Digital Economy : Towards an actual valuation of digital assets

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Picking From The Money Tree --- Image by © Images.com/CorbisMaybe you missed the information if you tried to disconnect this summer but a very important was made in July in the perspective of building an actual digital economy. The United States decided to change the way GDP is calculated in order to better take intangible assets into account.

Practically speaking it means that R&D and “artistic creation” won’t be considered as investment and not expenses. As the US Bureau of Economic Analysis (BEA) says :

Developing intangible assets becomes an investment.

Expenditures by business, government, and nonprofit institutions serving households (NPISH)for research and development (R&D) are recognized as fixed investment. The new treatment improves BEA’s measures of fixed investment and allows users to better measure the effects of innovation and intangible assets on the economy.
Similarly, expenditures by private enterprises for the creation of entertainment, literary, and artistic originals are recognized as fixed investment, further expanding BEA’s measures of intangible assets.
Here’s the change implied by the new calculation model :
RD GDP
What’s the purpose ? You must have noticed impressive yet impossible to explain valuation gaps between, for example, web companies and more traditional businesses, with no rationality regarding to their assets. It’s because finance and accounting do not take into account their intangible assets that represent the greatest part of their value. Intangible assets, as a matter a fact, account for up to 81% of the value of Fortune 500 companies. That said, note that intangible assets are not peculiar to the digital industry : regardless to the industry it’s, at different levels, today’s economy fuel. So there was a big gap between the real economy and the economy as shown by traditional indicators, a gap that had to be filled because it was the cause of incoherent decisions or even of “non decisions” that were at least as prejudicial.

Making Digital Economy acceptable from a financial and accounting standpoint

As a matter of fact, putting expenses aiming at developing intangible assets in the wrong cell had two consequences. The first was to undervalue the effort made in R&D, creation and anything related to the knowledge economy. The second was, logically, decisions made in the wrong direction, compliant with norms but penalizing in the long-term. As I already wrote the digital economy won’t exist without a legal and financial framework allowing to value it, understand its impact and its actual value. In the same way, investing in human capital is something everyone consider as essential but is still a financial heresy.
The matter is not to discuss how relevant such investment are but make them acceptable. Since the way we used to show numbers does not reflect the reality anymore (how would you represent R&D investments with a system designed for factories in the early 1900s) we need to change the way we use numbers. I always have in mind the example of Dannon – even if in a different field – that “hacked” their ERP to make decision favoring carbon neutrality acceptable so managers making “good” decisions regarding to carbon neutrality objectives won’t appear as making bad ones in the system.
So that’s a fundamental decision and a major turn for both the digital economy and the digitization of economy. The digital economy will find a better context to grow up and the rest of the economy – and that’s even the most important point – will be able to make better decision in the pursuit of its digitization and invest in actual transformation and not window dressing. At least in theory.

A strong signal with a little impact

In theory because if the BEA will measure things in a new way, nothing will change in accounting and financial norms. It’s a strong signal that may make businesses think different but won’t make some decisions more acceptable. Building tomorrow’s enterprise, developing the right assets, favor “on the job” learning and innovation will remain an expense, not an investment. But it’s surely a mandatory step to raise awareness and go ahead to the next stage which is the reinvention of an accounting system that’s a major barrier to enterprise transformation, destroys value and even jobs. But if the US can change alone the way they calculate GDP – with chances others will follow – changing accounting norms requires a large international consensus. Unfortunately we’re very far from that.
But the stake is high. Just to mention digital assets (which are only a part of intangible assets), McKinsey say they represent up to 8,6% of worldwide GDP and sustains a third of the global growth. So it’s urgent to stop doing nothing. A look at what McKinsey says gives an overview of the potential that lies there :
They are manifold: the unique designs that engage large numbers of users and improve their digital experiences; the digital capture of user behavior, contributions, and social profiles; the environments that encourage consumers to access products and services; and the intense big-data and analytics capabilities that can guide operations and business growth. They also include a growing range of new business models for monetizing digital activity, such as patents and processes that can be licensed for royalty income, and the brand equity that companies like Google or Amazon.com create through digital engagement.
Here’s why the CEO of a midsize business told me a couple of weeks ago :
“if we estimate that people should spend 20% of their time learning and improving their skills, innovating, formalizing knowledge to turn individual experiences into company assets and if I could treat 20% of the payroll as investments and write if off, it would change the face of social business, we could go faster and even hire.

Developing digital economy by considering digital assets as investments

That’s why we should go further than GDP calculation and tackle accounting norms : considering a part of the payroll as investment and being able to write if off would have impressive impacts in terms of investment, cash and jobs.
It happens in a far far away country called the United States. As for knowing when countries like France will follow the same way, consider than digital is more than a matter of content and pipes and see it as a matter of productivity, competitiveness and business models transformation, that digitizing all industries is even more important than the digital industry…nothing makes me say it’s going to happen tomorrow or the day after. I’m not even sure such ideas came through our leader’s minds. In theory Europe will adopt the same model as the US for GDP calculation in 2014 (following an agreement that happened in…2008) but I’m surprised to see that the matter is absent from the economic debate.