Copyright by Institute of Organization and Managment in Industry ORGMASZ Vol 1(1); p. 37 - 45 Year 2008 10.

2478/v10061-008-0005-y

Intellectual Capital Measurement Methods

Jolanta Jurczak*

Introduction
Evolution of economy has caused important changes in activity of companies on the global market. Nowadays we are observing a growth the importance of intellectual resources as an effective tool for increasing corporate competitiveness. This fact has caused the need to manage companies and to measure their performance in a new way. Measuring Intellectual Capital is essential and very important in order to compare different companies, to estimate their real value or even to control their improvement year by year. Also to improve the way in which companies manage its intellectual resources that generate value and give back some benefits in consequences maximizing advantages for the company. Authors like Kaplan and Norton (1996), Stewart (1997), and Kerssens (1999) use phrases like If you cant measure it, you cant manage it to justify the search for new Measurement Methods.1 But to measure Intellectual Capital is necessary to determine exactly what the Measurement Methods are, which are the best and which the company should choose to evaluate its assets in proper way. Properly using Intellectual Capital Measurement Methods can cause the creation of competitive advantage and in consequence create development of the whole company at the present day.

The Concept and Classification of Intellectual Capital

Intellectual Capital (IC) are an increasingly important part of running a successful business but defining it is a difficult proposition. Intellectual Capital is a issue which is not determined completely. There is not one definition of Intellectual Capital. Different authors give different interpretation of this concept. Moreover many descriptions of Intellectual Capital are quite specific and created by individual companies for use within a specific industry. Edvinson and Malone describes Intellectual Capital as a knowledge that can be converted into value.2 According to them IC encompasses the applied experience, organizational technology, customer relationships and professional skills that provide the company with a competitive advantage in the market. According to Roos, Pike and Fernstrom (2005) Intellectual Capital can be define as all nonmonetary and nonphysical resources that are fully or partly controlled by the organization and that contribute to the organizations value creation.3 The authors divide Intellectual Capital into three categories based on their economic behavior: relational, organizational and human.Stewart defines Intellectual Capital as intellectual material knowledge, information, intellectual property, experience that can be put to use to create wealth.4
*

Jolanta Jurczak, MSc., eng - Ph.D. student at Warsaw University of Technology, Faculty of Production Engineering

1 D. Andriessen, The Financial Value of Intangibles: Searching for the Holy Grail (Paper presented at the 5th World Congress on the Management of Intellectual Capital, January 1618, 2002), p. 2. 2 L. Edvinsson, M. S. Malone, The Copyright Book: Intellectual Capital, Harper Business 1997, p. 44. 3 G. Roos, S. Pike, L. Fernstrom, Managing Intellectual Capital in Practice, Butterworth-Heinemann, New York 2005, p. 19. 4 N. Bontis, The Copyright Paper: Assessing knowledge Assets: A Review of the Models Used to Measure Intellectual Capital, 2000, p. 2.

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Bratnicki and Struzyna characterize Intellectual Capital as the sum of knowledge which possess people who creates a community of the company and a practical transformation the knowledge in components. He has divided Intellectual Capital on components like organizational and social capital and human capital. Another definition given by Bukowitz and Williams present Intellectual Capital in dynamic way as a form nonmaterial assets, which thanks to flows of knowledge can generate a potential to create goods.5 It includes three main elements like: human capital, customer capital and organizational capital. Interesting approach to the components of Intellectual Capital present Grudzewski and Hejduk, who say that an intelligence of the organization is not a simply sum of intelligence of it employees but it is a result of existing the synergy phenomenon. The intelligence of the company is built by different elements like: communications intelligence, technological intelligence, innovation intelligence, financial intelligence, marketing intelligence, organizational intelligence, social intelligence and ecological intelligence. As we can see there are many definition of Intellectual Capital. These definitions differ each other in some way but they are not disqualify each other. Most of them present Intellectual Capital as a knowledge capital or capital which derives from knowledge. Some of them says that Intellectual Capital is a intelligence of a organization or a form nonmaterial property. All presented definition are correct and right because they include all those factors that are nonfinancial and valuable for a companys business. But its necessary to notice that not all knowledge constitute the Intellectual Capital. The basis of IC is Knowledge which is useful for the company. This knowledge can be Intellectual Capital then, if we can process and utilize it for the company good.6 Therefore basis of previous definition Intellectual Capital can be described simply as all connected each other Knowledge Resources (material or nonmaterial, tangible or intangible) that the organization disposes in creating value needed to gaining competitive advantage in long term .7 Intellectual Capital is a complex concept. It possess big and complicated structure, which is not exactly specified. In order to measure IC, it is necessary to understand the distinguish between the different components of IC. Detailed structure of IC have been presented in fig. In the approach Intellectual Capital can be divided into organizational capital, relational capital and human capital. Human capital (HC) consists of knowledge capital, competence capital, attitude and intellectual agility all members of the organization and their ability to quick taking decisions, cope with the problems and create good interpersonal relationship. Organizational Capital (OC) is dependent on productivity of the organization, its structural capital, culture and ability to development. It is a kind of investment in systems, tools and philosophy, which decides about the process of flows knowledge. This capital encompasses: intellectual property (patents, copyright, licences, trademarks), structural capital (organizational structure, database or computer equipment), business processes capital (organizational culture, style of management or software) and market and development capital. Relational

5 W. R. Bukowitz, R. L. Williams, The Knowledge Management Fieldbook, Financial Time, Prentice Hall, London 2000, s. 223. 6 T. A. Steward, Intellectual Capital, Bantam Doubleday Dell Publishing Group, New York 1997. 7 Own definition of Intellectual Capital.

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Figure . Components of Intellectual Capital

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Source: own work on the basis of: L. Edvinsson, M. S. Malone, The Copyright Book: Intellectual Capital, Harper Business 1997 and G. Roos, S. Pike, L. Fernstrom, Managing Intellectual Capital in Practice, Butterworth-Heinemann, New York 2005.

Intellectual Capital Measurement Methods

Capital (RC) concerns connections and relation of the organization with the external environment. It is value of relationship with customer, strategic partners, employees etc. The figure shows that physical infrastructure is also a very important part of intellectual capital of the organization, which differs a bit from definition by Roos, Pike and Fernstrom. The reason for including physical assets into Intellectual Capital assets is that they may have components, such as databases, servers, and physical networks like intranets, which are based on specific knowledge and the combination of them is unique to one organization. In the end is necessary to notice that Intellectual Capital includes both created knowledge all the organization and its individual participant, their experience, abilities and innovations and also all the things that support efficiency of work in the organization (computers equipment, databases, organizational structures, patents, trademarks, licences) but also methods, techniques or relationships with stakeholders worked out by the organization. These elements combine and interact with each other in unique way to create value. Detailing and describing list of all components of the Intellectual Capital structure is a very difficult task. Intellectual Capital structure components are individual for each company. But if the managers of companies know detailed structure of IC existing in their companies, they will be aware of size and value intellectual potential, which they possess. It can cause a better understanding the concept. Than they could choose proper Measurement Methods and proper manage their assets. Companies, which learn to measure and manage their Intellectual Capital in a new way can significant improve their performance in a competitive market.

Methods Of Measuring The Intellectual Capital

The interest on managing the Intellectual Capital has caused the development of different methods of measuring it. There are several group of methods of measuring the Intellectual Capital, which can be used in order to evaluate this assets. Some of these methods were attempts made by different companies for their internal use rather than the development of a universal measuring method. But they still exist and are basis to create new methods. According to Luthy (1998) and Williams (2000) all methods can be divided into four main groups:8 1. Direct Intellectual Capital Methods (DICM) estimate the dollar value of intangible assets by identifying its various components. Once these components are identified, they can be directly evaluated, either individually or as an aggregated coefficient. 2. Market Capitalization Methods (MCM) calculate the difference between a companys market capitalization and its stockholders equity as the value of its intellectual capital or intangible assets. 3. Return on Assets Methods (ROA) average pre-tax earnings of a company and divide them by the average tangible assets of the company. The result is a company ROA that is then compared with its industry average. The difference is multiplied by the companys average tangible assets to calculate an average annual earning from intangibles. By dividing the above-average earnings by the companys weighted average cost of capital or an interest rate, one can derive an estimate of the value of its intangible assets or intellectual capital. 4. Scorecard Methods (SC) identify various components of intangible assets or intellectual capital and indicators and indices are generated and reported in scorecard or
8

http://www.sveiby.com/articles/IntangibleMehtods.html, and G. Roos, S. Pike, L. Fernstrom, op. cit.

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as graphs. SC methods are similar to DIC methods, except that no estimate is made of the dollar value of intangible assets. The four main approaches for measuring intangibles (Direct Intellectual Capital Methods, Market Capitalization Methods, Return on Assets Methods and Scorecard Methods) have various advantages and disadvantages, presented in Table.
Table. Categorization of the IC measurement methodologies with their characteristics Originator and year Methodologies of first publication Economic Value Added (EVA) Human Resource Costing & Accounting (HRCA) Calculated Intangible Value Knowledge Capital Earnings Value Added Intellectual Coefficient (VAIC) Accounting for the Future (AFTF) Stewart (1997)

Description

Characteristics

ROA Methodologies Calculated by adjusting the firms disclosed profit with charges related to intangibles. Changes in EVA provide an indication of whether the firms intellectual capital is productive or not. Calculates the hidden impact of HR related costs which reduce a firms profits. Intellectual capital is measured by calculation of the contribution of human assets held by the company divided by capitalized salary expenditures. Calculates the excess return on hard assets, then uses his figure as a basis for determining the proportion of return attributable to intangible assets. Knowledge Capital Earnings are calculated as the portion of normalized earnings over and above expected earnings attributable to book asset. Measures how much and how efficiently intellectual capital and capital employed create value based on the relationship to three major components: capital employed, human capital and structural capital. A system of projected discounted cash flows. The difference between AFTF value at the end and the beginning of the period is the value added during the period. MCM Methodologies Tobins q Stewart (1997) The q is the ratio of the stock market value of the firm divided by the replacement cost of its assets. Changes in q provide a proxy for measuring effective performance or not of a firms intellectual capital. Takes the Companys True Value to be its stock market value and divides it into Tangible Capital+(Realized Intellectual Capital+Intellectual Capital Erosion+SCA (Sustainable Competitive Advantage) The MCM approaches also have an element of rigor in that they rely on financial figures which, if not perfect, are auditable. They attempt real valuations and may appear useful in many situations since they can give crude comparisons between companies The ROA approaches have an element of rigor in that they rely on financial figures which, if not perfect, are auditable. They attempt real valuations and may appear useful in many situations since they can give crude comparisons between companies within the same industry. However, they give far too little detail for an adequate comparison. The methods are also very sensitive to interest rate assumptions. With the exception of VIAC, these are a means of explaining a financial feature and attributing changes in them to the efficiency in the deployment of intellectual capital resources. These methodologies avoid direct comparison with market values but link to some of the factors that market makers use in their assessments of companies.

Johansson (1997)

Stewart (1997) Luthy (1998) Lev (1999)

Pulic (1997)

Nash (1998)

Investor Assigned Market Value (IAMV)

Standfield (1998)

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Market-toBook Value Stewart (1997) Luthy (1998) The value of Intellectual Capital is considered to within the same industry. be the difference between the firms stock mar- However, they give far too ket value and the companys book value. little detail for an adequate comparison. DIC Methodologies Technology Broker Brooking Value of intellectual capital of a firm is assessed (1996) based on diagnostic analysis of a firms response to twenty questions covering four major components of intellectual capital: Market Assets, Human-centred Assets, Intellectual Property Assets and Infrastructure Assets. The base of the develop of the Technology Broker method is that the market value of a company is the result of the addition of tangible assets and the intellectual capital. Bontis (1996) A technology factor is calculated based on the patents developed by a firm. Intellectual capital and its performance is measured based on the impact of research development efforts on a series of indices, such as number of patents and cost of patents to sales turnover, that describe the firms patents. Accounting methodology proposed by KMPG for calculating and allocating value to 5 types of intangibles: 1) Assets and endowments, 2) Skills & tacit knowledge, 3) Collective values and norms, 4) Technology and explicit knowledge, 5) Primary and management processes. Methodology for assessing the value of Intellectual Property. A project initiated by The Canadian Institute of Chartered Accountants. TVC uses discounted projected cash-flow to reexamine how events affect planned activities. SC Methodologies Human Capital Intelligence Sandia Navigator Fitz-Enz (1994) Edvinsson and Malone (1997) Sets of human capital indicators are collected SC methods offer the poand benchmarked against a database. Similar tential to create a more to HRCA. comprehensive picture of an organizations health Intellectual capital is measured through the than financial metrics, and analysis of up to 164 metric measures (91 intel- they can be easily applied lectually based and 73 traditionally metrics) that at any level of an organizacover five components: 1)financial, 2)customer, tion. 3)process, 4) renewal and development, 5)hu- They also measure intellectual capital resources from man. The idea is the Intellectual Capital is formed by the bottom up. They are the addition of the Structural Capital and Human very useful for not-for-proCapital. This Structural Capital is also formed fit organizations, business by: Human Capital and Organization Capital; units, government agenand this last one is formed by the Innovation cies, and for environmental and social purposes. Their Capital, and the Process Capital. The DIC is intended to be holistic and offer the potential to create a more comprehensive picture of an organizations health than financial metrics. The methods are more detailed and can be easily applied at any level of an organization. They measure intellectual capital resources from the bottom up and can therefore be faster and more accurate than ROA and MCM measures with respect to resources. Since they do not need to be measured in financial terms, they are very useful for not-for-profit organizations, business units, government agencies, and for environmental and social purposes. Their disadvantages are that they cannot be connected easily to financial results

CitationWeighted Patents

The Value Explorer

Andriessen & Tiessen (2000)

Intellectual Asset Valuation Total Value Creation, TVC

Sullivan (2000) Anderson & McLean (2000)

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Value Chain Scoreboard Intangible Asset Monitor Lev (2002) A matrix of nonfinancial indicators arranged in three categories according to the cycle of development: Discovery, Learning, Implementation, Commercialization. Management selects indicators, based on the strategic objectives of the firm, to measure four aspects of creating value from intangible assets. By: 1) growth, 2) renewal, 3) utilization / efficiency; and 4) risk reduction / stability. The Intangible Assets Monitor consists on a formal presentation of several relevant indicators for measuring assets according to the company strategy. This indicators form the base to create and develop a company with knowledge focused strategy. It can be integrated in the management information systems. The object is to represent the intangible assets from different perspectives: growth and renewal, efficiency and stability. Intellectual capital is broken down into 3 areas: human, relational and organizational plus the conventional physical and monetary resources. These are all subdivided. Several user-friendly plots are produced including a navigator, a conceptual diagram of how the company works in IC terms. Indices are defined based on the key resources and resource transformations in the navigator. The purpose of the method is to help managers to visualize growth by measuring the Intellectual Capital. For the creators of the method, the importance of the specific measures varies from one company to another. They suggest four high level categories as the foundation for discussion in individual cases. The develop of measures within these categories is formed by a three stage process: 1. A critical review of existing indicators 2. Development of indicators that represent the flows between different Intellectual Capital categories 3. Develop a hierarchy of Intellectual Capital indices All the indices have to be aggregated into a single index that can be used to make comparison over time of the same unit or even compare with other business units. The critical factor for the successful application of the method is the process of creation of the Intellectual Capital Services, and this is the point in which the experience of the Intellectual Capital Services lies, the assistance to the companies to create their own ICIndex. Drivers of value are derived from an extensive literature survey and advanced statistics. Metrics are weighted and combined to give a Value Creation Index. The index is compared and combined with financial data. disadvantages are that the indicators are contextual and the meanings of the resource definitions can vary between each organization and each purpose, which makes comparisons very difficult. They cannot be connected easily to financial results.

Sveiby (1997)

Intellectual Capital Navigator and Intellectual Capital Index (IC Index)

Roos and others (1997)

Value Creation Index

Ittner and others (2000)

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Balanced Score Card Kaplan and Norton (1996) A companys performance is measured by indicators covering four major focus perspectives: 1) financial perspective 2) customer perspective, 3) internal process perspective, 4) learning perspective. The indictors are based on the strategic objectives of the firm. Its main purpose is to translate an organizations mission and strategy into comprehensive measures capable to give information of the management system. The Balance Score Card uses two different types of indicators: Driver: This indicators determine the result Output: This indicators are the responsible of showing the results The Balance Score Card remarks the importance of the financial objectives by including performance drivers of these financial objectives. It also tries to visualize the intangible assets for the future growth. One of the pillars of the Balance Score Card is the assumption that investing and managing intangible assets is more decisive than investing and managing physical and tangible assets.

Source: own work on the basis of: http://www.sveiby.com/articles/IntangibleMethods.htm, and G. Roos, S. Pike, L. Fernstrom, Managing Intellectual Capital in Practice, Butterworth-Heinemann, New York 2005, p. 249255.

The most popular Measurement Methods as well as the most widely used or just the easiness of their applications of all nonfinacial Measurement Methods are: The Balanced Scorecard, VAIC, Skandias IC Navigator, Intellectual Capital Navigator IC-Index, The Technology Brokers IC Audit, Sveibys The Intangible Asset Monitor (IAM). Most of the presented methods use financial criteria to evaluate the intangible assets and they give only a global value. The most commons are: Economic Value Added (EVA), Marketto-Book ratio, Calculated Intangible Value, Market Value Added (MVA), Tobins Q Ratio. In my opinion the most suitable method to measure Intellectual Capital efficiency and connected it with value of the organization is VAIC created by Pulic and classified in ROA group methods. VAIC is different and more detailed. In the method there are links between the activities of the company, the resources used and the financial outcome.

Conclusion

Nowadays many corporations around the world have found that measuring and managing intellectual capital can provide them with a competitive advantage. Although there are several Intellectual Capital Measurement Methods it must be considered that calculated intangible value is not precise. Most of the methods are difficult to apply, require too much information, indicators or are not completely described. Other methods are not numerical, so they only provide a reference. But in all methods, the aim is to allow managers to manage more effectively all resources, increasing the performance and competitive position of the company. The important issue is whether all of these approaches can be auditable, useful and secure for all companies. Can they be use in different companies or institutions all over the world in the same way?
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Estimating the value of intellectual capital at the organization is a very difficult proposition. In my opinion credible method of measuring intellectual capital resources does not exist. Intellectual Capital in different companies or institutions can be valued in different ways by different indicators or index. Therefore it may not be possible to quantify Intellectual Capital in way that allow us to compare the value of the assets between one company and another. In my opinion each company must select a method depending on its purpose, situation and audience. Nevertheless it is important to try managing these assets within companies and seek new, better solutions in effective Intellectual Capital measuring area.

Bibliography
Andriessen D., The Financial Value of Intangibles: Searching for the Holy Grail (Paper presented at the 5th World Congress on the Management of Intellectual Capital, January 1618, 2002) from http://www.weightlesswealth.com 2. Bontis N., The Copyright Paper: Assessing knowledge Assets: A Review of the Models Used to Measure Intellectual Capital, 2000. 3. Brooking A., Intellectual Capital, International Thomson 1998. 4. Bukowitz W. R., Williams R. L., The Knowledge Management Fieldbook, Financial Time, Prentice Hall, London 2000. 5. Edvinsson L., Malone M. S., The Copyright Book: Intellectual Capital, Harper Business 1997. 6. Edvinsson L., Malone M. S., Intellectual capital: The proven way to establish your companys real value by measuring its hidden brainpower, Piatkus 1997. 7. Norton D., Kaplan R., The balanced scorecard: Translating strategy into action, Harvard Business School 1996. 8. Roos G., Pike S., Fernstrom L., Managing Intellectual Capital in Practice, Butterworth-Heinemann, New York 2005, p. 19. 9. Steward T. A., Intellectual Capital, Bantam Doubleday Dell Publishing Group, New York 1997. 10. http://www.know-net.org 11. http://www.sveiby.com 1.

Summary
Enterprise efficiency and competitiveness depend on intellectual resources, as well as the ability to apply them in the market competition. Intellectual capital of a company may be used more effectively when identification and measurement of its components are possible. The article presents a classified and grouped review of different Intellectual Capital Measurement Methods describing them and providing companies with information about a variety of ways and advice how to choose a proper measurement method.

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