MEASURING THE VALUE OF INTANGIBLES Geneva, July 11, 2006 to discover the roots of companys future success

2 When we want to assess future potential of a company, what shall we look at? LOOKING BEYOND FINANCIAL ASSETS... Managing an organisation by focusing simply on its financial assets would be like driving a car looking just in the rear mirror. Profits are fruits of the past performance – so what indicators do you have about potential and future value of a company?

3 What are the intangibles? DEFINITION OF INTANGIBLES The factors not shown in the traditional balance sheet, but which are of critical importance for the companys future success. We believe that future value of company depends mainly on intangibles. Different methods were developed to assess and allow benchmarking of areas that are of critical importance for the future of organisations, but still are not shown in traditional financial or operational reports.

4 Market value, book value and intangibles TOTAL VALUE = Financial capital + Intangible capitals In $ billions Source: adaptation from AIAF, 2005 Country tangible intangible Other intangibles

5 Measuring the value of intangibles Companies have to develop and utilise new accounting methods, since those that have been implemented so far: Are too focused on the past Miss anticipatory power Capture critical changes too late Don t take into adequate consideration some resources, such as intangible assets Elaboration from Sveiby, Non-monetary methods Holistic Methods Atomistic Methods Monetary Methods Main Intangible Assets Measuring Models

6 IC Rating TM background: the Value Platform Relational structural capital Human capital Organisational structural capital Business Recipe Business Recipe Value Source: Intellectual Capital Sweden There are 3 main perspectives behind IC Rating Platform: 1)Human Capital People, employees 2)Organisational Structural Capital All processes, procedures, systems and culture that are left when employees are not in place 3)Relational Structural Capital Network of clients, suppliers and partners. All these 3 perspectives work in the framework of particular Business Recipe (market, strategy of the firm), which is individual for every company. Good performance in all these areas builds Financial Capital in the future.

7 IC Rating Platform KEY ISSUES Demand from competitors Contribution from I.P. (attract customers & employees) Protection of I.P. (long term/ hard to copy) KEY ISSUES Structured and docu- mented knowledge (methods, routines and systems) Organisation & culture KEY ISSUES Business related skills Internal leadership Co-operation and comple- mentary experiences in the mana- gement team KEY ISSUES Business specific knowledge General competence Contribution to develop- ment of structural capital KEY ISSUES Loyalty Potential Strength - image enhancing - demanding Dependence KEY ISSUES Awareness Reputation Relevant differen- tiation KEY ISSUES Business critical networks and alliances (excluding current customers) Intellectual Capital Business Recipe Human Capital Organisational Structural Capital NetworkBrand Custo- mers Processes Relational Structural Capital Emp- loyees Manage- ment Intellectual Properties KEY ISSUES Business environment; - Competition - Entry threats Business idea Strategy Vision Source: Intellectual Capital Sweden

8 IC Rating: three perspectives Present day Accounting 1. Effectiveness Present value of IC effectiveness in creating future financial value 2. Risk Threat against present effectiveness * probability of threat coming true 3. Renewal and Development Efforts to renew and develop present effectiveness Future Source: Intellectual Capital Sweden

9 IC RATING is done using well-known Standard & Poors scales Source: Intellectual Capital Sweden

10 IC RATING is mainly based on interviews with people Source: Intellectual Capital Sweden PROCEDURE: Rating is primarily based on interviews with carefully select respondents who knows most about this company, of which 2/3 is external (customers, lobby organizations, competitors, suppliers, partners, etc.) 1/3 is internal (employees), rating of intellectual capital is weight average of answers for more than 150 questions that are strictly connected to business performance of the company, rating usually takes 4-6 weeks.

11 IC RATING and IP assessment Source: Intellectual Capital Sweden 17 questions out of about 150 are focused on IP evaluation Examples of key issues to be pointed out during the evaluation process: Market awareness about company's IP IP influence on companys brand Company's IP replaceability Time period during which the IP has value IP contribution to rise barriers to entry Etc.

12 Case Study: Effectiveness perspective Source: Intellectual Capital Sweden ProcessManagement Employees NetworkBrandCustomers HumanRelation Organisation Business Recipe Intellectual Properties Intellectual Capital A BBB BB CC A BB B CC C BBB Selected findings: This rating was done for start-up company. As in case of most young and small companies, structural capital is almost non-existent. But, company is operating in market with good perspectives. Good score in relation box shows that companys network is a main source of its current advantage. Customers base as well can be assessed as satisfactory.

13 Case Study: Risk perspective Source: Intellectual Capital Sweden Selected findings: Organisational Capital shows almost no risk as its efficiency is to low to be threatened. Although efficiency of relation capital was average (BBB), the risk perspective shows that its strongly threatened by some aspects. It may be that there are very few customers or customers are heading to bankruptcy or many more. To discover true reason we must look closer to the Customer box and see answers to the questions of which the box is composed. ProcessManagementEmployees NetworkBrandCustomers HumanRelation Organisation Business Recipe Intellectual Properties Intellectual Capital - R RR - R RRR RR RRR --

14 Case Study: Renewal & Development perspective Source: Intellectual Capital Sweden Selected findings: In renewal and development perspective we can see substantial efforts in the Human Capital box. These means that company currently conduct several initiatives, which are focused on improving human capital effectiveness. Poor renewal efforts can be observed in the brand box, which together with not so good efficiency (only BB) should make management put more attention in this area. ProcessManagementEmployees NetworkBrandCustomers Human Relation Organisation Business Recipe Intellectual Properties Intellectual Capital A A BBB BB BBB A CCC A BBB

15 Case Study: Customer relations box decomposition Source: Intellectual Capital Sweden Selected findings: It turned out that main threat for customer effectiveness comes from two things: being a strategic supplier and vulnerability for the changes. The company itself had one big customer, which generated most of the revenues. Relations with this customer was great, duration was long, it was process competence and image enhancing customers. The only thing that made the risk so high was that customer was preparing to conduct services offered by the company itself Relation Interaction Duration of Customer Relation Image Creating Competence Enhancing Process Strengthening Strategic Supplier Non-vulnerability Share of budget Company Benchmark

16 IC RATING - A Comprehensive View Source: Intellectual Capital Sweden BB + BB BBB +BBB CC A BB BB + BB BBB B BBB CCC RR RR RR Affärsmiljöns tillväxt på 5 års sikt Affärsmiljöns lönsamhet på 5 års sikt Affärsmiljöns konkurrenssituation Potentiella hot mot affärsmiljön Vår tillväxt med utgångspunkt i vårt affärsrecept Vår lönsamhet med utgångspunkt i vårt affärsrecept Vår position i affärsmiljön Processer för intern administration Processer för kundhantering Processer innovation Processer för distribution och logistik Processer för utveckling av medarbetarna Processer för försäljning Processer produktion IR:s förmåga att skapa inträdesbarriärer IR:s förmåga att göra oss oberoende av konkurrenternas prissättning IR:s varaktighet Ledningens fokus Kundhantering Effektivitet Ledningens samspel Tydlighet i ledarskapet Internt ledarskap Affärsegenskaper Intern atmosfär Sakkunskaper Nätverk för försäljning Nätverk för personal och kompetens Leverantörs- och distributionsnätverk Kännedom Anseende Relevant differentiering Kundlojalitet Kundbaspotential Sårbarhet mot kundavhopp Imagekunder Kompetensutvecklande kunder

17 IC RATING and financial performance Source: Intellectual Capital Sweden R xy =.80; p<.01 Increase in turnover 2001 (%) IC Rating 2000 A high IC RATING value, indicates a high turnover growth in the years to come. IC RATING alone is a better predictor of future profits, than methods only using financial input data.

18 Beyond IC RATING: IP monetization and brand equity Monetary evaluation of some IP forms (e.g.: brands) can complement methods like IC RATING that basically provide qualitative findings and point out improvement areas There are many methods to evaluate the brand equity: Based on cost criteria, oriented to the past and to the resources spent on the brand Based on the benefits flows: the value of the brand is determined by the cash flows that it generates Based on market indicators and, therefore, on ex post performances The monetary assessment of the brand allows the company to have immediate benefits, e.g.: Further financing from investors trough specific financial tools (e.g.: sale- lease back) A better rating according to Basel II criteria

19 Thanks Mauro De Bona Campus - Innova Group skype: maurodebona