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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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.

Ethical lubricant

Nir Kossovsky - Tuesday, November 17, 2009
Operating costs such as internal frictional costs are the bane of any executive accountable for the bottom line. True, they can be cut – usually through workforce reductions – but the long-term effects on surviving employees may include net losses in productivity and even greater internal frictional costs.

Here is good news, executives. There is a proven strategy for lowering internal frictional costs. This is it. Be ethical. Be sustainable. Be safe. And be known for it.

In other words, all you need to do is apply the best practices found in other companies that are superior stewards of their intangible assets – the business processes that lead to reputations for ethics, safety, quality, innovation, security, and sustainability. Companies that follow these practices tend to out perform their peers and better reward their shareholders.

The relationship between these business processes, reputation, internal frictional costs, and value creation are illustrated on a webpage of one of our members, Steel City Re, a leader in risk and reputation management. The latest data affirming these principles comes from Kelly Services, Inc. (NASDAQ: KELYA, KELYB), a world leader in workforce management services and human resources solutions.

According to the Kelly study announced late last month,

Major public issues such as a company’s reputation for strong ethical practices have become critical factors in choosing where to work, even to the point where many employees are prepared to sacrifice pay or promotion in order to work for organizations that are actively engaged in good social responsibility practices. More specifically, concerns about ethical behavior outweigh concerns about the environment by all generations, when making employment choices.

Here are some other key findings:

  • Almost 90 percent of respondents say they are more likely to work for an organization that is considered ethically and socially responsible, something that is consistent across all age generations.
  • 80 percent are more likely to work for an organization that is considered environmentally responsible, a figure that is considerably higher among older age groups.
  • In deciding where to work, an organization’s reputation for ethical conduct is considered ‘very important’ by 65 percent of Gen Y, 72 percent of Gen X, and 77 percent of baby boomers.
  • 46 percent of Gen Y would be prepared to forego pay or promotion to work for an organization with a good reputation, rising to 48 percent for Gen X and 53 percent for baby boomers.
  • In deciding where to work, policies to address global warming are considered ‘very important’ by 31 percent of Gen Y, rising to 35 percent among Gen X and 36 percent for baby boomers.
Here's the action part. Want to cut operating costs? Ramp up your company’s reputation for ethics, sustainability, safety, etc. Become a superior risk and reputation manager.

Want to know how to do it? Join the Intangible Asset Finance Society. We provide a forum for executives to discover better ways to increase the visibility, transparency, and value of intangible assets. These assets comprise 50% of the average company's value. Click here for information on membership and affiliate with us on LinkedIn.

Life saving value

Nir Kossovsky - Tuesday, October 27, 2009
In each blog piece, we champion intangible asset management on the premise that superior stewardship creates enterprise value. We point out that management entails the adoption and conformance with specified business processes. We often provide enterprise-level data showing intangible asset value creation.

Today's note on safety also enumerates process steps and provides more granular value data. First, the value: 18 months, 1500 lives, $200 million.

Now the back story and process steps. This past Friday, HHS Secretary Kathleen Sebelius today announced the award of $8 million to fund a national expansion of the Keystone Project.

The Michigan Keystone Intensive Care Unit (ICU) Project, a partnership between the Michigan Health & Hospital Association and Johns Hopkins University, sought to change clinicians’ behaviors when inserting catheters into ICU patients. It was hypothesized that introducing best practices in the execution of an invasive medical procedure on relatively infection-prone patients would reduce the incidence of health care-associated infections.

Health care associated infections are among the top ten leading causes of death in the United States. Such life-threatening infections significantly drive up the cost of health care by nearly $28 to $33 billion per year.

These are the process changes the team deployed. First, the team made a process checklist, measured infection rates, and changed hospital culture. The checklist’s components consisted of hand washing; using a cap, gown, and mask; cleaning the patient’s skin with a disinfectant; avoiding placing catheters near the groin; and removing unnecessary catheters. These five steps were associated with a 66-percent reduction in these infections throughout the state. The ROI calculation: for every dollar invested, $200 was saved.

The take home message: to effect business process changes, defining and measuring key metrics, deploying processes (train, observe, and encourage conformance), and communicate benefits arising comprise the best practices. Follow this sequence, and you will be able to show a favorable ROI and maybe even save lives.

New fundamentals

Nir Kossovsky - Monday, October 05, 2009
Nell Minow, editor and co-founder of the Corporate Library, a provider of corporate governance research, ratings and investment risk analysis, penned a Financial Times op ed piece on 2 October suggesting that going forward, fund managers and analysts will look at four new fundamental elements “that will become as important as cash flow and return on investment.” To no surprise around here, these four comprise intangible asset metrics and business processes. While we do not necessarily agree with Minow's views, her comments are worth noting. This is what she wrote, briefly:

1. Accounting: Investors will demand better information about human and intellectual capital, risk management processes, and sustainability. Our friend, Ken Jarboe of the Athena Alliance, has been delving into this topic for years. You can link to the Athena Alliance here.

2. Boards of Directors: Investors will demand greater competence and selfless engagement from members of the Boards of their companies. They will want from Directors what private equity firms demand of early stage company executives: "skin in the game." This notion compresses to the concept of Governance, about which the Society has organized a Committee chaired by Cathy Reese. Without leaving with us a pound of flesh, you can download her 6 Feb 09 "how to" presentation on this subject from our Events page.

3. Compensation: We read Minow’s comments in this light: executive compensation must better align the interests of senior management with the long-term interests of the firm and its stakeholders. Compensation processes, writes Minow, are a key indicator of risk. While we still see benefits in incentives and material compensation, notwithstanding the growing chant of mobs with pitchforks, we like the part in Minow's piece about processes and risk management. In fact, we like anything that links risk management to overall corporate reputation. This is especially when a company uses financial instruments to signal superior risk management. The Society presented a Mission:Intangible Monthly Briefing on Risk and Reputation Management 10 July 09 that you can download from our Events page.

4. Investors: Going forward, investors will look to see if the existing investors are providing sufficient oversight to ensure that the Board of Directors is providing sufficient oversight to ensure that management is providing sufficient oversight of the firm’s operations. Did you follow that? The business process is oversight; the intangible asset affected is trust. To us, the take home message is this. The greater the trust (a product of transparency), the less oversight burden for all. And how can investors signal trust? According to Minow, investors can signal trust by being "overweight relative to the index." In other words, extra skin in the game. See #2 and #3 above. 

The bottom line is this. Investors will seek companies that have their business processes under better control, can quantify and report the value of these proceses to their stakeholders, can manage their risks, and can signal their material conformance with the preceding  through non-traditional channels. The Society provides a working environment for best-practices discovery for executives seeking to accomplish the above. Won't you join us?

It's personal

Nir Kossovsky - Thursday, September 24, 2009
During the 6 February 2009 MISSION:INTANGIBLE Monthly Briefing, Fish & Richardson’s Cathy Reese, who chairs the Society’s IA Corporate Governance Committee, indicated that under Delaware Law, Directors and Officers had a Duty of Care to oversee the management of the business processes that help establish reputation. She noted that absent oversight systems, Members of the Board could be personally liable to shareholders for adverse events that impaired a company’s reputation.

Cathy’s warning of shareholder-driven exposure is just the beginning. Now companies are seeking restitution, too. According to the newspaper Deutsche Welle, after spending nearly 2.5 billion euros to cover legal bills and fines stemming from an international bribery scandal, Munich-based Siemens AG (NYSE:SI) is seeking payments from its former leadership team. Siemens was investigated for paying 1.3 billion euros in kickbacks between 2003 and 2006 to potential buyers in 12 countries, including Italy, Greece, Russia and Nigeria. In Germany and in the United States, the company was found guilty of corruption and ordered to pay combined fines of just over a billion euros. After the 2006 investigation, Siemens then accused some of its former managers of having failed to stop illegal practices and wide-ranging bribery.

It gets more interesting. The Financial Times reports that some of Siemens’ investors have threatened to sue the company if it did not claim damages from its former managers.

The value of risk and reputation management at the board level should be painfully obvious. The consequences of failing to manage a firm’s business processes for ethics, sustainability, innovation, quality, safety, security, etc. – the drivers of reputation – can place officers and directors at great personal peril. Yes, it’s personal.

Dominating Dominos

Nir Kossovsky - Tuesday, September 08, 2009

Copious amounts of ink and countless electrons have been deployed in the debate over the commercial impact of social media. The debate? Yes, there are contrarians such as Jon Baskin, a speaker at our 2008 fall conference, who discount much of the power attributed to social media venues like Facebook and Twitter. While wary, we are slowly being persuaded.

Consider the case of Dominos Pizza (NYSE:DPZ). In late May, we analyzed the affair where employees of a franchisee disparaged Domino’s reputation through YouTube. In short, they challenged the quality of the product. In as much as quality is a life-supporting intangible asset, we saw this as a reputation body blow; and so did a good part of the mainstream business media.

We were wrong. We succumbed to conventional wisdom, when we should have equivocated. After all, the Steel City Re Corporate Reputation Index reported a steady climb in Domino’s reputation ranking for the preceding 8 months indicating the potential for outperformance going-forward, or at the very least, some degree of resilience. The index beat our gut instincts.

In our May 27 note, we compared Dominos to the three highest ranking firms among 47 in the Restaurant sector, Panera Bread Co. (NASDAQ:PNRA), McDonald’s Corp. (NYSE:MCD), and Chipotle Mexican Grill Inc. (NYSE:CMG). To appreciate our error with respect to Dominos, we revisit their economic performance of all four since 11 May, a few days before the YouTube affair.

As shown in the chart pasted from BigCharts.com below, Dominos suffered a 10% market cap drop in the period immediately following the affair (red arrow). Trading volume surged. Then there was a rebound as the Company rolled out an aggressive and effective campaign to restore its reputation. And the metric for success? Its returns beat those of two of the three most highly ranked firms in the restaurant sector from that period.



While many might attribute the rebound to excellent marketing, the Society would posit that Dominos' reputation resilience was evidence of substantive business processes that drive quality, and a communications effort that allowed stakeholders to appreciate its value.

What are those quality processes? They are systems that improve managerial motivation, provide time for managerial oversight, and technology that enhances quality while reducing opportunities for adverse human intervention - malicious or otherwise.

Dominos' greatest reputation risk lurks in an among the employees of the franchisees. Its strategy to mitigate that risk comprises two creative HR-focused processes. First, it requires that every franchise owner be 100% committed to the business -- no outside (distracting) revenue opportunities. Dominos wants the fortune of its franchise owners to depend on the success of the franchise. Second, it provides vertically integrated dough manufacturing and supply chain systems that allow the franchise owner to dedicate more time to human resource management rather than engage in “back-of-store” activity typical of the industry. Then there is innovation and technology. Dominos is constantly innovating process and system improvements to increase quality: the efficient, vertically-integrated supply chain system described above, a sturdier corrugated pizza box and a mesh screen that helps cook pizza crust more evenly; and the Domino’s HeatWave® hot bag, which was introduced in 1998, that keeps pizzas hot during delivery.

In summary, Dominos showed reputation resilience because it understands that its value is tied to the quality of its product. Dominos also showed that it understands well that its reputation for delivering a quality product can be protected through business processes and systems.

Employer brand

Nir Kossovsky - Wednesday, September 02, 2009
Stefan Stern writes on management for the Financial Times. In yesterday’s issue, he reviewed the concept of “employer brand.” According to the consultancy Business in People, (BiP), the employer brand “encapsulates how your workforce behaves, the impression employees create while carrying out their work, how well they are managed and led, whether or not they feel engaged, and so on.” It is an intangible asset that attracts and retains employees.

In the language of the Intangible Asset Finance Society, “employer brand” translates to “business processes and reputation.” And as the call out in the FT article affirms, “when it comes to retaining good people or attracting new ones, your image and reputation count.”

So far so good. Stern writes that Hiscox Ltd (LON:HSX), an insurance firm, realized a 30% increase in EBITDA last year. The firm’s CEO engages BiP. Proof that a good reputation arising from good human resources business processes fosters above average returns. And we have no argument with the conclusion.

Stern then writes that BT Group plc  (NYSE:BT), the telecommunications conglomerate, failed to honor its commitment to attend a recruiting fair leaving an indelible stain on their reputation. And their stock price is down 30% over the past year. BT's attitude to people, he notes, is very different than Hiscox's and by implication explains the differences in economic performance. 

We can not independently test the contrasting reputations with the Steel City Re Corporate Reputation Index since it currently does not extend to companies trading on non-US exchanges, and we do not dispute the economic results. But we would like to verify the implied relationship since it is a core area of interest to the Society.

Fortunately, Stern’s newspaper, the FT publishes a sentiment index through its affiliate, Newssift. The FT Newssift sentiment data that offer rough measures of reputation as reflected in the business press, do not support Stern’s argument.

As shown below, for the twelve month period between 2 Sep 2008 and 2 Sep 2009, articles in the business press covering Hiscox were positive 43% of the time, and negative 23% of the time; articles covering BT were positive 49% of the time and negative 18% of the time. By this metric, BT has a superior reputation.



We have invited Stern to comment.

NGO no no

Nir Kossovsky - Thursday, July 16, 2009
We dedicate most of the time and effort of this communication channel to a discussion of the intangible assets that underpin reputation. Usually, the subject matter involves corporate behavior.  Awareness of issues associated with corporate behavior may come to light because of government regulatory action. More often, it is the result of NGO-driven publicity. In a break with tradition, the subject of today's note comprises NGO transparency. 

An on-line Wall Street Journal op-ed posted earlier this week alleged that Human Rights Watch, a 30-year old NGO dedicated to defending and protecting human rights, sent its leading Middle East official, Sarah Leah Whitson, to extract money from potential Saudi donors by bragging about the group's "battles" with the "pro-Israel pressure groups." The ongoing dialogue appears to affirm the allegations.

NGOs are important actors in both the geopolitical and commercial worlds. They encourage and monitor corporate compliance with many of the best practices comprising key business processes that underpin reputations for ethics, safety, and sustainability. They are respected and feared by much of the business community. Their primary tool is the threat of headline risk. Their moral authority depends on their reputation for independence. Their value is ephemeral. Loss of reputation and moral authority can be catastrophic.

Ronelle Burger and Trudy Owens from the University of Nottingham recently published a study that was motivated by “widespread calls for NGOs to become more accountable and transparent.” They conclude that “… NGOs with antagonistic relations with the government may be more likely to hide information and be dishonest.“

Human Rights watch has an antagonistic relationship with the Israeli government. The Israeli government wasted no time questioning HRW's "moral compass. "

Quis custodiet ipsos custodes?


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%.




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