The market for retail business in Russia continues to develop rapidly. Indeed, the emerging prospects are lost on neither domestic nor international players, while the competition between retail operators grows each year. With the step-by-step saturation of the Moscow market, ever more chains are turning their gaze to the country’s regions, which look much more fertile compared to the competition on the Moscow market. However, not everything is so simple on the attractive Russian market, and foreign retailers are well aware of this, as several international operators have been probing the unsure ground of the local retail market for several years now.

The stable growth of incomes in Russia over the past several years, as well as the actively developing consumer-credit market, has provided for annual growth in retail turnover. According to figures provided by the State Statistics Service, the Russian retail market grew by 12.1% from January to August 2006 vis-a-vis the same period for the previous year. Moreover, the amount of indoor (“civilized”) retail has grown sharply, while there has been a sharp decrease in the number of outdoor markets and mobile retail points. Consumers now prefer to shop in comfortable conditions and, no less important, buy famous brand-name goods. Accordingly, this justifiable wish on the part of consumers is reflected in the strengthened expansion of international retailers on the Russian market. However, for a business to succeed it is not enough to simply have favorable prospects, as, despite its openness, the Russian market is also full of unpleasant pitfalls. Therefore, foreign operators must prepare thoroughly before entering the Russian market, trying, as much as possible, to learn from the mistakes of others.

Searching for an inroad
Among the international pioneers of the Russian market are IKEA, Stockmann, Auchan and Ramstore. These valiant souls were among the first to appreciate the potential of Russia as a sleeping giant, and, having taken a risk, now enjoy the advantage of trailblazers. Moreover, only a few years ago a consumer was not spoiled by such a large selection and gratefully accepted anything new. However, operators opening their stores in Russia today must compete for clients on the increasingly competitive market. Indeed, both foreign and Russian retail operators alike who have expanded their chains here have had time to gain customer loyalty, set up logistics networks and establish relations with suppliers. However, it must be noted that retail chains today are entering a more civilized market, where many problems encountered by the trailblazers no longer arise or are easily solved.
Nevertheless, operators are still justifiably wary of bureaucratic issues and the lax enforcement of property rights, as well as the not-always civilized methods of conducting business, particularly in the regions. Therefore, not all foreign operators risk independently entering the Russian market, with many preferring to operate via franchising by selling a license to use their brand name. Accordingly, there is a trend by brand owners to develop the “unveiled” product independently, ensuing the sale of the franchise. An example would be the sale of six Zara stores, opened via franchising by Stockmann, to the owner of the brand, Inditex. It seems Inditex initially considered it risky to enter the Russian market, but, after time had passed, decided to develop a successful brand independently.
Another means of decreasing the risks for Western retailers is a partnership with a local player rather than second-hand knowledge of the rough conditions of Russian business. For example, the German company REWE Group, owner of the Billa chain of supermarkets, entered into a partnership with the Marta holding. Subsequently, at the beginning of 2006, fifteen Marta supermarkets were transferred to REWE Group for the further rebranding under the Billa brand. This type of alliance is beneficial to both foreign and Russian business partners alike.
To enter a new geographical market successfully, brand-name store owners often consider the possibility of buying a local chain for further rebranding under its own brand name. However, the lack of transparency of Russian retailers on the Russian market and the incongruity of the asking price with the offer of the investor results in sufficiently rare sales deals, although the situation is improving bit by bit. For example, last year Kesko (Finland) bought five of the Stroimaster stores in St. Petersburg and is now developing the chain under its own K-Rauta brand, with plans of entering other Russian cities.

The potential of regional markets
As for the geographical preferences of foreigners entering Russia, so far in the majority of cases they have first entered the Moscow and St. Petersburg markets. “Moscow is a good starting point for foreign retailers: having successfully opened in the capital, they begin in the regions,” says Dmitry Zotov, general director at Torgovy Kapital. But there are cases of first entering the Russian market in the regions, as the first stores of the Castorama chain of the British company Kingfisher opened in February this year in Samara, and then later opened in St. Petersburg. “The company is geared toward developing throughout Russia, and not only in Moscow,” says Andrei Medov, director of development and external affairs at Castorama Russia. “Since the very beginning we were searching for projects for quick completion; therefore we happily seized the opportunity to open in Samara and St. Petersburg.” At this time the chain’s stores are being built in Moscow, St. Petersburg and Rostov-on-Don.
Now both Russian and foreign operators understand the necessity of having a presence in the regions, as the Moscow market has reached saturation and the growing buying power for goods and services throughout Russia is causing retailers to open in the relatively free markets of the country’s regions. Cities with populations exceeding one million people are the first in which the chains will open, but the citizens of small Russian cities are starting to see an intense interest from retail operators as well. According to the press service of Metro Cash&Carry Russia, in 2007 the company will enter all Russian cities with populations of one million or more, and later stores will open in cities with populations of less than one million citizens. Jussi Kuutsa, development director of international operations at Stockmann, also notes, “in terms of the company’s development, cities with populations of one million people offer the best prospects, but cities with 500,000-900,000 citizens also present interesting possibilities.”
“The regions are attractive also for giving retailers the possibility of first entering the market, and, in the case of success, they have high profitability,” notes Zotov. However, there are not only positive aspects to entering the regions; there are also a number of real difficulties: “It must be noted that entering some of the regions is made difficult by the undeveloped logistics chain, and, as a result, a high number of delays in connection with delivering products,” says Olga Yasko, director of the market analysis department for retail real estate at Colliers International. Nevertheless, the market players understand the threat of delays, as the “entrance fee” to the regional markets gets more and more expensive each month.

Russian know-how versus Western technology
Russian retailers, naturally, are not sitting with folded arms, waiting for the newcomers. They are actively expanding and striving to be efficient as the Western retail presence expands. “The increased competition caused by the entrance of the international retailers is causing the Russian chains to raise the quality of service and expedite extensive development,” says Yasko. “For example, the entrance of Auchan affected the development of the hypermarket format among the domestic chains, such as Mosmart, Nash Hypermarket and others. A similar process was caused by the entrance of Media Markt, as the base players of this market segment began to enlarge their retail formats, such as the appearance of ETO, the Tehnosila hypermarkets and others.
Additionally, an increase in the number of mergers is also expected, as noticed in the merger of Pyaterochka and Perekriostok on the market this year. Similar deals will allow the companies to decrease delays, combine their finances and logistics, as well as strengthen their market positions to compete successfully with international chains.
Overall, Russian retailers believe that the Western companies will not succeed in shaking their sound base and business. “The entrance of the majority of Western companies has not dramatically changed the arrangement of power on the Russian market,” says Filipp Kapchits, general director of the Sela corporation’s representative office in St. Petersburg. “The companies which entered the market first, be they Russian or foreign brands, have a significant advantage over the newcomers and a temporary monopoly. They have successfully set up relations with consumers and won their loyalty.” However, the segment in which the company operates, clothes and accessories, is still not acutely competitive, and as far as the variety of brands is concerned, the market is still quite a ways from saturation nationwide.
Foreign players predominate within the quickly developing DIY segment, as it was namely they who began developing the current format in Russia, having brought Western standards to the market for goods for the house and refurbishment and gradually having forced (albeit slowly) the opening of construction markets. “The DIY segment is closer to the Western players, as this format initially developed in the West,” says Vitaly Efimkin, head of investment projects at the Tashir Group, which is developing the Nash Dom chain of construction hypermarkets. “But this does not concern us, as indeed the volume on the DIY market, according to various estimates, is from four to six billion dollars per year in Russia. This market is only 20-30% filled at best, so there are enough buyers and possibilities for everyone to make a profit.”
Until recently, the electronics segment in Russia was represented by Russian chains only, but by the end of this year alone the entrance of the Media Markt chain (a division of the German Metro Group) is expected. The appearance of an international competitor does not concern M.Video: “If you look at the facts, you will see that Media Markt won the Eastern European market because at that time there were not any local specialized chains and such an understanding as competition did not exist,” the company comments. “Now in Russia the base competition exists between formats, and also a lot depends on the quality of service. We make a huge effort to maintain a high level of service, as the consumer trends will develop specifically in this direction.”
The heightened competition between the retail chains works to the advantage of both the retail market and consumers alike, as Russian retailers are required to raise standards of service, concentrate on training personnel and optimize the business processes with the company. The gap between foreign and domestic retailers in professionalism and technical equipment is gradually decreasing; therefore, both domestic and Western players do not divide the market into Russian and non-Russian when assessing it. Both segments present highly competitive retail chains.

Market prospects
Experts do not forecast a drop in consumer activity in the near-term, meaning the entrance on the domestic market of new retail operators will continue. The economic potential of Moscow and St. Petersburg is higher than the potential of other cities; therefore, there are more foreign players here so far. Nevertheless, in the near-term this situation will level off. “Investment is coming to the regions and the standard of living is increasing,” says Zotov. “Furthermore, the regions of Russia no longer perceive Western companies as something far off and incomprehensive.” Foreign operators ready to enter the Russian regions are now developing the infrastructure and establishing relations with the local authorities and suppliers step-by-step.
Food-products operators and the DIY format are the most actively developing in the regions today. Also, there are good prospects for the department-store format; therefore, Western chains such as Wal-Mart and Carrefour are studying the possibility of doing business in Russia.
Russian chains are expected to search for the possibilities of combining their strengths to compete effectively with the newcomers. Indeed, the number of mergers is increasing, and the acquisition of small-time players by large retailers is also growing. Accordingly, taking into consideration the intensifying competition, the only means for the majority of retail operators to survive will be to search for their own unique niche of the market segment, which will necessitate reviewing the existing retail format.
Overall, the situation on the Russian retail market is developing favorably for retail operators. Furthermore, when intelligently conducting business, the majority of foreign retailers entering the market can find their niche and peacefully co-exist with the local players.