Capitalism Without Capital -The Rise of The Intangible Economy

My Latest Book Read : Capitalism Without Capital -The Rise of The Intangible Economy by Jonathan Haskel and Stian Westlake 

Authors of this book - Jonathan is professor of Economics at Imperial College London and Stian is a senior fellow at Nesta. 

The premise of this book is simple : in nineteenth and twentieth century capitalists owned  factories and workers supplied labor , now a lot of things changed, now most of the assets are intangible, this has changed the way industries and businesses function. In most of the businesses investment in intangible assets now exceeds that in tangible assets. The authors argue that these assets are fundamentally different from tangible assets because of the “four S’s”: scalability, sunkenness, spillovers, and synergies. These properties combine to produce greater uncertainty in the value of intangible investments. For companies looking to fund these investments, the authors’ argument favors equity over debt and private equity over public. 

This book is an interesting read, but interpreting many lessons is a challenge. 

Microsoft is an interesting example , it was the most valuable company in the world in 2022 , worth US$365 billion. On its balance sheet were traditional assets of are just 1% of its market value. The balance of the value was made up of product design, the ideas generated through its research and development program, its brand, global supply chain and internal structures, and human capital built up through training.

Corporate investment is increasingly in intangibles. 

Authors have given another example of fitness business. A gym these days looks similar to Gold’s Gym in Venice Beach, Los Angeles, established in 1965 and featured in Arnold Schwarzenegger’s 1977 breakout movie, Pumping Iron. But if you sign up for a BODYPUMP class, you are powering the intangible economy. The programs are designed and owned by Les Mills International, a company in New Zealand. In 2005, these classes were available in 10,000 venues, in 55 countries, with an estimated 4 million participants a week.

This is not simply an IT story. “The rise of intangible investment,” the authors note, “began before the semiconductor revolution, in the 1940s and 1950s.” Software and data processing are part of the story, but it also includes the growth of brands, as well as organizational innovations (e.g., kaizen lean production techniques at Toyota and Six Sigma quality control at General Electric). Today’s successful manufacturing businesses are those that have invested heavily in intangible assets.

Intangible investment comes in three forms:

1. Computerized information, such as software

2. Innovation, including research and development

3. Economic competencies, including branding, the organizational capital built into distinctive business models, and training

The heart of the book is an explanation of the “four S’s” that differentiate intangible investments: scalability, sunkenness, spillovers, and synergies. All four can be illustrated by the story of how EMI used the proceeds of the Beatles’ record sales to develop the CT scanner, only to watch GE and Siemens turn its invention into a commercial success.

1. Music rights are scalable. Beatles records could be pressed again and again at minimal cost.

2. When EMI pulled out of the CT scanner business, it recouped very little of its investment in R&D, specialized knowledge/expertise, and brand because of the sunkenness of these costs.

3. Where EMI failed, GE and Siemens were able to use the technology developed by EMI and build successful businesses. They benefited from spillovers.

4. Intangibles become more valuable when combined. The development of the scanner came from the cauldron of EMI’s research on computing, imaging, and electrical engineering, combined with the expertise of doctors. Such synergies are often both large and difficult to predict.

These four properties combine to produce two more general characteristics. First, there is greater uncertainty about the value of intangible investment compared with tangible investment. The combination of sunkenness and spillovers may mean the investment will yield nothing, as in the case of EMI. Alternatively, the combination of synergies and scale can lead to unexpected success, which creates option value for the owners of intangible assets.

Second, intangibles tend to be contested. As the authors explain, “People and businesses will often vie to see who can control them, own them, or benefit from them.”

What are the implications of the foregoing for investors? Intangible assets are more readily funded by equity than by debt. When things go wrong, intangible assets offer little in the way of collateral value. Most developed countries’ tax systems, however, favor debt over equity.

Furthermore, intangibles’ option-like quality makes them a good fit for private equity funding, with the flexibility to draw down capital when it is required. For example, the distinct stages of biotech development mean companies need to go back to capital markets again and again.

In addition to funding, venture capital firms in Silicon Valley provide “informal links between portfolio companies, allowing them to exploit the synergies of intangibles.” These links are an ingredient in the persistence of performance of the best venture capital firms.