Enterprise Intellectual Capital Management: A Brief Conceptual Summary
Wednesday, January 24, 2018
Posted by: Abbie Elliott
Enterprise Intellectual Capital Management: A Brief Conceptual Summary
By William Elkington
The views and opinions expressed in this article are those of the author and do not reflect the policy or position of Rockwell Collins, Inc.
Ad hoc is the approach of most companies when it comes to an intellectual capital management program. This fails to fully exploit the company’s intellectual capital. This article demonstrates how intellectual capital can be fully utilized and safeguarded.
In most 21st century Fortune 500 companies, there is a need for systematic intellectual capital management (ICM). In most companies, ICM is ad hoc and everyone has a role. The players do their best, but often the work may not be coordinated. Sometimes there are organizational conflicts over intellectual capital matters, since priorities around intellectual capital may be different, from organization to organization and business unit to business unit. And analytical methods used to assess short-term performance versus long-term competitiveness may be non-existent or rudimentary.
When two or more business units draw on the same store of intellectual capital, the way one deploys the common intellectual capital in its business may put another business unit’s ability to generate sales and profits in jeopardy. Intellectual capital may become trapped in an organization without a charter to generate sales and profits, such as a software tool developed by a manufacturing organization; for value optimization, the tool may be best licensed to other manufacturing organizations, but the manufacturing organization may have no practical way to accomplish this. These are merely a few examples. The opportunity for so many players in intellectual capital management to come into conflict and to sub-optimize the value of the enterprise’s IP is significant.
We use the term “intellectual capital management” rather than “IP management” because a great deal of a company’s valuable “i-stuff” is not protectable under IP law (patent, copyright, trademark, and trades secret law). That is particularly true in jurisdictions where there is no statutory protection for trade secrets.
In many Fortune 500 companies, a more significant investment is made annually in the generation, improvement, and protection of various kinds of “i-stuff” that is not protected or protectable under IP law (than in the generation, improvement, and protection of “i-stuff” that is protectable under IP law). In some, the IP investments are dwarfed by investments in the rest of the company’s intellectual capital.
Some examples of intellectual capital that may not be protectable under IP law are the following: innovation management processes, quality management processes, enterprise risk management processes, engineering processes that make use of commercially available tools, privileged relationships with customers, suppliers, and regulatory authorities, a company’s reputation, the kinds of questions routinely asked by leaders at stage-gate decision meetings, priority setting processes and analytics for new investments, what David Teece calls “dynamic capabilities” (“Dynamic Capabilities and Strategic Management: Organizing for Innovation and Growth,” 1997), etc.
In highly collaborative industries and in industries in which extensive supply chains are required in developing economies, there may be more of a company’s non-IP intellectual capital value put at risk than IP value.
It is a commonplace that most companies’ sales and profits derive much more substantially today from their intangible than their tangible assets. Peter Drucker pointed this out in his 1993 book, Post-Capitalist Society. Sixty to eighty percent of the equity value of a typical 21st-century operating company is in its intellectual capital, according to various economists, intellectual capital valuation experts, and professors of finance and accounting. There have been multiple studies that have calculated this, such as “What Ideas are Worth: The Value of Intellectual Capital and Intangible Assets in the American Economy” (Hassett, K. and Shapiro, R., 2011, http://www.sonecon.com/docs/studies/Value_of_Intellectual_Capital_in_American_Economy.pdf)
Most companies do not have an organization charged with leading intellectual capital management for the corporation, in contradistinction to human capital management. Why is this? As with human capital management, most of the people in the modern corporation have some responsibility for intellectual capital management, but which organization is it that has the responsibility to pull all the requisite disciplines together to develop a coherent approach to intellectual capital value optimization and risk reduction? What coherent process is being used to manage and balance the business priorities regarding intellectual capital management? How are these priorities developed, communicated, and deployed? How is expertise in these areas developed, reinforced, and rewarded?
Who has responsibility for the enterprise policy, process, and instruction in the management framework that is used to manage the intellectual capital? When organizational interests and priorities come into conflict in the field of ICM, how are these resolved? Who has responsibility for the enterprise dashboard in the area of intellectual capital management? And by “dashboard,” we might consider a set of metrics having to do with value extraction and risk. Who is the developer and keeper of the enterprise tools used to analyze and assess alternative intellectual capital investment, management, and value extraction approaches? Who is charged with developing the strategic framework and tools optimally to deploy the developed intellectual capital to generate value?
Intellectual capital management should be thought about as a discipline, in the same way that human capital management is, with major sub-disciplines. At the heart of ICM, though, is an understanding of value. This is the value that might be obtained through various strategies and the value that might be put at risk through various actions or inactions.
For a company wanting to make progress on doing ICM better, there are many paths to the castle of excellence at the heart of the ICM kingdom. Often there is some precipitating event or set of events that pull a company forward, along one path or another. One might think of this event or these events as “IC reality.” Until IC reality begins its inevitable pull, most companies will not have the requisite motivation to make significant changes in the way they do ICM.
Sometimes, IC reality is a litigation experience. Sometimes, it is a set of anecdotes pulled together by an energetic employee or an agenda advanced by an activist investor. Sometimes, a company experiences a significant blow to its reputation. Sometimes, an innovative executive creates a new way of deploying some of the company’s IP value and demonstrates this new way successfully. Sometimes, a customer may require unusually broad and valuable rights to a company’s intellectual capital to buy some of its products, perhaps threatening the withdrawal of future business unless the company agrees. These can be awakening and motivating events that get a company going down a particular path toward our castle of excellence. But just because a company begins down such a path, this doesn’t mean that the chosen path will take the company toward the castle of excellence in the most expeditious way. Sometimes, a company will wander in one region of the ICM kingdom, never getting to the castle of excellence.
But we lose ourselves in metaphor. Sometimes a company will focus on one area of ICM excellence without developing a comprehensive vision for itself; the risk here is that it will optimize one area of excellence and sub-optimize the rest. It will develop a great deal of energy for brand management excellence, for example, and will pour its efforts into this area, but will fail, for example, to see where its core competencies and technologies may be deployed in other product markets to take full advantage of their potential value. Or it may focus on supplier licensing and will prune investments in technologies it concludes are secondary or tertiary, rather than invite IP finance investors to partner to take advantage of the investments it has already made in such secondary or tertiary technologies. Or it may choose, for example, to optimize the potential for its technological innovation and to sub-optimize its capabilities in business model innovation or in the protection of its intellectual capital rights and value in its interactions and collaborations with customers and suppliers.
There are three axes in the field of intellectual capital management: value extraction, value protection, and risk mitigation. To do work effectively, a common language is required that can be understood by all disciplines throughout the enterprise, and the lexicon of that language should begin with the most critical concept in ICM: “IC value.” In operating companies, asset protection (through both legal and business process means) and return generation are the central tenets. In other words, the most efficient way to translate the language of intangibles into the language everyone in a business will understand is to translate that language into the language of tangibles—into the language of dollars and cents. However, the metrics for such conversion frequently do not exist and one must resort to a relative value. Other ideals such as corporate mission, corporate values, and vision are part of the analysis. Often, this is where the intuition and expertise of the licensing expert and/or ICM team becomes critical for converting the intangible to a relative value which can be compared to other relative values.
So, if an enterprise wishes to begin on a journey to the castle of ICM excellence, and it wishes to establish an organization that will have immediate relevance to all areas of the company, it will do well to develop policy, procedure, instruction, tools, education, communication, and change management strategies relevant to the cultivation of IC value. It will tie IC rights disposition decisions to a consideration of IC value and the risk to that value. And it will tie the value of the IC rights in question to the company’s delegation of authority (DOA) policy and procedures. Championing this will get everyone’s attention, because the board is fundamentally charged with ensuring proper governance practice, including control of assets and actions by authority.
Questions of IC value and the risk to that value should be central to the thinking of everyone in the enterprise. This is a significant change for most enterprises today—for the board, senior leadership team, and everyone else. In many companies today, when people are making decisions about investments in and doing transactions concerning IC and IC rights, one often encounters skepticism as to the relevance of value calculations. But without an understanding of IC value, how do leaders in 21st-century corporations demonstrate that they have a good handle on what they are doing? How can they exhibit reasonable care and good business judgment in their IC management decisions, if they cannot point to a quantitative assessment of that value? How can they justify to their investors that they are good custodians of a precious asset class—their intellectual capital—if they cannot apply quantitative analysis effectively to it?
The IC management organization should consider helping its business units understand the relative value or competition sensitivity of the major areas of their IC. It should develop a paradigm or rubric for this sort of assessment. Understanding this can have significant implications for what IC rights one would be willing to grant to others and what level of rigor to apply to IC access controls.
Such an organization should consider working with its IT security and physical security organizations to develop business processes for implementing the technology selected by these organizations to secure the enterprise’s IC.
The IC management organization should consider working with its business units and its procurement organizations to develop policy and process around doing transactions with customers and suppliers when IC rights are being dispositioned. It should also consider what requirements for IC custodianship its customers and suppliers should be willing to live up to when they are given access to the company’s IC, to include what the technologies and business processes should be that are used to grant the other party access. Likewise, it should consider requirements for managing its business partners’ IC.
Such an organization should consider working with the group or groups working on standards that support the enterprise business strategy. These can be business process standards in the field of IC management, as well as technical standards related to the company’s present or future products and services.
The IC-management organization should consider working closely with the enterprise risk management organization to characterize the levels of IC related risk, the measures that are being applied to mitigate that risk, the obstacles that must be overcome to reduce that risk, and the progress that is being made. In addition, it should consider working closely with internal audit to ensure that the policies and procedures that it develops are taken seriously by the enterprise. In other words, auditing compliance with ICM policy and procedure regularly is an excellent way of communicating senior management’s seriousness about and commitment to IC management excellence.
Such an organization should consider taking responsibility for licensing of IC and for collaborative arrangements where IC is at the heart of business relationships, in transactions having a potentially high impact on the enterprise. Intellectual capital agreements can be tricky and are particularly so in collaborations, strategic partnerships, and joint ventures, for example. One may want people who are well skilled and practiced leading the strategy and negotiations in potentially high impact IC transactions. It is easy for such IC-based relationships to be framed up in such a way that success is difficult to achieve.
The IC management organization should also consider courses tailored to the different practitioners throughout the enterprise on the various relevant policies, processes, tools, and role expectations. In business-to-business enterprises, leaders responsible for new product development or for pursuing new business may need to have conversations about IC and IC value with customers and suppliers, but they may not have the experience and confidence to conduct such discussions effectively. So, courses in this area may prove helpful.
Since “Rembrandts in the Attic: Unlocking the Hidden Value of Patents” (Rivette, K. and Kline, D., 1999), many people in ICM have thought that ICM is really patent licensing to augment revenues from products and services. This attitude has been particularly prevalent in high technology companies developing consumer products and services. For many companies both inside and outside high technology, however, there is only a small probability of contributing materially to the company’s bottom line on a regular basis through patent licensing. The focus of the exercise should be on assembling a fulsome IC portfolio to wrap them in for outlicensing/ disposition, while understanding what impact the transaction would have on other, desired product candidates. For most companies, ICM may include some patent licensing, but ICM experts are likely to contribute more value elsewhere, such as the areas discussed above.
The concept of IC management alluded to here is a business function rather than a legal function. It is grounded in business process and financial analysis. Just as human resources departments rely heavily on the office of general counsel, so too will the IC management department. But its essential function is business and financial rather than legal, and the core of its contribution is strategic, in nature.
Intellectual capital is invisible to most people in the 21st century operating company, because our generally accepted accounting principles (GAAP) largely ignore it (as noted by Baruch Lev in “Intangible Assets: Concepts and Measurements” in “The End of Accounting and the Path Forward for Investors and Managers”). And because of the paucity of research and education in the field in our colleges and universities. So, it becomes the job of the IC management department to make IC and IC value visible to the employees of the enterprise.
This may mean that IC management will regularly interact with the board of directors. Again, if intellectual capital is 60 to 80 percent of the equity value of the 21st century company, a company’s investors will probably want to know that the company—from the board down through the employees having access to valuable IC—is putting a commensurate level of discipline and resource into its management of these precious assets. Otherwise, over the long term, a company may risk shareholder suits and possible damage to its brand and equity value, and it may potentially fail to optimize the intellectual capital value.
For most 21st century Fortune 500 companies, intellectual capital is the basis for competitive success. Therefore, systematic approaches to its management are called for. Just as most companies have recognized over the past 50 years that quality management needs to be done systematically in order for the company to maintain consistently high quality in its products and services, so too over the next 50 years most companies will recognize that intellectual capital management needs to be done systematically throughout the enterprise to maintain competitiveness, an acceptable share value, and beneficial reputation or brand. The quicker a company develops and masters a systematic approach to IC management, the more effective it will likely be at differentiating itself with its business partners, customers, and investors.