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Cost of a bad rep

Companies are expected to report on less tangible assets, such as brands. But can FDs value how reputation impacts the bottom line? Peter Crush investigates

EVERYONE AGREES that, in business, reputation is everything. Growing reputations can resuscitate firms in an instant, but as tech giant Sony recently found – when the personal details of 77 million gamers were recently compromised (see box) – reputational knocks can cripple corporations just as fast.

As effects of a worsened reputation become ever-more obvious, so are calls for reputation to be financially reported as an intangible asset on a company’s balance sheet.

“All FTSE-100 companies should be acknowledging the yearly change – positive or negative – in their reputations and report accordingly,” says Spencer Fox, MD of the Reputation Institute, which in May published its index of the UK’s most reputable companies, according to consumer opinion. “Reputation is now the biggest driver of value. We predict that public opinion and investors will force reputation to be routinely reported within the next five years.”

The Companies Act already requires finance directors to report on concepts such as principal risk and, when it was introduced into the Financial Reporting Council’s Corporate Governance Code in March 2011, significant risk. However, these are factors that affect reputation and experts are divided about how trying to work out the contribution that reputation makes to a company’s value could, or should, be done.

“Reputation first came on the radar during the takeovers of the 1980s,” says Garry Honey, visiting professor of risk at Plymouth University School of Management. “It was when the likes of KPMG – where I worked at the time – tried to calculate the value ‘goodwill’ has as an extra asset on the balance sheet. But even back then we were never comfortable with it, and although there is growing pressure to try to report it now, FDs still don’t know how to do it.”

While Honey concedes that reputation is a value that “FDs should recognise and try to articulate”, attempting to give it a monetary value is impossible: “If you could do that, insurance products would exist for companies to insure themselves against a fall in reputation, but the principle of moral hazard involved makes this impossible.”

Up to a point, others do not agree. Marketing experts argue that ‘brand valuation’ has become a common measure, with reputation simply a constituent part of the value of a brand.

“Royalty reliefs, as part of a discounted cashflow analysis, are an accountant-accepted formula for valuing a brand,” says Mike Rocha, MD of consultancy Brand Finance. “When looking at reputation loss, you can see how the brand rating score would reduce the royalty someone would be willing to pay.”

Brand baggage

According to Brand Finance, Toyota (which last year had to recall 1.5 million cars), had a pre-recall estimated brand value of $27.3bn (£16.8bn). Some $3bn was wiped off after this, which Rocha says is the reputational ‘cost’ expressed financially. He says the impact this loss in reputation has on future growth can also be factored in.

“By our calculations, BP’s brand value halved after the Gulf of Mexico spill. This was reflected in its share price. We’ve recalculated it since and it’s improved – today’s share price confirms this,” he says.

“What’s subjective, is how people define ‘brand’ and ‘reputation’. We’re not saying you can’t put a price on reputation, but ultimately the proportion of a brand’s value driven by reputation will differ between products and sectors.”

So is there really an answer, and are FDs themselves actually interested in yet another reporting measure?

“There’s definitely a link between reputation and business performance,” says Fox at the Reputation Institute. “Our research proves that if a company improves its reputation index score by four points, it will increase stakeholder supportive behaviours by 6%.”

Fox says that 70% of consumers would recommend the Reputation Institute’s top 10 ranked companies to friends – these include Boots, M&S, Mothercare and John Lewis – compared with just 43% of those in the bottom 10. Moreover, those with a history of good reputation are also better equipped for surviving threats.

“Some 70% say they would give a company ranked in the top 10 ‘the benefit of the doubt’ when facing a crisis, compared with 43% for those in the bottom 10 [which included BP, RBS, Network Rail, Thames Water and Southern Water],” he says.

BT chief medical officer Paul Litchfield, also chairman of Business in the Community’s Workwell Steering Group, which has successfully campaigned for businesses to report wellness on annual reports, says: “Whether they like it or not, FDs need to work out ways in which to verbalise reputation, because more reporting on less tangible assets is being demanded.”

But it is precisely because reputation means different things to different groups of stakeholders that any attempt to record it cannot be one size fits all, according to My-Linh Ngo, associate director of sustainable and responsible investment at Henderson Global Investors, a consultancy that values other businesses.

“Companies aren’t islands, so we measure all the factors we think affect reputation, including corporate standards, its supply chain, CSR pledges and its contracts with staff,” she says.

Significantly, though, she says companies that do not openly report the data it needs are already starting to be viewed adversely.

“Looking at what a company reports reflects a certain mindset, and if something is missing it indicates they don’t think it’s an issue,” she says. “This makes us wary because it may well hide the fact that certain policies aren’t working.”

Value driver

Linh Ngo concedes reputation is a subject where the challenge is first about definition, rather than measurement per se.

“Some companies already report on issues that feed into what their reputation might be, but they don’t necessarily think about them in that light,” she says. This might explain why companies prefer to rate themselves around metrics they deem to be reputation standards of sorts – such as their employee or customer satisfaction surveys. Others, such as the likes of Sky, M&S and GSK, report on where they sit on well-revered indexes such as the Dow Jones Sustainability Index.

Kevin Goodall, FD of business continuity company Assist, says: “We have attempted to look at how we value our reputation, because we see it as an asset we can use to grow the business, but it is extremely difficult to come up with any sort of formula. As such, we have tended to promote aspects, such as our customer satisfaction, repeat business and technical accreditation [Assist is a Gold-standard Citrix provider].”

According to frozen foods company Birds Eye, which in the past has had reputation issues but is now one of the best-improving companies in the Reputation Institute’s top 100, reputation is still something it admits it is not entirely clear about reporting, but sees it as something it is addressing. Last year, it launched a marketing campaign that pledged to reduce water consumption in manufacturing by 20% and reduce CO2 emissions by 30% by 2020, as well as send zero waste to landfill by 2015 and source 100% of its fish from certified fisheries.

“We recognise that our success relies on how we are perceived as a business,” says its finance spokesperson. “While we know a good reputation can earn a business trust and loyalty from its consumers, we do not put a ‘value’ on reputation. We don’t think we can.”

Birds Eye simply accepts that it knows reputation is an “invaluable commodity that has the power to affect the bottom line”. Garry Honey says: “What I’d like to see is FDs report something that says, ‘I understand reputation is intangible, but here’s what we’ve been trying to do to offset it,’ as FDs are really charged with managing the risk to which they expose their company.”

This may not be enough, though. “For any corporation it makes sense to try to report to shareholders the strength of its reputation,” says Dave Allen, founder of brand consultancy BrandPie. “It is a precious asset, and the discipline of reporting on its value to an agreed formula will help investors understand how well the management team is performing.” Could a formula be forthcoming? Some say yes.

“FDs need to get into the ‘blended returns’ space,” argues Geoff Burnard, chief investment officer of Charity Bank. Charity Bank only lends to companies it assesses make a difference to the communities in which they are based. It has lent £150m in the past 10 years by applying a set of conditions to companies, including rating their governance and CSR. But Burnard argues FDs must agree to work with independent bodies to ensure the drivers of reputation are assessed impartially.

“Investors and consumers are suspicious of self-accredited reporting because there is always a sense that companies are manipulating the data. Although some social governance standards are more stringent, there’s still a sense that corporations are one step ahead of the true picture,” he says. “Fortunately, I believe stakeholders will be asking more questions about what a company is doing, be it with its supply chain or employees.”

Rocha adds: “The demand is clearly there for brave FDs to disclose across their key stakeholders. Many are not keen, but pressure is building year on year. We haven’t reached the tipping point yet, but lots of companies, including Vodafone, Tata and HSBC, are now reporting on the value of their brand. Reputation is sure to follow next. The challenge for FDs is to define it first, then be confident about not reducing it to a single number.” ?

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