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Hie Evolution of Intellectual Capital

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Hie Evolution of Intellectual Capital


Intellectual capital has existed since the beginning of time, but its modern version is much broader than ever before. Chapter 3 traces how this evolution has taken shape and what its implications are: since the beginning setting the stage value creation and value extraction beyond the firm next steps.

"Companies that make their profits by converting their knowledge into value are called knowledge companies." Patrick H. Sullivan, intellectual capital consultant with ICMG andpioneer in value extraction

SINCE THE BEGINNING...

Intellectual capital has existed in one form or another from the beginning of human history. Our cave-dwelling ancestors created and mobilized their skills, knowledge, and values for advantage. Evidence of this is the markings they put on cave walls to indicate the migratory patterns of the game they hunted. These caves were also the sites for the rituals that brought new and updated knowledge, skills, and values together, cultivating and sharing them across the generations. The ability to grow and leverage that knowledge made the difference between our Cro-Magnon hunter forebears who flourished successfully and their Neanderthal neighbors who did not have these capabilities and did not survive.

In traditional societies key knowledge was held as proprietary by the ruling hierarchy. It was often guarded and sacred. The priests of ancient Egypt developed a system for knowing when and to what extent the River Nile would flood. It was through their intellectual capital that they could manage the growth of agriculture, which was the basis for the physical wealth of the pharaoh.

The pattern of closely held knowledge and know-how held over the centuries. Maps and trade route knowledge were kept as state secrets. The ability to cultivate and manage this kind of intellectual capital was the basis for states, like Venice, to become the leading trading and military powers during the Renaissance era. In the late 1400s the small kingdom of Portugal, shut out of the rich Mediterranean Sea commerce, catapulted itself into becoming the leading and wealthiest power of its time by strategically gathering, creating, and using its new knowledge in seamanship, ship design, cartography, navigation, and networked intelligence to establish the first global empire. Portugal became a model of what a country could do when it learned how to leverage its intellectual capital.

In the nineteenth century the merchant bankers of Europe, starting as itinerant traders, grew into the owners of financial institutions that financed the wars and empires of the world for over a century. They were able to do this because they knew how to leverage their intellectual capital throughout their global networks. They responded rapidly to changing conditions, cultivating the best information and strong relationships. Their business ethic was so trusted that it became more powerful than the currency they traded. The integrity of their ethic was infused into everything they did and was at the core of all of their transactions. Their fortunes lived and died on trust. The principals of a banking house could trust each other and their clients trusted them, and so they could amass and transfer large quantities of resources globally with ease, providing their customers with the resources they needed.

SETTING THE STAGE

Since the 1980s the creators of the intellectual capital discipline have grappled with the significance of growing value of intangibles in organizations, in proportion to the traditional factors of production, financial capital and tangible resources. This growing gap in value could no longer be easily ignored. They tried to answer the question as to why organizations with basically the same financial, physical, and labor resources could produce quite different levels of value. They assumed that there had to be some other factor that explained the levels of productivity and the market value.

As the information age dawned, these gaps grew far more pronoun­ced as new companies -with very little financial and physical resources began to have market capitalization value at much greater levels than other organizations that were heavily invested in equipment, had vast workforces, and sizeable financial capital reserves. All of the build­ings, desks, computers, and even cash reserves of companies like Microsoft accounted for only a small fraction of market value and did not explain the discrepancy between the book value of organi­zations and their market value. This raised major issues about, firstiy, how to determine valuations for these organizations, and secondly, how to manage these changing organizations in our rapidly changing times.

These discrepancies were rooted in the radical shift of what deter­mines value and the specific drivers for value in organizations. Several pathways have been developed to produce what we know today as intellectual capital. One was staked out by Hiroyulti Itami, who published the book Mobilizing Invisible Assets in 1980 in Japan, based on his studies of the effect of invisible assets of Japanese corporations.

In 1986, David Teece of the University of California at Berkeley wrote a major paper on commercialization of technology, which emphasized key points of a resource-based view of organizations. This view empha­sizes that firms have "differentiated, or unique resources, capabilities and endowments."1 These resources are "sticky," meaning that they are not easily added or discarded, and are an organization's intellec­tual resources. In this perspective "skills acquisition, managing their knowledge and know-how and learning become fundamental strategic issues."2

Also, during the 1980s Karl Eric Sveiby, in Sweden, started to realize, as he worked to develop his own service-based non-manufacturing enterprise, that this type of organization had very little in the way of tangible assets. He discovered that the one thing that did count was its "invisible knowledge-based assets."3 Sveiby saw that people in service businesses paid far less attention to financial information and were more concerned about "their people, their networks and their image." Sveiby pioneered the issue of managing intangible assets in his first book, The Know-How Company, in 1986. In 1988 he published the New Annual Report which introduced the idea of "knowledge capital," and in 1989 published The Invisible Balance Sheet. These initiatives paved the way for the idea that knowledge capital was of value to organizations and could be represented in real and convincing ways.

Sveiby carried the idea of working from a knowledge perspective further in his 1997 book, The New Organizational Wealth, where he held that managers have to free themselves from the mental straight-jackets of the industrial age and cultivate the unlimited resources comingfrom the ability of people to create knowledge. He stated that, in contrast with conventional assets, knowledge grows when it is shared.

It was becoming evident that useful knowledge was the real differ­ence that people contribute to their organizations and that those contributions show up in all areas: in research and development func­tions, managerial functions, marketing and sales, and in operations. In short, all areas of an organization were engaged in creating and infusing value in an organization.


VALUE CREATION AND VALUE EXTRACTION

These efforts have resulted in two general dimensions of intellectual capital. The practitioners involved in an organizational development perspective have tended to emphasize the capabilities forwealth gener­ation or the "value creation" side and those involved in accounting for that wealth have tended to concentrate on what is required on the "value extraction" side of intellectual assets. Both are necessary in a successful organization. Realizing the source of wealth generation is the key to continual renewal of firms and having a reliable way to value and market the fruits of intellectual capital is increasingly necessary for an organization to optimize its value to its stakeholders.

The efforts of the 1980s laid the groundwork for journalists, academicians, and practitioners to better name the shifts they were experiencing. Thomas Stewart, of Fortune magazine, began to notice that the traditional sources of wealth of land, labor, and capital were giving way to "intellectual capital." He saw more and more that muscle power, machine power, and energy power were steadily being replaced by brainpower. Intrigued by the notion, he wrote an article called "Brainpower" in 1991- That article was the catalyst for the Swedish insurance company, Skandia, to decide to recast itself as a firm that would distinguish itself by managing its intellectual capital.

A second cover story called "Intellectual Capital" was published in Fortune in 1994 and drew an enormous response. For Stewart, the Age of intellectual capital had arrived. He published Intellectual Capital: The New Wealth of Organizations in 1997, which aimed to show "how the untapped, unmapped knowledge of an organization" was a major competitive force.5

The groundswell had begun. A related major event occurred in 1994 when a group from industry, academia, and policy research met in California to tackle the questions of: Does the existing management language value knowledge as an essential resource for creating value and wealth? What are the meaningful predictors of a company's future prosperity?1 How shall we value and measure intellectual capital?6 This group became known as The Gathering, and continues to have ongoing sessions focused on sharing experience in developing and applying practices that yield practical results for their organizations. Leif Edvinsson had become the world's first person to hold the title of corporate director of intellectual capital for Skandia, the largest insur­ance and financial services firm in Scandinavia, in 1991- He was charged with developing a unit of Skandia with the first-ever organizational struc­ture for presenting the human, structural, and other components of intellectual capital. Edvinsson's team developed the Skandia IC model aimed at creating sustainable performance-based value by targeting four distinct areas of focus (Financial, Customer, Process, and Renewal and Development) along with the one common crosscutting Human area. Skandia integrated these five factors in a dynamic reporting model, which it called the Navigator. This, according to Skandia's then CEO, Bjorn Wolrath, enabled Skandia to have:

... broadened, balanced, type of accounting and reporting results in a more systematic description of the company's ability and potential to transform intellectual capital into financial capital.7

Skandia drew on its Navigator when it published its landmark Intellec­tual Capital Annual Report in 1995.

Others companies - details of some of them can be found via a job search engine - began their major efforts to map and harvest their intellectual capital assets. Dow Chemical created a position of Director of Intellectual Assets and embarked on a major re-evaluation of its research and development efforts and patent inventory, creating the tools and technology to optimize a strategic "knowledge for value" perspective. Hughes Aircraft set up an intellectual capital program called the Knowledge Highway. The Canadian Imperial Bank of Commerce (CIBC) formed its leadership development program grounded on the premises of intellectual capital. CIBC used its growing bank of skills to start a loan program to finance knowledge-based companies using intellectual capital valuations as the key criteria.

In 1996 another foundation block in the history of intellectual capital occurred when the United States Security and Exchange Commission (SEC) held a symposium on intellectual capital. Commissioner Stephen M. H. Wallman convened this session to explore how to account for and report intellectual capital. A result of the session was that Wallman "advised companies to begin experimenting with the disclosure of hidden assets through published supplements."8 Shortly thereafter, Dr Baruch Lev founded the Intangibles Research Project at New York University's Stern School of Business. The project has been a centerfor research into the dynamics of intangible assets and has sponsored four annual conferences, with delegates from around the world presenting and discussing research and trends in the field.