Focus Areas

The New ROI: Return on Intangibles

Nov 4th 2009
By C Mahalingam

In a bullish environment, some companies received more market value than others. In a bearish
market, some companys market value eroded more than others. Intangibles are so valuable because
they say something about the future performance of organizations, says C Mahalingam

The unprecedented pace of change is making it almost impossible to predict future beyond a few years.
The economic depression that the world is currently facing was not predicted, even though the
subprime housing bubble was building up for a while now. The irrational exuberance exhibited in the
financial markets continued unabated leading to disastrous consequences plunging most of the vibrant
economies into an overnight tailspin. Collapse of the financial system, economic slump, mounting job
losses and near complete erosion of purchasing power became a vicious cycle reinforcing each other.

Organizations such as Lehman Brothers and American Insurance Group (AIG) that were once considered
as built to last collapsed like pack of cards! Those that survived a possible eclipse from existence went
through dramatic value erosion as we witnessed in the case of Citi Corp. Organizations that were solely
built on tangible assets such as financial capital, or physical assets such as buildings and machinery,
eroded much faster than anyone could have imagined. Welcome to the world of Intangibles!

Intangibles Impact a Firms Market Value

Intangibles as a source of lasting value for organizations are not new. Past several decades witnessed a
clear shift in value towards intangibles as evidenced by many studies. The Economist offers an amusing
definition of intangibles: An intangible is anything in a firm that generates value that you cannot drop
on your foot.

Intangibles include a wide range of organizational dimensions. It can be a firms brand, culture, talent
and capabilities. More recently, intangibles have also expanded to cover new and unique organizational
designs and process that provide a lasting competitive advantage to organizations. Google is a great
example of unique organizational design, culture and management practices that come to represent a
value-enhancing intangible. By definition, these are unique to an organization and even more
importantly embedded in their DNA, and therefore not easy for the competition to copy or emulate.
Brookings Institute has documented the following shift in value from Tangible assets to Intangible
assets:

Growing Importance of Intangibles (Brookings Institute):

Intangible(%) Tangible(%)

1982 38 62
1992 62 38
2000 85 15

Future organizations must focus on creating Intangible Value

Business Leaders and HR leaders must learn more and more about the contribution of intangibles. They
must identify those intangibles that will be unique to their organization and provide a long term,
sustainable competitive advantage, besides bringing in measurable increase in the market value for their
organizations. Human Capital practices constitute a significant intangible as has been recognized in the
last two decades. Research by many Human Capital consulting firms as well as by professors of repute
from business schools such as Ross School of Business (University of Michigan), Stanford, Rutgers,
Cornell and London have confirmed a positive, measurable correlation between human capital practices
and firm value.

HR Guru, Dr Dave Ulrich and his colleague at Result-Based Leadership Institute, Norm Smallwood, have
produced a master piece book titled: How Leaders Create Value in which they have systematically
explained the value intangibles can create for organizations besides providing a road-map for creating
such intangibles. Dave Ulrich went on to name these intangibles as Investor Intangibles since investors
are willing to pay a significantly higher price for those organizations that demonstrate these intangibles
in their DNA!

The language of Value Creation for HR Professionals

HR professionals in the past did not quite have the benefit of the language of value creation. Their
contributions within their respective organizations, as well as sharing of best practices outside in
professional forums and platforms centered on controlling costs and delivering services with efficiency
and speed. Even during the decades of HR automation that came to be characterized as the era of E-HR,
the premise (and promise) was more to do with delivering HR services with speed, eliminating
cumbersome paperwork and occasionally establishing a self service Business to Employee (B2E) portal
on the intranet.

With the increasing awareness of the power of intangibles on building organizational value, HR
professionals have found a new language for articulating their value to their organizations. It is true that
not all investor intangibles are in the domain of HR. For example, establishing an effective R&D program
that delivers patentable product or formulation that fulfills a long-unfulfilled human need, or cures a
long-dreaded disease can be an intangible of lasting value - so is the brand reputation built over time for
a reliable service or product. A vast majority of intangibles that an organization can build rest within the
domain of the HR function as these intangibles are built with human capital.

HR professionals with right competencies, professional attitude and business acumen can create
significant measure of intangibles for their organization with the help and participation of the business
leaders. This provides a unique opportunity for the HR professionals to demonstrate that they can
create value rather than than cut costs, become strategic players rather than remain strategic partners.
After all, the HR professionals who do not score will be wasting an opportunity of their life time besides
letting their organizations down!

Intangibles as the Future Focus of organizations

Business and HR leaders need to evolve a well thought out strategy towards investing in and building
organizationally appropriate and uniquely advantageous intangibles for their organizations. While
intangibles are difficult to create and even more difficult to sustain over time, there are two types of
intangibles that HR professionals must be aware of:
The first one is more fundamental in nature and will therefore take a longer time and stronger
commitment from the organization and its leadership. This relates to the DNA of the organization. I
would place under this category, intangibles such as culture, management models and leadership brand.
These are almost impossible for the competition to emulate. Here lies the competitive advantage.
Semco Corporation, General Electric, South West Airlines, SAS Institute and Google, are examples of
corporations that have created such intangibles.

Then comes the next level of intangibles which are difficult to create but not impossible to replicate by
the competition - business processes, ability to innovate, speed, customer centricity as shared mindset,
organizational learning, and talent. Innovation (Nokia as an example), speed (Federal Express as an
example), organizational learning (McKinsey as an example), ability to execute (Dell as an example),
employee engagement (SAS Institute as an example) are case in point.

Architecture for Intangibles

Dr Dave Ulrich and Norm Smallwood have made what may be called a first systematic effort in
articulating a clear architecture for creating intangibles that add value to an organization. Their
framework provides for the following four levels of intangibles for creating sustainable competitive
advantage.

Level 1: Delivering Consistent and Predictable Earnings: Leaders make and keep commitments when it
comes to delivering their commitments to shareholders.

Level 2: Articulating a Future Growth Vision: Leaders make a compelling case and create a widely shared
vision for ground around customers, innovation and geography.

Level 3: Ensuring Future Competencies aligned to Business Strategy: Leaders invest in building
leadership, technical and behavioral competencies in their people that are fully derived from, and
aligned with their business strategy. This helps mobilize people towards one direction, making every day
behavior strategy-focused, and avoids intentional or unintentional pulling in different directions and the
consequent frittering of employee energy.

Level 4: Creating Organizational Capabilities: Leaders create organizational capabilities such as hiring
appropriate talent, executing decisions with speed, building leadership capability across organizational
levels, making people accountable to one another, generating and generalizing knowledge across
organization, collaboration between individuals, teams & business units, instituting & institutionalizing a
customer-focused culture and the like.

Culture, Management Models & Leadership Brand as Intangibles

HR professionals should work with business leaders to diagnose and understand if the existing culture
and management models are proving to be a valuable intangible or a burden. This diagnosis is not easy
and thankfully so - if only it is easy, anyone could do this! Let us look at each of these three key
intangibles in some detail:

Culture: There are many different definitions of organization culture. Most of these definitions revolve
around values, beliefs and embedded assumptions about how people should behave. The simplest
definition of culture is: how things happen here. Scholarly work on culture in the past has been very
inward-focused in terms of leadership behaviors, how professed values are practiced and the like. The
recent work by Dave Ulrich and others has a refreshingly different outside-in focus. Culture in this new
context is more around the shared mindset of employees about creating the right brand or identity for
the customers they are serving. For example, South West Airlines has created a great identity in the
minds of its customers as dependable, on-time, economical and fun-filled airlines to fly. This customer
identity has become its culture.

Management Models: Dr Gary Hamel (of Core Competence fame, together with Dr C K Prahalad) has this
to say in his best selling work: The Future of Management: Whiplash change, fleeting advantages,
technological disruptions, seditious competitors, fractured markets, omnipotent customers, rebellious
shareholders- these 21st century challenges are testing the design limits of organizations around the
world and are exposing the limitation of management model that has failed to keep pace with the
times! He provides vivid examples of organizations such as Google, Whole Foods Market, South West
Airlines and W.L Gore & Associates that have stood the test of time by innovating management models,
and thereby creating a lasting competitive advantage. HR professionals as Organizational Architects,
have both a long way to go, as well as have a golden opportunity to create a formidable intangible by
working on management models.

Leadership Brand: Leadership Brand is an emerging intangible in the context of a firm brand or product
brand which is already well established. For example, Proctor & Gamble has been steadily investing in
creating a strong portfolio of brands that included 16 brands that were delivering a whopping US 1
billion in annual sales. Leadership Brand, as a new and emerging intangible for HR leaders to invest in
and create, will deliver even a superior value to a firm than the firm brand or a product brand. An
organization can be said to have a strong leadership brand when its leaders across organizational levels
and geographies practice leadership in ensuring that customers expectations are tuned to employee
behaviors in a consistent manner.

Companies such as Nordstrom, Nokia, Marriot and General Electric have done a tremendous job of
establishing a leadership brand that helps customer experience the desired employee behavior at all
times.

Rewriting the HR Agenda

HR leaders have come a long way in their understanding of how they can create value. Value creation
calls for more than tinkering and tweaking with HR systems and processes. It demands that HR leaders
think outside the box and become radically innovative. And innovation should be focused on creating
intangibles like the ones discussed above. There lies the future of organizations and their
competitiveness, and of course for the HR professionals, there lies their own future and credibility as
strategic partners and players. The new mandate or agenda for HR professionals is crystal clear: creating
significant return on the new ROI Return on Intangibles!

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