Reputation Risk And Reputation Risk Management Management Essay

There have been hundreds of aircraft crashes over the last ten years. The tragic catastrophes had negative impacts on the reputation of many airline companies. Whether the reputation is harmed or enhanced is generally determined by airlines’ management in handling the crisis. Management of mass fatality events in Air Industries is much more complex and difficult because of its unique features: massive sudden loss of lives, heightened and intense media attention, be it traditional or now social media, international dimensions of the crisis.

Introduction

In the last few years, a variety of crises come in different forms- strike, layoffs, products recalls or allegations of misconduct, which can make damages to the financial, aviation, food & drink retailer and computer industry. While some of this damage may seem small, they would be likelihood to damage the reputation of a company.

Reputation is considered as the most valuable intangible asset. Findings from Aon Corporation’s recent 2007 Global Risk Management Survey indicate that damage to reputation is the top risk faced by major companies. Warren Buffet said: “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.” The hard-owned reputation is much more vulnerable in 21st century, as the globalization and development of technologically interconnection make news more easily transmitted and more transparent. Once reputation is compromised, it may be costly to rebuild reputation and the period may be extremely long. What’s worse, reputation capital may never be recovered (see Figure Below).

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Reputation has becoming increasingly important to any company as the world becomes more complex. Tangible factors of business are becoming less significant and rapidly replaced by the intangible factors. The management of reputation is critical to reputation and value recovery. Reputation risk in airline industry is extremely important as the airline industry is highly competitive. Airline profit may be influenced by several factors: fuel costs, average fare level and passenger demand. The principal competitive factors in the airline industry are fares, customer service, routes served, flight schedule, types of aircraft, safety record and reputation (JetBlue, 2008). Mass fatality events such as airline crashes are too frequent tragic events which should be faced by airline industry. Though al airlines tried their best to avoid any crashes, it is an obvious hazard of the industry. The effects of an air crash in the firm’s reputation may be extremely destructive.

This paper is mainly focus on the risk management in airline industry when facing mass fatality event and seek to identify the key drivers of value recovery following an air crash. This paper is organized into five main parts. Literature review of reputation, reputation risk and reputation risk management is presented in the next part. Method is presented in the part three. Part four is mainly about evaluating the effectiveness of Air France in dealing with the AF 447 crash. Part five will give the unique feature of mass fatality events after evaluating the eight air crashes in 2010. The discussion of impact of specialist service firm takes place in part six. Conclusion and recommendation comprise the last part of this paper.

Literature Review:

Reputation, reputation risk and reputation risk management

“Reputation is an accumulation of perceptions and opinions about an organization that reside in the consciousness of its stakeholders.” Though reputation is considered as an intangible asset which will not be presented in any balance sheet, it will represent the market value (Jenny Rayner, 2009). Research from The Economist Intelligence Unit 2005 indicates reputation is the most valuable asset in the capitalist economy. Reputation, as a highly vulnerable asset is becoming more and more critical. A research conducted by The Conference Board Business Information Service on business magazines and academic journals indicates that people pay more attention on the reputation, as the data shows the number of publications including ( in their title or abstract) the phrases “corporate reputation” and “reputation risk” has more than doubled since the year 2000. ( Matteo Tonello, 2007)

According to Rayner (2009), the seven drivers of reputation:

Financial performance and long-term investment value: A company that demonstrates a consistent financial performance is deemed a reputable company and, therefore, a safe investment.

Corporate governance and leadership: The effective corporate governance of the business helps to safeguard the company’s reputation.

Delivering customer promise: Companies have to maintain customer expectation, so as to maintain a good reputation.

Workplace talent and culture: Employees must be satisfied with their working environment so as to exalt the company name.

Corporate social responsibility: companies can benefit from a good reputation if they demonstrate a commitment to corporate social responsibility.

Communications and crisis management¼šA company must have a contingency plan in place, in order to deal with any crisis, so as to maintain company reputation.

A reputation risk occurs when the negative information or business events are transmitted publicly, which makes damage to the company’s reputation capital and has a negative impact on the value of the company. Its “compounded” nature which will distinguishes reputation risk from other types of risks makes reputation more critical (Matteo Tenello, 2007). Research from The Economist Intelligence Unit also qualifies reputation risk as a “risk of risks”. Usually reputation risk is treated as negative threats or having downside impact, however it also may bring positive impact. Jenny Rayner defines reputation risk as “Any action, event or situation that could adversely or beneficially impact on organization’s reputation.” Some of airline companies such as Easy Jet, Virgin Airlines and Lufthansa enhanced their reputation by developing green technologies ( energy-efficient and bio fuel). These top three most Eco-Friendly Airlines gain the competitive advantage in the airline industry, though climate change is a potential business threat. (Stewart, 2009)

Airlines industry is becoming more and more complex, as the air transportation market becomes more competitive. The air transport business is sensitive to changes in fuel costs, average fare levels and passenger demand. Airlines are exposed to the risk to mass fatality events. It is very important for airline management to implement Enterprise Risk management and ERM implementation will help the airline managers to manage the risk and apply strategy (Ayse Kucuk Yilmaz). Another research about strategic management in the airline business points out that “airline industry operate in a highly dynamic environment where various legal, social, technological and economic forces interact with each other.” A new Enterprise Sustainability Risk Management Framework is designed to help airline managers to establish a holistic and systematic sustainability risk management process that generates the risk indicators, risk sources, objectives and reporting system (Ayse Kucuk Yilmaz). Enterprise Risk Management is defined as “a process, affected by an entity’s board of directors, management and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives.” Benchmarking Survey 2008 indicates that Enterprise Risk Management Implementation has becoming more and more critical and requisite- almost 70% of companies have ERM process and function. The three main benefits of ERM process and activity is “Better control of uncertainty, loss avoidance and better conformity of achieving organization’s objectives.”

Enterprise Risk Management integrated Framework (ERMIF) is developed by the Committee of Sponsoring Organizations (COSO) of the Treadway Commissions. Jeffrey T.Resnick points out that “ERMIF framework can help companies identify the event/issue categories which must be considered in the building of any robust risk-management system, including reputation.” According to Jeffery T.Resnick (2006) the eight phase of the reputation audit process are:

Identify Reputational Risk Elements & Stakeholders

Prioritize Elements & Stakeholders

Inventory Available Reputation Information & Identify Information Gaps

Design Audit Instruments & Methodology

Conduct Audit

Consolidate Findings and Report to Management

Develop Draft Solutions Document & Implement

Create & Implement Reputation Monitoring Programs

In his paper, the eight phases are integrated seamlessly into the Enterprise Risk Management Integrated Framework. Once reputation events are identified in the initial reputation audit, it still needs to be reevaluated. Generally, the duration of previous audit is two years and the audit should be reviewed after two years. How often the audit be revaluated depends on how dynamic environment the industry operate in. An industry which operates in a more highly dynamic environment should review its reputation audit mote frequently. (Jeffrey T.Resnick, 2006)

Effective identification of risk and effective response plan are regarded as two fundamental disciplines to manage reputation risk. Effective identification of risk can expose those risks or threats to reputation, which will help the risk managers to reduce them into an acceptable level. Effective response will work when negative events occurs, which will diminish the damage to reputation (Protiviti, 2012). Reputation Risk Management can not be regards as crisis management planning. It is not a specialist function to be active when emergency occurs. Holistically operating Reputation Risk Management will have effective impact on the organization’s actions, behavior and standards (David Davies). Jeffrey T.Resnick (2006) states that the protection against the most potentially damaging reputational events must be proactive, not just reactive.

Efficient market hypothesis is often used to observe the stock performance after the new information is known by public. Efficient market hypothesis asserts that the price of the stock reflects the available information. The price fluctuation after an air crash can also be explained by the efficient market hypothesis. The research on the relationship between air crash-stock market performance and the aviation disaster fatality finds that the number of deaths in an aviation disaster has a negative effect on the market value of the crash airline. Compared with the non-crash airlines, the loss of market value of crash airlines is much higher by the air crashes. It is obvious that the stock price of the airlines will reflect a decrease after an increase in fatalities, regardless of the degree of fatalities. However, the degree of fatalities is the key factor that determines the market value of the non-crash airlines after an air crash occurs. The switching effect, which means the passengers begin to consider switching to other non-crash airlines from the crash airlines, will make the non-crash airlines benefit from the misfortune of the airlines when the number of deaths in an accident is lower than 10. However, when the number of deaths in an accident in more than 10, the spillover effect will occur and lead to a decrease in the stock prices of the non-crash airlines. The degree of fatalities in an air crash reflects people’s anxiety following aviation disasters and reinforces the negative impact of an air crash on the performance of the stocks of the airlines. (Ho, Qiu and Tang, 2011)

“Share prices respond to new information and, as crisis breaks, the additional information is used by analysts to re-estimate the future cash flows they expect from a firm” (Oxford Metrica, 2011). According to Oxford Metrica, a value reactionTM of zero is represented as a market without any crisis. There will be two possible value reactions in one calendar year (261 trading days) following the crises. The two different value paths are classified as recoveries and Non-recoveries. In the first few trading days, the new shocking information about the crashes are transmitted to the public and there will be a directly and immediately decrease in their share prices. The additional information about a firm and its managerial talent in dealing with the unexpected and extreme will be received by the public. Good management of the crisis will increase the confidence of the investors and thus results in a upgrade in the value of the firm. However, poor management of the crisis will have an exacerbated impact in value. (Oxford Metrica, 2011)

Methodology:

This study is based on secondary research that looked at scholarly research on reputation risk management in airline industries. This research studies eight airplane crashes during 2010 and discussed the unique features of mass fatality events in airlines. As some of these articles offered a list of lessons to be learned after an air crash, this study did a thematic analysis and synthesized the finding s of the research to come up with a list that identifies elements of best practices, these elements were used as criteria to evaluate the effectiveness of Air France in handing the AF447 crash.

4. Case study of airline crashes:

Air France

On 01 June 2009, Air France Airbus A330-200 crashed into the sea while on transatlantic flight from Rio de Janeiro-Galeao International Airport, RJ(GIG) to Paris-Charles de Gaulle Airport(CDG). All 216 passengers and 12 crew members were killed after a chain of events triggered by ice crystals blocking the plane’s pitot tubes, which provide airspeed readings to the pilots. The airplane was in contact with the Brazilian ATLANTICO control centre on the INTOL- SALPU- ORARO- TASIL route at FL350. At around 2 h 02, the Captain left the cockpit. At around 2 h 08, the crew made a course change of 12 degrees to the left, probably to avoid returns detected by the weather radar.

At 2 h 10 min 05, likely following the obstruction of the Pitot probes by ice crystals, the speed indications were incorrect and some automatic systems disconnected. The airplane’s flight path was not controlled by the two copilots. They were rejoined 1 minute 30 later by the Captain, while the airplane was in a stall situation that lasted until the impact with the sea at 2 h 14 min 28.

The search crews operated by Brazil, France, the United States and Spain started to search the victims after the crash. (“Brazil Calls Off Search,” 2009) Twenty days later, and after 51 bodies had been recovered, the search operation for more victims” bodies was called off by the reasons that the location where flight 447 went down was in 13,000 feet of water and mountain terrain underwater. (Potter, 2009)

The final official report was released on 05 July 2012. According to the final report, the accident resulted from the following succession of events:

Temporary inconsistency between the airspeed measurements, likely following the obstruction of the Pitot probes by ice crystals that, in particular, caused the autopilot disconnection and the reconfiguration to alternate law;

Inappropriate control inputs that destabilized the flight path;

The lack of any link by the crew between the loss of indicated speeds called out and the appropriate procedure;

The late identification by the PNF of the deviation from the flight path and the insufficient correction applied by the PF;

The crew not identifying the approach to stall, their lack of immediate response and the exit from the flight envelope;

The crew’s failure to diagnose the stall situation and consequently a lack of inputs that would have made it possible to recover from it.

The company made an advance payment of approximately 17,500 Euros to each victim’s family and did not dispute the figures initially put forward by lawyers and insurers.

Source: Yahoo Finance

The share price recovery of Air France is hampered by the financial crisis from November2009 to June 2010. In spite of the financial crisis, Air France made an impressive recovery from the disaster. Air France shares recover strongly and over 20 percent of value is generated for shareholders before February 2010.

Attributes of Air France’s response which drove the share price recovery can be concluded as:

Air France takes a rapid and credible action:

Air France immediately activated its crisis communication plan to manage priorities: looking after the victims’ families and issuing initial information after Air France’s technical operation center had realized that AF447 crashed into the Atlantic on June 1, 2009. Air France immediately activated a dark website http://alphasite.airfrance.com/en/s01/ dedicated to providing information to the victims’ families and the media. Six press releases were issued by the company between 13:21 and 20:30 local time, updating the information of the plane, confirming the information of the passengers who were on board flight AF 447, establishing a special toll-free number for the victims’ families or friends to call from France, Brazil and other countries, expressing deepest sympathy to the relatives and friends of the victims and offering medical and psychological assistance to the families and friends of the victims. Air France also stated that all the information in its possession on the disappearance of flight AF447 had been sent to French Accident Investigations Bureau for civil aviation (BEA) and the Aircraft manufacturer Airbus.

Air France also showed its resolute commitment to safe improvement and to compensation. The company made an advance payment of approximately 17,500 Euros to each victim’s family and did not dispute the figures initially put forward by lawyers and insurers. Air France provided an update about the replacement of the Pitot sensors on its fleet of A330s and A340s on July 31, 2009, which was recommended by Airbus. (Pitot Sensors, Press Releases, 2009)

Air France performs sensitive, accurate and transparent communication:

Air France has adapted an open and direct communication strategy. Its immediate six press releases not only updated frequently, but also provided accurate information of plane, passengers and crew. The frequent updating press illustrates Air France’s transparency in dealing with this crisis. The company kept in doing everything possible to investigate the causes of the crash before the investigating agency issues its report. When Air France’s CEO met with members from the AJPAE (French Professional Aviation and Space Journalists Association), he announced that the investigation would be “long and difficult” given the location of the accident. (Press Releases, 2009, Meeting of the Chief Executive Officer with the AJPAE, para.4) Assumptions about the possible causes of the crash were pure speculation before report issued by investigating agency. Air France also adapted two-way communication by establishing a special toll-free number for the victims’ families or friends, meanwhile by offering psychological and medical support. (Press Releases, 2009)

Air France showed Empathy and compassion in dealing with the crisis:

Air France was immediate in their expression of compassion over the tragedy, and focused their resource on recovering and identifying the victims and assisting their families and friends. A medical and psychological assistance unit has been set at Paris-Charles De Gaulle 2 and Rio de Janeiro airport for the families and friends of the victims. Meanwhile Air France has kept in showing and communicating compassion, sympathy and concern to the families’ losses. The frequently updating press releases continued emphasizing the company’s “anxiety,” “distress” and “deepest sympathy” to the mourning families. An interreligious ceremony for the relatives and friends of the victims was held on June 3, at 4 p.m. at Notre-Dame Cathedral in Paris. At the same time, two memos were issued by Air France to ask journalists to respect the privacy of the families staying at the hotels of CDG Airport and inform them that they could not attend the religious ceremony out of respect the families’ grief. (Press Releases, 2009)

Strong personal leadership of the Chief Executive:

Research by the Oxford Metrica makes a conclusion that leadership skills of the Chief Executive are the most important factor that will influence the response. “Strong personal leadership is absolutely critical to the recovery of an airline’s reputation an value (Oxford Metrica, 2010). Air France’s CEO Pierre-Henri Guorgeon, who had joined the Air France Group only five months before the AF447 crash, showed his strong personal leadership in dealing with this extremely difficult exercise. He gave the company’s first public statement in a press conference held at 1p.m at Rossy (Hichri, 2009). His speech highlighted his company’s deepest sympathy and pain to the relatives and friends of the victims and resolute commitment to investigate the cause of the crash. On June 11, 2009, Air France CEO met with members from the AJPAE (French Professional Aviation and Space Journalists Association) to discuss the current situation and outlook for air transport. His successful respond to the media not only reiterated that assumptions made by some media were pure speculation but also expressed the company’s deepest sympathy and commitment to investigate the cause of the crash. Air France’s CEO met with the families of the victims in Brazil and attended a mass held at the Church of the Immaculate Conception in memory of the crash victims. His impressive respond to the media and action to the victims’ families showed Air France’s commitment to do everything they could to investigate the cause of the crash, to help the victims’ families and to improve safety. This gave investors confidence in Air France’s ability to deal effectively with the aftermath.

Unique features of Mass Fatality Events in Airlines:

Natural catastrophes and man-made disasters claimed nearly 304000 victims and resulted in economic losses of close to USD 218 billion in 2010. 304 catastrophic events occurred, including 167 natural catastrophes and 137 man-made disasters. The total number of victims of natural catastrophic events is 297127, which is about 97.9 percent of the total number of victims, while about 6446 people were victims of man-made disasters. Earthquake is the deadliest event in 2010 which claimed 227050 lives and losses caused by earthquake accounted for almost one-third of all insured losses in 2010. (See Table Below)

Man-made disasters are subdivided into the following categories: major fires and explosions, aviation and space disasters, shipping disasters, rail disasters, mining accidents, collapse of buildings/bridges and miscellaneous (including terrorism). 16 aviation disasters occurred in 2010, resulting in 820 victims and additional insured losses of more than USD 1 billion.

Peril

Date

Events

Firms

Fatalities

Aviation disaster

2010

16

16

820

Major explosions

2010

27

27

783

Rail disasters

2010

7

7

330

Total

50

50

1933

Source:….

Compared with low fatality events, mass fatality events usually lead to a sudden loss of mass lives, which will gather much more heightened and intense media attentions. Research by Oxford Metrica found that compared with the corporate catastrophes in general, mass fatality events have double the impact on shareholder value. In further, good management of a mass fatality event is even more impressive to investors, and on the contrary, the inability to manage such events is even more disappointing, than in less tragic corporate crises. The second finding is that “the market makes a rapid judgment on whether it expects reputation to be damaged or enhanced by a crisis. However, shocking news takes time to be digested and, in the case of mass fatality events, the multiplier effect on value takes, on average, 100 trading days to emerge prominently. The third finding is that strong leadership of senior management and honest and transparent communications are the two most critical factors that determine the value recovery of a company faced with non-fatal reputation crises. According to the research by Oxford Metrica, honesty, sensitivity and compassion with which management responds to mass fatality events are much more paramount. Furthermore, Oxford Metrica mentioned that the engagement of specialist services will contribute to the value recovery.

Mass fatality events in Air Industries are much more complex because of its unique features. These features are massive sudden loss of lives, heightened and intense media attention, be it traditional or now social media, international dimensions of the crisis.

Date

Country/Place

Type

Operator

Engines

Number of Victims

25-JAN-2010

Mediterranean

Sea, Lebanon

Boeing 737-8AS (WL)

Ethiopian Airlines

2

CFMI CFM56-7B27

90 dead

10-APR-2010

Russia Smolensk

Tupolev 154M

Polish Air Force

3

Soloviev D-30KU-154-II

96 dead

12-MAY-2010

Libya Tripoli International Airport

Airbus A330-202

Afriqiyah Airways

2

General Electric CF6-80E1A3

103 dead

1 injured

17-MAY-2010

Afghanistan

Hindu Kush Mountains, Salang Pass

Antonov 24B

Pamir Airways

2

Ivchenko AI-24

44 dead

22-MAY-2010

India Managalore-Bajpe Airport

Boeing 737-8HG¼ˆWL¼‰

Air India Express

2

CFMI CFM56-7B27/3

158 dead

8 injured

28-JUL-2010

Pakistan Islamabad

Airbus A321-231

Airblue

2

IAE V2533-A5

152 dead

24-AUG-2010

China

Yichun Lindu Airport

EMbraer ERJ-190LR

Henan Airlines

2

General Electric CF34-10E5

42 dead

04-NOV-2010

Cuba Guasimal

ATR-72-212

Aerocaribbean

2

Pratt & Whitney Canada PW127

68 dead

Source:

There are a total number of 144 air crashes in 2010(From Aviation Safety Network). This table shows the Air crashes occurred during the year 2010 with number of fatality more than 40. Four of the total eight air crashes occurred with aircraft manufacturers: Airbus and Boeing, both of which are world’s leading aircraft manufacturers. Airline crashes are all too frequent tragic events. In the context of the volume of air traffic, they are actually rather unusual events. The massive sudden loss of lives will gather heightened and intense media attention. The globalization and development of technologically interconnection make news more easily transmitted and more transparent. The information of air crashes could be easily found by internet. Media is becoming very important in disseminating information to the public before or after a crisis. After a crash, saturation in news coverage goes on for days. The public witness horrifying images of death and anguish taken within minutes of a crash. The TV news reports on dramatic shots such as collapsing family members who have lost relatives in an air crash (Pinsdorf, 1991). According to David Fuscus1, the media is becoming more interested in covering airlines news. Roger Cobb and David Primo conclude that the number of victims in the accident and its proximity to metropolitan determines the extent to which the media covers the accident after analyzing three airline accidents of US Air, Value Jet and TWA (Caldwell, 2004). An international demission of air crash will gather much more attention than a general crash. The nationalities of victims on flight Air France 447 were confirmed on 01 June 2009. They were from 33 countries; most of them were from France, Brazil, Germany, Italy, China and America (Press Release, 2009). The media from these countries would cover the news of this crash after the crash; the pressure from the public would be unprecedented.

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Mass fatality events in Airline industry are unique, because the sudden air crashes would not only have a negative effect on the airline operator but also on the aircraft manufacturers and engine manufacturers. Furthermore, air crashes by one operator will also influence its competitors. In a word, airlines compete on customers, but cooperate on safety. Specifically, the airline industry is highly competitive. Airline profits are sensitive to even slight changes in fuel costs, average fare levels, and passenger demand. Passenger demand and fare levels historically have been influenced by, among other things, the general state of the economy, international events, industry capacity, seasonality, and pricing actions taken by other airlines. The principal competitive factors in the airline industry are fares, customer service, routes served, flight schedules, types of aircraft, safety record and reputation, code-sharing relationships, capacity, in-flight entertainment systems and frequent flyer programs (JetBlue, 2008).

Main Aircraft Engine Manufacturers

Main Aircraft Manufacturers

Pratt & Whitney

Airbus

Rolls-Royce

Boeing

Armstrong Siddeley

Bombardier

General Motors

Cessna

CFM International

Dassault

De Hacilland

Embraer

Ford Moter Company

Gulfstream

Chevrolet

Hawker Beechcraft

Electric Company

Learjet

Source:

Operator

Number of Airbus

Number of Boeing

easyJet

244

89

British Airways

120

376

Air France

299

212

Lufthansa

294

240

Virgin Atlantic

35

33

Source:

The table indicates the main aircraft engine manufactures and aircraft manufacturers in the world. Airbus and Boeing aircraft are widely owned by most of large airline companies. Table 2 illustrates the number of Airbus and Boeing aircraft owned by the 5 operators. It shows Airbus and Boeing aircraft are the top-2 most frequent aircraft that used in commercial lines. In the report of Snecma, it points out that the world’s best selling engine CFM56 turbofan family, which is developed, produced and marketed through subsidiary CFM International, equally owned with General Electric has been powered more than 6,200 Airbus and Boeing aircraft. CFM56 engines hold nearly 50% of the engine market for all mainline jets (over 100 seats). This means the same type of Airbus or Boeing with the same engine is likelihood to be owned by more than one Airline Company. As mentioned in report of JetBlue, safety record is one of the competitor factors. The air crash of an Airbus aircraft with operator Air France will not only have a negative effect on the Air France but also have a negative effect on the other operators who had the same type of Airbus aircraft. Passenger would be worried about the safety of the same aircraft after the air cr