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. Last Updated: 07/27/2016

Import Goods or 'Go Native'?

To think of Russia as a place to manufacture consumer goods would tax the imagination of most Westerners. On first impression, even the market itself hardly seems worthwhile. Real wages, officially measured, remain 20 percent lower than in 1992. Per capita incomes, down 43 percent since the break up of the Soviet Union, are one-third below those in Brazil. Gaudy "New Russians" aside, the Western perception of "homo Sovieticus -- the consumer," is of a non-discerning creature, with little to spend and even less idea how to spend it. In most Western eyes, Russia displays limited potential as a place to sell consumer goods, let alone manufacture them.

Yet if only because 150 million people live here, the Russian market cannot be ignored. Greater Moscow and St. Petersburg alone are a concentration of 18 million consumers -- the same as Australia. And beyond the dubious statistics, genuine spending power is amassing. Whereas ruble wages were hammered during 1995, real currency appreciation more than doubled dollar-purchasing power. More fundamentally, there is Russia's informal economy, some 45 percent of gross domestic product by official estimates, which buzzes away untaxed, generating consumer goods.

Despite this potential, Russian firms have all but stopped producing consumer goods. Most of the factories that once turned out bad quality, poorly designed consumer products have yet to emerge from the shock of reform. Domestic consumer-goods production has been in free fall for the last half-decade -- in 1995, it had fallen to 48 percent of its level in 1991, and was still shrinking at the start of 1996.

Foreign firms that can see beyond the stereotypes are consequently presented with a double incentive: Not only does Russia represent a huge untapped consumer market, but the domestic consumer-goods manufacturing sector is flagging. The initial reaction was the well-known import drive -- between 1991 and 1995, the import-share among sales of consumer goods in Russia rose from 12 percent to a staggering 56 percent. But this is not the entire story. Westerners can take advantage of the Russian market not only by importing, but by manufacturing finished goods on site. And quietly, often shrewdly avoiding attention, Western manufacturers are restructuring Russia's consumer goods manufacturing industry from within.

The arguments against "going native" here -- manufacturing rather than importing -- are legion. The unpredictable legal environment makes assessing an investment in a new "greenfield" or existing "brownfield" plant a disconcertingly inexact science. The lack of "grandfathering" legislation means tax changes can render profitable projects into non-viable nightmares overnight. The specter of retroactive tax liabilities looms. The tax heat proved too much for IBM, which recently closed its personal computer assembly plant in Zelenograd, close to Moscow.

In addition to tax doubts, direct investors in manufacturing plants face the contractual uncertainties of land and real-estate ownership. In fact, most joint-ventures are more spooked about their local partner seizing their stakes than they are about Communist presidential hopeful Gennady Zyuganov's talk of renationalization. And unlike portfolio investors, Westerners creating their own Russian factories have to live with local realpolitik. Horror stories abound of vaguely written rules administered by corrupt provincial apparatchiks. Foreign direct investors' dealings with federal, oblast and then local bureaucrats involve considerable heartache and palm-greasing.

Despite these difficulties, many foreign food manufacturers in Russia are not only surviving, but thriving. The major Western chocolate makers all have local production facilities: The Russian confectionery market is worth the same as France. In some good categories, Western domination is so strong that the Russian markets for chocolate, soft drinks, hair-care and tobacco are no longer races for entry, but games of market share.

The firms currently enjoying market share are those that increased their investments quickly. The tobacco firm, Philip Morris, was a conspicuous early entrant. So, too, was Coca-Cola, which began a $500 million Russian development program in 1991 and now operates 10 plants across the country. In fact, Coke benefits from a 50 percent reduction in import duty granted on commitments over $100 million. Other qualifying firms with considerable market share include Asea Brown Boveri and Mars.

Many Western manufacturers view distribution as the key to successful consumer good manufacturing in Russia. Although the Soviet distribution network has developed since supplies were shunted from regional warehouses to state outlets, the monopolistic commercial distributors of the new Russia are notoriously high cost. And, the highly concentrated urban wholesalers and the lack of retail chains seriously cramp foreigners' style. As a result, many Western manufacturers have made further investments to overcome distributional headaches.

And although relying instead on long-term relations with distributors off their payroll, Mars has nevertheless invested heavily in its distributors' capital equipment. Western managers say an in-house distribution network not only helps avoid a collusive domestic system, but allows them to keep their fingers on the pulse of the market.

The race for market entry has now switched away from consumer non-durables -- food, drinks and toiletries -- and toward consumer durables such as televisions, refrigerators and stereos. In both categories, Russia shows a strong demand for internationally branded goods. Indeed, several Western firms have carved out strong market positions as importers of consumer durables into Russia.

But the question remains, will Western consumer-durable companies begin manufacturing in these parts in the same manner as their non-durable counterparts? It so happens, the answer already is yes. Phillips, Tetra Pak, Aga and Cargill all have, or are about to take, considerable stakes in manufacturing plants in Russia. They have decided that manufacturing durable goods here is worthwhile. These brave pioneers should reap considerable benefits for "going native" particularly if Russia's outlook toward Western imports becomes less friendly after June 16.

For IBM, the U.S. computer company, the tax heat proved too much. Their personal computer assembly plant in Zelenograd, close to Moscow, recently closed. Opened in 1993, the operation was a victim of Russia's brutal tax regime.

Coke set up a dedicated transport and warehouse network in Russia, just as it does everywhere else. Sun Brewing, an Indian concern that owns five brownfield breweries, also does its own distribution.

: Sony televisions as well as Snickers bars.