Reebok 2006 Annual Report Download - page 105

Operational Risks
Sourcing Risks
Raw material and labor costs account for approximately 80%
of the Group’s cost of sales. Hence, the adidas Group faces
risks from significant increases of these costs and also
from business interruptions at one of our major suppliers,
which would have a material impact on the Group’s ability
to meet short-term customer demand. For example, finan-
cial difficulties and subsequent closure of three factories in
Indonesia supplying footwear to Reebok reduced the Group’s
net income by around € 8 million in 2006. To mitigate the risk
of higher sourcing costs, we exploit economies of scale from
our higher sourcing volume following the Reebok acquisi-
tion. To reduce the risk of business interruptions, we work
with vendors who demonstrate reliability, quality, innovation
and continuous improvement. By doing so, we are confident
that our strategic supply partners will be most competitive
in the medium and long term in offsetting price increases. In
addition, we pursue a regionally balanced sourcing strategy
and collaborate closely with our vendors in search of new,
innovative materials. As a result, we assess sourcing risks as
having a medium likelihood of occurrence and a low potential
financial loss.
Customer Risks
Customer risks arise from our dependence on key custom-
ers who could exert bargaining power resulting in consider-
able margin pressure and product cancellations. To limit this
risk, the adidas Group has a broad distribution strategy. As a
result, no customer at brands adidas, Reebok and TaylorMade
accounted for more than 10% of brand sales in 2006. Further,
following the Reebok acquisition, we are actively reducing the
brand’s dependence on key accounts by strengthening our
business in the sporting goods and athletic specialty retail
channels. A strong reduction of business with one of our
brands’ biggest retailers, which we regard as unlikely, could
nonetheless adversely impact regional sales and profitability
to a medium extent.
IT Risks
A Group-wide breakdown of IT systems or a significant loss of
data could result in considerable disruptions to our business.
In order to mitigate these risks, we perform scheduled back-
ups and engage in proactive maintenance. System security
and reliability are tested via internal tests and external audits
on a regular basis. Periodic reviews of the Group’s systems
architecture ensure that the Group meets changing busi-
ness requirements and fulfills the highest safety standards.
In 2006, the downtime of our major IT applications was well
below 1% of total running time. This gives us confidence in
the assessment of IT risks as having a low likelihood of occur-
rence, but a significant potential financial impact.
Overall Risk
Central risk management aggregates all risks reported by
brand, regional and headquarter functions. Based on the com-
pilation of risks explained within this report and the current
business outlook, adidas Group Management does not fore-
see any individual or aggregate risks which could materially
jeopardize the ongoing business health and viability of the
Group. In comparison to the prior year, portfolio and own-
retail risks increased in importance due to the magnitude
of expected synergies from the Reebok integration and the
higher share of own-retail activities at brand adidas. However,
financing and brand image risks have become less prevalent
as we have completed the financing of the Reebok transac-
tion and now have a broader portfolio of brands addressing
distinct consumer groups. As a result, management regards
the Group’s overall risk exposure as largely unchanged. This
assessment is supported by the continued positive responses
to our financing demands, as in 2006 the adidas Group issued
several private placements in various regions and currencies
that were all oversubscribed (see Treasury, p. 85). The adidas
Group therefore has not sought an official rating by one of
the leading rating agencies. We believe that the Group’s earn-
ing power forms a solid basis for our future business devel-
opment. As outlined above, we have taken appropriate pre-
cautions against typical business risks that could negatively
affect our financial standing and profitability situation.
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