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portreMarket Profile: Russia

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1 Market Profile: Russia © Planet Retail Ltd 2008

Executive Brief

Macroeconomics

Local currency: Russian Rouble 2004 2005 2006 2007 2008 National Statistics

Inhabitants (mn) 143.974 143.420 142.894 142.370 141.844

GDP (USD mn) 591,599 764,143 984,979 1,221,195 1,479,096

GDP / capita (USD) 4,109 5,328 6,893 8,578 10,428

GDP (% nominal growth) 28.7 26.8 23.9 16.6 16.4

GDP (% real growth) 7.2 6.4 6.7 7.0 6.5

Consumer price inflation (%) 10.9 12.7 9.7 8.1 7.5

Consumer spending (USD mn) 296,839 380,479 479,781 586,019 693,816

Consumer spending / capita (USD) 2,062 2,653 3,358 4,116 4,891

Retail sales, net (USD mn) 190,214 238,803 295,865 356,690 417,185

Retail sales, net / capita (USD) 1,321 1,665 2,071 2,505 2,941

Grocery retail sales, net (USD mn) 83,062 102,312 124,730 148,593 171,876

Grocery retail sales, net / capita (USD) 577 713 873 1,044 1,212

Foodservice sales, net (USD mn) 12,723 16,642 21,353 26,419 31,658

Foodservice sales, net / capita (USD) 88 116 149 186 223

Total food spending, net (USD mn) 95,785 118,954 146,083 175,012 203,534

Total food spending, net / capita (USD) 665 829 1,022 1,229 1,435

Planet Retail Statistics

MGD, Total sales (USD mn) 55,072 77,264 106,589 152,625 202,450

MGD, Total sales / capita (USD) 383 539 746 1,072 1,427

MGD, Grocery sales (USD mn) 48,439 67,812 93,468 133,485 175,444

MGD, Grocery sales / capita (USD) 336 473 654 938 1,237

Horeca universe, total sales (USD mn) 15,843 20,766 26,697 33,098 39,740

Horeca universe, total sales / capita (USD) 110 145 187 232 280

Horeca universe, food sales (USD mn) 15,013 19,638 25,196 31,175 37,356



Horeca universe, food sales / capita (USD) 104 137 176 219 263

EEO sales (USD mn) 15,606 20,203 25,731 31,743 37,958

EEO sales / capita (USD) 108 141 180 223 268

Key Economic Indicators

GDP, 2004-2013 (USD mn)

GDP Real Growth and CPI, 2004-2013 (%)

Consumer Spending, 2004-2013 (USD mn)

Total Food Spending, 2004-2013 (USD mn)



Key Characteristics

Population in context

Despite a shrinking population which has recently fallen below the 145 million mark, Russia is by far the largest consumer market in Central & Eastern Europe. Approximately 8.5% of Russians live in the capital Moscow and its suburbs, and there are 12 cities in the country with more than 1 million inhabitants. Political situation

More than 15 years after the collapse of the Soviet Union in 1991, Russia continues to struggle to create a democratic political system and fight bureaucracy. However, Mr. Putin’s dominant position in Russian politics will keep the country politically stable for the next couple of years.

Economy in context

Thanks to its large population, Russia is by far the biggest economy in Central & Eastern Europe. On a per capita basis, however, the country remains far behind the region's more advanced lead economies, such as Hungary, the Czech Republic and Slovakia. However the economy is growing very fast (partly as a result of high oil prices), and the economic situation in Moscow, St Petersburg and Tyuman is much better than weak national averages suggest.

Key regions

Russia's undisputed number one cultural and economic centre is the capital Moscow. Another key centre is St Petersburg. Besides these two areas, investors have started to pay attention to the Volga region, Central Russia, North Caucasus and Urals.

Market concentration

Russia's food retail market is extremely fragmented due to the size of the country and the underdeveloped retail scene. It is only Moscow and St Petersburg that significant consolidation has taken place. In fact, the St Petersburg market is becoming saturated. On a countrywide basis, the top five grocers capture a combined share of around 15% of the modern grocery distribution. Food market facts

After the Russian economic crisis in 1998, many international players in the food sector left the country or filed plans to expand there. The following years of global companies' absence was well used by domestic players which are now in a strong position. Metro Group and Auchan are the only foreigners amongst the country's top 5, which is in striking contrast with other CEE markets where Western domination is much stronger. However, foreign interest has increased again strongly in the last couple of years forcing local players to react proactively, and as a result Moscow, St Petersburg and other regional cities are now in the middle of an unprecedented investment boom.

Legal aspects

For investors moving into Russia, bureaucracy and corruption are amongst the most obvious problems. In terms of retail regulation, opening hours are largely liberalised. However, legislation might become more restricted over the coming years as the competitive situation in Moscow and St Petersburg is changing fundamentally.

Future prospects

The outlook for Russia’s economy is highly favourable, with roughly 6% real GDP growth expected in the foreseeable future. This will be mainly due to high international oil and gas prices, a major driver of the country’s economy, as well as increasing domestic demand coming in the wake of fast-rising wages. A further economic boom will be supported by expected membership of the World Trade Organisation.



Economy & Demography

Population

Despite its shrinking population, which has recently fallen below the 145 million mark, Russia is by far the largest consumer market in Central & Eastern Europe. Approximately 8.5% of Russians live in the capital Moscow and its suburbs, and it is worth mentioning that this 12 million area alone has more inhabitants than countries such as Belgium, Portugal, Hungary or the Czech Republic. Meanwhile, 77% of the national population live in urban areas, which is a very high value by CEE standards. The population is divided into roughly ten percent living below the poverty line, a small super-rich elite in Moscow and St Petersburg and a large and struggling lower middle class. After Moscow, St Petersburg is the country's second-most important economic and cultural centre. Still, there are 12 cities in the country with more than one million inhabitants and all of them are listed below. In terms of religion, roughly one quarter of the population are Russian Orthodox and 10% or 15% Muslims. The illiteracy rate in Russia is low at less than 5%.

Regional Centres

Region No. of inhabitants (2003) Moscow 12,100,100

St Petersburg 4,891,100

Urban Centres

City No. of inhabitants (2003) Moscow 8,376,000

St Petersburg 4,619,800

Novosibirsk 1,396,800

Nizhniy Novgorod 1,346,400

Yekaterinburg 1,260,000

Samara 1,150,000

Omsk 1,137,900

Kazan 1,109,500

Ufa 1,094,900

Chelyabinsk 1,081,200

Rostov 1,012,500

Perm 1,002,500

Political development

More than 15 years after the collapse of the Soviet Union in 1991, Russia continues to struggle to create a democratic political system and fight bureaucracy.

Despite obvious progress in the last few years, democracy deficits continue to include the over-representation of former army and secret service officers in the state administration as well as the continued suppression of criticism of the government.

The parliamentary elections in December 2003 were "free but not fair", according to official observers from the European Council, and unsurprisingly confirmed President Putin and his supporting parties in power. And it was no surprise either that Mr Putin also emerged as the winner from the presidential elections that were held in March 2004. The United Russia party of President Vladimir Putin won the presidential election in November 2007, which was described by international observers as “unfair”. Mr Putin’s victory proves its unchallenged supremacy in Russian politics.

The presidential election in March 2008 won Dmitry Medvedev, the first deputy prime minister of Putin's cabinet, and Mr. Putin is high likely to become the Prime Minister.

Putin’s most impressive achievement during its 8-year presidentship was the consolidation of the Kremlin's power by the building of "power vertical," an authority tree to take decision-making rights back to the root, namely the central government, and to save the then largely dysfunctional state from falling apart.



Economic growth

After 10 years of crisis, peaking in August 1998 with the devaluation of the rouble, the Russian economy bounced back more quickly than many expected. In fact, since 1999, the country has enjoyed solid economic growth (albeit from a very low level when compared with Western standards) with annual GDP growth rates ranging from around 5% to 10% in real terms.

This will be mainly due to high international oil and gas prices, a major driver of the country’s economy, as well as increasing domestic demand coming in the wake of fast-rising wages.

A further economic boom will be supported by expected membership of the World Trade Organisation. Even though the outlook is very positive in the short term, Russia may encounter problems in the medium term due to government’s aspiration to centralise the economy.

In the short term, not all Russians will benefit from the prospering economy as the country continues to be heavily characterised by inequalities. The population is divided into a roughly 10%-strong stratum living below the poverty line, a small super-rich elite and a large and struggling lower middle class.

Consumer price inflation

Consumer price inflation has been very high but improving constantly since Russia’s economic crisis in the late 1990s, coming down from 86% in 1999 to 9.7% in 2006. As the long-term trend continues, inflation should remain below the 10% mark, giving greater planning security to companies and making money saving more attractive to private consumers, whose saving rates are now expected to rise.

In the longer term, this will create the mass market basis for non-food chains selling bigger ticket itmes, such as furniture, high value entertainment electronics or branded clothing.

Consumer spending

With the economy growing fast, consumer spending is also increasing quickly as housing and utility costs are relatively low.

In Moscow and St Petersburg, consumer spending is concentrated as highly as nowhere else in the country (per capita spending here is probably three and two times above the national average, respectively), so virtually all significant retail operations - including both domestic and foreign players operate in these two areas. Despite recent expansion schemes carried out mainly by domestic players to move into the provincial main cities, we cannot expect any massive change of consumer spending growth in Russian regions. An exception is the Ural region (Tyuman, Ekaterinburg), where the buying power is by 40-50% higher than in Central Russia.

It is worth mentioning that despite the growth, wages continue to be extremely low by Western standards. The average monthly salary exceeded USD500 in August 2007. Earnings of supermarket employees in Moscow (where wages are significantly higher than elsewhere in Russia) typically range from EUR200 to EUR250 per month, whereas in the country's provinces, many pensioners receive as little as EUR20 a month, largely living outside the monetary economy. Certainly, this says a lot about the mass market's actual spending power.

Economic Indicators

Local currency: Russian Rouble 2004 2005 2006 2007 2008 Inhabitants (mn) 143.974 143.42 142.894 142.37 141.844

GDP (USD mn) 591,599 764,143 984,979 1,221,195 1,479,096

GDP / capita (USD) 4,109 5,328 6,893 8,578 10,428

GDP (% nominal growth) 28.7 26.8 23.9 16.6 16.4

GDP (% real growth) 7.2 6.4 6.7 7 6.5

Consumer price inflation (%) 10.9 12.7 9.7 8.1 7.5

Consumer spending (USD mn) 296,839 380,479 479,781 586,019 693,816

Consumer spending / capita (USD) 2,062 2,653 3,358 4,116 4,891Note: For definitions of market sizes, please refer to our macroeconomics section.



Retail Sales Retail sales

On a nationwide basis, retail sales account for almost 60% of consumer spending in 2007, which a very high proportion when compared with Western European standards. This is because the overall standard of living here continues to be much lower than in Western Europe or North America, so local consumers can only spend a relatively small proportion of their incomes on non-retail items, such as property, cars, holidays, health and education - and this is especially true given the fact that price differences between Russia and the West are much smaller than the differences in incomes would suggest. As is the case with Russia's economic output and private consumer spending, retail sales are also mainly concentrated in Moscow, St Petersburg and Tyuman, where per capita figures are a lot higher than the national average (probably three and two times as high, respectively). However, the modern retail has recently started to spread into densely populated regions or industrial regions.

Grocery retail sales

Some 40% of retail sales in Russia are generated through the food retail sector. This is a relatively high value when compared with most Western European countries and is once more mainly due to the relatively low standard of living. In practice, this means that Russian consumers have less money left to spend than people in Western countries on non-food items such as entertainment electronics, clothing or DIY goods. In Moscow, St Petersburg, Tuyman or Ekaterinburg, where the standard of living in clearly higher than the national average, the proportion of non-food spending is also higher than elsewhere. According Romir Monitoring Holding, 67% of Russians living in cities larger than 500,000 inhabitants mainly buy their groceries at supermarkets, although half of consumers continue visiting open markets on a regular basis. In 2006, an average monthly basket per capita amounted to USD180.

Growth & forecast

Russia's economy is booming and the same is true for the national retail sector. Even if growth should slow down in the medium term as a result of government’s aspiration to centralise the economy, the overall outlook for the next couple of years is very positive as there will be much room for consumption increases. The outlook is particularly positive for Moscow, St Petersburg and other regional cities, where huge populations with above-average incomes. Whereas the majority of retailers has started to expand in the Urals and Western Siberia (the base of Russian oil industry), the Volga region and North Caucasus (each of population over 15 million) will become the most attractive regions in the medium term. The winning formats will be hypermarkets, price oriented supermarkets and cash & carry, last of which will benefit from the tens of thousands of independent businesses operating in and around Russia’s large cities. Retail market sizes

Local currency: Russian Rouble 2004 2005 2006 2007 2008 Retail sales, net (USD mn) 190,214 238,803 295,865 356,690 417,185

Retail sales, net / capita (USD) 1,321 1,665 2,071 2,505 2,941

Grocery retail sales, net (USD mn) 83,062 102,312 124,730 148,593 171,876

Grocery retail sales, net / capita (USD) 577 713 873 1,044 1,212

MGD, Total sales (USD mn) 55,072 77,264 106,589 152,625 202,450

MGD, Total sales / capita (USD) 383 539 746 1,072 1,427

MGD, Grocery sales (USD mn) 48,439 67,812 93,468 133,485 175,444

MGD, Grocery sales / capita (USD) 336 473 654 938 1,237Note: Grocery sales include food, beverages, tobacco products, drugstore items and small everyday non-foods household goods.



Retail Structure

Hypermarkets & superstores

With the retail investment boom in full swing, a wave of new hypermarket openings has taken place. Until 2005, almost all hypermarkets were located in Moscow and St Petersburg. However, domestic retailers have started to launch their outlets mainly in the provincial cities with more than one million inhabitants.

Apart from Auchan and Metro Group (Real), the hypermarket sector is dominated by domestic retailers such as Lenta, X5 Retail Group, O’Key, Mosmart, Sedmoi Kontinent, Paterson, Magnit and Kopeika.

The clear market leader is Auchan, who has established its foothold particularly in Moscow through the acquisition of Ramenka hypermarkets (formerly owned by Migros Turk).

In terms of the store numbers, the market leader is X5, operating over 30 Carousel and Perekrestok hypermarkets, followed by Lenta. It is interesting to note that X5 run twice as much hypermarkets as Auchan in 2007, but Auchan's turnover was bigger more than twice than the turnover of the X5's hypermarkets.

Usually, hypermarkets in Russia feature shopping galleries with mostly foreign or independent food and non-food outlets as well as restaurants. These increase the hypermarket's overall consumer attraction by making it possible for them to spend whole afternoons shopping around, getting everything they need in just one location.

The latest players to arrive on the scene (following the entry of Globus in 2006) were the South Korean Lotte and Carrefour. Whereas the former opened a hypermarket within a company-owned up-market department store in Moscow in the summer of 2007, the latter is going to launch its first store in Moscow in the late 2008. Despite the store opening in the capital, Carrefour plans to expand mainly in the provincial cities.

Meanwhile, US giant Wal-Mart carried out research on the market. “Nothing specific has come of that, but we are interested in opportunities in the market” Wal-Mart stated in 2006, and essentially confirmed this view once more in early 2007. In the long term, the Swedish Coop Norden and the German Schwarz Group plan to enter Northern Russia.

In contrast to the retailers mentioned above, Edeka decided to withdraw from the market and offered its hypermarket for sale in spring 2006, whilst Migros Tuerk sold its Ramenka network to its joint venture partner Enka in September 2007. Enka sold one store and leased 13 outlets to Auchan in December 2007.

Opening a hypermarket in a newly-constructed standalone building around Moscow requires an investment of some USD40 million, while opening a hypermarket within a shopping center will typically cost around USD20 million.

Supermarkets & neighbourhood stores

Supermarkets play a key role in both Moscow's and St Petersburg's food supply, but apart from Rewe's Billa network that was launched in September 2004, all major operations in Russia are run by domestic companies.

Virtually all of their outlets are located in Moscow and St Petersburg, although recently expansion into Russia's provincial cities has also started. However, some of these regional expanding schemes are taking place on a franchise basis.

The clear leader in the supermarket sector is X5 Retail Group with its strong store bases in St Petersburg, Moscow and the Ural region, followed by Dixi. But it is important to mention that in terms of product offer, store design and operational efficiency few of Russia's domestically operated supermarkets live up to standards known in Western Europe or North America.

French group Auchan, which already operates hypermarkets in Russia, planned opening new supermarkets (Atak) in Moscow. However, it put the expansion on hold in 2007 due to bureaucratic hurdles and logistic difficulties. Meanwhile, Rewe of Germany confirmed plans to expand only in Greater Moscow in the short term.

Given the largely low incomes in Russia (especially in small cities and towns) and country’s geographical structure, independent neighbourhood stores continue to play a key role in the national food supply. The same is definitely true for the open markets, although both channels (also including kiosks, small sales containers and street vendors) have been recently modernised or closed due to changes in the law.



In the middle of this massive volume independent trade, it is worth mentioning that the fast-growing Magnit chain - based in Krasnodar but trading across Russia - has now become a major player in the national food sector. Trading from an average of 250 square metres, the stores mainly cater for the low-income population, which gives it an advantage in the numerous small towns where no other modern grocers have ventured due to their small sales potential.

Discount stores

A rising format in Ukraine's most important cities is the so-called "soft discounter", or "economy supermarket". However, while these stores do not show typical signs of rationalisation through efficient operations and low staff numbers, offer only a limit range of private label products and do not operate appropriate logistics and distribution facilities, they cannot be considered as discount stores of the Western European format.

Apart from a few Auchan's Atak stores, there are currently no Western style discount stores in Russia. However, Auchan plans to double its number of outlets in 2008, while Lidl has announced that it sounds out the Russian market.

Convenience & forecourt stores

Forecourt shops are a booming format in Russia. Although there are only a couple of major international operators active in the market, cities such as Moscow and St Petersburg are getting saturated. The market leader is the domestic Lukoil, operating about 1,500 forecourt shops, followed by TNK-BP with its roughly 1,000 such stores. Shell, further Western European player, is running a much smaller network of roughly ten stores, most of them located in St Petersburg. Among Russian companies, it is worth mentioning PTK, Yukos and Russneft (market leader in Moscow).

Since 2007, Finnish-based retail and distribution group Rautakirja has been expanding its kiosk operations by establishing a joint venture with the Russian OOO Partner Service Group.

Drugstores & pharmacies

The Russian pharmaceutical retail is comprised of traditional municipally-run (state-run) drugstores, operating since the Soviet era, privately-owned pharmaceutical firms and chain operators who have entered the market comparatively recently.

The internationalisation of Russian drugstore retailing started in October 2005, when Hong Kong-based AS Watson agreed to take over health & beauty chain Spektr Group in St Petersburg and Aliance Boots launched the My Favourite Pharmacy format. In 2007, German Celesio acquired Protek Holding, which operates a pharmacy network Rigla.

However, the expansion of the foreign retailers has been continuing gradually. The clear market leader is the Russian company Pharmacy Chain 36.6, which is rapidly expanding through opening new outlets and acquisitions of regional chains.

Department & variety stores

The South Korean Lotte opened a department store in Moscow at the beginning of 2007.

E-Commerce

Internet retailing is still in its infancy in Russia. The number of active web-surfers, entering Internet on an average 1-2 times a week is larger in megapolises (Moscow, St.Petersburg, Ekaterinburg) and big cities (with population above 500,000), while inhabitants of smaller settlements use internet far rarer – frequency of several times a month is typical of them.

Currently, virtual stores are mainly limited to the Moscow region. Key representatives include grocery retailers Sedmoi Kontinent and Nyam-Nyam.

In quarter I of 2006 once or several times a week Internet was browsed by 17% of the respondents, while 7% of those surveyed browsed it on a daily basis.



Cash & carry and warehouse clubs

Modern style cash & carry outlets are a relatively new phenomenon in the Russian market. The leading player in the sector is the German-based Metro group, which since its market entry in late 2001 has already opened about 30 outlets in Moscow, St Petersburg, Central Russia, Southern Russia and Urals. Currently, it is going to expand in Western Siberia. Setting up a new store costs on the average between USD15 million and USD18 million.

X5 Retail Group is considering development of a cash & carry network, whilst German-based Rewe Group is reported to launch its Selgros cash & carry banner in the summer of 2008. (Initial plans to open the first outlet had bee cancelled in 2005).

Delivered wholesale

Due to the little developed cash & carry structure, delivered wholesale continues to play a very important role in the Russian food sector, especially outside Moscow and St Petersburg where there are extremely few companies buying directly from suppliers.



Top 5 Retailers

Retail environment

The market concentration in Russia is very low due to the country size and the very fragmented retail scene. Modern grocery retail is dominated by domestic retailers such as X5 Retail Group, Magnit and Kopeika. Apart from these, there are some large internationals such as Metro Group, Auchan and Rewe, however, with an exception of Metro Group, their expansion has continued gradually.

The majority of modern grocery stores are located in Moscow and St Petersburg. While in Moscow are the leading retailers X5 Retail Group, Dixi, Kopeika and Sedmoi Kontinent, St Petersburg with its almost saturated retail sceene dominates X5 Retail Group, Lenta and O’Key.

Recently, competition in Moscow and St Petersburg has become strong which led to retailers’ expansion into regional cities, densely populated areas such as Nyzniy Novgorod and Volga region and industry cities such as Ekaterinburg and Tuman in Ural and Novosibirsk in West Siberia. Additionally, most of them have adopted a multi-format strategy and try to identify the most successful banner.

In contrast to that a handful of food shops trading from more than 500 square metres are operated in cities with less than 500,000 inhabitants and people mainly do grocery in small neighbourhood stores and open markets. The only modern grocery formats in these cities are presented by Magnit.

In fact, it is thought that small, independent shops (including kiosks) and open markets (including street vendors) still capture a combined 67% of the Russian retail market.

Top 5 retailers in context

There are few key economies in the world where the grocery leader has a market share of less than 15%. The reason why this is the case in Russia is that most retail investment in the huge country is limited to Moscow, St Petersburg and regional cities with more than one million inhabitants, and even in these cities modern structures have yet to establish themselves as the mass market standard.

It will take decades rather than years before a concentration level similar to Western standards can be reached, if it can be reached at all - given the virtually endless space which the country occupies geographically. In the USA, the top five grocers capture around 30% of the market as many retailers limit themselves to regional dominance, also due to the huge distances within the country. This 30% mark is probably where Russian market concentration will stop in the long term.

X5 Retail Group and Metro Group are likely to stay the market leaders in the next half decade. But it will be worth watching Auchan. It may shake up the ranking in the next view years thanks to the acquisition of Ramenka and its fast expansion.

Top 5 grocery retailers , 2008

Company No of Stores Sales Area (sq.m)

Average Sales Area (sq.m)

Grocery Banner Sales (USD mn)

Market Share (%)

X5 Retail Group 1,868 1,680,812 900 7,504 4.3

Magnit 2,320 660,000 284 5,352 3.1

Metro Group 73 615,200 8,427 4,359 2.5

Auchan 58 630,000 10,862 4,085 2.3

Dixi 460 185,240 403 1,936 1.1

Sub Total 4,779 3,771,252 23,236 13.3

Other 152,208 86.7

Total 175,444 100Note: For definitions of market sizes, please refer to our macroeconomics section.



Internationalisation

Inward investment

Since 2000, foreign investors have been showing increased interest in the Moscow and St Petersburg regions. After Migros Türk, which already entered the market in the late 1990s (and left in 2007), the early 2000s saw international heavyweights such as Germans Metro Group and French grocer Auchan enter Russia. Another German grocer, Tengelmann, followed in late 2003 - albeit only with its OBI DIY store banner and on a franchise basis - and Rewe Group in September 2004 launched its Billa supermarket network in a joint venture deal with Marta (followed by the acquisition of 16-strong Prodmak in early 2005). In late 2006, German Globus opened its first store.

In 2007, South Korean Lotte opened a store in Moscow, Finish Rautakirja launched its kiosks, and DIY retailer Kesko opened its first K-Rauta store in St Petersburg. Additionally, Carrefour is going to launch its first outlet in Russia (Moscow, Krasnodar) in the second half of 2008. Meanwhile, some others are at least openly contemplating the move, e.g. Lithuanian Norfa planned to open its first store in Ryazan in 2007. However, the store opening was postponed. Schwarz Group has stated that it sounds out the Russian market, whilst the Swedish Coop Norden plans to enter the market in the longer term. Wal-Mart has eyed Russia since 2005. It stated in late 2007 that it hopes to be in Russia "at some point in the future" and hired a top manager with Eastern European expertise in the spring of 2008.

While all of this sounds very dynamic, due to opaque real estate market, overpriced plots and relatively low incomes of the population, most foreign players (except Metro) are now expanding significantly slower than originally announced. The average supermarket transaction in Russia is only USD4,40 (and probably USD10 or USD15 in Western-style hypermarkets).

The Russian retail scene has seen already some withdrawals. German Edeka (Marktkauf) sold its outlet to Metro Group in 2006 and Migro Türk sold the Ramenka hypermarkets to its joint venture partner Enka, who has leased 13 hypermarkets and sold one hypermarket to Auchan in 2007.

Nonetheless, foreign retail investors are viewed favorably by the authorities as they help reduce the black market and increase VAT collection, while also providing a distribution system that will support the national food manufacturing industry.

Outside food retailing in the most narrow sense of the word, Hong Kong-based AS Watson in October 2005 agreed to buy health & beauty chain Spektr Group in St Petersburg and German Celesio acquired Protek Holding (operating a pharmacy network Rigla) in 2007.

Outward investment

For Russian retailers who are currently investing in their local networks and expanding into regions, international expansion is still hardly a topic. However, there are some exceptions such as X5 Retail Group, Paterson or Sedmoi Kontinet. X5 Retail Group has been operating a couple of Perekrestok stores in Ukraine since 2005 and a small Pyaterochka store network in Kazachstan. Paterson entered Ukraine in 2005, but it put on hold further development in 2006. Meanwhile, Sedmoi Kontinent expanded with is hypermarket banner in Belarus in 2006 and O'Key will open its first hypermarket in Ukraine in late 2007.



Supply Chain Characteristics

Buying groups

As a highly professional food retail sector is still in the process of creation, competition in most areas of the country is so weak that no significant buying group has been founded so far. It is, nonetheless, worth mentioning that a relatively small number of SPAR outlets are operating both in Moscow (since October 2000) and Tula, although the two networks are run by different franchisees and on a rather centralised basis.

The future of SPAR in Russia looked doubtful at one stage, after the network in Nizhniy Novgorod was acquired by Moscow-based retail company Perekrestok in late December 2003, with a good chance of being re-branded, and a controlling stake in the operator of the Moscow SPAR network, Marta, was acquired by the German-based Rewe group in July 2004. However, having identified Russia as one of its future key markets, SPAR International managed to build a new franchise structure in the country by late 2004, making sure that its banner is going to spread again in the short to medium term. SPAR operated about 80 store at the end of 2006 and hopes to double its number in 2007.

Wholesale

Especially outside Moscow and St Petersburg, the Russian market is heavily dominated by traditional structures. This not least implies the existence of tens of thousands of small, regionally operating independent wholesale companies.

Manufacturers

Many of the world's leading manufacturers of fast moving consumer goods already have manufacturing plants in Russia, and their number has increased markedly since the end of the Russian economic crisis in 1998 and 1999. However, some remain hesitant about entering the market due to the still low incomes of the population as well as non-optimal conditions for investment. Nonetheless, Russia has good prospects to become a key export base for products to be sold in Western Europe in the medium to long term as wages will continue to be extremely low by Western standards for many years to come. Regarding supply contracts of domestic manufacturers with retailers operating in Russia, long-term price agreements are not made very often. Instead, both parties tend to renegotiate prices with each new delivery. With Russian weak infrastructure and large distances, transport costs became an important part of competition. Many supermarket operators, especially leaders with their increasingly cross-national networks, are now building new, more efficient logistics systems.

Private labels

The development of private labels in Russia is also in its infancy. Up until 2004, Russian retailers had not launched private label ranges. However, with the arrival of global players such as Auchan, which offered private labels at extremely competitive prices, many domestic chains began launching their own ranges, particularly at economy price points. Among the most progressive retailers in this arena are Sedmoi Kontinent and the X5 Retail Group. Both retailers offer standard private labels and economy lines, which account for about 5% of both companies' sales. As the market for private labels grows in Russia, the local players are forecast to widen their ranges and launch premium private label brands.

According to a survey carried out in Moscow and St Petersburg and presented in July 2005, 55% of respondents who shop at modern grocery outlets stores said they knew about the existence of their preferred chains' private labels, but only 30% of them actually bought some.



Regulatory Framework

Competition law

In general, the Russian retail market is as liberal as one would expect in a Central & Eastern European country. However, there is a possibility that this might change in the short term as the Russian government intends to centralise the economy. It has created a draft of retail law which would considerable regulate retailers’ expansion in the regions and control contracts between retailers and manufacturers.

Foreign restrictions

As the examples of Metro Group or Auchan clearly demonstrate, full foreign ownership of grocery operations in Russia is possible. Also, there aren't any material restrictions on foreign ownership of land plots which may affect retail companies, although the acquisition process may be more difficult than that in practice.

Property regulations

Foreign market players active in Russia have described the planning process as one that works, even if it can take a long time. Nonetheless, corruption remains a major problem in Russia. In fact, the amount of corruption in business life is thought to have increased almost tenfold in the years from 2001 to 2005, according to the local Indem foundation, now reaching an estimated USD316 billion per year. This corresponds to almost 2.7 times the Russian state budget. The main reason for this lies in a combination of low wages in the public administration and lack of sufficient control of administrative departments and institutions both by the government and the public. Regarding control by the government, the official “fight against corruption” has increasingly been used as a selective tool against members of the opposition and critical voices in general. Regarding control by the public, most newspapers and TV or radio stations are now state controlled. Property prices in Moscow are high by international standards as retailers are battling for the best pitches in an environment characterised by a current undersupply of attractive land plots. Until further notice, the standard solution for foreign retailers in Russia is to lease their pitches (often for a period of 49 years), although it is important to stress that foreign land ownership for retail purposes is legally possible. However, especially the city governments of Moscow and St Petersburg are still hesitant about giving the green light to foreign retailers wishing to buy land.

Opening hours

Opening hours in Russia are largely liberalised, and retailers wishing to open around the clock seven days a week can easily do so (and some are in fact doing this).

Pricing

Prices have been fast increasing since 2007 due to the monopolistic behaviour of Russian manufactures, rising global energy prices, higher prices for EU food imports and a low efficiency of the agriculture sector.

In October 2007, retailers such as X5 Retail Group, Metro Group, Auchan, Kopeika, Mosmart, Rewe and Lenta signed an agreement with the Russian government to freeze the prices of six products (white bread, dark bread, milk, kefir sunflower oil and chicken eggs) until the end of January 2008. In early 2008, the agreement was extended to 1 May 2008 in a deal that can be seen as a political move ahead of the presidential election in March 2008.

In terms of legislation, selling below cost is not prohibited in Russia. Nonetheless, powerful local lobby groups have launched several well-publicised (but ultimately unsuccessful) accusations of unfair pricing against foreign players. The abolition of the 5% sales tax at the beginning of 2004 resulted in lower prices for consumers at least in the country's leading grocery operations. Meanwhile, VAT continues to be levied.

Since 1 July 2006, it has only been allowed to sell imported wine and spirits with an excise label.



News Coverage

Bulletin Articles

X5 to strengthen its foothold in the Russian hypermarket sector

21 Jan 2008 X5 Retail Group has announced that it will exercise its option to acquire the Carousel hypermarket chain. The company has already started due diligence on Formata Holding, which owns the chain. Once this is completed, the company will decide on the structure of the deal. No less than 75% of the option price must be paid in cash, while the remaining amount can be settled with X5 shares. X5 has mandated Goldman Sachs to act as its financial advisor on the potential acquisition.

X5 gains option on Carousel

X5 gained the right to acquire Carousel following its formation in 2006 when Perekrestok and Pyaterochka merged. Pyaterochka already held an option to acquire Carousel and this preferential right was transferred to X5 as part of the deal. According to the contract, the option must be executed no later than July 1, 2008. The amount of the transaction will depend on Carousel’s financial performance, the value of its real estate, land assets and debt. Carousel’s price is estimated to be around USD1 billion, with debts thought to be in the region of USD300-400 million.

A boost to X5’s hypermarket strategy

Carousel is a well managed company, which rapidly expanded in 2006 and opened 13 new hypermarkets in lucrative locations. The retailer has a strong base in St Petersburg, but it has also expanded in Moscow and regional cities such as Nizhnyi Novgorod (Central Russia), Ekaterinburg (Urals) and Volgograd (Southern Russia). However, in the wake of the possible acquisition by X5, Carousel slowed down its expansion in 2007 and opened only three hypermarkets. By the end of the year, it operated 22 outlets, but owned 18 plots. Its store portfolio would perfectly suit X5’s existing hypermarket network. In fact, the successful integration of the Carousel network is of key importance to X5’s multi-format strategy. So far, X5’s expansion plans were focused only on its Pyaterochka and Perekrestok supermarket formats. The development of hypermarkets has been limited to the Perekrestok banner, which has been expanding gradually. Similarly to Carousel’s management, X5 has been waiting for the Carousel acquisition to unify its hypermarket strategy before pushing on with rapid expansion of its own. X5 could operate both the large Carousel hypermarkets and the smaller Perekrestok banners separately. Geographically, the location of the Carousel stores will suit X5’s regional coverage with very little overlap. Carousel has got a strong base of 14 outlets in St Petersburg, but it operates only a couple of outlets in Moscow. In contrast, Perekrestok is not present in St Petersburg, but it operates around 15 stores in Moscow and Central Russia.

Carousel operates a strong hypermarket chain in St Petersburg

The acquisition should complement X5's existing network



Russia: Top Five Grocery Retailers by Sales, 2007 & 2008

Rank Company Retail Banner Sales,

2007 (USD mn) e No. of stores,

2007 Retail Banner Sales,

2008 (USD mn) f No. of stores,

2008

1 X5 Retail Group

5,705 1,505 8,649 1,866

2 Metro Group 4,802 49 6,025 61

3 Auchan 3,257 25 5,539 45

4 Magnit 3,976 2,198 5,324 2,320

5 Kopeika 1,849 455 2,468 522 Note: Ranked on 2008 sales. e - estimate; f - forecast Source: Planet Retail - www.planetretail.net

Carousel to be Frank?

Another possible scenario is the remodelling of the Carousel stores to X5’s new Frank banner. X5 announced in early 2006 that it planned to launch a new hypermarket format called Frank, but the first store openings have been postponed to 2009. Frank will be a price oriented format and target consumers with low incomes. If X5 remodelled Carousel hypermarkets to the new Frank banner, it would diversify itself from competitors further and gain an advantage in highly competitive St Petersburg. X5 Retail seems to be on the right track. Having established its position in the Russian supermarket retail scene through the merger with Perekrestok, the Carousel network will strengthen its position in the hypermarket sector and widen the gap between its nearest rivals Metro Group and Auchan.

Daily News

DIXI first quarter revenue rise 22 Apr 2008

Russian retailer Dixi has reported a 49% increase in first quarter consolidated revenues to USD459 million. The accounting standards used were not provided.

EUROSET will not be acquired by MTS 22 Apr 2008

Mobile TeleSystems (MTS) has said that under no circumstances will it acquire the Russian mobile phone retailer Euroset. The mobile provider's president, Leonid Melamed, informed a press conference that it would be impossible to consolidate such a low-margin business, adding that MTS only intended to expand cooperation with Euroset. According to various media reports, Euroset is planning to sell 25% of its shares and is in talks with MTS on the matter. Euroset has also refuted the information. MTS is, however, developing its network and is planning to involve retailers such as Euroset in the process, Melamed said.

CARREFOUR Romania boss to head to Russia 18 Apr 2008

As reported by Piata, Jacobo Caller Celestino, general manager of Carrefour Romania, will take over the management of Carrefour’s operations in Russia, according to sources on the retail market. Patrice Lespagnol has been appointed as general manager of Carrefour Romania. Previously, Lespagnol worked for Carrefour's Spanish subsidiary as operating manager.

X5 RETAIL FY results 17 Apr 2008

Russian group X5 has published its audited full year financial results. The net sales rocketed by 53% to USD5,320 million, while the net profit soared by 41% to USD 144 million. Gross profit amoutned to USD1,404 million, an increase of 51%. EBITDA amounted to USD479 million, an increase of 62% year-on-year. “Our strong operational performance in 2007, supported by rigorous working capital management, resulted in healthy cash flow generation, enabling the company to finance almost half of its capital expenditure programme from its own



resources. These results also provide a solid foundation for the implementation of our ambitious expansion program throughout 2008 and beyond", X5's CFO Evgeny Kornilov commented.

MAGNIT expectations from rights issue 17 Apr 2008

Russian retailer Magnit yesterday announced that it expects to raise up to USD480.25 million in a rights issue of new stock to finance the expansion of its hypermarket and c-store chains. Magnit said in the statement: "The proceeds of the global offering are to be used to finance further expansion of the company's chain of hypermarkets as well as to continue expansion of its convenience store operations and further development of its logistics capabilities."

ALDI renews trademark registration in Russia 17 Apr 2008

According to Vedomosti, German discount retailer Aldi has renewed the trademark registration for its banner in Latin and Cyrillic letters (????) at Russia's patent agency Rospatent. Aldi first registered the trademarks there in 1998.

TEKHNOSILA considers IPO for 2008 16 Apr 2008

Russian electronics retailer Tekhnosila does not rule out the possibility of carrying out an initial public offering (IPO) in the medium-term, public relations director Nadezhda Senyuk has said. "We will be ready to carry out an IPO by the end of 2009-beginning of 2010, but whether we will decide to do an IPO at that time or not is still a very big question," Senyuk said last week at a conference in St. Petersburg on the restructuring of Russia's retail electronics market. "This year, Tekhnosila plans to raise about USD200 million, but while before we planned to raise these funds with a public instrument, this year, assessing the market it has become clear that this is not as advantageous as, for example, simply loans," she said. Senyuk also said that the company's analysts reckon at the moment that it would be best to carry out an IPO in the West, particularly in London. However, this situation could change, and another exchange might become more attractive, she added.

EUROSET in discussion to sell up? 16 Apr 2008

Russian mobile phone services provider Mobile TeleSystems is in talks on the possible acquisition of mobile phone retailer Euroset, a newspaper has said. Vedomosti reported that Euroset's co-owners Yevgeny Chichvarkin and Timur Artemyev were in talks about selling control to Mobile TeleSystems, a unit of services conglomerate Sistema. The newspaper cited a source close to Sistema and a business partner of Euroset as saying MTS and a financial partner could form a company to take a majority stake in Euroset by purchasing Artemyev's 50% stake and part of Chichvarkin's holding. Euroset's two owners, however, said the report was not true. Vedomosti quoted Chichvarkin as saying the information was "nonsense" and Artyemev as saying it was "untrue".

EUROSET discusses joint tariff plan with MTS 16 Apr 2008

Russian mobile phone retailer Euroset and Russian mobile phone carrier MTS are discussing a joint tariff plan, MTS spokeswoman Irina Osadchaya has said, as reported in newspaper Vedomosti. The plan is expected to be available throughout Russia and Euroset could also provide other services to MTS customers for a fee. Euroset plans to eventually make a choice between the joint plan and its mobile virtual network operator (MVNO) with regional carrier SMARTS, Euroset President Alexei Chuikin said separately. Earlier this year, Russian newspaper RBC Daily reported Chuikin as saying that Euroset could drop its MVNO project, as its customer base growth had not been satisfactory.

HILTON to introduce DOUBLETREE brand to Russia 15 Apr 2008

Continuing its expansion in Russia, Hilton has announced a franchise agreement with ZAO Russkaya Kompaniya Razvitiya (a wholly owned subsidiary of the London & Regional group (L&R), to introduce the Doubletree by Hilton brand in Russia. The agreement is part of a ‘Strategic Development Alliance’ Hilton has with L&R to open 25 new Hilton hotels of selected brands in Russia. The first Doubletree is expected to open later this year in Novosibirsk and will mark the third new brand Hilton has launched in Russia this year.



Photos

Auchan in Russia, (Krasnodar) Auchan -

Hypermarkets

Auchan in Russia, (Krasnodar) Auchan -

Hypermarkets

Euroset in Russia, (Moscow) Euroset - Mobile phone stores

Euroset in Russia, (Moscow) Euroset - Mobile phone stores

Euroset in Russia, (Tverskaya Street, Moscow) Euroset -

Mobile phone stores


Mobile phone stores


Mobile phone stores


Mobile phone stores


Mobile phone stores


Mobile phone stores

Accor

Pharmacy Chain 36.6 in Russia, Mila -

Drugstores


Drugstores


Drugstores

Sodexo

Globus in Russia, Hyperglobus - Hypermarkets

Mir in Russia

Mir in Russia, Mir - EEO e-commerce

Sedmoi Kontinent in Russia, Sedmoi

Kontinent - Supermarkets









Dunkin' Brands in Russia, (Saint

Petersburg) Baskin-Robbins - Ice cream

& Juices



& Juices



& Juices



& Juices

Kroshka Kartoshka in Russia, (Saint

Petersburg) Kroshka Kartoshka - Snack

bars

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