Making the Invisible Visible

Recent research confirms that while most executives agree that intellectual capital is critical to the future success of their businesses, their approaches to measuring and managing this performance enabler are either poor or nonexistent. This has provided the impetus for the AICPA, in conjunction with CMA Canada and CIMA, to create a Management Accounting Guideline (MAG) on intellectual capital. Impacting Future Value: How to Manage your Intellectual Capital provides detailed guidelines across the following five steps of successful intellectual capital management.

STEP 1: HOW TO IDENTIFY THE INTELLECTUAL CAPITAL IN YOUR ORGANIZATION
Included in this step is an assessment of its value. Not all intellectual capital is automatically valuable to an organization. It is only valuable if it helps to deliver the organizational objectives. Intellectual capital value drivers can be identified by conducting interviews and facilitated workshops, or via mail or online surveys.

Together with physical and financial capital, intellectual capital is one of the three vital resources of organizations. Intellectual capital includes all intangible resources that are attributed to an organization and contribute to the delivery of the organizational strategy. These intangible resources can be grouped into human, structural and relational capital.

Once intellectual capital has been identified, its value can be assessed. When valuing intellectual capital, it should be kept in mind that its value depends on an organization’s specific strategy and that intellectual capital dynamically interacts with and depends on other resources.

STEP 2: HOW TO MAP THE INTELLECTUAL CAPITAL AND ASSESS ITS STRATEGIC IMPORTANCE
A value creation map is a visual representation of an organization’s unique strategy at a specific point in time. This means it has a limited life span and, as a consequence, must be revised regularly (usually annually). Every value creation map is unique to the current strategy of an organization, and no two value creation maps should be the same.

This visual representation has two primary functions— to ensure that the strategy with all its intellectual capital value drivers is integrated and coherent, and to enable easy communication of the strategy and the role and importance of intellectual capital in delivering the strategy.

STEP 3: HOW TO MEASURE INTELLECTUAL CAPITAL
After identifying and mapping the intellectual capital value drivers, organizations can start measuring them.

The aim of performance measures should be to provide meaningful information that helps reduce uncertainty about intellectual capital and enable learning. Measures ought to help managers and stakeholders make betterinformed decisions that enable performance improvements. An excellent way of ensuring that an indicator is worth measuring is to establish the question(s) the indicators will help to answer. So-called key performance questions (KPQs) are designed to identify what it is managers want to know about the various intellectual capital value drivers.

KPQs make sure any measure has a purpose and a clear aim. If there is no question that needs to be answered, there should not be a need to measure anything. For both existing or newly developed methods, it is important to assess whether it is possible to collect meaningful data and whether the data will help answer your questions. It is also important to assess whether the data warrant the costs and effort of measurement, which can be significant. If no meaningful data can be collected, or if the data are not really helping you answer the KPQ, or if the costs are not justified, then it is necessary to rethink and design different indicators.

A model using key performance questions and key performance indicators is described in detail in the guideline.

STEP 4: HOW TO MANAGE THE INTELLECTUAL CAPITAL IN YOUR ORGANIZATION
Once intellectual capital is measured, it can be managed. With relevant assessments, it is possible to understand current performance levels, to know whether intellectual capital has improved or deteriorated and to understand whether any activities and initiatives have affected performance. This information can be used to inform decision making, to test and review strategy, and to manage risks associated with intellectual capital.

To create effective feedback and learning from intellectual capital information, organizations need to regularly review performance. These reviews should take place monthly, and should be used to discuss the performance of the key value drivers that should lead to learning and decision making. Guiding principles for creating formative performance review meetings in organizations—to ensure that intellectual capital indicators are used to improve learning and, ultimately, performance—are included in the guideline.

The strategic assumptions expressed in the value creation maps are principally just that—assumptions. However, maps that are developed correctly, with the participation and involvement of as many key people as possible, usually reflect reality extremely well. Nevertheless, many organizations want to test their assumptions and collect evidence of their correctness. The performance data derived from the performance indicators can be used for that purpose, and the value creation map, or parts of it, can be verified.

Mapping and verifying how intangible value drivers affect firm performance are powerful, and can support reviews of the strategy. The absence of vital intellectual capital components can lead to purchasing, licensing-in, or merger and acquisition decisions. If an organization possesses intellectual capital that is irrelevant to the current value proposition, this could be sold or licensed out.

After identifying critical intellectual capital value drivers, organizations must manage any related potential risks.

STEP 5: HOW TO REPORT INTELLECTUAL CAPITAL
The objective of reporting intellectual capital is to provide information about the intellectual capital of an organization to its stakeholders. Traditional financial reporting cannot explain the value of intellectual capital. Various initiatives have been created to address the limitations of traditional financial reporting in disclosing information on intellectual capital, but no standard has yet been agreed upon. Even so, many organizations have produced voluntary reports and discovered clear benefits, including improved understanding of the strategy by its stakeholders, as well as improved image and reputation

Elements of good intellectual capital reports include:

A brief introduction (one page or less) outlining the strategic context and the key strategic challenges the organization will be facing. This part of the report should set the scene by describing the anticipated changes in the external and internal context and its strategic implications.

A narrative description (about two pages) of the strategy and visual representation of the organizational value creation map.

Descriptions of each of the intellectual capital value drivers, where possible data and performance indicators should be used to clarify the objectives and targets. A brief description of the key activities that are planned to help achieve the objectives should be provided. Each description should be at least half a page and no more than a full page.

The drawback with these voluntary reports is that the ontent varies widely in terms of what is reported and measured. This in turn makes it difficult to compare organizations, which is one of the objectives and deliverables of traditional financial reporting. It could, therefore, be argued that these reports are not very useful. However, the value of intellectual capital can only be understood in the context of an organization’s unique strategy.

Also, to be relevant and meaningful, many indicators of intellectual capital will be specific to organizations or sectors. This is why these reports need to include different indicators to reflect the unique nature of the strategy and associated intellectual capital. However, this doesn’t mean that there will never be more widely accepted indicators for intellectual capital that are appropriate across entire industries and facilitate some kind of comparison.

Bernard Marr is chief executive and director of research of the U.K.-based Advanced Performance Institute. His e-mail address is
bernard.marr@ap-institute.com.