Business Risks

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The Otsuka group's business operations are subject to various risks. Although the group makes every feasible effort to consider and implement preventive measures aimed at minimizing, avoiding and hedging against foreseeable risk factors, it may be very difficult or impossible to ensure that all risk factors have been reduced or eliminated. If a risk event occurs, it could have a significant adverse effect on the group's operating results and financial condition.
The group's risk management system, and the items that the group judges to be its principal risks, are described below, but they do not purport to cover all of the risks associated with the group's business operations. Forward-looking statements contained in these items are based on the information available as of the fiscal year end.

1. Risk Management System

Overview of Risk Management System

To further enhance risk management at Otsuka Holdings (“the Company”) and its main operating companies, the Company introduced enterprise risk management (ERM) in July 2020 for the purpose of recognizing and assessing group-wide risks, and prioritizing allocation of resources to the control of principal risks.

As part of ERM activities, we have established a group-wide risk management framework and a system for risk assessment, and are identifying principal risks through risk assessments at the main operating companies, and formulating countermeasures against those risks.

These risk management activities are reported to the Risk Management Committee, which is chaired by the President and Representative Director of the Company. The Risk Management Committee monitors principal risks, examines past risk management activities and considers proposals for their improvement, and regularly reviews the risk management system.

Details of Risk Management Activities

In conducting risk assessments, risk awareness in management is shared through management interviews at the Company and its main operating companies (top-down approach), and assessments and risk control are conducted by front-line employees (bottom-up approach). This enables us to comprehensively identify the risks that exist in the group. Each company formulates risk management policies and risk management action plans for risks that are judged to be its principal risks, and regularly reviews the risk situation and the progress of action plans.

In addition, the Company aggregates and visualizes the results of each group company's assessments to gain a comprehensive understanding of the risks that exist and the control situation in the group. Based on these results, the Company has identified the group's principal risks. (See 2. Principal Risks.)

Otsuka Group's Risk Management System

2. Principal Risks

As stated in 1. Risk Management System, based on the results of group-wide risk assessments at Otsuka Holdings and its main operating companies, the Company recognizes the following principal risks, and is taking steps to mitigate them.

(1) Risks Related to Management Based on Corporate Philosophy

Talent Recruitment and Development Risk

<Overview of Risk>

If the corporate culture and corporate philosophy are not sufficiently understood, and if the group is unable to secure personnel who can operate its businesses in accordance with the group's strategies, the group's competitiveness and operating results could be adversely affected in the long term. Furthermore, if the group is unable to secure sufficient talent to carry out critical and high-level strategies such as overseas expansion, M&As and alliances, and digitalization, the group's competitiveness and profitability may not grow as expected and measures to prevent misconduct and respond appropriately may not be implemented, which could have a significant adverse effect on achievement of targets, and on the group's operating results and financial condition.

<Response>

In order to discover and develop the next generation of management talent early on, the group has established the Otsuka Global Academy to secure personnel capable of business management based on the group's strategies. The group also believes that diverse human resources, without regard to attributes such as nationality, race, ethnicity, age, gender, disability or sexual orientation, are necessary to generate the innovative products and ideas that will drive long-term business growth. Accordingly, promotion of diversity is included in the Otsuka Group Global Code of Business Ethics, and by providing systems and mechanisms to support diverse human resources the group is securing talent to support sustainable growth.

Risk Related to Corporate Social Responsibility

<Overview of Risk>

Stakeholder concern about matters such as ESG issues and the U.N. Sustainable Development Goals (SDGs) is rising year by year, and initiatives to contribute to the creation of a sustainable society are becoming increasingly important. Should the group be unable to respond adequately, the resulting harm to its social standing could adversely affect the group's operating results or sustainable growth.

<Response>

The group understands that CSR is integrated into our businesses across the Otsuka group of companies, which aims to grow while contributing to the creation of a healthy and sustainable society. Additionally, in 2019 the group determined Society (Health, People, Quality in All We Do), Environment (Climate Change, Resource Recycling and Conservation, Water Resources), and Governance as its material issues, or “Materiality.” For each of these, the group has set goals that take into account social issues, and aims to resolve issues through the business activities of its operating companies. The Otsuka Group Sustainability Promotion Committee, chaired by a director of Otsuka Holdings, has also been established as a forum for sharing the group's sustainability activities.

(2) Risks Related to Business Strategy

Risk as a Holding Company

<Overview of Risk>

Failure to fully realize the benefits from governance under the holding company structure, such as appropriate allocation of resources, planning and review of group strategies, and monitoring and supervision of group companies, could have a significant adverse effect on the group's operating results and financial condition. Moreover, inability to procure funding as planned or a rise in funding costs due to changes in global economic conditions could have a significant adverse effect on the group's operating results and financial condition.

<Response>

In the Otsuka group, strategic decisions and allocation of resources appropriate for the group as a whole are made based on reports of business operations from group companies and analysis of those reports. The group's core businesses are the Pharmaceutical Business and the Nutraceutical Business. In particular, the group allocates resources primarily to products and pipeline in the psychiatry and neurology area, products and pipeline for the Japanese market, and new technologies in the Pharmaceutical Business, and new businesses and pioneering high-growth markets in the Nutraceutical Business.

Furthermore, to respond appropriately to changes in domestic and international market environments, the group examines the possible existence of various risks, and promptly reports the findings to management. Specifically, the group focuses on proposing solutions based on new concepts that address yet-to-emerge needs and social issues, and creating original products based on its unique and diverse businesses. In addition, the group's distinctive and diverse products enable it to disperse its overall business risk and respond to changes in the market environment related to changes in personal consumption trends.

The Company also enacted the Otsuka Group Global Code of Business Ethics and related global policies, and is using these as the basis of standardized training throughout global operations, which in turn will lead to the creation of a system for the collective control of group companies. Based on matters prescribed in the Regulations of the Board of Directors and the Affiliated Company Management Regulations, information from domestic and overseas group companies is collected and exchanged regularly, and by requiring the approval of the Company for important matters, a group cooperation framework has been established. In addition, the Company periodically conducts internal audits of domestic and overseas group companies, and has built a monitoring framework and established a group-wide internal reporting system.

The Company maintains good relationships with financial institutions in order to ensure its ability to maintain a certain level of financial soundness. The Company is proactively diversifying its funding sources, and raises funds through bond issues and other methods as necessary. The Company also maintains line of credit commitments with multiple financial institutions as a precaution against the event that it is unable to raise sufficient funds using these methods due to market disruption. In addition, it makes timely revisions to funding plans based on the most current information.

Risk Related to Corporate Brand Management and Reputation

<Overview of Risk>

Failure to properly cultivate and manage the Otsuka group's corporate brand may adversely affect the group's image. The spread through social media of inappropriate expressions in the group's advertisements or other media, or the spread of criticism or misinformation about the group's business activities or image could lower the group's brand value or credibility, depending on various factors, which could have a significant adverse effect on the group's operating results and financial condition.

<Response>

To properly cultivate and manage the group's corporate brand, the Company established rules for use of the corporate brand at each group company, and promotes initiatives for management of the corporate brand and maintenance and improvement of its value. The group's corporate symbol is managed primarily by the CI Management Committee in accordance with unified group rules.

Moreover, prevention of inappropriate expressions in advertising and social media has been incorporated into in-house training, and a system has been established to collect information from group companies on matters that could affect the group's reputation. The Company has prepared appropriate media responses in the event that problems affecting the group's reputation occur, and has clarified procedures and responsibilities for communication with the media in the Otsuka Group PR Guidelines. In addition, training on appropriate communication with the public in the event that risks do materialize is conducted for the senior management of group companies.

Risk Related to Uncertainty of New Drug Development

<Overview of Risk>

Development of pharmaceuticals requires substantial investments in research and development, and the drug development process, including the step of obtaining approval based on strict regulatory review, is a long-term endeavor. Delay or suspension of development due to inability to confirm the expected efficacy in late-stage clinical trials could shorten the period of exclusivity until patent expiration or allow competing products to reach the market first. As a result, the group would be unable to obtain revenue commensurate with research and development expenses, which could have an adverse effect on medium-to-long-term business plans. Moreover, a decline in profit margins or recording of impairment losses on intangible assets due to a decline in the operating rate of facilities in which the group invested ahead of product launches could have a significant adverse effect on the group's operating results and financial condition.

<Response>

Decisions on development plans for pharmaceutical compounds are made at Board of Directors meetings. Setting of budget priorities related to the development and review of research and development directions is carried out by advisory committees such as the Global Strategy Meeting to manage the development portfolio appropriately. In addition to its core therapeutic areas—the psychiatry and neurology area, and the oncology area—the group focuses on research and development that address unmet medical needs in the cardiovascular and nephrology area, and is enhancing its pipeline. The group monitors clinical trials, and if problems are recognized, implements countermeasures in cooperation with the relevant departments. The group reduces risk by also conducting impact analyses that consider the possibility that projects do not proceed according to the development plan, and by expanding its pipeline through in-licensing.

Risk Related to Business Alliances and Acquisitions

<Overview of Risk>

Business alliances and acquisitions related to the group's key growth strategies may not produce the expected group synergy due to factors such as changes in the operating environment after the acquisition or alliance is made, resulting in dissolution of the alliance or financial losses. In that event, the dissolution of the alliance or the recording of impairment losses on goodwill or intangible assets due to inability to realize the anticipated benefits from the acquisition or alliance, could have a significant adverse effect on the group's operating results and financial condition.

<Response>

In order to make appropriate strategic alliances and acquisitions and pursue subsequent sustainable growth, the group conducts detailed due diligence and valuation of the target companies or assets, holds extensive discussion by the Board of Directors, and monitors business operations after the investment. The group also engages outside experts when necessary, and works to develop in-house talent with the ability to effectively execute alliances and acquisitions.

Risk Related to Digitalization

<Overview of Risk>

If the group's digitalization policy and support measures are not carried out properly, delays in digitalization at the group's operating companies may prevent the group from securing a competitive advantage or expanding its market share. This could have a significant adverse effect on the group's operating results and financial condition.

<Response>

By harnessing its collective capabilities, the group is striving to introduce advanced technology with a sense of urgency, primarily in group companies and business divisions. As specific measures, the group is conducting proof-of-concept demonstrations and practical application in a variety of contexts, from the research and production fields, to smartphone apps for patients. In addition, measures are being taken to raise the base level of IT knowledge and skills group-wide by holding seminars for employees on the latest technologies, such as AI/machine learning and IoT, to improve their IT literacy, and by sharing successful case studies throughout the group.

Risk Related to Healthcare Cost Containment Measures

<Overview of Risk>

In Japan, the Ministry of Health, Labour and Welfare has announced a policy of containing the growth of healthcare costs to put the brakes on rising healthcare expenditure, and is taking measures such as promoting the use of generic drugs, in addition to conducting regular drug price reductions. In the U.S., an important market for the group, there is also pressure from managed care, insurance companies and health insurance reforms enacted in March 2010 to cut the prices of brand-name drugs, and the use of lower-priced generics is being promoted. The future direction of healthcare cost policies could have a significant adverse effect on the group's operating results and financial condition.

<Response>

The group works to provide innovative new drugs at appropriate prices and consider factors such as improvement of the healthcare environment, while also demonstrating the value of its new drugs. In addition, while maintaining its system for compliance with regulations, the group keeps a constant eye on drug pricing reforms, including annual revisions of drug prices, and trends in public administration, in Japan and in other countries, and examines response measures in a timely manner. At the same time, amid increasing public consciousness of prevention and health due to soaring healthcare costs and other trends, the group will draw on its characteristics as a total healthcare company to become an indispensable contributor to people's health worldwide.

(3) Risks Related to Production and Marketing of Products

Risk Related to Side Effects

<Overview of Risk>

The group's pharmaceuticals, medical devices and other products may cause unexpected serious side effects that would affect the safety profile of the product. In that case, the group may be required to respond with measures such as revising the package insert, suspending sales, or recalling the product, which could have an effect on revenue and development plans.

<Response>

The group has a global organizational structure for product safety management, has established global standard operational procedures, and ensures to collect safety information through measures including training for all employees. In all countries/regions where the group's products are sold, safety information collected by group companies, alliance partners or others is centrally managed in a global database. Safety information is evaluated internally by physicians and reported appropriately to authorities in accordance with the regulations of each country/region, and a system has been established for implementing safety measures.

Risk Related to Food Safety

<Overview of Risk>

In domestic and international markets, the food industry has faced various problems in recent years such as contamination with harmful substances. The occurrence of an incident that exceeds the group's quality control capacity could have a significant adverse effect on the group's operating results, financial condition and social trust.

<Response>

To secure food safety for customers, the group takes every possible measure for the quality control and safety assurance of not only products the group manufactures in-house but also products made by contract manufacturers, both in Japan and in other countries. Specifically, the group conforms to all legal and regulatory requirements, as well as governmental and industry standards, including Japan's Pharmaceutical and Medical Devices Act and Food Sanitation Act, and group companies work to acquire ISO 9001 (for quality), and ISO 22000 and FSSC 22000 (for food safety) certifications. Leveraging its global network, the group works toward continuous quality improvement by establishing guidelines, setting indicators for monitoring quality activities, and conducting internal audits. In global operations, systems and regulations differ in each country/region. Therefore, the group encourages each of its plants to acquire certification under international standards, and conducts internal audits of plants on a regular basis. Through these initiatives, the group is reducing risk related to food safety.

Risk Related to Natural Disasters and Pandemics

<Overview of Risk>

Should the group fail to adequately formulate response policies or implement response measures in the event of a disaster or pandemic, the resulting delay in recovery from damage to its factories, research laboratories, business sites or other facilities, and reduced consumption of its products in the Nutraceutical Business and other businesses, could have a significant adverse effect on the group's operating results and financial condition.

<Response>

The group formulates business continuity plans (BCPs) to continue its business activities to the extent possible and maintain stable supplies of products even in the event of a major earthquake or other disaster. Specifically, in preparation for natural disasters, the group has established a system for confirming the safety of employees and their families, ensures channels of communication between group companies, maintains stockpiles of emergency supplies, and conducts regular drills. From the standpoint of business continuity management (BCM), group companies are cooperating to create a framework for business continuity across the group, securing proper raw materials and product inventories, and working to strengthen measures such as alternate production capability and logistical systems. As part of these efforts, group companies jointly conduct desktop simulation drills annually. Furthermore, in order to respond appropriately to changes in domestic and international consumption patterns of products in the Nutraceutical Business and other businesses due to a natural disaster or pandemic, group companies study the likelihood of various risks, and promptly report the results to management.

For the ongoing COVID-19 pandemic, the Risk Management Committee has led the way in formulating the response policy that has been shared with group companies. In addition to practicing basic infection prevention measures, such as daily temperature checks, hand washing, and mask wearing, the group is taking every reasonable measure, including implementing a work-from-home system, introducing and enhancing systems for web conferencing, and using thermographic cameras to conduct fever screenings of visitors at production sites.

Risk Related to Supply Chain Disruption

<Overview of Risk>

The increasing risk of stagnation in the global economy due to the spread of a novel infectious disease, or increased geopolitical risk, also poses an increasing threat to the group's supply chains. A delayed response in studying the impact on the group or in the planning and execution of strategies could affect business continuity and have a significant adverse effect on the group's operating results and financial condition.

<Response>

The group strives for procurement that is fair, equitable and transparent, and to build good relationships with suppliers. In addition, the group seeks to ensure the quality of raw materials and maintain stable procurement and supply. In the pharmaceutical manufacturing and distribution process, the group ensures a high level of quality control by setting its own standards that conform to Good Manufacturing Practice (GMP) and Good Distribution Practice (GDP). The group also conducts risk assessments in advance for key raw materials to identify possible risks and take countermeasures. The group diversifies suppliers by purchasing from multiple companies in principle, secures alternative raw materials, maintains appropriate inventories and has multiple production locations. In addition, systems have been established to maintain the business continuity of the group overall in the event of the spread of a novel infectious disease. Through these measures, the group is reducing risk related to supply chain stability arising from factors such as stagnation of the global economy due to the spread of infectious disease, or increased geopolitical risk.

Risk Related to Raw Material Price Increases

<Overview of Risk>

Raw material prices may fluctuate due to various factors including weather conditions, natural disasters, market prices, economic conditions, fuel costs, and exchange rates. Manufacturing costs could increase if raw material prices rise sharply for any reason. Any inability to respond to the market situation, the failure of negotiations with business partners, or the occurrence of other difficulties arising from supplier-related problems with the procurement of raw materials, could have a significant adverse effect on the group's operating results and financial condition.

<Response>

The group strives for procurement that is fair, equitable and transparent, and to build good relationships with suppliers. In addition, the group seeks to ensure the quality of raw materials and maintain stable procurement and supply. To reduce risk from a sharp rise in raw material prices, the group takes various measures, including purchasing from multiple companies in principle, gathering information such as raw material market trends, securing alternative raw materials, maintaining appropriate inventories, and reducing costs by improving productivity. After taking such measures, there is also a possibility that the group may be able to adjust product prices to reflect the increase in raw material costs.

Risk Related to Expiration of Patent Protection

<Overview of Risk>

The pharmaceutical products that the group manufactures and sells could be exposed to intense competition from generics once the patent protection term that the group can exclusively exercise expires. This could have a significant adverse effect on the group's operating results and financial condition.

<Response>

The group takes measures to bring novel products to market, such as focusing on research and development of new products that will drive sustainable growth. In addition, the group works to extend the lifecycle of products by adding indications or changing dosage forms.

Risk Related to Patent Infringement

<Overview of Risk>

Expected earnings may not eventuate if the intellectual property rights that are held by the group or licensed to the group by other companies are infringed by a third party. Also, the group may be required to conduct product recalls, terminate manufacturing or sales, and/or pay substantial amounts of compensation if a product manufactured or sold by the group is determined to have infringed a third party's intellectual property rights.

<Response>

The group has systems in place to properly manage intellectual property, including patents. Through continuous monitoring, the group remains alert to the risk of infringement of its intellectual property by third parties. The group also conducts investigations and gathers information using outside experts, databases and investigative organizations to remain alert to the risk of infringement of the intellectual property rights of third parties. In addition, should an intellectual property dispute arise, the group takes steps to minimize the impact on its businesses in cooperation with the relevant parties inside and outside the group.

Risk Related to Litigation

<Overview of Risk>

Regarding the group's operational activities, there is a possibility that a suit may be brought relating to product liability, labor issues, patent infringement, breach of contract, environmental pollution, or other issues. Any judgment, decision or settlement unfavorable to the group could result in a significant adverse effect on the group's operating results, financial condition, business strategies and social trust.

<Response>

The group has established an internal reporting system to monitor signs of possible litigation. The Company's Legal Affairs Department also exchanges information with group companies and responds appropriately. Furthermore, the Company consults with outside counsels as necessary to reduce litigation risk.

(4) Other Risks Related to Business Management

Risk Related to Information Management

<Overview of Risk>

Regarding the management of information, the group is exposed to the possibility that information falsification, misuse, and leakage could occur due to system malfunctions, accidents or cyberattacks. This could have an adverse effect on the group's operating results and social trust.

<Response>

The group has established the Otsuka Group Information Global Security Policy as its basic policy on information management and security. In addition to promoting a shared awareness of the importance of information management and information security at all group companies, the group reinforces awareness of that importance through training for executives and employees. To raise the level of, and constantly improve, security across the group, the Group Information Security Committee has been established to examine concrete measures and share up-to-date information concerning information management and information security. In addition, the group has strengthened its ability to respond to cybersecurity emergency situations by conducting emergency drills led by the Computer Security Incident Response Team (CSIRT), with a focus on core systems and controlling the risk of external cyberattacks.

Risk Related to Global Business Operations

<Overview of Risk>

Outside of Japan, the group conducts business operations mainly in the U.S., Europe and Asia, including research and development, manufacturing and sales activities. As such, it is not possible for the group to completely avoid risks related to maintaining global operations, including each country's laws and regulations, economic conditions, political instability and uncertainty in the business environment, and as a result there may be a significant adverse effect on the group's operating results and financial condition.

<Response>

To mitigate risk related to global business operations, the group gathers information, appropriately manages and supports business operations based on the local operating environment, and makes revisions to business strategies with a longer-term perspective when necessary, with collaboration among relevant departments as needed.

Risk Related to Foreign Exchange and Stock Prices

<Overview of Risk>

In the fiscal year ended December 31, 2020, 53.6% of the group's revenue was from outside of Japan, and a significant portion of revenue will continue to be based in foreign currencies. There is a possibility that the group's operating results may be significantly affected by a sharp appreciation of the yen that exceeds the Company's expectations. In addition, foreign exchange rates may have a significant adverse effect on the group's operating results and financial condition when foreign currency financial statements prepared by the group's foreign subsidiaries and affiliated companies are translated into yen. If the stock market weakens, valuation loss on stocks held by the group or an increase of net defined benefit liability due to a decrease in pension plan assets could have a significant effect on the group's operating results and financial condition.

<Response>

The group uses forward exchange contracts to hedge the foreign currency risk of some foreign currency transactions and foreign currency monetary assets and liabilities. For stocks it holds, the group periodically examines the fair value of the stocks and the financial condition of the issuer, and reviews its stockholdings as necessary, taking into account its relationship with the issuing company. In addition, the group invests pension plan assets in a diversified portfolio of multiple investment products, and adjusts the portfolio as necessary. Through these measures, the group reduces risk related to foreign exchange and stock prices.

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