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Late last week on Twitter, Harold Jarche commented on a post by Jay Deragon saying:

McKinsey gets intangible capital wrong http://t.co/P0CUdpCgbb I would follow the money to find out why ;)

— Harold Jarche (@hjarche) August 8, 2013

Follow the money? It’s a line of thinking that I’m usually too polite to follow but I think Harold’s right, it's time to give it a try...

Following the money ends up showing how the momentum of the status quo yields considerable profits for many advisors but ends up holding back individual companies and our entire economy. The status quo is that intangibles are considered to be undefined and unknowable.

Yet nothing could be further from the truth. The data are very clear.  Investment in intangibles. has outpaced investment in tangibles for over 20 years. You can’t get better data than hard dollars invested. But accounting doesn’t track the investment so competencies, data, processes, networks and new business models exist outside the balance sheet. All this has led to a situation where 80% of corporate value is now intangible. That means that most of the value created using computers, the internet and social technologies exists completely outside of traditional accounting and management information systems.

All your advisors and partners and colleagues are smart people. Yet they see these same facts and usually choose to ignore them. Why? Well, change is hard and if you follow the money, you’ll see that there is profit in the status quo:

• Accountants can charge for lots of analysis of “intangibles” that have to be re-valued every year
• Bankers can charge more for lending to “higher-risk” companies with fewer “assets”
• Investors can control the valuation of your company because value drivers are considered subjective and “intangible”
• Analysts can profit from information asymmetries caused by the 80% intangible information gap
• Consultants can charge for custom diagnoses of intangibles
• And a lot of managers feel that they earn their pay by making sense of all this for their companies

If you ask any of these advisors about the importance of intangible capital in your business, they’ll all nod their heads. But when it comes time to “get serious” about the discussion, they opt to return to the tried and true tools of business. Financial statements. Org charts. Valuations. Competitive strategy. The lip service to the “soft stuff” ends. Big boys focus on what they call the hard side of business.

What they don’t know or choose to ignore is that there is a whole body of work developed over the last 20 years about how to measure, manage and monetize intangibles. At Smarter-Companies we have open source tools to identify intangibles and a proprietary platform that uses stakeholder feedback to measure intangibles. Yes, stakeholder feedback. Rather than asking you to rely on their individual (albeit informed) judgment, our ICountants will help you open up the lines of communications with the people who know your organization best. There’s nothing soft about the data generated by an ICountant. And its use is threatening to traditional advisors who currently control the definition and measurement of your core strategic assets.

By the way, an ICountant charges $5 to $20,000 for a standard assessment of intangibles where McKinsey charges anywhere from $100,000 to $1 million for a custom assessment. If what we say is right, players like McKinsey are going to have to up their game. For now, though, they are going to protect what they have. What consultants and advisors like McKinsey have for now is control. They get paid to tell you what’s really going on in your company. And as long as what’s going on remains “intangible” and undefined, then they make more money.

So there’s your choice. Pay up to the big boys and their chosen set of hard data. Or get a new set of hard data about the intangibles driving your success. It’s up to you. To learn more about your own intangible capital and the value creation it offers your organization, visit us at www.smarter-companies.com . We’ll help you take control of your money and your information.

Jay Deragon pointed out yesterday an interview with Eric Schmidt, executive chairman of Google about disruptive technologies. He opens by saying:

We’re going, in a single lifetime, from a small elite having access to information to essentially everyone in the world having access to all of the world’s information....It changes education. It changes the way intellectual property works, it changes the way businesses work, it changes the way the media works, on and on and on. We’re in the middle of that right now.

The story of intangible capital is wrapped up in this shift. Organizations have to be run differently as information, knowledge and connections multiply. The result will be an enormous wave of innovation unlike anything even that of the Industrial Revolution.

But this new world can be overwhelming and seemingly complex on the ground. Managers today lack basic tools to see the forest for the trees. We see ICounting as a simple way to begin to make sense of the rich potential of the intangible capital created by "everyone in the world having access to all of the world's information."

ICounts tools are a simple path to identifying and measuring the value created by organizations as they build offerings on top of this ubiquitous and powerful information flow. Now, more than ever, teams need a balance sheet to tell them what they have and what they can do with it.

Strategic capital is a critical element of Intangible capital. It can be both an asset and a liability--it all depends on how stakeholders view the performance of your strategic capital.

The strategic capital is how you put the other elements of your intangible capital to work. You can have great people, great systems and processes, great partners—but without the right strategic capital, you have no reason for being.

It all begins with a clear definition of the purpose of your business. Your value proposition needs to make sense when compared with your stakeholders’ needs and the knowledge and resources necessary to meet those needs. To get it right, you need knowledge of your market, your business opportunity and the business model you create to take advantage of that opportunity. And, maybe most importantly, you need to have a culture that serves as the guiding force behind decisions made across your organization.

The right strategy is an asset. This includes knowing what customers you want to serve, how you will serve them, with what products and services, at what prices and how you will attract them, service them and build lasting relations with them. It also involves attracting the right human capital, partners and other resources necessary to fulfill your stated purpose.

The core focus of strategic capital must be, “Do we have the right resources to deliver on our strategy?” These resources include:

1. Human capital that connects with your value proposition and is equipped to deliver on it
2. Structural capital (processes, systems, knowledge) that support your value proposition.
3. Relationship capital including customers at the core of your value proposition and partners who support your ability to deliver.

Intangible capital is a system of moving parts and no one part operates without the other in terms of creating value for the entire organization and all its stakeholders. Strategic capital is a critical part of this system and, like each intangible capital element, can be measured and monitored. Without having a measure and the ability to monitor the progress it is like steering a boat across the ocean with no navigational equipment.

The ICounts Graphs tell the story of a company in a succinct way. Here’s the story of what one company discovered through this assessment process (see note below).

Profile: Software and services company in the healthcare space

Why they undertook the assessment: The company had grown consistently over its ten-year history. But growth had stalled and they had just been turned down for a new credit line. They wanted to jumpstart growth in a way that would build long-term value. They also wanted to be able to tell their story to external financial players (banks, investors, acquirers)

ICounts Graphs assessment: The Graphs process started by identifying the core intangible capital with which the company creates value for its customers—and generates revenue and profits. Then each IC element was measured via interviews with stakeholders, including management, employees, customers, suppliers and external experts. The findings were delivered in a detailed report including rating data as well as stakeholder comments.

What the external view told them: The external view was really exciting for this team. There had been little staff turnover during the ten years since founding with the original team augmented by strategic hires over time. To have such high above-average scores validated a lot of their hard work. But how to leverage this going forward?

What the internal view told them: The internal view made it clear that their software was by far their greatest strength, a wonderful foundation for future growth. But the processes for marketing and selling the software were inconsistent and uneven, leading to a weak brand. They were also held back by weak external partnerships. In an industry where a hospital may have up to 50 software packages running from different vendors, inability of a software company to partner can be an issue.

What the action view told them: The action view led to several key initiatives: a new website, reorganization of the sales team, a new high-end service offering to co-innovate with key clients around their emerging challenges and the creation of a project management offering (enabling the company to charge for its improved project management processes).

Results: Over the next two years, using their internal resources and selective external help, the company grew by 27%. They also used the Graphs report to help them get multiple offers from banks for their first credit line. They continue to build the value and success of the company.

Using a tool like the Graphs helps tell the whole story of a company in a simple but integrated way--and to use the information as a focus for future action. It gives a holistic view that’s hard to get with other traditional management and measurement tools. What's the whole story of your company?

For more information, read the papers at Optimizing Intangibles or read about the ICounts Graphs.

Note: These are profiles and results of real companies. The names and certain characteristics have been changed to protect the identify of the company and to ensure that no confidential client information is revealed.

Relationship Capital is one of the four cornerstones of intangible capital. It can be both an asset and/or a liability depending on how stakeholders view the performance of your relationship capital.

This includes all kinds of relationships with customers, partners, suppliers, community, government, media, institutions, groups and people who have an interest in the success of your organization. All these interactions involve the sharing of knowledge, the solving of problems and the creation of connections--and the creation of brand and reputation. If it works, you’re creating value. If it doesn’t work, you’re destroying value. Here are some examples:

• If you have poor customer service you are hurting your relationship capital
• If your marketing message is unclear and not attracting the right audience you are not building relationship capital
• If your suppliers are irresponsible, you are harming your relationship capital with your community and customers
• If you treat your suppliers as “low price” providers rather than long-term partners, you are hurting your relationship capital
• If you violate the trust of your stakeholders, your reputation suffers and decreases your reserve of relationship capital.

None of this is particularly new. Businesses have always existed to serve customers (Drucker said that is the main purpose of a business). But the stakes are higher now. And the connections are faster and, many times, tighter than they used to be. Real-time communications mean that customers are often directly wired into your business. So are suppliers with just-in-time inventory fulfillment. And the ability to connect directly with suppliers makes it easier to outsource elements of your business that, in the past, might have stayed inside your own operation. This trend brings with it great flexibility and access to expertise. But it has big management challenges.

Indeed, real-time communications have another implication. Since the exponential uptake of social networking, the ability to assess the quality and trustworthiness of an organization has become transparent. Bad behavior is harder to hide. And companies don’t just get blamed for their own behavior, they are (rightly) held accountable for the behavior of their partners. This means that external relationship management is as important as the management of internal operations.

External relationships are one of the key drivers of wealth creation. Relationships can be evaluated as assets, no less important than physical assets or bank accounts. In ICounting, we measure the strength of relationship capital as an asset. And we also see external stakeholders as key partners (along with internal stakeholders) in performing those measurements. After all, who knows better than your stakeholders how you are doing?

This is a different perspective from traditional financial-based systems. Your Accountant can tell you whether you have profited in the past from your relationships. Intangible capital measurement can help you see whether you will be able to sustainably profit in the future.

One of the very basic tenets of accounting is that you only show as assets those things that you own. It’s completely obvious and sensible. That tenet will never change. Nor should it.

But this is one of the tenets that makes it hard to rely on accounting alone to understand how organizations work in today’s world. Because what defines a company or an organization today is not really what you own. It’s about what you attract. Can you attract the right people, the right partners, the right customers to collaborate and contribute to your mission and your business model? Will these people contribute their ideas and knowledge to support that mission? Are they engaged and do they trust you enough to share their best ideas? Will they help you build a better organization going into the future?

These relationships are assets but not the kind you own. That’s where ICounting comes in. ICounting identifies the key assets (both owned and volunteered) that an organization can count on to fulfill its mission. How does an ICountant know that an intangible is an asset that the organization can count on? By measuring them in the right way—going right to the source and asking the stakeholders themselves. If you identify all the key intangible capital assets connected to an organization and if the stakeholders say that those assets are a positive contribution to meeting their needs, then you have one of the best measures you can get. Stakeholder satisfaction today tells you much more about next year’s profits than last year’s profits do.

Figure out all the intangibles you need to keep your stakeholders satisfied and you’ll have the best kind of asset inventory. You’ll understand which assets are driving your results.

For more on this idea, check out our new paper, Do You Know Which Intangibles Drive Your Organization’s Results?

Words matter.

They shape our thinking and shape our conversations.

Here are some really common conversations I have with new business acquaintances:

I ask what they do. They ask what I do. I say (of course!) that I work with intangible capital. Some people ask what I mean by that. Most immediately add their own mental interpretation of what I mean by “intangible capital:”

…If they work mostly with the law (and sometime technology), they say, “Oh, like intellectual property!”

…If they are accountants or financial types, they say skeptically, “Oh, like Goodwill…”

…If they are bankers, they might say, “Oh, like intangible assets? We don’t lend on them.”

…If they are in marketing, they say, “Oh, you mean brand and reputation!”

…Many business people say, “Oh intellectual capital, that’s tied closely to people…”

And so on. The point is that it can be hard to talk about intangible capital when people bring so many preconceptions to the conversation. That’s why we often use the Blind Men and the Elephant example. In this poem, each blind man feels a part of the elephant and makes an assumption about what the whole elephant looks like. That’s what happens with intangibles. Most people are trained to just look at one part and they miss the significant of the whole.

And the whole is really important. 80% of the value of the average business today is intangible and yet mainstream business continues to dismiss intangibles as soft and/or unknowable. I guess I really don’t care what word people use but I do hope that people will develop a holistic understanding of intangible capital.

...It’s not just IP. It’s not just people. It’s not just knowledge or data. It’s not just brands or relationships. It’s not just culture.

...It’s all these things working together in a dynamic, social system. Intangible capital requires holistic thinking and holistic management. And it works best when there is a shared understanding of collaborative advantage.

Good intangible capital management fuels growth, innovation and performance. Don’t be a blind man (or woman). Start looking at the big picture before the elephant stomps all over you.

This drawing was done by Collective Next in Boston.

There is a clear and succinct post at WSJ I recommend called Shift to Valuations, Estimates Challenges Auditors  that talks about the challenges auditors face in their evaluation of corporate financial statements. Emily Chanson summarizes a speech by Jay Hanson of the Public Company Accounting Oversight Board (PCAOB):

estimates and measurements are one of the most frequently identified trouble spots by the U.S. auditor watchdog, as managers and accountants have to spend more time focusing on the fair value of financial instruments, goodwill impairments and intangible assets in the new economy.

I had this same discussion a number of times over the years with my father. He was a CPA and CIA (Certified Internal Auditor, a little more settled than the espionage types). In the first half of his career he was an auditor at Exxon then was an independent auditor with his own practice and ultimately served one term as the State Auditor of New Mexico. He’s gone now but he and I used to have long conversations about changing financial standards and the challenges that intangibles create for accountants.

You see, accounting has the unenviable challenge of applying a tool set designed for the tangible economy to the rapidly-changing and radically-different intangible economy. These standards favor tangible assets and generally recognize spending on intangible assets as operating expenses. This approach has failed to measure or capture the enormous value in the knowledge, ideas and connections that companies have been able to build using information technology and the internet over the last 30 years. These intangible knowledge and collaboration assets are the key drivers of revenues and profits in almost every company today. But since they exist outside the balance sheet, the tangible net worth of the average public company in the U.S. is equal to just 20% of its total corporate value. The rest is., well, intangible and generally not well-understood.

The accounting profession is trying to adapt to this changing world by focusing more intensely on fair value rather than historic costs. But the truth is that accounting (as it is conceived today) will never be able to fully account for many of the intangibles in a business. Many intangibles like people, relationships and culture are not owned assets that can be isolated and quantified on a balance sheet. But they are critical to the competitive (and collaborative) advantage of every company.

This is why we are advocating the promulgation of ICounting. It is a separate skill set that is complementary to Accounting. It is less worried about resources that are owned and controlled and more about resources that are available and connected to an enterprise. Accounting uses financial transactions as a way of measuring financial health and success of an organization. ICounting uses value transactions (the exchange of knowledge, trust and solutions) as a way to understand the health and success f an organization. Each has its place.

Mr. Hanson explains that the PCAOB finds that

auditors fail to check the reasonableness of management assumptions, don’t weigh valuation risk properly, and don’t appropriately consider positive and contradictory evidence in evaluating estimates

How to check "reasonableness and risk," how to "evaluate estimates" in today’s business without understanding the intangibles? Even the Accountants will have to learn ICounting.

On the closing day of Sibos, the Innotribe team and I lead an exercise to introduce the bankers in the room to the basic ideas around ICounting. It was really fun to work with Mariela Atanassova with staging some of our core exercises for this audience. Thanks Mela!

I opened with a few slides about the growth of intangibles. Since we had limited time, I used data from the U.S. but with such an international audience, I promised that I would share some data on investment patterns in other countries. Here’s the link I promised to the intangibles data available from the economists at the Conference Board (thank goodness for them or we wouldn’t have any data on this very important trend).

We anchored the discussion by talking about how in accounting, we take an inventory, classify and measure all the assets of a company. ICounting follows the same path but the focus is on intangible capital.

Then we got into it. We divided the group into groups that looked at PowerBank, a traditional bricks and mortar institution, and Mew Bank, a web-based upstart. Using our open source ICounts tools, the teams created simple inventories of the intangibles of each. Then we explored how to measure these intangibles, especially focusing on the concepts of stakeholder assessment, which is one of the root concepts of ICounting. At Smarter-Companies we posit that outside-in measurement is more important and more powerful than inside-out metrics and financials that business traditionally uses.

The Innotribe team created a series of fun media that had a sample of traditional and social media items about the two organizations. We talked about how these affected the reputation of the banks and explored the question of whether it was enough to just react to what happens in the media. ICounting is a way of getting ahead of this kind of reactive approach—to proactively know what your intangibles are and how well they are performing.

One of the comments that I loved was that many of the emerging topics in SWIFT start in Innotribe and move to the main sessions over the period of several years. Let’s hope that’s the case with intangibles!

Soon after, we had the closing session around a modern-day campfire of glowing globes. The words used by participants talking about their experiences included trust, humans, transparency, personalization, shared values. Interesting language from a bunch of bankers. They also talked about disruption and change. We hope that ICounting will help them think proactively about how to deal with these changes.

I’m a little obsessed about the untapped intangible capital inside organizations. This IC represents potential growth, innovation and the prosperity we crave for our communities. But it often lies fallow because management and even the employees themselves fail to understand their collective power.

That’s why I started a blog named Smarter Companies back in 2008 and why I chose the name for the new company I launched in January of 2013. Why Smarter Companies? Because I have seen first hand the power that is unleashed: When organizations see their knowledge and connections as assets. When organizations support sharing and learning and collaborating inside and outside the walls of their org.

There is a huge need for innovation and change inside companies today. If we are going to do something about it, the first step has to be really practical. That’s why we are offering a number of tools (most of them open source) to answer simple questions:

• How important are intangibles to the future of your organization?
• What are your unique intangibles?
• How do they combine to create value for your customers and stakeholders?
• How well does this system work? Where are the opportunities for improvement and monetization?

These are the basic questions that an organization needs to get started with the task of managing for maximum intangible value—and to become a smarter company.

Hope you will visit our site, check out the community, the tools, the marketplace and join our mission to make every company as smarter company.

Accounting has roots that go back 500 years to Columbus-era Venice when local  merchants built global businesses and needed ways of keeping track of their financial transactions. This system worked well over the following centuries even as the global economy changed dramatically through industrialization. That’s because it is a system to track financial transactions. The system works really well for arms-length purchase and sale of tangible assets.

This system helped measure the financial health and success of an organization. But in today’s economy, accounting is facing some real challenges. A lot of the value created in and by an organization happens outside the view of the accounting system. In order to understand the health and success of an organization today, you need to look beyond the assets captured in the accounting system.

Workers thinking, processes improved, problems solved, lines of code written, designs drawn, relationships created, worker motivated—all of these exist in the accounting system only as operating expenses, here today and gone tomorrow. That’s the problem. Because what’s happening inside companies today leaves behind a footprint, a lasting value, a renewable and, most importantly a re-usable resource. Human capital, relationship capital, structural capital (knowledge, processes, designs, etc) and strategic capital are all long-lived assets that are the infrastructure driving the financial success of companies today.

ICounting is based on the principle that the knowledge and data and processes and relationships you form in your work have a lasting value. Rather than relying on financial transactions, ICounting looks at the value created by the exchange of knowledge and solutions. And the long-term infrastructure that gets left behind in the form of competencies, processes, data, networks, designs and trust. If you want to understand the health and success of an organization, you’ll need to understand these “intangibles.” And to do that, you’ll need to find an ICountant. Or to become an ICountant. For more information, visit the ICounts section of our website.

I have to confess that I have been surprised by the depth of the reaction to the latest changes in the GDP calculations which count R&D and creative works as investments with lasting value rather than current expenses that don't last. 

This is something that has been in the works for years. Back in 2006, the NY Times explained that the BEA had begun to experiment with the idea of adding intangibles like R&D to GDP calculations.  And Michael Mandel contributed thoughtfully to the discussion a few years later as the Economics Editor of Business Week. Then it was formally announced as a test in the BEA satellite accounts in 2010. The change is about R&D and creative properties which are actually among the most mainstream and well-understood intangibles. Overall the changes add roughly 3% to GDP which is the equivalent, as Credit Suisse describes it, of adding another New Jersey to the economy. It's significant but not that significant.

So I didn’t expect to have many people notice when they flipped the switch. I was wrong. And I’m happy to be wrong.

The official roll out of the new changes has been covered by the New York Times, Bloomberg, Financial Times  and McKinsey (here’s my response to their paper) which is more than an intangibles issue has maybe ever gotten. Smarter-Companies bloggers Ken Jarboe, Bill Miller, and Jay Deragon have all added to the conversation.

Is the reaction about these particular changes? I don't think so. I think the reaction is a bell weather of something more. It’s the growing unease with the failure of mainstream information sources (national and business accounting as well as traditional management tools) to keep up with the changes in our economy. I’ve been very pleased with the coverage as writers have acknowledged that this is just the tip of an iceberg of change.

In fact, the intangibles story is actually much, much bigger than this change implies. Spending in the U.S. on intangibles began exceeding spending on tangibles over 20 years ago (see the graph halfway down the page). In financial (rather than national accounting terms), roughly 80% of corporate value today is intangible.

My bottom line? We need to be supportive of the institutionalization of new information and practices. R&D and creative properties are just the beginning. Other kinds of intangibles that should eventually be measured include data, processes, networks. The example I always like to use is Federal Express. Even though it has enormous investments in tangible assets, its core competitive advantage comes from the system it has created for planning, coordinating, tracking and optimizing the movement of packages. This system is a more valuable and longer-lived asset than any of its planes or trucks or sorting equipment. But we are years (probably decades) away from being able to measure this asset in traditional frameworks like GDP or even financial accounting..

But we don’t need economic (or accounting) record-keepers to tell us what we already know: that tangible assets are basically commodities. Intangibles are the source of competitive advantage in today’s world. So if you want to grow your business, improve performance and/or get paid for the intangible value you create, you'll need to get better at measuring and managing intangibles right now. That’s why we have started a movement for ICounting.

ICounting includes open source tools to inventory, illustrate and model the workings of the unique intangibles of an organization. Give them a try. Join the conversation. Change the global conversation. Intangibles aren’t going away and the future of your company and our economies depend on them. Get started by counting all your intangibles now.

I’ve been active in the field of intangible capital for many years. So I had a flurry of emails in my inbox this week from colleagues making sure that I saw your new report Measuring the Full Impact of Digital Capital. Since you don’t invite comments on line, I am emailing this to you and also publishing it in my blog.

First of all, thank you for joining the conversation about intangibles. I agree with your subtitle, “Although largely uncounted, intangible digital assets may hold an important key to understanding competition and growth in the Internet era,” except that I wouldn’t include the “may.” Knowledge and collaboration are the raw material with which we can solve our global challenges and create greater prosperity and well being. Intangibles are changing our economy and our lives.

But please know that by entering the conversation, you are taking on a responsibility. There is a need for collaboration at every level of our economy to come up with ways of helping businesses and organizations see, measure and manage their intangibles more effectively. To pull this off, we all need to be working together. Given your stature in the international business community, you can make a powerful contribution to the conversation. But it may require you to think a little differently. (In case you need a few ideas on how to do this, I have a few suggestions:)

Use or acknowledge the vocabulary that is used by others – It the short run, it may feel like it is in your interest to try to create a new name (digital capital) for intangibles. But it also makes it hard for your work to contribute to the foundation of a lot of good thinking that has gone on to date in the fields of intellectual/intangible capital and knowledge management, among others. Creating a new vocabulary ends up closing, rather than opening conversations.

Be more transparent about how you calculate your numbers – The research you cite (such as The Conference Board data) does not identify digital capital as a category so it’s hard to understand how you came up with your numbers. There have been too many black box solutions in this space. This, too, closes rather than opens conversations.

Take a leap and be honest about the control issue – One of the key differences between tangible and intangible assets is the fact that most intangibles (especially digital assets) are not subject to the same economics as tangibles. This is not the 1950’s and organizations are not (or should not) be run exclusively by white men in white shirts giving orders from corporate headquarters. Intangibles are not controlled but, rather, they are attracted. A lot of the kinds of data that you talk about in your paper (such as user, behavioral and social media data) are provided through the consent of the user. That consent is earned through trust and can be withdrawn. The good news is that the marginal cost to use digital assets is generally low so the profits for responsible, productive use can be quite high.

Help your clients think holistically – The control issue is one of the reasons why it is dangerous to look at intangibles in isolation. To use your vocabulary, good digital capital only exists as long as there are users, customers, partners and employees contributing to it every day. And it only has value if there is a valid business model paired with a compelling value proposition. So talking about digital capital without talking about the ecosystem around it can be dangerous. The framework in use by most in the IC community for describing that ecosystem includes human, strategic, structural and relationship capital. Each element (including digital assets) needs to be identified, measured and optimized individually but also as part of a system.

Contribute to our open source community – Finally, there is a pressing need to help businesses develop basic skills around the identification and management of intangibles. These skills and methodologies cannot and should not belong to one company. They need to be developed in an open, dynamic way that memorializes the collective learning of us all. I hope that we can persuade you to participate in an open conversation. McKinsey can help lead the business community into an emerging future of undiscovered value from intangible capital and we’d be honored to work with you in sharing what we’ve discovered from our own work.

We’ve tried to lead by example by publishing a few basic open source tools on our Smarter-Companies website. We welcome ideas on how we can set these ideas free and create a truly open conversation about the future of measurement and management in the Digital Economy. I look forward to your future contributions to the intangibles conversation and would be more than happy to engage in open dialog.

Intangible Capital. Intellectual Capital. Intangible Assets. Intellectual Property. These phrases get used a lot and many people think they are the same thing. This post is intended to help you understand the difference. Our objective is to provide clarity to our terms and correlation to the impact IC has on business results.

The study of intangibles emerged as a field in the 1990’s to explain the significant shift in our economy and businesses as knowledge became the key competitive advantage in the global market. This shift reversed the historical pattern of tangibles accounting for 80% of total corporate value to the exact opposite today with the value of the average company today being 82% intangible. How to describe this critical asset class? The field is still emerging and as such, there can be confusion about the meaning and usage of different words and phrases.

The terms intangible capital, intellectual capital, intangibles and intangible assets are often used interchangeably. Although we prefer the phrase “intangible capital” because it has a more precise definition (see below), “intangibles” is also frequently used. Below, for your reference, are some definitions of these and related terms:

INTANGIBLES / INTANGIBLE ASSETS

Strictly speaking, the definition of “intangible” comes from the field of accounting. Intangibles are organizational resources that do not appear on the balance sheet. On average, more than 80% of the value of today’s public corporations is intangible.

This phrase is both our friend and our enemy. It orients people that we are talking about assets and resources that are not tangible. But it also feeds into the broad misconception that intangibles are unknowable and unmeasurable. Nothing could be further from the truth (which is why we wrote Intangible Capital).

Why do we not find a different word? Well, as tempting as that sounds, it wouldn’t solve the problem. Accounting standards and norms are critical foundations of our economy. We have to find ways of orienting people within their own experience. So when talking about intangibles, let’s start with what people know and help them learn and expand their understanding from this base.

INTANGIBLE CAPITAL (IC)

This is a phrase and a concept that comes out of the study of intangibles in an organization. It takes people beyond the strict definitions found in accounting and takes a fresh look at what is going on. Basically, the rise of the importance of intangibles is part of the story of the end of the industrial economy and the rise of the new economy based on information technology and the internet. In this new economy, knowledge, connections and collaboration are the key assets driving growth and performance. To paraphrase Baruch Lev, there is no tangible asset today that is more than a commodity. The unique, the valuable part of business comes from how tangibles are used, how work is done, how the future is innovated.

The field of IC has identified four main categories of knowledge intangibles, each of which has a different character. It is important to understand individual intangibles as well as how they work together as a whole:

• Human Capital - This includes all the talent, competencies and experience of your employees and managers. This is the intangible capital that “goes home at night.” More on human capital
• Relationship Capital – This includes all key external relationships that drive your business, with customers, suppliers, partners, outsourcing and financing partners, to name a few. This kind of capital also includes organizational brand and reputation. Due to the growing importance of networks in organizational structures, this is also sometimes called Network Capital. More on relationship capital
• Structural Capital – This includes all knowledge that stays behind when your employees go home at the end of the day. There is significant structural capital in today’s organizations including recorded knowledge, processes, software and intellectual property. More on structural capital
• Strategic Capital – This is a category that is not always included in academic definitions of IC. However, in our experience, this category of knowledge is the necessary complement to the others. It includes all the knowledge you have of your market and the business model that you have created to connect with market needs. The driving force behind Strategic Capital is purpose. It also includes culture. Culture and purpose are the glue that holds the rest of IC together. More on strategic capital

INTELLECTUAL CAPITAL / INTELLECTUAL PROPERTY

Some people use the phrase intellectual capital instead of intangible capital.

We prefer to use “intangible capital” rather than “intellectual capital” for two reasons: 1-intellectual sounds too elitest–intangibles are real and practical so let’s not make them sound inaccessible and 2-people often confuse intellectual capital with intellectual property.

Intellectual property is a specific type of intangible asset that can be protected legally through copyrights, trademarks and patents. It is a subset of Structural Capital. Many people think that intellectual and intangible capital is primarily intellectual property. Hopefully, this discussion helps you understand that there's much more to the picture!

Over the weekend, I led a session for the NorthEast Regional Council Quarterly Educational Session for IMA, the Institute of Management Accountants.

This was my third talk with an IMA group and it was as fun as the last ones. Unlike CPA’s who end up trying to lecture me on GAAP (they seem to believe that if only I understood their rules I wouldn’t be making all this fuss), Management Accountants have an open mind. They are accustomed to thinking of accounting information as management information. And they are always intrigued by the possibility of filling in the information gap between corporate value and the tangible net worth of the average business. The gap, by the way is on average 80%--which is why I keep telling the CPA’s that there’s a problem here….

Anyway, beside the usual presentation, I also got them to do a quick exercise. We used the ICounts™ Inventory open source methodology in a group exercise. We created an inventory of Federal Express’ intangibles. We didn’t do as well as the company could do itself (give me a call Fedex if you want to try!) but since it’s a business we all know pretty well, the group did a good job.

We answered the first six questions of the inventory:

1. Who are your clients? (relationship capital)
2. What do you do to create value (strategic capital)?
3. What are the key processes and knowledge that support the model (structural capital)?
4. Who are the key partners that support the model (relationship capital)?
5. What are the key competencies your people need to support the model (human capital)?
6. What are the key elements of the culture your organization needs to keep this system working?

Here are a couple happy management accountants with the stickies that the group developed. We didn’t try to work on the last question [How do these pieces fit together and link to a market (strategic capital)?] but it’s a valuable one if you are going to use the inventory in your own organization.

It was a great meeting with the added bonus that the venue was across the street from the Worcester Art Museum so I finally got to tour this very nice building and collection.   Thanks again IMA!

Sometimes when I talk about intangible capital I feel that people think I am speaking in a foreign language. We use terms that are different from what has been taught in our colleges, our businesses and in the marketplace.

Intangible capital does have its own language. We speak about human capital, strategic capital, structural capital and relationship capital while most of the market has no reference to what exactly these terms mean. As Nilofer Merchant says “Language encodes our thinking. To write a new future, we need to use a new language.”

Making Complexity Simple

People understand that that success in business is impacted by the quality of the people they hire, the support systems in place to facilitate processes and information to serve the customer, the sales and marketing efforts that attract the customer and keep them after the sale and the strategic purpose of the organization that aligns all of these resources with a common aim. All of these are the intangibles that produce the tangible results—yet it’s extremely rare for businesses to actually track these intangibles in a coherent way.

The intangible language is not the language used today by businesses yet if you listen to what businesspeople are talking about—it’s the intangibles. So we have a communication gap. We are talking about the same things but we are not talking the same language.

Why try to talk the same language? Why should businesspeople adopt IC thinking? Because intangibles are the root of strategic advantage. There is virtually no tangible asset you can buy that will give you a competitive edge today—it’s about how you use assets, how capable your people are, how strong your partners are.

Our guidepost for creating this language needs to be simplicity. Clayton Christensen said “Disruptive innovation transforms an existing market or sector by introducing simplicity, convenience, accessibility and affordability where complication and high cost are the status quo”.

To create a new language we need to bridge the gap between the old language and the new. It will take time and adaptation for us to come up with a common language that everyone can understand.

This is the first of a series of posts that we will continue over the next month or so to try to advance our language. We look forward to everyone’s input so we can ultimately get to a place where it is simple, convenient and understandable. Our goal is to not dumb things down or make things complicated rather it is about speaking in a language that everyone can understand.

In financial accounting, a balance sheet or statement of financial position is a summary of the operational infrastructure of a business. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A balance sheet is often described as a snapshot of a company's financial condition.

Until recently, corporate financial condition was directly tied to the health of a company’s tangible assets. You could read a balance sheet and understand where the value was: equipment, building, land, inventory. It was all there. Until the introduction of the personal computer, the internet and social technologies, the tangible net worth of a business (tangible assets minus liabilities) averaged roughly 85% of a company’s corporate value.

This traditional balance sheet was useful for getting a holistic view of the entire productive capacity of a company. You could see whether the company was continuing to invest in its production facilities. You could see whether inventory was moving. You could see whether the company had enough assets to cover its liabilities. You could see what those assets were.

As information technology created more and more opportunities for automation, a new class of productive assets arose. They include knowledge, data, processes, know-how, networks, relationships, brands and much more. Most of these “assets” never make it to the financial balance sheet and are described as “intangible.” In an intangible economy, the core assets of a company are NOT on its balance sheet. They are invisible and usually go unmeasured.

Since no one is keeping track of these new assets, there is no easy way to see whether a company is continuing to invest in its productive assets. You can’t see whether knowledge is growing. You can’t see whether the company has enough intangibles to meet current obligations and fuel future growth. You can’t see what these intangible assets are. BUT just because you can’t see them doesn’t mean they aren’t there. Companies invest million in intangibles--their accounting isn’t capturing the value.

What’s the alternative? Smarter-Companies has a modest proposition: let’s create a new kind of balance sheet. One that accomplishes the same goals as the original one but one that fits the new reality of today’s economy. It would show all the productive assets of a company. At this stage, it won’t show cost/value data. Rather, the arbiter of value will be the company’s stakeholders. Their feedback will determine whether an intangible is an “asset” (those intangibles that are strongest) or a “liability” (those intangibles that are weakest) in reports prepared by an ICountant.

The illustration in this post shows an example of what the proposed “Alternative Balance Sheet” might look like if you displayed the stakeholder ratings as assets and liabilities.

This example was based on a recent ICounts Graph Report for Smarter-Companies. Our IP and business model are our greatest strengths. Our marketing and branding still haven’t caught up with our potential. There’s lots more detail behind this in our report.

It’s not exactly like the balance sheet you’re used to seeing. But we think that it begins to fill in the information gaps on the traditional balance sheet and focus on what’s important in today’s businesses.

What do you think? Does this fill in some gaps? Is it an analysis worth doing? How else can we get at the intangibles? What would your alternative balance sheet look like?

One of the challenges of business today is that most of the drivers of innovation, performance and value aren’t visible. That’s because mainstream accounting and management systems aren’t built to track and measure digital assets, knowledge and collaboration. Yet these intangible assets make up 80% of the value of the average business.

A lot of the solutions that I have seen over the years try to over-simplify what’s going on. Human capital folks will tell you it’s about people. IT folks will tell you it’s about systems and data. Intellectual capital practitioners will tell you it’s about IP. Marketers will tell you it’s about reputation. Strategists will tell you it’s about business model.

The truth is that it’s about all of these things. A company’s ability to innovate and grow, its ability to generate better profits and performance, its ability to create lasting, realizable value—they all depend on intangible capital.

So it’s important to understand each piece of the puzzle and also how they all fit together. It’s especially important to be able to measure how the pieces work together as a system. But this is hard to do because intangibles are mostly invisible. You can’t walk around an office or a factory and get a good feel for what’s going on inside peoples’ heads or their computers.

That’s why it can be really helpful to identify and measure the unique intangibles of a company. And put those measures into an easy-to-understand visual format. In our new paper ICounts Graphs – Six Cases we show how this approach can paint a picture of these invisible but very important assets.

The examples shown here are outtakes from two of the six cases. You can see that these companies each have very different challenges and opportunities. That’s the way it should be. No two companies are alike. And their measurement systems should make that clear.

If you like the way we are measuring intangibles with ICounts Tools, we’d be happy to help you measure your own or your clients’ businesses. Or create your own system. The important thing is to make your intangibles tangible. To make it easy to find barriers to success and opportunities for growth.

Your future success depends on intangibles. Take control of that future.

I have an admission to make. I was at this enormous Sibos banking conference with 9,000 people and managed to basically never leave the stimulating environment created by Innotribe. Innotribe creates a world unto itself that you enter by heading through a portal and down a hall filled with ever changing music, video and displays. And the space itself was designed to make it clear that different thinking was going on.

The discussion tracks were Value, Innovation, Big Data and Practice. The Practice track included hands-on sessions for experiencing activities like scenario thinking and visual thinking. In our Value track, we had a discussion and then an exercise about intangible value and a discussion of alternatives to GDP, and a great game by Happathon. Innotribe also leads a Startup Challenge that featured all kinds of financial technology startups. The thing that really surprised me was the number of companies that are developing their products for/in less-developed countries. Of course, disruptive innovations often come from the bottom of the market and even though I have been hearing about innovation at the bottom of the pyramid for quite awhile, I was still surprised to hear so much about it, even in the general session. It seems that a billion people that already have cell phones don't have bank accounts. There's obviously an opportunity there.

However, in spite of the open discussion about the unbanked, there was a lot of discomfort in some of the discussions about potential disruptions to the industry, especially the part served by Swift members around payments and clearing. Swift is, after all, a network that predates the internet. Many of the products in the startup program were potentially really disruptive to this network and to the business models of the banks in the network. The most extreme example of this was Bitcoin, represented there by Patrick Murck. This degree of change is hard to deal with when you are the incumbent. But there’s no hiding from change.

We also heard this (natural) discomfort in the discussion about investment management and intangible capital. A lot of people took issue with my statement that Facebook and Twitter could/should go directly to their networks to raise money. One audience member explained that the investment management industry provides transparency and stability. Another explained that governments need to control the industry and would never allow big changes. Really? I pointed out that the crowdfunding movement is a sign of governments taking Christensen’s advice on disruptive innovation and how large organizations at risk need to create experimental programs to figure out new possibilities.

My advice to many delegates was to pull out The Innovator's Solution and face coming changes head on. What was clear to me is that we live at a moment where the entire financial system can and will be changed. It's all part of the trends we regularly talk about at Smarter-Companies. Power is shifting and the outcomes, we believe, will be better futures for organizations and their stakeholders. Be part of it!

Just received David Gurteen's latest Knowledge Lletter and was struck by his opener:

Some sound advice here from David Ogilivy. We send an email when we would do better to walk around to the person we wish to engage and have a conversation with them or failing that pick up the phone.

In reading this, I made a connection with a statement by Peter Block that struck me when I read it at the time.

Connection -- We must establish a personal connection with each other.

Connection before content. Without relatedness, no work can occur.

Credit: Civic Engagement and the Restoration of Community: Changing the Nature of the Conversation by Peter Block

I've had a number of conversations along the same lines recently. It's not enough to say that we live in a "knowledge" economy. Because the value of knowledge is very small unless it is put to work (then it can be infinite).

How do you put knowledge to work? It happens collaboratively.

Knowledge put to work is intangible capital. IC is a dynamic system including all the elements pictured above. It's impossible to talk about work today without talking about each of these elements, how they interact and how the system creates value. This concept of work as a dynamic collaborative system is very different from the linear processes that characterized work in the industrial era. 

Connection before collaboration, before work is done? It makes a lot of sense. But it speaks to a very different view of the organization, one that demands new approaches to measurement, new approaches to management. one that truly values the intangibles held in human, relationship, structural and strategic capital. What to get work done? Start thinking differently.