Book Notes: Capitalism Without Capital

Why market valuations for some companies are so high when the traditional way of analyzing those companies through their fundamentals don’t support those valuations?

Why it seems that Investment indicators are in low levels when interest rates are so low? Is there an additional element hidden in plain sight that could constitute what could be call there is a “Dark Matter of Investments” ?

What is the relevance of Organizational Design, Process Engineering, Training, Innovation management for companies?

The answer to these and other relevant questions is the growth in relevance of intangible assets.

The book resumes decades of research in intangible investments: How to measure them, what are their characteristics and how they event might explain some atypical behaviors of the stock market

In this post I will write some of the notes I took while reading the book

Basic Concepts

Investment: What happens when a producer either acquires a fixed asset or spend resources to improve it.

Asset: An economic resource that is expected to provide a benefit over a period of time.

Intangible Assets: Complex pricing systems, ambitious branding, marketing campaigns, detailed process, new product designs, new business models, training.

Over time , intangible investments (investing in intangible assets) have steadily increased . Data suggest intangible investment overtook tangible investment around the time of the global financial crisis.

Is it possible that the rise of intangible investment is nothing more than a consequence of improvements in IT? Is the intangible economy a sort of corollary of Moore’s Law or an epiphenomenon of what Erik Brynjolfsson and Andrew McAffe call the Second Machine Age? Or is it that IT and the research that lead to it was shaped by and economy hungry for intangible investments rather than intangible investment happening as a response to the serendipitous invention of various forms of IT

How to measure Intangible Investments

Measuring investments is a very relevant component of GDP , but the “investment” concept was strictly limited to physical stuff . It did not take long for economists to start questioning this.

In 1962 Fritz Machlup (one of the first economists to examine knowledge as an economic resource) wrote a book entitled “The Production and Distribution of Knowledge in the United States” in which he asked whether different types of knowledge were valuable things that could be produced and started to measure spending on everything from research and development to advertising and branding to training.

Recognizing that Research and Development and Knowledge Production was a vital force in raising GDP a working group of the OECD ment in Frascati, Italy in 1963, to agree on a common framework for measuring R&D, codifying the approach in what became known as the “Frascati Manual” , revised in several subsequent editions, the latest being in 2015.

The thing that reignited economists interest in the measurement of intangible investments where computers and software development. In 1999 the US BEA introduced software as an investment tinto the calculation of IS GDP.

The idea of a new economy also prompted economist to examine the role of knowledge investment more generally. Theorist worked out economic models where knowledge played a key role in promoting growth, either via spillovers of knowledge from one producer to another, or via the competitive process of investment in continuous product improvement.

Then began a painstaking process of defining and measuring the different types of investment. In 2005 Corrado, Hulten and Sichel produced the first set of estimates for the United States.

Types of Intangibles

Computerized Information: Software and Databases
Innovative Property: R&D, Patents, Copyrights.
Economic Competencies: Training, Market Research, Creating Distinctive Business Models.

How to measure Intangible Investments

Measuring intangible investment is a not as straightforward as measuring tangible investments. First we need to find out how much firms are spending, but not all of that spending will be dedicated specifically to the creation of a long-lived asset. The process has a lot of subtleties .

For example when software development is done in-house, staticians imagine there is a software “factory” inside the firm and try to measure how much spending it takes to run the factory, but how much time is dedicated to the creation of a long-lived asset. For programmers might spend 90 percent of their time but how much time should be assigned to managers ?
How about Marketing, Organizational Capital and Training? Should those be treated as an Investment?

Not all of this questions have been settled yet , but it is a fact that they are very relevant , an example of this is that the intangibles agenda is central to the OECD Innovation Strategy.

Characteristics and Implications of Intangible Investments

The Four ‘S’ of Intangible Investments:

Scalability: Intangible assets can usually be used over and over in multiple places at the same time. The idea that knowledge is scalable is not new and it has been studied extensively , it sits at the heart of Endogenous Growth Theory. In an economy where investments are highly scalable:

1. There will be some Intangible-Intensive companies that have grown very large.
2. A relative small numbers of dominant large companies
3. Business looking to compete with the owners of scalable assets are in a tough position. Winner-takes-all scenarios are likely the norm

SunkenNess: If a business makes an intangible investment and later on decides it wants to back out, it’s often hard to reverse the decision and try to get back the investment’s cost by selling the created asset, it is usually a Sunken Cost.

If intangibles are generally sunken costs, then why invest? Because some of the returns might be very high. But also, an investment in knowledge , even if it fails to create a marketable asset directly, might still be valuable if it creates information that resolves uncertainty form the firm. What is called “Option Value”and the Options approach to Capital Investment.

SpillOvers: It is relatively easy for other businesses to take advantage of intangible investments they don’t make themselves.

As a civilization we have been making rules about the ownership of tangible investments since at least 4,000 years ( there is evidence in ancient clay tablets from Mesopotamia).

With intangible investments is more recent with the development of industrial patents, countries started to tweak their patent and copyright systems to encourage more invention.

There is a premium on the ability to manage spillovers: companies that can make the most of their own intangibles, or that are especially good at exploiting spillovers from others investments will do particularly well.

A significant part of the strategy of intangible-rich companies is combining and managing their intangibles in such a way as to minimize the spillovers and maximize the benefits they get from them

Being well networked, knowing about important developments in ones field, and having the standing to bring together collaborations, ask for favors, and coordinate partnerships become more important in a business where investments have greater spillovers

All this means that in an “intangible-intensive” economy, the ability to make good the problem of spillovers becomes very important. This calls for a particular range of skills:
-Technical Skills or Engineering Knowledge
-In some cases, legal expertise or a talent for deal-making
-Softer Skills like leadership and networking.

Synergies: Ideas and other ideas go well together: This is especially true in the field of technology.

Brian Arthur in his 2009 book “The nature of technology” states that technological Innovations are “combinatorial”. Any given technology depends on the bringing together of already-existing ideas. “Every novel technology is created from existing ones, and therefore….every technology stands upon a pyramid of others that made it possible in a succession that goes back to the earliest phenomena that humans captured”.

Intangible investments also show synergies with tangible assets, in particular information technologies. The relationship between investment in computers (tangible) and investment in processes, supply chain development, and organizational change (all intangibles), has been documented in detail by Erik Brynjolfsson. In his 2002 paper “Intangible Assets: Computers and Organizational Capital” he concludes that the business that got the most out of their software were the ones that invested in organizational change too and that the organizational complements to firms’ installed computer capital are treated by investors as intangible assets.

The intangible investments explanation to Secular Stagnation

Secular Stagnation is a condition when there is negligible or no economic growth in a market-based economy, when growth is measured based on the level of investments, it is a puzzle for some economists when there is a low level of investment even when there are Low Interest Rates.

However it is somehow strange that:
-corporate profits are higher than ever.
-profits are not evenly distributed
-Decrease in Productivity

An intangible explanation:
1. Mismeasurement: Intangible investment is not included in national accounts.
2. Leaders are better are appropiating spillovers and Laggards have low incentives to invest.

Financing the intangible economy: How all these affects banks?

Intangible investments also will have an impact in the financial services industry. If one of the main criterias to lend to businesses is to analyze if there is tangible investments that can be used as collateral to minimize risk. We should expect the following tendencies:

-Shift away from bank lending as a means for financing business or design new debt products secured against intellectual property

-Shift toward the use of equity

-Changes in financial accounting standards to include intangible investments in balance sheets.

-Increase in private companies, to avoid disclosure because of spillover-rich intangibles.

-Or promote block investing in an ecosistem even if there is spillovers, it wouldn matter

Competing, Maging and Investing in the Intangible Economy

What will succesful companies look like in an intangible-rich economy, and how can managers an investors create and invest in them?

How can firms improve performance that is sustainable? By Doing something distinctive or having a distinctive asset. It’s more likely that intangible assets can be distinctive, things as Reputation, Product Design and Trained employees providing customer service.

Even more valuable, weaving all these assets together make the organization itself an intangible asset.

1. In “Synergistic” firms, maybe only the managers know whats going on, since only the managers can see the big picture and realize how the synergies might link up.
2. In intangible-intensive firms there will be a premium on managers who can share information both up and down the organization and keep loyal workers sticking to the firm.
A well managed organization:
-Continuously monitoring & improving processes.
-Setting Comprehensive and stretching targets
-Promoting high performing employees or fixing underperforming ones
How can managers build a good organization in an intangible intensive firm?
Choosing the right organizational design, depending on whether your organizational predominantly uses or produces intangible assets.

Producer: Allows information to flow, promotes serendipitous interactions, keep key talent, promote skills to manage the innovation process.

User: More hierarchies, shor-term targets.

The intangible economy will place a premium on good organization and management. With more sunk costs, spillovers, and the opportunity for scale and synergies, the need for additional coordination rises, and so good organization and management will be in higher demand.

Are you creating intangible assets (writing software, doing design, producing research)?. If so, you probably want a flat organization with more autonomy, fewer targets, and more access to the boss. This allows information to flow, helps serendipitous interactions, and keeps the key talent.

How can an outside investor detect if a firm is building its intangible assets?
Can investors get information about intangibles from accounting data? Baruch Lev answers this question ins his 2016 book The End of Accounting (excerpt from the book in the WSJ can be found here). According to Lev, much of companies intangible investments are hidden from view, because by current accounting standards, intangible investments are expended (charge the entire cost of the asset in one year to costs) when they should be capitalized (recognizing that the spending created and asset) . In consequence financial accounts have become much less informative of company earnings.

So what should investors do? One option is to avoid the problem of finding out the information altogether and buy shares in every company. i.e. Diversify.

But also an alternative strategy arises for investors who can identify good intangible investments and back companies that make them. Asset Managers can serve investors by being much more canny about a firm, going beyond the information in the accounts. Understanding the deep innards of the company and the way that external conditions will allow it to use it’s intangible assets will be a highly valued skill.


Intangible investments theory has been studied by more than two decades, I guess the interest in intangible investments has gained relevance because we have more evidence that the hypothesis proposed in the original research seems to be correct.

Recently , Michael J. Mauboussin from Morgan Stanley published an excellent paper where he analyzes the implications for the investment management profession. The key insight: Understanding the magnitude and return on investment provides an investor with a better understanding of a company’s future earnings. The challenge is that the mix of investment has shifted over time and is today more intangible than tangible. That means the recording of investments has largely migrated from the balance sheet to the income statement. An investor’s job has not changed but the analytical approach has.

Sarah Ponczek from Bloomberg also published an article where she writes about the influence on intangible investments in the recent market rally, a remarkable example: “The value of Moderna Inc.’s intangible assets heavily rely on the biotech firm’s ability to develop and distribute a coronavirus vaccine. Consider the math: Moderna’s market-cap amounts to about $28 billion, yet the company’s tangible book value (what can be found on its balance sheet) is less than $1.2 billion. That means $26.9 billion — or 96% — of Moderna’s market value is derived from intangibles.”

Besides the valuation and economic implications I found the book very useful for professionals whose jobs revolves around, Digital Transformation , Strategy/Business Development or Portafolio/Program Management , since it gives a robust explanation of the relevance of Business Process Engineering , Managing correctly the intangible investment process in Software Projects, Managing correctly the innovation process through Open Innovation Programs, and how companies should treat Employee Training Spending as an Investment

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