Case Study

W14258 VISA INC.: ACCOUNTING FOR MARKETING 1 Professor Neil Bendle wrote this case solely to provide material for class discussion. The author does not intend to illustrate either effective or ineffective handling of a managerial situation. The author may have disguised certain names and other identifying information to protect confidentiality. This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) [email protected]; www.iveycases.com. Copyright © 2014, Richard Ivey School of Business Foundation Version: 2014-07-08 Amy Wilkins 2 was nervous. She was interested in the global payments industry, and she was preparing for arguably the most important job interview of her career. Working at Visa would be a dream come true for Wilkins, as she would be reporting directly to the chief marketing officer, which would provide a great way to build her profile in the organization. Wilkins thought that, just as for companies, the way for interview candidates to succeed was to promise — and then deliver — something that no one else could. There would be more experienced marketers going for the job, but who else would understand financial reporting and thus know how marketing fit in the company? Wilkins decided to learn about Visa Inc.’s marketing through the company’s published accounts. She was aware that the Visa’s management placed a lot of emphasis on marketing and on its brand, and she wanted to see how the accounts reflected the results of these marketing efforts. Specifically, Wilkins wanted to assess how the Visa brand was reflected in the company’s statements. As she jotted down some questions on an envelope, Wilkins laughed since it occurred to her that maybe she could account for marketing at Visa Inc. better than the financial accountants were doing currently. That would be a real competitive advantage! The Visa Inc. 2008 10-K 3 in Wilkins’s hand was a massive 336 pages long. Her financial accounting professor had mentioned that financial reporting was for investors, and that certainly seemed right; this bulky document definitely did not seem designed to aid marketers. Nuggets of information were strewn throughout the accounts, but where to look? 1 This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives presented in this case are not necessarily those of Visa Inc. or any of its employees. 2 Amy Wilkins is a fictional character. All the data is from the 10-K returns of Visa Inc., 2007-2013. Students are encouraged to read the original documents if they wish to better understand Visa Inc. 3 An annual report of a company’s financial performance, as required by the Securities and Exchange Commission This document is authorized for use only by Paul Bailo ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. Page 2 9B14A032 WHAT DOES VISA INC. DO? Despite the Visa brand’s long history, the current company, Visa Inc., had been newly created in 2007, followed by an initial public offering in 2008. Outsiders often compared Visa Inc. to a bank, but that seemed incorrect. Visa gave a diagram of its business model, which involved four players. 1. Merchants: Places that accept visa cards. For example, Joe’s Pizza. 2. Acquirer: A financial institution that signs up the merchants. For example, Joe’s Pizza banked with TD Bank. The bank worked with Joe to allow him to take Visa payments. 3. Issuer: Another financial institution that produces Visa branded cards. For example, Chase issued a Visa credit card to Manuel, a student, and offered him a $1,000 line of credit. Manuel borrowed from Chase when charging a pizza to his credit card. 4. Card Holder: the user of the card – in our example, Manuel who visited Joe’s Pizza. Visa Inc., through VisaNet, facilitated the interaction between acquirers and issuers, ensured that the technology worked smoothly, and maintained the Visa brand that internationally signaled hassle-free payment. At the beginning of the 2008 10-K, the company explained its business as follows: “Visa operates the world’s largest retail electronic payments network and manages the world’s most recognized global financial services brand” (Visa Inc. 10-K Year Ending 30th September 2008, p. 4). HOW DOES VISA INC. ACCOUNT FOR MARKETING? Wilkins had seen numerous advertisements for Visa over the years, and she knew they did not come cheap. Visa also sponsored any number of major sporting and cultural events, such as the Olympics and FIFA World Cup. 4 She thought Visa must also spend a considerable sum cementing its relationships with the financial institutions. How was this spending accounted for? The Financial Accounting Standards Board (FASB) had rules on how to account for marketing. In a note to the accounts, Visa Inc. explained how marketing expenditures were reported: Marketing. The Company expenses costs for the production of advertising as incurred. The cost of media advertising is expensed when the advertising takes place. Sponsorship costs are recognized over the period in which the Company benefits from the sponsorship rights. Promotional items are expensed as incurred, when the related services are received, or when the related event occurs. (Visa Inc. 2013 10-K, Note 1, p. 65) Wilkins considered the implications of the note. What was implicitly assumed by these accounting policies? For instance, what was the assumed impact of advertising? Sponsorship commitments were incurred when the agreements were signed, but usually the money was not paid over until later. Wilkins noted that the accounting policy of informing investors in the financial accounts about agreements as they were made allowed investors to understand the company’s unpaid commitments. She detailed these sponsorship commitments (see Exhibit 1). Wilkins then considered Visa Inc.’s overall marketing spending, and she remembered – perhaps inaccurately – a general principle from accounting that went something like this: Expenses should be accounted for when the benefit is felt. Wilkins was unsure of what was meant by this rule. Brand4 Visa Inc. 2010 Annual Report. This document is authorized for use only by Paul Bailo ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. Page 3 9B14A032 building advertising, for example, seemed to be accounted for in exactly the same way as all other types of advertising. VISA INC. INCOME AND EXPENDITURE Wilkins next considered Visa Inc.’s sources of revenue. She noticed the large negative impact of incentives on revenues, and reading the notes to the accounts served to clarify what was happening. The incentives were in respect of agreements designed to increase volume, gain merchants and win product acceptance. These were accounted for as negative revenue (rather than as costs) because the incentives were, in effect, discounts to drive business. If Visa accounted for the revenue without removing the incentives, doing so would overstate the revenue of the company, potentially misleading investors. Wilkins looked the sources of revenue in a table created from the 10-Ks (see Exhibit 2). The notes to the accounts told her that service revenues were earned from financial service institutions for supporting the Visa network. Data processing revenues involved fees associated with transactions over the Visa network. International Transaction revenues included Visa revenues from cross-border transfers and currency exchange. Other revenues included revenues from cardholder protection services, licensing fees and some revenues from Visa Europe. Next, Wilkins wanted to understand the company by seeing where its money went. The headline expense figures (see Exhibit 3) raised questions. How did personnel relate to marketing or network and processing? Was there an obvious trend in expenditures? How much did operations cost? Further, there were significant litigation provisions for which Wilkins could not understand the details, so she decided to avoid discussing those at the interview. She looked at the operating income and net income after taxes. There were minor adjustments, including those for a non-controlling interest. Wilkins could not bring herself to read them, thinking that perhaps accountants cared about that sort of thing. HOW DOES BOOK VALUE COMPARE TO MARKET VALUE? Early in her business training, Wilkins had been told that financial accounts did not try to reflect the market value of the firm. The question she wanted to answer was: How much did the value of the firm show in the accounts, (known as the book value), differ from the market value (i.e., what it would cost to buy all the shares of the company at the current share price)? The market-to-book value was calculated by dividing the market value of a firm by the book value of a firm. Financial accounts (the book value) often capture the value of tangible assets, those you can point to (e.g., property), but often omit intangible assets, those that you cannot point to (e.g., brand value). As such, the market-to-book measure is used as a rough measure of the reliance of the company on intangible assets. The higher the market-to-book value calculated, the more reliance on intangible assets, relative to tangible ones. Indeed, Wilkins had even seen arguments that a rising market-to-book value measured company performance, the argument being that companies that used their assets more effectively had higher market-to-book value. She thought it would be useful to calculate market-to-book value across the years. To calculate this figure, Wilkins took the market capitalization (the total value of the shares as traded on the market) as at the end of September for each year (see Exhibit 4). She divided this market value by the book value of the assets reported in the 10-K annual returns. Book value, she decided, was the total equity figure shown on the balance sheet (see Exhibit 5). This figure represented the value of book assets owned This document is authorized for use only by Paul Bailo ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. Page 4 9B14A032 by the shareholders, that is, after all liabilities were removed. (Clearly, if the company had borrowed to purchase an asset, and funds were still owed to the creditor, the full economic value of the asset would not be due to the shareholders). After constructing this market-to-book value, Wilkins was unsure what to make of it. She gave some thought to what it meant. WHAT IS ON THE VISA INC. BALANCE SHEET? Wilkins created a table for the balance sheet (see Exhibit 6), but she felt it was less informative than she hoped. The liabilities looked reasonable enough. She noticed the major swings in liabilities often seemed to be connected to litigation. Further liabilities included incentives promised, which had been charged to the expenditure accounts but not yet paid over. Indeed, there were also assets for incentives paid over but for which the benefit had not been received. Wilkins noticed that, in 2012, there had been a large change in current assets owed to Visa, but upon closer inspection, she realized these seemed to be owed by tax authorities. She concluded that accountants must enjoy spending a lot of time trying to ensure that costs and benefits got allocated to the correct periods, what they called accrual accounting. Two lines on the balance sheet seemed surprising to Wilkins. First, she turned to goodwill: Goodwill represents the excess of the purchase price over the fair value of the net assets acquired in a business combination. Goodwill is not amortized but is evaluated for impairment at the reporting unit level annually as of February 1, or more frequently if events or changes in circumstances indicate that impairment may exist. (Visa Inc. 10-K, 2012, Note 1) Wilkins did not know what this meant, but she calculated the impact of goodwill on the balance sheet. It seemed significant, but it changed very little over time. The intangible assets of Visa Inc. were also shown on the balance sheet. From the 2008 10-K, Wilkins created a table to show the balances in respect of intangible assets when the company was created (see Exhibit 7). The headings suggested that these intangible assets were related to marketing activities. Wilkins wondered how the value of these marketing assets had changed, given the sizable investments Visa Inc. had made in marketing. WHAT IS HAPPENING WITH VALUATIONS OF THE VISA BRAND? Wilkins assumed a brand would be classified as an intangible asset, but she was unsure whether it had been recorded in the accounts. Surely this brand was a massive asset for the company, given that the brand was central to Visa Inc.’s activities. To estimate brand values, Wilkins looked up publicly available brand valuations and produced a table of these values (see Exhibit 8). The valuations had been conducted at different times, by different brand consultants, using different methods, so Wilkins knew she should be careful about making direct comparisons. Even so, the brand valuations gave some range for the value of the Visa brand. Wilkins considered valuations from Millward Brown, who produced the BrandZ analysis, and from Interbrand. Both these valuation approaches used an earnings split methodology. (This process involved estimating a percentage of the net present value of profits as being generated by the presence of the brand.) She also looked at Brand Finance, a firm that used a method called relief from royalties. This This document is authorized for use only by Paul Bailo ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. Page 5 9B14A032 valuation used the estimated cost that a person would have to pay to rent the brand name based upon market comparables. Wilkins wondered what she could do with these numbers. Did they make sense? Wilkins thought that perhaps, with a few strong assumptions, she could estimate the portion of the difference between Visa Inc.’s book value and its market value due to the omission of brand valuations. First, she created an average of the brand values, and then she compared that figure to the difference between the book value and the market value. She next compared the brand value to the book value of the firm. Her thinking was that perhaps brands were classified as immaterial. Perhaps accountants did not worry about brands because the value of the Visa brand was too small to bother with. Finally, Wilkins compared the brand values to market values to see what percentage of the company’s value was coming from the brand. She reviewed these values over time to see whether the proportion had changed much. RATIO ANALYSIS Wilkins calculated four common ratios used in financial analysis: return on assets, return on equity, return on invested capital, and total asset turnover (see Exhibit 9). She worried that if financial accounting policies systematically understated the value of marketing assets, then these figures might be misleading. Wilkins thought that maybe she could recreate accounts that represented marketing in a different way. (After all, her preparations for a job interview were not covered by FASB rules.) She recast the accounts in two ways. The first involved simply treating all marketing expenditure as though it were purchasing a marketing asset (e.g., customer loyalty). She knew that assuming all marketing was an investment, as opposed to driving immediate sales, was a strong assumption. She took some comfort in the fact that some investments may have been hidden in the personnel costs and the incentives – so this might come out about right overall. She then thought about depreciating the marketing asset but decided that, for her purposes, that exercise would require a lot of effort for not much benefit, given her objectives. Secondly, Wilkins took another, even more radical approach. She assumed that the average of the brand valuations from the three agencies was the true asset value of the Visa brand. Each year, she would ensure that this brand value appeared on the Visa Inc. balance sheet. Given that this change in asset value was not necessarily an operational change, Wilkins decided to bring any gains or losses from the brand valuation directly onto the balance sheet (e.g., she directly increased owners’ equity when the brand value rose). Wilkins wondered how these changes would affect the four ratios she had calculated. UNDERSTANDING VISA INC.’S MARKETING Wilkins looked at the mountain of data she had accumulated. What could she say about Visa? She felt sure that she had learned a lot about marketing at Visa Inc., but she remained far from convinced that the approaches used by financial accountants were ideal for her purposes. Even so, with her improved understanding of the accounts of Visa Inc., Wilkins felt she was well prepared for the interview. This document is authorized for use only by Paul Bailo ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. Page 6 9B14A032 EXHIBIT 1: SPONSORSHIP COMMITMENTS 2013 Pg. 91 Payments Due By Period, From Current Year (All Millions) Less than 1 Year 1-3 Years 3-5 Years More than 5 Years Total Marketing & Sponsorships 2012 Pg. 98 $116 $120 $119 $110 $150 $231 $214 $94 $86 $202 $168 $105 $239 $162 $7 Less than 1 Year 1-3 Years 3-5 Years More than 5 Years Marketing & Sponsorships 2007 Pg. 91 $115 Less than 1 Year 1-3 Years 3-5 Years More than 5 Years Marketing & Sponsorships 2008 Pg. 85 $237 Less than 1 Year 1-3 Years 3-5 Years More than 5 Years Marketing & Sponsorships 2009 Pg. 50 $178 Less than 1 Year 1-3 Years 3-5 Years More than 5 Years Marketing & Sponsorships 2010 Pg. 57 $108 Less than 1 Year 1-3 Years 3-5 Years More than 5 Years Marketing & Sponsorships 2011 Pg. 58 $178 $107 $152 $97 $25 Less than 1 Year 1-3 Years 3-5 Years More than 5 Years Sponsorships $18 $24 $3 — $580 Total $703 Total $513 Total $585 Total $558 Total $381 Total $45 Source: Visa Inc. 10-Ks EXHIBIT 2: SOURCES OF REVENUES All Millions Service revenues Data processing revenues International transaction fees Other revenues Incentives Total operating revenues Year to 09/30/2013 09/30/2012 09/30/2011 09/30/2010 09/30/2009 $ 5,352 $ 4,872 $ 4,261 $ 3,497 $ 3,174 4,642 $ $ 3,975 $ 3,478 $ 3,125 $ 2,430 $ 3,389 $ 3,025 $ 2,674 $ 2,290 $ 1,916 $ 716 $ 704 $ 655 $ 713 $ 625 $ (2,321) $ (2,155) $ (1,880) $ (1,560) $ (1,234) $ 11,778 $ 10,421 $ 9,188 $ 8,065 $ 6,911 Source: Visa Inc. 10-Ks This document is authorized for use only by Paul Bailo ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. Page 7 9B14A032 EXHIBIT 3: EXPENSES AND NET INCOME Year to 09/30/2013 09/30/2012 09/30/2011 09/30/2010 09/30/2009 $1,932 $1,726 $1,459 $1,222 $1,143 All Millions Personnel expenses Network & processing1 $468 $414 $357 $425 $393 Marketing2 $876 $873 $870 $964 $918 3 Professional fees Depreciation & amortization $412 $397 $385 $333 $337 $288 $286 $265 $353 $226 General & administrative expenses4 Litigation provision (benefit) Total operating expenses $451 $3 $4,539 $451 $4,100 $8,282 $414 $7 $3,732 $359 -$45 $3,476 $338 $2 $3,373 Total Operating Revenues Operating Income Non-Operating Income (Net) Income Before taxes $11,778 $7,239 18 $7,257 $10,421 $2,139 68 $2,207 $9,188 $5,456 200 $5,656 $8,065 $4,589 49 $4,638 $6,911 $3,538 462 $4,000 Income Tax Provision Adjustment For Non-Controlling Interest Net income attributable to Visa Inc. $2,277 $0 $4,980 $65 $2 $2,144 $2,010 $4 $3,650 $1,674 $2 $2,966 $1,648 $1 $2,353 Notes 1 Called Network, electronic data processing (EDP) & communications expenses prior to 2012 2 Called Advertising, marketing & promotion expenses prior to 2012 3 Called Professional & consulting fees prior to 2012 4 Called Administrative & other operating expenses prior to 2012 Source: Visa Inc. 10-Ks EXHIBIT 4: MARKET CAPITALIZATION OF VISA INC. Market Value As At End of Sept (Thousands) 2013 $89,754,613 $67,642,513 2012 2011 $45,809,735 2010 $34,260,090 2009 $32,715,030 2008 $33,984,908 Source: Visa Inc. 10-Ks This document is authorized for use only by Paul Bailo ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. Page 8 9B14A032 EXHIBIT 5: RETAINED EARNINGS All Millions Previous retained earnings (accumulated deficit) 09/30/2013 09/30/2012 09/30/2011 09/30/2010 09/30/2009 09/30/2008 $7,809 $6,706 $4,368 $2,219 $186 -$501 Net Income $4,980 $2,144 $3,650 $2,966 $2,353 $804 Cash dividends declared & paid -$864 -$595 -$423 -$368 -$318 -$85 -$3,951 -$446 -$889 -$449 $0 $0 Other Adjustments $0 $0 $0 $0 -$2 -$32 Change in Year $165 $1,103 $2,338 $2,149 $2,033 $687 $7,974 $7,809 $6,706 $4,368 $2,219 $186 $21 -$171 -$176 -$151 -$188 -$70 $0 $0 $0 $0 $0 $1,136 Repurchase of class A common stock Accumulated Earnings at Year End Accumulated Other Comprehensive Income (loss), net Temporary Equity Non-Controlling Interest Paid in Capital $0 $0 $0 $3 $4 0 18,875 19,992 19,907 20,794 21,160 21,060 Class C Treasury stock Equity at End of year 0 0 0 0 -2 -35 $26,870 $27,630 $26,437 $25,014 $23,193 $22,277 Source: Visa Inc. 10-Ks EXHIBIT 6: ASSETS AND LIABILITIES All Millions Total current assets Investments & Client Incentives Property, equipment & technology, net Total other assets Intangible assets Goodwill Total assets 09/30/2013 09/30/2012 09/30/2011 09/30/2010 09/30/2009 09/30/2008 $7,822 $11,786 $9,190 $8,734 $9,241 $11,174 $2,849 $3,341 $796 $195 $620 $997 $1,732 $521 $11,351 $11,681 $35,956 $1,634 $151 $11,420 $11,681 $40,013 $1,541 $129 $11,436 $11,668 $34,760 $1,357 $197 $11,478 $11,447 $33,408 $1,204 $125 $10,883 $10,208 $32,281 $1,080 $634 $10,883 $10,213 $34,981 Total current liabilities Deferred tax liabilities Total other liabilities Total liabilities $4,335 $4,149 $602 $9,086 $7,954 $4,058 $371 $12,383 $3,451 $4,205 $667 $8,323 $3,498 $4,181 $715 $8,394 $4,442 $3,807 $839 $9,088 $7,165 $3,811 $1,728 $12,704 Total Equity $26,870 $27,630 $26,437 $25,014 $23,193 $22,277 Source: Visa Inc. 10-Ks EXHIBIT 7: INTANGIBLE ASSETS – FORMATION OF VISA INC. 2007 Intangible Asset Tradename Customer relationships Visa Europe franchise right $ millions $2,564 $6,799 $1,520 $10,883 Source: Visa Inc. 10-Ks EXHIBIT 8: BRAND VALUATIONS Source: Millward Brown BrandZ, Brand Finance, and Interbrand This document is authorized for use only by Paul Bailo ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies. Page 9 9B14A032 EXHIBIT 9: RATIO ANALYSIS Operating Revenues Operating Expenses Adjustment Capitalizing Marketing Spend Operating Expenses Operating Income Non-Operating Income Tax Adjustment for Non-controlling interest Net income After Tax Year to 09/30/2013 09/30/2012 09/30/2011 09/30/2010 09/30/2009 $11,778 $10,421 $9,188 $8,065 $6,911 $4,539 $8,282 $3,732 $3,476 $3,373 $4,539 $7,239 18 2,277 0 $4,980 $8,282 $2,139 68 65 2 $2,144 $3,732 $5,456 200 2,010 4 $3,650 $3,476 $4,589 49 1,674 2 $2,966 $3,373 $3,538 462 1,648 1 $2,353 Total Assets Marketing Assets Total + Marketing Assets $35,956 $0 $35,956 $40,013 $0 $40,013 $34,760 $0 $34,760 $33,408 $0 $33,408 $32,281 $0 $32,281 Total Liabilities Total Equity $9,086 $26,870 $12,383 $27,630 $8,323 $26,437 $8,394 $25,014 $9,088 $23,193 Accumulated Earning Beginning of Year Net income After Tax Adjustment for Increase in Brand Value Dividends and Share Buy Back Accumulated Earnings End of Year $7,809 $4,980 $6,706 $2,144 $4,368 $3,650 $2,219 $2,966 186 $2,353 -$4,815 $7,974 -$1,041 $7,809 -$1,312 $6,706 -$817 $4,368 -$320 $2,219 Paid Up Capital Adjustments Total Equity 18,875 21 $26,870 19,992 -171 $27,630 19,907 -176 $26,437 20,794 -148 $25,014 21,160 -186 $23,193 Ratios 26.4% 18.5% 32.8% 13.9% 10.7% 7.8% 26.0% 5.4% 18.3% 13.8% 26.4% 10.5% 14.3% 11.9% 24.1% 8.9% 11.1% 10.1% 21.4% 7.3% ROIC ROE Total Asset Turnover ROA Notes: Return equals Net Income After Tax Current practice is to ignore most marketing assets, count as 0 ROIC is Return on Invested Capital = Return/Paid Up Capital ROE is Return on Equity = Return/Total Equity Total Asset Turnover = Operating Revenues/Total Assets ROA is Return on Assets = Return/Total Assets Source: Visa Inc. 10-Ks and case writers This document is authorized for use only by Paul Bailo ([email protected]). Copying or posting is an infringement of copyright. Please contact [email protected] or 800-988-0886 for additional copies.

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