Reputation risk and Tylenol

The Riskczar Philosophy on reputation risk is that it is a second order risk. This means the risk to your reputation or brand is not something that can be directly mitigated or insured against, it is harmed when some other “up stream” event occurs. You cannot actually prevent reputation risk, but you can prevent the events that cause it.

Let’s take a closer look at the Tylenol tampering crisis in 1982 when capsules were laced with potassium cyanide, killing seven people. The Tylenol brand was harmed and their market share dropped from 35% to 8% following the scare. Could this drop have been prevented?

Let’s imagine that in 1979, Johnson & Johnson, who manufactured the product, had conducted a risk assessment, identifying reputation risk as one of many risks. Let’s also assume that they had developed sophisticated models enabling them to quantify the financial loss of a catastrophic decline in market share like this. Having identified and assessed this risk, their next step would be to develop some action plans to mitigate, avoid, reduce, transfer or accept this risk of this drop in market share.

Well, how do you do it? Aside from buying millions of dollars of put options on your stock (which may not even be legal), I cannot think of any way of hedging the financial losses. When the brand is harmed, the public loses trust and they don’t buy your product any more.

Risks have causes and effects so imagine a chain of events that looks like this:

Downstream cause x –>   Downstream cause y –>   Reputation is harmed –>   Financial loses are suffered

Reputation damage has root causes as well as effects, so what you do is identify the root causes of the reputation risk and then develop action plans against those.

One technique comes from Six Sigma, called Five Whys, where we start with a question like: “What could cause financial losses?” then continue asking Why? (up to five times) to those responses until you determine the root causes. For example:

Tylenol loses market share and suffers financial loses (problem)
Why? Reputation is harmed (first why)
Why? Someone tampers with the bottle and with the pills (second why)
Why? There are no preventative or detective controls; and capsules can be pulled apart (third why)
Why? Design defects to box, bottle and pills (fourth why)

After completing this analysis, you can develop and implement action plans for the second, third and forth whys which ultimately harm reputation and cause financial losses.

After the event, Tylenol stopped making capsules and began making caplets (preventative control); and they began using tamper-resistant packaging (detective controls) which we see today. J&J also did a fabulous job of damage control. They went public, recalled all products and saved their reputation. One might suggest their communication plan was also an effective control.

So remember, while you may not be able to protect your reputation (second order risk) you can do your best to treat the root causes.

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