Escalating tensions with the Ukraine have undermined a promising growth spurt for the Russian luxury goods industry, explains Fflur Roberts of Euromonitor.
It is no secret that Russian consumers have always loved to shop for luxury and have an unrivalled capacity to splurge. Russian men hanker after luxury cars and watches and women after luxury handbags and shoes.
International shopping sprees to some of the world’s most iconic capitals have become de rigueur, with luxury stores like Harrods and Galeries Lafayette clambering over themselves to open their doors to wallet-toting Russian visitors; London’s luxury department stores Harrods and Selfridges even have Russian-speaking sales staff.
Escalating tensions with the Ukraine have however undermined a promising growth spurt for the Russian luxury goods industry at home and abroad. Robust GDP increases had underpinned wage rises in the emerging BRIC nation, which, combined with pension hikes, fed through into consumer spending gains.
“ Russia is the world’s ninth biggest luxury goods market ”
However, luxury goods marketers must now contend with Russia’s increasing isolation and Europe’s least equal income distribution, running from Muscovite oligarchs to rural-dwelling retirees.
Sales of luxury goods in Russia reached RUB363 billion (US$10.4 billion at fixed exchange rates) in 2014, making it the world’s ninth biggest luxury goods market, accounting for 3% of global sales.
Whilst sales growth remained positive at 4% in 2014 in real terms, worsening relations with the West, uncertainty owing to sanctions and capital flight are all having a chilling effect on investment, which could pose serious threats to the future of Russia’s luxury goods industry.
“ Russia’s economic growth model continues to be dependent on energy exports ”
Aside from the heightened risks facing the Russian luxury goods industry in 2014, owing to the conflict with the Ukraine and subsequent capital flight, Russia’s economic growth model continues to be dependent on energy exports, leaving it vulnerable and open to external shocks.
This is one of the major weaknesses facing Eastern Europe’s largest and most populated economy and a concern for major luxury brands concerning both domestic and international luxury spend.
Russia was the world’s second largest oil and natural gas producer in 2013. Exports of mineral fuels accounted for nearly 75% of total exports in the same year. Nothing can better exemplify Russia’s energy dependence issues than the economic contraction the country suffered following the global financial crisis of 2008-2009, when global oil prices fell as demand for luxury goods plummeted.
Marussia Motors, Russia’s own high-performance car brand
As a result, Russia’s real GDP growth declined by 7.8% in 2009, the worst performance of the BRICs. In the second half of 2014, weaker than expected oil prices are once again causing problems for the Russian economy, especially as the government budget for 2014-2015 was based on an oil price assumption of US$100 per barrel.
Geopolitical tensions are having strong negative consequences, but Russia’s poor prospects reflect much more than the effect of sanctions. They also underline the country’s weak policy framework and outdated growth model.
Russia’s extensive dependence on the energy sector (a characteristic which reflects the weak policy framework) leaves the country vulnerable to external shocks and promises little in the way of economic growth. A slight recovery in growth is projected in 2015, on the back of stronger exports and stabilisation of investment.
In 2013, Moscow produced a new 5-year plan to modernise the economy and boost annual growth to 5% by 2018.
Officials had hoped to raise investment to 25% of GDP by 2015 (up from about 20% in 2011), but that target is not realistic in the present circumstances. Fixed investment is well below that of other emerging markets and has been declining for several years. Effective ways to bolster investor confidence are urgently needed.
“ Russia’s real GDP growth declined by 7.8% in 2009, the worst performance of the BRICs ”
Much on par with other BRIC countries, the most prominent age band in the total population in receipt of an annual gross income of over US$150,000, and the key target consumer group for luxury goods, is the 30-34-year-old cohort, comprising 14%, followed by the 35-39-year-old demographic on 13%.
As elsewhere in Eastern Europe, 30-somethings entered the workforce at a time of economic flux, when Russia was rebuilding, following the collapse of the Soviet Union. Young enough to learn the skills suited to the emerging marketplace – IT literacy, foreign languages and business principles – many rose rapidly through corporate structures or were able to set up their own companies in a relatively competition-free arena.
These affluent Russians are a much documented consumer niche – Moscow currently stands as the city with the second highest number of billionaires in the world, after London – and wealthy 30-somethings can be targeted with a range of luxury goods and services, from sports cars and luxury real estate to luxury watches and designer fashion.
“ Moscow currently stands as the city with the second highest number of billionaires in the world ”
Indeed, Moscow’s luxury real estate is among the most expensive in the world, with only London and Monaco actually more expensive. In 2013, Moscow’s most expensive apartments cost on average US$23,000 per sq m. In the same year, the upscale real estate market received significant attention from Russia’s top public officials, as the law forbade them from investing in foreign property.
Unsurprisingly, Moscow is also the most notable cauldron of economic activity, as well as luxury goods sales, in Russia, exceeding the country’s second largest city, St Petersburg, three times in population terms and by nearly 60% in average household income terms.
Population ageing will, however, shake up the demographic distribution of the most affluent stratum of Russian society. By 2030, the over-65-year-old cohort will have surged to account for almost 18% of the population earning an annual gross income of over US$150,000, ahead of the 40-44-year-old age bracket, on 14%.
The St. Regis Moscow Nikolskaya
Consequently, luxury brands and retailers whose products and services are built around rich Russians may wish to gear their ranges towards an increasingly mature consumer profile, homing in on senior citizens.
Similarly, the Russian middle class – that is, households in receipt of between 75% and 125% of median income – grew in absolute terms over the 2008-2013 period, from a base of 14.2 million to reach 16.2 million at the end of 2013. As is the case in fellow BRIC countries, Russia’s middle class presents various opportunities to luxury goods marketers.
Growing incomes have boosted the confidence of this demographic, and its members – keen to narrow the lifestyle gap between themselves and their wealthier compatriots or peers in Western European and EU markets – will be open to a range of goods and services.
The high-profile indulgences of the wealthiest Russians mean that middle-class consumers are already conversant with luxury brands, so more affordable versions of high-end ranges could also find advantageous terrain.
“ An import ban would be of huge concern for all luxury brands and retailers, domestic and foreign alike ”
Since Russian military intervention in the Ukraine began in 2014, relations between Russia and the West have soured considerably.
Luxury retailers’ concerns over the country reached a new high in September 2014 when it was suggested that Russia was considering a ban on imports of foreign clothing in retaliation at Western sanctions imposed on Moscow. An import ban would be of huge concern for all luxury brands and retailers, domestic and foreign alike.
Possible sanctions aside, to add insult to injury, the falling value of the rouble has made imported luxury goods even more costly on the back of luxury tax and import duties that are already placed on such products. Consumer confidence is at an all-time low and many wealthy consumers are tightening their purse strings.
“ The falling value of the rouble has made imported luxury goods even more costly ”
The current situation between the Ukraine and Russia is also having a negative effect on tourism development, which is causing jitters amongst some of the world’s biggest luxury brands and retailers. Due to the current tense atmosphere in Russia, employees of defence and law enforcement agencies in the country have been banned by local authorities from travelling abroad.
These organisations have a combined total of more than four million employees. According to Euromonitor International, growth in outbound trips from Russia will drop to 4% in 2014, following an impressive hike of 15% in the previous year. A major slowdown in the number of trips taken across all key luxury shopping destinations, such as the UAE, France and the UK, is clearly visible.
The official advice of the Russian government is to opt instead for domestic tourism. Similarly, domestic trips in Russia are set to rise by around 5% in 2014 and 2015 consecutively, representing an increase of one percentage point on 2013 figures.
Russian fashion designer, Valentin Yudashkin
On the upside, Russian luxury goods retailing is undergoing a period of retrenchment amidst ongoing expansion and growth, with retailers making better use of information technology and spending more on new software systems. All of this is supporting the rise of omni-channel retailing strategies.
Russia has one of the most vibrant e-commerce sectors in the world, as a surging online population, driven by improving fixed and mobile broadband access, is making the move from offline stores.
Already the largest market for internet users in Europe, Russia is seeing strong demand for designer apparel and footwear and super premium beauty web retail especially. M-commerce services remain relatively underdeveloped and mobile shopping is set to provide the next growth spurt for the sector.
Whilst bricks-and-mortar is still the preferred channel for today’s Russian consumer, with over 95% of all luxury sales in Russia taking place in-store, the internet has been transformative not only in the way luxury consumers interact, but also in the way the industry operates. Online value sales of luxury goods in Russia currently stand at RUB16 billion (US$454 million fixed exchange rate) having increased by 15% on 2013.
“ Online value sales of luxury goods in Russia currently stand at RUB16 billion ”
However, to date, online retailers have focused on major cities like Moscow and St Petersburg, where the majority of luxury goods internet retailing sales take place.
This narrow focus enables them to operate their own distribution networks and offer same day or next day delivery. While this strategy limits the potential consumer base, these urban customers are wealthier, have better access to the internet and are more comfortable with online shopping.
Outside these cities, the government-run postal service is responsible for deliveries. Following severe problems with the quality of its services, the company has undergone an overhaul in order to meet the needs of a rapidly growing internet shopping culture.
Nonetheless, companies investing in their own logistics remains a better bet. Lamoda, one of Russia’s leading fashion e-tailers, has invested in its own infrastructure, including a warehouse in Moscow, 20 satellite centres in remote cities, as well as its own fleet of couriers and cars to deliver to customers.
“ To date online retailers have focused on major cities like Moscow and St Petersburg ”
Thus far, Russia has not introduced direct sanctions against any multinational luxury goods players or their products, but the ongoing tense geo-political situation in Russia and the Ukraine is expected to negatively impact a number of companies’ performances in 2015 and beyond.
Sales of luxury goods in Russia are expected to reach RUB449 billion by 2019 (US$12.8 billion at fixed exchange rates), up by 24% in real terms in the five years from 2014. Whilst this growth remains in double digits, it is a far cry from the 83% growth witnessed during the 2009-2014 historic review period.
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