Managing by communication

The construction of an intellectual-capital statement, which defines how knowledge resources are configured and developed, goes hand in hand with the development of a knowledge-management strategy. Per Nikolaj Bukh, Mette Rosenkrands Johansen and Jan Mouritsen demonstrate how Danish firms are using intellectual-capital statements as a management and communication tool oriented towards employees, customers, partners and investors.

Intellectual-capital statements have been used – mainly in the Scandinavian countries – since the beginning of the 1990s. The main idea is to create a report, often as a supplement to the annual report, in which the firm’s strategy for managing knowledge and the activities initiated to pursue the strategy are explained.

The report, which can be published internally or externally, does not measure knowledge in monetary terms. Rather, it pays attention to the knowledge-management initiatives and results. It shows whether a company has improved the development and management of its knowledge resources and whether they are an integrated part of the company’s knowledge management strategy.

This article reports on the experiences of Danish firms that have developed intellectual-capital reports. Since 1998, more than 100 Danish companies from the private and public sector have worked with knowledge-based strategies built on methodologies developed by a team of researchers on behalf of the Danish Ministry of Research. First, we briefly describe the model that forms the basis of the intellectual-capital report. We then demonstrate how the methodology has worked using the experiences of Danish software firm, Systematic Software Engineering.

Why report on KM?

There are several reasons why companies start working with intellectual-capital statements. They are management tools developed primarily to fulfil internally oriented objectives and communication tools designed to achieve externally oriented goals.

Internally oriented objectives

Some of the Danish firms that started working with intellectual-capital statements in the late 1990s were already familiar with knowledge management, while others were novices. For the beginners, working with intellectual-capital statements may have been a catalyst for knowledge management as it has become part of the company’s strategy.

For firms where knowledge-management activities were already underway, working with intellectual-capital statements helped systematise activities, initiate more relevant projects and develop a coherent strategy. Many firms had been looking for a systematic approach to managing and sharing knowledge, and a methodology that linked knowledge management to their overall strategies. Figure 1 illustrates the results from a survey of firms using intellectual-capital statements. The results show the internally oriented objectives these firms had for developing intellectual-capital reports.

Externally oriented objectives

Intellectual-capital statements can also be used to communicate how firms work with knowledge management: what are the aims of knowledge-management activities? What initiatives does the firm have? Figure 2 shows the results of the same survey that also asked firms what externally oriented objectives they had from the development of an intellectual-capital statement.

When an intellectual-capital statement is published it is clearly about communications to various parties:

It communicates identity: who we are and where we are heading;
It gives an impression of what it is like to work at the company to prospective employees, including how their competencies will be developed and what their assignments will be;
It illustrates to partners the company’s capabilities and working methods, and how they match with their partners’;
It communicates the company’s competencies to customers and how they are developed to match customers’ future needs;
It communicates to investors the company’s competitive advantage based on its competencies and how they are developed by management.

Reporting on knowledge resources – not knowledge

An intellectual-capital statement focuses on how a firm develops its knowledge resources. Intuitively, knowledge is information, insight and thinking, either as personal insight or gained from books or IT systems. In a business it is used to improve innovation, processes and performance.

However, as knowledge is intangible – it cannot be seen, described, changed, developed or evaluated – it has to be translated into knowledge resources that can be pointed at and identified as knowledge. These resources can be described, developed, evaluated and combined in new ways. They can be managed, which means they can be described in an intellectual-capital statement. Typically, there are four types of knowledge resource: employees, customers, processes and technologies:

Employees – This knowledge resource includes employees’ skills, personal competencies and experience. Collectively they offer a combination of different types of people, education, motivation, commitment and willingness to adapt, for example;
Customers – This includes the customer mix, relationships between customers and users, their satisfaction and loyalty, and any company referrals. They offer insight into users’ and customers’ needs and the degree of co-operation required with customers and users in product and process development;
Processes – This relates to the knowledge content embedded in the company’s stable procedures and routines. These can be the company’s innovation processes and quality procedures, management and control processes, and mechanisms for handling information;
Technologies – The technological support of the other three knowledge resources is covered here. Focus is usually on the company’s IT systems (software and hardware) such as the intranet, and IT competencies and usage.

A company’s knowledge management is therefore about these four types of knowledge resources and their interaction.

The elements of the intellectual-capital statement

The intellectual-capital statement consists of four elements, which together express an organisation’s knowledge-management work. The four elements link users of the company’s goods or services to the company’s need for knowledge resources. They include establishing the need for knowledge management, such as the knowledge narrative and management challenges, a set of initiatives to improve knowledge management and a set of indicators to define, measure and follow up on initiatives.

Knowledge narrative

The first element is the knowledge narrative that expresses the company’s ambition to increase the value a user receives from a company’s goods or services. This value can be called the ‘use’ value and describes the difference a product or service makes to a consumer. The knowledge narrative also shows which types of knowledge resources are required to create the ‘use’ value the company wants to supply. This ambition establishes a narrative because it merges the user’s and company’s knowledge resources. The knowledge narrative argues for how knowledge is supposed to lead to improvements for the user.

Management challenges

The second element is a set of (knowledge) management challenges that highlight the knowledge resources that need to be strengthened through in-house development or by outsourcing them. This can be achieved by intensifying co-operation with innovative customers, developing greater expertise in specific fields or acquiring better insights into the company’s control processes. Management challenges such as these have a certain degree of permanence over time. They do not usually change every year as they are closely linked to the knowledge narrative and therefore to the individual knowledge resources in the company. The starting point to resolve these management challenges could be to address the existing knowledge resources. But it could also be to introduce new resources that are currently not found within the company.

Knowledge-management initiatives

This set of initiatives addresses the management challenges. The initiatives are related to the composition, development and procurement of knowledge resources and how to monitor their development and effects. This could be, for example, investing in IT, hiring more R&D consultants or software engineers, or launching training programmes in company processes and procedures. Vocational and social activities can also be introduced to increase employee satisfaction. These are all, in principle, short-term actions. Comparing one year with the next, initiatives must be seen to work, even if specific types of initiatives are repeated over several years. These are specific initiatives that certain players are responsible for. Somebody hires personnel, somebody launches training initiatives, and somebody develops the required procedures and routines.

Key performance indicators

The fourth element is a set of indicators that identify whether the initiatives have been launched or whether the management challenges are being met. Indicators make the initiatives measurable. It is therefore possible to determine whether they have been started, and what effect they have had. Some indicators are directly related to specific initiatives such as training days or amounts invested in IT. Others are indirectly related to specific initiatives such as the number of R&D consultants or newly appointed software engineers.

It is important to emphasise that these elements are interrelated. The relevance of a single element only becomes clear when it is seen in relation to the other. The indicators cannot be interpreted individually, and the knowledge narrative becomes ‘free prose’ if not illustrated by the indicators. In figure 3, the four KM elements are illustrated for the software firm Systematic Software Engineering (Systematic). The model functions as an analytical framework identifying each of the four elements in the knowledge-management strategy, and as a structure for the intellectual-capital statement.

The indicators show how initiatives are launched and put into effect. The initiatives formalise the problems identified as management challenges. The challenges single out what has to be done if knowledge resources are to be developed. The knowledge narrative also sums up, communicates and re-orientates what the company’s skills and capacity do or must do for consumers, and which knowledge resources are needed within the company.

Systematic Software Engineering: reporting on knowledge

Systematic Software Engineering is a Danish software house that develops and sells technical-system solutions, products and support primarily to ministries of defence but also to the public healthcare sector, and private transport and service companies. Systematic was founded in 1985 and has, especially during the last three years, grown rapidly from 130 employees in 1999 to 320 in 2003, which includes subsidiaries in the UK and US. In 2001/2002, annual sales amounted to c25m. It is the stated aim of Systematic to develop its core business areas from being primarily a supplier of defence systems to also supplying civilian markets.

In recent years there has been a steady increase in the proportion of civil contracts with electronic patient journals, and electronic trade and security systems being the core business areas.

Initiating knowledge management

The first steps towards publishing an intellectual-capital statement were taken in 1998. At the same time, efforts were also made towards process improvements in software development. A major achievement for the company came in 2002, when it was awarded level-three certification according to the capability-maturity model (CMM) – an American quality model developed to systematically improve software-development processes. It is still investing heavily in this area where, for example, more than 9,000 engineering hours were spent over six months on enhancing efficiency and improving internal processes. The company aims to obtain level-four certification in 2004, which will bring Systematic into the European elite as only ten companies in this region meet such documented quality and maturity standards.

Systematic’s intellectual-capital report is concerned with management’s efforts to influence the structure of the firm’s knowledge resources. The management team sees the intellectual-capital statement as an alternative to the traditional annual report, and most symbolically, at the end of the intellectual-capital statement, the reader will find a two-page version of the annual financial statement. In this way the financial statement is presented as a supplement to the intellectual-capital statement, and compared with the financial statement, it is a colourful and expressive form of communication.

One of Systematic’s strategic goals is to be among the best in its fields of operation, hence the company must continuously improve and innovate and keep a watchful eye on the day-to-day business. Systematic’s knowledge-management strategy also extends its competitive advantage. For example, in March 2002 the company was awarded a contract for more than c16m for the delivery of a mission-planning system that will form an essential part of the future Nato-wide air command and control system (ACCS). The order was received after more than four years’ of sales efforts. The firm explicitly states that one of the reasons why it won the contract was due to its extensive capability in knowledge management. This achievement emphasises the need to continue concentrating their efforts on knowledge management.

The intellectual-capital report

In line with Danish guidelines for intellectual-capital reporting, Systematic identifies four managerial challenges to be addressed within knowledge management:

Partnership with customers;
Software process improvement;
Recruitment and retention of employees;
Competence development.

Connecting the four management challenges is the software process improvement, which represents a theme common to every activity in the company. All the management challenges are described in substantial detail in the reports, but as an illustration the first challenge, ‘partnerships with customers’, demonstrates how most of the Danish intellectual-capital reports are designed with the creation of ‘use’ value in mind.

This management challenge also relates to a set of activities that enhance and create partnerships with customers. The activities are described in the intellectual-capital statement to illustrate the concrete actions Systematic takes to address this management challenge. The activities are all related to the ‘use’ value the company endeavours to deliver to systems users and customers.

In software engineering and development, user requirements are seldom adequately defined nor used in the system-requirement specification, which is the foundation of the system’s architecture, design, coding and test activities. Systematic has adopted a number of procedures and techniques that manage the critical interface between the firm and the solution’s users: user-oriented knowledge-management activities.

It has, for example, chosen to employ a number of (non-software engineering) specialists with years of operational experience in the fields of defence and healthcare. These employees contribute user-specific expertise to the development of the system and thereby bridge the gap that often exists between the customer/end-users and the system engineers. Furthermore, customers – and preferably end users – are actively involved throughout the development process at human-computer interaction workshops, the development of prototypes, planning of test scenarios, and in project and steering-group meetings.

In order to increase the engineers’ understanding of the customers’ and end-users’ environments, Systematic has implemented a project called Meet the Customer. The objective is that all employees meet, and preferably visit, a relevant customer or end-user at least once by the end of 2002, for example, spending a day in a hospital ward or at an operational command unit.

Also, employees from Systematic participate regularly in national and international conferences and seminars, where trends and new opportunities can be observed. The focus on customer satisfaction is, like in many other firms, also seen as a vital measure of the ability to create value for customers and, as a result, generate new sales opportunities. Every second year, Systematic assesses customer satisfaction with project and consulting performance. The survey is conducted by independent consultants in the form of interviews with key customer contacts.

Today, Systematic has published three intellectual-capital statements. These reports, via indicators and corresponding text and illustrations, illuminate certain aspects of customer relations, employee development, and customer and employee satisfaction, the effectiveness of processes, and certain forms of innovation in areas of product development and process improvement.

The experiences gained by Danish companies show that constructing and publishing an intellectual-capital statement can be an effective tool for systematising the knowledge-management activities already initiated and aligning them to a company’s strategic objectives.

The purpose of the intellectual-capital statement is often two-fold. It functions as an internal management tool and as a tool to communicate with employees, customers, co-operative partners and investors on how the firm works by developing knowledge resources to generate value.

Jan Mouritsen is professor at the Copenhagen Business School. He can be contacted at jm.om@cbs.dk

Per Nikolaj Bukh is BDO Professor at the Aarhus School of Business. He can be contacted at pndb@asb.dk

Mette Rosenkrands Johansen is a PhD student at the Aarhus School of Management. She can be contacted at mrj@asb.dk