Intellectual capital and the new wealth of nations II. (human capital versus intellectual capital)(includes case studies)

In the second part of his analysis of intellectual capital and the issues it raises for managers, the author concentrates on the distinction between intellectual capital and human capital. In particular, he argues that intellectual capital in economic growth, the creation of wealth and competitive advantage. He concludes with a discussion of why business education has not made intellectual capital central to its curriculum despite its importance.

A potential stockmarket flotation which particularly intrigued the London financial press earlier this year involved a relatively large company which was expected to raise some 2.4bn [pound sterling]. Although valued about six-times larger than Body Shop and significantly bigger than Dixon's (a British electrical retail giant), the company had no retail outlets, no factories, no physical products and few staff. The business was altogether weightless. Its products could be reduced to a number of computer signals which could be flashed around the world for hundreds of millions of people to buy. It was a classic example of intellectual capital, an idea. Called Formula One, it was owned by Bernie Ecclestone. The reason the idea was so valuable was that it regularly attracted about 400m ABC1 viewers worldwide.

But intellectual capital is not only big ideas like Formula One. It is also millions of relatively small innovations which contribute to wealth and economic growth. Such capital will provide the future wealth of nations because international trade will increasingly be in intellectual capital. Alan Greenspan, chairman of the US Federal Reserve Board, recently pointed out that the weight of US output is now only a little higher than it was a century ago but its value in real terms is 20 times higher. Although increased skills and a shift to service industries are part of the story, much of the weightless portion of this trade can be defined as intellectual capital. This article is based on the premise that future wealth creation and economic growth predominantly will depend on intellectual capital -- the generation of ideas which can be transformed into revenues.

To suggest that prosperity no longer depends on building physical capital is not new. Indeed, much of the value of large knowledge-intensive corporations already stems from their patents - which are potential intellectual capital viewed as economic goods. The importance of intellectual capital has been under-emphasised in business education. Amongst the questions to be answered are:

* What is intellectual capital and how can we describe its characteristics?

* How do we measure intellectual capital?

* What role is played by intellectual capital in the generation of wealth?

* What is the difference between intellectual and human capital?

* How does intellectual capital influence economic growth and wealth creation?

* What are the implications for managing intellectual capital at both the government and firm levels?

* If intellectual capital is important why has it no become central to business education?

The Characteristics of intellectual Capital

In order to identify the characteristics of intellectual capital, we can start by considering different ways of looking at a stereotypical factory. Assume a simple process of manufacturing chocolate. Milk, sugar, flour and cocoa are put into a machine and converted into chocolates by the action of pulling a lever and applying pressure to the mixture. Thus, labour and capital -- respectively the strength to pull a lever and the machine -- converts the less valuable raw materials into the more valuable chocolates. The chocolates are more valuable than the sum of the inputs.

Assume that the factory produces too many chocolates to be consumed immediately so they require transportation and storage which can theoretically add further economic value (even if the storage reduces their value to the consumer, by reducing the quality of the chocolates!). Even more labour and capital can be applied in specific ways to the chocolate which will further increase its value. For instance, it might be wrapped, it might be delivered to a specific place at a specified time, it might be displayed in a shop window by a retailer. We might also specify who owns the property rights of specific protocols, procedures and processes associated with the chocolate -by 1970 the transformation of property rights accounted for half of US GDP (Wallis and North 1986). All these applications will add some further value to the chocolate. Our stereotypical factory describes any production facility where raw materials, physical and human capital combine to manufacture produce which are more valuable than the sum of their inputs.

One way to view such a stereotypical factory, therefore, is as a relatively constrained management system with a limited number of physical sequences which are repeated over and over again and add value to specific outputs. Managers learn and perfect these sequences and are remunerated for supervising their repeated operation and enhancing their efficiency. This describes orthodox management and the way it has tended to view the factory throughout the 20th century.

An alternative approach is not to perceive the factory and production as a constrained set of rigid processes, but as series of transformation activities resulting from an idea. Viewed in this alternative way, we see that when the van driver delivers the chocolate; when the retailer displays it; when the lawyer prepares the sales contract and assigns property rights etc.... labour and capital are employed to change the characteristics of the physical output as a result of an technological formula. The difference in value is the result of intellectual capital. In this case, it takes the form of technology which enhances value by changing the physical characteristics of the raw materials or by dreaming up a brilliant marketing package. But the same principle also applies in any scenario where the nature of the underlying good can be transformed by the application of labour and capital. The productive unit need not be a factory: it can be an individual, a company, an industry or, indeed, a nation.

Assume that our stereotypical factory requires 52 distinct independent steps to process a specific physical output. Given that these steps could theoretically be carried out in any order, this means that there are an enormous number of possible different ways to order these steps in a sequence. Let us assume further that the overwhelming majority of possible productive sequences are impractical. it is still highly probable that the actual sequence used repeatedly in our stereotypical factory and taught as part of management training is sub-optimal because even a small fraction of the enormous number of ways in which 52 steps could theoretically be ordered is an still extremely large number. This also suggests that the factory is not as constrained as management orthodoxy might imply.

Many companies understand this point and recognise that always there will be room for improvement by way of a large number of relatively small changes. 3M is a classic example of this. Notwithstanding such exceptions the organisational potential available to managers suggests that the factory example, which suggests something constrained and rigid, is inadequate for examining how to maximise wealth creation in the modern world. A more appropriate …