Boosting corporate financial performance with intellectual capital Dr. Kin H. Chan Senior Programme Director & College Principal Lecturer, Institute for China Business Dr. Sam Chu Associate Professor, Faculty of Education, The University of Hong Kong. 1 7 Sep 2011

Why this topic?  When there is close interaction between these 3 categories of IC (Hermans & Kauranen, 2005) the firm is able to create value from its business activities and growth can be anticipated  A well-balanced combination of these three categories of IC requires proper knowledge management. 2

3 Agenda  What is IC?  How to evaluate KM utilization of an organization?  Is there a relationship between KM utilization and IC performance? ()?  How do listed companies in HK compare with other Asian counterparts in IC performance (VAIC TM )?  Q&A

4  The concept of intellectual capital (IC) first appeared in a book published in 1836 by Nassau William Senior (Marr, 2007)  No single definition of IC evolved from different academic disciplines (Marr, 2007) Background: What is Intellectual Capital (Marr & Roos, 2005)

5  IC – economic value of structural capital and human capital of a company (Petty and Guthrie, 2000)  IC = human capital + structural capital (Edvinsson, 1997)  IC – Difference between book and market value of a company (Edvinsson & Malone, 1997)  Book Value = Assets – Liabilities  Market capitalization = Current stock price X number of outstanding shares Background: What is Intellectual Capital

6  A tripartite model for IC, comprising human capital external capital (e.g. relationships with customers and suppliers) internal capital (e.g. patents, technology and systems) (Sveiby, 1997) Background: What is Intellectual Capital

7 Human capital - composed of the skills and competencies of the company’s personnel. Structural capital - includes the way of organizing the company’s activities and also the intellectual property rights of the company. Relational capital - stresses the importance of external networks.  (Hermans & Kauranen, 2005) Background: Components of IC

8  In 1995, IBM bought Lotus for $3.5 billion. 14 times Lotus’ book value. Background: Components of IC

9  42 valuation methodologies on measuring intangible assets (Sveiby 2010)  Some of the more well-known methods: Economic value added TM, Market-to-book value, and VAIC TM Methods on measuring IC

10  Is the worth of Intellectual Capital always reliable?  When will the IC of a listed company be exaggerated? Is it when the stock price of the company goes up crazy  Or is it during the period that the stock price comes down quickly? Methods on measuring IC

11 Methods on measuring IC VAIC TM Methodology  Ante Pulic’s value added intellectual coefficient (VAIC TM ) is designed to assess the efficiency of key resources in business organizations (Pulic, 2000). adding value and creating wealth through  employing physical capital  human capital  structural capital

12 Methods on measuring IC VAIC TM Methodology  The key assumption is that human capital is an investment, not a cost.  Value-added = Output – Input  Value-added intellectual coefficient defined through its components: human capital coefficient, structural capital coefficient, physical capital employed coefficient

Methods on measuring IC VAIC TM used by business enterprises  A Croatian company 13 Source:

Methods on measuring IC VAIC TM used by business enterprises  SHIPYARD ULJANIK 6 Years after 14 Source:

15 Methods on measuring IC Advantages for using VAIC TM  Apply widely in different contexts due to its ease of administration  Objective and financially-based measure of IC efficiency as it makes use of audited financial data (Chan, 2009a)  Standardized and objective measurement (Firer and Williams, 2003)

16 Methods on measuring IC Limitations of the VAIC TM Methodology  Inability to handle companies with negative book value of equity or negative operating profit  Interactions among the components of intellectual capital (Bontis et al., 2000)

17 Prior studies on VAIC TM Prior studies of IC outside Mainland China  UK - Zéghal and Maaloul (2010) investigated whether or not there was a correlation between IC and corporate performance in 300 UK businesses using data from the year They found a positive relationship with economic and financial performance only in high-tech industries.  TW - intellectual capital had a positive impact on market value and financial performance (Chen et al., 2005).  India - high correlation between VAIC TM score and business survival

18 Prior studies of IC in Hong Kong  Chan (2009a, 2009b) laid the groundwork for IC research and developed the framework for the empirical studies on Hong Kong no strong association between IC and four corporate financial indicators in constituent companies of the Hang Seng Index for moderate association was found between the individual components of IC and corporate financial indicators

Prior studies of IC in Hong Kong  Chu, Chan & Wu (2011) measured VAIC TM of HK listed companies, and found it was positively associated with profitability of businesses. In particular, structural capital played a notable part in enhancing corporate profitability 19

Evaluation of KM utilization of an organization  KM maturity model Knowledge Management Framework Assessment and Knowledge Journey in KPMG (2000) KNM TM in Hsieh, Lin and Lin (2009) KM 3 in Gallagher and Hazlett (2000) Knowledge Management Capability self- assessment Framework in Collison and Parcell (2004) 20

KM Capability self-assessment framework (Collison and Parcell, 2004) 21 KM StrategyLeadership Behaviours NetworkingLearning before, during and after Capturing knowledge Level 5 Clearly identified Intellectual assets. KM strategy is embedded in the business strategy. Framework and tools enable learning before, during and after. Leaders recognise the link between KM and performance The right attitudes exist to share and use others’ know-how. Leaders reinforce the right behaviour and act as role models. Clearly defined roles and responsibilities. Networks and CoPs have a clear purpose, some have clear deliverables other develop capability in the organisation. Networks meet annually. Prompts for learning built into business processes. People routinely find out who knows and talk with them. Common language, templates and guidelines lead to effective sharing. Knowledge is easy to get to, easy to retrieve. Relevant knowledge is pushed to you. It is constantly refreshed and distilled. Networks act as guardians of the knowledge. Level 4 Discussions ongoing about organisation’s Intellectual assets. A KM strategy exists but is not linked to business results. A clear framework and set of tools for learning is widely communicated and understood. KM is everyone’s responsibility; a few jobs are dedicated to managing knowledge. “Knowledge sharing is power.” Leaders set expectations by “asking the right questions”, and rewarding the right behaviours. Networks are organised around business needs. Networks have a clear governance document. Supportive technology is in place and is well used. Learning before, during and after is the way we do things around here. “Customers” and partners participate in review sessions. Just-in-time-knowledge is current and easily accessible. One individual distils and refreshes it, though many contribute. That individual acts as the owner. Level 3 There is no framework or articulated KM strategy. Some job descriptions include knowledge capture, sharing and distillation. People are using a number of tools to help with learning and sharing. KM is viewed as the responsibility of a specialist team. Some leaders talk the talk, but don't always walk the walk! People are networking to get results. Networks are created People can easily find out what the company knows. Examples of sharing and using are recognised. Peers are helping peers across organisational boundaries. Networks take responsibility for the knowledge, collects their subjects knowledge in one place in a common format. Searching before doing is encouraged. Little or no distillation. Level 2 Most people say sharing know- how is important to the organisations success. People are using some tools to help with learning and sharing Some managers give people the time to share and learn, but there is little visible support from the top. Ad hoc networking to help individuals who know each other. People learn before doing and programme review sessions. They capture what they learn for others to access. In practice few do access it. Teams capture lessons learned after a project. Teams look for knowledge before starting a project. Access to lots of knowledge, though not summarised. Level 1 A few people express that know- how is important to the organisation. Isolated people with a passion for KM begin to talk and share how difficult it is. KM viewed as a management fad. Leaders are sceptical as to the benefits. Leaders think networking leads to lack of accountability. "Knowledge is power" Knowledge hoarders seem to get rewarded. People are conscious of the need to learn from what they do but rarely get the time. Sharing is for the benefit of the team. Some individuals take the time to capture their lessons in any number of cupboards and databases. They are rarely refreshed, few contribute, even fewer search.

Questionnaire 22

23 Scores of KM capability self-assessment Five dimensions of KMMean score KM Strategy 3.64 Leadership Behaviours 3.60 Networking 3.33 Learning Before During and After 3.70 Capturing Knowledge 3.61 Overall Performance 3.58 Sample mean of KM maturity level in China listed companies (N=26) (Chu et al., 2011)

24 VAIC TM vs KM scores VAIC ™ Company Average KM Maturity Level Score KM dept? A N B N C Y D Y E N F N G N H N I Y J N U N V N W N X N Y N Z Y … (Chu et al., 2011)

Relationship between KM scores and VAIC TM 25 (Chu et al., 2011)

26 Conclusion & Limitations  A clear correlation between KM scores and VAIC TM was not identified.  May need to expand the study to cover many more companies  Relatively small sample size  Respondents tend to reply positively about their companies’ maturity level in KM  VAIC TM based on hard data (data from financial reports) while our KM data was from a perceptual survey

References 1  Andriessen, D. (2004), Making sense of intellectual capital: designing a method for the valuation of intangibles, Elsevier Butterworth-Heinemann, Burlington, MA.  Bontis, N., Keow, W. and Richardson, S. (2000), “Intellectual capital and business performance in Malaysian industries”, Journal of Intellectual Capital, Vol. 1 No. 1, pp  Chan, K. H. (2009a), “Impact of intellectual capital on organizational performance: An empirical study of companies in the Hang Seng Index (Part 1)”, The Learning Organization, Vol. 16 No. 1, pp  Chan, K. H. (2009b), “Impact of intellectual capital on organizational performance: An empirical study of companies in the Hang Seng Index (Part 2)”, The Learning Organization, Vol. 16 No. 1, pp  Chen, M., Cheng, S. and Hwang, Y. (2005), “An empirical investigation of the relationship between intellectual capital and firms' market value and financial performance”, Journal of Intellectual Capital, Vol. 6 No.2, pp  Chu, K.W.S., Wu, W.Y.W, Chan, K.H., Fu, O. (2011) “The relationship between knowledge management and intellectual capital in listed companies of mainland China”, paper submitted for 8 th International Conference on Intellectual Capital, Knowledge Management & Organisational Learning, Bangkok, Thailand, October  Collison, C. and Parcell, G. (2004) Learning to Fly: Practical Knowledge Management from Leading and Learning Organizations, Capstone Publishing, Chichester, West Sussex.  Edvinsson, L. (1997), “Developing Intellectual Capital at Skandia”, Long Range Planning, Vol. 30, No.3, pp  Edvinsson, L. and Malone, M.S. (1997), Intellectual Capital: Realizing Your Company's True Value by Finding Its Hidden Brainpower, Harper Business, New York, NY.  Firer, S. and Williams, M. (2003), “Intellectual capital and traditional measures of corporate performance”, Journal of Intellectual Capital, Vol. 4 No. 3, pp

References 2  Hermans, R. & Kauranen, N. (2005). Value creation potential of intellectual capital in biotechnology – empirical evidence from Finland. R&D Management, 35:  Marr, B., Roos, G. (2005), "A strategy perspective on intellectual capital", in Marr, B. (Eds),Perspectives on Intellectual Capital: Multidisciplinary Insights into Management, Measurement, and Reporting, Elsevier, Boston, MA,.  Marr, B. (2007), “What is intellectual capital?”, in L. A. Joia (Ed.), Strategies for information technology and intellectual capital, Idea Group Pub., Hershey, PA, pp  Petty, R., and Guthrie, J. (2000), “Intellectual capital literature review – measurement, reporting and management”, Journal of Intellectual Capital, Vol. 1 No. 2, pp  Pulic, A. (2000), “VAIC – an accounting tool for IC management”, International Journal of Technology Management, Vol. 20 Nos. 5-8,  Sveiby, K. E. (1997), The new organizational wealth: managing and measuring knowledge based assets, Berrett-Koehler, San Francisco, CA.  Sveiby, K. E. (2010), “Method of measuring intangible assets”, available at: (accessed 9 August 2010) 28

29 Contact me  Questions? Collaborations? Dr. Sam Chu Associate Professor Division of Information & Technology Studies Deputy Director, CITE Faculty of Education, The University of Hong Kong Pokfulam Road, Hong Kong. Tel: (852) Homepage: