Russian market:: Pay more attention to retail sales

Following the year 2007, export of watches to Russia seems to stop in one place. What is going on and what can we expect to happen in the Russian market?
After the supply crisis of 2005-2006, Russia demonstrated a considerable jump: + 49%. However the first six months of 2008 were not that much inspiring.
The first half of 2008 is characterized by 8% revenue growth and 7 % quantity decrease. This is almost stagnation. What has happened? Did Russians stop buying watches?
Of course, they did not. They are buying and will be buying them in the near future. While oil price is about 100 USD, Russia is provided by a considerable money inflow, which will partly be spent on watches, jewellery and other Luxury goods. At that the demand is unstable, which is explained by the following factors. The basis of Russia's wellness is natural resources. And, like in other countries which economy depends on raw materials export, people in Russia differ a lot in income. Most part of the population has not more than 500 USD monthly salary, and at the same time Russian oligarches  are buying houses and palaces in Europe, most expensive cars and yachts.

It is the minor super-rich group of people, which helps watch companies to meet sales plans. Taking into consideration the coming crisis these people are simply not in the mood to make purchases. Especially strong impact on rich consumers imposed South Ossetian crisis. Experts even began talks on rapid price decrease for elite apartments in Moscow. In order to increase demand on exclusive watches, there's need for positive changes and some quite period in politics and economy.

The demand among those who belong to middle class is different. On the one hand, inflation prevents people from making savings, and stimulates spending all money, that is there are increased purchases, including purchases of watches. On the other hand more and more people depend on prices.  Their income grows faster than inflation. However alongside with income, expenses are also growing. It partly happens due to increased prices for goods they used to buy. But even more it depends on changed consumption model  - to more expensive goods and services and wider range of services. Prices on property increase 20 % a year and are one of the highest in the world. Prices on cars in Russia are twice as much as in United States. Analyzing his or her budget, a person surprisingly finds out that in spite of growing salary, he doesn't have enough money. In these circumstances buying watches goes down and down the to-do list. Hence, in spite of constantly increasing salary, people don't have enough money to make such purchases. That is why middle class buys watches less than rich people.
 
Investing in watches
 
 Income and demand are macroeconomic factors, not depending on manufacturers or sellers.
Retail totally depends on watch market operators and also imposes great impact on sales. What has been happening in Russia in the last 2 years?
Growth and development of watch market in Russian cities is obvious without any additional fugures and research works.

Watch market is developing and growing: there appeared more shops, their interiors became better, and the assortment considerably widened.
The supply crisis of 2005-2006 was followed by astonishing sales growth of 2007: wholesale companies renewed import of watches, there appeared strongest demand on goods. Wholesalers were just happy: almost during a year everything they brought, was bought immediately. Monthly growth rates, Russian market demonstrated in Jenuary- April 2007, compared with last year, were fantastic: 124%, 160%, 106%, 235%!

During the last two years the amount of shops, selling Swiss watches, grew about 20-30 %. It is not increased demand on watches, but situation at the market of commercial real estate which became the reason of such expansion.
 
Newly appeared gigantic shopping centers attract buyers, who now seldom come to old watch shops. For example, Tolyatti. The general amount of square meters of shops here  grew 3,5 times in the period of 2004-2007.  That is why retailers are trying to predict which new shops will be more perspective, again and again investing in opening new points of sale.
Here alongside with quantitative changes we also witness qualitative ones. Visitors of trading malls are oriented on fashion and brand – that results in more considerable demand on fashion-watches comparing to classical models.

Competition among watch shops leads to so called upgrading:  increased shopping space, wider assortment, better interiors and equipment. Watch shops renew equipment, get bigger. For example, whereas 30-60 square meters were a norm for shop floor 4 years ago, now most shops have 50-100 and sometimes 300 square meters of shop floor. Investments into design and equipment are shocking. For example, astonishing by its gorgeous atmosphere Cleopatra, located in Volgograd,  watch shop cost over a million Euro. At the same time displayed collections are also widening. Whereas in 2003 watch shops had 15-20 Rado watches and 40-50 Longines waches displayed, now you will find 23-40 Rado watches and 100-120 Longines. Points of sale having less watches of the a.m. brands, seem inappropriate and have no chance for success.  So, increased stock is another reason for growing export to Russia in 2007.

Enjoying new nice shops we don't always think what is happening on the other side of shop windows. According to information from certain chain stores and separate shops, investment to watch retail increased 2-3 times compared with 2006.

Opening of new points of sale, new equipment, widening of assortment – all that implies spending money.
People usually invest in order to get more money, but this system is not always working at the Russian watch market.
 
Business cost
 
Official inflation amounted 11,9% in 2007. However, it doesn't reflect the change of business cost, for example, of a watch shop. Let's analyze this change.
Rental payment grows 30-70 % every year. Rental payment in popular trade malls of Moscow grew 1,5 times for the past year and exceeded 7000 USD 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 meter in most expensive places in regions cost 300-400 USD per year. Now rental payment amounting 3000 Euro per square meter doesn't seem too much.

Salary depends on the state: salary of civil servants grew and so did the list of privileges. And, hence, business had to increase expenditures for staff salary over 50%. That explains twice increased expenses of the shop. Most services also became more expensive: security, advertising and so on.
Hence, increased expenditures of a shop during the last year may amount 50-60 %. Please, 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 margin decrease. New logistic structures and opening of expensive Russian offices resulted in increased expenditures. And retail prices were to be 30% higher than in Switzerland. Some manufacturers set lower recommended prices especially for Russia in order to avoid price difference with Europe - additional 15-20 % to price in Switzerland. This also resulted in lower margin of shops. If before retailers got watches from distributor with 50 % discount from retail price, now the discount amounts 30-40 %.

Watch manufacturers reduced the list of shops selling their goods. They explained it by too many points of sale, and the fact that not all of them correspond to the brand image. Two years ago Tisson was available in more than 400 shops all aver Russia. Now according to the company's plan, there should be 150-200, maximum 250 points of sale. Omega was available in 39 shops in Moscow, whereas now there are only 10 left.  It turned out to be a shock for many retailers, because these brands were the core of their business. 

Summing up, we get the following: watch sales in Russia are generally increasing, but if we take into consideration growing export and amount of shops, increased investments and expenditures, we will see that watch retail trading considerably lowered.
 
"Brave" and "careful"
 
When market growth and profitability decrease are coming together, retailers are divided into two major groups: so called "careful" and "brave". "Careful" are targeted at maintaining positions and saving clients, while "brave" are targeted to occupying new positions and getting more clients.

Among "careful" there are Consul, Louvre, Mercury, Moscow Time and other large chain stores. They've been working at 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 is clients they managed to attract during years of work. Their main task is not to lose positions. They carefully examine risks, including risks of financial crisis, cross course of currencies, bankruptcy of a certain trading center and so on. Their position is the following: our shops have stable clients and are strong enough to sell any goods. That is why we choose not most famous brands in Russia, but those bringing us most profit.

They refuse any project if according to some reasons the risk of failure is high or profitability is insufficient. Such policy results in reduced orders for traditional brands. At the same time it is these shops which contribute to success of new unknown brands at the market. More expensive and at the same time decreased margin on popular brands makes them boring for 'careful' market participants.  It is easier for them to offer a potential buyer a new exclusive brand, than to explain why well-known brands became two-three times more expensive. Moreover, they have really good clients, which had enough of old brands. On the other hand there are new and developing retail companies with no constant clients of their own. Famous brands are of utmost importance to them to attract new clients.

Throughout the territory of Russia it is clearly seen that number of points of sale belonging to brands, which not so long ago claimed that promotion to regions is weak, is increasing.

"Brave" are happy to sign contracts with famous brands in spite of non-profitability.  It is these companies which compensate purchases, declined by old partners.
In a year or two the business results will be obvious Business results will become obvious in a year or two, when shops will be able to make profitability analysis of working with brands and when the time comes to return credits, taken on business expansion.

Which strategy of the two will become a success? Time will show us. However,  there was time when "careful" were also "brave", and they seem to have changed the strategy due to certain reasons.

Country of chain stores

It's clear that fugures only highlight the situation at the market in general. Profitability of each company depends on assortment, ability to find and train staff, getting better locations in trading centers and attracting investments.

It is two latter factors that form dynamics of development for each market participant. Here chain stores and regional shops, belonging to big holdings, occupy best positions. These two categories of market participants are showing biggest growth rates.

From hundreds of market participants Russia is turning to market of chain stores. Largest Federal companies (Moscow Times, Consul, 3-15) own 30-50 stores in the territory of Russia. During the last two years market participants, who own chain stores, have been expanding to other territories besides local. For example, companies from Novosibirsk have shops in Omsk and Barnaul, companies from Rostov – in Krasnodar and some other cities. 

Problem of monoboutiques 

Monoboutiques have become very popular during the last 2-3 years. Breguet, Chanel, Omega, almost all Richemont brands alongside with others have their own boutiques in Moscow. Maurice Lacroix, TAG Heuer and Seiko declared on coming opening of their boutiques. Unlike chain stores with their commercial benefits, monoboutiques appeared because of marketing targets and ambitions of watch manufacturers. There is some information that only 2-3 such boutiques in Moscow are profitable. This fact is obvious: if we count the cost of rent for 100-300 square metres in downtown Moscow, we get 1,5-5 million USD. Here comes the question, if there are a lot of brands making supplies to Russia  for over 10 million USD.
Manufacturers state that boutiques are not commercial projects, but marketing instrument, targeted at creating image of the reputable brand.
Perhaps it is true. However according to my personal impressions, establishment of most boutiques did not have the least influence on any of these factors.
But what will happen when boutiques will have to be closed? It will have to be done sooner or later, unless the company is going to bear constant losses of its shop.

Strategic success or…

Speaking of retail, we constantly mention manufacturers on purpose. They turned into a strong power, influencing the situation at the market. Manufacturers are mostly targeted at total retail control and getting strategic success. However there are crucial mistakes that are of no good for retailers and in the long-term perspective they might turn into disaster for manufacturers.
For example, it is reduction of retail points of sale. Doing this, manufacturers worked for the sake of image. Negative consequences are already obvious. Will they be able to reach their goals.
Perhaps they will. Some shops really increased sales of Tissot and Omega brands. But this rule does not work for all shops.

Hundreds of shops with unsold stock are having hard times now: it is almost impossible to bring back money invested in the goods, taking into consideration the fact that they cannot even advertise the goods. I'm not going to protect retailers: business is business and everybody solves his or her own problems. Lets say, shops will get rid of the goods through, say, Internet. But sellers will show this way their negative attitude to the brand. And taking into consideration the fact that there are hundreds of such shops the consequences might be crucial. Finally it can turn in a way when it would have been cheaper to buy out the rest of the goods instead of getting such anti-advertising.

Another negative consequence is decrease of brand presence at the market. It is inevitable, because shops are looking for new brands to fulfill the emptiness. Active promotion of "shop in shop" is also a questionable matter. It is profitable for manufacturers, but not always to retailers. It is suitable for boutiques or places, visited by a lot of people, like Duty Free. In other cases manufacturers solves his problems and at the same time ruins the shop's economy, consequently, losing clients after all.

At the same time representative offices still have the most important problem unsolved – providing after sale service. Russian consumer law is rather strict: if watches were not repaired during 45 days, the shop must pay penalties. There are almost no manufacturers paying for guarantee repair work, there are also difficulties with spare parts delivery. That is why it is often impossible to repair watches in time, and retailers have to bear all expenditures for goods of inappropriate quality.
 
One of the reasons for opening representative offices is assistance to points of sale. Retailers truly state that it is more comfortable to work with representative offices, than with dealers. However sometimes it is reasonable to work with distributors, because it is really expensive to have an office. At that it's extremely hard to find qualified specialists in Moscow, and their salaries are often higher than in Europe. Office rental payment is also quite high. All these expenditures influence price, at which shops purchase goods. Consequently, subsidiaries sell watches to Russian retailers with the same price a buyer pays in a shop in Dubai or Geneva. Not surprising that there appear more and more suitcase traders, supplying watches to buyers avoiding customs and Russian shops. That is, instead of so called grey market we got growing black market.

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 contact with buyers. In spite of seemingly good state, Russian retail is facing hard times and needs support. If manufacturers will provide support, they'll get stable market in a year or two. If they pressure too much, we'll see dozens of closed points of sale. Such an outcome can hardly be called a strategic success of any manufacturer.

Speaking of slow growth rates, nothing crucial is actually happening. Market is simply congested with goods. Not only figures of growth rates are important, but also their basic level. And additional 8% fixed in the period from January till July 2008, begin from record performance of early 2007.