Make the invisible visible: identify intellectual capital

By Bernard Marr, chief executive and director of research, Advanced Performance Institute.

To deliver value an organisation must know what its goals are and how to achieve them. Clear strategy enables everyone to focus on what matters most.

The problem is that some of the things that matter the most are invisible, which makes them more difficult to handle. Invisible assets like the information your organisation holds, its image and reputation, its core expertise and knowledge or its customer relationships can all be vital enablers of performance. Collectively, these invisible or intangible assets are referred to as your intellectual capital (IC).

Recent research shows that most executives agree IC is critical for the future success of their businesses; but that their approaches to measuring and managing it are either poor or non-existent. This has provided the impetus to create a Management Accounting Guideline (MAG) on the subject.

The MAG ‘Impacting future value: how to manage your intellectual capital’ is jointly published by AICPA, CMA Canada and CIMA. Its aim is to provide finance professionals with practical tools and techniques to identify, measure, manage and report IC.

Successful IC management

The MAG provides detailed guidelines on the five steps of successful IC management:

1. how to identify the IC in your organisation
2. how to map the IC and assess its strategic importance
3. how to measure IC
4. how to manage the IC in your organisation
5. how to report IC.

In this article we concentrate on the first steps and look at how to identify the relevant IC in your organisation and visualise strategy with its IC value drivers in a value creation map. Organisational strategies are often formulated and communicated in lengthy business plans in excess of 30 pages. There is overwhelming evidence that such long documents are not good tools to communicate and clarify strategy because people tend to not read them, or only pick the sections which seem relevant to them.

It is often difficult to clearly understand the relationships between IC related objectives and other sections of a lengthy plan. Current best practice is to produce visual value creation maps which depict the strategy with all its components on one piece of paper. Such a map is able to show at a glace the intended outcomes as well as the core activities and underpinning IC enablers. However, before we go into any more detail on this let’s first define what exactly we mean by intellectual capital.

What do we mean by IC?

Together with physical and financial capital, IC is one of the three vital resources in organisations. IC includes all non-tangible resources that are attributed to an organisation and contribute to the delivery of the organisational strategy. Intangible resources can be split into three component classes: human capital, structural capital, and relational capital (see Figure 1).

Figure 1: Classification of intellectual capital

Human capital

The principal sub-components of an organisation’s human capital are naturally its workforce’s skill-sets, and depth and breadth of experience. Human resources can be thought of as the living and thinking part of the IC resources. Human capital includes the skills, knowledge and competencies of employees, as well as know-how in certain fields that are important to the success of the enterprise, plus the aptitudes and attitudes of its staff.

Relational capital

Relational capital includes all the relationships that exist between an organisation and any outside party, both with key individuals and other organisations. These can include customers, intermediaries, employees, suppliers, alliance partners, regulators, pressure groups, communities, creditors or investors. Relationships tend to fall into two categories – those that are formalised through, for example, contractual obligations with major customers and partners, and those that are more informal.

Structural capital

Structural capital covers a broad range of vital factors. Foremost among these factors are usually the organisation’s essential operating processes, the way it is structured, its policies, its information flows and content of its databases, its leadership and management style, its culture and its incentive schemes. It can also include intangible resources that are legally protected. Structural capital can be sub-categorised into culture, practices and routines, and intellectual property.

The different elements in these three categories can overlap. The aim is not to create a rigorous framework that clearly separates IC elements into different categories, but to provide a framework that can be used to understand and identify IC in your organisation.

Identifying and assessing your IC

The first step towards understanding the IC in your organisation is an inventory check which involves the identification of what IC your organisation possesses. The above outlined categorisation of IC can be used to facilitate a discussion about the current stock of resources. It can be used to create a template that guides you through the different categories of IC and prompts you to think about the different types of intangibles in your organisation (see Figure 2).

Figure 2: Identifying your resource stock

Even though most organisations own a wide stock of IC, some will be more valuable in the delivery of your value proposition than others. One reason for this is that the value of IC is context specific to the unique strategy of your organisation. Another reason is that IC dynamically interacts with and depends on other resources. Let’s look at each of these reasons again:

• The value of IC is context specific. For example, the know-how of building engines is essential for Honda but of little value to a financial services firm.
• IC elements are not static – they dynamically interact with each other and often depend on other resources to be valuable. For example, the brand awareness and reputation of Amazon.com while critically important would fade rapidly without its efficient distribution network, the well-designed internal processes, and the strong supplier relationships it has developed. It is therefore impossible to value a brand name without taking into account all the other important factors, such as reputation, people, processes, etc.

This means that individual IC resources interrelate with other intangible and tangible resources to form core competencies. These in turn allow an organisation to perform its core activities to deliver its output value proposition and strategic deliverables. Having achieved some clarity about the strategic role of IC in your organisation, it is then a good idea to map this strategy into a value creation map.

Mapping the IC value drivers

A value creation map is a visual representation of the organisational strategy. There are two primary functions of mapping your key value drivers into a visual map. The first is to ensure the strategy, with all its IC value drivers, is integrated and cohesive. This ensures that everything that is part of your strategy has a valid place and helps you to achieve the overall goals of your organisation. The second is that it enables easy communication of the strategy and the role and importance of IC in the delivery of that strategy.

A value creation map brings together the three key elements of an organisational strategy, namely its output value proposition, its core activities, and its enabling strategic elements or drivers of performance.

• The output value proposition (or output deliverables) answers the question of why your organisation exists and what its roles and deliverables are. It identifies the key output stakeholders of the organisation and describes what value your organisation is delivering to them. It is mainly derived from the analysis of the core purpose and the output stakeholder requirements. Clarifying the output value proposition allows organisations to put any IC into the strategic context.
• The core activities are the vital few things an organisation has to excel at in order to deliver the above value proposition. The core activities essentially define what an organisation has to focus on and what differentiates it from others. Core activities are directly linked to the organisational core competencies.
• The enabling strategic elements (or value drivers) are the other strategic elements or objectives an organisation has to have in place or has to deliver in order to perform its core activities and meet its output stakeholder value proposition. These enabling elements or value drivers derive from the assessment of the resource architecture and IC.

These three components are then placed in relationships with each other and visualised on one piece of paper to create a completely integrated and coherent picture of the strategy. A value creation map is therefore a visual representation of an organisation’s unique strategy at a specific point in time. This means it has a limited life-span and has to be revised regularly (usually annually). Every value creation map is unique to the current strategy of an organisation and there should never be two value creation maps that are the same.

The basic template of a value creation map is shown in Figure 3 and an example of how a leading hotel has applied this tool to visualise their strategy is depicted in Figure 4.

Figure 3: Value creation map template (Source Marr, 2008)

 

Figure 4: Hotel value creation map

Success and value creation of any organisation in today’s economy is above all driven by IC. In order to positively impact the future value it is therefore critical to understand and manage the intellectual capital that underpins the value creation in your organisation. Here we have looked at value creation maps which represent one aspect of IC management, for the full tool kit and guidelines please refer to the management accounting guideline 'Impacting future value: how to manage your IC'.

CIMA members can access this MAG free of charge at our CPD Centre and can register there for a related infocast that will be held on Thursday 19 June 2008. Non-members can register for the infocast under the Web Events section of the AICPA website. The Management Accounting Guideline is also available for purchase on this site.

May 2008

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