Identifying and Managing Risks
ARM has a robust risk management process in place to identify key risks; assign ownership for each risk at a senior management level, identify both existing and planned management activities against each risk; assess the residual likelihood and impact of each risk; and to ensure ongoing monitoring and reporting of each key risk.
At a strategic level, our risk management objectives are to:
Strategic risks are managed through a number of regular forums where key risks are discussed and existing management activities challenged. These include regular sessions with both the Holdings Board and the senior management.
Operational risks are managed in accordance with the ARM Management System (AMS), which defines key policies and processes across the organisation. ARM has a number of sources in place to provide assurance over compliance with the AMS.
Risk review process
Strategic and operational risks are identified, prioritised and reported on within the Corporate Risk Register (CRR). The CRR includes a description of the overall risk, the risk factors, the risk owner, the operational response and management activities including sources of assurance and the residual likelihood and impact.
Risks are identified through senior management discussion (top-down) and regular reporting from every part of the business (bottom-up). Relevant risks are entered onto the CRR and given an owner at senior management level. ARM's ongoing operations and internal controls may mitigate the likelihood and/or the impact of the risk. The residual likelihood and impact of the risk is assessed to identify any further mitigating activities that may be required.
The CRR is monitored by the Risk Review Committee, chaired by Mike Muller, Chief Technology Officer. The Risk Review Committee meets on a quarterly basis to review the CRR. Each risk owner is required to review and demonstrate that risks are being appropriately managed. A more detailed explanation of the Risk Review Committee's activities is included in the Governance and Financial Report 2013 on pages 19 to 20. The Audit Committee is responsible for overseeing the risk management framework and ensuring that the risk management process is operating effectively. The Executive Committee and the Board review the CRR on a regular basis.
Internal audit assurance
ARM's internal audit function develops an annual internal audit plan designed to provide assurance that the management activities for the key risks identified are designed and operating effectively.
ARM's principal risks and uncertainties
How risk management relates to our strategy for long term growth
ARM's strategy is for our technology to continue to gain market share in long-term growth markets, to increase the value ARM receives from each device, and to develop new technologies that can generate additional royalty revenue. ARM's principle risks may impede ARM's progress in executing on this strategy.
1. A change in the industry business dynamic may lead to loss of market share and/or reduction in value of IP
We work in the highly competitive and fast moving semiconductor industry. Many of the other companies within this industry are well resourced and may consider processor and physical IP as attractive markets for them to enter with competitive products. Start-up and open source technology initiatives could develop competing or alternative ways for companies to design their chips. The cost of developing software in many end market applications is increasing, which may also result in new technologies that might not suit ARM's current product portfolio or skill set. We may not be able to adapt to these changes, resulting in a loss of market share.
At the end of 2013 ARM had approximately 350 Partners, and over 1,000 companies in the ARM Connected Community. These companies depend on ARM technology for part of their business, and we meet with thought leaders within our industry and related sectors to discuss their business context and strategy. ARM is well positioned to detect any change within the semiconductor industry, and react accordingly. ARM's management team reviews our strategy and our long-term product development plans to test that we are developing the technology to meet the future needs of the industry.
2. A competitor's product or technology may lead to loss of market share
ARM faces competition both from large semiconductor companies and from smaller IP companies. Intel is developing x86-based processors for use in PCs and servers, and is looking to deploy these chips in markets such as tablets, mobile phones and embedded markets, including the Internet of Things. There are many small semiconductor IP companies competing with ARM, especially in emerging markets where there are lower barriers to entry. Any success by our competition would result in a reduction in royalty revenue to ARM.
ARM works closely with leading semiconductor companies who together have a long history of developing cost-efficient, low-power chips. Together we have created a highly competitive market and OEMs have enjoyed a wide choice of chips at different capabilities and pricing. ARM's established ecosystem includes many software and chip design engineers who understand how to build ARM-based chips and write software optimised for ARM processors. ARM has enabled thousands of companies to offer products that are compatible with and support other ARM-based technologies, reducing the complexity and cost of developing an SOC or product around an ARM processor. ARM invests in this ecosystem to help further reduce the total cost of developing and maintaining a portfolio of ARM-based chips.
3. ARM may face challenges managing its business in new geographic markets
Chinese semiconductor companies have become responsible for an increasingly significant proportion of ARM's revenues, and we expect that proportion to continue to grow. India has had a strong semiconductor presence for many years, although revenues from that region are smaller. ARM has little knowledge and experience of the markets in Russia, South America and Africa, which have different political cultures to the markets we are established in. In all these regions local governments are supporting and funding local technology companies, which could give rise to new competitors and new markets.
ARM has had offices in both China and India for many years, and 19% of our workforce is split between these two countries. We have regional development offices to support the other regions, and combined with regular visits by management, we track opportunities and meet local decision makers.
4. We could suffer significant damage to our brand and reputation
ARM's technology is used in billions of consumer and enterprise products, many of which are depended on by individuals and businesses, and are used to store, manage or transmit huge amounts of personal, confidential or proprietary information. A fault or bug associated with one of ARM's products could damage ARM's corporate reputation and lead to a loss of brand value.
ARM has rigorous quality assurance, and verification and validation processes to reduce the risk of faults or bugs. ARM regularly gathers feedback from its customers and Partners to determine whether the perception of ARM is changing, and that corrective action can be taken early if customers are becoming less satisfied with our products or behaviour.
5. ARM's technology may not meet customer requirements in the future
The technology industry is characterised by rapid change, as new innovation continually improves the way that chipsets are designed and manufactured, and how they are deployed by OEMs and used by consumers. A change in the end market that does not favour ARM or our business model could occur, requiring ARM to either change its investment approach or risk losing share. Either way, ARM could become less profitable in the future as a result of such a market change.
ARM has well-established product specification and development processes, and we work with thought leaders within various industries to ensure our technology is suitable for next generation digital products. We spend some of our R&D budget on longer term programmes to investigate how new scientific developments might impact the industry, and how technologies in adjacent markets might impact ARM and our ecosystem.
6. ARM's current people, processes and/or infrastructure may not be adequately scalable to meet our growth ambitions
We have grown our headcount rapidly over the last few years, as we have hired more engineers to develop the next generation of processors and the supporting technology our customers need. If this growth rate continues we may find our existing organisational structure, culture and infrastructure cannot be adapted to meet the greater number of staff.
Our multi-year planning process includes product development reviews alongside long-term investment plans for recruitment, training, facilities and IT. We also hold regular surveys of employees to measure job satisfaction and engagement levels across the organisation, and in sufficient detail to identify early problems with specific teams, locations or departments.
7. ARM may have to defend itself against third-parties who claim that we have infringed their proprietary rights
Whilst we take great care to establish and maintain the integrity of our products, we may have to protect our intellectual property or defend our technology against claims that we have infringed others' proprietary rights. From time to time, third-parties, including our competitors, may assert patent, copyright and other intellectual property rights to technologies that are important to our business. Any infringement claim brought against us or our Partners, could result in substantial costs and divert management's attention.
Any assertion of intellectual property rights by a third-party against our technology could result in our licensees becoming the target of litigation and we may be bound to indemnify such licensees under the terms of our licence agreements.
We focus on designing and implementing our products without the use of intellectual property belonging to third-parties, except under strictly maintained procedures and with the benefit of appropriate licence rights. In the event that a third-party successfully proves that it has intellectual property rights covering a product that we have licensed to customers, we will take steps to either purchase a licence to use the relevant technology or work around the technology by developing our own solution so as to avoid infringement of that third-party's intellectual property rights. From time to time ARM enters into cross-licensing agreements and non-assert agreements with leading technology companies.
8. Significant concentration in our customer base may increase the risk to ARM's growth ambitions
Changes in technology trends and/or economic conditions may cause companies within the semiconductor industry to consolidate further, thereby reducing the number of customers that ARM may sell its technology to and potentially making ARM more dependent on a smaller number of customers. Any change to the product plans of a major customer may have an impact on the technology that ARM was developing, and so result in both additional costs, and a delay in revenues.
We have licensed our processor technology to approximately 350 Partners, about half of which are now paying royalty revenues. Much of our royalty and licence revenues are generated by the top 20 semiconductor companies. ARM typically develops 2–3 new processors each year, reducing the impact of a customer asking us to change the specification of a product.
9. Assumptions that fundamentally underpin ARM's valuation may be undermined, leading to a sudden depreciation of share price
ARM's valuation is based on the financial markets' view of our growth opportunity and the value of ARM's assets. Revisions to assessments of our future markets could impact estimated cash flows. Changes to assumptions about the value of ARM's assets, including goodwill, could lead to the impairment of certain of ARM's assets.
At least once every year, we present to the financial markets the latest forecasts on the growth of the semiconductor industry and ARM's view of our opportunity to win share within that market.