Bonus Feature: Brief Updates on the Top Ten Reputational Crises of 2011

Some of the entries in last year’s top ten list would have made this year’s list as well. Here is how they fared during the last 12 months.

News Corp. (2011: #1)

The News Corp. phone hacking scandal continued unabated. Former tabloid editors Rebekah Brooks and Andy Coulson were accused by British prosecutors of conspiring to pay public officials in exchange for information. Later in the year, the final report of the Leveson Inquiry criticized News Corp. as follows: “Most responsible corporate entities would be appalled that employees were or could be involved in the commission of crime in order to further their business. Not so at the News of the World.” The report also proposed a new arbitration scheme conducted by a new regulator. In December, News Corp. chair and CEO Rupert Murdoch announced a proposed split of the company into a publishing and a bigger media company. The publishing company will retain the name News Corporation and will consist of newspapers, including The Wall Street Journal, The New York Post, and Harper Collins. Mr. Murdoch will serve as chairman. The bigger company will be called Fox Group and will include Fox Broadcasting, 20th Century Fox and cable channels like Fox News and FX. It will be led by Chase Carey, currently News Corporation’s president and chief operating officer.

TEPCO and the Japanese Government (2011: #2)

A series of reports by the Japanese government as well as independent panels harshly criticized Tokyo Electric Power Co. (TEPCO), the operator of the Fukushima nuclear power plant, as well as Japanese regulators for insufficient preparedness and inadequate crisis response measures. Both TEPCO and the Japanese government were also criticized for lack of transparency and timely release of information. Anti-nuclear power sentiment in Japan has grown strongly over the last year. Only two of the country’s reactors are online and Japan’s new nuclear regulatory body is in the process of issuing new regulations. That said, the recent parliamentary elections awarded the traditionally pro-nuclear LDP a majority of seats. How this will affect Japan’s new regulatory landscape and its nuclear policy remains to be seen.

Penn State (2011: #3)

Another horrific year for Penn State. Jerry Sandusky was found guilty on 45 of 48 counts of sexual abuse and sentenced to 30-60 years in prison. The scandal had far-reaching outcomes for the university. The July 2012 report of an independent investigation led by former FBI director Louis Freeh stated that former Penn State University President Graham Spanier and legendary Penn State football coach, the late Joe Paterno, along with Athletic Director Timothy Curley and school vice president Gary Schultz, had known about allegations of child abuse on Sandusky’s part as early as 1998, and were complicit in failing to disclose them.  In doing so, Freeh stated that the most senior leaders at Penn State showed a “total disregard for the safety and welfare of Sandusky’s child victims” for 14 years and “empowered” Jerry Sandusky to continue his abuse.

Following the report, the NCAA imposed sweeping penalties on Penn State — among the most severe ever imposed on an NCAA member school — including a fine of $60 million, a four-year postseason ban, scholarship reductions and vacating of all victories from 1998–2011. In doing so, NCAA President Mark Emmert stated that the sanctions were levied “not to be just punitive, but to make sure the university establishes an athletic culture and daily mindset in which football will never again be placed ahead of education, nurturing and protecting young people.” The Big Ten Conference subsequently imposed an additional $13 million fine. Former Penn State officials Spanier, Curley and Schultz have since been brought up on criminal charges for their role in the abuse scandal.

German Politicians (#4)

More problems for German politicians. In addition to further claims of plagiarism against various politicians (including the current minister of education and research), German Federal President Christian Wulff had to step down after being investigated for corruption. While the actual amounts (by international standards) seemed small (paid vacations, a favorable mortgage, etc.), they raised major questions of character and judgment. Moreover, the former President’s efforts to diffuse the issue landed him in more hot water. At the end, it was all too much.

ERGO (2011: #5)

Having survived the embarrassing revelations regarding a 2007 “incentive trip” for its top salesmen which involved the hiring of prostitutes in Hungary as well as various other allegations, German newspaper Handelsblatt reported that Ergo had paid for employees to visit a swingers club in Jamaica and a brothel on the Spanish island of Majorca. The company had previously stated that the 2007 event had been a singular incident. Confronted with the new revelations the company first argued that the cases are not comparable and engaged in a brief battle with the newspaper, but later promised improved transparency, among other things providing a website with details on any “inappropriate behavior.”

Netflix (2011: #6)

After the Qwikster disaster, Netflix stock somewhat recovered to about $94, better than last year’s $67 per share, but still far from its height at $300 reached before last year’s crisis. However, a July Facebook posting by CEO Reid Hastings boasting of exceeding 1 billion hours of video streaming in a month for the first time led to a statement by the SEC that it may sue the company. This led to an interesting debate about what disclosure means in the digital age.

HP (2011: #7)

HP certainly would have made the 2012 list. This time over its Autonomy acquisition, now discussed as a candidate for “worst corporate deal ever,” possibly edging out the previous leader: the Time Warner-AOL merger.  HP is suing former Autonomy executives and auditors over alleged misrepresentations, while investors are suing HP.

Fifa (2011: #8)

The Fifa corruption scandal is continuing, though at a lower level of intensity.  The person in charge of investigating corruption at Fifa reported “resistance,” especially by some older members. The investigative panel also asked European lawmakers to get involved.

The U.S. Government (2011: #9)

Having narrowly avoided disaster over the debt ceiling, the U.S. government now tries to avoid the “fiscal cliff,” a legacy problem created by the negotiated solution of the debt ceiling crisis. We’ll keep our fingers crossed.

The Republican Candidates (2011: #10)

47%!

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Top Ten Reputational Crises – The 2012 Edition

Welcome to our second annual list of the top ten crises of the year. This was another banner year for corporate crises and scandals.

1. Global Banking

2012 was a particularly harsh year for global banking. Bank of America, Deutsche Bank, Goldman Sachs, HSBC, J.P. Morgan Chase, Morgan Stanley, Standard Charter, and UBS all would have been strong candidates to make the 2012 list on their own. Issues included the Libor scandal, rogue traders, fraud, money laundering, and a botched IPO (Facebook), among others. In addition, prominent hedge fund managers were convicted (Galleon) or investigated (SAC Capital) over insider trading, as U.S. authorities significantly stepped up their investigative and enforcement efforts.

All this contributed to a new low in public trust for an industry already held in low public esteem. But how much does this matter? Cynics may argue that while the entire industry is mistrusted, it still fulfills an irreplaceable function in global commerce. Moreover, the size and interconnectedness of global banks may make them (in the words of Andrew Bailey, chief executive designate of the UK’s Prudential Regulation Authority) “too big to prosecute.” Finally, if the entire industry is mistrusted, no one bank can be singled out. But this view is short-sighted; it overlooks the increasing willingness by politicians and regulators to take action. Public officials may act due to genuine outrage or policy concern, or in response to public pressure. The result is that financial institutions increasingly need to play defense; they fight merely to continue existing business practices – not an encouraging prospect.

2. Costa Concordia

Image courtesy of CyrOz via a Flickr Creative Commons license.

According to Karl Marx (a quote recently revived in the movie Argo) history repeats as tragedy and ends as farce. But as the Costa Concordia crisis showed, sometimes the move from tragedy to farce requires no repetition.  As a reminder, the cruise ship Costa Concordia, operated by Costa Crociere S.p.A. and owned by Carnival Corp., partially sank on the night of Jan. 13, 2012, after hitting a reef off of the Italian coast and running aground at Isola del Giglio.  More than 4,000 people on board had to be evacuated (more than thirty were confirmed dead), and the images of the half-sunken cruise liner made evening news across the world (it still warranted a 60 Minutes story as late as last weekend). Things took a turn to the bizarre when it became known that Captain Francesco Schettino had deviated from the ship’s computer-programmed route to treat people on Isola del Giglio to the spectacle of a close sail-past or “near-shore salute.” Captain Schettino was later charged (among other things) with abandoning incapacitated passengers. To refute the allegations, Captain Schettino had claimed that he had fallen into a lifeboat by accident. In addition to these operatic details, the crisis raised serious issues over safety practices at the ship’s operating company, a forceful reminder that, once a company finds itself in the spotlight, all its previous actions will be scrutinized as well.

3. Apple and Foxconn

Image courtesy of plasticpeople via a Flickr Creative Commons license.

A soaring stock price, passionate customers, and an iconic status are no guarantees against reputational crises. This is one of the lessons from the controversy over labor conditions at Apple supplier Foxconn. Following months of controversy over illegal overtime, inadequate safety conditions and poor workers’ housing, and highlighted by a string of reported suicides by distraught workers, Apple and its main manufacturing contractor, Foxconn, agreed to significantly improve labor conditions at Chinese factories. 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. Apple’s initial response was slow and somewhat evasive, but eventually Apple’s new CEO Tim Cook decided to take a leadership position on the issue of global labor standards.

This case illustrates an increasingly important phenomenon: the rise of private regulation of global commerce via reputational crises. The strategy works as follows: advocacy groups target a particularly well-known company that is likely to generate broad media coverage. If successful, the reputational damage forces the company to change its business practices, setting a benchmark for the industry. This “regulatory” activity is entirely driven by private entities, while public entities play little to no role. Even though Foxconn’s compliance with new standards is not mandated by a new law, the practical effect is the same.  This is the force of regulation through reputation.

4. Walmart

It was an annus horribilis for Walmart. What started as an isolated corruption case in Mexico has now engulfed the company as a whole involving senior management and the board. A December 18 article in the New York Times states this as follows: “Rather Walmart de Mexico was an aggressive and creative corrupter offering large payoffs to get what the law otherwise prohibited. ” Moreover, according to the same article, Walmart’s leadership was informed about the allegations, but decided to shut them down. This (still ongoing) issue follows on the heels of  the recent fire at the Tazreen Fashions factory in Bangladesh, a maker of clothing items for Walmart and other retailers. Bangladesh is the world’s second largest apparel manufacturer after China, and the fire, caused by gross negligence, has refocused attention on the country’s unsafe working conditions.

These crises have re-energized the anti-Walmart coalition in the U.S., which had lost some of its steam after Walmart embraced sustainable supply chain practices, universal health care, and even moderated its anti-union stance, at least in some instances.  The case also points to the exposure for globally operating companies due to supply-chain risk: reputational risk cannot be outsourced.

5. Lance Armstrong and Livestrong

Image courtesy of Angus Kingston via a Flickr Creative Commons license.

When Lance Armstrong was stripped of his record seven Tour de France titles following the damning report by the U.S. Anti-Doping Agency (USADA), and lost major sponsors Nike and Anheuser-Busch, the crisis quickly spilled over to his cancer foundation Livestrong. Although Armstrong stepped down as chairman, the foundation has faced the difficult challenge of creating a successful separate existence after being so closely associated with its founder.

This is not the first case where a personal scandal has created severe difficulties for associated entities. Examples include Martha Stewart’s Omnimedia, as well as Tiger Woods’ corporate sponsors. The risk associated with highly personal brands is that the personal life of the endorser/founder/owner is closely tied to the success of the business entity. In case of a personal scandal, the positive spillover from an admired celebrity can quickly turn to a reputational crisis for the associated entity, now caused by a negative spillover, especially if the scandal undermines the very values on which the personal brand was built. Things seem to go reasonably well, so far. Livestrong’s donations actually increased immediately after Armstrong’s resignation, though some donors asked for their money back.

6. Susan G. Komen Foundation

Image courtesy of Joel Kramer via a Flickr Creative Commons license.

Nonprofits feature prominently this year on this year’s list. This may be a coincidence, or a reflection of a broader trend that managing reputational risk is as important for nonprofits as for companies. After all, what are the assets of successful non-profits other than their people and their reputation?

Nonprofits may believe that they have a reservoir of goodwill, a trust bank account that can be drawn upon when times get tough. This view is largely misguided. Trust does not work like a bank account; it resembles a currency. The same message coming from a trusted source will have more credibility. But if trust is not maintained, this multiplier effect can vanish quickly.  When Susan G. Komen for the Cure, the nation’s largest breast cancer advocacy organization, considered cutting off most of its financial support to Planned Parenthood in late January 2012, it was quickly engulfed in a firestorm of protest, initially stirred by social media advocacy before it reached traditional media channels. Now caught on the battle lines between pro-life and pro-choice advocacy groups, the leadership quickly stumbled. Unconvincing, overly bureaucratic, justifications gave way to a quick reversal of its decision to cut funding for Planned Parenthood. Subsequently, CEO Nancy Brinker and President Elizabeth Thompson announced plans to step down from their posts. But recovery has been difficult. Participation at its signature Race for the Cure is down by 19 percent, according to a recent New York Times article. Once the Komen foundation had been associated with the vitriolic abortion debate, any decision was criticized by somebody, a common feature of highly polarized issues. During last October’s National Breast Cancer Awareness month, the foundation ran a new ad campaign focusing on the individual women whose lives have been saved by the foundation’s work. While this particular attempt to refocus public attention on the mission was well-executed, it remains to be seen whether the Komen foundation can ever fully recover its past status.

7. Chick-fil-A

Another controversial issue, another company. This time the controversy was over gay rights and the company was the family-owned fast food chain Chick-fil-A. The uproar began in late July when President and COO Dan T. Cathy stated that Chick-fil-A supported “the biblical definition of the family unit.” While the deeply religious roots of Chick-fil-A’s founder and family owners were well known, the new comments quickly led to boycott threats by gay rights groups, statements by public officials in cities such as Boston or Chicago that the company was not welcome there, and the decision by the Jim Henson Company, creator of the Muppets, to no longer supply the company with toys.

What made this case particularly interesting was the support of Chick-fil-A by conservative advocacy groups and politicians, including then candidate for the Republican presidential nomination Rick Santorum and former presidential candidate Mike Huckabee. Conservatives asked supporters to increase their visits, effectively organizing a “buy-cott.” The sales impact on Chick-fil-A seems to have been limited, raising the intriguing and somewhat worrisome specter of consumer preferences being significantly correlated with political ideologies. Picture the Whole Foods shopper compared to the Cracker Barrel customer, Starbucks versus Dunkin Donuts. But before embracing another new marketing fad companies should be careful with (unintentionally?) defining themselves as a “Republican” or “Democractic” brand. Otherwise, they will be in for some interesting times.

For more details on the impact of boycotts, see my Harvard Business Review blog post.

8. The BBC

This fall the BBC faced the biggest crisis since its existence. The first blow was revelations that TV personality Jimmy Savile had sexually abused children while he worked for the BBC. Moreover, prior to the revelations by a rival news program, an investigation conducted by a BBC’s news program had uncovered credible evidence that Savile was a pedophile. Yet the BBC canceled the investigation in December 2011, the same month the network ran a glowing tribute to Savile. A recent report on the incident pointed to chaos and confusion rather than a cover-up.

Image courtesy of Elliott Brown via a Flickr Creative Commons license.

But that was not all. In the aftermath of the Jimmy Savile scandal, BBC flagship program Newsnight investigated a North Wales child abuse scandal. A former resident of the Bryn Estyn children’s home was reported on Newsnight claiming that a prominent but unnamed former Conservative politician had sexually abused him during the 1970s. Rumors on Twitter and other social media named the politician. After The Guardian reported a possible case of mistaken identity, the politician stated that the allegations were wholly false and seriously defamatory. The accuser unreservedly apologized, stating that as soon as he saw a photograph of the individual, he realized that he had been mistaken. The BBC subsequently apologized.

The decision to broadcast the Newsnight report without contacting the person first lead to further criticism of the BBC, and the resignation of its Director-General George Entwistle. Following Entwistle’s resignation, Lord Patten, Chairman of the BBC Trust, called for a “thorough, radical, structural overhaul” of the organization. Tony Hall, a former BBC journalist and subsequent successful director of the Royal Opera House, was appointed the head of the BBC. While this appointment inspired confidence, the BBC has a tough road ahead.

9. Japanese companies in China

We can now add “country of origin” to the ever increasing list of headaches for today’s multinational companies. The most recent example is Japanese companies operating in China following the controversy over a cluster of uninhabited islands northeast of Taiwan.  This conflict has had severe consequences for Japanese companies doing business in China. Compared to last year, Toyota has seen its sales drop by 49 percent, Honda by 40 percent, and Nissan by 35 percent.

Other examples of this phenomenon  include the 2005 boycotts of Danish products in the Muslin world after the Danish newspaper Jyllands-Posten published satirical cartoons which depicted the prophet Mohammed, as well as the oil company CITGO, which is owned by Venezuela’s state-owned national oil company. Venezuela’s leader Hugo Chávez gave a highly inflammatory speech in 2006 where he called then President George W. Bush the “devil” and “sick man.” As a result, CITGO faced immediate calls for boycotts in the U.S.

These intense reactions are usually triggered by moral outrage, either because of violated national pride or firmly held religious beliefs. In the ensuing angry protests, companies may find themselves the target of popular rage. The strategic options for companies to respond are limited. They usually are well-advised to stay out of the political debate, in part because allying themselves with one government will alienate the other. A more promising strategy is to highlight local roots. The problem with such strategies is that they run counter to a brand-based strategy that has downplayed local independence up to this point. Having it both ways is difficult for companies: you live by the brand, you die by the brand. This insight holds even if the brand damage is beyond the company’s control.

10. The NFL

The NFL is by far the most successful sports league in the United States.  TV viewership is up and fan passion runs as high as ever. Moreover, compared to other leagues (the NHL comes to mind) bargaining issues were resolved successfully leading to a landmark 10 year agreement. So, why did the NFL make the list? No, it’s not the issue of replacement referees, highlighted by the missed call in the Packers-Seahawks game. The issue is player safety, especially the issue of head trauma and concussions that are being linked to dementia and player suicides. In June 2012, more than 2,000 former NFL players filed a lawsuit against the NFL, the biggest sports-related lawsuit ever, accusing the league of concealing information linking football-related injuries to long-term brain damage. The suit alleges that the “NFL exacerbated the health risk by promoting the game’s violence” and “deliberately and fraudulently” mislead players about the link between concussions and long-term brain injuries.

What we have here is an example of slow-burning crisis that remains unresolved and leads to repeated flare-ups, especially whenever another player tragedy hits the headlines. The NFL has responded decisively, donating $30 million to the National Institutes of Health for brain-related research, changing concussion policies, and engaging in ongoing rule changes. That said, at this point there is no solution to the problem. Moreover, some of the policies intended to better protect players are resented by some players, e.g. the controversy over penalties for Steelers linebacker James Harrison. The recent decision by former commissioner Paul Tagliabue to vacate player suspensions over the Saints bounty scandal was a further setback in this direction. Maintaining the popularity of the game while making it safer will be a challenge for years to come.

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Companies and conflicts: When governments fight, multi-national companies also suffer

The controversy over a cluster of uninhabited islands northeast of Taiwan (known as Senkaku in Japanese and Diaoyu in Chinese) has not only led to an increasingly tense confrontation between the Chinese and Japanese governments. It has also had severe consequences for Japanese companies doing business in China. Compared to last year, Toyota has seen its sales drop by 49 percent, Honda by 40 percent, and Nissan by 35 percent.

We can now add “country of origin” to the ever increasing list of headaches for today’s multi-national companies. This is not an entirely new phenomenon. Other examples include the 2005 boycotts of Danish products in the Muslin world after the Danish newspaper Jyllands-Posten published satirical cartoons which depicted the prophet Mohammed. A less dramatic example includes the oil company CITGO, which is owned by Venezuela’s state-owned national oil company. Venezuela’s leader Hugo Chávez gave a highly inflammatory speech in 2006 where he called then President George W. Bush the “devil” and “sick man.” As a result, CITGO faced immediate calls for boycotts in the U.S.

These intense reactions are usually triggered by moral outrage, either because of violated national pride or firmly held religious beliefs. In the ensuing angry protests, companies may find themselves the target of popular rage. The strategic options for companies to respond are limited. They usually are well-advised to stay out of the political debate, in part because allying themselves with one government will alienate the other. Changing the company’s headquarter location is usually not an option either, at least not in the short run, and may have little effect anyway if the company is strongly associated with its country of origin.

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Four Perspectives on Re-establishing Trust

I recently was interviewed by Nikkei Business Journal on the occasion of the publication of the Japanese translation of Reputation Rules. The following article, translated from the original Japanese that appeared in the May 7, 2012 edition of Nikkei Business Journal, summarizes the interview. It was translated by Trevor Devlin.

“What Professionals Have to Say

Four Perspectives on Re-establishing Trust

Olympus—shaken by its attempts to hide huge losses. Tokyo Electric Power—which continues to be strongly criticized following the accident at one of its nuclear power plants. There is no space here to mention all the organizations which have seen the damage go from bad to worse due to their inept responses to accidents or scandals. We asked the leading authority on ‘reputation management’ to comment on the keys to riding out the crisis when a company’s reputation is imperiled.

Daniel Diermeier – Professor at the Kellogg School of Management at Northwestern University

Trust in the Tokyo Electric Power Company (TEPCO) has suffered severe damage since the accident at its Fukushima Daiichi (Fukushima No. 1) Nuclear Power Plant following the devastating Tohoku earthquake and tsunami of March 2011.  In addition there is the case of Olympus Corporation, which saw its reputation as a top-flight enterprise suddenly turn into that of a ‘problem company’ when the dismissal of the company’s then president led to the discovery that the company books had been cooked so as to hide enormous losses. Trust in an organization can evaporate overnight as the result of a single accident or scandal, and the situation can then be further exacerbated by subsequent clumsy responses. There have been countless demonstrations of this insight in the past.

In order to safeguard against such a situation, an enterprise must actively make efforts to manage its company image among the general public, in other words engage in ‘reputation management.’

However, even if executives say that they want to manage the reputation of their company, in many cases they do not know how to go about things. With the goal of explaining to such people what risk management consists of, last year I published the book Reputation Rules (Japanese title = Hyoban wa manjimento seyo—Kigyo no fuchin o sayu suru reputeeshon senryaku, Hankyu Communications). In it I introduced the rationale behind reputation management and some specific methods for achieving it.

The first critical element in reputation management is not to leave things to some specialized internal division, declaring for example, ‘That’s a job for the Public Relations Department.’  The reason why is that when an accident or embarrassing incident occurs, no PR Department or other single unit of a company is capable on its own of  stemming the loss of trust or preventing errors in response from causing a snowballing deterioration in the company’s image. That is crystal clear from the cases of TEPCO and Olympus.

It is not easy to restore a reputation once it has been shattered. The loss may be sudden, but the rehabilitation will definitely take a long time. Furthermore, the involvement of the entire company is needed to achieve this end. In order to do that, top management needs to give reputation management the same attention it gives other management capabilities, and make the necessary effort to take the initiative.

Based on that premise, we first need to consider how the reputation of an organization like a corporation is formed. And how exactly can an accident or scandal take a toll on a company’s reputation.  It is necessary to thoroughly comprehend the processes at work here. My analysis will focus on the case of TEPCO, in which the accident at its Fukushima Daiichi Nuclear Power Plant led to major damage to its corporate image around the world.

The reputation of a given company is built upon the “trust” that the company has developed among the customers who are the users of the products or services produced by that company.  I believe that there are four factors which can cause the degree of trust to fluctuate up or down. These four factors are ‘transparency,’ ‘professional knowledge,’ ‘commitment’ and ’empathy.’

If these four elements are achieved in balanced fashion, the company’s reputation will be enhanced. Conversely, if these four elements are not fulfilled, the firm’s reputation will surely decline.

In addition, by measuring the degree to which it has fulfilled each of these four factors, a company can determine whether or not its corporate reputation is high. Furthermore, it can analyze which factors can be employed to increase customer trust in the company and then adopt appropriate countermeasures. The “Trust Radar” shown below explains this is schematic fashion.

Image courtesy of Daniel Diermeier Consulting

Transparency, the first of these four necessary qualities, does not simply refer to the degree that information is provided to the public. It also addresses the question of how easy-to-understand is the information provided.

If the party receiving the information judges the degree of transparency to be low, it may conclude that ‘critical information is being intentionally hidden.’ For example, what is going to happen if even though critical information is revealed, it is so replete with specialist terminology that the party receiving the information cannot make heads or tails of it? There will be a strong probability that the verdict will be that the use of technical terminology is an attempt to obfuscate an issue. In such an instance, it could hardly be claimed that there is a high degree of transparency present.

In the case of TEPCO, initially the company was reluctant to release information concerning the accident at the Fukushima Daiichi Nuclear Power Plant. Furthermore, the information released in response to demands from the mass media was full of technical terminology, so it was hardly to be expected that the content would be comprehensible to a layman. As a result, no matter how much information TEPCO might release, the impression remained that the company ‘is hiding something.’

Second, there is the factor of ‘professional knowledge,’ which primarily refers to the degree of reliability of the technology that a company possesses.  It is the members of the company themselves who know best about what they are doing, so it is only natural to expect that they would know best how to respond if any problems arise.  Actually, in the majority of cases, professional knowledge does not become a factor in impairing trust in a company as it is simply assumed that the company possesses the necessary expertise.

However, in the case of TEPCO, this professional knowledge element too became a major factor in dissipating trust. Not only was there the fact that a major accident occurred at the nuclear power plant despite the presence of many experts within the company, but also the fact that TEPCO proved incapable of providing clear explanations concerning the methods being used to resolve the phenomena and problems arising from the explosions, etc. following the accident. For that reason, not only individuals who were familiar with nuclear power plants, but also citizens in general, were filled with doubts about whether TEPCO really had the professional expertise required to deal with nuclear accidents. A similar phenomenon was observable in the case of the accident in the Gulf of Mexico in which there was a major crude oil leak from a seafloor well operated by the British petroleum major BP.

The third factor is commitment, which refers to the methods and sense of responsibility displayed in responding to problems.

If a thorny problem such as a major accident or scandal occurs, people expect the CEO (chief executive officer), chairman and other leaders of the corporation to take the initiative and provide leadership, while also accepting the responsibility to explain the situation also work to resolve the issues.

In the case of TEPCO, such expectations were sadly disappointed. Not only did the top executives who were expected to provide expectations rarely appear at news conferences to offer their own explanations, in the midst of the crisis the company’s president himself was hospitalized and completely disappeared from public view. The fact that just when his company was enmeshed in a crisis the president should become unavailable was the worst possible situation imaginable.

Empathy, the fourth factor, refers to feelings of commiseration for victims. The representatives of TEPCO repeatedly voiced apologies at press conferences and in other venues, and they assiduously went about apologizing directly to those people who were forced to lead their lives as homeless evacuees as a result of the accident at Fukushima Daiichi. Nevertheless, many of the people who were being apologized to felt that these were nothing more than pro forma apologies and were not really genuinely coming from the heart.  In this manner, TEPCO managed to violate all four principles required to instill trust.

Incidentally, ever since the occurrence of the previously mentioned spill from the BP oil well, that company has been working to restore the Gulf of Mexico to its original state. These efforts have been well received, and the company has enjoyed a marked recovery in degree of trust, especially in terms of the two factors of commitment and professional knowledge. As a result, the company’s reputation has been begun to rebound in the United States.

What then can be done to enhance the four elements that go into to shaping the reputation of an organization? The key here becomes organizational (corporate) governance. Next, I would like to consider the case of Olympus.

The scandal surrounding Olympus concerned efforts over several years to window-dress the company’s settlement accounts so as to conceal enormous losses. The principal victims in this case were the company’s own shareholders, and not consumers who had purchased the company’s products.

Normally, in such cases in which it is discovered that a firm’s accounts have been window-dressed, the news does not make it to the headlines of the front page of daily newspapers or become a topic for street corner conversation.  Although there are exceptions, such as the case of Enron in the United States, usually such affairs do not become hot topics among average citizens. Why then should it be that the Olympus affair attracted so much attention?

What made the Olympus case special was the “story element” involved. The spotlight on the “stage” of the concealment of the losses was due to the presence of fascinating “actors” and an easy-to-understand story concerning the related “circumstances.”

The main role in this story was played by the Englishman Michael Woodford, the former president of the company. When after he had gained the position as leader of this world-renowned brand name company the Board of Directors suddenly decided to oust him, Woodford refused to go softly into the night and instead reacted by disclosing the company’s internal secrets. The development of events in the case was truly dramatic. They garnered attention from overseas, so that the situation developed into a major scandal which ended up attracting the global media as well as investigative authorities.

In order to resurrect the image of Olympus, which had thus been pulled down into the dust both at home and abroad, at the very least there needs to greatly improve governance by the Board of Directors.

After all, with the very existence of the company in peril, the Board of Directors has no choice but to commit itself to resolutely carrying out reforms. In order to respond to the situation, the Board might have to dismiss its current leadership, or otherwise move to rapidly implement reforms. In a case where the Board of Directors is under the control of top executives, so that it cannot voluntarily make appropriate decisions, it is impossible for it to get a handle on conditions or rectify conditions, meaning that things will deteriorate even further.

In the case of Olympus, if governance by the Board of Directors had been functioning properly, at an early stage there would have been a wholesale shakeup among the directors as well as within the ranks of top management, so that the running of the company would have been entrusted to individuals who could improve the company’s soiled image, or take other such measures. In that case, it might have been possible to extinguish the “fire” at an early stage.

The fact is that when a company has lost the confidence of its customers and investors, there are instances in which it can prove effective to bring in a highly respected third party.

For example, at the beginning of the 1990s in the United States the major investment firm Salomon Brothers (the current Salomon Smith Barney) was plagued by numerous scandals, including improper bids for U.S. Treasuries. Shortly after discovery of the incidents, an executive within the company was appointed president.

This president revamped the management team, inviting in renowned investor Warren Buffett. The market’s immense trust in Buffett proved highly effective in restoring trust in the company.

Such countermeasures for dealing with the situation after problems have caused a company’s reputation to be hard hit require restructuring in terms of corporate governance. Before fashioning and implementing such countermeasures, it is critical to evaluate the impact caused by the problems in question. If managers error in judging the degree of impact, then naturally the countermeasures they adopt to deal with the situation will likely not fare well.

Here I would like to introduce come effective concepts for evaluating the impacts caused by incidents and scandals.

Please take a look at the graph on the following page. The vertical axis represents the degree of shock damage delivered to the corporate reputation by an incident, scandal or other problem, while the horizontal axis indicates the degree of importance the issue has on the business of the company (core business or not). The background considered when creating this graph is that when a given issue arises the reality is that the impact on a company’s reputation will vary according to company and type of industry.

Image courtesy of Daniel Diermeier Consulting

For example, in the summer of 2009 the problem of rapid acceleration of Toyota vehicles surfaced in the United States. For all automakers, the issue of the safety of the motor vehicles which are their mainstay products looms very large. But for Toyota the importance of safety surpasses that at other carmakers. That is because the value of the Toyota brand is rooted in its superior product quality vis-a-vis other brands.

I think I can say without fear of being judged wrong that if, for example, the luxury British carmaker Jaguar suffered a similar problem with rapid acceleration, it would not have caused the same amount of reputational damage as what happened to Toyota. That is because for Jaguar owners another concern, namely design, trumps vehicle safety.

Or let’s consider another case. Assume that a case of food poisoning occurred in the United States at the cafeteria of a motor vehicle manufacturer like Toyota. However, since food poisoning has nothing to do with the core operations of the carmaker, food safety or quality would have nothing to do with the core competitiveness of Toyota.

Nevertheless, what would be the reaction if a similar case of food poisoning occurred in the employee cafeteria of the hamburger chain McDonald’s or another major restaurant chain?  Even though the actual fact of there being victims of food poisoning would be the same for both companies, the question of safety in the employee cafeteria would have no direct relationship to the core business activities of an automaker, while it would have a direct relationship to the core business of a restaurant firm. Thus, the impact exerted by an incident on such a corporation’s reputation would be incomparably greater than in the case of the automaker.

In other words, the degree to which a given problem is related to the business activities of an enterprise and the degree of such impact are extremely important considerations. This is the key in determining the scale of the blow that will be delivered to its reputation.

In measuring the degree of the blow to the reputation, another important concept is the “degree of attention paid.”  Specifically, I would say that a judgment needs to be made whether “this issue will become news reported on the front page of major newspapers in Japan and overseas.”

Well then, what kinds of incidents and accidents are likely to become the lead story on page one of newspapers. Two factors are determinative.

First: ‘How important would this issue be considered within the country in question?’ Although a certain issue might garner a tremendous amount of attention within a country, it would not attract nearly as much notice in another country. For example, when it comes to animal welfare, this is very important concern in Great Britain, although that is not true in France. When considering the impact of an issue, it is essential for top managers to understand the cultural background of the country or region involved.

Let me offer another specific example. When it was discovered in 2005 that the now defunct Kanebo Ltd. had embellished its financial results, it became a big story in Japan and a Japanese auditing firm was forced to undergo a major restructuring as a result.  However, there was hardly any real-time reporting of the affair in the United States, and in the United Kingdom it was largely limited to a bit of reporting in the Financial Times.  Kanebo was not a very well known corporate name in Europe or North America. If it had involved a scandal for a company with a international name value on the order of Toyota, no doubt it would have become global news.

In judging the degree of notoriety another important factor is, as mentioned earlier, the degree to which a story line is present or absent. There is always trouble like the Toyoda sudden acceleration issue popping up.  However, what caused the problem to grow so big was the fact that it made a good story.

The initial impetus for the story was an accident in the State of California in which four passengers riding in a Toyota died. The fact that one of the passengers in the vehicle sought to get help by cellphone was given wide coverage in the U.S. media. That triggered strong interest in the U.S. public, and it subsequently developed into a major issue involving a large-scale recall (recall and no-cost correction of the problem).

What top management needs to do in such a situation is to try to understand how their strategic situation has changed. If that had been done, then in the case of the aforementioned accident which occurred in California, it would not have been considered nothing more than an accident on par with about 500 such accidents which occur annually. However, by the time that the story of the accident had become widely circulated, it no longer was merely one incident among a kind of accident that frequently occurs.

What things like this force us to recognize is that managers need to have the skill to quickly judge that ‘this story has spread, and the problem has shifted to another dimension into the realm of crisis.’ No matter what the issue might be, if a good story line is involved, it is going to attract attention.  When that happens, if you try to offer a defense from a technical perspective, then you can be pretty well sure that most people will not be willing to lend an ear to difficult-to-understand explanations. (In fact, it was later proven that the cause of the accident in question was not related to the electronic system in Toyota vehicles, but that vindication took more than a year.)

In order to gain attention, it is common for corporations to try to use the appeal of celebrities, athletes or other well-known public figures to do all they can to attract consumers to that company’s products and services. However, in cases where a good story line causes a lot of attention to be focused on an accident or scandal, the improper behavior of the people involved can make the situation even worse.

I am convinced that people basically want to trust companies. They also expect companies to develop the four components of trust, namely ‘transparency,’ ‘professional knowledge,’ ‘commitment’ and ’empathy’ to a high degree. When unexpected problems arise, people are overcome with anger and fear, and they feel that these expectations have been betrayed.

Even if a corporation believes that the reactions among people are unwarranted, all they can do is soldier on and strive relentlessly to recover their trust.  In the final analysis, the hearts of consumers are not things that you can expect to control completely.”

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An interview with The Wall Street Journal on the anniversary of the Fukushima nuclear plant disaster

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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Counting Down the Top 10 Reputational Crises of 2011

To mark the first year of the Reputation Rules: The Blog, we are publishing our list of the Top Ten Reputational Crises of 2011. The idea is to not just look back on these events, but also to draw some general lessons from these cases. There are many more that could have been added (Olympus, Johnson & Johnson, SC Johnson, German Federal President Christian Wulff, Dominique Strauss-Kahn, the Governator, and many more), but here are the ones that made the list.

Image Courtesy Politico

1. News Corp.

What started out as a sordid story about hacking into voicemail accounts and other personal information has turned to an annus horribilis engulfing not only the Murdoch media empire, but also the British government and Scotland Yard: a British Watergate. After a year full of arrests, resignations and investigations, News Corporation and the Murdoch family are facing the biggest crises in their history. The BSkyB acquisition had to be abandoned and shares have plummeted. James Murdoch, the company’s likely heir apparent, is now in the crosshairs of government investigations to determine whether he knew more about wide-spread hacking than originally admitted. Observers have called his position “untenable” and the investigations having reached a “tipping point.”

Nobody knows where the crisis will end. But it’s already offering a few lessons.

First, newspapers and media companies are especially bad at managing reputational crises. This is not only illustrated by the News Corp. crises but other cases such as the Jayson Blair scandal at the New York Times or “Memogate” at CBS’ 60 Minutes. Operating in an intensely politicized atmosphere in their daily lives, news organizations typically interpret any criticism immediately as another politically motivated act and miss the underlying business issue—a crisis that threatens competence and integrity, which are the pillars of news organizations. The response is often defensiveness, which further erodes trust.

Second, good governance structures pay off in a crisis. Ineffective boards or ill-placed personal loyalties are a problem in good times; in bad times they are a disaster.

Third, dormant issues can very quickly become life-threatening crises as public perception tends to change rapidly. One of the striking aspects of the News Corp. scandal is that the allegations of hacking into voicemail messages and private accounts and bribing police officers were ongoing for years. But the dynamics dramatically changed when the reports related to Milly Dowler (and other similar cases such as murder victims or soldiers killed in action) surfaced in early July. The horrific case of Milly Dowler and her family immediately triggered reactions of sympathy for the victims and disgust and outrage for the new villains: News of the World, News Corp. and Rupert Murdoch.

Fourth, once a company loses public opinion, politicians will adjust, turning from friends to enemies in a heartbeat. At that stage politicians and public officials need to save their own skin amidst allegations of inaction or complicity.

For more details and commentary, see my blog post “The British Watergate” as well as my appearance on BBC’s The Hub.

2. TEPCO and the Japanese Government

Whenever disaster strikes, companies and governments are not only criticized for their immediate handling of the crisis, but also their ability to reassure the public. Maintaining trust during a crisis is just as important as solving the crisis at an operational level.  Both TEPCO and the Japanese government were criticized for lack of transparency and timely release of information.

What also became apparent is that leaders are not only in the spotlight for their current conduct. Indeed, their preceding actions (or inaction) too come under heavy scrutiny.  TEPCO’s history of safety violations quickly took center stage, while the Japanese government was criticized for lack of oversight and a too cozy relationship with the nuclear power industry.

For an early assessment of the Japanese crisis, see my video interview with the Kellogg School of Management.

Next we have two crises involving universities.

Image Courtesy CBS Las Vegas

3. Penn State

The revolting details of the Penn State case have dominated U.S. headlines over the last months. While the future of the protagonists in this sordid tale is now decided in the courts there are important lessons here for any business, but especially for universities and other non-profits.

First, “crimes of omission”, i.e. looking the other way, not acting forcefully or simply the lack of appropriate processes are unacceptable in today’s business environment. An organization’s reputation critically depends on the decisions of its people, including what they neglect to do. Lack of awareness, missing processes, or confusion over values is deadly. No institution can simply count on its members to “do the right thing”.

Second, universities (and other non-profits) are especially at risk when those entrusted to them are victimized. While for-profit companies are typically thought of as being competent—but not necessarily caring—nonprofits are seen as being caring, but not always competent. These perceptions are considered a given; they are “table-stakes”. Losing them threatens the very core of the institution.

Finally, sage words on the reputational risk of universities from a somewhat unlikely source: a rating agency. In its evaluation of Penn State’s credit rating, Moody’s Investors Service stated the following:

“Higher education is first and foremost a business that is driven by reputation…Student demand, the attraction of faculty, and the ability to draw donations are all based on reputation.”

Image Courtesy Speak Ethics

4. Politicians and Plagiarism

Our first German crisis takes us to an unlikely domain: doctorates for politicians. Many German politicians have obtained doctorates, frequently in the social sciences, history or law. Last year saw a wave of plagiarism allegations against German politicians. The most prominent casualty was the German defense minister Karl-Theodor zu Guttenberg (above), who not only lost his “Dr.” designation but also had to resign from the German government and (perhaps temporarily) exit political life.

The scandal also heralds a subtle shift in the control over scientific expertise and quality. The initial charges and evidence were the result of a crowdsourcing effort on a Wiki called “Guttenplag”. Guttenberg’s degree-granting university (the University of Bayreuth) found itself first on the back foot, but then stated that the minister had “extensively violated academic standards and intentionally cheated.”

Our next two crises illustrate the risks of brand-driven strategies: you live by the brand, you die by the brand!

5. ERGO

Crises can come from anywhere, and just when you think you’ve seen it all there comes an example that is truly jaw-dropping. Such is the case of the German insurer Hamburg-Mannheimer, now part of ERGO, which itself is owned by the insurance giant Munich Re, which counts Warren Buffett as an investor.  A staple of German advertising lore, it featured a long running advertising campaign featuring a conservative insurance agent “Herr Kaiser” and his trademark greeting, “Nice to see you.”  Overall, it presented a reliable, if a little boring image of stability and personal attention.

Boring no more.  After its acquisition, ERGO engaged in an aggressive advertising campaign with goals of defining itself as a consumer brand with a focus on trust, clarity, and transparency. In May 2011, however, the German press discovered and reported that Hamburg-Mannheimer had organized an “incentive trip” for its 100 best salesmen in 2007. The company had rented the famous Gellert Baths—an art deco spa in Budapest, Hungary—and hired about 20 prostitutes. The prostitutes wore color coded wrist bands to indicate which men (ranked by sales performance) were allowed to have sex with them. (Prostitution is legal in Hungary and Germany).

A few weeks later, the German press reported that during 2005-06 the company had overcharged 70,000 customers nearly $234 million for the so-called “Riester-Rente”, a state-subsidized retirement product.  Subsequent reports suggested that errors may have been known to the company as early as October 2005.  In addition, sales representatives allegedly had advised clients with existing life insurance policies to switch to accidental insurance policies. This resulted in higher commissions for sales representatives, but was frequently not in the financial interest of the customer.

The initial company response was slow and defensive, despite the fact that the company knew this was coming – a rare luxury in a reputational crisis. Three weeks after the initial report, and after intense pressure on the CEO, ERGO outlines new processes including the creation of a whistle-blowing hotline and the appointment of an external body to monitor operations and conduct regular compliance audits. The company also outlined its plan to create new guidelines for incentive schemes.

One of the more interesting aspects of the ERGO crisis was the apparent mismatch between brand positioning (a focus on trust and transparency) with an aggressive sales culture. Reputational ambition needs to be connected with reality on the ground. Otherwise, the next crisis is just around the corner.

See also my case study in the Financial Times

6. Netflix

It was a horrible year for Reed Hastings, Netflix’s CEO and Fortune’s 2010 “Business Person of the Year.” The stock is down almost 2/3 for the year, currently trading at about $69 per share after having reached $300 per share earlier this year. A calamitous change in its pricing model, followed by the “Qwickster” disaster, lead to a mass exit of subscribers. Netflix now expects a loss for 2012 and the web is suddenlyfull of “Netflix haters”.

This is a stunning fall from grace, but it illustrates a broader point. Brands are now largely about trust, but trust is fragile. When trust is violated (or perceived to be violated), trust quickly turns to betrayal, and passionate support to rage. Add to that the difficulty of operating in a (social) media environment with less and less control over the message customers receive, and this new brand fragility is not an exception, but a common risk that needs to be managed.

The next two crises have their roots in severe problems of governance (we could have added News Corp. to that list). Well-functioning governance structures are critical during a crises, and here they are the trigger for the crisis.

Image Courtesy SFGate

7. HP’s Board

A year after the controversial ouster of CEO Mark Hurd, HP’s board again made negative headlines, this time for its dismissal of Léo Apotheker, less than a year after his appointment and after endorsing his strategy for transforming HP. Again there were reports of leaks by board members and deep divisions within, leading CNN Money–among many others–to ask: “Is HP’s board the worst ever?”

Image Courtesy The Telegraph

8. FIFA

A year of corruption allegations, investigations, resignations, and the highly controversial reelection of FIFA president Sepp Blatter, all on the heels of a heavily criticized selection process for the World Cups of 2018 (to Russia) and 2022 (to Qatar). Blatter then had to apologize for controversial comments on racism in soccer, reigniting calls for his resignation and thorough governance reform.

We typically do not think of sports governing institutions as bodies in need of reputation management, but not only are their responsibilities broad (they determine rules, collect dues, negotiate TV and advertising contracts, sponsor local development initiatives, etc.), they are entrusted with ensuring the integrity of the game, and its history.

9. The U.S. Government

The reputation of countries is measured in different ways, bond ratings being only one of them. The U.S. political system has had a rough year. As the country watches another example of Congressional brinkmanship, many observers ask themselves how it could have come this far. There are many explanations for the ongoing inability of the U.S. political system to come to decisions, from the surge of the Tea Party to positioning for the 2012 Presidential Election. But down-to-the wire budget negotiations are nothing new to the U.S. political landscape. The worst consequences are mostly avoided, but sometimes bad outcomes result, as in the 1995 shutdown of the federal government. As a consequence, passports and visas were left unprocessed, national parks were closed, and veteran services curtailed.

Through its extensive set of checks and balances, the U.S. Constitution was designed to force policy makers into these bargaining situations. The need to find common ground between the president and the chambers of Congress would ensure moderate policies with broader support. Other democracies, such as Great Britain, lack this structure, as parliamentary democracies encourage unity between the executive and its supporting majority in parliament.  There are pros and cons to each structure. A British Prime Minister can make far-reaching decisions without periods of extensive bargaining. This was last seen in the austerity measures passed in October 2010, which implemented far more radical cuts in the UK budget than discussed in the current U.S. debate.  On the other hand, the possibility of radical change can lead to highly disruptive policy changes as different parties assume power, as seen in the waves of nationalization and de-nationalization of British industry in the 70s and 80s.

Such inefficient policy shifts are far less likely in a system of checks and balances, but in addition to the usual bargaining shenanigans known from any negotiations, there are unintended consequences that make the current situation particularly severe. In a paper with Roger Myerson, the 2007 Nobel laureate in Economics, we have argued that a system of checks and balance can create incentives for Congress to create inefficient decision structures. The argument goes as follows: in a bargaining situation each chamber wants to get the best deal for its members and their constituents. By creating internal veto players, such as powerful party leaders and committee chairs that need to sign off on any deal, the chamber can secure a better outcome for itself.

The problem is that having more players that need to agree makes a deal less likely.   The consequences are fewer agreements and an inability to pass tough policies and gridlock. What can be done?

First, anything that creates bonds across chambers will be a positive step, whether these are joint committees or strong personal relationships. Second, voters that hold members of Congress accountable for failure change the incentives to engage in intransigent behavior. Third, moving from a system where all chambers have to agree with the president to one where only one chamber needs to sign off would create incentives to remove internal hurdles and lead to more efficient bargaining while maintaining the quintessential features of checks and balances.

For more, see my blog post “Checks and Balances and the Debt Ceiling Crisis”. 

10. The Republican Candidates

This year’s installation of the demolition derby known as the U.S. primaries demonstrated the limits of managing reputational crises. Even the short-lived popularity of Herman Cain’s “9-9-9” tax proposal could not overcome ongoing allegations of sexual harassment and adulterous affairs, and feeble attempts of humor could not save Perry from his “senior moment”.

For my take on how Herman Cain and Rick Perry handled gaffes during their campaigns, please see the Huffington Post’s “Perry, Cain manage crises with humor, defiance”.

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The Trust Reservoir is Empty

Consumers are becoming less trusting of corporations, causing greater reputational risks. What’s to blame?

In the last year, trust in companies has steadily deteriorated, and this may be indicative of much more than simply an annus horribilis for business. The PR firm Edelman’s 2011 Trust Barometer shows that trust in business in the U.S. is now approaching levels found in Russia. The data in the rest of Europe are not much better.  Only some of the other BRIC counties (China and Brazil) show slightly increased trust. Moreover, NGOs are now trusted more than companies in almost every country, even China.  Business leaders and corporate boards are starting to take notice, but are unsure what to do.

In very recent memory, we’ve seen some of the world’s most recognized companies, all leaders in their industry, battling reputational crises.  And now the world is looking in horror at the Fukushima disaster, which in the words of late night talk show host Jay Leno, may make us look back at the Deepwater Horizon oil spill as the good old days.

But the root causes go deeper. Trust in business has been eroding at a steady pace over the last decade and CEOs are now among the least trusted professionals.  Four main factors are responsible for the increase in reputational risk.

1. First, media coverage, whether traditional or social, has dramatically increased globally. This increased scrutiny has made it virtually impossible for companies to hide. Transparency is expected, while companies have less control over their messages; once an issue is on the Web, it will likely stay there forever.
2. The second factor is an unexpected consequence of globalization. The globalization of activist organizations has matched the global reach of companies. NGOs have increasingly succeeded 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 for globally operating companies that, when effective, leave the companies with no choice but to change their business practices.
3. Third is a shift in expectations about corporate conduct, especially among younger population segments. Evidence for these trends can be found in the explosive growth of areas such as corporate social responsibility, sustainability, and socially responsible investing. Some critics have dismissed these trends as passing fads that lack impact, but reputational crises are increasingly being driven by moral outrage, whether over environmental concerns or executive perks.
4. The final factor is the rise of business models based on trust. To develop unique customer experiences and solutions, companies need to get closer to customers’ unarticulated—perhaps even unconscious—desires and needs. This requires trust.  While this shift has undoubtedly created new opportunities for value creation, even the mere perception of broken trust will lead to a feeling of betrayal, a strong emotion indeed.

How have companies responded to these trends?  Poorly.  Most companies still view stewardship of the company’s reputation as a narrow issue best left to the PR department.  For the most part, the response is an underfunded initiative greeted by nervous questions from the board. Underdeveloped capabilities in the presence of growing reputational risks will lead to an increase in reputational crises. That mismatch is untenable.

Most companies still believe that building a strong reputation is easy and only requires common sense; it is merely a natural consequence of doing right by customers, employees and business partners.  This approach is flawed. Good business practices are important, even necessary, but they are not sufficient for successful reputation management. A company’s reputation needs to be actively managed by the business leaders, led by the CEO as the steward of corporate reputation. While experts such as public relations specialists may play an important role, they should not own the process. The reason is that challenges to a company’s reputation typically arise out of a specific business decision, but reputational risk awareness is not part of the decision process.

Successful reputation management is difficult. It requires a high level of strategic sophistication and mental agility that sometimes runs counter to day-to-day business decisions. A company’s reputation is shaped not just by its direct business partners, customers, and suppliers, but also by external constituencies. Frequently, constituencies that have lain dormant for many years can suddenly spring into action, particularly in the case of reputational crises. Companies need to have a process to identify such risks.

A company’s reputation consists of what others are saying about the company, and not just its business partners and customers. It is essentially public. This necessitates the ability to assume external actors’ perspectives and viewpoints, especially when they are critical or even hostile towards the company.  This requires a strategic rather than defensive approach by business leaders.  Anger or self-pity are not helpful.

A strategic approach requires the emotional fortitude to treat reputational difficulties as understandable — and even predictable — challenges that one should expect in today’s business environment. As a result, companies should handle reputational crises like any other major business challenge: based on principled leadership and supported by sophisticated processes and capabilities that are integrated with the company’s business strategy and culture.

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