A validation study on the intangibles audit

A validation study on the intangibles audit

Walden University

SCHOOL OF MANAGEMENT

This is to certify that the doctoral dissertation by

Bryan L Forsyth

has been found to be complete and satisfactory in all respects,

and that any and all revisions required by

the review committee have been made

Review Committee

Dr Lilburn Hoehn, Committee Chairperson,

Applied Management and Decision Sciences Faculty

Dr David Metcalf, Committee Member,

Applied Management and Decision Sciences Faculty

Dr Joseph Barbeau, Committee Member,

Applied Management and Decision Sciences Faculty

ProvostDenise DeZolt, Ph.D

Walden University2007

A Validation Study on the Intangibles Audit

byBryan Forsyth

A.A., LA Tech University, 1986B.S., Southern Illinois University, 1990M.A., Ottawa University, 1999

Dissertation Submitted in Partial Fulfillment

of the Requirements for the Degree of

Doctor of Philosophy

Applied Management and Decision Sciences

Walden University

August 2007

A tangible asset can be recognized and listed on the balance sheet Alternatively,

intangible assets are non-physical items (e.g patents, knowledge, competencies) Theproblem is managers are not able to easily recognize and articulate the value of intangibleassets, including the value of knowledge management initiatives in their organizations.The purpose of this research was to highlight the importance of evaluating intangibleassets The research questions focused on the relationship between earnings and

intangible assets and the validity and reliability of an asset assessment instrument Surveyresearch was used to gather data from a sample of 400 members of American Society forTraining and Development (ASTD) Statistical analyses included factor analysis,

Cronbach’s Alpha, and Pearson’s r The results showed there is a direct correlation

between company earnings and the four supporting intangibles variables: strategies, core,organizational, and leadership competencies The asset assessment instrument was

demonstrated to have a high degree of reliability, but it should be used carefully because

of lower validity scores One key recommendation is that managers should considerdisciplined methods to assess intangible assets because these variables contribute tocompany earnings From a positive social change perspective, an increased awareness ofthe importance of intangible assets may help managers make appropriate investmentdecisions regarding knowledge management and other organizational change initiativesthat could lead to further profitable growth and success of organizations

A Validation Study on the Intangibles Audit

byBryan Forsyth

A.A., LA Tech University, 1986B.S., Southern Illinois University, 1990M.A., Ottawa University, 1999

Dissertation Submitted in Partial Fulfillment

of the Requirements for the Degree of

Doctor of Philosophy

Applied Management and Decision Sciences

Walden University

August 2007

3262591 2007

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TABLE OF CONTENTS

LIST OF TABLES……… iv

LIST OF FIGURES……… v

CHAPTER 1: INTRODUCTION TO THE PROBLEM 1

Introduction to the Study 1

Statement of the Problem 2

Background of the Problem 3

The Purpose of the Study 5

Theoretical Support for the Study 6

Assumptions 11

Scope and Delimitations 12

Limitations 12

Definition of Terms 12

Research Questions 13

Significance of the Study 14

Summary and Overview 15

CHAPTER 2: LITERATURE REVIEW 17

Introduction to the Literature Review 17

Defining Intangible Assets 18

Defining the Need for Valuation 22

Links between Systems Theory and Intangible Assets 25

Potential Tools or Methods for Measuring Value in Intangibles 27

Current Valuation and Implementation Methodologies 33

Summary 42

CHAPTER 3:METHODOLOGY 45

Introduction 45

Research Design and Approach 45

Population 46

Sampling Procedure 47

Sample 48

Instrumentation 48

Data Collection Procedures 51

Data Analysis 52

Measures to Protect the Participants 56

CHAPTER 4: RESULTS 58

Introduction 58

Data Generation 58

Results 59

Summary 66

CHAPTER 5: SUMMARY, CONCLUSIONS AND RECOMMENDATIONS 68

Recommendations for Practice 74

Recommendations for Future Study 77

Social Significance 79

Concluding Statement 80

REFERENCES 82

APPENDIX A: THE INTANGIBLES AUDIT (IA) 84

APPENDIX B: AUTHOR’S PERMISSION TO USE THE INTANGIBLES AUDIT 87

APPENDIX C: ELECTRONIC MAIL INTRODUCTION AND INVITATION TO COMPLETE THE SURVEY INSTRUMENT 89

APPENDIX D: HUMAN CAPITAL SURVEY FOR THE TECH SECTOR 90

CURRICULUM VITAE 97

LIST OF TABLES

1 Pearson r Correlation for the Intangible Audit Survey 60

2 Cronbach Alpha Reliability Analysis for the Intangible 62

Audit Survey

3 Factor Analysis Relating to the Validity of the Audit Questions 64

4 Pearson r Correlation Indicating Implied Importance of Variables 66

vFigure 1 Cronbach alpha scree plot relating to the validity of the

intangible audit 64

CHAPTER 1:

INTRODUCTION TO THE PROBLEM

Introduction to the StudyLiebowitz (1999) conducted a very exhaustive literature review and created anexcellent handbook for someone thinking about entering the intangible domain At theend of the chapters, there were areas recommended for further research, which will beconsidered as partial justification for this work in conjunction with all of the other

evidence found and presented here

Future work should focus on building practical experience through extensiveexperimenting, prototyping, and testing—especially in the process, technology,organizational, and implementation perspectives In addition, the conceptualframeworks and integration across KM [knowledge management] perspectivesneed more investigation and development Although considerable progress hasbeen achieved in KM across a broad front, much work remains to fully deliver thebusiness value that KM promises (pp 1-20)

The work proposed here will address some concerns that Liebowitz shared with hisreaders Specifically, he shared some questions that would warrant further empiricalresearch activity to minimize the likelihood that intangible assets continue to be

trivialized at the risk of the corporation These questions included:

• To what degree are actual knowledge management projects consistent with thestrategies of firms and business units?

• How are firms justifying their knowledge management activities with regard tocompetitive advantage issues?

• What specific measures of knowledge management and its relationship to

business performance have companies actually adopted, and what kinds of resultshave they achieved? (Liebowitz, 1999, pp 2-10)

In short, the Sveiby (1997), Stewart (2001), Sullivan (2000), Rumizen (2002), andClare and Detore (2000) generally agree that there is not currently a consistent model thatcan be used to assess, track, and improve intangibles in organizations There is also

agreement that there is no consistent framework for introducing valuation and

measurement into the process Little empirical research has been done to demonstrate theconnection between the timing of the introduction of measures and the effects on theoverall implementation process In fact, based on a survey done by the American

Productivity and Quality Center (APQC; Crager, J., 2002), there is evidence that

companies engaged in intangible practices are using some type of valuation and

measurement system, but these companies are still the minority APQC is currentlyundertaking just such a study to help practitioners understand the intricacies of valuationand measurement and perhaps to create such a consistent framework

Statement of the ProblemThe problem in this study is that managers are not able to recognize and articulatethe value of intangible assets in their organizations This situation can lead to decisionsbeing made without considering what investors and the market might consider as keyfactors in the street value of a company There has not been enough empirical researchdone to provide managers with the necessary tools to aid them in making decisions with asense of certainty that they are doing what is right for them as well as their employeesand company There has been limited validation of instruments such as the intangibleassets audit to demonstrate the linkage between variables such as earnings, strategy,competencies, and organizational as well as leadership capabilities If the topic of

intangible assets is as important as authors referenced in this study claim it to be then itwould follow that more scientific inquiry is needed to illustrate what tools might be validand therefore more useful in decision making related to this part of a business

Background of the ProblemUlrich and Smallwood (2003) proposed the definition of intangibles to be “…thevalue of a company not accounted for by current earnings” (p 6) This is commonlyknown as the market value in today’s business world The authors further stated that

“companies with high intangible value have higher P/E [price to earning ratio] multiplesthan their competitors, and like coaches of successful teams, their leaders have earned theperception that they can be trusted to deliver on their promises about the future” (p 6).The accountants that try to determine the worth of a company that is being sold usuallycome up with a number that differs from what the true value is when the company isactually sold This is because accountants do not typically include the value of intangibleassets Some of the more savvy investors will inquire deeper into the fabric of the

companies operations and management practices before offering to buy The firm’smarket value is a combination of the “stock price times shares outstanding” (p 6) Thisstock price may often be many times the value of the tangible assets and in the past has

been labeled goodwill when the company was sold Many of the leading thinkers such as Ulrich and Smallwood are making the case for this goodwill to be more defined as the

way companies perceived value changes in today’s market Furthering this position andmaking this case more empirical is the aim of this research

Clare and Detore (2000) argued that current investments related to managingknowledge and intangibles is very large, perhaps in the range of billions of dollars KMcould turn out to be as important to organizations, if not more so, than process

reengineering or other improvement programs that have been widely discussed Therecould also be a danger of another management fad Unless methods are developed and

utilized that would get and keep the attention of the top decision makers of an

organization, KM could easily fall victim to the same fate many other similar movementshave in the fields of human resources and organizational development Many corporatedollars can be wasted leading to more frustration and more of a loss of credibility withtop decision makers Clare and Detore (2000) stated that

the opportunity to use knowledge management to achieve competitive advantage

is very real The KM valuation methodology is a rigorous financial framework foranalyzing the costs, benefits, and risks associated with investing in the knowledgeassets of an organization (p 7)

The purpose in creating an evaluation methodology was to assist decision makers

at all levels in the organization in making calculated risks and educated choices around

KM proposals Some of the areas that are viewed as typical KM projects or strategiescurrently being pursued by major organizations are best practice gathering and utilization,competitive intelligence functions, establishing roles and duties for top level leadersaround KM, buying or designing software applications to be used as infrastructures orknowledge repositories, building corporate libraries and universities, identifying andcommercializing knowledge as rapidly as possible, deliberately having post action

reviews to discover what has been learned that could be reused in the future, and creatingportals that would allow for one location to search for any and all information or data theorganization has available Clare and Detore (2000) posited that these many differingtypes of KM projects and strategies do, in fact, have some similar themes They

suggested that these themes “are designed to create and/or leverage the knowledge assets

of the firm, involve significant costs and subtle risks, and promise significant, but oftenhard to measure or intangible benefits” (p 8)

Therefore, Clare and Detore (2000) concluded that there is a compelling case forthe newly created field of KM and very real difficulties associated with measuring andcreating value around intangible assets Given this, with all the competing proposals forcorporate investment of capital, why should a KM proposal get the funding to continue toexist? These are some deficit areas that have been posed in the literature that have enticedthis researcher to further investigate useful instruments and tools that might help

managers make better decisions in regards to their intangible assets

The Purpose of the StudyThe purpose of this study is to gain further understanding of how companies arecurrently valued in the market place and how that viewpoint might need to be adjusted oraltered to reflect a new more current reality Tools and instruments that have been

developed and utilized to date will be examined and one tool in particular has been

analyzed in an attempt to help manager’s gain a deeper understanding of what is

important to building their company’s market value and might offer a somewhat differentmeans of gathering data in order to make informed decisions Validation of the

instrument in question has been done to the degree possible within the parameters of thestudy Ultimately, this study has been designed to be used as a practical means of gainingunderstanding of the concept of maximizing market value by maximizing intangibleassets The application of these concepts would be possible by using the instrument to bevalidated during the course of this study

This research is aimed at helping the reader understand how the valuation ofintangible assets has progressed over the years and how intangible calculations havebecome more of a key factor in the market value of a company and to increase

understanding of a tool that could aid manager’s in getting a better picture of intangiblevalue and help lead them toward solutions about how to maximize value All of thisshould lead to more enhanced decision making that includes areas closely related toincreasing market value of the company in question.

Theoretical Support for the StudyClare and Detore (2000) described a theory of business knowledge or

epistemology and claimed this theory would be an essential place to begin the intangiblediscussion in any organization Many practitioners avoid theory at the expense of thecreation of an architecture that could be critical in building the valuation model necessary

to convince decision makers of the real value of intangible assets This omission is one ofmany noted in the literature that have led to failures in implementing these types ofprograms

The business theory or epistemology should contain at least five essential

elements, which are a model of knowledge, a relationship to information, a link to

economic value, a cognitive process, and, the defined role of technology In order todefine further the business knowledge that is part of the valuation process, a practitionerwould first create a model that would have formal and testable descriptions of knowledgeutilized in the organization In the literature, theorists have identified and labeled manytypes of knowledge such as tacit and explicit, procedural, meta, and situational Second,the clarity of the relationship to information would help to distinguish between

knowledge, information and data These distinctions are important for categorizing itemsand assigning responsibility properly For instance, purely explicit information or datamanagement might best be addressed through an information technology

(IT)/management group, or perhaps the human resources group depending on the content

or context; whereas, a knowledge engineer or someone else who truly understands KMmight best address the retrieval and storage of tacit knowledge The third element wouldinvolve a link to economic value Asking questions such as, how could our knowledgefoster sound decision-making or innovation? How do these knowledge factors impact theincome statement or balance sheet? The fourth element would involve the practitionerascertaining how both individual and group knowledge is cognized Questions leading tothese answers might include how do individuals or groups get creative, learn

experientially, typically solve problems and collaborate? What are the current norms andpatterns that need to be enhanced or altered, or just left alone? The fifth and last element

is the technology factor Here one could ask what role technology will play in this

architecture There is danger that the technology aspect of the architecture could

dominate the program and that potential problem would need to be addressed If

technology is to be a dominant component of the program, then let it be by design and for

a purpose If technology is to be central to the success of the project, then perhaps the ITgroup should lead the effort

Just as we need a mission and business model to guide strategic thought about ourcorporations, we need a business epistemology to guide strategic decisions abouthow to manage knowledge in our corporations (Clare and Detore, 2000, p 18)Clare and Detore (2000) theorized that in order for knowledge to be categorized

as an asset, it would need to have three distinguishing factors, which were content,

structure and reasoning The content is data or information in its purest form before thereal value has been added by human interaction and utilization Once there is the

presence of some content, the data or information would need to have some structure

such as a hierarchy or some scheme or categorization, which would create logic andunderstanding for others engaged in the usage of this data/information The reasoningcomponent is the active cognitive process that the human factor would necessarily add tothe data/information in order to create required value Sound problem solving or

decision-making by the user creates this value Individuals or groups, to varying degrees

of success, can accomplish this reasoning element This success would largely depend onthe intentional design of a structured architecture along with the understanding of theusers in how to create value

In order to further define their theory of intangible asset valuation, Clare andDetore (2000) reviewed some of the literature on systems theory and attempted to create

a link between constructs such as core competencies, value constellations, and mentalmodels in order to advance Knowledge and Organizational Learning Management (K &OLM) in organizational systems The fundamental way in which organizational systemshave been required to organize and perform as of late have been changing at a

phenomenal rate unlike any other in history Mergers and acquisitions, downsizing,critical skill shortages in our culture, globalization, and a host of other factors are

impacting the way in which systems are required to evolve If, in fact, the requirements to

be a successful competitor in the global economy include creating and sustaining a

culture of innovation, quality, and continuous improvement, then it is also logical toassume that the argument could be made for investment in K&OLM Knowledge and itsrelationship to changes in organizational systems could be summed up as follows:

Knowledge is a key factor of production in every industry and is the scarcestresource around which the business firm competes Innovations in communicationand coordination technologies are causing a shift in the relative transaction costadvantage of firms causing an explosion of innovation in the shape and structure

of the modern firm as it reconfigures to increase the value created by knowledgeand to learn faster than competitors (Clare and Detore, 2000, p 92)

The definition of a system that Clare and Detore used was “any collection of

components that through a set of relationships operate together to perform some overall function or achieve a purpose.” (p 94) The basic elements of any system are viewed as

components or a set of variables that are being considered as critical for the functioning

of the system as a whole The distinction of a component is that it cannot be broken downinto any lesser element If we were discussing human systems then the component would

be the functioning systems within the individual Other forms of components wouldconsist of capital, information or materials The relationships that exist among

components are varied and instrumental in the actual shape and effectiveness as well asefficiency of the system

The two most common systems structures are known as hierarchies and networks.The hierarchy has a more formal structure and is designed to facilitate interaction

between levels and to create a sense of authority and power The network is an opensystem where components (in this case, the individuals) are free to go in any directionthey choose to get what ever it is they need or want without fear of repercussion Everybusiness organization on any scale has both types of systems Each system has its ownmerits and the challenge presented is to design an architecture that could maximize thebenefits offered by each system Feedback is another element of a system and could beviewed as output from a component of the system coming back into the system as input.There is circular activity between the output, input and the corresponding environment.Diagrams would be created called causal loops that could take shape in one of two ways.Clare and Detore (2000) described these two loops as vicious cycles, where negative self-

reinforcing outcomes are the norm, or virtuous circles, where positive self-reinforcingoutcomes are common The loops could be utilized in the process of managing

knowledge assets Whether these loops are positive or negative would likely be a directresult of the alignment of the people (components) and the type of system they exist in

Achieving alignment means designing and implementing components that havecomplementary functions that service the purpose of the system as a whole Itmeans wiring inputs, states, and outputs together across subsystems to createsystem-wide interdependence that gives rise to the structure and behavior that isrequired for high performance in the operating environment Achieving alignmentmeans leveraging the unique properties of individual components without

allowing them to dominate and thereby sub optimize the overall functioning of thesystem (Clare and Detore, 2000, p 104)

K&OLM and systems alignment are complementary and work toward the sameend The connections between K&OLM and systems theory become more evident as onediscovers more about the two topics If there is an understanding of what the organizationknows and how this knowledge can be utilized to achieve greater speed to market andcustomer satisfaction as well as being able to increase the speed of knowledge

acquisition, then the system is likely to function at high levels in a competitive businessenvironment The business epistemology holds the keys to success in linking the

elements of the system and the creation of subsequent value in relation to the economics

of the firm Clare and Detore (2000) posited that

the knowledge architecture, one of the chief components of knowledge

management, seeks to achieve alignment on a large scale and establish economies

of knowledge, transaction costs advantage, and rapid learning Finally, for anorganization whose primary assets and offerings are intangible, knowledge

management is the chief means of creating strategic alignment This is true

because in such firms, knowledge assets dominate the organizational architecture.(p 108)

Other theorists in search of new methods to measure noneconomic goals havedevised measurement systems The works of Sveiby (1997), Stewart (2001), Sullivan(2000), and Kaplan and Norton (1996) are all related to the question of how to begindefining new methods of measurement and valuation in the Third Wave The work donehere is another logical extension of that need for a different means of measuring the non-economic intangible assets of the corporation

AssumptionsOne assumption made for this study was that participants completing the surveyhad an understanding of what kind of progress their company would have made over acertain length of time in relation to growing in market value It was also assumed thatsurvey participants understood the type of Human Resources Development (HRD)

programs currently being implemented in their organizations This author assumed thateach manager asked to complete the survey functioned in an environment where there ishealthy communication and understanding of current events and the overall fiscal health

as it changes over the quarters If this were not the case, the results would likely come outthe same as this type of environment presumably would not create the type of marketvalue as others where managers are well informed This would likely further validate theinstrument

According to Ulrich and Smallwood (2003) there are some key assumptions thatthis premise of intangibles rests on and they are:

1 Intangibles determine an increasingly sizable portion of a firm’s market value

2 Intangibles are not random; they can and should be managed

3 Intangibles are the responsibility of leadership at all levels of an organization

A CEO worries about intangibles as they affect the entire firm; a vice presidentfocuses on intangibles within a more limited domain of influence; a first-linesupervisor emphasizes the intangibles within the work team

4 Intangibles can be increased by applying a set of management tools and

organization known as the American Society of Training and Development (ASTD).They are typically full-time workers who are colleagues in the field this study impactsmost The average age is 30to 45 years old Using the qualifying criteria, the researchergathered data meaningful and applicable to the research questions in this study

LimitationsThe data would not be generalizable beyond the participants of the study due tothe limitations of the instrument itself The instrument must be changed to be more validand then further research can occur at which point more generalization is possible

Another limitation involved participants that were too busy to complete the instrument.Many of these people are limited on time and too interested in other things to spend anytime on participating in research This issue was overcome by sending the survey to alarge population base

Definition of Terms

Knowledge: For the purposes of this study, knowledge was considered tacit or

explicit Explicit knowledge was defined as all written documents (books, papers,

manuals) or information found in computer systems (software, saved documents, networkdrives, etc.) that when applied in unique individual ways on the job create added value

for the company Tacit knowledge which involves expertise and knowledge of an

organization’s key workers is of value if applied to solve problems that make the

organization more productive in some way

Management: The management element was the determining factor as to whether

or not the employees were granted the latitude to participate in the gathering, creation,documenting, and usage of this information and knowledge in such a way that would, intime, bring about system wide efficiencies

Intangible Assets: Ulrich and Underwood (2003) proposed the definition of

intangibles to be “…the value of a company not accounted for by current earnings” (p 6).This is commonly known as the market value in today’s business world Throughout thisresearch, the reader will see the terms KM and intangible assets used interchangeably

KM is actually a subordinate term but might have a specific application to that segment

of the work

Research QuestionsResearch Question #1: What is the relationship between company earnings andthe company’s current strategies to include core competencies, organizational

capabilities, and leadership capabilities as measured by the participant responses? Thehypothesis would be that there is a positive correlation between the implementation ofHRD programs and the value of intangible assets The Pearson correlation was used toanswer this question and support or refute the hypothesis The hypothesis was that therewas a positive relationship between the company’s earnings and the company’s currentstrategy, core competencies, organizational capabilities, and leadership capabilities

Research Question #2: To what degree is the Intangible Assets instrument validand reliable? The hypothesis is that the instrument is valid and reliable Pearson r,

Cronbach’s alpha and exploratory factor analysis will be used to support or refute thishypothesis

Research Question #3: As a result of this research, what is the rank order ofimportance for these variables that might allow for the acceleration towards an increase

of results in relation to market value? The hypothesis in this case would state that

managers decision making would be more enhanced leading to measureable

improvements in the value of intangible assets in a shorter period of time

Significance of the StudyThis research could benefit managers of companies large and small to make betterand more informed decisions based on assets that have gone previously unseen or notproperly recognized in a formal way It could help managers by making the

invisible/intangible assets visible and illustrating a correlation between the current marketvalue of the company and the problem areas that need to be improved to create the

desired value as seen by the marketplace

The social significance of this study could be the positive impact that this newfound awareness could have on managerial decisions that favor employees and theirgrowth and development This growth and development would ideally lead to higherlevels of satisfaction by employee groups and increased motivation which in turn wouldlead to higher productivity and more market value related to intangible assets This wholeprocess would ideally lead to a cycle of upward momentum that would continue to

increase market value, job satisfaction, and retention of key employees All of this is

good for people who work for these companies and the economy as a whole The field is

in desperate need of empirical research and this study could contribute to a significantincrease in the knowledge of this particular aspect of intangible assets

The design of this study allows for replication with other similar intangible assetsprograms under similar circumstances The study could be used to educate people on how

to implement such an audit program successfully, and could potentially save many peopleand companies a lot of time and money by avoiding failure in managing their intangibleassets properly

The tools being validated in this study are original based on the literature reviewand have led to new discoveries and applications in this field so lacking in empiricalwork This study could be used to further enhance empirical studies done by students atWalden University and other like institutions

Summary and Overview

In chapter 1, the relationship between intangible assets and KM was presented.This researcher also identified some key areas where there are gaps in the literature whichmight be used to justify this study In addition, some research questions were identifiedthat would prove instrumental in guiding the literature review and hence the rest of thestudy The following literature review serves to help the reader gain a deeper

understanding of why this issue exists and why it is a problem worthy of study In chapter

2 the literature review consists of viewpoints from different authors related to intangibleassets The ranges of views extend from empirical to anecdotal and the suggested

methodologies range from very much accounting based to very qualitative as in

observations and interviews In chapter 3 of this dissertation, a methodology is presented

that serves to create and contribute original knowledge to the field and in particular, thearea of intangible assets management Chapter 4 consists of the data analysis and findingsthat resulted from the analysis The data revealed some results that agreed and some thatdisagreed with the researcher’s hypotheses In chapter 5 the summary, recommendationsand conclusions are presented The researcher concluded that there is much more work to

do before this concept of intangible assets becomes a normal way to do business

CHAPTER 2:

LITERATURE REVIEWIntroduction to the Literature ReviewThis literature review consists of viewpoints from different authors related tointangible assets The ranges of views extend from empirical to anecdotal and the

suggested methodologies range from very much accounting based to very qualitative as

in observations and interviews A few of the key authors reviewed here include Clare andDetore, Ulrich and Smallwood, and Sveiby Their work in this area has been extensiveand they offered much in terms of insights and research that has already been conductedwhich would lead this researcher to insights that can further the field through this

dissertation project

In this review the term intangible assets has been defined by selecting a definitionthat would help further the understanding for the reader based on the potential outcome ofthis research The review further aids the reader in understanding why this is importantand why there might be a need for valuation of intangible assets A number of potentialtools and methodologies for measuring this value were reviewed and analyzed Someapproaches that have been used to implement these types of methods are also shared withthe reader

After an exhaustive search of the following databases, nothing additional wasfound that would be of value to this body of knowledge Databases searched includeUniversity Microfilms, Inc (UMI); Econolit; Academic Search Premier; Business SourcePremier; ERIC; Sociological Abstracts; ABI Inform; and Wilson Business Abstracts.Keywords used in this literature search were combinations of the following: knowledge

management, organization(al), learning, measurement, valuation, deficit, value, tools,barriers, intellectual, capital, and implementation.

Defining Intangible AssetsThis literature review contains terminology related to intangible assets that hasbeen defined many different ways Terms such as revenue, cash flow, profits and value-added as well as other financial or economic terms have typically been major concerns ofleaders who have been charged with making key organizational decisions Another term

used quite often within the accounting profession and with leaders is asset The term has meaning in two differing realms to include tangible and intangible assets The tangible

assets are simply items that the organization owns that could be bought and sold on the

open market for an established price The term, intangible asset has been much more

difficult to operationalize to show that its true value might be used to make key decisions.Williams (as cited in Clare & Detore, 2000) defined intangible assets for the generallyaccepted accounting principles (GAAP) as

certain long-lived legal rights and competitive advantages developed or acquired

by a business enterprise Intangible assets differ considerably in their

characteristics, useful lives, and relationship to operations of an enterprise andmay be classified as follows: identifiably manner of acquisition

determinate of indeterminate life transferability (p 430)

Some intangible assets familiar to the accounting profession might include: patents,copyrights, franchises and trademarks These terms could be helpful in understanding thecurrent state of business economics and basic accounting principles already established asnorms; however, these terms do not properly describe other equally important intangibleassets

One of the leading pioneers in the argument for a new type of accounting systemdescribed intangible assets as invisible and created an invisible balance sheet that could

be used to illustrate what these elusive assets might be worth Sveiby (1997) used a steelindustry example of market valuation based on recognition of invisible (intangible)assets One of two competing companies made an effort to utilize a strategy for

leveraging intangible assets and their return on equity went up to 17% as compared to thecompetitor’s 3% Once the market recognized this fact, their market value went up threetimes that of their competitor The current accounting system only allows for recognition

of intangible assets on the sale of a company This is called goodwill and entered into the

books as a lump sum and depreciated over a 40 year period

The stock market price of a company is the market’s valuation of the shares in theequity Each share certificate represents a share in the company’s equity or bookvalue When the market price is higher than the book value, conventional stockmarket theory regards the premium as the market’s assessment of the futureearning potential, a potential that is converted into goodwill as the company isacquired So there must be something among the company’s assets that will yield

higher than bank interest in the future These assets are invisible because they are not accounted for They are intangible because they are neither brick nor mortar

nor money Nevertheless, these invisible, intangible assets need not be a mystery.They all derive from an organization’s personnel (Sveiby, 1997, p 8)

Others defined intangible assets in a more practical way than did the GAAP (asnoted above) Rumizen (2002) broke intangibles down into three distinct categories,which includes human competence, external structure and internal structure Humancompetence includes all the areas that knowledge workers bring with them to the job andtake home with them when they leave Areas include, “values, experience, social skills,and educational background” (p 242) External structure involves “how the organization

is regarded externally and includes trademarks, brand names, and image” (p 242)

Internal structure is what the organization truly owns and has rights to such as “databases,processes, models, and documentation Intellectual property such as patents and tradesecrets also are part of internal structure” (p 242) These three elements were said to be

critical in considering intangible assets and were comparable to those of Sveiby (1997),Stewart (2001), Sullivan (2000), Rumizen (2002), and Clare and Detore (2000) who alsoargued for a new system of accounting.

According to Baruch (as cited in Ulrich & Smallwood, 2003),

the importance of intangibles as indicated through the market-to-book ratio (theratio of capital market value of companies compared to their net asset value) ofthe S&P 500 from 1977 to 2001, which has risen from 1 to over 6 in the past 25years—suggesting that for every $6 or market value, only $1 occurs on the

balance sheet (p 7)

Ulrich and Smallwood (2003) further defined intangible assets as items that arenot obvious in the balance sheets such as patents and brand names, image and personnelwith unique talents and a strong desire to make value added things happen Companiessuch as Coca-Cola, Microsoft, Merck, Amazon, General Motors, and 3M, all have

something unique in regard to intangible assets that create a lot of discussion among theanalysts on Wall Street and in other financial circles that also creates much wealth for theleaders and the investors

According to Baruch (as cited in Ulrich and Smallwood, 2003), intangibles arefurther defined as

discovery, organization, and human resources Discovery intangibles include

patents, trademarks, R & D programs, royalties, and innovations Firms able toinnovate through discovery have higher market value that firms that do not

Organization intangibles include technology, brands, and customer costs When

leaders know how to manage these organization factors, they build more future

value from present earnings Human resource intangibles focus on training,

culture, and leadership Lev [Baruch] further suggests that the human resourcedomain of intangibles requires more work (p 7)

Stewart (2001) argued that the old methods of accounting for assets in

organizations no longer made sense in our current information age This same argumentmade by Clare and Detore (2000), Sveiby (1997), Sullivan (2000), and other theorists that

have debated on this topic With the strong presence of the Internet and e-commerce, theremoval of the Berlin Wall, and the globalization movement, the business communityneeds to be moved to action to find a more appropriate means to determine value andworth in this information economy

In December 1999 Alan Greenspan, chairman of the Federal Reserve Board,complained that accounting wasn’t tracking investments in intellectual assets, andthat technological change has “muddied” the “crucially important” distinctionbetween capital assets and ordinary expenses (Stewart, 2001, p 269)

Twenty-five years ago the book value and the market value of a company werefairly well aligned However, in many companies today, there is a dramatic differencebetween the physical assets that a company owns and the value ascertained by the

marketplace The more knowledge based a company is as in the case of a consultingfirm the more intangible assets matter If the argument were to be taken further, themajority of the intangible assets come from the people involved in making the firmprofitable Hence, the case can be made for the criticality of ensuring the people areinvolved in the value creation process as well as the continuous development and focus

on retention of those people

Make no mistake: Accounting’s failure to disclose intellectual capital is not just atheoretical problem It costs investors money (perhaps you, dear reader, amongthem) At the very least it reduces prosperity by distorting flows of investmentcapital, which should go to where it can be most productively employed (Stewart,

Defining the Need for ValuationClare and Detore (2000) argued that current investment being made in the idea ofmanaging knowledge is very large, perhaps billions of dollars KM could be as important

to organizations, if not more so, than process reengineering or other improvement

programs that have been widely implemented in the past There is also a danger of KMbecoming another management fad If methodologies cannot be constructed and utilized

in order to keep the attention of the decision-makers of the organization, then KM couldeasily fall victim to the same ill fate many similar programs have Many corporate dollarscould be wasted thus creating more frustration in related fields of practice and lesseningcredibility with decision makers Clare and Detore created a valuation methodology andstated:

the opportunity to use knowledge management to achieve competitive advantage

is very real The KM valuation methodology is a rigorous financial framework foranalyzing the costs, benefits, and risks associated with investing in the knowledgeassets of an organization (p 7)

The purpose in creating this methodology was to assist decision makers at alllevels in the organization in making calculated risks and educated choices around KMproposals as opposed to just approving these projects or strategies based purely on

convincing rhetoric and anecdotal evidence Some major organizations are currentlyinvesting in KM projects or strategies including best practice gathering and utilization,competitive intelligence functions, establishing roles and duties for top level leadersaround KM, buying or designing software applications to be used as infrastructures orknowledge repositories, building corporate libraries and universities, identifying andcommercializing knowledge as rapidly as possible, deliberately having post action

reviews to discover what has been learned that could be reused in the future, and creating

portals that would allow someone to search any and all information or data the

organization has available Clare and Detore (2000) posited that these many differingtypes of KM projects and strategies do, in fact, have some similar themes It was notedthat these themes “are designed to create and/or leverage the knowledge assets of thefirm, involve significant costs and subtle risks, and promise significant but often hard tomeasure or intangible benefits” (p 8) Therefore, Clare and Detore concluded that therewas a compelling case for the newly created field of KM and there are very real

difficulties associated with measuring and creating value around intangible assets Giventhis, with all the competing proposals for corporate capital, why should the KM programsget the funding to continue to exist?

The literature illustrated many differing views on what KM is and how it is ofvalue to the organization Davenport and Prusak (2000) mentioned that the anecdotalmeans of creating value would only take the practitioner so far There also needs to bevalue created in the minds of the users in terms of significant investment in reward

systems for using the system Putting people of importance in high-level positions wouldindicate the value of KM to the firm and send a clear message that making the systemwork is critical for long-term survival of the firm Also, including requirements for

reusing and creating new knowledge into an employee’s performance review would lendmore credence to the act of engaging in KM Davenport and Prusak posed that valuecould be created by managing the internal Human Resources function in such a way thatleaders and workers would sense an obvious importance-surrounding KM They

described many human resource actions in terms that have been typically associated withthe financial community; however, the actions proposed here would likely not endure

Davenport and Prusak discussed the possibility of using more of an accounting basedapproach to measure intangible assets around KM but made it obvious that this area waslargely unexplored.

Rosenberg (2001) suggested that KM implementation begin by building a

business case There must be justification in terms of performance improvement; theremust be evidence that this is the best solution, weighed against others possibly less

expensive or time consuming; and, senior leaders need to have an understanding thatknowledge is an asset along with the value of such assets Other means Rosenberg

offered to convince senior leaders to invest included

using success stories; educating executives on the value of KM and

Organizational Learning (OL); coaching the executives to say and do the rightthings to be successful; working with the political factors that are found in thatparticular organization; and, ignoring the disbelievers (p 226)

In comparison with Stewart (1997), Clare and Detore (2000), Sveiby (1997), andKaplan and Norton (1996), Rosenberg (2001) took a very similar position on the need tocreate value around the proposition of utilizing KM principles

the value of e-learning is the sum of its ability to save money, generate benefit to

the business (enhance skill and knowledge, improve job performance, and impactresults), be available to anyone, at any place and at any time, and do all of this atthe speed of business Eliminate any one of the criteria, cost quality, service, orspeed, and e-learning’s value falls precipitously Thus the value proposition for e-leaning is: E-Learning Cost Efficiency + E-Learning Quality + E-Learning

Service + E-Learning Speed = E-Learning Value (p 27)

The obvious difference was that Rosenberg used a simple equation without any

operationalization, which would not do much for practitioners

More recent work (Echols, 2006) serves to reinforce the belief there is certainvalue in studying return on investment (ROI) as it relates to human capital Echols madethe case that the need for training as is typically conducted in today’s corporations is of

limited value and has a limited future With the rapid pace of the changing global

economy there is more of a need for higher levels of education in the form of collegedegrees The best return on companies human capital investment is sending its employeesthough college programs that can lead to “critical thinking skills, communication,

writing, and other fundamental capabilities ” (p 39) In the past, a straight progressionthrough college at an early age was the norm; however, today this is very risky for both

an individual and a company

The correlation between turnover and return on investment is analyzed and theargument is made that below 31% turnover per year the investment in college degrees foremployees is worth the money If a company has low turnover numbers their return oncapital deployed is said to be higher Echols illustrated the differences in a few tables.These examples were from differing industries such as health care, food and drug

retailing The best case scenario was with the Mayo Clinic, which had a turnover number

of 6 % and an ROI number of 128% The worst case was Whole Food Markets, whichhad a turnover rate of 32 % and a negative ROI of -4 % (Echols, 2006)

Links between Systems Theory and Intangible Assets

In order to further define their theory of KM valuation, Clare and Detore (2000)reviewed some of the literature on systems theory and attempted to create a link betweensome of the latest constructs such as core competencies, value constellations, and mentalmodels in order to advance KM in organizational systems The fundamental way inwhich organizational systems have been required to organize and perform as of late havebeen changing at a phenomenal rate unlike any other in history Mergers and acquisitions,downsizing, critical skill shortages in our culture, globalization, and a host of other

factors are impacting the way in which systems are required to evolve If, in fact, therequirements to be a successful competitor in the global economy include creating andsustaining a culture of innovation, quality, and continuous improvement, then it is alsological to assume that the argument could be made for investment in KM Knowledgeand its relationship to changes in organizational systems could be summed up as follows:

Knowledge is a key factor of production in every industry and is the scarcestresource around which the business firm competes Innovations in communicationand coordination technologies are causing a shift in the relative transaction costadvantage of firms causing an explosion of innovation in the shape and structure

of the modern firm as it reconfigures to increase the value created by knowledgeand to learn faster than competitors (Clare & Detore, 2000, p 92)

The definition of a system that Clare and Detore used was “any collection of

components that through a set of relationships operate together to perform some overall function or achieve a purpose” (p 94) The basic elements of any system are viewed as

components or a set of variables that are being considered as critical for the functioning

of the system as a whole The distinction of a component is that it cannot be broken downinto any lesser element If we were discussing human systems then the component would

be the individual Other forms of components would consist of capital, information ormaterials The relationships that exist among components are varied and instrumental inthe actual shape and effectiveness as well as efficiency of the system

Norton and Kaplan (1996) claimed that there is a series of systemic cause andeffect relationships that should be considered when using their Balanced Scorecard Thecause and effect chain was said to begin with the desired financial outcome and workedbackwards through customer’s desired outcomes, internal processes, systems

effectiveness and efficiency, and ultimately went back to employees as the ultimatedetermining factor leading to success in the whole equation Questions must be asked

about competencies and how to best retain the most competent people in order to makethe whole cause and effect chain possible If the cause and effect relationships were to beconsidered during all phases of incorporating a Balanced Scorecard into a business

system, the results were supposed to be inevitable This study will help to either defend

or refute that position

Potential Tools or Methods for Measuring Value in Intangibles

Ulrich and Smallwood (2003) created architecture for intangibles which resulted

in the Intangible Audit being addressed in this research The architecture consists of fourlevels which are designed to help business leaders make better choices that might lead tomore of a significant impact on the market value of their company The underpinning ofleaders’ ability to build confidence and market value is their ability to make and deliverpromises that lead to valuable growth for the company This would be level one of thearchitecture In level two, a leader is able to “articulate a future growth vision” (p 14).This vision includes three areas and they are the customer, innovation, and geography Inthe third level, the leader needs to “ensure future competencies are aligned to strategy”(p 17) This might involve the following areas, “product innovation, research and

development, patents, the source of ideas, operating efficiency, productivity, processprojects, customer intimacy, segment service brand, distribution, logistics channels,technology, hardware and software, and new technology” (p 14) Lastly, the fourth level

of the architecture involves the leader creating capabilities The capabilities were said toinclude “shared mindset/culture, learning, accountability, talent, collaboration, speed, andquality of leadership” (p 14)

Ulrich and Smallwood (2003) also offered the following suggestions that mighthelp leaders decide where to begin and what to do with intangibles.

1 Compare your P/E ratio to that of your top competitors for the past 5 to

10 years How are you doing?

2 Audit your leadership intangibles The survey in figure 1.2 [Appendix

1] provides some basic questions to use

3 Find ways to present your leadership intangibles to your investors

4 Find ways to present the intangibles to employees and invite them to

find actions they can take to improve them

5 Create a map that shows probably chains of causation from intangibles

to financial results of your company (p 21)

Sveiby (1997) categorized possible methods for measuring and demonstratingintangible value in the organization into four major categories These categories were:

“direct intellectual capital methods (DIC); market capitalization methods (MCM); return

on assets methods (ROA); [and], scorecard methods (SC)” (p 1) The MCM and ROAmethods were said to be useful in decision-making related to mergers and acquisitions;however, the practitioner could mislead people into making inaccurate decisions due tofluctuations in variables used to calculate returns The DIS and SC methods were said to

be easier to apply and could create a more comprehensive view of intangible assets;however, there could be difficulty in using these tools for comparison across regions aseach method and measure it produces is somewhat unique to that user

Norton and Kaplan (1996) argued that their Balanced Scorecard method offered away to operationalize mission and strategy statements

The Balanced Scorecard translates mission and strategy into objectives and

measures, organized into four different perspectives: financial, customer, internalbusiness process, and learning and growth The scorecard provides a framework, alanguage, to communicate mission and strategy; it uses measurement to informemployees about the drivers of current and future success By articulating theoutcomes the organization desires and the drivers of those outcomes, seniorexecutives hope to channel the energies, the abilities, and the specific knowledge

of people throughout the organization toward achieving the long-term goals

…the scorecard does not strive to keep individuals and organizational units incompliance with a pre-established plan, the traditional control system objective.The Balanced Scorecard should be used as a communication, informing, and

learning system, not a controlling system (p 25)

The four different perspectives were introduced with familiar financial indicators

at the forefront of the scorecard Norton and Kaplan (1996) posited that action taken toincrease the other three intangible indicators would show a direct correlation with

increasing financial numbers Sveiby (1997), Stewart (2001), and Tiwana (2000) alladvocated the same three intangible categories as described by Norton and Kaplan Thecustomer perspective would be used to account for satisfaction, retention, acquisition,profitability, and/or market as well as account share in targeted markets In determiningwhich area to focus on, users of the scorecard would need to ask the customers what theyvalued the most and then try to deliver in those areas Also, the organizational leadersmust discuss what goals need to be established that will enable the organization to

determine what future needs its customers might have and how to best meet those needsbefore customers ask for that help

Tiwana (2000) advocated the usage of Norton and Kaplan’s (1996) BalancedScorecard as a means to track progress with a KM program and posed some advantagesand disadvantages of doing so The advantages were listed as follows:

• Ability to provide a snapshot of the intellectual health of your firm at anypoint in time

• Built-in cause-and-effect relationships that can help you guide your

knowledge management strategy

• Sufficient (neither too many nor too few) number of performance drivers andmetrics

• Capability to communicate the knowledge management strategy throughoutthe firm

• Capability to link individual goals with the overall knowledge strategy of the

firm This implies that each employee can do his own and continue to

contribute toward the goals of the knowledge management system and

strategy without even realizing it!

• A direct, and often missing, link between long-term knowledge and

competence goals of the firm and its annual budget

• Translation of the lofty visions of a firm into more doable, realistic,

manageable, and specific performance goals

• Logical integration into the overall strategy of your business, and still makesense

• Objective measurement of the contribution of knowledge to the more

intangible sources of competitive advantage, such as customer satisfaction andemployee skills and competencies

• Direct link to financial measures and your knowledge management system’seffect on the company bottom line (p 436)

Tiwana demonstrated a balanced approach to his assessment of the BalancedScorecard by stating some disadvantages He also noted that this process was more

involved and difficult to implement than some other related processes such as the

Intangible Asset Monitor (Sveiby, 1997), or the House of Quality model also

demonstrated in Tiwana’s work The scorecard would also have to be unique to each areaand it would not be possible to successfully transfer scorecards directly from one area toanother without doing the work involved to make it relate to each areas needs,

capabilities and desired outcomes

The internal business process perspective aspect of the scorecard differed frommany other possible tools in this realm because the scorecard creates a focus on the long-term internal state in relation to the innovative environment as well as the past and short-term solutions to problems And lastly, the learning and growth perspective encompassedthe capabilities of the people, the state of the systems to include technology, and

procedures used by the people During a periodic review of the scorecard, questionswould need to be asked about the current and desired future state in these above listedareas along with a review of any action plans that might apply