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A worklng paper for lM8l
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Abhishek Gupta
June 2009
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Abhishek Gupta has done his Masters in Business Administration (M.B.A., International
Business) from University Business School, Panjab University, India. He has also done his
Bachelors in Commerce (Economic Honors) from GGDSD College, Panjab University, India.
A university rank holder (both in Masters and Bachelors), he has many academic
accomplishments.
During the course of his Exchange semester at Dauphine University, Paris, France in 2009,
he worked on an internship project with IMRI (Institut pour le Management de la Recherche
et de l'Innovation) for whom he has written this paper.

Abhishek Gupta has worked as Summer Trainee at Ballarpur India Ltd. (a leading paper
company) where he was responsible for promoting a new product in the market. The task
involved conducting a market research for the product and ensuring shelf space at new
counters.

He has special interests in academics and business management studies.

In case of any queries or suggestions or some other related work, feel free to contact him at
avigupta1987@gmail.com .
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I would like to thank IMRI (Institut pour le Management de la Recherche et de l'Innovation)
for providing me with the opportunity of doing an internship project with them. It has been a
great learning experience and I feel honoured to have worked with some true professionals.
I would like to thank my institute, University Business School, Chandigarh, for providing me
with this opportunity of going on an Exchange Program to Dauphine University, Paris, where
I got a chance of working with such an esteem and reputed organisation, IMRI.
I express my deep sense of gratitude to Emilie-Pauline Galli and Renelle Guichard (both
IMRI staff), for providing me with the required resources, guidance and atmosphere essential
for the execution and completion of the project. Without their support and valuable inputs at
every stage, this project would not have been possible.
I also wish to extend my gratitude to Prof. Richard Oren (Professor at Dauphine University,
Paris) for bringing me into contact with IMRI. Without his unconditional support at the
beginning, this project could never have been initiated.


Abhishek Gupta
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Introduction 5
Definitions 6
Intangible Assets 6
Innovation 9
Relation between Intangibles and Innovation 10
Intangibles Should they be treated as Expenditure or Capital
Investment?
12
Understanding Expenditure and Capital Investment 12
From Business Point of View 12
From National Accounts Point of View 13
Mathematical Explanation 14
Difficulty in Treating Intangibles as Expenditure 15
Measuring Innovation 17
At Business Level 17
Metrics to Measure Innovation 17
Methods/Approaches to Measure Innovation at Firm
Level
20
Methods/Approaches to Measure Innovation at National
Level
26
Data Collection Approaches 28
Currently Used Measurement Systems 30
Conclusion 31
Reporting of Intangibles 31
More Work to Be Done 33
Bibliography 36
Annex 38
Evaluation of Innovation Metrics over Generations 38
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Today we are living in a world of knowledge economy. Innovation is more important than it
ever was, especially in this era of global economic crises where differentiation becomes the
key distinguishing factor between the performances of firms.
Empirical research and surveys show that innovation leads to new products and services,
better quality, and lower prices. In todays knowledge economy and global economic
environment, companies have to face a lot of competition and hence differentiation has
become a key success factor. This requires continuous innovation (Lev & Daum, 2004; Stone
et al, 2008).
Through this paper I have attempted to bring about a better understanding of innovation and
intangibles and their constituents. Treatment of intangibles as either expenditure or capital
investment has also been looked upon.
I have also tried to identify metrics that can be used for the evaluation of innovation process
and focused on various approaches/methods, which can be used to measure innovation both
at firm level and national level.
Then I have looked at the various data collection approaches and what measures are used
currently by practitioners to measure innovation.
The paper ends by suggesting how intangibles can be reported and what all must be done in
the future by the government and business community for supporting and promoting
innovation as well as suggesting new areas of research for innovation.
The focus is that these measures can be further used in order to evaluate the performance of
R&D units.

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The purpose of this section is to establish a better understanding of intangibles and innovation
as well as their characteristics. It would also identify the key components of an innovation
process.
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An intangible asset is an asset that is not physical in nature. Intangible assets don't have the
obvious physical value of a factory or equipment, but they can prove very valuable for a firm
and can be critical to its long-term success or failure. For example, a company such as Coca-
Cola or Google wouldn't be nearly as successful were it not for the high value obtained
through their brand-name recognition. Although brand recognition is not a physical asset that
you can see or touch, its positive effects on bottom-line profits can prove extremely valuable.
Corporate intellectual property (items such as patents, trademarks, copyrights, business
methodologies), goodwill and brand recognition are all common intangible assets in today's
marketplace.
Practical aspect of intangibles (Lev & Daum, 2004):
(a) Intangible assets by themselves neither create value nor generate growth: they need to
be combined with other production factors. They need efficient support and
enhancement systems otherwise the value of intangibles dissipates much quicker
than that of physical assets.
(b) The value of intangible assets is related to the future. They represent capabilities and
potential for future growth and income.

Blair and Wallman (2001) have divided intangible assets into three subcategories based on
the degree to which they can be controlled and/or sold by the firm.
Assets that can be controlled and owned by the firm and can be separated and sold,
for example, patents and databases.
Assets that can be controlled and owned by the firm but not separated out and sold,
for example, R&D and organizational processes.
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Assets that may not be wholly controlled by the firm and are therefore not owned by
the firm, for example, knowledge and skills of labour force.

These differences in degree of controllability and ownership not only influence business
strategies, they have strong implications for measurement and accounting.

Constituents of Intangibles
After developing an understanding of intangible assets, I would like to list down those assets,
which have been considered by researchers over a period of time as core of an innovation
process. These assets are considered economically valuable and are recognized legally. I have
categorized these assets based on works in various research papers by Vosselman (1998),
Nakamura (1999), Webster and Jensen (2006), Jarboe (2007), Marrano et al (2007), Horsten
et al (2008) and Aizcorbe et al (2009).
Human Capital knowledge and skills of individual employees
o Education
o On-the-job training
o Executive time
Organizational Capital knowledge and skills owned by the firms. These knowledge
and skills owned by the firms are usually outputs of innovation processes, which are
often used as inputs for further innovation. These are:
o Licences, Patents & Copyrights
o Brand names and Trademarks
o New processes
o Business Model
o R&D
o Mineral Exploration
o Architectural and engineering designs
o Computerized Information
! Computer Software
! Computerized Databases
o Reputation for quality
o Trade secrets
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Relational Capital knowledge and resources embodied in external stakeholders.
o Control over distribution networks
o Control over markets
o Marketing
! Market Research
! Market Design
! Sales & Advertising
Clever use of advertisement
! Logistics
Production Knowledge Capital knowledge of development of new products and
processes.
o It involves the expertise and efficiency gained by the firms either over a period
or purchased for a particular product or types of products or production lines
etc., which are unique to the firm and give them an advantage.
Continuing the emphasis on importance of knowledge, human resources have been
recognized as very strong and capable intangible assets by firms as it recognized that it is the
humans within the organization who are responsible for the outcome at the end.
It can be illustrated by this figure (Frederick, 2009)



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Innovation is the use of knowledge (either existing or new) to create new products or services
or processes that can be used for reaping benefits, either economic or otherwise. But
innovation in context to business is done for reaping financial benefits for the firms through
creating products or services that generate value for the customers and hence can be marketed
to them. It also involves creating processes internal to an organization, which would enable
more efficient use of existing resources and better the current way of doing things.

The article Innovation Measurement - Tracking the State of Innovation in the American
Economy, (2008) defines innovation as the design, invention, development and/or
implementation of new or altered products, services, processes, systems, organizational
structures, or business models for the purpose of creating new value for customers and
financial returns for the firm.

In the Oslo Manual, OECD (2005) defines innovation as the implementation of new or
significant improved products, operational processes, organizational processes and structures,
and marketing methods.

To further understand innovation, it would be interesting to mention various attributes of
innovation given by Stone et al (2008).
The 10 Attributes of Innovation (Stone et al, 2008)

Attribute 1. Innovation involves the combination of inputs in the creation of outputs.
Attribute 2. Inputs to innovation can be tangible and intangible.
Attribute 3. Knowledge is a key input to innovation.
Attribute 4. The inputs to innovation are assets.
Attribute 5. Innovation involves activity for the purpose of creating economic value.
Attribute 6. The process of innovation is complex.
Attribute 7. Innovation involves risk.
Attribute 8. The outputs in innovation are unpredictable.
Attribute 9. Knowledge is a key output of innovation.
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Attribute 10. Innovation involves research, development, and commercialization.
Application of knowledge is the key to an innovation process of which both tangible and
intangible assets form crucial parts. Since inputs to innovation are used for further innovation
processes in the future as well, they are considered as assets. But, the combination of inputs
often results into a failure that makes this process complex and risky and hence makes the
output unpredictable.
The 10
th
attribute given by Stone et al (2008) is derived from the three interconnected stages
of innovation given by Lev (2001).
Three interconnected stages of innovation (Lev, 2001):
1. Learning and Discovery - Whether internal to an organization or external in networks
or with partners, this stage focuses on the generation and acquisition of knowledge
and skills (the research stage)
2. Implementation - Demonstrating technical feasibility (the development stage).
3. Commercialization Promoting product diffusion and facilitating financial and
economic returns.
To put simply, it means innovation process requires generation and/or acquisition of
knowledge and skills, either internal or external to an organization. This knowledge forms the
basis for carrying out the innovation or the implementation of knowledge as required. Once
results of innovation are positive and a new product, process, or service has been developed,
these must be commercialised in order to obtain financial returns.
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Innovative activities emerge from the application of intangible assets that integrate
knowledge, skills, and technologies in the development and commercialization of products
and processes.
An understanding of the resources, tools, technologies, materials, markets, and needs in the
situation at hand is very important for innovation. Because these resources and knowledge
processes are used repeatedly and provide returns for the future, they are considered to be
assets. This is the reason why innovating organizations willingly spend significant amounts
of resources on research and the acquisition of knowledge (e.g., intellectual property).
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Rose et al (2009) suggest that innovation is driven by a firms (or any entitys) investment in
tangible capital (such as computer networks) or intangible capital (such as organizational
structure or human capital/training). These innovative activities could lead to tangible outputs
(e.g., new or improved products or processes) or intangible ones (e.g., more experienced
employees, who are more likely to engage in future innovations).







Relation between Innovation and
Tangible and Intangible Assets
(Rose et al, 2009)
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Over the years expenditures on intangibles have been expensed, i.e. they have been treated as
expenses to business rather than an investment. Even in terms of national accounts and
calculation of GDP, treating intangibles as investment or expenditure brings out different
results.
Before suggesting weather intangibles should be treated as expenditures or capital
investments, it would be important to develop a brief understanding of the differences
between expenditures and investments in our context.
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Expenditures are something, which are charged to Profit & Loss accounts of the current year
and are not included in the balance sheet as assets. Investment in assets on the other hand
would mean that the money spent on the acquisition/creation of intangibles would not be
expensed in that particular year, but would be included in the balance sheet as an asset. The
difference is interesting to understand because assets are supposed to provide economic
returns even in the future while expenditures are for a particular time period.
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It is important for businesses to include their own expenditure on intangibles as investments
because
Businesses manage what they measure.
Treating intangible investments as expenditures would mean higher expenses, which
would lead to lower profits. It means low taxes on one hand but also lower stock
prices on the other.
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Even from the accounting point of view, rising investment in intangible assets reduces
measured current profits and raises expected future profits. The stock market recognizes that
such investments usually generate future profits. That is why investment in R&D generally
makes stock prices rise.
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Research shows that intangible investment worth billions of dollars has been excluded from
national published data of countries. This understates all investments, income and savings.
Nakamura (1999) suggests that intangibles should be treated as investment. According to him
by not counting spending on R&D and other intangible assets as investment, US national
accounts understate not only investment but also national income and national saving. This is
because treating spending on intangible assets the same way we treat spending on tangible
assets would raise measured business investment. Thus, similar treatment would also raise
measured output of goods and services. For example: making the adjustment for R&D
investment alone would raise measured U.S. gross domestic product in the 1990s roughly 1.5
percent. (Nakamura, 1999)

Aizcorbe et al (2009) suggest treating spending on intangibles as investment would have two
primary effects on the national income and product accounts:
It would increase GDP and gross domestic income (GDI) in periods when firms invest
in intangibles.
It would also add a new inputintangible capital or the stock of knowledge and
the value of the capital services generated by that capital would be measured in the
income account in subsequent periods.

To further emphasise the importance of treating intangibles as capital investment in national
accounts, let us study the findings of Corrado et al (2006) and Belhocine (2008).
Corrado et al, (2006) suggest that as much as $800 billion is excluded from U.S. published
data (2003), and this leads to the exclusion of more than $3 trillion of business intangible
capital stock. In order to emphasise the importance of this omission, they added this
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intangible to the growth framework used and observed the following changes in observed
patterns of U.S. economic growth.
1. The rate of change of output per worker increases more rapidly when intangibles are
counted as capital.
2. Capital deepening becomes the unambiguously dominant source of growth in labour
productivity.
3. The role of multifactor productivity is correspondingly diminished, and labours
income share is found to have decreased significantly over the last 50 years.

Belhocine (2008) has suggested the following impacts of omission and improper
measurement of intangible inputs in the Canadian economy.
Since spending on intangibles is not treated as investment, aggregate savings and
investment may be significantly understated in official statistics. Monetary policy-
makers could be misled by such an imprecise picture of the economy.
Fiscal policy can be affected in various ways such as in the design of a fair tax
system.
Resource allocation and investment decisions within firms and across firms in a given
industry become more difficult.
The lack of good information on intangibles will lead to opaqueness and volatility in
capital markets given the increased difficulty to estimate the future cash flows that
some investments will generate.

Hence, even from national accounts point of view, it is pretty much important to treat
intangibles as capital investment.
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Corrado et al, (2006) have used mathematical functions to suggest that it is more suitable to
classify intangible expenditure as capital rather than as expenditure or intermediate good.
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This they have done by considering a world of three goods, consumption C, tangible
investment goods I, and an intangible N. When intangibles are regarded as being an
intermediate good, labour L and tangible capital K are allocated to the production of all three
goods, and N is an input to C and I.
According to them the concept of GDP when intangibles are treated as capital investment is
more comprehensive and larger in magnitude than when they are treated as expenditure.
(For detailed mathematical explanation, refer to Intangible Capital and Economic Growth
by Corrado, Hulten & Sichel 2006, Pg 4)

It is of immense importance to measure and account for all the investment in intangibles
because otherwise it is detrimental to both national statistics and planning as well as to
business decision-making. Underestimating investments leads to wrong estimation of income
and savings and hence a possibility of flawed policymaking. Also because businesses use
national account data (GDP, per capita income, growth rate etc.) to make their decisions
relating to investments and operations in various countries, so business decision-making
would also suffer.
Nakamura (1999) suggests that it also leads to an impact on the stock markets as stock
markets anticipate the future earning and growth capacities of firms.

After realizing the importance of treating intangibles as investments, it is necessary to
understand why intangibles are still expensed in businesses or in national accounts.
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Even though it has been widely proposed and acknowledged that intangibles must be treated
as investments because of various flaws of treating intangibles as expenditures, there are a
few obstacles, which deter researchers, businesses and national account statisticians from
doing so.
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It is a fact that it is very hard to estimate the future benefits of the intangibles and reliable
measurement may not be possible. Belhocine (2008) has established that it is hard to measure
intangibles as investments due to certain specific attributes of intangibles.
1. Visibility
2. Not appropriable
3. Marginal cost to produce an extra unit is zero
4. Uncertainty in outcome of production
5. Some elements are short lived and some are long lived
6. Lag can exist between production of intangibles and their full exploitation

Even though it is hard to measure intangibles, their importance is unquestionable both for
businesses and national accounts. I believe it is imperative to account for intangibles, as it
would enable much better and informed decision-making.
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After understanding the concept of innovation and realizing its importance as a capital
investment, it would be interesting to see how we can measure innovation.
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From a business perspective, it is very important to measure innovation and keep a track of
intangibles for the purpose of innovation. It is important because usually businesses manage
what they measure (Frederick W. 2009). According to McKinsey survey 2008 (Stone et al,
2008) companies pursue four types of innovation: product, service, process, and business
model.
Hence not measuring intangibles would lead to faulty management decision-making. But, it is
also important for businesses to decide what they should measure and what they should not to
measure, as measurement of intangibles is a very expensive process.
In order to aid the decision of what should be measured and what should not be measured, it
would be interesting for businesses to follow the guidelines given by Andrew et al (2007) in
this regard. Andrew et al (2007) have categorized components of innovation that need to be
measured.
1. Inputs, or resources, such as people and money
2. Processes, which act on and transform the inputs
3. Outputs, or end results which include cash results and indirect benefits like stronger
brand
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BCG 2007: Senior Executive Innovation Metrics Survey and McKinsey survey 2008 (Stone
et al, 2008) have given several metrics which are used by firms and several others which are
important but are not used by the firms.
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These metrics have been ranked in the order of preference or usage by the firms. The metrics
used most commonly are put on the top.

The most important metrics according to companies and reasons:
Revenues realized from offerings launched in last 3 years example: Percentage of
sales from new product/service

o Allows evaluation of different projects
o Provides bases for future capital allocation to different projects
o Revenue is a measure to make sure if high impact ideas are being chosen
o 3 years is considered a reasonable time period to judge performance of
innovation initiative

Projected versus actual performance example: Return on investment, Profit growth
due to new product/service, Customer satisfaction, Net Present Value of the entire
new product/service portfolio

o Important for internal performance measurement
o Important for communicating with the shareholders
o Forecast accuracy is considered important for revenues and profits
o Helps to hold teams accountable for delivering results

Total funds invested in growth projects example: R&D spending as a percentage of
sales, Number of people actively devoted to innovation, Total number of R&D
projects, Number of new products or services launched

o A measure of senior managements commitment to innovation and growth
o Comparing R&D spending with those of competitors
o It forces to keep track of project portfolios and hence brings managements
attention towards the project
o Long-term survival of companies is based on identifying and funding future
growth projects.
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Allocation of investments across projects example: Number of new projects funded
v/s number of old projects funded, Different kinds of projects funded

o Ensures balancing of money across projects
o To maintain a strategic balance between traditional and innovative products
o To recognize how much money is being spent for the future and for the
present

The BCG 2007: Senior Executive Innovation Metrics Survey also lists down metrics that are
usually ignored by the firms but are very important.

Metrics which arent commonly used:
The extent to which new offerings cannibalize existing products
The percentage of ideas funded
The no. of projects killed or tabled at each milestone.

The McKinsey study concludes the metrics would be more useful if the firms had a way to
standardize the metrics so that they could benchmark their performance against their
competitors.

I believe the above listed metrics can provide very useful guidelines to firms to measure the
impact of innovation. Using these metrics would enable a better understanding of the efforts
put in for innovation and the desired results. Evaluating results is very important from
business perspective as it gives them a sense of direction and belief of having the ability to
achieve what they desire. Moreover, if they are able to measure their performances against
competitors, it would give them the much needed awareness of where they stand and what
they can or must do in order to do well in this competitive business environment.
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After understanding what needs to be measured, it is also important to understand how it shall
be measured. Different researchers have suggested different methods to measure innovation.
Cash Curve
Andrew et al (2007) have suggested the use Cash Curve for measuring innovation. According
to them each and every aspect of innovation need not be measured. One way to select which
aspects need to be measured is the cash curve.
The cash curve is a depiction of cumulative cash investments and returns (both expected and
actual) for an innovation over time, from idea generation through to the point when product
or service are removed from the market. It makes explicit 4 factors that affect the success for
an innovation and its ability to generate a return. These are:
Start-up costs (pre-launch investments)
Speed (time to market)
Scale (time to volume)
Support costs (post-launch investment)


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The following are some sample metrics for each of them.
Start-up Costs
The number of full time staff involved
Operating expenses
Capital expenditure
Speed
Actual time to market
Time to key checkpoints
Actual versus planned full-time employee hours
Scale
Actual versus planned volume produced
Actual versus planned product availability
Actual versus planned first year sales
Actual versus planned distribution
Actual versus planned timing of ad campaigns
Support Costs
The extent to which new offerings cannibalize existing products
Marketing and promotional activities
Pricing actions
Key staff devoted to the project
Product maintenance and service cost
The cash curve is an effective tool as it takes into account all the costs, volume and speed.
The problem lies in making initial estimates. If initial estimates were not good, then
comparison would be flawed.


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Balanced Scorecard

Frederick (2009) has suggested the use of a Balanced Scorecard for measuring innovation.
The balanced scorecard is a strategic planning and management system that is used
extensively in business and industry, government, and non-profit organizations worldwide to
align business activities to the vision and strategy of the organization, improve internal and
external communications, and monitor organization performance against strategic goals. It
was originated by Drs. Robert Kaplan (Harvard Business School) and David Norton as a
performance measurement framework that added strategic non-financial performance
measures to traditional financial metrics to give managers and executives a more 'balanced'
view of organizational performance.






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The balanced scorecard is one effective way as it takes into consideration even the non-
financial measures and keeps a track of companies strategic goals. But it does not provide a
framework to measure investment in intangibles or innovation.


Computing Aggregate Innovative Indices

Though this approach is used mainly for national level as discussed later in the paper, it is
also used at the firm level (Stone et al, 2008).
Eg. Porters Diamond Cluster Model attempts to explain the process of innovation as it
occurs within individual firms (Porter 1998) and Skandia Navigator links inputs such as
human and organizational capital with outputs such as innovative products, market share, and
profits.




Porters Diamond Model
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Monetizing Innovation The Residual Method
Another approach to measuring innovation focuses on measuring the dollar value of
innovative activities. Some researchers, such as Lev (2001), measure intangibles as a proxy
for innovation and estimate the value of intangible assets as the residual left when book value
is removed from the firms market value. This residual is a catchall for intangible assets and
does not reflect the importance of various assets to a firms innovative productivity. Others,
such as Nakamura (2001), Corrado, Hulten and Sichel (2006); Hill and Youngman (2003),
and Arundel (2007), treat expenditures on intangible assets as investments in innovation
capacity.
The quintessential example of a company where this difference is high is Amazon, which (in
June 2007) had a book value of $550 million and market capitalization of $35 billion.

Advantages of the method:
It offers the potential for revealing deep insight into the innovation process.
(According to Stone et al, 2008)
It seems more transparent. (According to Stone et al, 2008)
Explains why stock prices (market value) are different from actual physical value
(book value) of firms.
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It is easy to understand and calculate.

Limitations of the method:
The monetization approach is only as strong as the methodology behind the process
for monetizing the intangibles. (According to Stone et al, 2008)
It considers innovation as synonymous to intangibles but we have seen earlier that
they are different.


Accounting Methods for Measuring Intangibles

According to Stone et al (2008), accounting guidelines traditionally treat funds spent on
intangible assets as expenses, not as investments that are expected to yield future returns. As
a result, these funds are not capitalized on the balance sheet. Since the accounting data are
relied upon by managers and outside investors, the accounting rules favour objective,
verifiable valuations such as arms-length, market-based transactions.
When firms are purchased, the catchall term goodwill is used to capture the value of the
intangible assets purchased. If the purchase price exceeds the book value of the assets, then
the difference is considered to be the value of the intangibles.

Advantages of the Method:
Logical method.
Easy and practical in its approach.

Limitations of the Method:
This method can only be applied in case of Mergers & Acquisitions.
It is like the residual method given by Lev (2001) and hence has similar limitations.



The methods discussed above like Cash Curve, Balanced Scorecard, Porters Diamond
Model, The Skanda Navigator give us different methodologies to use all or some of the
above-mentioned metrics. These provide as readymade tools to the firms to use the metrics
for innovation and evaluate their impact. They help in detailed planning in order to make the
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right decisions keeping in view the firms long-term goals and strategic plans. For example,
Porters Diamond Model goes to the extent of taking into consideration even the luck factor
and government policies. I would say they give the companies an insight before foraying into
the unseen territory and then evaluating their success therein. The importance of this to
businesses can never be understated.
These methods are proactive in their approach and hence go in line with modern day business
thinking and practices.

The accounting method and the residual method, though have practical usability and are used
pretty often, do not really give an insight to the businesses as to what should be measured and
what should not be measured. These methods can only be used to determine the value of
intangibles. They do not suggest any course of action to be followed by firms.

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Computing Aggregate Innovative Indices

The aggregate indices approach (Stone et al, 2008) is frequently used in evaluating the level
of innovation within a nation or other political unit. This approach focuses on applying an
understanding of the innovation process and assessing the factors that play a critical role in
innovation.
The European Unions European Innovation Scoreboard ranks the innovation of European
nations.
The EU Scoreboard includes indicators such as:
Broadband penetration rate (lines per 100 people).
Participation in lifelong learning (percentage of population age 25 to 64).
Investment in people and business R&D expenditures.
Early stage venture capital.
Employment in high technology industries.
New patents issued.
New trademarks approved.

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According to Stone et al (2008), as a tool for studying innovation, the aggregate indices
approach is useful only in a very narrow range of applications.

Advantages of the method:
This approach typically collects data about a wide variety of innovation factors.
In making comparisons among political units, this approach can allow for fine
discriminations.

Limitations of the method:
Only limited financial data are typically collected.
The primary focus of the data-collection effort is on qualitative data (allowing for a
few exceptions).
Further, the indices are typically created based on correlation analyses. As a result, the
data are for the most part limited to producing scorecards or providing descriptive
analyses of the innovation within a firm, political unit, or country.

Contribution of Intangibles to Growth Indirect Method

Nakamura (2001) focused on measuring the total investment in intangible assets and its
contribution to growth. He figures out the correlation between GDP and consumption. He
says that an increase in consumption is due to intangibles, which have not been accounted
for. He used several methods to estimate the investment in intangible assets.

First, he estimated the number of employees in innovative occupations such as
engineering, science, and the arts and then used their median pay to estimate the
amount of investment.
Second, he estimated the decline in the percentage of revenues attributable to the cost
of goods sold. He argued that the decline is due to increased investment in intangible
assets.
Next, he used an indirect method. Evidence shows that the ratio of consumption to
GDP is relatively stable, assuming all investment is properly measured. If true, this
implies that a rise in consumption indicates some investment (such as intangibles) is
not being counted.
Page | 29

Finally, he measured the direct expenditures used to develop intangible assets. He
estimated that $1 trillion per year is invested in intangible capital.

Advantages of the method:
Brings out the impact of not treating intangibles as investment.

Limitations of the method:
It is an indirect method. So the results obtained are just estimations.
Other direct methods can give more precise results.

As studied earlier, it is essential to measure innovation even at the national levels. The
methods discussed above are not very precise and do not give exact evaluations but provide
fair estimates.
I believe more work needs to be done in order to establish measures to evaluate innovation at
national levels.
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After looking after methods/approaches to measure innovation, it is important to learn how
data is collected for this purpose.
Data Collection Approaches

There are 4 types of data collection approaches (Belhocine, 2008):

1. Bought-in expenditure data. These data consist of items that have a recorded
transaction on the market. These data are typically available if a survey of purchases
exists, for example, in the case of pre-packaged software.

2. A second approach to collecting data relies on the consequence of the non-existence
of bought-in expenditure data. It consists of gathering the revenue estimates of
Page | 30

knowledge- good providers. For example, the revenues of the advertising industry can
be used as an approximation for firms expenditures on advertising.

3. A third type of data that is used stems directly from activities of the firm, which is
known as own-account spending or self-constructed goods.

4. Educated guess on the size of some spending given certain background information.
For example, the own-account spending on organizational change and development is
set as 20% of the wage of executives by Corrado et al. (2005).
Page | 31


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We have seen in the paper earlier what different measurement systems can be used and how
data can be collected. It is also quite interesting to see the different measurement systems,
which are being used by practitioners these days.
Four measurement systems currently popular among practitioners to manage intangible
resources (Bontis et al, 1999):
(i) Human resource accounting;
(ii) Economic value added;
(iii) The balanced scorecard; and
(iv) Intellectual capital




Page | 32

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It is has been accepted that intangibles investments need to be measured and innovation is
very essential in this knowledge economy. Treating intangibles as capital investment is better
for both the national accounts as well as for the firms, as we have established earlier. A few
measurement systems have been discussed along with their advantages and disadvantages
(wherever feasible) which are used currently and which can be used in the future.
I believe firms should use measures that they believe are flexible and more suited to their
business needs because each measure is different in its approach. All methods have their
positives and negatives, so I would suggest the firms shall consider the innovation metrics
and know what they need to measure.
In case of measurement for national accounts, the residual method suggested by Lev (2001) is
a very handy method to study the impact of intangibles but is not the right measure for
measuring either intangibles or innovation.
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During the course of the paper it has become quite evident that it is important to report for
intangibles. But usually firms dont understand how to do that. Frederick (2009) has given
some suggestions for solving the problem of intangible reporting.
Also we shall see what the governments and businesses must do for innovation in the future
and new areas of research for innovation.

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After developing a thorough understanding of intangibles and innovation and the importance
of measuring innovations, we shall look at various ways of reporting intangibles.
Page | 33

Frederick, W. (2009) has given the following suggestions for solving the problem of
intangible reporting.

1) Fundamental overhaul: rethinking the accounting treatment of intangibles:
Capitalisation of a great number of expenditures that could be considered
investments such as training.
Dual track reporting with core information that corresponds to existing
reporting and supplemental information provided under a different reporting
framework that does not require the same standards of verifiability as
accounting statements.
American Institute of Certified Public Accountants (AICPA) resulted in a
report by the so-called Jenkins Committee
(a) Disclosure of more forward looking information such as business
plans, opportunities, risks and uncertainties
(b) More emphasis on factors leading to long term values, including
non-financial measures that indicate how the important business
processes are functioning
(c) A closer connection between the information used internally for
management of the company and the information that is publicly
released.
2) Disclosure of greater detail in the existing reporting framework:
Accounting need not be altered fundamentally.
New information can be provided as supplemental disclosures in footnotes.
Key non-financial performance indicators must be identified and discussed.

3) Supplemental reporting outside of the existing accounting framework:
It says fundamental change to traditional financial reporting is neither feasible nor
desirable.
It is not desirable because the existing system of accounting and financial
reporting will not yield the information that is required,
Nor feasible because barriers prevent change to the accounting system and
because the existing system works; it provides a certain group of users with
adequateif not perfectinformation on what they need.
Page | 34

As a result, an entirely new form of reporting is needed that is designed
specifically for the needs of users and is separate from traditional accounts.

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Innovation is very important today for nations at large and businesses in general. Hence
(Innovation Measurement - Tracking the State of Innovation in the American Economy,
2008) has suggested what the government and businesses should do for innovation.

In particular, it recommends that the government:
Create a stronger framework for identifying and measuring innovation in the national
economy.
o Create a supplemental innovation account for the National Income and
Product Accounts (NIPAs) in order to expand the categories of innovation
inputs and allow those inputs to be tracked as they flow between industries.
o Improve service sector data and increase survey coverage to provide the data
needed to improve estimates from the integrated GDP/productivity accounts
and supplemental innovation account.

Better leverage existing data among the statistical agencies to allow for the consistent
estimation of the contributions of innovation in the gross domestic product (GDP) and
productivity accounts and to develop greater understanding of innovation.
o Develop linkages within and between existing data; for example, develop
linkages between establishment-based data sets and firm-based data sets to
provide both greater consistency in estimations and to provide researchers a
broader range of innovation data.
o Develop more robust classification methods; for example, classify firms on the
basis of both domestic and international activities

Increase access to data in order to facilitate more robust innovation research.
Convene one or more workshops or forums under the auspices of the Secretary of
Commerce to discuss innovation drivers, impediments and enablers.
Page | 35

Continue participation in the international dialogue related to measuring and
analyzing innovation and ensure that U.S. efforts are internationally compatible to the
extent possible.
Consider development of a national innovation index when more work has been done
on both data collection and analysis of innovation drivers.
Support funding necessary to implement the above recommendations.


In particular, the paper recommends that the business community:
Create, expand and assess firm and industry level measures of innovation and develop
best practices for innovation management and accounting.
o Institute firm-level measures of innovation to test the correlation of particular
measures with known innovation and to measure innovation in the firm and its
impact on firm performance. Possible measures might be based on market
share or on innovation intensity.
o Develop and implement best practices in innovation management and
accounting.
Participate in research activities and, as appropriate, make innovation information
available to researchers.

The same paper (Innovation Measurement - Tracking the State of Innovation in the American
Economy, 2008) also suggests some new areas of Research Exploration

In particular, it recommends exploration of the following research areas:

Identification and assessment of innovation outcome measures.
o Assessment of the effectiveness of measures based on market share as
innovation measures and the feasibility, cost, and burden of developing such
measures.
o Assessment of the feasibility, cost, and burden of developing measures of
innovation intensity, including a review of other countries experience in this
area and consideration of a pilot project.
o Analysis of the qualitative and quantitative impacts of specific drivers,
impediments and enablers on innovation outcomes
Page | 36


Identification of gaps in innovation data and how they might be filled.
o Identification of new data that would be useful in measuring innovation.
o Assessment of the feasibility, cost and burden of collecting data on intellectual
property transactions
o Identification of ways to overcome gaps and shortcomings in historical
measures of intangible investments.

Analysis of relationships between innovation activities and collaboration, innovation
performance and firm performance.
o Analysis of the relationship between innovation and occupational employment
using firm-level micro-data
o Evaluation of whether firms with high innovation intensities perform better
than otherwise similar firms with low intensities
o Assessment of the effect of collaboration on innovation outcomes and
identification of the key elements of successful collaborative activities
o Assessment and analysis of cross-national innovation activities of firms
o Analysis of publicly filed financial and other data on firms, particularly as the
data become more user-friendly, to identify innovative practices and firm.


Page | 37

:-H7-(G,0LJ'

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Page | 40

!99?F

Evaluation of Innovation Metrics over Generations
The indicators for intangibles have evolved over the years as we have moved towards a
knowledge based economy.
Milbergs and Vonortas (n.d.) portrayed innovation metrics as evolving through four
generations (see Table 3):
The first generation of metrics reflected a linear conception of innovation focusing on
inputs such as R&D investment, and the like.
The second generation complemented input indicators by accounting for the intermediate
outputs of S&T activities.
The third generation focused on a richer set of innovation indicators and indexes based on
surveys and integration of publicly available data.
The fourth generation metrics of the knowledge-based networked economy remain ad hoc
and are the subject of measurement.