Intangible Assets-Based Enterprise Management - A Practical Approach

Intangible Assets-Based Enterprise Management – A Practical Approach Juergen H. Daum Chief Solution Architect, Business Solution Architects Group, SAP, Neurottstrasse 15a, D-69190 Walldorf, Germany E-Mail: jhd@juergendaum.com, Website: http://www.juergendaum.com Keywords: Intangible Assets, Intellectual Capital, Enterprise Management, Strategy and Performance Management, Decision Support, Leadership and Organizational Model Abstract: Urgent action is required to include an intangible asset perspective in enterprise management. This is shown by many everyday examples of managers, who aren’t able to make informed decisions without such an approach. The mission of this paper is twofold: First, to present a practical approach for changing perspectives of managers and to develop a concepts for a new, enhanced way of enterprise management. Second, to create the foundation for more informed managerial decision-making in situations, where the traditional financial control approach to enterprise management doesn’t provide appropriate support. The paper starts with a view on some examples of managerial challenges related to intangible assets. It then presents an approach to enterprise management that integrates the intangible assets perspective and that can better support managers in strategy and performance management and in decision making. It concludes with a brief discussion of the consequences for the leadership and organizational model. Introduction What are intangible assets? Intangible assets or intellectual capital1 are immaterial resources (not financial assets/financial capital or physical resources such as fixed/current assets) that, as a factor of production, play a fundamental role in the value creation process of an enterprise and that enable it to compete successfully. Intangible assets are usually divided into the following main categories: - Human capital: Employees’ individual professional expertise and skills, social skills, entrepreneurial engagement, ability to innovate and respond to changes - Relationship capital: Customer capital (brands, customer relationships, relationships with marketing and distribution partners etc.), other business partner capital (supplier relationships / supplier network, contract manufacturers etc.), and relationships with investors and banks/financial service firms and with other important stakeholders (such as environmental pressure groups in the oil industry) 1 The term “intangible assets” is used in this paper with two meanings – integrating the concept of “intangible assets” (with roots mainly in the accounting world) and “intellectual capital” (with roots in the world of knowledge management and based on a dynamic perspective of the enterprise) 1 - Structural capital: Business infrastructure/processes, working methods, information systems, databases, intellectual property (patents, copyrights, trademarks), organizational design, location advantages, corporate culture What is enterprise management? Enterprise management comprises the leadership and organizational concept, and the management processes and tools that enable an enterprise2 / its management to organize and manage the process of achieving the enterprise’s objectives - i.e. to create value added for its stakeholders. It is based on two pillars: - The leadership and organizational model: Mission, values and overall objectives of the enterprise, organization structure and philosophy, corporate and management culture, incentive system and concept, approach to organizational development (focus on social mechanisms and human behavior – increase organizational and people productivity through organizational design, shared values and common goals) - The performance management/steering system: Definition of an explicit strategy, the process of target setting, resource allocation, planning, performance monitoring&forecasting and decision making for corrective actions (focus on performance transparency and on controlling the process of target achievement – increase the capability of the enterprise to achieve its targets through “rational management”) What is the problem? The capability of companies to create economic value, i.e. customer value, shareholder value, and stakeholder value, is increasingly dependent on intangible assets – on immaterial resources and production factors. Today, intangible assets are predominantly responsible for a company’s3 capacity to innovate and thus for its capability to create added value in a highly dynamic, highly competitive global business environment and to “make a difference”. So it is no surprise that companies in all industries are investing more in intangible assets than ever before – with trend values arcing even higher. A clear “symptom” of this is the fact that the gap between market values and book values of corporations has been constantly growing over the last 20 years. As a result, even companies of the “old industries” possess today significant intangible assets (Gu/Lev, 2001, p. 12) – although they are not visible in their balance sheets or internal management accounts and reports. And that is the very problem: our enterprise management concepts and control instruments have failed to keep up with this development. They provide a much too narrow angle, and exclude the 2 The term “enterprise” stands in this paper for an entity, in which investors invest / where ownership is held. An enterprise usually consists of several business units. 3 The term “company” stands in this paper for an entrepreneurial unit, i.e. for a business unit or for the entire enterprise 2 most important factors of production of our companies and economies of today, which are increasingly knowledge-based and service-oriented: the intangible assets along with their intrinsic production forces and risks. Intangible Assets: A Challenge for Enterprise Management While intangible assets are regarded widely as the main value drivers of today’s enterprises, the day-to-day live of corporate managers doesn’t reflect this fact sufficiently. Many managers are still fully occupied with managing costs, managing the sales pipeline, approving capital investments (solely based on financial plans) and with managing and motivating their people through (traditional) incentive schemes. How to create and strengthen intangible assets in the enterprise’s operations and how to leverage intangible assets to boost business performance and to create competitive advantage has not yet become part of common management practice. On the other hand managers are confronted increasingly with decision that require an intangibles-based approach to enterprise management in order to make sure that these decisions really contribute to value creation and support the long-term survival of the company. But they still do not dispose of the managerial / analytical concepts to support such decision-making in a sufficient way. A clear indication for this is the fact, that most managers are faced with a severe challenge when asked to explain what constitutes the value of their enterprise or how this value can be retained and expanded in future. Examples of managerial challenges related to intangible assets The true challenge for management of a pharmaceuticals multinational, for example, is not simply to manage the research and development pipeline and communicate its value development (in the form of discounted cash flows from potential future revenues from new products) to the capital markets – which is difficult enough in itself – but also to handle the premium on enterprise value that financial analysts call the “confidence factor” or “future value”. This confidence factor is the capital markets’ reflection of the company’s actual or assumed ability to actively shape an unknown future in its own best interests – that is, exploit as-yet unknown market trends (and the accompanied opportunities and challenges) much more effectively than the competition and generate growth (in the form of new and additional business). The confidence factor can amount to up to 50% of the overall enterprise value, and is added on top of the value of existing assets on the books, plus the estimated value of the R&D pipeline (see Figure 1). It is based to a large extend on the company’s intangible assets and management’s capability to create new value added from them. But how can management deal with it? How does the “confidence factor” affect the reality of day-to-day business, and how can management influence it positively? Without a systematic analysis of intangible assets on hand – particularly in combination with the value of the company’s growth options – this question cannot be answered, and management is flying blind.

Intangible Assets-Based Enterprise Management - A Practical Approach - Juergen H. Daum Chief Solution Architect, Business Solutions Architects Group (BSAG), SAP EMEA Presentation at the 2005 PMA IC Symposium, 15 December 2005, Stern School of Business - New York University Juergen H. Daum Function in the BSAG at SAP EMEA CFO Relationships, advisory role in „Finance Transformation“ and „Enterprise Performance Management“ projects Finance and management background was a CFO in a mid-sized German company before joining SAP in 1992 Spent five years in SAP’s field organization in Germany and Europe sales, consulting, product management with the focus on financials and enterprise mgmt. Six years in development global product manager for SAP R/3 EC and Strategic Enterprise Management (SEM), then as global program manager for mySAP Financials Since 2002: advising senior executives, CFOs, and controllers of European companies current focus on finance transformation & enterprise performance management Frequently publishing and speaking on enterprise performance management, finance and management topics; author of the book "Intangible Assets and Value Creation“ (2003) and “Beyond Budgeting” (2005). E-Mail: juergen.daum@sap.com, Personal Website http://www.juergendaum.com  Juergen H. Daum 2005, Presentation at the 2005 PMA IC Symposium, 15 December 2005, New York University - Stern School of Business Page 2 The main message of my presentation and my paper is: We have to solve practical day-to-day problems of managers – otherwise the IC/IA-movement will fail to be regarded as something relevant. The good news is: Managers are increasingly aware that it is impossible to manage the value creation process without integrating intangible assets in the managerial analysis and the management system. The traditional shareholder value management concept (the “management mantra” of the 1990s) is increasingly criticized, because it doesn‘t provide the tools to really manage for value and sustainability – i.e. the need exists for something new and more advanced.  Juergen H. Daum 2005, Presentation at the 2005 PMA IC Symposium, 15 December 2005, New York University - Stern School of Business Page 3 Agenda Intangible Assets: A Challenge for Enterprise Management (Examples) A Change of Perspectives: Towards a New Concept for Enterprise Management Understanding and Optimizing Enterprise Performance Conclusion  Juergen H. Daum 2005, Presentation at the 2005 PMA IC Symposium, 15 December 2005, New York University - Stern School of Business Page 4 Example of a Pharma-Multinational How financial analysts value the company: „Confidence Factor“ Can account for up to 50% (or “Future of total enterprise value Value”) Analysts recognize with the “confidence Value of the factor” the company’s (as-yet unknown) R&D Pipeline options for future growth (i.e. its ability to actively shape an “Net Assets” / unknown future by exploiting unmet demand and/or new technologies to ‘make Book Value a difference’ and to generate additional revenues / create new businesses) How can management manage the “confidence factor” in the reality of the day-to-day business?  Juergen H. Daum 2005, Presentation at the 2005 PMA IC Symposium, 15 December 2005, New York University - Stern School of Business Page 5 Example of a Consumer Products-Multinational internally created Intangibles (e.g. brands) + realized acquisition synergies 2004 Goodwill + acquired Intangibles (e.g. brands) 2.5 bn = 19% Tangible Assets + Working Capital The „Black Hole“ from an internal management control perspective “reach” of 8.8 bn balance sheet Start of acquisition strategy mid 1990s “reach” of mid 1980s traditional 2.0 bn management accounting Enterprise value: 1.2 bn 3.5 bn 13.3 bn What is driving ROI (of all assets)? How to maximize value from investments in advertising?  Juergen H. Daum 2005, Presentation at the 2005 PMA IC Symposium, 15 December 2005, New York University - Stern School of Business Page 6 Example of the European Finance Shared Services Center of another Consumer Products-Multinational After 4 years in operation the general manager is asking himself the following questions: How can we move up the value chain and compete with low-cost service providers from India or China? Which (low value adding) tasks and processes are possible candidates to be outsourced? Which are the tasks and processes we should never outsource, because the related resources and assets (business know-how, human capital etc.) represent our “family silver”? How can we identify our “family silver” and strengthen and leverage it to create value-added in the future? How do we really create value? Which are the assets that create competitive advantage ?  Juergen H. Daum 2005, Presentation at the 2005 PMA IC Symposium, 15 December 2005, New York University - Stern School of Business Page 7 Business 2010 – Embracing the Challenge of Change Business 2010 is an intensive research program, conducted by the Economist Intelligence Unit and sponsored by SAP – involving a survey of 4,018 executives and business leaders around the globe The results of the analysis suggest that, to compete successfully in 2010, executives will do well to heed the following messages: Revisit your business model - regularly Respondents identify new business models as a greater source of competitive advantage than new products and services Be nimble, be quick Adaptability to change and achieving the requisite speed of innovation are regarded as the greatest management challenges that organizations face Know thy customer, and invite him in The way organizations interact with customers will be the area of greatest change in their operations between now and 2010 (requiring e.g. better customer insight) Do what you do best Consolidation of existing market players and new entrants from emerging markets are seen as major competitive threats forcing organizations to focus on what they do best  Juergen H.