Massmart Annual Report 2008

Group risks and responses

The Group Risk Register summarises the major risks facing the Group, taking into account the likelihood of occurrence, the potential impact and any mitigating factors or compensating controls.

The Risk   Our Response

Another major store fire

   

In the last 15 years Makro has had three stores totally destroyed by fire. The most recent fire, in May 2004, allegedly caused by a sub-contractor working on the roof, occurred despite significant and costly fire detection and prevention measures implemented following the previous Makro store fire in 2001. Depending upon the cause of any future potential fire, it is unlikely that Makro would be able to secure adequate catastrophe insurance cover or, alternatively, may secure adequate insurance cover but at a significant premium. Compounding this risk is the relatively high insurable values associated with inventory contained in the Group’s larger warehouse formats in CBW, Makro and Builders Warehouse.

 

Makro and the rest of the Group work closely with external risk assessors, insurance brokers and our major insurers in order to ensure that our stores have the highest possible level of fire detection and prevention.

Information technology

   

With millions of transactions daily, the Group is dependent upon reliable, secure, effective and efficient IT systems, including data and information. Major IT implementations or initiatives can distract management, be costly, destabilise the current IT platform and/or perform sub-optimally post-implementation a possible over-reliance on one or more service providers. Finally, at a strategic level, there exists the potential for misalignment between business strategy and IT capability, which can result in reduced operational effectiveness.

 

All the Group’s IT development, for hardware and software, must be specifically approved and then monitored by the Group’s Technology, Information & Processes Forum (TIP), representing all the Chains’ IT executives, Massmart Internal Audit and, where appropriate, the external service providers. Divisional Boards must sign off all IT developments. Massmart Internal Audit has significant IT expertise and independently assesses all IT developments and is part of the ‘go-live’ decision on any project. External auditors review the IT general control environment in the major Divisions on an agreed rotation basis.

 

Poor business model or Strategic execution

   
Through non-adherence with, or poor implementation and execution of, our business model and/or strategy, the Group’s longer-term financial performance and competitive positioning could be severely compromised. The resultant financial performance may be sub-optimal on either an absolute or on a relative basis.   The Group insists on strategic clarity at Massmart Corporate and the Divisions. The strategies of all Divisions and the Group are formally documented and are reviewed annually at Divisional level, at Group Executive Committee level and then with the Board. The annual budget process is an output of these reviews. A Division’s strategies dictate management’s operational tactics and priorities.

Talent retention and succession

   
This covers four broad issues including: the national scarcity of retail-specific skills; the challenge to develop and retain sufficient business and leadership skills internally to ensure our longer-term competitiveness; a possible over-dependence on key leaders in the Group; and the need for an actively managed leadership succession pipeline. This risk has recently been aggravated by an increase in executive emigration.   The Group considers this a major area of focus and deals with it on several levels. The Executive Committee actively monitors and manages the progress, development and likely succession plans for the “Top 200” employees, as well as monitoring a further 200 employees. In addition, there are in-house education programmes prepared and presented in conjunction with local and international business schools that focus on developing our middle and junior executives. Annual ‘fire-side chats’ are held with each executive in the Group, which are attended by that person’s superior and a third person – either the Group Organisation Executive or HR person in that Division. The Group’s remuneration policy, including short-term incentives, is to pay salaries in the mid to upper quartile.

Insufficient progress with transformation

   
There is the possibility of adverse or undue reputational exposure due to the Divisions or the Group not fulfilling, or under-delivering, towards BEE requirements. In the broader national context, inadequate transformation at all levels by us and other South African businesses will curb the country’s longer-term growth potential and maintain the current, unacceptable and unsustainable, levels of social and economic inequality. This issue includes insufficient black representation at Group and Division executive level.   The Board-approved BEE Strategy, dated February 2004 and covering the elements of the Code of Good Practice, has been effectively implemented Group-wide and we believe that much progress has been achieved. Transformation is a major agenda item at all Divisional and Group board meetings and a senior executive at Massmart has overall responsibility for delivering to the strategy. A BEE staff share issue amounting to 10% of the pre-dilution shares of Massmart was implemented in October 2006. All permanent Massmart employees, not already participants in the current share trust, are beneficiaries. The shares awarded to general staff have voting and dividend rights. A transformation incentive has been implemented for Divisional executives.

HIV/AIDS

   
This refers to the impact of the consequences of the virus on Massmart and its broader community. Separate from the human tragedy, potential business impacts include higher levels of employee deaths, reduced available skills, lower productivity and higher absenteeism, and higher direct and indirect costs of employment. Accelerated death rates amongst our consumer base may affect local sales or may render uneconomic certain stores that are significantly exposed.  

Over the last four years, HIV prevalence has been measured in all the Divisions by an external agency. The Group’s estimated infection rate, using statistical methods, is 5,4% amongst employees. All the Divisions are at various stages of rolling out AIDS support initiatives and offering voluntary counselling and testing programmes. In 2006 Massmart implemented a comprehensive HIV/AIDS awareness and treatment programme which includes the provision of free anti-retrovirals to all permanent staff and spouses.

Economic volatility

   
This concern focuses on two potential impacts, the first being the financial impact on the business’s trading and the second being the possible adverse effect on consumer expenditure of dramatic changes in key economic variables including inflation, interest and exchange rates. With approximately 30% of the Group’s merchandise being imported, directly and indirectly, any sudden changes in the exchange rate will affect the stock valuation, although there may be a lag where the Group has entered into forward exchange contracts on its own direct imports to combat this eventuality. Furthermore, foreign currency fluctuations in those African countries where Game operates stores can also affect the level of sales and earnings reported by those stores in South African currency, as well as resulting in potentially adverse balance sheet translation differences. Increases in interest rates will make South African corporate funding more expensive, with an adverse impact on profitability. Higher inflation rates may affect Group profitability where these cost increases cannot be controlled or additional productivity associated therewith is not forthcoming. Lower inflation rates may make long-term property leases with higher fixed escalation rates appear expensive and potentially affect profitability. South African consumer behaviour appears to be more affected by sudden and large changes in economic variables, including exchange rates and local interest and inflation rates, than by gradual changes in these variables. It follows that a sudden deterioration in one or several of these economic variables may dampen levels of consumer expenditure, thereby reducing sales growth and potentially Chain or Group profitability too.   All direct foreign exchange liabilities are covered forward, resulting in certainty about the expected landed cost of merchandise and also providing a 4 to 6 month buffer against changing the cost of imported inventory should there be any sudden deterioration in the exchange rate. The value of inventory in the supply chain between manufacturer and retailer has also been actively managed lower by all participants. This reduces the extent of any imported inventory that is over- or under-valued following a sudden change in the exchange rate. Interest rates on the Group’s medium-term debt has been fixed to provide certainty as to the future cost of this funding, and this will keep the Group immune to any adverse increases in corporate borrowing rates. Where possible, property lease escalation rates are negotiated as low as possible, taking market conditions into account, and certain property leases are inflation-linked, within a cap (maximum rate) and collar (minimum rate). Salary and wage increases are negotiated in the context of the current South African socio-economic environment, and where a negotiated increase may be higher than is suitable, productivity measures may be introduced to reduce the net cost of the higher wages.

Fraud, security and crime

   
There is the risk of human, financial and reputational exposure through high levels of inventory shrinkage, armed robberies for cash or merchandise, and losses from fraud, internal and external. The rate of armed and violent crime has increased to unacceptable levels and if left unchecked can adversely affect employees, customers, the business and the overall business environment.   The Group is continually improving its procedures and controls to ensure that the risk of potential losses or injury through criminal incidents is minimised. Massmart is also an active participant in the Business Against Crime/ECR forum that shares information on all incidents of crime across the major retail chains. There is a whistle-blowing facility, Tipoffs Anonymous, through which employees, customers or suppliers can report unethical or dishonest acts. Staff fraud is dealt with severely.

Supply chain

   
Supply chain describes all the business processes and activities around the buying, recording, receiving, moving, storage, display and sale of inventory in the Group, and is not restricted to logistics but extends into IT systems and business processes around those systems. An efficient and effective supply chain should ensure the lowest-cost movement, and holding, of inventory and the optimisation of in-store inventory levels for given levels of demand. An effective or inefficient supply chain may result in sub-optimal inventory management, with duplication of costs and over- or under-stocking affecting holding costs or rate of sales.   Massdiscounters, Makro and Builders Warehouse have implemented IT software to automate the forecasting and replenishment (F&R) of inventory. Massdiscounters are most advanced with about 50% of their sales by value being automatically replenished. This is about 40% in Builders Warehouse, and Makro is launching its F&R drive during the 2009 financial year. In August 2008 the Group’s first regional distribution centre (RDC), for Massdiscounters’ use, was opened in the Western Cape. Depending on the success of this, RDCs will be required in Durban and Johannesburg.

Complexity associated with expected sustainability standards of conduct

   
There is a growing threat of potentially significant reputational risk associated with the failure to meet stakeholders’ increased expectations around sustainability in its many forms. These expectations may be shaped by a variety of standards of conduct as encapsulated in codes such as, but not limited to, Global Reporting Initiative, Global compact, JSE Limited Socially Responsible Investment Index, Broad-based Black Economic Empowerment codes of good practice, Marine Stewardship Council, Forestry Stewardship Council and ISO 14001 certification. Increasingly, the Group needs to comply with some or all of these standards.   The Group has implemented transparent and honest stakeholder interactions with special interest groups, which inform our view on stakeholder expectations and the management thereof. There is ongoing identification, monitoring and adoption of relevant principles and standards of sustainability that are consistent with Massmart’s core values and industry norms.