Using System Dynamics ILEs in service business interventions
to support Intellectual Capital Planning
Carmine Bianchi “’, Enzo Bivona “”
Abstract
Modelling knowledge in SD organisational interventions may become a puzzling task because of difficulties in
achieving a common shared view among business key-actors about the impact of Intellectual Capital (IC) investments
on future company performance.
Such difficulties are not only related to the intangible nature of IC, but also to the indirect role of knowledge in
affecting performance drivers and outcomes. This phenomenon is particularly relevant in service businesses, where
intangibles account for a high percentage of total assets.
In order to overcome such problems, a conceptual framework has been developed by the authors to build a generic SD
model aimed to support business decision makers in IC planning, with particular regard to serv.
Such model has provided the basis for developing two ILEs focused on a telecom mobile service provider and an
insurance company. The first application was related to an education project, while the second one was linked to a
consulting assignment.
The use of a conceptual framework as a basis to build an ILE has proved to be a successful strategy in order to better
communicate business key-actors the potential of SD in modelling and assessing IC policies.
Main key-issues underlying model development and the ILEs’ application are discussed in the paper, and most
significant outcomes from simulations are commented.
Introduction
Why may the market value of a firm be significantly higher than its book value? What are the
primary causes of success for a company against its competitors? How can one explain that firms
relying on large capitals are likely to achieve a lower performance, compared to those competitors
having limited financial resources? What are the reasons of the sudden collapse of those businesses
identified as “pillars” of the economy, given their perceived strong profitability and image?
To answer the above questions a helpful concept is that of intellectual capital (IC). IC refers to a
knowledge system that can be both related to the individuals working in a firm, and to the business
organisation itself. IC originates from investment policies, whose main levers are referred to hiring,
training and organisational expenditures.
IC expenditures are often budgeted on incremental basis and conceived as discretionary costs. They
are usually planned without a closer look on the impact they will be able to generate on the future
business performance during planning time horizon (Ornati et a/, 1982; Tyson & Fell, 1986).
Conventional accounting performance measures are likely to cause managers to act myopically in
planning such expenditures. Holding decision makers accountable for only short-term earnings or
returns may induce them to reduce or postpone IC expenditures, even though they could promise a
© Full Professor of Business Management, University of Palermo (Italy), Faculty of Political Sciences, Director of
CED‘ System Dynamics Group, bianchi@unipa it, http://www.unipa.it/~bianchi - www.ced4.it
© Assistant Professor in Business Management, University of Palermo (Italy), Faculty of Political Sciences, CED‘
System Dynamics Group, Master Phil. in System Dynamics, University of Bergen (Norway),
enzobivona@sciepol.unipa.it
positive net present value. Such behaviour has been defined as investment myopia (Merchant, 1998,
p. 460).
The above problems are relevant in the management of business knowledge, as the responsibility
centres focused on the development of human and organisational resources are often oriented only
on current and bureaucratic, rather than strategic, issues (Tyson & Fell, 1986, p. 7-29; Matthis &
Jackson, 1984, chapters 1 and 2).
This paper proposes a shift of focus in defining the role of the Personnel/Organisation unit.
Particularly when the firm operates in a business where knowledge is a main driver of success, such
a unit can play a crucial role in the planning process. Adopting a strategic approach in IC policies
implies other units are involved in reasoning about effects IC expenditures will generate on business
performance over time.
In order to foster such a change in perspective and to tackle myopic behaviour in IC management, a
methodological framework for assessing IC is provided to support decision makers in evaluating the
short and long-term effects of their policies.
IC is likely to be assessed in both monetary (likewise other tangible assets commonly included in
financial statements) and non-monetary terms (Stewart, 1997, p. 222-246; Sveiby 1997; Edvinsson
and Malone 1997). Its monetary evaluation is usually done according to different approaches, such
as: cost (Flamholtz 1985), market (Friedman and Lev 1974), and income (Reilly and Schweihs
1998). Furthermore, other “hybrid” methods have been proposed by the literature (Tobin 1969;
Stewart 1997).
The approach adopted in this paper for IC monetary assessment combines both the cost and income
method. We propose to assess IC according to its potential impact on the future company
performance in achieving a sustainable growth. We also remark that such a monetary evaluation
must be combined with a non-monetary assessment, to provide a conceptual framework aimed to
explore the impact of IC expenditures on business strategic resources, drivers and performance
indicators.
According to this perspective, a dynamic feedback view of IC accumulation and depletion processes
allows one to support the management of human and organisational capital development in a
planning setting.
This paper shows how such processes have been embodied into a generic SD model, tailored to the
context of service firms, where knowledge usually plays a crucial role for the business success and
continuity. Such model has provided the basis for developing two ILEs focused on a telecom
mobile service provider and an insurance company. The first application was related to an education
project, while the second one was linked to a consulting assignment.
The paper is divided into three main parts.
In the first part, an analysis of the IC concept and a framework for its assessment are outlined.
In the second part, the structure of a generic SD model describing IC accumulation and depletion
processes and their relationships with key-intangible assets in a service business is discussed.
In the third part, an analysis of two ILEs based on the generic SD model is done, with particular
reference to: 1) the structure of the two simulators, 2) main feedback loops used in debriefing
simulated results; 3) what players can learn from scenario analysis in a planning context.
The concept of Intellectual Capital
The concept of “Intellectual Capital” is related to those expenditures aimed to improve the
capabilities of people and the organisation to understand, to learn, i.e. to better frame the system
where decisions are made, to attain a performance increase.
Without learning, leading to a significant knowledge stock, a firm is not able to develop strategic
assets (Amit and Schoemaker, 1993, p. 36-37; Kogut and Zander, 1992, p. 384-387). Hence, IC is
as a primary strategic asset for the acquisition and deployment of others, to foster business growth.
Organisational routines and the interaction processes between the firm and its relevant environment,
combined with the existing stock of knowledge (i.e. IC), will be likely to build up other strategic
assets (e.g. product portfolio, distribution channels, customer base, image) (Kogut and Zander,
1992, p. 384; Dierickx and Kool, 1989, p. 1508; Morecroft 1997).
The concept of knowledge is not only referred to individuals’ or business’ know-how, i.e., the
attitude to find proper means to achieve pursued goals. It can also be related to other two
dimensions: the what and why. The concept of know-what refers to the attitude to detect specific
subjects or issues on which to be focused (Kogut and Zander 1992). The concept of know-why is,
instead, referred to the understanding of cause and effect relationships between issues and events
related to business performance, as a result of a learning process which shapes the way of thinking
of individuals and the company (Quinn et a/. 1996; Nonaka 1991) "
} According to the literature, IC not only consists of human capital, but also relates to structural and organisational
capital. The first one results from the process of individual knowledge elicitation, in order to act on human capital as a
lever to build up business knowledge (Edvinson and Malone 1997). The second one, relates to investments in
organisational and information structures, and procedures, to improve decisional capabilities of the firm. The third one,
relates to investments aimed to build strong and long term relationships with external counterparts (e.g. customers,
suppliers, competitors) to give rise a shared knowledge system, which may relate to products, information, distribution
systems, etc. (Stewart 1997).
The above said perspective shifts the focus of analysis from the concept of intellectual property —
associated to the acquisition of patents, trade marks and other intangibles usually posted in a
financial statement — to that of intellectual resource, i.e., a production factor profiling a capability
to frame the relevant system and make proper decisions. This view suggests that IC cannot be
defined as a physical resource (or a “sum” of different physical assets), which can be financially
measured and posted in a financial statement. It is, rather, a system of intangible resources
providing the company with a know-how, know-what and know-why.
This paper aims to demonstrate the powerful role of SD modelling in helping planners to focus not
only on the assessment of IC value, but also on understanding the impact of IC investments on other
strategic assets, performance drivers and outcomes.
A conceptual framework for IC assessment
The conceptual framework used by the authors as a basis to build a generic SD model for IC
planning in service businesses combines a non-monetary with a monetary assessment. The former
tries to capture the impact of policies implying IC expenditures > on those strategic resources
embodying knowledge, which in turn affect drivers and outcome performance indicators. The latter
aims to define in monetary terms the synthetic value of company knowledge, based on the indirect
effect of IC expenditures on future financial results.
In order to assess IC, it is not proper to add up single components, such as: human, structural and
customer capital (Stewart 1997). In fact, they are an attribute of the whole business system, rather
than well identified resources. This makes illusory any attempt to assess IC as a sum of the three
above components’.
A framework for such analysis is provided in figure 1, depicting the building blocks for a combined
IC monetary and non-monetary assessment, referred to a generic service business.
> It is worth remarking that financial expenditures on IC do not necessarily cover the domain of organisational
knowledge. This last concept also embodies learning processes resulting from the current fulfilment of company
routines and procedures. However, in this paper a narrower concept of business knowledge will be adopted, being
referred to those capitalised financial expenditures budgeted by the firm in order to improve its own knowledge system.
> “Edvinsson and Malone (1997, p. 187) propose that intellectual capital is the arithmetic mean of all capital
components in play” (Joia 2000, p. 72).
1 |:
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(nese Know-how - Know-what - Know-why| aril
capital ‘Monetary value performance
expenditures
Inteliectual Capital
monetary assessment
FIGURE 1 - A conceptual framework for a combined IC monetary and non-monetary assessment
Figure | shows how different primary strategic assets embodying business knowledge are built as
an effect of IC policies (hiring, training, organisational and information systems investments).
If we refer to service firms, knowledge affects performance drivers, such as customer response time
and innovativeness, which in turn determine customer service, time to market and “product”
portfolio quality. The above drivers lead to four synthetic outcome measures, such as sales
revenues, operating income, ROI and market share.
Based on the non-monetary framework commented above, the lower section of figure 1 shows the
rationale of the adopted monetary method for IC assessment. To sketch an IC plan, a desired ROI
on IC expenditures must be set. If one multiplies IC expenditures by the desired ROI, it is possible
to determine the desired IC investment productivity in monetary terms, i.e., desired delta
performance.
The ratio between the actual delta performance (in terms of both operating income and
investments) and the desired one provides what we call performance ratio. Such ratio is a synthetic
expression of the percentage of IC expenditures that one can capitalise each year t,
Provided that IC assessment is done in the model in a planning context, we need to calculate each
year the net present value ° of:
a) IC expenditures;
5) Actual delta performance;
c) Desired delta performance.
An example of such an assessment is provided in table 1.
Simplified Intellectual Capital plan (All values are in Eur/.000)
Year 1 Year 2 Year 3 Year 4
1 IC expenditures (*) 400 400 400 400
2 Cumulative IC expenditures 400 800 1200 1600)
3 Delta Performance (**) 32 60 80 88
4 Desired ROI on IC expenditures 0,10 0,10 0,10 0,10
5 Desired Delta Performance (2 x 4} 40 80 120 160
6 Discounted ratio 0,10 0,10 0,10 0,10
7 Discounted factor 1,10 1,21 1,33 1,46
8 Discounted IC expenditures (1 / 7) 363,64 330,58 300,53 273,21
9 Discounted Delta Performance (3 / 7) 29,09 49,59 60,11 60,11
10 Discounted Desired Delta Performance (5 / 7) 36,36 66,12 90,16 109,28
11 Performance ratio (9 / 10) 0,80 0,75 0,67 0,55
12 Capitalised Discounted IC expenditures (8 x 11) 290,91 247,93 200,35 150,26
13 Initial Intellectual capital 500,00 740,91 914,75 1.023,63
14 IC obsolescence rate 0,10 0,10 0,10 0,10
15 IC obsolescence (13 x 14) 50,00 74,09 91,48 102,36
16 Intellectual capital (13 + 12 - 15) 740,91 914,75 1.023,63 _1.071,53
(*) {fis assumed that annual IC expenditures are sustained on a quarterly basis.
(**) It is assumed that invested Capital in operational activities will not change during the planning period.
TABLE | — A Simplified Intellectual Capital plan
Based on the above remarks, the adopted method tries to match the cost and income approaches to
provide a monetary assessment of IC.
The above method was shared by the authors with the business clients, which were in both cases the
Directors of Organisation units and their staff. Main critical issues which emerged from discussion
about the method were about:
* The suggested method for IC monetary evaluation is focused on the capitalisation of IC expenditures. For prudential
reasons, although the productivity of such expenditures might lead to a very high return, implying a performance ratio
greater than one, the maximum values of capitalised IC expenditures cannot be higher than those actually sustained by
the firm.
* In order to prudentially assess IC, the discount rate should be the highest between that which is related to the specific
risk on invested capital and the average interest rate on borrowed capital. The reason for choosing the highest value is
that the discounted ratio must take into account both the operating and financial risk on invested capital. The higher is
the business risk the higher will be the discount rate, which will lead to a lower IC monetary value.
1. the relationships between IC expenditures and IC value;
2. the indirect relationship between IC expenditures and business performance;
3. the relevance of the performance ratio for assessing IC expenditures productivity;
4. the relevance of the planning time horizon according to which the impact of IC
expenditures on business performance is assessed;
5. the relevance of both the discount rate and the desired ROI on IC expenditures.
Concerning the first issue, it was remarked that though IC value may also depend on policies which
do not imply any expense, a causal relationship can be found between IC expenditures, business
performance and therefore IC value. Consequently, the adopted method is focused on only
monetary inputs.
Concerning the second issue, it was outlined that that, although the relationship between IC
expenditures and performance is indirect, without a significant knowledge stock a firm would not
be able to build other strategic assets, leading to an improvement of drivers and outcome measures.
It was suggested that such method does not pretend to give an exact value of IC. It only aims to
outline a meaningful range of IC expenditures that could be capitalised. Therefore, this value is not
assessed in order to be posted in a company financial statement. The main reason to estimate it is,
instead, to support a learning-oriented planning process, to foster communication between the
Organisation function and other units which will exploit the knowledge potential of the firm.
About the third issue, it was remarked that although the above synthetic performance indicator is
only related to a monetary parameter that is associated to profitability, other performance measures
are captured in the non-monetary framework for IC assessment, depicted in figure 1.
Regarding the fourth issue, it was underlined that a too short time horizon could originate
managerial myopic behaviour. In fact, in order to overcome poor financial results, managers could
irrationally reduce expenditures leading to the acquisition of other strategic resources (e.g.,
production capacity, distribution systems, patents). Although this policy would be likely to keep
profits on a desired standard in the short term, on a longer time horizon it could prejudice company
competitiveness and profitability. Therefore, in order to capture such phenomena, the planning time
horizon must be long enough to detect them, and cannot be pre-defined. It must be calibrated
according to the decided investment policy and the characteristics of the industry where the firm
operates.
The same remarks are also relevant about the setting of both the desired ROI and the discount rate.
The conceptual framework for IC assessment discussed above is likely to support a basic
understanding of policy levers impacting on business knowledge and effects produced on drivers
and outcome measures. However, a deeper comprehension of knowledge accumulation and
depletion processes over time can be fostered if a SD perspective is applied to the static framework
depicted in figure 1.
Based on such framework for IC assessment a generic SD model was built by the authors to support
a learning-oriented planning process for IC expenditure in service businesses.
A dynamic feedback view of IC accumulation and depletion processes
By focusing stocks and flows affecting business strategic assets’ dynamics, SD is adopted to frame
and manage systems that are characterized by complex cause-and-effect relationships (Bianchi and
Bivona, 2002). This is the case of IC accumulation and depletion processes.
To move from a static to a dynamic view of such processes, aimed to better support the
Organisation unit in IC planning, the causal relationships among main business variables affecting
IC dynamics were analysed through group model building sessions. Each session involved the
director of the Organisational unit and three collaborators. Once sketched the main stock and flow
structure of the SD model, the behaviour of key variables was validated by using company past
data.
Figures 2 and 3 show a simplified view of the main structure of the model built by the authors,
based on two pilot service businesses, operating in the telecommunication and insurance industries.
The SD model provided the basis for an ILE that will be analysed in the last part of this paper. The
above figures portray the stock and flow model variables impacting on both the human resource
knowledge index and organisational structure index. Both indexes are the two synthetic non-
monetary measures for IC assessment previously illustrated in figure 1, mentioned as know-how,
know-what and know-why. The above two measures impact on main business drivers and
performance indicators.
As figure 2 shows, the dynamics of the company human resource endowment has been modelled as
an aging chain, portraying in sequence: new hired, in training personnel, trained employees and
experts e
® A different stock and flow analysis of the company skill resources has been provided by Winch (2001), Hafeez and
Abdelmeguid (2003) and Warren (2002, p. 207-224).
TRAINING
“> PROGRAMME ~ ~ ~ ~
EMPLOYEES’ LENGTH ~s
PRODUCTIVITY
HIRING
POLICY
!
[e)
Herlgnaep Resignation | Resignation /
Ps AS i af /
t s / ¢
; via yi
TIME TO aoe 2 here -
TRAINING me ENG:
PROGRAMME
< TRAINING SS om
PROGRAMME
LENGTH > Sie Obsolescence Obsolescence
time
FIGURE 2 - A simplified picture of the model stock-and-flow structure affecting
the human resource knowledge index
The company hiring policy affects the first stock. The outflows of this stock are affected by the
average time to start training programmes for new hired personnel. This influences the number of
people going to an “in training” stage and also affects the number of new hired employees who
decide to resign. In fact, if this time is too short (if compared to industry practice), the resignation
rate increases.
The average training programme length affects the outflow of people in training into the stock of
trained employees. The shorter is such period, the higher the outflow will be. However, a too short
training programme length (if compared to the industry standards) is likely to reduce human
resource productivity and, consequently, customer service.
The same reasoning is relevant for the “retraining” of trained employees and experts. Furthermore,
it was remarked a relationship between the time to start retraining and employees’ turnover. In fact,
this increases if the mean time between two education programmes is longer than the industry
standards.
An aggregate measure of human resource knowledge is provided by a stock index, whose inflow
(learning) is triggered by a co-flow associated to the number of employees moving from a level to
the next, being each one characterised by a different potential.
At the same time, the human resource index level is dissipated by an obsolescence outflow,
associated to the human resources resignation rates and a normal obsolescence time.
i
EMPLOYEES’
PRODUCTIVITY
= | CUSTOMER SERVICE
ORGANISATIONAL
STRUCTURE
INVESTMENTS
_
N
~
Organisational / Sacer
structure index increase
Obsolescence
TIME TO MARKET time
PRODUCT EMPLOYEES
PORTFOLIO RESIGNA Pi TON
TRAINING
PROGRAMME
LENGTH
HIRING Learnin
POLICY ~~ Learning Obsolescence Obsolescence
time ~___7
FIGURE 3 - A simplified picture of the model stock-and-flows affecting the organisational
structure index and performance drivers
Figure 3 shows how the organisational structure index is affected by an inflow triggered by
company investments and decreased by an obsolescence rate which is related to different internal
and external factors (e.g. technological progress, competitors innovation).
Both human resources and organisation structure indexes are likely to influence the three main
performance drivers previously depicted in figure 1, i.e. : time to market, product portfolio and
customer service.
An analysis of cause and effect relationships between IC policies, performance drivers, and other
strategic assets, financial performance and IC policies is depicted in figure 4.
10
Figure 4 shows how the above three performance drivers impact on company image, which affects
the change in customers. The customer base, in turn, influences sales revenues, operating income
and liquidity, which can allow the firm to sustain an IC growth policy (R1, R2, R3).
To what extent such policy can be sustainable?
Understanding the dynamics of IC monetary value can be helpful to answer this question.
On this concern figure 4 shows how the operating income affects the performance ratio. According
to such ratio, the firm will be able to capitalise IC expenditures.
The higher is the performance produced by IC expenditures, the higher capitalised IC expenditures
will be.
The figure also shows how the IC stock is also affected by an outflow that is associated to business
knowledge obsolescence, which may depend on physical/technical issues (Knott et al. 2003, p. 193-
194) or shifts in the industry dominant logic. Such a phenomenon represents a limit to knowledge
growth (see balancing feedback loop B1) 2
Figure 4 also depicts a small reinforcing feedback (R4). The effects it produces can be significant if
the firm — e.g., relying on a satisfactory level of the current IC stock — strongly reduces its annual
budgeted IC expenditures. Such a myopic policy can generate in the short term illusory increasing
returns, in terms of performance ratio on IC expenditures. In fact, a lower stock of cumulative IC
expenditures will reduce the desired delta performance (given a desired ROI). This will increase the
performance ratio * and, consequently, the flow of capitalised IC expenditures. However, in the
medium-long term, the effects produced by such loop will become weak. In fact, the above
commented limit to IC growth, underlined by the draining effects generated by the obsolescence
rate, will gradually reduce the level of IC monetary value. This could imply structural problems in
the strategic capability of the firm to foster future growth.
It is worth remarking that the effects generated by obsolescence are difficult to perceive by decision
makers, due to the inertial depletion of IC. Quite often, the human mind or information systems are
unable to promptly capture such effects (Sterman 1994, p. 299-302), which become evident only
when it is too late to timely recover a satisfactory level of company knowledge.
7 A second limit to IC growth, which is not made explicit in figure 4, but is embodied in the SD model developed by the
authors, is given by the likelihood that the positive loop enhanced by the increase of other strategic assets affecting
company performance, can continue to be dominant. In fact, as far as IC monetary value reaches a threshold level,
related to an available technology, the productivity of further IC expenditures declines. This may reduce the
capitalisation of IC expenditures.
* In fact, desired delta performance is the denominator of the performance ratio.
11
HR Knowledge and
Organisational
structure indexes
cn Customer
/ IC policies A [ come J =S=
Delta
Liquidity
Delta
— Cumulative IC Z IC monetary Customers
— expenditures O value [—
IC expenditures IC increase Ic
B1 Obsolescence
Desired ROL R4 rate
on IC .
Investments Desired Delta
"i Performance Performance
Operatin:
eee 2 “~—_>_ ratio Sales
—_ TT “
FIGURE 4 - Main relationships between IC and other strategic assets underlying a service business
An ILE embodying an SD and accounting model to support IC management in a planning
setting: an application to a telecom and insurance firm
The conceptual framework depicted in figure 1 and the feedback stock-and-flow structure described
in the previously figures 2, 3 and 4 have been used by the authors to build an ILE, that was
customised to two firms operating in the telecom and insurance industries.
The first context allowed the authors to experiment and tailor the generic SD model ° in an
educational setting, to involve the Organisation and other units into a learning-oriented planning
process, according to which IC expenditures are conceived as developmental, rather than
discretionary, costs. A learning-oriented planning process is likely to improve communication
between different decision makers, to detect weak points in the currently adopted budgeting
methods and performance indicators, to overcome myopic behaviour in IC planning.
° Model equations are available from the authors on request.
12
The second context allowed the authors to apply the ILE as a supporting planning tool in an
insurance firm.
Figures 5a and 5b show the main feedback loops related to the two analysed businesses, resulting
from group model building sessions conducted to customise the generic SD model structure
previously commented (see figures 2, 3 and 4).
LZ ie Se
serwonk oguart < Samer (R2)_— wworarrvess
rd (1) a \
PES. (R3,
ais (
cusroser UMAN
BASE RESOURCES
KNOWLEDGE
cams (RS) wxxe aad
f ~ 1 3)
A. RESOURCES
_ (RS) sae Bue
weg
Na ee 7 @ i mage
APPRAISERS _
INVESTMENTS
NA ee 7)
TRAINING
INVESTMENTS.
Figure 5a — Main feedback loops related to the Figure 5b - Main feedback a related to the
telecom mobile service provider insurance company
Figure 5a shows how hiring new employees allows a telecom mobile service provider to improve
time to fix customer requests and customer service. This contributes to increase company image and
customer base. Further, a larger customer base is likely to generate two effects.
On the one hand, it increases sales revenues, which provide more financial resources to be invested
in:
- training, that boosts the human resource knowledge index and, as a consequence, improves both
time to fix customer requests and the level of service provided (see feedback loop R1 in figure 5a);
- organisational structure.
An improvement of the organisational structure is likely to trigger innovativeness and two
important performance drivers of company growth, such as plan flexibility and time to market. This
is also likely to enhance company image, which in turn enlarges the customer base (see reinforcing
loops R2, R3 and R4 in figure Sa). Such growth could be also fostered by network investments,
(e.g. systems, antennas) which would improve company local coverage. This would imply an
enhancement in company image and — other conditions being equal — customer base (see feedback
loop R6 in figure Sa).
On the other hand, however, a larger customer base could generate bottlenecks in providing
customer services, due to a given available labour force. Such a phenomenon is captured by the
13
model through the balancing loop B1 portrayed in figure 5a, which links customer requests to
service as a result of time to fix customer requests. Hiring new employees is likely to
counterbalance the above limit to growth (reinforcing loop RS in figure 5a).
Figure 5b shows the same feedback structure described above, referred to an insurance company
operating in the non-life market segment. In particular, in this context a higher customer base
increases — other conditions being equal — the number of claims. A growing number of claims tends
to increase the average time to process them, if neither staff (appraisers) nor its skill are increased in
the short run. This reduces the level of service provided to customers, and deteriorates company
image. As a consequence, customer base decreases (see loop B1 in figure 5b). In order to restore the
desired level of customer service, the firm may hire new damage appraisers and/or train them more
intensively (see loop RS in figure 5b).
An ILE (continued): the main sectors of the ILEs’ structure
The two ILEs developed by the authors consist of five main sectors:
- a guided introduction, including the concept of IC and the problem context. In the first
application (telecom) this was also supported by a case-study aimed to raise relevant debating
points for class discussion and group simulation;
- an input window, which allows the user to customise the simulator, according to different issues,
such as: the initial number of employees in each training stage (classroom vs. on-the-job
training) or knowledge level (trained vs. expert), normal training programme length in the
industry, normal organisational investments obsolescence time (see figure 6a);
- acontrol panel embodying main policy levers and scenario options. As it is possible to see from
figure 6b, the control panel includes four main parts: 1) a list of navigation buttons, which allow
the user to have easily access to different ILE’s windows (i.e., inputs, income, financial and
cash flow statements, IC monetary and non-monetary assessment graphs, and business case-
study); 2) policy levers, ranging from employees to be hired each month, frequency and length
in training programmes related to the different employees skill levels, organisation and network
investments; 3) a set of different scenario buttons, including: market growth rate, customer
mobility (churn) from a company to another, competitors attractiveness; 4) main graphs and
indicators (products, HR knowledge index, company and competitors customer base, market
share and employees) aimed to give the player a first insight on the dynamics of strategic
resources. Through the control panel, users can make their decisions twice a year '°, over a four
years planning time horizon;
- reports including financial, income, and cash flow statements, as well as an IC monetary
assessment;
- graphs including main variables related to IC monetary and non-monetary assessment !,
'° The reason for choosing a six month period to set company IC policies is related to the need to replicate in the ILE
the practice followed by firms, in our experience, in reviewing their IC plans.
" The time unit of graphs is days.
14
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TEE classroom waining programmes (3y5)?
| papeceerncnyrasneratn as ent experince amoeyes
irs)? (2 Tinteroom rang proramnes? ry
Figure 6a — The ILE input window (telecom Figure 6b — The ILE control panel (insurance
application) application)
An on-line help is available for users in order to provide them the meaning of different variables
displayed in the ILE.
In order to better support learners to perceive relationships between different model sub-systems
and understand effects generated by their IC policies over time, a set of window messages has also
been designed. Such window messages are mainly oriented to let users know about customers
complains on company service, emerging difficulties in business liquidity and available equity, and
the failure of their policies due to financial reasons, or a too low service provided to customers.
In the following section the results of two scenarios related to the telecom mobile service provider
(Nextcel) and the insurance company (Non-life Insurance Spa) 2 will be commented.
An ILE (continued): an analysis of two simulation scenarios in a telecom mobile firm
Through facilitated simulation sessions (Vennix 1996), users are supported to understand the hidden
feedback structure of the relevant system and to envisage what changes could be made to the
system’s structure, through different policies, in order to affect key-variables’ behaviour (Davidsen
1996). To this end, different small groups of 2-3 participants are built to work together and discuss
IC policies to adopt and analyse their effects produced over time.
In order to repeat past simulations, to analyse them or change some choices according to the
working hypotheses that emerge through group discussion, the ILE allows players to record their
” The names of both firms have been disguised.
15
own decisions on a text file. During the small group discussion, players are also asked to distinguish
stock and flow variables and sketch feedback loops related to observed behaviours from adopted
policies. An important issue on which their analysis is focused by facilitators is about processes
fostering or tackling business growth.
Scenario 1: a myopic IC policy
The first scenario implies a medium customer mobility (about 2.5 years), and a high attractiveness
for competitor B, and medium for competitor C.
According to this scenario, Nextcel monthly hires 30 employees on average.
In order to face the sharp annual market growth rate (35%), new hired personnel is primarily
allocated to deal with daily customer requests. This increases the average time to start training
programmes for new hired from 10 (i.e. the industry standard) to 30 days. Likewise, training
programmes length is set to 15 days (while the industry standard is 20) for all the three employees
skill levels. For the same reason, also the average frequency of training programmes for both
trained employees and experts (every 180 and 360 days respectively) is lower than the industry
standard (i.e., 60 and 180 days).
Such scenario also implies a prudential organisation investment policy. Network investment policy
is calibrated to the “medium” option.
As shown in figure 7, the company investment policy is able to produce a satisfactory yield,
portrayed by positive EBITDA, ROI E ROE and growing bank balances.
INCOME STATEMENT (Euro/.000)
FOURTH YEAR
[Sales revenues 2.271.473 35.072 "9.968.443 2.656.569
lOperating costs 792815 1.216489 092.478 962.711
IEBITDA* 1.478.957 2.318.589 2.272.985 1.703369
[Depreciation 968.196 668,194 63.198 667.268
lOperating income ato.762 2.150.395 1604-771 1.096.591
Financial costs 179.246 49.2028 ° °
INet income 07 516 2.102.067 “1604.71 1.096.591
[Financial indicators
cumulated cash flow 490.798 1.379.810 1.199.602
IBank balances 1.119.509 2814988 4.002.945,
IROL 10% 16% 3%
RoE 20 26% 19%
FINANCIAL STATEMENT (Euro/.000;
[Total employees FIRST VEAR” GECOND YEAR THIRD YEAR! FOURTH VEAR
[customer base _[Coverage investments 3.000.000 9.000.000 3.000.000 3.000.000
Company Coverage [Organisational investments 994.695 934.595, 934.595 994.696
lother long term investments: 1.169.799 1.169.799 1.168.738 1.169.788
lAccounts receivable 959.578 4,981,624 1.051.991 883,673
Positive bank balances o 02.546 2.814.958 4.002.448
[Total investments 5.960.861 6.724.107 3.368.639 9.990.452
Equity. 1.528.621 ‘3627.701 5.230.828 6287419
lLong term debts 2.147.659 2.269.012 2.352546 2.822.005
lother long term del (Euro/.000)]
INegative bank bal ST YEARS YEAR YEAR. FOURTH YEAR
[Debts for training ¢+ Depreciation
lEquity and liabilitiq~Internal flows of funds 208, Troaez 2272968
Change in net working capital 295.082 (269.982 205.096
| Change in non current investments 519380 862.700 678.251
|= Net cash flow 490.738 1.983.680 1.979.810
FIGURE 7 - Main accounting reports embodied by the ILE and portraying the first scenario results
16
According to the adopted IC monetary evaluation method, the 100% of IC expenditures (i.e., those
related to employees hiring and training, as well as to organisation) would be capitalised.
If one would have to evaluate this scenario only based on the monetary values portrayed by the
accounting reports, it can be considered very satisfactory.
However, a dynamic analysis of non-monetary IC indicators and other business strategic and
intangible variables can be useful to better understand the sustainability of such scenario over time
and the meaning of the above accounting values.
As shown in figure 8, in the first eighteen months, the company hiring policy would be able to
provide a reasonable customer service. Nevertheless, from the second half of the simulation,
customer service significantly deteriorates. Consequently, provided the high competitiveness of the
market, both the company market share and image dramatically decrease.
Employees Employees productivity Customer Service
er x 180.000: gO
2 had c
8 2500. 3 3 064
é @ 150.000 5
e & 0,34
207 130.0004
a 720 1.440 0 720 1.440 a 720 1.440
Customer base
Market share Company image — 1) NexTCEL= (2-3) COMPETITORS
0,08.
8 07 @ 0,504 o
5 0,08 5 5
ra 3 0454 &
poe i
= i = + oO
5 ons & 040
0 720 1.440 a 720 1.440 0 720 1,440
Figure 8 — Effects of IC policies on employees productivity,
service and customer base in the first scenario
As shown in figure 9, this policy does not allow the company to foster a significant increase in the
human resource knowledge index. Consequently, plan flexibility performance improvement is too
weak to allow Nextcel to sustain its market share. Furthermore, the low training investments are a
primary cause of turnover increase, due to employees dissatisfaction. The increase in personnel
turnover is the cause for the reduction of hiring and training expenditures sustained by firm.
As shown in the previous graphs, the positive financial results expected from the adopted policies
are trivial. As a matter of fact, a closer analysis of the business competitiveness shows that the level
of its strategic assets would be substantially reduced. Such assets (e.g. company image, customer
service, plan flexibility) would not allow Nextcel to keep a sustainable competitive advantage and
17
sustain growth in the long run 'S The effects of such phenomenon are captured by the bottom-right
graph in figure 8. In fact, although in the first half of the simulation the firm is able to subtly
increase its customer base, this happens as an indirect effect of three reasons, i.e.: a) the sharp
market growth rate; b) the primary allocation of new hired personnel to front-office activities, and
c) the short training programme length. The effects of such myopic policy become evident only in
the second half of the simulation, when the customer base collapses, in spite of the significant
market growth rate. Such a scenario provides an analysis of the causes underlying the limits to
growth experienced by Nextcel.
Hiring and training costs HR knowledge index Plan flexibility
400.000 @ » 06
8 8
= 300.000 2 £ 0s
8
3 200.000 @ 0,80 @ 04
400.000 e g 08
7 ° a7s 5 02
fy 720 4.440 fy 720 1.440 fy 720 1.440
Company Innovation a
index Employees turnover Operating income
— 0,08. 3—3—3 (1J— 5.000.
g 98 8 — New _ 4.000
= 0p € 008 - 2—2—2 hired 8 3.000
2 04 © one @—3 2000
FE oo e™ errr MET 4000
Oi 5 oof arg 0
00- wed Expert
0 720 1.440 Q 720 1.440 0 720 1.440
Figure 9 — Effects of IC policies on human resource knowledge index, innovation,
and plan flexibility in the first scenario.
The above counterintuitive results demonstrate that the availability of only financial and other static
quantitative indicators may not be able to provide decision makers a systemic and dynamic view of
observed phenomena. This can be particularly true for the investigation of the impact generated by
IC investment policies on service companies’ performance where both knowledge and other key-
intangible resources play a crucial role. In fact, IC expenditures contribute to the accumulation of
knowledge and other related strategic assets, most of which are intangible and subject to delays and
inertia. For this reason, an SD model embodying financial, other quantitative measures and
intangible assets have provided business decision makers more fruitful insights to assess sustainable
policies.
Scenario 2: a sustainable long-term oriented IC policy
' Such phenomenon has been analysed in the system dynamics literature by different scholars. The People Express
case-study (Whitstone 1983) offers a good example of the risks that a company may face when a myopic policy
ignoring the perils of growth can imply. See also Senge (1990, chapter 8) and Morecroft (1997).
18
A second scenario implies the same market assumptions of the previous one (i.e. medium customer
mobility, a high competitor B attractiveness and medium competitor C attractiveness). In this
scenario, in order to cope with the sharp growth in the customer base, implying an increasing need
of people available to deal with requests and launch new products, the company decides to hire and
train a growing number of employees. It starts to monthly hire 60 people and, in order to sustain
growth, it gradually reaches a rate of new hired personnel equal to 450 people per month. Network
investment policy is calibrated to the “medium” option a
Further, such a run implies that the length of employee training is gradually increased. In the first
18 simulation months such length is kept unchanged (i.e., 15 days). In the next months, it is
increased to 18 days and, only from the second half of the third year, it is set to 20 days. Likewise,
the training programme frequency is gradually increased so to meet the industry standards.
To sustain such IC policy, from the end of the second year, organisational investments are also
increased (from medium to high).
Employees Employees productivity Customer Service
800.000- 1.07
10.000 0.94
Cee 600.000 os
074
8.000 400 .000-
0.64
4.000-
200.000. 084
2.000
0 360 «720 1.080 1.440 0° 60,720, 4.080 1.440
o 360 720 «1.080 1.440 CPRtoner bade
Market share Company image —11) NEXTCEL
==2:3) COMPETITORS
08:
on 30,000,000.
0,10: ra
0,7-
0.09. Pad
. 20.000.000:
0.08 a
06 <c
On! 410.000.000 oo i
0.08:
Os: | anon mere!
0 360720 1.080 1.440, a 360720 1.080 1.440 0 360 «720 1.080 1.440
Figure 10 — Effects of IC policies on employees productivity,
service and customer base in the second scenario.
Figure 10 shows that, in the second and third year, the company would improve its competitive
position (see, in particular, market share and company image). However, although competitive
performance increases, such a scenario would allow the firm to earn a lower operating income,
which would imply a capitalisation of only the 18% of IC expenditures related to the four years
plan.
'4 In the two scenarios network investment policy has not be changed in order to make more understandable effects
generated by IC expenditures on business performance.
19
The reason why the firm finds difficulties in increasing its market share, image, customer service
and operating income, particularly between the second and third year, can be associated to the
effects produced by the sales growth, due to both the high market growth rate and the undertaken IC
policy. In fact, the number of experts is not sufficient to both support the increasing volume of
current activities (e.g., dealing with customer requests, launching new tariff plans) and the
education of the massive number of new hired employees that growth requires. Furthermore,
customer service oscillates because of the difficulty of the firm to face growth through its skilled
employees. Such oscillations are at the same time the cause and effect of market share fluctuations.
As a matter of fact, a lower customer service reduces demand, which in turn decreases the workload
for Nextcel employees. This increases — other conditions being equal — customer service again,
leading to a further rise in demand.
The limits to growth in IC expenditures productivity are also captured by the behaviour of the
human resource knowledge index, displayed in figure 11.
Hiring and training costs HR knowledge index Plan flexibility
§,000.000-
0.8.
4.000..000-
3.000.000- 0,80 06
2,000.000- oy
1,.000.000-
0,75- 0,2-
0- F
oO 360 720 1.080 1.440 oO 360 720 1.080 1.440 tt) 360 720 1.080 1.440
Company Innovation index Employees Operating Income
1.0 po 6.000:
0,05-
0.8-
of 0,044 —3———;: 4.000:
a 0.03. —(1) New hired
oe. —{2) Trained 2.000.
. 0.02 —13) Expert
0,0- T T T 1 o.
0 360 720 1.080 1.440 0 3680 720 1.080 1.440 0 360 720 1080 1.440
FIGURE 11 - Effects of IC policies on human resource knowledge index, innovation,
and plan flexibility in the second scenario
In spite of such limits, the gradual increase of hiring and training costs on a side, and organisational
investments on another, allows the firm to pursue a balanced and sustainable IC growth. However,
as previously remarked, according to the adopted IC evaluation method, the second scenario would
allow the firm to capitalise only the 18% of IC expenditures.
How can one explain that a policy leading to better competitive results is likely to give rise to a
lower percentage of capitalised IC expenditures, if compared to scenario 1?
20
In order to understand the reasons of this phenomenon, it is necessary to analyse the net of
causalities underlying the conceptual framework for IC non-monetary assessment, portrayed in
figure 4.
A comparative analysis of Nextcel Scenario 1 and 2
Concerning the first scenario, the above considerations suggest that although the performance
increase achieved in the four years gives a satisfactory yield, the endowment of strategic assets
would not be able to sustain future growth. In fact, customer service, image and innovativeness are
significantly lower than in the second scenario. The human resource knowledge index is, instead,
very close in both scenarios. It is, rather, slightly lower in scenario 2 from the second to the third
year, because of difficulties in getting enough experts available for new hired training. Another
reason explaining this phenomenon is that a more aggressive hiring and training policy generates a
higher weight of rookies over the number of experts, whose initial level of knowledge is low.
However, in the last year, the above index starts growing in scenario 2, while it levels-off on a
constant value in scenario 1.
Furthermore, differently from scenario 1, the second scenario implies a higher endowment of
strategic assets that allow the firm to sustain future growth.
Such analysis, supported by the discussion on main relationships between IC and other strategic
assets underlying Nextcel growth (see figure 4) is used in the de-briefing session to help players to
learn how:
- the percentage of capitalised IC expenditures refers to the flow of results generated by
investments done in a given time period. As a consequence, although a small investment can
give a satisfactory yield, it could not provide the firm the necessary stock of strategic assets to
sustain future growth;
- such investments in strategic assets will allow the company to achieve a performance increase.
This will make the capitalisation of IC expenditures possible;
- the higher is the growth rate of the firm, the higher will be the stock of its strategic assets (e.g.,
customer base, image and plan flexibility) needed to make growth sustainable. However, to
build a higher level of strategic assets, higher IC expenditures will be necessary (see the R1, R2
and R3 reinforcing loops in figure 4);
- consequently, IC obsolescence will provide a limit to further growth in the IC stock (see the B1
balancing loop in figure 4).
An ILE (continued): an analysis of two simulation scenarios in an insurance firm
The ILE previously discussed has been also customised to an insurance firm, in order to support its
IC planning processes. The firm will be referred hereinafter as Non-life Insurance Spa. The model
was calibrated on the past behaviour of the business key-variables, and the ILE was used with the
21
management to test and validate different scenarios. In particular, two runs will be analysed and
discussed in the following pages.
Both scenarios imply a low annual market growth rate (about 3%), a medium customer mobility
(about 2 years), and a high attractiveness of the “top 10” competitors and medium for other
competitors. It was also assumed that competitors adopt low monetary incentives to their sales
managers.
The company market share is 3%. It has about 500 agencies, 180 damage appraisers and 25 sales
managers. The company personnel is very qualified if compared with the industry standard.
The company combined ratio (the percentage of the premium paid out in claims and expenses) is
0.98 while the loss ratio (the percentage of each premium dollar spent on claims and associated
costs) is 0.79. A drop in both such ratios represents an improvement, while an increase represents a
deterioration. The simulation covers a four years time span, through which the management aims to
increase the number of agencies up to 570 and company market share from 3 to 4.5%. It is also
expected that company growth policies have to contribute to reduce the combined ratio of 1 or 2%.
Furthermore, the management is very concerned about the assessment of IC value resulting from
alternative growth policies. In fact, company growth can not be achieved to the detriment of IC
monetary value.
The model was developed and calibrated with the Organisation unit of the firm, and simulation
sessions facilitated by the authors, were run together with participants from the following units:
Organisation, IT, Finance, Commercial and Appraisal.
Non-life insurance Spa was used to focus the IC planning process on only accounting and monetary
values and some IC expenditures (e.g., education) were considered as a current expense.
The conceptual framework described in figure 1, on which the simulator was based, was therefore
illustrated to the participants to the project and share with them in order to foster a shift of mind in
the way the firm was used to plan IC expenditures.
Scenario 1: a myopic IC policy
In a first simulated scenario, the management decided to monthly:
- acquire 10 new agencies in the first year and 15 in the remaining planned period;
- hire 1 sales manager;
- hire 10 junior damage appraisers in the first year, 8 in the first half of the second year and 5 in the
remaining planned period.
A weak training policy for both sales managers and damage appraisers was also undertaken. In
particular, training programme frequency was the double of the industry standard.
22
To meet the desired market share, sales managers’ commercial efforts were supported through high
monetary incentives and growing marketing investments. To cope with the expected increasing
number of claims, the management also decided to invest in IT and provide high monetary
incentives to damage appraisers. Moreover, in order to maintain a satisfactory financial yield, after
the second year, company investments in product portfolio were substantially reduced.
As shown in figure 12, the company investment policy was proved to be able to produce a
satisfactory yield, in terms of operating and net income and related performance indicators (i.e.,
ROI and ROE). In fact, both combined and loss ratios show a positive trend during the planned
period.
INCOME STATEMENT (Euro /.000)
FIRST YEAR ID YEAR
(1) Non-life insurance gross written premiums 1.272.916 1.364.743 474. 1.555.672
(2) Insurance losses 962.632 964.865 923.967 953.948
(3) Net change in reserves for unearned premiums 95.977 74.243 78.290 88.693
(4) Loss and net chaneg in reserves (2) +/- (3) 1.058.609 1.039.107 4.002.257 1,042,640
(5) Commercial expense 159.498 174.695 192.920 206.422
(6) First Margin (1) - (4) - (5) 54.809 450.940 279.419 306.610
(7) Training and personnel costs 13.486 13.408 13.947 14.439
(8) Second Margin (6) - (7) 41.323 137.532 265.471 292.171
(9) Administrative expenses 69.965 81.590 92.861 98.370
(10) IT depreciation & agencies acquisition costs 6.053 7.820 9.998 11.635
(11) Operating income (8) - (9) - (10) 34,695 48.122 162.613 182.166
(12) Financial result 3.904 5,759 11.356 18.072
(13) Taxes 0 22.630 73.067 84.100
(14) Net income (11) +/- (12) - (13) 30.791 31.251 400.902 116.138
Other performance indicators
Combined Ratio (*) 1,03 0,96 0.89 0.88
Loss Ratio (**) 0.83 0.76 0.68 0.67
Expense Ratio (***) 0,20 0,20 0,21 0,214
ROL 0% 2% 8% 8%
ROE 0% 14% 37% 33%
Company Customers 1.019.421 1.113.087, 1.179.000 1,242,519
Total Sales Managers 2 29 30 32
Total Damage appraisers 196 204 210 218
FIGURE 12 — Non-life Insurance Spa operating income related to first scenario results
According to the adopted IC monetary evaluation method, figures resulting from first scenario
allow to capitalise the 100% of IC expenditures. Such business results would seem to achieve
management goals.
However, from the analysis of IC non-monetary indicators and other business strategic factors
reported in figures 13 and 14, it is possible to argue that the sustainability of such scenario is weak.
In fact, in spite of an acceptable customer service provided by the company, due to an initial
reduction in the time to settle claims, and a stable sales managers’ knowledge index, this policy
produces a significant deterioration of company product portfolio quality and damage appraisers’
knowledge index. Such a phenomenon is due to the low IC investments, if compared to the
commercial investments aimed to significantly increase the number of agencies.
23
Further evidence of the limits of this policy is provided by the fact that although company image
initially shows a growing trend, in the fourth year it starts to decline. The same behaviour can be
also referred to the dynamics of customer service.
The above analysis suggested participants how the desired market share cannot be achieved by only
a sustained commercial investment policy, if this is not supported by proper investments in damage
appraisers and sales manager training.
Person
Damage Appraisers
20 a —
Damage Appraisers
knowledge index
360
720
1 080 1 440
Hiring and training costs
Euro/.000
15.00
(¢) 360 720 1.080 1.440
, i) 360 720 1.080 1.440
Product Portfolio Quality
| rome
Time to settle claims
Days
0 360
720 1.080 1.440
Customer Service
+ t t 1
0 360 720 1.080 1.440
0 360 720 1.080 1.440
Figure 13 — Effects of IC policies on damage appraisers knowledge index, time to settle claims,
product portfolio quality and customer service (/= first scenario ; 2 = second scenario)
Person
Euro/.000
Sales Managers
Sales Managers
knowledge index
Insurance agencies
2 570
504 Pe oe oo 8 wr
isl j Pe a) fo —— 2 ® aan Pg j
404 ,
35 ro 0,94: 2 ee f
——I 5 7
pal al <7 0,92 10 ot
0 360 «720 1.080 1440 0 360 720 1.080 1.440 O 360720 1.080 1.440
Operating Income Market share Company image
600 0,045 2 09
wm wv
300: ie 9,040 0.9
4!
0,03 Le
OPN 2 a omen 0,85:
NY 0,030: Peel
9 360 «720 1.080 1440 «0 ~«=«800 7201080 1.440 «gS 40 720 1.080 1.4d0
Figure 14 — Effects of IC policies on sales manager knowledge index, operating income, company
image and market share (/= first scenario ; 2 = second scenario)
From figures 13 and 14, it is possible therefore to observe that company strategic assets dynamics
(i.e. damage appraisers’ knowledge index, product portfolio quality, company image and customer
24
service) would not allow the firm to keep a sustainable competitive advantage and sustain growth in
the long run.
The analysis of the dynamics commented above was supported by managers group discussion,
framed according to the rationale depicted in figure 5b.
Likewise, in the first run previously commented about the Nextcel case, also in this context
financial results proved not to be sufficient to provide decision makers a comprehensive and a
systemic picture of the relationships between relevant variables for IC policies.
Scenario 2: a balanced long-term oriented IC policy
A second scenario was developed according to the same market and competitors assumptions
adopted in the first run.
This scenario differs from the first one, since the analysis of previous simulations suggested
managers to balance investments in both commercial and damage appraisal sectors, in order to
increase personnel knowledge and skills. The explored issue was about weather a stronger IC policy
would have allowed the firm to sustain commercial growth in the long run.
The above scenario was outlined through a gradual increase of both the duration and frequency of
personnel training programmes. Such strategy was also based on a monthly:
- acquisition of 15 new agencies since the first year;
- hiring of 5 sales managers in the first year and 3 in the remaining simulation time;
- hiring of 20 junior damage appraisers in the first three years and 5 in the last year;
- hiring of 5 senior damage appraisers in the first three years and 6 in the last year.
Investments in personnel monetary incentives, marketing and IT systems were also increased, if
compared to the previous scenario.
The above decisions allowed the firm to build a sustainable competitive advantage and profitability
in the medium/long term, in spite of the negative operating income produced in the first year
because of the intensive investment policy (see figure 15).
25
INCOME STATEMENT {Euro-/.000)
SECOND YEAR THIRD YEAR __FOURFTH YEAR
196 7
@) Insurance losses 949.717 891.755 1.005.484 4.114.278
(14) Net income (11) +/- (12) - (13) 32.252 87.956 421.076
Other performance indicators
Combined Ratio (*)
Expense Ratio (***) 0,21 0,23 0,23
ST”
ReE™ 0% 35% 30% 30%
Total ae anaes
Damage appraiser:
FIGURE 15 — Non-life Insurance Spa operating in income related to second scenario results
A comparison of the two scenarios allowed managers to perceive how higher investments in
damage appraisers hiring and training, in the second scenario, were able to increase knowledge,
which in turn contributed to improve customer service and product portfolio quality. Both
performance drivers, together with a higher endowment of agencies and sales managers, increased
the business competitive position (see, in particular, market share and company image).
According to these decisions, managers were able to reach both targets: desired market share (4.5%)
and number of agencies (470). The operating income depicted, at the same time, a better profile
than in scenario one. Such financial results also allowed the firm to capitalise the 100% of the IC
expenditures at the end of the fourth year.
26
Concluding remarks
This paper has shown the potential impact of ILEs embodying SD and accounting models to
support top management decisions in allocating business resources in a planning setting for IC
management.
Human resource training and organisational expenditures are often budgeted on an incremental
basis, as discretionary costs. They are planned without a closer look on how the interaction between
IC and other strategic assets will allow the firm to improve its performance and achieve a
sustainable growth in the long run.
By focusing stocks and flows affecting business strategic assets’ dynamics, the SD methodology
has been adopted by the authors to provide business decision makers a learning vehicle supporting
them to frame and manage the complex and peculiar system characterised by IC.
A shift of mind in managing IC was fostered by introducing a new conceptual framework for IC
monetary and non-monetary assessment. Such a framework was embodied in ILEs that were
customised to the two firms on which the SD intervention was done.
The scenarios commented in the last section of the paper, suggest how managing IC only based on a
monetary and static approach is likely to lead decision makers to a myopic resource allocation in the
planning process. This may also happen when a non-monetary analysis of IC indicators is not
supported by a dynamic view of the processes driving the accumulation and depletion of strategic
assets.
Further empirical research will be necessary to experiment the contribution of both the conceptual
framework for IC analysis and assessment, and the ILEs to top managers’ learning processes, in an
educational and a planning setting.
27
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