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.

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.

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.

This past Monday’s Agenda, a newsletter for board members published by a subsidiary of the Financial Times, carried a story about social media and how boards should be aware that adverse stories can destroy massive value within hours. Senior reporter Amanda Gerut referenced materials discussed in the Society’s book, Mission Intangible, that sharpen the pixels on the value story and identify specific items in the P&L statement that are impacted by reputation. She also cited the Dominos Pizza case (NYSE:DPZ), a story we first looked at last year and to which we now return.

As summarized by Ms. Gerut, “On Easter Sunday last year, two Domino’s Pizza employees uploaded a two-minute prank video to YouTube of the duo abusing food they were preparing. The video was quickly picked up by other websites and within 72 hours had jeopardized Domino’s $490 million in domestic revenues and $1.4 billion spent on brand building during the past five years.” According to a Seeking Alpha earnings call transcript, the company lost between 1% and 2% in domestic same-store sales for the second quarter of 2009. This is to be expected. Both pricing power and market share are impacted by reputation. Moreover, as we previously noted, Dominos suffered a 10% market capitalization drop in the period immediately following the video. Again, no surprise. Net income, earnings multiples, cost of credit, and other drivers of value are also impacted by reputation.

It is now 2010, and Domino’s equity value is higher than it has been in years. Tim McIntyre, vice president of communications at Domino’s, who helped shepherd the company through the viral video incident, is on the lecture circuit advising directors that their duties of oversight include social media. Is there a connection? Might it be the $2 million insurance payment the company received following the event? Or perhaps the stock surge is due to the December 2009 launch of new crust, new sauce and new cheese? After all, quality is a major driver of intangible asset and reputational value in the food sector.


And yet the Steel City Re Corporate Reputation Index shows a decline over the past year in Domino’s ranking (bright red line, above). We expected to see reputation resilience because we felt Dominos' had a good story about all of its quality processes; but Dominos never exploited its latent intangible assets--the business processes that underpin reputation. It never explained how its processes provide better assurances than other pizza franchises that the quality of its product is protected. This is one reason why be believe it has experienced a two-year ongoing decline in reputation ranking relative to the 42 companies in the Restaurants and fast food franchisers sector.


And yet the stock price surged just before the books for 2009 were closed. Part of the discrepancy with the Reputation Index, and the surge in value, may be explained by the company’s pay down of debt with a net reduction in borrowings of about $75.7 million, which we see in our intangibles chart (above) as a reduction in % intangible asset value.



If we look at select elements from the corporate financials, we see debt pay down and an increase in shareholder’s equity (book value) by about $100 million.



The cash to pay down debt, however, was not necessarily from sales of pizza alone. In fact, total revenue in 2009 was down 20 million compared to 2008. Fortunately, Dominos found an extra $57 million in income from other sources.



In our experience, a company whose reputation index value is low and continues to drift downward tends to underperform its peers. We’ll continue to watch, because the increased value could be due to better quality pizza. Or it could be less leverage and more cold hard (tangible) cash.

Steel City Re Corporate Reputation Index Metrics

Top 5 firms in the Restaurants and fast food franchisers sector ranked by their Steel City Re Corporate Reputation Index as of 10 June 2010 and their corresponding rankings 4 weeks, 12 weeks, and one year ago.

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.

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.