Goodwill - What is it and what's it worth?

As reported in the Telegraph two weeks ago Fat Face the surfwear retailer reported losses of £225m in its accounts to end May 2009. The retailer has been forced to write off hundreds of millions of pounds of "goodwill". It conceded that its value has more than halved since it was bought by private equity firm Bridgepoint in 2007.

In general use "goodwill" is an accounting term used to reflect the portion of the value of a business entity not directly attributable to its assets and liabilities. It is an intangible asset that reflects the ability of the business to make a higher profit than would be derived from selling the value of the tangible assets. This value is often created and or crystallised at a point of acquisition or merger. However businesses have also been known to write "goodwill" valuations into their balance sheets to reflect what they believe is the true value of the business.

Actually valuing "goodwill" is much more of a challenge than simply accounting for it. In the case of Fat Face the explanation for the write down was "that it will take longer for the brand to achieve its full potential than ... previously believed". BC Partners recently wrote off the whole of its investment in Foxtons estate agents "... we made the wrong call". Frequently premiums paid for acquisitions are not reflected in subsequent financial performance.

Valuations of "goodwill" can get inflated to unrealistic and unsustainable levels. For example:

• A business may have traded during exceptionally benign economic and market conditions, achieving levels of profitability that cannot be sustained when more "normal" conditions are restored.
• A business may achieve a genuinely competitive advantage but then does not have the ability to sustain that in the face of greater competition and/or changes in market conditions.
• And of course - when greed overtakes fear as the main driver of judgement

In contrast we had an example of a client whose advisors were quite unable to understand why the business had superior ability to make profits compared to its competitors and the consequent superior value of the business. They failed to attract buyers for the business at anything like its true worth.

So valuing "goodwill" is not easy and there are no clear criteria or formulae for getting it right. However the consequences of getting it wrong, whether upside or downside, can be serious. If we apply our Competitive Strength perspective to this we can immediately see the fundamental problem. Valuing "goodwill" is about the future but all the data and dimensions used are from the past and present - what a business has shown it can do in economic and market conditions that have existed up to now, rather than what it will need to be able to do in conditions as they might be in the future. Every offer for investment carries the health warning - past performance is no guarantee of future returns!

What is really needed is 20:20 foresight, but is that possible? We believe it is. Whilst it is very difficult to forecast the future it is possible to make an objective assessment of a business' ability to cope with and even to thrive in whatever the future turns out to be.

The key is to be able to make an objective assessment of the Competitive Strength condition of a business entity. This is a new business measure and is made up of two components:

How capable a business is compared to those that want to beat it

and

How capable a business is of mitigating the impact of those forces out there that could cause it to be beaten.

Competitive Strength is the manifestation of the deep seated managerial and behavioural values and competences in a business that are the main determinant of whether, over time, it will substantially outperform its competitors and successfully withstand unpleasant surprises. The rock solid research which identified this linkage also established that there are massive differences between the financial performance and sustainability of an average Competitive Strength condition and the truly excellent - much greater than previously thought.

This is because the greater the Competitive Strength the higher the organisational level of Changeability. Changeability, quite literally the organisational "ability and capacity for change" is a key attribute for superior performance and sustainability. We first defined and publicised this new business culture criterion in our "Why Excellence" seminars in 2003. It has been good to see that research carried out by Dr. Michael Jarrett, adjunct professor of organisational behaviour at London Business School and published in his book "Changeability" in 2009 has confirmed our own work and experience.

Hence the Comparative Competitive Strength condition of a business is a reliable indicator of its ability to make a higher profit than would be derived from selling its tangible assets and the potential value of its "goodwill". You don't have to forecast the future, just objectively assess the business' ability to to cope with and thrive in whatever that future might be - 20:20 foresight achieved!

By combining the research with our own work on Changeability we developed the Competitive Strength Report to enable business leaders and managers to objectively measure the Comparative Competitive Strength condition of their organisation, to clearly understand the implications for it future financial performance and its survival and to decide quickly and clearly what they need to do about it. What is more the web based process is fast (3 weeks), requires a minimum of executive time and is very low cost, so is it accessible by a very wide range of types and size of business.

So if you are a business owner thinking about an exit, or you are considering an acquisition, or you an investor considering where to make your next investment, or an advisor to clients in any of these scenarios,go to our website for more information on Competitive Strength and how it can help you make that all important valuation of "goodwill".

Exceeding Expectations is brought to you by Steve Goodman and Tony Ericson. It is one of our "Excellence Quartet" of blogs promoting the concept of Excellence as the key to prosperity. Each article uses a recent business/financial topic to highlight different perspectives and conclusions from those obtained using conventional thinking and techniques.

Different thinking - Different results

Self-stuffing Turkeys. New? No

BA cabin staff have announced that they will strike for 12 days over Christmas.

The public response has been overwhelmingly negative. The media is awash with puns on Turkeys and Christmas.

Is it that word “British”? Does this word in a company name cause its employees, like the tragic folk at the British Motor Corporation/British Leyland, to believe that they are entitled to unlimited public support and funding despite their employer being seriously uncompetitive and underperforming on every front?

30 years ago and nothing learned. BMC/BL and even its final incarnation Rover is long gone, and all its jobs with it.

BA has been at a very low level of Comparative Competitive Strength for far too long. Its management has shown few signs of understanding this, its shareholders and advisors certainly do not. So it is not too surprising that its cabin staff should be deluded too.

Over the last ten years BA has swanned along smug in the self belief of its own invulnerability and almost god given right to go on for ever whilst in fact sliding steadily down through the Comparative Competitive Strength level of Comfortable into now the lower levels of Constrained. The fact that 90% of the cabin staff have just demonstrated they do not understand how desperate the situation is reflects the poor quality of management and leadership. Mr Walsh’s dramatics have been too little and far too late to be believed, and too many of his management have remained in denial. It is no wonder communications have failed. Look again at BMC and then subsequent BL and Rover leaderships.

Are we about to witness the Longbridge tragedy all over again? Is BA off to join BMC in The Abyss? Is this perhaps a terrible insight into the psychology of large scale corporate failure? Is this yet another case where sheer size, market dominance and organisational inertia obscures the recognition of corporate death at the time of actual occurrence. The business appears to carry on but ultimately, much later, and as a “sudden surprise”, the sunlight hits the wrong bit and the whole zombified structure suddenly collapses in a heap of mouldy dust?

Might the more thoughtful BA cabin staff use this time away from work to find out what happened to the workers at BMC? Could they realise that there is no such thing as a Perpetual Money Machine, and team up with BALPA and other longer sighted employees to work together to win themselves the management leadership and business transformation that they all so desperately need? And get themselves a future?

This forthcoming tragedy is predictable and therefore potentially preventable. Indeed, as Louis Gerstner demonstrated at IBM, it might even be reversible. A key indicator is the Comparative Competitive Strength Report. If you would like to know more about this uniquely independent and objective assessment of the managerial and leadership potential competitive capability of an organisation, and the financial implications of that, please have a look at the introduction on our web site here.

Exceeding Expectations is brought to you by Steve Goodman and Tony Ericson. It is one of our "Excellence Quartet" of blogs promoting the cause of Excellence as the key to prosperity. Each blog has a new article each month using a recent business/financial topic to highlight different perspectives and conclusions from those obtained using conventional thinking and techniques. You can read the other three blogs are "You're having a laugh ... Seriously?",Business Bloop of the Month Award", "Capitalism or ... Common Sense" .