D. Ulrich of the School of Business, University of Michigan, suggests a simple formula to define intellectual capital (IC).

Ulrich suggests that many organizations⁽¹⁾ have neglected this form of capital, in spite of the fact that IC, unlike physical capital, actually appreciates over time. (For example, consider the market value of a typical human software programmer after two years as compared to the value of the software or hardware he or she started on after two years!)

There are two significant measurement implications to the management of intellectual capital.

1. You must measure both competence and commitment
   (see The Three Rs of Performance by S. Montague, 1997, pp 28-31.)
   
   

   Given the formula definition, two measures for intellectual property are key:
   
   

   1. A skills (core competence) inventory should be completed. (See J.B. Quinn, Intelligent Enterprise: A Knowledge and Service Based Paradigm for Industry, 1992, or The Three Rs of Performance for guidance.)
      
      
   2. Employee satisfaction/morale should be systematically and periodically measured. (This can be done by taking objective measures of sick days, turnover rates, suggestion rates, etc and/or by an internal staff survey - see The Three Rs of Performance.)
   
   
   
2. When Outsourcing or Improving 'Efficiency' Consider the IC Effects
   
   

   As Ulrich notes, large organizations like GE have been keen to "work out" or out-source non-core functions that do not have an obvious direct client nor clear 'value-added'. While this concept seems valid enough, we need to be careful that by outsourcing the 'boring' 'non-value-added' work that we are not in some way diminishing needed IC.
   
   

   For example, what if a large public or private insurer chose to outsource all claims functions? This would contrast to a former hands-on operation which had business units gaining first-hand knowledge of customer claims and problems. The new operation would have all processing handled by an outside group. Might this diminish the learning and customer closeness which formerly existed for business units? In other words, could this attempt to gain 'efficiency' actually reduce IC and therefore reduce quality? (This could in turn reduce demand and hurt profitability - see below.)

The strategy to outsource claims processing in this case reduces learning and by definition in-house IC, therefore reducing quality and profitability.

(For more explanation of each of the above icons see The Three Rs of Performance, 1997, Core Component Model, Section 2.)

On the other hand, the outsourcing of certain functions (e.g., information technology management) might allow for resources to more appropriately concentrate on core competence thereby improving learning, IC, quality, demand and profitability.

The point is that outsourcing could serve to increase or decrease an organization's vital IC. Only a balanced analysis of core performance elements using a balanced set of measures - will allow for an appropriate perspective.

In summary, Intellectual Capital is becoming more and more recognized as a key new-economy asset. Organizational measurement systems must meet the challenge to measure and manage this asset properly.

(1) For Thomas Stewart, author of Intellectual Capital: The New Wealth of Organizations - Doubleday, 1997, pp 76-77, this definition is almost certainly too limited. He sees IC coming from human capital, structural capital and customer capital, as follows:

"the capabilities of the individual is required to provide solutions to customers, the structural capital - the packaging of human capital, permitting it to be used again and again, and finally the customer capital or the depth, width and attachment of customers to a franchise."

These concepts correspond to the core elements of our Three Rs model in terms of human resources, physical / process resources, and user reach and results.

See The Three Rs of Performance section 2. In other words, Stewart's broader view of intellectual capital and its sources encompass virtually the whole Three Rs framework. (See also Intellectual Capital: Realizing Your Company's True Value by Finding its Hidden Roots, Edvinsson and Malone, Harperbusiness, 1997.)