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Rethinking Manufacturing Investments for a Learning Economy

Discover how investing in companies where intangible capital is the key to building long-term value.

Larry White, CMA, CFM, CPA, CGFM, Executive Director of the Resource Consumption Accounting Institute.
Larry White, CMA, CFM, CPA, CGFM, Executive Director of the Resource Consumption Accounting Institute.

Discussions of internal investments normally focus on planning for a capital budget—meaning physical infrastructure that is capitalized on financial statements. Manufacturing will always be a capital-intensive business, but information technology (IT) and digital/data components of capital projects are rapidly becoming a larger proportion of the project budget. Additionally, the annual non-capital spending to maintain and improve the IT and digital/data components is increasing. Less noticeable is the growing spending on workforce and workforce skills and capabilities necessary to operate and redesign business practices and processes in the technologically advanced environment of SMART manufacturing. What we are experiencing is the next iteration of capitalism; one that increasingly relies on learning, knowledge, and intellectual capital to drive economic success. Perhaps this is a little less true in manufacturing, where physical capital remains dominant, but it is happening.

In capital markets, traditional physical capital is less than 10% of the market value of businesses. The investment analyst’s discussions have shifted from investing in companies with tangible or physical capital to build long-term value, to investing in companies where intangible capital is the key to building long-term value. We have traditionally thought of intangible capital as “goodwill” that primarily resulted from the purchase of another company and was amortized over time in accordance with accounting rules. According to McKinsey and Company, today’s intangible investments revolve around:

  • Brand capital—creating and maintaining brands customers have confidence in, reputation;
  • Human capital—recruiting and retaining personnel and processes to grow their capability and creativity;
  • Innovation capital—research and development, process improvement, market/customer research, intellectual property; and
  • Data and analytics capital—digital strategy on how to incorporate these capitals into corporate/organizational capability, proprietary data, flexible architecture, rapid/adaptive implementation.

The McKinsey study noted that top performers across all industries invested in intangibles at a rate 2.6 times more than their competitors. Specifically for manufacturing, “Even in sectors with relatively lower growth such as manufacturing, top growers are using high investment in intangibles to outgrow the market. Some companies that have outperformed their sectors have diversified into intangible-like adjacencies. For instance, manufacturing companies in slower-growing industries have used their intangible assets to carve out resilient niches within the industry or find new growth markets.”

One significant difference frequently noted about investments in intangible capital is that they often appreciate in value over time if properly managed, nurtured, and cultivated while physical assets depreciate. Many forms of intangible capital build on each other and grow in capability when used frequently. Even failures are often looked at as an investment in organizational learning and a foundation for future innovation.

Organizations have long had operating budgets and capital budgets, but today’s economy calls for more refined planning. Investment strategy still needs to consider traditional capital investment needs, but must also consider investments in brand, human capability investment, innovation, data/analytics investment, and any other capabilities needed by your organization. Articulating these specific categories of investments helps leaders and managers think of the capabilities they need to develop to plan and achieve the organization’s strategies and goals. Thinking of intangible capital as investments rather than operating expenditures often promotes more open and innovative discussion.

Manufacturers are on the bleeding edge of many new technologies­—Industrial Internet of Things platforms, digital twins, robotics, artificial intelligence, predictive maintenance, etc.—and alternative approaches to traditional business such as manufacturing-as-a-service. Organizational learning, knowledge, and intellectual capability are critical. It is important to recognize that capital markets will value intangible investments as much as improvements in physical capabilities. Manufacturing set the pace implementing and advancing continuous improvement—an intangible capability from an accounting point of view. Investing to improve a wider range of intangible capabilities simply extends organizational learning to the broader business of manufacturing. 

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