This is the lead issue?
KOSSOVSKY: Well, in part. Lead paint affected some of the toys but unsafe design was really the dominant issue in the series of product recalls. But let’s back up for a second. Mattel is a toy manufacturer.

One of the things that’s implicit when a parent buys a child a toy, is that it is safe for the child. […] So when a toy acquires the attribute of risk, there’s a huge impairment to that value. Since the company’s value is tied to the value of the toys, there’s a huge enterprise value impairment associated with it.

U.S. based?
KOSSOVSKY: U.S. based, out of Southern California, with a very nice view of the Sierra Nevada range. If you think about what the value proposition of a toy is — well, it gives pleasure [laughs], not much else to a toy other than perhaps education value, either of which for a child is wholly intangible. Mattel is best known for Hot Wheels and Barbie. Barbie is a few cents of plastic and a lot of intangible value. It’s fantasy, it’s aspiration, it’s a lot of things, but very little tangible value in a Barbie. This is a company that makes its money from intangible value. One of the things that’s implicit when a parent buys a child a toy, is that it is safe for the child. So a toy’s supposed to give pleasure and a whole host of laudable things, but it’s not supposed to create danger. So when a toy acquires the attribute of risk, there’s a huge impairment to that value. Since the company’s value is tied to the value of the toys, there’s a huge enterprise value impairment.

So in Mattel’s case, we would have looked at the business processes associated with design and fabrication focusing on the safety controls. We would have compared Mattel’s safety controls against best practices, and I suspect we would have found that Mattel had limited visibility into the practices of its downstream suppliers. This lack of visibility created a risk — the risk that became manifest is the summer of 2007. We would have brought best practices further down in Mattel’s supply chain and created a validation and certification program within the supply chain that would have assured Mattel, and through Mattel to its customers, that its products met the highest levels of safety.

Now Barbie’s a product that’s 30, 40 years old, maybe. Before Mattel comes up with new products, are they taking into account this risk, this safety risk into how it is packaged and priced? Are they predicting they’re going to have X amount of problems with safety?
KOSSOVSKY: No. I don’t think the companies have historically looked at these that way. I’ll give you a very classic old example and a very current one. So the older example, the company’s not necessarily thinking about the value of safety or reputational value, is the Ford Pinto. The Ford Pinto, you recall, had a gas tank that blew up. It was a fundamental design problem, so the car was inherently was risky. The internal analysts concluded that the cost of the litigation associated with a few potential deaths was much lower than the cost of repairing the tank in all of the cars.

This was thinking done before or after it became apparent?
KOSSOVSKY: My guess is that most of the thinking began when reports of problems began surfacing. Once the problem was recognized, there was a question of, do we recall the car and replace every gas tank at a cost of X. Or do we continue selling the car and pay whatever we expect to pay based on the litigation that arises from potential injuries or deaths? And those who are more quantitatively-oriented produced pretty convincing numbers that it made more sense to suffer the rare but real accident of a car being rear-ended with a full gas tank, exploding, and potentially injuring or killing the occupants. And on a numbers basis, it may or may not have been a quick calculation; on the other hand, the reputational impact, the intangible impact of that was not factored in the calculation was far greater. And thus still today, when you say, “Ford,” you think Ford Pinto. You think fiery death. You think all sorts of things that are attributed to a car company. And it’s not a good thing.

This a severe blow to the intangible side?
KOSSOVSKY: Yes, it was severe to Ford — it did wonders for the Japanese car industry. Safety was not an intangible asset not factored in the calculation, while at the same time, quality was being factored into Japanese products and safety was being factored into certain European products. Let me add that according to the Intangible Asset Finance Performance Index, Ford is still facing challenges. The company has shed most of its physical assets and is comprised purely of intangible assets — the average among the 9 companies in the Automobile reference group is 65%. They’re Return On Equity for the past two years is -24.5% while their reference group has returned -8.9%. Their IA index ranking is in the 13th percentile within the Automobile sector, and 18th percentile within the broad market.

Let’s look at a completely different intangible asset — integrity. So we have a lot of investment banks that have gentlemen’s agreements or contractual agreements to fund certain buyouts. Contractually they can back out of those contracts with a penalty clause.

I think that many companies are not aware of [safety]. Or they may become aware of it and not be able to recover and become sensitized.

KKR, Kolbert, Kravis, Roberts.
KOSSOVSKY: No, it’s not the private funds, it’s the major banks. The major banks are sort of wrapped into the deal as well. The funds are backing out and they’re having their issues, but the major banks have largely not had any fingerprints on this. They may have encouraged the funds to back out of an acquisition, but didn’t have any fingerprints. But the banks have the right to do that as well. And the legal teams are arguing this, are recommending that the banks begin to pull out of deals. Pay the breakup fee, but back out. And the banks are arguing that the cost of the reputation of backing out of a deal will be quite substantial. So there’s a tug of war right now of whether the break up fee is worth paying, given that the risk of going into a deal can be pretty substantial today with the valuations being as risky as they are. And the banks are responding by saying, that all may be true, but you’re not factoring into your calculations that reputational impact. What is the reputational impact? Well, go back to the San Francisco earthquake, Swiss Re, which was not such a huge company back at the turn of the last century, made good on every obligation it had to pay claims on the San Francisco earthquake. And it was a point of pride that Swiss Re continued to repeat in its marketing materials as late as 2003, that we pay. And that’s an incredibly important reputational element for a financial services company. What will kill a financial service company? Go down your list of firms: EF Hutton started backing out and where are they today? Drexel Burnham. Any type — ING Barings. Or even a service company like Anderson. As soon as reputation is impaired, the company is in deep trouble. So the banks are really wrestling with this. And that’s news as of this morning.

Okay, So how would we have helped any of these financial companies. We would have looked at the business processes associated with risk taking focusing on the integrity and risk controls. We would have compared a company’s controls against best practices, and with some of the institutions I just named, I suspect we would have found that management had limited visibility into the practices of some of its divisions. This lack of visibility created a risk — the rest is history. Since the loss of integrity can be fatal to a financial service company, we would have deployed a catastrophic risk product designed to provide funding during the critical window when cutomers hold back and key employees contemplate jumping ship.

And have these companies done an analysis? Do they have a hold on what they view as their intangible assets or are you enlightening them towards that, also?
KOSSOVSKY: Those that are aware — and perhaps there’s no more aware in the world of it’s intangible asset value than Coca-Cola Company — know how important that brand is.

So what you’re talking about is safety, I think that many companies are not aware of it. Or they may become aware of it and not be able to recover and become sensitized. Mattel’s now been sensitized. Coca-Cola’s been sensitized. But most companies are not aware of reputational impact or the intellectual properties behind that that drive them. So no. They generally aren’t aware of the extent to which these things are drivers of their value. Why? Well cause they’re intangible. So in a culture that you manage what you can measure, and that’s been the mantra of the Six Sigma movement, total quality measurements, the statistical process controls measure. All those mantras are built around managing what you can measure. Intangibles, by definition, you can’t measure.