No fear of sanctions among Russian retailers

Date : 21 October 2014

While the ban on imported products has presented EU suppliers and manufacturers with a challenge, Russian retailers do not see it as a significant problem and remain positive in their outlook of the new market situation. New opportunities are arising for foreign suppliers in non-EU countries and domestic retail players may slow down store development in 2015.

The Russian government imposed a one-year embargo on the import of fruit, vegetables and dairy products from countries which supported the EU and US sanctions against Russia almost 3 months ago. How are Russian retailers dealing with the consequences of these sanctions and what implications do we foresee for retailers, manufacturers and consumers – find out in our report.

Ordinary shoppers less affected and while retailers remain confident

As we have learnt from our recent trip to Russia, ordinary shoppers have been less affected by the out of stock situation in grocery stores in contrast to middle class and premium shoppers who buy imported, high-end products like French cheese and Norwegian salmon. Consequently, it was upmarket retail chains like Azbuka Vkusa and partly German Globus which have been hit hardest by the import ban, while large retailers like Magnit, X5 Retail Group and Dixy Group were affected to a lesser extent. In our conversations with leading retailers we found out that they remain very positive about consequences of the import ban and believe that they will be able to replace banned products without significant problems. Indeed, Russian media has reported that Magnit, the largest retailer in Russia, has already replaced suppliers of all banned goods. Even though the banned product categories account for between 5% and 10% of retailers’ revenues, retailers say they do not anticipate any negative impact on their annual profit as they pass price increases on to shoppers.

Opportunity for Serbia and Turkey, while domestic suppliers unwilling to invest

New opportunities are arising for producers of beef in Brazil and Argentina, salmon in the Faroe Islands, fruit and vegetables in Kazakhstan, Turkey and Serbia. However, Russian retailers will have to increase control over the product quality and consumers may spot differences in quality until new suppliers have brought their products, packaging and supply chains up to expected standards.
Some produce may be sourced from domestic suppliers, but we remain sceptical about this possibility as the Russian government has not taken any clear measure to support local suppliers and farmers. This will discourage both producers as well as investors from allocating funds into the expansion of production facilities (providing there is funding from banks). Indeed, the search for suppliers abroad will remain the common, less risky strategy.  

Photo: Serbian apples (left), Russian apples (right). An issue which will retailers face, difference in the product quality and packaging.

By-pass via Belarus – not a solution for big players

Some of Russia’s suppliers have started to source banned products from the EU via third-party companies in Belarus, a trade ally of Russia, as well as via Turkey. Although these routes may bring French Brie to Russian shelves, we believe that only small retailers and independent players will be able to use this distribution channel. Accounting transparency, quantity and consistency in supply will make this opportunity unrealistic for large players.

Substitution of private label products not an alternative

One could suggest that investment in private label products could be an alternative to replacement of banned products. However, we consider this solution as unlikely for two reasons: many Russia’s manufacturers do not have the capacity and technology to secure consistent delivery in the quantity and quality required by retailers in the short term. For the same reason as investors, they are unlikely to react to the market situation and to invest in the expansion of their production facilities without any guarantee from the Russian government. Secondly, many private label products or their ingredients were sourced from EU countries. As a result, the revenue share of private label products may decline in many grocers in 2014/2015.

Food inflation growing

As we predicted in our analysis at the beginning of August 2014, food inflation has accelerated with prices rocketing by 20% in product categories like Norwegian salmon. According to Rostat, food inflation almost doubled to 8.4% in September 2014 in comparison to 4.4% in September 2013.
Inflation growth contributed to high like-for-like (LFL) sales in Q3 2014 as reported by Magnit and X5 Retail Group. Magnit’s LFL sales growth was up 17.2% in Q3 2014 in comparison to 4.3% in Q3 2013, while X5 Retail Group reported 13.3% in Q3 2014 in comparison to -1.7% in Q3 2013.

2015 – slow-down in store expansion

We forecast that retailers’ revenue growth in 2015 will be driven mainly by inflation, while LFL sales consumer spending will continue to decline. We expect a strong drop in LFL sales of electronics and fashion retailers which has been partly seen already in H2 2014.
Grocery retailers may cut down on their store expansion plans, investing more into store efficiency and assortment optimisation to meet the needs of squeezed shoppers looking for cheaper alternatives. As the penetration of private label products remains low, we expect branded manufacturers to be put under pressure to increase their branding, price and promotional activities. It will be retailers with developed private label ranges like Auchan, as well as retailers operating price-oriented store formats like Atak (Auchan) and X5’s Pyaterochka who may benefit from the future market scenario.

Miloš Ryba is a Senior Retail Analyst International at IGD. Miloš has been analysing global retailers and emerging markets for more than a decade. His deep expertise lies in Central & Eastern Europe and Central Asia. Miloš regularly presents at leading conferences in Europe, Middle East and Asia and features in European and North American media.