A useful convergence? Intangible Capital, Sustainability and the IIRC

Over the decade or so that I have been focused on intangible capital, there has been a parallel conversation going on about sustainability. These are two broad fields with many players and approaches but I’ll try to generalize the two (excuse the shorthand versions):

  • Intangible Capital – also known as IC, Intellectual Capital, Innovation Capital, Digital Capital – Focused on the changes in the core operating assets of organizations that have occurred as we move from an industrial to an IT-fueled, knowledge-based economy.
  • Sustainability – also known as ESG (Environmental, Social and Governance) and Triple Bottom Line (People, Profits, Planet) – Focused on the fact that the industrial approach of not considering the human, societal and environmental effects of corporate actions are endangering our collective future.

Both conversations are about the path to prosperity—measured in both financial and nonfinancial ways. But there hasn’t been too much attempt to unite the two views. One notable exception is the IIRC (International Integrated Reporting Council). 


I admit that I resisted the IIRC approach for a long time. For one thing, we at Smarter Companies have been more focused on innovation and value creation than on corporate reporting, which appears to be the IIRC’s primary focus. And I feared that combined the two made it harder to tell the stories of each of these different fields of study—mixing apples and oranges. It’s kind of ironic because I have often talked about the new design constraints for modern businesses (many of which were related to environmental and social concerns), but I wasn’t able to make that connection. But I’ve increasingly seen the need to find a way to talk about the connection between our mission and that of my colleagues interested in sustainability, especially because IC is about the gift of new knowledge resources that we humans have been given at the moment we need them most. IT and IC hold the key to greater sustainability.

In December, the IIRC released their latest framework document. The framework is written in a purposely vague way as the intention is to start a conversation rather than legislate a solution (an approach I agree with). What spoke to me most in the report was this diagram explaining how organizations create value using what they call the “Six Capitals” (with my overlay of the IC knowledge factory):

I think this graphic does provide a framework for integrated thinking about corporate value creation that includes both IC and sustainability thinking. And it’s given me a way to talk with colleagues about the intersection between our respective work.

At Smarter Companies, we focus on three of the six capitals: Human, Relationship and Intellectual (which we call Structural Capital—read here to see why we avoid the word intellectual). We use an additional category we call Strategic Capital that actually corresponds really well to their central box with business model, external environment and culture. These four categories make up what we call the “Knowledge Factory” in the book Intangible Capital.


The Knowledge Factory is how organizations use Manufactured Capital and generate Financial Capital. It’s also how organizations build or destroy Natural Capital. So all of the capitals are important and contribute an integrated whole. So I say good for the IIRC for trying to get us all to think holistically. Maybe this is a base we can all build upon.


What do you think? Is there a convergence here that will help us advance both fields?

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Comment by Andrea Gasperini on March 9, 2014 at 11:04am

Hi everyone, after reading all your interesting comments I am very pleased to add my observations  hoping they can be useful for the discussion.

With reference to the argument of the importance of intangible assets and the sustainability also the point of view of my workgroup in Aiaf “Mission Intangibles®” (Association of Italian Financial Analysts) is very similar to that indicated by Mary which described the thought of "Smarter Companies" focused on innovation and value creation.

It's true that the International Integrated Reporting Council ( IIRC ), seems pursue the aim to develop a new International <IR> Framework for integrate the economic and the qualitative and quantitative information provided by businesses, with particular reference to issues of sustainability socio - environmental and corporate governance. The IIRC is thus presented as an organization which aims to establish the systematic guiding principles that indicate how the information should be presented and what are the content elements that must be included in the Integrated Report with the objective of helping the companies to communicate in the best possible way their value creation story.

But we must consider that the primary target group of users of a <IR> Framework are the  investors and financial analysts who are interested to understand the value creation of the companies and therefore it seems me that it can be identified a convergence of intent.

Being able to tell in a transparent modality their story of value creation “primarily” to investors is one of the key elements of a “True Integrated Report”.

 

I think that the challenges that must be addressed in the preparation of an Integrated Report are the following:

  • by companies the commitment to describe in a concise and reliable modality their set of capitals available, including large importance is assigned to the three dimensions of capital human, relational and structural / organizational and the business activities (the Business Model) through which this assets are converted into products and services ( outputs) and therefore the achievement of results ( outcomes ) that have an impact on the value creation,
  • the investors must include this information into their financial models in order to assess the ability of companies to create value in the short, medium and long term and understand the potential impact on the organization's strategy, on its business model or on one or more capital that are used and on which has an influence,
  • both - preparers and users - it is necessary that use a common taxonomy of communication that includes Key Performance Indicators ( KPIs ) and Key Risks Indicators (KRIs) .

 

Therefore I believe that a wider adoption of Integrated Report in the coming years depends on many factors, including :

  1. the efforts that will be made by those who have to prepare a Business Report in adopting the integrated structure
  2. the reporting quality that include the intangible assets,
  3. the level of satisfaction of the expectations of investors and financial analysts with respect to the contents of this form of reporting, which is directly proportional to the standardization and comparability of materiality of the information that are communicated.

If the value, not only economic but also social and environmental, that is generated and communicated in an integrated way will then be appreciated by the Financial Markets and banks in the assessment of the creditworthiness of their customers this will involve a strong incentive for companies to invest in intangible asset, social and natural environment, and use the instrument of the Integrated Report for their communication .

 

With reference to the discussion about the definition of the term “Intellectual Capital” I think might be interesting to read the Backgroud Paper realized from ACCA for IIRC “CAPITALS - BACKGROUND PAPER FOR <IR> “ paragraph 4:

 

4 . Categorization and descriptions of the capitals

4A The role of the capitals model in the Framework

4:22  Some modification to the description of intellectual capital would be appropriate (in particular recognition of “organizational capital” as a component of intellectual capital). The IIRC may also like to take a further step in this direction and consider renaming intellectual capital as “organizational capital”.

 

And the IIRC "The International Framework <IR> December 2013 " chapter 2

 

FUNDAMENTAL CONCEPTS

2.18 Organizations may categorize the capitals differently, some organizations define intellectual capital as comprising what they identify as human, “structural” and “relational” capitals.

Comment by Mary Adams on February 21, 2014 at 11:42am

The Baldrige discussion is interesting to me. I remember Ken mentioning this to me years ago. John's idea about systems thinking is right on.

What else should/could we in the IC community learn from the Baldrige example?

Comment by Mary Adams on February 21, 2014 at 11:40am

John - You're right about the systems thinking (and about the knowledge system!).  I will spend some time with the great list you have at Colabria.  Mary

Comment by Paul Hobcraft on February 21, 2014 at 3:57am

A really good conversation, so many take away points in here I think. Nick and Kenan quite rightly relate to the Baldridge award as it was a real breakthrough for many organizations to work towards. Irrespective of its reinforcing points of emphasis on "quality or organizational excellence", they are not such comfortable bed fellows to innovation which strives not for effectiveness or efficiency from the existing stand point of six sigma, lean and all that improves processes. Innovation tends to conflict as it is often messy but can still be organized, it looks more for the intangibles through knowledge application.

I fully support Kenan point we do need a new knowledge / intangible / innovation related framework to reflect the needed changes that are happening all around us from knowledge, technology, global competition, rapid change etc. I think it becomes a problem if we try to compare as surely many "then default" as Mary questioned.

To adopt something different you do need to change the mindset. A new framework that 'attempts' integrated reporting gets us moving differently I feel.

Comment by Nick Shepherd on February 20, 2014 at 3:40pm

Thanks Mary and Keenan - I did not want to suggest that Baldrige has always worked as "the ultimate" model - I was just using it as an illustration on terminology - however Kenan, I agree with your point that it started out as a quality award (as most of them did) but most have morphed into "organizational excellence" in an effort to recognize quality - in terms of optimal use of resources and assurance of meeting customer needs - is a more basic foundation of success that just financial results, and that to do this there are key factors (e.g. planning, leadership, people etc.) that must all be brought together and integrated. Your point Mary about the strategic capital is to me the capability of leadership to actually achieve this. So I look at the excellence awards more as a learning process and stepping stones to a new era of corporate accountability. This in fact was the topic of my 2005 book on corporate governance "Governance, Accountability and Sustainable Development: an agenda for the 21st Century." I think we need to look at this as a journey that we have to guide people through?

Comment by Kenan Jarboe on February 20, 2014 at 1:58pm

Just a comment on the Baldrige award - which highlights the importance of the language we use. Baldrige started as a quality award, using the quality framework.  The items evolved over time into more innovation measures and away fro strict "quality".  A one point I did a word search on the questions/criteria and the word "innovation" was used more than the word "quality" (correcting for the use of the word "quality" in the award title).  But the framework and public perception never seemed to evolve - and it remains viewed as essentially part of the "quality" movement.

We need a new knowledge/intangibles framework to convey a different conceptualization.  Even if many of the specific details are the same in both frameworks.

Comment by Mary Adams on February 20, 2014 at 1:42pm

Nick - I think back to the article you and I wrote for the Institute of Management Accountants several years ago. You understood this intersection better than I did. I especially like the connection between the going concern perspective and sustainability.

I also like your comments about strategic capital.  I guess the underlying message of all of these movements and conversations is that as you say

an underlying piece of the strategic framework is the ability to combine mission (task / what we do) and values (principles that we follow in how we do it)

Which maybe answers my question but I would like to hear your answer....If, as you say, most of what we are talking about is and has been in the Baldrige standards for a long time, why are we even bothering with all these conversations? What's different now? Why do we need new frameworks?

Comment by Mary Adams on February 20, 2014 at 11:39am

Thanks John for your comments. I agree with you about knowledge and flow. My only defense is that when I use this vocabulary, it helps people understand how knowledge works as a system. Connecting that system to the financial perspective that still is important in business is important to getting attention for our ideas. I'm glad you're here to remind us that we have a long way to go!  Mary

Comment by Nick Shepherd on February 19, 2014 at 5:31pm

Well certainly glad to see your comments as well as the really interesting responses from others. I remember a few years ago when I authored the two publications for the Institute of Management Accountants (IMA) I had wanted to integrate intangible assets and sustainability (because I believe that by definition they are connected) however IMA felt that this was too big an issue to try and get accountants to make that leap! If we focus on the value creation model - which I think is the underlying idea of IIRC, then I believe that the approach of the 6 capitals make sense. Too a degree we have to be a bit careful about words versus substance here as we know from past experience that although when we use Baldrige as a model for organizational excellence it has a certain framework and "aspects" that it uses - however if you compare the underlying content of the Baldrige model to every other model globally you will see in excess of a 95% correlation - the factors needing to be addressed to assess organizational excellence are ultimately the same whatever the labels you use! Accountants for years have used something called the "going concern" test as part of their annual audits - to make sure the organization had the ability to continue after the year end as that was an important aspect for shareholders to whom they reported. No point in having a great audit and then failing shortly afterwards (and here we see the problems with financial reporting being the basis for shareholders having faith in the capacity of their organization to continue to operate just looking at financials!). To me this clearly illustrates why intangibles are in fact part of sustainability - if an organization doesn't identify, measure and manage the underlying factors that create value then the organization is not sustainable be definition. Leaders can increase short term financial results yet decimate long term sustainability by causing valuable talent to flee the organization (which also aligns with my passion for leadership today as being the core enabling capability). This again links with your comments on strategic capital Mary - because an underlying piece of the strategic framework is the ability to combine mission (task / what we do) and values (principles that we follow in how we do it). It is these latter aspects that actually support the protection of the intangible aspects of an organizations capability - how it treats its employees and others such as clients. If we treat them badly - ultimately we reduce our "goodwill" which is our intangible capital and at some point in time become non-competitive and ultimately cease to operate. This is why companies like Toyota have it right and why the P5 model we use (Purpose, Passion, Process, People and Performance) combines both the task aspects together with the human aspects. Without Passion nothing works (as you say why do people come to work?) and this is created from a combination of "my desire to be part of what we are doing together with being valued as a member of the team doing it."

What it is to try and change the world - and remember what they used to do to missionaries?

Comment by Kenan Jarboe on February 19, 2014 at 3:11pm

I assume the advisory committee was disbanded -- we have not had any contact/interaction after the report came out for comments (last March).  According to their strategy document, the next few years are for "market testing, development and early adoption"  -- so I think the push from here on is for adoption. 

http://www.theiirc.org/wp-content/uploads/2013/12/COUNCIL-20131205-...

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