Trading With 3rd World and Emerging Markets:
How Tangible Is Goodwill?

Content
Introduction
What gives rise to Goodwill?

1. Product Brand
2. Perception of the industry in the country of origin
3. Tradition in the country of origin
4. Ability to incur large credits and trade deficits

Why businnesses with goodwill still loose market share
Why companies often write down goodwill
Conclusion

Introduction
In discussing this topic, we need to understand and appreciate exactly what goodwill is.
In some accounting statements, especially after a merger, the item can be found as an asset, listed as intangible. This is because payment has been made for the assets of a company acquired beyond its book value to the owners.
This may represent some hidden value, which manifests in a premium in the selling prices of its products above competing products, and must show up as increased profitability or some steady income stream beyond what is normally shown as "cost of goods sold".

Intellectual property and goodwill although different, are similar in many aspects. They are both acquired over a period of time.
The former is documented, and then registered. Users are, for example expected to pay for the use of a design, idea, process or procedure in the case of patents, and one is not expected to write or sell a publication protected by copyright without the consent of the owner.

Goodwill, on the other hand, may be the expertise employed by a business in the presentation or the packaging of a product or service, derived from observed patterns or a market research, a procedure in sales or cost economics, evidenced by a greater profitability of a business, or a premium in the price of the product as a result of an reputation for customer satisfaction acquired over a period of time.
Payment for this is only realizable when the company goes through a merger or is acquired by another company in form of goodwill.
The law provides for registration of a trade mark or brand name, it is evident that not all assets in this regard can be documented or registered. Some employment contracts forbid an employee from seeking employment in a similar industry or competing business for an agreed period after disengagement.

We may want to know the relevance of this to trade with third world countries or emerging economies.

In Nigeria, for example, a manufacturer's goodwill can account, in some cases for more than 200% premium in the price of products like human or veterinary drugs and medications, vehicle and machinery parts. Premium on electronic goods like a mobile telephone handset are much less, but are still substantial.
The allure of cheap alternatives may be irresistible to buyers in the third world. Many are willing to take the risk, which could come at a very high price. (Nigeria's satellite project).

The goodwill attributed to a durable product manufacturer, usually trickles down to its second hand value, which is another market on its own. Some vehicles, used in Europe, may attract higher prices than some new unknown brand from some emerging countries.



Vehicle (and sometimes equipment) purchasers are often influenced by the estimated second hand resale value when deciding on a brand. Trade in these used vehicles was estimated at about US$50 billion annually in year 2003.

What gives rise to goodwill?

1. Product brand, which has built a reputation over the years in which customers refer to.
   This gives a certain appeal to prospective users and guarantees a degree of preference over competing products. As mentioned previously, customer satisfaction, reliability, durability, over the years as a result of a consistent policy as regards quality control, and high manufacturing standards. Buyers will most certainly be attracted to any variation of the brand, either in packaging or design, targeted at another market segment, or in a cost reduction exercise. This translates to higher profits.
   A typical example is a list of medications collected from a local pharmacy in Nigeria for the same dose. These medications are antibiotics, anti malaria and analgesics respectively.

   Medication	Brand Name	Maker	Price	Unknown Brand Price
   Ampicillin/ Cloxacillin	Ampiclox	Beecham	N500 (US$3.25)	N100
   Chloroquine/ Artesunate	Camoquine	Roche	N760 (US$5.00)	N550
   Paracetamol	Panadol	GSK	N50 (US$0.34)	N30

   Based on the average exchange rates in April, 2010
   
   

   Most pharmacies in Nigeria stock both products, to take care of some who will never buy an unknown brand, as well as those who cannot afford a known brand, as income gaps can be very wide.
   The issue of substandard and fake drugs has always been very contentious in Nigeria.



2. The perception of the industry the country of origin. A country may have a competitive or quality advantage in an industry for several reasons. There may be several producers competing for the same market, with very discerning consumers who react decisively to quality.
   These businesses find it easier to establish a quality competitive advantage when exporting. These in turn are substantially enhanced by the existence of very well developed consumer protection agency, rights group and an effective standards organization. The result is that any such product from such country attracts special attention, and can easily build its own reputation for quality over a shorter period, and by extension, goodwill. An example may be cars from Germany, aircraft from the United States, etc.


3. The country may also possess a very long tradition in the industry dating back to several generations.
   Examples are watch manufacturing in Switzerland, dairy production from Denmark or Holland, higher education in the United Kingdom, laces from Austria etc. Some previously unknown brands may therefore possess some inherent goodwill just as a result of its country of manufacture or origin. The retained perception of the country in enforcement of high standards, a well functioning judicial system which promptly adjudicates in disputes with regard quality and commercial matters will also enhance goodwill. Many of the factors in the last paragraph also apply.
   
   
4. A Country's ability to incur large debts or trade deficits without attracting greater interest rates or being viewed as a risky market can also be regarded as goodwill. This will enhance product development efforts as well as a high research and development expenditure of resident industries.
   


5. Conversely, a very good brand may suffer a reduction in goodwill value if production is transferred to another country not known for enforcement of high standards, as in the case of some electronic consumer goods like telephone handsets.

A strategic move to locate production close to major markets or supply chain should be differentiated from one where low labour costs serves as the main incentive. Movement to some other countries may enhance goodwill, where those countries are noted for quality products, standards enforcement etc.

Transferring production overseas must be followed by the transfer or existence of an equally reliable supply chain in the new location in terms of quality. The failure of this may reduce goodwill. Producers must always consider the extra investment required to sustain brand goodwill when production base shifts,

So, why do many businesses with goodwill in their financial statements loose market share to companies which produce cheaper products?
This is because many cannot effectively manage goodwill, as they do not understand its dynamics. The sustained demand for a product with goodwill attracts a premium price over the competition. High prices normally attract new entrants who attempt to offer the same product or equivalent at a lower price, thus increasing supply.

Failure to respond with a price reduction gives the new entrant an easy access to the market resulting in a loss of market share in spite of the goodwill. They should therefore respond to constantly reducing prices of competitors by reducing their own prices while still keeping the premiums constant, or even reducing such.

This is because the percentage premium which serves as goodwill, gives considerable latitude in a price war, as new entrants rarely factor in this possibility (price war) when submitting business plans to investors and lenders.

If this does not cripple the competition, then the business must consider re engineering and restructuring its production, and/or its product or production technology, as the loss of market share might be a result of disruptive technology, to which every business must respond. (Refer to the Swatch experience).

Why then do companies often write down goodwill acquired from another company after a merger or acquisition?

Many businesses regard a merger or acquisition merely as the removal of a stubborn competitor from the market. In as much as they try to take over its market share, they end up having to write down what was paid for goodwill without a commensurate increase in sales and profitability.
Businesses must investigate thoroughly, the factors that have given rise to the goodwill they intend to pay for when acquiring another business. They must understand its dynamics to know if they can make their own structure flexible enough to take advantage of such, if those factors are still relevant.

Conclusion

Many businesses in the developed countries have wound up, or incurred heavy losses simply because they cannot leverage the goodwill in their businesses when competing against what they see as competition from low wage countries.
This, in turn, is because they have not exploited the opportunities available in trade with third world and emerging economies to the full.

(Example: sales of American cars in China)Tagging on some of these markets may reduce marginal production costs, and, by implication, prices through increased economics of scale.
Some of these may be mundane efforts such as little modifications to goods for certain destinations, inexpensive concessions to some customers/clients who are also opinion leaders, databases of profitable customers, or simple marketing procedures in some markets.
Many Nigerians traders and consumers are fiercely loyal to some brand names because of their limited education, as they find it very difficult to compare specifications. You will be surprised to know that many auto mechanics and technicians still refer to wheel and engine bearings as "Boris" after a brand that existed in the 1960s and 70s.

Goodwill, acquired through brand reputations, or country of origin, may be more valuable than what is usually acknowledged while trading with the developing world.