- The first time the Russian watchmaking industry experienced sanctions was in 1770.
- High import duties discourage official imports of cheaper watches.
- In 2014 many retailers started talking about a new crisis and a decline in sales.
- The mid-range sector is now showing mid-range results.
- Watch imports from Switzerland to Russia increased by 70% between 2004 and 2013.
- The state will actively promote the “buy Russian” idea, and we can expect to see an expansion in Russian watch-assembly plants.
- The main result of the current crisis will be the appearance of new consumers.
Exports to Russia are still good, but the mood of retailers is worsening. Where does the Russian watch market stand right now? Where did it come from, and where is it heading?
This year, the economic sanctions against Russia made it a popular topic of conversation in Europe. But this is by no means a new situation.
In fact, the first time the Russian watchmaking industry experienced sanctions was in 1770. The first watchmaking factories were established under the reign of Catherine the Great. Francois Freinet de Fermat was given 6,500 roubles by the Russian state to buy the necessary equipment and find skilled watchmakers in France. At the time, however, the French government had placed a ban on craftsmen leaving the country, so de Fermat and the eleven artisans he hired were arrested, and his tools and machines were confiscated.
The next conflict between Russia and Europe arose at the start of the Soviet era in the 1920s; the Soviet government had decided to build its first watchmaking factory, but European companies refused to sell equipment to Russians. The Soviet Union’s first watch plant did not appear until several years later. Restrictions on sending equipment and technology to Russia lasted throughout the Soviet period, and some were still in place at the end of the 20th century.
I mentioned these examples to remind readers that the economy is always subject to political pressure. If we are to predict what will happen to Russia’s economy and marketplace, it is vital to understand the political situation. I could be wrong about some things, and some of my assessments of the actions of the Russian government could be inaccurate, but I hope this report will help readers to understand the basic trends.
The major thrust of Russia’s political and economic policies over the last decade has been to maintain self-sufficiency, not in order to enforce isolation but to reduce economic dependency on other countries, and to strengthen the government’s popularity. Consequently, most of the decisions we have seen over recent years that affect the Russian market are simply a continuation of the policies established in the early 2000s.
Russian leaders appear to believe that the global economic crisis was initiated in the US, when the economic bubble burst. They have attempted to minimise the impact of the crisis on Russia by protecting their market from its negative effects. Nevertheless Russia’s 145 million population is not big enough to make the majority of its industries profitable. That’s why, as well as pursuing its isolationist policy, the Russian government has also sought market expansion and integration with other countries, notably through customs union.
However, the course to restoring the self-sufficiency of the old Russia, as it was in the Russian Empire and the Soviet Union, was set around 2002. To achieve this goal two elements were essential: resources must be concentrated in the hands of the state, and the country must be made more manageable.
In 2003 the “Yukos affair” hit the headlines. The financial goal of the trial from the government’s point of view was to profit from the oil business. Prior to this the Russian government received almost no income from oil exports because of the Production Sharing Agreement, and because no taxes were paid. In 2003 oil export revenues represented just 15% of total state revenues, rising to 33% in 2004, and 42% in 2005. At the same time, the arrest of Khodorkovsky signalled the departure of oligarchs from government, and the state became more manageable. In the 1990s most goods were imported into Russia illegally, but the clampdown on smuggling did not begin until 2005. The following diagram shows how official Swiss exports to Russia changed beginning in 1999. We can see that in 2007 the export value was 77% greater than in 2004. In reality, sales volumes were not growing quite so fast. According to Russian retailers, the peak in luxury watch sales occurred in 2004–2005, at a time when the majority of shipments were being smuggled into the country. The reason why the peak represents the beginning of the anti-smuggling campaign is that in 2005 a proportion of goods began entering Russia by official channels.
In 2012 the next wave of economy restructuring started. The government adopted a rearmament programme and began to fight corruption, which restricted the consumption of luxury goods. Then followed a process of “deoffshorisation”, along with a crackdown on capital flight and against the political opposition. All of this created frustration among the public and a negative media backdrop.
Now let’s discuss how political processes influence today’s watch market, and how they will influence it in the future.
Russia moved from socialism to capitalism in the 1990s. It was a time of blatant, often illegal, accumulation of capital. Russia’s first rich people – the so-called “new Russians” – were businessmen and gangsters. They had money and ambition, but no experience in consumption. Russian consumers had no idea about brands; they were ready to buy anything just to stand out from the crowd. This situation created unique conditions for the development of many brands in Russia that were almost unknown in the rest of the world.
In the 2000s the typical consumer of luxury goods changed, with corrupt officials and members of the security ministries becoming the main customers, despite having often modest official salaries.
Russians tend to make most of their purchases abroad, and this is not just because of high prices at home. Since the two main categories of buyers purchase goods with money from illegal income, they prefer to buy goods abroad, or through trusted agents. As a result, up to 90% of watches came into Russia via smuggling. This was not a problem for manufacturers, although it did create difficulties for distributors. For example, most brands calculate their advertising budgets on the basis of local sales volume, so these budgets were lower than they should have been.
As a side note, the typical image of Russians abroad, based on visitors to upscale boutiques in Zurich or Hong Kong, does not correspond with reality: fewer than 15% of Russians have passports, which means that 90% of Russian have never been abroad. Around 40% of Russians survive on a monthly income of $500 or less, and cannot afford expensive watches. Moreover, high import duties discourage official imports of cheaper watches, with the result that around 75% of watch sales in Russia take place on the black market.
This is a significant problem, for both the cheapest and the most expensive watches. Russian market volume is estimated to be between 16 and 24 million pieces per year, but only 2.5 to 3 million of these are official imports. Two million timepieces are assembled by Russian companies from imported movements, but components are quite often sourced through illicit channels.
Watch sales in Russia grew during the 1991–2013 period. Even the crises of 1998 and 2008 merely slowed growth a little, and did not lead to any significant changes for the market. In 2014 many retailers started talking about a new crisis and a decline in sales.
Consumption began to decline in 2013 as a result of preconditions formed in 2012, including a deceleration in GDP growth and the strengthening of the state sector, which in turn reduced the income of private business. However, there were also subjective factors affecting demand in various sectors.
The biggest impact on the luxury market was the government’s crackdown on corruption – after all, in most cases people were buying tourbillons with money from bribes. When the government realised that the high level of corruption was a serious threat, it took active measures. These days it is not so easy to accept bribes, and spending “dirty” money has become far more risky.
Over the last two years it has become dangerous to show off expensive watches. Of course, sometimes this just leads to a change in demand. As the head of one watch company noted, “Putin has forbidden officials to wear rose gold, so we now have increasing demand for white gold and platinum.” But the fact is that the consumption pattern for luxury goods is changing.
The second reason for the decline is consumer nervousness. Many wealthy Russians have had their assets in Cypriot banks frozen. The United States’ adoption of the “Magnitsky Act” in 2012, news about the freezing of Ukrainian oligarchs’ assets, and the recent economic sanctions against Russia have shown that it has become dangerous to keep deposits in American and European banks.
As a result, many Russians are trying to transfer assets to Asian countries or repatriate their money to Russia. This process is also being facilitated by the Russian government, which continues its fight against offshore companies.
The v now showing mid-range results. 2011–2012 represented a turning point in demand among the middle classes. The income level of many Russians reached the point where an increase of even twenty or thirty percent no longer brought significant changes to their lifestyle or satisfaction.
Consequently, those who were no longer satisfied with mere consumption began to take part in protest rallies and demonstrations as a way to give meaning to their lives. Their consumption patterns moved towards less flashy and less expensive products, intended not for showing off but for personal pleasure.
A negative mood has dominated among consumers since 2013. Incomes continued to grow – average salaries increased from 26,700 roubles in 2012 to 30,000 roubles in 2013 – but consumption decreased. This was related to, on the one hand, the sharp rise in mandatory payments, and on the other, nervousness. Even at the peak of the crisis in 2008–2009 the Russian authorities continued to claim that the situation was under control, and many people believed them. However, in May and September of 2013, both the President and the Prime Minister officially acknowledged that the crisis had reached Russia, which immediately led to a drop in sales of all types of goods. There is also an opinion that the government welcomed this opportunity to adopt tougher measures, particularly against the political and financial elite, and those who disagreed with state policy.
Interestingly, as of July 2014, Russian banks reported an increase in personal savings, which suggests that people have disposable income but prefer not to spend it. At the same time some sectors, such as cinemas and computer games outlets, continue to grow.
One of the causes of the negative mood among consumers was expressed by former finance minister Yevgeny Yasin, who claimed that since 2000 incomes had grown far in excess of the economy. Now, as the ratio returned to normal, people felt as if their quality of life was declining.
Although retailers have been talking about a crisis since last autumn, the volume of imports into Russia is still growing. One of the real reasons for retailers’ complaints is a surplus of stock. Watch v increased by 70% between 2004 and 2013, while over the same period the number of specialised watch stores increased threefold.
A simple calculation shows that the turnover of each store can be expected to halve. Moreover, the business is starting to becoming concentrated in the chain stores and monobrand boutiques. More than 40% of watch stores are owned by the 25 largest operators, each of which holds from 10 to 65 stores. Last year, Richemont built its own dedicated shopping street in Moscow, and is now no longer dependent on retailers. Thus, the turnover of independent shops can be expected to decline further, despite growth in the market as a whole.
Most outlets in Russia are located in shopping malls, where cookie-cutter shops stock a virtually identical brand portfolio. This inevitably leads to price competition and makes retail business unprofitable.
The second wave of the crisis hit the Russian watch market in 2014. Although it is frequently associated with events in Ukraine and economic sanctions, the real situation is more complicated, with evidence of both negative and positive effects.
• There has been a general decline in consumer demand in Russia, estimated at 5–30% across different sectors. The main reason for this is the mood of uncertainty, not income levels. While small and medium businesses experienced a real drop in revenues and have been forced to lay off employees, state companies continued to increase expenditure and salaries. As a result, the average salary grew in the first half of 2014, albeit more slowly than before. Personal savings also grew. Some retailers are saying that their revenue now depends on the news: a peaceful day in Ukraine will translate into better sales.
• The Olympic Games in Sochi and the annexation of the Crimea led to a rise of patriotism, which will be an important factor in the years to come. Many Russians feel nostalgic for the USSR; they remember it as an era of high social welfare and confidence about the future. They are the ones currently running the country, and are trying to bring back the best features of the socialist past. A rise in patriotism is likely to make Russians more tolerant of a slight drop in living standards and the narrowing of the market. At the same time we can expect a change of attitude towards money and luxury goods: Orthodox Christianity and 70 years of socialism have laid the foundations for a negative perception of wealth. The privatisation of the 1990s is still seen as a gross injustice in Russian society. We can expect to see a change in consumer attitudes towards foreign goods and the tightening of state import controls, up to the point where Russia may withdraw from the World Trade Organisation (WTO).
• The crisis in Ukraine has also brought with it some positive effects: some researchers suggest that it could increase Russia’s GDP by 3% or more. Russia will benefit by shifting orders from Ukraine to domestic plants, revitalising agriculture and industry, reducing smuggling, accelerating modernisation and developing its own independent financial market. Lastly, more funds will be spent within the country rather than abroad. As far as the watch market is concerned, the crisis has certainly created a negative mood. But on the other hand, there are some advantages. Ukraine has traditionally been a source of smuggled goods into Russia: in some years, import figures for certain goods into Ukraine have equalled imports into Russia, despite a wide variance in the capacities of the two markets. This year many distributors note that the decline in consumer demand has been offset by the disappearance of smuggling, resulting in no decline in sales. This summer the number of Russian visitors to Europe dropped by 40%. This, combined with many watch brands’ decisions to equalise prices between Europe and Russia, also supported domestic demand. Industrial output in the April–July period increased by 1.5%. As a result, the demand for watches is growing in a number of industrial cities.
Watch imports into Russia continued to grow up to the end of July. The fastest-growing category was watches with an export price of over 1,500 euros (which translates to a retail price of 4,000+ euros). It is difficult to say whether this reflects a real trend in demand or not, as the increase is partly a result of the rise in official transactions and a reduction in smuggling. Another reason is that some major brands are trying to increase the stocks of their Russian subsidiaries.
What can we expect from Russian market in the next year or two? In all probability, there will be a drop in both income and demand. This will affect the luxury sector far more than the mass market, as the state will try to prevent a serious fall in the standard of living of the general population.
The state will actively promote the “buy Russian” idea, and we can expect to see an expansion in Russian watch-assembly plants. The strategy of rebuilding the manufacturing sector will force the government to promote a new set of values: creation rather than consumption, something that watch brands would do well to note when it comes to devising their marketing strategies.
The greatest changes can be expected in luxury goods and “status symbols”. A significant proportion of past buyers will drop out of the market: some will encounter business difficulties, some will be forced to adopt a low profile as they dodge anti-corruption campaigners, and some capital owners will leave the country. The rest will start buying more simple and less flashy goods. The drop in demand will force brands to concentrate on their own boutiques, making many retail stores unprofitable.
Foreign purchases will decrease: fewer Russians will keep money abroad and the number of foreign trips will decrease accordingly. VISA has already noted a fall in purchases from Russia. Companies interested in selling goods to Russians will be forced to develop their presence in Russia.
Well-known brands with effective advertising will suffer less, while new, unknown products will find it much more difficult to break into the market.
Most experts do not expect a major upheaval in the Russian economy. The structure of the industry, exports and foreign exchange reserves will help to reduce the negative fallout. However, some observers feel the next few years will be psychologically difficult for Russians. While we have become used to dramatic boom/bust cycles, we now face a slow decline and accompanying loss of perspective. The low plateau into which we are heading is new to us, and may be worse than the sharp shocks we have experienced previously.
Who will be the main consumers over the next one to three years? Just as consumer profiles in the 1990s were different from those of the 2000s, the main result of the current crisis will be the appearance of new consumers.
For example, although the ban on food imports from the EU has seriously affected many companies, it has opened up new opportunities for Russian farmers and importers from the BRICs nations. In six months’ time they will have collected their earnings, and will be looking for new, more prestigious cars, apartments and watches. An increase in orders for Russian industry has already led to an increase in demand for industrial workers. Salaries in certain professions have risen from $1,000 last winter up to $3,000 by the end of the summer. These people will be new consumers too.
All this means that brands should not stop their advertising and marketing activities. To have a good business in a year or two, it’s important to prepare the ground today.
Source: Europa Star October - November 2014 Magazine Issue