The Russian market - paying more attention to retail sales

November 2008

Following a very successful 2007, the export of watches to Russia seems to have come to an abrupt halt. What is going on and what can we expect to happen in the Russian market?

After the supply crisis of 2005-2006, Russia made a considerable jump in 2007 with a gain of 49 per cent. However the period from January to July 2008 was unfortunately far less exciting with an eight per cent growth in revenue and a seven per cent decrease in quantity. This is what most people would consider to be stagnation. So what happened? Did Russian consumers suddenly stop buying watches?
No, of course they didn’t. They are still buying and will continue to buy in the near future. With oil prices at around the US$100 a barrel mark, a considerable amount of money is rolling into Russia, which will partly be spent on watches, jewellery and other luxury goods. However, demand is unstable, which is explained by the following factors: Russia's health is predominantly based on its natural resources, and like in other countries where the economy depends on the export of raw materials, the income of the Russian people differs drastically. While Russia’s oligarchs are purchasing lavish houses and palaces throughout Europe, expensive cars and yachts, the majority of the population doesn’t earn more than US$500 a month.
It is this minor group of super-rich people, which usually helps watch companies meet their sales plans. However, the recent South Ossetian crisis, the predicted slump in Moscow’s elite property market and the growing concern regarding the global financial situation haven’t exactly put people in the mood for shopping. There is a need for positive change and more stability in political and economic arenas.
Demand among those who belong to the middle classes is different. On one hand, inflation prevents people from saving and stimulates them to spend their money on items such as watches. However, on the other hand, even if their income is growing faster than inflation, so are their expenses, leading them to pay more attention to the price of goods, especially those that they are used to buying. But it also depends on a changed consumption model towards more expensive goods and services and a wider range of services. Prices on property increase 20 per cent a year and are one of the highest in the world. Cars in Russia are twice as much as those in the United States. Analyzing his or her budget, a person surprisingly finds out that in spite of a growing salary, he or she doesn't have enough money. Hence, in spite of constantly increasing salaries, the middle classes buy fewer watches than the rich.

Investing in watches
Income and demand are macroeconomic factors and do not depend on manufacturers or sellers. Retail operations rely heavily on individual watch market operators, which have the greatest impact on sales. So what has been happening in Russia these last two years?
Growth and development of the watch market in Russian cities can be seen everywhere – shops are popping up by the dozen, the interiors of existing shops have been improved and the assortment of watches considerably widened.
The supply crisis of 2005-2006 was followed by an astonishing sales growth in 2007: wholesale companies renewed imports of watches due to a strong demand on goods. 2007 was a happy year for wholesalers as almost everything they brought was immediately sold. Russian monthly growth rates for the period January to April 2007 over the previous year were 124 per cent, 160 per cent, 106 per cent and 235 per cent!
Retailers’ appetite for watches is not a direct result of demand, which hasn’t increased that much, in fact shop owners estimate the demand from final consumers to be no greater than 25 to 30 per cent. The vast majority of watches delivered to Russia over the last year and a half went to fill new shops.
Over the last two years the number of Swiss watch shops grew about 20 to 30 per cent. But, again, it was not a result of increased demand, but rather due to the fact that the commercial real estate market was more attractive for such developments. Gigantic new shopping centres attract buyers, who now seldom go to old shops.
Alongside quantitative changes we have also witnessed qualitative ones. Visitors to the big shopping centres are often fashion orientated and brand conscious, resulting in a higher demand for fashion watches compared to the more classical models.
Competition among watch shops has lead them to invest in upgrading: increased shopping space, a wider assortment of product and better interiors and equipment. Four years ago, 30 to 60 square metres were the norm for a shop floor, now most shops have 50 to100 square metres, and sometimes as many as 300 square metres. Investments into design and equipment have been astounding. For example, the stunning interior of the Cleopatra boutique, located in Volgograd, cost over US$1.4 million to refurbish. In addition to the increased size of shops, the range of the collections on display has also been expanded.


Business cost
In 2007 the official rate of inflation was 11.9 per cent. However, this figure doesn't reflect the business costs of running a watch shop. Let's analyze the situation.
Rental payments grow 30 to 70 per cent every year. Rental payments in the popular shopping centres and malls of Moscow multiplied by one and a half in the past year alone and exceeded US$7,000 per year. In other large cities there are fewer buyers than in Moscow and they don't have as much money. Two or three years ago one square metre in the most expensive places cost US$300 to 400 per year. Now rental payments that amount to US$4,500 per square metre don’t seem exorbitant.
Salaries generally depend on the state. A civil servant’s salary grew from 30 to 40 per cent in 2007 and so did the list of privileges. Therefore, businesses had to increase expenditures for their staff’s salaries by over 50 per cent. Most services also became more expensive - security, advertising and so forth.
Therefore, the increased expenditures of a shop during the last year may amount to 50 to 60 per cent. Although it is important to note that the figures only include growth of direct expenditures and do not reflect other factors, such as price growth of trade stock, expenditures on upgrading of equipment and so on.
At the same time watch shops are facing a decrease in their margins. New logistic structures and the opening of expensive Russian subsidiaries have resulted in increased expenditures. In addition to the fact that retail prices are 30 per cent higher than in Switzerland. Some manufacturers set lower recommended prices especially for Russia in order to avoid price differences with Europe which can be as much as 15 to 20 per cent in comparison to the Swiss price. This also results in lower margins for shops. If retailers were receiving watches from a distributor before, with 50 per cent discount off of the retail price, now the discount amounts to between 30 and 40 per cent.
Moreover, watch manufacturers have reduced the number of shops selling their goods. They justify this cut by saying that they have too many points of sale and not all of them correspond to the brand image. Two years ago Tissot had over 400 points of sale nationwide; now according to the company's plan, there are between 150 and 200, with a maximum of 250 points of sale. Omega was available in 39 shops in Moscow, whereas now there are only 10 left. These cutbacks have turned out to be a shock for many retailers, because these brands were the core of their business.
To sum up, watch sales in Russia are generally increasing, but if we take into consideration growing exports and the escalating number of shops, increased investments and expenditures, we will see that watch retail trading has considerably lowered.
The ‘brave’ and the ‘careful’
When market growth and profitability decrease come together, retailers are divided into two major groups - the so called ‘careful’ and the ‘brave’. The ‘careful’ ones target maintaining positions and saving clients, while the ‘braves’ strive to occupy new positions and increase their client base.
Among the ‘careful’ there are Consul, Louvre, Mercury, Moscow Time and other large chain stores. They have been in the market for a long time and have famous brands in their portfolio. These companies are not rushing after brands. The basis of their business comes from clients that they have looked after for many years. Their main task is not to lose their position. They carefully examine risks, including financial crisis problems, changes in currencies, bankruptcy of a certain trading centre and so on. Their position is that they have enough stable clients and are strong enough to sell any goods. It is for this reason that they choose brands that bring the most profit and not necessarily the most famous names in Russia.
These ‘careful’ retailers refuse new projects if the risk of failure is high or if the profitability is insufficient. Such policies result in reduced orders for the traditional brands, which are often more expensive and less interesting from a margin point of view. This creates opportunities for new, unknown brands in the market. It is easier for retailers to offer a customer a new exclusive brand, than to explain why a well-known brand became two times more expensive. Moreover, they have really good clients, which are often open to something new.
In the ‘brave’ camp are new and developing retail companies with no big clients of their own. Famous brands are of utmost import-ance to these retailers in order to attract new customers. The ‘brave’ are happy to sign contracts with famous brands in spite of non-profitability. It is these companies that compensate for purchases that were declined by old partners.
Business results will not be available for a year or two, until then the shops will not be able to make a profitability analysis and we will have to wait and see which of the two strategies was the best. There was a time when to be ‘careful’ was also to be ‘brave’, but that strategy has changed.


A country of chain stores
It is clear that the figures only highlight the general situation of the market. The profitability of a company depends on many different things: ability to find and train staff, obtaining better locations in trading centres and attracting investments. It is these factors that form the dynamics for development of each market participant. Here chain stores and regional shops, belonging to big local holdings, occupy the best positions. These two categories of market participants are showing the largest growth rates.
From hundreds of market participants, Russia is turning into a market of chain stores. The largest Federal companies (Moscow Times, Consul, 3-15) own 30-50 stores all over Russia. There are some cities where there are local chain stores with 10-20 shops. During the last two years some of these companies have been expanding to other territories too. For example, companies from Novosibirsk have shops in Omsk and Barnaul, companies from Rostov have expanded to Krasnodar and other cities.

The problem of monoboutiques
Monoboutiques have become very popular during the last two to three years. Breguet, Chanel, Omega, almost all of the Richemont brands, as well as many others, now have their own boutiques in Moscow. Maurice Lacroix, TAG Heuer and Seiko have also announced the forthcoming opening of their own boutiques. Unlike chain stores with their commercial objectives, monoboutiques appeared because of marketing targets and the am-bitions of watch manufacturers. There are rumours that only a couple of these monoboutiques in Moscow are actually profitable. This fact is obvious when you do the maths - if we count the cost of rent for 100 to 300 square metres in downtown Moscow, we arrive at a sum of US$1.5 to 5 million per year. So the question is, how many brands are supplying the Russian market with over US$10 million of product?
Manufacturers state that boutiques are not commercial projects, but marketing instruments, targeted at creating brand image. Perhaps it is true. However, in my personal opinion, the establishment of these monoboutiques hasn’t had an enormous impact on brand image. And what will happen if the boutiques are forced to close? It is surely just a question of time, unless the company is willing to bear constant losses in its shop.


Strategic success
Speaking of retail, we constantly mention the mighty manufacturers and how they have been influencing the situation in the Russian market. Manufacturers are mostly aiming for total retail control and strategic success. However they are making mistakes that are not only no good for retailers, but could in the long-term, prove disastrous for manufacturers themselves. For example, manufacturers have been reducing the number of retail points of sale, for reasons of improving brand image. But, will they be able to reach their goals? Perhaps they will. Some shops really have increased their sales of brands such as Tissot and Omega. But decreasing the number of outlets does not increase sales for all shops.
Negative results are already becoming evident. Hundreds of shops with unsold stock are currently having a hard time. It is almost imposs-ible for them to turn the money invested around, taking into consideration the fact that they cannot even advertise the goods. My intention here is not to protect retailers, business is business, and everybody has to solve his own problems. Let’s just say that shops will be obliged to find other ways of moving their goods, such as via the Internet. Shop staff may end up with a negative attitude towards the brand and transmit this to their customers. Taking into consideration the fact that there are hundreds of such shops, the consequences could be huge. The situation could become so sour that it would be better for a brand to buy back the goods rather than be submitted to such negative advertising.
Another negative consequence is the decrease of brand penetration in the market. This is inevitable due to the fact that shops are looking for new brands to fill the empty space. Active promotion of corners and shop-in-shops is also a questionable matter. Manufacturers put pressure on the stores to carry their shop-in-shops for better visibility and increased space, but it isn’t always in their best interest long term - for two reasons. Firstly, the shop isn’t affectively using its space, and secondly, the interior design of the store becomes a mish mash of different display units, which are not attractive to the consumer. Over time, these two factors can easily result in reduced sales and even the closing of a store, resulting in the manufacturer losing a point of sale, which is obviously not the aim of the manufacturer when pushing for a corner.


After sales regulations
Subsidiaries have the most serious problem of all - after sales. Russian consumer law is rather strict, if watches are not repaired within 45 days, the shop must return the consumer’s money and pay him compensation. Hardly any manufacturers are footing the bill for repairs under guarantee. It is the retailer who must repair the watch, but it is not always easy as receiving spare parts is also problematic. For this reason it is often impossible to repair watches in time, and retailers have to bear all expenditures for goods of inappropriate quality.
One of the benefits of opening branch offices is to assist the points of sale. Retailers clearly prefer to work with subsidiaries than with dealers. However, sometimes it is more reasonable to work with distributors due to the expense incurred by having an office. In addition to the fact that it is extremely hard to find qualified specialists in Moscow whose salaries are often higher than their counterparts in Europe. All these expenditures influence the price of goods paid by the retailer. Consequently, subsidiaries sell watches to Russian retailers at the same price a buyer may pay in a shop in Dubai or Geneva. It is therefore hardly surprising that more and more suitcase traders are appearing on the market, supplying watches directly to buyers in order to avoid customs and Russian shops. So instead of a so-called grey market, a black market is being created.
Manufacturers often say that shops are the most important factor of success, that they are not only a money source, but also an advertising tool and feedback channel. Things may look good from the outside, but Russian retail is facing hard times and needs support. If manufacturers will provide support, they will be rewarded in a year or two when the market stabilizes. If they pressure too much, we'll see dozens of closed points of sale. Such an outcome can hardly be called a strategic success for any brand.
The slow growth rates from January to July 2008 may at first seem worrying after the record performance in 2007, however the situation is stable. The market is just simply congested with goods. The good news is that even if things aren’t as dynamic as many people would like them to be, watches are still selling, which is the name of the game after all!

Source: Europa Star October-November 2008 Magazine Issue