Presentation of the risk situation

We have allocated the entire METRO risk portfolio to risk groups. In addition to general risks, the Management Board of METRO AG identified and assessed the particularly relevant risks (gross risks) METRO was exposed to during the reporting period. These are listed in the following overview:

Due to the correlations between the two, we integrated the ‘deficient rental coverage’ risk reported in the previous year into risk no. 3 ‘challenges in the business model’. In order to increase transparency, we now present the risks no. 9 ‘trade regulations’ and no. 10 ‘more stringent regulation pertaining to deferred compensation’ separately. We also added the new risk no. 4 ‘inadequate construction processes’.

In mid-2018, Real created the prerequisites for a new collective bargaining partnership outside the HDE structures (association of German retailers) by terminating the future collective agreement concluded in 2016 with Verdi Real’s business was spun off from Real SB-Warenhaus GmbH to METRO SERVICES GmbH (which was renamed real GmbH) which applies collective agreements that were concluded between DHV – Die Berufsgewerkschaft e. V. (a trade union) and AHD – Unternehmensvereinigung für Arbeitsbedingungen im Handel und Dienstleistungsgewerbe e. V. (a registered association for the retail and service industry). This strengthens Real’s sustainability, as it offers a competitive salary structure for new employees. At the same time, this poses the risk of a significant short-term increase in personnel expenses. For example, this eliminates the temporary reduction of holiday pay and Christmas bonuses for Real employees, followed by an adjustment to match the regional collective agreements for the retail industry that would be different than in the case of a future collective agreement. In the medium and long term, however, this solution will lead to a competitive personnel cost structure at Real. This eliminates previous year’s risk ‘failed collective bargaining negotiations at Real’.

The aforementioned changes lead to new contents for risks no. 4 and no. 9 compared to the previous year. The following sections outline the risks bearing particular relevance and the essential risk control measures. In principle, all group segments are affected.

Risks related to the business environment

Macroeconomic and political risks (risk 1)

As a company with global operations, METRO depends on the political and economic situations in the countries in which it operates. The fundamental business environment can change rapidly. Changes in political leadership, civil unrest, terrorist attacks or economic imbalances can jeopardise METRO’s business. At the country level, the political and/or economic situations in Russia, Ukraine, China, Italy, Spain and Turkey are particularly noteworthy for reporting period 2017/18. The potential risks include the loss of property and real estate assets, changes in the exchange rate, trade restrictions, capital controls, regulatory restrictions and unexpected weakening of demand. The global economy is increasingly marked by tense trade relations between the US, Europe and China, as can be clearly seen in the expansion of the imposed punitive tariffs, as well as the planned withdrawal of the United Kingdom from the European Union (Brexit). We see both issues as a risk. A continuous monitoring of the economic and political developments and a review of our strategic objectives allow us to respond to these challenges in a timely and appropriate manner. Our international presence comes with the advantage of being able to balance the economic, legal and political risks as well as fluctuations in demand between the countries.

Interruption of business activities (risk 2)

Our business operations could, for example, be interrupted by a failure of IT systems, natural disasters, pandemics or terrorist attacks. Important business processes such as purchasing/product ordering, marketing and sales have used IT systems for many years. Systems for online retailing must be continuously available, as these systems are a prerequisite for unlimited access outside normal store opening times. As a result, the continuous availability of the infrastructure is a critical factor in the development and implementation of our IT solutions. Systems that are essential for business operations in the stores, especially checkouts, are largely self-contained and can continue to be used for some time even during events such as network failures or the failure of central systems. In case of partial network failures, they can automatically reroute data or switch to redundant routes. Modern technologies such as remote server management and cloud computing allow us to use our hardware efficiently. In addition, our centralised IT systems can be quickly restored in the event of one or several servers failing. We operate several central IT centres, which enables us to compensate for major business interruptions or limit their duration to the absolute minimum. We also have a disaster recovery plan to restore IT centres in Germany after extended outages (for example, outages caused by fire, natural disasters or criminal actions). We also prepare ourselves for the risk of an interruption of our business activities by employing a comprehensive business continuity management system. A professional crisis management allows for a rapid crisis response and thereby ensures the protection of our employees and customers. This includes evacuation plans, training measures and specific instructions. We insure ourselves against the loss of tangible assets and any impending loss of revenues or profits resultant from business interruptions wherever it is possible and serves the purpose.

Specific industry sector risks

Risks related to the retail business

Challenges in the business model (risk 3)

Particularly, the retail and wholesale trade in the markets in which we operate is characterised by rapid changes and fierce competition. A fundamental risk is consumers’ fluctuating propensity to consume. Changes in consumer behaviour and customer expectations pose additional risks, among others, in the face of demographic change, rising competition and increasing digitalisation. If we fail to adequately address our customers’ needs and price developments or if we miss trends with regard to our assortments or appropriate sales formats and new sales channels, this could potentially impede the development of our sales and income and also jeopardise our objectives in terms of growth and profitability. We address these risks by developing country-specific customer-focused value creation plans. The operating partners and international working groups (federations) monitor and support the implementation and achievement of objectives. We are, for example, expanding our range of regionally traded products in all sales lines and are progressively gearing our assortments to meet our customers’ increasing demands with regard to environmental, social and health considerations. We are also expanding our sales channels by employing an omnichannel strategy to grow our delivery sales and online activities. We support our customers with franchise concepts. Furthermore, we are monitoring our competitors even more closely. Our various strategic projects aim at further optimising our purchasing and sales processes and at creating additional value for our customers. We aim at creating sustainable value, ensuring the recoverability of assets and thereby mastering the challenges faced by our business model. As a wholesale and food specialist, we want to further increase our customer focus, accelerate our growth, simplify our structures and increase the implementation speed, thereby improving our overall operational performance. Decisions on new store locations are subject to an extensive assessment. As we continually monitor the profitability of our store network, we can identify adverse developments at individual stores at an early stage and respond quickly. In the event our measures fail to secure success and it appears to be unlikely that the situation will change in a sustainable way, we dispose of the respective outlet. This allows us to continually optimise our store network. Loss of rental income caused by insolvencies of third-party tenants and the risk of vacant and unused selling space entail the risk of a deficient rental cover or an impairment of the underlying asset. We counter these risks with our strategic and operational real estate management and anticipatory investment planning. Due to the substantive correlation, we integrated this risk which was separately reported in the previous year, into risk no. 3 ‘challenges in the business model’.

Real estate risks

Inadequate construction processes (risk 4, new)

Inadequate or ineffective internal controls within our construction and installation processes could lead to infringements and quality losses as well as reputational damage. The safety and health of customers, suppliers and employees could be at risk. Generally, we strive to provide a safe and healthy environment. We take decisive actions to prevent potential accidents and health hazards. Thus, we establish clear rules and procedures to identify, minimise and ultimately prevent risks. We support implementation through frequent training sessions and internal inspections.

Risks related to business performance

Supplier and product risks

Quality risks (risk 5)

As a wholesale and retail company, METRO depends on external producers and service providers. Defective or unsafe products, exploitation of the natural environment, inhumane working conditions or infringements against our compliance standards could potentially cause major damage to the reputation of METRO and pose a lasting threat to the company’s success. We therefore continuously audit our own-brand suppliers to assess their adherence to METRO’s stringent procurement and compliance standards. These include the food safety and quality standards recognised by the Global Food Safety Initiative (GFSI), such as the International Food Safety Standard and the GLOBALG.A.P. certification for agricultural products. The standards help to ensure the safety of foods on all cultivation, production and sales levels. Own-brand suppliers without a recognised and valid audit certificate may qualify for preliminary inclusion in METRO’s supplier base by undergoing and passing a special assessment (METRO Assessment Solution) conducted by an accredited certification body. Violations of conditions can lead to exclusion from our supplier network or, in the case of unacceptable production methods, to a product being blacklisted. If suppliers do not provide a corresponding certificate, it jeopardises the due diligence of METRO towards the customer. The potential of placing non-safe products on the market which are unsuitable for human consumption or use or even health-hazardous represents a very high reputation risk and comprises the threat of lasting damage to customer relationships. Should a quality incident occur despite these measures, the process steps for resolving interruptions and incidents described in our manual will set out the procedure to resolve the incident in the interest of our customers. In order to avoid the risk of outdated or inadequate quality measures, we additionally and continuously look for possible improvements for our quality assurance systems.

We are not the only ones who have these concerns. Our customers place priority on quality and safety and are becoming increasingly interested in the environmental and social sustainability of the products sold in our stores and of the processes used to produce these products. If there are any reservations or even specific incidents concerning METRO’s own-brand suppliers, METRO faces the risk of reputational damage. This in turn could have negative consequences on our rating in sustainability indices. In light of this, METRO adopted a group-wide purchasing policy for a sustainable supply chain and procurement management that applies to all products.

Financial risks

Planning reliability (risk 6)

Unexpected deviations from the budget or the forecast could potentially result in METRO missing its budget targets and making wrong business decisions. This could lead to unexpected negative financial consequences. We therefore place a high priority on measures designed to mitigate these risks. We do so by consistently implementing strategic measures that are directed at improving our income position. We support the operational units in their pro-active implementation of the strategy by providing them with value creation plans. We also mitigate risks by conducting effective internal controls, a closer interlocking of strategic planning with the budgeting process as well as a greater involvement of the supervisory bodies. The fact that our financial year differs from the calendar year allows us a high degree of planning certainty at an early stage, with the highly profitable Christmas quarter being the first quarter of our financial year. The outlook report offers insights into our expectations for the development of our business in the coming financial year.

Other risks

Transaction risks

Risks associated with the demerger and the sale of the hypermarket business (risk 7)

The demerger of the former METRO GROUP was concluded on 13 July 2017 with the initial listing of METRO AG shares on the stock exchange. The former METRO GROUP has split into a wholesale and food specialist (the new METRO AG) and a company focused on consumer electronics and services (CECONOMY AG, formerly METRO AG). The demerger may be subject to additional legal risks, adding to the tax risks inherent in the implementation; in detail, these risks are: prospectus liability, meaning shareholder claims stemming from share trading with insufficient information, continuing liability for all liabilities of CECONOMY AG existing as of the effective date of the demerger/spin-off for a period of 5 years and liability risks stemming from legal claims by shareholders of the former METRO AG in relation to the demerger, for which METRO AG has agreed to absorb the costs under the demerger agreement. We are preparing for any potential complaints by way of legal defence strategies. Potential claims resulting from prospectus liability are covered by a prospectus insurance policy. We are continuously monitoring the financial position of CECONOMY AG.

In its meeting on 13 September, the Management Board of METRO AG decided to sell the hypermarket business. In this context, delays in the negotiation, conclusion and implementation of the transaction can lead to risks such as the unanticipated commitment of managerial capacities or increases in planned transaction costs. Significant deviations from the planned sales revenue could have a negative impact on earnings. To limit risks, METRO uses professional support from investment banks and external consultants in the marketing process.

Human resources risks

Development of employee numbers and attractiveness as an employer (risk 8)

The expertise, dedication and motivation of our employees are crucial success factors for METRO’s success in a competitive market. One prerequisite for achieving our strategic goals are highly qualified experts and managers. It is an ongoing challenge to recruit and retain these valuable employees for the group, in particular in the face of demographic change and fierce competition for the best talent. Intra-company programmes for the continued qualification of employees and the strengthening of corporate culture are also indispensable. Variable, performance-based remuneration components based on company targets and personal goals are designed to stimulate our employees’ performance. We also conduct annual performance reviews with our employees to assess the past year and agree on future measures for professional development. Targeted training programmes, which we implement in cooperation with various partners, allow us to attract young people to start their career at METRO and to foster their development with an eye on their individual personal strengths. In Germany in particular, METRO companies place great value on in-house training and apprenticeship programmes. We ensure the success of our succession planning by offering tailor-made career and professional development plans, especially on senior management level.

Legal and tax risks

Trade regulations (risk 9)

The European Union and national governments are increasingly adopting or amending regulations regulating trade and unfair trading practices that could affect our business. In the Corporate Public Policy department, we collect, discuss and analyse important social, regulatory and political issues and try to represent our interests at the political level through responsible lobbying. In order to increase transparency, we now represent this risk separately from risk no. 10 ‘more stringent regulation pertaining to deferred compensation’.

More stringent regulation pertaining to deferred compensation (risk 10)

In addition to purchase price agreements, we also enter into agreements on so-called later income with the suppliers of merchandise for our wholesale and retail operations. These agreements are concerned with purchasing terms and conditions, such as product-specific deferred rebates, reimbursement of expenses or remuneration for services, such as advertising or other marketing-related services.

We have observed tendencies to subject agreements on later income between buyers and suppliers to increased regulatory restrictions. This is mainly the case in the Eastern European countries, but has also been observed in other METRO countries, including in the European Union. Some of these restrictions go as far as prohibiting certain contractual terms. Antitrust law is at the same time utilised to counter a presumed relative market power by introducing regulation that interferes with terms in a way that entails unilateral impediments for retailers and wholesalers. At present, the European Union is working on a directive that will regulate unfair trading practices. This directive might have a far-reaching impact on existing business processes and condition systems worldwide, depending on its precise content. Said content will be the outcome of the legislative process and cannot be predicted sufficiently at present.

We continuously and systematically monitor the risks stemming from increasing regulation on later income. We address these tendencies to excessive regulation in a preventative approach by permanently adjusting our contractual relationships with suppliers in the concerned jurisdictions and/or in relation to certain product categories, with the goal to ensure that any later income arrangement complies with the applicable laws at all times. We also take care to appropriately provide for the respective limitation periods under civil law. We analyse the historical structures of supplier terms and conditions in the context of a transformation programme spanning over a number of years and modernise the terms as required. Without active management, there would be a risk that added value in the form of later income in selected product groups and/or countries could no longer or only partially be collected as a result of changes to the regulatory framework. This would have corresponding results on the total comprehensive income.

In order to increase transparency, we now present this risk separately from risk no. 9 ‘trade regulations’.

Tax risks (risk 11)

Tax risks can primarily arise in relation to the assessment of financial matters by the tax authorities (including transfer price issues). Additional risks may result from differing interpretations of sales tax (VAT) regulations. The Corporate Group Tax department of METRO AG has established appropriate guidelines to ensure early detection and minimisation of tax risks. These risks are regularly and systematically examined. The resultant risk mitigation measures are then coordinated between all persons involved.