Definition of Terms: What is Intellectual Capital?

The most important definition of intellectual capital is the one that makes the most sense for a particular organization. Chapter 2 examines how different definitions came about and how a good definition will lead to a framework for action:

• user-based definitions
• beyond "goodwill"
• an evolving notion
• from definition to framework for managing
• intellectual capital and knowledge management.

INTELLECTUAL CAPITAL

"The new source of wealth is not material, it is information, knowledge applied to work to create value."
Walter Wriston, former chairman of Citibank

USER-BASED DEFINITIONS

People from a range of backgrounds have, over time, developed the discipline of intellectual capital. Because each was dealing with a specific set of issues and problems, their definitions directly reflect their unique perspectives and the very specific sets of problems they were working to resolve. Each of the perspectives they developed is true for its specific user need. Thinking that only one of these definitions is correct and therefore the others are wrong is not accurate or effective. A great deal can be gained by looking at intellectual capital through these different definitions. Each lens gives us an opportunity to see our organizations differentiy enough to derive greater value than any single definition could provide. All of them are valid and it is up to the user to select the definition that works best to meet any particular set of needs.

A definition of intellectual capital from a managerial perspective is:

the knowledge, applied experience, organizational technology, relationships, and professional skills that provide for a competitive edge in the market.

This is a definition that takes into account the people who make up the organization, the structural dimensions of the organization, and all of the relationships of the organization. Definitions that come from a human resource and organizational development background emphasize that the intangible resources are based on implicit human experiences that must be actively turned into the stuff that provides a competitive advantage for the organization.

A more dynamic version of this definition says that intellectual capital is:

knowledge that can be converted into value or profit. It is the value embedded in the ideas embodied in people, processes, and custo me rs/stake h o lde rs.

DEPICTION OF TERMS: WHAT IS INTELLECTUAL CAPITAL?

Definitions from an accounting and capital markets background see knowledge and related capabilities as assets that can be managed as such. That these assets exist and are not adequately recognized is an enormous concern for any valuation of an enterprise.

A definition that is located more in an information technology framework is that intellectual capital is: the intellectual material that has been formalized, captured, and leveraged to produce a higher-valued asset.

This definition assumes that knowledge resources can be captured and processed and that the outcomes from these efforts can exist separately from the people that created them.

A fourth perspective is even more active and states that intellectual capital is: the ability to transform knowledge and intangible assets into wealth-creating resources.

All of these definitions start with a knowledge base, and are tied to a mechanism by which we transform that capability into a competitive organizational advantage or into profit itself.

All of these definitions are usable and complementary. They all acknowledge that there are intangible resources that are a vital compo­nent of the value in an organization and that those resources must be recognized and mobilized for the benefit of the organization. This is true whether that organization is a for-profit enterprise, a not-for-profit entity, or a public sector institution.

BEYOND "GOODWILL"

Furthermore, all of these definitions are true and are much better than the previous catch-all definition of "goodwill" that lumped together all the dimensions of intangibles with the view that says they are collectively: an intangible, saleable asset arising from the reputation of a business unit and its relationships -with its customers, as distinct from its stock, etc.

INTELLECTUAL CAPITAL

While the term "goodwill" contains many of the aspects of intellectual capital, it has serious drawbacks. The most significant is that in our increasingly knowledge-based era intangibles are becoming the domi­nant value of the organization, which raises the question of whether the traditional accounting framework is worth its salt either for valu­ation or for navigating the organization. "Goodwill" is based on an industrial-age business model, when intangibles held considerably less value. Additionally, goodwill is treated as an asset with a limited life and so can be amortized. The thing with intangibles is that they can have renewable value. The knowledge that goes into apiece of software can be used innumerable times without any loss of its value, and perhaps with a gain. Brands or patented knowledge also does not necessarily decline in worth over time.

In a related way, the term "goodwill" is neutral or passive. It does not actively reflect that the various intangibles can be discretely treated, and leveraged or managed for what they have become, i.e. the most valuable elements of the organization.

To accommodate the transition into the new economic reality, both the US Financial Accounting Standards Board (FASB) and the Accoun­tancy Standards Board of the UK (ASB) are reviewing the goodwill issue and plan to write new guidelines for reporting on its value. FASB is preparing two FASB guidelines on "Business Combinations" and "Goodwill and Intangible Assets" which will require American companies to periodically determine the fair market value of their intellectual property. Revising the practices and standards concerning goodwill is not easy. There are many controversial and costly reporting issues involved. Regardless of the difficulties, the accounting profes­sion has come to realize that this change must be made. As these standards are accepted and become operational, they will be a major force in moving intellectual capital from being an interesting but rela­tively minor concern to being a major financial reporting and strategic consideration.

AN EVOLVING NOTION

Intellectual capital is an evolving notion. The more practice people have gotten under their belts the more they have been able to integrate the different understandings that come from its different origins. In the simplest sense, intellectual capital is an organization's wealth that goes beyond what its cash or property, traditionally the two core elements of what is considered capital, can account for. A number of people prefer to use the term intangibles instead of intellectual capital, since these assets are not weighable, touchable, nor do they have dimension. Yet these "intangibles" do have value and canbe considered assets, if law and accounting practices permit. Some countries are significantly friendlier to viewing intangibles as assets than others. Australian accounting rules, for example, permit the incorporation of intangible assets in annual reports, whereas acknowledgment of value for reporting purposes is far more restricted in the United States.

The movement to consider patents as assets instead of costs is part of this evolutionary argument. Under current accounting rules a patent only becomes an asset at the transaction point where it is sold. The implications on the valuation of an organization and how it looks at its research and development are strongly affected by the accepted definitions of accounting practices. These patents and other intellectual property will be far more likely to be undervalued, undermanaged, and unexploited unless they are seen as working assets. If this is the case for the most commonly accepted form of intellectual capital then the chances of the other forms of intangibles or intellectual capital never being acknowledged as having value, being appropriately managed, and being adequately valued are extremely high.

While intangibles is a useful term, there is a tendency for intangibles to be considered more from the perspective of assets than from the equally important view of seeing them as capabilities. The narrower view can limit understanding of how intellectual assets work as the basis and ingredients for creating real organizational wealth. From this perspective the broader term intellectual capital may be of greater value for managers.

Even so, there is room for disagreement as to whether intellectual capital is the best term for an organization's non-financial and non-physical resources. One leading practitioner, Hubert Saint-Onge of Clarica Insurance, has decided to use the term "knowledge capital" instead of intellectual capital based on his experience that knowledge capital is more broadly acceptable to the staff of his organization. He sees that most people in his company more readily accept that they have knowledge and that knowledge has value than if what they know and use is called "intellectual capital." The reality is that there is room for different terms as long as there is a legitimate understanding of what those terms mean and how they are to be used.