Risk management
Managing risks is explicitly on the agenda of the management in order to protect the business from the effects of disasters, failures and reputational damage. Continuity and sustainability of the business is as important to stakeholders as growing and operating it.
Risk management and control system
The Heineken risk management and control systems are aimed at a reasonable level of assurance, that the risks of the Company are identified and managed and that the operational and financial objectives are met, in compliance with applicable laws and regulations. A system of controls to ensure adequate financial reporting is included. Heineken’s internal control system is based on the COSO Internal Control Framework.
Risk profile
Heineken is a single-product company, with a high level of commonality in its worldwide business operations spread over many mature and emerging markets. The worldwide activities are exposed to varying degrees of risk and uncertainty, some of which, if not identified and managed, may result in a material impact on a particular operating company, but may not materially affect the group as a whole.
Risk management
Doing business inherently involves taking risks, and by managing these risks Heineken strives to be a sustainable and performance driven company. Business risk assessments are part of Heineken’s business planning and performance monitoring process, which was further structured in 2006. Operational risks are mainly managed through the progressing embedding of Key Controls based on Heineken common processes and systems. The risk management and control systems are considered to be in balance with Heineken’s risk profile, although such systems can never provide absolute assurance. Following Heineken’s continuing growth and changing risk profile, the Company’s risk management and control systems are subject to continuous review and adaptations.
Responsibilities
The Executive Board, under the supervision of the Supervisory Board, has overall responsibility for Heineken’s risk management and control systems. Regional and operating company management are responsible for managing performance, underlying risks and effectiveness of operations, within the Rules set by the Executive Board, supported and supervised by group departments.
Heineken Company Rules
In 2006, the Heineken Company Rules on the various functional areas were reviewed and updated. Group departments further strengthened their monitoring activities.
Business planning and performance monitoring
The main pillar of Heineken’s internal governance activities is the business planning and performance monitoring process. Operating companies strategy, business plan and quarterly performance are discussed with Regional Management. Regional performance is discussed with the Executive Board. The approved business plans include clear objectives, performance indicators and target setting, which provide the basis for monitoring performance compared to plan. In 2006, the process of planning and reporting were further streamlined and aligned to the regional management structure introduced in 2005.
Internal control in operating companies
Heineken is progressing on the group-wide development and implementation of uniform processes, common IT systems and control frameworks based on best practices. At the end of 2006, 71 per cent of Heineken’s operations (based on revenue) work in accordance with the evolving Heineken common system. In developing and implementing common systems, risk assessments were included and controls established or adjusted. These internal controls ensure the integrity of the information processing in supporting the day-to-day transactions and financial and management reporting. In 2006, further progress was made on establishing and using Heineken best practice Key Control Frameworks for testing and further improving controls in the operations.
Code of Business Conduct and Whistleblowing
After the introduction of the Code of Business Conduct and Whistleblowing Procedure two years ago, almost the whole group has implemented their local policies and procedures at the end of 2006. The whistleblowing implementation is to be finalised in 2007. The Corporate office is closely monitoring the implementation and effectiveness. The Integrity Committee oversees the functioning of whistleblowing and issued two reports to the Executive Board and the Audit Committee in the year under review on effectiveness of the procedure and reported cases.
Supervision
The Executive Board oversees the adequacy and functioning of the entire system of risk management and internal control, assisted by Group departments. Group Internal Audit provides independent assurance on the entire risk management and internal control system.
The Assurance Meetings at operating company and regional level, oversee the adequacy and operating effectiveness of the risk management and internal control system. Regional Management and Group Internal Audit participate in these meetings to ensure effective dialogue and transparency.
The outcome and effectiveness of the risk management and internal control systems have been discussed with the Audit Committee of the Supervisory Board.
Financial reporting
The risk management and control system over financial reporting contains clear accounting rules and a standard chart of accounts. The Heineken common systems, as implemented in almost the entire group in terms of turnover, support common accounting and regular financial reporting in standard forms.
The worldwide external audit activities – which are based on local statutory requirements, and therefore more detailed than necessary for the audit of the Heineken N.V. consolidated figures – provide additional assurance on fair presentation of financial reporting on operating company level. Within the parameters of their financial audit assignment, external auditors also report on internal control issues through their management letters and attend local and regional Assurance Meetings.
Considering Heineken’s risk management and control system described in this section, the financial reporting is adequately designed and worked effectively in the year under review in providing reasonable assurance that the 2006 financial statements do not contain any material inaccuracies. This statement cannot be construed as a statement in accordance with the requirements of Section 404 of the US Sarbanes-Oxley Act, which is not applicable to Heineken N.V.
Main risks
Under the explicit understanding that this is not an exhaustive list, Heineken’s major strategic, operational, financial and regulatory risks are described below, including the risk mitigation measures in place or planned enhancements.
Strategic risks
Heineken brand perception and Company reputation
As both the group and its most valuable brand carry the same name, reputation management is of utmost importance. Heineken enjoys a positive corporate reputation and our operating companies are well respected in their region. Constant management attention is directed towards enhancing Heineken’s social, environmental and financial reputation. The Heineken brand is key to Heineken’s growth strategy and is the most valuable asset of the Company. Anything that adversely affects consumer and stakeholder confidence in the Heineken brand or Company could have a negative impact on the overall business.
The Company reputation and sales could be damaged by product integrity issues. Therefore, production and logistics are subject to rigorous quality standards and monitoring procedures, which are further strengthened in 2006. Brand perception is managed by strict marketing control procedures. A Code of Business Conduct and Whistleblowing Procedure aim to prevent any unethical and irresponsible behaviour by the Company or its employees. Reference is made to Heineken’s Sustainability Report 2006 for reviewing Heineken’s priorities in the area of social responsibility supporting Company reputation.
Pressure on alcohol
An increasingly negative perception in society towards alcohol could prompt legislators to introduce restrictive measures. Limitations in advertising and availability could lead to a decrease in sales and damage the industry in general. Sales of Heineken products could materially decrease.
Heineken’s Alcohol Policy is based on the principle to produce, market, and sell beer in ways that have a positive impact on society at large. With this policy, Heineken promotes awareness of the advantages and disadvantages of alcohol, encouraging informed consumers to be accountable for their own actions. In 2006 the launching of the ‘Enjoy Heineken Responsibly’ programme (a responsibility message on back labels directing consumers to a dedicated website) in Heineken’s markets was finalised. Markets are becoming more and more engaged to promote responsible consumption, in partnership with third parties. The alcohol policy compliance monitoring was strengthened in 2006.
In 2006 the European Commission announced the creation of an EU Forum on alcohol, similar to their approach on obesity. The role of the industry has been acknowledged and developments around the issue are closely monitored.
Attractiveness of beer category under pressure
Heineken has many operations in mature – mainly Western European – beer markets where the attractiveness of the beer category is being challenged by other beverage categories. In }these markets, management focus is on product innovation, portfolio management and cost-effectiveness in order to secure market position and profitability. Since Heineken is acquiring new businesses in emerging markets, the relative dependency on profitability from mature markets will decline over time.
Stability Africa & Middle East Region
In the Africa & Middle East Region volume growth is driven by economic growth in Nigeria and the Middle East and continued stability and economic growth in Central Africa. Compared to previous years the Region is in most areas at peace, with some uncertainty coming up in Nigeria due to the elections in 2007. The situation in Lebanon remains fragile which could escalate further in the Middle East and could affect our operations in Egypt and the United Arab Emirates.
Operational risks
Reorganisations from Fit2Fight
Heineken’s Fit2Fight programme has the objective to reduce fixed costs versus 2005 by €200 million net of inflation by the end of 2008. Reorganisation projects that will save €450 million by the end of 2008 (after inflation) have been identified, mainly in supply chain, wholesale and support functions in Europe. There is risk that due to social unrest, the production quality and supply continuity are affected, negatively impacting financial performance and Company reputation.
The operating companies concerned will manage the reorganisation projects with care; the right speed, alignment with relevant industrial and external relations and consistent communication to employees. Contingency plans have been put in place. Total restructuring and other costs are estimated at €325 to 375 million before tax.
Acquisitions and business integration
In the pursuit of further expansion, Heineken seeks to strike a balance between organic and acquired growth within the limits of a conservative financing structure. In acquisitions, specifically in emerging markets, Heineken will be faced with different cultures, business principles and political, economic and social environments. This may affect corporate values, image and quality standards. It may also impact the realization of long-term business plans including synergy objectives, underlying the value of newly acquired companies.
In order to mitigate these risks, Heineken has further strengthened its business development and integration activities, which includes significant involvement from relevant group departments, operating companies and regional management in carrying out effective due diligence processes and preparing take charge and integration plans.
Business continuity
Business interruptions could affect sales and market shares. These are not considered a major risk due to the relative size and spread of operations. An exception is the supply of beer products from the Netherlands to the USA, one of Heineken’s most profitable markets. Contingency measures are in place, and Heineken’s group purchasing department manages long-term contracts with preferred suppliers in order to secure supply of critical raw and packaging materials. Monitoring business continuity risks was further structured in 2006, including on the launch of Heineken Premium Light in the USA.
IT security
Heineken’s worldwide operations rely increasingly on information systems.
Heineken has a strict IT security policy to ensure confidentiality, integrity and availability of information. Tools are used to support compliance with that policy and compliance monitoring is applied. A more structured IT auditing approach is implemented in 2006. Progressing centralisation of IT systems and infrastructure has a positive impact on ensuring IT security measures.
Financial risks
Currency risks
Heineken operates internationally and reports in Euros. Currency fluctuations, especially relating to the US Dollar, could materially affect overall Company results. Heineken has a clear policy on hedging transactional exchange risks, which postpones the impact on financial results. Translation exchange risks are not hedged. The sensitivity on the financial results with regard to currency risks are explained on page 107.
Capital availability and liquidity risks
There could be insufficient capital generated in order to finance the long-term growth.
Sufficient access to capital is ensured to finance long-term growth and to keep pace with the consolidation of the global beer market. Financing strategies are under continuous evaluation. Strong cost and cash management and strong controls over investment proposals are in place to ensure effective and efficient allocation of financial resources.
Regulatory risks
Tax
Heineken and its operating companies are subject to a variety of local excise and other tax regulations. The EU Council did not adopt the Commission proposal to adapt the minimum excise rate for beer with the rate of inflation. This adjustment would have lead to increases in some European markets. The developments surrounding this issue are continuously monitored.
In principle, Heineken’s sales prices are adjusted to reflect changes in the rate of excise duty, but increased rates may have a negative impact on sales volume.
Litigation
Due to increasing legislation there is an increased possibility of non-compliance. Additionally, more supervision by regulators and the growing claim culture may potentially increase the impact of non-compliance, both financially and on the reputation of the Company. Therefore, various Heineken Company Rules and monitoring measures are in place to enable compliance with laws and regulations. Every half year all majority- owned companies formally report outstanding claims and litigations against the Company in access of €1 million to Group Legal Affairs, including an assessment of the amounts to be provided for.
Heineken is defending itself against two main accusations: one from the European Commission on restricting competition in the Netherlands during the second half of the 1990s, and one on unlawfully advertising and marketing products to underage people in the USA. These two cases are further explained on page 111.
There may be current risks that the Company has not fully assessed, and are currently identified as not having a significant impact on the business but which could – in a later stage – develop a material impact on the Company’s business. The Company’s risk management systems are focused on timely discovery of such incidents.
