Amidst the exodus of foreign companies and retailers from Russia, the biggest worry for the country is that the state-capitalist model that the Kremlin has championed, in which official cartels control the commanding heights of the economy, is extended to the retail sector.
Amidts the 2014-2015 crisis, Russian car market faces economic woes. Pictured: Assemblage shop of SsangYong's New Actyon crossover, based on the C200 concept car. Photo: RIA Novosti
While macroeconomic indicators seemed to be bouncing off their lows from December, this past month has brought more depressing economic news from Russia, although this time from the retail side. In February, Adidas halted plans for expansion in the country and is likely to shutter 200 stores throughout Russia by year’s end.
Compounding this news was the announcement in March by Finnish retailer Stockmann that it was closing 60 percent of its stores in Moscow, while fellow Mega-mall tenant and Swedish icon Ikea is pulling its online magazine over fears of running afoul of Russia’s stringent anti-gay laws.
This latest wave of retail withdrawal comes on top of previous exits from the Russian market at the end of last year, with fashion outlets such as Esprit and the UK’s high-end River Island pulling out even before the macroeconomic collapse in December.
What is behind the most recent exodus of retail outlets from Moscow? And what are the implications for Russian consumers?
The first and perhaps most obvious culprit for these recent exits is the collapse of the Russian economy from stagnation into recession. Given the disparate nature of the foreign retailers and producers who are leaving or scaling back business, it is undeniable that Russia’s economic predicament is causing such a broad swathe of companies to retreat from Russia.
While the immediate danger of a catastrophe for the Russian economy has passed somewhat from the dark days of December, the structural weaknesses throughout the country continue to leave the economy fragile. The collapse of the ruble, touted in some circles as a way to spur Russian exports, also leaves industries heavily dependent upon imported inputs relatively disadvantaged. One of these industries is the automotive industry, hugely affected by relative price differences. Even heavy hitters in the Russian market such as Korean automobile producer SsangYong have seen plummeting sales over the past year, with SsangYong taking the unprecedented step of halting exports to Russia in January after sales plummeted by 41 percent.
And, consistent with the import-dependent nature of the automobile industry around the world, the ruble’s issues are not limited to hurting foreign producers: Russia’s largest producer, AvtoVaz, saw losses increase nearly four-fold in 2014 to $406 million. The company noted that this was due to the fact that 20 percent of the production cost of its Lada models is comprised of imported components.
In tandem with the overall macroeconomic situation, the continuing issue of Russia’s poor business environment has also reared its head. The difficulty of doing business in the country has already been discussed elsewhere at length, and is nothing new; that is, a poor investment climate already existed two years ago, and Ikea has been threatening to leave Russia for the past six years.
The investment climate cannot solely be to blame for the current exodus of foreign companies. But if considered jointly with the poor economy, volatile price swings, a shrinking market, and political pressure, the poor business environment does not facilitate the desire of a multinational to remain in Russia. In this sense, the continual need for licenses, permits, signatures, and stamps may represent a hurdle too high in an environment where profitability isn’t guaranteed.
Of course, there are also industry- and firm-specific causes behind the recent wave of exits from the market. To return to the automobile industry, Russian demand for cars has been far below what analysts were forecasting just three years ago, in line with a general slowdown in car sales in emerging markets more generally. According to a report by industry analyst Roland Berger, the predicted number of cars sold in Russia by 2020 will actually be 18 percent less than predicted in 2012, due mainly to sluggish internal demand.
This poor performance has led General Motors to pack up its Opel brand and most of its Chevrolet line, leaving the country for good in line with a broader reappraisal of global its investment strategy. At the same time, however, other producers are continuing with their plans, with Ford and Volkswagen (according to RT) holding firm in their investments and perhaps poised to pick up some of the market share that GM is leaving behind.
Silver lining in the recession
This simple fact, that some firms are staying while others are leaving, may prove a clue to effects (both positive and negative) that this recent turnover in the Russian market may have for the economy. As economist Joseph Schumpeter correctly pointed out 70 years ago, the "process of creative destruction is the essential fact about capitalism," weeding out failing companies via competition and leaving firms better suited to serving customers in their place.
Competition globally, and not just in Russia, could be a reason why GM is leaving and Ford is staying, and this can only benefit the Russian market. Similarly, the withdrawal of loss-making entities may result in a welcome reallocation of capital and labor throughout the economy, as resources move to higher-value uses.
Seen from a nationalistic standpoint, as well, the scaling-back of foreign companies might provide a boon for Russian companies if they can fill the niche. The Western companies that are present in Russia have already proved that there is a market for high-quality athletic apparel (Adidas), modular furniture (Ikea), all-in-one stores (Stockmann), and the like. If Russian firms can achieve the same level of quality as these firms at competitive prices, they may be able to capture some of this demand and substitute Russian brands for international ones. This may also provide a boon to the job market, which has been reeling of late, especially at the lower-skilled end (whose workers have already taken a hit in terms of employment opportunities).
Drawbacks from foreign companies leaving Russia
However, there are many drawbacks to the withdrawal of foreign capital and know-how. In the first instance, there is no guarantee that Russian firms can benefit from the vacuum that is opening, from either the supply or demand side. In terms of supply, as noted above, relative price changes may make imported inputs difficult to come by, meaning Russian firms are in the same boat as Western ones.
And with external capital markets drying up as a result of political risk, Russian firms will have a more difficult time accessing the money needed to expand. Similarly, even if the funding can be found, Russian firms have excelled in providing an alternative to Western brands, not a supplement. Reorienting production lines for higher-end tastes may prove difficult in the short-run.
From the demand side, as well, there is little guarantee that Russian firms will have a niche to fill. Given that the main reason that companies are leaving has to do with the profitability of the Russian market, the continuing recession does not inspire confidence in future retail growth.
Indeed, consumption was the one thing driving Russian GDP growth post-global financial crisis, and with the entire economy facing difficulties, it is less likely that Russian consumers will have the same disposable income to drive demand for goods. Thus, not only Western firms but also some of Russia’s demand may also be leaving the country for the long haul.
For the longer-term, the deleterious effects of a Western withdrawal may escalate. This is especially true, given that Western companies were instrumental in introducing some business practices to Russia after the collapse of Communism, including the creation of a customer service-driven ethic.
Despite strides in Russia in technology-driven sectors such as bio-pharmaceuticals or software, retail and the point of interaction with consumers still remains a weakness. Other know-how and technology, especially related to managerial acumen, is also lacking in Russia, and Western firms are world leaders in this area. Their exit from Russia means a generation of Russian managers no longer has access to these practices.
Yet, despite all of these drawbacks, on balance it seems preferable that Western firms remain in Russia. Of course, this is dependent upon Russia’s economy recovering, which is in turn dependent upon deep structural changes and Russia abandoning its current policies of intervention in Ukraine.
If the current trend continues, the biggest worry Russia may have is that the state-capitalist model that the Kremlin has championed, in which official cartels control the commanding heights of the economy, is extended to the retail sector. This “socialism with a capitalist veneer” could leave Russians wondering how they returned to the late 1980s in such a short time... and why they can no longer find Adidas tracksuits in stores.
The opinion of the author may not necessarily reflect the position of Russia Direct or its staff.