Briefly reviews the context for the increased interest in more explicitly valuing intangible assets and explores the strengths and weaknesses of current approaches involving Intellectual Capital, the Balanced Scorecard (BSC), and Knowledge Management. Contends that overemphasis on developing and leveraging intangible assets is counterproductive, and that all organizational assets, financial, tangible and intangible must be managed as a system if the value of the intangible assets is to be fully realized. Proposes a new approach, Systemic Knowledge Management (SKM), to visualize and harmonize the organizational factors and dynamic interactions involved in effectively and efficiently managing these assets. Illustrates SKM using system dynamics models. Highlights the relevance and practicality of utilizing system dynamics simulations for strategic planning and for operational decision making with regard to overall asset management. Discusses how a combination of SKM and the BSC can be utilized. Points out that a particular strength of the SKM approach is that it is fully consistent with traditional accounting practice.
There can surely be no quibbling if I begin this article by saying that an organization's competitive potential rests almost wholly on how well it manages and deploys its corporate assets. These assets are comprised of financial, and tangible and intangible elements. For simplicity, consider financial assets as cash, and tangible assets as including plant, equipment, and inventory; intangible assets as including core competencies and technologies, management skills, culture, brand image, consumer loyalty, patents, distribution channels, and the like.
Traditionally corporate assets have been narrowly defined to include essentially only financial capital and tangible assets. However, it is clear that organizations require a much broader range of resources to be successful in any current market, and must ensure the right mix of tangible and intangible resources to effect desirable business outcomes. This is to say that organizations must not only value intangible assets for their inherent contribution to business success, but must actively and carefully consider their state in relation to financial and tangible assets during business strategizing and plan implementation.
This article first briefly examines the context for the emergence of interest in valuing more definitively an organization's intangible assets, and ways in which effective husbandry of such resources has been encouraged. I will then explore my contention that such approaches do not go far enough, and that all assets, financial, tangible and intangible, must be treated as part of a total system if the full benefits of their potential are to be realized. As part of this discussion I will show that current methods of dealing narrowly with intangible assets are adequate for a 'fire sale' or for high level strategizing, but that an approach founded in system theory offers a much more practical way to plan and run an organization's business. Such an approach is part of what I call Systemic Knowledge Management; this concept will also be explored here.
Current Competitive & Financial Business Contexts
The current competitive environment is driven largely by the emergence of the knowledge society, where as Drucker has described (Drucker, 1992), organizations move from productivity based on "make and move" to one based on "knowledge and service". The emergence of this "knowledge era" is radically changing what creates value in organizations, whereby the long-term viability and prosperity of an organization increasingly depends on its management's ability to leverage the hidden value of its intangible assets. While the intangible assets of firms are increasingly essential to their survival, most organizational decision makers have no idea whether they are augmenting such assets or depleting them; if they are depleting them, they are sapping their ability to create value, with tragic consequences for the organization. Any of the approaches reviewed or described in this article will improve this situation, inspite of any shortcomings noted.
Based on past practices, managers tend to lead their firms as though they were made up of only financial and tangible assets (Walsh, 1996). Effective management of intangible assets requires a radically different approach to both management and leadership. Valuing and measuring intangible assets promotes strategic organizational learning (Itami, 1988) and generates the renewable organizational capabilities required to meet customer expectations on an ongoing basis (Leonard-Barton, 1986). Organizations have had to face up to the challenge of enhancing capability to match the rapid evolution of market demands. In the knowledge era, the creation of corporate value results from the acceleration of organization learning which is the engine to generate intangible assets, including critical core capabilities.
More and more firms are coming to understand that in ignoring the importance of intangible assets they run a mortal risk. Predictably, the holistic harmonized management of all of the organization's resources has been ignored in the rush to leverage these assets. This is an important mistake since the basics of systems theory (Checkland, 1981; Rapoport, 1986) instruct that optimizing the individual members of a system will not optimize the system's performance; it is the interactions of the members which must be optimized. Unfortunately, if this lesson is not learned, efforts to optimize how intangible assets should be managed will give us the same dismal results that TQM, process re-engineering, and the learning organization have provided. The following three sections will serve to underline the non-systemic nature of much of the current activity in this area.
Intellectual Capital (IC)
Although a wide variety of authors (for example: Machup, 1984; Itami, 1987; Sveiby, 1987; Drucker, 1988; Aaker, 1989; Hall, 1989; Crawford, 1991; Sakaiya, 1991) published books and articles highlighting the emerging need for appropriate management of intangible assets, and the coming impact of skill-based competition, very little stir in organizational circles seems to have been created until Thomas Stewart (1994) published a cover story popularizing Intellectual Capital. From 1994 - 1996 the author was a member of a Lotus Notes based network called ICON (Intellectual Capital On-Line Network) sponsored by the Canadian Imperial Bank of Commerce, which was influential in connecting leading-edge international practitioners on this topic, and driving its exploration and practical application. Since then interest has spiraled (Brooking, 1996; Edvinsson & Malone, 1997; Stewart, 1997; Roos et al, 1997) and conferences also now abound. In particular, a practical development of IC, called the Balanced Score Card, first described by Kaplan & Norton (1992), has come into common usage, and will be discussed in more detail in the next section.
Intellectual Capital is a system composed of three elements; Human Capital; Customer Capital; and Structural Capital. Definitions provided by Saint-Onge (1998) are fairly typical: Human Capital is defined by Saint-Onge as "The capabilities of the individuals in an organization that are required to provide solutions to customers"; Structural Capital is defined as "The organizational capabilities of the organization necessary to meet market requirements"; and Customer Capital is defined as "The depth (penetration), width (coverage), and profitability of the organization's franchise". In my own work and for the purposes of this article I tend to use simpler definitions for two of these terms: Human Capital comprises transient knowledge and capabilities in the sense that they are "free to walk out of the organizational door at close of business day"; Structural Capital comprises the captured knowledge and capabilities that remain behind.
These three elements of Intellectual Capital represent and comprise the organization's stock of intangible assets. Value creation takes place as knowledge is exchanged between these three elements. This serves as the basis for the acceleration of learning and the systematic development of core organizational capabilities (Leonard-Barton, 1995). For instance, the firm creates value with customers when individual members (Human Capital) interact with customers, and when customers interact with, and are impressed by, the firm's Structural Capital. The quality of these interactions will enhance or diminish the Customer Capital of the firm (Saint-Onge, 1998).
Intellectual Capital as a topic to stir thinking and interest in the efficient and effective utilization of intangible assets has been invaluable. However, by its unwavering emphasis on intangible assets, IC masks the systemic nature of how organizations are called upon to function in the real marketplace; that is by manipulating their financial, tangible and intangible assets in harmony. The conceptual nature of IC leads to a 'list' based approach to an understanding of the management of such assets which ignores the highly complex dynamic interactions of its three Capital constituents, and of their interaction with the organization's financial and tangible resources. The sub-optimization and side-effects which such non-systemic approaches engender have been detailed by Senge in his treatise on the learning organization (Senge, 1990). Ackoff (1987) and others have used the terms "messes" and "wicked problems" to describe the complex interrelated problems that organizations face daily; the narrow and simple analytical approach adopted by IC practitioners cannot solve such problems (Rosenhead, 1989; Checkland & Scholes, 1990).
In addition, IC has not encouraged organizational managements to explore the dynamics of their strategic options, and the consequences of their decisions, over time; a prime benefit of systems thinking (Senge, 1990). Although IC is based on dynamic principles, in practice its application is static. That is IC is typically used to produce a "snapshot" of an organization's annual subjective valuation of its intangible assets, and descriptions of the status of any related programs etc. A well established example of this is provided by the Swedish company Skandia in a comprehensive supplement to its annual reports. Less formal snapshots of the current status of an organization's intangible assets are not new; for example, they are intuitively built into an organization's stock-market share value versus its book value, and are compiled for "fire sale" transactions such as a take-over, merger, or bankruptcy. Such valuations have traditionally been categorized as "good will", and practices are available to include these data in routine corporate accounting.
Unfortunately such informational snapshots provide little assistance in managing a business in the hurly burly of current markets. Consider the following hypothetical case: two organizations with exactly the same financial, tangible and intangible assets in the same market apply their capabilities using different strategies over the same five year period. It is not illogical to postulate that one firm does well and the other poorly. IC would not have shown that this might happen a priori, but would only provide a snapshot of the organization's intangibles, year by year. The benefits derived when an organization explores its strategic options in a more dynamic fashion as part of a Systemic Knowledge Management approach will be discussed in a later section.
The Balanced Score Card (BSC)
The Balanced Score Card was first described in 1992 (Kaplan & Norton), and has continued to increase in popularity. Although not originally claimed as an IC approach it's close relationship will be highlighted in this section; however, like most strategic planning methods, it simplifies, masks, and reduces to routine much of the complexity of IC theory and practice, and thus is an appealing approach for busy managers. It has been amply detailed in articles by its originators Kaplan and Norton (1993, 1996), and in a book that they have authored (1996). There has grown up a considerable body of articles by other authors expounding its virtues and describing its application to various companies.
On inspection, the relationship between the BSC and IC is fairly obvious. Three of the four elements of the BSC are Internal Business Perspectives, Innovation and Learning Perspectives, and Customer Perspectives. These three elements are interpreted in practice (Kaplan and Norton, 1996) in the same manner as Structural Capital, Human Capital and Customer Capital. By adding Financial Perspectives as its fourth element, the BSC does meet one of the concerns that I have expressed in the previous section. That is the need to consider an organization's financial position in relation to any Human, Structural or Customer Capital initiatives envisaged. The BSC does place emphasis on the measurement of change within the four elements. However, the BSC is still a 'list' based method for either establishing strategy or for monitoring its progress. In other words it still suffers from most of the drawbacks associated above with the IC approach itself.
This is not to say that the BSC is not an extremely useful way of focusing and monitoring an organization's asset management; it is to say that it is not a sufficient method. Use of the BSC in combination with more dynamic asset management approaches looks promising based on work I will describe in a later section.
Knowledge Management (KM)
During the various discussions that took place in the early '90s around Intellectual Capital, the word "knowledge" in various forms was explored and pursued. However, in general, Knowledge Management essentially referred to the I/S technologies dealing with informational databases, artificial intelligence, and more recently, Internet/intranet applications where information is shared across I/S networks.
There has been a growing trend to treat knowledge management in a more systemic organizational sense to include the social as well as the technological implications of any attempt to manage an organization's intangible assets. In this context, knowledge is information that has been understood, interpreted and validated through practice and it provides a convincing platform for action. The understanding and interpretation required to derive actionable meaning from information involves both tacit and explicit knowledge. This is because information is perceived, interpreted, and codified not only through the "lens" of an individual's or organization's explicit knowledge, but also through the more subtle additional "lenses" of their tacit-knowledge assumptions. This is why it is so essential that the explicit and tacit dimensions of organizational knowledge be developed in a complimentary and dynamically reciprocal manner (Nonaka and Takeuchi, 1995).
The social implications of treating knowledge management in this broader and more useful sense include consideration of questions involving such cultural factors as the degree of trust and openness in organizational communities; the personal consequences of collaboration; effective learning platforms; and many other subtle aspects of human interaction. Knowledge management in this sense has become part of the overall IC movement. However, the emphasis is moved from IC's strategic manipulation of the three Capitals with its resulting influence on the flow of knowledge, to a strategic emphasis on the management of knowledge and its flows, with a resulting impact on one or more of the three Capitals. The work of Davenport and Prusak (1997) is typical of this new more practical approach and includes an appreciation of the social and technological issues involved in any attempt to manage knowledge.
The change in emphasis from IC to KM has lead to more detailed exploration of "what knowledge is", and its categorization with a view to identifying what knowledge an organization needs to successfully implement its strategies, where this knowledge resides, and whether remedial action is required to manage it more effectively or efficiently. Know-how, know-what and know-why for example, are categories of knowledge which might be scrutinized and prioritized via a Knowledge Audit (Drew, 1996) before a knowledge management system is implemented or designed. In my own work I utilize knowledge categories such as data, information, intuition, skill, understanding, and wisdom. All the social aspects of any such knowledge management system would be addressed as well as the I/S implications.
Although this effort to root IC in a more practical area has been useful, it still suffers from too narrow a view of what constitutes the knowledge by which an organization must conduct its business in the market place. That is it addresses the "intangibles" subsystem but still fails to consider its containing system which also involves the "financial" and "tangible" subsystems.
Systemic Knowledge Management System (SKM)
As noted in preceding sections, concern for, and management of, financial, tangible and intangible assets have become increasingly disconnected even as interest in addressing the potential of intangible assets has increased. This is not atypical as people are notoriously incapable of thinking and acting systemically, and indeed competitive pressures on academics and other internal and external experts promote specialization. Systemic Knowledge Management was borne from a need to remedy this situation, first by attempting to redress the lack of sensitivity to the systemic issues, and secondly by providing practical alternatives to current thinking which would be based on SKM principles. The first mention of SKM was in relation to efforts to establish this e-journal on the World Wide Web in 1996; the journal actually began formal publication in 1998 (Journal of Systemic Knowledge Management, http://www.free-press.com/journals/knowledge/).
Systemic Knowledge Management is defined as those processes, tools and infrastructures by which an organisation continuously improves, maintains and exploits all those elements of its knowledge base (related to its financial, tangible and intangible assets) which the organisation believes are relevant to achieving its goals. SKM includes the processes, tools and infrastructure by which these goals are modified as the organisation's knowledge base changes.
The organisation's knowledge base is defined to include the data, information, intuition, knowledge (know how), understanding (know why), and wisdom, residing throughout the organisation and in areas of overlap with partnered customers.
Figure 1 represents the overall organizational system of financial, tangible and intangible assets in the form of a Venn diagram. Areas where elements do not overlap represent asset potential; areas of overlap between two elements represent areas in which competitive opportunities can be partially captured; areas where all three elements overlap represent the opportunities which can be optimally addressed by the organization.
Figure 2 shows that the subsystem "intangibles" can itself be represented by a Venn diagram where the system is made up of Human Capital, Structural Capital and Customer Capital. Overlaps or lack of overlap of the three Capital elements can be construed in the same way as for the system represented in Figure 1.
IC, and KM all operate as if Figure 2 were all important. BSC operates with partial but limited sensitivity to Figure 1. Neither IC, BSC nor KM are sensitive to the dynamic complex nature of the systems with which they deal. That is the way in which the three elements in Figures 1 or 2 can move in relation to one another and the speed of change and the inter-relatedness of the elements. Without this understanding organizations are forced to run their business as if they were a football team which could only see the scoreboard at the end of every quarter, and had to try to win the game with no feedback on the play by play. The kind of dynamic understanding required has been amply explored through system dynamics (Checkland & Scholes, 1990) and has been popularized in relationship to learning organization practice (Senge, 1990; Morecroft & Sterman, 1994) and in strategic war-games simulations (Treat, Thibault & Asin, 1996).
Figure 3 provides a simple dynamic, view of how interconnections between financial, tangible and intangible assets might be visualized generically, and could be manipulated for commercial advantage through a Systemic Knowledge Management System (SKMS). In this particular case the SKMS takes as its inputs the vendor's degree of satisfaction with measurements of the number of orders placed by customers and the customers' expectations; the vendor's own delivery capability; and the current state of the vendor's own financial assets. Based on these inputs, the SKMS dynamically deploys the organization's available finances for long term commercial viability. Notice that traditional accounting practices are not violated in this approach; however, any consequences of investments and expenditures will be clearly evident in the measured responses. This affords an appropriate balancing mechanism for strategic thinking and operational decision making with respect to the status of financial, tangible and intangible assets.
Such models are typically computer based, and are readily constructed from a technical point of view. The linkages shown in the model in Figure 3 could be readily converted into causal loops as part of an overall casual-loop diagram (Senge, 1990) simulating the given SKMS. Final consensus by organizational stakeholders on the form and operation of organizational factors and causal-loop linkages is the more time-consuming aspect of such modeling, but contributes enormous learning during both creation, testing, and operation of the model. Computerized simulation runs representing a number of years of commercial operation are feasible in very short lengths of time. Operational parameters can be changed at intervals representing real-time elapsed months, years etc. In this way a dynamic sense of how to run an organization for long term viability can be gained. Strategies of all kinds can be tried out on the model without risk to the organization; although such exercises should not be considered as predictive, they do offer directional and other strategic insights. Figure 4 shows how additional layers of complexity can be developed so that the real practical insights can be gathered during simulation runs.
All manner of outputs can be measured and reported during the simulations to help understand the dynamics of the situation, to aid decision making, and to assist in the design of real-life business-monitoring processes. An example of the application of this approach to SKM has been demonstrated by Drew & Smith (1996). These authors explored the case of a manufacturer of specialty automobiles which has various strategies open to it with respect to how it would invest in tangible- or intangible-related initiatives. It was shown that long term viability and financial success for the company were very sensitive to timing and extent of investment and costs of the various alternatives. The example was not meant to be predictive, but to highlight the opportunities management would have to explore mindsets and strategies before committing to them in real time.
In such simulations, the BSC can be combined with a dynamic model to provide the best of both approaches. First, the BSC is used for discussion of high level strategy and for preliminary decisions making. The simulation can then be run to explore the potential results if the strategic choices were operationalized. The BSC/simulation process is iterated until a satisfactory strategy is developed. The BSC can then be used to measure and monitor operational results and the simulation run from time to time with fresh data to provide a window on emerging potential threats and longer term outcomes.
Directions for Practice and Research
Fundamentally the IC approach has served us well in providing a framework within which to explore the nature and value of intangible organizational assets, and its emergence in practical forms such as the BSC and KM I/S are invaluable. However, in this article I drew attention to a critical shortcoming of IC-based approaches in that they emphasize the importance of intangible assets at the expense of financial and tangible assets. Furthermore I noted that BSC and KM I/S approaches do not explicitly acknowledge the dynamic inter-relatedness of all of an organization's assets. To overcome these shortcomings I contended that it is critical for an organization to manage its financial, tangible and intangible assets as a dynamic system, and I proposed a new approach which I called Systemic Knowledge Management (SKM).
There is more than adequate theory and practice in the areas of systems thinking and system dynamics to justify faith in their application to organizational planning, issue resolution and learning. The extension of these disciplines to aid in the management of corporate assets seems both logical and practical. In this article I outlined, and illustrated through a generic case, the manner in which system dynamics could be applied to develop a SKM system with unique advantages. Benefits included allowing practitioners to give full weight to traditional accounting practices and experience, whilst making plain the potential impact of including intangible assets in strategic and operational deliberations; a very important point if divisions between organizational and financial experts are to be reconciled. The advantages of further enriching or substantiating annual or other "snapshot" reporting with SKM derived data is obvious.
So how might an organization begin to implement SKM? As mentioned in a previous section, the BSC provides a proven strategic framework when implemented on a sound consensual informational footing, and includes the necessary provision for the financial, tangible and intangible assets of the organization. I believe that this is the most efficient entry point for most organizations starting on an SKM journey. Sophisticated collectives, perhaps well-developed as learning organizations, could take a more fundamental bottom-up approach to the categorization of their knowledge assets with consequent development of SKM systems tailored specifically to their detailed needs. For most organizations, development of complex structures such as the learning organization, are carried out over very long time frames if they are carried out at all; by combining the BSC with SKM, systemic knowledge management of assets could be achieved in a very short time, with consequent early capture of benefits.
Whether the SKM effort were based on an existing or newly introduced BSC initiative, the stakeholder groups used to develop and maintain the BSC would form natural clusters for exploration and development of SKM's system dynamics models. Such clusters would include individuals motivated to progress SKM, since they would have the most to gain from shared insights, and enhanced understanding of how their business might be run to optimize long term viability and profitability. Skills in system dynamics modeling could be readily gained by the individuals involved, since methods for model development and simulation exploration are amply covered in the literature, and are supported with appropriate commercially available computer based software and languages.
When introduced in this fashion, the BSC would provide a straightforward strategic planning, monitoring, and decision making framework, whilst the SKM would provide the learning platform for exploration in detail of the asset-management underpinnings. There would also be a natural iterative feedback between the BSC and the SKM with respect to identification of variables truly critical to quantitative and qualitative monitoring.
It is the author's hope that sufficient background information has been provided in this article to encourage organizational practitioners to feel secure in implementation of an SKM approach when combined with a BSC in the fashion outlined here. It is also the author's hope that others will join in research to extend the ideas presented here; in particular in exploration of the pros and cons of introduction of SKM where no BSC is in use.
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Walsh, C., Management Ratios, Pitman Publishing, London, 1996The author acknowledges valuable dialog with Hubert Saint-Onge during the preparation of this manuscript