Performance Measurement from the Intellectual Capital Perspective. A theoretical approach through a groupware-based intranet application


Diploma Thesis, 2000
96 Pages, Grade: 1 (A)

Excerpt

CONTENTS

Figures

Tables

Abbreviations

1 Introduction

2 Strategic Management in the Information Age
2.1.1 The Industry-Based View of the Firm
2.1.2 The Resource-Based View of the Firm
2.2 A New Type of Organization
2.2.1 Characteristics of the New Organization
2.2.2 New Organizational Forms
2.2.3 New Strategies
2.3 Value Creation in the Information Age

3 Intellectual Capital
3.1 Shortcomings of Traditional Accounting Methods
3.2 Economics of Knowledge-Based Resources
3.3 The Concept of Intellectual Capital
3.3.1 Human Capital
3.3.2 Structural Capital
3.3.3 Customer Capital

4 Performance Measurement with the Balanced Scorecard
4.1 Financial Perspective
4.2 Customer Perspective
4.3 Internal Business Process Perspective
4.4 Learning and Growth Perspective
4.5 The BSC as a Strategic Management System
4.5.1 Cause-and-Effect Relationships
4.5.2 Implementing a Balanced Scorecard
4.5.2.1 Clarifying and Translating Vision and Strategy
4.5.2.2 Communicating and Linking
4.5.2.3 Planning and Target Setting
4.5.2.4 Strategic Feedback and Learning
4.6 A Critical Look at the Balanced Scorecard

5 Enabling the Balanced Scorecard
5.1 Requirements for an Automated Balanced Scorecard
5.1.1 Strategic Requirements
5.1.2 Technical Requirements
5.1.3 A Critical Look at Automated Balanced Scorecard Solutions
5.2 NetFicient
5.2.1 NetFicient Add-Ons
5.2.2 NetFicient Knowledge
5.2.3 eSurvey and NetFicient Project
5.2.4 A Critical Look at NetFicient to Support a Balanced Scorecard
5.3 Conclusion

6 Outlook

Appendix

A-1 The Structural Analysis of Industries – Porter’s Five Forces
A-1.1 Threat of Entry
A-1.2 Intensity of rivalry among existing competitors
A-1.3 Pressure from substitute products
A-1.4 Bargaining power of buyers
A-1.5 Bargaining power of suppliers

A-2 Sveiby’s Balance Sheet of Intangible Assets

A-3 Intellectual Capital Measures
A-3.1 Financial Perspective
A-3.2 Customer Perspective
A-3.3 Internal Business Process Perspective
A-3.4 Learning and Growth Perspective

Bibliography

Figures

Figure 1-I - Outline

Figure 2-I – Porter’s Three Generic Strategies

Figure 2-II - Strategic Changes in the Business Environment

Figure 2-III - Shifting Strategy Focus

Figure 3-I - Conceptual Roots of Intellectual Capital

Figure 3-II - Stewart’s Three Columns of Intellectual Capital

Figure 3-III - Structural Capital

Figure 3-IV - Buyer-Seller Intimacy as a Reason for IC Growth

Figure 3-V - Skandia’s Navigator

Figure 4-I - The Balanced Scorecard

Figure 4-II - Core Measures of the Customer Perspective-

Figure 4-III – The Internal Business Process Perspective’s Generic Value Chain

Figure 4-IV - The Learning and Growth Perspective

Figure 4-V – Cause-and-Effect-Relationships

Figure 4-VI - The BSC as a Strategic Framework for Action

Figure 5-I - Systems and IT Development Focus of the BSC

Figure 5-II - Enabling the BSC.

Figure 5-III - Requirements for an Automated BSC

Figure 5-IV - Strategic Requirements

Figure 5-V - Connecting the BSC to Existing Back-End Systems

Figure 5-VI - Gentia’s Automated BSC Solution

Figure 5-VII - Gentia’s Supplementary CRM Application

Figure 5-VIII - Three Phases of the BSC Process

Figure 5-IX - Net Ficient Add-Ons.

Tables

Table 2-I - Deutsche Bank’s Internet Strategy

Table 3-I - Book-to-Market Ratios in Million US $

Table 3-II - Four Modes of Knowledge Conversion

Table 5-I - Pros and Cons of Automated BSCs

Table 5-II - Pros and Cons of using NetFicient in a BSC Process

Table 5-III – Summary of how to Exploit the Solutions Mentioned in a BSC Process

Abbreviations

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1 Introduction

The transformation from the industrial age to the information age1 or knowledge society2 represents a time of great change for business organizations as well as for individuals. Service industries replace manufacturing industries and the traditional factors of production: land, labor, and capital are replaced by intellectual assets as the scarce resources. “If there is one distinguishing feature of the new economy that has developed as a result of powerful forces such as global competition, it is the ascendancy of intellectual capital.”3 Intellectual capital (IC) and its measurement is the main topic of this research project. The declining importance of physical assets as well as the quest for shareholder value creation have made the performance evaluation of companies that used to be solely based on financial figures inadequate. For information age companies it is essential to value performance beyond quantitative measures.4 Practitioners like Security Exchange Commissioner (SEC) Steven Wallmann as well as academics like New York University’s Stern School of Business accounting professor Baruch Lev stress the current accounting model’s bias towards physical assets and emphasize the necessity of incorporating non-financial measures to evaluate organizational performance.5 The Balanced Scorecard (BSC) is a performance management and measurement system that fulfills this criterion. In addition to the traditional Financial Perspective, the BSC measures performance from the Customer Perspective, the Internal Business Process Perspective, and the Learning and Growth Perspective, thereby functioning as a tool to navigate businesses in a competitive environment that is growing more and more complex. The aim of the thesis is to illustrate how the BSC can be used as a strategic management system that places a strong focus on IC and its measurement. Furthermore, it will be analyzed how information technology (IT) can be used to facilitate a BSC and its implementation.

The research project is based on a cooperation between Deutsche Bank AG and the Groupware Competence Center of the University of Paderborn. Along with Lotus Development GmbH, the two cooperation partners developed the product NetFicient, a groupware-based intranet application. NetFicient is marketed by the Deutsche Bank department GTS/Commercial Banking Applications/eCommerce/eCommunities internally as well as externally. The increasing utilization of BSCs was the reason to examine how potential NetFicient customers could benefit from the various NetFicient functions when introducing a BSC.

The paper begins with an introduction to Strategic Management in Chapter 2. It is intended to provide a brief overview of the historical evolution of strategy in management literature. The most important frameworks are going to be mentioned, however, the center of attention are the changes in the competitive environment that organizations have to cope with nowadays. Therefore, an emphasis is placed on the strategic prerequisites companies have to accomplish in order to successfully compete in the ‘new economy’. Besides, the shifting perception about value creation will be briefly illustrated. Chapter 3 will deal with IC. The above mentioned shortcomings of traditional accounting will be explained with a focal point on economics of knowledge-based resources. Furthermore, the IC concept will be illustrated and explained. A case study about Skandia, a Swedish financial services and insurance company will be leading on to the BSC concept, presented in Chapter

4. The potential of the BSC to function as a strategic management system - focusing on performance measurement from the IC perspective by adding non-financial measures to the traditional financial ones - will be examined. In Chapter 5 enabling systems for BSCs will be discussed. On the one hand, automated BSC solutions are going to come under scrutiny and on the other hand it will be assessed how NetFicient can contribute to a BSC process.

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Figure 1-I - Outline

2 Strategic Management in the Information Age

The word strategy has its roots in the Greek language where strategia means generalship (formed from stratos – the army). It is not a coincidence that concepts and theories of corporate strategy or business strategy go back to a military background. Strategic management professors Henry Mintzberg and Brian Quinn even start their book on ‘The Strategy Process’ with a lengthy description of the battle of Chaeronea where Alexander the Great from Macedonia defeated the Athenian and Theban troops in 338 BC by carefully analyzing the strengths and weaknesses of his own troops as well as looking at the troops of his opponents.6 Robert M. Grant, another leading researcher on strategic management outlines two similarities between military and business strategy: the distinction between strategy (“the science or art of planning and directing large-scale military movements and operations”7) and tactic (“a plan, procedure, or expedient for promoting a desired end”8). According to Grant tactic is the scheme to win a specific battle while a strategy is the means to win the whole war.9 He emphasizes three common characteristics of strategic decisions military as well as business-related: 10

1. They are important.
2. They involve a significant commitment of resources.
3. They are not easily reversible.

Hence, the translation of these rather martial words into the peaceful world of business means that strategy is the ‘battle’ of a company to create a competitive edge in the market. Therefore, companies formulate visions (defined as “view of a realistic, credible, attractive future for the organization, a condition that is better in some important ways than what now exists”11) and mission statements (“a firm’s mission provides a framework for organizing and communicating its basic identity and intentions”12) as a center for their strategy. The underlying goal of any business strategy must be the creation of value (value creation will be treated later on in this chapter) by performing activities different from the competition and therefore delivering a higher value to the customer. Without activities “a strategy is nothing more than a marketing slogan that will not withstand competition”13 Mintzberg/Lampel have identified ten different schools of business strategy formation since 1960 that have been treated in management literature. These schools are reinforcing each other and researchers do not hesitate to stress that strategic management is an evolutionary process. Therefore, it is not possible to address a certain school to a specific event or time.14 Nevertheless, it is possible to make a distinction between two perspectives in strategic management that are gaining relevance with the rapid changes currently occurring within the business environment.

Management literature has treated strategic management from two perspectives:

- The industry-based view.
- The resource-based view.

As the aspect of strategy will be relevant for chapter four both views will be briefly discussed.

2.1.1 The Industry-Based View of the Firm

In 1980 Michael Porter’s book “Competitive Strategy”, a groundbreaking work on strategic management appeared. According to Porter the strategic focus of a company had to be on the external environment, i.e. the industry a firm was competing in. The essence of his book was the idea that industry competition was driven by five forces (see Appendix 1) and that a company had the possibility to create a competitive advantage in its industry by choosing one of three generic strategies:

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Figure 2-I – Porter’s Three Generic Strategies 15

Choosing overall cost leadership as a strategy a company has to defend its low-cost position by achieving significant economies of scale and the maintaining of a relatively high market share.

The choice to compete on differentiation usually yields above-average returns by establishing, for example, a high brand loyalty and a resulting lower sensitivity to prices.

The focus on a specific market segment or product line creates a defendable market position by serving a narrow target group superior to other competitors.

For the information age company this differentiation does not represent an adequate approach anymore as Porter denies that, under normal circumstances, a company can choose more than one of the three generic strategies.16 Nowadays, the business environment has significantly changed. Through the World Wide Web (WWW), mobile communications and other technological breakthroughs companies are able to choose more than one of the generic strategies. Computer producer Dell’s built-on- demand strategy17 is a good example of a company being able to capitalize on the advantages of mass customization achieving significant economies of scale. In other words Dell can pursue the strategies cost leadership and differentiation simultaneously while still serving the mass market.18 Hence, it is not sufficient anymore to solely focus on the external environment of a company as there is an urge to take internal factors into consideration that were neglected before.

2.1.2 The Resource-Based View of the Firm

The information age company needs to shift its focus of strategic management from the external industry analysis to a combination of external analysis and a focus on the internal environment of a company. Locating an attractive industry and trying to make money by choosing to compete on one of the generic strategies is not enough anymore. The resource-based view of the firm emphasizes the uniqueness of each organization.19 It regards each organization as a combination of physical and

intangible assets that interact with each other in order to create a competitive edge in the market.20 But the competition on resources is nothing particularly new. It is, moreover, the resources that have changed over the last years. Not too long ago the most crucial resources were factors like capital (now more or less abundantly available to everybody with an internet-related business idea through venture capitalists or business angels, and increasingly backed by a large number of private investors on equity markets), brand loyalty (currently most traditional consumer goods companies have significant problems with the valuation of their shares on the stock markets21 because customers tend to switch brands more easily and increase their purchases of private labels), or technological leadership (a technology can usually be copied without bigger problems nowadays).22 Today the resource-based approach “sees competencies, capabilities, skills, or strategic assets as the source of sustainable competitive advantage for the firm”.23 IC becomes the most valuable resource for any organization. Especially in this rapidly changing business environment the management of resources must be paid careful attention to. Investment in resources (such as training or research and development (R&D)), upgrading resources (“moving beyond what a company’s already good at”24), and last but not least leveraging existing resources into new markets foster the need to reassess the traditional structure of organizations.25 In order to achieve these objectives a new type of organization is needed.

2.2 A New Type of Organization

Currently organizations experience a business environment that is characterized by the rapid diffusion of what not long ago were considered sustainable competitive advantages such as new technologies, management techniques, or superior customer service.26 It is the challenge of the information age company to find new sources of competitive advantage. But traditionally organized companies do not allow for the flexibility needed to compete in this environment. Moreover a new perception about

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Figure 2-II - Strategic Changes in the Business Environment

2.2.1 Characteristics of the New Organization

It is obvious that economies, especially Germany where the old ‘Deutschland AG’27 is still omnipresent, need to rethink their attitudes towards business culture. Lengthy decision processes through hierarchies and complicated ownership structures often restrain companies from reacting quickly to changes in the competitive environment. Kjell Nordström and Jonas Ridderståle, two professors from the Stockholm School of Economics as well as internet entrepreneurs (Spray Ventures, Razorfish) in their rather unconventional book ‘Funky Business’ have identified four characteristics that a company needs to posses to be successful on the market as well as internally in retaining key people and key competencies in the company. An organization needs to be:28

1. Focused: Market transparencies lead to demanding stakeholders. Nothing but superior value creation will be accepted. “So, funky organizations do not aspire to be the very thing for everyone. Instead, they are trying to become something for someone.”29
2. Leveraged: Organizations have to recognize their core competencies, core business and core customers in order to leverage their main resources. In the information age this leverage can be used to compete in several industries without producing the actual good or service.
3. Innovative: Innovation goes beyond actual product development and can mean human resource innovations, financial innovations, or service innovations. It is a mindset that “turns the company into an idea and dream factory”.30
4. Heterarchical: Organizations need structures that foster experimentation. Failures must be accepted (“In Silicon Valley, failure is not a black dot – it is a badge of achievement.”31) and employees must feel that they were on playgrounds rather than in pyramids where strong hierarchies restrain innovation and creativity.32

Particularly, the plea for more freedom to experiment and the ability to accept failures as a part of the development process of IC is something that is lacking in the German business environment. The a.m. characteristics are the basis for the creation of new strategies.

2.2.2 New Organizational Forms

Industrial age companies are usually organized hierarchically and often vertical integration was the means to control the whole value chain from production process to after sales service. But this type of organization does not fulfill the conditions needed to compete in the future. Sophisticated employees desire more responsibility and require a share of the company’s profits and for the development of resources partnerships and alliances are going to be formed with other companies that were formerly regarded as competitors. New organizational forms evolve through:33

1. Internal disaggregation: Decentralization and empowerment create an environment that shifts decision-making responsibility to the manager of the strategic business unit (SBU) while ownership of assets stays with the corporation.
2. External disaggregation: “Corporations spin off parts of their business to the financial markets, thus reducing or surrendering their ownership interest.”34 This means is becoming more and more common as it makes performance visible and creates the incentive for employees to act as entrepreneurs (practical examples are AT&T’s spin-off of Lucent Technologies and Siemens’ spin-off of Infineon).
3. Relational forms: Alliances, joint-ventures, licensing agreements and especially joint-partnerships become more and more important for the information age company. A good example is Deutsche Bank’s internet strategy:35

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Table 2-I - Deutsche Bank’s Internet Strategy

For organizations that are dependent on IC like Deutsche Bank these new organizational forms create the environment needed to develop the characteristics that allow for the flexibility to compete in the information age.

2.2.3 New Strategies

Studying modern management literature, one realizes a shift in the fundamentals of strategy. While strategies of industrial age companies placed a predominant emphasis on the analysis of competition, the information age company shifts its focus to the buyer. The strategy to successfully compete in the future is what Kim/Mauborgne from INSEAD in Fontainbleau call value innovation. They describe shifts in the three basic building blocks of strategy: competition, customers, and corporate capabilities.36 Competitive strategy is not about outperforming the competition by building layers of competitive advantage but “makes competition irrelevant by offering fundamentally new and superior buyer value in existing markets and by enabling a quantum leap in buyer value to create new markets”.37 Reinventing existing industries is the reason for the success of many young and innovative companies like online investment bank Charles Schwab, airline Virgin Atlantic, German online broker ConSors or internet auctioneer Ebay just to name a few.

Customer strategy shifts from the delivery of superior service for a specific customer segment to targeting the mass market and accepting to eliminate unprofitable customers.38

The third building block of strategy - corporate capabilities - shifts due to the recognition that companies cannot develop all of the relevant capabilities on their own. Moreover, companies need to consider new organizational forms in order to combine capabilities with other companies (a good example for this is General Motor’s virtual logistic platform TradeXchange that rival car producers DaimlerChrysler and Ford decided to join in order to make procurement more efficient39). Furthermore, a shortage of qualified personnel, especially in the information technology sector makes building up of non-core capabilities expensive. The shift of strategy focus is illustrated below:

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Figure 2-III - Shifting Strategy Focus 40

A very important aspect in the development of new strategies is employee motivation. In the industrial age the prevalent strategy was the allocation of scarce resources in order to achieve a goal. Nowadays, companies use stretch goals i.e. the motivation of employees by setting goals that are not feasible at first sight. Stretch goals are achieved by leveraging resources41 and they are supposed to transform the company in case they are reached.42

2.3 Value Creation in the Information Age

The ultimate goal of every business all over the world is the creation of value.43 Nevertheless, the term value is subject to different interpretations in different cultures. The underlying idea of value in this thesis is based on the shareholder value approach predominantly used in the Anglo-Saxon influenced business world. While the stakeholder approach, prevalently used in continental Europe, advocates that companies have a social responsibility and should pay respect to public interests along with shareholder interests44 shareholder value supporters argue that companies do neither have the political authority nor the competence to decide what is in social interest. Moreover, they claim that an emphasis on shareholder value will maximize stakeholder interests in the long run as well.. Formerly the performance management of companies was based on accounting measures like Return on Investment (ROI):

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Especially in IC-based companies where the focus of investments is on intangible assets such as R&D, employee training, and information, the accounting based measure ROI becomes problematic because only a small part of the overall investment is capitalized in the book value of assets.45 In addition, the ROI is a single-period measure disregarding future events. Finally, the nominator and the denominator are subject to accounting allocations based on individual decisions made in each company such as depreciation and capitalization methods. Instead of traditional accounting measures companies start to focus on cash flow-based valuation methods treating investments in physical assets and investments in intangible assets identically. The investments are solely evaluated on the cash-flows they create in the future and discounted by the cost of capital.46 Alfred Rappaport, the author of the fundamental work on shareholder value, ‘Creating Shareholder Value’, defines the approach as follows: “The shareholder value approach estimates the economic value of an investment by discounting forecasted cash flows by the cost of capital.”47 The result of this calculation is Net Present Value, which is

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In contrast to the one-period measure ROI, discounted cash flow-based measures include cash flows over the entire forecast period.

In order to maximize shareholder value companies should focus on the creation of economic profit which is defined by Copeland/Koller/Murrin from McKinsey & Company as:48

Abbildung in dieser Leseprobe nicht enthalten 49

WACC are equivalent to the weighted debt and equity costs.50

“Economic profit measures the gap between what a company earns during a period and the minimum it must earn to satisfy its investors.”51 In the long run the maximization of economic profit will lead to the maximization of the company value. “Company value is determined by its discounted future cash flows, and value is created when a company invests capital at returns that exceed the cost of capital.”52 The difference between Economic profit and traditional accounting profit is the charge for the opportunity cost of capital (WACC) which contains the cost of equity while accounting profit does not.53 A business venture is not profitable unless it returns a profit exceeding its cost of capital. The economic profit concept takes into account that companies have to pay for the capital they invest.

Information-age companies will see themselves forced to rely on discounted cash flow-based measures as they depend on substantially high initial investments to develop and market products compared to costs that occur when manufacturing and distributing the products.54 The discounted future cash flows will respect these high upfront investments better than an accounting-based measure such as ROI.

3 Intellectual Capital

As addressed in the previous chapter the business environment is subject to rapid transformation. But new strategies, new types of organization, and new perceptions about value creation call for new ways to measure performance. Looking at the current valuation of companies on the stock markets two things become evident: traditional accounting measures have to come under scrutiny and the performance of information age organizations has to be evaluated differently than that of industrial age companies. This chapter will present the concept of IC. Outlining the shortcomings of traditional accounting methods IC will be defined. Furthermore, it is intended to provide the reader with an insight into Knowledge Management (KM) and its role in the IC concept as it has unarguably been one of the most frequently discussed terms in modern management literature. A focus will be on the economics of knowledge. The second part of the chapter will introduce IC measurement methods emphasizing the value creation potential of IC that has significantly increased over the last years. Finally, a case study about Skandia, will conclude this chapter because Skandia was the first company to ‘live’ IC. The case study will lead on to the BSC that will be discussed in Chapter Four.

3.1 Shortcomings of Traditional Accounting Methods

The accounting system of double entry bookkeeping goes back over 500 years to the Venetian monk Luca Pacioli who in 1494 published a study called ‘Summa de arithmetica, geometrica, proportioni et proportionalita’.55 Since then only more rules were added but no significant changes were made. The accounting principles used nowadays are clearly biased towards physical assets which has worked just fine for industrial age companies.56 The main purpose of accounting is the delivery of information to management, investors, creditors, monitors, and other stakeholders such as partners, customers, and employees.57 New technologies, however, allow for more transparency, more transaction speed and faster reaction time to market changes, in other words quicker access to more disaggregated information. This information is then collected, processed and finally aggregated into annual reports by accountants only to be disaggregated again by analysts.58 The relevance of annual reporting (even quarterly reporting) diminishes substantially when considering that capital markets can erase or add billions of dollars of a company’s value within minutes. Even analysts start to look for information that go beyond mere financial reports when placing a company on their recommended lists.59 For example, companies like Sun Microsystems, Amazon, or the virtual auctioneers Ebay.com or Ricardo.de operate with little assets (some of them are even far from making profits) compared with companies from traditional industries. Nevertheless, the stock markets value them at many times their net assets value. The following table contains a list with some of the top performing companies from the Fortune 500 list showing their market value on the 17th May 2000, as well as revenues, profits, and net assets in 1999. In case of companies operating in the IT sector such as Microsoft, Cisco Systems or Oracle neither revenue nor profits would justify the high market capitalization according to traditional accounting methods.

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Table 3-I - Book-to-Market Ratios in Million US $ 60

The example clarifies that intangible assets can account for a huge proportion of a company’s value and that “our current system of financial measurement has become increasingly disconnected from what appears to be truly valuable in the new economy”.61 Conventional accounting methods do not adequately measure the value of companies mainly relying on intangible assets. Internally generated assets such as R&D expenses, brand names, patents, and employee skills, i.e. the drivers of future company performance are neglected.62 Expenses for R&D, employee training, and IT infrastructure are treated as costs which leads to a short term deterioration of profits which in turn reduces the value of the balance sheet.63 It is paradox that a company that cuts cost by reducing R&D, training, etc. might well show short term profits while running into ‘intellectual bankruptcy’.64 The call for additional information outlining the future earning potential of companies becomes more vehement. SEC commissioner Steven Wallmann and accounting professor Baruch Lev emphasize the need to extend traditional accounting information by including non-financial information to foster a broader awareness of knowledge-based companies. Wallmann outlines several reasons why traditional financial reporting looses relevance:65

- It is problematic to define the outer edges of a company as new organizational forms evolve.
- It is problematic to value and measure soft assets.
- Timing of reporting becomes problematic as rapid acceleration of events affects share prices and product life cycles become shorter.

It becomes evident that a new measurement system is needed that does not solely focus on ex-post financial figures but treats them among a broader set of measures.66 The IC concept is the basis for new performance measurement which takes into account that information age companies are confronted with changing economics.

3.2 Economics of Knowledge-Based Resources

The most significant issue about the nature of IC based resources is the fact that the law of diminishing returns does not apply. Without going into more details, the law of diminishing returns states that the more a given resource is used, the smaller will be the incremental return from this resource.67 Companies in industries like agriculture, heavy industries, bulk-goods production or mining work with limited physical resources where at one point return is declining as further expansion would be more expensive than the profit gained.68

Knowledge-based resources on the other hand are not intrinsically scarce. Information age companies face increasing returns for several reasons:69

- IC assets are appreciable. I.e., while plants, machinery, and real estate start to depreciate, the value of IC grows through sharing. Knowledge assets can be used simultaneously by many people. Users add, adapt and enrich the knowledge base.70
- While high up-front investments in R&D are necessary in order to develop, e.g. a software program, marginal costs of the new products are low.71 This allows for significant scale economies as units sold increase.
- Especially high tech businesses benefit from network effects, i.e. a product has to be compatible with industry standard in order for the user to be able to access the product (e.g. MS Windows 95, 98 or 2000).
- Customers must get used to the product or must even be trained to use it. Afterwards incentives to switch products are low.

But it is also necessary to respect the problems associated with knowledge economics. Knowledge assets need to be cultivated. While a software that becomes a standard might have a great potential for future value creation, expiring patents loose value as soon as they are shared with the whole industry. Companies need to continuously refresh and update their knowledge base.72 Furthermore, it is difficult to evaluate an investment into knowledge. And even, if the investments in knowledge generate value, it is not foreseeable who is going to benefit from it most. McKinsey

& Company consultants Day and Wendler identified three reasons why this is so:73

- Knowledge is owned by people and is therefore hard to control.
- Knowledge assets are difficult to trade as property rights are hard to enforce.
- Knowledge is often generated in partnerships, alliances, and other new organizational forms. This makes the exact distribution problematic.

It becomes clear that knowledge based resources are subject to different economics which offers considerable chances. However, companies, especially those that solely rely on knowledge-based assets in order to create knowledge intensive products and services, have to acknowledge the difficulties that can emerge. The concept of IC is meant to provide a platform to make the value creation potential of knowledge assets more transparent.

3.3 The Concept of Intellectual Capital

Definitions of IC all have one thing in common: they outline the value creation potential and future earnings capabilities of non-physical assets. Despite the strong focus on KM which, is according to Fortune author Thomas Stewart, in most cases nothing more than “glorified data processing”74, the IC concept takes a strategic and a measurement perspective:

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Figure 3-I - Conceptual Roots of Intellectual Capital 75

The strategic stream focuses on the creation and use of knowledge while the measurement stream is focused on the development of a new measurement system that evaluates non-financial data as well as traditional financial ones.

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Edvinsson/Malone emphasize the interaction of individual knowledge and organizational structure that provide organizations “with a competitive edge in the market”.76 In order to capitalize on IC they furthermore stress the necessity to make IC financially measurable.

Karl Erik Sveiby distinguishes between three types of intangible assets, namely employee competence, internal structure, and external structure. He introduced a balance sheet of intangible assets (see Appendix 2).77

Cambridge-/UK based consultancy The Technology Broker’s Annie Brooking uses the a.m. difference between book value and the market value of a company. By including intellectual property assets she takes a slightly different approach than the other authors mentioned.78

The most coherent definition offers Stewart who defines IC as “packaged useful knowledge”79. His concept of dividing IC into Human Capital, Structural Capital, and Customer Capital is consistent with Skandia’s80 and Dow Chemical’s81 distinction of Customer Capital, Organizational Capital, and Human Capital.

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Figure 3-II - Stewart’s Three Columns of Intellectual Capital

This division allows for an easier measurement of IC. The concept of Stewart will be presented more detailed in the following paragraphs. And as one cannot manage what cannot be measured82 a list of indicators for IC measurement is included in the Appendix 3.

3.3.1 Human Capital

At the beginning of the information age Human Capital becomes more and more important.83 Not the physical assets but the brains that created Notes were the reason for IBM’s acquisition of Lotus at 15 times its book value.84 It is crucial to realize that Human Capital is more mobile than ever and that the best people can easily walk out the door taking all their skills and knowledge with them. Thus, Human Capital cannot be owned by the company but only rented.85 It can be defined as the employees’ capabilities, their knowledge, their skills, and their experience. For a company to capitalize on its Human Capital it is essential to establish what is commonly referred to as efficient KM. Although KM is only a small part of the IC concept I am going to present it as a digression because of its growing importance. The intention is to offer a brief introduction to KM theory by giving some definitions and comparing the knowledge approaches of Japanese and Western companies. It is difficult to clearly distinguish between KM and Intellectual Capital Management as the two terms are often used synonymously although they are in fact complementing each other.86 However, according to Edvinsson “the goal of KM is to improve a company’s value creation capability through the more effective use of knowledge”87 while the focus of Intellectual Capital is “to improve the company’s value generating capabilities through identifying, capturing, leveraging, and recycling intellectual capital” 88 or as Johan Roos from IMD in Lausanne puts it: “Whereas knowledge management is a theory in search of practice, IC is a practice in search of theory.”89

Thus, IC includes value creation as well as value extraction. KM is not the focus of this study. Moreover, I am trying to show the role of KM within the IC approach and the necessity to give some definitions in order to make IC measurable.

Digression: Knowledge Management

The original definition of knowledge goes back to the philosophical branch of epistemology in methodology.90 However, in this thesis the focus will be on organizational knowledge definitions in order to establish a connection to KM. Davenport/Prusak distinguish between data (“a structured record of transactions”91), information (a message that is supposed to influence the attitude of the receiver towards a certain topic or object92) and knowledge (a mix of “framed experiences, values, contextual information and expert insight”93) with data as a necessary input for the creation of information and knowledge as refined and processed information. With respect to the affluent availability of information and data through the WWW and organizational intranets this distinction grows more important as an organization has to chose carefully what kind of knowledge has a potential for value creation.

Sveiby uses the definition competence for practical knowledge94 that was used first by Prahalad/Hamel who defined core competencies as the main source for long-term competitive advantage.95

Finally, the academics Nonaka and Takeuchi describe knowledge as a “dynamic human process of justifying personal belief toward the truth”96 in their study on knowledge creation in Japanese companies. They explain the phenomenon of organizational knowledge creation with the interaction of tacit and explicit knowledge:97

Also called codified knowledge98, explicit knowledge is described as “knowledge that is transmittable in formal, systematic language”.99 Sveiby also uses the definition focal knowledge which describes the knowledge one has about an object that is in focus.100 Tacit knowledge is being defined as “personal, context-specific and therefore hard to formalize and communicate”.101 In Japanese companies knowledge is primarily believed to be tacit.102 It is based on experience, learning and subjective judgments. The social interaction between tacit and explicit knowledge allows for organizational knowledge creation.103 In today’s business environment organizations have to create incentives for the employees to share their knowledge and making it accessible inside an organization as well as internalizing outside knowledge from the external business environment. The following matrix shows the four modes of knowledge conversion:

illustration not visible in this excerpt

Table 3-II - Four Modes of Knowledge Conversion 104

The challenge information age companies are facing is the creation of an organizational infrastructure that allows for a flow of knowledge and information. After the waves of downsizing and reengineering in the 1980s employees especially in middle management are reluctant to share their knowledge as they regard it as an insurance to stay on their job. Organizations have to find ways to reward knowledge sharing and punish knowledge hoarding. Especially in the professional service sector (e.g. management consulting, accounting) where knowledge is the fundamental asset of the company105 salaries are directly tied to the individual contribution to the corporate knowledge base. Furthermore, corporations need to install a knowledge market that allows a potential knowledge buyer to locate a knowledge seller.106 Sometimes this can simply be achieved by installing a new espresso machine or water dispenser as the basis for bilateral knowledge exchange is mutual trust.107 It is crucial to realize that a technological infrastructure is necessary but the best group- and shareware system does not guarantee for knowledge exchange if individuals do not see an incentive to share their knowledge.

The process of knowledge creation is vital for the survival of information age companies. Despite the current emphasis on KM Takeuchi argues that knowledge creation cannot be managed. It is furthermore the lack of management, the lack of control that allows for the natural emergence of knowledge.108 What all definitions have in common is the fact that knowledge, managed or not, nowadays is considered the most valuable resource that, in an organizational context, is meant to create value for the business.

One thing becomes evident regarding KM: the necessity to link Human Capital to a specific organization. Especially in the information age company the need to retain qualified employees becomes ever more critical. Knowledge workers are turning out to be increasingly disloyal towards their employers. Their loyalty belongs to their profession or, what modern management literature calls community of practice.109 A programmer who leaves a company to start up his or her own business is lost for the company but still belongs to the community. With employee ownership programs, stock options, and an increased tendency towards performance based salaries companies are trying to meet this challenge and try to increase loyalty and motivation among employees. Some companies are even actively supporting the formation of communities of practice inside the organization in order to benefit from the informal exchange of knowledge.110

3.3.2 Structural Capital

In contrast to Human Capital, Structural Capital is owned by the company. Databases, organizational charts, process manuals as well as intellectual property such as brand names and patents are the Structural Capital of a company.111 With Structural Capital being the part of IC that is owned by the organization its management is essential for the creation of shareholder value. It can be defined as a system to collect and process knowledge in order to transform it into a corporate property. Technological progress such as Internet or groupware applications like Lotus Notes make information a good that is abundantly available to everybody. It is the challenge of Structural Capital management to recognize the information that has a potential for value creation and make it available throughout a company. According to Stewart, Structural Capital has two purposes:112

1. Codifying bodies of knowledge that can be transferred, to preserve the recipes that might otherwise be lost.
2. Connecting people to data experts and expertise – including bodies of knowledge – on a just-in-time basis.

Edvinsson/Malone call structural capital the “embodiment, empowerment, and supportive infrastructure of Human capital”113 and quote Hubert Saint-Onge from the Canadian Imperial Bank of Commerce who stresses that the better the Structural Sapital of a company the better the Human Capital (he defines the relationship between structural capital and human capital as a mutual one, using the term ‘double arrow dynamics’).114

[...]


1 Stewart (1997): p. 3

2 Drucker (1996): p. 67

3 Bontis (1998): p. 64

4 Eccles (1991): p. 131

5 Lev (1997): p. 1; Wallman (1997): p. 104

6 Mintzberg/Quinn (1991): p. 6

7 N.n. (1997): p. 778 (Webster’s Universal College Dictionary)

8 N.n. (1997): p. 802 (Webster’s Universal College Dictionary)

9 Grant (1998): p. 15

10 Grant (1998): p. 15

11 Fry/Killing (1995): p. 17 (A vision answers the question: “What do we want our business to look like in five years from now?” Fry/Killing (1995): p. 14)

12 Fry/Killing (1995): p. 17 (A mission gives the answer to: “Why are we in business?” Fry/Killing (1995): p. 14)

13 Porter (1996): p. 64

14 Mintzberg/Lampel (1999): pp. 21

15 Porter (1980): p. 35

16 Porter (1980): pp. 35 and 41

17 Schinzer (1998): p. 6

18 Kim/Mauborgne (1999): p. 45

19 Grant (1998): p. 112

20 Collis/Montgomery (1995): p. 118

21 Baumann/Gorgs/Salz/Zöttl (2000): pp. 86

22 Wernerfelt (1984): p. 174

23 Nonaka/Takeuchi (1995): p. 46

24 Collis/Montgomery (1995): p. 126

25 Collis/Montgomery (1995): p. 127

26 Porter (1996): p. 63

27 The term refers to the linkages between the big industrial conglomerates, banks and politics caused by cross-ownership of stocks and supervisory board mandates.

28 Nordström/Ridderståle (1999): pp. 128

29 Nordström/Ridderståle (1999): p. 132

30 Nordström/Ridderståle (1999): p. 152

31 Nordström/Ridderståle (1999): p. 193

32 Nordström/Ridderståle (1999): p. 168

33 Day/Wendler (1998): pp. 9

34 Day/Wendler (1998): p. 10

35 N.n. (2000): p. 89 (Der Spiegel)

36 Kim/Mauborgne (1999): pp. 49

37 Kim/Mauborgne (1999): p. 43

38 Kaplan/Norton (1996): p. 73

39 N.n. (2000): presentation Andersen Consulting

40 Kim/Mauborgne (1999): p. 50

41 Hamel/Prahalad (1994): pp. 129

42 Kaplan/Norton (1996): p. 226

43 Grant (1998): p. 32

44 Rappaport (1998): p. 5

45 Rappaport (1998): p. 22

46 Rappaport (1998): p. 31

47 Rappaport (1998): p. 32

48 A similar concept invented by New York based consultancy Stern Stewart is Economic Value Added (EVA).

49 Volkart (1999): p. 543

50 Hostettler (2000): p. 53

51 Copeland/Koller/Murrin (1996): p. 116

52 Copeland/Koller/Murrin (1996): p. 96

53 Due to generally accepted accounting principles, only the interest which is the cost of debt, are deductible as expenses.

54 Rappaport (1998): p. 31

55 Stewart (1999): p. 58

56 Wallmann (1997): p. 104; N.n. (1998): p. 22 (WM Data, Annual Report 1998)

57 Wallmann (1996) p. 141

58 Karlgaard (1997): pg. 4

59 Horváth/Kaufmann (1998): p. 41

60 N.n. (2000): www.fortune.com

61 Baum/Ittner/Larcker/Low/Siesfeld/Malone (2000): www.forbes.com

62 Lev (1997): www.forbes.com

63 Edvinsson (1997): p. 366

64 Roos/Roos (1997): p. 413

65 Wallmann (1996): pp. 141

66 Eccles (1991): p. 131

67 Mankiw (1997): p. 526; Roos/Roos/Dragonetti/Edvinsson (1997): p. 10

68 Reiß (1996): pp. 90

69 Urich (1998): p. 15; Roos/Roos/Dragonetti/Edvinsson (1997): pp. 13

70 Day/Wendler (1998): pp. 19-20

71 Marginal costs are defined as the increase in total cost that arises from an extra unit of production. Mankiw (1997): p. 272

72 Day/Wendler (1998): p. 20

73 Day/Wendler (1998): p. 20

74 Stewart (1999): p. XIII

75 Roos/Roos/Dragonetti/Edvinsson (1997): p. 15

76 Edvinsson/Malone (1997): p. 44

77 Sveiby (1997): pp. 8

78 Brooking (1997): pp. 13

79 Stewart (1997): p. 67

80 N.n., (1998): p. 4 (Human Capital in Transformation)

81 Petrash (1996): p. 366

82 Pettit (2000): p. 2; Kaplan/Norton (1996): p. 21

83 Silverman/Lewis (2000): p. 24

84 Edvinsson/Malone (1997): p. 34

85 Edvinsson/Malone (1997): p. 11; Stewart (1997): p. 101

86 Wiig (1997): p. 400

87 Edvinsson (1997): p. 372

88 Edvinsson (1997): p. 372

89 Roos (1998): p. 151

90 Epistemology deals with the ways of interpreting knowledge. v.Krogh/Roos/Slocum (1996): p. 157

91 Davenport/Prusak (1998): p. 2

92 Davenport/Prusak (1998): p. 3

93 Davenport/Prusak (1998): p. 5

94 Sveiby (1997): p. 37

95 Prahalad/Hamel (1990): p. 81

96 Nonaka/Takeuchi (1995): p. 58

97 The concept of tacit and explicit knowledge was developed by the Hungarian medical scientist and philosopher Michael Polanyi (1891-1976). Sveiby (1997): p. 30

98 Davenport/Prusak define codified knowledge as organizational knowledge that “has been put into a form that makes it accessible to those who need it.” Davenport/Prusak (1998): p. 69

99 Nonaka/Takeuchi (1995): p. 59

100 This definition also goes back to Michael Polanyi. Sveiby (1997): p. 30

101 Nonaka/Takeuchi (1995): p. 59

102 Nonaka/Takeuchi (1995): p. 8

103 Nonaka/Takeuchi (1995): p. 61

104 Nonaka/Takeuchi (1995): p. 62

105 Hansen/Nohria/Tierney (1999): p. 106

106 Davenport/Prusak (1998): pp. 25

107 Davenport/Prusak (1998): p. 35

108 Takeuchi (1998): www.sveiby.com.au

109 Communities of practice are defined as: “A group of professionals, informally bound to one another through exposure to a common class of problems, common pursuit of solutions, and thereby themselves embodying a store of knowledge.” Stewart (1999): p. 96

110 Wenger/Snyder (2000): p. 60

111 Roos/Roos/Dragonetti/Edvinsson (1997): p. 42

112 Stewart (1997): p. 132

113 Edvinnson/Malone (1997): p. 35

114 Edvinsson/Malone (1997): p. 35

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Details

Title
Performance Measurement from the Intellectual Capital Perspective. A theoretical approach through a groupware-based intranet application
College
University of Paderborn  (Institute for Economics)
Course
International Business Studies
Grade
1 (A)
Author
Year
2000
Pages
96
Catalog Number
V294
ISBN (eBook)
9783638102162
File size
952 KB
Language
English
Tags
Performance, Measurement, Intellectual, Capital, Perspective, International, Business, Studies
Quote paper
Vincenz M. Behn (Author), 2000, Performance Measurement from the Intellectual Capital Perspective. A theoretical approach through a groupware-based intranet application, Munich, GRIN Verlag, https://www.grin.com/document/294

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