Swedish meatballs are funny. Just ask the Muppets. But there is nothing funny when Ikea has to pull Swedish meatballs from the shelves because they, too, have been contaminated by horse meat. Once again, it's the supply chain, stupid!

Now comes further news from Expert Recall that the US Food and Drug Administration documented 552 food product recalls in the fourth quarter of 2012, setting a new record high in at least nine quarters. It's not just food. Recalls of 85 consumer products were announced at the request of the CPSC in the fourth quarter of 2012, representing a six-quarter high. Last, 45% of the of pharmaceutical companies documented in the fourth quarter faced more than one event—the largest percentage of companies with repeat violations in at least ten quarters.

The global supply chain is in desperate need of better oversight and operational control. Yes, supply chains were once a great source of value creation. But the push for cost savings has created a whole new set of risks. Many of these issues were discussed most recently at the February Mission Intangible Monthly Briefing where the Society's program featured Daniel Diermeier, IBM Professor of Regulation and Competitive Practice and Director, Ford Motor Company Center for Global Citizenship, Kellogg School of Management, Northwestern University and author of Reputation Rules: Strategies for Building Your Company's Most Valuable Asset; and Scott Childers, Director of Integrated Trade Management at The Walt Disney Company, and a member of the Society's Reputation Leadership Council.

But awareness of the problem is not new, and with this 16th blog note on supply chain issues, Huygens once again calls attention to the fact that a firm's reputation is no better than what is ultimately made possible by the weakest member of the supply chain. It doesn't matter if the supply chain member is  the supplier of meat for (beef) meatballs, the active molecule for preparations of Sodium Heparin, or the maker of fencing materials for NASCAR-sanctioned speed raceways. The retailer at the end of the chain is where all supply chain risk concentrates.

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.

"They’ve found horse meat in Tesco burgers? It’s an unbridled disaster." Through internet-wide humor, at the very least, Tesco is being reminded that supply chains can be a major source of quality risk. As the FT reports:

Having inquired into the provenance of beefburgers that contained horsemeat, it has dumped Silvercrest, its supplier of frozen burgers, essentially for deviating from the list of Tesco-approved meat suppliers. “The breach of trust is simply too great,” said Tim Smith, the UK retailer’s technical director, in a statement. (The owner and founder of Silvercrest’s parent told the FT earlier this month it had been “let down” by its own suppliers.)

Humor aside, stakeholders do not appear to be materially shaken by this turn of events -- a supply chain quality control (operational) failure -- with respect to Tesco's reputational value.

The Steel City Re Reputational Value Metrics, explained in greater detail in the 2012 book, Reputation, Stock Price and You, show no difference in RVM volatility between historic and current periods. RVM is a non-financial measure of reputational value and is holding steady in the 70th percentile. The company's CRR, a measure of reputational ranking, is at the 26th percentile. Its economic returns are median, and its reputational forecast suggest slightly below median stability with directionality indicators being positive.

The data suggest that stakeholders, having already ranked the company at the lowest quartile, were less shocked by Tesco's discovery of horse meat than they were pleasantly surprised by the company's swift response. First, severe action against a supplier to punish it for its failure and second, a commitment to  test the DNA of meat going forward to mitigate future potential problems. These comprise textbook reputational value crisis management practices. [A textbook response, it should be noted, is not PR; but rather substantive operational fixes. Pass the hint to Boeing.]

For supply-chain watchers, note the references to "trust" and "being let down." Supply chains can not operate effectively absent trust nor can they operate only on the basis of trust. Tools that help companies verify that which is the basis for trust will become increasingly important. Stay tuned.

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.

In early 2008, Baxter International (NYSE:BAX) began a series of product recalls involving the drug, Heparin, that was manufactured with ingredients sourced from a supplier in China. Yesterday, the first of the product liability litigation cases arising reached the verdict stage.

According the to the Chicago Tribune (9 June, Japsen), a Cook County Circuit Court jury Thursday awarded $625,000 to the estate of a man who his attorneys say was given a dosage of a blood thinner made by Baxter International Inc. that contained a contaminated ingredient found in the company's supply chain in China.

The verdict is the first from a case against Baxter and its supplier, Wisconsin-based Scientific Protein Laboratories, from hundreds of lawsuits filed against the Deerfield-based medical product giant. A mountain of litigation has been leveled against the companies after U.S. regulators determined in 2008 that Baxter's heparin was contaminated, from fake ingredients sourced in China.

The Wall Street Journal (9 June, Kell) quotes Baxter spokeswoman Deborah Spak as saying the company is taking responsibility for legitimate cases of harm related to the contamination seriously, adding that Baxter will "vigorously defend claims that are not consistent with the definition established by public health authorities." Baxter's therapies treat serious medical problems such as cancer, immune disorders and trauma. The company is coming off a challenging year due to economic weakness, costs pegged to the U.S. health-care overhaul and some product-quality and regulatory challenges.  It's stock price has appreciated around 50% over the trailing twelve months and shares rose an additional 0.3% to $59.05 in after-hours trading -- not the sort of economic performance associated with a company facing new challenges.

Turning to the reputation metrics from Steel City Re, Baxter is wrapping up the trailing twelve months ahead at the 88th percentile from a start at the 72nd. Its reputation metric volatility, exponentially weighted, is down to about 6%, its reputation velocity is on the upswing at 7% and its reputation vector is positive at 1%. All are signs of reputational recovery. Economically, it is outperforming the median of its peer group comprising 172 companies in the Pharmaceutical sector by a comfortable 17.82%



Finally, while the sector as a whole is demonstrating increased level of reputational volatility reaching around 36%, the Company's intangible asset fraction got a small boost and is now around 90%, slightly above that of the median of its peer group.

We conclude that as with Johnson & Johnson's supply chain issue of the early 1980's, Baxter took the hit early on (2008) and has since progressed with the expected long-term costs of this quality/safety issue already deeply embedded in the stock price and in reputation-related expectations.

In Douglas Adams’ The Hitchhiker's Guide to the Galaxy, “the only thing that went through the mind of the bowl of petunias as it fell was 'Oh no, not again.' Many people have speculated that if we knew exactly why the bowl of petunias had thought that we would know a lot more about the nature of the Universe than we do now.”



We can reasonably assume that similar thoughts raced through the minds of BP (NYSE:BP) executives on 20 April as the Deepwater Horizon drilling rig exploded, caught fire, and sank. And while we are probably equally clueless about the nature of the Company, as are stakeholders who own its reputation, of this we can be certain: it is sinking.

As illustrated in the series of Steel City Re Corporate Reputation Index charts below, BP and the other firms associated with this safety and environmental disaster are experiencing an acceleration of a steady reputational decline. And as noted in the book, Mission Intangible and more recently in an article in CFO magazine, these declines are indications and warnings of an increased risk of a reputational event.

Not that BP is unaware. The New York Times quotes BP CEO Tony Hayward on Friday as saying, “Reputationally, and in every other way, we will be judged by the quality, intensity, speed and efficacy of our response.”

BP has blamed the rig’s owner and operator, Transocean (NYSE:RIG), for the accident. Further investigation is now suggesting that a drilling subcontractor, Halliburton (NYSE:HAL), may have failed to execute a critical task that prevents gas and oil from escaping from the well.

The process is called ‘cementing’ and it is challenging. A 2007 study by the U.S. Minerals Management Service found that cementing was the single most-important factor in 18 of 39 well blowouts in the Gulf of Mexico over a 14-year period. More recently, Halliburton (NYSE:HAL) has been accused of performing a poor cement job in the case of a major blowout in the Timor Sea off Australia last August. An investigation is under way.

As a case study of risk and reputation management, this has almost all the main elements. Consider the following:

1. Iconic brand, BP, working through subcontractors - a key source of risk (we explore this topic further this Friday, see below)
2. History of failures in managing the processes of assuring safety - a reputation lacking resilience 
3. Marketing campaign built around sustainability laid to waste by a massive oil spill - lack of authenticity

The LA Times notes in a story on 1 May that experts were cautious about attributing blame, pending what are expected to be lengthy investigations by Congress and the Department of Homeland Security, which oversees the Coast Guard.

Satisfy your intellectual curiosity!

If the above issues pique your interest, here are several things you can do right now:

1. Register free of charge for the next IAFS Mission Intangible Monthly Briefing set for Friday 7 May at 12h00 EDT. The conversation will feature Scott Childers from Walt Disney and Bob Rittereiser from Zhi Verden on “Process-driven reputation risk in supply chains”
2. Purchase the book, Mission: Intangible. Managing risk and reputation to create enterprise value, at the IAFS Store (or any online book retailer) 
3. Become a member of the Intangible Asset Finance Society.
4. Join our community on Linked-In.

Next Friday, May 7, the Society's monthly Mission Intangible Monthly Briefing will feature Scott Childers from the Walt Disney Company (NYSE:DIS) who is calling for holistic supply chain vendor management, and Bob Rittereiser from Zhi Verden whose Global Trademaster™ product provides total supply chain visibility. A note this past Monday in the Wall Street Journal explains why this is so important.

On Monday U.S. Federal, state and local law enforcement officials, part of the National Intellectual Property Rights Coordination Center said they made their biggest-ever seizures of counterfeit goods this month in two operations that netted more than $240 million in a sweep of more than 30 U.S. cities. Immigration and Customs Enforcement announced the double-barreled operation on Monday to coincide with World Intellectual Property Day.

Commemorating a day to heighten awareness of intellectual property with arrests may not be festive, but it is appropriate. Fake goods do more than rob intellectual property owners of revenue. Fake goods raise the specter of a full range of reputation-linked issues that go beyond cash flow to create risk in areas as  diverse as ethics (international labor standards), quality, safety, security, and sustainability. The article further notes that next week, the Naval Criminal Investigative Service and the Defense Criminal Investigative Service will begin targeting counterfeit goods that could get into the military supply chain. The U.S. General Services Administration will target fake goods in the federal civilian supply chain.

To target effectively, one needs intelligence. According to Mr. Rittereiser, Zhi Verden’s Global Trademaster™ provides that intelligence; according to Mr. Childers, having that intelligence is a necessary component for world class supply chain management.

Act on your intellectual curiosity!

If the above issues pique your interest, here are several things you can do right now:

1. Register free of charge for the next IAFS Mission Intangible Monthly Briefing set for Friday 7 May at 12h00 EDT. The conversation will feature Scott Childers from Walt Disney and Bob Rittereiser from Zhi Verden on “Process-driven reputation risk in supply chains”
2. Purchase the book, Mission: Intangible. Managing risk and reputation to create enterprise value, at the IAFS Store (or any online book retailer) 
3. Become a member of the Intangible Asset Finance Society.
4. Join our community on Linked-In.

Last Sunday at pharmaceutical giant Eli Lilly's (NYSE:LLY) warehouse near Hartford, Connecticut, thieves stole $75 million dollars worth of anti-depressants and other prescription pills -- enough to fill a tractor-trailer --- now headed for the black market. "It was a very brazen, well planned crime. It appears as though the criminals broke in through the roof, rappeled down through the roof, disarmed the alarm and then proceeded to steal several dozen pallets of pharmaceutical products which were loaded onto a truck and taken", said Ed Sagabiel with Eli Lilly and Company.

We make three points. First, this is a physical security breach that does not, on its surface, appear to have any reputation impact. The financial impact will be minimal because the event is one of the perils commonly covered by property and casualty insurance. The second is that this is the type of physical security risk most companies are best prepared to mitigate - physical removal. Most are not in a position to mitigate the reverse security risk of physical introduction--the type of physical security risk that nearly brought Johnson & Johnson (NYSE:JNJ) to its knees a quarter of a century ago.
 
Here's a worst case spin from a reputation perspective. Fact: Lilly has lost control of $75 million (wholesale) of product. These drugs are all branded and marked as authentic Lilly ethical pharmaceuticals which stakeholders expect will be safe and effective. Suppose branded product reentered the market after being adulterated. Suddenly, the Johson & Johnson fiasco seems like child's play.

You ask for a motive? How about the mother of all insider trades? Would criminals who execute a Mission:Impossible-style heist have the financial acumen to short Lilly equity or go long on Lilly credit default swaps as they flood the market with adulterated pharmaceuticals? Could they recognize returns in excess of $75 million in fungible liquid assets? 

And this brings us to the third point. Superior reputation management includes both crisis management and scenario modeling exercises. Because even rumors suggesting the above could be damaging.

Heads Up - Date Change

The Mission: Intangible Monthly Briefing for April 2010 will be held one week later than usual in deference to those who celebrate Good Friday. On 9 April 2010 at 12h00 EDT, the second Friday of the month, we will host a conversation featuring incoming Integrity and Corporate Responsibility Committee Chairman Paul Liebman from Dell (NASDAQ:DELL) and IA Value Signaling Committee Chairman Jon Low from Predictiv. The title for the one hour moderated discussion is: Ethics - A valuable intangible asset? Mary Adams from Intellectual Capital Advisors hosts.

As always, registration for this popular series is complimentary and slides will be available for download in advance of the event. To register now, click here.

Join Us

If the above intrigues you or challenges you to learn more, look no further. The Intangible Asset Finance Society wants to be your business resource. Join us and be part of an organization that provides a wealth of educational materials, including a new book, to further your executive career, and exciting monthly conferences such as the upcoming one on ethics mentioned above.

It is significant that there is little public gloating from other auto manufacturers as Toyota Motors’ (NYSE:TM) leadership globally offers mea culpas. Although it is Toyota’s reputation that is melting under the heat of headline risk, competitors are only too aware that the next tolling of the bell could be for them.

This is why. While the damaged intangible assets are three of the big six: ethics, safety, and quality, the underlying problem is the global supply chain. According to Bob Rittereiser, CEO of Zhi Verden, a supply chain systems and information management company, “the stark reality today is that the global supply chain is a business operating system with global reach, thousands of participants, established practices, government requirements, blazed paths, known bottlenecks and many known risks, yet no one is in charge!” Or, said differently by John Hurrell, Chief Executive, Association of Insurance and Risk Managers, “The complexity of supply chains puts your reputation in the hands of the lowest common denominator.”

Reputation drives intangible asset value. As reported in Mission: Intangible -- Managing Risk and Reputation to Create Enterprise Value (IAFS with Trafford Press, March 2010), research shows that superior reputations pay off with (i) pricing power , (ii) lower operating costs, (iii) greater earnings multiples, (iv) lower beta (i.e., stock price volatility) and (v) lower credit costs. And when reputation is damaged, these benefits are lost. All told, we estimate the reputational impact, so far, to be a $2 billion cost to Toyota's earnings and a $25 billion cost to its market capitalization.

Previously we shared Toyota's reputation metrics from the Steel City Re Corporate Reputation Index. We take time out from our membership drive to offer this financial breakdown shown at left.

Legend. Income Statement Impact (values in $‘000). Lost sales and a 3% loss in pricing power will reduce Toyota’s gross profit by around $900 million. Costs associated with the worldwide recalls, litigation, insurance subrogation, and regulatory compliance will cost at least another $500 million. The lower credit ratings will increase borrowing costs by at least another $71 million, and non-cash depreciation expenses associated with a 3% write down of Toyota’s automobile asset base will reduce earnings by another $540 million. Data source: Steel City Re.

Join Us

If the above intrigues you, frightens you, or challenges you to learn more, look no further. The Intangible Asset Finance Society wants to be your business resource. Join us and be part of an organization that provides a wealth of educational materials to further your executive career.

Innovation: Hot Policy and Practice Issues

Be sure, by the way, to register for a complimentary seat at the 5 March Mission:Intangible Monthly Briefing, held by phone at 12h00, EST. It's an innovation smack down. Athena Alliance President and intangible asset policy expert Kenan Jarboe goes head to head with Steel City Re's Judith Giordan, Managing Director of IA Finance and former senior technology executive with Pepsi, Henkel, International Flavors & Fragrances, and Polaroid. Yes, as always, registration is complimentary and slides are already posted on the website events page.

In the Society’s pantheon of intangible assets that create enterprise value, one has defied efforts to build for it a universally compelling business case. Sustainability, unlike ethics, innovation, quality, safety and security, is not a practice that in our experience reliably has created enterprise value for its practitioners. Further, if one subscribes to the theory that there is wisdom in crowds, than the murkiness surrounding the value of sustainability persists. This is why. According to a recent survey of 1,400 CFOs from a stratified random sample of U.S. companies with 20 or more employees, two-thirds of CFOs don't expect to boost sustainability efforts in next 12 months.

When asked whether they expect their companies’ emphasis on green initiatives to increase, decrease or remain the same in the next 12 months, 68 percent of chief financial officers (CFOs) interviewed said they anticipate no changes. More than a quarter (28 percent), however, said they expect an increased focus on the issue.

When we first saw this report, we assumed that those expecting to increase their focus would be companies that distributed product through Wal-Mart (NYSE:WMT). More generally, we expected retailers and and their supply chains would be investing in green to conform with Wal-Mart’s sustainability requirements – or at least remain competitive.

We were not wrong. Looking horizontally at the data, while overall 28% expected to increase investments, 33% of the CFOs from companies in the retail sector expected to do so. Furthermore, while overall 5.15% expected to increase investments significantly, 6.3% of the CFOs from the retail sector were gearing up for bigger green initiatives.

However, we were surprised by some of the findings. First, the sector from which a plurality of CFOs expected to increase investments the most was finance – nearly 36%. At the other end of the spectrum was transportation – only 19%. However, nearly half of those in the transportation sector expected to make significant increases.

Growth and/or maintaining the status quo were not on everyone’s agenda. Sectors planning to cutback, according to the CFOs surveyed, include business services, construction and – ready for this – retail at 5.2, 4.8, and 3.8% respectively.

The survey was developed by Robert Half Management Resources.