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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McDonald's - Curb Your Enthusiasm

C. HUYGENS - Sunday, May 24, 2015
McDonald's is objectively in difficult straights. Economic news for Q1 reported in mid April was dismal with global sales down by 2.3%, revenues down 11%, and income down 28%. Strategically, the company mollified investors by returning $1.4 billion to shareholders through dividends and share repurchases.

But there is reason for guarded optimism. The company is beginning to understand what drives its reputation, if its public reporting is a valid indicator. Mentions of reputation are up 300% in item 1A Risks.

For the first time in the company's K's and Q's, it acknowledged in 2015Q1 that quality impacts the firm's reputation. "Food safety is a top priority, and we dedicate substantial resources to ensure that our customers enjoy safe food products…In 2014, food quality issues were discovered at a supplier to McDonald’s and other food companies in China. As a consequence of this issue, results in China, Japan and certain other markets were negatively impacted due to lost sales and profitability, including expenses associated with rebuilding customer trust. Any future instances of food tampering, food contamination or food-borne illness could adversely affect our brand and reputation as well as our revenues and profits."

"With new U.S. leadership, the U.S. is focused on a strategic roadmap that includes a revamped marketing approach…" Might quality by part of the turnaround? Hard to say. There is no indication that it is part of the increased investment into marketing. "Selling, general and administrative expenses as a percent of revenues increased to 9.8% for the quarter 2015 compared with 9.3% for 2014, and as a percent of Systemwide sales increased to 3.0% for the quarter 2015 compared with 2.9% for 2014, as weaker foreign currencies are having a bigger impact on revenues and sales."

Exuberance should be tempered by the sobering fact that the term quality only makes one other appearance in the filing. Quality is mentioned in a string of attributes on which the company competes, "We compete on the basis of product choice, quality, affordability, service and location"-- issues that are relevant to marketing. Quality is not discussed in the context of operations or controls.

Turning to the reputation value metrics, which can be viewed as either controls on the process that affect reputation or a window into stakeholder assessment of governance, and there are again reasons for guarded optimism. McDonald's Reputation Value Metric is still in the 99th percentile among the 76 firms in the restaurant peer group with a very low Consensus Trend. On the other hand, the sobering news is that its reputation value metric has been declining for nearly a year.

The data suggest that the enterprise's reputation for a reliable, repeatable quality experience, currently at 80% of its potential, may be restored. First, McDonald's should recognize that the aforementioned list are the core values that underpin the expectations of the stakeholders who consumer McDonald's products. That would tackle the quality challenge.

The Company also faces significant pressures on the labor front. The Company should appreciate that employees who are engaged with a Company that is well respected will find intangible benefits of employment  will offset some fraction of wage costs.

These benefits become transparent on the P&L, and in enterprise value, but they come only to those whose governance organization understands the rules of doing business in the 21st century.

McDonald's: Fear, uncertainty and doubt

C. HUYGENS - Thursday, October 23, 2014
McDonald's stakeholders need to hang on to more than a burger. The once-simple business model of innovative delivery of a simple menu at a fabulous price in a clean and secure environment has been under attack from so many quarters for so long that it is leaving stakeholders worried. The jump in the value risk (VR) metric below since August reflects this fear in much the same way that the Chicago VIX does.

McDonald's is a firm that achieved greatness through supply chain innovation, product innovation, real estate management innovation, workforce innovation, and marketing innovation. It stands to reason that one way out of this quandary of stakeholder uncertainty is to meet their expectations for -- innovation.

Consensiv's Jonathan Salem Baskin, writing for Forbes, states, "It’s hard to remember, but McDonald’s started out as the disruptor in its industry. Its innovations were many, ranging from standardized, efficient experience in menu and restaurant design, to great marketing. McDonald’s perfected, and then consistently improved the Holiday Inn model that allowed it to blow up thousands of quirky and sometimes risky hamburger stands, and replace them with food that was reliably good in restaurants that were consistently fine."

The bottom line: McDonald's should "…disrupt the industry completely, by flexing its resources muscles and embarking on changes that its competitors couldn’t copy or catch, and for which its customers would pay."

Read more at Forbes.

McDonald's and Yum: Deserving a break today

C. HUYGENS - Thursday, August 14, 2014
On Sunday, 20 July, Dragon TV of Shanghai, China, precipitated a reputation crisis at two global companies. The TV station reported that food supplier Husi, owned by OSI Group of Aurora, Ill., repackaged stale beef and chicken, updated the expiration dates, and sold the adulterated meat to McDonald's, KFC and Pizza Hut restaurants.

A reputation crisis begins when a company fails properly to set expectations or fails to meet them, and then stakeholders turn on a company and lower their expectations. The going-forward economic consequences result from how customers thereafter respond to prices, how effectively employees work, creditors set borrowing rates, suppliers set terms, and how severely regulators impose penalties.

For Yum Brands and McDonald’s, the changes in stakeholder expectations are  reflected in customers’ reduced demand--or at least some analysts expectations of  future customer behavior. Royal Bank of Canada analysts projected that Yum’s China sales at KFC and Pizza Hut could drop off 10-15% for at least 6-8 weeks after the July event. An executive at McDonald’s Japan reported a 15-20% drop-off in daily sales. Forward-looking equity investors are seeing more sustained losses. Between July 15 and August 14, Yum! Brands equity lost 15% of its value; McDonald’s shed around 7%, and the benchmark S&P500 composite equity index lost about 1.2%.

[Added Saturday 16 Aug] A more encompassing view of expected stakeholder behavior shown below, according to analysis published by Consensiv, the reputation controls company, based on reputation value metrics we use at Steel City Re, affirms that all-things-reputationally at McDonald's are not as bleak as equity investors might be signaling. The company's reputation premium is near the top (and heading upward), and its value risk is in the lowest quartile of its peer group.

Chipotle: This is how we do it, people

C. HUYGENS - Monday, July 28, 2014
The fast-casual food industry is taking a beating on the reputation front. A wide range of stakeholders are finding unmet expectations. Customers, at least those in China, are wrestling with food quality issues again as another supplier is caught offering up below-grade product. Employees, at least those in the USA, are wrestling with pay issues. Investors are grumpy about heavily compensated executives who are not managing the above to a level investors believe is worthy of the lofty compensation the executives command.

In this maelstrom, at least one company seems to be above it all with about $785 million of reputation value in play over the past 6 months, or about 3.8% of market cap. Chipotle Mexican Grill (CMG) is riding high with equity values climbing as much as 13% last Tuesday after the chain reported 2nd quarter that comparable sales skyrocketed 17.3%. The only negative in terms of reputation management is that the company apparently didn't foreshadow this fabulous growth sufficiently to equity investors who were delighted with the surprise. (Good reputation management means minimizing surprises). Here are the numbers.

Yum!: Political indigestion

C. HUYGENS - Wednesday, October 30, 2013
Once upon a time, it seemed that Yum! Brands (YUM), Yankee imperialists by almost any other name, were going to win the hearts and minds of the populace of the Middle Kingdom. Fast forward, and the Economist's February 2013 label, "Yucky Kentucky" seems to be taking hold.

The current chapter began about one year ago when a media report on China's national TV station alleged that some poultry farmers in KFC's supply chain violated both Chinese regulations and Yums! supplier terms by doping chickens to speed up their maturation and marketability.

"Toxic chickens!" The Chinese, who've had their fair share of food-associated mortality, apparently shunned the branded products. KFC’s January sales in China fell by a dramatic 41 %. Regulators made recommendations, Yum! took them to heart, and importantly, acknowledged the relationship between its operations and its reputation in its 2013 annual report.

Cultural, geographical and legal distance make it very difficult to first perceive and interpret early warning signals correctly and then to react quickly and appropriately. One spin on the January 2013 fall in sales, and the September 2013 report of a 70% fall in net income, is that Yum!'s reputation in China has been permanently damaged by the affair. The narrative fits the "hero to zero" story and Warren Buffett's adage about losing a reputation in five minutes after a life time of investment.

But solid reputations exhibit resilience, unless...

Yum! doesn’t operate under the usual franchise system in China. It owns most of its stores -- approximately 5000 restaurants in 800 Chinese cities. Yum!'s success provides less local benefits at a time when the domestic economy is struggling. A plausible alternative explanation for Yum!'s woes is more political: the company is being tagged with the stigma of being an imperialist monster that has no respect for the local environment and whose only interest is exploitation of the local market for domestic economic purposes.

Cold war diatribe? Consider last week's accusation by China's state-controlled media that Starbucks Corp (SBUX) charged too much for coffee and that Samsung Electronic Co.'s smartphones don't work properly. Suppose that toxic chickens, or red herrings, are only the tip of the iceberg of regulatory interference -- a heavy handed effort by Chinese authorities to turn around a flagging economy by encouraging domestic consumption.

After 10 years averaging 10.5% growth in the prior decade, China has pared economic growth projections to an average of 7 percent this decade. That's arguably optimistic. Besides a property bubble arising from credit expansion, the entire economy's debt burden is in the same vicinity that preceded crises or sharp slowdowns in Japan and other Asian nations. Even after adjusting for inflation, wages have tripled in the past decade.

According to Bloomberg, "When the U.S.-China Business Council, a Washington-based trade group, surveyed U.S. executives this month, the chief complaints included rising costs and bureaucratic red tape. Almost 70 percent of the more than 100 U.S. firms polled said profit margin would be flat or narrow this year. Only 39 percent are optimistic about the next five years in China; 58 percent felt that way in 2011."

Governments have an uncanny ability to reorient stakeholder expectations. Central bankers have been performing this magic for more than a year with respect to the credit and equity markets. It was not the fire, loss of life, nor oil spill of the Deepwater Horizon that escalated the disaster to the level of the board of directors. Rather, as Carl-Henric Svanberg, Chairman of BP, declared in May 2010, "This has now turned into a reputation matter, a financial squeeze for BP, and a political matter…"

The reputation metrics for Yum! reflect the battle for the hearts and minds of stakeholders, and the power of government to reset those expectations in a heartbeat. The consequences are clear: substantial loss of Reputation Premium from the top percentile among the 65 companies in the restaurants sector to the 70th percentile; and significant confusion in stakeholder expectations evidenced by a top quartile measure of uncertainty - the Consensus Trend -- at 5.2% equaling the two year average level of reputational value uncertainty, the Consenus Benchmark, also now at 5.2%.



For more background on the Consensiv reputation controls, click here. To view the October 2013 reputational value league table at CFO.com, click here.

Yum!: Tums, please

C. HUYGENS - Wednesday, October 09, 2013
Reputation is the confidence stakeholders have that a company will fulfill expectations. A reputational value crisis arises when a company fails to do so and stakeholders realign their expectations.

Last year, Yum! Brands' supply chain quality control processes failed and toxic chickens were served through their KFC outlets in China. The problem has come home to roost. From yesterday's Associated Press wire story, "KFC's parent company Yum Brands says its profit fell 68% in the third quarter, as its China unit struggles to recover from a controversy over its chicken supply and bird flu scare. Results missed expectations and Yum lowered its outlook. Shares fell 6% in aftermarket trading."

Expectations of food quality appear to be near-universal, and customers the world over, provided they have a choice, will do just that: choose. For the time being, Yum! is not top choice.

Chipotle and Jet Blue: What's the message?

C. HUYGENS - Tuesday, September 24, 2013
In this week's issue of Forbes magazine, Mission Intangible Monthly Briefing moderator Jonathan Salem Baskin, Managing Director of Consensiv, asks an existential question about the meaning of the branding campaigns currently being run by Jet Blue and Chipotle. Both companies initially established reputations for doing things differently. Jet Blue provided a level of service and amenities through an energetic and committed staff that in combination comprised a superior offering; Chipotle offered an innovative approach to fast-food with a service level, production process, and quality level of fresh ingredients that couldn't be beat.

The companies were darlings of all stakeholders. But have they lost their way? Looking at the Steel City Re reputational value metrics, the two companies have strikingly different reputational value profiles. Jet Blue's Reputation Premium is below average ranking at the 38th percentile relative to its peers - it's leaving significant value on the table; even equity investors are placing the company in only the 59th percentile in terms of its trailing twelve month return on equity. Trying to squeeze a price premium or better worker concessions, better supplier terms, or better credit terms from a vague campaign doesn't seem like the best use of promotional dollars.



Chipotle is wrestling with other issues. In the past two months, its reputation premium dropped from near the top of its peer group to the 73rd percentile. Its return on equity dropped precipitously, too, to the 33rd percentile, and its Consensus Trend -- an indicator of movement in stakeholder perceptions -- for Chipotle is down to the 73rd percentile having spiked near 11%, a critical level. All these measures indicate the company's stakeholders are confused by what the firm stands for.



As Jonathan describes the campaign, it doesn't sound like there is a clear effort to address what is a clear reputational value problem. Notwithstanding recent issues, among its large market cap peers, Chipotle is relatively rich in Reputation Premium and has been a constituent of the Consensiv 50 for the past two months. Seeing a time line of the campaign against these measures would help answer the question of whether the campaign is helping or hurting. More generally, it would be refreshing to review a marketing case study where the action line between promotional content and value-creating stakeholder behavior could be tracked.

Yum: Tasting better

C. HUYGENS - Wednesday, March 13, 2013
Whether the market rewards or punishes a company depends on what the market expects, according to the book Reputation, Stock Price and You. This week's news on YUM! Brands is illustrative.

From Reuters, good news as sales only fell 20% as a result of the toxic chickens disclosure.

KFC parent Yum Brands Inc reported an unexpected 2 percent rise in February sales at established restaurants in China, boosted by Chinese New Year and easing worries about a food safety scare that drove away customers. Shares in Yum jumped 6.6 percent in extended trading to $72.32, their highest level since November, after the results were far better than the estimated 8.7 percent drop expected by three analysts polled by Consensus Metrix. Yum also said on Monday first-quarter same-restaurant sales in China fell 20 percent, less than its prior forecast for a 25 percent drop.


Also from Reuters, more good news as Chinese appear to be less overtly angry -- or at least they're not talking about it.

Chinese consumers' anger at KFC over a food safety scare has abated as the number of negative posts about the fast food chain owned by Yum Brands Inc on the country's most popular microblogging platform fell by two-thirds. China's half a billion microbloggers posted 3 million overwhelmingly negative comments about KFC in the month that began on Dec. 18, when state media started reporting on the scare over contaminated chicken, a Reuters review of data from the Twitter-like platform Weibo shows. The number fell from Jan. 18 to Feb. 18, but microbloggers still posted more than 1 million comments on KFC, indicating that the largest foreign fast food chain in China still has its work cut out for it as it tries to reverse a steep sales slide.

The Steel City Re reputational value metrics provide an integrated view of expectations and the economic consequences of the behaviors arising. The data on YUM show that the company's arch rival, McDonald's (MCD) has benefited from the turmoil. By all of the reputational vital sign measures, MCD advanced. Both companies are at the low end of the spectrum of historic RVM volatility. RVM is a non-financial measure of reputational value. The absolute measures are in the 4-5% range, which on an actuarial basis place YUM at an imperceptibly  higher risk of material future market value loss. The current RVM volatility of MCD is also greater than YUM and is attributable in part to the significantly greater rise in ROE. The levels for MCD and YUM on the former measure both suggest a better than average future course. On these two measures, as well as the CRR, a measure of relative reputational ranking, MCD has benefited from YUM's slide. Going forward, the data suggest that many customers will come back. It is not clear, however, if equity investors are not getting to far ahead --  a variation on a parent's admonition take care lest one's eyes turn out to be bigger than one's stomach.

YUM! Brands: Toxic chicken

C. HUYGENS - Tuesday, January 08, 2013
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.


McDonald's: Receives a break

C. HUYGENS - Tuesday, December 11, 2012
The Wall Street Journal reported yesterday that McDonald's Corp. (MCD) surprised investors by reporting higher November sales. Analysts, according to the Journal, remain cautious about the months ahead. Credit for the gain goes to the Company's Dollar Menu which "helped reverse a downward slide from the month before, when McDonald's posted the first drop in monthly same-store sales in nine years. Same-store sales globally rose 2.4% in November, fueled by a 2.5% rise in U.S. same-store sales. Analysts were expecting sales to be flat around the world."

McDonald's can afford to deliver its Dollar Menu because the company runs one of the best supply chains in the world. As described in Reputation, Stock Price, and You, "[McDonald's] approach to its relationship with suppliers reflects its ethical culture and the innovations Kroc brought to the business." Among the benefits of the Company's strategy are net lower costs--benefits the suppliers grant McDonald's that we now call reputaitonal value.

Turning to the Steel City Re Reputational Value Metrics, the improved returns are obviously welcomed, but are less surprising. For the trailing twelve months, McDonald's has steadily ranked #1 among the 64 companies in the Restaurant and Fast Food Franchisers sector.


Weighing in at more than twice the size of its closest competitor, YUM! Brands, the company has to work much harder to grow. However, its phenomenal operational controls mitigate risks that might cause it to stumble, so when its CRR--a measure of relative reputational ranking-- hugs the #1 spot for a year while its ROE plummets, one can reasonably expect a turnaround. The data forecast a steady state for McDonald's with respect to key reputational metrics, the RVM and the CRR. And so while Yum! enters a turbulent reputational period, expect McDonald's equity investors to relax and return to the fold.



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