External affairs at a crossroads

For the third consecutive McKinsey survey on managing external affairs, a majority of executives say external-affairs issues will affect their companies’ income.¹ 1. “External affairs” includes, but is not limited to, activities performed by departments such as external affairs, public affairs, corporate affairs, government and regulatory affairs, corporate communications, public relations, and corporate social responsibility. But even those reporting successful outcomes say their companies struggle to quantify the impact these issues will have on their business. These are among the key findings from the fourth McKinsey Global survey on how companies manage external affairs, which asked global executives about the relative value created by external-affairs activities, the specific actions companies pursue, and the strategies companies use to interact with stakeholders.² 2.This survey was in the field from January 29 to February 8, 2013, and received responses from 2,186 executives representing the full range of regions, industries, company sizes, tenures, and functional specialties. To adjust for differences in response rates, the data are weighted by the contribution of each respondent’s nation to global GDP.

While respondents largely agree that governments’ and regulators’ involvement will grow in the coming years—and that these groups’ decisions will affect operating income—few report that their companies have put in place the right organizational capabilities, such as adequate resources or systematic measurement of outcomes. The executives reporting more robust capabilities are likelier than others to say their companies take key external-affairs actions on a regular basis. And these more “active” companies are likelier than others to see successful results: that is, frequently succeeding at managing their reputations and shaping policy and regulatory decisions. There’s no single strategy for stakeholder engagement that works best for all companies, respondents say, and the ways in which companies interact with stakeholders vary among geographies, sectors, and even within our “success” group. But the results and our experience suggest that not engaging isn’t an option; neither is neglecting the organizational capacities and resources that support meaningful action.

Steady views, stalled success

This year’s responses indicate that executives have reached a consistent view on how—and by how much—external issues matter. First, respondents agree that, among stakeholders, customers (followed by governments and regulators) will have the greatest impact on company value. They also tend to assert that these issues will decrease operating income as government and regulator involvement in their industries will keep increasing.

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The importance of external affairs continues to be more acute in certain regions and industries than in others. A growing share of executives in Latin America (39 percent, up from 31 percent last year) expect income will increase as a result of external-affairs issues, while those in other regions are still wary of the financial impact.³ 3.Pluralities of respondents in every region (including Latin America) say external-affairs issues will have a negative impact on their companies’ operating income. This year, half of executives in North America say so, down slightly from 52 percent who said the same last year. The smallest shares expecting increased income from external-affairs issues are in North America and Europe (24 percent and 25 percent, respectively), which was also true in the 2012 survey. And respondents in emerging markets are more likely than those in developed economies to say their CEOs consider external affairs a top priority (Exhibit 1). Across industries, much larger shares of respondents in health care and energy than in other sectors expect external-affairs issues will reduce income (Exhibit 2). Meanwhile, financial-services executives are still the most likely among their peers to expect increased government and regulator involvement, to rank these two as the stakeholders with the greatest effect on company value, and to say external affairs is a top CEO priority.

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Despite the general consensus on the significance of stakeholders and these issues, respondents say efforts to mitigate risk or create value through external affairs have stalled. In line with results from the past two surveys, just 21 percent say their companies frequently succeed at shaping government policy or regulatory decisions. A larger share than before report success at reputation management, which may owe partly to this year’s rewording of the question: we asked respondents how well their companies manage reputation among civil-society groups, and 45 percent say they frequently succeed at doing so.⁴ 4.In the previous two surveys, we asked respondents how effectively they managed their corporate reputation to mitigate risk or create value. Last year, 27 percent answered “very effective, so it was a significant source of competitive advantage” (while 61 percent said “somewhat effective, mostly by actively managing risks and handling crises as they arise,” and 6 percent said “not at all”). In 2011, 30 percent of respondents said “very effective,” 58 percent said “somewhat,” and 7 percent said “not at all.”

A need for more action

Overall, the results suggest that this struggle to influence policy and manage reputation links back to a lack of organizational capabilities and actions taken. While most respondents (69 percent) say their top-management teams or CEOs become directly involved in strategy if needed, much smaller shares report capabilities related to decision making, sufficient talent and resources, cross-functional buy-in, skill development, and the systematic measurement of outcomes.⁵ 5.After top-management and CEO involvement, equal shares of respondents (27 percent) say their companies have processes to ensure that external-affairs issues are considered in daily decision making and that they have sufficient in-house talent and resources to build an economic fact base for external-affairs activities. This is followed by having a formal, cross-functional strategy process that involves both internal functions and external partners (24 percent), developing external-engagement skills across the organization (21 percent), and systematically measuring external-affairs outcomes (16 percent). Ten percent of executives say their companies have none of these capabilities.

At companies with stronger capabilities, more executives say they are pursuing four activities that, in our experience, make up the foundation of an external-affairs program: educating policy makers and regulators on industry issues, engaging these stakeholders on committees or industry associations, modeling the impact of potential policy actions, and hiring lobbyists to shape policy or regulatory outcomes. Nearly one-third of executives say their companies often engage in the first three, while 9 percent report hiring lobbyists—but across actions, these shares are much larger if the company has established any of the six capabilities we asked about.

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In turn, respondents at companies that often pursue each of these activities are much more likely than those who don’t to report successful reputation and policy outcomes (Exhibit 3). Larger shares at the “success” companies say each of the six capabilities we asked about is in place at their organizations. They also are likelier than others to rate their companies as effective at a range of related practices, including the activity that all respondents most often cite: maintaining stakeholder relationships (Exhibit 4). But even successful companies struggle when it comes to quantifying the economic impact of external-affairs outcomes for themselves and their industries.

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Reputational strengths and weaknesses

Consistent with the findings from a September 2012 survey⁶ 6. In the survey, 61 percent of all respondents said their overall reputations were either significantly differentiated from or better than those of competitors in their industries. on reputation, executives are quite confident about their companies’ standing: 62 percent say their reputations are significantly differentiated from or better than their competitors’. One tool companies can use to stand out is social media. Among respondents who say their companies use social media to track reputation-related stakeholder concerns, 58 percent say they successfully manage reputation, while only 44 percent of those not using social media report frequent success.

Still, respondents note a few weak spots. When asked to identify their companies’ reputational strengths, respondents most often select high-quality products and services, trustworthy leadership, and values-driven business conduct. When asked about their vulnerabilities, the largest shares cite innovation, strong financial performance, and societal contributions (Exhibit 5).

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Strategic engagement

When asked to identify the strategy their companies use to engage with governments and regulators, respondents tend to report either a proactive or an improvement-focused approach, though there is no single strategy that leads the way. Even respondents at successful companies report using a wide variety of strategies, though they do engage more often than others in the first place.

Likewise, the approach varies by geography (Exhibit 6). Executives in Latin America are most likely to report a defensive stance toward engagement, even though they’re most likely to expect governmental and regulatory involvement will increase in the next few years. Still, they engage more often than average; only 9 percent say they have not engaged at all with these stakeholders in the past year, compared with 16 percent of the global average who say the same.

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Looking ahead

• First and foremost, engage. It’s good news that so many respondents say their companies are engaging with stakeholders—and doing so with a positive, proactive mind-set—because a lack of engagement is not an option. To get ahead of potential challenges, executives need to assess their specific context (that is, their countries and industries) before deciding on the best strategy.
• Determine the value at stake. Even the most successful organizations are struggling to quantify how external-affairs outcomes will affect their companies: only 19 percent of executives at these companies say they do this well, which is an even smaller share than all respondents in 2009 who said their companies quantified the potential impact of government actions very or extremely effectively. All companies would do well to build capabilities that can enable more rigorous measurement, especially since majorities of respondents expect external issues to have some financial impact (either positive or negative) in the coming years.
• Build skills. The results affirm that the strength of a company’s skills and resources is linked to the success (or failure) of its outcomes. Even with goodwill and CEO support, companies cannot make real progress on their external-affairs agendas unless they develop and professionalize the underlying capabilities, especially the ones much more likely to be found at successful companies: sufficient talent and cross-functional processes.