The VeraSage Institute, the think tank he founded with colleagues in 2001, is declared to be "free and independent from the tyranny of time," even going to the extent of writing a formal Declaration of Independence and allowing others to pledge their names to the quest.

In addition to being appointed to Accounting Today's Top 100 Most Influential People in the profession between 2001-2007, Baker is well known for his two best-selling books: Professional's Guide to Value Pricing and The Firm of the Future co-authored by Paul Dunn [see our interview].

Since the publication of The Firm of the Future in 2003, Baker has been working on a four-part book series on Intellectual Capitalism. The first book in this series is Pricing on Purpose: Creating and Capturing Value [see our interview]. His second book in the series is Measure What Matters to Customers: Using Key Predictive Indicators.

His third book comes out this November: Mind Over Matter: Why Intellectual Capital is the Chief Source of Wealth. In a conversation with SmartPros, Baker discussed this new book.

SmartPros: You begin the book with a good dose of economic and political history, and include an entire speech given by Ronald Reagan in 1988. Why did you choose to begin the book with this foundation?

Baker: The book starts with this provocative, counter-intuitive thought: "There is no such thing as a natural resource, except for the mind of man." I've always been fascinated with the economy of mind. Ever since Adam Smith refuted the mercantilist view of the wealth of nations -- that it resides in gold and other tangible items -- and economists have been teaching the physical fallacy, I've explored these topics in greater depth.

What you conclude is there is no such thing as a natural resource. Minds, ideas, imagination, and knowledge are what create all wealth. Oil is not wealth; in fact, it was a nuisance to farmers. It wasn't until man invented the combustion engine that this liquid had any value, and if we ever discover a cheaper way to power our automobiles, oil will lose value just like whale oil did in the past. The resource is the idea, not its tangible representation. Ideas have always been more valuable than their mere execution, which is why architects make more than steelworkers.

Economists who have studied intellectual capital estimate that approximately 70 to 80 percent of a developed nation's wealth resides in its human capital. That's an astonishing statistic, and I have to believe it's also true in PKFs. After all, what else do they sell?

The reason for including Ronald Reagan's May 31, 1988, speech at Moscow State University -- besides it being one of the best speeches of his presidency -- is because it does such a good job at articulating the point that mind is more important than matter. Even though the speech is 20 years old, Reagan is explaining the knowledge economy, and in effect, telling the Moscow students that their economy is destined for the ash heap of history. It's an incredibly prescient and timeless message, set in a dramatic setting of Reagan standing before an enormous bust of Lenin and a mural of the Russian Revolution. Of course, history since 1988 -- with the fall of the Berlin Wall and collapse of the Soviet empire -- has proven him right.

SmartPros: In the books in the Intellectual Capitalism Series, you propose a new practice equation which reads: Profitability = Intellectual Capital x Price x Effectiveness. We would like to examine each of the elements in a moment. But first let us understand your criticism of the traditional formula.
 
Baker: The new practice equation was an outgrowth from my teaching and studying the accounting and legal professions and how most firms operate. Since I firmly believe learning starts with theory, I have noticed most PKFs have been operating under the following practice equation for at least the past 100 years -- think of it as the firm of the past:

 Revenue = People Power x Efficiency x Hourly Rate

There are several problems with the above theory. First, since most firms have a relatively high contribution margin (revenue less direct labor costs), it gives them a false sense that any revenue is good. This in turn leads them to accept customers who are not as valuable to the firm as others, since marginally valuable customers take up a firm's precious capacity, and keep it from reserving capacity for its most valuable customers.

Second, the way most firms were built in the last century was by leveraging people, literally building a pyramid structure. As technology came on the scene -- and especially when the computer hit the desktop -- the pyramids began to flatten and firms started to leverage technology.

Third, most firms focus on efficiency by measuring such things as utilization rates and billable hours. Yet, if you study statistics going back at least 50 years, you'd find utilization rates and billable hours are within a very narrow range. In other words, whether PKFs are using a quill pen or a laptop computer, they can charge only so many hours in a year. PKFs have let efficiency retard their effectiveness, innovation and creativity. Consider Google, which provides its employees up to 20 percent free time to work on whatever projects they think will add value to its customers. It's not the most efficient scenario. I think most PKFs leaders would be horrified to implement a similar policy. Hence, PKFs are not hotbeds of innovation and creativity.

Last, the almighty hourly rate. The professions have taught approximately two generations of professionals that the only thing they sell is their time. This is unadulterated nonsense, for a very fundamental reason -- no client buys time. How can you sell something the client doesn't buy? Clients buy expectations, results, sleep, peace of mind -- not hours. The focus on hourly rates has held PKFs back from getting paid for the value they create, and that has to change.
 
SmartPros: In what ways is your new practice equation different? Why is it better?
 
Baker: The old equation doesn't explain why PKFs are successful, nor does it offer viable alternatives for leveraging the critical success factors in a knowledge economy. The new practice equation for the firm of the future:

Profitability = Intellectual Capital x Effectiveness x Price

This theory has many advantages over the old one. First, rather than focusing on top line revenue, the firm is forced to think about the profitability of each customer. Not all clients are created equal, and many firms could stand to lose up to 40 to 60 percent of their customers, and they'd be more profitable if they did so.

The firm of the future: (1) Considers the profitability of each customer. (2) Creates and sells intellectual capital. (3) Focuses on effectiveness, not efficiency. (4) Prices up front.

Second, PKFs don't sell hours. They create and sell -- and their clients buy -- intellectual capital (IC). This is a far broader view than thinking about leveraging people and hours. Microsoft didn't create the wealth it has by pricing by the hour, and I doubt Bill Gates keeps a timesheet. A firm's IC consists of three components: human capital (its people); structural capital (its systems, proprietary software, checklists, resources, etc., that enable it to perform its work); and social capital (customers, vendors, suppliers, referral sources, alumni, alliances, etc.). These components are the real levers of profitability in any PKF, not people hours.

You can't leverage an hour, nor can you create more time; time is simply time, and all businesses -- indeed, all living beings -- are constrained by it. So what? But you can create an infinite amount of IC. There are so many more ways to leverage the three components of IC, but it requires a radical change of mindset to get away from the notion that "billable hours" drive a firm's profitability. As Archimedes said, "Give me a lever long enough, and I shall move the earth." The real lever in a PKF is its IC, and my book sets out to prove that theory, both at the macro and micro level.

Third, the firm of the future will focus on effectiveness, not efficiency. There's not much the average firm can do to squeeze another 15 to 20 percent efficiency from its human capital, which are only fallible human beings, after all. The focus on billable hours has hindered PKFs from focusing on being effective with their clients. If you study surveys of how clients select -- or fire -- their professionals, efficiency is never mentioned. It is always because of outstanding service, or lack of service -- issues such as "they don't ignore me," "they are proactive in looking after my interests," "they are aggressive in helping me pursue opportunities." You can't do all of these things if you are focused on nothing but billable-hour quotas.

Last, PKFs need to recognize they are businesses just like the airlines, hotels, rental car companies, etc. Businesses have prices, not hourly rates. You'd never fly an airline that tried to charge you $4 per minute. The idea is simply ludicrous. In fact, PKFs need to start pricing up-front for everything they do, period. No more excuses. The retort that a firm can't do that because it doesn't know exactly how long it is going to take is specious. The customer doesn't care how long it takes, they only care about the price relative to the value, and they want to make that comparison before they buy, not after.

From the firm's perspective, it is much better to know the client doesn't agree with the price before they do the work, which helps it prevent committing precious firm capacity to clients who don't value the work. PKFs are subject to the same laws of economics, price, and consumer psychology as every other business.

In conclusion, I believe this theory -- and of course there is much more to it, this is just a brief synopsis -- is superior to, and will eventually supplant, the old theory.

SmartPros: You point out that GAAP is deficient at measuring intellectual capital. What do you think needs to be done to remedy this deficiency?
 
Baker: I don't think anything can be done to GAAP to make it recognize intellectual capital, for a very fundamental reason: Accounting is not a theory, it is simply a way to record historical transactions. IC requires a theory, which is why economists study this topic, not accountants. In fairness to GAAP, it was never meant to value a business, but simply record the value of transactions that already have taken place.

Take goodwill. This is simply a term accountants use to describe our ignorance. What causes a company to pay a premium over the book value of another enterprise? That requires a theory, and the accounting profession simply doesn't have the intellectual capital to answer that question. It's not that GAAP needs to be replaced, it's that it needs to be supplemented with more meaningful information regarding the future. GAAP looks backwards, as do all measurements. In order to peer into the future, you need a theory.

SmartPros: The late Peter Drucker called our times the era of the knowledge worker. How does an accountant make himself a "knowledge worker"?
 
Baker: Peter Drucker introduced the concept of knowledge workers in 1959, and PKFs have still not come to grips with the significance of this change. The biggest change is knowledge workers own the means of production in their heads, unlike the Industrial Era where tangible capital was owned by Henry Ford, etc. Today, PKFs need knowledge workers far more than knowledge workers need them, which means firms have to earn their loyalty and inspiration. Like it or not, knowledge workers are volunteers, and one doesn't micro-manage volunteers.

Like it or not, knowledge workers are volunteers, and one doesn't micro-manage volunteers.

Most PKFs still treat their people as if they were assets or resources -- look at the terms they use to describe their people -- as if they were owned and controlled like cattle. They also try to fit knowledge workers into pre-defined jobs, an idea from the Industrial Era's organizational chart. But jobs don't have value, only people do. PKFs not only have to attract talent, they have to develop and inspire them, which means life-long education, challenging and interesting work, rewarding innovation and creativity, and other such characteristics that are the ultimate arbiters of a firm's success.

Just to give you an example. We at VeraSage believe most PKFs don't have knowledge workers because their leadership treats their people more like factory workers. Here are some of the tectonic shifts that will have to take place for leaders of PKFs to reap the rewards of knowledge workers:

• Understand that knowledge workers are paid for ideas, not hours, like union employees.
• Allow at least 15 percent of knowledge worker time for innovation and creating better ways to add value to clients.
• Understand judgment and discernment are far more important than measurements in assessing performance.
• Focus on outputs, results, and value, not inputs, efforts, activities, and costs.
• Don't require timesheets that account for every six minutes of their day.
• Trust their workers to do the right thing for the firm and its clients.
• Recognize that individuals have value, not jobs.
• Allow their workers to monetize the value of their output, through profit sharing or other incentives that allocate the wealth created by minds, not machines.
• Select workers who are passionate, self-motivated, and don't need constant supervision.
• Allow knowledge workers autonomy -- that is, self governance, while holding them accountable for results.

If these criteria describe your firm, congratulations, you are a true knowledge organization. PKFs can learn from Apple CEO Steve Job's philosophy: "You cannot mandate productivity, you must provide the tools to let people become their best."

There is an old military saying that instructs that the soldier is entitled to competent command. Unfortunately, most PKFs that we have come into contact with around the world do not fit the above criteria, which is why their people function more like manual laborers -- or service workers -- than actual knowledge workers. I think it's sad -- an incredible waste of talent.

The first PKFs that truly understand the difference between knowledge workers and service/manual workers will have an enormous window of opportunity to attract, develop, and profit from their human capital investors. The PKFs that don't will continue to struggle in the competition for talent. It's the difference between remaining a firm of the past or becoming a firm of the future. The choice is yours.

SmartPros: Does Mind Over Matter complete the Intellectual Capitalism Series?

Baker: No, there is one more book, tentatively titled, The Invisible Handshake: Doing Well and Doing Good. This book will set out the moral and ethical case for capitalism by arguing that Adam Smith's Invisible Hand is really based on a handshake -- that is, trust, faith in the future, and serving others. Businesses succeed by serving others first, it's not at all based on greed, nor is it a zero-sum world.

As one who teaches ethics, I take seriously the moral misconduct of businesspeople, but also want to make the case that profits are a sign of successfully serving others, and enterprise is a serious moral calling.

SmartPros: Thank you, Ron, for taking the time to discuss your book. We remind readers that they can learn more about your "quest to bury the billable hour" at www.verasage.com, and that your new book Mind Over Matter will be available in early November at Wiley.com.