Saturday, July 23, 2011

Goodwill Hunting

Have you measured your goodwill lately?  Have you ever taken stock of your goodwill and thought about how to build it and how to leverage it to make things happen?  Well, sit back and learn from Fortune 100 companies who have missed the boat on goodwill and then take those lessons and light the world on fire...

Since 1939, GAAP (Generally Accepted Accounting Principles) rules have added much value to society by reducing corruption and dishonesty in accounting.  Of course there are still people who find loopholes and cheat people out of their money but GAAP reduced the number of cheaters.  While GAAP has been a net plus for corporate transparency it has also had some unintended consequences.  One I note is the mathmatification of corporate goodwill (brand equity).  Mathmatification looses the intrinsic nature of goodwill, the value of a companies reputation.  Using a strict math definition causes goodwill to be undervalued with companies either throwing it away too easily or not building enough.

Warren Buffet often thinks about the issue of goodwill and how to calculate it as noted in this article about See's Chocolates.  I could not find any conversation about how goodwill gets built.

Let's agree on a working definition of economic goodwill for this discussion.  I am referring to the emotional value customers place on a company's brand.  If people truly love a company, they are loyal to the death and they will build a halo around the company in the form of glowing press and recommendations.  When consumers truly love a product they demand that product in the workplace.  High goodwill causes customers to say, "I do not know how I could live without that product".  This kind of high powered, emotional energy drives the stock prices up translating goodwill to shareholder equity.

How goodwill works:
Goodwill is created when customers feel they got a good deal.  In other words selling a product for less than what could be charged.  For every dollar a customer "saves" the company will earn between 1.25 and 1.50 in goodwill.  Companies that give customers a "good deal" over the long-haul build up substantial goodwill.  Apple is a company that does this well.  Many people will say but they charge a premium for their products, how can that be a good deal?  The reality is Apple's customers feel they got a good deal for their products so Apple is building goodwill while charging a premium compared to the competition.
The inverse is also true, goodwill is destroyed by charging false profits.  False profits are every dollar extracted from a customer above what they would happily pay.  Monopolies that use their pricing power to exact a higher price, companies that use "stickiness" to force customers to buy high priced add-ons are destroying goodwill.  For example, if you buy a car and find you have to use their high priced garage for maintenance or void the warranty, false profits.  Anytime a customer feels they were forced to pay more than was fair goodwill is being destroyed.  Goodwill gets destroyed at the same or greater rate than creation.  In other words, for every additional dollar a customer is forced to pay the compaany looses 1.25 - 1.50 in goodwill.  IBM did this in the late 1970s, once you bought your first piece of IBM equipment you had to buy all IBM and boy did they make you pay more and more the more invested you were in IBM.

Companies can actually get to a point where they have negative goodwill.  When a company gets in this state customers are willing to pay a premium price for an inferior product from a competitor just to avoid business with a company they hate.  Comcast is the most glaring example of this today.  People will do almost anything to break free from Comcast including watching TV on their computer over the Internet, a far inferior experience to sitting on the couch with your clicker.

Historically goodwill was not as relevant as it is today.  In the past, the stock market was ruled by big, financially savvy investors.  Today the market does not follow standard investing guidelines.  Companies like Microsoft triple their earnings over 10 years, increase margins, penetrate new markets like xBox and STILL have a P/E lower than most utility companies.  Microsoft has squandered its goodwill.  No amount of cool product introduction, no amount of success with Bing is going to make the stock price move.  Firing Ballmer might create a blip on the radar but unless the new guy stops trying to wring every loose penny out of your average Mr and Mrs knuckle head the stock is not going to budge.  Have your doubts?  Watch this clip and then let me know...

As individuals we can measure our goodwill too.  For individuals your customers are all the people you interact with in your life.  Your "customers" feel they are getting a "good value" from your relationship if you add more to their life most people.  If you are a taker, your goodwill is getting destroyed if you are a giver you are creating goodwill.  Succeeding at anything in life requires the help and support of others and goodwill is how you "acquire" that help and support.  I graduated from college in 1990 the worst job market since the 70s.  I received more then 80 reject letters before I leveraged my goodwill for an introduction to the managing partner of Accenture's Seattle office.  And the rest of my career, as they say, is history.

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