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Impacting FutureValue: How to Manage yourIntellectual Capital

By

Bernard Marr

MANAGEMENT ACCOUNTING GUIDELINE

M A N A G E M E N T

S T R A T E G Y

M E A S U R E M E N T

Published by The Society of Management Accountants of Canada, the AmericanInstitute of Certified Public Accountants and The Chartered Institute ofManagement Accountants.

Copyright © 2008 by The Society of Management Accountants of Canada (CMA Canada), the American Institute of CertifiedPublic Accountants, Inc. (AICPA) and The Chartered Institute of Management Accountants (CIMA). All Rights Reserved.

No part of this publication may be reproduced, stored in a retrieval system or transmitted, in any form or by any means, withoutthe prior written consent of the publisher or a licence from The Canadian Copyright Licensing Agency (Access Copyright).For an Access Copyright Licence, visit www.accesscopyright.ca or call toll free to 1 800 893 5777.

ISBN: 1-55302-220-3

NOTICE TO READERS

The material contained in the Management Accounting Guideline Impacting Future Value:How to Manage your Intellectual Capital is designed to provide illustrative information with respect to the subject matter covered. It does not establish standards orpreferred practices.This material has not been considered or acted upon by any senior or technical committees or the board ofdirectors of either the AICPA,CIMA or CMA Canada and does not represent an official opinion or position of either the AICPA,CIMA or CMA Canada.

INTRODUCTION

Intellectual capital helps to drive successand create value.Although physical andfinancial assets remain important,intellectual capital elements such as theright skills and knowledge, a respectedbrand and a good corporate reputation,strong relationships with key suppliers,the possession of customer and market data, or a culture of innovation setenterprises apart.

Growth, above-average earnings, andsustainable competitive advantages areno longer driven by investing in physicalassets such as factories, offices, ormachinery, but instead by investing in and

managing intellectual capital.The successof leading companies such as Amazon,Google, Microsoft, and Wal-Mart is based on their intellectual capital. Physicalassets such as distribution warehouses,office buildings, and stores are important,but not as much as (for example) know-ledge about customers, technology, andmarkets. For example, organizations such as Wal-Mart, with its huge storeinfrastructure, couldn’t perform as well as it does without (a) the intelligence to build its stores at the right locations,(b) the knowledge about consumers to stock the right goods, and (c) itsexpertise in inventory replenishment.Intellectual capital allows organizations to

IMPACTING FUTURE VALUE:HOW TO MANAGE YOUR INTELLECTUAL CAPITAL

CONTENTS EXECUTIVE SUMMARY

Success and future value creation in today’seconomy depend on the ownership andappropriate management of intellectual capital.Superior performance is no longer driven bytraditional physical assets, but instead primarily byintellectual capital.That term includes knowledge,skills, brands, corporate reputation, relationships,information and data, as well as processes, patents,trust, or an innovative organizational culture.The importance of intellectual capital as anenabler of future performance is now generallyaccepted among executives across the world.Most organizations, however, still lack practicalskills, tools, and techniques to identify, measure,and manage this vital performance driver.Thismanagement accounting guideline (MAG)addresses this lack by introducing five key stepsfor successfully managing intellectual capital,namely: (1) how to identify intellectual capital inyour organization, (2) how to map its impact,(3) how to measure it, (4) how to manage it, and(5) how to report it. Practical and easy-to-applytools and techniques are provided for each ofthese steps, to equip managers and accountantswith the necessary skills to successfully manage the intellectual capital of their organizations.

INTRODUCTION 3

ABOUT THIS MAG 4

WHAT IS INTELLECTUAL CAPITAL? 5Defining Intellectual Capital 5

FIVE STEPS TO SUCCESSFUL INTELLECTUAL CAPITAL MANAGEMENT 7

1. Identifying your Intellectual Capital 7

2. Mapping the Intellectual Capital Value Drivers 10

3. Measuring Intellectual Capital 14

4. Managing Intellectual Capital 24

5. Reporting Intellectual Capital 27

CONCLUSION 29

USEFUL WEBSITES 29

REFERENCES AND ENDNOTES 30

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leverage their tangible resources.Withoutappropriate intellectual capital, physical assets arejust commodities that can yield, at best, averagereturns.1 Identifying and managing the rightintellectual capital is and will increasingly be thekey differentiator between successful, mediocre,and failing enterprises.

It is therefore not surprising that intellectualcapital has moved from the periphery to the coreof modern businesses. Organizations that want toremain competitive in today’s world need toolsand techniques to manage their intellectual capital. In fact, executives around the world haveconfirmed this in a recent survey by Accentureand the Economist Intelligence Unit,which foundthat most executives believe that intellectualcapital is absolutely critical for the future successof their businesses.2 The same survey also findsthat most executives agree that their currentapproaches to measuring and managing intellectualcapital are either poor or non-existent. Otherrecent surveys, including one that surveyed 780 Chief Executive Officers and Chief FinancialOfficers of the 5,000 largest companies in theUnited States, and another involving 15 of theworld’s leading banks and financial services firms,found that measuring and managing intangibles is the least developed in current performancemeasurement and management systems.3 A reportfrom the Brookings Institution, an independentresearch and policy institute, outlined that thelarge and growing discrepancy between (a) theimportance of intangible assets to economicgrowth, and (b) our inability to clearly identify,measure, and account for those assets is a seriousproblem for business managers, investors, andgovernments.4 Also, Intellectual capital is not only critical for commercial enterprises, butincreasingly it matters as well in government andnot-for-profit organizations. Studies in governmentorganizations have found that intangibles such as corporate reputation, human capital, andrelationships with key stakeholders are of vitalimportance.5

The internal problem of identifying, measuring,and managing intellectual capital also applies toexternal reporting, where there are growingfrustrations with the inability of traditionalfinancial reporting to account for and report onintangibles.The increasing gap between (a) whatorganizations report in their annual reports(mainly traditional physical and financial assets),and (b) what actually matters the most (theintangibles) is reflected in the ever increasingvariance between book value (mainly traditionalassets or liabilities recorded in the balance sheet)

and market value (the value of a public companyas measured by the share price times the numberof shares issued).

To positively impact future value, organizationsrequire a better understanding of intellectualcapital and the latest tools available to identify,measure, and manage this important value driver.This MAG provides such understanding and out-lines the latest tools that will equip managers andaccountants with the necessary skills to bettermanage intangibles to improve organizationalperformance and drive future value. In addition,this MAG looks at the latest tools for externalreporting of intellectual capital, to improve theexternal communication of the company’s value to its shareholders and stakeholders.

ABOUT THIS MAG

This guideline is aimed at finance professionals andaccountants in business who would like to betterunderstand how to manage intellectual capital. Inparticular, it is for those who are responsible forimplementing or improving the management,measurement, and reporting of intellectual capitalin their organizations. It will also be useful toanyone looking for a general introduction and an overview of the key ideas and challenges ofmeasuring, managing, and reporting intangibles.This guideline follows on from the CIMA report‘Understanding Corporate Value:Managing andReporting Intellectual Capital,’ published in 20036.This earlier technical report provided an overviewof tools and approaches for managing andreporting intellectual capital. However, the worldhas moved on since 2003, and new tools andstandards have emerged. Also, this MAG providesclearer guidance and practical tools to enable thereader to better measure, manage, and reportintellectual capital.

This MAG outlines five key steps for successfullymanaging intellectual capital. Each step contains a number of practical and easy-to-follow tools and techniques. Although all of these tools andtechniques are rigorously grounded in the latestresearch, they have been selected because of theirpractical relevance and easy application.The firststep looks at how to identify intellectual capitalwithin an organization. Step two provides tools forassessing the strategic value of intellectual capitalby visually mapping how it helps organizations toaccomplish their strategic objectives. Step threediscusses how to measure intellectual capital andprovides tools and techniques to do so. Step fouroutlines how to use the resultant information tobetter manage intellectual capital in organizations.

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It explores how to improve decision making,how to review the strategy, and how to assess therisks associated with intellectual capital.The finalstep discusses the reporting and disclosure ofintellectual capital, and provides guidance on howto prepare such reports. Before discussing each ofthe five intellectual capital management steps, weprovide a detailed definition of what intellectualcapital is – to dispel a lot of confusion about themeaning of this term.

WHAT IS INTELLECTUAL CAPITAL?7

Before we can identify, measure, manage, andreport on intellectual capital, we need to under-stand what we mean by that term.The concept of intellectual capital is often discussed, but notalways well defined.8 And a multitude of differentwords have been used to describe the same or asimilar concept. People tend to use terms such as assets, resources, or performance drivers; and they often replace intellectual with words such asintangible, knowledge-based, or non-financial. Any of these words (or a combination of them) can be found in the management literature. Also,some disciplines (such as the financial accountingand legal disciplines) have created quite narrowdefinitions, such as ‘non-financial fixed assets thatdo not have physical substance but are identifiableand controlled by the entity through custody andlegal rights,’ the definition found in accountingstandards. Although narrow definitions like thisare necessary to ensure consistency in balancesheets and other external reports, they are lessuseful in creating a broader understanding ofintellectual capital.This is so because they excludemany commonly accepted intangibles, such ascustomer relationships or knowledge and skills of employees, as they cannot be controlled by the firm in an ‘accounting’ sense. All of this has led to some considerable confusion about whatintellectual capital is and is not.

In this guideline, we will use the terms ‘intellectualcapital’ and ‘intangibles’ interchangeably. It isimportant to stress that there is no generally rightor wrong way to classify intellectual capital. Forthe purpose of this guideline, it is important toprovide as broad a classification as possible, toensure that the reader gets a complete picture of what intellectual capital encompasses.The keyobjective of this broad classification (definedbelow) is to increase the general understanding of what intellectual capital is, and therefore tofacilitate the identification of intellectual capitalwithin organizations.The classification should be

used as a template to ensure that all possibleintangibles are identified. Debates about apotential overlap, or whether one intangibleshould be put into one category or another,are therefore, at this point, not productive orparticularly useful.What is important is that we identify all intangibles that matter to ourorganizations.

Defining Intellectual Capital

Together with physical and financial capital,intellectual capital is one of the three vitalresources of organizations. Intellectual capitalincludes all non-tangible resources that (a) areattributed to an organization, and (b) contributeto the delivery of the organization’s valueproposition. Intangible resources can be split into three components: human capital, structuralcapital, and relational capital (see Figure 1). Each of these is discussed further below.

Human Capital

The principal sub-components of an organization’shuman capital are its workforce’s skill sets, depthof expertise, and breadth of experience. Humanresources can be thought of as the living andthinking part of intellectual capital resources.9

These can therefore walk out at night whenpeople leave; relational and structural capital onthe other hand remains with the organizationeven after people have left. Human capital includesthe (a) skills and competencies of employees,(b) their know-how in certain fields that areimportant to the success of the enterprise, and (c) their aptitudes and attitudes. Employee loyalty,motivation, and flexibility will often be significantfactors too, because a firm’s ‘expertise andexperience pool’ is developed over time. A highlevel of staff turnover may mean that a firm islosing these important elements of intellectualcapital.

Relational Capital

Relational capital includes all the relationships that exist between an organization and anyoutside person or organization.These can includecustomers, intermediaries, employees, suppliers,alliance partners, regulators, pressure groups,communities, creditors, and investors. Relation-ships tend to fall into two categories – those thatare formalized through, for example, contractualobligations with major customers, suppliers andpartners, and those that are more informal.

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Although the former tended to be predominant inthe past, today, the latter have a more importantimpact on how the enterprise is managed. Intoday’s integrated economy, with just-in-timesupply chains, relationships with trading partnersand suppliers can be crucial. Brand image,corporate reputation, and product/servicereputation, which reflect the relationshipsbetween organizations and their (current andpotential) customers, also fall into this category.

Structural Capital

Structural capital covers a broad range of vitalelements. Foremost among these are usually (a) the organization’s essential operatingprocesses, (b) how it is structured, (c) its policies,information flows, and content of its databases,(d) its leadership and management style, and (e) its culture, and (f) its incentive schemes.Theycan, however, also include legally protectedintangible resources. Structural capital can be sub-categorized into Culture, Practices and Routines,and Intellectual Property.

Organizational culture is fundamental to achievingorganizational goals. Organizational cultureprovides a common way of seeing things, sets thedecision-making pattern, and establishes the valuesystem.10 Cultural resources include corporate

culture, organizational values, and managementphilosophies.They provide employees with ashared framework to interpret events, a frame-work that encourages individuals to operate bothautonomously and as a team to achieve thecompany’s objectives.11

Processes and Routines, which reflect sharedorganizational knowledge, can be importantorganizational resources. Practices and routinesinclude internal practices and processes; these can be formal or informal (tacit) procedures andrules. Formalized routines can be reflected inprocess manuals that provide codified proceduresand rules; informal routines include understood(but unstated) codes of behavior and workflows.One example of a process that has become avaluable strategic resource is Southwest Airlines’airplane turnaround, which they have optimized to only last 25 minutes.This process, introduced asa necessary part of Southwest’s start-up as a low-cost carrier, has today become a keydifferentiator.12

Intellectual property – owned or legally protectedintangible resources – is becoming increasinglyimportant. Patents, copyrights, trademarks, brands,registered designs, trade secrets, database content,and processes whose ownership is granted to thecompany by law have become a key element of

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Figure 1: Classification of Intellectual Capital

Human Capital

• Knowledge and skills• Work-related experience• Competencies• Vocational qualification• Employee engagement• Emotional intelligence• Entrepreneurial spirit• Flexibility• Employee loyalty• Employee satisfaction• Education• Creativity

Relational Capital

• Formal relationships• Informal relationships• Social networks• Partnerships• Alliances• Brand image• Trust• Corporate reputation• Customer loyalty• Customer engagement• Licensing agreements• Distribution agreements• Joint ventures

Structural Capital

• Organizational culture➢ Corporate values➢ Social capital➢ Management philosophy

• Processes and routines➢ Formal processes➢ Tacit / informal routines➢ Management processes

• Intellectual property➢ Brand names➢ Data and information➢ Codified knowledge➢ Patents / copyrights➢ Trade secrets

PhysicalCapital

FinancialCapital

IntellectualCapital


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competition.13 Intellectual property is owned bythe organization and not its employees. Itrepresents the tools and enablers that help todefine and differentiate an organization’s uniqueoffering to the markets in which it operates.Examples of intellectual property includetrademark symbols such as the McDonald’sArches and the Nike Swoosh, or the patented ‘1-click’ buying option at Amazon.com.Coca-Cola,for example, made a conscious decision to keepthe formula for Coke a trade secret that it activelyprotects. Had they patented the formula instead,their patent protection would have run out manyyears ago, most likely destroying its market share.

FIVE STEPS TO SUCCESSFULINTELLECTUAL CAPITALMANAGEMENT

In this MAG, we will outline five key steps forsuccessfully managing intellectual capital (seeFigure 2).The first step is to identify anorganization’s intellectual capital. Once this isknown, we need to assess its value. It is importantto understand that not all intellectual capital isautomatically valuable to an organization. It is onlyvaluable if it helps to deliver the organizationalobjectives. In step two, we therefore assess therelevance of intellectual capital by mapping thestrategy (with its intellectual value drivers) onto a strategic map.The third step is to extractmeaningful management information frommeasuring the performance of intellectual capital.In step four, this management information canthen be used to analyze performance and todevelop management insights that informorganizational decision making and learning. Finally,in step five, external reports can be produced tocommunicate the value of intellectual capital tointernal and external stakeholders.

Figure 2: Five-Step Intellectual CapitalManagement Model

Each of these five steps will be discussed in detailbelow.We will explain what each step involves,and provide a number of tools and techniquesdesigned to help the practicing manager to bettermanage the organization’s intellectual capital.

1. Identifying your Intellectual Capital

The first step, an inventory check, requiresidentifying an organization’s intellectual capital.The categorization of intellectual capital outlinedabove can be used to facilitate a discussion aboutthe current stock of intangibles. It can be used tocreate a template that informs people about thedifferent categories of intellectual capital, andprompts them to think about their organizations’different types of intangibles (see Figure 3).

Intellectual capital can be identified throughconducting interviews, facilitated workshops, orvia mail or online surveys. From experience,face-to-face individual interviews or surveys workbest, as they allow everyone to have a say, free ofthe suppressing influence of stronger or moredominant participants in workshops.

It is important to emphasize again that theobjective of this classification template is tofacilitate a discussion about as many differentresources (intellectual, physical, and financialcapital) as possible, to create the most realisticpicture of the existing resource architecture.

Individual responses from surveys or interviewscan then be analyzed and compiled into a list of allthe major resources. At this point, it is no longeras important to use the categories introduced inFigure 1, as it is to present the individual resourcesin a language that is understood within theparticular organization. Different organizationstend to use organization-specific terminology todescribe the same resources. It is always advisableto use the organization’s commonly used languageinstead of the categories or examples provided inthe template below. Using terminology such as‘human capital’, for example, can cause misunder-standing or even cynicism, especially if thisterminology is not commonly used within theorganization.

Intellectual Capital Underpins Competencies

Even though most organizations possess a widevariety of intellectual capital, some will contributemore to delivery of their value proposition thanothers.This is because (a) the value of intellectualcapital depends on an organization’s specificstrategy, and (b) intellectual capital dynamicallyinteracts with and depends on other resources:

1. Identifing your intellectual capital

2. Mapping the key value drivers

3. Measuring intellectual capital

4. Managing intellectual capital

5. Reporting intellectual capital

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• The value of intellectual capital depends on an organization’s specific strategy. Forexample, the know-how of building engines is essential for Honda, but of little value to afinancial services firm; likewise, the compe-tencies associated with creating light anddurable composite materials so essential forsuccessful Formula One motor racing teams is undoubtedly probably of little value to atelecommunications firm.

• Intellectual Capital elements are not static –they dynamically interact with each other,and often depend on other resources for their value. For example, Amazon.com’s brandawareness and reputation, although criticallyimportant, would rapidly fade without itsefficient distribution network, well-designedinternal processes, and strong supplier relation-ships. It is therefore impossible to value a brandname without taking into account all otherimportant factors, such as reputation, people,processes, etc. Cases such as the accountingfirm, Arthur Andersen, have shown how abrand name can disappear overnight if thesupporting intangibles such as trust orreputation fall away. Often referred to as theinterconnectedness of resource stocks, suchrelationships are extremely important tointangibles.

This means, therefore, that individual intellectualcapital resources interrelate with other intangibleand tangible resources to form core competencies.

In turn, these allow an organization to perform itscore activities to deliver its value proposition andstrategic deliverables (see Figure 4). A coreactivity is an excellently performed internalactivity that is central, not peripheral, to acompany’s strategy, competitiveness, and valueproposition. An organization should only havevery few (usually between 2 and 5) core activities.

Figure 4: Intellectual Capital Underpins Capabilities andCore Competencies

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Figure 3: Identifying Your Resource Stock (Source Marr, 2008)

Resource Category Examples of Sub-categories: Intellectual Capital elements with a significant presence in our organization:

Human Capital Knowlege, education, technical knowledge and expertise, skills, know-how, attitudes, experience,motivation, flexibility, commitment, creativity, etc.

Relational Capital Customer relationships, supplier relationships,reputation, image, trust, contractual relationships,informal relationships, alliances, relationships with regulators, partners, etc.

Structural Capital Processes, tacit routines, organizational structure,governance and management approaches,organizational culture, social capital, shared identity,patents, brand names, copyrights, trade secrets,codified information and knowledge, e.g., in databases or process manuals, etc.

Physical Capital Property, plants, location of buildings, information and communication infrastructure, machines,equipment, natural resources, physical infrastructure,office design, etc.

Financial Capital Cash, investments, bonds, loans, budget, etc.

Value Proposition /Strategic Deliverables

CoreActivites

OrganizationalResources

(intangible and tangible)


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To understand the role and strategic importanceof intellectual capital in any organization thereforerequires a clear understanding of the firm’sstrategic direction and objectives.

Assessing the Strategic Value of IntellectualCapital

The relative importance or strategic value ofintellectual capital can only be assessed in thecontext of the existing organization.The questionsto ask are: How important are our differentintellectual capital resources to achieving ouroverall value proposition? Or, how strong are ourexisting resources and how can we utilize themmore effectively? Independently assessing (a) theimportance of the different resources to deliveryof your value proposition, and (b) your resourcestrengths allows organizations to perform a gapanalysis.This lets you understand whether you are building the appropriate intellectual capital for your value proposition, or whether you areunder- or over-investing in certain areas.

This assessment is best done individually, either in interviews or by survey. Or it can be done in a workshop setting.The easiest way to performthe assessment is to use the list of key resourcesidentified above, and then to add columns toassess the relative strengths and the importanceof these resources to delivering the currentstrategy (see Figure 5). Conducting both assess-ments allows organizations to highlight any gaps.

The results from the individual assessments canthen be aggregated and displayed in a resourcemap. Such a map visually represents the relativestrength or importance of the different resources(intangible and tangible). It is also possible to

include the two data sets (strengths and impor-tance), and to use different size bubbles toindicate any gaps.

Figure 6 illustrates such a resource map, onecreated for a leading online retailing business14

to understand the relative importance of itsresources to deliver the existing value proposition.The value proposition of this well-known retailerwas to become the world’s preferred source for aparticular type of goods by providing consumersnot only with top level service, but also highquality value-added information, excellent price,simple transactions, and an enjoyable shoppingexperience. In this example, managers assessedstructural capital and human capital as the mostimportant intellectual capital value drivers(indicated by the biggest bubbles).This commercialenterprise places particular emphasis on itsknowledge of the market and its customers,plus itsprocesses and brand. Other important resourceswere its relationships, especially with its suppliersand lenders, as the business is still in the growingphase and unprofitable.This map helped theorganization to understand the relative importanceof its intellectual capital in order to allocate itsresources appropriately.

As discussed in Figure 6, intellectual capitalinteracts with other resources to create a corecompetency, which in turn helps to deliver thevalue proposition.This means that resourceinterdependencies can only be assessed in relationto the organization’s existing core competenciesand value proposition. If you have defined yourstrategic deliverables and core activities, you canthen use the above resource list to understandhow the resources combine to deliver your corecompetencies and value proposition.15

Figure 5: Assessing the Importance of Intellectual Capital

Identified Key Relative strengths of these resources Relative importance of these resourcesResources Examples in our organization to delivering our value proposition

0 = not at all important 0 = not at all important10 = vitally important 10 = vitally important

Our specific subject 7 10knowledge

Our perceived 4 9reputation

Relationships with 4 6key partners

Our patent for X 9 2

Our brand X 8 7

Etc.

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Studies have found that organizational resources(especially intangibles) are interdependent andenhance each other in affecting organizationalperformance. For example, a strong brand namemight improve performance, but a strong brandname combined with the right market knowledgeand customer service processes can improveperformance even more. As a consequence,organizations should attempt not only to (a) understand the direct effect of each organi-zational resource on performance, but also to (b) assess the interdependencies and their effectson performance.16 For this purpose, you can use a matrix to rate how resource A depends onresource B to deliver the core competency, untilthe all resource combinations are rated.The scaleused for assessing the relationships could bebetween 0 and 5, with 0 indicating no relationshipand 5 indicating a very strong interdependency.Again, these matrices can be completed byindividuals and then aggregated.

Applying these tools will allow organizations togain a solid understanding of their intellectualcapital infrastructure. In the next section we willdiscuss how to map this into an integrated pictureof strategy.

2. Mapping the Intellectual CapitalValue Drivers

A value creation map is a visual representation of the organizational strategy. Mapping your key value drivers into a visual map has two primaryfunctions.The first is to ensure that the strategywith all its intellectual capital value drivers isintegrated and coherent; the second is to enableeasy communication of the strategy and the roleand importance of intellectual capital in deliveringthe strategy. A value creation map brings togetherthe three key elements of an organizationalstrategy, namely, its value proposition, its coreactivities, and its enabling strategic elements orperformance drivers:

• The value proposition (or output deliverables)identifies an organization’s purpose and itsroles and deliverables. It also identifies thekey output stakeholders of the organizationand the value delivered to them. It is mainlyderived from the analysis of the corepurpose and the stakeholder requirements.Clarifying the value proposition allowsorganizations to put its intellectual capitalinto a strategic context.

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Figure 6: Visualizing the Relative Importance of Key Resources (Source Marr, 2006)

Organizational Key Resources

Physical Capital Relational Capital Financial Capital

Structural CapitalHuman Capital

Distribution Network

Budget

ITInfrastructure

LenderRelationships

Brand

MarketingKnow How

SupplierRelationships

Distribution Know How

ProcessDesign

Know How

PatentsProcesses


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• The core activities are the vital few things anorganization has to excel at to deliver itsvalue proposition.They essentially define (a) what an organization should focus on,and (b) what differentiates it from others.Core activities are directly linked to theorganizational core competencies.

• The enabling strategic elements (or valuedrivers) are the other strategic elements or objectives an organization requires toperform its core activities and to deliver itsvalue proposition.These enabling elementsor value drivers derive from the assessmentof the organization’s resource architectureand intellectual capital.

These three components are then placed inrelationship and displayed on one piece of paperto create a completely integrated and coherentpicture of the strategy. A value creation maptherefore visually represents an organization’sunique strategy at a specific point in time. Ittherefore has a limited life-span.17 As a conse-quence, the maps need to be regularly revised(usually annually), and no two value creation maps should be the same.The basic template of a value creation map is shown in Figure 7.

A value creation map (a) reflects a sharedunderstanding of strategy and the importance ofintellectual capital in the context of this strategy,and (b) facilitates its communication. Based on

such shared understanding, an organization canthen assess and manage its intellectual capital.

How maps are portrayed can vary depending onpreferences, levels of understanding, and availabledata.The most basic display does not show anycause-and-effect relationships or individual inter-dependencies between the enabling elements.Placing all these elements in one box indicates the interdependence of these different enablersor value drivers and the fact that, as a bundle of enabling elements, they support the coreactivities.

Value creation maps showing cause-and-effectrelationships (see the example in Figure 8)18

provide the most insight. Such maps indicate themost important cause-and-effect relationshipsbetween the different enablers. For example,better training builds up relevant knowledge,which in turn improves customer serviceprocesses.This type of value creation map is truly operational, thus promoting a deep andcomprehensive understanding of the role andimportance of intellectual capital.

Because a value creation map without cause-and-effect links is easier to create (because thedetailed interdependencies do not have to bedetermined), there is a danger that intellectualcapital elements may be added that don’t have areal impact on performance. A value creation

Output Stakeholder Value Proposition / Output Deliverables

Enabling Strategic Elements / Value Drivers

Figure 7: Value Creation Map Template (Source Marr, 2008)

Core Activity 1 Core Activity 11 Core Activity 111

Human Resources

e.g. Know How

Relational Resourcese.g. Supplier Relationships

Structural Resourcese.g. Information

and Data

PhysicalResources

e.g.Technology

Financial Resourcese.g. Funding

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map with cause-and-effect links displays the most important interdependencies between thedifferent enablers, thus ensuring that each elementis clearly linked to the core activities and valueproposition.This makes value creation maps easierto interpret and analyze, and makes possible thetest and verification of assumed causalrelationships and interdependencies.

We therefore recommend that organizationscreate value creation maps (preferably with cause-and-effect links) that map the key relationshipsbetween the intellectual capital and the strategicoutputs of an organization. Such maps can becreated (preferably by a small task force) from the data collected in the first step of identifyingthe intellectual capital. A workshop with a wideraudience (usually the senior management team)can then be conducted to discuss and finalize the map.

Case study:Thomas Miller

The Thomas Miller Group is a global insurancegroup that includes mutual insurance companies(known as Clubs).The TT Club,one of the Group’s

key companies, is a leading provider of insuranceand related risk management services for theinternational transport and logistics industry.TheTT Club has its global headquarters in the City of London, the central hub for insurance firms,but has 20 office locations around the world. Itscustomers range from the world’s largest shippinglines, busiest ports, global freight forwarders, andcargo handling terminals, to smaller companiesoperating in niche markets. Since its inceptionover 20 years ago, the TT Club has steadily grownits premium income at an average rate of 10% perannum.Customer loyalty has been an essentialfactor in this growth. Indeed, 90% of its customersrenew their policies with the TT Club each year.

Developing a value creation map (with cause-and-effect links) was part of the TT Club’s strategicplanning cycle. It wanted to better understand itsstrategic value drivers, with an emphasis on thenon-financial and intangible performance drivers.Developing the value creation map involved a setof interviews with members of the senior manage-ment team, the CEO, and board members.Themap was finalized in a facilitated one-day planning

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Figure 8: Value Creation Map TT Club (Source Marr, 2006)

(1.1) Provision of Sustainable Financial Security Through Excellent and Customized Trusted Insurance Covers for the Global Transport Industry, together with Value Added Services

(2.2) UnderstandingChanging ClientRequirements &

Underwriting Risk

(2.3) Building andMaintaining Close

Relationships with Industry

(2.1) Claims Handling andService Delivery

Structure,Processes,Systems

Reputation as Recognized Specialist in

Transport Industry

Relationships with Transport Industry, with re-insurers, and brokers

Knowledge / ExpertiseCapital Strength /

Access to Re-Insurance

Recruiting,Training,Developing, and Retaining

Good People

Customer Care Ethos

Network / Global Presence and Headquarter

in the City of London


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workshop with the senior management team.The value creation map for the TT Club is shownin Figure 8.

The TT Club decided that its value propositionwas to provide sustainable financial security forthe global transport industry, by offering excellentcustomized insurance covers and value-addedservices that customers trust.They identifiedthree core activities: (1) claims handling anddelivery of services, such as risk assessments and advice; (2) understanding the industry andchanging client demands and underwritingrequirements; (3) building and maintaining closerelationships with the industry, which gives the TT Club the status of an independent body within the industry.

These competencies are delivered through thecurrent structures, processes, and systemssupported by the reputation and recognition of the TT Club as a specialist member of thetransport industry.These competencies are alsodelivered through relationships not only withinthe transport industry, but also with re-insurersand brokers. At the foundation of the valuecreation map is the ability to recruit, train,develop, and retain good people who help tocreate the needed knowledge and expertise.This knowledge and expertise together with thestrong customer care ethos, helps to shape the TT Club’s reputation in the industry. Knowledgeand expertise also shapes the development of itsprocesses, structures, and systems.

Another key enabler is capital strength and accessto re-insurance, one of the strongest resources ofthe TT Club. Access to re-insurance depends on astrong and dynamic relationship with re-insurers.Capital strength is also an important driver ofreputation; without capital strength,TT Club’sreputation would suffer very quickly.The TTClub’s global presence helps it to create localrelationships, which in turn help its reputation andrecognition in the field. Having its headquarters in London enables the TT Club to develop thecrucial relationships with (a) brokers who selltheir products, and (b) re-insurers to make re-insurance deals.

Case study:The Royal Air Force19

We discuss below how the Royal Air Force of the United Kingdom (RAF) has applied the valuecreation mapping tool to identify and map itsintellectual capital value drivers.The RAF has50,000 service and civilian personnel, and morethan 500 aircraft. It supports operations in the

Gulf region, Kosovo, and Afghanistan, and alsomaintains an RAF presence in Cyprus, Gibraltar,Ascension Island, and the Falkland Islands. Its key peacetime responsibility is to maintain therequired readiness of its forces to support therequirement to operate as an expeditionary air force.

The RAF has applied the value creation map tocascade the overall strategy into the forces andRAF stations across the UK. Based on interviews,a value creation map was created for differentstations.The essential resources on which thestation relied (e.g., people, equipment, runways,and buildings) were evident.There were alsoseveral obvious core activities that needed littlethought.These included flight training, servicing of aircraft, and administrative support. However,the importance of maintaining fighting spirit andcohesion across the unit called for competency ina number of intangible, but nonetheless essential,value drivers.The emerging picture was translatedinto a value creation map that charted how theenabling strategic elements flowed to the coreactivities, then to the delivered output, all toachieve the overall mission.

The goal was always to represent the essence of a station on a single A4 page. In the RAF context,the resultant diagram was termed the StrategicMap.The draft strategic maps were then subjectedto rigorous review during a presentation given to station commanders and their executives.Although there were differing views on the keyinterdependencies and the relative importance of core activities, agreement was achieved on themap’s essential components. After the StrategicMap had been agreed upon in principle, anassociated table was generated that explained the intended scope of each element.

Figure 9 outlines the value creation map for oneof the RAF stations, showing its value proposition,core activities, and intellectual capital value drivers.This version does not include the cause-and-effectlinks between the different intellectual capitalelements. Overall, this station (RAF Waddington)exists to generate world-class ExpeditionaryIntelligence, Surveillance,Target Acquisition, andReconnaissance (ISTAR) Capabilities.There werethree core activities at which the station had toexcel, namely, (a) to successfully contribute tooperations and other tasks (today and in thefuture), (b) to provide and develop a sufficientnumber of capable and prepared people, and (c) to maintain, sustain, and develop sufficientcombat-ready equipment.The station agreed oneight intellectual capital enablers of performance

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that it required to continue to deliver itsobjectives.These performance drivers are to:enhance and maintain competencies, training, andpersonal development; develop excellentmotivation, fighting spirit,morale, and ethos;maintain and improve equipment; direct andcoordinate output to ensure optimal use ofresources; foster a culture of innovation andcontinuous improvement; communicate andengage proactively and openly; enhance health,fitness, and well-being; and cultivate a positiveimage and reputation.

In addition to these intellectual capital enablers,the stations identified a number of otherresources it needed, including finance, infra-structure, equipment and stock, external services,and manpower. All of these are allocated to thestations.Together, all the elements form a cohesivepicture of the strategy for RAF stations.

3. Measuring Intellectual Capital

After identifying and mapping the intellectualcapital value drivers, organizations can startmeasuring them.We often have a misconceptionthat intellectual capital is difficult or impossible to measure.This is not the case. Many tools andtechniques are available to measure intellectualcapital, and it is most probably easier to measurethan you think.This section outlines a model that will assist you in developing performanceindicators for your intellectual capital valuedrivers. Figure 10 shows the intellectual capitalperformance indicator design model. It starts withidentifying which intellectual capital element youwant to measure. Every intellectual capital valuedriver on the value creation map should bemeasured, and for each of them the indicatordesign model should be followed.

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Figure 9: Value Creation Map RAF (Source Marr & Shore, 2008)

(1.1) To generate world-class Expeditionary ISTAR Capabilities

(4.1) Financial Resources

(4.2) People:Manpower

(4.3) Equipment & Stock (4.4) External Services (4.5) Infrastructure

(2.3) Maintain,Sustain & DevelopSufficient Combat Ready Equipment

(2.2) Provide & Develop Sufficient Capable & Prepared People

(3.1) Enhance & MaintainCompetencies,Training &

Personal Development

(3.2) Develop ExcellentMotivation,Fighting Spirit,

Morale & Ethos

(3.3) Maintain & EnhanceEquipment

(3.4) Direct and Coordinate Output to Ensure

Optimal Use of Resources

(3.5) Foster a Culture ofInnovation and Continuous

Improvement

(3.6) Communicate & EngageProactively and Openly

(3.7) Enhance Health,Fitness & Well-being

(3.8) Cultivate Positive Image & Reputation

(2.1) Successfully Contribute to Operations & Other Tasks,Today and in the Future


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After you have decided on the intellectual capitalvalue driver to measure, it is important to decidewhether it is worth measuring in the first place.Measuring performance should provide us withmeaningful information that helps to reduceuncertainty about intellectual capital, and enableus to learn about the intellectual capital valuedriver and its performance.Measuring performanceshould help us to make better informed decisionsthat enable us to improve our performance.An excellent way of determining whether anindicator is worth measuring is to establish thequestion(s) the indicator will help to answer.So-called Key Performance Questions (KPQs)20

are designed to identify what managers want toknow about the various intellectual capital valuedrivers. KPQs make sure that any measure has a clear purpose. If there is no question that needs to be answered, then there is no need for measurement.

Having identified that a question should beanswered, you should think about how to collectthe measurement data. At this point, you can

assume that this intellectual capital value driverhas probably been measured before, and thatsomeone has designed a method for measuring it,so don’t re-invent the wheel. Do some researchon already developed measurement methods.Thiscan usually be done with simple Internet searches.If methods already exist (the most likely case),then it is important to assess whether any ofthem are appropriate to use. Not all methods will be useful for your purpose. If no appropriatemethods seem to exist, you will need to designnew measurement methods.

For both existing and newly developed methods,it is important to assess (a) whether it is possibleto collect meaningful data, and (b) whether thedata will help to answer your questions. Finally, itis important to assess whether the resultant datawarrants the cost and efforts of measurement(which can be significant). If no meaningful datacan be collected, if the data is not really helpingyou to answer the KPQ, or if the costs are notjustified, then it is necessary to rethink and designdifferent indicators.

Figure 10: IC Performance Indicator Design Model (Source Marr, 2008)

Design new measurement method

Start measuring

• Instrument?• Source of data?• Formula?• Frequency?• Targets / Benchmarks?• Who measures?• Expiry date / Revision of data?• Audience• Reporting

Do we have a key performance question to answer?

Which IC value driver do we want to measure?

Don’t measure, rethink!Yes No

Can we use existing methods to measure it?

No Yes

Can we collect meaningful data?

Yes No

Does it help us answer our KPQ?

Yes No

Are the measurement costs and efforts justified?

Yes No

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After you have developed indicators, it is necessaryto identify (a) the measurement instrument, i.e.,how the data will be collected (e.g., survey orinterviews); (b) the source of the data; (c) theformula used to compute the indicator; (d) thefrequency of measurement; (e) any targets orbenchmarks; (f) who will measure; (g) how longthe indicator will be collected before it needs tobe reviewed; (h) the target audience for thisindicator; and (i) the reporting formats. Below, welook at developing key performance questions anddesigning performance indicators in more detail.

Designing Key Performance Questions™

Key Performance Questions (KPQs)20 askmanagers exactly what they want to know aboutthe various intellectual capital value drivers. KPQsare asked to ensure that indicators are useful andmeaningful.They make sure that we are clearabout what it is we want to know. Also, by firstdesigning KPQs we are able to ask ourselves:‘What indicators will best help us answer our key performance questions?’

An example of how powerful KPQs can be inmanaging strategic performance comes fromGoogle – one of today’s most successful and mostadmired companies. Google CEO Eric Schmidtsays21: “We run the company by questions, not byanswers. So in the strategy process we’ve so farformulated 30 questions that we have to answer […]You ask it as a question, rather than a pithy answer,and that stimulates conversation.Out of the conversa-tion comes innovation. Innovation is not something thatI just wake up one day and say ‘I want to innovate.’I think you get a better innovative culture if you ask itas a question.”

Any student of science learns that it is importantto know what you are looking for before you startcollecting any data. If we start collecting datawithout knowing what we are looking for, weoften collect the wrong or unnecessary data, anddevelop few or no insights about the reallyimportant questions we need answers to. In ourdesire to find measures and get our hands on thedata, we often fail to clarify what it is we reallywant to know. For example, after deciding that therelationship with our partners is important andthat we ought to measure it, we need to pause toclarify what it is we want to understand. Here iswhere KPQs come in – defining the question orquestions we want answered forces us to morespecifically spell out just what it is we want toknow. Once we have the question, we then haveto ask ourselves: what information will answer thisquestion and what is the best way of collecting it?

KPQs should not be designed solely in theboardroom. Designing KPQs provides a greatopportunity to engage everyone in the organi-zation, as well as some external stakeholders.Here are some guidelines for designing KPQs:22

• Design between one and three KPQsfor each intellectual capital valuedriver: If the intangibles matter in deliveringyour strategy, then you should developmanagement questions you want answered.Try to keep them to the vital few (seeFigure 11).

Figure 11: KPQs and KPIs

• Involve people in the process:Try toinvolve people in the design of KPQs byasking them what questions they believe are most relevant. After designing a list ofKPQs, get feedback from the subject matterexperts or different parts within andoutside the organization. For example, askthe marketing department to discuss andrefine the KPQs that relate to brand andreputation. Remember that KPQscommunicate to everyone what reallymatters to an organization, and that themore people understand and agree withthese questions the more likely it is thateverybody will pull in the same direction.

• KPQs should be short and clear:A good KPQ is relatively short, and clear.A KPQ should only contain one question.Asking a string of questions makes it muchharder to guide meaningful and focused datacollection.The language should be clear andnot contain any jargon or abbreviations thatmight not be understood. Likewise, ensurethat the question is clearly written, usinglanguage those in your organization (andthose consulted outside) are comfortableand familiar with.

• KPQs should be formulated as openquestions:Closed questions such as ‘Howmany people in our organization have highereducation qualifications?’ or ‘Have we met

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IntellectualCapital Value

Driver

KPQ

KPQ

KPI

KPI

KPI

KPI


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our employee satisfaction target of 89%?’can be answered with a simple answerwithout any further discussion or expansionon the issue. However, open questions suchas ‘To what extent are we sharing know-ledge?’ or ‘How well are we increasing ourcorporate reputation?’ trigger a widersearch for answers by seeking more than a‘yes’ or ‘no’ response. Open questions makeus reflect, they engage our brains to a muchgreater extent, and they invite explanationsand ignite discussion. All of this is vital whenit comes to intellectual capital.

• KPQs should focus on the present andfuture:Questions should be phrased in away that addresses the present or future:“Are we increasing our market share?”instead of questions like “Has our marketshare increased?” By focusing on the future,we open up a dialogue that allows us to ‘do’something about the future.We then lookat data in a different light, trying to under-stand what the data and managementinformation means for the future.This helpswith data interpretation and ensures thatwe collect data that helps to inform ourdecision making.

• KPQs are refined through usage:After KPQs have been created, theiranswers should be evaluated, to see howwell (a) the performance indicators answerthe questions, and (b) the indicators helppeople to make better informed decisions.Once KPQs are in use, it is possible torefine them to improve their focus.

Below, we have listed some example KPQs toillustrate how organizations have developed keyperformance questions for some of theirintellectual capital value drivers:

• To what extent are we enhancing ourinternational reputation?

• How well are we sharing our knowledge?

• To what extent are we retaining the talentin our organization?

• How well are we promoting our services?

• How do our customers perceive ourservice?

• How effective are we in managing ourrelationships?

• How well are we innovating?

• How well are we communicating in ourorganization?

• How well are we working in teams?

• How well are we building our newcompetencies in X?

• To what extent are we continuing to attractthe right people?

• How well are we fostering a culture ofinnovation and continuous improvement?

• To what extent do people feel passionateabout working for our organization?

• How well are we helping to develop acoordinated network to perform clinicaltrials?

• How motivated is our staff?

• How well are we sharing one set of values?

• How well are we protecting our intellectualproperty?

Designing Performance Indicators forIntellectual Capital

Once we have the KPQs and know what it is we want to know, we can design performanceindicators for our intellectual capital. Over thepast decade, many tools and techniques have been developed to measure intellectual capital.Sophisticated measurement and analysis methodsare usually used in fields such as physics andfinancial accounting, which have a long history ofmeasurement and already have reliablequantitative measurement instruments.Themeasurement of intellectual capital is a relativelyyoung field, without many generally acceptedmeasurement instruments. It is natural that areasof measurement evolve and improve over time,and that more generally accepted methods willemerge. For example, temperature wasconsidered very qualitative and immeasurableuntil Daniel Fahrenheit developed the mercurythermometer to measure it.Today, we all acceptthis form of measuring temperature.We will seesimilar evolutions for areas of intellectual capital.

Most measures of intellectual capital are indirector proxy measures. For example, in measuringwork-related competencies we might use thenumber of people with vocational qualifications asa proxy measure. Or, if we want to measure trustin our organizations, we collect survey data asproxies.This is completely legitimate and some-thing we do in other more sophisticated areas ofmeasurement. Just think of temperature, wherewe measure the expansion of mercury, or timewhere we measure the rotations of cogs.

The one danger with using proxy measures is that we sometimes oversimplify the process andsimply measure what is easy to count. For

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example,we might want to understand intelligencebut just measure IQ test scores. Another problemis that we tend to focus on numbers more thantheir meaning. As Dee Hook, founder of the Visanetwork, rightly said “in years ahead,we must getbeyond numbers and the language of mathematics tounderstand, evaluate and account for such intangiblesas learning, intellectual capital, community, beliefs andprinciples, or the stories we tell of our tribe’s valuesand prosperity will be increasingly false.”23

Words such as performance assessment seemmore appropriate in this context than ‘measure-ment.’ Assessment goes beyond the assignment ofnumbers. Instead, we should assess performanceby systematically collecting information to enableus to gain the required insights and answer ourKPQs. Performance assessment can take the formof numbers, but should also include writtendescriptions, symbols, or color codes.

Furthermore, when it comes to intellectual capital,the word indicator rather than ‘measure’ seemsto more appropriately reflect indirect measure-ment using proxy indicators. An indicator‘indicates’ a level of performance, but it does notclaim to ‘measure’ it. For example, a new indicatorto assess customer satisfaction levels will indicatehow customers feel; however, it will never‘measure’ customer satisfaction in its totality.

We often associate counting with objectivity and reliability, and perception-based data withunreliability.This belief needs to change when itcomes to intellectual capital. Many studies haveshown that perceptual assessments are as reliable,if not more reliable, than archival data.24 Percep-tion data can (a) provide richer insights into thereal level of performance, and (b) allow us toactively involve people in assessing performance.We can involve people by asking them, forexample, to rank competitors, evaluate the servicedelivery or organizational culture, or assess thelevel of relationships with different suppliers.Theseassessments can take the form of numbers orgrades; however, they can also be represented bysymbols such as traffic lights or thumbs up ordown, as well as by written assessments.Writtenassessments capture much more information,allowing us to more naturally communicateassessment outcomes. If numbers are used toassess intellectual capital, it usually makes sense to supplement them with at least a comment fieldto provide some explanatory narrative.

An important step in designing indicators forintellectual capital value drivers is to decide on the measurement instrument that will beused to collect the data. Before designing any new

instruments, it is important to check what hasalready been developed and used by others.When deciding on the instrument, it is importantto keep the KPQ in mind when assessing whethermeaningful data can be collected. In many areas of intellectual capital, improved measurementinstruments have led to more insightful andmeaningful performance indicators.

The most suitable measurement method is most likely simpler than you first think; also, youusually have access to more data than you expect.Designing the right measurement instrumentmight only require more resourcefulness.25 Forexample, instead of using the ubiquitous andintrusive customer satisfaction survey, manyservice providers, such as hotels or banks, nowuse focus groups to identify what really matters to their target customers.They then employprofessional mystery shoppers/users to assessservice levels against the identified criteria. Callcenters, for example, used to count only thenumber of abandoned calls, or call duration, asmeasures of customer service delivery. Now theyuse instruments such as audio taping telephoneconversations between service agents andcustomers, and use coaches to randomly listen to conversations to assess the qualitative aspectsof call handling.To enable the user to considerdifferent measurement instruments, we presentbelow an overview of different instruments formeasuring intellectual capital value drivers:

• Surveys and Questionnaires provide arelatively inexpensive way of collecting dataon intellectual capital from a large pool ofpeople who might be at different locations.26

This can be done via mail, e-mail, internet, ortelephone. One big problem with this is thehuge influx of surveys over the past fewyears, as more and more organizationsrequire data for their non-financial indicators.As a consequence, it is now harder topersuade people to complete a survey. It is always a good idea to reduce the amountof time and effort required to collectperformance data, not only for yourorganization, but also for your customers,employees, suppliers, etc. Surveys areregularly used to measure intellectual capitalvalue drivers such as employee engagement,corporate culture, customer attitudes,innovation climate, or brand image.

• In-depth interviews are guided conversationswith people, rather than the structuredqueries found in surveys.They put forwardopen-ended (how,why,what) questions in aconversational, friendly, and non-threatening

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manner.27 Interviews can be conducted face-to-face, or via telephone or video-conference. Interviews, which enableinteraction directly with respondents, mayprovide new insights about performance.They provide examples, stories, and criticalincidents that are helpful in understandingperformance more holistically.28 In-depthinterviews can, for example, be used toassess intellectual capital value drivers such as relationship with key customers,suppliers, or partners. In addition toproviding a performance score, they canalso yield invaluable contextual informationabout, for example, how to improverelationships between key customers,partners, or employees.

• Focus groups are facilitated group discussions(5-20 participants) in which participants canexpress and share their ideas, opinions, andexperiences.They provide a unique andinteractive way to gather information, andallow the collection of rich, qualitativeinformation. Focus groups are good ways ofassessing employee- and customer-relatedintellectual capital value drivers such ascustomer experience, customer or staffengagement, team-working climate, or trust.

• Mystery shopping approaches assess a serviceby using a ‘secret shopper’ posing as a clientor customer. Some companies hire theirown mystery shoppers; other firms hireexternal suppliers to provide this service.The beauty of this assessment approach is that it is less intrusive than surveys orinterviews.Many retail businesses,banks,and hotels have used mystery shopping to assess customer experience.Trainedmystery shoppers can also be used formany other intellectual capital assessments,such as assessing an organization’s cultureor atmosphere.

• External Assessments.External organizationsand institutions can provide independentperformance assessments and indicators.Good examples of external assessments are independent surveys that measure thebrand recognition, customer awareness,or market share in specific segments. Anindependent company creates a set ofcriteria, and then measures everyone againstthese criteria to assess, for example, therelative position or values of brands orcorporate reputations.The advantage ofexternal and independent assessments isthat the data they provide allows

comparisons between organizations.However, external assessments might betoo generic, and often use assessmentapproaches that don’t provide the answersto the internal KPQs. External assessmentsare best used to supplement, cross-check,and validate other internal indicators.

• Observations allow us to collect informationby observing situations or activities withlittle or no manipulation of the environment.The observer can either take the role of apassive onlooker / outsider, or can becomeinvolved in activities and, therefore, take the role of partial or full participant.“Thepower of using observation methods is thatit engages all of our senses not just oursight. It enables us to take in and makesense of the entire experience through ournose (smell), eyes (sight), ears (hearing),mouth (taste), and body (touch).Unlikeother data collection methods, observationdata can provide us with a more holisticunderstanding of the phenomenon we’restudying.”28 Observation outputs can takethe format of score sheets, check lists,narrative reports, and video or audio taping.Observations have been successfully used in assessing organizational culture, skill andexperience levels of employees, emotionalintelligence, and creativity. Another exampleis employee safety. Instead of waiting foraccidents and injuries to occur and thencount those, so-called Safe Behaviormeasures can be used: Observers pro-actively look for safe behaviors that wouldprevent the most common accidents, andrecord those on a behavioral observationform.This information can then be shared,providing immediate feedback on potentiallyunsafe behavior.

• Peer-to-peer evaluation is the assessment ofperformance by participants who vote onor assess each other’s performance, eitheropenly or anonymously.This enables peopleto learn from each other, and to considertheir own performance from the perspec-tive of others. Peer-to-peer evaluations havebeen successfully used to gauge intellectualcapital value drivers, including trust, know-ledge and experience, teamwork, andrelationships.

There are many more fascinating ways ofcollecting qualitative performance data – for moreinformation and an example see the Handbook ofQualitative Research.29 To guide the indicator design,we have developed an intellectual capital indicator

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template (see Figure 12) that can be completedfollowing the model described in Figure 10.

The top part of the template states the intellectualcapital value driver that is being assessed, theKPQ, and Ownership of the question.Ownershipidentifies the person(s) or function(s) responsiblefor managing the intellectual capital value driverthat is being assessed. Every indicator should begiven a clear name.

The Data collection method describes themethod or instrument used to assess theintellectual capital value driver. As discussedabove, selecting the appropriate data collectionmethod is important. It is important to considerthe strengths, weaknesses, and appropriateness of different data collection methods. Here, thedesigner of an indicator should briefly describethe data collection method, specify the source of the data, state how often the data is to becollected, identify the scale to be used to measureit, and identify who is in charge of collecting andupdating the data.

Source of the data identifies where the datacomes from.This ensures that the designer of anindicator ask a number of questions about theaccess to data. Is it readily available? Is it feasible to collect it? Will the data collection method, forexample interviews with senior managers, providehonest information? If not, maybe different datacollection methods could be combined?

Frequency of data collection identifies howoften the data for that indicator should becollected. Some indicators are collectedcontinuously, others hourly, daily, monthly, or even annually. It is important to decide whatfrequency will provide sufficient data to answerthe KPQ, and how regularly it is feasible tomeasure. Organizations might want to continu-ously track indicators of website usage, becausesome of them might be readily available fromserver reports. External indicators for brandranking, for example, might only be available onceor twice a year. One of the biggest pitfalls ofintellectual capital measurement is that data is notcollected frequently enough. For example, manyorganizations conduct employee surveys once ayear or even every eighteen months.This is notvery useful, as the time between the assessmentsis too long, and impacts of corrective actionscannot be tracked. Instead of surveying allemployees once a year, it is possible, for example,to survey a representative sample (let’s say 10%)of employees every month. Individuals will

still complete a survey once a year, but theorganization receives monthly information thatallows them to answer their KPQs and act on thedata much more quickly.

Formula / scale / assessment – Here, thedesigner of the indicators identifies how tocapture the data. It may be possible to create aformula. Or an aggregated indicator or index thatis composed of other indicators may be used.Here the designer also specifies (a) which of thefollowing scales is to be used: nominal (numberingof categories, e.g., football players); ordinal (deter-mination of greater or less, e.g., street numbers);interval (determination of intervals, e.g., degreesFahrenheit or Celsius); and ratio (determination of equality and ratio in a continuum with a realzero, e.g., length, time, temperature in Kelvin); or(b) whether the indicator cannot be expressed inany numerical form.

Targets and performance thresholds identifythe desired level of performance in a specifiedtimeframe (e.g., 5% increase of market share bythe end of March next year). Many firms use ‘traffic lighting’ to illustrate performance levels.Here, the designer of an indicator would specifythe thresholds for red (under-performance),amber (medium performance), green (goodperformance), and sometimes blue (over-performance). Here, it is also worth thinking aboutinternal or external benchmarks; these can bederived from past performance, from other similarorganizations or departments, or from forecasts.

Data entry identifies the person, function, orexternal agency responsible for data collectionand data updates.This could be an internal personor function, or an external agency, because manyorganizations outsource the collection of specificindicators. Outsourcing is especially common forindicators such as customer satisfaction, reputa-tion, brand awareness, and employee satisfaction.

Expiry / revision date – Indicators are some-times introduced only for a specific period of time (e.g., for the duration of major projects,or to keep on eye on restructuring efforts).It is common practice to introduce a significantnumber of indicators once and collect dataforever, because no one ever goes back andidentifies the indicators that are no longer needed.Other obviously temporary indicators areintroduced without giving them an expirationdate; however, for those indicators a revision dateshould be set that allows the designers to reviewthe template and check whether it is still valid.

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Estimated costs – Another aspect that should be considered is the cost and effort required tointroduce and maintain a performance indicator.Many managers and measurement experts assumethat creating and maintaining measurementsystems does not incur significant costs. On the contrary, however, measurement is expensive,especially if the indicators are supposed to berelevant and meaningful to aid decision makingand learning.Costs can include the administrativeand/or outsourcing costs of collecting the data, aswell as the cost of analyzing and reporting on theperformance. It is important to ensure that thecosts and efforts are justified.

Reporting – Here, the designer of an indicatoridentifies how to report the performanceindicator, identifying the audience, access restric-

tions, the reporting frequency, and reportingformats.

Audience and access identifies who will receivethe information on this performance indicator.Reports on indicators can have differentaudiences. It might therefore be a good idea toidentify primary, secondary, and tertiary audiences.The primary audience will be those directlyinvolved in the management and decision makingrelated to the strategic element that is beingassessed.The secondary audience could be otherparts of the organization that would benefit fromseeing the data. A possible tertiary audiencecould be external stakeholders.

Reporting frequency identifies how often toreport on this indicator. If the indicator is to

Figure 12: Indicator and Index Design Template (Source: Marr 2006)

TEMPLATE FOR DESIGNING

KEY PERFORMANCE INDICATORS

Intellectual Capital Element Name the strategic element from the Value Creation Map which is being being Assessed: assessed with this indicator.

Key Performance Question(s)™ Name the question(s) related to performance that this indicator is helping to answer.

Ownership / Person Responsible / Identify the person(s) or function(s) responsible for the delivery / performance Champion / Coordinator of the measured strategic element.

Indicator Name Pick a short and clear indicator name.

Data Collection Method / Describe how the data will be collected.Instrument

• Source of Data Describe where the data will come from.

• Frequency Describe how frequently this indicator will be collected. If possible, include a forward schedule.

• Formula / Scale / Assessment Describe how performance levels will be determined.This can be qualitative, in which case the assessment criteria need to be identified, or it can be numerical or using a scale, in which case the formula or scales with categories need to be identified.

• Targets and Performance Identification of targets, benchmarks, and thresholds for traffic lighting.Thresholds

• Data Entry Name the person or role responsible for collecting and updating the data.

Expiry / Revision Date Identify the validity date of this indicator, or when it will have to be revised.

How much will it cost or what Estimate the costs incurred by introducing and maintaining this indicator.will the person / days required be to collect the data and is it justified?

Reporting

• Audience / Access Name the key audience for this indicator and clarify who will have access to it.

• Reporting Frequency Outline how frequently this indicator will be reported to the different audiences (if applicable).

• Reporting Formats Describe how the performance indicator will be presented (numerical, graphical,narrative formats). Here it is good to especially think about visual representation that makes it easy to understand and digest.

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support decision making, then it needs to providetimely information.The reporting frequency candiffer from the measurement frequency. Anindicator might be collected hourly, but onlyreported on at a quarterly performance meeting.

Reporting formats identify how best to presentthe data.They should clarify whether the indicatoris reported as, for example, a number, a narrative,a table, a graph, or a chart.The best results areusually achieved if performance is reported in amix of numerical, graphical, and narrative formats.Considerations here also include the presentationof a data series and past performance. A graphcontaining past performance might be very usefulto analyze trends over time; this could also includetargets and benchmarks. Increasingly as well,organizations use traffic lights or speedometerdials to present performance data.

When designing any indicator for the intellectualcapital value drivers, it is essential to constantlyevaluate the validity and information value of theindicators.The following questions are relevant.To what extent do the indicators enable us toassess the particular intellectual capital element?How well do the indicators help us answer theKPQ(s)? If the indicator is not providing us withthe required information, we should not measureit at all.

When it comes to intellectual capital, a singleperformance indicator will rarely give us sufficientinformation.We therefore recommend combiningdifferent measures into one index.This providesorganizations with a more rounded and balancedview on their intellectual capital. Human healthallows us to illustrate the point. Only taking yourblood pressure to assess your heath would not be sufficient. However, taking blood pressure,cholesterol and blood tests, together with anumber of other tests, and combining these into a health index, provides a much more balancedand reliable assessment of physical health.Thesame is true in business. If a company wants tomeasure customer relationships, a number ofindicators such as loyalty, trust, commitment,profitability, and referrals can be measured andcombined into a customer relationship index.We outline below two illustrative examples ofhow organizations have applied the indicatordesign model in practice.

Case study:Measuring Partnerships atInterCorp30

A major blue chip company, InterCorp, wanted tomeasure its partnerships with its key suppliers, an

important intellectual capital value driver. Initially,InterCorp didn’t develop KPQs. Instead, it tried tofind the quickest and easiest way to get some data.After some research, InterCorp identified anexternal company that specialized in partnershipevaluations.This company had designed a genericquestionnaire to measure partnerships. InterCorpoutsourced its data collection to this company,who then started to collect the partnership datatwice a year. Initially, InterCorp was pleased withthe service, as the external company provided itwith detailed reports containing graphs, tables, andtrend analyses on about 50 different questions onthe survey. Although, on the surface, InterCorpseemed happy with how things were going, thepartners were telling a different story.Theybelieved that a lot of unnecessary data wascollected, which took them a lot of time and effort(about 6 man-days for each survey). It very quicklybecame clear that all of the data InterCorp werecollecting was ‘interesting to know,’ but only that.Not one decision based on the survey data hadbeen taken over the past three years.

InterCorp went back to the drawing board andidentified the question(s) they really wantedanswered.The KPQ they came up with was “Howwell are our partnerships progressing?” Afterdeciding on this KPQ, they then asked themselveswhat data they would need to answer thisquestion, and how best to collect the data.InterCorp needed data that would assess therelationships, but didn’t want to use the samesurvey again, as it was collecting too muchunnecessary data. After some deliberation andresearch, InterCorp agreed that the best approachwould be to ask its relationship managers oraccount managers for an assessment. InterCorprealized that its own account managers would beable to make this assessment without the need fora lengthy survey. InterCorp designed a system thatautomatically e-mailed a very simple form to theaccount managers with just two questions:“Howwould you assess the relationship with companyX?” and “How well is the partnership withcompany X progressing?” The form included ascale next to the question. Initially this was a 10-point scale, from very bad to very good.This waslater refined into a 3-point scale. In addition, theform also included a field for a written comment(see Figure 13). Account managers were asked toassess the partnerships by ticking a box on a scaleand by providing a short written comment on whythey picked that particular assessment.

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Figure 13: Partnership KPQs

InterCorp realized that asking only the accountmanagers might produce a biased view on thesituation, so it decided to also e-mail a modifiedform to its partner companies. Preferring not to ask for any written assessment, the form usedfor the partner companies only included the twoscaled questions. After account managers and the partner companies had completed the shortsurvey, the results were compared in a database.In over 95% of the cases, the internal and external assessments were identical.Where major differences in opinion occurred, thedatabase triggered another e-mail to the internalaccount manager, prompting him or her to pick up the telephone and discuss any potential issueswith the partner organization. InterCorp alsorealized that it was not collecting such datafrequently enough.They decided that monthlydata was required to be able to react to potentialissues before they became big problems.InterCorp now has a very simple and cost-effective monthly performance measurementsystem in place, one that allows it to get all theinformation needed to answer its KPQ aboutpartnerships with its suppliers, one of its criticalintellectual capital value drivers.

Case study:Measuring staff engagement at TradeBank31

TradeBank is a leading Trading Bank that believesthat its people, with their skills and knowledge,are its most important intellectual capital valuedrivers.TradeBank believed that one of the keyenablers of success was the level of staff engage-ment. In the past, they had conducted traditionalstaff satisfaction surveys, but found that eventhough people might have indicated satisfactionwith their jobs, many were not engaged. Managersin TradeBank believed that engagement is muchmore important than staff satisfaction, as itindicates how passionately people feel about theirjobs, and how connected they feel to the organi-zation. According to the Gallup Organization,

engaged employees are passionate about whatthey do, feel a strong connection to their company,and perform at high levels every day while lookingfor ways to improve themselves and the companyas a whole. Unengaged employees on the otherhand show up every day and put in just enougheffort to meet the basic requirements of their jobs.Without passion or innovation, these employeesneither commit to the company’s direction, nordo they work against it. Actively unengagedemployees present a big problem for businesses.Negative by nature, these people are unhappy intheir work, and they compound their lack ofproductivity by sharing this unhappiness withthose around them. According to GallupResearch, an average organization has about 25%engaged employees, just over half not engagedemployees, and just under a fifth activelydisengaged employees.TradeBank was keen toimprove its ratio and ensure that more employeeswere closely engaged.

Managers in TradeBank agreed to the followingKPQ: “To what extent are our employeesengaged?” In their research of existing datacollection methods, they came across the Q12survey tool32 that was developed by the GallupOrganization.This 12-question survey wasdesigned to assess engagement, especially on an emotional level. After some deliberation,TradeBank felt that this survey would allow it to gain the information to answer its KPQ. Inaddition, the survey would allow TradeBank tobenchmark itself with its competitors.Thefollowing 12 questions, based on the Q12 survey,were incorporated into TradeBank’s staff survey:

1. Do I know what is expected of me at work?

2. Do I have the right materials andequipment I need to do my work right?

3. At work, do I have the opportunity to do what I do best every day?

4. In the last seven days, have I receivedrecognition or praise for doing good work?

5. Does my supervisor or someone at work,seem to care about me as a person?

6. Is there someone at work who encouragesmy development?

7. At work, do my opinions seem to count?

8. Does the mission / purpose of myorganization make me feel my job is important?

9. Are my coworkers committed to doingquality work?

Problematic Indifferent PositiveHow would you assess the relationship with company X?

Written Comment:

Worse Same as Better than before before than before

How well is the partnershipwith company X progressing?

Written Comment:

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10. Do I have a best friend at work?

11. In the last six months, has someone atwork talked to me about my progress?

12. This past year, have I had opportunities atwork to learn and grow?

TradeBank decided to poll a representative sampleof its employees every month to regularly checkfor possible changes. Each employee still receives a survey only once a year, but the company getsvalid data every month to answer its KPQquestion and to test the impact of staff engage-ment on retention, satisfaction, and performancelevels. In TradeBank, the results of staff engagementare reported to the senior management teammonthly.The data is provided in aggregated form(staff engagement index) and compared withcompetitor positions. Engagement is best reflectedby changes over time.The data is thereforepresented in a trend chart over time, togetherwith a narrative commentary by the HumanResources Director that puts the assessment intocontext and extracts the key learning points.

4. Managing Intellectual Capital

Measures allow organizations to manage.Thisapplies to management of intellectual capital.Without relevant assessments, it is impossible (a) to understand current performance levels,(b) to know whether the intellectual capital hasimproved or deteriorated, and (c) to understandwhether any activities and initiatives have affectedperformance. Organizations that have meaningfulperformance information about its intellectualcapital can use it to inform decision making, to test and review strategy, and to manage risksassociated with intellectual capital. Each of thesewill be discussed in further detail below.

Informing Decision Making

Performance information about intellectual capital and other drivers of success providesperformance feedback.This in turn underpinslearning and decision making.33 Let us use ananalogy from the world of education to illustratethe appropriate and inappropriate use ofperformance assessments to generate feedbackand learning. In schools,we tend to use exams ortests to determine the learning outcome of anacademic program, let’s say a language course,at the end of the program or at the end of aparticular phase of the program.This is called asummative assessment. Summative assessments are judgments about the student’s learning,usually in the form of a grade.They are seen to

provide reliable and comparative data, and theassumption is that such tests will somehow leadto improvements in student learning.However,this assumption is questioned by many, because these assessments are not designed to providecontextualized feedback that is useful for helpingstudents and teachers during the course of aprogram to improve learning.

By contrast, formative assessment provides feed-back to an ongoing program, with the objective of improving learning. It occurs (a) when teachersfeed performance information back to students in ways that enable the student to learn, and fine-tune or modify what they have been doing,or (b) when students can engage in a similar,self-reflective process.

In summative assessments the number or result(e.g., grade) is at the centre of attention. On the other hand, the key objective of formativeassessments is improving.The former is backwardlooking, whereas the latter is about positivelyaffecting the future.The problem with summativeassessments is that they can lead to dysfunctionalbehaviors:Teachers might only teach what isimportant to pass the exams, with little actuallearning, and students might try to do as little asthey can get away with to meet the minimumrequirement. Suddenly, the emphasis is not onlearning, but on playing the numbers game.

We have all seen similar problems in organizations.It is therefore important to ensure that organi-zations do not fall into the same traps as schoolsdo with exam results.To create effective feedbackand learning from intellectual capital information,organizations need to regularly review perfor-mance.These reviews should take place monthly,and should be used to discuss the performance ofthe key value drivers that should lead to learningand decision making.We provide below someguiding principles about how to create formativeperformance review meetings in organizations, toensure that intellectual capital indicators are usedto improve learning and, ultimately, performance:

• Name the meeting appropriately:Takethe word ‘review’ out of the name of themeeting. Its main purpose is to learn, andimprove future performance. Insight fromthe past can help us with future decisionmaking, but it can’t be the main focus of the meeting.Therefore, call them StrategicPerformance Improvement Meetings orsomething similar, so that the name moreaccurately reflects the purpose of themeeting.

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• Use the value creation map to guide themeeting structure and agenda:The valuecreation map is used to guide the meeting,and provides a structure or agenda for themeeting. A good way to do this is to set anagenda made up of the individual elementsfrom the strategic map.

• Use the key performance questions toguide and focus the discussions: Askingquestions in an inquiring way develops aspirit of curiosity that serves as a catalystfor learning. The KPQs have been designedto raise the most important performancequestions, and should therefore be usedhere.The KPQs can then become theagenda items or even headings for sub-meetings.

• Use performance indicators to facilitatefinding answers:The individuals (or groupof individuals) responsible for the differentstrategic elements take responsibility foranalyzing the performance data before the meeting, with the aim of answering the posed question(s). Findings from theanalysis, with their interpretations, are thenpresented during the meetings.

• Create an atmosphere of purpose, trust,and respect:The atmosphere in thesemeetings is purposeful, but relaxed andfriendly. Mutual trust, respect, and supportlead to personal commitment, joint decisionmaking, and learning. Instead of a blameculture, the focus is on future performance,dialogue, decision making, and actions.A chairman ensures that all agenda itemsare fully discussed and that any dialogue isconstructive and aimed at improving futureperformance.

• Ensure that collaborative decisionmaking and learning takes place:The performance information is openlydiscussed, and the performance indicatordata is used to inform the dialogue and joint decision making.

The steps outlined here provide the ingredientsfor successful Performance ImprovementMeetings.They are an essential ingredient inunderstanding and managing intellectual capital,and can be used to inform strategy reviews.

Test and Review the Strategy

The strategic assumptions expressed in the value creation maps are principally just that –assumptions. However, maps that are developedcorrectly, with the participation and involvement

of as many key people as possible, usually reflectreality extremely well. Nevertheless, manyorganizations want to ‘test’ their assumptions and collect ‘evidence’ of their correctness.Theperformance data derived from the performanceindicators can be used for that purpose, and thevalue creation map, or parts of it, can be verified.

Chris Ittner and David Larcker from the WhartonSchool in Pennsylvania found in their survey of leading companies that (a) just over 20% ofthem consistently laid out the cause-and-effectrelationships between chosen drivers of strategicsuccess and outcomes, and (b) even fewer actuallyverified these causal models. And yet, thosecompanies who did, achieved on average, analmost 3% higher return on assets, and an over 5% higher return on equity than companies thatdidn’t use cause-and-effect maps.

Organizations can identify sub-sets of their causalvalue creation map or individual linkages betweenelements of the map, and then ‘test’ those usingstatistical tests such as regression and correlationanalyses.Various companies have successfullytested relationships between elements of theirstrategy. One example comes from Sears,Roebuck and Co., a leading retailer that offers awide range of home merchandise, apparel, andautomotive products and services through morethan 2400 stores in the USA and Canada. Searswanted to validate the relationship betweenemployee satisfaction, customer satisfaction, andsales volumes – a key output measure. ArthurMartinez, CEO of Sears at the time, initiated this effort to understand and test the drivers ofperformance. Sears collected data to test theassumed relationships between sales volume,customer satisfaction, and employee satisfaction.Analyzing this data, Sears was able to validate itsassumptions and establish that a 5-point increasein employee satisfaction led directly to a 1.3-pointincrease in customer satisfaction, and a 0.5%higher sales volume over a 9-month period.

Mapping and verifying how intangible value driversimpact firm performance is powerful, and cansupport reviews of the strategy.These reviews canlead to different resource allocations, outsourcingor insourcing, and decisions whether to buy orsell intellectual capital as well as mergers and de-mergers. Intellectual capital that is central tothe value proposition of organizations needs to be tightly managed internally.The absence of somevital intellectual capital components can lead topurchasing, licensing-in or merger and acquisitiondecisions. If an organization possesses intellectualcapital that is not relevant to the current valueproposition this could be sold or licensed out.

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Manage Intellectual Capital Risks

After identifying critical intellectual capital valuedrivers, organizations need to manage any relatedpotential risks. Although companies are familiarwith the management of financial risks anddisaster risk, the risk management of intellectualcapital is usually underdeveloped.We now take a quick look at different risks associated withintellectual capital, and propose a simple risk logto manage and mitigate these risks.

• Human capital risks – A key risk that isregularly overlooked in organizations is riskrelated to their staff and to the knowledgethey possess. Organizations are oftenunaware that some individuals with criticalknowledge and expertise could walk outany day. Another associated risk is the factthat knowledge is an important but alsovery vulnerable resource – it tends todeplete over time if it is not nurtured.

• Structural capital risks – Risks tostructural resources include threats toorganizational processes and routines, andthreats posed by losing database contentsand software because of hackers andviruses.There is also an increasingly commonrisk of intellectual property theft, as well asthe danger to business success created bymore powerful regulatory regimes that arerightly intolerant of ‘old school’ exploitationpractices.

• Relational capital risks – In today’snetworked economy, relationships arecrucial ingredients for all organizations inboth the private and public sectors.Theirreputation hangs on these vital relation-ships, and often the risk needs to bemanaged throughout the supply chain that helps to deliver the products and/orservices the organization sells or provides.

Risk assessment then is a highly significant factorin managing intellectual capital in today’s businessenvironment. Given that intellectual capital is a keyvalue driver in most organizations, it is advisableto begin accumulating data that gives organizationsuseful information about their greatest riskexposures.

The first step in assessing risk, therefore, must beto identify possible areas of risk.The best way todo this is to review all the elements of the valuecreation map to identify potential risks.These riskscan then be captured in a ‘risk log’.This is a tablethat can be used to identify, describe, assess, andquantify potential risks. It often requires obtaining

factual information about these risks and thenprioritizing their relative importance. Organiza-tions need to assess the potential risk areas for the component parts of their organization,categorize them, and then decide which are mostimportant to manage.

The risk log can become a working document thatis part of the Performance Management system.We outline below the various steps involved increating such a risk log.

1. Identify potential risks for each intellectualcapital value driver on the value creationmap.This element-by-element approachensures that all potential risk areas thatcover all intellectual capital value drivers are discussed. Moreover, using the valuecreation map also helps organizations toidentify how potential risk areas mightimpact each other. However, it is unlikelythat all potential risks for each element willbe identified and prioritized straightaway.The risk log will usually grow over time asmore potential risk areas are identified, butsome will also tend to fall away as they areeither mitigated or become less relevantover time.

2. Describe the essence of the potential risksfor each element. Here, it is possible to givethe risk a name, but it is more important tocreate a short narrative description of thetype of risk.

3. Define the risk level. Here, the likelyconsequences and potential impact of thisrisk are evaluated.

4. Define the likelihood level.Here, the likelihoodthat this risk might turn into a reality isevaluated. In addition, the likelihood iscompared to the assessed likelihood of thelast review cycle.This indicates whether thelikelihood is increasing, staying the same, ordecreasing.

5. Ascribe an appropriate scoring systemaccording to: (a) the risk level (potentialseverity) of each risk (e.g., 1-5), the criteriafor which may not necessarily be all financialones, and (b) the likelihood level (probabilityof occurrence) of the risk (e.g., 1-5).Thesetwo scores can then be added to create therisk score.This scoring system not onlyhelps to identify management priorities, butalso to assess whether the likely severity ofeach risk has changed, and whether thefirm’s potential exposure to it has increasedor diminished since the last review.

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6. Assign responsibility (ownership) formanaging each defined risk, and define a review frequency for re-evaluation ofsubsequent risk mitigation activities.

Completing the risk log is best done within aproject team. Different sub-teams can be assignedto assess the risks of the different intellectualcapital elements of the value creation map.Thisensures that people who are knowledgeable inthe subject matter work together and arrive ateither a unanimous or an aggregate score.

5. Reporting Intellectual Capital

The final step is then to report the intellectualcapital, which will be the subject of this finalsection. Disclosing the value of intellectual capitalcan be done for different reasons. However, theyall share one key objective, which is to provideinformation about the intellectual capital of anorganization to its stakeholders. However,different stakeholders have different informationneeds:

• To make better informed investmentdecisions, shareholders and investors want to know more about the intellectualcapital an organization possesses.Traditionalaccounting based reports that used to serve this purpose do not paint an adequatepicture of an organization’s intellectualcapital. If investors do not fully understandthe organization and its intellectual capitalvalue drivers, their valuations are lesscertain, and any uncertainty generallyincreases the costs of capital.

• Analysts want to better understand theintellectual capital value drivers to bettervalue organizations.Without detailedinformation about the intellectual capital acompany possesses, and an understating ofhow it helps them to deliver their strategy,analysts can make incorrect valuations.Thisleads to volatility and uncertainty,which inturn leads to investors and banks placing ahigher risk level on organizations.This thenincreases the cost of capital.

• Employees want to understand the healthand position of their organization, and todayintellectual capital is an essential element of this.They are especially interested, asthey form a major part of this intellectualcapital and need to understand that theorganization has processes in place todevelop, manage, maintain, and protect itsintellectual capital.

• The organization has an interest incommunicating its position to partners,suppliers, the wider public (includingpotential future employees), all of whomhave an interest in understanding the futurevalue of an organization.

The Limitations of Traditional FinancialReporting

The answer to whether or not traditional financialreporting can deliver on these information needsis simply No! There is now widespread agreementthat the current financial reporting system isincapable of explaining the value of intellectualcapital. Restrictive accounting rules mean thatmost intellectual capital cannot be included on the balance sheet, especially if it is internallydeveloped. Instead, all cost incurred to developintellectual capital must usually be directly chargedas expenses in the income statement. Forcompanies that invest in intellectual capital, thisimmediate expensing results in a reduction of thecurrent profit and financial position.The problemis that accounting standards specify that acompany can only recognize an asset if (a) it isidentifiable, (b) it is controlled, (c) it is probablethat future benefits specifically attributable to theasset will flow to the enterprise; and (d) its costcan be reliably measured.This considerablyreduces the list of intellectual capital items thatare recognized in financial reporting. Regardless of the long list of intangible resources relevant toorganizations, the categories recognized inaccounting are very limited; they mainly refer to:(a) goodwill, (b) research and development, and(c) other identifiable intangibles such as patents,software, licenses, copyrights, or brands. Goodwillis an all-inclusive asset category defined as theexcess of the cost of an acquired company overthe sum of identifiable net assets. In many acquisi-tions, the purchase price is higher than the valueof the net assets included in the balance sheet.Goodwill therefore allows firms to account forthe ‘unidentifiable assets and liabilities’ that cannotbe recognized in the firm’s balance sheet usingcurrent accounting standards. Goodwill thereforeonly appears in acquisition transactions. Further-more, although identifiable intangible assets maybe acquired separately, as a part of a group ofassets or as part of an entire enterprise, unidenti-fiable assets cannot be acquired separately. Also,internally generated goodwill is not recognized in balance sheets, and, together with otherintangibles, has to be expensed immediately alongwith investments in advertising, training programs,customer lists, and start-up costs34.

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The restrictive accounting rules have caused huge confusion in understanding the availableinformation on intellectual capital in traditionalfinancial reporting, making them unsuitable asuseful information sources about intellectualcapital.

Voluntary Reporting of Intellectual Capital

Various initiatives to address the limitations oftraditional financial reporting have createdframeworks and guidelines for separate reports to disclose information on intellectual capital.These initiatives have mainly been in Europe,where various governments and the EuropeanCommission have sponsored such projects.Thefirst of its kind was sponsored by the DanishGovernment, with the aim of designing guidelinesfor firms to prepare intellectual capital statements.The guidelines were then tested with about 100 firms and not-for-profit organizations whoexperimented with producing intellectual capitalstatements. Following this test phase, guidelineswere issued by the Danish Government on howto prepare intellectual capital statements.35 Thiswas followed by a number of projects funded bythe European Commission to produce guidelinesfor intellectual capital reporting.36 More recently,initiatives in the German-speaking part of Europe(Austria, Switzerland, and Germany) have createdframeworks for intellectual capital statements(called ‘Wissensbilanz’).The German initiative issupported by the German Government, and aworking group has been set up to coordinateresearch and practical application of thesevoluntary reports on intellectual capital.The latestinitiative is InCaS (Intellectual Capital Statements –Made in Europe), which has just started. It is anattempt to bring all the previous developmentstogether into one European Framework ofintellectual capital reporting.

The various guidelines are all very similar.They all (a) provide a breakdown and classification ofintellectual capital (which are in line with theclassification outlined in this MAG), (b) providesome guidance on the identification and measure-ment of intellectual capital, and (c) outline atemplate or blueprint for reporting intellectualcapital in intellectual capital statements.

The drawback of these voluntary reports is thatthe content of actual intellectual capital statementsvaries widely in what is reported and measured.This in turn makes it difficult to compare organi-zations, which is one of the objectives anddeliverables of traditional financial reporting.One could therefore argue that these reports are

not very useful. However, the value of intellectualcapital can only be understood in the context of an organization’s unique strategy. Also, to berelevant and meaningful, many indicators ofintellectual capital will be specific to organizationsor sectors.This is why these reports need toinclude different indicators to reflect the uniquenature of the strategy and associated intellectualcapital. However, this doesn’t mean that there willnever be more widely accepted indicators forintellectual capital that are appropriate acrossentire industries and that will facilitate some kindof comparison. Even though external reporting onintellectual capital still has some way to go, manyorganizations have produced voluntary reports37

and discovered clear benefits, including improvedunderstanding of the strategy by its stakeholders,as well as improved image and reputation.

Building on the different guidelines and blueprintsfor intellectual capital reports produced to date,we encourage organizations to produce andpublish intellectual capital reports.These reportscan be used to communicate the importance ofintellectual capital both internally to staff as well as externally to business partners, suppliers,investors, and the wider public. However, they areonly successful if they are set in the context of theorganizational strategy, and if they go beyond themere reporting of measures to include narrativeand interpretive commentary.

Good intellectual capital reports contain thefollowing elements:

• A brief introduction outlining the strategiccontext and the key strategic challenges theorganization will be facing. This part of thereport should set the scene by describingthe anticipated changes in the external andinternal context and their strategic implica-tions for the organization. [about one pagelong]

• A brief narrative description of thestrategy and visual representation of theorganizational value creation map. It isimportant to highlight the interdependenciesand causal relationships between thedifferent elements of the strategy and, inparticular, how the intellectual capital valuedrivers help to deliver the strategy. [thestrategy narrative should be about 2 pageslong]

• Descriptions of each of the intellectualcapital value drivers.More detaileddescriptions should be provided for each of the intellectual capital value drivers,outlining the objectives, strategic targets,

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and associated activities for each.Wherepossible, data and performance indicatorsshould be used to clarify the objectives and targets. A brief description of the keyactivities (tasks, projects, programs) that are planned to help achieve the objectivesshould be provided [each descriptionshould be between one-half and one page long].

CONCLUSION

Success and value creation of any organization intoday’s economy is driven by intellectual capital.To positively impact the future success and value,it is therefore critical to manage the intellectualcapital that underpins value creation.This MAGintroduces five key steps for successfully managingintellectual capital, namely (1) how to identifyintellectual capital in your organization, (2) how to map its impact, (3) how to measure it, (4) howto manage it, and (5) how to report it. Practicaland easy-to-apply tools and techniques have beenintroduced, including (a) an intellectual capitalclassification and identification approach, (b) valuecreation maps to show how intellectual capitalsupports the organizations in delivering itsobjectives and value proposition, (c) key perfor-mance questions to guide the design of indicators,(d) techniques of measuring intellectual capitaltogether with an indicator design template,(e) guidelines about strategic performanceimprovement meetings that facilitate decisionmaking and learning, (f) an intellectual capital riskmanagement tool, as well as (g) guidelines on howto produce intellectual capital reports.Together,these tools and techniques should provide a solid platform enabling practicing managers andaccountants to better manage intellectual capital –a skill that will become ever more critical toorganizations in the global knowledge economy.

USEFUL WEBSITES

• Advanced Performance Institute:www.ap-institute.com

• The Gurteen Knowledge Website:www.gurteen.com

• Intellectual Assets Centre:www.ia-centre.org.uk

• InCaS Intellectual Capital Statements:http://www.psych.lse.ac.uk/incas/

• Intellectual Capital Services:www.intellectualcapital.nl

• Prism Project Website:www.euintangibles.net

• Working Group Wissensbilanz:www.akwissensbilanz.org

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REFERENCES AND ENDNOTES1 Lev, B. (2001). Intangibles – management,

measuring and reporting. Brookings InstitutionPress and Blair, M.M. and S.M.H. Wallman(2001). Unseen Wealth, Brookings InstitutionPress, Boston.

2 Molnar, M.J. (2004).‘Executive Views onIntangible Assets: Insights From the Accenture/Economist Intelligence Unit Survey ‘,AccentureResearch Note ‘Intangible Assets and Future Value’,Issue one, April.

3 Marr, B. (2007). Managing Strategic Performancein Banks and Financial Services Firms: From ‘GoingThrough the Motions’ to Best Practice, Actuate.Marr, B. (2005). Business Performance Manage-ment: Current State of the Art, Hyperion (bothavailable from www.ap-institute.com).

4 Blair, M.M. and S.M.H. Wallman (2001). UnseenWealth, Brookings Institution Press, Boston.

5 See for example: Carmeli, A. and A.Tishler,(2004).‘The Relationships Between IntangibleOrganizational Elements and OrganizationalPerformance’, Strategic Management Journal,Vol. 25, pp. 1257-1278.

6 Understanding Corporate Value:Managing andReporting Intellectual Capital, CIMA, London.

7 For more information please see: Marr, B. (ed.)(2005). Perspectives on Intellectual Capital –Interdisciplinary Insights into Management,Measurement and Reporting, Elsevier, Boston and Marr, B (2006). Strategic PerformanceManagement: Leveraging and measuring yourintangible value drivers, Butterworth-Heinemann,Oxford.

8 Marr, B. and K. Moustaghfir (2005). DefiningIntellectual Capital: A three-dimensionalApproach, Management Decision,Vol. 43 No. 9,pp. 1114-1128

9 Roos, J., G. Roos, N.C. Dragonetti and L. Edvinsson (1997). Intellectual Capital:Navigatingthe New Business Landscape, Macmillan, London.

10 Itami, H. (1987). Mobilizing Invisible Assets,Harvard University Press, Cambridge,Massachusetts, pp. 23.

11 Marr, B., G. Schiuma, and A. Neely (2004).‘The Dynamics of Value Creation: MappingYour Intellectual Performance Drivers’, Journalof Intellectual Capital, Vol. 5, No. 2, pp. 312-325.

12 See for example: Heskett, J.L., W.E. Sasser andL.A. Schlesinger, (2003). The Value Profit Chain:Treat Employees Like Customers and CustomersLike Employees, Free Press, New York (pp. 203).

13 See also Clotier, L.M. and E.R. Gold. (2005).‘A Legal Perspective on Intellectual Capital’,in Marr, B. (ed.), Perspectives on IntellectualCapital, Elsevier, Boston; and R. Hall (1989).‘The Management of Intellectual Assets:A New Corporate Perspective’, Journal ofGeneral Management, Vol. 15, No. 1, pp. 53.

14 Due to strict confidentiality agreements thename of this business cannot be revealed.

15 Göran and Johan Roos have been instrumentalin developing an understanding and mappingapproach of resource interactions. For theirinsights on resource interactions see, forexample: Roos, G. and J. Roos (1997).Measuring Your Company’s IntellectualPerformance. Long Range Planning,Vol. 30, No. 3,June, pp. 413; and Gupta, O. and G. Roos (2001).Mergers and Acquisitions Through anIntellectual Capital Perspective. Journal ofIntellectual Capital, Vol. 2, No. 3, pp. 297-309; andPike, S. G. Roos and B. Marr (2005). Strategicmanagement of intangible assets and valuedrivers in R&D organizations. R&D Management,Vol. 35, No. 2. pp. 111-124.

16 See e.g. Carmeli, A. and A.Tishler (2004).‘The Relationships Between IntangibleOrganizational Elements and OrganizationalPerformance’, Strategic Management Journal,Vol. 25, pp. 1257-1278.

17 Usually 12 months, which is in line with theannual planning cycle of most organizations, butthis can be shorter or longer depending on thedynamics in the external environment.

18 One of the earliest uses of influence diagramswas by J. Forrester to represent a causal loopin a feedback system. Later, Professor RonaldHoward from Stanford University and hiscolleague, Dr James Matheson, refined andpopularized influence diagrams. See: Howard,R. A. and J. E. Matheson (1990). Principles andApplications of Decision Analysis,Volume I.Strategic Decisions Group: Menlo Park,California; and Howard, R. A. and J. E. Matheson(1990). Principles and Applications of DecisionAnalysis,Volume II. Strategic Decisions Group:Menlo Park, California; and Howard, R. A.(1965) Dynamic Inference, Journal of theOperations Research Society of America,Vol. 13,No. 5, Sept-Oct, pp. 712-733.

19 This case study is based on: Marr, B. and I. Shore(2008). Cascading Balanced Scorecards:UsingStrategic Maps to make Performance Relevant toRAF Stations, Management Case Study,The Advanced Performance Institute (www.ap-institute.com)

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20 The concept of Key Performance Questionswas developed by Bernard Marr and the termsKey Performance Question and KPQ aretrademarks of the Advanced PerformanceInstitute.

21 Eric Schmidt in an interview with JeremyCaplan for TIME, October 2, 2006.

22 For more information please see: Marr, B.(2008). What are Key Performance Questions?Management White Paper,AdvancedPerformance Institute, London (available atwww.ap-institute.com).

23 Quoted in Boyle, D. (2001). The Sum of OurDiscontent:Why Numbers Make Us Irrational,Texere, New York, pp. 29.

24 See for example: Ketokivi, M.A. and R.G.Schroeder (2004). ‘Perceptual Measures ofPerformance: Fact of Fiction’, Journal ofOperations Management,Vol. 22, No. 3,pp. 247-264; Boyd, B.K., G.G. Dess, and A.M.A. Rasheed (1993). ‘Divergence BetweenArchival and Perceptual Measures of theEnvironment: Causes and Consequences’,Academy of Management Review,Vol. 18,No. 2, pp. 204-226;Venkatraman, N. and V. Ramanujam (1987), ‘Measurement ofBusiness Economic Performance: AnExamination of Method Convergence’, Journalof Management,Vol. 13, No. 1, pp. 109-112.

25 These assumptions are stated in: Hubbard D.(2007). How to measure anything: Finding thevalue of intangibles in business,Wiley, Hoboken,New Jersey.

26 For more information see e.g. Dillman, D.A.(1999). Mail and Internet Surveys: The TailoredDesign Method,Wiley, New York.

27 Yin, K. (2003). Case Study Research. Design andMethods (Applied Social Research MethodsSeries,Vol. 5), Sage, Newbury Park, CA.

28 Russ-Eft, D. and H. Preskill (2001). Evaluation in Organization – A Systematic Approach toEnhancing Learning, Performance, and Change,Perseus, Cambridge, MA.

29 E.g. Denzin, N.K. and Y.S. Lincoln, (ed.) (2005).The Sage Handbook of Qualitative Research (3rd edition), Sage,Thousand Oaks.

30 Please note that InterCorp is a fictitious name chosen to protect the anonymity of our client.

31 Please note that TradeBank is a fictitious name chosen to protect the anonymity of our client.

32 The Q12 survey tool was developed by theGallup Organization (www.gallup.com), otherstaff engagement surveys are offered forexample by Mercer and Satmetix Systemscalled Employee Acid Test and EmployeeCommitment Assessment.

33 See e.g. Greve, H. (2003). OrganizationalLearning from Performance Feedback:A Behavioural Perspective on Innovation and Change, Cambridge University Press,Cambridge.

34 In certain regulatory regimes after an acquisi-tion transaction, some of these intangibleresources will be recognized as assets apartfrom goodwill in the acquirer’s balance sheetif they comply with the recognition criteriafor “identifiable” assets and liabilities.

35 Danish Agency for Trade and Industry –Ministry of Trade and Industry (2002).A Guideline For Intellectual Capital Statements –A Key to Knowledge Management, DanishAgency for Trade and Industry, Copenhagen,

36 These projects included:The E*Know Net,MERITUM, PRISM projects.

37 Best examples can be found in Scandinavia,Germany and Spain.

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Barry Baptie, MBA, CMA, FCMABoard Director and Business Consultant

Richard Benn,CMA, FCMAVice President, Knowledge and ProgramDevelopmentCMA Canada

Mark DixonUK CNS Finance LeadHewitt Associates

Michael Fortini,CPADirector of CompliancePearson plc

Brian Freeman, FCMAFinance DirectorHaymarket Worldwide

Jasmin Harvey, B. Comm., B. Econ., ACMAManager – Sustainability and Risk ReportingQantas Airlines

John Hemming, B. Comm., ACMADevelopment SpecialistChartered Institute of Management Accountants

Stuart Hunt, ACMABusiness Controller (Sales and Marketing)InterfaceFLOR

Michael Marshall, ACMASenior Financial Controller for the UK and IrelandEnterprise Rent-A-Car Limited

Chee Kin Tang, MBA, CPA, ACA, ACMA, FRSASenior Resource Management OfficerWorld Bank

Wim A.Van der StedeCIMA Professor of Accounting and Financial ManagementLondon School of Economics & Political Science

Kenneth W. Witt, CPATechnical Manager, Business Industry and GovernmentAmerican Institute of Certified Public Accountants

S T R A T E G Y


M A N A G E M E N T

This Management Accounting Guideline was prepared with the advice and counsel of:

The views expressed in this Management Accounting Guideline do not necessarily reflect those of theindividuals listed above or the organizations with which they are affiliated.


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ABOUT THE AUTHOR:

Bernard Marr is chief executive and director of research at the Advanced Performance Institute. Prior,he held positions at the University of Cambridge and at Cranfield School of Management. Bernard Marris a globally recognized authority and best-selling author on strategic performance management andregularly advises organizations and governments across the world. He is acknowledged by the CEOJournal as one of today’s leading business brains and has contributed to over 100 books, reports andarticles on topics such as performance management, performance measurement, and intellectual capital.Bernard Marr can be contacted via e-mail at [email protected]

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