Risk Management System
The purpose of the Bertelsmann risk management system (RMS) is the early identification and evaluation of, as well as response to, internal and external risks. The internal control system (ICS), an integral component of the RMS, monitors the effectiveness of the risk response measures that have been implemented. The aim of the RMS is to identify, at an early stage, material risks to the Group so that risk response measures can be taken and controls implemented. Risks are possible future developments or events that could result in a negative deviation from outlook or objective for Bertelsmann. In addition, risks can negatively affect the achievement of the Group’s strategic, operational, reporting and compliance-related objectives.
The risk management process is based on the internationally accepted frameworks of the Committee of Sponsoring Organizations of the Treadway Commission (COSO Enterprise Risk Management-Integrated Framework and Internal Control-Integrated Framework, respectively) and is organized in subprocesses of identification, assessment, management, control and monitoring. A major element of risk identification is a risk inventory that lists significant risks year by year, from the profit-center level upward, and then aggregates them step by step at the division and Group levels. This ensures that risks are registered where their impact would be felt. There is also a Group-wide reassessment of critical risks every six months and quarterly reporting if no risk event occurred. Ad hoc reporting requirements ensure that significant changes in the risk situation during the course of the year are brought to the attention of the Executive Board. The risks are compared against risk response and control measures to determine the so-called net risk. Both one-year and three-year risk assessment horizons are applied to enable the timely implementation of risk response measures. The basis for determining the main Group risks is the three-year period, similar to medium-term corporate planning. Risk assessment is the product of the estimated negative impact on the free cash flow should the risk occur and the estimated probability of occurrence. Risk monitoring is conducted by Group management on an ongoing basis. The RMS, along with its component ICS, is constantly undergoing further development and is integrated into ongoing reporting to the Bertelsmann Executive Board and Supervisory Board. Corporate and Divisional Risk Management Committee meetings are convened at regular intervals to ensure compliance with statutory and internal requirements.
The auditors inspect the risk early-warning system for its capacity to identify developments early on that could threaten the existence of Bertelsmann SE & Co. KGaA according to section 91 (2) of Germany’s Stock Corporation Act (AktG), then report their findings to the Supervisory Board. Corporate Audit conducts ongoing reviews of the adequacy and functional capability of the RMS in the Penguin Random House, Arvato and Be Printers divisions as well as the Corporate Investments and Corporate Center segments. The risk management systems of RTL Group and Gruner + Jahr are evaluated by the respective internal auditing departments of those divisions and by external auditors. Any issues that are identified are promptly remedied through appropriate measures. The Bertelsmann Executive Board defined the scope and focus of the RMS based on the specific circumstances of the company. However, even an appropriately designed and functional RMS cannot guarantee with absolute certainty that risks will be identified and controlled.
Accounting-Related Risk Management System and Internal Control System
The objectives of the accounting-related RMS and ICS are to ensure that external and internal accounting is proper and reliable in accordance with applicable laws and that information is made available without delay. Reporting should also present a true and fair view of Bertelsmann’s net assets, financial position and results of operation. The following statements pertain to the Group financial statements (including the “Notes to the Group Financial Statements” and “Combined Management Report” sections), interim reporting and internal management reporting.
The ICS for the accounting process consists of the following areas. The Group’s internal rules for accounting and the preparation of financial statements (e.g., IFRS manual, guidelines and circulars) are made available without delay to all employees involved in the accounting process. The Group financial statements are prepared in a reporting system that is uniform throughout the Group. Extensive automatic system controls ensure the consistency of the data in the financial statements. The system is subject to ongoing development through a documented change process. Systematized processes for coordinating intercompany transactions serve to prepare the corresponding consolidation steps. Circumstances that could lead to significant misinformation in the Group financial statements are monitored centrally by employees of Bertelsmann SE & Co. KGaA and by RTL Group (for the preconsolidated subgroup), then verified by external experts as required. Central contacts from Bertelsmann SE & Co. KGaA and the divisions are also in continuous contact with local subsidiaries to ensure IFRS-compliant accounting as well as compliance with reporting deadlines and obligations. These preventive measures are supplemented by specific controls in the form of analyses by the Corporate Financial Reporting department of Bertelsmann SE & Co. KGaA and RTL Group (for the preconsolidated subgroup). The purpose of such analyses is to identify any remaining inconsistencies. The Group- and division-level controlling departments are also integrated into the internal management reporting. Internal and external reporting are reconciled during the quarterly segment reconciliation process. The further aim in introducing a globally binding control framework for the decentralized accounting processes is to achieve a standardized ICS format at the level of the local accounting departments of all fully consolidated Group companies. The findings of the external auditors and Corporate Audit are promptly discussed with the affected companies and solutions are developed. An annual self-assessment is conducted to establish reporting on the quality of the ICS in the key Group companies. The findings are discussed in Audit and Finance Committee meetings at the divisional level.
Corporate Audit and the internal auditing departments of RTL Group and Gruner + Jahr evaluate the accounting-related processes as part of their auditing work. As part of the auditing process, the Group auditor also reports to the Audit and Finance Committee of the Bertelsmann SE & Co. KGaA Supervisory Board about any significant vulnerabilities of the accounting-related ICS that were identified during the audit and the findings regarding the risk early-warning system.
Major Risks to the Group
Bertelsmann is exposed to a variety of risks. The major risks to Bertelsmann identified in the risk reporting are listed in order of priority in the table below. In line with the level of possible financial loss, the risks are classified as endangering, considerable, significant, moderate or low for the purposes of risk tolerability. The risk inventory carried out did not identify any risks that would be classified as considerable or endangering.
Given the diversity of the businesses in which Bertelsmann is active and the corresponding diversity of risks to which the various divisions are exposed, the key strategic and operational risks to the Group identified below are broken down by business segment. Risks from acquisitions and information-technology risks were identified as the primary risks and are therefore described separately. This is followed by an outline of legal and regulatory risks and financial-market risks. These risks are largely managed at the corporate level.
Overview of Major Risks to the Group
|Priority||Type of risk||Low||Moderate||Significant||Considerable||Endangering|
|1||Pricing and discounting|
|4||Audience and market share|
|5||Changes in market environment|
|6||Cyclical development of economy|
|7||Integration risks, Penguin Random House|
|9||Legal and regulatory risks|
|10||Financial market risks|
|Risk classification (potential financial loss in three-year period): low: < €50 million, moderate: €50–100 million, significant: €100–250 million,
considerable: €250–500 million, endangering: > €500 million.
■ Existing risks
Strategic and Operational Risks
The global economy continued its moderate growth in 2014. In 2015, global growth should gradually accelerate. Although uncertainty over general economic developments has eased, Bertelsmann’s business development is still dogged by certain risks. Assuming the continuing normalization of the overall economic situation, Bertelsmann expects stable development of Group revenues for 2015. In addition to the risk associated with economic development, other significant Group risks include pricing and discounting risks, customer risks, supplier relationship risks and any loss of audience and market share as well as risks from changes in the market environment. How these risks develop depends, among other things, to a large extent on changes in customer behavior due to factors such as the digitization of media, the development and implementation of products and services by current and future competitors, bad debt losses as well as default and interference along the production chains in individual sectors, such as IT. The integration risks associated with the Penguin Random House merger and employee-related risks are moderate risks for Bertelsmann.
For RTL Group, the ongoing digitization presents the risk of an increasing fragmentation of the markets as audiences will have more choice (for example through online platforms) and at the same time the market entry barriers are reduced. The possible consequences of this are decreasing audience and advertising market shares and therefore, ultimately, lower revenues. RTL Group is countering the risk, in particular by continuously revising and developing the channels and program strategies, for example, by establishing complementary families of channels and constantly adapting these to international program trends. Increasing competition in the area of program acquisition and TV production with the risk of potential cost increases could also impact RTL Group’s ability to generate revenues. To reduce this risk, long-term contracts are signed with major content providers and the program share of own productions is being expanded. Furthermore, economic development directly impacts the TV advertising markets and therefore RTL Group’s revenue. This risk is being countered by focusing on developing non-advertising revenue streams, e.g., distribution revenues from platform operators. To reduce the risk of customer losses, active customer relationship management is established.
The significant risk for Penguin Random House is the risk of increasing margin pressure due to falling e-book prices and changes in terms of sale. In order to address this risk Penguin Random House is negotiating intensively with its customers and is monitoring market price developments. Penguin Random House also faces bad-debt risks, which are minimized through careful management of account balances and mitigated by credit insurance coverage. Aside from this, the merger of the two companies remains a major risk, in particular the process of integrating the companies’ IT systems. Management has established work streams to deliver the integration plans and is closely monitoring progress through an integration management office. On the physical side of the business, the overall trend toward greater digital sales could threaten the long-term viability of certain customers, thus leading to decreased store sales, and will likely result in continued margin pressure. The risk minimization strategy for this includes continuous monitoring of customer relationships, increased e-book sales and online sales of physical books, as well as commercial efforts to improve market share. Finally, Penguin Random House continues to be subject to pricing demands from its suppliers and to the risk of a general economic downturn. Management controls these risks through careful management of supplier relationships and by maintaining a flexible cost structure that allows for a quick response in the event of an economic downturn.
For Gruner + Jahr, the risk of a deterioration of the overall market environment and resulting declines in advertising and circulation revenues represents the greatest risk. This is compounded by a changing market environment in which price pressure and declining revenues as a result of further concentration in the agency market and aggressive advertising conditions on the part of competitors cannot be ruled out. The risk remains that the growing importance of digital advertising options will lead to declining margins. Besides the risk of losing key customers, such as advertising customers switching to other media, there is the risk of rising costs on the supplier side. The risks are being countered by active cost and customer management, the development of new forms of offerings and price and quality improvements. Advertising restrictions discussed at the EU level (e.g., car advertising) could lead to declining advertising revenues.
Arvato sees itself as particularly exposed to risks from customer and supplier relationships as well as risks from a changing market environment. The establishment of a matrix organization focusing on Solution Groups as well as central key account management is helping to target customers effectively. The potential loss of key customers is also being countered through long-term contracts offering comprehensive service packages with simultaneously flexible cost structures as well as through integrated service elements. On the supplier side, key risks include the quality of goods and services purchased as well as the procurement costs if the increase can not be passed on to the customers. As a result of a simultaneous increase in dependency on a few suppliers, margin pressure is increasing in a number of segments. Countermeasures include entering into long-term contracts, an active exchange with existing suppliers and monitoring the supplier market. Competition is intensifying because competitors are expanding their value chains and are thus following Arvato’s strategy. In addition, new competitors entering the market could intensify the competitive pressure and lead to lower margins. By constantly developing the range of services, the aim is to improve the competitive position and to increase customer loyalty through integrated solutions together with a trend toward higher value added. A worsening of the economic environment could result in declining revenues and thus lower margins, which would necessitate cost-cutting measures and capacity downsizing. Broad diversification across customers, sectors and regions helps to reduce this risk. The ongoing trend toward digitization entails further risks for individual customer segments of Arvato, particularly in manufacturing and distribution of physical media products. These risks are being addressed, for example, by developing business priorities, which comprise digital services. Furthermore, business segments that offer no strategic or economic prospects are being deliberately scaled back.
For Be Printers, customer risks, in particular greater dependence on a few major customers in structural terms, remain the most significant risks. This is being countered, in particular, by entering into more flexible customer contracts as well as taking out credit insurance and ensuring active debtor management. Furthermore, deterioration in the economic environment also may lead to declining circulations with a negative impact on earnings. In addition, price and margin pressure result from a market environment which is characterized by overcapacity as well as existing trends toward consolidation. There are further risks on the supplier side associated with rising raw-material prices – particularly for paper – that cannot be passed on to customers. These risk minimization strategies are based, in particular, on constantly optimizing cost structures and making them more flexible, the use of price-adjustment clauses and ongoing market monitoring.
Corporate Investments is comprised of the fund activities and strategic-growth segments of music rights and education as well as the Group’s remaining club and direct-marketing businesses. From a Group perspective, the identified risks are of minor importance.
Finally, it should be noted that because of demographic change, risk reporting is placing a greater emphasis on employee-related risks. These include, for example, a shift in the age distribution of the workforce, challenges in recruiting qualified personnel and the departure of top executives. This risk applies to all divisions. Countermeasures include further training measures and health programs, more extensive recruiting measures and interdivisional talent development.
As well as organic growth, the Group’s development strategy includes targeted acquisitions of promising businesses. Acquisitions completed in 2014 present opportunities as well as risks. The choice of the right investment projects and the allocation of investment funds already involve risks, which are taken into account by strict investment criteria. Integration into the Group requires one-time costs that are usually offset by increased benefits in the long-term thanks to synergy effects. In this context, there are risks in that the integration costs may be higher than expected or the predicted level of synergies may not materialize. The integration processes are therefore being permanently monitored by management.
Information Technology Risks
For a global media company like Bertelsmann, the reliability and security of information technology is crucial and can often give the company a competitive edge. The ability to provide and process information in a timely, comprehensive, error-free and confidential way is crucial to Bertelsmann’s success. Challenges arise, on the one hand, from the many non-standardized internal processes as well as from external potential risks such as cyber-attacks, which have dramatically increased in the market and competitive environment. The widespread use of cloud-based IT solutions and the significant growth of mobile solutions present further challenges. In 2014, Bertelsmann responded to the stricter regulatory conditions by introducing an information security management system (ISMS, based on industry standard ISO 27001) across the Group. The management system includes regular and structured monitoring of compliance with the regulations as well as systematic recording of information security risks and deriving appropriate measures.
Legal and Regulatory Risks
Bertelsmann, with its worldwide operations, is always exposed to a variety of legal and regulatory risks ranging from litigation to varying interpretations of tax-assessment criteria. These risks are being continuously monitored by the relevant departments within the Group.
In November 2008, RTL II filed legal actions against IP Deutschland, a wholly owned subsidiary of RTL Group, and Seven One Media (“SOM”) as a result of the 2007 proceedings of the German Federal Cartel Office against the discount scheme agreements (“share deals”) offered by IP Deutschland and SOM. RTL II’s claim is currently limited to access to information, on the basis of which the claimants want to prove that they suffered damages from these discount schemes. The court of first instance in Düsseldorf decided to order an expert report.
Foreign investments in media companies in the People’s Republic of China are subject to restrictions. In order to comply with local legal provisions, some of the Bertelsmann participations in China are held by trustees. Bertelsmann has agreements with these trustees with respect to the securing of Bertelsmann’s rights. This type of structure is common for investments in China and has been tolerated by the Chinese authorities for many years. However, a basic risk exists that it will not be possible to safeguard such structures through Chinese courts if the People’s Republic should change its policies toward foreign investment and, for example, no longer recognize offshore investments in general or in the media area in particular. In addition, it cannot be ruled out that Chinese authorities or courts in the future will interpret existing provisions differently from the previous practice. In the event that legal violations can be proven, in an extreme case, Bertelsmann could be exposed to considerable fines and the revocation of business licenses, leading to immediate closure of participations in China. This would affect Arvato and Gruner + Jahr as well as Bertelsmann Asia Investments (BAI). In the past, however, such extreme measures by the Chinese authorities have only been reported in exceptional cases.
Aside from the matters outlined above, no further significant legal and regulatory risks to Bertelsmann are apparent at this time.
Financial Market Risks
As an international corporation, Bertelsmann is exposed to various forms of financial market risk, especially interest-rate and currency risks. These risks are largely controlled centrally on the basis of guidelines established by the Executive Board. Derivative financial instruments are used solely for hedging purposes. Bertelsmann uses currency derivatives mainly to hedge recorded and future transactions involving foreign currency risk. Some firm commitments denominated in foreign currency are partially hedged when they are made, with the hedged amount increasing over time. A number of subsidiaries are based outside the euro zone. The resulting translation risk is managed based on economic debt in relation to operating EBITDA (leverage factor). Bertelsmann’s long-term focus is on the maximum leverage factor permitted for the Group. Foreign-currency translation risks arising from net investments in foreign entities are not hedged. Interest-rate derivatives are used centrally for the balanced management of interest-rate risk. The cash-flow risk from interest-rate changes is centrally monitored and controlled as part of interest-rate management. The aim is to achieve a balanced ratio of different fixed interest rates by selecting appropriate maturity periods for the originated financial assets and liabilities affecting liquidity and through the ongoing use of interest-rate derivatives. The liquidity risk is regularly monitored on the basis of the planning calculation. The existing syndicated loan, as well as appropriate liquidity provisions, form a sufficient risk buffer for unplanned payments. Counterparty risks exist in the Group in invested cash and cash equivalents and in the default of a counterparty in derivatives transactions. Financial transactions and financial instruments are restricted to a rigidly defined group of banks with an excellent credit rating. Existing risks from investing cash and cash equivalents are continuously monitored. Financial investments are generally made on a short-term basis so that the investment volume can be reduced if the credit rating changes (see also further explanatory remarks on “Financial Risk Management” in section 25 of the notes).
The overall risk position is at the previous year’s level. The top ten Group risks have remained unchanged since the previous year, although the relevance of the individual risks has changed. While risks resulting from changes in the market environment are rated lower, the significance of pricing and discounting risks has increased. The continuing digital transformation of businesses is already largely anticipating technological changes, so that the risks connected with this are being increasingly reflected in other operating risks such as pricing and discounting risks. As a result of the diversification of Group businesses, there are no concentration risks stemming from dependency on individual business partners or products in either procurement or sales. The Group’s financial position is solid, with liquidity needs currently covered by existing liquidity and available credit facilities.
No risks endangering Bertelsmann’s continued existence were identified in financial year 2014, nor are any substantial risks discernible from the current perspective that could threaten the continued existence of the Group in the future.
Opportunity Management System
An efficient opportunity management system enables Bertelsmann to secure its corporate success in the long term and to exploit potential in an optimum way. Opportunities are possible future developments or events that could result in a positive deviation from outlook or objective for Bertelsmann. The opportunity management system, like the RMS, is an integral component of the business processes and company decisions. During the strategy and planning process, significant opportunities are determined each year from the profit center level upward, and then aggregated step by step at the division and Group levels. By systematically recording them on several reporting levels, opportunities that arise can be identified and exploited at an early stage. This also creates an interdivisional overview of Bertelsmann’s current opportunities. A review of major changes in opportunities is conducted at the divisional level every six months. In addition, the largely decentralized opportunity management system is coordinated by central departments in the Group in order to derive synergies through targeted cooperation in the individual divisions. The interdivisional experience transfer is reinforced by regular meetings of the Group Management Committee.
While the above-mentioned opportunities associated with positive development may be accompanied by corresponding risks, certain risks are entered into in order to be able to exploit potential opportunities. This link to the key Group risks offers strategic, operational, legal, regulatory and financial opportunities for Bertelsmann.
Strategic opportunities can be derived primarily from the Group’s four strategic priorities. Strengthening core businesses, driving forward the digital transformation, developing growth platforms and expanding in growth regions constitute the most important long-term growth opportunities for Bertelsmann (see the “Strategy” section). In particular, there are general opportunities for exploiting synergies as a result of the portfolio expansions. There are individual operational opportunities in addition to the possibility of more favorable economic development and the potential for efficiency improvements.
For RTL Group, a better-than-expected development of the TV advertising market as well as increasing audience and advertising market shares are major opportunities. Furthermore, the rapidly changing digital environment is opening up opportunities as the media landscape fragments. High-quality content can be distributed across multiple platforms nationally and internationally. New revenue streams could be generated by exploiting the existing TV content across multiple platforms and by creating native digital content. With the expansions of its presence in the digital space, RTL Group could increase online video advertising sales on all screens and TV platforms and establish pay models in the on-demand business. In this context new advertising sales could emerge through the offering of new interactive forms of advertising parallel to linear TV use and a more effective targeted advertising in the digital environment. As an established content producer with a global presence, RTL Group could further expand its digital distribution through multichannel networks and digital streaming platforms.
The combination of Penguin and Random House has enhanced the publishing opportunities for Penguin Random House overall. With a significantly larger market share, the publishing group could further increase its leading market position, attract exceptional writing talent and publish more bestselling debut publications. As the world’s largest trade book publisher, Penguin Random House also has opportunities to invest more heavily than its competitors. Especially in emerging and multilingual markets, the group could take advantage of a growing demand and offer products to the widest possible readership. The increasing digitization of the book markets offers opportunities for new product development and more efficient marketing channels. The development of new products and enhancements to existing offerings could make books more appealing for a wider audience. Moreover, building networks and tools for authors could support them to better connect with their readers.
For Gruner + Jahr, a better development of the advertising and sales markets represents significant opportunities. The initiated transformation from a magazine to a house of content is providing further opportunities. The new structure of G+J Germany integrates the printing and digital businesses, allowing it to implement product innovations faster and more efficiently. As well as expanding and developing the existing media brands, there are opportunities for growth, particularly in the development and expansion of digital activities. The development of digital formats such as websites, e-mags and apps are additional sources of revenue for Gruner + Jahr. There are also opportunities for generating other additional services, such as commerce and paid services, within the context of content offerings. In terms of marketing, G+J could gain new customers by designing customized forms of advertising in the online, mobile and video media channels. Developing new special advertising formats and implementing integrated campaigns could also help to attract potential new customers.
Arvato’s new organizational structure in the form of a matrix enables it to exploit growth potential more effectively. A clear division into Solution Groups while taking into account the regional dimension, together with the introduction of a central key account management system, will increase Arvato’s flexibility, innovative power, international presence and local expertise in the future. This will enable it to respond quickly and flexibly to customer requirements and market trends. There are potential business opportunities, primarily in the financial solutions and e-commerce business segments and in the growth markets, particularly China. The global e-commerce market will continue its dynamic growth over the next few years as a result of ongoing digitization. Arvato could participate significantly in this growth, primarily through the services offered by the SCM and Financial Solutions Solution Groups. A further growth opportunity from the digital transformation lies in providing support to customers with CRM solutions via multiple interaction channels throughout the consumer lifecycle. Establishing global Solution Groups can provide additional opportunities for acquiring new customers, particularly key international customers.
The Be Printers print businesses may decline less steeply through additional volumes of existing and new customers. This would provide opportunities from the targeted servicing of market segments that are still growing. Moreover, the prospect of further consolidation of the printing market could effectively strengthen Be Printers’ market position.
Within Corporate Investments, potential music-catalog takeovers and other artist signings offer growth opportunities for BMG. In the long term, Bertelsmann plans to establish the education business as a third pillar alongside media and services. Entering the e-learning, medical-education and education-services business segments will open up opportunities in markets growing rapidly over the long term. The takeover of the US online education provider Relias Learning in 2014 offers additional organic growth potential through the expansion of the business activity to related market segments. For fund activities, there is also the opportunity to realize higher-than-expected profits thanks to increasing market valuations. In the club and direct-marketing businesses, lower restructuring costs could boost business performance.
The current innovation efforts detailed in the “Innovations” section offer further potential opportunities for the individual divisions.
Other opportunities could arise from changes to the legal and regulatory environment.
The financial opportunities are largely based on a favorable development of interest and exchange rates from Bertelsmann’s point of view.