The Control of Intangibles in the Knowledge-intensive Firm

The knowledge-based view of the firm positions knowledge as the key competitive resource of the firm. The key role of knowledge-intensive firms is to coordinate knowledge that is owned by individuals (Grant, 1996). Co-operation, coordination and organization design are the key parameters for any accounting and control system; hence, when these change as is the case with the knowledge-intensive firm, a subsequent change in the design of MACS will occur. This theoretical paper develops a MACS for knowledge-intensive firms, drawing heavily on advances made in strategy and organization theory. Particularly, the community of practice concept and the co-production of knowledge as opposed to additive production of value are central in its argument. Introduction The ways how firms are organized and how they have structured their value-creation processes have always been relevant to management accounting. Organization structure dictates work flow and work responsibilities on which need to be informed and reported. The many different structures firms can adopt in order to be efficient and effective in creating marketable value is wide ranging. Expressing organization structures via the monetary values that stop and start through these structures are the lifeblood of accounting. Cash flows and departmental budgets, inventory costs and inventoriable product costs, customer service and marketing costs, all are accounting representations of organization structure. More recently, the ways that value is created for the customer has provided combined organizational and accounting inventions such as the value chain and activity-based costing, product/market combinations and target costing, and mass customization and throughput costing. The value creation structure of the firm has similarly been affected by the type of output and input it produces. Industrial output is conceived as value adding to the classic factor inputs of capital, labour and nature, with the value adding process being dictated by economies of scale and price/quantity parameters. Technological changes have added economies of scope and a time parameter to this classic perception. More recently, further technological advances suggest information to be a key parameter for value creation stating we have concluded the industrial era and entered the information era. An extension of that argument is that all classic factor inputs can be retraced to the one originating input of knowledge. Knowledge on the capital, labour and nature inputs of the firm precede the actual purchasing and activation of these inputs and, therefore, is the key competitive resource of the firm. Knowledge also is a dominant resource during the value creation process and after the value creation process, when insight into the wishes of the customer and his experiences with the product become crucial for sustaining the value creation process. Knowledge thus permeates the firm in all its aspects; it provides the basis as well as argument for its organization structure, for its flows and for its stocks and repositories. Paper to be presented at the 22 Annual Congress of the European Accounting Association, Bordeaux, France, 5-7 May, 1999 2 Management accounting as an expression of organization structure is likely to follow suit and acknowledge how it both can express these new ways of organizing and how it can incorporate arguments from these new domains into its managerial technology base. In other words, both function and (theoretical) form need to be addressed. This paper is build up as follows. First, the knowledge-based view of the firm is explicated, using the work by Grant (1996) and Spender 1996). It is argued that knowledge-based firms are most likely to be service firms or production firms with a strong service orientation. Second, against the backdrop of the knowledge-based theory of the firm and using the example of services, the various value creation modes of chains, shops and networks are proposed and discussed. It is suggested that a key feature of these value constellations is their co-production basis as opposed to a single economic actor, additive production basis. Third, the unit of analysis for value constellations is introduced and discussed. Drawing from organizational learning and knowledge management literatures, the community-of-practice concept is proposed as building block for a MACS for the knowledge-intensive firm. It is indicated that the role of MACS for knowledgeintensive firms is in controlling by designing structures of collaboration, having control systems act as bridges between individual activities and competences and organizational processes and structural capital. The knowledge-based theory of the firm This section largely follows the work by Grant (1996) and Spender (1996) and is in itself a mixture of strategy and organization design. It is, however, correct to state that knowledge is conceived as the key resource of a firm. But the definition of knowledge remains elusive; for example, Penrose’s distinction between a firm’s tangible resources and the services these provide gave way to the, now widely accepted, idea that these latter services embody a firm’s knowledge. When applying these services in and on the tangible resources of the firm (its assets), knowledge is created and maintained. In the case of concrete application of services, using existing work routines and procedures, knowledge is used visibly and is stated to be explicit. However, it is the less visible and more unconsciously application of individual skills and insight and organizational “ways we do things around here” that provide the flexibility and competitiveness of the firm. This tacit knowledge is held both at individual and organizational level. The interaction between individual and organizational level, and explicit and implicit use of knowledge implies that knowledge is permanently embedded in organizational processes and less a commodity or asset that can be traded or reported on (Penrose, 1959). Few theoretical frameworks are amble to address this interactive view, simultaneously handling the individual and the collective level of analysis as well as incorporating the context of interaction. Only sociotechnical systems theory has made an attempt to address this confluence of elements (Trist and Murray, 1995; De Sitter et al., 1997) but has problems to incorporate the tacit knowledge of individuals in designing its practical and managerial systems. Spender (1996: 56) suggests that a dynamic knowledge-based theory of the firm needs to address an holistic mode of analysis as opposed to reductionist, perceiving a firm as an assembly of interrelated components the latter of which tends to be the main accounting view of the firm. Accordingly, the rules of analysis include ‘interpretative flexibility’, boundary management or closure and identification of the relevant actors. Paper to be presented at the 22 Annual Congress of the European Accounting Association, Bordeaux, France, 5-7 May, 1999 3 Interpretative flexibility allows for the interpretation of events and processes by individuals and organizations and the ways how organizational participants and the firm acts – no best practice exists but, instead, a set of trajectories for each organizational domain that interact in their interrelatedness. Boundary management and closure mechanisms are the aspects of internal processes that create their autonomy and selfregulation and define the interactions with others. They provide stability and identify explicitly a unit of analysis. The identification of relevant actors positions the firm in an interactive network of entities which can only be partly decomposed or separated for analysis. The accounting perception of ‘internal markets’ for transfer pricing or external product markets is an example of actor identification. Grant (1996) builds on the more epistemological treatment of the knowledge-based theory of the firm by Spender, and proposes that the role of the firm is one of pure stewardship, i.e., its role is to integrate the knowledge owned by its individual members. A firm’s key task is to provide structural arrangements of co-ordination and co-operation of specialist knowledge workers. Conventionally, the focus is on co-operation, aligning individual and organizational goals and subsequently relying on authority relations of some sort for co-ordination. Efficient co-ordination in knowledge-integrating institutions is defined as the effective integration of specialized knowledge while minimizing knowledge transfer through cross-learning by organizational members. The latter condition refers to the fact that most knowledge is tacit and transfer of tacit knowledge is both difficult to achieve and time consuming. Working together, i.e., integrating each others knowledge into an output, is efficient if all workers do not have to acquire first all the knowledge of the others before getting started: limited cross-learning is needed in so far as workers have to understand the boundaries of each others area of knowledge specialization before they can start integrating both areas in an output. In other words, minimal knowledge transfer through cross-learning allows fast co-ordination. Grant (1996: 115) continues by suggesting four mechanisms for integrating knowledge: (4) rules and directives; these are impersonal mechanisms, such as plans, schedules, standardized information and communication systems, that act as standards to regulate interactions between individuals. They also minimize the need for communication between specialists as they are a vehicle for translating tacit knowledge into explicit knowledge, for example by creating a set of operating procedures (“how to’s”). The majority of management accounting instruments fall in this category. (2) sequencing; this also minimizes cross-learning knowledge transfer and continuous communication by assigning a time slot to each expert in which he can independently provide his input without having to depend on other experts. The intuitive reflex here is to think of a Tayloristic-type assembly line where sequence is set by technology. Management accounting instruments usually do not address the issue of time-based 1 “Tacit knowledge equals knowing how and is revealed through its application. If tacit knowledge cannot be codified and can only be observed through its application and acquired through practice, its transfer is slow, costly, and uncertain (Kogut and Zander, 1992). Explicit knowledge equals knowing about facts and theories, and is revealed by its communication. The critical distinction between the two lies in transferability and the mechanisms for transfer across individuals, across space, and across time. This ease of communication is its fundamental property (Grant, 1996, p. 111)”. Paper to be presented at the 22 Annual Congress of the European Accounting Association, Bordeaux, France, 5-7 May, 1999 4 interfacing; the aspect of performance requirements or standardization (i.e., what needs to be done in the assigned time slot) is the closest it gets to conventional management accounting notwithstanding that performance standardization is more an issue of management control than management accounting. (3) routines; defined as organizational and not administrative routines, they constitute “..relatively complex patterns of behavior ... triggered by a small number of initiating signals or choices and functioning as recognizable unit in a relatively automatic fashion (Winter, 1986: 165).” Routines take over in the absence of other mechanisms of communication or co-ordination. Their key characteristic is the support of complex interaction patterns and, as such, coincides with the concept of mutual adjustment. Routines in management accounting are basically triggered by the outcomes of computations or by performance reports/reviews. Hence, organizational routines as defined above tend to follow the management accounting rules and directives. An example would be the monthly performance evaluation meetings based on the reports generated by the management accounting system. Another example is the informal follow-up on a lagging machine-efficiency value that a production planner gets on his computer screen and the fact that he subsequently knows who to call/talk to and when. (4) group problem solving and decision making; different from the other three mentioned mechanisms, this mechanism deliberately does not try to avoid cross-learning and minimize communication but, instead, uses personal communication modes. Group problem solving and decision making explicitly addresses the necessity of crosslearning in situations of high uncertainty where the full spectrum of knowledge, both explicit and tacit, is needed. The knowledge-based firm, thus, seems to rely on three mechanisms of efficient coordination as much as it can, and only use the least efficient and most costly form of coordination when uncertain, complex and uncommon tasks or outputs are required. In terms of coordination and MACS, the knowledge-based firm is postulated to contain a strong portion of what is generally conceived as bureaucratic mechanisms – SOPs, standardized accounting (time) controls, and basic reporting. However, the use made of these instruments is assumed to be different. Rules and directives, sequencing and routines are maintained to allow fast and efficient cross-learning and information exchange, updating organizational members on the state of affairs, and relatively less on providing information for decision making. The latter seems to be taking place in the group problem solving & decision making coordination mechanism, where missing information is exchanged and the tacit understanding of situations and context is developed. In Spencer’s perception, ‘interpretative flexibility’ is exercised in these group meetings and coordination mode while simultaneously the inclusion or exclusion of group members for that meeting indicates a form of boundary management – Board Meetings contain board members while product development meetings contain the product development team of experts. As a result of acting out these mechanisms, Grant implies a modular or team mode of organizing with various forms of temporary (project) organizations being created each time a knowledge output is required (Grant, 1997). The members of these temporary organizations are then sourced from the various knowledge domains within the firm where they have their home base. The organization design thus Paper to be presented at the 22 Annual Congress of the European Accounting Association, Bordeaux, France, 5-7 May, 1999 5 assumes a twofold structure; a permanent structure of knowledge home bases (knowledge resource pools) and a continuously changing superstructure of temporary organization, created for knowledge application and deployment. The latter coordination mode also points at the deficiencies of hierarchical modes of organizing. As no individual organizational member can possibly integrate all knowledge of the subordinates in his team, a manager can only effectively coordinate of he is able to involve all experts in a horizontal coordination fashion. The reverse side of lateral coordination is that decision making becomes equally less hierarchical; decision-making authority is equally distributed among team members and co-determination becomes a fact. However, hierarchy might have disappeared within the knowledge-base team, it might still play a role to organize the various teams and their interfaces. Notably the interface between the permanent knowledge home bases of individuals and the temporary teams to which they are assigned requires attention; hierarchy can act to arbitrate between conflicting membership roles and in establishing at what level cross-learned knowledge is controlled and measured. Decision making authority based on hierarchy within knowledge teams makes room for decision-making authority based on competence. The most experienced or best-educated team member is likely to have the largest influence in making decisions. Nevertheless, hierarchy in a vertical sense and outside a team environment is far from obsolete. Institutional norms tend to require hierarchy and so do growth and size demand hierarchy in (loose) coupling the teams. Moreover, hierarchy is implied in various professions or knowledge-based activities where experienced seniors or masters wield more influence than less experienced juniors or apprentices (Lowendahl and Revang, 1999). For MACS, the pushing of hierarchy to the outside of the teams and into the skeleton of the organization, means that vertical reporting flows and team-based performance measures are far from being abandoned. In effect, accounting routines can provide a basis of stability in the intra-organizational team environment and can act as boundary management tools in addition to team membership and assignment. It is plausible that knowledge home bases or ‘competence pools’ are more strongly represented in MACS than the teams – the ‘actors’ in Spender’s sense. In other words, the twofold structure of the organization implied by the knowledge-based theory of the firm is likely to be reflected by the intensity and reliance of MACS in the skeleton organization versus its team ‘weak parts’. This makes the role of interfaces and boundaries an important one for MACS – it determines the location and constraints of accounting and managerial technologies. Knowledge-based firms and the service industry Knowledge-based firms tend to be more prominent in the service industry as a result of their relatively higher capacity for customer responsiveness. Customers demand increasingly tailor-made products and services which translates back into the firm as an increasing demand for highly knowledgeable employees that have a high level of professional expertise and/or large experience in solving unique customer problems (Lowendahl and Revang, 1999, 1998). Customer responsiveness is a requirement at business level that comes in addition to existing requirements of cost efficiency (low cost offerings) and timely delivery. The term ‘mass customization’ has been coined to describe the internal structural changes a firm has to undertake in order to match a highly Paper to be presented at the 22 Annual Congress of the European Accounting Association, Bordeaux, France, 5-7 May, 1999 6 crystallized market demand. The circumstances of fast technological change, notably in communication technologies, are acting as enablers for this internal structural changes. Apart from structural changes, firms are also finding themselves suddenly competing on a factor market of scarce expertise and experience. The professional individuals carrying this expertise and experience require as well internal structural arrangements that accommodate the execution of their expertise (Lowendahl, 1997). The existence of nonhierarchical modes of coordination and the distribution of decision-making authority is but one consequence of this confluence of demands on organizational design. For customer responsiveness and expertise to be fully utilized, horizontal and modular organization structures are presently being invented and experimented with in practice. A key characteristic in these structure experiments seems to be a combination of ownership, authority and expertise/experience. The main resource of knowledge-based firms is human expertise and that is owned by the individual, who is only willing to exercise that expertise if the organization acknowledges that ownership, both in terms of decisionmaking authority and in terms of other internal routines that put the expert at center stage. The latter ranges from reward systems to performance measurement, and from reporting and information flows to assigning interesting (customer) problems. In more generic terms, a combination of human capital and competence with organizational routines and systems is being looked for. The organizational design literature has acknowledged this development for some time already and a flood of new structure concepts has emerged. To name just a few, we are familiar with virtual organizations, horizontal organizations, network organizations, learning organizations, self-designing organizations and organizations as brains. All try to combine the unique individual with the organization and find some balance. Earlier experience with addressing this combination was limited to sociotechnical systems and it is there we might also find a starting point. The Tavistock studies form the 1950s pointed out that a new kind of team-based organization had emerged under ground in the British coal mines, disregarding completely the formal aboveground organization. Nowadays we again acknowledge the existence of an informal organization that operates next to the formal organization, this time for white-collar workers and focussing on the communication flow behind cooperating, highly competent individuals (Krackhardt and Hanson, 1993). The reactions to this acknowledgement usually take the form of either surpressing it and keeping the informal organization ‘underground’ usually expressed with reference to company goals adherence, or organizing according to the informal and deliberately bringing ‘above ground’, usually expressed with adherence to knowledge management and facilitating information technology. Value constellations From a MACS point of view, the quest for new internal structures can be reframed as a quest for new value constellations apart from the well-known value chain. Porter’s value chain concept matched the industrial organization perspective on competitive strategy, expressed in the structure-conduct-performance (SCP) assumption – once the firm was positioned in the right market, its conduct was largely determined and its performance assured. With the rise of global competition and the sharp increase in technological Paper to be presented at the 22 Annual Congress of the European Accounting Association, Bordeaux, France, 5-7 May, 1999 7 development, industries and sectors have seen their traditional barriers lowered. Performance has become less a matter of positioning and more of discretionary management decision making. The role of management has changed accordingly and moved from improving strategy making, to improving structures and process, to focussing on the interface between systems and people (Bartlett and Ghoshal, 1994, 1995a, 1995b). Porter’s value chain analysis is well introduced into activity-based costing and management, while his cost driver and value driver concepts have become standard terminology among accountants worldwide. Value chain analysis allows a decomposition of the firm into activities, each of which can be individually assessed on its importance. Assessment takes place by using cost drivers and value drivers as linkage mechanisms between the whole of the chain and its parts. Porter’s claim is that the value chain logic is universally valid, but that competitive advantage, however, is dependent on the relationship of each firm’s specific activities vis-à-vis its industry. However, the value chain logic has shown itself to be difficult to apply in service industries precisely because of the above-described organizational designs resulting from the combined requirements of customer responsiveness and unique knowledge resources. The SCP framework and value chain analysis are obviously not worthless but the impossibility to apply it has given rise to the thought that various other forms of value constellations might exist. Next to Porter’s additive logic in which activities are integrated as components in a horizontal chain with the firm as level of analysis, two alternative constellations are proposed in the strategy literature each of which strongly focussing on customer interfacing and less on the transformation process. Service delivery and interaction with the customer requires intensity in terms of communication that creates activity interdependency other than by transaction only. The exchange of information and the identification of the actors in that exchange go beyond market transactions with a purely economic or financial basis. Of course, these are not separate from a financial expression but information exchange and knowledge creation go before the economic transaction has crystallized. Equally, the exchange of information as, for example in the informal internal organization, is not limited by the formal structural boundaries of the firm; the exchange of information is based on the individual’s interpretation of what the problem is and on who the right person is to interact with to solve it. In other words, Spender’s interpretative flexibility, boundary management and relevant actor identification are detectable in service delivery, information exchanges and problem solving. Value chains, shops and networks The two alternative value constellations suggested in the strategy literature are the value shop and the value network (Stabell and Fjeldstad, 1998), see table 1. The value shop constellation involves the mobilization and organization of resources around resolving a particular customer problem, for example, a professional service firm such as a consultancy. The value network constellation creates value by facilitating a network relationship between its customers, for example, banks, insurance companies or telephone companies. All three constellations involve a set of activities but the linkages between these activities (the process design) are different. That is, the interdependencies and the technologies used for linkages (Thompson, 1967) have different characteristics. A value chain performs a fixed set of activities that are performed by ‘long-linked Paper to be presented at the 22 Annual Congress of the European Accounting Association, Bordeaux, France, 5-7 May, 1999 8 technology’, meaning value is created by transforming inputs into products. Long-linked technology states that the interdependence between the primary activities is sequential, with the output of one activity is the input of the other. Customer value is thus created by the cost reductions the product can provide in the customer’s activities or by the performance improvements the customer can gain by using the product (Stabell and Fjeldstad, 1998: 416). Value shops use an intensive technology to solve customer problems, meaning that it organizes activities and mobilizes resources according to the problem to be solved. The more advanced the problem, the intense the technology used for linking interdependencies. Finally, the value network relies on mediating technology to link customers who want to be independent, with the firm providing the networking service facilitating relationships between customers distributed in time and space. The providing firm itself is not the network, instead the network is its ‘product’. The value created in the particular set of customers that are connected, the EIASM would be a perfect example in casu.