Example Finance Essay

Measuring the Strategic Readiness of Intangible Assets

In 2000, the market-to-bookvalue, or in other words, the ratio of the stock-market value to accountingvalue of the largest 500 companies in the U.S, increased to 6.3. In simplewords this means that for every six dollars of market value, only one dollarappeared on the balance sheet as a physical or financial asset. The cause ofthis large difference has been attributed to the rise in value of intangibleassets. (Source: Getting a grip on Intangible Assets, HarvardManagement Update)

In the pastdecade, there has been an increasing academic and corporate focus on thesubject of intangible assets offering clarity to business leaders on the waysto measure and manage these assets in context of a business's strategic goals. Onregulatory front, European Union is soon to introduce standards for reportingon intangible assets.

Our report aimsto analyse one such academic framework, developed by Robert S. Kaplan and DavidP. Norton, which highlights the importance of strategic readiness ofintangible assets. The methodology of this conceptual framework is creation ofa Strategy Map on which intangible assets have been mapped and measured.

Three key thingsthat emerge from the analysis of this work named Measuring the StrategicReadiness of Intangible Assets and written for Harvard Business Review in 2004are:

1. Identification of the important intangibleassets in a business organization.

2. Mapping these intangible assets to a business'sstrategy.

3. Understanding the factors that enable these intangibleassets to contribute to the success of the business.

Introduction

It isincreasingly clear from the example at the beginning, that, in 21^stcentury's knowledge-driven, services-dominated, economy, it is the intangibleassets, and not so much the physical and financial assets, which are playing anincreasingly important role in shaping a business's success. At the same time, itis realized by management, that there is a need to objectively evaluate thereadiness of these intangible assets in enabling a business to achieve itsstrategy.

For the benefitof analysis, we start by defining intangible assets as any nonphysical assetsthat can produce economic benefits. These cover intellectual capital, knowledgeassets, human capital and organizational capital as well as more specificattributes like quality of corporate governance and customer loyalty. (Zadrozny,Wlodrek).

So what isrequired to map and manage these assets for the success of a business's strategy?

Analysis of Situation

According toKaplan and Norton, while developing Balanced Scorecard (aconcept for measuring a company's activities in terms of its vision andstrategies, and helps to give managers a comprehensive view of the performanceof a business), they identified three major categories of intangible assets:

No.	IntangibleAssets	EncompassingElements
1	Human Capital	Skills; Training;Knowledge
2	InformationCapital	Systems;Databases; Networks
3	OrganizationCapital	Culture;Leadership; Alignment; Teamwork

Further, whileunderstanding the critical success factors that transform a businessorganization into a performing and strategy focussed entity, the articlediscusses how these assets need to be mapped to the organization's strategy ona framework called strategy map. Finally it explains the route by way ofwhich, quantitaive values can be assigned which clearly help an organization tounderstand the readiness of these assets in enabling an organization achieveits strategy.

Discussions and Findings

As we discover,there are unique features of intangible assets that make their behaviordifferent from the physical and financial assets. These are:

1. Intangibles assets mostly cannot create valuefor an organization in a standalone form. They need to be combined with otherassets. The implication of this is on a firm's ability to assign a value tothese assets on a standalone basis.

2. These assets rarely affect financial performancedirectly, unlike physical or financial assets which immediately start payingoff. Intangible assets contribute indirectly through a chain of cause andeffect. For example, the investment in training a team in total qualitymanagement may decrease defects and therefore may give rise to customersatisfaction and heighten positive brand perception.

3. While human capital and information capital areeasier to map and manage, organizational capital is much more fuzzy.

4. Human capital may be measured by mapping thejobs and identifying the strategic job families before focusing on gettingthese jobs ready for strategy implementation. Information capital may beevolved by identifying and creating a portfolio of transactional, analyticaland transformational computer applications and sturdy network infrastructurethat give a positive edge to the manner in which business is conducted. Onesuch example is the complete transformation in retail banking with deploymentof information systems that empower a customer exponentially.

5. Organizational capital is the most challenging elementto map and manage because of the complete behavioural change required inconducting business at all levels. Changing the base culture - that involvesthe employees' shared attitudes and beliefs, and the Climate - whichcomprises of the shared perception of the organization's policies, proceduresand practices, require a grip on deep-rooted, socio-psychological dynamics atwork within the organization. For example, changing National Health Services (NHS)culture from a budget oriented operations to a dynamic business plan orientedoperations that focuses on health consumer, is more challenging than mappingthe strategic jobs and putting state-of-the-art information capital. Forbringing organizational capital readiness, leadership plays a very importantrole, as do communication and knowledge-sharing.

6. Once these intangible assets are brought instate of strategic readiness, they start contributing in generating cash forthe business. For example, if McDonalds sets a service response time of 30seconds and trains its human capital to achieve this target, the customerturnover at the counter will increase and lead to higher revenues.

7. Finally, for these assets to come into a stateof strategic readiness, they need to be aligned with the organization'sstrategy. If they are not properly aligned, it can lead to chaos. For example,is McDonalds promises its customers a 30 seconds service but does not care tobring its human, information and organizational assets up to requiredstandards, there will be widespread dissonance amongst its customer base andthe risk of erosion in brand value will be very high.