Risks and uncertainties
H &M carries out regular risk analysis for both operational and financial risks. Operational risks are mainly associated with the business and the external risks that affect the group. Some can be managed through internal routines and in some cases the group can influence the likelihood of a risk-related event occurring. Other risks are determined to a greater extent by external factors. If a risk-related event is beyond the company’s control, work is aimed at alleviating the consequences.
There are risks and uncertainties affecting the H&M group that are related to fashion, weather conditions, macroeconomic external factors and geopolitical changes, sustainability issues, foreign currencies, taxes and various regulations, but also in connection with expansion into new markets, the launch of new concepts and how the brand is managed. There are also some risks related to the group's reputation, so called "reputational risks". A description of H&M’s operational and financial risks is given below, with more detailed information concerning financial risks being given in note 2, Financial risks in the annual report 2016.
As one of the world’s leading fashion companies H&M attracts great interest and is constantly in the spotlight. To safeguard and manage the brands it is important that the H&M group continues to be developed and run according to its strong values, which are characterised by high business ethics.
It is of the utmost importance that the H&M group lives according to the high aims set out in its policies and guidelines on business ethics. Should H&M fail in this respect, there is a risk that the company’s reputation and brand could be damaged. Accurate, transparent and reliable communication can prevent occurrences of reputational risk, and can also help alleviate the consequences of any incidents.
Operating in the fashion industry is a risk in itself. Fashion has a limited shelf-life, and there is always a risk that some part of the collections will not be well received by customers. Fashion purchases are often emotional and may therefore be negatively affected by unforeseen geopolitical and macroeconomic events.
Within each concept it is important to have the right volumes and the right balance in the mix between fashion basics and the latest trends. In summary, each collection must achieve the best combination of fashion, quality, price and sustainability.
To optimise fashion precision, the group buys items on an ongoing basis throughout the season. Fashion is becoming increasingly global, but shopping patterns vary between different markets and sales channels. The start of a season and the length of that season can vary from country to country, for example. Delivery dates and product volumes for the various markets and channels are therefore adjusted accordingly.
The H&M group’s products are purchased for sale based on normal weather patterns. Deviations from normal weather conditions affect sales. This is particularly true at the transition between two seasons, such as the transition from summer to autumn or from winter to spring. If the autumn is warmer than usual it may have a negative effect on sales of weather-related garments in particular, such as outerwear and chunky knitwear.
NEGATIVE MACROECONOMIC CHANGES AND GEOPOLITICAL RISKS
One or more markets may be affected by events that have a negative effect on the macroeconomic situation or geopolitical environment in the country. These changed macroeconomic or geopolitical circumstances, such as political instability and sudden negative events in one or more countries, may result in rapid changes in the business environment and in economic downturn, which is likely to change consumer purchasing behaviour and thus negatively impact the group’s sales.
Uncertainties also exist concerning how external factors such as foreign currencies (see below), raw materials prices, transport costs and suppliers’ capacity will affect buying costs for the group’s products. There are also risks associated with social tensions in sourcing markets, which may lead to instability for the suppliers and in manufacturing and deliveries.
The group therefore needs to monitor such changes closely and have strategies in place to deal with fluctuations as advantageously as possible for both the company and external stakeholders.
There are a number of risks associated with sustainability issues in practically every sector. These sustainability risks may be related to factors such as climate change, dwindling natural resources, working conditions, corruption and politically unstable sourcing markets. H&M works actively to support social development, to run its operations ethically, to be climate smart and to use natural resources responsibly. Among other things, H&M uses its size and influence to help move this development in the right direction and to work for long-term improvements in human rights and the environment. To ensure that H&M products are of good quality and are produced under good working conditions, there is a programme of continual follow-up and knowledge building to ensure compliance with H&M’s Code of Conduct (Sustainability Commitment). H&M’s training and follow-up of its anti-corruption code, the Code of Ethics, is also an important part of ensuring that employees and suppliers live up to H&M’s strict requirements regarding business ethics.
Nearly half of the group’s sales are made in euros, and the most significant currencies for the group’s purchasing are the US dollar and the euro. Fluctuation in the US dollar/euro exchange rate is the single largest foreign currency transaction exposure for the group. Large and rapid exchange rate fluctuations, particularly as regards the USD as a sourcing currency, may also have a significant effect on purchasing costs, even if this may be regarded as relatively competition-neutral over time. To hedge flows of goods in foreign currencies and thereby reduce the effects of future exchange rate fluctuations, payments for the group’s flows of goods – i.e. the group’s purchases of goods and in the majority of cases also the corresponding foreign currency inflows from the sales companies to the central company H & M Hennes & Mauritz GBC AB – are hedged under forward contracts on an ongoing basis.
In addition to the effects of transaction exposure, translation effects also impact the group’s results. These effects arise due to changes in exchange rates between the local currencies of the various foreign sales companies and the Swedish krona compared to the same period the previous year. The underlying profit/loss in a market may be unchanged in the local currency, but when converted into SEK may increase if the Swedish krona has weakened or decrease if the Swedish krona has strengthened.
Translation effects also arise in respect of the group’s net assets on consolidation of the foreign sales companies’ balance sheets. No exchange rate hedging (known as equity hedging) is carried out for this risk. For more information on financial risks see note 2, Financial risks in the annual report 2016.
Purchasing costs may be affected by decisions at a national level on export/import subsidies, customs duties (see more below), textile quotas, embargoes, etc. The effects primarily impact customers and companies in individual markets. Global companies with operations in many countries are affected to a lesser extent, and among global corporations trade interventions may be regarded as largely competition-neutral.
Current changes in administrative rules relating to customs around the world mean increased challenges in the area as regards the application of customs legislation. H&M provides the customs authorities with relevant information on an ongoing basis in order to ensure customs values are managed correctly and to facilitate trade in accordance with the rules of the WTO Customs Valuation Agreement.
For multinational companies today’s global environment involves complex tax risks, such as the risk of double taxation and tax disputes. As a large global company, H&M closely monitors developments in the field of tax. H&M is present in many countries and through its operations contributes to the community via various taxes and levies such as corporate tax, customs duties, income taxes and indirectly via VAT on the clothes sold to consumers.
H&M complies with national and international tax legislation, and always pays taxes and levies in accordance with local laws and regulations in the countries where H&M operates. H&M’s tax policy, which can be found at hm.com, reflects and supports H&M’s business. H&M follows the OECD Transfer Pricing Guidelines, which means that profits are allocated and taxed where the value is created. In 2016 H&M became ISO certified for direct taxation and transfer pricing.
H&M works continually to ensure that its tax strategy is designed to limit any distortion arising from differences in tax legislation in different parts of the world.
The OECD guidelines on transfer pricing can be interpreted in various ways, and consequently tax authorities in different countries may question the outcome of H&M’s transfer pricing model even though the model complies with the OECD guidelines. This may mean a risk of tax disputes in the group in the event that H&M and the local tax authorities interpret the guidelines differently.