The world of intangible asset valuation
It’s been a while since we last looked at intangible asset valuation (see The Future of the Future, KMWorld, Nov./Dec. 2013). and much has changed since that article was published. In a nutshell, here’s what’s going on and why it’s important.
For starters, the global economy has become increasingly more volatile, making traditional currency-based metrics less stable and less reliable indicators of real economic value. That situation is likely to grow worse in the coming years.
Not that currency-based metrics were all that reliable in the first place. As Karl-Erik Sveiby puts it: “The main problem with measurement systems is that it is not possible to measure social phenomena with anything close to scientific accuracy. All measurement systems, including traditional accounting, have to rely on proxies, such as dollars, euros and indicators that are far removed from the actual event or action that caused the phenomenon. This creates a basic inconsistency between managers’ expectations, the promises made by the method developers and what the systems can actually achieve, and makes all these systems very fragile and open to manipulation.”
In spite of those shortfalls, many executives still insist on using monetary return-on-investment (ROI) metrics when deciding whether or not to invest in intangible assets, including KM. If you attempt to use other indicators of value such as TBL (the Triple Bottom Line of economic, social and environmental benefits), you’re likely to encounter either blank stares or hateful glares.
What’s a KM advocate to do? Before we attempt to answer that question, let’s take a closer look at what’s going on in the marketplace …
When everything becomes intangible
On any balance sheet, cash is king. “Good as gold,” as the expression goes. Cash-related measures such as working capital and free cash flow are considered indicators of a company’s ability to weather market volatility. Check out the cash positions of market leaders such as Apple, Google or Microsoft. The numbers are staggering, with those three companies alone holding more than $200 billion in cash reserves.
But cash is nothing more than 1’s and 0’s sitting in a server somewhere in the cloud. That digital “cash” could vanish in an instant, which is exactly what happened in the recent theft of $81 million from the government of Bangladesh’s account with the Federal Reserve Bank of New York. At the very least, it might become inaccessible due to any number of disruptions including power outages, denial of service attacks, etc.
In fact, the whole notion of monetary value is being called into question. For instance, almost one-third of government financing in the developed world consists of bonds and notes that pay less than zero percent interest. That’s right, we’re talking trillions of dollars earning negative interest. Call that strike one.
You might ask, “But what about real tangible assets such as plant and equipment? Or raw materials inventories such as oil and mineral reserves?”
The cold, hard truth is those good old tangible assets “ain’t what they used to be” either. The recent volatility in the global futures markets has sent those types of assets into a tailspin, with many commodities down 60 percent or more in the past two years.
This impacts the value of plant and equipment. For example, according to Baker Hughes, the number of active oil rigs in the United States has gone from a peak of 1,900 two years ago to less than 500 today. That’s 1,400 very expensive, non-performing assets sitting idle.
And don’t think for one minute that tangible asset volatility is limited only to heavy industry. Those hundred-plus acre server farms popping up around the globe are just as vulnerable. That’s strike two.
That leaves us with intangible assets, which still make up around 80 percent of a company’s total value. Sticking with our examples of Apple, Google and Microsoft, as of this writing they have intangible asset valuations of $479 billion, $409 billion, and $359 billion respectively.
But here’s the kicker. According to Belgium-based Areopa and its model of 15 different types of intellectual capital, the vast majority of that capital is at significant risk, because it’s not actually owned by the company. Like those digital 1’s and 0’s, it can disappear at any time, for any number of reasons. Such as price pressures due to off-shoring. Or disruptive technologies like cognitive computing. Or people just plain up and quitting.
In summary, money itself is becoming less stable, tangible asset values are falling and large portions of an organization’s intellectual capital are at risk. That’s three strikes, and we’re in the late innings of our decades-long transition to a knowledge-based economy.
What to do
Despite the clear and present danger of ever increasing risk exposure, it’s astonishing how few organizations have even bothered to take inventory of those assets. On the tangible side, every PC, peripheral and smartphone, every desk, is tagged and tracked in a database.
But what about those hundreds of billions of dollars of intangible assets? In most cases, they’re lumped into a few line items and perhaps a half-page of footnotes in a financial statement. You would think with so much riding on this particular class of asset that companies would pay more attention.
That does not have to be the case. An easy way to get started is to create a balance sheet just like the one your organization already has. Only make it a balance sheet of your intellectual capital. You can use Areopa’s 15 categories or a combination of one or more of the many other frameworks that are available. But use something.
Then put on your appraiser’s hat and estimate the value of each intangible asset. Start with monetary value. Then look at other dimensions appropriate to your industry. What is the societal contribution? Level of sustainability?
The sky’s the limit. Just be sure to pick factors relevant to your organization’s strategic contribution and growth.
Finally, assign a risk rating to each category. Start with simple, subjective measures such as low, medium and high. Then apply those ratings to the internal and external factors exerting the greatest influence on your organization’s ability to perform on a sustained basis.
You can’t even begin to address the chaos in the global market if you don’t first get a grip on what’s inside your organization, especially your brain trust. Your completed balance sheet will give you a whole new way of looking at the value of your enterprise. You’ll gain important insights into how your intangible assets can work together not only to respond to, but also stay one step ahead of, the wild changes in the marketplace.
As an added bonus, try building your own personal intellectual capital balance sheet. You might be surprised at how much hidden wealth you already have that could be put to better use.