The most significant risks and uncertainties and risk management responses
The following describes risks and uncertainties assessed as significant and related risk management responses.
Continuous decline of purchasing power and demand especially in Finland
The weak outlook for the Finnish economy, increases in taxes and public payments resulting from the indebtedness of the public sector, coupled with increasing unemployment, weaken purchasing power and consumer confidence and may cause a long-term decline in the level of demand. This would have negative repercussions especially on Kesko's home improvement and speciality goods trade and car trade in Finland. In the food trade, price is increasingly important. In spite of the weakening of consumer demand, the Group has maintained good profitability and a strong financial position. Additional savings, which had already been decided, are being implemented while identifying new saving opportunities throughout the Group’s functions. The merger initiative in progress is aimed for Kesko to have a more focused corporate structure than before, a uniform corporate culture, a more simple Group structure and more efficient and uniform operating practices.
Weakening of the Russian economy and operating conditions
The level of uncertainty regarding economic development in Russia is high and political and country risks in Russia have risen. The fall of crude oil prices cuts the revenues of the Russian state. The low exchange rate of the rouble weakens purchasing power, demand and profitability, and strong fluctuations in the exchange rate increase hedging costs. The economic sanctions imposed by the EU and the USA make it difficult to obtain financing in Russia. Russia's counter-sanctions have impacts especially on food stores' operations and raise the price level in Russia even on a wider scale. Unpredictability of officials and rapid changes in laws and their application, coupled with unexpected changes in the operating environment can make business operations more difficult and delay expansion. In the long term, however, Kesko sees Russia as an opportunity and will continue to make carefully considered capital expenditures in Russia. From the perspective of the profitability and expansion of operations, the key is to be able to acquire and build well located store sites, develop the existing network, store concepts and selections, purchasing and logistics operations, as well as recruitment of personnel. Risk management also includes training personnel in, for example, responsible operating practices, as well as developing operating models and controls. In order to manage counterparty risks, special attention is paid to the selection of business partners especially in purchasing and store site operations. In order to achieve synergies, cooperation between the divisions in Russia and Group control have been increased.
Decline in price levels and intensification of price competition in the Finnish food trade
The level of food prices in Finland declined in 2015. As consumers' purchasing power has decreased, competition has become more intense and stores have lowered their prices in order to increase market shares. The decline in price levels and the intensified price competition can weaken the profitability of Kesko's grocery trade and retailers. Kesko develops the stores’ selections, services, store concepts and the store network continuously. In addition, the aim is to offer customers the best digital services in the food trade.
Acquisitions in progress
After completion, the acquisitions of Suomen Lähikauppa Oy and Onninen Oy will provide a significant business opportunity for Kesko, but they also entail risks. The takeover and integration of the companies into Kesko Group will be demanding, long lasting processes and their success will impact on the achievement of the objectives set for sales, profit and synergies. Phased and systematic takeover and integration plans, sufficient resources, uniform management and reporting models, prioritisation of strategic initiatives and implementation of synergies, among other things, are used for ensuring the success of the acquisitions.
Strong change in the trading sector caused by digitalisation
E-commerce and online services are becoming increasingly popular in the retail trade, especially in the speciality goods trade. International e-commerce increases price transparency and consumers' alternatives at the same time when making decisions to buy products and services and buying and marketing them become more personalised and increasingly take place online. The achievement of business objectives requires an active approach and strong expertise in the development of online services and online stores that are attractive to customers and the adoption of a multichannel approach with supporting electronic customer communications. The risk is that some of the traditional brick and mortar stores become unprofitable and that the progress of e-commerce and online service development projects is outpaced by competitors, or that competing online stores and online services are found more attractive by customers. In addition, competition can be intensified by companies entering the value chain of trade by introducing new business models. For the food trade, the challenges in the development of e-commerce include the cost effectiveness of logistic models and the suitability of the existing store sites for e-commerce. According to the new strategy, Kesko’s objective is to offer the best digital services in the trading sector. They include digital interaction with customers across all channels, targeted and personalised digital marketing, innovative online store solutions and customer oriented mobile services. In order to achieve the targets, digital business experts have been recruited more than before.
Business interruptions and information system failures
The trading sector is characterised by increasingly complicated and long supply chains and a higher dependency on information systems, data communications and external service providers. Extended failures in information systems and payment transfers, or in other parts of the supply chain, can cause significant losses in sales and weaken customer satisfaction. Continuity planning aims to ensure disturbance-free operation of critical functions, operation during disturbances and a sufficiently fast recovery from a serious disturbance. External service providers' preparedness is ensured through audits. Continuity plans are tested regularly to ensure their usefulness and timeliness and crisis preparedness is maintained through rehearsal of responses to crisis situations.
Retailers' operating conditions
Kesko's chain operations are, contrary to those of most competitors, based on a retailer business model to a significant extent. The competitive advantages of the retailer business model include the retailer's local expertise and ability to rapidly respond to changes in customer needs or competitive situations. Decision-making concerning the development of the chains' operations and the implementation of changes in business operations can, however, be outpaced by competitors. A prolonged decline in the level of demand and sales can weaken the profitability and performance of retailer operations in Finland. The development of store concepts and retail processes is an ongoing activity in Kesko's different divisions and chains. The chains’ quality programmes and the support and advisory services provided to retailers are aimed to ensure a uniform quality in the implementation of chain concepts and to maintain retailers' operating conditions as local market situations change.
With a view to increasing the market share, good store sites are a key competitive factor. The acquisition of store sites can be delayed by town planning and permit procedures and the availability and pricing of sites. Considerable amounts of capital or lease liabilities are tied up in store properties for years. When the share of e-commerce grows, the market situation changes, or a chain concept proves inefficient there is a risk that a store site becomes unprofitable and operations are discontinued while long-term liabilities remain. These risks are managed through long-term store network planning, careful preparation of each decision to make capital expenditure in a store site, long-term cooperation with lessors, as well as management solutions and the sale and leaseback operating model. In cases where Kesko is the property developer, the aim is to build stores sites in which space solutions and use can be flexibly modified, as necessary. The needs of multi-channel operations are taken into account when new premises are designed and existing ones are renewed. Flexibility and continuity of leased premises are ensured by extension options included in lease agreements.
Product safety and supply chain quality
A failure in product safety control or in the quality assurance of the supply chain can result in financial losses, the loss of customer confidence or, in the worst case, a health hazard to customers. The risk is managed so that, for example, the Product Research Unit verifies the quality of products sold by Kesko Food and K-citymarket Oy and the product safety of companies manufacturing own brand products. Own control ensures compliance with foodstuffs regulations. The product recall procedure enables defective products to be rapidly removed from sale.
Employee competencies and working capacity
The implementation of strategies and the achievement of objectives require competent and motivated personnel. There is a risk that the trading sector does not attract the most competent people. The acquisitions in progress as well as other significant business and development projects, coupled with an increased need for special competencies increase the key-person risk and the dependency on individual expertise. In connection with strategy work, the competencies required in strategy implementation are identified and personnel plans are prepared. Personnel surveys are in a key role in the development of human resources management. Diversified training possibilities and career paths are available to personnel. Wellbeing at work and the working capacity of personnel is promoted with the help of a programme aimed to develop wellbeing at work at Kesko. Kesko's employer image is developed through systematic cooperation with stakeholders and internal and external communications.
Suppliers and distribution channels
In divisions strongly dependent on individual principals and suppliers, such as the car and machinery trade, ownership arrangements and changes in the strategy of a principal or supplier, changes in product selections, product pricing and distribution channel solutions can mean weakened competitiveness, or a loss of sales or business. Good market shares, growing sales and active development of business operations create a basis for a long-term cooperation.
Crime and malpractice
Crimes are increasingly committed through data networks and crime has become more international and professional. A failure, especially if it affects the security of payment transactions and personal information, can cause losses, claims for damages and reputational harm. There is a risk that controls against such crime are not sufficient. Chip card terminals have been introduced to improve the security of card payments. The confidentiality of customer and personal information is ensured by up-to-date data security solutions and audits. Crime and malpractice are prevented with the help of technical equipment, by providing information, training and instructions, as well as using more effective controls.
Responsible operating practices and reputation management
Various aspects of corporate responsibility, such as the ethicality of production and purchasing, fair and equal treatment of employees and environmental protection are increasingly important to customers. Any failures of responsibility would result in negative publicity for Kesko. Kesko's challenges in corporate responsibility work include, among other things, communicating its responsibility principles to suppliers, retailers and customers, and ensuring responsibility in the supply chain. Responsible working principles are promoted with the help of e-learning and value discussion programmes arranged in all of Kesko's operating countries. Kesko's responsible sourcing is guided by ethical purchasing principles and compliance with them is ensured with the help of continuous training of the purchasing personnel. The responsibility of sourcing is also maintained by ensuring the existence and timeliness of suppliers' product safety systems and own control plans.
Compliance with laws and agreements
Compliance with laws and agreements is an important part of Kesko's responsibility. Non-compliance can result in fines, claims for damages and other financial losses, and a loss of confidence and reputation. In order to ensure compliance with laws, the Group implements training programmes and conducts self-assessments. Contractual risks are managed by harmonising agreements and agreement processes and by electronic archiving of agreements.
Reporting to the market
Kesko's objective is to produce and publish reliable and timely information. If any information published by Kesko proved to be incorrect, or communications failed to meet regulations in other respects, it could result in losing investor and other stakeholder confidence and in possible sanctions. The accuracy of financial information is challenged by the tightly-timed schedule for disclosures and dependence on information systems. The risk is reduced by scheduling and by providing detailed instructions for the process, as well as ensuring the availability of the right resources, clear responsibilities and sufficient expertise.
Risks of damage
Accidents, natural phenomena and epidemics can cause damages or business interruptions that cannot be prevented. There is also the risk that insurance policies do not cover all unexpected accidents and damages. Insurance policies against financial impacts from damages are taken out in accordance with principles confirmed by Kesko's Board. Kesko Group has international insurance programmes which cover, for example, property damages, business interruption losses and liability damages. The Group's risk management function manages the implementation of the Group's insurance programmes in a centralised manner.
Financial risks are described in a note to Kesko's financial statements for 2015.