In 1976 the composer Andrew Lloyd Webber formed the Really Useful Company to monetise the rights to his intellectual works Cats, Evita, Phantom of the Opera and Sunset Boulevard. Ten years later he listed on the London stock exchange at a market value of 35 million pounds. The assets at that time consisted of a West End theatre valued at 2 million pounds, the rights to the compositions, a seven-year contract with Webber, and an insurance policy on his life. Today Webber’s wealth is estimated at over 800 million pounds and the Really Useful Group is one of the largest theatre operators in London.
Intellectual capital is the value in a business that you can’t touch. It covers everything that isn’t physical but adds to the abilities and productive capacity of a firm. Intellectual capital includes customers, brands, data warehouses, software, information systems, staff capabilities, patents, trademarks, research and development, technology, and products designed but not yet launched.
Since the turn of the century, much of the world economy has been based on intellectual capital. The value of intangible assets has grown much faster than tangibles and we can expect the growth in intangible asset values on and off company balance sheets to continue.
Intellectual assets can’t be expected to develop by themselves. They have to be managed. Winning companies like Apple and Microsoft became experts at managing their intellectual capital long before other companies. They:
- manage their intangibles actively, not passively;
- treat intellectual resources as valuable assets, not as costs;
- appoint a champion to nurture and grow each component;
- keep asset registers of people, patents, contracts, customers and software, and verify their existence annually;
- prepare business plans and set measurable goals for each intellectual capital component;
- ensure legal ownership resides with the organisation and not in the minds of key employees;
- invest in systems, succession and training to ensure the momentum for growth is continuous;
- ring fence and make their knowledge and ideas difficult for competitors to copy by registering patents, copyrights and trademarks;
- understand that intellectual assets have a life span that needs to be monitored and renewed; and
- develop key performance indicators for each element of intellectual capital which they constantly measure.
The world post-COVID 19 economy in the 4th industrial revolution will be driven by intellectual capital. The winning companies will innovate and improve themselves continuously, choosing to re-invest their profits in new products, technology, and the skills and knowledge of their employees, rather than in physical assets such as vehicles or machines. Many listed companies already have market values of ten or even twenty times the value of their tangible assets. Today over half the world’s population are Internet users, feeding their own intellectual capital.
Managers reject the accounting notion that only tangible assets should be measured and valued, while intangibles should not. They look for guidance to help them understand, manage and measure non-physical intellectual capital assets. In many cases their systems and processes don’t give them enough support. Return-based financial measures encourage managers to hold back investing in intangibles.
Intellectual capital covers everything that isn’t physical that adds to the abilities and productive capacity of a firm. We can divide intellectual capital into four categories:
- Human capital is the knowledge, loyalty, know how, abilities and creativity of employees.
- Structural capital refers to an organisation’s innovations, designs, products, business processes, and organisation culture. Structural capital manifests in the form of documents, media, processes, systems, data, brands, patents, trade-marks and trade secrets.
- Relational capital includes a firm’s relationships with the outside world including investors, shareholders, customers, employees, partners, and communities. These relationships can be informal or formally contracted.
- Natural capital is the goods and services provided by the natural environment, the renewable and non-renewable natural resources (plants, trees, animals, air, water, soils, and minerals) that yield a flow of benefits to an organisation. Organisations develop sustainability policies to help manage these assets.
in contrast, Physical capital is of two kinds: manufactured capital and financial capital.
- Manufactured capital is the machines, buildings, tools, equipment, vehicles and any other physical assets that provide the infrastructure to produce a firm’s goods and services, or protect the process of production. You will find manufactured capital listed and categorised in company asset registers and on the asset side of a balance sheet.
- Financial capital is the money that a firm uses to finance its activities and operations. It consists in the main of shareholder equity, interest bearing debt and creditor finance, and includes facilities that the firm can access in the future if needed.
Analysts try to estimate the total value of a firm’s intellectual capital as the difference between the market value of a firm and the shareholders’ equity reported on its balance sheet. Share prices are however volatile and don’t always indicate the true value at a point in time. Stock markets can rise to unsustainable heights and sink to devastating lows based on hysteria, but the fundamental concept of intellectual capital still stands. The values of the individual components of intellectual capital are much more difficult to estimate.