Creating a European system for reporting intangibles

Last year, Athena Alliance was part of a team studying the feasibility of creating a European system of data collection on the intangible assets of enterprises. The final report, prepared for the use of the European Commission, Enterprise Directorate General, is now available on their website at their “papers” page or at their “announcements” page.
Athena Alliance’s part of the project was a look at the history of the US financial reporting system and at the American experience specifically reporting intangible assets. We will be publishing a separate report on reporting intangibles in the US in the near future.

Urge to merge

The recent business headlines have been dominated by big firm mergers. First was Sprint and Nextel (following on the Cingular – AT&T Wireless merger). Then Procter & Gamble buying Gillette. Now, the talk is about SBC absorbing AT&T. What is going on? Wasn’t this new economy supposed to be all about networks and free agents and agile virtual companies? So, why the continued combination to create even larger companies?
In today’s Christian Science Monitor, Ron Scherer offers a set of explanations for “Why businesses are once again keen to merge”: 1) excess corporate cash, including the repatriated overseas earnings allowed under the latest tax bill, and 2) continued global pressure.

Corporations are embarking on what is being called a “new wave” of mergers. Although this may result in tens of thousands of layoffs, it may also mean that the improved efficiencies are passed on to consumers. It’s too early to say how large the wave will be compared with the late 1980s, when hostile mergers dominated the news. But they are likely to become more common, since US companies have more than $1 trillion in cash.

“What we are seeing is that as you get late in the economic cycle, companies look for alternative ways of growing their business,” says Fred Dickson, chief market strategist at D.A. Davidson. “Companies loaded with cash have to put it to work or face screaming shareholders.”

. . .

The mergers are also increasing because of competition from abroad, says Anthony Chan, managing director at JPMorgan Fleming Asset Management in Columbus, Ohio. “The race for efficiency is on,” he says. “It’s driven by globalization pressures: China has such low labor costs that US companies have to be able to compete by improving efficiency.”

I agree that companies sitting around with lots of cash are likely to try to buy other companies. Expansion by acquisition is supposedly a tried and true method. But, as the story points out in its closing paragraph “some of the mergers in the past haven’t worked too well because of different corporate cultures.”
Thus, I hope that we are not in a new conglomerate building phase. Acquisition for the sake of acquisition is bad corporate strategy – and bad public policy. Far better for those funds to be channeled into innovation and the development of new products and services. But our anti-trust (competition) policies don’t cover dumb corporate investments – only those that restrain competition. Other policies are needed to promote business combinations that foster innovation.
Such a combination may very well be what is happening in the case for the P&G/Gillette merger. This is an example of an innovative company expanding its product line by acquiring another innovative company. I doubt very much that the merger would produce the orders of magnitude in efficiency needed to compete with the low wages in China that Mr. Chan of JPMorgan talks about. Synergies of innovation are more at work here than just economies of scale.
I fear, however, that the mindset of increased efficiencies and economies of scale are still predominate in the boardrooms, Wall Street and Washington. That is well and good within limited parameters. But the real question in the intangible economy is not efficiency but innovation. How we help create synergies of innovation should be at the top of our economic policy agenda.

A civil service for the intangible economy

The Bush Administration yesterday unveiled it new civil service regulations for the Department of Homeland Security, with plans to expand the system to the rest of the government. (See today’s Washington Post story “Civil Service on the Way Out At DHS” and the DHS Press release.) [Note: if you remember back, this was exactly what the major fight over the creation of DHS was all about: that the workforce provisions were a stalking horse for government-wide changes.]
The responses were predictable. The changes are touted as necessary to get rid of outmoded regulations and move the government into the 21st Century, and denounced as an attempt to eliminate worker protections.
I have not analyzed the new regulations in any depth. However, I remain skeptical whenever I read that one of the goals of the change is “expanding management rights.” For all the rhetoric about “our people are our most important asset,” workers are still most treated as an expense – a cost to be minimized. [Of course, except at the highest level of the corporations, where money is no object in recruiting talent. But that that is another issue: the myopia that “talent” is only at the top or in specialized positions].
Thus, when I hear people talk about the need for greater “flexibility” in the labor force, I have to ask, “flexibility for whom?” Are we talking about greater flexibility for management to rearrange labor resources? Or are we taking about flexibility that truly empowers workers by freeing them from unnecessary, outmoded and constricting rules and regulations? Some degree of former type of flexibility is necessary to adapt to changing economic conditions. But, that type of ultimate management flexibility can easily degenerate into arbitrariness.
Some years ago I did work on “high-performance work organizations” — organizational structures where front-line workers are empowered to make decisions and take action rather than simply act as drones following someone else’s orders. What is desperately needed is a set of workforce policies to implement this type of organizational structure where workers can utilize all their skills and knowledge. If workers are our greatest asset, why do we continue to waste that asset by not allowing them the flexibility to act?
When judging these new regulations, I believe we must pose this basic question: are these really 21st Century intangible economy regulations to empower employees and foster the best possible utilization and development of their skills and knowledge? Or are they 20th Century industrial age regulations simply to give management a freer hand to minimize the cost of labor as an input of production? Those are two very different sets of regulations – and we need to be able to tell them apart.

Losing brand value

Chuck Martin’s On the Mind column in the latest issue of Darwin Magazine had an interesting story on how to lose brand value. He talked about the difference in service between his local Mercedes-Benz dealer and his Ford dealer. As you can probably guess, the Mercedes dealer showed a complete lack of interest in customer service:

Even while some companies can focus on creating and delivering great products at the right price, all that effort can be wasted if not properly handled at the local level. This is a version of the concept of thinking globally while acting locally.
The relationships and the competition in each marketplace can be totally different, requiring different approaches, as appropriate. The same holds true for delivery and service of national products at the local level. And the irony is that actions at the local level can impact perceptions of the global brand, at least within a given market.
As a small example, when I had my Mercedes-Benz serviced at a local dealer over the course of a year, most service visits required a second or third visit to complete the repairs. It negatively impacted the brand, at least at a local level.
. . .
By contrast, when I had my Ford serviced at its local dealer, virtually every service experience over the course of a year was positive. I was greeted by name, the service was completed on time and the price was as quoted.

I guess I am not very surprised at the local Mercedes dealer’s lack of understanding of the value of his brand. Too often companies (and local dealers) fail to understand the fluid nature of brands: the top brands today can quickly become yesterday’s also-rans and the lower tier brands can leap to the top. The example of Samsung is a case in point, as we discussed in an early posting.
As Chuck points out, the rise of hype-fast communications networks (not just the Internet, but phone text-messaging creating “smart-mobs”) raises the stakes for brand management. Look at what happened to the value of Coke stock globally after an isolated incident in Belgium.
But the issue is more than just how a local perception affects a global brand. Maintaining brand value is a constant struggle between upholding universal standards (corporate HQ “total control”) versus localization of the product and service. McDonald’s has always been the old text book case – a standardized product (reinforced by training at McDonald’s University) with permitted local variations (non-beef patties in Hindu India, use of peanut oil for fries in SE Asia). If the local variations are not allowed, then the brand risks local irrelevancy. This loose-tight organizational dynamic is one that every company needs to master, especially as the services part of the value-creation equation becomes more and more important in this intangible economy.

Deficits, deficits and more deficits

The Intangible Economy doesn’t mean an economy that is intangible. It means an economy powered by the value created by intangibles (knowledge, innovation, technology, skills, etc). It can not exist “in the air” but grounded in both physical resources (tangibles) and financial resources.

Now we have the latest deficit projections from the Congressional Budget Office (as reporting in the Wall Street Journal):

As details of President Bush’s new $80 billion request for wars in Iraq and Afghanistan were emerging Tuesday, Congress’s top budget analyst projected $855 billion in deficits for the next decade even without the costs of war and the administration’s Social Security plan.

. . .

The projection, for the years 2006 through 2015, is almost two-thirds smaller than what congressional budget analysts predicted last fall. But the drop is largely due to estimating quirks that required it to exclude future Iraq and Afghanistan war costs and other expenses. Last September, their 10-year deficit estimate was $2.3 trillion.

The CBO now also projects this year’s shortfall will be $368 billion. That was close to the $348 billion deficit for 2005 it forecast last fall. If the estimate proves accurate, it would be the third-largest deficit ever in dollar terms, behind only last year’s $412 billion and the $377 billion gap of 2003.

Besides lacking war costs, the budget office’s deficit estimates also omitted the price tag of Mr. Bush’s goal of revamping Social Security, which could cost $1 trillion to $2 trillion and dominate this year’s legislative agenda. Also left out were the price of extending Mr. Bush’s tax cuts and easing the impact the alternative minimum tax would have on middle-income Americans, which could exceed $2.3 trillion, the report said.

As every economist worth their salt has been saying, this trend is unsustainable. This morning’s Financial Times of London ran a story on how foreign central banks are moving away from the dollar as a reserve:

Central banks are shifting reserves away from the US and towards the eurozone in a move that looks set to deepen the Bush administration’s difficulties in financing its ballooning current account deficit.

In actions likely to undermine the dollar’s value on currency markets, 70 per cent of central bank reserve managers said they had increased their exposure to the euro over the past two years. The majority thought eurozone money and debt markets were as attractive a destination for investment as the US.

A major intangible asset of the United States is our credit rating and the financial power of the dollar. With red ink as far as the eye can see, I would how long this intangible asset will last.

Copyright (or wrong?)

Last week, American University’s Center for Social Media released its study Untold Stories: Creative Consequences of the Rights Clearance Culture for Documentary Filmmakers. The report used numerous examples to illustrate how our copyright system has spun out of control. Stories about the reprt in the Washington Post, the Toronto Global and Mail
and Wired appropriately focused on the example of how the famous Eyes on the Prize documentary of the civil rights movement can no longer be shown – because all of the copyright permission for the clips used have expired.

The implications of this “clearance culture” are clear:

These rights practices consume time that might be better spent on the creative enterprise of the film itself, and sap already-strained budgets. More importantly, filmmakers often shape their film projects to avoid the problem of rights clearance, omitting significant details. On some occasions, the avoidance of clearance problems may help to dictate filmmakers’ choices of subject-matter, influencing them (for example) to avoid projects involving current events or modern history – which tend to be minefields rather than mere thickets because strict compliance through licensing is required.

Now, copyrights (and other forms of intellectual property protection) are an important tool for protecting intangible assets. But, as this story points out, they can also become major barriers to the creation of new intangible assets. As any good Schumpeterian knows, the forces of creative destruction need to be able to operate if economic growth is to be sustained. This lesson holds especially true for in the intangible economy where ideas are built on ideas and knowledge builds on knowledge. Finding a new balance between the rights of IPR holders and users will be a major public policy task as we move forward.

One of the places to start is with a reinvigorated fair-use doctrine, which allows use of copyrighted materials for purposes of teaching, commentary and criticism. But, many feel that fair-use provides only marginal benefit and has been gradually whittled away. Larry Lessig, in his book Free Culture, warns of the risks and cost of relying on fair-use as a legal defense.

Another suggestion in the report concerns the creation of a central clearance process – a one-stop shop for obtaining copyright permission. A variation on this is the Creative Commons alternative copyright. Under this approach, authors can pick and choose which rights to retain and which are automatically waived. For example, material publish on this blog utilizes the Creative Commons approach to automatically waive copyright for any non-commercial use as along as attribution is given while retaining copyright control over any commercial use.

All of this is an attempt to find the right mix of protection and use. As a recent article in the USC Annenberg’s Online Journalism Review, “Send ‘free’ to work: Creative Commons brings copyrights into the digital age”, “The challenge for the owners of intellectual property is how to make “free” work for them.” But the task goes beyond making copyright work for owners – it must work for all of us, including for future generations. It would be ironic indeed if in the name of fostering the creation of information, our legal framework conspires to prevent the documentation of the information age.

Thanks to Olga Francois at digital-copyright email list for alerting me to this story. To subscribe to the digital-copyright email list, e-mail:

(mis?) measurement in financial services

One of the tidbits that came out of the Advancing Knowledge conference (see previous posting) was a nice example of how our current thinking inadvertently penalizes investment in intangibles. This is from Bob Hunt, a senior economist at the Federal Reserve Bank of Philadelphia:

The standard efficiency analysis for commercial banks is to examine some variation of the ratio of non-interest expense to average assets.

Bank expenses are divided into two large categories – interest expense and non-interest expense. Interest expense is the cost of borrowed funds (e.g. deposits), but the primary focus is on non-interest expense, which includes such things as the cost of buildings, etc.

One problem with this measure is that banks don’t amortize much of their investments in new products and services, or in reducing the cost of providing existing services. In particular, banks have no conception of investing in research and development. This is all expensed, and it appears in the non-interest expenses of the bank. As a result, a bank that is investing heavily in new products and services may appear less efficient than a bank that isn’t making these investments.

Yet, efficiency is an important measure of the health of a nation’s banking sector and a key economic goal of the financial regulations. It has become clear that financial institutions have been using technology and other innovations to become more efficient. But as Dr. Hunt points out:

Our accounting for this sector is rooted in a very static view of the industry even though there is ample evidence of financial innovation in the U.S. over the last 30 years.

We simply don’t have an accurate measure of R&D performed by the financial services sector. Some recent input-output tables performed by the Bureau of Economic Analysis suggests that this sector produced about $20 billion of software for its own use. Based on the conventional accounting, it appears that nearly all this effort was expensed.

NSF is now generating estimates of R&D in financial services in its survey of industrial R&D, but that is a very recent innovation and it is not exactly clear who is being surveyed and what is being measured.

Any new measure of innovation in the financial services sector would be a welcome step, but can not stop at simple estimated of R&D. As I have argued before, we need a survey of innovation, similar to the EU’s Community Innovation Survey – not just a measure of R&D. At best, R&D is a proxy measure of inputs to the innovation system. At worse, it is a misleading indicator of how well we are doing. We need to do better.

Brands – again

This may fall into the beating-a-dead-horse category, but this morning I picked up my latest issue of The Economist to find Samsung touted as the poster child of brand value in the digital age. Not one of those top US brands that PPI bragged about (see my posting yesterday) but the upstart from Asia.

Samsung was once best known for making things like cheap microwave ovens. In the past few years it has transformed itself into one of the “coolest” brands around, and is successfully selling stylish flat-screen TVs, digital cameras and mobile phones. After a record-breaking year, it is poised to overtake Motorola as the world’s second-biggest maker of mobile phones. And it is snapping at the heels of Japan’s Sony for leadership in the consumer-electronics business.

This would have seemed inconceivable a decade ago. But Samsung has proved that a combination of clever brand-building and well-designed, innovative products can work miracles. In such a competitive market, a brand without good products will quickly fade. But the real surprise is that the opposite is also true. The market is crowded with firms with a few snazzy products, but weak brands. To thrive and grow on the scale Samsung has achieved requires a strong brand, as well as innovative products.

In all fairness I must mention that the Economist also gives a tip of the hat to a US brand: Apple. But the point remains, strong brands alone are not enough to guarantee economic success. Yesterday’s second-string brand may become today’s powerhouse. And today’s health of a nation’s inventory of brands is no indicator of tomorrow’s prosperity.

Brands and trade

My friends at the Progressive Policy Institute sent me an email today with their latest Trade Fact of the Week contrasting two views:

The CIA’s National Intelligence Council last week, in a report on the possibilities of the world in 2020, noted the rapid growth of India and China and wondered about the possibility of an “Asian century.” One piece of evidence is the growing international appeal of Asian popular culture: Japanese anime and manga, Korean music, Chinese and Indian cinema, and so on.
On the other hand, Western business and entertainment brands seem still to be in pretty good shape. Since 2001, the consulting firm Interbrand has joined with Businessweek to publish an annual list of the world’s top 100 “brands,” defined as the likely future earnings of a company name. The brand values range from $67 billion (Coca-Cola) to $2 billion (Polo); they are distributed around the world as follows:

• Fifty-eight of the brands are American, including the top seven and 13 of the top 16. The diversity of the American list is striking: the top 20 U.S. brands range from high-tech businesses Microsoft, IBM, Intel, HP and Cisco; to diversified manufacturers GE and automaker Ford; Disney in entertainment; consumer-goods firms Coca-Cola, Marlboro, Gillette, and Pepsi; fast-food chain McDonald’s; and financial services providers Citibank and American Express.
• Thirty-four brands are European, among these Nokia leads in eighth place. The remaining 33 are split fairly evenly: nine are German, eight French, four and a half British (giving half credit for ownership of Shell to the U.K and half to the Netherlands), four Swiss, three and a half Dutch, three Italian and one Swedish. These are more nationally specialized than the American list: four of Germany’s nine entries are automakers, while Italy’s three members are high-end fashion firms Gucci, Prada, and Armani. The British entries, a bit more diverse, include the Hong Kong and Shanghai Bank, the Reuters news service, two energy companies and a liquor firm.
• Eight firms are Asian, led by Toyota at ninth place, Honda and Sony in 18th and 20th, and Korea’s Samsung in 21st. The other four are Japanese: Canon, Nintendo, Panasonic, and Nissan. No firm on the list is based in mainland China, Hong Kong, or Taiwan. Neither do India, Southeast Asia, Latin America, the Middle East, or sub-Saharan Africa have entries.

While I often agree with PPI’s point of view (and sometimes don’t), I have to take exception with their analysis. Brands are a very, very, very important intangible asset. But they are only part of the value equation. Brands are marketing devices – signals of quality, consistency, etc. As such, they allow a company to capture a higher portion of the value-added.

However, except for those pure service providers, there is still a portion of value in the intangible economy created by the tangible product itself. As our huge trade deficit attests, many of those things being sold under those American brands are made elsewhere, especially in countries that currently have no leading brands on the list (China, India, and Southeast Asia).

If history teaches us anything, it is that economies are not static. A number of those brands, both US and foreign, were not around or not as powerful 20 or 30 years ago. Simply because we lead in the number of brands today is no assurance that the scenarios outlined by the CIA are not accurate. We need to continue to build on our brand strength – not assume that it will carry us forward. As they warn in the financial markets, past performance is no guarantee of future success.