Pharma’s Reputational Tornado Zone

July 10, 2018
Companies that want to differentiate themselves need to adopt new operational and risk management defenses

Reputational risk is often equated with the risk of negative media coverage and, by that definition, is simply a marketing challenge. But given its complexity, a more accurate way to define reputational risk is to consider it as the risk of economic damage from angry, frightened or disappointed stakeholders. While negative media may both precipitate and arise from the anger, companies that embrace the stakeholder-centered definition demonstrate that they understand the need to set and then meet stakeholder expectations — while knowing which operational failures will trigger economically damaging behavior.

Reputational damage has tangible, measurable economic impacts. A study by Steel City Re found the cost of reputational attacks against companies has risen by more than 500 percent over the past six years. The study found an increasing level of anger among the population and the weaponization of social media driving these losses — along with influencers ranging from activist investors to politicians who direct stakeholder anger toward specific targets.

Pharma companies that want to elevate and differentiate themselves and their leadership need to adopt new operational and risk management defenses. It’s no longer enough to simply do the right thing. Nor is it enough to rely on the communications team to fight a bad message with a good message.

Types of Reputational Risk

In pharma, just like other industries, the most prevalent operational failure underpinning reputation risk is an ethical breach by a rogue who decides to violate clearly stated policies. We’ve seen many examples of how the actions of these bad players can be devastating for their companies and for the reputation of the entire industry. Years of ethical behavior can quickly be overshadowed by one company being accused of price gouging or by the behavior of an individual like former Turing Pharmaceuticals CEO, Martin Shkreli. Reputation can also be seriously damaged by a societal issue like opioid abuse, which, in this case leads to litigation about what may or may not have been certain sales practices at a few companies.

The reputation of the pharmaceutical industry runs along two tracks. Because of a long and positive record supported by FDA regulation, its reputation for product safety is very strong. Because of that reputation, most of us accept the notion that quality or safety failures, when they occur, are anomalies and not reflective of overall product safety within the industry. In fact, stakeholders have come to expect universal safety in the products of an ethical pharmaceutical industry to such an extent that any disappointment inevitably leads to the pile on of litigators, regulators and bloggers.

Unfortunately, the industry’s reputation for corporate governance and corporate practices do not share that insulation and, in fact, the industry has been a popular target for many years among politicians, the media and public policy activists.

Now, with litigation over opioids cutting a wide swath through the industry, even well-run companies that handled their marketing practices in the most ethical way possible could still see significant reputational damage.

Changing Cultural Landscape

Social media in particular has dramatically increased the speed at which cultural change — such as those in attitude and perception of events or practices — can take hold. Issues once considered acceptable — or at least posing an acceptable level of risk — can become bright red lines at the speed of a tornado. For example, companies that have been using data acquired through Facebook for marketing efforts, may now find their own reputations at risk as a result of management flaws and faulty risk management at a company they have no control over.

An additional consideration in the current environment is the ability of outside parties to disseminate false information widely, rapidly and repeatedly. If Russians creating false identities could get people to turn out for political rallies they’d invented, how difficult would it be for a group with an agenda to cause a panic related to product safety or to undermine the reputation of an entire industry?

Proactive Reputational Risk Management

Companies need not only to have systems in place for defending against reputational attacks based on what today’s known risks are — they need to have systems in place that allow for agility and adaptability. And they need to build their defenses prospectively because, as with tornados, once the danger is on the horizon, it’s already too late.
The relationship between reputation, stakeholder expectations and enterprise value are all tightly knit and central to dealings with stakeholders by individual companies and the industry as a whole. When a company fails to meet expectations, stakeholder behavior changes and there are measurable economic consequences for the company. Market cap, sales and margins can decline, employee recruitment and retention can become more difficult and expensive, credit markets become less favorable and, perhaps most important in a highly regulated industry, government at all levels — state and federal, legislative and executive — can apply additionally burdensome pressure and public scrutiny.

[pullquote]Today’s companies must demonstrate to stakeholders that they are well governed and ethically run. Rapid analysis, decision-making and communications — as they relate to corporate reputation — will enable forward-looking companies to gain a competitive advantage over their peers as they mitigate crises so that they never occur, react to crises to contain damage, or if they are very good, leverage a crisis to create reputational value.

Real World Examples

Consider how Merck & Co.’s CEO, Ken Frazier, boosted his company’s market cap in the aftermath of the white supremacist activities in Charlottesville. Frazier resigned from President Donald Trump’s Manufacturing Advisory Council — a move supported by his board, company stakeholders and the public at large — and for the next 10 weeks, Merck outperformed the S&P 500 pharmaceutical index by about 3.5 percent. For a company of its size, that translates to creating an excess of almost $6 billion in value. And as evidenced by a surge in Google activity, this act raised Frazier’s profile very quickly in the public eye.

The success of Frazier’s move was not merely a lucky break for a well-grounded, intuitive CEO. The speed with which he responded to the president’s comments and distanced himself from the advisory council indicate that Merck had a communication, analysis and decision-making mechanism in place that enabled them to process a weekend event and make a board-level decision by Monday morning. They clearly had a risk management system built into their governance structure that could handle it. This single event put Merck in a stronger position to fend off future reputational issues. It created a clear and convincing narrative that goes far beyond one situation and projects a company that is able to adapt and move quickly in the face of approaching storm clouds.

Reputation ROI

The generalizable lesson is that there is a return on an investment in reputation risk management. And while most companies don’t have spectacular opportunities for public display, their day-to-day interactions with the capital markets could be better exploited. Analysis of how credit markets have behaved toward companies dealing with reputational issues, shows that, all things being equal, the variance between great and poor reputations can alter the cost of capital by around 80 basis points. Steel City Re’s RepuSPX index — an equity index of companies arbitraging underappreciated reputational value — has outperformed the S&P by 375 percent over the past 15 years.
Why is this so? Because the rating of bonds by credit analysts, the recommendations for equity by buy-side analysts, and the decision to prosecute by regulators are all social processes. All are influenced by stories, and when those stories speak to authentic systems for risk management, quality governance, and compliance in terms that are simple, convincing, and completely credible, there is value.

Third party warranties and insurance, throughout history, have helped tell such stories. The better known examples favorably impacted a wide arc of stakeholders and changed the course of history.

In the early days of fire insurance, for example, not every building was insurable — only those constructed according to standards that mitigated the risk and protected life and safety. Which buildings do you think were viewed as safer by tenants? Which property owners do you think were viewed as most responsible? When Hartford Steam Boiler Inspection and Insurance Company began offering insurance to riverboats in the 1860s, “inspection” was part of its name for a reason — and only those that met its standards qualified. Which vessels do you think were viewed as more desirable by travelers and shippers?

The importance of having a pre-positioned, convincing and credible narrative is exemplified by the effect Federal Deposit Insurance had on banks. Whatever threats or social media attacks target the banking sector, consumers believe their deposits are secure and don’t feel the need to start a run on the bank. Having Federal Deposit Insurance in place assuages stakeholder fear with a credible counter story: that there’s an authority saying the bank is being run well. Today, that’s the critical element of mitigating the anger, fear or disappointment of stakeholders that underpins reputational risk.

Wise companies recognize the tangible economic impact of reputational crises and the benefits these types of third party warranties can have in mitigating them. They create a predisposition in stakeholders’ minds to understand and move past an operational failure. It preconditions them to the idea that the company is dedicated to their needs and values, has identified future risks to stakeholder expectations and is doing what is ethically prudent to mitigate them. At the same time, the company also needs to manage stakeholder expectations and bridge the gap between what stakeholders expect and what the company can practically achieve.


Personalization of Reputational Attacks

This reputational risk phenomenon has another aspect — one that is very personal. When an angry public is spurred by the media, social media, activist investors and politicians, they vent their anger not only at the corporate entity, but at the individuals who lead it. Once the crisis hits, CEOs and board members very quickly begin to realize that the attacks are coming at them directly. The relationship between board and CEO can unravel quickly when millions of dollars in compensation are potentially at risk. The personalization of corporate reputational attacks has become commonplace and unfortunately, personal reputations are not as resilient as corporate ones.

As the litigation over opioids continues and pressure from the president and government agencies keeps this issue and the pricing issue front of mind, the pharmaceutical industry and its leadership remain in the spotlight. The bottom line is this: To manage reputation risk, create value, and differentiate oneself from the competition, companies must understand stakeholder expectations and the impacts associated with the failure to meet them. By building preemptive defenses, including insurance products that deter attacks by signaling strength and mitigate whatever damage occurs, companies can build storm shelters to protect against the inevitable tornados in their future.

About the Author

Dr. Nir Kossovsky | CEO