Wärtsilä Corporation Annual report 2014

Strategic risks

Strategic risk assessment is part of the strategic planning process within the Group. At Wärtsilä, a risk is defined as a strategic risk if it has the potential for imposing a long-term impact on the business.

Business environment risks

The business cycles in the global economy, and in customers’ industries, influence the demand for Wärtsilä's products, as well as our financial condition and operating result. The flexible multi-product manufacturing model based on capacity outsourcing, together with a stable business mix with a large share of sales deriving from Services, brings Wärtsilä certain stability in a cyclical market. Important economic matters that indirectly affect Wärtsilä, its clients, and suppliers include inter alia, the liquidity and solvency of financial institutions, and thus not only their capability but also their willingness to extend credit, the counter cyclical stimulus programmes adopted by governments – especially in the power and infrastructure sectors, the enhanced activities of multilateral institutions such as the International Finance Corporation, the availability of export credit schemes and guarantees, and other such factors. However, Wärtsilä’s relatively large order book gives the company time to adapt to changes in market conditions.

The implementation of more stringent environmental regulations is important for Wärtsilä’s future growth potential as we have a comprehensive portfolio of products and services that allow customers to meet such stricter requirements. A delay in legislation implementation may present a risk to Wärtsilä and possible changes in the legislation timeline and scope are, therefore, actively monitored.

Market and customer risks

In the Power Plants business, the market situation remained challenging during the year, as macro-economic uncertainty and slower global growth projections continued to impact investments in new power generation capacity. Nevertheless, economic growth in the emerging markets and the strengthening of the US dollar against the euro supported the demand for new power plants. Orders were received from all geographic regions, limiting the risk of over exposure to one particular market. Power Plants has three customer segments: industrial customers, IPPs (Independent Power Producers) and utilities. All customer types were represented in the order intake.

Wärtsilä is well represented in all the major shipbuilding markets, and is active in all the main vessel segments. This mitigates both geographical and single customer risks. Marine market activity has been good during 2014, although it was slower in the latter part of the year. Challenges resulting from the uncertainty in the global economy and the business environment within the shipping and ship building industries continue to affect markets. Overcapacity in several shipping markets is currently one of the major obstacles to a full recovery. In the offshore segment contracting is expected to be impacted by the decline in oil prices. The importance of fuel efficiency and environmental regulations are clearly visible and offer opportunities for Wärtsilä. The regulatory environment is also driving the adoption of gas as a fuel in the wider marine markets. The shipbuilding market continues to be dominated by Asian yards, notably China and South Korea.

Service market activity developed well in 2014, with increased demand from marine customers and healthy activity in power plant related services. Wärtsilä Sevices’ mid- and long-term activities are expected to grow in line with the development of the existing installed base and general global economic developments. Wärtsilä has more than 10,000 individual customers engaging in service and spare part sales annually, and the current active engine base is 181,000 MW. Thus, dependency on any single customer or customer segment is minor. During the last few years, Wärtsilä has increased its focus on credit management processes to better manage the increasing risks resulting from higher leverage and decreasing profitability in certain customer segments. Exposure to individual customers is limited, but an industry-wide impact might also affect the profitability of Wärtsilä’s Services business.

Competitive situation and price risk

In the liquid fuel based power plant market, Wärtsilä’s main competitors are MAN D & T, Caterpillar (MAK), and Rolls-Royce. In natural gas based power generation, the main competitors are gas turbine manufacturers, such as GE and Siemens. In Wärtsilä’s main market, i.e. the market for installations of up to 500 MW, orders totalled 16.5 GW (25.0) during the first nine months of 2014. Wärtsilä’s market share increased to 10.5% (7.1). Wärtsilä’s success in the market can be attributed to its flexible power generation solution, which can be used in a wide range of different applications and power plant sizes.

For Ship Power, the competitive landscape remained largely unchanged in 2014. The most significant competitors in the main engine markets are MAN D & T, Caterpillar (MAK), and Hyundai Heavy Industries (HiMSEN). Wärtsilä has a strong position in medium-speed engines with a 52% market share in 2014. In auxiliary engines Wärtsilä’s market share was 3%. In propulsion equipment, the competition is more fragmented and varies by product category. One of the main competitors for these products is Rolls-Royce. In environmental solutions, as well as in flow and gas products, the markets are very fragmented. Alfa Laval is one of the main competitors in environmental solutions. Price competition has continued to be intense in the marine markets. The strategic move of becoming a systems integrator with automation and ship design capability has proven to be important in the competition for new projects with larger and more value-added scopes. The concept of selling packaged solutions reduces price volatility. However, larger projects may increase variations in business volume, depending on the timing of the projects.

In the Services business, Wärtsilä has no direct competitors capable of offering a similar portfolio of services from a single source. Excluding the networks of other engine manufacturers, there are few global players in the service market. The customers’ continued focus on optimising operating expenditure can lead to a further increase in competition for services where price is more important than quality. The main action to mitigate this risk is to promote the value based offering.

Political and legislative risks

Wärtsilä is present in more than 200 locations in nearly 70 countries and has delivered power plants to 170 countries. Political developments and changes in legislation can have a significant impact on Wärtsilä’s business. Wärtsilä actively monitors political and legal developments in its markets, and engages in dialogue with various official bodies on projects of importance to its operations and intellectual property rights. Much of this engagement takes place through interest groups and trade organisations. The company monitors political and legislative changes at both the corporate and subsidiary levels.

In recent years there has been increased regulatory activity by different governments worldwide, which has led to the need for emphasising due internal processes to ensure compliance. As an example, more trade sanctions were introduced in 2014. This has required increased internal efforts to ensure that adequate procedures are in place.

Climate change and sustainability risks

Wärtsilä has assessed its sustainability risks, including climate change risks, in both its strategic and operative risk assessments. However, the risks were not found to be significant. The potential business risks related to sustainability, climate change, and Wärtsilä's products are in the areas of regulatory emission restrictions and changes in customer attitudes to using combustion engines and fossil fuels. The risks in environmental legislation changes are related to the complexity of the overall field of different emissions, the balance between commercially available fuels and their resulting emissions, available abatement technologies, the impact on overall energy efficiency, and the resulting financial feasibility of the various alternative ways to meet regulatory demands.

Being at the forefront of technological developments mitigates sustainability risks and gives Wärtsilä many opportunities arising from tightening environmental regulations. Over the years, Wärtsilä has worked continuously to improve the efficiency of its products while at the same time seeking ways to reduce emissions. The fuel flexibility of Wärtsilä's products enables the utilization of various fuels, including gas and those from renewable sources, while their operational flexibility enables the installation of large capacity based wind and solar energy systems without hampering the reliability of the electricity grid. Wärtsilä's technology also enables energy to be generated with a minimum use of water. The lack of fresh water is expected to be one of the major challenges facing the world in the future. In shipping, Wärtsilä can reduce the carbon footprint of vessels through optimised ship design, and optimal propulsion solutions.

Environmental Solutions offer alternative technologies to reduce SOx emissions and to treat waste and ballast water. In Power Plants, Wärtsilä's Smart Power Generation concept supports the increase in low carbon power generation, including wind, solar and natural gas fired plants. Wärtsilä offers several retrofit solutions for the after-sales market to reduce emissions and to increase fuel efficiency.

For more information, please see the separate Sustainability report included in this annual report.

Technology risks

Wärtsilä aims to increase the competitiveness of its solutions and manage technology risks through solid R&D work and innovation. The development of new products is based on the strategic view of optimising lifecycle value for customers with modern and sustainable power solutions through, for example, environmental technologies, ship design, and electrical & automation solutions. As a technology leader, Wärtsilä places strong emphasis on emissions control, enhancing efficiency, and maintaining the cost competitiveness of its products.

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