Understanding intangible assets and building them

If you ask a common man, what is the most required capital to start, maintain and develop a business; the answer would be unsurprisingly- “money”. Money or financial capital is still considered as the fundamental ingredient to a business enterprise. According to this stand point the first step in starting a business is to bring some financial capital and then convert into assets required to conduct the business. Assets are the valuable economic resources owned by the company. Assets are of two types – tangible and intangible. Tangible assets include land, plant, machinery, building, furniture, fixtures, raw materials, finished goods and money claims such as receivables, deposits etc. There is a solid system of practice to manage the tangible assets of the company and the balance sheet indicates the information about this.

Traditionally book value (plant, machinery, land and stock) is considered as the major measure of a company’s worth. Is the information provided in the balance sheet alone a predictor of future success? How does a business organisation survive and change effectively over time? Trying to answer these questions leads us to feel that surplus money alone is not the only factor that helps a business organisation survive; there are other aspects which contribute to the survival and success. Understanding these other factors seems to be elusive and intangible. Intangible assets of the company are accepted to be having value to the company but it is arbitrarily and insignificantly put in the bracket called “goodwill”. Finally we use an equation …

Company worth = Book value + goodwill

Goodwill is an intangible asset. Intangible assets may be defined as those non-monetary assets that cannot be seen, touched or physically measured and which are created through time and/or effort. There are two primary forms of intangibles - legal intangibles (such as trade secrets, copyrights, patents, trademarks etc.) and competitive intangibles (such as knowledge activities (know-how,knowledge), collaboration activities, leverage activities, and structural activities). Legal intangibles generate legal property rights defensible in a court of law. Competitive intangibles, though legally non-ownable, directly impact effectiveness, productivity, wastage etc within an organization - and therefore costs, revenues, customer service, satisfaction, market value, and share price. Intellectual capital is those efforts and application human beings employ in creating the intangible assets.

Every business organisation that exists has intellectual capital behind it, but generally its presence is ignored. Actually the first capital that is invested in any business start up is intellectual capital. An idea, a dream or a passion is what is invested first in any enterprise. Tangible structures are the carriers of intangibles. Concreteness and abstractness are the sides of the same coin. Concrete structures imply the presence of abstract processes.

But a large part of the current management control systems focuses on managing money and its relationship with other functions. Consciously very few organisations attempt to manage intangible assets. Topical research indicates that managing intangible assets is apparently the foundation of survival and growth of the business organisation.

Look at the example of this Company A, a private limited company, agreed to acquire a leading manufacturer of commercial pressure cookers for roughly Rs 25 crore in excess of the book value. The pressure cooker company has a well-known trademark and a customer relationship with major retailers in all the major cities for over 30 years.

With a 30-year history and annual sales turn over around Rs. 150 crore, the trademark has substantial value and awareness in the marketplace. Market surveys conducted among key customer groups indicated brand attributes of quality, durability and trustworthiness, which all provide the customer with a sense of comfort when purchasing the company's products. The customer relationship is an interesting situation. For over 30 years, the customers have been recommending this brand of pressure cooker to its friends and neighbors. In conducting on-site visits at the various locations, it is discovered that over 95% were extremely happy with the quality of the product and would not consider purchasing a lower priced alternative.

Based on the above, do you consider the Rs. 25 crore purchase price in excess?

If ‘no’ is the answer that comes to your mind, then chances are that you have acumen for knowing the intangible assets. The above firm has lots of intangible assets.

Characteristics of intangible assets

Intangible assets enhance the cash flow of the firm. They do it by at least three possible ways:

1. Increasing cash flows, either through top-line sales growth or increasing margins as a result of driving out costs. For example, a collaborative relationship creates the possibility for vendor-managed inventory and an increase in operating margins. Or considerate customer base that pays for the service faster.
2. Enhancing earlier cash flows, such as the more rapid introduction of new products through collaborative relationships with suppliers.
3. Preventing volatile cash flows, such as through long-term stable relationships with suppliers or getting a blanket order from the customers for a specific period of time.

Intangible assets have a number of unique characteristics such as:

• Intangible assets are more difficult to copy and substitute and hence more likely to lead to a competitive advantage compared with tangible assets.
• Intangible assets are not tradable and cannot be disposed from the firm – to acquire them you need to buy the firm.
• Intangible assets are more likely to make other assets – tangible and intangible – more productive. In fact it could be argued that intangible assets (such as customer satisfaction capability) are required to unleash the value of tangible assets (the store).
• In fact, intangible assets such as the relationship between a buyer and a supplier are more likely to grow stronger and appreciate over time.

Suffice it to say that tangible assets account for only about 30 percent of the value of firms: the remaining 70 percent is the value placed on the intangible assets.

Relationships with customers, employees and suppliers, and the associated firm culture and capability of partnering to develop these relationships, are examples of intangible assets that enhance a firm’s competitive position. These assets need to be built day by day. Companies cannot simply purchase a trusting relationship as they do to acquire a technological product.

By developing close relationships with suppliers, employees and customers, firms have the opportunity to both reduce costs and grow the business through collaboration-based strategies. There is the potential to have your cake and eat it too. If the focus is just on financial profits and not investing in the intangible assets, then the real potential for unique business is wasted.

Each relationship, idea, dream and passion counts in the organisational success.

Contributed by : Sasikanth Prabhu