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LEE Dae-Sik

The Disappearing “High Risk, High Return” in Russia

LEE Dae-Sik

Mar. 20, 2012

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Russia has stepped into high-gear to strengthen its investment environment as evidenced by President-elect Vladimir Putin's "One hundred 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 Russia financial crisis, 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% in 2003. KT, which started its mobile communications business in Siberia in 1997, rose to No.1 and enjoyed a 40% market share, annual revenue of US$80 million, and operating profit of US$37 million in 2007 despite a total investment of only US$23 million.

But the intensified competition between global companies for Russia's rapidly expanding consumer market is lowering the possibility of achieving a high return. In 2000, the scale of Russia's retail market totaled 2.4 trillion rubles. Fast forward to 2011 and the amount is 8 times as much, totaling 19.1 trillion rubles (approx. US$650 billion). Household spending also leapt to 51% from 34% of GDP during 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% in 2004, 37% in 2005, and finally to 15~20% in 2010.

Another catalyst is tightened customs regulations, which has spurred many foreign manufacturers to set up local production bases in Russia to avoid the higher costs. Home appliance giants including Italy's Merloni, Turkey's Vestel, Sweden's Electrolux, Germany's Bosch & Siemens, 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 dominance.

This new characteristic is expected to become more prominent when Russia enters the WTO in the middle of this year. Due to binding import tariffs, companies with production facilities in Russia will no longer benefit from reductions in customs duties. It will become more advantageous to produce at home where there's better infrastructure rather than face the operational obstacles and risks Russia presents. In the "Doing Business" survey, out of 183 countries, Russia ranked 178th in gaining construction permits, 183th in getting electricity and 111th in starting a business. Furthermore, with the ever increasing wages and prices, 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 25%-35% to 5%-15%, crimping the pricing 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 for local production facilities?

The Korean automaker Kia is a prime example of such changes. Last year, Klaxon, Russia's best-selling car magazine, selected Kia's Pride to win the "2011 Golden Klaxon." Kia customized the Pride model to local needs thus maximizing customer satisfaction. To adapt to Russia's climate, Kia enabled the Pride to start even in minus 35 degrees Celsius weather and installed anti-freezing mechanisms on wipers. More than 17,000 Prides were sold in the three months after its debut in Russia and the rate is steadily increasing.

A similar example can be found in the food industry. Korean brands Orion and Korea Yakult each sold over 40 billion won and 180 billion won worth of Choco Pies and noodle cups, respectively, in 2010. For the Choco Pies, the amount of chocolate powder used was adjusted to satisfy the taste buds of Russian consumers, who have a strong penchant for chocolate and marshmallows, and the wrapping color was changed to red to be more eye-catching to the locals. For Yakult's cup noodles, beef and chicken flavors were added and the originally round cups were changed to square-shape for easy carrying by the frequent long-distance travelling Russians.

The common ingredient here is that all of these companies have local production facilities and have all conducted their own vigorous research on customer preference and customized a strategy for Russia. To survive and succeed in the current Russian market minus the high risk high return structure, companies must apply a straightforward approach rather than an abnormal one. Companies should concentrate on the demands of the Russian consumers, and develop and customize their products accordingly. An added bonus is that the government's efforts to improve the investment environment will also increase the advantages of having a local production base.

This column originally appeared in Korea JoongAng Daily.
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