Markets and Risks

MARKETS

Markets in which Burberry operates
Burberry operates in the global luxury sector which, for Burberry's relevant categories, is estimated to be an approximately £145bn global market.

The luxury goods market has grown on average by 7% per annum during the last four years. During 2008, growth slowed and industry analysts expect the market to contract during 2009. Despite current headwinds associated with the global economic environment, the fundamental longterm drivers of growth in the luxury market remain:

economic growth - the luxury market has generally grown at two to three times the rate of the global economy
consumption associated with the rapid expansion of emerging economies including China and Russia
growth in high net worth individuals (HNWIs) in both core and emerging markets; HNWIs are defined as consumers with financial assets (not including their primary residence) in excess of US$1m; they have a higher propensity to purchase luxury goods than other consumers
increasing demand for luxury brands, as consumer aspirations develop, spend by working women increases and a greater number of men select luxury brands
more international travel and tourism
continuous product innovation by luxury brands creating demand for new products

The luxury goods market is made up of apparel, accessories including handbags and shoes, perfume and cosmetics and hard luxury, including watches and jewellery.

Competitive position
In the year to 31 March 2009, Burberry's reported sales were £1,202m. Converting wholesale and licensing revenue to retail sales value (how much the consumer spends on Burberry products), the global sales under the Burberry brand are estimated to be £3.5bn. Burberry is among the top ten global luxury brands.

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 globally; while others are small, more localised operations. Burberry's relevant peer group differs by product category - womenswear, menswear, non-apparel and childrenswear.

Management remuneration is partially based on Burberry's performance relative to peers. A full list of the comparator group, which includes Hermès, LVMH, PPR and Richemont is provided on page 69 of this report.

RISKS

The management of the business and the execution of the Group's growth strategies are subject to a number of risks, the occurrence of any one of which may adversely affect the management of the Group and the execution of growth strategies.

The key business risks affecting the Group are set out below. The steps the Group takes to address these risks, where they are matters within its control, are also described. Such steps will mitigate but not eliminate these risks. Some of the risks relate to external factors which are beyond 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, whose membership includes the Chief Executive Officer, Executive Vice President - Chief Financial Officer, Executive Vice President of Corporate Resources, Senior Vice President of Supply Chain, Senior Vice President Commercial Affairs and General Counsel and Director of Audit and Risk Assurance. At the invitation of the Committee, the Director of Intellectual Property, Head of Corporate Responsibility, Head of Risk Management and representatives from other assurance teams regularly attend meetings. The assessment of the Group's risks and the processes in place for management and mitigation of these risks are considered 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 has 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 has affected the level of consumer spending on discretionary luxury items. During a recession, when disposable income is 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.

During the year, the Group announced a global cost efficiency programme to underpin future profitability, the implementation of which is well advanced and is in line to provide the business with the planned benefits.

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, among other things, to maintain operational and financial control over their businesses. Should these licensees fail to effectively manage their operations the Group's income from royalties would decline. Failure to manage these key relationships effectively could have a material impact on the sales, profitability and reputation of the Group.

To minimise the risks in Japan, Burberry has its own offices and operations in Tokyo and closely monitors its relationships with licensees. 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.

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
In 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 resources internally, 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.

During the year, the Group established a company in the Middle East with its longstanding franchisee to enable both parties to capitalise on further opportunities in certain parts of the Middle East.

Burberry could suffer if its supply chain is unable to produce and deliver goods at a competitive price, on time and to its specification
Burberry continues to evolve its sourcing strategy, refining its selection of suppliers to maintain and enhance product quality whilst improving sourcing efficiency. During the year, the Group announced a global cost efficiency programme which included the restructuring of its Spanish operations and consolidation of its UK manufacturing operations; the implementation of these initiatives is well advanced. These initiatives may adversely affect relationships with existing suppliers during the transition period. If Burberry's suppliers failed to ship products on time, or quality is substandard, 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. The Group continues to rationalise its distribution network to minimise unnecessary costs and to improve delivery timeliness and accuracy.

During the year, the Group established a global planning function to further improve inventory management processes and effective product flow, facilitated by improved reporting and visibility provided by SAP. 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.

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 Burberry Check and outerwear are both an integral part of the brand's success. The Group has evolved its design calendar to enable increased product refreshment and replenishment so as to be more responsive to fashion and consumer trends and to respond more efficiently to changing circumstances and to reduce the risks associated with placing excessive capacity with key product suppliers.

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 seasonal marketing initiatives.

Burberry's operating results are subject to seasonal fluctuations and vary based on the weather
In recent years, the world has seen more unpredictable global weather patterns. 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.

The cumulative change and significant growth within the business places a significant pressure on resources
The combination of the continued development of the Group's IT infrastructure, the development of the global supply chain and the implementation of the global cost efficiency programme combine to exert significant pressure on the business. Governance processes have been put 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 to further support these key initiatives and external consultants are used to supplement internal skills where required.

Burberry is dependent on the strength of its trademarks and other intellectual property rights
Burberry's trademarks and other proprietary rights are fundamentally important to the success and competitive position of the business. Unauthorised use of the ‘Burberry’ name, the Burberry Check and the Prorsum horse logo 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 trademarks, or similar trademarks, 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 trademarks, Burberry's brand image could suffer.

The Group has a dedicated team operating internationally to register and protect its trademarks 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 trademarks and other proprietary rights will be adequate to prevent imitation of Burberry's products by others. Trademarks 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.

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.

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 and the inability to recruit people with the right experience and skills to facilitate future business growth could adversely impact Burberry's results. To mitigate these issues the Remuneration Committee regularly benchmarks the Group's incentive schemes against the market and considers the framework in place to recruit, incentivise and retain key individuals. In addition, there is an ongoing recruitment and succession planning programme 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.

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.

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 underpenetrated 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.

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 is improving 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.

Major incident
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.