Studies Eastern European Markets
Eastern European Markets
Tauno Tiusanen - Sirpa Vinni - Jari Jumpponen
THE INVESTMENT CLIMATE IN RUSSIA
- PART II - Case Studies
Research Report N:o 19, 2002. Lappeenranta University of Technology. Studies in Industrial Engineering and Managemen

    Introduction

    The first volume of "The Investment Climate in Russia" emphasized the general features of the Russian business climate. In this second part the focus is on complementing the overview of business climate through several case studies.
    Some final conclusions

    Russian road from Soviet central planning to decentralized market was in the 1990s paved with stones. Economic dynamism and stability were in short supply. Capital formation (savings) took place in the resourceful country, but propensity to invest on the spot was extremely low; capital flight in massive scale took place, while local capacities became more and more outdated.
    Under unstable economic circumstances in Russia, FDI-activity was very thin. Many other TEs offered much more attractive investment environment than Russia. Differences in FDI-statistics within TE group of countries is striking.

    The transitional crisis of Russia hit the bottom in 1998, when the currency (RUB) collapsed amid permanent deficit spending of the state. Panic took over in the currency exchange market. This negative event brought up a turning point. Alonside with the strong depreciation of the rouble, oil price experienced a remarkable increase. These two factors started an economic boom, which let to an upturn in investment. Combined with relative stability in the political scene, prospects for increasing prospery have essentially improved.

    Even if economic growth resumed in 1999 after a long slump, the investment climate in the early 21st century is far from perfect. Institutional reforms are not yet completed. Russia is still after ten years of transition a relatively isolated country: for example, Russia is one of the few countries in the global economy without a seat in the WTO. Thus, Russia is a rather risky playing ground for international investors.

    However, Russia has some positive features, which are missing in TEs of Central Eastern Europe. With almost 145 million people, Russia offers a big market. The country has a resource base with oil, gas, mineral and timber, which is unique in the world. Furthermore, Russia has a big pool of human capiltal, for example, engineers. Thus, on the long run Russia is definitely interesting object for international companies. There is plenty of potential, unsatisfied demand on the large market. Low average living standard in present time is an impediment for rapid or strong invasion of Western investors.

    Material for concrete FDI-cases included above has been collected during the transitional period in Russia. Many selected examples show that early FDI entry has been beneficial: in the TE-market it is in many branches essential to establish the brand image as early as possible. Latecommers must spend much more money to establish themselves on the Russian market.
    When material with FDI-activities is collected over several years, there is the obvious danger that stored knowledge becomes outdated. In the meantime, Hartwall (Finland), the important shareholder of BBH, merged with Scottish-Newcastle Brewery, one of the real gigants of beer industry. Brewing business in the world has more and more oligopolistic features. Carlsberg (Denmark) has long ago swallowed its local rival, Tuborg. Carlsberg, owner of Koff in Finland and Neva in Russia is one of the really big players of the global beer game. SUN breweries is allied with Interbrew (Belgium). Heineken (Netherlands), one of the biggest brewers in Europe, acquired Bravo brewery in St. Petersburg with a capacity of 25 million decaliters a year.

    It is interesting to observe, how TEs are involved in global, oligopolistic markets. In the communist time, big international companies with global reach were called "monopolies", which were described as worst enemies of mankind. Now these economic agents influence the economic and also cultural scene of TEs in many branches from candy-making to car manufacturing. From long-term point of view, this development is genuinely revolutionary.

    It is self-evident that this development is not appreciated by every individual in post-communist countries. Sensitivities are especially clear in Russia, which has her imperial past and former superpower status (as the most important state of the former Soviet Union). Thus, foreign investors ought to prepare themselves for these sensitive issues when entering the market. Mutual benefits of FDI must be expained in very concrete terms. Cultural differences ought not to be ignored.

    When TE-markets are assessed, it is vital to consider the problem of undervaluation of TE-currencies. TE-countries have a relative modest living standard in Western comparison. However, the gulf in well-being is not as deep as calculations made by using official ERs presuppose. Purchasing power parity (PPP) adjustment is a powerful tool of realism, when TE price levels are considered. PPP adjustment figures show that there is some real leeway for consumption in emerging markets of TEs. Western retailers selling branded (Western) goods in TEs are not without clientele.

    As shown, Russia has been much less successful in attracting FDIs than some other TEs (especially The Czeh Republic; Hungary and Estonia). Relative FDI-figures (per capita) are very modest indeed in the Russian case. One of the reasons is that Russia has been reluctant to allow foreign investment in banking sector. Acquisitions of banks have involved big sums of money in many TEs.

    FDIs in Russia have taken place in income inelastic spheres. High and low income people must drink and eat, in other words, these activities are not dependent on personal wealth. The demand for food and beverages is thus said to be income inelastic.

    In consumer durables Western markets are saturated. In household appliances innovation is relatively low. Households only seldom buy a new cooker or a washing machine when a new model enters the market. Producers must find new markets with real need to get modern appliances, and thus, plenty of dynamism has been spotted in TEs. Every international company in this sphere must try to get a place of this new cake, one way or another.

    Car manufacturing is a different ballgame. Rich customers are ready to pay for quality and prestige. Thus, low price combined with local (TE) production is not a must in upmarket car business. FDI-movement in Russian case has thus been rather slow.

    It can be maintained that FDIs have not been a strong engine in improving economic structure in transitional Russia. Entries in high.tech branches and engineering have hardly taken place. Thus, technology exchange in the framework of FDIs has so far had a limited scope only.

    In all categories of consumer goods brand identity must be created in the early period of transition. Label must be made known with various forms of advertising and sales promotion. In these activities costs have a tendency to increase. That is visible in all TEs, Russia included. In every oligopolistic market, price war is a dangerous game. Prices must be somehow in harmony with local (low) earnings. However, competition must be decided with other tools of marketing mix. No Western brand in post-communism is strong enough to sell without propaganda, not even famous cola-drinks. Monopolies cannot be established in TEs. Creating brand loyalty takes time and money in every new market.

    It was pointed out above that forecasting economic trends in Russia is exceptionally difficult, because of the high dependency on global commodities market (which are by definition volatile). However, it is highly likely that the second decade of Russian transition will be better than the first one. Thus, we can also predict that the future of FDIs in post-communist Russia will be much more exciting than the past.


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