Intangible Assets as a Source of Competitive Advantage Essay

Intangible Assets as a Source of Competitive Advantage Look No Further Managing Intangibles seems to be a smart idea. But to bet on it, one has to create a whole new organization. The concept of intangibles is not new, but across the globe, companies are slowly coming to grips with it. tury back physical, tangible assets created wealth; today, it’s intangible assets that are creating wealth. It’s a concept that packs a lot of punch but has no form as such. It questions capitalism for its emphasis on buying assets like plant and machinery, and hiring executives and workers to run those to make money in the process.

Managing Intangibles seems to be a smart idea. But to bet on it, one has to create a whole new organization. Management control systems are built around the framework of strategy, structure and systems. Typically, the top management is considered as the resource allocator and is the grand strategist, while the junior management is considered as implementors and middle management as administrators of the strategy. Using intangible assets means that you move from this structure to the purpose, process and people structure. Here the role of the top management is only to create an overarching purpose and allow people the freedom to deliver.

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Companies which are hot on intangible assets look out for a completely different set of signals in business than those which are not. Researches have shown that customer loyalty and employee commitment are two of the most important intangible assets. As such a company that believes in intangible assets wouldn’t so much look for market share figures as it would for customer satisfaction figures. As the concept of intangible assets gathers EFFECTIVE EXECUTIVE S T RA T E G Y F orget plant, machinery, capital. Think of people, processes, brands, relationships….

World over, business is moving into a new era, where competitive advantage comes from intangible assets. Welcome to the age of a new asset, the Intangible Asset, which is changing the way businesses behave across the world. It is not openly available, easily leverageable across businesses and not easily substitutable. As is evident, unlike tangible assets (like plant, land, machinery), there’s nothing solid about the intangible ones. They are a bit abstract, with the nature of intangible assets varying from company to company, and industry to industry. At least till about a quarter of a cen- APRIL 2008 44

STRATEGY: Intangible Assets as a Source of Competitive Advantage momentum, experts feel that the disclosure requirements of companies may alter radically. For example, future investors may look for things like a customer satisfaction index or employee satisfaction index in companies where they plan to put their money. Experts have predicted that in the very near future, intangible assets and their use will become the heart of the annual report and financial statements, added on as appendages. Clearly, the future of business cannot get more radical than this. Changing Face of Business Who are the Citizens of This Brave New Corporate World?

The concept of intangibles is not new, but across the globe, companies are slowly coming to grips with it. International companies like 3M, General Electric, Intel, Microsoft, ABB, Kao Corporation and Indian companies like Infosys, Hindustan Unilever Ltd. , and Reliance in India have already started leveraging intangible assets smartly. To give an illustration, ABB (created by the merger of Asea & Brown Boveri) was launched from the platform of intangible assets: both companies wanted to benefit from the combined integrated pipeline of technological products that each possessed in its portfolio.

Swarup Kumar Dutta is a B-Tech and an MBM who has worked in the corporate sector for 13 years in fields as varied as Corporate Project Management, Supply Chain, Marketing, TQM Corporate Planning and academics. His current interests are in the areas of Business strategy, TQM and General Management. He also conducts MDP’s for corporates. His paper on “Challenges and Roles of Young Professionals in the New Millennium” has won him Young Manager’s Award conducted by BDMA. His paper on “Best Practices of the organization” was adjudged the 2nd best paper in the Outstanding Young Managers Competition conducted by Baroda Management Association.

He can be reached at [email protected] org The story of intangible assets is one of the changing faces of business globally. Consider the shifts that have happened in the modern industrial era. The first phase of industrialization which commenced some 200 years ago and lasted roughly till World War II belonged to entrepreneurial capital. Following the footsteps of the English East India Company, entrepreneurs built huge empires across businesses as diverse as railroad, oil, shipping, steel and trading.

This gave way to the second phase of industrialization, which came to the fore roughly in the last six decades, thanks to the amount of managerial capital invested. The same entrepreneurs who built business empires graciously withdrew to allow professional managers to manage their business affairs. However, while these managers have, over time, become better at managing their companies, there’s been a sea change in the nature of business, as well as its conduct, as the environment has changed dramatically. The argument is still going on as to what’s kicking off the third shift in the series?

The third shift is an era of intangible assets. Something is of competitive advantage if it is not openly available, easily leverageable across businesses and not easily substitutable. Intangible assets meet all the three requirements. For example, employee commitment or relationships are difficult to imitate. tance has dropped relatively. Several large corporations relate intangible assets to something which cannot be easily replicated. Take the case of Nicholas Piramal, one of the topnotch pharmaceutical companies in India, which believes that two of its most valuable assets are its ability to anage relationships and its huge distribution network. The CEO of Nicolas Piramal has gone on record to mention that it is this ability to create and manage strategic alliances is its single most source of competitive advantage. (See Exhibit) Why is Something as Mundane as Managing Relationships an Intangible Asset? Why are Intangible Assets a Source of Competitive Advantage in Today’s Economy ? Probably because of its inherent nature. Though competition has become fiercer accessing the means of doing business has become easier.

Any tangible asset like machinery or capital is no longer a scarce resource. So in a scenario like this, what is the only non-replicable, unique, proprietary, competitive advantage your business has? This does not in any way mean that hard assets will not be needed anymore; it’s just that their impor45 Precisely because most Indian managers have made a hash of managing their business alliances. The landscape of India is littered with corpses of failed joint ventures (Godrej-P &G, TVS- Suzuki, Kinetic- Honda, etc).

Little wonder that the capital markets have started rewarding companies that own and nurture their intangible assets, creating a major impact on the outlook of business. Most industry observers feel that this stamp of approval from stock markets around the world will lead company managements to develop these assets more and more. Typically, companies with intangible assets have a higher market to book value ratio. In most developed markets around the globe, the difference between a company’s market price and its book value is a good indicator of the worth of its intangible assets.

Research done by Mckinsey & Co suggests that the ratio of market value to asset replacement value is one of the major indicators of intangible performance. Unfortunately in India, because of various inefficiencies in the market, the market to book value ratio is perhaps not such a precise indicator of the extent to which a company’s management drives its intangible assets. However, it’s still an indicator of sorts. In any sector of the industry it is found that the market to book value ratio is very high for companies that have EFFECTIVE EXECUTIVE APRIL 2008 STRATEGY: Intangible Assets as a Source of Competitive Advantage

Exhibit The Intangible Advantage People Create the Intangible Assets which Drive Performance Non- physical Assets Brand/ reputation Intellectual property Databases/ software Distribution Content Distinctive Competencies Knowledge management Project finance Talent management Marketing Innovation Special Relationships Government access Web Business-to- business Retail customers proven brands, strong distribution setups and R& D capabilities. Yet, at the heart of this entire debate over intangible assets lies a paradox: while the stock markets are willing to recognize intangible assets as something real, accounting norms do not.

Clearly the stock market’s point of view is that even if you can’t feel the asset, it’s for real. Accountants hold an entirely opposite perspective—if you can’t feel it, it can’t be for real. It’s not as if valuing intangible assets on the balance sheet was never attempted. It was tried out in the UK in the mid-1980s. There the accounting practices are far more developed and stringent than in India. But companies began to realize their valuation efforts didn’t have a significant impact on lenders, who continued to use traditional parameters, and continued to lend against current fixed assets instead of future cash flows.

In principle, they didn’t have a problem with it, but they felt it was a subjective issue requiring personal judgment. Therefore, intangibles were given the go-by. balance sheets today? The answer is yes and no. It’s yes, if you believe that by allowing intangibles on the balance sheet you force companies to take these assets seriously. This will and will hopefully push corporates into developing their intangible assets further, which in turn will lead to a better performance. The answer is a no if you take the stock market point of view. Assume that a company’s ultimate objective is to create shareholder ealth, which is then reflected in the price of its stock. Now if the stock markets already believe that intangible assets are for real, does it really matter whether it is there on the balance sheet or not? Here as long as the company is conscious of the importance of intangible assets, the purpose is served. For example, Kao Corporation in Japan or Microsoft doesn’t go about mentioning its intangible assets on its balance sheet; yet Microsoft’s market capitalization is one of the highest in the world, as also Kao Corp, which is one of the most outstandingly innovative FMCG companies in the world.

The Impediments There are many impediments to valuing intangible assets. The first is to see how much intangibles as a whole contribute to cash flows. The second is to split the intangibles and see how much of the intangibles is contributing to the flows. But does it matter that intangible assets (except perhaps in the form of “goodwill”) can’t find their way into company APRIL 2008 Four Things to Look for in Intangible Assets O Employee Satisfaction Index Despite all good HR practices, your employees may still be dissatisfied and you wouldn’t know it unless you consciously track their level of satisfaction.

Over time, the trends will give you a feel of whether you are eroding your people assets or building on 46 them. Research overseas has shown that there’s a strong correlation between how the market values a company and how happy its employees are. O Customer Satisfaction Index This is critical. As competition increases, it is your contented customers who will drive your market shares, and therefore, your profits. The day may not be far away when customer satisfaction ratings become a statutory disclosure standard for a public issue, equity or debt.

O Share of Talent Most companies track their market share or even profit share. But the really smart ones will look at their share of talent. In successful companies, the top management spends a lot of time hiring and nurturing the best available talent. O Capturing Organizational Knowledge An organization’s knowledge, in a sense, is the sum of the knowledge of all the people who have actually worked there and a bit more. But what happens is that when people leave companies, they usually take away whatever they have ever learnt with them. That’s a vital loss, and you have to ensure a way of not letting that happen.

Make sure that people work in teams that are mutually supportive so that learnings are always shared among the employees. This, of course, is a debate that can continue endlessly. Reality lies elsewhere. Many modern companies make a precondition before a merger that the key employees they might have targeted need to be there post acquisition for they realize that without the expertise of these people, the acquisition was useless. Thus we can say that intangible assets are important as a source of competitive advantage to modern businesses. Reference # 03M-2008-04-08-01 EFFECTIVE EXECUTIVE