Organizational capital

Organizational capital is the ability of an organization to mobilize and sustain the process of change required to execute strategy.^[1] Working practices such as Just In Time, accounts payable processes and Total Quality Management contribute to organizational capital. Buildings, equipment and vehicles are considered as capital assets which businesses buy to receive a financial return on the investment. Similarly, if a business implements new working practices or administrative procedures, its aim is to increase efficiency to receive a financial return.

Organizational capital can be thought of as any procedures according to which cooperating individuals perform tasks; it can include work techniques, accounting practices, and management procedures.

Adam Smith and the Division of Labor

Perhaps the most famous example is the division of labor as illustrated by the pin factory Adam Smith described in the first chapter of The Wealth of Nations. Smith explained how the process of making a pin was divided into as many as 18 separate steps, including: drawing out the wire, straightening the wire, cutting it, pointing it, grinding the unpointed end in preparation for adding the head, making the head, affixing the head, whitening the pin, and packaging it (putting the pin “into the paper”). Labor was divided by assigning one or more of these discrete tasks to a single worker. In this manner, Smith assures us, ten men could make some 48,000 pins a day, whereas if each man had “wrought separately and independently…they certainly could not each of them have made twenty.”^[2] By dividing the tasks among the ten workers, production was increased from, at most, 200 pins a day to 240 times that number.

This huge productivity improvement was achieved without any additional physical inputs – that is, without increasing the number of workers, the size of the factory, or even the number or quality of the tools. In fact, by picturing the factory just before the tasks were divided, we can see that the number of tools needed would actually have been reduced. Imagine each man working separately, making complete pins by himself. Each man needs the whole array of tools used to draw the wire, cut it, point it, and so on, so that ten complete sets of tools are required. After dividing the tasks among the workers, however, only a single set of tools is necessary.

The division of labor is an example of organizational capital; knowledge that, when applied, can increase productivity as much as (and perhaps more than) introducing machinery. In fact, the division of labor was a necessary precursor to the invention of the machines so common in modern factories. One can scarcely imagine, for example, how to design a single machine capable of making a complete pin. Yet one can readily conceive of a machine that can cut wire into predetermined lengths, of another that can put a point on each of the cut segments, and so on. The exercise of separating the pin-making process into distinct tasks made possible the automation of those tasks; organizational capital begets physical capital.

Breaking Bottlenecks

We can raise our pin factory’s productivity even more by applying Eliyahu M. Goldratt’s insights as described in his book, The Goal.^[3] Suppose, for example, our factory’s profitability is falling. Thousands of feet of wire are going into the plant, but far less of that wire is coming out in the form of finished pins. We’re paying for raw materials that are not returning any revenue. A walk through the plant reveals a large pile of cut wires in front of the “pin pointer,” and another pile of pointed wires in front of the pin header. The task of cutting the wire must be taking less time than the job of pointing it, which, in turn, must take less time than adding a head. To "break" these bottlenecks, we could have the wire cutter and pin header take their breaks and lunch hours at different times, and then have the cutter add heads while the regular header is away. This would speed the task of pin heading and, at the same time, allow the pointer to catch up with the cutter.

Production could also be increased by locating the various work stations in the factory so as to facilitate the flow of the unfinished pins between them, and by arranging the available light sources to their best advantage. Again, in each case, productivity is raised without increasing either the workforce or tangible capital.

Unlike tangible capital, organizational capital is not an exclusive resource. That is, while only a single person can use a physical resource such as a lathe or a drill press at one time, any number of people can employ the idea of the division of labor or use Goldratt’s techniques to identify and break bottlenecks. At first glance, then, organizational capital appears to fall outside the traditional definition of economics: the study of the use of scarce resources that have alternative uses. However, exclusive is not synonymous with scarce. Organizational capital is, in effect, institutionalized knowledge; knowledge is a scarce commodity and institutionalized knowledge scarcer still.

Organizational capital may, in some cases, be more difficult to change, or “upgrade,” than is tangible capital. This is because new techniques can conflict with existing institutions in unexpected ways. For example, both Goldratt’s insights and just-in-time inventory practices run afoul of accounting standards which treat inventory (including “work-in-progress”) as an asset. When either of these new paradigms is implemented, one impact is that inventories are sharply reduced. While falling inventories lead to lower costs and higher profits, they show up on a company’s books as a drop in assets and, therefore, in the company’s net worth. Such a drop may be enough to cause management to have second thoughts about implementing the changes.

Determining the Value of Organizational Capital

The value of a business's organizational capital is determined by calculating the changes in cash flow resulting from the combination of changes in processes, procedures, and communications within the business.

Research

Academic work on organizational capital began in the United States in the 1970s with the research of Professor John F. Tomer.^[4] In 1987, Tomer provided an academic definition of organizational capital in his book Organizational Capital: The Path to Higher Productivity and Well-Being.^[5]

More recently (2009), Professor Ahmed Bounfour, of the University of Paris, edited the book Organisational Capital: Modelling, Measuring and Contextualising.^[6] This book provides an overview of organizational capital as a concept, and offers different perspectives - IT, marketing, business and societal modeling - for managing organizational capital as an intangible asset.

See also

• Capital (economics)
• Physical capital
• Value added

Notes

1. ^ Kaplan, Robert S.; David Norton (2004). Strategy Maps: Converting Intangible Assets into Tangible Outcomes. Boston, MA, USA: Harvard Business School Publishing. p. 275. 
2. ^ Wealth of Nations. An Inquiry into the Nature and Causes of the Wealth of Nations
3. ^ The Goal. The Goal
4. ^ Tomer, John. [1]
5. ^ Organizational Capital. The Path to Higher Productivity and Well-Being
6. ^ Organisational Capital. Modelling, Measuring and Contextualising