The year 2009 continued to be affected by the subprime loans crisis, which had started in the second half of 2007 and swiftly spread worldwide, hitting the financial markets first and then the real economy, with effects on the major world economies and their consumption. All this has resulted in large downward revisions in the global economic growth forecasts.
This situation has also affected the fashion industry and consequently our Group, which is now exposed to larger risks and uncertainties because of the events which continue to affect the performance of the global economy and financial markets.
However, taking on risks is an integral part of doing business and our Group, which has long had procedures for managing risks in the areas most exposed, has not found itself totally unprepared for the changes in the global economic environment; rather, it is facing the particularly difficult situation by adopting existing procedures and also by taking strategic corrective actions, aimed at mitigating the impact of the crisis both on sales and profits.
The more important risks identified are strategic, market, operational, financial and legal/compliance risks, as described below.
Strategic risks
Strategic risks include the factors which influence the strategic opportunities and pose a threat to our Group. More specifically, the Group must guarantee its ability:
-to take advantage of business opportunities that may develop in new geographical areas and operating segments;
-to evaluate market potential correctly;
-to allocate resources generated on more profitable markets to potential growth areas;
-to seek out the world over specific skills and industrial areas in which to invest its know-how in order to ensure quality products and processes;
-to protect its brands, which are essential for succeeding and competing on the market;
-in a global, complex market featuring international players, to choose and integrate the models best suited to a presence in each local market (license vs. partnership; wholesale vs. retail).
Market risks
Market risks include the possible effects on our business arising from changes in the market.
-On the distribution front, competition could increase also because of the low barriers to entry. Benetton competes with local, national and global department stores, with specialist retailers, independent retailers and manufacturers, as well as with e-commerce companies. The Group's principal focus is on product quality, assortment and presentation, store ambiance, customer service and sales and marketing plans. It also competes for the most attractive commercial sites and terms of store rental and purchase.
-Our business is sensitive to changes in consumer spending decisions. It may also be influenced by the business environment, interest rates, tax rules and rates, local economic conditions, uncertainty over the future economic outlook and shifts in spending towards other goods and services. Consumer preferences and economic conditions may change from one market to the next.
-Our business is to some extent sensitive to the weather. An excessively mild winter, for example, may have consequences in terms of lower sales of higher margin products, with a negative impact on our results and financial position.
-We must be able to combat deflationary price pressure associated with increased competition and changes in consumer preferences, which could have negative effects on our results and financial position.
-The market for prime-location properties is very competitive. Our ability and that of our partners to find sites for new stores depends on the availability of properties that meet our criteria, and the ability to negotiate terms that meet our financial targets. In addition, we must be able to renew lease agreements for existing stores under the best terms possible, to enhance the value of the property portfolio used in the business, and to monitor any investment opportunities that might arise on international markets.
Operational risks
Operational risks refer to possible adverse consequences associated with processes, internal organization or systems and external events relating to the current management of the business.
-The success of our strategies is influenced by the commercial network's response. The policy of incentivizing our network of partners, in keeping with the Benetton business model, had the goal of fostering greater investment capacity, in order to open new stores, renovate existing ones and boost price competitiveness for the end customer. The success of this strategy depends on the ability to involve and guide our network, establishing specific objectives and regularly checking the results achieved. It should be stressed that our business model carries a risk of late customer payment and trouble in collecting credit in general.
-We are exposed to risks associated with commercial expansion and brand extension. Our actions are designed to develop the existing commercial network and to strengthen our brands. Conversely, our growth could be negatively affected if we were not capable of: identifying appropriate markets and locations for new stores; maintaining expected levels of customer service; preventing a drop in sales and profits by stores selling Benetton products when we open directly operated megastores in the same regions or shopping areas; managing inventories on the basis of effective needs; delivering goods in due time. Our Group's systems, procedures and controls must be capable of supporting expansion. If not, the success of these strategies would not be guaranteed.
-Our success also depends on the Group's ability to offer products that meet with consumer tastes. Our level of sales and profits also depends on the ability to anticipate and respond quickly to changes in fashion trends and consumer tastes. If our collections should fail to meet with customer approval, this would result in lower-than-planned sales, higher discounts, lower margins, higher inventories and higher unrecoverable receivables.
-The Group's strategy of growth and expansion has caused fixed and operating costs to rise. In order to enhance our image and market share, we have also invested in selling our products through retail stores, even though our Group has traditionally distributed its products through an extensive worldwide customer network. However, these retail activities have resulted in an increase in fixed and operating costs. These investments also expose us to the risk that some of the chosen locations may prove to be unsuitable, due to demographic changes or location of shopping areas.
-We must be able to organize and coordinate integrated production/logistics and commercial processes in order to meet the needs of a commercial calendar that satisfies the demands of ever-more sophisticated consumers.
-Our future performance depends on our ability to develop the business in emerging markets. We are committed to taking forward the new commercial strategies. We are devoting particular attention to emerging markets like China and India, also involving agreements with large-scale retailers for the opening of "stores in store" in large shopping centers in the major cities. Our initiatives include the creation of new partnerships to manage and develop commercial activity.
-We are making several changes to our information systems the very nature of which involves the risk of temporary business interruption. The modifications involve replacing current company systems with the latest versions, implementing changes and buying more integrated systems with new functions. We are aware of the risks associated with these activities, involving possible business interruption and inaccuracy of the data transferred. We nonetheless consider that we have taken all the necessary steps to limit these risks through testing, training and preparatory work, as well as through due commercial contact with suppliers of the replacement technology.
Financial risks
We include in financial risks those associated with exchange rates, interest rates and credit.
Exchange rate risks
Our Group's assets, liabilities, sales, costs and hence operating profit are and will continue to be affected by exchange rate fluctuations in selling currencies and so in the price of products sold, the cost of sales and operating profit. Fluctuations in foreign currency exchange rates against the Euro may negatively impact assets, liabilities, sales, costs, operating profit and the international competitiveness of production by our different factories. Although we take out hedges to manage this exposure, there is a risk that the strategies adopted could fail to protect the results from negative effects arising from future fluctuations.
Interest rate risks
We hold assets and liabilities that are sensitive to changes in interest rates and which are needed to manage liquidity and financial requirements. These assets and liabilities are exposed to interest rate risk, which is sometimes hedged through the use of derivatives.
Credit risk and country risk
Our Group is exposed to risks associated with the internationalization of its business, including risks associated with late payment by customers in certain countries or with trouble in collecting credit in general. Our business is also exposed to political and economic instability in certain countries where we operate, to changes in laws, to language or cultural barriers, and to price or exchange rate controls.
Legal/compliance risks
Legal/compliance risks include:
-the possible inadequacy of company procedures designed to guarantee the observance of the principal laws in Italy and abroad affecting the Group, such as those governing the activities of listed companies and their related groups (Italy's Consolidated Law on Finance, Italy's CONSOB Regulations, Regulations of Borsa Italiana S.p.A., etc.). Issues associated with security, anti-trust and privacy regulations are also of particular importance;
-the possible occurrence of events that negatively affect the credibility of our financial reporting (annual and interim financial reports), the accuracy of market disclosures and the safeguarding of assets;
-the risk that an unexpected event interferes with the process of adopting Italian Law no. 262/2005 containing provisions to protect investors and regulate financial markets, forcing management to revise priorities to ensure prompt compliance;
-the risks associated with the problems of keeping abreast of developments in the various sets of accounting standards adopted by our Group (IFRS and local accounting principles);
-its international presence exposes the Group to different tax regimes. Changes in the related rules could expose the Group to risks of non-compliance.