Maintaining and enhancing brand image and reputation through the creation of strong brand identities is crucial for sustaining and driving revenue and profit growth. It is also an important credential as we extend our brands into new categories and geographies. ...

Maintaining and enhancing brand image and reputation through the creation of strong brand identities is crucial for sustaining and driving revenue and profit growth. It is also an important credential as we extend our brands into new categories and geographies. The adidas Group faces considerable risk if we are unable to uphold high levels of consumer awareness, affiliation and purchase intent for our brands. To mitigate this risk, we have defined clear mission statements, values and goals for all our brands. These form the foundation of our product and brand communication strategies. We also continually refine our product offering to meet shifts in consumer demand and to contemporise our offering to respond to current trends. Central to all our brand image initiatives is ensuring clear and consistent messaging to our targeted consumer audience, in particular at point-of-sale. Market share gains at TaylorMade and continued growth in the adidas Sport Style division give us confidence that image risk for these brands remains low.
During the past twelve months, the launch of several new Reebok product initiatives such as EasyTone™ and JUKARI Fit to Fly™ has started to improve the overall consumer experience for the Reebok brand and rebuild brand image. While these results are encouraging, the risk from loss of brand image remains higher at Reebok than in our other brands, although we believe the risk has moderated compared to the prior year.
Aggregating these risks, we now believe that in the medium term brand image risk for the Group has a low likelihood of occurrence. Nevertheless, a significant deterioration in brand image could have a high potential financial impact on our Group.

New adidas, Reebok and Rockport own-retail stores require considerable up-front investment in furniture and fittings as well as ongoing maintenance....

New adidas, Reebok and Rockport own-retail stores require considerable up-front investment in furniture and fittings as well as ongoing maintenance. In addition, own-retail activities often require longer-term lease or rent commitments. Retail also employs significantly more personnel in relation to net sales than our wholesale business. The higher portion of fixed costs compared to our wholesale business implies a larger profitability impact in cases of significant sales declines.
The Group reduces this risk by only entering into lease contracts with a duration of less than ten years. Store performance is measured by a retail scorecard consisting of nine quantitative key performance indicators. All shops are ranked by their weighted average score. Underperforming stores are restructured or closed as appropriate.
With improvements in consumer spending expected to lag behind economic recovery in 2010, the risk of a lower performance of our retail stores remains unchanged compared to the prior year. We therefore believe the likelihood of major own-retail underperformance remains medium. Due to the ongoing growth of our own-retail activities as a percentage of Group sales, we continue to assess the potential financial impact from own-retail underperformance, which may also involve impairment charges and store closures, as medium.

Raw material and labour costs account for approximately 70% of the Group’s cost of sales. Prices of materials such as rubber, and those which closely correlate with the oil price, are especially subject to the risk of price changes. ...

Raw material and labour costs account for approximately 70% of the Group’s cost of sales. Prices of materials such as rubber, and those which closely correlate with the oil price, are especially subject to the risk of price changes. As our ordering process and price negotiations usually take place around six months in advance of production, our sourcing function has visibility and reaction time to manage and plan for sharp increases in input costs.
To reduce the financial impact on our product margins from higher sourcing costs, we are implementing further lean manufacturing techniques at our partner factories, eliminating time and cost from the procurement process, re-engineering our products and selectively increasing prices where possible. In addition, in the medium term we have the ability to adapt our sourcing structure to take advantage of more competitive pricing in other locations.
As a result of the significant slowdown of global economic activity, raw material prices declined compared to the prior year. This development is forecasted to positively impact our sourcing costs in 2010. As we begin planning for 2011, renewed price increases cannot be ruled out given the projected macroeconomic recovery. Therefore, we continue to assess the medium-term risks from rising input costs as having a medium likelihood of occurrence and a medium potential financial impact.

Over 95% of our product offering is sourced through independent suppliers mainly located in Asia. ...

Over 95% of our product offering is sourced through independent suppliers mainly located in Asia. To reduce the risk of business interruptions following a potential supplier default, we work with vendors who demonstrate reliability, quality, innovation and continuous improvement. In addition, we have bought insurance coverage for the risk of business interruptions caused by physical damage to supplier premises. In 2009, the Group again significantly reduced the number of independent manufacturers through the further rationalisation of our supplier organisation. This exercise has allowed us to reduce risk by simplifying our sourcing structure and focusing on the highest-quality suppliers, without compromising our flexibility or competitiveness.
Therefore, we continue to assess supplier risks as having a low likelihood of occurrence and a low potential financial impact.

The adidas Group faces a risk of selling defective products, which may result in injury to consumers and/or image impairment. ...

The adidas Group faces a risk of selling defective products, which may result in injury to consumers and/or image impairment. We mitigate this risk through rigorous testing prior to production, close cooperation with suppliers throughout the manufacturing process, random testing after retail delivery, open communication about defective products and quick settlement of product liability claims when necessary. In 2009, we did not recall any products.
Our assessment of product quality risk remains unchanged versus the prior year. We regard the likelihood of significant product liability cases or having to conduct wide-scale product recalls as low. As we have insurance protecting us against the financial consequences of significant product liability cases, we also assess the financial impact as low.

As we place initial production orders around six months in advance of delivery, the adidas Group is exposed to inventory risks relating to misjudging consumer demand at the time of production planning. ...

As we place initial production orders around six months in advance of delivery, the adidas Group is exposed to inventory risks relating to misjudging consumer demand at the time of production planning. A sudden decline in demand has the potential to cause excess inventories. This can have negative implications for our financial performance, including higher levels of clearance activity and inventory obsolescence as well as reduced liquidity due to higher operating working capital requirements.
On the other hand, a sudden increase in demand can lead to product shortfalls at the point of sale for both our wholesale partners and own-retail operations. In this situation, our Group faces the risk of missed sales opportunities and/or customer and consumer disappointment, which could lead to a reduction in brand loyalty and our reputation as an on-time, in-full supplier. In addition, the Group faces potential profitability impacts from costs such as air freight in efforts to speed up replenishment.
In order to mitigate these risks, we continuously strive to improve our forecasting and material planning processes. Our replenishment programmes are essential to shorten production lead times, ensuring availability of products while avoiding excess inventories.
In 2010, compared to prior years, precise demand and inventory planning will remain difficult, given the lack of clarity on how rapidly consumer spending will recover. However, compared to the prior year, our inventory situation has improved substantially. Therefore, we assess the associated inventory risk as having a medium likelihood of occurrence and medium potential financial impact on our Group.

Customer risks arise from our dependence on key customers who have the ability to exert bargaining power and can therefore cause considerable margin pressure or cancel orders....

Customer risks arise from our dependence on key customers who have the ability to exert bargaining power and can therefore cause considerable margin pressure or cancel orders. These risks exist not only due to the relative size of some of our major customers, but also as a result of our limited ability to influence how they conduct business and the external impacts of the consumer environment in which they operate.
To limit these risks, we utilise a broad distribution strategy which includes expanding our controlled space activities. This enables us to reduce negative consequences resulting from sales shortfalls that can occur with key customers. Specifically, no customer of our Group or any of our operating segments accounted for more than 10% of Group sales in 2009.
When necessary, we also restrict or limit the distribution of our products to protect brand image or product margins. By differentiating our product offer to customers, we limit the risk of increased price competition on specific products which can result in margin erosion.
Although the economic environment remains challenging, given the operational improvements taken by several retailers in 2009, we believe the risk of a strong reduction of business with one of our biggest retailers now has a low likelihood of occurrence. Such an event, however, could have a medium financial impact on the sales and profitability of the Group.

Event and promotion partnerships play an important role in building brand image and generating sales of licensed products. ...

Event and promotion partnerships play an important role in building brand image and generating sales of licensed products. The adidas Group faces the risk of either losing key partnerships or having to accept unfavourable terms due to intensified competition for attractive contracts. During 2009, for example, the National Olympic Committee of China and adidas decided not to renew their promotion partnership.
To mitigate these inherent risks, we regularly seek to extend our most important partnership agreements before contract expiry. For example, in 2009 adidas extended its partnership with UEFA for the UEFA EURO 2012™ and UEFA EURO 2016™ football championships, as well as for the UEFA Champions League.
We also regularly include change-of-control clauses as well as non-cash compensation components in contracts to avoid the risk that negotiations are reduced solely to price. In addition, we follow a strategy of broadening the Group’s portfolio of premium partnerships in order to reduce our reliance on single affiliations.
In 2009, competition for top promotion partnerships continued to grow as several smaller competitors increased spending in this area. As a result, we still believe there is a medium likelihood of losing important individual promotion contracts. Nevertheless, given the maturity of our most important contracts, we assess the potential financial impact of this risk to be low in the medium term.

Innovative and attractive products generate strong sales and – more importantly – create a halo effect for other products. ...

Innovative and attractive products generate strong sales and – more importantly – create a halo effect for other products. The speed with which new product technologies and fresh designs are brought to market is decisive for maintaining competitive advantage. In 2009, all brands generated the majority of their sales with products which had been brought to market over the past 12 to 18 months. If the adidas Group failed to maintain a strong pipeline of new innovative products over a sustained period of time, we would risk a significant sales decline. We focus on pursuing our innovation and design strength. To ensure we can quickly adapt to changing consumer preferences, we focus on streamlining research and development processes to speed up the time to market.
We continue to assess the occurrence probability of this risk, which could potentially have a significant financial impact, as low.

Achieving the adidas Group’s goal of becoming the global leader in the sporting goods industry is highly dependent on our employees and their talents. ...

Achieving the adidas Group’s goal of becoming the global leader in the sporting goods industry is highly dependent on our employees and their talents. Loss of key personnel in strategic positions, to competitors or others, is therefore a significant risk we face. In addition, as labour markets become increasingly competitive, we also face the risk of being unable to identify, recruit and retain the most talented people that best meet the specific needs of our Group. To reduce this risk and enable our employees to make use of their full potential, we strongly engage in developing a motivating working environment. Our goal is to make the adidas Group the “Employer of Choice” within our industry. This is supplemented by offering attractive reward and incentive schemes as well as long-term career opportunities and planning.
Our overall assessment of personnel risks remains unchanged compared to the prior year. Although we expanded our own-retail activities (where employee turnover is higher than the Group average) and increased our employee base in emerging markets (where higher levels of wage inflation increase the volatility of the employment market) in 2009, the current economic environment is likely to reduce employee turnover.
Therefore, we continue to regard the occurrence likelihood of these risks as low. Should these risks materialise, they could have a medium financial impact on our Group.

We face the risk that our employees breach rules and standards that guide appropriate and responsible business behaviour. In order to successfully manage this risk, the Group Policy Manual was launched at the end of 2006 to provide the framework for basic work procedures and processes. ...

We face the risk that our employees breach rules and standards that guide appropriate and responsible business behaviour. In order to successfully manage this risk, the Group Policy Manual was launched at the end of 2006 to provide the framework for basic work procedures and processes. It also includes a Code of Conduct which stipulates that every employee shall act ethically in compliance with the laws and regulations of the legal systems where they conduct Group business. All of our employees have to participate in a special Code of Conduct training as part of our Global Compliance Programme.
We continue to regard the likelihood of grave misconduct as low. Should they materialise, these risks could have a medium financial impact on the Group.

Key business processes including product marketing, order management, warehouse management, invoice processing, customer support and financial reporting are all dependent on IT systems. ...

Key business processes including product marketing, order management, warehouse management, invoice processing, customer support and financial reporting are all dependent on IT systems. A significant systems outage or loss of data could result in considerable disruptions to our business. Insufficient project management could delay the execution of projects critical to the Group or make them more expensive than planned.
To mitigate these risks, our IT organisation proactively engages in system preventive maintenance, service continuity planning and adherence to applicable IT policies. Data security is managed by restricting user access based on job description, requiring password changes at predefined frequencies on our most critical systems and adhering to data protection regulations. We perform multiple backups at alternating data centre locations for the Group’s core enterprise resource planning system (ERP) on a daily basis. In addition, for the ERP system, our contingency solution allows us to quickly switch to a remote site if necessary – without any loss of data. System security, controls and reliability are reviewed and tested by the Internal Audit function.
Our target availability of 99.7% for major IT applications was exceeded in 2009. IT project risks are further mitigated by utilising a proven project methodology for all IT projects that includes tight cost control and regular risk reviews for all major projects. In addition to these fundamental controls, the adidas Group has continued to focus on additional IT control initiatives in 2009. These include the development of a five-year IT Strategic Plan aligned with and approved by senior business management, as well as the periodic review and approval of IT project budgets by a governance board. A new team was formed within our IT organisation to manage all compliance-related activities, including the phased implementation of Segregation of Duties (SOD) controls within the ERP environment.
Based on these factors, we believe the risk of a major IT default continues to be low. Such a default, however, would result in a significant potential financial impact.