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September 14, 2003

Beyond Linear Economics 2 - A very human measurement crisis 

These extracts from the superb paper by Richard Youngman in the EU Library on Intangibles

Measuring intangibles, such as human capital, brands, intellectual property and other innovation outputs, and organizational capabilities, constitutes perhaps the greatest challenge for business today. Accounting, as we know it, was invented over 500 years ago to track executed transactions. This worked well in the Italian city-state trading industries, but is severely challenged where years can separate the start of production and associated end-transactions, as in, say, the bio-technology industry and where the historical cost of the physical inputs no longer comes close to relaying the full economic realities of the underlying production processes. The principles of accounting are entrenched in our managerial practices and thought processes. They influence decisions both within firms and by external agents such as the capital markets. We measure less and less of what actually matters, but take decisions accordingly. This, in the eyes of some, is very dangerous. "Focusing exclusively on financial objectives distorts the structure of [organisations]…and in ways that ultimately jeopardise them. This is the most important business lesson of the past decade,” comments the leading UK economist John Kay.

The firm no longer represents a mechanical form, a bundle of owned and static assets arranged in the most efficient Taylorist manner. It is a living organism, a beehive of ideas, to which mobile and transitory individuals bring with them some of the key tools for production. Rather like the natural sciences’ understanding of living organisms (such as the human body) penetrated the surface, so economics and management, as disciplines, need to more successfully penetrate the “black box” that is the firm. Productivity and profitability are poorly explained by mere observation of the volume and cost of the inputs into, and outputs from, this black box. Quality of the processes within the black box are crucial elements in determining the outputs (the products/services) and their relative and ongoing success in the marketplace. In the 20th century we focused on margin, investment and asset productivity to achieve comparative advantage. This game has run its course. The winners of the 21st century game will increasingly focus on architecting capabilities – the capability to innovate and the capability to act – and managing risks such as reputational loss.

Measurement matters because human society is very number-centric in its pursuit of understanding. As Lord Kelvin put it, “When you can measure what you are speaking about and express it in numbers, you know something about it; but when you cannot measure it, when you cannot express it in numbers, your knowledge is of a meagre and unsatisfactory kind.”The aim of measurement in this context is to develop a language for thinking, talking and doing something about the drivers of the company’s future earnings by focusing in on what they need to do and know to deliver value to the end user. Under this measurement methodology, “valuing” is a learning process to identify the “living” means by which (net) present value is created and transformed, rather than reducing the firm’s (net) present value to one static numeric value.

As Herb Kelleher, the legendary CEO of SouthWest Airlines, the only sustained US success story in the capital-intensive airline industry, put it, “It’s the intangibles that are the hardest thing for a competitor to imitate…so my biggest concern is that somehow…we lose the esprit de corps, the culture, the spirit. If we ever do lose that, we will have lost our most valuable competitive asset.”

You can join a discussion thread I moderate fro the Euroepan Union on Intangibles & Intangibles here. We delight in any questions. This provides more background to those who have done most to develop Human KM (Knowledge Management) as an inter-disciplinary inquiry.
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