VideoIncreasingly , intangible knowledge assets are dwarfing the value of tangible book assets at many companies. But don't ask for details. While corporate reports heap praise on various efforts to capitalize on knowledge, they fail to supply reliable, objective benchmarks for measuring the values a company gets from its patents, brands, trademarks, capital expenditures, and research-and- development programs.
Intuition may allow observers to generalize about these elusive assets, but they certainly deserve sharper focus from the company's own finance department, if only to help explain today's spiraling market values. Despite critics who still insist that knowledge assets are unfathomable by nature, securities analysts, board members, and curious shareholders are clamoring for better information from corporate managers.
The drumbeat is not lost on Ron Soler, the Sunnyvale, California- based director of finance at Lockheed Martin Corp., in Bethesda, Maryland. "We currently have no formal measure of knowledge assets," he notes, "but these assets are our survival assets, and the most strategic for our long-term viability."
To assist financial managers in grappling with knowledge assets, CFO's second annual Knowledge Capital Scoreboard updates and expands last year's techniques--and its conclusions. (See "Se eing Is Believing," CFO, February 1999.) In the 2000 edition, the methodology, designed at CFO's request by Prof. Baruch Lev of New York University's Stern School of Business, pierces the knowledge capital veil in more detail. Top companies in 20 industries were ranked according to their levels of knowledge capital, from a high of $211 billion at mighty Microsoft Corp., down to $332 million at our smallest knowledge-rated company, Adolph Coors Co. At our median company, $21 billion of knowledge capital amounted to three times book value.
In general, the most frequently used measures of knowledge capital emphasize input. Companies know to the nickel how much they are spending on various projects, including R&D. Professor Lev's methodology, though, proposes ways to measure the earnings impact resulting from knowledge-based activities.
This year's Scoreboard also offers striking evidence that knowledge capital predicts market performance with more accuracy than does either operating cash flow or net earnings. Further, companies that achieve high performance levels consistently show higher investments in three key drivers of knowledge capital: advertising, R&D, and capital spending.
Homespun Metrics
Executive resistance to making routine use of knowledge-capital numbers is understandable, Lev notes. "With the incredible potential of knowledge assets comes great managerial difficulties and challenges," he says. "It is much harder to manage knowledge assets than physical assets."
That said, some companies have developed approaches to managing knowledge assets even without the aid of formal measurement tools. Genentech Inc., the pioneering biotech firm in South San Francisco, hasn't had much luck finding a metric for knowledge. When the company looked at the biotech industry's market values and compared them with R&D spending levels at the most research-intensive pharmaceuticals companies, for example, it found little correlation. Still, it says it believes it is doing well, benefiting from strategic R&D spending increases that were made in 1995 and 1996--increases that were made intuitively. "In our business, research and development-- particularly development--is a very big component of our economic investments and of our expenses," says Brad Goodwin, vice president, finance, at Genentech. Yet the asset created "does not get reflected on our balance sheet."
Some companies can manage fairly successfully using homegrown definitions of knowledge capital, but the lack of a systematic tool precludes useful comparisons with competitors. A good measuring tool can also help companies evaluate their own skills in building knowledge capital, and devise a best-practices strategy.
Part of the exercise may sound exotic, but the Scoreboard's calculations for measuring knowledge capital will strike a familiar chord with seasoned finance executives. As it did last year, our formula uses some commonly accepted analytical tools, and beyond information found on balance sheets, rests on three elements: an estimate of "normalized earnings," the standard expected returns for broad asset classes, and a proxy for knowledge capital's rate of return.
Capturing The Full Payoff
Absent hard and fast rules for computing normalized earnings, the Scoreboard relies on three years of historical profits through 1998, plus Wall Street's consensus estimates of earnings through 2001. While expected growth rates can be computed at any number of levels of detail, the Scoreboard uses as a base only two broad classes of book assets: tangible assets and financial assets, with respective expected rates of return of 7 percent and 4.5 percent after tax. (When available, more detailed growth estimates can be substituted.)
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