Enterprises are built on a foundation of natural, human, intellectual, and financial capital, which must be managed effectively and efficiently. Understanding the costs, risks, and returns associated with each form is essential to building sustainable advantage.
In economic theory, land, labor, and capital resources are the three factors of production and distribution of goods and services. In free markets, production and distribution activities are intended for profit, and the prices that determine gross revenue are set by supply and demand. Net income results from operating profit (revenue less cost and expenses), dividends, net interest, gains on sales of capital assets, and other miscellaneous items. Net interest income comprises interest revenue less interest expense. Net income creates wealth, which is a source of future capital, and so the cycle repeats.
Land is a collective term for natural capital. Labor is a collective term for human capital and the intellectual capital it uses. Labor includes entrepreneurs, executives, managers, and associates (supervisors and staff). Intellectual capital includes but is not limited to those methods that are learned as competencies (knowledge and skills). Capital, or more specifically financial capital, means wealth in the form of money or monetary equivalents used in the production and distribution of goods and services, and is intended to generate income.
Entrepreneurs can be considered to be a distinct factor of production and distribution separate from the other three; economies would not exist with them. However, management competencies are required to organize production and distribution activities to generate income.
Utilization is about practical use of assets – capital has a cost, and therefore must be used effectively and efficiently. It is important to understand the costs, risks, and returns associated with the use of each type of capital resource.
Sustainability is about being able to provide for current generations without damaging the ability of future generations to provide for themselves. Sustainable means being able to continue over time, either by developing, enhancing, or maintaining the current state, or by changing it. Advantage means favorable, superior, and beneficial.
Natural capital represents anything related to the environment that is used by the enterprise, and is the initial source of all raw materials, including air, soil, and water. Sustainability is especially important with respect to the use of natural capital. Misuse of natural capital damages the environment.
Historically, natural capital has been available at lower cost than its real value because sustainability has been ignored. In the future, natural capital is likely to cost more to cover both the remedial efforts to repair the environment, and the preservation efforts going forward. The risk of investment is misuse, which be lowered by avoiding the use of contaminants and pollutants, and by encouraging energy conservation and recycling programs. Opportunities should be pursued to use alternative fuels and other materials that do not impact the environment negatively.
“Green” profit improvement programs are initiatives that can be put in place to find alternative resources and processes that are environmentally friendly, and to find offsets to any increased costs that may be incurred. The economics related to the use of natural capital can change dramatically if sustainability is pursued with vigor. A paradigm shift is occurring towards the ecological economy.
The return on investment in natural capital results in higher quality resources such as pollution-free air, purified water, and contaminant-free soil. Such resources have significant benefits over the long-term, especially for quality of products and/or services, and for health.
Human capital, otherwise referred to as “human resources,” represents those characteristics of individuals that enable them to be economically productive for both themselves and the enterprise. Human resources comprise both employees and independent contractors. The characteristics of human capital include confidence, competencies, education and training, experience, and commitment.
An enterprise is dependent on its human resources for results – process and product/service capabilities are a function of people capabilities. Therefore, it is important that human resources are developed to their full potential.
Ongoing education and on-the-job training programs to develop knowledge and skills are essential to keeping individuals economically productive as conditions change. Hence, education and training programs should be considered to be an investment, not an expense, when relevant. Well educated and trained employees must follow responsible leadership that motivates them to be productive and efficient. The value of well educated, trained, productive, and efficient human resources appreciates over time. However, to use human resources the most effectively, it is important for management to obtain feedback from its people, especially those on the front line.
The risks of investment in human resources include individuals that are unwilling or unable to reach their full potential, or leave. The result is wasted education and training efforts. The return on investment results from the enterprise becoming more effective and efficient. An enterprise can also contribute educated, trained, productive, and efficient human resources into the local community for the social good.
Intellectual capital represents knowledge that gives an advantage, and hence must be protected. The more proprietary the knowledge is, the more the advantage that can be gained because competitors cannot use it without a licensing agreement. Intellectual capital is derived from people (human capital), and is manifested in processes and functions, and in products and/or services.
Intellectual capital defines the enterprise and product and/or service brands, builds a competitive barrier, provides a defense against other holders of intellectual property, and increases revenue generation and financing opportunities. More specifically, it consists of data, formulae, licenses, recipes, service marks, software, trade dress, trademarks, trade names, trade secrets, and written materials.
Intellectual property can be protected through copyrights, patents, and registrations of service marks, trademarks, and trade names. Patents are public information.
Almost every enterprise has some form of intellectual capital ranging from the “secret sauce” in the recipes of menu items at lifestyle restaurants to the code in Microsoft Windows. The Coca-Cola Company has a secret recipe for the ingredients of the world famous beverage, and non-generic products of pharmaceutical enterprises are covered by patents.
The risks of investment in intellectual capital include its failure to perform as specified, which could cause product liability claims, or its inability to generate income at all. The returns on investment include profits from competitive advantage not otherwise available, and revenue from licensing opportunities offered to third-parties.
Financial capital represents money and monetary equivalents, and consists of equity (ownership) and debt (long-term loans in various forms) invested in the enterprise as operating and investment capital. Equity comprises capital stock, current period income, other comprehensive income, and retained earnings less treasury stock. Operating capital is used to finance activities in the current cycle, and investment capital is used to finance capital assets, such as facilities and equipment, and positions in other enterprises. Operating capital can also be sourced from advances, borrowings, credit extensions, and short-term loans that are not considered part of the capitalization of the enterprise.
The risks of investment in financial capital include losses from revenues not covering costs and expenses, and depreciation because fair or market value is lower than cost. The returns on investment include profits from revenue in excess of costs and expenses, gains from appreciation because fair or market value is greater than cost, and from dividends and net interest income.
In a knowledge-based economy, the value of intellectual capital and the human capital that uses it is increasing. “Tribal knowledge” represents know-how within the enterprise that is essential to delivering products and/or services, and must be captured in practices such as policies, processes, and procedures. Using business intelligence as information for competitive advantage can be a differentiator in the marketplace.
However, the greatest opportunities may be in the delivery of knowledge-based products and/or services that result from digital construction and manufacturing processes. Innovation, infrastructure, and information are three factors of production in a knowledge-based economy. Knowledge is only of value if it is put into practice.
Utilizing capital effectively is an enterpriship (entrepreneurship, leadership, and managerial) competency.
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