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Home > Business Strategy Best Practice > Understanding Reputation Risk and Its Importance

Business Strategy Best Practice

Understanding Reputation Risk and Its Importance

by Jenny Rayner

Executive Summary

  • Reputation is a critical intangible asset; it is an indicator of past performance and future prospects.

  • Reputation is based on stakeholders’ perception of whether their experience of a business matches their expectations.

  • Knowing your major stakeholders, how they perceive you, and what they expect of you is vital in managing reputation risk.

  • Everyone working for an organization bears some responsibility for upholding its reputation.

  • Reputation risk is anything that could impact reputation—either negatively (threats) or positively (opportunities).

  • Risks to reputation should be integrated into the business’s enterprise risk management (ERM) framework so that they receive attention at the right level and appropriate actions are taken to manage them.

Introduction

Reputation is the single most valuable asset of most businesses today—albeit an intangible one. A 2007 global survey1 rated damage to reputation as the top risk, although half the respondents admitted that they were not prepared for it. Hard-earned reputations can be surprisingly fragile in the globalized, technologically interconnected 21st century. The trust and confidence that underpin them can be irrevocably damaged by a momentary lapse of judgment or an inadvertent remark.

That is why understanding reputation risk has become a key focus for businesses in all sectors. It is now recognized that reputation risks need to be managed as actively and rigorously as other more quantifiable and tangible risks.

Reputation and Its Value

Reputation is an accumulation of perceptions and opinions about an organization that reside in the consciousness of its stakeholders.

An organization will enjoy a good reputation when its behavior and performance consistently meet or exceed the expectations of its stakeholders. Reputation will diminish if an organization’s words and deeds are perceived as failing to meet stakeholder expectations, as illustrated by the reputation equation below.2

Reputation − Experience = Expectations

Reputation has intrinsic current value as an intangible asset. Although reputation will not appear as a discrete balance sheet item, it represents a significant proportion of the difference between a business’s market and book values (less any quantifiable intangibles such as licenses and trademarks). Since intangibles usually represent over 70% of market value, reputation is often a business’s single greatest asset.

Reputation also plays a pivotal role in a business’s future value by influencing stakeholder behavior and, hence, future earnings potential and prospects. A good or bad reputation can affect stakeholder decisions to maintain or relinquish their stake—be they investors, customers, suppliers, or employees. The “corporate halo” effect of a reputable business can help to differentiate products in a highly competitive sector, may allow premium pricing, and can be the ultimate deciding factor for a prospective purchaser of services. A strong reputation can help to attract and retain high-quality employees and can deter new competitors by acting as a barrier to market entry. Reputation can also shape the attitude of regulators, pressure groups, and the media towards a business and can affect its cost of capital.

Perhaps the greatest benefit of a good reputation is the buffer of goodwill it provides, which can enable a business to withstand future shocks. This “reputational capital,” or “reputation equity,” underpins stakeholder trust and confidence and can persuade stakeholders to give a business the benefit of the doubt and a second chance when the inevitable unforeseen crisis strikes.

Defining Reputation Risk

Reputation risk should be regarded as a generic term embracing the risks, from any source, that can impact reputation, and not as a category of risk in its own right. Regulatory noncompliance, loss of customer data, unethical employee behavior, or an unexpected profit warning can all damage reputation and stakeholder confidence.

Reputation risk is not only about downside threats, but also about upside opportunities. Climate change, for example, is a potential business threat, but many firms have spotted and exploited the flip-side opportunity for competitive advantage by developing green technologies and promoting themselves as environmentally friendly, thereby enhancing their reputation.

Reputation risk can therefore be defined as:

“Any action, event or situation that could adversely or beneficially impact an organization’s reputation.”

Identifying Reputation Risks

The most crucial stage of the reputation risk management process is identifying the factors that could impact reputation. Risks have to be recognized and understood before they can be managed. Considering the seven drivers of reputation is a useful starting point, as these are also fertile sources of threats and opportunity to reputation (see figure above.3)

Businesses should consider not only the risks under their direct control, but also risks in the “extended enterprise” relating to suppliers, subcontractors, business partners, advisers, and other stakeholders. Could the values, business practices, or activities of its partners expose the business to reputation risk by association?

One way of approaching this is to consider the expectations of each major stakeholder group against the drivers of business reputation to develop a “heat map” of potential trouble spots and zones of opportunity. Major mismatches between expectations and experience can be analyzed to highlight areas where action is needed to bridge the gaps.

Asking the following questions may also help to uncover reputation risks:

  • What newspaper headline about your business would you least (or most) like to see? What could trigger this?

  • What could threaten your core business values or your license to operate? Such risks can seriously damage reputation and lead to an irreversible loss of stakeholder confidence.

  • Could there be collateral risk arising from the activities of another player in your sector? If so, the reputation of your own business may be vulnerable and come under intense stakeholder scrutiny.

  • Could reputation risk exposure arise from an acquisition, merger, or other portfolio change? A mismatch of values, ethos, culture, and standards resulting in inappropriate behavior could seriously damage reputation. Conversely, if the acquisition target enjoys a superior reputation, it could provide a competitive edge.

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Further reading

Books:

  • Atkins, Derek, Ian Bates, and Lyn Drennan. Reputational Risk: Responsibility Without Control? A Question of Trust. London: Financial World Publishing, 2006.
  • Fombrun, Charles J., and Cees B. M. van Riel. Fame and Fortune: How Successful Companies Build Winning Reputations. Upper Saddle River, NJ: FT Prentice Hall, 2003.
  • Larkin, Judy. Strategic Reputation Risk Management. Basingstoke, UK: Palgrave MacMillan, 2003.
  • Rayner, Jenny. Managing Reputational Risk: Curbing Threats, Leveraging Opportunities. Chichester, UK: Wiley, 2003.

Article:

  • See articles in The Geneva Papers on Risk and Insurance Issues and Practice 31:3 (July 2006). Find issue in “Archive” at: www.palgrave-journals.com/gpp

Reports:

  • Coutts and Company. “Face value: Your reputation as a business asset.” London: Coutts and Company, 2008.
  • Economist Intelligence Unit. “Reputation: Risk of risks.” White paper, 2005.
  • Resnick, Jeffrey T. “Reputational risk management: A framework for safeguarding your organization’s primary intangible asset.” Opinion Research Corporation, 2006. Online at: www.carma.com/Reputational_Risk_White_Paper.pdf

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