Invest in Your Workforce and Build Intellectual Capital

Employees are Undervalued “Intangible Assets”

“Employees are a company's greatest asset - they're your competitive advantage.” – Anne M. Mulcahy

If you examine a company’s financial statements, employees are not found in the categories that tend to be equated with competitive advantage and value creation (either assets or revenues). Employees only show up under liabilities (in the form of accrued vacation, accrued bonuses etc.) and expenses (salary and benefits costs.)

What do CEOs mean when they refer to employees as valuable assets?

Assets – Tangible and Intangible

In accounting lingo, an asset is a resource owned by an organization that will provide value in the future. Assets (and liabilities) are recorded on the balance sheet.

There are two primary types of assets – tangible and intangible. Tangible assets (sometimes called fixed assets) include land, factories, and equipment. By contrast, an intangible asset is anything that cannot be seen or touched. In other words, intangibles assets don’t exist in physical form. Yet they have value to a business, as they do create future revenue and cash flow.

Commonly cited intangible assets include:

-          Intellectual Property (patents, copyrights, trademarks)

-          Brands

-          Customer data

Less obvious examples of intangible assets include:

-          Signed contracts of which portions have not yet been billed

-          Existing customer lists which can be a reference in acquiring new customers

-          Workforce skills or know-how (sometimes called Intellectual Capital)

Intangible Assets are the Primary Component of Company Valuations

Intangible assets have become significantly more important to the value of companies over the past few decades. The graph below shows the split of the market capitalization of the S&P 500 between the value of tangible assets (recorded on the balance sheet) and intangible assets (not on the balance sheet) over time.

In the August 2018 edition of the GatesNotes blog reviewing the 2017 book Capitalism Without Capital, Bill Gates notes that understanding this trend of the growing importance of intangible assets is critical to lawmakers creating good economic policy. He notes that the US did not include software in its calculation of GDP until 1999 (a fact that seems hard to fathom given how important the products created by software companies are to our lives today).

The value of intangible assets is generally not recorded on a company’s balance sheet (except when accounting for a business combination – purchase of the stock of a company.) Even in such a case, under the accounting rules (ASC 805), the value of the workforce is considered goodwill and not separately calculated as is the value of other intangible assets such as IP, customer relationships, contracts, technology etc.

In the normal course of business, all costs incurred associated with investing in intangible assets are recorded as expenses in the current period and only show up on the income statement. So, when a company chooses to invest in enhancing the value of an intangible asset (whether brand building or employee training), it leads to increased losses in the near term.

Increases in losses or decreases in cash flows are typically inversely correlated with value creation. However, the graph above clearly shows the importance of investing in intangible assets as a driver of positive value creation.

Employees are an Overlooked Intangible Asset

The value of some intangible assets including IP, R&D (hardware or software development) and brand is broadly accepted. Brand Finance, a UK-based consulting firm, releases an annual survey on the value of company brands with separate rankings by industry and country.

As a former CFO, I know how much easier it is for functional leaders to make a business case to invest in all categories of intangible assets except people.

a.       Intellectual Property: Investments can take the form of: (i) creating a quarterly program (hackathon of sorts) to encourage new patent generation; or, (ii) paying outside counsel to file patents, trademarks, and copyrights in all major countries.

b.       R&D: Most annual plans include hiring more engineers to extend the code base (add new functionality) or upgrade the code base (fix errors and increase efficiency.)

c.       Brand: Brand building takes the form of investment in new content, paid advertising and sponsorhips/events.

d.       Data: Unlocking value from a company’s “data asset” can require purchase software to store and mine insights from the data.

In contrast, money spent directly on employees (for skill development, training etc.) is viewed as an expense, almost akin to a perk such as a new benefit. When budgets are stretched, as they often are at private companies, these investments are the first to get cut or not even given thoughtful consideration in the budgeting process.

The Case for Active and Continuous Investment in Employees

The best case I’ve seen for proactively investing in employees was written by Maia Josebachvili in 2016 when she was VP of Strategy and People at Greenhouse Software. Her background and career (not surprisingly) spans roles across People, Finance and General Management, and she currently leads M&A and Investing at Stripe. I believe those with a broad set of experiences, including Finance and People Operations, are better positioned to see the value of investing in the workforce.

She lays out a case for improving employee lifetime value (ELTV) shown below as the incremental output (value) that can be created (the darker green shaded area) through a series of improvements in how people are treated.

How to Get More out of Your Workforce

My biggest takeaway from my limited tenure leading a People Operations function is that organizations spend a disproportionate amount of time, energy, and money in hiring/recruiting and not nearly enough once the hire starts.

Building off the thoughts offered by Maia and adding a few of my own, here is a roadmap to investing in employees and earning a return while also ensuring employees feel valued and cared for.

1.       Onboarding Matters

a.       I have written about the importance of onboarding in the past.

b.       A well-run onboarding program ensures a new employee is productive in a faster timeframe. Employees feel a greater sense of mastery when they contribute and the companies earns a return on their investment more quickly.

c.       The best onboarding programs that explain the “why” behind a company, how customers benefit from the product as well as how the different groups work together to deliver the value proposition. This approach helps an employee feel connected to the corporate mission and better understand how their role contributes to creating customer value.

2.       Hiring

a.       Bringing in the right person is critical. However, too many employers and recruiters believe that means finding someone who has already done everything written down in the job description as the responsibilities of the role.

b.       I recommend takeinga chance on someone who has some of the skills but not all. They compensate for that skill weakness with a lot of hunger, curiosity, work ethic and desire to grow/learn.

c.       While this may be a risky prospect in filling jobs at VP and higher levels, it is my preferred approach when hiring for other roles.

d.       Those who know you believe in their potential are likely to work harder, be more loyal and more committed to the business.

e.       I believe in looking for “hidden gems” in hiring, as it is hard for start-ups to compete with unicorns and public companies for obvious top tier talent.

3.       Leadership Part 1

a.       Leadership is at its core about making others as successful as they can be while creating the best outcome for the organization. This applies as much to business as to sports.

b.       A large component of good leadership is creating the “right” culture where people can thrive by feeling safe and trusting in their manager and teammates.

c.       First impressions of leaders matter, so start out with the right message at the first meeting with new teams and new hires.

d.       You can read more of my thoughts on effective leadership here.

4.       Training and Development

a.       Investment in training and development allow employees to reach a higher ceiling in terms of output and value creation for their employer.

b.       I recommend going beyond functional specific training for the current role.

c.       Offer training to help employees gain mastery in their current role, prepare them for future roles, and offer them opportunities to better understand how the business creates value. All this training will lead to a deeper talent pool of future leaders.

d.       Employees today expect development opportunities from their employers. Training is the best way to let employees know you care about them and want them to succeed both in this job and beyond.

5.       Leadership Part 2

a.       Too many managers take what I consider a “zero-sum” perspective regarding the people on their teams. They stay away from career planning discussions. Managers are afraid that any help they might offer to the employee in their career path beyond this company has no benefit to the manager nor to the current employer, but rather simply costs time.

b.       I encourage all leaders to tell their teams that they are committed the long-term career success of each employee, beyond this job or this company. In return the employee commits to give their best effort to this role.

c.       I have found quarterly career check-ups with direct reports effective. Meet outside the office, ideally even outside normal office hours for an early breakfast.

Investment in the Workforce Enhances “Intellectual Capital”

Investments in employees today will result in higher payoffs in future periods.

Forward thinking executives who know how hard it is to build a competitive moat around a business realize how “intellectual capital” can be a differentiator. Intellectual capital, explored in depth in this piece, is the sum total of all the employees skills, knowledge, experience and relationships.

Building lasting businesses which can adapt and innovate amidst continuous change in technology, the competitive landscape and macro-economic conditions will be those which invest in their workforce and build their intellectual capital.