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Think big, act small, be patient.

Yes, Russia is big. But the phrase, "It's too big to ignore" has become a cliche. Moreover, it says nothing about the timing or methods of market entry. To consider market entry into Russia, it is important to revisit some basic questions:

1) Why is Russia important at all?

2) What is it that makes us all so nervous?

3) How can we balance the risks and opportunities of market entry?

In exploring these questions, our bottom line is: Despite well documented risks, most global firms should enter Russia now through plant a seed" strategies. Cliche or not, Russia is the riskiest market you have to be in.

Why Can't Russia Be Ignored?

Our first question is relatively easy. Russia can not be ignored for five reasons:

One, Russia is world-class in terms of land mass and natural resources. Statistics are revealing here: Russia has 55 times the land mass of Poland and it represents about 75% of the land of what was formerly the Soviet Union. On this land mass sits 16% of the world's oil, 19% of its timber, 18% of its crude steel, and 12% of its coal production, among other resources.

Two, Russia is a vast, untapped consumer market. Its roughly 150 million consumers make comparisons with Eastern Europe - its frequent competitor for Western business leaders' attention - almost laughable. Cigarette production in the two factories in St. Petersburg - Klara Tsetkin and Uritsky - equals that of Hungary. The Moscow or the Volgograd regions are equal in consumers and in industrial production to Hungary and Czechoslovakia combined. Moreover, from Russia you gain easy access to 51.4 million more consumers in Kazakhstan and Ukraine.

Three, its people are educated. The communists did not do a lot right, but they managed to provide a relatively good education system, especially in the sciences: 99% of Russia's population is literate, most people have 11 years of education, and 12% have higher degrees.

Four, it has some good technologies and industries. Russia's oil, natural gas, hydro and nuclear energy, metal making, and timber industries are known to be relatively strong and have a strong, albeit politically subsidized, export track record. At the same time, these are considered to be the growth industries.

Five, |first-mover' advantages have been created by market upheaval. Russia's leaders have embarked on unprecedented economic reform. The sheer scale of Russia's privatization and market reform efforts - creating new companies starved for foreign investments - are opening up opportunities for the strong-hearted who are willing to accept political risk to pursue buy now, buy low' strategies. One consumer products company, by entering contracts with the two largest producers to help them privatize, was able to exploit such a strategy and secure a near monopoly production position in Russia's northwest region with very little short-term cash investments. * Bottom Line: These five factors mean that Russia inevitably pops up on every business leader's "should investigate" list.

Four Opportunities

More specifically, companies must look at four strategic opportunities Russia presents: 11 Source of unit or revenue growth: For one consumer products company with whom we worked, obtaining only a 3% share of the St. Petersburg and Moscow markets would represent 25% unit growth. Capturing this share is, of course, far from certain. * Source of low-cost supplies or production: Russia is being explored by dozens of companies as a source of cheap materials and cheap assembly. One wire producer has found that assuming they can bring Russia's process controls to Western standards, they can achieve a 25% materials cost savings (this factors in free-market energy prices). * Source of new capabilities: For example, some firms are moving quickly to gain control of key technologies where Russia has world-class capabilities in metallurgy, avionics, and other fields. 11 Means to consolidate regional positions in Europe, Central Asia, and the Far East: This last opportunity is the most difficult, at present. Because of its vast size, Russia can help firms strengthen their regional positions in three different markets. How this will be done, however, is an issue global companies are just beginning to explore.

Why Do Firms Hesitate to Enter?

Of course, the question of Russia is not simply about opportunity - it is also about risk. There are six reasons why firms are hesitating to move into Russia:

One, the need to protect home markets. This is not the greatest time to be an emerging market, be it Russia, Hungary, China, Vietnam, or Brazil. Global capital is relatively scarce due to the domestic preoccupations of the Japanese, Germans, and Americans. Most global companies, dealing with recession in their home markets and fierce competition in their overseas markets, are worried more about consolidation than expansion, and business executives are more concerned with finding ways to raise short-term operating income than increasing long-term market investments.

Two, Russia ranks low on emerging markets lists. If it is generally a bad time to be an emerging market, it is a loathsome time to be Russia. Global companies are faced with unprecedented market opportunities due to for simultaneous events:

- The destruction of the Soviet bloc;

- The resolution of the Latin American debt crisis;

- Me trickle-down effect of Japanese and Korean growth in Asia; and

- The re-emergence of China along what history will probably decide is a fundamentally better reform path than that of the Russians (economic first, political later).

Russia's 150 million consumers represent only 4% of the former Communist, Latin American, Southeast Asian, Indian, and Chinese bloc. There are lots of places to sell toothbrushes, it seems, and, unfortunately, Russia has its history and its future battling against itself.

Three, Russian history. Most business leaders know enough about Russia to know its rather limited history with capitalism. Russia's supporters point to the potential to lead Europe in industrial growth; but realists point out that in recent times, Russia has had a dreadful habit of reversing reforms, often at the expense of its most successful entrepreneurs - the fate of the NEPmen and Kulaks 70 years ago still haunts today's entrepreneurs. The recent coup and stillrabid parliamentary debate about the evils of capitalism keep the threat of reversal ever constant. Finally, and most important for today's investor, Russia's confusing and weak property laws do nothing to create confidence that investment dollars will be protected from political winds.

Four, Russia's future. If Russia's history causes pause, its future offers little comfort. The task at hand is unprecedented and daunting. One example: In the 1980s the U.K- dominated world privatization; and in 1990 alone, 67% of the asset value of privatized companies came from the U.K. Yet, throughout its 15- year privatization effort, the U.K. privatized about 90 companies. Deputy Prime Minister Chubais, in charge of Russian privatization, will receive 3,000 to 5,000 applications to privatize - over the next 12 months. Even worse, one needs to place this challenge in the context of hyperinflation, currency instability, massive unemployment, and destroyed supplier and distributor networks.

Five, Russia's neighbors. Poor Russia tends to lose even if companies decide to enter. Many business leaders are deciding on what we call "Budapest Launchpad Strategies," i.e., the idea that the best way to enter Russia is through Eastern Europe. Companies can cut their teeth on the idiosyncrasies of post-communist economies without jumping headfirst into Russia. Moreover, they can establish a base of operations in Hungary or Poland to serve Russia at a later point.

Six, the headlines are bad Finally, the headlines coming from Russia are often bad - old communists march on Red Square, Yeltsin's opponents decry his economic mismanagement, front-page photographs of angry and frightened Russian workers abound. Such headlines inevitably send shock waves through a company: Board members shoot off letters asking why the CEO would even consider a Russian venture, stockholders get nervous, etc. Given factors one through five above, it is no wonder that many decisionmakers are holding off on a decision on Russia.

Bottom Line: Given these six factors, many firms are stuck: They recognize the opportunities but hesitate even to look at the market because of risk. They are not only balancing risk versus opportunity but also opportunity against opportunity, which is, of course, the heart of strategic thinking.

Three Common Pitfalls

This usually leads to one of three results:

Analysis paralysis: Firms conduct study after study of the Russian market. Most of the studies go like this: There are 150 million people. This means that we can sell 600 million units per year at U.S. consumption rates. But, we'd have to give them away because the consumer cannot afford our product. Besides, Russia is going to hell in a hand basket." Every three months, firms commission a new study and it always concludes the same: The opportunity is huge but the timing to enter is premature.

Contact-based approaches: Usually, after three such studies, one go-getter in the firm decides that what is needed is less analysis and more action. He or she has received a call from a Russian who can guide them into the market and introduce them to the "right" people. Four people fly off to Moscow, usually take one trip to Nizhny Novgorod, meet three deputies and two directors, drink a lot of vodka, and sign four Protocols of Intent. The go-getter is overjoyed with his/her success, returns to headquarters, but is suddenly left with nagging questions: Who were those guys? What exactly were they in charge of? Did they own anything or have any right to negotiate?

Half-way measures: This third common pitfall has two variants: * Scenario One: The CEO meets Yeltsin and decides the firm must be in Russia, especially since Yeltsin provides assurances that he will expedite all requests to set up a venture. Me CEO shoots a letter out to the European division saying, "We must be in Russia," and gives the division director the lead. Unfortunately, the director is given no operating income relief and is left trying to invest in Russia while meeting annual targets. * Scenario Two: The international sales manager makes a trip to Russia and closes a small deal to export $500,000 in product. He works the deal himself and maybe it meets half of his expectations. He sets up three more deals and believes things are moving. Suddenly, corporate finds out that the division is in Russia after corporate decided to hold off investments. The sales manager is not given the support necessary to move his modest business ahead.

None of the three outcomes is desirable and all, in our view, are avoidable. In order to solve the question of Russia, we believe firms need to radically rethink how they look at the market while keeping their strategy hats on. Firms must think big but act small.

How Can We Balance Risk and

Opportunities?

The strategic opportunities in Russia over the long term are great. In the short term, however, the situation is bleak. How, then, can firms position themselves to gain access to Russia's opportunities without unnecessarily exposing themselves to risk? We believe that firms must rethink the way they view Russia. They must think in terms of buying an "option" on Russia's future.

We offer a final list to support this new thinking. We believe that the answer to the Russia Question falls into three buckets.

Bucket One: Change How You Think

About Russia.

Do not think about Russia, think about the region of Samara: The Soviet Union is dead and, for that matter, Russia is a bit wheezy. Luckily, micro-economic success, which is primarily what firms worry about, does not necessarily care about "Russia." Successful entry into Russia today will depend far more on the region that firms enter and their ability to achieve regional success. Firms should target Russia the same way they think about targeting investments in the U.S. - on a region-by-region basis. This seems obvious, but until recently, we were trained by Soviet and Western analysts to view Russia as a monolith. It is not, and never was.

Next, be contrarian: Avoid Moscow, St. Petersburg, and large-scale restructuring and huge defense conversion projects: As a corollary to thinking regionally, most firms should avoid the obvious stops on everyone's Russian tour - this includes Moscow (too corrupt), St. Petersburg (too trendy), and defense "industries or enterprises" (conversion will take a long time). On the latter issue, it is worth noting that in a 1960s report on U.S. defense conversion efforts, the Arms Control and Disarmament Agency (ACDA) noted that there has never been a successful case of a defense product being converted to commercial use. They repeated this observation in 1990. See, however, |factory-within-a- factory' approaches discussed below.

Achieve higher ROIs through low Rs but lower Is: The reason so many investments in Russia are not made is that the return on investment is so low. This is due to conservative estimations of return and assumptions about high investment. When firms shift their thinking to regional entry strategies, they should also greatly downsize their expectations about return and investment. Firms should adopt "plant a seed strategies" in the regions during periods of high macro-risk.

View returns in terms of first-mover advantages: For serious global firms, the Russian entry decision will be made in terms of 15- to 30-year paybacks. Nonetheless, they still make financial decisions based on five-year operating cash flows of their Russian business. This all but ignores the benefits of first-mover advantages in calculations, and generally leads to a "no" decision on entry. But the main reason for entering Russia today is to secure first-mover advantages. These include: gaining years of in-country operating experience with small investments, securing supply and distribution channels, developing new channels, buying cheap production assets and factory space, developing early brand awareness, etc.

Bucket Two: Do Not Change the Way

You Think About Strategy.

Firms must change how they look at Russia by shrinking the market into a series of manageable investments. This does not mean that firms should also change their basic approaches to strategy. And yet, too often, firms move into Russia believing that all Western decisionmaking goes out the window because it is the "Wild, Wild East!" Despite the chaos in the market, firms must focus on the following two priorities in decisionmaking.

Make fact-based, not contact-based, approaches: Firms must abandon the notion that they cannot make a fact-based decision in Russia. Consumers exist. Competitors exist. Profits exist. They can be interviewed, analyzed, and calculated. Such analysis can separate fact from opinion and make for better decisions. As in every market, it pays to know what customers want, what competitors are providing, and how a profit can be created by providing more for less.

Rely on consensus-building frameworks: Firms must realize the road to Russia begins at headquarters. They cannot enter the market unless they build consensus internally about why they should invest. We encourage firms to gain consensus when answering these three questions about moving into Russia:

1) Is there a compelling reason to be in Russia in the long term?

2) Do the early mover advantages outweigh the early mover risks?

3) If yes" to both questions, can I develop an entry strategy that minimizes capital at risk in the short term?

It is to this last question, how to minimize capital at risk in the short term, that we offer our final list.

Bucket Three: Firms Should Stop

Thinking and Jump.

We are bullish on Russia because we think the stock is cheap and it is a good time to buy. We do not, however, think Russia is a risk-free market for shareholder capital. Over the next five years, it will be the riskiest market global firms have to be in. We argue that firms should enter Russia one region at a time and with small investments. But, even these small investments can and should be protected. We offer five ways.

Let the market talk ,6re product through the chain: With consumer products clients, we argue that the first step to entering Russia is to send a container of product over and throw it onto the streets. The best way to get a feel for customers, competitors, and costs, in our view, is to first fire products through the chain" and see what happens. This approach generally pays for itself because firms can secure small container-size deals, it is real, and it gets the organization mobilized to the fact that there is a market "over there."

Control the value chain: Most ventures break down in Russia because Western firms underestimated the need to control all supply and distribution channels. Because such efforts will require more investment dollars, you must limit the size of the overall project rather than try to skimp on upstream/downstream investments. Thing Big - Act Small. It is better to try a small deal and get it right by developing good suppliers and distributors than be locked into the same dollar investment with control over only one part of the chain.

Pursue factory-within-a-factory solutions but cautiously evaluate technology niches and labor/materials-intensive areas: We discussed the need to be cautious about large-scale ventures. This is not to be confused with avoiding large enterprises. Firms should aggressively consider factory-within-a-factory ventures, focusing on the best lines. With each deal, firms must be very clear on what they are getting from the Russian partner. In general, the most likely benefit will be some technology or labor/materials cost savings. With technology, be tremendously suspect of process controls: Russia can produce high technology goods but usually at great production costs because of no quality controls. Given that most Russian technologies are one to two generations behind, they are likely to be approaching commodity status where the game is production control, not simply end-product quality.

With labor costs, remember that Russia's labor wages are discounted heavily due to additional subsidies the state provides in housing, vacations, medical benefits, day care, and other so-called "social assets." Labor will catch on very quickly that if you are not providing these, they must demand higher wages to compensate. With materials costs, remember that input prices now still reflect subsidized energy costs. As these lift, you'll see a dramatic rise in downstream prices.

Seek multilateral funding: The hidden secret in Russia is this: Multilateral agencies, such as the World Bank, have hundreds of millions of dollars that they need to spend on micro-support, i.e., monies to enterprises, but have no means to target enterprises or determine whether the investments are good. The term you will hear is "pilot privatization" support. They desperately need the cooperation of Western business in identifying good targets for their capital. The Overseas Private Investment Corporation (OPIC) provides investment insurance and a variety of services and is a good source for medium- to long-term financing for overseas investment projects through loan guarantees and direct loans. These organizations will help you develop a project, finance a project, and implement a project. They are rewarding first movers in Russia.

Do block and tackle' implementation: Remember that, in the end, entry into Russia is "Entrepreneurship 101." We have helped firms develop detailed entry strategies, and there is one common thread to the implementation plan - be flexible and prepare to do almost anything (that is legal). We have helped load up vans to relocate tenants from a building clients have purchased. We have helped buy logging equipment to sell Russian timber to make pulp to give to Russian factories to make cigarette paper to supply to factories to make cigarettes to barter for metal that will help our client make paper clips. Think Big. Act Small. Be Patient.

Have performance milestones, and view withdraw as a positive decision: Finally, firms need to monitor their results against performance milestones and be prepared to withdraw if none of their goals are met. This forces firms to clearly articulate goals and stick to them. It also rewards managers for taking the risk of entry and taking a rational decision to withdraw.

The Bottom Line

If firms think about Samara, not Russia, and think about "plant a seed strategies," not huge capital investment projects, we think they will push much more aggressively for investment in Russia today. Today, Russia is tremendously risky and uncertain, but there is one thing that is absolutely certain. In 25 years, the leading Western firms in Russia will have one thing in common - they were there for the wild days. They had a long-term plan, but they started small. They will share stories of the crazy days in Samara and they will reap the profits gained from being a first mover.
COPYRIGHT 1993 Directors and Boards
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Copyright 1993 Gale, Cengage Learning. All rights reserved.

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Title Annotation:entering the Russian market
Author:Allen, James; Rogers, Paul; Smith, John
Publication:Directors & Boards
Date:Jan 1, 1993
Words:3421
Previous Article:Ten commandments for investing in the Eastern Bloc.
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