Return on Intangibles

This article appears in the October 2013 issue of Chief Learning Officer.

Understanding learning’s value depends on measuring what can’t be touched. 

In his marvelous book Intellectual Capital, Tom Stewart asked, 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 twenty years of the twentieth 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 toolkit.

In the Industrial Age, tangible assets produced wealth, so investors put their money on plant 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. Things you couldn’t see (intangibles) became more valuable than things you could see and touch (tangibles).

In 1980, tangible assets accounted for 80% 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% of the value of the market. Instead of relying investing in expectation of a continuation of a stable past, investors began betting on the future.

In a scant two decades at the end of the twentieth century, an amazing flip-flop took place. Investors who had put their money predictable output began betting on the future. In 1980, tangible assets accounted for 80% of the market cap of companies in the S&P 500. By 1999, the situation was reversed, with intangible assets accounting for 80% of the value of the market.

That change in what investors value is fundamental to understanding return on investment, but sadly many L&D managers are saddled with outmoded, mid-twentieth 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 seventies, nobody had this anomaly figured out. Shouldn’t stockholder’s 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 the 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 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 the returns on intangibles. Fearing a lack of precision in assessing their value, they leave them out of Return on Investment calculations entirely.

Business people love the security of firm numbers: they feel objective, even when they’re not the right numbers. The downside is that leaving intangibles out of the equation almost guarantees that they will not receive the attention they deserve, leading to unbalanced and suboptimal decisions.

Most business managers recognize that they’re managing a living organization, not a balance sheet, but many managers of L&D are still in a fog. Why? Because they’ve learned a narrow view of Return on Investment, namely ROI 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 IP and proprietary processes can be sold off at a discount but you can’t bank on it.

Were I 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.

 

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