Medium-term risks

Worsening of economic conditions

The global economy remains fragile and it continues to be difficult to predict customer demand and raw material costs. AkzoNobel is susceptible to decreased growth rates within high growth markets and/or continued economic and market downturn in mature markets. The effects could lead to a decline in demand and deteriorating financial results, which in turn could result in the company not realizing its financial targets.

Mitigating actions

• Continue our strategy to bring down our operational cost base and reduce complexity
• Leverage our Global Business Services to further standardize core functional processes in all regions across the organization
• Further deploy the commercial excellence programs and more sustainable product solutions to capture organic growth and offset the effects of decreased economic growth rates
• Have contingency plans prepared for a selected number of scenarios, dealing with geographical or segment slowdowns

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 geo-political, social or economic developments and developments in laws, regulations and standards could adversely affect our business and results of operations. Our ambition to grow the business in a balanced way across the globe will further expose us to these risks.

Mitigating actions

• Strategically spread our activities geographically and serve many sectors to benefit from opportunities and reduce the risk of instability
• Carefully monitor the political, economic and legislative conditions across the company
• All significant investments, and the countries and industry segments in which AkzoNobel conducts its business, are decided on by the Executive Committee
• A combination of country organizations and service centers is in place in order to address country-specific and local business risks

Sourcing of raw materials and energy

Prices of key raw materials and energy can be volatile and are affected by economic conditions and regulations. This can limit our ability to protect our margins. The chart below shows our relative spend on these key raw materials, excluding energy. The risk may further increase as a result of the non-level playing field for energy and raw materials on a global level (for example shale gas, national policies, subsidies) and emission trading rights, which affect the competitive position of businesses and our customers.

Mitigating actions

• AkzoNobel’s Procurement sourcing processes (ALPS, Source) and organization are designed to actively leverage the cost, quality and delivery of raw materials and energy, including the performance of suppliers. This includes managing the risks related to single sourced materials, the forecasting of price trends and governance to ensure the supply base provides the best terms and conditions
• Our supplier sustainability program, focused on sustainable raw materials and carbon reduction, includes internal programs for key suppliers and critical suppliers and participation in the Industry group with external assessments and audits

Product liability

Product liability claims could adversely affect our company’s business and results of operations. Claims with high impact on our organization, while unlikely, could follow from the use of former, current or new technologies and compounds.

Mitigating actions

• Quality improvement programs are in place in our different Business Areas
• Product stewardship is embedded in the company’s HSE and sustainability agenda. Product stewardship is also integrated into product slate decisions
• We have a central policy to optimize insurance coverage, which relates to specific insurance programs covering product liability

Environmental risks and liabilities

We use, and have used in the past, organic and inorganic compounds (some of which are hazardous to the environment) in product development programs and manufacturing processes. We have been, and may still be, exposed to risks of contamination and associated substantial costs related to compliance with environmental laws and regulations, and claims relating to property damage and personal injury.

The trend that with time, regulations and standards are becoming increasingly stringent, continues and is in part a reflection of growing public concern about human health and the environment in general.

Mitigating actions

• Conduct all our activities in the safest and most responsible manner
• Contingency plans and assignment arrangements are in place to mitigate known material operational risks and monitor progress
• A dedicated group of experts assesses, manages and resolves environmental liabilities. Sites with a higher environmental risk profile are subject to management review periodically
• Mandatory annual environmental liability reviews are conducted to review risks, monitor progress in resolving our liabilities and assess changes in company exposure
• Corporate directives are issued for recurring risk categories such as manufacturing sites that are closing
• Accrue and charge environmental clean-up costs or indemnifications against earnings when it is probable that a potential liability has materialized and an amount can be reliably estimated (see Note 19 of the Consolidated financial statements)

Information Technology

One effect of the company’s longer term Information Technology strategy is increased reliance on fewer, consolidated, critical applications, including our industrial process control systems. The amount of digital exchanges of business transactions with customers, suppliers and other stakeholders is increasing. Non-availability of our critical IT systems, or unauthorized access through cybercrime or other events, can have a direct impact on our production processes, our competitive position and the reputation of our company.

Mitigating actions

• Continuously test and update the systems used for information security
• Further implement measures such as redundant design, back-up processes, virus protection, anti-spoofing and forensic scans
• Centrally monitor access control processes to our key IT systems
• Launch training on IT security via e-learning
• Roll-out of the new IM security standard for industrial control systems to our manufacturing locations

Post-retirement benefits

Our current policy is to contribute to defined contribution schemes wherever possible, although we still have a number of defined benefit pension and healthcare schemes from the past. Generally, these schemes have been funded through external trusts or foundations, where AkzoNobel faces the potential risk of funding shortfalls.

Mitigating actions

• 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. The funded status of these schemes is affected by the trustees’ investment decisions, market conditions, demographic experience and any regulatory actions. This may require additional funding from the former employing entities and may adversely impact our business and results
• We practice proactive pension risk management and continuously review options to reduce the financial risks associated with all of our defined benefit plans (see Note 14 of the Consolidated financial statements)

Access to funding

The fragility of the global economy and the financial systems could have an impact on free cash flow generation and may limit our access to funding, thereby reducing our strategic degrees of freedom.

Mitigating actions

• Maintain a strong investment grade credit rating: our long-term senior unsecured debt rating is BBB+ by Standard & Poor’s and Baa1 by Moody’s
• Focus on cash management is stressed in our monthly Operational Control Cycle meetings and relevant metrics are included in our remuneration policies
• 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

Fluctuations in exchange rates

Exchange rate fluctuations can have a positive and negative impact on our financial results. We have operations in more than 80 countries and report in euros. We are particularly sensitive to movements in the US dollar, pound sterling, Swedish krona and Latin American and Asian currencies.

Mitigating actions

• A centralized treasury function and hedging policy is in place for certain currency exchange rate risks (see Note 22 of the Consolidated financial statements)
• At a more operational level, risks are reduced by the prevalence of local-for-local production
• Reduce as much as possible the impact of transactional exposure on the results of our businesses by striving for natural hedges in our main currencies

Decline of asset values

Impairments and book losses could adversely affect our financial results.

Mitigating actions

• Perform impairment tests for intangibles with indefinite lives (goodwill, some brands) every year and whenever an impairment trigger exists. For tangibles and other fixed assets, impairment tests are only carried out whenever an impairment trigger exists (see Notes 7 and 8 of the Consolidated financial statements)
• Continuous monitoring of acquisition and divestment opportunities, and the management of assets held for sale, are performed by the Executive Committee

Complying with laws and regulations

Our international footprint exposes us to continuously expanding laws and regulations. We may be held responsible for any liabilities arising out of non-compliance with these laws and regulations.

Mitigating actions

• Monitor and adapt to significant changes in the legal systems, regulatory controls, customs and practices in the countries in which we operate
• Remain dedicated to minimizing AkzoNobel’s compliance risk by fostering an open and transparent culture, continuously educating our employees worldwide and increasing awareness
• Monitor overall compliance through our comprehensive annual non-financial letter of representation process, as well as our annual competition law compliance declaration
• Embed company-wide standard setting and compliance awareness through activities and training programs, including training on the new Code of Conduct

Innovation and identification of major transforming technologies

Our success depends on the sustainable growth of our business through research, development and innovation. If we are not able to identify and adopt major transforming technologies in a timely manner, this may lead to loss of our leadership positions, and adversely affect our business.

Mitigating actions

• Advance our technology road maps and innovation strategies with appropriate research and development spend. In 2015, this amounted to 2.3 percent (€347 million) of total revenue
• Bring to market suitable new technologies using innovation core processes to assess market needs and relevant know-how
• Enhance our global open innovation capability to identify, assess and acquire the most recent promising technologies
• When applicable and appropriate, invest in venture funds

Attraction and retention of talent

We face the challenge of ensuring continued alignment between a rapidly evolving business environment and qualifications, capabilities and talent of our workforce. This is an increasingly complex process as the labor market poses different challenges across disciplines and regions. Having the right people, with the right capabilities, experience and background will, to a large extent, determine the success of our organization and requires the development of an increasingly longer term view on future talent needs.

Mitigating actions

• Strengthen AkzoNobel Employee Value Proposition based on revised company purpose and stronger company brand strategy
• Further improve talent and succession action planning and follow up
• Roll-out new leadership behaviors with impactful leadership assessment and development curriculum and integration into our Performance and Development Dialog
• Further build and develop the AkzoNobel Academy with strong functional competency frameworks and well-defined development curriculum and career planning

Production process risks

Risks in production processes can adversely affect our results. They arise from areas such as personal health and safety, process safety and product safety. Unlikely scenarios can involve major incidents with a high impact on our organization, causing business continuity risks and reputation damage.

Mitigating actions

• The AkzoNobel Leading Performance System (ALPS) is being implemented to reduce complexity and drive continuous improvement
• Continue the implementation of the Safety Common Platform introduced in 2013 and the Process Safety Management (PSM) framework, which was introduced in 2014. The framework provides a set of common, state-of-the-art safety requirements for all our manufacturing sites
• Carry on with business continuity planning and make sure there are appropriate risk transfer arrangements in place

Management of change

In order to achieve our overall strategy, we have implemented – and continue to implement – numerous changes in our operating model across all functions and businesses in order to further enhance cost efficiency and quality of services.

Mitigating actions

• Ongoing focus on core principles and values intended to set the desired behavioral changes in motion. The values and behaviors have been included in the performance management process
• Senior management is involved in all critical projects that have been prioritized and are supervised by the Executive Committee to ensure an aligned and integrated vision for the company’s change agenda
• Project management and change management are both included in the curriculum of the AkzoNobel Academy
• Consolidate change management by streamlining and aligning the work of a range of supporting processes under the umbrella of Global Business Services