In 2008, in line with the provisions of the Self-Disciplinary Code for Listed Companies and legislative decree no. 195/2007 (transparency), the Mondadori Group drew up guidelines for its Internal Control System, established a Risk Management function and launched a Risk Management process aimed at identifying and managing the principle risks and uncertainties facing the Group’s various businesses.
The Mondadori Group based its model for the classification, identification and evaluation and management of risks on Enterprise Risk Management (ERM) principles, which are based, in turn, on the international standard outlined by the Committee of Sponsoring Organisations of the Treadway Commission (COSO Report), one of the most authoritative and widely adopted approaches at both a national and international level.
The Model’s main characteristics are described below.
In the risk management process, the Risk Management function is charged with the supervision of activities and the coordination of the subjects involved.
Risks are classified in well-defined categories in the Model and evaluated according to two parameters, probability and consequences, not only economic but also in terms of market share, competitive advantage and reputation.
Such evaluations are made at both an inherent level, in other words where no actions to mitigate risks are in place, and at a residual level, where such actions are in place.
The deputy chairman and chief executive define the Group’s strategic objectives, which the executive management translates into objectives for their respective areas (either Businesses or Central Functions).
By means of self-assessment, the heads of business units or functions identify risks within their areas and carry out risk evaluation, firstly at an inherent level and then, having identified any mitigation measures, at the residual level.
The Risk Management function gathers and processes such evaluations and submits an overview of the risks to first line management in the various Areas.
When the risks facing all Areas have been validated, the Risk Management function groups the risks into categories and carries out a consolidation process that weights each risk according to the relevance of its Area to the Group as a whole.
The results of the Risk Management process are first communicated by the Executive Responsible for Internal Control in a report to the chief executive, the Internal Control Committee and the Board of Statutory Auditors and subsequently by the chief executive to the Board of Directors. This constitutes the basis for further analysis by the relevant structures and company officers.
The Internal Audit function is responsible for ensuring that risk mitigation measures have been put in place by the various Areas and that they are effective.
The Risk Management function, in collaboration with the heads of the company, plans and implements risk response measures for specific issues that may have emerged, and aimed at aligning the residual risk with a level deemed to be acceptable (risk appetite).
The Risk Management process provides for an annual review of the risk situation, to be conducted as indicated above.
The following is a summary of the principal risks and uncertainties facing the Group, as identified by the procedures outlined above.
Economic risk
The global economy
Following the period of economic-financial crisis that peaked in the first half of 2009, 2010 was characterised by signs of gradual recovery throughout the year, albeit at different rates in the various geographical areas. Driven by strong internal demand, the robust expansion of the emerging economies was confirmed, while more advanced economies saw more modest growth. However, the recovery is not without elements of fragility and uncertainty, such as the sustainability of public debt and consumer spending, which are affected by the weakness of the labour market in many advanced countries, as well as inflationary pressures in emerging countries.
The Eurozone is expected to end 2010 with an average level of growth of 1.7% (Source: Eurstat), mainly driven by exports but penalised by tensions about the sovereign debt of certain countries. 2011 is expected to see a slight slowdown of the recovery, to around 1.5%, with persisting differences between countries, with Germany experiencing decidedly better growth, France in line with the average for the area, and Italy growing at a slower pace.
The Italian economy
GDP growth in 2010 was 1.1% (Source: ISTAT), with the pace of growth slowing down during the year, registering +0.1% in the final quarter (GDP growth had been 0.3% and 0.5% in the preceding quarters), somewhat below the average performance recorded in the Eurozone as a whole (0-3%). This result is firstly due to the weakness of domestic demand following the end of tax incentives and only partially compensated by an upturn in exports. Overall, industrial production started to grow again compared with the previous year, even if less vigorously than other countries in the area. There remains great uncertainty about a recovery in consumer spending, with households faced by a fall in the growth rates of disposable incomes and conditions in the labour market, with unemployment in December 2010 at 8.6%, an increase of 0.2% on the same month of 2009 (Source: ISTAT). Current expectations are for a continued rate of growth of around 1% in 2011 and 2012, below the EU average.
Financial and credit risks
Financial risk
Financial risk derives from the Group’s exposure to potential losses connected to financial cycles that depend on business operations, exchange and interest rate volatility and the availability of financial resources on the market (liquidity risk).
The management of the Group’s financial risk is regulated by a policy document (“General financial risk management policy”) approved by the board of directors. It defines guidelines regarding categories of risk and outlines objectives, hedging procedures and operational limits.
Exposure to exchange rate risks is related to the geographical spread of the Company’s business, in particular the acquisition of publication rights of foreign authors and the publication of some of the Group’s magazine titles in other countries, which produces financial flows in currencies other than the euro (mainly the US dollar and the pound sterling). Such risks are reduced by negotiating forward purchase or sale derivative contracts.
The Group also utilises various forms of funding to cover the requirements of its business; changes in interest rates can lead to increases or reductions in the cost of borrowing and consequently on margins.
In line with its risk management policy, the Mondadori Group hedges interest and exchange rate risks by using financial instruments, mainly interest rate swaps. The Group is well aware of the need to organize its resources in a way that will ensure the stability of its equity and financial structure. To this end, the reduction of liquidity risks is ensured through the use of committed loans, ensuring a higher level of flexibility on its financial covenants and extending the average maturity of its loans.
Risks associated with receivables
The persistent unfavourable economic and financial situation continues to put average payment days under pressure, with a consequent need for increased vigilance regarding the possible impact on the financial position (esp. in the Advertising and Trade Books Areas). Similarly, there are still risks attaching to possible breaches of contract or default by counterparties.
The imbalance between terms and actual payment is most marked for the Group companies that do business with the public administration, though this has a limited impact on the Group as a whole.
Business risks: the competitive environment and strategic risks
The markets in which Mondadori Group operates continue to be subject to uncertainty and stagnation. The publishing sector, and the media in general, having passed through an extremely critical phase, remains characterised by big changes, particularly of a technological and structural nature, that demand the reconfiguration of the businesses in order to take advantage of the growth opportunities that are emerging.
In the Book Area, trade books are beginning to see the first signs of a huge transformation in the book market that is sweeping the world, the result of the spread of new technologies, and in particular the e-book. In this regard the company has moved quickly and developed a strategic development plan, with partnerships and agreements with leading players (e.g. Telecom, Google) and organising itself to achieve its objectives, which includes maintaining its leadership position, also in the new world of publishing. The actions that have been taken have gone some way to offsetting the risks form various operational areas, which range, for example, from digital rights management to the evolution of technological standards and the definition of new competitive levers.
Albeit less that a year ago, the other main risk factors derive from the current state of the traditional market and regard the concentration of revenues and margins on a small number of highly successful titles and the growing competitiveness of rivals. In order to effectively face such risks, the Area has the advantage of a wide-ranging catalogue and bargaining power in the market for rights, ensuring rapid identification of investment and diversification opportunities.
The Educational Area is faced with a series of changes in its business models, determined by both technological and legislative changes. For Mondadori Education this means an increased focus on innovation and updating know-how and competences, with a view to providing multimedia textbooks and digital content. The necessary investments, as well as the risk of a generalised fall in average prices, mean there is also a risk from increased competition and concentration in the sector. The company meanwhile continues to pursue its investment policy based on product quality, while at the same time developing the integration of print and digital.
With the definition of the legislative framework, Mondadori Electa is facing the effects of a slowdown in all of the market segments in which it operates, with the risk of an increase in competition and a significant change in the margins from the cultural heritage business. Uncertainty will remain over the coming months about the assignment of licences for additional services at Italy’s principal museums and archaeological sites.
To this should be added the difficulties in book sales following the effective end of the add-on sales phenomenon. A redefinition of the business model, specific attention to the economics of the production process and editorial innovation are the paths that the company is pursuing in its efforts to deal with the current market scenario.
The consumer magazine market in Italy continues to be characterised by weakness and instability, which in turn has generated a persisting critical situation for circulation, add-on sales and advertising revenues.
Nevertheless, the Magazines Italy area was able to achieve results that contrasted with the market in general, consolidating its leadership position and offsetting risks thanks to a balanced mix of circulation and advertising revenues, opportune re-launches and support for the titles, a focus on reorganisation and internal processes and the valorisation of the brands and editorial content.
Regarding Mondadori France, the market scenario is still characterised by falling circulations, albeit to a lesser degree than in Italy. Meanwhile there was a clear reduction in the level of risk from declining advertising revenues, which are recovering, and increasing competition in the up-scale segment, despite which Grazia confirmed its excellent performance both in terms of circulation and advertising revenues. In order to continue to deal effectively with the situation, the management is continuing to pursue the strategic repositioning of the portfolio, along with a constant focus on editorial quality.
In order to promptly exploit the opportunities presented by the rapid growth of new ways of using and new platforms for accessing content (the web and mobile), a Digital area has been created, with the task of providing cross-platform support to the single businesses and creating new initiatives. At the same time, precise guidelines for strategic development have been drawn up, consequently shifting risk factors to the operational level, which has led to the mapping of a series of problem areas and issues able to respond to the expansion of the company’s business interests and the specific issues that this raises, including the possibility of acquisitions and/or partnerships and the management of users on social media. Among others, human resources has become a strategic area due to the need to ensure that the company has an adequate combination of technical competences and the capacity to effectively manage the company’s editorial activities.
Despite the negative impact of the global financial crisis, which has severely penalised consumer spending across the world, the Group’s results in the area of International activities have been constantly improving. The positive performance of existing titles and the continuing geographical expansion of the network of up-scale titles, in particular the launch of new editions of Grazia, have contributed to lowering the risks from a slump in the advertising market, confirming the international appeal of the Group’s brands.
In advertising, the risk related to a downturn in advertising investments remains, even if the figures for 2010 show a market that, overall, is in a more positive trend and grew by 4.7% (Source: Nielsen). However, there were significant differences between the different media, with the internet still clearly growing (+20.1%), followed by direct mail and radio, while the decline of print media continued compared with 2009. Despite this oscillating trend in the market, Mondadori Pubblicità was able to record results that were in line with the previous year, thanks to important efforts to offset risks through changes at both the organisational and commercial levels, brand extension activities, as well as the creation of events and a more marked personalisation of the offering, also through integrated and multimedia solutions.
The management of the Direct area is facing increasing competition, on the one hand from other bookshop chains (both directly owned and franchises) and big retail chains and, on the other, from players (also from outside the sector) competing with for Mondadori Retail for the most commercially strategic locations. One of the most significant critical factors here is the possible impact on sales through traditional channels of technological innovations for the use of editorial and media content (eg. e-books). Careful monitoring of the main competitors, the adoption of adequate strategies and the implementation of a policy aimed at building customer loyalty and the valorisation of sales outlets will enable management to promptly and effectively respond to such risks.
The maturity of the businesses, regulatory restrictions and changes in the market that impact on the activities of Cemit and Mondolibri make further development difficult. Consequently, the companies are pursuing specific actions and initiatives to consolidate and build loyalty in the existing client base.
The marked upturn in advertising investments (+7.7% on 2009), the decline of which represented the most significant source of risk last year, has enabled Monradio to achieve a positive performance, also thanks to intense communication efforts, multimedia development and a broad review of the schedule. To this should be added the excellent results in terms of listeners, which confirm that R101 is among the most vibrant players in Italian radio and able to continue to close the gap with the well-established and consolidated stations.
Legislative and regulatory risks
Mondadori Group operates within a complex regulatory environment, modifications to which could have an impact on both costs related to internal Governance & Compliance processes regarding specific areas (such as legislative decrees 231/01 and 196/03 concerning privacy, and law 262/05 concerning investor protection and fiscal compliance) and its capacity to compete in certain business areas.
With regard to the latter of these, as has been previously indicated, the activities of Mondadori Education are closely conditioned by educational reforms, and this implies a series of compliance measures to ensure that textbooks are suitable for the new syllabuses and new ways of using didactic materials, with a significant impact on the dynamics of the entire sector.
With regard to the Cultural Heritage area in which Mondadori Electa operates, the expected changes in the way in which concessions are assigned for public services at museum sites have now taken place, with a shift from integrated management to separate bids for contracts for different services. This will mean a radical change in the market scenario that will facilitate the entry of new players, also from outside the sector, and inevitably to a re-scaling of margins that will make it necessary to redefine the business model.
For the Magazines Italy area, the effective elimination of postal subsidies for subscriptions from 1 April 2010 has resulted in a significant increase in postal charges, which has nevertheless been offset by the agreement reached between the FIEG (the Italian press federation) and Poste Italiane, which reduces by around 50% the effects of the new charges. In view of the negative impact on the economic and financial situation, the Area’s positive results are even more remarkable, above all in comparison with market trends, thus confirming the management’s ability to face such external events even where its influence is marginal.
Brand protection risks
Conscious that its brands, content and authors represent its growth opportunities for the future, the Mondadori Group considers them as assets to be protected and developed. The Group’s policies and activities are consequently focused on avoiding situations or events that could damage its image or have negative repercussions on the activities and results of its various businesses.