Some risks may be due to events in the outside world and affect a certain sector or market, while others are associated with the group’s own business.
The H&M group 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 procedures, 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 mitigating the consequences.
There are risks and uncertainties affecting the H&M group that are related to the shift in the industry, fashion, weather conditions, macroeconomics and geopolitical events, 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. A description of the H&M group’s operational and financial risks is given in the section operational risk, with more detailed information concerning financial risks being given in the annual report 2020, note 2, Financial risks.
The H&M group’s approach to risk management and internal control is described in more detail on pages 21–33 of the corporate governance report. The description includes how the H&M group works according to the COSO framework, which is issued by the Committee of Sponsoring Organizations of the Treadway Commission and has five components: Control Environment, Risk Assessment, Control Activities, Information and Communication, as well as Monitoring Activities.
Major shift in the industry further accelerated by the Covid-19 pandemic
For a number of years society has been influenced by the growing digitalisation that has rapidly changed consumers’ shopping habits. More and more purchases are being made online – and mainly from mobiles, which have become an important part of the shopping experience. Customers are looking for a smooth, simple and inspiring experience in which stores and online interact and enhance each other, and in recent years the H&M group has therefore made substantial investments to provide this. The industry’s shift to being increasingly digital was accelerated further in 2020 when the Covid-19 pandemic made even more customers start shopping online because a large proportion of physical retail stores were temporarily closed to reduce the spread of infection. During the pandemic awareness of the importance of sustainable development was furthered reinforced among consumers and as a result there is increased focus on sustainable solutions among companies in the industry, with the H&M group at the forefront. As the competitive landscape is redrawn by new business models and players, profitability in the industry has been squeezed by increased competition. In 2020 the pandemic put a further significant squeeze on profitability and brought great challenges for the whole industry.
It is important to learn the lessons of the Covid-19 pandemic and going forward there is the risk of not just future pandemics but also other unpredictable and unexpected adverse events. For the H&M group this means having good risk mitigation plans and crisis management capacity by being adaptable, flexible and able to act.
As one of the world’s leading fashion companies the H&M group’s brands attract great interest and are constantly in the spotlight. To safeguard and manage its 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 ambitions set out in its policies and guidelines on business ethics and has good knowledge, insight and procedures in respect of the production of its products. It is also of the utmost importance that the H&M group lives up to the high ambitions that it has set itself in the area of sustainability. Should the H&M group fail in these respects, there is a risk that the group’s reputation and brands could be damaged. Accurate, transparent and reliable communication can prevent occurrences of reputational risk, and can also help mitigate 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 sufficiently commercial, i.e. will not be well received by customers. Purchasing decisions are also increasingly influenced by customers’ desire to live more sustainably.
Within each concept it is crucial to have the right volumes and a correct 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 H&M group works intensively to optimise the extent of ongoing buying during the season in parallel with detailed analysis of day-to-day sales and stock levels in different markets. Today fashion is global, but shopping patterns vary between different markets and sales channels. The start of a season and the season vary from country to country. Delivery dates and product volumes for the various markets and channels are therefore adjusted accordingly. During the year the organisation was also adapted to enhance the capability to create even more relevant customer offerings regionally and locally. An increasing degree of accuracy will also help reduce overall resource consumption and create a more sustainable business model.
The H&M group’s products are purchased for sale based on assumptions concerning weather patterns. Deviation from these assumptions affects sales. This is particularly true at the transition between two seasons, such as the transition from summer to autumn or from autumn to winter. 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. The climate risk analysis that the company has carried out according to guidelines issued by the Task Force on Climate-related Financial Disclosures (TCFD) has shown that climate change may have further effects on the conditions for producing and distributing products in certain regions and countries (see also page 50). The increasingly clear effects of climate change mean that these variations are likely to increase in the future.
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, e.g. virus outbreaks in one or more countries and in the worst case a pandemic, may result in rapid changes in the business environment, such as significant disruption in the supply chain, 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 the following section), 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 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.
The H&M group has a highly ambitious sustainability strategy which aims to lead the change towards a more sustainable fashion industry, with both new business opportunities and risks. Some of the main risks identified by the company include shortage of natural resources, climate change and its impact, failure to uphold human rights early in the value chain, corruption, political and social instability in production and sourcing markets and changed consumption patterns and customer attitudes. This last factor could ultimately have major effects on the H&M group’s sales – both positive and negative. The outcome depends on how successful the company is in its work to implement the sustainability strategy and the H&M group’s ability to develop an even more sustainable customer offering and a sustainable business model.
For a more detailed description of risks related to sustainability see the sustainability report on pages 45–53, and particularly pages 49–50 for the climate risk analysis according to TCFD.
There is great confidence in the H&M group’s ability to create relevant fashion and relevant customer experiences to suit the year’s seasonal shifts in both the northern and southern hemispheres.
The H&M group is modifying its organisation and ways of working in all channels with the aim of having both the capability and the capacity to adapt to customers’ needs and expectations faster than its competitors.
Information security and cybersecurity
All companies that trade online are exposed to various types of risk related to information technology. The risks to which the H&M group is exposed in this area are general. These are hacking attempts on networks, disruption of system stability, and attempts to access customer accounts or login details from employees by means of phishing. The H&M group manages this type of risk continually. Continual adjustments and improvements are made in respect of the organisation, systems, procedures and subcontractors with a view to dealing with security risks in the best way possible.
Data protection and GDPR
The H&M group works actively to protect data and privacy. Managing customers’ and employees’ data in a lawful and confidence-inspiring way has a high priority.
A central team provides central support and guidance on data protection issues, and each country has coordinators tasked with ensuring that the framework established by the central organisation is implemented. Data protection risks identified during this work are compiled quarterly.
Nearly half of the group’s sales are made in euros, while the most significant currencies for the group’s purchasing are the US dollar and the euro. Fluctuation in the US dollar’s exchange rate against the euro is the single largest foreign currency transaction exposure for the group. Large and rapid exchange rate fluctuations, particularly as regards the US dollar 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 companies H & M Finance AB and 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. For more information on currency hedging see note 2, Financial risks.
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. In the event of a major trade war between two countries this would affect not just sourcing costs but generally also the entire flow of goods from production to the customer, which the companies would need to mitigate.
Customs issues: Related party customs valuation continues to attract attention at a global, regional (EU) and national level, from both authorities and importers such as the H&M group. It will therefore continue to be important for the H&M group to proactively monitor and manage future developments in this area. One challenge is that customs authorities around the world are not taking a consistent approach to the assessment of pricing between related parties, despite the fact that the basis for customs duties is established according to the same global (WTO) customs valuation rules.
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, the H&M group closely monitors developments in the field of tax. The H&M group 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 VA T on the clothes sold to consumers.
The H&M group complies with national and international tax legislation, and always pays taxes and levies in accordance with local laws and regulations in the countries where the H&M group operates. The H&M group’s tax policy, which can be found at hmgroup.com, reflects and supports H&M’s business. The H&M group follows the OECD Transfer Pricing Guidelines, which means that profits are allocated and taxed where the value is created.
The H&M group 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 the H&M group’s transfer pricing model even though the model complies with the OECD guidelines. On 18 December 2020 the OECD published its Guidance on the transfer pricing implications of the COVID-19 pandemic, which represents the consensus view of the 137 members of the Inclusive Framework on Base Erosion and Profit Shifting (BEPS) regarding application of the arm’s length principle and OECD Transfer Pricing Guidelines to the situations and challenges associated with the Covid-19 pandemic.
The unique economic circumstances arising from the Covid-19 pandemic, and the associated measures taken by governments, have caused difficulties with the practical application of the arm’s length principle. This may mean a risk of tax disputes in the group in the event that the H&M group and the local tax authorities interpret either the general guidelines or the specific Covid-19 guidelines differently.