Measuring corporate IQ.

A number of companies have flirted with measuring their "corporate IQ." But few have been able to capture the value-creating potential of their intellectual capital and other intangible assets, which could be worth more than three times the company's book value. Here is one model for measurement - and a blueprint for getting to the next step.

For more than 10 years, an increasingly popular concept has been that the only sustainable sources of value for today's corporations are their organizational capabilities - capabilities such as innovation, speed, knowledge and continual learning, adaptability, and collaboration. Collectively, intangible capabilities such as these could be characterized as an organization's "corporate IQ."

Despite the efforts of accountants, consultants, and business leaders, little real progress has been made in measuring and managing an organization's intangible, value-creating potential. For example, conventional accounting might show a company making large profits using tangible assets, while its intangible assets are losing value. Several notable companies suffered from diminishing intangible assets long before the problems became obvious on their financial statements.

Conversely, many of today's best-performing companies - Microsoft among them - steeped with intangible assets, have market capitalization greatly exceeding their book value. While these aren't hard assets in the traditional sense, they should and do add real market value. In fact, the intellectual assets of a company are often worth three or four times the company's tangible book value. While it's more obvious how this can happen with the service sector and information or technology companies, it's increasingly applicable in other sectors, including manufacturing, where experts estimate that about 75 percent of the market value comes from knowledge.

As a result, companies such as Dow Chemical, Canadian Imperial Bank of Commerce, Hughes Aircraft, and Skandia have undertaken significant efforts to measure and manage their intellectual assets. Such efforts have dealt mostly with intellectual assets from one of two perspectives: human capital (the knowledge, skill, and capability of individuals to meet customer needs) or structural capital (the nonphysical, company-owned assets such as databases, customer files, software, manuals, trademarks, patents, etc.). Other generally recognized categories of intellectual assets include customer capital, innovation capital, and organizational capital.

While some companies have developed their own metrics to capture and monitor, most of those metrics are either cost-based (for example, R&D expenses as a percentage of total expenses, or training costs per employee) or intermediate indicators (such as employee turnover, productivity, or customer satisfaction). These have limited utility. To capture the value-creating potential of an organization's intellectual and other intangible assets, and thus better understand the company's potential market capitalization, we need earnings-based, bottom-line measurements so that these intangibles can be identified, measured, managed, and leveraged to create competitive advantage and improved financial performance.

Understanding and valuing such intangibles as corporate IQ require a systems perspective of an organization's day-to-day operation. Such a perspective recognizes that organizations are dynamic and comprise interdependent subsystems or processes, each interacting in complex, nonlinear ways. In the knowledge enterprise model [ILLUSTRATION FOR FIGURE 1 OMITTED], four processes - Leadership, Customer, People, and Operations - are linked by three value drivers - Core Competencies, Customer Preference, and Shareholder Value. This linkage forms the Enterprise Value Chain.

Understanding this value chain and the centrality of core competencies to value creation enables an organization to better leverage the processes - and the intangible assets within those processes. Current business publications are replete with examples of companies that have done just that. Leadership processes might, for example, create a vision that focuses on not only meeting or anticipating the market's needs, but creating those needs with innovations. This might entail making R&D funding a priority, establishing streamlined procedures for accessing and deploying that funding, and creating a risk-taking culture. These organizational capabilities have added record-setting value to such companies as 3M and Microsoft.

Another example of how intellectual capital is marshalled is seen at Wal-Mart: Each Monday, several hundred store managers and executives fly to different store locations to talk with store managers, employees, customers, and competitors. On Wednesday, these managers organize their findings and spend Thursday analyzing their collective learning and determining any changes in merchandising, pricing, or marketing. These changes are then discussed with all store managers coast-to-coast each Friday. As a result, customer processes create new or additional value for Wal-Mart's customers that translates into financial gains for its stores.

Then there's Starbucks, the highly successful owner of 700 (and counting) coffee outlets, whose revenues have grown at a compound rate of 60 percent for eight consecutive years. Operating in an industry characterized by an unskilled labor pool, minimum wage, and high turnover, Starbucks' success story includes a highly leveraged set of people processes. Through a careful matching of people and roles, customer-focused training, a strong performance culture, profit sharing through a stock-option plan, and sound team capabilities, Starbucks' people processes - intangible as they are - add clear value to this business.

Through our affiliation with Mark Huselid (Rutgers University) and Brian Becker (State University of New York at Buffalo), we have made substantive advancements in bottom-line metrics that apply to people processes such as those leveraged by Starbucks. First, we use a research-based index to determine the degree to which a company has deployed what we call High Performance Work Systems. This work consistently has found that firms with higher values on this index, controlling for other variables, have statistically higher levels of economic performance. Specifically, changes in a company's HPWS are associated with changes in market value of $15,000 to $60,000 per employee. As the total system of work practices becomes more effective, so does the value-creating capacity of human capital [ILLUSTRATION FOR FIGURE 2 OMITTED]. This work has powerful implications not only for the value-creating potential of intangible assets within the people processes, but for other components of the value chain that depend on human capital as either an input or output.

The final link in our Enterprise Value Chain deals with operations. At E.I. du Pont de Nemours, for example, the operations processes were turned inside out to launch a substantial financial turnaround. Customer-oriented business goals were established against which various projects were evaluated for alignment. Jobs were redesigned to better motivate employees, who were put into problem-solving teams. Experts attribute Du Pont's success - in part - to management's ability to convince employees of the company's vision, how it was to be achieved, and what was expected from everyone - all vital ingredients of an effective operating process. Du Pont discovered the value-creating potential of various intangible assets that were practically invisible until the company conducted a rigorous examination of its operations processes.

While these processes may not represent hard assets per se, they represent value. In fact, most, if not all, of the value derived from intangible assets can be traced back to this process stream. Today's successful companies recognize and leverage their individual processes as value sources. Today's highly successful companies, however, manage these processes as one integrated and aligned system. In highly successful businesses, the core competencies are the alignment source, synthesizer, and multiplier. As such, they enable the processes and value drivers to interact so that the cumulative value created is greater than the value that might come from any single process.

To optimize the value-creating potential of these processes and core competencies, one must understand "value" in the context of what can be called a multiplier effect. As the model implies, these value chain processes form a conduit that links the value drivers of Customer Preference and Shareholder Preference. While each process, in isolation, can directly affect one or more value drivers, the true value-creating potential of the organization is sub-optimized if the entire value chain is not aligned through the core competencies. Core competencies act as a universal joint of sorts, continually realigning the various processes and enabling them to interact optimally as both inputs and outputs of one another. This alignment determines the level of overall corporate performance. To appreciate this statement, one need only look at any process and imagine the myriad disconnects that can undermine organizational performance.

For example, in the Leadership process, is the organization's vision compelling enough that business unit leaders enthusiastically buy in, and translate the vision into operating priorities? Does the reward framework adequately emphasize the risk taking needed for continual innovation or knowledge sharing? Is the vision merely connected to, or honestly driven by, customer preference? Do the individual and group capabilities exist that are needed to provide solutions to customers, as well as maximize the return on operating revenue?

Clearly, if the answer to most of these questions is "no," the impact on the organization would be disastrous. If some, but not all, of the processes were aligned and managed effectively, the organization probably would survive, and possibly prosper. But only when there is a fit and congruence among most - if not all - of the processes, can the organization's performance be optimized. It is this same fit and congruence for which our work with Huselid-Becker revealed clear correlations between process changes and bottom-line measurements. With this understanding of value-chain components and how they might affect corporate value, the next challenge is to measure (prove) and manage (leverage) the impact.

Given the pivotal role played by core competencies, it is important to note that such competencies increasingly are derived from elusive knowledge sets lodged in the minds of an organization's people. This helps explain the interest in measuring and managing intellectual capital. The ultimate goal of accounting for intellectual capital is to gauge the relationships among the assets that make up core competencies. By quantifying the impact such assets have on others, management can more readily identify intellectual capital deficits and more precisely determine where to invest for improved organizational performance. Such measurements also can provide early warning signals of negative changes in financial performance.

From our work with Huselid-Becker, we know that the processes dealing with human capital, and the intangible assets housed therein, can be enhanced and managed to add specific and measurable economic value. This added value comes in the form of additional sales, market value, and profits per employee - all of which can be used to more completely explain a company's financial results. Much more work needs to be done, however, to develop similar metrics - both bottom-line and intermediate - for the other components of intellectual capital. To do so will require a sustained focus and commitment from CEOs in general, as well as a blueprint for getting there.

A general example of such a blueprint might be as follows:

1. Identify the organization's various sources (i.e., processes) of intangible assets.

2. Identify the specific components of value within those sources.

3. Develop a metric that defines each component in terms of cost, actual dollar value, or a relationship ratio (for example, the percentage of new ideas that ultimately become new products).

4. With those metrics, establish a baseline present value or measure of each component.

5. Develop a value-flow analysis that reflects the flow of or relative changes in a company's intangible assets over time.

An absolute measure of corporate IQ may never be possible. But failing to measure it is a missed opportunity. The best companies are attempting to capture enough quantification to assess their progress in leveraging the power of their intangible assets, and to more credibly communicate that value to all their stakeholders.

Nicholas G. Moore is chairman and chief executive of New York-based Coopers & Lybrand L.L.P., a $1.9 billion professional services firm.