Why Reputational Risk Keeps Grabbing the Limelight

           – Economist Intelligence Unit, Risk of Risks

What would a serious blow to your company’s reputation cost? This was once a rather academic query–most organisations could afford to consign it to the back burner.

Today though, the costs are increasingly coming into sharper focus.  A recent study by Deloitte for example, suggests what happens when a company’s reputation plunges south.

WHEN REPUTATION TAKES A BEATING

                                             Source:  Deloitte Reputation Survey October 2014

For just about any company leader, loss of revenue, damage to brand value and the costs from regulatory investigation and possible penalties are serious matters. Today, these are transforming company responses to anything adversely risking their reputation. See also Reputation: perception or reality, does it really matter?

Where did reputational risk concern come from?

Reputation risk damage has evolved from a quiet place where academics once wrote speculative papers. Now, the impact is so important it’s hitting top management agendas regularly. See for example: Can Co-op bank’s leaders pass the ethics test?

While the cost of a reputation disaster event still cannot easily be measured accurately, even so, the evidence about costs keeps accumulating. It adds up to a simple, hard to ignore fact: a serious reputation hit can cost a company the equivalent of a king’s ransom.

Consequently, some 57% of company leaders say they expect to give more attention to this kind of risk. For example, this chart shows how damage to reputation is now the number one risk concern affecting global business operations:

Such high level worries can be traced back to a series of widely-reported commercial calamities. These include: Johnson and Johnson’s notorious Tylenol terror,  Ford’s Pinto plight, and more recently GM’s ignition switch shambles  along with BPs unending Gulf gothic horror story.  

There are numerous other, less high-profile reputation disasters in numerous industries, from pharmaceuticals to hospitals, from outsourcing to insurance.

Almost in sync with these trust-destroying events, came the ongoing revelations in financial services, stemming from the 2008 crisis onwards.

The plummeting reputation of various banks and allied institutions for instance, has brought this into the limelight, causing major re-thinks about culture, values and how to regain public trust.

Note for example, a leading UK bank’s somewhat tardy decision recently to finally appoint one of its senior executives to devote most of his or her time to dealing with reputational risk.

Legislators around the world have been further making sure the limelight does not dim, by raising the cost stakes.  Anti-competitive measures for example, now actually do more than impose a financial penalty. Executives are increasingly at risk of landing in jail. In the UK for example, even the most senior executives may be

“fined or sent to prison for up to 5 years if you are involved in cartel activity. Company directors may be disqualified from being a director for up to 15 years.”
Cartel Offence Prosecution

In the US, don’t  miss the revealing current story of price fixing of car parts by Japanese suppliers. Possible jail sentences are still looming. [1]

In Australia too, individuals now face criminal or civil penalties, including up to 10 years in jail. These run in tandem with large scale fines for various forms of reputation damaging conduct such as cartel creation.

Tougher constraints on tax evasion by previously immune global firms may similarly do far more than impose a reputation hit, which for example Starbucks experienced over avoiding UK taxes. Jail has now become a real possibility for failing to take responsibility over wrongly or misleadingly transferred tax revenue.

For banks too the net is closing almost daily. Much of the industry is therefore busily down-sizing. HSBC, mired in reputation disaster, has even chosen to move its headquarters from London—a visible assurance it’s taking seriously the demand to separate retail from non retail banking.

All this activity is happening so previously gung-ho top brass in many institutions can feel more confident they’ll be alerted about potentially serious reputation events occurring on their watch.

Reputation as a strategic risk

Alongside the rise and rise of reputational concerns, runs the worldwide leadership deficit.

In its Outlook on the Global Agenda 2015, the recent World Economic Forum rated disaffection with leaders as the third largest challenge for the year. Most of those surveyed (over 87%) said current leaders are failing to get things done.” This includes company leaders failing to treat reputation as a strategic issue.

However some companies have started to grasp the strategic nettle, usually involving the ultimate challenge of cultural change.

Take Serco for example. Two years ago it generated a calamitous reputation failure by over-charging its important UK customers.

Not only did they lose confidence in the firm, their dissatisfaction spread like ripples in a pond, well beyond the confines of the UK borders.

Newly  acquired company leaders set about restoring the firm’s reputation and re-building trust.

They soon realised, for all its previous international success, Serco now needed an entire corporate makeover affecting all 100,000 of its employers around the world. The new Serco reputation strategy became:

“to increase awareness amongst its thousands of employees of its business values and …bolster the corporate culture from the inside out.”

This still has some way to go. For example,  the U.K.-based Robert Smith, Director Assurance at Serco Group PLC (Serco) recently claimed

“I am often asked what the business case for ethics is and I simply reply, “reputational risk management.”

This is an understandable yet far too limited view of corporate ethics. See for example: ANALYSIS: Reputation Risk Handbook

If company leaders only act responsibly when they see a clear possibility of serious reputational damage they would for example, seldom bother with sustainability issues, and they’d probably ignore many other social and environmental consequences until these result in actual costs.

However,  the new Serco approach is certainly a strategic one. It involves a comprehensive effort to change a previously weak culture concerning peoples’ ethical behaviour:

“We took a strategic focus that attempted to ‘join the dots’ across a variety of initiatives covering  employee engagement, talent management, business operations and corporate communications and identified a number of different channels for engagement (print, web, webcasts, forums, training etc.) to ensure consistent and clear messages were getting through.”
[2]

The Ones that Got Away

The failure of companies to treat potential reputational loss as a strategic issue was highlighted earlier in a CIMA report.

With impeccable timing, just one year before the 2008 financial crisis, it concluded reputation risk was not being taken seriously enough because of four basic reasons:

Accountability, Calculating, Probability and Character

How far do these obstacles still exist? As we’ve seen, since that report, many companies have been taking a closer look at what it means to suffer reputational risk. See for example: Exclusive: Interview with “Reputation Risk” author

For instance, re-affirming the earlier Economist Unit study mentioned above, Deloitte’s latest survey also found over 80% of executives rated reputation risk as “more important or much more important than other strategic risks their companies are facing.” [3]

Equally significant, a similar percentage of executives are focusing on managing this risk and the researchers concluded

“Reputation risk is a board and C-Suite issue”.

Accountability:  or having someone senior in charge of risk and reputation management, is probably the most common new steps taken by companies.

For example, Brazil’s oil and gas giant Petrobras immersed in a major corruption scandal, decided late last year to appoint a director of governance, risk management and compliance, mainly to ensure risk mitigation and avoid a repeat of situations of fraud and corruption. Others have made similar decisions.

Calculating: making sense of the likely costs from damage to reputation demands so many assumptions it’s ultimately meaningless:

“Companies struggle to categorise—let alone quantify—reputational risk. Risk managers are divided on whether reputational risk is an issue in its own right or simply a consequence of other risks.” [4]

“Despite the recent attention focused on operational losses, however, there has been only minor progress in quantifying reputational risk. [5]

Attempts such as Deloitte’s to put some kind of number on the consequences certainly help. But this area looks set to remain a black box for some time yet.

Who for example would care to produce an estimate of the reputation cost to BP from its Gulf debacle? Or how do you calculate the total impact from a breach of cyber security? Currently business leaders rely on insurance to deal with such an event. But they “over estimate by a factor of five how well covered they are by insurance.” [6]

Technology is often pushed by software companies as a way of making sense of the potential costs and risks. However, these solutions assume you can somehow automate ethics and they’re unlikely to significantly reduce reputational risk. As one recent study put it:

“…just investing in IT does not lead to a win-win situation as it can have unintended consequences and involve multiple barriers toward actual benefit realization.

Probability: This is the chance of reputational damage actually occurring in the future. Unfortunately, this cannot be reliably forecast, since reputation depends so much on human behaviour. The latter is notoriously difficult to factor into models of a reputational disaster.

Careful stakeholder analysis can however, reduce some of the uncertainty. This maps the various separate interests and as one specialist puts it:

“The key to predicting reputation risk is to monitor the sentiment held by each of the key stakeholder groups: investors, customers, employees, regulators, media etc. Sentiment tracking is a vital tool.”

As a tool to predict a possible risk to reputation, tracking sentiment can remove or at least reduce the element of surprise. The main aim of risk management after all, should always  be “No surprises”.

Scenario planning is yet another way of bringing the probability of reputational damage into sharper focus. Around a third (36%) of large companies say they don’t do “what if” scenarios to prepare for such risks. Companies in the Americas are least likely to do this.

Maybe one day robots will be able take on this difficult task of assessing the probabilities–see for example Rise of the ethical robot and what it means for us and our leaders

Character: this is the risk of perceptions about a company’s complete “persona” going awry.

A company alone does not control this, though it can certainly influence how others perceive it. For handling this kind of risk the starting point is realising that

What an organisation stands for is as important as what it sells.

Corporate character is not just a result of its mission statement, logo or advertising. Instead, its the sum of everything its leadership and employees say and do—the  beliefs they hold, the values they profess and the ways they behave.

“Don’t Wait” is the big lesson so far

All the above adds up to a single lesson for companies of just about any size:

“Don’t wait for a reputational damaging event to happen.”

Instead, anticipate and prepare as systematically as you can.

Why?
Because in the long run it’s cheaper to be ready for a reputation land mine exploding under your feet, than shuffling along hoping it’ll never happen.