Hidden gem? Perceptions of business opportunity and risk in Russia. A survey from the Economist Intelligence Unit Sponsored by Clifford Chance

Transcription

1 Perceptions of business opportunity and risk in Russia A survey from the Economist Intelligence Unit Sponsored by Clifford Chance

2 About the survey The Economist Intelligence Unit surveyed 455 executives around the world in April 2007 about their perceptions of the challenges and opportunities they face in doing business in Russia. The survey was sponsored by Clifford Chance. Some 40% of the respondents are based in Russia, and the remainder evenly split between respondents from Asia-Pacific, North America and Europe. They come from a wide range of industries, and approximately 65% of respondents represent businesses with annual revenues of more than US$500m. The results of the survey were supplemented by a number of interviews of executives operating in Russia, conducted by the Economist Intelligence Unit s editorial team. The Economist Intelligence Unit s editorial team conducted the survey and wrote the executive summary. The findings expressed in this summary do not necessarily reflect the views of the sponsor. Our thanks are due to the survey respondents and interviewees for their time and insight. May 2007 The Economist Intelligence Unit

3 Introduction Key findings The Russian economy has experienced a period of unprecedented growth over the past five years. While high global energy and commodity prices have provided much of the impetus, strong corporate profits and investment have also been key drivers of this economic success. Foreign direct investment into Russia has soared in recent years, and along with the other so-called BRIC countries, Russia has moved squarely onto the agenda of the world s leading multinational companies. However, perceptions of Russia as a place to do business vary widely. The increasingly autocratic approach of the administration of Vladimir Putin has taken centre stage in the global media, and raised concerns among some businesses about the risks involved in operating on the Russian market. At the same time, questions remain about the quality of the business environment and the ease of doing business in Russia. This survey seeks to understand how both firms operating in Russia and those watching from the outside perceive its growth prospects and the opportunities and challenges it presents. We also seek firms views on political risk and the impact of the presidential succession in 2008 (when Mr Putin is expected to step down). Executives are bullish about the prospects for growth in Russia Despite increasing tensions between the Putin administration and both the EU and the US, and signs that oil prices will fall gradually over the coming few years, respondents in our survey are broadly optimistic about Russia s market potential. Of the 130 respondents whose firms currently have no operations or trading relationships in Russia, almost 40% expect that their firms will enter the market in the coming two years. The executives whose firms are currently headquartered in Russia, operating in Russia, or trading with Russian firms are even more bullish almost 80% expect their companies investment in Russia to increase either moderately or substantially over the same period. Financial services and information technology (IT) firms are the most confident, with 87% of respondents in both of these sectors expecting to increase involvement in Russia in When asked about the profit growth potential of the Russian market over the coming two year period, 54% of respondents called it high or very high. This was less than the 71% who rated India as highly or the 76% most bullish about China over the coming two-year period. However, it was ahead of the 43% who see Brazil as a high or very high potential market, and well ahead of the EU, Japan, and the US. Respondents who are currently active in Russia proved more confident about the future than those who have yet to enter the market. 62% rated the profit potential of the Russian market as high or very high, compared to 37% of those not operating in Russia today. The slightly lower level of optimism that executives have about profits in Russia relative to some other big emerging markets is in part the result of rapidly 2 The Economist Intelligence Unit 2007

4 rising costs. Adrian Marley, Country Director of Russia for DHL, says: the growth levels we and our clients are planning for are staggering. However, bottom-line growth is getting harder to achieve one senior executive in the consumer goods industry says that our costs are rising considerably, especially for labour and real estate. Real estate prices are becoming extortionate in Moscow, especially relative to projected sales per square metre. Firms in the pharmaceutical and fast-moving consumer goods industries also complain of rising costs of advertising biting into their bottom line. Access to the massive domestic market is a key driver of firms investment plans for Russia With a population of over 140m, private consumption per head of almost US$3,400 in 2006, and real disposable income expected to rise at 9-10% per annum over the next five years, the domestic market offers a massive opportunity for businesses in Russia. When we asked respondents to identify the reasons that their firms entered (or are considering entering) the Russian market, access to the domestic market was by far the most popular choice (62% of respondents). The opportunity to enter into a joint venture came distant second, with one quarter of respondents citing this as a factor in their market entry. With labour costs rising at double-digit rates in real terms nation-wide, and much faster in Moscow, not surprisingly only 18% of respondents cited access to skilled labour as a central element in their decision to do business in Russia. There were however significant variations across industry. With the Russian educational system churning out large numbers of highly-qualified technical and engineering candidates, IT firms were three times more likely to cite skilled labour access (57% of IT respondents, compared to 18% in the full sample). Unsurprisingly, almost half of energy firms named access to natural resources as their primary motivation for working in Russia, compared to just 14% in the full sample. Firms face a range of business environment weaknesses and constraints, but opinions vary between local players and outsiders While overall growth prospects appear good, Russia is still a difficult place to do business, and firms cited a number of constraints they face either in their daily operations or with respect to their plans to invest in Russia. Corruption was overwhelmingly the mostcited problem in the business environment (53% of respondents), followed closely by political risk (44%) and the inefficient bureaucracy (28%). One-fifth of respondents felt that contract enforcement and legal issues represent significant problems for doing business. Global perceptions of the Russian market, however, differed in several key areas from the perceptions of those working in Russia today. Of the executives we surveyed whose firms have no operations or trading Which of the following represent the most significant constraints on your firm s operations or investment plans in Russia? Select up to three. Operations/trading in Russia No operations/trading in Russia Corruption Political risk Inefficient bureaucracy Tax system complexity Other legal environment issues Infrastructure weaknesses Scarcity of qualified staff Contract enforcement Distribution problems Exchange rate strength Lack of access to financing Labour costs Source: Economist Intelligence Unit survey, May The Economist Intelligence Unit

5 relationships in Russia, 53% considered political risk a significant constraint on their business, well ahead of the 40% of those who are active on the market. However, the routine day-to-day issues also appear to be misunderstood by companies which have yet to invest in the market. Firms operating in Russia are much more concerned about tax system complexity, scarcity of qualified staff, and bureaucratic inefficiency than those on the sidelines looking in. The general manager of a major firm in the apparel industry identifies the archaic labour code as a major problem it s not conducive to good business growth. Labour laws make it extremely difficult if not impossible to fire underperforming workers, which causes a double problem given the lack of qualified candidates in the market. The judiciary also poses a substantial bottleneck to doing business. Bernard Meunier, CEO of Nestle Russia, says his firm often gets bogged down in the court system and cases take much longer to complete than in other markets. Issues with corruption and the bureaucracy cause problems for multinational firms not just between these firms and the authorities, but also by placing them at a disadvantage relative to their domestic competitors. A senior executive from a FTSE 100 firm from the pharmaceutical industry points out that his firm often had to wait months to get new products approved by the authorities, while his competitors were able to get through the process in as little as three months. Equally, his operations faced internal operational constraints which made dealing with these issues more difficult: like other global firms which are required to uphold global standards for governance and the like, we needed to operate ahead of the local competition (which were not subject to these constraints) just to compete. The complexity of the tax system means that tax compliance consumes an inordinate amount of executive time and effort. I m providing signatures a day on documents for the tax authorities, says Mr Marley. Despite the vast expanse of the country, only 6% suggested that distribution problems were an impediment perhaps because so few non-russian companies do business across the country. Fewer than 5% of respondents considered access to financing and labour costs to be significant barriers, while only 8% cited exchange-rate strength, despite an estimated 30% real effective appreciation of the rouble from Fewer than 10% of firms not operating in Russia felt that infrastructure weaknesses were a significant constraint, while over 20% of active firms have problems in this area. Infrastructure requirements will likely intensify in the future, according to one executive: in my industry, there is a growing need to invest heavily in the infrastructure to service what is a huge country. Increasingly it s not enough to play only in Moscow and St Petersburg firms need to be national players to win. Russia compares favourably to global competitor markets Despite its flaws, it appears that overall Russia compares relatively well to other major investment markets. After excluding those respondents who have no direct knowledge, over half of respondents rated Perceptions of Russian operating environment (% of respondents answering Russia is better or About the same ) India China Poland Brazil EU Japan US Source: Economist Intelligence Unit survey, May The Economist Intelligence Unit 2007

6 the operating environment in Russia as either the same or better than that in India, China, and Brazil. In fact, over 40% of respondents suggested that it s at least as easy to do business in Russia as in Poland, one of Central Europe s leading investment destinations, and 9% of respondents (12% of those operating in Russia) felt that the operating environment in Russia is either the same or better than in the EU as a whole. The presidential succession in 2008 is being watched closely by senior executives While it is clear that the next president of Russia will be hand-picked by Mr Putin, it is much less clear at the moment exactly who Mr Putin will back. Despite the fact that none of the potential candidates are likely to oversee any dramatic shift in the direction of economic and enterprise policy, this uncertainty represents a source of risk for businesses making longer-term investment decisions. When asked about this risk, almost 10% called it high, while over 40% consider it moderate. A manager from the healthcare sector suggests that the outcome is unlikely to have any major impact on the business environment: it will probably result in some delayed investment, but I wouldn t expect any big problems to come out of the presidential succession. Eric Rasmussen, who heads the Russian operations of the European Bank for Reconstruction and Development (EBRD), doesn t quite agree There s no question that the election presents risk to business, especially in a system which is so centralised around a single person. He does, however, point out that the succession will be heavily managed, which combined with the recent passage of a three-year state budget will minimise the likelihood of a radical policy shift after State intrusion in the private sector is an issue across industries, but some sectors are more affected than others The relationship between government and the private sector remains an area of frustration for many businesses operating in or considering investing in Russia. We asked respondents whether either direct government intervention forced renegotiation of contracts or reduction of a share in a joint venture, for example or bureaucratic interference from tax or regulatory authorities represented a problem in their operations or their plans to invest in Russia, and the responses were striking. Almost two-thirds of respondents suggested that direct government intervention is either a major problem or a minor problem for their businesses, while over 80% of firms said that bureaucratic hassles are a problem for them as well. Unsurprisingly, firms in the energy sector one which is clearly considered strategic by the Kremlin and therefore under its direct control were significantly more likely to cite direct state intervention in their operations as a major problem. Respondents in the healthcare sector were also more likely to see bureaucratic interference as a major problem. However, firms not operating in Russia appeared much more concerned about both of these areas than those that are actually doing business there. All of the executives we interviewed agree that while regular and sometimes capricious visits from tax and health and safety authorities take place, these interruptions represent some part of the cost of doing business in Russia and neither suggested that they were being prevented from implementing their firms strategies by the authorities. Respondents were somewhat mixed about the prospects for improvement over the coming two-year period. While half felt that the role of the state in their sector is likely to stay about the same or decrease somewhat, one in ten felt that state involvement would increase substantially. Again, healthcare The Economist Intelligence Unit

7 sector respondents seemed most concerned one in five expect a substantially expanded role for the state in their industry in the coming two years. In a number of areas, American firms appear significantly more sceptical than their global counterparts about the Russian market Perceptions about the Russian market in our survey varied considerably by region, and in particular it appears that North American executives are more wary of the market than those based in Europe or Asia. Of those firms not currently operating in Russia, almost 40% expect to enter the market in the next two years, but only 27% from North America have the same plan. Equally, of firms currently doing business in Russia, almost 40% expect to increase their investment substantially in , while only 12% of North American firms will do so. This is in part due to a more pessimistic view of market developments. While 11% of respondents expect the operating environment to improve substantially in , and a further 51% expect it to improve moderately, just 4% and 33%, respectively, of North American executives share these views. North American executives also appear more sensitive to the ambiguities of the public sectorprivate sector relationship than their global colleagues: American respondents were much more likely to cite political risk and corruption as constraints on their operations or investment plans, and they felt that the presidential succession process presented more risk than respondents from Europe or Asia. Mr Rasmussen of the EBRD believes the distinction is telling: Some American firms still tend to operate with a Cold War mentality for many the Russian market is still a black box. The general director of a large American firm s Russian operations agrees that many American firms are perhaps not as battle-hardened as their European competitors in particular. Relative to their big European competitors, he says that sometimes we feel like we ve come a long way from home to do business here. How do you expect the operating environment in Russia to change over the next two years? All respondents North American respondents Improve substantially Improve moderately Remain mostly unchanged Deteriorate moderately Deteriorate substantially Source: Economist Intelligence Unit survey, May The Economist Intelligence Unit 2007

8 Strategic implications There is money to be made in Russia: Respondents were very bullish about growth prospects, both in absolute terms and also relative to other major markets around the world. The executives we spoke with raised concerns about rapidly rising costs for human resources, real estate, and raw materials, but it doesn t appear that these will significantly limit the bottom-line potential of the Russian market for some time to come. Firms must know what they are getting into: Even those respondents and interviewees who are most enthusiastic about the future are quick to point out that doing business in Russia remains tough, and firms need to find ways to deal with the added complexity of managing in the Russian environment. This will mean needing to find new and persuasive ways to argue to corporate headquarters for either additional resources or expanded operational leeway. Politics as usual seems most likely: While there is no doubt that the presidential succession next year has some potential to create a period of political stagnation or even upheaval, most businesses are pushing forward with investment plans for the long term. American jitters present an opportunity?: Survey and anecdotal evidence shows that American firms are still relatively more hesitant about the market, perhaps as a result of being less well-prepared to deal with the peculiarities of the Russian market. This presents an opportunity for European and Asian competitors of the largest American firms to steal a jump on their rivals. The Economist Intelligence Unit

9 Appendix: Survey results Hidden gem? Appendix: Survey results In April 2007, the Economist Intelligence Unit conducted a survey of 455 executives around the world. Our sincere thanks go to all those who took part in the survey. Please note that not all answers add up to 100%, because of rounding or because respondents were able to provide multiple answers to some questions. Which of the following best describes your firm s involvement with the Russian market? Do you expect your firm to enter the market, or begin trading in the Russian market, in the next two years? My firm is headquartered in Russia 25 My firm has significant operations (either fully owned or via a JV partner/licensing agreement) in Russia 26 Yes No My firm trades with Russian firms 21 My firm has no operations or trading arrangements in Russia 29 How do you anticipate your firm s level of investment in the market will change in the coming two years? Increase substantially 40 Increase moderately 40 Remain mostly unchanged 15 Decrease moderately 1 Decrease substantially 2 Don t know 2 8 The Economist Intelligence Unit 2007

10 Appendix: Survey results Hidden gem? What are the most important reasons for your firm to enter, or consider entering, the Russian market? Select up to three. Access to the domestic Russian market Opportunity to enter JV or invest in local company Presence in Russia needed to be credible in our industry Access to skilled labour Use Russian market as an export platform Access to natural resources Other Not applicable/don t know Which of the following represent the most significant constraints on your firm s operations or investment plans in Russia? Select up to three. Corruption Political risk Inefficient bureaucracy Other legal environment issues Contract enforcement Tax system complexity Infrastructure weaknesses Scarcity of qualified staff Lack of understanding of the market/ local consumers Exchange rate strength How would you characterise your understanding of the Russian business environment? Distribution problems Lack of access to financing Excellent Good Average Poor None Labour costs Other Not applicable/don t know How would you compare the operating environment in Russia with that of the following markets? India Russia is better Russia is worse About the same Don t know China Brazil Poland EU US Japan The Economist Intelligence Unit

11 Appendix: Survey results Hidden gem? How do you expect the operating environment in Russia to change over the next two years? How great a risk does the 2008 presidential election in Russia represent to your operations in, or investment plans for, Russia? Improve moderately Remain mostly unchanged Improve substantially Deteriorate moderately Deteriorate substantially Don t know Very high Moderate Minimal None Don t know/ Not applicable How would you rate the profit growth potential of the following markets over the coming two-year period? Rate on a scale of 1 to 5, where 1=Very high potential and 5=Very low potential. India China Brazil 1 Very high potential Very low potential Don t know For your firm, are direct government intervention in Russia (eg, forced renegotiation of contracts or reduction of share in a joint venture) or bureaucratic interference (eg, intrusive tax or regulatory authority) a problem for existing operations or a deterrent to entering the market? Direct government intervention Bureaucratic interference Major problem or deterrent Minor problem or deterrent Not a problem or deterrent Don t know Russia Japan EU US Over the coming two-year period, do you expect state involvement in your sector to increase or decrease? Increase substantially Increase somewhat Stay about the same Decrease somewhat Decrease substantially Don t know The Economist Intelligence Unit 2007

12 Appendix: Survey results Hidden gem? Where are you personally based? Russia Asia-Pacific Western Europe North America Middle-East and Africa Latin America What are your organisation s global annual revenues in US dollars? $500m or less 50 $500m to $1bn 14 $1bn to $5bn 14 $5bn to $10bn 6 $10bn or more 16 Elsewhere in Eastern Europe What is your primary industry? Financial services Professional services IT and technology Energy and natural resources Government/Public sector Manufacturing Construction and real estate Education Transportation, travel and tourism Agriculture and agribusiness Consumer goods Healthcare, pharmaceuticals and biotechnology Entertainment, media and publishing Telecommunications Chemicals Retailing Automotive Logistics and distribution Aerospace/Defence The Economist Intelligence Unit

13 Whilst every effort has been taken to verify the accuracy of this information, neither The Economist Intelligence Unit Ltd. nor the sponsor of this report can accept any responsibility or liability for reliance by any person on this white paper or any of the information, opinions or conclusions set out in the white paper.

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