A Quiet Retail Invasion?

Market Potential
The 1998 crisis forced many foreign retailers in Russia to close their doors and it is really only now that they are returning in force, and then only after lengthy research and consultations with local players. A good example is Carrefour which planned to open its first hypermarket in the Atrium shopping center in 1999. However the unstable economic situation forced a rethink. Over the next few years, the world’s second largest retailer regularly announced plans to enter the Russian market but it was only ten years later that this finally took place. Details are scanty but it is known that at the start of 2008 Carrefour will open a store in the Fili shopping complex.
According to market experts, it will be harder for new grocery retailers to gain a foothold than it was for the pioneers like Auchan, Metro, Ramenka, REWE and Globus. At that time there was virtually no local competition and retailers quickly occupied vacant niches. Today however most formats are already operating in Russia and introducing something new will not be that easy. Having said this, market experts comment that the prospects are excellent for retailers with strong concepts and the means to realize them. Analysts from MDM-Bank estimate that last year the largest retail operators comprised about 6% of the grocery segment in Russia in comparison with 64% in France. Jeff Kershaw, senior director at CB Richard Ellis Noble Gibbons, thus comments, “Over the next few years the main expansion of Western retailers in Russia will be in segments without large players with big market shares – like the grocery, household goods and clothing.”
A relatively high level of competition in the grocery sector will only benefit the market and force Russian chains to improve service levels and develop faster. For example, the market entry of Auchan had an impact on the development of the hypermarket format by Russian chains, like Mosmart and Nash Gipermarket.
According to the vice president and commercial director of Torgovy Kvartal, Elsa Rosenthal, “Today, apart from competition among grocery retail operators, we are also seeing strengthening competition in the consumer goods segment (particularly recently) and the DIY segment which has a number of new Russian players. However competition in the grocery segment is still not very strong, the market is not saturated and is ready for the entry of new retailers, both Western and Russian.” Peter Partma, general director of Castorama, comments, “Recently the household goods and DIY segment has grown faster than the rest of the market, making it one of the most interesting segments for foreign retailers.”
Market experts are unanimous that Western chains have a number of competitive advantages when it comes to the Russian market: strong marketing strategies, a single format, high service levels, well developed logistics systems, operational efficiency, access to international financing and developed brands.

Entry Strategy
The most common way for Western Retailers to enter the Russian market is via franchising in which the retailer provides the right to sell products and use of the retail brand to a local firm. According to Yussi Kuutsa, development director at Stokmann, this is because although the Russian market offers strong consumer spending power it is still one of the most difficult markets in the world. Franchising minimizes risks because it is the local firm which invests in the development of the business. It also minimizes the personnel requirement while providing an opportunity for an international brand to quickly gain market share. In fact the only real disadvantage is that profit levels are much lower in comparison to those that could be achieved from successful direct market entry.
A lot of foreign grocery retailers and virtually all Western clothing retailers are operating in Russia under franchise. However there is a lot of variation in the types of franchising which can range from the development of a very strong business relationship with a lot of input from the retailer to the signing of a franchise agreement.
“Classical examples include: Russkaya Torgovaya Gruppa (RTG) which is developing a chain of British House (BHS) and C & A department stores under franchise, Maratex (formerly BTI Systems) which is developing the Peacocks department store chain, Enrof which is franchising Mexx and Topshop and Sport Fashion Group which is developing the Reebok and Debenhams department store chain. In the restaurant segment, Brothers & Co owns the franchise for Sbarro in Russia, the CIS, the Baltic States and Eastern Europe and Rosinter Restaurants owns the franchise for T.G.I. Fridays in Russia, the CIS and Eastern Europe,” says Julia Dalnova, director of the retail real estate department at Knight Frank.
Franchising is often only used at the early stages as a way of reducing market entry risks. If the brand proves popular then the retailer buys back the franchise and develops it independently. Inditex introduced the Zara branch into Russia by selling a franchise to the Stockmann Group. At the start of 2006 Inditex brought back the franchise and began developing its own store chain.
According to Ms. Dalnova another way of entering the Russian market is to use an existing franchisee in another country. “A good example is British department store chain Marks & Spencer which is being developed in Russia by Turkish franchisee, Marka Magazacilik which is part of Fiba Holding. Because the franchise had already operated very successfully in Turkey it expanded and opened several department stores to Russia and the Ukraine.”
One of the most expensive and risky ways of entering the market is to set up a joint venture in which the local firm manages the retail operation and the Western retailer provides financing and strategic support. This is how British pharmacy chain, Boots successfully entered the Russian market in 2005 and established a chain of stores with Apteki 36.6. Together they are developing the No. 7, Botanics and Toni & Guy brands. Another successful example of this type of partnership is Yum! Brands which is owned by Kentucky Fried Chicken and Rosinter Restaurants who are jointly developing the Rostiks-KFC chain.
There are also well-known examples of unsuccessful partnerships between Russian and Western firms which have resulted in serious losses. “The Spar chain had a dispute with Russian holding Marta. Marta owned a subfranchise for Moscow and fell out with the Russian Spar franchisee, Spar Central Russia. Marta applied for a master franchise in the regions, but it ended up coming to terms with Spar Central Russia. As a result, Spar Central Russia sold the subfranchises to different firms and acquired a chain of stores in the regions. In 2005 it acquired a large chain in Vladimir,” says Ms Dalnova. The conflict resulted in the closedown of a number of Spar stores.
Another popular form of market entry is a partnership with a Western development firm already operating in Russia. The advantage of this approach is that the developer is aware of local conditions and can offer retail operators standard lease agreements and professional management. A good example is Ramstor which is a joint venture of Turkish retail operator, Migros, and development firm, Enka (initially they each acquired a 50% stake but recently Migros sold its stock to Enka). According to Ms Dalnova, “This type of partnership made it much easier for Migros to enter the Russian market. Enka already had seven years of experience of operating in Russia which meant it was able to overcome a lot of bureaucratic and administrative obstacles. The successful partnership helped them create some of the very first modern shopping centers in Russia and Ramstores opened near Molodezhnaya and Kashirskaya subway stations and on Sheremetyevskaya Street in Moscow. The store’s turnover also includes rental income from areas

leased to other retail operators.”
“If we look at the type of interaction between developers and retail operators, usually this is confined to the renting of retail areas. Developers are happy to have Western retail brands in their shopping centers, and so they offer them good lease terms and lower rental rates than to Russian retailers because popular Western brands usually generate the main number of visitors. Also Western chains are willing to provide a fixed percentage of turnover as well as fixed rental payments,” says Ms Rosenthal.
Other types of cooperation between developers and retailers include the acquisition of development franchises to develop brands within shopping chains. Crocus Group acquired several franchises for its retail chain; however it did not promote these brands to the mass market.
“In the West developers design and build hypermarkets for large retailers, fill them with tenants and then sell them directly to the retailer. In Russia there are no examples of this type of built-to-suit retail projects,” says Mr Kershaw. The least successful route for foreign retailers in Russia has been the acquisition of local retail operators followed by the modernization of their stores. According to Mr Kuutsa, “When Western retailers buy a Russian chain there is a strong chance that the price will be overstated. Also the reorganization of a Russian retail operation to meet Western retail standards requires a considerable investment. Previously some market experts thought that Wall-Mart and Carrefour would opt for this approach since creating a chain from scratch would take too long, and they would be overtaken by the competition.” However not everyone agrees with this, “I have never had much faith in rumors of the acquisition of Russian chains by Western retail giants like Carrefour, Wal-Mart and Tesco .
There has been a lot of talk about this over the last five or six years but nothing has come of it,” says Ms Dalnova.

Market Problems
“The main obstacle to market entry is a serious shortage of modern retail sites and retail areas which has resulted in extremely high rental rates. There are also problems relating to transparency and the degree of protection provided to tenants often leaves much to be desired,” says Olga Yasko, head of the analysis department at Colliers International.
The lack of a developed infrastructure is also delaying the regional expansion of Western chains, and Western retailers encounter more problems with corruption in the regions than in Moscow.
It seems that many foreign retailers are not just ready for Russian market conditions. In 2001, German firm AVA announced plans to build a Marktkauf hypermarket chain. After a two-year delay only one hypermarket was built in Kotelniki, Moscow region. Later it was closed because of strong competition from Auchan, and AVA decided to pull out of Russia.
Another example of an unsuccessful attempt to enter the Russian market is Turkish department store, Boyner, which operated in the Mega-Khimki shopping center from December 2004 to November 2006. Despite ambitious plans to develop a nationwide chain, it only managed to open one store and then decided to exit the Russian market.
Other short-lived experiments include: Karstadt, Galery, La Fayette and Kookai which has already made two unsuccessful attempts to gain a foothold in Russia. Today the brand is being developed by Sela Corporation. According to the general director of Sela’s St. Petersburg office, Phillip Kapchits, over the next five years they plan to open 100 stores. Experts estimate the total investment at 10-15 million dollars but it is still too early to see if this third attempt by Kookai will prove successful.
“The main difficulty for foreign retailers is Russian customs and tax legislation. Also many Western retailers simply overestimate their own abilities. For example they often just assume that Russia is a good source of cheap labor and they take on staff for very low salaries. Then it quickly becomes clear that these employees are not up to the job and they have to let them go and look for more qualified staff usually by hiring them away from Russian chains. This is creating a shortage of qualified staff,” says Mr Kapchits.

Prospects
According to analysts from A. T. Kearny, one of the most promising segments for foreign investors is smaller cities. “With a strong strategy a smaller city can be very attractive for retail operators who have missed the window of opportunity for larger cities as well as for well-established retailers looking to expand.
Many Western chains, which started out in Moscow and St. Petersburg, have already switched their focus to the regions. The Metro chain has already opened over 10 retail outlets in the regions; Auchan opened a hypermarket in Kazan in 2006 and is currently building another one near Yekaterinburg; and IKEA is currently expanding into a number of Russian cities.
It is expected that this trend will continue and the market entry of large retail chains like Carrefour, Selgros (and perhaps Wall-Mart) will force large Russian retail chains to become more competitive, reduce costs and operate more efficiently. “It is still too early to talk about very strong competition between retail operators,” concludes Mr Kapchits. The grocery segment is still a long way from saturation and it seems that there is still room for everybody.