Maintaining a strong reputation is critical for a company’s sustained success. Yet, almost every day a new crisis makes the headlines. These developments indicate a fundamental misalignment between growing reputational risk and its management.
The sorry state of corporate reputations
CEOs and board members routinely list reputation as one the company’s most valuable assets.1 Yet, every month a new reputational disaster makes the headlines, destroying shareholder value and trust with customers and other stakeholders. During the last year, leading companies ranging from Toyota to Goldman Sachs, and BP to Johnson & Johnson battled severe reputational crises. More recent examples include News Corp., Japanese nuclear operator TEPCO, or the German insurer ERGO. While the sources of the crisis may vary from case to case and from industry to industry, in all cases financial markets punished the companies leading to a severe and sustained erosion of their market values. Often the loss of public trust is only the beginning of a company’s troubles. Lawsuits, public hearings, and investigations soon follow. In some cases pubic officials may sense an opportunity to pursue policy agendas or occupy the role of heroes taking on corporate villains. In other cases, regulators and politicians may feel the pressure of the public to take decisive action changing competitive environments.
In every single case, observers have pointed out specific mistakes by senior management and offered advice on how to avoid similar disasters. But it would be a mistake to just focus on the specific tactical mistakes in any given case and miss the broader trends that manifest themselves in ever more frequent and severe corporate crises. The Economist recently pointed out that executives have an estimated 82% change of facing a corporate disaster over the next five years, up from 20% a decade earlier.2 The 2011 Edelman Trust Barometer, an annual survey of over 5000 respondents in 23 countries on five continents, shows that quality, transparency, and trust are the main factors influencing corporate reputations, while consistent financial performance was at the bottom of the list. Trust is now an essential part of business success.[ms-protect-content id=”9932″]
But in recent years trust in companies has steadily deteriorated, and this may be indicative of much more than simply an annus horribilis for business. The Edelman Trust Barometer shows that trust in business in the U.S. is now approaching levels found in Russia. The data in the rest of Europe are not much better. Only some of the other BRIC counties (China and Brazil) show slightly increased trust. Moreover, NGOs are now trusted more than companies in almost every country, even China, and CEOs are now among the least trusted professionals. Business leaders and corporate boards are starting to take notice, but are unsure what to do.
While the recent global financial crises and recession may have further exasperated this development, the root causes for the erosion in trust go deeper. Four main factors are responsible for the increase in reputational risk.
First, media coverage, whether traditional or social, has dramatically increased globally. This increased scrutiny has made it virtually impossible for companies to hide. Transparency is expected, while companies have less control over their messages; and once an issue is on the Web, it will likely stay there forever.
The second factor is an unexpected consequence of globalization. The globalization of activist organizations has matched the global reach of companies. NGOs have increasingly succeeded in forcing private regulation: the “voluntary” adoption of rules and standards that constrain certain forms of company conduct without the involvement of public agents. In many cases, the mechanism driving change is the creation of reputational crises for globally operating companies that, when effective, leave the companies with no choice but to change their business practices.
Third is a shift in expectations about corporate conduct, especially among younger population segments. Evidence for these trends can be found in the explosive growth of areas such as corporate social responsibility, sustainability, and socially responsible investing. Some critics have dismissed these trends as passing fads that lack sustained impact, but reputational crises are increasingly being driven by moral outrage, whether over environmental concerns or executive perks.
The final factor is the rise of business models based on trust. To develop unique customer experiences and solutions, companies need to get closer to customers’ unarticulated – perhaps even unconscious – desires and needs. This requires trust. While this shift has undoubtedly created new opportunities for value creation, even the mere perception of broken trust will lead to a feeling of betrayal, a strong emotion indeed, a phenomenon recently experienced by Netflix who alienated its passionately loyal customers first with an ill-advised price hike, followed by a confused communication strategy.
How have companies responded to these trends? Poorly. Most companies still view stewardship of the company’s reputation as a narrow issue best left to the PR department. For the most part, the response is an underfunded initiative greeted by nervous questions from the board. Underdeveloped capabilities in the presence of growing reputational risks will lead to an increase in reputational crises. That mismatch is untenable.
The wrong mind-set
Surveys of board members and CEOs suggest that this message is finally sinking in. Corporate leaders understand the important of reputation, but are struggling with establishing a process to manage reputational risk.
The problem begins with having the wrong mindset, as most companies view reputation as a corporate function, not a core capability. This attitude is based on the following beliefs:
• A good reputation follows naturally from having good business practices and doing right by one’s customers, employees, and suppliers.
• If there is a problem, it can be safely delegated to Public Relations, Legal, or outside advisors.
• Reputation management requires little else but common sense and the willingness to do the right thing.
Each one of these beliefs is flawed. First, the need to manage the organization’s reputation actively is critical for any organization. Moreover, the importance of doing so is likely to increase, not decrease, in the near future. Of course, good business practices are important, even necessary, but they are not sufficient for successful reputation management.
Second, the responsibility for reputation management lies with business leaders, who cannot and should not simply delegate it to specialists such as lawyers or public relations experts. Although such experts can play a valuable role in the reputation management process, they should not own it. In most companies, if a reputation management process exists at all, it is typically located within the corporate communications department. If the company’s reputation is truly one of its most precious assets, why delegate it to a department that all too often has insufficient funding and lacks influence over business decisions? Yet, most companies do precisely that. The operating word here is delegate. Communication will play an important role in any reputation management process, but such a process needs to be tightly integrated with the business. Reputation management should be the responsibility of the business leaders, led by the CEO as the steward of the corporate reputation.
Challenges to a company’s reputation typically arise out of a specific business context and thus require management and execution as an integral part of business decisions. This is critically important for the prevention of reputational crises, which can arise as a result of any business decision, whether it involves product design, marketing strategy, the pricing model, the compensation process, or even market entry or M&A activities.
A company’s reputation consists of what others are saying about the company, and not just its business partners and customers. It is essentially public. Successful reputation management therefore requires the ability to assume external actors’ perspectives and viewpoints. Many of these actors (although certainly not all of them) are motivated by moral or ideological concerns that the company or its managers do not share, and indeed may be openly hostile to the company’s business practices. This often leads to a defensive, reactive posture on the part of business leaders, which may engender overly emotional reactions based on anger or self-pity.
Effective reputation management will always be challenging and, like any business skill, will require innovation and adaptation. However, appropriate capabilities can dramatically reduce the complexity of reputational challenges, help spot problems early, and assist in the development of effective strategies that are deeply integrated with the rest of the business.
Building a reputation management capability
An effective reputation management system requires the right strategic mind-set, supported by processes, values and culture. Reputational challenges are essentially public. They put the company on stage in an environment of intense media coverage, a highly motivated, even hostile advocacy environment, observed by a skeptical public. What looked like a good business decision a few months ago when it was done in the context of typical business processes driven by cost savings and value creation may now look highly problematic, even monstrous.
Reputational challenges can arise from any area of day-to-day decision making, but executives tend to make decisions without consideration for the reputational impact. The key skill for business leaders is the ability to maintain an external perspective throughout the decision-making processes and incorporate this perspective into the design of the business decision, e.g. the launch of a new product and its market-entry strategy. Companies need to understand that their decisions are creating a record today that will serve as the basis for their story tomorrow. Assessing reputational risk requires anticipating what a reputational crisis would look like and then take proactive steps to prevent and prepare.
Underneath these topics lurks a hard truth: most reputational challenges do not happen because of some external event or misfortune, but rather arise as the direct consequence of company actions. In other words, companies usually bear at least some responsibility for finding themselves in trouble. Why? Companies make decisions without considering the reputational impact of those decisions, so decision makers fail to act as the stewards of the company’s reputation. Figure 1 illustrates this point.3
Figure 1 captures the difficulties that are inherent in reputation management, because it shows how control and impact move in opposite directions. During a reputational crisis, the stakes get higher as the company loses control. Customers and other stakeholders are paying attention, but the company must make decisions under extreme time pressure and with limited access to critical information. It is far better to manage one’s reputation well in advance of a crisis, while the stakes are still low, the company retains substantial control, and time pressure is limited.
Companies must therefore recognize the reputational impact of any business decision before it is made whether they are related quality control (Toyota and Johnson & Johnson), safety (BP), product design and disclosure (Goldman Sachs), compensation (AIG), or executive conduct (HP). In all these cases, managers in departments ranging from HR to Engineering made decisions that had massive reputational consequences. Were these managers aware of these potential consequences? Did they act as guardians of the company’s reputation, or did they merely focus on their narrow expertise and incentives? For most companies, the answer is the latter. Managers make decisions using all sorts of criteria, but the protection and enhancement of the company’s reputation rarely receives more than lip service.
The concept of reputation dynamics is the key to integrating reputational stewardship with everyday business decisions. It emphasizes the fact that a company’s environment during a reputational crisis will look very different from its environment in normal times. In the case of AIG’s retention agreements, for example, a confidential contract between two parties faced sudden scrutiny in the glaring spotlight of 24-hour news coverage, simplified for a mass audience, with an emphasis on emotional impact and moral outrage. Advocacy groups that typically lie dormant or unorganized may jump on the stage, followed by politicians, regulators, and other officials.
The spotlight will focus not only on the company’s current actions, such as how the CEO answers questions and what the company will do to fix the problem, but also on its past actions. Reporters will ask when the company first knew about the problem, or why management didn’t do more to fix it. The thought process behind each past decision can be brought out into the public arena and questioned. These past actions and decisions are now part of the record and cannot be changed. Even those actions that looked reasonable at the time may wither under scrutiny from a hostile audience in a crisis context after their negative consequences come to light.
After the Gulf of Mexico oil spill, every minute decision that BP made concerning its safety processes took on disproportionate significance, leading to severe criticism of the company. And when Toyota had to recall its cars, commentators quickly alleged that its aggressive growth strategy had sacrificed quality and safety.
These considerations also address the misconception that reputation management can be left to specialists from the communication, legal, or compliance function. The key to successful reputation management is that all decision makers in the organization view themselves as stewards of the company’s reputation. Proactive reputation management needs to anticipate the possibility of such developments and incorporate them into decision making. It requires a mindset that reflects an awareness that through our business decision today, we are creating the facts that will be the basis for our story tomorrow. This approach constitutes the critical switch from a crisis management to a risk management mindset. Taking reputational risk seriously does not necessarily mean refraining from giving the green light to decisions that carry some reputational risk. Rather, the goal of proactive reputation management is to identify possible risks and mitigate them through current actions to reach an acceptable balance level of risk and control. Future reputational risk can be managed today only if it is identified and weighed during the decision-making process.
People and processes
Who should own reputation management? Many executives answer: everyone. That sounds reasonable enough, but it is easy for things that are owned by everybody to actually be owned by nobody. Questions about decision rights, reporting, and accountability still need to be answered. Locating reputation management in the organizational structure of a company can be tricky, even for companies that “get it.”
The reason why reputation management belongs on the CEO’s agenda is that not only is reputational risk one of the main risks facing the company, but the company’s reputation is also one of the few sources of sustained competitive advantage. Companies with stellar reputations can charge premiums and are difficult to imitate.
One of the CEO’s main tasks is to integrate reputation management into the operational processes of the business. One approach to accomplishing this task has been to create a separate corporate function: a chief reputation officer (CRO) or chief reputational risk officer (CRRO). This approach works only if the position carries weight and if the company can avoid creating yet another corporate officer with little budget and less influence. The danger in this approach is that it could create additional barriers to an integration of reputation management and business strategy and actually hurt the process rather than help it.
An alternative is the creation of a corporate reputation council (CRC). This is a cross-functional unit composed of senior executives with actual decision-making authority. It is critical that the CRC mirrors the actual operating structure of the business. One of the reasons that Toyota was slow in responding to the 2010 sudden acceleration crisis was the lack of a truly global decision-making structure. While Toyota’s economic fortunes were heavily dependent on robust U.S. sales, decision making was largely centered in Japan, with little input from the United States.
Good governance and decision-making structures are necessary for effective reputation management, but even these alone are not sufficient. Here is why:
• Reputation consists of the perceptions of customers and other constituencies.
• In many cases, these perceptions are derived not from actual experience with the company or a deep knowledge of any given issue, but from an ever-changing mixture of opinion and information driven by the media, peer-to-peer Web sites, and various influencers ranging from experts to advocacy groups.
• Proactive reputation management requires companies to identify issues early, connect them with the business strategy, develop prevention and preparation strategies, and implement possible changes in business practices in advance of an issue’s gaining momentum.
This sequence can break down at various points. Executives may not realize the importance of reputation management for business success, governance structures may be lacking, or incentive structures may reward short-term vision. But companies may also fail to adopt effective strategies simply because they are unaware of the imminent danger. In other words, even perfectly designed governance and decision-making structures will be ineffective if they lack critical intelligence: decisions are then made in the dark.
This is the business case for investing in intelligence capabilities. Because reputation is driven by many ever-changing actors, the strategic landscape is frequently diffuse and unclear. Because successful reputational strategies need to be designed before a crisis occurs, simply surveying customers, investors, or other business partners will not do. Once customers or investors start to worry, it is too late – the deck is already stacked against the company. Therefore, in many cases, governance structure and intelligence capabilities need to be integrated. We call this integration the Reputation Management System. Figure 2 illustrates this integration.4
Finally, business leaders also need to understand that even the most advanced reputation management system is implemented by people. They need to assess the situation, evaluate its risk and then make the appropriate decision. Getting this right requires not only a strategic mind-set but values and culture to provide guidance to individuals. We cannot expect each employee of a company to correctly assess the reputational risk of an issue, but we can expect him or her to raise a red flag when something does not “look right”. It is here where the leadership of the company’s CEO matters most.
About the author
Daniel Diermeier is the IBM Distinguished Professor of Regulation and Competitive Practice and Director of the Ford Motor Company Center for Global Citizenship, Kellogg School of Management, Northwestern University. His work focuses on reputation management, political and regulatory risk, crisis management, and integrated strategy. His research has been published in numerous academic journals in management, economics, and political science and has been featured prominently in the global media. He is the author of the book Reputation Rules: Strategies for Building your Company’s Most Valuable Asset (McGraw-Hill, April 2011). Professor Diermeier has served as an advisor to some of the world’s leading companies. In 2007 he was the recipient of the prestigious Faculty Pioneer Award from the Aspen Institute, named the “Oscar of Business Schools” by the Financial Times.
1. As examples consider “Concerns about Risks Confronting Boards: First Annual Board of Directors Survey,” Eisner LLP, May 2010, http://www.eisnerllp.com/Nep/PressReleases.aspx?id=5045 (accessed October 13, 2011); “Risk Reputation Report,” The Economist (Economist Intelligence Unit, December 2005); Diermeier, D., Loeb, H. (2011, June). Building a Reputation Management Capability. White Paper for Edelman Crisis & Issues Management. http://www.edelman.com/expertise/practices/crisis/9 (accessed October 13, 2011)
2. “Brand Rehab,” The Economist, April 8, 2010, page 70.
3. The figure is adapted from Daniel Diermeier, Reputation Rules: Strategies for Building your Company’s Most Valuable Asset(McGraw-Hill, April 2011); Figure 7-1, page 183.
4. The figure is adapted from Daniel Diermeier, Reputation Rules: Strategies for Building your Company’s Most Valuable Asset(McGraw-Hill, April 2011); Figure 8-5, page 224