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Russia's protracted recession: How are consumers and companies coping?
www.pwc.ru/consumer-business-report
June 2016
B
Contents
Introduction 1
Summary of key findings 2
This time it’s different 5
Consumers’ response 6
Impact on business 14
Getting ready for the future 18
Contacts
“Change before you have to”
Jack Welch
1
Introduction
After lengthy boom times, Russia’s consumer market is now undergoing a sharp contraction that is ushering in fundamental change. We believe that the effects of this protracted downturn will be severe and will radically alter the consumer and business landscape for years to come. In light of this, we have conducted this survey for the second year in a row to track what the most significant changes are and how attitudes and perceptions among consumers and companies alike are being reshaped by the “new normal”.
We hope that our findings will give businesses and investors the insight they need to assess the opportunities and risks in Russia as well as provide clear-cut guidance for developing future strategies.
• How is the economic downturn affecting companies and consumers?
• What are the short- and long-term expectations for the duration of the current economic situation?
• How are consumers changing their spending habits as a result of the crisis?
• Can we expect similar trends to roll over into the post-crisis period?
• What will Russia’s post-recession consumer market look like?
• Is the crisis affecting consumers across different segments?
• How are companies adapting to the new realities?
• How can companies best prepare for the post-recession?
About the survey:
In conducting the survey, we used the same methods and metrics as last year, and covered the same time period. To better understand the various aspects of Russia’s current economic crisis, we conducted in-depth research, consisting of:
• a survey of 2,000 Russian citizens representing a cross-sample of Russia’s urban population
• 20 in-depth, follow-up interviews with consumers that we had interviewed for last year’s survey, which we conducted while personally accompanying subjects on their everyday shopping trips, where we sought to pinpoint how their behaviour as consumers had changed and what was driving the change
• a survey of 62 middle managers at Russian and multinational corporations with a presence in the Russian market, focused on understanding the impact the crisis is having on their businesses
• over 18 interviews with top managers of companies active in Russia about the strategic challenges they face, as well as the opportunities that the crisis has brought and how they plan to respond
• open-source and publicly available research and data on economic indicators and consumer confidence
• comparisons to other foreign markets that have recently experienced a crisis
• analysis of the current crisis in the context of past Russian economic downturns
This year we have focused primarily on in-depth interviews with the same people we spoke to last year so as to accurately gauge how their attitudes may have changed and why.
We should note that the opinions of consumers and managers may occasionally paint a picture that differs from the hard statistics that we have benchmarked them against. For example, sales managers have been quite negative due to declining volumes, although higher prices have partially compensated for this, but the decline in volume has tainted their perceptions more.
Key questions covered
2
Summary of key findings
Russia is now mired in a protracted recession, which differs significantly from the country’s last steep downturn in 2009 and will likely have a much slower path to recovery. While signs of recovery may now be visible on the horizon they offer substantially less prospects for renewed growth than in previous decades due to a very different set of macroeconomic conditions
While consumers and companies alike appeared to be somewhat in denial last year, both still hoping for a quick recovery, our research shows that there is now a widespread acknowledgment and acceptance of the current situation and outlook.
The survey shows that consumers are feeling significant effects from the crisis and have become more negative in their perceptions of their personal circumstances and their expectations for a limited recovery.
The upper middle class has started to feel the impact of the crisis more, while people at the lower end of the scale are very concerned whether they will be able to bounce back once recovery finally sets in.
Businesses that had been quite hopeful for a quick recovery only a year ago were mainly making purely tactical changes then, but have now adjusted their perceptions and are preparing for the “new normal” with more structural changes to their business models.
Consumers are changing their behaviour to a significant degree
During the period of fast growth seen over the previous decade, Russian consumers were very luxury and brand focused, and driven to spend.
The short-term impact of the crisis has been a widespread switch to cheaper brands, cutting down on consumption, buying more on promotion and shopping at low-budget retailers.
In terms of attitudes, consumers have become 1) more discriminating and critical about what they buy and what services they get, resulting in a stronger trend toward switching to other retailers or making complaints when dissatisfied; 2) more price and quality conscious concerning what they buy; and 3) even more price and finance conscious, which affects personal savings strategies.
In addition, consumers have changed their long-term outlook and now feel
more insecure about the future, and unsure of whether they can rely on government pensions to cover their needs once they retire.
This protracted recession is leading Russian consumers to become more price-sensitive and display cautious behaviour, which is actually similar to that of Polish consumers. The two groups are comparable in disposable income levels, although Poland experienced a much more subdued upturn and slower growth in disposable income than Russia has.
We expect these behaviours to stick and the recession to act as an accelerator for certain trends that had already started long before it set in.
Our research from economic downturns in other countries shows that several behavioural changes can be “sticky” (e.g. channel shifts, private label acceptance or switching brands).
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Russian сonsumers have also indicated that they plan to continue with certain newly acquired habits after the recession.
Before the recession set in, consumers had already started to show greater sophistication and more awareness of the choices they have and differences in product quality in their search for value.
As noted, they now feel more uncertain about their future prospects, which may lead to higher savings rates once they are able to save again.
The changes we observed differ across segments and geography; in particular, we now see a strong divergence between Moscow and Russia’s other regions.
In the previous decade, all Russian regions sought to catch up with Moscow in terms of the pace of development and growth in disposable income, which supported rapid expansion into the regions to seize on the consumer boom.
Now, we are starting to see a divergence, with Moscow showing greater stability while its medium-sized peers across Russia, cities with less diversified economies, are deteriorating much faster.
As we have seen elsewhere, major cities in Russia look and behave more like those in other countries, which could mean that Moscow and some other cities will vary greatly from the rest of the country.
In response to these changes, companies need to adapt their offerings (i.e. what to offer, how to offer it, at what price, and how to communicate value to consumers).
This will require adaptation to new realities and an understanding of the consumer’s needs.
Paradoxically, though, many companies have cut back on basic market research just when obtaining consumer insights is becoming a critical factor in weathering the recession. Thus, they may not be communicating the right messages (e.g. different values should be highlighted, a different product mix).
In the past two decades companies have been focused on managing rapid growth, launching new products, increasing production capacity and building distribution channels
During this period, businesses grew more complex, while the focus on costs has lessened and the maturity of processes has not developed at the same relentless pace.
With post-recession growth expected to be modest at best, market dynamics are changing fundamentally, prompting companies to adapt and transform the way they operate to prepare for the “new normal”.
Not only because of shrinking demand, but also because of changing consumer behaviour, the higher cost of imports and overcapacity in many markets is changing the competitive dynamic and forcing companies to rethink their business models and enhance their capabilities.
Whereas last year companies were mainly carrying out purely tactical changes (e.g. cutting spending on travel, marketing, etc.), the changes are now becoming more structural in nature (e.g. operating model, cutting production and logistics costs).
However, we see considerably more space for further adaptation as companies still have a lot of room for making improvements in business processes and workforce productivity.
In addition, companies need to rethink their product offerings and competitive geographies (for example, several segments have now become more cost-competitive compared to others, which should help boost exports).
Therefore, even given the challenges of a protracted downturn, Russia’s new economic environment offers ample opportunities to succeed and grow profits for those companies that are sufficiently agile and can adapt successfully, together with their customers, to current market conditions.
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5
This time it’s different
This recession has not been as steep as previous downturns, but it is affecting consumers, while the road to recovery is less clearIn contrast to 2008-2009, when Russia and the rest of the world experienced a full-blown banking crisis, and 1998, when Russia was hit with a debt and currency crisis, what we’re seeing this time around is more of a textbook recession in an economy that is still heavily dependent on commodities. However, there is no doubt that the severity of this recession has been exacerbated by the imposition of sanctions by the United States and the European Union as well as Russia’s counter sanctions, which have increased inflation and restricted financing.
Although the economic slowdown may have seemed somewhat sudden, growth had been limited long before the oil price took a sharp plunge.
This time is also different because of the more protracted nature of the downturn. While the current drop in GDP may be less steep than previous declines (-4% in 2015 versus -7.8% in 2009), we are now already well into the second year of decline. The most optimistic growth forecast for 2016 is currently -0.2%, while a contraction of 1.2% has already been posted for 1Q 2016.
But, most importantly, this recession has had a heavy impact on the consumer, with high inflation and limited salary growth resulting in a sharp decline in real incomes (-4% in 2015) and, consequently, purchasing power. In April 2016, real disposable incomes fell 7.1%, marking the severest decline since May 2015, when a 7.7% drop-off was posted, according to Russian Federal State Statistics Service (Rosstat) data.
With Russia’s economy now in its second year of recession, the current downturn is beginning to show signs that the inevitable recovery will be slow and difficult. Moreover, current macroeconomic factors are not supportive of a speedy, robust recovery.
Consumer behaviour can play a critical role on the path to recoveryWe expect Russian consumers’ response to their declining purchasing power to echo how their Western European and Japanese peers reacted in the aftermath of their countries’ crises in 2009 and
1997-1998, respectively. Specifically, consumers cut back on spending for an extended period in the post-crisis stage due to shaken confidence, changed perceptions of long-term financial security, endangered pensions, and the increased need to reduce personal debt loads, such as the trend seen in several Western European countries of voluntarily paying down mortgages early.
In Europe, dampened consumer confidence and subdued spending habits had a negative impact on long-term recovery prospects. Unlike in the EU, however, Russian consumers tend to have relatively lighter personal debt burdens given the considerably lower level of mortgage lending in Russia. But, there’s no question that consumer confidence has been shaken and long-term perceptions have become more cautious, thus negatively influencing future spending decisions, which in turn could well further dampen recovery prospects.
Совершать меньше покупок
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Consumers’ response
Consumers are more downcast this time around...Eighty-six percent of consumers responded that Russia is experiencing a crisis, or slightly more than in last year’s survey. In addition, this year 79% of consumers surveyed said that they are personally affected by the crisis, representing a 5% year-on-year increase. While this may not signal a big change in percentage terms, it represents considerably more in terms of perception. More than one-third of those surveyed said they saw their income fall in the past 12 months. If we match the dynamics of income distribution for all respondents with CPI, we see that 91% have experienced a real decline in income.
What this means essentially is that a number of consumers are continuing to fall out of the middle income bracket into the lower income strata. In speaking with some of our in-depth interviewees from last year, we noted that, by and large, they have not seen any positive change and view the current situation and the future in a more negative light.
“The crisis started for me when one of my friends got laid off.”
…and are now more pessimistic about the prospects for recovery and the futureOur respondents this year believe that the crisis will not end before early 2019, compared to last year’s survey when the expectation was for recovery to arrive by mid-2017 (by comparison, businesses are more optimistic on this account, believing that the crisis will end by 2018).
Some of those we interviewed last year who had been expecting a quicker recovery, now tell us that they simply “don’t see any reason why the situation would improve in future”.
Figure 1: Reported income decline has accelerated, with visibly more people reporting nominal income declines of -10% or more
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Real income decline
Share of respondents whose nominal income has changed in respective way, %
Increase
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45No change
91%
2Q 20181Q 2019
Last year - same for business and consumers
2Q 2017
Figure 2: Consumers and business executives now differ on when the downturn will end
Weighted average duration based consumers’ and businesses’ responses
Business
Consumers
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Previous consumer behaviour patterns are no longer viable as they were shaped largely by the legacy of the “rapid growth” story of the 2000s
Real incomes had been growing rapidly in Russia over the past decade (on average by about 7% annually in real terms). As a result, people were consuming more, including buying on credit, behaviour that was driven by the widespread expectation that things would only get better and that a higher income tomorrow would cover debts incurred today. Currently, however, declining real incomes and very modest, downsized expectations for the future are making such confidence-driven consumption patterns untenable.
“For example, before the crisis I could make impulse purchases; I could buy an expensive, brand-name handbag just because I wanted it. But, now, I realise that I must be more rational about what I buy, although it’s not pleasant for me.”
As a result, we are seeing fundamental change in consumer behaviourChange is visible first of all in consumption and shopping: the overwhelming majority of our respondents say that they have begun taking measures to cut expenses (84% versus 79% last year). Thirty-six percent of survey respondents said they can afford “a lot less” goods and services, while 28% responded “noticeably less”. In core categories (food, apparel, cosmetics and hygiene) 52% of respondents are either buying less or have started buying cheaper products, compared to 47% in our 2015 survey.
Increased purchases of goods on promotion are extremely visible this year. As well, this has become the most popular tactic for saving on food purchases.
Our in-depth interviews suggest that impulse purchases have been virtually eliminated from normal shopping routines. Our interviewees tend to interpret this not just as a way to realise savings, but more of an overall step in the right direction as such “impulse purchases were useless anyway and often unhealthy”, as one respondent put it regarding impulse purchases of food items.
Meanwhile, private label products are enjoying a high rate of adoption across all income brackets. Russian consumers tend to be well aware of private label goods (only 11% are unfamiliar with the category). A majority of respondents (73%) have
bought private label goods, with 13% reporting having bought more private label items this year. Meanwhile, 55% of respondents believe that goods sold under a private label are no worse than brand-name goods. Respondents are now more willing to try private labels, as demonstrated by increased use of private label items among big city residents and higher-income shoppers. In our in-depth interviews, we often heard that opting for a private label item is seen as a “good habit to have acquired”, with three-quarters of those who tried such items saying they would keep buying them even after the crisis.
“I have tried private labels and now see that the quality is OK. Going forward, I will continue […] – I no longer have any prejudices against them.”
“I didn’t think about it [private label] before, but now […] I’m choosing whatever’s cheaper.”
Buy less
2015 2016
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Figure 3: Buying more on promotion or discounted items is the most growing savings tactic
Share of consumers who have resorted more to specific savings tactic*, %
* more than 1 answer possible
8
Consumer attitudes toward buying on credit have significantly changed: thirty-nine percent of respondents claim to have taken out some type of loan (same as last year). However, the vast majority of respondents (88%) have no plans to take out any further loans in the upcoming year. This is confirmed by our in-depth interviews, in which some respondents said taking out loans during such a crisis is highly risky, and even “irresponsible”. One said: “I don’t know what will happen tomorrow and, in general, any sort of credit represents a sort of bondage you are sinking yourself into. But, who knows what will happen tomorrow? Maybe everyone will be laid off. The situation isn’t very clear.” Such comments are indicative of the current declining trend in Russian banks’ consumer loan portfolios and the increased share of non-performing loans.
This year, we are seeing even less propensity to save anything for the future, although the underlying reasons differ: most respondents (60%) are unable to save, and the number of non-savers has increased since last year (55%). Among those respondents that actually have managed to save, 65% claim that the amount they could earmark as savings declined over the past 12 months. In line with last year, of those respondents that managed to save anything at all, 68% first spend only on everyday needs and save the rest of their income. Only 32% save first and then spend the rest of their income on current consumption. Our in-depth interviews suggest that this “spend-first” behaviour is sometimes driven by people’s historical experience of having lost savings in the collapse of the Soviet Union and Russia’s 1998 default crisis. Such a “spend it while you have it” mentality may also be due to fears of galloping inflation that threatens to erode the value of rouble-denominated savings. This also reflects significantly reduced consumer trust in Russia’s
national currency, which we hear from our respondents and can see in official statistics, which show a shift in bank deposits away from rouble accounts toward foreign currency accounts.
“I don’t trust the rouble; all of my savings are now going directly into dollars or euro.”
There’s a limited sense of financial security: the vast majority of respondents listed financial security as their most important basic need. One of the factors driving this is the perception of current instability and worries about unemployment.
Figure 4: The percentage of past-due loans is increasing in Russia and has now exceeded peak levels last seen during the previous crisis
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Key rate rise and subsequent tightening of issuing consumer loans
Individuals loan portfolio, trln RUB in Apr’16 prices
Share of loans with past-due (>90 days) payments in individuals loan portfolio, %
9.4%
are not saving60%
40%
2015* 2016
* 55% were not saving in 2015
Source: The Central Bank of the Russian Federation
9
Many of our interviewees mentioned fears about getting laid off in the near future.
“[Ever since the crisis began,] I’ve been afraid to lose my job and that I won’t be able to find a new one. So, now you just have to work more, and do what you can to hold on to the job you have.” But, another very important driver is uncertainty about long-term sources of financial support and lack of faith in the pension system.
“They say there won’t be any pension; I wouldn’t be surprised.”
“I don’t rely on [the pension system]. I rely more on my children.”
Most importantly, we’re observing a change in consumer mentality: people are becoming much more critical and demanding. In our in-depth interviews, we heard how respondents are now critically evaluating the quality of the products or services they are getting, and how they are taking action and demanding satisfaction. “After [getting unsatisfactory service], we called in a TV reporter and went back to that [local supermarket] to demand an apology from the store manager”, one interviewee told us. As another person said: “After unwanted construction work started in our backyard, we [the neighbourhood community] initiated a class-action lawsuit, something we would not have done one or two years ago.” People are also now more conscious of their purchases and savings. “We started to gather in groups to pool our resources and buy everyday items at wholesale prices”, one in-depth interview subject said.
2015 2016
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Share of respondents across different household income groups who have increasingly reacted to recession during the last 12 months, %
Figure 5: The higher income brackets are starting to catch up to lower income brackets in terms of adopting ways to economise
We are seeing how consumer responses differ across various Russian regions and income brackets
Compared to last year, the highest income brackets are noticeably catching up to their less affluent peers in terms of adopting cost-saving measures.
We have also noted an apparent divergence between Moscow and other Russian regions, with Moscow consumers markedly more upbeat: consumers in Russian cities with 500,000 to 1 million-plus inhabitants report being most affected by the crisis and their situation is getting worse. This group experienced the greatest nominal decline in income (reported -4.0% based on our 2015 survey vs -7.4% this year). These cities had the lowest number of respondents claiming that nothing has changed in their behaviour since the crisis began. In contrast, Moscow-based consumers feel better than a year ago and much better than consumers in Russia’s other cities.
Moscow had one of the lowest rates of decline in income, and was the only
city where the rate of decrease has shrunk (reported -2.6% based on our 2015 survey vs -2.1% this year). Our in-depth interviews show that Moscow inhabitants on average have a more positive assessment of the current state of the economy – 3.09 versus 2.75 out of 5 by those from other regions.
Figure 6: Moscow residents assess the current state of the economy more positively on average
Respondents’ average assessment of the current state of Russia’s economy
3.092.75
RegionsMoscow0
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Overall, Russia’s “new” consumption patterns are reminiscent of countries marked by longstanding consumer frugality, such as Poland; clearly, the crisis is accelerating this shift
Polish consumers, while having similar disposable income levels, have developed along a very different path than their Russian peers. Specifically, they have not enjoyed the type of high-growth boom marked by rapidly rising disposable incomes that had until recently supported high consumer spending in Russia.
As a result, Poles have exhibited frugal spending habits for a long time, providing fertile ground for developing private labels, discounters and economy retail formats in the non-food segment. The Russian consumer is only now approaching such spending patterns, and rather abruptly so as massive changes in consumer behaviour have occurred within the span of just 12 months. One high-income Muscovite explained, “There is no longer this idea of being ‘chic’. Now, we have started to be more practical, more down-to-earth.” A middle-income respondent said: “My approach has become more rational, even though wages haven’t changed. Something in my head has just changed.”
As previously, we are seeing reduced expenses across categories, where both similarities and differences can be observed
In all product categories, this year we have seen the increased importance of promotions, which is by far more pronounced in the food segment, potentially due to other measures (such as buying less) approaching their maximum level.
Similar to last year, a degree of brand loyalty has also been observed in different categories. In the food category, for example, 35% reported switching to other brands (versus 31% last year), while this number is two times lower in apparel at 17% (versus 16% last year).
“I still want quality clothing. Yes, it’s expensive, but it should be quality and not look like what everybody else is wearing.”
Share of consumers who have appealed to buying more on promotion or discounted items, %
ApparelFood Cosmetics, perfume& hygiene items
24%
38%
18%
10%
8%17%
2015 2016
Figure 8: Disposable incomes in Poland and Russia in international dollars (PPP)
Poland
Russia
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Poland
Russia
CAGR: +5%
CAGR: +10%
Figure 7: Food category is where buying on promo appears to be most important
Source: Euromonitor
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Figure 10: The longer this crisis lasts, the greater the changes will be in consumers long-term behaviour
2015
Private label
30
10
Fewer impulse purchases
35
5
Price/promo monitoring
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Cheaper retailers/hypermarkets
2015 2016
Share of respondents who would like to retain their new habits after the economic situation becomes better, %
Among the higher income bracket, we see continued reduction of entertainment and recreational spending. Interestingly enough, in our in-depth discussions with people at their homes, they tended to speak differently about this. For example, while many still describe travel as one of their priorities in life, patriotism is now frequently cited as a reason for cutting back on foreign travel.
“Travel is a priority; I’m trying to save more on food, household items, etc.”
Our findings last year suggested that these “new” behaviours are here to stay; this year, we’re seeing further proof that “sticky” habits are becoming even stickier
Increasingly, consumers are more likely to continue closely monitoring prices and product promotions even after the crisis ends. Forty-five percent of respondents from different income brackets and regions agree on this, compared to 35% in the previous survey. “No matter what, I’ll buy on promotion, and it seems to me it will always be like this”, answered a middle-income respondent. In addition, more consumers now prefer to stick with cheaper retailers – 20% versus 15% in last year’s survey. Some form of shopping discipline has begun to be the norm, as 65% of respondents said they are taking a more rational approach to spending as well as resisting the temptation of impulse purchases. However, only 15% said they have become accustomed to more “rational” shopping when it comes to shoes and clothing, i.e. buying purely out of necessity, while 30% would like to spend more on such items when the crisis ends. Buying fewer everyday goods is probably the only measure that will reverse once income growth starts picking up.
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Share of people with monthly household income of over RUB 50,000 who have cut spending on …
Eating outDomestic
travelForeigntravel
Share of respondents who have started to buy fewer items or cheaper goods during the past 12 months by monthly household income in RUB, %
4247
3340
5467
2015 2016
2015 2016
20152016
Figure 9: Higher-income consumers have cut spending on eating out and travel
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Figure 11: UK consumers continue to stick to economy measures even after economy went up
GDP per capita real growth in UK vs discounters share, %
GDP real growth
7.7
3.3
20103.6
3.52015
2010
2015*1.9
0.8
-4.9
-1.3
2008 2009 2010 -2015
Discounters share(Modern Grocery
Retail)
Looking back at the EU experience, we observed that people didn’t necessarily give up a number of the anti-crisis savings tactics they had adopted during the downturn once the EU economies recovered from the 2008-2009 crisis. Great Britain is a good example: During the 2008-2009 crisis, discounters like Aldi and Lidl started to grow rapidly based on their “economy” value proposition. Our own consumer research back then showed that retailer choice was one of the most “sticky” behaviours. In the years that followed, one can clearly see those findings confirmed, as discounters are not only continuing to grow, but also accelerating the pace of growth.
Bill Simon, former CEO of Walmart’s US operations, noted that thrifty behaviour has become an essential feature of the modern consumer: "If you look at data from Millennials, who have really sort of grown up with this, price is more important to them ... than it was to the last generation." (Source: Reuters)
So, companies must adapt their offerings to cater to the “new” consumer
The frugal consumer is here to stay: our intensive research into consumer habits confirms that Russian consumers are fundamentally changing their spending behaviours in ways that are likely to be permanent. Having lived through more than one economic crisis, Russians will likely continue to be more cautious in their spending, even after the economy eventually returns to growth.
This will require rethinking the consumer offering, including:
• What to offer? – What is the optimal product mix; which new products should be introduced and which current ones should be dropped from the assortment? How can we extend the current brand or launch a new one at different price points?
• How to offer this? – Which channels will need investment in the new environment?
• At what price? – Given changes in price sensitivity, is the price and promotion strategy still valid or should it be adjusted?
• And, how do we communicate this value to consumers?
Continuing on the latter theme, the fundamental laws of branding are not changing: the “brand promise”, or the role of the brand for the consumer, means:
• presenting an image and inducing aspiration;
• conveying information about the product; and
• reducing the risk of a unsatisfactory purchase.
Even in the current situation, the role that brands play is still very important. Over 65% of our respondents say that brand consideration is part of their purchasing decisions, across categories.
But the focus is clearly shifting from aspiration to value. The majority (56%) of those who stay with favourite brands also display a higher-than-average sensitivity to promotions.
Can brand owners retain such loyal but frugal customers before they make a “sticky” switch to cheaper segments? We believe that the answer is: Yes, they can
But, this will take a paradigm shift. Yet, what we too often see during a recession is that many companies cut back right away on the basic market research that provides critical consumer insights and, so, may not be communicating the right things (e.g. reinforcing the quality message). This effectively breaks the OODA-loop of marketing (Observe, Orient, Decide and Act). Instead, such companies essentially put the proverbial “cart before the horse” by starting with action (i.e. cutting spending on marketing) just when initial
* Cumulative to 2009
Source: Euromonitor
13
observation (i.e. gaining consumer insight through research) is most critical.
At the same time, however, we are seeing many leading players already adapting to the new environment, for example by fully leveraging big data to understand their consumers’ actual definition of “value”, as well as using advanced analytics to model effective and profitable promotional campaigns, and following the consumer across shopping channels to offer the right product at the right time. Clearly, those companies that make such efforts will be the winners, not only now but in the longer-term “new normal” environment as well.
Brands must be redefined to keep pace with today’s rapidly changing market environmentToday’s consumers are looking for more value; they are more selective because they now have less spending power. Given this, many brands are having a difficult time adjusting after a relatively long boom period. Russian consumers in particular have been very brand loyal. As consumers are downshifting, changing their values and buying patterns, retailers are responding by expanding their private label offerings.
As the crisis has deepened, brands have been affected unevenly across segments and market positioning. For example, many local food manufacturers have been able to cope and even thrive, while importers of branded durable goods have been hit hard. The "calm middle" of non-food FMCG seems to be experiencing moderate difficulty, trying to pass exchange rate-induced cost inflation along the value chain to retailers and consumers.
During such turbulent times, there is a big temptation to save on promotion, cut marketing budgets and, most dangerously, cash in on brand names by introducing cheaper, lower-quality versions of a well-known product under the same brand name. But, this can be a major mistake. In times of crisis, brands change neither in function nor in value. While fewer consumers may have the money to afford premium brands (which is a temporary effect), this fact should have no influence on those who still can and want to buy their favourite brands and enjoy the quality they are used to.
To mitigate the effects of the crisis, successful brand owners can employ a range of tactics to stave off a decline in the bottom line. First, shrinking package size (without changing quality or messaging) can allow for selling either smaller, more affordable units, or larger, longer-lasting units of a product. Second, a crisis can have a telescoping effect, leading to more granular consumer insights and thus the need for more focused market research. Yet, so often when a crisis hits you see the typically knee-jerk, seemingly intuitive reaction of cutting costs on market research, which is a soft target as one of the easiest discretionary spending items to reduce.
While most companies automatically economise on market research in times of crisis, the most successful ones take a counterintuitive tack and do the exact opposite – they invest more in market research. After all, when if not during a crisis does a company need to better understand what has changed in the mind of the consumer and in their shopping behaviour? Finally, branding and marketing efforts overall should keep aiming at reaching the consumer, while being ever mindful of subtle changes in consumers’ value systems. For example, if pre-downturn advertising tends to place greater emphasis on emotional appeals to pride, status and self-indulgence, when crisis sets in the same marketing vehicles and branding instruments are typically re-messaged to deliver a more functional appeal centred on product performance, endurance, total cost of ownership, and other practical considerations.
So, increased insight into changes in consumer spending should help Russian consumer goods companies to rethink their communications strategies and brand portfolios (i.e. where to stretch, change and innovate), as well as to focus on how best to distribute their products, especially given changes in channel mix and the sharp divergence of the Greater Moscow consumer market from the rest of the country.
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Impact on business
Echoing last year’s survey, most companies report being affected by the crisis, although 14% say it has been in a positive way In line with last year, 72% of managers say that their companies have been affected by the crisis, either positively or negatively. A strong majority (58%) report that the effect has been negative.
And, most respondents are feeling increasingly more negative about the economic environment than they did one year ago, and are not expecting an “instant” recovery In this year’s survey, only 45% of managers believe that the economy will improve within the year, compared to 68% in 2015. In line with last year, managers continue to think that the crisis will be over in two years; but, this time, recovery is expected in 2018, not 2017. However, respondents have no illusions about the prospects for “instant” recovery. There is a consensus view among them that Russia’s current economic situation is exceptional, with 55% of respondents saying they believe the current recession will have an even more pronounced negative impact on the Russian economy than the last crisis in 2009.
The current crisis is having a profound impact on corporate performance, as company after company reports revenue declines for the second year in a row (in real terms)On average, companies in all sectors are experiencing additional declines in revenue. In the past 12 months, companies reported an average revenue decline of 7%, in addition to the 10% decline reported last year. When asked about their companies’ revenues, the managers we surveyed tend to think in broader terms than pure revenues, often focusing on a mix of sales volumes, prices and actual revenues. As a result, we see their responses as being indicative of real-term revenue
growth dynamics, the core drivers of which can be outlined as follows:
• 67% of respondents report shrinking general market demand (due to lower real disposable income or cost-cutting)
• 33% have been affected by a decrease in market prices
• 29% report that they are losing market share, which may be of greatest relevance for middle and premium segment players, whose consumers are increasingly trading down and switching to cheaper analogues
At the same time, companies are suffering from cost increases, leading to a significant squeeze on profits The vast majority of managers reported increases in material costs (90% versus 77% last year) and similarly high level of overheads. As expected, an especially strong impact has been seen among those companies that rely on imported materials. “[We have to raise prices as] we use imported materials and local distributors have raised their prices”, a regional dairy products company reported.
Figure 12: The majority of businesses have been negatively affected by the crisis
Figure 13: How did the market share of your company change in money terms? Why?
Negatively affected
Positively affected
58% 14%
A premium multinational distiller: “[We have lost market share as] consumer purchasing power has decreased and our product is not so cheap”
A mainstream Russian distiller:“[We have gained market share as] our product is more attractive for the consumer, and thus they have started to consume more of it.”
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But, this negative effect from the crisis is not uniform, with some sectors and types of companies either suffering or benefiting more than others Fourteen percent of respondents reported a positive effect from the crisis on their companies. The main beneficiaries have been local manufacturers whose products compete with imports and have not had to raise prices as much as their competitors (56% of those that are positively affected). Agribusiness sector companies have also benefitted greatly from exchange rate changes, Russia’s counter-sanction measures and government support programmes. Despite having seen numerous export-boosting initiatives among our clients last year, official statistics show that exports overall have declined (when measured Jan-Feb 2016 versus Jan-Feb 2015).
Banks and industrial companies have taken a more significant hit compared to consumer goods, which is attributable to the relatively protected status of demand for foodstuffs as well as the supportive effect of consumer price inflation on nominal revenues. However, consumer goods companies are on a downward trend (managers report on average stronger revenue declines than last year: -4% vs -1% in 2015). This echoes with the increased frugal behaviours of consumers. This is also seen in official data with a real consumer goods market growth rate of 2015 versus 2014, where 2015 looks worse almost in all categories.
Larger companies, however, enjoy a stronger position than smaller-sized operations, and are reporting feeling less of the negative impact of the crisis, with some even posting gains in market share. On average, the smaller companies (i.e. less than 2,000 employees) that we surveyed reported average revenue decreases of 12%, whereas larger companies (i.e. more than 2,000 employees) saw average revenues decrease by only 2%. In future, we expect changes in market consolidation, with small and medium-sized companies being forced out or exiting the market altogether.
Figure 14: The most negative aspects of the crisis
Share of respondents who experienced effect from negative aspects of the crisis, %
Increase of material cost
90%Sales decrease due to lower demand
67%
Increase of overheads
60%
Inability to finance new projects
47%29%
Increase of working capital cost
Agriculture the new oil?Russia’s agricultural sector is booming. The protective measures implemented by the Russian government in response to European sanctions and Turkey’s actions in Syria have created unique conditions for local agribusinesses by allowing them to boost production as part of Russia’s import substitution effort. In addition, the recent rouble depreciation has enhanced the competitiveness of local Russian meat and grain products to the point where many domestic agribusiness companies have begun to look at expanding their sales geographies with a view to entering new foreign markets and becoming international players.
For large-scale agricultural producers, this implies rerouting outbound logistics flows and obtaining product certifications in accordance with international requirements. For medium-sized players, tapping such new opportunities requires making major investments in production practices, process maturity and infrastructure. As we observed recently, several players who are seeking to capture this growth opportunity have increased production volumes by extensively scaling up their farming operations while, at the same time, neglecting such critical success factors as improving processes, biosecurity, coordinating transport infrastructure and optimising distribution networks. As a result, Russia is fast becoming a European leader in animal antibiotics use, while simultaneously approaching the bottom ranks of Europe’s national-level animal health ratings, as evidenced by an outbreak of porcine reproductive and respiratory syndrome virus (PRRSV). So, to achieve sustainable success while avoiding the types of food scares and outbreaks of disease that China and some other countries have experienced, Russian agribusiness players must catch up with best practices by introducing processes that increase food quality and security.
There are many opportunities for agricultural production companies to improve efficiency given the low level of process maturity. These include typical process development initiatives but also the introduction of “lean” best practices, which have proven to be highly effective in the agricultural sector across the entire production chain (provided that employees are properly trained). One specific challenge for meat production companies is cross-functional coordination, which requires thorough sales and operational planning and tightly aligned KPIs, which to date has typically not been the case in Russian agribusiness.
We have also noted that very few Russian agribusiness players currently have strong, mature go-to-market and branding strategies in place, thus providing ample room for improvement. This is visible in the massive amounts budgeted and spent on above-the-line (ATL) and below-the-line (BTL) marketing without precise monitoring of the effects, thus leading to margin leakage and underperforming sales channels with low service levels and dissatisfied customers.
In conclusion, this could well be the beginning of a golden age for the Russian agribusiness sector, which already boasts many large-scale companies. But, to succeed in the longer term and capture the nascent export potential, these companies will need to ensure that their internal corporate structures are in shape and limber enough to keep pace with the rapid market growth.
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In response to a more structural crisis, more companies have started to take optimisation measuresKey categories of immediate cost cutting are still on top of the list:
• Procurement still tops the list of cost-cutting priorities (buying fewer and cheaper materials, cutting down on fleet management and office supplies)
• Cutting marketing expenses is still cited as a key optimisation measure
• Cost reduction in production and logistics have increased significantly
In addition, this time we are seeing a significant increase in structural cost reductionsWithin procurement, we have noted some changes in the status quo for key measures. Specifically, we are seeing an increasing number of procurement managers who reported having changed supplier terms (up by 15 percentage points [pp] versus 2015), as well as procurement policies (up by 17pp versus 2015) and procurement localisation (up by 12pp). Meanwhile, straightforward reductions in stock keeping units (SKUs) (down by 41pp) and simple volume reductions (down by 26pp) have become less popular. Very notable is the reported increase in the share of companies that are implementing sales and distribution optimisation initiatives, which is up by 31pp compared to 2015. In particular, many companies have started to rethink service levels, with the share of managers reporting this up by 14pp versus 2015. This trend effectively mirrors what we are seeing among our clients, who are increasingly initiating route-to-market optimisation projects.
67%
37%
34%
22%
47%
47%155
319
1
Increase compared to 2015, %
2015
Procurement
Production
Sales and distribution
Logistics
Marketing
Value proposition
64% 60%
55%
55%
Advertising reduction
Discounts reduction
Marketing channels change
POS marketing reduction
2016
2015
36%
Promo costs reduction
86%
38%57%
48%76%
64%
86%
Figure 15: Companies are now more focused on optimisation
Figure 16: Main measures for cutting marketing costs
Share of respondents who implemented optimization measures, %
Share of respondents who implemented certain measures in marketing, %
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Within marketing, we have seen a decreasing focus on reductions in such “discretionary” spending items as advertising (still the No. 1 cost-cutting target but down by 22pp versus 2015), while more companies have reported changing marketing channels (up by 17pp).
Overall, we are seeing a more sophisticated approach in how such cost-cutting measures are being applied as opposed to top down temporary reductions.
However, much more can be doneFor example, companies are not reporting a strong focus on their value propositions: 78% of sales managers state that they have taken no measures to change their value propositions. A regional dairy products company told us, “[We are losing customers to cheaper products, but] … we cannot switch to producing lower-segment products as this requires re-equipping our production lines, which we do not have the money for.”
Production optimisation, which should follow value proposition (e.g. by implementing “design-to-cost” approaches and lean transformation), has yet to become a top priority for corporate cost optimisation efforts. In addition, our survey found that 79% of companies do not use outsourcing, while 71% have not localised production.
In the long term, we expect to see a shift even further towards complex restructuring of business modelsWe believe key success factors are changing and that, to be successful, companies must 1) address changing consumer needs and 2) become “leaner”. This would require adjusting value propositions, which in turn should induce fundamental changes in business models, including production changes. In addition, given the still immature state of business processes among Russian companies, we think that there is still room for widespread adoption of lean, continuous improvement techniques, especially among local manufacturers. Finally, overall corporate strategies should be more closely linked to KPIs for individual departments, including cross-functional KPIs.
Russian retail market has been growing exponentially in the past and is now going through its first significant longer term slowdown. The significant devaluation of the currency rate forced retailers to increase prices but consumers have not been able to afford this. This has immediately led to a shift of consumers to lower priced formats such as the soft discounters in food retail. As a result, the key promise of retailers has become low prices. To support this promise they drastically changed assortment by including a higher share of cheaper products and by decreasing the width of its assortment. Private labels and cost optimization are key levers for supporting affordable price and good quality of goods. In spite of decreasing consumption, developers are trying to hold their profits and we see a deficit of attractive places for new stores. Some big box retailers are testing new formats of stores, which look like real discounters.
While retailers can still increase their market shares, in many segments store density is reaching high levels. This is exacerbating the need to be cost competitive. In the past gross margins were high for Russian retailers and operations costs were less efficient than international benchmarks, partly due to the complexity of the country, partly due to the focus of management on rapid growth. Now retailers are forced to lower their cost base and optimize their assets in order to maintain profitability in an environment with increased competition and cost pressure. Western retailers started this development many years ago as their markets were already more consolidated. For Russian retailers with less to no market growth there is ample opportunity to do and most retailers are only at the beginning of a significant operational transformation that provides a lot of potential.
This operational transformation consists of several areas. For example using new technology such as big data analytics and predictive analytics help retailers to convert their huge number of their data into real money in sales and decreasing of advertising costs, however this development is still in its infancy, as we still see limited local capabilities and with a lot of potential to be achieved. The spreading of automation processes for time planning of staff in stores and equipment of stores tools like self-checkout machine, roll containers and other tools for reducing labour cost has become visible. We are helping many retailers to implement lean stores processes and rationalise assortment as reliable answer for current challenges. Integrated planning to lower working capital and supply chain costs and increase service levels is another lever with a lot of prospects for many retailers.
Retail moving rapidly from growth paradise to cut throat competition
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Getting ready for the future
While the crisis of 2008-2009 was short and steep, and followed by a period of strong growth, we are now looking ahead toward a post-recession period that will be marked by much slower growth. Therefore, the challenge for companies today is not only to successfully navigate the current recession but also to operate within the bounds of the so-called “new normal”.
Limited growth on the horizonAfter nearly two decades of rapid expansion during most years, the growth outlook for Russia is now a lot less rosy for the next 5-10 years, barring a currently unforeseen very strong uptrend in oil prices and fundamental renewal of economic infrastructure and regulatory reform.
First, most economies develop in waves and very few are able to grow three decades in a row, especially once they reach the middle-income level.
As very open economies with high levels of investment in technology and education and a strong focus on services, South Korea and Taiwan have been notable exceptions. While most emerging countries went through a significant slowdown after reaching a certain state of a production oriented industrial economy.
Second, several of the factors that had driven strong growth in Russia’s economy in the previous decades are now no longer in play, at least for the medium term, with the obvious main factor being high oil prices. However, such other factors as a growing working-age population, high investment flows and increased utilisation of the Soviet-legacy asset base combined with the oil price to support growth. But, all of these factors have now changed. Oil is less likely to return to its historical highs, as increased supply from shale plays will
likely create a ceiling. The working-age population will decline over the next few years due to Russia’s low birth rates in the 1990s amid the economic shocks of the Soviet collapse. Russia’s fixed asset base is mostly well utilised but in need of renovation. However, increasing of the asset base will require more new investment, which is stymied by continuing capital outflows (and current sanctions).
As consumers change their shopping habits and cautious companies look at potentially postponing spending and investments, the inevitable recovery could well be delayed further.
Therefore, even in a post-recession and post-sanctions economy (the latter is vital for improving the climate for attracting financing), Russia’s growth outlook is modest at best with scenarios of GDP growth of between 1.5-2.5% most likely.
Figure 17: As customers become more demanding, it is vital that companies successfully shape perceptions of the desired customer experience to their competitive
Expectations are being shaped by experiences outside of your industry, where content, interactions and features may be much richer and more compelling.
Easy access to research and data will expose efforts to mislead and enable comparison to your competitors; transparency and authenticity are required.
Undifferentiated products and services, lack of loyalty, easy access to alternatives and low barriers to defection mandate extra effort to retain your customers.
... expect more ... are informed ... have choices
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Supply driven market:· Focus on fast growth· Competition for customer new to market· Customers are more focused on availability then on costs
Success factors: · Rapid expansion · Good distribution· Reliable quality
Demand driven market:• Customers are more mature and more price and quality conscious • Competition is higher
• Market is oversupplied• Switching between the suppliers is more often
Success factors• Consumer insight• Cost excellence• Flexible operating model
From managing rapid expansion...
... to optimizing for the "new normal"
Riding the wave Fighting for every inch
Figure 18: The slower growth environment will lead to change in market drivers and success factors
There are, however, some potential benefits to be derived from lower oil prices. The so-called “Dutch disease” of a strong currency due to high oil and gas sales tends to make other industries less competitive. As the noted Dutch football player Johan Cruijff once said: “Every disadvantage has its advantages.” Now is as good a time as ever to diversify the Russian economy. Toward that end, several sectors have become more cost competitive in comparison with other countries, opening up opportunities to develop more export-oriented industries.
Succeeding in Russia’s “new normal” will require a fundamental change in corporate business models
The country as a whole needs to see a rebalancing of the economy in this changed environment, and the same applies to companies.
Previously, most companies were focused on managing rapid growth in what we would define as a very supply-driven market. Demand was
growing so fast across segments that companies were building new plants, launching new products, expanding into new cities, and competing for new customers and new markets. At the same time, customers – both ordinary consumers and B2B – were more focused on product availability and quality than on price.
In the past two decades, Russian businesses have modelled their structure on a rapid-growth model – one that no longer exists. Management teams were very focused on the top line and a lot less concerned about their cost structure and managing their processes. At the same time, though, rapid growth led to the increased complexity and scale of their companies.
In today’s new landscape, we are seeing a shift toward a more demand-driven market, with more supply capacity than demand in several segments, where customers are more mature and more price and quality conscious, with tougher competition with more professional procurement departments and more switching between suppliers
and, potentially, between brands. This has compelled companies to fight for market share, which requires both a focus on the top line through product differentiation and providing a strong customer experience, while simultaneously managing the cost structure and bottom line to be price competitive and profitable. Together, these strains are forcing companies to rethink their business models so as to better navigate the “new normal” of low growth and a more frugal and sophisticated customer, and the coming post-crisis competitive landscape.
The changes that we are seeing now were wholly predictable and entirely logical. But, they are occurring much faster than in a number of other markets, with Russia’s current recession acting as an accelerator.
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Challenges (and opportunities) aheadOur survey and our experience with clients show that companies are beginning to improve their business practices in order to deal appropriately with the new reality. While we believe these are moves in the right direction, they signal what is just the beginning of what should prove to be a significant transformational journey for those companies that seek to operate successfully in Russia over the next decade.
Meanwhile, those companies that are slow to adapt will place the future of their business in jeopardy. However, companies that are serious and dedicated about their own transformation will be able to grow their share of the large Russian market, with the added potential of expanding their revenue base beyond Russia through increased exports.
Figure 19: Previous growth drivers are no longer at play: current consensus expectations for the medium term economic development are rather moderate
-8
-4
0
4
8
12
2008 20122006 200720042002 2005 20182010 20152014 20172009 2011 201320012000 2003 2016 2019
Real GDP annual growth in 2000 – 2015 and 2016-2019 consensus forecast*, %Aver.
Annual Growth: 1%
2013-2014 1H: • High oil price• No sanctions• Stagnation explained by the
structural economic reasons
2018 on:• 2013 dynamics to
continue unless structural changes happen in the economy
Aver. Annual
Growth: 1.5%
• Growth of working-age population
• Relatively high investment flow
• Increased utilisation of fixed asset base inherited from USSR
• Fast-growing oil production sector
– Intensive exploration of natural resources
– Oil price increase
• Other factors of labour productivity growth
– Steady stream of high-achieving new graduates
– Transfer of “simple” technologies
• Decrease in working-age population
• Low investment amount
• Utilisation of fixed asset base at ceiling level
• Stagnation of oil production sector
– Limited exploration of new fields
– Stable oil price
• No other factors in labour productivity growth
Before 2008 After 2018Key factors of GDP growth
VS.
*International Monetary Fund, The World Bank, J.P. Morgan, Ministry of Economic Development of the Russian Federation, S&P, Sberbank, Morgan Stanley, Economist Intelligence Unit, Global Insight
Within the business community, the word “crisis” generally carries a negative connotation, and along with it a pessimistic outlook and lower expectations. However, it is our view that the new environment in Russia offers ample opportunity to succeed and grow, provided that companies have the requisite agility and ability to adapt to today’s challenging market conditions.
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Special thanks
Anastasia Shevchenko
Anna Dzhalladyan
Igor Koganovsky
Ilya Malyarenko
Kirill Kuzmin
Ksenia Butorina
Louise Dickson
Mikhail Molozhaviy
Olga Ivanova
Stephen de Bethune
Tatyana Metelkina
Vyacheslav Buyevskiy
© 2016 PwC. All rights reserved.
PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity.
Contacts
PwC Russia provides industry-focused assurance, tax, legal and advisory services. Over 2,500 professionals working in PwC offices in Moscow, St Petersburg, Ekaterinburg, Kazan, Rostov-on-Don, Krasnodar, Voronezh, Novosibirsk, Vladikavkaz and Ufa share their thinking, experience and solutions to develop fresh perspectives and practical advice for our clients. Together, these firms form the PwC network, which includes over 208,000 employees in 157 countries.
Please contact us for a more detailed discussion of the matters covered in the survey:
www.pwc.ru/consumer-business-report
Dmitry LyakhovetsDirectorConsulting Services+7(495) 967 [email protected]
Martijn PeetersPartnerConsulting Services+7 (495) 967 [email protected]
Anton ZadorozhnyySenior ManagerConsulting Services+7 (495) 967 6000 [email protected]
