Organizations have been focused for far too long around the importance of financial capital. It determines and drives organizations destinies. We are caught in a constant focus upon our achieving a return on our (financial) capital as our measuring criteria. Organizations strive for improving their ROCE, RONA, IRR, EVA and a host of other financial measures.
As Clayton Christensen has been arguing the agenda of organizations begins and ends with the “search for numbers”. I think there is a time for changing this, we need to search for the knowledge that makes-up eventually the numbers.
There has been a distant voice for some time putting forward the need to appreciate and value the other capitals sitting within organizations. Much of the discussions have been housed under the term “intellectual capital” which denotes the sum of knowledge made up and contributed by our human assets, our organizational structures and our relationships that are developed. These are the ‘capitals’ that transform into economic value through organization action. It is the financial capital that simply finances this.
Financial capital dominates any discussions
Yet financial capital and all its associated aspects rules, no, it utterly dominates. It totally fails to tell us in numbers alone where and what creates the value, it simply reports it. It is this financial capital through our profit and loss, our balance sheets hides the value, or spreads it out in ways no one really understands its make-up.
Certainly those attempting to judge an organization just have to rely on a ‘history of numbers’ and some ‘selective’ market view to make investment judgements. Equally those often running our organizations have a restricted view of where their real capital lies, as they focus on the numbers and then work down.
Today, in a rapidly changing world, the reliance of financial capital being the absolute measure is being challenged thankfully. Our business world is facing considerable disruptions from the accepted past practices, performance has become more volatile, more dynamic, more reliant on understanding that knowledge is where the value lies.
“Business as usual” is thankfully in steep decline, the necessity today is to be constantly evolving and learning and that comes from knowledge acquisition, assimilation and then transforming and exploiting this into new value. These ‘absorptive capacities’ are where we need to direct our understanding of new, value creating capital. We need to report on these far more as they offer the ‘residing’ value.
Learning capital needs to emerge and dominate future discussions
We need to give increasing incentives for organizations to learn. We need to judge the quality of this learning, not listen to ‘bland’ statements often presented. We need to know where this knowledge is targeted in narrative, discussions, spillovers and interactions. What is being exploited, what is being determined in the decision-making process to give greater confidence that our invested financial capital is “in good hands”.
Keeping reliant on just discussing the financials within organizations we know is not enough. We have to force better discussions on the make-up of the other capitals, as these are still poor, left to individual interpretation and variable and we need to change this.
As organizations become more open (open innovation for instance) the strength of linkages, of knowledge exchange, the translation of these activities is becoming really valuable to understand and focus upon more. Through many of our activities we actually ‘borrow’ and it is then the ‘dynamic linking’ that we bring into the process, gives up the increased potential of innovation. It is the ease of learning, the ability to acquire and apply knowledge that creates the potential for innovation.
How many organizations really articulate their knowledge capital in acquisition, assimilation and transformation? Do we know how ‘path dependent’ they are- are they lagging in the market, are they simply opportunistic, are they locked-in far too much in potential downside risks. Do they suffer from cognitive failure, do they lack the appropriate competencies to meet the constant challenges occurring around them. How much of this can you really extract from cold, hard numbers? Not a great deal.
Recognizing where our true value resides
The real problem we have is the lack of appreciation of what makes up our value, the real underlying wealth creating value, the one that truly ‘generates’. The tangible part is easier to appreciate (plant, land, material etc.) but is becoming a significantly declining part of the total sum of value of our organizations- sometimes it is only making up 30 percent.. It is our difficulties of understanding the intangibles as it is a very challenging task. Yet this has huge implications on the ‘health’ of the organizations we continue to invest in. Most organizations resort to “inferring” the value. This needs to change. The value today is in the interactions between the different components that make up our intangibles, out intellectual capital.
We are in need to identify what ‘drives’ organizations for gaining and sustaining real advantage, and showing why it has the potential for creating new wealth. This needs to be far more forwards looking; it needs to be more open and more transparent. The call is growing increasingly for a new valuation model. Static knowledge where we view financial numbers is just not good enough, we do need to understand the underlying dynamic capabilities that make-up the organization.
Conflicting signals of what makes up intellectual capital dominate still
The same old problem exists today that has plagued the concept of intellectual capital and its promotion. The community that has been arguing for this as a measuring of the real value of an organization remain divided, locked in their own interest and models; the conflicting nature of these different views has held intellectual capital back. Organization management will never invest the dedicated time and interest unless they see some level of coherence and understanding that can be translated into an actionable framework.
There have been many attempts but nothing has really changed our traditional reporting of financials with some (restricted) board discussions. Organizations are hiding under rocks, taking cover from the potential relentless sun that would force them to adapt. We need to change this.
Some change might’ be in the reporting air
One organization attempting to radically alter this current (one-eyed) reporting we have today is the www.theiirc.org proposing their integrated reporting mechanism, where they are shifting the focus more to where value creation lies. They argue this will improve the quality of the information available to provide for a more efficient and productive allocation of capital. It promotes a more cohesive and efficient approach to corporate reporting that draws on different strands that cover more fully, the factors that are materially important.
The focus is future orientated; it pushes to gain a connectivity of information, in all the capitals and their dependences, and seeks the ability to have integrated thinking that account for the (changes in) connectivity and interdependencies. It expects a greater understanding of how the organization tailors its business model through its activities, performance and outcomes in its use of all the capitals.
The key for the IIRC has been to seek out the connectivity of information flows into the management reporting, analysis and decision-making so internal and external reporting has this integrated reporting as required.
Are we on the cusp of a real change in reporting?
Are we going to see this initiative gathering momentum in the coming years? It does seem so as the detailed guiding frameworks in understanding all an organizations capitals, of the thinking behind business models and capital have been piloted and tested and recently published. I have written on it here in my “shifting attitudes, thinking responsibly” post.
All I hope, no fervently wish, is that the intellectual capital community comes together and can find the same determination to provide greater understanding of the capitals, so this integrated reporting gains even greater momentum and paves the way for improved understanding of the real value that resides in our organizations.
There is a time, and that surely is now as the right time, in coming together over a recognized ‘standard’ definition of intellectual capital and its organization measurement. What must stop is the continued pushing individuals narrow views of what makes up our capitals but to focus on what our customer needs. Those measurements, which may not be perfect but ones our business organizations will engage in, invest their time and establish the structures to capture those aspects that make up the Intellectual Capitals (IC).
Organizations need to feel utterly comfortable in deploying emerging guidelines so as to understand, test, develop and talk about their capital and the residing values it offers by deploying it through their ecosystem of connected parties. Offering conflicting ideas or frameworks is never welcome within organizations, they want to feel comfortable in investing and backing in the one that they ‘feel’ the winner.
We urgently require a common standard in approach for measuring all our organizations capital.
Measuring often many intangibles is for many very uncomfortable territory, until the approach becomes ‘standard’. If those within the IC community continue to offer conflicting advice, organizations are very reluctant to commit.
Can the IC community come together and give them a clear model to work from? Please, or will it be eventually taken out of those existing hands, passed into the hands of a new, more business savvy group of individuals that can ‘piece together’ capitals in a way organizations will actually welcome and adopt. To encourage acceptance you need clarity, a common understanding and approach, then the value potential begins to emerge with any adoption , because it offers clear language and common measurement instruments that organizations understand and can work with.
It is a growing imperative to gain a common framework to measure the sums of all our capitals.