Valuation is not
It is true that many well-recognized accounting approaches exist for measuring and reporting point-in-time, discrete, valuations of intangible 'asset'. However, there is no tool or framework for leadership teams and owners, to strategically manage the value creation opportunities and risks arising from intangibles. Leadership teams often rely on conventional financial metrics, which are biased towards costs. Traditional accounting and finance metrics, often regarded as the unquestioned measures of success inside a firm, overlook Intangible Systems as a whole. This is limiting leadership's capability to shape the future. This represents a huge problem, as the total value of intangible company assets is close to US$50 trillion globally.
owners, to strategically manage intangibles.”
We believe that this gap between what creates value and what gets measured inside companies, is one of the root causes of the steady stream of corporate crises and the plunging longevity of companies worldwide. It has become too significant a problem to ignore, especially for founders and owners who are building an institution for the long run.
So how can we
bridge this gap?
Together with owners of large and small companies across different industries, Longwealth has developed a unique Value Creation from Intangible Capital (VCIC) framework that sensitises conventional metrics such as ROI, ROCE, IRR to the value drivers of the company’s interlinked ‘system’ of intangibles The framework can dramatically improve the company’s ability to guide capital allocation for the future and unearth drivers of superior returns.
unique framework for founders
and owners to manage value
creation through intangibles.
For example, one of India's top real estate firms was convinced that its Intangible Systems (Brand, Culture, and Innovation) was far more valuable than its land bank. The VCIC framework revealed that the company had a significant commercial upside by going beyond the conventional Net Asset Value models used in the industry. The VCIC framework was used to educate investment bankers to look beyond conventional valuation models to Added Value from Intangible Systems. Further, the owner and leadership were convinced that there were significantopportunities for value creation within the existing business which could be further enhanced to drive ROCE and ROI rather than adding acreage, square feet space and new project launches. It launched a new program of strategic initiatives to create value from its intangibles that was much less capital intensive then adding new projects and acreage. The company continues to outstrip industry benchmarks in terms of valuation and P/E multiples as a result of creating more value from intangibles.
How the value creation from intangibles approach works
By their nature, intangibles such as Brand, Culture and Innovation/IP are interdependent. Their strategic management, therefore, must be done through scenarios and probability. Moreover, since intangibles drive the bulk of the company’s future potential, the VCIC framework allows leadership to see the outcomes of its current assumptions in the form of scenarios of future revenue, profit, EVA or ROCE. By linking intangibles to conventional metrics like ROCE and ROI, the VCIS framework often leads management to prioritise different projects that create far more value and improve the short and long-term value of the company.
For example, India’s economic growth brought with it rapid change to a major hospitality player and an impetus to raise its game. The company has a legendary system of intangibles (brand, culture of hospitality, ability to innovate). The VCIC framework helped to underline the centrality of value creation from its unique Intangible Systems. This became the fulcrum for a transformation process lasting several years. The VCIC framework fused ARR, RevPar metrics of key properties, F&B brands and Spa, in turn connecting it to the Revenue, Margins and ROE of the whole group. A bottom-up granular view of Value Creation/Erosion scenarios allowed management to question strongly held assumptions, resource allocation priorities and execution focus. The transformation journey continues as leadership remains committed to releasing the full potential from its Intangible Systems.
As these examples illustrate, by better appreciating the hidden value of Intangible Capital through the VCIC framework, companies can deliver significantly higher returns on capital both in the short-term as well as the long run. It is also perhaps the most underestimated value lever for generating economic surplus in the least capital intensive way.
Accounting conventions demand Intangible Asset Valuation (IAV) driven by the idea Of separately identifying intangibles into brand. customer lists, software, patents etc. This results in peace meal bits Of the Intangible body Of an organization Which can be used for business combination A) and reporting purposes. The focus Of such an approach is to ascribe a point in time valuation based on a discounted cash flow model With a strong bias towards market comparable transactions. Further, conventional corporate finance dictates applying a fixed perpetuity growth rate based on GDP or category growth estimates into the future all Of which are external to the organization. The IAV results are discrete, fixed, linear and market driven.
On the Other hand, Intangible Value Creation Capital (IVCC) is based on the fundamental insight that in real life, Intangibles namely brand, culture and innovation/IP are the scarcest form of capital that interact (contrasts with 'separation') with each other in cohesion, Rather than seeking a fixed numerical outcomes, the value creation dynamics of Intangible Capital express themselves as Scenarios. The results are vasty different from traditional valuation with dynamic scenarios which reflect non-linear upside or downside in the future. The bulk of future potential is driven by the Intangible Capital determined by self-directed actions rather than external factors like GDP industry growth. It moves leadership through future time to see the outcomes of management's current assumptions, biases in the form of scenarios of future revenue, profit, EVA or ROCE.
Therefore the IVCC results are United (not discrete), Dynamic (not fixed), Non-linear (not linear) and Self Directed (not external). This is the essence of why valuation should be mistaken as value creation.
How to start creating
from your intangibles
Implementing the VCIC framework can be done in different ways, based entirely on the priorities and the situation at the company in question.
1. Bridging founder's vision with value creation drivers of Intangible Capital (Brand, Culture, Innovation and Values)
Often, vision starts out and remains in a highly esoteric mindspace of a few people in the leadership team. Unless vision finds its moorings within the Intangibles, Structure, Strategy and Processes cannot mechanically execute it. Most Vision to Value Creation gaps lie within the company’s Intangible Capital. A dipstick can reveal which part of the vision is being translated into value and which not being fully assimilated or perhaps where vision needs to be fine-tuned to meet stakeholder realities.
2. Building awareness around the role of the executive mindset and its impact on unlocking the full potential of the Intangible Capital
Mindset and hinge assumptions of the top team are perhaps the most subtle influencers of intangible capital. When Intangibles falter or perform below their full potential, the root causes can often be traced back to the mind state of the leadership team. In particular, hinge assumptions or biases held by the top team create a tinted lens through which all strategic choices are made. Surfacing these self-limiting mental constructs or even worse wilful blindness can help the top team to introspect on how their mindset is impacting value creation or can perhaps be the single biggest risk for commercial sustainability.
3. Developing a line of sight between Intangible Value Creation Drivers and ROI, ROCE and IRR measures
Traditional accounting and finance metrics, frequently overlook Intangible Capital as a whole, thereby limiting leadership's capability to shape the future. However, if the same conventional metrics such as ROI, ROCE, IRR are sensitized to Intangible value drivers they can aid management to foresee implications from a value creation upside/risk perspective. Such a step change can dramatically improve their ability to guide capital allocation for the future and unearth drivers of superior returns.
4. Sensitivity scenarios which surface non-linearity of future cash flows and Inflection Points.
Traditional DCF models assume a base case scenario which is linear and immutable. However, company destinies especially post 2008 are characterized by significant non-linearity either in terms of upside or risk. Unless management is actively engaged in visualizing non-linear value creation scenarios, significant opportunities and risks are quite likely to be missed out and collective awareness and actions much delayed.
5. Institution memory building on Intangible Value Creation drivers, their impact on quality of strategic choices and decision making
The steep fall in the longevity of companies in the past few decades highlights the need for Institution Building. Often traditional governance processes based on tick box approaches give a false sense of security while depletion of Intangible Capital and Value Creation is afoot. Boards could play a proactive role by digging deeper into future oriented value creation scenarios and inflection points sufficiently ahead of time.
6. Communicating Full Business Potential of Intangible Systems for internal and external audiences.
Organizations thrive on hope and an ability to do good as well as create value. Even so, most companies hand down hyperfinancial targets to management and end up demotivating people. Value Creation drivers of Intangible Capital not only address financial outcomes but also provides a humanistic model which inspires employees to amplify their personal contribution to a purpose. Such an Intangible Value Creation framework can be shared with shareholders periodically rather than focusing only on quarterly numbers. Properly explaining the strategy for creation value from intangibles can also help attract the right investors to the company.
7. Developing multidisciplinary capability inside organisations to develop systems to monitor Value Creation from Intangible Capital.
It is obvious that Intangible Capital runs across traditional organizational boundaries or silos. As such, no line of sight is available to the top team on the interconnected workings of brand, culture and innovation and their collective impact of future cash flows. By building an inter-disciplinary approach, connecting data and metrics, new causal connections can be mapped and hidden patterns can be recognized. Ideally this capability should be internally developed inside organisations and an external observer can curate and finetune its outputs for decision making.