Betting On A New Label: Made In Russia

Multinationals are scrambling to cut costs by producing locally

At G.D. Searle & Co.'s gleaming, new $24 million factory in the Moscow suburbs, technicians are fine-tuning equipment that will soon produce medicines for hypertension. In St. Petersburg, U.S. chewing-gum maker Wm. Wrigley Jr. Co. is about to open a $70 million plant. Meanwhile, France's Groupe Danone has boosted yogurt production in Russia and doubled its advertising on local television.

Russia's economy is a mess, its currency shaky, its government gripped by crisis--a country, it would seem, to avoid at all costs. But the battle for Russia's consumer market has never been fiercer. With the ruble down 75% since last August, most Russians can no longer afford imported goods. To defend hard-won market share, multinational consumer companies that entered Russia after the fall of communism are slashing costs by switching from importing to local manufacturing. And local production is so cheap that companies such as Nestle are planning to export from Russia for the first time.

Most consumer giants don't expect short-term profits from their new investments. That's no surprise, with consumer spending now running 16% below 1997 levels. Instead, companies are betting on a long-term rebound in Russia's economy by spending more now to increase market share while local players and smaller, foreign rivals are weak. Foreigners poured $1.3 billion into Russian industry in the last quarter of 1998, even though investment was down 37%, to $2.2 billion, for the whole year.

Some multinationals are investing to protect their positions. Companies such as Nestle and Gillette started buying up or building Russian factories in the mid-1990s. Now, Procter & Gamble Co. and Germany's Henkel sell 70% of the laundry detergent in Russia. Coca-Cola and Pepsi-Cola together claim nearly half the soft-drink market. Even McDonald's Corp. has set up local companies to supply everything from pickles to construction materials for its restaurants. Because of local sourcing, McDonald's says, its Russian operations remain profitable.

For most multinationals, however, the mainstay of their Russian business was importing goods and selling them to consumers avid for Western quality. At Danone, for example, 80% of its Russian sales relied on imports from its European factories. That business disappeared when the ruble crashed. Now, Danone is quadrupling production at one Russian factory, while building a new $100 million plant. Since the switch to local production, Danone's yogurt sells for just 5% more than Russian brands, down from 40% more a year ago.

The future looks grimmer for companies that won't manufacture locally. Hershey, Del Monte, and the Dunkin' Donuts chain, which entered Russia in the mid-1990s, have already shut down Russian sales units. Their departure is giving a lift to some domestic manufacturers, such as Wimm-Bill-Dann, a big juice producer, whose market share has grown to 40% in the last six months.

AD BLITZ. But Russian food producers that rely on imported raw materials are struggling, and that has emboldened foreign players. While its Russian rivals absorbed huge price hikes on imported chocolate last fall, Nestle unleashed an advertising blitz to introduce its locally produced Rossiya candy. Undercutting competitors with candy bars selling for just 13 cents, Nestle grabbed at least 10% of the market, analysts say.

Even multinationals with deep pockets may be in for a rough ride, though. Cadbury Schweppes PLC, which spent $140 million on a candy factory in Novgorod in 1997, says it lost $25 million in Russia last year. Yet Cadbury and other companies are gambling that Russia's 150 million consumers will one day have the money to spend on their brands. "You aren't looking to get your money back in three months or six months," says G.D. Searle manager John Robson, pointing to state-of-the-art equipment in his factory. The long view is the only one to take in Russia.

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