In his new book, Corporate Diplomacy: Building Reputations and Relationships with External Stakeholders, Wharton management professor Witold Henisz advises senior managers to build the capability to strategically develop their most important relationships — before it’s too late. In an interview with Wharton management professor Stephen J. Kobrin, Henisz explains how to determine who are the most important stakeholders to focus on and how to avoid the mistakes made by companies that have lost more than $100 million by failing to develop relationships with external stakeholders.

An edited transcription of the conversation follows.

Stephen J. Kobrin: What is “corporate diplomacy”?

Witold Henisz: Corporate diplomacy is the senior-level capability to build and maintain relationships with external stakeholders and deliver on the greatest needs or the greatest objectives of those stakeholders in a way that delivers shareholder value.

Kobrin: Why is it important?

Henisz: It’s important because firms are increasingly looking for growth and revenue opportunities abroad in emerging markets, frontier markets and foreign markets. In these foreign markets, they are necessarily interacting with more stakeholders, stakeholders who vary in their economic philosophies and ideologies, who have different histories, different language backgrounds and different cultural backgrounds. The ability to deliver on the growth opportunities in these emerging markets requires successful interactions with more and more diverse stakeholders.

Kobrin: If there are more and more diverse stakeholders, how do you tell which are the most important and which you should be focusing on?

Henisz: There is both a short and a more subtle longer answer to that. The short answer is the stakeholders who can do you the most financial harm are the most important. But that can give rise to some shortcuts which are really damaging. If we only pay attention to the squeaky wheel or if we only pay attention to the stakeholder who threatens violence, we are really creating perverse incentives. A fuller answer is we want to focus on the stakeholders with whom a productive relationship — a relationship in which we’re helping that stakeholder obtain his or her objectives — is delivering on shareholder values.

“Corporate diplomacy is the senior-level capability to build and maintain relationships with external stakeholders and deliver on the … objectives of those stakeholders in a way that delivers shareholder value.”

We need to know how much they can hurt us, how much they can help us and whether we can build and maintain a long-lasting relationship with them.

Kobrin: How do you figure that out? How do you determine whether they can help you or hurt you?

Henisz: It really takes a financial analysis. You have to understand how they impact the bottom line. In what ways do they impact revenues or costs? That’s where this approach differentiates itself from the corporate sustainability movement or corporate social responsibility (CSR) movement. It’s not about just the moral case. We are really … trying to understand where it appears on the P&L statement. What are the costs that could be avoided through a better relationship? What are the revenue gains that could be obtained, and how could the actions we undertake with stakeholders, helping them achieve those objectives, really show up on the balance sheet? Then we figure out what the return is on them.

Kobrin: You must have to engage stakeholders?

Henisz: You certainly do. You have to build that relationship with them. It’s not just about talking to them. It’s not just about a communication strategy. It’s really rolling up your sleeves, working with them to obtain their goals. A simple story of this is if one of the biggest needs is housing, for example. One approach might be to bring some pre-fab housing into Florida and have some contractors put it up. Then you have created their homes. But no, you really haven’t. Somebody else has.

If you can get your country manager or if you can get your CFO to be out there laying mortar, putting up cinder blocks, helping someone build their home using local technology with local contractors, creating local jobs and working side by side with the resident, then you have really started building a relationship with them. You want to be in the trenches with them. You want to be part of the action. You want to be working with them in the attainment of their goals.

Kobrin: Are you arguing, then, that corporate diplomacy is really a mainline management function?

Henisz: Absolutely. It’s not something that should be segmented into, “Well, we have a government affairs team. We have a community affairs team. We have a sustainability team.” We are really thinking from a strategic perspective about how to integrate those. Who is more responsible for integration than senior management, whether it be the country manager or the general manager or the C-suite, if we’re in a multinational corporation?

Kobrin: That brings up an interesting point. How do you integrate corporate diplomacy into the mainstream of the corporation?

Henisz: Great question. It’s another way in which this approach differentiates itself from the CSR movement. We are not deciding what’s better, what’s right. We’re not just focused on what stakeholders care about. We’re speaking the language of finance. We’re speaking net present value (NPV), return on investment (ROI). We’re turning everything into the same decision calculus that senior management already uses. We’re not going to present a parallel analysis or a parallel set of objectives. We’re not going to do triple bottom line. We’re going to link everything to the key performance indicators (KPIs) that the managers are currently tracking. Whatever is on that dashboard that they look at in the morning, whatever indicators they are tracking on a daily basis, we’re going to figure out how external stakeholders link into that and how we can monitor that and improve upon those existing KPIs.

If we’re thinking about a big investment decision, how do we decide whether we’re going to go ahead with a $100 million or a billion-dollar investment? We’re going to work through that same project valuation cash flow model, the one that’s already on the books, the one that they already use in the investment committee meetings. We are not going to create a green light, red light, smiley face, frowny face that goes on top of the ROI. We are going to use that same calculation, and we’re going to augment it by bringing in the way stakeholders can affect it.

Kobrin: You note in the book that perceptions matter more than facts. What do you mean by that?

Henisz: Too often, when we’re confronted with an allegation of a human rights abuse, an environmental spill, unfair treatment of workers, we respond with the facts. We respond with, “No, here are our policies.” “No, here’s what the scientists tell us.” “Here’s what really happened.” But nobody makes a political or social judgment about whether you are behaving appropriately or how they feel about you based on the facts. They do it based on emotion, based on gut. Think about how you go into the ballot box. When we go in and we decide who we are going to vote for, we are not pulling the lever based on a net present value calculation of our future lifetime earnings under a Republican or Democrat or Socialist or Conservative. We are doing something more subtle.

“Nobody makes a political or social judgment about whether you are behaving appropriately or how they feel about you based on the facts. They do it based on emotion, based on gut.”

We are thinking about who we trust, who we have more confidence in. I’m arguing that stakeholders are doing the same thing. If we’re going to shape the way they feel about us, we can’t just stop at, “Are you better off, or are you worse off?” “What are the facts about what really happened?” We have to assess how they trust us, whether they trust us, and we have to try to build that trust.

Kobrin: Does that relate to a social license to operate?

Henisz: Exactly. Social license to operate is a broader construct than just, “Are you better off or worse off?” It’s looking at a more holistic perspective of how we perceive a company. The social license to operate is the perception by a stakeholder that you are behaving in an appropriate manner, that you are acting in a way they perceive as fair or just. What you are trying to do is build up, not just whether they perceive you’re helping them or hurting them financially or materially, but are you behaving appropriately? Do you deserve their trust? That takes more than just thinking about the facts. It takes more than just thinking about the financial benefits. It requires thinking about the relationship.

Kobrin: How do you know when you have it? And who gives it to you?

Henisz: Each stakeholder gives it to you. The social license to operate is granted by each stakeholder at a moment in time. It can be withdrawn by any stakeholder at a moment in time. This really focuses the attention on an ongoing process. It’s not just the design and the implementation of the entry strategy. It’s everything you do every day — who you hire, who you partner with, who you contract with, where you build, how you build — all those things on a day-in, day-out basis affect each stakeholder’s degree of social license or the degree to which they grant you the social license.

You have to monitor that in real time. You have to watch it in real time. You have to adapt to change in real time. It’s something that’s an ongoing management function, not just something at the time of entry, not just something at the time of crisis, something that senior management should be focused on on an ongoing basis….

Kobrin: What are the critical takeaways that you would suggest to managers who either are or should be corporate diplomats?

Henisz: One of the lessons I draw from looking at the frontlines and looking at the experience of best practices is many of the firms I survey in the book have written off $100 million or billion-dollar losses because they have mismanaged their relationships with external stakeholders. As a result, they have reflected, they have built new tools, new capacities, they have tried to become better corporate diplomats. So, they have learned from their mistakes.

One of the takeaways from the book is that it’s possible to learn from someone else’s mistakes. You don’t have to wait until you write off $100 million or a billion dollars to invest in this capacity. You can learn from the firms that were there first, that were on the frontlines, that lost and learned. Why not learn from someone else’s mistakes, learn from best practice? That’s what I try to pull together in the book.