AREOPA

Provoking Innovative Intelligence

Intellectual Capital Management

The Challenge decreasing fast and it is equally recognised that non-

The foundations of all of the economies of the West financial (or intangible) assets are now the main
have now shifted from an industrial base to a service drivers of performance and market value. To date
and knowledge base. This shift is nearly complete, however there exist little or no objective quantitative
and it is irreversible. Economic theories have begun measures of intangible assets, and where they are
to reflect this, but theory has been slow to be claimed to exist (e.g. in the valuation of brands,
translated into practice. There is currently a lack of intellectual property, patents, etc.) they are very
consensus around intellectual capital definitions, specific and limited in scope.
management practices and accounting. This Spotlight AREOPA has developed a model for identifying and
focuses on the issues that must be addressed in an quantifying intangibles as components of intellectual
uncertain world and complex business environment capital (IC). This model serves to evaluate a
to enable the enterprise to be successful in company’s return on all the capital it employs, helping
implementing intellectual capital management (ICM) to explain the difference between book and market
practices. value. It also provides guidance as to how and where
management should put its attention to grow the
Year 1900 1940 1980 organisation’s overall IC.
Production 73,4% 57,2% 34,2%
Workers AREOPA positions intellectual capital calculation as a
management tool and not as a simple financial
Personal 9,0% 11,7% 13,3% calculation of the intangible assets of the organization
Service
and thus explaining the difference between book
Managerial & 13,3% 23,6% 36,1% value and market value. Management wants to
Administrative understand the value of the intellectual capital of the
Technical & 4,3% 7,5% 16,1% organization. By giving a monetary value to the
Professional intellectual capital, management starts to understand
the value and the impact.
Total % of 26,6% 42,8% 65,8%
‘Knowledge ®
Workers’ AREOPA’s 4-Leaf Model identifies the sources of
added value and competitive advantage in
businesses and in particular of virtual organizations -
What is Intellectual Capital Management? collaborative networks of otherwise independent
We have defined it as the disciplined approach to the economic entities - that build their business models
identification and productive employment of around the internet using minimal financial assets.
intellectual capital in the creation of economic value
for the enterprise. It incorporates the management of
intellectual assets, human capital and intellectual
property (IP). It is related to knowledge management,
but emphasizes the valuation and productive
employment of intellectual capital.

Intellectual capital management gives executives a

way of turning "people are our best asset" from lip
service into reality.

Innovation accounts for more than half of

productivity growth worldwide and IC is
the mother of innovation. As a key driver
of economic value for every company, IC
must be identified, managed, measured
and protected. The Four IC Classes
Source: Gartner Research
The four base classes are Human, Customer and
Structural Capital, plus Strategic Alliance Capital.
Positioning IC Calculation
The importance of financial assets in the The latter gives recognition to the fact that
determination of a company’s market value is partnerships, alliances and networks are increasingly
important factors of business in the New Economy.

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The strength of the alliance or network significantly
impacts the leverage any one company may have in
its market, and therefore affects its value. Think of
how Dell Computers made it big by leveraging on its
suppliers such as Intel, HP, etc. . And Cisco has built
its entire business model around the internet, and
heavily relies on outsourced service providers to fulfil
its business cycles from ordering over manufacturing
to delivery and billing. Although its partners may not
take the front stage, they are nevertheless crucial in
assuring the quality that Cisco sells to its customers.
The ideas become more dispersed here, but careful
A second crucial observation is that, apart from harvesting yields a list of 100 to 150 elements.
Structural Capital, the base IC classes are in fact
shared capital (Stewart, 1997). For instance, Human The next development concentrates on the attributes,
Capital (HC) is shared with its ‘owners’: when the variables and parameters that are linked to or
person leaves, he/she takes his/her skills & characteristic for the element at stake.
competences, reputation and potential along. Similar
rules apply to both Customer Capital (CC) and
Strategic Alliance Capital (SAC): when the customer
takes his business elsewhere or an alliance breaks
up, the customer’s revenue potential and
partnership’s leverage are lost and a “zero-sum
game” relationship is restored.
However, not all may be lost in such extreme but
realistic scenarios since at least the customers’ name
may remain on the company’ reference list, and a
former partner may still perform as arm’s length
supplier: these indicate that some CC and SAC has
become structural, and is therefore unaffected by the
departure of a customer, respectively strategic
alliance.

The consequence of this is that Intellectual Capital

may flow from one region into another (neighbouring)
region ! And this is where the management of IC
comes into play. It is important for companies to
realize where their IC is situated, and which actions
need to be taken to convert IC that is at risk of being
lost into IC that has become structural; i.e. to And that is where it stops. IC reporting is primarily
structuralize its Human, Customer and Strategic limited to indicators, leading to pertinent question:
Alliance Capital to the maximum extent possible. “What’s the use of all this?”

IC Building Blocks, elements, variables and

indicators
Studies around IC have managed to reach a
consensus around the building blocks. There seems
to be an agreement that human capital and structural
capital are two of the corner stones, although the
term organisational capital is often used for the latter.
Talking about relational capital the ideas seem to
become a little bit more confused: customer capital is
certainly one of the aspects here, where in some
publications this chapter also comprises alliance and
partner capital. Trying to capture the entire picture,
social and even cultural capital is added to the list.

Once the main blocks are defined, the specialists

descend one step further into the depths of the IC
secrets, summing up all the elements that are part of
the inventory of each major sphere.
Some managers that are confronted with the (sales)
talks from IC promoters are ‘lured’ into starting an IC
exercise, often called: the putting together of an IC
Balance Sheet (Wissensbilanz in Germany and
Austria). All of these projects start with the listing of
chapters and elements and generate or calculate
indicators at best. In many cases these ‘IC Balance
Sheets’ are then used for internal and/or external
communications, i.e. as show pieces to show the

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innovative spirit of the management. And then there
is silence …
What is missing? The answer is simple and twofold:
1. The value of IC assets needs to be expressed in
ONE and the same common denominator, so
that values can be added up and compared, i.e.
money, the only measure known and understood
by everyone;
2. The report format needs to be clear, known and
understood by the average manager. Maybe a
classical (financial) balance sheet format might
fulfil this requirement.
Designing a report in a balance sheet format is
simple. Everybody talks about IC assets, which
means that ordering IC assets in a similar manner as
financial assets on a balance sheet is easy. Financial
assets are financed with equity (shareholder’s
capital) and external funds (banks, financial
institutions, suppliers, creditors, etc.). The ‘financing’
or IC assets can be approached in exactly the same
way. IC assets are either owned by the company
(explicit), whereas other assets are ‘borrowed’ to the
company (tacit). This presentation leads to the
liabilities side of the IC balance sheet.
IC Accounting
If the IC balance sheet is what we want to get to, then
we have to decide what we need to do in order to get
to this report. Applying the basic accounting rules
seems to get us quite far:
1. Designing an IC Chart of Accounts (CoA) is not
complicated because the asset list pretty clear
and complete;
2. IC accounting rules are a bit more complicated,
but looking for the ‘events’ that drive IC value in
line with ‘events’ that drive general accounting
such as incoming invoices and bank statements
for example should get us there;
3. IC valuation rules are the core of the matter. In
general accounting rules have been defined to
calculate the value of stock, bad debts, foreign
exchange values, and depreciation rates of fixed
assets. Financial accounting is a picture of the
past. IC accounting looks into the future.
The main challenge is to come up with a valuation
system which is transparent, auditable, and
repeatable (objective), and … simple. The basic
principle is based on two components:
1. A component covering the book value of the
element, based on items such as acquisition or
construction costs, depreciation and
amortization;
2. A component covering the future potential value
of the element, probably the net present value of
future cash streams.
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The former follows the same principles used for
tangible assets, e.g. the building of a new plant
(which is comparable to building knowledge in a staff
member). The latter requires more complex
econometrical formulas based on parameters and
variables typical for each element.
Double Counting
One of the main points of concern in IC accounting is
the question of avoiding double counting. Human
Capital is needed to realise Customer Capital. Adding
up both values may result in double counting the
same potential. The 4-leaf model helps in visualising
this phenomenon.
Are Human Capital Euros equal to Structural
Capital Euros?
Another major concern is the equality of the unit of
measurement used, i.e. the monetary unit of all the
asset values. Expressing all values in Euros for
example does not mean that all these values are of
the same nature. Special care has to be taken to
assure comparability.
Conclusion
A lot has been done, but all remains to be done.
Unless we manage to translate IC into the language
and the format of the manager, the interest in this
area will remain primarily academic.
Auditors will have to be convinced that IC valuations
are based on sound rules that are transparent,
objective and auditable. But auditors will have to
‘open up’ to the need of the knowledge economy
where the majority of the assets utilised in a company
are no longer to be found on the balance sheet.
AREOPA
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E-mail: info@areopa.com