The advantage to mankind of being able to trust one another penetrates into every crevice and cranny of human life: the economical is perhaps the smallest part of it, yet even this is incalculable.
John Stuart Mill(1848)
“A basic duty of every organization is to earn stakeholder trust.”
Our hypotheses are that 1) while cultures and levels of economic development may vary widely, trust is defined by universally shared attributes, sometimes summarized as “character” and “competence”; 2) ethical values are aligned with these attributes; and 3) therefore trust is a reliable proxy for evaluating ethical behavior.
Business leaders intuitively understand that trust is important. Nearly 70% of respondents to the PwC 17th Annual Global CEO Survey (2014) agreed that the purpose of the business is to balance the interests of all stakeholders.[iii] This survey showed that more than 50% of CEOs surveyed regard trust as a major concern and that the absence of trust constitutes a real threat for growth, a sharp rise from 37% who cited concerns last year.[iv] Their concern, however, has not lead to concerted efforts to generate trust. The World Economic Forum frames today’s trust agenda: “What is required is a common understanding that aligns expectations [between business and society], and clarifies business’s wider role and purpose beyond the creation of financial value. It is this understanding that will foster and rebuild trust. Efforts to close the trust gap . . . face two key challenges: 1. The absence of a clear business case . . . [and] 2. . . . a fundamental disconnect between how the public and business understand ‘trust.’”[v]
In this post we propose to address the first challenge identified by the World Economic Forum. An individual business may or may not care about the benefits that flow from trustworthy systems and a strong ethical climate (which we will address in another post) but it must care about its own bottom line. A strong business case does exist, at the firm level, for generating stakeholder trust. In particular:
- A buyer’s/investor’s economic decisions are not solely based on financial considerations; trust also plays a significant role.[vi]
- Businesses do not have to choose between financial value and stakeholder trust. Companies that earn trust also have better financial results. This means that rather than creating costs and interfering with business, as some believe, business ethics and trust are in fact a profitable strategy.
- Stakeholder voices, thanks to the internet and social media, are an increasingly influential source of information for the public. An organization’s future success will depend more than ever on understanding and responding to these voices.
Our primary focus is on business and its stakeholders, defined as small and large groups affected by the business – groups such as customers, employees, creditors, suppliers, investors, community, and even government. Research described below is primarily based on the experience of large Western business organizations. However, while this paper will concentrate on business, the stakeholder trust principle applies to any culture and any organization, including government, academia, NGOs.
Trust and Reputation
Reputation Institute’s 2015 Global RepTrak®100 describes reputation as a function of trust and reports that “[r]eputation predicts all forms of [public] support”, including “would buy the product, would say something positive, would recommend the products, would trust to do the right thing, would work for, would invest in.”[vii]
A purchase price acquisition study suggests that about 1/3 of the average price is goodwill.[viii] Two firms have recently undertaken the challenge of quantifying the impact of reputation on share price; their independent analyses produced very similar results. One concludes that for firms in the Standard & Poor's 500 Index, reputation currently accounts for an average of 31% of share price.[ix] Another organization reports that “as of 1 January 2012 [corporate reputations] accounted for close to 26% of the total market capitalization of the S&P500” and concludes that “reputation therefore is a useful leading indicator of investment risk. In most cases, 91% of companies, reputation is having a positive impact and creating shareholder value. In the remaining 9% it is destroying value . . . a notional 5% improvement in the strength of an extant reputation would yield a market capitalization growth of 2.5% in a company in the S&P500 and 2.2% in one in the FTSE100.”[x]
Firms should not assume that strong financial performance alone generates a strong reputation. TheWorld Economic Forum 2015 research ranked financial returns last of ten factors critical to reputation (39%), while trust is one of the top four factors (65%).[xi] By 2013, trust was the primary driver of corporate reputation, replacing “operational excellence” (“admired top leadership, globally ranked as a top company, consistent financial returns”), which dropped from 76% in 2008 to 39% in 2013. These operational qualities are still important but are considered fundamental competencies rather than distinguishing characteristics.[xii]
Stakeholder prioritization of behavior over product is illustrated by the fact that an operational crisis, such as a product recall, will result in a share price drop of an average of 37% on day one, while a behavioural crises, such as bribery and corruption issues, produces much sharper declines: initial share price falls averaging 50%-plus, and many companies will still suffer declines more than a year after the event. “The study also found that behavioural crises also accounted for 40% of incidents where leaders resigned.”[xiii]
A business’s reputation is particularly important as a bulwark against the risk of contagion due to a decline in trust in its industry. The 2015 World Economic Forum study reports that “those with stronger trust appear to have weathered recent challenges [for example, the 2008 financial crisis] better than those who lacked it.”[xiv] Evidence of the firewall benefits of trust are reported by the Edelman Trust Barometer: when a company is trusted, negative information reported 1-2 times will be believed by only 25%, while for a distrusted company, the information will be accepted by 57%.[xv]
Two Stakeholder Groups and Value Creation
We recognize that the research discussed above does not specifically explore stakeholder trust. We suggest, however, that the bulk of a firm’s reputation is based on its interactions with stakeholders. This is increasingly true given the technological platform that stakeholders now have to make public their interactions. Before the internet provided such platforms, a company’s communication with the public was mostly initiated by the company itself. In the “internet-and social-media-enabled goldfish bowl where companies now operate,”[xvi] stakeholder voices are increasingly available, through customer product ratings, comments on various websites, etc.
Each organization has its own unique sets of stakeholders. Most, however, have at least two stakeholder groups in common: “customers” (recipients of organization’s activity) and employees. Research on trust within each of these stakeholder groups supports the business case for generating stakeholder trust. Trust by employees may create the greatest value, partly because it influences the level of trust held by other stakeholder groups[xvii]; but creating trust in customers is also valuable and will likely contribute to a firm’s bottom line. We will first discuss customers and then turn to employees.
(NOTE: This analysis will focus on commercial business, where value is easily measured in financial terms. We believe, however, that the principles apply to all organizations.)
Customer Purchase Behavior.[xviii] Customer purchase decisions will often include judgments based on a combination of instincts and trustworthy data, including experience with a company’s employees, its reputation, expert reports on product/service quality, marketing materials, and, increasingly, ratings provided by other customers. In other words, stakeholders are both the judge of an organization’s trustworthiness and, potentially, providers of information that will influence the trust of other stakeholders.
For trusted companies:
- 80% of customers chose to buy product/services
- 68% recommended to friends/colleagues
- 54% paid more for products and services
- 48% shared positive opinions online
- 40% defended company
- 28% bought shares
For distrusted companies:
- 63% refused to buy products/services
- 58% criticized to friends/colleagues
- 37% shared negative opinions online
- 18% sold shares
Customer Loyalty. By nearly all measures, it is more profitable to keep customers happy than to attract new customers; and trust drives 22% to 44% of overall customer loyalty.[xix] Examples include:[xx]
- A 5% increase in customer retention can increase a company’s profitability by 75%.
- 80% of a company’s future revenue will come from just 20% of existing customers.
- Attracting new customers will cost a company 5 times more (some estimates are as high as 9 times more) than keeping an existing customer.
- A customer that uses multiple products is less likely to change providers; this also creates efficiencies in product servicing.
- “An average business loses 10 percent of its customers each year, while cutting customer losses by 5 percent can boost profits by 25 to 125 percent.”[xxi]
- Loyal customers are an engine of profitability, according to a Bain study. An evaluation of customers who were classified as “promoters” showed that, on average, an industry’s “promoter” group grew more than twice as fast as its competitors.[xxii] For companies whose customers are other businesses (B2B), “promoters” have an average lifetime value typically three to eight times that of "detractors," depending on segment and industry. Promoters stay longer with the company, buy more products, usually cost less to serve and are more likely to refer the supplier to colleagues and friends. As a result, B2B loyalty leaders tend to grow four to eight percentage points above their market's annual growth.[xxiii]
- Organizations with loyal customers are twice as likely to exceed the forecasts of financial analysts.[xxiv]
Employee Engagement. Employee engagement is defined as the emotional commitment the employee has to the organization and its goals.[xxv] The Edelman Trust Barometer reports that “[e]mployees are considered the most trusted source across most clusters of trust attributes . . . The public wants to hear directly from employees as ambassadors for the company who can attest to its integrity, the quality and relevance of products and services offered and the operational strength of the company, including its leadership.”[xxvi]
Research provides much evidence of the economic value of employee engagement.
- A Russell Investment Group study reports that the 1998-2008 stock performance of publicly traded companies on Fortune’s annual list of the “100 Best Companies to Work For” returned five times as much to investors as the market in general.[xxvii]
- A 50% increase in the Trust Index Employee Survey score correlates with a 12-fold increase in profits
- Trust Index Employee Survey top-ranked companies produce three times the cumulative market return as others in the Russell 3000 or Standard and Poor 500 companies[xxviii]
- Gallup’s Q12 Survey 2012 Reports[xxix] show that “companies scoring in the top half on employee engagement nearly doubled their odds of success compared with those in the bottom half.”
- PwC reports that the innovative companies are most clearly differentiated by a higher degree of trust in management. (Entrepreneurship is also highly correlated with trust.[xxx]) Innovation is also increasingly tied to collaboration: their research finds that the most innovative companies collaborate over three times more often (34%) than the least innovative ones (10%). According to the GE Innovation barometer, lack of trust in a partner company is one of the key barriers for not collaborating with other companies.[xxxi]
- Trust Index Employee Survey shows that top-ranked companies have up to 50% less staff turnover than competitors.[xxxii]
- Employees who rank life satisfaction on a 10-point scale indicate that 1 point increase in trust in management has the same impact as a 36% increase in income.[xxxiii]
Despite all this evidence of benefits, there is much unrealized potential in most organizations. One study of American workers suggests that three-quarters of employees today would consider taking a new job and one-third are actively looking.[xxxiv] Gallup’s research finds that 18% of workers are not only not engaged but actively disengaged.[xxxv] This lack of employee engagement also contributes to legal risk;[xxxvi] project implementation risk;[xxxvii] funding costs;[xxxviii] and security costs.[xxxix]
An understanding of broad levels of social trust can be extended to stakeholder trust. Current research described above suggests an impressive business case at the level of the individual firm: creating stakeholder trust improves the bottom line.
Why, then, do so many individual businesses fail to articulate the creation of stakeholder trust as a goal, and why does the World Economic Forum claim that the business case has not been made? The World Economic Forum itself might provide an answer. It suggests that “Trust as an asset appears inherently intangible and difficult to measure.”[xl]
We respectfully disagree. Measurement is critical to the operationalization of this principle, and measurement is possible. In a post soon to come we will discuss some of the factors that might be used in creating trust metrics.
[vi] Francis Fukuyama describes the role of trust in economic decisions as the “missing twenty percent of human behavior about which neoclassical economics can give only a poor account.” (Fukuyama, Francis (1996-06-18). Trust: Human Nature and the Reconstitution of Social Order (p. 13). Free Press. Kindle Edition.). Several Nobel laureates have, however, addressed the importance of this question, including:
Friedrich Hayek (http://en.wikipedia.org/wiki/Extended_order);
Daniel Kahneman (Fairness as a Constraint on Profit Seeking: Entitlements in the Market”, by Daniel
Kahneman, Jack L. Knetsch, Richard H. Thaler The American Economic Review, 76(4), pp. 728 – 741,
September 1986; https://www.imf.org/external/pubs/ft/fandd/2009/09/pdf/people.pdf);
Amartya Sen (Rational Fools: A Critique of the Behavioral Foundations of Economic Theory, Philosophy and
Public Affairs, Vol. 6, No. 4 (Summer 1977), pp. 317 – 344;
[viii]Price Allocation Study by Houlihan Lokey http://www.hl.com/us/press/insightsandideas/4862.aspx
[x] The Impact of Reputation on Market Value, Simon Cole WORLD ECONOMICS• Vol. 13 • No. 3 •
[xix] “Connecting Customer Experience to Revenue: A Sellers’ Compass™”. New Business Strategies, NBS Consulting Group, Inc., 2013, http://www.newbizs.com/wp-content/ uploads/2013/02/NBSTSellersCompassWhitePaper2013.pdf.
[xxiv] “Connecting Customer Experience to Revenue: A Sellers’ Compass™”. New Business Strategies, NBS Consulting Group, Inc., 2013, http://www.newbizs.com/wp-content/ uploads/2013/02/NBSTSellersCompassWhitePaper2013.pdf.
[xxx] Kodila-Tedika, Oasis, and Julius Agbor Agbor. “Does Trust Matter For Entrepreuneurship: Evidence From A Cross- Section Of Countries”. Munich Personal RePEc Archive, University of Kinshasa, Brookings Institution, Stellenbosch University, 29 October 2012, http://mpra.ub.uni-muenchen. de/46306/8/MPRA_paper_46306.pdf.
[xxxiii] Helliwell, Huang and Putnam 2009 http://faculty.arts.ubc.ca/jhelliwell/papers/w14589.pdf
[xxxiv] Hall, Alan. “I’m Outta Here! Why 2 Million Americans Quit Every Month (And 5 Steps to Turn the Epidemic Around)”. Forbes Magazine, 11 March 2013, http://www.forbes.com/ sites/alanhall/2013/03/11/im-outta-here-why-2-million-americans-quit-every-month-and-5-steps-to-turn-the-epidemic-around.
[xxxv] Edmund, Larry. “A State of the Workplace from Gallup: What The Greatest Managers Do Differently.” 2014 HCI Employee Engagement Conference, July 2014.
[xxxvi] While business ethics compliance is often regarded by businesses as a troublesome imposition of costly processes, a major incentive to incur these costs is the risk of legal action, for example, for violation of the American Foreign Corrupt Practices Act or the UK Bribery Act. Prosecution can be enormously expensive, both financially and reputationally. It should be noted, though, that compliance is “necessary but not sufficient”. A World Economic Forum study describes the “compliance equals gaining trust” strategy as a common fallacy (http://www.weforum.org/reports/white-paper-decoding-complexity-trust-industry-perspectives).
[xxxvii] A KPMG study finds that 83% of all mergers and acquisitions don’t meet their goals, and on average 50% of top executives leave the acquired company within the first year after the deal; 45% of Fortune 500 CFOs blamed post-M&A failure on “unexpected people problems” (Agenda. KPMG, April-May 2011, http://www.kpmg.no/arch/_ img/9808354.pdf). Similar problems can damage a company’s ability to undertake major projects requiring cross-organizational cooperation.
[xxxviii] A bank or investor will consider “character” as an important component of their funding and pricing decision. An organization’s culture will heavily influence this evaluation.
[xxxix] A low trust culture can often require expensive procedures to protect the company against perceived risk of loss from employees and customers. A visitor to Kyrgyzstan describes buying a Snickers bar: guards stood by the shop door; the Snickers bar was protected behind a glass wall; a revolving tray under the glass wall ensured that candy and exact cash can be simultaneously exchanged – all creating costs that far exceeded the profit on a Snickers bar! Costs incurred to protect against employee theft or to control employee time usage can also be quite high, in addition to discouraging employee engagement.