Digital
Communities @Work TM
A Concept
Describing the Next Wave in Human Capital Management
Hakan Altintepe, A.T. Kearney, Inc
ABSTRACT
In this article, the author aims to bring clarity to a long overdue mystery around the management of human capital. First, he lays out a widely used approach, which describes how most Fortune 1000 organizations are managing their most valuable knowledge assets. Then, he identifies and elaborates the fundamental shortcomings of this approach. Finally, the author suggests a practical and innovative solution for large organization to better harness the potential of their human capital. The author believes that the concepts introduced in this article will stimulate the thinking of executives to establish an upper hand on the rapidly emerging strategic issue of human capital management.
During the past two decades as dependency on critical business knowledge has increased, many Fortune 1000 organizations have adopted a fairly standard, top-down approach to human capital management. According to this approach, the corporate management is responsible for determining what knowledge to capture, how to organize it, who to grant permission for access. Employees, on the other hand, are responsible for creating the critical business knowledge. The whole system depends upon a simple expectation that employees contribute their knowledge to corporate systems for the benefit of their whole organization.
This standard approach to human capital management reveals striking conceptual similarities to the socialism. The socialism is an idealistic system that was originally developed to accelerate wealth creation for the benefit of a whole community. It assumed that people work hard and allow their production given to others. However, it failed to achieve this goal due to its fundamental defects and unrealized assumptions. In this paper, the author asserts that the standard approach suffers similar defects. The socialism came to an end when its perfect execution by communist governments could no longer justify its shortcomings against free-markets. He extrapolates that even a perfect execution of the standard approach cannot succeed, as innovative organizations search for and adopt alternative means for the better management of their human capital.
Fortunately, recent technological developments and changes in competitive business environments has created a significant opportunity for large organizations to better manage their human capital: digital communities that adopt free market principles will be most suited to establish a frictionless environment for the knowledge exchange, and therefore, for the growth of human capital. In simple terms, the Digital Communities @WorkTM refers to an innovative business concept that will create digital communities of practice or interest at large organizations, by leveraging the Intranet and Enterprise Information Portal (EIP) technologies. Digital communities will stimulate collaboration and knowledge exchange among employees and members of the extended enterprise. The Digital Communities @WorkTM will most likely to lead to a new intranet-based, killer application that will push the effectiveness of human capital management to the next level. Particularly, the resulting communities will represent the collective brainpower of a whole enterprise by accelerating collaboration among employees to a new measure never achieved before.
What differentiates digital communities from today’s collaborative environments is that they will adopt free market principles to acquire, organize, distribute, and evaluate knowledge; and reward members based on their contributions. These communities will no longer treat knowledge as a public good. They will set aside a credible budget to compensate members proportional to the value of their contributions. The size of the compensation budget will depend on the productivity of the whole community. Digital communities will create a constructive competition within efficient markets; similar to those already established for physical goods that only citizens of the free-market nations are privileged to enjoy today.
Digital communities will lead to a new kind of corporate brainpower that will exponentially increase as more employees become better connected with others. In the end, organizations that successfully nurture these communities will create an unequalled corporate intelligence, and thereby, outperform their competition.
Although digital communities will prove to be invaluable to large organizations, their implementation will be nontrivial, and it will require a major paradigm shift in the way executives view how knowledge be acquired, captured, organized and distributed within their organizations. Furthermore, enterprises, which decide to nurture digital communities, will need to overcome significant challenges in developing complex analytical infrastructures to manage the balance of demand and supply of knowledge through comprehensive, flexible, and efficient incentive programs.
Fortune 1000 executives will significantly benefit from carefully evaluating the benefits and the risks of digital communities, and from preparing their organizations for this emerging opportunity.
INTRODUCTION
Demand for knowledge enabled products and services are burgeoning, and competitive pressures in business markets are increasing. The role of knowledge as a strategic differentiator is becoming clearer in all sectors. The management of human capital, where corporations’ most valuable knowledge assets reside, has been receiving a significant executive attention at most Fortune 1000 organizations. Effective use of knowledge assets has become a universal necessity to succeed.
Unfortunately, most Fortune 1000 organizations are still uncertain about whether they are able to maximize returns from investments on their human capital. Why? Because, conventional wisdom and traditional financial tools employed throughout evaluations of investment options offer little relief when something as ‘sacred’, and puzzling as human capital is involved. In the absence of adequate tools and frameworks, executives prefer to remain conservative rather than freewheeling, despite their awareness of the lucrative opportunities that are systematically sacrificed. These executives are looking for clear answers to the following basic and common sense questions:
Ø What is my ROI on human capital initiatives, and how does it stand against my competition?
Ø How do I make sure that every dollar I invest in knowledge assets is best allocated for the highest financial return?
Ø In today’s knowledge economy, how can I become as prudent and informed with my investments on knowledge assets as I am with capital spending on my physical assets?
Ø What financial opportunities am I forfeiting due to managing knowledge assets at arms length?
One of the most significant bottlenecks of today’s human capital management is the contribution of knowledge by employees into corporate systems. As far as tacit knowledge that resides in the minds of employees is concerned, most Fortune 1000 organizations rely upon a similar approach: create massive databases, expect employees to contribute insights, and distribute those insights to authorized employees at zero cost (a public good approach). Isn’t this analogous to how socialism tried to create wealth, and failed? Socialism assumed that people would work hard and share their production with others. In reality, lack of ownership and competition severely inhibited creation of wealth in their communities. By the same token, zero-cost access to other employees’ insights diminishes the excitement and motivation needed to create valuable knowledge and share it with others. Today, many Fortune 1000 enterprises are far from unleashing the full knowledge potential of their human capital.
In his article, we will together explore alternative and innovative remedies for this universal bottleneck. First, we will develop an analytical framework to assess the significance of human capital at Fortune 1000 organizations. Using this framework, we will highlight the major shortcomings of standard management practices applicable to human capital, today. Next, we will analyze the knowledge value chain at large enterprises to find out why standard management practices cannot yield the optimum performance. Finally, we will suggest an innovative approach to unleash the full potential of the employee knowledge.
Knowledge is a prominent,
present-time strategic economic driver
From prehistoric hunter tribes to the digital communities, mankind has been witnessing an astonishing economic evolution. During this journey, every time a strategic economic driver emerged, the indisputable judgment of the natural selection promoted those who best converted new drivers into competitive advantages to leaders of a new era. For example, physical strength was a crucial characteristic, and hence an economic driver, in the prehistoric age. Back then, strong hunters were, hence, very influential, and held ruling positions in their communities. By the same token, ‘land’ during the agricultural age, and ‘transportation capability’ during the colonial age emerged as strategic economic drivers, providing unequalled competitive advantages to those who controlled them.
Natural resources such as oil, gas, steel and chemicals gained strategic importance during the industrial age. Nations that acquired prominent control over these resources dominated the rest of the world economically and politically until technology replaced physical resources, and became the next strategic economic driver.
During the last three decades of the past century, enterprises such as Microsoft, Intel, and Merck started differentiating themselves through acquisition and capitalization of the knowledge rather than the physical resources. This trend led to technological innovations in software, space technology, semiconductors, computers and electronics. Consequently, knowledge emerged as the next strategic economic driver. A new breed of information savvy organizations pushed the titans of the industrial age into sidelines, and become the leaders of the emerging technology age.
During the early phases of the technology age, due to practical, organizational and economic reasons it was appropriate to top-down manage the business knowledge. This led knowledge to be created, exchanged and retained primarily among a few elite in each organization such as executive managers, lead scientists, and executive sales people. The rest of employees were merely expected to execute the decisions or innovations initiated by the elite.
Since then, the advent of personal computers, the Internet and the electronic delivery of information enhanced the importance of knowledge to a new level that all ranks of employees now accumulate, process and generate insightful information. Today, all employees, rather than a few individual stars, constitute the new corporate brainpower that impacts the corporate bottom-line. Knowledge, which is concentrated in employee networks, has become a prominent economic driver, signaling that we have reached a new milestone in our relentless economic evolution: Today, we are welcoming the digital age!
Historic trends shed a significant light into future events. Therefore, I predict that only those enterprises, that can convert employee knowledge into competitive advantages, will lead in the digital age. In the remainder of this section, we will review emerging trends in valuation of large enterprises, and uncover clues that either support or reject this prediction.
Intangibles rather than tangibles compose most of
the market value of today’s enterprises
Market value of an enterprise can be described as the total market value of all underlying tangible and intangible assets. Tangible assets consist of economic resources such as cash, receivables, investments, properties, plants, equipments, etc. We can easily identify and appraise tangible assets. Intangibles, on the other hand, are very hard to identify, categorize and appraise. In this article, we group corporate intangibles into five main categories, i.e., human capital, intellectual property, customer assets, business relationships and organizational assets.
Figure 1. Market
value of an enterprise consists of tangible and intangible assets, i.e., human
capital, intellectual assets, organizational assets, customer assets, and
business relationships
Prior to the digital age, price-to-book ratio was a common measure for corporate valuation, as companies mainly leveraged tangible rather than intangible assets to generate earnings. In 1980, the Price-to-Book of largest companies in the U.S. was 1.2[1]. Today however, the Price-to-Book has reached 9.9x[2]. In other words, the premium that market is willing to pay for an enterprise beyond its book value increased roughly from $0.2 to $8.9 for every $1 worth of tangible asset[3]. This 4350% increase in the premium manifests an immense appreciation of corporate intangible asset[4]. In fact, market to tangible book ratio for large U.S. enterprises average about 12.2, indicating that intangible assets constitute more than 90% of the overall market value of U.S. enterprises[5].
Knowledge-based industries, particularly in science and technology sectors, have been growing faster than most other industries. During the last 10 years, industries that have leveraged knowledge as one of their primary resources have not only transformed the economic structure in the U.S., but also in many other countries. For example, recent reports indicate that the international trade in the knowledge sector is growing five times faster than in natural resource intensive industries, reaching to $3.5 trillion in 2002[6]. Furthermore, the Market-to-Book ratio averages at 14.2 among highly knowledge-based companies, whereas this ratio remains to be only 3.5 among industries that moderately depend on knowledge.
Table 1. Intangible assets consist of a larger portion of the market value in knowledge-based industries[7] then the rest of the economy
|
Industry |
Dependency on Scarce Knowledge |
Market Value ($ MM) |
Price to Book |
|
Network Communications |
High |
$733,803 |
22.3 |
|
Computer Software |
High |
$808,167 |
19.0 |
|
Semiconductors |
High |
$605,875 |
12.2 |
|
Pharmaceuticals |
High |
$853,078 |
9.8 |
|
Medical Products and Equipment |
High |
$116,760 |
7.8 |
|
Telecommunications |
Medium |
$1,175,630 |
4.3 |
|
Retail |
Medium |
$305,611 |
4.1 |
|
Motor Vehicles and Parts |
Medium |
$146,675 |
2.1 |
|
Textiles |
Low |
$5,778 |
1.6 |
|
Airlines |
Low |
$33,316 |
1.5 |
|
Utilities |
Low |
$253,245 |
1.3 |
|
Energy |
Low |
$3,467 |
1.3 |
Table 1 illustrates a trend that intangible assets in knowledge based industries such as network communications, computer software, semiconductors, pharmaceuticals, etc. are more valuable than intangibles in other industries. This finding leads to the conclusion that knowledge-based intangibles like human capital constitute a significant portion of all corporate intangibles, which already account for most the market value of large enterprises.
The total worth of human capital
at Fortune 1000 organizations is estimated between $1.0 trillion - 3.1 trillion
The book value of corporate equity includes all tangible assets after liabilities and a portion of intangible assets that are not homegrown, but acquired through merger and acquisitions. These intangibles, called goodwill, make up on the average 27%[8] of the book value of corporate equity among large enterprises. To find out the total value of intangibles among Fortune 1000, we subtract from the total market value of corporate equity the total book value of these firms, and then add the goodwill value to it. Consequently, we estimate that intangibles that contribute to the market value of Fortune 1000 organizations be worth $10.4 trillion as of December 1999, see Table 2.
Table 2 The total intangibles among all Fortune 1000 companies is estimated to be $10.4 trillion in 1999[9]
|
Total market value of fortune 1000($ trillion) |
$12.5 |
|
Book Value ($ trillion) |
$2.9 |
|
Intangible Assets not on Books ($ trillion) |
$9.6 |
|
Intangible Assets on Books (27% of Equity)($trillion) |
$0.8 |
|
Total Intangibles ($ trillion) |
$10.4 |
In Figure 1 we have defined intangibles as the collection of five asset subcategories such as business relationships, customer assets, organizational assets, Intellectual assets, and human capital. The value distribution of these subcategories within overall intangibles differs in each sector. To determine the total value of human capital within Fortune 1000 organizations, we estimate the distribution of each subcategory per sector. Our distribution criterion is the perceived importance of each asset category to the sustained value proposition of firms in that sector. Subsequently, we calculate the weighted average of asset category distribution based on the market value of each sector.
Table 3 Based on the best guess estimate of a small number of management consultants, intangibles are almost evenly distributed over five asset subcategories at Fortune 1000 companies
|
Sectors |
Market Value Distribution |
Business Relationships |
Customer Assets |
Organizational Assets |
Intellectual Assets |
Human Capital |
|
Basic Materials |
3% |
30% |
20% |
30% |
5% |
15% |
|
Capital Goods |
2% |
20% |
20% |
30% |
10% |
20% |
|
Conglomerates |
5% |
20% |
20% |
20% |
10% |
30% |
|
Consumer Cyclical |
4% |
30% |
20% |
20% |
10% |
20% |
|
Consumer/Non-Cyclical |
5% |
30% |
20% |
20% |
10% |
20% |
|
Energy |
4% |
30% |
5% |
20% |
30% |
15% |
|
Financial |
14% |
20% |
30% |
10% |
20% |
20% |
|
Healthcare |
11% |
20% |
10% |
20% |
25% |
25% |
|
Services |
19% |
10% |
20% |
20% |
20% |
30% |
|
Technology |
27% |
20% |
20% |
10% |
20% |
30% |
|
Transportation |
1% |
25% |
15% |
30% |
10% |
20% |
|
Utilities |
2% |
30% |
10% |
20% |
10% |