When CVS/Caremark announced that it would forego some $2 billion in sales of tobacco and related products recently, CEO Larry J. Merlo stated that: “We came to the decision that providing health care and selling cigarettes just don’t go together in the same setting.” What he did not say, however, is how that laser-like focus on the company’s strategy also turned reputational risk into an opportunity. CVS is now one of a small group of companies that have realized that their reputation is the most valuable asset they have and that building a stronger reputation by avoiding risks to that reputation can create a significant competitive advantage. Let’s look at how these companies are protecting their reputation and brands while enhancing and realizing strategic value from them.

First, companies need to look into their business practices and ask two questions: What are we doing that we should not be doing? And, what aren’t we doing that we should be doing? A half-day session on these questions with your executive committee will usually uncover reputational risks that could easily lead to problems or even a crisis. For example, Coca-Cola uses an extraordinary amount of water to make the world’s top brand of soda with estimates ranging from four to 250 bottles of water per bottle of Coke.  Before being attacked for behavior that could easily be labled unsustainable, the company teamed up with the World Wildlife Fund (WWF) a few years ago in a project to put all of the water back that they take out. In other words, they plan to become water neutral.  They then told this to the world in a co-branded ad with the WWF. They didn’t say how or when, but the commitment is clear and endorsed by a reputable partner.  Similarly, McDonalds got rid of smoking in its restaurants ten years before any laws changed banning this activity. How do these companies come to such conclusions?

Here is how the conversation might have gone at CVS. Organizations like the American Cancer Society and the American Lung Association have been against the sale of tobacco in pharmacies for many years and municipalities in California and Massachusetts have started to put legislation in place that would ban the sale of cigarettes in a variety of settings including pharmacies.  Given the risk that someday key constituencies and antagonists would start to focus on this problem more aggressively anyway, why not get out in front of the problem?  And the benefits of doing so should be obvious from the outpouring of support CVS received with its announcement.  From the White House to the American Lung Association, CVS has received kudos for what seems to be a focus on shared value with society rather than the reckless pursuit of revenue at any cost. This kudos lead to the unusual occurrence of positive publicity for CVS’s business in major media outlets like the New York Times and CNN.

But some senior executives have asked me where does it all end?  CVS sells alcohol in some states, and also sells soda and food that some might say are as bad as cigarettes.  Shouldn’t a healthcare company also worry about obesity?  In addition, there is the matter of giving up $2 billion in revenue.  CVS has hinted that it intends to find ways to make that money back, but the company could have done whatever it has planned, continued to sell cigarettes, and made even more money.  That’s how most companies would have looked at the situation.

Finally, how can we calculate the intangible value associated with this rise in reputational capital for CVS? The fact is that we cannot easily measure, or even estimate what that might be without first tracking data across multiple constituencies for many years, and then doing some pretty heavy math and statistics that most of these companies know little about. Still, even without easily pinning a dollar figure to the intangible value of doing the right thing, we’re pretty certain that there is indeed real bottom-line benefit.

Our research and the research of organizations that have specialized in the measurement of reputation like Communications Consulting Worldwide that companies with a strong reputation have a price advantage: they pay less to suppliers, and can charge more to customers. They have a competitive advantage too in that they can get the best recruits to work for them, tend to have more stable revenues, face fewer risks of crisis, and when something bad happens they are given the benefit of the doubt by their stakeholders.  And finally, highly reputed companies are more stable, which means they have higher market valuation and stock price over the long term and greater loyalty of their investors, which leads to less volatility.

So why doesn’t every company do what CVS did? Because senior managers tend to focus on the short-term operational and financial aspects of their companies rather than the intangible assets that are worth so much more. Because it is hard to argue with shareholders who will complain (as they did by reducing CVS’s stock price the day of the decision) that they aren’t getting the return on their investments fast enough. Because you can’t manage what you don’t measure, which means that while CVS could tell us how much they stood to lose, they couldn’t put a number on what they stood to gain by doing the right thing for their customers and for society.

When our alumni magazine, Tuck Today, recently asked several of us to think about what the future might hold for our various disciplines, I said that I envisioned a future where companies would be more focused on earning their reputation the old fashioned way by doing things we admire rather than things that are expedient. That managers would regularly ask themselves what they should stop doing because it would look bad on the front page of the newspaper someday, and that they would be willing to take risks for the long-term acquisition of a stronger reputation.  CVS, I hope, has shown us the future.

This blog first appeared on Harvard Business Review on 2/7/2014.

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