Letter from Russia: Moving towards a legal market

April 2008

Russia is customarily considered one of the most important and potential markets. However if you ask any export manager what he knows about the Russian market, I assure you, his answer won’t be complete. Unfortunately, nobody in the world has a full and objective understanding about the Russian watch market.

In order to hold a confident discussion on the subject one must have figures. According to Swiss customs, about 360,000 watches, to the amount of 296 million CHF, were imported into Russia in 2007. That shows a growth of 112 percent in terms of quantity and 49 percent in terms of volume, compared to the previous year. 2006 exports showed more expensive models (in some periods the average watch price invoiced was 2,000 CHF), and in 2007, the average price was 780 CHF. This means that shipments of both expensive and cheap models were restored. Seeing such figures we can imagine that the export managers were most certainly touching their bonuses.

However if we were to calculate an export manager’s salary based on the Russian customs records, he would be dying from hunger! Russian customs registers less than 50 percent of watches sent from Switzerland to Russia. Some would say that this is unacceptable and they would be correct. But some people are claiming great progress and they are not wrong either, especially when you consider that only two years ago Russian customs officials only registered 10 percent of Swiss watches. The cheaper watch segment was even worse. Only an estimated analysis is possible here and before 2006 there is absolutely no data on the middle and low-end market segments.

Vacheron Constantin

The most expensive watches

Russian companies were unwilling to declare the goods some years ago due to complicated customs procedures and high customs duties (20 percent duty and 18 percent VAT). These payments resulted in prices being 20-40 percent more expensive than Europe. This shows that Russia is not one of the leaders in sales of expensive watches. The country has some of the highest watch prices in the world.

Such a considerable price gap is especially noticeable for expensive watches and, thus, stimulates consumers to buy watches during trips abroad, explaining the reason for so many Russian-speaking staff in watch shops across Turkey, United Arab Emirates and Germany. Some brands, not having any distributors or shops in Russia, willingly place advertisements in in-flight magazines such as Aeroflot and other companies flying from Russia.
“We’ve got a lot of examples where customers are not willing to buy expensive watches in Russia. They explain it by saying that they intend to buy in Europe and other countries”, says Mikhail Kasparov, Deputy Director of LPI, the distributor of Ulysse Nardin, Carl F. Bucherer, Maurice Lacroix and other brands.

The advantage of buying a cheaper watch is lost because customs duty is three Euros per watch. This results in abrupt price growth of even the cheapest products. For example, popular and reasonably priced brands such as Q&Q become more than twice as expensive after customs procedures.
All these reasons result in illegal imports. Even information from Switzerland doesn’t completely reflect the numbers of watches arriving in Russia. In addition to official and semi-official channels, many watches are still delivered to Russia illegally. Re-export is particularly common from CIS countries and UAE. In 2006, when all official shipments of watches to Russia were suspended, Tissot models appeared in Russian shops with price tags in Ukrainian Hryvnas.

There is no information on the exact volumes of such shipments, however they are immense. According to some estimations, about half Ulysse Nardin watches delivered to Turkey are then re-exported to Russia.
Another disadvantage for legal exports is complicated customs procedures. The paperwork an take several weeks and even the slightest mistake in delivery formalities made by the sender may stop the delivery. For example, if our export manager makes up his mind to give a present to his Russian client and writes on the export documents that it isn’t a watch, the Russian client will have a good reason to be worried instead of being happy - non-declared goods can become a reason for opening a criminal investigation.

Player № 1

So, what happened in 2007 for registered Russian figures to increase? Did customs duties decrease and formalities become easier? No, they didn’t. The reason is higher pressure from the state in 2005-2006.
It is no secret that in the middle of the nineties the state and business sectors in Russia lived separate lives. Huge taxes and constant legislation changes incited companies to do business under the table. Since the turn of the century central authorities started to strengthen and the state started to impose pressure on business through paying taxes and customs duties.

Although they were often at the mercy of security ministries who would break the law and line their own pockets, joining the state policy. Under the pretext of a criminal investigation for smuggling and other such crimes, militia would often confiscate and sell huge supplies of goods at cut prices. This phenomenon got the name ‘ware raiding’ in Russia.

There wasn’t a single company, regardless of the extent of its transparency, who felt confident at this time. This was also true for alcohol, meat, household appliances and computer sellers. In the summer of 2006, a large shipment of Motorola mobile phones were confiscated becoming the most notorious case of ware raiding. Only a complaint from the American company to George Bush and then his personal conversation with Vladimir Putin helped bring the goods back to the owner.

Watch companies weren’t spared. Distributors took the bulk of the impact upon themselves. In the period between summer 2005 and summer 2006 their activity was mostly paralyzed. The process turned out to be very painful and worrying because none of the watch dealers knew who would be next. Regardless of the size of the wholesaler or whether he was conducting a legal or an illegal operation – he could become a raid victim at any moment. Logistic operations were intercepted; goods worth considerable amounts of money were confiscated. In order to have the slightest hope for protection, although no guarantee, distributors turned to legal logistic systems resulting in almost a complete turnaround for the Russian watch market.

Audemars Piguet

New leaders

Most significant changes took place at the wholesale level. A change towards legal logistic operations demanded time from distributors. Still having significant expenses with rent, utilities and so forth, they were deprived of goods and inflow of money. New business structures increased the cost price and decreased profitability. Owners of some companies decided to pull their money out of risky and low profitable business.

Rebuilding businesses of old and partly depleted companies turned out to be more difficult than creating new ones. Some old players with many years of experience left the market and new companies appeared instead. Bristol and Prime-Time (the subsidiaries of Consul), Belka (the general distributor of Casio) ceased to exist. CMS-Group business also stopped. A lot of companies lost their power to some extent.

Only those old companies who reorganized their logistics long before the crisis, managed to keep and even strengthen their position in the market. The best example here is Time&Technolgies, which is the leader in the fashion watch market today. New companies, such as Art Moda, LPI, Lux-Style, TBN Time, Weiner Watch Group appeared instead of old ones. These companies were initially created using legal business structures. They got contracts for the distribution of many popular brands in Russia.

The example of LPI Rus Company is of utmost interest here. It is the first case of a European distribution company coming to the Russian market. Due to the fact that LPI Rus’ head office is located in Switzerland, it is easier for it to attract funds and deal with suppliers. On the other hand, the core of the company is actually formed from former Bristol management employees, who have extensive knowledge of the Russian market and great trade experience. This resulted in the fact that LPI Rus became the first newly created company who managed to establish relations with Russia. “Like any other company working in Russia, we’re facing much greater problems than European firms. However relying upon our own example we’re trying to negate the belief that it is impossible to do legal business in Russia. Yes, it is much more difficult than in any other country, but it is still possible” –describes Mikhail Kasparov about the situation.

Gerald Genta

Subsidiary offices

Distributors suspended shipments for a considerably long period of time and made producers find new ways of working in Russia. As a result, 2006-2007 was marked by the mass arrival of foreign watch companies to Russia. Alongside LPI Rus, there appeared a subsidiary of Austrian Weiner Watch Group, Citizen, Seiko, Ulysse Nardin and TAG Heuer and the Swatch Group Sales office (instead of Information Bureau) with several dozen clerks.

It is clear that not all companies opened offices due to the supply crisis. Swatch Group sales in Russia increased to such an extent that its office would have opened anyway. The crisis just accelerated the process. Richemont established its office in Moscow more than five years ago, but the crisis imposed a great impulse on its brands’ development within the Group. Whereas before, Richemont brands were on sale only in Moscow and three other cities, today one can buy them in different parts of the country. Baume & Mercier opened 21 new shops, Jaeger-LeCoultre – 11, Montblanc – more than 10. Sales of most brands went up to two-digit figures at least and Jaeger-LeCoultre achieved the best result having its sales increase two fold. The number of employees at the Richemont office doubled. The success of the Group is explained by three factors: the absence of goods from other suppliers, the growing demand of expensive goods and shop owners’ concern due to the expansion of federal chain stores.

However, the examples of Richemont and Swatch Group are still the exceptions to the rule. Other branch offices do not deal with sales, but function as marketing offices. Some companies have a mixed structure in Russia with an independent distributor who delivers goods to one or several retail chain stores and the office of the company deals with the marketing.

Seiko shows the most interesting example, having only one person representing the company in Russia, and at least three new business plans offered during the past year. Initially Seiko worked only through a distributor. Then it declared that it planned to supply watches through its subsidiary office and a distributor at the same time. The company started to make deliveries to two chain stores in addition to supplying the distributor, which was no longer playing the key role in the market and not generating any considerable sales volume. Of course, such a mess had a negative impact on the and the reputation of the brand in Russia. However, the company’s problems don’t stop here, Russia is run from the German office and the Russian distributor rarely receives the most popular watches, just the leftovers from what doesn’t sell in Germany.

Brands now use multi-level structures, which are explained by a number of facts. Sales office demands quite different resources than marketing ones. At least, there is a need for people. The core of most offices of brands consists of former employers of wholesale companies. Experienced human resources are never enough, and managers coming to this field from other market branches are hardly acquainted with the peculiarities of working in the watch market, which results in a great number of mistakes. Warehouse servicing demands money and is risky - checks, dealing with law enforcement authorities and so on. All this means money and there is no guarantee that investments will be covered by sales. Partial transfer of functions for outsourcing prevents some problems, but also creates new ones. Thus, Swatch Group uses outsourcing structures for warehousing. However the fact that warehouses are not equipped for storing watches lowers the service level. And that in turn undermines the company’s image.

Time will tell if the multi-level structure used by some brands is justified and economically viable. Some consider it the right way. Others state that in many cases subsidiary offices are not economically effective. A lot of subsidiary offices appeared due to panic, when it seemed to be the only way to establish watch supplies to Russia. No economic calculation was made at all. LPI Rus employers think, “If our company had existed one and a half years ago and producers had recognized our abilities, many subsidiary offices wouldn’t have appeared, because there would have been no need for them”.

However subsidiary offices played a major role moving the Russian market towards a more legal system.


Twice as much

Unlike wholesalers, raid problems and changing for new structures of work almost didn’t have any impact on retailers. However moving towards a legal market also brought a lot of changes into their life.

First of all, the pressure from large federal chain stores on independent stores increased. Due to lower margins a lot of distributors redirected their energy towards developing their own chain stores and were quite successful. Consul is the best example. The company refused to use distributors, and instead opened about ten new stores in different Russia cities during last year. “Though we didn’t face any problems caused by ware raiding, we decided to direct investments from distribution to more profitable and stable retail business. We decided to do this not because of troubles with customs formalities, we are still purchasing watches directly, it was purely based on economic grounds”, says Alexander Konovalov, the President of Consul. The quantity of shops increased throughout all chain stores - Moscow Time, 3-15, Louvre and others. Largest chain stores amounted to about 40 shops. In order to sustain large chain stores, independent shops had to make serious rearrangements of their assortment.

Price shocks, which Russia survived in 2007, became the second outcome of changing to a legal system. On one hand, new logistic structures brought price growth. But on the other hand, many brands changed their priorities to more expensive watches in 2007. Put together, these trends resulted in the average price growth of some brands more than doubling. Retailers were very worried about this phenomenon. Would there be a demand for such expensive watches?

Retailers also had other headaches with different events happening in the Russian market too. First of all – changes in shop types. In the period from 2004 to 2007 a large number of large trading malls were built in the cities. For example, in the last two years, the general floor space of trading centres in Togliatti (one of the largest cities in the Volzhski region) grew three fold! It is clear that the flow of visitors to these shops was proportional and there were less people in each of them.

At the same time rent payment grew in all the cities. In Moscow it went over the shocking price of 10,000 Euros per square metre a year. In other cities, it jumped from 2,000 to 3,000 Euros per square metre a year. Owners of trading centres set a minimum square size for watch shops - not less than 50 to 60 square metres. Employees’ salaries also considerably increased. Many owners of watch shops estimated that the general increase on its business expenditures grew by 30 to 35 percent in 2007 (official inflation was a little less than 12 percent).

Such hardening of external terms made retailers think about their assortment, shop design, the optimization of trading stock and staff training. We may conclude that in 2007 many shop owners were facing a change of consciousness. Before their business worked by itself and demanded a minimum of thought and effort and now retailers take things quite seriously.
In the period since 2006 to 2007 most watch shops faced complete changes. The arrangement of the brands and trading stock of each of them widened considerably. The assortment of shops in general became more expensive.

The period of shipment suspension, when retailers were looking for any goods to put in empty shop windows, lead to considerable strengthening of brands, which hadn’t seen strong positions in the market before. The watch segment with prices ranging from US$500 to US$10,000, where Swatch Group was the only leader for a long time, widened and included Richemont, LVMH and a number of independent brands. More and more shops and boutiques started to appear that targeted the high-end brands. A Breguet boutique and a large, two-level, luxury Louvre shop, covering about 800 square metres, opened in Moscow.

At the same time the cheap watch segment, in which a great number of small shops were functioning two years ago, practically ceased to exist. Importers stopped purchasing watches with FOB prices less than US$10 due to high import duty, and in turn these goods didn’t allow retailers to have a sufficient turnover to cover their rent and expenses. Most shops specializing in such watches either disappeared or started to sell more expensive goods. Alongside the luxury watches were the fashion brands, which turned into a rapidly growing goods category. “Fashion watches became most suitable for consumers of new trading malls. Today they can be considered as a separate market segment”, says George Keeny, the President of Time &Technologies. Shops targeting fashion brand watches became the norm. The quantity of non-expensive Swiss Made watches also increased.

When choosing suppliers, shops began to pay attention to who was working legally and this became the trend in 2007. According to Alexey Roumyantsev, Time Life Co Director, legal business for retailers means safety and strictly scheduled supplies.

Nowadays, Russian shops lack new brands, which are able to attract consumers and help to establish strong positions among competitors. At the same time not all brands can provide profitability to shops. Jewellery, included in the assortment of watch shops, is also one of the growth factors. Unlike Europe, most Russian watch shops only sell watches and sometimes accessories, and very seldom one can find jewellery there.

Breguet Boutique

Motives for growth

But, let’s go back to the figures. What explains such significant market growth in 2007 (49 percent in terms of money and 112 percent in terms of quantity)? Will this outcome be repeated this year?

The first motive of the gigantic growth is personal sector increase. According to official data, retail trade turnover in Russia in 2007 grew approximately 15 percent (and 30 percent according to other sources). Heads of watch companies state that their turnovers grew to the same extent and not more. Demand growth on the majority of goods dealt with established economic stability in the money market. The first provides guarantees on future and stimulates consumer expenses. Besides, the Russians are used to saving and keeping money in USD currency, however the dollar has been decreasing for over a year. The Euro is growing, but no one knows how long this tendency will last. The Ruble is not suitable; according to official information, inflation amounted to more than 12 percent. According to public opinion, prices on most products grew at least 20 percent. Russian banks are not trusted, besides the income they offer is lower than the inflation rate. People were deprived of their investment tools. Having realized that their savings were losing value, they reduced long-term investments and began spending money.

The goods covering warehouse reserve for shops and wholesalers form the difference between 49 percent growth of watch purchases and 30 percent sales growth. After a long suspension of supplies, Russian companies now buy more than they sell. Quite considerable trading stock was delivered to newly opened monobrand boutiques. A decrease of watch shipments in November (-6 percent in terms of quantity and – 10 percent in terms of value to 2006) and in December (-37 percent in terms of quantity and + 8 percent value) shows that the formation of necessary trading stock is completed.

While oil prices are floating at the US$100 a barrel mark and the economic situation in Russia is stable, watch sales will continue to grow. Although it is unlikely that growth rates in 2008 will be as high as in 2007. That is, if import duties remain the same.

New turn

Empty protection
Two years ago import duty did not make a serious impact on the market, because the majority of watches came to Russia illegally. But today it leads to sales drops. Lowering or absolving a duty could be very profitable to the watch market and the state.
According to calculations, lowering or even cancelling a duty would increase the amount of money coming to the treasury from the import of watches. This would happen due to increased volumes of officially imported watches. First, those 50 percent of watches will turn into legal shipments, which are ‘lost’ nowadays on their way from Swiss customs to Russia. Secondly, ‘black’ imports and re-exports from other countries would make no sense. The quantity of watches Russians buy abroad would sharply decrease, resulting in increased tax revenues.
It is common knowledge that there is a reason for everything. Many suppose that it is not possible to achieve the complete abolition of customs duties in Russia. However there are some good examples. Since autumn 2007 duty on import of television sets is zero.

Besides, Russia is a big and unpredictable country. Managers of foreign companies should bear in mind that they also have to deal with Russian laws and tax systems. For example, investigation into the company Sharp and trafficking became one of the most notorious criminal investigations in winter 2007. The economic police put serious pressures on the distributors, trying to make them admit that the Japanese Group had put fake low prices on invoices. This is subject to Russian criminal law. In this kind of situation it is quite possible that the export manager, appropriately serving a Russian partner, will have to stay somewhere in Siberia for a considerable length of time – obviously against his will.

Source: Europa Star, Viacheslav Medvedev