|
Knowledge management and intellectual capital
are the buzzwords that have launched a thousand books, articles and
conferences. Are they just another passing fad, or do they offer
useful measures of performance? That's hard to tell. As yet, nobody practicing knowledge management has succeeded in measuring whether their knowledge assets have increased or diminished. The measurement schemes out there are jumbles of facts, subjective evaluations and opinions. These schemes show only that knowledge management is evolving from magic to astrology and is still far from offering managers repeatable, unambiguous and useful metrics. To overcome that deficiency, I will show that knowledge assets are indeed quantifiable. Here's a way to measure knowledge based on hard numbers, not opinions.
Linking knowledge assets AND financial measuresThe true measure of knowledge is in observing outputs.The surest way to determine an organization's worth is to sell it. The price reflects whether the company's worth is greater than its reported financial assets. That happens during mergers, acquisitions, buyouts and whenever company stock is traded. The value of a company's knowledge can be explained as the difference between its reported financial assets and its actual market value, which is the share price multiplied by the number of shares. Unfortunately, it's impractical to calculate the value of a company's knowledge that way. Stock prices fluctuate for reasons unrelated to anything employees may know. Hostile acquisition offers don't necessarily reflect the acquirer's esteem for the knowledge of the company's managers. Therefore, one must seek out valuation in ways that reflect the economic values the employees create.
Calculating Knowledge Capital®Knowledge Capital forms when employees think or talk about how they are delivering goods and services. That usually occurs when workers are engaged in overhead tasks, not when they're actually delivering goods or services.If learning, training, talking, writing and communicating make for improved productivity, it will reveal itself as improved economic performance and will become measurable in dollars. That real money is the return on the newly created Knowledge Capital. It discloses the value of the knowledge that has been unleashed by informed actions.
What are the measurable annual outputs from the accumulation of knowledge?I call that "information value-added"; economists call it net surplus economic value. It's what's left after you pay suppliers, the government, employees, creditors and shareholders and after you replace obsolete assets. But information value-added isn't the same as Knowledge Capital. Knowledge Capital is that intangible source that makes it possible to generate annual profits. To state it another way: If Knowledge Capital is the principal, then information value-added is its annual yield. If you know what the investors' minimum expected rate of return is, it's easy to calculate the worth of the asset from which it originates.That approach makes Knowledge Capital a calculable number.Take, for example, the valuation of the Knowledge Capital for Microsoft. At the end of 1996, its financial capital was $7 billion. After subtracting from its 1996 profits of $2.2 billion the interest payments for the capital, which was $210 million, we are left with Microsoft's information value-added of $2 billion. To generate such an amount implies, using Microsoft's low cost of equity capital, the presence of an intangible principal of $67 billion ($2 billion divided by .03, the fraction of financial capital used to pay interest), which is then Microsoft's Knowledge Capital.It just happens that the stock market valuation of Microsoft at the end of 1996 was $98.6 billion. In other words, exuberant investors attributed to Microsoft a Knowledge Capital valuation of $91.6 billion ($98.6 billion minus $7 billion in financial assets). Any way you look at it, Microsoft's Knowledge Capital lies somewhere between $67 billion and $91.6 billion. A comparable analysis of 359 U.S. industrial companies shows Knowledge Capital worth $1.7 trillion, or 217% of their net financial assets. Clearly, knowledge is more important than what the accountants record as tangible assets.
Putting the measures to workThe gain in the worth of a company's Knowledge Capital is arguably the most important indicator of its success in the Information Age. It should be instrumental in changing the attitudes of accounting-minded executives about the value of information.For example, if a company scraps 100 forklift trucks before their depreciation is written off, it would be recorded as a loss for accounting purposes. But if 1,000 employees with career-life learning costs of at least $150 million leave a corporation, none of the financial reports would reflect that as a loss. And the stock market may actually recognize it as a gain. Many of the faults with today's information management practices can be traced to such bias, which favors accounting over knowledge-generating assets. One can view Knowledge Capital as the consequence of a stream of expenses that makes a company more effective. Meetings may contribute to greater employee awareness. Training is useful if put to good use. Software need not be an expense if it's reused. Everything that contributes to an accumulation of knowledge can become a capital investment with sound information management practices. Every manager should, therefore, monitor which portion of his overhead expense is temporary and how much of it builds capital. Such monitoring is possible by tracking a firm's overhead-to-Knowledge Capital conversion efficiency. For example, the 10-year sum of all overhead expenses for a prominent pharmaceutical company adds up to $18.9 billion. For that period, I calculated its Knowledge Capital growth as $8.6 billion. With a conversion efficiency of 45.5%, that firm belongs to the U.S. elite, and I can prove that by numbers, not by opinion surveys. (Microsoft's overhead-to-Knowledge Capital conversion efficiency is a spectacular 451%.)
Implications for CIOsBy recognizing that Knowledge Capital is a measurable quantity, the executives in charge of information management should be able to shift from their preoccupation with short-run expense efficiency to a new perspective: how to create valuable knowledge assets. The right set of measures will help in explaining and justifying how to accomplish that objective.
Paul Strassmann (www.strassmann.com) holds the registered trademark on Knowledge Capital® from the U.S. Patent and Trademark Office. He can be contacted at paul@strassmann.com. |
Go back up to the Strassmann, Inc. home page.