A half century ago, organizations began to realize that the value of a business extended beyond the combined worth of its physical assets. Until that time, assembly lines, materials, buildings, machinery, and slide rules, along with the other line items on the accounting ledger, had been tallied to determine the overall valuation of a business. However, as organizations began to rely more on human capital, it became clear that accounting for “soft” factors must also find a way into business valuation.
In 1969, US economists James Tobin and William Brainard introduced a concept that became known as “Tobin’s q.” As organizations sought to come up with a better solution for placing a value on assets, they looked to better quantify the differences between market value and the replacement value of that business or assets. Tobin and Brainard had developed a formula to address these differences. Tobin’s q was developed to account for the ratio between the market value and the replacement value of that same asset.
Tobin was later awarded the Nobel Prize in economics. The principles behind Tobin’s theory became a basic concept of business valuation.
One of the key findings associated with his equation was that there were two factors not generally measured by accountants: market hype and intellectual capital.
Market hype is made up of speculation as to what the company could potentially do. Is it poised for growth? What’s the buzz on the street about the company? Is there a merger in the future? These are the types of questions that create this hype and speculation.
Intellectual capital is more complex, as it involves many different pieces. These pieces are parts of three basic components: organizational capital, customer capital, and human capital.
- Organizational capital, also known as structural capital, contains the supportive infrastructure that allows the human capital to succeed. This includes such essentials as databases, patents, networks, strategies, and processes.
- Customer capital is a factor of the relationships a company has with its customer. If a business builds strategic partnerships with a number of key, prominent clients, that business is likely to be valued much higher than one that is starting with only a few customers. This is also dependent upon what type and level of knowledge and information is shared between the business and the customer. The stronger the customer connection, the higher the value of the entity.
- Human capital is created by the skills and knowledge of the individuals within that organization. It’s the “people” component of Tobin’s equation. However, it extends beyond simply what the employees know and can do; it requires action.
Employee Engagement and Economics
Organizations have taken note of the importance of human capital, as most businesses today are dependent upon this human aspect. Many are now taking great care to ensure that they hire high-caliber individuals. They also develop these individuals, providing training needed to develop organizational and customer capital. They spend a great deal of time, effort, and money to ensure employees are compensated to a degree that this capital will remain within the organization, yet retaining knowledge and capability are not enough.
Companies today have learned that they must create the environment in which employees choose to actively contribute to the intellectual capital element of Tobin’s q. This is why employee engagement has moved from being discussed as a nice-to-have to being viewed as a critical factor in business success. Unless an employee is engaged in what he or she does, a business may possess a high degree of intellectual capital, but may be unable to unlock that potential.
It’s not about the “soft stuff” anymore. This soft side of performance has bottom line implications, and significantly impacts the value and success of an organization. Employee engagement is the key to unlocking that value.