Description of Risks
The top five risks and other important risks as derived from these categories during the year under review (and the corresponding responses) are described in the Integrated Annual Report 2016.
(N.B.: These descriptions are to be considered as an elucidation of the Integrated Annual Report; they will not be updated during the year.)
In the Corporate Risk Assessment the likelihood and impact of events that could jeopardize the achievement of the (financial) targets set in the ‘Driving Profitable Growth’ strategy for 2016 - 2018 need to be addressed. In setting these targets, assumptions were made about the macro-economic and financial conditions in the global markets. Although DSM is positioned itself to be able to adjust quickly to sudden adverse market conditions, those cannot be ruled out. If an economic downturn or financial instability were to occur, this could have a significant detrimental effect on the achievement of the targets. This effect could be aggravated by major movements of currency exchange rates.
The strategy to grow the company through increased presence and business in the High Growth Economies is being successfully implemented. This implies that the relative exposure to the business climate in these regions is also increasing. DSM is further reinforcing its governance and resources in these regions in order to grab the opportunities and manage the downside risks these regions present. There is, however, always a risk that the markets will not grow as expected and/or that opportunities in these markets will be missed. In addition, price pressure from these countries may jeopardize profitability in established markets.
DSM has considerably reduced its exposure to cyclical and commodity markets. Price pressure and other competitive challenges may, however, always cause the profitability of DSM’s activities to deviate from the projected levels.
DSM has subsidiaries in more than 50 countries. These subsidiaries can be exposed to potentially unfavorable changes in (financial) regulations and political climate that might hamper the exploitation of projected opportunities or might impair the value of the local business.
In the current strategy period, DSM’s main focus is on organic growth and – unlike in the previous period – not on sizeable acquisitions. Hence, this type of risk should inherently be lower in this period. However, this doesn’t exclude that we do smaller acquisitions and partnerships, with the corresponding risks (mainly related to making the wrong forecasts, failing to effectively integrate the new activities, or getting into a conflict with the partner). Through the multiple acquisitions and partnerships that DSM has executed in the previous strategy periods (and the actual performance of those undertakings), DSM believes that it has developed very solid practices for finding the right targets, assessing their attractiveness, making value creating deals, integrating the new activities, dealing with partners and following up on performance, thereby providing an adequate risk mitigation.
Fully exiting the activities in Pharma and Base Materials – all put in partnerships as a first step towards a full exit in the previous strategy period – is one of the main priorities in the current strategy period. The risks associated to this relate to business performance at the desired time of exit, generating sufficient buyer interest, and striking the most value creating deal for DSM. Through the multiple divestments made or initiated in the previous strategy periods, DSM believes that it has developed very solid practices and a certain savviness in this, providing adequate risk mitigation.
Innovation is another main growth driver in DSM’s strategy. The company has strengthened its market intelligence and enhanced its market and customer orientation. In addition it has taken a multitude of actions to create an excellent innovation process and the company has reinforced its product launch capabilities. Nevertheless, the actual developments in the targeted markets, the speed with which new products and technologies are accepted and the emergence of new competition will always constitute risks to the success of the chosen strategy.
In the Emerging Business Areas, efforts have been concentrated in the areas of Biomedical and Bio-based Products and Services. The developments in these areas are subject to the uncertainties inherent in new technologies and markets.
DSM’s success in implementing its strategy is highly dependent on an effective organizational structure, the ability to attract, develop and retain capable people with the right and diverse backgrounds, the appropriate leadership and behaviors and the creation of an entrepreneurial yet responsible culture. The DSM talent agenda addresses these key areas through
- A ONE DSM Culture Agenda and a Leadership Model, setting common behavioral standards for employees and leaders
- A focused talent acquisition agenda including potential assessment for all executive levels
- A new talent management approach focused on development, and linked to our diversity aspirations
- A set of tools and training to enhance our people management effectiveness
Special attention is being given to enhancing regional and functional effectiveness and creating a diverse workforce. Nevertheless, the achievement of the strategic targets may be hampered by organizational inefficiencies, a lack of key people and/or an unsupportive culture.
DSM has reinforced its processes and capabilities to establish, protect and exploit Intellectual Property rights as these rights are of increasing importance to DSM’s strategic development. Nevertheless, the risk exists that, in certain situations, DSM will not be able to valuate or protect its intellectual property effectively (e.g. in patent or license disputes or other litigation). This, in turn, may lead to negative financial impacts.
DSM implements various policies to avoid supply chain disruptions (e.g. multiple supplier-strategy) as well as to secure our Global Trade Control (GTC) policy and decrease price volatility (e.g. commodity hedging). Nevertheless, the increasing complexity and interdependence of worldwide supply streams as well as increasing (perceived) pressure on availability of resources may lead to GTC non-conformities, price fluctuations and availability issues, influencing DSM’s profitability and/or business continuity.
Sustainability is DSM’s core value and plays a central role in its strategy implementation. It is seen as a measure of responsible behavior (implementing high standards in social, environmental and business-ethical matters as described in the DSM Code of Business Conduct) as well as a business driver; developing products, processes and behaviors that make the value chains in which DSM takes part more socially and environmentally sustainable in an economically viable way. The risks related to the first area are amongst others, reported in other risk categories such as Safety, Health and Environment, Human Rights, and those related to non-compliance with DSM rules and external laws and regulations.
For sustainability as a business driver, DSM has set ambitious targets, and although it has put rigorous programs in place to clarify and achieve these targets, there is considerable risk that difficulties will occur in doing so for every target, particularly as the activities are highly innovative and, for their success, dependent on cooperation in novel stakeholder relationships. We also see competition increasing, leading to changing sustainability from a differentiator to a qualifier. Not achieving clear and accepted definitions on the sustainability standards and/or not reaching the set targets may lead to reputation damage for DSM and hence to financial damage related to credibility issues in (financial) markets and/or to extra internal management attention.
The DSM brand is a key intangible business asset which brings DSM’s mission and core value to expression and has grown considerably in value over the last five years to € 729 million in 2015 (as measured by BrandFinance). The value of the brand is related to the awareness, consideration and preference levels of DSM’s key stakeholders globally. The main risks are that the DSM brand promise is not lived up to by DSM and that the brand is not protected well enough across the globe from an IP/Trademark point of view. Related to the former risk mitigation actions have been put in place by training key audiences within DSM as well as key suppliers (brand e-learning program) on the proper application of the DSM brand. In terms of IP an annual strategic global trademark review takes place through which mitigating actions are defined.
Any failure by any of its business units to meet production safety, social, environmental and/or ethical standards could harm DSM’s reputation and thereby impact on its business and results. DSM has confirmed sustainability to be its core value and, on the basis of this, has formulated a Code of Business Conduct specifying desired behavior on the social, environmental and economic dimensions. The Code is distributed in 17 languages, (e-) learning has to be followed by all employees and compliance is being actively monitored and followed up. This should reasonably assure appropriate employee conduct. Moreover, the company mitigates its reputation risk by making substantial efforts to reduce the probability that any of its units will fail to comply with internal requirements and/or external laws and regulations. Nevertheless, it cannot be ruled out that accidents may happen, mistakes are made by individual employees or issues may arise, potentially leading to complaints, liabilities, loss of business and / or customer’s resp. reputation damage.
To ensure adequate response to a condition or event, either internal or external which, if it continues, will have a significant effect on the functioning or performance of DSM or on its future interests, DSM implemented Issue Management (IM). This proactive management process makes DSM prepared, enables adequate response in the shortest possible time, and secures continuing follow-up to mitigate/take advantage of the impact on share price, LtO and/or reputation (eg. global, regional, local impact).
In the CSD it has been defined that the successful implementation of our strategy “Driving Profitable Growth” requires world class Marketing and Sales performance. Over the past years DSM has made enormous progress in catching up with resp. outpacing peer companies wrt M&S skills, capabilities and processes. DSM Marketing and Sales is driving the further professionalization of the M&S disciplines across DSM. In addition the Net Promoter Score (NPS), a mandatory customer feedback process, has been defined to increase customer loyalty, reduce customer churn, evaluate the DSM company brand and is the KPI for external orientation. Appropriate Quality Assurance systems and processes are in place to mitigate the risks of non-compliance wrt to specifications and customer agreements. Similarly, extensive measures have been put in place to comply with the complexities of trade embargoes. Although digital still is in its infancy in B2B marketing, the company has taken appropriate measures as defined in requirements and guidelines, to mitigate risks on privacy / customer data as well as the use of social media. Nevertheless, it cannot be ruled out that issues may arise, potentially leading to complaints, liabilities, loss of business and / or customers, resp. reputation damage.
DSM tries to mitigate production process risks by spreading production where possible, but concentration is necessary in order to achieve economies of scale. The design of any new facilities and/or production processes requires incorporation of state-of-the-art safety and security facilities. Plants are designed according to the highest technical and technological standards and are regularly and systematically inspected against predefined risk and maintenance standards. Nevertheless, technical and technological risks may not always be sufficiently well known or controlled so as to exclude any mishaps. These could affect the quality, costs and/or availability of products.
The influence of major physical disruptions caused by mishaps affecting the supply chain or facilities in the company has been inventoried and business continuity plans have been put in place. Unexpected developments may nevertheless result in interruptions of supply to customers, causing financial and reputational damage.
As a result of DSM’s strategy, the company’s product portfolio has shifted. This has been accompanied by a corresponding shift in the product liability risk profile. To protect itself against these risks, DSM has put in place highly demanding process and product requirements and is putting in a great deal of effort on an ongoing basis to assure that all its units comply with internal and external regulatory requirements (e.g. FDA). Additionally, DSM has stepped up its efforts to structurally assess product liability exposures, and the company has enhanced its sales contracting policies. Nevertheless, product liability issues leading to financial and/or reputational damages can never be totally excluded.
DSM continuously improves its measures to mitigate ICT risks. We also recognize that ICT incidents are today’s reality. A cyber resilience strategy has been defined in 2015 to address the need for additional cyber security detection and response capabilities. An agile risk management process is in place to assess ICT risks, define necessary controls and monitor compliance of all ICT services. Although DSM has implemented industry standard risk mitigating measures, ICT complexity and shortcomings in technology, processes and employee behavior could still lead to ICT risks materializing which can have a material impact on DSM assets, operations and reputation. The digital transformation could increase the impact of incidents as the business becomes more dependent on secure and reliable ICT services. On the other hand, digitization could also offer opportunities to build new business models that are less vulnerable for ICT risks, e.g. by via partnerships.
Strategy implementation for a large part takes place through the implementation of major programs and projects in a variety of fields, such as innovation and new business development, capacity expansions for existing businesses, mergers and acquisitions, organizational change, business process development, ICT and human resources. DSM has recognized that it needs to further improve its capability to manage programs and projects and has a Project Management Excellence program in place to support this. This includes specific project management training courses. Independent Value Assurance Reviews and Unit owned Roadmaps are in place to mitigate the risk of failure of major projects and support the journey towards excellence in Project Management. Programs and projects may nevertheless fail to produce the (financial) results projected.
DSM employs strict practices with regard to the assessment and control of (information) security risks. In the design of the processes governing the goods and money flows, strict standards of Internal Control have been taken into account and the functioning of these controls is being monitored regularly. Nevertheless, (information) security incidents and/or misappropriation of goods or money through mistakes or fraud may still occur, possibly causing material damage to the company.
DSM invests in a good relationship with its employees and tracks employee engagement, amongst other things by conducting worldwide surveys. Nevertheless, it cannot be excluded that risks materialize in the area of industrial relations.
DSM implements strict policies with regard to the containment of safety, health and environmental risks. Nevertheless, safety, health or environmental elements may not always be sufficiently well known or controlled so as to prevent any possible mishaps. SHE-risks are mitigated via a SHE-management system that is kept up-to-date and includes, amongst others, requirements, audits, a multi-year program and competence management.
*) For the risk categories marked with an asterisk, potential financial losses are limited by (global) insurance policies.
The main financial risks faced by DSM relate to liquidity risk and market risk (comprising interest rate risk, currency risk and price risk). DSM’s financial policy is aimed at minimizing the effects of fluctuations in currency-exchange and interest rates on its results in the short term and following market rates in the long term. DSM uses financial derivatives to manage financial risks relating to business operations and does not enter into speculative derivative positions.
DSM maintains internal controls over external reporting in order to ensure that external reporting is complete, transparent and free from material inaccuracies. Failure of these controls may result in shortcomings that may cause the external reporting does not provide the desired true and fair view of the financial position and business performance of DSM.
Although DSM has replaced several defined benefit plans with defined contribution plans in the last years, DSM still has defined benefit pension plans in a number of countries. The funded status and pension cost of defined benefit pension plans are impacted by financial markets (mostly through investment returns and interest rates) and by changes in life expectancy. Low interest rates cause DSM’s pension cost to increase and therefore have an adverse effect on profitability and cash flows.
To control pension risks for DSM, a Pension Committee (chaired by the Chief Executive Officer of DSM) is in place. The pension committee determines DSM’s pension strategy and monitors and anticipates on pension risks worldwide. Pension plans are managed by local trustees in accordance to local regulations. The investment strategy of the pension plans is aligned with the risk profile of the underlying pension liabilities through an integrated balance sheet management approach. This integrated approach improves the risk management process, risk identification and strategic decision making, leading to a more balanced approach towards risk. The volatility in pension costs for DSM of these plans is limited by contractual arrangements.
Defined contribution schemes in a low interest rate environment, give rise to a new type of risk. As a result of the low interest rates the price of an annuity has increased, leading to lower results in defined contribution schemes. An insufficient level of pension could inhibit employees to retire at an appropriate age, which is a risk that is addressed in the development of the pension plan (for instance through a life cycle investment mix).
Financial risks additional to the macroeconomic risks mentioned above include commodity price risk and credit risk. Furthermore, the major credit rating agencies may change their assessments of DSM creditworthiness; thereby affecting the company’s borrowing capacity and/or the conditions under which DSM can borrow money causing fluctuations in the cost of finance. The company aims to maintain a strong investment grade long-term credit rating and spread the maturity profile of outstanding bonds in order to have adequate financial flexibility.
Risk of non-compliance with the DSM Code of Business Conduct and with Corporate Policies, Requirements and Directives
DSM has put in place a Code of Business Conduct, Policies, Requirements and Directives to induce ethical behavior in the company and clearly mark the limits of risk taking in (operational) processes. Implementation is monitored and reported by the units and through independent full operational audits. Nevertheless, it cannot be excluded that non-compliances may occur, leading to risks and possible financial and/or reputational damage.
DSM operates in fields to which a multitude of (international) laws and regulations apply. Although a great deal of attention is given to full compliance with all these laws and regulations, breaches may still go unnoticed, possibly leading to fines, loss of permits, breach of contract plus liability for damages and/or reputational damage.
DSM anticipates regulatory developments and contributes to such developments where appropriate. Changes in laws and regulations may nevertheless impact the company’s ability to implement its strategy and/or may have detrimental effects on profitability.