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JIC
6,4 Strategic use of IC reporting in
small and medium-sized IT
companies
558
A progress report from a Nordic project
Eggert Claessen
Tolvumidlun hf., Reykjavik, Iceland

Abstract
Purpose – The purpose of this paper is to report on how IT sector organizations in all five Nordic
countries have worked together to start a project on using intellectual capital (IC) reporting to improve
strategy formulation in SMEs in the IT sector. The project, called PIP (Putting IC into Practice), is
partly funded by the Nordic Innovation Centre ([Link]).
Design/methodology/approach – The paper builds on the existing literature as well as the
experience from the Nordic project.
Findings – The objective of the project is to produce, implement and disseminate harmonized
indicators for realising intangible values in companies. Results from the project include the
identification of common indicators for intangible values and how they can be used as supportive
evidence for IC reporting. By using these indicators with strategy maps and scorecards, the companies
are provided with tools and information to improve their strategy formulation process and develop
further their competitive advantage.
Practical implications – The project aims to provide ways to put IC into practice as a tool for
management in order to improve performance. Providing an open source framework for assisting the
knowledge transformation process within companies is an important step is this respect. If successful,
this will affect the management and reporting of IC.
Originality/value – This paper reports on the practical application of the resource-based view of
strategy, where intangible resources play a major role in the internal development path of a company.
Even though the scope is limited to SMEs in information technology in the Nordic countries, the
results are of interest, especially in terms of practical value to other types of companies and industries.
Keywords Intellectual capital, Disclosure, Knowledge management, Small to medium-sized enterprises
Paper type Case study

Introduction
The development in world business has changed the focus in management from
looking only at tangible resources to looking at intangible assets and their relationship
to future value creation. The problem for management has been that there appear to be
gaps between what gets measured internally and what gets reported externally. This
can be attributed to lack of reliability of measurement of intangible asset and a lack of
understanding of how to present valid measures due to the characteristics of
intangibles (Gray et al., 2004). Rylander et al. (2000) argue that the goal of disclosure
Journal of Intellectual Capital should be to provide relevant, reliable, and timely information to those who need to
Vol. 6 No. 4, 2005
pp. 558-569 know it so that they can make decisions concerning their relations with the company.
q Emerald Group Publishing Limited
1469-1930
Supporting the argument for successful implementation of measures and reporting is
DOI 10.1108/14691930510628825 Thomas (2003), who suggests that corporate reports are more likely to generate
rewards in the capital markets if the reader can visualize a link between strategy and Strategic use of
areas such as employees, the environment and corporate performance. IC reporting
There is a growing number of companies that have started to report their intangible
assets or indicators for such in their annual reports (Guthrie and Petty, 2000). The
companies may however be hesitant to disclose important figures for fear of giving
away their competitive advantage but a lack of external disclosure standards and the
lack of clarity in intellectual capital (IC) constructs for disclosure can also hinder 559
measurement and reporting. There is also the question of the perceived importance of
different intangible resources across companies or industries, which should call for
more detailed studies of what is disclosed of IC and for what reasons. Such reasons are
identified by Marr et al. (2003) and reveal that IC disclosure is not limited to external
reporting. IC disclosure also has practical implications internally as it can help
organizations in the strategy formulation, strategy execution assessment, assist in
diversification and expansion decision and finally as a tool in determining
compensation.
This practical aspect of IC disclosure is the subject of a Nordic project initiated by
the IT sector organizations in the five Nordic countries and the Nordic Innovation
Centre. The objective of the project is to produce, implement and disseminate
harmonized indicators for realising intangible values in the Nordic countries. It aims to
provide new ways to put IC into practice as a tool for management to improve
performance by providing an open source framework for assisting the knowledge
transformation process. It is expected that the harmonization of indicators for IC will
change the consulting practice when dealing with intangible resources within
companies and how IT companies, in particular, identify and use their competitive
advantage from a strategic perspective (PIP-Project, 2005).
The motive and rationale of such a project can be questioned in terms of relevance
and importance. The main argument is that IC disclosure is presumed to be relevant to
companies internally and also to outside stakeholders. The IC report deals with
intangibles, so only a limited part of it is discussing monetary value. This means that
the reader has to form an opinion based on his understanding of the content of the
report. This is why harmonization of contents and indicators is important. In order to
create a common language for understanding the IC report in the same manner as
traditional accounting practices have done for financial statements, it is necessary to
handle the subject in the same manner.
From a management perspective the question is also whether there is any relation
between IC measures or indicators and the managerial steering models available and if
this affects the strategy formulation process. In order to use IC as a resource in strategy
formulation, it is necessary to understand what constitutes as a resource and how it
can be used to leverage the competitive situation of the firm. The resource based
perspective was identified by Penrose (1959) and continued with Wernerfelt (1984) and
Grant (1991) but the intangible or knowledge aspect was addressed by Grant (1996)
and further by Sveiby (2001), where the knowledge based theory of the firm looked at
knowledge as an important resource in developing corporate strategy. Even though
there is a vast body of available literature, Marr et al. (2003) state that there is little
empirical testing of theories in the area of strategy development, diversification and
expansion.
JIC IC reporting
6,4 Traditional accounting information has been loosing relevance as the gap between
market value and book value has been increasing. Nakamura (1999) has explained this
as being partly because investors started to value the increasing level of investment in
IC as potential sources of future profitability. IC reporting is intended to fill the gap in
traditional accounts but as IC reports are relatively new, i.e. 15 years at most compared
560 to over 300 years of traditional financial accounting, there is some controversy over the
usability of IC reports.
From an accounting perspective, the question is whether IC statements can be
systematically read and analysed in a way that is comparable with the reading and
analysis of financial statements. Mouritsen et al. (2003) offer a guarded “yes” as an
answer, saying that the IC statement analysis method has much in common with the
principles behind financial statement analysis but point out that the method is new and
has only been tested by a few analysts. In order to explore the similarities between the
financial statement and the IC statement, two parallel sets of questions have been
prepared. For the financial statement the questions are: What are the company’s assets
and liabilities? What has the company invested? What is the company’s return on
investment? For the IC statement the questions are: How is the company’s knowledge
resource comprised? What has the company done to strengthen its knowledge
resources? What are the effects of the company’s knowledge work? (Danish Ministry of
Science, Technology and Innovation, 2003)
The accounting community has addressed these questions and tried to fit them into
the traditional accounting framework. Lev et al. (2005) offer an overview of current
practices for accounting for intangible assets. The basic approaches to accounting for
intangibles is matching outlays with future revenues or expensing the outlays in the
years incurred if they cannot be matched with future revenues. The current accounting
standard for intangibles, IAS 38, lists the criteria as being able to identify the asset, the
future economic benefits will flow to the enterprise and that the cost can be measured
reliably. This could apply easily to intangible assets such as brand and patents but
identifying, measuring and reporting internally generated IC causes serious problems
for accounting.
According to Mouritsen et al. (2005), shortcomings in corporate reporting have been
addressed by various initiatives in Europe. Projects like E *Know Net, MERITUM and
PRISM, dealt with the creation of a network of researchers and practitioners for
research into the management and reporting of intangibles. On a Nordic level, the most
noticeable projects have been the Danish government program, Nordika and Frame
projects. These projects, like other mentioned, have been of a practical nature as they
have produced a framework or guidelines for IC reporting. A common element of these
guidelines is the need for not only finding measures for IC but also to use a narrative to
explain how IC is used in the operation of the firm (Mouritsen et al., 2001a, b).
The narrative is intended to provide the reader with enough information to
determine the nature of a company’s business and its potential for value creation in the
future. Mouritsen et al. (2001a, b) explain this as the knowledge narrative being a
storyline explaining the capabilities of the company and how the firm will be able
create value in the future. It is both a description of the company’s ability to create
value and the value proposition itself. It also identifies the challenges that the company
faces where management explains how it will put in place or develop measures to use
the company’s resources to realize the expectations for value creation. Indicators or Strategic use of
numbers that in relation to the knowledge narrative explain the development of the IC reporting
company’s resources support any claims made in the narrative and is the only form of
measure available in the IC report.
The idea of using storytelling or narrative as way to get the corporate message
across has been addressed by Denning (2001) where he asks the question whether
stories really have a role to play in the business world. Stating that most executives 561
operate with a particular mind-set, it is analysis that drives business thinking by
cutting through the fog of myth, gossip, and speculation to get to the hard facts,
undistorted by the hopes or fears of the analyst. The strength lies in the objectivity,
which is at the same time also a weakness. But at a time when corporate survival
requires disruptive change, leadership involves inspiring people to act in unfamiliar
and often unwelcome ways. This is when the most logical arguments might not work,
but effective storytelling could translate dry and abstract numbers into compelling
pictures of a firm’s goals (Denning, 2004). This view is supported by Simmons (2001),
saying that a story can do what facts cannot, just as knowledge can become wisdom, so
do facts become a story. The story can influence the interpretation of the facts. The
story also delivers the context in which the facts are evaluated. People are not rational
which means that facts are not only the facts! This is why narrative forms could
further different business goals.
The two sets of questions addressed by traditional and IC accounting relate to the
same management problems, but are not identical as the answers are based on
different types of data. This makes it technically impossible to carry out a uniform
financial analysis on both sets. The fact that detailed accounting standards have been
established over time to specify the correct use and interpretation of figures and
concepts, has created a common context for addressing financial issues that makes the
IC statements seen as giving a less credible and less relevant company evaluation.
Recent accounting scandals have proven that not all financial statement figures are as
unambiguous and informative as could be expected (Chatzkel, 2003). This is why the
role of IC statements is becoming greater as it completes the view of an organization
and its possibilities for value creation in the future.

The PIP project

A Nordic project on IC disclosure and dissemination of IC practices called PIP, Putting
IC into Practice, started formally on February 15, 2004. The project is scheduled to take
30 months and has the objective to produce, implement and disseminate harmonized
indicators for realizing intangible values in the Nordic countries. It aims to provide new
ways to put IC into practice as a tool for management to improve performance by
providing an open source framework for assisting the knowledge transformation
process. The project is focused on SMEs in the IT industry, as the majority of IT sector
organization members are SMEs and the IT industry has a history of being IC
dependent.
The project is the collaborative effort of IT sector organizations in the Nordic
countries, i.e. Denmark, Finland, Iceland, Norway and Sweden. It is partly financed by
the Nordic Innovation Centre, which partly dictates how the project is organized. It has
a steering committee with representatives from each of the member organization, a
project leader and two project co-ordinators, who are responsible for the daily
JIC operations of the project. This management team is responsible for preparing the
6,4 material used in the project, the organization of work meeting and represent the project
externally. The project is divided into four phases and tasks. Table I gives an overview
of the phases.
The project’s participants consist of three generations of entrants. There are ten
companies, two from each country starting as first generation companies, another ten
562 added as second generation after eight months from start and finally the last ten as
third generation enter the project in month 24.

Phase one
First generation companies started their work by identifying the IC indicators relevant
to the business. The work was based on the reporting experience gained from the
NORDIKA project and the proposed set of indicators from the Icelandic IC group (see
[Link]). The participants had to decide on what indicators to use and how
they were measured and also list new indicators if not already available. The first
challenge was to articulate the IC in a structured manner. In order to initiate the
process, the project leader and project co-ordinator visited the participants. In these
meetings, there was a brainstorming session aimed at identifying the company’s
vision/mission, management challenges and initiatives and finally indicators to
measure status of these. These sessions varied between companies and depended
mostly on what the company had already done in this respect. The level of
participation within the companies was also very different as some involved all
employees at their daily lunch whereas in others only the manager and chairman were
involved. When working with participants, the management team noted that the level
of participation affected the output in the way that the more people involved, the more
time it took.

Phase two
In this phase the second generation companies were invited to the project. The task for
all companies was to write the preliminary IC report using the Danish guidelines
(Danish Ministry of Science, Technology and Innovation, 2003) for IC reporting. In

Phase one Phase two Phase three Phase four

Identify indicators Implementing Identifying proper Presenting the results of

indicators in management tools for the project final report
participating participating
companies companies
Decide on the meaning External reporting of Measurement of input Further dissemination
of indicators results from in new models by and post project
implementation harmonized indicators continuum
Create liaison networks Revision based on Evaluation of
with accountants, results contribution, i.e. to
consultants etc. learning process and
economic results
Table I. Prepare results for
Project overview dissemination
addition the participants studied the IC reports already published by Nordic IT Strategic use of
companies for comparison. The Danish format for IC reporting is made up of two-parts IC reporting
consisting of a knowledge narrative on one hand and supporting indicators on the
other. The narrative addresses the previously mentioned vision/mission, management
challenges and initiatives. These are reported in the three accepted dimensions of IC i.e.
human, structural and relational capital (Mouritsen et al., 2001a, b).
The preliminary reports from the participating companies contained a very similar 563
narrative. The first part of the report can be described as “creating value with values”.
In this part the company stated its vision/mission and explained its business area. An
example would be issues such as:
.
honesty and professionalism;
.
respect for life and personality;
.
empowerment of skills and knowledge; and
.
social responsibility

Further to this, each company would explain its main area of business and its
ambitions in this respect. The next part was management challenges. These would
include issues like main goals and objectives. Such goals and objectives would be
about:
.
profitability;
. growth, both monetary and non-monetary;
.
market position, customer relations; and
.
new markets, products or customer groups.

Finally there was a description of the company’s IC. This description would be
supported by some of the indicators that the project supplied to the partners. Each
company put forward a set of indicators that was either in the pre-described list or new.
The management team compiled a set of the common indicators identified and used
by all. These would be recommended to the companies as a starting point in IC
reporting. In addition the companies had listed which indicators would be included in
their formal IC report due for phase two and the reason for discarding indicators, if not
used. The reasons quoted by the companies for not using indicators were mostly
relevance or not having the possibility to measure.
The IC indicators were then arranged into 15 categories along the three different
dimensions of IC, i.e. human, structural and relational capital. Table II lists the
categories.

Human capital Structural capital Relational capital

Employees Information systems Customers

Staff turnover and recruiting Quality management Market and image
Skills and competence Innovativeness Visibility of expertise
Employee satisfaction and attitude Competence development Networks Table II.
Executive competency Working conditions Categories of IC
Governance indicators
JIC The total number of indicators identified was around 100. The experience from the first
6,4 draft of the IC reports indicates that the participating companies did not use them all or
measure them all in the first instance. All intended to measure these indicators before
their next IC report, even though they would not be disclosed in the external IC report.
The companies stated that having guidelines or a structured framework for IC
disclosure was an important step in realizing intangible assets. The challenge was to
564 identify the right causal relationships and track the right elements as measures loose
validity over time and the nature of things being measured is maybe not correctly
understood.
The first learning point was to identify what indicators to use and what these
indicators represented. As Grojer (2001) points out, there is currently no accepted and
understood method for disclosure. There was also the issue of avoiding the mistakes
outlined by Ittner and Larcker (2003) where they identify three major errors in using IC
indicators. The first one, not to link measures to strategy. The second, not validating
the links and make sense of the causal relationship between measures and meaning.
The third, not setting the right performance targets.
The second learning point was to look at the indicators that none or only some of the
companies used. Unused indicators were considered irrelevant to some of the
companies in the IT industry but had apparent value for others. If unused indicators
had value to some of the companies, this opened the question if there was some added
or hidden meaning that the companies did not realize.
When further comparing the preliminary IC report that the companies prepared,
there is a difference between firms in the narrative, both in terms of visualisation of
components and usage of numbers. (Mouritsen et al., 2001a, b) ask the question about
the validity in terms of being a true and accurate description of IC. This implies an
impression of diversity when reading an IC report. Even though the reports did not
have a set model, it is important to note that they had a formal structure. This can be
compared to the traditional financial accounts where the published accounts have
categories like fixed and current assets, but behind the numbers in these categories are
a number of individual accounts that are summed up in this way. The participants
agreed that this would strengthen the validity of the IC report.

Phase three
The participants met for a work meeting to review the indicators and started work on
identifying relevant managerial steering models. This was done on the premise that
you can manage what you can measure. Based on Argyris (1977), Argyris’ (1991)
“double loop learning” and Ryle’s (1949) concept of “knowing how and knowing that”
the cognitive perspective was the assumption that having better information about the
company’s resources would improve management strategy formulation and decisions.
Prior to the meeting, the management team had suggested to the participants that they
would use a revized version of the Kaplan and Norton (2004) strategy map. This was
done to adapt the dimensions of the strategy map to the IC reporting dimension, as
Kaplan and Norton have chosen not to use the generally accepted definitions of IC
(Marr and Adams, 2004).
The critical success factors (CSF) of the company were then aligned with the
company’s vision/mission. The reason for selecting CSF instead of key performance
indicators is to counter the argument that strategy maps confuse the two dimensions,
importance and influence. Just because something takes place often does not mean that Strategic use of
it matters. It also confuses real activities with the influence of these activities. IC reporting
The maps created by the companies listed only a few critical success factors, not
more than 12 and usually fewer. When presented with large and complex causality
maps, the participants unanimously voted them to be too complicated to be of practical
use. The model for the map is shown in Figure 1. The companies agreed that, the
simpler the model, the more it would help. The main thing was to identify the IC values 565
and how they affect the company and how the future vision/mission of the company
could be translated into a plan for execution.
The map was then aligned with the harmonized set of indicators and others that
were company specific. From this, the companies developed scorecards in a Kaplan
and Norton (1992) fashion. They made an effort to work on the limitations of this
method as identified by Norreklit (2003) in terms of identifying cause and effect
relationships and using the scorecard as a strategy implementation tool. The
companies were now at a stage where they had developed a model for deployment and
could adapt the process to their companies, both in terms of affecting strategy
formulation and reporting their IC.
The participants stated that they often struggled with the communication of the
vision of rapid growth or being involved with heavy development of their product and
services, which means poor economic performance for a period that exceeds the normal
accounting year. They wanted a method for communicating their intent and future
vision. This is much in line with Hamel and Prahalad (1989) discussion of the need for
companies to have ambitions to drive their strategy. They use the term “strategic
intent“ to describe how companies that began with ambitions that were out of all
proportion to their resources, but created an obsession with winning at all levels. This
meant that the companies needed to envision a desired leadership position and
establish the criterion the organization would use to chart its progress. The PIP project
deals with these issues to a great extent in its process.

Figure 1.
A PIP strategy map
framework
JIC As the knowledge narrative of the IC report is a story with structure and evidence, it is
6,4 a question if it is the criterion to chart the possibilities of the company. The story
visualizes intangible values and helps to identify strengths and weaknesses. This is a
vital part of the strategy formulation process as information is the key to creating
knowledge. Concurring with the participants view on how detailed the story needs to
be, Denning (2001) makes the point that the more specific all the elements are, the less
566 intelligible it becomes. This is why it is not necessary for the IC report to state exact
numbers like the financial accounts do. The purpose, or use, is different. The story in
the IC report has done its work, when the reader will already be thinking in his own
context and situation how it could be different. The reader imagines a parallel story in
his own mind where things would be different if their know-how and expertise were
organized in a different way (Denning, 2001). The stories however need to be based on
the same understanding of what the elements of the story are, or what they represent.
Otherwise a common understanding or benchmarking is impossible. In terms of
creating a competitive advantage (Porter, 1985), the story can provide the manager or
strategist with the material needed to utilize his strategic capabilities to the fullest.
Therefore the narrative becomes the springboard for change.

Phase four
At the end of the project a possible 30 companies will have completed the learning
journey, as this is designed as learning by doing. The project is different, because the
participating companies are doing the work instead of external advisors even though it
can be argued that the project management team has an advisory role. Every effort is
made to create a liaison with accountants, consultants, academics, etc., and the work is
based on previous experience in Nordic projects and corresponding literature. It is also
worth noting that the companies get some compensation for their work as the Nordic
Innovation Centre is partly financing the project. This is new to the field of IC research
in the Nordic countries, as in the Nordika and FRAME project, this was not the case.
This form of support has proven to be a major influence or catalyst for the companies
when deciding on whether to join the project or not.
The final phase of the project has a planned post-project continuum where the IT
sector organizations will promote the project framework to their members and to other
industries. The success of the project depends largely on this issue.
The first generation companies have mostly finished the first two phases of the
project, i.e. identifying indicators, writing the first IC report. They have also started work
on identifying managerial steering tools, which falls into phase three of the project. When
interviewed, the participants have expressed great expectations to the project. They are
very interested to find an entry level to make their intangible assets visible. All of them
agreed that working with other companies in the industry provided them with an
excellent opportunity to start some practical application of IC management.
One of the companies had already managed to chart its value creation process and
communicate effectively to stakeholders based on the work done in the project. Even
though the participants had not yet implemented any special managerial steering models,
the preliminary results from the IC reporting exercize showed that addressing IC in a
structured manner provided them with a platform to manage these issues. As most of the
companies are very small, i.e. eight-180 employees, they stated that having the chance to
join a project like PIP very crucial to the process of managing IC within their companies.
Conclusion Strategic use of
When considering the various models and methods available to companies it raises the IC reporting
question whether the PIP project can contribute to the management of SMEs.
(Mouritsen et al., 2001a, b) state that based on the results from the implementation of
the Danish guidelines there is a clear indication that the companies involved
considered their ability to manage their intangible assets to be improved. They further
state that when firms talk about IC statements, they are expressing their interests in 567
controlling and managing the activities of the firm. There are three types of
interventions desirable for management i.e. resources, activities and effects. These
interventions form the basis of the knowledge management within a firm.
The participants have stated that working with other companies in the same
industry has provided them with the opportunity to learn more than just IC theory and
IC management because of the many things that companies have in common. The
chance to have a dialogue in work groups has provided possible solutions to other
practical problems. The fact that the IT sector organizations are involved in the project
creates a valuable link for the participants and the future of initiatives similar to PIP.
One of the problems in the project has been the turbulent nature of the IT industry
that has resulted in changes in the participating companies. This has led to the
replacement of two of the first generation companies and major structural changes in
others. This puts added pressure on the project management team and emphasizes the
need for strong leadership in a project of this nature.
By participating in the PIP project, the companies hope to improve their operations
and value creation mechanisms. The question to be answered is whether these
objectives can be met? Participants have already agreed that systematically
identifying their IC has enabled them to better manage their companies. Even
though the relationship between IC management and performance has been identified,
it is not possible to establish any causality. There are also limitations to these
conclusions due to the limited number of participating companies. It is suggested that
these issues would be addressed in a longitudinal study of a larger scale. This would be
a logical next step for further research.

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