Principle risks and uncertainties

Reduced profitability

We operate in extremely competitive markets. If we fail to compete effectively or are subject to higher input prices that cannot be recovered by raising selling prices without losing volumes we could lose sales and profits.

We set ourselves the target of continually reducing our cost base and are able to invest in our supply chain to help achieve this.

No one customer accounts for more than 15% of total revenues and we continually strive to widen our customer base. Despite challenging trading conditions we have maintained investment in marketing our four key brands. Our innovation programme continues to generate new products that reinforce our appeal to customers. We recognise the importance of strong customer relationships and the executive team plays an active part in maintaining and developing these. They are also involved in major customer negotiations. We conduct customer surveys to benchmark our performance and we continuously monitor the service and quality levels provided to our customers and consumers, and have procedures in place to react quickly to any issues. Our commitment to corporate responsibility is an important part of our overall proposition to some customers.

Consumers could move away from dairy products for economic, health, ethical, or other reasons leading to lower sales and profits.

Consumers are at the heart of our business and we regularly monitor consumer trends. We continue to promote the health benefits provided by dairy products and develop healthier products. We also continue to maintain our focus on developing a compelling new product development pipeline, enabling us to react to consumer trends, for example with more environmentally-friendly packaging, and healthier variants of our key brands. We have increased our direct involvement with government to understand and influence future legislation that could affect future consumer demand.

Volatile milk and non-milk costs (vegetable oils, diesel, electricity, gas and packaging) could reduce margins unless we can manage cost risk, find other cost efficiencies elsewhere or increase selling prices.

Milk prices could become increasingly volatile as European milk production quotas are abolished from April 2015.

This area is closely reviewed by the Management Board which has established a risk committee to monitor and hedge forward non-milk commodity prices as appropriate. The risks associated with purchasing large volumes of milk have been reduced by establishing milk pools linked to major customers. We seek to absorb short term cost movements through supply chain efficiencies. Our purchasing and commercial teams have clear lines of communication between them to ensure customers are kept aware of changes to our cost base and requests for price increases can be fully justified.

We have reviewed the effect that we believe the abolition of milk quotas will have on our business. We believe it is commodity cheese markets, in which we don’t operate, that are most likely to be affected, but we will continue to monitor this closely.

Inability to source milk

Without milk we would not have a business. Restricted milk supply due to economic factors, weather, fuel availability or an epidemic which affects dairy cows could restrict milk supply. This in turn could lead to lower sales and profits. Consumer confidence in dairy products could also be adversely affected.

We invest significant resources in maintaining strong relationships with our milk suppliers by attending forums and discussing current issues and pressures that affect both the farms and our business. The majority of our milk comes directly from farms on contracts that include a notice period of between three months and one year. Our experienced milk procurement team understand milk production and are alert to changes in supply. We aim to pay a fair, market related milk price and closely monitor the milk price we pay to suppliers in order to ensure we can purchase the right quantity of milk to meet demand forecasts and have established procedures for allocating milk between our businesses if a short term shortfall in supply does arise. We have contingency plans established for major incidents and work closely with DEFRA and industry bodies to ensure these are appropriate. These plans are regularly tested and reviewed with the Management Board.

We are dependent on key suppliers and could lose sales and face financial penalties from customers if suppliers’ failure leaves us unable to supply. Failure of key information technology suppliers could adversely affect our financial systems.

Our purchasing team regularly monitors suppliers’ ability to supply and puts in place alternative arrangements, including dual purchasing, if appropriate. We have taken specific actions to reduce our dependency on information technology suppliers.

An accident, product contamination, the failure of equipment or systems or deliberate act could disrupt production, affect food safety, cause injury, and/or cause reputational damage with adverse consequences. We are also reliant on information technology and exposed to losses in the event that systems fail.

Dairy Crest takes product quality very seriously and has rigorous quality controls in place to minimise potential risks. Plans are maintained to respond quickly to any product quality concerns and minimise any impact to the Group. Our business is also committed to the health and safety of all our employees and maintains systems aimed at ensuring everyone is able to complete their work safely. All of our manufacturing sites have a trained engineering resource, are supported by our major equipment suppliers and hold appropriate stocks of spare parts. They also all have fire protection systems and regular fire drills. Our information technology systems are regularly backed up and duplicated in the majority of areas. We have procedures in place to help us deal with major incidents and insurance cover for property damage and business interruption risks.

Disease epidemic

A disease epidemic such as swine flu could adversely affect the health of our employees and prevent them working, leaving us unable to service customers.

Contingency plans which include working with industry bodies are in place for known epidemic risks.

We need to retain high quality employees to provide customers and consumers with safe, high quality products and services.

We carry out rigorous selection procedures and benchmark pay and benefits to ensure we can attract and retain the best people. We have a wide bonus scheme and a range of other incentives to reward good performance. Our Long Term Alignment Plan aligns the interest of management to shareholders and helps to retain key senior employees. There is a performance review and talent management scheme to identify and develop our own people. To encourage two-way communications with employees we invite them all to attend an annual roadshow at which they are encouraged to ask questions important to them. We undertake regular surveys to monitor the relationship with our employees and their engagement.

Pension scheme

Despite the action we have taken to reduce the risks associated with our pension scheme, including closing the scheme to future accrual in 2010 and buying insurance to meet the liabilities associated with many of our retired members in 2008 and 2009, the deficit could continue to increase and we may then have to increase our contributions.

We continue to work closely with the Trustee of the Pension Fund to improve the Fund’s financial position at an acceptable cash cost to the business. Our one-off cash contribution of £40 million to the Pension Fund in April 2013 reduces the risk of the deficit increasing.

Our sector is subject to a number of complex statutory requirements. There is a risk of fines or lawsuits and reputational damage if we fail to comply.

We have a strong in-house legal function supported by external advisers. We have undertaken Group-wide training in respect of competition law and actively monitor and adjust to on-going legal and regulatory changes. We have a Business Conduct Policy, and a programme designed to ensure that all relevant employees understand what is and is not permissible under the UK Bribery Act.

To remain competitive we periodically undertake major transformational projects following strategic reviews. Successful execution of these projects is often key to delivering strategic objectives. At the same time we have to ensure that major projects do not divert from the on-going day-to-day delivery of products and services to our customers.

We have a good track record of managing projects and use experienced and appropriately skilled senior managers to lead these. Supervisory governance structures are also put in place to help successful delivery. We are aware that too much change concentrated in too short a timescale can be detrimental and manage this by ensuring key project resource is full time with appropriate backfilling and use of third parties.