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 / Autumn 2008 / Issue 52(originally published by Booz & Company)


The Real Value of Intangibles

There is no accepted standard for appraising the worth of nonphysical assets like brands, human capital, and managerial expertise. Yet these are the essence of 21st-century business.

Illustration by Lars Leetaru

When Google Inc. published its 2007 annual report, the assets listed on its financial statements did not include the value of the Google Network — the thousands of third-party Web sites that use Google’s advertising programs to deliver ads to their sites, and from which the company derived nearly US$6 billion and 35 percent of its total revenues that year.

Nor did it include a value for Google’s brand identity, ranked first in the world and valued at $66 billion in 2007 by market researcher Millward Brown Optimor, or for the company’s crème de la crème workforce, whose freedom to experiment with new product ideas using company time and equipment has contributed demonstrably to the company’s bottom line.

In fact, because of the often perverse effect of disclosure regulations, Google’s annual report could publicly acknowledge these tremendous assets only through the looking glass, as potential liabilities. That is, in the standard “risk factors” section of the report, Google executives could say only that their partners, employees, brand, and reputation were of such great value that if they dropped the ball in any of these areas, their business would be adversely affected. That’s a pretty twisted way to have to frame the assets that deliver more than one-third of your company’s revenue.

When one considers the limits of the current approach to asset measurement and valuation, Google may look like an extreme case, but its situation is different only in scale from many other corporations that are also stuck with outdated ac­counting and reporting methods. The book value of today’s global corporation is derived largely from procedures invented hundreds of years ago to record costs in trans­actions such as the buying or selling of grains, animals, buildings, ma­chinery, and other tangible assets.

Although cost may help determine the value of physical assets, the same cannot be said for intangibles. These assets — intellectual property, software investments, staff and managerial expertise, market research, advertising, business pro­cesses, organizational structures, and the like — are the real stuff of which 21st-century companies are made. Today, $100,000 can buy a patent that turns out to be worthless or an employee whose great idea tacks a million dollars onto the bottom line. As a result, traditional accounting practices that can record only what things cost, or their resale value, are hopelessly inadequate in representing intangible assets.

In fact, based on the difference between reported book and stock values, intangible assets now make up between 60 and 80 percent of global corporate worth. The mon­etary value represented by those percentages is staggering. Leonard Nakamura of the Philadelphia Federal Reserve Bank declared in 2001 that the value of gross in­vestments in such intan­gibles as alliances and networks, human capital, and leadership was greater than $1 trillion annually for the United States alone. Reports from both the Federal Reserve and the National Bureau of Economic Research (NBER) calculated that as much as $800 billion of intangible investment was excluded from published data on U.S. gross domestic product in 2003. The exclusion translated to more than $3 trillion of intangible corporate value. When the authors of the NBER working paper — Carol Corrado, Charles Hulten, and Daniel Sichel — added intangible assets to the sources-of-growth framework used by the Bureau of Labor Statistics, they saw “a signi­ficant difference in the observed patterns of U.S. economic growth” that drive investment, corporate strategy, and government market interventions.

What a remarkable statement! Even more remarkable is that the statement did not set off a firestorm in the financial press or trigger an immediate demand for reform from the business community. If the absence of effective accounting for intangibles is significantly skewing official statistics, that means the daily decisions being made by investors, managers, and regulators are actually based on financial data that has only a marginal connection with economic reality — and does not even acknowledge the existence of the most important drivers of value in the global economy.

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