Intangibles and knowledge management

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Yesterday, I had the enjoyable privilege of participated in a session at the Digital Government Institute's Government Knowledge Management Conference. The session was a lively discussion among the panelists and audience kicked off with brief opening remarks by the panelists. The full background set of slides upon which my remarks were based are now available on line at "Measuring Intangibles as part of KM".

Bottom line: government needs to pay more attention to its intangible assets - and knowledge management activities of the federal government can help.

As readers of this blog will know, one of my pet peeves is the lack of awareness of intangibles in many of our economic polices and programs. An example I often cite is the long standing issue of the inclusion/exclusion of intangibles in the Qualified Small Issue Manufacturing Bonds program (aka Industrial Development Bonds - IBDs). As I have noted in a number of earlier postings, only traditional factories are eligible for low cost financing under this program. The 2009 stimulus bill included a minor change to allow the use of these bonds to finance facilities manufacturing intangible property. The change allowed local government to support new facilities for software development or bio-tech research facilities, for example, as well. But that provision expired at the end of 2010 and was not included in any tax extenders legislation. This simply act of putting physical and intangible investments on the same footing was forgotten and ignored.

However, new legislation was introduced in the House of Representatives just before the August recess to remedy that situation. The bill, Modernizing American Manufacturing Bonds Act (H.R. 5319), would make four changes to the Qualified Small Issue Manufacturing Bonds program, one of which deals with the intangibles issue. As a briefing paper by the Council of Development Finance Agencies (CDFA) explains:

Expanding the Definition of Manufacturing to Include both Tangible and Intangible Manufacturing Production for Qualified Small Issue Manufacturing Bonds

Issue Brief:

Qualified Small Issue Manufacturing Bonds are the bedrock financing tool for small- to mid-sized manufacturers. This financing tool has been providing affordable capital to our nation's most important industry for over three decades. Current federal law defines a "manufacturing facility" as one that produces tangible property. However, manufacturing processes, production, and technology have changed significantly since this definition was established. Today's manufacturers encompass more modern, high-tech, and intangible manufacturing practices such as bio-technology, energy generation, food processing, software, design and formula development, and intellectual property. In relationship to Qualified Small Issue Manufacturing Bonds (commonly known as Industrial Development Bonds or IDBs), the current definition as outlined in the tax code reflects an old philosophy and outdated approach to manufacturing. This outdated definition of manufacturing has resulted in the increasingly limited use of this job-generating economic development tool.

Recommendation:

CDFA proposes updating the definition of manufacturing as it relates to Qualified Small Issue Manufacturing Bonds to allow for companies who produce both tangible and intangible property to access the capital markets. The measure would broaden the definition to include facilities that manufacture, create, or produce intangible property. The expanded definition would be sufficiently broad to cover software, patents, copyrights, formulas, processes, designs, patterns, know-how, format, and similar intellectual property. Under this new definition, knowledge-based businesses could access low-cost, tax-exempt IDB financing. This updated definition would align the growing high-tech manufacturing sector with the tools necessary to finance industry growth and expansion. This change will make an immediate difference throughout the country to help retain and create jobs, spur manufacturing investment, and accelerate the nation's economy.

It is unclear what will happen to the legislation once Congress returns from recess. The proposal could once again be brushed aside as a minor point in a larger tax bill. And of course the future of any tax bill is itself very cloudy. At least CDFA is to be commended for continuing to raise the point. Maybe someday our lawmakers might just get it.

Improving how we use intangibles to boost productivity

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Thanks to a recent posting over at the Smarter Companies blog, I am catching up on a McKinsey report on Innovation Matters: Reviving the Growth Engine from June 2013. The report introduces an index of "Innovation Capital" as a combination of "Physical Capital" (i.e. ICT infrastructure), "Knowledge Capital" and "Human Capital". While this builds on the work of Carol Corrado, Chuck Hulten, Jonathan Haskel and others, I'm not sure it captures all the components of intangible capital. For example, the report talks about the need for collaboration and building the ecosystem, but never mentions relational capital. In fact a number of the policy prescriptions are aimed at building knowledge linkages i.e. social/relational capital. Nor are intangibles solely about innovation and productivity. In our current economy, intangibles are needed as inputs for ongoing operations as well.

But it was not the new index I found the most interesting. There was one graph that caught my attention: the relationship between "Innovation Capital" and productivity. The graph confirms that innovation capital (or intangible capital) is important for productivity growth. The striking feature, however, is that the U.S. gets less productivity growth from its investments in innovation capital than other nations. The U.K. gets the same amount of labor productivity growth as the U.S. from a smaller investment in innovation capital and Finland gets a much higher rate of labor productivity growth with about the same level as the U.K. investment.

Labor productivity v innovation capital - McKinsey 2013.png

The McKinsey report also has a graph on R&D spending that shows the U.S. basically on the trend line while a number of other nations, specifically Finland, Sweden and Germany, are significantly above the trend line. In other words, they get a much bigger productivity bank for their R&D buck.

TFP v R&D - McKinsey 2013.png

By the way, there is a variation the first graph in the work cited in the McKinsey report by Carol Corrado, Jonathan Haskel, Cecilia Jona-Lasinio and Massimiliano Iommi, "Intangible Capital and Growth in Advanced Economies: Measurement Methods and Comparative Results" which shows the same basic story with other nations, such as Finland, Ireland and even Slovenia get greater productivity growth from their investments in intangible capital. [Note the axis are reversed in this graph from the McKinsey graph.]

Intangible v MFP - Corrado 2012.png

These graphs were an eye-opener for me. For years I have been advocating policy measures to foster investment in and development of intangible assets. These include policy such as a knowledge tax credit and creating business assistance programs focused on intangible asset management (see "U.S. Policies for Fostering Intangibles").

But the data presented here makes another important point: increasing investment in intangibles is not enough; policy must also look at the effectiveness of that investment in raising productivity. Why is it that the U.S. does so badly in the productivity return on its intangible asset investments compared to other nations (as point out in the first chart)? This will require a new line of research as to how intangibles actually work in boosting productivity in the economy.

The McKinsey report has some insight on that with its finding about the effect of investment in "Knowledge Capital" versus "Human Capital." Their analysis shows that an investment in Human Capital generates a higher marginal return. But as I alluded to before, those two categories may be to gross for detailed investigation and may miss key elements. A more granular description is needed. In addition, the interaction between various types of intangible capital needs to be taken into account. As the McKinsey report points out, development of human capital is needed to realize any gains in other forms of capital.

Obviously, much more work needs to be done. One starting place is a more refined set of metrics about investment in specific types of intangible assets. Current efforts to collect data on these investments needs to be expanded and augmented with better official data. Likewise we need a more detailed understanding of policies in those more effective countries. A great deal of cross country studies have been done on innovation policy. But I am not aware of any that look specifically at how investments in intangible assets translate into productivity increases.

Sounds like we need to update and create a new (and rather substantial) research agenda.


Benefits of the human run factory

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Sunday's Washington Post ran an interview with Jeffrey Rothfeder about his new book, Driving Honda: Inside the World's Most Innovative Car Company. There are a number of interesting points raised in the interview ("Honda's global strategy? Go local"). He discussed Honda's decentralized localization strategy and the company's mindset of the need "to be there" i.e. to understand the product from a ground-up, hands-on approach.

One comment stood out. Rothfeder described Honda's new plant in Lincoln, Alabama. The plant makes a number of different models on the same assembly line:

That is one of the most productive and flexible auto plants in the world. Uniquely, instead of setting up assembly line stations, where one person puts in the dashboard, the next station will put the radios in, and the next one will put the steering wheel in, at Honda they have zones of workers, so the zones put in five or six things. Those zones are also required to look at quality control.
Also, every car can be built to zone specifications. Whether it's a Civic that's come down the line or an Accord, if you're putting in a dashboard, it's going to be the same process. So workers are agnostic about what car is there.

Interesting. But what he said next was more profound:

Because of the flexibility, they are one of the least automated factories. Because they need human beings to work on these cars. If you're going to have a robot put in a dashboard that has differences from one car to the next, you have to change the arms of the robot for every car. That can take hours.
Some would say that Honda not being automated and having more workers would hurt productivity. But it just shows what they make up for in flexibility. Again, their profit margins are better than anyone in the industry.
They do automate things once they feel like it has become a commodity. But once you automate, you can never improve anymore. A robot will never tell you, "Hey, I could do this better." You're limited by the technology, ironically. (emphasis added)

So maybe we are approaching this whole debate over robots replacing humans wrong. The debate is usually focused on how robots/automation can do the physical tasks while humans do the thinking tasks (such as learning). But, if Honda is right, the physical activity and the learning aspects of a job are inseparable. It is what economists call learning-by-doing. The doing/learning division of labor that seems to underpin much of the technology displacement debate comes straight from the paradigm of Frederick Winslow Taylor's "scientific management." While we claim to have long since abandoned Taylorism as an operating principle, we apparently have not shook off its hold on our conceptualizations.

Honda's factories may show a way to get past the Taylorist mindset. Humans and robots working to together - not as replacements but a compliments. As the post-Taylorist organizational theories stress, learning and development of tacit knowledge can only occur through, as Honda's philosophy say, "being there." Luckily, much of the new "maker movement" is based on the same philosophy. The spread of this doing-and-learning philosophy may be the way to really spark a renaissance of manufacturing in the United States.

[For more on public policy and post-Tayorist idea of "high-performance work organizations", see my somewhat dated paper "Time to Get Serious About Workplace Change."]


PWC and the Manufacturing Institute has put out a new report on additive manufacturing (or 3D Printing - 3DP as they call it): 3D printing and the new shape of industrial manufacturing. (Click here for the full report in PDF format.)

Their bottom line:

• Manufacturers--from small job shops to multinational industrial products firms--are crossing the threshold from tinkering with prototypes to the production of final products.
• 3DP has the potential to shrink supply chains, save product development times and increase customization offerings to changing customers with expectations that products be tailored to their preferences and needs. Indeed, 3DP has arrived on the factory floor and into R&D.
• According to a PwC survey of US manufacturers, two of three companies are already adopting 3DP in some way -- from experimenting with the technology to making final products.

One of the points I find so interesting is that last bullet about the widespread use of some form of 3D printing. Note that I carefully use the term "3D printing" rather than "additive manufacturing." That is because few of the uses are for actually manufacturing. Most companies use it only for prototyping (24.6%) or are just "experimenting to determine how we might apply" (28.9%). Only 13.1% are actually manufacturing using additive techniques (9.6% prototyping and limited production; 2.6% production for products that cannot be made from traditional methods; 0.9% for final products/components).

According to the report, one of the most likely uses for actually additive manufacturing in the near term is in after-market and obsolete parts production. Such a widespread use could dramatically change the inventory and delivery components of the manufacturing cycle by creating a one-off "Just in Time" system for end use consumers.

The report also sees increased use in the near term of additive manufacturing for low-volume, highly specialized products. Like many analysts, they see additive manufacturing complimenting/supplementing rather than replacing traditional manufacturing.

Also like many other analysts, they see additive manufacturing as a "double-edge sword" for workers: displacing low skilled factory floor workers while creating highly skilled jobs for technically trained workers. Interestingly, they find that almost half of the companies interviewed felt that there is a "lack of current expertise in our company to fully exploit the technology." This points to a large opportunity for our educational and training systems.

The challenge will be especially great for the worker training system to make sure that workers are trained in these new skills. That includes not just technical skills in operating the machinery (aka printers) but also design skills to take advantage of the technology and business skills to develop new products and markets.

I've noted before that additive manufacturing is a disruptive technology. This report gives us a better understanding of the current view from the manufacturing world. As the report states, "there are signs that the technology is on the cusp of being mainstreamed ..." Companies and individuals need to get ready for the disruption.


    Note: the views expressed here are solely those of the author and do not necessarily represent those of Athena Alliance.


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