Reputational Spillovers

Reputational spillovers occur when the actions of one firm affect the reputations of other firms. Reputational spillovers result from observers’ inability or unwillingness to distinguish the actions of one firm from those of similar other firms, particularly those in the same industry; instead, they assume that all such firms have similar characteristics. Reputational spillovers can be positive, whereby other firms benefit from improvements to their reputations unrelated to any actions they have taken, but most attention has been given to negative spillovers, whereby other firms’ reputations are harmed. Those firms subject to reputational spillovers may mitigate their risk of being punished for the actions of similar other firms by making their unique characteristics more salient to observers and by cooperating with similar others to improve practices across the group. This entry discusses how reputation can be seen as a shared resource and how reputational spillovers are managed.

Reputation as a Shared Resource

A firm’s reputation is held in the minds of its observers. Observers assess a firm, and thereby form its reputation, on the basis of limited insights about the firm’s true and complete characteristics. For example, few know the intimate and detailed workings of Wal-Mart or Exxon, yet many have opinions, even strong ones, about these corporations.

Given limited time, attention, and direct insights, observers necessarily rely on heuristics—mental shortcuts—when assessing firms. One common shortcut, and the basis of reputational spillovers, is to assume that all firms of some type have similar characteristics and behave in similar ways. Rather than assessing the characteristics of each firm separately, when observers become aware of information that reflects on the character of a particular firm, they may make the same attribution about the character of other firms. For example, knowing little about differences in the production methods of electric car manufacturers, people may assume that if one model of electric car suffers a fire, all electric cars are susceptible to such fires. Unless observers are willing and able to distinguish important characteristics of one manufacturer from another, even if all other electric car manufacturers have technology or procedures that render their cars fireproof, the reputations of all electric car manufacturers will be sullied by the actions of just one. Such dynamics have been shown to occur across myriad industries, from automobiles and airlines to nuclear power and chemical plants.

Reputational spillovers can be favorable. For example, positive reputational spillovers underpin the retail franchising business model. Before the prevalence of franchising in the United States, travelers faced considerable uncertainty about the quality of restaurants and hotels in unfamiliar towns. McDonald’s and Holiday Inn realized that customers valued consistency and so set up franchise locations that allowed their brand names and associated reputations to carry over from one restaurant or hotel to the next. Travelers who knew nothing of the operating practices of restaurants and hotels in unfamiliar locations assumed that one McDonald’s or Holiday Inn was operated like any other and so used this heuristic to select where to eat and sleep while traveling.

Reputational spillovers are more commonly conceptualized as an intra-industry rather than an intra-firm phenomenon, though. Positive intra-industry reputational spillovers can help new industries to emerge more quickly. For example, coffee was a cheap commodity product in the United States until Starbucks established a strong reputation for premium coffee and a comfortable experience. New entrants to the premium coffee market thereafter benefited from Starbucks’ reputation, as consumers became more willing to try expensive coffee houses, assuming that their experiences would be similarly enjoyable.

Negative reputational spillovers are generally of greater concern to managers because their firms risk suffering harm from misdeeds for which they bear no responsibility. In this way, reputational spillovers effectively leave industries at the mercy of their weakest firms. The nuclear power industry is perhaps the clearest example. Though plant designs and practices differ across nuclear facilities, the entire U.S. nuclear power industry was hobbled by a partial meltdown at a single facility of a single firm. No new nuclear power plants have been licensed and put into operation in the United States since the Three Mile Island incident in 1979.

Managing Reputational Spillovers

Because firms can be affected by the actions of their rivals, firms logically have an interest in how their rivals act. Where firms are exposed to the risk of harm from the behaviors of rivals, firms will seek to regulate those risky behaviors. Typically, efforts to regulate the behaviors of industry members are coordinated through industry trade associations. Industry trade associations often oversee certification programs, codes of conduct, and a variety of self-regulatory programs. Examples include the chemical industry’s Responsible Care program, the lumber industry’s Sustainable Forestry Initiative, and the clothing industry’s Apparel Industry Partnership.

Industry self-regulatory programs help alleviate reputational spillovers either by strengthening the industry’s weakest links or by dividing the industry into distinctive subgroups. If all firms in an industry abide by a strong code of conduct, then the likelihood of future misdeeds, such as nuclear meltdowns or toxic chemical releases, decreases, and so the conditions that might precipitate future reputational spillovers are ameliorated. On the other hand, firms in an industry self-regulatory program may seek to brand their efforts as distinctive from firms in the industry that do not participate in the program. If effective, then incidents at nonparticipating firms will not reflect on participating firms, because observers will assume that the characteristics of participating firms differ from those of nonparticipating firms.

Because the public attends poorly to such distinctions, and since ensuing regulations tend to be broad-brushed rather than specific to any subgroups, industry-wide improvement by which all firms are brought up to a higher standard are a superior means of mitigating reputational spillovers—simply, they decrease the likelihood of misdeeds occurring at all. However, the ability of industry trade associations to coerce firms into abiding by a code of conduct and to punish those who fail to live up to standards is limited, and so self-regulatory programs tend to encompass only a section of industry participants.