76% Of Foreign Investors In Russia Did Not Exit The Russian Consumer Market In 2022. We Identify The 2023 Opportunities And Evolutionary Tactics Required For Those Who Stayed Or Wish To Enter.

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Vyacheslav Volodin, the speaker of the Russian State Duma, has stated that following the imposition of Western sanctions upon Russia, 24% of Western-owned businesses exited the Russian market. But 76% of foreign companies continue to operate in Russia. We examine the issues related to those remaining and the opportunities and evolutions they need to be aware of to remain competitive – in Russia. It should be noted that Volodin did not state the sources of his assessment, however Russian market analysts have also provided their opinions on the Russian consumer market trends and changes in 2023. We discuss these issues in this article.

Measuring the Exodus

Back to Volodin first: According to him, the Russian Government wishes to maintain and encourage the smooth functioning of foreign invested businesses in Russia, stating that “It is critical that the funds remain inside the country and are used for its development.”

This partially rings true. In 2022, a number of laws were adopted restricting the work of foreign companies in Russia in certain key strategic areas, and especially within the energy sector where new requirements were introduced to protect Russian investments. For example, all developers of Russian oil and gas fields are now required to be legal entities registered in Russia. Companies with foreign participation can no longer participate in concessions related to transport infrastructure and transportation. A draft law is under consideration to limit their participation in the housing and communal services sector. This effectively prohibits foreign companies in these sectors operating in these fields without having real responsibility under Russian law and being subject to Russian taxes. Previously, many of these investments were contractual only between Russia and the foreign party, who did not have to maintain a Russian legal presence for the entire operations. That loophole has now been closed. However, many of these businesses are MNCs and not smaller brands or trading businesses.

According to Volodin, 75.9% of foreign invested companies continue to operate in Russia and are satisfied with the business climate. For those who left, the abruptness of sanctions meant 2022 fiscal year financial plans were thrown out of the window, meaning they lost their expected Russia 2023 revenues and all investments made in developing the domestic Russian market. Losses are hard to calculate but can be measured in billions of dollars.

That market has also now gone for those who left. The vacated niches are now occupied by Russian domestic and investors from other countries, such as China. Elements of the Russian market also grew in 2022 – the production of clothing in Russia grew by 42% last year, and in pharmaceuticals, by 15%.

Measuring the numbers of foreign entities remaining in Russia is however subject to some criteria, resulting in some technical disagreements as to measuring these. The criteria by which this is determined contain some ambiguity. For example, if a foreign investor sold its shares to the Russian management team, a Russian investor or an investor from a friendly country, and has severed relations with the original parent company, then the question of whether it left or remained is at least debatable.

The Yale University Assessment

Experts give different estimates of the number of companies that have left – it all depends on which companies to count, says Anna Fedyunina, Deputy Director of the Center for Structural Policy Research at the Russian National Research University, Higher School of Economics. She stated that “Perhaps one of the most quoted source about this today is the Yale University project, which has been based on open statements by companies, and claims to account for the number of companies that have left or changed their strategy in the Russian market. According to their data, 24% of enterprises left the Russian market, almost 50% of the remaining enterprises announced a temporary suspension of activities, while another third limited investments or their operations. Their conclusion was that only 22% of the rest are conducting normal activities.”

That indicates an overly negative position, Fedyunina believes. According to her, the Yale data may not reflect the real picture. The Yale University project was focused primarily on identifying the reaction of large and medium-sized businesses that had their own assets and were represented in Russia by official distributors with Russian capital. That is not the same as wholly-foreign owned businesses as it measures only Russian owned foreign brand distributors who were effectively cut off from distributing the foreign parents imported products. It does not take into account foreign-owned businesses selling Russian-made products. Accordingly, Yale’s report discusses retailers and omits the larger picture.

Fedyunina continues: “The Yale figures also do not take into account those foreign enterprises that have continued to work in Russia, but transferred their assets to Russian top managers or sold their assets to domestic third parties, or reshored ownership from Russia to Kazakhstan for example. I think that in reality the figures for the number of enterprises that have left Russia has been exaggerated.”

As for the Russian distributors – they have moved onto contracts with other imported brands and are familiarizing themselves with Chinese, Indian and other globally produced products.

Is A Russia Market Exit Really An Exit?

Ivan Ermokhin, of the Russian Center for Competence and Analysis of OECD Standards, RANEPA, says that some foreign companies completely left Russia and have liquidated their Russian businesses. But, according to a study by the Center for Strategic Research, this is only 7% of the total foreign investors in Russia. The most important of these for the Russian economy are companies from technology sectors, including equipment, automotive and others, since the replacement of these companies by domestic manufacturers and companies from friendly countries does not happen quickly.

Of the possible ways to solve this problem, Emokhin mentions the transfer of assets to local top managers or in favour of foreign, but Russia-friendly investors. “A vivid example is the sale of the Polish company LPP (owned by the brands Reserved, House and others) of its assets to a Chinese investor. Incidentally, many of these transactions contain a provision allowing for the repurchasing of an asset.”

Companies Who Left Russia

Several research businesses in Russia have commented on the true position of Russian market exits.  According to the consulting company NF Group (formerly Knight Frank Russia), as of October 2022 in Russia, after rebranding or selling a business, 17 previously major international brands remained operating in the country, including McDonald’s (now “Tasty Dot), L’Occitane (reopened as “L’ Oksitan”), OBI (OBI – double change of ownership), brands of the Polish LPP Group (after the sale of the Chinese FES retail), Levi’s (rebranded to “JNS” and “JEANS”’) and Reebok (renamed “Sneaker Box” after the sale of the Turkish owned brand marketeers FLO Retailing).

At the same time, according to NF Group, 17 international brands left the Russian market, while about 180 announced the suspension of their activities in Russia. Among those who left Russia are Finnish Prisma, Hesburger, Paulig Cafe & Store, American Nike, Converse, Victoria’s Secret, British Lush, chocolate manufacturer Lindt (Switzerland), lingerie brand Triumph (Germany), Jacquemus (France), JYSK (Denmark), and cosmetics manufacturer Watsons (China). It should be noted that the businesses that left were significant market players with international PR to consider. It should also be noted that these are in the minority when it comes to such a status.

Impact On Russia’s Auto Industry

According to NF Group, the withdrawal of foreign companies from the automotive industry had the greatest impact for the Russian economy, which caused a sharp decline in the production and sales of cars in Russia. That in turn affected smaller downstream auto-components manufacturers – including foreign and Russian businesses and resulted in temporary closure of numerous auto factories in Russia as these are multi-billion-dollar operations and losses can quickly pile up. It also requires time for new investors to replace those who left, with new business and financial planning all needing to be put in place.

But this negative situation in the Russian auto sector is now changing: this market is gradually being filled by Russian and Chinese manufacturers, including by buying out the production capacities of departed brands. Often these have been at literal ‘fire-sale’ prices as the foreign investor, having exited Russia, has written off the capital investment and the equipment, with no chance of it being repatriated as second-hand assembly plants, much of it geared to Russian auto specifications.  This means that the new investors have been given a financial boost by avoiding part of the significant upfront capital cost to enter the Russian market as the equipment was already in place and available at knock-down investment costs, while and the Russian auto consumer market is stable. Our overview of Chinese auto brands entering the Russian market during 2023 can be viewed here. That brings forward the profitability of these businesses and returns them to Russia as fiscal tax contributors sooner rather than later.

Impact On Russian Aviation & Maintenance

According to Artmen Tuzov, an executive director with the capital market department at IVA Partners the damage from the departure of foreign companies is noticeable not only in the automotive industry, but also in the aviation industry. That has caused difficulties with Russia being able to make lease payments on aircraft, due to sanctions being placed on Russian use of US Dollars and Euros and contracts typically designated in these currencies. Lessors owed money are now under pressure to resolve this issue as their shareholders do not want debts either despite the sanctions. That is now starting to happen with Aeroflot now consistently making alternative arrangements to buy these aircraft at a rate of about ten a month.

Spare parts for Boeing and Airbus remain an issue, with the cannibalisation of older aircraft increasing (normal practice) until alternative parts can be found or made. Russia has a significant aviation industry and is up to that challenge, as are China and India, with India’s aviation component industry a global player – the third largest in the world. Indian manufacturers for example also make parts for Boeing and Airbus, meaning that with assistance, Russian self-sufficiency in aviation components is therefore a matter of just a few years. Illustrating this is that China, India, Russia and Iran are also involved in setting up an aircraft maintenance facility near Tehran.

IKEA’s 2022 Losses

As for the losses incurred by those who pulled out, the billion-dollar loss estimates are not unfounded. To understand and at least roughly estimate the scale of this, an example was IKEA, whose departure was very noticeable in Russia, with the brand being much-loved in the country.

IKEA had in fact has been a long-term strategic partner in Russia and had built a substantial platform over 22 years since it established its first branch in Moscow in 2000. A gigantic infrastructure of real estate, services, a supply chain system of thousands of suppliers, and even its own bank: “Ikano-Bank” for servicing customers and suppliers had all been built and operational issues worked out and developing smoothly. IKEA took a decision to pull out and in doing so simultaneously, immediately destroyed all of this corporate structure. The result has been that in August 2022, when IKEA released their annual results, the owner of most Ikea stores, Ingka, reported a more than five-fold drop in its annual net profit due to higher interest rates and its exit from Russia.

Barrons Magazine, part of the US analytical firm Dow Jones, quoted Ingka as saying that said its net profit for the 2022 fiscal year fell to Euros 287 million (US$299 million), down from Euros 1.6 billion in 2021. Ingka said that this was mainly due to rising interest rates, which hit its financial market investments. Central banks have hiked rates worldwide in efforts to curb soaring inflation. It also stated that “The net income was also impacted by the effects of scaling down operations in Russia.” The true extent of the losses caused by the Russia exit will not be announced but must be in the hundreds of millions of dollars. The measure of the damage caused will more likely be revealed in the August 2023 financial statements when hiding the Euros 1.3 billion in lost profits cannot be explained away again by interest rates. Such losses also fail to answer why IKEAs board apparently put themselves in a position to be liable for such significant interest costs, which seems unlikely. The real answer to their loss is more likely to be related to their Russia exit. The same can almost certainly be said concerning other high-profile Western brands who exited the Russian market.

Companies Who Remained In Russia

Yulia Makarenko, deputy director of the Banking Development Institute, has agreed with Volodin’s synopsis, saying that “A lot of companies from various fields remained in Russia. Another thing is that they simply continued to work, limiting themselves to a press release on their websites or in social networks in order to reassure employees and their relatives. They have tended to be PR savvy in the way in which they’ve handled their PR to their international shareholders and customers.

In contrast, the brands that chose to leave did so loudly. Many MNCs – for example, from the automotive industry – were put under extreme pressure by the Western authorities and the media and needing Government support back home were seen to have visibly “slammed the Russian door”.  But many also came up with workarounds to return, such as retaining brand, but not operational ownership in Russia (McDonalds for example still own their Russian trademarks) or negotiating options to buy back the business at agreed earnings multiple at a later date.

Still, there remains the question over whether Russia’s domestic manufacturers be able to completely replace Western departed brands. However, the market is adapting. It’s not just the example of “Tasty Dot”, which has by and large successfully replicated the original McDonalds and has critically managed to retain much of the customer base. This rebranding practice has become widespread in Russia. Under other names, alternative clothing and cosmetic brands opened in the autumn – and often in the same places in shopping centers and airport departure lounges. Some brands have taken advantage of the market gap. Korean cosmetics were already known as being high quality in Russia, but remained niche due to the dominance of largely French brands. Today, they dominate the high-end cosmetics markets with many retailers now providing ‘Korean Cosmetics’ signage where once French brands reigned supreme. Russian consumers are adapting and with favourable results. What was once exotic, and niche has become mainstream and prized.

Remaining Brands – Adapt & Prosper

Artem Tuzov, an executive director with the capital market department at IVA Partners also agrees with Volodin’s assessment, stating that “The estimate of the number of remaining foreign companies in Russia looks absolutely real. The thing is, that many companies from many countries did not join the sanctions against Russia. Also, in countries politically unfriendly to Russia, individual businesses continue to work with Russia. This includes large Western conglomerates in primarily medicine, fertilizers and grain – within the framework of important agreements with the United Nations. We continue to trade with them. At the same time, China, which has not joined the sanctions, has been Russia’s main trading partner for many years.”

“In general, the advantage of capitalism is that entrepreneurs are ready to circumvent any sanctions for the sake of making a profit. UN sanctions would be an exception, and then difficulties would really arise. However, the UN has not imposed sanctions on Russia and it cannot. Therefore, the departure of foreign companies from Russia is not catastrophic.”

Are Russian Manufacturers Ready to Adapt to Change?

Anna Fedyunina, Deputy Director of the Center for Structural Policy Research at the Russian National Research University, Higher School of Economics, states that in the national context, the number of German enterprises operating in Russia has decreased quite significantly since the 2010s: there were over 6,200 at the beginning of the 2010s, and by 2021 there were just under 3,700, a consequence of the 2008 Russian economic crisis.  However, she states that “This phenomenon was not considered as a direct threat to the economy.”

In her opinion, it is more important to discuss not the number of enterprises that left or remain, but the vacant market niches and how Russian or other foreign enterprises will be able to fill them.

Russia has experience and successful examples of import substitution, which became especially evident after the initial 2014 sanctions. Prospects in the Russia market for foreign investors will depend on a number of factors: the predictability and transparency of doing business, the presence of entrepreneurial initiative, and the ability to attract cheap and long-term money to finance projects in addition to conduct research and create market demands for the preferences of the Russian consumer.

Creating “New” Brands

Examples of this can be found in the Russian Grocery trade, which has had to replace one in seven brands on the shelf after the departure of foreign brands, according to the Russian Association of Retail Companies (AKORT). Most of the new, “refreshed” brands were in the carbonated drinks, household chemicals, breakfasts, pasta and confectionery lines. Retailers changed the brands of departed manufacturers, as a rule, to domestic ones. A similar trend has been noted in the non-food sector, the Association of Internet Trade Companies (AKIT) noted. Experts believe that domestic retailers and manufacturers face the difficult task of promoting domestic products positioned to replace the market niche left by Foreign-owned brands under new trademarks that are not familiar to Russian consumers. This suggests a marketing drive – and time to develop familiarity is required to fulfil the market opportunity.

Igor Karavaev, Chairman of the Presidium of the Association of Russian Retail Companies, has said in an interview given to Izvestia www.iz.ru that the overall level of brand rotation from Foreign to new brands in retail chains will be approximately 15–16% of the total merchandise. “So far, the reduction of international brands on the shelves can hardly be called massive. Many manufacturers, especially those localized in Russia, still continue to work in the Russian market The change in the assortment matrix occurs gradually, as the stocks of foreign manufacturers sell out, so it is difficult to predict the timing of the cessation of sales of certain brands in stores.”

Russian brands are able to replace the products of companies that are leaving the market. For example, the share of Russian products is increasing in such categories as carbonated drinks (about 100 new items have appeared here), breakfast cereals, pasta and confectionery, household chemicals and care products.

An important role in replenishing the assortment is played by private labels of retail chains (PL), as their popularity now outstrips the demand for international brands. For example, in 2022, demand for private label retailers in the diaper category grew by more than 130%, outpacing sales of global brands.

Then there is Russia’s own legal approach to brand ownership. On 5 March 2022, Russia issued its Decree No. 299, which allows local companies or individuals to use the intellectual property rights owned by those from ‘unfriendly countries’ without consent and without paying any compensation. That works in Russia but may be difficult to enforce externally. Then there is the issue of possibly later wanting to work with the brand owners – who may be resistant to those that ‘took’ their brands even if legally permitted to do so. At the same time, Russia expanded the abilities for Russian individuals to file for trademarks in Russia, making it easier. The way to approach this is to understand that usage of an existing brand does carry problems, and in any case, these tend to be related to the larger MNCs who maintain a global identity. It would be hard to convince a Russian consumer the ‘new’ brand was the same as the original one. Meanwhile, the Russian language dominates and has specific linguistic and cultural applications: research should be conducted, and when a brand name arrived at, registered in Russia immediately.

This article has been translated, extensively adapted, and additional commentary by Chris Devonshire-Ellis added from the article Остаться на долю: 76% иностранных компаний не стали уходить из России that originally appeared on the Izvestia news website on January 11.  

Research for the Russian market can be carried out by Dezan Shira & Associates in association with our (non-sanctioned) Russian partners. Contact Maria Kotova at russia@dezshira.com for assistance.

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