As another relatively quiet week in the market comes to a close, we thought we would step back from analyzing the market and briefly introduce to our readers a topic that we care greatly about and one that most of our readers are probably unfamiliar with. That topic is investments in intangible assets. The first question that probably comes to your mind after reading the previous sentence is...Why?
Simply, we here at GaveKal Capital believe that investments in intangible assets is what drives innovation in our global knowledge economy and intangible investments create massive reservoirs of wealth for companies that follow an innovation leading strategy that currently are being ignored by most of the financial community.
One of the first steps in understanding investments in intangible assets is frankly just recognizing what constitutes an intangible asset. An intangible asset is an asset that is not physical in nature. Because of this fact, investments in intangible assets have broadly been overlooked. There are three main categories of intangibles: 1) Computerized Information 2) Scientific and Creative Property 3) Economic Competencies.
Computerized information is the knowledge that is embedded in computer programs and computerized databases. Software programs and databases provide huge productivity gains for employees as they are able to leverage this technology. However, in order for these software programs and computer databases to be useful, most employees will need to undergo hours of initial training. Once these programs and databases are firmly in place within an organization, there needs to be a continuous reinvestment in time (learning the newest version and features, keeping a database up-to-date in order to keep the information useful) and money (buying the best hardware to compliment the software, upgrading software).
Scientific and creative property includes two main components: scientific R&D and non-scientific R&D. Scientific R&D is the most traditionally accepted and recognized form of intangible investment. For example, this is the type of R&D that a pharmaceutical company undertakes in order to create a new cholesterol drug. Scientific R&D is now included in the calculation of GDP for the United States as of last summer. It boosted the level of nominal GDP by about $500 billion so it is obviously not inconsequential. Scientific R&D, however, has a very specific definition of which fields that the R&D takes place in in order to be included in this category. Scientific R&D must take place in the math, natural sciences, and engineering fields. This means that R&D that takes place in things such as quality control, product testing and design, sales promotion effectiveness, and research in social sciences are not included. There is a separate category for these items and it is called non-scientific R&D. The latest research on intangibles actually estimates that spending on non-scientific R&D is about 2.5x greater than scientific R&D in the United States.
Last, but certainly not least, is the economic competency category. Economic competencies also include two sub-categories and account for the greatest share of intangible investments in the US economy. The two categories are: brand equity and firm-specific resources.
Brand equity is the knowledge and value embedded in brand awareness and recognition. Marketing and brand awareness have become extremely important as the global economy has flattened and customers and producers are increasingly located halfway around the world from one another. In order for companies to compete and gain market share in this type of a dispersed marketplace, consumers must be able to recognize and have positive associations with a company or products brand.
Firm-specific for all intents and purposes of this post is investments in worker training. The current knowledge economy is very much a service economy. As such, worker training becomes imperative as a companies workers become the primary way a consumer interacts with a companies brand or product. If the consumer has poor interaction with an employee, they may never come back to that company or product again.