship with re-insurers. associated table was generated that explained Capital strength is also an important driver of the intended scope of each element. reputation; without capital strength,TT Club’s reputation would suffer very quickly.The TT Figure 9 outlines the value creation map for one Club’s global presence helps it to create local of the RAF stations, showing its value proposition, relationships, which in turn help its reputation and core activities, and intellectual capital value drivers. recognition in the field. Having its headquarters This version does not include the cause-and-effect in London enables the TT Club to develop the links between the different intellectual capital crucial relationships with (a) brokers who sell elements. Overall, this station (RAF Waddington) their products, and (b) re-insurers to make exists to generate world-class Expeditionary re-insurance deals. Intelligence, Surveillance,Target Acquisition,and Reconnaissance (ISTAR) Capabilities.There were Case study:The Royal Air Force19 three core activities at which the station had to excel, namely, (a) to successfully contribute to We discuss below how the Royal Air Force of operations and other tasks (today and in the the United Kingdom (RAF) has applied the value future), (b) to provide and develop a sufficient creation mapping tool to identify and map its number of capable and prepared people, and intellectual capital value drivers.The RAF has (c) to maintain, sustain, and develop sufficient 50,000 service and civilian personnel, and more combat-ready equipment.The station agreed on than 500 aircraft. It supports operations in the eight intellectual capital enablers of performance 13 MANAGEMENT

STRATEGY Figure 9: Value Creation Map RAF (Source Marr & Shore, 2008) MEASUREMENT

(1.1) To generate world-class Expeditionary ISTAR Capabilities

(2.1) Successfully Contribute to Operations & Other Tasks, Today and in the Future

(2.2) Provide & Develop Sufficient (2.3) Maintain, Sustain & Develop Capable & Prepared People Sufficient Combat Ready Equipment

(3.1) Enhance & Maintain (3.2) Develop Excellent (3.3) Maintain & Enhance Competencies,Training & Motivation, Fighting Spirit, Equipment Personal Development Morale & Ethos

(3.4) Direct and (3.5) Foster a Culture of Coordinate Output to Ensure Innovation and Continuous Optimal Use of Resources Improvement

(3.6) Communicate & Engage (3.7) Enhance Health, (3.8) Cultivate Positive Proactively and Openly Fitness & Well-being Image & Reputation

(4.1) Financial Resources

(4.2) People: Manpower

(4.3) Equipment & Stock (4.4) External Services (4.5) Infrastructure

that it required to continue to deliver its 3. Measuring Intellectual Capital objectives.These performance drivers are to: After identifying and mapping the intellectual enhance and maintain competencies, training, and capital value drivers, organizations can start personal development; develop excellent measuring them.We often have a misconception motivation, fighting spirit, morale, and ethos; that intellectual capital is difficult or impossible maintain and improve equipment; direct and to measure.This is not the case. Many tools and coordinate output to ensure optimal use of techniques are available to measure intellectual resources; foster a culture of innovation and capital, and it is most probably easier to measure continuous improvement; communicate and than you think.This section outlines a model engage proactively and openly; enhance health, that will assist you in developing performance fitness, and well-being; and cultivate a positive indicators for your intellectual capital value image and reputation. drivers. Figure 10 shows the intellectual capital In addition to these intellectual capital enablers, performance indicator design model. It starts with the stations identified a number of other identifying which intellectual capital element you resources it needed, including finance, infra- want to measure. Every intellectual capital value structure, equipment and stock, external services, driver on the value creation map should be and manpower. All of these are allocated to the measured, and for each of them the indicator stations.Together,all the elements form a cohesive design model should be followed. picture of the strategy for RAF stations. 14 IMPACTING FUTURE VALUE: HOW TO MANAGE YOUR INTELLECTUAL CAPITAL

Figure 10: IC Performance Indicator Design Model (Source Marr, 2008)

Which IC value driver do we want to measure?

Do we have a key performance question to answer?

Yes No Don’t measure, rethink!

Can we use existing methods to measure it?

Design new measurement method No Yes

• Instrument? Can we collect meaningful data? •Source of data? •Formula? •Frequency? Yes No •Targets / Benchmarks? • Who measures? • Expiry date / Revision of data? Does it help us answer our KPQ? • Audience • Reporting Yes No

Start measuring Are the measurement costs and efforts justified?

Yes No

After you have decided on the intellectual capital assume that this intellectual capital value driver value driver to measure, it is important to decide has probably been measured before, and that whether it is worth measuring in the first place. someone has designed a method for measuring it, Measuring performance should provide us with so don’t re-invent the wheel. Do some research meaningful information that helps to reduce on already developed measurement methods.This uncertainty about intellectual capital, and enable can usually be done with simple Internet searches. us to learn about the intellectual capital value If methods already exist (the most likely case), driver and its performance. Measuring performance then it is important to assess whether any of should help us to make better informed decisions them are appropriate to use. Not all methods that enable us to improve our performance. will be useful for your purpose. If no appropriate An excellent way of determining whether an methods seem to exist, you will need to design indicator is worth measuring is to establish the new measurement methods. question(s) the indicator will help to answer. For both existing and newly developed methods, So-called Key Performance Questions (KPQs)20 it is important to assess (a) whether it is possible are designed to identify what managers want to to collect meaningful data, and (b) whether the know about the various intellectual capital value data will help to answer your questions. Finally, it drivers. KPQs make sure that any measure has is important to assess whether the resultant data a clear purpose. If there is no question that warrants the cost and efforts of measurement needs to be answered, then there is no need (which can be significant). If no meaningful data for measurement. can be collected, if the data is not really helping Having identified that a question should be you to answer the KPQ, or if the costs are not answered, you should think about how to collect justified, then it is necessary to rethink and design the measurement data. At this point, you can different indicators. 15 MANAGEMENT

STRATEGY After you have developed indicators, it is necessary KPQs should not be designed solely in the to identify (a) the measurement instrument, i.e., boardroom. Designing KPQs provides a great MEASUREMENT how the data will be collected (e.g., survey or opportunity to engage everyone in the organi- interviews); (b) the source of the data; (c) the zation, as well as some external stakeholders. formula used to compute the indicator; (d) the Here are some guidelines for designing KPQs:22 frequency of measurement; (e) any targets or • Design between one and three KPQs benchmarks; (f) who will measure; (g) how long for each intellectual capital value the indicator will be collected before it needs to driver: If the intangibles matter in delivering be reviewed; (h) the target audience for this your strategy, then you should develop indicator; and (i) the reporting formats. Below, we management questions you want answered. look at developing key performance questions and Tr y to keep them to the vital few (see designing performance indicators in more detail. Figure 11). Designing Key Performance Questions™ Figure 11: KPQs and KPIs Key Performance Questions (KPQs)20 ask managers exactly what they want to know about the various intellectual capital value drivers. KPQs KPI KPQ are asked to ensure that indicators are useful and Intellectual KPI meaningful.They make sure that we are clear Capital Value about what it is we want to know. Also, by first Driver KPI designing KPQs we are able to ask ourselves: KPQ ‘What indicators will best help us answer our KPI key performance questions?’ An example of how powerful KPQs can be in • Involve people in the process: Tr y to managing strategic performance comes from involve people in the design of KPQs by Google – one of today’s most successful and most asking them what questions they believe admired companies. Google CEO Eric Schmidt are most relevant. After designing a list of says21: “We run the company by questions, not by KPQs, get feedback from the subject matter answers. So in the strategy process we’ve so far or different parts within and formulated 30 questions that we have to answer […] outside the organization. For example, ask You ask it as a question, rather than a pithy answer, the marketing department to discuss and and that stimulates conversation. Out of the conversa- refine the KPQs that relate to brand and tion comes innovation. Innovation is not something that reputation. Remember that KPQs I just wake up one day and say ‘I want to innovate.’ communicate to everyone what really I think you get a better innovative culture if you ask it matters to an organization, and that the as a question.” more people understand and agree with Any student of science learns that it is important these questions the more likely it is that to know what you are looking for before you start everybody will pull in the same direction. collecting any data. If we start collecting data • KPQs should be short and clear: without knowing what we are looking for,we A good KPQ is relatively short, and clear. often collect the wrong or unnecessary data, and A KPQ should only contain one question. develop few or no insights about the really Asking a string of questions makes it much important questions we need answers to. In our harder to guide meaningful and focused data desire to find measures and get our hands on the collection.The language should be clear and data, we often fail to clarify what it is we really not contain any jargon or abbreviations that want to know. For example, after deciding that the might not be understood. Likewise, ensure relationship with our partners is important and that the question is clearly written, using that we ought to measure it, we need to pause to language those in your organization (and clarify what it is we want to understand. Here is those consulted outside) are comfortable where KPQs come in – defining the question or and familiar with. questions we want answered forces us to more • KPQs should be formulated as open specifically spell out just what it is we want to questions: Closed questions such as ‘How know. Once we have the question, we then have many people in our organization have higher to ask ourselves: what information will answer this education qualifications?’ or ‘Have we met question and what is the best way of collecting it? 16 IMPACTING FUTURE VALUE: HOW TO MANAGE YOUR INTELLECTUAL CAPITAL

our employee satisfaction target of 89%?’ •How well are we building our new can be answered with a simple answer competencies in X? without any further discussion or expansion •To what extent are we continuing to attract on the issue. However,open questions such the right people? as ‘To what extent are we sharing know- •How well are we fostering a culture of ledge?’ or ‘How well are we increasing our innovation and continuous improvement? corporate reputation?’ trigger a wider search for answers by seeking more than a •To what extent do people feel passionate ‘yes’ or ‘no’ response. Open questions make about working for our organization? us reflect, they engage our brains to a much •How well are we helping to develop a greater extent, and they invite explanations coordinated network to perform clinical and ignite discussion. All of this is vital when trials? it comes to intellectual capital. •How motivated is our staff? • KPQs should focus on the present and •How well are we sharing one set of values? future: Questions should be phrased in a •How well are we protecting our intellectual way that addresses the present or future: property? “Are we increasing our market share?” instead of questions like “Has our market Designing Performance Indicators for share increased?” By focusing on the future, Intellectual Capital we open up a dialogue that allows us to ‘do’ something about the future.We then look Once we have the KPQs and know what it is at data in a different light, trying to under- we want to know, we can design performance stand what the data and management indicators for our intellectual capital. Over the information means for the future.This helps past decade, many tools and techniques have with data interpretation and ensures that been developed to measure intellectual capital. we collect data that helps to inform our Sophisticated measurement and analysis methods decision making. are usually used in fields such as physics and financial accounting, which have a long history of • KPQs are refined through usage: measurement and already have reliable After KPQs have been created, their quantitative measurement instruments.The answers should be evaluated, to see how measurement of intellectual capital is a relatively well (a) the performance indicators answer young field, without many generally accepted the questions, and (b) the indicators help measurement instruments. It is natural that areas people to make better informed decisions. of measurement evolve and improve over time, Once KPQs are in use, it is possible to and that more generally accepted methods will refine them to improve their focus. emerge. For example, temperature was Below, we have listed some example KPQs to considered very qualitative and immeasurable illustrate how organizations have developed key until Daniel Fahrenheit developed the mercury performance questions for some of their thermometer to measure it.Today, we all accept intellectual capital value drivers: this form of measuring temperature.We will see similar evolutions for areas of intellectual capital. •To what extent are we enhancing our international reputation? Most measures of intellectual capital are indirect •How well are we sharing our knowledge? or proxy measures. For example, in measuring work-related competencies we might use the •To what extent are we retaining the talent number of people with vocational qualifications as in our organization? a proxy measure. Or,if we want to measure trust •How well are we promoting our services? in our organizations, we collect survey data as •How do our customers perceive our proxies.This is completely legitimate and some- service? thing we do in other more sophisticated areas of •How effective are we in managing our measurement. Just think of temperature, where relationships? we measure the expansion of mercury, or time where we measure the rotations of cogs. •How well are we innovating? •How well are we communicating in our The one danger with using proxy measures is organization? that we sometimes oversimplify the process and simply measure what is easy to count. For •How well are we working in teams? 17 MANAGEMENT

STRATEGY example, we might want to understand intelligence instruments, it is important to check what has but just measure IQ test scores. Another problem already been developed and used by others. MEASUREMENT is that we tend to focus on numbers more than When deciding on the instrument, it is important their meaning. As Dee Hook, founder of the Visa to keep the KPQ in mind when assessing whether network, rightly said “in years ahead, we must get meaningful data can be collected. In many areas beyond numbers and the language of mathematics to of intellectual capital, improved measurement understand, evaluate and account for such intangibles instruments have led to more insightful and as learning, intellectual capital, community, beliefs and meaningful performance indicators. principles, or the stories we tell of our tribe’s values The most suitable measurement method is and prosperity will be increasingly false.”23 most likely simpler than you first think; also, you Words such as performance assessment seem usually have access to more data than you expect. more appropriate in this context than ‘measure- Designing the right measurement instrument ment.’ Assessment goes beyond the assignment of might only require more resourcefulness.25 For numbers. Instead, we should assess performance example, instead of using the ubiquitous and by systematically collecting information to enable intrusive customer satisfaction survey, many us to gain the required insights and answer our service providers, such as hotels or banks, now KPQs. Performance assessment can take the form use focus groups to identify what really matters of numbers, but should also include written to their target customers.They then employ descriptions, symbols, or color codes. professional mystery shoppers/users to assess service levels against the identified criteria. Call Furthermore, when it comes to intellectual capital, centers, for example, used to count only the the word indicator rather than ‘measure’ seems number of abandoned calls, or call duration, as to more appropriately reflect indirect measure- measures of customer service delivery. Now they ment using proxy indicators. An indicator use instruments such as audio taping telephone ‘indicates’ a level of performance, but it does not conversations between service agents and claim to ‘measure’ it. For example, a new indicator customers, and use coaches to randomly listen to assess customer satisfaction levels will indicate to conversations to assess the qualitative aspects how customers feel; however,it will never of call handling.To enable the user to consider ‘measure’ customer satisfaction in its totality. different measurement instruments, we present We often associate counting with objectivity below an overview of different instruments for and reliability, and perception-based data with measuring intellectual capital value drivers: unreliability.This belief needs to change when it • Surveys and Questionnaires provide a comes to intellectual capital. Many studies have relatively inexpensive way of collecting data shown that perceptual assessments are as reliable, on intellectual capital from a large pool of 24 if not more reliable, than archival data. Percep- people who might be at different locations.26 tion data can (a) provide richer insights into the This can be done via mail, e-mail, internet, or real level of performance, and (b) allow us to telephone. One big problem with this is the actively involve people in assessing performance. huge influx of surveys over the past few We can involve people by asking them, for years, as more and more organizations example, to rank competitors, evaluate the service require data for their non-financial indicators. delivery or organizational culture, or assess the As a consequence, it is now harder to level of relationships with different suppliers.These persuade people to complete a survey. It assessments can take the form of numbers or is always a good idea to reduce the amount grades; however,they can also be represented by of time and effort required to collect symbols such as traffic lights or thumbs up or performance data, not only for your down, as well as by written assessments.Written organization, but also for your customers, assessments capture much more information, employees, suppliers, etc. Surveys are allowing us to more naturally communicate regularly used to measure intellectual capital assessment outcomes. If numbers are used to value drivers such as employee engagement, assess intellectual capital, it usually makes sense corporate culture, customer attitudes, to supplement them with at least a comment field innovation climate, or brand image. to provide some explanatory narrative. • In-depth interviews are guided conversations An important step in designing indicators for with people, rather than the structured intellectual capital value drivers is to decide on queries found in surveys.They put forward the measurement instrument that will be open-ended (how, why, what) questions in a used to collect the data. Before designing any new conversational, friendly, and non-threatening 18 IMPACTING FUTURE VALUE: HOW TO MANAGE YOUR INTELLECTUAL CAPITAL

manner.27 Interviews can be conducted comparisons between organizations. face-to-face, or via telephone or video- However,external assessments might be conference. Interviews, which enable too generic, and often use assessment interaction directly with respondents, may approaches that don’t provide the answers provide new insights about performance. to the internal KPQs. External assessments They provide examples, stories, and critical are best used to supplement, cross-check, incidents that are helpful in understanding and validate other internal indicators. 28 performance more holistically. In-depth • Observations allow us to collect information interviews can, for example, be used to by observing situations or activities with assess intellectual capital value drivers little or no manipulation of the environment. such as relationship with key customers, The observer can either take the role of a suppliers, or partners. In addition to passive onlooker / outsider,or can become providing a performance score, they can involved in activities and, therefore, take also yield invaluable contextual information the role of partial or full participant.“The about, for example, how to improve power of using observation methods is that relationships between key customers, it engages all of our senses not just our partners, or employees. sight. It enables us to take in and make • Focus groups are facilitated group discussions sense of the entire experience through our (5-20 participants) in which participants can nose (smell), eyes (sight), ears (hearing), express and share their ideas, opinions, and mouth (taste), and body (touch). Unlike experiences.They provide a unique and other data collection methods, observation interactive way to gather information, and data can provide us with a more holistic allow the collection of rich, qualitative understanding of the phenomenon we’re information. Focus groups are good ways of studying.”28 Observation outputs can take assessing employee- and customer-related the format of score sheets, check lists, intellectual capital value drivers such as narrative reports, and video or audio taping. customer experience, customer or staff Observations have been successfully used engagement, team-working climate, or trust. in assessing organizational culture, skill and • Mystery shopping approaches assess a service experience levels of employees, emotional by using a ‘secret shopper’ posing as a client intelligence, and creativity. Another example or customer.Some companies hire their is employee safety. Instead of waiting for own mystery shoppers; other firms hire accidents and injuries to occur and then external suppliers to provide this service. count those, so-called Safe Behavior The beauty of this assessment approach measures can be used: Observers pro- is that it is less intrusive than surveys or actively look for safe behaviors that would interviews. Many retail businesses, banks, prevent the most common accidents, and and hotels have used mystery shopping record those on a behavioral observation to assess customer experience.Trained form.This information can then be shared, mystery shoppers can also be used for providing immediate feedback on potentially many other intellectual capital assessments, unsafe behavior. such as assessing an organization’s culture • Peer-to-peer evaluation is the assessment of or atmosphere. performance by participants who vote on • External Assessments. External organizations or assess each other’s performance, either and institutions can provide independent openly or anonymously.This enables people performance assessments and indicators. to learn from each other,and to consider Good examples of external assessments their own performance from the perspec- are independent surveys that measure the tive of others. Peer-to-peer evaluations have brand recognition, customer awareness, been successfully used to gauge intellectual or market share in specific segments. An capital value drivers, including trust, know- independent company creates a set of ledge and experience, teamwork, and criteria, and then measures everyone against relationships. these criteria to assess, for example, the There are many more fascinating ways of relative position or values of brands or collecting qualitative performance data – for more corporate reputations.The advantage of information and an example see the Handbook of external and independent assessments is Qualitative Research.29 To guide the indicator design, that the data they provide allows we have developed an intellectual capital indicator 19 MANAGEMENT

STRATEGY template (see Figure 12) that can be completed still complete a survey once a year,but the following the model described in Figure 10. organization receives monthly information that MEASUREMENT allows them to answer their KPQs and act on the The top part of the template states the intellectual data much more quickly. capital value driver that is being assessed, the KPQ, and Ownership of the question. Ownership Formula / scale / assessment – Here, the identifies the person(s) or function(s) responsible designer of the indicators identifies how to for managing the intellectual capital value driver capture the data. It may be possible to create a that is being assessed. Every indicator should be formula. Or an aggregated indicator or index that given a clear name. is composed of other indicators may be used. Here the designer also specifies (a) which of the The Data collection method describes the following scales is to be used: nominal (numbering method or instrument used to assess the of categories, e.g., football players); ordinal (deter- intellectual capital value driver. As discussed mination of greater or less, e.g., street numbers); above, selecting the appropriate data collection interval (determination of intervals, e.g., degrees method is important. It is important to consider Fahrenheit or Celsius); and ratio (determination the strengths, weaknesses, and appropriateness of equality and ratio in a continuum with a real of different data collection methods. Here, the zero, e.g., length, time, temperature in Kelvin); or designer of an indicator should briefly describe (b) whether the indicator cannot be expressed in the data collection method, specify the source any numerical form. of the data, state how often the data is to be collected, identify the scale to be used to measure Targets and performance thresholds identify it, and identify who is in charge of collecting and the desired level of performance in a specified updating the data. timeframe (e.g., 5% increase of market share by the end of March next year). Many firms use Source of the data identifies where the data ‘traffic lighting’ to illustrate performance levels. comes from.This ensures that the designer of an Here, the designer of an indicator would specify indicator ask a number of questions about the the thresholds for red (under-performance), access to data. Is it readily available? Is it feasible amber (medium performance), green (good to collect it? Will the data collection method,for performance), and sometimes blue (over- example interviews with senior managers, provide performance). Here, it is also worth thinking about honest information? If not, maybe different data internal or external benchmarks; these can be collection methods could be combined? derived from past performance, from other similar Frequency of data collection identifies how organizations or departments, or from forecasts. often the data for that indicator should be Data entry identifies the person, function, or collected. Some indicators are collected external agency responsible for data collection continuously, others hourly, daily, monthly, or and data updates.This could be an internal person even annually. It is important to decide what or function, or an external agency, because many frequency will provide sufficient data to answer organizations outsource the collection of specific the KPQ, and how regularly it is feasible to indicators. Outsourcing is especially common for measure. Organizations might want to continu- indicators such as customer satisfaction, reputa- ously track indicators of website usage, because tion, brand awareness, and employee satisfaction. some of them might be readily available from server reports. External indicators for brand Expiry / revision date – Indicators are some- ranking, for example, might only be available once times introduced only for a specific period of or twice a year.One of the biggest pitfalls of time (e.g., for the duration of major projects, intellectual capital measurement is that data is not or to keep on eye on restructuring efforts). collected frequently enough. For example, many It is common practice to introduce a significant organizations conduct employee surveys once a number of indicators once and collect data year or even every eighteen months.This is not forever, because no one ever goes back and very useful, as the time between the assessments identifies the indicators that are no longer needed. is too long, and impacts of corrective actions Other obviously temporary indicators are cannot be tracked. Instead of surveying all introduced without giving them an expiration employees once a year,it is possible, for example, date; however,for those indicators a revision date to survey a representative sample (let’s say 10%) should be set that allows the designers to review of employees every month. Individuals will the template and check whether it is still valid.

20 IMPACTING FUTURE VALUE: HOW TO MANAGE YOUR INTELLECTUAL CAPITAL

Figure 12: Indicator and Index Design Template (Source: Marr 2006)

TEMPLATE FOR DESIGNING KEY PERFORMANCE INDICATORS Intellectual Capital Element Name the strategic element from the Value Creation Map which is being being Assessed: assessed with this indicator. Key Performance Question(s)™ Name the question(s) related to performance that this indicator is helping to answer. Ownership / Person Responsible / Identify the person(s) or function(s) responsible for the delivery / performance Champion / Coordinator of the measured strategic element. Indicator Name Pick a short and clear indicator name. Data Collection Method / Describe how the data will be collected. Instrument • Source of Data Describe where the data will come from. • Frequency Describe how frequently this indicator will be collected. If possible, include a forward schedule. • Formula / Scale / Assessment Describe how performance levels will be determined.This can be qualitative, in which case the assessment criteria need to be identified, or it can be numerical or using a scale, in which case the formula or scales with categories need to be identified. • Targets and Performance Identification of targets, benchmarks, and thresholds for traffic lighting. Thresholds • Data Entry Name the person or role responsible for collecting and updating the data. Expiry / Revision Date Identify the validity date of this indicator,or when it will have to be revised. How much will it cost or what Estimate the costs incurred by introducing and maintaining this indicator. will the person / days required be to collect the data and is it justified? Reporting • Audience / Access Name the key audience for this indicator and clarify who will have access to it. • Reporting Frequency Outline how frequently this indicator will be reported to the different audiences (if applicable). • Reporting Formats Describe how the performance indicator will be presented (numerical, graphical, narrative formats). Here it is good to especially think about visual representation that makes it easy to understand and digest.

Estimated costs – Another aspect that should tions, the reporting frequency, and reporting be considered is the cost and effort required to formats. introduce and maintain a performance indicator. Audience and access identifies who will receive Many managers and measurement experts assume the information on this performance indicator. that creating and maintaining measurement Reports on indicators can have different systems does not incur significant costs. On audiences. It might therefore be a good idea to the contrary, however,measurement is expensive, identify primary, secondary, and tertiary audiences. especially if the indicators are supposed to be The primary audience will be those directly relevant and meaningful to aid decision making involved in the management and decision making and learning. Costs can include the administrative related to the strategic element that is being and/or outsourcing costs of collecting the data, as assessed.The secondary audience could be other well as the cost of analyzing and reporting on the parts of the organization that would benefit from performance. It is important to ensure that the seeing the data. A possible tertiary audience costs and efforts are justified. could be external stakeholders. Reporting – Here, the designer of an indicator Reporting frequency identifies how often to identifies how to report the performance report on this indicator.If the indicator is to indicator,identifying the audience, access restric- 21 MANAGEMENT

STRATEGY support decision making, then it needs to provide important intellectual capital value driver.Initially, timely information.The reporting frequency can InterCorp didn’t develop KPQs. Instead, it tried to MEASUREMENT differ from the measurement frequency. An find the quickest and easiest way to get some data. indicator might be collected hourly, but only After some research, InterCorp identified an reported on at a quarterly performance meeting. external company that specialized in partnership evaluations.This company had designed a generic Reporting formats identify how best to present questionnaire to measure partnerships. InterCorp the data.They should clarify whether the indicator outsourced its data collection to this company, is reported as, for example, a number,a narrative, who then started to collect the partnership data a table, a graph, or a chart.The best results are twice a year.Initially, InterCorp was pleased with usually achieved if performance is reported in a the service, as the external company provided it mix of numerical, graphical, and narrative formats. with detailed reports containing graphs, tables, and Considerations here also include the presentation trend analyses on about 50 different questions on of a data series and past performance. A graph the survey. Although, on the surface, InterCorp containing past performance might be very useful seemed happy with how things were going, the to analyze trends over time; this could also include partners were telling a different story.They targets and benchmarks. Increasingly as well, believed that a lot of unnecessary data was organizations use traffic lights or speedometer collected, which took them a lot of time and effort dials to present performance data. (about 6 man-days for each survey). It very quickly When designing any indicator for the intellectual became clear that all of the data InterCorp were capital value drivers, it is essential to constantly collecting was ‘interesting to know,’ but only that. evaluate the validity and information value of the Not one decision based on the survey data had indicators.The following questions are relevant. been taken over the past three years. To what extent do the indicators enable us to InterCorp went back to the drawing board and assess the particular intellectual capital element? identified the question(s) they really wanted How well do the indicators help us answer the answered.The KPQ they came up with was “How KPQ(s)? If the indicator is not providing us with well are our partnerships progressing?” After the required information, we should not measure deciding on this KPQ, they then asked themselves it at all. what data they would need to answer this When it comes to intellectual capital, a single question, and how best to collect the data. performance indicator will rarely give us sufficient InterCorp needed data that would assess the information.We therefore recommend combining relationships, but didn’t want to use the same different measures into one index.This provides survey again, as it was collecting too much organizations with a more rounded and balanced unnecessary data. After some deliberation and view on their intellectual capital. Human health research, InterCorp agreed that the best approach allows us to illustrate the point. Only taking your would be to ask its relationship managers or blood pressure to assess your heath would not account managers for an assessment. InterCorp be sufficient. However,taking blood pressure, realized that its own account managers would be cholesterol and blood tests, together with a able to make this assessment without the need for number of other tests, and combining these into a lengthy survey. InterCorp designed a system that a health index, provides a much more balanced automatically e-mailed a very simple form to the and reliable assessment of physical health.The account managers with just two questions:“How same is true in business. If a company wants to would you assess the relationship with company measure customer relationships, a number of X?” and “How well is the partnership with indicators such as loyalty, trust, commitment, company X progressing?” The form included a profitability, and referrals can be measured and scale next to the question. Initially this was a combined into a customer relationship index. 10-point scale, from very bad to very good.This was We outline below two illustrative examples of later refined into a 3-point scale. In addition, the how organizations have applied the indicator form also included a field for a written comment design model in practice. (see Figure 13). Account managers were asked to assess the partnerships by ticking a box on a scale Case study: Measuring Partnerships at and by providing a short written comment on why InterCorp30 they picked that particular assessment. A major blue chip company, InterCorp, wanted to measure its partnerships with its key suppliers, an

22 IMPACTING FUTURE VALUE: HOW TO MANAGE YOUR INTELLECTUAL CAPITAL

Figure 13: Partnership KPQs engaged employees are passionate about what they do, feel a strong connection to their company, Problematic Indifferent Positive and perform at high levels every day while looking How would you assess the for ways to improve themselves and the company relationship with company X? as a whole. Unengaged employees on the other hand show up every day and put in just enough Written Comment: effort to meet the basic requirements of their jobs. Worse Same as Better Without passion or innovation, these employees than before before than before neither commit to the company’s direction, nor How well is the partnership do they work against it. Actively unengaged with company X progressing? employees present a big problem for businesses. Negative by nature, these people are unhappy in Written Comment: their work, and they compound their lack of productivity by sharing this unhappiness with InterCorp realized that asking only the account those around them. According to Gallup managers might produce a biased view on the Research, an average organization has about 25% situation, so it decided to also e-mail a modified engaged employees, just over half not engaged form to its partner companies. Preferring not employees, and just under a fifth actively to ask for any written assessment, the form used disengaged employees.TradeBank was keen to for the partner companies only included the two improve its ratio and ensure that more employees scaled questions. After account managers and were closely engaged. the partner companies had completed the short survey, the results were compared in a database. Managers in TradeBank agreed to the following In over 95% of the cases, the internal and KPQ: “To what extent are our employees external assessments were identical.Where engaged?” In their research of existing data major differences in opinion occurred, the collection methods, they came across the Q12 database triggered another e-mail to the internal survey tool32 that was developed by the Gallup account manager,prompting him or her to pick Organization.This 12-question survey was up the telephone and discuss any potential issues designed to assess engagement, especially on with the partner organization. InterCorp also an emotional level. After some deliberation, realized that it was not collecting such data TradeBank felt that this survey would allow it frequently enough.They decided that monthly to gain the information to answer its KPQ. In data was required to be able to react to potential addition, the survey would allow TradeBank to issues before they became big problems. benchmark itself with its competitors.The InterCorp now has a very simple and cost- following 12 questions, based on the Q12 survey, effective monthly performance measurement were incorporated into TradeBank’s staff survey: system in place, one that allows it to get all the 1. Do I know what is expected of me information needed to answer its KPQ about at work? partnerships with its suppliers, one of its critical intellectual capital value drivers. 2. Do I have the right materials and equipment I need to do my work right? Case study: Measuring staff engagement 3. At work, do I have the opportunity to at TradeBank31 do what I do best every day? TradeBank is a leading Trading Bank that believes 4. In the last seven days, have I received that its people, with their skills and knowledge, recognition or praise for doing good work? are its most important intellectual capital value 5. Does my supervisor or someone at work, drivers.TradeBank believed that one of the key seem to care about me as a person? enablers of success was the level of staff engage- 6. Is there someone at work who encourages ment. In the past, they had conducted traditional my development? staff satisfaction surveys, but found that even 7. At work, do my opinions seem to count? though people might have indicated satisfaction with their jobs, many were not engaged. Managers 8. Does the mission / purpose of my in TradeBank believed that engagement is much organization make me feel my job more important than staff satisfaction, as it is important? indicates how passionately people feel about their 9. Are my coworkers committed to doing jobs, and how connected they feel to the organi- quality work? zation. According to the Gallup Organization, 23 MANAGEMENT

STRATEGY 10. Do I have a best friend at work? provide reliable and comparative data, and the 11. In the last six months, has someone at assumption is that such tests will somehow lead MEASUREMENT work talked to me about my progress? to improvements in student learning. However, this assumption is questioned by many, because 12. This past year,have I had opportunities at these assessments are not designed to provide work to learn and grow? contextualized feedback that is useful for helping TradeBank decided to poll a representative sample students and teachers during the course of a of its employees every month to regularly check program to improve learning. for possible changes. Each employee still receives a survey only once a year,but the company gets By contrast, formative assessment provides feed- valid data every month to answer its KPQ back to an ongoing program, with the objective question and to test the impact of staff engage- of improving learning. It occurs (a) when teachers ment on retention, satisfaction, and performance feed performance information back to students levels. In TradeBank,the results of staff engagement in ways that enable the student to learn, and are reported to the senior management team fine-tune or modify what they have been doing, monthly.The data is provided in aggregated form or (b) when students can engage in a similar, (staff engagement index) and compared with self-reflective process. competitor positions. Engagement is best reflected In summative assessments the number or result by changes over time.The data is therefore (e.g., grade) is at the centre of attention. On presented in a trend chart over time, together the other hand, the key objective of formative with a narrative commentary by the Human assessments is improving.The former is backward Resources Director that puts the assessment into looking, whereas the latter is about positively context and extracts the key learning points. affecting the future.The problem with summative assessments is that they can lead to dysfunctional 4. Managing Intellectual Capital behaviors:Teachers might only teach what is important to pass the exams, with little actual Measures allow organizations to manage.This learning, and students might try to do as little as applies to management of intellectual capital. they can get away with to meet the minimum Without relevant assessments, it is impossible requirement. Suddenly, the emphasis is not on (a) to understand current performance levels, learning, but on playing the numbers game. (b) to know whether the intellectual capital has improved or deteriorated, and (c) to understand We have all seen similar problems in organizations. whether any activities and initiatives have affected It is therefore important to ensure that organi- performance. Organizations that have meaningful zations do not fall into the same traps as schools performance information about its intellectual do with exam results.To create effective feedback capital can use it to inform decision making, to and learning from intellectual capital information, test and review strategy, and to manage risks organizations need to regularly review perfor- associated with intellectual capital. Each of these mance.These reviews should take place monthly, will be discussed in further detail below. and should be used to discuss the performance of the key value drivers that should lead to learning Informing Decision Making and decision making.We provide below some guiding principles about how to create formative Performance information about intellectual performance review meetings in organizations, to capital and other drivers of success provides ensure that intellectual capital indicators are used performance feedback.This in turn underpins to improve learning and, ultimately, performance: learning and decision making.33 Let us use an analogy from the world of education to illustrate • Name the meeting appropriately: Take the appropriate and inappropriate use of the word ‘review’ out of the name of the performance assessments to generate feedback meeting. Its main purpose is to learn, and and learning. In schools, we tend to use exams or improve future performance. Insight from tests to determine the learning outcome of an the past can help us with future decision academic program, let’s say a language course, making, but it can’t be the main focus of at the end of the program or at the end of a the meeting.Therefore, call them Strategic particular phase of the program.This is called a Performance Improvement Meetings or summative assessment. Summative assessments something similar,so that the name more are judgments about the student’s learning, accurately reflects the purpose of the usually in the form of a grade.They are seen to meeting. 24 IMPACTING FUTURE VALUE: HOW TO MANAGE YOUR INTELLECTUAL CAPITAL

• Use the value creation map to guide the of as many key people as possible, usually reflect meeting structure and agenda: The value reality extremely well. Nevertheless, many creation map is used to guide the meeting, organizations want to ‘test’ their assumptions and provides a structure or agenda for the and collect ‘evidence’ of their correctness.The meeting. A good way to do this is to set an performance data derived from the performance agenda made up of the individual elements indicators can be used for that purpose, and the from the strategic map. value creation map, or parts of it, can be verified. • Use the key performance questions to Chris Ittner and David Larcker from the Wharton guide and focus the discussions: Asking School in Pennsylvania found in their survey questions in an inquiring way develops a of leading companies that (a) just over 20% of spirit of curiosity that serves as a catalyst them consistently laid out the cause-and-effect for learning. The KPQs have been designed relationships between chosen drivers of strategic to raise the most important performance success and outcomes, and (b) even fewer actually questions, and should therefore be used verified these causal models. And yet, those here.The KPQs can then become the companies who did, achieved on average, an agenda items or even headings for sub- almost 3% higher return on assets, and an over meetings. 5% higher return on equity than companies that • Use performance indicators to facilitate didn’t use cause-and-effect maps. finding answers: The individuals (or group Organizations can identify sub-sets of their causal of individuals) responsible for the different value creation map or individual linkages between strategic elements take responsibility for elements of the map, and then ‘test’ those using analyzing the performance data before statistical tests such as regression and correlation the meeting, with the aim of answering analyses.Various companies have successfully the posed question(s). Findings from the tested relationships between elements of their analysis, with their interpretations, are then strategy. One example comes from Sears, presented during the meetings. Roebuck and Co., a leading retailer that offers a • Create an atmosphere of purpose, trust, wide range of home merchandise, apparel, and and respect: The atmosphere in these automotive products and services through more meetings is purposeful, but relaxed and than 2400 stores in the USA and Canada. Sears friendly. Mutual trust, respect, and support wanted to validate the relationship between lead to personal commitment, joint decision employee satisfaction, customer satisfaction, and making, and learning. Instead of a blame sales volumes – a key output measure. Arthur culture, the focus is on future performance, Martinez, CEO of Sears at the time, initiated dialogue, decision making, and actions. this effort to understand and test the drivers of A chairman ensures that all agenda items performance. Sears collected data to test the are fully discussed and that any dialogue is assumed relationships between sales volume, constructive and aimed at improving future customer satisfaction, and employee satisfaction. performance. Analyzing this data, Sears was able to validate its • Ensure that collaborative decision assumptions and establish that a 5-point increase making and learning takes place: in employee satisfaction led directly to a 1.3-point The performance information is openly increase in customer satisfaction, and a 0.5% discussed, and the performance indicator higher sales volume over a 9-month period. data is used to inform the dialogue and Mapping and verifying how intangible value drivers joint decision making. impact firm performance is powerful, and can The steps outlined here provide the ingredients support reviews of the strategy.These reviews can for successful Performance Improvement lead to different resource allocations, outsourcing Meetings.They are an essential ingredient in or insourcing, and decisions whether to buy or understanding and managing intellectual capital, sell intellectual capital as well as mergers and and can be used to inform strategy reviews. de-mergers. Intellectual capital that is central to the value proposition of organizations needs to Test and Review the Strategy be tightly managed internally.The absence of some vital intellectual capital components can lead to The strategic assumptions expressed in the purchasing, licensing-in or merger and acquisition value creation maps are principally just that – decisions. If an organization possesses intellectual assumptions. However,maps that are developed capital that is not relevant to the current value correctly, with the participation and involvement proposition this could be sold or licensed out. 25 MANAGEMENT

STRATEGY Manage Intellectual Capital Risks factual information about these risks and then prioritizing their relative importance. Organiza- After identifying critical intellectual capital value MEASUREMENT tions need to assess the potential risk areas drivers, organizations need to manage any related for the component parts of their organization, potential risks. Although companies are familiar categorize them, and then decide which are most with the management of financial risks and important to manage. disaster risk, the risk management of intellectual capital is usually underdeveloped.We now take The risk log can become a working document that a quick look at different risks associated with is part of the Performance Management system. intellectual capital, and propose a simple risk log We outline below the various steps involved in to manage and mitigate these risks. creating such a risk log. • Human capital risks – A key risk that is 1. Identify potential risks for each intellectual regularly overlooked in organizations is risk capital value driver on the value creation related to their staff and to the knowledge map.This element-by-element approach they possess. Organizations are often ensures that all potential risk areas that unaware that some individuals with critical cover all intellectual capital value drivers knowledge and expertise could walk out are discussed. Moreover,using the value any day. Another associated risk is the fact creation map also helps organizations to that knowledge is an important but also identify how potential risk areas might very vulnerable resource – it tends to impact each other.However,it is unlikely deplete over time if it is not nurtured. that all potential risks for each element will • Structural capital risks – Risks to be identified and prioritized straightaway. structural resources include threats to The risk log will usually grow over time as organizational processes and routines, and more potential risk areas are identified, but threats posed by losing database contents some will also tend to fall away as they are and software because of hackers and either mitigated or become less relevant viruses.There is also an increasingly common over time. risk of intellectual property theft, as well as 2. Describe the essence of the potential risks the danger to business success created by for each element. Here, it is possible to give more powerful regulatory regimes that are the risk a name, but it is more important to rightly intolerant of ‘old school’ exploitation create a short narrative description of the practices. type of risk. • Relational capital risks – In today’s 3. Define the risk level. Here, the likely networked economy, relationships are consequences and potential impact of this crucial ingredients for all organizations in risk are evaluated. both the private and public sectors.Their 4. Define the likelihood level.Here, the likelihood reputation hangs on these vital relation- that this risk might turn into a reality is ships, and often the risk needs to be evaluated. In addition, the likelihood is managed throughout the supply chain compared to the assessed likelihood of the that helps to deliver the products and/or last review cycle.This indicates whether the services the organization sells or provides. likelihood is increasing, staying the same, or Risk assessment then is a highly significant factor decreasing. in managing intellectual capital in today’s business 5. Ascribe an appropriate scoring system environment. Given that intellectual capital is a key according to: (a) the risk level (potential value driver in most organizations, it is advisable severity) of each risk (e.g., 1-5), the criteria to begin accumulating data that gives organizations for which may not necessarily be all financial useful information about their greatest risk ones, and (b) the likelihood level (probability exposures. of occurrence) of the risk (e.g., 1-5).These two scores can then be added to create the The first step in assessing risk, therefore, must be risk score.This scoring system not only to identify possible areas of risk.The best way to helps to identify management priorities, but do this is to review all the elements of the value also to assess whether the likely severity of creation map to identify potential risks.These risks each risk has changed, and whether the can then be captured in a ‘risk log’.This is a table firm’s potential exposure to it has increased that can be used to identify, describe, assess, and or diminished since the last review. quantify potential risks. It often requires obtaining 26 IMPACTING FUTURE VALUE: HOW TO MANAGE YOUR INTELLECTUAL CAPITAL

6. Assign responsibility (ownership) for • The organization has an interest in managing each defined risk, and define communicating its position to partners, a review frequency for re-evaluation of suppliers, the wider public (including subsequent risk mitigation activities. potential future employees), all of whom have an interest in understanding the future Completing the risk log is best done within a value of an organization. project team. Different sub-teams can be assigned to assess the risks of the different intellectual The Limitations of Traditional Financial capital elements of the value creation map.This Reporting ensures that people who are knowledgeable in the subject matter work together and arrive at The answer to whether or not traditional financial either a unanimous or an aggregate score. reporting can deliver on these information needs is simply No! There is now widespread agreement that the current financial reporting system is 5. Reporting Intellectual Capital incapable of explaining the value of intellectual The final step is then to report the intellectual capital. Restrictive accounting rules mean that capital, which will be the subject of this final most intellectual capital cannot be included on section. Disclosing the value of intellectual capital the balance sheet, especially if it is internally can be done for different reasons. However,they developed. Instead, all cost incurred to develop all share one key objective, which is to provide intellectual capital must usually be directly charged information about the intellectual capital of an as expenses in the income statement. For organization to its stakeholders. However, companies that invest in intellectual capital, this different stakeholders have different information immediate expensing results in a reduction of the needs: current profit and financial position.The problem is that accounting standards specify that a •To make better informed investment company can only recognize an asset if (a) it is decisions, shareholders and investors identifiable, (b) it is controlled, (c) it is probable want to know more about the intellectual that future benefits specifically attributable to the capital an organization possesses.Traditional asset will flow to the enterprise; and (d) its cost accounting based reports that used to can be reliably measured.This considerably serve this purpose do not paint an adequate reduces the list of intellectual capital items that picture of an organization’s intellectual are recognized in financial reporting. Regardless capital. If investors do not fully understand of the long list of intangible resources relevant to the organization and its intellectual capital organizations, the categories recognized in value drivers, their valuations are less accounting are very limited; they mainly refer to: certain, and any uncertainty generally (a) , (b) research and development, and increases the costs of capital. (c) other identifiable intangibles such as patents, • Analysts want to better understand the software, , copyrights, or brands. Goodwill intellectual capital value drivers to better is an all-inclusive asset category defined as the value organizations.Without detailed excess of the cost of an acquired company over information about the intellectual capital a the sum of identifiable net assets. In many acquisi- company possesses, and an understating of tions, the purchase price is higher than the value how it helps them to deliver their strategy, of the net assets included in the balance sheet. analysts can make incorrect valuations.This Goodwill therefore allows firms to account for leads to volatility and uncertainty, which in the ‘unidentifiable assets and liabilities’ that cannot turn leads to investors and banks placing a be recognized in the firm’s balance sheet using higher risk level on organizations.This then current accounting standards. Goodwill therefore increases the cost of capital. only appears in acquisition transactions. Further- • Employees want to understand the health more, although identifiable intangible assets may and position of their organization, and today be acquired separately, as a part of a group of intellectual capital is an essential element assets or as part of an entire enterprise, unidenti- of this.They are especially interested, as fiable assets cannot be acquired separately. Also, they form a major part of this intellectual internally generated goodwill is not recognized capital and need to understand that the in balance sheets, and, together with other organization has processes in place to intangibles, has to be expensed immediately along develop, manage, maintain, and protect its with investments in advertising, training programs, 34 intellectual capital. customer lists, and start-up costs . 27 MANAGEMENT

STRATEGY The restrictive accounting rules have caused not very useful. However,the value of intellectual huge confusion in understanding the available capital can only be understood in the context MEASUREMENT information on intellectual capital in traditional of an organization’s unique strategy. Also, to be financial reporting, making them unsuitable as relevant and meaningful, many indicators of useful information sources about intellectual intellectual capital will be specific to organizations capital. or sectors.This is why these reports need to include different indicators to reflect the unique Voluntary Reporting of Intellectual Capital nature of the strategy and associated intellectual capital. However,this doesn’t mean that there will Various initiatives to address the limitations of never be more widely accepted indicators for traditional financial reporting have created intellectual capital that are appropriate across frameworks and guidelines for separate reports entire industries and that will facilitate some kind to disclose information on intellectual capital. of comparison. Even though external reporting on These initiatives have mainly been in Europe, intellectual capital still has some way to go, many where various governments and the European organizations have produced voluntary reports37 Commission have sponsored such projects.The and discovered clear benefits, including improved first of its kind was sponsored by the Danish understanding of the strategy by its stakeholders, Government, with the aim of designing guidelines as well as improved image and reputation. for firms to prepare intellectual capital statements. The guidelines were then tested with about Building on the different guidelines and blueprints 100 firms and not-for-profit organizations who for intellectual capital reports produced to date, experimented with producing intellectual capital we encourage organizations to produce and statements. Following this test phase, guidelines publish intellectual capital reports.These reports were issued by the Danish Government on how can be used to communicate the importance of to prepare intellectual capital statements.35 This intellectual capital both internally to staff as well was followed by a number of projects funded by as externally to business partners, suppliers, the European Commission to produce guidelines investors, and the wider public. However,they are for intellectual capital reporting.36 More recently, only successful if they are set in the context of the initiatives in the German-speaking part of Europe organizational strategy, and if they go beyond the (Austria, Switzerland, and Germany) have created mere reporting of measures to include narrative frameworks for intellectual capital statements and interpretive commentary. (called ‘Wissensbilanz’).The German initiative is Good intellectual capital reports contain the supported by the German Government, and a following elements: working group has been set up to coordinate research and practical application of these •A brief introduction outlining the strategic voluntary reports on intellectual capital.The latest context and the key strategic challenges the initiative is InCaS (Intellectual Capital Statements – organization will be facing. This part of the Made in Europe), which has just started. It is an report should set the scene by describing attempt to bring all the previous developments the anticipated changes in the external and together into one European Framework of internal context and their strategic implica- intellectual capital reporting. tions for the organization. [about one page long] The various guidelines are all very similar.They all (a) provide a breakdown and classification of •A brief narrative description of the intellectual capital (which are in line with the strategy and visual representation of the classification outlined in this MAG), (b) provide organizational value creation map.It is some guidance on the identification and measure- important to highlight the interdependencies ment of intellectual capital, and (c) outline a and causal relationships between the template or blueprint for reporting intellectual different elements of the strategy and, in capital in intellectual capital statements. particular,how the intellectual capital value drivers help to deliver the strategy. [the The drawback of these voluntary reports is that strategy narrative should be about 2 pages the content of actual intellectual capital statements long] varies widely in what is reported and measured. • Descriptions of each of the intellectual This in turn makes it difficult to compare organi- capital value drivers. More detailed zations, which is one of the objectives and descriptions should be provided for each deliverables of traditional financial reporting. of the intellectual capital value drivers, One could therefore argue that these reports are outlining the objectives, strategic targets, 28 IMPACTING FUTURE VALUE: HOW TO MANAGE YOUR INTELLECTUAL CAPITAL

and associated activities for each.Where USEFUL WEBSITES possible, data and performance indicators • Advanced Performance Institute: should be used to clarify the objectives www.ap-institute.com and targets. A brief description of the key activities (tasks, projects, programs) that • The Gurteen Knowledge Website: are planned to help achieve the objectives www.gurteen.com should be provided [each description • Intellectual Assets Centre: should be between one-half and one www.ia-centre.org.uk page long]. • InCaS Intellectual Capital Statements: http://www.psych.lse.ac.uk/incas/ CONCLUSION • Intellectual Capital Services: Success and value creation of any organization in www.intellectualcapital.nl today’s economy is driven by intellectual capital. • Prism Project Website: To positively impact the future success and value, www.euintangibles.net it is therefore critical to manage the intellectual •Working Group Wissensbilanz: capital that underpins value creation.This MAG www.akwissensbilanz.org introduces five key steps for successfully managing intellectual capital, namely (1) how to identify intellectual capital in your organization, (2) how to map its impact, (3) how to measure it, (4) how to manage it, and (5) how to report it. Practical and easy-to-apply tools and techniques have been introduced, including (a) an intellectual capital classification and identification approach, (b) value creation maps to show how intellectual capital supports the organizations in delivering its objectives and value proposition, (c) key perfor- mance questions to guide the design of indicators, (d) techniques of measuring intellectual capital together with an indicator design template, (e) guidelines about strategic performance improvement meetings that facilitate decision making and learning, (f) an intellectual capital risk management tool, as well as (g) guidelines on how to produce intellectual capital reports.Together, these tools and techniques should provide a solid platform enabling practicing managers and accountants to better manage intellectual capital – a skill that will become ever more critical to organizations in the global .

29 MANAGEMENT

STRATEGY REFERENCES AND ENDNOTES 13 See also Clotier,L.M. and E.R. Gold. (2005). ‘A Legal Perspective on Intellectual Capital’, 1 Lev, B. (2001). Intangibles – management, MEASUREMENT in Marr,B. (ed.), Perspectives on Intellectual measuring and reporting.Brookings Institution Capital, Elsevier,Boston; and R. Hall (1989). Press and Blair,M.M. and S.M.H. Wallman ‘The Management of Intellectual Assets: (2001). Unseen Wealth,Brookings Institution A New Corporate Perspective’, Journal of Press, Boston. General Management,Vol. 15, No. 1, pp. 53. 2 Molnar,M.J. (2004).‘Executive Views on 14 Due to strict confidentiality agreements the Intangible Assets: Insights From the Accenture/ name of this business cannot be revealed. Economist Intelligence Unit Survey ‘, Accenture 15 Research Note ‘Intangible Assets and Future Value’, Göran and Johan Roos have been instrumental Issue one, April. in developing an understanding and mapping approach of resource interactions. For their 3 Marr,B. (2007). Managing Strategic Performance insights on resource interactions see, for in Banks and Financial Services Firms: From ‘Going example: Roos, G. and J. Roos (1997). Through the Motions’ to Best Practice,Actuate. Measuring Your Company’s Intellectual Marr,B. (2005). Business Performance Manage- Performance. Long Range Planning,Vol.30, No. 3, ment: Current State of the Art, Hyperion (both June, pp. 413; and Gupta, O. and G. Roos (2001). available from www.ap-institute.com). Mergers and Acquisitions Through an 4 Blair,M.M. and S.M.H. Wallman (2001). Unseen Intellectual Capital Perspective. Journal of Wealth,Brookings Institution Press, Boston. Intellectual Capital,Vol. 2, No. 3, pp. 297-309; and 5 See for example: Carmeli, A. and A.Tishler, Pike, S. G. Roos and B. Marr (2005). Strategic (2004).‘The Relationships Between Intangible management of intangible assets and value Organizational Elements and Organizational drivers in R&D organizations. R&D Management, Performance’, Strategic Management Journal, Vol. 35, No. 2. pp. 111-124. Vol. 25, pp. 1257-1278. 16 See e.g. Carmeli, A. and A.Tishler (2004). 6 Understanding Corporate Value: Managing and ‘The Relationships Between Intangible Reporting Intellectual Capital, CIMA, London. Organizational Elements and Organizational 7 For more information please see: Marr,B. (ed.) Performance’, Strategic Management Journal, (2005). Perspectives on Intellectual Capital – Vol. 25, pp. 1257-1278. Interdisciplinary Insights into Management, 17 Usually 12 months, which is in line with the Measurement and Reporting, Elsevier,Boston annual planning cycle of most organizations, but and Marr,B (2006). Strategic Performance this can be shorter or longer depending on the Management: Leveraging and measuring your dynamics in the external environment. intangible value drivers, Butterworth-Heinemann, 18 One of the earliest uses of influence diagrams Oxford. was by J. Forrester to represent a causal loop 8 Marr,B. and K. Moustaghfir (2005). Defining in a feedback system. Later,Professor Ronald Intellectual Capital: A three-dimensional Howard from Stanford University and his Approach, Management Decision,Vol.43 No. 9, colleague, Dr James Matheson, refined and pp. 1114-1128 popularized influence diagrams. See: Howard, 9 Roos, J., G. Roos, N.C. Dragonetti and R. A. and J. E. Matheson (1990). Principles and L. Edvinsson (1997). Intellectual Capital: Navigating Applications of Decision Analysis,Volume I. the New Business Landscape, Macmillan, London. Strategic Decisions Group: Menlo Park, California; and Howard, R. A. and J. E. Matheson 10 Itami, H. (1987). Mobilizing Invisible Assets, (1990). Principles and Applications of Decision Harvard University Press, Cambridge, Analysis,Volume II.Strategic Decisions Group: Massachusetts, pp. 23. Menlo Park, California; and Howard, R. A. 11 Marr,B., G. Schiuma, and A. Neely (2004). (1965) Dynamic Inference, Journal of the ‘The Dynamics of Value Creation: Mapping Operations Research Society of America,Vol.13, Your Intellectual Performance Drivers’, Journal No. 5, Sept-Oct, pp. 712-733. of Intellectual Capital,Vol. 5, No. 2, pp. 312-325. 19 This case study is based on: Marr,B. and I. Shore 12 See for example: Heskett, J.L., W.E.Sasser and (2008). Cascading Balanced Scorecards: Using L.A. Schlesinger,(2003). The Value Profit Chain: Strategic Maps to make Performance Relevant to Treat Employees Like Customers and Customers RAF Stations, Management Case Study, Like Employees,Free Press, The Advanced Performance Institute (pp. 203). (www.ap-institute.com) 30 IMPACTING FUTURE VALUE: HOW TO MANAGE YOUR INTELLECTUAL CAPITAL

20 The concept of Key Performance Questions 28 Russ-Eft, D. and H. Preskill (2001). Evaluation was developed by Bernard Marr and the terms in Organization – A Systematic Approach to Key Performance Question and KPQ are Enhancing Learning, Performance, and Change, trademarks of the Advanced Performance Perseus, Cambridge, MA. Institute. 29 E.g. Denzin, N.K. and Y.S. Lincoln, (ed.) (2005). 21 Eric Schmidt in an interview with Jeremy The Sage Handbook of Qualitative Research Caplan for TIME, October 2, 2006. (3rd edition), Sage,Thousand Oaks. 22 For more information please see: Marr,B. 30 Please note that InterCorp is a fictitious (2008). What are Key Performance Questions? name chosen to protect the anonymity of Management White Paper,Advanced our client. Performance Institute, London (available at 31 Please note that TradeBank is a fictitious www.ap-institute.com). name chosen to protect the anonymity of 23 Quoted in Boyle, D. (2001). The Sum of Our our client. Discontent:Why Numbers Make Us Irrational, 32 The Q12 survey tool was developed by the Te xere,New York, pp. 29. Gallup Organization (www.gallup.com), other 24 See for example: Ketokivi, M.A. and R.G. staff engagement surveys are offered for Schroeder (2004).‘Perceptual Measures of example by Mercer and Satmetix Systems Performance: Fact of Fiction’, Journal of called Employee Acid Test and Employee Operations Management,Vol. 22, No. 3, Commitment Assessment. pp. 247-264; Boyd, B.K., G.G. Dess, and 33 See e.g. Greve, H. (2003). Organizational A.M.A. Rasheed (1993).‘Divergence Between Learning from Performance Feedback: Archival and Perceptual Measures of the A Behavioural Perspective on Innovation Environment: Causes and Consequences’, and Change, Cambridge University Press, Academy of Management Review,Vol. 18, Cambridge. No. 2, pp. 204-226;Venkatraman, N. and 34 In certain regulatory regimes after an acquisi- V. Ramanujam (1987),‘Measurement of tion transaction, some of these intangible Business Economic Performance: An resources will be recognized as assets apart Examination of Method Convergence’, Journal from goodwill in the acquirer’s balance sheet of Management,Vol. 13, No. 1, pp. 109-112. if they comply with the recognition criteria 25 These assumptions are stated in: Hubbard D. for “identifiable” assets and liabilities. (2007). How to measure anything: Finding the 35 Danish Agency for Trade and Industry – value of intangibles in business,Wiley, Hoboken, Ministry of Trade and Industry (2002). New Jersey. A Guideline For Intellectual Capital Statements – 26 For more information see e.g. Dillman, D.A. A Key to , Danish (1999). Mail and Internet Surveys: The Tailored Agency for Trade and Industry, Copenhagen, Design Method,Wiley, New York. 36 These projects included:The E*Know Net, 27 Yin, K. (2003). Case Study Research. Design and MERITUM, PRISM projects. Methods (Applied Social Research Methods 37 Best examples can be found in Scandinavia, Series,Vol. 5), Sage, Newbury Park, CA. Germany and Spain.

31 MANAGEMENT

STRATEGY This Management Accounting Guideline was prepared with the advice and counsel of: MEASUREMENT Barry Baptie, MBA, CMA, FCMA John Hemming, B. Comm., ACMA Board Director and Business Consultant Development Specialist Chartered Institute of Management Accountants Richard Benn, CMA, FCMA Vice President, Knowledge and Program Stuart Hunt, ACMA Development Business Controller (Sales and Marketing) CMA Canada InterfaceFLOR Mark Dixon Michael Marshall, ACMA UK CNS Senior Financial Controller for the UK and Ireland Finance Lead Enterprise Rent-A-Car Limited Hewitt Associates Chee Kin Tang,MBA, CPA, ACA, ACMA, FRSA Michael Fortini, CPA Senior Resource Management Officer Director of Compliance World Bank Pearson plc Wim A.Van der Stede Brian Freeman, FCMA CIMA Professor of Accounting Finance Director and Financial Management Haymarket Worldwide London School of Economics & Political Science Jasmin Harvey, B. Comm., B. Econ., ACMA Kenneth W. Witt, CPA Manager – Sustainability and Risk Reporting Technical Manager,Business Industry Qantas Airlines and Government American Institute of Certified Public Accountants

The views expressed in this Management Accounting Guideline do not necessarily reflect those of the individuals listed above or the organizations with which they are affiliated.

32 IMPACTING FUTURE VALUE: HOW TO MANAGE YOUR INTELLECTUAL CAPITAL

ABOUT THE AUTHOR: Bernard Marr is chief executive and director of research at the Advanced Performance Institute. Prior, he held positions at the University of Cambridge and at Cranfield School of Management. Bernard Marr is a globally recognized authority and best-selling author on strategic performance management and regularly advises organizations and governments across the world. He is acknowledged by the CEO Journal as one of today’s leading business brains and has contributed to over 100 books, reports and articles on topics such as performance management, performance measurement, and intellectual capital. Bernard Marr can be contacted via e-mail at [email protected]

33 For more information on other products available contact:

In Canada: The Society of Management Accountants of Canada Mississauga Executive Centre One Robert Speck Parkway, Suite 1400 Mississauga, ON L4Z 3M3 Canada Tel (905) 949 4200 Fax (905) 949 0888 www.cma-canada.org

In the U.S.A.: American Institute of Certified Public Accountants 1211 Avenue of the Americas New York,NY 10036-8775 USA Tel (888) 777 7077 Fax (800) 362 5066 www.aicpa.org Visit the AICPA store at www.cpa2biz.com

In the United Kingdom: The Chartered Institute of Management Accountants 26 Chapter Street London SW1P 4NP United Kingdom Tel +44 (0)20 7663 5441 Fax +44 (0)20 7663 5442 www.cimaglobal.com Email Technical Information Services at [email protected]