The study is aimed to be meaningful for hotel managers and other industry players and decision makers. The effects of investment extend into the future and have a decisive influence on the rate and direction of firm’s growth. Wrong capital allocation leads to undesirable and unprofitable expansion of assets, what results in high operating expenses. So, wrong investment allocation would not let the firm to maximize profitability, be competitive to its rivals, maintain market share, etc. This study is important, because it helps decision makers to avoid wrong investments through identification of relevant intangible assets that are essential and consistent with the firm strategy. The study contributes to financial performance enhancement of a company.
The study contributes to the external investors through providing them with the intangible assets' “missing” information. Since traditional accounting rules measure only tangible assets, firm’s real value cannot be evaluated correctly, allocating more to the shareholders and influencing potential investors’ decision making. Current study aims to explain the impact of intellectual capital on financial performance of a firm, hence contributes to determine a more accurate measure of the long-term value of lodging industry players.
Finally, current research is important for Taiwanese economy in general. Service sector in Taiwan was accounted for about 67% of the country’s GDP in 2010.
Tourism industry is the fastest rising one (YOY 25% since 2009) and one of the largest portion of all tourism expenditure was on accommodation 9.06%. So, investment decisions of various hoteliers would have an effect not only on a particular firm, but whole industry, its development and country’s profitability.
Key Words
Intellectual Capital
Intellectual capital can be represented by knowledge, information, intellectual property, experience and other knowledge-based items that can be put to use to create
wealth (Stewart, 1997). According to Sveiby (1997) and Magrassi (2002) it is the difference in value between tangible assets (financial and physical) and firm’s market value.
Structural Capital
Structural capital, also often named as systems capital (or process capital) may be developed by a firm internally or acquired externally. Structural capital represents the codified knowledge bases that do not exist within the minds of employees, e.g.
databases, filing cabinets, organizational routines (Bontis 1996).
Customer Capital
Defined by Bontis as relations capital, it incorporates connections outside the organization including the knowledge embedded in customers, suppliers, related industry associations, and everyone it takes to attract and retain loyal customers (Choo and Bontis, 2002).
Human Capital
According to Bontis (2002) human capital embodies the knowledge, talent and experience of employees; it is a source of innovation and strategic renewal; is the profit lever of the knowledge economy.
The concept of human capital recognizes that not all labor is equal and that the quality of employees can be improved by investing in them. The education, experience and abilities of an employee have an economic value for employers and for the economy as a whole (http://www.investopedia.com/terms/h/humancapital.asp).
Strategic Orientation
According to Porter (1991), strategic orientation is a combination of the goals for which the firm is striving and the means (policies and actions) by which it is seeking to achieve its targets.
Strategy denotes the firm's position in its industry. Two orientations were identified by Porter (1991), which are: low-cost leadership and differentiation. Low-cost leadership reduces costs below those of competitors for a given level of quality.
Differentiation champions developing products that customers value and that rivals
find hard, if not impossible, to match or copy. Differentiation accelerates innovation, whereas cost leadership champions efficiency (Daniels, Radebaugh, Sullivan, 2013).
Lodging Industry
Lodging is a sub-category of hospitality industry that mainly includes different types of accommodation, in the root it is a set of products and services that have evolved out of guest needs and preferences (Clayton and Powers, 2008).
1.6 Taiwan Tourism Industry Introduction
Tourism in Taiwan is becoming more and more attractive topic to discuss for economists and business people. Presented recent growth rate make tourism one of the fastest rising industry. In 1976 Taiwan welcomed its first million visitors, in 1989 two million visitors arrived, in 2005 the number reached three million visitors mark, then year 2009 surpassed four million mark, in 2010 and 2011 – Taiwan welcomed six and seven million visitors respectively and reached average 25% growth rate year over year (Tourism Bureau, 2010). It is obvious that tourism industry in Taiwan is gaining momentum and clarifying its position on the international arena.
The main purpose of international travellers visiting Taiwan is tourism and pleasure.
This sector has grown by 48.8% since 2006 and reached 4,677,300 visits (64% of total number) in 2012. Taiwan considered to be a country with high-tech technology, so it has another very important group of visitors for both Taiwanese economy and lodging industry - business people, who travel constantly to Taiwan on continuous basis rather than one time for tourism purpose. Hotel stay satisfaction results in loyalty to accommodation provider and increases the chance for future retention.
However, it is not only foreigners who are traveling in Taiwan, Taiwanese nationals also travel domestically: in 2010, locals took 120 million domestic trips, spending
$23.81 billion on travel-related activities, while more than NT$27.59 billion was generated in foreign receipts, meaning that local travelers’ segment plays an important role in Taiwanese tourism industry. Hence, total contribution from tourism sector was 51.4 billion NTD in 2010.
The largest portion of all tourism expenditures was on transportation (32.28%), followed by shopping (24.06%), dinning (21.89%), and accommodation (9.06%). So, 4,656,800,000 NTD (NTD 51.4billion x 9.06%) were generated by Taiwanese hotels in 2010, proving that hospitality industry plays an important role in Taiwan’s inbound market.
To sum up, tourism industry is an important economic influencer and a profitable business in Taiwan, so the current thesis contribution would be meaningful. With the growing tourism and increasing inbound visitors, hotels quantity in Taiwan would increase, however simultaneously lodgers should pay more attention to service quality and maintain it at a certain level. It should be kept in mind that a current traveler is more experienced, more demanding and possesses higher expectations in terms of value for money. Hence, Taiwanese government together with hospitality players has to develop a professional and competitive service with well-trained, courteous and attentive human resources, who would be supported by organizational structure and systems.
1.7 Taiwan Service Industry Introduction
The service sector, including the hotel industry, has been the main contributor to the growth of the Taiwanese economy during the last decade. According to the Council for Economic Planning and Development (CEPD), the service sector in Taiwan has largely accounted for a New Taiwan (NT) dollar at $9.1 trillions consisting 67.1% of the country’s GDP in 2010. Service sector has become the main body of Taiwan’s economic activities as well as the most important source of jobs (providing 58.8% of the overall number of employment).
Besides, among Taiwan’s service industry development plan are such strategies as enhancement of the international competitiveness of Taiwan’s service industries and creation of differentiated services. Government realizes that achievement of these goals would greatly depend on the workforce and human resource development at a certain quality. So, strengthening talent cultivation, promoting service industry-related academic courses, increasing the practical content and reinforcing job-skill training in
schools, enhancing foreign-language capabilities are some objectives to improve the quality of human capital thus provide sustainable competitive advantage for Taiwan’s lodging and service industry in general (CERD, 2009).
Service and especially hospitality industry has its own specialties: working environment, everyday uncertainty, dealing with dynamic changes, facing different clients with similar and unfamiliar cultural backgrounds - all these demand lodging firms to create unique organizational culture and climate, and managerial efficiencies to get over work situations. Those climate and efficiency could be reached only through implementation of hidden assets, which cannot be duplicated easily and eventually lead to competitive advantage. For lodging industry, innovation and competitive advantage come from intellectual capital (Saldamli, 2008, p.351; Lee and Ghiselli, 2010).
1.8 Taiwan Lodging Industry Introduction
According to King (1995) hospitality is characterized by a mixture of tangible and intangible products, interpersonal relations and simultaneous production or delivery of service. He highlights the significance of employee service orientation in the industry.
Hospitality is a broad category of fields within service industry, which includes lodging, food and beverage (F&B), event planning, cruise line and other fields within tourism industry. (http://en.wikipedia.org/wiki/Hospitality_industry)
Lodging is a hospitality’s sub-category that mainly includes different types of accommodation. In the root, it is a set of products and services that have evolved out of guests’ needs and preferences (Clayton and Powers, 2008, p. 265). People who travel and stay away from home for more than a day need lodging for sleep, rest, safety, shelter, storage of luggage and access to common household functions (http://en.wikipedia.org/wiki/Lodging).
In 2011 Taiwan lodging industry was represented by 106 hotels with total amount of rooms equal to 50,666. Among the upper mentioned hotels 70 are international middle
and higher scale hotels and 36 are standard tourist hotels (home stays, guesthouses, youth hostels) (Tourism Bureau, 2012).
Due to current industry position and importance to country’s development, lodging industry was selected as the setting to this study. Besides, it provides an opportunity to discover the importance of intellectual capital investment identified in the previous studies as significant to hospitality industry players. Furthermore, lodges are using uniform system of accounts for hotels, making it possible to acquire an identical breakdown of expenses by department across individual hotels, which are critical resources to conduct this study. Plus, this enabled researchers to minimize data bias.
Chapter Two Literature Review
The following chapter briefly describes relevant to this research concepts, covering customer capital, human capital, structural capital, and different types of intellectual capital interactions, also differentiation and low-cost leadership strategic orientations.
2.1 Studies on Intellectual Capital
Intellectual capital has been firstly defined by Stewart in 1997 as "the intellectual material - knowledge, information, intellectual property, experience - that can be put to use to create wealth." In 1998 The Society of Management Accountants of Canada defined intellectual assets as “those knowledge-based items, which the company owns which will produce a future stream of benefits for the company”. Later, in year 2000, Dzinkovsky would say: “Intellectual capital can be thought of as a total stock of capital or knowledge-based equity that the company possesses.” According to Bontis and Fitz-Enz (2002), effective management of intellectual capital assets will yield higher financial results.
In our research, we would adopt the three-category classification model taken from Bontis (1998), who states, that intellectual capital consists of human capital, structural capital and customer capital. Intellectual assets are highly distributed, difficult to find and prone to leave. They are in peoples’ heads, in employees’ notes, in memories from past experience, on computer discs and in networks. However, combination of human assets and company structures is critical; intellectual capital includes the access to and the use of all employee knowledge and applied experiences and also the company’s organizational structure, technology and systems. Without structure human being is notably less effective and efficient at wealth-creation (Bradley, 1997, p.58). Besides, structural capital belongs to the organization as a whole. It can be traded, it is kind of “tangible” intangible asset, something that can be shared and reproduced at large scale and relatively low cost, it also stays with organization,
whereas human capital is the source of innovation and stays with the employee and his individual knowledge/ skill/ talent. Thus, human capital doesn’t belong to the company and cannot be replicated. However, based on Edvinsson and Malone (1997) example of Skandia Navigator case, human capital is still the heart of an organization, while systems capital and customer capital are its walls:
Figure 2.1
Relationships between different types of intangible assets
Source: Skandia Navigator (Edvinsson and Malone, 1997)
Later in 2000, Fitz-Enz would say that accounting function (accounting focus in Skandia Navigator case) is only telling the state of past financial health, but it says nothing about the future. To see the future, we need leading indicators, which are able to create competitive advantage and enhance firm’s future financial performance.
Bontis also mentioned that, the three constructs that make up Intellectual capital are known to affect each other positively. In other words, an intellectual employee (human capital) is practically useless without the supportive structure of an organization (structural capital) that can utilize and nurture his or her skills. Rudez H.N. and Mihalic T. in 2007 demonstrated that the connection between human and structural capital in the hotel industry is stronger than any other capital combinations.
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They have also shown the impact of structural, human, end-customers and non-end customers on financial performances. Their research has also shown that very well developed non-customer-relationship capital has the strongest connection to end-customer-relationship capital (business partnership impact on customers’ wants and requirements, where business partners are commercial partners, governments, tourism promotion organizations, the media, etc.), which is in turn strongly connected with the firm’s financial performance (Rudez, Mihalic, 2007, p. 198). The following is more specific and deep introduction of tree-category intellectual capital classification.
2.1.1 Introduction to Customer Capital
Customer (relational) capital incorporates connections outside the organization including the knowledge embedded in customers, suppliers, related industry associations, and everyone it takes to attract and retain loyal customers (Choo and Bontis; Walsh , Enz and Canina, 2008). However to create, accumulate and leverage linkages and relationships to external marketplace entities is not that fast or easy. The process addresses all aspects of identifying customers, creating customer knowledge, building customer relationships through service programs development and execution, and shaping their perceptions of the organization and its products (Srivastava, 1998).
Strong, favorable, and unique firm associations in customer’s memory are able to influence his decision-making process and result of it. It usually occurs if a company develops customer-based brand equity. Brand, according to American marketing association dictionary (AMAD), is the “name, term, design, symbol, or any other feature that identifies one seller's good or service as distinct from those of other sellers” because of customer’s brand knowledge (including brand awareness and brand image). Fundamentally, it produces greater consumer, because favorable beliefs and attitudes for the brand are manifested in repeat buying behavior, so it increases profitability through enhancing revenue; and conclusively decreases vulnerability to competitive marketing actions (Keller, 1993 p. 8; Park, 1991). Besides previously mentioned benefits, brand affects consumer’s willingness to pay a price premium for product/service, so provides owner with a higher margin (Wu, 2010; Netemeyer, 2004; Srivastava, 1998) making it a must-have in hospitality industry.
However to build a brand with attachment, trustworthiness, consumer added value and respectable social image takes long time, so in order to save on opportunity costs and obtain an immediate access to unique, positive brand identities, image, associations, awareness and reputation, hotels enter into franchising contracts. Keller found that acquiring brand identities, such as brand name, symbol or logo, hotel immediately increases its awareness, which greatly effects consumer decision making, because firstly, consumer correctly generates a brand from memory when thinks about product category, so having a brand with high awareness increases the likelihood that the brand (and the hotel) would be among members of a consumer’s consideration list. Secondly, awareness helps consumers correctly discriminate particular brand from other competitors. Furthermore, customers’ lack of consumer motivation (in a business trip, when company is paying for a hotel, when hotel is just a necessity - a place to sleep) or lack of consumer ability (when consumer doesn’t know anything about other brands or a place he is going to) results in consumer low involvement.
Previous studies suggest that consumers are likely to base their choices on brand awareness considerations under low involvement circumstances. Finally, brand awareness influences the formation and strength of brand associations in the brand image. In summery, customer-based brand equity plays a very important role in a product/service life, and franchising or acquisition of a brand with strong positive associations simplifies life of a company greatly.
In hospitality industry, a hotel can affiliate ten-year Holiday Inn brand for Total Royalty Fee USD 2,451,752 on its property. With this contract it purchases assess to Holiday Inn’s name, logo, goodwill, marketing, customer relationship management, referral and reservation systems, but what is very important is it gets access to its brand awareness and customer’s recognition through Holiday Inn logo (Rushmore, 2009), so market acceptance time is reduced (hotel owner benefit), simultaneously customer solution development cycle time is minimized (customer benefit).
From a financial point of view, strong customer capital contributes to greater customer loyalty leading to high retention rates, hence lowering cash flow vulnerability, risks, and, therefore, lower costs of capital and higher price-earning multiples (Srivastava, 1998). The recognition of customers, brands, loyalty programs as market-based assets brings a question weather marketing expenditures should be
treated as operating expenses or capital investments (Srivastava, 1998). In this research we agree with the previous studies and are to raise the same question if advertisement, marketing and brand costs should be in an expenses category or should be recognized as an investment. Besides, marketing expenditures have return, which is shown in the future revenues and cash flows, however it has never been studied or calculated as a return, because “Customer Capital Investment” category has never existed.
2.1.2 Introduction to Systems Capital
Structural capital is “the embodiment, empowerment, and supportive infrastructure of human capital”, is where the value added by the nonlinearities of the knowledge creation process is assumed to reside (Edvinsson, 1997; Bontis, 1998). Structural capital is everything in an organization that supports employees (human capital) in their work. It is a nonhuman stock of codified operational knowledge which helps to plan, organize, lead and control the staff to deliver promised service to a client.
Structural capital includes hardware, software, processes, patents, organizational culture, information system, proprietary databases, etc. According to Bontis, it is structural capital that allows intellectual capital to be measured and developed in an organization.
Theoretically, structural capital, also often named as systems capital (or process capital) may be developed by a firm internally, however to build systems capital requires a long learning scale, hence the majority of lodging industry members- property owners acquire structural capital through contracting external management providers. The length of management contract may vary from 5 to 20 years.
Management company receives a base fee (3-5% of total revenue regardless net operating results because they are nonprofit guarantee contracts), brand fee (depends on number of rooms), incentive payments (3% of gross operating profits), sales and marketing fees, training fees, reservation fees, and salary packages for expatriate managers, so at the end of the day, the sum is pretty big. For hotel owners, management contracts even though often criticized for being too expensive, give access to the global distribution system, reservation referrals from the management parent company, well-recognized brand name, standard operating procedures (SOPs)
and management expertise. Yet trends are changing, owners are becoming more experienced, thus more powerful negotiators. To decrease the gap between payment fee and obtained value, they now ask management contractors to take bigger risk responsibility through adjusting percentage distribution of a base fee and incentive payments, hence turn the agreement to being more advantageous to property owners (Enz, 2002, p 952).
To illustrate managerial contract, an example from Hong Kong hospitality industry is provided:
A hotel management company Marco Polo Hong Kong Management Limited (MPHML) and The Hong Kong Hotel Limited (HKHL) entered into the “Hotel Management Agreement” dated 2 April 2007, for the appointment of MPHML as the
A hotel management company Marco Polo Hong Kong Management Limited (MPHML) and The Hong Kong Hotel Limited (HKHL) entered into the “Hotel Management Agreement” dated 2 April 2007, for the appointment of MPHML as the