Intellectual Capital

Author: Thomas Stewart
Publisher: Doubleday Publishers, 1997


Nobody is saying it, but what the craziness in the stock market is all about right now is “Intellectual capital”. The technology and firms, whose stock market valuations are driving the financial community and “bricks-and-mortar” firms to despair, have officially marked a new era in our societal evolution. The old paradigms for stock market valuations aren’t working. Many measures, like book value, don’t mean anything anymore. Why? Because the biggest assets are “off-balance sheet”. People.

Intellectual capital ultimately is about recognizing these people assets “on the books”, to restore some sense to old valuation models. It won’t be long before the accounting community, keepers of the conventions of financial reporting, will be forced to address the valuation of intellectual assets.

In the meantime, the topic sits there, waiting for those inclined to be out on the forefront of organizational development.

Our review starts with a summary of ten principles for managing intellectual capital. If that whets your appetite for greater understanding, what follows is a summary of the key points in the book. [Bracketed] references are to page numbers in the book.

Ten Principles For Managing Intellectual Capital

Several key principles of intellectual capital management emerge from a close look at human, structural, and customer capital:

1. Companies don’t own human and customer capital; companies share the ownership of these assets with, in the case of human capital, their employees; and in the case of customer capital, with suppliers and customers. Only by recognizing this shared ownership can a company manage and profit from these assets. An adversarial relationship with employees, like one with suppliers and customers, may save or make a few dollars in the short run, but at the expenses of destroying wealth.

2. To create human capital it can use, a company needs to foster teamwork, communities of practice, and other social forms of learning. Individual talent is great, but it walks out the door; corporate stars, like movie stars, have to be managed like the high-risk propositions they are. Interdisciplinary teams capture, formalize, and capitalize talent, because it becomes shared, less dependent on any individual. Even if group members leave, the knowledge stays behind. If the company provides the locus of learning – if it’s the hotbed of new or expert thinking in any area – it will be the chief beneficiary of learning in the field, whether or not some of it “leaks” to other companies.

3. To manage and develop human capital, companies must unsentimentally recognize that some employees, however intelligent or talented they are, aren’t assets: Organizational wealth is created around those skills and talents that are a) proprietary, in the sense that no one does them better and b) strategic, in that the work they do creates the value customers pay for. People with those talents are assets to invest in. Others are costs to be minimized, as far as your business is concerned; the skills might be assets for someone else.

4. Structural capital is the intangible asset companies own outright; it’s therefore what managers can most easily control. Paradoxically, however, it’s what customers – who are where the money comes from – care least about. Just as that government is best that governs least, so those structures are best that obtrude least. Manage your company, therefore, to make it as easy as possible for your customers to work with your people.

5. Structural capital serves two purposes: to amass stockpiles of knowledge that support the work customers value, and to speed the flow of that information inside the company. Manufacturers have learned that just-in -time inventories are more efficient that ware-houses full of stuff you have just-in-case; so it is with knowledge. What you need should be ready-to-hand; what you might need should be easy to get.

6. Information and knowledge can and should substitute for expensive physical and financial assets; every company ought to examine its capital spending and ask: Can inexpensive intangibles do the work of costly physical assets?

7. Knowledge work is custom work. Mass-produced solutions won’t yield high profits. Even in businesses long characterized by mass production, there are opportunities to create special relationships – often by providing management service – that will yield value and profits for both you and your customer.

8. Every company should re-analyze the value chain of the industry it participates in – along its whole length, from rawest of raw materials to end user – to see what information is most crucial. Generally, for knowledge work, it will be found downstream, toward customers.

9. Focus on the flow of information, not the flow of materials. Whether you’re looking at human, structural, or customer capital, or their interactions, don’t confuse the “real” economy with the “intangible” one. It used to be that information supported the “real” business; now it is the real business.

10. Human, structural, and customer capital work together. It’s not enough to invest in people, systems, and customer separately. They can support one another; they can detract from one another.

It’s worth listing a few of the ways in which this interaction takes place:

Human capital and structural capital reinforce each other when a company has a shared sense of purpose combined with an entrepreneurial spirit; when management places a high value on agility; when management governs more by carrot than by stick. On the other hand, human and structural capital destroy each other when too much of what goes on in an organization isn’t valued by customers, or when the corporate center attempts to control behavior rather than strategy.

Human capital and customer capital grow when individuals feel responsible for their part in the enterprise, interact directly with customers, and know what knowledge and skills customers expect and value. An employee who doesn’t know or have those skills lowers the value of both human and customer capital. So does an internally preoccupied organization. It’s become common to speak of “internal customers” to encourage people to treat their colleagues as if they were as important as those outside. Nonsense. There is no such thing as an internal customer, no substitute for the real thing. Rather than encourage colleagues to treat each other like customers, get them out to mingle with the genuine article.

Customer capital and structural capital grow when the company and its customers learn from each other; when they actively strive to make their interactions informal – to be “easy to do business with.” If a cynic in your shop wonders if you’re more loyal to the customer than to the company, you’re on the right track. On the other hand, if your interactions with customers are limited to writing orders and fielding complaints, your customer and structural capital are working to destroy each other. Every industry has a “most informed vendor” – someone, perhaps not the category leader, who knows the most about the business and is willing to share his expertise with his suppliers and customers. That guy wins.

The following takes you through the principles of intellectual capital in greater detail:

  • Technology capital investment exceeded production capital investment for the first time in 1991 [21]
  • Graph of employment by type 1900-2000 [42]
  • The rise of the knowledge worker fundamentally alters the nature of work and the agenda of management [47]
    • Managers’ work was defined by POEM: plan, organize, execute, monitor
    • Consider instead DNA: define, nurture, allocate [191]
      • Who are we? What is our business? What is our mission and vision? What value do we create?
      • What people and skills do we need? How do we reward and retain? What systems do we need?
      • What resources do we need? How do we get them? What are our best alternatives? How do we measure? [192]
  • Six step process for managing intellectual capital [62]
    • Begin with strategy: define the role of knowledge in your business
    • Assess competitors’ strategies
    • Classify your portfolio: What do you have? What do you use? Who controls?
    • Evaluate the cost and value of your intellectual assets. Decide what to keep, sell or abandon
    • Invest in what you decide to keep. Identify gaps and fill.
    • Assemble your new asset portfolio and start process again
  • Managing the knowledge of a business is an essential task, but receives insufficient direct attention
  • Data, information, knowledge and wisdom: to be differentiated
  • Knowledge assets exist and are worth cultivating only in the context of strategy. You cannot define and manage intellectual assets unless you know what you are trying to do with them [70]
  • Intellectual capital exists in a corporation’s people, structures and customers [75]
  • human capital is the capabilities of the individuals required to provide solutions to customers
  • what people must know to serve customers and benefit themselves [93]
    • competency models, or maps to career paths [94]
      • what customers expect from us
    • False correlation of learning with training is one of the most common mistakes [94]
      • employees must define their own knowledge-gaining actions [94]
    • learning happens best in groups: community of practice [95]
      • these achieve knowledge transfer and innovation [97]
        • need to avoid barriers to learning in these groups [98]
  • structural capital is the labs, information systems, corporate intelligence, knowledge of distribution channels and management skills of a company
    • it is the knowledge that doesn’t go home at night [108]
    • it is the strategy and culture, structures and systems, routines and procedures [109]
    • created through continuous recycling and creative utilization of shared knowledge and experience [110]
      • an encoded in-house Yellow Pages [115]
        • maps to locate in whose heads knowledge resides
        • a file of “lessons-learned” [116]
        • keeps the best people on the leading edge and passes their knowledge-gaining to all [124] [132]
      • What do we know and where is it stored?
  • customer capital is the value of the relationships with your customers: the depth(penetration), width (coverage) and attachment (loyalty) of your customers [77]
    • maps of buyer/seller relationships [160]
  • A sample model for learning culture [80]
  • The marginal value of investing in people is approximate three times higher than investing in machinery (85)
    • distinguish between paying people and investing in them
  • “Work out” program:
    • “town meetings” to glean from employees ways to simplify, eliminate the unnecessary
  • Human capital is easily dissipated: it needs to be massed and concentrated and galvanized in the context of action [89]
  • Four quadrant analysis of workforce [90]:
INFORMATE: difficult to replace, low value-added CAPITALIZE: difficult to replace, high value-added
AUTOMATE: easy to replace, low value-added DIFFERENTIATE, or OUT-SOURCE: easy to replace, high value-added
  • human capital is the upper right quadrant
  • four quadrants require different strategies: informate, automate, outsource, capitalize [91]
    • Informate means to change something to add more value
    • Outsourcing removes need to invest in something that isn’t proprietary
      • alternate is to differentiate
        • turn generic knowledge into proprietary knowledge [93]
  • Individuals acquire the human capital, but must be willing to cede this value to the company
    • requires a sense of cross ownership
      • companies should be membership communities which create the continuity and sense of belonging [101]
        • encourage informal groups
        • create trans-organizational communication
        • staff transfers across business units
        • commitment of resources [102]
  • Principle barrier to entry in an information industry is the ability to concentrate intellectual property [105]
  • Gainsharing: system of rewarding employees economically for attaining desired goals [105]
  • It is amazing how poorly companies organize information about their suppliers, customers and competitors [117]
  • Speed of inflow-mation: vertical org structure is the slowest [123]
  • The system of knowledge may be more valuable than the thing known [129] because things known lose their value as they become obsolete, but the systems for knowledge-gaining are always valuable
  • Knowledge classification grid (135)
EXPLICIT: knowledge that you know you have KNOWN GAPS: knowledge that you know you don’t have
TACIT: knowledge that you don’t know you have UNKNOWN GAPS: knowledge that you don’t know that you don’t have
  • Employee approach: “I do not expect that you will give me lifetime employment; therefore, what skills must I gather to make me valuable to my next employer?” [200]
  • Signals for employees to monitor their value-giving [201]
  • Vertical climbs may be passe: the new sign of success is the richness of your work’s content and the size of its impact [206]
  • Tools to measure quantitatively intellectual capital [226-41,45]
  • Graph of value-gaining from customer relationships [242]