Thought Leadership

Mind over matter

The Economic Times, December 15, 2006

Guru speak:

In the knowledge economy, wealth is all in the mind says Leif Edvinsson, uber-guru of the Intellectual Capital movement. Finance chiefs in Mumbai might find him less than endearing, but in the knowledge city of Bangalore, Leif Edvinsson is an instant hit.
“Why should a CFO have so much power when he is in charge of only 20% of the company’s assets?” he demands to know, eliciting happy smiles and a mild round of applause from his audience. The Swedish professor is one of the founder leaders of the global Intellectual Capital (IC) movement, which believes that IC- defined as the factors not shown in the traditional balance sheet, but which are of crucial importance to an organization’s future success– needs to be measured, accounted for and reported. Consider this: in 1980,book value accounted for 80% of the market value of the companies in the Standard & Poor index, but now the figure is down to 20% - which is where Edvinsson’s dig at CFOs comes from.

Indeed, the figures for the top ten companies in the ET-500 list show that Indian stock markets give even less weight to book value (see table: India Inc’s Intellectual Capital). Book value accounts for less than 10% of the market cap of India’s top three IT companies, with IC making up over 90% of their value. Market analysts view this premium over the book value of a scrip as a company’s potential to perform in the future, but it’s a calculation shrouded in mystery. The accounting profession, meanwhile, has traditionally seen IC as an intangible that cannot be accounted for, rather rudely referring to it as “wasting assets.”

Edvinsson believes that IC is much too important to be so ignored and much of his work over the past decade has been dedicated to creating a system to measure a company’s IC, as a combination of its human capital, internal systems and external relationships. “IC has come to be the prime creator of economic value,” he says.” If it is not transparently accounted for, sentiment rules the stock markets and volatility results.”

Denmark has already made IC statements a mandatory part of corporate reporting, while Germany and Japan are preparing guidelines on how IC should be audited to give a clearer picture of their economies. Last year, the EU set up an expert group on IC reporting, which works under the rather colorful name of The New Club of Paris. A founding member of this club, Edvinsson envisions a future where IC will be the world’s primary measure of wealth. Today, world trade is mostly in the form of financial services and the share of physical products is down to less than 10% - the next phase, he predicts, will be trade in thought. “We’ve spoken the language of financial accounting for thousands of years. In the knowledge economy, we have to learn the language of knowledge economics,” he says.

American household consumption figures provide Edvinsson with another example of how knowledge economics works.

Americans spend more on intangibles than tangibles and the bulk of this is on higher education. So any policy that reduces American consumption would end up reducing its IC, which is something no country would want. India, of course, is a prime example of a country that has benefited from its investments in higher education, which have propelled it into the knowledge economy.

So how does a nation build upon the IC of organizations and create an innovative society? In his latest book Intellectual Capital for Communities, Nations, Regions and Cities, Edvinsson has taken the theory of IC beyond business to whole nations. The best companies have created knowledge management systems that convert their human capital to organizational IC. The next logical step is for city communities to leverage their organizational IC into regional IC.

Edvinsson says that cities, which were traditionally developed to support the trade flow of goods, must now be reconfigured for the trade of ideas and intellectual assets. Urban design then becomes critical to attract and support creative people to come, work and live in such areas. “The cities with the highest IC concentration are not necessarily the megalopolises, but smaller places like Zurich and Vancouver,” he says, “These are peaceful, well connected, wealth creating cities with high grade educational systems.”

Now a professor at Lund University, Edvinsson started his career as an accounting professional, which gave him an insider’s view of how inadequate traditional accounting can be when it comes to capturing the value of a firm. In 1991, he was appointed director for Intellectual Capital at Swedish financial giant, Skandia, which became the first company in the world to compile an IC report into its annual financial report. Edvinsson then went on to set up Intellectual Capital

Sweden (ICS), a consulting firm offering corporate IC rating services based on his model and he’s on the boards of several European companies working towards producing IC reports.

In the ten years of its existence, ICS has spread its reach through a series of global partnerships, the latest of which is a tie-up with Bangalore-based Bizworth, a firm set up by four consultants, all of whom happen to have a background in finance. Bizworth has IC-rated four companies over the past year (the first was MindTree Consulting) and Chairman S.R. Gopalan, who was earlier the head of finance at Wipro, expects the concept to take off in a major way. “IC is especially important for Indian companies for whom limitations in financial and physical capital can best be counter-balanced by leveraging intellectual assets,” he says.

Meanwhile, Edvinsson, after addressing a CII seminar in Bangalore, is using the trip as an opportunity to check out the city’s potential to become a global IC hub, the very visible infrastructural constraints notwithstanding. He says Bangalore needs to model itself on Silicon Valley. “Bangalore is just too big. Just like Silicon Valley is ten different cities, Bangalore needs to be split up into ten manageable areas.”

For more information contact SR Gopalan at +91 80 41142626
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