External risks

External Strategic – Top five risk

Worsening of economic conditions

One of the principal uncertainties continues to be the development of the global economy, which remains fragile, and it is difficult to predict customer demand and raw material costs. Chronic fiscal imbalances may further adversely impact the global, regional or national economies in markets where we operate. AkzoNobel is susceptible to decreased growth rates within high growth markets and/or continued economic and market downturn in mature markets. The effects lead to a decline of demand and deteriorating financial results, thereby not realizing our financial targets.

Risk corrective actions

As a key element of our strategy, we are committed to bringing down our operational cost base and reducing complexity. This will be done through introducing and implementing standardized core functional processes in each region across the organization, helping to reduce operational costs, as well as making the company more agile and competitive. We are also continuing with our performance improvement programs in the three Business Areas and began a structured program of commercial excellence to offset the effects of decreasing economic growth rates.

External Strategic – Top five risk

International operations

We are a global business with operations in more than 80 countries. We are therefore exposed to a variety of risks, many of them beyond our control. Unfavorable political, social or economic developments and developments in laws, regulations and standards could adversely affect our business and results of operations. Our aspirations to fuel growth in high growth markets will further expose us to these risks.

Risk corrective actions

We spread our activities geographically and serve many sectors to benefit from opportunities and reduce the risk of instability. Political, economic and legislative conditions are carefully monitored by responsible functions at corporate, Business Area and business unit level. The Executive Committee decides on all significant investments and the countries and industry segments in which AkzoNobel conducts its business. Country organizations are in place in order to mitigate country specific, but business generic risks.

External Operational

Energy pricing and emission trading rights

Our Specialty Chemicals business operates two energy-intensive businesses, Pulp and Performance Chemicals and Industrial Chemicals. The latter conducts its business primarily in Europe. A non-level playing field for energy on a global level (e.g. shale gas, national policies, subsidies) and emission trading rights can affect the competitive position of these businesses and the competitive position of our customers.

Risk corrective actions

We will continue to analyze and review our competitive positions and we are proactively managing energy usage and costs. We operate several cogeneration units which enable us to make efficient use of combined heat and power. We are implementing our Carbon Policy and are working on energy efficiency programs. In addition, we are driving to diversify our energy source portfolio to reduce the amount of gas-based heat, for example by investing in energy from waste and biomass. Carbon management plans are closely monitored and strategically managed. We have policies for energy contracts and have long-term purchase contracts in place (see Note 23 of the Financial statements).

External Operational

Product liability

Product liability claims could adversely affect our company’s business and results of operations. Unlikely long-term implications with a high impact for our organization could follow from the use of new technologies and compounds.

Risk corrective actions

Quality improvement programs are in place in our different Business Areas. Improving our management of change procedures in this area is a joint responsibility for the RD&I, Supply Chain, Marketing and Procurement functions. In addition, product stewardship has been incorporated into the company’s HSE and operational eco-efficiency agenda. Product stewardship is also integrated into product slate decisions in the Operational Excellence program. We also have a central policy to optimize insurance coverage which relates to specific insurance programs covering product liability.

External Operational

Sourcing of raw materials

Prices for key raw materials can be volatile and are affected by economic conditions. The table on the right shows our relative spend on these key raw materials, excluding energy. We may also be impacted by inability to access sufficient raw materials, business interruption or product discontinuation at key suppliers. These potential circumstances may increase cost and expenses for raw materials and energy. Changes in product mix may adversely affect future results and growth. We are, to some extent, able to pass on higher input prices to our customers, but this largely depends on market conditions.

Risk corrective actions

In 2013, Procurement was selected as a company-wide core process. As part of this process, our strategic sourcing methodology includes the structural periodic review of all critical raw materials, aiming to bundle the purchasing power in both product related and non-product related requirements. We use our purchasing power and long-term supplier relationships to acquire raw materials and safeguard their constant delivery in a sustainable manner, to secure volumes and cooperate on innovation and sustainability. We have an inventory of single sourced raw materials and are actively pursuing plans to mitigate dependencies. We monitor markets in which we operate for opportunities and adapt our purchasing accordingly. We also monitor our critical value chains to understand the critical suppliers and markets of our suppliers. This enables us to signal risks and opportunities at an earlier stage.

The following graph shows the percentages of our € 5.4 billion total spend in raw materials, excluding energy.

Breakdown of total raw material spend in %

Breakdown of total raw material spend in % (excluding Decorative Paints North America, divested in April 2013) (pie chart)

External Operational

Environmental liabilities

We use, and have used in the past, hazardous materials and biological compounds in several product development programs and manufacturing processes, including waste thereof. We have been, and can be, exposed to risks of accidental contamination or past practices that give rise to current liabilities. We could be exposed to events of non-compliance with environmental laws, regulatory enforcement, property damage, possible personal injury and any resulting claims for damage. Regulations and standards are becoming increasingly stringent.

Risk corrective actions

We are committed to conducting all our activities in the safest and most responsible manner. We have a specialist group managing these issues. Contingency plans and assignment arrangements are in place to mitigate known risks and regular reviews are conducted to monitor progress and assess financial and reputational exposure. Our policy is to accrue and charge against earnings environmental clean-up costs, damages or indemnifications when it is probable that a liability has materialized and an amount can be estimated (see Note 20 of the Financial statements).

External Financial

Retirement and healthcare benefits

Our policy is to sponsor defined contribution pensions and post-retirement benefits wherever possible, but we have a number of defined benefit pension and healthcare schemes from the past. Generally, these schemes have been funded through external trusts or foundations. AkzoNobel is at risk from potential funding shortfalls in these defined benefit schemes.

Risk corrective actions

We practice proactive pension risk management. Our policy is to offer defined contribution schemes to new employees and, where appropriate, to existing employees. The most significant defined benefit schemes are the ICI Pension Fund and the AkzoNobel (CPS) Pension Scheme in the UK. Both are closed to new entrants. They are managed and controlled by independent trustees. Changes in the value of the assets or liabilities of these defined benefit schemes, and therefore their funded status, and investment and other decisions by their independent trustees, may require additional funding from the employing entities and may adversely impact our business and results. Additional funding may, in the case of the UK schemes, also result from decisions by the UK Pension Regulator or, in certain cases, by the scheme actuary and trustee, subject to the powers of the UK Pensions Regulator. In each case, additional funding may adversely affect our business and results. We are committed to further de-risking over time. For more information about our post-retirement benefit provisions, see Note 15 of the Financial statements.

External Financial

Fluctuations in exchange rates

Exchange rate fluctuations can have a harmful impact on our financial results, as experienced in 2013. We have operations in more than 80 countries and report in euros. We are particularly sensitive to the relation between the euro and US dollar, pound sterling, Swedish krona and Latin American and Asian currencies.

Risk corrective actions

We have centralized treasury and a hedging policy is in place for certain currency exchange rate risks (see Note 23 of the Financial statements). At a more operational level, risks are reduced by the prevalence of local-for-local production, which is the norm in many of our businesses.

External Financial

Decline of asset values

Impairments and book losses could adversely affect our financial results.

Risk corrective actions

The Executive Committee continuously monitors acquisition and divestment opportunities and the management of assets held for sale. We do impairment tests for intangibles with indefinite lives (goodwill, some brands) every year and whenever an impairment trigger exists. For tangibles and other fixed assets, we do impairment tests whenever an impairment trigger exists (see Note 7 and 8 of the Financial statements).

External Financial – Top five risk

Cash flow

The potential for further deterioration of economic conditions may have an impact on the free cash flow generation of our businesses. Furthermore, we are potentially exposed to funding of pension schemes. This may lead to insufficient free cash flow generation which limits our strategic degrees of freedom.

Risk corrective actions

Our balance sheet and debt profile are strong. We have a long-term senior unsecured debt rating of BBB+ by Standard & Poor’s and Baa1 by Moody’s. We are committed to maintaining a strong investment grade rating. Regular review meetings are held between rating agencies and AkzoNobel senior management. We will engage in restructuring of underperforming parts of our portfolio if deemed strategically appropriate. We have a prudent financing strategy and a strict cash management policy, which are governed by our centralized treasury function (see Note 23 of the Financial statements). Focus on cash management is stressed in our monthly Operational Control Cycle meetings and relevant metrics are included in our updated remuneration policies.

External Compliance

Complying with laws and regulations

We may be held responsible for any liabilities arising out of non-compliance with laws and regulations.

Risk corrective actions

We are monitoring and adapting to significant and rapid changes in the legal systems, regulatory controls, customs and practices in the countries in which we operate. These affect a wide range of areas including competition law, anti-bribery and export control and sanctions. We are dedicated to minimizing our compliance risk with special emphasis on the application of our Code of Conduct. We advertise the use of our company-wide complaints procedure called SpeakUp!, which enables all our employees to report irregularities in relation to our Code of Conduct. We provide mandatory training regarding the code to all employees and additional mandatory training regarding specific relevant subjects to selected employees. We monitor compliance through our comprehensive annual non-financial letter of representation process, as well as our annual competition law compliance declaration (see the Governance and compliance section).