Cécile Lafforgue MSc Business Innovation

November 2011

INTELLECTUAL CAPITAL AND COMPETITIVENESS

Identify intellectual capital and related intangible assets and intellectual property. Why are they important for corporate competitiveness?

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Since the last century, the world has shifted from a traditional industry-based economy focused on primary resources towards a knowledge-based economy where value is now mainly created from intangible resources. This “new economy” is continuously stressed by the development of information and communication technologies (ICT) such as Internet, computing or microelectronics which raise new challenges for firms (Boisot, 1999). As a consequence, market prices1 of companies are higher than their book value itself, the physical value shown on the balance sheet. The gap between these two valuations is due to the existence of intangible elements which cannot be accurately accounted. For example, Microsoft Corporation bought the telecommunication firm Skype for a price of $8.56 billion in May 2011 - $6 billion more than its value in 2009 – whereas the latter lost $7 million on a $860 million revenue in 2010 (Woyke, 2011). Such a high transaction was justified as the buy of “a fast-growing, well-positioned global asset with an unbeatable brand” (Maney, 2011). This puts in evidence that these intangible elements, which are commonly called intellectual capital, intangible assets and intellectual property have a crucial importance. In order to properly understand the predominance of these intangible components in the business context today, the first part of this essay aims to identify and define intellectual capital and intellectual property. Then, the competitiveness of companies and the new challenges raised by ICT will be described more in depth in the second part to highlight the role of these intangible resources, essentially through the example of Skype.

Part 1: Identification of intellectual capital and the related intangible assets and intellectual property 1) General view and main approaches of the intangible resources of a company The value in companies resides in tangible resources (e.g. land, machinery, computers, and buildings) on one hand, and non-physical on the other hand, the latter not being directly shown in the balance sheet (Brooking, 1998). According to Lev (2001, cited in Marr and Moustaghfir, 2005), intangible assets refer to as “a nonphysical claim to future benefits”. Other synonymous terms such as “intellectual capital” - as first highlighted by Stewart (1948) - and “knowledge assets” are used essentially by managers and economists. However, the term “intangible assets” is mainly used by accountants (Marr and Moustaghfir, 2005). “Intellectual capital” will be the generic term used in this essay and can be divided into four main categories of assets covering the main views on the subject: markets assets, human-centred assets, infrastructure assets and intellectual property assets (Brooking, 1998).

2) Main categories of intellectual capital 1

The market price is the price at which companies are quoted on the exchanges.

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From a marketing perspective, intellectual capital is based on market assets which create a corporate reputation (Flatt and Kowalczyk, 2008) and enable brands to differentiate themselves from other companies. They are also called relational or customer capital (Stewart, 1948) and they encompass elements such as brand identity, positioning, customer satisfaction or distribution channels. For example, FedEx, which successfully managed the implementation of ICT in its supply chain is so wellknown for its speed delivery services, that as a result it is common to verbally say “to FedEx a parcel” instead of “to send a parcel” (Brooking, 1998). The “human capital”, as originally identified by Adam Smith (1783) is the second part of intellectual capital which focuses on knowledge embedded in individuals. This knowledge is related to the skills, know-how, abilities, background-education and experience of each individual. For example, nowadays businesses need people with a significant computer literacy because of the growth of ICT. These human-centred assets are the basis of a company which will be unable to exist without (Stewart, 1998). Then, emerge the infrastructure assets, also known as “structural capital” (Stewart, 1998). It aims to create a group synergy, encourage team work, develop collective knowledge and corporate culture within and outside the firm by creating networks (Flatt, Kowalczyk, 2008). In other words, this represents “the way things are done in the firm” (Teece, 2007) thanks to the implementation of clear routines. For example, international online businesses can set up calendars, rules and processes known and shared by each team member to coordinate the deployment of their marketing operations in several countries and then improve the efficiency of the structure. At last, intellectual capital encompasses intellectual property. It develops and protects the inventions, innovations and creations of companies produced thanks to the knowledge of the employees (Brooking, 1998). The protection gives a real advantage to the owner because it regulates replication by others who have to pay to use it. Once value has been made out of it, it becomes an intangible asset (Imparato, 1998). Intellectual property embraces patents, copyrights, trademarks and open-source technologies such as originally ball-point pens or cellular phones. Finally, intellectual capital represents any valuable intangible resources of companies such as brand identity, communication, customer relationship, knowledge, education, experience, processes, networks, application of patents & copyrights used in order to generate future wealth (Marr and Moustaghfir, 2005).

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Market assets

Intellecutal Property

Human Capital

Value creation

Infrastructure Assets

Intellectual capital and the related intangible assets

Part II: Intellectual capital and competitiveness in the new economy 1) The new challenges raised by ICT The quick development of ICT raises new challenges for firms which can now access more information and easily replicate what is produced by rivals. Therefore, markets are overflowing with similar products from contender brands. This directly impacts the behavior of consumers. Indeed, the use of internet for comparison purposes enables them to have a better understanding of the offer. Then, companies must satisfy new needs by focusing on innovation to launch new products (Teece, 2007). In such a context, even the infrastructure of companies is evolving as shown by the dematerialization of the work place with many more employees working from home using ICT. As a consequence, the share of intellectual capital and related intangible assets is increasing and has become superior to the tangible resources. As a matter of fact, these resources enable a company to stand out in busy markets, to improve its efficiency and drive innovation. They give companies a better chance of to creating a competitive advantage than material assets (Rastogi, 2000). Hence, their management is vital to achieve the challenges raised by ICT and get real competitive advantage, in the aim of financial performance and growth. 2) Global definition of competitiveness Corporate competitiveness generally means “as good as or better than others of a comparable nature” (Oxford dictionaries) or “the ability to produce the right goods and services of the right quality, at the right price, and at the right time” (Heseltine, 1994). However, competitiveness is a much more complex notion. It can be driven by several tangible and intangible factors such as shareholder and customer value, technology or strategic changes, financial investment (Feurer and Chaharbaghi, 1994).

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Therefore, it is unlikely that the exploitation of one or the other intangible assets on their own naturally brings significant competitive advantages, but their combination does (Buigues et al, 2000). A holistic approach has to be taken into account to understand how intellectual capital drives competitiveness (Feurer and Chaharbaghi, 1994). 3) How to use intangible assets to stay competitive in the edge of e-business a. Attracting and keeping the customers In this new edge, a strong strategic position related to offers, sale prices and brand image strengthens competitive advantages. Indeed, the exploitation of “power of brands” (Brooking, 1998) and market assets - also known as the “market power approach” - generates customers acquisition by applying cheap prices for the best product and then pushes competitors back (Porter, 2008). Moreover, a customer is more likely to consume a product or service from a well-known brand because it inspires trust and reinsures the customer. (Brooking, 1998). Skype succeeded in this by acquiring 23 million users (Spiegel, 2011) thanks to a free and secure product fully integrated with a strong brand identity, recognized by both consumers and contenders. As keeping a customer is cheaper than getting a new one, hence firms use their knowledge assets to create bonding strategies and increase retention (Hax and Wilde II, 2001). These strategies focus mainly on launching complimentary products thanks to a better understanding of customer needs. Further to its merging with Microsoft, Skype is integrated to the social network Facebook and will be in all Microsoft products too (e.g. computers, phones, Xbox). As a matter of fact, these alliances were a real strategic action on behalf of Microsoft to rival Google Voice and the communication platform of Apple, Facetime (Spiegel, 2011). This locks the customers in a network where they get all the services that they need and then stops them from using products of competitors (Dyer and Singh, 1998). b. Reducing costs and improving efficiency In the meantime, alliances reduce costs of firms by sharing expenses such as research or marketing and then directly improve productivity and competitiveness. This “transaction cost economy” as highlighted by Williamson (1975) is the result of an appropriated use of other intangible resources such as structural assets to increase efficiency related mainly to work organization. Indeed the resource-based view (Penrose, 1958) evidences that specialization of skills creates synergy and improves the efficiency of the structure. The efficiency can also be related to customer experience, meaning for a customer to satisfy a need as quick as possible (Amit, Zott, 2001). For example Skype enables users to communicate to their relatives in a very easy and quick way. It then makes it an attractive and efficient product which satisfies a need of communication. c. Anticipating the changes and innovating At last, the skills specialization drives us to our last point regarding the relationship between intangible resources and competitiveness: the anticipation of changes. Indeed, on top of specialization, the “dynamic capabilities” of workers help firms to be aware of the evolution of the market and then to react more quickly to changes (Teece, 2007), which is crucial in the today’s Cécile Lafforgue – Intellectual Capital and Competitiveness – Nov 2011 Page 5 / 9

context as discussed earlier. Moreover, anticipating the changes thanks to research and development increases innovation and novelty. According to Schumpeter and the concept of “creative destruction” (1942), the launch of a product or service before others gives a real advantage because each time a product is created, it destroys another. (e.g digital music vs CDs). This can be counterbalanced with the example of Skype which could have replaced mobile phones. On the contrary, it increased the will of developing better complimentary products as shown by the project of the new Windows 7 phone, in which Skype will be implemented in the aim of customer acquisition and retention. Finally, competiveness is a complex notion driven by several factors such as financial investment or technology changes. Many approaches explain the relationship between competitiveness and intellectual capital. The market power approach, the network approach, the transaction costeconomy, the resource based-view, the dynamic capabilities and the creative destruction show that the combination of intangible resource develops strong competitive advantages and enables firms to respond more quickly to new challenges on the markets. More specifically in the world of e-business, complimentary, novelty, efficiency and lock-in driven by intellectual are the key elements of value creation and competitiveness (Amit and Zott, 2001).

Customer attraction and lock-in

Intellectual capital Anticipating changes and novelty

Improving efficiency and reducing cost

Competitiveness in the new economy

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To conclude, the new economy has never been so challenging for the survival of companies. The market is continuously evolving by the quick development of information and communication technologies. All intangible assets related to the market, human-capital, infrastructure of a firm and intellectual property are becoming predominant in the structure of companies. These elements create value and have a crucial importance for the future of businesses, especially e-businesses, in the aim of growth and financial performance. In fact, according to Baruch Lev, they are “their hard competitive edge” (2001). As one asset is not enough to gain a real competitive advantage and is interrelated to all others, it is more than important that companies identify this kind of resources and find the best combination in order to attract and keep customers, to be more efficient and simply to anticipate the changes continuously implemented by the growth of ICT in the value chain. Many complimentary approaches have to be considered in the strategies of firms. As changes are continuously appearing, this cannot be a one-off project but has to be developed on an ongoing basis. The purchase of Skype by Microsoft is a successful example of exploitation of intangible assets so far. Although the true value of these intangible assets is difficult to measure, it would seem they are indispensable to manage strategic choice and disserve further analysis.

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REFERENCES Books Brooking, A. (1998). Intellectual Capital, International Thomas Business Press Buigues, P., Jacquemin, A., Marchipon J.-F. (2000), Competitiveness and the value of intangible assets, Edward Elgar Year Boisot, Max H. (1999), Knowledge Assets, securing competitive advantage in the information economy, Oxford Universtity Press Imparato, N. (1999), Capital of our time, Hoover Institution Press Lev, B. (2001), Intangibles: Management, Measurement, and reporting, Brookings Institution, Washington DC cited in Marr, B., Moustaghfir, K. (2005), Defining intellectual capital a threedimensional approach. Management Decision, Vol. 43 Issue 9, p1114-1128 Penrose, Edith T. (1959), The Theory of the growth of the firm, Oxford Basil Blackwell Stewart, Thomas A. (1998), Intellectual capital the new wealth of organizations; Nicholas Brealey Journal Articles Andersen, B. and Striukova, L. (2010) Where Value Resides in the Modern Enterprise, Strategic Change: Briefings in Entrepreneurial Finance, Vol 19, No 3-4, Pp 103-123. Amit, R. and Zott, C. (2001), Value Creation in E-business, Strategic Management Journal, Volume 22: 493-520 Dyer, Jeffrey H., Singh, H. (1998), The Relational View: Cooperative Strategy and Sources of Interorganizational Competitive Advantage, The Academy of Management Review, p660-679 cited in Amit, R. and Zott, C. (2001), Value Creation in E-business, Strategic Management Journal, Volume 22: 493-520 Feurer, R., Chaharbaghi, K. (1994) Defining competitiveness: A holistic approach, Management Decision, Vol. 32, Iss. 2; p49-60 Flatt, Sylvia J., Kowalczyk, Stanley J. (2008), Creating competitive advantage through intangible assets: the direct and indirect effects of corporate culture and reputation, Competitiveness Research, Vol. 16 Issue 1, p13-30 Hax, A. and Wilde II, D. (2001), Discovering New Sources of Profitability in a Networked Economy, European Management Journal, Vol.9, No 4, p379-391 Heseltine, M. (1994), Competitiveness: what, why and how? European Business Journal, 3rd Quarter, Vol. 6, Issue 3, p8-15 Maney, K. (2011), Skype the inside story of the boffo $8.5 Billion Deal, Fortune, Vol. 164, Issue 2 Cécile Lafforgue – Intellectual Capital and Competitiveness – Nov 2011 Page 8 / 9

Marr, B., Moustaghfir, K. (2005), Defining intellectual capital a three-dimensional approach. Management Decision, Vol. 43 Issue 9, p1114-1128 Rastogi, P.N. (2000), Knowledge management and intellectual capital - the new virtuous reality of competitiveness, Human Systems Management, Vol. 19 Issue 1, p39-48 Porter, Michael E. (2008), The five competitive forces that shape strategy., Harvard Business Review, Vol. 86, Issue 1, p78-93 Schumpeter, J.-A. (1942), Capitalism, Socialism and Democracy, Harper cited in Amit, R. and Zott, C. (2001), Value Creation in E-business, Strategic Management Journal, Volume 22: 493-520 Spiegel, A. (5/10/2011) Microsoft to buy Skype for $8.5 Billion: How to not screw it up, Forbes.com Teece, David J. (2007), Explicating dynamic capabilities: the nature and micro foundations of (sustainable) enterprise performance, Strategic Management Journal, Vol. 28 Issue 13, p1319-1350 Williamson, OE. (1983), Organizational innovation: the transaction cost approach, cited in Ronen, J. Entrepreneurship, p101-133 Woyke, E. (2011), Skype Details Its Future With Microsoft And Facebook, Forbes.com

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