Thinking about these steps leads me to believe this is simply an articulation of the best long-term business strategy. Of course, most people will agree that the goal is to produce a quality product! And to ensure that the quality is delivered consistently! Who wouldn’t follow these steps? It makes so much sense.

Ah yes, it seems obvious, but one needs to consider why companies fail to do this. Let’s look at a recent, high profile case in the news relating to Wells Fargo. Why didn’t Wells Fargo ensure that accounts being opened by some of the 5,300 staff that were terminated were in fact requested and authorized by their clients? How could over 2% of the total staff be fired and this not raise questions from senior management, in particular the Audit Committee of the Board?

Many things have been cited as contributing to this untoward outcome, in particular, unrealistic sales targets for retail bank employees that were part of the business culture. The culture of the bank was not as described in the Code of Conduct. While profits did grow and senior managers were rewarded for achieving that growth, clearly reporting of problems to senior management either was non-existent or ignored by senior managers. Neither bodes well.

But let’s think about a completely different regulatory environment – that of the FDA. These same six steps have to be part of the business model so that FDA inspections do not result in product recalls, FORM 483s or even Warning Letters. All three of these events entail reputational damage for the business. Not having these, or at worst only on a very exceptional basis, would indicate to the market that the business is indeed following an appropriate business model. In this case, the market perceives that the business produces quality products, and discloses in its labeling all relevant facts so that medical professionals and their patients can make informed decisions about their products. And this applies to the food industry as well. Consider the damage to Chipotle’s reputation and the impact this has had on their revenues.

So we again come to those few salient questions. Why wouldn’t a business deliver a quality product or service? And why would they not choose to do so consistently? The answer is really quite simple. Consistently delivering a quality product or service is not free. Doing so requires overheads such as maintaining documentation, continuing staff training, monitoring of business activities, and consistently reporting to management so their decision making is consistent with business performance. Ah yes, and those audits really are necessary to ensure there are no gaps and the business is consistently delivering quality to its customers. We believe that you inspect to get the expected!

Over the long term, a firm’s reputation strengthens as customers trust that the firm delivers quality in its current and new product offerings. This leads to more effective product introductions and quicker adoption by the target market. The net effect is that doing the right thing will, in the long term, increase the firm’s profitability which no doubt is in the interest of all stakeholders. But short term profits might suffer and that is the rub in this myopic financial world, especially for publicly traded companies.

Oh yes, those overheads mentioned above. They reduce the near-term bottom line and therefore the bonus potential, i.e. bonuses of the current management. Cutting some of those overhead expenses means current management can participate in a larger bonus pool in the short term. And as tenure in managerial roles has reduced over time, what’s to worry about if it hits the fan three or four years down the road? The probabilities are that management change will have occurred and the new managers will have to clean up the mess – likely at greater expense than the cost savings chosen by the previous management – and the firm’s reputation will be damaged. Repairing reputational damage is always expensive, if it is even possible.

What happened at Wells? The head of the retail division that was responsible for opening over 2 million unauthorized accounts to meet sales targets retired in July with a package worth $125 million. This executive was lauded by the CEO as the embodiment of the firm’s culture and a champion for customers. When asked by the Senate Banking Committee if her past bonuses would be clawed back, not to mention his own, the CEO said he couldn’t comment on that as it would be determined by the Board. Time will tell whether the CEO survives and whether any bonuses are clawed back by the Board. Needless to say the reputational damage is perceived by investors who have marked down the bank’s shares. That, in addition to the $185 million fine are the costs being born by shareholders. Arguably all for increased short-term bonuses to management.