Adidas and Reebok scandals

Its about Adidas and Reebok scandals

1. ADIDAS AND
REEBOK SCANDAL

Introduction
It was late March and Prem, 44, the former managing director of
Reebok’s Indian entity was in Phoenix, Arizona, for a bi-annual
meeting to present the company’s business plan for the fast-
growing Indian market. Reebok’s India businesses were to be
downsized in 2012 and, though there were differences between
Prem and his boss Ronald Auschel on how swift the downsizing
should be, Prem believed he’d managed to do the balancing act
needed to stay at the helm. Instead, he was asked to summarily
step aside.

A month later, on April 30, in an earnings release, Adidas would
announce exceptional sales and profits in its global operations.
Those results were overshadowed by what the company termed
as ‘commercial irregularities’ in its Indian operations. It said the
company would be taking a euro 125 million write-off and
restating its results for the year 2010. It asked investors to brace
for a further euro 70 million write-off. A week later, the company
filed a criminal complaint against Prem. Prem hit back with two
cases—one for defamation and another for recovery of his past
dues amounting to Rs 12.7 crore in the Delhi High Court.

2. The Delhi High Court is expected to hear the cases in July. Unless
both parties eventually arrive at an out-of-court settlement,
there’s every chance that the last has not been heard on this rather
unexpected high-voltage drama inside the world’s second largest
sports shoemaker.

So what really led to a sudden escalation of hostilities between
the swashbuckling go-getting Indian executive and a highly
conservative German multinational? Was it merely a clash of
corporate cultures, given that Prem belonged to the erstwhile
Reebok set-up which Adidas bought out in 2005? Or was he
penalised for repeatedly questioning the Adidas system which
prided itself on conformity and discipline?

In what could the second biggest corporate scandal after Satyam,
Reebok India has alleged a Rs 8,700 crore fraud by its former
Managing Director Subhinder Singh Prem and former Chief
Operating Officer Vishnu Bhagat.
Reebok lodged an FIR with the Gurgaon police alleging that Prem
and Bhagat had 'stolen' products by setting up 'secret
warehouses', fudged accounts and indulged in fictitious sales to
cause a multi-crore dent to the company.
When the alleged scam came to light in March 2012, Singh, who
had been made the Managing Director of Adidas India in 2011 as
a part of an integration of the businesses of both Adidas and
Reebok brands, was dismissed from the company. Bhagat's
services were terminated too.
The company's financial director, Shahim Padath, later lodged a
formal complaint against the duo. The economic cell of Gurgaon

3. police conducted a probe and found that Singh and Bhagat had
allegedly rented four warehouses without informing their seniors
and used them to store goods and claimed they were supplied to
genuine dealers.
They also allegedly siphoned off goods to ghost companies and
distributors across the country, claiming they were defective
pieces.

Before we delve into the answers, let’s first start at the beginning

what happened exactly?

Reebok’s rise in India reads like a fairytale success story. Globally,
the brand ranks a distant fourth after Nike, Adidas and Puma,
but in India it had built up an impressive network of over a 1,000
stores by 2012 and is the market leader. As Prem explains in an
interview with Forbes India, “The reason why we grew was that
yes we were looking at distribution. We believed in the spirit of
the Indian market. We were in 325 cities. We had over a 1,000
stores.” In pursuing this aggressive expansion, he says he had the
support of global headquarters and Reebok had innovated with
products, price points and distribution all of which resulted in
making it the largest sportswear brand in India with sales of
about Rs 700 crore.

4. When Reebok opened its first
store in Delhi in 1996, under the
leadership of Mukhtesh Pant, it
took a leaf out of a concept
pioneered by Benetton in India: It
promised a minimum guarantee
to its franchisee. “The whole idea
of a minimum guarantee is that
the company is convinced that
the retailer will make money, but
the retailer is not convinced,”
says Harminder Sahni, managing
director, Wazir Advisors. Since
then, the concept of a minimum
guarantee has become an
industry practice. So the moot
question: Why did Prem face so much flak for it from Adidas’
global HQ in Germany?

It may have had to do with the fact that sports goods companies
around the world follow an entirely different model: They rely on
the wholesaler. The company sells its goods on a 44-45 percent
margin to a wholesaler, who is then responsible for selling them.
He could set up stores or could sell them to smaller franchisees,
but the key point is that the wholesaler is responsible for anything
that doesn’t sell. The rewards are his, but the risk is also his once
the goods are off the company balance sheet. Globally, these
wholesalers would decide when to plan stock clearances, how
long to have the sale for, how much to discount goods and so
on—all decisions that are typically taken by companies in India.

5. Now in India, the situation was very different. With an
underdeveloped retail market, Reebok realised that there were
few wholesalers of repute that they could deal with. Remember
Reebok was the first international sports goods company looking
to set shop in India at a time when few Indians could afford to
pay Rs 2,000 for a pair of shoes. Understandably, individual shop
owners were also wary of buying expensive merchandise that
may or may not sell. Their risk had to be balanced out.
One way of doing this was to compensate them for their costs. In
exchange, the company would balance their upside. So Reebok
entered into deals with individual shop owners that took care of
their rental and staff expenses. There were also instances when
companies were forced to enter into minimum guarantee
agreements at prime retail locations where the shop owners had
the upper hand and could demand their pound of flesh. In return,
the maximum profit these shops could make was capped at 30
percent. Reebok guided them on how to buy and sell, trained the
staff and also planned the store fit-outs. It also supported them
with strong promotional budgets.

Industry watchers say that where Reebok slipped up was in
selecting the right partners. Some shop owners had no interest in
selling shoes and treated it purely as a financial investment that
fetched a good return. In its aggression to expand in the
marketplace, Reebok ended up opening too many outlets in areas
that could only support one or at most two.

Adidas too, relied partly on the minimum guarantee model to
drive its distribution reach. And even after Adidas bought
Reebok for $3.8 billion in 2005, both brands learned to live with
this Indian reality. But things start to unravel by 2010.

6. The Conflict



A forensic audit of Reebok India Co. has found fake transactions
with unauthorized customers, allegedly concocted to exaggerate
the company’s revenue and possibly aimed at meeting targets.
It also shed new light on a messy affair that is being investigated
by both the Gurgaon Police and the Serious Fraud Investigation
Office (SFIO), an arm of the ministry of corporate affairs.
The audit, conducted by the German arm of Ernst and Young
(E&Y), shows transactions between Reebok India and companies
owned by Sanjeev Mishra, who ran a staffing services company

7. that supplied contract employees to the shoemaker, among other
circuitous and complex transactions.
Mint has seen a copy of the audit report.
The audit also shows leakages in some transactions that seem to
have benefited various individuals or other entities. However, it
is silent on the exact gains derived by the main accused.
E&Y declined to comment on the matter.
Adidas AG acquired Reebok International Ltd, the parent of
Reebok India, in 2005. In May this year, Adidas claimed it had
uncovered a fraud of the magnitude of Rs.870 crore at the Indian
operations of Reebok. Since then, 12 people, either former
employees of Reebok India, including its former managing
director Shubhinder Singh Prem and former chief operating
officer Vishnu Bhagat (the two are the main accused), or
associates like Mishra, have been arrested.
Prem and Bhagat left the company on 26 March.
Praveen Agarwal, the lawyer representing both Prem and Bhagat,
said his clients deny “any findings in the E&Y report” that hold
them responsible for any loss to Reebok India.
Mishra’s lawyer Harish Bharadwaj declined comment because
“the matter is pending in court”.
A spokesperson for Reebok India said the exact gains of the two
main accused are yet to be assessed.
“The falsification of accounts at RIC (Reebok India) will result in a
restatement of the prior year financial results of the Adidas
Group of €125 million. There has been no change to these
previously reported numbers. Due to the poor state of the

8. customer accounts, reconciliations are taking much longer than
anticipated. As a result, the exact amount of the restatement
cannot yet be determined. The financial gains attributed to the
two accused have not yet been fully deciphered,” she said in a
mail.
In its original complaint to the Gurgaon Police, Adidas offered a
break-up of theRs.870 crore number: Rs.530 crore on account of
so-called parallel accounting that inflated sales, which were not
passed on to the company; Rs.147 crore in goods invoiced but not
dispatched; Rs.63 crore in goods returned and pending
inspection;Rs.0.9 crore on account of secret warehouse
bills, Rs.14.82 crore in interest lost on a franchisee referral
programme; and Rs.98 crore on account of payments to and from
customers (dealers and distributors).
Agarwal said the Rs.530 crore is a difference in “reconciliation”
and “as such, a non-monetary loss to the company”. The audit
report backs this.
Interestingly, as Mint reported on Monday, the Gurgaon Police
has arrived at a number of Rs.11.3 crore, and not Rs.870 crore,
after its investigations.
To be sure, this could be because the police is “essentially looking
at the criminal aspect”, according to an official at SFIO, who did
not want to be identified. This person added that his agency is
looking at the “accounting aspect” and that the lower estimate by
the police does not necessarily absolve the accused.
E&Y was appointed by Adidas to conduct the financial
audit. Mint couldn’t immediately ascertain the total value
assigned by it to the irregular transactions it discovered.

9. Agarwal claimed that the audit firm is being paid Rs.130 crore for
its services. Mintcouldn’t independently verify this number.
According to the E&Y report, around Rs.147.25 crore of goods
were “billed but not delivered” and stored in secret warehouses
owned by Shivam Enterprises and Oriya Sales, both owned by
Mishra.
Reebok India hired the warehouses in October 2009, and between
then and June 2012, paid a rent of Rs.1.43 crore.
On its books, Reebok showed the goods as having been sold to its
dealers and distributors, according to the forensic report—it even
had invoices—but it had no intention to deliver them, merely to
inflate sales.
The company, the report adds, also inflated sales by storing stock
returned by dealers and distributors in other designated (read: on
the book) warehouses, but simply chose not to account for them
for a long time. The forensic audit shows mail trails between
employees to the effect.
E&Y’s report also shows that Reebok India showed higher sales
revenue by effecting retrospective increases in the price of goods
already sold to dealers and distributors. This increased both the
sales revenue and the accounts receivable (or amount due from
dealers and distributors). These retrospective price increases
netted the company around Rs.86 crore, according to the report.
The firm also seems to have done some circular trading,
according to the report, selling goods to be repaired to Mishra’s
Shivam Enterprises and Oriya Sales forRs.35.2 crore, when their
value was actually lower by around Rs.14.3 crore. Interestingly, it
received only Rs.3.08 crore for these.

10. Some of these goods were further sold to dealers for Rs.3 crore by
the two companies, which also sold back the rest to Reebok India
through Om Trading, another Mishra-owned company,
for Rs.14.4 crore. And Reebok paid Rs.4.1 crore of the Rs.14.4
crore.
In effect, according to the report, Reebok received Rs.3.08 crore,
while paying Rs.4.1 crore. Mint couldn’t establish how the
company accounted for these transactions or whether its books
recognized the reduction in stock (since Shivam and Oriya sold
some goods) in the final leg.
In a similar transaction, Reebok India, the audit shows, also sold
defective goods worth Rs.21.5 crore to a company called KK
Enterprises as recently as December 2011, but actually moved
them to a secret warehouse from where some part was sold to
some unauthorized buyers.
These sales transactions to the unauthorized buyers were off the
books. The remaining goods were booked as sales returns in May
without accounting for the goods sold to the unidentified buyers.
The Gurgaon Police filed its charge-sheet in the case on 12
November. SFIO will submit its report to the ministry of
corporate affairs by 30 November, said the SFIO official quoted
above.
Investor Concern
A quick investigation and trial may help rebuild investor
confidence after India slipped to 46th place, behind Grenada,
among the 183 nations ranked for ease of doing business in the
World Bank’s 2012 “Doing Business Report.” It was 44th in 2011.

11. “Investors will be keeping an eye on the investigation and on
what would be the consequences for Reebok and other brands
there going forward,” said Mark Josefson, an analyst at Silvia
Quandt Research GmbH in Frankfurt, Germany. “It’s good that
Adidas quantified what the costs will be. The investigation
speeds up the planned reorganization process within India for the
Adidas Group at large.”
Adidas estimated last month that irregularities at Reebok India
may cost as much as 125 million euros ($155 million). Reebok
India filed the criminal complaint on behalf of Adidas. The parent
company operates about 900 Reebok franchise stores and about
700 Adidas licensed retailers in India.
The Economic Times newspaper reported earlier today the
Serious Fraud Investigation Office will investigate Reebok India.
The probe is the second conducted by the agency in the past 16
months involving an overseas company. Citigroup Inc. was
investigated in January 2011 after a local employee illegally
siphoned off almost $66 million from investors.
The Serious Fraud Investigation Office was set up under the
Ministry of Corporate Affairs to detect and prosecute fraud. It
consists of experts on subjects including accounting, taxation, law
and capital markets, according to its website.
Adidas AG’s Reebok business in India will be investigated by the
country’s anti-fraud agency for suspected accounting
irregularities, government officials said.
Adidas filed a criminal complaint on May 21 after saying last
month it had found flaws at the Indian arm of its Reebok unit.
Police are investigating two former Reebok India executives after
the company made allegations of fraudulent practices worth as

12. much as 8.7 billion rupees ($155 million), one person involved in
the inquiry said on May 23.
The Serious Fraud Investigation Office on May 29 was asked to
investigate the matter and submit a report within four or five
months, two government officials familiar with the matter said
today. They declined to be identified because they aren’t
authorized to speak publicly. Investigators may request more
information from Adidas’ headquarters in Herzogenaurach,
Germany, if needed, one of the people said.
“We don’t comment on pending investigations,” said Katja
Schreiber, a spokeswoman for Adidas. “We shall continue to
cooperate with the authorities in their investigation.”
Adidas shares gained 0.5 percent to 59.96 euros as of 11:41 a.m. in
Frankfurt. The stock has risen 19 percent this year, the second-
best performance in Germany’s benchmark DAX Index.
Experiencing Shoe-Bite
For over six years after Adidas acquired Reebok, the two
businesses in India operated as separate entities. The companies
had very different operating styles and management reported to
the US and Germany respectively. People who regularly
interacted with Reebok say that its American culture was more
aggressive, and bordering on brash.
Adidas, on the other hand, operated in a more disciplined
manner. Its employees went about scouting the market more
methodically. When Adidas also started using the minimum
guarantee approach about five years ago, its teams were
forbidden from deviating from certain minimum parameters
while negotiating these deals. Everything had to be approved by
its headquarters in Gurgaon. At Reebok, the teams could make a

13. business case for a store that would be approved later. This had
its downsides because there were allegations that some
employees took advantage of the system to indulge in corrupt
practices.

As a result, two things happened. Reebok grew rapidly. After
losing money in its initial years in India, Reebok managed to wipe
them out and closed its 2011 books with a profit of Rs 50 crore. It
paid out about Rs 120 crore in royalty. Annual sales stood at
about Rs 700 crore. Adidas, he says, has lost Rs 137 crore in the
time it has been in India and sells roughly Rs 450 crore worth of
shoes and merchandise every year.
In May 2011, Prem was appointed the India managing director of
the Reebok-Adidas combine. That’s when the cookie began to
crumble. The business was hit on multiple fronts. A hike in excise
duty on apparel, an increase in value added tax and a rupee that
swung between 49 and 54 to the dollar increased costs by Rs 100
crore. Sales declined and Reebok closed the year with Rs 650 crore
in sales.

The decline in the fortunes of the Indian operations was badly
timed. Under Route 2015, Adidas AG began to push for more
control over the Indian operations. While Prem was made
managing director, they insisted that finance be headed by
someone from within the Adidas fold. Shahin Padath was given
the task of integrating the finances of the two businesses in India.
It is unclear whether he approved last year’s financial statements.
The company declined to provide a specific answer. Late last
year, Adidas AG began to push for the appointment of Frederic
Serrant as sales director. Prem resisted because he felt a local was
better suited. But his bosses in Germany decided to send Serrant
to India to work on the Route 2015 project to downsize stores.

14. People familiar with the situation say what eventually did Prem
in was the high receivables on the books. They say that Reebok,
with its aggressive sales team, stuffed stock on retailers. “Stuffing
the retailer channel in this business is not uncommon,” says
Devangshu Dutta, chief executive, of Third Eyesight, a retail
consultancy. “The problem comes when sales slow [down].”
Prem agrees that the company’s receivables were high, but says
that all the stock was accounted for. This is probably the reason
why Adidas was keen on downsizing Reebok’s operations more
aggressively. When Prem refused he had to move on.

Conclusion
On the evening of March 25, Prem completed his review and was
told he should step aside so that Heckerott could take over. He
agreed and boarded a plane to India the next day reaching Delhi
on the 27th evening. On the 28th, he emailed his resignation.
Prem says the next day he received an email saying Adidas was
surprised he had resigned as he had been terminated for a reason.
Thereafter, he sent two emails in April asking Adidas what the
cause for his termination was only to be met with silence.
Meanwhile, Adidas asked KPMG, its auditors in India, to conduct
a forensic audit of its books. Their conclusion was unequivocal.
There were commercial irregularities in Reebok’s side of the
business that had to be dealt with. When contacted, KPMG
declined to comment.

On the morning of April 30, a few hours before the company
announced its annual results, the legal team at Adidas informed
Prem that he had been terminated due to commercial
irregularities. Adidas clarifies that it is not accusing him of

15. profiting personally, but declined to make available a copy of the
criminal complaint that it has filed with the Economic Offences
Wing of the Gurgaon Police. For now, Prem, who has filed two
cases against Adidas AG, says he plans to follow them to their
logical conclusion. He refuses to settle with his former employers.
“I have to fight for my honour.”
The Gurgaon Police filed its charge-sheet in the case on 12
November. SFIO will submit its report to the ministry of
corporate affairs by 30 November, said the SFIO official quoted
above.
Prem and Bhagat and the other executives have been in judicial
custody since September. They have been booked for falsification
of records, diversion of funds, causing loss to the company and
wrongful gain.
Foresight
Remembering last year's Rs 870 crore fraud at its arm Reebok
India as a 'thing in the past', Adidas India MD Eric Haskell has
said the company is now focused on building the brand and
driving growth.
"This (Reebok fraud) is deep in the past for us. We are focused on
growing the business. We have been busy with product launches
and new marketing activities in 2013," Adidas Group India
managing director Eric Haskell told
Adidas, which owns Reebok, had to take euro 211 million hit on
account of the fraud at Reebok India that was allegedly
committed by the company's former managing director
Shubhinder Singh Prem and former chief operating officer
Vishnu Bhagat. The matter is under investigation.
Haskell said the company has always co-operated in the probe.
The fraud was uncovered in May 2012.

16. In March this year, Adidas group had announced that due to the
irregularities at Reebok India it had restated its financial
statements which "led to a reduction of net income attributable to
shareholders of euro 58 million for 2011. In addition,
shareholders' equity of the opening balance sheet for 2011 is
negatively impacted by euro 153 million".
The Serious Fraud Investigation Office (SFIO) submitted its final
report to the ministry of corporate affairs, which is expected to
take a final decision soon.
The report is said to have found violations by the Indian as well
as overseas management personnel at Reebok.
Meanwhile, Haskell said, fitness brand Reebok India is targeting
40 per cent of total sales from women customers as it plans to
open 100 fit-hub concept stores by April 2014.
"There is a big emphasis on focusing on women consumers. We
are seeing big increase in the percentage of women's business...
we are targeting 40 per cent business from women's stores as we
open 100 fit hub stores by April 2014," he said.
The Reebok fit-hub stores offer fitness and training products
besides advice, guidance and information on community based
fitness events.
Out of the 100 such stores, 50 will be new and the remaining half
will be renovated ones, he said.
By 2015, the company plans to convert all of its 400 plus existing
stores into fit hub stores.

Acknowledgement: A hearty thank to Kapil Thakur sir for giving
us such an interesting topic for research and assignment.