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XVII

HIGH PRESSURE CAPITALIZATION

  AS recently as 1914, when the B. F. Goodrich Company of Akron, Ohio, included an item of $57,000,000 for goodwill, patents, and trade-marks as a basis for the capitalization of the company, conservative bankers indulged in widespread criticism of this as an uneconomic and unsound business procedure.

  The criticism was based upon the assumption prevalent in the banking and investment world of that time that only tangible assets were properly capitalizable by industrial corporations. But the criticism incidentally showed that a complete misconception existed as to what actually was being capitalized. The bankers assumed that it was goodwill of the kind then most generally associated with that term. As a matter of fact, what was capitalized was an entirely new kind of goodwill--a thing different from the old in its genesis and its effect although easily confused with the old because of the similar nomenclature. The new goodwill acquired a standing and respectability to which it was not entitled by the simple process of taking over the name of the old goodwill which it in so many instances completely eclipsed in aggregate value.

  What is the "new" and what is the "old" goodwill? And in what way does the capitalization of the new add to distribution costs while the capitalization of the old fails to do so?

  A good definition of what I call the old goodwill is contained in the judgment of the court in the case. of Washburn v. National Wall Paper Company, (81 Federal Rep. 20):

  When an individual or a firm or a corporation has gone on for an unbroken series of years conducting a particular business, and has been so scrupulous in fulfilling every obligation, so careful in maintaining the standard of the goods dealt in, so absolutely fair and honest in all business dealings that customers of the concern have become convinced that their experience in the future will be as satisfactory as it has been in the past, while such customers' good report of their own experience tends continually to bring new customers to the concern, there has been produced an element of value quite as important--in some cases, perhaps, far more important, than the plant or machinery with which the business is carried on. That it is property is abundantly settled by authority, and, indeed, is not disputed. That in some cases it may be very valuable property is manifest. The individual who has created it by years of hard work and fair business dealing usually experiences no difficulty in finding men willing to pay him for it if he be willing to sell it to them.

  It will be seen that the goodwill of which the court spoke involves years of good conduct which include (1) fulfillment of contracts; (2) maintenance of standards in the product; and (3) absolute fairness and honesty. This kind of conduct by a concern creates great confidence in it among its existing customers and a trade reputation which attracts a stream of new customers. It is not essential to the creation of this kind of goodwill that the product of the company be patented or trade marked. If the conduct of the company or the quality of its product creates a "clientele" for it, it has the old goodwill.

  The new goodwill distinguishes itself from the old primarily by virtue of the fact that it does not come into existence in the same way; in that (1) it is not dependent upon years of "good" conduct, (2) does not require scrupulous fulfillment of contract, nor (3) absolute fairness and honesty in business. The two kinds of goodwill may come and in many cases do come into existence at the same time, but the old exists as a very valuable asset in many firms which have never developed any of the new goodwill, while many firms have developed very valuable high pressure goodwill without undergoing the discipline and practicing the conduct essential to the creation of the old goodwill.

  The new goodwill is solely and simply the excess over normal profit which is earned by the sale of products through high pressure marketing. It is this capacity for earning excess profits and not the old goodwill which is being used increasingly as a basis for the goodwill capitalization which is conspicuous in present day finance.

  Goodwill based upon the confidence of customers and goodwill based upon high pressure marketing are two different things. The one is created without adding to the cost of distributing the product--the other can only be created by adding to it.

  The new goodwill is not something which inheres in an individual or in an organization--it can hardly be said to inhere in a product--it is something which develops from high pressure exploitation of a name or brand. It exists only in conjunction with brand specification. It comes into existence only by creating consumer demand for one brand as compared with one or more competing products.

  The natural consequence of the discovery of the limitless possibilities of the new goodwill has been a decline in the relative importance attached by the business world to the technique of production in favor of the technique of marketing. If efficiency in marketing and advertising builds capitalizable goodwill more rapidly than efficiency in production, then effort and expenditure is naturally devoted to more and better sales promotion rather than to greater and more efficient production. This peculiar inversion of the normal economic process is made clear in some testimony of Roger W. Babson before a congressional committee in 1918:

  For instance, I have in mind a man who owns some asbestos land. This land is worth little or nothing. The question came up as to whether he should get an engineering expert to develop that land and take his chances on selling the product, or whether he should get an advertising expert to create a demand for that product and then prepare to develop the property. In the first place, if he takes the money and uses it and gives it to the engineer and lets him hire day laborers to work up that proposition, he can charge those expenses to invested capital, and they are recognized by you as invested capital. If, however, he gets a publicity man and uses that money to develop a market for the product, then that is handled and treated by you on an entirely different basis. (Reported in Printers' Ink, July 25, 1918.)

  Mr. Babson makes the customary assumption of those who are interested in promoting the idea of capitalizing goodwill--that demand for a product will not develop unless it is created by some form of high pressure selling. He assumes that an investment of money for the development of asbestos land and an investment of money for advertising to create a demand for asbestos are true alternatives. As a matter of fact, they are not alternatives at all. Even after the making of an investment for the creation of the demand, an investment for the development of the land still has to be made. The real question is whether the two investments are truly analogous--whether the advertising should be treated as an incidental expense or whether it should be included in the capitalization as an investment in publicity upon which dividends should be paid precisely the same as an investment in land or factories. If the advertising is normal in volume; if it is merely a selling expense, no investment in it is necessary for the cost of the advertising is then paid out of income like any other expense. On the other hand, if it is proposed to really invest money in advertising; to spend more money in advertising than can be secured from current sales; then it is obvious that prices must be raised sufficiently to furnish the additional profit to pay interest and dividends upon the capital invested in advertising.

  One of the most succinct statements of this doctrine is that made by a well known advertising agent, Clarence D. Newell, president of the Newell-Emmett Company, Inc., New York. (Advertising and Selling Fortnightly, November 3, 1926.)

  Advertising may be considered both as a method of business and as a productive service to business. Advertising as a method of business has for its objective the increase of sales volume.

  Its cost may be added to current selling expense in the belief that such addition will increase profit to a greater degree than it increases expense. Or it may be invested out of capital or surplus in the belief that at some future time it will yield a profit on that investment.

  The capitalizing of goodwill created through advertising is the subject matter of a book called "Trade-Mark Advertising as an Investment," by Arthur Acheson. I quote one typical case which Mr. Acheson describes in his book.  (Pages 11-12-13, "Trade-Mark Advertising," New York Evening Post, 1917.)

  Some years ago a certain breakfast food concern bought up a number of mills making and advertising competing brands of food. They then allowed all but one of these brands to die, concentrating much of their advertising upon this one brand. At the time of this combination, all of the tangible assets of the new organization could easily have been reproduced for about a million dollars. They capitalized the new concern for three and one-half millions dollars, the excess above a million representing old trade-mark values. At the end of a comparatively short term of years, while the value of the tangible assets of this company had increased to about three million dollars, the company was recapitalized for twelve millions. The president of the company, at that time, over his own signature, in a daily paper, stated that the profits on their one advertised brand in the preceding year, would pay six per cent on a capitalization of fifteen million dollars. Taking their tangible assets then at three million dollars, the nine millions represented what they considered the capitalizable value of their accrued advertising. The bulk of this nine million dollar value had been built up in a period during which not over half this amount had been expended in advertising. This is not a unique case; a number of such and even greater growths in the capital value of brands have been made in the past twenty-five years.

  Some idea of the extent to which the new goodwill has been capitalized by national advertisers can be secured from the following list giving the amount of goodwill shown by their balance sheets:

                                               Goodwill

  American Chicle Co. ................1924   $ 8,766,099
  Ward Baking Corp. ..................1924    11,383,413
  Goodyear Tire & Rubber Co. .........1924    12,500,000
  R. J. Reynolds Tobacco Co. .........1924     1,319,091
  Continental Motors .................1923     5,908,316
  Borden Sales Co. ...................1923     5,942,876
  Hartman Corp. ......................1923     4,992,992
  Corn Products Refining Co. .........1923    16,000,000
  Shredded Wheat Co. .................1922     4,500,000
  Fisher Body Corp. ..................1924     3,268,340
  General Motors .....................1923    22,440,811
  William Wrigley Jr. Co. ............1923     6,000,000
  V. Vivaudou, Inc. ..................1922     6,772,975
  Hupp Motor Co. .....................1922     3,858,920
  Simmons Co. ........................1922     2,430,479
  Liggett & Myers ....................1922    40,709,711
  Pierce Arrow Motor Car Co. .........1922     5,000,000
  General Cigar Co. ..................1922    19,326,000
  Julius Kayser & Co. ................1922     5,644,000
  Torrington Co . ....................1922     1,923,697
  Cluett Peabody & Co. ...............1922    18,275,000
  P. Lorillard Co. ...................1921    21,137,927
  Coca-Cola Co. ......................1921    24,966,230
  Stewart-Warner Speedometer Corp. ...1920     9,188,433
  American Cotton Oil Co. ............1920    23,594,869
  Pyrene Mfg. Co. ....................1918     1,002,450
  American Tobacco Co. ...............1918    54,099,430
  Tobacco Products Corp. .............1914     2,000,000
  B. F. Goodrich Co. .................1913    57,000,000
  Onyx Hosiery Co. ...................1913     1,500,000

This list is by no means complete, even as to those carrying the largest amounts, but it is sufficient to give the reader all idea of the extent to which the capitalizing of goodwill has been incorporated in modern business practice.

  Some of the corporations which earn the very largest sums from profits based upon goodwill are not included in the above list.

  For every corporation which includes in its financial statements the value of its goodwill, there are probably a dozen corporations which list goodwill at $1 or which carry no item to represent it at all. In these cases goodwill has been written off, surplus credited, and generally large stock dividends paid. When written off, a secret reserve results. But whether the goodwill is carried on the balance sheet at its true value, or whether it exists merely as a secret reserve, in either case the company has to earn profits over and above that which might be considered normal.

  The most modern method of capitalizing goodwill uses the device of a no-par stock corporation. Incorporation as a no-par stock corporation has for national advertisers the inestimable advantage of making it very easy to issue stock in unlimited amounts purely upon the earning power of goodwill--without publishing the fact that the security back of the stock consists principally of goodwill. A recent example may be worth analysis. On March 18, 1826, the stock of the Lambert Company, which was to take over the ownership of 56¼ per cent. of "Listerine" was offered the general public. The company was capitalized as follows:

                                                     To Be
                                       Authorized    Issued 
                                         Shares      Shares 

Common Stock (without par value) .......1,000,000    281,250 
Deferred Stock (without par value) .....  100,000    100,000

  This stock was offered at $41.75 per share. On this basis, the 281,250 shares of common stock to be issued had a value of $11,742,187.50.

  Now what did this $11,742,187.50 represent?

  According to Gerard B. Lambert, President of the Lambert Pharmacal Company, the net tangible assets of the company were approximately $1,000,000. As the newly formed Lambert Company owned only 56¼ per cent. of the net tangible assets, the $11,742,187.50 represented $562,500.00 of net tangible assets and $11,179,687.50 of "goodwill." This, however, was stock which represented only 56¼ per cent of the "goodwill." The value of the entire "goodwill" on the same basis was therefore $19,875,000.00. Consumers of the company's products therefore pay not only dividends on tangible assets of $1,000,000 but on "goodwill" of $19,875,000, and, of course, all the costs of production, advertising, and distribution.

  The advertising history of the Lambert Pharmacal Company is exceptionally interesting. The company was founded 47 years ago. But until 1921, Listerine was marketed with only trifling expenditures for national advertising. It was an "ethical" medical preparation. Then high pressure methods of marketing were adopted. Advertising expenditures jumped by the hundreds of thousands yearly. By 1925, advertising had increased to over $2,000,000 for the year. The company itself expected it to exceed $3,000,000 in 1926.

  What followed is told in the following table:

                              Net Profits of Lam-
Years Ended               bert Pharmacal Company After
December 31               Federal Income Taxes at 13½% 

  1922 ......................... $  724,542.53
  1923 .........................  1,078,437.31 
  1924 .........................  1,499,210.77 
  1925 .........................  2,011,940.89

  This makes ownership of the name Listerine better than ownership of a gold mine. That the exploiters of the name appreciate the fact is demonstrated by their policy of launching new products from time to time, such as Listerine Tooth Paste and Listerine Throat Tablets. The name is plainly going to yield its uttermost farthing of "goodwill."

  No one could accuse Printers' Ink, the leading trade paper in the advertising field, of overstatement of this subject of goodwill. An editorial in that publication entitled "Selling the Good Will Idea," in the issue of September 23, 1920, paints a beautiful picture of the importance of what I have called high pressure goodwill.

  Sell the Good Will Idea. Not many years ago a judge of the Supreme Court of the United States, in a carefully written opinion, characterized a certain business as entirely "advertising begotten." In other words, as he went on to explain, its product was intrinsically neither superior nor inferior to the product of a host of competitors, and the only distinction which it could claim was the wholly intangible good will toward its trade name which had been fostered by intelligent advertising. That it lead gained an annual sale almost equal to the sales of all its competitors put together was due, not to intrinsic superiority, but to the fact that it had been made known to millions of consumers while competing goods, of equal merit, had remained in obscurity.

  In brief, if some mighty catastrophe should destroy every vestige of the company's tangible property, it could go on again tomorrow, but if some miracle of oblivion should erase from the minds of the people all knowledge of a certain arbitrary symbol, the business would be gone.

  And therein lies the great security of the company's position; that while catastrophes may, and often do, destroy physical property on a large scale, good will is beyond the reach of fire, or flood, or earthquake. Only the slow process of neglect can destroy it.

  All of which is neither new nor startling, of course, but it represents a fundamental upon which the advertising men need to tighten their grasp every now and again. Especially today, on the verge of what seems likely to prove a period of trial for the half hearted, weak-kneed advertiser, it is important that this truth should be firmly grasped and clearly set forth.

  The time has pretty nearly gone when advertising contracts could be closed on the basis of "13½ pages open; better take 'em quick!" The tune is coming when many executives will be wondering whether that advertising appropriation would not look better under "net profits" in the annual statement than in the pages of the magazines and newspapers. And that is exactly where it will go, in many instances, unless the good will idea is clearly and firmly grasped and understood.

  It is a fact, clear and indisputable, that a favorable public opinion is property more valuable than factories or machinery, or even than money in the bank. Once it is created, only neglect can destroy it, but neglect is sure and often swift to destroy. And that which is destroyed is the most valuable property in the world.

  The advertiser who understands this, will remain an advertiser and grow bigger. The concern, no matter how large, which fails to grasp it, may well fall from the ranks and grow less. And the most successful advertising men of the immediate future are likely to be those who can best sell the good will idea! (Printers' Ink, September 23, 1920, p. 170.)

  The present period of capitalizing goodwill by the issuance of securities based primarily upon consumer demand for branded products is proof of the fact that the selling of the goodwill idea is proceeding along the lines suggested by Printers' Ink. Manufacturer after manufacturer is engaging systematically in the business of trying to earn dividends upon what amounts to the efficiency with which he indulges in marketing extravagances. What an appalling situation--that competition, because it has been shifted from the field of quality and price of product to the field of advertising, has apparently become powerless to check the uneconomic marketing methods upon which the capitalization of high pressure goodwill is based. Apparently the process of inventing new and more effective methods of high pressure distribution, high pressure selling, and high pressure advertising can therefore continue uninterrupted. Apparently high pressure marketing can support itself indefinitely upon the millions of dollars which the investing public will put into corporations which earn dividends by selling branded products at premium prices to a gullible public.


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