Wednesday, May 29, 2013

Intangible Asset ROI Needs Clear Attribution

I recently read a proposed calculation method for the ROI of a public company's intangible assets.  It advocated simple division of net income into the sum of goodwill and other intangibles to find "intangible asset ROI."  I've seen variations of this calculation elsewhere, so I wonder if it's gaining traction.  It looks easy, but my gut tells me nothing in business should be that easy.

I disagree with that method for two reasons.  First, the entire net income of a corporation is attributable to the application of all of its assets.  Calculating ROI means breaking out how much of the income from all business segments is directly attributable to intangible assets.  Using the brute-force method above will lead to wild conclusions.  Consider a fast-food conglomerate whose intangible assets consist of the brand and menu recipes.  If it acquires another chain of restaurants, the new goodwill from the acquisition will push the "intangible asset ROI" down for the year.  Faulty decision-making will follow if executives decide that intangible assets aren't delivering value.  A company with little IP but lots of plant and equipment would portray an absolutely whopping intangible asset ROI by using this method.  Furthermore, goodwill can be impaired, which would invalidate any assignation to intangible assets until the impairment is resolved.

Even companies that are presumably heavy on intangibles can't deliver value without fixed assets.  Social media companies need server farms.  Entertainment companies need video production facilities and broadcast studios.  Analysts and executives looking to unlock value need to probe financial statements to see just how much income is attributable directly to intangible assets.  Not every reporting company breaks down revenue attribution to asset categories the way they do for strategic business units.  That's why finding the ROI for intangibles is just so dog-gone intangible.