:: Jeremy Lee | How’s Your Organization Intellectual Capital (Part 1 of 2)

How’s Your Organization Intellectual Capital (Part 1 of 2)
By Jeremy Lee

Ever think about the Intellectual Capital (IC) in your organization. How is the health of your organization IC? Are you measuring the most important thing in your organization?

The term “Intellectual Capital” was first used by economist John Kenneth Galbraith in 1969. Peter Drucker further expounded the term in his book on the post capitalist society. Today the term is widely used in business publications and has many complex connotations and is often used synonymously with intellectual property, intellectual assets and knowledge management.

Intellectual Capital is today viewed as the last and probably only sustainable competitive advantage in business. It cannot be replicate unlike process, products, machine and people (note the distinction that labor in itself should not be considered as intellectual capital, it is the knowledge within the labor that is of outmost importance).

Source: Saint-Onge et. Al.

So what is Intellectual Capital? According to Thomas A Stewart, intellectual capital is “intellectual material –knowledge, information, intellectual property, experience-that can be put to use to create wealth.” Therefore intellectual capital is intellectual material that is of value to an organization. It refers to a particular type of knowledge which is of value to the company.

The Securities Equities Commission Chairman Steven H.M. Wallman defines it as “assets currently valued as zero in the balance sheet.”

Although most practitioners and authors are unable to pint down a standard definition of what is Intellectual Capital, they agree that intellectual consist of 3 areas Human Capital (Employee Competence), Structural Capital (Internal Structure) and Relationship Capital (External Structure), see diagram above.

Most organization today are only beginning to realized the importance of Intellectual Capital, but many still lack the know –what and know-how to manage and measure it properly to reap its potential. Additionally there are those that advocate the measuring of Intellectual Capital is for service-oriented companies to boost their value, by accounting for the invisible. This argument is far from true as in the manufacturing and technology industry, intellectual capital is just as critical.

For many organizations today, their main module of assessing their performance lies in the financial statements and management accounting statements. However both these reports may be in need of a revolution to make them relevant to the needs of the companies of today. Present day accounting practice of double entry first appeared in Luca Pacioli book published in 1494. The present balance sheet was introduced in 1868 with income statements predating the Second World War. As for Management Accounting systems, in 1987 Johnson and Kaplan held compelling arguments arguing that “Corporate management accounting systems are inadequate for today’s environment.”, despite changes to the system since then, in an era of real time measurement, value creation, human capital and network (relationships), the focus on cost measurement (cost per man-hour, revenue to asset), is equivalent to comparing the black coal factories at the dawn of the Industrial Revolution in 18th Century England to the modern spotlessly clean high technology manufacturing plants of today or the large multi-billion dollar corporations such as Microsoft.

Measuring your organization intellectual capital should not be seen as a novelty, it is critical to the survival of the organization. After all, what gets measured gets managed. Intellectual capital gives you information on the well being of your organization from the human, organizational and relationship perspective. However are these critical aspects of business accounted for in your organization?

Measuring the intellectual capital (IC) within companies benefits 2 parties, the external party represented by the stakeholders-customers, creditors and shareholders and the internal party for management decision making. These two parties based on their usage of the information will want to achieve different objectives from the measurement. The external party is interested in the current performance of the company and the financial health of a company. Their emphasis is on a particular place in time. Whereas management is more interested in flow and trends that are happening within an organization.

The problem with the measurement of intangibles is its subjectivity and it’s untried methods. Yet despite all that, it would be a crime to treat IC similar to the current the financial measurements that we are using in our financial reporting, it is an even worse crime not to measure it. Karl-Erik Sveiby a guru in the area of Intellectual Capital rightly mentioned that "If we measure the new with the tools of the old, we will not "see" the new.”

In the following article, we will examine the ways of measuring intellectual capital.