Intangibles In The Old Economy? Of Course!
By Baruch Lev
In the first essay on intangibles --
"Intangible (Intellectual) Assets" -- posted on 06/14/2001, I presented the
definition of intangibles (non-physical sources of future benefits); discussed the major types of intangibles
(discovery, customers, human resource, and organizational capital); and talked about the unique capabilities of
intangibles (nonrivalry, scalability) to create economic value.
In this essay, I will address an
important, current question which is frequently raised in seminars, conferences
and by readers of media reports on intangibles: What is the relevance of intangibles in "old economy"
sectors? Stated differently, now that
the tech bubbles have
burst and most of the dot-coms
vanished, are intangible assets still important value drivers? In short, should we still be concerned about
intangibles? Good and timely questions
"Lets look at
As a "numbers person," I would
rather consider data than engage in philosophical/conceptual answers to the
above questions. A few months ago, I
was asked by Fortune
magazine to augment
their celebrated annual Fortune 500 list with a ranking of the 50 U.S. corporations with the largest intangible
capital in 2000. This ranking (produced
with my colleague Marc Bothwell, a fund manager with Credit Swiss Asset
Management) appeared in Fortune,
July 18, 2001 issue. Intangible capital
and the earnings generated by intangible assets were computed according to a
proprietary methodology which I have developed, and which will be the topic of
a forthcoming essay.
Examination of the list of "Top 50
by Intangibles" is revealing in addressing the "are intangibles still
important?" question. Leading the top
50 is a decidedly old economy company: General Electric (appliances, turbines, jet engines, finance), with an estimated
intangible capital of $254 billion in 2000.
Only two other companies (Pfizer with $219 billion and Microsoft with
$205 billion) surpass the $200 billion intangibles mark.
Of the top 25 companies ranked by
intangible capital, more than half are old economy: GE, Philip Morris, Exxon, Wal-Mart,
Coca-Cola, Procter & Gamble, Ford, Honeywell, Boeing, Pepsico, UPS, Home
Depot, and Walt Disney. Of the bottom
25 companies, a full 18 are old economy (e.g., Chevron, Alcoa, Dow Chemicals,
Conclusion: Intangible assets, the prime creators of
value and growth are clearly not restricted to technology and science-based
(e.g., pharmaceutical) companies. These
assets are as dominant and pervasive in old economy sectors as they are in the
currently somewhat discredited new economy.
So, stay tuned to the intangibles saga unfolding on this Web site.
What are the old economy
What are the intangibles of Philip
Morris, Procter & Gamble, Home Depot, and the rest of the "dinosaurs"? They are of a varied nature — a mixed
bag. For some companies (e.g., Philip
Morris, Coco-Cola, Pepsico, Sara Lee) the major intangibles are obviously brands. The reputation of a product enables the
producer to consistently capture a large market share (e.g., Marlboro
cigarettes), and/or charge higher prices than its competitors (e.g., Bayer
aspirin). Wal-Mart's private-label
products, aggressively pursued in recent years, are an example of a brand
creation in process.
In other old economy companies, such
as DuPont and Dow Chemicals, the dominant intangibles are unique production
processes (organizational capital), constantly innovated by "process R&D,"
which enable these companies to manufacture products at costs substantially
lower than their competitors.
For others, such as Procter &
Gamble or 3M, important intangibles emanate from the R&D process, similar
to that of technology companies, in the form of new products and services. A new form of R&D, practiced primarily
by chemical companies, is "client-based research." Teams of R&D personnel spend considerable time on customers'
locations, developing new products and improving old ones in close cooperation
with the customers. This overcomes the
major problem with R&D -- getting the new products quickly to the market.
Some old economy companies have a
great success with the
Internet, which is of course an intangible.
According to recent press reports, JC Penney, which saw its stock price increasing the
last three months, has the most successful on-line sales of all retailers.
Whence the value creation?
In a recent extensive research
sponsored by the Council for Chemical Research, I have estimated the rate of
return on (efficiency of) investments in property, plant & equipment, and
R&D in the chemical industry (the study titled "R&D Productivity in the
Chemical Industry" is available on my Web site: baruch-blev.com, in the section "New
New"). Results are very
instructive: while investment in
physical assets by chemical companies yields just the cost of capital (7-8 percent, annually) —
namely, they don't create significant value -- investment in R&D yields an
annual return of about 18%, far higher than the cost of capital. R&D, an important intangible, is thus a
major value-creator in the old economy sector of chemical manufacturers.
In general, whether dealing with old
or new economy companies, value is primarily created by intangible assets:
ideas, people, and organizational processes.
This is true in high growth (boom) periods, and perhaps even more so in
the current low-growth environment. The
challenge to both investors and managers is to identify the intangible sources
of value, quantify them, and optimize the allocation of resources to intangible
and tangible investments. More on these
in forthcoming essays.
My book, Intangibles-Management, Measurement, and Reporting, was just published by
the Brookings Institution Press. This
is the first comprehensive book on intangibles, dealing with managerial and
information issues, by bringing together the most current research and