Exploring the Value Of Your Innovation Capital

Innovation Capital

Following on from my last post of “Place your future bets- invest in Innovation Capital” which outlined the significant contribution innovation capital plays in our economic growth, let me offer some further thoughts on its value to really capture and understand, so we can measure it within our organizations.

We have the three components; of physical capital, knowledge capital and human capital that are the innovation-related assets, these make-up Innovation Capital.

I have been arguing that innovation capital draws from the core of intellectual capital and its suggested (and broadly recognized) components of human, structural and relational capitals or social capital. I have previously discussed this converging up, as the ‘nesting effect’

Innovation capital needs assessing and measuring so we can understand the relationship between this innovation capitals (and its present and future potential) and organization performance. We need to know the innovation capital ‘stock’.

Why, well ‘stock’ can be ‘static’ and we need to make this more ‘dynamic’ so innovation can ‘flow’ from this constant renewing of our capitals and be transformed into new value.

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Place Your Future Bets – Invest In Innovation Capital

Value of Innovation CapitalRecognizing the value of our innovation-related assets is where the ‘smart money’ should go. To gain growth and to improve productivity is through innovation. We need to translate knowledge into new values.

When you pause and consider the make-up of Innovation Capital you realize it makes such an economic contribution and  in a report from McKinsey & Co, they have set about identifying this to produce the above summary, covering 16 countries, to understand the real value of this Innovation Capital.

These numbers are big and still don’t fully capture everything associated with innovation as much remains ‘hidden’ or ‘attached’ to other activities as well.

We need to shift our thinking on what makes up Innovation Capital

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Innovation requires the nesting of all capital

Nested capitalsInnovation cannot exist without all the capitals that contribute to its make-up. Yet we simply fail to appreciate all the capitals that innovation requires. It is a real pity as they are truly nested.

Equally many innovators are simply not prepared to put in the necessary work to achieve this understanding and the organization’s innovation looses out, stuck in perpetual incremental mode, lacking in anything really new or radical.

All the capitals ‘fire’ innovation. They make innovation combustible.

More often than not when we talk within business of capital we tend to default to the financial kind. Of course providing the financial capital into innovation is vital; it provides the potential ‘burn’ but what is often understated and certainly under-appreciated is the other capitals. These have been ‘tagged’ under intellectual capital or are often ‘lumped’ into our intangible assets.

What we need is to recognize the real “nesting effect” all our capitals.

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Visualizing the innovating future through narrative reporting

The push for narrative reporting

How do we capture all the activities that have the potential to generate wealth within organizations?  Most remain hidden as they lie within out knowledge-based capital. This the second part of two posts (part one here) discussing our need to capture and report on ALL our assets, both the tangible and intangibles.

Knowledge-based capital today is more important to understand in its make up than often the reported financial numbers. One generates the other and investors need to see what goes into an organizations knowledge capital to provide them with continued confidence or not.

Recently the OECD provided an extensive report on “Supporting Investment in Knowledge Capital, Growth and Innovation

I spent a fair amount of my time this last Saturday working through this document from the OECD. No, it was not because I had nothing better to do, it was simply because it ‘points’ towards one area I totally believe needs resolving, capturing knowledge and where it resides and how it works. Then we can begin to place increased focus upon improving the capabilities and capacities we all need for innovation to do its necessary work, that of regaining our growth and vitality in many markets. The problem is we often do not know which are the most valuable or critical to focus upon.

Also if we can capture this understanding well, the recognition, once and for all, that people and what they do is vital and often completely undervalued. The recognition of the importance of our intellectual capital we might begin to create more of the environments necessary to nourish it. To allow this ‘creating’ to take place more effectively than today and value it for what it truly provides.

The present impasse in grappling with this knowledge generating side within our business organizations has been a lack of regulatory requirement to disclose that much around any knowledge generating activity for fear of ‘revealing’ the competitive advantages. What is discussed is only what management chose to provide for giving a ‘certain gloss’ to their reporting or unyielding probing by interested parties.

Certain countries, especially in Northern Europe have been able to make far more headway on getting intellectual capital statements recognized and part of a annual reporting but these are still not easy to align and compare. Knowledge-based capital is far too important not to understand today. Yet we avoid embracing the idea, we prefer to reject this type of asset and capital reporting with cries of “too difficult”

The movement today is towards narrative formats

How can we move forward? The suggestion is narrative reporting. Generally speaking, narrative disclosure can take several forms: companies can publish an Intellectual Capital Statement or include a description of their intangible assets in the Management Discussion and Analysis (MD&A) section or the report on environmental, social and corporate governance (ESG) and sustainability.

What is recognized is that narrative reporting need not be purely qualitative. It can include some form of valuation. There is on-going argument this might be based on KPI’s tailored to an industry but realistically very few report on recognized KPI’s, comparable with others in their industry or field. Also how would you tackle differences in national approaches. Standardising our reporting has never been easy and when you contemplate ‘capturing’ more intangible aspects, it gets significantly harder. Yet we must try.

There is a movement towards sustainability reporting as the basis for these narrative reports. For instance the Global Reporting Initiative. (GRI). This is seeking a broader acceptance of what can make up a more integrated reporting framework. Discussions have a long way to go to bring in the harder, less tangible aspects though.

Narrative formats have both risk and benefit to report upon.

Investors chase for a better understanding of what is actually going on within organizations. Organizations push back, yet attracting fresh and on-going investment is the life blood, so some form of ‘uneasy dance’ takes place while you have no regulatory guidelines or enforcement.

Information gaps are increasing, sometimes for both the investor and the manager fail to be identified and recognized, as serious warning signals. Many get caught in this inability to identify ‘what makes up’ the organizational capital and lose their investments or jobs from this lack of appropriate understanding.

Strategic and operational weaknesses need to be ‘jumped upon’ very quickly, if spotted, yet the more intangible ones often remain hidden to investors and even management and what effect this might have. High profile people, when they leave create these tensions and performance concerns. Can you imagine if you have a real drift of your talent walking out of the door, what that does to future performance?

Achieving a greater transparency

We need to have a more transparent understanding of the value of people, of the systems, dependencies, relationships and these make up intellectual capital. The push for achieving better board governance and effectiveness does push the board to question more and more, in the depth and breadth of information they receive and act upon.

The arguments for putting in place more effective narratives of performance that connect across the business in more coherent and effective ways, surely reputations are enhanced? By thinking about ways to align reporting and communication strategy, the ‘being forced’ to collate a coherent set of narratives and contextual information has market attractiveness advantage. It gives growing confidence. So where should the unit of assessment take place?

Stating value creation and business models has the narrative potential

One view I particularly favour has been outlined by Vivien Beattie and Sarah Jane Smith in their academic paper “Value Creation and Business Models: Refocusing the Intellectual Debate” We should focus on the business model, even for our intangibles or by extension our knowledge-based capital. I think this is absolutely right.

The business model and how we can describe it has become more ‘top of mind’ and significantly improved in its place through visual tools like the Business model canvas by Alexander Osterwalder and Yves Pigneur- Equally a number of other visualizing techniques, caught up in this canvas modelling movement, such as the culture mapping canvas, business opportunity canvas or the different value proposition discovery methods, have the incredible potential for the most powerful way for narrative reporting to make a business come alive.

Today the people side, or the articulating of the value of the intangibles, is not adequately addressed in these canvases we have. We need to bring them into telling the business model value story far more.

We need to tell the value creation story

The business model should be articulating how the company will convert resources and capabilities into economic value. It is the ‘transformation’ of resources into future potential value that tells us the “why and how,” in their potential, to decide to  invest or not, to believe in or not.Venture capital always looks extremely hard at the team within any start up or needing new capital. They seek to go under the bonnet and know what is making this ‘opportunity’ tick or not.

Financial statements are totally inadequate to evaluate today’s business

By not capturing the intellectual assets or all the knowledge-based capitals we are left with a totally out of date, inadequate set of financial statements. These today  totally fail to inform those on the outside as well as often those inside at the top of organizations, where the real wealth creation aspects lie.

We live far more in a knowledge based world that is generating more today than our physical assets yet we lack the ability to clarify this. We need measures, frameworks and clarity on where the knowledge lies and its make up in ways that capture these and can describe them effectively focusing upon the vale creation points that will exploit future opportunities.

The Business Model can be the crucial focal point, even more than today

We need to push for at least obtaining a narrative description of the knowledge-based assets and there is nowhere better than how organization’s management perceive their business models, what and where are the drivers and value propositions and how they are communicating on their strategies and value creation and the essential enablers of this.

Incidentally with effect from 1 October 2013 in the United Kingdom, organizations will also have to prepare a strategic report as a result of changes to the narrative reporting framework in the UK, intended to increase the quality of narrative reporting and introduce a clearer reporting structure. Can this go further?

We do need to refocus many of the fragmented debates around knowledge, our intangibles and intellectual assets and for me there is no better place than lifting this up to where the business model tells the compelling story or not.

 If not, then don’t expect future investments, you will not deserve them.

Part one – the background. Pushing towards a new frontier- visualizing the future

Pushing towards a new frontier – visualizing the future.

We all know that innovation is hard to measure. Assessing innovation capabilities can be particularly hard as they are made up of so many intangibles. We need to frame these capabilities in much better ways, as they mostly remain shrouded in mysteries to render it difficult to know what each business actually needs to  invest in, to achieve their goals. Knowing what and where they need to improve their innovation capabilities becomes a critical need to know point for gaining unique competitive advantages.

So much of innovation activity is left to chance and it leaves all involved as vulnerable, open to being beaten to the next ‘big’ innovation breakthrough. I would strongly argue that organizations should build their innovation capabilities in systematic ways, yet few do, let alone understand what this truly means. We simply need too.

Understanding the ‘beating heart’ of organizations

One of the biggest gaps is trying to put a finger on the pulse of what makes up innovation. So much of the capabilities are intangible, locked up in those intellectual capitals of the organizations. Those that center on  people, their networks and relationships, the make-up of the structures that support their activities or restrict them, the ability of applying good or bad practices, the every day routines of each of the individuals that work within the organization.

These touch the very nerve center of organizations; you are striking at the very core of organizations, those intellectual combinations they make up so much that determines organizational performance. They expose or they enhance organization performance.

To some degree management wants to be able to measure these intangibles but it also can provide some ‘chilling and damning’ evidence of inefficiencies and managements lack of ability to really improve internal performance, let alone market performance. It is usually the external factor, of poor market performance, kicking in that galvanize the need for internal change. This then becomes reactionary, often too late and market advantages can quickly dissolve.

Knowledge-based capital needs fully capturing.

The critical need today is to capture the rise in the importance of all the knowledge-based capital aspects. Business organizations are recognizing knowledge-based capital.

Knowledged based capital

Knowledge-based capital is critical. As shown above it is becoming more important than the product. Organizations are recognizing the value of knowledge.

Were you aware that the value of many of the world’s most successful companies resides almost entirely in their KBC. In 2011, for example, physical assets accounted for only about 13% of the value of Nestlé, the world’s largest food company. (source OECD)

What is knowledge-based capital?

OECD describes it as such: Knowledge-based capital comprises a variety of assets. These assets create future benefits for firms but, unlike machines, equipment, vehicles and structures, they are not physical. This non-tangible form of capital is, increasingly, the largest form of business investment and a key contributor to growth in advanced economies.

One widely accepted classification groups KBC into three types: computerised information (software and databases); innovative property (patents, copyrights, designs, trademarks); and economic competencies (including brand equity, firm-specific human capital, networks of people and institutions, and organisational know-how that increases enterprise efficiency) (Corrado, Hulten and Sichel, 2005).

Knowledge-intensive is the new wealth creator

As products are becoming more knowledge-intensive, educations have produced knowledge aware and savvy employees. We are pushing outside our one organization into growing networks to collaborate where this is this consistent acceleration of new information and use of communication technologies all intensifying the need to manage knowledge. Knowledge is today’s valuable commodity, yet we poorly measure it.

Equally, knowledge-based capital is essential to investment decisions and where the potential for growth can lie. The use of data analytics, external networks, outsourced R&D and our changing management practices are reinforcing that organization change is needed, yet we are not sure on where to invest or how to structure these. We are poking around a little bit too much. More like searching for the needle in the haystack, rather than controlled experimentation and exploration.

Ben Bernanke, the chairman of the United States Federal Reserve, suggested within his speech at a conference on the New Sources of Growth project in 2012 : “As someone who spends a lot of time monitoring the economy, let me put in a plug for more work on finding better ways to measure innovation, R&D activity, and intangible capital. We will be more likely to promote innovative activity if we are able to measure it more effectively and document its role in economic growth”

Are we advancing our understanding of knowledge-based capital?

The good news today, is we are seeing some advances on capturing and measuring knowledge-based capital. Recently the OECD produced one of its usual 300 page plus reports – so few read them – on “Supporting Investment in Knowledge Capital, Growth and Innovation

This report summarizes OECD’s attempt to provide the evidence of the economic value of knowledge-based capital and to help meet the policy challenges it raises. These are across the areas of innovation, taxation, entrepreneurship, competition, corporate reporting and intellectual property. Something that is not easy to summarize at all, as all have simmered away under different ‘doctrines’ and ‘churches’ of denomination, pursuit and faiths.

Learning to communicate our understanding of our real internal value

We do need to find better ways to unite and describe the value creation that knowledge-based capital brings. In particular our intellectual and organization capital and the importance this has to have sustaining investment put into it for future wealth creation

Part two discusses the suggested way forward, through narrative reporting. I believe this should also be through the broader narrative of the business model as the medium for this as we slowly open up in our (long await) acceptance about the importance of our intangibles and the contributions made through these knowledge-based contributions.

Part two– a way forward. Visualizing the innovating future through narrative reporting concludes.