Russia: An Initial Market Entry Analysis - Essay Example

Russia: An Initial Market Entry Analysis Table of Contents I. Introduction 3 II. Environmental Overview 4 A. Economic Factors 4 B. Political Factors 5 C. Cultural Factors 6 III. Market Characteristics & Opportunities 7 A. Major Sectors and Industries 7 B. Major Companies 8 1. Domestic 8 2. Foreign 9 C. Business Customs 10 D. Marketing Customs & Issues 12 IV. Conclusion 13 Works Cited 16 Russia: An Initial Market Entry Analysis I. Introduction The world's biggest nation has undergone major economic facelifts as it braced itself to compete in the globalization of the world market. Without question, Russia is a geographic giant and perhaps possessing one of the world's most formidable military forces. However, its economic power has not pumped up the muscle of the former Soviet Union. While the land mass of Russia is larger than any nation-almost twice that of the United States-its economy is only the ninth largest in the world (Weidenbaum 2004, p. 681). Russia's transition from communism to capitalism has been a slow, albeit a positive, step. And while Russia is experiencing the pains of creating a new economic system, some progresses are already underway. It was in 1991 that the communist Soviet Union was dismantled and the Russian government proposed numerous radical reforms designed to transform the economy from one that was centrally planned and controlled to one based on capitalist principles. The Encyclopdia Britannica (2007) summed up that the major components of the reforms included establishing privately owned industrial and commercial ventures (using both foreign and Russian investment) and privatizing state-owned enterprises. Furthermore, the Russian government issued vouchers to citizens that enabled them to purchase of shares in privatized firms to promote privatization, though in practice these vouchers frequently were sold for cash and were accumulated by entrepreneurs. Moreover, a commodity- and stock-exchange system was also established to uplift the economic transition of a country fraught in political instability. Dolinskaya (2002) maintained that Russia's growth performance had already worsened before the beginning of economic transformation. The fundamental reason for the slowdown was the nature of Soviet economic growth, which was based on mobilization of resources rather than increases in productivity. However, at present, is Russia still struggling to get its economy on the right track How does Russia cope with the onset of globalization Does Russia deserve the attention of international investors This paper will attempt to find answers to these questions by sifting through current economic data and analyzing the potentials of the Russian market. II. Environmental Overview A. Economic Factors During the 1990s, the Russian economy experienced severe disruption as it moved from a centrally-plannedmodel to a free market system. Difficulties in implementing fiscal reforms aimed at raising government revenues and a dependence on short-term borrowing to finance budget deficits led to a serious financial crisis in 1998. In addition, lower prices for Russia's major export earners (oil and minerals) and a loss of investor confidence exacerbated the financial problems (Spulber, 2003, p. 206). The result was a rapid and steep decline in the value of the ruble, the flight of foreign investment, a breakdown of commercial transactionsvia the banking system, and the threat of runaway inflation. Nevertheless, Russia weathered the crisis well. Russia's economic performance has been strong in recent years, reflected in robust Gross Domestic Product (GDP) growth, strong external and fiscal positions, and growth in productivity and consumption. These achievements are attributed not only to favorable commodity prices, especially high oil prices, but also to generally prudent macroeconomic policies. In fact, Russia is presently in its eighth year of strong growth and now has the world's fifth largest foreign exchange reserves (Euromonitor International, 25 February 2007). As Russia's economy has strengthened, it has moved away from the European democratic model that other Eastern European countries have adopted. However, the Euromonitor International (25 February 2007) analyzed that the key sectors are marred by corruption and inflation remains to be a threat. Luckily, Euromonitor International (25 February 2007) predicted that total retail sales will double between 2005 and 2010 from US$245 billion to US$526 billion. The economy now depends as much on consumer demand as it does on high oil prices. Moreover, foreign direct investments (FDI) rose by 43% in the first half of 2006, but total investment is still modest in comparison with other transition economies. B. Political Factors Since taking office, Vladimir Putin's government faced several pressing issues on the domestic landscape, including a weak economy, decentralized power and waning international recognition. In terms of the economy, one third of the population lives in poverty while the country's wealth is concentrated in a small percentage. President Putin announced his intention to modernize the economy with the hope of rescuing Russia's economy from several years of depression. President Putin suggested that his government would espouse market reform. The essence of Putin's political programme was the attempt to construct a dynamic and future-oriented politics of the centre. By definition, such a programme is in danger of becoming amorphous to the point of meaninglessness; but it does also have the potential to transcend traditional divisions and to lead the country on to a balanced developmental path conforming to native traditions while encouraging integration into the international community (Sakwa, 2004, p. 58). Unfortunately, Russia has suffered from very high criminal activity ranging from petty street crime to white collar and bureaucratic corruption. Although early in his presidency, President Putin announced his intention to fight corruption at all levels, little improvement has been made. In mid-2001, Transparency International ranked Russia as a corrupt country giving it a score of 2.3, with 10 being highly "clean" and one being highly corrupt. Organized crime has influenced politics in Russia; often, political parties are funded with mafia money. Corruption and organized crime have also affected foreign investment in the country. In 2001, over 7,000 murderers escaped punishment and remain free; and 30,000 people have disappeared. In a February 2002 speech directed at law enforcement officials, Putin harshly criticized the current state of law enforcement and demanded that changes be made to ensure the safety of the Russian citizens in business and daily life (Sokolov 2004, p. 70). Euromonitor International (25 February 2007) deemed that Putin accumulated an enormous amount of power in his hands. Several of the country's most ambitious "oligarchs" are in self-imposed exile while another languishes in jail. The country's difficulties in Chechnya continue following the assassination of the president in May 2004. More recently, the violence has spread to Moscow and other parts of the country. In such chaos, there is increasing scope for opportunistic foreign terrorist funding and support. C. Cultural Factors According to CultureGrams World Edition (2007), many Russians are interested to searching for new social values and were optimistic about a future of freedom and opportunity after 1991. In reality, Russia's social fabric and economic stability have so deteriorated that Communists and nationalists have regained popularity with people who are tired of Russia's chaos, declining living standards, rampant crime, and unemployment. Those who are taking advantage of economic opportunities are far fewer than those who wonder each month whether they will be paid. Prosperity promised within a few years now seems a generation or more away. Still, social status is often measured by the acquisition of power and wealth. Respect for authority continues. Though frustrated, many Russians seem resigned to their situation and are willing to endure it the best they can. For example, they continue to work when not paid. And, to compensate for the lack of wages, many families feed themselves by gardening. Moreover, friendship is extremely important to Russians, who are warm and open with trusted friends. They rely on their network of friends in hard times and will go to great lengths to help friends whenever possible. III. Market Characteristics & Opportunities A. Major Sectors and Industries According to the data gathered by Euromonitor International (25 February 2007), agriculture still contributes only 2.5% to GDP and is nominally privatized. Output has been rising but farm production is still below the levels it was a decade ago. Farmers have suffered greatly because of the debt write-offs provided to state farms. On the other hand, manufacturing accounts for 27.7% of GDP and output was rising steadily until 2005 when a slowdown occurred. Growth fell to 4.0%, down from 8.3% the previous year. Manufacturers are being hurt by rapid wage growth, capacity constraints and expansion of the state sector. The sector saw a modest recovery in 2006 with output rising by around 5%. Moscow expects car makers to invest more than US$2 billion by 2010 with new companies capturing more than 50% of the market. There are massive mineral and forest resources with iron ore, copper, aluminum, manganese, salt and precious metals all being produced, though facilities are in need of modernization. Oil and gas are thought to account for up to 30% of GDP but employ less than 1% of the population. Raw materials, such as oil, natural gas, and metals, make up more than two-thirds of all export revenues. However, key sectors are marred by corruption and most natural resources are in the hands of a few oligarchs. Opportunities abound the retail sector in Russia, which has experienced strong growth of retail trade that goes in hand with its rising consumer income and expenditure. After grocery retailers, retailers of durable goods in Russia are predicted to benefit the most. Also, Military & Aerospace Electronics(November 2006) reported that revenues in the Russian electric-motors market will rise to $1.5 billion by 2012, while the Ukrainian electric-motors market will expand to $287.8 million over the same period. While old and outdated equipment is undermining the competitiveness of the Russian and Ukrainian manufacturing sectors, this created opportunity for replacement sales in this industry. B. Major Companies 1. Domestic In the domestic scene, Russia excels in the oil and energy market. This sector accounts for an estimated 5-6% of the world's proven oil reserves and around one-third of global natural gas reserves. According to the Economist Intelligence Unit -Viewswire (25 January 2007), energy accounts for some 30% of Russia's GDP, and in 2006 exports of crude oil, oil products and natural gas, amounting to US$192bn, made up 63% of merchandise goods exports (up from 55% in 2004). Russia has benefited from high international oil prices since 1999, and this has been the main driver of Russia's overall economic recovery in recent years. Until recently the oil sector had been largely in the hands of half a dozen private oil companies, although the pipeline network operator, Transneft, remained state-owned. However, the judicial campaign against the leading private oil company, Yukos, culminated at the end of 2004 in the takeover of the company's key production asset, Yuganskneftegaz, by state-owned Rosneft. In 2005, the Sibneft oil company was acquired by the gas giant Gazprom (which had earlier passed into majority state ownership), and more energy assets are likely to be brought under state control. Gazprom is by far Russia's largest gas producer, accounting for over 80% of total production. The number two gas producer is the privately held Novatek, which accounted for just 4% of production. Russia exported 203 billion cubic meters of gas in 2006 (2.3% less than in 2005). Half of gas exports went to Western Europe, one-fifth to central and eastern Europe and one-third to the Baltic states and other countries in the Commonwealth of Independent States (CIS). 2. Foreign An improved climate in Russia in 2004 encouraged foreign companies to consider investing in international joint ventures (IJVs) in the former Communist country. With President Putin's improved fiscal management policies, Russia was regarded as more politically stable. New land, as well as new legal and labor laws, along with a more stable rouble, an under-exploited natural resource potential, and a skilled, educated population of 145 million, make it an attractive market (Jack, October 9 2003). Those already taking advantage of those opportunities include 35,000 Western companies that have set up shop in Moscow alone and more than 20,000 joint ventures in Russia. Of those IJVs, 2,800 are U.S.-Russian. They include Caterpillar, IBM, GE, Ford, Hewlett-Packard, Pepsi-Co., Eastman Kodak, McDonald's, Gillette, and AT&T, as well as thousands of smaller IJVs-primarily in software, hotels, and heavy industrial production. Many, like Bell Labs, are involved in research and development, taking advantage of the Russians' high-level education and technical capabilities. Moreover, car manufacturers are also taking interest in investing in Russia. For example, Renault (France) announced that it was to invest $150m into its small Moscow plant, making it the largest foreign investment to date in the automotive sector, and a sign of the country's growing importance for international carmakers (Europe Intelligence Wire,3 February 2007). Russian cars still account for 90% of the market but are rapidly losing popularity, and Renault is not alone in scenting opportunities in the domestic market. General Motors (GM) and Ford (both US) have also set up operations in Russia. C. Business Customs As a former Communist state, Russians are basically pessimistic and usually do not express much hope for a better life in the future. Even generally optimistic Russians might not show their true feelings in public but rather express frustration with everyday life. Still, Russians see their heritage and social structure as unique (CultureGrams World Edition, 2007). According to the U.S. Department of State Commercial Guide (1996), Russian business customs could be traced back to the knowledge that Russia has lived for over a thousand years under authoritarian and autocratic rule. Unlike other countries in Eastern Europe such as Hungary, Poland and East Germany, Russia has no institutional memory of democracy or market economy. The pessimism by Russians could be explained by the corrupt Russian system of unequaled red tape. In order to undertake business, businesses need a series of stamps, forms and signatures comprise a frustrating maze for Western business which often sees no point in the exercise. It is said that patience, long suffering and often the goodwill of Russian partners is the only key to success. It is also important to note that documents, even though notarized in the United States attesting to the viability of a company, these will still be rejected by Russians. The U.S. Department of State Commercial Guide (1996) recommended that American businesses should tender a notarization in the American Embassy. Moreover, the U.S. Department of State Commercial Guide (1996) gave important pointers to interested foreign investors: Russian businesses place a very high value on personal interaction and relationships. Business is rarely conducted on the phone, and decisions are almost exclusively reached in face-to-face negotiations. Such meetings usually begin with an exchange of business cards (it is helpful to have yours also printed in Russian) and progress through serious, seemingly endless speeches accompanied by tea and cookies early in the day or vodka toasts for later meetings. When invited for dinner meetings, the evening can often be very long and seemingly unproductive, but may be the necessary groundwork for an agreement signed at a later date. Russians put great stock in personal relations. A hand shake may be more binding for them than the actual signed agreement. Contract sanctity is not a well institutionalized concept in Russia with the signatory or with Russian courts. The Embassy knows of cases where Russian businesses simply abrogated signed contracts when difficulties arose or they deemed the contract no longer advantageous to their side. Russians are zero-sum thinkers. Though westerners expect negotiations to result in win-win agreements for both sides, Russians often think that they can only win in a negotiation if the other side loses. To succeed in business, Russians often have to scheme and plot ways to circumvent rules and find loopholes in government regulations. Often Russian businesses allow this approach to spill over into negotiations with private persons and firms. D. Marketing Customs & Issues As it is still on transition, the business culture of Russia is composed of entrepreneurs, closely associated with the basis of Russian society. Unscrupulousness regarding the means of attaining their market objectives was combined with virtually protestant labor ethics, their willingness to bribe officials, and pay the "kryshas" (protection cover') justified as a lesser evil. On the other hand, it was this stratum of entrepreneurs, which having no access to political leverage, was much better placed to perceive market impulses and tended to be profit- rather than rent-oriented. It is common knowledge that by the mid-1990s, there emerged a model of socioeconomic development in Russia, where business found itself squeezed between corrupt officialdom and criminal bands like between the rock and the hard place. The former can, on seemingly legitimate grounds, destroy any business by numerous audits, penalties, revocation of licenses and permits, while the latter, having true information on the actual size of the turnover, put entrepreneurs under control through blackmail and intimidation. Under such conditions, it would seem that any entrepreneur willing to go ahead with his business is faced with a dilemma: either put one's pride into the pocket, bribe officials and pay the smart money' to racketeers, or abandon the business altogether (Astrakhan & Chepurenko, 2003). Astrakhan & Chepurenko (2003) have resolved that Russian entrepreneurship, for the time being, does not generate respect for the law, but rather responds to the state over-regulation by avoiding and evading it. This has an adverse impact on the shaping up of economic culture of the society as a whole. This circumstance influences the behavior of small and medium enterprises (SMEs) in their deals with partners and the state. In recent years, the Russian government has emphasized foreign direct investment, particularly through structural reforms. High tax levels and high costs of compliance with the Russian tax regime, inconsistent government regulation, the inability to obtain redress through the legal system in several cases, as well as crime and corruption, together function todiscourage potential investors. That said, the 1991 Investment Code guaranteed foreign investors rights equal to those enjoyed by Russian investors while national treatment of investors was confirmed by the 1999 Law on Foreign Investment. However,the 1999 law included aclause that protects certain large investments from unfavorable changes in tax or other legislation for a selected periods. In addition, there are restrictions on foreign investment in specific sectors, such as aerospace. Potential investors should be encouraged by structural reform and privatization; however, economic restructuring could be hindered by political pressures and continuing deficiencies in the regulatory system. IV. Conclusion Marketing in Russia could be a formidable task for a firm interested in successfully establishing their business Russia. Although Russia has become much more integrated into the global economy under Putin, there are still gargantuan tasks to implement in order for a variety of reforms to open up to competition and investment. Policy makers pay lip service to reforms such as removing barriers to competition and reducing administration pressures on the economy, but more and more strategic assets are being returned to state control. More importantly, the Russian government should learn to quell the culture of corruption that emanates in its business environments to make their market more inviting to investors. Here are some suggestions that could help foreign companies minimize the risks in venturing business in the Russian Federation: 1. Choose the Right Partner. The primary reason for international joint venture (IJV) to fail is the poor match between partners-because of lack of compatible goals or strategy, because the Russian partner company is unreliable, or because it lacks the necessary licenses to either produce a product or to export it, or to be involved in development of natural resources. Check with regional government offices about whether the prospective partner has the requisite licenses, appropriate registrations, and reliable bank backing and history. Also check on the status of future rights to assets that were previously under the control of the state, such as those for property or natural resources, or such as a reserve of shareholdings for future privatization voucher holders. The choice of a Russian partner can make or break a venture. A local partner may come with risks because one could end up inheriting the partners' "krysha" (Brzezinski, 14 May 1998). Businesspeople must realize that there are established procedures for getting out of disputes with partners and that those procedures take place outside of the court system. In Russia, a handshake is more binding than a 100-page legal document, so disputes are best solved quietly-often through the mediation of "kryshas". 2. Find the Right Local General Manager. In a survey of thirty-three successful joint ventures, Lawrence and Vlachoutsicos (1993) found that delegating to the right Russian (or Ukrainian, etc.) executive is the secret to success for an IJV because that manager is familiar with the local networks and ministries, the suppliers and markets, and the maze of regulatory issues involved. In addition, local managers are part of the culture of the Russian mir, or collective. This involves direct bonds of loyalty between managers and employees, hands-on management practices, and wide consultation but top-down final decision making. 3. Choose the Right Location. The political risk of investments in Russia decreases from south to north and west to east. Because most people in Siberia have stayed far away from communism and the centers of power and political turmoil in the European parts of Russia, investments there and along the Pacific Coast are more reliable. These areas also have considerable natural resources available. Now that regional leaders have more autonomy, and some have set up economic zones with tax privileges, it is recommended that IJVs branch out, away from Moscow to those areas, and to the Russian Far East, where many Japanese IJVs have set up. 4. Control the IJV. The venture's best chance of success is to be vertically integrated to retain control of supplies and access to customers. In Russia, McDonald's, for example, controlled these elements as well as the quality of its inputs for its stores by setting up its own farms for potatoes and beef. Despite the many drawbacks in the market entry in Russia, Economist Intelligence Unit -Viewswire (25 January 2007) still sees a positive outlook in doing business in the country. This is because consumption remains the main source of growth, supported by strong real wage growth and a rise in government spending. Russia could still fulfil Putin's stated goal of doubling output for the period 2003-2010. Foreign retailers are transforming retail space, with international-standard shops replacing the open-air markets, kiosks and counter-service stores of the previous Soviet era. All these scenarios are making Russia one of the fastest-growing regions for international consumer giants and investing there may spell success for firms in the future. Works Cited Astrakhan, I., and Chepurenko, A. "Small Business in Russia: Any Prospects after a Decade" Futures 35.4 (2003): 341-350. Brzezinski, M. "Foreigners Learn to Play by Russia's Rules," Wall Street Journal, May 14, 1998. CultureGrams World Edition. "Russia", 2007. ProQuest Information and Learning. 08 March 2007. . Dolinskaya, Irina. "Explaining Russia's Output Collapse." IMF Staff Papers 49.2 (2002): 155-157. Economist Intelligence Unit - Viewswire. Russia: Energy and Electricity Profile, (January 25, 2007). 08 March 2007. . Encyclopdia Britannica. "Russia". 2007. Encyclopdia Britannica Online. 8 Mar. 2007 . Euromonitor International. Russia: Country Profile. UK: Global Marketing Information Database, February 25, 2007. Europe Intelligence Wire. "Renault to Invest $150m in Russia".(Feb 3, 2007):NA. Jack, Andrew. "A New Dawn Brightens Moscow's Skyline," Financial Times, October 9, 2003, 1-3. Lawrence, P. and Vlachontsicos, C. "Joint Ventures in Russia: Put the Locals in Charge," Harvard Business Review, January-February 1993, 44-54 Military & Aerospace Electronics. "New Market Opportunities Emerge for Electric Motors in Russia and Ukraine."17.11(Nov 2006):50(1). Sakwa, Richard. Putin: Russia's Choice. New York: Routledge, 2004. Sokolov, Vsevolod."From Guns to briefcases: The Evolution of Russian Organized Crime."World Policy Journal21.1(Spring 2004):68-74. Spulber, Nicolas. Russia's Economic Transitions: From Late Tsarism to the New Millennium. New York: Cambridge University Press, 2003. Steen, Anton. Political Elites and the New Russia: The Power Basis of Yeltsin's and Putin's Regimes. New York: Routledge Courzon, 2003. U.S. Department of State Commercial Guide. "Country Commercial Guide: Russia", 1996. 08 March 2007. Electronic Research Collections. . Weidenbaum, Murray. "The Uncertain Prospects for the Russian Economy," Vital Speeches of the Day 70, no. 22 (September 1, 2004), p. 681. Read More