Industry and business risks

General market risks. The situation of the world economy has become significantly more uncertain and subject to volatilities, leading to risks for the development of demand for motor vehicles. And competitive pressure in the automotive markets is as high as ever. Customers have meanwhile become used to a certain level of sales-supporting actions. If this competitive pressure in the automotive markets becomes even tougher, possibly due to further worsening of global economic developments, it could lead to the increased application of sales-promoting financing offers and other incentives. That would not only reduce revenues in the new-vehicle business, but would also lead to lower price levels in used-vehicle markets and thus to falling residual values. In many markets, a shift in demand towards smaller, more fuel efficient vehicles is apparent; this is the result of customers’ significantly increased sensitivity to vehicles’ environmental friendliness and the development of fuel prices. A further shift in the model mix towards smaller vehicles with lower margins would place an additional burden on the Group’s financial position, cash flows and profitability. Due to the competitive pressure in automotive markets, it is essential for us to continually and successfully adapt our production and cost structures to changing conditions. We continually analyze our competitiveness. Clear strategies have been formulated for all divisions. Each division consistently pursues the goal of growing profitably and increasing its efficiency.

The recent crisis years have also led to a worsening of the financial situation of some suppliers, dealerships and vehicle importers. For this reason, it is still not possible to rule out supporting actions, which would have a negative impact on Daimler’s profitability, cash flows and financial position.

Risks relating to the leasing and sales-financing business. In connection with the sale of vehicles, Daimler also offers its customers a wide range of financing possibilities – primarily leasing and financing the Group’s products. This business involves the risk that the prices realizable for used vehicles at the end of leasing contracts are below their book values (residual-value risk). An additional risk is that some of the receivables due in the financial services business might not be recoverable due to customer default (credit risk). Another risk connected with the leasing and sales-financing business is the possibility of increased refinancing costs due to potential changes in interest rates. An adjustment of credit conditions for customers in the leasing and sales-financing business due to higher refinancing costs could reduce the new business and contract volume of Daimler Financial Services, thus also reducing the unit sales of the automotive divisions. In addition, risks could arise from of a lack of matching maturities with our refinancing. Daimler counteracts residual-value risk and credit risk by means of appropriate market analyses, creditworthiness checks on the basis of standardized scoring and rating methods, and the collateralization of receivables. Fixed-rate and variable-rate derivative financial instruments are used to hedge against the risk of changes in interest rates. The risk of mismatching maturities is minimized by coordinating our refinancing with the periods of financing agreements. Further information on credit risks and the Group’s risk-minimizing actions is provided in Note 31 of the Notes to the Consolidated Financial Statements.

Production and technology risks. In order to achieve the targeted levels of prices, factors such as brand image, design and product quality play an important role, as well as additional technical features resulting from our innovative research and development. Convincing solutions, which for example promote accident-free driving or further improve our vehicles’ fuel consumption and emissions such as with diesel-hybrid or electric vehicles, are of key importance for safe and sustainable mobility. Because these solutions generally require higher advance expenditure and greater technical complexity, there is an increasing challenge to realize further technological advances while simultaneously fulfilling Daimler’s own quality standards. If we fail to perform this task optimally or if technical developments at an advanced stage prove not to be marketable, that could adversely affect the Group’s future profitability.

Product quality has a major influence on a customer’s decision to buy a car or commercial vehicle. At the same time, technical complexity continues to grow as a result of additional features, for example for the fulfillment of various emission, fuel-economy regulations and safety instructions, increasing the danger of vehicle malfunctions. Technical problems could lead to recall and repair campaigns, or could even necessitate new engineering work. Furthermore, deteriorating product quality can lead to higher warranty and goodwill costs.

Risks related to the legal and political framework. The legal and political framework has a considerable impact on Daimler’s future business success. Regulations concerning vehicles’ emissions, fuel consumption and safety play a particularly important role. Complying with these varied and often diverging regulations all over the world requires strenuous efforts on the part of the automotive industry. We expect that we will have to expend an even larger proportion of our research and development budget to ensure that we fulfill these regulations. Many countries have already implemented stricter regulations to reduce vehicles’ emissions and fuel consumption, or are now doing so. For example, new legislation in the United States on greenhouse gases and fuel consumption stipulates that new car fleets in the United States may only emit an average of 163 grams of carbon dioxide per kilometer as of 2025 (approximately 100 grams per miles). These new regulations will require an average annual reduction in CO2 emissions as of 2017 for cars of 5% and for SUVs and pickups at first of 3.5% (this rather lower rate applies until 2022). This will hit the German premium manufacturers and thus also Daimler harder than for example the US manufacturers. As a result of strong demand for large, powerful engines in the United States and Canada, financial penalties cannot be ruled out. Regulations on the CO2 emissions of new cars also exist in the EU. For 2015, all new cars in Europe will have to meet a fleet average of 130 g CO2/km. The relevant limit for Daimler depends on the portfolio of cars we sell in the European Union and will depend on vehicle weight. Furthermore, the EU Parliament and the EU Council of Ministers are currently dealing with an EU regulation proposed by the EU Commission calling for fleet averages to be reduced to 95 g CO2/km by the year 2020. Daimler will have to pay penalties if it exceeds its limits. The Chinese authorities have defined fleet average fuel consumption as of 2015 of 6.9 liters per 100 kilometers (approximately 160 g CO2/km) as the industry’s target for new cars. As the legislative procedure for 2015 has not yet been concluded, there is a risk that although each car will be calculated for the average of the fleet, it must individually at least meet the previous limits, posing a big challenge for cars with powerful engines. Sanctions have not yet been announced. For the year 2020, a new, very demanding target of 5.0 l/100 km has been stipulated (approximately 116 g CO2/km), although the exact details are still under discussion. Similar legislation exists or is being prepared in many other countries, e.g. in Japan, South Korea, India, Canada, Switzerland, Mexico, Brazil and Australia. Daimler gives these targets due consideration in its product planning. The increasingly ambitious targets require significant numbers of plug-in hybrids or cars with other types of electric drive. The market success of these drive systems will be primarily determined by regional market conditions, for example the battery-charging infrastructure and state support. But as market conditions cannot be predicted with certainty, a residual risk exists. Very demanding regulations for CO2 emissions are also planned for commercial vehicles, which will present a challenge for the Mercedes-Benz Vans division, especially in the long term. Legislation on reducing the greenhouse-gas emissions and fuel consumption of heavy commercial vehicles has also been passed or is under discussion. We therefore have to assume that the statutory limits will be very difficult to meet in some countries. In addition to emission, consumption and safety regulations, traffic-policy restrictions for the reduction of traffic jams and pollution are becoming increasingly important in the cities and urban areas of the European Union and other regions of the world. Drastic measures such as general vehicle-registration restrictions like in Beijing, Guangzhou or Shanghai can have a dampening effect on the development of unit sales, especially in the growth markets. Daimler therefore continually monitors the development of statutory and political conditions and attempts to anticipate foreseeable requirements and long-term targets already during the phase of product development. The biggest challenge in the coming years will be to offer an appropriate range of drive systems and the right product portfolio in each market, while fulfilling customers’ wishes, internal financial targets and statutory requirements.

As of 2013, the EU has stipulated the use of a new refrigerant with reduced climate-damaging potential. In so-called real-life tests in mid-2012, Daimler ascertained a higher flammability than previously assumed. Daimler’s safety concerns are serious and no alternative is available to the prescribed refrigerant at present. For this reason, Daimler is holding constructive discussions with the relevant German and European authorities in order to arrive at possible alternative solutions together with other manufacturers and suppliers. If no solution is found in good time, this could result in negative effects on the production costs of the vehicles involved due to the required technical modifications and on the development of sales.

Procurement market risks. Procurement market risks arise for the Group in particular from fluctuations in prices of raw materials. After the economy-related fall in raw-material prices in late 2011, that trend reversed in early 2012 and led to price increases especially in the first quarter. As the year progressed, lower commodity prices were offset by the loss in value of the euro. The development of raw-material prices and their volatilities in the past three years also reflect worldwide expansive monetary policies as well as diverging economic expectations in the United States, Western Europe and Japan and the emerging markets. The outlook for future price developments remains uncertain, due in particular to the ongoing development of the debt crisis and the increasing influence of institutional investors. That influence can be seen in the stronger demand for commodity investments, and is exacerbating the high volatility of prices in raw-material markets. Vehicle manufacturers are generally limited in their ability to pass on the higher costs of commodities and other materials in higher prices for their products because of the strong competitive pressure in the international automotive markets. Daimler continues to counteract procurement risks by means of targeted commodity and supplier risk management. We attempt to reduce our dependency on individual materials in the context of commodity management, by making appropriate technological progress for example. Daimler protects itself against the volatility of raw-material prices by entering into long-term supply agreements, which make short-term risks for material supplies and the effects of price fluctuations more calculable. Furthermore, in connection with some metals, we make use of derivative price-hedging instruments. Supplier risk management aims to identify suppliers’ potential financial difficulties at an early stage and to initiate suitable countermeasures. Also after the recent crisis years, the situation of some of our suppliers is still difficult due to the tough competitive pressure. This has necessitated individual or joint support actions by vehicle manufacturers to safeguard their own production and sales. In the context of supplier risk management, regular reporting dates are set for suppliers depending on our assessment of them, in which key performance indicators are reported to Daimler and any required support actions are decided upon.

Information technology risks and unforeseeable events. Production and business processes could also be disturbed by unforeseeable events such as natural disasters or terrorist attacks. Consumer confidence would be significantly affected and production could be interrupted by supply problems and intensified security measures at territorial borders. Information technology plays a crucial role in our business processes. Storing and exchanging data in a timely, complete and correct manner and being able to utilize fully functioning IT applications are of key importance for a global group such as Daimler. Risks of occurrences which could result in the interruption of our business processes due to the failure of IT systems or the loss or corruption of data are therefore identified and evaluated over the entire lifecycles of applications and IT systems. Daimler has defined suitable actions for risk avoidance and limitation of damage, continually adapts these actions to changing circumstances. These activities are embedded in a multi-stage IT risk management process. For example, the Group minimizes potential interruptions of operating routines in the data centers by means of mirrored data sets, decentralized data storage, outsourced archiving, high-availability computers and appropriate emergency plans. In order to meet the growing demands placed on the confidentiality, integrity and availability of data, we operate our own risk management system for information security. Despite all the precautionary measures that we take, we cannot completely rule out the possibility that IT disturbances will arise and have a negative impact on our business processes.

Reputation. The general public is becoming increasingly aware of companies’ behavior in matters of ethics and sustainability. Compliance of corporate actions with applicable law and ethical principles is essential for the Daimler Group. Furthermore, customers and capital markets critically observe how the Group reacts to the technological challenges of the future and the extent to which we succeed in placing up-to-date and technologically leading products on the market. Dealing securely with sensitive data is also a precondition for conducting business relations with customers and suppliers in a trusting and fair environment. Daimler applies comprehensive packages of measures so that risks affecting the Group’s reputation are subject to formal internal controls.

Specific risks in the area of human resources. Daimler’s success is highly dependent on our employees and their expertise. Competition for highly qualified staff and management is still very intense in the industry and the regions in which we operate. Our future success also depends on the extent to which we succeed over the long term in recruiting, integrating and retaining executives, engineers and other specialists. Our human resources instruments take such personnel risks into consideration, while contributing towards the recruitment and retention of staff with high potential and expertise and ensuring transparency with regard to our resources. One focus of our human resources management is on the targeted personnel development and further training of our workforce. Our employees profit for example from the range of courses offered by the Daimler Corporate Academy and from the transparency created by LEAD, our uniform worldwide performance and potential management system.

Because of demographic developments, the Group has to cope with changes relating to an aging workforce and has to secure a sufficient number of qualified young persons with the potential to become the next generation of highly skilled specialists and executives. We address this issue by taking appropriate measures in the area of generation management. An additional factor is that production in Germany might be impacted in connection with collective wage bargaining.

Risks relating to equity holdings and cooperations as well as other business risks. Daimler bears in principle a proportionate share of the risks of its joint ventures and associated companies in growth markets for example. In order to utilize additional growth opportunities, and also against the background of increasing national regulations, particularly in the emerging markets, cooperation with partners in joint ventures and associated companies is of increasing importance; the same applies to the resulting risks. The Group includes associated companies and joint ventures in the consolidated financial statements using the equity method of accounting. Any factors with a negative impact on those companies’ earnings have a proportionate negative impact on Daimler’s net profit. In addition, negative business developments at our associated companies or substantial decreases in the share prices of listed companies in which we hold an interest can also mean that impairment losses have to be recognized on the carrying values of the equity investments. If the development of these companies in important markets should fail or be delayed, this could have additionally an impact on the achievement of our growth targets. The successful implementation of cooperations with other companies is also of key importance to realize cost advantages and to combat the competitive pressure in the automotive industry.

The Group is also exposed to a number of risks arising from guarantees it has issued. For example, Daimler holds an equity interest in the system for recording and charging tolls for the use of highways in Germany by commercial vehicles of more than 12 metric tons gross vehicle weight. The operation of the electronic toll-collection system is the responsibility of the operator company, Toll Collect GmbH, in which Daimler holds a 45% stake and which is included in the consolidated financial statements using the equity method of accounting. In addition to Daimler’s membership of the Toll Collect consortium and its equity interest in Toll Collect GmbH, risks also arise from guarantees that Daimler issued supporting obligations of Toll Collect GmbH towards the Federal Republic of Germany concerning the completion and operation of the toll system. Claims could be made under those guarantees if toll revenue is lost for technical reasons or if certain contractually defined parameters are not fulfilled, if additional claims are made by the Federal Republic of Germany, or if the final operating permit is not granted. Additional information on contingent obligations from guarantees granted and on the electronic toll collection system and the related risks can be found in Note 28 (Legal proceedings) and Note 29 (Guarantees and other financial commitments) of the Notes to the Consolidated Financial Statements.

Risks connected with pension benefit plans. Daimler has pension benefit obligations, and to a smaller extent obligations relating to healthcare benefits, which are not completely covered by plan assets. The balance of obligations less plan assets constitutes the funded status for these employee benefit plans. Even small changes in the assumptions used for the valuation of the benefit plans such as a reduction in the discount rate could lead to an increase in those obligations. The market value of plan assets is determined to a large degree by developments in the capital markets. Unfavorable developments, especially relating to equity prices and fixed-interest securities, could reduce that market value. Higher or reduced plan assets or a combination of the two would have a negative impact on the funded status of our benefit plans. Plan assets at December 31, 2012 did not include significant investments in bonds issued by countries which are currently especially affected by the European sovereign debt crisis. Lower yields from plan assets could also increase the net expenses relating to the benefit plans in the coming years. Information on the Group’s pension benefit plans can be found in Note 22 of the Notes to the Consolidated Financial Statements.