by David Boyle
Deming had a rival Total Quality Management guru, J. W. Juran. Both were understood only in Japan, and they managed to carry on the feud between them well into their late 80s. Perhaps this was because they were so similar: both grew up in tarpaper shacks, Deming in Minnesota, Juran in Wyoming – though he had actually been born in Romania. Both were influenced by the Bell Laboratories physicist Walter Shewhart, the man who turned statistical ideas into a manufacturing discipline. Both also rose to such eminence in Japan that they won the Order of the Sacred Treasure, Second Class. Goodness knows what you have to do for the first class.
Total Quality Management had given Japanese industry a powerful edge by the competitive 1980s, before a combination of Japanese banking mismanagement and the sheer economic power of Wall Street pushed the Americans back in front. By then, Western manufacturing had caught on. Toyota were implementing 5,000 quality suggestions a day from employees, but their rivals at Ford were offering over half their executive bonuses for contributions to quality. Sometimes, you will notice, it is hard even to describe these things without resorting to numbers.
The next big management idea was ‘re-engineering’, which in practice meant sacking coachloads of staff, but in theory – according to one of its gurus, Michael Hammer – it meant making the company ‘easy to do business with’. Trying to measure this elusive concept, which Hammer turned into the acronym ETDBW, led to a disturbing discovery for big manufacturers. They found that most orders went through 15 to 20 departments in the average American business before they were actually fulfilled. Each department provided an excellent opportunity for mistakes and delay. It was an expensive process too. One company found it cost $97 to fulfil an order for batteries worth just $3. One soft drinks company found that only 55 per cent of its invoices were correct.
So the stage was set for the latest twist in management thinking, and it looks as though the one who got there first was the Swedish business writer Kark-Erik Sveiby. Twenty years ago he was a partner in Sweden’s oldest business magazine Affarsvarlden, having previously been a commercial manager at Unilever’s Swedish toiletries company, and he was given the task of doing the magazine’s books. This was difficult, because the magazine outsourced almost everything. They had almost no assets to put in the books, apart from their brand name, which Sveiby valued at one krona. ‘I kept forgetting to put it in, so the books wouldn’t balance,’ he told Fortune magazine. ‘Then I would reflect that our brand was really worth much more.’
Out of that thought emerged the Konrad Group, meeting on St Konrad’s Day in Sweden and discussing how you might measure know-how in a company. Soon Japan’s business guru Ikujiro Nonaka was studying how business can create knowledge, Fortune’s columnist Thomas Stewart was starting to write about intellectual capital and the movement was beginning to grow.
As a result, Sveiby’s insight has turned into a major business trend called ‘knowledge management’, and European companies are now spending about 5 per cent of their revenues on it. Bizarre and unexpected new job titles are popping up around the corporate world, with bizarre and unexpected salaries to match, like ‘learning manager’, ‘knowledge engineer’, ‘intellectual capital controller’ or ‘chief knowledge officer’. Soon Coca-Cola was hiving off its tangible assets altogether in a bid to become just the sum of its brand and its management ability.
Thomas Stewart explained the problem they had. Under conventional accountancy, a company that dumps 100 delivery vans before they are worn out, has to record them in their books as a loss. But if they dump 100 employees they have trained, and who have bags of know-how and ideas about the company, they don’t have to record it anywhere. In fact, they get lauded on Wall Street and their directors get even fatter pay cheques. The experience and knowledge of employees have no value on conventional measuring scales. Accountants have found it very hard to measure such things.
But they do have a value. Knowledge is wealth, in fact, which is why the old measurements don’t work any more. Count up the value of companies’ fixed assets and you come up with a figure wildly different from their actual value on the world markets. Securities analysts now believe that 35 per cent of market value of the stocks they follow is not covered anywhere on the balance sheets. ‘How ironic,’ says the American business professor Baruch Lev, ‘that accounting is the last refuge of those who believe that things are assets and that ideas are expendable.’
Lev is an academic accountant who believes the whole profession is going to have to change, because the way we measure the economy is suddenly so out-of-date. His research shows that American business now invests almost as much in their intangible assets as they do in old-fashioned buildings and equipment. Microsoft is an extreme example. Its balance sheet lists assets that amount to only about 6 per cent of what the company is worth. ‘In other words,’ says the futurist Charles Leadbetter, ‘94 per cent of the value of this most dynamic and powerful company in the new digital economy is in intangible assets that accountants cannot measure.’
This is not just an interesting but useless theory. Knowledge may be intangible but it creates ‘real’ money. Microsoft created 21,000 millionaires among its employees in 1997 alone – and provided goodness knows how much wealth to its founder Bill Gates. Then there was the odd story of the media company DreamWorks SKG. It was formed with capital of just $250 million, but was mobbed by investors who quickly drove up its value to $2 billion, purely because of the intangible and unmeasurable value of its founders, Steven Spielberg, David Geffen and Jeffrey Katzenberg.
Now, if you were to take that intangible difference between the measurable and the unmeasurable, and put it under a microscope, what would you find? The first thing would be the mildly intangible – those legal fictions like intellectual property and copyrights – but let’s put those aside for the moment, because they don’t actually make up the gap. The rest is the seriously intangible, like the skills, capabilities and expertise of the workforce – or maybe even the team of outside consultants they have gathered round them – plus the value of the brand name and its future sales potential, and the reputation of the company.
Thomas Stewart defines intellectual capital as the sum of everything everybody in a company knows that gives it a competitive edge:
It is the knowledge of a workforce. The training and intuition of a team of chemists who discover a billion-dollar new drug or the know-how of workmen who come up with a thousand different ways to improve the efficiency of a factory. It is the electronic network that transports information at warp speed through a company, so that it can react to the market faster than its rivals. It is the collaboration – the shared learning – between a company and its customers, which forges a bond between them that brings the customer back again and again.
‘Reputation, reputation, reputation,’ exclaimed Othello, noticing something similar. ‘I have lost the immortal part of myself, and what remains is bestial.’ But how do you measure such things?
The short answer is that it is impossible, but that’s not good enough for businesspeople who see their rivals making enormous profits simply from their ability to measure intangibles and sell them. Or to boost the value of their companies: Coca-Cola believes its brand name is worth $39 billion. And there are all those hi-tech companies which have never made a profit, like the Internet bookshop Amazon.com, but which still made its owners billionaires as the belief in their value shot them thrillingly up the Wall Street markets. Suddenly a website like @ Home was worth the same as Lockheed Martin, or the Internet share-trader E*Trade was worth the same as the giant American Airlines. The point was that, even if you couldn’t put a value to your intangible assets yourself, the markets would measure it for you. Precisely.
As the old-fashioned measuring systems break down – those tried and tested columns invented by Fra Pacioli – the divisions between the real and the hyped begin to go fuzzy. If enough people believe it, the hyped can become real. ‘Do you believe in fairies?’ asks Peter Pan, and Tinker
bell recovers if the audience does. It’s the same with the modern world of hi-tech stocks.
So measuring the unmeasurable matters, which is why there has been such a flurry of business gurus, all of them trying to corner the market by naming the missing factor. Should we call it ‘intellectual capital’ like Thomas Stewart, or ‘working knowledge’ like James Brian Quinn, or ‘managing know-how’ like Karl-Erik Sveiby? In fact three books came out with the title Intellectual Capital in 1997 alone. But they all agree on the main point. That easily measurable money is no longer the most scarce commodity in the world. Information, know-how, intelligence is – get hold of that and the money will pour forth. All the old-fashioned balance sheets could do was give a vague idea of what you might get for a company if you bought it, chopped it up and sold it. As one management writer said, you might as well say a human being is worth £1.90, because that is what our various chemical components might be worth.
And so it was that the Swedish company Skandia published the first annual report supplement on intellectual capital, and another Swedish company Celemi published the world’s first audit of its intangible assets. Soon the idea had spread so completely to the US business world that they were convinced they had thought of it themselves, christening the whole phenomenon the ‘new economy’.
‘I have seen the new economy and it works!’ exclaimed Vice President A1 Gore. But it wasn’t quite clear, even then, whether it does. The Dutch engineering business Kema put a price tag of over $400 million on its highly-intelligent staff, but then found that their $12 million profits in 1994 looked rather small in comparison. The board member responsible for IT joked that maybe they should file for bankruptcy. Other companies missed the point by sinking vast sums into their computer systems, then ignoring their staff altogether. The result was that their ‘intellectual capital’ often decided to look at the jobs pages, and drifted away.
ING Barings bank lost half of its most successful Taiwanese team when it just got up and walked out of the door to Merrill Lynch. This never used to happen in the good old days of measurable bricks and mortar. Suddenly an accounting problem became a serious personnel headache. There was the strange story of the sacking of advertising guru Maurice Saatchi from the company that bore his name. Saatchi forced the board to dismiss him, but he was followed out of the door by some key staff and two crucial accounts – Mars and British Airways. The stock halved in value, and the Saatchi & Saatchi shareholders found they actually only owned half of the company. The rest of the value had seeped away almost overnight.
‘In the knowledge society,’ writes Peter Drucker, ‘the most probable assumption for organizations – and certainly the assumption on which they have to conduct their affairs – is that they need knowledge workers far more than knowledge workers need them.’ If you can’t measure your assets, you don’t know where they are, then you may not notice when they disappear. It’s not a healthy situation for a cut-throat company.
So what could they do? What they have done is to try to empower their workforce, open up information inside the company, and measure anything that moves, mining the tons of resulting data for patterns and strange parallels. And that’s just the start when you are trying to measure what counts. Remember, urges the business manual Blur, ‘every sale is an economic, informational and emotional exchange’. That means extending ‘the emotional experience of your customers to every aspect of your organization’. If you thought intellectual capital was difficult to measure, try empathy.
Jeremy Bentham would be turning in his grave, if he had one. Yet businesses still have to make the attempt if they are going to measure their progress, and the difficult fact is they will probably find a way – and stake their future on it. What makes the new world of numbers different from the old is that no two companies, and probably no two people, would measure it in the same way.
II
Or try ethics. While the business world has carried on in their own sweet way looking at the bottom line figures, the profits and losses, the earnings per share, a whole sector of the financial services industry has emerged to measure companies in a different way. Not according to how much they make, but how nice they are (or how ethical) and then to invest in them accordingly. It’s called ethical investment.
Ethical investment is suddenly trendy in financial services. Expensive conferences are held on the subject. Enormously expensive software is used to track the ethical performance of companies around the world. Rival tables are produced and pored over. Even Dow Jones has launched its own ‘Sustainability Index’. And well over £2.8 billion is now invested ethically in the UK alone. Across the Atlantic, where ‘Christian’ investment goes into anti-abortion companies, they claim it is fifty times that.
The whole idea began with the investment fund Pax Christi during the Vietnam War, and grew from there via disinvestment in South Africa in the 1980s, into an industry which even the biggest pension funds have to take seriously. It also took strength from disastrous revelations of corporate greed, like Exxon Valdez. Or like the Bhopal disaster in 1984, when a Union Carbide toxic gas leak killed 2,500 people and injured 200,000 after misrepresenting its safety record. Now the British government has ruled that every pension fund must reveal not just its profits, but make an ethical ‘statement of investment principles’.
It’s a new world. Only a generation ago, General Motors chief Charlie Wilson (later US Defence Secretary) could say in public that: ‘What’s good for the country is good for General Motors, and what is good for General Motors is good for the country.’ These days we don’t see ‘good’ in such clear-cut, easily measurable, Utilitarian terms. Instead we try to give our lives more of a moral coherence, a kind of joined-up self-government, so that we don’t spend our lives campaigning for the protection of tropical forests only to find our pension money is invested in logging companies. And we don’t pray for peace, only to find our hard-won savings are invested in boosting Britain’s arms exports to unsavoury regimes.
Quite what we do next is still argued about, but we start by measuring the moral efficacy of our investments. We ask about interest rates less and about human rights policies more. Then we invest in the companies with the cleanest or greenest record. It’s rather a strange shift, especially for hard-nosed business people who had never looked anywhere but the bottom line before.
As the years have gone by, the fashions have changed. Should we be avoiding what’s downright wrong or should we be seeking out the good and investing in it – or some strange combination of the two? The return of what they call ‘positive criteria’ – measuring the good in companies rather than the bad – has been steady over the past few years, with the UK ethical investment researchers EIRIS starting to screen companies according to their positive employment and environmental policies. In the UK, the massive £20 billion pension fund run by British Coal have adopted just such a policy – denying that it is anything more than hard-headed economic sense. ‘Obviously if you are a major polluter, then that is going to cut into your future profits,’ they said. British Coal have since been followed by the other two pension funds in the biggest three – BT’s and the university lecturers.
As always, measuring something like ethics depends on how you define it. That has become the job of the 25-strong staff of the EIRIS, perched in their offices above the railway line at Vauxhall Station – their intensive meetings drowned out every few minutes by the roar of the Eurostar express dashing along underneath. It’s their job to define exactly what we mean by human rights, or ‘involvement in genetically modified food’, and to scour the media for the growing bundles of stories where companies get caught out in ‘unethical’ activity. They get paid to do this because – now that the ethical investors are flexing their muscles across the world – then dumping an oil-rig on the bed of the North Sea (like Shell) can cost you a lot of money. So can teaming up with an American TV evangelist who vilifies homosexuals (like the Bank of Scotland).
This is the strange paradox of e
thical investment. It began as a way for people to accept a lower return for their money because they were keeping their consciences cleaner. But now there are so many of them that the money seems to be going their way too. Generally speaking, and in the long term, ethical companies seem to perform just as well. There are now so many ethical investors that sustainable strategies can raise a company’s share price by 15 per cent, according to the latest study. Two American academics worked out that winning an environmental award boosts your share price by an average of 0.82 per cent. Bribery or corruption accusations cut it by 2.3 per cent. That is, I suppose, as precise a measurement of the money value of morality as it’s possible to get. But when an undercover journalist secretly filmed animal rights abuses taking place in laboratories owned by Huntington Life Science a few years ago, and showed what she shot on Channel 4, their share price slumped from 124p to 18p and stayed there.
In other words, ethics has gone from an obscure way of measuring corporate success to something as vital as it is undefinable. By 1998, there were fifteen companies in the FTSE 100 with over 5 per cent of shares owned by ethical investors. That’s enough for serious leverage. In fact, it’s probably enough to mount a takeover bid. So watch out, Abbey National, Vodafone, Railtrack and Severn Trent – the ethical corporate raiders may be coming.
So, with a collective shudder, the business world has begun to realize that the rules were changing. EIRIS is busy measuring their morality, and shareholder activists are irritating them with questions at their company AGMs, asking directors to justify their pay packets. ‘Justify? Can you justify YOUR salary?’ bawled an enraged Lord King, the former British Airways boss, at the 1999 AGM of a small company called Aerostructures Hamble of which he was nonexecutive chairman.
