CahierdeRecherchedel’IMRI

2009‐03

RapportdestageA.Gupta:

AStudyofMetricsandMeasurestoMeasure

InnovationatFirmLevel&atNationalLevel

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AStudyofMetricsandMeasurestoMeasure

InnovationatFirmLevel&atNationalLevel

AworkingpaperforIMRI(InstitutpourleManagementdelaRechercheetdel'Innovation)

Abhishek Gupta June 2009

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ABOUTTHEAUTHOR

Abhishek Gupta has done his Masters in Business Administration (M.B.A., International

Business) from University Business School, Panjab University, India. He has also done his

Bachelors in Commerce (Economic Honors) from GGDSD College, Panjab University, India.

A university rank holder (both in Masters and Bachelors), he has many academic

accomplishments.

During the course of his Exchange semester at Dauphine University, Paris, France in 2009,

he worked on an internship project with IMRI (Institut pour le Management de la Recherche

et de l'Innovation) for whom he has written this paper.

Abhishek Gupta has worked as Summer Trainee at Ballarpur India Ltd. (a leading paper

company) where he was responsible for promoting a new product in the market. The task

involved conducting a market research for the product and ensuring shelf space at new

counters.

He has special interests in academics and business management studies.

In case of any queries or suggestions or some other related work, feel free to contact him at

avigupta1987@gmail.com .

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ACKNOWLEDGEMENT

I would like to thank IMRI (Institut pour le Management de la Recherche et de l'Innovation)

for providing me with the opportunity of doing an internship project with them. It has been a

great learning experience and I feel honoured to have worked with some true professionals.

I would like to thank my institute, University Business School, Chandigarh, for providing me

with this opportunity of going on an Exchange Program to Dauphine University, Paris, where

I got a chance of working with such an esteem and reputed organisation, IMRI.

I express my deep sense of gratitude to Emilie-Pauline Gallié and Renelle Guichard (both

IMRI staff), for providing me with the required resources, guidance and atmosphere essential

for the execution and completion of the project. Without their support and valuable inputs at

every stage, this project would not have been possible.

I also wish to extend my gratitude to Prof. Richard Oren (Professor at Dauphine University,

Paris) for bringing me into contact with IMRI. Without his unconditional support at the

beginning, this project could never have been initiated.

Abhishek Gupta

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INDEX

Title PgNo.

Introduction 5

Definitions 6

• Intangible Assets 6

• Innovation 9

• Relation between Intangibles and Innovation 10

Intangibles – Should they be treated as Expenditure or Capital

Investment?

12

• Understanding Expenditure and Capital Investment 12

• From Business Point of View 12

• From National Accounts Point of View 13

• Mathematical Explanation 14

• Difficulty in Treating Intangibles as Expenditure 15

Measuring Innovation 17

• At Business Level 17

• Metrics to Measure Innovation 17

• Methods/Approaches to Measure Innovation at Firm

Level

20

• Methods/Approaches to Measure Innovation at National

Level

26

• Data Collection Approaches 28

Currently Used Measurement Systems 30

Conclusion 31

• Reporting of Intangibles 31

• More Work to Be Done 33

Bibliography 36

Annex 38

• Evaluation of Innovation Metrics over Generations 38

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Introduction

Today we are living in a world of knowledge economy. Innovation is more important than it

ever was, especially in this era of global economic crises where differentiation becomes the

key distinguishing factor between the performances of firms.

Empirical research and surveys show that innovation leads to new products and services,

better quality, and lower prices. In today’s knowledge economy and global economic

environment, companies have to face a lot of competition and hence differentiation has

become a key success factor. This requires continuous innovation (Lev & Daum, 2004; Stone

et al, 2008).

Through this paper I have attempted to bring about a better understanding of innovation and

intangibles and their constituents. Treatment of intangibles as either expenditure or capital

investment has also been looked upon.

I have also tried to identify metrics that can be used for the evaluation of innovation process

and focused on various approaches/methods, which can be used to measure innovation both

at firm level and national level.

Then I have looked at the various data collection approaches and what measures are used

currently by practitioners to measure innovation.

The paper ends by suggesting how intangibles can be reported and what all must be done in

the future by the government and business community for supporting and promoting

innovation as well as suggesting new areas of research for innovation.

The focus is that these measures can be further used in order to evaluate the performance of

R&D units.

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Definitions

The purpose of this section is to establish a better understanding of intangibles and innovation

as well as their characteristics. It would also identify the key components of an innovation

process.

INTANGIBLEASSETS

An intangible asset is an asset that is not physical in nature. Intangible assets don't have the

obvious physical value of a factory or equipment, but they can prove very valuable for a firm

and can be critical to its long-term success or failure. For example, a company such as Coca-

Cola or Google wouldn't be nearly as successful were it not for the high value obtained

through their brand-name recognition. Although brand recognition is not a physical asset that

you can see or touch, its positive effects on bottom-line profits can prove extremely valuable.

Corporate intellectual property (items such as patents, trademarks, copyrights, business

methodologies), goodwill and brand recognition are all common intangible assets in today's

marketplace.

Practical aspect of intangibles (Lev & Daum, 2004):

(a) Intangible assets by themselves neither create value nor generate growth: they need to

be combined with other production factors. They need efficient support and

enhancement systems – otherwise the value of intangibles dissipates much quicker

than that of physical assets.

(b) The value of intangible assets is related to the future. They represent capabilities and

“potential” for future growth and income.

Blair and Wallman (2001) have divided intangible assets into three subcategories based on

the degree to which they can be controlled and/or sold by the firm.

• Assets that can be controlled and owned by the firm and can be separated and sold,

for example, patents and databases.

• Assets that can be controlled and owned by the firm but not separated out and sold,

for example, R&D and organizational processes.

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• Assets that may not be wholly controlled by the firm and are therefore not owned by

the firm, for example, knowledge and skills of labour force.

These differences in degree of controllability and ownership not only influence business

strategies, they have strong implications for measurement and accounting.

Constituents of Intangibles

After developing an understanding of intangible assets, I would like to list down those assets,

which have been considered by researchers over a period of time as core of an innovation

process. These assets are considered economically valuable and are recognized legally. I have

categorized these assets based on works in various research papers by Vosselman (1998),

Nakamura (1999), Webster and Jensen (2006), Jarboe (2007), Marrano et al (2007), Horsten

et al (2008) and Aizcorbe et al (2009).

• Human Capital – knowledge and skills of individual employees

o Education

o On-the-job training

o Executive time

• Organizational Capital – knowledge and skills owned by the firms. These knowledge

and skills owned by the firms are usually outputs of innovation processes, which are

often used as inputs for further innovation. These are:

o Licences, Patents & Copyrights

o Brand names and Trademarks

o New processes

o Business Model

o R&D

o Mineral Exploration

o Architectural and engineering designs

o Computerized Information

Computer Software

Computerized Databases

o Reputation for quality

o Trade secrets

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• Relational Capital – knowledge and resources embodied in external stakeholders.

o Control over distribution networks

o Control over markets

o Marketing

Market Research

Market Design

Sales & Advertising

• Clever use of advertisement

Logistics

• Production Knowledge Capital – knowledge of development of new products and

processes.

o It involves the expertise and efficiency gained by the firms either over a period

or purchased for a particular product or types of products or production lines

etc., which are unique to the firm and give them an advantage.

Continuing the emphasis on importance of knowledge, human resources have been

recognized as very strong and capable intangible assets by firms as it recognized that it is the

humans within the organization who are responsible for the outcome at the end.

It can be illustrated by this figure (Frederick, 2009)

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INNOVATION

Innovation is the use of knowledge (either existing or new) to create new products or services

or processes that can be used for reaping benefits, either economic or otherwise. But

innovation in context to business is done for reaping financial benefits for the firms through

creating products or services that generate value for the customers and hence can be marketed

to them. It also involves creating processes internal to an organization, which would enable

more efficient use of existing resources and better the current way of doing things.

The article “Innovation Measurement - Tracking the State of Innovation in the American

Economy, (2008)” defines innovation as the design, invention, development and/or

implementation of new or altered products, services, processes, systems, organizational

structures, or business models for the purpose of creating new value for customers and

financial returns for the firm.

In the Oslo Manual, OECD (2005) defines innovation as the implementation of new or

significant improved products, operational processes, organizational processes and structures,

and marketing methods.

To further understand innovation, it would be interesting to mention various attributes of

innovation given by Stone et al (2008).

The 10 Attributes of Innovation (Stone et al, 2008)

Attribute 1. Innovation involves the combination of inputs in the creation of outputs.

Attribute 2. Inputs to innovation can be tangible and intangible.

Attribute 3. Knowledge is a key input to innovation.

Attribute 4. The inputs to innovation are assets.

Attribute 5. Innovation involves activity for the purpose of creating economic value.

Attribute 6. The process of innovation is complex.

Attribute 7. Innovation involves risk.

Attribute 8. The outputs in innovation are unpredictable.

Attribute 9. Knowledge is a key output of innovation.

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Attribute 10. Innovation involves research, development, and commercialization.

Application of knowledge is the key to an innovation process of which both tangible and

intangible assets form crucial parts. Since inputs to innovation are used for further innovation

processes in the future as well, they are considered as assets. But, the combination of inputs

often results into a failure that makes this process complex and risky and hence makes the

output unpredictable.

The 10th attribute given by Stone et al (2008) is derived from the three interconnected stages

of innovation given by Lev (2001).

Three interconnected stages of innovation (Lev, 2001):

1. Learning and Discovery - Whether internal to an organization or external in networks

or with partners, this stage focuses on the generation and acquisition of knowledge

and skills (the research stage)

2. Implementation - Demonstrating technical feasibility (the development stage).

3. Commercialization – Promoting product diffusion and facilitating financial and

economic returns.

To put simply, it means innovation process requires generation and/or acquisition of

knowledge and skills, either internal or external to an organization. This knowledge forms the

basis for carrying out the innovation or the implementation of knowledge as required. Once

results of innovation are positive and a new product, process, or service has been developed,

these must be commercialised in order to obtain financial returns.

RELATIONBETWEENINNOVATIONANDINTANGIBLEASSETS

Innovative activities emerge from the application of intangible assets that integrate

knowledge, skills, and technologies in the development and commercialization of products

and processes.

An understanding of the resources, tools, technologies, materials, markets, and needs in the

situation at hand is very important for innovation. Because these resources and knowledge

processes are used repeatedly and provide returns for the future, they are considered to be

assets. This is the reason why innovating organizations willingly spend significant amounts

of resources on research and the acquisition of knowledge (e.g., intellectual property).

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Rose et al (2009) suggest that innovation is driven by a firm’s (or any entity’s) investment in

tangible capital (such as computer networks) or intangible capital (such as organizational

structure or human capital/training). These innovative activities could lead to tangible outputs

(e.g., new or improved products or processes) or intangible ones (e.g., more experienced

employees, who are more likely to engage in future innovations).

Relation between Innovation and Tangible and Intangible Assets

(Rose et al, 2009)

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Intangibles–ShouldtheybetreatedasExpenditureorCapitalInvestment?

Over the years expenditures on intangibles have been expensed, i.e. they have been treated as

expenses to business rather than an investment. Even in terms of national accounts and

calculation of GDP, treating intangibles as investment or expenditure brings out different

results.

Before suggesting weather intangibles should be treated as expenditures or capital

investments, it would be important to develop a brief understanding of the differences

between expenditures and investments in our context.

UnderstandingExpendituresandCapitalInvestment

Expenditures are something, which are charged to Profit & Loss accounts of the current year

and are not included in the balance sheet as assets. Investment in assets on the other hand

would mean that the money spent on the acquisition/creation of intangibles would not be

expensed in that particular year, but would be included in the balance sheet as an asset. The

difference is interesting to understand because assets are supposed to provide economic

returns even in the future while expenditures are for a particular time period.

FromBusinessesPointofView

It is important for businesses to include their own expenditure on intangibles as investments

because

• Businesses manage what they measure.

• Treating intangible investments as expenditures would mean higher expenses, which

would lead to lower profits. It means low taxes on one hand but also lower stock

prices on the other.

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Even from the accounting point of view, rising investment in intangible assets reduces

measured current profits and raises expected future profits. The stock market recognizes that

such investments usually generate future profits. That is why investment in R&D generally

makes stock prices rise.

FromNationalAccountsPointofView

Research shows that intangible investment worth billions of dollars has been excluded from

national published data of countries. This understates all investments, income and savings.

Nakamura (1999) suggests that intangibles should be treated as investment. According to him

by not counting spending on R&D and other intangible assets as investment, US national

accounts understate not only investment but also national income and national saving. This is

because treating spending on intangible assets the same way we treat spending on tangible

assets would raise measured business investment. Thus, similar treatment would also raise

measured output of goods and services. For example: making the adjustment for R&D

investment alone would raise measured U.S. gross domestic product in the 1990s roughly 1.5

percent. (Nakamura, 1999)

Aizcorbe et al (2009) suggest treating spending on intangibles as investment would have two

primary effects on the national income and product accounts:

• It would increase GDP and gross domestic income (GDI) in periods when firms invest

in intangibles.

• It would also add a new input—intangible capital or “the stock of knowledge”— and

the value of the capital services generated by that capital would be measured in the

income account in subsequent periods.

To further emphasise the importance of treating intangibles as capital investment in national

accounts, let us study the findings of Corrado et al (2006) and Belhocine (2008).

Corrado et al, (2006) suggest that as much as $800 billion is excluded from U.S. published

data (2003), and this leads to the exclusion of more than $3 trillion of business intangible

capital stock. In order to emphasise the importance of this omission, they added this

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intangible to the growth framework used and observed the following changes in observed

patterns of U.S. economic growth.

1. The rate of change of output per worker increases more rapidly when intangibles are

counted as capital.

2. Capital deepening becomes the unambiguously dominant source of growth in labour

productivity.

3. The role of multifactor productivity is correspondingly diminished, and labour’s

income share is found to have decreased significantly over the last 50 years.

Belhocine (2008) has suggested the following impacts of omission and improper

measurement of intangible inputs in the Canadian economy.

• Since spending on intangibles is not treated as investment, aggregate savings and

investment may be significantly understated in official statistics. Monetary policy-

makers could be misled by such an imprecise picture of the economy.

• Fiscal policy can be affected in various ways such as in the design of a fair tax

system.

• Resource allocation and investment decisions within firms and across firms in a given

industry become more difficult.

• The lack of good information on intangibles will lead to opaqueness and volatility in

capital markets given the increased difficulty to estimate the future cash flows that

some investments will generate.

Hence, even from national accounts point of view, it is pretty much important to treat

intangibles as capital investment.

MathematicalExplanation

Corrado et al, (2006) have used mathematical functions to suggest that it is more suitable to

classify intangible expenditure as capital rather than as expenditure or intermediate good.

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This they have done by considering a world of three goods, consumption C, tangible

investment goods I, and an intangible N. When intangibles are regarded as being an

intermediate good, labour L and tangible capital K are allocated to the production of all three

goods, and N is an input to C and I.

According to them the concept of GDP when intangibles are treated as capital investment is

more comprehensive and larger in magnitude than when they are treated as expenditure.

(For detailed mathematical explanation, refer to ‘Intangible Capital and Economic Growth’

by Corrado, Hulten & Sichel – 2006, Pg 4)

It is of immense importance to measure and account for all the investment in intangibles

because otherwise it is detrimental to both national statistics and planning as well as to

business decision-making. Underestimating investments leads to wrong estimation of income

and savings and hence a possibility of flawed policymaking. Also because businesses use

national account data (GDP, per capita income, growth rate etc.) to make their decisions

relating to investments and operations in various countries, so business decision-making

would also suffer.

Nakamura (1999) suggests that it also leads to an impact on the stock markets as stock

markets anticipate the future earning and growth capacities of firms.

After realizing the importance of treating intangibles as investments, it is necessary to

understand why intangibles are still expensed in businesses or in national accounts.

DifficultyintreatingintangiblesasInvestments

Even though it has been widely proposed and acknowledged that intangibles must be treated

as investments because of various flaws of treating intangibles as expenditures, there are a

few obstacles, which deter researchers, businesses and national account statisticians from

doing so.

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It is a fact that it is very hard to estimate the future benefits of the intangibles and reliable

measurement may not be possible. Belhocine (2008) has established that it is hard to measure

intangibles as investments due to certain specific attributes of intangibles.

1. Visibility

2. Not appropriable

3. Marginal cost to produce an extra unit is zero

4. Uncertainty in outcome of production

5. Some elements are short lived and some are long lived

6. Lag can exist between production of intangibles and their full exploitation

Even though it is hard to measure intangibles, their importance is unquestionable both for

businesses and national accounts. I believe it is imperative to account for intangibles, as it

would enable much better and informed decision-making.

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MeasuringInnovation

After understanding the concept of innovation and realizing its importance as a capital

investment, it would be interesting to see how we can measure innovation.

AtBusinessLevel

From a business perspective, it is very important to measure innovation and keep a track of

intangibles for the purpose of innovation. It is important because usually businesses manage

what they measure (Frederick W. 2009). According to McKinsey survey 2008 (Stone et al,

2008) companies pursue four types of innovation: product, service, process, and business

model.

Hence not measuring intangibles would lead to faulty management decision-making. But, it is

also important for businesses to decide what they should measure and what they should not to

measure, as measurement of intangibles is a very expensive process.

In order to aid the decision of what should be measured and what should not be measured, it

would be interesting for businesses to follow the guidelines given by Andrew et al (2007) in

this regard. Andrew et al (2007) have categorized components of innovation that need to be

measured.

1. Inputs, or resources, such as people and money

2. Processes, which act on and transform the inputs

3. Outputs, or end results which include cash results and indirect benefits like stronger

brand

MetricstoMeasureInnovation

BCG 2007: Senior Executive Innovation Metrics Survey and McKinsey survey 2008 (Stone

et al, 2008) have given several metrics which are used by firms and several others which are

important but are not used by the firms.

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These metrics have been ranked in the order of preference or usage by the firms. The metrics

used most commonly are put on the top.

The most important metrics according to companies and reasons:

• Revenues realized from offerings launched in last 3 years – example: Percentage of

sales from new product/service

o Allows evaluation of different projects

o Provides bases for future capital allocation to different projects

o Revenue is a measure to make sure if high impact ideas are being chosen

o 3 years is considered a reasonable time period to judge performance of

innovation initiative

• Projected versus actual performance – example: Return on investment, Profit growth

due to new product/service, Customer satisfaction, Net Present Value of the entire

new product/service portfolio

o Important for internal performance measurement

o Important for communicating with the shareholders

o Forecast accuracy is considered important for revenues and profits

o Helps to hold teams accountable for delivering results

• Total funds invested in growth projects – example: R&D spending as a percentage of

sales, Number of people actively devoted to innovation, Total number of R&D

projects, Number of new products or services launched

o A measure of senior management’s commitment to innovation and growth

o Comparing R&D spending with those of competitors

o It forces to keep track of project portfolios and hence brings management’s

attention towards the project

o Long-term survival of companies is based on identifying and funding future

growth projects.

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• Allocation of investments across projects – example: Number of new projects funded

v/s number of old projects funded, Different kinds of projects funded

o Ensures balancing of money across projects

o To maintain a strategic balance between traditional and innovative products

o To recognize how much money is being spent for the future and for the

present

The BCG 2007: Senior Executive Innovation Metrics Survey also lists down metrics that are

usually ignored by the firms but are very important.

Metrics which aren’t commonly used:

• The extent to which new offerings cannibalize existing products

• The percentage of ideas funded

• The no. of projects killed or tabled at each milestone.

The McKinsey study concludes the metrics would be more useful if the firms had a way to

standardize the metrics so that they could benchmark their performance against their

competitors.

I believe the above listed metrics can provide very useful guidelines to firms to measure the

impact of innovation. Using these metrics would enable a better understanding of the efforts

put in for innovation and the desired results. Evaluating results is very important from

business perspective as it gives them a sense of direction and belief of having the ability to

achieve what they desire. Moreover, if they are able to measure their performances against

competitors, it would give them the much needed awareness of where they stand and what

they can or must do in order to do well in this competitive business environment.

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Methods/ApproachestoMeasureInnovationatFirmLevel

After understanding what needs to be measured, it is also important to understand how it shall

be measured. Different researchers have suggested different methods to measure innovation.

Cash Curve

Andrew et al (2007) have suggested the use Cash Curve for measuring innovation. According

to them each and every aspect of innovation need not be measured. One way to select which

aspects need to be measured is the cash curve.

The cash curve is a depiction of cumulative cash investments and returns (both expected and

actual) for an innovation over time, from idea generation through to the point when product

or service are removed from the market. It makes explicit 4 factors that affect the success for

an innovation and its ability to generate a return. These are:

• Start-up costs (pre-launch investments)

• Speed (time to market)

• Scale (time to volume)

• Support costs (post-launch investment)

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The following are some sample metrics for each of them.

Start-up Costs

• The number of full time staff involved

• Operating expenses

• Capital expenditure

Speed

• Actual time to market

• Time to key checkpoints

• Actual versus planned full-time employee hours

Scale

• Actual versus planned volume produced

• Actual versus planned product availability

• Actual versus planned first year sales

• Actual versus planned distribution

• Actual versus planned timing of ad campaigns

Support Costs

• The extent to which new offerings cannibalize existing products

• Marketing and promotional activities

• Pricing actions

• Key staff devoted to the project

• Product maintenance and service cost

The cash curve is an effective tool as it takes into account all the costs, volume and speed.

The problem lies in making initial estimates. If initial estimates were not good, then

comparison would be flawed.

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Balanced Scorecard

Frederick (2009) has suggested the use of a Balanced Scorecard for measuring innovation.

The balanced scorecard is a strategic planning and management system that is used

extensively in business and industry, government, and non-profit organizations worldwide to

align business activities to the vision and strategy of the organization, improve internal and

external communications, and monitor organization performance against strategic goals. It

was originated by Drs. Robert Kaplan (Harvard Business School) and David Norton as a

performance measurement framework that added strategic non-financial performance

measures to traditional financial metrics to give managers and executives a more 'balanced'

view of organizational performance.

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The balanced scorecard is one effective way as it takes into consideration even the non-

financial measures and keeps a track of companies’ strategic goals. But it does not provide a

framework to measure investment in intangibles or innovation.

Computing Aggregate Innovative Indices

Though this approach is used mainly for national level as discussed later in the paper, it is

also used at the firm level (Stone et al, 2008).

Eg. Porter’s Diamond Cluster Model attempts to explain the process of innovation as it

occurs within individual firms (Porter 1998) and Skandia Navigator links inputs such as

human and organizational capital with outputs such as innovative products, market share, and

profits.

Porter’s Diamond Model

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Monetizing Innovation – The Residual Method

Another approach to measuring innovation focuses on measuring the dollar value of

innovative activities. Some researchers, such as Lev (2001), measure intangibles as a proxy

for innovation and estimate the value of intangible assets as the residual left when book value

is removed from the firm’s market value. This residual is a catchall for intangible assets and

does not reflect the importance of various assets to a firm’s innovative productivity. Others,

such as Nakamura (2001), Corrado, Hulten and Sichel (2006); Hill and Youngman (2003),

and Arundel (2007), treat expenditures on intangible assets as investments in innovation

capacity.

The quintessential example of a company where this difference is high is Amazon, which (in

June 2007) had a book value of $550 million and market capitalization of $35 billion.

Advantages of the method:

• It offers the potential for revealing deep insight into the innovation process.

(According to Stone et al, 2008)

• It seems more transparent. (According to Stone et al, 2008)

• Explains why stock prices (market value) are different from actual physical value

(book value) of firms.

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• It is easy to understand and calculate.

Limitations of the method:

• The monetization approach is only as strong as the methodology behind the process

for monetizing the intangibles. (According to Stone et al, 2008)

• It considers innovation as synonymous to intangibles but we have seen earlier that

they are different.

Accounting Methods for Measuring Intangibles

According to Stone et al (2008), accounting guidelines traditionally treat funds spent on

intangible assets as expenses, not as investments that are expected to yield future returns. As

a result, these funds are not capitalized on the balance sheet. Since the accounting data are

relied upon by managers and outside investors, the accounting rules favour objective,

verifiable valuations such as arm’s-length, market-based transactions.

When firms are purchased, the catchall term “goodwill” is used to capture the value of the

intangible assets purchased. If the purchase price exceeds the book value of the assets, then

the difference is considered to be the value of the intangibles.

Advantages of the Method:

• Logical method.

• Easy and practical in its approach.

Limitations of the Method:

• This method can only be applied in case of Mergers & Acquisitions.

• It is like the residual method given by Lev (2001) and hence has similar limitations.

The methods discussed above like Cash Curve, Balanced Scorecard, Porter’s Diamond

Model, The Skanda Navigator give us different methodologies to use all or some of the

above-mentioned metrics. These provide as readymade tools to the firms to use the metrics

for innovation and evaluate their impact. They help in detailed planning in order to make the

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right decisions keeping in view the firms’ long-term goals and strategic plans. For example,

Porter’s Diamond Model goes to the extent of taking into consideration even the luck factor

and government policies. I would say they give the companies an insight before foraying into

the unseen territory and then evaluating their success therein. The importance of this to

businesses can never be understated.

These methods are proactive in their approach and hence go in line with modern day business

thinking and practices.

The accounting method and the residual method, though have practical usability and are used

pretty often, do not really give an insight to the businesses as to what should be measured and

what should not be measured. These methods can only be used to determine the value of

intangibles. They do not suggest any course of action to be followed by firms.

Methods/ApproachestoMeasureInnovationatNationalLevel

Computing Aggregate Innovative Indices

The aggregate indices approach (Stone et al, 2008) is frequently used in evaluating the level

of innovation within a nation or other political unit. This approach focuses on applying an

understanding of the innovation process and assessing the factors that play a critical role in

innovation.

The European Union’s European Innovation Scoreboard ranks the innovation of European

nations.

The EU Scoreboard includes indicators such as:

• Broadband penetration rate (lines per 100 people).

• Participation in lifelong learning (percentage of population age 25 to 64).

• Investment in people and business R&D expenditures.

• Early stage venture capital.

• Employment in high technology industries.

• New patents issued.

• New trademarks approved.

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According to Stone et al (2008), as a tool for studying innovation, the aggregate indices

approach is useful only in a very narrow range of applications.

Advantages of the method:

• This approach typically collects data about a wide variety of innovation factors.

• In making comparisons among political units, this approach can allow for fine

discriminations.

Limitations of the method:

• Only limited financial data are typically collected.

• The primary focus of the data-collection effort is on qualitative data (allowing for a

few exceptions).

• Further, the indices are typically created based on correlation analyses. As a result, the

data are for the most part limited to producing scorecards or providing descriptive

analyses of the innovation within a firm, political unit, or country.

Contribution of Intangibles to Growth – Indirect Method

Nakamura (2001) focused on measuring the total investment in intangible assets and its

contribution to growth. He figures out the correlation between GDP and consumption. He

says that an increase in consumption is due to intangibles, which have not been accounted

for. He used several methods to estimate the investment in intangible assets.

• First, he estimated the number of employees in innovative occupations such as

engineering, science, and the arts and then used their median pay to estimate the

amount of investment.

• Second, he estimated the decline in the percentage of revenues attributable to the cost

of goods sold. He argued that the decline is due to increased investment in intangible

assets.

• Next, he used an indirect method. Evidence shows that the ratio of consumption to

GDP is relatively stable, assuming all investment is properly measured. If true, this

implies that a rise in consumption indicates some investment (such as intangibles) is

not being counted.

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• Finally, he measured the direct expenditures used to develop intangible assets. He

estimated that $1 trillion per year is invested in intangible capital.

Advantages of the method:

• Brings out the impact of not treating intangibles as investment.

Limitations of the method:

• It is an indirect method. So the results obtained are just estimations.

• Other direct methods can give more precise results.

As studied earlier, it is essential to measure innovation even at the national levels. The

methods discussed above are not very precise and do not give exact evaluations but provide

fair estimates.

I believe more work needs to be done in order to establish measures to evaluate innovation at

national levels.

DataCollectionApproaches

After looking after methods/approaches to measure innovation, it is important to learn how

data is collected for this purpose.

Data Collection Approaches

There are 4 types of data collection approaches (Belhocine, 2008):

1. “Bought-in” expenditure data. These data consist of items that have a recorded

transaction on the market. These data are typically available if a survey of purchases

exists, for example, in the case of pre-packaged software.

2. A second approach to collecting data relies on the consequence of the non-existence

of bought-in expenditure data. It consists of gathering the revenue estimates of

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knowledge- good providers. For example, the revenues of the advertising industry can

be used as an approximation for firms’ expenditures on advertising.

3. A third type of data that is used stems directly from activities of the firm, which is

known as “own-account” spending or “self-constructed” goods.

4. Educated guess on the size of some spending given certain background information.

For example, the own-account spending on organizational change and development is

set as 20% of the wage of executives by Corrado et al. (2005).

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CurrentlyUsedMeasurementSystems

We have seen in the paper earlier what different measurement systems can be used and how

data can be collected. It is also quite interesting to see the different measurement systems,

which are being used by practitioners these days.

Four measurement systems currently popular among practitioners to manage intangible

resources (Bontis et al, 1999):

(i) Human resource accounting;

(ii) Economic value added;

(iii) The balanced scorecard; and

(iv) Intellectual capital

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Conclusion

It is has been accepted that intangibles investments need to be measured and innovation is

very essential in this knowledge economy. Treating intangibles as capital investment is better

for both the national accounts as well as for the firms, as we have established earlier. A few

measurement systems have been discussed along with their advantages and disadvantages

(wherever feasible) which are used currently and which can be used in the future.

I believe firms should use measures that they believe are flexible and more suited to their

business needs because each measure is different in its approach. All methods have their

positives and negatives, so I would suggest the firms shall consider the innovation metrics

and know what they need to measure.

In case of measurement for national accounts, the residual method suggested by Lev (2001) is

a very handy method to study the impact of intangibles but is not the right measure for

measuring either intangibles or innovation.

LookingAhead

During the course of the paper it has become quite evident that it is important to report for

intangibles. But usually firms don’t understand how to do that. Frederick (2009) has given

some suggestions for solving the problem of intangible reporting.

Also we shall see what the governments and businesses must do for innovation in the future

and new areas of research for innovation.

ReportingofIntangibles

After developing a thorough understanding of intangibles and innovation and the importance

of measuring innovations, we shall look at various ways of reporting intangibles.

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Frederick, W. (2009) has given the following suggestions for solving the problem of

intangible reporting.

1) Fundamental overhaul: rethinking the accounting treatment of intangibles:

• Capitalisation of a great number of expenditures that could be considered

investments such as training. • Dual track reporting with “core” information that corresponds to existing

reporting and supplemental information provided under a different reporting

framework that does not require the same standards of verifiability as

accounting statements. • American Institute of Certified Public Accountants (AICPA) resulted in a

report by the so-called Jenkins Committee (a) Disclosure of more forward looking information such as business

plans, opportunities, risks and uncertainties (b) More emphasis on factors leading to long term values, including

non-financial measures that indicate how the important business

processes are functioning (c) A closer connection between the information used internally for

management of the company and the information that is publicly

released. 2) Disclosure of greater detail in the existing reporting framework:

• Accounting need not be altered fundamentally.

• New information can be provided as supplemental disclosures in footnotes.

• Key non-financial performance indicators must be identified and discussed.

3) Supplemental reporting outside of the existing accounting framework:

It says fundamental change to traditional financial reporting is neither feasible nor

desirable.

• It is not desirable because the existing system of accounting and financial

reporting will not yield the information that is required, • Nor feasible because barriers prevent change to the accounting system and

because the existing system works; it provides a certain group of users with

adequate–if not perfect–information on what they need.

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• As a result, an entirely new form of reporting is needed that is designed

specifically for the needs of users and is separate from traditional accounts.

Moreworktobedone

Innovation is very important today for nations at large and businesses in general. Hence

(Innovation Measurement - Tracking the State of Innovation in the American Economy,

2008) has suggested what the government and businesses should do for innovation.

In particular, it recommends that the government:

• Create a stronger framework for identifying and measuring innovation in the national

economy.

o Create a supplemental innovation account for the National Income and

Product Accounts (NIPAs) in order to expand the categories of innovation

inputs and allow those inputs to be tracked as they flow between industries.

o Improve service sector data and increase survey coverage to provide the data

needed to improve estimates from the integrated GDP/productivity accounts

and supplemental innovation account.

• Better leverage existing data among the statistical agencies to allow for the consistent

estimation of the contributions of innovation in the gross domestic product (GDP) and

productivity accounts and to develop greater understanding of innovation.

o Develop linkages within and between existing data; for example, develop

linkages between establishment-based data sets and firm-based data sets to

provide both greater consistency in estimations and to provide researchers a

broader range of innovation data.

o Develop more robust classification methods; for example, classify firms on the

basis of both domestic and international activities

• Increase access to data in order to facilitate more robust innovation research.

• Convene one or more workshops or forums under the auspices of the Secretary of

Commerce to discuss innovation drivers, impediments and enablers.

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• Continue participation in the international dialogue related to measuring and

analyzing innovation and ensure that U.S. efforts are internationally compatible to the

extent possible.

• Consider development of a national innovation index when more work has been done

on both data collection and analysis of innovation drivers.

• Support funding necessary to implement the above recommendations.

In particular, the paper recommends that the business community:

• Create, expand and assess firm and industry level measures of innovation and develop

best practices for innovation management and accounting.

o Institute firm-level measures of innovation to test the correlation of particular

measures with known innovation and to measure innovation in the firm and its

impact on firm performance. Possible measures might be based on market

share or on innovation intensity.

o Develop and implement best practices in innovation management and

accounting.

• Participate in research activities and, as appropriate, make innovation information

available to researchers.

The same paper (Innovation Measurement - Tracking the State of Innovation in the American

Economy, 2008) also suggests some new areas of Research Exploration

In particular, it recommends exploration of the following research areas:

• Identification and assessment of innovation outcome measures.

o Assessment of the effectiveness of measures based on market share as

innovation measures and the feasibility, cost, and burden of developing such

measures.

o Assessment of the feasibility, cost, and burden of developing measures of

innovation intensity, including a review of other countries’ experience in this

area and consideration of a pilot project.

o Analysis of the qualitative and quantitative impacts of specific drivers,

impediments and enablers on innovation outcomes

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• Identification of gaps in innovation data and how they might be filled.

o Identification of new data that would be useful in measuring innovation.

o Assessment of the feasibility, cost and burden of collecting data on intellectual

property transactions

o Identification of ways to overcome gaps and shortcomings in historical

measures of intangible investments.

• Analysis of relationships between innovation activities and collaboration, innovation

performance and firm performance.

o Analysis of the relationship between innovation and occupational employment

using firm-level micro-data

o Evaluation of whether firms with high innovation intensities perform better

than otherwise similar firms with low intensities

o Assessment of the effect of collaboration on innovation outcomes and

identification of the key elements of successful collaborative activities

o Assessment and analysis of cross-national innovation activities of firms

o Analysis of publicly filed financial and other data on firms, particularly as the

data become more user-friendly, to identify innovative practices and firm.

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ANNEX

Evaluation of Innovation Metrics over Generations

The indicators for intangibles have evolved over the years as we have moved towards a

knowledge based economy.

Milbergs and Vonortas (n.d.) portrayed innovation metrics as evolving through four

generations (see Table 3):

• The first generation of metrics reflected a linear conception of innovation focusing on

inputs such as R&D investment, and the like.

• The second generation complemented input indicators by accounting for the intermediate

outputs of S&T activities.

• The third generation focused on a richer set of innovation indicators and indexes based on

surveys and integration of publicly available data.

• The fourth generation metrics of the knowledge-based networked economy remain ad hoc

and are the subject of measurement.