The Components of Value Measurement

The worth of a company goes beyond dollars and cents.

THE VALUE MEASUREMENT AND REPORTING Collaborative (VMRC) is a global effort intended to help boards of directors, senior management, investors and other stakeholders make better strategic decisions using value measurement and reporting. Its members believe the value of a company lies not only in its present operational value but also in its potential to create value in the future.

BUSINESSES REPORT VERY LITTLE EXTERNALLY about their human, relational or organizational capital. As a result it’s difficult for investors to know how well a company measures or manages factors that have the potential to create future value. The VMRC did research on how human capital, customers and clients and innovation affect future value creation in three industries—natural resources, pharmaceuticals and telecommunications.

A LARGE MAJORITY OF NATURAL RESOURCES companies did not disclose any measures that would allow observers to better understand the value of their customer base. Among pharmaceutical companies, only 19% commented on human capital and even then it was to report only the number of employees.

THE VMRC RESEARCH CONFIRMED THERE IS LITTLE publicly available information on the factors that drive a business’s future value. No companies in the three sectors commented about the number of product categories purchased per customer or the expected life of a customer. Only pharmaceuticals companies disclosed products they had under development.

WHILE MORE WORK IS NEEDED BEFORE COMPANIES disclose information about their potential for future growth, some have begun to reveal these critical data. Two companies in the research sample disclosed information about their virtual R&D team and two others provided details about the number of new ideas they had generated.

F. ANNE DROZD, FCA, is president of ACHOS, a management consulting company in Gabriola Island and Toronto, Ontario, Canada, that provides services to the Canadian Institute of Chartered Accountants, among other organizations. She is a director of the VMRC. Her e-mail address is or .

hat creates value in a company? The Value Measurement and Reporting Collaborative (VMRC) believes value is defined not only in monetary units but also in objects, ideas, events or processes. The VMRC, in which the AICPA participates, is a global effort of the accounting profession to help boards of directors, senior management, investors and other stakeholders make better strategic decisions using value measurement and reporting. Its members say a company’s worth exists not only in its present operational value as accounted for historically in its financial statements, but also in its potential to create future value.

Managing the factors that influence corporate performance is one way management adds value to the bottom line. Every investment analyst tries to look beyond the financial data for information about a company’s potential. Accordingly, CPAs in senior management, board members, analysts and investors should be interested in a framework of principles and criteria to measure and report value creation and maintenance.

Research undertaken on the VMRC’s behalf by Roland J. Burgman, Reporting on Intangibles and Intellectual Capital Assets, shows the market value of equity and net debt is larger than the present value of current operations for companies in the Russell 3000 index (excluding real estate companies). This difference between the two—which the research refers to as a company’s intellectual capital of a human, relational or organizational nature—is called future growth value.

CPAs in senior management, board members, analysts and investors should be interested in a framework of principles and criteria to measure and report value creation and maintenance.

Depending on the definition, intellectual capital can be the term for all value drivers or value drivers can encompass intellectual capital. Regardless of how CPAs apply the term, the issue is that while information about factors that have the potential to create value may be available internally, businesses report very little of it externally. Companies sometimes disclose future value information quantitatively or qualitatively in a management discussion and analysis (MD&A) statement, in the president’s message or on their corporate Web sites. The overall lack of information means it’s difficult for an analyst or investor to know how well a company is measuring or managing these factors. Even when the information is available, it often is not comparable within industries or across sectors.

Acknowledging Burgman’s study as a foundation, the VMRC commissioned further research focused specifically on three of the factors that drive a business’s potential to create value—human capital, customers/clients and innovation—in three industries: natural resources, pharmaceuticals and telecommunications. (See the box at left for a list of these studies.) The two years of publicly available data the researchers reviewed included annual reports/filings, annual MD&A statements, supplementary reports and corporate Web sites.

Each research sample included about 60 companies headquartered in North America, South America, Europe, Africa, Asia and the Australasia region. The research showed that 20% of the companies in all three sectors referred to human capital in some way. It most often was discussed within the framework of intellectual capital—the interaction of human, organizational (structural) and customer (relational) capital. Companies disclosed human capital in both quantitative (numbers of people, staff costs) and qualitative (quality of work life, ethics and values) terms. The three industries weighed these components differently.

VMRC Research

Customer and Relational Capital Measurement and Reporting in the Context of Value Creation by Jerry Gerard, Cynthia Hiris, Steve Villani and Alan Wunsche, March 2004.

Innovation Measurement and Reporting in the Context of Value Creation by Alan Wunsche, Jerry Gerard and Bill Swirsky, November 2003.

Measurement and Reporting of Human Capital by Enrico Ulliana, John Macey and Peter Grant, November 2003.

In all sectors researched, customer and relationship capital were key sources of future wealth and a source of considerable goodwill in corporate acquisitions. However, the research showed that disclosure of this factor was surprisingly low. Some 22% of the companies in the research sample in the natural resources industry provided information about customer and relationship capital, as did 20% of the pharmaceuticals companies and 31% of the telecommunications sample. Even in cases where companies disclosed standard industry measures of customer and business partner relationships, they presented them on a historical basis without attached valuations. As a result investors and other stakeholders were unable to determine, with any degree of certainty, the potential of the business to create value based on its customer and relationship capital.

Innovation is the value driver on which the highest percentage of companies reported—39% in the pharmaceuticals group. However, information on this vital factor often was limited. For example, while new product introductions are a fundamental indicator of innovativeness, more than 90% of the companies in the research sample did not disclose this measure. Disclosure often was limited to tangible research and development expenditures and the outcomes of R&D activities.

Research on human capital showed that companies in the natural resources sample cited safety and accident statistics much more often than did companies in the other two areas. Members of this sector also made relatively frequent references to environmental and community development programs directed at gaining acceptance of operational activities. Other information of a qualitative nature, such as ethics and values, enhancing employee value through training and communication and consultation with employees, also merited some references.

In customer and relational capital, a large majority of the research did not disclose any measures that would allow observers to better understand the value of a company’s customer base. A few, however, did provide product-line descriptions. An even smaller number disclosed market share or number of customers.

For innovation capital, the natural resources sector’s reports and communications stressed pragmatic management and product development. Possibly for competitive reasons, there was very little disclosure of products under development. Reporting focused on innovative practices and products to combat commercialization. More complete and consistent reporting of innovation capital would allow investors and other stakeholders to make more informed decisions about a business’s potential.

In the pharmaceuticals industry, only 19% of companies commented on human capital. The most common statistic reported was the number of employees. The research showed the industry to be driven by science, sales and finance. Science generally was referred to as a process, with people apparently incidental. The implication is that of the three components that make up intellectual capital, the science portion of the process—relational and organizational capital—is more important than human capital, the people part of the process.

In customer and relational capital, the research showed pharmaceutical companies primarily sell to “channel partners” (hospitals, wholesalers and doctors, for example). In cases where the companies sold branded products, they went to significant lengths to disclose ultimate consumer/patient needs. The implication is that branding provides considerable customer equity. Number and description of product lines were the most frequently disclosed quantitative information. The existence of joint ventures and research agreements sometimes was given as an example of relationship capital.

With regard to innovation capital, the pharmaceuticals industry focused reporting on the number of patents secured to protect intellectual property. However, companies referred to the loss of patent protection more often than they did to the nature of new patents. In addition pharmaceutical companies frequently showed the stage of commercialization of new products under development, but generally did not value the entire pipeline on a forward-looking basis. The absence of such a valuation makes it difficult to examine a company’s future growth or its long-term viability—particularly when measured on a consistent basis and reported annually.

Initial research showed that companies don’t regard human capital as an important value driver. To compensate, researchers extended the sample to include computer software and hardware companies—technology-driven businesses. Even with the extension, the level of voluntary disclosure of any human capital information was very low, only 11% of the sample. Information on how much a company spends on staff training, employee diversity and leadership development and recognition would allow stakeholders to make better decisions about whether a business is being managed in a way that will help it maximize its future growth potential. Information about human capital also would help for some of the existing differences between book and market values.

Research in the customer and relational capital area disclosed that the industry has a standard set of customer metrics, for example, average revenue per user, which many companies use. Customer satisfaction often was described as a differentiator and a source of competitive advantage. Companies provided extensive business unit and geographic segmentation of results.

Disclosure of new product introductions in the telecommunications sector offered insights into the innovative strategies of the organizations in the research sample. Alliances and development pipelines were disclosed to a lesser extent.

Current Operations Value
Future Growth Value

Russell 3000 companies as of May 30, 2004*

*Excluding real estate companies.

Source: Reporting on Intangibles and Intellectual Capital Assets by Roland J. Burgman.

The research on human, customer and relational and innovation capital in the three industries resulted in two obvious conclusions.

The first confirmed the anecdotal evidence that there generally is a dearth of publicly available information on the factors that drive value creation and maintenance within a business. In customer and relationship capital, none of the three sectors commented publicly about the number of product categories purchased per customer or about the life or expected life of a customer. With regard to innovation capital, no company disclosed the net present value of new patents granted or the net present value of its patent portfolio. Only in the pharmaceuticals sector did all the companies in the sample comment on the number of new products in the development pipeline and provide information about the number and description of product lines.

It seems some companies are willing to disclose information the majority did not. For example, two companies disclosed details of their virtual R&D teams accessible through partnerships. Two companies provided information about the number of new ideas generated. In terms of customer and relationship capital, one company disclosed the number of orders per customer, two the average customer tenure and two average margins per customer and projected revenues and margins associated with new in-licensing agreements.

It’s interesting to note that none of the companies in the innovation capital study disclosed the years of experience of their employees. However, one company in the human capital research sample did so. Clearly, there is considerable distance to travel before information that drives a significant portion of the company’s market value—its potential for future growth—is available.

The second conclusion is that the identified value drivers do not act in isolation. For example, the inventory of innovation capital measures includes human, relational and structural capital. The inventories of human capital and customer and relationship capital are even more complex. In addition the company’s strategy, governance and leadership must be considered for each factor.

The next step should be to bring theory and reality together so that what companies disclose is useful to investors and analysts, who want not only historical results but also potential future growth information. At the same time, value reporting must not open the door to litigation or put the reporting company at a competitive disadvantage. This is a challenge the VMRC is taking up in developing a framework of principles and criteria that characterizes value measurement and reporting worldwide.

The Value Measurement and Reporting Collaborative, , is a multiparty, global group of stakeholders including the AICPA that is working to develop a value measurement and reporting framework and to communicate the need for value reporting on a consistent basis to the business and financial community.

Membership is open to organizations that are knowledgeable about measuring the value potential of businesses and understand the importance of reporting value that goes beyond financial information. For more information about the collaborative, CPAs and other interested parties should contact Erin Mackler at .


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