In his book “Intellectual Capital,” Thomas Stewart wrote: “What’s new? Simply this: Because knowledge has become the single most important factor of production, managing intellectual assets has become the single most important task of business.”
In the last 20 years of the 20th century, Wall Street investors changed the way they determined what a company was worth. That’s why return on intangibles is the most important metric in the CLO’s tool kit.
In the Industrial Age, tangible assets produced wealth, so investors put their money in plants and equipment. In the network era, know-how, innovation and relationships became the keys to profitability, and investors began to value these invisible things more than physical assets.
In 1980, tangible assets accounted for 80 percent of the market cap of companies in the S&P 500. In a scant two decades, an amazing flip-flop took place. By 1999, intangible assets accounted for 80 percent of the value of the market. Instead of relying on expectations for a stable past, investors began betting on the future.
That change in what investors’ value is fundamental to understanding return on investment, but sadly many learning and development leaders are saddled with outmoded, mid-20th century notions and procedures that don’t value intangibles at all.
Mechanically, intellectual capital is a company’s market capitalization — its value on the stock market — less its book value — the value reported on its balance sheet. When I attended business school in the 1970s, nobody had this anomaly figured out. Shouldn’t stockholders’ equity be marked to market? The historical figures on the balance sheet failed to report what a company was worth.
Intellectual capital comes in several forms. Human capital is the know-how and abilities of an organization’s people; relational capital is personal and business links to customers, partners and suppliers; and structural capital is the infrastructure, processes, culture and intellectual property that define how an organization operates.
Intellectual capital is largely a matter of mind and relationships. It’s impossible to measure directly, but you know in your heart that it’s real. What’s more important, the plant or the people? Where’s the real value to come from? The biggest upside to increasing intellectual capital is improving know-how, relationships and processes; that’s what gives investors the confidence to up their ante.
Yet some experts tell CLOs not to quantify returns on intangibles. Fearing a lack of precision in assessing their value, they leave intangibles out of return on investment calculations entirely.
Business people love the security of firm numbers, even when they’re not the right numbers. Leaving intangibles out of the equation almost guarantees that any related issues will not receive the attention they deserve, leading to unbalanced and suboptimal decisions.
Most business managers recognize they’re managing a living organization, not a balance sheet, but many learning and development leaders are still in a fog. Why? They’ve learned a narrow view on return on investment as seen through the eyes of a bank loan officer.
Commercial loan officers want assurance that if a loan goes south, they will be able to get their money back. Presumably, a borrower who cannot repay a loan is in trouble, perhaps bankrupt. The business is headed down the tubes. The banker looks at liquidation value. What could the bank sell the pieces of the company for? What can be salvaged?
In a fire sale, intangibles are worthless. The human capital has already walked out the door. Relationships are frayed, and there’s no one to maintain them. Brand is tarnished. Perhaps some intellectual property and proprietary processes can be sold off at a discount, but you can’t bank on it.
If I were evaluating a company in foreclosure, I’d list intangibles off to the side because I wouldn’t expect to be able to liquidate them. When I’m working with a going concern, it’s the opposite. I pay more attention to leveraging the intangibles because that’s where the big upside resides.