As the saying goes, there are only two types of companies: those that have had operational failures, and those that will. On 18 October, RR Donnelley & Sons, the printing-services firm, released the 8K quarterly earnings report for Google, the internet services company, 4 hours earlier than expected. The markets closed with the S&P500 down 0.24%, RR Donnelley down 0.88%, and Google down 8.00%.

This is how the Wall Street Journal’s MarketBeat blog reported the story, excerpted. First, Google’s take on the matter:

Earlier this morning RR Donnelley, the financial printer, informed us that they had filed our draft 8K earnings statement without authorization. We have ceased trading on Nasdaq while we work to finalize the document. Once it’s finalized we will release our earnings, resume trading on NASDAQ and hold our earnings call as normal at 1:30 PM PT.

Now, Donnelly’s take:

We are fully engaged in an investigation to determine how this event took place and are pursuing our first obligation – which is to serve our valued customer.

The value of that service is now being questioned. As reported in the New York Times blog, Dealbook:

An executive at Webfilings, a company based in Ames, Iowa, that sells an application that allows companies to self-file, used last week’s events as a marketing opportunity, reminding customers that “this unnecessary mistake reinforces the need for public companies to completely control the release of their financial data,” as Mike Sellberg wrote on the Webfilings blog.

The reputational risk for Donnelley is security--one of the six pillars of reputational value. As Chuck Malloy from Intel told Dealbook, “We own the liability and the risk, and this allows us to maintain the integrity of the reporting process. If there’s a problem, it’s our problem.”

The reputational value metrics from Steel City Re do not indicate that the operational failure has matured into a reputational crisis (7% drop in market cap, massive media attention, regulatory approbrium, etc.), but the event is nevertheless impacting Donnelley's reputation adversely. Looking first at the Vital Signs, (Column 2 Row 2 below), the current RVM volatility is only slightly higher than the historic volatility, both below the median at the 17th to 19th percentile. The company’s reputational rank is the 33rd percentile, ROE at the 13th percentile, and forecast stability is below the median. Basically, the quick view is that baseline expectations among stakeholders are low.

Indications that stakeholders as a group do not expect the incident to be critical, but recognize that no good will come out of it, are reflected in the three volatility measures (Column 1 Rows 2-4, and Column 2 Row 4). All show low levels of volatility for both CRR, a measure of reputation rank, and RVM, a non-financial measure of reputational value. The volatility, which is indifferent to overall market risk (VIX), is leading to a further loss in  both reputational value and reputation ranking relative to peers. Add to that the company's drop in  equity value, and you have near-universal concurrence among stakeholders: thumbs down.

The accounting firm Eisner Amper published their third annual survey, Concerns About Risks Confronting Boards. Based on the opinion of 193 corporate directors, the data show that excluding financial risk, 66% believe that reputational risks are the most concerning currently. The top three reputational risks of 2012 were quality (30%), ethics/integrity (24%), and “public perception” (16%). Security was #4 at 12%. These three named risks, along with innovation, safety, and sustainability (8%), comprise the six major sources of reputational risk according to research published by the Society in the 2010 book, Mission: Intangible.

A few weeks ago, two of the biggest names in technology found themselves grappling with huge and potentially embarrassing debacles. As the Economist newspaper (28 April) summarized in their colorful headline, Online reputations in the dirt, on 26 April, "Amazon’s finance chief, Thomas Szkutak, said the firm was still trying to get to the bottom of a glitch that caused numerous websites it hosts for other businesses to crash or run painfully slowly during the previous week. The same day, Sony of Japan revealed that names, addresses, passwords and possibly credit-card details of 77m accounts were stolen when hackers gained access to the network it runs in 60 countries for its PlayStation online-gaming system, as well as for Qriocity, a service offering music, films and television shows.”

Reputation, of course, is the amalgam of impressions held by stakeholders, and it is shaped by such intangibles as these six (6): the means by which a company fosters ethical conformance, innovates, assures quality; and assures safety, sustainability and security. Business processes, really. And reputation manifests in many ways. Importantly, it sets expectations.

Of these six reputation drivers, Amazon faced a quality issue while Sony faced a security issue. The reputational consequences to these two companies are explained, in part, by stakeholders’ preexisting expectations, the degree to which those expectations were impacted by events, and the nature of expectations set going forward. Related, in that like reputation, it is forward looking, is the equity market’s reaction to these two different reputational experiences.


The Amazon reputational experience following the quality event shows increased volatility these past few weeks that is actually less than historic reputational volatility. In other words, stakeholders as a group seem overall unimpressed over background levels. As such, the equity jump is less surprising than it would be otherwise. It reflects the fact that Amazon suffered a reputational even and was resilient (relative to its baseline).

The experience at Sony is quite different. Sony's baseline reputational volatility is almost an order of magnitude less than Amazon's, and its reputation ranking is near the top of the peer group. Its stakeholders believe they have a good sense of what drives the company, and the degree to which it is a state of control. Equity investors, however, don't appear to understand how such a major security event could occur in the setting of what reputationally would appear to be a company in control. Their response is panic, and in our interpretation, suggests that Sony is now undervalued by the equity markets.

Turning to crude metrics of fractional intangible asset value, Amazon is almost purely intangible and thus the high degree of volatility is not too surprising. There may be much upside, but -- excluding IP -- there is probably no floor to the downside

Sony, in contrast, has a surprisingly small intangible asset fraction that is far lower than the median of its peer group. The large book value fraction of the company's value speaks to the relative stability of its economic metrics, but the huge drop from 40 to 20% intangible, as with the drop in stock price, is unreasonable for a company with such iconic brand and technology prowess.

Perhaps it is the overlay of the background geophysical crises in Japan that is making Sony's equity investors especially jumpy?

In prior postings, we quoted Alan Greespan, former Chairman of the Federal Reserve, asserting shortly after the financial markets collapsed that  “In a market system based on trust, reputation has a significant economic value.” 
 
Ab actu ad posse valet illatio. We now quote Robert Gates, Defense Secretary, affirming the point with respect to the most ethereal of the intangible assets, security, as described in an NPR story on the Afghan Wikileaks.

"It's amazing how much trust matters, whether it's with governments or with individuals around the world. And it seems to me that as a result of this massive breach of security we have considerable repair work to do in terms of rebuilding trust, because people are going to feel at risk."

And that's why reputation is so valuable. Quod est.

Next Friday, May 7, the Society's monthly Mission Intangible Monthly Briefing will feature Scott Childers from the Walt Disney Company (NYSE:DIS) who is calling for holistic supply chain vendor management, and Bob Rittereiser from Zhi Verden whose Global Trademaster™ product provides total supply chain visibility. A note this past Monday in the Wall Street Journal explains why this is so important.

On Monday U.S. Federal, state and local law enforcement officials, part of the National Intellectual Property Rights Coordination Center said they made their biggest-ever seizures of counterfeit goods this month in two operations that netted more than $240 million in a sweep of more than 30 U.S. cities. Immigration and Customs Enforcement announced the double-barreled operation on Monday to coincide with World Intellectual Property Day.

Commemorating a day to heighten awareness of intellectual property with arrests may not be festive, but it is appropriate. Fake goods do more than rob intellectual property owners of revenue. Fake goods raise the specter of a full range of reputation-linked issues that go beyond cash flow to create risk in areas as  diverse as ethics (international labor standards), quality, safety, security, and sustainability. The article further notes that next week, the Naval Criminal Investigative Service and the Defense Criminal Investigative Service will begin targeting counterfeit goods that could get into the military supply chain. The U.S. General Services Administration will target fake goods in the federal civilian supply chain.

To target effectively, one needs intelligence. According to Mr. Rittereiser, Zhi Verden’s Global Trademaster™ provides that intelligence; according to Mr. Childers, having that intelligence is a necessary component for world class supply chain management.

Act on your intellectual curiosity!

If the above issues pique your interest, here are several things you can do right now:

1. Register free of charge for the next IAFS Mission Intangible Monthly Briefing set for Friday 7 May at 12h00 EDT. The conversation will feature Scott Childers from Walt Disney and Bob Rittereiser from Zhi Verden on “Process-driven reputation risk in supply chains”
2. Purchase the book, Mission: Intangible. Managing risk and reputation to create enterprise value, at the IAFS Store (or any online book retailer) 
3. Become a member of the Intangible Asset Finance Society.
4. Join our community on Linked-In.

Last Sunday at pharmaceutical giant Eli Lilly's (NYSE:LLY) warehouse near Hartford, Connecticut, thieves stole $75 million dollars worth of anti-depressants and other prescription pills -- enough to fill a tractor-trailer --- now headed for the black market. "It was a very brazen, well planned crime. It appears as though the criminals broke in through the roof, rappeled down through the roof, disarmed the alarm and then proceeded to steal several dozen pallets of pharmaceutical products which were loaded onto a truck and taken", said Ed Sagabiel with Eli Lilly and Company.

We make three points. First, this is a physical security breach that does not, on its surface, appear to have any reputation impact. The financial impact will be minimal because the event is one of the perils commonly covered by property and casualty insurance. The second is that this is the type of physical security risk most companies are best prepared to mitigate - physical removal. Most are not in a position to mitigate the reverse security risk of physical introduction--the type of physical security risk that nearly brought Johnson & Johnson (NYSE:JNJ) to its knees a quarter of a century ago.
 
Here's a worst case spin from a reputation perspective. Fact: Lilly has lost control of $75 million (wholesale) of product. These drugs are all branded and marked as authentic Lilly ethical pharmaceuticals which stakeholders expect will be safe and effective. Suppose branded product reentered the market after being adulterated. Suddenly, the Johson & Johnson fiasco seems like child's play.

You ask for a motive? How about the mother of all insider trades? Would criminals who execute a Mission:Impossible-style heist have the financial acumen to short Lilly equity or go long on Lilly credit default swaps as they flood the market with adulterated pharmaceuticals? Could they recognize returns in excess of $75 million in fungible liquid assets? 

And this brings us to the third point. Superior reputation management includes both crisis management and scenario modeling exercises. Because even rumors suggesting the above could be damaging.

Heads Up - Date Change

The Mission: Intangible Monthly Briefing for April 2010 will be held one week later than usual in deference to those who celebrate Good Friday. On 9 April 2010 at 12h00 EDT, the second Friday of the month, we will host a conversation featuring incoming Integrity and Corporate Responsibility Committee Chairman Paul Liebman from Dell (NASDAQ:DELL) and IA Value Signaling Committee Chairman Jon Low from Predictiv. The title for the one hour moderated discussion is: Ethics - A valuable intangible asset? Mary Adams from Intellectual Capital Advisors hosts.

As always, registration for this popular series is complimentary and slides will be available for download in advance of the event. To register now, click here.

Join Us

If the above intrigues you or challenges you to learn more, look no further. The Intangible Asset Finance Society wants to be your business resource. Join us and be part of an organization that provides a wealth of educational materials, including a new book, to further your executive career, and exciting monthly conferences such as the upcoming one on ethics mentioned above.

The IAFS launched its 2010 membership drive this past week. This is why. On February 28, new US SEC regulations will drive into the boardrooms risk, reputation and intangible asset management. 

You have a decision. Will you be at the table or on the menu?

These regs mean that every board member, in fact every top executive, can expect major new challenges. Members of the Intangible Asset Finance Society (IAFS) will be prepared. Here’s how:

1. Thought Leadership. The IAFS is the only interdisciplinary Society of professionals committed to the financial exploitation of intangible assets. That translates into enhanced pricing power; lower operating and credit costs; and higher net incomes and earnings multiples.

2. Risk Management. A lost reputation can destroy a firm overnight. IAFS can keep you up to date with risk management strategies for ethics, innovation, quality, safety, environmental sustainability, and security.

3. Preferential Pricing. Society members receive preferential rates for IAFS products at our new store and discounted registration to various professional meetings. Discounted registrations for the March ICAP Ocean Tomo meeting in San Francisco and the June IP Business Congress in Munich, for example, are now offered.

4. Incentive Premium. Sign on for your academic or corporate membership including payment by March 15 and receive a complementary copy of the IAFS’s latest book, Mission: Intangible. Managing risk and reputation to create enterprise value (a $29.95 value).

Click here to learn how our strengths in Thought Leaders and Risk Management, financial benefits such preferential pricing, and premiums such as the book shown at right make joining the Society today an offer you can't refuse.

If Google Trends, the website search volume and story volume indicator is to be believed, then the world is currently more interested in reputation than other big issues. Earlier, we noted that reputation was giving the issue of 'cash flow' a run for its money. The chart below shows that relative to terrorism, reputation is now a dominating issue of interest, mirabile dictu.

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.

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.