Finally, parts of intangible capital that drive economic growth are beginning to be measured by the federal government (US Bureau of Economic Analysis - BEA) and recognized as more important to valuation and economic and business growth than investments in tangible capital.
On July 31, 2013, the BEA will release, for the first time, GDP figures categorizing R&D as fixed investment. It will join software in a new category called intellectual-property products.
For more explanation, see the McKinsey news.
However, McKinsey doesn’t drill down into the data to reveal the large shift in business investment in a specific type of intangibles since the 1970, which the authors of a reference paper have called non-scientific R&D and business investment in information (such as software and analytics – big data).
The 2009 reference paper is -
INTANGIBLE CAPITAL AND U.S. ECONOMIC GROWTH, by Carol Corrado (The Conference Board, New York), Charles Hulten (University of Maryland and NBER), and Daniel Sichel (Federal Reserve Board, Washington DC) published in Review of Income and Wealth, Series 55, Number 3, September 2009.
The paper points out that in 1999 intangibles contributed about $ one trillion in GDP but intangibles were not measured by the federal government and so GDP was inaccurate. The gap now is larger.
This error in measurement of GDP and what drives growth of GDP is what is causing the change at the BEA.
According to the reference paper, the three main categories of intangible capital are as follows. Note that the category of R&D is split into scientific and non-scientific R&D and the split is very significant.
• BCI: BUSINESS INVESTMENT IN COMPUTERIZED INFORMATION, mainly business investment in computer software
• INP1 (scientific R&D) & INP2 (nonscientific R&D) - two parts:
INNOVATIVE PROPERTY (INP) , includes the National Science Foundation
(NSF) Industrial R&D series. However, as the authors say – “the NSF’s survey is designed to captureinnovative activity built on a scientific base of knowledge and therefore does not fully capture resources devoted by businesses to innovation and new product/process R&D more broadly. This “other” R&D—called non-scientific R&D—includes the revenues of the non-scientific commercial R&D industry, as measured in the Census Bureau’s Services Annual Survey (SAS), such as the costs of developing new motion picture films and other forms of entertainment, investments
in new designs, and a crude estimate of the spending for new product development by financial services and insurance firms.” The authors found that, by the late 1990s, investment in non-scientific R&D had grown from insignificant in the 1950’s to be as large as investment in scientific R&D.
• EC1&2: ECONOMIC COMPETENCIES - two parts:
o “Spending on strategic planning, spending on redesigning or reconfiguring existing products in existing markets, investments to retain or gain market share, and investments in brand names” Note, the authors say only about 60 percent of total advertising expenditures are for ads had long-lasting effects helping to build brand names.
o Investment in FIRM-SPECIFIC HUMAN AND STRUCTURAL RESOURCES - includes the costs of employer-provided worker training and an estimate of management time devoted to enhancing the productivity of the firm.
The category of investment in firm-specific human and structural resources is now the LARGEST TYPE OF BUSINESS INTANGIBLE INVESTMENT. Scientific R&D is a minor, but important, factor in intangible capital. Therefore, R&D and industrial research, are minor, but important factors in innovation that creates business and economic growth. That’s the main reason why the scope of IRI research should be broadened.
The quantification of the categories of intangible capital can be seen in the reference paper in Table 1 BUSINESS INVESTMENT IN INTANGIBLES. In 2000-03 (in $ billions) , BCI was 172.5, SCIENTIFIC R&D/INP was 230.5, NON-SCIENTIFIC R&D/INP was 237.2, EC1 (including brand equity) was 160.8 and EC2 (FIRM SPECIFIC RESOURCES) was 425.1. Note that EC1 and EC2 were about 48% of the total in intangible capital , and EC1 & EC2 combined with NONSCIENTIFIC R&D were 67% whereas SCIENTIFIC R&D was only 18%. The balance was in BCI at 14%.
The most important fact revealed in the paper is how the business investment in intangibles has dramatically changed since 1970. From 1950 through 1970, business investments in INP1 (SCIENTIFIC R&D) and EC2 as FIRM SPECIFIC RESOURCES – TRAINING/KNOWLEDGE CAPITAL were roughly equal whereas BCI and NON-SCIENTIFIC R&D were effectively ZERO.
However, in 2000-03 BCI and non-scientific R&D are 14% and 19% respectively for a total of 33% !!! Now they are even larger.
IMPLICATION FOR REORGANIZATION OF COMPANIES -
This very large shift in the business investment in information and nonscientific R&D since 1970 plus the increased investment in training to acquire knowledge has large implications for the senior management (CEO) of companies such as the creation of a Chief Innovation Officer (CINO) to manage innovation for business growth with new business models built on new families of products and services beyond the existing product or service families in existing businesses. The CINO should manage all the intangible capital required for radical innovation that can transform the business including both advanced scientific and nonscientific R&D, advanced marketing, and the component of intangible capital which includes knowledge management and the advanced information and communication technology now managed by the Chief Information Officer. In addition, the Chief Financial Officer should expand accounting to measure intangible capital. Marketing, R&D, and IT split into two parts – one group managed by the COO and general managers of existing businesses another group managed by the CINO.