1 Strategic Risk Management Case Study Polaris Industries (PII) SEV 621 – Strategic Risk Management December 2016 The Center for Strategy, Execution and Valuation Kellstadt Graduate School of Business DePaul University Dr. Mark L. Frigo Team Members: Stephanie Jaussi Rano Khudayberdieva Daniel Lewis Kyle Olson Jigar Patel Timothy Pierard Matthew Plese Cheryl Procter-Rogers Jacqueline Recchia Alyssa Rotz Alexander Schusler Peter Smith George Szydlo
Transcript
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Strategic Risk Management
Case Study
Polaris Industries (PII)
SEV 621 – Strategic Risk Management December 2016
The Center for Strategy, Execution and Valuation
Kellstadt Graduate School of Business DePaul University Dr. Mark L. Frigo
Team Members:
Stephanie Jaussi
Rano Khudayberdieva Daniel Lewis Kyle Olson Jigar Patel
Timothy Pierard Matthew Plese
Cheryl Procter-Rogers Jacqueline Recchia
Alyssa Rotz Alexander Schusler
Peter Smith George Szydlo
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Table of Contents Storyboard 4 Company Overview 4 Polaris History 4 Company Financial Performance 8 Company Strategy 12 The Commitment Tenet
Ethically Maximize Wealth 13 The Goal Tenets
Fulfilling Unmet Customer Needs 15 Target Appropriate Customer Groups 16
The Competency Tenets Deliver Offerings 16 Innovate Offerings 17 Brand Offerings 18 The Supporting Tenets Partner Deliberately 19 Map and Redesign Process 19 Engage Employees and Others 20 Balance Focus and Options 20 Communicate Holistically 21 Foundation Tenets Genuine Assets 22
Vigilance to Forces of Change 22 Disciplined Performance Measurement and Valuation 23
Risk Disclosures and Analysis 35 Summary, Conclusions, and Lessons Learned 39 Bibliography 41
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Storyboard for the Case This case describes an overview of the Strategy, Strategic Risk, Risk Metrics and Risk Disclosures of Polaris Industries, Inc. and the Lessons Learned.
Company Overview Polaris Industries, Inc. (Polaris, PII), traces its roots to Hetteen Hoist & Derrick, a company in Roseau, Minnesota, that dates back to 1945. Two brothers, Edgar and Allan Hetteen and their friend David Johnson developed the snowmobile product and market in the 1950s. The current company Polaris originates from was founded in 1954. It is headquartered in Medina, Minnesota.
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Today, Polaris has branched beyond its humble beginnings. It employees over 8,000 people and does business in over 100 countries.1 Its market cap as of December 2, 2016, was $5.6 billion. Its 2015 sales were $4.7 billion, a 5% growth from 2014. Its profit for 2015 was $455 million, a 0.25% increase from 2014.2 As seen by the following chart, its 10-year performance, as compared to the S&P 500, is quite impressive, but it has run into trouble in the last couple of years.
Source: www.marketwatch.com
1 Polaris Industries Inc. website, http://www.polaris.com/en-us/company, Web. 3 December 2015 2 Polaris Industries Inc. 2015 Annual Report.
As stated in the Polaris 2015 annual report, its vision, strategy, and guiding principles are: Vision “Fuel the passion of riders, workers and outdoor enthusiasts around the world by delivering innovative, high-quality vehicles, products, services and experiences that enrich their lives.” Strategy “Polaris will be a highly profitable, customer-centric, $8 billion global enterprise by 2020. We will make the best Off-Road and On-Road vehicles and products for recreation, transportation and work supporting consumer, commercial and military applications. Our winning advantage is our innovative culture, operational speed and flexibility, and passion to make quality products that deliver value to our customers.” Guiding Principles ● Best People ● Best Team ● Safety & Ethics Always ● Customer Loyalty3 Polaris has branched beyond its beginnings in snowmobiles. It now produces a wide array of products from off-road vehicles to motorcycles to utility vehicles, along with replacement parts, accessories, and garments. Its products, brands, and reporting segments are listed below:
Source: Polaris Industries Inc. 2015 Annual Report.
3 Polaris Industries Inc. 2015 Annual Report.
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Polaris now seeks to fulfill the outdoor vehicle needs of consumers in the summer and in the winter, with All-Terrain Vehicles, motorcycles, and side-by-side vehicles. This is exhibited in the below image. In 2013, Polaris acquired the Indian motorcycle brand, and went to Sturgis that year to launch the Chieftain motorbike.
In addition, it is now a company with global reach, as demonstrated by its 2015 Sales by Geography:
Source: Polaris Industries Inc. 2015 Annual Report. The Polaris global reach included more than just customers. In addition to its existing manufacturing facilities in the United States and Mexico, in 2014 Polaris opened a new manufacturing facility in Opole, Poland.
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Financial Performance of the Company This section includes a summary of Polaris’s financial performance, including the latest Credit Suisse HOLT Lens data.4
The chart below titled, “Sales Growth (%)”, shows that Polaris has been growing since 2010 at a higher than average rate amongst competitors in the Leisure Products category. However, it should be noted that sales growth for 2015 were the lowest since 2009.
The chart below titled, “Margins (%)”, shows that Polaris’s margins have been relatively high. One of Polaris’s key strategies is to use Lean and Six Sigma techniques to rid bottlenecks and waste in the manufacturing process. Since 2009, Polaris has had above average margins within the Leisure Products industry. This can be attributed to the leaner processes, better-trained employees, and Polaris’s abilities to implement new manufacturing technologies.
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Value Relevant Track Records As of December 2, 2016, Polaris’s future percentage was 47.85%, which represents where investors believe a firm is positioned on a product life cycle. With a market capitalization of 5.812B and with an implied market value of assets of 3.031B, Polaris is positioned stronger than rival Harley Davidson (HOG) whose future percentage amounts to 33%. Polaris’s percent future more closely aligns with companies including Wynn Resorts, Jack in the Box Inc., and AutoZone Inc. who all have future percentages of 41%, which is no greater than the US Median. However, these firms lag larger growing companies (e.g. Groupon, Tesla, Netflix) who all possess future percentages exceeding 70% ("Life-Cycle Performance - % Future", 2016).
Company CFROI 3 Year Median
Next Year 2016 CFROI
% Future
Polaris 27.32 16.15 47.85%
Harley Davidson 11.64 14.08 33.00%
Thor Industries 22.78 28.07 22.97%
Strategy and Reinvestment The purpose of a competitive life-cycle analysis allows firms to identify areas for potential change early on while risks may still be proactively addressed. Similarly, it provides a methodological approach for firms like Polaris to address their resource allocation decisions. Polaris needs to address the tenets of Return Driven Strategy Framework to determine where to employ assets. As the company recovers from its 2016 recalls of the RZR 900 and 1000 models, additional assets allocated to the business must ensure that they meet customer needs and do so in a way that does not jeopardize potential returns. Innovating offerings requires not only ensuring that the offerings meet customer needs but that they also are built ethically and offered in a way that does not pose significant harm to consumers. In short, Polaris must stop the fade by focusing on proven strategies that increase CFROI while doing so within the firm’s risk appetite. As Polaris grows and takes market share from their rivals, their rivals will surely notice the loss of sales and take responsive action to recover market share as the industry is relatively stagnant. Such competitive pressures will give rise to increased competition and the risks inherent in a rivalry-driven market. These risks are further identified and detailed as part of the overall risk analysis of Polaris.
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Intangible Assets With a focus on its “four centers of excellence” in Minnesota, Iowa, Wisconsin, and Mexico, along with an emphasis on lean manufacturing, Polaris has utilized operational efficiencies as its primary competitive advantage. Whereas Harley Davidson’ marketing, brand reputation, and engaged employees set HOG apart, Polaris has relied on its cost structure, process improvements, and breadth of offerings as their advantage. Like most firms, this expertise and proven cost-focus approach are key, genuine assets even though they are not reported on the firm’s balance sheet. Using the Return Driven Strategy Framework, Polaris has particularly focused on targeting appropriate customer groups as it has appealed to a wide range of the market. While Harley has focused its primary attention on Baby Boomers, Polaris’s focus on a wider age range has broadened their market. With a wide market and a focus on process improvements, Polaris is utilizing their core philosophy as a key advantage, even though the firm has experienced minor setbacks such as the 2016 recalls. However, competitive forces remain strong. HOG continues to aggressively market their offerings and as both companies experienced deteriorating sales in Q3 2016, it is possible that the market share may easily slip away from Polaris if they fail in safeguarding their core processes. Of chief concern is the death of Polaris co-founder David Johnson on October 8, 2016. Such times of change require a firm to remain true to their core business processes and strategy. Resisting this turbulent force of change and remaining true to their core values and strategies is essential for the long-term competitive viability of Polaris. Despite proven past success as a high-performance company, Polaris faces strong pressure and significant future risks that must be proactively addressed. Likewise, the key assumptions of the business must be articulated and validated and the firm must clearly articulate their risk appetite. Percent Future Consequently, considering the forces upon Polaris and its CFROI, Polaris is likely currently in the competitive fade segment of the market along with rival Harley Davidson. Why does Polaris have a higher future prospect than Harley? Overall, the motorcycle market is relatively stagnant with limited growth in the overall market. Sales growth is expected after 2016 to grow only by the single digits. Yet, Polaris has grown by taking market share from Harley. For instance, in 2015 Harley saw sales fall by 3.4% whereas Polaris motorcycle sales went up 67% during this same period (Duprey, 2016). As Harley contracts, Polaris has been able to grow market share. Polaris has also appealed to a wider market than only motorcycles – opening themselves up to new customer groups across the world as they compete in over 100 countries. Investors are accordingly assigning Polaris a higher future percentage than Harley. Yet, both firms have had difficulties in 2016 and remaining true to their core strategies and safeguarding
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their genuine assets will be critical to ensuring that the firm remains competitive and that their economic returns do not quickly fade to no greater than the long-term cost of capital.
Company Strategy
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Tenet 1: Ethically Maximize Wealth Polaris has defined what maximizing wealth ethically looks like in their annual reports, quarterly financials and Code of Business Conduct and Ethics. In summary, Polaris looks to maximize wealth in the following statement, “Polaris will be a highly profitable, customer centric, $8B global enterprise by 2020. We will make the best off-road and on-road vehicles and products for recreation, transportation and work supporting consumer, commercial and military applications. Our winning advantage is our innovative culture, operational speed and flexibility, and passion to make quality products that deliver value to our customers.” 5 The company has further defined their strategy for 20206: ● 5-8% in annual organic growth ● Global markets becoming 33% of Polaris revenue ● $2 billion from acquisition and new markets ● Quality, Delivery, cost improvement ● Sustainable, profitable growth – net income margin>10% It is clear that Polaris’s strategy is to maximize wealth ethically. One of Polaris’s guiding principles is ‘Safety & Ethics Always.’ They are transparent in publishing financials on a quarterly basis. Additionally, their Code of Business Conduct and Ethics and encourages 5 Polaris Industries Inc. 2015 Annual Report 6 Polaris Industries Inc. 2015 Annual Report
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employees to report any violations of the Code anonymously. The Code contains a “Polaris Creed” and Policy is outlined through a comprehensive approach labeled as “Understand It, Live It and Work it.”7 It is explicitly stated that the Code will drive success (wealth) and is maximized through internal and external stakeholders. The Code is meant to guide actions and business objectives and will prepare them to face ethical dilemmas. Commit Managers and understand investor's wealth depends on improving livelihood of employees and customers: Polaris understands that wealth should be facilitated through stakeholders. Their success relies on attracting and retaining key employees including managers and considers the relationship with employees to be ‘excellent.’ Without a diverse management team and workforce strategic objectives could be impeded. Their letter to shareholders explicitly states, “We have an unwavering resolve to be great for our customers, our employees, our shareholders and all other stakeholders.”8 Additionally, many of the employees own their products and serve as dual customers/employees. 750 employees are involved in a testing group and can provide feedback to aid in development. Polaris has made several acquisitions in the past 5 years relating to a variety of different business units. They expect increase in sales and decrease in costs primarily from efficiencies related to procurement, distribution, and expanded product offerings. Employ Genuine Assets: Polaris believes their ‘winning advantage’ is their innovative culture, operational speed and flexibility and passion to make quality products that deliver value to customers. Genuine Assets: Polaris created genuine assets that enabled the company to sustain growth and maximize profitability. These include efficient production scheduling methods, the Indian motorcycle brand, company employees, and innovative products and patents. How wealth is measured in terms of cash flow performance: In their 2015 Annual Report, Polaris measures wealth through Cash Flow Return on Investments, Asset Growth Rates and Stock Price Valuations relative to the S&P 500. Management compensation incentives also affects ethically maximizing wealth. The Compensation Committee ensures that executive compensation stay within the guidelines of the Securities and Exchange Commission. Cash Flow Return on Investments should be twice corporate averages.
7 Polaris Industries Inc. Code of Conduct and Business Ethics 8 Polaris Industries Inc. 2015 10K
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● Polaris debunks any potential misleading data in financial statements by stating the Return on Invested Capital for 2015 (32%). They also compare it to their peer average (+13%).
Asset Growth Rates should exceed average market levels. ● The position of the competitive life cycle puts them in competitive fade stage.
Relative to the S&P, Polaris leads the average by 8% but their trend has leveled out since 2015. ● Market capitalization is also measured in the Holt Lens and states that they aim to reach the
objective of high performance companies ($10 billion).
Tenet 2: Fulfill Otherwise Unmet Customer Needs Polaris’s strategy is to deliver quality products to customers. Additionally, building customer loyalty is one of their guiding principles. Their strategy is apparent through their position as a market leader for strategic business units and product lines (Specifically Off-Road Vehicles, Snowmobiles, RZR and Ranger). Continually identify exactly what needs cause customer to buy Consumers feel confident in investing in the Polaris brand not only because of the quality of the products but in many cases the dealer relationship promotes consumer confidence in the Polaris product lines. The dealer employees are empowered to educate the customer and provide extended service and warranty. The dealer is able to fulfill customer to fill an order quickly and efficiently due to the Retail Flow Management system. The data from this system will also help Polaris stay abreast of customer trends for a variety of product lines (ATVs,Motorcycle, Slingshot, Parts, Garments and Accessories). Continually identify what customers would buy if it were available They have continued to validate product offerings by testing in the lab and the field. For example, they have a 750 person employee test group where they use feedback for new products and improving existing ones to adjust the offerings to meet customer unmet needs. Focus on real reasons for purchase and price based on customer value The real reasons their customers purchase is because of the vehicles enhance the activities that they perform in their lives. The customers trust the quality and value the vehicle’s function because they enhance the hobbies or professions they possess like hunting or navigating on multi-acre land that they own. Additionally, the American Muscle Brand is prominent in their transportation and recreational vehicles. The pricing is based on targeting customers groups with disposable income that are interested in recreational vehicles (specifically ATVs, RZRs and Rangers). They have a good, better, best pricing strategy to capture more of the consumer market.
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Competition Wars Polaris believes they can cut into market share by building highly recognizable brand products, like the classic Indian branded ‘Scout’ motorcycle and Victory branded ‘Vegas 8-ball’ bike, at an affordable price point to offer unique products. In addition, Polaris has the potential to attract a potentially new, younger customer base that is interested in having a classic brand at a more reasonable price. Polaris has lowered their cost of goods through their expansion of manufacturing into Mexico. Additionally, the brand will gain recognition with the existing demographic because of Polaris’s unveiling of the Indian Launch at Sturgis—the infamous motorcycle rally which attracts thousands of current motorcycle riders. Tenet 3: Target Appropriate Customer Groups Polaris is focusing on existing consumer base (United States – 78% of sales) and expanding their international sales (currently 14% of sales). They are investing and focusing on marketing their core business unit (Off-Road/Snowmobile (78% of sales) and broadening their base with acquisitions (like Taylor-Dunn for industrial customers) and product lines like the Slingshot and Indian motorcycle. Group Customers based on characteristics of Tenet Two /Identify where there is high potential for unique offerings: Polaris has made strides in marketing to a new customer base while collaborating with well-known brands like Jack Daniels and Zac Brown Band. Additionally, they can leverage some of the online forums and product launches that may appeal to this demographic. Target customer groups whose needs are large enough to justify upfront and ongoing investments: Designating R&D and manufacturing dollars towards product lines that will appear to the new generation of Polaris owners will justify upfront costs and ongoing investments if Polaris is going to achieve their 2020 strategic objectives. For example, Polaris admits that they did not devote enough resources to their Indian dealer network and are rectifying the situation. COMPETENCY TENETS Tenet 4: Deliver Offerings The Deliver Offerings Tenet is a very important one to a company because it speaks to the company’s strategy in providing the “effectiveness of the firm in providing the goods, services, and intangibles to achieve the higher three tenets.”9 As you will see in the next tenet, Innovation is an important piece in fulfilling the customer’s unmet needs; however, what good is it to have a product if you are not able to get it into the hands of your target market. This is why Polaris sees
9 Frigo, Mark L. and Anderson, Richard J. Strategic Risk Management A Primer for Directors and Management Teams. Edition 1.0, 2010, pg. 81
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strategic value in implementing a new dealer ordering system called Maximum Velocity Program (MVP). It is through this system that larger dealers are able to place ORV orders in two week intervals. This ordering cycle then feeds into the production process allowing to quicker turnaround times in the production of the product and ultimately getting the product to the consumer. In a similar strategy, Polaris has also integrated the Retail Flow Management (RFM) ordering system for their motorcycle business and most ATV business. The premise is similar; however, because of the products being discussed, dealers are able to make orders on a daily basis as well as make stock orders. Polaris believes that when executed fully, they can reduce the fulfillment times down to less than 18 days. This is a huge advantage for Polaris and their customer base will not have to wait as long for their product and for their needs to remain unmet. It is evident that Polaris is employing “Genuine Assets which allow the firm to operate effectively and efficiently in ways which other firms cannot, when measured by the ability to produce and deliver offerings which achieve the higher tenets.”10 Lastly, Polaris has also made investments in building a new production facility in Huntsville, Alabama. The purpose of this new facility is allow the company to easily meet the production demands of their customers and also have more flexibility and capacity. This facility will be 725,000 square feet and will aid in the production of their ORV and Slingshot product lines. This also shows its support for innovation as the Slingshot is a brand new product line. Tenet 5: Innovate Offerings Innovation is necessary for a high performance company to be successful as it offers the opportunity for the company to continually meet the unmet needs of the consumer. Polaris has definitely taken this approach as they have been feeling the pressure from their competitors in the industry. Polaris highlights the fact that the “side-by-side vehicle market sales have increased approximately 4% during 2015,”11 and has grown consistently over the past few years with the key driver being the relentless innovation that they have seen from their competitors and new entrants. It is evident that this industry is dependent, in part, on innovation in order to grow. Polaris has pointed to innovation as being a key growth component of their growth strategy and expects this piece of their business to continue to gain more and more share of their total business in the years to come. They have accepted the reality that they cannot “compete as effectively with their competition”12 but see the global market as a place that they can have the most opportunity and chance for success. Polaris has made many big bets on innovation in the past year: Introducing twenty ORV models, the RZR XP 1000 Turbo, the Polaris General 1000, adding to the Indian Motorcycle brand with the new Scout Sixty, expanding their AXYS snowmobile lineup by seven new models and purchasing several companies. While it is evident that Polaris has taken innovation very 10 Frigo, Mark L. and Anderson, Richard J. Strategic Risk Management A Primer for Directors and Management Teams. Edition 1.0, 2010, pg. 81 11 Polaris Industries Inc, 2015 10K 12 Polaris Industries Inc, 2015 10K
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seriously, we must also, “Beware of innovation for innovation’s sake, and ensures that the customer needs are always the focus of innovation.”13 Polaris must ensure that the various innovation objectives that they have undertaken and introduced meets an unmet need of their customers. Innovating only to obtain a product into the market before a competitor is a quick way to diminish your company in the eyes of the customer. Polaris realizes that even though they have numerous innovation projects in the works that there “is no assurance that this level of investment in research and development will be sufficient to maintain our competitive advantage in product innovation, which could cause the business to suffer.”14 They have invested a significant amount of money, approximately $166.4 million, into their R&D program with 750 employees dedicated to the development of these products. Their dedication to this process is evident and their identification of the risk involved is impressive. As the book Driven astutely points out, we must “Recognize the importance of failure in innovation; failure at the right time and at the right levels is absolutely necessary for successful innovation toward the achievement of extraordinary performance.”15 While many of the innovation offerings at Polaris may in fact fail, there is no better time to fail that when you are an industry leader and seeing year over year sales growth. Tenet 6: Brand Offerings Branding is a “psychological bridge”16 that connects a customer’s need to a company’s offering that ultimately meets that need. The ultimate goal here is to have the customer associate your company’s product with fulfilling a specific need that is unmet. In the case of Polaris, they have utilized their Genuine Assets to help in this association. One way that we see this is through their acquisition of Indian Motorcycle in 2011. There is a great deal of brand significance that comes with the purchases, as the customer base this appeals to is very loyal. Indian Motorcycle is the first motorcycle in the United States so the history and brand nostalgia allows greater weight to be placed on the importance of the brand offerings meeting the customer needs and they will want to feel like they are “a part” of something greater. Polaris is capitalizing on this by re-launching the brand with new product offerings that meet today’s customer needs. Polaris also has a long-standing reputation in their snowmobile segment of dependable, having high quality and for great performance. On top of these characteristics, being first to market is often associated with the company. Consumers enjoy when they know they can depend on a product and know that it will perform as needed, when needed. They also enjoy knowing that when they purchase a Polaris snowmobile, they are purchasing a product that has the latest enhancements over the competition. This ties in very heavily with the innovation tenet that Polaris has invested in. This only enhances the consumer's’ purchase experience and helps them
13 Frigo, Mark L. and Anderson, Richard J. Strategic Risk Management A Primer for Directors and Management Teams. Edition 1.0, 2010, pg. 101 14 Polaris Industries Inc, 2015 10K 15 Frigo, Mark L. and Anderson, Richard J. Strategic Risk Management A Primer for Directors and Management Teams. Edition 1.0, 2010, pg. 101 16 Frigo, Mark L. and Anderson, Richard J. Strategic Risk Management A Primer for Directors and Management Teams. Edition 1.0, 2010, pg. 117
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to justify the purchase. THE SUPPORTING TENETS Tenet 7: Partner Deliberately This tenet has the underlying premise that an effective organization will plan and build business relationships with the correct partners that will aid them in certain operational activities with the ultimate goal of being able to effectively offer their customers an innovative product that meets their needs. Polaris has taken many strategic actions in order to strive to accomplish this goal. Polaris believes that it will be through “targeted acquisitions, non-consolidating investments, alliances, and new joint ventures and partnerships”17 that they will be able to achieve strategic growth and gain the most opportunity in growth their global presence to 33% of their total revenue stream by the year 2020. It is through these partnerships that they will be able to mitigate some of the risks associated with a changing economy and market and have a more diversified portfolio that will ultimately meet the unmet needs of the consumer. We have seen this with their recent partnership with Brammo. This company primarily focuses on the development of electric vehicles; however, Polaris is interested in its electric motorcycle business. With the ever-changing risk in regulations and the environment, the consumers are becoming more conscientious about the products they use and the effect they have on the world. By partnering with this company, Polaris is obviously trying to ensure they are able to meet these customers’ needs when they become more prevalent in the future. As the book Driven points out, a high performing company must “Deliberately choose partners based on an assessment of the Genuine Assets brought by each partner and how that can help the firm to build unique offerings as the competency tenets require.”18 Tenet 8: Map & Redesign Processes One of Polaris’s key strategic objectives is to enhance their LEAN enterprise by improving their quality, delivery and costs. They are being particularly aggressive with this tenet over the next five years as they see the absolute importance in making this strategy successful. They have stated they have goals of “reducing our average delivery time by approximately 40 percent and improving quality by at least 25 percent. By implementing LEAN properly, we can significantly increase our delivery speed and reliability to our customers, improve our product quality, and reduce factory inventory—all while reducing the cost to produce our new and innovative products.”19 With Polaris emphasizing their efforts to maximize their manufacturing processes, they have concluded that they need someone to have ownership and oversight on the LEAN strategy. Kenneth J. Pucel is the Executive Vice President of Global Operations, Engineering and LEAN. Kenneth comes from a background of managing Boston Scientific Corporation’s supply chain and manufacturing processes so his experience matches well with his 17 Polaris Industries Inc, 2015 Annual Report 18 Frigo, Mark L. and Anderson, Richard J. Strategic Risk Management A Primer for Directors and Management Teams. Edition 1.0, 2010, pg. 133 19 Polaris Industries Inc, 2015 Annual Report, p. 9
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responsibilities to enhance Polaris’s LEAN strategy. We have seen Pucel’s commitment to this process as we saw under the Deliver Offerings Tenet when Polaris invested in building a new production facility in Huntsville, Alabama. Commitment to its capacity to meet consumer demands drives wealth to the shareholders as costs can be effectively managed and a focus on quality can be maintained. Tenet 9: Engage Employees & Others Polaris is a great example of a company that has designed and implemented hiring, training and incentive programs to create engaging and dedicated employees and dealerships. Seasonality plays a large role in the employment variability of its employees as there could be large increases during production timeframes went they are ramping up for the next seasons demand. On average, in 2015, Polaris employed 8,100 full time employees. This is a large increase of 16% over the previous year. This growth in the number of employees shows the company’s commitment to its own growth objectives. Reductions in your workforce can be cause for concern as the company may be struggling and trying to cut costs. Growth shows optimism and a demand level that is increasing. Engagement is very important to a company’s success. If an employee is not committed to the strategy and objectives of the company, little progress can be made. One key program that Polaris has instituted is their offering to receive a free product from their various product line ups after one year of employment. This increases employee retention as well as incentivizes them to help the company grow. If there is no growth, this “perk” goes away. This also enables the company to create excitement around their products as well as create customers out of their employees. What better genuine assets can a company have than their employees being spokespeople and advocates in the marketplace. Tenet 10: Balance Focus and Options As part of Polaris’s 2015 annual plan, they have focused on five areas that they believe will be the driving strategies that will make them successful in the years to come and into 2020. These include: 1) Best in Powersports PLUS growing at 5-8% annual organically; 2) Global Market Leadership with more than 33% of their revenues coming from this market; 3) Growth Through Adjacencies with more than $2 billion of their revenue coming from acquisitions and new markets; 4) Lean Enterprise is Competitive Advantage with significant quality, delivery and cost improvements; 5) Strong Financial Performance with sustainable, profitable growth and Net Income Margin being greater than 10%.20 It is evident that Polaris is taking a strategically targeted and focused approach to identifying what till mean success for their company in the coming years. Following these strategic objectives, Polaris has made significant investments in making their manufacturing and supply chain operations more efficient, acquiring numerous companies with Genuine Assets that will lead to them fulfilling unmet needs and investing in innovation.
20 Polaris Industries Inc, 2015 Annual Report
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Investing in numerous opportunities allows Polaris to take on risks in some areas and gives them the options to take on even higher risks in other areas with the assumption that some of their investments will pay off. This level of diversification can give Polaris the flexibility to adapt to market conditions and its consumers. As the book Driven states, “Build flexibility into business plans, and attempt to allocate resources in ways to avoid “points of no return” when creative planning can allow for this flexibility.”21 Tenet 11: Communicate Holistically Communication is a key aspect of the Return Driven Strategy and one that is utilized by Polaris. Clear and consistent communication is important to the success of a high performance organization. Polaris, in this regard, is very transparent with its employees, shareholders and partners when it comes to its financial status, newsworthy events such as recalls and its commitment to being a steward in the community for environmental topics. From new employees to people that have been with the company for years, there is a concise communication as to what the direction the company is going and the steps needed to be taken in order to get there. Key stakeholders are also away of the direction the leadership team wants to take the company in the coming years. They have also included webcasts as part of their quarterly calls to again build on the trust that they are communicating in a holistic manner. Being transparent on these topics only enhances the relationship the company has with its employees and key stakeholders, which also feeds into our first Tenet of Ethically Maximize Wealth. The book Driven mentions that a company must “Design communications with specific purpose of achieving the higher tenets, noting how every communication has the potential to impact all aspects of the business, not just the ones intended.”22 Polaris has shown great discipline in ensuring that their communications to the market are not just advertisements, but also an extension of what the company stands for which leads to more brand awareness, sales and ultimately an increase in shareholder equity. When it comes to innovation, Polaris has come out with the Slingshot; however, the awareness for this product is very low at only 15%. In order to strategically change this, they have significantly increased their event presence. In fact, in 2015, Polaris “sponsored their first-ever Owner’s Ride at Sturgis, where 700,000+ motorcyclists couldn’t miss the line of sleek Slingshots hugging the curves.”23 By instituting these events, they can utilize their current customer basis to create more awareness for their innovative products and the company in general. This is all done with the intent of ethically maximizing wealth.
21 Frigo, Mark L. and Anderson, Richard J. Strategic Risk Management A Primer for Directors and Management Teams. Edition 1.0, 2010, pg. 173 22 Frigo, Mark L. and Anderson, Richard J. Strategic Risk Management A Primer for Directors and Management Teams. Edition 1.0, 2010, pg. 187 23 Polaris Industries Inc, 2015 Annual Report
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FOUNDATION TENETS Genuine Assets Polaris created genuine assets that have enabled the company to sustain growth and maximize profitability including efficient production scheduling methods, the Indian motorcycle brand, company employees, and innovative products and patents. Over the years, Polaris has expanded its business to offer multiple products in various categories, and began growing through strategic acquisitions. This helped Polaris develop vertical integration, and flexible manufacturing, which allows Polaris plants and employees to have cross product manufacturing capabilities. All of this has enabled Polaris to implement Retail Flow Management (RFM) system for motorcycle and ATV manufacturing. “The RFM system allows dealers to order daily, create a segment stocking order, and eventually reduce order fulfillment times to what we expect will be less than 18 days.”24 This program enables Polaris to maximize efficiency, reduce costs, and maximize profits for shareholders. Since acquisition and relaunch of Indian motorcycles, and improvements in Victory motorcycle models, revenue from motorcycle sales from 8% of its revenue to 15% of Polaris’ revenue, increasing for 5 years straight. Indian is an iconic brand, and once Polaris acquired the brand and redesigned the motorcycle models, adding a new Thunder Stroke 111 engine to its Chieftain model, the sales has increased 67%. In addition to motorcycles, Polaris offers motorcycle gears and accessories, and has Indian Motorcycle Riders Group. Polaris has invested heavily in creating a workforce who is dedicated, talented, and who is reward is aligned with company’s performance. Its business model has seasonal variability, and due to implementation of RFM, employees are cross-trained to build various products, such that if Polaris was to receive a snowmobile order off season, it has the workforce and facility to build and complete the order. These employees are flexible, skilled, and dedicated to company’s success. In addition, Polaris holds a large portfolio of patents, trademarks, copyrights, trade secrets. Company’s success has attracted much attention and attempts have been made by competitors to copy the design or technology. Polaris protects its intellectual property rigorously, and maintains its competitive advantage. Vigilance to Forces of Change As Return Driven Strategy states, every return-driven firms are vigilant to forces of change, and consider it with every tenet and in overall strategy to drive high returns and wealth-creation. To remain ahead of the game, Polaris invests heavily in Research and Development, strategically acquiring companies that offer products or technological innovations that enables entrance into category quickly, and designs products and offerings that targets broader demographic to capture
24 Polaris Industries Inc, 2015 Annual Report, p. 32
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the shift in demographic. Polaris’s sales come from ORVs, ATVs, and Snowmobiles combined makes up the largest portion of its business. Understanding that these are recreational vehicles that are also seasonal, Polaris diversified its business to include motorcycles, commercial and defense units, and GEM. As the oil prices declined sharply, reducing disposable income in its’ key customer bases, Polaris’ overall financial performance was positively offset by growth in its motorcycle sales. In addition, as Polaris’s key customer bases for its ATV, ORV and Snowmobiles age and has increased spending power, Indian brand motorcycles is a great product offering for Generation X and Baby Boomer customer demographics. With shift and growth of electric powered vehicles, Polaris acquired Brammo, and introduced Victory Empulse TT, Polaris’s first electric motorcycle. Polaris recognizes that there is a demand for environmentally friendly but powerful vehicles, which will likely translate well to motorcycles as well. Company stated in its annual report, “Our strategy in the electric market is similar to the Tesla Motors® model, where green is on par with performance.”25 Disciplined Performance Measurement and Valuation Polaris has continuously demonstrated its ability to understand what drives the business, and how its strategy and business plans, implementation of the plans, and results are interconnected. This is evident through careful examination of company’s quarterly results and earning calls summaries. It is evident that Polaris continuously monitoring its’ strategy and execution of business plan, and continuously adjusting the strategies and goals based on performance and market conditions. As the Return Driven Strategy states, “Even simply knowing whether or not a business’s performance is directionally good or bad can be difficult to discern from the financials.”
25 Polais Industries, Inc. 2015 Annual Report.
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Assumptions
Operations Assumptions Successful Design and Launch To achieve company’s year 2020 financial and market share goals, Polaris embarked on ambitious product updates and redesigns, as well as launch of brand new products. They launched over 20 new ORV and 2 motorcycle models in 2014, and 2015. Their product launch was to strengthen its #1 market share position in ORVs category through successful design and launch of new MY’14.5 and MY’15 ORV models including RZR XP 900 trail and RZR XP4 900 trail.26 Polaris assumed that the products were well designed and adequately tested for its safety and quality. Superior Product Quality During the design and launch of new products, Polaris was confident in superior design and quality of the products that are being introduced. In the previous years under the leadership of current CEO, Scott Wine, Polaris has experienced steady growth and products consistently well. Polaris has not experienced any mass recalls of products, further assuring the company leaders that Polaris’s product quality is superior to that of competitors. 26 Polaris Reports Record First Quarter 2015 Results, Polaris Industries, Inc. 23 April, 2015
25
Viable Acquisition Candidates Exist (and Capital available to Execute) Polaris’s business plan includes growth through acquisitions, as company stated in its annual report. Their strategy is based on assumption that viable acquisition candidates exist and capital will be available to execute the strategy. Continued growth is important for Polaris to continually maximize shareholders’ wealth, create a more LEAN and flexible manufacturing and distribution channels. For that reason, company intends to continually acquire business units that add value, aid in creating a more LEAN and increase efficiency. Polaris assumes that its access to capital will also remain steady and available, as company identifies number of viable acquisition opportunities that financing will be available to execute these plans. Demand Consistency/Growth Assumption Business Unit Growth Remain Consistent In order for Business Unit growth to remain consistent, Polaris assumes that their product offerings are satisfactory to meet customer’s otherwise unmet needs. Polaris’s largest segments of products (Off-Road Vehicles and Snowmobiles) rely partially on assumptions of weather (snowmobiles) and that the market segment will continue to use Polaris vehicles for their transportation and recreation needs. Polaris assumes their top product lines will continue to ‘win’ at side by side comparisons to similar products. Additionally, as of the 3rd quarter of 2016, the company has enhanced new safety and quality improvements in order to combat recalled product and they assume this will contribute to a reduction in recalled products. Consumer spending will Remain Consistent with Economic Conditions The assumption that demand will remain consistent is based on the economic climate and that retail trends will remain consistent. In their 3rd Quarter (2016) earnings report, they address the fact that “North American Retail Trends Continue to be weak.”27 In their Q3 2016 PII Earnings Presentation, ty address the fact that Global Markets Economies are weak and unpredictable and the price of Oil has continued to put pressure on usage of their vehicles. In addition, in many of their business units, discretionary income will be used to purchase their products so they have to assume that customers will continue to have it. There may be an opportunity to analyze the United States Disposable Income Economic Forecast to help mitigate this risk. Growth in Energy Efficient Vehicles Their investment in electric vehicle segment contributes to what they assume to be an accepted innovation by their customer base. They also assume that legislation for these vehicles will not change.
27 Polaris Industries, Inc. 2015 Annual Report, pg. 5
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External Factors Assumptions Weather will Remain Favorable/Consistent Long Term The growth of Polaris various product segments is directly associated with the underlying assumption that the weather will directly influence a need to be fulfilled with the customer. Polaris has hefty growth goals through the year 2020; however, when it comes to their snowmobile product line, which is part of their largest product segment, is largely impact on seasonal weather shifts. Global warming can have a significant impact on the demand for these types of vehicles. They have seen in the past that having a late snowfall, less snowfall in general and warmer weather can negatively impact their sales in certain regions; however, with global warming having more of a worldly impact, the regional impact with start to spread to other areas. The short-term impacts may be minor but the long-term implications for their product line can be dramatic. If this is the case, Polaris will need to rely on other product segments that are not directly related to weather in order to achieve their long-term growth objectives, and not their staple product line. Polaris has stated that, “There is no assurance that weather conditions or natural disasters could not have a material effect on our sales, production capability or component supply continuity for any of our products.”28 Polaris has identified this as a risk to their company; however, the overall assumption that weather will be favorable is a primary driver of their lofty growth in the coming years. Consistent Regulatory Guidelines When setting growth targets, a company must take into account the various costs associated with their products development, production and delivery to the consumer. One external factor that can have a great deal of implications on the costs associated with the product and the overall availability of the product are Regulatory Guidelines. Polaris has assumed that the Regulatory Guidelines will remain consistent in the coming years in order to achieve their growth by 2020. These regulatory guidelines can include safety guidelines, environmental guidelines, trade and sanction guidelines. If the Consumer Product Safety Commission determines that snowmobiles and off-road vehicles need to have stricter safety requirements, this will add to costs of developing and producing these products, ultimately limiting their growth. In the same regard, if the National Highway Transportation Safety Administration sees that motorcycles or other vehicles need to adhere to stricter guidelines, the same will limiting factors will slow Polaris’s growth. When it comes to the environment, if the Environmental Protections Agency deems it necessary to have firmer emissions regulations, this will take the costs associated with the development of Polaris’s products to new levels as they will need to increase their R&D to develop new products that meet these guidelines. Lastly, there is an assumption that Polaris will be able to deal internationally as they have done 28 Polaris Industries, Inc. 2015 Annual Report, pg. 15
27
so in the past; however, there are many political and regulatory factors that could negatively impact the company’s objectives since they are looking to growth their international presence to 33% of their total revenues. If there are sanctions imposed on countries that Polaris currently does business with or with a country that Polaris is trying to penetrate, this can limit Polaris’s growth strategy and they will need to redirect attention to other areas of the world. In the same regard, Polaris will need to meet certain regulatory guidelines that may exceed those of the United States. This would mean additional costs associated with doing business in that country. The growth opportunity and the size of the market may be appealing to Polaris; however, the costs associated with gaining entry may exceed their expected return on investment. Strategic Risk The strategies that Polaris employs are directly aligned and linked with their risks. Like any company, Polaris faces a multitude of risks. The image below highlights the most important strategic risks that Polaris should focus on. These risks include Operations, Market, Customer, and Regulatory.29
The following table highlights the key strategic risks and the potential events that may result. Countermeasures are given for each strategic risk.30
29 Frigo, Mark L. and Anderson, Richard J. Strategic Risk Management A Primer for Directors and Management Teams. Edition 1.0, 2010. 30 Frigo, Mark L. and Joel Litman, Driven: Business Strategy, Human Actions and the Creation of Wealth, Strategy and
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Key Strategic Risk
Potential Events Countermeasures
Investor As the sole risk in the first tier, it’s vital to understand that every risk below in the Strategic Risk Management framework flows up to and impacts Investor Risk. • Accounting fraud would have a
detrimental impact. • Bringing to market an offering that
has a known engineering or production flaw that can cause harm to the customer, environment, animals, other humans, etc.
• Establish, communicate and maintain an ethical and value-driven culture
• Ensure constant and fluid communication amongst all facets of Polaris.
• Create a whistleblower protection program.
Customer • Customer liability claims • Weather can hinder demand • Retail credit market deterioration may
cause dealers to be unable to finance purchases
• Build quality products that will not fail
• Keep ATVs on the floor at dealerships in case there is no snow
• Explore options to begin offering Polaris financing
Market • Decreasing number of potential customers due to tragic events
• Unforeseen changes in demographics’ needs
• Foreign currency exchange fluctuations
• Maintain databases of customer demographic profiles
• Identify trends among customer groups
Innovation • Flaws in measuring the effectiveness of innovation strategy
• Competitors’ innovation moving more quickly causing Polaris to lag behind and miss sales
• Ensure proper monitoring of innovation activities
• Collaborate constantly with marketing research data to create offerings that meet customers’ needs
• Take time to learn from mistakes • Encourage creativity and ‘out of
the box’ ideas
Execution 2008.
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Operations • Unidentified manufacturing process bottlenecks create waste
• Lack of quality in production leads to filed product warranties and claims
• Mergers and Acquisitions – Synergy between Polaris and potential affiliates manufacturing process
• Hire a consulting firm to identify undiscoverable processes that could be leaned
• Ensure new strategies have sufficient operating support
Brand-Reputation • Polaris’ thermal related issues to its RZR turbo vehicles presents concerns with its reputation to provide quality and safe off road vehicles
• Faulty products lead to a negative impact on the brand
• New product offerings which do not mesh with current offerings may cause brand confusion
• Polaris has created an independent safety and quality unit while also leveraging outside engineers and technicians for proper repair in a timely manner
• Going forward, Polaris would be best fit to have a unit to monitor its reputation among customers, shareholders, and all third parties it has relationships with.
Partnering • Inability to find future partnerships through third parties or M&A activity that provide value for Polaris
• Managing the ineffectiveness of activities of partnerships
• Ensure performance measures and monitoring are in place with current partners to hold each side accountable
• Keep consistent measures in place for future partnerships
• Evaluate lessons learned from issues with current partners to strengthen agreements with future partners
Value Chain • Increase cost in raw materials, commodities and transportation
• Failure to maintain distributor relationships
• Keep raw materials somewhat in bulk in order to have time to adjust to new prices
• Be sure to meet all contractual obligations with distributors.
Employee Engagement
• Declining sales and cost cutting efficiencies may lead to increased employee turnover as Polaris is unable to retain and appropriately compensate its staff
• Speed of delivery may lead to overworked and burnt out employees in manufacturing plants
• Ensuring employees understand Polaris’ strategy and vision to stay engaged within the firm
• Provide rewards and recognition for employees outside standard compensation
30
Planning • Accounting for the possibility of weather that may adversely affect sales
• Termination of supplier contracts • Disruption or delay in manufacturing
facilities
• Keep ATVs in stock within reason during the winter.
• Head hunt suppliers until Polaris has a confident list of potential replacements
• Ensure a safe, smooth process in creating value in products
• Implement a plan in case one facility is not usable, have other facilities pick up some of the slack
Communication • Ensure the strategic visions and objectives are communicated among shareholders, employees and their consumers
• Create a two-way street of communication
• Take an empty cup approach as leaders of the organization as they hear from employees
Regulations • Changing shifts in society’s beliefs related to offerings which creates new laws
• Ever-changing political landscapes
• Current and future offerings must comply with laws and regulations
• Establish a venue that allows new and potential laws to be communicated with directors and executives
• Be forward looking in aligning future offerings with trends in the regulatory world
31
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Risk Metrics
Financial Perspectives ● Liability and Warranty Claims - Due to the nature of use for the majority of Polaris products,
there is a higher than usual likelihood of bodily harm and failed components within the vehicle. Funding is accrued yearly for possible litigations expenses and warranty claims against Polaris products. Accrued versus actual dollars can be used to measure the effectiveness of planning against liability and warranty claims. (Probability = Low / Speed = Fast)
● Foreign currency exchange - Polaris international sales represent roughly 14% of overall
revenue. This portion of sales is susceptible to a currency translation loss. Polaris actively manages its exposure to the ever-changing currency fluctuations by engaging foreign currency hedging contracts. (Probability = Low / Speed = Fast)
● Economic changes - A reduction in disposable income leads to a reduction in power sports
spending. Additionally, through a funding agreement with GE, if the consumer defaults on the product loan, Polaris is responsible for purchasing the vehicle back from GE. While Polaris cannot control economic conditions, a close watch of domestic and international GDP can lead to a proper sales forecast and budget. (Probability = High / Speed = Slow)
● Mergers & Acquisitions - As with all mergers and acquisitions there is an inherent risk with
33
the diversion of management’s attention, potential loss of key employees, adverse effects of acquired company’s profitability, incorrect accounting estimates, and the inability to strategically align joint ventures and partnerships. The effectiveness of the mergers or acquisitions is measured with a compartmentalized CFROI analysis. (Probability = High / Speed = Slow)
Internal Business Process Perspective ● Regulatory Changes - Polaris products are subject to extensive United States federal, state,
and international safety, environmental and other government regulation. The change or implementation of these regulations can significantly impact R&D expenditures and raw material costs. (Probability = High / Speed = Fast)
● Manufacturing/Infrastructure - Disruptions in supply chain from procurement through
consumer purchase can negatively affect product quality, product cost, and on-time delivery. Any type of natural disaster can significantly affect the timeliness of manufacturing and delivery of product globally. (Probability = Low / Speed = Fast)
● Climate Change - Polaris products are specifically designated for certain weather conditions.
If the yearly climate fails to yield a significant amount of snow, the winter designated product lines will have a direct correlating decrease in revenue. (Probability = Low / Speed = Fast)
● International Operations - International expansion is a strategic growth initiative at Polaris.
International expansion requires significant attention from management, in addition to a focus on economic, political, and social factors within each foreign country. International business practices and pricing pressures continue to challenge management. (Probability = High / Speed = Slow)
Innovation and Growth Perspective ● Patents, TM protecting IP - WIth an increasingly competitive market, protecting Polaris’s
intellectual property and trademarks could lead to litigation expenses previously unforeseen. (Probability = Low / Speed = Slow)
● Innovation challenges - The development of new product and enhancements of existing
product comprise a significant portion of yearly sales growth. With the continued advancement of the market and consumer demands, rapid development of new product lines continues to be a challenge. (Probability = Low / Speed = Slow)
● Attracting and retaining employees - Although Polaris employee turnover remains low,
Polaris continues to monitor employee turnover and is focused on retaining and attracting engaged, driven, and value-providing talent. (Probability = High / Speed = Slow)
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Customer Perspective ● Intense Competition - While the power sports market remains extremely competitive, Polaris
heavily invests on new and innovate products to continue to capture a major percentage of this market. The Polaris market presence is continually monitored and analyzed in each vertical market within power sports. (Probability = High / Speed = Fast)31
31 Polaris Industry Inc. Annual Report. "Polaris 2015 Annual Report." (n.d.): n. page. Web. 3 December 2016.
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Risk Disclosures and Analysis This section includes Polaris’s risk disclosures. Below are the specific disclosures that were noted in Polaris’s 10-K filings from 2012-2015.32
Disclosure Strategic Risk 2012 2013 2014 2015
Safety, environmental, and other government regulations
Disruptions at manufacturing and distribution facilities
Operations Risk X
Weakening of the financial condition of a material number of our suppliers or financing sources
Partnering Risk
39
Summary, Conclusions, and Lessons Learned
40
As seen in the discussion above, Polaris has placed a great emphasis on growth. Their slogan in their 2014 Annual Report was even “We’ve had the pedal to the metal.”34 This may have led to some of their current issues. In the last few years, Polaris’s performance has stumbled as they have been hit with declining sales in snowmobiles and off-road vehicles, recalls, questionable product offerings, and rising environmental and regulatory issues. These realized risks have been a drag on company performance, and this has been dramatically reflected in the stock performance in the last few years. Our team conclusion is that Polaris management has been so focused on growth they have not adequately prepared for nor appropriately addressed the risks Polaris faces. Polaris would benefit from a thorough understanding and application of the principles of Strategic Risk Management. This would include addressing the high priority risks under Operations, Market, Customer, and Regulatory, as discussed previously. We conclude the Polaris still has a strong foundation and with appropriate risk management strategies could address its current shortcomings and continue its high performance. Without, however, a comprehensive application of Strategic Risk Management to the company, Polaris risks losing its High Performance Company status.
Analysis of the Strategy, Execution and Strategic Risk of Polaris
SEV 621Strategy Execution and Strategic Risk ManagementDecember 2016Dr. Mark L. Frigo and Richard J. AndersonThe Center for Strategy. Execution. and ValuationStrategic Risk Management LabKellstadt Graduate School of BusinessDePaul University
❑ Polaris emphasized Growth over Strategic Risk Management❑ In the last few years it has realized risks and struggled to respond❑ Without application of Strategic Risk Management, Polaris could lose its
(L-R) Jigar Patel, Alyssa Rotz, Matthew Plese, Stephanie Jaussi, Peter Smith, Cheryl Procter-Rogers, Dr. Richard Anderson, Dr. Mark Frigo, Kyle Olson, George Szydlo,
Jacqueline Recchia, Rano Khudayberdieva, Daniel Lewis, Alexander Schusler, Timothy Pierard
Summary Stats:Employees: over 8,000Countries served: over 100Market Cap: $5.6 billion (as of Dec 2, 2016)2015 Sales: $4.7 billion (5% growth)2015 Profit: $455 million (0.25% growth)
10 Year Share performance vs. S&P 500 (source: Market Watch)
Where is the company on the Competitive Life Cycle?
• Polaris’ % Future: 47.85%• Polaris is likely in the Competitive Fade Segment• Positive % Future but below the high end of 70+% in firms like Tesla and
Netflix• By comparison, Harley Davidson has a smaller % Future at 33%
High-Level Strategic Risk Profile Key Strategic Risk Description of Risk
Operations Risk • Lack of Quality in Production Leads to Warranties and Claims • Unidentified Manufacturing Process Bottlenecks Creates Waste
Customer Risk • Targeting Wrong Customer Groups Through Current and New Offerings• Lacking Valid and Reliable Customer Data
Regulatory Risk • Ever-Changing Political Landscapes• Changing Shifts in Societal Beliefs
Market Risk • Overlooking Potential Market Segments• Decrease in Population of European and Asian Markets
Brand ReputationRisk
• Deficiencies to the Product Line can have a Negative Impact on the Brand• New Product Offerings which do not Mesh with Current Offerings May Cause Brand
Confusion
Innovation Risk • Competitors’ Innovation Moving More Quickly • Flaws in Measuring the Effectiveness of Innovation Strategy
Employee Engagement Risk
• Lean Transformation of Cost Cutting Efficiencies and Faster Delivery of Products may Lead to Employee Turnover/Disengagement
Partnering Risk • Inability to Find Viable Partners for Future M&A Activity to Strengthen their Market Position
If occurring, the events in red font have the greatest impact on Polaris.
• Polaris remains a High Performance company• But, Polaris has been hit by realized risks• Polaris needs to discipline its pursuit of
growth• Polaris would benefit from a thorough
understanding and application of the principles of Strategic Risk Management.
• This includes addressing the risks discussed:o Operationso Marketo Customero Regulatory
• Without Strategic Risk Management, Polaris will experience rapid competitive fade, and drift to no economic returns.
STRATEGIC RISK MANAGEMENT FRAMEWORK
POLARIS INDUSTRIES Risk Disclosure and Analysis
Team 3 Members:
Stephanie Jaussi Rano Khudayberdieva
Daniel Lewis Kyle Olson Jigar Patel
Timothy Pierard Matthew Plese
Cheryl Procter-Rogers Jacqueline Recchia
Alyssa Rotz Alexander Schusler
Peter Smith George Szydlo
Risk Disclosure Analysis
1
Polaris Industries, Inc.
POLARIS INDUSTRIES, INC. ANALYSIS OF RISKS USING RETURN DRIVEN STRATEGY SUMMARY OF RISKS THROUGH THE RETURN DRIVEN STRATEGY FRAMEWORK Ethically Maximize Wealth, Potential Risks to Tenet One It is critical that Polaris aligns ethically with meeting its goals and objectives as outlined in the company’s Code of Business Conduct and Ethics and that the company is aware of forces of change that may impact shareholder wealth potential and interest in further investment in the company. What management has disclosed?
● “We intend to grow our business through potential acquisitions, non-consolidating investments, alliances and new joint ventures and partnerships, which could be risky and could harm our business” (Polaris 12-31-2014 10K Filing)
What might be missing?
● The disclosures do not address anything about the compensation incentives that drive key management personnel to make decision on the business. Are these incentives truly aligned with ethically maximizing wealth creation? And if so, what structures, incentives, and systems are in place to confirm that wealth creation is untaken in an ethically responsive manner.
Risk Disclosure Analysis
2
Polaris Industries, Inc.
● The CFROI has declined from 32% to 25% from year 2013 to 2015 and it is expected to decrease to 15% in year 2016. This decrease could cause management to focus on acquisitions, increasing their sales which would bring in more cash flows (Credit Suisse HOLT Lens ™ Login." Credit Suisse HOLT Lens ™ Login. Web. 02 Dec. 2016.). But not all cash flows are created equal if these new sales are not sustainable or if they significantly bring down the firm’s contribution margins.
● The disclosures do not address how new acquisitions (related to tenet 5) may be difficult to integrate, disrupt their business, dilute stockholder value, or divert management attention. Having strong governance can have a large and quantifiable impact on the organization and in the industry. Likewise, acquisitions for the sake of acquisition can fall prey to the underlying assumption that bigger is always better. This is not true (cf. Anderson, Richard J. The Role of Assumptions in Strategy and Strategic Risk Management Working Draft - V3. N.p., 23 Nov. 2016.)
● Polaris looks to maximize wealth by focusing on growth and remaining customer centric. That means Polaris will have to focus on increasing their revenues while acquiring different companies. There is not enough information on how they will achieve their strategy by focusing on “quality, delivery, and cost improvement.” (cf. Annual Report)
Fulfill Otherwise Unmet Customer Needs, Potential Risks to Tenet Two
Polaris must find a strategic approach to meeting unmet customer needs in the face of continued competition, product recalls and the threat of government regulations. To be able to address any changes in government regulations, the company must be vigilant to the consumer and political discourse of this industry. What management has disclosed?
● A significant adverse determination in any material product liability claim against us could adversely affect our operating results or financial condition.
● Significant product repair and/or replacement due to product warranty claims or product recalls could have a material adverse impact on our results of operations.
● Retail credit market deterioration and volatility may restrict the ability of our retail customers to finance the purchase of our products and adversely affect our income from financial services.
Risk Disclosure Analysis
3
Polaris Industries, Inc.
What might be missing?
● Regarding warranty claims, Polaris did not report the possible brand and reputation risk of having the dealers and administrators handle the warranty claims.
● The annual report indicates that Polaris is focusing on customized package vehicles to meet specific customer needs and targeting appropriate customer groups. For example, Polaris ACE’s patented design is very attractive to women and men in their 50s who never owned an ORV. (Source: Annual Report)
● From the annual report, total change in sales for international operations from 2014 to 2015 is - 5%. Polaris is preparing to deliver higher-quality vehicles and shorter lead times to customers all over the world. Polaris should assess the implications of increased competition and the slowing industry trends and to re-evaluate and refine their product and marketing strategies. If customers do not truly want these services in sufficient levels to justify their introduction, the company would destroy value by investing in them.
● Polaris continues to “implement the Retail Flow Management (RFM) pull model across the product lines by focusing on improving customer service, better managing inventory, and better responding to consumer trends.” (Annual Report) This will help Polaris stay well-informed of customer trends for a variety of product lines such as ATVs, Motorcycle, Slingshot, Parts, Garments and Accessories, etc.
● Regarding product recalls, Polaris must focus on reducing repair and replacement costs for the recalls that might have a materially large impact on their reputation and can cause them to lose customers. These recalls might cause customers to question the safety of Polaris’ products.
● Polaris has around “750 employees who are engaged in the development and testing of existing products and research and development of new products” (Source: Annual Report) focusing on customer needs. Does the company ensure that these employees are acting in the company’s best interest and, if hired by a competitor, will not disclose confidential information? Does Polaris adequately recruit the best candidates and invest in them so that the firm is well positioned to identify cutting-edge market needs?
Target Appropriate Customer Segments. Potential Risks to Tenet Three
Risk Disclosure Analysis
4
Polaris Industries, Inc.
Polaris understands that any shift in customer needs can dramatically impact operations. For sustainable long-term growth, the company must continue to analyze current and potential markets to identify customer groups where there is higher potential for the business to provide genuine assets to fulfill unmet customer needs. What management has disclosed?
● Fluctuations in foreign currency exchange rates could result in declines in our reported sales and net earnings.
● Our business may be sensitive to economic conditions that impact consumer spending.
What might be missing?
● Polaris’s pricing targets customer groups with disposable income that are interested in recreational vehicles such as ATVs, RZRs and Rangers. As demographics of customers change, Polaris needs to ensure that they continue to appeal to the correct target markets, which may differ from the markets they have pursued previously.
● From looking at the Stock Performance Graph for the Recreational Vehicles Industry Group in the annual statement, assuming $100 invested at the end of December 31, 2010, total return to shareholders in 2013 is $233.37 while total return to shareholders in 2015 precipitously dropped to $167.94. Polaris must have better strategy to capture more of the consumer market and focus on improving their stock performance by increasing their CFROI. (Source: Annual Report)
● Polaris continues to gain market share for motorcycles by using different marketing strategies. For example, Polaris’ marketing strategy includes movie placements, including “Daddy’s Home” with Mark Wahlberg. Polaris has made steps in marketing to a new customer base with collaborations with well-known brands like Jack Daniels and Zac Brown Band. However, if one of their affiliated brands becomes irrelevant or engages in ethically questionable actions, Polaris needs to have a backup plan in order to exit such relationships before Polaris’ brand suffers potential garnishment.
● In the off-road industry, Polaris will have to target other customer segments as there was a 10% decline in retail sales and 12% decline in the international ORV revenue. Strategy may need to be revisited and, if drastic enough declines are likely, Polaris needs to be committed to leave the market despite the sunk costs
Risk Disclosure Analysis
5
Polaris Industries, Inc.
already invested in the line. Staying in a market that has no future will only hurt the firm’s CFROI.
● Polaris did not disclose the risks of working in Emerging Markets Countries and the government and regulatory problems they may face. Such problems may cause a negative impact to the Company’s financial statements, brand, product demands, etc. Especially since Polaris is present in nearly 100 nations, keeping the firm in-line with the appropriate markets in so many diverse nations is complex and an extraordinary task.
Deliver Offerings. Potential Risks to Tenet Four Strategic planning is essential for establishing the goals of Polaris. However, continuous improvement using a proven implementation methodology will ensure the company minimizes risks while delivering new products that meet customers’ needs. Delivering an exceptional product that meets unmet customer needs as expected is the company’s number one challenge. What management has disclosed?
● If we are unable to continue to enhance existing products and develop and market new products that respond to customer needs and preferences and achieve market acceptance, we may experience a decrease in demand for our products and our business could suffer.
What might be missing?
● There are no criteria for how management should choose with whom to partner, especially with the risk of the third parties potentially producing similar products in the future, which could impact the company’s CFROI.
● Polaris is focused on producing and delivering the ORV products to the customers by implementing a new dealer ordering system called Maximum Velocity Program (MVP), where ORV orders are placed in approximately two-week intervals. If that new system is late-to-the-market or fails to meet customers’ needs, their business could suffer value deterioration.
● By implementing the Retail Flow Management (RFM) pull model across the product lines (e.g. ATVs, Motorcycles, Slingshot, and a portion of PG&A), Polaris has been able to manage their inventory better and respond to their customers quickly. But in order to get more business, Polaris will have to expand the model
Risk Disclosure Analysis
6
Polaris Industries, Inc.
further to other vehicles that Polaris offers. Is the business adequately investing in this process to do so? It is not evident from their disclosures.
Innovate Offerings. Potential Risks to Tenet Five Meeting customers’ unmet needs must drive their research and development efforts towards innovation. Comment on risks that could impact the company’s ability to innovate its offerings in the future. What management has disclosed?
● We face intense competition in all product lines, including from some competitors that have greater financial and marketing resources. Failure to compete effectively against competitors would negatively impact our business and operating results.
● Fourteen percent of our total sales are generated outside of North America, and we intend to continue to expand our international operations. Our international operations require significant management attention and financial resources, expose us to difficulties presented by international economic, political, legal, accounting, and business factors, and may not be successful or produce desired levels of sales and profitability.
● We may be subject to information technology system failures, network disruptions and breaches in data security.
What might be missing?
● Management has accepted that they face a risk of not effectively competing with the competition. Polaris has been on top of innovation recently as they introduced twenty new ORV models, expanded AXYS platform into seven new models, expanded their productions, and acquired other businesses. In order to keep up with the competitors, they will have to invest wisely in R&D and advertising their products. And for any innovation offerings, a truly disciplined approach must be used that ensures products are not brought to market if they will not succeed, regardless of the sunk costs in the development.
Brand Offerings. Potential Risks to Tenet Six
Risk Disclosure Analysis
7
Polaris Industries, Inc.
Polaris’ brand reputation is an important asset for the company. All efforts to protect and enhance the brand must link to customer purchasing and pricing. What management has disclosed?
● A significant adverse determination in any material product liability claim against us could adversely affect our operating results or financial condition.
● Significant product repair and/or replacement due to product warranty claims or product recalls could have a material adverse impact on our results of operations.
What might be missing?
● The pricing pressures in the industry likely pose a serious competitive threat to their brand’s offerings. If Polaris were to continue to cut prices to gain market share from industry leaders like Harley Davidson, they could decrease price in such a way that customers no longer feel their offering is a quality offering but is instead a cheap and unreliable alternative. Since price is indicative of a product’s quality and attributes, preserving margins and keeping brand integrity in the face of a continually price sensitive market poses a serious risk.
● Polaris does not seem to invest further to promote the Polaris brand as the firm does not advertise in ways to reach potential customers through new mediums (e.g. television, radio, billboard advertisements)
● There could be a potential risk to the brand if the acquired companies and partners fail to perform to keep up with the industry’s standards. If any brand is viewed as “second rate” or lacking in quality, the brand will be adversely affected.
Partner Deliberately, Potential Risks to Tenet Seven The best partnerships bring with them genuine assets that allow Polaris to innovate, brand, and deliver products that fulfill customer unmet needs. Potential partners must be fully vetted to consider all the possible risks that could impact the company and its creation of wealth for stockholders. What management has disclosed?
● Failure to establish and maintain the appropriate level of dealers and distributor relationships or weak economic conditions impacting those relationships may negatively impact our business and operating results.
Risk Disclosure Analysis
8
Polaris Industries, Inc.
● We depend on suppliers, financing sources and other strategic partners who may be sensitive to economic conditions that could affect their businesses in a manner that adversely affects their relationship with us.
● We manufacture our products at, and distribute our products from, several locations in North America and internationally. Any disruption at any of these facilities, or manufacturing delays could adversely affect our business and operating results.
What might be missing?
● Monitoring dealer and distributor satisfaction is critical to addressing concerns to create win-win scenarios. Neither the annual report nor the disclosure addresses how Polaris will support dealers and distributors beyond financial reimbursement during a recall, manufacturing delays, or other scenarios. They do not disclose how they will change their operations going forward to better protect themselves from such a disturbance.
● Polaris must engage in rigorous contingency planning to prepare for any issues that might arise with suppliers and partners. Because the marketplace is dynamic, regular planning sessions keep planning relevant. And even further justifying this, since the business operates in a number of nations, contingency plans should be established to ensure operations continue seamlessly in the event of a disaster anywhere globally.
● A thorough and honest review of lessons learned and accountability measures helps to minimize partnering risks.
● Polaris must consider other options if desirable partnerships are not readily available. This lack of resources can impact operations negatively.
● Polaris has plans to expand globally, has opened a new plant in Huntsville, Alabama, and will complete other acquisitions over the next few years. Not properly vetting new partners to ensure they align ethically and operationally can impact all the higher level tenets and create unnecessary investor risk.
Map and Redesign Processes. Potential Risks to Tenet Eight Polaris must focus on the internal and external environments and quickly address any shifts that can impact operations and the upper level tenets. The forces of change are constant, therefore the entire organization must be poised to recognize and act on the need for changes in operational designs and processes.
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What management has disclosed?
• Increases in the cost of raw material, commodity, and transportation costs and shortages of certain raw materials could negatively impact our business.
What might be missing?
• Polaris must have practical options to guard against a growing sentiment that going offshore to reduce costs will be met with tough US penalties under President Trump.
• The desire to maintain a competitive pricing structure can possibly reduce margins, making it difficult to meet the desired net income margin of 10%. Cash Flow ROI will suffer if a plan to minimize value chain risks is not identified.
• A plan to continuously monitor operations for process improvements and efficiencies can support Polaris’ competitive advantage as a genuine asset that delivers unique capabilities.
• A plan to maintain and enhance supplier relationships will minimize blind spots to increases in costs and other factors.
Engage Employees and Others. Potential Risks to Tenet Nine Polaris must remain a high-performance company to continue to attract and retain talent. The incentives must align ethically and support the higher level tenets. It is also critical that the communication efforts with employees avoid miscues and minimize misperceptions, misinformation, inaccurate information and mistakes in assignment of roles and responsibilities. What management has disclosed?
• Our operations are dependent upon attracting and retaining skilled employees, including skilled labor. Our future success depends on our continuing ability to identify, hire, develop, motivate, retain and promote skilled personnel for all areas of our organization.
What might be missing?
● Polaris has made several significant senior management changes over the past year that may impact the organization’s culture and employee engagement. While the new leaders have relevant experience, there remains a reasonable
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period of time as they each adjust to their new roles. Polaris is wise to monitor any shifts in expectations and employee dynamics during this phase.
● Polaris is betting on the successful execution of many business strategies to create shareholder wealth and meet unmet customer needs. Poor planning, as was the case with the Spirit Lake Paint scenario, can impact employee morale and demotivate talented employees. Polaris must consider how the operational efforts will impact employees and have a plan to avoid burnout and frustration, particularly in the manufacturing plants as lean manufacturing is implemented.
● As roles and needs of the organization change, a review of management compensation and incentive plans will ensure equity across the organization and that adequate training and development is available to enhance employee engagement, minimizing turnover and other risk factors.
Balance Focus and Options. Potential Risks to Tenet Ten For Polaris to have sustainable growth over the long-term, the company must have a clear vision forward while remaining nimble to the changing in the marketplace, economy and government regulations. What management has disclosed?
● Changing weather conditions may reduce demand and negatively impact net sales and production of certain of our products.
● Termination or interruption of informal supply arrangements could have a material adverse effect on our business or results of operations.
What might be missing?
● The Spirit Lake Paint planning disaster exposed a cultural weakness within Polaris that must be addressed. Polaris must consider and accept input from both internal and external stakeholders. The leaders must have “an empty cup” to consider all possible outcomes. For major initiatives, designated teams can both monitor the implementation progress and establish contingency planning throughout the life of any business plan.
● Polaris must build flexibility in their business plans and create an environment through management compensation and incentive plans that align with supporting a change culture.
● Polaris will need contingency plans to support any disruption or delay at manufacturing facilities.
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Communicate Holistically. Potential Risks to Tenet Eleven Polaris failed to disclose any risks to their communication strategy. What might be missing?
● The competitive landscape calls for an effective communications strategy to maintain Polaris’ leadership position in the marketplace, retain high level talent, and to support the company’s vision and goals.
● In addition, a crisis communications plan will minimize misperceptions, misinformation, inaccurate information, and mistakes in assignment of roles and responsibilities during a crisis period. An effective strategy means less damage to Polaris’ reputation, credibility, and employee and stockholder confidence.
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FOUNDATIONS OF RETURN DRIVEN STRATEGY FRAMEWORK Genuine Assets Risks According to Polaris’ 2015 annual report, their competitive advantage continues to be their innovative culture, operational speed and flexibility, and their passion to make quality products that deliver value to its customers. The competitive environment creates a challenge to sustain such high performance standards without taking strategy risks to innovate and protect their brand reputation. What management has disclosed?
• Our reliance upon patents, trademark laws, and contractual provisions to protect our proprietary rights may not be sufficient to protect our intellectual property from others who may sell similar products and may lead to costly litigation.
What might be missing?
• As a leader in the marketplace, Polaris must be prepared to proactively address confusion in the market through targeted communication and marketing strategies designed to educate key stakeholders, especially customers on the value proposition inherent in its products and the explicit promise behind the brand, including its patents and trademarks.
Vigilance to Forces of Change Risks According to the book “Driven: Business Strategy, Human Actions and the Creation of Wealth,” forces for change can be scientific and technological breakthroughs, regulatory changes and shifting demographics. Polaris is faced with risks in each area and must have a plan to accurately identify emerging forces of change. What management has disclosed?
● Additional tax expense or tax exposure could impact our financial performance. ● Our products are subject to extensive United States federal and state and
international safety, environmental and other government regulation that may require us to incur expenses or modify product offerings in order to maintain compliance with the actions of regulators and could decrease the demand for our products.
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What might be missing?
● Polaris faces sustainability risks due to the number of product launches, acquisitions and expansion into other countries it is currently executing and planning to pursue. A plan to identify and assess its exposure to investor risk is critical.
● As consumer buying preferences change, the firm needs to have a plan in place to quickly address any changes in the market place before significant value is destroyed.
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POLARIS INDUSTRIES, INC. RISK DISCLOSURES Item 1A. Risk Factors
The following are significant factors known to us that could materially adversely affect our business, financial condition, or operating results, as well as adversely affect the value of an investment in our common stock. Our products are subject to extensive United States federal and state and international safety, environmental and other government regulation that may require us to incur expenses or modify product offerings in order to maintain compliance with the actions of regulators and could decrease the demand for our products. Our products are subject to extensive laws and regulations relating to safety, environmental and other regulations promulgated by the United States federal government and individual states as well as international regulatory authorities. Failure to comply with applicable regulations could result in fines, increased expenses to modify our products and harm to our reputation, all of which could have an adverse effect on our operations. In addition, future regulations could require additional safety standards or emission reductions that would require additional expenses and/or modification of product offerings in order to maintain compliance with applicable regulations. Our products are also subject to laws and regulations that restrict the use or manner of use during certain hours and locations, and these laws and regulations could decrease the popularity and sales of our products. We continue to monitor regulatory activities in conjunction with industry associations and support balanced and appropriate programs that educate the product user on safe use of our products and how to protect the environment.
A significant adverse determination in any material product liability claim against us could adversely affect our operating results or financial condition. The manufacture, sale and usage of our products expose us to significant risks associated with product liability claims. If our products are defective or used incorrectly by our customers, bodily injury, property damage or other injury, including death, may result and this could give rise to product liability claims against us or adversely affect our brand image or reputation. Any losses that we may suffer from any liability claims, and the effect that any product liability litigation may have upon the reputation and marketability of our products, may have a negative impact on our business and operating results. Because of the high cost of product liability insurance premiums and the historically insignificant amount of product liability claims paid by us, we were self-insured from 1985 to 1996 and from 2002 to 2012. From 1996 to 2002, and beginning again in 2012, we purchased excess insurance coverage for catastrophic product liability claims for
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incidents occurring subsequent to the policy date that exceeded our self-insured retention levels. The estimated costs resulting from any losses are charged to expense when it is probable a loss has been incurred and the amount of the loss is reasonably determinable. We had a product liability reserve accrued on our balance sheet of $19.7 million at December 31, 2015 for the probable payment of pending claims related to product liability litigation associated with our products. We believe such accrual is adequate. We do not believe the outcome of any pending product liability litigation will have a material adverse effect on our operations. However, no assurance can be given that our historical claims record, which did not include ATVs prior to 1985, motorcycles and side-by-side vehicles prior to 1998, and Global Adjacent Markets vehicles prior to 2011, will not change or that material product liability claims against us will not be made in the future. Adverse determination of material product liability claims made against us would have a material adverse effect on our financial condition.
Significant product repair and/or replacement due to product warranty claims or product recalls could have a material adverse impact on our results of operations. We provide a limited warranty for ORVs for a period of six months, for a period of one year for our snowmobiles, for a period of one or two years for our motorcycles depending on brand and model year, and for a two year period for GEM, Goupil and Aixam vehicles. We may provide longer warranties related to certain promotional programs, as well as longer warranties in certain geographical markets as determined by local regulations and market conditions. We also provide a limited emission warranty for certain emission-related parts in our ORVs, snowmobiles, and motorcycles as required by the EPA and CARB. Although we employ quality control procedures, sometimes a product is distributed that needs repair or replacement. Our standard warranties require us or our dealers to repair or replace defective products during such warranty periods at no cost to the consumer. Historically, product recalls have been administered through our dealers and distributors. The repair and replacement costs we could incur in connection with a recall could adversely affect our business. In addition, product recalls could harm our reputation and cause us to lose customers, particularly if recalls cause consumers to question the safety or reliability of our products.
Changing weather conditions may reduce demand and negatively impact net sales and production of certain of our products. Lack of snowfall in any year in any particular geographic region may adversely affect snowmobile retail sales and related PG&A sales in that region. Additionally, to the extent that unfavorable weather conditions are exacerbated by global climate change or otherwise, our sales may be affected to a greater degree than we have previously
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experienced. There is no assurance that weather conditions or natural disasters could not have a material effect on our sales, production capability or component supply continuity for any of our products.
We face intense competition in all product lines, including from some competitors that have greater financial and marketing resources. Failure to compete effectively against competitors would negatively impact our business and operating results. The snowmobile, off-road vehicle, motorcycle and global adjacent markets are highly competitive. Competition in such markets is based upon a number of factors, including price, quality, reliability, styling, product features and warranties. At the dealer level, competition is based on a number of factors, including sales and marketing support programs (such as financing and cooperative advertising). Certain of our competitors are more diversified and have financial and marketing resources that are substantially greater than ours, which allow these competitors to invest more heavily in intellectual property, product development and advertising. If we are not able to compete with new products or models of our competitors, our future business performance may be materially and adversely affected. Internationally, our products typically face more competition where certain foreign competitors manufacture and market products in their respective countries. This allows those competitors to sell products at lower prices, which could adversely affect our competitiveness. In addition, our products compete with many other recreational products for the discretionary spending of consumers and, to a lesser extent, with other vehicles designed for utility applications. A failure to effectively compete with these other competitors could have a material adverse effect on our performance.
Termination or interruption of informal supply arrangements could have a material adverse effect on our business or results of operations. We have informal supply arrangements with many of our suppliers. In the event of a termination of the supply arrangement, there can be no assurance that alternate supply arrangements will be made on satisfactory terms. If we need to enter into supply arrangements on unsatisfactory terms, or if there are any delays to our supply arrangements, it could adversely affect our business and operating results.
Fluctuations in foreign currency exchange rates could result in declines in our reported sales and net earnings. The changing relationships of the United States dollar to the Canadian dollar, Australian dollar, the Euro, the Swiss franc, the Mexican peso, the Japanese yen and certain other foreign currencies have from time to time had a negative impact on our results of
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operations. Fluctuations in the value of the United States dollar relative to these foreign currencies can adversely affect the price of our products in foreign markets, the costs we incur to import certain components for our products, and the translation of our foreign balance sheets. While we actively manage our exposure to fluctuating foreign currency exchange rates by entering into foreign exchange hedging contracts from time to time, these contracts hedge foreign currency denominated transactions and any change in the fair value of the contracts would be offset by changes in the underlying value of the transactions being hedged.
Our business may be sensitive to economic conditions that impact consumer spending. Our results of operations may be sensitive to changes in overall economic conditions, primarily in North America and Europe, that impact consumer spending, including discretionary spending. Weakening of, and fluctuations in, economic conditions affecting disposable consumer income such as employment levels, business conditions, changes in housing market conditions, capital markets, tax rates, savings rates, interest rates, fuel and energy costs, the impacts of natural disasters and acts of terrorism and other matters, including the availability of consumer credit could reduce consumer spending or reduce consumer spending on powersports products. A general reduction in consumer spending or a reduction in consumer spending on powersports products could adversely affect our sales growth and profitability. In addition, we have a financial services partnership arrangement with a subsidiary of General Electric Company that requires us to repurchase products financed and repossessed by the partnership, subject to certain limitations. For calendar year 2015, our maximum aggregate repurchase obligation was approximately $146.4 million . If adverse changes to economic conditions result in increased defaults on the loans made by this financial services partnership, our repurchase obligation under the partnership arrangement could adversely affect our liquidity and harm our business.
Failure to establish and maintain the appropriate level of dealers and distributor relationships or weak economic conditions impacting those relationships may negatively impact our business and operating results. We distribute our products through numerous dealers and distributors and rely on them to retail our products to the end customers. Our sales growth and profitability could be adversely affected if deterioration of economic or business conditions results in a weakening of the financial condition of a material number of our dealers and distributors. Additionally, weak demand for, or quality issues with, our products may cause dealers and distributors to voluntarily or involuntarily reduce or terminate their relationship with us. Further, if we fail to establish and maintain an appropriate level of
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dealers and distributors for each of our products, we may not obtain adequate market coverage for the desired level of retail sales of our products.
We depend on suppliers, financing sources and other strategic partners who may be sensitive to economic conditions that could affect their businesses in a manner that adversely affects their relationship with us. We source component parts and raw materials through numerous suppliers and have relationships with a limited number of sources of product financing for our dealers and consumers. Our sales growth and profitability could be adversely affected if deterioration of economic or business conditions results in a weakening of the financial condition of a material number of our suppliers or financing sources, or if uncertainty about the economy or the demand for our products causes these business partners to voluntarily or involuntarily reduce or terminate their relationship with us.
Increases in the cost of raw material, commodity and transportation costs and shortages of certain raw materials could negatively impact our business. The primary commodities used in manufacturing our products are aluminum, steel, petroleum-based resins and certain rare earth metals used in our charging systems, as well as diesel fuel to transport the products. Our profitability is affected by significant fluctuations in the prices of the raw materials and commodities we use in our products. We may not be able to pass along any price increases in our raw materials to our customers. As a result, an increase in the cost of raw materials, commodities, labor or other costs associated with the manufacturing of our products could increase our costs of sales and reduce our profitability.
Retail credit market deterioration and volatility may restrict the ability of our retail customers to finance the purchase of our products and adversely affect our income from financial services. We have arrangements with each of Capital One, Sheffield Financial, Synchrony Bank, Chrome Capital and FreedomRoad to make retail financing available to consumers who purchase our products in the United States. During 2015 , consumers financed approximately 31 percent of the vehicles we sold in the United States through the Capital One revolving retail credit and Sheffield Financial, Synchrony Bank, Chrome Capital and FreedomRoad installment retail credit programs. Furthermore, some customers use financing from lenders who do not partner with us, such as local banks and credit unions. There can be no assurance that retail financing will continue to be available in the same amounts and under the same terms that had been previously available to our customers. If retail financing is not available to customers on
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satisfactory terms, it is possible that our sales and profitability could be adversely affected. Our income from financial services is affected by changes in interest rates.
We intend to grow our business through potential acquisitions, non-consolidating investments, alliances and new joint ventures and partnerships, which could be risky and could harm our business. One of our growth strategies is to drive growth in our businesses and accelerate opportunities to expand our global presence through targeted acquisitions, non-consolidating investments, alliances, and new joint ventures and partnerships that add value while considering our existing brands and product portfolio. The benefits of an acquisition, non-consolidating investment, new joint venture or partnership may take more time than expected to develop or integrate into our operations, and we cannot guarantee that acquisitions, non-consolidating investments, alliances, joint ventures or partnerships will ultimately produce any benefits. In addition, acquisitions, non-consolidating investments, alliances, joint ventures and partnerships involve a number of risks, including: • Diversion of management’s attention;
• Difficulties in integrating and assimilating the operations and products of an
acquired business or in realizing projected efficiencies, cost savings, and synergies;
Potential loss of key employees or customers of the acquired businesses or
adverse effects on existing business relationships with suppliers and customers;
• Adverse impact on overall profitability if acquired businesses or affiliates do
not achieve the financial results projected in our valuation models;
• Reallocation of amounts of capital from other operating initiatives and/or an
increase in our leverage and debt service requirements to pay the acquisition purchase prices, which could in turn restrict our ability to access additional capital when needed or to pursue other important elements of our business strategy;
• Inaccurate assessment of undisclosed, contingent or other liabilities or
problems, unanticipated costs associated with an acquisition, and an inability to recover or manage such liabilities and costs;
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• Incorrect estimates made in the accounting for acquisitions, incurrence of non-recurring charges and impairment of significant amounts of goodwill, investments or other related assets that could adversely affect our operating results;
• Dilution to existing shareholders if our securities are issued as part of transactio
consideration or to fund transaction consideration; and
• Inability to direct the management and policies of a joint venture, alliance, or
partnership, where other participants may be able to take action contrary to our instructions or requests and against our policies and objectives.
Our ability to grow through acquisitions will depend, in part, on the availability of suitable acquisition targets at acceptable prices, terms, and conditions, our ability to compete effectively for these acquisition candidates, and the availability of capital and personnel to complete such acquisitions and run the acquired business effectively. These risks could be heightened if we complete a large acquisition or multiple acquisitions within a relatively short period of time. Any potential acquisition could impair our operating results, and any large acquisition could impair our financial condition, among other things. Our reliance upon patents, trademark laws, and contractual provisions to protect our proprietary rights may not be sufficient to protect our intellectual property from others who may sell similar products and may lead to costly litigation. We hold patents and trademarks relating to various aspects of our products, such as our patented “on demand” all-wheel drive, and believe that proprietary technical know-how is important to our business. Proprietary rights relating to our products are protected from unauthorized use by third parties only to the extent that they are covered by valid and enforceable patents or trademarks or are maintained in confidence as trade secrets. We cannot be certain that we will be issued any patents from any pending or future patent applications owned by or licensed to us or that the claims allowed under any issued patents will be sufficiently broad to protect our technology. In the absence of enforceable patent or trademark protection, we may be vulnerable to competitors who attempt to copy our products, gain access to our trade secrets and know-how or diminish our brand through unauthorized use of our trademarks, all of which could adversely affect our business. Others may initiate litigation to challenge the validity of our patents, or allege that we infringe their patents, or they may use their resources to design comparable products that do not infringe our patents. We may incur substantial costs if our competitors initiate litigation to challenge the validity of our patents, or allege that we infringe their patents, or if we initiate any proceedings to protect our proprietary rights. If the outcome of any such litigation is unfavorable to us, our business, operating results, and financial condition could be adversely affected. Regardless of whether
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litigation relating to our intellectual property rights is successful, the litigation could significantly increase our costs and divert management’s attention from operation of our business, which could adversely affect our results of operations and financial condition. We also cannot be certain that our products or technologies have not infringed or will not infringe the proprietary rights of others. Any such infringement could cause third parties, including our competitors, to bring claims against us, resulting in significant costs, possible damages and substantial uncertainty.
Fourteen percent of our total sales are generated outside of North America, and we intend to continue to expand our international operations. Our international operations require significant management attention and financial resources, expose us to difficulties presented by international economic, political, legal, accounting, and business factors, and may not be successful or produce desired levels of sales and profitability. We currently manufacture our products in the United States, Mexico, Poland, France and China. We sell our products throughout the world and maintain sales and administration facilities in the United States, Canada, Switzerland and several other Western European countries, Australia, China, Brazil, Mexico and India. Our primary distribution facilities are in Vermillion, South Dakota, Wilmington, Ohio, and Rigby, Idaho, which distribute PG&A products to our North American dealers and we have various other locations around the world that distribute PG&A to our international dealers and distributors. Our total sales outside North America were 14 percent, 15 percent and 16 percent of our total sales for fiscal 2015 , 2014 and 2013 , respectively. International markets have, and will continue to be, a focus for sales growth. We believe many opportunities exist in the international markets, and over time we intend for international sales to comprise a larger percentage of our total sales. Several factors, including weakened international economic conditions, could adversely affect such growth. In 2014, we completed construction of a manufacturing facility in Poland. In 2015, we acquired a company with manufacturing operations in China. The expansion of our existing international operations and entry into additional international markets require significant management attention and financial resources. Some of the countries in which we manufacture and/or sell our products, or otherwise have an international presence, are to some degree subject to political, economic and/or social instability. Our international operations expose us and our representatives, agents and distributors to risks inherent in operating in foreign jurisdictions. These risks include:
• Increased costs of customizing products for foreign countries;
• Difficulties in managing and staffing international operations and increases in infrastructure costs including legal, tax, accounting, and information technology;
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• The imposition of additional United States and foreign governmental controls or regulations;
• New or enhanced trade restrictions and restrictions on the activities of foreign agents,
representatives, and distributors; and the imposition of increases in costly and lengthy import and export licensing and other compliance requirements, customs duties and tariffs, license obligations, and other non-tariff barriers to trade;
• The imposition of United States and/or international sanctions against a country,
company, person, or entity with whom we do business that would restrict or prohibit our continued business with the sanctioned country, company, person, or entity;
• International pricing pressures;
• Laws and business practices favoring local companies;
• Adverse currency exchange rate fluctuations;
• Longer payment cycles and difficulties in enforcing agreements and collecting
receivables through certain foreign legal systems;
• Difficulties in enforcing or defending intellectual property rights; and
• Multiple, changing, and often inconsistent enforcement of laws, rules, and regulations, including rules relating to environmental, health, taxes, and safety matters.
Our international operations may not produce desired levels of total sales or one or more of the factors listed above may harm our business and operating results. Any material decrease in our international sales or profitability could also adversely impact our operating results. If we are unable to continue to enhance existing products and develop and market new products that respond to customer needs and preferences and achieve market acceptance, we may experience a decrease in demand for our products and our business could suffer. One of our growth strategies is to develop innovative, customer-valued products to generate revenue growth. Our sales from new products in the past have represented a significant component of our sales and are expected to continue to represent a significant component of our future sales. We may not be able to compete as effectively with our competitors, and ultimately satisfy the needs and preferences of our customers, unless we can continue to enhance existing products and develop new innovative products in the global markets in which we compete. Product development requires significant financial, technological, and other resources. While we expended $166.4
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million, $148.5 million and $139.2 million for research and development efforts in 2015, 2014 and 2013 , respectively, there can be no assurance that this level of investment in research and development will be sufficient to maintain our competitive advantage in product innovation, which could cause our business to suffer. Product improvements and new product introductions also require significant planning, design, development, and testing at the technological, product, and manufacturing process levels and we may not be able to timely develop product improvements or new products. Our competitors’ new products may beat our products to market, be more effective with more features and/or less expensive than our products, obtain better market acceptance, or render our products obsolete. Any new products that we develop may not receive market acceptance or otherwise generate any meaningful sales or profits for us relative to our expectations based on, among other things, existing and anticipated investments in manufacturing capacity and commitments to fund advertising, marketing, promotional programs, and research and development.
We manufacture our products at, and distribute our products from, several locations in North America and internationally. Any disruption at any of these facilities, or manufacturing delays could adversely affect our business and operating results. We manufacture most of our products at 16 locations, including North American and international facilities. We also have several locations that serve as whole goods and PG&A distribution centers, warehouses, and office facilities. In addition, we have agreements with other third-party manufacturers to manufacture products on our behalf. These facilities may be affected by natural or man-made disasters and other external events. In the event that one of our manufacturing facilities was affected by a disaster or other event, we could be forced to shift production to one of our other manufacturing facilities. Although we maintain insurance for damage to our property and disruption of our business from casualties, such insurance may not be sufficient to cover all of our potential losses. Any disruption in our manufacturing capacity could have an adverse impact on our ability to produce sufficient inventory of our products or may require us to incur additional expenses in order to produce sufficient inventory, and therefore, may adversely affect our net sales and operating results. Any disruption or delay at our manufacturing facilities could impair our ability to meet the demands of our customers, and our customers may cancel orders or purchase products from our competitors, which could adversely affect our business and operating results.
Our operations are dependent upon attracting and retaining skilled employees, including skilled labor. Our future success depends on our continuing ability to identify, hire, develop, motivate, retain and promote skilled personnel for all areas of our organization.
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Our success depends on attracting and retaining qualified personnel. Our ability to sustain and grow our business requires us to hire, retain and develop a highly skilled and diverse management team and workforce. Failure to ensure that we have the leadership capacity with the necessary skill set and experience could impede our ability to deliver our growth objectives and execute our strategic plan. In addition, any unplanned turnover or inability to attract and retain key employees, including managers, could have a negative effect on our business, financial condition and/or results of operations.
We may be subject to information technology system failures, network disruptions and breaches in data security. We use many information technology systems and their underlying infrastructure to operate our business. The size and complexity of our computer systems make them potentially vulnerable to breakdown, malicious intrusion and random attack. Recent acquisitions have resulted in additional decentralized systems that add to the complexity of our information technology infrastructure. Likewise, data privacy breaches by employees or others with permitted access to our systems may pose a risk that sensitive data may be exposed to unauthorized persons or to the public. While we have invested in layers of data and information technology protection, and continually monitor cybersecurity threats, there can be no assurance that our efforts will prevent disruptions or breaches in our systems that could adversely affect our business. Item 7A. Quantitative and Qualitative Disclosures about Market Risk Inflation, Foreign Exchange Rates, Equity Prices and Interest Rates The changing relationships of the U.S. dollar to the Japanese yen, the Mexican peso, the Canadian dollar, the Australian dollar, the Euro, the Swiss franc and other foreign currencies have had a material impact from time to time. We actively manage our exposure to fluctuating foreign currency exchange rates by entering into foreign exchange hedging contracts. Japanese Yen: During 2015, purchases totaling approximately two percent of our cost of sales were from yen-denominated suppliers. Fluctuations in the yen to U.S. dollar exchange rate primarily impacts cost of sales and net income. Mexican Peso: With increased production at our Monterrey, Mexico facility, our costs in the Mexican peso have continued to increase. We also market and sell to customers in Mexico through a wholly owned subsidiary. Fluctuations in the peso to U.S. dollar exchange rate primarily impacts sales, cost of sales, and net income.
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Canadian Dollar: We operate in Canada through a wholly owned subsidiary. The relationship of the U.S. dollar in relation to the Canadian dollar impacts both sales and net income. Other currencies: We operate in various countries, principally in Europe and Australia, through wholly owned subsidiaries and also sell to certain distributors in other countries. We also purchase components from certain suppliers directly for our U.S. operations in transactions denominated in Euros and other foreign currencies. The relationship of the U.S. dollar in relation to these other currencies impacts each of sales, cost of sales and net income. At December 31, 2015, we had the following open foreign currency hedging contracts for 2016, and expect the following currency impact on net income, after consideration of the existing foreign currency hedging contracts, when compared to the respective prior year periods:
Foreign Currency
Foreign currency hedging
contracts
Currency impact compared to the prior
year period
Currency Position
Notional amounts (in
thousands of U.S. dollars)
Average exchange
rate of open contracts 2015 2016
Australian Dollar (AUD) Long $ 20,336
$0.71 to 1 AUD Negative Negative
Canadian Dollar (CAD) Long 81,747
$0.77 to 1 CAD Negative Negative
Euro Long — — Negative Negative
Japanese Yen Short 10,066 120.44 Yen to
$1 Positive Positive
Mexican Peso Short 32,857 16.20 Peso to
$1 Positive Positive Norwegian Kroner Long — — Negative Negative Swedish Krona Long — — Negative Negative Swiss Franc Short — — Positive Positive The assets and liabilities in all our foreign entities are translated at the foreign exchange rate in effect at the balance sheet date. Translation gains and losses are reflected as a component of accumulated other comprehensive income (loss), net in the shareholders’
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Polaris Industries, Inc.
equity section of the accompanying consolidated balance sheets. Revenues and expenses in all of our foreign entities are translated at the average foreign exchange rate in effect for each month of the quarter. Certain assets and liabilities related to intercompany positions reported on our consolidated balance sheet that are denominated in a currency other than the entity’s functional currency are translated at the foreign exchange rates at the balance sheet date and the associated gains and losses are included in net income. We are subject to market risk from fluctuating market prices of certain purchased commodities and raw materials including steel, aluminum, petroleum-based resins, certain rare earth metals and diesel fuel. In addition, we are a purchaser of components and parts containing various commodities, including steel, aluminum, rubber and others, which are integrated into the Company’s end products. While such materials are typically available from numerous suppliers, commodity raw materials are subject to price fluctuations. We generally buy these commodities and components based upon market prices that are established with the vendor as part of the purchase process and from time to time will enter into derivative contracts to hedge a portion of the exposure to commodity risk. At December 31, 2015, derivative contracts in place to hedge our diesel fuel exposures for 2016 are immaterial. Based on our current outlook for commodity prices, the total impact of commodities is expected to have a positive impact on our gross margins for 2016 when compared to 2015. We are a party to a credit agreement with various lenders consisting of a $500 million revolving loan facility. Interest accrues on the revolving loan at variable rates based on LIBOR or “prime” plus the applicable add-on percentage as defined. At December 31, 2015, we had an outstanding balance of $225.7 million on the revolving loan. Assuming no additional borrowings or payments on the debt, a one-percent fluctuation in interest rates would have an approximate $2.0 million impact to interest expense in 2015.
BIBLIOGRAPHY— Polaris.com Inc. (2015). 10-K Annual Report for the year ending December 31, 2015; Retrieved December 2, 2016, from SEC EDGAR website. Frigo, Mark L. and Joel Litman, Driven: Business Strategy, Human Actions and the Creation of Wealth, Strategy and Execution 2008. Anderson, Richard J. The Role of Assumptions in Strategy and Strategic Risk Management Working Draft - V3. N.p., 23 Nov. 2016.
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