Brand new order

Conserving value in
a changing environment
How consumer products companies are
adapting to the tougher reality of the
maturing Russian market
July 2013
Economic snapshot
1
2 Conserving value in a changing environment
Russia is one of the very few countries in the world that is not, and does not have to be,
obsessed with austerity. The budget de cit last year was a comical -0. 02% and is running
currently at -0. 2%. As in China, the Russian Government chooses not to allow a collapse in
consumer spending and will increase social spending as it sees t, but perhaps not on the
scale of early 2012.
Russian GDP is trending downward, similar to all markets in the world, and will probably nish 2013
at about 2. 3% to 2. 6%. This remains good compared with other markets except China (which is
also slowing) . Next year, we expect moderate improvement to about 3. 2%, presuming stable global
outlook.
Ination dipped under 7% in June. As expected, ination is on the way down, and slower
administrative prices from the Government, a better grain harvest and softer demand will see
ination at 5. 9% in December this year and at about 5. 7% by the end of 2014.
Retail sales are running at 3. 5% growth, and we expect an average of about 3. 8% this year and over
4% next year; non-food still performs much better than food.
Nominal wages were among the highest in the world six months ago at 15% but have fallen to about
11% now; with ination falling to 6% soon, this means that real wages will average 5% this year
and next.
Unemployment stayed close to record-low levels at 5. 4% in June; this means that in some towns and
cities there is effectively zero unemployment.
Consumer con dence indicators in Russia were historically booming in the 2000s at +6 but collapsed
to -35 in 2009. Since 2011, they have recovered to about -6, which actually means that Russians
(with Turks, Swedes and Germans) are among the most con dent in Europe.
The ruble bounced down this summer along with all emerging market currencies as the markets
overreacted to possible higher US interest rates next year. The ruble will probably stay in a softer
corridor of about 32. 2 to 32. 8 to the US dollar for the next 6 to 8 months. But the ruble could come
under more downward pressure in the medium term as shale gas developments kick in. We could see
the ruble possibly weaker than 33. 2/33. 5 to the US dollar in 18 to 24 months, but shale gas effects
are dif cult ones to predict. Having said this, the Russian Central Bank has enough reserves (over
US$500b) to prevent a ruble crash.
With China growing over 7% and maintained risk in the Middle East, the oil price looks set to average
US$98 to US$104 per barrel over the next 12 to 24 months ( this is also the consensus view) , which
should ensure that Russian GDP stays within the parameters noted above.
1. All factsin thissection of the report are sourced from DT Global BusinessConsulting GmBH. The viewsof third parties
set out in thispublication are not necessarily the viewsof the global EY organization or itsmember rms. Moreover, the
viewsshould be seen in the context of the time they were expressed.
3 Conserving value in a changing environment
Executive summary
Russia remains an attractive market for consumer
products companies, but the days of double-digit
growth and large pro ts with little effort belong to the
pre- nancial-crisis era. In the brand new order, todays
Russian market is a challenging environment, which is
changing and maturing in many ways. Companies are
positive about the future in Russia, but business as
usual is no longer enough: new thinking and a step
change in the way business is conducted are required.
In July 2013, EY hosted an industry roundtable for country
leaders of some of the worlds largest consumer products
companies operating in Russia. A number of key themes emerged:
Most executives faced a slowdown in the rst half of 2013 in
Russia, which for some came as a surprise. A number have
been caught in the budget trap : having set budgets when the
outlook was more promising.
Managing global HQ expectations remains a key challenge.
Facing sluggish growth in developed markets, global HQs are
looking to squeeze additional pro t from Russia, but this is
now far more dif cult to achieve as the market slows and costs
continue to rise.
Retailers are pursuing volume growth on an unprecedented
scale. On-shelf availability is becoming a real issue in some
categories because of the increase in promotion. One executive
expressed his concern by saying: The reaction of retailers and
manufacturers is overly aggressive and is destroying value.
Executives continue to feel pressure to adapt to the changing
and increasingly varied needs of the Russian consumer,
highlighting the split of the middle class and differences
across regions in Russia.
In this challenging environment, executives agreed that they
need to address the basics by focusing on portfolio, pricing and
distribution. They need to be more granular in understanding
the consumer and take different approaches to their business.
Executives recognize the need to bring in people with different
mindsets and capabilities. As one executive explained: It is all
about people.
Executives have been aware for some time of the challenges
of dealing with Russias maturing consumers, its dif cult retail
market and the demands of global HQ. In this context, they
accepted that they needed to work harder and smarter to
compete effectively. Over the last 18 months, they have made
some changes to their business, perhaps focusing on the low-
hanging fruit. However, the environment has become even
tougher in the last six months. Executives now recognize that they
need to take a different, more disruptive approach to all aspects
of the business. In addressing these issues, executives are asking
themselves a key question: How do you manage the short-term
demands on the business without damaging its long-term future?
Finding the answer will be critical to long-term success.
Emmanuelle Roman
Global Consumer Products Markets Leader
eroman@ uk.ey.com
+44 20 7951 1651
Dmit ry Khalilov
Commonwealth of Independent States
Retail & Consumer Products Leader
dmitry. khalilov@ ru.ey.com
+7 495 755 9757
4 Conserving value in a changing environment
Managing global HQs
expectations in a
slowing market
Adapting to more mature
and sophisticated
consumers
Most consumer products companies reported a slowdown in
Russia this year. For some companies, the slowdown was apparent
in the latter part of 2012. Others, however, were taken by surprise
by the suddenness and depth of the slowdown, and its underlying
causes remain unknown. At the same time, the cost of doing
business from staff costs to demands from distributors and
retailers continues to increase in Russia. Despite this, executives
are facing pressure to maintain or even increase pro ts.
The middle class in Russia is changing; it is becoming more
polarized, with consumers migrating up toward premium goods
for some products and dipping down into value ranges for others.
There is still a strong market in Russia for western luxury brands,
but for many consumers, Russian brands are now an acceptable,
good enough and even a desirable choice and are providing
more competition.
The growing sophistication of the Russian consumer means that
companies need to be more sophisticated in their approach to the
market and need to understand the nuances of different consumer
segments. The trend toward greater sophistication is expected
but needs to be met with a proper value proposition, and
companies are moving away from being order takers and
are becoming strategic marketers.
Before the recession, Western consumer products companies
were focused on premium brands at the top end of the market.
However, building a long-term business solely on premium is not
possible. Companies have had to start targeting other areas of
the consumer pyramid and address the challenge of making the
equation work for affordable products in a high-cost-of-business
environment. As one executive noted: The key is to innovate at
the higher end but to keep the base moving as well.
To help drive innovation, consumer products companies recognize
the need for better collection and analysis of market data. As
one executive explained: Its not just to see the numbers but to
understand them as information and have a strategy based on it.
It is clear that the next phase of growth is the regions and many
companies are starting to look at Russia as seven countries
in one. Management of the business needs to become more
sophisticated to address these regions in Russia because a one
size ts all approach is no longer suf cient: each country
across Russia has different needs, different price considerations,
different value expectations and requires different distribution
models.
Managing these global HQ expectations is one of the biggest,
and most time-consuming, problems faced by country CEOs.
Explaining why performance has fallen short of expectations is
made more challenging because, although available third-party
data covers the top of the market and modern retail, it lacks the
in-depth insight of traditional trade and regional markets that
would provide a truer picture of on-the-ground market reality.
Consumer products companies are caught between trying to drive
volume and protect pro t at the same time. Under pressure on
both sides and facing targets that were set when the economic
outlook was more promising, some companies are struggling to
meet performance expectations. We are caught in a budget
trap, said one major player. Weve made promises to HQ on
pro t, yet we are trying to protect volumes here at a scale I have
not seen in my seven years in Russia.
Despite the weakness of the current economic climate, global
HQs are trying to squeeze more pro t from Russia, which reects
both the limited potential of many other markets as well as the
expectations created by past performance. Historically, companies
invested in Russia by redirecting pro ts generated from premium
products in developed markets. Pro ts are under pressure in
Europe and the US, but Russia is still expected to deliver without
this investment. While there is some recognition from global
HQs that achievable growth rates are now lower, the pressure to
increase pro tability remains.
The cost of business is on t he rise here,
and Im having t o look at operat ions and
rest ruct ure under enormous pressure t o
deliver more pro t .
Managing HQ is my hardest job. Their
appet it e t o squeeze what t hey can from
Russia is enormous.
The middle class is split t ing up. People
are st ill looking for brands, but many more
ot hers are now looking for value
for money.
We used t o run cent ral promot ions in
Russia. We see now t hat we need t o run
separat e programs across t he count ry and
at t ack region by region. We need t o
get it right one by one.
5 Conserving value in a changing environment
2. Prot or lose: balancing the growth-prot paradox for global consumer products
companies and retailers in Asias emerging markets, EY3.
Companies moving into the regions need to expand in a
very focused way. A key message from the forthcoming EY
publication Prot or lose,
2
based on a survey of Asia-based
consumer products and retail executives, is that traditional
scaling approaches are increasingly challenged in emerging
markets because of higher-than-expected levels of competition
and consumer variance. This nding has applicability for Russia;
companies should consider creating scale by adopting a portfolio
approach across multiple market niches and anking particular
market segments.
Generally, retailers in Russia are viewed as unsophisticated. One
executive noted, for example, that there had been little progress in
many areas of category management over the last decade, partly
because of a short-term focus. Retailers, however, are expected
to mature, allowing the development of more collaborative
relationships with consumer products manufacturers.
Evolving consumer needs are likely to provide impetus for
change and lead to signi cant shifts in the retail and channel
landscape. One executive reported, for example, that one retailer
had recently split its discount and upper retail segments from a
supplier management and team leadership perspective.
Also, retailers are driving into Russias eastern regions and are
therefore providing new outlets to drive consumer products
business eastward as well.
An opportunity exists for manufacturers to work with those
retailers, which are willing to adjust to evolving market and
consumer conditions, and forge win/win relationships through
the sharing of best practices and point-of-buying strategies.
There is much more to be done with retailers, such as grow the
category and go to the regions.
The reaction of retailers to the slowing Russian market,
particularly those not performing as well as expected, has been
to compete more aggressively on pricing and promotions. This
approach reverberates down to consumer products manufacturers
through an unrealistic squeezing of terms, backed up by a threat
of destocking. Many manufacturers still feel they have a
win/lose relationship with retailers, which has become more
dif cult recently because of the sluggish demand conditions.
One executive summarized the situation succinctly as follows:
There is no trust today between manufacturers and retailers.
Evolving from win/lose
to collaborative retailer
relationships
The current react ion of ret ailers t o t he
dip in t he market is beyond imaginat ion.
The price promot ions and giveaways are
dest roying value and chipping away at our
invest ment in t he brands.
Ret ailers here will look like Germany and
France in a few years. Theyll want privat e
label. Weve got some t ime here t o plan t he
st rat egy and get it right .
Retailers are taking product promotions into their own hands
and in some cases destroying brand value; for example, by
offering 50% off or buy one get one free on products that the
manufacturer would never offer to the consumer under these
conditions. Many manufacturers believe that retailers have the
power to ruin the business if this behavior continues over
a longer period of time. Having said this, there are also examples
of brand erosion led by manufacturers that are protecting share
and cost absorption in their operations.
Looking ahead, some of those attending the meeting believe that
it is only a matter of time before retailers move into private label
in a big way. The question for consumer products companies is
whether to participate in private label as a manufacturer or to
try to ght it.
Views from Ivan Butyagin, Consumer Products
Advisory Leader, CIS
Wholesalers and cash and carries are dest abilizing t he market in
t radit ional t rade channels because of t heir aggressive price policy,
which is harming t he margin level of consumer product s companies
dist ribut ors and put t ing t heir shelf cont rol at risk. Companies can
respond by:
Assessing dist ribut ors efciency and consolidat ing t hem wit h a
view t o eliminat ing t he weakest
Boost ing dist ribut ors mat urit y in supply chain and cust omer
service
Assessing t rade spend efciency wit h a view t o get t ing t he right
balance bet ween modern t rade and t radit ional t rade channels
Different iat ing t rade market ing approaches by region across
t he count ry
We would also suggest t hat companies pay special at t ent ion t o
regional ret ailers since t hey have become signicant players on a
regional level and are very oft en more efcient t han federal players
in t heir home region.
Despite the current issues, executives at the meeting were
optimistic about the longer-term future of retailer relationships.
One executive felt that the equilibrium would be restored at
some stage in the future.
6 Conserving value in a changing environment
Disrupting the business
to meet the new
market reality
As the Russian market matures, consumer products companies
recognize that their strategic and business approach must also
mature and become more like the approach taken in developed
markets.
An ongoing focus on greater ef ciency is one aspect of this
change. As one executive noted: When we were growing at
20% no one was worrying about a few rubles. Now we are under
much more scrutiny. Our spending here has become visible
and obvious.
However, adapting to a market that is no longer growing at a
double-digit pace requires more than just cost cutting. Our teams
carry on doing what they have always done, and it is wasted, said
one executive. Companies, therefore, are looking at restructuring
and disrupting the way they are doing business, recognizing that
a more segmented strategy is needed to cope with a maturing
consumer and widely differentiated regional markets.
One key message from the meeting was that companies
need to address the basics, from portfolio through pricing
to distribution, as well as take a more granular approach to
understanding the consumer. Companies that are prepared to
look differently at the market and disrupt their business are
reaping the rewards. As one executive explained: We invested
heavily in each initiative that our analysis identi ed as a potential
performance accelerator in the new market environment. We grew
faster than expectations in the rst half of 2013 because of the
investments we have made in digital activity, rural penetration and
relevant local innovation.
There are a number of strands to the changes companies are
making to their strategy:
Strategic planning and marketing
Companies believe that they need a more sophisticated approach
to strategic planning and marketing. They must start applying
best-in-class portfolio management to strike the right balance
between portfolio and pricing and must look at their distribution
models. A more segmented approach will be vital, with a mix of
brands in each category and offers at different price points for
different consumer segments.
We are going back t o really underst anding
what brings value t o t he consumer at a
cert ain price point .
I need rowers, not surfers, but I have
surfers. They are not t he same people.
Human resources
To take the business to the next level of growth requires a shift in
what is expected from staff in consumer products companies and,
there was agreement at the meeting that a general upgrading
is needed.
A different mindset as well as different capabilities is required.
People who guided the business while growth and pro tability
were relatively easy to achieve may not have the necessary
mindset for the new increasingly tough environment.
One executive said that: For a little too long I trusted people
with 10 to 15 years experience but who had not had to do
anything dif cult.
To tackle the challenges ahead, companies are looking for
motivated and skilled workforces with the right capabilities.
There is a real need for real marketers, data crunchers
and strategists.
In some cases, compared with their counterparts elsewhere in
Europe, staff in Russia is now not up to scratch. There is also
concern that it is becoming more dif cult to retain talent, certainly
in Moscow, and the remuneration offered by Russian companies
and their increasing sophistication poses a competitive threat.
A number of executives mentioned that they had a much easier
time nding good female talent.
Looking for talent beyond Moscow and St. Petersburg is a must.
On a positive note, there was agreement that motivated, talented
and cheaper labor is available in greater Russia if companies are
prepared to look for it.
Some companies, rather than just tapping these new talent pools
for individuals, are taking the more disruptive step of moving
entire departments to different areas. Potential also exists to
move certain back-of ce functions out of Moscow. One executive,
for example, said that: Ive moved some back-of ce functions to
Siberia. There is a good university there for talent, and the people
cost four times less. This is likely to become a growing trend as
more companies embrace the need for a step change in their
approach.
7 Conserving value in a changing environment
In t he past , we didnt need t o learn,
we just had t o sell. Now we need analyt ics
t o underst and why somet hing is selling,
or not , and what exact ly is happening
in t he channels.
The int ernet is bigger t han TV in Moscow,
TV viewing is down, and publicat ions are
down by 20%. E-commerce is coming!
Companies are hopeful that technology and POS scanners may
help provide more accurate market data, and there could be scope
to develop an industry-led technological solution.
Messaging to consumers
Russia is experiencing the same long-term media trends as
developed markets: print media is dying, and internet viewing is
growing at the expense of TV. At the meeting, it was claimed that
in 2013 internet viewing has outstripped TV for the rst time
although there was no mention of how this was measured.
Most companies around the table, however, have not signi cantly
invested in social media, although most rms said they had a
social media manager. This is clearly an opportunity for forward-
looking rms.
Questions executives
are asking
How do you manage demands from global
HQ to grow volumes and pro ts without
damaging your future?
The next phase of growth is the regions
do you centralize or decentralize?
How can we develop a win/win relationship
with retailers and avoid potential brand
value destruction from excessive promotional
activity?
Should we ght the trend toward private
label or participate with retailers?
Where can we nd the motivated and skilled
workforce with the right mindset that the
business needs?
Should we build in-house data analytic
capability to deepen our understanding
of the maturing consumer?
7
Data and data analysis
Meeting the needs of a maturing consumer requires good data,
which must then be turned into insights to be used in strategy.
There is a growing recognition that, given the shortcomings of
available third-party market data, taking the signi cant step of
developing proprietary data could drive competitive advantage.
One company present at the meeting, for example, had created
an in-house data analytics group.
Conserving value in a changing environment
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How EYs Global Consumer Product s Cent er can help
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Consumer products companies are operating in a brand new
order, a challenging environment of spiraling complexity and
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To succeed, companies now need to be leaner and more agile,
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ey.com
Prot or lose executive summary
Prot or lose: balancing the growth-prot
paradox for global consumer products
companies and retailers in Asias emerging
markets
While emerging markets are not new, they
have reached a pivot point. In the brand new
order, the center of gravity has shifted to Asia.
The fragility of mature markets and increased
scale of emerging market operations mean
that performance in Asia is now critical to
both the top and bottom line. Companies
cannot just invest to grow they need to be
pro table. In EYs new executive summary of
our forthcoming report (available in September)
we share the eight business imperatives that we
believe companies need to address to achieve
pro table long-term growth in emerging Asia.
Executive
summary
Prcht cr Icse
Balancinq Lhe qrowLhprolL paradox
lor qlobal consumer producLs
companies and reLailers in Asia's
emerging markets
Brand new order
Disrupt or be disrupted: creating value in the
consumer products brand new order
A brand new order has been established
incremental improvement is no longer an
option. Companies need to disrupt themselves
in order to continue to create value. To do this
they need to reframe their purpose, reshape
their operating model and ruthlessly execute
or face consumer ambivalence and
obsolescence.
2013 Russia Attractiveness Survey
Shaping Russias future.
This survey highlights the latest foreign
direct investment ( FDI) trends in the country
and explores the views of 206 international
business leaders from around the world on its
attractiveness as an investment destination.
Ernst & Youngsattractivenesssurvey
Russia2013
Shaping Russiasfuture
GrowingBeyond