Intellectual Capital: The New Wealth of Organizations

In October 1994, I spoke about intellectual capital at the first of what has become a series of conferences called "The Knowledge Advantage," sponsored by the Strategic Leadership Forum and Ernst & Young. During a question period following my talk, someone asked, "Do you think this stuff will become a fad like reengineering?"

"I don't think so," I confidently answered. "There's nothing to sell." The management of intellectual capital--organized knowledge that can be used to produce wealth--didn't seem to lend itself to being packaged and sold. So long as no one had a commercial reason to push the idea, I figured it would not be pushed too far.

So much for my crystal ball. The response to the publication of Intellectual Capital--more accurately, the response to the ideas it discusses--has been far greater than I could have imagined. As the year's crop of annual reports showed up in my mailbox in the spring of 1998, a bit more than a year after the first publication of this book, I found the phrase "intellectual capital" in one glossy document after another. I have received letters, phone calls, and e-mail from every continent except Antarctica. Both the World Economic Forum, whose principal constituents are big companies from advanced economies, and the World Bank, whose principal clients are the least-developed nations, have taken up intellectual capital as major themes of their work. In advertisements in The Economist, Slovakia touts its intellectual capital as a reason for businesses to invest there. For the government of Peru, it became a focus of a 1998 National Competitiveness Summit; for the Brookings Institution, a think tank in Washington, D.C., it is the subject of a major study group; in company after company--banks in Australia, technology companies in Silicon Valley, chemical companies in Europe--managing intellectual capital has become a prominent subject of both conversation and action. And on Dilbert's Web site (at http://umweb2.unitedmedia.com/comics/dilbert/career/bin/ms2.cgi), "intellectual capital" has become one of the phrases that pops up in Scott Adams's random "mission statement generator."

I don't mean to claim credit (or accept blame) for anything other than having unfurled a sail in time to catch a wind--as others also have. But it's quite a wind. If companies handle it well and aren't blown off course, they will, I am more convinced than ever, find themselves propelled to new lands, rich with unexpected opportunities. Certainly the trends described in Part One, "The Information Age," have in this very short time grown much, much stronger. In April 1998, the U.S. Department of Commerce published a superb report, The Emerging Digital Economy by Lynn Margherio (available at www.ecommerce.gov or from the Government Printing Office in Washington), that irrefutably and dramatically updates the discussion in Part One, showing that knowledge continues to increase its dominant or defining role in national output, corporate competitive advantage, and labor markets. Intellectual assets continue to displace physical and financial capital as factors of production. Overall, McKinsey consultant Lowell Bryan has estimated, U.S. companies today require 20 percent less in the way of tangible assets to produce a dollar's worth of sales than they did a genedefining role ration ago. The same is true for working capital as the substitution of information for inventory continues unabated. (See Chapter 2.) Not that "old economy"
assets don't matter--they do and in many industries always will. But the relative importance of intellectual capital continues to grow, in the economy as a whole and in every company I can think of, and in most cases it is now knowledge that gives one company an advantage over another, rather than, say, physical scale or scope.

No wonder competition for intellectual capital has heated up. Part Two of this book describes the three broad categories in which intellectual capital can be placed--human capital, structural (or organizational) capital, and customer capital. Competition has become keener for all three. Human capital is especially prized--and, as always, especially mismanaged. Part of the intense demand for talent in the United States can be ascribed to a long-running economic boom that (at this writing) has cut unemployment to historically low levels. But is it just the boom? Economist Paul Krugman, warning against American economic triumphalism and remembering the gloomsayers of the late 1980s, warns us not to mistake a cycle for a trend. Certainly unemployment will rise again one day. Surely it is to the cycle that one can attribute the frothiest excesses of late-1990s American labor markets, where cocky young technical workers treat a company as if it existed to cater to them--and it meekly acquiesces--and where an ordinarily xenophobic Congress votes to lower immigration barriers for some skilled workers.

But there also are trends, structural changes, that deepen the demand and raise the rewards for knowledge work not just in the United States but also in countries such as France and Germany that struggle with high unemployment. The knowledge economy demands skills many workers simply do not have; and of almost all workers, it demands flexibility, alertness, and the ability to make decisions without consulting a manual or a foreman. Lynn Margherio writes: "Jobs characterized by a transfer of information from one party to another--travel agents, insurance agents, stock brokers, customer service representatives--will likely see routine tasks like order taking disappear, and more complicated tasks replacing them." The best workers are always most in demand; now they are so much at a premium that more and more of them choose to work on their own, for profit rather than a wage. Egalitarian labor markets, such as those of Western Europe and Japan, have begun to break with long-held, socially dear traditions of compensation and governance in order to reward and manage knowledge workers as the Information Age demands. Bill Gates, CEO of Microsoft, says, "The war for talent gets tougher and tougher."

Companies have begun to take their customer capital seriously, too, to view it and manage it as the asset it is. Among many examples is Westpac, one of Australia's biggest banks, where the management of customer capital has become a principal means by which the bank is struggling back (successfully so far) from a near-death experience earlier in the decade. Chapter 9 cites a study of U.S. banks that showed that only three of five retail customers are profitable. On the commercial side, Westpac was doing less well even than that. (The bank won't reveal precisely what percentage was unprofitable.) Westpac undertook a systematic evaluation of its customer base, first assessing each customer relationship to see if it was profitable (including a charge for the cost of capital), then looking more closely to see if it was profitable in some areas of its relationships (say, commercial loans) but not in others (foreign exchange, perhaps). Unprofitable customers weren't jettisoned, except rarely. Instead the bank set up ways to work with them to find ways to add value to the relationship. Usually the way to do that has been by selling knowledge--that is, the bank's expertise. Sometimes Westpac even shares with customers the details of its own profitability and asks for their help. After all--as I discuss in Chapter 9--customer capital is an asset that belongs to both the buyer and the seller, jointly and severally; each has a stake in making it grow. For Westpac, the percentage of profitable customers has been steadily rising--and so has their loyalty--as the bank and its clients jointly invest in the value of the relationship.

It is the management of structural capital that is giving off the pheremones of a fad, because it's here that humankind's ingenuity has created something to sell: "knowledge management." It could be "the next big thing," The Wall Street Journal presciently told readers late in 1996, a few months before this book appeared. Knowledge management has become a multibillion-dollar software and consulting business, growing in a startling pace. It has attracted the talents of the consultants in all of the Big Six (or Five, or Four) professional services firms and of programmers for dozens--make that hundreds--of software developers. Says Thomas Davenport, a professor at Boston University who was the first proponent (and then the most thoughtful critic) of reengineering and has also been one of the first and best advocates of knowledge management: "Old reengineering consultants are coming up to me and asking, 'How do I get into knowledge management?'" On his way to the spring 1998 International Human Resources Information Management convention, Tom came across a magazine devoted to knowledge management that, he said, is in fact a magazine about digital imaging, simply retitled.

Fads aren't necessarily bad. Fads extend--then distend--the boundaries of ideas. It is from their excesses that we learn to do things we could not have imagined doing, and learn what not to do--preferably from other people's mistakes rather than from our own.

There are a couple of mistakes already in evidence.

First, too much of what passes for knowledge management is just glorified data processing. On page 71 of this book, I briefly distinguish between intellectual capital and intellectual working capital. This distinction was a new idea to me--it came to me while I was working on the proofs of the book. In the past eighteen months, I've come to think it's a valuable distinction, and especially important to keep in mind as knowledge management becomes the rage. Intellectual working capital is workaday information--the flow or torrent of data, facts, meter readings, and so forth. Of this stuff, I wrote, "A worker might need precise, up-to-date information at any given moment, but not necessarily at this moment. What he does need, at every moment, is a way to get the data he might need at any moment."

Implicit in those somewhat knotty sentences is a truth that might be lost in some corporations' full-throttle rush to "do" knowledge management. Intellectual working capital should not be managed the same way as intellectual capital. It wants different aims, different measurements, and possibly different means. These pieces of information are to the New Economy what inventory and receivables are to the Old Economy. Working capital is a Bad Thing. It is a cost to be minimized, not an asset whose value should be increased. It is not to be stored but to be kept moving. Intellectual working capital is a through-put, cycle-time, inventory-management problem.

Knowledge management advocates correctly decry the wastefulness of constantly "reinventing the wheel"; one way to do that is to create a digital warehouse in which is stored every wheel anyone has ever invented. But that dream--the dream of a corporate master file, an encyclopedia where every needed fact, every policy, every conceivably valuable piece of knowledge can be found with just a few clicks of the mouse--is both impractical and wrong. Impractical because technology and markets are changing so quickly that it would be impossible to possibly create such an omnium-gatherum of corporate brainpower, unless one is willing to spend such enormous amounts of money setting up and maintaining the encyclopedia that it will not be worth the effort. Wrong because that's not the right way to do warehousing--unless your company's value proposition is to be a storehouse for knowledge, as a silo is for grain. One wants the smallest possible warehouse, which stocks only what's otherwise hard to get in a timely way. Knowledge management and knowledge databases should really be about linking people to people to serve customers, people needing expertise with people who have expertise. They should be about connection, not collection.

I see a second mistake being made by advocates of knowledge management. Too often they focus inside companies. Much of knowledge management has been an inside job, automating and animating the files. It's hyperlinked, hypersonic librarianship. Too little is about serving customers. Consultant Stan Davis points out that business people frequently confuse an organization with a business. Organizations are defined from the inside out: They are described by who reports to whom, by departments and processes and matrices and perks. A business, on the other hand, is defined from the outside in, by markets, suppliers, customers, and competitors.

There is money to be saved by improving knowledge management in the organization. But there is money to be made by managing the knowledge of the business. What is the knowledge customers are paying for? Real customers--not phony "internal customers" but people with money in their hands? It's their money that is important, not the money the budget committee has allocated to knowledge management.

This inward focus may have come about because the two groups most often charged with knowledge management are staff functions--human resources and information systems departments--with little direct contact with customers. In some companies they are even rivals, whose fight over the agenda is really a fight to get control of the budget.

This makes me nervous. Both HR and IS are beleaguered. HR is under pressure to cut costs and to show that it can deliver hard business results, not just kerfluffle about "being change agents." IS is a money pit. When old whiners find a new battle, watch out. Nothing in corporate life is more dangerous than a staff function looking for work.