Volkswagen: quantifying the reputational damage

"Reputation, reputation, reputation! Oh, I have lost my reputation! I have lost the immortal part of myself, and what remains is bestial." This lament from Shakespeare’s Othello might seem too harsh for Volkswagen as a result of the emissions scandal. But its reputation and brand value have unquestionably suffered a big hit. Since the scandal reached the mainstream media, Volkswagen’s market cap has declined by about 30% or over €20 billion. Equity analysts are trying to gauge the direct costs of the product recalls and fines, together with incremental marketing costs and the intangible component of the damage: lost sales resulting from broken trust.

Can the economic impact of reputational damage be quantified? And could a robust reputational risk framework have helped Volkswagen to avoid or mitigate the damage? The answer to both questions is yes.

But first some definitions. In this article the term ‘brand’ is used in a product context. 'Brand equity' describes the aggregation of buyer attitudes towards an automotive brand. It is a predictive measure, as brand equity influences an individual’s propensity to buy a particular brand in a specific price range. The term ‘reputation’ is used to describe stakeholder attitudes towards Volkswagen as a company. In addition to motorists, corporate stakeholders include staff, investors, banks, regulators and journalists. These groups can influence the opinions of motorists and also impact enterprise value through the cost of capital and operating costs.

For Volkswagen, the corporation and core brand share the same name. Yet within certain thresholds, consumers can disapprove of a corporation’s behaviour without this flowing through to their affinity towards the product brand. However, there is a tipping point where the erosion of reputation flows through to brand equity and reduces demand for the product. Brand equity has been described as a "reservoir of future cash flow" and is gauged through a combination of measures such as brand familiarity, perceived quality, image and ultimately brand affinity or preference. In the case of Volkswagen, both corporate reputation and brand equity have been damaged. The emissions scandal will have eroded motorist perceptions of the quality and image of Volkswagen, particularly trust in the brand.

Quantifying reputational damage
Many brand-owning companies commission quantitative research to track brand equity and corporate reputation. This provides an important input to valuing a brand at a point in time. Data history enables econometric modelling to isolate and quantify the impact of brand equity on sales. Hence, it is possible to make an informed estimate of the financial impact of actual – or hypothetical – changes in brand equity. Think of this as a marriage between consumer research and discounted cash-flow modelling.

Internally, Volkswagen is likely to have the inputs required to estimate the impairment in brand value. On the other hand, equity analysts will be missing key parts of the puzzle.

Before the scandal, published league tables estimated the value of the Volkswagen brand to be as high as $30 billion. How much value has been destroyed by the damage to brand equity? Studies that I have carried out show that several important factors influence the extent of value destroyed by reputational damage:

• Strong brands are more resilient and better able to recover from adverse publicity.
• A company’s response to an adverse event can either magnify or mitigate value destruction (speed and honesty are helpful).
• Reputational damage has a cumulative effect. The value destroyed by a second or third event is greater than if each occurred in isolation.
• The proximity of the reputational damage to the essence of a brand influences the extent of damage. For instance, the loss of trust in Arthur Andersen was terminal.

In the absence of brand tracking and other data concerning the economics of the Volkswagen brand, only a qualitative view can be offered. This is that the scandal has resulted in a drop in Volkswagen’s brand value measured in billions of dollars. But the initial strength of the brand will allow it to recover lost market share in the medium to long term – provided that the brand is skilfully managed. This will be no easy task. All stakeholders will be watching Volkswagen closely and regulatory probes and legal action will continue to taint the brand. Earnings pressure will be generated by vehicle recall costs and lost sales, but cuts in R&D and marketing would increase the likelihood of further bad news, triggering the multiplier effect to reputational damage.

Importance of automotive brands
The automotive industry is capital intense and reliant on ongoing R&D and tech-related intellectual property. Brands are also an important value driver, but perhaps Bill Ford was overstating it when, as co-chairman of Ford Motor Co in 2006, he said, "It's easy to build a car; it's harder to build a brand."

Owners of automotive brands should have research on the contribution of their brand to sales volume and price. For example, a published study identified two identical vehicles that came off the same production lines and were sold through similar channels. Although the cars were identical in all respects but the badge, one had a 10% price premium and almost a 100% volume premium.

Value-based reputational risk management
Reputational risk is the Achilles heel of many otherwise strong risk management frameworks. Here are some pointers (gained in developing a system for an oil company that had learned about reputational damage the hard way):

• Track corporate reputation among key stakeholders and brand equity in all markets.
• Quantify the value of your brand portfolio and its contribution to enterprise value.
• Identify events that could have a negative impact on brand or corporate reputation.
• Estimate the potential impact of key event-based risks on brand equity and value.
• Identify controls and disaster responses that mitigate risk, and actions (or inactions) that are likely to magnify value destruction.

Above all, ensure that your risk management processes are commensurate with the value at risk. Prevention is easier – and much cheaper – than cure.