Principal risks and uncertainties

Identifying and monitoring risks

The Group faces a number of risks and uncertainties that may have an adverse impact on the Group's operation, performance or future prospects.

It is important for the Board to effectively manage risks and opportunities in seeking to achieve the Group's objectives. The Directors have overall responsibility for risk management and internal control systems. The Board's system of risk management is described in the statement of corporate governance.

The risks and uncertainties described below represent those which the Directors consider to be the most significant in achieving the potential success of the Group's strategy. However, these risks and uncertainties do not comprise all of the risks associated with the Group and are not set out in any order of priority. Additional risks and uncertainties currently not known to the Directors and/or which the Directors believe to be less material may also have a material adverse effect on the Group's business, financial condition or future prospects. The relevant mitigating factors are also described below.

Risk area Potential impact Mitigation
Strategy
New CFC and expansion of current CFC A critical part of the Group’s strategy is to expand its operations by further developing the current CFC and building at least one additional CFC in the UK to increase its capacity to service customers. The Group’s ability to develop the current CFC and replicate its business model in the second CFC cost-effectively and in a timely fashion will depend upon a variety of factors notably: the Group’s ability to hire and train employees to operate the CFCs; management resources; the Group’s ability to roll out the business systems and infrastructure, in particular, in any new CFC; reliable developers and the availability of appropriate equipment and the contractors to design and install such equipment. The Group has purchased a 999-year lease on a site in Dordon, Warwickshire for the construction of the second CFC, and groundworks have commenced. The Group has a detailed plan for the management and resourcing of the second CFC project and the Directors have oversight of the project to ensure that it stays on schedule and within budget.

The Directors are confident that the business systems of the existing CFC can be replicated and enhanced in the second CFC (and in any further CFCs in the future) within the parameters of the capital expenditure budget set for the project and that it can continue to successfully complete projects to expand the existing CFC.
Operational
Single CFC The Group is dependent on the continued operation of the CFC (and to a lesser extent, the Spokes) in order to satisfy customer orders. Any disruption (such as an IT failure or a fire) to the operation of the existing CFC, in particular, or a Spoke may therefore have an adverse effect on the Group’s financial position or affect the ability of the Group to economically deliver products to certain customers. The Group has disaster recovery procedures in place to minimise possible disruption to the business. The Group is in the advanced stages of a plan aimed at achieving the industry recognised “Highly Protected Status”. The CFC is protected by fire and security systems and has a full contingency plan to manage power outages. The Group also has insurance policies in place which cover business interruption to certain maximum levels. In addition, the Group’s plans to build at least one additional CFC in the UK will limit, in part, the effect of any failure at the current CFC. Also, Spokes are able, to some extent, to serve geographies of neighbouring Spokes.
Road network The Group’s delivery service is reliant on deliveries by road: from suppliers to the CFC and from the CFC and the Spokes to customers. This means that inclement weather, particularly snow, and sometimes traffic congestion may reduce the number of deliveries that can be made and/or increase their cost. The Group fits winter tyres to its delivery fleet for the winter period and can optimise its delivery routing system with road speed adjustments, for example, for inclement weather. The Group also subscribes to a dedicated weather information service to give it early warning and more accurate details of extreme weather.
Relationships with third parties
Relationship with Waitrose Ocado’s reputation and brand is based, at least in part, on its relationship with Waitrose. If the Sourcing Agreement with Waitrose were to end or if Waitrose were unable to source products for the Group, Ocado would need to engage additional personnel to: (i) find or create replacement own-label products; and (ii) find appropriate suppliers and negotiate equivalent prices itself.

The Sourcing Agreement also contains provisions which restrict the extent to which Ocado can source products other than from Waitrose, and the extent to which Ocado’s range of Ocado own-label products may be expanded. If the parties terminate the Sourcing Agreement after certain competitors of Waitrose or John Lewis gain control of the Company, Ocado is obliged to pay Waitrose £40 million.
The Group has a successful relationship with Waitrose (which is now in its eleventh year) and in May 2010 agreed a new sourcing arrangement which will continue this relationship until at least 2017. The Group is not particularly dependent on the Waitrose supply chain as about 85% of products are delivered directly to the CFC by the relevant supplier or manufacturer.

Ocado currently stocks approximately 250 Ocado own-label products, and is in the process of extending this range. The Directors do not believe that the restrictions on Ocado own-label products will have a significant impact on the growth of the business or their intended expansion of the range of products stocked by Ocado.
IT systems and security and intellectual property
IT systems The Group relies to a significant degree on the efficient and uninterrupted operation of the internet and its IT and communications systems. The Group’s business model relies on the complex integration of the Group’s website, the highly automated CFC, goods handling equipment and the order fulfilment and delivery operations. Operational problems in the Group’s core systems and technologies (such as computer server or system failures, network outages, software performance problems or power failures) can result in customer orders being unable to be captured on the Group’s website or processed through the CFC, or errors and delays in their delivery. The Group has an IT strategy that is aimed at ensuring plans are in place to have information systems and new technology that provide the capabilities necessary for the Group to maintain the integrity and reliability of its business. The Group has disaster recovery and business continuity contingency plans to maintain the security, integrity and efficiency of its IT infrastructure. The Group’s IT systems are housed in a purpose-built data centre and it has a separate disaster recovery data centre which houses standby servers for all the critical systems and resilient data storage systems. All critical communication links are provided via two diversely routed fibres and the internet connectivity is provided by two major internet service providers.
IT security and fraud If any compromise in the Group’s IT security measures or payment processing systems were to occur, the Group’s reputation may be harmed and it could lose its customers. The Group relies on third parties to provide payment processing services and is exposed to typical fraud risk in relation to card payments. The Group is also subject to IT regulations and compliance requirements. The Group uses encryption and authentication technology to provide the security necessary to effect the secure transmission of information from its customers, such as card payments and to reduce possible fraud. The Group’s customers’ confidential data is protected by a range of both physical and industry standard systems controls. The Group’s website is regularly tested for vulnerability by both internal and external teams. Relevant accounting, IT and other procedures and controls at all levels are clearly set out and some of which are audited across the business to reduce the risk of fraud. Ocado is undertaking a plan to ensure compliance with the Payment Card Industry Data Security Standards.
Intellectual property rights The business and IT systems and intellectual property are not protected by patents or registered design rights which means that the Group cannot inhibit competitors from entering the same market if they develop the similar technology independently. In addition, third parties may independently discover Ocado’s trade secrets and proprietary information or systems. The Group is reliant on copyright and confidentiality and licence agreements with its employees, customers, suppliers, consultants and others to protect its intellectual property rights.
Financing
Funding for capital expenditure The Group’s £100 million debt facility may be terminated by the lenders if the Sourcing Agreement with Waitrose is terminated for any reason. The Group is able to manage whether any such termination rights will arise under the Sourcing Agreement and hence any potential impact on the debt facility (with the exception of the change of control termination right described above).
Exchange rate, interest rate and commodity fluctuations Any depreciation of sterling in relation to the euro will increase the sterling equivalent of the price paid for the machinery used in the second CFC and to expand the capacity of the current CFC (which is mostly purchased from suppliers located in countries that have adopted the euro). Fluctuations in the cost of commodities (in particular, steel) required to build the second CFC and in interest rates will impact on the costs to the business. The Group has a policy, controlled by the treasury committee (and authorised by the Directors), to hedge certain foreign currency and interest rate exposures through the use of derivative financial instruments and fixed and floating instruments. There are approval parameters for hedging arrangements and a policy to monitor and review hedging arrangements including short and long-term foreign exchange rates, interest rates and counter-party risk.
Regulation
Health and safety law A violation of health and safety laws relating to the Group’s operations or construction of the second CFC or expansion of the current CFC could lead to injury to employees, negative publicity and reputational damage, fines, costly compliance procedures and in very serious circumstances, a temporary shutdown of all or part of the business, or a delay in construction of the second CFC. The Group’s health and safety department maintains and monitors procedures, which are aligned with the relevant regulations and industry standards. The Group’s staff are trained in safe workplace practices. The Group is in the process of developing safety procedures and reporting structures for the second CFC construction project.
Product safety The Group is subject to a wide variety of regulatory requirements including those in relation to the manner in which it sources, stores, handles and sells products (such as meat and fish) to customers and relating to the operating of its physical facilities. Any assertion or regulatory investigation that the products supplied by the Group caused illness or injury to customers or others could adversely affect the Group’s reputation with existing and potential customers. There is an established legal and regulatory team in place to monitor developments and to ensure that all existing regulations are complied with. The Group has a food technology department which monitors procedures to ensure quality standards and compliance with applicable food law and which liaises with the Waitrose food technology department.
Governmental regulation A change in regulations relating to the internet and online retail operations, consumer protection laws, the processing of customer data, the environment (such as carrier bags), or the sale, licensing or storage of products could adversely affect the manner in which the Group currently conducts its business. Regulations govern the weight limits of the loads that each van can take and the number of hours that drivers can work on consecutive days, impacting the potential efficiency of the business. The Group has an established governance process in place to monitor regulatory developments and to ensure that all existing regulations are complied with. The Group’s delivery routing software and customised vans (which are specifically designed to improve load-carrying capacity) help maximise the operational efficiency of the Group’s delivery infrastructure within the scope of the existing regulatory requirements.
Staff
Key management, staff retention and recruitment The Group is reliant on its key management and staff for the operation of its business. The Group’s ability to recruit or adequately replace, retain and motivate suitably qualified and experienced staff is important for the Group’s success. The relationship between the Group and its workforce could change if the Company were to formally recognise a union to represent its staff. The business has had good relations with its workforce to date. The Ocado Council, the Group’s employee council, was established by the Group in January 2010 with a remit to discuss the terms and conditions of employment for the workforce and provide for further engagement with staff. The Directors continue to keep staff remuneration and incentivisation under review to ensure it remains competitive. The Directors expect to have constructive communications with any union seeking recognition by the Group.
Risks relating to the industry
Competition and the online grocery market The trend in UK food retailing of moving from the traditional grocery market to the online grocery market may not continue.

The Group may be adversely affected (in loss of market share) by the entrance of new competitors in the online grocery market or if the traditional grocery retailers invest heavily in their online operations. The Group also expects some increased competition from the Waitrose online business, Waitrose.com when certain exclusivity provisions which limit the extent to which the Waitrose.com service may compete with the Group in the Greater London area expire in June 2011.
The Directors believe that the online grocery market will continue to grow rapidly in the UK, particularly as the number of people shopping online continues to increase.

Ocado has a business model which is predicated on offering our customers a superior service in terms of product quality and convenience, reliability and accuracy of delivery, as well as environmental efficiency. The Directors believe that as the Group’s proprietary intellectual property and bespoke IT systems (including the Group’s website, the stock management systems, the CFC, the customer delivery system and the van routing system) become more sophisticated, so the barriers to entry for a potential online competitor become greater. The Directors do not anticipate a significant overall impact on the Company from the increased competition from Waitrose.com.
UK and global economic conditions The Group’s performance may depend on factors outside the control of the Group which impact on UK consumer spending, including political, financial and economic conditions. The Group regularly reviews its approach to pricing, marketing and product range for appropriateness to market conditions and to adapt to customer feedback. Despite the recent economic downturn the Group’s sales have continued to grow rapidly.