April 19, 2021
How reputational risk is a strategic risk
by David Mayer
Why aren’t more companies proactively managing their reputational risk?
Gerald Ratner once joked that his jewellery products were, ‘cheaper than an M&S sandwich but probably wouldn’t last as long’. His comments led to a loss in value for his business of £500m, new leadership and a rebranding. Yet when Apple released the iPhone 4 with its antenna design flaw and then compounded the error with initially misleading explanations, customers and the markets didn’t care. Both Chipotle and Chick-Fil-A have suffered reputational challenges but only one has seen that materially impact business results. Why does one company weather the storm while another faces its full fury? It matters now, more than ever, because companies are expected to take positions on polarizing social issues, for example Georgia’s voting rights, their reputations need to be sufficiently strong to navigate turbulent topics. Lippincott’s definition of a ‘Go-to’ brand and its measurement through Brand Aperture™ provides the insight to manage reputational risk.
If reputation can matter for a company’s very survival, why isn’t there more focus to measure, manage and mitigate the very real downside? We believe that the answer is two-fold. Today, Marketing ‘owns’ reputation and it’s most commonly treated as a reactive matter to be addressed by PR after a previously unknowable event occurs. This ownership combined with a perception that reputation can’t be robustly linked to future outcomes often means that it’s not considered by enterprise risk management. Yet reputational risk can be anticipated, quantified and mitigated. Risk and Marketing would benefit from working together to measure the major dimensions of risk and then apply their respective disciplines to address identified weaknesses.
The four metrics of reputational risk
Two dimensions, the degrees of goodwill and substitution provide an assessment of a company’s current state and therefore the vulnerability to reputational risk when issues arise.
Degree of goodwill
Every company will make mistakes, from a faulty product to major societal failings. How customers and communities interpret and act on those mistakes depends highly on the motives they attribute behind those mistakes. Southwest Airlines has as many cancellations and lost bags as other major airlines but has 6x fewer customer complaints. That’s because passengers believe that Southwest has their best interests at heart and are much readier to forgive. In our own research Southwest ranks 13th on this measure while other airlines languish as low as 135th. It’s not just customers that matter. General market reputation influences how strongly politicians, regulators and the judicial system responds. If the general public perceive bad intent, there is pressure to curb a business. If that business is seen as a good actor, then the pressure works in the opposite direction. T-Mobile was able to acquire Sprint despite this concentrating the market from four to three competitors in part because it has been seen as a force for good in that industry, particularly in lowering prices while also leading the 5G rollout.
We consider goodwill to be like a battery. Companies build goodwill by delivering great service and being considered a force for good in society. That goodwill can then be paid off against mistakes that happen. The larger the stored goodwill, the greater the resilience to problems that emerge. Goodwill is also finite, exhaust it and the protection evaporates. BP was able weather both the Alaskan pipeline spill and the Texan oil refinery explosion in part because John Browne had made meaningful efforts to recognize and begin addressing climate change when in 2001 the corporate strategy was to move ‘Beyond Petroleum’. A combination of the two events plus Tony Haywards abandonment of alternative energy exhausted any goodwill remaining meaning that in 2010 when the Deepwater Horizon oil spill occurred there was little to shelter BP from condemnation and punishment, resulting in costs totalling $65bn.
Degree of substitution
If a company provides us a product or service that we can’t get anywhere else, then we don’t necessarily have to like them to use them. Uber, with Travis Kalanick as CEO, was well known for its sharp elbows. However, the service was transformational, disrupting a market that had been stifled by regulation and that wasn’t serving customers’ interests. Without an easy alternative, people were willing to keep using Uber often despite feeling guilty about it. However, once credible alternatives emerge, in this case Lyft, the protection from reputational risk can deteriorate rapidly. In 2017, Uber lost 11% pts of market share in the US as #DeleteUber trended and there were credible alternatives in the market for people to switch to. It was no coincidence that this was also the year that CEO Dara Khosrowshahi was hired who initiated a charm offensive, recognizing the need to build goodwill.
It’s not just unique features that are important, it’s also the personal investment involved and ease of portability to move somewhere else. While it can be relatively simple to copy functionality, if I’ve spent hours personalizing a service to my own needs or there is a network effect with those around me then it may be just too much hassle to be worth moving. Banking and social networking are both categories that benefit from substitution being hard.
Two further dimensions indicate rising or falling vulnerability to reputational risk. While not a direct measure of risk, they provide early warning or reassurance for how current actions will influence future perceptions.
Degree of momentum
An explicit measure of whether people feel that a company’s best days are ahead or not. Heavily influenced through marketing but anchored in the credibility of delivering on communicated promises. Momentum is an indicator for the direction of travel of a company’s vulnerability to reputational risk, the composite of goodwill and substitution.
Degree of affordability
Affordability is a measure of value for money. It is not the absolute value that matters, naturally luxury goods are less affordable, it is the direction of travel. If affordability drops over time, people may begin to feel that their goodwill is being taken advantage of, that they or a vulnerable population are being gouged. It’s tough to build or sustain goodwill with that perception. If affordability drops relative to competition, this is a warning that a company’s services may become easier to substitute.
How to measure reputational risk
We can’t directly quantify the dollar value of reputation risk due to the many extrinsic variables that would influence a particular event. However, we can measure the amplitude of that risk through three straightforward metrics and use benchmarks to estimate the value at risk from different categories of event. These have been derived from a larger evaluation of brand performance called Brand Aperture™ which now has over 40,000 consumer responses across 500 brands. It is from this that we have derived our reputational risk scores.
Customer Reputational Risk (CRR) = Average among customers of ((1-Degree of Goodwill) + Degree of Substitution)
CRR measures the risk that customers will abandon a brand given a particular event. Let’s demonstrate how this works taking two examples from the quick service restaurant (QSR) industry.
Both Chick-Fil-A and Chipotle have suffered reputation damage in the recent past. For Chick-Fil-A this derived from the founders’ belief in the ‘biblical definition of the family unit’ and that implication for LGBTQ rights. There followed petitions and boycotts. For Chipotle, the challenge came from an outbreak of E. Coli in Washington and Oregon.
Why is it that Chick-Fil-A weathered the storm while Chipotle’s CEO called their event the most challenging quarter in the company’s history? Part of the answer lies in the difference in their Customer Reputational Risk (CRR) scores. Within the US the CRR scores span from a low of 31 to a high of 84, on a scale of 0-100 with a higher score indicating a higher reputational risk.
Median US CRR = 60
Chick-Fil-A CRR = 53 (-7 vs median indicating lower reputational risk)
Chipotle CRR = 68 (+8 vs median indicating higher reputational risk)
Chipotle has a +15% pts higher reputational risk than Chick-Fil-A. Within their CRR scores both brands are considered easily substitutable, after all there are plenty of alternative meal solutions. The difference between the two is primarily one of goodwill. Chick-Fil-A is the most loved QSR brand in the category and that loyalty helped retain customers while the company navigated the bad publicity. The impact can be seen in their respective sales growth with Chick-Fil-A gaining almost $2bn more incremental sales than Chipotle from the time of their respective challenges.
Market Reputational Risk (MRR) = Average among all aware of ((1-Degree of Goodwill) + Degree of Substitution)
MRR measures the risk that regulators, legislators or the judiciary may act more harshly to the interests of a company because of a lack of General Public positive sentiment. In essence, MRR measures a company’s risk to its permission to operate.
Let’s compare the MRR between Apple and Facebook, both of whom are navigating political turbulence around privacy and competition. Within the US, the MRR scores span from a low of 38 to a high or 90, on a scale of 0-100 with a higher score indicating a higher reputational risk.
Median US MRR = 74
Apple MRR = 48 (-26 vs median indicating a lower reputational risk)
Facebook MRR = 81 (+7 vs median indicating a higher reputational risk)
Facebook, with a higher MRR, faces more headwinds in its permission to operate. It is not surprising then that in 2020 Facebook spent $19.7m lobbying in D.C. while Apple spent a relatively restrained $6.7m. In fact, Facebook spent more than any other technology company. However, it is also worth noting that Facebook isn’t that far above the median so although the risk is elevated there are others, mainly financial service providers, at even greater risk.
Future Reputational Risk (FRR) = Average among customers of (Degree of Momentum + Degree of Affordability)
FRR provides an early warning of problems ahead as it is measures two leading indicators of reputation. We choose to only measure this among customers because this group is most engaged with what the company is doing, with their word of mouth being a key driver of future market sentiment.
The retail market is undergoing transformative change with new entrants such as Aldi plus the shift online challenging incumbent business models. Within the US, the FRR scores span from a low of -3.7 to a high of 2.1 about a median of 0, with a higher score indicating the likelihood of future reputational risk.
Median US FRR = 0
Aldi FRR = -2.4 (A negative sore suggests lower future reputational risk)
Rite Aid FRR = +1.3 (A positive score suggests higher future reputational risk)
Aldi is currently America’s fastest growing Grocer. It’s ability to undercut Walmart, win awards for the quality of its products and the convenience of a small format are a winning combination with the US shopper. In contrast, Rite Aid is a business in transition. With stagnant growth and a new leadership team in place, the necessary changes that are being made are yet to be felt by consumers either on the value or momentum dimensions. This is unsurprising as the rebranding and new store format introduced in 2020 are yet to scale across the estate. It does reinforce for management and shareholders the imperative of the transformation underway.
The three scores taken together provide a rapid diagnostic for the current and future levels of reputational risk. The natural next question to ask is how an organization can use this insight to actively manage that risk proactively as a complement to the continued importance of reactive crisis management.
The playbook for enabling reputational risk to influence business decisions
This doesn’t need to be a complex exercise, the metrics are straightforward to collect while the velocity of change is typically slow, requiring only periodic assessment. The most substantial barrier is creating the initial governance model between marketing and risk.
Collect the data
There are only four questions to collect that evaluate both current and future states. It’s important however to measure companies across a breadth of industries to appropriately calibrate your standing. This data typically only needs to be gathered annually unless a crisis is occurring when more frequent polling can be helpful.
In most cases these questions can be added to existing brand measurement undertaken by marketing. Just be sure that sampling is representative of the overall market, not just the current customer mix.
Turn data into insight
While it is straightforward to create a dashboard for the metrics, more thought is required for the complementary roles that Risk and Marketing should play to act on that insight. The questions to ask are:
- Do my CRR, MRR & FRR scores indicate an existing or emerging risk to my reputation?
- What will it take to address that risk?
- Do those actions deliver a return on the investment?
The company CRR and MRR scores relative to overall market and industry medians indicate the degree of risk. FRR provides an indication of trajectory. The role of the Risk group is to assess the magnitude of the risk. This can involve looking at past events and quantifying the volatility of outcomes. As longitudinal reputational risk data is collected, the relationship between scores and outcome becomes quantifiable within the specific market context of the organization.
Where a risk is identified, the role of the Marketing group is to provide creative solutions for addressing that risk. In many cases these actions will be aligned with business as usual but as with any business there is always a competition for allocating resources. This is where the risk team can work with marketing to consider the full system economics of making the investments to mitigate future downside as well as deliver more direct returns.
Our own analysis has also shown that companies with a lower than median CRR have revenue growth at 5x that of those with an above median CRR and during Jan-May of 2020 also saw only ½ the decline in shareholder value relative to their industry indexes. Not only does managing reputational risk protect against the downside, it’s also a strong predictor of overall business performance.
Govern the response
In most cases, there is little collaboration between the Enterprise risk function and Marketing. The reputational risk dashboard provides the rationale for a joint periodic review of the data and alignment on the actions to address any concerns/opportunities raised. Risk brings credibility that the risk is real, Marketing brings the thought leadership for how any risks can be addressed. All leadership worries about the unknown, unknowns. With this governance in place, we make visible one of those intimidating intangibles. At last we provide CEOs with important insight into an area of risk that they hadn’t previously been aware and more importantly a mechanism to resolve that risk.
Actively managing reputational risk
Reputational risk provides a material, and in some cases an existential, risk to a company’s future. Yet, for many it continues to be treated as a disaster recovery exercise. While the functions of Risk and Marketing play very different roles within an organization, spanning the divide between the two will be mutually advantageous to each, the company overall and its other stakeholders. Just as other enterprise risks are actively managed, it’s time that the same is true for reputation.
Brand Aperture™ is the new standard for measuring brand performance. Learn more about our intuitive suite of tools here.
 From Brand Aperture™ a brand performance system developed by Lippincott