Monday, November 21, 2011

How to calculate effect of intangible capabilities on financials of the company?

What is the most frequent challenge that ‘C’ suite executives pose? – “Where are the number? How much are the returns on investment?” The same question is asked when managers or consultants propose refinement of internal intangible assets of the company. It becomes really difficult to quantify or sometimes even coming up with qualitative measures about the investment and returns of capitalizing on capabilities. The following article provides the first step towards a framework which can quantify the investments and returns. The capabilities are the intangible assets to the company like talent, strategic unity and sharing, accountability, collaboration, leadership.

The best way to address this problem is to start with putting these capabilities into two buckets: Capabilities that helps improve internal operations and capabilities that refines company’s client facing strategy. For example, capabilities like collaboration and unity are focused on internal side of the organization while customer connectivity aims primarily to improve client services. The next step should be to derive metrics which are components of the capabilities. For example, talent can be divided into measurable metrics like average education level of employees, number of international achievements per employee, etc. These metrics lead to a chain of impacts that ultimately affects financial results of the company. For example, when the company tries to increase the education level of the employees, it has to increase the training and education budget which directly increases the expenditure. At the same time, because of increased educational level, the overall production efficiency goes high and costs go down. Similarly, each metric could be measured in a semi-quantifiable manner: high, medium, low. This impact (high, medium, low) on financials can best be measured by the company leadership as they have a high level idea of the company as a whole. Finally, when all these metric chains are classified in impact on revenue and impact on cost (both in long term), a rough investment decision can be made. The ones having maximum impacts should be allocated the maximum investment. The advantage of this step towards a framework is that it can give a better deterministic value of returns and investments. These steps are fundamental to design an investment strategy and helps visualize how and where the money goes on capabilities.

Concluding, the matured and well established companies know their important intangible assets and capabilities but calculating the indirect impact they create n financials is still unknown. Just knowing that there is some positive effect on financials is not sufficient in this era of quantification. More precise and innovative approaches are required to help leaders decide how much to invest and how much to expect out of refinement of internal capabilities.

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