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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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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.

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