[Viewpoint] Adapt to Russia, or get frozen out

Russia has stepped into high gear to strengthen its investment environment as evidenced by President-Elect Vladimir Putin’s “100 steps forward” slogan. The goal is to elevate Russia from its lowly 120th place to 20th in the World Bank’s “Doing Business” index. And Russia’s entry into the World Trade Organization this year will help speed up the process. As such, companies must now devise a new marketing strategy for Russia as the current “high risk, high return” strategy is no longer a viable option.

“First mover takes all” has long been used to describe most business sectors in Russia. After the 1998 financial crisis in Russia, when the government imposed a moratorium on payments to foreign creditors, Korean home appliance makers nearly stood alone in Russia and enjoyed continuous annual growth. Sales of Korean home appliances grew an astounding 89 percent in 2003. KT, which started its mobile communications business in Siberia in 1997, rose to No.1 in the market. In 2007, it owned 40 percent of the market and posted annual revenue of $80 million and operating profit of $37 million, despite only having invested $23 million in its operation there.

But the intensified competition for Russia’s rapidly expanding consumer market is lowering the probability of high returns. In 2000, the scale of Russia’s retail market stood at 2.4 trillion rubles ($81.7 billion). Fast forward to 2011, and the amount has grown eight-fold to 19.1 trillion rubles. Household spending also leapt from 34 percent of gross domestic product to 51 percent of GDP over the same period, forming the nucleus of the Russian economy. On the other hand, Korean home appliance makers have seen their profits continuously decline, falling to 71 percent in 2004, 37 percent in 2005, and between 15 and 20 percent in 2010.

Another catalyst for growth has been the tightening of customs regulations, which has spurred many foreign manufacturers to set up local production bases in Russia to avoid the higher costs of exporting there. Home appliance giants including Italy’s Merloni, Turkey’s Vestel, Sweden’s Electrolux, Germany’s Bosch, and Korea’s LG and Samsung have all constructed factories in Russia. In short, as the consumer market expands and the customs process becomes more transparent, competition will continuously heat up, reducing the chances of any one player dominating the market.

This new characteristic is expected to become more prominent when Russia enters the World Trade Organization in the middle of this year. Due to binding import tariffs, companies with production facilities in the country will no longer benefit from reduced customs duties. It will become more advantageous to produce at home, where there is better infrastructure, rather than face the operational obstacles and risks that Russia presents. In the “Doing Business” survey, out of 183 countries, Russia ranked 178th in terms of gaining construction permits, 183rd in terms of access to electricity and 111th in terms of ease of starting a business. Furthermore, with wages and prices constantly increasing, the cost of production is also rising. The auto industry may be the biggest loser in the new tariff matrix. Import duties on vehicles will fall from between 25 and 35 percent to between 5 and 15 percent, crimping the price advantage of local automakers in Russia.

How will companies have to change their strategies to target the Russian market? And will this mean the end of the road for local production facilities?

Kia is a prime example of such changes. Last year, Klaxon, Russia’s best-selling car magazine, selected Kia’s Pride for the 2011 Golden Klaxon award. The carmaker customized its Pride model to suit local needs, thus maximizing customer satisfaction. To adapt to Russia’s climate, Kia made sure the Pride would be able to start even in temperatures as low as minus 35 degrees Celsius (minus 30 degrees Fahrenheit). It also installed antifreezing mechanisms on wipers. More than 17,000 Prides were sold in the first three months after its debut in Russia, and the rate is steadily increasing.

A similar example can be found in the food industry. Korean brand Orion sold over 40 billion won ($35.5 million) worth of Choco Pies in Russia in 2010, while Yakult, also Korean, sold 180 billion won worth of instant noodles that year. For its Choco Pies, Orion adjusted the amount of chocolate powder it used to satisfy Russian taste buds and adopted more eye-catching, red packaging. Meanwhile, Yakult added beef and chicken flavor noodles. It also introduced square-shaped containers that are easier to carry over long distances.

The common ingredients here are: local production facilities, vigorous research and customization. To succeed in Russia today, companies must concentrate on the demands of Russian consumers and develop their products accordingly. Moscow’s efforts to improve the nation’s investment environment will also increase the advantages of having a local production base.

* The author is a research fellow at Samsung Economic Research Institute.

by Lee Dae-Sik