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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Indeed, a key economic lesson learned these past two years is that iconic firms with global operations, a stable of business partners, and reputations for ethics, safety, security, and quality; must have better managerial oversight of their partners. There are several strategies for improving oversight. To protect and restore its reputation rapidly, Boeing appears to be pursuing a strategy of total control by acquiring troubled suppliers. It is not an inexpensive proposition. The latest acquisition is reported today in the Financial Times:
"Boeing has been forced to take over one of the key suppliers to the 787 Dreamliner, its troubled new jet, in an effort to gain tighter control of the production process.
It has agreed to pay at least $580m for the facility that makes chiefly composite sections for the 787, a planned family of long-range jets that is running more than two years behind schedule.
The purchase of the South Carolina plant from Vought Aircraft Industries - owned by the Carlyle Group, the private equity firm - is the second time Boeing has been forced into an acquisition to strengthen its global supply chain.
Last year, the US aircraft maker took over Vought's stake in Global Aeronautica, a joint venture with Alenia of Italy that assembles 787 fuselage sections. Vought said it received $55m from that deal."
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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.
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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.
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Here’s the question – who pays for the protection afforded to private companies engaged in protecting America’s critical assets? The answer is: it depends.
Chemical plants, nuclear power plants, airlines, telecommunications companies, transportation companies, you name it – most of the costs associated with protecting private companies are borne by the companies, their shareholders and when possible, their customers. With a glaring exception – if you are a foreign shipping company and one of your ships transits the Gulf of Aden and is hijacked by four criminals intent on gaining ransom money – the US Navy and insurance companies are happy to pick up the tab for the rescue and protection of the crew, the ship and its cargo. One might think this is a justifiable national security response because the shipping company is threatened from conducting its operations. However, these pirates are common criminals, not terrorists and the shipping companies are choosing to undertake the risk but not take appropriate measures to prevent the hijackings because they can rely on the US and other navies for protection – at the cost of the US taxpayer. So the US taxpayer is not only burdened with failed management of US financial institutions and auto makers, along with irresponsible credit card and mortgage holders, but now we’re subsidizing foreign companies who refuse to implement solutions to minimize or avoid the risk to their ships and their clients’ cargo.
Which brings forth the question, why are shippers deferring to the navies of the world? The easy answer is the US Navy isn’t going to charge the shipping companies. However, there is more - the shippers, as a group, have failed to grasp the reputation benefits associated with improved security, reduced risk and better service. Some companies do understand the value of protecting their reputation – contrast Dry Ships Inc. (NASDAQ:DRYS) vs. Diana Shipping Inc. (NYSE:DSX). Since experiencing a hijacking in February 2009 Dry Ships Inc., the company's reputation as measured by the Steel City Re IA index has tumbled from the 80th percentile to 36th percentile, based on the market’s perception that they are not managing security issues well. Diana by contrast has gained on the Steel City Re reputation index moving from the 30th percentile to the 80th.
Diana has out performed its peers by 24% while Dry Shipping has under performed by 18%. Why do these percentages matter? Because they demonstrate the value of good security programs, their recognition by the markets and the impact on their shareholder value.
This is something our government needs to underscore with the private sector – good security is good for business. And by security, I don’t mean staffing the ships with heavily armed mercenaries. As romantic an alternative that as that might be against a romanticized criminal, it isn’t a practical solution. A meaningful security solution entails planning, analysis, and risk mitigation and avoidance to keep ships out of harms way. The US Navy, while fully capable of such a task, neither has the time or resources in its current configuration to deal with seaborne criminals.
We need to rethink our policy and its implication for Homeland Security. Security is key function to businesses and there are measures shipping companies (foreign and domestic) can take to reduce the burden on the US and the US Government should have other priorities than to once again bail out more unwilling or irresponsible managers.
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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?
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Risk & Insurance magazine's senior editor, Dan Reynolds, reviews the Society's conference call from 3 April with the leading question, "Imposing best practices on trading partners today is considered vital, but how does one secure an increasingly global trading community?" He then brilliantly summarizes Robert Rittereiser's hour-long presentation in a short, entertaining and accessible article.
Rittereiser knows risk. As Reynolds summarizes, "In Rittereiser's deep past, he was a chief financial officer and chief administrative officer of Merrill Lynch & Co. and a president and CEO of E.F. Hutton. On Wall Street, according to press coverage from his glory days, he had a reputation as a guy people hired to solve problems. These days, he is on the board or serving as an officer with several risk management companies, including the Pittsburgh, Pa.-based companies Zhi Verden and Steel City Re."
To link to the the Risk & Insurance article, click here. To acess the original slides from the Intangible Asset Finance Society call or inquire about purchasing a recording, click here.
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- JPMorgan: Bowl game, Tampa, 21 May - Dimon 1, Activists 0
- RepuStars 2013 May 18
- Boeing: Boing
- Johnson & Johnson: Bromides and platitudes
- JPMorgan Chase: Saying foolish things?
- RepuStars 2013 May 11
- Program - 17 May 2013 - Register Now
- Reputation: The future of hiring
- PetroChina: Reputation of a different color
- RepuStars 2013 May 4
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