We are living in the middle of an historic revolution that is taking us from an industrial to a social, intangible capital-based economy. This revolution is visible everywhere but one place that I love to watch is in how the intangible capital economy is changing one of the oldest human activities: agriculture.  Here’s some context:

One of the turning points in human history came when men and women figured out how to control production of food. These practices of the Agricultural Revolution improved over the next 10,000 years but it was still largely a physical process using human and animal labor. Throughout this time, a large portion of the human population worked just to produce food.

What changed? The Industrial Revolution. This is when machines were put to use to replace human and animal labor. This mechanization made it possible for less and less labor to be required to do basic activities. And agriculture changed with it. This table from Wikipedia says it all:

• 3,000 years ago primitive agriculture fed 60 million people
• 300 years ago intensive agriculture fed 600 million people
• Today industrial agriculture attempts to feed 6 billion people

This also meant that labor requirements for agriculture continue to drop. This table shows the male workforce in the U.S. and shows food production jobs declining from 42% to 4% of the workforce during the last century. 

But the industrialization of agriculture brought many negative outcomes that present challenges for the future such as high energy use, chemical and waste pollution and overabundance of low-nutrient foods. In these opportunities and the latest revolution lie the seeds of the future.

Today we live at the birth of a new Revolution. Fueled by information and social technologies, we are automating our minds just as the industrial era automated our bodies. And, just as the Industrial Revolution dramatically changed agriculture so, too, will this new Revolution.

Automating our minds creates intangible capital. And IC is fueling radically different approaches to agriculture that use less energy, use fewer chemicals, lower waste and improve diets. Here are a few fun examples:

• Rooftop gardens run on an iPad that harvest only what’s needed by their customers each day
• Sysco’s program to connect small, local producers to the University of Michigan
• Local production creating local jobs
• Smaller scale production creating healthier communities

These new approaches are still tiny changes in a world-wide system. But they show us how intangible capital--people using information technology to build collaborative, innovative solutions to old problems--can radically change the thinking even in the oldest and most traditional of industries. How will your industry be revolutionized by intangible capital?

Mary suggested I post the full page from my website (chaitassociates.com) where she got a quote that she recently tweeted.. Here's the quote:

"If senior executives managed their organizations' fixed assets and financial capital the way that they manage their companies' knowledge assets and intellectual capital, they would be fired...and likely sent to jail."

...Larry Chait 2010

and here's the rest of the page:

On average, the value of an organization's intangible assets of  (its knowledge and intellectual capital) is up to three times the value of its tangible assets.  Yet in most organizations, overseeing those assets consumes little or no management attention.

Multiple factors argue that access to—and effective use of—knowledge will become increasingly important:

• Rapid, never-ending pace of change that is seemingly increasing
• Ongoing shift to knowledge and innovation as bases of competition
• Burgeoning of available information and access to such information

Next-generation managers who have a deep understanding of how knowledge is created and leveraged in organizations—and practical skills in how to achieve such leverage—will have a clear advantage over their peers.  Managers without these skills—and their companies—will find it difficult to thrive, and potentially, survive.

Your company's intellectual capital  includes the collective wisdom and expertise of your people, as well as your trade secrets, software code, and customer relationship data.

Unfortunately, most companies have inconsistent and ineffective ways to organize, access, share, communicate, and apply these valuable resources.  Rather than leverage knowledge and intellectual capital, they suffer from a "brain drain."

People can be trained in how to capitalize on an organization's growing and changing body of knowledge:

• Identify and prioritize your most critical knowledge resources
• Structure those resources into an easily accessible "knowledge taxonomy"
• Select and implement the appropriate  technologies 
• Create the processes and shape the behaviors necessary to maximize the use of intellectual capital at every level of the enterprise

So, to stay out of jail, manage your knowledge well!  

Larry Chait

Most of what we do as managers and most of what is still taught in business schools is a toolset that was perfected in the industrial era for managing factories. It shows people how to manage from the top down and is built on the assumption that the boss has all the answers. Org charts are the prototypical view of the organization under this model.

We all know that the world has changed. That the industrial era is over. That top-down isn’t enough. There are lots of conversations about how to deal with this change. Companies doing network analyses. Looking for ways to create more inclusive management models. Working to understand the elusive phenomenon that is innovation.

But the mainstream is still ignoring one of the basic underlying shifts in the foundation of organizations. As we moved from the Industrial to the Social Economy, the core competitive (and collaborative assets) of organizations shifted from being mostly tangible to now being mostly intangible. Today 80% of the value and 100% of the competitive advantage of companies resides in intangible assets like people, knowledge, processes, networks, relationships, culture and business models.

It is a rare business person that has any tools beyond their own good instincts to deal with this shift. Accounting calls these things goodwill. Financiers call them “soft” assets. Business schools ignore the research that shows how absolute and final this shift is.

What business people and organizations need are a few of the same things that they have in their toolset if they were to manage an old-style factory: a way to identify intangibles, inventory them, model their operation, measure them and optimize their performance. It’s not that exotic. It’s common sense management. People need a similar toolset for intangibles.

It’s absolutely critical if individuals, organizations and economies are going to solve some of the exciting and potentially mind-bending opportunities out there: improving the health of our people, the quality of our environment and the strength of our economy. The solutions are all out there, inside our minds, waiting for the right environment to nurture the collaboration and innovation to find them.

That’s why I founded Smarter-Companies and created the ICounts Tools. To empower organizational leaders with tools to focus on what’s important: intangible capital. Join us on our mission to change management and empower people and organizations to build a better future.

I have been receiving notices of newly published content from the MIT, Center for Information Systems and Research (CISR). A new report on an apparent turnaround in organizational operation at the SEC caught my eye. Given my roots in knowledge management, promotion of collaborative methods and practices, and Smarter-Companies' focus on intangible capital it seems a natural fit for us to care about what the SEC is doing to safeguard investor assets.

Apparently, in 2009 a new Chairman of the SEC, Mary Shapiro, was appointed and took on the role of reforming the institutional practices that resulted in lax oversight of operators such as Bernie Madoff. By 2012, Shapiro was able to report successful institutional practices had been implemented to meet her goal, "...a transformation from paper-based, localized operations to a more collaborative environment with specialized expertise and the ability to quickly identify and address activities that threatened financial stability or investor well-being. The transformation required standardizing some core processes, introducing new organizational roles and responsibilities, implementing a modern technology base, and cultivating a new mindset about how to use and share data."

For the story and lessons learned, please read this study:

Working Paper 388: The US Securities and Exchange Commission: Working Smarter to Protect Investors and Ensure Efficient Markets; by Barb Wixom and Jeanne W Ross; Nov 30, 2012. Link: http://cisr.mit.edu/blog/documents/2012/11/30/mit_cisrwp388_sec_wixomross.pdf/. You will need to create an account to download the study but it is well worth the read and great to learn that entrenched enterprises can change for the better. Be sure to go to the end where the use of social networking tools to see securities and investor relationship are brought into visual focus for the reader.

As 2013 has opened, the merger business has, as theNY Times reported, “roared back to life” with more activity than has been seen since 2007, the year before the Great Recession began.

Corporations have $1 trillion in cash on their balance sheets and buyout firms have literally billions of dollars of money to put to work. Cash, a stronger stock market, a rebounding lending market and enough confidence in the future all will help fuel a new boom of takeovers.

But will this M&A activity be more successful than in the past? Because the track record of mergers in general is not very strong. For those of us in the intangible capital community, this is no surprise. Why? Well, it’s because there is little structured diligence around intangibles even though 70% of the average deal ends up being booked to intangibles.

Intangible capital includes people, processes, knowledge, relationships, culture and strategies—all the things that everyone knows to be important but never get the attention they should. One of the biggest reasons is that intangible capital exists largely outside the current accounting model. (There are good reasons for this but it doesn’t mean that intangibles are not financial assets. To the contrary, billions are spent developing and buying intangibles every year)

Can a deal that works on paper and in the projections really work if the intangibles are wrong? No way.

I lived through my first financial cycle as a young business student in the 1980’s. I’ve seen a lot of them. And it makes me sad that a lot (but not all) businesspeople are going to go through this one without a good ICounting toolset.

Don’t be left out. Don’t screw up your mergers. Use an ICountant to plan it out.

One way in which networks differ from traditional organizations and even traditional knowledge organizations is that the roles are dispersed and not organized in a definitive manner. There are no departments, no functions, no bureaucracy. In a network operating at its optimum, the roles (and the people in them) can join together in various combinations in order to do the work of the network.

In traditional organizations, we could plot how the work of the enterprise is performed. We have called this "plot" the work process, the transformation process or the value chain. Traditionally, it was a linear sequence of activities that added value to preceding activities leading to the completed output that was handed off to customers. Even in more knowledge-driven organizations, there was some high-level sense of sequence though work was carried out in deliberations that might not necessarily be in sequence.

I believe that the value chain approach used in traditional organizations has less applicability in understanding and acting upon a network. This is not to say that a sequence of activities cannot in particular cases be identified. It is to say that such a sequence can no longer be generalized as an operational blueprint for the network enterprise. In fact, such a formalized approach is antithetical to a network and the unique value that can be gained from a network.

A useful way of thinking about a network is in terms of its value propositions. For any given network, there is an overarching purpose. Purposes are then translated into value for customers, members, society and the network itself. The value proposition is an articulated statement of benefit to each interested party. There could be one value proposition or several value propositions. A given value proposition could cover one or more groups of interested parties.

The value proposition becomes an organizing mechanism for the network. The value proposition becomes an embedded intangible structure that influences or governs what emerges or is planned within the network.

Ideally, value propositions influence planful activities. They also catalyze conversations in networks. Conversations can occur spontaneously or as the result of facilitating actions by network weavers or coordinators. These conversations can result in ad hoc configurations or more planful configurations to carry out the work of the network. We could call these configurations clusters, communities of practice, or committees. They can be in existence short-term until a new idea runs its course, longer-term to deal with a common grouping of ideas though with varying membership, and can spin off into other initiatives.

A network can be assessed in terms of whether its actions and factors like relationships, trust, inclusion, interactions, funding, convenings, etc. further the given value proposition or not. We can ask, is desired value being provided to interested parties; are we being innovative in how we pursue the value proposition? We can take action to bring alignment to these factors and the given value proposition.

In one network, my data indicated the following candidates for value propositions:

• Improve professional competencies and effectiveness.
• Transfer skills and theory.
• Build interpersonal competencies.
• Create good relationships among members and clients.
• Build a better world.

In another network, an educational consortium, some aspects of the stated value proposition were:

• Through collaboration and cooperation provide greater academic and intellectual opportunities for students and faculty members than could be offered at any single campus, and
• Achieve greater efficiency in operations and administration and greater opportunities for innovation.

What can a network do to create greater alignment between a given value proposition and network actions and factors?

One step is to be explicit about these network value propositions. Think about them and even rethink them. Publicize them, talk about them, and create greater awareness throughout the network. Discuss whether the network has the most desirable balance among its different value propositions. Assess the impact that the network is having on interested parties and create network conversations about how to increase positive impact in line with these value propositions. A network can also share amongst its members what is working well in advancing these value propositions.

I’m really happy to announce that the International Conference on Intellectual Capital and Knowledge Managementis going to be in the U.S. this fall. It’s been five years since the last time the conference was in the U.S. so I am very excited—I think the U.S. is more ready than ever for the intangible capital message!

The dates are October 24-25 at George Washington University in Washington DC. I am on the committee and also helping organize a mini-track on What Works in IC? Practical Perspectives. Download information on the track here. The deadline for submitting an idea is April 4.

This is a great opportunity for IC practitioners to share their experiences. There are many kinds of submissions that you can consider:

• Academic Research Papers
• Work in Progess/Posters
• PhD Research Colloquium
• Case Study Submissions
• Non-Academic Contributions
• Round Table Proposals
• Product Demonstrations and Exhibitor Opportunities

I plan to submit a paper as well as do a demonstration of our ICounts open source products. I invite you to consider doing the same.

This is a great opportunity to share what you have learned and build your network of IC/KM practitioners. Hope to see you there.

If I can answer any questions, please fee free to contact me!

Elders vs Egos

The Battle for the Ethos of the Modern Business

Why Past Practices are Essential to Embrace in the New Economy

So much of the traditional conversation surrounding leadership in organizations today is really off base. Like so many other things in our modern society much of the discussion around leadership is very ego based and is focused upon self promotion and/or creating one’s professional brand. 

In fact, according to Dave Logan, best selling author of Tribal Leadership, approximately 85% of all leadership books are written from what he calls the Stage 3 leadership perspective. He defines Stage 3 leadership as being one that is ego based and ego driven. 

For instance, you will see many books on leadership promoting the individual who wrotethem; promoting an industry tycoon or suggesting one acts as a fighter pilot or even as a ninja when leading others. The latter of which was clearly written by an individual who clearly never studied the ancient Japanese martial art of Ninjutsu. I spent four years studying that discipline and I can tell you he had no clue what he was talking about. But he is selling books.

But that is the nature of Stage 3 leaders and leadership models. They are based upon more fluff than substance and designed to get you to buy into to some “fantasy” instead of actually giving you tools that work under fire. And lets face it, real, in the trenches leadership, on a day to day, human to human and incident by incident basis is always a trial by fire. So these folks, while perhaps well intentioned, are actually doing you more harm than good and are taking your money in the process. 

Dave’s research also reveals that 49% of all organizations operate under a Stage 3 egocentric leadership model. Another 25% of organizations are being run by apathetic leaders and another 2% by “vindictive” leaders. 

This means that 76% of all organizations operate under leadership models that empower the wants and needs of a few and which enforce authority as opposed to ones that respect, mobilize and maximize the potential of everyone in the organization. 

This is not good news because the modern era of business demands we maximize our human capital resources. Just as machines and repetitive processes generated the most financial capital in the 20^th century the human attributes of creativity, communication and collaboration are the dominant drivers of profits in this century. And egos restrict access to these critical resources.

Since the world has changed forever so too must our leadership models. To not adapt to the modern conditions will prove disastrous. Because study after study has proven, without a doubt, that people simply do not respond well to egotistical managers. And a company hemorrhages money when leadership is weak and the workforce is non-responsive.

The Return of the Elders

If you look up “elder” in the dictionary you get several bland and technical definitions. But if you ask yourself, or others around you, to define an elder I bet what comes out are words that have a sense of reverence about them. People naturally have positive associations with elders. And even if they don’t know how to describe one perfectly, they know one when they see one. 

I submit the reason for this is because the essence of what a true elder is touches upon our souls first, then the mind. And since dictionaries are written by and for brains they do a poor job of describing a word that actually connects to our anthropological tribal DNA. This speaks to the true power of, and the amount of influence, elders have on us, and by extension, our organizations.

One of the sources of their power is the fact that elders are not appointed by those in power. They are anointed by their peers. Elders are also not ego driven and therefore, are not viewed as a threat by anyone other than those who are ego driven. 

Elders are just comfortable being who they are; nothing more or nothing less. 

Who they are reflects wisdom, authenticity and integrity. How they act expresses inner strength and peace. Their words teach and heal. Their actions build and repair. They are in the tribe but are not controlled by it. They hear and listen to a higher power than typical human consciousness. And they help others to connect, or at least benefit from, that which benefits them.

People sense this and trust this. As a result they allow these special people to influence their thinking and to even enhance it. So far removed from any desire for power are elders that many don’t realize they are one. If they do realize it, they don’t allow it to affect them, other than to perhaps make them more committed to consistently acting responsibly.  

They don’t look for followers and as a result they have them. And they are loyal. 

The Importance of Engaging Elders in the Management Process 

By now it is clear why elders are so influential in the organization. They hold leadership positions whether management knows it or not. They are trusted and respected; their advice and insights are sought after and are listened to. Often people will ask elders whether or not to trust, or follow, management decrees. This means their influence often times exceeds management’s.

While this may unnerve some in management they have nothing to fear as long as they operate with the best interest of the tribe and the culture in mind. It is only if leadership becomes too self centered and begins abusing their authority or feeding themselves at the expense of the tribe that they might find themselves in a political conflict with the elders.

If that happens the elders will always win the hearts and minds of the tribe while those in authority will only get that labor which they can force from people. Since we are in a human capital driven economy this loss of employee engagement will result in losses of productivity, profits and possibly even people. 

So it is in the best interest of management not only to know identify the elders but to have healthy relationships with them as well.

To be effective a modern manager must have the tribe’s trust. This is where the elders can help. They must effectively communicate with the tribe. This is where the elders can help. And they must be able to motivate and mobilize the tribe. And once again, this is where the elders can help.

Simply put: Elders mobilize tribes. And it is through tribes that most work gets done. In fact recent research done by the McKinsey Group reveals that 67% of all work done in an organization is done through informal networks (tribes) that operate outside of the org chart. 

Since profitability is tied to accessing, mobilizing and leveraging the human capital of their tribes it is crucial that you find a way to include the input and insights of elders.

When you combine this additional leadership resource with a healthy management team you significantly increase your ability to maximize your profits. 

An Ethos that promotes Elders over Egos is a formula that simply cannot fail.

The following are traits of Tribal Elders.

1. They are humble
2. They seem to lack ego because they are comfortable with who and what they are.
3. They have opinions but never push them on others
4. They don’t care about titles or prestige but they don’t exhibit false or unnecessary modesty either
5. They are committed to principles but are detached from outcomes 
6. They live the “Serenity Prayer”
7. You trust them, unless you are a troublemaker. Then they unnerve you
8. They don’t insist upon being heard yet are willing to speak if you are willing to listen
9. They support growth 
10. They don’t sweat the small stuff. But they seem to see “everything” and understand most things.
11. They are kind. But don’t mistake their kindness for weakness. Few are stronger in spirit or character.
12. They listen more than they speak and understand more than they show.
13. They are committed to creating the next generation of elders but do not seek followers.
14. They have strong, steady moral compasses that are not affected by the “group consciousness”
15. They are, at all times, students, teachers and learners about life.
16. They believe in a power greater than themselves.
17. They are wise enough to be forceful and powerful when it is in the best interest of the greater good
18. If they had a motto it might read something like: I am what I am and I will be that with as much honor and grace as I can muster.

If your organization has the benefit of having one or more elders in it then consider yourself fortunate. If you are one, you probably don’t identify yourself as one but others do. So thank you for your service. 

Jeffrey Deckman is the founder of Capability Accelerators, a consulting firm that specializes in developing resilient leadership teams and organizations...One human at a time. If you have questions or comments he can be reached at JDeckman@CapabilityAccelerators.com

www.CapabilityAccelerators.com   www.TheBiggerKnow.com 

- Before hitting the launch button, go through the checklist

Preparing a privately held company for sale – exit planning – entails a fairly extensive list of things that need to be done and considered.  The process should start several years in advance of the sale. The goal is to ensure that the Intellectual Capital being needed by the company is owned by (literally and figuratively) and resides in the company.

Among the many issues are:

• Succession planning, talent acquisition, training and talent retention
• Process review
• Diversification of risk

You will appreciate that most companies are purchased by private equity firms. To receive the highest possible price for your company, you need to be viewed as a platform company instead of an add-on. To be an attractive platform company, your company needs to have reached a stage where it sustains itself. It has Human Capital, Structural Capital and Relational Capital.  Put another way, it has good people, depth on the bench, and a process for recruiting, training and retaining them.  It has internal processes that reflect an in depth understanding of the business in all respects including a strategy and a vision that extends out 5-10 years.  And it has good or great customer and vendor relationships.  In the absence of this self-sustainability, the buyer is really just buying your customer relationships, or technology, or some other part of the whole.

You – the current owner/operator – need to be expendable. Who is your replacement? Potential buyers want to know the company will survive once you leave. That requires talent acquisition, training, talent retention and succession planning. One of the challenges entrepreneurs have is letting go of the reins and bringing in someone that is their equal (or more than their equal). You need to have a real management team in place, with cross training of all your staff. There should be two people or more that know every job.

Well ahead of marketing the company for sale, a review of all internal processes needs to be conducted. This is part of the due diligence a buyer will go through. They prospective buyers will ask themselves “Is the company as efficient and effective as it can possibly be using best practices and current technology?. If the company were being designed from the ground up today, is this the way you would put it together?” If not, look into the steps that can be taken in the next year or two and reflected in the financial statements the following year. Have you integrated current technology into your business processes? Software that increases efficiency is generally a good investment, even in the short-run. Related to this is where technology is headed, and whether the company has reviewed its strategic marketing plan to reflect the changing competitive landscape.

Diversification of your customer base is increasingly important given the rate of change in technology. Sales concentrations impair sales price and are an impediment to capital raising, as lenders are concerned about both uncollectable accounts receivable and unabsorbed overhead. One of the things that’s hard to predict is how changing technology will affect your customers. If you were dependent on Borders Book, or currently, Best Buy, anyone would rightfully be concerned about the outlook for your company. The best thing you can do is diversify your customer base, and watch the stock price of your customers. If they are public, watch their public competitors’ stock prices, and make this monitoring an integral part of your CFO’s job. There should be a natural tension between your CFO and Sales. If there isn’t, you don’t have balance.

These are some of the first things to think about before planning the sale of your company.  Exit planning is a job on top of your job, and we assume you are already fully employed.  Talking to us when you being the process achieves two related goals.  First, completing your exit plan.  Second, we increase our knowledge of the company to a level where we can market it with greatest effectiveness.   To learn more, contact us.

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EE = EBITDA

Transforming Human Capital into Financial Capital.

Jeffrey S. Deckman, Founder, Capability Accelerators

02.14.12

   EE = EBITDA is an obscure but interesting formula that, once I came to understand, revealed an exciting new source of increased profits that any business can realize.

The “blow up” of this formula is:

Employee Engagement = Earnings Before Interest Taxes Depreciation Amortization

Before going any further I want to say that Employee Engagement (EE) is certainly not the only factor that impacts EBITDA but it does have a significant impact on your bottom line. It just also happens to be one of the easiest ways to increase profitability you will ever come across. 

Why? 

Because, of all the ways to increase profits such as increasing prices; decreasing costs and generating more sales increasing your levels of EE is almost completely within your control. This is because EE is largely determined by the leadership culture of your organization. And you get to control that.

In fact, a recent Melcrum Employment Engagement Survey of over 1600 HR professionals found that “The actions of senior leaders and direct managers are the most important drivers of employee engagement by a factor of between 400% and 700%.

So not only is this “silent profit driver” largely in your control but the financial impact of increasing the levels of EE in your organization is undeniably real.

In fact, I doubt you could find a single CEO of a Fortune 500 company who even questions whether increasing EE increases EBITDA. 

The Numbers behind the Science: 

In an effort to be as informative as possible as quickly as possible let me get right to the math. 

A recent study done by the Gallup Group in October of 2011 involving thousands of participants revealed that, on average, 71% of people are “disengaged” from their work. Within this group 55% are considered “not engaged”. These people do their jobs but not much more. The other 16% are considered “actively disengaged”. These are people who are actually working against the best interests of the organization. 

This leaves only 29% of the workforce who are considered “highly engaged”. These are the ones who put in extra time; think about their jobs during off hours and are energized. They are the ones who generate the most per capita profit.

This means that 7 out of 10 people in organizations are not engaged in their work. Imagine the lost productivity and profits that represents! And in today’s economy this can spell death to an organization.

The High Cost of Low Employee Engagement

Lets look at how the level of EE in your organization affects your profitability.

The following EE vs Productivity numbers are generally accepted throughout the industry, give or take a few percentage points: 

• “Highly engaged” workers are 90% productive 

• “Not engaged” workers are 60% productive 

• “Actively disengaged” workers are 40% productive. 

When you combine the EE and the productivity numbers the impact on profits becomes clear:

• 29% are highly engaged and are 90% productive.

.29 * .90 * 100 = 26.1% productivity level

• 55% are not engaged and are 60% productive.

.55 * .60 * 100 = 33% productivity level

• 16% are actively disengaged and are 40% productive

.16 * 40 *100 = 6.4% productivity level

This means that your overall productivity levels are:

26.1% + 33% + 6.4% = 65.5%

To make this real lets assume a company spends $2 million on employee compensation. Under this scenario their ROI on that investment is: 

2,000,000.00 * 65.5% = 1,310,000.00. 

This represents a $690,000 “payment vs. performance” gap.

The Big Difference of a Small Adjustment

Now lets look at the impact to your bottom line that will occur if you simply increase the

highly engaged numbers by only 5% and decrease the actively disengaged numbers by the same amount. And if your company is like most, and if you decide to make EE a
priority in your organization, moving your EE numbers 5% in this fashion is not unrealistic at all. 

WARNING: These numbers are almost un-believable!

• 34% are now highly engaged @ 90% productivity.

.34 * .90 * 100 = 30.6% productivity level

• 55% are still not engaged and still 60% productive.

.55 * .60 * 100 = 33% productivity level

• 11% are now actively disengaged and are 40% productive

.11 * 40 *100 = 4.4% productivity level

New productivity levels = 30.6% + 33% + 4.4% = 68% 

New Profitability Calculations: 2,000,000.00 * 68% = $1,360,000.00

This represents a $50,000 improvement in the “payment vs. performance” gap in only one year!

What is also important to realize is that as long as you keep your management teams fine tuned and your culture healthy this $50,000.00 continues to flow to the bottom line year after year. Imagine the impact to your Retained Earnings and the vaule of your business that this will have in just a few short years.

All of a sudden investing in developing solid management teams with excellent leadership skills becomes one of the most important and easy ways to drive significant profits right to your bottom line.

In Closing

If you are like I was when I first started looking at these figures, your initial thinking may be that they can’t be right. But I can tell you that study after study from organizations ranging from the Harvard Business School to the McKinsey Group prove them out.

So while we have all been trained to increase profits by cutting costs; capturing more clients and negotiating for higher prices few of us have been taught how to activate one of the most significant profit drivers available to us: increased Employee Engagement.

And at a time when profits are very tight, competition is tough and the market is demanding it should be very comforting to realize that with just a few internal adjustments you can uncover a source of profits that will not only increase your bottom line but will also increase company morale.

During economic times such as these understanding the EE=EBITDA formula can be a real life saver.

Jeffrey Deckman is the founder of Capability Accelerators, a consulting firm that specializes in helping clients convert human capital into financial capital. If you have questions or comments he can be reached at JDeckman@CapabilityAccelerators.com

Jay Deragon had a great post last week on analysis versus synthesis. His points are really well taken and directly applicable to the challenges of intangible capital management.

Intangible capital includes a broad range of asset that all have as their basis, in one way or another, knowledge, learning and connection--things like people, data, systems, processes, networks, relationships, intellectual property, culture, business models are all part of intangible capital.

If you ask a manager if they are managing their intangible assets and show them a list, the answer is “of course I’m managing them.”  But the truth is that in most cases, intangibles are being managed as individual items or systems according to traditional org charts (sales, marketing, human resources, IT, operations, etc).

The right question is whether intangible capital is being managed as a system. This holistic, systemic view of intangibles fits the definition that Jay cited of synthesis:

Synthesis (from the ancient Greek) is used in many fields, usually to mean a process which combines two or more pre-existing elements and results in something new.

This is the thinking that we need in business today. We can’t view separate parts of an organization in isolation. We need to be able to see the big picture and understand how this system works.

A similar sentiment was outlined in a great article about the Secrets of the Flux Leader in Fast Company late last year that quoted John Landgraf from FX Networks:

"When I say we need a smarter organization, I mean we need multiple, different kinds of brains, of intelligence, on topics, rather than just specialists," Landgraf says.

 

*For a world of constant change, a company needs widespread mental plasticity. "In the old-style economy, where objects tend to remain in place, you could segment these types of intelligence. So you put your crazy intuitive people in marketing and your analytic people in engineering," he explains. "But as we've moved to an economy in which the adoption of new ideas happens so fast, you need all kinds of intelligence in all parts of a business. You can't have people siloed in their particular areas of strength. You have to value all styles, because you will never know which type will solve a problem."

This systemic view is harder today than in the past because most of the action is going on inside computer systems and peoples’ heads. You can’t walk through a factory and see exactly what’s going on.

So we need new management models. To be successful, an organization also needs to create a shared vision at a system level of how knowledge and connection are created and leveraged by your organization.

Use your intangible thinking to take the knowledge that already exists in your organization’s network and create something completely altogether new and very, very powerful.

There’s a new report out summarized under the headline Goodwill Impairment Holds Steady this week on the Business Finance site.

The article is full of data on things like total impairments, goodwill as a percentage of total assets, total reported versus total impaired goodwill, percentage of companies reporting impairment. All this data seems to indicate that there must be something important going on. I’m here to tell you it’s not.

What’s wrong with this picture? Instead of analyzing trends on the total amount of goodwill, someone needs to say STOP and ask why all this goodwill is there in the first place?

Because basically, goodwill is a plug number that gets booked when one company buys another. The accountants identify assets of the acquired company that can be added to the balance sheet of the acquiring company. According to an E&Y study right before the Great Recession, the acquirers' accountants can, on average, they account for 50% of the purchase price.  The rest goes into goodwill.

The reason for this is that most of the value in business today is in knowledge assets that are not eligible to be put on the balance sheet. Investments in intangibles wash through the income statement with current year operating expenses. Intangible infrastructure gets built but no one tracks it.

But when there is an acquisition, the imbalance of this approach quickly becomes apparent. Accountants have to account for the full purchase price but they don’t have any way of determining where most of the intangible value is (they usually can identify a few things like customer lists and trademarks). So they put the unidentified portion on the balance sheet and basically say that 50% of the value purchased is derived from a feeling of your customers—the “good will” that they hold for you in their hearts.

Then the charade continues as the accountants and valuators periodically recalculate the value of the business. Using fancy spreadsheets and projections, they determine if this “good will” has decreased which is then booked as a financial loss. Then, with studies like this one, the whole system just keeps rolling on. The conversation looks at all the factors that the accountants look at but nothing about the fundamentals of the underlying acquisitions.

Do you want to break away from this charade? I wish I could tell you to fire your accountants but you can’t—they have to play this game and will continue to play this game for years until accounting standards catch up with the shift away from the Industrial Era (yes, that’s where this problem started. But 10-15% goodwill back then was a logical concept. 50% is getting surreal….)

But you can develop ICounting expertise and hire an ICountant. They will help you identify all the “intangible” but very real assets you have built through years of investments in information technology, processes, data, networks, relationships, competencies (all of which are knowledge assets of one form or another). An ICountant can also help you measure these assets using both quantitative and qualitative means.

Just because the accountants call it goodwill doesn’t mean that’s what it is. Goodwill is an accounting construct. The reality is that there is a core of knowledge assets that drive the performance of a company. Don’t make another acquisition without looking beyond this artificial construct and identifying what you are really buying. 

For those who still don’t think social technologies will turn corporations upside down, here’s a dispatch from the front lines that you shouldn’t ignore: Even if It Outrages the Boss, Social Net Speech Is Protected.

In it, the NY Times reports that

Federal regulators are ordering employers to scale back policies that limit what workers can say online.

Employers often seek to discourage comments that paint them in a negative light. Don’t discuss company matters publicly, a typical social media policy will say, and don’t disparage managers, co-workers or the company itself. Violations can be a firing offense.

But in a series of recent rulings and advisories, labor regulators have declared many such blanket restrictions illegal. The National Labor Relations Board says workers have a right to discuss work conditions freely and without fear of retribution, whether the discussion takes place at the office or on Facebook.

I talk a lot about the limits to command and control management. In a knowledge-based social economy, it doesn’t make sense to let top-down communication dominate your conversation with anyone including your employees, customers, partners and lots of other kinds of stakeholders. But this ruling makes it clear. Two-way conversation is mandatory, not nice to have.

We’ve already seen countless examples of how customers can change the conversation about companies via social media. But this adds a new wrinkle. Does it mean that there will be a floodgate opened for unhappy employees to vent? Probably not. But the possibility shouldn’t be discounted. And you should welcome that.

Why should you welcome this? Because it reminds you that your actions in business can and will be held up to the scrutiny of others. It’s harder than ever to keep a secret, to control a conversation, to get away with something you would rather not have other people see.

Well, that’s not possible. So live your life, do your job, run your company in a way that will stand up to scrutiny. Not everyone will agree with everything you do. But if you are fair and transparent, you’ll be in a strong position in any disagreement.

Even more than that, the feedback from conversations with your stakeholders is gold. It often tells you more about your business in a few minutes than you can find in piles of management reports. Learning and adapting is critical to companies that depend on intangible capital. So stop trying to control the conversation and jump into it. Embrace free speech and start listening. You’ll learn something and you’ll build the trust of your stakeholders. You’ll be on  the path to building a much smarter company.

(By the way, this why all our measurement methodologies at Smarter-Companies are based on stakeholder feedback).

- Talent acquisition, talent management and succession planning are the keys to the ultimate creation of Human Capital and Shareholder Value Maximization.

The creation of enterprise value, the key to shareholder value maximization, is primarily dependent on the creation of Human Capital.  That has been my conclusion for some time, and according to Andrew McKenna, Chairman of McDonald’s Corporation, whom I heard speak this Tuesday, it seems to be his opinion too.

Mr. McKenna identified three key roles for the board of directors:  Succession planning, talent acquisition and talent management.  Without these, an enterprise has no viable future.  With these, in time it will build the Structural Capital and Relational Capital it needs to prosper.

Lower middle market companies commonly suffer from a key man (or woman) issue.  This is really just a lack of succession planning.  To build a valuable enterprise, we must hire, train, and nurture our successors.

In his first job, Mr. McKenna went to his boss to resign.  His boss asked why.  Mr. McKenna said he wanted to start his own company.  His boss asked what kind.  McKenna said, the same as yours, I’m going to be your competitor.  His boss asked who was going to finance it.  McKenna said he thought he could find financing.  His boss said, let me finance it.  McKenna asked why.  His boss said, I want you to be successful so you can buy my company.  And thus began Andrew McKenna’s rise in the corporate world.

A failure to build your company to a size that is self-sustaining isn’t an easy thing to do.  But dental practices do something different but similar all the time.  During his or her career, a dentist builds Relational Capital, as well as some Structural Capital (the office, systems, assistants, equipment, etc).

But the dentist is the talent, and when selling a practice, a new, talented dentist is sought out by the current practitioner to acquire all or part of his practice over time, thus harvesting some of the inherent Relational Capital built up over a career of quality work.  Since the buyer must be successful, the seller must seek out talent, manage it, and in the process set up his successor and buyer. In so doing, he maximizes the value of his company in the sale process, as it is sold over time.

The maximization of the enterprise value affects everything else: the ability to raise capital, the value in mergers and acquisitions, and the resistance to financial distress.  It is common for an entrepreneur to be either the key salesperson or an inventor with a technical background.  Neither tends to focus on their succession plan.

So, regardless if you are the head of one of the largest enterprises in the world, or the smallest, the same principles apply.  Talent acquisition, talent management, and succession management are the keys to value creation. To learn more, contact us

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What is this logo worth?  And to whom?     

As a bit of background, enterprise value is the total unlevered value of the firm.  If you subtract from that the market value of its tangible assets, what you have left is the market's appraisal of the total value of the intangible assets.  That is what has come to be called Intellectual Capital, and we abbreviate it as IC. 

IC is further divided into three components:  Human Capital, Structural Capital and Relational Capital. 

Human Capital comes and goes everyday, either up and down the elevator, or into and out of the parking lot.

Structural Capital is all the stuff the Humans have to work with: processes, systems,  infrastructure, intellectual property, your Six Sigma program, that sort of thing.

Relational Capital is made up of your relationships with your customers, suppliers, and depending on your industry, perhaps government or regulators.

When we look at a company like Google, or Facebook, you can see quite easily that there was some person or persons that started it all, and the company grew from there.  It is all about a person or group that had a vision or idea, and they hired and motivated other like-minded souls, and voilà, they became a force to be reckoned with.

It's a bit harder to see this effect when you look at an established company, like McDonald's   McDonald's is by many standards a relatively young company.  It was 1948 before the first hamburger was sold, and 1955 before Ray Kroc joined the company.  It's market cap as of today was $94.4 billion, and its enterprise value was $107.9 billion.  The book value of its tangible assets comes to just $29.0 billion.  That's just 27% of enterprise value, leaving the other 73% to Intellectual Capital.

For fun, lets compare that to Navistar, the old International Harvester.   Their market cap was $1.45 billion today, their debt was $4.4 billion, bringing their EV to $5.86 billion.  That compares to tangible assets of $10.5 billion.  Navistar's IC is a negative $4.64 billion.  It suggests a huge Human Capital, Structural Capital or Relational Capital  problem.  We don't see the same thing at Deere or Cat, so we know its not the industry.

Back to McDonald's, while this extra value isn't all attributable to the company's current workforce, it is all due to the company's current and past workforce.  Ray Kroc obviously gets credit for some part of that, but when you try to account for the fact that the company's earnings and revenue have grown at 9% a year for the last three years, you have to believe that something has been institutionalized.

What we are looking at is Human Capital that has been converted into Structural Capital and Relational Capital over the years.  The company now has a way of doing things (Structural Capital), a brand (Structural Capital), and a brand cache with its customers (Relational Capital).  It also has an awesome supply chain (Structural Capital) with its suppliers (Relational Capital), and impeccable quality control (Structural Capital) and marketing (Structural Capital).  But it all began with the Humans at an earlier time that precedes the current employees tenor.

So here is the point:  Human Resources - HR - is a staff function almost everywhere, and a backwater in many companies.  Yet, arguably, it is the single most important driver of shareholder value.  Why isn't it a line function?

The argument I hear is that the performance of HR is too hard to measure.  I disagree.  My belief is that the performance of HR is measured over too short of period of time, much as the rest of corporate America measures most everything.  If it didn't occur this quarter or this year, it just doesn't matter.

That is, to put it mildly, misguided.

Companies love to promote and move people and not hold them accountable for their past decisions.  I have argued in the past that banking is the poster child of this.  They reward salesmen based upon their loan production in the last quarter or year, while the performance cycle should be over the business cycle.  By the time the economy turns down, many of these 'top' salesmen are in different jobs or functions and not accountable for their decisions.

This should be changed.  Compensation should match the period over which real performance is measurable.

It takes at least two years for someone to grow into their job.  And long after that the decisions that HR makes effects their motivation and performance.  Things like training.

HR's job is to get the best people possible into the value-creating jobs.  They are also responsible for the training, measurement, compensation, perks and all else that goes into rewarding employees for good work.

Large companies need to start to focus on the HR function and bring it into the line as a real partner.  Smaller companies will find that they need to outsource certain skills.  But still, the buck stops at the top.

And speaking of the top, smaller companies commonly suffer from what has been called a "key man issue".  A key man issue is simply a failure to hire and train a successor, whether due to an absence of scale or inclination.   Its presence is a huge deduction from the enterprise value of the company.  If a business owner wants to really maximize the value of his company, he has to prepare for his own departure, whether through sale, death or other means.  He has to define what his company's secret sauce is, what its seven secret ingredients are, and ensure they survive his passing.  That is, if he values his wealth.

Resistance to HR being a line function will be felt from all sides.  HR people will not want to feel the heat of the kitchen.  If so, they aren't the heat resistant type and will need to be replaced.   Managers won't want to relinquish control of hiring and compensation decisions.  I would suggest that they either have the wrong person in HR or the manager needs to become his own HR person.  The later is the logical decision in a smaller company, with outsourced HR as a resource.

In the Knowledge Era, Human Resources should be made a line function, staffed with very talented people that take on the responsibility for the company's future.  The senior HR person should report directly to the President, and no one else.  Together, they should be the two most important people at the board meeting.

To learn more, contact us

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In combination with mapping the value of the entity or benchmarking, an owner must ascertain other aspects of the business that differentiate it from the pool of existing industry participants.

A professional business valuation, conducted by an objective expert, is the vehicle that identifies where a company’s underlying intangible value is lurking to help sellers increase shareholder wealth, as well as obtain a better deal price and identify strategic buyers.

In some cases, the intangible value of the business is far more valuable than the actual tangible value of the business. There are two ‘types’ of intangibles: Blue Sky and Goodwill. Blue Sky is the difference between the reported book value of the business and the asking price for the business. Goodwill is the remaining difference in the value of the company, as determined by a professional valuator, after all intangible and tangible assets are quantified.

For acquisition purposes, intangible value means the difference between:

• An attractive, lucrative investment and a profit for the seller; and
• An asset purchase and a breakeven or loss for the seller.

A strategic plan, which includes regular business valuations, is key if the owner ever hopes to receive desired shareholder wealth or a desirable price upon the sale of his or her business. An owner must develop a plan, execute that plan, monitor the results achieved and continually modify the plan. Not only does a business owner need to gauge the health of the business on a regular basis, the owner must also monitor the business’s attractiveness with each strategic step toward the planned exit and enhance that attractiveness to prospective outside buyers whenever possible.

From a business perspective, there are certain intangible value drivers that make a company more valuable, and these drivers make the company a more attractive investment from a buyer’s perspective. Owners must also examine the anti-drivers, or those factors that decrease the investment value. Intangible value varies not only by company, but by industry as well.

The construction/contracting industry

Contractors may be largely comprised of asset value; however, for all contractors, and especially those who do not have a substantial balance sheet (electricians, plumbers, etc.), intangible value is seen in these drivers.

• Bidding process: Is the company invited to bid? Invitations indicate community and industry goodwill.
• Bonding: Does the company qualify for sufficient bonding? Is the company required to be bonded for the contract service provided? As a bonded contractor, does the company gain contracts competitors may not?
• Clientele and diversity: Who is it comprised of (government, commercial, residential) and is it transferable? A diverse base enhances intangible value.
• Contracts and billing: The value of signed contracts to be completed and how a company bills work in progress is important. Do signed contracts exist and are they transferable to an unrelated new owner?
• Working capital: Many construction companies can be difficult to replicate due to the amount of working capital required to fund long-term projects. Maintaining sufficient working capital is critical to funding existing projects and gaining new contracts. Many construction contractors fail from lack of working capital despite showing profitability.
• Marketing and new sales techniques: How is new business generated?
• Diversity and nature of specific contracting service: Do the services offered allow for repeat business?
• Experience of management and personnel: Are managers and personnel certified?
• EEOC and workers’ compensation claims: Has the company experienced any significant litigious claims/issues?
• Longevity in industry: The business’s history is important. How long has the company operated in the industry, and is the name well-respected and recognized in the community as well? Those companies that are established with many years of operation are typically more marketable than those that are less rooted in the community.
• Union affiliated: In some regions and circumstances, union affiliation drives value down.

The retail industry

In many ways this industry is similar to wholesalers; however, retailers have a higher dependence on the immediate community and clientele base. In addition to many of the intangible value drivers of wholesale businesses, retailers must focus on improving these drivers.

• Accessibility, convenience and aesthetics of retail location: The location must be easily accessible, conveniently located and aesthetically pleasing (clean, organized, well-maintained) to visit. Along those same lines are sales per square foot and sales per employee, which are two very important benchmarks for a retail operation.
• Pricing and inventory: For retail operations, the amount of inventory can be substantial. Keeping inventory current and free from obsolescence is important.
• Branding and recognition: This coincides with marketing and clientele. Name recognition within a local community is essential to viability. The name must be associated with the customer needs.
• Marketing, advertising and sales techniques: How effective are current marketing and advertising techniques at attracting new customers? How do these techniques compare to local competitors? How often are new techniques employed?
• Repeat clientele: Repeat clientele are essential value drivers for the companies within the retail industry, and a high volume of referred clientele signals efficient operations management and a core position within the community and industry at large.

The manufacturing industry

Many small, closely-held job shops have slim margins and high costs. Therefore, the company must be seen not only as an investment vehicle but one that can provide a living wage for a buyer. Owners desiring to sell their manufacturing company should consider growing the business’s intangible value so that a future acquisition (synergistic or otherwise) significantly exceeds the value of the machinery and equipment.

• Machinery and intellectual property: Does the company stay abreast of technological trends, and is it able to maintain those trends? Manufacturing facilities should maintain technologically advanced machinery. The age of equipment is also important. Moreover, trademarks, patents and intellectual properties are all intangibles that increase the value of a manufacturing operation.
• Growth: Growth or improvements must be consistent for several years (preferably three or more), not just one or two.
• Bad debts and uncollected, lost accounts: This is a significant problem with job shops. Does this exist and if so, how are these issues overcome so that the expense rarely occurs?
• Certification: Is the company ISO certified (preferred) or ISO compliant?
• Clientele and diversity: Who is it comprised of (government, commercial), and is it transferable? A diverse revenue base enhances intangible value, whereas a concentration of clientele increases risk. Again, client concentration increases business risk. Be leery of maintaining equipment specific to any one particular client.
• Competition: If applicable, how does the company overcome competition from foreign (overseas) manufacturers who have substantially less production costs and expenses?
• Contracts: Do they exist, and are they transferable to an unrelated new owner?
• Employee benefits: If benefits are offered, is the company able to maintain the expense?
• Employee costs and retention: High labor costs in the United States, relative to foreign labor costs, have affected the manufacturing sector. What is the turnover rate, and how does the company retain productive, experienced employees?
• EPA, EEOC and workers’ compensation claims: Has the company experienced any significant litigious claims/issues?
• Experience of management and personnel: Is management and personnel certified and/or are they experienced journeymen? Buyers want to know who and how many have technical skills.
• Job costing: Does management track the cost of productivity per employee and per machine to assess profits and future growth?
• Marketing and new sales techniques: How is new business generated, and how are existing clients retained?
• Union affiliated: Again, union affiliation can drive a company’s value down.
• Working capital: Does the company maintain a sufficient ratio of sales to working capital? Steep working capital requirements create barriers to entry. Sufficient working capital is imperative for a manufacturing operation, as it implies effective operations management and an adequate turnover of receivables and inventory.

The transportation/trucking Industry

Companies within the transportation and trucking industry can be classified as either contract or service related. Typically the capital assets are held within the company itself and therefore the majority of ownership value tends to be derived from the balance sheet. To achieve a value above the fair market value (or market value) of the assets, an owner must enhance the goodwill of the company by examining those intangible value drivers listed for service entities and contractors. Trucking companies may be acquired by existing competitors to expand regional markets. However, in many cases, anti-drivers (listed as follows) hurt the investment value of a trucking enterprise.

• Cargo and freight: Does the company transport hazardous materials or freight? If not properly managed, this type of transport service could be a detriment to the company as fines and litigious matters could consume the company’s goodwill.
• Customer relationships and revenue growth: Routes and solid customer relationships contribute significantly to a transportation company’s bottom line. Also, what is the annual revenue mileage per vehicle?
• Employee retention: Long-haul truck drivers vs. short-haul, sleeper cabs versus day cabs; although the ranks of long-haul drivers expanded almost two percent over the past two years, short-haul drivers typically have a lower percentage of employee turnover. What employee retention tools does the company have in place to retain experienced and low risk drivers?
• Citations, fines, penalties, extraordinary property damage: How effective is management at controlling and reducing these types of expenses, including insurance costs (and claims) and property damage (cargo or personal). Citations and fines many times become a matter of permanent and public record.
• Licensing, permit, and the upkeep of maintenance: How effective is management at maintaining licenses, permits and tractor upkeep and maintenance records? Losing control or poor management of these areas will not only financially devastate a company but are many times a matter of permanent record if violated.
• Regional vs. multi-regional versus international: Does the company operate in multiple states or cross country borders (Mexico and Canada)? If so, how effective is management at maintaining multi-regional licenses, permits and international requirements?

The wholesale industry

Many entities within this industry are acquired to expand product diversity and regional market areas. Typically, closely-held wholesale entities have slim profit margins; therefore, to attract outside buyers, the intangible value must be enhanced and maintained. As with the other industries, the intangible value drivers for wholesalers are dependent on a basic set of factors.

• Clientele, repeat clientele and diversity: Who is it comprised of (government, commercial, residential), and is it transferable? Repeat clientele are essential value drivers, and a high volume of referred clientele signals efficient operations management and a core position within the community and industry at large. A diverse base enhances intangible value.
• Competition: Are products priced competitively? How does the company offer competitive prices and still maintain high-quality, timely wholesale services?
• Contracts: Do they exist, and are they transferable to an unrelated new owner?
• Diversity of products, inventory and pricing: A diverse product base alleviates dependence on a product, for example, with profits dependent on the health of the economy (regional or national) or industry trends and existing technology. Inventory should be current or free from obsolescence. In addition to the size of the operation, the quantity and quality of product lines is important. Pricing and purchases should focus on achieving a gross profit margin of 25 percent or more.
• EPA, EEOC and workers’ compensation claims: Has the company experienced any significant litigious claims/issues?
• Operations and facilities: Maintain adequate logistical distribution channels, good supplier pricing and terms with adequate facility size and location.
• Marketing and sales techniques: How are new contracts generated, and how are existing contracts renewed? Does the company also market via a well- constructed Web site to capture the everincreasing Internet sales business?
• Method of delivery: How are products delivered and shipped, and how effective is management at overseeing the efficiency and cost-effectiveness?
• Union affiliated: In some regions and industry sub-categories, union affiliation drives value down.
• Working capital: Does the company maintain a sufficient ratio of sales to working capital? Sufficient working capital implies effective operations management and an adequate turnover of receivables and inventory. Inventory must also be maintained at levels of profitability and consumer/ seasonal demand.

A business has intangible value drivers and anti-drivers, respectively, which make a company more valuable or decrease its value. Additionally, a company’s intangible value and goodwill are also directly correlated to the particular industry in which the company operates. Utilizing business valuation, owners must monitor the business’s attractiveness with each strategic step toward their planned goals. Overall, owners must recognize where their company’s underlying intangible value is lurking to maximize shareholder wealth, as well as maximize sell price.

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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!

Reposted from Jeffrey Deckman's WOW! bytes of wisdom blog powered by WOW! transformations a talent development consulting firm based in Boston, MA. 

EE = EBITDA is an obscure but interesting formula that, once I came to understand it, I realized uncovers an exciting new source of increased profits that any business can realize.

The “blow up” of this formula is:

Employee Engagement = Earnings Before Interest Taxes Depreciation Amortization

Before going any further I want to say that Employee Engagement (EE) is certainly not the only factor that impacts EBITDA but it does have a significant impact on your bottom line. It just also happens to be one of the easiest ways to increase profitability you will ever come across.

Why?

Because, of all the ways to increase profits such as increasing prices; decreasing costs and generating more sales increasing your levels of EE is almost completely within your control. This is because EE is largely determined by the leadership culture of your organization. And you get to control that.

In fact, a recent Melcrum Employment Engagement Survey of over 1600 HR professionals found that “The actions of senior leaders and direct managers are the most important drivers of employee engagement by a factor of between 400% and 700%.

So not only is this “silent profit driver” largely in your control but the financial impact of increasing the levels of EE in your organization is undeniably real.

In fact, I doubt you could find a single CEO of a Fortune 500 company who even questions whether increasing EE increases EBITDA.

The Numbers Behind the Science

In an effort to be as informative as possible as quickly as possible let me get right to the math.

A recent study done by the Gallup Group in October of 2011 involving thousands of participants revealed that, on average, 71% of people are “disengaged” from their work. Within this group 55% are considered “not engaged”. These people do their jobs but not much more. The other 16% are considered “actively disengaged”. These are people who are actually working against the best interests of the organization.

This leaves only 29% of the workforce who are considered “highly engaged”. These are the ones who put in extra time; think about their jobs during off hours and are energized. They are the ones who generate the most per capita profit.

This means that 7 out of 10 people in organizations are not engaged in their work. Imagine the lost productivity and profits that represents! And in today’s economy this can spell death to an organization.

The High Cost of Low Employee Engagement

Let’s look at how the level of EE in your organization affects your profitability.

The following EE vs. Productivity numbers are generally accepted throughout the industry, give or take a few percentage points:

   “Highly engaged” workers are 90% productive

   “Not engaged” workers are 60% productive

   “Actively disengaged” workers are 40% productive.

When you combine the EE and the productivity numbers the impact on profits becomes clear:

   29% are highly engaged and are 90% productive.

.29 * .90 * 100 = 26.1% productivity level

   55% are not engaged and are 60% productive.

.55 * .60 * 100 = 33% productivity level

   16% are actively disengaged and are 40% productive.

.16 * 40 *100 = 6.4% productivity level

This means that your overall productivity levels are:

26.1% + 33% + 6.4% = 65.5%

To make this real let’s assume a company spends $2 million on employee compensation. Under this scenario their ROI on that investment is:

2,000,000.00 * 65.5% = 1,310,000.00.

This represents a $690,000 “payment vs. performance” gap.

The Big Difference of a Small Adjustment

Now let’s look at the impact to your bottom line that will occur if you simply increase the highly engaged numbers by only 5% and decrease the actively disengaged numbers by the same amount. And if your company is like most, and if you decide to make EE a priority in your organization, moving your EE numbers 5% in this fashion is not unrealistic at all.

WARNING: These numbers are almost un-believable!

   34% are now highly engaged @ 90% productivity.

.34 * .90 * 100 = 30.6% productivity level

   55% are still not engaged and still 60% productive.

.55 * .60 * 100 = 33% productivity level

   11% are now actively disengaged and are 40% productive.

.11 * 40 *100 = 4.4% productivity level

New productivity levels = 30.6% + 33% + 4.4% = 68%

New Profitability Calculations: 2,000,000.00 * 68% = $1,360,000.00

This represents a $50,000 improvement in the “payment vs. performance” gap in only one year!

What is also important to realize is that as long as you keep your management teams fine-tuned and your culture healthy this $50,000.00 continues to flow to the bottom line year after year. Imagine the impact to your Retained Earnings and the value of your business that this will have in just a few short years.

All of a sudden investing in developing solid management teams with excellent leadership skills becomes one of the most important and easy ways to drive significant profits right to your bottom line.

In Closing

If you are like I was when I first started looking at these figures, your initial thinking may be that they can’t be right. But I can tell you that study after study from organizations ranging from the Harvard Business School to the McKinsey Group prove them out.

So while we have all been trained to increase profits by cutting costs; capturing more clients and negotiating for higher prices few of us have been taught how to activate one of the most significant profit drivers available to us: increased Employee Engagement.

And at a time when profits are very tight, competition is tough and the market is demanding it should be very comforting to realize that with just a few internal adjustments you can uncover a source of profits that will not only increase your bottom line but will also increase company morale.

During economic times such as these understanding the EE=EBITDA formula can be a real life saver.

 ***

Jeffrey Deckman is the founder of Capability Accelerators, a consulting firm that specializes in helping clients convert human capital into financial capital. If you have questions or comments he can be reached at:  www.capabilityaccelerators.com or  JDeckman@CapabilityAccelerators.com

This essay was written for a book to be published later this year in Italy by Smarter-Companies member Andrea Gasperini. We'll share a link to the book when it comes out!

I write this essay as we enter the year 2013. A new year is a popular time for predictions. There’s always risk in trying to make predictions but I welcome the opportunity to sketch out some of my ideas as a way to add to the collective conversation about the field of IC.  To do this, I’ll use the basic journalism questions we were taught in school:

Who is going to drive the future adoption of IC ideas? I believe consultants are the key.

The basic definition of IC includes many categories of knowledge—human, relationship, structural and strategic capital. This definition suggests a holistic vision of organizations. Today, only the CEO takes charge of such a holistic vision. Yet, the CEO cannot do the work of developing and implementing IC concepts. The same goes for the COO and CFO, two other managers who have a broad vision of the organization.

Consultants, on the other hand, get paid to bring new ideas to companies. They have the flexibility, time and ability to organize projects aimed at driving change and improvements (assuming they are hired to do so). So consultants will be key change agents 

In the long run, however, I do not believe that any one person will be responsible for IC. That's because IC will be everyone's job.  Everyone in business will have to have some basic skills in what I like to call ICounting. ICounting will be a skillset, not a job.  And at the beginning, consultants will be important in introducing this skillset to the market.

What will be the character of the IC ideas that are adopted? Simple and specific.

The IC community has done amazing work to develop concepts and frameworks for the knowledge intangibles that have become the core asset class in organizations today. But intangibles are not an easy subject and too many of the solutions are complex and theoretical.

Management teams don’t have time for a lot of theory. They need relevant and actionable information. To me, this suggests that most of the conversation with management teams needs to be about their own unique intangibles. This is why my company has offered two simple tools as open source methodologies:  The first is the ICounts Index which helps business people determine the relative importance of tangible vs. intangible assets in their own companies.  The second is the ICounts Inventory which helps business people create a list of the core intangibles of their company.  This inventory can be the foundation for all kinds of strategic measurement and management projects. But the right next steps depend on the company and the situation. There’s no one right answer except to keep it simple and specific to the unique intangibles of each organization.

Over time, the uses of IC information will grow more prevalent, more complex and more detailed. But it will start out simply.

Where will this happen? – From the bottom up

One of the great lessons of the era in which we live is that top-down solutions don’t work well anymore. Knowledge and power don't flow from the top down today. We need to remember that. IC will never be adopted because someone tells companies they have to do it. The action will be with individuals, teams, divisions and, eventually, larger organizations.  Their inspiration will come from each other and from the internet, but not from the business schools or the government or the IASB.

This has been a tough lesson for the IC community. Even though we in this community are forward thinkers, we are like everyone in our generation, a product of our formation. A lot of the things we were taught about making things happen date back to the industrial era. Too often we default to looking for the top-down solution, for the set of rules or requirements that will require adoption of our ideas. Give up that dream now. Start thinking about how to foment change from the bottom up.

Why will business people finally pay attention to IC? – Social is the tipping point

When you see the data, the shift away from the industrial economy has happened gradually over decades (albeit with two spikes with the introduction of the PC and the internet). IC is already the currency of our current era. But the ideas have not taken hold because most people have been able to cope with the new economy using the old core of tools (GAAP accounting, organization charts, and command and control management) with just small adjustments at the margins. Until now, using old tools might have slowed you down but they haven’t been viewed as a liability.

But now we are at the point where old management concepts are actually doing harm to companies. They block the movement of knowledge and learning. They prevent innovation. They motivate employees to guard rather than share knowledge. They encourage competition rather than collaboration.

The introduction of social technologies is turbo-charging this trend. Social technologies (beginning but not ending with social media) empower employees, customers, partners, stakeholders and the general public to comment and critique everything an organization does. They also create the opportunity for individuals to share their knowledge—but only if they want to. This shifts the balance of power. If you don’t have engaged stakeholders who trust you, you don’t have a license to do business. Mainstream managers are sensing this and scrambling to find an alternative set of tools for their toolkit. IC is at the core of this nee toolkit.

When will IC cross the chasm?  In 2015

OK. This one is a shot in the dark. But I feel that the shift is already beginning  and we will move from early innovators to the mainstream business community in a couple years or so. Why? Economic stagnation and the need for innovation make the need for change more urgent all the time. And, as explained above, social technologies are making it clear that change is necessary. But the real reason that I believe that it will happen is because these new social technologies will make it easy to change (more on this below)

How – By building a collaborative ecosystem

One of the great opportunities of the moment in which we live is the ability to create collaborative ecosystems. John Dumay calls this the shift from competitive advantage to collaborative advantage. A community that bands together to collaborate in building a market has the potential to disrupt the status quo and compete with even the largest company or the most entrenched ideas.

To spread IC thinking, we need to adopt 2.0 collaborative thinking and change the world from the bottom up. At Smarter-Companies we are creating a prototype of such an ecosystem.  We are offering our own tools and training side by side with the tools developed by other companies.  None of us has all the answers but together we can come close.  And by collaborating and sharing what we learn, we will get better and faster answers than we could on our own.

What's the future of IC? Let's create it together!