RISKS FROM RISING INPUT COSTS
Raw material and labor
costs account for approximately 70 % of the Group’s cost of
sales. Prices of materials such as rubber, which closely
correlate
with the oil price, are especially
subject to the risk of
price increases. 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 collaborate closely with our vendors
to increase efficiency in manufacturing processes and search
for new materials. In addition, we have exploited economies
of scale from our higher sourcing volume following the Reebok
acquisition and are constantly improving production efficiency.
see Global Operations We may also compensate for this risk
by increasing the selling prices of our products – although this
is subject to the prevailing consumer and retail climate. 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.
We continue to assess the risks from rising input costs as having a medium likelihood. As a result of the time lag between ordering and production, we believe the short-term financial impacts from input cost increases are low. However, with the sharp oil price increases during 2007, ongoing wage inflation in Asia and increasing freight costs, we believe the potential financial impact from rising input costs has grown for the medium term. This could have a medium financial impact on our profitability beyond 2008.
SUPPLIER DEFAULT RISKS
Over 95 % of our product offering is
sourced through independent suppliers mainly located in Asia.
see Global Operations 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. The Group has
also significantly reduced the number of independent manufacturers
by combining the adidas and Reebok sourcing
organizations.
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.
We continue to assess supplier risks as having a low likelihood of occurrence and potential financial impact.
PRODUCT QUALITY RISKS
The adidas Group faces a risk of
selling defective product, 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 2007, approximately 3,400 FSMK hockey
masks which were delivered to retail in Canada, Europe and
the USA, were subsequently recalled voluntarily due to a
quality
issue. The issue arose during subsequent random
testing
of products after market launch. During these random
tests, a
hockey puck was aimed at full speed directly at the
face masks. Many of the masks dented and the coating
chipped slightly. No incidents or injuries were reported before
or after the recall.
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.
CUSTOMER RISKS
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 impact how they conduct business and
the external impacts of the consumer environment in which
they operate.
To limit these risks, we utilize a broad distribution strategy which includes our expanding controlled space activities. This enables us to reduce negative consequences that result from sales shortfalls that can occur with key customers. Specifically, no customer at brands adidas, Reebok and TaylorMade-adidas Golf accounted for more than 10 % of brand sales in 2007. In addition, we are proactively cooperating with key retail partners to further optimize sales through innovative point-of- sale initiatives (e.g. our shop-in-shop concepts at Dick’s Sporting Goods).
When necessary, we also restrict the distribution of our brands to protect brand image or product margins, and to streamline supply. For example, in the course of 2007, the Group decided to limit the Reebok product offering to an important mall-based key account in North America who had continually discounted Reebok product. Although we have been strengthening Reebok’s business in other retail channels such as sporting goods, we expect this development will have a significant negative impact on Reebok segment sales in North America throughout 2008. Nevertheless, the Group projects only a low impact on the Group’s overall contribution in 2008 from this action.
Due to the current difficulties at mall-based retailers and the overall economic environment in the USA, we continue to view a strong reduction of business with one of our brands’ biggest retailers as having a medium likelihood of occurrence. Such an event could have a medium financial impact on the sales and profitability of a particular region. However, on a Group level, we continue to view the financial impact from customer risks as low.
