NOTE 42
The Kesko Group has established a risk management process, based on the risk management policy confirmed by the Board. The divisions have made risk assessments and updated them in accordance with the strategy process and the rolling planning framework. The divisions' risks and their management responses have been discussed by the division parent companies' and the Group's management. In their respective responsibility areas, the Group units have assessed the risks threatening the Group's objectives and the management of such risks.
On the basis of the divisions' and Group units' risk analyses, the corporate risk management function has prepared summaries of major risks and their management on a quarterly basis. The resulting risk report has been handled by Kesko Corporation's Board of Directors' Audit Committee. The main risks and uncertainties, and changes in the risk situation compared with the previous financial statements have been reported in the interim financial reports. The following is a description of the risks and uncertainties assessed to be significant.
The general economic development continues to involve significant uncertainties. Developments in the employment situation, tax increases resulting from the debt burden of the public sector, and consumers' confidence in the future have an essential impact on consumers' purchasing power, consumer demand and businesses' investment readiness.
Kesko has adjusted its operations to meet the lower demand by a more efficient use of capital, and by adjusting the number of employees and costs. A prolonged or deeper economic recession would necessitate further adjustments.
The achievement of objectives requires efficient store concepts which are attractive to customers. In the chain business model, a competitive edge is gained by store concepts and brands that are based on customer needs and differentiated from the competition, coupled with efficient, high-quality concept implementations. Customer satisfaction and brand surveys, and competitor monitoring are used to find out customer needs and market changes. Changing customer needs are satisfied and competitiveness is reinforced by developing concepts and operating systems, and by reforming brands. High-quality concept implementation is ensured throughout the chain by strict chain control and regular concept measurements.
Kesko aims to achieve growth also through international expansion in selected business areas. Failures in these projects may put growth and profitability at risk. In the present economic situation, all risks involved in investments are thoroughly assessed. On the other hand, it may be possible to complete acquisitions of businesses and store sites more easily and on better terms.
In international operations, uniform operating practices and processes are a prerequisite for improved efficiencies and synergy benefits. In Kesko's international operations, category management and purchasing and sourcing are steered in a centralised manner, and a supporting shared information system is being implemented.
Expansion and operations in Russia involve both opportunities and risks. The unpredictability of officials and sudden changes in the interpretation and application of laws may complicate operating activities or delay expansion in Russia. This risk is managed by training personnel, and by developing operating systems and controls, and by providing guidelines.
Kesko's challenge is to combine the possibilities of online trading, electronic customer communication and the retailer business model into an efficient system. Kesko develops electronic customer communications and the chains' online store sites in order to improve customer satisfaction and increase sales.
The automation of financial administration routines may be delayed by suppliers' and retailers' technical facilities and abilities to adopt new operating systems. Kesko is implementing a shared service centre project for the purpose of improving cost-efficiency and the uniformity of financial administration practices.
Kesko is carrying out several significant information system projects. Insufficient resources and poor project management involve a risk that the expected benefits will be delayed or that the project costs will be exceeded. Strict control by the division's management, skilled project management and competent
people are necessary for the success of these projects.
As a result of the recession, B2B customers and retailers increasingly experience economic and financial difficulties, which involve a risk of growing credit losses. Division parent companies are responsible for managing credit risks related to receivables from customers. The companies have established a credit policy, whose implementation is monitored. The aim is to ensure the payment of receivables by carefully assessing customers' creditworthiness, by specifying the terms of customer credits and collateral requirements, and by efficient credit control and credit insurances where applicable.
Finland is Kesko's only operating country that belongs to the euro area. International expansion has increased currency risks, and the Baltic currencies, the Latvian lats in particular, are at risk of being devalued. Hedging against currency exchange fluctuations is made more difficult by hedging costs that, in some cases, have become excessively high. The management of the Group's currency risks is centralised in the Group Treasury.
These and other financial risks (incl. counterparty risk, liquidity risk, exchange rate risk in purchasing operations, interest rate risk and commodity risk related to electricity forward exchanges) are described in more detail in note 41 to Kesko Corporations' 2009 financial statements.
The trading sector is characterised by increasingly complicated and long supply chains and an increasing dependency on information systems, telecommunications and external service providers. Disturbances in the supply chain can cause major losses in sales and returns. These problems may affect the customer in that there are no products available in the store or the store is closed. Kesko has prioritised the most critical information systems with regard to business operations, and the continuity management projects underway are aimed at securing undisturbed critical operations and a sufficiently fast recovery after a serious disturbance. The plans are tested regularly to ensure their efficiency and updatedness and to maintain readiness for crisis situations.
In divisions that are strongly dependent on individual principals and suppliers, such as the car and machinery trade, changes in ownership, or in a principal's or supplier's strategy concerning the product selection, pricing and distribution channel solutions can mean a reduction in competitiveness or sales, or a loss of business. Good market shares, growing sales and development of operations create a basis for long-term cooperation.
Suppliers may have increasing difficulties in deliveries, as a result of the recession. There is also a growing risk of bankruptcies. The financial situation and delivery accuracy of the major suppliers are monitored and substitute suppliers are examined.
Store sites are a significant competitive factor. Considerable amounts of capital or lease liabilities are tied up in store properties for years. As a result of the recession or changes in the competitive situation, there is a risk that store sites may become unprofitable and that operations will end while the long-term liabilities remain. The acquisition of good store sites can be slowed by scarcity of plots, zoning and permit procedures and trends in plot prices. Each operating country has its special characteristics arising from, for example, legislation and the authorities. Foreign real estate owners' readiness to make repair or extension investments has weakened in some cases as a result of the recession.
These risks are managed by long-term store network planning, careful preparation of each store site investment decision and the sale-leaseback system. In cases where Kesko manages the construction, the aim is to design a store site that can be modified for different uses as necessary. In the case of leased premises, the flexibility and continuity requirement is taken into account by extension options included in the leases.
Different aspects of responsibility are increasingly important for customers, and possible responsibility failures would weaken Kesko's reputation. Kesko's challenges in responsibility work include communicating its responsibility policies to customers, retailers and suppliers, and ensuring the ethicality of production. In monitoring the social compliance of its suppliers, Kesko primarily concentrates on suppliers operating in the so- called ‘high risk’ countries. China is Kesko's most important non-EU import country, and our own local monitoring team has been established in Shanghai. Their duty is to guide, train and supervise the suppliers of Kesko's division parent companies, focusing on the terms of employment and working conditions, as well as on matters relating to compliance with environmental and chemical legislation.
Recession entails a growing risk of financial malpractice. Preventive measures have included more effective communications, training and guidelines as well as tightened controls. Information technology is increasingly used to trace incidental transactions, and prevent and reveal malpractices.
Retail stores incur significant financial losses arising from wastage. Wastage can result, for example, from spoilage or breakage of goods, theft or other malpractice, and unsuccessful purchasing. The Group continuously develops methods and tools for more efficient wastage management and reduction. Wastage prevention training is arranged for retailers, supervisors and sales staff in different contexts, and it is a key area in training new store personnel. Wastage teams have been established in stores to find out the reasons for the store's wastage and to establish efficient wastage management measures. Best practices are adopted for wider use.
The requirements of stakeholders and the law for safe information handling to prevent damages and malpractice have increased, especially with respect to credit card payment and personal information. Kesko is carrying out a project to introduce chip card payment terminals. Audits and up-to-date information security solutions are used to ensure the confidentiality of customer and personal information. Appropriate guidelines are central in ensuring the confidentiality of business secrets. Critical transactions, such as payments, are protected with job descriptions, acceptance limits, access rights and system controls.
The implementation of strategies and the achievement of goals require competent and motivated people. There is a risk that the trading sector will not attract the most competent people. The increased need for specialised expertise increases dependence on the competences of individuals and the risk of losing key people. In connection with strategy work, the competencies required for strategy implementation are identified, and personnel plans are drawn up. Personnel surveys play a central role in the development of HR management and the promotion of working capacity. Kesko's employer image is developed by systematic stakeholder cooperation and internal and external communications.
Kesko's objective is to provide safe products for its customers. A failure in the quality assurance of the supply chain, or in product control may result in financial losses, the loss of customer confidence or, in the worst case, a health hazard. In order to manage this risk, the Product Research Unit controls the quality of products sold by Kesko Food, Citymarket Oy and Anttila, and supervises companies manufacturing products for Kesko Food. The trading sector’s self-control practices ensure that the regulations and rules concerning foodstuffs are observed. The practice of recalling products ensures that defective products are withdrawn from sale quickly.
A pandemic, or an epidemic of widely spread disease, would have extensive effects on business operations. At least temporarily, it could impact demand and the availability and quality of goods and services. Kesko's continuity management principles concerning the safeguarding of critical functions require that the unavailability of a major part of the personnel or the key people because of an epidemic or some other reason must be prepared for. Up-to-date continuity plans and their testing maintain the abilities to control exceptional situations. Substitute arrangements are made to ensure that the resources for functions will be maintained. Ensuring efficient internal and external communications plays an important part in continuity planning.
Compliance with legislation, agreements and Kesko's ethical principles is an important basic value in all of Kesko's operations. Non-compliance may result in fines, compensation for damages and other financial losses, and a loss of confidence or reputation. The Group has specific training programmes, especially in competition legislation, to avoid this. Self-assessments are made in matters concerning competition legislation.
Contractual risks are managed by harmonising agreements and the processes of entering into agreements, and by electronic archiving of contracts. An essential issue in the chain agreements between Kesko and the retailers is finding solutions for the high-quality delivery of customer promises and commitment to the chain business operation.
In international operations, problems also arise from different interpretations and procedures concerning, among other things, taxation and official regulations.
The objective of Kesko's corporate communications is to produce and publish reliable information at the right time. If some information published by Kesko proved to be incorrect or a release failed to meet regulations, it might result in investors and other stakeholder groups losing confidence, and possible sanctions. The accuracy of financial information is challenged by tight schedules and dependence on information systems. This risk is managed through careful scheduling and ensuring the right resources and sufficient competencies.
Damages, accidents and crimes are prevented through uniform practices and cost-efficient safety precautions. The financial consequences of damage are covered with insurance, in accordance with the policy defined by the Kesko Board of Directors. The Kesko Group uses international insurance programmes to cover, among others, property, business interruption and liability risks. The Group's risk management function steers the implementation of insurance programmes in a centralised manner.