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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SAP AG: Blind to intangible risks

C. HUYGENS - Wednesday, December 01, 2010
SAP is the dominant solution provider in the $8 billion enterprise management and business intelligence software sector. The company's products provide businesses with an integrated view of their operations for cost and asset value optimization, and predictive analytics to help identify opportunities and risks. But their software doesn't manage intangible assets, and the risk their software didn't help them see was a breach of ethics and intellectual property management best practices by a partner company that they subsequently acquired.

Cutting to the chase, Oracle (NASDAQ:ORCL) last week won a $1.3 billion jury verdict against rival SAP (NYSE:SAP), netting the biggest copyright-infringement award ever. According to Bloomberg News, the jury delivered the verdict Tuesday, after an 11-day trial in federal court in Oakland. The lawsuit started in 2007, with Oracle claiming the German company's TomorrowNow business made hundreds of thousands of illegal downloads and several thousand copies of Oracle's software as part of a plan to steal customers.

SAP acquired the TomorrowNow in 2005 and closed it in 2008. SAP had hoped to use the unit to lure thousands of customers of PeopleSoft and JD Edwards, which Oracle had acquired, to purchase SAP software, according to evidence presented at trial. The unit garnered 358 customers.

The award was more than analysts had estimated - and far beyond the $160 million that SAP had set aside for the litigation.The immediate equity costs -- SAP is underperforming the mean of its 217 peers in the Systems and Subsystems sector by 7.71% -- are therefore understandable. What about the long-term reputation effects?

One week out from the verdict,  the signals are mixed. Over the trailing twelve months, The Steel City Re Corporate Reputation Index has risen from the 92nd to the 96th percentile. The Exponentially Weighted Moving Average of the volatility of the Index, which had been falling for most of the past six months, has been rising over the past few weeks to .4%. This is a negligible amount. On the other hand,  the trailing twelve week Index velocity is negative and the vector is negative, and these are worrying signs. The intangible asset fraction is unchanged at around 93% beating the sector mean of around 80%.

If the stakeholder community looks at SAP and concludes that they are really a good company that had a rogue unit, then they will come through this period with a loss equal to the cash costs of litigation. If the stakeholders view SAP as a behemoth that may harbor other TomorrowNow-like risks, then there will be significant long-term costs.


Flight safety

Nir Kossovsky - Tuesday, May 19, 2009
Recent news of Colgan Air, Inc., an operating company owned by Pinnacle Airlines Corporation (NASDAQ:PNCL) prompted us to consider the intangible asset of safety and the financial consequences of the reputation arising.

On 12 February, flight 3407 from Newark to Buffalo crashed while on an approach to Runway 23. A total of 50 people were killed. This loss of lives in Colgan Air Flight 3407 the greatest loss of lives on a domestic American flight due to an accident since 2001. Then on 12 May, flight 3260 from Newark to Buffalo lost a wheel after landing on Runway 23. There were no injuries and the passengers deplaned normally. The next day, the NTSB began its hearings on the 12 February crash.

Colgan Air operates under the brand of three iconic companies: Continental Connection, United Express and US Airways Express. It has been involved in two well publicized safety incidents. From an intangible asset perspective, what are the reputations of Pinnacle, Continental, United, and US Airways and is there any evidence that the two events had an impact?

We turned to the Steel City Re Intangible Asset (corporate reputation) Index for insight into stakeholder’s perceptions. As shown in the chart below, the relative rise in Pinnacle’s index ranking ends abruptly twice in a temporal association with the safety events described above. Also of note is that Pinnacle’s index shows a progressive drop -- ongoing reputation erosion – for the 8 months prior to the February crash. Financially, over this period, Pinnacle has underperformed the median of its 20 peers by 22%. Index EWMA volatility is very high at 5 log orders.
 


Among the 21 companies tracked and ranked in this index, all four companies -- Pinnacle, US Airways (NYSE:LCC), United Airlines (NASDAQ:UAUA), and Continental Airlines (NYSE:CAL) -- rank in the bottom quartile as of 15 May 2009. In the period following the 12 February crash, and measuring rank on a percentile scale, Pinnacle’s rank dropped 20%, US Airways dropped 15%, Continental dropped 10%, and United was unchanged. Other members of the bottom quartile are Jet Blue (NASDAQ:JBLU) and American Airlines (NYSE:AMR).

The membership of the top quartile among 21 publicly traded airlines as of 15 May comprises Copa Holdings (NYSE:CPA), Allegiant Travel (NASDAQ:ALGT), LAN Airlines (NYSE:LAN), Ryanair Holdings (NASDAQ:RYAAY), and Southwest Airlines (NYSE:LUV).

Beverage grandmasters

Nir Kossovsky - Wednesday, May 06, 2009
This note explores whether a proposed transaction by a $75B beverage company, Pepsi Inc. (NYSE:PEP), is motivated by costs savings, brand enhancement, or reputation protection. Seeing no perceptible movement in the reputation index of either the company or its arch rival, we conclude that notwithstanding which of the three was the initial trigger, the greatest value may be in reputation risk management.

On 20 April 2009, Pepsi proposed buying the outstanding shares it does not own in its two largest bottlers, Pepsi Bottling Group (PBG.N) and PepsiAmericas (PAS.N), in a $6 billion cash and stock deal. Many in the financial press suggested it was a cost-cutting initiative. Jon Baskin, a marketing iconoclast, a keynote speaker at the Society’s 2008 annual conference, and the author of the book, “Branding OnlyWorks on Cattle,” opined that the move represented brilliant, strategic branding. In Jon’s words:

Think about it. New packages and formulations, available at new and different locations, priced and supported in novel ways...all thanks to a holistic approach to the brand, vs. some archaic top-down application that sees it only as image and words. It's these actions, and real investments, that will build sustainable, long-term brand growth.

Cost savings and long-term brand growth are both good things, reflect well on management and enhance reputation. So, with two weeks having now elapsed during which the market has had an opportunity to digest the news, and while the deal is still in the negotiation phase (the bottlers rejected it on Monday), we called on the Steel City Re corporate reputation index to see what impact the news has had on the reputations of Pepsi and its arch rival, The Coca Cola Company (NYSE:KO).

As shown in the charts below, the short answer is “not much.” Pepsi tops the fifteen-member Soft drink sector; Coke is in the 92nd percentile. Volatility is nil. In fact, in the midst of the most tumultuous market since the great depression, these two iconic firms emerge with nearly identical profiles comprising exceedingly stable reputation metrics. With Pepsi and Coke’s market caps at $75B and $100B respectively, are they too big to budge?






Big, yes, but not too big to trip and fall. As we see it, both pay exquisite managerial attention to their reputations. Ethics, quality, safety, security and sustainability are all watchwords. Innovation is alive and well. So the competition between these two is analogous to that of two chess grandmasters. They see all, know all, and understand the implications of every move and its derivatives. The game, therefore, is waiting for one or the other to make a mistake. It is a game where risk management is the winning play. And given the relative values of the physical assets and intangible assets at the two companies, reputation loss arising from a business partner where visibility and control are weaker – supply chain headline risk, if you will – is one of the major risks we believe needs to be managed.

So let us put our own spin on Pepsi’s announced acquisition: from an intangible asset finance management perspective, it is a prudent move to manage reputation risk arising from a third party. While it may not increase Pepsi’s brand value or enhance its reputation, it may prevent the sort of reputation loss that destroyed nearly 14% of Coke’s value 10 years ago.

Falling Dominos

Nir Kossovsky - Monday, April 27, 2009
On or about 13 April, 2009, in a small Domino's Pizza (NYSE:DMZ) franchise in North Carolina, two employees posted a prank video of some unsanitary and scatological food-preparation practices. Thanks to the power and reach of social media, within a few days there were more than a million views on YouTube and a viral spread of the subject on Twitter. Google trends reported a 50% increase in searches for "Dominos Pizza."

According to Patrick Vogt who writes for the CMO Network on Forbes.com, .'..the cost to the Domino's national brand equity over the long term is still undetermined. Two recent surveys seemed to indicate that it will take time for the national brand to recover. An online research firm called YouGov confirmed that the perception of Dominos' brand quality went from positive to negative in approximately 48 hours. In addition, a national study conducted by HCD Research using its Media Curves Web site found that 65% of respondents who would previously visit or order Domino's Pizza were less likely to do so after viewing the offensive video."

By any conventional marketing metric, this would appear to be a corporate reputation crisis. From the Intangible Asset Finance Society's perspective, this appears to be a failure in the business processes that give rise to reputations based on quality - a universally important intangible asset. We ran a quantitative reputation analysis using the Steel City Re Intangible Asset Index.



The data show that this past week, Domino’s IA Index dropped from an 11 month high of the 52nd percentile to the 47th percentile among the 47 companies of the Restaurant sector. This past year, the company has had a progressively declining IA index, EWMA volatility at 4 logs or more, and an economic return that is 14% below the median of its peers.

Much has been written about the marketing challenges associated with the employee prank and the slow corporate response. We believe the real story, as suggested by the index data, is that Dominos is currently perceived to be no more than an average steward of its intangible assets. Its business process controls are weaker than the leading firms, and thus, its resilience in the face of this challenge will likely disappoint shareholders.

Dominos can resolve this problem with classic risk and reputation management – better business process controls on the human factors that underpin its reputation for product quality. Training, compliance and monitoring, and behavior enforcement tools need to complement its media-focused crisis management campaign. Because this is a franchise-sourced risk, there are unique insurance instruments that can increase the efficiency of compliance enforcement.

Marketing and crisis communications efforts are important but not sufficient. Customers need to know that in addition to management’s contrition, there are material changes in the company’s operations that place management in an improved state of control -- a level of command and control that will preclude this challenge to quality from happening elsewhere in the organization.

Dominos' mid-range reputation ranking contrasts with the top Restaurant sector IA index companies this week. In the top position, Panera Bread Co. (NASDAQ:PNRA), with an EWMA of three logs and an superior economic return that is 72.32% in excess of the median of its peers; McDonald’s Corp. (NYSE:MCD) in the 97th percentile slot, with extraordinary IA index stability comprising a near zero EWMA and an economic return that is 21.36% in excess of the median; and Chipotle Mexican Grill Inc. (NYSE:CMG) in the 95th percentile position with a lively EWMA of 4 logs and a marginally superior return at 1.18% above the median.


Imposing behavior

Nir Kossovsky - Tuesday, April 07, 2009
Cadbury plc (NYSE:CBY), Kellogg (NYSE:K), Mattel (NYSE:MAT) are iconic firms whose products, cash flows, and reputations have been sullied by their business partners through ethical breaches including melamine in milk, salmonella in peanut butter, and lead paint. These three are but a sample of firms afflicted by an epidemic of trading partner (third party) risk who have placed their corporate reputation at financial peril.

Risk & Insurance magazine's senior editor, Dan Reynolds, reviews the Society's conference call from 3 April with the leading question, "Imposing best practices on trading partners today is considered vital, but how does one secure an increasingly global trading community?"  He then brilliantly summarizes Robert Rittereiser's hour-long presentation in a short, entertaining and accessible article.

Rittereiser knows risk. As Reynolds summarizes, "In Rittereiser's deep past, he was a chief financial officer and chief administrative officer of Merrill Lynch & Co. and a president and CEO of E.F. Hutton. On Wall Street, according to press coverage from his glory days, he had a reputation as a guy people hired to solve problems. These days, he is on the board or serving as an officer with several risk management companies, including the Pittsburgh, Pa.-based companies
Zhi Verden and Steel City Re."
 
To link to the the Risk & Insurance article,
click here. To acess the original slides from the Intangible Asset Finance Society call or inquire about purchasing a recording, click here.


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