Bernard Marr Management Consulting Practice in Intellectual Capital 2005

Journal of

Intellectual CapitalManagement consulting practiceon intellectual capitalGuest Editor: Bernard Marr

Volume 6 Number 4 2005

ISBN 1-84544-843-X ISSN 1469-1930

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Access this journal online __________________________ 467

Editorial advisory board ___________________________ 468

Management consulting practice on intellectualcapital: editorial and introduction to special issueBernard Marr __________________________________________________ 469

Implementing the KPMG Value Explorer: criticalsuccess factors for applying IC measurement toolsDaniel Andriesson_______________________________________________ 474

Intellectual capital: management approach in ICS LtdS. Pike, L. Fernstrom and G. Roos _________________________________ 489

An integrated framework for visualising intellectualcapitalChristina Boedker, James Guthrie and Suresh Cuganesan_______________ 510

Data envelopment analysis as method for evaluatingintellectual capitalKarl-Heinz Leitner, Michaela Schaffhauser-Linzatti, Rainer Stowasser andKarin Wagner__________________________________________________ 528

Journal of IntellectualCapital

Management consulting practice on intellectualcapital

Guest EditorBernard Marr

ISSN 1469-1930

Volume 6Number 42005

CONTENTS

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EDITORIAL ADVISORY BOARD

Guy AhonenProfessor in Knowledge Management, Head ofDepartment, Hanken Business School, Finland

Sabin Azua MendiaManaging Director, BearingPoint, Spain

Margareta BarchanCo-founder and Executive Board Member,Celemi, Sweden

Derek BinneyChief Knowledge and Technology Officer,CSC Australia, Australia

David H. BrettCEO and Founder, Knexa, Canada

Annie BrookingChief Executive Officer, Lux Inflecta, Iceland

Wendi BukowitzProduct Development, Mellon, Human Resourcesand Investor Solutions, USA

Leif EdvinssonManaging Director, Universal NetworkingIntellectual Capital AB, Sweden

Luiz Antonio JoiaAssociate Professor, Brazilian School of Public andBusiness Administration, Getulio VargasFoundation, Brazil

Baruch LevPhilip Bardes Professor of Accounting and Finance,Stern School of Business, New York University,USA

Bernard MarrResearch Fellow at the Center for BusinessPerformance, Cranfield School of Management, UKand Visiting Professor of Intellectual Capital,University of Basilicata, Italy

Jose Mara Viedma MartiProfessor of Business Administration, PolytechnicUniversity of Catalonia, Spain and President ofIntellectual Capital Management Systems (ICMS),Spain

Jan MouritsenDepartment of Operations Management,Copenhagen Business School, Denmark

Klaus NorthProfessor of International Management, WiesbadenUniversity of Applied Sciences, Germany

Sharon L. OrielDirector, Global Intellectual Capital Tech Center,The Dow Chemical Company, USA

Richard PettyLecturer, Faculty of Business and Economics,The University of Hong Kong, Hong Kong, China

Kurt P. RaminCommercial Director, International AccountingStandards Committee Foundation, UK

Goran RoosChairman, Intellectual Capital Services Ltd, UK

Hubert Saint-OngePrincipal, SAINTONGE/ALLIANCE Inc., Canada

Patrick H. Sullivan SrPresident, Intellectual Capital Management GroupInc., USA

Karl-Erik SveibyProfessor, Swedish School of Economics andBusiness Administration, Helsinki, Finland

Management consulting practiceon intellectual capital

Editorial and introduction to special issue

Bernard MarrCentre for Business Performance, Cranfield School of Management,

Cranfield, UK

Abstract

Purpose With intellectual capital and intangible assets high on the agenda of executives aroundthe world, and little practical evidence of good practice in measuring and managing these assets, thereis a great need for help. This editorial to a special issue on the topic introduces the problem andhighlights key issues. The special issue provides an overview of how management consultingcompanies acting in this space suggest tackling the problem. The purpose is therefore to bringtogether the approaches of different management consulting firms and to make their differencesexplicit.

Design/methodology/approach All major general management consulting firms as well asspecialist consulting firms focusing in the area of intellectual capital and intangible assets weredirectly invited to submit a paper for this special issue. The call for papers was also made publiclyavailable in the journal and through e-mail campaigns by Emerald. All submissions underwent adouble-blind refereed selection process.

Findings Even though many submissions were received for this special issue, most of the authorswere not able to demonstrate a sufficient understanding of the constructs nor were they able to justifythe tools and methodologies developed. Reviewers were made aware of the practical background ofmany of the authors and it was ensured that sufficient and constructive feedback was provided. Evenwith various rounds of reviews many papers had to be rejected as they resembled marketingbrochures rather then logical discussions. This unfortunately shows that there still is a massive skillsgap in the industry and companies should be careful before they engage with any managementconsulting firm to help them measuring or managing their intangibles.

Practical implications The focus of potential papers was not academic rigor (as opposed to theSpecial Issue Vol. 5 No 2) but the provision of an overview of the state of the art in intellectual capitalconsulting practice. The papers therefore provide practitioners with good insights into currentpractice.

Originality/value This special issue is the first to bring together in a structured and rigorousformat different management consulting approaches to the measurement and management ofintellectual capital and intangible assets.

Keywords Management consultancy, Intellectual capital, Intangible assets

Paper type Viewpoint

Intellectual capital today and consulting firms interest in the topicToday, many organizations recognize the importance of intellectual capital as aprincipal driver of firm performance and a core differentiator. Also governments arerecognizing the importance of intellectual capital. The European Union aims for theirmembership countries to invest a minimum of three percent of their GDP into researchand development initiatives. In the UK, for example, Prime Minister Tony Blair wrotein a recent Government White Paper that creativity and inventiveness is the greatest

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source of economic success but that too many firms have failed to put enoughemphasis on R&D and developing skills. Patricia Hewitt, Secretary of State for Tradeand Industry, added in a recent DTI report that increasingly it is the intangible factorsthat underpin innovation and the best-performing businesses.

An increasing number of firms start to report more of the intangible aspects of theirbusiness, even without the force of regulations. This trend is especially observable inEurope with various initiatives by the European Commission (e.g. projects such asMETITUM, E *KNOW NET, PRISM). Another example is presented by the DanishDepartment of Trade and Industry, which produced guidelines of how companies canproduce intellectual capital reports. In Austria, the Government has passed a law thatall universities have to report on their intellectual capital, in the UK companies will beforced to produce an Operating and Financial Review outlining many intangibleelements of their business, and countries as diverse as Iceland, Germany, or Spain havestarted their own initiatives.

At the same time accounting guidelines are being developed and standards arebeing questioned and reviewed. With the introduction of the International AccountingStandards more emphasis will be placed on accounting for intangible components andstricter compliance rules force companies to report on other intangible aspects of theirperformance. Leading software companies such as SAP, Hyperion, Oracle, 4GHI orPeoplesoft are developing applications to address this, and even governments arebeginning to measure the intellectual capital of cities, regions, and countries.

Many consulting companies have discovered different areas of this increasingawareness and interest in intellectual capital to offer their services likePricewaterhouseCoopers who offer their services to help companies in their valuereporting initiatives to increase transparency in corporate reporting or WatsonWyatt whooffer human capital audits. In recent reports or marketing material from differentconsulting firms this trend is apparent: Accenture writes that todays economy dependson the ability of companies to create, capture, and leverage intellectual capital faster thanthe competition. Cap Gemini Ernst & Young believes that intangibles are the key driversfor competitive advantage and KPMG states that most general business risks derive fromintangibles and organizations therefore need to manage their intangibles very carefully.PricewaterhouseCoopers writes that in a globalized world, the intellectual capital in anyorganization becomes essential and its correct distribution at all organizational levelsrequires the best strategy integrated solutions, processes and technology.

Even though the leading management consulting firms recognize the importance ofintellectual capital they seem to suffer from the same predicament as the field as awhole. Intellectual capital is defined differently and the concept is often fuzzy. As aresult, many firms provide point solutions only addressing particular isolated aspectsof a firms intellectual capital such as:

. help with implementing accounting for some intangibles;

. legal advice of how to protect intellectual property such as patents, copy rights,etc.;

. guidance on building customer or stakeholder relationships;

. improved stakeholder dialogue and value reporting;

. human capital or capabilities assessments; and

. solutions for valuing brands.

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Even though these are all important areas, the danger is that organizations are missingout on the big picture. What is often not clearly understood is that intellectual capital isa truly multidisciplinary field. Below we will expand on this problem.

Misunderstanding intellectual capital as a barrier for convergenceThe multidimensional nature of intellectual capital, as defined by many members ofthe community, is often not well understood which means definitions are not alwaysvery clear and neither are the boundaries of what people mean when they talk aboutintellectual capital. In a recent book to address exactly the multidimensional nature ofintellectual capital, Marr (2005) writes that it could happen that when one talks toaccountants they might refer to intangibles as non-financial fixed assets that do nothave physical substance but are identifiable and controlled by the entity throughcustody and legal rights as defined by the Accounting Standards Board in FRS 10,their main standard for reporting intangibles and goodwill. Such a stringent definitionexcludes many commonly accepted intangibles like customer satisfaction, knowledgeand skills of employees as they cannot be controlled by the firm in an accountingsense. If one then went to a HR manager she might refer to intellectual capital as skills,knowledge, and attitude of employees. A marketing manager might argue thatintellectual capital such as brand recognition and customer satisfaction are at the heartof business success, whereas the IT manager might view key intangibles as beingsoftware applications and network capabilities.

Furthermore, different words are being used to describe very similar constructsfrom different perspectives, which adds to the confusion. In accounting, most peoplewould refer to intangible assets to explain the non-financial and non-physical drivers ofsuccess. In Economics the phrase knowledge assets is often used to describe similarideas and in strategic management they use intellectual or intangible resources orcapabilities. The potential power of the field of intellectual capital is to create a trulyinter-disciplinary view of these different constructs and ideas.

When intellectual capital is defined by members of the intellectual capitalcommunity, it is often divided into various components, which refer to the skills andcompetencies of people in the organisations (human capital), then componentsreferring to relationships with customers or other stakeholders (relationship capital),and components referring to organisational culture, routines and practices, orintellectual property (organisational or structural capital). Even though thesecomponents are often defined or bundled slightly differently, it shows how broadthe scope of the concept of intellectual capital really is.

One key role of members of this community is to make the concept of intellectualcapital more accessible to the different fields who often clearly recognise the importanceof intellectual capital components, but miss out the big picture and therefore theinterdependencies and interconnections between the different elements. Much emphasishas recently been placed on the interactions and interdependencies of differentintellectual capital components. Firms are now realizing that for example, by valuingtheir brands companies only get a partial view of the truth since their brand value islinked to other crucial aspects such as their processes that produce high-qualityproducts and services, their relationship, the reputation, and the competencies of theiremployees. Examples such as Arthur Andersen show how quickly a well-recognizedbrand can disappear over night if some of the other organizational components are


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missing. What the field of intellectual capital has to offer is a more comprehensive viewof the organizational elements and how they deliver value and competitive advantage.By converging some of the point solutions into a more strategic overall package,consulting firms would be able offer their clients a truer and more insightful help. Thecurrent misunderstandings and the isolated point solutions offered by many, mostlymajor firms, does seriously make one question the thought leadership claimed in muchof their marketing material. There is a huge opportunity here for consulting firms tomake a major impact, what is needed is some help from the intellectual capitalcommunity to shape these solutions into the right format.

Aim of this special issueThe aim of this special issue was to bring together the approaches of the differentmanagement consulting firms and to make their differences explicit. The call forpapers was sent to all major consulting firms, specialist firms, and made publiclyavailable in the journal and through e-mail campaigns by Emerald. All submissionsunderwent a double-blind refereed selection process. Authors were asked todemonstrate a thorough understanding of the subject and include the following:

(1) A historic description of how the concept of intellectual capital evolved in yourfirm, how it entered the agenda, and how its importance evolved.

(2) A definition of intellectual capital as a concept and its components (if applicablea firm-specific definition).

(3) If applicable, a description of how the definition of the concept of intellectualcapital evolved (e.g. did the definition become more specific or broader?).

(4) The evolution of tools and approaches developed to understand and manageintellectual capital (e.g. identify, measure, value, report).

(5) An overview of the current approach(es) towards managing intellectual capitalwith a special emphasis on actual case studies.

(6) If possible, provide justifications for the tools and approaches used andevidence of its impacts.

(7) A look into the future where do you see the field heading to? Will theimportance of intellectual capital increase further? What will be theimplications?

The focus of potential papers was therefore not academic rigor (as opposed to theSpecial Issue Vol. 5 No 2) but the provision of an overview of the state of the art inintellectual capital consulting practice.

Even though we received many submissions for this special issue, most of theauthors were not able to demonstrate a sufficient understanding of the constructs norwere they able to justify the tools and methodologies developed. We ensured thatreviewers were aware of the practical background of many of the authors and thatsufficient and constructive feedback was provided. Even with various rounds ofreviews papers were finally rejected as they resembled marketing brochures ratherthen logical discussions.

However, this special issue on consulting practice on intellectual capital includes alist of exciting papers which demonstrate a sub-set of the many activities going on in

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this area. The first paper by Daniel Andriessen discusses the implementationchallenges of the KPMG Value Explorerw. The paper reports on an empiricalinvestigation of the critical success factors for implementing an intellectual capitalvaluation method. The second paper by Stephen Pike, Lisa Fernstom, and Goran Roosdiscusses the theoretical roots of the intellectual capital approach adopted by ICSLimited. Their approach is a strategic one founded in the thinking of theresource-based view of the firm. The third paper by Christina Boedker, JamesGuthrie, and Suresh Cuganesan outlines an integrated framework for the visualizationof intellectual capital. The fourth paper in this special issue is by Karl-Heinz Leitner,Michaela Schaffhauser-Linzatti, Rainer Stowasser, and Karin Wagner and discussesdata envelopment analysis as a tool to assess intellectual capital generation in theAustrian University Sector. The fifth paper by Thomas Housel and Sarah Nelsonoutlines a valuation tool based on complexity and information theory to quantify thevalue creation intellectual capital in firms. The sixth paper is by Eggert Claessen anddiscusses the progress of a Nordic project on harmonizing the reporting of intellectualcapital in small and medium size IT companies. In the seventh paper Kristine Jacobsen,Peder Hofman-Bang, and Reidar Nordby, Jr outline the IC Rating Model developed byIntellectual Capital Sweden and show its application in a case study. The final paper inthis special issue is by Roland Burgman, Goran Roos, John Ballow, and Robert Thomaswho describe the future value management approach developed by Accenture andAssetEconomics.

Overall, I hope that this special issue as well as the dialogue with many other majorconsulting firms will prompt consultants to better understand the nature of intellectualcapital and the potential for cross-disciplinary learning.

Reference

Marr, B. (Ed.) (2005), Perspectives on Intellectual Capital Interdisciplinary Insights intoManagement, Measurement and Reporting, Elsevier, Boston, MA.


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Implementing the KPMG ValueExplorer

Critical success factors for applying ICmeasurement tools

Daniel AndriessonINHOLLAND University of Professional Education, Diemen, The Netherlands

Abstract

Purpose The purpose of this paper is to describe the results of an empirical study into the criticalsuccess factors for implementing an intellectual capital valuation method, the KPMG Value Explorer.

Design/methodology/approach For this study the design approach was used as researchmethodology.

Findings The research shows the strengths and weaknesses of the method and identifies fourgeneral critical success factors for the implementation of intellectual capital valuation andmeasurement tools.

Research limitations/implications The research was based on six case studies. Application ofthe method with other companies may provide further grounding of the conclusions.

Practical implications The research shows that practitioners who want to implement anintellectual capital valuation or measurement method must: perform a proper diagnosis of the problemat hand; have knowledge of the strengths and weaknesses of the method they want to use; understandthe application domain of the method the class of problems and the class of contexts for which themethod needs to provide a solution; and possess the necessary skills to implement the method.

Originality/value Successfully implementing a method for the valuation or measurement ofintellectual capital is not an easy task. Practitioners yet receive little support from the intellectualcapital research community. Little research has been done into the factors that influence the success ofa method. This paper is a first attempt at systematically identifying some of the factors for thesuccessful implementation of an intellectual capital valuation or measurement method.

Keywords Intellectual capital, Research methods, Measurement, Critical success factors

Paper type Research paper

IntroductionOver the last ten years many methods have been proposed for the measurement orvaluation of intellectual capital (IC). (For overviews see: Bontis, 2001; Bontis et al., 1999;Luthy, 1998; Petty and Guthrie, 2000; Sveiby, 2002 and Andriessen, 2004a). Littleempirical research has been done on how these types of methods are beingimplemented and what the critical success factors are for successful implementation.

As a result there is an abundance of information on how to measure or value IC, butthere is little knowledge how to successfully apply these methods in practice.Implementing a new measurement method is an intervention into the daily operation ofa company. How successful are these interventions? What are their effects?Implementation of these methods requires certain skills and conditions. What are someof those skills and conditions? What are some of the mistake to avoid? What are criticalsuccess factors?



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The field of IC research has come to the phase where it needs to start evaluating thesuccess and effects of its methods. In addition it needs to give practitioners testedguidelines on how to successfully implement and use these methods. In this paper Ipresent a systematic analysis of the implementation and effectiveness of the KPMGValue Explorer. The Value Explorer is a method for the identification and (financial)valuation of intangible resources developed by the Knowledge Advisory Services teamof KMPG The Netherlands.

In 1997, KPMG The Netherlands founded an innovation unit focused at the impactof the knowledge economy on businesses. This Knowledge Advisory Services (KAS)unit developed new management approaches and assisted clients in three areas:developing knowledge-based strategies, improving knowledge sharing, and measuringand reporting intellectual capital.

In 1998 KAS participated in a pilot study initiated by the by the Dutch Ministry ofEconomic Affairs (Ministry of Economic Affairs, 1999) to develop a new approach forthe measurement and reporting of intangibles. The purpose of the study was to givefour accounting firms the opportunity to develop new approaches to intangiblesreporting and try these with a number of their clients. KPMG developed the ValueExplorer (Bontis et al., 1999; Andriessen and Tissen, 2000; Andriessen, 2001). Nocompetitive research was conducted prior to its development. Developing the tool wasnot a strategic decision but came out of the opportunity offered by the Ministry. TheValue Explorer was used by the KAS unit in a number of client engagements, six ofwhich are used as case studies in this paper. After the KAS unit was abolished in 2003the tool was no longer used within KPMG. I still use it as a strategic tool.

First I describe the research methodology used for designing, implementing andtesting the method. Then I provide a brief outline of the method itself. I continue byreporting the findings from six companies where the method was used. I conclude bysummarizing the critical success factors for implementing an IC measurement method.

MethodologyThe design approachI used the design approach (Andriessen, 2004a,c; Van Aken, 2004; Weggeman, 1995) asmy research methodology for this study. I used the reflective cycle to generate designknowledge about the method. Figure 1 shows an overview of the reflective cycle. Thereflective cycle starts with a general diagnosis and description of the problem.

The second step in the reflective cycle is designing a first draft of a method thathelps solve the problem. For this the design cycle is used which consists of thefollowing four activities. First, create a general diagnosis and description of theproblem. This gives an impression of the application domain of the method. Theapplication domain describes the class of problems the method needs to address andthe class of contexts to which it needs to be applicable. Second, develop therequirements for the method based on the class of problems and the class of contexts,as well as demands from clients, from users, and from the environment. Third, draft afirst version of the method based on these requirements and on available theory.Finally, check whether this design meets the requirements. This evaluation may lead tochanges in the design, but also to changes in the problem definition and therequirements. According to Van Aken (1996), a researcher should continue this processuntil an adequate design is created.

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The third step in the reflective cycle is the selection of a case to test the draft method.The fourth step in the reflective cycle is to use the method to solve the case-specificproblem using the regulative cycle. The regulative cycle consists of five activities.First, diagnose the specific situation to define the problem in its context. Second,develop specific requirements that supplement the general requirements. Third, makeamendments to the method. Fourth, implement the method. And fifth, evaluate theoutcome of the method. This evaluation often leads to further modifications of thedesign, but also to changes in the way the problem originally was perceived andsometimes to changes in the set of specific requirements.

The fifth step in the reflective cycle is to reflect on the results using three evaluationquestions:

(1) Was the case part of the application domain?

(2) What did this case reveal about the success of the method?

(3) What did this case reveal about improvements to the method?

As a sixth step in the reflective cycle, design knowledge is developed in three areas. First,knowledge about the class of problems for which the method was designed. This maylead to further refinement of the problem definition. Second, knowledge about the class ofcontexts for which the method is applicable. The so-called indications andcontraindications demonstrated under what circumstances the method producesproper results. They are the conditions for success that need to be fulfilled. Third, insightinto the means-end relationships that underlie the method and that produce its results.

Figure 1.The reflective cycle

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CasesThe Value Explorer was implemented at six medium size companies (Table I). The firstthree cases Bank Ltd, Electro Ltd and Automotive Ltd were part of a study fundedby the Dutch Ministry of Economic Affairs that took place in 1998 and 1999. Thesecompanies were selected because they were medium-size knowledge-intensivebusinesses covering various industries. The fourth case was Logistic Services BU.The management of Logistic Services BU wanted to value its core competencies. Thefifth case was Professional Services LLP. It wanted to report intellectual capital in itsannual report. Lastly, Consulting Department was a small consulting unit within alarger financial institution. They wanted to determine their strengths and weaknessesas part of their decision process about becoming an independent consulting firm.

The methodIntroductionThe Value Explorer is based on the concept of core competencies to identify thestrategically important intellectual capital in an organization. In a previous work(Andriessen, 2004a) I published a revised and improved version of the method, namedthe Weightless Wealth Toolkit.

StepsThe Value Explorer offers a five-step approach:

(1) Identify the intellectual capital by making a list of the core competencies of theorganization.

(2) Conduct a value assessment by using a checklist that assesses the added value,competitiveness, potential, sustainability and robustness of those corecompetencies.

(3) Perform a financial valuation of the intellectual capital by allocating a portion ofthe expected normalized earnings of the organization to the identified corecompetencies.

(4) Develop a management agenda based on the findings making recommendationsto management on how to improve the value of the intellectual capital.

(5) Create a report for management using a value dashboard.

I have reported the full do-it-yourself method in Andriessen (2004a). Let me describethese steps in a little more detail.

Case study Industry Type of organization

Bank Ltd Banking Subsidiary of listed companyElectro Ltd Engineering Subsidiary of listed companyAutomotive Ltd Automotive Private companyLogistic Services BU Logistics Department of listed companyProfessional Services LLP Professional services Professional partnershipConsulting Department Banking Department of subsidiary of listed company

Table I.Overview of case studies

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The first step is to identify the IC in the company. Of course, there are a large number ofintangibles. And while many of these may exist in a company (in fact, the majority willexist in a company, whether you realize it or not), not all of them are equally important.What we need to do is track down those intangibles, which add value to the company. Inthe first step towards establishing the value of intellectual capital, we have to decidewhich intangibles are the most relevant to us. Not only to find out the economic value ofa company but because those intangibles which add value to your company are the oneswhich are of strategic importance to your future success. Such intangibles, however,should never be viewed in isolation. It is only when they combine that the economicsynergy is created. All this brings us to the critical question: how do you decide which ofthe many intangibles within a company are of strategic importance? And the answer isto define core competencies of the company. A core competence is a skill cluster whichlies at the centre of competitive success and which contributes to the long-term corporateprosperity. It is a bundle of various types of intellectual capital, including skills and tacitknowledge, values and norms, technology and explicit knowledge, processes andreputation. Listing a companys core competencies can identify this intellectual capital.For example, one of the core competencies of Electro Ltd was its ability to design energyconversion systems, which was a combination of implicit and explicit knowledge, certaindesign processes and the companys reputation in this field.

The second step is to determine how todays core competencies often built up over along period and representing a considerable investment in time, money, people, and skills equip a company for competitive success in a changing market. When discussing corecompetencies, traditional literature maintains that unless a suggested core competencemeets all the criteria laid down for it, it should not be considered as such. While this is finein theory, it does not always work in practice. In extreme cases, an analysis alongtraditional theoretical lines may show that a company has no core competencies at all.For many companies a company competence may qualify as a core competence, even if itdoes not meet all criteria laid down. In our view, the strength of each of the competenciesis of far greater relevance than the name we give to them. Such strength is not consistent.It varies. A competence may be very strong in one area, but weaker in another. Formanagers, it is important to be able to assess the varying strengths of the competenciesthey have defined. And for this reason the Value Explorer contained a list of criteria,which will help to determine the practical strength of each competence.

The third step is to put a monetary value on the identified intellectual capital. Thereare three ways to do a financial valuation: the cost approach, the market approach andthe income approach. The cost approach is based on the economic principles ofsubstitution and price equilibrium. These principles assert that an investor will pay nomore for an investment than the cost to obtain an investment of equal utility (Reillyand Schweihs, 1999). Thus, the price of a new resource is commensurate with theeconomic value of the service that that resource can provide during its life. The marketapproach is based on the economic principles of competition and equilibrium. Theseprinciples assert that in a free and unrestricted market, supply and demand factors willdrive the price of any good to a point of equilibrium. In the market approach, ananalysis is made of similar resources that have recently been sold or licensed. Thesemarket data are used to estimate a market value. The income approach is based on theeconomic principle of anticipation. The value of intangible resources is the value of theexpected economic income generated by these resources.

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Each approach has its strengths and weaknesses. The problem with the costapproach is that in many cases cost is not a good indication of value. Many of the mostimportant factors that drive value are not reflected in this approach. In the marketapproach, an analysis is made of similar resources that have recently been sold orlicensed. The market data are used to estimate a market value. The market approachcan only be used if data are available on the transaction of intangible resources that aresimilar to the subject resources. When the subject resources are unique, which is oftenthe case, this approach is not appropriate. The income approach is based on aprojection of economic income and thereby on somehow predicting the future.Therefore, it always contains a level of uncertainty and subjectivity. All incomeapproach analyses are based on the premise that the analyst can project economicincome with a reasonable degree of certainty. The term reasonable degree of certaintyis, by its very nature, subjective (Reilly and Schweihs, 1999, p.182).

The Value Explorer uses an income approach. It analyses the expected earnings of acompany. It then assesses the contribution of the identified intellectual capital to thecreation of these earnings, taking into account other forms of capital (financial assets,tangible assets) that are used to produce these earnings. It uses a discount rate tocalculate the present value of the intellectual capital earnings.

The fourth step is to analyse all data and draw a management agenda. Theidentification of the core competencies, the assessment of their strengths andweaknesses and the financial valuation will have given valuable insight into problemsand challenges that management need to respond to. These are prioritised and writtendown in a management agenda.

Finally the management agenda is combined with a graphical representation of theoutcome of the assessment and valuation (see Figure 2 for an example for Bank Ltd).

Figure 2.Value Dashboard of

Bank Ltd

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FindingsMotives for using the Value ExplorerWhen KPMG went to market with the Value Explorer we found that clients had avariety of motives to use the method. These motives can be grouped into twocategories (see also Andriessen, 2004b): improving internal management andimproving external reporting. Companies that wanted to improve their operationswere primarily interested in the Value Explorer to support their strategy developmentprocess. These companies wanted to identify the hidden drivers of their success tobetter leverage them and to create an intellectual capital-based company strategy.Companies that wanted to improve their external reporting were intrigued by thepossibility of providing evidence to their stakeholders on their unique competenciesand hidden assets.

Success of the Value ExplorerIn the six case studies the success of the method was limited (see Table II). In two casesthe limited success was the result of poor implementation: At Bank Ltd we stopped theimplementation process before it was finished because the team ran out of budget.Although the process was never properly finished, the end report was used in thedecision-making process about Bank Ltds independence. However, according to theCEO, its contribution to the decision was limited. At Automotive Ltd themanager/owner of the company stopped the process because of other priorities. Wewere not able to convince him otherwise.

When the implementation was successful, in only one case the problem was solved.Consulting Department became a successful, independent company. According to themanager, the method had been very important in facilitating the discussion aboutindependence. It helped to make explicit important considerations for outsourcing. Inthree other cases, the problem was not solved. The general manager of Electro Ltd hadbeen very satisfied with the results at the time of the final presentation. However,circumstances beyond our control changed the situation completely and the companyfiled for bankruptcy. At Logistics Services BU, a similar thing happened. The method

Problem type Problem definitionSuccessfulimplementation?

Problemsolved?

Contributionof method?

Internal managementElectro Ltd Develop a strategy based on

available technologies and skillsYes Wrong

problemNot available

LogisticServices BU

Create a future for LogisticServices Ltd

Yes No Some

ConsultingDepartment

Create a future for ConsultingDepartment

Yes Yes Big

Automotive Ltd Improve strategy-makingprocess

No No None

External reportingBank Ltd Remain independent within

holding companyNo Yes Limited

ProfessionalServices LLP

Report on intangibles Yes No Not available

Table II.Appraisal of the successof the method in six casestudies

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contributed to the decision to effect a management buyout. However, in the end, keyplayers decided not to join the new company and the buyout was cancelled. Accordingto two participants, the method contributed to the decision-making process. It createdenthusiasm and energy within the group, and it helped to develop a proper businesscase because it created insight into the four core competencies and their strengths andweaknesses. At Professional Services LLP, all the necessary conditions for successfulimplementation were met. However, we discovered that the method did not produceresults that could be reported easily externally. More on this result will follow below.

Necessary conditions for successTo explain these disappointing results we need to take a look at the reflective cycleagain. The feedback arrows in Figure 1 indicate four errors that can be made whendesigning and implementing a method:

(1) we did not diagnose the situation correctly and we have identified the wrongproblem;

(2) we used a poor method that was unsuccessful and we need to fix it;

(3) the case did not match the application domain of the method. In other words, weselected the wrong tool for the job;

(4) we implemented the method poorly.

Figure 3 summarizes these errors, redefined as necessary conditions for a successfulimplementation of a method. Let us look at each of these necessary conditions in detailto see if they can explain the performance of the Value Explorer in the six cases.

Problem definitionsEach of the six companies had a different motive for applying the method. Fourcompanies wanted to improve their internal management. Two wanted to use themethod for external reporting purposes. However, the exact problem was not alwaysimmediately clear.

Internal management. Electro Ltd, was an organization in turmoil. In the previousseven years, this electric installation and engineering company had had five generalmanagers, each one leaving within a year. The company was self-centred,product-oriented and lacked market-focus. For the previous two years, the numberof contracts won had declined rapidly. The profits from national and international

Figure 3.Necessary conditions for asuccessful implementationof a management method

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projects were under severe pressure. The newly appointed general manager wasworking on a turnaround, improving the market-orientation and sales capability of thecompany and developing a strategy focused on specific product/market combinations.The General Manager wanted to use the method to develop the new strategy, setpriorities and determine focus. However, it turned out Electro Ltd had a severe cashflow problem. This problem became urgent just after the project was finished. Thecash flow problem was never solved and the company went bankrupt. In a sense, themethod was solving the wrong problem.

At Automotive Ltd key players did not share the initial problem definition. Themain contact was through the financial controller. He was working hard to formalize anumber of processes within the company. When the company was small, it could runits operation in a rather informal way. Now, as it grew bigger, there was a need formore transparency and rules and regulations. One of the controllers ambitions was toimprove the strategic decision-making process. Until then, the owner had made allstrategic decisions based on limited market research and without an explicit corporatestrategy. The financial controller hoped that a discussion on intellectual capital wouldhelp make the strategy process more explicit. Talking to the owner, the KPMG teamdid not sense this need, nor did the team notice that the owner was worried about anyother specific problem. He was willing to co-operate, as long as it would not consumetoo much of his time or the time of his staff. When it did, he terminated theimplementation of the method.

Both Logistic Services BU and Consulting Department were reconsidering theirposition. Management wanted to develop a new future for the company, based on thecompanys intangible strength. However, the management of these companies did notknow what the strength of the company was and wanted to have insight into its futurepotential. In both cases the Value Explorer proved to be helpful.

External reporting. Bank Ltd was an independent private bank that was part of aworldwide financial institution. As a small private bank, it nurtured its independenceand objectivity in serving clients. Management faced the challenge of convincing theholding company that Bank Ltds independent position within the Holding and thebanks distinct style and identity were vital for its future success. It wanted to use theValue Explorer to give the holding company insight into the importance of the banksintellectual capital, to promote a non-intervention policy on behalf of the holdingcompany and to secure independence in the future. As the CEO phrased it: What is thevalue of our independence?. The method proved to be useful, however, as we will see,we made some mistakes implementing it.

Professional Services LLP offered a wide range of consulting and auditing servicesto its clients. It was well aware of the transition in the global economy from anindustrial to an economy based on intellectual capital. At the end of the millennium, itwanted to express this transition in its annual report. Professional Services LLP hadthe idea that this would be a nice theme for its annual report. The idea was to analysethe intellectual capital of the firm, assess its strengths and weaknesses and use thisinformation to report externally, proving to the outside world that the company hadprepared for the future. As we will see we found the Value Explorer was not theappropriate tool for this job.

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Quality of the methodStrengths of the Value Explorer. At the four cases where the Value Explorer wasimplemented successfully, we found the method had a number of strengths. These canbe grouped into the five steps. The first step of the method is the identification ofintellectual capital with the help of core competencies. The Value Explorer searches forthe combined power of intangible resources. It determines the way individualintangibles contribute to a companys uniqueness and cumulative capabilities. Itdetermines which intangibles are important and how they contribute to companysuccess. We found that the use of core competencies to identify intangible resourcesprovides a new and positive view on a company, and a common language that canexplain the companys success, install a sense of pride, boost the companysself-confidence, and identify new opportunities.

The second step of the method is the value assessment of the core competenciesusing five checklists. We found that the value assessment helps to create a realisticview on the capabilities of a company that are genuine core competencies. In addition,the assessment highlights strengths and weaknesses of core competencies. Theseweaknesses can be the starting point for improvement initiatives.

The third step is the financial valuation of the core competencies. The financialvaluation highlights the absolute importance of intangibles. Both the CEO of Bank Ltdand the manager of Consulting Department acknowledged the importance of themonetary value figure in conveying the significance of intangible resources to otherstakeholders. The manager of Consulting Department phrased it as follows: Withinthe financial services industry, people speak the language of money. If something hasno monetary value attached to it, it is not considered important (personalcommunication). The added value of the financial valuation of intangible resources liesin the fact that numbers attract management attention. This finding is in line with theview of Mouritsen et al. (2001) about the importance of indicators in intellectual capitalstatements. They state that these indicators are especially important because theydemonstrate seriousness on the part of top management. In addition, the financialvaluation shows the relative importance of the core competencies. The financialvaluation uses money as a common denominator to compare the usefulness of thecompetencies. This can help when making decisions about investments in intellectualcapital.

The fourth step of the method is the management agenda. The management agendareflects the implications of the findings for management. It provides an action plan onhow to strengthen the companys intellectual capital. We found that the managementagenda can help to make the important step from valuation to action, making themethod practical and meaningful.

The fifth step of the method is the end report, which contains the value dashboard.We found that the value dashboard of the method helps to communicate the findings inan effective and comprehensive way by providing insight into the strengths,weaknesses, and value drivers of core competencies in one comprehensive picture.

Weaknesses of the Value Explorer. We also found the Value Explorer has certainweaknesses. First, the version of the method that was used lacked a diagnosis phase. Itdid not include a step in which the analyst checks whether the problems of the companyfit the class of problems for which the method was designed. We found the method

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jumped to solutions (Kerssens, 1999), did not prevent pigeonholing (Perrow, 1970), or,phrased differently, the method suffered from the child-with-a-hammer-syndrome[1].

Second, we found that the step from creating an inventory of intangibles andcapabilities to defining core competencies is still a more or less creative and unguidedstep. The personal skills of the analyst play an important role. The existing guidelinesfor this step did leave room for personal preferences, diminishing the reliability of theoutcome.

Third, we found that the results of the method are internally focused. The methoddescribes important intellectual capital of a company without looking at theenvironment. Roos et al. (2001) distinguish between two approaches to strategy:external analysis and the resource-based view. They state that a strategy processshould combine the best of both approaches. The method takes care of theresource-based view, identifying the valuable resources of the company. However,before a company can develop a new strategy, an external analysis of majorenvironmental, competitive forces must be made.

Right method for the jobWe found the Value Explorer has certain strengths, however, the question remains,under what circumstances is it the right tool for the job? There are two sides to thisquestion. What class of problems is the method able to solve and under whatcircumstances can it be successful?

The findings from the case studies indicate that the Value Explorer is not anappropriate tool for the external reporting of intellectual capital. We found that theresults of the method are not self-evident and must be accompanied by an extensivereading instruction. Interpretation of the results requires insight into the underlyingmethod. Furthermore, clients are reluctant to publish the results. Professional ServicesLLP considered the reporting of financial valuations risky. In addition, supportingevidence for core competencies often includes data about competitors. ProfessionalServices LLP was reluctant to report these data because it might provoke criticism.The method highlights a companys strengths but also its weaknesses. ProfessionalServices LLP and Electro Ltd were hesitant to report these weaknesses to the outsideworld. Finally, these companies considered data about their core competenciesconfidential information. As the CEO of Electro Ltd put it: I will not published thisinformation for the next six years (personal communication).

In three cases we found that the method was a useful tool to help improve the way acompany is managed. We found that the method can help in solving problems of futureorientation and strategy development, by helping to create resource-based strategiesfor companies that lack insight into or are insecure about the intangible resources thatmake these companies successful.

A second factor that influences the application domain of a management method isthe class of contexts in which the method can be used. We found that the methodworked well for knowledge-intensive, middle-size companies employing from 50 to1,000 employees. The tests showed it also works with smaller units that are part of abigger company (Logistics Services Ltd, Consulting Department). Tests also proved itcan be used with bigger companies (Professional Services LLP), providing that theanalyst focuses on the core competencies of the company that various departmentshave in common. The tests highlighted that the following conditions must be fulfilled

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to ensure a successful implementation. The company must have an issue about itsfuture direction. If there is no clear issue, as in the case of Automotive Ltd, it is lesslikely that the method will produce useful results. In addition, management of thecompany must have a certain willingness to reflect on the organization and to reviewcritically the organizations strengths and weaknesses. Management must haveenough time to participate at least to join in the interviews and visit the endpresentation. At Automotive Ltd these two conditions were not met, which in partexplains the early termination of the project. Finally, management must have thewillingness, as well as the mental ability, to look at the company from an intangibleperspective. This, too, was lacking at Automotive Ltd

Quality of the implementationThe last necessary condition for a successful implementation of an IC method is thequality of the implementation itself. One can have a company with an urgent problemand use a good method that is suitable for the case at hand and still be unsuccessfulbecause the method is not implemented properly.

De Caluwe and Stoppelenburg (2003) identify six process criteria for successfulimplementation of methods by outside consultants:

(1) level of involvement of the consultant and the client system with theassignment;

(2) intensity of communication between the consultant and the client system;

(3) degree to which the approach is being developed along the way;

(4) extent to which the consultant provides concrete directions to the client system;

(5) level of equivalence between the consultant and the client system; and

(6) extent to which a specific method was used

We used these criteria to assess the quality of the implementation. We found that intwo cases the quality of the way we implemented the method did not meet thesecriteria. At Bank Ltd two of the conditions for a successful implementation were notfulfilled: We had not involved important players of the client system at crucial stagesof the implementation, and there was lack of communication between ourimplementation team and the client system on the input and output of the valuation.The mistake we made was that at the meeting where we presented the results of themethod, we told the management of Bank Ltd that the draft report was the final resultof the study. We would only correct major mistakes. If the bank wanted additionalresearch, analyses, or calculations, it would have to pay us more. The managementteam was very surprised. To their expectation, this report was merely the feedback ofthe results of the second workshop. It was the first time that the management team hadseen the results of the valuation. They had additional questions and suggestions forimprovement, and were disappointed that we did not want to do any additionalanalysis. They thought the results of the analysis were interesting, but the project wasnot yet finished. This mistake had a big impact on the success of the method. When Iasked the CEO of Bank Ltd about the implementation two years after the project wasfinished, he showed not so much disappointment about the method and its potentialresults, but disappointment about the fact that the project was not finished properly.

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At Automotive Ltd we found three of the conditions for successful implementationwere not fulfilled. The level of involvement of the client system with the engagementwas minimal. The communication between the implementation team and the clientsystem was deliberately kept to a minimum in order not to take too much of the clientstime. There was no equivalence between the client system and our implementationteam. These factors explain part of the lack of success. The lack of a clear and urgentproblem, and the very pragmatic mind-set of the owner were other important factors.As a consequence the owner was not convinced that the implementation was veryuseful and he terminated the project.

ConclusionsBased on the implementation of one particular method for the valuation of intellectualcapital at six companies I draw the following conclusions about critical success factorsfor implementing an intellectual capital valuation method. I formulate my conclusionsas hypotheses.

First there is the need for a proper diagnosis of the problem at hand. The valuationof intellectual capital can help to solve several types of company problems (Andriessen,2004a). We need to do a thorough diagnosis to determine the specified problem of thesituation at hand. This is especially essential when our intention is to improve theinternal management of your organization. There can be many reasons why acompany is performing sub optimally or poorly. There can be many ways to optimise acompanys performance. It is not sufficient merely to identify the problem at hand asan internal management problem. Instead, we should analyse the specific context ofyour organization and diagnose its unique situation. We may find that the intellectualcapital perspective is an appropriate perspective to diagnose the problem. Using thisperspective implies focusing on the intellectual capital of a company, the way it ismanaged, its strengths and weaknesses, and its potential. However, to avoidpigeonholing, we must be aware that other perspectives may be equally or moreappropriate. Otherwise, there is a clear risk that an inappropriate or unimportantproblem will be solved, as we saw in the case of Electro Ltd

Second, we must understand the strengths and weaknesses of the method we intendto use. This includes the internal validity of the method. Many of the existing methodshave internal validity weaknesses (Andriessen, 2004a). In addition we must haveknowledge of the weaknesses of IC measurement methods in the way they work inpractice. Unfortunately not much research has been done into the practical weaknessesof existing methods.

Third, we must clearly understand the application domain of the method: the classof problems and the class of contexts for which the method provides solutions. Whatproblems can it solve and for what kind of problems is it not the appropriate tool? Thisquestion is crucial to avoid pigeonholing. In what circumstances and under whatconditions can it be used? This includes critical conditions for success like for examplethe IC-intensiveness of the company, its size, the willingness of management to beinvolved and the presence of the appropriate skills set to make sense of and use theresults.

Fourth, we must posses the necessary skills to implement the method. This is truewhether one implements a method as a manager or as a consultant. As a consultantthis skill-set includes basic consulting skills on communicating with and involving the

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client, diagnosing the situation, creating a tailor-made solution, providing concretedirections and creating a level of equivalence. However as a manager implementing anIC measurement method requires similar skills. Implementing such a method in yourown company also requires for example buy-in from important stakeholders and aproper problem diagnosis.

Successfully implementing a method for the valuation or measurement ofintellectual capital is not an easy task. Practitioners yet receive little support from theintellectual capital research community. Little research has been done into the factorsthat influence the success of a method. This paper is a first attempt at systematicallyidentifying some of the factors for the successful implementation of an intellectualcapital valuation or measurement tool. This paper focused on the KPMG ValueExplorer. We need more of this kind of research about other available methods.

Note

1. Give a child a hammer and, to the child, suddenly everything becomes a nail.

References

Andriessen, D. (2001), Weightless wealth: four modifications to standard IC theory, Journal ofIntellectual Capital, Vol. 2 No. 3, pp. 204-14.

Andriessen, D. (2004a), Making Sense of Intellectual Capital, Butterworth Heinemann, Burlington,VT.

Andriessen, D. (2004b), IC valuation and measurement; classifying the state of the art, Journalof Intellectual Capital, Vol. 5 No. 2, pp. 230-42.

Andriessen, D. (2004c), Reconciling the rigor-relevance dilemma in intellectual capital research,The Learning Organization, Vol. 11 Nos 4/5, pp. 393-401.

Andriessen, D. and Tissen, R. (2000), Weightless Wealth: Find Your Real Value in a Future ofIntangibles Assets, Financial Times Prentice Hall, London.

Bontis, N. (2001), Assessing knowledge assets: a review of the models used to measureintellectual capital, International Journal of Management Reviews, Vol. 3 No. 1, pp. 41-60.

Bontis, N., Dragonetti, N.C., Jacobsen, K. and Roos, G. (1999), The Knowledge Toolbox: a reviewof the tools available to measure and manage intangible resources, EuropeanManagement Journal, Vol. 17 No. 4, pp. 391-401.

De Caluwe, L. and Stoppelenburg, A. (2003), Organisatieadvies bij de Rijksoverheid; kwaliteitonderzocht, Tijdschrift voor Management en Organisatie, Vol. 57 No. 1, pp. 25-52.

Kerssens, I.C. (1999), Systematic design of R&D performance measuring systems, thesis,University of Twente, Enschede.

Luthy, D.H. (1998), Intellectual capital and its measurement, Proceedings of the Asian PacificInterdisciplinary Research in Accounting Conference (APIRA), Osaka, available at: www3.bus.osaka-cu.ac.jp/apira98/archives/htmls/25.htm

Ministry of Economic Affairs (1999), Intangible Assets: Balancing Accounts with Knowledge,Information Department of the Ministry of Economic Affairs, The Hague.

Mouritsen, J., Larsen, H.T. and Bukh, P.N. (2001), Valuing the future: intellectual capitalsupplements at Skandia, Accounting, Auditing & Accountability Journal, Vol. 14 No. 14,pp. 399-422.

Perrow, C. (1970), Organizational Analysis: A Sociological Review, Wadsworth, Belmont, CA.

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Petty, R. and Guthrie, J. (2000), Intellectual capital literature overview: measurement, reportingand management, Journal of Intellectual Capital, Vol. 1 No. 2, pp. 155-76.

Reilly, R. and Schweihs, R. (1999), Valuing Intangible Assets, McGraw-Hill, New York, NY.

Roos, G., Bainbridge, A. and Jacobsen, K. (2001), Intellectual capital analysis as a strategic tool,Strategy and Leadership Journal, Vol. 29 No. 3, pp. 21-6.

Sveiby, K.E. (2002), Methods for measuring intangible assets, available at: www.sveiby.com/articles/IntangibleMethods.htm

Van Aken, J.E. (1996), Methodologische vraagstukken bij het ontwerpen van bedrijfskundigesystemen, Bedrijfskunde, jaargang, Vol. 68 No. 2, pp. 14-22.

Van Aken, J.E. (2004), Management research based on the paradigm of the design sciences: thequest for field-tested and grounded technological rules, Journal of Management Studies,Vol. 41 No. 2, pp. 219-46.

Weggeman, M. (1995), Creatieve Ambitie Ontwikkeling, PhD thesis, Tilburg University Press,Tilburg.

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Intellectual capitalManagement approach in ICS Ltd

S. Pike, L. Fernstrom and G. RoosICS Ltd, London, UK

Abstract

Purpose The purpose of this paper is to demonstrate how the ICS intellectual capital methodologywas developed starting from the underpinning academic theory.

Design/methodology/approach The approach is founded upon a number of theoretical strands.The basic intellectual capital approach is based on a development of the resource based theory of thefirm. Most intellectual capital approaches have problems with meaningful measurement. ICSaddresses the valuation of intellectual capital resources by using axiology and multi-attribute valuetheory to produce a valuation framework and measurement theory to ensure that the results arereliable.

Findings The ICS intellectual capital approach generates navigators (maps) of how resources areused in companies which have proven to be very useful. It has also demonstrated the value of deeperanalysis of the intellectual capital resources. The measurement part, which is often used independently(known as the Conjoint Value Hierarchy (CVH), is shown as a powerful aid to decision making as wellas to more straightforward valuation.

Research limitations/implications The limitations are that the navigator and its associatedanalyses are non-rigorous while the CVH is rigorous, transparent and auditable. This mismatch canlead to problem and the challenge is to integrate them.

Originality/value While parts have been reported previously, this paper is the first integratedreview of ICS methodology.

Keywords Intellectual capital, Measurement

Paper type Research paper

The development of our concept of intellectual capitalThe paper begins with a review of the historical background to resource-basedaccounting and intellectual capital. This is then used as the starting point for adescription of the intellectual capital approach used in ICS Ltd[1]. Aspects ofmeasurement are then discussed as they apply to intellectual capital methodologies.The paper concludes with a review of the key barriers to the development ofintellectual capital thinking as seen by ICS Ltd and some initial views on the importantissues to be talked as matters of priority.

Intellectual capital has a surprisingly long history, one founded in themeso-economics of the first third of the twentieth century which was then developedin the second third into the micro-economic (firm-based) views. Chamberlin andRobinson (Chamberlin, 1933; Robinson, 1933) and later Penrose (1959) werecontributors in this early work. Schumpeters work of 1912 (Schumpeter, 1934)predates this work and sees the use of new resource combinations by entrepreneurs asthe foundation of cyclical economic growth. However, Schumpeters perspective wasmacro-economic and invention, as distinct from innovation, was treated as exogenousto the firm. Examination of the contributions of Robinson and Chamberlin show howthe concepts they developed have survived to the present. For example, Chamberlin



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pp. 489-509q Emerald Group Publishing Limited

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identified that some of the key capabilities of firms included technical know-how,reputation, brand awareness, the ability of managers to work together and particularly,patents and trademarks, many of these are common in relatively recent strategy andmarketing literature (Day, 1994; Hall, 1992). Edith Penroses much cited work on thetheory of the growth of the firm dismissed the view that a firm was just anadministrative unit and saw it instead as productive resources at the disposal ofmanagers. She suggested that a firm is best gauged by some measure of the productiveresources it employs. This led directly to the development of ideas concerningcompetitive advantage in the last third of twentieth century.

The concept of sustainable competitive advantage based on the utilisation ofresources is simple and stems from the assumption that the desired outcome ofmanagement is a sustainable competitive advantage. Sustainable competitiveadvantage demands the possession of certain key resources and that they havecharacteristics such as quality or value, high barriers to duplication and so on (Barney,1991). Sustainable competitive advantage can be achieved if the firm effectivelydeploys and maintains these resources in its field or operation. The key issue and themost important feature of useful intellectual capital[2] approaches is one of exposingstrategic choice.

Penroses work provided further guidance for the development of intellectual capitalas an approach to business management. For example the clear definition of what aresource can be and how it differs from activities and services is crucial. This led to thenotion that services yielded by resources depend on the resources that are used. Agiven resource can be used in different combinations with other resources to givedifferent services or generate a variety of other resources. Furthermore, thedevelopment of a firm is constrained to an extent by the nature and qualities of theresource it currently posses. This thinking led others to consider the development anddeployment of resources (Amit and Schoemaker, 1993; Barney, 1986, Barney and Zajac,1994, Lei et al., 1996; Schoemaker, 1992) and the relationship between resources and thescope of the firm (Chatterjee and Wernerfelt, 1991; Markides and Williamson, 1996;Prahalad and Hamel, 1990; Robins and Wiersema, 1995).

The term resource-based view of the firm was first used in 1984 in a paper(Wernerfelt, 1984) which was later awarded the Strategic Management Journal awardfor best paper. It was also in this decade that the rise of the new economy gathered paceand the traditional Porterian structures were found to be inadequate to describe firmsand the performances of firms even in the same industry (Cubbin, 1988; Hansen andWernerfelt, 1989). This later observation immediately brought in researchersconcerned with strategy and strategic decision making (Amit and Schoemaker, 1993;Barney, 1986, 1991; Dierickx and Cool, 1989; Lippman and Rumelt, 1982; Peteraf, 1993;Reed and DeFillippi, 1990). Interest in these issues was not confined to academics. InSweden, consultants, company chief executives and others convened what becameknown as the Konrad Group[3] to review the role of resources, both tangible andintangible in value creating or maintaining sustainable competitive advantage infirms. They issued a first publication in January 1988 entitled the New Annual Reportand issued their final report in 1989 presenting the first method on intangiblemeasurement, The Invisible Balance Sheet (Den Osynliga Balansrakningen). Thepublication presents key indicators for accounting control and valuation of know-howcompanies.

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The issue of achieving and maintaining sustainable competitive advantage bymeans of combining and using resources naturally leads to the question of how thegoodness or suitability of the resources should be described and measured. Barney(1991) proposes four conditions: value, rareness, inimitability and non-substitutability.Grant (1991) argues that levels of durability, transparency, transferability andreplicability are important while Collis and Montgomery (1995) suggest five tests:inimitability, durability, appropriability, substitutability and competitive superiority.Amit and Schoemaker (1993) go even further, producing a list of eight criteriaincluding complementarity, scarcity, low tradability, inimitability, limitedsubstitutability, appropriability, durability and overlap with strategic industry factors.

In the development of intellectual capital at ICS, supporting thinking was alsobrought in, notably to assist with the treatment of value extraction from innovation(Teece, 1986) and human resources (Handy, 1989). The first methodology was publishedin 1997 (Roos et al., 1997). To support the work overall and give a different perspectivefrom the Konrad Group work, the work of Itami (1987) was used. Itamis treatment of themobilization of resources being particularly helpful in the formulation of thinking ofresource transformations. It was obvious at this stage that different managers incompanies had different views on the importance of the resource transformations in thecompany and key outside stakeholders, such as investors, may take yet another view.The ability to accommodate multiple stakeholder view is therefore important.

The preceding paragraphs have touched on a number of issues that need to beconsolidated into a homogeneous whole if it is to yield a practical approach to businessmanagement. These can be summarized as follows:

. It is strategic.

. It is about all a firms resources.

. It is about their characteristics and quality.

. It is about how they are used in combinations to create value.

. It is about how value is seen by a wide selection of stakeholders.

. It is about how they are developed to ensure sustainable competitive advantage.

The measurement of intellectual capital has been problematical but it is the acid test ofa working theory. Without measurement and the ability to predict then intellectualcapital as a means of managing and explaining a firms performance remains ahypothesis since it fails the classic test of the scientific method.

A key question at this stage is to determine what should be measured. There isincreasing pressure from regulators, especially the Financial Accounting StandardsBoard in the USA who have been pressing and moving towards the mandatorydisclosure of certain elements of intangible resources and the recording of elements ofgoodwill in mergers and acquisition; see FAS141 (Financial Accounting StandardsBoard, 2001a) and 142 (Financial Accounting Standards Board, 2001b). Thus, there is agrowing requirement to disclose data on intangible resources. The ideal solution is toconstruct a single measurement system that is comprehensive inside the firm and ismodular (permitting the simple use of parts throughout the firm) and which permitsthe disclosure of benchmarkable data (across the business sector of the firm therebyallowing meaningful comparison in the market) without compromising strategicintent.


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When addressing intangible resources and their contribution it is clear thatfinancial style measures are inappropriate. While some measures of intangibleresources such as hiring and wage costs might be comparable, the value derived fromany employee depends on how he or she is used and such is the complexity of the valuecontribution that ascribe a financial value to him or her is meaningless. Thus the widerconcept of value has to be invoked. The study of value, known as axiology, moralphilosophy and values stretches back to the ancient Greeks and, like many otherthings, seems to have lain largely dormant between the end of the classical period untilrenaissance times in the West. In the nineteenth century, the positivist movementsought to put science onto firm philosophical (rather than technical) foundations and inthe early twentieth century, the logical positivists of the Vienna circle developed thisfurther admitting only theories, methodologies or approaches that had either a basis inlogic (such as mathematics) or could be proved experimentally (such as the othernatural sciences). This second group can be problematic on the grounds of impliedsubjectivity. However, it can lead to the admission of axiology (see Frondizi, 1971), thestudy of value, into the fold of acceptability from the positivist point of view.

Axiology is and must be a general approach applicable to all questions of value butit has constraints in exploitation. Fortunately, most commentators admit economicvalue into the fold. Zuniga (2000) in her thesis on a general theory of value, discusseseconomic value and uses an example to demonstrate compliance. Both Zuniga and,much earlier, Menger (1883) discuss the nature of goods and value in an economicsense and distinguish between first order goods (which have immediate value) andhigher order goods (which are enablers). They also consider the issue of independenceof view and argue that while value and valuations may be personal, all observers maybe wrong in their valuations since there is an ultimate ex post arbiter of value which isthe market.

Axiology requires extension from its simple philosophical roots to enable it to beused in complex situations such as the valuation of intellectual capital in companies.Multi-attribute value theory (MAVT) (Keeney and Raiffa, 1993) is the most widely usedtheory in solving multi-attribute decision-making problems. Practically all approachesto multi-attribute decision making explicitly or implicitly make use of the concept ofthe relative importance of criteria the weights of criteria or attributes within ahierarchical system of value. While there are many approaches to the issues ofweighting or determining the relative importance of attribute, the pair-wisecomparison methodology of Saaty (1980) has been found to give good results and iswidely used.

The foundation of measurement is measurement theory, a branch of appliedmathematics. If it is adhered to then reliable measures can be obtained which mangerscan use. If it is not, and adherence appears uncommon in non-financial measurement,then what results is a selection of probably misleading results of no real use tomanagers. While indicators, as distinct from proper measures, have their place asrough guides, care has to be exercized in their use. Table I compares measures andindicators.

ICS has developed a simplified indicator system known as the IC Index for internalmanagerial use but this is not discussed in this paper, since it is extensively covered inother publications (Roos et al., 1997; Roos and Jacobsen, 1999, Bontis et al., 1999; Bontis,

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2000; Pike and Roos, 2000; Neely et al., 2002; Marr et al., 2002; Pike and Roos, 2004;Marr et al., 2004).

Measurement theory has its very early roots in ancient Greece but the ideas of themodern theory of measurement date from the ninteenth century work ofHelmholtz(1887) and others. However, its formalisation is a surprisingly recentevent. The catalyst for the formalization of measurement theory is generally acceptedto be the psychologist S.S. Stevens (Stevens, 1946), but it was not until the 1960s thatmeasurement was fully axiomatized with the publications of Scott and Suppes (1958)and Suppes and Zinnes (1963).

In pragmatic applications of measurement theory, a multi-stage process is generallyinvolved in which the representation of the object to be measured and themeasurements system are kept separate. In the first stage, an empirical relation systemis specified to define the relations among the attributes of the studied entity, in thiscase, the company. Second, an isomorphic numerical relation system is defined, toprovide values for the measures of the attributes and relations among these values.The general form of these measurement systems is hierarchical with a preciselydefined business value context at the top. The pragmatic rules and requirements of anempirical relation system suited to modern business systems have been set out byMPherson and Pike (2001) and extended later (Pike and Roos, 2003). In the empiricalsystem, there are two rules that must be observed:

(1) That at every level of detail, the sum of the meanings adds up and completelydescribes the meaning of the company and what it does. This is the condition ofcompleteness and ensures that nothing (important) is missed out.

(2) Every attribute at every level is independent in terms of meaning from everyother at the same level. This is the condition of distinctness and preventsdouble counting.

MPherson and Pike (2001) then continue with the numerical isomorph in which realmeasures are found which satisfy the desired measures in the empirical system.

Measurement system Indicators

AdvantagesAccurate if built properlyProduces a complete view of the objectData can be disclosedResults can be benchmarkedCan be the basis of derived measuresCan be used with other business modelsTransparent and auditableTakes multiple views of value into account

Quick to buildEasy to operate

DisadvantagesTakes care and time to set upData requirement can be largeData quality requirements are stringent

Purpose specificCannot be benchmarked with safetyTakes a single average view of valueCannot be aggregated to value complex objectsPossibility of duplication

Table I.Comparison of proper

measurement andindicators


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Unfortunately, some of the attributes of value that should be measured are hard toobserve in practice and proxies must be used for them.

. That the proxies are agreeable and do not change the meaning of the attributesabove them in the hierarchy by violating either of the first two rules. This meansthat the real measurement system truly reflect the intention of what is to bemeasured.

. The commensurability condition ensures that data is all on the same 0 to 1scale and is all defined on a ratio scale. This means that there is no chance thatany of the results or later statistical post-processing are invalidated because ofpoor data.

. The mathematical constraints on the aggregation function are often lumpedunder and independence banner and assure that ill-conceived combinationschemes which would produce wrong answers are not permitted.

By combining measurement theory with axiology and multi-attribute value theory it ispossible to develop bespoke or general measurement systems to measure businessperformance and account for the value in intangible resources and their use.

Our concept of intellectual capitalICS defines intellectual capital[4] as any intangible resources or transformations ofthose resources, which are under some level of control of the company that adds to acompanys value creation (Roos et al., 1997).

ResourcesThe researchers of the 1980s and early 1990s produced a variety of definitions. It isgenerally agreed that tangible resources are either monetary or physical, are owned bythe firm, behave with diminishing returns and can be valued with reasonableagreement according to generally accepted accounting principles. Intangible resourcesin contrast may or may not be owned by the firm, they might only be partially underthe firms control, may they have complex return characteristics and they are hard tovalue. Indeed, Edvinsson and Malone (1997), while credited with equating marketvalue to the sum of intellectual capital resources and tangible resource results, were notthe first to suggest such an erroneous relationship. Grant (1991) suggested that the IPof pharmaceutical companies as tradable entities was the cause of the significantdifference between market value and book value.

The definition of resources must surely be one of the most embarrassing features ofthe intellectual capital movement. Over the past ten years there have been a greatnumber of formulae for describing intangible resources with few exploring muchbelow a level where there are two groups of tangible resources and another two or threegroups of intangible resources. None so far have backed their definitions withsemantics or mathematics. This means that methodologies are not interchangeable andcomparisons cannot be made between any two firms, as there is no guarantee that likeresources are being compared.

The ICS methodology has a hierarchical menu of resources starting with level 1which comprises monetary, physical, human, organizational and relational resources.These are defined by a set of underlying resources at finer levels of granularity. Thusthe menu continues with some 30 standard level 2 resources which are supported in

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turn by up to 100 firm-specific level 3 resources. While the list may seem a long one, itis customized for different firms at level 3 only. Furthermore, while level 3 resourcesare used in the precise definition of the level 2 resources, in practice, it is usuallyunnecessary to consider more than about 25 resources since the efficiency,effectiveness, opportunities, threats to the firm are almost always visible even atthis level of granularity. Although

Bernard Marr Management Consulting Practice in Intellectual Capital 2005

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