MOST SIGNIFICANT RISKS

The demand for KONE’s products and services and the competitive environment are impacted by the general economic cycles and especially the level of activity within the construction industry. As China accounts for approximately 35% of KONE’s sales, a sustained market decline in the Chinese construction industry would have an adverse effect on KONE’s growth and profitability. Liquidity constraints in the Chinese property markets started to raise market concerns during 2021 and the financing environment remains tight. KONE’s customer portfolio is well diversified, limiting individual customer risks. However, a worsening liquidity situation among Chinese property developers could impact construction activity and customers’ payment discipline in China and, consequently, the demand and commercial terms for KONE’s solutions.

The war in Ukraine has increased geopolitical risks and added to the disruption of global supply chains. The resulting shortage of materials and services, as well as rising costs, may expose KONE to business disruptions, rescheduling of orders and profitability risks. Global supply chains have also suffered from governmental lockdowns in China due to COVID-19 outbreaks. In April, lockdowns in the Shanghai area led to the closure of KONE’s factories in Kunshan and Nanxun, but efficient recovery actions in May-June helped to mitigate the impacts. A deterioration of the COVID-19 situation in China would have an adverse impact on the Chinese economy, construction activity, availability of workforce and the demand for KONE’s services and solutions.

High inflation, rising interest rates and supply chain disruptions have weakened the global economic outlook, which represents a risk to KONE’s business and profitability. KONE aims to mitigate these risks with more dynamic pricing strategies and contract models as well as ongoing actions to improve productivity and lower product costs.

In addition to the level of market demand, the competitiveness of KONE’s offering is a key driver for growth and profitability. A failure to anticipate or address changes in customer requirements and in competitors’ offerings, ecosystems and business models or in the regulatory environment could result in a deterioration of the competitiveness of KONE’s offering. Furthermore, structural changes in the competitive landscape of the elevator and escalator industry, such as increased competition and customer consolidation in China, could affect market dynamics and KONE’s market share.

Empowered employees with relevant competencies and skills are key to the successful execution of our strategy. With business models and ways of working changing in the elevator and escalator industry, KONE needs new organizational capabilities, as well as new competencies and talent on the individual employee level in the field of, for example, digitalization. At the same time, the competition over talent, such as skilled field workforce, is increasing. Securing the needed resources and their competence management is critical. A failure to develop and retain the required capabilities or obtain them through recruitment could have an adverse impact on KONE’s growth and profitability.

The majority of components used in KONE’s supply chain are sourced from external suppliers, a significant number of which are located in China. KONE also subcontracts a significant amount of installation activity, outsources certain business support processes and works with partners in e.g. digital services and logistics. This exposes KONE to component and subcontracted labor availability and cost risk as well as to continuity risk in partnerships. A failure to secure the needed materials, components or resources, or quality issues within these, could cause business disruptions, rescheduling of orders and cost increases. Labor availability constraints may also impact progress at construction sites. The pressure on global supply chains continued during the second quarter, resulting in, for example, increased material prices, logistics costs and constraints in component availability, in particular semiconductors.

As one of the leading companies in the industry, KONE has a strong brand and reputation. Issues that impact the company’s reputation or brand could have an effect on KONE’s business and financial performance. Such reputational risks could materialize in the case of e.g. safety, cybersecurity or non-compliance incidents, major delivery issues or product or service quality issues.

KONE’s business activities are dependent on the uninterrupted operation, quality and reliability of its manufacturing facilities, sourcing channels, operational service solutions and logistics processes. The operations of KONE, its suppliers and customers also utilize information technology extensively and KONE’s business is dependent on the quality, integrity, availability and confidentiality of information. Thus, KONE is exposed to IT disruption and cybersecurity risks, as operational information systems and products may be vulnerable to interruption, loss or manipulation of data, or malfunctions which can result in disruptions in processes and equipment availability. Geopolitical tensions may lead to extreme data protectionism, the use of cyber, hybrid and even conventional warfare, causing local and global digital disturbances that may impact KONE, our customers and our suppliers.

A breach of sensitive employee or customer data may result in significant penalties as well as reputational damage. Such incidents could be caused by, including but not limited to, cyber-crime, cyber-attacks, ransomware, information theft, fraud, or inadvertent actions from our employees and vendors.

Physical damage caused by fire, extreme weather conditions, natural catastrophes or terrorism, among other things, could also cause business interruption for KONE or its suppliers.

The majority of KONE’s sales and result are denominated in currencies other than the Euro, which exposes KONE to risks arising from foreign exchange rate fluctuations. KONE is also exposed to counterparty risks related to financial institutions, through the significant amounts of liquid funds deposited with financial institutions, in the form of financial investments and in derivatives. Additionally, KONE is exposed to risks related to liquidity and payment discipline of its customers, which may impact cash flow or lead to credit losses. Significant changes in local financial or taxation regulation could also have an impact on KONE’s financial performance, liquidity and cash flow. For further information on financial risks, please refer to notes 2.4, 3.2 and 5.3 in the Financial Statements for 2021.

The assessment and analysis of KONE’s most significant risks also covers non-financial risks. In line with the requirements of the Finnish Accounting Act, KONE has identified the most significant non-financial risks regardless of their materiality for KONE as a whole. In addition, KONE applies TCFD guidelines on the reporting of climate-related risks. The typical effect of the non-financial risks materializing would be reputational damage to KONE or a negative impact on the surrounding society, environment or individuals. In addition to the risk mitigation actions described below, KONE aims for transparent and reliable communication in order to prevent reputational risks and to enable proactive management and learning from incidents, should they occur

Climate and environmental risks

We recognize climate and environmental risks as having a potential negative impact on our business in the short to medium term. While the effect is not determined to be significant, we expect climate risks to keep increasing in relevance and potential impact. Overall, we identify, assess and manage climate and environmental risks as integral part of our company-wide business risk management process and ISO 14001 environmental management system. Certain KONE functions and locations, e.g. the Supply Chain function or selected operational sites, conduct detailed climate and environmental risk assessments according to relevant business requirements.

Climate and environmental risks are classified as transition risks and physical risks as well as risks of negative impacts on the climate. Some of the most relevant climate and environmental risks for KONE are physical risks to our supply chain and own operations, for example, as a result of extreme weather events. These risks can materialize, for example, in the form of delivery disruptions or interruptions in our own manufacturing, installation or maintenance activities. KONE’s products are also subject to physical risks and possible damages due to changing environmental conditions or extreme weather events.

To mitigate the physical risks, we engage in several risk mitigation activities related to component availability and interruptions to our own or suppliers’ operations, as described in the risk management table in this text. We use, for example, dedicated location-based software tools to regularly monitor our supply chain locations for risks related to extreme weather events such as fires, floods or hurricanes. In terms of our product development, we apply design specifications and specific procedures that aim to ensure product resilience even in harsh and changing environmental conditions. For example, rigorous environmental testing is a part of KONE’s product development to ensure that our products sustain exceptional and changing weather conditions, such as temperature variations and moisture.

The most relevant transition risk to KONE arises from potential shifts in the supply and demand for low carbon materials, electricity and fuel, which may increase operating costs in the short to medium term. Also, technological improvements or innovations that support the transition to a lower-carbon, energy-efficient economy may impact KONE’s competitiveness and our customers’ demand for both KONE’s solutions and services. Not being able to offer the solutions and services our customers require could have a detrimental impact on KONE’s business. In addition to potential product-related requirements, emerging climate-related regulation may also impact our operations. For example, the need to transition towards more sustainable mobility solutions is evident for KONE’s current fleet of over approximately 18,000 service and benefit vehicles.

To mitigate the market transition risks, KONE evaluates plausible scenarios for market supply and demand, as well as the impact of emerging regulation in our high-level business plans. KONE is an active member in relevant industry forums and research consortiums and proactively monitors the regulatory landscape. To mitigate the technology transition risk, KONE bases its innovation work on the needs of our customers and equipment users. All in all, KONE sees the transition towards sustainable solutions as a source of innovation and competitive edge rather than a threat. As part of KONE’s climate pledge, we have set ambitious greenhouse gas reduction targets for our offering and operations and aim to have carbon neutral operations by 2030. The pledge will guide our work for more climate-friendly products, services and ways of working, and we actively collaborate with our suppliers and partners to achieve our targets.

Social and employee related risks

Safety is a top priority at KONE and potential safety incidents are among the most significant social and employee related risks. Incidents are mitigated through, for example, extensive training and communication, consistent safety management practices, standardized maintenance and installation methods and regular process audits. We also identify and assess risks related to any type of bullying, harassment, equal employment practices, working conditions and any form of discriminations. We address such risks by having adequate policies and processes in place and by training our managers and employees. We offer our employees channels for reporting misconduct as there is zero tolerance for this type of behavior. In 2021, the safety and wellbeing of KONE employees continued to be a top priority due to the conditions caused by COVID-19 pandemic.

Major repairs or retrofits in public infrastructure locations may also affect the daily life of many people and therefore, may have a reputational impact.

Both safety and quality have a key role in product design, supply, manufacturing, installation and maintenance and they involve strict quality controls. We follow globally implemented principles in how to manage potential incidents and implement improvements

Human rights related risks

The most significant human rights related risks are in the supply and delivery chain and are related to terms and conditions of work. All our suppliers and installation subcontractors are expected to sign KONE’s Supplier Code of Conduct, which sets out our ethical business practice requirements, including the standards we require in terms of labor and human rights. During 2021, we continued to prioritize our work on human rights in the supply chain and rolled-out online supplier human rights assessments to over 200 suppliers’ production sites.

Anti-corruption and bribery related risks

KONE requires its employees and partners to adhere to high ethical standards and to comply with its Code of Conduct, Distributor Code of Conduct and Supplier Code of Conduct. These codes cover numerous compliance topics, including competition law, trade sanctions compliance, and labor and human rights issues, as well as prohibiting corruption and bribery.

In 2021, we completed an anti-bribery and corruption risk assessment, which identified our highest risks as relating to third party intermediaries, sourcing and sales activities. Follow-up actions to mitigate risks were started in 2021 and will continue in 2022.

Unethical business practices among KONE’s employees or various stakeholders could cause reputational damage for KONE as well as a possible financial impact. The risks of such behaviors and practices materializing are included in the scope of KONE’s regular audit programs. In 2021, KONE implemented a supplier screening solution, which monitors entities against sanctions, watch lists and adverse media attention, including corruption and human rights issues. Processes under our Global Delegation of Authority policy help to mitigate the risk of unauthorized payments, donations and sponsorships. The most important action for internal mitigation continues to be the development of KONE’s corporate culture through training and awareness building. Ethics & Compliance KPIs and actions have been integrated into our new Sustainability strategy. All employees are required to complete at least one annual training on ethics & compliance, and supplier and distributor Code of Conduct sign-up rates are tracked annually.

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