Market Entry Strategies for German Companies in Russia

Table of Content

List of Tables

Executive Summary

1. Introduction

2. Methodology

3. Trade relations and investment environment
3.1. Bilateral trade volume
3.2. German direct Investment in Russia
3.3. Business environment

4. Legal framework for investment into Russia
4.1. Legal forms of investment
4.1.1. The Representative Office
4.1.2. The Branch Office
4.1.3. Corporate Enterprises
4.1.3.1. The Limited Liability Company (OOO)
4.1.3.2. The Closed Joint Stock Company (SAO)
4.1.3.3. The Open Joint Stock Company (OAO)
4.1.4. Other forms of commercial activity
4.1.4.1. Joint Partnership
4.1.4.2. Limited Partnership
4.1.4.3. Additional Liability Companies
4.1.4.4. The Production Cooperative
4.2. Taxation

5. Social Environment for Market Entry
5.1. Human Resources
5.1.1. Educational System
5.1.2. Labor Market
5.1.2.1. Current situation in Russia
5.1.2.2. Expatriates and local employees
5.1.2.3. Recruitment
5.1.2.4. Human Resources Management
5.2. Corruption and crime
5.2.1. Corruption
5.2.2. Crime
5.3. Cultural environment

6. Market entries of German companies
6.1. Market entry barriers
6.1.1. Certification
6.1.2. Customs regulations
6.2. Form of market entries
6.3. Joint Ventures
6.4. Regional choice
6.5. The Russian Consumer
6.6. The Marketing Mix
6.6.1. Product
6.6.2. Price
6.6.3. Placement
6.6.4. Promotion
6.7. Success Factors
6.7.1. Strategic options
6.7.2. Operational choices
6.7.3. Marketing

7. Conclusions

8. Appendix
8.1. Questionnaires
8.2. Interview

9. Bibliography

List of Tables

Table 1: German Import and Export to and from Russia

Table 2: Changes in Exports and imports to Russia, 2006-2007

Table 3: German Export to Russia

Table 4: VDW Membership figures 1995-2006

Table 5: Total investment in Russia by main country 2006

Table 6: Russian FDI

Table 7: Ranking in the Doing Business project 2007

Table 8: Accreditation of Representative offices and branches

Table 9: Income Tax rates in various countries

Table 10: Basic tax rates in Russia

Table 11: Average monthly salaries in Russia

Table 12: Average net wages (€) in Moscow

Table 13: Criminal Threats for German companies (example)

Table 14: Recommended path of market entry

Table 15: Retail turnover and population in Russia

Table 16: Perception of quality by Russian consumers

Table 17: Market Segmentation of the Russian Textile Market

Executive Summary

The paper focuses on the experience of German companies that have trade relations with Russia. It begins with a brief overview of the economic, legal and social environment in Russia and how these influence German businesses. It subsequently describes the performance of German companies based on expert interviews with business decision makers. The aim of this paper is to draw a conclusion in respect to developing a best practice for doing business in Russia by pointing out a number of success factors including Human Resources, choice of region and the right marketing mix.

1. Introduction

Germany is Russia’s biggest trade partner. According to Russian official statistics, Russia imported 8.1% from and exported 13.4% to Germany in 2006.^[1] For Germany, Russia ranks eighth in overall trade volume, with exports about 23 Billion € and imports about 30 Billion €. Due to high prices for oil and gas, which amount for roughly 60% of Russian exports^[2], the statistics indicates a negative trade balance for Germany since 2003.^[3]

Germany is Russia’s oldest trade partner, as well. No other West-European country has the same history of cultural, social and economical exchange with Russia as Germany does. The very term `German´ (немец - `the mute´) in Russian language was century long the word for all `foreigners´.

Having left behind a century of forced antagonism, both countries are nowadays converging steadily. Today, the Russo-German trade relationships become more and more important for both countries.

This paper focuses on the strategies German companies pursue on the Russian market. The fundamental question is empirical in nature: “What have German companies done in Russia?”. The ultimate aim, however, is to gain empirical evidence for theoretical reasoning: ”What should German companies do in Russia?”.

The paper consists of three parts. The first part gives a brief overview over Russo-German trade relations and Direct Foreign Investment. The Second part describes the legal, social and cultural environment in Russia and how German companies cope with it. The third part focuses on their strategy in response to their aims and to the environment. .

2. Methodology

The present thesis is primarily based on firsthand research conducted with decision makers of German companies operating on the Russian market. The approach was chosen with regards to the empirical nature of the subject as well as the immense advantage of having the most direct available source of information. The research was conducted by surveying German business representatives using a survey similar to that used annually by the Association of German Economy in the Russian Federation (Verband der Deutschen Wirtschaft in der Russischen Föderation - VDW).

The primary sources of this thesis are the interviews conducted and the latest survey of the VDW. The findings of the interviews are supplemented with contemporary newspaper and journal articles from German, English and Russian publications mostly from internet sources.

The interviews were conducted as researcher administered expert interviews using a paper and pencil questionnaire. The initial questionnaire contained approximately 40 questions on 12 different topics. Because early experiences with the questionnaire showed that the individual respondents, their companies, industries, experiences and knowledge were too diverse to be covered by one set of questions, this questionnaire was used more as an aide rather than a strict guideline.. Further research discovered that a “guided conversation” was the best method to attract and maintain the respondents’ attention and provided the most information. Hence, the specific discussion guide could be altered in the course of the individual interview. After 5 interviews the first questionnaire was slightly amended in order to improve its usefulness.

For seeking interview participants, a variety of sources were used: Membership rosters of the VDW and similar associations such as the Chambers of commerce, references in publications, key-word internet research and networking.

All prospective interview participants were initially contacted by e-mail. The message was standardized and contained as attachment a copy of the letter from the FOM examination board, containing the thesis´ topic, as a proof of purpose. The prospective participants were intentionally not given the questionnaire unless they explicitly requested it. This happened twice and resulted in written replies that were too short and too meaningless for further use. After this, the questionnaire were principally not given to the participants.

The response rate of the interview request was approximately 15%. Of these, about 10% finally agreed to conducting a interview. Finally, 24 interviews were conducted. Since all but one respondent were contacted by phone, the initial email asked for a time and telephone number to contact the participant. The interviewer principally agreed to any proposals regarding the time in order to increase the success rate.

Most of the respondents were contacted during the daytime in their offices. Only a few asked to phone them at home in the evening. The earliest interview begun at 06:30 in the morning, the latest ended 21:30 in the evening. The average interview lasted about 15 minutes. The shortest was 5 minutes, the longest 48 minutes. However it should be noted that some of the interviews took the natural course into “off the record” topics in personal areas (study, current job, plans for the future etc.)

All telephone interviews were recorded directly into the PC using a telephone adaptor. The recording was subsequently transmitted via FTP server to a typing service that wrote it down word for word. The interview text was later marginally shortened for expletives and queries. All omissions are marked in the text.

3. Trade relations and investment environment

According to official statistics, German export to Russia has reached an all time high of 23.4 Billion € in 2006. Since 2004, exports have increased by nearly 35 % while imports from Russia more than doubled on account of high energy prices. Russia accounts for 4.13% of all imports to Germany and 2.61% of its exports. However, it should be mentioned that generally all statistics regarding Russia have limited reliability. Export is measured on the basis of customs declarations that at the same time determine customs duty. The understatement of customs value of exports to Russia was therefore common practice for a long time and is still in use. Thus, it is possible that the actual figures are considerably higher than the official ones.^[4]

3.1. Bilateral trade volume

The trade between Germany and Russia had an overall volume of 53.5 Bio. € in 2006.

Table 1: German Import and Export to and from Russia^[5]

illustration not visible in this excerpt

(source: Statistisches Bundesamt)

The sizable increase in imports from Germany is in line with overall statistic of Russian imports since 2004. The dramatic surge in oil and gas prices following the war in Iraq 2003 has brought the country enormous wealth that is now going to be consumed and invested.

Table 2. Changes in Exports and imports to Russia, 2006-2007^[6]

(source: Goskomstat)

German exports to Russia consist mainly of industrial goods like machinery, plant equipment and electrical engineering. Consumer goods are first of all cars and car parts while food, fabrics, clothes or pharmaceuticals play a minor role. It should, however, be taken into account that the statistics do not show products manufactured in Russia by German companies. Especially food makers may often feel impelled to produce near their customers to ensure freshness and reduce the risk of deterioration of their products during transport.^[7]

Table 3: German Export to Russia 2006^[8]

illustration not visible in this excerpt

(source: bfai)

3.2. German direct Investment in Russia

The booming Russian economy is increasingly seen not only as a profitable export market for German companies, but also as a promising field for direct investment. Reasons for this expansion may be problems with long-distance transports^[9], stagnating home market^[10], cost advantages in comparison to export^[11] or customer requests for faster availability of spare parts and improved service.^[12] According to another recent survey among German commercial enterprises, half of the participants planned direct investments in Russia in the near future.^[13] Probably the best indicator to show the increasing interest of German companies in Russia is provided by the membership statistic of the Association of German economy in the Russian federation (VDW) in Moscow. Since 2002, member figures increased by almost 45%.

Table 4: VDW Membership figures 1995-2006^[14]

illustration not visible in this excerpt

(source:Verband der Deutschen Wirtschaft in der RFVDW)

According to estimations by the VDW, approximately 4500 German commercial enterprises are currently active in the Russian Federation, of these over 3000 in Moscow.^[15] This figure would make the German business community the biggest in Russia.

In contrast to German estimations, the official Russian statistics show Germany ranking only number 5 in investor countries. However, the validity of these official numbers is widely disputed among experts. Cyprus, the United Kingdom, Luxemburg and the Netherlands are ranked 1-4 respectively, and are classical save havens for Russian flight capital. The same applies to rankings 7,8,9, the Virginian Islands, Switzerland and the USA were many Russian companies operate offshore affiliates. The ranking and real amount of German FDI is therefore believed to be considerably higher than official statistics may indicate.^[16]

Table 5: Total investment in Russia by main country 2006^[17]

illustration not visible in this excerpt

(source: Goskomstat)^[18]

Table 6: Russian FDI^[19]

illustration not visible in this excerpt

(source: HVB)3.3

3.3. Business environment

The World Bank’s “Doing Business” project lists Russia at rank 106 (of 176) for “ease of doing business”. The prevalent challenges of Russia are `Licensing´ (the cooperation with local authorities), tax procedures and trans-national trade procedures (customs clearance). The availability of credit improved by 72 ranks in 2006, fostering the purchase power of consumers and commercial enterprises.

Table 7. Russian Ranking in the Doing Business project 2007^[20]

illustration not visible in this excerpt

(source: World Bank)

4. Legal framework for investment into Russia

4.1. Legal forms of investment

All direct investment in Russia are subject to governmental registration. A foreign company has principally two fundamental options of establishing legal presence in Russia: Setting up a Representative office or branch as organizational structure without legal entity, or the foundation of a Russian affiliate company.

4.1.1. The Representative Office

The Representative Office (RO, Russian: «представительство») is a relict of Russia’s communist past. Under Soviet rule, all legal entities were state owned and centrally controlled. In order to facilitate foreign trade, both to capitalist and communist countries, the Soviet Union set up so called Representative offices abroad, often as part of its embassies. In return, it allowed foreign legal entities to do the same in Russia, -almost exclusively in Moscow.

The legal basis for ROs is still the decree Nr. 1074 “, “On rules for operation and the order of accreditation of representative offices of foreign firms, banks and organizations within the SSSR” (ОБ УТВЕРЖДЕНИИ ПОЛОЖЕНИЯ О ПОРЯДКЕ ОТКРЫТИЯ И ДЕЯТЕЛЬНОСТИ В СССР ПРЕДСТАВИТЕЛЬСТВ ИНОСТРАННЫХ ФИРМ, БАНКОВ И ОРГАНИЗАЦИЙ) “dated Nov.30th 1989 of the Council of Ministers of the SSSR^[21]. This decree repeals older regulations from 1977 and amends the legal rights of such offices.

The Soviet legislation was augmented, -but not replaced-, by the Civil Code of 1995^[22].

The Russian Civil Code, Chapter 4, Article 55 defines ROs as a isolated subdivision of legal entities that are not located at the place of registration of the legal entity, but somewhere else. The text does not explicitly demands the legal entity being abroad, so a Russian legal entity may set up a RO as well as a foreign one. This point of view was finally introduced with the “Law on Limited Liability Companies“ (Федеральный закон "Об обществах с ограниченной ответственностью" (ООО) от 08.02.1998 N 14-ФЗ) in 1998. The law’s Chapter 1, Article 4 deals explicitly with ROs and branches of Russian LLCs.^[23] Similar provisions can be found in the laws on Joint Stock Companies. The purpose of the RO is to represent and defend the interest of the legal entity. Officially, ROs are not allowed to undertake commercial activity, but confine their activity to market research, participation in fairs and exhibitions, advertising or customer care. However, in the past many authorities turned a blind eye when foreign companies carried out commercial activities through their ROs, although this gradually changed in recent years^[24]

The RO is a very popular among western businesses wanting to conduct business in Russia. The main advantages include lower requirements for accounting and the VAT exemption, which is especially important for renting office space. Other important aspects are easier visa-granting for German expatriates and their dependents^[25], as well as the reputation that comes along with being a foreign company in Russia, since foreign companies in Russia are still held in a higher esteem than Russian ones. This might be an advantage when dealing with governmental authorities as well as with Russian business partners^[26].

4.1.2. The Branch Office

The Russian Civil Code of 1994, Part 1, Chapter 4, established the branch or subsidiary (Russian: «филиал») of a legal entity into law. The second clause of §55 describes the new instrument.

The branch shall be the legal entity's set-apart subdivision, situated outside of the place of its location and performing all its functions or a part thereof, including the functions of representation.(Translation: M.S.)^[27]

Representative Offices and branches differ in their possible range of activity, the maximum term of accreditation, the applicable fees and with regard to their accounting and tax compliance duties.

Both forms are not separate legal entities, but subdivisions of non-domestic legal entities. The function of the RO is to represent and defend the interest of the legal entity. The branch, on the other hand, may perform all functions of the legal entity, in this respect also commercial function, and may function as a RO as well. However, this means that a branch may act in the name of the legal entity, for example sign contracts or conduct negotiations, without being an acting entity itself. For both forms, RO and branch, ultimate unlimited liability lies with the establishing legal entity.

The registration of both entities is called accreditation (аккредитация) in Russian. For the process of registering a RO one may choose between the State Registration Chamber within the Ministry of Justice («Государственная Регистрационная Палата», GRP) or the Russian Chamber of Commerce and Industry («Торгово-Промышленная Палата» TPP) within the Ministry of Industry and Trade. It should be noted that a branch can only be registered with the GRP.

The maximum term for the registration of a RO is 3 years in both organizations. A branch however can be accredited with the GRP for a duration of 5 years.^[28]

The accreditation fees and the duration of the procedure differ slightly between GRP and TPP:

[...]

^[1] Federal State Statistics Service of the Russian Federation (GOSKOMSTAT), Foreign Trade of the Russian Federation with far abroad countries

27.09.200

http://www.gks.ru/free_doc/2007/b07_12/25-05.htm

^[2] Bundesagentur für Außenwirtschaft (ed.) , Wirtschafsdaten kompakt – Russland 2007

10.09.2007

http://www.bfai.de/ext/anlagen/PubAnlage_3297.pdf

^[3] Statistisches Bundesamt, Außenhandelsatlas

27.09.2007

http://ims.destatis.de/aussenhandel/Default.aspx

^[4] Interview Nudelmann, Schwartau, 99-119

^[5] Statistisches Bundesamt, Außenhandelsatlas

29.09.2007

http://ims.destatis.de/aussenhandel/Default.aspx

^[6] Federal State Statistics Service of the Russian Federation (GOSKOMSTAT), Changes in exports and imports

27.09.2007

http://www.gks.ru/free_doc/2007/b07_06/2/16-02.htm

^[7] Interview Graf, Ehrmann, 124-133

^[8] Bundesagentur für Außenwirtschaft (ed.) , Wirtschafsdaten kompakt – Russland 2007

10.09.2007

http://www.bfai.de/ext/anlagen/PubAnlage_3297.pdf

^[9] Interview Graf, Ehrmann, 124-133, Interview Dietrich, Prinovis, 102-106

^[10] Interview Scholz, AGN, 45-50

^[11] Interview von Korff, Impress, 14-19

^[12] Interview Kosalla, Flender, 37-40

^[13] Ostausschuss der Deutschen Wirtschaft (ed.), Deutsche Unternehmen bauen Russland-Engagement aus, Stand der Deutsch-Russischen Wirtschaftsbeziehungen, Oktober 2006

25.09.2007

http://www.ihk-muenchen.de/internet/mike/aktuell/Anhaenge/Engagement_in_Russland.pdf

^[14] Verband der Deutschen Wirtschaft in der Russischen Föderation (VDW), Moskau

27.09.2007

http://www.vdw.ru/dbw/public_vdw/Homepage/$frameset/start

^[15] E-Mail from Rene Harun, VDW office manager in Moscow, to author, 15.08.2007

^[16] Lichter, Waldemar, Deutsche Investoren bauen Russland-Engagement aus, Bundesagentur für Außenwirtschaft, 27.10.2006

28.09.2007

http://www.bfai.de/fdb-SE,MKT20061026113105,Google.html

^[17] Federal State Statistics Service of the Russian Federation (GOSKOMSTAT), Volume of foreign investment in the economy of the Russian Federation in 2006, by main country investors.

28.09.2007

http://www.gks.ru/free_doc/2007/b07_12/23-12.htm

^[18] Federal State Statistics Service of the Russian Federation (GOSKOMSTAT), Volume of foreign investment in the economy of the Russian Federation in 2006, by main country investors.

28.09.2007

http://www.gks.ru/free_doc/2007/b07_12/23-12.htm

^[19] Hypovereinsbank (ed.), Investitionsleitfaden Russland 2006, p.20

05.09.2007

www.hypovereinsbank.de/firmenkunden/media/pdf/2006-09-investitionsleitfaden-russland.pdf

^[20] World Bank, Doing Business project, 2007

28.09.2007

http://www.doingbusiness.org/ExploreEconomies/?economyid=159

^[21] Поставление Совета Министров СССР от 30 ноября 1989 г. . № 1074

31.08.2007

http://www.palata.ru/about/zakon/post1074.php

^[22] Гражданский кодекс РФ, часть первая от 30 ноября 1994 г. N 51-ФЗ,

31.08.2007

http://www.gk-rf.com/

^[23] Федеральный закон "Об обществах с ограниченной ответственностью" (Об ООО) от 08.02.1998 N 14-ФЗ

31.08.2007

http://www.consultant.ru/popular/ooo/48_1.html#p69

^[24] PriceWaterhouseCooper -PWC, Moscow (ed.), Legal Flash Report Nr. 2, 27.05.2005

25.08.2007

http://www.pwc.com/at/pdf/newsletter/cee_per_country/russland/PwC_CEE_RS_Newsletter_2005_06.pdf

^[25] Interview Kaczmarek, DKA, 237-241

^[26] Verband der Deutschen Wirtschaft in der Russischen Föderation VDW (ed.), 100 Fragen und Antworten zum Russlandgeschäft 2006, p.26 (Interview Sirotina)

27.09.2007

http://www.hk24.de/produktmarken/international/anhaengsel/Russland_100Fragen_2006.pdf

^[27] Гражданский кодекс РФ, часть первая от 30 ноября 1994 г. N 51-ФЗ, Глава 4. Юридические лица

31.08.2007

http://www.gk-rf.com/glava04.html

^[28] Schulze, Gerit, Repräsentanzen und Filialen können in Russland innerhalb von sieben Tagen akkreditiert werden, Bundesagentur für Außenwirtschaft, 09.12.2006

31.08.2007

http://www.bfai.de/DE/Content/__SharedDocs/Links-Einzeldokumente-Datenbanken/fachdokument.html?fIdent=MKT20061208104509