Markets and Risks

MARKETS

Burberry is a global luxury brand with a distinctive British heritage, core outerwear base and one of the most recognised icons in the world. Burberry designs, sources and markets apparel and accessories, selling through a diversified network of retail, digital commerce, wholesale and licensing channels worldwide.

The business is managed by channel, region and product, supported by corporate functions.

Company and industry estimates

Burberry operates in the global luxury sector which, for Burberry's relevant categories, is estimated to be an approximately €150bn global market.

Since 2004, the global luxury goods market had grown by around 8% per annum prior to the economic downturn in late 2008. In 2009, it is estimated that the global luxury market declined by around 9%, as consumer confidence and spending fell. Industry analysts expect the sector to show some recovery in 2010, although not as high as the 8% seen prior to 2008.

Burberry competes with a variety of luxury goods companies. Some are large international conglomerates, owning many luxury brands; others are focused on a single brand locally; while others are small, more localised operations. Burberry's relevant peer group differs by product category – non-apparel, womenswear, menswear and childrenswear.

Retail: includes 131 mainline stores, 262 concessions within department stores and 47 outlets, as well as digital commerce in 27 countries

Wholesale: includes sales to prestige department stores and specialty retailers worldwide, as well as sales to its franchisees who operate 97 Burberry stores, mainly in Emerging Markets

Licensing: royalty income primarily received from Burberry's licensees in Japan, its global licensees for fragrance, eyewear and timepieces, and from small menswear and European childrenswear licensees

Balanced channel mix
Burberry sells its products to the end consumer through both the retail (including digital commerce) and wholesale channels. For 2009/10, retail accounted for 58% of revenue and wholesale 34%.

Burberry also has selective licensing agreements in Japan and globally, leveraging the local and technical expertise of its licence partners.

RISKS

The management of the business and the execution of the Group's growth strategies are subject to a number of risks. The risks set out below represent the principal risks and uncertainties which may adversely affect the management of the Group and the execution of its growth strategies
The steps the Group takes to address these risks, where they are matters within its control, are also described. Such steps may mitigate but not eliminate these risks. Some of the risks relate to external factors which are outside the Group's control. The order of the risks is in no way an indication of their relative importance, and each of the risks should be considered independently. If more than one of the events contemplated by the risks set out below occurs, it is possible that the combined overall effect of such events may be compounded.

Risks are formally reviewed by the Group Risk Committee (the 'Committee') who meet at least three times a year. The membership of the Committee comprises the Chief Executive Officer, Executive Vice President – Chief Financial Officer, Executive Vice President of Corporate Resources, Chief Operations Officer, Senior Vice President Commercial Affairs and General Counsel and the Director of Audit and Risk Assurance. At the invitation of the Committee, the Director of Intellectual Property, Director of Corporate Responsibility, Head of Risk Management and representatives from other assurance teams regularly attend Committee meetings. The assessment of the Group's risks and the processes in place for management and mitigation of these risks are reviewed by the Audit Committee on a regular basis. Key business risks are also considered by the Audit Committee and are considered generally as part of the Group's strategic development and ongoing business review processes.

The global economic downturn affected consumers' purchases of discretionary luxury items which has adversely affected Burberry's sales in certain markets
In common with all Burberry's competitors, the global economic downturn affected the level of consumer spending on discretionary luxury items. During a recession, when disposable incomes are lower, a global downturn will adversely affect Burberry's sales in certain markets.

A significant proportion of the Group's sales are generated by customers (in particular Middle Eastern, Russian, Japanese, Chinese and other Asian customers) who purchase products while travelling either overseas or domestically. As a result, shifts in travel patterns or a decline in travel volumes could materially affect trading results.

Following a further review of Burberry's Spanish business, the Group announced the planned restructuring of its Spanish Operations consistent with its strategy of aligning Burberry in Spain with its global business model.

Changes to the political regime or tax and fiscal regulations in the countries in which the Group operates could have an adverse impact on the Group's operations or revenues
The Group operates in many countries including the emerging markets. These countries have a variety of legal and regulatory systems which may be changed retrospectively or prospectively and which may not be enforced in a predictable or consistent manner, particularly in times when public sector debt is high and tax revenues are falling. Furthermore, some of these countries have not had stable governments historically and have been subject to political instability.

When the Group enters a new market, governance processes are in place to monitor the implementation programme, which includes oversight by the Group's legal, company secretariat, tax and audit and risk assurance departments. The Group uses the services of professional consultants to advise on legal and regulatory issues and to monitor ongoing developments.

If Burberry loses key management or is unable to attract and retain the talent required for its business, its operating results could suffer
Burberry's performance depends largely on its senior managers and design teams. The resignation of key individuals or the inability to recruit individuals with the relevant talent and experience to enable future business growth could adversely impact Burberry's performance.

To mitigate these issues the Remuneration Committee regularly benchmarks the Group's incentive arrangements against Burberry's global competitors and considers the framework in place to recruit, incentivise and retain key individuals. In addition, there are regular ongoing recruitment, talent review and succession planning programmes overseen by the Executive Vice President of Corporate Resources and Chief Executive Officer to ensure that the Group strengthens and develops its senior management team by identifying, developing and nurturing high-potential talent. During the year, the Group introduced a Leadership Council to identify and develop high-potential individuals within the organisation.

The cumulative change and significant growth within the business places a significant pressure on resources and its IT systems
The combination of the continued development of the Group's IT infrastructure, the focus on maximising the benefits of digital media, combined with the ongoing development of the global supply chain and the implementation of a number of other significant projects combine to exert significant pressure on the business. Governance processes are in place for each major programme to monitor and manage the progress of these initiatives and these are supplemented by monthly operational meetings with senior management to review operational performance. The senior management team has been strengthened and organisational structures realigned to further support these key initiatives and external consultants are used to complement internal skills where required.

There is a risk of over-reliance on key trading partners
In a number of key product categories Burberry is reliant on a small number of suppliers. During the year, the Group continued to strengthen its supply chain management team to enable the further evolution and development of the manufacturing base and also to mitigate the risk associated with over-reliance on a number of key product suppliers. Where suitable alternatives exist, the Group has reduced volumes with such suppliers and continues to look for suitable additional alternatives where necessary.

The Group has a number of key customers whose business represents a substantial portion of sales. The Group dedicates resources to these customers and maintains close relationships with such customers to understand and respond to their needs.

The Group closely manages its relationships with key suppliers and customers which includes monitoring their financial and non-financial performance.

A substantial proportion of the Group's revenue and profits is reliant upon business in Japan and key global licensees
A significant source of profit is derived from the royalties received from licensees, specifically the Group's licensees in Japan and the fragrance licensee InterParfums S.A. Burberry relies upon licensees to, among other things, maintain operational and financial control over their businesses. Should these licensees fail to effectively manage their operations, the Group's royalty income would decline. Failure to manage these key relationships effectively could have a material impact on the sales, profitability and reputation of the Group.

The Group regularly implements royalty reviews and audits of licensees, but cannot guarantee that they will reveal any non-compliance with the terms of the relevant licence.

To minimise the risks in Japan, Burberry has its own offices and operations in Tokyo and closely monitors its relationships with licensees. During the year, the Group amended the terms of its apparel licence with Sanyo Shokai and Mitsui in Japan. The amendment, together with the non-apparel joint venture formed with Sanyo Shokai and Mitsui in November 2008, better positions the Group to optimise its presence in Japan and the high-growth Asian region.

Burberry may be unable to control its wholesale and licence distribution channels satisfactorily
The Group relies upon the ability to control its distribution networks and licensees to ensure that products are sold in environments consistent with the Group's luxury image. An action by any significant wholesale customer or licensee, such as presenting Burberry products in a manner inconsistent with our preferred positioning, would be damaging to our brand image. If, due to regulatory, legal or other constraints, the Group is in any way unable to control its wholesale distribution networks and licensees, the Burberry brand image, and therefore results and profitability, may be adversely affected.

The Group relies upon its licensees, suppliers, franchisees, distributors and agents to comply with relevant legislation
The Group expects its licensees, suppliers, franchisees, distributors and agents to comply with employment and other laws relating to their country of operation and to operate to good ethical standards. The Group, however, is unable to guarantee that this is the case, although it continually monitors and improves its processes to gain assurance that its licensees, suppliers, franchisees, distributors and agents comply with its terms and conditions and relevant local legislation and good practice.

Burberry could suffer if its supply chain is unable to produce and deliver goods at a competitive price, on time and to its specification
If Burberry's suppliers fail to ship product on time, or product quality does not achieve Burberry's standards, this could result in the Group missing delivery dates to its customers, potentially resulting in cancelled orders or price reductions. Further, such a failure could affect wholesale customers' confidence which could adversely affect subsequent seasons' sales.

Burberry continues to evolve its supply chain strategy, refining its selection of suppliers to maintain and enhance product quality whilst improving sourcing efficiencies. The Group continues to rationalise its distribution network to minimise unnecessary costs and to improve delivery timeliness and accuracy.

The Group's planning and pricing function has continued to improve inventory management processes and effective product flow, facilitated by improved reporting and visibility provided from the new IT infrastructure. Further opportunities exist to improve inventory management processes and these will help ensure that the Group continues to produce merchandise of the right quality, in accordance with its ethical policy and delivered in accordance with its requirements.

During the year, the Group announced the restructuring of its Spanish operations consistent with its strategy of aligning Burberry in Spain with its global business model.

The inability to anticipate and respond to changes in consumer demand and product category trends on a timely basis could adversely impact sales
The Group's business depends, in part, on the ability to shape, stimulate and anticipate consumer demand by producing innovative, fashionable and functional products. Categories are cyclical, so it is critical the Group builds responsive product teams to exploit trending categories, launch new categories and balance core apparel and non-apparel categories.

The Group has evolved its product hierarchy and design calendar to enable continued brand momentum, product refreshment and replenishment to be more responsive to fashion and consumer trends and to respond more efficiently to changing circumstances.

Burberry continues to protect its classic core market by adding innovation to further stimulate sales to current customers, while attracting new customers to the brand. The Group balances and plans all categories and brand icons through a strict product hierarchy. To continue brand momentum, and to protect market share in apparel and non-apparel categories, the Group features outerwear and the Burberry Check icons as part of its marketing initiatives.

In response to high demand, the Group introduced the April Showers capsule range in April 2010 to fulfil consumer demand and drive brand momentum.

Burberry is dependent on the strength of its trade marks and other intellectual property rights
Burberry's trade marks and other proprietary rights are fundamentally important to the success and competitive position of the business and are intrinsic to maintaining brand value. Unauthorised use of the 'Burberry' name, the Burberry Check and the Prorsum horse trade marks, in particular, as well as the distribution of counterfeit products damage the Burberry brand image and profits. If a third-party registers one of the Group's trade marks, or similar trade marks, in a country where the Group does not currently trade, this would create a barrier to commencing trade under those marks in that country. In addition, if a third-party publishes harmful material using our trade marks, Burberry's brand image could suffer. The Group has a dedicated team operating internationally to register, protect and enforce its trade marks and other intellectual property rights. Where infringements are identified, the Group resolves these through a mixture of criminal and civil legal action and negotiated settlement.

Nevertheless, it is not possible to guarantee that the actions taken to establish and protect the Group's trade marks and other proprietary rights will be adequate to prevent imitation of Burberry's products by others. Trade marks and intellectual property rights, while subject to international treaties, are largely driven by national law and the protection of intellectual property rights varies from one jurisdiction to another.

The Group cannot therefore necessarily be as effective in all jurisdictions in addressing counterfeit products. In many territories the Group is dependent upon the vigilance and responsiveness of law enforcement bodies whose priorities may differ from the Group's. They are also subject to budgetary constraints and prioritise their actions accordingly. Whilst the Group works closely with customs and other law enforcement bodies, ultimately the Group cannot direct their actions.

In key emerging markets, including China and the Middle East, Burberry is largely dependent upon third-party operators with the associated lack of direct control and transparency and as the Group moves into increasingly higher risk locations the operating and reputational risk increases
In a number of key emerging markets, Burberry operates through third-party franchisees. In particular, a third-party retail operation has been developed in China. The Group largely depends upon the expertise of these franchisees given its relative lack of experience in this region. During the year, the Group has strengthened its emerging markets team, and where appropriate has its own staff based within these operations who work closely with franchisees to further develop operational models to enable greater control and visibility.

The Group has established joint ventures in Japan, the Middle East (excluding Saudi Arabia) and India to collaborate with experienced operators in high-growth, under-penetrated markets and improve its ability to ensure the operations are managed in accordance with the Group's global standards.

Burberry is exposed to foreign currency fluctuations
Burberry derives a significant percentage of its profits from its Japanese licensing arrangements. As a consequence, the Group is exposed to a significant risk associated with the Yen to Sterling exchange rate. In addition, the Group is continuing to expand its operations in the United States and Europe as part of its strategy to accelerate retail expansion in key under-penetrated markets. As the Group's presence in the United States and Europe increases, it is exposed to an increased risk associated with the US Dollar to Sterling exchange rate and Euro to Sterling exchange rate.

The Group manages a significant proportion of the foreign currency exposures by the use of forward exchange contracts. Currency fluctuations affecting the Yen, Euro, US Dollar and other currencies will nevertheless affect results and profitability.

Burberry's operating results are subject to seasonal fluctuations
Burberry's business, particularly with respect to apparel, broadly operates on a seasonal basis (Spring/Summer and Autumn/Winter) and the Group has experienced, and expects to continue to experience, substantial seasonal fluctuations in sales and operating results. In particular, results vary based on the weather because of the large proportion of outerwear products Burberry offers and the effect of the weather on retail markets generally. As a result of these fluctuations, comparisons of sales and operating results between different periods within a single financial year are not necessarily meaningful. In addition, these comparisons cannot be relied on as indicators of the Group's future performance.

Burberry faces increasingly intense competition
Competition in the luxury goods sector has intensified in recent years and Burberry is faced with increasing competition in many of our product categories and markets. The Group competes with international luxury goods groups who control a number of luxury brands and may have greater financial resources and bargaining power with suppliers, wholesale accounts and landlords. If Burberry is unable to compete successfully, operating results and growth may be adversely impacted.

A significant incident such as a natural catastrophe, global pandemic or terrorist attack affecting one or more of the Group's key locations could significantly impact the operation of our businesses
In such circumstances, the uninterrupted operation of the business cannot be ensured, particularly in the short term. Business continuity plans are in place to mitigate but not eliminate the operational risks.