HUGO BOSS summarizes risks associated with 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 possible dependencies on individual suppliers or production sites, a possible increase in product costs, and the possible divergence between production and sales.
HUGO BOSS attaches great importance to the careful selection of suppliers and the establishment and maintenance of long-term strategic partnerships. However, there is a risk that production from one or more suppliers may be temporarily interrupted due to supplier-related or regional events. Excessive dependence on individual suppliers or production sites could lead to disruptions in the Group’s supply chain and thus to sales risks. HUGO BOSS therefore pursues the goal of a regionally balanced strategic sourcing mix in order to minimize risks, such as local or regional capacity shortfalls as far as possible. In this context, the production and sourcing process is coordinated centrally by the Sourcing/Production department. Supplier relationships are regularly monitored and evaluated with the aim of identifying risks in a timely manner and initiating appropriate measures to ensure product availability. In fiscal year, the largest external supplier accounted for 7% of the total sourcing volume, while the largest single external production site accounted for 3% (2020: 8% and 5%, respectively).
In the medium term, within the framework of important strategic initiatives relating to the topic of “nearshoring”, the Company is pursuing the goal of relocating a part of its sourcing volume closer towards its sales markets Europe and the Americas, thus further strengthening their respective share of the global sourcing mix. The expansion of the Company’s own production capacities at the Izmir (Turkey) site plays a central role in this. In addition to closer proximity to its most important sales markets, HUGO BOSS will also benefit from greater independence from external influences. Sourcing and Production
In view of earthquake risks and possible risks due to political uncertainties, particularly comprehensive measures have been implemented at the Company’s largest production site in Izmir (Turkey) in order to limit the impact of a production downtime on Group revenues. For the majority of the production volume, contingency plans are in place to transfer production to external suppliers. In addition, the financial risk in the event of an earthquake is partially covered by insurance policies. Based on the measures implemented, Management considers risks from dependence on individual suppliers or the regional distribution of sourcing volumes to be unlikely overall. The related financial impact may in principle be high.
Wage increases in production, in particular in emerging economies, and a rise in the price of relevant raw materials such as cotton, wool and leather, may lead to higher product costs and thus have a negative impact on the profitability of the Group. In particular, in the wake of the COVID-19 pandemic, global value chains are exposed to particular strains. Challenges include shortages in terms of global sourcing and production capacities and a related increase in material and production costs. HUGO BOSS counters these risks 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 that risks from higher production costs are possible in principle and that these could have a significant negative impact on earnings development.
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 the appropriate allocation can lead to over-scheduling resulting in high inventory levels on the one hand. On the other, it can also lead to under-scheduling with the risk unrealized sales opportunities. In order to reduce this risk, the Group is working on constantly improving its forecasting quality and on further increasing the flexibility of merchandise management across distribution channels and markets. At the same time, HUGO BOSS aims to coordinate purchasing and sales even better in the future by further shortening the collection development times, thereby enabling it to respond even better to market trends and customer needs. In view of the generally high volumes, the scheduling risk is generally classified as possible. Depending on the extent, the related financial impact could be high.
Overall, the aggregated potential impact of risks associated with suppliers and sourcing markets is considered to be high. The aggregated likelihood of occurrence is classified as possible.
Quality risks
When sourcing materials and manufacturing its products, HUGO BOSS places the highest emphasis on quality. Intensive quality controls at all stages of production and the incorporation of customer feedback are intended to contribute to the continuous improvement of the production process. In addition, both the Company’s own production sites as well as those of its partners are regularly monitored to ensure strict compliance with central quality guidelines. Incoming goods inspections as well as intensive quality tests at the Metzingen site are designed to ensure the high quality standards of HUGO BOSS. Nevertheless, the Group considers a certain degree of product returns for quality reasons to be possible. The impact on earnings development is considered to be high despite the recognition and regular review of corresponding provisions for returns. Sourcing and Production
Logistics risks
HUGO BOSS is exposed to logistics risks that 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 significantly delayed product availability. In addition, the temporary downtime or loss of warehouse locations may lead to lost sales opportunities. The storage of inventories is centered on selected sites directly operated by HUGO BOSS. The distribution centers for hanging goods, flat-packed goods and the Company’s online business, all located in the immediate vicinity of the headquarters in Metzingen, form the core of the Group-wide logistics network.
In light of the COVID-19 pandemic, competition for global transport and logistics capacity has intensified noticeably. On the one hand, this has led to a significant increase in freight costs. At the same time, risks arise with regard to disruptions or significant delays in product availability. Thanks to its resilient value chain and timely and forward-looking actions, HUGO BOSS was able to secure sufficient product availability in fiscal year 2021. The Company benefited in particular from its well-balanced global sourcing mix, the flexibility of its own production sites, long-term strategic partnerships with suppliers, and the successful onboarding of new partners as part of the general business recovery and strong growth in 2021. In addition, in the prior fiscal year, HUGO BOSS took new, solution-oriented and in some cases unconventional approaches in transportation and logistics. In addition to shifting early from sea to air freight, a small number of passenger aircrafts were chartered to ensure product availability in the short term for the fast and uncomplicated shipment of goods from Asia to Europe. HUGO BOSS will continue to use all means at its disposal in the current fiscal year to ensure sufficient product availability at the point of sale. However, significant interruptions in product availability and related lost sales opportunities cannot be completely ruled out. Sourcing and Production
With the aim of constantly improving the efficiency and flexibility of its logistics while minimizing logistics risks as far as possible, HUGO BOSS will continue to work on further optimizing its global logistics platform in the future. In addition, compliance with 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 stored in warehouses. Based on the measures implemented, the likelihood of occurrence of logistics risks in 2022 is considered to be unlikely. However, the related financial impact could in principle be significant.
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 the duration of storage and consequently the recoverability of merchandise. In the wholesale business, sales and distribution risks mainly relate to a possible dependence on individual wholesale partners as well as bad debt losses.
The aim of the centrally organized inventory management is to ensure the forward-looking, optimal allocation of Group-wide inventories while at the same time maintaining flexibility in order to be able to respond to increases or decreases in demand at short notice. Downturns in demand or misjudgements of sell-through rates can have a negative impact on inventory turnover. HUGO BOSS therefore strives to continuously improve its inventory management. Granting additional discounts as a countermeasure inevitably has a negative impact on the gross margin and ultimately on the Group’s profitability, and is therefore constantly monitored by the Group Controlling department. A centrally managed pricing policy, differentiated retail formats and coordinated collections are aimed at achieving a constant improvement in retail productivity.
Inventory risks may result from increased storage periods and a potential reduction in their marketability as a consequence. In line with the principle of net realizable value, impairments on inventories are recognized accordingly and reviewed on a monthly basis. As part of the process, system-based analyses of movement rate, range of coverage and net realizable value are applied across the Group. Sufficient write-downs were recognized as of the reporting date in the opinion of the Management. Notes to the Consolidated Financial Statements, Note 12
Attention is paid to ensure a balanced customer structure to avoid a potential overdependence on individual customers in the wholesale channel. The Group Controlling department constantly monitors key performance indicators such as the order intake, sales and supply rates and reports these on a regular basis to the Managing Board. In this way, countermeasures can be initiated promptly in the event of risks arising. Group Management
In the wholesale channel, the Group is exposed to the risk of bad debt losses due to the potential insolvency of individual trading partners, as well as to cumulated losses resulting from an economic slowdown in individual markets. The Group-wide receivables management follows uniform rules, for example regarding credit rating checks and the setting of and compliance with customer credit limits, monitoring of the age structure of receivables, and the handling of doubtful receivables. In individual 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 reviews compliance with the Group guidelines. As of the reporting date, there was no concentration of default risks due to significant outstanding receivables from individual customers. The overall financial impact of potential bad debt risks is considered to be significant. Notes to the Consolidated Financial Statements, Note 13
In summary, Management estimates the likelihood of occurrence of sales and distribution risks as possible. The cumulative financial impact is assessed as high mainly due to potential discounts and impairments.