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COURSES 1& 2

The Intangible Economy: an Overview.


Understanding Economic Change
Generally speaking and according to our perception at present, we could say
that production and products pertain to the material universe: production,
which is based on natural resources and energy, is fundamentally tangible.
We got so used to this idea that we do not attempt to analyze it any more.
Our economic and legal constructions are based on production, ownership
and exchange of tangible goods.
Economy, as it appeared after the industrial revolution, comprised activities
related to the transformation of natural resources and was mainly an
economy of goods. Under the mass production system with homogenous
goods, the knowledge content of goods was low and the most important
phase of the production process was manufacturing, since firms relied on
economies of scale for market performance. Hence, the tangible aspects of
factors of production were the most important (productivity thereby
explained by the amount of physical capital and quantity of labor employed).
Nevertheless, with the development of the economy and society as a whole,
the importance of knowledge increased, leading to information and ideas
playing a crucial role in determining economic performance. Nowadays, the
knowledge content of goods is higher, and the pre- and post- manufacturing
phases are crucial for value creation.
The new type of economy that is emerging is more about a shift of mindset
relating to building and extracting value - in both the tangible and intangible
worlds. Far from being new topics, knowledge and intangibles have been
important throughout history (for over 30 years we have been talking about
intangible and tangible investments, for example; moreover, because our
economic systems have always been functioning based on information,
knowledge, human skills and competences, intangible activities have always
been present).
The difference is that, today, a firms intangible assets are often the key
element in its competitiveness. Increasingly, the capacity to combine external
and internal sources of knowledge to exploit commercial opportunities has
become a distinctive competency.
Nowadays, these intangible activities and realities, the competences and jobs
associated with them, the exchanges and transactions that they determine,
the value and wealth that they create have become so important that they
induced transformations in production and trade.
Consequently, we can talk about intangible economy, information economy,
knowledge economy (Daniel Bell 1973, The coming of the post-industrial
society), digital economy (Tapscott, 1996), information society ... names for
the new economy proliferate.

The economic landscape of the present and future is no longer shaped by


physical flows of material goods and products, but by ethereal streams of
data, images and symbols.
The well-known three stages (Clark, 1940) or three waves (Toffler, 1981)
theories of economic evolution can thus be reformulated. At the core of the
agricultural economy, there was a relationship between man, nature and
natural products. The core relationship of the industrial economy was
between man, machine and machine-created artificial objects. The intangible
economy is structured around relationships between man and ideas and
symbols. The source of economic value and wealth is no longer the
production of material goods but the creation and manipulation of intangible
content.
The shift to the intangible is general and long-lasting. Intangible
inputs account for over 70% of the value added in the car production.
Somewhat more surprisingly, 70% of the cost of producing butter is due to
intangible factors [Blanc and Breton, 1994]
The intangible economy is too often seen as a purely technology-driven
phenomenon.
This is a dangerous oversimplification. The development of the intangible
economy owes at least as much to basic trends in consumer behavior and in
business environment. Shift toward higher relative demand for leisure,
information and knowledge is a strong and long-lasting trend in consumer
behavior. Business innovations such as brand-driven competition and
unbundling of computer hardware and software have been a major
dematerialization factor.
Although information and knowledge are the main vectors of the Intangible
economy, they are not the only ones. It is as much an economy of useful
information and knowledge as it is of wasteful entertainment and
distraction.
The intangible economy is all around us. Yet, we have great difficulty to
apprehend it: by definition, intangible phenomena are elusive. Not limited by
physical constraints, they defy attempts to fit them into standard economic
categories and taxonomies.
To better understand the intangible economy, we will approach it from three
different perspectives (Goldfinger, 1994). The main elements of the
Intangible Economy framework, according to Charles Goldfinger (1997), are:
Supply perspective: Intangible assets, used by firms to establish and
maintain their competitive position and survival. They include: the brand,
the intellectual property, the human capital, research and development
information, know-how.
Demand perspective: Intangible artifacts: final output for consumption.
Economic system perspective: Logic
of
dematerialization:
an
interrelated set of trends and forces that affect all economic activities,
changing the nature of economic transactions and market structures.
1. Supply perspective: intangible assets

a. DEFINING INTANGIBLES
It is widely acknowledge that nowadays non-physical assets remarkably
contribute to increase the competitiveness and the value of firms.
The definitions provided by the main standard setting bodies in the world
usually characterize intangible assets as non-physical and non-monetary
sources of probable future economic profits accruing to the firm as a result of
past events or transactions. Intangibles are usually defined as identifiable
(separable) non-monetary sources of probable future economic benefits to an
entity that lack physical substance, have been acquired or developed
internally from identifiable costs, have a finite life, have market value apart
from the entity, and are owned or controlled by the firm as a result of past
transactions or events.
However, definitions elaborated for accounting purposes may appear
restrictive. When an enterprise has insufficient control over the expected
future economic benefits arising from a team of skilled staff and from
training, or when intangibles are not clearly identifiable, there might be
serious problems in finding these to meet the definition purposed.
In some cases, intangibles are identified with goodwill and considered as the
excess cost of an acquired company over the value of its net tangible assets
(White et al., 1994). In the UK, the Accounting Standards Board has embraced
this idea considering that all intangibles should be understood as part of
goodwill, as it is unlikely that they can be sold without selling the whole
business.
In literature, broader definitions, especially designed for management
purposes, have been suggested. Intangibles have been defined as resources
that are not visible in the balance sheet, but that add value to the enterprise"
(Edvinsson, 1997), or as "non-physical sources of value (claims to future
benefits), generated by innovation (discovery), unique organizational designs,
or human resources practices" (Lev, 2001; p.13). As a working definition, the
High Level Expert Group (Eustace, 2000; p.31) took intangibles to be Nonmaterial factors that contribute to enterprise performance in the production
of goods or the provision of services, or that are expected to generate future
economic benefits to the entities or individuals that control their
deployment.
One of the most recent and all-encompassing definitions is given by Baruch
Lev: An intangible asset, like any other asset (a machine or a rental property),
is a source of future benefits that lacks the physical embodiment (Baruch Lev,
2005).
The Coca-Cola brand name is an example of a highly valuable intangible
asset that enables owners to generate substantial revenues and profits over
extended periods.
b. TAXONOMY OF INTANGIBLE ASSETS
Aware of the importance of intangible assets, the accounting profession
has also proposed a four part classification of intangible assets:
brands, intellectual property, publishing rights and licenses.

For consumer goods companies, Coca-Cola, Nestle or Danone, brand


management is the top priority guiding all their strategies. Brand is also
essential for Information Technology companies such as Intel and Compaq,
which are spending substantial sums to build it. Leading marketing
specialists, such as David Aaker, consider brand an integral part of firms
equity (Aaker, 1991). Attempts are often made to quantify this brand
equity. An American business monthly, Financial World, publishes each year
a brands survey, which values them on the basis of their sales, profitability
and growth potential. For leading brands such as Coca-Cola, Marlboro or Intel,
this valuation largely exceeds the total balance sheet of parent companies
(Financial World reference).
Acknowledgement of the importance of intangible assets is not limited to
brands. Intellectual property - patents, trademark, technological know-how is considered as a critical competitive weapon, particularly in software,
electronics and biotechnology. The control of intellectual property rights is
often a matter of survival for companies. In merger and acquisition
transactions, the book value has become largely irrelevant to the company
valuation, which is determined primarily by intangible assets (Petersens and
Bjurstrom, 1991). Apparently extravagant amount paid for media assets, such
as Hollywood studios or newspapers, can be explained by the crucial role
attributed to brands, contents and publishing rights in the emerging realm of
infotainment, combining information and entertainment (The Economist,
1994).
The proposed classification is far from exhaustive. It excludes what many
consider the most critical asset: human capital, the quality of firms
workforce. It also ignores the company culture, its accumulated knowledge
(which is often informal and unprotected) and its network of relationships
with customers and suppliers, which constitute the main asset of banks,
telecom companies, retailers and many other organizations.
The main reason for the non-inclusion is the lack of agreement among
experts on how to treat intangible assets, because of their characteristics.
First, they are highly heterogeneous, not only between categories but also
within a given category: one hour of software programming does not equal
another hour of programming. The revenue-generating capacity of an
intangible asset is much more uncertain than that of a physical investment.
When a plant adds another machine, it can easily quantify the potential
increase in output. On the other hand, when a computer department hires
another programmer, it cannot predict with certainty either the quantity or,
more importantly, the quality of his/her contribution.
Intangible assets are difficult to separate, thus violating one of the cardinal
rules of traditional asset valuation (OECD, 1992). It is difficult to separate
intangible assets from current expenditures. Whether an advertising
expenditure can be classified as current expenditure or investment depends
on its purpose. Similarly, not all training or software expenditures can be
treated as investment.
More importantly, intangible assets often interact with each other,
making it difficult to identify their separate contribution. When, in October

1992, Intel decided to give its new microprocessor a recognizable name,


Pentium, rather than a number, 80586, it was because it wanted to establish
a brand name and simultaneously to reinforce intellectual property
protection.
Because intangible assets are, by definition, non-physical, they do not
follow the classical progressive depreciation rules. Some assets
depreciate very rapidly, others, like a good wine, appreciate with age, stills
others follow non-linear and often unpredictable life cycles.
Intangible assets raise the issue of ownership. Physical assets are fully and
exclusively owned by the firm, which justifies their placement on the balance
sheet. The situation of intangible assets is considerably more ambiguous. For
instance, a firm owns its brands and other forms of intellectual property. But
does it own its labor force, its human capital? And some intangible assets are
completely outside the legal perimeter of the firm. This is the case of
customer base, which constitute the critical determinant of firms profitability
(Reichert, 1997).
Thus, we can distinguish between three types of corporate intangible assets
shown in the following figure. These comprise (I) formally registered
Intellectual Property Rights. More broadly, we can define (II) Intellectual
Assets which comprise both the above registered property rights as well as
unregistered corporate knowledge, codified in the form of drawings, software,
databases, blueprints, formulae, manuals, and written trade secrets. Finally,
category (III) comprises uncodified Human and Organizational Capital.

The gradation from category I to category III is analogous to the gradation


shown in Figure 2 from information to knowledge, and finally to wisdom or
strategy. Information or data alone can be an intangible asset with value
within the firm, or for sale/license outside the firm. But information is not
necessarily knowledge until it is organized into a usable, codified form. This is
the difference between a mere patent or formula and an efficient
manufacturing capability. Even knowledge is insufficient. For a firm to be
competitive, this knowledge must be assimilated and embedded in its
personnel. Even that is not enough. Effective strategy requires
organizationally embedded knowledge plus wisdom in how to use that
knowledge in the competitive marketplace.

c. MEASUREMENT ISSUES
When do intangible assets need to be valued?
Besides the important issue of stock market valuation, there are several
principal business circumstances in which intangible value needs to be
measured:
(1) A company sale, merger or acquisition: The acquiring company will
appropriate the physical assets or the purchased firm, but it also needs to
determine what the injection of new knowledge is worth. Accounting
measures do not coincide with economic or market-based values (Reilly,
1995). Many mergers and acquisitions are justified on the grounds of
combinatorial synergy between the knowledge base of the two companies.
However, there could also be combinatorial incompatibilities, knowledge
transfer costs over many years, and cultural compatibility problems between
the merging organizations.
(2) Sale, purchase or licensing of separable assets such as brands,
patents, copyrights, databases or technology. By `separable assets' is meant
transferable knowledge, intellectual property or market rights, and partially
codified knowledge that can be sold or licensed to another firm. Here, only a
portion of the intangible assets of a company are spun off to another firm by
a transfer of rights and/or by training the other firm in the use of the
transferred knowledge. The question is how much should the company
licensing or acquiring these assets pay?

(3) Lawsuits involving intellectual property infringement: Here courts need


to determine infringement costs and penalties.
(4) Tax liability calculations in the context of transfer of intangible assets
and technology to affiliated firms, possibly in another country.
(5) Corporate alliances: During negotiations over the creation of a joint
venture (JV) or the many other forms of strategic alliances such as
management service contracts, franchising, co-marketing, etc. the valuation
of the knowledge contributions of each partner is a key issue. This decides
the equity share of JV partners, royalty rates and other fees.
(6) R&D management: Putting a value on prospective future knowledge
generated by R&D investments is key to selecting between competing R&D
projects. Valuing each partner's contribution in co-development projects is
another crucial measurement area.
There are several benchmarks used for valuation of separable intangible
assets:
1. development cost
Development costs are sunk, irretrievable; what was spent in the past by
the developer has no bearing on the buyers willingness, or ability to pay.
They usually have little bearing on the value of the developed intangible
asset outside the market purview of the developer (except in the case of
specific contract research).
2. transfer cost
The costs to transfer the technology and capability represent the minimum
compensation to recoup only the direct incremental cost of the agreement.
The direct cost of the transaction includes:
o the incremental legal and negotiation cost
o the training and teaching costs
The seller will expect to recover this cost, part of the R&D cost and to make
some profit.
Thus, the marginal cost of knowledge transfer comprises a `floor price' or
minimum value for the knowledge.
3. market value
The value of the transferred knowledge in the new market is a ceiling price or
a maximum value payable to the seller. In the case of an existing market, the
knowledge only improves efficiency and reduces costs, the ceiling price being
the marginal cost savings resulting from the transfer of knowledge.
4. opportunity cost
The profits on business lost to the knowledge developer as a result of the
knowledge transfer plus the floor price represent the minimum compensation
to justify the transfer
5. consequential costs
Lost profits to the knowledge supplier, as a consequence of misuse of IP or
technology leakage, increased competition, and degradation of intellectual
property value comprise a possible addition to the floor price or minimum
compensation needed to justify the transfer.

6. industry norms courts and tax authorities


Negotiators' demands are often moderated by reference to `Industry norms'
such as sector averages and the `25% criterion' - licensee, 25% of the
incremental profit licensor
The compensation demand of a knowledge supplier ranges between floor
price (direct transfer/training costs) and ceiling price (incremental profits); in
practice, it can be moderated downward by comparing with other options
that may be available to the knowledge acquirer, such as (a) obtaining the
expertise from another source (b) developing the capability in house with
their own R&D and (c) risking deliberate patent or copyright infringement.
The knowledge supplier's compensation demands can be influenced upwards
or downwards by options such as (a) compensation available from alternative
alliance/ JV partners in the target market and (b) the Discounted Present
Value of entering the market themselves by establishing a subsidiary, or
other means.
The indirect benefits to the knowledge supplier can be:
o profit margins on other supply/purchase deals (spare parts) with
the partner or their associates, engendered by the agreement
o network externality or scale benefits
while the indirect costs can include:
o liability claims by foreign customers
o poor quality control
o customer service leading to diminution of brand
Direct payments for knowledge are made in the form of contractually
specified fees and royalties and returns on equity investment in case the
knowledge supplier takes an equity position in the recipient firm.
One of the main problems associated to the intangible assets is linked to the
remarkable constraints in measuring them. The research into measuring the
intangible assets of companies has produced a plethora of proposed methods
and theories over the last few years.
The approaches fall into at least four categories of measurement approaches:
Market Capitalization methods (MCM) that is based on calculation of the
difference between a company's market capitalization and its stockholders'
equity as the value of its intangible assets. Examples are the Tobins q
(evocated, among others, by Stewart, 1997 and Bontis, 1999 - Tobins q is the
ratio of the stock market value of the firm divided by the replacement cost of
its assets; changes in q provide a proxy for measuring effective
performance or not of a firms intellectual capital) and the Market-to-Book
Value (Stewart, 1997; Luthy,1998; Lev, 2001 - according to this approach the
value of intellectual capital is considered to be the difference between the
firms stock market value and the companys book value).
Return on Assets methods (ROA) that imply that average pre-tax earnings
of a company for a period of time are divided by the average tangible assets
of the company.

The result is a company ROA that is then compared with its industry average.
The difference is multiplied by the company's average tangible assets to
calculate an average annual earning from the Intangibles. Dividing the aboveaverage earnings by the company's average cost of capital or an interest
rate, one can derive an estimate of the value of its intangible assets. One
example is provided by the Economic Value Added (EVA - It is calculated by
adjusting the firms disclosed profit with charges related to intangibles.
Changes in EVA provide an indication of whether the firms intellectual capital
is productive or not) (Stewart 1997).
In light of the shortcomings of cost-based and transaction-based
valuation approaches, accountants recommends another approach, the
Discounted Cash Flow (DCF) method which determines the economic value of
an asset by looking at its cash generating potential.
Both the four part classification mentioned earlier and DCF approach were
endorsed by the International Accounting Standards Committee (IASC) in its
1994 Draft Statement of Principles on Intangible Assets [IASC, 1994].
This by no means implies that the consensus on intangible assets has been
achieved. The DCF method is far from universally accepted.
Thus the issue of accounting treatment of intangible assets remains largely
unsettled.
2. Demand perspective: intangible artifacts
Intangible artifacts include different forms of information and communication,
cultural elements, audio-visual media, entertainment and leisure, finance etc.
As it is well known, goods are essentially entities of economic value over
which ownership rights can be established and that can be exchanged. As
goods are distinct entities, which are separate from their producers or
owners, the production and trading of goods are two different activities,
which can be organized separately and carried out at different locations and
times. Complex channels of distribution can be developed with goods
changing hands several times as they pass from their original producers to
their eventual users or consumers. Goods can be consumed or used long
after they are produced at locations which are remote from their place of
production.
Intangible artifacts share the economic characteristics of goods just
described.
They are entities over which ownership rights can be established and which
are of economic value to their owner. They are also intangible because they
have no physical dimensions or co-ordinates in space. They are the originals
created by authors, composers, scientists, architects, engineers, designers,
software writers, film studios, orchestras, and so on. These originals are
intangibles that have no physical dimensions or spatial co-ordinates of their
own and have to be recorded and stored on physical media such as paper,
films, tapes, disks etc.
The producer of the original is their first owner, but the ownership may be
transferred to another economic unit. The ownership right is often legally

recognized through a copyright or patent, but the copyright or patent is only


a legal instrument which should be clearly distinguished from the entity over
which the ownership right is established, in the same way as the deeds of
ownership are obviously very different from the house or property to which
they relate. Originals may be used to produce, even mass produce, copies
that in turn may be used in further processes of production or directly for final
consumption. The original intangible can be bought and sold as often as
required. Intangibles artifacts can be traded and re-traded in the same way
as material goods. They can also be instantaneously transmitted
electronically.
All artifacts are joint products, combining intangible content with physical
support or a set of supports1:
- song with a magnetic tape for an audiocassette;
- software on a disk
- history and a building site for a classical monument
- TV commercial or a TV show
- financial or insurance product
- football game
- holiday village
Traditionally, content and support were tightly linked, making them either
unique or reproducible on a small-scale only.
The development of technologies of storage and replication of content has
loosened the links: the same content can now be easily and cheaply
replicated and associated with various physical supports : a song can be sung
live, pressed on a CD or shown as a video-clip ; a payment can be made in
cash, via card or wire transfer.
(the cost of replication is very low, and getting lower over time and
replication devices are readily available to the consumer. )
Artifacts with an identical content appear in various disguises and shapes.
The dissociation of content and support has led to the proliferation of
intangible artifacts in two ways.
First, it has lifted capacity constraints limiting a large-scale
consumption of intangibles. A theatrical show or a sports game could be only
watched by those who could physically attend the theatre or the stadium.
Today, television can multiply the number of spectators ad infinitum. One
could argue that a stadium attendance and a TV watching of a sport event
are two different artifacts, with different consumption, distribution and pricing
characteristics.
That is precisely the second dimension of proliferation: the same
content provides a source for a family of artifacts: a book can be offered as a
hardcover, as a paperback, as a CD-ROM or on-line. The ability to generate
such families is what makes companies such as Disney successful: each film
idea, Aladdin or Lion King, generates not only movies but also videos, park
attractions, books, toys and other sources of revenues, thus leveraging the
content by a factor of two to four.
1

The type of support can differ, depending on the nature of the intangible content:
objects (disks, tapes, CDs, paper etc), environment (location, resort, atmosphere),
people, mixed.

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The consumption of intangible artifacts displays specific and interrelated


properties:
- it is joint (always consumed with other products, tangibles or intangibles).
- it is non-destructive: the same artifact can be consumed repetitively either
by a same consumer or by a different one. Originals have infinite lives. They
are fixed assets for which there is no wear and tear, but they may become
obsolete and therefore subject to depreciation.
- it is non-subtractive (or non-rival): ones consumption does not reduce
anyone elses consumption. In other terms, the opportunity cost of
sharing is zero.
Intangible artifacts have some of the characteristics of public goods. In
particular, there is no rivalry in their consumption. The use of an original to
produce one copy does not reduce the scope, in a purely technical sense, for
using it to produce others, although it may reduce the demand for further
copies. Similarly, the use of a chemical formula or engineering design by one
producer does not reduce the scope for others to use it.
An original is not a public good, however, in the sense that providing it to
some users does not necessitate providing it to everyone, whether they want
it or not. Otherwise, property rights could not he established. Legally, the
owner of an original has the right to exclude, or prevent, people from using it,
even though copies may be produced illegally.
Sharing is a notable property of intangible artifacts. Although they are often
produced for the use of a specific consumer, the exclusivity cannot be
durably maintained. Sharing can be sequential or simultaneous. However,
simultaneity in time does not mean simultaneity in space: it is possible to
consume the same artifact in several locations, as shown by television or online networks
The pervasiveness of sharing creates extensive externalities:
- the traditional equality purchase equals consumption," which is the
cornerstone of consumer behavior measurements in the market economy, is
no longer universal.
For intangible artifacts, purchase does not equal consumption (how many
people read all the books they buy?) and consumption does not necessarily
imply purchase: in newspapers or in broadcast television, the number of free
riders frequently exceeds that of paying consumers by a factor of three or
four.
Sharing affects not only consumption but also production. Many
intangible artifacts are produced through interaction between consumers and
producers. Consumers not only often provide elements of content but they
create their own combination of content as well as a content-support
association. Facilitated by the low cost and the availability of replication
technology and the content-support dissociation, such interaction becomes
the prevailing mode of creating and consuming intangible artifacts.

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Economic characteristics of intangible artifacts render conventional pricing


and transaction mechanisms largely inadequate to capture their economic
value. The standard approaches are difficult to apply.
Production costs cannot be used as guide for pricing as there is no
proportionality between inputs and the output. Mass consumption does not
imply mass production. Bestselling books, records or movies are created by
small creative teams and their revenues are not related to their costs.
Economies of scale for intangible artifacts are determined by consumption
not by production.
Yet, the other approach based on the willingness to pay also has serious
pitfalls, given the ease of replication and sharing and associated externalities.
Another problem, which particularly affects informational artifacts, is what
Joseph Stiglitz called the infinite regress: it is impossible to determine
whether it is worthwhile to obtain a given piece of information without having
this information (Stiglitz, 1985).
Traditionally, the pricing of intangibles was a function of convenience and was
based on the support rather than on the content. Thus, the price of a book
was determined by its thickness and the printing quality. This pricing largely
ignored the content: the price for an excellent book was the same as the
price of a bad one.
The advance of dissociation created opportunities for unbundling: content
can now be priced separately from the support. Price discrimination, based
on the estimated value of content, becomes more common. Commercial online services, for instance, differentiate between standard and premium
services, which are sold at higher prices. Yet, the bundling has its
advantages, in particular the simplicity of administration. It facilitates pricing
of composite artifacts, comprising several types of content (multimedia
software or amusement parks). It also allows cross-subsidies. In financial
services for instance, equity research is bundled into brokerage commissions.
Thus, the range of intangibles pricing schemes is getting broader and more
complex.
Furthermore, depending on the supplier-consumer relationship, different
pricing arrangements can apply to apparently similar artifacts. Computer
software can be sold as a stand-alone product or it can bundled with
hardware or be distributed as a shareware or freeware over a network
(Dyson, 1992; Varlan, 1994, 1995). Internet provides a fascinating laboratory
of various approaches to pricing through various combinations of selling,
sharing and giving away.
As pricing of intangibles focuses on content, it highlights its inherent volatility
of valuation. Although physical goods also show variation in price, the
amplitude of changes is considerably larger for intangible artifacts. Their
value is highly time-sensitive and can change dramatically: the same artifact
can be valued very differently by the same user - financial information can be
worth millions of dollars in the morning and nothing in the afternoon.
3. Economic system perspective: logic of dematerialization

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The impact of the intangible economy is pervasive and affects all sectors and
activities.
The dematerialization logic is unsettling to the extent that it runs against
some of the key tenets of the conventional logic of economics.
The three fundamental features of dematerialization
abundance, interpenetration and indeterminacy.

logic

are:

A. Abundance
Intangible economy is structurally abundant.
Physical goods are subject to physical decay and their consumption marks
the beginning of the end of their economic life. Intangible artifacts, on the
other hand, are not only extremely cheap to replicate but furthermore are not
eliminated through consumption.
The intangible economy puts on top of the abundance of production the
abundance of accumulation.
The lifecycle of popular intangible artifacts is considerably longer than that
of material goods: we will forever read Balzac books, listen to Bach music or
watch Bergman movies.
Financial systems generate too many transactions, Hollywood, too much
entertainment, Internet, too much information. The gap between supply and
demand of intangible artifacts is so huge that it has created an information
overload, also called infoglut: the inability to absorb the torrential and
continuously swelling flood of data, images, messages and transactions
(Tetzeli, 1994). Moreover, the overload is self-perpetuating: to navigate
through it we need catalogues, indexes, documentation, whose very
proliferation calls for more cross-references, hypertext links and so on.
Efficient infoglut management requires more rather than less information.
Information about information is a growing business.
Abundance confronts consumers with a dilemma. On the one hand, they
want to take advantage of the increased choice of products and artifacts. On
the other hand, they seek to minimize the cost of search.
In response to the first objective, new modes of consumption have emerged:
zapping, surfing or browsing. They are characterized by a short attention
span, latency, high frequency of switching and capriciousness. They blur the
distinction between consumption and non-consumption, rendering pricing
problems even more intractable.
The expanded range of output makes consumer choice more difficult, by
continuously raising the cost of acquiring information about the output. To
minimize this cost, the choice is increasingly determined by criteria other
than product characteristics such as brand familiarity or mimicking and
fashion (Bikchandani and al., 1993; Veblen, 1899).
Brand and fashion-driven demand force suppliers to continuously renew
their offerings and to actively manage their product portfolio. Product cycle is
becoming shorter. Obsolescence is no longer an external constraint, it
becomes an instrumental variable. In certain areas, such as personal

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computers, obsolescence leads to cannibalization: new products are


introduced to replace products that are still successful. Intel and Compaq are
particularly skilful in the use of cannibalization to keep their competitors off
balance (Chreiki, 1995; Allen, 1992).
Ubiquity of failure and the wager economy
A crucial implication of supply abundance is the ubiquity of failure. Flops
are the rule, successes, an exception.
- In Hollywood, one movie is made out of a hundred scenarios under
development, and only one in six movies released makes money.
- In the publishing industry, the overwhelming majority of books are
unprofitable.
The flop rule is not limited to intangibles.
- In the pharmaceutical industry, only one in 4000 synthesized compounds
ever makes it to market and only 30% of those recover their development
costs (Moore, 1995).
- In consumer goods industry, over 80% of new products launched in the
United States fail within two years (Powers, 1993).
Furthermore, the cost of launching new products is rising rapidly: 50 million
dollars for a movie, 250 millions for a new drug, several billions for a new car.
This has become a wager economy: higher and higher stakes against lower
and lower odds.
The wager analogy helps to explain why most companies continue to
generate new products at a rapid rate. As long as a player remains at the
table, he has a non-zero probability to recoup his losses. Only if he walks
away, his loss becomes final. Also, what really matters is not so much how
many times one plays but the overall magnitude of the gain (or loss).
There are of course other factors.
One is the need for brand preservation. New products can be considered as
visible signals of both brand continuity and renewal.
Another factor, which particularly applies to intangible artifacts, is what can
be called a bookstore effect. The best bookstore is the one that offers the
widest choice. Furthermore, a well-stocked bookstore stimulates browsing
which leads to greater book consumption. It is however not enough to have a
wide assortment, it is also important to keep it current, hence the need for
continuing introduction of new products.
- The bookstore effect explains for example while Reuters maintains 20 000
pages of data in its on-line financial information services, while the
overwhelming majority of its clients use only four or five. The value of its
databases is derived not only from particular pieces of information but also
from the total inventory of data.
The main product management challenge is not how to increase the
probability of success any more but rather how to capitalize on it, how to
transform hits into megahits. In this respect, the true champions are
Hollywood studios such as Disney, which are extraordinarily adept in spinning
out ancillary products - videotapes, computer games, toys, clothing, etc. from their hit movies. These products generate, on average, two to three
times more revenues than movie attendance (Goldman, 1995]).

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B. INTERPENETRATION
The intangible economy undermines traditional frontiers and distinctions.
Sectoral boundaries are crumbling: previously separate activities of
telecommunication, informatics, electronics and audio-visual entertainment
are now overlapping.
Time-honored distinctions between work and leisure, home and work-place,
intermediate good and final output, consumer and producer, product and
service, become blurred. Not only are the boundaries porous and overlaying,
they are unstable.
The interpenetration profoundly changes the nature of the firm and its
relationships with the environment. Internal links, between firm and its
employees, become weaker; external links, between firms and its suppliers,
become stronger. While employees are told to work at home, suppliers are
invited to work on premises. Functions traditionally considered as central to
the very existence of the firm are now subcontracted or outsourced. This
leads to the advent of the virtual corporation (Davidow and Malone,
1992]).
Nike, leader in sport shoes, does not manufacture any shoes. Nor
does Dell, a leading supplier of computers, own any production
plant. In the semiconductor industry, many leading firms are fable
less concentrating on chip design and subcontracting their
production (Rapaport and Halevi, 1991). In computer services,
outsourcing is one of the highest growth sectors.
Dematerialization logic modifies the market power balance and the value
chain structure. In the industrial economy, the central position in the
value chain was that of final product assembly, while the position of
subcontractor was subordinate.
Despite the fact that Michelin contributed more to the development of the
automobile, by facilitating road travel with maps, signs and guides, than
Renault or Citroen, the latter gained greater market power: few people ever
buy their cars in function of the brand of its tires. In the intangible economy,
a subcontractor often assumes a dominant position. Thus, in personal
computers, Intel and Microsoft, are in a considerably stronger position, and
are more profitable, than IBM or Compaq, which control final assembly. Their
dominance is due to their ability to establish intellectual property rights over
key product components, in this instance microprocessor architecture and
operating system software.
These changes in the value chain structure reflect a fundamental trend: the
weight of the value chain is moving closer to the consumer.
This trend has led to the emergence of power retailers such as Wal-Mart in
the US, Marks and Spencer in the UK, Galleries Lafayette in France or Ikea in
Sweden. They decide which products are put on the scarce real estate of
store shelves. They also set prices and become increasingly involved in
product design. One visible sign of their increasing power is the development
of own-label brands. According to Boston Consulting Group estimates (Reid,

15

1995), own-label brands represent close to 30% of total grocery sales in the
UK, 25% in Germany, over 20% in France, and their share is growing.
C. INDETERMINACY
The dematerialization logic is not deterministic. It does not point to a single
optimal trajectory. It actually widens the range of choices and alternatives.
Instability and volatility which govern the demand for intangibles become
pervasive and affect all aspects of the economy, national competitiveness,
business hierarchies and market structures, prompting frequent and massive
reversals of judgments and opinions.
The hierarchy upheaval is even more dramatic in business. Out of 500
American corporations that comprised the Fortune 500 ranking in 1995, 40%
have disappeared by now.
Market dominance can be achieved with unprecedented speed and lost with
equal if not greater rapidity, particularly in fast growing sectors such as
telecommunications and computers.
The intangible economy is molded by contradictory cross-currents:
globalization and localization, concentration and fragmentation, vertical
integration and horizontal competition. This is what John Naisbitt refers to as
a Global Paradox (Naisbitt, 1994; Alesina and Spolane, 1995).
Contradictory crosscurrents are the strongest in the business area. On the
one hand, the competition has never been keener; the fight for market share
and shelf space, more brutal; the rivalry between firms, more intense. At the
same time, alliances proliferate in all sectors and all areas and management
theorists extol the virtues of co-operation and sharing (Badaracco, 1991,
Nalebuff and Brandenburger, 1996). This coexistence of competition and
co-operation has prompted Ray Noorda, the founder of Novell, the
leading provider of networking software, to coin a new term - the
coopetition.
At the core of the intangible economy, contradictory forces are at work:
economies of scale and increasing returns, on the one hand, value shift to the
consumer and market upheaval, on the other hand. These forces will continue
to coexist and to interact, thus maintaining indeterminacy.
Contrary to the industrial economy, economies of scale in the
production of intangible artifacts are limited: adding twice as many
programmers to a software development project is unlikely to cut in
half its completion time or cost, it may actually double it. However,
economies of scale in distribution can be significant, due to a
combination of high fixed costs of creating the distribution
infrastructure and low variable costs of using it. They are a major
vector in the downstream value chain shift. They also constitute the
main rationale for the wave of mergers in sectors such as banking,
retailing and media, whose prime objective is to create large and
ubiquitous distribution networks (Wysocki, 1995).

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Scale effects are accentuated by the consumption characteristics of


intangible artifacts. Thus the bookstore effect favors a supplier
concentration as consumers tend to use a supplier with a largest choice.
Sharing leads to network externalities: the value of a given artifact is
enhanced by the number of other consumers using it. Large networks tend to
grow larger, at the expense of smaller networks. The joint and nondestructive (repetitive) nature of intangibles consumption entails what Brian
Arthur, Stanford economist and a leading proponent of the increasing returns
theory, calls the lock-in effect: once a user is committed to a given
technology and accumulates artifacts which depend on it, the cost of
switching becomes very high. A supplier who manages to impose his
technological standard, whether it is VHS for Matsushita or Windows for
Microsoft, locks in consumers and grabs practically a 100% market share. For
Brian Arthur, the combination of lock-in effect and increasing returns not only
leads to monopolistic concentration but also threatens technological
progress. This implies the need for government intervention, such the US
Department of Justice restrictions on the activities of Microsoft (Arthur, 1995).
And yet, there are clearly countervailing forces at work. The cardinal one is
the shift of the market power to the consumer. Wider availability of
information and lower transaction costs eliminate information asymmetry and
drastically lower the search costs. It also reduces the incentive for vertical
integration (Huber, 1992). It is the consumer who acquires the integration
capability. The rapid pace of technological innovation and the capriciousness
of demand limit the lock-in effect and favor the emergence of new product
families and market segments, which offers scope for new entrants and for
the supplier hierarchy reversal. Ultimately, the reduction of supplier
monopoly power comes not from increased competition in the existing
segments or from government intervention but from the creation of new
markets.
So far, the intangible economy has demonstrated an enormous capacity to
sustain innovation and to generate new markets. There is no reason to doubt
its continuing ability to do so.
The dematerialization logic, the underlying logic of the intangible economy,
affects all economic relationships and profoundly transforms the ways firms
and markets are organized and transactions are carried out; it induces
important changes in the nature of the firm and the process of value creation,
the organization of production and market structure.
The result of those changes has been an increase in competition at all levels,
and the need to define new strategies in order to adapt to such changes.
In many industries, the increased competition has induced firms to adapt
strategies to protect their market power- increasing the differentiation of their
product, by increasing product renewal and by personalizing products.
The product has therefore become more complex, in the sense of having a
higher knowledge content.. As shown in the following figure, along the
production process, this means that the knowledge-intensive phases of
production have become more important.

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At the firm level, such changes have meant new governance forms, new
organization, indeed a change in the very nature of the firm. The vertically
integrated firm may no longer be the best form of governance of the
production process.
In order to produce products with high knowledge content, knowledge
management within the firm becomes crucial. In such a context, the aims of
knowledge management are twofold: (i) collect and process as much
knowledge as possible on markets, technologies, etc, and (ii) create
knowledge. For both objectives the organization as network is more
effective.
The network exists not only within the firm (decentralization and flatter
hierarchies), but also between the firm and its environment, since networks
are created for production (with suppliers) and also for innovation.
The network that is external to the firm concerns relationships with suppliers
(see the vast literature on suppliers networks in the car industry, such as
Asanuma, 1989, Chanaron and Lung, 1995, Boyer et al., 1998) but also
relationships with competitors in order to jointly perform R&D activities or
even to develop products.
Concerning supply networks, the single firm no longer carries out all activities
of the production process within its boundaries, but rather outsources some
of its activities to external firms, at various stages of the production process.
As a result, the overall production organization is realized by a network of
firms.
In fact, outsourcing appears as a strategy complementary to internal
decentralization and is well fitted to the objectives of management and
creation of knowledge for product differentiation.
Each firm in the network specializes in a part of the production process and
develops high competence and a mastery of the knowledge relevant to that
particular activity, while the membership of the network ensures the coordination of the various activities.
The large, vertically integrated firm primarily relied on the ownership of
highly specialized assets (assembly lines, machinery, etc.) with human
capital tied to these assets, in order to gain market power and create value.
The ownership of such assets was the major source of power in the
corporation; the boundaries of the firm were clearly defined by the ownership

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of such assets; as a result, the key issue in the firm was the separation of
ownership and control and economists focused their analysis of the firm on
this issue. As Chandler (1990) argued, the primary advantage of the modern
business enterprise was its scale and scope.
In the new firm, power is distributed differently than in the vertically
integrated firm. In the past, the ownership of the firms valuable resources
was concentrated in the hands of the shareholders, the owners of the
company. The current situation is different: the valuable resources are
distributed among different actors: employees, who bring their human
capital; suppliers, with innovative or other capacities; and so on.
In these conditions, the determinants of market power are no longer low
costs and firm size, but rather the ability to manage networks: this is the case
of Nokia, Microsoft, Gucci, LVMH and a number of automobile manufacturers
The relevant unit of analysis in the study of firms competitiveness should
therefore be the network of which the firm is part, rather than the
single firm. The objective of the firm is to manage and create knowledge in
a network, in order to differentiate and frequently renew products and gain
the loyalty of customers. The ability to organize and control a network
therefore appears as a key determinant of competitiveness.
The firm continues to be the basic repository of property rights, strategic
management and accumulation of capital. However, business practice is
increasingly a function of ad hoc networks whose expertise is solicited for the
achievement of specific business project goals. In terms of its internal
organizational structure, the network enterprise is characterized by several
main trends:
- its organization is structured around process, not task;
- it has a flat organizational hierarchy;
- the work process is organized on the basis of teams;
- customer satisfaction is the primary measure of business performance;
- the structure of reward is based on team performance
- the maximization of contacts with suppliers and customers is an integral
part of the business process
- information and continuous training of employees at all levels are
considered critical to business success

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