MISSION INTANGIBLE

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MISSION:INTANGIBLE, the blog of the Intangible Asset Finance Society, offers critical comments on intangible asset, corporate reputation, and finance; supplemented by quantitative reputation metrics. Intangible assets include business processes, patents, trademarks; reputations for ethics and integrity; quality, safety, sustainability, security, and resilience; and comprise 70% of the average company's value. MISSION:INTANGIBLE is a registered trademark of the Intangible Asset Finance Society.

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McDonald's: Fear, uncertainty and doubt

C. HUYGENS - Thursday, October 23, 2014
McDonald's stakeholders need to hang on to more than a burger. The once-simple business model of innovative delivery of a simple menu at a fabulous price in a clean and secure environment has been under attack from so many quarters for so long that it is leaving stakeholders worried. The jump in the value risk (VR) metric below since August reflects this fear in much the same way that the Chicago VIX does.

McDonald's is a firm that achieved greatness through supply chain innovation, product innovation, real estate management innovation, workforce innovation, and marketing innovation. It stands to reason that one way out of this quandary of stakeholder uncertainty is to meet their expectations for -- innovation.

Consensiv's Jonathan Salem Baskin, writing for Forbes, states, "It’s hard to remember, but McDonald’s started out as the disruptor in its industry. Its innovations were many, ranging from standardized, efficient experience in menu and restaurant design, to great marketing. McDonald’s perfected, and then consistently improved the Holiday Inn model that allowed it to blow up thousands of quirky and sometimes risky hamburger stands, and replace them with food that was reliably good in restaurants that were consistently fine."

The bottom line: McDonald's should "…disrupt the industry completely, by flexing its resources muscles and embarking on changes that its competitors couldn’t copy or catch, and for which its customers would pay."

Read more at Forbes.

McDonald's and Yum: Deserving a break today

C. HUYGENS - Thursday, August 14, 2014
On Sunday, 20 July, Dragon TV of Shanghai, China, precipitated a reputation crisis at two global companies. The TV station reported that food supplier Husi, owned by OSI Group of Aurora, Ill., repackaged stale beef and chicken, updated the expiration dates, and sold the adulterated meat to McDonald's, KFC and Pizza Hut restaurants.

A reputation crisis begins when a company fails properly to set expectations or fails to meet them, and then stakeholders turn on a company and lower their expectations. The going-forward economic consequences result from how customers thereafter respond to prices, how effectively employees work, creditors set borrowing rates, suppliers set terms, and how severely regulators impose penalties.

For Yum Brands and McDonald’s, the changes in stakeholder expectations are  reflected in customers’ reduced demand--or at least some analysts expectations of  future customer behavior. Royal Bank of Canada analysts projected that Yum’s China sales at KFC and Pizza Hut could drop off 10-15% for at least 6-8 weeks after the July event. An executive at McDonald’s Japan reported a 15-20% drop-off in daily sales. Forward-looking equity investors are seeing more sustained losses. Between July 15 and August 14, Yum! Brands equity lost 15% of its value; McDonald’s shed around 7%, and the benchmark S&P500 composite equity index lost about 1.2%.

[Added Saturday 16 Aug] A more encompassing view of expected stakeholder behavior shown below, according to analysis published by Consensiv, the reputation controls company, based on reputation value metrics we use at Steel City Re, affirms that all-things-reputationally at McDonald's are not as bleak as equity investors might be signaling. The company's reputation premium is near the top (and heading upward), and its value risk is in the lowest quartile of its peer group.

This Week at Lake Reputation-be-gone

C. HUYGENS - Friday, July 25, 2014
"It was hardly a quiet week at Lake Reputation-be-gone," Garrison Keeler might have said. "Walgreen, McDonald's & Yum!, and current poster-child GM had their respective moments in the sun...again."

Walgreen's issue is an ethical one. The company whose motto proclaims it to be "the pharmacy that America trusts" would just as soon not pay America $4 billion in taxes over the next five years. The company is now deciding whether to take advantage of the US tax law loophole that would reward it substantially with a lower tax base were it to acquire controlling interest in a Swiss-based company and nominally relocate its headquarters overseas.

McDonald's and Yum! were apologizing for supply chain issues that again raised questions of food quality and safety in the Chinese operations. Earlier this week, Chinese regulators closed the Chinese division of an Illinois-based good supplier (OSI) after a TV report showed workers picking up meat from a factory floor and mixing expired lots with fresh lots of meat. Upton Sinclair would have been proud.

GM announced six additional automobile recalls this week bringing its total for the year to 60 announcements covering 29 million cars worldwide. Quality and safety issues are at the forefront, but they are not all associated with supply chain failures. Some, in fact, are due to assembly and integration issues in GM's wholly-owned operations.

As is the case after every major operational issue, the press is making much ado about the damaged reputations of these firms. The events are certainly news-worthy and embarrassing. Whether they cause stakeholder to reassess their respective relationships with the companies, however, is the central issue in a reputation crisis.

Walgreen's issue is unlikely to have any effect on most stakeholders. Equity investors will be thrilled, and creditors equally so. Legislators are unhappy, but it is not clear their opinion matters much since they have proven their inability to do much of anything.

This is Yum!'s second bout of China-related supply chain safety and quality. The toxic chickens of 2012/2013 gave them quite a reputation scare, which is why they may have dumped OSI like a hot pan. McDonald's is new to this type of crisis and is sticking with OSI. Also, McDonald's maintains qualitatively different types of relationships than Yum! with its suppliers. By forgiving OSI, McDonald's is demonstrating the benefit of OSI's historically stellar reputation…to OSI.

GM is now in a league of its own. Credit the company with fabulous spin control by declaring that Wednesday's additional recalls signified how the company had enhanced its approach to safety.

Yum: Tasting better

C. HUYGENS - Wednesday, March 13, 2013
Whether the market rewards or punishes a company depends on what the market expects, according to the book Reputation, Stock Price and You. This week's news on YUM! Brands is illustrative.

From Reuters, good news as sales only fell 20% as a result of the toxic chickens disclosure.

KFC parent Yum Brands Inc reported an unexpected 2 percent rise in February sales at established restaurants in China, boosted by Chinese New Year and easing worries about a food safety scare that drove away customers. Shares in Yum jumped 6.6 percent in extended trading to $72.32, their highest level since November, after the results were far better than the estimated 8.7 percent drop expected by three analysts polled by Consensus Metrix. Yum also said on Monday first-quarter same-restaurant sales in China fell 20 percent, less than its prior forecast for a 25 percent drop.


Also from Reuters, more good news as Chinese appear to be less overtly angry -- or at least they're not talking about it.

Chinese consumers' anger at KFC over a food safety scare has abated as the number of negative posts about the fast food chain owned by Yum Brands Inc on the country's most popular microblogging platform fell by two-thirds. China's half a billion microbloggers posted 3 million overwhelmingly negative comments about KFC in the month that began on Dec. 18, when state media started reporting on the scare over contaminated chicken, a Reuters review of data from the Twitter-like platform Weibo shows. The number fell from Jan. 18 to Feb. 18, but microbloggers still posted more than 1 million comments on KFC, indicating that the largest foreign fast food chain in China still has its work cut out for it as it tries to reverse a steep sales slide.

The Steel City Re reputational value metrics provide an integrated view of expectations and the economic consequences of the behaviors arising. The data on YUM show that the company's arch rival, McDonald's (MCD) has benefited from the turmoil. By all of the reputational vital sign measures, MCD advanced. Both companies are at the low end of the spectrum of historic RVM volatility. RVM is a non-financial measure of reputational value. The absolute measures are in the 4-5% range, which on an actuarial basis place YUM at an imperceptibly  higher risk of material future market value loss. The current RVM volatility of MCD is also greater than YUM and is attributable in part to the significantly greater rise in ROE. The levels for MCD and YUM on the former measure both suggest a better than average future course. On these two measures, as well as the CRR, a measure of relative reputational ranking, MCD has benefited from YUM's slide. Going forward, the data suggest that many customers will come back. It is not clear, however, if equity investors are not getting to far ahead --  a variation on a parent's admonition take care lest one's eyes turn out to be bigger than one's stomach.

YUM!: Food safety issue comes home to roost

C. HUYGENS - Wednesday, February 06, 2013
Everybody has problems. Boeing has an airplane problem. Tesco has a hamburger problem. And YUM! has a chicken problem. Three different commercial sectors each with quality problems, often leading to safety issues, with one common element. All of the problems originated within the companies' supply chains, comprise failures in operational oversight and control, and have the potential for blossoming into full-on reputational crises.

Reputational crises are expensive. Customers slow down their purchase frequency and extend the their purchase decision cycle, to say nothing of their resistance to premium pricing. But the pain goes further. Vendors offer less favorable terms; creditors raise the cost of capital, employee turnover is but one indicator of morale problems that start brewing, NGOs take interest, and regulators start paying more attention. And of course, equity investors, who have the shortest fuse, sell. That is why Huygens prefers to call them, "reputational value crises."

CNBC reported yesterday that Yum Brands, the parent of restaurant chains Taco Bell, KFC, and Pizza Hut, reported surprise weakness in China. "This skews to the worst case for the company," said David Palmer, managing director and senior food & restaurant analyst at UBS, who covers the company. China represents almost half of the business, in profit terms, for the company, he said in an interview on CNBC's "Squawk on the Street."

Forbes reported, "At YUM’s analyst day on December 6, 2012, we asked CEO David C. Novak what his “defense” was to media exposes that one of KFC China’s suppliers had pumped its chicken full of chemicals to expedite their growth. The story prompted a furious social media reaction. His answer was “No worries. It will blow over.” When asked how, he shrugged: “It always has.”

Turning to a measure of reputational value, the Steel City Re reputational value metrics, the measures for YUM! in contrast to McDonald's, the sector reputational leader, are informative. The problem, it seems, hasn't blown over. The company's reputation ranking is sinking steadily and the forecast last week as shown below, before this week's news, was for further deterioration. The steadiness of the deterioration was suggested by the RVM volatility measures and the median forecast stability numbers. RVM, as Huygens' followers know, is a non-financial measure of reputational value.

YUM!'s loss would reasonably be expected to by McDonald's gain. MCD, with a CRR, a measure of relative reputational ranking, buried at 1.0 for the sector, could only gain in RVM.  MCD's RVM volatility suggests this is the case, and not surprisingly, its ROE has been climbing as YUM!'s has been sinking. 

The moral: supply chains are great sources of cost savings, value, operational risk, and reputational value risk. Their operations need to be overseen and controlled no less so than organic operations. And if the excuse is that the whole point of outsourcing was to reduce the costs associated with organic controls and oversight, well, then, add that sentence to the ever-growing collection of things that seemed like a good idea at the time.


YUM! Brands: Toxic chicken

C. HUYGENS - Tuesday, January 08, 2013
Shares in YUM! Brands fell earlier this week, but the Steel City Re Reputational Value Metrics show that the damage was done some weeks ago (see spike in chart column 2, row 1). This sudden upwards movement in the company's Current RVM volatility was triggered by news reports that the chicken in the company's flagship product, KFC, was contaminated.  RVM, a non-financial measure of reputational value, is volatile. Spikes in volatility are often associated with subsequent sharp market value changes. The charts compare and contrast YUM! with McDonald's Corporation, a premier manager of supply chains described further in the book, Reputation, Stock Price and You.

Back to our toxic chickens. As the FT explains:

In November, Chinese media accused Su Hai Group, one of the chicken suppliers to KFC (Yum’s flagship brand in China with 3,700 outlets), of injecting antiviral drugs and growth hormones into poultry in ways that violated mainland food safety regulations. This was followed by a CCTV report a month later that accused another KFC supplier, Liuhe Group, of similar practices that helped accelerate the growth cycle of the chickens from 100 days to just 40 days. Shortly after the TV report aired, the Shanghai Food and Drug Administration (SFDA) said it found that eight of the 19 batches of chicken samples Yum sent to a testing laboratory in 2010 and 2011 contained overly-high levels of antibiotics.


McDonald's: Receives a break

C. HUYGENS - Tuesday, December 11, 2012
The Wall Street Journal reported yesterday that McDonald's Corp. (MCD) surprised investors by reporting higher November sales. Analysts, according to the Journal, remain cautious about the months ahead. Credit for the gain goes to the Company's Dollar Menu which "helped reverse a downward slide from the month before, when McDonald's posted the first drop in monthly same-store sales in nine years. Same-store sales globally rose 2.4% in November, fueled by a 2.5% rise in U.S. same-store sales. Analysts were expecting sales to be flat around the world."

McDonald's can afford to deliver its Dollar Menu because the company runs one of the best supply chains in the world. As described in Reputation, Stock Price, and You, "[McDonald's] approach to its relationship with suppliers reflects its ethical culture and the innovations Kroc brought to the business." Among the benefits of the Company's strategy are net lower costs--benefits the suppliers grant McDonald's that we now call reputaitonal value.

Turning to the Steel City Re Reputational Value Metrics, the improved returns are obviously welcomed, but are less surprising. For the trailing twelve months, McDonald's has steadily ranked #1 among the 64 companies in the Restaurant and Fast Food Franchisers sector.


Weighing in at more than twice the size of its closest competitor, YUM! Brands, the company has to work much harder to grow. However, its phenomenal operational controls mitigate risks that might cause it to stumble, so when its CRR--a measure of relative reputational ranking-- hugs the #1 spot for a year while its ROE plummets, one can reasonably expect a turnaround. The data forecast a steady state for McDonald's with respect to key reputational metrics, the RVM and the CRR. And so while Yum! enters a turbulent reputational period, expect McDonald's equity investors to relax and return to the fold.


Nokia vs. Apple: Yearning for a bite

C. HUYGENS - Thursday, February 17, 2011
On Monday 14 February, Barron’s released its list of the world’s most respected companies. Apple (NASDAQ:APPL) tops the list at #1 yet again. And lest your curiosity be left hanging, finishing off the top 5 are Amazon (NASDAQ:AMZN), Berkshire Hathaway (NYSE:BRK), IBM (NYSE:IBM) and McDonald’s (NYSE:MCD).

And then there is Nokia (NYSE:NOK), the world’s biggest telephone handset-maker. Quotes the Economist, “We are standing on a burning [oil] platform,” Nokia’s CEO, Stephen Elop, wrote in a memo to all 132,000 employees. If Nokia did not want to be consumed by the flames, it had no choice but to plunge into the “icy waters” below. In plainer words, the company had to innovate -- quickly.

The value of Apple’s reputation for innovation, earned by actually being innovative, is that while the most respected company in the world only commands 4% of the telephone handset market, it commands 50% of the profits. That's pricing power, a benefit of a superior reputation, in the extreme.

Turning to the reputation metrics, Apple’s popular standing is reflected in its stable top ranking in the Steel City Re Corporate Reputation Index. Over the trailing twelve months, it has made the jump from the 97th percentile to the 100th percentile among the 51 companies in the Electronic Data Processing Equipment sector, and over the past six months, it hasn’t budged from that spot. Its corresponding trailing twelve month return on equity is 58.63% greater than the median of its peer group, its EWMA volatility is 1%, its trailing twelve week reputation velocity is 0.0, and its trailing twelve week reputation vector is undefined.

Its peer group shows a U-shaped drop and recovery in reputation standing relative to the market as a whole, and the intra-sector volatility is at the upper end of average. Significantly, the intangible asset fraction of the group has been progressively rising these past 12 months.

Nokia should wish for such metrics. Over the trailing twelve months, it has dropped from the 36th percentile to the 19th percentile among the 30 companies in the Diversified Electronics sector. Its corresponding trailing twelve month return on equity is 52.22% below than the median of its peer group, its EWMA volatility is 2%, its trailing twelve week reputation velocity is -10%, and its trailing twelve week reputation vector is -.8% which is a material level.

Its peer group shows a slight rise is reputation standing relative to the market as a whole, and the intra-sector volatility is at the low end of average. Last, its intangible asset fraction has dropped from 86% to 78% of market capitalization while the median of its peer group now stands at 88% of market cap.

Mr. Elop believes that one advantage Apple has over Nokia that he believes he can overcome is its access to the innovative genius that is resident in Silicon Valley. Stay tuned, as Finland comes to California.

Dominating Dominos

Nir Kossovsky - Tuesday, September 08, 2009

Copious amounts of ink and countless electrons have been deployed in the debate over the commercial impact of social media. The debate? Yes, there are contrarians such as Jon Baskin, a speaker at our 2008 fall conference, who discount much of the power attributed to social media venues like Facebook and Twitter. While wary, we are slowly being persuaded.

Consider the case of Dominos Pizza (NYSE:DPZ). In late May, we analyzed the affair where employees of a franchisee disparaged Domino’s reputation through YouTube. In short, they challenged the quality of the product. In as much as quality is a life-supporting intangible asset, we saw this as a reputation body blow; and so did a good part of the mainstream business media.

We were wrong. We succumbed to conventional wisdom, when we should have equivocated. After all, the Steel City Re Corporate Reputation Index reported a steady climb in Domino’s reputation ranking for the preceding 8 months indicating the potential for outperformance going-forward, or at the very least, some degree of resilience. The index beat our gut instincts.

In our May 27 note, we compared Dominos to the three highest ranking firms among 47 in the Restaurant sector, Panera Bread Co. (NASDAQ:PNRA), McDonald’s Corp. (NYSE:MCD), and Chipotle Mexican Grill Inc. (NYSE:CMG). To appreciate our error with respect to Dominos, we revisit their economic performance of all four since 11 May, a few days before the YouTube affair.

As shown in the chart pasted from BigCharts.com below, Dominos suffered a 10% market cap drop in the period immediately following the affair (red arrow). Trading volume surged. Then there was a rebound as the Company rolled out an aggressive and effective campaign to restore its reputation. And the metric for success? Its returns beat those of two of the three most highly ranked firms in the restaurant sector from that period.



While many might attribute the rebound to excellent marketing, the Society would posit that Dominos' reputation resilience was evidence of substantive business processes that drive quality, and a communications effort that allowed stakeholders to appreciate its value.

What are those quality processes? They are systems that improve managerial motivation, provide time for managerial oversight, and technology that enhances quality while reducing opportunities for adverse human intervention - malicious or otherwise.

Dominos' greatest reputation risk lurks in an among the employees of the franchisees. Its strategy to mitigate that risk comprises two creative HR-focused processes. First, it requires that every franchise owner be 100% committed to the business -- no outside (distracting) revenue opportunities. Dominos wants the fortune of its franchise owners to depend on the success of the franchise. Second, it provides vertically integrated dough manufacturing and supply chain systems that allow the franchise owner to dedicate more time to human resource management rather than engage in “back-of-store” activity typical of the industry. Then there is innovation and technology. Dominos is constantly innovating process and system improvements to increase quality: the efficient, vertically-integrated supply chain system described above, a sturdier corrugated pizza box and a mesh screen that helps cook pizza crust more evenly; and the Domino’s HeatWave® hot bag, which was introduced in 1998, that keeps pizzas hot during delivery.

In summary, Dominos showed reputation resilience because it understands that its value is tied to the quality of its product. Dominos also showed that it understands well that its reputation for delivering a quality product can be protected through business processes and systems.

Falling Dominos

Nir Kossovsky - Monday, April 27, 2009
On or about 13 April, 2009, in a small Domino's Pizza (NYSE:DMZ) franchise in North Carolina, two employees posted a prank video of some unsanitary and scatological food-preparation practices. Thanks to the power and reach of social media, within a few days there were more than a million views on YouTube and a viral spread of the subject on Twitter. Google trends reported a 50% increase in searches for "Dominos Pizza."

According to Patrick Vogt who writes for the CMO Network on Forbes.com, .'..the cost to the Domino's national brand equity over the long term is still undetermined. Two recent surveys seemed to indicate that it will take time for the national brand to recover. An online research firm called YouGov confirmed that the perception of Dominos' brand quality went from positive to negative in approximately 48 hours. In addition, a national study conducted by HCD Research using its Media Curves Web site found that 65% of respondents who would previously visit or order Domino's Pizza were less likely to do so after viewing the offensive video."

By any conventional marketing metric, this would appear to be a corporate reputation crisis. From the Intangible Asset Finance Society's perspective, this appears to be a failure in the business processes that give rise to reputations based on quality - a universally important intangible asset. We ran a quantitative reputation analysis using the Steel City Re Intangible Asset Index.



The data show that this past week, Domino’s IA Index dropped from an 11 month high of the 52nd percentile to the 47th percentile among the 47 companies of the Restaurant sector. This past year, the company has had a progressively declining IA index, EWMA volatility at 4 logs or more, and an economic return that is 14% below the median of its peers.

Much has been written about the marketing challenges associated with the employee prank and the slow corporate response. We believe the real story, as suggested by the index data, is that Dominos is currently perceived to be no more than an average steward of its intangible assets. Its business process controls are weaker than the leading firms, and thus, its resilience in the face of this challenge will likely disappoint shareholders.

Dominos can resolve this problem with classic risk and reputation management – better business process controls on the human factors that underpin its reputation for product quality. Training, compliance and monitoring, and behavior enforcement tools need to complement its media-focused crisis management campaign. Because this is a franchise-sourced risk, there are unique insurance instruments that can increase the efficiency of compliance enforcement.

Marketing and crisis communications efforts are important but not sufficient. Customers need to know that in addition to management’s contrition, there are material changes in the company’s operations that place management in an improved state of control -- a level of command and control that will preclude this challenge to quality from happening elsewhere in the organization.

Dominos' mid-range reputation ranking contrasts with the top Restaurant sector IA index companies this week. In the top position, Panera Bread Co. (NASDAQ:PNRA), with an EWMA of three logs and an superior economic return that is 72.32% in excess of the median of its peers; McDonald’s Corp. (NYSE:MCD) in the 97th percentile slot, with extraordinary IA index stability comprising a near zero EWMA and an economic return that is 21.36% in excess of the median; and Chipotle Mexican Grill Inc. (NYSE:CMG) in the 95th percentile position with a lively EWMA of 4 logs and a marginally superior return at 1.18% above the median.



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