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2017

An Exploratory study of the measures and benefits

of intellectual capital - A Case study of software
development and innovation companies in Nairobi
County

Diana Kuria
Strathmore Business School (SBS)
Strathmore University

Follow this and additional works at http://su-plus.strathmore.edu/handle/11071/5541

Recommended Citation

Kuria, D. (2017). An Exploratory study of the measures and benefits of intellectual capital - A Case

study of software development and innovation companies in Nairobi County (Thesis). Strathmore

University. Retrieved from http://su-plus.strathmore.edu/handle/11071/5541

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 AN EXPLORATORY STUDY OF THE MEASURES AND BENEFITS OF INTELLECTUAL
CAPITAL: A CASE STUDY OF SOFTWARE DEVELOPMENT AND INNOVATION
COMPANIES IN NAIROBI COUNTY

DIANA KURIA

Dissertation submitted in partial fulfilment of the requirements for the award of Degree
of Master’s in Business Administration at Strathmore Business School

Strathmore Business School

Nairobi, Kenya

May, 2016
 DECLARATION

I declare that this work has not been previously submitted and approved for the award of a degree by
this or any other university. To the best of my knowledge and belief, the dissertation contains no material
previously published or written by another person except where due reference is made in the dissertation
itself.

Diana Kuria (MBA/1778/11)

Signature: ………………………………….

Date: ……………………………………

Approval

The dissertation of Diana Kuria was reviewed and approved for examination by the following:

Prof. Ismael Ateya (Supervisor)

Faculty of Information Technology
Strathmore University

Date: ………………………….
Signature: ……………………..

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 ABSTRACT
Empirical studies done have sought to answer the question: “What happen to companies’ intellectual
resources?” While only a few provide the answer to the question: “Why?” however, the second problem
is even more important than the first one in some cases. The final, yet equally important, question of
Intellectual Capital (I.C) transformation is: “How much does intellectual capital contribute to companies’
performance?” This has guided the current study to be focused at examining if and how Nairobi software
development and innovation companies identify the measures and benefits from managing their
intellectual capital.

We adopted a literature review approach, drawing our conceptual foundations from existing models and
theories. The exploratory research was conducted using questionnaires and interviews, to gather
qualitative data and validate the findings. We then compared our findings to the existing methods/
processes from our literature review. This was to help us understand the link between existing intellectual
capital measures and benefits from intellectual capital to those by software companies.

The sample considered in the study consisted of sixteen Nairobi software companies selected due to
their innovations from a targeted 30 potential respondents. Content gathered helped us to code the
responses and use metric weighting to obtain an analysis to guide our findings. This resulted in a 53.33%
response rate from the survey. Findings indicated that 28% of all the respondents stated that the main
value I.C. brings to the organization was profit generation. 25% said I.C. improved productivity within the
organization, 16% viewed I.C. as being used in strategic positioning of the company whilst another 16%
was innovations from staff. Customer loyalty and cost reduction were realized to be impacting the
organizations at 9% and 6% respectively.

The study findings provide a useful insight on the understanding and management of intellectual capital
by Nairobi software companies. These findings indicate that most Nairobi software companies use their
intellectual capital in efforts to maximize profit and productivity within the company. In addition, there is a
focus on the pricing of their final products more than creating brands. This has resulted in Nairobi software
developing companies not appropriating high benefits from Intellectual capital like increased customer
loyalty and increased market share, which were for a majority key indicators in their companies’ strategic
goals. The study findings can be used to guide and create awareness of how software companies can
measure and realise the desired benefits from the management of intellectual capital.

iii
 DEFINITION OF TERMS

Asset: A resource controlled by the entity as a result of past events and from which future
economic benefits are expected to flow to the entity; International Financial
reporting standards (IFRS) (Section 2, paragraphs 2.6-2.36)

Are future economic benefits controlled by the entity as a result of past transactions
or other past events; and "control of an asset". Statement of Accounting Concepts
4 (paragraph 39 to 45)

The capacity of the entity to benefit from the asset in the pursuit of the entity's
objectives and to deny or regulate the access of others to that benefit. Statement
of Accounting Concepts 4 (paragraph 39 to 45)

Intangible asset: An intangible asset is an identifiable non-monetary asset without physical

substance held for use in the production or supply of goods or services, for rental
to others, or for administrative purposes (IAS) 38, section 2 - 3.

Are non-monetary assets which are without physical substance and identifiable
(either being separable or arising from contractual or other legal rights). Intangible
assets meeting the relevant recognition criteria are initially measured at cost,
subsequently measured at cost or using the revaluation model, and amortised on
a systematic basis over their useful lives (unless the asset has an indefinite useful
life, in which case it is not amortised). International Accounting standards (IAS) 38,
section 2 – 3.

Intellectual capital: Intellectual capital is the intellectual material (knowledge) that has been formalised,
captured and leveraged to produce an asset of higher value to the organisation
(Oliver, 1999). Intellectual capital is seen to comprise elements of human capital,
structural capital and customer capital and exists when an enterprise is able to
utilise these in a way which produces additional value or competitive advantage
for the enterprise.

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 ABBREVIATIONS/ACRONYMS

BSC - Balance Scorecard

IAM - Intangible Asset Monitor

IC - Intellectual Capital

ICM - Intellectual Capital Measure

IP - Intellectual Property

RO - Real Options Theory

RandD -Research and Development

TM - Terror Model

VAIC – Value Add Intellectual Capital

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 TABLE OF CONTENTS
DECLARATION................................................................................................................................................................. II
ABSTRACT ...................................................................................................................................................................... III
DEFINITION OF TERMS ................................................................................................................................................ IV
ABBREVIATIONS/ACRONYMS..................................................................................................................................... V
TABLE OF CONTENTS ................................................................................................................................................. VI
LIST OF FIGURES ...........................................................................................................................................................IX
LIST OF TABLES .............................................................................................................................................................X
ACKNOWLEDGEMENTS ...............................................................................................................................................XI
CHAPTER 1: INTRODUCTION ....................................................................................................................................... 1
1.1 INTRODUCTION .................................................................................................................................................. 1
1.2 BACKGROUND TO THE STUDY ............................................................................................................................ 3
1.3 PROBLEM STATEMENT ...................................................................................................................................... 7
1.4 RESEARCH OBJECTIVES .................................................................................................................................... 7
1.5 RESEARCH QUESTIONS ..................................................................................................................................... 8
1.6 JUSTIFICATION................................................................................................................................................... 8
1.7 SCOPE ............................................................................................................................................................... 8
1.8 LIMITATIONS ...................................................................................................................................................... 8
1.9 SUMMARY .......................................................................................................................................................... 9
CHAPTER 2: LITERATURE REVIEW .......................................................................................................................... 10
2.1 INTRODUCTION ................................................................................................................................................ 10
2.2 ELEMENTS/TAXONOMIES OF INTELLECTUAL CAPITAL ...................................................................................... 10
2.2.1 Human Capital ............................................................................................................................................ 11
2.2.2 Structural Capital ........................................................................................................................................ 12
2.2.3 Relational Capital ....................................................................................................................................... 13
2.2.4 Customer Relationship Capital ................................................................................................................. 13
2.2.5 Organization capital ................................................................................................................................... 14
2.2.6 Innovation Capital ....................................................................................................................................... 14
2.2.7 Process Capital ........................................................................................................................................... 14
2.3 FACTORS THAT IMPACT ON INTANGIBLE COMPANY VALUE ............................................................................. 14
2.3.1 Intangible Capital ........................................................................................................................................ 14
2.3.2 Ownership Structure .................................................................................................................................. 15
2.3.3 Corporate Governance .............................................................................................................................. 15
2.3.4 Company Characteristics .......................................................................................................................... 15
2.3.5 Industry Characteristic ............................................................................................................................... 16
2.3.6 Reactions of Analysts and Customers .................................................................................................... 16
2.4 CONCEPTUAL FRAMEWORK: M ANAGEMENT OF INTELLECTUAL CAPITAL TO CREATE VALUE .......................... 17
2.5 HOW INTELLECTUAL CAPITAL BRINGS VALUE TO A COMPANY ........................................................................ 19
2.5.1 Profit Generation......................................................................................................................................... 19
2.5.2 Strategic Positioning .................................................................................................................................. 20
2.5.3 Acquiring the Innovations of Others ......................................................................................................... 20
2.5.4 Customer Loyalty ........................................................................................................................................ 20
2.5.5 Cost Reductions ......................................................................................................................................... 21
2.5.6 Improved Productivity ................................................................................................................................ 21
2.6 REPORTING/DISCLOSURE OF THE VALUE CREATED FROM MANAGING INTELLECTUAL CAPITAL ....................... 21
2.6.1 An Outlook of The Meritum Guideline ..................................................................................................... 21
2.6.2 An Outlook of the Danish Guideline......................................................................................................... 23

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 2.6.3 Comparing Meritum and Danish Approaches ........................................................................................ 24
2.6.4 IC Rating(tm) developed by Intellectual Capital Sweden ..................................................................... 24
2.7 MEASURING THE VALUE CREATED USING IC M ANAGEMENT............................................................................ 25
2.7.1 Economic Valuation Models...................................................................................................................... 25
2.7.2 Generic IC Valuation Models ............................................................................................................................. 28
2.7.3 Individual Company Intellectual Capital Valuation Models ............................................................................ 35
2.8 DISCUSSION ON THE INTELLECTUAL CAPITAL VALUE CREATION MODELS, THEORIES AND FRAMEWORKS ........ 40
2.9 SUMMARY ........................................................................................................................................................ 40
CHAPTER 3: RESEARCH METHODOLOGY .............................................................................................................. 42
3.1 INTRODUCTION ................................................................................................................................................ 42
3.2 RESEARCH APPROACH AND DESIGN ............................................................................................................... 42
3.3 PURPOSE OF THE RESEARCH .......................................................................................................................... 42
3.4 GENERALISATION, VALIDITY AND RELIABILITY................................................................................................. 42
3.5 POPULATION AND SAMPLING ........................................................................................................................... 43
3.5.1 Sample ............................................................................................................................................................... 43
3.6 DATA COLLECTION METHODS ......................................................................................................................... 45
3.7 DATA COLLECTION TOOLS .............................................................................................................................. 45
3.8 DATA ANALYSIS METHODS.............................................................................................................................. 46
3.9 RESEARCH STRATEGY .................................................................................................................................... 46
3.10 CREDIBILITY AND RELIABILITY OF RESEARCH FINDINGS.................................................................................. 47
3.11 RESEARCH METHODOLOGY ASSUMPTIONS ..................................................................................................... 47
3.12 ETHICAL ASSURANCES .................................................................................................................................... 47
3.13 RESEARCH METHODOLOGY OVERVIEW ........................................................................................................... 48
CHAPTER 4: DATA ANALYSIS AND PRESENTATION............................................................................................ 49
4.1 INTRODUCTION ................................................................................................................................................ 49
4.2 INTELLECTUAL CAPITAL DEFINITION AND M ANAGEMENT ................................................................................. 49
4.2 DATA ANALYSIS .............................................................................................................................................. 49
4.2.1 Correspondents Analysis .......................................................................................................................... 50
4.2.2 Correspondents years of experience in software innovation managment ......................................... 51
4.2.3 Size of Correspondents Organisations ................................................................................................... 51
4.2.4 Role of Correspondents in the Orgainsation Business Framework .................................................... 52
4.3 DEFINITION AND CATEGORISATION OF INTELLECTUAL CAPITAL IN SOFTWARE DEVELOPMENT .......................... 52
4.3.1 IC Element most applied in the organisation .......................................................................................... 53
4.3.2 Level of importance that each IC Element plays in Value Creation .................................................... 54
4.3.3 IC categorisation to identify most applied IC element ........................................................................... 55
4.4 FACTORS IMPACTING ORGANIZATION INTANGIBLE COMPANY VALUE ................................................................ 57
4.5 MEASUREMENTS AND FRAMEWORKS APPLIED TO I.C. MANAGEMENT VALUE CREATION .................................. 58
4.5 DISCLOSURE AND REPORTING I.C. .................................................................................................................. 59
4.6 TYPES OF VALUE CREATED AND EXTRACTED USING I.C TO THE ORGANIZATION .............................................. 60
4.7 SUMMARY FINDINGS ON VALUE CREATED AND EXTRACTED USING I.C MANAGEMENT IN ORGANIZATIONS........ 61
CHAPTER FIVE: VALIDATION OF THE FINDINGS AND BUSINESS APPLICATION .......................................... 62
5.1 OVERVIEW OF FINDINGS................................................................................................................................... 62
5.2 THE PROPOSED IC M ANAGEMENT FRAMEWORK (MODEL) .............................................................................. 63
5.2.1 Background to the Proposed IC Management Framework (Model) ........................................................ 63
5.2.2 ASSUMPTIONS TO THE PROPOSED IC M ANAGEMENT FRAMEWORK (MODEL) .................................................. 64
5.3 REVISED PROPOSED IC MANAGEMENT FRAMEWORK (MODEL) ....................................................................... 65
5.3.1 Enablers (Company strategy and Ownership structure) ....................................................................... 65
5.3.2 IC Components’ (Employee knowledge, skills and capability, Intellectual property and Product life
cycle) 65
5.3.3. IC Reports and Disclosures (Balance Sheet and Income statement) ................................................ 66
5.4 FEEDBACK MECHANISM .................................................................................................................................. 67

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 5.5 VALIDATION OF THE PROPOSED FRAMEWORK .................................................................................................. 67
5.6 SUMMARY OF FINDINGS FROM OUR VALIDATION SURVEY OF THE PROPOSED BUSINESS FRAMEWORK ON IC
MANAGEMENT ............................................................................................................................................................... 69
CHAPTER 6: CONCLUSION AND RECOMMENDATIONS ....................................................................................... 71
6.1 CONCLUSION ................................................................................................................................................... 71
6.2 RECOMMENDATIONS ........................................................................................................................................ 72
6.3 LIMITATIONS OF THE STUDY ............................................................................................................................ 72
6.4 SUGGESTIONS FOR FUTURE RESEARCH ........................................................................................................... 73
REFERENCES ................................................................................................................................................................ 74
APPENDICES ................................................................................................................................................................. 81
APPENDIX A: RESEARCH QUESTIONNAIRE ........................................................................................................... 81
APPENDIX B: RESEARCH VALIDATION QUESTIONNAIRE................................................................................... 93

viii
 LIST OF FIGURES
Figure 2.1: Relation of Intellectual Capital and Companies’ Success 18
Figure 2.2: Meritum Guideline 22
Figure 2.3: Phases of IC reporting statements Danish guideline 24
Figure 2.4: Economic Value Added 25
Figure 1.5: Market Value Add Model-Source 26
Figure 2.6: Tobin Q Source 26
Figure 2.7: Monte Carlo Simulation Source 27
Figure 2.8: Real Option Theory Source 28
Figure 2.9: Balanced Scorecard 28
Figure 2.10: Performance Prism 29
Figure 2.11: Hierarchy of Knowledge Assets 31
Figure 2.12: Value creation Map 32
Figure 2.13: Skandia IC Navigator Model 36
Figure 2.14: Ramboll’s Holistic Company Model 38
Figure 4.1: Distribution of Staff in the Role towards IC Management 52
Figure 4.4: Different elements that can constitute I.C. 53
Figure 4.5: Factors Impact on Intangible Company Value 58
Figure 4.4: Awareness of IC Valuation Methods by Companies 59
Figure 4.6: Perceived Value IC Brings to an Organization 60
Figure 5.1: Relation of Intellectual Capital and Companies’ Success 64
Figure 5.2: Diagram of a Proposed IC Valuation Framework 65

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 LIST OF TABLES

Table 2.1: Knowledge Assets- Source 30

Table 2.2: Intellectual capital index 36
Table 2.1: Celemi’s intangible assets monitor 38
Table 2.2: Bates Gruppen Company IQ Measurement System 39
Table 3.3 Population analysis on the roles in the organization 44
Table 3. 2 Population analysis on the correspondent selected year(s) in the software development
sector 44
Table 3.3: Size of the organization based on the annual revenue 44
Table 4.4 Correspondents Analysis 50
Table 4.2 Number of year(s) in innovation development 51
Table 4.3: Size of Organization (based on revenue) 51
Table 4.4: Role of staff in the Organization 52
Table 4.5 Level of importance that each element plays in IC value creation 54
Table 4.6: Analysis of HC elements applicable to IC value creation 55
Table 4:7: Analysis of SC elements applicable to IC value creation 55
Table 4.8: Analysis of RC elements applicable to IC value creation 56
Table 4.9: Analysis of product innovation cycle 56
Table 4.10: Factors that influence product innovation cycle 57
Table 4.11 Factors that influence intangible company value 57
Table 4.12 Factors that influence product innovation cycle 57
Table 5.1: Analysis of IC factors influence on human capital 67
Table 5.2: Analysis of IC factors influence on product lifecycle 68
Table 5.3: Analysis of IC factors influence on business processes 68
Table 5.4: Analysis of IC factors influence on Knowledge process 68
Table 5.5: Analysis of IC benefits contribution to an organization 69
Table 5.6: Analysis of IC value realization to an organization 69
Table 5.7: Analysis if organizations prepare financial with IC value 69
Table 5.8: Analysis if IC valuation modes in financial statements 69

x
 ACKNOWLEDGEMENTS

This has been a very educative and fulfilling journey.

I wish to thank firstly, my family for their dear support and encouragement. Professor Ismail Ateya, my
supervisor and the Strathmore staff also played a pivotal role in this journey. Last but not the least my
sample software development companies: you were open and supportive and quite eager to have my
dissertation for your future reference.

xi
 CHAPTER 1: INTRODUCTION

1.1 Introduction

The term Intellectual Capital (IC) was initially published by John Kenneth Galbraith in 1969 (Bontis,
1998). John believed that Intellectual Capital meant more than just “intellect as pure intellect” but
rather incorporated a degree of “intellectual action”. In this sense, intellectual capital is not only a
static intangible asset per se, but an ideological process; a means to an end. Recently, Intellectual
Capital has been viewed at the group of knowledge assets that are attributed to an organization and
most significantly contribute to an improved competitive position of this organization by adding value
to defined key stakeholders (Marr & Starovic, 2012).

For an organisation to survive and thrive; it needs to acquire a competitive advantage position in the
market. They should not only innovate on products, marketing channel, market and service, but also
enhance the Research and Development (RandD) ability to respond to the market and guide to
product innovation. There is also need to focus on the utilisation and management of their Intellectual
Capital. The target of Intellectual Capital management is to distinguish, acquire, utilize and benefit
from Intellectual Capital to realise value rewards from the organisation’s process chain.

Intellectual Capital evaluation seems to be one of the most important and relevant topics in the
development of strategic management (Roos et al., 2005). When defining the strategy of the
company, managers and owners always have a shortage of information about the potential
effectiveness of different investments. This problem is even more acute if companies’ intangibles are
considered. It seems to be important due to their heterogeneity, as well as non-physical and non-
financial nature (Pike et al., 2005). This is why many Intellectual Capital evaluating methods have
appeared in recent years (Sveiby, 2010). Despite a strong empirical background, this issue has not
been fundamentally well studied. Most of the research has been devoted to the Intellectual Capital
impact analysis, but has provided contradictory results (Firer & Williams, 2003; Tseng & Goo, 2005;
Shiu, 2006).

We need to start by defining what intellectual capital is. Researchers like Stewart (2001) indicate
that intangible assets also can be represented by IC of a company. They divide Intellectual Capital
into human capital, structure capital, customer capital, organization capital, innovation capital and
process capital. They also focus on the measurements and components of intellectual capital in some
specific industry. Bontis (2008) defined and classified Intellectual Capital of an organization into three
basic forms: human capital represents the individual knowledge stock of an organization as
represented by its employees. structural capital is a valuable strategic asset, which is comprised of
non-human assets such as information systems, routines, procedures and databases; relational
capital is the knowledge embedded in relationships with customers, suppliers, industry associations

1
or any other stakeholder that influence the organization’s life. This is the definition that we will adopt
in this dissertation.

Additional definitions’ include: Intellectual Capital is the information that is shared by organization
members and that can be converted to competitive advantages and profitability, and is the total of the
organizational processes that is based on this information (Wise, Victoria, Demediuk, Sims, and
Sciulli, 2003). Intellectual Capital is related to the sustainable competitive advantage of organizations
and being related to organizations sources, capacity and perfection (Cabrita & Vaz, 2006). The most
recent definition of Intellectual Capital has been done by Mojtahedi and Ashrafipour (2012). They
defined it as the group of knowledge assets that are attributed to an organization and most
significantly contribute to an improved competitive position of this organization by adding value to
defined key stakeholders

Intellectual Capital grew out of studies conducted in different parts of the world in the 1970s and
1980s. First, there was Hiroyuki Itarni’s work on invisible assets in Japanese corporations and his
publication in 1980 (and in English in 1987) of Mobilizing Invisible Assets. Second, there were the
studies by a number of economists such as Penrose (1959), Rumelt (1984), Teece (1984); Wemerfelt
(1984) and Teece (1986), who were looking at new ways to understand business organizations and
especially how they might extract value from innovation. And third was the work of Sveiby (1996) in
Sweden who began to look at human capital issues in organizations. In essence the new view
emerging was that business advantage could be built around resource efficiency. The business
implications for this were that a business’s invisible assets such as skills, learning and knowledge
were becoming key strategic issues.

Meanwhile, in the commercial world, pioneers were getting to grips with how intellectual capital might
be applied. Leif Edvinsson, corporate director of intellectual capital at Skandia AFS, a Swedish
insurance company, was one such who labeled intangible assets as Intellectual Capital when he
produced Skandia's first annual report supplement on the subject in 1995. Hubert St Onge, the father
of customer capital, and the man responsible for developing learning programs for the Canadian
International Bank of Commerce, began to get interested in how to translate learning into both human
and structural capital.

The Chartered Institute of Management Accountants (CIMA, 2001) on various journals have reviewed
intellectual capital as difficult to measure: Firstly, the reason is historical. Accounting rules, although
revised on a regular basis, were initially designed for assets such as plant or machinery – tangible
things that represented a source of wealth during the industrial age. Secondly, some intangibles are
hard to measure. Creativity, for example, is at the heart of a knowledge-generation process yet is
essentially an unpredictable process with unpredictable outcomes. It can manifest itself in many ways.
For companies such as Sony and 3M, product and process innovation play a key role in market

2
differentiation. This leads us to the third problem: the idiosyncratic nature of IC. This refers to, what is
valuable for one company may be worthless for another. This has resulted in diverse measuring
systems that make comparability across companies and sectors difficult.

Finally, intellectual capital can have two dimensions. The Meritum Guidelines (Meritum, 2002)
distinguish between intangible resources and intangible activities as a way of highlighting IC’s static
or dynamic character: The intangible resources of a company, a static notion, can be measured at
any given time. Thus worker competencies (human capital), intellectual property rights (structural
capital), customer satisfaction or agreements with suppliers (relational capital) would be considered
under this category. Intangible resources can also be analysed in a dynamic sense.

1.2 Background to the study

This study aims to propose a framework for the evaluation of intellectual capital transformation..
Among the impact factors are the industry to which the companies belong (Clarke et al., 2010), the
companies’ sizes and ages (Al-Twaijry, 2009), and socio-political and economic environment
(Tovstiga & Tulugurova, 2007). The final, yet equally important, question of Intellectual Capital
transformation is: How much does Intellectual Capital contribute to companies’ performance? This
question formed the focus of this study on the measures and benefits of Intellectual Capital. Software
development and innovation companies in Nairobi were selected for ease of logistics, and also pilot
the findings in response to the study questions.

Companies are undertaking activities to acquire or internally produce intangible resources, to sustain
and improve existing ones and to measure and monitor them. These dynamic activities thus imply an
allocation and use of resources that are sometimes not expressed in financial terms and,
consequently, may or may not appear in the corporate financial reports. This dynamic nature of IC
means that its individual components are often not valuable by themselves but work only as a system.
In other words, it is the Intellectual Capital elements that interact to generate value for companies.
For example, a company may have good programming skills that enable it to develop software;
however, they might be worth little unless accompanied by a strong distribution network, loyalty and
commitment from its employees and a powerful brand name. This dynamic combination of intangibles
is often the recipe for success in companies such as Microsoft, Google, Facebook, Linkedin among
other social media and Software as a service (SAAS) companies.

The exploratory study was focused to the software development and innovation companies in Nairobi
County. The Kenyan Government, through its ICT Board, in 2010 placed an opportunity for proposals
for its $4-million grant towards a local content and software application using mobile and/or the web
(Kemibaro, 2010). This was a concerted effort by the government to meet its mandate to make Kenya
a Top 10 Global Technology hub. The government made a call to innovators and entrepreneurs to

3
propose both innovative applications and content for the Kenyan Government as well as the private
sector. The response was remarkable with over 2 000 proposals sent in.

Chao (2014) observed that a mobile evolution has been and is taking place in the city of Nairobi.
Digital entrepreneurship has given the tech sector a boost: creating jobs, providing customers with
innovative services and providing new streams of revenue. With mobile phone use growing at an
exponential rate, there is a wide market available for Nairobi to join the global community. What led
to this burst of economic growth? Several factors have contributed to the seemingly overnight
development of Nairobi as a startup hub: innovation, government support and startup identity. By
choosing Nairobi as the headquarters for a tech company, entrepreneurs are taking advantage of the
momentum that has driven the city into success.

In today’s business; technology is increasingly becoming fundamental for businesses to harness any
competitive advantage. In response, software development companies and consultants are
increasingly producing various technological innovations, thus raising questions such as: are the
innovations being effectively managed to realise economic and other benefits? What is the impact of
competitive advantage, market share and brand / recognition on their innovation success? Is there a
business framework to help guide on what measure that are applied to effective IC management?

Chao (2014) suggested that there are a growing number of start-up technology hubs within the city
of Nairobi. The intention of the start-up community is to specialize each technology hub, so that they
will become ‘centers’ focused on specific themes. As the hub develops, it will be able to become a
resource for others to rely on and can become part of the network of hubs that crisscross the nation.
There are currently six in Nairobi as at January 2016 and there is a sense that for many, this will be
the best opportunity they will have to take their innovations to the next level. The creation of startup
technology hubs is one of the most important resources that Nairobi has been developing over the
years. In the startup market, there is an inadequate number of successful entrepreneurs to turn to for
advice and guidance, so the collaboration that is found in hubs is essential. Hubs in Nairobi offer
classes, social activities and co-sharing space to support the growing technology market.

In September 2016, Facebook founder and CEO Mark Zuckerberg made a surprise visit to Kenya.
The 32-year-old Internet entrepreneur and philanthropist announced his arrival via his Facebook page
where he pointed out that his mission is to meet with Kenyan entrepreneurs and developers and learn
about mobile money. The post read: “Just landed in Nairobi! I'm here to meet with entrepreneurs and
developers, and to learn about mobile money -- where Kenya is the world leader. I'm starting at a
place called iHub, where entrepreneurs can build and prototype their ideas. Two of the engineers I
met -- Fausto and Mark -- designed a system to help people use mobile payments to buy small
amounts of cooking gas, which is a lot safer and better for the environment than charcoal or kerosene
(Wanjala & Mwangi, 2016).

4
Upon our research we came across the African Garage that creates an ecosystem to enable an idea,
start-up and an enterprise to grow by connecting them to the right industry mentors, investors,
knowledge institutions and partners. Since their inception in 2014 African Garage has grown to an
innovation Centre both residential and virtual in order to serve start-ups in different part of the
continent. We believe in knowledge sharing and collaborations so as to leverage on the cost of start-
ups.

The rise of technology hubs has increased effort towards the increase and nurturing of tech
innovators. We were interested to find out why many tech innovators were not being able to launch
their products to the next level such as create brands. This is as regards to benchmarking to
successful global tech innovators like Google and Microsoft among others. Locally in Nairobi, one
innovative product getting world-wide attention is the mobile payment platform M-pesa that was
launched by local mobile service provider, Safaricom. It is fast becoming a staple in transaction
payments across Kenya, and is an integral part of many of the East African nation’s start-ups
(Ng'weno, 2010).

The September 2016 statistics from Consumer Barometer surveys by Google Kenya and
the Communications Authority (Kemibaro, 2016), Kenya sector statistics for the period April to June
2o16, report as below:

i) Mobile Penetration in Kenya

According to the latest sector statistics from the Communications Authority (CAK, 2016), Kenya now
has over 90% mobile penetration. In the period April to June 2016, mobile subscriptions reached 39.7
million up from 38.3 million subscriptions recorded last quarter. This translates to an increase of 3.7
percent or 1.4 million new mobile subscriptions during the quarter.

ii) Smartphone Uptake in Kenya

According to Google’s Consumer Barometer (Kemibaro, 2016) smartphone uptake in Kenya is now
at 44% in 2016. This is a massive jump from 2014 when smartphone uptake was measured in the
same survey as being only 27%. This suggests inexpensive smartphones that are now going for as
little as Kenya shillings 3,000.00 are clearly driving a massive shift from feature phones which used
to be the dominant mobile device in Kenya.

iii) Mobile Money Uptake in Kenya

The latest numbers from the Communications Authority for the period April to June 2016 indicate that
there are now 26.3 million mobile money subscribers in Kenya (CAK, 2016). At the same time, a total
of 227.3 million mobile commerce transactions were made which translated to Kenya shillings404.1
billion in terms of purchases made. The person to person mobile money transfers recorded in the
5
period was valued at Kenya shillings 429.4 billion. Numbers like this give credence to the fact that
Kenya is the global leader when it comes to mobile money!

iv) Increasing SMS usage in Kenya

In a world hooked on Over the Top (OTT) Instant Messaging services such as WhatsApp and
Facebook Messenger it’s easy to assume that SMS is essentially dead and buried? This is not the
case according to the sector statistics from Communications Authority, Kenya. Indeed SMS sent
during the quarter increased significantly to 11.6 billion messages from 6.5 billion registered last
quarter. This growth came from the ‘Create Your Plan Bundles’ SMS tariff that was introduced by
Safaricom during the period under review. This tariff lets Safaricom customers send as many as 50
messages per day for only Kenya Shillings10.00 (CAK, 2016).

v) Increasing Internet Subscriptions in Kenya

According to the Communications Authority sector statistics, Internet subscriptions grew by 8.2% to
26.8 million during the quarter under review up from 24.8 million subscriptions recorded last quarter.
This represents an increase of 35% compared to the 19.9 million subscriptions reported during the
previous year. The estimated number of Internet users in Kenya grew from 37.4 million posted last
quarter to 37.7 million users during the period under review (CAK, 2016). In a nutshell, more and more
Kenyans are getting online and probably via inexpensive smartphones.

vi) Broadband Internet Subscriptions are on the increase in Kenya

According to the Communications Authority Sector Statistics (CAK, 2016), The number of broadband
subscriptions in Kenya increased remarkably by 36.7% per cent during the quarter to reach 10.8
million subscriptions up from 7.9 million subscriptions recorded in the preceding quarter resulting in
broadband penetration of 24.5%. This means that over a quarter of Kenyans now connect to the
Internet on 3G connections or better. In addition, this massive jump in uptake is most probably being
driven by affordable smartphones coupled with increased broadband access nationwide not to
mention increasingly more affordable mobile data charges.

vii) Kenyans Use of Social Media, Search, Email and Video and Smartphones

According to Google’s Consumer Barometer (Kemibaro, 2016) it is social media, search, email and
video that are most popular activities by smartphone users in Kenya on a weekly basis. Social media
dominates with 58% followed by search engines at 39%. Behind search engines is email at 30%
followed by video at 25% which is remarkable given how bandwidth and data bundle intensive video
can be.

6
 viii) Internet Users Penetration

According to Google’s Consumer Barometer Kenya (Kemibaro, 2016) has 22 million Internet users
which is an increase of 4% over the last 2 years. This seems like a modest level of growth and deviates
somewhat from the Communications Authority’s latest sector statistics. The main difference seems
to be that the Communications Authority tracks Internet subscriptions whereas Google tracks actual
unique users, hence the variance. That being said, either way, it looks like almost 50% of Kenya’s
population is now online and these are mostly mobile internet users.

From the earlier statistics, the daily use, M-PESA, a mobile payments’ system has formed and
launched in the country. Kenya (and Nairobi) is embracing the technology which allowed for cashless
payments, prepaid bus fares and school fee payment and tracking. The success (and public
acceptance) of M-PESA helped to motivate and inspire the startup crowd: it is possible to create a
system of technology platforms, even when there was a startling lack of technology to use.

1.3 Problem Statement

Intellectual Capital is an asset that can be exploited for money gains or other useful purpose, like
creating brands. The term combines the idea of the intellect or brain-power with the economic concept
of capital, the saving of entitled benefits so that they can be invested in producing more goods and
services. Intellectual Capital can include the skills and knowledge that a company has developed
about how to make its goods or services; individual employees or groups of employees whose
knowledge is deemed critical to a company's continued success; and its aggregation of documents
about processes, customers, research results, and other information that might have value for a
competitor that is not common knowledge.

Bontis (2008) argued that intellectual capital is becoming the preeminent resource for creating
economic wealth. Tangible assets such as property, plant, and equipment continue to be important
factors in the production of both goods and services. However, their relative importance has
decreased through time as the importance of intangible, knowledge-based assets has increased. This
shift in importance has raised a number of accounting questions critical for the valuation of intangible
assets, such as software, technological innovations, among others like brand names, trade secrets,
production processes, distribution channels, and work-related competencies.

1.4 Research Objectives

i. Explore Intellectual Capital factors that influence business frameworks applicable to software
and/or innovations companies.
ii. Review theories, business models, metrics and benefits applicable to intellectual capital
management.

7
iii. Analyze how software companies determine the components of their intellectual capital.
iv. Propose a business framework that can be applied by software development companies to
measure and realize the benefits from managing their intellectual capital.
v. Validate the proposed business framework based on case studies of Software Development
Companies in Nairobi County that have a recognized innovation.

1.5 Research Questions

i. What Intellectual Capital factors form the business frameworks applicable to software and/or
innovations companies?
ii. What theories, models and metrics are currently being applied to measure and realize the benefits
from managing intellectual capital in software development or innovation processes?
iii. How can the software development companies or innovators determine or identify the
components of their intellectual capital?
iv. What is the probable business framework applicable to measure and realize the benefits from
managing intellectual capital from innovations?
v. How can the above proposed IC management framework be validated?

1.6 Justification

New business models have shifted from the previous focus on tangible assets to intangible assets’
like intellectual capital and knowledge assets. Bontis (2008) suggested that Intellectual Capital is
becoming the preeminent resource for creating economic wealth. Tangible assets such as property,
plant, and equipment continue to be important factors in the production of both goods and services.
However, their relative importance has decreased through time as the importance of intangible,
knowledge-based assets has increased. This has created the need to have an in-depth understanding
of intellectual capital to enable design and implement these desired business frameworks.

1.7 Scope

The study is focused on reviewing and analyzing models and theories of intellectual capital
management applicable to software development and innovation entities. Other areas that touch on
IC were therefore not be the point of focus. Geographically, this study was carried out in 16 software
companies located in Nairobi County.

1.8 Limitations

The dissertation is focused on the IC business framework of Nairobi software developing companies.
The valuation models will hold valuation factors constant.

8
1.9 Summary

Chapter one in this study has served as the introduction by providing information on the study
purpose, problem statement as well as details regarding the study background. This will guide what
the study is about and give the important questions and or issues to be addressed in the next chapters.
Moreover, the rationale and significance of conducting the study is given in detail to justify the
importance of the study to the technology innovators and influence on technology innovators
leadership behaviours as regards to IC management to create and realise value from their
innovations.

9
 CHAPTER 2: LITERATURE REVIEW

2.1 Introduction

IC elements were critically reviewed, value creation theories, metrics and business models, to help
understand the factors and their impact on intellectual capital valuation. Prior research on Intellectual
Capital has been the subject of a rapidly expanding research effort since the term was first introduced
into the literature in the mid-1990s. It is possible to identify several interlocking strands within this
research:

i. Taxonomies of Intellectual Capital: there have been a number of attempts to identify the various
constituents of IC. A key distinction is between human capital and structural capital, or the
competency of an organisation and the results from these competencies. The latter is often sub
divided into external (or customer) capital, and internal (or organisational) capital.
ii. Management of intellectual capital: here the focus is upon the requirement on management to
grow the stock of an organisations intellectual capital, in order to ensure the sustainability of
competitive advantage. The links with the knowledge management literature are very evident
here, not least the observation that it is important to recognise how dependent, organisations are
on intellectual capital before it is lost to the organisation.
iii. Valuing intellectual capital: intellectual capitals hidden value status has resulted in a number of
attempts to estimate the value of an organisations stock of intellectual capital. Underlying such
work is the belief that it is possible to devise an enhanced balance sheet that will provide
information in greater accord with market valuations.
iv. Case studies and field studies: there have been a number of companies in which Intellectual
Capital and attempts to account for it have been extremely influential in promoting interest in the
topic, for example Skandia, CIBC, Celemi, and more recently Coloplast. There have also been a
small number of field studies of intellectual capital measurement and reporting practice,
documenting the extent of interest in accounting for intellectual capital. Surveys of intellectual
capital accounting practice are less numerous.
v. Reporting intellectual capital: mechanisms for reporting the success (or failure) that organisations
have enjoyed in growing their stocks of intellectual capital, together with a number of additional
reporting frameworks have appeared in the literature. These frameworks overlap with the idea of
a business reporting framework to a considerable extent, that despite their distinct origins,
intellectual capital and business reporting are in fact intimately related developments.

2.2 Elements/Taxonomies of intellectual Capital

Intellectual capital of an organization can be defined and classified into three basic forms: human
capital, structural capital and relational capital (Serrano-Cinca et al., 2003; Cabrita & Bontis, 2008).
10
From the categories given, the significance and impact of each in this chapter is explored. Edvinsson
(2002) viewed Intellectual Capital as both what is in the heads of employees (human capital) and
what is left in the organization when people go home at night (structural capital).

2.2.1 Human Capital

Royal and O'Donnell (2008), suggested that human resource capital is a very important element of
value creation. Wiig (2004) pointed out that the human resource capital may include knowledge,
understanding, skills, experience and the relationship between employees, so the human resource
capital is a property leased by the company staff.

Barth et al. (2001) and Roos (2005) hoped to establish human resources indicators for investors to
judge the value of the company; they believed that corporate managers may be more focussed on
short-term performance of the financial statements, but many market investors think the company is
long-term, especially with technical or specialized knowledge of the business. This means that many
companies in a highly competitive environment to grow, of course, in the short term profitability will
be under the business cycle and the effects of fluctuations in systemic risk, but the most stable
companies in the knowledge and human resource capital.

Royal and O'Donnell (2008) set the clamp of human resources capital in the community between the
capital and knowledge management, reflecting the human resource capital is the backbone of
intellectual capital. Nielson et al. (2006) proposed human resource capital as the core of Intellectual
Capital components. These components include skilled staff and knowledge and management
philosophy the company's performance has been affected. Human resources can play to improve the
efficiency of capital value innovation, because it can create the market competition capability.

According to Edvinsson (2002), human capital is the organization or staff possession of individual
tacit knowledge, that is, skills necessary to perform their functions. Human capital consists of the
skills, competencies, and abilities of individuals and groups. These range from specific technical skills
to “softer” skills, like salesmanship or the ability to work effectively in a team. An individual’s human
capital cannot, in a legal sense, be owned by a corporation; the term thus refers not only to individual
talent but also to the collective skills and aptitudes of a workforce. Indeed, one challenge faced by
executives is how to manage the talent of truly outstanding members of their staff: how to use it to the
utmost without becoming over dependent on a few star performers, or how to encourage stars to
share their skills with others. Currently there is more emphasis on leadership. Terms like values and
vision, empowerment and teamwork, and facilitating and coaching are simply a reflection of the fact
that organizations are groping towards a means for managing the knowledge worker. They know this
new breed of worker doesn’t want to be managed; s/he wants to be encouraged to be as
entrepreneurial and go-getting as the structures of the organization will allow.

11
Ahmad and Mushraf (2011) identified human capital as one of the important variables in the study of
Intellectual Capital. It is the dimension of intellectual capital which deals with the human knowledge
and its experience, which is based on other elements and which will influence a company's value by
affecting the other elements. Employee knowledge and capabilities are the important sources of
innovation. It is appropriate to deduce that human capital closely influences innovation capital.
Employees are needed to carry out the internal process of a company. Employees are also required
to perform all customer services. By providing quality of service while implementing internal
processes, the capability of employees would affect process efficiency and customer satisfaction.
According to Wang and Chang (2005), human capital affects business performance through
innovation capital, process capital and customer capital.

According to Skandia’s model, the hidden factor of human and structural capital is a mixture of
intellectual capital added together. On the other hand Human capital is explained as the combination
of Innovation capital, Process capital and Customer capital. Human capital is the ability of company’s
individual employees to meet the task at hand.

2.2.2 Structural Capital

Structural capital has not been defined adequately in the past studies, in which it had different tags
but similar meanings among different intellectual capital concepts. Based on the past literature,
structural capital can be process capital (Buren, 1998) and organizational capital, and it also interlink
with innovation capital. In addition Bontis (2002) explained structural capital as the knowledge
entrenched within the schedules of an organization that includes technological modules and
architectural competencies. According to Edvinsson (2002), structural capital, the organization itself
embodies structural tacit knowledge, which exists in: the myriads of relationships that enable the
organization to function in a coordinated way (but) are reasonably understood by the participants in
the relationship and a few others.

Structural capital comprises knowledge assets that are indeed company property: intellectual property
such as patents, copyrights, and trademarks; processes, methodologies, models; documents and
other knowledge artefacts; computer networks and software; administrative systems; and so forth. A
data warehouse is structural capital and is the decision-support software that helps people to use the
data. Further knowledge management process is converting human capital, which is usually available
to just a few people, into structural capital, so it becomes shareable. Generally speaking, the
knowledge infrastructure in Gold et al. (2001) explained the variables such as organization structure,
culture and technology.

On the other hand, as discussed by Bontis (2001), structural capital is the hardware, software,
databases, organizational structure, patents, trademarks and everything else that employees use to
support their business activities and processes. The extract of structural capital, however, has more

12
emphasis on the the knowledge embedded within the routines of an organization. The cultural and
technological aspect, which is combined with structural capital, has more involvement toward
knowledge base infrastructure. Structural capital includes technological factors and technical
competencies argue that the relationship between structural capital and human capital can be located
within social network. The social characteristics interconnect each individual in an organization. The
social characteristic is one of the outlets. These outlets are the owners of the tacit knowledge within
their social networks. Among different components of intellectual capital, structural capital is the most
difficult as it is related to other capital in terms of definition. The main focus of structural capital is to
embrace a sound foundation, with views from organizational capital, process capital, even innovation
capital and the knowledge management model.

2.2.3 Relational Capital

Relational capital is defined as customer capital. Sometimes customer capital and relational capital
are defined similarly. The focus of relational capital is on the organization. In the knowledge-based
society, Intellectual Capital plays a significant role in the establishment of intangible and knowledge
towards value creation.

Early literature reviews explained human, organizational and customer capital as different entities and
suggested that they are interconnected causally so that human capital creates knowledge which then
can become constant in organizational capital to promote customer relations. Relational capital,
consists of more identifiable items such as, licenses, franchises, but also the less definable, such as
customer interactions and relationships (Ahmad & Mushraf, 2011). Intellectual Capital can be defined
and classified into human capital, structure capital, customer capital, organization capital, innovation
capital and process capital. They also focus on the measurements and components of Intellectual
Capital in some specific industry (Stewart, 1997; Bukh et al., 2001; Serrano-Cinca et al., 2003).

2.2.4 Customer Relationship Capital

Kamath (2008) defined customer relationship capital as a value-added capital. Pure definition of
customer relationship capital is organized foreign relations establishment, maintenance and
development, including customers, suppliers and strategic partners. The term customer capital is
further explained as the relationship between companies and their customers. This is one of the
important dimensions which influence the inward relationships of an organization and the customer.
The notion that customer capital is separate from human and structural capital indicates its central
importance to an organization’s performance. In the measure of skills, Bannany (2008) and Kamath
(2006, 2008) recommended the use of value-added customer relations intellectual capital as a
measure of capital, after all, customer loyalty, customer satisfaction and contribution are of value-
added enterprises.

13
2.2.5 Organization capital
Organizational capital is an enterprise's investment in its systems, its operational philosophy, and its
supplier and distribution channels. It is the systematized, packaged, and codified competencies of the
organization as well as the systems for leveraging that capability (Bukh et al., 2001; Serrano-Cinca et
al., 2003).

2.2.6 Innovation Capital

This involves the capability to renew the organization as well as the outcomes of innovation. Those
outcomes include protected commercial rights, intellectual property, and intellectual assets. Intel-
lectual property is the best-known element of intellectual capital and is the sphere of patents,
trademarks, copyrights, and trade secrets (Bukh et al., 2001; Serrano-Cinca et al., 2003).

2.2.7 Process Capital

This is all the processes of an organization that enables goods and services to be created and
delivered to internal and external customers. Unfortunately, in most cases these processes are never
valued at all. However, when a process is effective in producing value it has a positive value to a
company. When a process is ineffective at producing value it will have a negative value (Bukh et al.,
(2001 Serrano-Cinca et al., 2003).

2.3 Factors That Impact on Intangible Company Value

In order to guide ourselves on how to identify the measure of gauging value gained from IC. We need
to study the general company metrics to identify value gained from intangible assets. Rao et al.,
(2004), Black et al., (2006), Gleason and Klock (2006) and Fukui and Ushijima (2007), identify which
category or factors affect the company’s intangible values. These values are intangible capital,
ownership structure, corporate governance, company characteristic, industry characteristic, and
reactions of analysts’ and customers, respectively. They used the company value as a forward-looking
performance measure. This value represents the market’s valuation of the expected future stream of
profits which are based on an assessment of the return that can be generated from a company’s
tangible and intangible assets.

2.3.1 Intangible Capital

Intangible investment increases company’s value in the same fashion that tangible assets increase
value. Advertising research and development expenses are viewed as investments which can
increase a company’s intangible assets with predictably positive effects on future cash flow and
company value (Gleason & Klock, 2006). Each of them, over the past few decades, has had a strong
impact on the relationship between company performance and intangible capital stocks (Klock &
Megna, 2000; Rao et al., 2004; Gleason & Klock, 2006 ; Fukui & Ushijima (2007) although the
directions are not always consistent with the expected direction.

14
2.3.2 Ownership Structure
Claessens et al. (2000) and La Porta et al., (2002) indicate that the voting rights of controlling
shareholders are high or higher than their cash flow rights; hence, controlling shareholders could
extract wealth from the company, but only bear a little cost with holding low cash flow rights. In this
situation, they could make decisions for entrenchment of minority shareholders’ interest and let
company value decrease. One alternative to mitigate the problem of controlling shareholder
entrenchment is to increase the controlling shareholder’s cash flow capability Fan and Wong (2005).
Higher cash flow in the company means that it will cost more to reduce the value of the corporation
and thus, entrench the minority shareholders’ benefit. In addition, it accrues a complementary effect,
which lets the agency’s conflict occurred between controlling shareholder and minority shareholders
minimize, and consequently, the company value increases Claessens et al., (2000) and La Porta et
al., (2002).

In business groups, the situation of entrenchment is more serious (Morck & Yeung, 2003; Silva et al.,
2006) because of pyramid ownership structure, different kinds of stocks, and cross-shareholdings. By
such structures, they make the gap between voting rights and cash flow rights larger and the incentive
of entrenchment stronger, and then the value of company decreases (Wiwattanakantang, 2001).

2.3.3 Corporate Governance

When the agency problem arises in companies, which can affect company value; corporate
governance may play an important role (Lins, 2003). These monitoring mechanisms are usually based
on the board of directors (Xie et al., 2003; Larcker et al., 2007). Because boards are charged with
monitoring management to protect shareholders’ interests, they avoid company values being
entrenched especially the empirical evidence on the efficacy of the monitoring that outsiders provide
(proxy for board independence) appears in many studies (Bhagat & Black, 2002; Oxelheim & Randoy,
2003). Otherwise, large shareholders or institutional shareholders are other general monitoring
mechanisms.

Jung and Kwon (2002) and Lins (2003) show that institutions, external, or large non-management
shareholder are incentivized to monitor their management and protect their assets. Wiwattanakantang
(2001) indicated that companies with more than one controlling shareholder have higher return on
assets by monitoring each other to reduce agency cost, related to companies with no controlling
shareholder. Oxelheim and Randoy (2003) suggested that foreign exchange listing signals a
company’s commitment to the higher disclosure standards prevailing in the market in which it lists.

2.3.4 Company Characteristics

A company’s value may be affected directly or indirectly by factors related to the nature of the
company. Sales growth is a proxy for growth opportunities which increase company value, but the
company size is likely to be inversely related to expected growth opportunities. (Fukui & Ushijima,

15
2007). Rao et al. (2004) found that companies with higher growth opportunities have lower leverage.
Older companies have better disclosure, more liquid trading, more attention from analysts, and more
diversified activities leading to lower risk of financial distress and then higher company value.
However, younger companies may have more growth opportunities and likely be faster growing and
perhaps more intangible asset intensive (Black et al., 2006). Diversification leads to lower risk of
financial crisis and higher company value.

Allayannis and Weston (2001) indicated that industrial diversification is an outgrowth of agency
problem between managers and shareholders, thus reducing value. Regression results show that the
average relationship between diversification and company value is negative. Internationalization
theory notes that foreign direct investment occurs when a company can increase its value by
internationalizing markets from some of its intangible assets, such as production skills or consumer
goodwill. On the other hand, Allayannis and Weston (2001) find that multi-nationality is positively
related to company value.

2.3.5 Industry Characteristic

The degree of industry concentration should affect the company’s relative bargaining power. When
an industry is fragmented and concentration is low, the degree of competition in the industry is likely
to be more intense and the company’s bargaining power is decreased. Therefore, prior research
indicates that higher concentration can provide more market power which can lead to a higher
company value Anderson et al., (2004). On the other hand, many literature reviews argue that a higher
company IC value reflects better market efficiency rather than market power. The effect of the
concentration index on company value is negative as stated by Rao et al. (2004).

For the traditional manufacturing industry, land, capital, and labor are critical factors to judge a
company’s value. However, in the knowledge-intensive industry, for example high-technology
industry, knowledge and innovation are the dominating resources and are far more important than
physical assets (Tseng & Goo, 2005). Therefore, intangible assets determine a large part of a
company's value. Klock and Megna (2000) show that in communications industry, the industry
average Tobin’s Q is in excess of ten. This means that the market value is about ten times higher
than book value. But in traditional industries, most companies’ Tobin’s Q is nearly equal to one or less
than one. Company value varies by industry.

2.3.6 Reactions of Analysts and Customers

Lang et al. (2003) indicated that the more analysis and information is available, the more the
company’s information environment is better, and the cost of capital is reduced. Analysts are one of
outside users of financial statements and own professional domain knowledge; therefore, improving
company value by increasing the cash flows that accrues to shareholders (Lang et al., 2003). Although
such an effect on valuation might be offset by an increase in investor interest, reduced uncertainty,

16
and reduced agency conflicts within companies, the relation between analyst following and valuation
is not clear.

According to the marketing theory like Heisenberg Uncertainty Principle of marketing, it is believed
that the more a marketer of a company understands why and the way how a consumer behaves, the
decision making process in general and the purchase decision or indecision in particular, the more
likely the company will be able to sell the intended products or services to the consumer. Thus,
increasing company’s market share will in turn, bring profitability, and thus affect the company value.
Black et al. (2006) and Morgan and Rego (2009) show that market share is positively related to Tobin’s
Q proxy for company value.

2.4 Conceptual Framework: Management of Intellectual Capital to Create Value

Intellectual Capital is knowledge that can be exploited for some money-making or other useful
purpose. The term combines the idea of the intellect or brain-power with the economic concept of
capital, the saving of entitled benefits so that they can be invested in producing more goods and
services. Intellectual capital can include the skills and knowledge that a company has developed
about how to make its goods or services; individual employees or groups of employees whose
knowledge is deemed critical to a company's continued success; and its aggregation of documents
about processes, customers, research results, and other information that might have value for a
competitor that is not common knowledge.

Bontis (2008), stated that Intellectual Capital is becoming the preeminent resource for creating
economic wealth. Tangible assets such as property, plant, and equipment continue to be important
factors in the production of both goods and services. However, their relative importance has
decreased through time as the importance of intangible, knowledge-based assets has increased. This
shift in importance has raised a number of accounting questions critical for the valuation of intangible
assets, such as software, technological innovations, among others like brand names, trade secrets,
production processes, distribution channels, and work-related competencies.

The market value of a company's shares ultimately reflects the value of all its net assets. In the
industrial era, physical assets, such as land, capital, and labour are critical factors to judge a
company’s value. However, in modern economies, the development of communication technology,
electronic commerce, and the internet makes these resources circulate around the world quickly,
letting the knowledge-based economy era evolve (Abu-Musa, 2009). In addition, the value of the
knowledge industry increases rapidly.

Organization for Economic Co-operation and Development (OECD) (2004) concluded that knowledge
economy is in possession, distribution, production, and has knowledge as a critical resource in

17
economics. Therefore, the important successful factors for companies are the capability and the
efficiency in creation, expansion, and application of knowledge (Kessels, 2001).

Greenstein-Prosch et al. (2008) and Flensburg (2009) Chan et al., (2001), Eckstein, (2004) argued
for the method for creating company value transfers from traditional physical production factors to
intangible knowledge. In this situation, a large part of a company's value may reflect its intangible
assets. Not only consider the tangible assets, but also respect the power of intangible assets that is,
the difference between the market value and book value of a company, when we evaluate a
company’s value. Intangible assets are company’s dynamic capability created by core competence
and knowledge resource, including organization structure, employment expert skills, employment
centripetal force, research and development, innovation capability, customer size, famous brand, and
market share.

Other studies such as Wiwattanakantang (2001), Lang et al. (2003), Gleason and Klock, (2006), Fukui
and Ushijima, (2007) investigated various types of impact factors on intangible assets value. Gleason
and Klock (2006) and Black et al., (2006) showed that advertising, research and development
expenditure are positively related to Tobin’s Q, (a proxy for intangible company value), but company
size has negative relation with it.

Wiwattanakantang (2001) examined the effect of controlling shareholders including various type of
controlling, participation in management, and pyramids on corporate value and found no significant
evidences on Tobin’s Q. Fukui and Ushijima (2007) investigated the industry diversification of the
largest Japanese manufacturers. Regression results show that the average relationship between
diversification and company value is negative. However, research to date (Wiwattanakantang, 2001;
Lins, 2003; Black et al., 2006) provides mixed evidence on the various factors affecting the company
value. Figure 2.1 illustrates how intellectual capital adds value to a company success

Figure 2.1: Relation of Intellectual Capital and Companies’ Success. Source: Edvinsson (2002)

18
The method for creating company value transfers from traditional physical production factors to
intangible knowledge is important. In this situation, a large part of a company's value may reflect its
intangible assets. Not only are the intangible assets considered the power of intangible assets (that
is, the difference between the market value and book value of a company) should also be respected
when we evaluate a company’s value as argued by Chan et al. (2001) and Eckstein (2004).

Commonly used performance measures, such as return on equity or return on total assets, become
much less useful in intangibles-intensive companies. Similarly, the human capital assets of
companies; stocks of skills, competencies, know-how in a company, and the resources being
expended to renew and expand them – are outside the visible spectrum of information that is typically
available to investors; they simply don’t show up on the financial radar. So without the reporting
systems that enables them to make decisions, will investors be willing to put new capital into worthy,
but intangibles-reliant, business ventures? What is needed now is a new system, or at least a parallel
one, to supplement the existing financial measures that will allow decision makers to evaluate these
issues. Without it, only guesswork remains.

2.5 How Intellectual Capital Brings Value to a Company

Growth, above-average earnings, and sustainable competitive advantages are no longer driven by
investing in physical assets such as factories, offices, or machinery, but instead by investing in, and
managing intellectual capital. The success of leading companies such as Amazon, Google, Microsoft,
and Wal-Mart is based on their intellectual capital. Physical assets such as distribution warehouse,
office buildings, and stores are important, but not as much as (for example) as knowledge about
customers, technology, and markets. For example, organizations such as Wal-Mart, with its huge
store infrastructure, couldn’t perform as well as it does without the intelligence to build its stores at
the right locations, the knowledge about consumers to stock the right goods, and its expertise in
inventory replenishment. Intellectual capital allows organizations to leverage their tangible
resources. Identifying and managing the right Intellectual Capital is and will increasingly be the key
differentiator between successful, mediocre, and failing enterprises.

Harrison and Sullivan (2000), argued that once a company comes to the understanding that it has
Intellectual Capital, then how does it convert it into something of value? The answer is that it depends,
at least in part, on the kind of value the company wishes to extract from its Intellectual Capital. At a
recent meeting of the ICM Gathering, member companies, all sophisticated in extracting value from
their Intellectual Capital, described how their companies had actually received value from their
intellectual assets.

2.5.1 Profit Generation

Firstly, this can be by income from products or services, sales, licensing royalties, joint venture income
and strategic alliance income. Secondly, income from the Intellectual Property itself, through: sales,

19
licensing royalties, joint venture income donations (tax write-offs), price premiums and increased
sales from convoyed sales and repeat sales (Harrison & Sullivan (2000).

2.5.2 Strategic Positioning

This can be achieved from: market share, leadership (innovation, technology, among others.),
standard setting and name recognition through branding, trade marking and reputation (Harrison &
Sullivan (2000). Tan, Plowman and Hancock (2007), moreover noted that as a result of the
emergence of using intangibles as strategic assets to survive in a highly competitive business
environment in which business companies and other groups are competing for exceptionally limited
resources, and the growing importance of knowledge as a commodity there is need for strategic
positioning.

In this knowledge-based economy era, the implementation and the application of knowledge and
information technology have become the most crucial issues and competitive advantages of every
organization. The primary method for creating company value is based on transferring from traditional
physical production-factors to intangible knowledge (Eckstein, 2004). Intangible assets are company’s
dynamic capability created by core competencies and knowledge resources, including organization
structure, employment expert skills, employment centripetal force, research and development,
innovation capability, customer size, brand recognition, and market share. It represents the future
growth opportunities and profitability toward company value (Ittner, 2008).

According to Marr (2004), intellectual capital most significantly contributes to an improved competitive
position of an organization. Furthermore, Intellectual Capital enables the organization to add value to
important status thus leads to improvement in its competitive advantage. The value added origins
from the enhancement of effectiveness and efficiency of organizational routines. Thus intellectual
capital is the key factor in succeeding in that. To obtain competitive advantage, it is crucial for an
organization to utilize knowledge efficiently and to enhance their innovation potential. Reporting these
intangible assets systematically to customer partners and investors, as well as creditors has become
a crucial success factor. Managing IC is therefore becoming increasingly important for future oriented
organizations.

2.5.3 Acquiring the Innovations of Others

Companies can opt to use of innovations of other successful companies like the Enterprise Resource
Planning Systems to improve business process efficiency and ensure they are aligned to industry
best practices as per Harrison and Sullivan (2000).

2.5.4 Customer Loyalty

This can be achieved through initiatives like customer loyalty programs as noted by Harrison and
Sullivan (2000).

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 2.5.5 Cost Reductions
Companies have had to identify critical activities to enable eliminate avoidable processes to make
operational savings as observed by Harrison and Sullivan (2000).

2.5.6 Improved Productivity

Through review of business processes and staff incentive scheme, companies have managed to
increase their assets and employee yield as further observed by Harrison and Sullivan (2000).

2.6 Reporting/Disclosure of the value created from managing Intellectual Capital

There has been a need by any company to document how it has increased its market value or in
strategic terms created value from it resources. In light of IC, there have been significant contributions
from European researchers the “Guidelines for the Management and Disclosure of Information on
Intangibles (Intellectual Capital Report)”, developed by the MERITUM Project, and “A Guideline for
Intellectual Capital Statements – A Key to Knowledge Management”, developed by a task-force
coordinated by the Danish Agency for Trade and Industry.. Both approaches consist on a set of
recommendations, addressed to practitioners, on how to manage and report on intellectual capital.
They are arguably the most relevant guidelines in place aiming to provide practical guidance to
companies in the process of managing and reporting on intellectual capital. Among existing initiatives,
they probably have the strongest institutional and corporate support.

2.6.1 An Outlook of The Meritum Guideline

The MERITUM Guidelines are based on best practices observed among eighty European companies
and were validated through a Delphi study. It was in two main parts; a model for intellectual capital
management and a set of recommendations on how to prepare ‘Intellectual Capital Reports’ (Bukh, et
al., 2000).

The model for intellectual capital management proposed by the MERITUM Guidelines, according to
Gogan, Borca, Rennung, and Sîrbu (2015) and Meritum (2002) comprises three phases:

i. Identification: After clearly articulating the ‘vision of the company’, this phase consists in
identifying the ‘critical intangibles’ required to attain the company’s strategic objectives.
Next, a set of ‘intangible resources’ and ‘intangible activities’ are attached to each critical
intangible, by means of which the latter will be attained and the process will be monitored.
As a result, a ‘network of intangibles’ emerge, providing the company with a clear picture
of current intangible resources, of those which have to be developed in the future and of
the activities which need to be deployed in order to attain its strategic objectives.
ii. Measurement: This phase involves defining specific indicators to be used as a proxy
measure of the different intangibles which were identified in phase 1. The Guidelines

21
 explain the desirable characteristics that these indicators should have and provides
examples of good practice.
iii. Action: As it is said in the Guidelines, this phase entails the consolidation of the intangibles
management system and its integration within the company’s management routines It is
a learning process that involves monitoring and evaluating the effect that the different
activities have on the company’s intangible resources, critical intangibles and strategic
objectives.

V A L U E C R E A T IO N

V is io n of th e
S TR A T E G IC O B JE C T IV E
f ir m

C R IT ICA L IN TA N G IB LES

I n t a n g ib le s I n t a n g ib le s
R e so u rce s A c t iv it ie s

R e so u rce s
H u m a n C a p ita l R esourc e A c t i v it y
a nd
A c t iv it ie s S tru c tu ra lC a p ita l R esourc e A c t i v it y

R e la t i o n a l C a p i t a l R esourc e A c t i v it y

S y s te m of
I n d ic a t o r s S Y S T EM O F IN D IC A T O R S

Figure 2.2: Meritum Guideline-Source: Bukh, Nikolaj, Mouritsen and Larsen (2000)

On a second stage, the MERITUM Guidelines ((Meritum, 2002; Gogan, Borca, Rennung, & Sîrbu,
2015) describe how to prepare an Intellectual Capital Report, comprising three parts (See Figure 2.
2).

i. The ‘vision of the company’, that is, a narrative of the company’s strategic objectives and
critical intangibles.
ii. ‘Summary of intangible resources and activities’ which represents a disclosure of the
activities to be developed in order to attain the strategic objectives.
iii. ‘System of indicators’, which allow the reader to assess how well the company is doing
in attaining its objectives.

The Guidelines classify the different intangible resources and activities, as well as their corresponding
indicators, under the following three categories of Human capital, Structural capital and Relational
capital. Finally, the Guidelines conclude with a set of recommendations regarding how to collect

22
 information, who should prepare the information inside the company and the frequency of reporting
(Meritum, 2002).

2.6.2 An Outlook of the Danish Guideline

The Danish Guideline describes how to prepare an ‘Intellectual Capital Statement’ in practice. It draws
on the experience of seventeen Danish companies which participated in the project by means of
preparing two sets of intellectual capital statements under the supervision and guidance of the Danish
Guideline’s task-force. Thus, it includes in-depth examples from the intellectual capital statements
prepared by these companies (Bukh, et al.,1999).

The Guidelines emphasize the fact that the intellectual capital statement is an integral part of working
with knowledge management within a company, but does not specifically describe a model for
knowledge management. It proposes a process for preparing intellectual capital statements
comprising four phases (Meritum, 2002):

i. Knowledge narrative: Involves defining the mission of the company, the ‘use value’ (that is, the
value for the final customer) of the product or service offered by the company and the conditions
of production, with a special emphasis on the system of knowledge and competencies.
ii. Management challenges: This phase consists of the identification of a set of ‘management
challenges’ which are to be addressed in order to develop and realize the ambition defined in the
knowledge narrative. In other words, it involves translating the company’s knowledge narrative
into specific management challenges. More importantly, it involves a selection of an action plan
among the different strategic alternatives available to implement the knowledge narrative.
iii. Actions and indicators: In this phase, the objective is to develop detailed actions attached to each
management challenge, as well as specific indicators to measure the impact of each of those
actions. With respect to the classification of these actions and indicators, the Danish Guideline is
very flexible, proposing some examples but not a unique classification method.
iv. Reporting: This phase involves the final preparation of the Intellectual Capital statement, which
is composed of text, figures and illustrations. The text serves to communicate the company’s
knowledge narrative, its management challenges and actions, as well as to provide a general
description of the company. Figure 2. 3 presents an overview of the different management
challenges, the actions attached to them and the specific indicators used to measure the impact
of those actions.

23
 K N O W L E D G E N A R R A T IV E

M ANAGEM ENT CHALLENGES

A C T IO N S A N D IN D IC A T O R S

R E P O R T IN G

Figure 2.3: Phases of IC reporting statements Danish guideline. Source: Bukh, et al. (1999)

The Danish Guideline signals as good practice to report on the accounting policies used and to include
a statement of an auditor in the Intellectual Capital statement. Finally, in its appendixes, it provides
some detailed examples; a survey of indicators that could be used in an Intellectual Capital statement;
a summary of the differences between Intellectual Capital statements and social statements; and a
glossary of terminology.

2.6.3 Comparing Meritum and Danish Approaches

As it was argued in the introduction to this study, there is a clear need to compare the different “soft
regulations” (or guidelines) currently available for practitioners, two of the most important of which are
the MERITUM and the Danish Guidelines. This comparative study is not only based on my own
appraisal but also relies on the opinions of the authors of the guidelines under analysis, which were
gathered through in-depth personal interviews, and telephone conversations.

It can be concluded that the process described in the two guidelines is very similar: they are, in effect,
very coherent with each other. Nevertheless, some relevant differences among the two guidelines can
be found in their terminology, in their methodology and scope, and in the way they classify actions and
indicators. This will form the guideline/basis of this research. Earlier, it was stated that factors
influencing and impacting IC, according to software developers and innovators. Findings will be
categorised as the Action / Activities versus indicators / Resources.

2.6.4 IC Rating(tm) developed by Intellectual Capital Sweden

It is also worth noting that a tool for measuring and describing an organization’s non-financial assets
– IC Rating(tm) has been developed by Intellectual Capital Sweden. Scandinavian countries board
members and managers presently use IC Rating primarily for valuation, benchmarking, organizational
development, and/or external reporting. This proprietary tool is used to measure and describe non-
financial assets that are not reported or described in traditional financial statements, but that are of

24
critical importance to the long-term success of an organization and also rates and measures an
organization’s future potential.

2.7 Measuring the Value Created using IC Management

This section is to review various theories, metrics and models that have been developed and applied
to gauge the value created from the management of intellectual capital. These can be grouped in
three main categories: Economic Valuation Models, Generic IC Valuation Models and Individual
Company Intellectual Capital Valuation Models. These have been reviewed in more detail in the
following sections of this chapter.

2.7.1 Economic Valuation Models

There have been some proposed IC Valuation models, according to Petty and Guthrie (2000). These
approaches were developed to allow external stakeholders to put an economics value on an
organization. Mainly based on publicly available data and used by finance professionals. This forms
the critique as to their practical application to IC valuation.

2.7.1.1 Economic Value Added

The EVATM was developed by Stern Stewart (Chen & Dodd, 2001). The model derives the difference
between a company’s net operating income after taxes and its cost of capital of both equity and debt.

EVATM = Residual Income (RI) + Accounting Adjustments (CapChg)

Where:

RI = Net Operating Profits after Taxes (NOPAT) – Capital Charge

NOPAT = Earnings before Extraordinary Items + After Tax Interest

EBEI = Cashflow from Operations + Accurals

ATInt = Net Interest Expense x (1 – Tax Rate)

CapChg is the charge for the use of capital

Figure 2.4: Economic Value Added- Source: Petty and Guthrie (2000)

Equation in figure 2.4 shows the relationship between interest on the debt and a charge for the equity
capital based on a cash equivalent equity multiplied by a cost of equity. The aim of the EVA TM is to
arrive at earnings that are close to cash and compare this return to a capital base that is expressed
in cash equivalent terms. The above evolved to capture the three main factors, namely, capital
employed efficiency, Human capital efficiency and structural capital efficiency. VAIC is the total sum

25
of the three factors. Critics of this theory note that it is too focused, on the structural-functional
approach and views all strains on society as disruptive.

2.7.1.2 Market Value Added

MVA is the difference between the market value of a company (both equity and debt). That can be
further broken down as Cash In (funds from investors) and Cash out (market value of the company).
The equation 2.2 indicates:

MVA = Market value of Debt + Market value of Equity – Total Adjusted Capital.

Figure 2.5: Market Value Add Model-Source: Petty and Guthrie (2000)

MVA is a benchmark for market performance between companies (Evans, 1999). Critique of the
model is that is focuses on historic activity.

2.7.1.3 Tobin’s Q Ratio

It is a measure to help predict investment decisions independent of macroeconomic factors such as
interest rates. The equation in figure 2.4 states the relationship between market value and assets
value as:

Q = Market Value / Asset Value

Figure 2.6: Tobin Q Source: Petty and Guthrie (2000)

A positive Q ratio value can be ascribed to the intangible value of intellectual capital which is not
captured in traditional accounting systems Luthy (1998). It measures the result of human activity over
time as expressed in the market value of a company. Critique of the model is that results between
two periods as regards the cashflows are not the same which is contrary to the theory.

2.7.1.4 Monte Carlo Simulation

A two-dimensional (or second-order) Monte Carlo simulation is useful to estimate “uncertainty” in the
risk estimates stemming from parameter uncertainty. A two-dimensional Monte-Carlo simulation is a
Monte-Carlo simulation where the distributions reflecting ”variability” and the distributions
representing ”uncertainty” are sampled separately in simulation, so that ”variability” and ”uncertainty”
in the output may be estimated separately.

26
The calculation of the model:

Net income on intangible assets = Normalized earnings – (Required return on physical assets
* Value of physical assets) – (Required return on financial assets * value of financial assets)

Value of intangible assets = Net income on intangible assets / required rate on intangible
assets

Figure 2.7: Monte Carlo Simulation Source: Petty and Guthrie (2000)

2.7.1.5 Real Option Theory

It provides an approach, developed by Stewart C. Myers of Massachusetts Institute of Technology to
value the opportunities arising from IC. It is based on non-financial assets which are non-tradable,
that is not financial instruments. Real Option Theory has some similarity to the Black – Scholes model
on which financial options are based but applies non- financial inputs. It focuses on the companies
RandD activity, the risk of the RandD activity, the speed with which it is completed and introduced on
the market in relation to similar actions of competitors (Johnson, Neave & Pazderka, 2001).

The model focuses on future returns and income risk as correlation between IC and income is positive.
Criticism of the model is that projection of future returns and income risk is subjective. Note further
that the model holds other business factors constant. Figure 2.6 shows how real options model is
applied in solving challenges. For example, when there is a contingent investment decision, there is
no other approach that can correctly value this kind of chance and uncertainty is large enough so that
it is sensible to wait for more information; this way a company can avoid regret for irreversible
investments. When that is done, the value seems to be captured in possibilities for future growth
options, rather than current cash flow.

RO is a comprehensive and integrated solution (using the financial theory, economic analysis,
management science, decision sciences, statistics, and econometric modelling) to apply options
theory to value real investment projects to improve the decision making process.

27
Figure 2.8: Real Option Theory Source: Petty and Guthrie (2000)

2.7.2 Generic IC Valuation Models

These are a consolidation from various disciplines like human resources and operations management
among others.

2.7.2.1 The Balanced Scorecard

The Balanced Scorecard (BSC) created by Robert Norton and David Kaplan (Kaplan & Norton, 1996)
to provide managers with a translation of their organization’s mission and strategy into a
comprehensive set of the performance measures that provide a framework for a strategic
measurement and management system. The emphasis is on achieving financial benefits and
acknowledging performance drivers of these financial objectives.

Financial

Vision
&
Strategy
Learning
Customer and
Growth

Figure 2.9: Balanced Scorecard-Source: Kaplan and Norton (1996)

The balance of the scorecard as shown in figure 2.9 demonstrates that it is between the external
measures for shareholders and customers and internal measures of critical business processes,
innovation, and learning and growth. The BSC collects the results of human activity over time and
expresses them as both internal and external measures. The determinant of the measures are aligned
to the company’s strategy. Criticism of the model is that is focuses on the framework but it does not
offer a financial valuation.

28
2.7.2.2 Performance Prism
The performance prism is a second-generation performance measurement and management
approach developed by Cranfield School of Management in collaboration with Consultancy
Accenture. It recognises the importance of companies taking a holistic approach to stakeholder
management in today’s culture of involvement. Its advantages are that it addresses all stakeholders
– not only investors but customers and intermediaries, employees, suppliers, regulators and
communities. It does this in two ways: by considering the requirements of those stakeholders and,
uniquely, what the organisation wants and needs from its stakeholders.

Figure 2.10: Performance Prism-Source: Adams, Crowe, and Accenture, (2000).

In figure 2.10, the reciprocal relationship and the exchange process with each stakeholder is
examined. The performance prism addresses the strategies, processes and, importantly, the
capabilities that are needed to satisfy these two critical sets of wants and needs. The flexibility of the
performance prism allows it to be applied to any organization or organizational component. The focus
on intangible performance drivers makes the framework useful for companies attempting to measure
their Intellectual Capital. Also, it creates a visual map of how the different areas of performance
interrelate. It explicitly acknowledges that all five facets of the performance prism should be covered
in a so-called success map. This way, it avoids the often-criticised narrowness of the balanced
scorecard. Criticism of the model is that, like the BSC it focuses on the framework but it does not offer
a financial valuation

29
2.7.2.3 Knowledge Assets Map Approach
The knowledge assets approach takes a knowledge-based view of a company. It was specifically
designed to help companies identify and measure their knowledge-based assets and their
contribution to value.

Table 2.1: Knowledge Assets- Source: Marrand Starovic (2012)

KNOWLEDGE FACTORS
ASSETS
Stakeholder Number/quality of partnering agreements; number/quality of distribution agreements;
relationships number/quality of licensing agreements; public opinion survey; market share; length of
relationship; partner satisfaction index; customer retention.
Human Demographics indicators: for example, number of employees; number of employees in
resources alliances; average years of service with company; average age of employees; full-time
permanent employees as percentage of total employment; employees working at
home/total employees; number of women managers.

Competence indicators: like, employees with high qualifications; people with PhD
and/or master’s degree/total employees; average years of service with the company;
number of years in specific professions and definition of a competence map.
Attitude indicators: for example, average level of happiness as measured with Likert-
type scale; savings from implemented suggestions from employees; number of new
solutions, products and processes suggested; qualitative descriptions of employees
(commitment, loyalty, entrepreneurial spirit, enthusiasm); motivation and behaviour
indicators.

Human resource management practices indicators: for example, training

expenses/employees; employee turnover; time in training; expenses for Employee-
development activities (social and personal); indicators about activities to motivate
employees; indicators about recruitment practices.
Physical Scalability/capacity measures: facilities/equipment versus plan; time to execute server
infrastructure updates; system integration; use of Knowledge - sharing facilities.
Culture Management philosophy: number of internal disputes and complaints; qualitative
measures about employee satisfaction; feedback; values; behaviour; motivation;
commitment; loyalty; opinion survey.
Practices and Process quality: number of codified processes; networking practices; norms; Database
routines availability; intranet use.

Intellectual Revenues from patents; number of patents and registered designs; value of
property copyrights; value of patents versus RandD spend; trademarks; brand recognition
survey.

Having identified the critical knowledge assets, they can easily be integrated into broader frameworks
such as the performance prism. Knowledge assets are identified as the sum of two organisational
resources: Stakeholder and Structural. This distinction reflects the two key components of any
enterprise: its actors, who can be internal or external, and its constituent parts, or the elements at the
basis of an organisation’s processes.

30
Figure 2.11: Hierarchy of Knowledge Assets-Source: Marr and Starovic (2012)

Stakeholder resources as per figure 2.11 are divided into Stakeholder relationships and Human
resources – the external and internal actors of a company. Structural resources are split into Physical
and Virtual infrastructure, which refers to their tangible and intangible nature. Finally, the virtual
infrastructure is further divided into Culture, Routines and Practices, and Intellectual property.
Stakeholder relationships include all forms of relationships established by the company with its
stakeholders. These relationships could be licensing agreements, financial relationships, or contracts
and arrangements about distribution channels. It could also be customer loyalty, which represents a
fundamental link between the company and one of its key stakeholders.

Human resources contain knowledge provided by employees in forms of competencies, commitment,

motivation and loyalty as well as advice. Key components are also know-how, technical expertise,
and problem solving capacity, creativity, education and attitude. Physical infrastructure comprises all
infrastructure assets, such as structural layout and IT equipment such as computers, servers and
physical networks. This category is often overlooked as a knowledge asset but plays a key role in
how knowledge is shared.

Culture embraces corporate culture and management philosophies. Some important components are
the organization’s values, mission and vision. Culture is of fundamental importance for organizational
effectiveness and efficiency, since it provides a framework, sometimes implied, through which to
interpret events. Routines and practices cover internal practices and virtual networks and routines.
These routines could include tacit rules and procedures, such as manuals with codified procedures
and rules, databases and tacit rules of behaviour or management style. They determine how
processes are handled and how work flows through the organization.

31
Intellectual property is the sum of patents, copyrights, trademarks, brands, registered designs, trade
secrets and processes whose ownership is granted to the company by law. These are the tools and
enablers that allow the company to perform its daily processes to produce results. This framework
can be used to help identify knowledge assets, which can then be the basis for visualization of how
these assets are interrelated and transformed to satisfy stakeholder needs. Such visualization is
called a value creation map figure 2.10 which shows the pathways of how value is created in
organizations.

Figure 2.12: Value creation Map-Source: Marr and Starovic (2012)

Knowledge assets in figure 2.12 are represented in bubbles linked with arrows. The size of individual
bubbles represents stocks of particular knowledge assets in terms of strategic importance and arrows
of different thickness show the transformations and relationships between knowledge assets and
stakeholder needs based on a concept by Roos (1997). A map can used to visualize the static and
dynamic nature of IC and how it adds value to different stakeholders. It is possible to provide a wide
range of indicators for each of the categories listed. It is up to the management team identify the most
meaningful ones. Care needs to be taken when selecting the metrics as per figure 2.5. Many of those
proposed in accounting literature tend to be general and fail to address the types of knowledge that
play a critical role in value delivery for individual companies. Managers need to start by recognizing
that knowledge assets are unique to each company and the metrics selected should therefore reflect
this. Critique of the model is that is focuses on the framework but it does not offer a financial valuation

2.7.2.4 The Technology Broker’s IC Audit

Brooking (1998) identifies IC as;

i. Market assets, comprise of brands, customers, distribution channels and business

collaborations,
ii. Human-centered assets include education and work related knowledge and competencies,
iii. Intellectual property assets comprises of patents, copyrights and trade secrets and

32
 iv. Infrastructural assets include management processes, information technology systems,
networking and financial systems.
Criticism of the IC Audit index is that there is no empirical evidence that it leads to better economic
performance.

2.7.2.5 Tree or Model

This model explains the growth of the organization because of IC, its knowledge and its learning
ability. TM measure is based on the organizations ability to increase its IC. Learning is through
strategy, environment, culture and structure. This group of elements / pillars is the basis of an
organization IC growth. According to Garvin (2003) an organization learning is enhanced in five
activities, systematic resolution of problems, experimentation of the new focuses, use of their own
experience and the past to learn, learn from experiences and more appropriate activities of other
companies, bench marking and in transmitting quick and efficiently the knowledge to the whole
organization.

David Teece attempted to clarify management of intellectual capital through focusing on companies’
ability to capture the value of knowledge and the competencies it generates. Those seeing to
appropriate value from innovation, it is not only about owing the innovation but integrating it with other
assets to create value. Teece (1986) argued that innovation value is better valued at company level
than at the macro level of the market. The dynamic capabilities framework analyses the sources and
methods of wealth creation and capture by private enterprise companies operating in environments
of rapid technological change. The competitive advantage of companies is seen as resting on
distinctive processes (ways of coordinating and combining), shaped by the company's (specific) asset
positions (such as the company's portfolio of difficult-to-trade knowledge assets and complementary
assets), and the evolution path(s) it has adopted or inherited.

The importance of path dependencies is dependent if conditions of increasing returns exist. Whether
and how a company's competitive advantage is depleted depends on the stability of market demand,
and the ease of replication (expanding internally) and imitation (replication by competitors). The
framework suggests that private wealth creation in regimes of rapid technological change depends
highly in appropriating value from internal technological, organizational, and managerial processes
inside the company. In short, identifying new opportunities and organizing effectively and efficiently
to embrace them are generally more fundamental to private wealth creation than is strategizing, if by
strategizing one means engaging in business conduct that keeps competitors off balance, raises
rival's costs, and excludes new entrants (Teece, Pisano, & Shuen, 1997). This way of valuing
innovation aligned to management and the development of strategy. Firstly, deals with market entry,
and as well as looking at the implications for innovators themselves suggests some directions for
government policy, most critically robust and tight protection for Intellectual Property (IP). Government

33
 policy should be built on a facilitative intent rather than expect to be directive. IP protection is weak,
as the strategy of imitation makes sense, for a number of newly industrialized countries in the recent
past.

Teece (1986) reviewed the strengths and weaknesses of outsourcing and licensing as strategies for
the innovator, suggesting that market conditions and the implications for the innovating company may
result in different strategies at different times, in different markets. In regards to public anti-trust/anti-
monopoly policy, Teece (1986) argued that, at present at least, the new economy is not particularly
burdened by this problem. It is moving too quickly for monopolies to have serious impact as this will
not be corrected by markets in the medium term.

Criticisms of the model is that Teece (1986) suggested a more complex and time-consuming task
than what managers would want to undertake. Furthermore, despite starting with a reasonably
nuanced view of knowledge and information and their relation to IP, in the end useful knowledge
seems to come down to innovations and thus is modelled as amenable to capture given the
appropriate legal structures. While this is clearly the dominant understanding of ‘intellectual assets’ in
law, many companies have discovered it is actually tacit knowledge that may support their competitive
advantage.

It is a little less clear what Teece’s (1986) strategies would be for making the most of tacit knowledge,
nor how he would respond to models of innovation which did not stress an individualized process
which requires explicit reward for intellectual effort. Thus, where Teece perhaps fails to develop his
argument fully is in regard to alternative, non-instrumental views of innovation. Ironically, since Teece
focus on the new economy has been severely questioned by the return of many high flying new
businesses going to the ground with a bump. It transpires that the new information economy may not
be so different after all and while this does not necessarily undermine Teece’s theses, it certainly
suggests they need to be engaged with rather than accepted uncritically.

2.7.2.6 Citation Weighted Patents

Schmookler and Scherer developed this model. They used patent data in the economic analysis of
the technological change. This arose with the arrival of publicly computerized patent information
leading to econometric research using patent citations to increase the information content of the data
(Hall, Jaffe, & Trajtenberg, 2001). There are two assumptions while using patent citations according
to the foregoing authors.

i. Stock market investors hold the rational expectation that the present value of a company future
profits varies with its stock of knowledge,
ii. Valuable technological knowledge within the company tends to generate patents that future
researchers build on and therefore cite when doing their own innovation.

34
The working hypo-dissertation from the assumptions is that citations are the private value associated
with patent right and correlated to market value as investor value the companies’ stock of knowledge
(Hall et al, 2001). Criticism of this model is that the value of patented innovations is skewed. A few
are valuable but majority are close to valueless. The number of patents held by a company is not
highly correlated to the sum of the value of those patents (Hall et al., 2001). The approach provides
partial measure of stock of IC held by a company.

2.7.2.7 Sveiby’s the Intangible Asset Monitor

Sveiby’s (1997), model is based on the four modes of knowledge conversion of invincible based
assets identified by Nonaka and Takkeuchi. It states that knowledge is either tacit or explicit and
arises from socialization, externalization, internalization and combination. The total market value of a
company consists of its visible equity and three kinds of intangible assets, being external structure
and knowledge capital internal structure and individual competence. Internal structure comprises of
organization management, legal structure, manual systems, attitudes, RandD and software. Individual
competence includes education and experience. Criticisms of the model is that it does not include
some flow-related variables such as growth in revenue and growth in sales per administrative staff.
Secondly there is no known empirical evidence that it leads to better financial or economic
performance.

2.7.3 Individual Company Intellectual Capital Valuation Models

These were mainly developed by the Scandinavian companies, who derive part of their income from
consultancy and hence may have some bias in promoting a commercial interest.

2.7.3.1 Skandia’s IC Navigator

IC navigator was developed by Swedish financial services company – Skandia led by Leif Edvinsson.
This measure has been accredited for measuring intangibles’ assets. According to Bontis (2001) it
creates value for organizations, while Petty and Guthrie (2000) suggested that it is about the process.
The aim is the total market value equals Financial Capital and Intellectual Capital. The components
are Human capital and Structural capital (Customer capital and Organization capital which also
includes Innovation capital and Process capital) (Edvinsson & Malone, 1997).

35
Figure 2.13: Skandia IC Navigator Model-Source: Edvisson (2000)

It assumes the same the BSC of financial, operational and customer concerns. The model considers
the organization structure and process for nurturing its employees (Shand & Kalirajan, 1999). A
criticism of the model is that is has not been ratified by the International Accounting Authority.

2.7.3.2 Intellectual Capital Services IC Index

It was developed by Goran and Johan Roos of Intellectual Capital Services, they define IC as human
capital, customer and relationship capital and organizational capital comprising of business renewal
and development capital and business processes capital. The IC index is based on the four pillars
being:

Table 2.2: Intellectual capital index- Source: Roos, Goran and Johan (2005)

IC Index ELEMENTS

Customer and Relationship Growth in trust

capital Index Customer retention
Distribution channels,
Productivity and quality

Infrastructure Capital Index Efficiency

Effectiveness
Distributor efficiency

Innovation capital Index Ability to generate business

Ability to generate good products
Growth
Ability to improve productivity

Human capital Index Value creation per employee, training efficiency and effectiveness

36
The framework to develop the measures is a three-stage process;

i. A critical review of existing indicators

ii. Development of indicators that represent the flows between different IC categories
iii. Develop a hierarchy of IC indices.

A Criticism of the model is that is does not offer a financial valuation basis.

2.7.3.3 Ericsson’s Cockpit Communicator

Ericsson, the Swedish telecommunications company, has developed a commercial product called the
cockpit communicator, again based on the balanced scorecard and with five very similar perspectives:
innovation, employee, process, customer and financial (CIMA, 2001). Each is represented as the dials
in an aircraft cockpit and each has its own indicators. Following inputs relevant to each indicator, the
communicator suggests the actions that will match the organization’s strategies. The dials will
subsequently show if the company is on target in each perspective.

According to Ericsson, the aim of this product is:

a) a vision-driven organization, where priority is given to actions that are compatible with the
company’s strategies;
b) a communicated strategy linked to indicators and actions;
c) a balanced focus on past, present and future performance;
d) a balance between short-term results and long-term strategy;
e) ability to evaluate and change organizational strategy rapidly in line with performance and
changing business conditions;
f) Ability to manage, measure and communicate future values.

One criticism of the model is that is focuses on the framework but it does not offer a financial valuation.

2.7.3.4 Celemi’s Intangible Assets Monitor

International training consultancy Celemi monitors three overall categories: customers (external
structure); people (competence); and organization (internal structure). Under each of these
interdependent categories, the three key areas of growth/renewal, efficiency and stability are tracked,
each with its own performance indicators as per Table 2.3

37
Table 2.1: Celemi’s intangible assets monitor- Source: Sveiby, (1997)

OUR CUSTOMERS OUR STRUCTURE OUR PEOPLE

(EXTERNAL STRUCTURE) (INTERNAL STRUCTURE) (COMPETENCE)

GROWTH/RENEWAL
Revenue growth Organisation-enhancing customers
Image-enhancing customers Revenues from new products
RandD revenues
Intangible investments (% value added)
Average professional competence
years
Competence enhancing customers
Growth in professional competence
Experts with post-secondary degree

EFFICIENCY
Revenues per customer Proportion of admin staff Value added per expert
Revenues per admin staff Value added per employee

STABILITY
Customer satisfaction index
Repeat orders (years)
Five largest customers
Admin staff turnover People satisfaction index
Admin staff seniority (years) Median age of all employees
Rookie ratio Expert seniority (years)
Expert Turnover

Celemi also produces a management training game called Tango which uses intangible assets to
monitor thinking and accounting. A Criticism of the model is that is focuses on the financial valuation
and does not offer a framework.

2.7.3.5 Ramboll’s Holistic Company Model

As with other Nordic models, Ramboll’s holistic company model as per figure2.10.

Figure 2.14: Ramboll’s Holistic Company Model-Source: Sveiby (1997)

Figure 2.14 shows the key areas within which certain performance indicators are managed. These
key areas lead to three sets of results – customer, employee and societal – and all three combine to
produce the financial results. The key areas are values and management, strategic processes human
resources, structural resources and consulting services. For example, the performance indicators for

38
human resources are staff composition, staff turnover and competence building. These key
performance indicators (KPI’s) are then further subdivided. The ones for competence building, for
example, are supplementary training expenses excluding salary, the amount spent per course
participant and the hours off contributed by employees. Like many models already discussed, a
criticism of the model is that it focuses on the framework but it does not offer a financial valuation.

2.7.3.6 Bates Gruppen Company IQ Measurement System

Bates Gruppen is the Norwegian arm of Bates Worldwide and part of the Cordiant Communications
Group. It has recently proposed a method that consists entirely of non-financial measures. The
Company IQ allows a company to score its knowledge assets against those of a similar organization.

Table 2.2: Bates Gruppen Company IQ Measurement System

STAGE ACTIVITIES
Stage Identify why customers buy from your company as opposed to a rival. Through a workshop in
one which management select between eight and 12 attributes – for example, rapid response or good
design. The final list is sent to customers and employees’ who rate each attribute twice, once for
its value to customers and then for its uniqueness. A scale of one to seven is used. The results
are plotted on to a two-by-two matrix. Any attributes that make it into the top upper-right quadrant
that is are high on value and uniqueness – will be explored further.

Stage Identify the intellectual assets that produce star attributes – Bates Gruppen has identified 100.
Two Ideally, these should be divided as equally as possible between human, customer and structural
IC assets. All of these assets must either be measurable in absolute terms, for example, training
expenses, or capable of measurement using scales, customer satisfaction. At least 60 per cent
of the assets identified should be comparable to data from reputable benchmarking studies or
from the PIMS database – a huge repository containing data on items such as quality for
thousands of companies.

Stage To calculate your Company’s IQ. Scores on the 100 selected assets must first be weighted for
Three relative impact on profitability then compared with similar companies. Bates
Gruppen selected a median score of 100. The process does not end at stage three. As with any
measurement system some form of feedback has to be built into the system for a company to
remain competitive. The strength of assets within the 100 can be identified
and weaker ones improved. This method is more than just a measurement system. It
requires an organization to identify its highly valuable, unique capabilities and the
intellectual capital assets behind them. While calculating its IQ, a company may find it is
producing goods or providing services that are similar to those of a competitor or contain
features that add little value to customers. This will guide a company to take action that
has a direct impact on its profit maximizing capabilities.

Criticism with the model is that the system requires a great deal of work initially, including gathering
data from employees and customers who may be unwilling to participate or who may provide hastily
compiled information of little use. It may also be difficult for a company to divide its knowledge assets
equally between the three types of intellectual capital, meaning that some are incorporated to make
up the numbers while others are excluded. The suggestion that at least 60 per cent of the indicators

39
are comparable to those from other companies still leaves a lot open to subjectivity. An additional
criticism of the model is that it focuses on the framework but it does not offer a financial valuation

2.8 Discussion on the Intellectual Capital value creation models, theories and
frameworks
Accounting and intellectual capital are linked to each other because of the necessity to provide an
accounting perspective on value creation. At one level, there is a need to explain the hidden value
attributed to intellectual capital by the capital markets, that is, the excess of the market value of a
company over the book value of its assets, determined in accordance with prevailing accounting
principles. At the same time, it is important to set about documenting the growth of the value creation
capacity of a company in some manner, and in particular to provide an account of the prospects for
continued value creation. In addition, there is a necessity to clearly distinguish intellectual capital from
intangible assets in order that the repertoire of accounting treatments of the latter is not stretched to
accommodate the former.

A background of growing interest in the establishment of a framework for IC in business reporting to

be more comprehensive in customer oriented approach to the tasks traditionally associated with
financial accounting and reporting. Given intellectual capital central role in the value creation activities
of companies, there is a pressing need to ensure that the information that accountants make available
in any business report includes appropriate details of a company stock of Intellectual Capital. The
management of intellectual capital lies at the heart of value in the current “knowledge era” of business.
In addition to analysis of various models mentioned before by use of simulations and frameworks to
try and quantify the value created and extracted from IC.

Unfortunately, theories and models of valuing Intellectual Capital have been slow to develop. There
is an extremely limited literature on the study on valuation of intellectual capital. This is partly due to
the privacy and/ or limited disclosure of financial information, organization strategy and operations
frameworks, which are viewed as trade secrets. It is further hesitated by financial regulators not
embracing valuation models or recognition of intellectual capital in financial reporting and companies’
valuation.

2.9 Summary
The purpose of this of this study was to explore the various business frameworks that can be adopted
to enable an organization create value from its intellectual capital. It would not have been prudent not
to view all the models / frameworks enabling to quantify or issue a metric to gauge the value created
for a better understanding.

Continued research of this phenomenon should show that organizations with a high level of
intellectual capital will be those in which the value-added service of the company comes from deep

40
professional knowledge, organizational learning, and protection and security of information. Further,
one should note that knowledge assets, rather than the fixed capital, may reasonably be said to
provide the potential for sustained earnings. There is no dominant way to value Intellectual Capital,
thus there still lies a challenge on how such assets can be valued. The quest for innovators to seek
ways and methods to value, track how well they are investing and benefiting from intellectual capital
as rising recognition of the shift from tangible to intangible assets recognition.

The value many of these companies receive from their intellectual capital will be because of a well-
reasoned, well-planned, and well-executed set of management initiatives. These company’s design
of initiatives to ensure that specific forms of value deemed important to their business strategy are
routinely extracted from the company's intellectual capital. Companies that have defined a vision and
outlined the strategy for achieving it, are in a position to determine the roles their intellectual capital
could play in leveraging the strategy and in achieving the vision. Different companies will determine
different roles for their intellectual capital. Indeed, it is unusual to find two companies with exactly the
same roles for their intellectual capital simply because no two companies have exactly the same
context (vision and strategy). For example, for some product design and manufacturing companies
the role for intellectual capital may be to create the innovations that will become the company's
products and services of the future.

While to other manufacturing companies, where the company's value added involves assembly and
integration of components to create products and services, the intellectual capital may focus on
integrating the innovations of others and adding value through low-cost manufacturing or distribution.
In still other companies, the Intellectual Capital may be integral to creating a reputation or image that
the company uses to differentiate itself in its marketplace.

The set of roles any one company selects for its Intellectual Capital depends largely on the nature of
company it is, its vision and the strategy it has chosen. It should be noted that in IC value creation,
there is need to evaluate the whole company and not part of it. To evaluate an enterprise there is
need to project the future risk and income to enable compute the expected future return and income
risk.

41
 CHAPTER 3: RESEARCH METHODOLOGY

3.1 Introduction
This chapter presents the methods and study approaches involved to explore the applicable business
framework that will enable companies measure, create and extract value from their intellectual capital.
The aim of this chapter was to review the sample chosen, the techniques employed in arriving at the
samples and the instruments employed during the collection of the data. In addition, this chapter also
covers method of data analysis, data collected and the research design. This enabled us to compile
a proposed business framework on how software developing companies can manage their intellectual
capital to create and extract value from their innovations.

3.2 Research Approach and Design

A research approach is a procedure used to collect, analyze, interpret results and disseminate the
findings (Myers, 2008). Research approach can be qualitative, mixed method (qualitative and
quantitative) or quantitative design. Qualitative approach is subjective and involves a naturalistic and
interpretive manner of solving a scientific problem, where data is normally gathered using interviews
to generate qualitative data (Rubin & Babbie, 2010). Quantitative design is objective and normally
involves gathering quantitative data in the form of numbers; hence statistical methods can be used to
test hypotheses (Ary, Jacobs & Razavieh, 2002). For this dissertation a mixed method approach was
used due to the nature of the subject

3.3 Purpose of the Research

The purpose of this research was to review and analyze various business models that software
developing companies can adopt to identify if they are extracting value from their innovations. If so,
to further identify what factors comprises Intellectual Capital and the impact of each factor. Results
from this research contribute to identifying factors and their impact on Intellectual Capital management
and the various forms of value that can is extracted from Intellectual Capital. In addition, the study
shares a proposed business framework on how they can manage their Intellectual Capital to create
and extract value from their innovations that is aligned to the business environment, organization
strategy and operations.

3.4 Generalisation, Validity and Reliability

Findings were validated using case studies tools that are necessary in surveys and experiments.
Eisenhardt (1989) suggested that case studies are particularly well suited to new research areas or
research areas for which existing theory seems inadequate. This type of work is highly complementary
to incremental theory building from normal science research. The former is useful in early stages of
research on a topic or when a fresh perspective is needed, whilst the latter is useful in later stages of
knowledge (pp.548-549).

42
Case studies are useful in providing answers to ‘How?’ and ‘Why?’ questions, and in this role can be
used for exploratory, descriptive or explanatory research. It uses multiple data sources including two
or more of: direct detailed observations, interviews, and documents. In addition, case studies can
involve single or multiple cases as discussed in the next section on research design.

The taxonomies / elements that comprise intellectual capital applied to create value can be measured
using various qualitative and quantitative methods. This research methodology design includes
exploratory literature review and case studies which are useful in identifying the components of
Intellectual Capital and the various benefits that can be extracted from innovations. Value creation
can be considered as qualitative in nature given that it arises from interrelated activities from the
various elements of IC. Its measurement through questionnaires may be conducted, however, this
does not provide in-depth information since quantitative data provided by questionnaires merely
describe the phenomena but does not provide comprehensive understanding like in the case of
exploratory studies.

Hence, this explorative study adopted using qualitative and quantitative approach to validate the
findings through a proposed business framework that can guide a company on how to create and
extract value from the innovations. An exploratory case study is valuable means of finding out what
is happening; to seek new insights, to ask questions and to assess phenomena in a new light.
(Aunders, Lewis, & Thornhill, 2009). From the metrics gathered, the qualitative data for analysis was
compared to gauge the level of influence of the taxonomy on Intellectual Capital value creation and
extraction.

3.5 Population and Sampling

The population in this study comprised of software developing companies based in Nairobi and have
been recognised for an innovation. The number (population) of software developing companies is
currently uncertain in number.

3.5.1 Sample
The sample considered in the study consisted of thirty formally registered software companies
recognised for their innovation(s). A sample size of 30 for a qualitative interview was an appropriate
number since qualitative studies are not concerned about the numbers or representativeness of the
target population as noted by Steinberg (2008). In essence, qualitative interviews are conducted to
explain and explore phenomena in-depth to discover new constructs, themes and relationship.

However, the sample of 30 was a diverse sample given that the individual managers or the sample
units representatives were drawn from different companies with unique innovations. Involving 30
interviewees was quite a considerable number of interviews to reach saturation levels. In essence,
Alvesson and Skoldberg (2010) defined saturation during interviews as the point when no new data

43
is revealed by further collection of data since all the questions asked have been exhausted by the
initial qualitative interviews.

Below is an overview of the composition of our sample. Additionally, it is noteworthy that the software
companies were identified from the six technology hubs, which have recognized them for their various
innovations and further that could present duly registered company registration documents. This later
was critical to our study as it focuses on institutional frameworks applicable in IC management.

Table 3.1 Population analysis on the roles in the organization

Role in Organization Population size

Strategic / Executive 15

Administrative 14

Innovative 0

Others 1

Total 30

Table 3. 2 Population analysis on the correspondent selected

year(s) in the software development sector

Years in the field Number

Below 1 year 3

2-5 years 8

6-10 years 4

10-20 years 1

Above 20 years 14

Total 30

Table 3.3: Size of the organization based on the annual revenue

Size of Organization (based on annual revenue) Number

Small Organization 16

Medium Organization 6

Large Organization 8

30

44
These were the samples explored for the business framework, for they have applied to create and
extract value from their innovations using IC management. We identified from our literature review
that the value that can be created and extracted (benefits and measure) are profit generation, strategic
positioning, acquiring innovation from others, customer loyalty, cost reduction and improved
productivity. Further from our literature review we also noted some measure to the IC value created
like returns on investment, market value and market share which can also be quantified. The sample
shall be stratified having the assumptions that their innovations are unique, knowledge base,
ownership structure, attitudes, experience or perceptions are similar.

3.6 Data Collection Methods

The methodology / technique applicable to this study are the mixed method (qualitative and
quantitative) type. Qualitative data covered aspects of exploration of that factors that comprise
Intellectual Capital, their impact and the desired value creation and extraction from innovation aligned
to organisation strategy and operations. The quantitative one was to facilitate a proposal of a business
framework to analyse and guide on components like intangible capital, ownership structure, corporate
governance, company characteristic, industry characteristic, and reactions of analysts’ and
customers, impact on value analysis and translating extraction to profits, returns on investment,
market value and market share analysis.

3.7 Data Collection Tools

Data for this research was collected through the use of questionnaires, interviews, analysis of the
innovation creation value chain through a case study. The research interview was conducted using
indexed and open-ended questions targeting specifically on the IC components identification and
influence levels, as regards the desired value creation and extraction aligned to the corporate
strategy.

The questionnaires were designed to reach a better understanding on how software developing
companies currently manage their Intellectual Capital to create and extract value and the challenges
faced. Interviews were conducted upon accompanied appointments with a timeframe of one month.
This was to ensure the field survey was done at a cross sectional point of the industry trend similar
for all respondents in the sample. The anonymity of the respondents was also be maintained through
coding of the questionnaires.

The research questions focused on current performances rather than the hypothetical. The case study
was to understand current business frameworks applicable to manage IC, for the desired value
creation and extraction and their shortcomings. The case study is to also prompt and stimulates
further critical thinking on suitable measurements to innovations and intangible capital translating to
accredited disclosure and reporting methods acceptable and applicable. The mixture of the research
methodologies namely questionnaires, interviews and case study has enabled the researcher to apply

45
 the most applied business framework of IC management and test it in existing application to software
developing companies.

3.8 Data Analysis Methods

The dissertation shares an understanding on various Intellectual Capital value creation business
frameworks. We have also shared recommendations to software developing companies’ that can be
incorporated in their strategy and operations. These will be explored through the below research
objectives:
i. Explore the factors that influence the composition of Intellectual Capital business frameworks
applicable to of software and/or innovations companies.
ii. Review theories, business models, metrics and benefits applicable to intellectual capital
management.
iii. Analyze how software companies can determine components of their intellectual capital.
iv. Propose a business framework that can be applied by software development companies to
measure and realize the benefits from managing their intellectual capital.
v. Validate the proposed business framework based on a Case Studies of Software Development
Companies in Nairobi County that have a recognized for an innovation.

The greatest advantage of this method is that it is flexible and adaptable to change in cases where
the research encounters new data or insights.

3.9 Research Strategy

The study used secondary data from the literature review on Intellectual Capital management. This
was with respect to:

i. What are the factors that influence the composition of intellectual capital business frameworks
applicable to of software and/or innovations companies?
ii. What are the theories, models and metrics currently being applied to measure and realize the
benefits from managing intellectual capital in software development or innovation processes?
iii. How can the software development companies or innovators determine the components of their
intellectual capital?
iv. What is the probable business framework applicable to measure and realize the benefits from
managing intellectual capital from innovations?
v. How can the above proposed business management framework be validated?

46
 3.10 Credibility and Reliability of Research Findings
Corbin and Strauss (2008) and Corner (2009) defined reliability, as the ability of a data collection
instrument to yield the same results when used in a similar setting. On the other hand, validity refers
to how accurate a data collection instrument can be in measuring what it was developed to measure
(Dillman, 2010). To ensure that the study result is valid, the interviewer ensured that the interview
questions was specific regarding IC management value creation and extraction factors

The questionnaires and interviews were administered personally by the researcher to minimize
observer errors. The reason for choosing this method of delivery is to increase the response rate, to
ensure that the right person answers the questions and to generally raise the quality of the responses.
The researcher hoped to be present when the respondent filled out the questionnaire to ensure that
fewer items were not omitted in filling out the questions. Data collection involved travelling to software
developing companies’ premises that will form the sample under study to familiarize with the
respondents for easy interaction as well as for personal contact with them. Critical importance was
also to conduct interviews with company representative with authority or responsibility over company
operations and an overview of IC management.

The research also states the limitations of the study. Currently from the literature review, the main
limitation is; Firstly, there being no universally accepted definition and categorisation of Intellectual
Capital and secondly, no accredited theory or model for Intellectual Capital management to create
and extract value. Though we must acknowledge that most studies have limited themselves in
identifying various IC value creation and extraction, companies are deriving from their intellectual
capital or innovations management.

3.11 Research Methodology Assumptions

This study shall assumed that;

i. The respondents’ business environment will continue to be constant for the period of the
research.
ii. The respondent will be able and willing to provide necessary information.

3.12 Ethical Assurances

The current study was conducted according to ethical guidelines for survey administration and data
analysis. According to Cooper and Schindler (2010), informed consent means that individuals to be
sampled in a study are first informed about the study to comprehend its aims and benefits to them
before consenting to take part. Hence, this study was based on voluntary participation amongst the
target population, but they were encouraged to take part in the study by explaining to them the benefits
of the study to add to limited literature and implications for management.

47
Confidentiality was maintained by coding all questionnaires. There will be no disclosure of financial
values, strategy and operation activities of the companies, these will be used as simulators of the
explored framework analysis. The research questions avoided exposing the respondent to
embarrassment, harm or any other material disadvantage. Ethical consideration was also achieved
by asking permission to conduct the study. Moreover, the study participants could withdraw at their
own will and convenient time from the study.

3.13 Research Methodology Overview

Chapter three has included a discussion of the research method and design; participants, instruments,
and operational definitions of variables; data collection, processing, and analysis; methodological
assumptions, limitations, and delimitations; and ethical assurances.

48
 CHAPTER 4: DATA ANALYSIS AND PRESENTATION

4.1 Introduction
This chapter analyses the data that was collected from software developing companies in
Nairobi. The findings were as a result of the utilization of several statistical tools and
techniques summarized in form of graphs, tables and charts. The chapter will give an outline
of the research findings and a discussion of the various responses gathered from the
questionnaire.

The survey was structured in the format of the questionnaire. The questionnaire was divided
into four sections A, B, C and D. (Appendix A: Questionnaire). Section A was used to collect
information about the business/organizations with section B seeking to find out the different
definitions of IC. Section C was used to collect information about the value creation and
extraction frameworks applied to IC management. Section D is the final part of the
questionnaire that collects information about how IC is measured and reported in the
companies’ daily operations.

4.2 Intellectual Capital Definition and Management

Knowledge of Intellectual Capital definition and management amongst the interviewees was
explored during the qualitative interviews and a number of responses were received. It was
noted that they could extensively describe Intellectual Capital through mainly its components
and even relate their daily management activities to IC management.

Moreover, only a number of the interviewees could directly link their success to management
of IC. This implies that there is the conviction of IC’s ability to mobilize cognitive resources and
action to create and extract value to an organization. Compared to literature, these results
were in line with studies of various researchers such as Penrose (1959), Rumelt (1984), Teece
(1984), Wemerfelt (1984) and Teece (1986), who were looking at new ways to understand
business organizations and especially how they might extract value from innovation.

4.2 Data Analysis

This chapter solely focuses on presenting the gathered data in a meaningful way to facilitate
in the validation of findings and business application, which will be presented in chapter 5. The
sample size chosen faced various challenges resulting in a reduction in the number
respondents received. This was due to;

49
Firstly, a majority of non-respondents whom were at strategic and / or executive level felt that
the required information was their trade secret. Although they were cognizant that the
response would be anonymous but felt the feedback would too much risk for their institutions.
Secondly some of the respondents were unavailable within the timeframe due to various
business related reasons. Lastly and least was some could not comprehend the concept and
thus opted not to participate.

A total of 16 responses were received from the targeted 30 potential respondents, which
constitutes a 53% response rate for the survey. The responses gathered from the survey have
been analysed using Ms Excel and Rating scale and Ranking Average Calculations.

4.2.1 Correspondents Analysis

We look below into further into analysis from the questionnaire issued.

Table 4. 1 Correspondents Analysis

Total Sent Received Response Rate (%) Total (%)

Male : 20 11 55 68

Female : 10 5 50 31

30 16

There were 37% more male respondents in the survey than their female counterparts (table
4.0.1). The male respondents had a 55% response rate while the female response rate was
at 50%. We held that this demographic factor is non-critical as it was representative of the
ratio of male to female staff in software developing companies.

50
4.2.2 Correspondents years of experience in software innovation managment
Table 4. 2 Number of year(s) in innovation development

Years in the field Number Responses

Below 1 year 3 3

2-5 years 8 5

6-10 years 4 4

10-20 years 1 1

Above 20 years 14 3

30 16

The survey respondents are mainly composed primarily of people with 2-5 years of experience
in software development accounting for 50% of all the respondents. This may suggest that the
employees with similar experience are mostly/directly involved with IC management. It also
showed us that most people with 2-5 years of experience are mostly responsible or oversee
the operational innovation activities of the company.

4.2.3 Size of Correspondents Organisations

Table 4.3: Size of Organization (based on revenue)

Size of Organization (based on revenue) Sample Responses

Small Organization 16 6

Medium Organization 6 6

Large Organization 8 4

30 16

The respondents were stratified from all the three organisational size brackets.

51
4.2.4 Role of Correspondents in the Orgainsation Business Framework
Table 4.4: Role of staff in the Organization

Role in Organization Sample Responses

Strategic / Executive 15 9

Administrative 14 4

Innovative 0 2

Others 1 1

30 16

The survey showed that 56% of the respondents were in strategic roles (figure 4.0.4), 25%
were in administrative and 19% were in innovative and other roles in their respective
organisations.

Roles in Organization

17%
11% 50%
22%

Strategic / Executive Administrative Innovative Others

Figure 4.1: Distribution of Staff in the Role towards IC Management

4.3 Definition and categorisation of intellectual capital in software development

In the literature review, the main limitation is that there is no universally accepted definition
and categorization of Intellectual Capital. Intellectual Capital has been the subject of a rapidly
expanding research effort since the term was first introduced into the literature in the mid-
1990s. This has led to the development of various constituents or element of the same. These
elements were grouped into the three major forms Serrano-Cinca et al. (2003), Cabrita and
Bontis (2008), but the intangibility nature of the Intellectual Capital has led to different
companies defining I.C. and its elements differently.

52
Definitions from the correspondent were mainly described by the use of the elements of IC.
All were not aware of all the elements but could mention a good number. Below is a summary
of their IC definitions:

i. Value of systems and business process

ii. Mixture of human innovation process systems in the organization
iii. Difference between market value of a firm and intangible liabilities within the firm
iv. Company employee knowledge, business training and any proprietary information
that may provide the company with a competitive advantage
v. A combination of our employee expertise and business execution models
vi. Our technical resources and our existing client base
vii. Intellectual Knowledge
viii. Our business ideas that gives us a competitive advantage
ix. Information resources that gives competitive advantage

4.3.1 IC Element most applied in the organisation

During the survey, which factors which comprise I.C. in the respondents companies and how
each could define the term I.C were sought. Figure 4.2 presents a list of different elements
that can constitute I.C.

IC Element most applied in the organisaiton

6% 19%
13%
6% 6%
6%
19% 6%
19%

HC - Employee knowledge, skills and capability SC - New Employee mentorship

SC - Employee motivation SC - Business/Office Culture
IC - Intellectual Properties IC - Product life cycle trends
OC - Management Structure RC - Customer loyalty and satisfaction strategies
RC - Competitor assessment tactics Others

Figure 4.1: Different elements that can constitute I.C.

19% of the respondents chose employee knowledge, skills and capability, intellectual
properties and product life cycle as the most applied elements of I.C. that exists in their

53
company that influences innovation management. This was closely followed by customer
loyalty and satisfaction strategies at 13%. The rest of the IC elements: office culture,
business/office culture, competitor assessment tactics, management structure, new employee
mentorship and employee motivation scored 6% each.

This indicates that human capital is the common element of I.C. used in many companies, this
is due to the fact that the most prevalent elements chosen can best fall under the human
capital form of I.C. that is, Employee knowledge, skills and capability.

4.3.2 Level of importance that each IC Element plays in Value Creation

Employee knowledge, skills and capability has been highlighted the most critical IC element.
This should not be surprising (Edvinsson, 2002). Human capital is the organization staff
possession of individual tacit knowledge, that is, skills necessary to perform their functions.
Literature review noted that tacit knowledge was considered key to derive competitive
advantage.

Based on the above findings the survey sought also to know what level of importance each
element have in the organization. Using rating scale and ranking calculation, we see that
Employee knowledge, skills and capability is the most important element followed by
intellectual property and product life cycle (Table 4.2).

Table 4. 5 Level of importance that each element plays in IC value creation

IC Elements 5 4 3 2 1 Average

Employee knowledge, skills and capability 13 3 0 0 0 9

Business/Office Culture 1 2 5 8 0 6

Intellectual Properties 4 5 4 10 3 9

Management Structure 1 3 2 1 7 5

Customer loyalty and satisfaction strategies 3 1 1 2 7 5

New Employee mentorship 4 5 1 0 0 6

Employee motivation 6 1 1 6 0 6

Product life cycle trends 5 3 6 0 0 7

(Note: 5 being highest rank and 1 being lowest rank of importance)

Human resource, Marketing, Sales and Production were the most common departments
dealing with IC management. Interestingly, the Administration/Executive department were

54
missing at the top of this list. This we can attributed to IC being seen as more of operational
than strategic.

4.3.3 IC categorisation to identify most applied IC element

Edivisson’s (2002) framework named Skandia from the literature review was the basis applied
to review the business framework for IC managment. Table 4.3 helps explore further which IC
element is important in IC value creaiton and extraction.

Table 4.6: Analysis of HC elements applicable to IC value creation

Human Capital Indicators 5 4 3 2 1 Averages

Years of experience in production 14 2 0 0 0 9

Employee satisfaction 8 4 4 0 0 8

Turnover rate 2 3 11 0 0 7

Information technology literacy stuff 11 5 0 0 0 9

Training per Employee 11 2 2 0 0 8

Table 4:7: Analysis of SC elements applicable to IC value creation

Structural Capital Indicators 5 4 3 2 1 Averages

Revenue generated per RandD expense 6 9 1 0 0 8

# of computer links to the corporate database 1 6 1 8 0 6

Ratio of IS expense to total revenue 2 5 9 0 0 7

Product life-cycle trend 14 5 1 0 0 10

Average length time for product design 3 8 3 0 0 7

55
Table 4.8: Analysis of RC elements applicable to IC value creation

Relations Capital Indicators 5 4 3 2 1 Averages

Growth in business or service volume 9 5 2 0 0 8

% of repeated customers 4 11 1 0 0 8

Customer loyalty 5 5 6 0 0 7

Market share 7 5 4 0 0 8

Customer satisfaction 7 2 9 0 0 8

Tables 4.6, 4.7 and 4.8 further indicate a consistent view from the earlier independent IC
elements analysis. Human capital is key from employee skill and knowledge (Tacit
knowledge).

From the above analysis between the Skandia framework by Edvisson (2002) and Stewart
(2008) who also added process capital and innovation capital, it is noticeable that the first IC
element is similar, that is, employee skill and knowledge (human capital). However the second
and third differ. Secondly between intellectual property (innovation capital) and product life
cycle (structural capital) and thirdly Product life cycle and increase business growth (revenue
or profits). These were explored when validating the proposed business framework on IC
management.

This study will have a case study on software developing or innovations companies. We
thought it prudent to further explore what influenced their product development or innovation
cycle. From the table 4. 9 indicates that they either product develop or innovate an ad hoc
basis, as demand arose or when a need was identified.

Table 4.9: Analysis of product innovation cycle

Product development Number of respondents

On client demand 12

4
Quarterly (need identification)

From the table 4.10 product innovation is driven by management vision thus we shall also
explore further in the proposed IC management framework.

56
Table 4.10: Factors that influence product innovation cycle

What Intangible asset determines how often you develop new products Number

Employee Skills 4

Existing Knowledge asset 1

Competitors 1

Customer satisfaction/requirements 3

Existing information systems 2

Management vision 5

Others 0

16

4.4 Factors impacting organization intangible company value

Table 4.11 Factors that influence intangible company value

Factors Impacting Organization Intangible firm value Number

Intangible Capital 4

Ownership Structure 5

Firm Characteristics 3

Reaction from analyst and customers 1

Corporate Governance 1

Industry Characteristics 2

Others 0

Total 16

Table 4.11 indicates 28% of the respondents reported that ownership structure has the highest
impact in their intangible company value. This was a surprising finding contrary to literature
reviews. It was expected intangible capital would have more impact from external influence
which ranked second. Company characteristics (Structural Capital) came out as the third
influential factor to an organization I.C.

57
 Factors Impacting Organization Intagible firm
value
Intagible Capital
12%0% Ownership Structure
4% 32%
Firm Characteristics
28% Reaction from analyst & customers
8%
16% Corporate Governance
Industry Characteristics
Others

Figure 4.2: Factors Impact on Intangible Company Value

4.5 Measurements and Frameworks applied to I.C. management value

creation
Only 31% if the respondents admitted to having any knowledge of the existing models of I.C.
This was not a surprising finding considering the existence of I.C. in almost all the companies.
This finding may also be deemed worrying given the amount of capital and time invested in
I.C. acquisition and development.

Reviewing figure 4.0.4, one notes that only 31% of the respondents had prior knowledge on
the existing models of I.C. valuation, 60% had adopted the Skandia I.C. Navigator model for
valuation and I.C. Management framework in their companies. Ram boll holistic company
model and Intellectual capital I.C. index had an equal adoption rate of 20% each.

58
 Intellectual Capital Valuation Methods
Skandia IC Navigator

20% Intellectual capital IC index

20% 60% Bates Gruppen company

IQ measurement
Ericsson's cockpit
communicator
Ramboll holistic company
model

Figure 4.4: Awareness of IC Valuation Methods by Companies

4.5 Disclosure and reporting I.C.

Software or products costs of these companies were mostly comprised of human capital and
structural capital costs due to the ease of quantification. The common challenges they face
during the determination of the final product cost was the intangibility nature of I.C. and lack
of proper understanding of I.C. definition. In managing respective areas of responsibility, the
most useful human capital indicator was employee skill and knowledge.

Other additional factors that determine the price for the products or services they produce are:

i. Amount of workload (human resource) and quality of product.

ii. Time taken to develop the product (employee cost).
iii. Cost of resources used in development.
iv. Type of client big clients business charges vary from the small/individual clients.
v. Number of developers the project requires to be completed.
vi. Level of risk associated with the project.
vii. Complexity of user requirements and specifications.

59
4.6 Types of Value created and extracted using I.C to the organization
Table 4. 12 Factors that influence product innovation cycle

Value that IC brings to the organization Number

Profit generation 5

Strategic positioning 3

Improved Productivity 4

Cost Reduction 1

Acquisition of innovation from staff 3

Customer loyalty 2

Others 0

Total 16

From table 4.12, 28% of all the respondents stated that the main value that I.C. brings to the
organization was profit generation. 25% said I.C. improved productivity within the organization.
16% viewed that I.C. could be used in strategic positioning of the company whilst another 16%
perceived IC could lead to acquisition of innovations from staff. Customer loyalty and cost
reduction were realized to be impacting the organizations at 9% and 6% respectively. This
finding shows that most companies use their I.C. in efforts to generally maximize profit and
productivity within the company.

Value that IC brings to the organization

Customer loyalty
9%
Acquisition of
Profit generation
innovation from
28%
staff
16%

Cost Reduction
6%

Strategic
positioning
16%
Improved
Productivity
25%

Figure 4.3: Perceived Value IC Brings to an Organization

60
An overview of the strategic challenges in IC value analysis:

i. Lack of long term strategic insight.

ii. Gap between product development cycle and client requirements specification can
render a product valueless.
iii. Gap between innovative capability and implementation.

4.7 Summary Findings on Value created and extracted using I.C management
in organizations
This study’s findings suggest that a number of the interviewees could directly link their daily
operations and a few number to business success to management of IC. This implies that
there is the conviction of IC’s ability to mobilize cognitive resources and actions to create and
extract value to an organization. In addition, they faced the challenge of how to present the
value created and extracted. Compared to literature, these results were in line with studies of
various researchers such as Penrose (1959), Rumelt (1984), Teece (1984); Wemerfelt (1984)
and Teece (1986), who were looking at new ways to understand business organizations and
especially how they might extract value from innovation.

Moreover, the findings simulate the prior studies from literature review stating the key
elements of IC being firstly, employee skill and knowledge (human capital). However the
second and third differ. Secondly between intellectual property (innovation capital) and
product life cycle (structural capital) and thirdly Product life cycle and increase business growth
(revenue or profits). We explored these when we validated the proposed business framework
on IC management.

It was also noted that three factors that were indicated and influencing value creation and
extracted from IC management being from reaction from analysts and customers, intangible
assets and company characteristics. In addition it was also indicated that the organisation
leadership was very influential in the management of IC or intangible assets in value creation.

Lastly the value desired from IC were profit generation, improved productivity within the
organization, strategic positioning and ability to acquire innovations from staff. Customer
loyalty and cost reduction were considered least desired. The findings indicate that most
companies use their I.C. in efforts to generally maximize profit and productivity within the
company.

61
 CHAPTER FIVE: VALIDATION OF THE FINDINGS AND BUSINESS
APPLICATION

5.1 Overview of findings

The purpose of this research was to review and analyze various business models that software
developing companies can adopt to explore if they are extracting value from their innovations.
If so, to further explore what comprises Intellectual Capital and the impact of each factor.
Results from this research will contribute to identifying factors and their impact on Intellectual
Capital management and the various forms of value that can be extracted from Intellectual
Capital. In addition, a proposed business framework on how they can manage their Intellectual
Capital to create and extract value from their innovations that is aligned to the business
environment, organization strategy and operations, is presented.

While the previous chapter only focused on the findings, this chapter will focus on the business
application. From the research findings, these objectives can be fully achieved if we propose
a framework from the findings. As a result this chapter will attempt to draw from the findings
and develop from the most applied business IC management framework to validate our
findings.

These findings are likely to greatly contribute to business success. Findings from past studies
that showed howIntellectual Capital management is vital to business performance, is explored.
In addition, the findings reveal a shift from physical assets economy (business models) to
knowledge based economy (use of intangible assets) to create value and gain sustainable
competitive advantage.

Most of the software developing companies considered in the study are found to have no clear
Intellectual Capital framework or deliberate process in place. The reasons that drove most
software developing companies not to implement this in their businesses were given to be
because of an unclear definition of the term Intellectual Capital. These findings were consistent
with the research findings by Serrano-Cinca et al. (2003), Cabrita and Bontis (2008) as well
as Edvinsson (2002).

The researcher also noted that IC management was not popular in software developing
companies due to inadequate knowledge of the processes involved as well as the lack of
sufficient managerial expertise. This was clearly depicted by the findings that showed that only
17% of the respondents were in strategic and administrative roles. The study also established
that majority of the software development companies developed products on an ad hoc basis
as demand arose based on need or opportunities identified.

62
The trend of the software development companies is that a product innovation is viewed in a
number of ways such as; firstly, periodic /short term specific solution assignments-which may
have contributed to the lack of effort and emphasis towards the IC valuation processes.
Secondly, the products were either client owned or modification of off the shelf products. Thus
were not the assets of the software companies. Thirdly, the software developing companies
in the study faced challenges in the preparation and reporting of the Intellectual Capital. This
was due to inadequate resources and lack of the necessary skills and expertise to quantifying
software development work in progress and finished products. Lastly, IC valuation
implementation was further distressed by lack of expertise and formal accredited guidance in
the measurement of IC elements.

This research concluded that high performing software development companies (in terms of
annual turnover) had a strategic IC plan in their businesses. It could have been either written
or unwritten on how to deal with the companies’ Intellectual Capital both the tangible or
intangible aspects.

5.2 The Proposed IC Management Framework (Model)

Value creation processes play a central role in the financing, investing and operating decisions
of companies. Many methods are deployed to approximate the true value of a company and
the value created from its activities. Although these techniques are based on similar theories,
they may generate different results in their application.

5.2.1 Background to the Proposed IC Management Framework (Model)

Our proposed business model has included our findings coupled with the IC definition from
our literature review. The initial framework below from Edivisson (2000) is presented in a
diagram which shows the intangible activities that can be used in a business environment to
determine a company’s success. This shows a close relationship with the central idea (of an
IC management model) and contribute towards its successful proposition. Figure 5.1
illustrates how intellectual capital adds value to a company’s success

63
Figure 5.1: Relation of Intellectual Capital and Companies’ Success-Source: Edvinsson (2002)

From our finding 60% of the interviewees applied and were aware of the Skandia model above.
However from the findings’ various inputs have changed in the business models. This could
be from the further from the maturity of the knowledge based economy where, intellectual
capital is related to the sustainable competitive advantage of organizations from organizations
sources, capacity and perfection (Cabrita & Vaz 2006).

The most recent definition of Intellectual Capital has been done by Mojtahedi and Ashrafipour
(2012). They defined it as the group of knowledge assets that are attributed to an organization
and most significantly contribute to an improved competitive position of this organization by
adding value to defined key stakeholders. Thus noting not only do organisation wish to be
competitive but the competitive advantage aspect is important for them to be sustainable.

5.2.2 Assumptions to the Proposed IC Management Framework (Model)

The proposed model bears the same assumptions as the Skandia model. The process flow
assumptions were also the same developed by the balanced scorecard (1992) and the
Intangible assets monitor (1997).

Firstly the IC has to be managed and understood in order to create value for the organisation
and its stakeholders. Secondly, given the difficulties in determining monetary values for IC
most of the metrics considered in these frameworks do not attempt to place monetary values.
Metrics are instead aimed to support in management decision process and aid to develop the
IC management strategy. In addition, to make the flow understandable and manageable
through IC statements (ICS) that frames IC metric and narratives. Thirdly, the process flows
are inscribed in the day to day activities of the organisation to enable the interaction of these
IC elements like employee skills, processes customers and technology and make them visible
(Mouritsen & Larsen, 2005).Lastly the reporting of IC aims to provide information to internal

64
and stakeholders with an extended view on organisational performance by focusing on the
efforts of managing and developing IC assets.

5.3 Revised Proposed IC Management Framework (Model)

• IC WIP
Business Processes • IC
IC Finished
Reports product
• (balance
IC sheet asset
Measures value)

Firms Ownership Employee

Intellectual Product life • Profitability
knowledge, • Sales /
Strategy Structure property cycle
skills and Projected IC Benefits
(Innovation (structural
capability revenues
capital) capital) • Market share
(human capital)
• Innovative /
• Brand
strategic
products • Business
efficiency &
Knowledge Process sustainability
esprocessocesspppppp

Figure 5.2: Diagram of a Proposed IC Valuation Framework

In the proposed framework, (figure 5.2) a company’s success in business from our research
findings can be as a result of:

5.3.1 Enablers (Company strategy and Ownership structure)

From the literature review and highly guided by Rao et al. (2004), Black et al. (2006), Gleason
and Klock (2006), Fukui and Ushijima (2007), enablers that affect the company’s intangible
values were identified as;

a) Company’s Strategy (current challenges and effects of the current challenges).

b) Ownership / Management Structure.

This was well aligned to literature review findings in this study.

5.3.2 IC Components’ (Employee knowledge, skills and capability, Intellectual

property and Product life cycle)
In line with Stewart (2000), to find, understand and manage the concept of Intellectual Capital
effectively; first the elements that create intellectual capital should be defined. From this we
identified three IC components being:

a) Employee knowledge, skills and capability.

b) Intellectual property.
c) Product life cycle.

65
These components are greatly influenced by the earlier above named enablers.

5.3.3. IC Reports and Disclosures (Balance Sheet and Income statement)

For most software companies, product and process innovation play a key role in market
differentiation. This leads us to the challenge of the idiosyncratic nature of IC. What is valuable
for one company may be worthless for another. This has resulted in diverse measuring
systems that make comparability across companies and sectors difficult. In addition, it has
been argued that Intellectual Capital can have two dimensions. The Meritum guidelines
distinguish between intangible resources and intangible activities as a way of highlighting IC’s
static or dynamic character: This dynamic nature of IC means that its individual components
are often not valuable by themselves but work only as a system (Meritum, 2002). In other
words, it is the intellectual capital elements interacting that generates value for companies

The findings of our research highlighted the earlier above three named IC components and
factors if well managed are able to yield;

i. IC Benefits
a) Market share
b) Brand
c) Business efficiency and sustainability
ii. IC Measures
a) Profitability
b) Sales / Projected revenues
c) Innovative / strategic products
iii. IC Reports (balance sheet asset value)
a) IC WIP
b) IC Finished product
There are a growing number of methodologies for the measurement of Intellectual Capital (IC)
at the company level. The challenge for academics is to frame the phenomenon using extant
theories in order to develop a more rigorous conceptualization (Choo & Bontis, 2002). Given
the recent proliferation of IC models, it is appropriate to review the models and classify them
according to their temporal orientation, system dynamics, and causal direction characteristics.
For temporal orientation, each model will be examined to determine whether it provides a
historic report of performance, or measurements designed to manage and steer future
company performance.
Future oriented measurements are preferred over historic reports because they provide
information that can be a basis for future forecasting and guide in the present decision-making
especially in the resource allocation, vision alignment and strategy.

66
 Finally, the framework will be validated to determine whether it has a stock or resource focus
versus a flow or process focus. This is a good guide in resources allocation and processes
applied aligned to the vision and strategy.

5.4 Feedback Mechanism

Feedback mechanism and a validation system of the proposed framework was mobilised,
through the use of the mixed method; qualitative by use of questionnaires and quantitative by
analysis statistics gathered from the questions with rating scales.

5.5 Validation of the proposed framework

The validation system was through a validation questionnaire mixed with both rating scale
questions and open ended questions. Validation questionnaire to the sample of 16
organisations was issued. This feedback mechanism was important to;

i. Validate the relevance of the components applied to the framework

ii. Explore the extent of the challenges earlier shared impact on IC management
iii. Review to identify why there is a change in the business framework from the initial
commonly used framework identified from the literature review and findings.
iv. Validate the validity of our assumptions to the framework

Below is the statistical analysis applied to various inputs composing the proposed business
framework in IC management.

Table 5.1: Analysis of IC factors influence on human capital

5 4 3 2 1 Avg

a) Company Strategy 7 3 3 1 2 8

b) Ownership Structure 9 3 2 2 0 8

c) Intangible capital 2 14 0 0 0 8

d) Reaction from analysts and customers 1 3 5 5 0 6

e) Corporate Governance 3 4 3 4 2 7

f) Industry characteristics 3 4 3 2 2 6

67
Table 5.2: Analysis of IC factors influence on product lifecycle

5 4 3 2 1 Avg

a) Company Strategy 6 4 4 1 1 8

b) Ownership Structure 11 3 2 0 0 9

c) Intangible capital 2 7 4 3 0 7

d) Reaction from analysts and customers 1 3 10 2 0 7

e) Corporate Governance 3 1 7 4 1 6

f) Industry characteristics 8 1 5 2 0 8

Table 5.3: Analysis of IC factors influence on business processes

5 4 3 2 1 Avg

a) Companies Strategy 8 6 0 0 2 8

b) Ownership Structure 7 3 2 1 1 7

c) Intangible capital 5 5 4 2 0 8

d) Reaction from analysts and customers 1 3 12 0 0 7

e) Corporate Governance 3 1 9 2 1 7

f) Industry characteristics 4 3 5 2 2 7

Table 5.4: Analysis of IC factors influence on Knowledge process

5 4 3 2 1 Avg

a) Company Strategy 8 6 0 0 2 8

b) Ownership Structure 7 3 2 1 1 7

c) Intangible capital 5 5 4 2 0 8

d) Reaction from analysts and customers 1 3 12 0 0 7

e) Corporate Governance 3 1 9 2 1 7

f) Industry characteristics 4 3 5 2 2 7

68
 Table 5.5: Analysis of IC benefits contribution to an organization

5 4 3 2 1 Avg

a) Market share 0 12 3 0 1 7

b) Brand 0 0 15 1 0 6

c) Business efficiency 8 8 0 0 0 9

d) Business sustainability 9 6 0 0 1 9

Table 5.6: Analysis of IC value realization to an organization

5 4 3 2 1 Avg

a) Profitability 0 14 0 0 2 7

b) Sales / Projected revenues 2 0 12 2 0 7

c) Innovative / strategic products 10 6 0 0 0 9

Table 5.7: Analysis if organizations prepare financial with IC value

Yes No

6 10

Table 5.8: Analysis if IC valuation modes in financial statements

Yes No
a) IC WIP 6 10
b) IC Finished product 6 10
c) Other, internal management reports 16 0

5.6 Summary of Findings from our Validation Survey of the proposed

business framework on IC management
It is the intellectual capital elements interacting that generates value for companies, this is why
the crucial enablers as below determine the resource allocation and approved company vision
and strategy;

69
 a) Company’s Strategy (current challenges and effects of the current challenges).
b) Ownership / Management Structure.

The enablers influence the processes to be applied to yield the desired;

i. IC Benefits
ii. IC Measures
iii. IC Reports (balance sheet asset value)

The above is what will determine the levels and type of competitive advantage that the
company will focus on, or desire from its IC management to create and extract value.

70
 CHAPTER 6: CONCLUSION AND RECOMMENDATIONS

6.1 Conclusion

Previous studies have consistently stated that most software development companies do not engage
in IC valuation process or have not adopted any valuation models despite the fact that most literature
dictates that businesses should efficiently manage their Intellectual Capital resources in order to
compete effectively, and survive. This can be also validated from tables 5.5 and 5.6.

A range of mechanisms have emerged in recent years that allow companies to report developments
within the IC field. The research in its simplest term sought the kind of companies in which Intellectual
Capital accounting might be being adopted where, at least the discourse of IC made sense to the
managers and was an interest to them. These companies had begun developing metrics necessary
to document the success, or otherwise of the Intellectual Capital activities. Though these were seen
as great strides towards valuation of IC from tables 5. 7, the general absence of any sort of theoretical
underpinning showed sign of hampering such work as per tables 5. 8. From tables, 5. 1, 5. 2, 5. 3 and
5. 4 the success of a company in a business environment can be attributed to the correct mix of vision,
business strategy, measures and business process or activities as noted in tables, 5. 5 and 5. 6. The
business process runs hand in hand with the knowledge process as well as intellectual capital
elements. Thus the proposed models measure the extent to which the different IC elements have been
used in the business process.

This research appreciates from tables 5. 5 and 5. 6 that for most software development companies’
growth, above-average earnings, and sustainable competitive advantages are no longer driven by
investing in physical assets such as factories, offices, or machinery, but instead by investing in and
managing Intellectual Capital. Companies in Nairobi software are yet to adopt existing models of IC
valuation but are keen in any activity the enables profit maximization and employee motivation
strategies to unlock innovativeness’.

However, there were enterprises that did not have any IC valuation models as per table 5. 7 in place
and the top three reasons given for this was the lack of expertise, time while others had no interest at
all. These findings were in line with the Chartered Institute of Management Accountants on various
journals that reviewed intellectual capital as difficult to measure and who sought to explain the lack of
IC valuation in Software development companies. The researcher also noted that IC valuation was not
popular in Software development companies due to inadequate knowledge of the processes involved
as well as the lack of sufficient managerial expertise. This was clearly depicted by the findings that
only 17% of the respondents were in strategic and administrative roles.

The study also established that majority of the Software development companies developed products
on an ad hoc demand basis or upon identified market need requirements. This also validated the
findings, of Lang et al. (2003) that the main factor influencing IC valuation is reaction from analyst and

71
customers. Software value is mainly determined by the value perceived by external stakeholders;
investors, potential customers, stock analysts, among others.

6.2 Recommendations
Software Companies in Nairobi are yet to adopt existing models of IC valuation but are keen in any
activity profit maximization and employee motivation strategies. IC valuation needs to be firstly
adopted by the Accounting authorities in the International Accounting Standards to enable accountants
to spearhead in the valuation process. Companies need to shift their focus from costing their final
products more than creating brands to harness increased Intellectual Capital value like increased
customer loyalty and / or increased market share.

Previous studies have consistently stated that most Software development companies do not engage
in I.C valuation process or have not adopted any valuation models despite the fact that most literature
dictates that businesses should efficiently manage their intellectual capital resources in order to
compete effectively and survive.

From the literature review, one notes that most Software development company’s growth, above-
average earnings, and sustainable competitive advantages are no longer driven by investing in
physical assets such as factories, offices, or machinery, but instead by investing in and managing
intellectual capital. Companies in Nairobi software are yet to adopt existing models of IC valuation but
are keen in any activity profit maximization and employee motivation strategies.

Intellectual property awareness needs to be increased to enable innovators to understand it

importance and role. Many innovators sell off their propriety innovations without the consideration of
instead creating a royalty model and thus creating brands. In addition there is need to harmonise
intellectual property registration regionally and globally. It has been noted that it is a lengthy and costly
process to patent ones innovation regional let alone globally.

6.3 Limitations of the Study

Intellectual Capital has not been adopted with a single definition; this has driven most software
development companies not to implement IC management in their businesses framework. Valuation
of an innovation based organizations brand and uniqueness of the innovation thus limiting access to
information from companies on their IC as considered by many managers as strategy and not and
financial asset.

Majority of the innovation firms do not gradually value their innovation but only consider the final
product. They value their innovation from the buyer’s purchasing power. The organisations have
viewed the main and only benefit from innovation is the monetary return. This has resulted to
organisations not striving for the other benefits they desire like brands, increased market share among
others. This has prompted them to set their product innovation as demand driven or identified short
term needs solution assignments. From the literature review of successful innovations, like Mpesa and

72
Whatsapp, these were launched for long periods with a focus to create market demand and a brand
thus resulting in value creation.

This dynamic nature of IC means that its individual components are often not valuable by themselves
but work only as a system to generate value for companies. For example, a company may have good
programming skills that enable it to develop software. However, they might be worth little unless
accompanied by a strong distribution network, loyalty and commitment from its employees and a
powerful brand name.

From the literature review, there is no single most adopted Intellectual Capital framework process that
has been certified and globally recognised. Legally, many organisations find it costly to protect and
register their innovations. The consideration of intellectual property is only if the innovation is
considered to be strategic and has a ready market.

6.4 Suggestions for future research

Even with the high awareness of major business growth on the technology being software
companies globally, there is need to review why Nairobi software companies do not seek brand
recognition and instead are driven by sales / profitability indicators.

73
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 APPENDICES
Appendix A: Research Questionnaire

A Review and Analysis of how Nairobi software Software Companies Value and Benefit from
Intellectual Capital
Research Team and Confidentiality/Non-Disclosure Assurance
 The Intellectual capital Research from a Master student, from the Strathmore Business
School is conducting research on how Nairobi software Software developers and
Innovator Organizations manage and value their Intellectual capital.
 The data and/or information collected shall be treated with utmost confidence and shall
not be shared without your prior permission.

Research Objectives
i. What are the factors that comprise intellectual capital in software development or innovation?
ii. What are the theories, models and metrics currently being applied to value intellectual capital in
software development or innovation?
iii. How do the software development companies or innovators determine the value of these
innovations?
iv. What is the probable model applicable to intellectual capital and innovation valuation?
v. How can the above proposed model be validated?

Directions in responding to the Questionnaire:

 Please check all boxes that apply in each question where references to “you” or “your” refer

to your Business or Organization.

 “Personal Data/Information” means information that you or your organization collected or

stored regarding specific individuals e.g. employees, customers etc and may include

information such as identifying number, home address or telephone number, physical

characteristics, ethnicity or cultural affiliations, medical information, income, etc.

Please feel free to use additional paper if necessary for your comments.

Correspondence/Inquiries:

Diana Kuria (diana.kuria@sbs.edu)

Strathmore Business School

P. O. Box 59857- 00200 Nairobi, Nairobi

software

Mobile Number(s): +254 (0) 729267733

81
Definitions

Intellectual Capital It refers to those intangible assets/resources within an organization relating to

information and knowledge that are not generally measured or appreciated but contribute to an
organization’s success. Intellectual capital is seen to comprise elements of human capital, structural
capital and customer capital and exists when an enterprise is able to utilise these in a way which produces
additional value or competitive advantage for the enterprise.

Human Capital – “That which is in the mind of individuals.” Examples: knowledge, competencies,
experience, etc.

Structural Capital – “What is left after employees go home for the night.” Examples: work process,
information
systems, database, etc.

Customer Capital – Examples: customer relationships, brands, trademarks, etc.

82
83
PART A: YOUR BUSINESS/ORGANIZATION AND GENERAL INFORMATION

i. Individual Name (Optional)

___________________________________________________________________
__
ii. Business/Organization (Optional)
___________________________________________________________________
__
iii. What is your Job Title?
___________________________________________________________________
__
iv. What is your role in your organization?(Choose relevant)
Strategic
Administrative
Consultancy
Innovative
Other (Specify) ____________________________________________________

v. How long have you been in the software development company industry?(Choose
one)

vi. Please indicate the size of your business/organization (World Bank, 2004):

Small organization (Less than 50 employees)

Medium organization (Between 50 and 99 employees)

84
Large organization (More than 100 Employees)

85
PART B: INFORMATION/INTELLECTUAL CAPITAL DEFINATIONS

i. How does your organization define intellectual capital?

______________________________________________________________________
______________________________________________________________________
________________
ii. In your opinion which element/component of intellectual capital exists in your
organization?

Employee knowledge, skills and capability. New employee mentorship.

Business/office culture. Employee motivation.
Knowledge assets/intellectual properties. Product life-cycle trends
Management/organization structure. Competitor assessment tactics.
Customer loyalty and satisfaction strategies.
Others (Specify)
___________________________________________________________________

iii.
Based on the applicable elements in question ii, what level of importance does each
element play in your organization?
Very Not Check
Elements Useful Useful

Employee knowledge, skills and capability. 5 4 3 2 1

Business/office culture. 5 4 3 2 1

Knowledge assets/intellectual properties. 5 4 3 2 1

Management/organization structure.
5 4 3 2 1

Competitor assessment tactics.

5 4 3 2 1

New employee mentorship.

5 4 3 2 1

86
Employee motivation.
5 4 3 2 1

Customer loyalty and satisfaction strategies.

5 4 3 2 1

Product life-cycle trends

5 4 3 2 1

iv. What department in your organization deals with the specialization the
element/components of intellectual capital?

Human Resource Finance

Marketing Sales
Administration Production
Others (Specify) ______________________________________________________________

v. What categories of intellectual capital are in the corporate strategy of your organization?

Human Capital Structural Capital

Customer Capital Relation Capital
Organization Capital Process Capital
Innovation Capital
Others (Specify) _______________________________________________________________

87
PART C: INFORMATION/ VALUATION OF INTELLECTUAL CAPITAL

i. Which of the factors below impacts more on your organization intangible company
value?

Intangible capital Reaction from analyst and customers

Ownership structure Corporate governance
Company characteristics Industry characteristics
Other (Specify) ______________________________________________________

ii. Do you/organization have any knowledge about the various existing models of
intellectual capital?

iii. Which of these intellectual capital valuation models has your company adopted in its
corporate strategy?

Skandia IC Navigator Ericsson’s cockpit communicator

Intellectual capital services IC index Ramboll holistic company model
Bates Gruppen company IQ measurement system Celemi intangible asset monitor
Others (Specify)
__________________________________________________________

iv. Which department is responsible for extracting value from the company’s intangible
capital?

Human Resource Finance

Marketing Sales

Administration Production
Others (Specify)
_________________________________________________________

v. What values does intellectual capital bring to your organization?

88
 Profit generation Cost reduction
Strategic positioning Acquisition of innovation from staff
Improved productivity Customer loyalty
Others (Specify)
__________________________________________________________

vi. Briefly state the challenges identified with the value analysis activities?
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
________________________________________

89
 PART D: INFORMATION/MEASURING AND REPORTING INTELLECTUAL CAPITAL

i. How often do you develop new products?

________________________________________
ii. Which intangible assets mostly determines significantly how often you develop new
products?

Employee Skills Customer satisfaction/requirements

Existing knowledge asset Existing information systems
Competitors Management vision
Others (Specify)
_____________________________________________________________

iii. In your opinion which of the following indicators would be useful to you in managing
your area of responsibility?
Human Capital Indicators Very Not Check
Useful useful
Years of experience in production 5 4 3 2 1

Employee satisfaction 5 4 3 2 1

Turnover rate 5 4 3 2 1

Information technology literacy stuff 5 4 3 2 1

Training per employee 5 4 3 2 1

Are there any other indicator you feel will be useful? _________________________________________

Structural Capital Indicators Very Not Check

Useful Useful

Revenue generated per RandD expense 5 4 3 2 1

# of computer links to the corporate database 5 4 3 2 1

Ratio of IS expense to total revenue 5 4 3 2 1

Product life-cycle trend 5 4 3 2 1

90
 Average length time for product design 5 4 3 2 1

Are there any other indicator you feel will be useful? _________________________________________

Customer Capital Indicators Very Not Check

useful useful

Growth in business or service volume 5 4 3 2 1

% of repeated customers 5 4 3 2 1
Customer loyalty 5 4 3 2 1
Market Share 5 4 3 2 1
Customer satisfaction 5 4 3 2 1

Are there any other indicator you feel will be useful? _________________________________________

iv. What portion of the company’s intellectual capital is represented in the companies’
financial reporting?
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
________________________________
v. With which group of people do you/organization share the reports on intellectual
capital management, valuation and reporting data?

Employees in the organization Current and potential donors

Internal managers only Customers
Board of director/governors Investors/Shareholders
Supplier (goods, knowledge, services) Competitors
Others (Specify) ____________________________________________________________

91
vi. Please provide feedback or extra comments on the information not captured in the
questions above or on the overall research project.
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
________________________________________________________

Thank you for your participation in the research

92
 Appendix B: Research Validation Questionnaire
A MODEL FOR VALUATION OF INTELLECTUAL CAPITAL

Research Team and Confidentiality/Non-Disclosure Assurance

 The Intellectual capital Research from a Masters student, Strathmore Business School,
conducting research on how Nairobi software Software developers and Innovator
Organizations manage and value their Intellectual capital.
 The data and/or information collected shall be treated with utmost confidentiality and shall
not be shared without your prior permission.

Research Objectives

vi. What are the factors that comprise intellectual capital in software development and/or innovation?
vii. What are the theories, models and metrics currently being applied to value intellectual capital in
software development or innovation?
viii. How do the software development companies or innovators determine the value of these innovations?
ix. What is the probable model applicable to intellectual capital and innovation valuation?
x. How can the above proposed model be validated?

Directions in responding to the Questionnaire:

 Please check all boxes that apply in each question where references to “you” or “your” refer to
your Business or Organization.
 “Personal Data/Information” means information that you or your organization collected or stored
regarding specific individuals e.g. employees, customers etc. and may include information such
as identifying number, home address or telephone number, etc.

Please feel free to use additional paper if necessary for your comments.

Correspondence/Inquiries:

Diana Kuria (diana.kuria@sbs.edu)

Strathmore Business School

P. O. Box 59857- 00200 Nairobi, Nairobi

software

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Definitions

Intellectual Capital It refers to those intangible assets/resources within an organization

relating to information and knowledge that are not generally measured or appreciated but
contribute to an organization’s success. Intellectual capital is seen to comprise elements of
human capital, structural capital and customer capital and exists when an enterprise is able
to utilise these in a way which produces additional value or competitive advantage for the
enterprise.

Human Capital – “That which is in the mind of individuals.” Examples: knowledge,

competencies,
experience, etc.

Structural Capital – “What is left after employees go home for the night.” Examples: work
process, information systems, database, etc.

Customer Capital – Examples: customer relationships, brands, trademarks, etc.

The Proposed Framework (Model)

Valuation plays a central role in the financing, investing and operating decisions of
companies and many methods are employed to approximate the true value of a company
and its activities. Although these techniques are based on similar theories, they may
generate different results in application. Our proposed model will be based from our findings
coupled with the IC definition we opted for in our opening first chapter. The proposed
framework is presented in a diagram which shows the intangible activities that can be used
in a business environment to determine a company’s success. These show a close
relationship with the central idea (of an IC valuation model) and contribute towards its
successful proposition.

Figure1.0. 1 Diagram of a Proposed IC Valuation Framework

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 Intellectual capital IC • IC WIP
• IC Finished product
Repo • (balance sheet
asset value)
rts
IC
Firms Business Ownership Meas
Strategy Environment Structure Employee
• Profitability ures
knowledge, Product life Business
skills and cycle
• Sales / Projected
revenues IC
processes • Innovative /
capability strategic products Benefits
• Market share
• Brand
• Business efficiency
and sustainability

From the proposed framework, (figure 1.0.1) we seek to validate / identify through the score
sheet, to what extent you regard each component in identifying and valuing intellectual capital
in your company: We request you to grade the below using the high 5 to low 1 scale.

1. Do the below IC human capital components exist in your organization and if so

to what level?

High Low
d) Employee knowledge 5 4 3 2 1
e) Employee skills 5 4 3 2 1
f) Employee capability 5 4 3 2 1
2. Which of these factors influence product life cycle? Please tick one
High Low
c) Companies Strategy 5 4 3 2 1
d) Business environment 5 4 3 2 1
e) Ownership Structure 5 4 3 2 1

3. To what extent do the IC factors influence business processes?

High Low
a) Companies Strategy 5 4 3 2 1
b) Business environment 5 4 3 2 1
c) Ownership Structure 5 4 3 2 1

4. Please advise the level of IC benefits have contributed to your organization?

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 High Low
a) Market share 5 4 3 2 1
b) Brand 5 4 3 2 1
c) Business efficiency 5 4 3 2 1
d) Business sustainability

5. To what extent have you realized value from your organization IC using the
below scale?
High Low
a) Profitability 5 4 3 2 1
b) Sales / Projected revenues 5 4 3 2 1
c) Innovative / strategic products 5 4 3 2 1

6. Does your organization prepare financial statements inclusive of intellectual

capital?

7. If, you prepare financial statements, please select from below how you
represent your IC?
a) IC WIP________________________
b) IC Finished product ___________________
c) Other, please state___________________________

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