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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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Costco: Food for thought

Nir Kossovsky - Tuesday, January 05, 2010
While the CEO contributes materially to a company's reputation, the products and services also speak for themselves. This is true even when the CEO is a founder and a lightning rod for controversy. Consider John Mackey, CEO, Whole Foods Markets (NASDAQ:WFMI).

In late summer, we shared that he had courted controversy with the left-leaning segment of his customer base through a strongly worded op ed in the Wall Street Journal. We speculated about the reputation effects. On October 3, he reappeared in the Wall Street Journal in an interview that markedly softened the tone of the August writings. Last, at the end of last month, he finally agreed to relinquish the role of Chairman under pressure from a pension fund-based investment group.

Let's look at the numbers courtesy of Steel City Re , Big Charts.com and the FT's Newssift.com. Over the past twelve months, Whole Foods has had a volatile ride on the Corporate Reputation (IA) Index. It entered the year below the 40 percentile, and exited at about the same level having touched the 90th percentile in late October and diving below the 20th percentile in February. Meanwhile, its equity has returned to stakeholders about 140% for the year while the mean of the 24-member peer group matched the S&P500 returns of around 20%. Note the August 2009 dip on both the reputation index and the market cap.

Compare and contrast this extraordinary return for a company with a controversial CEO and a volatile corporate reputation with the returns of one of the highest reputation-ranked Food and Staples Retailing firms this past year, Costco Wholesale Corp (NASDAQ:COST). Its CEO, James D. Sinegal, is a quiet man, relatively speaking. The Steel City Re Corporate Reputation (IA) Index shows values in the 90th percentile or greater, excluding an early September 2009 dip. Yet the 12-month returns, while positive, are underperforming the S&P 500 by 13%.

With respect to sentiment, over the past 12 months, Newssift reports that of the 238 articles on Whole Foods and its high profile CEO, 32% were positive and 21% were negative for a ratio of 1.5. Of the 99 articles on Costco and its lower profile CEO, 35% were positive and 16% were negative for a ratio of 2. Yet Whole Foods outperformed Costco by a factor of 20. What gives?

There is a simple explanation -- reputation resilience. The financial benefits of Costco's high reputational standing are best seen over a two year window in the stock price chart below. While the markets suffered greatly in 2008 through March 2009, Whole Foods suffered massively with a 75% loss in market cap at its low point. Costco, however, outperformed the market over this two year window with a 24 month loss of about 7% compared to the S&Ps loss of about 22% and Whole Foods' loss of around 25%.

The dark lining to the silver cloud of reputation resilience is that there is less ground lost, and therefore less ground that can be made up. The polish on the silver cloud, however, is in cost of credit. Firms with superior reputations exhibit resilience and lower volatility. Firms with superior reputations have lower betas, lower costs of credit, and credit protection (credit default swaps). Whole Foods' beta is 1.19; Costco's is 0.79.

You're invited

Nir Kossovsky - Tuesday, December 29, 2009
To kick off the new decade, on Friday, January 8, we are hosting a live panel discussion among Society committee chairs about the critical intangible asset issues we will face in the '10s. Each of our chairs working in a different segment of the intangibles market will share their ideas on the most important issues. Our panel includes Scott Childers, Walt Disney Company; Marc Lucier, Deutsche Bank; David Hetzel, Motorola; Jon Low, Predictiv; Cathy Reese, Fish & Richardson; David Gould, Buchanan Ingersoll; Andy Gibbs, Andy Gibbs; Nigel Page, IAM magazine; and Judy Giordan, Steel City Re.

You too can participate in this special Mission:Intangible Monthly Briefing. You can register for free, and slides will posted on the website in advance of the event. Questions submitted by the audience in advance or during the broadcast will be fielded and addressed.

But we thought we would also reach out to a broader audience in the blogosphere and Twitterdom. We're talking to you. You may not be able to tune in to the Briefing, but you are interested in intangible asset finance. What do you think are the critical intangible asset issues for the coming decade? Please share your thoughts through comments on this post and help us spread the word about the discussion. If communicating by Twitter, please include #IAFS in your tweet. We will share highlights from the comments in the call as well as in follow-up posts on this blog. Or send us your questions directly at questions@iafinance.org.

We look forward to hearing from you and working with you in the coming decade to help spread the word about excellence in intangible asset management and corporate reputation.

And to all, best wishes for a happy, prosperous and new year.

Mary Adams, Moderator, M:I Monthly Briefings
Nir Kossovsky, Executive Secretary, IAFS

Faking trades

Nir Kossovsky - Monday, December 21, 2009
As financial intermediaries, brokers play a crucial role of matching buyers and sellers. Central among those role is facilitating price discovery. This is especially true in markets for bespoke, less liquid products. Having a reputation for ethical behavior is valuable—as are the underlying business processes that foster ethical behavior.

Faking trades to distort pricing could threaten the commercial viability of a broker were the practice found to be widespread. At the very least, it is fraud. On Friday 18 December, ICAP Securities USA LLC reached a settlement with the United States Securities and Exchange Commission (SEC). The company, a US subsidiary of ICAP plc (LON:IAP) and winner of a Queen’s Award for Enterprise, is alleged to have posted fictitious trades in 2004 and 2005 on some Treasury brokers’ screens to encourage trading by attracting those brokers’ attention.

ICAP is active in the wholesale markets in interest rates, credit, commodities, FX, emerging markets, equities and equity derivatives. ICAP has an average daily transaction volume in excess of $2.3 trillion. In June 2009, ICAP purchased the intellectual property markets division of Ocean Tomo thus becoming one of the largest market makers in a class of bespoke intangible assets. Intellectual property markets have suffered chronically from price discovery challenges.

ICAP Securities has agreed to pay the SEC disgorgement of $1 million and a penalty of $24 million as settlement to end the investigation. The settlement includes the concept of non-intentional fraud. ICAP Securities has also agreed with the SEC that ICAP Securities will appoint an independent consultant to review the improved control environment that is now in place. Shares of ICAP ADRs fell 46 cents or 3.37% in Friday’s session in New York to close at $13.19 a share. The S&P 500 index was up 0.58% and the financial services sector average was up 0.68%

Blankfein's feign

Nir Kossovsky - Wednesday, December 16, 2009
Let's turn briefly to reputation restoration efforts at Goldman Sachs (NYSE:GS). Lloyd Blankfein’s decision to withhold cash bonuses from himself and Goldman Sachs’ 30-person management committee reflects a child rearing philosophy that we share not. This is why. Allowing a child to send himself to bed without supper does not rectify the wrong; nor does it foster desired behavior. To paraphrase, “it is a tale told by Blankfein, full of sound and fury, signifying nothing.

As we have argued repeatedly, and now provide the business case in the Society's new book, Mission: Intangible. Managing risk and reputation to create enterprise value, the path to reputation restoration begins with changes in business processes. Excessive risk taking requiring parental bailout was the transgression. A commitment never to repeat the offense affirmed by evidence of substantive business process changes is the only acceptable penitence. The desired behaviors Mr. Blankfein should demonstrate are (1) institution of policies and procedures to better govern the actors that individually contributed to the collective risk and (2) deployment of methods to foster conformance with them.

Genzyme fixates on process

Nir Kossovsky - Friday, December 11, 2009
Earlier this week, Robert Bertolini, former Schering-Plough Corp. executive vice president and CFO, was elected to the board of directors at Genzyme Corp (Nasdaq: GENZ). Bertolini worked for the last six years at Schering-Plough, where he was responsible for overseeing tax, accounting and financial asset management before the company’s merger with Merck & Co. Prior to his time at Schering-Plough, he worked at PriceWaterhouseCoopers.

Why elect an accountant to the board of a leading biotechnology company? We think it is for his process expertise. This is why. Three weeks prior, the U.S. Food and Drug Administration notified Genzyme of new deficiencies at its primary manufacturing plant in Massachusetts. A five-week inspection of the facility made the timely approval of the new drug, Lumizyme, unlikely and comes after the location failed an inspection in May.

Today, Genzyme CEO Henri A. Termeer said Genzyme also hired Pamela Williamson from Serono Inc. to be Genzyme’s senior vice president and head of regulatory affairs and corporate quality compliance; Ulrich Goldmann from Novartis Pharmaceuticals to be Genzyme’s senior vice president of global medical affairs; Andrew Lee from Pfizer Inc. to be senior vice president of clinical research; and Michael Panzara from Biogen Idec Inc. to be Genzyme’s therapeutic area head and group vice president for multiple sclerosis and immune diseases. Genzyme has to focus on process improvements.

There is not much else to tweak. Its stakeholders are giving it the benefit of all doubts. Its reputation ranking (see IA index below) is near the peak of the Biotechnology sector according to the Steel City Re Corporate Reputation Index. Nevertheless, its stock price is back to 2004 levels, and trading activity level is rising--a harbinger of reputation changes.

This is what we read in the messaging. Reputation protection is the mission, and business process improvement is the strategy. Loss of reputation at this stage would lead to a precipitous drop in enterprise value and an empowerment of activist investors such as the hedge fund, Relational Investors LLC, of San Diego. Failure is not an option.

United: Reputation breeds indifference

Nir Kossovsky - Wednesday, December 09, 2009
Followers of Mission:Intangible know the mantra—reputations result from perceptions that stakeholders have about a company’s intangible assets. Superior reputations pay off with (i) stronger pricing power, (ii) lower operating costs, (iii) greater earnings multiples, (iv) lower beta, and (v) lower credit costs. And conversely.

From time to time we chronicle on these pages case studies where executives enhance a company’s lowly reputation through substantive operational changes, and where executives tarnish a company’s lofty reputation through process failure(s). In each issue of IAM magazine, detailed case studies now appear routinely. And a compendium will appear end of 2010 first quarter when the Society publishes its first book, Mission: Intangible. Managing risk and reputation to create enterprise value.

Today for the first time we looked at a company where executives tarnish a company’s already low reputation. The company, UAL Corporation (Nasdaq:UAUA), the parent company of United Airlines, is in the Airlines sector where competition for the bottom rank is keen. We’ve looked at this sector before in the context of flight safety. Safety is something stakeholders clearly consider material. Quality, on the other hand, is something stakeholders embrace with resignation. By quality, we use one of three Mission:Intangible standard definitions for this reputation-linked asset. This is it. Reputation is the extent to which a service meets or exceeds the expectations of customers or clients.

For United Airlines, expectations are low. The Steel City Re Corporate Reputation Index shows a low ranking among the 19 companies tracked. By our measure that ranking was not affected by Dave Carroll’s 6 July YouTube release, United Breaks Guitars (embedded below), a song written in protest because the airline would not compensate him for damaging his Taylor guitar. Nor was it affected by the 4 million view of that video before the end of the month. And we can not support claims by Chris Ayres of The Times Online in the U.K. that the Carroll mishap actually cost United $180 million, or 10 percent of its market cap. None of that.


In fact, we are dedicating time and effort to report that nothing happened. The dog didn't bark. The chart below plotting United, the Airlines sector median return, and the S&P 500 shows broad economic slides in July (red V) for all three while the reputation index for United which is volatile for the entire preceding year is remarkably flat. In August, the reputation slides briefly again but there is a broad economic bump upwards. 

Looking at this another way, this chart below shows that the overall reputation standing of the Airlines group (red diamond) rose over the coarse of the year while the variance narrowed. This suggests that the relative flat features of United's reputation are consistent with an industry wide reduction in volatility, if ever so briefly.

What can we learn from this case? First a low ranking reputation may deprive its owner of i) stronger pricing power, (ii) lower operating costs, (iii) greater earnings multiples, (iv) lower beta, and (v) lower credit costs, but there is a silver lining. As the data show, and we write this with all sincerity, a low reputation ranking makes it is easy to meet expectations and deliver quality service.

Headline risk reprieve

Nir Kossovsky - Thursday, December 03, 2009
Six weeks have passed since the Chairman of the Galleon Group, the hedge fund at the center of a suspected insider trading ring, and several executives, have been charged. Three of the companies caught in this scandal are going concerns. Their executives are accused of divulging confidential non-public information. Those companies are McKinsey & Company, IBM (NYSE:IBM), and Intel Corporation (NASDAQ:INTC).

Of the three, McKinsey & Company has a widely held reputation for discretion – an intangible asset that is essential to their operational effectiveness. Last month, we hypothesized that this reputation would help mitigate McKinsey’s headline risk. Evidence of this mitigation would be fewer articles in the business and legal press relative to the other two firms.

Once again, Society member Jim Singer of the Pepper Hamilton law firm and author of the blog IP Spotlight, helped us with the analysis. Lexis Nexis searches were conducted combining 2 comprehensive databases - Business News Publications and Legal News Publications for the dates 9/3/2009-11/22/2009. The first search was for the pairing of “Galleon OR Rajaratnam.” Jim then searched the resulting articles for the additional terms of McKinsey, IBM, or Intel. 

There were no citations meeting the search criteria prior to the government announcement of allegations. Following the announcement, the data show that McKinsey’s name is less frequently associated than the other two firms with the disgraced hedge fund. This observation is statistically significant for the first three weeks of the alleged scandal.

While the findings are not conclusive—McKinsey is privately-held whereas the other two are public—these data are consistent with our general observation that companies with strong reputations based on rigorous business processes make for sympathetic actors that are treated as victims rather than culpable agents when adverse events occur. In short, reputations arising from superior intangible asset stewardship help mitigate headline risk.

NB: Statistical analysis using the Chi Square test for the five weeks of data yields a p<.03, p<.001, p<.01, for the first three weeks, respectively, and then not statistically significant differences thereafter.

Exacting reputation

Nir Kossovsky - Tuesday, December 01, 2009
Intangible asset financial management is a serious matter affecting what is once again the source of 70% of the average public company's value. There is also a lighter side.

We entered the American Thanksgiving holiday with story about food (beer, actually) and reputation. We bookend the holiday by sharing a view of the inside flap from a carton of eggs. Not any egg carton, mind you, but one of the many that played an important role in the holiday meal supply chain.

Parva sub ingenti.

Reputation quaffing

Nir Kossovsky - Tuesday, November 24, 2009
The American Thanksgiving holiday to be celebrated later this week features an excess of food, televised football and beer. Beer is an important American cultural element. The American patriot and founding father, Benjamin Franklin, once quipped that “Beer is proof God loves us and wants us to be happy.” There is a reputation angle to this. Read on. 

During the 2009 broadcast of the NFC Championship football game Jan 18, Heineken USA launched a new campaign for its new marketing platform -- "Give Yourself a Good Name." The campaign showcases subtle ways in which consumers decide to "give themselves a good name" through their actions, their words and their choices. Let’s focus on actions as they are the embodiment of something the Society cares about very much – processes.

By drinking Heineken, the campaign suggests, consumers will be building a good reputation for themselves. This is the process hook. There's an admonition to drink responsibly, or not to throw your name away in drunken excess. An ethical call for socially responsible behavior.

There you have it. Increasing intangible asset value (ethics) through risk and reputation management at a most personal level.

Tastes great, even if it doesn’t beat the 2-year returns of the S&P500. Above, the S&P500 in sepia, AB Inbev (BE:ABI) in blue, and Heineken (NL:HEIO) in red. Data source: BigCharts.com

We wish all an enjoyable holiday. We'll return next week.

Recovering from the breach

Nir Kossovsky - Thursday, November 19, 2009
Today’s MISSION:INTANGIBLE note was prompted by my colleague Robert Liscouski, COO with Steel City Re and a former Assistant Secretary in the Department of Homeland Security. Bob is yielding his IAFS position to the incoming Chair of the Security Committee, Scott Childers from The Walt Disney Company.

To my query of what is hot in security business processes and reputation that will interest our IAFS members, Bob said this: data security. This is why. The new poster child for data security is Heartland Payment Systems, (NYSE:HPY). Heartland, the sixth-largest payments processor of credit and debit card transactions in the U.S., announced in January that its records were hacked. A recently apprehended cyber-gang, according to the Justice Department, compromised 130 million Heartland accounts.

What are the lessons of interest for IAFS members? There are two lessons covering, respectively, the costs of reputation loss and the potential for reputation restoration.

The first lesson is that this was an expensive breach with growing costs. Heartland reported in May that the breach had cost it $12. 6 million so far, which included legal costs and fines from Visa and MasterCard, who said the company was not compliant with payment-card–industry rules. Then, In filings for the Securities and Exchange Commission, Heartland said the 2008 data security breach cost it $32 million as of June 30. Most recently, as of 30 Sept in the 10-Q filing, the Company recorded pre-tax expenses of $105.3 million or about $1.74 per share, associated with the security breach, aka, the Processing System Intrusion.

The majority of these charges, or approximately $90.8 million, related to: (i) assessments imposed in April 2009 by MasterCard and VISA against us and our sponsor banks, (ii) settlement offers we made to certain card brands in an attempt to resolve certain of the claims asserted against our sponsor banks (who have asserted rights to indemnification from us pursuant to our agreements with them), and (iii) expected costs of settling with certain claimants with whom settlement discussions are underway.

There is more. The Heartland breach – which has so far resulted in 28 class-action lawsuits filed against the company precipitated a near-immediate 50 percent drop in Heartland's share price (shown in red). Total equity value lost, rebased against the S&P500 Index (shown in blue) as of today, is about $300 million. Data source: Big Charts.com.

The second lesson is that following its near-death experience, Heartland is now committed to building reputation resilience by establishing the new standard for data security processes. Heartland is raising the bar in retail payments security by bringing end-to-end encryption to its network. It will be expensive and a big logistical challenge to execute. However, as long as it's accompanied by good policy and process, Heartland's encryption initiative will plug a definite security gap in the payments system.

In turning to processes to cure the defects that led to the reputation loss, and by creating a new standard for best practices, Heartland is following the model established by Johnson and Johnson with their product security issue, and El-Al Israel Airlines with their hijacking-related security issues. It is a best practice that examplifies the values of the IAFS and its members. Won't you consider joining us?

Heads up: IAM magazine, the official publication partner of the Society, will feature a reputation-focused case study on Johnnson & Johnson (NYSE:JNJ) in the January 2010 issue, #40.

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