This is a book about the intangible economy and how big a role it now plays in the total economy. This is vitally important today as “conventional accounting practice is to not measure intangible investment as creating a long-lived capital asset.” However, investments in ideas, knowledge, aesthetics, networks, and organizational structures make up more and more of the current economy. As far back as the mid-1990s, in the United States, intangible investments overtook tangible investments, in terms of total dollars invested. The most common intangible investments include brands, software, databases, R&D, design, marketing, organizational capital, training, and intellectual property rights. These are often difficult to measure because quality improvements are hard to compute and many of the work happens “in-house”, so a dollar value is hard to calculate.
The authors point to four properties that make intangibles unique. 1) Scalability- “intangibles do not have to obey the same set of physical laws [as tangible investments]: they can generally be used again and again.” Scalability is increased by network effects. This often leads to industry concentration and winner-takes-all markets, where the monetary rewards for being second best are meager. 2) Sunkenness- investing in intangibles often means sunk costs. “It’s hard to recoup the money spent on setting up a sales force or on building an unsuccessful business unit or brand. Physical assets are often much easier to sell, even if they are quite specialized.” Intangibles are more likely to be firm specific. “Investments with high irrecoverable costs can be difficult to finance, especially with debt.” Intangibles do not make good collateral. Markets also have a hard time trading them because they are uniquely valuable to only one firm. 3) Spillover- “It is sometimes hard for the original investor to appropriate the benefits of intangible investment.” Often, it is another company that reaps the rewards of someone else’s initial idea by copying it, modifying it, scaling it up, or marketing it better. Ideas are non-rival and non-excludable (except through IP) so, in a sense, limitless. Therefore, they can be appropriated by others for their own use. Companies must spend time through secrecy, the law, or being first to market to make sure any competitors find it hard to copy them. 4) Synergies- combinations of ideas are often more important than any single new invention alone. “Technological innovation [is] “combinatorial.” That is to say, any given technology depends on the bringing together of already-existing ideas.” Intangible innovation, unlike tangible investment, brings together ideas that are not expended and used up, making the potential for synergies higher.
In general, intangible investment tends to be more uncertain. Due to sunk costs, investments could amount to nothing, but, due to scale, one can also hit a home run. Intangibles help lead to a superstar economy where a few concentrated firms reap most of the benefits. However, being a “fast-follower” can sometimes be more profitable than being first to market. The intangible economy can also lead to greater rent-seeking as companies use resources to lobby legislatures to defend their territory and keep competitors from imitating them. Company management has become even more vital in the intangible economy. “It involves designing new ways of working, developing hierarchies within firms, and putting in place software and systems to manage them.” Information flows more easily within an organization and so the manager has even more authority to delegate and does not rely on the autonomy of the worker. Knowledge is often process-specific and tacit. Often, new inventions and systems have to be combined correctly with proper physical assets before a company is able to reap gains. “New technological infrastructure is most useful in conjunction with new ways of working and without these new ways of working might not be very useful at all…. Nearly forty years after the development of the first central electrical power plant, still only slightly more than 50 percent of factory mechanical-drive capacity had been electrified.” The manufacturing industry’s organizational management needed time to catch up and create a new factory model to be paired with the new invention before gains were created. The intangible economy often requires systemic innovation. Electric car innovation would be worthless without a system of charging stations and added innovations in both electricity production and battery storage. It is the whole package and its network effects that often lead to success. “Systems innovation relies on leadership: the ability to convince other organizations, networks of partners, and even competitors to do what the systems innovator wants.” Financing the intangible economy is also a challenge. “Even those intangibles that can be sold, like patents or copyrights, present problems to creditors: they are typically difficult to value because a patent or a copyright is unique.” Debt/equity ratios of industries heavy on intangibles tend to skew equity heavy. “Current regulation disallows (almost all) intangible assets as part of capital reserves that banks must hold.” Tax systems also currently favor debt over equity, due to tax write-offs on interest, but not equity capital. Due to accounting rules about expensing versus capitalization, managers are also sometimes reluctant to invest more in R&D for fear that it will hurt short-term stock prices. This book neatly outlines some of the features of the intangible economy. It explains some of its unique characteristics, why intangibles are likely to grow even more in the future, and some of the hurdles faced as these shifts occur.
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