Risk and opportunity management review 2010
As a result of the recent financial and economic crisis, investor and financial market expectations with regard to transparent and comprehensive risk and opportunity communication have intensified. In 2010, we therefore reviewed our risk processes and systems in order to enhance our Group-wide risk and opportunity management approach, to increase internal awareness, as well as to improve internal and external reporting where necessary. The task of operating and evolving the system has been delegated to the Group Risk Management function, which is the owner of the centrally managed risk and opportunity management process.
The central Group Risk Management function has defined a network of senior management representatives, so-called Risk Owners, which include all direct reports to the adidas AG Executive Board and the managing directors of all our markets. As part of their regular duties, Risk Owners are obliged to manage and monitor risks and opportunities within their area of responsibility.
In the course of this process, we have developed and implemented an updated Group Risk Management Policy. This policy, which is available to all Group employees online, outlines the principles, processes, tools, risk areas and key responsibilities within our Group. It also defines reporting requirements and communication timelines.
Risk and opportunity management principles
The adidas Group is regularly confronted with risks and opportunities which have the potential to negatively or positively impact the Group’s asset value, earnings, cash flow strength, or intangible values such as brand image.
We define risk as the potential financial impact caused by the occurrence of an external or internal event (or series of events) that may negatively impact our ability to achieve the Group’s business objectives.
Opportunity is defined as the potential financial impact caused by an external or internal event (or series of events) that can positively impact the Group’s business objectives.
We have summarised the most important of these risks and opportun-ities in this Risk and Opportunity Report in three main categories: Strategic and Operational, Compliance-related and Financial.
Risk and opportunity management system
The adidas AG Executive Board has the overall responsibility to operate an effective risk and opportunity management system that ensures comprehensive and consistent management of all significant risks and opportunities. The adidas AG Supervisory Board has the responsibility to monitor the effectiveness of the Group’s risk management system. These duties are undertaken by the Supervisory Board’s Audit Committee. In addition, wherever relevant, our Global Internal Audit department also includes an assessment of Risk Owners’ compliance with the Group Risk Management Policy within the scope of their audit, as part of their regular auditing activities.
To facilitate effective risk and opportunity management, we have an integrated risk and opportunity management system in place, which focuses on the identification, evaluation, handling, monitoring and reporting of risks and opportunities. The key objective of this system is to protect and further grow shareholder value through an opportunity-focused, but risk-aware decision-making framework.
adidas Group risk and
opportunity management system
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Group Risk Management - Risk management policy & methodology
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Supervisory and Executive Boards
Monitoring &
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We believe that a key component of optimal risk and opportunity management is the identification and evaluation of risks, risk-mitigating actions and opportunities where they arise. In addition, a concerted approach to handling, monitoring and reporting is of key importance. Therefore, risk and opportunity management is a Group-wide activity which utilises critical day-to-day management insight from local business units.
The main components of our risk and opportunity management process are:
Risk and opportunity identification: The adidas Group continuously monitors the macroeconomic environment, developments in the sporting goods industry, as well as internal processes to identify risks and opportunities as early as possible. The Risk Owners have primary responsibility for the identification of risks and opportunities.
The central Group Risk Management function has defined a catalogue of potential risks (Risk Universe) to assist and facilitate the Risk Owners in identifying and categorising risks and opportunities. On the one hand, the respective Risk Owners actively monitor the potential financial impact from changes in the overall macroeconomic, political and social landscape. On the other hand, they closely observe brand, distribution channel and price point developments.
A key element of the identification process is primary qualitative and quantitative research such as trend scouting, consumer surveys as well as feedback from our business partners and controlled space network. These efforts are supported by global market research and competitor analysis. Through this process we seek to identify the markets, categories, consumer target groups and product styles which show most potential for future growth at a local and global level. Equally, our analysis focuses on those areas that are at risk of saturation, or exposed to increased competition or changing consumer tastes.
Risk and opportunity evaluation: In order to manage risks and opportunities in an effective way, we evaluate identified risks and opportunities individually according to a systematic evaluation methodology, which is applied consistently and allows adequate prioritisation as well as allocation of resources. According to our risk management methodology, a risk and opportunity score is calculated by multiplying the potential financial impact with the likelihood of occurrence. The financial impact represents the biggest possible potential effect on contribution, with contribution being defined as operating profit before intra-Group royalties.
The financial impact is evaluated by utilising five categories: Marginal, Minor, Moderate, Significant and Major.
Likelihood represents the possibility that a given risk or opportunity may occur.
The likelihood of individual risks and opportunities is evaluated on a scale of 0% to 100%, using five classifications to represent an aggregate likelihood for various risk and opportunity categories:
Unlikely, Possible, Likely, Probable and Highly Probable.
As risks and opportunities have different characteristics, we have defined separate methodologies for assessing the potential financial impact. For each individual risk, the gross risk score and the net risk score have to be evaluated.
While the gross risk score reflects the worst-case negative financial impact before any mitigating actions, the net risk score reflects the expected financial impact after all mitigating actions. This approach on the one hand allows for a good understanding of the impact of an individual mitigating action taken, and on the other hand provides the basis for scenario analysis and simulations. In addition, the respective Risk Owners are also required to assess each risk from a timing perspective in order to determine when the risk could materialise. In assessing the potential effect on contribution from opportunities, each opportunity is appraised with respect to viability, commerciality, potential risks and the expected profit contribution.
This approach is applied to longer-term strategic prospects but also to shorter-term tactical and opportunistic initiatives at both the Group and, more extensively, the brand and market level.
Risk and opportunity handling: Risks and opportunities are treated in accordance with the Group’s risk and opportunity management principles as described in the Group Risk Management Policy.
Risk Owners are in charge of developing and implementing appropriate risk-mitigating actions and exploiting opportunities within their area of responsibility. In addition, the Risk Owners need to determine a general risk handling strategy for the identified risks, which is either risk avoidance, risk reduction with the objective to minimise financial impact and/or likelihood of occurrence, risk transfer to a third party or risk acceptance. The decision on the implementation of the respective risk handling strategy also takes into account the costs in relation to the effectiveness of any planned mitigating actions if applicable.
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Risk and opportunity monitoring and reporting: Our integrated risk and oppor-tunity management system aims to increase the transparency of Group risks and opportunities. As both risks and opportunities are subject to constant change, Risk Owners not only monitor developments, but also the adequacy and effectiveness of the current risk handling strategy on an ongoing basis.
Risk reporting consists of two separate regular reporting streams:
On the one hand, Risk Owners are required to report to Group Risk Management gross risks with a possible impact on contribution above the threshold of € 50 million regardless of their likelihood of materialising and net risks with a possible impact over
€ 1 million on contribution and the likelihood of materialising. Material changes in previously reported risks and/
or newly identified risks with a potential net impact on contribution of more than
€ 5 million are reported on an ad-hoc basis. Opportunities are aggregated separately with Risk Owners reporting all opportunities with a net impact of above
€ 1 million on contribution.
On the other hand, Group Risk Management provides the adidas AG Executive Board with a quarterly report based on the Risk Owners’ input. Any issues identified that, due to their material nature, require immediate reporting to the Executive Board are reported outside the regular reporting stream on an ad-hoc basis.
Description of the main features of the internal control and risk manage-ment system relating to the financial reporting process pursuant to § 315 section 2 no. 5 German Commercial Code (Handelsgesetzbuch – HGB)
We regard the internal control and risk management system relating to the consolidated financial reporting process of the adidas Group as a system which is embedded within the Group-wide risk management system. The risk management system with respect to the financial reporting process aims at minimising the risk of false representation in our Group accounting and in external financial reporting.
To this end, Group-wide compliance with statutory provisions and internal Group regulations must be ensured. We regard the risk management system as a process based on the principle of segregation of duties, encompassing various sub-processes in the areas of Accounting, Controlling, Taxes, Treasury, Planning, Reporting and Legal, focusing on the identification, assessment, treatment, monitoring and reporting of financial reporting risks. Clearly defined responsibilities are assigned to each distinct sub-process in the various areas.
In a first step, the risk management system serves to identify and assess as well as to limit and control risks identified in the consolidated accounting process which might result in our consolidated financial statements not being in conformity with regulations.
The internal control system relating to the financial accounting process serves to provide reasonable assurance that the financial statements are prepared in compliance with regulations despite identified financial reporting risks. To ensure the effectiveness of the internal control and risk management system, the Internal Audit function regularly reviews accounting-relevant processes.
Additionally, as part of the year-end audit, the external auditor examines selected aspects of the system, including the IT systems, to assess their effectiveness. Even with appropriate and functional systems, however, absolute certainty cannot be guaranteed.
adidas AG defines uniform consolidated accounting policies and updates these on a regular basis, dependent on regulatory changes and internal developments. Clear regulations serve to limit employees’ scope of discretion with regard to inclusion and valuation of assets and liabilities, thus reducing the risk of inconsistent accounting practices within the Group.
These policies are available to all employees involved in the financial accounting process through the Group-wide intranet. Material changes are communicated to the subsidiaries Group-wide on a quarterly basis. We aim to ensure compliance with the financial accounting rules through continuous adherence to the four-eyes principle in accounting-related processes. Certain reporting obligations and the extent thereof are mandatory for the Group’s subsidiaries. Adherence to reporting obligations and timelines is monitored centrally by Group Accounting.
Financial accounting at subsidiaries is conducted either locally by the respective company or by a Shared Service Centre that provides this service for several subsidiaries. Most of the IT systems used are based on SAP AFS. Some Group companies use Navision-based ERP software that was developed in-house.
The individual financial statements are subsequently transferred into a central consolidation system based on SAP SEM-BCS. The regularity and reliability of the financial statements prepared by subsidiaries is reviewed at Group level by Group Accounting and Controlling. If necessary, the Group seeks the opinion of independent experts to review business transactions that occur infrequently and cannot be processed as a matter of routine. Controls within the consolidation process such as those relating to the consolidation of liabilities or of revenues and expenses are conducted both automatically (system-based) and manually. Any inadequacies are remedied and reported back to the subsidiaries.
All financial systems used are protected against malpractice by means of appropriate authorisation concepts and access restrictions. Access author-isations are reviewed on a regular basis and updated if required. The risk of data loss or outage of financial-accounting-related IT systems is minimised by Group IT through central control and moni-toring of virtually all IT systems, central-ised management of change processes and with support through regular data backups.
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