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WILD EAST

Russia is an alluring but sometimes scary place for Western retailers

BY CURT HAZLETT

One of Russia’s most promising new developments kicked off to a bumpy start. The Swedish furniture retailer Ikea was all set for the December grand opening of Mega Khimki, a $250 million mall it had financed and built near the Moscow airport, until regional officials called a halt to the ceremonies.

Shoppers’ cars could damage a gas pipeline that runs under the parking lot, the officials said, so Ikea would have to build a new roadway before the mall could open. Ikea’s top manager in Russia, Lennart Dahlgren, called the last-minute demand “sabotage against Russia,” and told local newspaper Izvestia that he feared for his life, though he did not say why.

Then Dahlgren did something rare for a company doing business in Russia: He talked openly about the corruption that plagues the country. “Like all Western companies in Russia we’re subject to blackmail, sabotage and pressure for bribes. In many cases we’re totally in the hands of local chieftains,” he said. “Ikea is big in Russia and doesn’t pay bribes.”

The situation was resolved quietly, and a few weeks later Mega Khimki took its place as one of Russia’s premier shopping centers. But the episode illustrates the rough-and-tumble nature of retail development in Russia, which by most accounts is one of the hottest emerging markets in the world — and one of the toughest in which to do business.

With its large and underretailed population becoming increasingly prosperous, Russia is poised for an explosion in retail development by both non-Russian and domestic companies. And while “there certainly are some question marks about the political situation,” said Frank Badillo, senior economist and global program manager at Columbus, Ohio-based consulting firm Retail Forward, “all in all, the positives outweigh the negatives there these days.”

Twenty-four shopping centers, most of them supermarket-anchored, opened in Russia last year. This added about 5 million square feet of gross leasable area to the market, according to London brokerage Cushman & Wakefield Healey & Baker, which in December acquired Stiles & Riabokobylko, one of Russia’s leading real estate services firms. Cushman & Wakefield says 43 centers are scheduled to open this year and next, which will pump in an additional 7.5 million square feet of GLA. Meanwhile, Russian retail sales grew 12.1 percent last year.

Russki risk
As Ikea’s experience shows, building in Russia can be frustrating. The bureaucracy can delay visas for a long time. Local planning regulations are often impenetrable or ambiguous, and corruption remains widespread at the regional and local levels. In fact, a Russian government survey of 158 foreign companies found that 71 percent consider corruption the biggest barrier to investing in Russia (story, Russia still mired in corruption, red tape).

Yet Russia offers powerful attractions to those willing to take the risk. The economy has boomed on the back of soaring oil and gas prices, and the gross domestic product is estimated to have grown 6.9 percent last year, making this one of the world’s fastest-growing economies. There has also been an unprecedented rise in consumer spending.

Ikea has been a pioneer of Westernized retailing in Russia and is now the country’s largest foreign retailer. It opened its first store there in 2000 and now has three anchoring malls it has developed — two in the Moscow area and one in St. Petersburg. Another will open late this year in Kazan, 500 miles east of Moscow. Co-anchored by Ikea and a Ramstore hypermarket (one of more than two dozen built in Russia by Turkish retail giant Ramenka), Mega Kazan will be the country’s largest regional mall, with 150 tenants and parking for 7,000 vehicles.

Irena Vanenkova, Ikea Russia’s manager of public relations, says the retailer hopes to have 22 stores there eventually, all of them in malls. “This has been a dream of Ikea’s founder,” she said, referring to 78-year-old Ingvar Kamprad, who recently surpassed Bill Gates as the world’s wealthiest man. (Ikea is an acronym of Kamprad’s name and his hometown of Elmtaryd in the Swedish province of Agunnaryd.) “He wanted to open stores in all Russian cities of more than 1 million population. He sees it as his mission.”

Except for the language, the Russian Ikea stores are indistinguishable from those in other countries. The three currently open span about 330,000 square feet, as large as all but one of the chain’s 21 American stores. The trademark blue-and-yellow facade is the same, and the units offer much of the same line of inexpensive but fashionable home furnishings.

Vanenkova said the Russian stores are among the top 10 Ikeas worldwide in terms of shopper visits. The first of them generated more than $100 million in sales its first year, three times what the company had projected, and last year drew more than 40 million visits.

With Ikea as a model, Vanenkova says, there are a lot of shopping centers getting built in Russia and a lot of new retailers coming over too. Among them are U.S. retailers interested in tenancy inside the Mega malls. Vanenkova declined to identify any of them.

Despite its popularity, Ikea Russia has yet to make a profit. Vanenkova points out that startup costs have been high, and Ikea’s Dahlgren says the operation will not be profitable until this year. One of the reasons is a 25 percent tariff on imported furniture, which makes it crucial that Ikea produce more of its goods in Russia. Only 13 percent of the Ikea furniture sold in Russia is locally made, Dahlgren told the Financial Times last year, and that will need to rise to 30 percent before the operation can turn a profit. To that end, Ikea has opened a furniture factory near St. Petersburg and has invested $400 million to help its local suppliers buy equipment and arrange credit. The ultimate goal is to make Russia a major supplier of Ikea goods worldwide, a sensible move, since Russia has a quarter of the world’s hardwood supply.

Back in the USSR
In a nation where connections matter, Ikea has benefited from its long-standing Russian ties. Founder Kamprad became interested in doing business in what was then the Soviet Union back in the 1960s and made two attempts to open stores there before finally succeeding in 2000.

“Ikea came in during the hard times and stayed, and it benefited from some long relationships it has established,” said Retail Forward’s Badillo. “Without the right relationships, it’s tough to do business there, and that’s kept companies out. But that’s changing.”

Retail Forward’s most recent Global Retail Outlook report ranks Russia as the fourth most attractive country in the world for retail expansion, taking into account both its potential growth and potential risks. Outranking it are China, the United Kingdom and Thailand.

Another global market consulting firm, A.T. Kearney, last year graded Russia the top country in the world for retail expansion. “With a growth rate of 30 percent for retail sales from 1999 to 2003 and a relatively sparse retail network to serve its growing market, Russia is full of promise,” said a Kearney report. “The opportunities in Russia rank among the best for retailers and their suppliers,” Badillo said. “There’s a lot of new market to be taken by retailers and suppliers.” And while much of the focus is on Moscow and its population of 9 million, there are even greater opportunities in the regions beyond Moscow, he says. In fact, Russia has 13 cities with populations of about 1 million, not counting Moscow and St. Petersburg.

How big is the potential? Russia’s largest investment banking firm, Moscow-based Renaissance Capital, estimates that just 2 percent to 4 percent of the population shops at modern facilities. Moscow has by far the largest concentration of retail in the country, but even there, 70 percent of sales take place at kiosks and in small shops.

Ikea’s ambitious goals and staying power would appear to give it a big head start in tapping this market. Certainly, sleazy officials aside, the Russians themselves are eager. The approval of Ikea’s Kazan store “was the quickest process in the whole of Ikea’s history, noted Vanenkova, “because the local authorities were so supportive and really wanted the people to have Ikea.” And it appears they will get their wish: The mall is slated to open just in time for the city’s 1,000th anniversary — assuming, that is, that no one at the last minute finds any gas lines running beneath the parking lot.