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...ppliers, customers, allies, local communities, government, shareholders, etc.), organisation (including structure, culture, routines and processes) and renewal and development (all the projects for the future: R&D, new plants, new products, BPR, etc.). The Knowledge Toolbox 13 Identifying the different types of intellectual capital can be likened to the identification of stocks of intangible resources: this however is not enough. It is essential to measure, and thus manage, also the flows of intellectual capital, that is the changes in the stocks of intangible resources (Roos and Roos, 1997). Dierickx and Cool (1989) make a fundamental distinction between stocks and flows of knowledge by using the bathtub metaphor: At any point in time, the stock of water is indicated by the level of water in the tub; it is the cumulative result of flows of water into the tub (through the tap) and out of it (through the leak). In the example of R&D the amount of water in the tub represents the stock of know-how at a particular moment in time, whereas the current R&D spending is represented by the water flowing in through the tap; the fact that knowhow depreciates over time is represented by the flow of water leaking throu...

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...ers exclusively. The corporate governance debate however is not so clear cut. Some organisation might thus resent this characterisation of their institutional goal, either because of their particular circumstances (for example, state-owned companies), on ideological grounds or simply because they believe that other perspectives on governance are more fruitful for their long-term development. It remains to be seen whether the EVA can be adapted to respond to these other governance viewpoints. BALANCED SCORECARD (BSC) After a multi-year, multi-company study sponsored by Harvard Business School, Kaplan and Norton (1996) suggested that managers need a multi-dimensional measurement system to guide their decisions: a Balanced Scorecard (BSC) including leading and lagging indicators and measurements The Knowledge Toolbox 9 focusing on the outside and the inside of the company. It was not the first time that companies were encouraged to monitor non-financial measures (Eccles, 1991). By the early 1990s, many organisations were already measuring cycle times, quality rates, customer satisfaction, market shares: all of these measures are non-financial. The new idea however, was to encourage the systematic measurement...

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...ies (mainly Skandia, Dow Chemicals and the Canadian Imperial Bank of Commerce) who started using it as a blanket denomination of all intangible resources. These companies realised that the existing frameworks (including some of the ones we reviewed above) could not address the issues they were facing, and tried to develop something new. Thus, IC is very much a practitioner-created concept, and only more recently did scholarly contributions appear to analyse its use and potential. OPERATIONALISATION Under the name of intellectual capital, we can classify all intangible resources (Bontis, 1996; Edvinsson and Malone, 1997; Roos and Roos, 1997), as well as their interconnections (Roos et al., 1997; Bontis, 1998). Thus, for this tradition, intellectual capital is quite simply the collection of intangible resources and their flows. The problem is the definition of intangible resources: for the purposes of this paper, suffice it to say that we will call resources any factor that contributes to the value generating processes of the company and is, more or less directly, under the control of the company itself. Thus, the goodwill of the local community is an intangible resource (because the company can influence) an...

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... blanket denomination of all intangible resources. These companies realised that the existing frameworks (including some of the ones we reviewed above) could not address the issues they were facing, and tried to develop something new. Thus, IC is very much a practitioner-created concept, and only more recently did scholarly contributions appear to analyse its use and potential. OPERATIONALISATION Under the name of intellectual capital, we can classify all intangible resources (Bontis, 1996; Edvinsson and Malone, 1997; Roos and Roos, 1997), as well as their interconnections (Roos et al., 1997; Bontis, 1998). Thus, for this tradition, intellectual capital is quite simply the collection of intangible resources and their flows. The problem is the definition of intangible resources: for the purposes of this paper, suffice it to say that we will call resources any factor that contributes to the value generating processes of the company and is, more or less directly, under the control of the company itself. Thus, the goodwill of the local community is an intangible resource (because the company can influence) and therefore a part of intellectual capital. The tax system, instead, is not, unless the com...

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...ursuing the objective of continuous improvement in their knowledge assets (Senge, 1990). The Knowledge Toolbox 2 But there is more. Recent contributions have suggested that knowledge and information are actually subject to increasing returns, as opposed to the decreasing returns typical of the traditional resources. If this is true, then knowledge and information become even more attractive to companies than before. Having a good base of knowledge means that a company can in future years start leveraging that base to create even more knowledge thus increasing its advantage on the competitors (Arthur, 1996). What is even more striking is that the market has long recognised the value of knowledge and other invisible factors in the value creating process. It is thus very common for companies to be valued more than their net assets would justify, precisely because of these invisible components. What has changed recently is the size of this “hidden value”. In 1986 Merck had the biggest gap: its net assets covered just 12.3% of its market value; in 1996, Coca-Cola’s assets were only 4% of its value, whereas the same figure for Microsoft was 6%. At the same time, some companies are trading below book ...

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...g-term development. It remains to be seen whether the EVA can be adapted to respond to these other governance viewpoints. BALANCED SCORECARD (BSC) After a multi-year, multi-company study sponsored by Harvard Business School, Kaplan and Norton (1996) suggested that managers need a multi-dimensional measurement system to guide their decisions: a Balanced Scorecard (BSC) including leading and lagging indicators and measurements The Knowledge Toolbox 9 focusing on the outside and the inside of the company. It was not the first time that companies were encouraged to monitor non-financial measures (Eccles, 1991). By the early 1990s, many organisations were already measuring cycle times, quality rates, customer satisfaction, market shares: all of these measures are non-financial. The new idea however, was to encourage the systematic measurement of these quantities, and to link all these measures in a coherent system. A similar suggestion emerged in France in the 1950s and 1960s, and coalesced into a tool called Tableau de Bord; the literature on the Tableau however was never translated, and thus had little echo across the Ocean (Epstein and Manzoni, 1998). OPERATIONALISATION The BSC organises its meas...

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...A NEW SET OF RULES Welcome to the information age, where products and companies live and die on information and the most successful companies are the ones who use their intangible assets better and faster. Knowledge and information are nowadays the drivers of company life, much more so than land, capital or labour. What does this mean for managers? The increased importance of knowledge does not simply add an additional variable to the production process of goods: it changes substantially the rules of the game. The capacity to manage knowledge-based intellect is the critical skill of this era (Quinn, 1992). The wealth-creating capacity of the enterprise will be based on the knowledge and capabilities of its people (Savage, 1990). Firms that are thriving in the new strategic environment see themselves as learning organisations pursuing the objective of continuous improvement in their knowledge assets (Senge, 1990). The Knowledge Toolbox 2 But there is more. Recent contributions have suggested that knowledge and information are actually subject to increasing returns, as opposed to the decreasing returns typical of the traditional resources. If this is true, then knowledge and information become e...

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...arted using it as a blanket denomination of all intangible resources. These companies realised that the existing frameworks (including some of the ones we reviewed above) could not address the issues they were facing, and tried to develop something new. Thus, IC is very much a practitioner-created concept, and only more recently did scholarly contributions appear to analyse its use and potential. OPERATIONALISATION Under the name of intellectual capital, we can classify all intangible resources (Bontis, 1996; Edvinsson and Malone, 1997; Roos and Roos, 1997), as well as their interconnections (Roos et al., 1997; Bontis, 1998). Thus, for this tradition, intellectual capital is quite simply the collection of intangible resources and their flows. The problem is the definition of intangible resources: for the purposes of this paper, suffice it to say that we will call resources any factor that contributes to the value generating processes of the company and is, more or less directly, under the control of the company itself. Thus, the goodwill of the local community is an intangible resource (because the company can influence) and therefore a part of intellectual capital. The tax system, instead, is not,...

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...micals and the Canadian Imperial Bank of Commerce) who started using it as a blanket denomination of all intangible resources. These companies realised that the existing frameworks (including some of the ones we reviewed above) could not address the issues they were facing, and tried to develop something new. Thus, IC is very much a practitioner-created concept, and only more recently did scholarly contributions appear to analyse its use and potential. OPERATIONALISATION Under the name of intellectual capital, we can classify all intangible resources (Bontis, 1996; Edvinsson and Malone, 1997; Roos and Roos, 1997), as well as their interconnections (Roos et al., 1997; Bontis, 1998). Thus, for this tradition, intellectual capital is quite simply the collection of intangible resources and their flows. The problem is the definition of intangible resources: for the purposes of this paper, suffice it to say that we will call resources any factor that contributes to the value generating processes of the company and is, more or less directly, under the control of the company itself. Thus, the goodwill of the local community is an intangible resource (because the company can influence) and therefore a part of ...

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...ure for Microsoft was 6%. At the same time, some companies are trading below book value, which might be suggestive of the existence of “intellectual liabilities” (Harvey and Lusch, 1999). Companies however were the first to realise that something was changing. In the last decade, the job title of Chief Knowledge Officer (CKO) has been showing up on annual reports and in job advertisements with ever-increasing frequency. Present and future success in competition will be based less on the strategic allocation of physical and financial resources and more on the strategic management of knowledge (Bontis, 1996), and these path-finding individuals have been given the unenviable task of channelling their organisation’s knowledge into corporate initiatives that become the essential source of competitive advantage. Unfortunately, knowledge is invisible and intangible, and thus it is not captured very well by any of the traditional measures, accounting or otherwise, that corporations master in their everyday operations. This means that managers run the risk of “forgetting” that knowledge and the other intangible assets are there, or underestimating their value and contribution, and thus take decision whi...

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...erformance, like Return on Assets (ROA) and Return on Equity (ROE) have long been criticised for their inadequacy in guiding strategic decisions. In particular, they do not consider the cost of capital incurred to fund the projects that generate these returns, and thus are severely lacking as instruments to guide managers in their quest for value-creating venues. They are also highly aggregated which means that they often confound the impact of different strategic factors, such as product differentiation leading to higher price recovery and productivity improvement providing a cost advantage (Stewart, 1994). In addition they often fail to shed light on underlying causes of high or low performance. For instance, a firm pursuing a cost leadership strategy may improve its productivity and lower its prices. The impact of these two managerial actions may be offsetting, and no change may be registered in the ratio to reflect these actions (Banker et al., 1996). Economic Value AddedTM (hereafter referred to as EVA, a registered trademark) was introduced by Stern Stewart & Co., a New York-based consulting firm, in the late 1980s as a tool to assist corporations to pursue their prime financial directive ...

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... operations to a new production method, characterised by a smaller optimal batch size. The added flexibility that came from the reduced batch size was balanced, however, by a reduced quality, or, to be more precise, a less uniformly high quality. The solution was simple and genial at the same time: companies started to customise steel, so that each batch would perform its appointed task perfectly, but would not be suitable to different uses. To pull off the revolution in the rules of the game, steel mills had to put an enormous information processing system in place, and rely heavily on that (Webber, 1993). Thus, though a ton of steel still remained a ton of steel, it contained a lot more information. Now, fifteen years later, we cannot say that steel mills are flourishing; they have certainly improved their position, though, since the beginning of the eighties. A NEW SET OF RULES Welcome to the information age, where products and companies live and die on information and the most successful companies are the ones who use their intangible assets better and faster. Knowledge and information are nowadays the drivers of company life, much more so than land, capital or labour. What does this mean f...

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...ional measures, accounting or otherwise, that corporations master in their everyday operations. This means that managers run the risk of “forgetting” that knowledge and the other intangible assets are there, or underestimating their value and contribution, and thus take decision which in the long term might prove harmful precisely because they damage the “intangible asset stock” of the company. What is even worse, the attention of the company will be focused on improving the efficiency of its physical assets only, because that is what gets measured, appraised and evaluated by senior managers (Hauser and Katz, 1998). Knowledge managers may thus feel that they have been asked the impossible: how can they use accounting tools, developed five hundred years ago to help merchants in the feudal era, to make the key success factors of the information age visible? Once the need for new tools is recognised, how do you choose among the many alternatives suggested by different sources? How do they stop jumping on the bandwagon of the latest faddish instrument that promises success and competitive dominance? The Knowledge Toolbox 3 We believe that answers to these three questions may come only from a deep understand...

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...ompanies were encouraged to monitor non-financial measures (Eccles, 1991). By the early 1990s, many organisations were already measuring cycle times, quality rates, customer satisfaction, market shares: all of these measures are non-financial. The new idea however, was to encourage the systematic measurement of these quantities, and to link all these measures in a coherent system. A similar suggestion emerged in France in the 1950s and 1960s, and coalesced into a tool called Tableau de Bord; the literature on the Tableau however was never translated, and thus had little echo across the Ocean (Epstein and Manzoni, 1998). OPERATIONALISATION The BSC organises its measurement system in four perspectives. The financial perspective includes traditional accounting measures. The authors however suggest the adoption of different measures for different parts of the company, sacrificing comparability to fit with the SBU’s strategy. The customer perspective groups measures relating to the identification of target groups for the company’s products in addition to marketing-focused measures of customer satisfaction, retention, etc. The internal business process draws heavily from the concept of the value chain. Kaplan and...

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...cessful companies are the ones who use their intangible assets better and faster. Knowledge and information are nowadays the drivers of company life, much more so than land, capital or labour. What does this mean for managers? The increased importance of knowledge does not simply add an additional variable to the production process of goods: it changes substantially the rules of the game. The capacity to manage knowledge-based intellect is the critical skill of this era (Quinn, 1992). The wealth-creating capacity of the enterprise will be based on the knowledge and capabilities of its people (Savage, 1990). Firms that are thriving in the new strategic environment see themselves as learning organisations pursuing the objective of continuous improvement in their knowledge assets (Senge, 1990). The Knowledge Toolbox 2 But there is more. Recent contributions have suggested that knowledge and information are actually subject to increasing returns, as opposed to the decreasing returns typical of the traditional resources. If this is true, then knowledge and information become even more attractive to companies than before. Having a good base of knowledge means that a company can in future years start ...

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...complicated. Another limitation is that the calculation of EVA uses book values of (net) assets. These will in many instances be based on historic cost, which might give little indication of current market or replacement value. The argument for using historic cost is however that the market values would have to be updated on a regular basis, and that the volatility of the values, and possible estimation subjectivity, would impose large costs on a measurement system, and reduce the objectivity of the measures. Although there is evidence to date showing that EVA and stock prices are correlated (Lehn and Makhija, 1996), can it be claimed that EVA is better at explaining stock price than alternative measures of performance? The evidence seems to suggest otherwise, as studies reveal no additional explanatory power over accounting profit in explaining stock price and only a relatively low correlation between variations in EVA and variations in stock prices (Dodd and Chen, 1997). As a final comment, it is important to note that EVA assumes a definite governance perspective: the starting point for the EVA analysis is that companies should be run in the interest of shareholders exclusively. The corporate governan...

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...knowledge and other invisible factors in the value creating process. It is thus very common for companies to be valued more than their net assets would justify, precisely because of these invisible components. What has changed recently is the size of this “hidden value”. In 1986 Merck had the biggest gap: its net assets covered just 12.3% of its market value; in 1996, Coca-Cola’s assets were only 4% of its value, whereas the same figure for Microsoft was 6%. At the same time, some companies are trading below book value, which might be suggestive of the existence of “intellectual liabilities” (Harvey and Lusch, 1999). Companies however were the first to realise that something was changing. In the last decade, the job title of Chief Knowledge Officer (CKO) has been showing up on annual reports and in job advertisements with ever-increasing frequency. Present and future success in competition will be based less on the strategic allocation of physical and financial resources and more on the strategic management of knowledge (Bontis, 1996), and these path-finding individuals have been given the unenviable task of channelling their organisation’s knowledge into corporate initiatives that become the essential s...

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...y of the values, and possible estimation subjectivity, would impose large costs on a measurement system, and reduce the objectivity of the measures. Although there is evidence to date showing that EVA and stock prices are correlated (Lehn and Makhija, 1996), can it be claimed that EVA is better at explaining stock price than alternative measures of performance? The evidence seems to suggest otherwise, as studies reveal no additional explanatory power over accounting profit in explaining stock price and only a relatively low correlation between variations in EVA and variations in stock prices (Dodd and Chen, 1997). As a final comment, it is important to note that EVA assumes a definite governance perspective: the starting point for the EVA analysis is that companies should be run in the interest of shareholders exclusively. The corporate governance debate however is not so clear cut. Some organisation might thus resent this characterisation of their institutional goal, either because of their particular circumstances (for example, state-owned companies), on ideological grounds or simply because they believe that other perspectives on governance are more fruitful for their long-term development. It rema...

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...ur. What does this mean for managers? The increased importance of knowledge does not simply add an additional variable to the production process of goods: it changes substantially the rules of the game. The capacity to manage knowledge-based intellect is the critical skill of this era (Quinn, 1992). The wealth-creating capacity of the enterprise will be based on the knowledge and capabilities of its people (Savage, 1990). Firms that are thriving in the new strategic environment see themselves as learning organisations pursuing the objective of continuous improvement in their knowledge assets (Senge, 1990). The Knowledge Toolbox 2 But there is more. Recent contributions have suggested that knowledge and information are actually subject to increasing returns, as opposed to the decreasing returns typical of the traditional resources. If this is true, then knowledge and information become even more attractive to companies than before. Having a good base of knowledge means that a company can in future years start leveraging that base to create even more knowledge thus increasing its advantage on the competitors (Arthur, 1996). What is even more striking is that the market has long recognised the va...

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...-creating venues. They are also highly aggregated which means that they often confound the impact of different strategic factors, such as product differentiation leading to higher price recovery and productivity improvement providing a cost advantage (Stewart, 1994). In addition they often fail to shed light on underlying causes of high or low performance. For instance, a firm pursuing a cost leadership strategy may improve its productivity and lower its prices. The impact of these two managerial actions may be offsetting, and no change may be registered in the ratio to reflect these actions (Banker et al., 1996). Economic Value AddedTM (hereafter referred to as EVA, a registered trademark) was introduced by Stern Stewart & Co., a New York-based consulting firm, in the late 1980s as a tool to assist corporations to pursue their prime financial directive by aiding in maximising the wealth of their shareholders (Stewart, 1994). In the broadest terms, EVA is a comprehensive financial management measurement system that can be used to tie together capital budgeting, financial planning, goal setting, performance measurement, shareholder communication and incentive compensation. The objective of EVA is to de...

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.... The remaining figure represents the human capital value of the firm in currency unit terms. CRITICAL REVIEW Anyone can see that there are too many assumptions that must be made when using HRA models. It is difficult to project what the size of a company will be in the next fiscal period let alone ten years from now. Furthermore, assumptions about tenure per employee, turnover and salary increases are all educated guesses at best. Some HRA models also include other assumptions which violate common sense, have been empirically disproven or are inconsistent with other tenets of the same model (Lindell, 1996). HRA’s problems have always been known. All of the models suffer from subjectivity and uncertainty and lack reliability in that their measures cannot be audited with any assurance. Both of these are measurement problems. Other criticisms of HRA include whether it is morally acceptable to treat people as assets and whether such measures are too easily manipulated. Although these arguments are salient comments on HRA, they beg the question of whether human assets in organisations do have value. The question thus arises: are “auditable” valuations of human assets necessary in the conventional se...

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...urn on net assets, and vice versa. CRITICAL REVIEW Even though EVA does not explicitly relate to the management of intangible resources, the implicit argument here is that the effective management of knowledge assets will increase EVA. All the same, this origin implies that no specific measures are developed for the assessment of the potential contribution of investments in intangibles. Indeed, some strategy researchers support the idea of using EVA measures as a surrogate measure for the stock of intellectual capital and that EVA can be viewed as a measure for return on intellectual capital (Marchant and Barsky, 1997). The implication is that these investments should still be judged according to the standard criteria for assessing any long-term project: net present value, cost benefit analysis, etc. The complication, which we hinted in the introduction, comes from the ephemeral nature of intangible resources: how do you estimate the value of a training program? Or of the creation of a best practice database? EVA pretends to do just that, through the innumerable adjustments to the value and the cost of capital that have been suggested. In defining the EVA measures, Stern Stewart & Co. has identified 164 dif...

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...y, and developed a lot more, by practitioners, consultants and researchers alike. EVA provides a common language and benchmark for managers to discuss value creation: projects become easily comparable, and managers can respond to the pressure for performance accountability through the use of an appropriate metrics (Young, 1998). More than that, EVA is blessed with widespread acceptance in the financial community, and thus can increase the legitimacy of a company in the eyes of the financial markets, as a valuable measure of corporate value creation or destruction over a given period (CS First Boston, 1996). OPERATIONALISATION According to the EVA supporters, maximising the shareholders wealth is not the same as maximising the company’s total market value. A company’s total value can be maximised simply by investing as much capital in it as possible. Shareholder’s wealth is on the other hand maximised only by maximising the difference between the firm’s total value and the total capital that the investors have committed to it. This difference is called market value added (MVA). The spread represents the difference between the cash that the firm’s investors have put into the business since the st...

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...untants have long known a closely related acronym: RI, or residual income (McConville, 1994). Residual income is the value remaining after a company’s stockholders and all other providers of capital have been compensated. The difference is that EVA has been taken a lot more seriously, and developed a lot more, by practitioners, consultants and researchers alike. EVA provides a common language and benchmark for managers to discuss value creation: projects become easily comparable, and managers can respond to the pressure for performance accountability through the use of an appropriate metrics (Young, 1998). More than that, EVA is blessed with widespread acceptance in the financial community, and thus can increase the legitimacy of a company in the eyes of the financial markets, as a valuable measure of corporate value creation or destruction over a given period (CS First Boston, 1996). OPERATIONALISATION According to the EVA supporters, maximising the shareholders wealth is not the same as maximising the company’s total market value. A company’s total value can be maximised simply by investing as much capital in it as possible. Shareholder’s wealth is on the other hand maximised only by maximis...