Design and implementation of a Human Capital oriented Balanced Scorecard in an engineering services unit

Contents

1 Introduction

2 Definition of Human Capital
2.1 What separates Human Capital from other assets
2.2 Human Capital - the un-word of the year 2004
2.3 The gap between book value and market value

3 Human Capital Measurement
3.1 Human Capital Accounting
3.1.1 Weighted personnel cost method
3.1.2 Method of future remunerations
3.1.3 Flamholtz’s Approach (Human Resource Accounting)
3.2 Deductive Summarizing Approaches
3.2.1 Market Value to Book Value
3.2.2 Tobin’s q
3.2.3 Calculated Intangible Value
3.3 Inductive Analytical Approach
3.3.1 Intangible Assets Monitor
3.3.2 Intellectual Capital Navigator
3.3.3 Balanced Scorecard
3.3.3.1 Nomen est Omen
3.3.3.2 Perspectives of Balanced Scorecard
3.3.3.2.1 The Financial Perspective
3.3.3.2.2 The Customer Perspective
3.3.3.2.3 The Business Process Perspective
3.3.3.2.4 The Learning and Growth Perspective
3.3.3.3 Human-Resource-Scorecard
3.3.3.4 Human Capital Management Scorecard
3.4 Human Capital Key Figures
3.4.1 Economic Value Added and Human Economic Value Added
3.4.2 Human Capital Value Added and Human Capital Return On Investment
3.4.3 Human Asset Worth
3.4.3.1 Employment Cost
3.4.3.2 Individual Asset Multiplier

4 Profile of the Business Unit “Engineering Services”

5 Design and Implementation of a Balanced Scorcard
5.1 Defining the Vision
5.1.1 Procedure: A journey into the Future
5.1.2 Formulating the Vision for the Engineering Services Business Unit
5.2 SWOT-Analysis
5.2.1 Procedure
5.2.2 Strengths of the Business Unit
5.2.3 Weaknesses of the Business Unit
5.2.4 Opportunities Coming from the Business Unit Environment
5.2.5 Threats Coming from the Business Unit Environment
5.2.6 Supplementary Interviews
5.3 Strategy
5.4 Perspectives and Key Figures
5.4.1 Financial Perspective
5.4.2 Customer and Partner Perspective
5.4.3 Process Perspective
5.4.4 Human Capital Perspective
5.5 Implementing the Balanced Scorecard
5.5.1 General Conditions
5.5.2 Communication and Training
5.5.3 Software Support

6 Conclusion

APPENDIX A: Celemi Intangible Assets Monitor 1999

APPENDIX B: Photo Documentation of SWOT-Analysis Workshop

APPENDIX C: Interview – Guide

Bibliography

List of Figures

Figure 1: Value of Soldiers in the Thirty Years War

Figure 2: Structure of Intellectual Capital

Figure 3: Tangible versus Intangible Assets

Figure 4: Market Value – Book Value Ratio of DJIA listed Companies

Figure 5: Increasing Importance of Intangible Assets in Organizations

Figure 6: Approaches to Determine the Value of Intangible Asset

Figure 7: Celemi Intangible Assets Monitor 1999

Figure 8: Intellectual Capital Navigator

Figure 9: The four Perspectives of a Balanced Scorecard

Figure 10: Factors of Service Quality from a Customer’s Perspective

Figure 11: Generic Value Chain

Figure 12: Interpretations of the Balanced Scorecard Approach

Figure 13: Human-Resource Scorecard (HR-Scorecard)

Figure 14: Human Capital Management Scorecard

Figure 15: 3D Representation of an Automatic Welding Line

Figure 16: Cost / Impact of Design Changes

Figure 17: Virtual Ergonomic Simulation

Figure 18: SWOT-Analysis

Figure 19: SWOT-Strategy-Matrix

Figure 20: Key Figures of the Financial Perspective

Figure 21: Key Figures of the Customer and Partner Perspective

Figure 22: Key Figures of the Process Perspective

Figure 23: Key Figures of the Human Capital Perspective

1 Introduction

Today it has become common for managers to claim that their employees are their greatest asset. The simple truth is: they are right. In an increasingly service and knowledge-based economy physical production factors are losing importance. “Unlike financial and physical ones, intangible assets are hard for competitors to imitate, which makes them a powerful source of sustainable competitive advantage” (Kaplan and Norton 2004, page1). Intangible assets include brands, customer goodwill, intellectual property and, first of all, human capital. Having a headstart in terms of know-how often means having a competitive edge. Therefore, human capital is becoming critical to business success. However, without a clear basis of measurement the avowal of the managers that their employees bring value to the organization is little more than empty rhetoric. People can potentially add huge value to the enterprise but tapping this source of value needs both measurement and management. The value added can only be shown externally if human capital is measured and effectively managed internally.

In order to be able to make the right decisions, it is important to know the value of human capital. This realisation is nothing new, as is shown in the following example. In 1642, Austria and Sweden agreed the following “price list”:

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Figure 1: Value of Soldiers in the Thirty Years War (Umantis 2004, p.2)

This table was to enable quick decisions as to whether the costs of taking a prisoner exceed the value of the individual person. Fortunately, the Thirty Years War is long since past and the term human capital is today predominantly used in an economic context. However, in order to also make the right decisions in business life, it is important to determine the value of the human capital of a company. Otherwise, it is not possible to observe the performance of this asset and, above all, it is not possible to exercise active control. However, how can the value of human capital be determined? The traditional methods of business appraisal are insufficient for recording intangible assets and determining their value. Accounting rules, although revised on a regular basis, were initially designed for assets such as plants and machinery, tangible things that represented the source of wealth in the industrial age. Since the 1960s, various approaches have been developed for determining the value of intangible assets. At the beginning of the 1990s, the topic gained a new momentum and regard thanks to the work of Robert S. Kaplan and David P. Norton. The result of this work is the Balanced Scorecard approach.

The research work of Kaplan and Norton had its origins in the increasing criticism of traditional performance measurement systems. These systems have the following inherent defects:

- One-dimensional
- Based on historical actions
- Only indicate short-term success
- Neglect intangible values
- Are insufficiently linked with the strategic objectives
- Reveal strategically relevant changes when it is already too late

The Balanced Scorecard provides a method to monitor the present performance, as well as capture information about how well the company is prepared for future challenges. However, it is more than just a performance-measurement system. By linking the key performance figures with the vision, the strategy and the objectives of the organisation, the Balanced Scorecard also serves as management tool. The simple and clear representation facilitates communication of the strategy pursued and the variables on all company levels. The key performance figures of the Balanced Scorecard are indicators of whether or not the chosen strategy is successful. Chapter 3.3.3 explains the Balanced Scorecard approach in detail.

2 Definition of Human Capital

What makes the difference between a successful and a less successful company? Jac Fitz-enz (2000, p.6) answers this question as follows: “The knowledge, skills and attitudes of the workforce separates the winning companies from the also-rans”. Sustainable competitive advantage is not created by tangible assets like buildings, equipment or cash. “All the assets of an organisation, other than people are inert. They are passive resources that require human application to generate value. The key to sustaining a profitable company or a healthy economy is the productivity of the workforce, the human capital.” (Fitz-enz 2000, p.1)

The term “human capital” was invented in the early 1960s by the agricultural economist Theodore William Schultz. Human capital is the embodiment of productive capacity within people. It is the sum of people’s skills, knowledge, attributes, motivations and fortitude. Schultz who was awarded the Nobel Prize for Economics in 1979 offered the following definition:

Consider all human abilities to be either innate or acquired. Every person is born with a particular set of genes, which determines his innate ability. Attributes of acquired population quality, which are valuable and can be augmented by appropriate investment, will be treated as human capital (Schultz 1981, p.21).

Jac Fitz-enz (2000, p. xii) describes human capital as combination of factors such as the following:

- The traits one brings to the job: intelligence, energy, a generally positive attitude, reliability, commitment
- One’s ability to learn: aptitude, imagination, creativity, an what is often called “street smarts”, savvy (or how to get things done)
- One’s motivation to share information and knowledge: team spirit and goal orientation

Each era in economic history has had different sources of wealth creation. Land was the source of wealth in the agrarian era. In the industrial era machinery and natural resources were the competitive factor. Today, in the knowledge era, human capital is considered to be the primary source of wealth (Bassie 2001). In the industrial era employees were considered to be a never dwindling resource (resource: from Latin resurgere = to rise again) that can easily be substituted. Whereas in the knowledge era the cognition becomes increasingly accepted that employees are a capital. The Dictionary of Phrases and Fable of 1898 defines capital as: money or money’s worth available for production (Brewer 1898). Like other assets the value of human capital can be increased by investing in it.

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Figure 2: Structure of Intellectual Capital (following Mayo 2001, p.32)

Evidence of the relevance of human capital for the success of an enterprise has been provided by numerous empirical studies. Huselid (1995) showed that enterprises which practise an active human capital management are awarded by lower employee fluctuation, higher employee productivity and better corporate financial performance. Cascio (1995) detected that massive layoffs affect stock prices negatively. Blimes (1996, cited Friedman et al. 1998, p.20) identified a strong correlation between shareholder value and investment in employee training and intrapreneurship programmes. Wellbourne and Andrews (1996) found that firms placing a high emphasis on their human capital were almost 20% more likely to survive for five years than firms that did not. The importance of human capital is also attested by a more recent study conducted by the consulting firm Boston Consulting Group. The study proved that “investing in human capital directly contributes to increasing shareholder value“ (Gertz 2004, p.19).

Managers today accept the fact that that investing in human capital positively affects the success of an enterprise. Most chief executive officers and general mangers “would readily assent nod the frequently heart statement that staff is a company’s greatest asset” (Mayo 2001, p.2). So, everything seems to be fine. But there is still a lot of work to do.

In 1992 Peter F. Drucker wrote: “All organisations now say routinely: People are our greatest asset. Yet few practice what they preach, let alone truly believe it” (Drucker 1992, p.8). More than a decade later this statement still seems to be valid. Employees often experience that they aren’t treated like an important source of wealth but like commodity. The problem, however, is not that enterprises do not value their employees, but that they do not know how to measure the value of their human capital. There is little consensus about how to determine returns on investment in human capital. “Even where there is an apparent link between, say, employee training and productivity, it isn’t always possible to confirm a causal relationship between the investment and the positive result, given the variety of factors – information technology and so on – that affect productivity” (LEV 2004, p.5). If we can’t measure our primary value producing asset, we can’t manage it. I.e. without measurement we cannot (Fitzenz 2000, p.4):

- Communicate specific performance expectations
- Know what is going on inside the organisation
- Identify performance gaps that should be analyzed and eliminated
- Provide feedback comparing performance to a standard or a benchmark
- Recognize performance that should be rewarded
- Support decisions regarding resource allocation, projections, and schedules

With the emergence of the knowledge economy, recognition of human capital as an important part of the enterprises total value has gained importance. This has led to two important issues:

- The methods to assess the value of human capital
- The methods to improve the development of human capital in enterprises.

2.1 What separates Human Capital from other assets

One critical characteristic differentiates human capital from all other assets. Human capital is the only asset which cannot be owned. Thomas Davenport (1999, p.7) describes this fact very clearly:

“Human beings have at its command personally assigned attributes, such as behaviour patterns, labour reserves, and working times. All of this makes up human capital – the shares they invest in their work. The employees – not some organizations – are the masters of this human capital. And they alone decide when, how, and where they want to deploy it.”

Employees provide their individual human capital to a company. The company can use this human capital only as long as the employee decides to keep working for them. A person’s contribution is subject to motivation and environment. It is important, therefore, to create a work environment that enables employees to exploit their individual potential and has a high motivational effect at the same time. Monetary incentives such as salaries, bonuses, and company shares are only one possibility. Other important values may be for example (Mayo 2001, p. 21):

- Challenging and interesting work
- Equipment and resources that would not otherwise be accessible
- Being associated with an organization of high repute
- Status and self-esteem
- Recognition: by the person’s manager, or by peers, or even publicly
- Opportunities for personal growth and career development
- Interesting colleagues to work with
- A satisfying and stimulating environment
- Social events
- Opportunities for travel and perhaps high standards of accommodation

Single items in the above list will be weighted individually by each employee. But even if the ranking of particular points may be different, they do have a significant effect on an individual’s performance. “The way in which we provide this value to people determines their motivation, commitment, and loyalty – and hence, their contribution to adding value to other stakeholders.” (Mayo 2001, p.21)

2.2 Human Capital - the un-word of the year 2004

May humans be characterized as capital? The word “human capital” was voted the un-word of the year 2004 in Germany. This displays the discomfort felt by many people with the idea of being compared with capital. The jury explained that this characterization not only degrades the staff in companies, but also turns human beings in general into a purely economic factor. The decision of the jury is not very plausible although, at first glance, this discomfort is quite understandable. The idea of “human capital” is not a word creation of the past few months, but has existed for more than 40 years. Quite contrary to the jury’s opinion, employees are not devaluated by characterizing them as capital. A change in perspective is manifested by the increasing use of this idea. In the past, employees were regarded as a resource without particular value and easily interchangeable. The designation as capital, however, signifies that employees do indeed represent a value for the company, and that this value can be increased when acted upon accordingly. Jens Jessen (2005) formulated it this way:

The concept of “human capital”, far from being inhuman, presents an appeal to capitalists to finally wake up and regard humans as capital too, and let them work as such. In addition, humans should be treated as well as other assets because they also need to develop, grow and become stronger.

2.3 The gap between book value and market value

In modern sectors of the economy often physical (tangible) assets are of secondary impact. “In an era when physical assets have essentially become commodities, the benefits of intangible investments yield – increased productivity, improved margins, and, most important innovative products and processes – are the only means companies can use to escape intensifying competitive pressures” (Lev 2004). Intangible assets are identifiable non-monetary assets without physical substance held for use in the production or supply of goods or services, for rental to others, or for administrative purposes.

Though intangible assets, e.g. a skilled and knowledgeable workforce, know how, brands, patents, strong customer relations, unique, smart internal processes and the like, represent an essential share of an enterprise’s value, they receive only little attention in today’s accounting and reporting systems.

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Figure 3: Tangible versus Intangible Assets (Becker et al. 2001, p7)

Traditional double entry bookkeeping seems to be not appropriate to represent an enterprise’s real value, especially if it is a knowledge driven company. “We still debit capital in order to credit assets” (Mayo 2001, p.19). The double entry system was first employed in the early 13th century in Florence. In 1494 the Italian monk Luca Bartolomes Pacioli described the double entry concept in his book Summa de Arithmetica, Geometria, Proportioni et Proportionalita (Everything about Arithmetic, Geometry and Proportion) and thus spread the method in Europe. In the double entry system, two entries are made for each transaction –one entry as a debit in one account and the other entry as a credit in another account. The two entries keep the accounting equation in balance, so that:

Asset = Liabilities + Owners’ Equity

Capital is labelled liabilities and thus appears on the opposite side of a balance sheet to assets. This accounting method served well for centuries but it is still based on transactions, such as sales. In today’s knowledge-driven economy often values are created or destructed long before a transaction occurs. GAAP treats practically all internally generated intangibles not as investment but as costs that must be immediately expensed, thereby seriously distorting enterprise profitability and asset values (Lev 2004, p.4) The successful development of software, for example, creates considerable value, but actual transactions, such as sales, may take years to materialize. Until then, the accounting system does not register any value created in contrast to the investments made into R&D, which are fully expensed. In an interview 2002 Baruch Lev, Professor of Accounting at New York University, stated: ”This difference, between how the accounting system is handling value created and is handling investments into value creation, is the major reason for the growing disconnect between market values and financial information” (Daum 2002). In fact, financial accounting methods are still based on an economic dominated by tangible assets. Financial statements which should in principle represent an enterprise’s asset base and its ability to generate profits, continue to reflect traditional concepts of the agrarian and industrial era heavily disregarding today’s most important assets. Financial reporting does not provide adequate information on intangibles and does not reflect how much an enterprise is worth. The growing gap between represented values and real values is reflected in figure 4. The chart shows ratio of market value to book value of the companies listed in the Dow Jones Industrial Average (DJIA).

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Figure 4: Market Value – Book Value Ratio of DJIA listed Companies (Available from: http://www.gold-eagle.com/analysis/stocks_over-valued.html) [Accessed: 27 December 2004]

Few enterprises identify in their annual report items which point to a connection between human capital and company value. As early as 1938, Archibald Bowman, in his poem published in the Journal of Accountancy, criticized the fact that human capital is not being recognized in balance sheets.

Though your balance-sheet’s a model of what balance-sheet should be,
Typed and ruled with great precision in a type that all can see;
Thought the grouping of the assets is commendable and clear,
And the details which are given more than usually appear;
Thought investments have been valued at the sale price of the day,
And the auditor’s certificate shows everything O.K.;
One asset is omitted - and its worth I want to know,
The asset is the value of the men who run the show. (Bowman 1938)

The few key figures that are reported, if at all, include employee satisfaction, employee turnover, expenses for training and further education, and revenue per employee. Only one of these key figures, the latter (revenue per employee), points out an employee contribution to the company’s value. Conventional accounting views employees as mere causes for costs. Salary payments, costs for training activities and the like appear on the “liabilities” side of the profit and loss statement but they do not appear as asset. The balance sheet treats employees as short-term variable expenses (Bukowitz et al. 2002). In reality, though, human capital is about assets that require a long-term investment. Laying off employees in bad times can, of course, result in short-term improvements of the profit and loss statement. On the other hand, if too many employees are fired, or the wrong ones, adverse effects can be expected, as Cascio (1995) has proven empirically.

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Figure 5: Increasing Importance of Intangible Assets in Organizations (Niven 2003, p.57)

There are two major issues that prevent enterprises from showing human capital in the balance-sheet:

1. Up to now, clear cut rules on how to evaluate human capital and other intangible assets are missing. While the valuation rules for tangible assets are both generally recognized and approved, intangible assets come with a multitude of national and institutional notions that are halfway contradictory. A presentation of the status quo can be found, for instance, in Schäfer (2004).

2. It is not easy to determine the value of an enterprise’s human capital. The increasing added value of intangible assets has far reaching consequences for the measuring systems. Real estate or production equipment, the foundation for wealth in both the agrarian age and in the industrial area, was easy to comprehend. However, the knowledge era demands completely new benchmarks. They must have the capability to detect, describe, and monitor the intangible assets that account for the success of today's businesses, and to deliver the necessary feedback (Niven 2003, p. 58). Approaches for evaluating intangible assets, particularly human capital, will be introduced in chapter 3.

3 Human Capital Measurement

The first approaches for assessing human capital were made at the beginning of the 1960s in the field of internal accounting. Although there was, in part, a need to be able to also use the results in external accounting for balancing the human capital asset, to this day, these methods have still not achieved wide acceptance (Persch 2003, p.118).

With the increasing importance of intangible assets for the market value of a company, new assessment approaches were developed in order to record these assets. These more recent approaches can be subdivided into deductive summarising and inductive analytical approaches.

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Figure 6: Approaches to Determine the Value of Intangible Assets (following North 1999, p. 188)

3.1 Human Capital Accounting

Human Capital accounting aims at depicting the human capital potential in monetary terms while moulding the enterprise’s financial statements. The most widely used models for evaluating human capital are:

Input model (cost based):

The actual value of human capital is understood to be the sum of all investments in the employees. These investments can be calculated per company as well as per person. Typical types of investment are remuneration, fringe costs, further education costs, social service expenses as well as expenses for workplaces, tools, and processes. The advantage of this model is that the required data can be determined quite simple and accurately. The results are largely independent of the particular investigator by focusing on the objective expenses. The disadvantage of this model is its exclusive orientation towards the present. Future development opportunities and risks for the value of human capital are not taken into account.

Output model (income based):

The future value of human capital is understood to be the sum of all earnings achieved with those employees, and its benefit for the stakeholders. This benefit can be determined either for a certain target group, or for the organization as a whole. It can contain tangible as well as intangible components. Considered are “the cash streams to be expected into the organization related to the contribution of the human asset, calculated as the present value of the expected net cash flows” (Mayo 2001, p.74). One problem of this approach is that qualitative components are entered on both the earnings as well as the expenses side, which can only be calculated by formulating assumptions. Qualitative expenditure is, for instance, opportunity cost created by investing time in training and leadership of personnel. Qualitative earnings are, for instance, the image gains for the company created by the employment and the actions of outstanding service providers.

Comparison model (market based):

This approach assumes that the value of a company’s human capital can be determined by comparison to fair market values. How much does a comparable business invest into its personnel? How were the employees in a comparable company evaluated? What is the threshold (e.g. regarding remuneration) above which our employees would join the competition? In this approach, the orientation towards evaluating human capital from a no doubt subjective third party point of view is interesting. The higher the positive difference between potentially achievable fair market value, and real transacted investments in personnel, the higher the (book) value of employees. In bookkeeping terms, such an evaluation result would point to a company’s hidden assets (Goodwill).

3.1.1 Weighted personnel cost method

Approaches for determining the value of individual employees and the value of employee groups for the company were first made at the beginning of the sixties. The weighted personnel cost method was developed by Roger H. Hermanson (1964). In it, the value of entrepreneurial human capital results from the cash value of future remuneration expenses multiplied by a productivity coefficient.

In the first step, personnel remuneration of the business is forecast for the next five years, and subsequently discounted to present day value by means of a discount rate. Hermanson suggests using the actual return on investment of a company as discount rate. Formally, this first step can be illustrated through variables Et (= periodic personnel costs), t (= index of periods) and d (= discount rate) as follows (Persch 2003, p. 129):

Cash value of remuneration expenses = Abbildung in dieser Leseprobe nicht enthalten(1 + d) –t

In the second step, the productivity coefficient is calculated from the ratio of the company’s return on investment (ROI) to industry return on investment during the past 5 years. In doing so, weighted productivity is determined, by weighting the ROI of the present year with 5, the one of the past year with 4, etc., and averaging it over the 5 years with a division factor of 15. With this the calculation can be illustrated formally through variables rt (= periodic return on investment), rb,t (= periodic average industry return on investment) and t (= index of periods) as follows (Persch 2003, p. 131):

Productivity coefficient = Abbildung in dieser Leseprobe nicht enthalten

If the productivity coefficient is greater than 1, one can conclude that the human capital of an enterprise was utilized meaningfully and its appreciation of value lies above industry average.

According to Hermanson, the multiplication of cash value of remuneration expenses and productivity coefficient results in the value of human capital. There are two objections to this approach: For one thing, the author doesn’t state reasons why a five year prognosis period seems adequate (Schäfer p. 70). For another thing, he expresses an increase in individual human capital, e.g. through further education of an employee, only indirectly, with appropriate salary increases. However, a causal relationship can be made clear cut only in the rarest of cases. Likewise, the assumption that an increased return on investment can be attributed to an increase in human capital is not always plausible.

3.1.2 Method of future remunerations

Baruch Leva and Aba Schwartz (1971) developed the method of future remunerations based on the approach by Hermanson. In doing so, the human capital value of individual employees is represented by the cash value of forecast remunerations at the valuation key date. The cash value of an individual employee can be formally illustrated with the help of variables Et (= periodic remuneration), d (= discount rate), a (= age of employee at valuation date), t (= index of periods) and T (= age of employee upon retiring from the company) as follows (Lev and Schwartz 1971, p. 107):

Cash value of remunerations to an employee = Abbildung in dieser Leseprobe nicht enthalten (1+d)-(t-a)

The accumulation of cash values of all employees results in the total human capital of a company.

Although this approach adapts the duration of this consideration to the affiliation of an employee to a company, it is nonetheless not particularly suitable for controlling the development of human capital in an enterprise. The individual human capital is equated with remuneration caused by the employee during his affiliation with the company. Employees are viewed more as an expense factor than as capital that needs to be increased.

3.1.3 Flamholtz’s Approach (Human Resource Accounting)

Eric Flamholtz is the father of this niche of study. He defines Human Resource Accounting as “the process of identifying, measuring and communicating information about human resources to decision makers” (Flamholtz 1974, p.44). He describes the measure of individual value as resulting from two interacting variables: a person’s conditional value and the possibility that he will stay with the company (Mayo 2001, p.76). The conditional value is a combination of productivity, transferability and promotability. A detailed description of Human Resource Accounting can be found, for instance, in Persch (2003). Flamholtz’s methods have not taken up widely in practice. “Interest in human accounting blossomed in the early 1970s, when several committees were set up by accounting bodies on the subject (Mayo 2001, p.74). However, it was waned since then, and was overtaken in the 1990s by some of the following approaches.

3.2 Deductive Summarizing Approaches

Deductive summarizing approaches are based on rating the difference between a company’s market value and book value. The determination uses data largely available from the balance sheet and the stock value. In this respect, market-to-book value ratio illustrates the simplest form. In another approach (Tobin’s q), James Tobin attempts to explains the gap between book value and market value with the cost of replacement. The Calculated Intangible Value (CIV) is built upon the analogy of calculating the brand value (North, 1999, p. 189). These methods are called deductive summarizing because they perform a theoretical, rather than a factual deduction of single assets from the total value of the intangible assets, and therefore, a breakdown of the total value into single assets does not take place (Persch 2003, p. 88).

3.2.1 Market Value to Book Value

The value of products and services is significantly determined by how much the customer is ready to pay for them. For companies listed on the stock exchange, this means that the market value can be calculated from the share price.

Market value = Share price x Total number of shares

In simple terms, the sum of all intangible assets can be calculated by subtracting the book value from the market value. The book value can be taken from the company’s annual balance. However, the significance of this difference is very limited because this mere value has still to be interpreted later on. In order to make possible simple comparisons both according to sector, as well as intersectorally, the quotient from the market value and book value is created, which has a little more significance than the difference alone. If, for example, two competitors in the same industrial sector differ clearly from each other in terms of market value, even though they dispose of similar tangible assets, it can be deduced that the company with the higher market value possesses intangible assets (human capital, customer relations, image, etc.) which distinguishes it from its competitors.

The biggest flaw of this method lies in the determination of the market value on the basis of stock price. The stock market is volatile and often responds to factors entirely outside of control of management. So can, for example, changes in interest level lead to changes in stock prices. However, the changeable interest level has no influence on the value of intangible assets, such as human capital. Furthermore, not every company is listed on the stock market and the determination of the market value in this form cannot be carried out.

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