Methods
for Measuring Intangible Assets
Copyright ©Karl-Erik Sveiby Jan 2001, latest update April 2007. All
rights reserved.
The research into measuring the Intangible Assets or
the Intellectual Capital of companies has produced a plethora of proposed
methods and theories over the last few years. In this latest update of the
Paper I provide a brief overview of approaches that I have come across with
links to more information. The list is an ever-expanding community effort,
so if you have a method that I have missed, please notify me!
Measure for Value Creation
- not for Control or PR!
Rarely is the question asked, why measure
intangibles? The answer is not self-evident.
Intangibles are difficult and expensive to measure and the results are so
uncertain, so the reason had better be a good one!
The Fundamental dilemma
The main problem with measurement systems is that it
is not possible to measure social phenomena with anything close to scientific
accuracy. All measurement systems, including traditional accounting,
have to rely on proxies, such as dollars, euros, and indicators that are far
removed from the actual event or action that caused the phenomenon. This
creates a basic inconsistency between managers’ expectations, the promises made
by the method developers and what the systems can actually achieve and makes
all these systems very fragile and open to manipulation. Therefore, the first
question for any one embarking on a measurement initiative must be: What
is the purpose of our measuring initiative?
Management Control purpose
– Don’t!
The most common reason for measuring and reporting is to
improve internal performance, i.e. management control.
It is so common that the purpose is generally not even stated explicitly. The
idea is founded on one of the most quoted management slogans; “you can only
manage what you measure”. It is a simple slogan and unfortunately completely
erroneous.
The trouble is that people don’t like being measured
upon. I don’t. Do you? Or are the measuring systems only for measuring the
others? We find all kinds of ways to evade and obstruct the systems. Then add
an individual reward system tied to the measurement system and we have an
explosive concoction. The temptations to manipulate the system become
overwhelming! Consider the latest management control failure:
Oil and gas reserves are very important of an oil
company like Shell. The trouble is that Shell in the late 1990’s made oil
reserves a target with a reward tied to it for the managers if they succeeded
in increasing them. Guess what, the Shell oil reserves displayed a healthy
development since 1998. Everything seemed to go well, until the end of
Oil and gas reserves cannot be measured exactly since
estimation of reserves involves subjective judgment. If this can happen with
physical resources, what do you suspect can happen with valuing intangible
assets? Is your company immune? If this could happen in Shell,
what do you imagine might going on in your own company? The traditional
accounting system that is heavily regulated by governing bodies and audit and
with heavy penalties imposed on offenders suffers from regular manipulation.
Imagine the abuse an intangibles measurement system is open to; there is no
standard, no audit and it is voluntary only.
PR purpose – Watch out!
Why
are the oil and gas companies pioneers in reporting
their environmental impact? Why is there a surge in triple-bottom line
reporting? The majority of the companies that have been the pioneers in reporting
intangibles externally, have done so for one major
reason; PR. The PR reason seems to hold true for most of the stakeholder
reporting, triple-bottom line reporting and also the IC scorecards pioneered by
companies such as Skandia and Celemi.
We need not suspect more sinister 'Enron' motives,
just because the purpose is PR, but we, as readers, must
be prepared to ask the why, when we judge the validity of the numbers
reported.
It seems that Skandia's
share price, for a while at least, benefited from the company
being one of the pioneers in IC reporting according to
presentations made by Skandia managers during the
boom years in 1999 - 2000. However, those who
bought Skandia shares based on their IC supplements
back then were looking at losses amounting to 90% in 2002! So unless
shareholders are prepared to ask the why, the costs for intangibles reporting
may come out of the their own pockets in the end.
Learning Motive – Why so
few?
So entrenched are the traditional measuring paradigms
that executives and researchers have not
even started to explore the most interesting
reason for measuring intangibles; the learning motive. Measuring
can be used to uncover costs or to explore value creation
opportunities otherwise hidden in the traditional accounts. What is the
trend of cost of staff turnover? What is the value of the learning that takes
place when staff interact with customers? What is the
value creation opportunity lost in having inadequate processes?
The learning motive promises the highest long-term
benefits. First; the learning motive offers the best way around the
manipulation issue. If the purpose is learning, not control or reward, the
employees and managers can relax. Second, a learning purpose allows more
creativity in the design of metrics, a more process-oriented bottom-up approach
and less of top-down commands.
But where does the fine line go? When is a system
control and when is it learning? When does learning become control? Admittedly,
this is not easy, but here are a few pointers. First; the process of developing
the metrics is different. The metrics are produced bottom-up, with heavy
involvement from all relevant groups. No trumpets from the accountants’ ivory
tower! Secondly, the indicators are used by the same people who produce them
and they use them to improve their own processes, not somebody else’s. Third,
the indicators are reported openly to everyone. Fourth; when the indicators
suggest a difference between say, a high-performing and a low-performing unit,
the units in question are required to meet and the difference becomes the
starting point of a dialogue to discover hidden value; are we measuring the
same thing? What is it that we can do better? Fifth; the indicators are never
the basis of a reward system. If rewards are to be distributed at all they
should be group-based and allocated to those, who make the highest value improvement,
i.e. possibly the previous low-performing unit!
The Four
Approaches for Measuring Intangibles
The suggested
measuring approaches for intangibles fall
into at least four categories of measurement approaches. The categories are an
extension of the classifications suggested by Luthy
(1998) and Williams (2000).
·
Direct Intellectual Capital methods (DIC).
Estimate the $-value of intangible assets by identifying its various
components. Once these components are identified, they can be directly
evaluated, either individually or as an aggregated coefficient.
·
Market Capitalization Methods (MCM).
Calculate the difference between a company's market capitalization and its
stockholders' equity as the value of its intellectual capital or intangible
assets.
·
Return on Assets methods (ROA).
Average pre-tax earnings of a company for a period of time are divided by the
average tangible assets of the company. The result is a company ROA that is then
compared with its industry average. The difference is multiplied by the
company's average tangible assets to calculate an average annual earning from
the Intangibles. Dividing the above-average earnings by the company's average
cost of capital or an interest rate, one can derive an estimate of the value of
its intangible assets or intellectual capital.
·
Scorecard Methods (SC). The various components of
intangible assets or intellectual capital are identified and indicators and
indices are generated and reported in scorecards or as graphs. SC methods are
similar to DIS methods, expect that no estimate is made of the $-value of the
Intangible assets. A composite index may or may not be produced.
The methods offer different advantages. The methods
offering $-valuations, such as ROA and MCM methods are useful in merger &
acquisition situations and for stock market valuations. They can also be used
for comparisons between companies within the same industry and they are good
for illustrating the financial value of Intangible assets, a feature, which
tends to get the attention of the CEOs.
Finally, because they build on long established accounting rules they are
easily communicated in the accounting profession. Their disadvantages are that
by translating everything into money terms they can be superficial. The ROA
methods are very sensitive to interest rate and discounting rate assumptions
and the methods that measure only on the organisation level are of limited use
for management purposes below board level. Several of them are of no use for
non-profit organisations, internal departments and public sector organisations;
this is particularly true of the MCM methods.
The advantages of the DIS and SC methods are that they
can create a more comprehensive picture of an organisation’s health than
financial metrics and that they can be easily applied at any level of an
organisation. They measure closer to an event and reporting can therefore be
faster and more accurate than pure financial measures. Since they do not
need to measure in financial terms they are very useful for non-profit
organisations, internal departments and public sector organisations and for
environmental and social purposes. Their disadvantages are that the indicators
are contextual and have to be customised for each organisation and each
purpose, which makes comparisons very difficult. The methods are also new and
not easily accepted by societies and managers who are used to see everything
from a pure financial perspective. The comprehensive approaches can generate
oceans of data, which are hard to analyse and to communicate.
The intangibles measuring approaches best suited for
the measuring motives are:
1.Monitor
Performance (Control). Best are Baldrige
award-type of performance indicators and KPIs.
2.Acquire/Sell Business (Valuation).
Best are Industry rules-of-thumb ($ per click, $ per client,
brand valuation).
3.Report to Stakeholders (Justification, PR).
Best are IC supplements, EVA, Triple-bottom line.
4.Guide Investment (Decision). None of the intangibles
approaches can beat traditional Discounted Cash Flow.
5.Uncover Hidden Value (Learning).
Best are score cards and Direct IC methods.
No one method can fulfil all purposes; One must select method depending on purpose, situation and audience.
34
Methods for Measuring Intangibles in Chronological Order
|
Approx. year |
Label |
Major Proponent |
Category |
Description of Measure |
|
2004 |
National Intellectual Capital
Index |
Bontis
(2004) |
SC |
A
modified version of the Skandia Navigator for nations: National Wealth is
comprised by Financial Wealth and Intellectual Capital (Human Capital + Structural
Capital) |
|
2004 |
Topplinjen/ |
Sandvik
(2004) |
SC |
A
combination of four indices; Identity Index, Human Capital Index, Knowledge
Capital Index, Reputation Index. Developed in Norway by consulting firm
Humankapitalgruppen. |
|
2004 (?) |
MAGIC |
EU
research project |
SC |
A project
partly funded by the European Commission. The method follows the Skandia model
with Human Capital, Organizational Capital, Market Capital and Innovation
Capital. MAGIC |
|
2003 |
Danish guidelines |
Mouritzen,
Bukh & al. (2003) |
SC |
A recommendation
by government-sponsored research project for how Danish firms should report
their intangibles publicly. Intellectual
capital statements consist of 1) a knowledge narrative, 2) a set of
management challenges, 3) a number of initiatives and 4) relevant indicators.
|
|
2003 |
IC-dVAL™ |
Bonfour
(2003) |
SC |
“Dynamic
Valuation of Intellectual Capital”. Indicators from four dimensions of
competitiveness are computed: Resources & Competencies, Processes,
Outputs and Intangible Assets (Structural Capital and Human Capital indices).
In
French |
|
2002 |
FiMIAM |
Rodov
& Leliaert (2002) |
DIC/MCM |
Assesses
monetary values of IC components. a combination both tangible and Intangible
assets measurement. The method seeks to link the IC value to market valuation
over and above book value. |
|
2002 |
IC Rating™ |
Edvinsson
(2002) |
SC |
An
extension of the Skandia Navigator framework incorporating ideas from the
Intangible Assets Monitor; rating efficiency, renewal and risk. |
|
2002 |
Value Chain Scoreboard™ |
Lev B.
(2002) |
SC |
A matrix
of non-financial indicators arranged in three categories according to the cycle
of development: Discovery/Learning, Implementation, Commercialization. Descibed in book Lev (2005): Intangibles. |
|
2002 |
Meritum guidelines |
Meritum
Guidelines (2002) |
SC |
An
EU-sponsored research project, which yielded a framework for management and
disclosure of Intangible Assets in 3 steps: 1) define strategic objectives,
2) identify the intangible resources, 3) actions to develop intangible
resources. Three classes of intangibles: Human Capital, Structural Capital
and Relationship Capital. Meritum
final report. If it doesn’t work
try this link. |
|
2001 |
Knowledge Audit Cycle |
Schiuma
& Marr (2001) |
SC |
A method for assessing six knowledge dimensions of
an organisation’s capabilities in four steps. 1) Define key knowledge assets.
2) Identify key knowledge processes. 3) Plan actions on knowledge processes.
4) Implement and monitor improvement, then return to 1). Described in Book
(2002). Profit with People by Deloitte & Touche. |
|
2000 |
Value Creation Index (VCI) |
Baum,
Ittner, Larcker, Low, Siesfeld, and Malone (2000) |
SC |
Developed
by Wharton Business School, together with Cap Gemini Ernst & Young Center
for Business Innovation and Forbes. They estimate the importance of different
nonfinancial metrics in explaining the market value of companies. Different
factors for different industries. The VCI focuses on the factors that markets
consider important rather than on what managers say is important. http://members.forbes.com/asap/2000/0403/140.html
|
|
2000 |
The Value Explorer™ |
Andriessen
& Tiessen (2000) |
DIC |
Accounting methodology proposed by KMPG for calculating
and allocating value to 5 types of intangibles: (1) Assets and endowments,
(2) Skills & tacit knowledge, (3) Collective values and norms, (4)
Technology and explicit knowledge, (5) Primary and management processes. |
|
2000 |
Intellectual Asset Valuation |
Sullivan
(2000) |
DIC |
Methodology for assessing the value of Intellectual
Property. |
|
2000 |
Total Value Creation, TVC™ |
Anderson
& McLean (2000) |
DIC |
A project initiated by the Canadian Institute of Chartered
Accountants. TVC uses discounted projected cash-flows to re-examine how
events affect planned activities. |
|
1999 |
Knowledge Capital Earnings |
Lev
(1999) |
ROA |
Knowledge Capital Earnings are calculated as the
portion of normalised earnings (3 years industry average and consensus
analyst future estimates) over and above earnings attributable to book
assets. Earnings then used to capitalise Knowledge Capital. Similar to CIV. |
|
1998 |
Inclusive Valuation Methodology
(IVM) |
McPherson
(1998) |
DIC |
Uses hierarchies of weighted indicators that are
combined, and focuses on relative rather than absolute values. Combined Value
Added = Monetary Value Added combined with Intangible Value Added. |
|
1998 |
Accounting for the Future (AFTF) |
Nash H. (1998) |
DIC |
A system of projected discounted cash-flows. The difference
between AFTF value at the end and the beginning of the period is the value
added during the period. |
|
1998 |
Investor assigned market value
(IAMV™) |
Standfield
(1998) |
MCM |
Takes the Company's True Value to be its stock market
value and divides it in Tangible Capital + (Realised IC + IC Erosion +
SCA (Sustainable Competitive Advantage). The method has not been described in
a refereed paper. |
|
1997 |
Market-to-Book Value |
Stewart
(1997) |
MCM |
The
value of intellectual capital is considered to be the difference between the
firm’s stock market value and the company’s book value. |
|
1997 |
Economic Value Added (EVA™) |
Stewart
(1997) |
ROA |
Calculated
by adjusting the firm’s disclosed profit with charges related to intangibles.
Changes in EVA provide an indication of whether the firm’s intellectual
capital is productive or not. http://www.sternstewart.com/evaabout/whatis.php |
|
1997 |
Calculated Intangible Value (CIV) |
Stewart
(1997) |
ROA |
Adaptation of a |
|
1997 |
Value Added Intellectual
Coefficient (VAIC™) |
Pulic
(1997) |
ROA (doesn't quite fit any of the categories) |
An
equation that measures how much and how efficiently intellectual capital and
capital employed create value based on the relationship to three major components:
(1) capital employed; (2) human capital; and (3) structural capital. VAIC™i
= CEEi + HCEi + SCEi http://www.vaic-on.net/start.htm
|
|
1997 |
IC-Index™ |
Roos,
Roos, Dragonetti & Edvinsson (1997) |
SC |
Consolidates
all individual indicators representing intellectual properties and components
into a single index. Changes in the index are then related to changes in the
firm’s market valuation. http://www.intcap.com/about_ics.html
|
|
1996 |
Technology Broker |
Brooking
(1996) |
DIC |
Value of
intellectual capital of a firm is assessed based on diagnostic analysis of a
firm’s response to twenty questions covering four major components of
intellectual capital: Human-centred Assets, Intellectual Property Assets,
Market Assets, Infrastructure Assets. |
|
1996 |
Citation- Weighted Patents |
Bontis
(1996) |
DIC |
A
technology factor is calculated based on the patents developed by a firm. Intellectual
capital and its performance is measured based on the impact of research
development efforts on a series of indices, such as number of patents and
cost of patents to sales turnover, that describe the firm’s patents. |
|
1995 |
Holistic Accounts |
Rambøll Group |
SC |
Rambøll is a Danish consulting group, which since 1995 reports
according to its own ‘Holistic Accounts” report. Based on the EFQM Business
Excellence model www.efqm.org . Describes nine key areas with
indicators: Values and management, Strategic processes, Human Resources, Structural
Resources, Consultancy, Customer Results, Employee Results, Society Results
and Financial Results. |
|
1994 |
Skandia Navigator™ |
Edvinsson
and Malone (1997) |
SC |
Intellectual
capital is measured through the analysis of up to 164 metric measures (91 intellectually
based and 73 traditional metrics) that cover five components: (1) financial;
(2) customer; (3) process; (4) renewal and development; and (5) human. http://www.12manage.com/methods_skandianavigator.html
|
|
1994 |
Intangible Asset Monitor |
Sveiby
(1997) |
SC |
Management
selects indicators, based on the strategic objectives of the firm, to measure
four aspects of creating value from 3 classes of intangible assets labelled:
People’s competence, Internal Structure, External Structure. Value Creation
modes are: (1) growth (2) renewal; (3) utilisation/efficiency; and (4) risk
reduction/stability. http://www.sveiby.com/Portals/0/articles/companymonitor.html
|
|
1992 |
Balanced |
Kaplan
and Norton (1992) |
SC |
A
company’s performance is measured by indicators covering four major focus perspectives:
(1) financial perspective; (2) customer perspective; (3) internal process
perspective; and (4) learning perspective. The indicators are based on the
strategic objectives of the firm. http://www.balancedscorecard.org/ |
|
1990 |
HR statement |
Ahonen (1998) |
DIC |
A management application of HRCA widespread in |
|
1989 |
The Invisible Balance Sheet |
Sveiby
(ed. 1989) The ”Konrad” group |
MCM |
The difference between the stock market value of a firm
and its net book value is explained by three interrelated “families” of
capital; Human Capital, Organisational Capital and Customer Capital. The
three categories first published in this book in Swedish have become a de
facto standard. Download English
translation of book here. Download article The Invisible Balance Sheet. |
|
1988 |
Human Resource Costing &
Accounting (HRCA) |
Johansson
(1996) |
DIC |
Calculates
the hidden impact of HR related costs which reduce a firm’s profits. Adjustments
are made to the P&L. Intellectual capital is measured by calculation of
the contribution of human assets held by the company divided by capitalised
salary expenditures. Has become a research field in its own right. HRCA
journal. |
|
1970’s |
Human Resource Costing &
Accounting (HRCA) |
Flamholtz
(1985) |
DIC |
The pioneering work on HR accounting. A number of
methods for calculating the value of human resources. |
|
1950’s |
Tobin’s q |
Tobin
J. |
MCM |
The "q" is the ratio of the stock market
value of the firm divided by the replacement
cost of its assets. Changes in “q” provide a proxy for measuring effective
performance or not of a firm’s intellectual capital. Developed by the Nobel
Laureate economist James Tobin in the 1950’s. |
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