Now that companies are waking up to the true value of intellectual capital, they must find ways of exploiting it - and locking it into the business.
When ICI recently bought a clutch of speciality chemical firms from Unilever for almost £5 billion, the price raised a few eyebrows. But ICI wasn't just purchasing physical assets. In the case of one of the star performers, National Starch, at any rate, it was acquiring applied knowledge, or intellectual capital. Nowadays more an applications engineering consultancy than a commodity manufacturer, National Starch has spent the last three or four years working on a knowledge programme. It has turned a latent strength - technical expertise - it into an actual, strategic one: a market-leading ability to design minutely specialised applications for its food manufacturer customers. 'This is a very successful programme,' says Chuck Lucier, chief knowledge officer for consultants Booz Allen & Hamilton.
'It's part of the reason Unilever got such a full valuation of the company on the sale.'
Over the past couple of years, consultancies like Booz Allen have witnessed a stampede of companies eager to get a touch of what seems like the nearest thing to a philosopher's stone that management has yet invented: a means of transmuting the base metal of everyday experience, the routine orders fulfilled and deals struck, into the folding green stuff. Knowledge management is hot - 'the next big agenda idea', according to a comprehensive forthcoming report by the research firm Business Intelligence, Creating the Knowledge-Based Business. Enthusiasts claim successful programmes can produce returns of hundreds or even thousands of per cent. But as the BI report also emphasises, knowledge management is a young discipline, its subject as elusive and intangible as air. Knowledge assets operate by disconcertingly different laws to material assets, and managing them requires an entirely new management lexicon. Reports BI: 'No large organisation ... has effective information management, let alone knowledge management practices, embedded throughout its organisation.'
Whether 'knowledge' can live up to the boldest ambitions of its champions is a moot point. But there is no doubt that it is an idea whose time has come. Peter Drucker (naturally) claims to have invented the term 'knowledge worker' in the 1960s, and excitable commentators have been bandying the idea of the information age around for at least 20 years. Now at last we can begin to see what it means to say with Drucker that the key productive resource of the new era is neither labour, land nor capital but knowledge.
In his book Intellectual Capital: The New Wealth of Organisations, Thomas Stewart cites a raft of statistics to show that the long-heralded new dawn has truly arrived. In the US the proportion of knowledge workers - those working with information rather than things - will have risen from 17% to 59% over the course of the century, while that handling material things will have halved to 41%. Perhaps most revealing of all, in 1991 US business for the first time spent more money on information technology - equipment to capture, process, analyse and distribute information - than on production plant and equipment. The gap has steadily widened since. Call 1991, says Stewart, 'Year One of the Information Age'.
In this context, the case for managing knowledge is simple. As Elisabeth Lank, the enthusiastic director of ICL's knowledge programme, puts it: 'If you run a factory making physical goods, you have a system for locating the parts, bringing the bits together at the right time and assembling them so that the finished product comes out the other end. In a knowledge business, the product is intangible, but the same principle applies: you need to know where the knowledge components reside so that you can bring them together in the service.' ICL realised early on that it couldn't be the problem-solving service outfit it aspired to become without knowing what knowledge it had and developing mechanisms to bring it to bear on the business. 'It really is an asset,' says Lank. 'And treating it as such changes the lens through which you view the world. How do you measure it, what do you need to invest in, what new roles must you create to make it work? As soon as you stop to think about it, it's obvious that in almost all companies knowledge is a vastly underused resource.'
It's not just companies which obviously sell know-how that are getting the picture. Witness Unilever - and ICI, Shell, IBM, Hewlett-Packard, Anglian Water, Glaxo Wellcome, Dow Chemical, Monsanto, Merck, BT ... Lucier at Booz Allen confirms that 75% of its clients are into knowledge management in some form. The growing knowledge component of even manufactured goods means that leaving it to chance is not an option. Today a car as much as a financial instrument competes by virtue of the embedded knowledge in its design and performance. In the information age, asserts Brian Arthur of the influential Santa Fe Institute, products are no longer 'congealed resources' but 'congealed knowledge'.
Leaving aside the sweep of macroeconomic forces, at the micro level knowledge management picks up on and crystallises several of the decade's most compelling management propositions. The first is the 1990s obsession with organisational learning. One result of delayering and downsizing was meant to be less bureaucracy, more knowledge sharing, faster decisions. In some cases it was. More often, the result was a forgetting, not a learning, organisation as companies flattened their stock of experience along with the hierarchy and found they had outsourced the ability to make the wheel, let alone invent it.
The second is growing discontent with conventional accounting. Traditional financial reporting captures the physical costs - capital, labour and materials - of doing business in the industrial age. But it doesn't come close to measuring the much greater immaterial costs - R&D, intellectual assets and services - of the information era. The most glaring inadequacy of the old accounting appears in the discrepancy between the book value of knowledge-based companies and the capitalisation that the market gives them. Take Microsoft. At the end of 1996, Bill Gates' firm had a market value of $85.5 billion and net fixed assets of just $930 million. A mere one-hundredth of its valuation is captured in the familiar balance sheet. Even for industrial firms, there's a growing gap between assets and worth that can no longer weakly be ascribed to 'goodwill'. What is the extra that the market is so willing to pay for? The best candidate: the knowledge or intellectual assets.
The third powerful trend that knowledge management taps into is the technology of the Net. A mere two years ago, even switched-on companies such as Reuters weren't sure whether the Internet was the real thing. Now we know. Almost all large companies now have a website, and three-quarters either have or are constructing an intranet. Granted, it is not the technology itself but what is done with it that is important. Nevertheless, the Net is vastly attractive (for those that get it right) as a vector of knowledge on demand.
'While technology isn't essential in a knowledge programme, it sure helps,' says Lucier. More subtle but in the long run perhaps even more significant will be the Internet's influence as the model of a knowledge-reproducing structure: fluid, inventive, distributed, self-organising, more like an ecology than any consciously built organisation.
So how do you manage knowledge? At conceptual level, knowledge management appears at first glance disarmingly simple. Construct a knowledge database of useful information already floating around somewhere in the organisation, make it available, perhaps via an intranet, and stand back to admire the results. BT, for instance, claims a first-year cost saving of £150 million from compiling an electronic internal telephone directory: hardly rocket science. Hewlett Packard boasts similar savings from its corporate directory of expertise, or Yellow Pages. 'In most organisations, there's some good accidental knowledge management going on,' says Lank. 'The question is making it conscious and systematic.'
Clearly, that is more easily said than done. According to Lucier, just 15% of the programmes he monitors are successes, in the sense of producing real business results, while 35% show no return for the effort. If anything, he believes, the meagre proportion of successes may be going down.
Why should this be? One reason is undoubtedly the faddism that has dogged every new management initiative of the last few years. There is plenty of evidence of CEOs loading knowledge management as the latest silver bullet without the understanding or the commitment to link it to business issues. Another: heavy selling by IT-based consultancies of intranets and other technology 'solutions' without regard to the underlying issues of the case, or to the behavioural implications of the new systems. Says Lank: 'Lots of companies have spent great amounts of money on intranets and Lotus Notes, without the culture to back it up. We've learned that while technology can help, what knowledge management is absolutely about is the way people work together.'
At a deeper level, there is - no way around it - an epistemological question: what is knowledge, anyway? As the Business Intelligence report shows, it can be cut in a variety of different ways: tacit/explicit, know-what/know-how, individual/group, data/wisdom ... None is definitive, and in each knowledge behaves - and must be managed - in bewilderingly different fashion (see boxes). In practice, says Mike McMaster, of consultants Knowledge Based Development, most knowledge management programmes attempt to simplify the nuances away by acting as glorified expert systems, aiming to capture, verify and make available existing knowledge on a systematic basis.
In this field, by general consent the big management consultancies are the most advanced practitioners. They need to be: in a business selling knowledge to international clients and expanding in some cases by 20% or 25% a year, they couldn't function without a deep well of corporate knowledge to draw on. A good example is Booz Allen's system - Knowledge On-Line - a 24-hour-a-day electronic database and data map of what the firm knows and who knows it. The programme operates at three different levels: as an educational tool to foster basic consultancy skills in a workforce where 40% of staff have a year's Booz Allen experience or less; as a repository of functional, often IT, knowledge and standardised methodologies for journeymen consultants; and as a means of developing leading-edge strategic thinking among the partners at the top.
Both the collection and dissemination elements of the activity require conscious effort and multiple approaches. Says Lucier: 'We say that knowledge management doesn't happen automatically because it involves four unnatural acts: people have to be willing to share best thinking, use other people's ideas, collaborate with other experts, and evolve their thinking.' Most organisations, he says, do a couple of these things well; which ones vary dramatically from company to company.
Does it work? While conceding that tracing a link between the programmes and the bottom line is nigh impossible, Lucier doesn't even feel the need.
'On a back-of-the-envelope calculation,' he says, 'the internal rate of return from the consultancy hours we save is in the thousands of per cent.
At low level, we measure how intensively people use the database. At high level, we have had an extraordinarily good few years of high profitability.
It's like asking Motorola if quality has made a difference: our business has prospered - and we are convinced that one of the reasons is knowledge.'
Many managers (and shareholders), of course, would go dizzy with delight at such important gains. But while accepting their value, some thinkers believe there is more to the business of knowledge than the mechanistic expert-systems approach. In their view, the high rate of failure in the new wave of programmes is precisely the result of its inability to capture knowledge's most precious quality: its ability to generate and recombine in new patterns. 'A lot of knowledge management seems no more than sexy up-to-date databases,' observes McMaster. 'They're great systems. What's missing is the generative aspects of intelligence - the life to make knowledge systems work.'
The conventional knowledge-management consensus is that creative knowledge production is impossible to analyse - opaque, unpredictable and therefore infuriatingly unmanageable. Not so, counters McMaster: while the result is unpredictable, and it certainly cannot be imposed from above, nothing is more certain than that a living dialogue between individual intelligences centring on tangible issues - whether cutting costs in assembling an offshore oil platform or making better welds - will recombine to produce usable knowledge. The chief resources required for this kind of knowledge work are time and space for the conversations to develop, perhaps a minimum of IT to cross the time zones - and crucially, the community of interest to provide the spark that makes things happen.
If the design principles are right, then knowledge sharing is the most natural thing in the world.
One of the best known examples of this kind of knowledge management is 3M. Powered by multiple overlapping scientific networks (communities of enquiry), the '15% rule' (which allows employees to spend that amount of time on their own projects), and the governing principle that 25% of company turnover must come from products introduced in the last four years, 3M scientists in hundreds of divisions produce an endless stream of new products, sometimes based on brand new knowledge, more often by recombining existing knowledge in different and creative ways. For another example, take - surprisingly - the Marines. Working closely with notions of complex adaptation developed at the Santa Fe Institute, the US Marines have quietly overhauled their fighting strategy. Out has gone the tradition of a rigid central battle plan. But radical decentralisation does not mean that individuals are left to fend for themselves. Instead units are schooled to work with a small set of basic rules (keep moving, use surprise, take high ground where possible, for instance) from which to generate their own unique strategic variations according to the circumstances.
The distilled knowledge lies in the deceptively simple rules; but just as important is the creative intelligence and urgent purpose of the fighting units that bring it to life.
Wise companies will accept that thinking about knowledge itself will evolve in just this way, in a rich interplay between theory and practice, structure and experiment, and human and organisational intent. Whatever the direction in which the formal frameworks of knowledge management evolve, though, it will be forward, not back. While the overall movement will contain fads and false starts, there is no doubt that the underlying change they are attempting to capture is as profound as the first industrial revolution 200 years ago. In the age of the 'man-made brainpower industries' (Lester Thurow's term), advantage will accrue to knowledge, not traditional natural resources. Finding out how to manage it best may take 15 or 20 years; the journey starts now.
INTELLECTUAL CAPITAL - HOW BEST TO MANAGE THAT WHICH CANNOT BE OWNED
To make intellectual capital both measurable and manageable, firms such as Skandia, the Swedish insurance company, and the Canadian Imperial Bank of Commerce (CIBC) have developed an influential three-part model.
First, human capital comprises the knowledge and talents that reside only in the human brain - the stuff that goes down in the lift each evening. This kind of capital is rented, not owned, and must be managed accordingly. When Microsoft went public in 1981, it was not to raise money to build new productive assets (it didn't need any): it was to tie the human capital to the firm by monetising its stake.
Much more amenable to management control is structural capital, the know-how contained in the company's distinctive processes and competencies - Motorola's quality, Marks & Spencer's collection of supply-chain routines.
This is where much of the best-known knowledge-management effort has been concentrated.
In a programme to capitalise intellectual assets, Dow Chemical is on target to increase licensing revenues from its patents by $125 million annually by the year 2000. Skandia, which published a pioneering supplement on intellectual capital in its annual report of 1994, has developed a 'prototyping' system which allows it to open an office in a new country in one year rather than in seven.
The more firms can upload knowledge from brains into systems and procedures, the more they can control it - and the less they depend on human stars.
The third type is customer capital: the value of a firm's relationship with its customers. Where oil companies compete to sell petrol solely on price, little customer capital is involved. There's more in a recognisable and distinctive brand - and a lot more in the long-term relationship between a supplier and Marks & Spencer. Like human capital, customer capital is shared, not owned, and can only be managed as a joint enterprise between the firm and its partners.
EXPLOITING ASSETS - KNOWLEDGE MANAGEMENT - HOW TO MAKE IT WORK
Like people, companies use such a tiny proportion of their collective brainpower that any improvement has the potential to deliver disproportionate gains. No wonder chief executives are dazzled by the prospect.
But attempts to make systematic use of corporate knowledge assets are not a recent invention. Motorola's company university and 3M's cross-divisional scientific networks are both successful home-grown learning and developing initiatives which predate the knowledge management craze.
The best Total Quality Management programmes are systematic attempts to build company learning. In Japan, the detergents and cosmetics firm Kao has dedicated itself to becoming an industrial university, a factory for producing knowledge.
Research at the Santa Fe Institute and elsewhere is focusing on the creative learning process that takes place in what are coming to be thought of as 'communities of practice', where shared purpose is an important component of group learning. For instance, when a suspicious Rank Xerox tried to stop its repair technicians spending so much time gossiping in the office rather than on the clients' premises, satisfactory repair rates plunged.
What the company had not realised was that the technicians had been using their office time to develop 'scenarios' to explain copier breakdowns undreamed of by the authors of the repair manuals.
But, how to get started? According to Chuck Lucier at Booz Allen & Hamilton, the starting point should be an urgent strategic priority, something which will benefit from and give leverage to the knowledge effort. For example, the aim might be to take an existing strength and build it into a strategic competitive advantage; to share learning around a group's subsidiaries by building a best-practices database; or to save costs with a corporate Yellow Pages.
Next, says Lucier, recognise that this is a change programme. 'In comparison, the content is trivial. The number one issue is change: getting people to act differently.'
Finally, build the infrastructure - 'Nothing will happen without a "knowledge engine".' For Lucier, this means linking knowledge processes to business processes; including reward and recognition; designating a few people to manage the effort full-time ('The biggest single mistake that chief executives make is to refuse this investment'); and, where necessary, apply IT.