ABOUT DIPLOMAPLC

STRATEGIC RISKS

Downturn in major markets

Adverse changes in the major markets in which the businesses operate can have a significant impact on performance. The effects will either be seen in terms of slowing revenue growth, due to reduced or delayed demand for products and services, or pressure on margins due to increased competitive pressures.

To mitigate the effects of such adverse changes, the businesses identify key market drivers and monitor the trends and forecasts, as well as maintaining close relationships with key customers who may give an early warning of slowing demand. Changes to cost levels and inventories can then be made in a measured way to mitigate the effects.

In addition, there are a number of characteristics of the Group’s businesses which moderate the impact of economic and business cycles on the Group as a whole:

• The Group’s businesses operate in three different sectors with different cyclical characteristics and across a number of geographic markets.
• The businesses offer specialised products and services and this offers a degree of protection against customers quickly switching business to achieve better pricing.
• A high proportion of the Group’s sales comprise consumable products and service contracts which are purchased as part of customers’ operating expenditure, rather than through capital budgets.
• In many cases the products will be used in repair, maintenance and refurbishment applications, rather than original equipment manufacture.

Loss of key supplier(s)

The Group’s businesses ensure that they have secure long term access to strong, differentiated product offerings by combining:

• Quality manufacturer-branded products, mostly sourced under long term distribution agreements.
• Own-brand products, manufactured under contract.
• Selective in-house manufacture and assembly.

There are risks to the businesses if a major supplier decides to cancel the distribution agreement or if the supplier is acquired by a company which has its own distribution channels in the relevant market. There is also the risk of a supplier taking away exclusivity and either setting up direct operations or establishing another distributor.

The potential impact on an individual business may be high where a supplier represents a significant proportion of the sales and purchases of the business. However, the potential impact on the Group is lower as no supplier represents more than 15% of Group revenue and only six suppliers represent more than 2% each of Group revenue.

Relationships with suppliers have normally been built up over many years and a strong degree of inter-dependence has been established. There are further actions planned and implemented by the operating businesses to control or to mitigate risks:

• Where dependence is high, long term, multi-year exclusive contracts signed with suppliers.
• Where possible, change of control clauses included in contracts for protection or compensation in the event of acquisition.
• Collaborative projects and relationships maintained with individuals at many levels of the supplier organisation.
• Regular review meetings and adherence to contractual terms.
• Regular reviews of inventory levels.
• Bundling and kitting of products and provision of added value services.
• Periodic research of alternative suppliers as part of contingency planning.

Loss of major customer(s)

As with any businesses, the loss of one or more major customers can be a material risk.

Specific large customers are important to individual operating businesses and a high level of effort is expended in ensuring that these customers are retained and encouraged not to switch to another supplier. In addition to providing high levels of customer service, close integration is established where possible with customers’ systems and processes.

The nature of the Group’s businesses, however, ensures that there is not a high level of dependence on any individual customers. No customer represents more than 5% of sector revenue or more than 2% of Group revenue.

Technological change

The Group’s businesses operate in specialised markets offering products which are often technical in nature. As a result, there is always the risk that a technological change will make specific products less competitive or in the worst case, obsolete. In addition to the write-off of unsaleable inventory, this can impact the sales performance of the business if replacement products are not available.

The Group’s exposure to this risk is reduced by the spread of businesses and technologies, as well as by the fact that the products, though technical, are typically not subject to very rapid technological change.

The operating businesses monitor the key technologies to get early warning of changes in product competitiveness, so that plans can be developed for changes in the supplier portfolio as required. Also, the businesses, with sufficient lead time, mostly have the opportunity to change suppliers in the event of a major technology shift.

Product liability

There is always a risk that products supplied by a Group business may fail in service, which could lead to a claim under product liability.

To offset this risk, technically qualified personnel and control systems are in place to ensure products meet quality requirements. The businesses, in their Terms and Conditions of sale with customers, will typically mirror the Terms and Conditions of sale from their suppliers. In this way the liability can be limited and subrogated to the supplier. In addition, this avoids the need for businesses to maintain material warranty provisions in their financial statements.

However, if a legal claim is made it will typically draw in our business as a party to the claim and the business may be exposed to legal costs and potentially damages if the claim succeeds and the supplier fails to meet its liabilities for whatever reason. To mitigate this risk, the Group has established Groupwide product liability insurance which provides worldwide umbrella insurance cover of £10m in all sectors.

Loss of key personnel

The success of the Group is built upon strong, self-standing management teams in the operating businesses, committed to the success of their respective businesses. As a result, the loss of key personnel can have a significant impact on performance, at least for a time.

Contractual terms such as notice periods and non-compete clauses can mitigate the risk in the short term. However, the more successful initiatives focus on ensuring a challenging work environment with appropriate reward systems. The Group places very high importance on planning the development, motivation and reward of key managers in the operating businesses to mitigate this risk:

• Ensuring a challenging working environment where managers feel they have control over and responsibility for their businesses.
• Establishing management development programmes to ensure a broad base of talented managers.
• Offering a balanced and competitive compensation package with a combination of salary, annual bonus and long term incentive plans targeted at the individual business level.
• Giving the freedom, encouragement, financial resources and strategic support for managers to pursue ambitious growth plans.