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THE KNOWLEDGE VALUE CHAIN: FROM ASSET MAPPING TO COST
Henley Management College, Greenlands, Henley-on-Thames, UK
In a knowledge-based economy, where the intellectual capital of an organisation is its most important asset,
current accounting procedures are proving inadequate in terms of reporting on intangible assets and providing
measures of future profit potential. Another important aspect is the assessment of inherent risks associated
with these intangible assets and assurance that sufficient measures are in place to protect them.
The objective of this paper is to examine the nature of the intellectual capital of a company, and to review
some prevailing models and practical examples of their application.
The transition into the Digital Information Age is bringing about the need for new approaches to the strategic
direction-setting of companies. Many of the changes being experienced are paradoxical in nature and require
new mind-sets and questioning of hitherto accepted business models. Governments in industrialised countries
around the world are focusing more attention on the transition from the post-industrial age towards a
‘knowledge-based’ economy. Many are announcing new policies and initiatives backed by substantial budgets
to ensure continued growth of their national economies in the future global marketplace.
In this post-industrial era, firms are facing increasing complexity for a number of reasons, two of which are
fundamentally altering the competitive context of firms and managers, namely knowledge and technology
dissemination (Lowendahl and Revang, 1998). They argue that these global changes, at the societal as well as
the individual level, affect strategic management theory and practice in two ways: they alter the relationships
between firms and external stakeholders; and they alter the relationships between firms and internal
One important effect of the information age is that shareholders are becoming better informed, more critical
and increasingly active. City analysts expect more detailed reporting from companies and are becoming more
sophisticated in the methods they employ. Thus it is increasingly important for top managers to develop more
appropriate tools for managing their intellectual assets effectively and to have adequate reporting measures in
place to satisfy their shareholders and potential investors.
2.1Economics of Knowledge
The concept of a ‘knowledge-driven economy’ is by no means new. In 1890, Alfred Marshall wrote
“Knowledge is our most powerful engine of production” in his Principles of Economics. Today, we can see a
number of processes at work, some entirely new, others that have developed over many years, which together
are transforming the way in which businesses and individuals operate. The UK Government’s white paper,
Our Competitive Future: Building the Knowledge Driven Economy, calls for a renewed focus on knowledge as
the means of improving economic performance. The paper goes on to define a knowledge-driven economy as
one in which the generation and the exploitation of knowledge has come to play the predominant part in the
creation of wealth.
Mid-nineteenth century energy physicists developed what may be one of the great metaphors of all time: that
of the closed equilibrium system. This is also the core metaphor of Alfred Marshall’s traditional economics
and of much of our management thinking today. Such an approach makes three important assumptions: that
the industry structure is known, that diminishing returns apply, and that all firms are perfectly rational
Beinhocker poses the question: But what happens if rapid technological or business-system innovation makes
producer costs and consumer preferences uncertain? What if we face not diminishing returns (where each
additional acre of soybean planted is on poorer land and thus yields a lower return), but increasing returns
(where each extra Internet browser sold increases the value of the World Wide Web and thus yields a higher
return)? What if firms lack complete information, or different firms interpret the same information in different
It is important to distinguish knowledge from the traditional factors of production, labour, land and capital
(Spender, 1996). Knowledge, it seems, has become the most important or ‘strategic’ factor of production, so
managers must now focus on its production, acquisition, movement, retention and application. Spender argues
that (i) different types of knowledge lead to different types of economic rent and that firms’ strategies, in the
pursuit of these economic rents, will also differ; and (ii) that the firm’s knowledge mix or profile may change
over time, being dominated by one type of knowledge at one time and by another type at another time.
According to a study of the CEO’s of large US companies carried out by Karl Wiig (1997), they
overwhelmingly agreed that “knowledge is our most important asset”. They also agree that knowledge-based
assets will be the foundation of success in the 21st century. Wiig states that progressive managers have
recognised that an enterprise’s viability depends directly on (i) the competitive quality of its knowledge-based
intellectual-capital and assets; and (ii) the successful application of these assets in its operational activities to
realise their value to fulfil the enterprise’s objective.
Recent studies provide evidence for the argument that companies that make effective use of knowledge tend to
perform better. The recent paper by Marchand et al. (2000) reveals three major factors in the information
orientation of a company: (i) IT practices, (ii) information management practices, and (iii) information
behaviours and values.
A dominant theory of business strategy is that of the resource-based view of the firm (Spender and Grant,
1996). This treats the company and the determination of economic rent as a collection of capabilities.
Economic rent is what companies earn over and above the cost of the capital employed in their businesses.
This is sometimes referred to as economic value-added (EVA). Economic rent is the measure of the
competitive advantage that effective established companies enjoy, and competitive advantage is the only
means by which companies in competitive markets can earn economic rents. The opportunity for companies to
sustain these competitive advantages is determined by their capabilities. Whilst there are many kinds of
capabilities, from the point of view of strategy, the key distinction is between distinctive capabilities and
reproducible capabilities. Distinctive capabilities are those characteristics of a company that cannot be
replicated by competitors, or can only be replicated with great difficulty, even after these competitors realise
the benefits which they yield for the originating company. Distinctive capabilities can be of many kinds.
Government licences, statutory monopolies, or effective patents and copyrights, are particularly stark
examples of distinctive capabilities. But companies in competitive markets have built equally powerful
idiosyncratic characteristics. These include strong brands, patterns of supplier or customer relationships, and
skills, knowledge and routines embedded in teams (Lowendahl and Revang, 1998).
2.3Sources of Competitive Advantage
In an economy where the only certainty is uncertainty, the one sure source of lasting competitive advantage is
knowledge (Nonaka, 1991). When markets shift, technologies proliferate, competitors multiply, and products
become obsolete almost overnight, successful companies are those that consistently create new knowledge,
disseminate it widely throughout the organisation, and quickly embody it in new technologies and products.
These activities define the “knowledge-creating” company, whose sole business is continuous innovation.
Organisations possess numerous resources, but it is the resources that are unique, inimitable, and valuable that
are central to competitive advantage (Prahalad and Hamel, 1990). An organisation’s knowledge base is one
such resource (Matusik and Hill, 1998). Firms increasingly rely on building and creating knowledge as a
necessary condition for survival in their respective competitive marketplaces (Nonaka, 1994). Fast changing
environmental demands and rapid imitation by competitors make it necessary for even leading firms to
continually build new knowledge. Not only must firms be able to create knowledge within their boundaries,
but they must also expose themselves to a bombardment of new ideas from outside in order to prevent rigidity,
to encourage inventive serendipity, and to check their technological developments against those of competitors
Competitive advantage is no longer derived from the traditional factors of production of the industrial age,
namely labour, land and capital, but increasingly from knowledge (Spender, 1996).
2.4Factors of Production
Knowledge is an asset unlike any other. According to Day (1998) there are four important characteristics from
the point of view of knowledge strategy, namely:
Extraordinary leverage and increasing returns: Most assets are subject to diminishing returns, but not
knowledge. The bulk of the fixed cost in knowledge products usually lies in creation rather than in
manufacturing or distribution.
Fragmentation, leakage, and the need for refreshment: As knowledge grows, it tends to branch and
fragment. While knowledge assets that become standards can grow more and more valuable, others, like
expiring patents or former trade secrets, can become less valuable as they are widely shared. The rapid
and effective re-creation of knowledge can represent a substantial source of competitive advantage.
Uncertain value: The value of an investment in knowledge is often difficult to estimate. Results may not
come up to expectations; conversely, they may lead to extraordinary knowledge development.
Uncertain value-sharing: Even when knowledge investments create considerable value, it is hard to
predict who will capture the lion’s share of it.
These four characteristics can make investing in knowledge assets particularly risky. Traditional models of
industry structure and conduct are an inadequate basis for strategy because they do not help managers
understand how value will be created, or who will capture most of it.
3.Auditing Intellectual Capital
3.1Current Accounting Practices
Our current accounting practices have been geared to the industrial revolution, where the assets of a firm were
vested in land, machinery and capital.
The control and safekeeping of shareholders assets is achieved through physical assets inventories and bank
balances. These do not apply to knowledge assets, which increasingly represent a major part of shareholder
value. According to Sveiby (1998), the traditional tools of financial reporting are quickly losing relevance in a
world where the most valuable assets are information, expertise, technology and skill. It is without question
nowadays, that knowledge has an economic value that is increasing. The value is more visible in companies
that lack traditional tangible values. The important issue from a management perspective is that the present
standards grossly understate the value of assets, and therefore give a skewed picture for companies where these
are not traditional assets. In addition to these is what Weinstein (1995) has coined the “master competence”:
the ability to orchestrate and derive most value from specific competences. Miles & Snow (2000) in describing
“the Future.org” refer to this as a “meta-capability”. As we move from the economic era of customisation to
one of innovation, so the key meta-capability of delegetion becomes one of collaboration, building a future
based on alliances, spin-offs and federations.
Brouthers and Roozen (1999) provide a framework for strategic accounting built around the concept of
environmental turbulence and differing information needs. For various levels of environmental turbulence,
managers have different information needs in terms of the scope, structure and content of information. They
describe ‘strategic accounting’ as a new, virtually unexplored area of strategic management. They found that
few firms have developed internal systems that can provide the strategic management information needed to
make informed strategic decisions. Such a strategic accounting system provides information necessary to
perform the following functions: (1) environmental analysis; (2) strategic alternative generation; (3) strategic
alternative selection; (4) planning the strategic implementation; (5) implementing the strategic plan; and (6)
controlling the strategic management process. In order to fulfil these information functions, a strategic
accounting system must contain information that is: (1) mostly non-financial; (2) focused on the future; (3)
both internal and external to the firm; and (4) based on realistic projections of the future, not simple
extrapolations of the past.
3.2A new approach to intellectual capital
The intellectual capital of a company has been variously described in terms of the intangible element of an
organisation's assets by authors such as Sveiby (1998) A simple but useful measure is the ratio of market to
book value. In the case of a publicly quoted company this is in effect valued by the market daily, whilst for a
private company a valuation may emerge in the process of an acquisition or merger. A general characteristic
of knowledge-based companies is that the market to book value ratio is considerably higher than for traditional
‘bricks and mortar’ companies. It is not an objective of this paper to examine these differences, but rather to
review models and methods for auditing and valuing the intangible asset components. Sveiby classifies the
invisible assets on an organisation's balance sheet as: (i) employee competence, (ii) internal structure and (iii)
external structure. Internal structure includes patents, concepts, models and IT and administrative systems.
These are created by the employees and are generally owned by the organisation.
Skandia, the financial services company, was one of the first to recognise the importance of its intellectual
capital and developed new ways of reporting these aspects of their business to shareholders (Edvinsson and
Malone, 1997). In 1991, Skandia made the new appointment of a director of Intellectual Capital in the belief
that the company's hidden, intellectual assets were of decisive importance. The company's own research led to
a model that has now been widely published. This is based on the formula “Intellectual = Human Capital +
Edvinsson and Malone define the main components as follows:
1. Human capital. The combined knowledge, skill, innovativeness, and ability of the company's individual
employees to meet the task at hand. It also includes the company's values, culture, and philosophy. Human
capital cannot be owned by the company.
2. Structural capital. The hardware, software, databases, organisational structure, patents, trademarks, and
everything else of organisational capability that supports those employees' productivity - in a word,
everything left at the office when the employees go home. Structural capital also includes customer
capital, the relationships developed with key customers. Unlike human capital, structural capital can be
owned and thereby traded.
and even more for knowledge management. For the purposes of this paper the definition provided by Sveiby
(1997) is adopted: “The difference between the market value of a publicly held company and its official net
book value is the value of its intangible assets”. The intangible assets are also described as the intellectual
capital of the company.
4.Auditing Intellectual Capital
The auditing of intellectual capital still has many features that are common to the traditional auditing of
physical assets. Yet because of their intangible nature, knowledge assets are sometimes difficult to identify –
companies often do not know what they know. To fill this gap, techniques are beginning to emerge for the
mapping of the knowledge domains and assets within organisations. These can provide information about who
holds or owns each major knowledge asset, where it comes from, how it kept, used and renewed, and how it is
4.1Mapping knowledge assets
The mapping techniques mentioned above are very much in their formative stages. Earlier attempts by
companies to map knowledge assets have in many cases resulted in long and poorly structured inventories that
prove difficult to use. This has generally been the result of an approach whereby the organisational structure is
used as the reference frame and employees across the whole organisation have been surveyed to identify what
knowledge assets they possess and use, and what they feel would be beneficial in the future. This approach has
inevitably led to the quite common situation where a major investment in IT infrastructure and new company-
wide systems fails to deliver the expected results.
In the author’s experience, projects that have been based on strategic alignment of knowledge systems and use
the organisation’s key processes as the framework for evaluation of knowledge assets have generally proven to
be more successful. This approach has been described as ‘value-based knowledge management’ and is a
natural extension of the ‘value-based management’ approach adopted by many companies, which is
underpinned by activity-based costing.
An important categorisation of knowledge was put forward by Polanyi (1966) who drew the distinction
between explicit and tacit knowledge. Tacit knowledge is personal, context-specific, and therefore hard to
formalise and communicate (Nonaka and Takeuchi, 1995). Explicit or “codified” knowledge, on the other
hand, refers to knowledge that is transmittable in formal, systematic language.
In auditing an organisation’s intellectual capital, one is viewing a dynamic situation with knowledge assets of
very different characteristics and shelf-lives. Some can be protected with patents for 25 years or more, whilst
others loose their value as soon as they are used, and others increase in value through use.
Furthermore, value of the intellectual capital may reside in the existing knowledge assets or, as in the case of
many firms, in the capability of generating new knowledge assets on a continuous basis. A daily newspaper is
a prime example of information that is generated continuously but has a very short shelf life.
It follows that a comprehensive audit of the intellectual capital of an organisation must review the knowledge
creating mechanisms as well as the existing knowledge assets.
4.3The knowledge value chain
A practical approach to mapping the knowledge assets and knowledge-creating mechanisms of an organisation
is to identify and map the ‘knowledge value chain’. An inventory of the more important knowledge assets is
created by following the main processes in the organisation, and identifying the stages at which key
knowledge assets are generated or utilised. A clear distinction is drawn between explicit and tacit assets as
these tend to follow different, but interlinked, value chains. Figure 1 below illustrates the principle behind this
approach and the 3-dimensional framework that emerges.
Knowledge Asset Category C
Knowledge Asset Category B
Knowledge Asset Category A
Explicit Knowledge Value-Chain
Explicit Gather - Store - Refine - Transfer - Apply
Tacit Knowledge Value-Chain Transfer - Apply
Gather - Store - Refine -
Gather - Store - Refine - Transfer - Apply
Figure 1: Knowledge value-chain analysis
The main stages of the knowledge value-chain are as follow:
Gather data: includes collecting data to go into the system and contributing to the system
Store data: includes organising information for ready access
Refine data: includes analysis, synthesis, abstracting, interpretation and also retention and disposal
Transfer information: transferring information to others via sharing, distribution or self service
Apply knowledge: (i) putting knowledge to use, for example to perform core tasks, make decisions, set
strategy or learn from experience; linking to business processes where knowledge creates value, or (ii) sell
or licence the knowledge asset
The source and application of knowledge assets falls into the following main categories:
Generated internally and used internally (economic rent)
Generated externally and used internally; licences, data and expertise bought in or outsourced
Generated internally and used externally; sold or licensed
In the case of licensing, such as software, there might be an ongoing commitment to renew the asset and this
may constitute a potential asset or liability to the company.
5.Knowledge asset mapping in practice
An approach adopted by the author in a number of consultancy assignments for companies in different sectors
and with differing degrees of knowledge-intensity, from manufacturing to publishing, is described below. This
method has assisted in forming a picture of the intellectual capital of those businesses and has provided senior
management with a tool for making related management and investment decisions. The approach consists of
the following mains steps:
1. Strategic review: a top-down review of the business strategy and the core competencies required to
deliver the business objects, followed by identification of the critical success factors
2. Process review: bottom-up identification of the key business processes and the knowledge assets they use
and/or produce, followed by the development of a knowledge inventory
3. Synthesis: evaluation of the knowledge inventory (step 2) in the context of the core competencies and
critical success factors (step 1), and a cost-benefit analysis of current and potential future knowledge
Where the company did not already have a clearly articulated strategic plan, some additional analysis was
carried out to elicit and capture the strategic intent of the management team. In some cases future scenarios
were developed using established methods (Weinstein, 1995). In other cases, where for example a balanced
scorecard (Kaplan and Norton, 1992) had already been implemented, it was a great deal easier to identify the
key core competencies and critical success factors for the business.
In mapping the key business processes, it was possible to make use of existing process maps which often
formed part of a quality assurance system such as ISO 9000.
The outcome of this process produced a clear picture of the organisation’s knowledge landscape and provided
a tool for evaluating, managing and exploiting the organisation’s intellectual capital.
For many organisations this can lead to a substantial improvement in the benefits derived from major
investments in IT systems that have hitherto failed to deliver expected results.
The benefits derived from the specific knowledge assets were viewed in terms of the additional value or
leverage derived from applying each asset in the key business processes that were identified earlier in the
Typically value would be derived from new synergies and areas such as:
revenue from new business opportunities;
new markets and customers;
efficiency gains; deriving more from existing assets; and
In the analysis of the respective costs for each knowledge asset the following factors were taken into account:
people, incl. Training;
tools, e.g. special software;
external experts and consultants; and
In determining the costs for different knowledge assets it was important to take timing into account as the cost
of delivering a particular asset to the business process that it serves depends to a great extent on the timescale
within which it is developed or sourced. In some cases it was found to be easier and faster to use relative
measures and marginal costs, instead of absolute costs, particularly when the necessary IT infrastructure was
already in place.
Once the benefits and absolute or relative costs for the key knowledge assets of the business were calculated or
ranked, these were plotted on a ‘knowledge-leverage’ grid as shown in figure 2. The chart indicates the
possible outcomes for investment in knowledge assets in each of the quadrants. Interestingly, the assets that
might provide the greatest competitive advantage were in the top right-hand quadrant. Where these assets are
reliant on technological solutions it is likely that in cost terms they will migrate towards the left of the chart
into the lower cost area, where access to those assets will become more general and, therefore, they will tend
to lose their competitive advantage.
High to success Competitive
K Leverage /
Low Gain Return
Cost of timely delivery
Figure 2: Knowledge-leverage grid
The method described above permitted the managers to undertake better-informed decisions regarding the
allocation of resources to the acquisition and creation of knowledge assets.
Figure 3 below illustrates this process of evaluating the current expenditure on knowledge assets (box with
dotted-line) and re-allocating that budget to the knowledge-assets that had been evaluated as value-generating
for the business (box with solid line). A further decision can be taken in terms of where the line is drawn to
optimise the spend in this area. This line is shown as the vertical dotted line – ‘value for money’. To the left of
this line further investment in seemingly useful knowledge assets will bring diminishing returns.
Potentially Available Useful Knowledge
Value for Money
Better use of
Figure 3: Budget re-allocation
This approach presents the opportunity for management to generate more benefit from the organisation’s
knowledge assets by re-allocation of existing resources without the need to increase the overall spend in this
area unless it can demonstrably bring substantial returns. In the case of value-based management, a growing
practice amongst major corporations, it allows delegation of such investment decisions to the operational level
whilst retaining the rigour and discipline of evaluating each knowledge project in terms of value-added to the
business, and ensuring that it is in line with the company’s general targets for ROI.
The depth of analysis can be varied and kept appropriate to the complexity of calculating the costs and
benefits. The method lends itself to both extremes. Scales can be absolute or relative; carefully and
exhaustively calculated, or arrived at through simple voting and ranking, which taps into people’s experience
and judgement (tacit knowledge). In practice a surprising degree of congruence between these approaches has
The approach can also be used to identify the assumptions underlying the valuation of knowledge assets and,
therefore, can provide a method for regularly re-evaluating them as well as assessing risks to the asset value.
Equally, the method can help identify opportunities for deriving additional value from existing assets. This can
lead to a knowledge portfolio approach. Some assets may have contingent value, depending on whether they
may be used in the future. For example, tracking a potential acquisition target over a period of time creates a
knowledge asset that may never be used. An extension of value-based knowledge management could be to
introduce a probabilistic approach in calculating present and potential future benefits by applying the
principles of options valuation. This method could provide a means of measurement that is based on the
additional revenue stream generated by an asset and future cash flows can be discounted to calculate NPV.
Other benefits of the value-based approach are that skills and tools are identified. This helps in developing a
KM strategy and plans which cover skills and training needs, confidentiality and access issues. Indeed, this
method can provide a framework for the whole KM process.
Another issue is maintaining knowledge assets. Refresh rates are identified and strategies for developing and
maintaining knowledge assets, analogous with maintenance of physical assets such as buildings and
machinery. The difference is that knowledge assets can actually increase in value with use, as mentioned
5.3Intellectual capital performance indicators
Whilst the value-based knowledge management method described above serves as a decision-making tool for
managers, a different approach is required to measure the overall performance of the business in terms of
efficiency in generating and using its intellectual capital. The method adopted by Skandia (Edvinsson and
Malone, 1997) employed a portfolio of performance indices covering the following areas:
renewal and development focus; and
Evidence confirming that firms with a clearly defined knowledge management strategy tend to perform better
is beginning to emerge. A key factor is a consistent approach that sets out company-wide rules of engagement
for evaluating, developing, sharing and investing in the intellectual capital of the firm.
A process-led approach that applies the principles of value-based management to knowledge can provide a
useful framework. An operational model of the organisation’s knowledge value-chain has been used to
develop a knowledge inventory that supports the valuation and management of knowledge assets, both tacit
Whilst an intranet that captures explicit knowledge is a common starting point for companies that are
developing a formal knowledge management system, it is the creation and sharing of tacit knowledge that can
bring most competitive advantage. The value-based approach examined in this paper can provide a means for
evaluating future plans and ensuring that a new KM system is developed in the areas that will bring most
Further research to fully evaluate the outcomes of value-based knowledge management could make a valuable
contribution to the understanding of this important area of strategic management.
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