Annual Report 2006
GfK Group: www.gfk.com
Risks
As the number four market research organization in the world, GfK will continue to actively make use of opportunities to expand its position in the market. However, opportunities are also associated with risks. The early identification, evaluation and professional management of risks enable GfK to leverage the opportunities presented in an entrepreneurially responsible manner.
The risk management of the GfK Group is under constant further development. As in prior years, the Group’s external and internal auditors confirmed the effectiveness of the system.
Basic principles of risk management: integrated system
PRINCIPLES OF RISK MANAGEMENT POLICY: as a basis for positive risk management, the GfK Group applies principles of risk management policy on which the risk management system in all the divisions must be based. The main principles are:
Only identified risks are manageable.
As a result of constantly changing circumstances and demands, identifying risks is one of the ongoing tasks that form an integral part of daily working practices. Risk management is an early warning system which enables appropriate measures to be implemented at an early stage to avert any negative impact on business growth. GfK’s horizontal organizational structure and the culture of open communication also increase transparency and facilitate the identification and management of potential risks.
Risks are systematically assessed.
Not all risks are of equal importance. To ensure efficient risk management, any risks identified must be assessed systematically in terms of the potential damage and the probability of the risk occurring. The potential damage is measured in terms of the estimated negative impact on the company’s income over the next two years. The aim of the risk assessment is to ascertain which risks could materially jeopardize the company’s success. To this end, GfK has specified standard quantitative and qualitative threshold values for all business divisions. In addition to the materiality of a risk, another criterion is whether a risk might endanger the company’s existence. By applying the threshold values, it is possible to define when such a risk would be present for the GfK Group.
Risk management is everyone’s responsibility.
It is the responsibility of every employee to avert potential damage to the company. In addition to basic knowledge of the risk management system, this requires a high level of risk awareness among employees. GfK uses targeted information material and holds workshops to raise risk awareness among its workforce.
RESPONSIBILITIES AND FUNCTIONS: due to the Group’s decentralized structure, direct responsibility for the early identification, management and communication of risks rests locally with the operating management of the individual GfK companies. Risk management coordinators at the companies ensure that the central regulations are applied in the respective organization and they also promote risk awareness.
As part of the overall responsibility for the risk management system, the Management Board has appointed a risk management committee which continually expands and updates the Group’s arrangements for efficient and effective risk management. This committee is responsible for the planning and ongoing development of the system’s methodology and for ensuring its effectiveness. Its key tasks include identifying risks relevant to the GfK Group and informing the Management and Supervisory Boards about the current risk situation within the GfK Group.
PROCESSES: in order to take full account of risks, the GfK Group applies an integrated risk management approach. This involves identifying and managing strategic and operating risks at the level of the various companies, at regional, divisional and Group level.
The core of this system is the annual risk inventory carried out by the risk management coordinators, which covers developments relating to risks identified in the prior year and new risks that have emerged. Using a checklist which contains all the areas to be monitored in terms of risk, risks are assessed according to the probability of their occurrence and the extent of potential damage, so that concrete measures can be specified to manage them. If new risks emerge during the year, or if the risk situation changes significantly, ad hoc reporting ensures that the Management Board is informed immediately.
In addition, a standardized reporting system, which is based on Group-wide standard criteria, guarantees that financial risks relating to current and future business trends are monitored. Based on the commercial data provided by the various business units of the company, Group Controlling produces monthly internal reports which provide information at an early stage about any possible risks to business performance. In addition, forecasts and budgets during the year provide important indicators of any imminent commercial risks.
A continuously updated set of guidelines, which specifies all mandatory approval processes, also forms part of the internal controlling process.
DOCUMENTATION AND MONITORING: all principles, functions and processes of the GfK Group’s risk management system are documented in a handbook, which applies throughout the Group. Every employee can access the handbook on the Intranet.
The internal Audit department regularly reviews the structure and effectiveness of the risk management system. Risk management is also assessed as part of all audits carried out at subsidiaries in Germany and abroad. The findings of such audits, combined with advice from the auditors, help to improve the early warning risk management system.
Assessing the risk situation: individual risks
MACRO-ECONOMIC RISKS: for financial year 2007, GfK expects additional impetus from ongoing positive economic growth.
GfK does not currently anticipate substantial risks from the macro-economic trend, which could result in significant order setbacks or a decline in sales at Group level.
As a result of GfK’s very broad client portfolio, bad debts are of secondary importance and have not impaired the liquidity position of the Group.
SECTOR RISKS: the past few decades have shown that, unlike other segments of the marketing and advertising sector, market research is relatively unaffected by economic fluctuations. In addition, as a full-service provider offering a vast range of studies and analyses and on the basis of its corporate network, the GfK Group is in a position to compensate for regional and sector-related fluctuations.
The risks detailed below relating to the individual business divisions do not therefore pose any major threat to the GfK Group’s business performance.
The market research segment in which the CUSTOM RESEARCH division provides services is characterized by the presence of large international suppliers as well as many smaller local suppliers. Market entry barriers are significantly lower on account of the much lower investment costs. Economic developments impact more quickly on the order books in this segment. GfK counters this risk with a range of high quality, up-to-date products and methods and for example, has developed online platforms to facilitate data delivery from clients via the Internet. Furthermore, cost-cutting opportunities have been consistently utilized.
The building of its global key account management system is designed to meet the requirements of major international clients. The expansion of the network was also progressed in order to develop new markets and client groups through global data. The acquisition of the NOP World companies and their successful integration into the GfK Group represents a major milestone in this regard.
The RETAIL AND TECHNOLOGY division’s excellent market position in the countries where today it operates its own companies makes a major contribution to the overall success of the GfK Group. GfK is the leading supplier of information on the consumer electronics and durables markets worldwide. Its strength lies not only in its vast market knowledge, but also in the competence of its local management and the use of cutting-edge instruments, which enable the division to provide global clients with up-to-date services. The systematic expansion into economically relevant countries in all regions of the world and the consistent broadening of the range of services are the strategic cornerstones for further enhancing this market position. In 2006, further investment was made in expanding the network in Latin America, Africa, the Middle East and Eastern Europe. The worldwide use of the StarTrack analysis and production system was an important measure in strengthening the division’s market position.
The CONSUMER TRACKING division continues to be characterized by fierce competition in the European markets. However, GfK again successively maintained its position in this difficult market environment. In 2005, the division’s business performance was still adversely affected by the necessary realignment of retail panel research in Switzerland, but once it was put onto a new contractual basis, the retail panel made a positive contribution to the development of the division in the past financial year.
In 2006, 35% of sales in MEDIA resulted from long-term contracts in continuous TV and radio ratings research with fixed order volumes. The resultant dependency on major clients represents a material risk which GfK has been successively countering for many years through close cooperation and client support. All major contracts in Media could be extended. In addition, in Germany a multi-year contract to digitally measure TV viewer behavior has been won. Moreover, future success has been secured through new technologies, such as the current development of a production platform for TV and radio research which can be used at an international level. The MEDIA division has also been strengthened in the print segment in the American market through the acquisition of Mediamark Research.
The market environment for the HEALTHCARE division is relatively strongly influenced by legal regulations. This brings with it special risks but also opportunities. GfK is responding to the growing demands on the part of the client by setting up special reporting systems and the targeted training of its employees. The comprehensive international presence is another factor which is of critical importance, particularly for its top clients, the international pharmaceutical groups.
Mergers and acquisitions affect all business divisions because they diminish the client base. This produces more major companies and as a result, the competition for their marketing budgets is fierce. GfK is positioned in this environment with high quality standards and innovative and differentiated technologies and methods. In addition, alongside key account management and individual client loyalty programs, the focus is increasingly on attracting new customers.
GfK’s dependency on major clients is however low on the whole. The proportion of top 10 clients in consolidated sales reduced in 2006 to 11%, down from 12% in the prior year.
Moreover, there is no division which generates more than 10% of Group sales with just one client. Consequently, the operating risks are also limited. The GfK Group’s global presence ensures that no regional dependencies arise that may represent a material risk.
OPERATING RISKS: competitors in some areas are continuing to use price dumping to attract clients. Although clients are very price-conscious, at the same time they are looking for tailored, integrated information solutions in conjunction with high quality, individual consultancy services. In order to meet these needs GfK uses “Fact-based Consultancy” which is part of its corporate strategy. Ongoing optimization of processes, cost-cutting measures and innovation secure the Group’s overall competitiveness.
GfK monitors the progress of major, cost-intensive innovation projects by means of a regular reporting system. At present, no material risks associated with research and development activities have been identified.
PERSONNEL RISKS: despite the sustained upward economic trend, the staff turnover rate at GfK rose only slightly. GfK’s success depends largely on the qualifications, motivation, performance and loyalty of its employees. In order to attract, integrate and retain specialists and managers long-term, GfK offers a differentiated training and continuous professional development program and works towards improving its HR policies on an ongoing basis. This process is supported by regular employee surveys.
FINANCIAL RISKS: in October 2006, GfK AG refinanced the syndicated credit facility agreed for the acquisition of NOP World at more favorable terms. The volume comprises loans of EUR 180 million and USD 170 million and runs until April 2010 as well as a revolving credit facility for EUR 250 million until October 2011. As of the reporting date GfK had utilized around 78% of the syndicated credit facility. In addition, GfK AG has access to bilateral credit lines totaling around EUR 61 million, of which only 4% had been used at the year-end.
These financing elements as well as cash holdings of around EUR 50 million secure the financing of the Group.
FOREIGN CURRENCY RISK: as a global company, the GfK Group is exposed to transaction and currency translation risks.
The transaction risk results from the sale and purchase of goods and services which are not paid for in the local currency of the respective business unit. Due to the fact that all GfK operating companies have sales and expenses in the local currency, the currency risk at GfK is restricted at operational level. Intra-Group guidelines also regulate that all GfK units monitor their currency risks and hedge against currency fluctuations for foreign currency projects of a certain size. As a rule, GfK provides in-house financing in the local currency of the subsidiary. The ensuing currency risks in the Group’s Treasury are hedged using derivatives. Hedging transactions usually run for a maximum of 12 months. The offsetting effects of the underlying transaction and the currency hedge are recognized in the income statement and are therefore identifiable.
As of the reporting date, December 31, 2006, existing currency hedges had a positive fair value of EUR 0.3 million.
The currency translation risk is due to the fact that many GfK companies are outside the euro-zone, while GfK reports its accounts in euros. In the consolidated financial statements, the balance sheets and the income statements of companies outside the euro-zone must be converted into euros. The translation-related effects from changes in exchange rates are shown under equity in the GfK consolidated financial statements. As the participations are generally of a long-term nature, GfK dispenses with hedging directly for net assets. Instead the Group tries to use natural hedges to provide cover for participations. To do this, the financing is in the currency of the respective company so that currency fluctuations are kept to a minimum. In order to eliminate volatility in the income statement relating to the reporting date valuation of currency liabilities, GfK uses hedge accounting according to IFRS pursuant to IAS 39 for long-term financing. Accordingly, valuation effects are reported under equity.
INTEREST RATE RISK: at GfK, interest rate risks mainly arise for financial liabilities. In 2005, GfK used the favorable interest rate conditions to safeguard interest rates on a long-term basis and ensure greater accuracy when calculating financing requirements. For this reason, as of the reporting date, GfK AG had hedged the majority of its financial liabilities through interest rate swaps, which impact on the income statement like a fixed-term loan.
As of December 31, 2006, the interest rate hedges had a positive fair value of EUR 11.6 million. The counterparty risk in connection with the positive fair value of all derivatives is seen as low, as transactions are only conducted with renowned German and international banks with a first class credit rating. Moreover, the counterparty risk is reduced as transactions are spread across several banks.
LEGAL RISKS: the concept of “apparent self-employment” is still a matter of debate in many countries. This harbors the risk that the interviewers and other freelancers working for GfK could become liable to social security contributions. GfK avoids additional costs by adjusting the employment terms where possible to the respective state legislation.
GfK is involved in civil law proceedings in a number of countries which have various causes in law. The management does not believe that these present a material risk to the GfK Group.
Material risks from compensation claims or the above legal proceedings have already been recognized as liabilities. This also applies to the legal dispute explained in the Notes resulting from the takeover of NOP World.
RISKS ENSUING FROM ACQUISITIONS: the acquisition of new companies and their integration into the Group are associated with risks. GfK prepares for such risks with extensive due diligence checks prior to any acquisition and through measures which support the acquisition process.
As part of its Excellence Program, a tailored concept was also developed to optimally cover the requirements of the company when integrating newly acquired companies. The participation of colleagues from the global GfK network ensures compliance with all requirements from an operating and communications perspective.
With the successful integration of NOP World, the biggest acquisition to date in GfK’s company history, GfK’s conceptual approach to company acquisitions has proved its worth. The activities of GfK and the former NOP World companies were pooled, internal reporting standards harmonized and corporate structures adjusted.
IT AND OTHER RISKS: setting up, maintaining and developing security measures to protect information systems and the data stored in them is crucial for a market research company such as GfK whose services are based on providing information about markets, consumers and brands. Precautions to secure information technology and associated applications have always been given the highest priority.
From 2002 to 2004, GfK carried out additional security checks with external support at its head office in Nuremberg. In 2006, implementation started worldwide on the resultant Group-wide mandatory IT security standards as well as the IT Security Policy based on the British Standard 7799. This is set to be completed in 2007. The Chief Information Officer (CIO) coordinates all of these measures and the Group-wide IT strategy and security concepts, working alongside the IT security specialists from the company headquarters in Nuremberg and the IT managers in the GfK companies outside Germany.
As part of its disaster recovery plan, GfK monitors other risks arising outside the IT area on a continuous basis. Essential risks from compensation claims and liability issues are covered either locally or on a Group-wide basis by umbrella insurance policies.
No major IT or other risks have currently been identified at the GfK Group.
Assessing the risk situation: overall risk
An assessment of GfK’s overall risk situation shows that the risks are limited and manageable and do not materially affect the net assets, financial position and result of operations of the GfK Group. No lasting damage to business growth at the GfK Group is currently anticipated due to individual risks or the interaction or accumulation of risks.
GfK has successfully mastered the challenge of integrating the former NOP World companies and incorporating them in day-to-day business operations. The assessment of the risk situation relating to this major acquisition is therefore lower than in 2005.
In summary, the overall risk position of the GfK Group continues to be low. At present there are no risks that could endanger the continued existence of the GfK Group.
GfK Annual Report 2006