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March 18, 2018

Intangibles In The Old Economy? Of Course!

By Baruch Lev

In the first essay on intangibles -- "Intangible (Intellectual) Assets" -- posted on 06/14/2001, I presented the definition of intangibles (non-physical sources of future benefits); discussed the major types of intangibles (discovery, customers, human resource, and organizational capital); and talked about the unique capabilities of intangibles (nonrivalry, scalability) to create economic value.

In this essay, I will address an important, current question which is frequently raised in seminars, conferences and by readers of media reports on intangibles: What is the relevance of intangibles in "old economy" sectors? Stated differently, now that the tech bubbles have burst and most of the dot-coms vanished, are intangible assets still important value drivers? In short, should we still be concerned about intangibles? Good and timely questions indeed.

"Lets look at the videotape"

As a "numbers person," I would rather consider data than engage in philosophical/conceptual answers to the above questions. A few months ago, I was asked by Fortune magazine to augment their celebrated annual Fortune 500 list with a ranking of the 50 U.S. corporations with the largest intangible capital in 2000. This ranking (produced with my colleague Marc Bothwell, a fund manager with Credit Swiss Asset Management) appeared in Fortune, July 18, 2001 issue. Intangible capital and the earnings generated by intangible assets were computed according to a proprietary methodology which I have developed, and which will be the topic of a forthcoming essay.

Examination of the list of "Top 50 by Intangibles" is revealing in addressing the "are intangibles still important?" question. Leading the top 50 is a decidedly old economy company: General Electric (appliances, turbines, jet engines, finance), with an estimated intangible capital of $254 billion in 2000. Only two other companies (Pfizer with $219 billion and Microsoft with $205 billion) surpass the $200 billion intangibles mark.

Of the top 25 companies ranked by intangible capital, more than half are old economy: GE, Philip Morris, Exxon, Wal-Mart, Coca-Cola, Procter & Gamble, Ford, Honeywell, Boeing, Pepsico, UPS, Home Depot, and Walt Disney. Of the bottom 25 companies, a full 18 are old economy (e.g., Chevron, Alcoa, Dow Chemicals, DuPont, Caterpillar).

Conclusion: Intangible assets, the prime creators of value and growth are clearly not restricted to technology and science-based (e.g., pharmaceutical) companies. These assets are as dominant and pervasive in old economy sectors as they are in the currently somewhat discredited new economy. So, stay tuned to the intangibles saga unfolding on this Web site.

What are the old economy intangibles?

What are the intangibles of Philip Morris, Procter & Gamble, Home Depot, and the rest of the "dinosaurs"? They are of a varied nature a mixed bag. For some companies (e.g., Philip Morris, Coco-Cola, Pepsico, Sara Lee) the major intangibles are obviously brands. The reputation of a product enables the producer to consistently capture a large market share (e.g., Marlboro cigarettes), and/or charge higher prices than its competitors (e.g., Bayer aspirin). Wal-Mart's private-label products, aggressively pursued in recent years, are an example of a brand creation in process.

In other old economy companies, such as DuPont and Dow Chemicals, the dominant intangibles are unique production processes (organizational capital), constantly innovated by "process R&D," which enable these companies to manufacture products at costs substantially lower than their competitors.

For others, such as Procter & Gamble or 3M, important intangibles emanate from the R&D process, similar to that of technology companies, in the form of new products and services. A new form of R&D, practiced primarily by chemical companies, is "client-based research." Teams of R&D personnel spend considerable time on customers' locations, developing new products and improving old ones in close cooperation with the customers. This overcomes the major problem with R&D -- getting the new products quickly to the market.

Some old economy companies have a great success with the Internet, which is of course an intangible. According to recent press reports, JC Penney, which saw its stock price increasing the last three months, has the most successful on-line sales of all retailers.

Whence the value creation?

In a recent extensive research sponsored by the Council for Chemical Research, I have estimated the rate of return on (efficiency of) investments in property, plant & equipment, and R&D in the chemical industry (the study titled "R&D Productivity in the Chemical Industry" is available on my Web site: baruch-blev.com, in the section "New New"). Results are very instructive: while investment in physical assets by chemical companies yields just the cost of capital (7-8 percent, annually) namely, they don't create significant value -- investment in R&D yields an annual return of about 18%, far higher than the cost of capital. R&D, an important intangible, is thus a major value-creator in the old economy sector of chemical manufacturers.

In general, whether dealing with old or new economy companies, value is primarily created by intangible assets: ideas, people, and organizational processes. This is true in high growth (boom) periods, and perhaps even more so in the current low-growth environment. The challenge to both investors and managers is to identify the intangible sources of value, quantify them, and optimize the allocation of resources to intangible and tangible investments. More on these in forthcoming essays.

My book, Intangibles-Management, Measurement, and Reporting, was just published by the Brookings Institution Press. This is the first comprehensive book on intangibles, dealing with managerial and information issues, by bringing together the most current research and practice.

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