This article originally featured in Baillie Gifford’s Autumn 2018 issue of Trust magazine.
Ask the average investor for an example of an ‘intangible’ asset and, if they respond at all, they will probably say ‘goodwill’ – a notional value imputed by the market. Yet companies are now spending more real money on intangible assets including software, research and training than they do on tangible assets such as buildings, machinery and computers. This has important implications for the economy at large.
Jonathan Haskel, professor of economics at Imperial College London and the most recent appointee to the Bank of England’s Monetary Policy Committee (MPC), grew interested in intangibles when he realised they might help explain shifts in productivity, his specialist subject.
He explores the new intangible economy in Capitalism Without Capital: The Rise of the Intangible Economy, co-authored with Stian Westlake, a senior fellow at Nesta, the UK’s national foundation for innovation. “I realised that the kinds of investments being made by firms were changing,” Haskel explains. He speaks with relaxed confidence, sipping coffee in the sun-filled courtyard of the Victoria and Albert Museum, across the street from his place of work.
By investments, Haskel means spending that creates a fixed asset. And as time has passed, more of these assets have been things that you can’t touch. Software and databases are intangible assets. So too are research and development, mineral exploration, design, training, market research, branding and business process re-engineering. Creating entertainment, literary or artistic originals falls under the same heading. Like physical assets, companies must spend time and money on them, which they repay by delivering value over a period.
In the US and UK, spending on intangibles overtook investment in physical assets in the mid-to-late 1990s, and Haskel says that for every dollar ploughed into tangible assets companies now spend around $1.15 on intangible assets.
They share four important features – the four S’s of intangible investment, as Haskel calls them. The first is scalability. Unlike physical assets, which can only be in one place at one time, intangible assets can usually be used over and over again, in different places, at relatively little cost.
That has allowed some intangible-intensive businesses to become very big. Starbucks, for example, has built on its brand, operating processes and supply chains to expand across the globe. Facebook, Google and Microsoft have grown likewise on a bare minimum of tangible assets. One consequence of the resulting tough competition has been industry concentration, with a growing winner-takes-all inequality between winners and losers.
The next feature is sunkenness. Intangible businesses typically have a higher level of sunk costs, meaning the assets are harder to value and to sell when things go wrong. They are more likely to be unique to the firm that owns them – Starbucks would have trouble selling its operating processes or its training manual, for example. Businesses with high irrecoverable costs can be hard to finance, especially with debt.
Then there are spillovers – it is easy for other businesses to copy their ideas. Patents aside, one firm using a piece of knowledge doesn’t prevent another firm from using it. After the iPhone was launched, all smartphones started looking just like it. But if companies can’t be sure they will reap all the benefits of their investments, they may invest less.
If they are prepared to tolerate winner-takes-all giant businesses, governments may require them to share spillovers in public-interest research ventures. “That could be part of the bargain over whether governments go after these big businesses or not,” Haskel says. He points to Bell Laboratories, which was part of former US telecoms monopolist AT&T. Bell Labs did a lot of research in the national interest, repaying government tolerance of its parent’s monopoly.
The pace of intangible investment has fallen off since the financial crisis, as companies have generally drawn in their horns. Haskel believes the spillover element has added further to the current productivity slowdown. “If I’m investing less in R&D, it holds back my productivity,” he says. “But it also holds back yours, because you’re not getting the spillover.”
The fourth common feature of intangibles is that they exhibit synergies. As Haskel puts it, some ideas can be worth more when combined with other ideas, particularly in technology. That’s typified by the rise in ‘open innovation’, whereby more firms use external as well as internal ideas. This in turn is a boost for large cities with plenty of spaces for social interaction, where these exchanges are more likely to happen.
... for every dollar ploughed into tangible assets companies now spend around $1.15 on intangible assets.
Because of the four S’s, one characteristic of investing in intangibles is uncertainty. Another is contestedness, as businesses vie to see who can control and own ideas. Knowledge workers become more important. Since these workers can walk out of the door in a way that physical assets can’t, managers in an intangible world need to share information up and down the company, and must keep key workers loyal. The most prized leadership will be that which allows firms to coordinate intangible investments in different areas and exploit synergies, Haskel predicts.
Internal spending on intangible assets – on design, perhaps, or software – is accounted for as an expense rather than capitalised as the purchase of a tangible asset from another company would be. So it doesn’t appear on the balance sheet. With more spending on assets being hidden from view, this makes life more difficult for financial investors in intangible businesses.
“If you invest by looking at company accounts, there’s not much there to help you,” Haskel points out. “This puts the onus on talented investment people who can get to know these companies better in a more informal way.”
Investing in this environment can only get harder, Haskel believes. But certain types of intangible investment seem to be systematically undervalued. “This suggests there are opportunities for investors who can identify good intangible investments and back companies that make them over the medium term,” he reckons.
The burden is now on analysts and investors to get close to these companies and figure out what they are doing, Haskel says. “I hope the book will give them a mental map of what kind of assets to look for when making investment decisions,” he concludes.
Edward Russell-Walling is a writer and editor specialising in business and finance. He has written for a wide range of publications including the Wall Street Journal and the Financial Times.
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