Knowledge-based Economy - The Hong Kong-PRD Context of Creating, Managing and Accounting of intangible Knowledge Assets
Dr Gordon McConnachie, Board Chairman, Scottish National Intellectual Assets Centre and European Affiliate of ICMG Inc, Palo Alto, California, USA
Dr Joseph Yau, Council Member of CIMA Hong Kong Division and Senior Program Director, Division of Accounting, School of Professional & Continuing Education, The University of Hong Kong
Alan Lung, General Manager, ABCM Consulting (China) Ltd
'Power grows out of the barrel of a gun' - Mao Tze-tung
'Money Talks' - Anonymous
'Knowledge is taking the place of capital as the driving force in organisation, worldwide' - Peter Drucker
Donald Tsang put a high priority on economic development when he addressed the Legislative Council for the very first time as Chief Executive of the HKSAR Government on 27 June 2005. One of his first acts as Chief Executive was to attend the '9+2 Pan PRD Co-operation Conference'¹ hosted by Zhang De-jiang, Guangdong Party Secretary and Politburo Member in Chengdu on 25 July 2005.
In his election platform, Tsang promised to '… drive Hong Kong's economy ahead at full steam'. There were broad reference to adhering to the principles of free enterprise and fair competition and a repeat of past initiatives such as: CEPA (Closer Economic Partnership Agreement with mainland China), turning Hong Kong into 'Asia's World City' and capitalizing on the economic development of the PRD and Pan-PRD (Pearl River Delta) region. However, there were little details on the specific strategies or how he would actually get it done.
Within the context of China and the Pan-PRD region, Hong Kong is a service economy. But Hong Kong can only be effective if it knows how to capture value from the highest rungs of the 'Economic Ladder'. For the Hong Kong economy to move forward, new economic engines are needed to supplement the strengths of the traditional industrial economy ones. In the PRD, companies and local governments cannot rely on the unlimited supply of low-cost labor forever. Labor costs in PRD are climbing. Resources, such as water and electricity are stretching to their limits. The demographics in China are also changing and there will be a labor shortage in 20 years time if enterprises and local governments continue to rely on labor intensive industries. But what would be the new strategic initiatives that will continue to create value for business and improve the quality of lives of citizens in Hong Kong and the PRD region in the next twenty years? Hong Kong will probably continue to be the third largest financial market in the world in the foreseeable future. But from mainland China's viewpoint, Hong Kong will not be an attractive economic partner if it continues to rely on the good will and strengths of the mainland economy but does not offer something unique in return.
So, what is the unique role that cannot be delivered by others in the 'Hong Kong-PRD' partnership?
Background to the Development of the Global Knowledge Economy
Since the late 1980s, there has been a movement to take a new look at the valuation of companies. The relevance of the traditional accounting methods was questioned. In the book 'Relevance Lost, The Rise and Fall of Management Accounting' published in 1987, Kaplan and Johnson of the Harvard University pointed out that traditional accounting is no longer providing sufficient information on companies' wealth production and growth. During the 80s and 90s, the concept of Knowledge Management and Management of Intangible Intellectual Assets were developed in Europe and the USA².
The founding fathers of Knowledge Management were Swedish. Karl-Erik Sveiby published his first book 'The Know-How Company' in 1986. He also coined the phrase 'Knowledge Management'. This 'Early Swedish Movement' in Knowledge Management was soon over-taken by activities of the American corporations. Americans have achieved more in this area than the rest of the world put together: success stories include Dow Chemical (USA), IBM (USA) and Neste (Finland).
However, many companies in the smaller European economies such as Finland, the Netherlands and Scotland were not as fortunate as larger corporations, since they do not have the resources. In Asia, Singapore is leading the Knowledge Management related initiatives, with South Korea and Taiwan trying to catch up. Amongst the Muslims nations in the Middle East, the Arabian Knowledge Economy Association was formed in Dubai, UAE in June 2005.
In mainland China, many are trying to start the Knowledge Management initiative. But other than the multi-nationals, China does not seem to have access to the international network and therefore the methodology and, more importantly, the practical experience to do it properly.
Implications on PRD Region and China as a whole
It is not by accident that the 'Bill Gates' of today's world is accumulating wealth and control power that rivals those of national governments. If Chairman Mao were to re-write his famous motto today, he would probably say: 'Power grows out of knowledge and the market place'.
Money still talks. But money is not worth a lot without the power of knowledge. Real competitive edge of businesses, of regions and of nations no longer comes from raw material and money to buy equipment. Economic power now comes from people - and the ability to organise the knowledge workers. In a world full of change, the only certainty is that there will be continuous change. And those who have the ability to harness knowledge outdo those who cannot.
The ability to selectively create and extract value from knowledge has become a requirement for an enterprise, including small and medium sized enterprises (SMEs), to compete successfully. As enterprises attempt to move up the economic value chain, theft of intellectual property has become a major issue between China and owners of Intellectual Property Rights (IPR) in the USA and the European Union (EU).
But focusing on IPR violations of Chinese enterprises alone (i.e. including violations made by some Hong Kong owned manufacturers in PRD) is like looking at the 'Bull's Eye' of an archery practice and ignoring the outer rings of the shooting target. China is not particularly behind Indian and Russian in its IPR protection3. However, the sheer scale and production efficiency of the Chinese economy makes the problem larger in the eyes of the EU and the USA. As a newcomer to the world economy, China may not hit the bull's eyes as it releases its first few practice arrows. But very soon, China will have its own IPR to protect and China will be motivated. And there are abundant profits to be made by China (net importer of IPR) and the USA /EU (net exporter of IPR to China) even if the 'arrows' hit the outer rings of the target at this stage.
However, there is a lack of appreciation of the issue and the requirements in the Hong Kong and the PRD. Hong Kong has abundant international networking experience, proven ability in modern management and in a legal system trusted by the international community. Hong Kong is uniquely placed to help China in this 'Intellectual Property Rights' management and to make the transition into the Knowledge Economy.
The Management of Intellectual Assets
Prior to discussing how Hong Kong might be able to help the PRD region to manage its intellectual assets, it is important to consider some definitions and words that carry specific meanings4:
Intellectual Capital means the sum of total knowledge within an organisation which has the potential to create value.
Intellectual Assets means those parts of the Intellectual Capital within an organisation which have been codified and which have a potential to create value.
Intellectual Property means those intellectual assets which have been legally protected.
Knowledge Management means the process by which the organisation generates wealth from its knowledge or intellectual capital.
For companies to maximise the value to be extracted from their intellectual capital, the first thing they need to do is to visualise it:
Human Capital: The value employees bring to future growth prospects.
Organisation Capital: This is the infrastructure supporting firms and providing to their human capital.
Customer Capital: This starts at the point where strength and loyalty of customer relationships start bringing in cash flow and thus contributing to future growth.
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Intellectual Capital The first step... to 'Manage it' is to 'Visualize it' Figure 1: Visualizing Intellectual Capital |
After visualisation, managers might make use of the following Intellectual Capital Management (ICM) initiatives:
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Strategy, Process and Organisation: Creating and/or aligning a company's or region's intellectual asset or capital strategy with vision, and implementing process and organisation changes. The concepts behind these initiatives are closely related to the three books: 'Balanced Scorecard', 'The Strategy Focused Organisation' and 'Strategy Maps' published by Kaplan & Norton.
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Value Extraction Support: Performing portfolio analysis, mining, commercialisation strategy, licensee identification, competitive analysis, licensing transactions, and portfolio management services at various levels. Primarily, this is about the setting up a value extraction process.
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Valuation: Performing asset appraisals, valuing investments and business alternatives for R&D and commercialisation decisions, and litigation support. Valuation is extremely important in the extraction, exchange (i.e. trading) and protection of Intellectual Assets.
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Advanced Measurement and Reporting: Implementing advanced intellectual capital reporting systems, assessing and implementing key performance metrics, and goodwill and intangibles allocations. Again, Kaplan & Norton's Balanced Scorecard can be applied as a fundamental Performance Management tool.
Successful Intellectual Capital Management is more likely to become a required core competency amongst successful companies in the 21st Century. Understanding and use of this knowledge is no longer an option for companies and governments in Hong Kong and the PRD region.
Around the world, there is already a number of regional Intellectual Capital Management Centers set up to facilitate companies to move towards this direction. The more significant ones are located in Scotland, the Netherlands and in Singapore5. Managers, government officials and accountants in our region could ill afford to ignore the value of Intellectual Capital Management if they do not want to fall behind competitors in the region.
Accounting of Intellectual Assets - Value in Context6
Intellectual Property (IP) Valuation is a very big and complicated topic. And it is not a small step to influence managers and accountants in Hong Kong to accept that they have a leading role to play in exploring and facilitating the growth of a Knowledge Economy in the Hong Kong-PRD region.
To start with, CEOs and CFOs are required to certify that the financial statements and other reports filed 'fairly present' the financial condition of a company. But how do you certify the value of Coca-Cola - a business that has a high proportion of intangible assets - the brand, the formula which is a trade secret and the Human, Customer and Organisation Capital? What would be Fair Market Value of any knowledge-based company that has capability in generating value in more than one context (e.g. through franchising and licensing) simultaneously? Fair Market Value has no meaning in this context, in fact it is misleading.
To begin with, we need to do away with 'Asset-based' or brick and mortar approach to valuation. Obviously, the 'Book Value' of a company's intangible assets that cannot be readily sold is meaningless. And intangible assets need to be discovered, managed and applied properly before they become assets.
Instead, we need to look at the 'Value Stream' or the 'Value in Context' approach. Dr Gordon McConnachie, who worked as the Intellectual Assets Manager of Dow Chemical, explained to us that Dow Chemical values their intangible Assets only when they need to make a business decision about them. In every case, Dow Chemical values the VTO (Value to Owner) and VTB (Value to Prospective Buyers) in the specific business situation. In many case, Intangible Intellectual Assets can generate multiple 'VTO' through licensing or traded patents. And Dow Chemical routinely calculates the Net Present Value (NPV) of the VTO and VTB of Intangible Assets that are generating values in specific contexts.
Perhaps one of the greatest problems of today is that people in position of power, including policy makers in governments and accountants who control assets and operations of companies, 'do not know what they need to know'. People are sometimes unconsciously incompetent and to move forward, some degree of unhappiness with the status quo is needed. The accounting community in Hong Kong is uniquely placed to help the PRD region and China as a whole to help establish, protect, manage, account for and create values from intangible intellectual assets.
1. The "9+2 Pan-PRD Regional Co-operation" consists of Hong Kong and Macau and nine provinces in South China: Fujian, Jiangxi, Hunan, Guangdong, Guangxi, Hainan, Sichuan, Guizhou and Yunnan
2. Professor Kaplan is closely linked to the development of Activity Based Costing and the Balanced Scorecard. Other than "Relevance Lost", Kaplan published "Cost & Effect" together with Cooper in 1997. Together with Norton, he coined the word "Balanced Scorecard" in 1996 and discussed the hidden strengths of "Intangible Assets" in his latest book: "Strategy Maps" published in 2004.
3. "China and Globalization", statement made by William Overholt, Asia Policy Chair Director, Center of Asia Pacific Policy of The RAND Corporate to the US-China Economic Security Review Commission of the US Senate on 19 May 2005.
4. Dr Gordon McConnachie, The Management of Intellectual Assets: Delivering Value to the Business, The Journal of Knowledge Management, Volume 1 Number 1, September 1997. Figure 1: Visualizing Intellectual Capital is used with permission of Dr McConnachie.
5. Intellectual Assets Center of Scotland, http://www.ia-centre.org.uk/, Intellectual Capital Center of the Netherlands, http://www.intellectualcapital.nl/ and the IP Academy of Singapore: http://www.ipacademy.edu.sg
6. Pre-publication draft of ‘Presenting Intangibles Fairly in CEO/CFO Certification' by Patrick Sullivan and Rob McLean of ICMG Inc., Palo Alto, USA, October 2004.
Article published originally in July-September 2005 issue of The Bottomline, CIMA Newsletter.
Article published with permission of authors.
The above does not necessarily represent the views of the HKDF.