What Is Reputational Risk?
Board directors covet their company’s reputation because it’s their most valuable asset. A recent joint study by Deloitte and Forbes affirmed this conviction. Their study surveyed 300 senior-level executives who agreed that their company’s reputation held the highest area of risk to their business strategies.
A Common Example of Reputational Risk
The results make sense if we look at a common and easily identifiable example of reputational risk. Most people have a favorite local restaurant or two. They love the menu choices and the way the food is prepared. The wait staff is friendly and efficient, and it’s easy to recommend the establishment to others.
If news were suddenly to erupt about health violations at the favored restaurant or patrons who became ill after eating there, it would certainly affect the restaurant’s reputation. For the short term, the restaurant would lose business. For the long term, depending on the steps the owners took to correct the conditions, the business might bounce back in time. Failure to respond would result in the most loyal customers looking for a new favorite restaurant.
For a restaurant, not publicly declaring the steps they took to improve the health or safety conditions would constitute reputational risk. Alternatively, the same restaurant could also take proactive steps to publicize the corrected conditions in the media, which would likely help regain some of the public’s trust.
Board directors need to be aware that reputational risk spreads fast, especially when the news is negative in nature. Boards that take steps to assess their reputational risk – and take steps to manage it – may be able to effectively gain an edge over the competition.
What Can We Learn About Reputational Risk?
Nearly all industries and organizations have some level of concern over reputational risk. Reputational risk can be a difficult term to understand because it’s difficult to define. Another thing that makes reputational risk difficult is that boards can create reputational risk during the course of making strategic plans without realizing it. In making business decisions, boards need to factor in the impact of reputational risk.
According to Risk Management Magazine, organizations can categorize risk into four categories:
- Activities by employees that create risk
- Issues related to products or customers that affect risk
- Risks related to governance matters
- Miscellaneous other types of risks
Reputational risks rank higher than threats to the business model and can result in the loss of capital. The loss of reputation also ranks higher than the impact of competitors and economic trends.
Social Media and Security Can Have Huge Impacts on Reputational Risk
Social media platforms play a large role in reputational risk. In addition to more traditional print and radio ads, companies are now also subject to how the public sees them on blogs, Facebook, LinkedIn, Twitter and other social media outlets. Within the social media channels, companies need to monitor consumer reviews and comments. Boards should be discussing the potential impact of social media and how to manage it as it pertains to reputational risk and as part of their overall strategic planning activities.
Security is another major issue regarding reputational risk. Cyber breaches make headlines on a regular basis. Regulatory bodies and legislators are increasingly tightening controls to protect consumers. Public news of a cyber breach or loose security can decrease an organization’s reputation quickly.
Aligning Reputational Risk With Strategic Risk
Since reputational risk carries such a high level of concern for board directors and senior-level executives, it makes sense that boards should give reputational risk a high priority.
The main reason that many boards overlook incorporating reputational risk strategies into their overall risk strategy is because they get used to focusing on operations. Boards and managers know that they can exercise some degree of control over the quality and quantity of their products. They can also strategize on how to manage their raw materials and human resources.
Many boards fear that it’s impractical or improbable to manage reputational risk because they have less control over it. Reputational risk takes its shape from outside the organization. Managing reputational risk means managing customers, employees, stakeholders and the media. Addressing reputational risk is a challenging and worthwhile endeavor. Boards need to acquire the right sets of tools to measure, monitor and analyze it.
Being Forward-Thinking Helps to Link Strategy and Innovation With Risk Management Programs
Data analytics are a board’s best friend when it comes to interpreting the market’s response to reputation. Data analytics can help identify risks to current business models. Data analytics can also help boards find new opportunities to develop newer business models.
For many boards, the standard approach to reputational risk has been to take a look back after an organization’s reputation was negatively affected. At that point, the board was eager to ask for legal assistance and advice. In addition, board directors would also seek the advice and consultation of public relations and communications teams to help navigate any negative publicity. Boards then would get to work putting all the pieces together to strategize how to prevent a similar future incident.
In the future, boards will need to be more forward-thinking and look for clues on the outside of the organization about the health of the organization’s reputation.
Being forward-thinking means taking a look at the characteristics of the market and how their competitors are managing their reputations. Looking into the future also means taking an objective look at their products and services, and how the outside world perceives them. What does the social media noise say about the company’s culture, workplace practices, safety records, quality and pricing?
Being forward-thinking also means that board directors will need to evaluate any critical risks that hold the potential to destroy their reputation and to devalue their brand.
B2B Relationships Affect Reputational Risk
In addition to consumer and public perceptions of an organization’s reputation, business-to-business relationships can have an important effect on reputational risk. Organizations have to consider the reputations of their vendors and suppliers because it can have an overflow effect on the reputation of their own operations.
A recent example of this pertains to the Conflict Minerals Rule, which is part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The Act requires companies to identify the minerals that they use in production when they come from certain areas where the sale could finance armed groups.
Boards can tackle reputational risk effectively when they put plans in motion to address it. Technology and innovation provide the tools to aid in incorporating reputational risk protection into their strategic planning efforts. Managing reputational risk means tackling it on the front end and considering all sources of risks, including risks associated with B2B relationships. There’s a lot of buzz out there on social media. Productive boards are listening to it.