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

In the previous article, we examine the need to measure intellectual capital. In this subsequent article, we are examining the 4 methodologies available for measuring Intellectual Capital. They are:

Direct Intellectual Capital Method (DIC):
The direct intellectual capital method focuses on measuring the value of intellectual capital by first identifying its various components and then directly evaluating them. It’s focus can be in areas such as market assets, intellectual property, technology assets, human assets etc. Basically there is no set areas and is up to the organisation to decide what and how they want to measure it.

Market Capitalization Method (MCM):
Here market value (MV) is defined by the buyer, the MV is determined by the market capitalization value of a company. The book value (BV) refers to the equity and reserve value after deducting the debt value in the balance sheet.
MV-BV=IC (Accountants refer to this as Goodwill and it is depreciated over time)

Return on Assets Method (ROA):
In this method the organization’s ROA is derived from organization’s average pre-tax earnings divided by the average tangible assets of the company over a period of time. This ROA is then compared with the industry average. The difference is then multiplied with the company’s average tangible assets to calculate the average annual earnings from intangibles. By dividing the average annual earnings from intangibles by the average cost of capital of the organization, one can estimate the value of its intellectual capital in monetary terms

Calculated Intangible Value
This method calculates IC using averages, profit and net present value. It was developed by NCI Research. The method is based on the principles of calculating brand equity. The NCI group that developed the method confers that the value of IC equals a company ability to outperform an average competitor that has similar assets. Basically a company’s return on assets for a period is calculated, this is then compared with the industrial average ROA. (the company’s ROA needs to be higher then the industrial figure). Used the industrial average on the company’s asset value to calculate the return. The excess between the company’s return and the calculated return after tax and net present value (perpetual) would be the IC value. The beauty of CIV is that it is industry specific and it is a calculated figure not related to assets.

Scorecard Method (SC)
The Balance Scorecard introduced by Norton and Kaplan (1996) is supposing used for aligning an organization to the strategy. The balance scorecard address a serious deficiency in traditional management systems: their inability to link long term strategy with short term actions. The Balance Scorecard consist of 4 perspective- which bears a resemblance to the definition of Intellectual Capital:
Internal Business Process Perspective ? Internal Capital
Customer Perspective ? External Capital
Learning and Growth Perspective ? Human Capital
Financial Perspective ? Financial Reports

Based on the principles of the Balance Scorecard, the scorecard method was derived. Here the measurements are derived based on the measurements derived from within the 4 perspective. This measuring system shows the extent to which the strategy of the company has been implemented, using qualitative indicators that shows the execution of strategic objectives. Fairly similar to DIC methods but more rigid in that it follows the principles set by the Balance Scorecard Approach developed by Kaplan and Norton.

Based on the above approaches, how do we then chose which to used. No one method is the best, it depends on the purpose of usage.

MCM methods are useful mergers and acquisitions exercises and for stock market valuations because of the monetary outcome. Additionally it can be used for comparison purposes and thus more readily accepted by the accounting professions. However because everything is translated to monetary terms, the information tends to be uninformative for operational purposes. This is where the DIC and SC methods are superior as they can easily be applied to any level of an organization. However the DIC and SC are customized and companies specific and makes comparison difficult even between companies in the same industry. Furthermore the DIC method is deemed too flexible, basically anything will do as it fails to have a certain structure dictated by the company. Likewise the SC method although systematic has been deemed too rigid by personalities It is because the indicators are all linked ultimately to financial results. Likewise the Scorecard Method fails to consider for the dynamics of the intangible, additionally the consideration for human capital and innovation capital is limited. The Scorecard also assumes that the performance of one perspective will automatically lead to another. It must be noted that the Balance Scorecard was originally formulated as a management system not as a sophisticated measurement system for Intellectual Capital, this role has been clearly emphasized by Norton and Kaplan (1996).

The DIC method is the most complex and expensive to implement because of the large number of components that have to be identified and individually measured, but many organizations such as Skandia of Sweden, Cowi of Denmark and Union Fenosa of Spain that used it to report their Intellectual Capital Report..

It is recognized that the intellectual capital of a firm plays a significant role in creating competitive advantage and thus stakeholders are asking with increase frequency that these intangible stock and intangible flows be measured and reported regularly. However as can be seen from the varied approaches used, there is still room for experimentation and improvement in the methodology for quantifying and reporting intellectual capital. There is no one suitable method, each method is unique and should be developed to suit the needs of the organization.

Intellectual Capital being both fluid (process) and a stock cannot and should not be seen to ultimately classified into a single monetary value. It is far too complex and diverse. Each company must find their own methodology for the time being, however that does not mean that it should not start looking into measuring it.

Last updated - 30 May 2004