Illustration of Risks

This report includes an explanation of financial and non-financial risks that we deem to be most relevant to the achievement of the company’s objectives in 2020 and beyond. According to our risk assessment methodology, risks related to the competitive and retail environment and risks related to consumer demand and product offering are considered material. Our presentation of risks in this year’s Annual Report differs from the 2018 Annual Report as we changed risk categories and therefore consolidated individual risks based on these updated categories. Changes in risk assessments are shown on a comparable basis. The risks overview table illustrates the assessment of all risks described below.

Risks related to the competitive and retail environment

Changes in the competitive landscape and the retail environment could impact the company’s success, in particular in the medium to long term. Strategic alliances amongst competitors and/or retailers, the increase in retailers’ own private label businesses and intense competition for consumers, production capacity and promotion partnerships between well-established industry peers and new market entrants pose a substantial risk to adidas. This could lead to harmful competitive behavior, such as sustained periods of discounting in the marketplace or intense bidding for promotion partnerships. Failure to recognize and respond to consolidation in the retail industry could lead to increased dependency on particular retail partners, reduced bargaining power and, consequently, margin erosion. Sustained pricing pressure in key markets could threaten the company’s financial performance and the competitiveness of our brands. Aggressive competitive practices could also drive increases in marketing costs and market share losses, thus hurting the company’s profitability and market position. The inability to adjust our distribution strategy in a timely manner to a changing retail industry, which is experiencing increasing substitution of physical retail stores by digital commerce platforms as well as increasing connectivity between physical and digital retail, could result in sales and profit shortfalls. A decline in the attractiveness of particular shopping locations such as shopping malls could lead to sales shortfalls in our customers’ and our own stores, higher inventory in the marketplace, increased clearance activity and margin pressure.

To mitigate these risks, we continuously monitor and analyze information on our competitors and markets in order to be able to anticipate unfavorable changes in the competitive environment rather than merely reacting to such changes. This enables us to proactively adjust our marketing and sales activities (e.g. product launches, selective pricing adjustments) when needed. We also continuously and closely monitor numerous indicators (e.g. order placement, sell-through rates at the point of sale, average selling prices, discounts, store traffic) that help us identify changes in the retail environment and quickly take appropriate action such as closing or remodeling own stores. We constantly adjust our segmentation strategies to ensure that the right product is sold at the right point of sale to the right consumer at an appropriate price. Continuous investment in research and development ensures that we remain innovative and distinct from competitors. see Innovation We also pursue a strategy of entering into long-term agreements with key promotion partners such as Real Madrid or James Harden, as well as adding new partners to refresh and diversify our portfolio, e.g. Mikaela Shiffrin or Boca Juniors. In addition, our product and communication initiatives are designed to increase brand desire, drive market share growth and strengthen our brands’ market position.

Risks related to consumer demand and product offering

Our success largely depends on our ability to continuously create new, innovative footwear and apparel products. Consumer demand changes can be sudden and unexpected, particularly when it comes to the more fashion-related part of our business. Therefore, we face a risk of short-term revenue loss in cases where we are unable to anticipate consumer demand or respond quickly to changes. In addition, creating and offering products that do not resonate with consumers and our retail partners is a critical risk to the success of our brands, especially considering our strategy to focus on key product franchises. see Adidas brand strategy In the short term, we consider this risk most relevant in our key markets Asia-Pacific and North America. Even more critical in the long term, however, are the risks of continuously overlooking new consumer trends, failing to introduce new product innovation and failing to continuously generate consumer excitement with our product offering and marketing activities.

To mitigate these risks, identifying and responding to shifts in consumer demand as early as possible is a key responsibility of our brand and sales organizations and, in particular, of the respective Risk Owners. Therefore, we utilize extensive primary and secondary research tools as outlined in our risk and opportunity identification process. By putting the consumer at the center of our decision-making we intend to create higher brand advocacy. As part of our adidas brand advocacy program, we continuously monitor the Net Promoter Score (NPS) and strive to understand consumers’ perception. see Adidas brand strategy We continuously expand our consumer analytics efforts to read and quickly react to changes in demand or trend shifts. In addition, direct touchpoints with consumers via our own digital channels and direct communication with consumers on social media platforms strengthen our understanding of consumer preferences and behavior and, as a result, help us to reduce our vulnerability to changes in demand. Through continuous monitoring of sell-through data and disciplined product lifecycle management, in particular for our major product franchises, we are able to better detect demand patterns and prevent overexposure. Our Speed programs also help us mitigate the risk as they enable us to be faster in case of demand shifts. By leveraging our promotion partnerships for launches of key product franchises and by carefully orchestrating launch events across markets and channels, we intend to maintain brand desire and consumer demand at a constantly high level. Open Source also helps us utilize external insights and capabilities in product creation and to drive consumer demand, brand desire, market share and profitability. see corporate strategy

Macroeconomic, sociopolitical, regulatory and currency risks

Growth in the sporting goods industry is highly dependent on consumer spending and consumer confidence. Economic downturns, financial market turbulence, currency exchange rate fluctuations and sociopolitical factors such as military conflicts, changes of government, civil unrest, pandemics, nationalization or expropriation, in particular in regions where adidas is strongly represented, therefore could negatively impact the company’s business activities and top- and bottom-line performance. Currency risks, for example, are a direct result of multi-currency cash flows within the company, in particular the mismatch of the currencies required for sourcing our products versus the denominations of our sales. Furthermore, translation impacts from the conversion of non-euro-denominated results into the company’s functional currency, the euro, might lead to a material negative impact on our company’s financial performance. See note 30 In addition, substantial changes in the regulatory environment (e.g. trade restrictions, economic and political sanctions, regulations concerning product compliance, environmental regulations) could lead to potential sales shortfalls or cost increases.

To mitigate these macroeconomic, sociopolitical and regulatory risks, adidas strives to balance sales across key regions and also between developed and emerging markets. We continuously monitor the macroeconomic, political and regulatory landscape in all our key markets to anticipate potential problem areas, so that we are able to quickly adjust our business activities accordingly upon any change in conditions. Potential adjustments may be a reallocation of manufacturing of our products to alternative countries, a reallocation of investments to alternative, more attractive markets, changes in product prices, closure of own-retail stores, more conservative product purchasing, tight working capital management and an increased focus on cost control. To mitigate the risk related to fluctuations in currency exchange rates, we utilize a centralized currency risk management system and hedge currency needs for projected sourcing requirements on a rolling basis up to 24 months in advance. In rare instances, hedges are contracted beyond the 24-months horizon. see treasury By building on our leading position within the sporting goods industry, we actively engage in supporting policymakers and regulators in their efforts to liberalize global trade and curtail trade barriers and also in order to proactively adapt to significant changes in the regulatory environment

IT and cyber security risks

Theft, leakage, corruption or unavailability of critical information (e.g. consumer data, employee data, product data) and systems could lead to reputational damage, regulatory penalties or the inability to perform key business processes. Key business processes, including product marketing, order management, warehouse management, invoice processing, customer support and financial reporting, are all dependent on IT systems. Significant outages, application failures or cyber security threats to our infrastructure, or that of our business partners, could therefore result in considerable business disruption or impact to business-critical data.

To mitigate these risks, our IT organization proactively engages in system preventive maintenance, service continuity planning, adherence to IT policies and maintenance of a comprehensive information security program. Information security governance, data security, security architecture design, continuity management and employee awareness programs help us to protect the company adequately. We have also secured limited insurance coverage for damage resulting from cyber security incidents.

Risks related to tax and customs regulations

Numerous laws and regulations regarding customs and taxes as well as changes in such laws and regulations affect the company’s business practices worldwide. Non-compliance with regulations concerning product imports (including calculation of customs values), intercompany transactions or income taxes could lead to substantial financial penalties and additional costs as well as negative media coverage and therefore reputational damage, for example in case of understatements or underpayments of corporate income taxes or customs duties. Changes in regulations regarding customs and taxes may also have a substantial impact on the company’s sourcing costs or income taxes. Therefore, we also create provisions in accordance with the relevant accounting regulations to account for potential disputes with customs or tax authorities. The increase in the potential impact of risks relating to tax and customs regulations in 2019 reflects the increasingly aggressive positions being taken by customs and tax authorities in audits.

To proactively manage such risks, we constantly seek expert advice from specialized law and tax advisory firms. We closely monitor changes in legislation in order to properly adopt regulatory requirements regarding customs and taxes. In addition, our internal legal, customs and tax departments advise our operational management teams to ensure appropriate and compliant business practices. Furthermore, we work closely with customs authorities and governments worldwide to make sure we adhere to customs and import regulations and obtain the required clearance of products to fulfill sales demand.

Compliance risks

As a globally operating company, adidas is subject to various laws and regulations. Non-compliance with such laws and regulations could lead to penalties and fines and cause significant reputational damage. For example, non-compliance with laws and regulations concerning data protection and privacy, such as the EU General Data Protection Regulation, may result in substantial fines. In addition, publication of failure to comply with data protection and privacy regulations could cause significant reputational damage and result in a loss of consumer trust in our brands. We also face the risk that members of top management as well as our employees breach rules and standards that guide appropriate and responsible business behavior. This includes the risks of fraud, financial misstatements or manipulation, anti-competitive business practices, bribery, corruption, discrimination and harassment at the workplace.

Our Fair Play Compliance Framework helps us to prevent, detect and adequately respond to these risks. Our Global Policy Manual provides a framework for basic work procedures and processes and our Fair Play Code of Conduct stipulates that every employee and our business partners shall act ethically in compliance with the laws and regulations of the legal systems where they conduct company business. In addition, our regional compliance managers and local compliance officers guide and advise our operating managers regarding fraud and corruption topics. Furthermore, we utilize controls such as segregation of duties in IT systems and data analytics technology to prevent or detect fraudulent activities. We are also working with external partners and law firms to ensure we are informed about legal requirements across the globe, and we take appropriate action to ensure compliance. To mitigate the risk of non-compliance with laws and regulations concerning data protection and privacy, we have developed a global privacy management framework that introduces the company’s privacy principles and provides guidance for the use and deletion of personal information. This framework applies to all adidas businesses worldwide and also sets our expectations of third-party business partners for managing personal information for or on behalf of adidas. Our global privacy officer and the global privacy department are establishing both the framework and monitoring capabilities to track and report its implementation. In addition, they are continuously providing further implementation guidance and training.

Risks related to organizational structure and change

Operating in a dynamic and fast-moving competitive environment, the company needs to cope with constantly changing requirements in respect of the workforce (e.g. adaptability, learning, skillsets, mobility, diversity) and workplace (e.g. flexibility and space management). Improper planning and inadequate or untimely execution of reorganization and transformation initiatives may reduce employee engagement, cause business disruption and inefficiencies, and negatively affect business performance. Frequent organizational changes could cause fatigue among the workforce and lead to reduced efficiency and productivity. A complex organizational structure and unclear roles and responsibilities can lead to delayed or sub-optimal decision-making, as well as inefficient and ineffective processes.

We mitigate these risks through continuous, open and transparent communication with our employees. Our Executive Board members as well as the senior management team across the company regularly update employees on organizational changes and openly explain the reasons for change. To adequately manage change and to ensure clarity about roles and responsibilities throughout the organization, we also utilize internal and external experts in project management, change management and communication, who actively educate and engage the workforce to embrace and support new organizational structures and processes. To increase flexibility and adaptability in the workforce and workplace and thereby reduce risks related to organizational change, we implement various mitigating measures such as strategic workforce planning, tailored on-the-job learning programs and development plans for our employees. Through People Pulse we continuously monitor employee satisfaction and identify potential challenges related to organizational structure and change, which allows us to take appropriate action as early as possible. see people and culture,