Changing to legal market

Big blind-spot

Russia is customary considered one of the most important and perspective markets. However if you ask any export manager what he knows about Russian market, I assure you, his answer won’t be big enough. Unfortunately, nobody in the world has a full and objective idea on Russia as a watch market.

In order to hold a confident talk on market one must have figures. According to Swiss customs, about 360 thousand watches to the amount of 296 million CHF were imported into Russia in 2007. That shows 112 % quantity growth and 49% volume growth compared to last year. At that in 2006 export was targeted to expensive models (in some periods average watch price in invoices was 2000 CHF), and in 2007 the average price was 780 CHF. That means that shipments of both expensive and cheap models were restored. Having such figures in disposal our imagined export manager is happy getting his bonuses.

However if we judged his salary according to Russian customs, he would die from hunger: Russian customs registers less than 50 % of watches sent from Switzerland to Russia. Some would say: that’s no good! And that is true. On the other hand, those saying “Great progress!” will also be right due to the fact that only 2 years ago Russian customs registered 10% of Swiss. The cheaper watches segment was facing even worse situation. Only empiric analysis is possible here: before 2006 there’s no certain data on middle and low market segments.

The most expensive watches

Russian companies were unwilling to declare the goods some years before due to complicated customs procedures and high customs duties (20 % duty and 18% VAT). These payments result in 20-40 % more expensive price compared to Europe. That shows that Russia is not just one of sales leaders of expensive watches. This country has one of the highest prices on watches in the world.

Such a considerable price gap is especially noticeable on expensive watches and, thus, stimulates consumers to buy watches during trips abroad.  That explains the fact that it is necessary to have Russian-speaking stuff in watch shops Turkey, United Arab Emirates, and Germany. Some brands, not having any distributors or shops in Russia, willingly place advertisement in in-flight magazines of Aeroflot and other companies, flying to Russia.

“We’ve got a lot of examples when customers are not willing to buy expensive watches in Russia. They explain it by intending to do it 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 cheap watches is minimal because customs duty is 3 Euro per watch. This results in abrupt price growth of the cheapest produce. For example popular and not expensive Q&Q become more than twice more expensive after customs procedures.

All these reasons bring out illegal import. Even information from Switzerland doesn’t completely reflect the demand on watches in Russia. In addition to official and semi-official channels part of the watches are still delivered to Russia illegally. Re-export is especially considerable from CIS countries and UAE. In 2006, when all official shipments of watches to Russia were suspended, there appeared Tissot models with price in Ukranian hryvnas in Russian shops.

There’s no information on the exact volumes of such shipments, however they are still impressive. So, according to some estimation, about half Ulysse Nardin watches which had been delivered to Turkey are then reexported to Russia. 

Another disadvantage for legal export is complicated customs procedure. The paperwork might take several weeks and even the slightest mistake in delivery formalities made by sender-company may bring to the arrest of delivery. For example, if our export manager makes up his mind to give a present to his Russian client and adds to the declared delivery some bonus box or display, the Russian partner will have serious reasons for being sad instead of being happy: non-declared goods may become a reason for opening a criminal investigation.

Player № 1

So, what happened and what brought to growth of market and figures, registered by Russian customs in 2007? Did customs duty decrease and formalities become easier? No, they didn’t. The reason is high pressure from the state in 2005-2006.

It’s not a secret that in the middle of 90-ties state and business in Russia lived separate lives. Huge taxes and constant legislation changes brought companies to making their business shady. In 2000s alongside with central authorities strengthening, the state started to impose pressure on business through paying taxes and first of all customs duties.

Mercy of security ministries, often breaking law and lining pockets, joined the state policy. Under pretext of criminal investigation on smuggling or anything else, militia confiscated and sold huge supplies of goods at cut prices. This phenomenon got the name “ware raiding” in Russia.

There wasn’t a single company, regardless the extent of its transparency, feeling confident at that time. That was also true for alcohol, meat, household appliances and computer sellers. Confiscation of large shipment of Motorolla mobile phones in summer 2006 became the most notorious case. Only American company’s complaint to George Bush and his personal conversation with Vladimir Putin helped to bring the goods back to the owner.

Watch companies weren’t an exception. Distributors took the bulk of impact upon themselves. In the period since summer 2005 up to summer 2006 their activity was mostly paralyzed. The process turned out to be very painful and nervous because non of watch dealers knew who’s next. Regardless the fact if the wholesaler was small or big or had legal or illegal business – any moment he could have become the raid victim. Logistic structure was stopped; goods on considerable amounts of money were confiscated from some companies. In order to have not even guaranties, but at least the slightest hope for protection, distributors turned to legal logistic structure. And that resulted in almost complete change of Russian watch market.

New leaders

Most significant changes took place in wholesale level. Change for legal logistic structure demanded time from distributors. Still having significant expenses on rent, stuff and so on, they were deprived of goods and inflow of money. New business structures brought to considerable growth of cost price and decrease of profitability of wholesalers. Owners of some companies decided to remove money from risky and low profitable business.

Rebuilding business of old and partly deplete 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 logistic structure long before the crisis, managed to keep and even strengthen their position at the market. The best example here is Time&Technolgies, which is the leader of fashion-watches 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 in new background, that’s why they’re using legal business structures. They got contracts on distribution of many popular brands in Russia.

The example of LPI Rus Company is of utmost interest here. It is the first case of European Distributor Company coming to the Russian market. Due to the fact that LPI Rus head office location is 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, having perfect knowledge of Russian market and huge trade experience. That 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 have legal business in Russia. Yes, this is much more difficult than in any other country, but is still possible” – Mikhail Kasparov describes the situation.

Representative offices

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

It is clear that not all companies opened offices due to supplies crisis. Swatch Group sales in Russia increased to such an extent that its office would be opened anyway. The crisis just accelerated the process. Richemont established its office in Moscow more than 5 years ago, but the crisis imposed a great impulse on brands development of the Group. Whereas before Richemont brands were on sale only in Moscow and 3 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 minimum and Jaeger-LeCoultre achieved the best result having its sales twice increased. The number of employees in Richemont office grew almost twice. The success of the Group is explained by 3 factors: absence of goods from other suppliers, growing demand on expensive goods and shop owners concern due to expansion of federal chain stores.

However, the examples of Richemont and Swatch Group are still the exceptions of the rule. Other representative offices do not deal with sales, they function as marketing offices. Some companies have mixed distribution structure in Russia: a brand has a distributor and at that, avoiding it, delivers goods to one or several retail chain stores. And the office of the company is dealing with marketing.

Seiko shows the most interesting example, having only one person representing the company in Russia, and at least 3 new business plans offered during the past year. Initially Seiko worked only through a distributor. Then it declared it’s going to supply watches through its representative office and a distributor at the same time. Not having brought this program into effect, in addition to supplies to the distributor the company began to make deliveries to two chain stores, which are not playing the key part at the market and not generating any considerable sales volume. Of course, such a mess has a negative impact on promotion and reputation of the brand in Russia. Seiko has enough problems beside this: Russia belongs to German office activities of the company, and the Russian distributor doesn’t get the goods popular here, but the scraps not sold in Germany.

Brands use structures of many levels, which is explained by a number of facts. Sales office demands quite different resources than marketing one. At least, there’s 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 peculiarities of working at watch market, which results in a great quantity of mistakes. Warehouse servicing demands money and is risky to the same extent as distributors are facing: checks, dealing with law enforcement authorities and so on. All that implies money and there’s no guarantee that investments will be covered by sales. Partial transfer  of functions for  outsourcing prevents some problems, but also creates other ones. Thus, Swatch Group uses outsourcing structure for warehousing. However the fact that warehouses are not equipped for storing watches, brings to significantly low service level. And that in its turn undermines the company’s image.

 Time will show if the structure of many levels, used by some brands, is justified and economically viable. Some consider it the right way. Others state that in many cases representative offices are not economically effective. A lot of representative offices appeared due to emotions, when it seemed to be the only way to establish watch supplies to Russia. And no economic calculation was done here. LPI Rus employers think : “If our company had existed 1,5 years ago and producers could have realize our abilities, many representative offices wouldn’t have appeared, because there would have been no need in them”.

However representative offices had a great part in changing for legal Russian market.

Twice as much

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

First of all, pressure of large federal chain stores on independent stores increased. Due to lower margin a lot of distributors redirected their force to developing their own chain stores and were quite a success. Consul is the brightest example for that. The company refused using distributors, and instead opened about 10 new stores during last year in different cities of Russia. “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. And we did like that not because of troubles with customs formalities. We are still purchasing watches directly. It had purely economic grounds under”, 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 amount about 40 shops. In order to sustain large chain stores, independent shops had to make serious rearrangement of their assortment.

Price shock, which Russia survived in 2007, became the second outcome of changing to legal market. On the one hand, new logistic structures brought to price growth. On the other hand, many brands changed their priorities to more expensive watches in 2007. Taken together, these trends resulted in average price growth of some brands more than twice. Retailers were much worried about this phenomenon: will there be a demand on such expensive watches?

Retailers got much headache with other events happening on Russian market. First of all – changes in shop types. In the period of 2004-2007 a lot of large trading malls were built in all cities. For example, for the last two years the general floor space of trading centers in Togliatti (one of the largest cities of Volzhski region) grew three times! It is clear that the flow of visitors in these shops arranged proportionally and became less in each of them.

At the same time rent payment grows in all cities. In Moscow it went over the shocking price of 10 000 Euro per square meter a year. In other cities, where personal sector is much lower, we can often have 2 000 – 3 000 Euro per square meter a year rent payment. Owners of trading centers set the minimal square size for watch shops: not less than 50-60 square meters. Expenses on salary to employers considerably increased. Many owners of watch shops give estimation of 30-35 % general increase on business expenditures in 2007 (official inflation is a little less than 12 %).

Such hardening of external terms made retailers to think on the assortment and shop design more carefully, optimize trading stock and stuff training. We may conclude that in 2007 many shop owners were facing a change of consciousness.  Before their business worked by itself and demanded minimum of thinking and working over it, and now retailers take it quite seriously.
In the period since 2006 up to 2007 most watch shops faced complete changes. The arrangement of 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 didn’t take strong positions at the market before. Watches segment with price arrangement from 500 to 10 000 $, where Swatch Group was the only leader for a long time, widened and included Richemont, LVMH and a number of independent brands. There appear more and more shops and boutiques targeted at high-level  brands. Breguet boutique and large two-level luxury Louvre shop, which is about 800 square meters, are also opened in Moscow.  

At the same time the segment of cheap watches, in which a great number of small shops were functioning 2 years ago, practically ceased to exist. Importers stopped purchasing watches with FOB price less than 10 $ due to high import duty, and in its turn this goods doesn’t allow retailers to have sufficient turnover for covering rent expenses. Most shops specialized in such watches either disappeared or started to sell more expensive goods of high quality, first of all fashion watches.

Alongside with luxury watches fashion brands turned into rapidly growing goods category. “Fashion watch 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 targeted at selling only fashion-brand watches became a norm. Quantity of not expensive Swiss Made watches also increases.

When choosing the supplier, shops began to pay attention if its activity is legal. And that became the trend of utmost importance in 2007. According to Alexey Roumyantsev, Time Life Co director, legal business for retailers means safety and strictly scheduled supplies.

Nowadays Russian shops are lack of 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 growth factors. Unlike Europe, most Russian watch shops sell only watches and sometimes accessories, and very seldom one can find jewellery there.

Motives for growth

Still, let’s go back to figures. What explains such significant market growth in 2007 (49% in money and 112% in quantity terms)? 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 2007grew approximately 15% (and 30% 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 deals with established economic stability and situation at 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 dollar has been decreasing for over a year. Euro is growing, but no one knows how long this tendency will last. Ruble is not suitable as store of value: according to official information, inflation amounted to more than 12 %. According to public opinion, prices on most products grew at least 20 %. 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 are 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% growth of watch purchases and 30% sales growth. After a long suspense of supplies Russian companies now buy more than sell. Quite considerable trading stock was delivered to newly opened monobrand boutiques.  Decrease of watch shipments in November (-6% in quantity terms and - 10% value to 2006) and in December (-37% in quantity terms  and + 8% value) shows that the formation of necessary trading stock is completed.

While oil price is floating at $ 100 mark and the economic situation in Russia is stable, watch sales will continue to grow. It is unlikely that growth rates in 2008 will be as high as in 2007. Of course, if import duties remain the same.

New turn

Emptiness protection
Two years ago import duty did not make serious influence on the market, because most part of the watches came to Russia illegally. But today it leads to sales drop. Lowering or abortion of a duty can be very profitable to watch market and the state. 

According to calculations, lowering or even complete abortion of a duty would provide increase of the amount of money coming to treasury from import of watches. That will happen due to increased volumes of officially imported watches. First, those 50% of watches will turn into legal shipments, which are “lost” nowadays in their way from Swiss customs to Russian. Second, “black” import and reexport from other countries will have no sense. The quantity of watches Russians buy abroad will sharply decrease. All that will result in increased tax revenues.

It is common knowledge that all that happens has reasons. Many suppose that it is not possible to achieve complete cancellation of customs duties in Russia. However there are some good examples. Thus, since autumn 2007 duty on import of TV-sets equals 0.

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 system. For example, investigation of Sharp trafficking became one of the most notorious criminal investigation in winter 2007. Economic police imposes serious impact on distributors, trying to make them admit that by their request representatives of the Japanese Group had put fake low prices in invoices. This is a subject to Russian Criminal Code. And in this occasion it is quite possible that our export manager, appropriately serving a Russian partner, will have to stay for a long time somewhere in Siberia. Of course against his will.