Concept Report Research and Advisory Services The Economics of Information The Relationship Between IT Spending, Profits, and Knowledge Capital® Concept Report, July 2001 Research by: Paul Strassmann Editied by: Jacques Halé Publishing by: Peter Bristow Chris Dickinson Steve Duke Samantha Henry Paul Makey Published July 2001 © 2001 by Paul A. Strassmann Important Notice The information available in this publication is given in good faith and is believed to be reliable. Butler Group expressly excludes any representation or warranty (express or implied) about the suitability of materials in this publication for your purposes and excludes to the fullest extent possible any liability in contract, tort or howsoever for implementation of, or reliance upon, the information contained in this publication. © P a u l A . S t r The Economics of Information a s s m a n n J u l y 2 0 0 CONCEPT REPORT 1 CONTENTS 5 Management Summary 11 Part 1: Transforming IT Costs into Profits 11 1.1 The Challenge 21 1.2 The Strategic Positioning of a Firm in Relation to IT 29 1.3 The Competitive Advantage in the Information Age 39 Part 2: Knowledge Capital® in European Firms 41 Introduction 45 2.1 Analysis of European Firms 55 2.2 Country Case – The UK Knowledge Capital® 65 Appendix A: Valuation of Knowledge Capital® 71 Appendix B: Valuation of Knowledge Capital® Rankings by Country 71 Belgian Firms 77 Danish Firms 83 Dutch Firms 91 Finnish Firms 97 French Firms 119 German Firms 139 Irish Firms 143 Italian Firms 151 Norwegian Firms 157 Portuguese Firms 161 Spanish Firms 167 Swedish Firms 177 UK Firms C o n c e p t R e p o r t Management Summary Concept Report, July 2001 © P a u l A . S t r a s This Report addresses the relationship between investment in Information s m technology (IT), its impact on the profitability of companies and the longer term a n potential of companies in creating wealth from the management of their n J information resources. A large number of companies are analysed in both the u l y USA and Europe using an original set of metrics. The conclusions have wider 2 0 implications than the pure management of IT and will be of special interest for 0 company executives, financial officers, IT managers, and IT strategists. 1 The first part deals with the economics of information in organisations and examines the role of investments in. The conclusions are not country specific and are derived from the study of USA and UK firms with UK banks analysed in some detail as case studies. The second part addresses the related issue of Knowledge Capital® as the measurable entity that is the direct result of good, or not so good, management of the live resources of an organisation, the value of the Knowledge Capital® as the measurement of the capability of a firm to generate wealth. The performance of European firms is analysed in detail by country and by activity sectors. Transforming IT Costs into It appears that the job of transforming IT costs into profits has suddenly Profits become easier, because the investments necessary to keep up with the successive technology cycle, from now on, will be finally assumed where they always belonged, the IT vendors. IT executives will also not have to carry the burden of having to justify and support a costly corporate IT infrastructure – a task that they never mastered anyway. As long as networked services remain competitive and make it easy to switch from one service to another, the curse of excessively long implementation cycles could be also lifted. If the above prospects appear to be too good to contemplate, there must surely something wrong with this vision. In fact, what’s wrong are the prospects of excessive uniformity, the arresting of innovation, and the handing over of opportunities to competitors who can now imitate and retaliate faster than ever before. More importantly, the question of profits remains unanswered. IT spending and profits are unrelated and will always remain that way. If control of IT evolution is subordinated to vendors’ profit growth expectations, what are the remaining sources of competitive advantage that would allow a firm to garner superior profits in the information age? In summary: l IT has not emerged as a directly measurable strategic player that can be shown to have a decisive strategic influence on corporate profitability. l IT spending does not exhibit a comparable level of positive correlation with profits as has been found with other PIMS strategic variables such as market share, capital intensity, and relative customer quality. This relegates IT spending to an important, but only to an enabling, catalytic role. From the standpoint of corporate strategy, IT can be then seen primarily as an attractive means that permits corporate management to re-balance its responses to rapidly changing competitive circumstances. Such a role is more than adequate as an enormous challenge for computer executives. IT managers must be involved in board-level decisions in order to link IT, in the least costly manner, to the enhancement of your firm’s strategic advantages! Knowledge Capital® in The second part of the Report deals with the measurable result of managing European Firms the intellectual resources of an organisation. It presents a detailed analysis of the reported financial results of nearly three and an half thousand European firms (3,398 to be precise) with the dual objective of computing the Knowledge Capital®1 accumulated by these companies, and comparing the effectiveness of different countries and industries in their ability to use this capital. C o n c e 1 ® Knowledge Capital is a Registered Trade Mark of Strassmann, Inc., New Canaan, Con., USA. p t R e p o r t 7 Knowledge Capital® – the original metrics developed by Strassmann, Inc. – is defined as Economic Profit/Cost of Capital. It is an objective measure of the capacity of a firm, or a country, to generate profits by other means than through the utilisation of financial capital. Together with the physical and financial assets of a firm, Knowledge Capital® gives a complete picture of the worth of an organisation and, in fact, it is reasonably correlated with the stock market valuation of a firm over the long run. Knowledge Capital® is assessed from the available data about European firms in order to derive comparative measurements across countries, sectors, and within sectors. In summary: l The average Knowledge Capital® in this study of European Firms was ?542 million per firm and represents only listed firms that provided full disclosure of their financial holdings in 1999. l The corresponding figure for US firms is $880 million, from a study of 7,287 firms in 1999. l The European interest rates for long-term government bonds in 1999 were comparable to the US Cost of Capital and do not account for the very large variance in the Knowledge Capital® valuations for individual countries or firms. l One of the most telling characteristics of Knowledge Capital® is the concentration of non-financial assets, both in positive as well as in negative terms: a few firms possess a disproportionate share of Knowledge Capital® gains as well as losses. The index of Knowledge Capital® concentration is defined as the share of Knowledge Capital® attributable to the top-ranked 5 per cent firms. l There is a high correlation between stock market valuation and Knowledge Capital for medium and large companies. A comparison of the performance of firms country by country reveals interesting results. For instance, the UK, with approximately one third of the 3,398 firms assessed in this report, accounted for one third of the total available Knowledge Capital®, with an average of ?525m ...in Germany, a very small number of firms gain in a per firm. Germany displays perhaps ® big way and lose in a big way. the highest index of Knowledge Capital concentration; in Germany, a very small number of firms gain in a big way and lose in a big way. However, there is a remarkably low proportion of net Knowledge Capital® in Germany, which averages only ?92 million per firm, as compared with ?2,242 million in the Netherlands or ?1,485 million in Belgium. The relatively unfavourable performance of Germany can be understood by an examination of ratios of positive and negative Knowledge Capital® contributions. In Germany there are 279 firms with positive Knowledge Capital® as compared with 246 firms with negative Knowledge Capital®, for a ratio of 1.1. In currency terms, the corresponding comparisons are ?195.5 billion positive versus ?147.5 negative, for one of the lowest European ratios of only 1.3. Dutch firms show a favourable performance, accounted by the fact that 129 of its firms show positive Knowledge Capital® when compared with only 28 firms with negative Knowledge Capital®, for a ratio of 4.6 – the highest such ratio in Europe. The average Knowledge Capital® per technology firm is Comparison of the performance of not significant...this should be seen as a serious firms sector by sector also dispels a disadvantage for Europe. number of generally accepted views. The exaggerated role often attributed to the technology sector is largely deflated by the finding that this sector accounts for only 3 per cent of the total available Knowledge Capital®. 8 © P a u l A . S t r a ® s The average Knowledge Capital per technology firm is not significant as s m compared with other sectors. From the standpoint of global competitiveness, a n this should be seen as a serious disadvantage for Europe.