In December 2009, outgoing P&G CEO AG Lafley said, “I am retiring with confidence in Bob McDonald and his team. This is the right time to complete our management transition.” Last friday, wags were reading into communiques the reverse. "This is the right time to restore our former management transition."

There are several ironies about all this. First, after weeks of governance experts piling on to the idea that Jamie Dimon could not be trusted with both the CEO and Chairmanship roles at JPMorgan Chase, nary a negative word could be found suggesting that there was anything wrong with AG Lafley taking on the roles at P&G of Chairman, CEO and President. Second, there was near-universal accolades for Lafley's reputation as a giant in innovation -- a point Huygens disputed previously when he suggested that P&G's current problems are a direct result of Lafley's strategy.

However, as an American Pragmatist, Huygens appreciates that what matters is what the markets expect. It was apparent to all that under McDonald, P&G’s profit margins, market share and stock price lagged relative to peers such as Unilever PLC (UL), Colgate-Palmolive Co. (CL) and Clorox Inc. (CLX). In light of abysmal performance, those expectations, reflected in the Steel City Re reputational value metrics (or the Reputation Premium, Consensus Trend, and Consensus Benchmark as those metrics are explained by Consensiv) are informative.

This snapshot, taken at the close of markets last Thursday only hours before the announced change of leadership, shows evidence of stakeholder unrest peaking nearly three weeks ago when the Current RVM Volatility (or Consensus Trend) peaked at nearly 5% and was at the 73rd percentile of the peer group after nearly a year of hovering in a much lower state of anxiety at the 33rd percentile. Meanwhile, return on equity dropped to the 29th percentile representing a 10-point drop from September of last year and consistent with Huygens' projections.  Over the same period, the Current CRR Rank (Reputational Premium) dropped from the 95th percentile to the 83rd percentile.

The data suggest that McDonald's fate was sealed about one month ago. Owing to the time of sampling, the data do not show what the majority of stakeholders expect from Lafley going forward, although it is fair to say that the 4% equity boost Friday signals that equity investors, at any rate, are optimistic.

Dell's endgame is nigh. The innovative business model that produced high quality low cost computers, and a service package to boot, has been overcome by events. Others are making computers better, faster and cheaper even as the market for PC's is being eroded by more powerful mobile solutions and remote storage.

Jonathan Salem Baskin, moderator of the Society's Mission Intangible Monthly Briefings, writes this for Forbes magazine (Jan 26):

Dell has suffered and languished for years. We all watched the long, slow slog, and at numerous points along the way the leaders of the business could have realized that things weren’t just ‘tough this quarter’ but ‘evidence of a deeper ill,’ and then done something about it. The company didn’t teleport to this point in time. I wonder if Dell failed to understand its reputation — the ongoing narrative of business performance, which has a closer connection to things like operating costs, profit margins, and how those qualities are valued by external stakeholders — and therefore missed its obligation to manage it? If so, it’s not fixable with marketing or financial legerdemain.

The reputational value metrics provided by Steel City Re affirm the above in stark quantitative terms. The company's reputational value vital signs, top left bar chart, show below median measures with decreasing volatility, a depressed CRR (measure of relative rank) at the 14th percentile, below median ROE, and an indication of expected change that is only a further exacerbation of ongoing negative trends. RVM (a measure of reputational value) volatility no longer follows sector or market concerns. The company's reputation is now wholly driven by expectations concerning its viability, not its profitability or renewed market engagement. The metrics are those of a company whose business model has evaporated - a failure of strategy at the highest managerial levels.

Innovation is the process by which products and services are made better, faster and cheaper. Outcomes are uncertain, which means the process is inherently risky where risk is a threat to an outcome that is desired. Because innovation is also one of the six major drivers of reputational value, innovation risk presents reputational value risk.

On CNBC's Kudlow Report last night, Jonathan Salem Baskin, a member of the Society's Reputation Leadership Council and moderator of the Mission Intangible Monthly Briefings, explained this to Bob Crandall, former Chairman and CEO of American Airlines' holding company, AMR. Click here to link to the CNBC clip.

As you recall, HP announced last Tuesday losses tied to alleged fraud at Autonomy. Huygens opined that Steel City Re’s Reputational Value Metrics prior to Hewlett-Packard’s announcement of the $8.8 billion charge indicated that stakeholders were immune to further surprise. That interpretation was good, but not good enough.

Last week, HPQ’s reputational ranking was at the 33rd percentile and its forecast stability was the highest among 22 peers. That's a poor showing for what was once the icon of Silicon Valley, but its been a bad year. After all, in addition to the boardroom personnel shenanigans, H-P this past August took an $8 billion writedown on the 2008 EDS acquisition representing more than half the $14 billion purchase price. Likewise, H-P is believed to have written down most if not all of the value of its 2010 acquisition of Palm for $1.2 billion.

Back in September, the Motley Fool explained why HP’s reputation—based on expectations of innovation--was on a downward spiral.

-Lack of invention/innovation: Well we can say that HP has not lived up to its tag line-invent. HPQ has filed 1 patent a week on an average last year as compared to 44 filed by International Business Machines (NYSE: IBM) and 88 filed by Samsung…(I)f patent filing is taken as a sign of innovation power for the company, then HPQ has miles to travel before it is in par with its competitors.
-Lack of competing factor: The last CEO of the company Leo Apotheker made an announcement in the public which led to a huge negative impact on its business.… In such a situation instead of taking a hasty decision of separating the PC business from its umbrella brand, HPQ should have worked more on how to improve its operating margin and bring down its overhead costs in this segment.
-Technological Pace: HPQ - the pioneer of the mobile device, is … unable to keep up the momentum in the mobility space. HPQ launched its Touchpad in July 2011 – a ray of hope. But as a shock to many, they removed the Touchpad within 45 days itself - reflecting non competence in this arena.
-Over reliance on webOS: WebOS lacked that appeal to the consumer sector…and which caused the failure of its Touchpad.

And then there were the governance matters:

-Fragile / Inconsistent top management: One of the signs that the company is going down the drain is when we see that the top management is fragile or changing regularly. This is quite visible in HPQ where the CEOs have changed many a times with the likes of Carly Fiorina, Mark Hurd, Leo Apotheker and now Meg Whitman.
-Maligning its own reputation: HPQ is quite famous in the imaging and printing group – one of its major sources of earnings. HPQ was busted a few months back for putting less and less ink into its Printer cartridges. … In their attempt to earn pennies they lost the trust factor of many of their precious loyal customers.

With the latest metrics now available, Huygens interpretation of last week's numbers was only partly right. The vital signs (top right graph, below) show rock-bottom historical volatility of RV, a non-financial measure of reputational value, meaning, as The Fool explained, every stakeholder had good reasons to not expect much from HP. Current volatility, however, has jumped from the 10th percentile to the 52nd percentile, meaning, HPQ is now "average" among firms in this highly risky technology sector. It could have been a greater shock, but, as the metric show, it simply wasn't. The RVM volatility time series, (top left graph, below), shows last week's spike raising current volatility to a level only slightly above the median for the whole sector. HPQ's CRR, a measure of relative reputational ranking, dropped over the week from the 33rd percentile to the 10th percentile. ROE remained at bottom, and the forecast stability dropped from 1.0--the most stable--to the the 29th percentile and clearly not the worst in this sector. Forward looking measures, (right column, bottom two rows) are signalling further reputational value deterioration. (For a deeper understanding of the metrics, read: Reputation Stock Price and You: Why the market rewards some companies and punishes others).

Yes, when everyone expects you to fall, it's hard to elicit any startle responses. It is even harder to surprise anyone with a fall when you are already on the floor. And yet, mathematicians have long suggested that there must be some practical application for imaginary numbers. Now, Pippin?

 
 

Last Thursday, Huygens reported that there was a sense Abercrombie and Fitch's (ANF) innovative marketing had run out of steam. The stock price was in the dumps. According to the Steel City Re Reputational Value Metrics, it was ranked in the 44th percentile (CRR) but its ROE ranked a dismal 10th percentile. However, reputational volatility measures indicated among stakeholders an expectation of "a steady improvement in both rank (CRR) and reputational value (RVM)."

Thurday one week later, as MarketWatch reports, "on Wednesday, the New Albany, Ohio-based company reported a third-quarter results that were better than expected and raised its outlook for the year, as same-store sales in the United States, its top market, rose 2%. Internationally, excluding the United Kingdom, sales saw some signs of health as the retailer pointed to positive momentum in its new stores in China and Korea and flat comparable sales." The stock surged 34% to $41.92.

The Steel City Re Reputational Value Metrics provide intelligence on reputational value that, more often than not, appears to be a leading indicator of stock price movement. The RepuStars Variety Corporate Reputation Composite Equity Index (Ticker: REPUVAR), reported each week on this blog, is the most direct demonstration of the information content of Steel City Re's measures of reputational value.

Abercrombie and Fitch, the casual apparel retailer, established a reputation for innovative, sexy marketing. Reputation is an expectation that spurs stakeholder behavior. A&F Quarterly, the company’s catalog that featured photo shoots by fashion photographer Bruce Weber, was so racy that shoppers were required to prove they were over 18 years of age to buy them. It had a circulation of 1.2 million in 2002 and was branded ‘soft porn’ by critics.

Its marketing strategy, reports the Daily Mail (Abraham, 31 August 2012), appears to be failing to woo customers as effectively as they once did. In addition to 71 store closing in 2012, it expects to have closed nearly a quarter of its 1055 global stores by 2012. Sexy and vacuous is no longer innovative—in the US and Europe. Meanwhile, overseas in China and the Middle East, sexy is innovative. Sales are growing.

Were it only so simple for Research in Motion. The company that established a reputation for innovation in the smart phone arena—invented the genre as we know it—has slipped dramatically in the minds of its stakeholders. As discussed here and elsewhere, including the new book, Reputation Stock Price and You, it is simply no longer innovative. Catch up is a much harder game. Turning to the reputation metrics for both Abercrombie and Fitch (ANF) and Research in Motion (RIMM) from Steel City Re, the former is down in the dumps with upside potential, while the latter is similarly situated, but with a bleak future.

ANF's reputation rank (CRR) has been on a choppy ride down to the 44th percentile among its peer group and its ROE is in the 10th percentile. The many volatility measures, however, suggest a steady improvement in both rank (CRR) and reputational value (RVM). RIMM's reputation rank is in the 23rd percentile and its ROE is in the 12th percentile. However, its volatility measures forecast--actually, only hint--possibly a slight improvement.

Ken Jarboe, Chair of the Society's Public Policy Committee and President of Athena Alliance, a non-profit research organization dedicated to identifying, understanding, analyzing, and educating on the information, intangibles, and innovation (I-Cubed) economy, has kindly allowed us to run this posting from the blog, The Intangible Economy.

Clay Christensen makes a very important point in his essay in Sunday's New York Times "A Capitalist's Dilemma, Whoever Wins the Election." Unfortunately, it is a point that has been made before in a slightly different form over 30 years ago.

Christensen begins by noting that "innovation" is actually made up of three types:

• Empowering innovations which "transform complicated and costly products available to a few into simpler, cheaper products available to the many." These are the new products and services that create jobs and new wealth. He cites the Model T, the first personal computers, the transistor radio and online services as examples.
• Sustaining innovations which "replace old products with new models." These are the newest version of an existing product. As such, they create few new jobs but "keep our economy vibrant." They also account for the bulk of what we call innovation. The example he sites is the a Toyota Prius replacing a Camry.
• Efficiency innovations which "reduce the cost of making and distributing existing products and services." These innovation generally reduce the number of jobs but may make the companies more internationally competitive (thereby saving some jobs).

Here is the important insight derived from this taxonomy: Ideally, the three innovations operate in a recurring circle. Empowering innovations are essential for growth because they create new consumption. As long as empowering innovations create more jobs than efficiency innovations eliminate, and as long as the capital that efficiency innovations liberate is invested back into empowering innovations, we keep recessions at bay.

The dials on these three innovations are sensitive. But when they are set correctly, the economy is a magnificent machine. In the last three recoveries, however, America's economic engine has emitted sounds we'd never heard before. The 1990 recovery took 15 months, not the typical six, to reach the prerecession peaks of economic performance. After the 2001 recession, it took 39 months to get out of the valley. And now our machine has been grinding for 60 months, trying to hit its prerecession levels -- and it's not clear whether, when or how we're going to get there.

The economic machine is out of balance and losing its horsepower. But why? The answer is that efficiency innovations are liberating capital, and in the United States this capital is being reinvested into still more efficiency innovations. In contrast, America is generating many fewer empowering innovations than in the past. We need to reset the balance between empowering and efficiency innovations. Christensen goes on to blame the situation on what he calls "The Doctrine of New Finance" with its emphasis on RONA (return on net assets), ROCE (return on capital employed) and I.R.R. (internal rate of return).

I believe he has a strong point - but am not sure this is such a new problem. Over 30 years ago, Robert Hayes and William Abernathy published in HBR their seminal paper Managing Our Way to Economic Decline. They argued there are three tasks of a manager:

• Short term--using existing assets as efficiently as possible.
• Medium Term--replacing labor and other scarce resources with capital equipment
• Long term--developing new products and processes that open new markets or restructure old ones.

Companies (and economies) fail when they concentrate on the first two tasks and ignore the third. Translated into Christensen's innovation terminology, economies fail when they emphasize efficiency (and sustaining) innovation (short and medium term objectives) over empowering innovation (long term objectives). Luckily, as history has shown, this emphasis can be overcome. Since the publication of the Hayes & Abernathy article in 1980, there has been a wave of empowering innovation.

As I've pointed out before, we overcame the competitiveness challenges of the 1980's by meeting them head on. We put in place a number of new government policies and companies engaged in a new wave of innovation. We need the next wave of policies to meet the new competitiveness challenges we face today. Christensen has outlined a few of his ideas in his article. There are many more that I could come up with. The point is not whether my list or Christensen's list is the right list. The point is to have a debate that recognizes the real forces underlying the problem. Simply cutting and "letting the economic work" is a recipe for a new round of managing our way to economic decline.
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There was a time not long ago when Procter & Gamble's reputation for marketing prowess was a reflection of its competencies in both communications and product innovation--old school marketing comprising the 4 p's of product, placement, promotion, and pricing. That reputation translated into pricing power and outsized margins that wound their way down to net income and stock price. No more. Bloomberg reports that Procter and Gamble is now trading at a 22% discount to the 31-company Bloombert Industies Global Household Products Index.

The loss of innovation Mojo traces back to what was then celebrated as a brilliant stroke of open innovation. P&G let go of control of innovation, killed-off the not-invented-here bias, and advanced the mindset of "proudly invented elsewhere." By 2006, more than 35 percent of P&G's new products in market had elements that originated from outside P&G. The Harvard Business Review promoted this turn of events as an evolution to be emulated.

Increasingly, its looking like another case of it-seemed-like-a-good-idea-at-the-time. "There’s been a dearth of pioneering brands emerging from the world’s largest consumer-products company. Spending on research and development in fiscal 2012 ended June 30 was $2.03 billion, or 2.4 percent of sales, the same as the prior year and down from 3 percent of sales in 2006. P&G’s most recent homegrown blockbusters -- Swiffer cleaning devices, Crest Whitestrips, and Febreze odor fresheners -- all went on sale at least a decade ago, reports Bloomberg."

The Steel City Re reputation metrics indicate that P&G is a well regarded powerhouse ranking in the 95th percentile among the 43 members of the Household/Personal Care products sector. But its reputation is shaky. Its most recent reputational volatility is ranked in the 58th percentile of its peer group; for the past year, it was only ranked in the 14th percentile. There is no clear directionality, but our experience suggests that when a stable giant begins to shake, the direction is more likely than not downward.

The rest of the nation is sweltering under a general heat wave but it pales in comparison to the burning platform supporting Bob McDonald in Cincinatti. Activist investor Bill Ackman is wielding the torch.

Writes Slate Magazine (R Cyran, 13 July), “Procter & Gamble is a hulking target for an uppity investor like Bill Ackman… Since Bob McDonald replaced Lafley as CEO in 2009, the shares are up 16 percent. The S&P 500 index, however, has gained more than 40 percent over the same span, and rival Colgate’s stock is up almost 50 percent.” We could go on documenting the case being built agains McDonald. Let’s cut to the chase and turn to the Steel City Re reputation metrics.



Over the past few years, Procter & Gamble morphed itself from an marketing/R&D/product development giant into a marketing/licensing/sales machine. Only problem is, it is paying a premium for innovation and is being squeezed by the big box retailers on the other end of the value chain. What do the reputation metrics show? There are 347 companies in the Consumer Non-Durables sector of which 44 compete in the Household/Personal care Industry where Procter & Gamble is one of 20 firms with market caps of $175 billion +/- 35%. Among this peer group, the company’s reputation rank has slipped to the 91st percentile. All of its directional derivative metrics – both its velocity and vector -- are negative. The vital signs chart shows that its reputation value is very volatile. Historically it ranked in the 7th percentile; now it is in the 68th percentile relative to its peers. Its return on equity is in the 60th percentile having lost 3% over the trailing twelve months (median -4%, S&P500 -0.6%). Forward looking metrics show an above average level of stability, which is not good when the trend is negative. Procter & Gamble is a company whose reputation once stood for innovation. The company monetized that innovation with fabulous marketing. It still has great brands, for sure, but what does that mean today if the value chain leaves little for the brand owner at the end?

In "Why RIM Lost Its Crew, Its Groove" (6 April), Richard S. Levick explains that the failure over at Research in Motion was due, in part, to their failure to engage their customers and understand their needs. Richard, who will be participating Friday 13 April in the Society's Mission Intangible Monthly Briefing on protecting reputation, knows his stuff. He contrasts RIM with Apple and Google, who may be no better at technology than RIM, but who are very good at understanding how their customers want to experience technology. Social media get a nod as being powerful enablers of engagement. We concur.

There's more to the story. Nokia, the European contender, doesn't even get an honorable mention.  Huygens is not expert at social media, but Huygens can measure reputation, and reputation in the technology sector is very sensitive to how stakeholder's perceive a firm for its innovation prowess. Having a big tent and ample data, we thought we would revisit Nokia after 14 months and see how they have evolved from a quantitative perspective. The trend is not promising if you are an equity investor.



Notwithstanding a few spikes above the median over the past year, and cutting to the chase, the bottom color chart shows in blue that Nokia's reputation ranking has sunk to a new low - the 13th percentile - among the 76 firms in the Telecommunications Equipment peer group. Its return on equity has followed a similarly dismal curve, in yellow, under performing the median of its peer group by 20%.

The upper charts provide more detail. Relative to its peer group, as reported in the chart labeled Vital Signs, Nokia's reputation has been all year long  -- up to last week -- exceptionally volatile ranking in the high 90th percentiles. The parity of current vs. historical volatility, and how that looks relative to Nokia's peers, is shown at top right.

While the trending is negative, it is not a stable trend. The Vital Signs report that reputational stability is in the 11th percentile while the middle charts show that the return on equity at the 26th percentile. This is high for the reputation ranking, all other things being equal. This could be viewed as either very good news, or bad news, depending on whether Nokia's price is felt to be ahead or behind its reputational metrics. So either a surprise rise, or another disappointing fall are just around the corner.

Hint: The RepuStars Variety Composite Equity Index calculated by Dow Jones Indexes is based on the thesis that although reputational value is usually fairly embedded in stock price, there are are arbitrage opportunities that can be exposed with reputational metrics. If we had to bet based on the above, we'd short NOK and predict the prices will drop from the 26th percentile to one closer to the rank's 13th percentile.