It is easy to say what the origin of the success of the top 5 retailers in Russia is. E.g. Pyaterochkas stores are very convenient to get to because they are located in densely populated areas. The company has been successful in getting good spots for its stores. The stores and the average purchases are small but they are so easy to get to that one can go there several times a week. Pyaterochka is also able to offer a good assortment of products at a low price. In Russia the income of majority of people is quite low and Pyaterochka targets its actions to this particular group. Volumes count. They have carefully selected the goods in their assortment so that a customer rarely needs to go to another shop to search for a certain product. EBRDs 3-year ownership clearly helped the company to rise to number one chain in Russia.
Metro Cash & Carrys success factor is clearly the best price-quality relation. It is inexpensive, but the quality of the products is very good. The assortment of goods is also wide, so practically everything can be found at Metro. The second factor is the cost managing approach. Metro can offer decent value for money for its customers because it has been able to control its costs partially because its stores are located far from city centers. Magnit has met the needs of people with less money in the regions (mainly south) with its hard discounter format and managed to be the first in many markets, at the same time when the others were battling for market shares in Moscow. Tander, which owns the Magnit chain, is originally a wholesaler, and it has a long history of dealing with suppliers. It must have helped creating the Magnit discounter chain.
Perekrestoks and Seventh Continents advantage of being the first in the Moscow market is gradually diminishing. Their main format supermarkets are being attacked by the hypermarket and discounter formats. Supermarkets are caught in between and they have not been able to expand fast enough to respond to these other formats. However, the author sees that by joining forces the domestic multi-format chains will be able to match the pressure of the other companies and become even the largest players in Moscow.
Pyaterochka has been the most successful of the Russian retailers but there are also rising stars. It is interesting to see how well Paterson will succeed against its rivals. In addition to existing competition, there is still room for new players in the market. The market is far from saturated. However, it will not be easy to enter the market, and it is almost impossible for a new domestic chain to establish business and survive. Because the domestic chains have to finance their expansion with their own cash flow, the companies that are big now are highly likely to survive in the competition. Small chains will be eaten.
All in all, the chains with the discounter format will be strong because there is a lack of investment capital available in the market. The chains have to finance their expansion mostly by themselves and the discounters are very cheap to establish. They are also easy to franchise. Thus, new stores can be built with a small input, even though there is not very much capital available.
The hypermarket segment is booming, but it does not compete with discounters at all because the hypermarkets are targeted for a different market segment, i.e. people with cars. In addition, they are usually located somewhere at the outskirts of the cities near the main highways and thus they do not compete for location as severely as discounters and supermarkets do. It is enough to be near the highways. One can find practically everything from hypermarkets and they are less expensive than supermarkets. It pays off for the customers to do their weekly shopping in hypermarkets. Thus, they are very efficient in generating revenues. The down side is that the hypermarkets need fairly large investments to establish.
The ability to establish new stores in the regions and thus take market share is of high importance in the competition. The best growth prospects are there nowadays. Even though Moscow is ahead in development, the regions are following behind and with time the difference will to a certain degree even out. The markets will saturate first in Moscow and just after that in the other regions.
In fact, at the moment the retail sectors growth in Moscow is already slower than the overall growth in Russia (see table 7). The author considers it to be likely that the large chains will evidently conquer the regional markets as well, despite of the opposition from regional governments and chains. Their size is beginning to be a clear advantage. Thus it is fair to say that the market survivors from the current players are among the top 15 retailers.
It was mentioned above that the Russian retail sector permanently has a high profit margin. According to the very basic market rule, sectors with high profits will attract supplementary capital from internal and external sources. Therefore, it can be predicted that there will be continuous dynamism in the Russian retailing in the foreseeable future. At the same time, it is obvious that the core of the Russian boom is in the export of energy bearers, such as oil and natural gas. Thus, there is rather high volatility in the Russian economic development, which is probably hindering an outright invasion of foreign retailers.
The new market entrants will cause tightening in the competitive environment when they come to Russia. However, it will not be easy to find success on the Russian market anymore, albeit there is still room for new players. The current players enjoy the advantage of being first in the market. They have gathered experience and learned how to do business in Russia. They know how to deal with corruption. They have also established a significant number of stores at important locations of the biggest and most promising cities. Thus the newcomers would have to seize customers from existing companies and that will not be easy without a functioning distribution net. At this point the author expects only big multinationals to enter the market, as it will take significant investment inputs to establish or to buy a critical mass of stores to be successful. The author will not rule this out, but considers new domestic players unlikely to enter the market. There is more room for market entrants in the regions, but the problem is that the margins might also be lower due to the lower wages in the regions and the operations thus less profitable. The second half of this decade will be interesting to observe: there is still plenty of leeway for intensified competition in the Russian retail sector.
Expanding to regions is the most important trend in the Russian retail sector today. Even though the Moscow markets are not saturated yet, the leading chains are expanding their operations to the regions. This is partly because the land plots for store construction and real estate are very expensive in the capital, and partly because being among the first in the regions gives good growth prospects and competitive advantage against other chains in those markets. In fact, in order to grow fast enough chains even have to enter the regions. The consolidation process will follow when the growth slows down. St. Petersburg is not necessarily the best place to expand to, even though the size of the population is great, because there is already competition in that market and the development of wages is not better than in the other regions.
The consolidation of the food retail sector has started but remains fairly undeveloped. Moscow is ahead of the regions in this respect. At first the larger chains will start to acquire small chains and independent shops. They will be compensated well for their business. As the competition gets tougher, the chains have to give up their huge margins and start to compete with prices. Those who have created good logistic schemes and implemented them are more efficient and thus generating more profits. If necessary, they can also pull the prices down and be profitable still.
The heavy mergers or acquisitions will start then and, according to analysts, the end-result will be that there are 5-10 players in the market. The estimated time frame for this development is 3 years in Moscow and 5-7 years in the regions. However, the growth will continue clearly at least for 10- 15 years.
The overall retail sector will continue its growth for some time with the increasing purchasing power of customers, before major changes in the environment will take place. Because the consumers have more money than before they will demand more and better products for their money in the future. The food producers should bear in mind that the price level in Russia is, however, significantly lower than in developed countries, and thus they have to sell 2.5 fold more of same products in Russia to achieve the same turnover as in EU (15) countries. Therefore, the producers must keep their utilization of production capacities high to achieve the best profits. On the other hand, the large number of people in the biggest cities makes long production series possible.
The growing income and the upcoming WTO membership of Russia make it possible for Finnish food producers to continue doing business with Russians by exporting. However, in order to get significant market shares, and above all, make decent profits in the Russian market, FDI is the best alternative. Brownfield investment would probably be a preferable method for entry because the local companies have already established working relationships with the suppliers of the scarce raw materials. Thus it would be difficult for a foreigner to start from scratch. Exchange rate protectionism is an attraction to produce in Russia in comparison to direct export: it makes import-substituting activities potentially profitable. With a weak US dollar and thus weak Russian ruble (RUR is regulated against USD), it would be the right time to invest now because EUR is very strong against USD at the moment. More can be obtained with less investments. At the same time the value of investments will grow along with the market growth if the business is well taken care of. Also, the longer you wait, the tougher the competition gets. If the ruble is allowed to float freely in the future, the appreciation of the ruble will bring investors bigger profits also in euro terms.
When entering the Russian markets, foreign food producers have to consider the location they want to establish their products in. Moscow, the Moscow region or at least immediate proximity to these areas provide the best prospects for business, compared to other regions in Russia, because the retailers buy a lot of goods locally and the market size in Moscow is huge. Especially perishable goods ought to be produced near the markets. On the other hand, also the toughest competition and pressure from the retailers are there, but by offering quality products with a functioning distribution net, the companies can be included among the strongest food producers in the business. Those suppliers who can deliver goods with high quality in right time, reliably and with proper documents are in a good position when retail chains are thinking about choosing suppliers.
However, the decision process starts with choosing a product and then the supplier. The retail chains will buy what the customers need and buy. Thus a proper market research is recommended before investing for food production in Russia. The food producers should also plan and implement logistics schemes carefully before entering the market. The same rules would also apply to everyone in Moscow, although corruption still exists. The wages are also on a higher level in the capital than in the rest of Russia.
Producers entering the market might also have to use Russian brands because the consumers prefer Russian food products. One solution is to acquire a strong brand from Russian markets, as this will raise the negotiations with the retail chain to a different level. If a producer possesses a strong brand, it is possible for it to negotiate favorable sales terms for it. All in all, it is fair to say that Russia offers a fairly stable and profitable environment for investments in food production, and the success factors are clear. There is potential in the market waiting for someone to take the chance.