Black and White brings you a two part interview and discussion about intangible assets with Dr. Nir Kossovsky of Steel City Re. John Eastman talks to Kossovsky about why some companies are excellent at developing intangible assets and communicating their efforts and why some have failed. Part two continues the discussion with an analysis of globalization, the valuation of intangibles, and new patent utilization ideas.

Tell me about intangible assets and Steel City Re.
KOSSOVSKY: We’re in the business of helping companies increase, protect, and recover the value of their intangible assets.

In fact the “hard assets” that are known as the tangible assets represent, on average, only 30% of the value of the company.

Describe for me the definition of an intangible asset in the context of what we typically think of an asset of a corporation.
KOSSOVSKY: Intangible assets, as a group, are the most valuable assets in companies today. When we typically think of an asset of a corporation, we think of the property, plant, and equipment, the cash and the cash obligations, the accounts receivable, and the various securities. These are the assets that sit on a company’s balance sheet and define what a shareholder owns through equity in a company. This is the book value. The problem is that today the market capitalization of these companies tends to be substantially greater than book value, which is property, plant, equipment, and cash on hand. In fact the “hard assets” that are known as the tangible assets represent, on average, only 30% of the value of the company. You look at a large company like GE, a conglomerate; and you see that the book assets only represents about 10% of GE’s market value. So where is the other 90% And the answer is, well, the other assets are what accountants call intangible. These assets represent the human capital, intellectual property, reputation for safety, security, quality, integrity, and all those other forms of knowledge and sources of value that, in fact, generate the cash flows for General Electric.

When did intangible assets come into their own in terms of market capitalization of a company? When did companies begin to value and count the intangible side of things?
KOSSOVSKY: So intangible is an accounting term. It is defined as something that an accountant cannot define. So it was not much of an issue long ago when a company was a big box and raw materials came in one end and out the other. Raw steel came in and a car came out the other end. Even today, General Motors is 60% intangible. What has happened is that companies have stopped owning the assets that create the goods. A lot of outsourcing has taken those assets off the books.

Due to globalization?
KOSSOVSKY: Yes, in part globalization. But more importantly, it is the vertical disintegration of the manufacturing value chain and the growth a widely distributed supply chain that has led to the removal of all these physical assets from a company’s books. U.S. companies no longer have the physical assets because they no longer do a lot of hard manufacturing. The value added today by U.S. companies is the magic of putting pieces together, the business processes that allow an assembly of components from all over the world, the tacit knowledge that drives the production and control of the economic engine.

And is the U.S. a leader in recognizing the value of intangible assets or did this come from global sources and not to say “who invented it” ?
KOSSOVSKY: The U.S. is the leader for several reasons. Some of them were accounting reasons; some were operational reasons. You may be familiar with what’s known as the DuPont Identity, or the DuPont Formula, which was a tool used in the bricks and mortar world of manufacturing to help management get a sense of how effectively it was running the company. It was a senior level managerial tool. And it relied on a return on assets, degree of leverage, and a return on sales — profitability. Those metrics reflected areas where a manager could make changes and observe an effect. He could squeeze more out of the bricks and mortar — the equipment to make it produce more. He could squeeze a little bit more out of every sale — reduce costs or increase the price — to get a little more profit. Or he could increase the leverage of the company to get a little more power out of the equity. Well, so that identity was what enabled managers to run a company.

So let’s first look at the accounting reasons. If you think about the math of that identity, if you begin to reduce your asset base, you improve your return on assets. So instead of having to improve the return side, you can reduce the assets side. So there was an accounting driver for companies to reduce their asset base and begin to outsource. Now let’s look at the operational reasons. It also turned out to be a less expensive mechanism. You could get cheaper labor and you could transfer the risk of ownership of the assets to somebody else.

So between the instant accounting benefits of taking assets off the balance sheet, the cost benefits, the P&L [profit and loss] benefits of outsourcing to separate source, as well as the risk benefits of letting somebody else worry about maintaining the equipment and the production line, companies move in that direction. U.S. companies have generally been in the forefront of any accounting driven or finance driven strategy. So U.S. companies have led that effort. The globalization movement only made it easier to find sources for the transfer of risk and an operational capacity.

So move ahead to the current day. Do global firms recognize their intangible assets and make use of them? Are they better at it than the U.S.?
KOSSOVSKY: There is plenty of room for improvement, but it is a difficult question to answer quantitatively because there are no universally applied accounting standards by which one can compare various corporate financial metrics. Further, there is no agreed upon universal standard for measuring intangible asset financial management prowess or effectiveness. That being said, Steel City Re in cooperation with the Intangible Asset Finance Society is spearheading a project on intangible asset finance metrics to develop quantitative metrics. But your general question is, do other companies in other parts of the world recognize that they have intangibles to monetize, or to use?

Well, who adheres more to best practices?
KOSSOVSKY: I don’t think anyone’s really asked that question. The notion of intangible asset finance and tangible asset, managing best practices, or return on intangible assets is a very new concept. Well, there was a first wave, which evolved around the intangible brand. And certainly companies have, for many years, appreciated the power of brand. But no one could beat Madison Avenue, which is a U.S. invention in terms of getting the most out of a brand. The Japanese have the keiretsu model, and so there’s a Mitsubishi. There’s a Matsushita… And they’ve sort of leveraged that brand name pretty broadly. So it’s a huge family, huge conglomerates that work off a similar brand. And that works to your benefit when the brand is good, and works against you when the brand is challenged.

We turn to Europe, and there really isn’t a great branding strategy, very few that really play that game well in Europe. So you come back to the U.S. and you realize that the U.S. has led in top brands, like Coca-Cola, an 81 billion-dollar brand. Now that being said, the Interbrand survey [an assessment of valuable brands] might be different to look at. BMW is a very powerful European brand, Rolls Royce, very powerful European brand.