Personal Capitalists

Personal knowledge capital is a valuable intangible asset, but most companies don't exploit it.

In our knowledge-based economy, there are many kinds of capital: organizational, intellectual, knowledge, human, structural, customer and innovation capital are all recognized concepts. However, at least one source of capital in an organization's intangible assets has not been clearly identified. I call it personal knowledge capital.

My own work on quantifying knowledge capital (KC) has been based on the assumption that a knowledge-based asset is the residual worth left after a business deducts expected returns on financial capital. But this approach does not address the intrinsic worth of employees. After all, even employees of a firm that has no knowledge capital possess KC of their own that they can market to other employers. In trying to recognize the worth of individuals--as opposed to the worth of corporations--I have distinguished two manifestations of knowledge capital.

Personal knowledge capital (PKC) is directly related to the total compensation a knowledge worker can obtain in the marketplace. We can calculate the relationship between an individual's PKC and salary on the assumption that employers "rent" a person's PKC. This approach discards classical theories about wages and sees individuals themselves as capitalists. The worth of someone's PKC is their annual salary divided by an interest rate that reflects the implied cost of capital.

The "knowledge interest rate" will vary with the overall economy. Yearly salaries can be seen as analogous to the worth of an annual bond coupon. Once you know the price of the coupon, you can find the nominal worth of the bond. For example, if labor markets are tight and a new employee represents a risky investment, the "coupon rate" for purchasing knowledge would be equivalent to a bond rated B or C. Thus, at 15 percent the PKC of an employee earning $40,000 per year would be $266,666 ($40,000 divided by .15). If the labor market is short on talent and employees need time to develop corporate know-how, however, the coupon rate for acquiring knowledge would be equivalent to a bond rated AA or A. In that case, at 6.5 percent the same employee's PKC would be worth $615,384 ($40,000 divided by .065).

In contrast, corporate knowledge capital (CKC) is reflected in the worth of corporate earnings to shareholders. We can value CKC by subtracting the worth of the company's PKC. This measure I discussed in detail in "Calculating Knowledge Capital" (October 1999 KMM).

The concepts of PKC and CKC are not merely theoretical. They lead to insights into the economic role of corporate knowledge. To illustrate this use, I collected 1999 financial results for 726 U.S. banks in the graph "Profits and Salaries." The results show no relation between a bank's average employee salaries and its corporate profits. If salaries reflect employees' market worth, the scatter graph tells us that the corporate values of knowledge capital cannot reflect that worth. For instance, the graph shows a number of banks paying employees an average salary of $50,000. Yet the profits per employee for these banks range from negative $70,000 per employee to positive $130,000 per employee. Such disparities demonstrate that corporate results and employee worth (as measured by compensation) are unrelated.

Plotting the relationship between personal and corporate knowledge capital per employee can make such a comparison explicit. The graph "PKC and CKC" shows that the employees' KC is not reflected in corporate knowledge. To calculate the average worth of the banking workforce in 1999, I used the average knowledge interest rate of 10 percent. These results show an even greater disparity than the others. For instance, an employee with $400,000 of PKC might be working for a bank with CKC anywhere from $5,000 to over $100 million per employee.

In many banks, PKC exceeds CKC, which suggests that either the bank cannot afford to "rent" (pay the salaries of) its employees or the employees will find it more rewarding to move to another bank that generates a surplus. In such surroundings, employees often will end up depreciating their PKC and ultimately lowering their market worth.

The converse argument is also true. In banks where PKC worth $100,000 is supporting CKC of $100 million, employees ought to use every opportunity to enrich themselves by acquiring more knowledge. This condition would call for adopting policies that would result in knowledge appreciation.

But the most important finding is that there is absolutely no correlation between how banks value the worth of their employees' knowledge and how well those banks perform in the marketplace. Similar comparisons for other industries all display identical characteristics.

Whenever executives propose to invest in knowledge management to enhance the worth of their workforce, first they ought to examine their positive or negative valuations of PKC and CKC. When employees are overvalued, which means that the CKC/PKC ratio is low, it would pay a bank to leverage employees' intrinsic capabilities. Employee knowledge enhancement should take top priority. If the opposite is the case, employee retention becomes important. Next month we'll consider how that translates into action.

Paul A. Strassmann originated the trademarked concepts "information productivity", "return-on-management" and "knowledge capital."