From the Building Smarter Companies Video Blog
In this episode, Mary Adams shares the mega-trends challenging traditional financial management and introduces the concept of integrated thinking and reporting.
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Chipotle recently announced that it was dropping pork from its menus in many of its restaurants because a key supplier was not raising its livestock according to their standards. It's a public way of saying that the chain means what it says about emphasizing healthy conditions for pigs and other livestock.
In intangible capital language, the organization's had to stay true to its purpose (strategic capital) and brand (relationship capital) by walking away from its supplier. The supplier had moved from an intangible asset into an intangible liability.
The move was reportedly taken after a routine audit. Companies like Chipotle have to manage their intangible capital carefully and so use disciplined management like these audits.
Chipotle would be just like any other fast food restaurant without its intangible capital. There are lessons and opportunities in stories like these....
Blackstone is the world’s largest investor. So it’s news when its CEO, Larry Fink, sends a letter to the CEO’s of the S&P 500. He sent one last year and just sent a new one this month that is printed in full at Business Insider in which he calls for longer-term thinking in American companies. It’s an exciting read for those of us who believe that longer-term thinking will drive greater profits and prosperity.
My colleagues in the integrated reporting (<IR>) movement have shared some great thoughts about the letter including in the IIRC newsletter and the <IR> LinkedIn Group. But I think there’s more to say about how the vocabulary he uses in the letter connects with the integrated reporting movement. (I don’t know if he meant to connect with the <IR> vocabulary but I think the comparison is instructive):
We are asking that every CEO lay out for shareholders each year a strategic framework for long-term value creation.
Integrated reporting is a framework for mapping and measuring long-term value creation. Its core concept is that each company has multiple types of capital. This capital is put to use in the short term to create value for customers, stakeholders and shareholders. But to be successful over the long term, this capital has to be put to work in a way that also preserves and hopefully increases the capital base for the future.
There’s nothing new about the need for companies to create short- and long-term value. What’s new is that traditional financials don’t capture two key types of capital that have grown in importance/attention. The first is the growth in the relative value of intangible knowledge capital (know-how, data, processes, designs, networks and even people). Since the rise of information technology a few decades ago, the intangible portion of corporate value has risen from 18 to 84%. Second is the growing realization that externalities like resource use and abuse are a relevant business issue.
We certainly support returning excess cash to shareholders, but not at the expense of value-creating investment. We continue to urge companies to adopt balanced capital plans, appropriate for their respective industries, that support strategies for long-term growth.
If you accept that the value creation system of a company includes tangible, intangible and natural capitals, these statements about “balanced capital plans” and “value-creating investment” take on new meaning. Companies spend enormous amounts of money on all of the capitals. Except for investments in tangible assets, this money is not considered capital expenditure so the accumulated effect of the investment is invisible (this is how the 84% corporate value gap happened).
When we wrote Intangible Capital in 2010, we included a chapter on what we called i-capex (intangible capital expenditure). I always thought that this would be a powerful place to start in measuring the capitals. It turns out that that chapter has been viewed as the most radical of all. Maybe the time has come to re-visit it?
But one reason for investors’ short-term horizons is that companies have not sufficiently educated them about the ecosystems they are operating in, what their competitive threats are and how technology and other innovations are impacting their businesses.
Everyone loves to complain that investors are short-sighted. But companies actually have themselves to blame in many ways. With such a large portion of corporate value intangible and off-balance sheet, the only hard data that analysts have is the income statement, which is by definition a short-term, backward-looking measurement. If we don’t give stakeholders (including investors) a replacement for what they used to get from a balance sheet, nothing will change. Which leads us back to the need for the framework that looks at the whole ecosystem…..
I’m actively working/looking for ways to build momentum for <IR> in the U.S. I have a short plan that I’m happy to share. I’d love to hear feedback here or email - adams at smarter-companies.com.
There’s a fascinating “Room for Debate” discussion at the NYTimes entitled Profiting Profits or Reinvesting Them with the prompt:
Corporations have gone from reinvesting about 90 percent of their profits into their business in the 1970s, to about 10 percent today, William Lazonick wrote in a recent Harvard Business Review article. Profits are instead being used to pay dividends to investors and to buy back stock to boost its price, benefiting the company’s executives. Can this trend be reversed to help fuel growth that benefits everyone?
Bill Lazonick is a friend and I’ve been meaning to write about his great article at HBR that inspired this debate. So I was thrilled to see it be the basis of a really rich discussion. His case is very clear. And he feels that change must come from regulators.
Lynn Stout, Law Professor at Cornell, makes the case for changing the definition of shareholder value and Peter Thiel co-founder of PayPal feels the root of the problem is a failure of imagination of corporate leaders: “The reason that big corporations aren’t using their profits to do new things is simply because they’re out of ideas, and the C.E.O.-politicians who run them are the last people we should expect to think of new ones.”
Unfortunately, the representative from the MBA world, Bruce Greenwald of the Columbia Business School, clouds the issue. He makes a few confusing statements that capital investment today “largely entails intangibles like acquiring customers, training workers and increasing product portfolios, all of which tend to be buried in operating expense….High profits with low levels of identifiable investment should be with us for the foreseeable future.” which doesn’t make sense. If companies were investing, they would either have lower profits or higher investments, not both.
What do ICountants have to contribute to the conversation? I’ll offer a few ideas and welcome more:
- Greenwald is partially right about the accounting. Investments in intangibles hit the income statement. And there is no way to track the accumulated investment in intangibles. Think about an automated process at an insurance company or a manufacturing plant. These processes are around forever but they do not exist as long-term assets. Since they are invisible, no one is held accountable for the care and building of their intangibles.
- These intangibles are the source of innovation and growth. Would investors look differently at a company if they could see this intangible infrastructure? It’s a little early to tell. One exciting new effort along these lines is the new fund at GaveKal Capital that tracks companies with strong innovation investment patterns.
- And Bill’s point is that CEO’s getting three-quarters of their compensation from stock options and stock awards aren’t thinking about investing in the future.It’s this incentive that is a big driver of the failure of leadership described by Thiel.
- But it’s too simplistic to expect that brilliant founders (or any of these factors) are the main answer. The lesson of intangible capital is that it is a holistic system. A leader can be critical in the functioning of the system. But the power is in the many individuals gathered together to create a unique set of answers to pressing problems. Complex problems needs holistic solutions.
There are some very clear calls here from people trying to change pieces of the system from the top down. Our work at Smarter-Companies is to drive change from the bottom up. I believe that if we can empower individual knowledge workers to take control of their organizations and their information, we’ll have a better shot at reversing the trend and building a more prosperous and profitable future.
In the last month or so, I’ve attended a program on Integrated Reporting and another on Integrated Thinking in New York, both organized by Skytop Strategies. Skytop has been boldly moving forward with an agenda of programs designed to bring together a diverse group of integrated thinkers in the U.S.
I’m excited that there is a growing community in the U.S. And it’s fun to compare and contrast the movement here with what I saw at the IIRC Convention in London. First of all, it’s important to note that, while the U.S. community is watching the integrated reporting movement closely, it is not following the model faithfully (not that anyone is—the idea is to allow diverse experimentation around the world). And in the U.S. it’s less about the reporting side of things. In fact, if you look at the IIRC examples database for North America, you’ll see just ten listings. To date, only Clorox and Smithfield Foods specifically call their publications “Integrated Reports.” Other companies bring integrated thinking to their traditional and/or sustainability reports. And many more (in U.S. and abroad) have their own names like net positive (King Fisher), net good (British Telecomm), total contribution (Crown Estate), shared value (Nestle) and net-works cycles (Interface). Others included core capacity, accountability, systems thinking.
So reporting is just one part of the story. (Many would say that reporting is just a catalyst to drive integrated thinking and that the thinking is the ultimate goal). In his keynote at the Skytop Integrated Thinking Symposium, Ralph Thrum framed this by talking about moving beyond the “license to operate” perspective of sustainability and CSR to a concept of thrivability and a “license to grow.” I like this because it gets to the area where I have always used these ideas: to use integrated thinking to drive growth and innovation.
My contribution was on a panel about what’s missing in existing guidance. I had laid out my position in Integrated Thinking: What's Missing that the roots of the movement really come from people trying to unite two completely different conversations—traditional and sustainability. . It was clear in both London and New York that this is still the driving dynamic. But these two are missing the internal sustainability view that takes into account the non-traditional, intangible assets that drive a company’s value creation capabilities.
It’s still early days for this movement. But I’m excited by what Skytop is doing. I met some great people and heard a lot of honest assessments by people on the frontlines striving to integrate thinking across their organizations. Skytop has lots more programs coming up including a deep dive on preparing an integrated report hosted by VMWare in January that will include a presentation by Clorox on how they developed their report.
It’s a fun and timely coincidence that a paper that I co-authored with John Dumay of Macquarie University in Sydney Australia has just come out—at the same time that John happens to be visiting in Boston.
In the paper, John and I each recount our personal journeys as IC practitioners and missionaries. We were prompted to write the paper by our discovery that we had independently progressed through several steps in the development of our thinking:
- Intuition – We both were interested in IC (the intersection between people, process, data, networks, culture and business models) long before we had vocabulary for or exposure to research on the subject.
- Control – Once we did get exposed to the concepts, our first impulse was to get our clients and collaborators to use the frameworks we had found in our research. But reality of today’s business is too complex to be captured in a one-size-fits-all framework. Neither of us had much success in imposing abstract frameworks.
- Value Creation – Eventually we each came to the realization that the only way to help people benefit from our ideas was to help them along their own learning journey and to use IC concepts as tools to help people, teams and organizations create value for themselves and their stakeholders.
The missionary analogy came to John as he was giving a talk to IC thought leaders held near the site of the famous Heidelberg Cathedral. The message was and is to stop preaching to the converted and to get out of the cathedral and into the field. To succeed as IC practitioners, therefore, we have to also be IC missionaries, spending time at the grass roots level and empowering people in a journey of self-discovery.
As we’ve caught up on each others’ work this week, we’ve been using the stages as shorthand for the attitudes and approaches we see in the market. And reminding each other that we have to keep focusing on the intersections between value creation and intangibles. Otherwise it’s all just a theoretical exercise.
Do the stages ring true to you? Where are you in your own journey? What kind of intangible capitalist are you?
Innovation Places is an especially interesting group of consultants who found themselves working together inside a large pharma company over the years. The center of focus was managing real estate portfolios. But the intersection between innovation, workplace design, network analysis, performance and culture became a bigger and bigger part of their work.
I always tell people that the one thing that unites our diverse community is the desire to “connect the dots” within organizations. In the ICountant training for this amazing crew last week, we explored some new “dots,” and deepened my understanding of the inter-relationship between tangibles and intangibles.
The crew has some amazing case studies that I’m going to make sure they share. Reach out and welcome them aboard!
I’m happy to be speaking on a panel Thursday at Skytop Strategies’ Symposium on Integrated Thinking. The panel is called Drivers of Integrated Thinking: What’s Missing from the Existing Guidance.
Sounds pretty esoteric right? Well it’s actually a hugely relevant conversation. Today, every company in the U.S. produces financial statements. And many produce some kind of sustainability statements (for the largest 250 companies in the world, the figure is over 95%). A lot of money and thought is invested in these two perspectives. But they are isolated in their own ghettos and most people have a hard time reconciling the two.
You'll see this in action if you go to a public company’s website. There is a section for investor relations where you can find the traditional financial reporting. There is usually a completely separate section for sustainability reporting (often harder to find). And there are rarely cross-links to take you, for example, from the financial to the sustainability reporting.It’s almost like alternate realities for the same company. Which makes sense on one level—the two kinds of reporting serve different purposes and have different stakeholders. But it begs the question for many—why are these two separate? And, at a deeper level, why is the thinking behind these two perspectives separate? And how can they be connected? This is the goal of integrated thinking. And for the companies taking on this challenge, it's the goal of integrated reporting.
Here’s the key point I want to bring to the discussion:
Traditional + Sustainability ≠ Integrated Reporting/Thinking
What do I mean by this? Traditional reporting/thinking is basically focused on how a company created (or not) shareholder value in past periods. Sustainability reporting/thinking is how the company created (or not) stakeholder value in past periods. But to be truly integrated, we need to ensure that a company ensures its own survival—creates corporate value—while meeting the needs of its shareholders and stakeholders. I’ve increasingly been using the phrase “sustainable value creation” to describe this, which is defined as:
Using the capitals (tangible, intangible and natural) available to a company in a way that creates value for shareholders and stakeholders today…and that also preserves/enhances the company’s ability to create value in the future.
In light of this definition, what’s missing from the various forms of guidance influencing integrated thinking? In my view, we’re missing a way for companies to take responsibility to their capitals, for building and maintaining an infrastructure that gets better every year. In our industrial past, explaining this was the job of the balance sheet. In fact, the tangible capitals on the balance sheet explained over 80% of corporate value. Today, they only explain 16%.
It’s like the instruction we receive on a plane: put your own oxygen mask on before you help others. Companies have to create value for shareholders and stakeholders in a sustainable way. And by the way, (with the exception of short-term traders) shareholders and stakeholders want that to happen too.
I look forward to discussing how to accomplish this at the Symposium!
It can be hard to understand corporate acquisitions, especially when they are as dramatic as this one. Facebook bought WhatsApp for $19 billion. Like most deals of this kind, it’s hard to judge whether the price makes sense. So I won’t try to address it specifically. But I do think that it's a great moment to talk about what drives value in companies today.
There’s clearly value in WhatsApp. Google made an earlier offer of $10 billion. Many speculate that Facebook had to buy the company to ensure that Google didn't get it.
Both companies were after the 450 million WhatsApp users. The success of all three of these companies is heavily dependent on their users. This kind of relationship capital is one of the big four categories of intangible capital, the other three being human, structural and strategic.
WhatsApp actually already has strategic capital in the form of a business model where they get paid (only a dollar and only after one year but that’s more than Facebook makes from their users). I actually like this because it puts the company in less of a dilemma than many other web companies who have to find a way to extract as much value as possible from their users without driving them away. (Another alternative would be to offer equity to users. This still sounds crazy today but I'm convinced that more inclusive financial models will come in companies with models heavily dependent on free users).
Human capital is critical to any company like this even though at 55 employees, WhatsApp is a great illustration of the leverage that can be gained from structural capital, the underlying software and data in their platform. Until recently the best discussion to my mind of this leverage was Paul Romer’s discussions of New Growth Theory. But right now I’m reading The Second Machine Age and I’m loving the authors' explanation of how the right algorithm can be replicated over and over again.
Getting the right algorithm is the holy grail of our time. It’s the starting point for everyone, including the tech giants. But none of them can succeed without all four forms of capital:
- people to develop the ideas and keep them growing (human)
- technology/processes/software to make the idea repeatable (structural)
- users and customers to co-create (relationship)
- and the right business model to ensure the sustainability and profitability of the system (strategic)
Why do we call this capital? Because they are all economic assets. I can assure you that WhatsApp spent significant sums on all of them. But the accumulated investment isn’t recorded in traditional accounting.
But most people know the assets are there. And most people deal with all these elements intuitively. And if you are a runaway success like WhatsApp, you might not need a more structured approach like we advocate with ICounting—identifying and measuring the key intangibles driving the success of an organization.
Of course, most companies don’t achieve these kinds of dramatic results. And they could use a little extra help to figure out their model and explain it to potential partners and funders.
What do you think? Does the IC perspective help shed light on these value drivers? Would IC information help the markets make better decisions (not just for mega-deals like WhatsApp but also mainstream companies)?
The signs are all around. LinkedIn’s endorsements. Social media wins and losses for companies (did you hear about JP Morgan’s Twitter debacle?). And this great comment by HubSpot founder Dharmesh Shah in Inc:
In the future, you won't just hit Ignore when you get an annoying sales call; you'll also be able to down-vote that phone number. Someday, we won't just see caller ID on our phones but also caller reputation. As new tools are developed, algorithms will do a much better job of evaluating a brand than an individual can, because algorithms will be based on thousands of data reactions.
What do all of these stories have in common? They are showing that measurement is moving from an inside-out activity (measuring using financial and quantitative indicators) to outside-in activity (measuring how stakeholders view the value you create).
At Smarter Companies, we focus most of our attention on intangible capital. That’s because this kind of asset already drives 80% of corporate value and 100% of competitive advantage of the average business today. (I shake my head every day wondering how much bigger the phenomenon has to get before people start paying attention…).
Intangible capital can and should be measured using inside-out metrics. But we focus our attention on the outside-in metrics. That’s because they are more powerful. And they are stakeholder-based. If you want to have a good leading indicator of an organization’s ability to generate growth, innovation and profit in the future, you’ll want to pay attention to whether a company is meeting its stakeholders’ needs.
It’s pretty simple on the surface. (Here’s an example of how we generate these measures). But it is ultimately revolutionary because it shifts the conversation about how to manage and build organizations. Measures that matter evaluate intangibles using stakeholder feedback. Do your measures matter?
I had the opportunity to Skype into several sessions of a wonderful program put on by SmarterCo partner Melanie Sutton of i-innovate in South Africa (including the recent closing session seen in this Facebook album)
The program was called i-mix and included students at the beginning of their careers. Melanie used the intangible capital framework to guide them on how to think holistically about developing their purpose, skills and relationships. While I was on the line, the students went around the table and shared some of the things they learned. I jotted down quick notes so these paraphrase a few of the comments but you’ll get the gist:
- I came here expecting to be given answers but realized that what IC teaches us is to explore and think for ourselves. We create the answers.
- You cannot be innovative without an environment that sparks innovation.
- Work is not a job description. It’s a team sport.
- Culture and collaboration go hand in hand. You can’t bee collaborative without a good culture.
Changing business is hard when you focus on people who have been doing things in the same way for decades. These young people can’t help but be agents of change as they go out into the workforce. Thank you Melanie!
There’s a great new study of the Chilean wine industry funded by the World Bank that shows a direct connection between the level of investment in intangible capital by wine producers and the explosive growth in Chilean wine exports (they grew at an compound annual growth rate of 9% over 20 years reaching $1.2 billion in 2010).
Here are the basics. The study shows that the great majority of both large and small producers (by number of hectares under production) spent considerable amounts in training (human capital in SmarterCo language), software (structural capital) and reputation/branding (relationship capital). Large producers also invested in global collaboration (strategic capital).
It’s interesting to note that investments in R&D are less frequent. This is important because many people tend to equate intangibles with R&D and patents. Although the spending on/use of R&D would be higher in other industries, we cannot ignore the supporting knowledge ecosystem around intellectual property.
In this graph, the IC investments (shown separately in blue, red and green—and totaled in purple) mirror the growth trajectory of the exports. The two brown lines show tangible indicators: the number of wineries and hectares under production. These, too, grew. But not as fast and not along the same trajectory as the intangibles.
The conclusions of the study included:
- Spending on intangibles is a statistically significant and economically important correlate of growth as reflected in exports, both at industry and firm levels
- Spending on reputation and branding and on learning through global collaboration…are more important of all
This study is very exciting for a number of reasons.
First, I’m heading to Chile for a week of meetings and presentations next week with our partner AKLOE. I am really excited to discuss this case with the innovation, business and academic communities in Santiago. I promise to report back on what I learn.
Second, the methodology used by Mark Dutz and his co-authors lbuilt on great work by The Conference Board, OECD and a research team in the U.K. including Jonathan Haskell that did a primary research project on intangibles spending a few years ago. Connecting these dots is important. I expect that we have the start of a powerful approach.
Third, I’m especially excited about the work because it looks at the actual spending on intangibles, something I’ve been advocating for years (see Ch 7 about i-capex in Intangible Capital). Measuring i-capex a simple and powerful way to begin to measure intangibles in a reliable fashion. I strongly believe that this will someday be standard practice. It just makes too much sense to not end up in the standard financial package.
Finally, they worked to also incorporate concepts of risk. This is an important part of the intangibles story that we all need to spend more time on. Awareness of intangibles as assets is growing. How to express/measure the liabilities is still less studied. At SmarterCo, we’re doing this by focusing on the relative strength/weakness of individual intangibles. But we all have a lot more work to do.
In Chile, we’ll also be training a new crop of ICountants. With this great example in their own backyard, maybe our colleagues there will break new ground for our field!
When I have made plane reservations for my college student sons over the past few years, they never insisted on an airline but they always thanked me profusely when I booked them on JetBlue.
That may be changing. The company made the announcement on Wednesday of a number of changes:
NEW YORK, NY -- (Marketwired) -- 11/19/14 -- JetBlue Airways (NASDAQ: JBLU) today outlined a long-term plan to drive shareholder returns through new and existing initiatives aimed at enhancing the Company's product advantage and service-oriented culture while delivering improved financial results. The revenue initiatives are expected to collectively generate more than $400 million in annual operating income on a run rate basis beginning in 2017…
Robin Hayes, JetBlue's President, said, "We believe the plan laid out today benefits our three key stakeholders. It delivers improved, sustainable profitability for our investors, the best travel experience for our customers and ensures a strong, healthy company for our Crewmembers. As we focus on executing this plan, JetBlue's core mission to Inspire Humanity and its differentiated model of serving underserved customers remain unchanged."...
The press release went on to outline changes that included reducing leg room in new planes, ending free bags for some fare categories, charging for wi-fi, and creating more premium class offerings. That’s inspiring to Wall St. but not to “Humanity.” Hayes would have been better to have left out that last sentence. The only thing worse than not having a purpose is pretending to have one.
What will my sons and many other consumers think of these changes? That JetBlue is putting short-term shareholder interests over long-term stakeholder interests. And remember that it is stakeholders--customers, employees and partners--who determine what kind of value the company creates over time. The press release says that they are looking to the long term but they're assuming that stakeholders are passive servants to the shareholders' interests. Don't bet on it.
The profit calculation is incomplete without a calculation of what a change like this will mean to the JetBlue’s intangible capital including reputation and brand. It should. Because intangibles are longer lasting assets than any airplane or luggage cart—unless you fail to take care of them. The accountants project $400 million in profit. What they need is an ICountant to help them figure out the loss in future revenues caused by its decline in brand equity. The only way to counteract Wall St’s short-term myopia is with solid data and communication about long-term value.
Who’s looking out for JetBlue’s intangible capital? Not the team that made this decision.
We spend a lot of time in this community talking about how to make companies smarter and more successful. But a few weeks ago, I realized that we have never really defined what we mean by "smarter companies." The answers are complex and rich and something we all need to continue to define.
But as I thought about it, I came down to three key characteristics that shine through:
Intangibles Focus – Knowledge intangibles are at the core of how value is created in today’s economy. This includes the knowledge in peoples’ heads and in re-usable forms (process, software, data, designs, etc.). Companies that recognize the growing importance of knowledge in these many forms have moved beyond industrial-era approaches to management and measurement so they can focus on the knowledge that can give them a competitive advantage.
Sense of Purpose – Access to and use of knowledge is a collaborative, collective effort. The amount of knowledge available to an organization—and the value it can create—is directly related to its ability to attract employees, partners and customers who share its mission. Purpose involves elements of both profit and prosperity. Companies that recognize the relationship between attraction and collaboration embed this purpose in what they do, how they do it, and how they tell their story.
Social Measurement – Traditional financial and quantitative approaches fall short in measuring the strength and performance of knowledge, collaboration and innovation. The use of social, qualitative measures is on the rise. It’s already used commonly for knowledge products like books, services like hotels and restaurants, and even for employers. Companies that recognize the importance of intangibles, attraction and collaboration spend time listening from the outside-in, not just measuring from the inside-out. They are turning measurement into a collaborative, social process.
Does this list speak to you? I welcome your feedback!
Maybe it’s just a coincidence but I received two messages today. One from a contact here in the Boston area. And another from Europe. I thought I would share the questions and my answers as a way to start a conversation about intangibles, intangibles measurement and “hard” business results. I would love to hear your thoughts....
Question 1: Is there any evidence that evaluators consider seriously the findings of an intangibles assessment in acquisitions or buying of shares? Can a company expect to benefit from having an intangibles assessment when talking to investors?
My answer: The evidence comes from what moves markets. Changes in financials move markets. But so do changes in management, company partnerships, failures of process, performance problems, lack of innovation. If a company wants to be judged just on the basis of its financials, then it should let the financials speak for themselves.
If there is an interest in telling a richer story, then a team has two choices: talk about the company or provide data about how and why the financials turn out the way they do. Our ICounts products, for example, provide hard third-party data about the performance of the kinds of changes described above. It's about controlling the conversation.
Question 2: What are the best stats (and supporting source reference) to support the following:
- % impact that ‘employee engagement’ has on profitability
- % impact that ‘employee diversity’ has on profitability
- % impact that ‘employee absenteeism’ has on profitability
- % impact that 'customer satisfaction' has on profitability (or any impact on anything)
- % impact that ‘sustainable investment’ has on investment return
- % impact that 'best practice' as demo’d by public companies v private companies has on profit performance
- % impact that managing environmental and natural resource intensity has on profitability
- % impact that doing sustainability reports (CSR) has on profitability
Answer: We don't know the answers. But we also don't know that answer to questions like:
- % impact that "having a good CPA" has on profitability
- % impact of "accurate financials" has on profitability
- % impact of "well-run company" has on profitability
Companies are actually complex systems. Questions like this are hard to answer whether you are talking about any aspect of their operations. This is why I advocate an approach that starts with creating a map of the system the company has built to deliver on its value proposition and purpose. For me, the more important questions are:
- How does the company generate/drive revenues and profits?
- How strong are each of these drivers today?
- What's important to the stakeholders (customers, partners, employees) who control whether the company succeeds or not?
Ultimately, the answers to these questions will explain the impact of intangibles on the overall system driving profitability.
What do you think? Did I do the subject justice? What's missing? What’s your answer?
Here in New England, a corporate drama is unfolding that illustrates so many of the core ideas that we hold in the ICounting/IC community.
The drama involves a family-owned supermarket chain called Market Basket. There’s a long story of conflict between two sides of the family: one that controls 51% of the company and the other that controls 49%. The long-time CEO Arthur T. Demoulas is from the minority shareholder group and was forced out by the majority group. There are primers on the situation at BostonGlobe.com and News for Shoppers (the photo is from their post).
What happened then? There was a stakeholder revolt that is showing the direct connection between intangible capital and financial results. Here’s the play-by-play using an IC scorecard.
Human Capital – The company had a reputation of taking care of its people and there was a general feeling that this would end with the departure of Arthur T. Many of the employees took a stand and said they wouldn’t work for the company if he was fired. They walked off the job and picketed in front of the stores. They called for suppliers and customers to do the same. The fact that key personnel in the distribution centers walked off the job ensured that the shelves were empty anyway.
Relationship Capital – Market Basket customers have a reputation of being very loyal to the company as well. It manages to have low prices and provides selection (especially of ethnic foods) not to be found elsewhere. With empty shelves and all the bad publicity, the customers are staying away. Volume is next to non-existent in the stores. Customers have taken their business elsewhere. Suppliers are getting hurt too.
Strategic Capital - The culture, the vision and the business model were apparent to all the stakeholders, except maybe the majority shareholders. Their position was a clear message to the market that values and practices were going to change.
The fourth category of IC is Structural Capital. It’s unclear if/how this is affected by the battle. In theory, the systems and the data are intact. That’s because this is the one kind of intangible that is clearly owned and controlled by the company. But, of course, it and the stores themselves are no guarantee of success.
Only Structural Capital is owned by the company. The other three forms of capital are volunteered and co-created by the employees, customers and suppliers. What attracts these stakeholders? Yes, there’s money involved but there is also a sense of shared values, shared knowledge and purpose.
Because companies have a certain amount of control and power in these relationships, many managers and shareholders take them for granted. In interviews, it’s clear that the employees feel that they are fighting against a style of management that would devalue their contribution going forward. In one interview I heard on the radio yesterday, a 40-year veteran of the company said that it was time to stand up to the kind of short-term management encouraged by Wall St.
And that’s where the story stands today. The company has given employees until Monday to return to work. No matter what happens, it’s clear that an enormous amount of financial, tangible and intangible value has been lost. The intangibles are directly connected to the ability of the company to produce revenues and profits going forward.
In and a wonderful editorial by MIT Prof Thomas Kochan at WBUR Cognoscenti, he puts out the call:
It is time to teach the next generation of managers how to lead companies in ways that better balance and integrate the interests of all stakeholders — owners and executives, middle managers who might someday lead the organization, front line employees who are the face of the company to customers, and customers and communities that support the business
Short term profits and long term value are generated through the will of the stakeholders, including employees, customers, suppliers and the community. These relationships are the most significant asset any company owns today. And failure to steward these assets destroys profits and value. That's why smarter companies pay attention to their intangibles.
Would the majority shareholders have made a different decision if their Accountants were also ICountants and were showing them the full capital picture of Market Basket? Hard to say. But I share Dr. Kochan's view. There's a lot to learn here. And it’s time to use measures that matter.
It focuses on the secondary market for high end Nike sneakers. The company has a clear pattern of pre-launch hype and limited release. This ensures quick sell-out of a line. It also creates an opportunity for those who buy and the re-sell the sneakers. Here’s a fun graph from the post that shows how this market’s pricing patterns mimic the Nike swoosh. The post ventures an estimate of the total profits from this post-sale trade:
….This suggests that resellers made $240 million last year, all but $10 million of it on Nike products. That $230 million is equivalent to 8.5 percent of Nike’s earnings in fiscal 2014. Knowing how difficult it is for a large company like Nike to add even 1 percentage point to its bottom line, Luber said, this isn’t a number to ignore.
So why doesn't Nike get greedy and try to capture more of this value for themselves? In contrast with JetBlue who made the decision last week to trade brand for cash flow, Nike presumably understands that this market creates a lot of buzz and demand for Nike’s product. Nike couldn’t sell at the kind of prices sometimes collected by traders. But they do get a brand boost from such passionate fans.
This is just another example of the intangible capital calculations that companies make every day. It's not always as clear as this one. In this case, Nike hasn't spoken about this publicly but the company seems to have someone who functions as an internal ICountantTM of sorts who can provide a counter-balance to the pure accounting view that dominates a lot of business decisions.
Here's a good explanation of ICountants.
Over the decade or so that I have been focused on intangible capital, there has been a parallel conversation going on about sustainability. These are two broad fields with many players and approaches but I’ll try to generalize the two (excuse the shorthand versions):
- Intangible Capital – also known as IC, Intellectual Capital, Innovation Capital, Digital Capital – Focused on the changes in the core operating assets of organizations that have occurred as we move from an industrial to an IT-fueled, knowledge-based economy.
- Sustainability – also known as ESG (Environmental, Social and Governance) and Triple Bottom Line (People, Profits, Planet) – Focused on the fact that the industrial approach of not considering the human, societal and environmental effects of corporate actions are endangering our collective future.
Both conversations are about the path to prosperity—measured in both financial and nonfinancial ways. But there hasn’t been too much attempt to unite the two views. One notable exception is the IIRC (International Integrated Reporting Council).
I admit that I resisted the IIRC approach for a long time. For one thing, we at Smarter Companies have been more focused on innovation and value creation than on corporate reporting, which appears to be the IIRC’s primary focus. And I feared that combined the two made it harder to tell the stories of each of these different fields of study—mixing apples and oranges. It’s kind of ironic because I have often talked about the new design constraints for modern businesses (many of which were related to environmental and social concerns), but I wasn’t able to make that connection. But I’ve increasingly seen the need to find a way to talk about the connection between our mission and that of my colleagues interested in sustainability, especially because IC is about the gift of new knowledge resources that we humans have been given at the moment we need them most. IT and IC hold the key to greater sustainability.
In December, the IIRC released their latest framework document. The framework is written in a purposely vague way as the intention is to start a conversation rather than legislate a solution (an approach I agree with). What spoke to me most in the report was this diagram explaining how organizations create value using what they call the “Six Capitals” (with my overlay of the IC knowledge factory):
I think this graphic does provide a framework for integrated thinking about corporate value creation that includes both IC and sustainability thinking. And it’s given me a way to talk with colleagues about the intersection between our respective work.
At Smarter Companies, we focus on three of the six capitals: Human, Relationship and Intellectual (which we call Structural Capital—read here to see why we avoid the word intellectual). We use an additional category we call Strategic Capital that actually corresponds really well to their central box with business model, external environment and culture. These four categories make up what we call the “Knowledge Factory” in the book Intangible Capital.
The Knowledge Factory is how organizations use Manufactured Capital and generate Financial Capital. It’s also how organizations build or destroy Natural Capital. So all of the capitals are important and contribute an integrated whole. So I say good for the IIRC for trying to get us all to think holistically. Maybe this is a base we can all build upon.
What do you think? Is there a convergence here that will help us advance both fields?
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