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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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.

Serving reputation for dinner

Nir Kossovsky - Tuesday, April 14, 2009
Tweens and adolescents often playfully disparage their meals with monikers such as "mystery meat" or "tuna surprise." While this is good fun, it is something quite different when the CEO of a major food products company similarly characterizes his company's products. David McKay of Kellogg Company (NYSE: K) raised a few eyebrows when he testified last month before the House Committeee on Energy and Commerce that Kellogg relied on third parties to assure food safety. We wonder what thoughts ran through the minds of financial analysts who knew at that time that competitors, such as Nestle, conducted their own supplier inspections thereby signalling to their stakeholders that food safety is a core business process and critical intangible/reputation asset.

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

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


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



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

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

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

Eclipse of the sun

Nir Kossovsky - Monday, April 13, 2009
Last Monday, 6 April, the world learned that IBM (NYSE:IBM) was no longer interested in acquiring Sun Microsystems (NASDAQ:JAVA). Speculation as to the reasons for the collapsed deal include price, intellectual property and hubris. Let's look at the intangibles of this deal from the perspective of the Steel City Re  Intangible Asset Finance (corporate reputation) (IA) index.

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



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



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


Imposing behavior

Nir Kossovsky - Tuesday, April 07, 2009
Cadbury plc (NYSE:CBY), Kellogg (NYSE:K), Mattel (NYSE:MAT) are iconic firms whose products, cash flows, and reputations have been sullied by their business partners through ethical breaches including melamine in milk, salmonella in peanut butter, and lead paint. These three are but a sample of firms afflicted by an epidemic of trading partner (third party) risk who have placed their corporate reputation at financial peril.

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.

Introducing MISSION:INTANGIBLE

Nir Kossovsky - Monday, April 06, 2009
Dear Reader,

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

As always, the Society welcomes your comments and feedback.

Nir Kossovsky
Executive Secretary

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