"The traditional model of accounting, which so beautifully described the operations of companies for a half a millennium, is now failing to keep up with the revolution taking place in companies...The chilling fact is this: At this moment we have no idea which companies, large or small, young or old, have sustainable organizational capability," writes Leif Edvinsson in his new book Intellectual Capital (Harper Business). Edvinsson, director of Intellectual Capital at the Swedish financial Services company Skandia, has become one of the world's leading proponents of intellectual capital measurement. In 1995, the company released a supplement to its financial statement that quantified the company's IC efforts using a system called Navigator. Since then, Skandia has released six such supplements, the most recent taking the next logical step of using data to make projections about the company's future performance. In Intellectual Capital, co-authored with Michael Malone, Edvinsson explains in detail the need for IC measurement and how it is done at Skandia. While critics question the value of the many metrics and indexes that have been compiled by Skandia, it is clear that existing methods of accounting fail to show us the real prospects of companies. Traditional accounting shows us where the company has been as opposed to what it is capable of doing next. That is what Skandia is attempting to do - show us the roots of the tree, not just the fruits that hang from its branches. KI Senior Editor Kimberly Merline recently spoke with Edvinsson about Skandia, IC measurement and the future of the IC movement.

KI: What is intellectual capital and why is it so important?

EDVINSSON: Intellectual Capital is something that is larger than human capital. It is future earnings capabilities of an enterprise and is sometimes measured as the gap between the market value and the book value, which is a kind of simplification but it gives you a rough estimate. To be a little bit more specific, it contains people, which might be called human capital, and the structural capital they leave behind...Then you have a number of components in structural capital like customer capital, process capital, innovation capital, etc...The definition we developed at Skandia in the early 90s is: Intellectual capital equals human capital and structural capital. To measure these, we have developed the Skandia Market Value Scheme, the Navigator and, recently, the third model, the Intellectual Capital Index.

KI: Could you tell us a little more about these three?

EDVINSSON: The first model is what we call the Skandia Market Value Scheme, which provides the building blocks for intellectual capital. That model gives you the first rough cut between human capital and structural capital. Structural capital is the supportive infrastructure of human capital. It includes such factors as the quality and reach of information technology systems, company images, proprietary databases, organizational concepts, and documentation. It includes intellectual properties such as patents, trademarks and copyrights. Structural capital contains customer capital and organizational capital. Then you go from that into process capital and innovation capital.

The second model is the Navigator, which is composed of five areas of focus: financial, customer, process, people, and renewal and development. Navigator has a lot of similarities with the balanced score card but it amplifies the dynamics of the interrelationships between the five areas. With this, we are able to have a supplementary accounting system that gives you four times the information than just financial information. We also have a computerized PC version so you can click and go on the various components of intellectual capital and see what kind of numbers you have for the different focus areas.

That leads to the third model, which is the intellectual Capital Index. Once you have the numbers, you can start to see their evolution and interrelated flows and by putting weight on them you can put them into an index. So it is like weather reporting where you have certain indicators of the weather. Then, based on that, you could give a forecast about how the weather will be tomorrow. We are taking the numbers from the Navigator and putting them into the Intellectual Capital Index.

We present a prototype model for that (in April's supplement on customer capital and the more recent supplemental report on Intelligent Enterprising). We have gone public with one unit (American Skandia) and its figures. As you can understand, this is becoming very sensitive data. On the other hand, you have to be trustworthy. So it is a balance between giving the information away and being trustworthy and not giving too much information. It is also helping to refine the model.

KI: You are currently involved with the Securities and Exchange Commission research project on the transparency of companies in the United States. Can you tell us about that?

EDVINSSON: Most companies have a mapping system to describe their history but lack the systematic description and visualization of future earning potential...That is why the SEC in Washington is very eager to have an increased transparency of American companies. They have initiated a research committee under the supervision of the Brookings Institute in Washington, DC. I am a part of that. The SEC thinks that Skandia has become a benchmark for other companies, and they think that American companies on the stock market should engage in a similar exercise. Some years down the road, the forecast is that there will be regulations for IC measurement.

KI: With Washington taking the lead, one wonders what unintended consequences will eventually emerge. Do you think new federal regulations are the best way to go?

EDVINSSON: Yes. It is like a language...the standard is a kind of grammar or lexicon for joint understanding and communication.

KI: How is Skandia doing overall?

EDVINSSON: We are doing very well. This year we became a global Fortune 500 company, which we think is a very good sign. We also got an award from the American Chamber of Commerce for being very innovative in the financial industry in the U.S. We have grown from being number 300 on the global scale for financial services to number 4 in less than ten years. That new unit (financial services) represents almost 70% of Skandia, so it is a kind of strategic renewal of an old insurance company. That is why we are going from being regarded as an insurance company to an intellectual capital company. Our CEO phrased it that way. It highlights the benefit of working with the roots for the future. If you nourish the roots, you become an innovation company or an IC company.

KI: How much do you attribute the success of Skandia to the active management of your intellectual capital?

EDVINSSON: It is hard to give you a precise number for it but it has nourished a new thinking; it has nourished innovativeness; it has nourished a new perspective. It has nourished growth of business as well as growth of nondomestic shareholders. Five or six years ago, less than forty percent of investors were foreign and now foreign ownership of Skandia is around 70%. By increasing Skandia's transparency, it gave insights to the investors, which led to the increase of foreign shareholders.

KI: Are there things going on in the company that are dramatically different since you started measuring IC in 1994?

EDVINSSON: If you are sitting on a board of directors meeting that has to give priorities to various activities within the organization and you have a Navigator telling you how a specific business unit is performing, then you increase the insight for that board of directors by four times. That helps you to make a choice between this unit and that unit and helps you to make a choice between maintaining the past and investing in the future, in strategic renewal, i.e. becoming an IC company.

KI: What do you do to encourage employees to add to the structural capital of the business? Is there a specific reward system that gets a buy-in from your employees?

EDVINSSON: Yes. Among other things, we have a personal navigator in some units hat measures indicators in the various focus areas and the reward system goes for both financial performance and intellectual capital performance...Measuring IC changes your mental focus from just harvesting to thinking about the importance of renewing...about what kind of structural capital there is and that I could leverage...about how much structural capital I am building by putting my knowledge into the systems software or knowledge recipes-packaged experiences, or codified knowledge for recycling, multiplying and commercializing - that could be reused and globalized.

One of the key learnings of this is that people can't be sent around the world for more than perhaps 100 days a year. So how do you then globalized the service business and the knowledge-intensive business based on people? You do it by building knowledge recipes and structural capital. You then globalize the structural capital and localize human capital. Using this model Skandia has been able to cut start up time for a new division in a foreign country from an industry average of five years to less than a year and sometimes to five or six weeks.

KI: How, specifically, is Skandia capitalizing on customer knowledge?

EDVINSSON: You can have customers on different levels if you see it as a value chain or a value constellation. Our prime customers are our alliance partners who are our financial advisers and brokers and other specialists that collaborate with us. Then jointly we service the ultimate customer. We try to develop knowledge for our alliance partners by having a Leader's College which is a kind of training program for them. It is a concept developed by America Skandia. Training is in economics, finance, as well as management. Then they take that knowledge to the ultimate customer.

We also have developed a technology called "Assess." It is an American Skandia CD-ROM, which has packaged the knowledge of financial planning. A broker or financial planner (presents this) to the ultimate customer. You can see it is a kind of teaching device and knowledge sharing for both the ultimate customer and the intermediary.

KI: Could you tell me about UNIC?

EDVINSSON: This stands for Universal Networking Intellectual Capital - a process to address the future by enveloping the driving forces and networks in intellectual capital. We are starting to develop competency alliances or, in technological terms, extranets. Knowledge development currently is done in the gray area or the edge between organizations. It was called white space management, meaning the innovations were taking place not within the boxes of the organizational chart but within the space in between the boxes. Today it is clear that development is taking place on the edge between the enterprise and its customer alignment.

We are developing a knowledge system called "Kennet" which is a kind of knowledge network together with some five other organizations. It is a joint prototyping of how to develop a knowledge network. We are developing together with our partners in the U.S. various types of technology support and organizations for financial service technologies, which means that we are working on the edge between Skandia and its business alignments.

By collaborating, you speed up the learning. The learning curve becomes steeper. And by doing that, you reduce the lead time, which means that the return is coming faster, and it also means that you are multiplying the productivity of a knowledge investment. It gives you a joint effort to explore and learn together - to come up with totally new solutions and new approaches. This we call Intelligent Enterprising, which is characterized by a global business perspective, the ability to take a leap and advance to the next curve. You need navigation tools that complement the accounting, knowledge recipes and sense-making values.

KI: What will your next book be about?

EDVINSSON: It is going to be about IC leadership - what characterizes a leader in an IC company. It is about how management, together with employees and the company's alliance partners, focuses on new opportunities. Instead of measuring market share, IC leadership must measure opportunity share. Traditional people are talking about how large their slice of the pie is instead of asking whether they can enlarge and create new business, which is the opportunity share. The number of companies that operate on the opportunity share basis is between 1-5%, which means that 95% have not explored it.

KI: Where do you see IC going in the next few years?

EDVINSSON: First, you can already see that the driving force is the Internet. It is becoming a highway for global trade on intellectual dimensions. In that, intellectual property like trademarks and knowledge recipes or software become the value drivers. We also need new curriculums at universities, as well as within corporations. How do we get the financial value out of being on the internet?

There are lots of costs to going up on that highway but you also need to develop that contractual agreement, the price tag, the systems for payment so it is not being locked up by the traditional regulations and traditional thinking. That is where I see intellectual capital coming in, the new currency on the global net. It might be called ICU for intellectual capital unit. It might be the new currency and, on another level, the new current. Once upon a time it was the mining of ore and gold that generated wealth. Tomorrow it is going to be the mining of minds.