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23/01/2006 | Russia's Regional Retail Revolution

WMRC Staff

In 2005 and the immediately preceding years, international retailers have been flocking to Russia, enticed by a burgeoning consumer culture that for historical reasons prefers to spend rather than save. At the same time, disposable income continues to outstrip the country's impressive GDP growth. Retailers have so far tended to limit themselves to Moscow and St Petersburg, the richest and most prestigious markets. This has begun to change, however, and as competition increases in these two cities, international retailers are tapping into other lucrative regional markets. Global Insight investigates some of these trends in the Russian retail market and assesses the impact on Russia's short-to-medium-term development.

 

2006: The Year of the Regions?

In November 2005, Russian president Vladimir Putin quietly promoted Defence Minister Sergei Ivanov and Head of the Presidential Administration, Dmitry Medvedev, to become deputy prime ministers, possibly indicating that the administration had begun to mobilise the state apparatus with the aim of securing a smooth political transition ahead of the 2007 parliamentary and 2008 presidential elections. The government has also begun to loosen fiscal policy with the aim of creating a 'feel good' factor, while continuing to establish state control over certain 'strategic sectors'. In the meantime, although the latest political reshuffle indicates that the state will tighten its grip over the strategic sectors in the short term, it has hitherto effectively left the non-strategic sectors, including the retail market, to their own devices. As a result, the retail sector has been and continues to be one of Russia's most dynamic growth sectors.

Indeed, since the symbolic launch of the first IKEA store in Moscow's Khimki region in late 2000, international retailers that have entered the Russian market have enjoyed unprecedented percentage increases in revenues. With a population that still essentially distrusts the state, given the restrictive controls of the historical Socialist system of distribution, it is quite natural for the vast majority of the Russian population to prefer to spend their ever-increasing earnings than invest. Russians also still retain a lingering distrust of the banking system, engendered by the 1998 financial crash that devastated half of the country's banks and at a stroke wiped out the savings of the burgeoning middle class. As a result, Russia is overwhelmingly a retailer's paradise.

Global Insight estimates that retail sales growth reached 24.3% in 2005 and, along with real disposable income growth (which was up 10.6% year-on-year in June 2005), is set to outstrip GDP growth in the short-to-medium term. Russia will therefore remain one of the world's most attractive consumer markets.

RussiaThe results of an annual study of mass merchant and food retail investment opportunities conducted by the management consultant firm AT Kearney and published in July 2005 reinforce Russia's claim to be in the top tier for retailers planning overseas expansion. The survey, which measures a number of factors including retail market attractiveness, retail saturation levels, and the differential between GDP and retail growth, ranked Russia second only to India as an emerging market destination for international retailers.

Nevertheless, despite the fact that over half of Russia's 143 million people live in cities with populations of over 100,000, which includes 11 cities with populations over 1 million, the vast majority of retailers have until now generally limited their activities to capturing the growing middle class market in Moscow and St Petersburg. A boom in the instant credit market and impressive growth rates in the consumer electronics and home improvement market testify to the fact that the retail market in Moscow and St Petersburg is far from saturated. Still, increasing competition in the two cities, matched by rising commercial property prices, has persuaded international retailers to join their domestic competitors and begin the expansion into the relatively untapped riches of Russia's regional cities, where a nascent middle class is rapidly maturing.

Having skilfully blazed the trail in Moscow, establishing the hypermarket concept that mirrors the new lifestyle of the middle classes and combines shopping, entertainment and leisure, IKEA opened a US$200-million 'Mega Mall' in Kazan, the capital of Tatarstan, in November 2005. Moreover, the company has already begun construction of further centres in Nizhny Novgorod and Yekaterinburg. The Swedish furniture giant has not been alone in seeking regional markets. The Turkish food retailer Ramstore has also opened outlets in Nizhny Novgorod in addition to Kazan, Samara and Rostov-on-Don, French retailer Auchan plans to open hypermarkets in Nizhny Novgorod and Yekaterinburg, while the Austrian Banking Group Raiffeisen International has capitalised on the increased demand for banking products and is in the process of expanding its branch network into the main regional cities.

Regional Dynamics

Although the expansion into the regional cities will undoubtedly be one of the main trends in 2006, this does not mean that the operational barriers that have hitherto prevented international companies from moving into Russia's regions have been eradicated. Even though Russia generally possesses a highly skilled workforce, the lack of experience in the retail market is telling and international retailers have reported difficulties in finding qualified managers who possess the necessary expertise to oversee a move to the regional hubs. A prerequisite for any expansion for major domestic or international retailers is the existence of a logistical system capable of moving goods rapidly and efficiently. Even in regional centres such as Samara and Kazan, modern buildings and warehouses are thin on the ground. According to real estate consultants Frank Knight, while Moscow has 0.35 square metres of office space per head, in Russia's third city, Novosibirsk, it stands at 0.15 square metres, while in Samara, it drops to 0.08 square metres. As a result retailers are not only forced to build hypermarkets and out-of-town superstores from scratch, but also have to construct any smaller developments. This takes time as investors are drawn into negotiating with the regional administrations, and remains one of the main deterrents for retailers.

Although a number of the many foreign enterprises in Moscow have had first-hand experience of corruption, as they have had to negotiate with the bureaucrats of powerful Moscow mayor Yuri Luzhkov, there is the general perception that the risks associated with venturing into the regions are too great. President Valdimir Putin has moved to draw a line under the Yukos saga in an attempt to repair the damaged investment climate, which has included the introduction of legislation designed to curtail the powers of the Federal Tax Service (FTS). However, the perception remains amongst a number of foreign investors that the risks of investing in the regions still outweigh the many potential benefits. There is, however, an ever-growing divergence in the investment climate in Russia's 89 regions, and each region has its own specific socio-political and macro-economic dynamic. Indeed, despite Moscow possessing a greater potential than St Petersburg, Russia's second city is regarded as a safer investment destination. In virtually every survey, both Nizhny Novgorod and Tatarstan are consistently close behind Moscow and St Petersburg, and both the city of Nizhny Novgorod and Kazan are at the forefront of the regional retail revolution.

Russia's Most Attractive Investment Regions (selected)

Region

Investment Risk (out of 89)

Investment Potential (out of 89)

St Petersburg

1

2

Lipetsk

2

34

Novgorod

3

66

Belgorod

4

24

Tatarstan

5

8

Rostov

6

10

Yaroslavl

7

37

Nizhny Novgorod

8

6

Moscow

9

1

Vologda

10

38

Krasnodar

16

9

Moscow Oblast (region)

19

3

Leningrad

21

19

Source: Expert Ratings Agency

Nizhny Novgorod

Connecting Moscow and Eurasian Russia, Nizhny Novgorod has long been an economically vital region. Under the Soviet regime, the city, then known as Gorky, was closed to foreigners and was the heart of the Soviet military industrial complex. Given its geographical location and the fact that it remains one of Russia's centres for car manufacturing and the iron, steel and chemical industries, it is still a highly attractive proposition for international retailers keen to leverage the regional market. A long-running power struggle between former regional governor Gennady Khodyrev on the one hand, and the local legislature and local businesses on the other, however, has hampered the region's investment climate. After years of uninspiring leadership, President Putin moved in October 2005 to parachute in Valery Shantsev, Yuri Luzhkov's powerful deputy, who also led Moscow's unsuccessful bid to host the 2012 Olympics, to replace Khodyrev. Although the rationale behind Shantsev's appointment had more to do with weakening Luzhkov's grip on power in Moscow, he has issued a number of decrees that have had the immediate effect of improving the region's investment climate without alienating local elites. Not only has Shantsev streamlined the advisory process for investors, but the new regional governor will also draw from his vast experience with foreign investors from his time in office in Moscow, in addition to using his Moscow business contacts to draw investment back into the region.

Tatarstan

The Republic of Tatarstan and its regional capital Kazan have been governed by the firm hand of Mintimer Shamiyev since the collapse of the former Soviet Union. During the mid-1990s, Tatarstan was virtually an independent state, and Shamiyev epitomised this resistance of the regions to the federal centre, having previously negotiated a strong autonomy in paying taxes to the centre and managing the regional economy. Although President Putin has managed to assert his authority over all of Russia's regions, including Tatarstan, in comparative terms Shamiyev continues to enjoy more autonomy and keeps the competing local elites in check. Nevertheless, while Shamiyev guarantees political stability in the short term, there is the perception that the local authorities continue to monopolise business circles, which has frustrated both Russian and foreign investors. Given the region's oil wealth, which has trickled down into the wages of the local population, the city of Kazan has become one of the main targets for international retailers, and the recent entry of IKEA into Kazan may prove to be a watershed.

Conclusion

As a response to ever-increasing foreign penetration into the retail market, Russia's retailers have begun the process of consolidation, especially in the food sector. The penetration of modern retail stores stands at 24% of food sales, which is still low when compared with other markets in Eastern Europe. At the same time, domestic retailers' expansion into the regions requires capital, and a number of retailers, including food chains Pyaterochka (which raised some US$600 million) and Seventh Continent, have raised additional capital through initial public offerings (IPOs). Indeed, Seventh Continent signalled its intent to increase its free float to 25% from the initial 13% floated. In addition, a number of other retail chains, including Kopeika and Arbat Prestige, Russia's largest chain of perfumes and cosmetics stores, are planning IPOs in 2006.

The state acquisition of Yukos's main subsidiary and the merger of state-owned oil company Rosneft with Gazprom underlines the growing state control over certain strategic sectors, which will continue into 2006. The government has not finalised which sectors it deems to be of strategic importance, but it is safe to assume that it will include the energy, defence, and fixed-line telecoms sector, while control, or at least de facto control, will be kept over the metals sector and some elements of heavy machinery. However, the retail boom and the upcoming IPOs within the Russian retail sector underline that there is an emerging middle class, both in Moscow and St Petersburg, as well as in the regional centres. Both the state and this emerging middle class will have their own vested interests and aspirations that do not necessarily coincide with one another; with the state by its nature seeking to project its influence throughout the economy, and a middle class seeking to limit the state's influence. The creation of the council for national projects in November 2005, which will be chaired by Dmitry Medvedev and aims to spend some US$4.6 billion on healthcare, education, housing and agriculture before the 2008 election, highlights the very real possibilities of the state encroaching further into the private sector. Although the regional retail boom, which will develop further in 2006, does not yet herald the onset of a power struggle between the state and the emerging middle classes, it does map a potential battleground for the future.

Contact: Raul Dary

24 Hartwell Ave.
Lexington, MA 02421, USA
Tel: 781.301.9314
Cel: 857.222.0556
Fax: 781.301.9416
raul.dary@globalinsight.com

www.globalinsight.com and www.wmrc.com

 

WMRC (Reino Unido)

 


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