Thursday, September 27, 2012

Conflict, Competition and Reputation--Structuring Market Behavior Within Risk or Regulatory Models

"Maintaining a strong reputation is critical for a company’s sustained success. Yet, almost every day a new crisis makes the headlines. These developments indicate a fundamental misalignment between growing reputational risk and its management." (Daniel Diermeier, The Need For Reputation Management Capabilities, The European Business Review 2012)

 (Daniel Diermeier, The Need For Reputation Management Capabilities, The European Business Review 2012)

Business is a risk taking enterprise.  And most forms have lots of competitors, each of which is delighted in enhancing their own markets at the expense of their competitors.  All enterprises have stakeholders whose interests sometimes align and sometimes conflict with those of the enterprise.  Each can affect the reputation of the others.  The new arena of conflict and competition centers on what had been a business backwater--corporate social responsibility--and its increasing significance in the economic decision making of enterprises.  This can pit national law against international standards and corporate against international regulatory frameworks. (Backer, Larry Catá, Multinational Corporations, Transnational Law: The United Nation's Norms on the Responsibilities of Transnational Corporations as Harbinger of Corporate Responsibility in International Law. Columbia Human Rights Law Review, Vol. 37, 2006).  Nonetheless, the adverse effects of business activities on social, environmental or human rights interests of others is now an important component of business operation--and is assessed in part by its reputation. Still, there is a risk to a conflation of competition and conflict with reputation stress. Where reputation enhancement involves strategies that minimize risk taking, the result can be a move from a competitive to a regulatory/managed market environment.  That change in fundamental behavior approaches of enterprises can affect the nature and character of globalization in important ways. 

Writing for the European Business Review, Daniel Diermeier, the IBM Distinguished Professor of Regulation and Competitive Practice and Director of the Ford Motor Company Center for Global Citizenship, Kellogg School of Management, Northwestern University, notes a substantiial decline in business reputation with substantial effects on a company's financial position:
 While the sources of the crisis may vary from case to case and from industry to industry, in all cases financial markets punished the companies leading to a severe and sustained erosion of their market values. Often the loss of public trust is only the beginning of a company’s troubles. Lawsuits, public hearings, and investigations soon follow. In some cases pubic officials may sense an opportunity to pursue policy agendas or occupy the role of heroes taking on corporate villains. In other cases, regulators and politicians may feel the pressure of the public to take decisive action changing competitive environments. (Daniel Diermeier, The Need For Reputation Management Capabilities, The European Business Review 2012)
That connection between reputation and performance is important.  It is a premise that underlies the effectiveness of soft law CSR and Business and Human Rights frameworks and suggests the structure of rule systems that regulate the relationships between business and its stakeholder communities. It also suggests the role of government--neither central to business operations nor entirely absent; more reactive than pro-active in the absence of crisis. Reputational risk and the "rules" for its mitigation provides a view to emerging polycentricity in governance regimes for multinational corporations especially and all enterprises in complex supply chain relationships. (Backer, Larry Catá, Inter-Systemic Harmonization and its Challenges for the Legal-State (March 17, 2011). The Law of the Future and the Future of the Law, Sam Muller, Stavros Zouridis, Laura Kistemaker and Morly Frishman, eds., Torkel Opsahi Academic Editor, 2011; The Pennsylvania State University Legal Studies Research Paper No. 13-2011)

He identifies four factors for the change in business environment and its re-focus on reputation as a proxy for performance: transparency in business culture, the development of a non-state sector monitoring apparatus, changes in consumer and investor willingness to act on their values, and the need to cultivate stakeholder communities:
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; and once an issue is on the Web, it will likely stay there forever.
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.
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 sustained impact, but reputational crises are increasingly being driven by moral outrage, whether over environmental concerns or executive perks.
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, a phenomenon recently experienced by Netflix who alienated its passionately loyal customers first with an ill-advised price hike, followed by a confused communication strategy. (Daniel Diermeier, The Need For Reputation Management Capabilities, The European Business Review 2012)
These factors identify not merely but also a governance environment in which the character of business risk has expanded and in which governance systems have grown beyond the state. (Backer, Larry Catá, Economic Globalization and the Rise of Efficient Systems of Global Private Lawmaking: Wal-Mart as Global Legislator. University of Connecticut Law Review, Vol. 39, No. 4, 2007).

The corrective, of course, involves a change of perspective and the cultivation of different governance habits.  It also requires a different approach to the calculation of risk. Diermeier focuses on the traditional markers of risk--financial and operational. "Challenges to a company’s reputation typically arise out of a specific business context and thus require management and execution as an integral part of business decisions. This is critically important for the prevention of reputational crises, which can arise as a result of any business decision, whether it involves product design, marketing strategy, the pricing model, the compensation process, or even market entry or M&A activities." (Daniel Diermeier, The Need For Reputation Management Capabilities, The European Business Review 2012).  But these concerns are as important in the area of adverse environmental, social and human rights activities of corporations.  

Consider the recent problems of Apple with its downstream supply chain manufacturer, Foxconn.  Compare Jay Greene, Riots, suicides, and other issues in Foxconn's iPhone factories, CNet Sept. 25, 2012) ("The weekend violence is the latest in a growing list of incidents that have heightened concerns over conditions in factories that make iPhones and other high-volume tech products. There have been employee suicides, explosions at two plants that make Apple gadgets, and reports of harsh working conditions. A New York Times investigation of the manufacturing of Apple products in China in January painted a picture of a company that wants to improve the workplace at its partners such as Foxconn but "falters when it conflicts with crucial supplier relationships or the fast delivery of new products."") with Cain Nunns, Apple's FoxConn factory riots haven't hurt profits, Alaska Dispatch, Sept. 26, 2012 ("These protests add to Foxconn's already dubious reputation for running its plants with military-style discipline, shoddy working conditions, forced overtime and low wages. . . . But that reputation hasn't seemed to dent the gains of those who profit most. Foxconn founder Terry Guo is one of Taiwan's richest men, and Apple is already the world's most valuable company.").

Yet the Foxconn riots make make Professor Diermeier's point.  "It’s Foxconn’s usual practice to put the blame on the workers, especially when violence occurs. By doing this it implies they are non-educated and like to fight among themselves, which legitimizes the use of military force against them. Second, it shifts the focus of discontent from the company to the workers themselves, so as to save Foxconn from publicly looking like a sweatshop,” Cheng added." (Cain Nunns, Apple's FoxConn factory riots haven't hurt profits, Alaska Dispatch, Sept. 26, 2012, quoting Yi-yi Cheng of Hong Kong-based labor rights group Students and Scholars Against Corporate Misbehavior.).  Foxconn suggests that reputational stress and its mitigation need not be harmonized with emerging human rights frameworks.  In this case, the mitigation of reputation risk may actually create incentives to deepen adverse relationships with labor, for example.  In the context of the human rights due diligence of the the U.N. Guiding Principles of Business and Human Rights, it suggests that such due diligence can be used to alert and divert human rights actions rather than to alert and mitigate.
  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. Successful reputation management therefore requires the ability to assume external actors’ perspectives and viewpoints. . . . Effective reputation management will always be challenging and, like any business skill, will require innovation and adaptation. However, appropriate capabilities can dramatically reduce the complexity of reputational challenges, help spot problems early, and assist in the development of effective strategies that are deeply integrated with the rest of the business. (Daniel Diermeier, The Need For Reputation Management Capabilities, The European Business Review 2012).
The object, then, remains centered on the enterprise, rather than on the enterprise within a web of obligations.  Norms can be used strategically and the relationship between enterprise and stakeholders can be reduced to a competition among distinctly interested competitors.  The difference from traditional markets is that operations markets now exists in multidimensional spheres: markets for profits; markets for reputation; markets for influence among governments; markets for consumer purchasing patterns; markets for secondary trading in shares; markets for media relations, etc.  Each, of course, affects the other, but none overlap completely. "An effective reputation management system requires the right strategic mind-set, supported by processes, values and culture. Reputational challenges are essentially public. They put the company on stage in an environment of intense media coverage, a highly motivated, even hostile advocacy environment, observed by a skeptical public. What looked like a good business decision a few months ago when it was done in the context of typical business processes driven by cost savings and value creation may now look highly problematic, even monstrous." (Daniel Diermeier, The Need For Reputation Management Capabilities, The European Business Review 2012).

Reduced to technique, reputation value maximization strategies must focus on efficient strategies for minimizing adverse impacts of corporate activity in a contextually driven environment in which the enterprise must balance maximization strategies among not necessarily compatible behavior norm structures.  Professor Diermeier suggests a mechanics for this purpose:
Companies must therefore recognize the reputational impact of any business decision before it is made whether they are related quality control (Toyota and Johnson & Johnson), safety (BP), product design and disclosure (Goldman Sachs), compensation (AIG), or executive conduct (HP). In all these cases, managers in departments ranging from HR to Engineering made decisions that had massive reputational consequences. . . . It emphasizes the fact that a company’s environment during a reputational crisis will look very different from its environment in normal times. In the case of AIG’s retention agreements, for example, a confidential contract between two parties faced sudden scrutiny in the glaring spotlight of 24-hour news coverage, simplified for a mass audience, with an emphasis on emotional impact and moral outrage. Advocacy groups that typically lie dormant or unorganized may jump on the stage, followed by politicians, regulators, and other officials. . . . he key to successful reputation management is that all decision makers in the organization view themselves as stewards of the company’s reputation. Proactive reputation management needs to anticipate the possibility of such developments and incorporate them into decision making. It requires a mindset that reflects an awareness that through our business decision today, we are creating the facts that will be the basis for our story tomorrow. (Daniel Diermeier, The Need For Reputation Management Capabilities, The European Business Review 2012).
Such an approach can be seamlessly integrated into enterprise decision making structures. 
One of the CEO’s main tasks is to integrate reputation management into the operational processes of the business. One approach to accomplishing this task has been to create a separate corporate function: a chief reputation officer (CRO) or chief reputational risk officer (CRRO). . . . An alternative is the creation of a corporate reputation council (CRC). This is a cross-functional unit composed of senior executives with actual decision-making authority. . . . Good governance and decision-making structures are necessary for effective reputation management, but even these alone are not sufficient.

 (Daniel Diermeier, The Need For Reputation Management Capabilities, The European Business Review 2012).
And so reputation value maximization strategies tend to mimic strategies for mitigating adverse environmental, social and human rights effects of enterprise activity.  Yet Professor Dermeier deftly shows how the process need not be bent to objectives of corporate social responsibility or respect for human rights.  What is a weapon in the hands of NGOs and other human rights and CSR motivated stakeholders in their engagement with the enterprise, pressure on reputation, becomes an object in its own right in the hands of the enterprise.  Thus reoriented, reputation enhancement can be liberated from programs of human rights due diligence to CSR objectives. This should serve as a caution for those who would design systems for enhancing the human rights and CSR practices of enterprises.

But there is a risk here as well.  business reputation is critically important.  But the maximization of enterprise value production (however that is calculated) is even more so.  Where risk management becomes central to the operations of an enterprise, where risk management becomes the core basis on which performance is assessed, the potential value maximizing utility of the enterprise itself may be put at risk. The trend toward managerialism in all aspects of organized life has been strong in recent decades.  It represents in a way both a desire to contain risk and evidence that as societries become richer they become more risk averse (e.g.Democracy Part XXV: Law as Command or Surveillance as Law in an Era of of the Mass Production of Political Organization).  The result is a better managed enterprise, but also one that is less willing to take risks and therefore more unlikely to achieve higher rewards.  The balance between risk and safety is a hard one, and also a moving target.  it is as likely a product of cultural premises as it is of the governance architectures put in place by governments and enterprises themselves.   This society appears to be moving decisively, though, to an era where risk taking is more dangerous and the management of the downside more central to operations than the attainment of the high reward at high risk.

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