Nearly 60 percent of the aggregate value of the
US stock market is based on investor expectations of future growth. And because
this future value tends to be concentrated in industries and companies that are
built on intangible assets, it is critical to find better ways to recognize,
report and manage these assets.
By John J. Ballow, Robert J. Thomas
and Göran Roos Outlook Journal, February 2004
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Help   As if CEOs didn't already have enough headaches trying
to make their quarterly and annual numbers, these days many of them are also
under increasing pressure at the longer-term end of the spectrum—in the form of
investor expectations about future growth. Indeed, the whole issue of "future
value"—that portion of a stock's price that does not depend on current
operating performance but rather on the company's anticipated growth—is one of
mounting concern to C-level executives faced with the task of delivering
share-price performance in a difficult economic climate.
Future value is not, of course, a new concept. Nor is it
equally important in all parts of the economy. It is, however, especially
critical in newer industry sectors and among companies whose value is based
heavily on intangible assets such as brand and proprietary knowledge—in other
words, industries and companies that are among the most important to driving
the economy.
Consider this: To justify its lofty share price, one highly
esteemed new-economy company will need to grow revenues by a staggering 60
percent a year over the next decade. At least, that is what an analysis of the
company based purely on its current operating results suggests. A share price
so closely linked to future value could be considered at risk.
A similar analysis of the entire US stock market shows that
as of May 2003, there was an extraordinary $7.6 trillion at risk—an amount that
represents 58 percent of the aggregate value of the US stock market, as
measured by the Russell 3000 Index. And this is not just a US phenomenon: A
joint Financial Times/Stern Stewart & Company study of the
UK stock market in September 2000 showed £864 billion of equity value at risk
among just the largest 200 listed companies.
Key Value Drivers
Clearly, the
potential market impact of future value is dramatic. If the means to analyze,
report and manage future value were commensurate with this impact, CEOs could
take comfort. But in fact, as many CEOs appreciate, powerful trends have put
the two far out of sync.
During the past 25 years, intangible assets have supplanted
tangible assets as the key value drivers in the economy. At the same time,
traditional accounting has remained focused on tangible assets. As a result, a
significant portion of corporate assets go underrecognized and underreported.
And because it is difficult—some would say impossible—to manage what is not
being measured, many of the assets that are most responsible for creating value
in today's economy are not managed as well as they could be.
Many C-level executives rely on fiscal-year,
accounting-based financial data to run their businesses; they focus on current
operating results, and they use those results to form strategies that do not
necessarily optimize future growth. In managing for today, they use relatively
straightforward accounting methods to link their own management decisions to
stock market impact. But when it comes to managing for tomorrow, the basis for
making these connections is far more tenuous.
The inadequacy of current accounting methods in a
knowledge-driven economy—and the search for more suitable methods—is not news.
In fact, articles on the subject began appearing in the business and academic
press in the late 1970s, and they became more common during the mid-1990s.
Formal methodologies such as economic value added and the balanced scorecard
are just some of the more visible evidence of the lively interest in the
subject among financial regulators, accounting professionals, consultants,
stock exchange officers and businesspeople.
In fact, a recent joint Accenture/Economist Intelligence
Unit study confirmed that today's senior executives see managing intangible
assets as a major issue. Fully 94 percent consider the comprehensive management
of intangible assets important; 50 percent consider it one of the top three
management issues facing their company.
At the same time, executives say performance measurement of
intangible and intellectual capital assets is insufficient or even nonexistent.
Only 5 percent of surveyed executives claim their company has a robust system
that measures and tracks all aspects of the performance of these assets. Sixty
percent say they apply only some of these measures, and one-third do not
measure the performance of intangible assets or intellectual capital at all.
Clearly, there is a wide gap between awareness of the issue and success in
addressing it.
 Defining
Assets
Accenture is committed to building a meaningful
understanding of future value and helping companies manage it better. As part
of our companywide high-performance business initiative, we have developed a
set of tools to precisely break down and analyze the constituent components of
future value; a comprehensive research database that examines drivers of future
value from both industry- and context-dependent perspectives; and a methodology
for applying the tools and research on a company-specific basis.
Central to our work is an understanding of what constitutes
"intangible value" (see sidebar). The
answer is more complex than might be expected; it depends not only on what
companies themselves determine but on the consensus of their investors and
other major stakeholders.
 To
define and classify assets, Accenture incorporates research done by
AssetEconomics, a strategy advisory firm, that considers both the form of the
asset—monetary, physical, relational, organizational or human—and its
recognizability, that is, its tangible or intangible characteristics. A
traditional monetary asset like cash, for example, is tangible; "borrowing
capacity" would be an intangible aspect of monetary assets. Similarly, patents
would be a type of tangible organizational asset, while "R&D productivity"
would be an intangible organizational asset.
The distinctions are important. First, they illustrate the
limited focus of current accounting, which considers just the tangible aspects
of traditional monetary and physical assets. Second, they show how companies
can overlook large categories of shareholder-value drivers, which in many
industries are the principal contributors to share price.
 Accenture's work in the area of human capital, for example, has
shown that the value created by investment in employee recruitment, training
and professional development, and retention can be precisely measured.
Moreover, those diagnostics can be applied strategically at the business-unit
or enterprise level to produce measurable increases in shareholder value.
To illustrate the impact of an intangibles-driven
perspective, consider the actual case of a leading global pharmaceuticals
company. In 1997, 80 percent of its share price was based on future value;
assuming that future value is the difference between a company's market cap and
its current value of daily operations (into perpetuity), only 20 percent of the
pharma's share price was actually based on its current value. An analysis of
the stock's history showed that the markets rewarded the success of its R&D
investments. But traditional accounting recognizes R&D only as an expense,
and it therefore has a negative impact on earnings per share. Because the
company's performance metrics and annual incentives were based on earnings per
share, senior executives tried to minimize R&D spending.
Undervalued, Undermanaged
Future-value analysis showed the company was very well managed—for the
traditional asset classes it recognized. But the same analysis showed that the
value of current earnings actually represented just 2 percent of the company's
total market value (using the general rule of thumb that capitalized current
operating value equals 10 times current earnings). This 2 percent was the focus
of the company's budgeting, planning, management systems, variance analysis and
month-to-month tracking. This means the other 98 percent of the company's
market value was undermanaged. Based on the future-value analysis, senior
management increased its R&D "expense" by £140 million and its R&D
capital expenditures by £90 million. The company's stock rose dramatically when
these investments were announced.
Future value is not evenly spread throughout the economy.
Indeed, it is highly industry-specific. Share prices in newer industry sectors
tend to reflect a higher proportion of future-value expectations than those in
mature ones. Similarly, industries based heavily on intangibles such as brand
and proprietary knowledge generally have higher future-value quotients than
those with heavy fixed-infrastructure investments. Our analysis of the Russell
3000 Index shows that future value as a percentage of enterprise value ranges
from a low of 16 percent for sectors such as banks or consumer durables and
apparel to highs of 106 percent for media and 127 percent for technology
hardware (see chart, below).
 Still,
similar companies, even within the same industry, can have very different
future values. If a company's future value is lower than that of its peers,
then senior executives should understand why, and they should develop a plan to
get its proper value recognized. At the same time, if a company's future value
is a very high percentage of its overall value, its executives, too, must
understand why and intently manage the company's key value drivers.
Failure to do so can result in a fall in market
capitalization if the market loses faith in the company's ability to meet its
expectations. Therefore, while certain industries may have higher average
future values than others, all companies need to understand and manage future
value.
What could companies do to better deal with this situation?
Industry benchmarking could be supplemented by research on the impact of
business conditions. However, analytic modeling that more accurately captures
the behavior of intangible assets is necessary as well.
Intangible assets behave differently than tangible assets,
as anyone who has witnessed the overnight destruction of a brand knows. And
because intangible assets and tangible assets have different characteristics,
they must be managed differently. For example, intangible assets tend to be
difficult to leverage in the short term; you can't get immediate value out of
your brand the way you can by increasing the production rate of a piece of
machinery. They also tend to be interdependent, and their value depends on the
industry and competitive context.
We have found that many CEOs believe that if they deliver
good current-year operational results, share price will take care of itself.
However, share price, of course, doesn't always act in predictable ways. The
tides of investment fashion and the fact that there is a relatively small
universe of market makers for any given stock affect share price. For the
C-level executive focused on managing shareholder value, key issues include the
diverse expectations and varied perceptions of value among prospective
investors.
The very lack of a universally accepted method of valuing
intangibles makes this challenge all the more acute. Only half of our survey
respondents believe that stock markets reward companies that invest in
intangible assets and/or intellectual capital, even when there is adequate
disclosure of these investments. We think careful analysis of the potential
market reaction is an integral part of future-value management. In this case,
value—like beauty—is in the eye of the beholder.
Our experience has shown that traditional financial modeling
tends to miss these behavioral dynamics—the relationships among intangible
assets themselves, and the way they're perceived in the marketplace. Accenture
and AssetEconomics are pioneering alternative, dynamic approaches that take
these patterns into account and deliver better insight. The advent during the
past few years of new and substantial streams of previously inaccessible data,
thanks to comprehensive corporate investment in enterprise systems, facilitates
the analysis.
Rewarding Investment
As discussed
above, future-value analysis is most effective when it is company-specific. To
show how the future-value analytic model works in action, consider a US
software company with a signature consumer product that derives nearly 97
percent of its enterprise value from future-growth expectations. It can be
reasonably assumed that the market is expecting investments in R&D,
marketing and goodwill to fuel this future growth. The analysis of the stock's
historical performance shows that the marketplace has rewarded the company for
investing in these intangibles, by increased future-value multiples of 15 to 30
times the investment amount.
 Suppose
this company could create a sustainable gross profit increase of $1. What
should it do with the money? If it takes the $1 as profit—and since its
executives' pay is tied to profitability, it is likely they would want to do
this—we calculate it would lead to $6 of additional value. However, we think
that if management instead invests in areas such as R&D and marketing, it
would lead to a remarkable $19 to $34 of increased value—a massive difference
that is not easily understood without a clear understanding of future value.
Strategic Applications
Currently,
no US companies include accounting for intangibles—in the full sense outlined
here—in their annual reports. Prominent companies such as General Electric and
Coca-Cola are stepping even further away by not providing guidance on quarterly
earnings estimates. Work is under way with professional-standards groups like
The American Institute of Certified Public Accountants and with rule makers
like the Financial Accounting Standards Board to look at a language for
reporting on intangibles. In the meantime, the US legal system and the current
regulatory climate (for example, the 2002 Sarbanes-Oxley legislation on
corporate governance and reporting) inhibit US companies from experimenting
with formal future-value reporting.
 Most
of the companies that have ventured into formal future-value reporting reside
in jurisdictions that do not have these particular constraints. The European
Union has been the source of much of the theoretical work to develop a new
understanding of intangibles and future value as well as the location of the
best-known future-value strategic applications. This trend will continue for
the foreseeable future. In fact, Denmark and Austria recently became the first
countries to encourage the reporting of certain aspects of intangible assets.
Many C-level executives today know which levers to pull to
have an impact on traditional assets. They are less informed about which levers
to pull to sustain and grow the value of their intangible assets. With the
growing importance of intangibles, their need to equalize these managerial
abilities is clear.
Their model may lie in the example of companies that,
intentionally and methodically, have mastered various components of the
knowledge economy. These industry leaders, tellingly, have garnered the lion's
share of all market value added during the past several years, as measured in
total return to shareholders.
We've seen the business press treat success in managing
intangible assets as separate stories—about, say, investment in brand, or
governance reform, or copyright law advocacy or knowledge management. However,
we believe these articles often miss the key point—that these successful
companies are prototype masters of intangible assets and, as such, avatars of
high performance.
Our research indicates that a number of companies are eager
to join this group, although to date they have lacked a viable operational
framework to translate their own intangibles into manageable market value. In
the next several months, Accenture and AssetEconomics will continue to outline
their perspective on future value and intangible-assets management, along with
the results of additional industry and company research.
With more than $7 trillion worth of the US stock market
based on future value and with current management approaches ill-suited to
managing it well, the need for a better approach is more critical than ever.
 About the Authors John J.
Ballow, a partner in the Corporate Strategy
Architecture service line, is the global lead for the company's
Shareholder Value Analysis
group. He specializes in economic value analysis, value management, finance
operations and strategy, and corporate financial management. Mr. Ballow has
more than 25 years' experience as a corporate finance officer, advisor and
strategist in financial management. He is based in New York.
Robert J. Thomas, an associate partner
in the Accenture Human Performance
service line, is the executive director of the Accenture Institute for High Performance Business
in Cambridge, Massachusetts. Dr. Thomas is a leading authority on leadership
and transformational change; his ideas on human capital development have
appeared in Harvard Business Review, Sloan Management
Review and The Wall Street Journal. His most recent
book, Geeks and Geezers: How
Era, Values, and Defining Moments Shape Leaders, was co-authored with
Warren Bennis and was one of the best-selling business books of 2002.
Göran Roos is one of the pioneers of
modern intellectual capital science. He founded Intellectual Capital Services,
a leading think tank on methodologies for the identification, management and
measurement of intangibles; he cofounded AssetEconomics, an organization
focused on measuring and managing intangibles for shareholder value; and he
cofounded Hands and Minds, a joint venture with the De Bono Institute on
real-time strategy identification and implementation processes. Mr. Roos has
written numerous books and articles on intellectual capital and strategy, and
he was named one of the 13 most influential thinkers for the 21st century by
the Spanish business journal Direccion y Progreso.
For more information, please
contact us.
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