What Apple and Airbnb have in common – intangible assets that power their profit margins
Richard Wong says ideas and innovation have become a new form of capital that cannot be seen but whose scalability enables companies to increase their bottom lines
Since the 18th century, when the Industrial Revolution started in England, to 1990, business investment centred on the acquisition of real, tangible assets, such as machines, tools, computers or office buildings. But, since then, investment in intangible assets – ideas, designs, research, specific human capital, client networks and the like – has been growing.
This change has far-reaching significance. Not only are the economic properties of the two different, but many statistical metrics do not take intangibles into account. As a result, analysts and policymakers lack the data they need to explain some current aspects of the economy.
Ideas and innovation and how they are organised and encouraged have become the new capital – intangible capital. This shift has arisen primarily due to the information and communications technology revolution, which has accelerated the process of globalisation, enabled nations to export production capacity instead of manufactured goods and facilitated the transmission of ideas across national borders.
What is new about today’s economy is not the role of ideas themselves, but rather that many of our best ideas remain disembodied. The idea is indeed valuable, but it does not take physical form.
This changes almost everything. Apple has created value out of intangible assets — its distinctive ability to combine design and software. It is now the world’s most valuable company, despite owning virtually no physical assets.
Understanding this may help to explain some of the peculiar features of the modern economy, including rising inequality and slowing productivity.
As Jonathan Haskel and Stian Westlake point out in their book, Capitalism without Capital: The Rise of the Intangible Economy, intangible investments have distinct characteristics in terms of accounting conventions, economic properties and business potential.
In company and national accounts, many forms of intangible investments are unmeasured. They may be expensed but not capitalised, except in restrictive circumstances such as late in the development stage. They may be valued but depreciated, or if bought-in, then valued as goodwill if the company is sold.
A consequence of all this is that firms making large intangible investments become fabulously profitable because they can realise huge sales with little capital. But if these intangible investments are not properly accounted for, then we undercount gross domestic product and therefore could miss early signals of future output and productivity.
In terms of economic properties, intangibles are typically “sunk investments” that are difficult to resell, which makes it harder to secure bank financing. They tend to generate “spillovers” because competitors can copy nonphysical investments, such as production processes, with relative ease. They are “scalable” – a firm can use an intangible asset in many places simultaneously, unlike a machine or an office.
They are also “synergistic” because they can interact with each other or with physical and human assets. For example, Airbnb combines its intangible assets – its network of housing hosts with its material technologies such as computers and smartphones.
Watch: Airbnb’s biggest China rival, Tujia, cracks US$1.5 billion valuation in 2017
The business-related differences between tangibles and intangibles rest on several qualities. One is “uncertainty”. Intangible investments seem more unpredictable and carry more risk because, if they go bad, recovering their value is difficult, although the upside potential is greater due to scalability and synergies.
Another quality is “option value” because, even if a firm does not derive a marketable asset from its sunk costs, it can still extract valuable information from the process that it can use for future opportunities.
However, the rules associated with intangibles are also “contestable”, making it harder to protect ideas and knowledge. One outcome of this is that firms seek and reward employees who are skilful at extracting proprietary value from contested ideas.
Taken together, the characteristics and qualities of intangibles give them enormous benefits centred on their scalability – which in turn worsens the productivity gap between leading firms and laggards.
For tangible-intensive industries, the gap stays the same because they have constant returns to scale. Intangibles, on the other hand, promise increasing returns to scale. Successful companies that expand become progressively more productive than less successful ones.
Evidence of this effect can be found in Organisation for Economic Co-operation and Development data from 2001-09 on the globally most productive “frontier” firms. Labour productivity levels increased in manufacturing frontier firms by more than 30 per cent but only about 5 per cent for non-frontier firms, and in service frontier firms, productivity rose by more than 40 per cent versus virtually no change for the rest.
There is considerable evidence that frontier firms pay higher wages to all workers, both skilled and unskilled ones. This is due in part to the sorting of more productive workers into the frontier firms. But frontier firms also invest more in intangibles, which raises the productivity of their workers. To retain these workers, the firms have to share their profits with them.
The result is that intangible-intensive industries with such frontier firms become more concentrated and also increase wage inequality.
What implications does the rising intangible economy have for Hong Kong’s economy and public policy, especially positive non-interventionism? I shall explore these issues in my next column.
Richard Wong is professor of economics and Philip Wong Kennedy Wong Professor in political economy at the School of Economics and Finance at the University of Hong Kong