A couple of weeks ago I participated in a conference at the National Academies on Intangible Assets: Measuring and Enhancing Their Contribution to Corporate Value and Economic Growth. The conference was sponsored by the Board on Science, Technology and Economy Policy (STEP).
What are intangible assets? Wikipedia defines them as "identifiable non-monetary assets that cannot be seen, touched or physically measured, which are created through time and/or effort and that are identifiable as a separate asset." A more vernacular definition might be "an asset that cannot be dropped on your foot."
STEP convened the conference because "US investment in intangibles, according to a 2006 Federal Reserve Board staff analysis, exceeds all investment in tangible property and, if properly accounted for, would raise productivity growth significantly. These assets - computer software, R&D, intellectual property, workforce training, and spending to raise the efficiency and brand identification of firms - are a subset of services, which now account for three quarters of economic activity. Increasingly, they are a principal driver of the competitiveness of US-based firms, economic growth, and opportunities for American workers. Some intangibles, like intellectual property, are being securitized, auctioned, and traded; a few years ago hardly anyone contemplated the existence, let alone the extent, of such ‘technology markets.’ Yet despite these developments, many intangible assets are not reported and are treated in the national economic accounts as expenses rather than investments. And there is no coordinated national strategy for promoting intangible investments apart, perhaps, from R&D."
Tangible assets generally have a physical existence, which makes them easy to see, feel and measure. They include real estate, equipment, and financial instruments like cash and accounts receivable. Intangible asset, on the other hand, have value but no physical existence, and include some of the most critical assets needed to compete in the 21st century, such as knowledge, R&D, organizational know-how, software, brands, patents, trademarks, copyrights and so on. Intangible assets – just like services - constitute a huge part of the economy. They determine competitiveness, innovation and jobs, yet economists struggle on how best to measure and deal with them.
As one of the speakers succinctly put it, to appreciate the seemingly mysterious nature of intangible assets, ask yourself the following question: What is the most important aspect of the iPod - its design and use in the marketplace, or the physical device and the factories that produce it? The design, branding, music distribution and overall market activities around the iPod are being done by Apple, mostly in the US. The manufacturing of the iPod is outsourced to other companies with factories in China. There is little doubt that the bulk of the value of the iPod lies in the mostly intangible assets that belong to Apple and that have contributed to Apple's strong financial performance in the last few years. The tangible assets of the iPod - the commodity components that go into the devices, the factories that produce them, and the tools used in their manufacturing - are much easier to see and measure, but have a lower economic value and yield lower profits.
The STEP conference included mostly economists from government and academia. I was pretty much the lone technologist among the speakers, and was likely invited because of my work in services sciences, innovation, intellectual property and related subjects. I have been quite intrigued about the increasing importance of these advanced capabilities, along with the talented people to make them real for leadership in the 21st century. I thought that participating in this conference on intangible assets – which all of these capabilities and talent clearly are – would be a good way to help organize my thoughts on the subject. I was not disappointed, and in fact, my ideas got focused around the concept of knowledge capital, as I will describe later.
Even though I know little about the formal field of economics, I felt that I had to display some semblance of economic bona fides out of respect for the audience. So I chose to organize my talk around a framework inspired by Adam Smith.
Adam Smith is widely acknowledged as the father of economics. The ideas he pioneered provided the intellectual underpinnings for free-market, free-trade capitalism. I told the audience at the conference that I chose Adam Smith as the inspiration for my talk not only because of my great admiration for his work, but because he is one of the few economists whose writings I am able to understand. Economists are well known for dealing in abstract concepts and in a language all their own, which is often inaccessible to non-economists - not unlike computer scientists, physicists and many other professionals. Since Adam Smith was one of the first economists, he wrote in simple language for a general readership, and that makes it much easier for me to understand his concepts and follow his reasoning. I said this only partly in jest.
Smith's writings were very influential in helping his contemporaries make sense of the economic forces around them that were giving rise to what became known as the Industrial Revolution. The essence of the Industrial Revolution was the application of technology, tools and process innovations to increase productivity and quality radically in the production of physical assets.
I find three Adam Smith concepts particularly noteworthy in this regard: the division of labor, the invisible hand, and moral sentiments. Could these same three concepts help us understand how technology, tools and process innovations are now increasing the productivity and quality of intangible assets and services in general in our emerging knowledge economy?
That’s the question I tried to answer. The division of labor helps to improve productivity by allowing workers to specialize and become experts in specific tasks; by encouraging the development of tools and machines to assist in such specialized labor; and by helping to organize the overall production system as a collection of such specialized tasks. The bigger the market you are aiming at, the more important the benefits of organizing production along these lines.
Clearly, these concepts apply with a vengeance to our present integrated, fast-changing global economy, where the tasks and markets are so much bigger and more complex than those in Smith's days. Service oriented architectures, services sciences, complex systems studies and similar efforts are our attempts to bring advanced technologies and innovation to these incredibly tough and important problems.
In The Wealth of Nations, arguably the most famous and influential economic treatise ever, Smith cautioned us not to try to control and predict the unpredictable, but to trust the invisible hand , his poetic metaphor for the workings of open, free markets. He wrote that when the individual "intends only his own gain, . . . he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was not part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it."
While open, free markets are far from perfect, they have historically fared a lot better than the alternatives, and are today accepted in most societies around the world as the preferred economic system. Given our unpredictable, emergent, digital economy, including the rise of globally integrated enterprises and industries, it would be a fool’s errand not to build your overall governance around the principles of open, free markets. And, in fact, our faith in free markets can be considerably strengthened by our recent ability to access and analyze real-time information in order to get a better handle on market vagaries and erratic behaviors.
We may not be able to control hurricanes, but we can do a lot to identify them, track them, and anticipate their strength and direction, as well as build infrastructures that are as resilient to the power of hurricanes as possible. In the same way, in our knowledge economy we should leverage the advanced technologies now at our disposal to deploy sophisticated information-based decision support and management, predictive analysis and simulations, and robust organizational structures. They help us stay on the lookout for outlying, perhaps cataclysmic, economic events, and minimize their impact on our business and societal institutions.
The last Adam Smith concept - moral sentiments - is a bit more subtle. Some have misinterpreted free market capitalism and the metaphor of the invisible hand as a kind of survival of the fittest competition in which anything goes. This is far from correct.
Adam Smith was a deeply moral man, in addition to being a brilliant economist and philosopher. He believed that human beings have strong principles that cause them to be interested in the fortunes of others, and to worry about others’ happiness even though they themselves may derive nothing from it. He wrote in his second major book, The Theory of Moral Sentiments, "Individuals in society find it in their self-interest to develop sympathy as they seek approval of what he calls the impartial spectator. The self-interest he speaks of is not a narrow selfishness but something that involves sympathy.”
It is easier to appreciate the balance between the fierce competition inherent in open, free markets, and the supportive community behavior found in well functioning human societies when talking about villages and neighborhoods, where people personally know each other, and where bad behavior can cause a businessman to lose his customers. But do moral sentiments scale in our global, anonymous, flat world, where unethical actions to enrich ourselves at the expense of others can hurt not our neighbors, but far away people we will never meet? Can technology and innovation help us deal with moral sentiments on a global scale?
It is fascinating, perhaps a re-affirmation of the power of the invisible hand, that one of the most innovative uses of technology in the last decade has been the rise of Internet-based social networks, open source communities and collaborative innovation platforms. These innovative technologies are bringing us closer together on a global scale, and are enabling us to scale the human sympathy that Adam Smith wrote about almost 250 years ago to today’s global dimensions.
There will clearly still be rogue executives, like those that ran Enron and WorldCom into the ground, as well as the kind of unethical financial behavior that led to the sub-prime lending crisis, just as there were undoubtedly bad merchants and con artists in Adam Smith's time. But, we are beginning to see the emergence of a kind of Sympathy 2.0 that will, we can hope, help keep companies honest, help temper their worst excesses and encourage and reward good behavior and corporate social responsibility.
I closed my talk by pointing out that talent is more important than ever in the knowledge economy, given the sophistication of the technologies, tools and innovations needed for leadership in our fiercely competitive world. In the Q&A session following my talk, someone in the audience pointed out that talent usually refers to a person's natural endowments or aptitudes. What I really meant, he offered advice, was something like knowledge capital.
Knowledge capital includes human capital, which generally refers to the skills and expertise that a person has. It also encompasses everything that is known about a particular business, industry, discipline or even a whole nation. As part of knowledge capital, I would also include most of the intangible assets that were being discussed in the conference, such as innovation, processes, R&D and intellectual property.
As with knowledge itself, it is unlikely that we will come up with a definition of knowledge capital that suits everyone. But as with intangible assets, what we really need is something less academic and more functional and pragmatic. What are the key characteristics of knowledge capital that contribute to economic growth, corporate value, increased productivity, job creation and overall competitiveness? What are the key indicators we should be carefully tracking to understand the contributions that knowledge capital is making to a company, an industry and the economy in general? What actions can we take to significantly enhance the value of knowledge capital to business and society? Hopefully, in the years ahead we will make progress in providing answers to these important questions.