BUSINESS: The Ultimate Resource

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BEST PRACTICE
Viewpoint: The Invisible Advantage by Jonathan Low and Pam Cohen Kalafut
In 1995 Sir John Browne took over the struggling oil giant BP and launched a series of dramatic moves that catapulted BP into a leadership position in the oil industry. He acquired Amoco and Atlantic-Richfield Co. and invested in innovative deepwater drilling which enabled BP to bring wells online faster. See Daniel Fisher, How Sir John Browne Turned BP Amoco into the Hottest Prospect in the Oil Patch, Forbes, April 2 2001. Finally, Browne has actively managed BPs brand and reputation by taking a strong environmental positionfocusing on reducing emissions and investing in cleaner forms of petrol. See Janet Guyon, A Big-Oil Man Gets Religion, Fortune, March 6 2000. Procter and Gamble has beaten Wall Streets revised expectations eight quarters in a row by instituting a back to basics strategy. Instead of developing and marketing new products P&G is focusing on the top twelve brands they already produce. A series of budget cuts and project realignment have yielded two billion dollars in savings in just over two years. See Katrina Brooker and Julie Schlosser, The UnC.E.O.; A. G. Lafley Doesnt Over Promise. He doesnt believe in the Vision Thing. All Hes Done Is Turn Around P&G in 27 months, Fortune, 16 September 2002. In 1989 Toyota challenged the luxury automobile business by introducing the Lexus. Just five months after its introduction, the Lexus LS 400 was named Best Imported Car of the Year by the Motoring Press Association. Lexus has garnered nearly every excellence award in the car industry several times over. It has built a brand name synonymous with superior quality, performance, and customer satisfaction, and has experienced 13 consecutive months of record sales. Jean Halliday and Alice Z. Cuneo. Lexus Eyes Brand I.D. Consultant, Advertising Age, July 9 2001. The $40 billion French Company LVMH Moet-Hennessey Louis Vuitton S.A. has used a multicultural approach to procure ideas and talent. The firm ventures outside France to cultivate and attract the best and brightest human capital and institutes a value system approach to indoctrinate employees. It even hired an orchestra director to show managers how to gather many different talents into one cohesive group. LVMH has developed a climate that encourages bold and innovative leadership. It has also entered into partnership with a school in France that focuses on training individuals in luxury brands and serves as an incubator for the company. See Concept Lanciaux, Building Brand Through People: LVMHs Luxury Talent, The Cap Gemini Ernst & Young Center for Business Innovation Perspective on Business Innovation: Valuing Intangibles, November 2001.

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BUSINESS: The Ultimate Resource

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Leadership, strategy execution, brand, human capital: these are the currencies in todays marketplace. Value is no longer created solely or even primarily by the corporate behemoths of the industrial era. People and their ideas are the most significant drivers of wealth creation in the new global economy. While the dot-com bubble may have fuelled false hopes and the dream of easy money proved illusory, an important underlying trend remains: traditional measures of success tied to such factors as value of assets and number of employees, like other standards of size or quantity, may, in fact, signal weakness rather than strength. Whether it is an Internet start-up or a Fortune 500 corporation, a companys intangible assets are essential to its success.

What Are Intangibles?

Intangibles comprise the human, intellectual, social, and structural capital of an organization. They include the people, ideas, networks, processes, and their offshoots that are not traditionally accounted for on the balance sheet. Intangibles are legitimate sources of worth in the global business context. The savviest investors rely heavily on intangibles in order to evaluate a companys performance and prospects. In fact, research at the Cap Gemini Ernst and Young Center for Business Innovation (CBI) shows that 35% of portfolio managers base their decisions about where to allocate their investment dollars on intangible assets and not on information in the balance sheet. In Decisions That Matter, Cap Gemini Ernst and Young Center for Business Innovation, 1999, a study conducted by the CBI, 81% of respondents said that they got poor information on the value drivers that were most important to them as managers. The study also pointed out that 71% of senior executives were not giving or getting the kind of information that they and their subordinates needed to manage their companies effectively. What we found was unambiguous. A majority of executives in every industry we studied believed that there were disconnects between the drivers they felt were critical to the companys success and what was actually being measured and reported.

What Are the Key Intangible Measures?

In the not too distant past, a professional investor or investment analyst looked at a companys size, its market share, its debt-to-equity ratio, and other easy-to-measure indicators of financial strength. Then they crunched the numbers and based their earnings estimates and their buy-or-sell recommendations mostly on the tangible and the countable. In the 1990s, academics realized that intangible assets were increasingly the source of value creation for most public companies and that financial statements alone were no longer adequate as a guide to a companys future. The Stock Exchange, and the financial professionals and analysts, questioned whether they really had the needed information. Recent events such as the Enron debacle have reinforced the degree to which intangible factors influence corporate value. Financial statements, despite the precision with which they are prepared, are sometimes illusory. Enrons swift destruction at the hands of the markets was driven relentlessly by the failure of its

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BUSINESS: The Ultimate Resource

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leaders to consider the impact of their actions on the capital markets assessment of intangibles like leadership, brand, human capital and, of course, reputation. In order to understand the growing importance of intangibles for stock exchange analysts and investors, the CBI conducted a 6-year research projectMeasures that Matter Value Creation Index Cap Gemini Ernst & Young Center for Business Innovation, 1999. That involved examining existing material on intangibles as well as interviewing hundreds of portfolio managers and examining about 300 investment reports. There are 12 key measures that we identified from our research and that consistently came up both in our own research and that of others: 1. Leadership: Management capabilities and experience, and the leaderships vision for the future. 2. Strategy Execution: Does management do what it says it will do? 3. Communication and Transparency: Does management communicate honestly and openly? Are its communications believed and trusted? Does it hold itself accountable? 4. Brand Equity: Strength of market position. The ability to expand the market and develop customer relationships, satisfaction, and loyalty. 5. Reputation: How is the company viewed globally? Where does it stand with regard to such things as environmental concerns, community concerns, regulators concerns, inclusion in most admired company lists, and the triple bottom line (a framework for corporate performance measurement based on economic, social, and environmental factors). 6. Alliances and Networks: Supply chain relationships; strategic alliances; partnerships. In a technologically driven global economy, few, if any, companies can afford to go at it alone. 7. Technology and Processes: I.T. capabilities; inventory management; turnaround times; flexibility; re-engineering; quality; internal transparency. 8. Human Capital: Talent acquisition; workforce retention; employee relations; compensation. 9. Workplace Organization and Culture: What makes a company a great place to work. Teams, employee involvement, etc. 10. Innovation: Ability to innovate; the R&D pipeline; flexibility; effectiveness of new-product development; knowledge creation and use. 11. Intellectual Capital: Patents; know-how; business secrets: the value of ideas in the intangibles economy. 12. Adaptability: The ability to evolve with the marketplace and change in order to prevail over those that cannot.

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It is important to understand that the market is already measuring intangible assets whether you like it or not. Now, it is necessary to understand and manage these intangibles on an industry level as well as a company level.

Intangibles at the Industry Level

In order to examine intangible assets on an industry level, the CBI created a statistical measure called the Value Creation Index (VCI) Value Creation Index. Cap Gemini Ernst & Young Center for Business Innovation, 1999.The VCI takes data from public and proprietary sources (such as company and industry reports, expert ratings, and government filings). Through a regression analysis and other statistical techniques, it is possible to quantify the impact of intangibles on market value beyond what would traditionally be captured in financial performance reports.

Intangibles at the Company Level: What Can Managers Do?

Intangibles can be very influential at the company level if businesses create a company-wide commitment to managing their intangibles. Managing intangibles involves identifying, assessing, and learning to improve them. While every organization is different there are five broad steps to consider. 1. Determine the critical intangibles for your business. Virtually every industry has three or four intangibles that are the most important. Some key questions leadership should examine are: What are the real drivers of value in our business? If we could gain a competitive advantage by improving our performance in two or three key areas, what would they be? It is also important not only to rely on three or four senior leaders, but also to incorporate insight from all levels. 2. Decide on metrics for the key intangibles. Examine already existing data collection (e.g. statistics about customers satisfactions and dissatisfactions) and work out how you can get other pieces of information that you do not have. Some intangibles are relatively easy to measure while others are more challenging. Where appropriate, poll your customers, suppliers, investors, employees, and other stakeholders. 3. Create a baselineand benchmark it against your competition. Ultimately, you want a movie of your management of intangibles; you want to see whether and how they are improving. Determine where you stand in comparison to your competitors strengths and weaknesses are and gauge them against your own. 4. Undertake initiatives to improve your performance on key intangibles. Intangibles can be managed. Performance can be improved. Assessing and measuring your intangibles helps you determine where to invest time and resources. Undertaking initiatives to improve performance helps you build value. 5. Communicate what youre doingfar and wide. The returns to transparency exceed the returns to secrecy. Share your insights into intangibles with employees, customers, suppliers, industry groups, investors, and stock exchange analysts. Show metrics and targets as well as the importance of specific intangibles. If you can then improve your companys performance, you will gain credibilityand the market will reward you for it.

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BUSINESS: The Ultimate Resource

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Parting Thoughts
There is considerable unseen and unrecognized valuean invisible advantagein the ideas and people who make up an organization. Many different establishments can benefit from the identification, measurement, and management of the kinds of intangibles we have highlighted. A growing acknowledgement of the beneficial power of good corporate governance has stimulated this movement, and will continue to do so. People at all levels can contribute to the understanding and management of the intangibles that, increasingly, will determine their organization future. We recognize that there are no easy or final answers. But we believe that whatever you do in this realm will be an improvement on the incomplete and frequently misleading picture painted by traditional financial measures. The legendary economist John Maynard Keynes once said, I would rather be vaguely right than precisely wrong. We agree.

The Best Sources of Help

Low, Jonathan, and Pam Cohen Kalafut. Invisible Advantage. Cambridge, Massachusetts: Perseus, 2002.

About the Authors

Jonathan Low and Pam Cohen Kalafut are leading researchers and experts on intangible value and its implications for business management, corporate growth, and economic policy. Under the auspices of the Cap Gemini Ernst and Young Center for Business Innovation ( www.cbi.cgey.com), they have conducted four major research initiatives on the topicMeasures that Matter, Success Factors in the IPO Transformation Process, Decisions that Matter, and The Value Creation Indexand published numerous articles and reports on their findings. Jonathan Low is a Senior Research Fellow at the Center for Business Innovation and Pam Cohen Kalafut is a Senior Manager in the Finance and Employee Transformation service line at Cap Gemini Ernst and Young.

Bloomsbury Publishing Plc 2004