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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Banking on reputation

Nir Kossovsky - Friday, May 15, 2009
On May 11, JD Powers released a study showing that nearly a third of consumers who switched banks said the deliberately excluded ones seen as financially unstable, or as having a bad reputation or questionable ethics.

Reputation is the impression formed by stakeholders of how a company manages its intangible assets. Risk management and ethics compliance are exemplary business processes for intangible asset management.

Stakeholders comprise employees, suppliers, customers, competitors, and investors. Reputation creates among stakeholders a set of expected behaviors. The Steel City Re Reputation Index is designed to capture the financial implications of both the aforementioned stakeholder behaviors and expectations of stakeholder behaviors as determined by corporate reputation. We used the Steel City Re Corporate Reputation (IA) Index to determine if there was a relationship between a bank’s financial stability, as reflected in its one-year ROE, and its reputation.

The table below shows the top 10 companies in the 175-company Regional banks sector. Over the past year, their median ROE was -10%. The median ROE for the year for the sector as a whole was -49% and the ROE for the bottom ten banks in this sector was -89%.

The data suggest that banks may benefit from transforming their current risk management processes into holistic risk and reputation management systems.
 

Rank

Ticker

Name

Index Value
11 May

Volatility Percentile

1

IBKC

IBERIABANK Corp.

1

7%

2

FFIN

First Financial Bankshares Inc.

0.99

2%

3

CFR

Cullen/Frost Bankers Inc.

0.98

3%

4

PFBX

Peoples Financial Corp.

0.98

54%

5

BMRC

Bank of Marin Bancorp

0.97

4%

6

UMBF

UMB Financial Corp.

0.97

25%

7

WABC

Westamerica Bancorp

0.96

3%

8

CBSH

Commerce Bancshares Inc.

0.95

2%

9

NKSH

National Bankshares Inc.

0.95

79%

10

BOKF

BOK Financial Corp.

0.94

6%

Popularity, reputation, and financial metrics

Nir Kossovsky - Friday, May 08, 2009
On 29 April 2009, the Reputation Institute released its annual survey on the nation’s most respected companies. Based on its surveys of the general public, the Institute ranked 153 companies on how esteemed, admired, trusted and liked each was. The top and bottom ranks were held by Johnson and Johnson (NYSE:JNJ) and Halliburton (NYSE:HAL), respectively.

The Intangible Asset Finance Society is interested in the relationship between the intangibles (the business processes that underlie reputation) and finance. So we turned to the Steel City Re Index for an independent quantitative view (and second opinion) of stakeholders’ collective assessments of the corporate reputations of these two iconic firms.

Unlike the Institute survey, the Steel City Re index is designed to capture forward looking indications of expected stakeholder behaviors that impact cash flow, enterprise value, and cost of credit. These indicators are good predictors of stock price, which remains the single most useful metric of value.

Data through 1 May 2009 show that Johnson & Johnson is in the top tier of the Pharmaceutical sector (see Ethical Pharmaceuticals) with an index ranking this past year that started in the 98th percentile and ended in the #1 position (100th percentile). Index EWMA volatility was low averaging only two orders of magnitude. It is therefore not surprising that its return on equity outperformed the median of 84 of its peers by 13%.



Halliburton, on the other hand, bounces between the upper quartile and second quartile of the Energy equipment and services sector having started the year in the 91st percentile and ended the year in the 86th percentile. Index EWMA volatility was much higher averaging four orders of magnitude. A falling index and high volatility, notwithstanding an above average percentile ranking, is rarely associated with superior economic returns. And indeed, over the past year, Halliburton outperformed the median of 69 of its peers by only .75%.



In fairness, there are significant sector effects behind these numbers. The median pharmaceutical index value among the 5000 companies tracked by Steel City Re ranged between the 20th and 30th percentile and the sector showed an index variance of between .35 and .4. In contrast, the Energy equipment and services sector began the year with a median index ranking in the 70th percentile which then fell precipitously in the fall of 2008 to a median in the 50th percentile. Overall variance, however, is much narrower indicating that the perceived differences among firms in this sector are much smaller than the perceived differences among pharmaceutical firms.




In summary, these data show that a top performer in a sector that is in the reputation doldrums will effectively surprise the markets and significantly outperform its peers; and that a good performer in a sector that has disappointed the markets may still marginally outperform its peers. But with the median pharmaceutical ROE closely matching the S&P500 returns, and the median energy equipment and services ROE underperforming the S&P500 by 20%, Halliburton’s low “popularity” is not surprising.

Bonus: Top and bottom ranked firms on the Steel City Re corporate reputation index for the Pharmaceutical and Energy services sectors as of 1 May are, for Pharma: Johnson & Johnson and Discovery Laboratories, Inc. (NASDAQ:DSCO); and for Energy equipment and services: Seacor Holdings, Inc. (NYSE:CKH) and ION Geophysical Corporation (NYSE:IO).

Beverage grandmasters

Nir Kossovsky - Wednesday, May 06, 2009
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.

Swine time

Nir Kossovsky - Monday, May 04, 2009
"Mixed feelings" is what one describes the emotional response upon learning that one's much hated in-law just drove off a cliff in the beloved family BMW. And so it is with today's note. There is nothing good to say about the increasing pandemic potential of the current influenza outbreak, other than the attention Intangible Asset Finance Society member and crisis simulations expert Chris Hatzi and his firm, Crisis Simulations, Inc., are receiving from the media.

Safety and security are ephemeral intangible assets that are central to corporate reputation. Many industries are experiencing the economic consequences of fear arising from a perceived lack of those two in the face of the flu and pirates. (See my previous blog on pirates). Chris and his colleagues at CSI have developed a unique training system -- lifelike and yet cash sparing -- to help stakeholders train for managing events such as the one looming over the horizon.

As Chris notes, simulation training will not prevent the event; but it will contribute greatly to an organization's -- or even a nation's -- resilience. You can see a media clip on Dr. Hatzi et. al. here: http://crisissimulations.com/_swf/katu.html

Ethical pharmaceuticals

Nir Kossovsky - Friday, May 01, 2009
Earlier this month, Novartis was named one of the three most ethical pharma and biotech companies in the world by Ethisphere Magazine, following an in-depth analysis over a six-month period by several non-governmental organizations and the publication's editors. Ethisphere claims that firms found to be more ethical outperform their peers. We're inclined to agree in principal, because it is our observation that superior stewards of intangible assets build resilient reputations and outperform their peers, and "ethics" is a major intangible asset. On the other hand, league tables are often disparaged as "rank and spank."

It seemed ironic that we should question an organization with a name such as "Ethisphere." Ok, we trust them. But we are obliged to verify. And what better tool to use than the Steel City Re Intangible Asset Finance (corporate reputation) Index, a quantitative tool that measures the financial impact of stakeholder behaviors that are reasonable indicators of corporate reputation.

As shown in the chart below, Novartis (NYSE:NVS) IA index ranking has fluctuated around 0.93 this past year. The EWMA IA volatility was generally very low with a log magnitude of 2. Overall, good IA index values suggesting a strong reputation and creating expectations for an above average return. And indeed, financially, it is outperforming its 84 peers in the Pharmaceuticals sector with an ROE this past year of 13.14% above the median.



As points of comparison, let's look at Pfizer (NYSE:PFE) and Eli Lilly (NYSE:LLY), two strong US-based pharmaceutical companies. Over this same time period, Pfizer's IA index decreased from 0.79 to .72 which is a worrying sign of reputation loss. On the other hand, IA volatility has been dropping slightly suggesting a tightening of the variance on reputation -- a feature we attribute to management's improving command, control and communications. Financially, it is marginally outperforming its peers with an excess ROE of less than 1%.



Last, take a look at Eli Lilly, a firm that has had ethical issues lately relating to criminal and civil charges, now settled, that it illegally marketed its schizophrenia drug Zyprexa. Over the past year, Eli Lilly's IA index decreased from a lofty 0.94 to .85. IA volatility has been fluctuating at levels much higher than either Novartis or Pfizer. Financially, it is underperforming its peers by 3%.



That Lilly's IA index dropped to below 0.8 and then rebounded is testimony to the firm's reputation resilience and is a feature we tend to see in companies with overall high IA index values. Still, there appears to be a rank order in these quantitative market-driven metrics measuring reputation that appear to substantiate, at least in part, the designation conferred by Ethisphere. And yes, the one other pharmaceutical firm that was recognized for its ethics, and that we cover for corporate reputation metrics with the IA index, also scored well. Astra Zeneca (NYSE:AZN). During this period, Astra Zeneca's IA index increased from 0.77 to .88 while its IA volatility has been dropping. Financially, it is outperforming its peers with an excess return of 23%.

The highly regulated ethical pharmaceutical industry (prescription drugs) emerged from the chaos, misbranding, and adulterated products world of the late 19th century. The public benefits derive from the confidence stakeholders have in the safety and effectiveness of the products when used as directed. Knowing how important the distinction between ethical and other products is to market confidence and price point, it should not be too surprising that both the regulatory hammer and the reputation impact can be significant.

The pirates of reputation

Nir Kossovsky - Tuesday, April 28, 2009
My colleague and former Assistant Secretary, Department of Homeland Security, Robert Liscouski recently posted this comment on the Adfero national security blog site. I reproduce his comments here because they address the intangible asset finance value of security. His observations affirm that when companies abrogate managerial responsibility for risk management, whether it is in the financial sector or the marine sector, corporate reputation is damaged and economic returns suffer. Conversely, companys are rewarded for paying attention to that which is valued by its stakeholders. Bob writes:

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.

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.


Valuation truth vs truthiness

Nir Kossovsky - Friday, April 24, 2009
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.


A tale of two chassis

Nir Kossovsky - Wednesday, April 22, 2009
Over the past year, the monolithic big three US auto companies have resolved into their individual identities revealing, a rising Ford Motor Company (NYSE:F) and a sinking General Motors Corporation (NYSE:GM). Among the 11 companies that comprise the Automobiles sector, Ford has outperformed its peers by 6.23% while GM has underperformed by 44.9%.

Looking at the reputation metrics from the Steel City Re Intangible Asset Finance (corporate reputation) Index below, Ford shows a rising IA index and decreasing EWMA IA Index volatility with a final log magnitude of 2 while GM shows opposite directional movements and a final volatility log magnitude of 3. Our question to you - what business processes do you think are the most important drivers of corporate reputation in this sector: safety, innovation, quality, sustainability, ethics or other?  We look forward to hearing from you on this blog (post a note) or email the Society at secretariat@iafinance.org.

By the way, in case you were wondering, the number 1 ranked firm in this sector as of 17 April is Honda Motor Company Ltd (NYSE:HMC) with a return on equity this past year of 45%.



Tsk tsk, Liska

Nir Kossovsky - Monday, April 20, 2009
You may have heard about the spat between Motorola Inc. (NYSE:MOT) and its former CFO, Paul Liska. Briefly, Liska believes he was dismissed for blowing the whistle on inaccurate financial forecasts; Motorola's version is that he was dismissed for "serious misconduct and incompetence."

Our interest was piqued by a recent JP Morgan analysis that reported "this entire soap opera likely ends with little or no impact to Motorola." We are less sanguine for we see evidence of significant , albeit restorable, reputation impairment.

Liska was dismissed 29 January. He was officially fired 19 February according to an SEC filing. As shown below, between 2 and 9 February, Motorola's reputation as measured by the Steel City Re Intangible Asset Finance (corporate reputation) Index dropped precipitously from the 82nd percentile to the 23rd percentile among 93 companies in the Communications Equipment sector.


The data indicate a decreasing IA index, an increasing EWMA IA index volatility with an average log magnitude of 4, and a not unexpected economic underperformance of 3% below peers. In contrast, Qualcomm Inc. (NASDAQ:QCOM) the #1 ranked firm in this sector, shows a decreasing EWMA IA index volatility with an average log magnitude of 3, and an economic return that exceeds its peers by 41%

We believe Motorola's reputation issues are significant and now center about the core issue of ethics. This additional concern exacerbates pre-existing concerns about innovation which have dogged the company for some time. To stakeholders facing ambiguous facts as they now stand, ethical concerns place all executive pronouncements under a cloud. The discounting effect on share price, in our opinion, is similar to the discounting we saw years ago when Research in Motion was laboring under the uncertainty of intellectual property litigation.

It doesn't have to be this way. Operational transparency and some fine footwork by corporate communications should be able to undo the damage if indeed, as JP Morgan suggests, Motorola's case is the stronger of the two. The reward for success by our estimation, if you want to put a number to it, is up to $11B in restored market capitalization (F-test 10E-30, adj. R2 0.79). But as most companies are learning in these challenging times, in reality, reputation is priceless.

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