March 2009 Archives

This morning, Athena Alliance published a new Working Paper: Frameworks for Measuring Innovation: Initial Approaches by Susan Rose, Stephanie Shipp, Bhavya Lal and Alexandra Stone of the Science and Technology Policy Institute. This paper utilizes and builds on the discussion of innovation published in an earlier report by the authors for the BEA - Measuring Innovation and Intangibles: A Business Perspective (also available on the Athena Alliance website).

We know that innovation is a key driver of economic growth. As such, governments and private firms seek to foster and manage innovative activity. However, our understanding of innovation, including our measurement ability, is still not adequate. As the Commerce Department's Advisory Committee on Measuring Innovation in the 21st Century Economy noted last year, we need "a stronger framework for identifying and measuring innovation in the national economy." In this paper, the authors seek to answer that challenge.

The report begins with a working definition of innovation that includes 10 attributes:

• 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.


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

One of the important points under attribute 4 is how intangible & tangible assets relate to innovation. The authors offer the following diagram (as also elaborated more on in the companion piece, Measuring Innovation and Intangibles: A Business Perspective).

Intangibles are not innovation -- but are inputs into the innovation process and are outputs from innovation. That is an important point to keep in mind.


The report then proposes two frameworks for measuring innovation:

• Framework 1 - Measures innovation activity by measuring the intangible assets that are created by and fed back into the innovation process at the firm or organizational level, which can then be scaled to the national level.


• Framework 2 - Measures innovation investments, especially the broader investments that set the stage for innovation.

The report goes on to provide an illustrative set of data sources for both frameworks, which demonstrates that appropriate data can be collected. Some of that data is already collected by the government, such as the National Science Foundation's data on R&D spending. Others are collected by private sources, such as Computer Economics data on information technology (IT) spending, staffing, and technology trends. Other data, such as the organizational capital embodied in design and prototyping, can be proxied from other data, in this case, by the revenues of engineering and design firms as collected by Census.

As the authors point out, the choice of framework used depends on the goal of the exercise. If the goal is to understand which parts of innovation (for example, R&D or alliances) contribute to growth and to understand the process, the first framework is more useful. Innovation researchers would prefer this framework because it would provide more detailed insight into the innovation black box.

The second framework is the one most able to capture the basic investments contributing to productivity and growth. This approach is much more fundamental and flexible in that it encompasses all innovative activities, even those that are not now known.


I am especially happy that Athena was able to publish this report. The frameworks presented in this report provide an important guide for future research, especially in the development of future data sources.

As all (sports) eyes converge on Detroit this weekend for the NCAA Final Four, all (economic) eyes will also be converging on the city's "brand" industry: autos. Today, the White House will announce details of its auto industry survival package. But leaks and actions have already outlined much of the plan, including the firing GM head Rick Wagoner (see stories in the Washington Post, New York Times, the Wall Street Journal and Politico). The Administration has rejected the company submitted plans and essentially said "try again." According to the White House fact sheet:

• Viability of Existing Plans: The plans submitted by GM and Chrysler on February 17, 2009 did not establish a credible path to viability. In their current form, they are not sufficient to justify a substantial new investment of taxpayer resources. Each will have a set period of time and an adequate amount of working capital to establish a new strategy for long-term economic viability.


• General Motors: While GM's current plan is not viable, the Administration is confident that with a more fundamental restructuring, GM will emerge from this process as a stronger more competitive business. This process will include leadership changes at GM and an increased effort by the U.S. Treasury and outside advisors to assist with the company's restructuring effort. Rick Wagoner is stepping aside as Chairman and CEO. In this context, the Administration will provide GM with working capital for 60 days to develop a more aggressive restructuring plan and a credible strategy to implement such a plan. The Administration will stand behind GM's restructuring effort.


• Chrysler: After extensive consultation with financial and industry experts, the Administration has reluctantly concluded that Chrysler is not viable as a stand-alone company. However, Chrysler has reached an understanding with Fiat that could be the basis of a path to viability. Fiat is prepared to transfer valuable technology to Chrysler and, after extensive consultation with the Administration, has committed to building new fuel efficient cars and engines in U.S. factories. At the same time, however, there are substantial hurdles to overcome before this deal can become a reality. Therefore, the Administration will provide Chrysler with working capital for 30 days to conclude a definitive agreement with Fiat and secure the support of necessary stakeholders. If successful, the government will consider investing up to the additional $6 billion requested by Chrysler to help this partnership succeed. If an agreement is not reached, the government will not invest any additional taxpayer funds in Chrysler.


• A Fresh Start to Implement Aggressive Restructurings: While Chrysler and GM are different companies with different paths forward, both have unsustainable liabilities and both need a fresh start. Their best chance at success may well require utilizing the bankruptcy code in a quick and surgical way. Unlike a liquidation, where a company is broken up and sold off, or a conventional bankruptcy, where a company can get mired in litigation for several years, a structured bankruptcy process - if needed here - would be a tool to make it easier for General Motors and Chrysler to clear away old liabilities so they can get on a path to success while they keep making cars and providing jobs in our economy.


• A Commitment to Consumer Warrantees: The Administration will stand behind new cars purchased from GM or Chrysler during this period through an innovative warrantee commitment program.


• Appointment of a Director of Auto Recovery: The Administration also announced that Edward Montgomery, a top labor economist and former Deputy Secretary of Labor, will serve as Director of Recovery for Auto Workers and Communities. Dr. Montgomery will work to leverage all resources of government to support the workers, communities and regions that rely on the American auto industry.

GM is at least one generation behind Toyota on advanced, "green" powertrain development. In an attempt to leapfrog Toyota, GM has devoted significant resources to the Chevy Volt. While the Volt holds promise, it is currently projected to be much more expensive than its gasoline-fueled peers and will likely need substantial reductions in manufacturing cost in order to become commercially viable.

They also see GM getting rid of Saab, Saturn and Hummer as a positive. As I've argued before, I hope that Saturn is spun-off and not shut down. It started as an innovative company and should be given a chance to fulfill that potential. (In case you missed it, Saturn has been running "we are still here" ads during the NCAA basketball games.)

The last part of the plan may be the most telling. It appoints a Director of Recovery for Auto Workers and Communities changed with dealing with the economic dislocation. As I've noted before, the auto industry task force has to missions: creating a new industry and mitigating the effect of the demise of the old industry. In my earlier comments, I thought those two missions were an either/or. Now I am beginning to believe they are really a both/and. Creating the new industry will require mitigating the negatives. It sounds like auto taskforce has laid out a plan for that latter. It remains to be seen if they can pull off the former.



By the way, on the Final Four: Go MSU! As a diehard Wolverine, giving any credit to my across state rival is tough. But Big 10, and especially Michigander loyalty wins out.

This morning I heard distinguished speakers once again repeat a questionable statement: that green technology will save American manufacturing.

Why do people think that the US is going to walk into the world market and outcompete everyone in a technology that is wide spread - and where, in some case, we are already behind?

Of course to revive manufacturing we will need to make products that the rest of the world wants to buy. Of course hybrid/alternative fuel vehicles and green technologies are important for both economic and environmental reasons.

But the ultimate question is not just what we make. It is how we make things. If we don't change how we make things, all the green technologies we developer here in the US will be end up being made elsewhere. That is a topic that some on Capitol Hill and elsewhere are focusing on (see earlier posting).

Part of the answer to that question is production costs. And part of US production costs are health case costs. Solving the health care cost issue will help solve the manufacturing.

Another part of the answer is the production process (and issue of productivity). The production process has changed over the past few decades. It has become more knowledge and intangible intensive. It has become more collaborative. The old categories of manufacturing and services are becoming fused (see earlier posting).

On the issue of collaboration, new technologies (i.e. cloud computing and virtual worlds) and organizational structures are driving the changes. As we argued in Virtual Worlds and the Transformation of Business:

Government policy should focus on the fact that the U.S. will compete based on its ability to develop collaborative skills, not traditional business skills. Innovative policies should help corporations bring in social networking practices. Changes in the tax code could encourage investment in collaboration skills, networks of collaborative enterprises, and a new collaborative infrastructure. The federal government and states should also promote policies to promote faster development of cloud computing, scalable data storage, and open networks. They should also develop innovative training programs that educate businesses and employees about how to use collaborative technologies and integrate them into traditional disciplines.

In other words, we need a policy built on the new realities of the production process.

The folks over at Marketmerge have published an interesting report on the role of IP in M&A activity. According to the survey of both private equity and corporate players, IP is becoming a more important factor in M&A transactions. But, issues of valuation are of concern. As the report notes:

respondents believe IP value is not fully reflected in traditional valuation methods like cash flow projections. Respondents rated exposure to patent litigation, freedom to operate and strength in key markets highest (at least 4 out of 5) in terms of importance, and yet all of these factors are overlooked or not readily incorporated by traditional valuation models. The failure of traditional valuation models to capture the unique features of IP assets and risks contributed to the particularly strong dissatisfaction of private equity respondents with current valuation techniques.

In other words, it is important to include intangibles (infringement risk, freedom to operate) in the valuation process for other intangibles (IP). This need to look at the intangibles of intangibles illustrates just how hard the valuation process really is. It is not clear to me that financial valuation models can ever incorporate all these factors. Better disclosure is probably the real goal.

Interestingly, there is a split between private equity and corporate responses to the problems of disclosure. Private equity respondents saw the failure to identify IP risks as a major problem in due diligence, whereas corporate respondents were more concerned about insufficient due diligence resulting in the failure to identified IP opportunities. That split probably reflect the differing motivations -- investment versus operation. Each perspective has a slightly different take on what information is most important in the disclosure (due diligence) process.

PS - thanks to Mary Adams over at the blog IC Knowledge Center for bringing this to our attention.

Yesterday's speech by President Obama on clean energy also touched on general issues of technology policy. One of which was that the proposed budget makes the R&D tax credit (more correctly called the Research and Experimentation Tax Credit) permanent. As the White House press release points out, "The credit has been extended 13 times with some extensions lasting just 6 months, and has also been allowed to lapse for almost a year - undermining its effectiveness because companies can't count on it."

This is not the first time budgets have been proposed that makes the R&D tax credit permanent. Every time, Congress has decided that it can save a little money in the budget process by passing a limited extension. With a price tag for the R&D tax credit of $75 billion and a lot of political backlash against the President's multi-trillion dollar budget, I'm sure Congress will be tempted to take the short-term extension route once again.

Funny thing, however, is that the short-term extension route doesn't really save any money overall. It simply is a budget policy game. The tax credit is still available each year and the money paid out (or technically, the taxes not collected). What it does do is undermine the effectiveness of the programs. With all the uncertainty, the incentives that the tax credits are supposed to provide look to companies to be shaky -- thereby rendering them less of an incentive.

In a perverse way, such budgetary games may save the taxpayer money. By reducing the certainty and therefore the power of the incentive, fewer companies undertake activities that qualify for the tax credit. Thus, its expenditures are lower that what it might be. On the other hand, the multiple extensions waste more tax payer money by making the program less effective.

It is like our no-cost approach we are trying to take toward zombie banks (as I mentioned yesterday). "Let's try to do is as cheaply and as risk-free to the taxpayer's as possible -- thereby guaranteeing that it really won't work and therefore actually increasing the cost to the taxpayers." It is like the standard excuse for failure -- "well, I'll try."

As Yoda once said: "do or do not, there is no 'try'." Or ask Nike has told us for years, "Just do it."

That is my advice to Congress on the R&D tax credit. Just do it!

More on mark-to-myth from an op-ed by James Chanos in today's Wall Street Journal - We Need Honest Accounting

Mark-to-market (MTM) accounting is under fierce attack by bank CEOs and others who are pressing Congress to suspend, if not repeal, the rules they blame for the current financial crisis. Yet their pleas to bubble-wrap financial statements run counter to increased calls for greater financial-market transparency and ongoing efforts to restore investor trust.
. . .
Obfuscating sound accounting rules by gutting MTM rules will only further reduce investors' trust in the financial statements of all companies, causing private capital -- desperately needed in securities markets -- to become even scarcer. Worse, obfuscation will further erode confidence in the American economy, with dire consequences for the very financial institutions who are calling for MTM changes. If need be, temporarily relax the arbitrary levels of regulatory capital, rather than compromise the integrity of all financial statements.

My thoughts exactly.

On Friday, the Department of Energy announced the first award under its loan guarantee program, "a $535 million loan guarantee for Solyndra, Inc. to support the company's construction of a commercial-scale manufacturing plant for its proprietary cylindrical solar photovoltaic panels." The program was created back in the Energy Policy Act of 2005 -- Title XIII - Incentives for Innovative Technology.

Unlike other programs, this loan guarantee is explicitly not an R&D program. Its purpose is the commercialization of new technologies. It is targeted at overcoming the problem of scaling up from the proven demonstration stage to the full-scale commercial operating stage.

It is interesting to note that the program recognizes the importance of intangibles in the commercialization process. The regulations on the loan guarantee program (10 CFR Part 609) acknowledges that fact by explicitly requiring access to the intangibles be safeguarded if the loan goes into default:

§609.10 Loan Guarantee Agreement
(11) The Loan Guarantee Agreement and related documents include detailed terms and conditions necessary and appropriate to protect the interest of the United States in the case of default, including ensuring availability of all the intellectual property rights, technical data including software, and physical assets necessary for any person or entity, including DOE, to complete, operate, convey, and dispose of the defaulted project;

Given that, it would be interesting to know if DOE's Credit Review Team required Solyndra to put up its intangibles as collateral on the loan, whether DOE even took those intangibles into account, and how they valued them.

On Friday, I was at a Google DC Talk on a new paper Envisioning the Cloud: The Next Computing Paradigm, written by the consulting firm Marketspace and commissioned by Google. The paper was a good summary of the potential of cloud computing (where the information resides at large data centers and is therefore much more accessible). According to the press release:

The paper outlines key factors that can allow consumers, businesses and the government to realize the full potential of the cloud:
   • Full connectivity: Government policies should encourage the deployment of wireline and wireless broadband access so that users can access cloud-based services anytime, anywhere.
   • Open access: A combination of market forces and FCC enforcement of existing laws can ensure users enjoy unfettered access to the Web sites and services of their choice.
   • Reliability: Competition will continue to drive cloud providers to enhance their reliability. Many companies already offer contracts that effectively guarantee near 100 percent uptime.
   • Interoperability and user choice: Because cloud computing is at such a nascent stage, forcing standards of interoperability may actually impede innovation. Because consumers already demand interoperability and portability, the market will drive providers to compete on these bases.
   • Security: Cloud providers must make a compelling case to users that their data is safe. While competitive market forces will drive service providers to differentiate themselves on security, the government can play a role by aggressively enforcing cyber-crime laws.
   • Privacy: A combination of market-driven policies and government action can best protect the data that consumers and businesses store online. Industry should develop common standards for security and privacy, and institute more protective and transparent privacy policies. Government should shield consumer data from inappropriate government scrutiny and define the rights of companies to use data about their users for commercial purposes.
   • Government adoption: The federal government should become an early adopter and fund research. It can also accelerate competitive forces by insisting on standards to enhance privacy, security, openness, sustainability and interoperability.

These recommendations fit with the conclusions of our own report on Virtual Worlds and the Transformation of Business, specifically the recommendation that government policies address the need for the technical infrastructure. Cloud computing is a key enabling technology to allow for a variety of new collaborative technologies, such as virtual worlds. As our Virtual Worlds report points out:

online social networking and Web 2.0 platforms are likely to transform core business operations and interactions with suppliers, customers, and supporting services. Virtual Worlds platforms that form the core of a new corporate operations ecosystem will not only allow for horizontal and vertical interactions but will expand the essential business, partner, and management linkages that enhance productivity over the long term.

Getting the cloud right is an important step toward reaching that potential. This new paper points us in the right direction.

With the release of the Treasury Department's latest program to deal with toxic assets, it might be helpful to go back to basics. Here is the general problem, as outlined by Tim Geithner in an oped in the Wall Street Journal:

Many banks, still burdened by bad lending decisions, are holding back on providing credit. Market prices for many assets held by financial institutions -- so-called legacy assets -- are either uncertain or depressed. With these pressures at work on bank balance sheets, credit remains a scarce commodity, and credit that is available carries a high cost for borrowers.

Last November, Hank Paulson made a very revealing comment in an interview in the FT :

"There are two ways of getting at illiquid assets," he said.
"One is to purchase them and have a price discovery that comes with that and the capital flows that come with that.
"The other is making sure banks have plenty of capital and encouraging them to continue the process of recognising losses and selling these assets."

For some time, we have been following the latter approach, referred to as "recapitalization" or, by some, as "nationalization." The new plan is based on the former.

In either case, there are a few major challenges. The financial system needs some incentive to disclose and get rid of the toxic assets (now called "legacy assets"). Some banks have already bitten the proverbial bullet and written-off those losses. Others seem to be unwilling to take the hit - probably for good reason since such a write-down might jeopardize their very existence. In some cases, they appear to be holding out for the "mark-to-myth" solution where market-to-market accounting rules will be suspended and they can value these illiquid assets at whatever looks good for the balance sheet. The danger with this approach, however, is that it simply allows the bad assets to fester. And, as long as the bankers and everyone else is sitting there looking at a pile of junk being counted on the balance sheet, lending will not resume. Therein lies the way to create our own "lost decade" similar to Japan in the 90's.

Creating the incentives to get the bad assets off the books is therefore key - Paulson's "encouragement." The nationalization route, to me, never had enough of an incentive to the banks to take the write-off hit. Bankers could simply take the cash and sit on it. Even with almost compete national ownership, the government had limited control -- witness AIG. So I have long favored the bad asset purchase approach.

In this case, however, the political system has put constraints on the process. Politicians and the public understand that the government has to absorb the risk if the banks are to give up the bad assets. But they don't want the government to put taxpayer dollars at risk. At the same time, they are putting pressure on the accounting system (through calls for suspension of mark-to-market) to lessen the regulatory requirements to write off the bad assets.

In other words, everyone is looking for a no-cost way to get around the basic fact that trillions of dollars of asset value has vanished. As long as the financial system refuses to write off those losses, the system will remain both frozen and fragile.

Here is a great example of the resistance of corporate executives to disclosing data. Seems that Bank of America tried to claim that information on whom and how much it paid out as bonuses was a trade secret. According to a story in today's Wall Street Journal, however:

In his ruling, the judge found Bank of America didn't make efforts to keep compensation data confidential, other than to encourage employees not to discuss pay in the workplace. There also is no evidence the bank took measures to prevent employees from sharing compensation information with third parties, the judge said.

"The record indicates that Bank of America has not taken the kind of measures to protect the secrecy of its employee-compensation information that one would expect it to have taken if this information were a trade secret," the judge said.

The judge also found that New York's Martin Act gives the attorney general the discretion to decide whether to keep information he gathers in the course of an investigation secret or make it public.

The short list is now out in the FT's Climate Change Challenge and the public is asked to vote for the winner. The five finalists (as described by the FT) are:

Carbonscape: A New Zealand company that has developed a machine to turn biomass such as agricultural waste into carbon-rich material, locking up the carbon that would otherwise enter the atmosphere as carbon dioxide. The material, known as biochar, could also be used as fertiliser or fuel.

ADEF: A US company founded by a former truck salesman, which has a $50 wheel cover for heavy trucks called the Deflektor. It is estimated to reduce fuel consumption by 2 per cent, giving a very quick return on the investment.

Kyoto Energy: A Kenyan company selling $5 solar cookers made of cardboard and acrylic. The cookers, which have recently gone into production in Nairobi, fight both deforestation in Africa and the health problems caused by cooking on wood fires.

Neem Biotech: A British company producing a feed additive called Mootral, to be fed to cows and sheep to reduce their flatulence. Farm animals make a significant contribution to greenhouse gas emissions and are attracting increasing interest from policymakers.

Loughborough University: British academics have designed ceiling tiles that can cool rooms, to be used alongside or instead of conventional air-conditioning systems. Air conditioning accounts for a significant proportion of electricity use, particularly in the US, and is growing rapidly in the developing world: reducing its demand for power could make a real difference to energy consumption.

As I noted in my earlier posting, the competition was open to more than just new technologies. The five finalists, however, are all in what I would call the gadget category. A number of ideas that were on the long list, however, focused on organization or business models:

Clean Gas Technology: "Thermal plasma" - gas heated to over 3000C - is used to treat combustion gases from factories and power plants and separate carbon and other pollutants. The technology has a valuable byproduct: raw materials that can be used to make products like plastics or paint.

Low-cost Bamboo Housing: Pre-fabricated housing kits made from bamboo will meet the growing demand for affordable housing in Latin America. The project aims to reduce demand for timber from rainforest trees and the use of expensive, energy-intensive materials like concrete and steel.

Biogas from Cassava Waste: Methane emitted from cassava crop waste will be used to generate zero emissions energy. The process will prevent emissions from rotting crops and create cheap, renewable, grid-connected electricity and organic fertiliser for low-income farmers.

Consumer Solar Packages: Owners of large-scale residential or commercial real-estate are offered free installation of solar thermal technology in return for signing a long-term utility agreement to purchase energy at a capped discounted rate. The innovative business model removes the key barriers to adoption: up-front costs and the risk of energy price fluctuations.

Solar Powered ICT Centres: A franchise network of solar-powered multi-media service centres aims to transform impoverished communities in developing countries. They will provide computers with Internet access and a cinema, offering a portfolio of pay-per-use entertainment and education services.

Customised Climate Forecasting: An easy-to-use, web-based tool will provide businesses and governments with the information they need to adapt to climate change. It will show how changes of temperature, rainfall and winds are likely to affect specific locations in the future, enabling customers to develop strategies for minimising risk.

Texting for shared taxis: This system will allow people to text their travel destinations to a central computer that will arrange for customers going to the same place to share taxi. It is designed to reduce congestion and fuel usage and meet the demand for quick and safe travel.

Some great ideas there that I hope are pushed forward, even though they are not finalists.

John Carney over at the blog Clusterstock as a great observation on the suspension of mark-to-market - or what he calls "mark-to-myth":

To put it differently, there's a serious risk of moving from mark to market to mark to myth. Do we really want financial statements to end with: here be dragons? Or, more seasonally, do we think its a good idea to allow companies to bet that there will be a little man with a pot of gold at the end of the rainbow that will form once the storm has passed?

There is a cautionary lesson here for reporting of intangibles, however. We need to avoid that "here be dragons" trap. While I argue for a safe harbor provision to allow for non-GAAP disclosure on intangibles (see earlier posting), the statements need to be carefully grounded in solid reality. That means coming up with some good standards for disclosure and valuation.

The outrage over AIG's recent bonus payments has draw greater attention to the issue of employee rewards in general and retention bonuses in particular. As the Wall Street Journal notes, even the AIG issue has been around for awhile:

In negotiating rescues of AIG late last year, some within the government argued the bonuses should be curtailed. Others said that such a move could cause employees to flee and prompt the firm's collapse. Instead, the government looked for other ways to limit executive compensation, including capping severance pay.

That statement highlights the purpose of the bonus - to keep key people from leaving as the ship is sinking. What we need to understand is whether these bonuses did that - or whether they were really based on past promises. That seems to be a point of contention. As the Washington Post reports:

Executives say they must pay retention bonuses to keep employees who are unwinding its Financial Products division, which nearly brought down the insurance giant with trading in exotic derivatives.

But a former senior Financial Products executive who spent eight years at the firm disagreed. Because the division is shrinking and no longer seeking new business, many workers have lost their relevance. The only key positions are employees who are working to extricate AIG from $2 trillion worth of outstanding contracts, the executive said.

"The guys who are getting paid all the big money are not really the ones who are important to the company," he said.

Justly or unjustly, retention bonuses have been seen as just the latest version of that story. Last year, I complained about Circuit City handing out retention bonuses for top executives while it laid off workers to replace them with lower-paid new hires. In other words, Circuit City was bribing the same executives who were driving the company into the ground to stay around to finish the job. Given Circuit City's final liquidation, it looks like at least that strategy succeeded.

Talent, i.e. human capital, is a critical part of any organization operating in today's I-Cubed (Information, Innovation, Intangible) Economy. It would be impossible to underemphasize this point. Attracting and retaining human capital is key to economic success -- along with development and nurturing that talent. The employee compensation systems are an important part of that attraction and retention process.

But our employee compensation systems are broken. The result is that our human capital system is broken. With a broken human capital system (and there are many other problems as well), we can not compete or prosper in this economy. Fixing the employee compensation system is part of assuring future economic success.

The CEO of AIG, Ed Liddy, goes before a Congressional hearing this morning. He will certainly be treated to an experience that maybe akin to that of being in the center of the Roman Coliseum when the lions are let loose. Whether he deserves such treatment is not my call or even concern. What I am concerned about is whether the Congressmen sitting on the dais go after the larger problem or not. Flailing Mr. Liddy alive may be great political theatre. But it does not get us to where we need to be.

Nor will simply going after the AIG bonuses. We nee to take a hard look at the employee compensation system -- and come up with a better way to ensure we have the human capital we need.

UPDATE: Here are a few interesting other commentaries today on the subject:
David Leonhardt of the New York Times argues for dealing with the broader issue of corporate pay in "Paying Workers More to Fix Their Own Mess" while Andrew Ross Sorkin, also of the Times, argues in favor of the bonuses in "The Case for Paying Out Bonuses at A.I.G." Over at the Financial Times, John Authers argues for a return to the private partner model in financial services to reign in the short termism created by corporate bonuses in "Short View: Bonus backlash".

On Monday, Chrysler Chairman Bob Nardelli posted a letter to all employees on the company's blog outline the company's financial situation. In the letter he talked about the pending deal with Fiat, that he claims is worth $8 to $10 billion in cash value. Reading the quote below, you will see that this estimate is based on synergies in the acquisition -- including lower technology development cost due to Fiat technology. In other words, it is due to intangibles! I wonder how they made that estimate - and if they will be releasing it to the government as part of their financing request?

The proposed Fiat alliance provides significant benefits to Chrysler. Fiat would make available to us its entire product portfolio and powertrain technology, worldwide distribution capabilities for vehicles we produce today and synergies in the areas of purchasing and engineering, among others. We estimate the cash value of Fiat's contribution to be between $8 and $10 billion considering the cost to develop these vehicles, platforms and powertrains from scratch. This is equal to or greater than the total amount of loans we have requested from the U.S. government. Even more importantly, Chrysler would save three to five years in development time, giving us a major competitive advantage. We would be able to offer our dealers exciting new products to help support their business. Because the Fiat vehicles, platforms and powertrains already have come up the learning curves of testing, validation and launch, startup issues already have been solved, which translates into improved quality and customer satisfaction. In addition, production of vehicles for Fiat in North America will allow Chrysler to increase its plant utilization, helping to preserve and create in excess of 5,000 manufacturing jobs. The overall contributions from Fiat and the synergies we realize will far exceed the value of the government loans.

Fiat's vehicle lineup produces the lowest CO2 emissions of any major European automaker, allowing us to immediately adapt their technologies into existing and new platforms. Their product portfolio is a perfect complement to ours - allowing us to introduce vehicles in the A, B and C segments to compete with our domestic competitors. From a distribution standpoint, they are where we aren't. For example, Fiat is No. 1 in Brazil and South America, and has agreed to help distribute our products worldwide. This is a unique alliance with clear advantages, enhancing our viability and job security while significantly advancing our ability to meet standards for emissions and fuel efficiency.

As a true (mostly) Irishman (my full name is Kenan Patrick Jarboe -- only the Jarboe part of me is not Irish), I'm proud to wish you all a Happy Saint Patrick's day -- even if the Washington Post is running a story (For Many Young Irish, First Taste of Hard Times) about the decline of the Celtic Tiger. My sense is that with its reserve of intangible assets and strong human capital built up over the last 20 years, the Celtic Tiger will do better than most when the economic situation turns around.

So enjoy a pint of good Irish stout, and look to better days. And by the way, as the cartoon below notes - stay away from the green beer.

Yesterday, President Obama announced new efforts to help small businesses through the Small Business Administration (SBA). The heart of the program is to have the Treasury Department by up SBA guaranteed loans from banks, so that banks have more capital available to lend to small businesses. The proposal also raises the SBA guarantee to 90% of the loan value.

Let me suggest another step the Administration could take to increase the flow of financing to small businesses: help small and medium size businesses borrow against their intangibles assets. As noted in our report Intangible Asset Monetization: The Promise and the Reality (and our paper "Building a capital market for intangibles"), the SBA is in a perfect position to take the lead in using intangibles to finance economic growth.

Use of intangibles as lending collateral is not unknown -- even if it is rare. There is a long history of such financial transactions. The first trade secrets case in the United States involved the debt on a bond secured in part by a secret chocolate-making process in 1837. In 1884, Ara Shipman loaned Lewis Waterman $5,000 to start a pen-manufacturing business, secured by Waterman's patent.

In recent years, a number of creative firms and entrepreneurial companies have structured financial arrangements secured by intangible assets and intellectual property to fund further innovation and business development. Even in the last Presidential campaign, Senator John McCain used an intangible -- his donor list -- as collateral against a loan.

The problem is not the ability to use intangibles as collateral. The problem is the lack of standards to make these transactions efficient and transparent. Each deal seems to be a one-off. As long as lending against intangibles is a unique undertaking, the transaction costs and the uncertainty risks associated with the deal will limit their widespread use. The creation of underwriting standards would greatly reduce the transaction costs and clarify the uncertainty.

So in the current situation, small and medium size businesses that are cash-poor but intellectually-rich are denied access to a source of financing that could drive further innovation. The SBA is in a unique position to remove this hurtle. Two actions are called for:
• First, SBA rules on lending against intangibles are unclear. The Administration should review laws and regulations to ensure that SBA loans can be used for the acquisition of intangible assets, and that intangible assets can be used as collateral for such loans.
• Second, the SBA should work with its commercial lenders to develop standards for use of intangible assets as collateral, similar to existing SBA underwriting standards.

Opening up this new channel of financing could help small and medium size companies find the money they need to continue innovation and technology development. This is especially important in today's economic climate where traditional credit has dried up and funds for new development are hard to find.

By the way, Athena Alliance is in the middle of a project to detail case studies of intangible asset lending. More on this later this year.

In his recent commentary on why Obama's centrist policy is really radical, Bob Reich makes an important point on competitiveness:

The only resource that's uniquely rooted in a national economy is its people -- their skills, insights, capacity to collaborate, and the transportation and communication systems that link them together. Everything else -- including capital, technology, designs, even plant and equipment -- can move around the globe with increasing ease.

Reich made that statement in the context of how Obamanomics favors public investment--in contrast to Reaganomics. He also pointed or the difference between bubble-up (Obamanomics) and trickle-down (Reaganomics) and deregulation (Reaganomics) verses government setting the rules (Obamanomics).

But I think Reich's comments stand alone in any context. And they are actually not that earth shattering. After all, what Adam Smith said was that people are the true wealth of nations. That is something we need to remind ourselves of continuously, it appears.

Last week saw the unusual media phenomena of cable TV's Comedy Central becoming the media's watchdog. Specifically, "The Daily Show with Jon Stewart" was turned into Columbia Journalism Review as Stewart went after CNBC's coverage of the Wall Street meltdown in a most un-comic way.

At one point in Stewart skewering Jim Cramer of CNBC's "Mad Money," Cramer's defense was, "we have 17 hours of air time to fill." Stewart's response was, "maybe you should cut back."

What a telling response! We have gone from "all the news that's fit to print" to "fill the space." Now, this is really nothing new - the cynic's take-off on the New York Times motto just cited is "all the new that fits we print." But we now live in an age of every expanding communications "space" - with 24+ hour cable, blogs, Twitter, etc.

In this age of data overload, it becomes more important to remember the age old difference between data, information and knowledge -- and between signal and noise. Finding the one good piece of knowledge, or even information, becomes increasing difficult as people simply fill the space.

The Jon Steward last week made that point by example. I find it interesting--and strangely reassuring--that a few hours of pointed satire can provide more knowledge and information than hours of "filled space."

Once again, BEA trade data shows a decline in the trade deficit, with the January deficit down $3.9 billion to $36.0 billion. That is the good news. As the Wall Street Journal reports:

The overall U.S. trade deficit was smaller than expected on Wall Street. Economists surveyed by Dow Jones Newswires estimated a $37.3 billion shortfall in January. The $36.03 billion gap was the lowest since $35.3 billion in October 2002.

The bad news is that both exports and imports declined - reflecting continued global economic weakness.

The other bad news is that the intangibles trade surplus declined ever so slightly in January as trade continues to slow. Both exports and imports were down for the month, but exports of intangibles dropped more than imports. Both private business services and royalties declined.

Our deficit in Advanced Technology Products also continued to decline, dropping to $1.967 billion in January. Both exports and import dropped in every area except biotechnology, where exports rose dramatically. The last monthly surplus in Advanced Technology Products was in June 2002 and the last sustained series of monthly surpluses were in the first half of 2001.

The other news is the revisions to the data for the second half of 2008. The size of both exports and imports of both private business services and royalties were reduced. Exports had been overstated by as much as $1 billion and imports by around a half a billion dollars. Consequently, the intangible trade surpluses for the last few months had been overstated by roughly a half a billion dollars. The total intangibles surplus for had been overstated by roughly $3 billion.

Based on the revised data, exports increased by 7% over 2007 while imports were up 6%. The intangibles trade surplus was $147.0 billion in 2008, compared with $136.7 billion in 2007. Total trade in intangibles increased to $506.1 billion in 2008.

Note: we define trade in intangibles as the sum of "royalties and license fees" and "other private services". The BEA/Census Bureau definitions of those categories are as follows:

Royalties and License Fees - Transactions with foreign residents involving intangible assets and proprietary rights, such as the use of patents, techniques, processes, formulas, designs, know-how, trademarks, copyrights, franchises, and manufacturing rights. The term "royalties" generally refers to payments for the utilization of copyrights or trademarks, and the term "license fees" generally refers to payments for the use of patents or industrial processes.

Other Private Services - Transactions with affiliated foreigners, for which no identification by type is available, and of transactions with unaffiliated foreigners. (The term "affiliated" refers to a direct investment relationship, which exists when a U.S. person has ownership or control, directly or indirectly, of 10 percent or more of a foreign business enterprise's voting securities or the equivalent, or when a foreign person has a similar interest in a U.S. enterprise.) Transactions with unaffiliated foreigners consist of education services; financial services (includes commissions and other transactions fees associated with the purchase and sale of securities and noninterest income of banks, and excludes investment income); insurance services; telecommunications services (includes transmission services and value-added services); and business, professional, and technical services. Included in the last group are advertising services; computer and data processing services; database and other information services; research, development, and testing services; management, consulting, and public relations services; legal services; construction, engineering, architectural, and mining services; industrial engineering services; installation, maintenance, and repair of equipment; and other services, including medical services and film and tape rentals.

At today's House hearing on mark-to-market, the head of FASB said new guidance on dealing with illiquid assets could be ready in three weeks (according to reports by the AP). My question to FASB, SEC and the House Committee members, will these new rules be simply regulatory forbearance -- i.e. giving the financial institutions a break (see earlier posting) -- or will they be truly useful in dealing with illiquid assets? If the former, then they are simply a politically expedient band-aid. If the latter, then they might have some really positive consequence for the financial system -- including for the valuation of intangible assets.

Speaking of the valuation issues (see yesterday's posting), the European Patent Office (EPO) is offering a new tool for patent valuation. According to the press release, "the tool uses 40 factors to assess each patent and visualises the input in spider and portfolio diagrams." The program can be downloaded for free and EPO has both on-line and in-person training.

I wonder what all the IP valuation firms think of this.

I rarely agree with Holman Jenkins. But his column in today's Wall Street Journal makes an important point on the mark-to-market debate:

Now comes Warren Buffett, a big investor in Wells Fargo, M&T Bank and several other banks, who, during his marathon appearance on CNBC Monday, clearly called for suspension of mark-to-market accounting for regulatory capital purposes.

We add the italics for the benefit of a House hearing tomorrow on this very issue. Mark-to-market accounting is fine for disclosure purposes, because investors are not required to take actions based on it. It's not so fine for regulatory purposes. It doesn't just inform but can dictate actions that make no sense in the circumstances. Banks can be forced to raise capital when capital is unavailable or unduly expensive; regulators can be forced to treat banks as insolvent though their assets continue to perform.

Most of the calls for suspension of mark-to-market are really for regulatory purposes for addressing capital adequacy. The problem is that such a suspension affects both regulatory and disclosure purposes. As such, it leaves investors in the dark and hinders the operation of the free market -- ironically something that the proponents if such a suspension claim as their guiding principle.

Jenkins's column makes clear what the advocates of the mark-to-market really want: regulatory forbearance on capital standards. If that is what they truly want, there are a number of other -- more straightforward and transparent -- ways to achieve that goal. These more direct methods would make clear that this is an emergency action that can be clearly monitored to determine when the emergency situation has eased.

Otherwise, if the mark-to-market advocates won't own up to regulatory forbearance as their goal, then I don't know what they really want to accomplish -- other than finding a way to pull the wool over investor's and the public's eyes as to how bad the situation really is. If that is the case, I hope policymakers will resist this attempt to return to the "cook-the-books-if-we-can-get away-with-it" mentality that got us into trouble in the first place.

In a speech yesterday, President Obama laid out his education agenda. The speech (according to the White House blog) proposed five pillars of reform:

1) "Investing in early childhood initiatives" like Head Start;
2) "Encouraging better standards and assessments" by focusing on testing itineraries that better fit our kids and the world they live in;
3) "Recruiting, preparing, and rewarding outstanding teachers" by giving incentives for a new generation of teachers and for new levels of excellence from all of our teachers.
4) "Promoting innovation and excellence in America's schools" by supporting charter schools, reforming the school calendar and the structure of the school day.
5) "Providing every American with a quality higher education--whether it's college or technical training."

As the President rightly pointed out:

The source of America's prosperity has never been merely how ably we accumulate wealth, but how well we educate our people. This has never been more true than it is today. In a 21st-century world where jobs can be shipped wherever there's an Internet connection, where a child born in Dallas is now competing with a child in New Delhi, where your best job qualification is not what you do, but what you know -- education is no longer just a pathway to opportunity and success, it's a prerequisite for success.

He stressed a number of points that I believe are critical, including a commitment to innovation in the educational process and life-long learning. Too long we have made live-long learning a meaningless buzzword -- on everyone's lips but not in their pocketbooks. In this context, the President talked about "working with all our universities and schools, including community colleges -- a great and undervalued asset -- to prepare workers for good jobs in high-growth industries; and to improve access to job training not only for young people who are just starting their careers, but for older workers who need new skills to change careers."

This is important. But that is only part of the equation. True life long learning takes place not when a fired worker needs new skills to get a new job, but when a worker continually upgrades their skills. And life long learning is not confined to the classroom -- but happens in everyday activities.

It is good that we are starting to see that worker training is part of the education activity. But we need to go further to breakdown the silos between "education," "worker training," and "learning."

Maybe, in few years, the President can make another speech -- a speech where he can talk about all that was accomplished under his "education agenda." And a speech where he can then challenge the American people to take the next step and support his "learning" agenda. For that should be our end goal -- not a nation of "educated" people, but a nation of learners.

Yesterday, Fed Chairman Ben Bernanke gave a major speech on Financial Reform to Address Systemic Risk. That speech signaled his desire to start the process of reform:

At the same time that we are addressing such immediate challenges, it is not too soon for policymakers to begin thinking about the reforms to the financial architecture, broadly conceived, that could help prevent a similar crisis from developing in the future. We must have a strategy that regulates the financial system as a whole, in a holistic way, not just its individual components. In particular, strong and effective regulation and supervision of banking institutions, although necessary for reducing systemic risk, are not sufficient by themselves to achieve this aim.

Today, I would like to talk about four key elements of such a strategy. First, we must address the problem of financial institutions that are deemed too big--or perhaps too interconnected--to fail. Second, we must strengthen what I will call the financial infrastructure--the systems, rules, and conventions that govern trading, payment, clearing, and settlement in financial markets--to ensure that it will perform well under stress. Third, we should review regulatory policies and accounting rules to ensure that they do not induce excessive procyclicality--that is, do not overly magnify the ups and downs in the financial system and the economy. Finally, we should consider whether the creation of an authority specifically charged with monitoring and addressing systemic risks would help protect the system from financial crises like the one we are currently experiencing.

As part of those efforts, however, let me add one more element: we must proactively deal with the issue of intangible assets. Intangibles are a major part of the wealth and the wealth generating capacities of companies and nations. To continue a financial system that simply ignores them is bordering on folly. Here are some suggestions, based on our report Intangible Asset Monetization: The Promise and the Reality. (See also our article in IAM Magazine "Building a Capital Market for Intangibles.")

Let me start with the issue of asset valuation - a key concern for intangibles. It should be noted that Bernanke specifically mentioned this problem in the context of accounting standard for valuing bank reserves. However, as the New York Times notes, "In a question-and-answer session after the speech, Mr. Bernanke said he did not favor a suspension of the mark-to-market accounting standards, but said that the weakness in current rules should be identified and corrected." I agree that a simply suspension of mark-to-market is unwarranted, and I believe would be counterproductive. Here I have to disagree with Steven Pearlstein who, in his column today, shifted his position and called for such a suspension.

The underlying issue is how to value assets that have only thinly traded market. As Bernanke said, "determining appropriate valuation methods for illiquid or idiosyncratic assets can be very difficult, to put it mildly." Yet, it is exactly the problem of appropriate valuation methods that we must address.

The truth is that accountants have been valuing "idiosyncratic assets", in the form of intangibles, for a long time - mostly for the purpose of M&A transactions and lawsuits. In fact, current account rules require than intangibles acquired from outside (such as in a merger or acquisition) be placed on the books.

One way to begin to get a handle on the valuation issue is to re-instate the joint FASB/IASB project on valuing internally generated intangibles - as well as externally acquired as under current rules. Such a project would have to grapple with the valuation problem head on. This project has had an on-again, off-again history for over a decade. It is time to just do it.

Another is to ratchet up other venues for research on valuation standards. The International Valuation Standards Council has two draft guidance notes on valuing intangibles (see earlier posting). These could serve as the starting point for more intensive research.

But the problem is not just valuation. The larger problem is disclosure. Increased transparency is needed. In fact, in some cases, simple disclosure may be enough - with out having to take the next step of valuation. A large part of the problem with the toxic assets is their uncertainty and complexity. And a large part of the liquidity and solvency issues of financial institutions stemmed from that uncertainty and lack of transparency.

The same can be said of intangibles. There is a lack of transparency - to the point of having a situation that company management doesn't even know what their intangible assets are. If the details of the intangible assets are disclosed, then each individual in the market can deal with the valuation in their own way. And if the market demanded greater disclosure, management would focus more attention on managing those assets better.

Two quick suggestions on improving disclosure of intangible assets. First, the SEC could expand the disclosure of intangible in the Management's Discussion and Analysis (MD&A) statement required as part of annual corporate filings. In 2003, SEC issued new guidance on including non-financial performance measures in the MD&A statements. SEC should undertake an evaluation of compliance with that guidance and, based on that evaluation, issue expanded guidance specifically on the disclosure of intangible assets.

Second, SEC should look seriously at creating a "safe-harbor" provision to allow for limited reporting of non-standardized financial information on intangibles. As noted before, current accounting rules limit the ability of companies to disclose financial information on internally generated intangibles - specifically limiting information that does not comply with Generally Accepted Accounting Practices (GAAP).

There are good reasons to limit such information. The purpose of GAAP is to ensure that the assumptions and rules used to compile financial information are understood by all. There is a real danger of non-GAAP information resulting in misleading financial statements.

However, it has long been recognized that some financial information not covered by GAAP can also be useful and relevant to investors. As a recent white paper by the AICPA Assurance Services Executive Committee notes:

In order for efforts to improve reporting and assurance to reach fruition, there is a need for improved safe-harbor legislation to protect directors, managers, and auditors who make a good faith effort to provide more high quality, transparent disclosures.

Such a safe harbor would allow companies to provide information, including estimates of value, on their IP portfolios, for example. Such overt disclosures would enable more accurate insight for investors and creditors alike while also promoting the above-the-board reputation of company management.

It will take some work to craft a safe harbor provision that facilitates greater disclosure while not undermining the regulatory purpose of avoiding misleading information. But it is a task that SEC can and should undertake.

So, as we move toward reforming the regulatory structure around the financial system, let us not forget about intangibles. There are a number of relatively easy steps (easy compared to some of the more challenging tasks facing financial reform efforts) that can be taken to increase disclosure of intangible assets. Those steps would both increase transparency in the system and foster greater understanding and utilization of intangibles. That would be a classic win-win.

Yesterday, I posted an item about the Kaufman Foundation's papers on innovation and entrepreneurship data. Today, I want to highlight one of those papers, the proposal for a Innovation Radar 2.0 Survey. This survey would be a follow on to an initial 2005 Web-based questionnaire.

What is especially important about this project is that it takes a broad view of innovation. The proposal paper, in and of itself, is a great argument for why a broad view is important. Let me quote at length:

Innovation is the essential driver of the growth of organizations and countries. However, we lack a robust and systemic approach to defining and measuring business innovation. The literature on innovation has at least three limitations. First, innovation is very narrowly defined and technology-oriented (Howells and Tether, 2007; Sawhney, et al. 2006; Van de Ven, 1986). In this narrow view, innovation and innovation management focus on R&D, new product development, or the product/process dichotomy. One group of scholars defines innovation as the adoption and implementation of a new technology, mostly driven by R&D or invention. For example, Garcia and Calantone (2002) view innovation as an iterative process to explore the market potential of a technology-based invention through adoption and diffusion. Another group of scholars regards innovation narrowly as new product development or product innovation (Hauser et al, 2006). For example, Han, Kim, and Srivastava directly (1998:32) state that "[i]n marketing, the conventional meaning of the term innovation largely refers to new product-related breakthroughs." The third group of scholars brings processes into innovation scope, thus, understanding innovation as product/process dichotomy. For example, Tushman and Nadler (1986:75) define innovation as "the creation of any product, service, and process, which is new to a business unit." In this literature stream, process innovation is a means to create new ways to develop new products and to improve process efficiency. This view emphasizes delivering tangible things to meet customer needs. This dichotomy still is technology-oriented.

However, innovation is not limited to R&D, new product development, and technology innovation. For example, Dell Inc. has become one of the world's leading personal computer manufacturers, not through R&D investments, but by bringing products to market more quickly and innovating on processes, such as direct selling, supply chain management, and manufacturing. Starbucks Corp. is regarded as a highly innovative company, not because of better-tasting coffee, but because the company is able to create an innovative customer experience referred to as "the third place"--a communal meeting place between home and work. Viewing innovation too narrowly blinds companies to opportunities and makes them vulnerable to competitors with broader perspectives (Sawhney, et al. 2006). A broad view of innovation is necessary.

In support of a broader view of innovation, Drucker (1977) states that non-technological innovations "are at least as important as technological innovation." In reality, there are many more dimensions to innovation, including solution innovation, customer experience innovation, organizational innovation, business model innovation, and so on (DOC, 2008; Moore, 2004; OECD, 2005). Considering the limitations of the narrow view, innovation is regarded as the adoption and implementation of any new ideas relative to the organization. For example, Van de Ven (1986) defines innovation as "the development and implementation of new ideas by people, who over time, engage in transactions with others within an institutional order." (p. 590). Recently, nontechnological innovation has caught more attention in the connected world (Djellal and Gallouj, 2001; Moore, 2004). Following this trend, OECD (2005) has broadened the concept of innovation to encompass marketing, internal organizational and external relationship innovation. Although there are different views and perspectives of innovation, a common theme in all definitions of innovation is that it is a new idea that is put into practice while paying special attention to its usefulness-a theme that originated from Schumpeter (1934).

Therefore, we define innovation as an initiative in any dimension(s) of the business system to create substantial new value for customers and the firm (Sawhney, et al. 2006). This innovation definition emphasizes three points: originality (an initiative to create new value), a holistic view (an initiative in any dimension(s) of the business system), and customer outcomes (the value generated by the initiative for customers and the firm). These points are emphasized in the recent definition by the Advisory Committee to Department of Commerce (DOC 2008), where innovation is defined 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."

A second limitation of the literature is the lack of a rich typology for innovation, with a few exceptions. (e.g. Damanpour, 1991; Djellal and Gallouj, 2001; Moore 2004) Past research has argued that distinguishing types of innovation is necessary for understanding organizations' adaptation behaviors (Damanpour, 1991; Downs and Mohr, 1976). Although researchers have suggested numerous innovation typologies, such as incremental versus radical (Dewar and Dutton, 1986), continuous versus discontinuous (Tushman and Anderson, 1986), sustaining versus disruptive (Christensen, 1997), exploitative versus evolutionary innovation (Jansen, et al. 2006), most innovation typologies focus on the degrees or types of technological innovation in a dichotomized form limited to the narrow view (Garcia and Calantone, 2002; Gatignon, et al. 2002). We contend that innovation is multifaceted and goes beyond technology. A new innovation typology is needed.

In recognizing the importance of non-technological innovation, Drucker (1977) argues, "The best way to organize for systematic, purposeful innovation is as a business activity rather than as functional work. At the same time, every managerial unit of a business unit should have responsibility for innovation and define innovation goals." (p. 57) Following this line of thinking, we believe that types of innovation should be related to business activity because by definition, innovation is an initiative in one or more dimensions (aspects) of the business system. Although the broad view of innovation originates from Schumpeter, this view rarely has found its way into typologies for innovation. Abell (1980) argues that a firm's offering, customer, and operations are related to three primitive dimensions along which any business unit's scope may be defined. Also, presence (how a firm takes its offerings to market) also is regarded as a key dimension in defining the core business (Zook and Allen, 2001). Therefore, we contend that a firm's offering, customer, operation, and presence are the four key dimensions for defining business innovation. These dimensions broadly are consistent with the typologies proposed by some scholars and authors (Djellal and Gallouj, 2001; Moore, 2004; OECD, 2005).

A third limitation of the literature is a practical and robust measurement approach for business innovation, despite a long history of innovation research (Boston Consulting Group, 2006; DOC, 2008). There are two broad streams of research on measurement of innovation. One stream seeks to measure innovation through innovation inputs, such as R&D intensity, as well as through innovation outputs, such as patents and patent-related index (Cordero, 1990; Lanjouw and Schankerman, 2004; Qian, 2007). These measures capture a narrow subset of all possible innovation activities. However, the linkage between such measures and organizational innovativeness and economic growth are unclear. For example, empirical evidence suggests that R&D spending has no significant relationship with nearly all measures of business success, based on an analysis of the top 1,000 global innovation spenders (Booz, 2005). More recently, Bessen and Meuer (2008) show that patents are not only insufficient, but also unnecessary to explain cross-national innovation and growth rates according to the macro level evidence. Gittleman (2008) also strongly argues that the value of using patents as indictors of innovation is very limited at the micro level. The other stream on innovation measurement takes a macro level view. For instance, efforts in the European Union have been made to measure country innovation capabilities through objective economic measures, such as Oslo Manual (2005), European Community Innovation Survey (CIS-4), and the European Innovation Scoreboard (EIS 2007). Recognizing the limitations of current innovation measurement, the U.S. Department of Commerce established in 2006 an advisory committee to improve the measurement of innovation. The committee outlined its recommendation calling for actions to develop innovation measurement in the 21st century economy (DOC, 2008). A holistic and comprehensive measurement framework for business innovation still has to be developed and validated.

That is, in my view, a good summary of the literature (in case you are interested, the references are available in the original document).

The proposal goes on to outline a survey based on a general manager's view of innovation. This framework would look at three strategies:

1) offering innovation strategy that provides functional value, 2) experience innovation strategy that creates emotional value, and 3) operational innovation strategy that delivers economic value. Each innovation strategy includes four types of innovation. Offering innovation strategy consists of technology, product, platform, and solution innovation. Experience innovation strategy includes customer, interaction, design, and presence innovation. Operational innovation strategy encompasses process, organization, supply chain, and ecosystem innovation.

There are a few places that I would take issue with their framework. For example, they equate "design innovation" with aesthetics. I would stress functionality.

However, for the most part, this is both an excellent introduction/overview of why we need to look at innovation broadly and a workable proposal for data collection using that broad view.

The Kaufman Foundation has put up its collection of papers from their November 2008 symposium on innovation and entrepreneurship data. These symposia are annual events and are part of Kaufman's activities to improve measurement. The proceedings contain a number of interesting proposals for data improvement -- such as an outline of the 2009 Duke/Georgia Tech Innovation Survey and a proposal for a Innovation Radar 2.0 Survey.

Among the papers is an update on the Commerce Department's report of the Advisory Committee on Measuring Innovation in the 21st Century Economy (see earlier posting).

While BEA is moving ahead with efforts to integrate intangibles into the System of National Accounts (see earlier posting), progress is slow. On the larger issue of innovation data, the update has this to say:

ORIGINAL RECOMMENDATION 5
Work toward development of a national innovation index.
UPDATE
No progress has been made on this recommendation. The creation of an innovation index requires a much greater understanding of the identifiers and causes of innovation in the national economy.

While I agree that the goal of creating a single national innovation index is both difficult and may not be the right direction, this is somewhat disheartening. However, work is progressing in a number of areas, including many other innovation surveys that are moving forward. The Duke-Georgia survey mentioned above includes a standard question on whether the company has introduced any new or significantly improved goods services or processes. The Next Generation Manufacturing Study, a multistate effort by the American Small Manufacturers Coalition (ASMC) that includes the MassMEP and 15 other MEP Centers, includes a similar set of questions. The proposed Innovation Radar 2.0 Survey is a more targeted approach to sample but takes a broader view of innovation "along twelve dimensions: offering, platform, solution, customer, customer experience, value capture, process, organization, supply chain, presence, network, and brand." These studies will give us a much better understanding of innovation in the US.

Another approach is that taken by Innovation Ecologies to create a new Regional Innovation Index, which is a set of measures. This is based, in part, on earlier work on a set of indices, Innovation Vital Signs Project, prepared by ASTRA--The Alliance for Science and Technology Research in America.

These and other efforts to improve our data on and understanding of innovation are important steps forward to crafting policies to overcome our current economic challenges and to thrive in the new I-Cubed Economy.

There was little good in this mornings news from this morning's jobs data from BLS. The unemployment numbers took another big leap upward in February, rising to 8.1% from 7.6% in January and 7/1% in December. Payrolls fell by 651,000 and the number of unemployed rose by 851,000 to a total of 12.5 million. The number of involuntary underemployed (part time for economic reasons) also rose sharply by almost 850,000 to 8.5 million.

The data was in line with economists expectations of an 8% unemployment rate. Everyone also expects that the rate could easily top 10% this year.

Those expectations were reinforced earlier this week by the conclusions of the Fed's latest Current Economic Conditions (aka the "beige book"):

Looking ahead, contacts from various Districts rate the prospects for near-term improvement in economic conditions as poor, with a significant pickup not expected before late 2009 or early 2010.

So, the hunkering down continues - and is likely to go on for some time yet. However, those companies who can use this situation to change their activities will come out in a stronger position. As I've noted before, entrepreneurs who looks for opportunities where others don't will lay the groundwork of new economic growth.

So, as we seek to ease the pain of this downturn, we must also work towards transformation. Our #1 priority should be to grow the economy in a different way - not simply reflate the bubble.

In other legislative news, earlier this week Senator Carl Levin, Chair of the Senate Permanent Subcommittee on Investigations, introduced S.506 - the Stop Tax Haven Abuse Act. A companion bill -- H.R.1265 -- was introduced yesterday in the House by Congressman Lloyd Doggett and has 56 co-sponsors.

In his statement on the bill, noted a tax avoidance technique using intellectual property:

Here's just one simplified example of the gimmicks being used by corporations to transfer taxable income from the United States to tax havens to escape taxation. Suppose a profitable U.S. corporation establishes a shell corporation in a tax haven. The shell corporation has no office or employees, just a mailbox address. The U.S. parent transfers a valuable patent to the shell corporation. Then, the U.S. parent and all of its subsidiaries begin to pay a hefty fee to the shell corporation for use of the patent, reducing its U.S. income through deducting the patent fees and thus shifting taxable income out of the United States to the shell corporation. The shell corporation declares a portion of the fees as profit, but pays no U.S. tax since it is a tax haven resident. The icing on the cake is that the shell corporation can then "lend" the income it has accumulated from the fees back to the U.S. parent for its use. The parent, in turn, pays "interest" on the "loans" to the shell corporation, shifting still more taxable income out of the United States to the tax haven. This example highlights just a few of the tax haven ploys being used by some U.S. corporations to escape paying their fair share of taxes here at home.

(The issue of these IP passive investment companies - both foreign and domestic - was covered in our report Intangible Asset Monetization: The Promise and the Reality.)

While the legislation does not specifically target these IP transactions, it does strengthen the "economic substance doctrine" which basically states that tax benefits are not allowable if the transaction does not have economic substance or lacks a business purpose -- i.e. if they are done for the purpose of avoiding taxes. The bill also expands tax reporting requirements for these passive foreign investment corporations. In addition, the bill also takes away patent protection for tax planning techniques.

According to the Wall Street Journal, "At a House hearing Tuesday, Treasury Secretary Timothy Geithner said the Obama administration supports the tax haven legislation, which is similar to a bill Mr. Obama co-sponsored as a senator."

As we noted in our Intangible Asset Monetization report, the issue of the use of IP in tax havens needs to be addressed. If the use of investment companies for IP is seen as a mechanism for tax avoidance, this creates a serious barrier to positive policymaking. As suggested in the report, it might be time to look at tax incentives for the creation of intangibles. But, that is not going to happen as long as the tax abuse issue is not addressed. The Levin bill may be a way of putting the tax abuse issue behind us - and moving on to other policy ideas.

Well, not quite anew. Yesterday, Senators Leahy and Hatch (with 5 other co-sponsors) introduced S. 515. the Patent Reform Act of 2009 while on the House side Judiciary Chairman John Conyers and Ranking Member Lamar Smith (and 3 other Members) introduced the same bill - HR 1260. According to Senator Leahy's statement on the Senate floor, "The legislation we introduce today picks up where we left off in those discussions. We have made some changes from the Committee-approved bill in response to concerns we heard from groups ranging from labor unions to small inventors to manufacturers." Chairman Conyers noted that "the text of the Patent Reform Act is in many ways a composite of the bill that passed the House and the bill that was reported out of the Senate Judiciary Committee last Congress."

Slowly, a bill that can pass the Congress may be emerging. But we will see. Predictably, the two sides of the debate immediately weighted in with opposite views: The Coalition for Patent Fairness praised the bill and the Coalition for 21st Century Patent Reform expressed concerns. So, the fight continues -- and the vacuum of Congressional policymaking on this issue may or may not be filled.

On the other hand, the Supreme Court has been more than willing to step into that vacuum and enacted the needed changes. But that is a piecemeal solution. To my way of thinking, better done by Congress.

Last year, I posted an item on how the buyout firm Terra Firma had put its plan to securitize its purchase of EMI records. The original idea appears to have been to sell bonds backed by the future music royalty rights in order to pay for the acquisition of EMI. Last year, Terra Firma switched to licensing as its monetization strategy. Now, even that is in doubt. According to the Financial Times:

Terra Firma, the buy-out house run by financier Guy Hands, has written off half its €2.6bn (£2.3bn) investment in EMI, the music group, accepting the likelihood of losses on one of the most eye-catching deals struck during the credit bubble.

So, a deal that looked great two years ago is a loss today. Such is the state of the market - and of intangible asset values.

Eric Rosengren, President of the Boston Fed gave an important address to the Institute of International Bankers - Addressing the Credit Crisis and Restructuring the Financial Regulatory System: Lessons from Japan. In it he stressed three points:
    •  First, undercapitalized banks behave differently than well-capitalized banks.
    •  Second, certain bank-regulatory and accounting policies may amplify the business cycle.
    •  Third, troubled assets need to be moved off bank balance sheets as quickly as possible.

I would like to highlight the last two points. On regulatory and accounting policies, he had this to say:

Under current policies, regulatory rules essentially follow U.S. generally-accepted accounting principles (GAAP) in determining an appropriate loan-loss reserve. U.S. GAAP accounting rules provide that a loan-loss reserve should reflect probable and estimable losses that have already been incurred in the loan portfolio, but have not yet been discovered. This is often referred to as the "incurred loss" model. The accounting profession often notes that these accounting rules were written in this way, in part, to inject more transparency into the reserve setting process and to address concerns about financial manipulation.

A criticism of the accountant's view is that as financial conditions deteriorate, loan loss reserves lag the increases in nonperforming loans and expected losses (see Figure 3). It can be argued that this is true because management failed to adequately assess changes in current loss estimates, or because reserve models are somewhat backward looking. In either case, it has been observed in previous periods of banking problems that loan-loss reserves were low at the beginning of the banking problems, lagged as problems became apparent, and likely to peak at the very time that we could most use bank capital to be at work financing economic recovery. Solutions to this predicament, which I will not expound on or argue for today, would do well to result in earlier loss recognition, more rapidly addressed problems, and indeed a curtailing of high-risk lending earlier in the cycle.

Again, my goal today is to point out some lessons we would all do well to consider and apply. Proposals to make reserving less procyclical will no doubt take different forms. To an economist's way of thinking, a reserve should not be limited to a view of a current period or snapshot in time, focusing on losses that are currently in the portfolio based on loans made previously - rather, expected future losses should also be considered. For example, if one anticipates that unemployment rates were to rise rapidly, a statistical calculation of expected losses looking through the cycle may be very different than the losses that are probable and estimable given current economic conditions. [Footnote 7] This more comprehensive view of loan losses could lend itself to addressing some of the perceived shortfalls associated with the current accounting model.

The third lesson I take from the Japanese experience is that troubled assets should be moved off bank balance sheets as quickly as possible. Banks with troubled assets focus on avoiding further losses and further depleting capital. Troubled banks in Japan were often more supportive of problem borrowers than borrowers who had good prospects going forward. Focusing on future growth requires removing the problem assets.

I agree. I have long been a supporter of the direct removal of bad assets - not just a recapitalization of troubled banks. The longer the toxic assets remain, the longer they will simply pollute the entire system. Better for the financial system to take the losses and move on. Yes, it will hurt. But it is a case of pay now or pay later. And later is always more expensive.

Let me end with Rosengren's conclusions:

In sum, the Japanese experience of the 1990s highlights the fact that forbearance can have significant macroeconomic consequences. Troubled banks are reluctant to expand balance sheets or to address problems with troubled assets. I believe it would be desirable to move quickly to remove problem assets from bank balance sheets, so banks can once again focus on future prospects rather than past mistakes.

In the longer run, we need to explore ways to make banking problems less procyclical. Certainly an area worth further careful investigation is whether current loan-loss-reserving policies can be recast to encourage less procyclical behavior.