No less important than identifiable assets, unidentifiable intangibles are firm assets that remain hidden, at least in an accounting sense, until some transaction (i.e., an acquisition) gives rise to their identification. Goodwill is the most commonly discussed unidentifiable. It usually is created as the result of firm-specific capital.
Goodwill
Goodwill has a very specific accounting meaning, which does not simply reflect some accumulation of customer loyalty or satisfaction, repeat busi- ness, or good relationships. Those are the result ofother assets, tangible or intangible. Customers come back because the products are superior, or the service is better, not because of goodwill. Goodwill, as defined by financial accountants, is a residual, created when one firm buys another firm for more than the fair value of the net identifiable assets, both tangible and intangible.
History and Taxonomy 23
Although there are other unidentifiable intangibles, conventional ac- counting rules do not provide much insight into measuring them. An exam- ple of such an intangible might be an efficiently organized factory floor.
Imagine that the floor organizational plan saves a firm 5 percent more in manufacturing costs than any other comparable firm. If the efficient orga- nizational plan can be patented, then, of course, it is no longer unidentifi- able. But often that efficiency lies unspecified; management may be unable to pinpoint the reasons for its cost savings. Or, alternatively, management may know the exact reasons but may wish to keep it a trade secret. Should the managers sell the firm, however, the value of the plan for factory floor efficiency can wind up as a component of goodwill.
Although customer lists are identifiable, frequently they are cited as intangibles that contribute to an excess of fair market value being paid in an acquisition. In other words, customer lists generate goodwill. But for us to correctly ascribe value to a customer list, we must be precise about exactly how the customer list adds value.
It could be that the form of the list itself (perhaps in an electronic database) is a valuable piece of information. For a company with many customers, accurate information on their location, whom to contact, or the models of products the customers have bought is itself valuable. War- ranty business is a case where accurately identifying customers is im- portant. The organization of the customer information is costly, so a database is valuable. Customer lists also can represent cost savings if the process of identifying customers itself is costly in terms of marketing and sales effort.
Alternatively, customer lists often are viewed as stand-ins for the long- term expected sales revenue that existing and prospective customers will generate. In this case, the lists are believed to represent repeat business or promising leads. If existing customers are locked in to long-term purchas- ing agreements, then interpreting the customer list as a valuable (identifi- able) intangible makes some sense. But in the long run, repeat business from existing customers or new business is going to result from desirable prod- uct attributes or other services the company delivers. Those features may be the unidentifiable intangibles that we wish to measure. In this view, a cus- tomer list does not mean much; rather, a desirable product offering is more likely to be the source of secure future revenues.
Human Capital
Before University of Chicago economist and Nobel Prize–winner Gary Becker published a book entitled Human Capitalin 1964, the term was not part of the ordinary business lexicon. Becker (along with Sherwin Rosen,
24 INTANGIBLE ASSETS
Milton Friedman, Jacob Mincer, and Ted Schultz) established the economic concept of human capital as distinct from financial or physical assets, because, unlike those assets, human capital cannot be separated from the humans who possess it. He writes:
Schooling, a computer training course, expenditures on medical care, and lectures on the virtues of punctuality and honesty are capital too in the sense that they improve health, raise earnings, or add to a person’s appreciation of literature over much of his or her lifetime. Conse- quently, it is fully in keeping with the capital concept as traditionally defined to say that expenditures on education, training, medical care, etc., are all investments in capital.18
Not too long after Becker firmed up the concept of human capital, economists and consultants began to subdivide and classify types of human capital. Without limitation, it means both physical and intellectual ability.
The terms “intellectual capital,” “organizational capital,” and “knowledge capital” frequently are used interchangeably and incorrectly. There is no meaningful distinction between intellectual capital and knowledge capital.
Both can belong to a firm or an individual. The term “knowledge capital”
may have gained currency primarily as a marketing tool in connection with a discipline called knowledge management. For simplicity, we use the term
“intellectual capital” throughout.
But the term “organizational capital” implicitly means capital that resides within an organization. And we must further distinguish who owns it within the organization. Some organizational capital comes about as a result of the specific arrangement of assets of a firm; other organizational capital simply resides within the firm, such as the educations of the employees.
This book does not consider the latter to be organizational capital—it is “ordinary” intellectual capital. The firm gets to make use of its employ- ees’ education, but the firm does not own the employees. Here we call firm- specific creations organizational capital. This kind of capital stays at the firm even when the workers go home at the end of the day. For example, an efficiency-creating assembly-floor layout, or a firm’s collected product knowledge base or list of frequently asked questions (FAQs) live on even when the employees who created them are no longer at the firm. And if that capital is codified in patents or copyrights or trade secrets, it then is no longer unidentifiable.
Another form of organizational capital is more temporal: It is the shared knowledge or efficiencies that result from particular employees working together. Take, for instance, an attorney and her legal assistant who have worked together for many years. The way that they get work done together
History and Taxonomy 25
may be highly efficient, and, as a result, it creates economic benefits for the firm. Yet neither can take those efficiencies home with her at night, nor can the firm keep the benefits without keeping the team together. Other scenar- ios can be imagined—where the team shares their methods with the rest of the firm, or where the two decide to write a management book—but for our purposes, what is important is to recognize that “gray area” organizational capital exists. It is one of the most difficult topics for valuation; these assets are generally hidden and difficult to assess in terms of ownership.