I read somewhere that intangible assets are very hard to recognize, but very easy to lose.
KOSSOVSKY: Well said.

So for companies who either are not aware, or not thinking properly, you assist them in identifying them?
KOSSOVSKY: Yes we help them identify their intangibles and their importance in increasing, protecting and recovering market value. The most important first step is awareness. I alluded before to the metric — the intangible asset finance performance index — we’ve developed in cooperation with the Intangible Asset Finance Society that helps us point out to executives how they are performing relative to their peers in terms of managing their intangibles. And then explain to them the extent to which they can improve sales, earnings, multiple net income, and then stock price stability based on superior management of those intangibles. Superior management means conforming to best practices.

Once executives appreciate that becoming superior managers of their intangible assets creates shareholder value, we can begin work. First we do a gap analysis between what they’re doing as managers and what they could be doing relative to best practice standards. We develop strategies to mitigate the risk to the drivers of intangible asset value. We have a series of insurance products that will transfer risks, once their intangible asset financial management conforms with best practices. And we do some crisis management strategies for when the rare, but inevitable, bad thing still happens.

So tell me about the insurance aspect.
KOSSOVSKY: We insure against random bad things happening to companies that conform to best practice standards, and our insurance does two things: it covers actual financial loss but more important, it signals to stakeholders that the company conforms to best practice standards.

Let’s recognize first what is risk and what’s insurable risk. There’s lots of risk: business risk, technology risk, capital risk, market risk, execution risk. These are five risks, all that relate to whole host of things that do not have any probabilistic function. Either you know what you’re doing or you don’t. The technology works or it doesn’t. So those are the kinds of risks that are best financed through a venture capital model or, what we’ll call it a self-insured model. You own the risk because you are in the best position to know what is the real risk. How’s the third party come in? It would be very hard to price it, so the pricing insurance would be extraordinary, much more expensive than venture capital, borrowed equity. So those are not insurable in the traditional way to look at insurance.

Jet Blue was not conforming with best practices. So as a result of a business process failure, the system failed. It cost them 30 million dollars in lost revenue.

Insurance covers what is called fortuitous risk or parametric risk or statistical risk. All things being equal, there is nonetheless a possibility that something’s not going to work. And for that, insurance is available. Insurance as we understand it is available. There are all sorts of risk transfer mechanisms. Insurance is one risk transfer mechanism. Better practices is another risk transfer mechanism, so just being aware of your product and being aware of what you add your value in, and conforming to best management practices is a huge risk mitigate, and that’s part of our practice. But for the risk that can’t be mitigated away — you can lead a healthy life, you can exercise and only drink fruit juices and still die of a heart attack. Life risk is covered through insurances because there’s a statistical thing that you just can’t address. If you lead a pretty crappy life and put yourself at risk by drinking ethylene glycol on a regular basis and so on, we no longer have a statistical risk, we now have a sort of moral hazard issue. We have operational issues, that’s not insurable at that point. So the risk for early stage technology is not insurable in a conventional sense. You can craft structures around that, but very, very complicated, if you talk about technology factors.

So explain to me more than about client experiences.
KOSSOVSKY: While I can’t disclose client matters, I can describe parallel stories that convey the point. Jet Blue is a good example since we are talking on the anniversary of the 2007 St. Valentine’s Day freeze. Jet Blue is an airline that was known for it’s customer service and customer service was it’s reputation. That was its principle driver value. About a year ago, there was a severe ice storm, and they were unable to service their customers. Planes were trapped. People were stuck in the planes. All in all, the serious complications of trying to get people and planes and aircrafts with flight attendants all to get to the same spot to move people. And it cost them about 30 million dollars in lost revenue.

This was in a short period of time?
KOSSOVSKY: Yes, they lost a lot of money over the course of three days. They had to shut down the airline and reboot it. So where did Jet Blue’s reputation of being so customer friendly come from? Well, one, it had a superior human resource manager program. The crew that they hired had a certain attitude and they were able to promote — balance the work activites, such that they could get a lot of service out of very happy, chipper people, so human resource business process, manager process. They had an investment in the physical assets. The planes had a little bit more leg room, and other amenities which were a little bit more expensive, but they were able to save cost on par to the human resource side, because they got a lot more labor out of their people. They didn’t have the union issues many of the conventional airlines had. But most important, a huge reliance on their information technology systems, reservations systems, the informational systems, all that was a very light and very inexpensive base system. Reservations were run by casual empolyees out of Utah on a distributed network. On the whole, it was a very informal structure.

And it was pushed pretty much to the limit. So when the load surge came, that system was unable to handle the surge and it collapsed. IT is a business process enabled by hardware and software and in many businesses, IT performs mission criticial functions. Information technology networks — their failures are insurable through cyber insurances and network insurances, because there are business processes and best practices for managing the system. Jet Blue was not conforming with best practices. So as a result of a business process failure, the system failed. It cost them 30 million dollars in lost revenue. It cost them approximately 1.2 billion dollars, their market cap at the point in time. A year out, their market cap has fallen 44 percent. That’s the intangible loss associated with their loss of that superior customer service reputation.

And to your knowledge, what are they doing about it now?
KOSSOVSKY: They deployed capital to repair the physical assets and bolster the intangible assets. They’ve invested heavily in IT. They went into a crisis management mode, which is a standard response. The CEO was kicked up to chairman. They brought in the operational people. And they’re just not considered the darling anymore. They were hurt. It’s very hard to regain your reputation.

Looking at the metrics, Jet Blue comprised 51% intangible assets over the past two years, on average. Its reference group, Airlines comprising 15 members, was also at about 50%. The company over the past two years returned -41.9% to shareholders while its reference group returned -15.2% and the S&P500 returned 6.0%. As an intangible asset finance manager, it ranked in the 19th percentile in the broad market and 20th percentile among other airlines.

To take a U.S.-based company whose name is on their product, who relies on Asia to manufacture its product. If the U.S. company has its best practices in place, the Asian company does not…
KOSSOVSKY: That is a huge risk, it is inherent in the global supply chain, and it is a challenge we are tackling head on. We have developed a mechanism to move that risk back out the way from the parent company to an intermediate family of companies and insurance products that will indemnify the intermediate company, provided that they conform to best practices. And we’ve seen…

It’s a moving target.
KOSSOVSKY: Yes, it is a moving target in the sense that best practices improve with understanding and technology. It is also a moving target in that business practices and needs evolve. But what we’ve seen in environments where there are networks — Wal-Mart, a huge network of suppliers, Cisco has a network of suppliers, Medtronics and its network of suppliers — that the company that has the client interface, the customer interface, has the throw weight to demand that it’s supply chain conform. And, if you will, acquire these features. I’ve heard that Cisco, just in domestic manufacturing, demands that its Silicon Valley suppliers fill out a 15 page microdot quality checklist. Cisco is seeking to derive an assurance that goods conform to certain quality expectations.