Trust: What is Trust Worth? (Pt 3)

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This is the third in a four-part series on Trust. We’ve previously defined trust and explained how to recognize opportunity. If you haven’t yet read those, please start here and here.

If you’ve been in the hospital recently, you probably understand the feeling of powerlessness.

Unless you are one of a few trained medical professionals, you experienced a serious health problem and didn’t know how to fix it. You were enrolled in a confusing system that infrequently engaged you in a full conversation on the trade-offs of possible treatments. The insurance ecosystem was opaque and designed to reduce the potential exposure of the payer rather than get you healthy. Complicated and confusing bills showed up well after you received your care. At a time when you are the sickest, a complex healthcare system is the hardest to navigate. In the name of efficiency and advancement, the US healthcare system has evolved to disempower you when you are most vulnerable.

At a time when you are the most sick, a complex healthcare system is the hardest to navigate.

The COVID-19 crisis has made issues with the healthcare system and structure abundantly clear.

With a reframing of trust, transparency, access, and personal control, the healthcare industry could change. Patients could go to the doctor more often (not less), invest in prevention, and access the right professionals at the right time. They may test from home for everything from COVID to vitamins and UTIs, or have an agent that helps them navigate the system. Providers can be fully informed and can better communicate with their patients. Those all represent areas for new market growth.

Healthcare spending in the US is one of our biggest expenses — $3 trillion annually — and growing. Much of that is waste created from distrust and opacity. The bigger the trust problem, the bigger the opportunity for innovation. But who is likely to fix the system? It’s probably not your insurance company. The incumbent healthcare system can’t see or doesn’t have time to see the opportunity to insert trust in a badly distrusted environment. In fact, they are probably incentivized to keep existing structures in place and usually concede that existing behaviors are set. But given the transparency of information, they are quite useful in evaluating what trust is worth.

The bigger the trust problem, the bigger the opportunity for innovation.

How We Can Measure Value

We examined three approaches for measuring the value of trust:

  1. Violations: How much enterprise value is lost when trust is broken?
  2. Relative Value: How much more than the industry average are trusted companies worth?
  3. Goodwill: Is trust captured in the accounting measure of intangibles? Is this actually a useful accounting metric after all?

1. Trust Violations: How much enterprise value is lost when trust is broken?

A crisis of trust in a publicly-traded company is one of the clearest ways to show the value of trust. There is an event or a series of events, and we can measure the implications for valuation. The market is the best proxy we have for public opinion, so if trust is fundamental to a business model and it is broken there should be a decline in value. If trust isn’t fundamental to a business model, we expect valuation should be less impacted.

A well-known example is the 2018 Cambridge Analytica scandal and data sharing violations at Facebook. They caused the #deletefacebook campaign and a drop in enterprise value (see chart below). For a while, it seemed that trust was worth over $100Bn or 30%+ of company enterprise value. But since then, the valuation of the business has recovered. Users learned that they cannot trust the company with their personal information, but the users aren’t the customers in this case — the advertisers are the customers. The recovery shows that trust is not actually inherent to FB’s business model — investors no longer seem to care because the customers/advertisers do not.

In our own surveys, we validated these findings. We examined a sample of 333 trust violations in public market companies and found a statistically significant impact in valuation between companies that had trust baked into their business model and those whose models don’t rely on trust. Companies whose model depends on trust are likely to have deeper sell-offs after a violation (22% vs. 14%) and also take longer to recover than those whose models don’t.

Equifax is an example of a company where trust is fundamental to the model and it experienced a trust violation. When it announced a hack affecting up to 143m Americans’ credit history in September 2017, the value of the company dropped ~30% (see chart below). Equifax’s core offering relies on discretion, reliability, and accuracy. To hand over such sensitive information, consumers definitionally believed the company had ability, integrity, and benevolence. With ability and integrity skills in question after the hack, the value of the company was worth less. It took the company 3 years to recover. Markets generally are up more than 30% since the hack, which could also suggest a ~15% trust violation discount to potential valuations.

2. Relative Value: How much more than the industry average are trusted companies worth?

Within an industry or job to be done, companies that are more trusted generally exhibit valuation premiums relative to competitors.

Understanding the right measures of relative value is not always clear for innovative companies. Going back to our earlier examples of financial services, let’s look at insurance. Traditional insurance companies generally trade on a multiple of net premiums, or on their book value. The insurtech Lemonade’s recent public listing has shown that these traditional metrics aren’t the right metrics and may fail to describe the business model. (see chart below).

Lemonade Relative Value

($ in thousands)

Another example of trust increasing valuations is in the personal care category. Well-known brands such as Unilever, P&G, L’Occitane, and others have been buying skincare and beauty brands at high valuations, rather than growing them internally. Glossier is a great example of this (though still owned by private capital). The company was able to build community — and trust — through a blog and then started selling its own products to its near-cult following. The large acquirers of these brands all trade for 1.5–4x revenue multiples though are buying these smaller, more trusted, more viral brands for 5–7x, with Glossier’s last private trade at 12x revenue.

Personal Care Brands Relative Value

3. Goodwill: Is trust captured in the accounting measure of intangibles? Is this actually a useful accounting metric after all?

Another method to quantify trust is to examine goodwill. Goodwill is an accounting metric that is often overlooked as it is messy. A reduction to goodwill is an indication by a company that its assets are worth less than previously expected, and it frequently shows the lost value of consumer trust. In large public companies, a reduction to goodwill is a non-cash item and is often strategically measured and (if appropriate) written down in one large chunk annually. Because it’s non-cash, goodwill write-downs don’t immediately reflect the performance of a business, but they are important to understanding long-term potential enterprise value.

According to the textbook definition, goodwill is an accounting measure used when the purchase price of an asset is above book value. This discrepancy exists when the buyer is willing to pay more for an asset because of what they believe to be its strategic value. Over time, if the potential higher value is not actualized, companies will write down a portion of the accumulated goodwill. When this happens the company publicly acknowledges that expectations for the business’ relationship with customers were not met.

For example, one of the largest public tech industry impairments in recent years was in 2016 for $941M at The Priceline Group, Inc. (now called Booking Holdings, Inc., BKNG) to reflect a reduction of expectations at OpenTable, which it acquired in June 2014. The stated reason for the impairment was slower than expected growth (including international expansion). The $941M write-down didn’t affect the company’s immediate financial position, but it importantly did show management’s reduced confidence in the asset and likely lower terminal value. Sometimes, but not always, write-downs correlate with a reduction in stock price because of how analysts integrate this non-cash information into their models and expectations. In the case of PCLN’s material write down, the stock price wasn’t immediately impacted (see yellow in chart below), but as investors understood the longer-term implications to growth, the stock price has been flat over the last 3 years and didn’t achieve the intended growth trajectory (see orange in the chart below).

BKNG Stock Price Chart

The State of Trust

We can look at the changing state of trust much like we look at changing energy in physics. The details are clearly different but the general principle applies — when trust shifts in one part of the ecosystem, it must mean that trust also shifts in another part. For example, we lose trust in institutions but gain trust in the community. Or we lose trust in the healthcare system but gain trust in patient advocates or over the top services. Finding how trust shifts, when, and where trust goes defines new areas of opportunity.

Part IV of the Trust series will explain how entrepreneurs build trust and areas of opportunity.

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