Why Intangible Assets Matter

The pandemic will further erode the importance of physical goods and that will impact jobs and corporate revenue

By Irving Wladawsky-Berger

Many are speculating about the long-term impact of the coronavirus on the economy, but they are still thinking in pre-pandemic terms. Going forward, the rise of intangible assets will hugely affect the pace of employment and corporate revenue recovery, according to several studies.

“Take all the physical assets owned by all the companies in the S&P 500, all the cars and office buildings and factories and merchandise, then sell them all at cost in one giant sale, and they would generate a net sum that doesn’t even come out to 20% of the index’s $28 trillion value,” said Epic S&P 500 Rally Is Powered by Assets You Can’t See or Touch, an article in Bloomberg published on October 21, 2020 — a day when intangible assets made up more than 84% of the S&P value.

“The rise of intangibles helps explain why many American workers have recently had it so rough, with wages stagnating and benefits disappearing,” adds the article.

And, given our increasingly digital post-pandemic new normal, we can expect the share of intangibles to go higher regardless of the GDP, “a source of deep concern for those who worry about things like employment and inequality.”

The pandemic will further erode the importance of physical assets, while accelerating spending on R&D, software, data management, IP and other intangible assets, whose share of business investment could rise by 11%, based on another recent report, When the Future Arrives Early, by Jason Thomas, of Carlyle Global Research. “Past increases in the intangible share of corporate outlays have been associated with slower recoveries in employment. If that relationship holds this cycle, a return to full employment in the U.S. may be much further off than the late-2021-or-2022 recovery in GDP.”

Intangible assets are easier to define as the opposite of tangible assets. Tangible assets are generally physical in nature, including vehicles, land, plants, equipment, and furniture, but they also include financial assets like stocks, bonds, account receivables, and cash which have a concrete contractual value. On the other hand, intangible assets are neither physical nor have a concretely specified financial value. Intangibles include patents, copyrights, trademarks, goodwill, brand value, human capital, R&D, software, and data. Despite having no physical existence, intangibles have a monetary value since they represent potential revenue, but that value must be established based on accounting principles. And, unlike tangible assets, intangibles are difficult to value and insure.

Exploding Growth

According to a 2019 research report by the Ponemon Institute, the value of intangible assets has truly exploded over the past several decades, right along with our increasingly digital economy. The Ponemon report lists eight categories of intangible assets: Intellectual Property; Brand; Public or Government-controlled Rights; B2B Rights; Data; Hard Intangibles, such as goodwill, software licenses, and internet domains; Relationships, and Non-Revenue Rights.

In 1975, the overall value of the S&P 500 was $715 billion, of which 17% was intangible. In 1985, out of a total value of $1.5 trillion, 32%, or around one third was intangible. By 1995, the percentages had switched, with intangibles now being 68% of $4.6 trillion.

Intangible values continued to climb to 80% out of $11.6 trillion in 2005; and to 84% of $25 trillion in 2018.

Further evidence of this intangible asset revolution is that in the industrial economy of the 19th and 20th Centuries, the largest companies by market cap were mostly based on manufacturing and oil extraction — with IBM, Exxon Mobil, Procter & Gamble, GE, and 3M the five largest in 1975. But by 2018, the five companies with the largest market caps were Apple, Alphabet, Microsoft, Amazon, and Facebook. Raw materials, physical plants and inventory are far less of a factor today than in the past.

Even firms in classic physical industries now rely more on intangible assets like intellectual property, software, data, marketing and brand reputation.

In his 2019 book More from Less: The Surprising Story of How We Learned to Prosper Using Fewer Resources, MIT’s Andrew McAfee wrote that the very nature of technological progress has been radically transformed over the past several decades. “We invented the computer, the Internet, and a suite of other digital technologies that let us dematerialize our consumption: over time they allowed us to consume more and more while taking less and less from the planet. This happened because digital technologies offered the cost savings that come from substituting bits for atoms, and the intense cost pressures of capitalism caused companies to accept this offer over and over.”

Post-pandemic Possibilities

The impact of the pandemic varied considerably across industries.

The pandemic has exacted a heavy toll on businesses based primarily on physical, tangible assets, such as restaurants, hotels, live events and travel. Earnings in these sectors dropped by 50% or more while businesses based on digital, intangible assets have been able to adapt surprisingly well.

“Within a matter of weeks, various companies of all sizes and complexity levels found that they were able to meet or exceed pre-pandemic business volumes with their employees working on a remote basis.”

Let me summarize the key takeaways of Carlyle’s whitepaper.

• The post-pandemic new normal will not be a reversion to the status quo. Future business conditions are unlikely to resemble those prevailing prior to the pandemic. “Recovery connotes a reversion to normal, but rather than a simple and swift return to pre-pandemic conditions, this recovery will be a longer-term process of adaptation and reinvention.”
• So far, the economic impact of the pandemic has differed primarily by industry sector. But within two years the key difference will likely be between companies within an industry sector, as some prove better at digital transformation than others, and some management teams focus on reinventing their business models and strategies “while others endeavor to return to January 2020 levels with only minor adjustments.”
• “As the pace of digitization accelerates, investors should consider the differences between business models rather than differences between industries,” the Carlyle whitepaper concludes. “In hindsight, 2020 may be the year that technology stopped being thought of as a sector in its own right and more of the key differentiator between all companies irrespective of industry.”
• “Rather than a temporary blip that quickly recedes from memory, the coronavirus recession will impact economic and financial conditions for some time to come. Recessions often take on lives of their own. Many corporate executives will use this time as an opportunity to rethink and re-imagine their businesses in ways that accelerate the pace of digitization and cause more investors to categorize in terms of business models rather than industries.”

This blog first appeared January 16 here: https://blog.irvingwb.com/blog/2021/01/the-intangible-asset-revolutino.html