Value Behind the Business Process Patent Controversy

A decision in the controversial patent case In re Bernard L. Bilski and Rand A. Warsaw v. U.S. Patent and Trademark Office is currently pending in the U.S. Court of Appeals for the Federal Circuit. Nominally, at stake is the future patentability of business methods. In fact, the patent question is but the most visible element. The scope of the underlying topic is far greater. The case highlights the importance of the business processes that link global business networks and create value in the intangible assets that comprise approximately 70%
of the average company's market capitalization.

Business Networks Link the World

Flat and lean enterprises that outsource non-core functions and collaborate with others are the new-economy model. With only limited physical assets, they are rich in intangible asset value and knowledge capital, and demonstrate superior returns on assets. In today's global markets for both goods and services, these enterprises depend on supply chains and robust business networks enabled by high-speed communication technologies. Such networks are the muscles and sinews of enterprise value and reputation.

Business processes guide the operations of these networks. They marshal the infrastructure and human resources within the networks to deliver goods and services. They also control intangible attributes of the processes and end-products ' environmental sustainability, quality, safety, security and integrity ' that comprise the intangible assets of the enterprises that participate in the network. From these processes flow another intangible asset: reputation. Reputations take shape from the perceptions that stakeholders have about an enterprise's intangible assets.

Thus, intangibles collectively support reputational value. The support, however, is much like a Roman arch. The individual values of the intangible assets are highly interdependent, and the loss of any one can cause the entire structure to collapse.

More Value than Meets the Accountant's Eye

It is difficult enough to account for individual intangible assets. As The New York Times business writer Denise Caruso opined last year, “More often than not, the most valuable assets of an innovative company ' its intellectual property, investments in computer software, staff and managerial expertise, non-scientific and scientific research and development, advertising and market research, and business processes ' have literally no place on the balance sheet.”

The accounting math completely breaks down when it comes to the interdependence of these assets. Consequently, current accounting processes are an inadequate system to deal with intangibles, as Patent Strategy & Management has noted in many pages. But there are other ways of looking at value and intangible asset management.

Measuring Value Through Loss

Supply chains are exemplary business networks that are held together by business processes that govern the intangible assets of both the products and enterprises involved. Disruptions in supply chains place the interdependence of the intangible asset value in stark relief and provide market measures of value. In 2007, a series of highly publicized problems with unsafe toys (e.g., numerous Mattel recalls for lead paint poisoning), food (e.g., the Castleberry meat recall for symptoms of botulism and Menu Foods Inc. pet food recall for causing kidney failure), medicine (e.g., children's cold medicine recalls) and other products highlighted risks to consumers and to the companies that depend on extensive supply chains of factories and subcontractors.

The 835 companies that announced a supply chain disruption between 1989 and 2000 experienced 33% to 40% lower stock returns than their industry peers. Twenty-five percent of companies that experienced an IT outage of two to six days went bankrupt immediately. Ninety-three percent of companies that lost their data center for 10 days or more filed for bankruptcy within a year. According to Weber Shandwick, a leading communications firm, 79% of the world's most admired companies lost their crowns over the past five years in their respective industries ' many from glitches in their supply chains.

While loss provides an unambiguous measure of value, it is hardly a preferred method. More to the point, one of the highest goals of management is to increase, protect, and restore intangible asset value in the event of a glitch. Financial survival through a glitch is resilience. Resilience is a consequence of superior intangible asset stewardship. And superior stewardship is a business process.

The Value of Reputation Resilience

The Johnson & Johnson Tylenol' case study is illustrative of the benefits of an integrated business process approach to protecting a central driver of corporate reputation. There were two glitches in J&J's supply chain ' in 1982, resulting in deaths in Chicago; and in 1986, resulting in deaths in Yonkers. In the intervening period, J&J's leadership inspired cultural transformation and linked operational risk to reputation and revenue. They identified critical vulnerabilities across all their business assets and implemented product and process changes, contingency plans, and communication strategies all comprising intangible asset financial management best practices. They re-engineered their business process.

The financial results speak to the value of their business process improvements. In October 1982, in response to reports of Tylenol poisoning, the capital markets experienced a surge in J&J selling, and the company lost 30% of its equity value. In February 1986, in response to new reports of Tylenol poisoning after the company had engaged in a comprehensive reputation resilience management program comprising many business processes, the company suffered no measurable reputational impairment.

The author's company, Steel City Re, has amassed a significant amount of empirical data showing that, more generally, superior managers of corporate intangible assets (reputation) reward shareholders with above-average equity returns. Our analysis of measures of superior stewardship ' which include higher pricing and revenues; lower employee costs and higher net income; higher earnings multiples and stock price stability ' show a close relationship between management quality and return on equity.

The Intangible Asset (Reputation) Financial Performance Index is an objective decision-market metric Steel City Re uses to project the expected financial gain or loss arising from reputational enhancement or loss. The data, viewed retrospectively, show that companies whose index rankings place them in the top 25% of the 2,483 companies studied during the 28-month period from December 2005 to February 2008 rewarded their shareholders with an average (portfolio) return of 18%, which is about three times the market return of 6%. Moreover, companies whose IA management was very good and who continued to improve, delivered outstanding returns. Among the companies whose average index ranking was in the top 25%, those whose index rankings did not decline during the 28-month period, numbering 290, rewarded their shareholders with an average (portfolio) return of 50%, which is about three times the group average. Companies whose index rankings declined, numbering 331, rewarded shareholders with average (portfolio) returns of -6%.

This superior return of on the order of three times greater than their peers reflects differences in management's perception of the role of intangible asset stewardship. Briefly, those views can be summarized as:

• Intangible asset management as the price of doing business (the “as little expense as possible” and/or defensive approach).
• Intangible asset management as a strategy (standardize across the operation to strengthen IAM but rationalize the cost).
• Intangible asset management as a strategic opportunity (seize opportunities to gain multiple benefits from IAM investments).

Achieving this highest level is a goal that most companies find hard to achieve.

The issues of the patentability of business processes will be resolved by the U.S. Court of Appeals in In re Bilski. But the underlying issue of how companies utilize and build upon their business processes to drive competitiveness and support 70% of the value of the average company will remain. It will take more than a court case to move companies toward better management of their business processes and intangible assets. Numerous corporate activities and public policies will need to be examined and reshaped. But the payoffs are great, as these intangibles and their attributes, including environmental sustainability, quality, safety, security and integrity, shape the quality of our lives and world. And that's a tangible goal worth pursuing.

Nir Kossovsky, MD, a member of this newsletter's Board of Editors, is CEO of Steel City Re, a risk management and assurance company, located in Pittsburgh, PA. He may be contacted at [email protected]. Dr. Kossovsky also serves as the Executive Secretary of the Intangible Asset Finance Society. This article is inspired, in part, by the content of the Society's conference titled 'Reputational Perils: The intangible value of safe, secure and ethical supply chains,' that was held Sept. 6-9, 2008 in the New York State Finger Lakes Region. Ken Jarboe, Ph.D, is President of Athena Alliance, a Washington, DC-based policy research organization focused on the emerging I-Cubed (Information, Innovation, Intangibles) Economy. He may be contacted at [email protected].

A decision in the controversial patent case In re Bernard L. Bilski and Rand A. Warsaw v. U.S. Patent and Trademark Office is currently pending in the U.S. Court of Appeals for the Federal Circuit. Nominally, at stake is the future patentability of business methods. In fact, the patent question is but the most visible element. The scope of the underlying topic is far greater. The case highlights the importance of the business processes that link global business networks and create value in the intangible assets that comprise approximately 70%
of the average company's market capitalization.

Business Networks Link the World

Flat and lean enterprises that outsource non-core functions and collaborate with others are the new-economy model. With only limited physical assets, they are rich in intangible asset value and knowledge capital, and demonstrate superior returns on assets. In today's global markets for both goods and services, these enterprises depend on supply chains and robust business networks enabled by high-speed communication technologies. Such networks are the muscles and sinews of enterprise value and reputation.

Business processes guide the operations of these networks. They marshal the infrastructure and human resources within the networks to deliver goods and services. They also control intangible attributes of the processes and end-products ' environmental sustainability, quality, safety, security and integrity ' that comprise the intangible assets of the enterprises that participate in the network. From these processes flow another intangible asset: reputation. Reputations take shape from the perceptions that stakeholders have about an enterprise's intangible assets.

Thus, intangibles collectively support reputational value. The support, however, is much like a Roman arch. The individual values of the intangible assets are highly interdependent, and the loss of any one can cause the entire structure to collapse.

More Value than Meets the Accountant's Eye

It is difficult enough to account for individual intangible assets. As The New York Times business writer Denise Caruso opined last year, “More often than not, the most valuable assets of an innovative company ' its intellectual property, investments in computer software, staff and managerial expertise, non-scientific and scientific research and development, advertising and market research, and business processes ' have literally no place on the balance sheet.”

The accounting math completely breaks down when it comes to the interdependence of these assets. Consequently, current accounting processes are an inadequate system to deal with intangibles, as Patent Strategy & Management has noted in many pages. But there are other ways of looking at value and intangible asset management.

Measuring Value Through Loss

Supply chains are exemplary business networks that are held together by business processes that govern the intangible assets of both the products and enterprises involved. Disruptions in supply chains place the interdependence of the intangible asset value in stark relief and provide market measures of value. In 2007, a series of highly publicized problems with unsafe toys (e.g., numerous Mattel recalls for lead paint poisoning), food (e.g., the Castleberry meat recall for symptoms of botulism and Menu Foods Inc. pet food recall for causing kidney failure), medicine (e.g., children's cold medicine recalls) and other products highlighted risks to consumers and to the companies that depend on extensive supply chains of factories and subcontractors.

The 835 companies that announced a supply chain disruption between 1989 and 2000 experienced 33% to 40% lower stock returns than their industry peers. Twenty-five percent of companies that experienced an IT outage of two to six days went bankrupt immediately. Ninety-three percent of companies that lost their data center for 10 days or more filed for bankruptcy within a year. According to Weber Shandwick, a leading communications firm, 79% of the world's most admired companies lost their crowns over the past five years in their respective industries ' many from glitches in their supply chains.

While loss provides an unambiguous measure of value, it is hardly a preferred method. More to the point, one of the highest goals of management is to increase, protect, and restore intangible asset value in the event of a glitch. Financial survival through a glitch is resilience. Resilience is a consequence of superior intangible asset stewardship. And superior stewardship is a business process.

The Value of Reputation Resilience

The Johnson & Johnson Tylenol' case study is illustrative of the benefits of an integrated business process approach to protecting a central driver of corporate reputation. There were two glitches in J&J's supply chain ' in 1982, resulting in deaths in Chicago; and in 1986, resulting in deaths in Yonkers. In the intervening period, J&J's leadership inspired cultural transformation and linked operational risk to reputation and revenue. They identified critical vulnerabilities across all their business assets and implemented product and process changes, contingency plans, and communication strategies all comprising intangible asset financial management best practices. They re-engineered their business process.

The financial results speak to the value of their business process improvements. In October 1982, in response to reports of Tylenol poisoning, the capital markets experienced a surge in J&J selling, and the company lost 30% of its equity value. In February 1986, in response to new reports of Tylenol poisoning after the company had engaged in a comprehensive reputation resilience management program comprising many business processes, the company suffered no measurable reputational impairment.

The author's company, Steel City Re, has amassed a significant amount of empirical data showing that, more generally, superior managers of corporate intangible assets (reputation) reward shareholders with above-average equity returns. Our analysis of measures of superior stewardship ' which include higher pricing and revenues; lower employee costs and higher net income; higher earnings multiples and stock price stability ' show a close relationship between management quality and return on equity.

The Intangible Asset (Reputation) Financial Performance Index is an objective decision-market metric Steel City Re uses to project the expected financial gain or loss arising from reputational enhancement or loss. The data, viewed retrospectively, show that companies whose index rankings place them in the top 25% of the 2,483 companies studied during the 28-month period from December 2005 to February 2008 rewarded their shareholders with an average (portfolio) return of 18%, which is about three times the market return of 6%. Moreover, companies whose IA management was very good and who continued to improve, delivered outstanding returns. Among the companies whose average index ranking was in the top 25%, those whose index rankings did not decline during the 28-month period, numbering 290, rewarded their shareholders with an average (portfolio) return of 50%, which is about three times the group average. Companies whose index rankings declined, numbering 331, rewarded shareholders with average (portfolio) returns of -6%.

This superior return of on the order of three times greater than their peers reflects differences in management's perception of the role of intangible asset stewardship. Briefly, those views can be summarized as:

• Intangible asset management as the price of doing business (the “as little expense as possible” and/or defensive approach).
• Intangible asset management as a strategy (standardize across the operation to strengthen IAM but rationalize the cost).
• Intangible asset management as a strategic opportunity (seize opportunities to gain multiple benefits from IAM investments).

Achieving this highest level is a goal that most companies find hard to achieve.

The issues of the patentability of business processes will be resolved by the U.S. Court of Appeals in In re Bilski. But the underlying issue of how companies utilize and build upon their business processes to drive competitiveness and support 70% of the value of the average company will remain. It will take more than a court case to move companies toward better management of their business processes and intangible assets. Numerous corporate activities and public policies will need to be examined and reshaped. But the payoffs are great, as these intangibles and their attributes, including environmental sustainability, quality, safety, security and integrity, shape the quality of our lives and world. And that's a tangible goal worth pursuing.

Nir Kossovsky, MD, a member of this newsletter's Board of Editors, is CEO of Steel City Re, a risk management and assurance company, located in Pittsburgh, PA. He may be contacted at [email protected]. Dr. Kossovsky also serves as the Executive Secretary of the Intangible Asset Finance Society. This article is inspired, in part, by the content of the Society's conference titled 'Reputational Perils: The intangible value of safe, secure and ethical supply chains,' that was held Sept. 6-9, 2008 in the New York State Finger Lakes Region. Ken Jarboe, Ph.D, is President of Athena Alliance, a Washington, DC-based policy research organization focused on the emerging I-Cubed (Information, Innovation, Intangibles) Economy. He may be contacted at [email protected].