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Archive for March, 2012

Last Thursday, Apple and its main manufacturing contractor, Foxconn, agreed to significantly improve labor conditions at Chinese factories. This decision followed months of controversy over allegedly illegal overtime, inadequate safety conditions and poor workers’ housing, as well as a string of reported suicides. The controversy was further fueled by a performance of actor and author Mike Daisey that was broadcast on National Public Radio but later turned out to be partially fabricated. Foxconn’s decision to make improvements followed an investigation by the Fair Labor Association (FLA) which found multiple violations of labor law, including extreme hours and unpaid overtime. For more details see this Reuters article on the subject.

Much of the existing media coverage on the story has focused on the crisis management aspect of the story. My own views can be found here and here. I had argued that Apple will have to take a leadership position on this issue due to their brand exposure and global impact, a position similar to Walmart’s embrace of sustainable supply chains a few years ago.

But this case illustrates a broader, more important phenomenon: the rise of private regulation of global commerce. Everywhere in the world, business activity is both enabled and constrained by formal and informal norms and regulations that structure market competition. These “rules of the game” vary significantly across countries and are subject to change, but significantly impact competitive positioning as well as firm and industry profitability.

Public institutions such as legislatures, agencies, and courts have traditionally been viewed as the dominant creator and enforcer of such structures, but increasingly companies and observers realize that new organization forms (NGOs and advocacy groups, non-profits, public-private partnerships etc.) have started to play an important role. Examples include global health, sustainability, human rights, labor conditions, fair trade and supply chain safety. The outrage over the labor conditions at Apple supplier Foxconn is simply the most recent example of this trend.

Not that this regulatory activity is entirely driven by private entities, but public entities play little to no role. Even though Foxxconn’s compliance to new standards is not mandated by a new law but rather by its main customer’s desire to contain reputational damage, the practical effect is the same as if a new law had been passed.

As I have argued in other writings, (Strategic Activism and NonMarket Strategy, Private Politics- A Research Agenda, Private Politics: Public Activism as an Alternative Regulatory Mechanism?, and Chapter 3 in Reputation Rules) the rise of private regulation is due to three mutually reinforcing factors:

  1. The dramatic rise in media coverage (both traditional and social).
    Companies now live in an ever-faster-moving news cycle, driven by intense competition between 24-hour news channels, wire services, and online news providers. Concerns over business practices in distant areas of the world are spread in minutes.
  2. The globalization of value and supply chains has limited the regulatory reach of individual companies.
    Yet, the globalization of business has been matched by the globalization of activists that look at companies as the main engine of social and political change.
  3. A change in values and expectations.
    Customers and the public (especially the younger segments) expect more and more from companies. Complying with local law and maximizing shareholder value is not enough. Companies are now expected to have a positive social impact from animal welfare to sustainable business practices.

These trends suggest that the factors that led to the Apple-Foxconn story will grow in importance. They also raise normative questions of legitimacy and social impact. Stay tuned…

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I recently spoke with The Wall Street Journal Japan’s Misako Hida about the future of Japan’s Tokyo Electric Power Company (TEPCO), which was previously at the center of Japan’s nuclear crisis during last year’s earthquake and tsunami. Marking the first anniversary of the Fukushima nuclear plant disaster, we discussed what went wrong with TEPCO’s crisis management strategies, and if the company could possibly recover from such severe damage to its corporate reputation. We also discussed other recent events in Japan such as the Toyota sudden acceleration crisis and the scandal at Olympus. The interview coincided with the Japanese edition of my book, “Reputation Rules: Strategies for Building Your Company’s Most Valuable Asset.”

The original interview (published in Japanese) has been condensed, edited and translated from its original Japanese form by Trevor Devlin.

“It has been more than one year since the Great East Japan earthquake and disaster. With recovery demand just gathering momentum, we have seen considerable fallout from the efforts by TEPCO to impose increases in electricity charges for major contracts as well as households, sharp division of opinion on whether there should be ‘de facto nationalization’ of the company, plans for a major shakeup in management, and a host of other pressing problems surrounding the company. TEPCO’s manner of responding to the nuclear power plant crisis, lack of crisis management consciousness and other issues elicited an avalanche of criticism from foreign media, and now it is also being bluntly criticized by Japan’s domestic media and political and business circles.

If we look back at TEPCO’s track record over the past year, what was its biggest problem? Can it possibly restore the reputation and trust it previously enjoyed in Japanese society as a top-notch infrastructure enterprise? We posed those questions to Daniel Diermeier, author of “Reputation Rules: Strategies for Building Your Company’s Most Valuable Asset” and professor at the Kellogg School of Management at Northwestern University, who is an expert on crisis management, corporate social responsibility and reputation management.

Misako Hida: What critical error has TEPCO made over the past year in response to the nuclear power station crisis?

Professor Diermeier:  It would probably be its failure at reputation management. Crisis management concerning things like natural disasters involves all kinds of issues, including operational problems, safety and financial issues. And although there is a tendency to give it short shrift, there is a need for enterprise reputation management. If a crisis occurs, public attention is going to be focused on that company. Since a merciless spotlight will shine on the firm, recollections of whether or not it got a good handle on the situation may well remain among the public decades later. In other words, competency in reputation management is a vital factor in the creation of a company’s long-term image. For that reason, such things as the Exxon-Valdez oil spill accident involving the international oil major Exxon-Mobil remain in the collective public memory more than 20 years later.

That being so, companies simply have to grapple with these difficult questions related to the management of operational crises and reputation crises. Reputation crisis management involves striving for the capability to keep the “trust” of the public, customers and regulating authorities.

Misako Hida: What is required to maintain or increase trust?

Professor Diermeier:  There are four critical elements involved, and all are interrelated. First, there is transparency. Here the question is whether a company can make the public and other concerned parties feel that it is not hiding anything. Second, it has to back things up with adequate “expertise.”  Third, leadership should be evidenced in a decisive ‘commitment’ (proactive involvement). Finally, there is ‘empathy.’ In other words, the company should show concern for and attentiveness to the needs of the victims.

In the case of TEPCO, all of these elements were lacking. First, there were grave concerns regarding its transparency, sharing of information and clarity. Because of the hospitalization of TEPCO’s president, Masataka Shimizu, there was an impression that the company’s management lacked leadership. There is no denying that top management left the impression that they had passed the ball to subordinates as far as empathizing and providing heartfelt consolation or relief to the victims and others affected by the disaster is concerned. All I can say is that it was shocking that they failed in every single respect. On top of the damage to the environment, this is the reason why TEPCO is under such strong criticism now.

As another example, roughly two years ago there was the case of the massive recall by Toyota Motor in which things unexpectedly snowballed. Here I don’t believe it was a case of a lack of expertise. The company had a clear understanding of the point at issue in the dispute, and carried out a very careful assessment of the situation. Later a report conducted jointly by the National Highway Traffic Safety Administration (NHTSA) of the U.S. Department of Transportation (in February 2011) and NASA showed that Toyota’s position had been correct and that the acceleration problem was not due to a failure of its electronic steering system but rather entrapment of the gas pedal by the floor mat. In the case of Toyota, the only real problem was that it excessively focused on the expert knowledge and forgot about transparency, commitment and empathy with its customers.

Misako Hida: In the case of TEPCO, which of these four qualities was most lacking?

Professor Diermeier: It was transparency. They did not provide the necessary information in timely fashion. When a natural disaster hits, people want to know the “truth.”  If the nation’s people are aware that there are things that are unknown (even to the company or the government), they will accept that fact. Clearly telling the public what is known and what is not known enhance transparency.

Furthermore, and this is also commonly true for other companies, TEPCO excessively used difficult technical language. The public is basically looking for simple, clear explanations. So if too much difficult-to-comprehend technical language is used, they suspect that something is being hidden, or that there is an attempt to dodge the issues.

When directly faced with an actual natural disaster, establishing transparency requires courage by leaders. In the case of TEPCO, the executives may have panicked, and were consumed with anxieties, worried about the long-term effects (of the nuclear accident crisis) on the company and their own careers, and they therefore tried with all their might to create a feeling that they were in control.

Misako Hida: Are such crisis management responses a product of Japan’s business culture?

Professor Diermeier: Not in all cases, but some other companies have the same kinds of issues. In a broader political or organizational sense, traditionally as far as violations related to issues of regulation and safety are concerned, as compared to Great Britain or the United States, ties between regulatory authorities and companies in Japan have been too close, and the former do not maintain sufficient independence. For that reason, when a crisis arises, the government also rushes to defend itself, and politicians are preoccupied with their own survival, so they do things like press for harsh responses towards the companies involved, which also embroils the regulatory authorities in the crisis.

Moreover, because of the desire for perfection found in Japanese society, you have a situation in which it is difficult to get companies to own up to mistakes.

Misako Hida: Can TEPCO regain trust?

Professor Diermeier: That would amount to open-heart surgery for the company, in other words it is comparable to a substantial transformation. They would have to reconsider all kinds of different aspects of their governing mechanisms and processes, as well as their corporate culture, to ferret out whether they are any deficiencies and which areas need to be improved.  There has to be top-to-bottom reconsideration of what needs to be improved. However, under the present management that would be nearly impossible. At the same time as undertaking wholesale revamping of their governing mechanisms, they also need to change their relationship with the authorities.

Misako Hida: Can other companies learn anything from TEPCO’s failures?

Professor Diermeier: Well, first of all, we are now in the age of global media, so the most important lesson to be learned from the example of TEPCO is the recognition that as soon as some incident takes place, the world’s media will come running en masse to report on it.

The next thing that can be learned is that as things now stand it is not enough for companies to be superior from the standpoint of operations and business. They also have to fulfill various other requirements related to things like labor standards and environmental standards. People have come to expect a lot more from corporations than in the past. Companies operating on a global scale are expected to be ‘good citizens.’

For that reason in particular, reputation is very important. If establishing itself as a global brand is an important consideration for a company, along with management competency concerning things like product quality and safety, it needs to establish management competency concerning reputation. Just as with product management and safety management, success demands the strategic mindset, processes and corporate culture essential for a proper reputation.”


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