ONLINE ANNUAL REPORT 2010

RISK

The Risk Committee comprises Messrs Nigel Matthews (Chairman), Dods Brand, Peter Maw, Guy Hayward, Kevin Vyvyan-Day (Chief Executive of Masswarehouse) and Norman Gray (Chief Audit Executive), and Ms Lulu Gwagwa. Nigel Matthews chairs both the Risk and Audit Committees to ensure the appropriate exchange of key issues between the two Committees and as recommended by King III.

The Board recognises its responsibility to report a balanced and accurate assessment of the Group’s financial results and position, its business, operations and prospects. Aspects of how this is achieved are covered in the section below.

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More information on the Committee can be found here

Corporate Governance

INTERNAL CONTROL FRAMEWORK

Massmart maintains clear principles and procedures designed to achieve Corporate accountability and control across the Group. These are codified in the Massmart Governance Authorities that describes the specific levels of authority and the required approvals necessary for all major decisions at both Group and Divisional level. Through this framework, operational and financial responsibility is formally and clearly delegated to the Divisional Boards. This is designed to maintain an appropriate control environment within the constraints of Board-approved strategies and budgets, while providing the necessary local autonomy for day-to-day operations.

Insight

Risk model

The Board is responsible for the risk management programme that attempts to balance the risks and rewards in achieving the Groupís objectives. On behalf of the Board, the Risk Committee oversees the Groupís risk management programme, which has a natural overlap with aspects of the Audit Committeeís mandate. Responsibility for risk management and loss prevention rests however, with the Group and Divisional Executive Committees.

Massmartís risk landscape, split into strategic and operational risk, can be summarised as follows:

Strategic risk

Business model

  • Non-adherence to business model or poor strategic execution
  • Insufficient progress with transformation

Human capital

  • Talent retention and succession

Economic

  • Economic volatility

Governance/Regulatory

  • Expected standards of sustainability conduct

Operational risk

Operating environment

  • Major store fire
  • Supply chain
  • In-store health and safety
  • Reliance on IT systems

Geo-political/Economic

  • Complexity of the Groupís African operations

Competitive

  • Competitor attack on our major merchandise categories

Financial

(covered in the Group Financial Statements on page 211)
  • Market risk (comprising interest rate risk, currency risk and other price risk)
  • Liquidity risk
  • Credit risk

RISK AND THE RISK COMMITTEE

The Board considers risk management to be a key business discipline designed to balance risk and reward, and to protect the Group against risks and uncertainties that could threaten the achievement of our business objectives.

The Board’s risk strategy has been established through debate with the executive directors where the Group’s risk tolerance has been considered and balanced against the drive towards the achievement of its strategies and objectives.

The Risk Committee is responsible to the Board for overseeing the Group’s risk management programme. The day-to-day responsibility for risk management, including maintaining an appropriate loss prevention and internal control framework, remains with the executives of the Group and of each Division.

The Committee’s primary role is one of oversight and therefore it reviews and assesses the dynamic interventions, within the Group’s available resources and skills, required in response to business-specific, industry-wide and general risks. The Committee tables a Group risk register, aggregated from those prepared by the Divisions and the Group Executive Committee, to the Board annually in August.

In addition to the two Committee meetings, an interim report is prepared annually in February by the executives on the Committee and is circulated to the Committee. This report comments on the status of the risks identified in the current Group risk register, notes any risk incidents that may have occurred since the previous Committee meeting and comments on the internal and external risk environment.

The Committee considers there to be two categories of Group risk which can broadly be described as Operational risks and Strategic/Environmental risks:

Operational risks by their nature can be immediately addressed or mitigated by local management actions. These risks – which include in-store health, safety and security, compliance, fire prevention and detection, IT systems and food safety, amongst others – are therefore the direct responsibility of each Divisional Executive Committee where a Loss Prevention or Risk Officer has line-responsibility for overseeing these risks.

Strategic/Environmental risks, in contrast, tend to be longer-term or more material in nature and can, in most cases, only be monitored, managed and partially mitigated through longer-term strategic or tactical business responses. These risks, which, for example, include executive talent retention and succession, transformation and supply chain, are the primary focus of the Group’s Risk Management process.

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. Together with the Audit Committee, the Risk Committee oversees the maintaining of a sound system of governance, risk management and control with regard to operations, safeguarding assets, reliability of management reporting, and compliance with laws and regulations.

LITIGATION AND LEGAL

In the normal course of business, Massmart is subject to various legal proceedings, actions and claims. These matters are subject to risks and uncertainties that cannot be reliably predicted. The Board does not believe that there are any material pending or threatened legal actions.

INFORMATION TECHNOLOGY

Protecting Massmart’s electronic assets is increasingly complex as networks, systems and electronic data expand and, in some cases, are shared with third parties and business partnerships. Depending on the internet for communication brings additional risk. Ensuring proper system security, data integrity and business continuity is the responsibility of the Board, but is given effect by the Audit Committee, the Risk Committee, the Massmart Technology Information and Process Forum (TIP) and Massmart’s formally contracted information technology business partners and providers and is independently reviewed by the external and internal auditors.

FINANCIAL RISK AND APPRAISAL

Financial targets agreed in Group budgets and strategy processes are predicated on assumptions about the future that are uncertain and may prove incorrect or inaccurate. The monitoring and management of this risk is the responsibility of the Executive Committee. Monthly performance is measured and compared to the budget and prior year, and corrective or remedial action taken as appropriate.

Despite extensive financial, accounting and management controls and procedures, including reviews by internal and external auditors, there are risks arising from the Group’s cash management and treasury operations, direct and indirect taxation, and employee or third-party fraud or economic crime.

In addition to financial reviews, Massmart has implemented voluntary processes that enable independent reviews of its corporate accountability performances. These include a biannual ethics review by the South African Institute of Ethics and an annual Socially Responsible Investment (SRI) Index review that is co-ordinated by the JSE.

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More detail on financial risk can be found here

Group Financial Statements

GROUP RISK LANDSCAPE

Risk landscape Risk Definition
Business model/Strategic execution Non-adherence to business model or poor 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.
 
Business model/ Strategic execution Insufficient progress with transformation There is the possibility of adverse or undue reputational exposure due to the Divisions or the Group not fulfilling, or underdelivering, towards B-BBEE requirements. In the broader national context, inadequate transformation at all levels by Massmart 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 executive level at the Group and Divisions.
 
Human capital Talent retention and succession This covers four broad issues being: 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.
 
Economic Economic volatility This concern focuses on three potential impacts, the first being the financial impact on the business and the second being the possible adverse effect on consumer expenditure of dramatic changes in key economic variables including inflation, interest and exchange rates. The third concerns adverse systemic socio-economic impact of the HIV/Aids pandemic.

With approximately 30% of the Group’s merchandise being imported, directly and indirectly, any sudden changes in the exchange rate will eventually affect the stock valuation.

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 translation differences affecting earnings.

Increases in interest rates will make South African corporate funding more expensive, with an adverse impact on profitability.

Higher cost inflation may affect Group profitability where these cost increases cannot be controlled or any additional productivity required 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 Group sales growth and potentially Group or Divisional profitability too.
 
Governance/ Regulatory Expected standards of sustainability conduct There is a growing potential threat of 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 Socially Responsible Investment (SRI) Index, Broad-based Black Economic Empowerment Codes of Good Practice, Marine Stewardship Council (MSC), Forestry Stewardship Council (FSC) and ISO 14001 certification. Increasingly, the Group needs to comply with some or all of these standards.
 

STRATEGIC RISK

Probability Potential impact Risk mitigation
Financial impact The Group insists on strategic clarity at the Divisions and Massmart Corporate. 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. A Division’s strategies dictate management’s operational tactics and priorities. The annual budget process is an output of these reviews.
 
     
  Business impact
Financial impact The Board-approved B-BBEE strategy covering the elements of the Code of Good Practice, has been implemented Group-wide and we continue to make good progress as measured by the improvement in the annual external B-BBEE rating and currently have a Level 4 status. Transformation is a major agenda item at all Divisional and Group Board meetings and a senior executive at Massmart has overall responsibility for delivering the strategy. A B-BBEE staff share issue amounting to 10% of the pre-dilution shares of Massmart was implemented in 2006 and all permanent Massmart employees, not already participants in the current share trust, became beneficiaries at that time. In 2008, the Group’s five black non-executive directors each purchased 20,000 heavily discounted Massmart shares. For several years an annual transformation incentive has been implemented for Divisional executives.
 
     
  Business impact
     
     
     
     
     
Financial impact This is a major Group focus area. The Executive Committee actively monitors 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 executive. The Group’s remuneration policy, incorporating short- and longer-term incentives, is designed to reward significant outperformance and provides an opportunity for staff to accumulate wealth and which can also act as a retention mechanism.
 
      
  Business impact
     
     
     
     
Financial impact All direct foreign exchange import liabilities are covered forward, providing certainty about the expected landed cost of merchandise and also providing a four- to six-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 is generally 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 have been fixed to provide certainty as to the future cost of this funding, and this will keep the Group partially 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 necessarily negotiated in the context of the South African socio-economic environment. Where a negotiated increase may be higher than is suitable, productivity measures may be introduced to reduce the net cost of the higher wages.

The Group continually explores means of keeping the net assets of Game’s African operations to a minimum, thereby potentially reducing the translation effect of any currency movement. This includes repatriating cash profits as frequently as possible and settling cross-border liabilities timeously.
 
     
  Business impact
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
Financial impact The Group has implemented transparent 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. Massmart is in the JSE SRI Index and it subscribes to MSC and FSC, inter alia.
 
     
  Business impact
     

GROUP RISK LANDSCAPE

Risk landscape Risk Definition
Operational Major store fire Since 1994 Makro has had three stores totally destroyed by fire. The most recent fire, in 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, Makro would be able to secure adequate catastrophe insurance cover but at a very 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 and now the RDCs in Massdiscounters.
Operational Supply chain Supply chain describes all the business processes around the movement 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 ineffective or inefficient supply chain may result in sub-optimal inventory management, with duplication of costs and over- or under-stocking affecting holding costs or rates of sales.
Operational In-store health and safety The Group’s large warehouse format means that large and sometimes heavy quantities of inventory are moved, stored and stacked – sometimes at great heights – in our stores. Despite compliance with all relevant legislation, there remains the risk of injury or death to customers or employees should bulky items collapse, with the associated significant reputational risk.
Operational Reliance on IT systems With millions of transactions daily, the Group is dependent upon reliable, secure, effective and efficient IT systems, including the management and storage of data and information. Major IT implementations or initiatives can distract management, be costly, destabilise other IT platforms and the business, and/or perform sub-optimally post-implementation. The Group may overly rely on one or more service providers. Reliable connectivity with key transactional intermediaries including banks is critical. Finally, at a strategic level, there exists the potential for misalignment between business strategy and IT capability, which can result in reduced operational effectiveness.
Geo-political/ Economic Complexity of the Group’s African operations This refers to the multiple levels of risk, and the associated complexity, of doing business in 14 countries across Africa, each with different regulatory, fiscal and customs environments. Political risk can become an issue. African currencies can be illiquid, making them vulnerable to any withdrawal of hard currencies. Bureaucracy and/or currency illiquidity can delay cash repatriations.
Competitive Competitor attack on our major merchandise categories This refers to the potential adverse impact of a sustained attack by a major competitor (local or international) on one or more of the Group’s major merchandise categories or formats.

OPERATIONAL RISK

Probability Potential impact Risk mitigation
Financial impact All Divisions work closely with external risk assessors, insurance brokers and our major insurers in order to ensure that our stores and regional distribution centres have the highest possible level of fire detection and prevention.
     
  Business impact
Financial impact Massdiscounters, Makro and Builders Warehouse have implemented IT software to automate the forecasting and replenishment (F&R) of inventory. Massdiscounters has about 65% of their sales by value being automatically replenished. This is about 70% in Builders Warehouse and 15% in Makro.

Massdiscounters now operates two substantial RDCs in Cape Town and Johannesburg, respectively. These have been very effective in addressing supply chain concerns and have improved inventory shrinkage levels and in-stock service levels in the stores.
 
     
  Business impact
     
     
     
Financial impact Risk officers in each Division are responsible for monitoring and improving compliance. There is a high executive awareness level. There has been formal communication with suppliers and logistics providers around specified stacking protocols. We continually use Massmart Internal Audit and third party service providers to review in-store health and safety procedures. Warning signs in higher risk areas are on display.
 
     
  Business impact
Financial impact All the Group’s IT development, hardware and software, must be specifically approved and then monitored by the Group’s Technology, Information and Processes Forum (TIP), representing all the Divisions’ 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.
 
     
  Business impact
     
     
     
Financial impact Careful pre-selection of countries for new stores, with a thorough evaluation of customs, tax, exchange control and business legislation. Regular repatriation of cash.

Although there is a natural economic hedge in place with our South African operation supplying the African store, for accounting purposes IFRS has broken this hedge, resulting in increased volatility of reported foreign currency movements. Dedicated executives across several functions monitor and manage the African operations.

Develop relationships with key government and regulatory authorities in those countries.
 
     
  Business impact
     
     
     
     
     
     
     
Financial impact Maintain a relevant and competitive product offering that offers affordable value to our customers. Invest in brand awareness and loyalty.

Manage low-cost efficient operations.

Ensure suppliers believe that our stores and associated supply chain offer an ideal route to market.

Optimise our store locations, and ensure regular store refurbishments and format renewal.
 
     
  Business impact
     
     
     
     

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