The Boeing Company (NYSE:BA) reported today that it would again delay the first flight of its new jet, the 787, the latest setback in a program that is considered crucial to the plane maker’s future. The New York Times reports that Howard Rubel, an analyst at Jefferies & Company, said the problem “doesn’t help the company’s credibility.”

Not so fast, Mr. Rubel. Credibility has many facets. The most important driver of reputation in the commercial aerospace sector is safety, and with the recent string of air disasters involving aircraft made by Boeing’s rival EADS NV (EPA:EAD), safety is very much on every stakeholder's mind.

The operational setbacks both Boeing and EADS have suffered highlight the difficulty of pulling off increasingly complex engineering feats involving new materials and global supply chains. And at least one financial lesson from the effort to create a global supply chain is that the savings from direct and tangible costs are being offset by intangible costs arising in the risks of a greater business network entailing less visibility and control.

Managing a complex supply chain is a business process, and failure to do it well – when stakeholders have been led to expect benefits – can be costly in terms of reputation. So returning to Howard Rubel’s comments, what is the net reputation impact?

We turn to the data from the Steel City Re IA (Corporate Reputation) Index. The Index, which correlates with reputation surveys such as those published by Forbes, Fortune, and Harris Interactive, captures the financial implications of stakeholder behaviors and expectations of stakeholder behaviors as determined by corporate reputation. The Index is a good leading indicator of financial performance and returns on equity.

The index shows that over this past year, Boeing’s reputation ranking has sunk from the 69th percentile to the 48th percentile among the 47 companies in the Aerospace and defense sector. Worst, volatility has been climbing and the Exponentially Weighted Moving Average volatility is now four log orders of magnitude. Not surprisingly, return on equity is 14% below the median of the peer group.



Looking at industry more broadly, we see that the overall reputation ranking of the Aerospace and defense sector relative to other industry sectors has been generally rising while variance within the group has been declining and assuming greater homogeneity.



Within this environment, the outstanding reputation holders comprising the top decile as measured by the Steel City Re Reputation Index are: American Science & Engineering (NASDAQ:ASEI); Precision Castparts Corp. (NYSE:PCP); TransDigm Group (NYSE:TDG); and United Technologies Corp (NYSE:UTX).

United Technologies interests us because our colleague, Nancy Lintner, former Chief Marketing Officer and a speaker at one of our annual meetings, developed an award winning communications campaign that highlighted a number of corporate intangibles. Over the past year, the Reputation Index ranking for United Technologies has climbed slightly from an already high 89th percentile to the 92nd percentile, and its EWMA volatility has declined. The company has rewarded investors with an ROE that is 6% above the median return of the Aerospace and defense peer group.

The Society is pleased to announce the 28 May 2009 launch of the IP Finance Institute and to welcome the Institute into the Society’s global alliance. The Society also congratulates Pier Biga, managing partner of ICM Advisors, who is Executive Director.



The Intellectual Property Finance Institute is the first European research and competence centre focused on IP Economics & Finance. The Institute is a non-profit organization which promotes and develops know-how transfer, research initiatives and projects about the IP as an economic asset and its use in IP-based financing solutions.

The Institute was co-founded by the Innovation Studies Group of the Politecnico di Torino, a leading international technology university, and ICM Advisors, a leading international advisory and research firm specializing in intangible asset valuation and IP-based financing.

This note explores whether a proposed transaction by a $75B beverage company, Pepsi Inc. (NYSE:PEP), is motivated by costs savings, brand enhancement, or reputation protection. Seeing no perceptible movement in the reputation index of either the company or its arch rival, we conclude that notwithstanding which of the three was the initial trigger, the greatest value may be in reputation risk management.

On 20 April 2009, Pepsi proposed buying the outstanding shares it does not own in its two largest bottlers, Pepsi Bottling Group (PBG.N) and PepsiAmericas (PAS.N), in a $6 billion cash and stock deal. Many in the financial press suggested it was a cost-cutting initiative. Jon Baskin, a marketing iconoclast, a keynote speaker at the Society’s 2008 annual conference, and the author of the book, “Branding OnlyWorks on Cattle,” opined that the move represented brilliant, strategic branding. In Jon’s words:

Think about it. New packages and formulations, available at new and different locations, priced and supported in novel ways...all thanks to a holistic approach to the brand, vs. some archaic top-down application that sees it only as image and words. It's these actions, and real investments, that will build sustainable, long-term brand growth.

Cost savings and long-term brand growth are both good things, reflect well on management and enhance reputation. So, with two weeks having now elapsed during which the market has had an opportunity to digest the news, and while the deal is still in the negotiation phase (the bottlers rejected it on Monday), we called on the Steel City Re corporate reputation index to see what impact the news has had on the reputations of Pepsi and its arch rival, The Coca Cola Company (NYSE:KO).

As shown in the charts below, the short answer is “not much.” Pepsi tops the fifteen-member Soft drink sector; Coke is in the 92nd percentile. Volatility is nil. In fact, in the midst of the most tumultuous market since the great depression, these two iconic firms emerge with nearly identical profiles comprising exceedingly stable reputation metrics. With Pepsi and Coke’s market caps at $75B and $100B respectively, are they too big to budge?






Big, yes, but not too big to trip and fall. As we see it, both pay exquisite managerial attention to their reputations. Ethics, quality, safety, security and sustainability are all watchwords. Innovation is alive and well. So the competition between these two is analogous to that of two chess grandmasters. They see all, know all, and understand the implications of every move and its derivatives. The game, therefore, is waiting for one or the other to make a mistake. It is a game where risk management is the winning play. And given the relative values of the physical assets and intangible assets at the two companies, reputation loss arising from a business partner where visibility and control are weaker – supply chain headline risk, if you will – is one of the major risks we believe needs to be managed.

So let us put our own spin on Pepsi’s announced acquisition: from an intangible asset finance management perspective, it is a prudent move to manage reputation risk arising from a third party. While it may not increase Pepsi’s brand value or enhance its reputation, it may prevent the sort of reputation loss that destroyed nearly 14% of Coke’s value 10 years ago.

The past week, Intellectual Asset Management magazine, the official publication partner of the Society, has been hosting a debate on intangible asset valuation. As Joff Wild, editor of IAM magazine describes it,

One subject area that always seems to generate a large number of reader comments is valuation. Witness, for example, the fantastic thread tha developed following a post I wrote back in January entitled Intangible values collapse - the old 70% to 80% claim is now officially dead and buried. Among those taking part in that conversation - indeed the man who indirectly inspired it - was Nir Kossovsky, executive secretary of the Intangible Asset Finance Society and CEO of Steel City Re. Now Nir has written in to question some of the points made by Pat Sullivan and Alexander Wurzer in their IAM article on IP/intangible valuation myths, which I recently previewed on the blog.

The Intangible Asset Finance Society has weighed in on the debate along with our colleagues at the Athena Alliance, with classic language and arguments from the school of American Pragmatism that reflect the financial market principles we support. To follow the debate on the IAM site, click here. To read the comments of Ken Jarboe, President of the Athena Alliance on the Alliance blog, Intangible Economy, click here.

Tweens and adolescents often playfully disparage their meals with monikers such as "mystery meat" or "tuna surprise." While this is good fun, it is something quite different when the CEO of a major food products company similarly characterizes his company's products. David McKay of Kellogg Company (NYSE: K) raised a few eyebrows when he testified last month before the House Committeee on Energy and Commerce that Kellogg relied on third parties to assure food safety. We wonder what thoughts ran through the minds of financial analysts who knew at that time that competitors, such as Nestle, conducted their own supplier inspections thereby signalling to their stakeholders that food safety is a core business process and critical intangible/reputation asset.

And while it has been a rough time as of late with Salmonella in peanuts and pistachios, the industry as a whole is settling down to a steady state of intangible asset volatilty. So it piques our interest when H. J. Heinz Company (NYSE: HNZ), a company that has made reputation enhancement a key business strategy, experiences a sudden drop in the Steel City Re Intangible Asset Finance (Corporate Reputation) Index.

The chart below shows Heinz. As seen in the upper chart, among the 56 companies comprising the Food Products Group, Heinz has ranked in the top 95th percentile earlier this year but has been declining and is now at the 83rd percentile. In terms of return on equity, this past year it has outperformed the median of its peers by 2.6% - the peer group having lost a median of about 27% over the past 12 months. As seen in the lower chart, Heinz's exponentially weighted moving average IA index volatility began this last six month period at under two orders of magnitude and is now approaching three orders.


Yet while Heinz is showing a reputation decline and increasing volatilty, the industry as a whole is showing increasing stability. In the upper half of the chart below, the variance amond different companies in the peer group is leveling off at about 0.25. Furthermore, among all 5000 companies tracked by the IA index, the median IA index value of the peer group is rising to about the 72nd percentile. Last, the lower half of the chart below shows that the % of value at the Heinz Company ascribable to intangible assets has been increasing and now stands at about 120% while the median fraction in the peer group has been decling slightly to about 60%.



How is all this to be interpreted: decreasing IA index, increasing EMWA IA index volatilty, increasing IA fraction?

We believe its all about reputation. We believe that the extraordinarily high level of intangible asset value comprising some 120% of the company's market value (implying a negative book value) means stakeholders are relying greatly on extra-financial information to set a fair market price. Stakeholders are going with their gut, and gut is driven by reputation -- the impression stakeholders form on management's stewardship of a firm's intangible assets. The increasing volatilty associated with a decline in the IA index suggests to us that the impression stakeholders are receiving from these extra-fiancial channels is increasingly less uniform. Higher stock price volatility and increasing cost of both equity and debt will be among the earliest pains Heinz may experience.

Not convinced? Google search the stock ticker for Heinz, Kellogg, General Mills (NYSE:GIS), and Ralcorp (NYSE:RAH) - food product companies whose IA index values as of 6 April were .83, .90, .94 and .96 respectively - and the term "reputation." The hit counts are 504, 484, 543, and 1950. Did we mention that Ralcorp also had a peanut recall issue, yet their EWMA IA index volatility is decreasing and their ROE for the year is 23% above the peer-group median?

Last Monday, 6 April, the world learned that IBM (NYSE:IBM) was no longer interested in acquiring Sun Microsystems (NASDAQ:JAVA). Speculation as to the reasons for the collapsed deal include price, intellectual property and hubris. Let's look at the intangibles of this deal from the perspective of the Steel City Re  Intangible Asset Finance (corporate reputation) (IA) index.

The charts below shows IBM. As seen in the upper chart, among the 48 companies comprising the Computers and Peripherals sector, IBM has ranked in the top 99th or 100th percentile this past year. In terms of return on equity, it outperforms the median of its peers by 33%. As seen in the lower chart, the volatility of its index score is only two orders of magnitude and is decreasing. This is a company with an exceedingly strong reputation that stakeholders believe they understand, and clearly like.



The charts below shows Sun Microsystems. As seen in the upper chart, among the same 48 companies comprising the Computers and Peripherals Group, Sun (JAVA) has ranked no higher than the 50th percentile a year ago and is now ranking below the 20th percentile. In terms of return on equity, notwithstanding the surge in anticipation of a potential deal, it has underperformed its peers by nearly 20%. As seen in the lower chart, the volatility of its index score is three orders of magnitude and is now increasing. This is a company with a rapidly deteriorating reputation that stakeholders are liking less, and are concerned they no longer know.



The data indicate that since Sun Microsystem's reputation is not going to help IBM, the latter can afford to wait until hubris is humbled and the price stabilizes.

Dear Reader,

Beginning this week and with surprising regularity, the Society will post a quantitative and qualitative analysis of the intangible asset management implications of a current news story involving a publicly traded company. These analyses will draw on IA index data published by Steel City Re. Periodically, the Society will also post announcements to supplement the monthly news alerts, the quarterly newsletter, and the bimonthly publication in IAM magazine.

As always, the Society welcomes your comments and feedback.

Nir Kossovsky
Executive Secretary