Ignore Reputational Risk at your Peril
As risk management matures and develops, reputational risk is gripping the imagination of many CEOs. A series of recent surveys illustrate that boards not only consider that reputational risk exposure is increasing, but that it is now the most serious threat to their company.
In a volatile global marketplace, where media coverage is almost simultaneous across the world and where reputation is seen as a key source of competitive advantage, trust and confidence are now understood to be key business drivers. However, reputation is subjective and elusive. It is not readily defined. It is an intangible asset. While it exists primarily in the minds of customers, shareholders and the public, it can have a profound impact on the balance sheet.
Reputation and public confidence is the sum of all that a company does, all that it markets and produces and the way it conducts business in the market place. Every time a company sells a product, provides a service, enters into a contract, builds a new facility, invests in research or technology, or enters into litigation, it is making decisions that define its reputation.
Given the potential impact of reputation, it is only prudent to manage it judiciously, with all the care given to any other company asset. Indeed, the value of reputation extends over a long period of time. Strong management, positive customer relations and favourable media coverage can - and do - make tangible and measurable contributions to future earnings. Customers and potential buyers, investors and creditors are constantly evaluating these intangibles in their decisions to purchase, invest or lend. Similarly, employees are evaluating companies and making choices about where to work.
What is reputational risk?
Reputation is important to any enterprise. It is a highly prized asset. It has to be earned and it is established slowly over time. It is all about engendering trust. It is developed by proving that the company is reliable, safe, dependable, consistent and compliant. This is accomplished in part by providing good quality products, high levels of customer service and accurate financial reports. Additionally, it must be ethical in its conduct. The development of trust is normally associated with existing and potential customers. However, it is wider than this. Employees, potential employees, shareholders, regulatory bodies, analysts, suppliers and joint venture partners are among the groups whose perceptions organisations cannot afford to damage.
However, trust is a fragile thing. It can be destroyed in the blink of an eye. Rebuilding may be very slow or not achievable at all. Significant damage to reputation can be created by a single catastrophic press revelation or by the drip-drip effect of a series of minor, less prominent events poorly responded to by weak press releases. Organisations whose reputational capital has been slowly eroded over time are far less able to survive the adverse publicity when a major crisis occurs. The compound effect of a series of events will diminish the trust that people may have had in an organisation, making them less likely to buy from it, work for it or associate themselves with it.
Reputational risk may be defined as the current or prospective risk to earnings arising from the adverse perception of the image of the company by clients, counterparties, shareholders or regulators.
Why is there a focus on reputational risk?
The current focus on (if not preoccupation with) reputational risk stems primarily from the fact that executives now see reputation as a major source of competitive advantage. However, on the other side of the coin changes in the business environment have also made companies more vulnerable to reputational damage. In particular, changes in business practices arising from increasing governance and legal and regulatory influences and closer scrutiny from regulators have made companies more vulnerable to reputational damage. Equally, the power, intrusiveness and thirst of media and communications industries have intensified the focus on corporate reputations.
What are the sources of reputational risk?
The vast majority of reputational risks stem from what companies produce or provide, how their staff behave, how the company behaves and what its guiding principles are. Some of the sources of reputational risk are included below:
- product or service faults or shortcomings (sometimes made more prominent by television programmes and newspaper features that invite and publicise consumer grievances);
- customers selecting alternative products due to an increased focus on buying from ethical suppliers;
- increased targeting by pressure groups resulting in adverse publicity;
- failure to meet the higher standards of governance imposed by regulators in the wake of the high-profile market failures of the past decade;
- failure to meet legal obligations;
- security breaches, particularly IT-related;
- default by a third party upon which the company depends;
- loss of sales arising from customers’ buying ‘agility’, exhibited by their readiness and ability to switch suppliers more than ever before;
- increased willingness of governments to intervene in business on issues of public concern;
- faster dissemination of ‘bad news’ through global news and media channels;
- exposure of staff mistakes or misdeeds;
- detrimental policies, exposure of unethical practices, bad planning or mishandling of a crisis;
- failure to achieve promised growth targets or declared strategy milestones.
What do past events tell us?
There have been a series of high profile events where well known brands have suffered reputational damage as a result of adverse events materialising. In all cases these events have been self induced either through inadequate management or risk seeking behaviour:
- Coca-Cola’s reputation was seriously tarnished when more than 100 people - including children - fell ill in Belgium in 1999 after drinking its products. The Belgium Health Ministry prohibited the sale of Coca-Cola drinks and 15 million cans and bottles of Coca-Cola drinks were recalled .
- Dell’s reputation was impacted when it was reported that faulty batteries were causing their laptop computers to self-ignite. At the time of the incident, analysts reported that the recall of 4.1m laptops would set the IT hardware company back something in the region of $400m (£211m) .
- Chief executive Adam Applegarth admitted that the reputation of Northern Rock had been damaged by the first run on a British bank in more than a century. Queues of worried customers wishing to withdraw their deposits formed at many of its 76 branches which held deposits of £24bn from 1.5 million savers.
Successive surveys illustrate the continued importance attached to reputation
A series of recent surveys have highlighted that reputational risks continue to be considered as the most serious risks facing organisations across the globe. Sales, income and profit are all directly affected by how companies are perceived in the marketplace.
- Aon: In 2006 Aon Global Risk Consulting conducted a Global Risk Management Survey , and based on responses from 320 organizations in 29 countries recorded ‘reputational risk’ (i.e., damage to reputation) as the respondents’ most serious threat.
- Ipsos Mori: In 2006 Hill & Knowlton, in conjunction with Ipsos MORI, published the results of a major survey on corporate reputation called ‘Return on Reputation’. In the survey, 282 financial analysts in North America, Europe and Asia were asked about reputation and its impact on their opinions and ratings of companies. Analysts put so much importance on reputation matters that the great majority (88% of North America, 91% of Continental Europe, 93% of UK and 94% of Asia Pacific) agreed with the statement that ‘a company which fails to look after the reputational aspects of performance will ultimately suffer financially too’ .
- EIU: In 2005 the Economist Intelligence Unit issued a white paper called ‘Reputation: Risk of risks’ , which described the results of a survey of 269 senior executives. Reputational risk emerged as the most significant and difficult threat to business out of a choice of 13 categories of risk. Some 84% of respondents felt that risks to their company’s reputation had increased significantly over the past five years.
- EU/PWC: In 2004 a survey was jointly undertaken by PricewaterhouseCoopers and the Economist Intelligence Unit (EIU) called ‘Uncertainty tamed? The evolution of risk management in the financial services industry’ . The survey of 130 senior executives in financial institutions worldwide discovered that financial services companies had pushed risk management further up the corporate agenda and regarded reputational risk as the greatest threat to their market value.
What can be done to preserve reputation?
While it is commonly acknowledged that reputational risk is difficult to manage, there is a consensus on the key elements of managing reputational risk:
- understanding of stakeholders’ expectations, information requirements and perceptions of the organisation;
- prompt and effective communication with all categories of stakeholder;
- strong and consistent enforcement of controls on governance, business and legal compliance;
- ensuring ethical practice throughout the supply chain;
- establishment and continual updating of a business continuity and crisis management plan and the team required to support them;
- continuous monitoring of threats to reputation;
- a clear vision: ‘what we stand for and are prepared to be held responsible for’;
- clear values, supported by a code of conduct, setting out expected standards of behaviour;
- an open, trusting, supportive culture;
- a robust and dynamic risk management system which provides continuous monitoring of threats to reputation and early warning of developing issues;
- organisational learning leading to corrective action where necessary;
- reward and recognition systems which support organisational goals and values.
The first point is accomplished through identifying the parties with whom the company needs to relate to effectively in order to fulfil its business goals, and establishing an ongoing dialogue with them to clarify and update the expectations of each party.
Next steps?
Businesses will clearly go a long way towards making a more resilient company if they both identify and address the potential impacts of risks to reputation. In addition, reputation management can be developed as an opportunity where superior products and customers can increase market share at the expense of competitors. Reputation can be enhanced through the ‘emotional attachment’ that stakeholders have with the company. Those companies that address global warming issues, tackle waste and recycling, support third world producers and are socially responsible, will engender respect and trust.
Sources
i BBC News, “Belgium bans Coca-Cola” Monday, June 14, 1999
ii CNN Interactive “Belgium widens Coke recall as more children fall ill”, June 14, 1999
iii The Times “Can Dell’s reputation withstand the fire?” August 16, 2006
iv Aon “Aon’s Global Risk Management Survey 2007: Reputational Risk”, May 28th, 2007
v Ipsos Mori “Reputation ‘Crucial’ To Ratings”, 15 March 2006 (Hill & Knowlton’s global survey of financial analysts’ opinion on corporate reputational management, research conducted by MORI).
vi EIU “Reputation: Risk of risks”, an Economist Intelligence Unit white paper, 2005.
vii EIU/PWC, ‘Uncertainty tamed? The evolution of risk management in the financial services industry’, 28 JULY 2004, (a joint paper by PricewaterhouseCoopers and the Economist Intelligence Unit).
The author
Robert Chapman is a risk management specialist and director of Dr Chapman Consulting. He can be contacted at
robert.chapman@drchapman-consulting.com