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© Rolls-Royce plc 2008 Legal Information
Business review: Principal risks and uncertainties
The Group continues to be exposed to a number of risks and has an established, structured approach to identifying, assessing and managing those risks. The risk committee has accountability for the system of risk management and regularly reports to the Board on the key risks facing the business and the mitigating actions the Group has put in place to deal with them. The Group has a consistent strategy and long performance cycles and consequently the risks faced by the Group have not changed significantly over the past year.
The principal risks reflect the global growth of the business, and the competitive and challenging business environment in which it operates. Risks are considered under four broad headings:
Business environment risks
Environmental impact of products and operations
The Group recognises that its activities have an impact on the environment and the approach taken is to be part of the solution to resolving the challenges faced by climate change.
A high priority is given to responding to the challenge of reducing the environmental impact of the Group's products and business activities. It is recognised that the solutions are not straightforward and that novel developments represent both significant threats and opportunities.
Our Environment Report was published in 2007 and shared with key stakeholders. This details our global strategy to address the risks and reports on the approach to working towards achieving challenging performance improvement targets for noise and carbon dioxide emissions by 2020. Technology acquisition programmes for more fuel-efficient products form a major part of the management of these risks.
External events which might affect demand for air travel or cause the business to be disrupted
Civil aerospace is an important contributor to Group revenues and profits. The willingness of passengers to travel by air is influenced by a range of factors, including economic, health and security issues. Exposure to this risk is mitigated by the Group's business strategy, which has enabled it to develop a broader, global business base, with the defence, marine and energy businesses being less susceptible to this type of risk. In addition, the civil aerospace business model, with its emphasis on increasing aftermarket services revenues, continues to be resilient, providing a high degree of protection against any shortfall in demand. The Group's ability to respond rapidly to changes in demand through the adjustment of its cost base is a key mitigation.
Disruption to the Group's business operations and the ability to respond to and recover from disruption for example, from an outbreak of pandemic flu, is recognised as a key element of, and risk to, both financial performance and the Company's reputation. The Group's operations strategy aims to deliver world-class manufacturing capabilities with an increasing global footprint, providing flexibility and ability to respond to disruption. A Group Crisis Management framework and plan is in place as part of the wider business continuity and risk management activities.
Strategic risks
Aftermarket
The Group's business model is balanced between original equipment delivery and aftermarket services. The growth in product sales has provided a larger base from which to generate aftermarket revenues. These continue to contribute over half of annual sales and are an essential element of the returns the Group expects to make from its investments. The ability to deliver the operational service to the satisfaction of its customers while managing the costs of the service, will determine the Group's profitability. The Group is focused on working in partnership with all of its global customers and driving improvement through the supply chain to provide a high standard of service to all its customers. The Group has made investments in service delivery capabilities and works closely with its customers to better understand their requirements, with a continued focus on standardisation and processes to manage cost.
Competitive pressures
The markets in which Rolls-Royce operates are highly competitive. The majority of its programmes are long term in nature and access to key platforms is critical to the success of the business. This requires sustained investment in technology, capability and infrastructure, which presents a high barrier to entry. However, these factors alone do not protect the Group from competition, including pricing and technical advances made by competitors which could adversely affect the Group's results.
The Group has developed a balanced business portfolio and maintained a steady improvement in operational performance. This, together with the establishment of long-term customer relationships and sustained investment in technology acquisition, allows the Group to respond to competitive pressure.
Financial risks
These are risks that arise as a result of movements in financial markets. Principal risks are: movements in foreign currency exchange rates, interest rates, commodity prices and counterparty credit risk.
A description of these risks and details of the Group's risk mitigation actions in this area are provided in the Finance Director's review.
Operational risks
Performance of supply chain
A significant element of the Group's risk profile is the delivery performance of its supply chain. The Group manufactures approximately 30 per cent by value of its gas turbine products, the remainder being provided through external supply chains. Strong growth in order intake has been experienced and any failure of the supply chain would present a risk to the delivery of products to meet customer requirements and achieve financial goals. The Group's supply chain strategy is to seek opportunities to simplify and globalise the external supply chain by forging deeper, strategic relationships with fewer but stronger global suppliers, working together on design and manufacture.
The Group is close to completing the modernisation of its production facilities, which will improve productivity and reduce costs. Investment in developing world-class manufacturing processes continues in Asia, North America and the UK. In addition, the Group has an established global business continuity programme, to manage the risk of a loss of a major capability or facility.
IT security
Continuing globalisation of the business and advances in technology have resulted in more data being transmitted across global communication links, posing an increased security risk. Security systems operate with the latest technology and Rolls-Royce maintains effective communications with other industrial companies and the appropriate government agencies to share information on potential threats.
Ethics
The Group recognises the benefit that is derived from conducting business in an ethically and socially responsible manner. This approach extends from the supply of raw materials and components to the manufacture and delivery of end products and services. It applies to the provision of a safe and healthy place of work and investment in technologies to reduce the environmental impact of the Group's products and operations. A failure in any of these areas could damage the Group's reputation and disrupt its business.
The Group is committed to embedding high ethical standards and a new Global Code of Business Ethics was issued to all employees during 2007. A training and engagement programme for employees will be completed during 2008 to strengthen employee awareness of the Group's values. The Group communicates its standards to its first-tier supply base through a supplier code of conduct.
Programme risk
The Group manages complex product programmes with demanding technical requirements against stringent customer schedules. This requires the co-ordination of the external supply chain, manufacturing operations, partners and engineering functions. Failure to achieve programme goals would have significant financial implications for the Group.
The Group employs project management controls on a routine basis. All major programmes are subject to Board approval and are regularly reviewed by the Board with a particular focus on any emerging risks.