Intellectual Capital and Knowledge Management.

Q&A James E. Copeland, Jr., chief executive officer of Deloitte Touche Tohmatsu, explains how defining your company's culture is a key step toward developing intellectual capital.

How leaders can leverage their human assets.

* Why is intellectual capital so important?

You seldom see a successful business strategy that doesn't have intellectual capital as its foundation. Even in the most mature industries, companies attempt to differentiate themselves on the basis of some element of intellectual capital. If we're going to serve companies that are trying to win in the marketplace, then we have to understand how intellectual capital plays into their strategies.

* How do you measure the worth of intellectual capital?

You can see the value of intellectual capital in the cost and value of goods and services increasing as a percentage over time. That means that from year to year, intellectual capital is becoming more and more important in the production of goods and services. A good example is the pharmaceutical industry, where probably 99.5 percent of the cost of their products represents the intellectual capital that is contained in them, as opposed to the substances that make up the products.

Then there's the stock market. In 1980, it was trading at a price-to-book-value ratio of about 1-to-1, or right at the book value of the tangible assets. Now that ratio is about 5-to-l -- the market value is five times the tangible cost. What could account in 20 years for that change? The answer is the intellectual assets of the companies.

* As much as intellectual capital comprises business processes, technology, marketing strategies, patents, customer data and other tangible knowledge, how is human capital factored into the equation?

The change of viewing employees as an asset or a source of revenue production rather than a cost is a whole mind shift for the business community.

People are coming to grips with the fact that you make your numbers because of the people you employ. So even now, with talk of economic downturns, we're out aggressively looking for people who can add intellectual content to what we do. And there are others like us.

Organizations should be reluctant to give up on the value of their intellectual capital. In prior downturns, many companies cut 10 or 20 percent of their work force. If you really believe in the concept of intellectual capital, that's taking income-producing capability and throwing it away. So there's a real cost to firing people.

* Because human capital has become so critical, has managing that knowledge asset moved beyond the realm of traditional human resources?

Absolutely. One of the biggest changes in business has been how human resources people are viewed. In times past, they were viewed as staff, whereas today they are considered an integral part of the line organization. Human resources specialists are great at helping our leaders accumulate, deploy and take advantage of intellectual capital. Still, it is the leaders' responsibility to really understand the value their employees bring to the organization. If not, then you'll never have a smoothly functioning, effective organization.

* Still, the recent downturn has forced many companies to let people go. Could that be seen as a harsh yet important lesson in knowledge management?

If you have no choice but to downsize, how you do that is very important. First, protect the core of your intellectual capital. You have to know the people who make a real difference in your organization and those who only marginally add value. You absolutely have to protect those core individuals, secure them -- recruit them again, so to speak.

Second, there is a right way and a wrong way to do hard things like downsizing. This is a time for creative decision-making, such as spinning off business segments, where you're not "firing" people, which has a terrible impact on the culture and the fabric of an organization.

Some years ago I was in a business unit when we went through a downsizing exercise. We recognized that while the impact is most severe on the people being out-counseled, it isn't positive on those who remain, either. We explained what happened and why, that there were 13 people on a 10-person lifeboat. We stood to lose all 13, or the three. Then we held ourselves accountable to them for the placement of the three people. We did things in a way that is consistent with our values and caring for and responsibility for each other.

* Are New Economy companies, which are largely built around intellectual capital, particularly stressed in navigating rough economic waters?

First, I don't really think there's a New Economy and an Old Economy, just companies that adapt to change and those that don't. Regardless, whether it's a mature manufacturer or a start-up Web consultancy, many people now running companies have never managed through a business cycle. It's not the same. You have to work much harder at morale, because people are frightened. They see job layoffs, stock options are under water, and it's harder to get people motivated to do their best every day. As a serious leader, you have to work on those areas, quickly, because the organization takes its cue from its leadership.

* At the same time, does the loosening of what has been a very tight talent market in recent years create opportunities to invest in intellectual capital?

Absolutely. You want to find unique talent that you can t replicate within your organization, people who add to your ability to create value, for your clients and internally. That's seen as a sign of boldness and strength.

A classic example would be Southern California during the last downturn in the early 1990s, which was led by budget slashing within the defense industry after the Berlin Wall came down. The region went into a recession, and most of our competitors were downsizing and ad adjusting to the differences in the market. However, we decided we would invest instead. We said, "Here's a real opportunity. There's going to be talent on the market, and we can move some people out there and provide the right kind of leadership." In a period of about three years, we went from number five to number one in the marketplace.

You cannot have knee-jerk reactions to changes in economic circumstances. Decide what your strategy is, understand the risks and rewards of it, and make your own decisions. It's not one-size-fits-all. Like a decline in the stock market, people lose trillions of dollars, but it's also the best buying opportunity. Pick your places. Reassess and decide where to make your investments in a time like this. It's not just in stocks, it's also in people.

Considering the job market over the past several years, does the downturn result in a jolt of reality?

I'm sorry for people who go through losing their jobs, but like most things, there are two sides to every coin. The work force will be much better educated coming through this. They will understand economic realities: that there are booms and busts; that when something seems too good to be true, it probably is; and that there is value to stability, continuity and consistency. That's important, because many people had convinced themselves that there truly was a "new economy" in the sense that you could go from job to job with ever-increasing salaries without seeing a relationship between value created and value received. There is no inevitability of success.

The cultures of organizations are forged in tough times, when people learn the most. They understand the business cycle. A curve on a chalkboard at a university is one thing, but living through one of these unhappy events is entirely different.

Is this also an opportunity to solidify your organizational strategy as being an employer of choice?

We really think so. One of the great things about the culture of our firm is that we see change as a positive thing, an opportunity to take advantage of attracting world-class people who would never be available in a boom economy. You don't see press releases about us cutting 10 percent of our partners and 10 percent of our work force. We're serious about intellectual capital. We believe that's what makes us successful.

So we're not into throwing people overboard. If you just toss them overboard and say good luck, the entire organization looks at that. It's all interconnected. If you deal with people in a ruthless way, everyone says, "Wait, in good times we've been talking about these shared values we have. Now all of a sudden times are a little harder. Does this mean that we share these values in good times, and at bad times we have another set of values?"

It's important that our people can trust us, that they know we're committed to excellence, and that they believe we care about what happens to them individually. Those are the three foundations of management and leadership. Remember the values and culture of your organization, and whatever you do, make sure your leadership is consistent with that culture -- whatever the economic environment.