Material operational risks
HUGO BOSS summarizes risks associated with the suppliers and sourcing markets, as well as quality, logistics and sales and distribution risks under material operational risks.
Risks associated with suppliers and sourcing markets
Risks associated with suppliers and sourcing markets exist in connection with a possible dependence on individual suppliers or production sites, a possible increase in product costs as well as any possible discrepancy between production and sales.
HUGO BOSS attaches great importance to the careful selection of suppliers and the establishment and maintenance of long-term strategic relationships. However, there is a risk that production from one or more suppliers may temporarily break down due to supplier factors or incidents affecting a particular region. An excessive dependency on individual suppliers or production sites could therefore lead to upheaval in the Group’s supply chain and therefore to sales risks. The Group therefore focuses on a balanced distribution of sourcing volumes. The production and sourcing process is coordinated centrally. Supplier relationships are regularly monitored and evaluated with the aim of identifying risks at the earliest possible opportunity and introducing appropriate measures to ensure the supply of goods. In fiscal year 2020, the largest external supplier once again made up 8% of the total sourcing volume, while the largest single external production site made up about 5% (2019: 8% and 5% respectively). Sourcing and Production
In view of the earthquake risk and possible risks as a result of ongoing political uncertainties, a particularly wide range of measures have been implemented at the Company’s largest production site in Izmir (Turkey) in order to limit the impact on the sales of HUGO BOSS of a possible downturn in production. For some production volumes, emergency plans are in place to transfer production to external suppliers. Also, the financial risk in the event of an earthquake is partially covered by insurance. Despite the measures that have been implemented, Management overall estimates that risks from the dependence on individual suppliers or the regional distribution of the sourcing volume are possible. However, the associated financial impact could generally be high.
Increasing wages for production employees, in particular in emerging economies, as well as an increase in the price of relevant raw materials to the Group such as cotton, wool and leather may lead to higher product costs and so have a negative impact on the profitability of the Group. HUGO BOSS counters this risk with margin-based collection planning, measures to improve efficiency in the production and sourcing processes, continuous optimization in the use of materials and regular review of its pricing policy. It is assumed at present that risks from higher production costs are in principle possible, and these may have a high negative impact on the development of earnings.
The forecasting of sales volumes, planning of production capacities and allocation of raw materials and finished goods as part of the sourcing processes involves scheduling risks. Deviations from an appropriate allocation can lead to excess allocation resulting in high inventory levels on the one hand. On the other hand, it can also lead to insufficient allocation and the risk of lost sales opportunities. In order to reduce this risk, the Group is making great efforts to continually improve the outlook quality and to keep making the goods management more flexible across channels and markets. At the same time, HUGO BOSS aims to coordinate purchasing and sales even better in future by further shortening lead times and thus to be able to react even better to market trends and customer needs. In view of the large volumes involved, the scheduling risk is in principle considered as possible. The associated financial impact could be high depending on their magnitude.
Overall, the aggregate potential impact of risks associated with suppliers and sourcing markets is considered to be high. Aggregated together, the likelihood of occurrence is considered as possible.
When sourcing materials and manufacturing its products, HUGO BOSS sets exacting standards with regard to quality. Thorough quality controls at all stages and the incorporation of customer feedback should contribute to the continuous improvement of the production process. Also, both the Company’s own production sites as well as those belonging to partners are regularly monitored to make sure they comply with central quality guidelines. Incoming goods checks as well as intensive quality tests at the Metzingen site aim at ensuring the high quality standards at HUGO BOSS. Nevertheless, the Group considers a certain amount of product returns for quality reasons to be possible. However, the impact on the development of earnings is considered to be high despite the recognition of appropriate provisions for returned goods and the regular review of the amounts recognized. Sourcing and Production
HUGO BOSS is exposed to logistics risks, which relate on the one hand to potential interruptions in the transport of goods, for example due to a possible shortage of sea and air freight. This directly involves risks of a general increase in freight costs, as well as significant interruptions in the availability of goods. In addition, the temporary downtime or loss of warehouse locations may lead to lost sales opportunities. The storage of inventories is focused on selected sites operated by HUGO BOSS. The distribution centers for hanging goods, flat-packed goods and the European online business, all located in the immediate vicinity of the headquarters in Metzingen, form the core of the Group-wide logistics network. Business Activities and Group Structure
HUGO BOSS will also work on the continuous optimization of its global logistics platform in future with the aim of continuously improving the efficiency and flexibility of its logistics while at the same time largely minimizing logistics risks. In addition, the adherence to comprehensive fire protection and safety measures is continuously monitored at all warehouse locations. HUGO BOSS has also taken out insurance to cover the direct financial risk from a loss of goods or equipment in warehouses. Based on the measures implemented, the likelihood of occurrence of logistics risks is considered to be unlikely. However, the associated financial impacts could generally be high.
Sales and distribution risks
Sales and distribution risks exist in connection with the Group’s own retail activities, in particular with regard to inventory management as well as slow-moving goods and the resulting impairment. In the wholesale channel, sales and distribution risks mainly refer to a possible dependency on individual wholesale partners as well as bad debts.
The aim of the centrally organized inventory management is the forward-looking and optimal allocation of the inventory across the Group while at the same time ensuring that it remains flexible, in order to be able to react to any increase or decrease in demand at short notice. Downturns in demand or erroneous assessments of sell-through rates can potentially have a negative impact on the inventory turnover rate. HUGO BOSS therefore aims to continuously improve its inventory management. The countermeasure of granting additional discounts necessarily results in a negative impact on the gross profit margin and ultimately on the Group’s profitability. It is therefore continually monitored by the central Controlling department. A centrally managed pricing policy, differentiated retail formats and collections adjusted to the respective retail formats serve to further improve the efficiency of selling space.
Inventory risks may result from inventories being kept in storage for longer and a potential reduction in their marketability as a consequence. According to the principle of net realizable value, impairments on inventories are recognized accordingly and are monitored on a monthly basis. As part of the process, system-based analyses of movement rate, range of coverage and net realizable value are applied in a uniform manner across the Group. Sufficient write-downs were recognized as of the reporting date from the Management’s perspective. Notes to the Consolidated Financial Statements, Note 12
Attention is paid to ensuring a balanced customer structure to avoid a potential overdependence on individual customers in the wholesale channel. The central Controlling department constantly monitors key performance indicators such as the order intake, sales and supply rates and reports on these to the Managing Board on a regular basis. If risks occur, countermeasures can be adopted promptly. Group Management
In the wholesale channel, the Group is exposed to a bad debt risk based on the potential insolvency of individual trading partners and a concentration of bad debts in the event of an economic slowdown in individual markets. The Group-wide receivables management follows uniform regulations, for example regarding the credit rating checks and the setting and observance of customer credit limits, monitoring of the age structure of receivables and the handling of doubtful accounts. In specific cases, this means that deliveries are only made upon prepayment or business is discontinued with customers with an unsatisfactory credit rating. The internal audit department regularly checks compliance with the Group guidelines. As of the reporting date, there was no concentration of default risks caused by significant overdue payments of individual customers. The overall financial impact of possible receivable default risks is considered to be moderate in the light of the measures described.Notes to the Consolidated Financial Statements, Note 13
In summary, Management estimates the likelihood of occurrence of sales risks as possible. The cumulative financial impact is largely classed as high due to the potential discounts and impairments.