Sir Bedevere: What makes you think she's a witch?
Peasant 3: Well, she turned me into a newt!
Sir Bedevere: A newt?
Peasant 3: [meekly after a long pause] ... I got better.

Witch burning circa 500 AD and battery burning circa 2013 are arguably unrelated, and yet here is Boeing, getting better. Not that its marketing and communications efforts can claim credit for making anyone feel better. Nor that the engineers necessarily figured out why the batteries burned. It's just that regulators have opined that the plane is safe, and having an independent third party's endorsement, like an insurance policy, signals much more reputational value than any marketing campaign ever could in this circumstance.

The Steel City Re reputational value metrics show that Boeing has bounced back to its prior levels. Relative to the 82-member Aerospace and Defense peer group, Boeing's reputation ranks in the 91st percentile, return on equity ranks in the 66th percentile, and its current reputational value metric volatility, what Consensiv terms the Consensus Trend, is down to the 34th percentile at only 1.2%.

One of the hallmarks of a reputational value crisis arising from an operational failure is that the latter is appreciated by stakeholders as a systemic problem. While Boeing has not yet received approval by the US FAA to fly, and international airlines are watching closely, the investigations suggest that the series of problems each represented unique idiosyncratic events. As Boeing's engineers explained, "things happen."

The Huntington Post reported last week that "a probe into the overheating of a lithium ion battery in an All Nippon Airways Boeing 787 that made an emergency landing found it was improperly wired," according to Japan's Transport Ministry. Boeing reports that it has developed a "fix" for the batteries and that once the FAA approves the 22 February plan, the company is ready to execute. Details of the fix are not being widely circulated. Meanwhile, the Europeans are hedging their bets and moving to the older battery class for the Airbus.

James Surowiecki, writing for the New Yorker, sides with the Europeans. In a culture were the expectation for safety is now paramount, it is not clear how the FAA is going to be able to give Boeing clearance. "Boeing is in a business where the margin of error is small. It shouldn’t have chosen a business model where the chance of making a serious mistake was so large." The author of the Wisdom of Crowds suggests it was a mistake to "give other companies responsibility for the Dreamliner."

Turning the the measures of expectation, the Steel City Re Reputational Value Metrics, Boeing (BA) is one of 80 in the aerospace and defense sector and currently ranks in the 77th percentile. The chart of vital signs shows a rising Current RVM volatility. RVM is a non-financial measure of reputational value, and its volatility is the quantitative expression of the uncertainty reflected in the narrative above.  That being said, the current RVM volatility is still in the 1-2% range which is very low. Of note, should things go badly for Boeing, the odds of a material market cap fall are much greater than for the average company because its stakeholders, as evidenced by the low RVM volatility, are not used to being surprised. Ironically, a gently rising RVM volatility may help reduce the shock.

The indications are for little or very gradual change in the near future with a forecast for ongoing downward slope from the 77th percentile for the CRR, a measure of relative reputational ranking. ROE can be expected to lag. Background on the metrics can be found in the book, Reputation, Stock Price and You: Why the market rewards some companies and punishes others.

Everybody has problems. Boeing has an airplane problem. Tesco has a hamburger problem. And YUM! has a chicken problem. Three different commercial sectors each with quality problems, often leading to safety issues, with one common element. All of the problems originated within the companies' supply chains, comprise failures in operational oversight and control, and have the potential for blossoming into full-on reputational crises.

Reputational crises are expensive. Customers slow down their purchase frequency and extend the their purchase decision cycle, to say nothing of their resistance to premium pricing. But the pain goes further. Vendors offer less favorable terms; creditors raise the cost of capital, employee turnover is but one indicator of morale problems that start brewing, NGOs take interest, and regulators start paying more attention. And of course, equity investors, who have the shortest fuse, sell. That is why Huygens prefers to call them, "reputational value crises."

CNBC reported yesterday that Yum Brands, the parent of restaurant chains Taco Bell, KFC, and Pizza Hut, reported surprise weakness in China. "This skews to the worst case for the company," said David Palmer, managing director and senior food & restaurant analyst at UBS, who covers the company. China represents almost half of the business, in profit terms, for the company, he said in an interview on CNBC's "Squawk on the Street."

Forbes reported, "At YUM’s analyst day on December 6, 2012, we asked CEO David C. Novak what his “defense” was to media exposes that one of KFC China’s suppliers had pumped its chicken full of chemicals to expedite their growth. The story prompted a furious social media reaction. His answer was “No worries. It will blow over.” When asked how, he shrugged: “It always has.”

Turning to a measure of reputational value, the Steel City Re reputational value metrics, the measures for YUM! in contrast to McDonald's, the sector reputational leader, are informative. The problem, it seems, hasn't blown over. The company's reputation ranking is sinking steadily and the forecast last week as shown below, before this week's news, was for further deterioration. The steadiness of the deterioration was suggested by the RVM volatility measures and the median forecast stability numbers. RVM, as Huygens' followers know, is a non-financial measure of reputational value.

YUM!'s loss would reasonably be expected to by McDonald's gain. MCD, with a CRR, a measure of relative reputational ranking, buried at 1.0 for the sector, could only gain in RVM.  MCD's RVM volatility suggests this is the case, and not surprisingly, its ROE has been climbing as YUM!'s has been sinking. 

The moral: supply chains are great sources of cost savings, value, operational risk, and reputational value risk. Their operations need to be overseen and controlled no less so than organic operations. And if the excuse is that the whole point of outsourcing was to reduce the costs associated with organic controls and oversight, well, then, add that sentence to the ever-growing collection of things that seemed like a good idea at the time.

Innovation is the process by which products and services are made better, faster and cheaper. Outcomes are uncertain, which means the process is inherently risky where risk is a threat to an outcome that is desired. Because innovation is also one of the six major drivers of reputational value, innovation risk presents reputational value risk.

On CNBC's Kudlow Report last night, Jonathan Salem Baskin, a member of the Society's Reputation Leadership Council and moderator of the Mission Intangible Monthly Briefings, explained this to Bob Crandall, former Chairman and CEO of American Airlines' holding company, AMR. Click here to link to the CNBC clip.

Shortly after John Morgan (JP, to his American friends) congratulated Andrew Carnegie on becoming the wealthiest man in the world, Carnegie's biographer queried the former steel magnate on his secret. "When I was younger," he replied, "I used to listen to what people say. Now I just watch what they do."

The Steel City Re reputational value metrics, as described in the book, Reputation, Stock Price, and You, comprise indexes of what people who watch people think they are going to do. Boeing's CEO, Jim McNerney, is staring at the same type of operational failure Rolls-Royce's CEO, John Rose, faced just over two years ago. The similarities end there.

At Rolls, there was no public communication until the company, on its own, identified within its supply chain the engineering problem that led to engine failure and a potentially catastrophic outcome. Eight weeks into the crisis, the first major announcement was the purchase by British Airways of 12 additional jumbo jets, all equipped with Rolls-Royce engines.

At Boeing, in the midst of unexplained glitches afflicting the 787 Dreamliner, Tom Downey, the planemaker’s senior vice president of communications, is providing play-by-play commentary on McNerney staff meetings. "Because of his knowledge of planes and electrical systems, 'he asks a lot of very specific questions,' Downey said", according to Bloomberg.

Huygens, ever the American pragmatist, makes no value judgement. Resolution of the problem quickly is the only outcome the markets - Boeing's customers, employees, vendors, investors, creditors, and regulators - really care about. Between now and then, the choice of no-communication or all-communication is a reflection of corporate culture.

What Huygens can share are the reputational metrics reflecting the expectations of stakeholders and the consequences of management's choices. Shown below are Boeing in the midst of an operational crisis that threatens to blossom into a reputational crisis, and Rolls-Royce, that resolved its operational crisis and avoided a reputational crisis.

Rolls' actions exceeded stakeholder expectations and investors rewarded the company (thereby rewarding earlier investors) with a respectable ROE >20% over the trailing twelve months. At this writing, for Boeing, stakeholder expectations are still sinking.

Last week, several Boeing model 787 aircraft were plagued with problems: fuel leaks, electrical fires, and faulty brakes. It is not a problem Boeing said. All new aircraft models go through this sort of shakeout on launch. Mission Intangible Monthly Briefing moderator Jonathan Salem Baskin, writing the CMO column for Forbes magazine, disagrees. "The 787 project was unlike any others — ACCORDING TO BOEING — and to then after-the-fact claim that every aspect of it has a corollary in the routine world lacks credibility." In other words, the safety of the 787 aircraft is a matter of growing concern and a standard PR-based reassurance campaign is unlikely to work. A slew of heated comments and strongly-worded views propelled the article to the most read list.

Huygen's commented previously in 2009 on the reputational risks that appeared to be brewing in Boeing's supply chain. Fast forward to 2013, and the Steel City Re Reputational Value Metrics are suggesting that the safety issue has created for Boeing both an airplane problem and a reputation problem. CRR, a measure of relative reputational rank, slipped to the 81st percentile this past week. RVM volatility, a measure of the variance of RVM -- a non financial measure of reputational value -- is up over historic trends. Forward-looking reputational value trends are negative. Collectively, these measures of reputational value loss help explain Boeing's poor return on equity at the 38th percentile of the 80-member Aerospace and Defense peer group.

Supply chain continue to hurt Boeing's (NYSE:BA) reputation. Strategies executed earlier in the 787 program to (1) reduce costs and (2) garner intangible political benefits associated with global job creation introduced lurking risks in the supply chain that are dogging this company. At the heart of the matter is oversight and control.
 
Indeed, a key economic lesson learned these past two years is that iconic firms with global operations, a stable of business partners, and reputations for ethics, safety, security, and quality; must have better managerial oversight of their partners. There are several strategies for improving oversight. To protect and restore its reputation rapidly, Boeing appears to be pursuing a strategy of total control by acquiring troubled suppliers. It is not an inexpensive proposition. The latest acquisition is reported today in the Financial Times:

http://www.ft.com/cms/s/0/cd36e146-6b56-11de-861d-00144feabdc0.html

"Boeing has been forced to take over one of the key suppliers to the 787 Dreamliner, its troubled new jet, in an effort to gain tighter control of the production process.

It has agreed to pay at least $580m for the facility that makes chiefly composite sections for the 787, a planned family of long-range jets that is running more than two years behind schedule.

The purchase of the South Carolina plant from Vought Aircraft Industries - owned by the Carlyle Group, the private equity firm - is the second time Boeing has been forced into an acquisition to strengthen its global supply chain.

Last year, the US aircraft maker took over Vought's stake in Global Aeronautica, a joint venture with Alenia of Italy that assembles 787 fuselage sections. Vought said it received $55m from that deal."

The Boeing Company (NYSE:BA) reported today that it would again delay the first flight of its new jet, the 787, the latest setback in a program that is considered crucial to the plane maker’s future. The New York Times reports that Howard Rubel, an analyst at Jefferies & Company, said the problem “doesn’t help the company’s credibility.”

Not so fast, Mr. Rubel. Credibility has many facets. The most important driver of reputation in the commercial aerospace sector is safety, and with the recent string of air disasters involving aircraft made by Boeing’s rival EADS NV (EPA:EAD), safety is very much on every stakeholder's mind.

The operational setbacks both Boeing and EADS have suffered highlight the difficulty of pulling off increasingly complex engineering feats involving new materials and global supply chains. And at least one financial lesson from the effort to create a global supply chain is that the savings from direct and tangible costs are being offset by intangible costs arising in the risks of a greater business network entailing less visibility and control.

Managing a complex supply chain is a business process, and failure to do it well – when stakeholders have been led to expect benefits – can be costly in terms of reputation. So returning to Howard Rubel’s comments, what is the net reputation impact?

We turn to the data from the Steel City Re IA (Corporate Reputation) Index. The Index, which correlates with reputation surveys such as those published by Forbes, Fortune, and Harris Interactive, captures the financial implications of stakeholder behaviors and expectations of stakeholder behaviors as determined by corporate reputation. The Index is a good leading indicator of financial performance and returns on equity.

The index shows that over this past year, Boeing’s reputation ranking has sunk from the 69th percentile to the 48th percentile among the 47 companies in the Aerospace and defense sector. Worst, volatility has been climbing and the Exponentially Weighted Moving Average volatility is now four log orders of magnitude. Not surprisingly, return on equity is 14% below the median of the peer group.



Looking at industry more broadly, we see that the overall reputation ranking of the Aerospace and defense sector relative to other industry sectors has been generally rising while variance within the group has been declining and assuming greater homogeneity.



Within this environment, the outstanding reputation holders comprising the top decile as measured by the Steel City Re Reputation Index are: American Science & Engineering (NASDAQ:ASEI); Precision Castparts Corp. (NYSE:PCP); TransDigm Group (NYSE:TDG); and United Technologies Corp (NYSE:UTX).

United Technologies interests us because our colleague, Nancy Lintner, former Chief Marketing Officer and a speaker at one of our annual meetings, developed an award winning communications campaign that highlighted a number of corporate intangibles. Over the past year, the Reputation Index ranking for United Technologies has climbed slightly from an already high 89th percentile to the 92nd percentile, and its EWMA volatility has declined. The company has rewarded investors with an ROE that is 6% above the median return of the Aerospace and defense peer group.