For every $100 invested in shares of Microsoft or Intel, only about $1 represents physical assets. Clearly, the real value of today's companies is not captured in traditional net worth accounting.
n his influential 1992 book, The Twilight of Sovereignty, former Citicorp chairman Walter Wriston observed that "the new source of wealth is not material, it is information, knowledge applied to work to create value." John Seely Brown, Xerox's chief technology officer, argues that we are moving from a production economy to a digital economy where instead of transforming material, companies are transforming knowledge. He sees three manifestations of this: Leaming will replace unlearning; instead of making products, most will make sense to the customer; and instead of whitecollar or blue-collar workers, we all may be wearing T-shirts. So what is this "knowledge economy" that management pundits and the business press claim will reshape corporate fortunes? And how can business leaders make use of it?
There is a fundamental confusion about what is meant by "knowledge." Skandia, the Swedish financial services firm, defines knowledge capital as the sum of human capital, the combined knowledge and skills of one's employees, together with the values and culture of the company; and structural capital, the hardware, software, brands, patents, and structural capabilities that support one's employees and customer relationships.
"If information is unorganized data, undigested observations, and facts," Harlan Cleveland wrote in The Knowledge Executive, "knowledge is organized information, internalized by me with everything I know from experience or study or intuition, and therefore useful in guiding my life and work." Knowledge is integrated with everything you know in such a way that it guides one's action. It confers advantage by enhancing one's ability to take action. Knowledge capital depends on people to create it, but also for a management process to harness it in some value-creating way. Participants in the following roundtable, held in partnership with Arthur Andersen, more or less embraced the latter meaning. Simply, knowledge is a resource that enables other things to happen.
Unlike other assets, knowledge doesn't diminish with use, The greatest cost is in its creation rather than its distribution. Users can benefit from knowledge as well as increase its value through contact and adapting it. Harvard Business School's James Brian Quinn writes that "the capacity to manage human intellect-and to convert it into useful products and services-is fast becoming the critical executive skill of the age." The question roundtable participants wrestled with is, how is this best done? One can create knowledge hoping that transfer mechanisms will take it from individuals to groups. At Enron, for example, CEO Ken Lay says that in the energy industry one must always be prepared to reinvent the business. He thinks in the next 10 years, more than half of Enron's revenue will come from lines of business it does not have today. Lay tries to maintain a knowledge sharing environment where lines of communication are open and new ideas are given a wide berth-even if many don't work out.
Arthur Andersen's Steve Samek believes that CEOs must ask themselves, which assets are driving the value today that perhaps you didn't recognize before? As Pat Sullivan of ICM Group adds in the following discussion, these assets by themselves are insufficient until they are harnessed to complementary hard assets and a process that converts an innovative idea into a salable product or service. If the necessary process or structure is not present to do this, consider an alliance with a company that can offer one.
DATA INTO KNOWLEDGE Steve Samek (Arthur Andersen): The bottom line question is, what is the embedded knowledge capital in your business and how can you convert it to a real revenue stream?
For some companies that have done recent acquisitions, the largest asset on the balance sheet may be intangible. We believe we need to get our minds wrapped around the assets. Specifically: catalog them, understand them, understand processes that drive them in the Knowledge Age, just as we did in the Industrial Age.
Measuring and managing these intangible assets may give companies a leg up by enabling them to leverage their old assets into something new. For example, if Barnes & Noble could create the same Internet value as Amazon.com, could they have a leg up because they have two ways to reach customers? We believe there is a whole bunch of knowledge assets that people heretofore haven't measured. One good example is Federal Express. Federal Express has 60,000 trucks, 600 planes; it created the business some 25 years ago on a concept that was pretty neat. And they made their value in the first part of the life cycle off that basic business model.
They realized a couple of years ago that with the change in technology, the value was going to be in package tracking, not so much in moving. And as you all know, they now have the technology and the systems to track a package literally within a couple of hundred feet of wherever it is in the country. And their market cap has gone up enormously with that innovation.
I've got a story that's iust unbelievableand I will always be a Federal Express customer for this reason. I have a summer home in Wisconsin and my home in Wheaton, IL. Memorial Day weekend, my secretary was sending me a package, and I got a call from Federal Express. They said, "Mr. Samek, are you going to be in Wheaton today or in your home in southern Wisconsin? Your secretary is sending it to Wheaton. But we notice you typically go to Wisconsin for the summer, and you have your packages delivered there."
Now, the ability to data mine that knowledge and apply it-it's unbelievable. John Binswanger (Binswanger): Our customer expects so much more from us now. And it's not just knowledge and information, but how do you really use it. We spend an awful lot of time in making process. I hear that every day in the office, "What is the process we're going to go through to accomplish a certain goal?" It's paramount in everything we're doing.
J.P. Donlon CE): We're all probably overloaded with knowledge. The question is, what is the knowledge that's useful to each one of us? Sometimes you don't know what you need to know.
Samek: Right. There's a pyramid you might have seen before called the knowledge hierarchy. It says there's a hierarchy that starts with data. Your checkbook is data; you turn it into information in the form of financial statements. Knowledge is the ability to mine that data, taking it to the next step. And frankly, at the top, knowledge can only be applied by somebody who's got the wisdom to see it.
What the CEO has got to be looking for, and understand is, what is the value, what is your market cap, and what's the gap between your balance sheet and your market cap-what's driving it? Where are the points of intersection with value that we create? And then, you almost laboriously look for the process and see how you can apply it outside of the existing mindset.
Ron Burns J. Walter Thompson: The real success will come to those who know what to do with the knowledge-how to interpret, how to use the intuition, the experience, the feel.
So how do you turn all this intellectual capital into ideas that will help enhance the value of these brands? Knowledge is power. But today, for us, knowledge is the price of entry. We must understand the market, the consumer, the category, the competitors, the brand, the media, the opportunities. But the real power is to use knowledge to create ideas that differentiate, reposition, redefine, and reinforce the products, services, and the companies to enhance the value.
How do you manage this intellectual capital or these ideas for our businesses around the world, locally, nationally, and on a global basis? How can we create a matrix between geographic interests and worldwide client or branding interests, meaning how do we beat back "not invented here"? And how do we empower and provide authority to the system to accomplish this?
And, finally, if we all believe this is possible, how do we incentivize this system so it actually accomplishes the larger goals for the corporation? How do we bonus on ideas as well as on performance? Peter Michel (Brinks Home Security): I have my entire customer base on computer; it's all electronic. So I know everything about every customer, which is a tremendous asset. But I grossly under-- exploit that data and underutilize it. So, for example, the value of customers is determined by how long they stay, how much they are paid up front, how much they refer, how much of a service problem they have.
It turns out I can go back into my database and I can crunch and slam and bang the thing, and I can get those things out. But it's all an uphill fight. What I need is to have a process to go in at the start of the relationship so the whole thing is cross-referencing every time. What's the relationship between how long they stay and how much they are paid up front, how happy they are and how much they refer?
So my problem is not getting into the 21st century; it is utilizing what's right in front of me. The magic here is how do we change the process, structure our initial intake and our ongoing reporting. I've got great management reporting, I've got great financial reporting, but I have useless decisions benefitting me for it. [Laughter Robert Marino (Convergys): We do the billing for a lot of cellular telephone companies in the U.S. and internationally. We do 20 million cellular telephone bills a month. We know all of the call detail records on that. We know your long distance, your usage, when you signed up for service, what kind of phone you have, and how many times you called into customer care.
And we've created a database because there's so much contention for that subscriber in flipping from cellular to PCS to digital. We've been working with our clients to figure out what causes you to churn. All of us have clients, and typically you want more than fewer. And when they leave, that's a problem. So can you figure out in a predictive algorithm which ones are more likely to move because of behavior? That's what we're doing in data mining, in data warehousing.
Mary Lou Quinlan (N.W. Ayer and Partners): Last year we did a couple of experiments with what I call knowledge capital. We know a lot about the communications business, the telecommunications business, and found a few souls who could see that if they took what they knew, they could leverage it into a product that we could sell. But it was finding entrepreneurial people in the organization who I could coach and reward differently.
And to make this happen in a company, often I found the CEO has got to be the beacon for it-certainly, the teacher, and the leader. You've got to get this cadre of people who can start to do it, so they see there's a light, and then institutionalize it with training, with rewards, with saying the new job of the future isn't just doing what you're doing, it's taking those dreams and bringing them into new revenue streams.
KNOWLEDGE INTO NOISE
Stanley Marshall (Fortis): A little over a year ago, we were talking about telecommunications, and all the marketing people were saying, "We've got a tremendous system; we've got all this knowledge about our customers. We can segregate them into different groups and maximize our returns." And just as they were getting beckoned to all this, and monitoring their information, Sprint comes along with a uniform rate and knocks everybody out of it. So all that knowledge became noise.
You have to think that part of the confusion is earnings versus market value. Well, you think your market value is such and such and such. Well, Amazon.com, what is its earnings right now? So it's not so much what that company is worth, it's what people think it's worth. It's perception. They think some time in the future they're going to earn a lot of money. I've seen all kinds of companies in, say, the cable industry-the same thing. They go on forever and ever thinking about the future.
It reminds me of that story told by a friend of mine from New York City whose father was in the dry cleaning business. And he had a saying that "You're going to lose money on every piece of laundry, and make it up in volume." [Laughter
If you want to distinguish between knowledge and noise, if you want to apply that screen of what's data, what's knowledge, somebody has to tell you that that's just noise over there, here's what you need to know.
Andrew Carter (Hyperion Capital Management): As of this morning, Amazon.com has a market value of $26.9 billion dollars or so. It had sales through the first threequarters of last year of $370 million, I think. Barnes & Noble has a capital market value of $2.5 billion, and it had sales of $2 billion. Now what you have is a 75 times differential between the capitalization of both companies. People talk about efficient markets, and I guarantee you, because I live in them all day, every day-they ain't. And they're never going to be. Because the people doing transactions in the markets have particular rows to hoe.
Paul Barringer (Coastal Lumber): We have in the lumber business wood products manufacturing; we have all the technology. We have optimizers that scan the logs and tell you how to cut them. We have things that take pictures of it; we have computerized carriages; we have all this technology in our industry. But our mills are located in someplace like Haca Valley, WV, and they're not run by college graduates. They're not run by anybody who understands this technology.
And this huge momentum that we've got to overcome in manufacturing to first of all attract people that can understand these things-I can't tell you how many mills I've been in that I walk in there, and the computer's turned off. They're scanning the logs and telling you how to saw the lumber to get 10 percent more yield out of it.
Daniele Rulli Fiat, U.S.A.): The question is, are you getting the right people in there? We're an extremely capital-intensive and people-intensive industry, automotive. The Fiat Group has 220,000 people. One of the questions we've started asking ourselves worldwide is, "Do our people have the right competencies first? And what are the new competencies that are needed?"
I have a feeling, at least in our industry, the thing goes through a big cultural transformation in people. The first thing we want to find out, "Do we have the right people in the mills, in the plants down south, around the world, in China, India, etc.?" And we are trying to map a personal little piece of this. We're trying to find out what kind of competencies the people do have, and what kind of competencies for the future. Once you know your assets, then you can decide how to change the process.
Donlon: Implicit in your statement is knowing what is "right." Have you made the decision as to what the right future competencies are?
Rulli: Yes, we've already made the decision, but we have to find out-you can conceive, you can have a vision. But the problem is between the vision you have and implementing the vision that you have in the real world. We have 220,000 people. Some of those 220,000 people have been with the company X years. We have to continue manufacturing cars. How do you transform these people in the process of change? That's the big thing. How do you transform people? I think you can have the vision; the vision is clear. Maybe Amazon.com has the advantage of having younger people. Some of our companies can't just abandon or change our people immediately. We have to make the transformation. So you have to learn where the competencies are, where the knowledge is, and then decide what you need.
Carter Beese (Riggs Capital Partners): I wonder if we could frame this discussion in a different way-the dark side of knowledge capital: Are we simply talking about disintermediation? And are we trying to figure out whether we're going to be a disintermediator or a disintermediatee? Samek: I don't think so. I think it's a piece of it. Levi Strauss continues to sell through the retail channel, but also offers customers the opportunity to purchase jeans directly from the company that are literally made to order. You can go into a store, or go to them, and get form-fitted jeans. And they will make it the night before and ship it FedEx. It is a value-added product that is, in one sense, disintermediating the retail channel, but in another sense is creating value. They're charging more per pair than they were before, because it's worth it to customers. So it's not either-or; I think it's both.
Jim Wadia (Arthur Andersen): One of the things that we learned at Andersen is at some stage in your company's life you're going to have to take an inventory of your knowledge. The very first building block, before knowing what to do with it and how to squeeze value out of it, is to take an inventory of it. And that is very tough.
Take the defense industry. A lot of the intangibles will be patents. Some of these patents go back 20, 30, 40 years. Patents have two types of income generation potential. One is the license of them, and the other is the abuse of them. So you can either license a patent, or someone else can sneak in and use your patent without actually paying the license fee.
Until you've taken inventory of your patent, and then test that inventory against what other people's use might be of your product, you don't know what income you're giving up. Bill Adams (Agile Web): We each have our own core competencies within our company, and there seems to be the desire to try to change the way we do things. And what we've learned at Agile Web over the last few years is, instead of changing what we do well, let's add another layer called the collaborative layer, that is, an ideal layer between corporations or between core competencies.
HOW MUCH DO YOU LOVE YOUR MOM?
Donald Herrema (Bessemer Trust Cos.): I have a sense of frustration just listening to all of us, a lot of us have this overwhelming desire to quantify things. I'm not trying to be critical, because I do the same thing, but we want to quantify this intellectual capital, intangible assets thing. And I don't think we can do that.
I think we have to dare to look at things differently, and that's unsettling. We want to have a point in time, even if it's happening faster and faster, that we can stop and say, "Okay, maybe the three-year plan is now going to be the three-month plan." Or maybe, "the three-year plan is now going to be a three minute-plan." Maybe there is no such thing. And maybe it's just relying on the art of it all, versus trying to quantify it, trying to have it be a science. Maybe it's saying, we don't know what the answers are, which means a lot of risk; it means leading versus managing the assets.
Patrick Sullivan ICM Group): There are some things that we find easy to quantify, and some we don't. One of the best examples that I can come up with is: How much do you love your mom?
Here is perhaps the most powerful force in the universe, and we can't measure it. So what do we do? We have lots of qualitative ways we use to describe this very powerful and very important force in our lives.
It's hard to put a number on how much intellectual capital you have. For those of you who represent public companies, think about your market cap. Now think of your last financial statement, and how much of your balance are total assets. And think about the difference between those two numbers, because that represents your intangibles. For many companies, those intangibles are largely comprised of the things we call intellectual capital.
There's a relationship between intangible intellectual capital and tangible assets. And it's when you can form unique relationships between your fixed assets and your intangible assets that are difficult to duplicate, that you create a strategic advantage over your competition. Maybe it's the fact that your distribution system is unique and very difficult to emulate, or it's some combination of ideas and knowledge that you've developed over time.
The second thing to learn was that there are systematic decisions that you can make that allow you to take an idea and to convert it in this form so that it can develop cash.
The equation for taking advantage of wherever you may find yourself in this little model is not a fixed equation. But one of the things we know is common is that there are some things that drive value. And they're different for each company.
Find the ways that value is created in your company for your customers. What drives that activity in an intellectual capital sense? And then what are all the ways I can think of to take that intellectual capital and to convert it into cash?
Donlon: How do your customers extract the knowledge capital that presumably was not there, with you as the intermediary? Are there any cutting-edge devices or techniques you could share with us?
Marino: What we've done is really benefitted by the software that we create in Convergys IMG, and then the telemarketing organization that's part of our organization called CMG, that it is very consistent, in terms of knowing the market segmentation, the value of the client, and how often and what kind of touch they get. If you're a high revenue or expect to be a high-revenue, high-operating income, you get touched or communicated very differently than a very low-end, segmented client that is not looking like it will ever change.
So we try to value and create an operating income stream with an expense stream to match opportunity. Now, is it perfect? No. But it's a step.
Sullivan: In the case of a service company you have an immense amount of knowledge in people's heads, and the question is what do they have and how can we release it? If you knew in an advertising company who knew what, you have a better idea of how to do something with that. There's a lot coming out now that's helping us understand more about what's in people's heads in terms of intellectual capital, which is the stuff that could be converted to profit.
The whole debate about putting things on the balance sheet-I happen to agree with you-is crazy. Balance sheets were created when hard assets were important. But with intangible assets, it's not important. It's like how much do you love your mom? I don't care how much. A lot's good enough for me. What I care about is that this intellectual capital stuff is what creates the ideas that generate the products and services that create the cash flow of the future of my company.
Michael Hegarty (The Equitable Cos.): We're trying to figure out how to use that knowledge to manage customer relationships from the point of view of giving customers "good, better, best" type of service so that you can differentiate and you can price for it. We're trying to figure out ways to transfer knowledge within sales organizations. How you connect somebody in California with somebody doing a similar thing in New Jersey? How do you share best practices? How do you take strategic information somebody might have and harness it for the company's benefit?
A lot of the examples that we've heard about making intellectual capital evident is more by way of identifying it and describing it so that you can then go do something with it. Like create the income statements of the future-rather than actually put a value on it and stick it on a balance sheet.
Burns: Every great idea has great champions, passionate champions. When you talk about Federal Express, I will bet you dollars to donuts that it came up with three people that were downstairs, five floors down, a passionate group, a sell that drove the idea up to the top. When you say, what is a chief executive officer? It is to nurture those champions in the organization.
And for our future it's what we do in communicating that very single-minded point of view for your company, for your brand, for your product, for your service. That, I think, is what we are all wrestling with and what is partly the future and the success that we'll have.
Quinlan: My first thought was how we got ourselves to this position, that is, allowing our ideas to become commodities and not be paid for them? Because it's difficult to take the same hammer and nail and say, "now you're gonna pay for it." So, I have found, one of the ways out of it almost means doing an inventory of the knowhow, pulling out some of the things we take for granted. We take so many ideas for granted you would be amazed. And we may have to re-brand them as their own properties that are worth new value. Because, unfortunately, an entire industry has devalued itself.
Barringer: I would just like to have comment on the company that I think epitomizes harnessing knowledge capital, and that's American Airlines spinning off its Sabre Technologies, the reservation system. How did they do that? Now, as I understand, Sabre Technologies is a $500 million company. They say they're making more money with that than they are flying people and cargo.
Marino: That's an interesting example, and one I'm somewhat familiar with. But what happened, I think, with American, they realized they created something like Federal Express-a process that worked very well, and the delivery system was American. I think they felt they would allow other people to use Sabre reservations and allow them to compete with their people and their assets, and American thought they could do it better.
So they had some courage and some trust to step out and say, I'll give you my asset, which is the Sabre reservation system, but because I personalize it and I deliver it through people; go ahead and compete with me 'cause I think I can do it better.
Samek: Basically AT&T did that with Lucent. They're competing with the land lines now, and they said nobody would buy from Lucent if they're going to compete. So they spun Lucent off to the shareholders, and it's the second most widely held stock in the country, doing very well. But they have compartmentalized and monetized the intellectual asset.
One needs to think about this in two ways. You can think about intellectual capital as something that produces value on an ongoing basis. In other words, it produces a continuing income stream. That's one way you can look at it and my preferred way.
The other way you can look at it is, intellectual capital is something that can be packaged and put together, and sold one time. Now, that doesn't create ongoing value. I personally have a preference for things that create ongoing value.
It gets down to one fundamental strategic question: What does the company want to be when it grows up? What's its strategy for getting there? And then, what bits and pieces of intellectual capital contribute to getting that vision to have value for you? By asking this question in the context that knowledge capital is a vital component of total value added the company offers, is recognizing the importance of harnessing knowledge in the knowledge age.…