Reputational risk: badge of dishonour

“It takes 20 years to build a reputation and five minutes to ruin it,” runs the famous quote by Warren Buffett.

But maintaining brand reputation by ensuring the highest standards possible across operations has become increasingly complex and challenging. While more aspects of many multinational supply chains have been outsourced to third and even fourth-party companies around the world, it is still the brand that picks up the tab when things go wrong.

“You can’t outsource reputational risk,” says reputation risk consultancy Reputability’s chairman Anthony Fitzsimmons. “BP is a classic example of this. They subcontracted out aspects of their operations, but when things went wrong [in the Gulf] outsiders still saw them as responsible.

“The point is that it was BP that was perceived to be responsible, regardless of whether some subcontractor might eventually be found to be technically to blame.

“People are not interested in who in the supply chain messed up. They are likely to regard ‘the brand’ as being responsible.”

Customers today expect firms across the spectrum to be careful that high ethical standards are observed throughout their businesses - a trend that has only increased in recent years - and will frequently deliver a harsh verdict on those who fail to live up to expectations.

“Even where allegations of complicity do not result in legal action, companies still face a range of non-legal risks if perceived to be complicit,” says Maplecroft principal human rights analyst Chris Kip.

Risking consumer wrath

Falling down on ethics can be disastrous, and extremely expensive to rectify. Because of increased media coverage and better access to information, there is now a far higher awareness of companies’ wrongdoings, while social media and other technology have helped consumers unite with pressure groups to take action against companies seen to be doing the wrong thing, with boycotts and other campaigns rapidly spreading between markets around the world.

And a collapse in sales and a falling share price are not the only consequences. Public exposure to criticism and the resulting brand damage can also mean that companies found to be benefiting from bad practice face reduced access to financial capital - or even a shareholder revolt. All of which is expensive to mitigate.

“Companies whose reputation has been tarnished because of association with dubious labour practices in the supply chain will find that they need to spend more - both in terms of finances and time of its employees - for advertising and other CSR [corporate social responsibility] initiatives to reassure investors and consumers that it is acting responsibly,” Kip says.

In the worst cases only the strong can survive. “Asset-rich businesses are more capable of riding out a big crisis than those based on debt,” Fitzsimmons says. “For example, [after the Gulf blow out] BP lost over 50% of its share value - a huge hit - but it was able to keep going because it was a financially strong business. Had it been financed mainly by debt, it could easily have collapsed or been taken over.”

There is no one-size-fits-all solution for all risks that companies could face in their operations’

Maplecroft principal human rights analyst Chris Kip

But it’s also worth remembering that complex supply chains don’t only pose an ethical risk - for example where there could be complicity in environmental damage or human rights abuses -complexity itself can cause problems for
business reputations.

“A classic example is the Airbus A380,” says Fitzsimmons. “This was manufactured by using factories in different European countries to produce different components, with the whole thing being assembled in Toulouse. When the fuselage segments were brought together to be joined up, the wiring wouldn’t mate. The whole thing had to be re-wired.

“That didn’t just cost Airbus about €3bn. It also damaged their reputation and caused a €5.5bn drop in their share price. Another example is the financial system in general. It’s so complex that no one knows what is really going on, let alone what will happen next week.”

In more challenging economic times, increasing competition can increase exposure to risk.

“You have to be very thoughtful when driving down costs,” says Fitzsimmons. “If you aren’t very careful, you will create new risks in the process of saving money. These risks can come back and bite you painfully hard.”

Because of this, prevention is far better than cure. But strategy must be tailored to an individual business. “There is no one-size-fits-all solution for all risks that companies could face in their operations,” Kip says. “There are steps businesses can all take, such as engaging in human rights due diligence to get a clear understanding of the human rights situation in countries where they are sourcing.

“Other measures could include the monitoring and auditing of suppliers to identify potential areas of risk - as well as evaluating the human rights impacts of their own operations.”

At its heart, Fitzsimmons says, maintaining reputation is a management problem. “The really difficult issues have to do with the soft issues such as culture, leadership, communication and incentives,” he says.

“The press often accuse business schools of being good at teaching hard skills, like finance and strategy, which are broadly conceptual or quantifiable, but poor at teaching the soft skills that are harder to quantify. Yet deficiencies in those areas leave ‘soft’ risks - and these can bring an organisation to its knees.”