Understanding How Reputational Risks Appear in Business Environments
Executives know the importance of their companies’ reputations. Companies with positive reputations tend to also attract better people. They are perceived to offer more value, and often allows them to charge a premium. A powerful reputation makes customers more loyal and willing to buy broader ranges of products and services.
This also has an effect on investors and shareholders, as the market believes that such companies will deliver sustained earnings and future growth. Furthermore, in an economy where the market value is heavily influenced by intangible assets such as brand equity, intellectual capital, and goodwill, companies are especially vulnerable to anything that damages their reputations.
However, with the increased reputational risk, most companies don’t do enough to manage their reputations. Companies tend to focus on handling threats to their reputations that have already surfaced. This is not risk management, but crisis management — a reactive approach to mitigate the damage.
Factors of Reputational Risk
There are three things that determine the reputational risk a company is exposed to. The first is whether its reputation exceeds its true character and delivery. The second is how much external beliefs and expectations change, which can widen or narrow the gap between the reputation and reality. The third is the quality of internal coordination, which can also influence the gap.
At the foundation of managing reputational risk is understanding that reputation is a matter of perception. The reputation of a company is the overall product of its reputation among its all stakeholders — investors, customers, suppliers, employees, the communities in which the firm operates etc. in specific categories like product quality, employee satisfaction, customer service, intellectual capital or financial performance. A positive reputation is built across different channels, which form the foundation of a strong company reputation overall.
At the same time, reputation is different from the actual behavior of the company and may be better or worse. When the reputation of a company is perceived to be more positive than in reality, a wide gap becomes a risk. Eventually when the company fails to live up to expectations, its reputation will start declining until it reflects more closely the reality.
The only constant is change — this also true in the business landscape. Changing beliefs and expectations of stakeholders relative to the company is another factor in creating a reputational risk. Expectations might change, whereas the company’s behaviour stays the same — creating a reputation-reality gap that becomes a risk.
Poor Internal Coordination
Another source of reputational risk is poor coordination of the decisions made by different business units. When one department creates an expectation that another group can’t fulfil, the company’s reputation is at risk. For example, the marketing department of a software company that launches an extensive advertising campaign for a new product before developers have finished the product. The company is forced to choose between pushing an unpolished product and failing to meet the release deadline.