Management And Accounting Web

Ulrich, D. and N. Smallwood. 2004. Capitalizing on capabilities. Harvard Business Review (June): 119-127.

Summary by Erin Lagor
Master of Accountancy Program
University of South Florida, Fall 2004

Auditing Main Page | Knowledge Management Main Page | Performance Measures Main Page

Although they may differ in degree, number, or type, intangible assets are important to all companies. However, because they are difficult to measure, we do not often hear about ways in which to measure them or even how important it is to measure them. Ulrich and Smallwood assert that a capabilities audit can make capabilities visible and meaningful to companies’ stakeholders (p. 127). This article describes what a capabilities audit is and gives a step-by-step method on how to conduct one.

Organizational Capabilities

What people really respect about companies are their capabilities, i.e., an ability to innovate, or to respond to changing customer needs. Organizational capabilities are key intangible assets that make a significant difference when it comes to market value (p. 119). Organizational capabilities are stable over time and more difficult to copy than other competitive advantages like product strategy or technology. A capabilities audit can show a company how measure up and how to build on intangible strengths (p. 119).

Organizational capabilities arise when a company delivers on the combined competencies and abilities of its individuals. The authors have identified 11 capabilities that well-managed companies all tend to have. “Such companies often excel in as many as three of these areas while maintaining industry parity in the others. When an organization falls below the norm in any of the 11 capabilities, dysfunction and competitive disadvantage will likely ensue” (p. 120). The 11 capabilities, explanations, and ways to evaluate them are indicated below.

1. Talent: Talent is the organizational capability that attracts, motivates and retains competent and committed people. Productivity measures, retention statistics, employee surveys, and direct observation are ways to evaluate a company's talent.

2. Speed: This is the ability to recognize opportunities and to act immediately. Acting quickly can refer to exploiting new markets, creating new products, establishing new employee contracts, or implementing new business processes. How long it takes to go from concept to commercialization, or from the collection of customer data to changes in customer relations. A return-on-time-invested (ROTI) index can monitor the time required for, and the value created by, various activities.

3. Shared Mind-Set and Coherent Brand Identity: This is the organizational capability that ensures that employees and customers have positive and consistent images of and experiences with an organization. The degree of alignment between internal and external mind-sets. Measuring the degree of consensus among employees can be measured by asking all employees what the top three things are that the company wants to be known for in the future.

4. Accountability: This is being good at obtaining high performance from employees. Performance accountability becomes an organizational capability when employees realize that failure to meet their goals would be unacceptable to the company. Measured by examining the tools the company uses to manage performance (i.e., appraisal forms, variance in compensation based on employee performance, etc.).

5. Collaboration: This is working across boundaries, ensuring efficiency and leverage. “Collaboration occurs when an organization as a whole gains efficiencies of operation through the pooling of services or technologies, through economies of scale, or through the sharing of ideas and talent across boundaries” (p. 121). Measured by calculating a company’s break-up value, and comparing the break-up value to the current market value of the assets.

6. Learning: This is generating and generalizing ideas with impact. New ideas can be generated by benchmarking, experimenting, continuously improving, etc. Look at what other companies are doing and hire or develop people with new skills and ideas.

7. Leadership: Being good at embedding leaders throughout the organization. Consistently producing effective leaders is generally an indication of a clear leadership brand. Companies can track the organization’s leadership brand by monitoring the pool of future leaders.

8. Customer Connectivity: Building long-lasting relationships of trust with certain customers. When a large number of employees have meaningful exposure to or interaction with customers, connectivity is enhanced (p. 122). Identify the key accounts and track the share of those important customers over time. Frequent customer-service surveys may also offer insight into how customers perceive the company's connectivity.

9. Strategic Unity: Articulating and sharing a strategic point of view. There are three levels of strategic unity: intellectual, behavioral and procedural (p. 122). Note how consistently employees respond when asked about the company’s strategy.

10. Innovation: Doing something new in both content and process. A vitality index, for instance, one that records revenues or profits from products or services created in the last three years provides a measurement. (p. 122).

11. Efficiency: Being good at managing costs. Inventories, direct and indirect labor, capital employed, and costs of goods sold can all be viewed on balance sheets and income statements.

Given a company’s history and strategy, an audit helps to determine which assets are most important. The audit is also able to reveal how well a company delivers on its most important capabilities and can lead to an action plan for improvement (p. 123).

The following five steps show how a company might go about auditing the entire organization, a business unit or a region:

1. Determine which part of the business to audit. Division, region, entire company, etc.

2. Create the content of the audit. Tailor the 11 generic capabilities to your own organization.

3. Gather data from multiple groups on current and desired capabilities. 90-degree, 360-degree, or 720-degree assessments. For a 90-degree assessment, Collect data only from the leadership team of the unit being audited. For a 360-degree assessment, Collect data from multiple groups within the company. Different groups can provide otherwise missed insights and/or perspectives. For a 720-degree assessment, Collect data from both inside and outside the company (investors, customers, suppliers, etc.).

4. Synthesize the data to identify the most critical capabilities requiring managerial attention. Look for patterns in the data. Determine the three capabilities needed to deliver on your company’s goals.

5. Put together an action plan with clear steps to take and measures to monitor, and assign a team to the job of delivering on the critical capabilities. Education/Training events, new performance standards, new technology to sustain the capability are all ways to take action.

The authors emphasize that a company should not necessarily choose capabilities with low scores in actual performance to concentrate on improving. If certain weak capabilities are not essential to meeting the company’s goals, they should not be the focus of the audit. Additionally, even if a company scores high on a capability, this may not mean that it does not still need to be improved. For example, if a company scores high on talent, the leaders can choose to further invest in talent since it is so critical to success. The idea is not necessarily to boost the capabilities that are weak. Instead, the idea is to identify and build capabilities that will have the strongest and most direct impact on the execution of strategy (p. 123).

Lessons Learned

No two audits will be exactly the same. The authors finish this article by giving companies the following advice about conducting capabilities audits:

Get focused.
Recognize the interdependence of capabilities.
Learn from the best.
Create a virtuous cycle of assessment and investment.
Compare capability perceptions.
Match capability with delivery.
Avoid underinvestment in organization intangibles.
Don’t confuse capabilities with activities.

Capabilities audits help companies assess company strengths and weaknesses. These audits also define strategy, support midlevel managers in executing strategy, and enable frontline leaders to make things happen. A capabilities audit helps customers, investors, and employees all recognize the intangible value of an organization (p. 127).

________________________________________

Related summaries:

Collingwood, H. 2001. The earnings game: Everyone plays, nobody wins. Harvard Business Review (June): 65-74. (Summary).

Grojer, J. 2001. Intangibles and accounting classifications: In search of a classification strategy. Accounting, Organizations and Society 26(7-8): 695-713. (Summary).

Jalbert, T. and S. P. Landry. 2003. Which performance measurement is best for your company? Management Accounting Quarterly (Spring): 32-41.(Discussion of EVA, tracking stock and balanced scorecard). (Summary).

Johanson, U., M. Martensson and M. Skoog. 2001. Mobilizing change through the management control of intangibles. Accounting, Organizations and Society 26(7-8): 715-733. (Note).

Kaplan, R. S. and D. P. Norton. 2004. Measuring the strategic readiness of intangible assets. Harvard Business Review (February): 52-63. (Summary).

Lev, B. 2004. Sharpening the intangibles edge. Harvard Business Review (June): 109-116. (Summary).

Martin, J. R. Not dated. What is a business valuation? Management And Accounting Web. http://maaw.info/BusinessValuation.htm

Porter, M. E. 1996. What is a strategy? Harvard Business Review (November-December): 61-78. (Summary).

Schilit, H. 2002. Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports. 2nd edition. McGraw Hill. (Summary).