EXECUTIVE
SUMMARY |
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
achos01@shaw.ca or
anne.drozd@cica.ca .
|
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.
|
THE POTENTIAL FOR FUTURE VALUE
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.
NATURAL RESOURCES
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.
PHARMACEUTICALS
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.
TELECOMMUNICATIONS
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
Vs.
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.
|
VALUE DRIVERS
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 FUTURE OF VALUE MEASUREMENT
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,
www.valuemeasurement.net , 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
emackler@aicpa.org . | |