Zoom in on Reputational Risk

When we talk about reputational risk, we refer to damage to a company’s name or brand resulting from the negative actions (inadvertent or not) of a top-tier supplier or sub-tier part of the supply chain. A common trigger of reputational risk can be non-adherence to, or ignorance of, domestic or international standards, regulations or legislation pertaining to issues such as forced labor, bribery, human rights and transparent labeling of goods in the food industry. These and other similar risks have increased with globalization, and reputational damage can be significant, as many cases have shown over the years.

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What causes reputational risk

The causes come from many quarters. Often they are the result of a supplier cutting costs and corners. This could be anything from a supplier failing to invest enough in the right health and safety equipment or working conditions or not disposing of waste in the official way. In severe cases of negative supplier behavior, the actions are purely criminal. And in some cases the results of non-compliance, inadequate checks and ignoring warnings can result in damage far deeper than reputational risk, as we saw with the Bangladesh Rana Plaza structural failure disaster some 10 years ago.

Other risks come from further down the supply chain, where a tier-one supplier might incorporate a contaminated ingredient or faulty part into their product in good faith. It is then the buying organization that runs the risk of reputational damage after they sell the product to their customers. It could even be that a tier-one supplier doesn’t have the right checks and balances embedded in their workflows which can lead to quality issues that ultimately can have disastrous consequences for end users and suppliers. In the Takata airbag case, as of January 2024 over 100 million airbag inflators worldwide have been recalled by more than 20 car makers, seriously damaging the reputation of several car manufacturers, not to mention the ultimate price paid by some drivers.

There has also been a considerable increase in the quantity and range of legislation that relates to social responsibility issues in the supply chain, and this also feeds into the reputation issue in its widest sense. Much of the legislation is national but can affect companies based in other countries if they work in the legislating territory or want to access its market, so few businesses can escape the consequences.

Another considerable issue is ‘conflict minerals,’ where natural resources used in the consumer electronics industry are mined under conditions that put workers at risk under a battle for control over resources. Regarding that matter, several international organizations and countries have issued directives and laws:

• UN Guiding Principles on Business and Human Rights (2011) includes a set of recommendations for companies to prevent harm and abuses through their activities. It emphasizes a company’s responsibility and suggests risk-based due diligence as a method.
• OECD Due Diligence Guidance (2011) covers responsible sourcing practices.
• Dodd-Frank Wall Street Reform and Consumer Protection Act Section 1502 (2010) is a US law that requires companies listed on US stock exchanges to be diligent regarding the source of minerals from the Democratic Republic of Congo and surrounding areas.
• The EU’s Regulation (EU) 2017/821, also known as the Conflict Minerals Regulation (2021), requires importers of tin, tantalum, tungsten and gold (3TG) to source these minerals responsibly and ensure they don’t contribute to conflict or human rights abuses.
• African Countries, including the Democratic Republic of Congo and Rwanda, have passed laws mandating companies to check their supply chains for human rights concerns.
• Chinese Due Diligence Guidelines for Responsible Mineral Supply Chains (2015) includes guidelines for responsible sourcing in China aimed at aligning Chinese company due diligence practices with international standards to allow for mutual recognition with existing international initiatives and legislations.

These directives force buyers to understand the risks and take appropriate action. They also bear the practical burden of requirements to collect data and report to the relevant authorities.

How reputational risk affects your business

Supplier negative behavior can cause:

• Loss of short-term sales: The risk requires a product to be withdrawn from sale, permanently or temporarily, as we have often seen in both the food and automotive industries.

• Interruption of supply: If a problem is discovered with a particular supplier, supply region or sector, there may be supply interruption while suppliers fix the problem or the buyer finds alternative sources of supply.

• Loss of reputation, brand equity and value: This is perhaps the risk of most concern to businesses. Even firms that are guilty by association are likely to see an effect on their reputation and brand perception, which can potentially lead to long-term brand and corporate value destruction.

• Legal action: Firms may be prosecuted via the various legislation mentioned earlier if they are seen to be complicit in what has happened in their supply chain, even if it is not necessarily their direct fault.

How to mitigate reputational risk

It is vital to create a culture of compliance and outline clear standards, specifications and employment practices for suppliers. Laws vary by country and region, so a buyer’s requirements of a supplier must sit within their local laws. The main mitigation approaches of inspecting premises and testing products are no longer enough and can be ineffective unless carried out frequently.

Supplier collaboration is making a positive impact in this area. The growing use of risk management tools means information can be shared, and users can receive alerts and triggers that indicate a potential issue before it becomes a problem. Social media is a growing source of supplier information today that is used alongside or within some of these tools. TPRM tools not only monitor issues like forced labor, working conditions and corruption; they can also alleviate the onerous task of reporting and provide compliance to the relevant regulations.

A big hurdle companies often face is that they rarely know their suppliers’ suppliers. Having agreements in place with direct suppliers that require them to report major changes down the supply chain can also help mitigate reputational risks that, especially in this case, are hard to prevent.

Conclusion

Reputational risk can be the result of ignorance, poor business practices or criminality in the supply chain. Mitigating strategies exist, but the traditional carrying out of occasional premise inspection is not enough on its own. Stricter regulations and directives today require more vigilance and reliable reporting.

It’s important to remember, however, that suppliers and the supply chain can also be used to build a positive reputation. Many organizations have improved their public image by supporting small or minority-owned firms, carrying out sustainability or ESG initiatives like forced labor/modern slavery/human rights or implementing supplier ‘Fair Trade’ policies. If reputational risk is managed well it can provide competitive advantage while mitigating issues. Essential to that, of course, is timely and relevant data.