Building a Reputation Risk Management Capability

White Paper
DANIEL DIERMEIER1 KELLOGG SCHOOL OF MANAGEMENT HARLAN LOEB2 EDELMAN

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BUILDING A REPUTATION

Reputation and Its Risks
CEOs and board members routinely list reputation among their organizations’ most valuable assets.3 Yet practically every month, a new reputational disaster makes the headlines, destroying shareholder value and trust with customers and other stakeholders. During 2010, leading companies ranging from Toyota and Goldman Sachs to BP and Johnson & Johnson battled severe reputational crises. Early this year the world anxiously watched the Fukushima disaster accompanied with heavy criticism for its operator Tepco and the Japanese regulators. While the source or sources of each crisis varies from case to case and from industry to industry, financial markets punish all the companies, triggering a severe and sustained erosion of their market values. Often the loss of public trust serves as only the beginning of a company’s troubles as lawsuits, public hearings and investigations ensue. However, it would be a mistake to simply focus on the specific tactical mistakes of any given calamity and miss the broader trends that occur with ever more frequency and severity. The Economist recently ventured that executives have about an 82 percent chance of confronting a corporate disaster over the next five years, up from 20 percent a decade earlier.4 The 2011 Edelman Trust Barometer, an annual survey of more than 5000 Informed Publics in 23 countries on five continents, found that quality, transparency and trust principally influence corporate reputations, while consistent financial performance ranked at the bottom.5 Trust is now an essential part of business success. Yet U.S. trust in business has declined over the past five years. This indicates that trust is fragile and needs to be re-earned. While trust in business remains higher in emerging markets, non-governmental organizations (NGOs) are on par with businesses in emerging markets and

Often the loss of public trust serves as only the beginning of a company’s troubles as lawsuits, public hearings and investigations ensue.

more trusted in developed markets, including the U.S., further articulating the importance of thirdparty partnerships.6 These developments warrant a broader explanation. One factor reflects the rise in reputational risk from increased public scrutiny. Companies now operate in an ever-faster-moving news cycle, driven by intense competition between 24-hour news channels, wire services, and online news providers. Add to that the rise of user-generated content, from blogs and Twitter to Facebook and YouTube. Social media not only is a medium for sharing information and opinion quickly and permanently, as the recent WikiLeaks campaign illustrated, it also can help diverse constituencies to better organize, as seen

In some cases, public officials 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 public pressure to take decisive action that changes competitive environments. One thing never wavers: observers identify specific mistakes by senior management and offer advice on how to avoid similar disasters.

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in the critical role played by Facebook and Twitter in the Tunisian and Egyptian uprisings. These developments mean that companies have less and less control over their messages, shifting the balance of power from companies to customers and other stakeholders. The second factor is the globalization of activist organizations and nongovernmental organizations that has matched the global reach of companies. Public institutions, however, are no longer the sole source of constraints on commerce. Instead, political activists and NGOs increasingly succeed 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 that, when effective, leave the companies with no choice but to change their business practices.7 As a third factor, expectations about business responsibility are increasing. In the 2011 Edelman Trust Barometer, 85 percent of all U.S. respondents agreed with the statement: “Corporations need to create shareholder value in a way that aligns with society’s interests, even if that means sacrificing shareholder value.” The corresponding numbers were 91 percent in Germany, 89 percent in the United Kingdom and China, and 74 percent in India. Companies are responding to these concerns as witnessed by the explosive growth of corporate social responsibility reports, sustainability programs, and socially responsible investing. Some critics have dismissed these trends as passing fads that lack impact, but this assessment may be premature. In addition to typical business issues such as quality and product safety, reputational concerns increasingly arise from moral or ethical concerns. Child labor, dolphin-safe tuna, and shade-grown coffee are just some of the best-known examples. Despite these efforts, companies find themselves in an environment of higher expectations matched with higher scrutiny leading to higher reputational risk. We suspect that the increase in reputational crises points to a mismatch between risks and corporate capabilities. In other words, while reputational risks have risen significantly, reputation risk management capabilities have not kept pace. But an increase in risk without a matching improvement in prevention and preparation capabilities will spark a marked escalation in severe incidents.

…companies find themselves in an environment of higher expectations matched with higher scrutiny leading to higher reputational risk.

…while reputational risks have risen significantly, reputation management capabilities have not kept pace. But an increase in risk without a matching improvement in prevention and preparation capabilities will spark a marked escalation in severe incidents.

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BUILDING A REPUTATION

The View from the Board
To explore this issue further, we conducted a series of in-depth interviews with a group of distinguished corporate directors. Through selection and evaluation of a company’s top leadership to ongoing oversight and counsel to management, corporate boards are entrusted to ensure the longterm viability and success of the enterprise. These responsibilities include the risk management process. We wanted to explore the views of board members on the role of reputational risk, how it has changed and whether companies are prepared sufficiently to manage it appropriately. The questions were: > Recent surveys among board members have suggested that reputational risk is among the most prominent risks faced by companies in today’s business environment. Do you agree with this assessment? Does it apply to your company? If you had to rank significant risks in general, where would reputational risk be located? Why? > Has the importance of reputation management changed over the last few years? If so, why? > Who “owns” reputation management in your company? What was the rationale for organizing it in this way? Do you think this organizational structure is sufficient for the tasks at hand? If not, what are the main obstacles to developing a proper capability? Why can’t they be overcome? > Do you think your company excels or lags competitors/other industries in how it manages its reputation? What are other companies doing particularly well? > What is the role of the board in the management of a company’s reputation? How does it differ from other aspects of business or other risks? > What are some of the specific difficulties that limit the effectiveness of board members in reputation management? Are they specific to your company or apply to most companies? > Are there any other aspects on the role of reputation that we have not sufficiently addressed? Is there anything else you would like to add?

The Panel
The panel comprised eleven directors serving collectively on more than 28 public boards, of which three are Fortune 500 and three are Fortune 100 companies; and 60 private boards within the financial, technology, services, and consumer and industrial goods industries. Additionally, our panel members have served on the boards of 27 non-profit organizations and educational institutions. One board member is board chairman of a public corporation and another is the Lead Director, while three others serve as chairman on boards at non-profit organizations and educational institutions. Furthermore, three individuals held C-suite positions including the role of CEO during their corporate careers.

The Interviews
The interviews consisted of in-depth phone conversations in an open format.8 They were conducted as free-flowing conversations using a list of questions. However, board members were encouraged to add their insights to the conversation as they saw fit.

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A Snapshot of Our Findings
All board members agreed that reputational risk ranks among the most important challenges faced by boards today. Almost all believe that reputational risk has increased or become more important. These quotes illustrate this sentiment.
“Boards deal poorly with low-frequency events with high severity. It’s difficult to make a board ‘think about the unthinkable’ when the probability of the event is so low.” “Managing reputational risk is always on my mind.” “Reputation has always been important, but its impact is more pronounced and enterprise critical.” “Reputation used to live in the background; now it lives in the foreground. How important varies by company and industry. For some companies, it is the most important asset.” “It takes forever to build a good reputation, but only a second to destroy it. Boards are subject to greater scrutiny on oversight. Members are concerned about reputational risk as well, as a good reputation is crucial to them personally; [reputational risk] is perhaps more important and worrisome than financial risk.” “It is the most important asset. With financial risk, you can recover. While employees are valuable, you can always find new ones. But reputation is your life currency, both individual and corporate. It takes years to build and is what you become known for.” “Reputational risk certainly ranks as one of the greatest risks and should be of great concern; it should rank among the top of the hierarchy from a risk perspective.”

Yet, board members proposed different solutions for how to manage reputational risk and which governance structures a company should put into place. The following gives an overview on the range of answers:
“There is no single answer; it depends on the board and on the situation.” “Boards are struggling; it is an important topic, but each board must fully grasp the concept and what it means to them.” “Reputation is owned at an individual level: Everyone is responsible for considering how decisions will look to the outside world. There are no standard processes, no singular template or influence that drives decision-making.” “Not the marketing department! People often confuse brand and reputation.” “Reputation cannot be outsourced; it must be protected by the office of the CEO or chairman.” “In my experience, it’s the role of the board to make sure processes are in place; however, in the end, the management must be the one to take action(s).”

The majority of board members welcomed receiving independent, outside counsel that does not originate with management, which is similar to other forms of advice such as legal, regulatory, or compensation related. Yet, some board members were concerned about the impact on the relationship with the CEO.

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In summary, the following themes could be identified: > Reputation management should be owned by everybody. But ultimate responsibility lies with the CEO and/or the board. > Boards are struggling with establishing a process to manage reputational risk. > Reputational risk tends to fall through the cracks because it is low frequency and high impact.

> Proactive oversight is key. Boards cannot just react to what management is doing but also look to introduce things that management might be unaware of. > A majority of board members agreed that external perspectives would help the boards to “think about the unthinkable,” but the management of such independent advice is tricky.

BUILDING A REPUTATION

Towards a Risk Management Capability
Our study uncovered an important tension in today’s boardrooms. On the one hand, board members are acutely aware of the importance of safeguarding their company’s reputation. On the other hand, directors are uneasy with the existing structures and processes. This gap suggests that companies have failed to build a sufficient capability to satisfy their corporate boards. Indeed, many companies view reputation as a corporate function, not a core capability. This attitude is based on the following beliefs: Each one of these beliefs is flawed. First, the need > A good reputation naturally follows from 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. to manage a company’s reputation actively is a critical need for any organization. Moreover, the importance likely will increase, not decrease, in the near future. Of course, good business practices are important, even necessary, but they alone are not sufficient for successful reputation management. > Reputation management requires little else but common sense and the willingness to do the right thing.

…good business practices are important, even necessary, but they alone are not sufficient for successful reputation management.

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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. Though such experts can play a valuable role in the reputationmanagement process, they should not own it. Communication plays an important role in any such process, but this procedure needs to be integrated tightly with the business. The approach is similar to the status of Human Resource departments that are much more effective in companies where the CEO owns the people process. HR departments play a crucial role in the day-to-day management of people by enabling, executing and facilitating much of this process, but the business leader still must own the process. The reason for this approach is simple.

(supported by well-designed processes) rather than by adding another corporate layer. An effective reputation management system requires the right strategic mindset, supported by processes, values and culture. Essentially, reputational challenges are 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 earlier, when done in the context of typical business processes driven by cost savings and value creation, now may look highly problematic, even monstrous. Reputational challenges can emerge from any area of day-to-day decision making. But executives tend to make decisions without consideration for the reputational impact. Their key skill 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 their decisions create a record today that will serve as the basis for their story tomorrow. Assessing reputational risk requires anticipating what a reputational crisis will look like and then taking proactive steps to prevent and prepare.

Most reputational challenges arise from a specific business context. Thus, they require management and execution as an integral part of business decisions.
In many cases, the most effective way to manage reputational risk rests with improving the capabilities of business leaders by helping them develop a sixth sense for reputational risks and opportunities

An effective reputation-management system requires the right strategic mindset, supported by processes, values and culture. Essentially, reputational challenges are 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.

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Figure 1 captures the difficulties inherent in reputa-

Most reputational challenges do not happen because of some external event or misfortune. Rather, they arise as the direct consequence of company actions.

tion 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. Therefore, companies must recognize the reputational impact of any business decision before it is made, whether they are related to 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 rang-

Underneath these topics lurks a hard truth: Most reputational challenges do not happen because of some external event or misfortune. Rather, they 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. The following figure illustrates this point.
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FIGURE 1: REPUTATION DYNAMICS

OPTIMAL

TYPICAL

Intensity

Stakes

TIME TO ACT

Control
Time

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ing from HR to Engineering made decisions that triggered 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. An easy way to improve decision-making processes is The Wall Street Journal test, which suggests that decision makers should ask themselves whether they would be proud if the decision were accurately reported on the front page of The Wall Street Journal. This test evocatively captures the idea that a decision may look different once it comes under public scrutiny. Strategic anticipation of reputational risk, however, goes beyond this simple approach by understanding the trade-offs between reputational risk and business opportunity. The concept of reputation dynamics offers the key to integrating reputational stewardship with everyday business decisions. It emphasizes 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 around-the-clock 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.

The concept of reputation dynamics offers the key to integrating reputational stewardship with everyday business decisions. It emphasizes that a company’s environment during a reputational crisis will look very different from its environment in normal times.

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three components: strategy, process, and culture.

The key to successful reputation management rests with all decision makers in the organization viewing themselves as stewards of the company’s reputation.

This approach constitutes the critical switch to a risk-management mindset from a crisis-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 repu-

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 rests with all decision makers in the organization viewing themselves as stewards of the company’s reputation. Proactive reputation management must anticipate the possibility of such developments and incorporate them into decision making. It requires a mindset that reflects awareness that business decisions today create the facts that will serve as the basis for the story tomorrow. To achieve this focus, companies need

tation management is to identify possible risks and mitigate them through current actions to reach an acceptable balance level of risk and control (see Figure 2). Future reputational risk can be managed today only if it is identified and weighed during the decision-making process. Once an issue’s reputational risk has been indentified, the company needs to move to the next step and take appropriate action. The effective mitigation of reputational risk has two critical components: prevention and preparation (Figure 3). Prevention consists of steps to reduce or eliminate

FIGURE 2: REPUTATION DYNAMICS—THE STRATEGY CONNECTION

PRO-ACTIVE DECISION

Intensity

High Risk

Acceptable Risk/Control

Little Control
Time

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FIGURE 3: REPUTATION DYNAMICS—STRATEGIES

ANTICIPATION

Intensity
PREVENTION IDENTIFICATION

PREPARATION

CONTAINMENT

SOLUTION

Risk Management

Crisis Management

Time

a particular risk. In a quality management context, it may result in additional quality controls; in a marketing context, it may demand the elimination of problematic sales practices. In an M&A context, it may require that a company walks away from an acquisition or renegotiates its terms when the target’s questionable business practices come to light during due diligence. In general prevention, strategies aim to reduce the likelihood that an adverse event will occur. Granted, one cannot prevent all risks, which brings preparation strategies into play. Should an adverse event materialize, these strategies attempt to mitigate its impact. For example, with prudent reputational risk management, a company is aware that it may lose control over customer perceptions during a reputational crisis. In an activist-rich environment, outreach and collaboration with moderate advocacy groups may create a credible ally that

proves invaluable during a future confrontation. This works only if outreach occurs before the company is targeted. Once the company becomes the villain, moderate advocates and other credible third parties will not touch it. Therefore, a preparation strategy must involve establishing relationships with trusted third parties in advance, so the company can call upon them in a crisis. Building such relationships takes time, mutual trust, and, most of all, anticipation; by the time a crisis strikes, it is too late. These strategies are not necessarily independent as they can mutually reinforce each other. For example, an insurance company could be concerned about the improper sales practices of its agents, knowing that even if the agents are independent contractors, the company will take the heat if a problem occurs. Policing each and every agent is impossible. But a prevention strategy, such as a strict compliance program, also demonstrates the

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company’s commitment to address the problem. The message is simple: “We have been aware of the problem, and we took the following steps to address it long before it became a media story.” Accompanying the policy with audits, secret shopper programs and similar efforts will enhance the effectiveness of this approach further. This may not solve the issue entirely. But it positions the company as proactive, thoughtful and concerned about its customers, while reinforcing its operational competence by demonstrating that the problem did not catch the company off guard.

To gain the maximum impact from a preparation strategy, companies need to design proactive steps that work within the proper risk segment. If the analysis suggests a high degree of advocacy potential, the policies must be easy to understand and communicate so they can serve as the basis for tomorrow’s story. A situation with low advocacy potential might justify a more technical approach. Similarly, a company will need to invest more in prevention and preparation strategies in situations where an issue is at the core of the business model.

BUILDING A REPUTATION

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 still must be answered about decision rights, reporting, and accountability. Locating reputation management in the organizational structure of a company can be tricky, even for companies that “get it.” Many board members agree that the ultimate accountability for reputation management processes rests with the board, that level of the organization whose job description centers on the long-term viability of the company. For one thing, the board can keep management’s incentives for short-term solutions in check. For another, by setting clear guidelines and emphasizing the need to safeguard reputational equity, the board can help management avoid shortsighted costcutting mistakes. As we have seen within the board, various options exist. Ultimately, the best spot depends on the sources of value and the types of risk. For example, companies with a very active and central stakeholder environment that could spill over into new regulations or legislation might choose to have the policy committee oversee reputation management. For most other companies, the audit committee could be the best spot since that’s where enterprise risk management typically resides. This location enables better integration with other risk dimensions—that is, financial, brand and operational

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risk—and facilitates trade-offs, planning, process evaluation and strategy reviews. Still, the board’s role is to oversee and supervise; it is not to manage the company. So, where should reputation management reside within a company’s decision-making structure? ….It belongs squarely on the agenda of senior management, including the CEO. It is worth pondering the role of the CEO in more detail. After all, many problems and issues demand the CEO’s attention. Does reputation deserve this prominence? To be successful, reputation management must be linked inextricably with a company’s business strategy. And couldn’t that be accomplished at a lower level of management? On the contrary, reputation management belongs on the CEO’s agenda because reputational risk ranks among the main risks facing the company and the company’s reputation ranks among the few sources of sustained competitive advantage. Companies with stellar reputations can charge premiums and are difficult to imitate. Another of a CEO’s main tasks involves integrating reputation management into the company’s operational processes. One approach to this creates 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 the company avoids

creating another corporate officer with little budget and less influence. The danger arises if it creates additional barriers to an integration of reputation management and business strategy and, consequently, hurts rather than helps the process. An instructive analogy features the head of human resources (HR). Some companies isolate the HR process from the rest of the business. Elsewhere, the CEO owns the people process, which, perhaps counter-intuitively, enhances the effectiveness of the head of HR rather than diminishes it. An alternative involves creating a cross-functional reputation decision-making body (RDB). This crossfunctional unit composed of senior executives has actual decision-making authority. Its composition needs to mirror the organizational structure of the company. For example, a matrix organization based on global territory and product line would name representatives from both the major territories and the business lines to its RDB. In addition, the main corporate functions (marketing, finance, supply chain, HR, communication, legal, government relations, and so on) also must be represented since reputational problems almost always are multidimensional. The decision structure must be designed to handle the complexity of such issues. It must be underscored that the RDB must mirror the business’ actual operating structure. One reason why Toyota was slow in responding to the

So, where should reputation management reside within a company’s decision-making structure? ….It belongs squarely on the agenda of senior management, including the CEO.

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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.
2010 sudden-acceleration crisis was its lack of a truly global decision-making structure. While Toyota’s economic fortunes depended heavily on robust U.S. sales, decision-making largely centered in Japan with little input from U.S. managers. Similarly, BP lacked a strong presence in the U.S. regulatory and political environment, even though BP’s U.S. oil and gas assets represented more than one-quarter of the group’s total annual production. Good governance and decision-making structures are necessary to manage reputation effectively. But even they are not sufficient. Here is why: > Reputation consists of the perceptions of customers and other constituencies. > These perceptions in many cases derive from something other than a company’s actual experience deep knowledge of any given issue. Instead, they derive from an ever-changing mixture of opinion and information driven by the media, peer-to-peer websites 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. Companies also may 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 prove ineffective if they lack critical competitive intelligence and analysis and decisions are made in the dark. This is the business case for investing in competitive intelligence and analysis capabilities. Because many ever-changing actors drive reputation, the strategic landscape frequently is diffuse and unclear. And because successful reputational strategies should be designed before a crisis occurs, simply surveying customers, investors or other business partners will not suffice. Once customers or investors start to worry, it is too late—the deck already is stacked against the company. Therefore, in many cases, traditional business research tools such as surveys and focus groups can only measure the damage rather than prevent it in the first place. Proactive reputation management requires strong competitive intelligence and analysis. Governance structure and competitive intelligence and analysis capabilities need to be integrated. We

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FIGURE 4: THE REPUTATION MANAGEMENT SYSTEM
CROSS-FUNCTIONAL REPUTATION DECISION-MAKING BODY

Strategy-Driven

Actionable

Alert

COMPETITIVE INTELLIGENCE AND ANALYSIS SYSTEM

Feedback

EARLY-WARNING SYSTEM

IMPACT ASSESSMENT

call this integration the Reputation Management System. Figure 4 illustrates this integration. The RDB governs the Reputation Management System. The system needs to represent the various business segments and critical corporate functions. Ideally, it should mirror the company’s organizational structure. In some businesses, it makes sense to extend the jurisdiction of the RDB to include regulatory and political developments as well as macroeconomic issues. In that case, it effectively becomes the corporate relations council. The governance structure must be connected closely with the competitive intelligence and analysis function. This means that the RDB provides strategic direction to the competitive intelligence and analysis function and receives actionable competitive intelligence and analysis connected directly to the corporate strategy. The competitive intelligence and analysis function provides the core capabilities of issue identification, evaluation and monitoring. The goals are to function as an early warning system and to assess the impact of

corporate actions through a feedback mechanism. Without a competitive intelligence and analysis function, the RDB will operate in the dark and make decisions based on intuition rather than data. A company’s competitive intelligence and analysis function may range from informal monitoring of various media sources and proactive stakeholder outreach to the creation of a fully developed internal competitive intelligence and analysis capability with its own staff and budget. Competitive intelligence and analysis functions are not just important for management; they’re important to boards, given their critical role as a guardian of the company’s reputation. It is surprising and worrisome that most corporate boards are not supported by a separate competitive intelligence and analysis function. Such a function is ideally provided by a third party, not by company staff. Much of the critical reputational competitive intelligence and analysis is external to the company, and it may lead board members to ask more probing questions of management.

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Some board members maintain that such an approach may be too adversarial and undermine trust with management. A candid, transparent and structured approach can mitigate these interpersonal risks. For example, it is preferable that the competitive intelligence and analysis function provide the board with ongoing competitive intelligence and analysis on a routine basis rather than doing so only when the situation looks more ominous. And, frequently, boards are required to seek independent counsel on legal, regulatory and financial matters. Overall, irritating management a bit seems a small price to pay to avoid acting in ignorance of looming dangers.

In sum, effective processes must support a strategic mindset. First, companies must develop a proper governance structure that should mirror the company’s organizational structure. A cross-functional council is preferable to a separate corporate function unless that function is endowed with sufficient influence and resources. Second, companies need a competitive intelligence and analysis capability. In contrast to other corporate capabilities, a competitive intelligence and analysis system is essential rather than optional. Reputational challenges can emerge from anywhere. The lack of competitive intelligence and analysis capabilities means that the company either acts in the dark or loses its ability to manage such issues proactively.

BUILDING A REPUTATION

People and Mindsets
Business leaders also need to understand that even the most advanced reputation management system is put into effect 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 mindset but values and culture to provide guidance to individuals. We cannot expect each employee of a company to assess the reputational risk of an issue correctly. But we can expect employees to raise a red flag when something does seem awry. It is here where the leadership of the CEO matters most. Acting as corporate steward means more than simply doing right by customers, employees and suppliers. It requires the ability to think strategically. On one hand, this implies viewing reputational decisions not solely as PR issues, but as decisions tightly connected to the company’s strategy, its core competencies and values, and its distinctive position in the marketplace. On the other hand, it requires the ability to view even a familiar business decision from the point of view of people who are not specialists, but still may have strong opinions on an issue. More often than not, these opinions are driven by powerful emotions and passionate views of what is right or wrong behavior. A strategic mindset also requires situational awareness. Essentially, reputation is public. It is driven by

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third parties with their own agenda. Understanding and anticipating the motivations and capabilities of these actors is essential for situational awareness. Assessing the reputational environment is critical whether we need to manage an ongoing issue or we want to assess the reputational risk associated with an important business decision. Yet reputational challenges are not simply the consequence of wrong decisions, accidents or bad luck. Frequently, they are created by activists, interest groups and public actors striving to force changes in business practices through “private politics.” Activists are competitors for the company’s reputation and, as such, must be treated as seriously as competitors in the marketplace. The last component of a strategic mindset involves avoiding the expert trap. Becoming an expert means learning to see the world in a particular way. A doctor learns to identify symptoms and decide on a diagnosis; a poker player learns to identify “tells” of opponents that provide critical information on the strength of their hand; and a music enthusiast can pick a pianist from dozens of recordings of the same piece. Of course, acquiring and using expertise in a coordinated fashion is tremendously valuable because it lies at the root of the efficient organization of business processes. In the context of reputational challenges, however, it can lead us astray.

When a company collapses from an earnings restatement, a trained accountant may focus on the fact that no accounting rules were violated. Everybody else, though, will be affected by images of crying employees leaving their office for the last time. A safety engineer will point to his company’s industry-leading safety standards and may be bewildered when the media focus on one specific victim. A loan officer may view missed mortgage payments as lost revenue, while the borrower may experience them as the fear of losing the family home. The difficulty lies in the public nature of reputational challenges where company actions are evaluated by non-experts through the filter of the media. This requires decision-makers to set aside their expertise and see the situation from the point of view of laypeople in a heightened emotional state. In summary, reputation risk management is not a corporate function, but a capability. It requires the right mindset integrated with the company’s strategy, guided by its culture and values, and supported by carefully designed governance and competitive intelligence and analysis processes. Developing this capability is as demanding and as challenging as developing customer focus or the ability to execute. Today’s companies need to embrace this challenge.

…reputation management is not a corporate function, but a capability. It requires the right mindset integrated with the company’s strategy, guided by its culture and values, and supported by carefully designed governance and intelligence processes.

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BUILDING A REPUTATION

Endnotes
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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 He is the author of the forthcoming book Reputation Rules: Strategies for Building your Company’s Most Valuable Asset (McGraw-Hill, April 2011), which serves as the basis for some of content of this White Paper.

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For details on the Edelman Trust Barometer, see http://www.edelman.com/trust/2011/ (accessed February 25, 2011).

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For details see David P. Baron, “Private Politics,” Journal of Economics & Management Strategy 12, no. 1 (2003): 31–66; and David P. Baron and Daniel Diermeier, “Strategic Activism and Non-market Strategy,” Journal of Economics & Management Strategy 16, no. 3 (2007): 599–634. For an overview see Daniel Diermeier, “Private Politics: A Research Agenda,” Political Economist 14, no. 2 (2007): 1–9.

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Harlan Loeb is Executive Vice President and Director of U.S. Issues, Crisis & Risk Management at Edelman and Professor of Crisis Litigation & the Court of Public Opinion at the School of Law, Northwestern University.
8

This approach has been successfully used in other domains of senior decision-makers, e.g. in the study of members of Congress. Richard F. Fenno, Watching Politicians: Essays on Participant Observation, (University of California, Institute of Governmental Studies Publishing: 1990) and Richard F. Fenno, Home Style: House Members in their Districts, (White Plains, NY: 1978).

3

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 February 24, 2011); “Risk Reputation Report,” The Economist (Economist Intelligence Unit, December 2005); Matteo Tonnelo, “Reputation Risk: A Corporate Governance Perspective,” The Conference Board Research Report No. R-1412-07-WG, December 2007; and Deloitte, “Risk Intelligent Governance: A Practical Guide for Boards,” Risk Intelligence Series Issue No. 16, http://www.deloitte.com/assets/DcomGlobal/Local%20Assets/Documents/dtt_riskintelligentgovernance.pdf (accessed February 24, 2011).
9

All figures are taken from Diermeier, Daniel. 2011. Reputation Rules: Strategies for Building Your Company’s Most Valuable Asset. McGraw-Hill. Used with permission.

4

“Brand Rehab,” The Economist, April 8, 2010, page 70. All informed publics met the following criteria: collegeeducated; household income in the top quartile for their age in their country; read or watch business/news media at least several times a week; follow public policy issues in the news at least several times a week.

5

Contact Us
HARLAN LOEB harlan.loeb@edelman.com DANIEL DIERMEIER d-diermeier@kellogg.northwestern.edu

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