World Duty Free Group, through an organised and systematic process, has adopted a pro-active risk management system in order to provide the Board of Directors and management with decision-making tools so that they can anticipate and manage the effects of these risks and, more in general, govern them.
Considering the fundamental contribution of the concessions in the United Kingdom and in Spain to the WDFG’s revenue – during financial year 2013, about the 74.1% of the total revenue -the loss or non- renewal of these concessions or any event which may negatively impact the volume of passengers transitioning through the UK or Spanish airports in which the Group operates (especially London Heathrow, Madrid Barajas and Barcelona El Prat), may adversely affect the financial, economic situation and the assets of the WDFG.
Concessions in the United Kingdom and in Spain are expected to expire starting from 2020 and the Group works proactively to mitigate this risk by diversifying activities through the acquisition of new contracts, both within and outside UK and Spain, and the renewal of existing contracts.
To reach these targets WDFG manages relationship with its licensors to understand and anticipate possible development opportunities in airports where already exist retail activities.
WDFG performs its core activity predominantly under concession agreements where it has the right to operate in certain airport commercial areas. Concessions are the Group’s core asset and, consequently, WDFG focuses its strategy on renewing its existing concessions and on acquiring new ones. Due to the strong competition in this sector, in the case of new acquisitions and/or renewals of concessions, the terms provided by the licensors may be less favorable than those currently in place.
The Group works proactively to mitigate the risk of not acquiring any new contracts or not renewing existing ones or not maintaining the profitability of the concessions.
In particular the Group works constantly, with the support of its current licensors, to analyze traffic trends and customer needs in order to present the best offer and to manage Travel retail and Duty Free shops on action. This means constantly reviewing products offer and services’ standards in order to keep them competitive in terms of quality and price and suitable to consumers’ different spending habits.
In some cases, the concession agreements in force may be terminated or cease to be in force for several reasons beyond the WDFG’s control, including an order by the competent authorities or courts nullifying them, or the licensors not granting their prior approval to transactions resulting in a change in control of a member of the Group.
In general, the Group mitigates this risk by following an approach aimed at building and maintaining a clear long-term partnership arrangement with the concession grantor, based in part on the development of concepts and commercial solutions that maximize the overall gain.
WDFG’s activity largely relies on the sales to passengers in transit through the airports in which the Group is present. The Group performance, therefore, is influenced by the evolution in the travelers’ spending attitudes and shows a significant correlation with the variation in the number of passengers. The travelers’ spending attitudes and passenger traffic are both highly sensitive to the general economic trends and, in particular, the trends in consumers’ confidence, the availability and costs of consumer credit, inflation or deflation, interest and exchange rates and the unemployment levels.
Particularly, impulse buying at an airport is strongly influenced by the exchange rate between the country of origin and the destination. It is essential to monitor the price perceived by the customer as a result of exchange rate fluctuations, in order to boost sales of products that are especially good value in certain countries.
The Group’s widespread operations around the globe, and its constant attention to product supply and demand in countries of origin and destination, help it identify the advantage customers will perceive from favorable rates of exchange, mitigating in practice this risk.
Furthermore, passenger traffic is also sensitive to events beyond the WDFG’s control, including for example: political instability, acts or threats of terrorism, hostilities or wars, increased security control time, fuel price escalations, emerging alternatives to air travel (such as high speed rail), strikes, disruption or suspension of services provided by airlines, amongst others.
Any event that may adversely impact air travelers’ spending attitudes, their dwelling time at the airport and passenger traffic (such as those mentioned above) may negatively affect the WDFG’s sales thus may adversely affect the WDFG’s financial-economic condition and assets.
The ability to operate under the duty-free regime is a competitive advantage for WDFG vis-a-vis those operators who cannot take advantage of this regime. Nevertheless, the respective governmental authorities of the countries where WDFG operates may amend or suppress the implementation of the duty-free regime for some categories of products, or modify the taxation regime applied to the products sold in traditional shops outside the airports, thus eliminating part of WDFG’s competitive advantage.
Furthermore, if the requirements for granting, maintaining or renewing certifications, licenses and authorizations to operate duty-free shops in airports are modified, and WDFG is not able to adapt to the new requirements, the Group may lose the authorization to operate under the duty-free regime, in general, in one of the markets where it operates or with respect to certain categories of products.
Particularly, sale of tobacco is heavily regulated and, as a general matter, the applicable regulations of the countries where the Group operates, or its concession agreements, impose some advertising and/or sale restrictions of tobacco products. Moreover, an increasing number of national and local governments have prohibited, or are proposing to prohibit, smoking in public places.
As the sale of tobacco represents an important share of the Group’s revenues, if the Group were no longer able to sell tobacco products under the duty-free regime in general or in some of the markets where it is present, or if the tightening of the ban on smoking caused a reduction in the sales of these products, the WDFG’s financial-economic condition and assets may be adversely affected.
To mitigate these risks, with the support of external specialists, WDFG stays constantly abreast of legal developments so it can adapt its processes, procedures and controls to the new requirements and bring personnel up to date. It also relies on constant monitoring and frequent audits of service quality with respect to contractual and legal obligations.
Reputation towards both clients and licensors has great importance for the WDFG. Reputation of the Group towards the licensors and also the clients represents one of the key elements based on which licensors grant or renew concession agreements. The reputation of WDFG towards clients could be negatively affected by the reduction of the perceived quality of the services rendered, with a consequent loss of appeal and clients; the reputation of WDFG towards licensors could be negatively affected by the inability of the same to fulfill its contractual obligations. In addition the reputation of the Group could also be affected by third parties’ conduct; for instance, in those countries where it operates through management agreements with local partners, by such partners’ conduct.
In relation to the above risks, during the years, WDFG obtained and maintained a good reputation towards both the licensors and the clients. An implicit confirmation of the good reputation of the Group is represented by its ability, during the years, to renew its expiring concession agreements and to obtain new ones.
Furthermore, WDFG monitors constantly the quality of the services rendered to clients (in terms of perceived satisfaction and product safety) and to licensors (in terms of compliance with the quantitative and qualitative parameters set forth in the agreements).
The concession agreements to which the members of WDFG are party contain provisions limiting the WDFGconcessioner’s ability to perform its activities in the relevant airports, including but not limited to, restrictions on the range of products to be offered for sale and to the applicable pricing policy.
Furthermore, the concession agreements typically entitle the licensors, even when the licensee is not in breach, to unilaterally modify certain terms of the concession (sometimes without any corresponding indemnification right), for reasons of public interest or airport safety.
By virtue of these clauses, which do not relate to the determination of the concession charges, the licensors may, among other things, modify the extension or the location of the WDFG stores, which could reduce the flow of passengers through them.
Among other things, the need to comply with these conditions may prevent the Group from appealing or capturing of its clients, thus adversely affecting the financial and economic situation and the assets of the Group.
Even if these risks exist, in the last three financial years none of the concession agreements entered into by WDFG has been unilaterally modified by the relevant licensor.
The concession agreements of the travel retail sector, and also many of those entered into by WDFGare typically for initial fixed term periods and generally provide for the licensee obligation to pay guaranteed minimum annual charges, not always in relation with the revenues actually generated or the flow of passengers. If the revenue generated by a concession is lower than that foreseen when the concession was acquired (even due to a reduction in the passengers spending attitude or, in some instances, in the number of passengers itself), the profitability of the concession may decrease or even become negative due to the obligation to pay the guaranteed minimum annual charges, thus adversely affecting the Group’s financial-economic condition and assets.
It should be noted, however, that airport commercial areas are an appealing distribution channel for the suppliers, which enhances WDFG bargaining power.
Furthermore, as regards the main suppliers that are also brand partners of the Group, the collaborative approach the Group has adopted with these suppliers may further reduce their interest in taking advantage of their potential bargaining power.