Firms need to wise up to their intellectual assets

There are valuable resources inside people's heads - but companies must learn how to retain them
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The Independent Online
The past few days have seen a sudden surge in the share price of high-technology companies. Just yesterday one such company, BTG, reported a loss of more than pounds 2m, but the price of the shares rose on the news that it had negotiated 52 licensing agreements. The company owns the know- how for products that range from a new gearbox being tested by Toyota and Ford, through a rheumatoid arthritis peptide now entering clinical trials, to daily disposable contact lenses licensed to Bausch & Lomb. Anyone who bought the shares a year ago when the company came to market would have seen the value of the investment rise sevenfold.

Now one can dismiss this as an example of the power of fashion in financial markets, the "animal spirits" noted by Lord Keynes, and I guess there is something in that. But it is also testimony to the value that markets put on ideas, for the worth of this firm is in the intellectual property it has developed. The assets, measured in conventional accounting terms of property, factories and so on, are tiny; the real assets are what goes on in people's heads.

But companies, in the main, are terribly bad at realising that they have to manage these assets. Two examples. I was talking, some months back, with the personnel department of one of the world's giant oil companies. They pointed out that if one added up the salaries they would pay to each year's crop of graduate trainees through the whole of their careers, the annual investment commitment they were making would be at least $3bn. Even for them that was a lot of money. The amount of time and thought they would put into investment in physical capital of that size was enormous. Yet each year they committed themselves to this investment in human capital with a tiny fraction of that thought.

The other example is a Swedish insurance company, Skandia, which has probably gone as far as any in assessing and trying to build its stock of human capital. I spent a day at its offices last month, where it was pointed out to me that if, say, physical assets were equivalent to only a quarter of the company's market value, no less than three-quarters of the value must lie in intellectual property. So the company had a fiduciary duty to shareholders to manage the three-quarters just as effectively as it managed the quarter.

How a company applies this rationale is of course another matter. Both these companies were at least trying to develop these non-physical assets and that is wholly to their credit. But we have all seen firms that proclaim in their advertisements and annual reports how important their employees are - and then proceed to "downsize", sacking half of them. "Downsizing" was an American invention and has been duly imported to the UK. But before you think this is a phenomenon unique to Anglo-Saxon economies, note that the country in which downsizing is currently happening most savagely is Germany, where there is tremendous concern that companies are getting rid of their most experienced employees in an effort to cut costs.

Indeed, throughout the developed world there is this curious paradox: intellectually, companies accept that the knowledge and experience of their staff is an important asset; yet in practice, when faced with the need to cut costs, they usually end up paying redundancy fees to get rid of these assets.

The willingness of companies to get rid of people is echoed in their willingness to dispose of business divisions. The nagging doubt that many people have had about the wisdom of aggressive downsizing has recently been reinforced by the recantation by one of its chief advocates, Stephen Roach.

As our sister paper, the Independent on Sunday, reported earlier this month, Mr Roach, chief economist at New York investment bankers Morgan Stanley, now believes that the relentless cost-cutting of American corporations was bad for business. "If you compete by building, you have a future," he said. "If you compete by cutting, you don't." He added that "slash and burn" restructuring was not a permanent solution.

Of course he is right. Trouble is, for many companies failure to cut costs would simply mean going out of business. This week, the new chief executive of Daimler-Benz, Jurgen Schrempp, survived an angry shareholders' meeting, thanks to the fact that since he had taken over in May he had shut down or sold most of its loss-making divisions. He had closed AEG, disposed of Fokker, and was about to sell the holding in Dornier. That was slash and burn with a vengeance.

But at least Daimler-Benz made this decision on the basis of hard financial figures. When companies downsize their headcount, they do so on the basis of fewer measured facts. This gives a clue to the seeming paradox that they know what they ought to do, but none the less frequently do the opposite.

The conventional explanation, advanced by people who for whatever reason are suspicious of the market system, is that financial markets are too short-termist: they demand good quarterly results and care little about the long-term health of the company. This view, popular in the Sixties and Seventies when it was used as an argument for state intervention, has recently enjoyed a new burst of popularity.

But examples such as BTG surely point in the other direction: that financial markets are prepared to put very high values on firms that develop their human capital. Often investors can be very "long-termist" in their perceptions, because they are happy to back companies with good long-term prospects, even though in the short term these are losing money.

I think the better explanation is that most companies are still very bad at measuring and developing human capital. They don't knowwhat they have got, and they have poor mechanisms for measuring and rewarding employees' performance. They value political skills, promoting people who are good at presenting ideas (or taking the credit for them), rather than the people who do the work. Because they don't know the real value of their people, they reward them in a haphazard way; and when it comes to curbing costs, they frequently get rid of the wrong people. They do this, not because they are stupid (though they may be); they do it because they have not developed the tools to enable them to be intelligent.

This is surely a much more important debate than the one about short- termism. It is an international concern, not a domestic one. The commercial world knows a great deal about running physical assets well: it can run car factories or supermarkets with great efficiency. But it is only just beginning to learn how to manage human assets: how best to use the minds of clever people.