Industry Shared Value

Many non-GAAP factors of production, like reputation, brand equity and other intangibles make up a large portion of U.S corporations' balance sheets. To create a more accurate accounting, I suggest these factors be unified in a wealth approach to sustainability called Industry Shared Value, and have estimates for 5000 US corporations that support my view: Collaboration can push shareholder value; inadequate collaboration can be a drag.

Many non-GAAP factors of production, like reputation and brand equity, were discussed at the Sustainable Life Media and Wharton’s IGEL event, Redefining Value: The New Metrics of Sustainable Business. I suggested they be unified in a business version of the wealth or capital approach to sustainability I pioneered at the World Bank.[i] In Modeling the Shared Value of Industry Collaboration, I focused on a factor of production ‘netted out’ in national wealth estimates. At the time of the event I could only show a firm-level wealth account for one company in one industry. I now have estimates for 5000 US corporations that support my view: collaboration can push shareholder value; inadequate collaboration can be a drag. Chart 1 gives a preview of results, with estimates of other ‘intangibles’ for reference.

What I call Industry Shared Value (ISV), and to a large extent other intangibles, arise in business models that seek profits by adding value to chains or network no one entity can own or control. Innovations in process, not just products, are “creating new value for customers and financial returns for the firm.”[ii] The ownership boundary of GAAP (Generally Accepted Accounting Practices) means it only measures “purchased intangibles,” to validate mergers and acquisitions (M&A). There is much to debate about intangibles but one thing is certain: they are created by prior actions of businesses, not M&A events. It is not surprising, then, that GAAP data are useless in estimating Return on Investment (RoI) for intangibles.

National accountants are measuring such prior actions as Own Account Intangibles, in satellite accounts, and linking them to GAAP purchased intangibles.[iii] The unifying principle is, “any use of resources that reduces current consumption in order to increase it in the future qualifies is an investment.”[iv]

Such amalgams permit RoI calculations for intangibles considered separable in GAAP. That only covers about half the $4 trillion of intangible assets M&A add to balance sheets of US corporations.[v] The rest is said to be inseparable and lumped in Goodwill. Most intangibles discussed at the Wharton conference fall in this category, based on examples FASB 141 gave of inseparables that must be in Goodwill: [vi]

• Brand equity and reputation since the customer base and customer support capability are explicitly inseparables;
• Corporate governance since favorable labor and government relations are inseparables; and
• Human capital since an assembled workforce and ongoing training are inseparables.

Rather than pushing on the closed door of inseparables, I would walk through the open door of satellites for own account intangibles. I would say Goodwill is not a misnomer but an invitation to show how use of resources affects inseparables. The complication is, as Hulten put it in Decoding Microsoft,

These investments form an infrastructural platform that helps defend against the vicissitudes of the marketplace, and the link between the cost of building and maintaining the platform and specific future outcomes is complex. Viewed this way, intangible platforms define the company just as much as the other way around. [vii]

‘Bottom-up’ metrics for own account intangibles can only do so much with inseparables. For example, Hulten estimates Microsoft’s own account intangibles at 28% of market cap at end-2006, which still leaves 45% unexplained. Some of this is what competiveness gurus Porter & Kramer call Shared Value or “identifying and expanding the connections between societal and economic progress.” [viii] The ‘top-down’ metrics behind Chart 1 split Shared Value in two. License to Operate (LTO) is the same for all publicly traded corporations. [ix]  ISV estimates value added, or subtracted, by societal and economic connections specific to the network or chain in which a corporation operates.[x]

My top-down approach suggests Shared Value (LTO + ISV) accounts for less than 10% of Microsoft’s firm value. Unrealized capital gains/losses are an additional factor for many corporations (around 7% for ICT) but probably only 1% for Microsoft since it is light on tangible assets. A top-down estimate of own account intangibles is therefore 40% higher than the bottom-up estimate, for Microsoft. That is Own Account Goodwill, or the collective value of ‘inseparables’ that purchase accounting (used in M&A events) might value.

There is obviously a fuzzy boundary between Own Account Goodwill and (LTO + ISV). There are devilish details to untangle in deciding which use of resources (time and money) creates which investment, if one use can serve multiple purposes, etc. I don’t pretend to have the answers but even crude estimates like those in Chart 1 suggest marked differences in ISV across industries. I am personally most interested in this aspect of wealth accounting but I do think the metrics outlined above can be a cross-check on estimates of own account intangibles like reputation and brand equity, and a way to consider Shared Value in the same (satellite) framework.

I plan to delve into ISV because these seem likely to show the highest RoI once top-down and bottom-up metrics converge. My Wharton presentation focused on one form of ISV, pre-competitive competition, because it is rich in case studies. A second form arises as corporations shift positions in value networks and chains. In both cases the initial value driver may be lowering transactions costs but the infrastructural platforms created tend to spawn new, innovative ways to add value to the network or chain. Collaborators then negotiate sharing of the increase value added.

Properly developed, such wealth accounts could inform purchase accounting, the term for what goes on in strategic planning for M&A. And since it is rooted in sustainability metrics, this approach could build a bridge between corporate strategic planners and those involved in Corporate Social Responsibility and Sustainability Reporting, which is how I define CSR.

But that is another story; my purpose here is to share a bit more about Industry Shared Value…

As Vice President for Sustainability Research at Gaia Metrics, John is responsible for the financial accounting framework the company uses to integrate social and environmental factors, and for defining new generations of the company’s benchmark indicators. In both these areas he uses what is typically called the wealth or capital approach to sustainability, an approach he pioneered as Senior Advisor in the World Bank’s Environment Department, first published in Monitoring Environmental Progress. Since relabeled the Bank’s Millennium Capital Assessment, it is the conceptual framework for, among others the Report of the Joint UNECE/OECD/Eurostat Working Group on Measuring Sustainable… [Read more about John O'Connor]