Foreign firms in Russia enjoy profits but problems with costs, staff persist

By bne IntelliNews March 8, 2007

Patrick Gill in Moscow -

Times are good for many foreign companies operating in Russia. Although net profit growth is slowing for most firms after the stellar results of the last few years, the scale of their operations is several times bigger than three or four years ago. Companies that were growing at 40% or more per year may now 'only' be growing at 20% a year, but profits are still four to five times higher in absolute terms than, for example, in Germany.

Not all is rosy, however. Despite the benefits of a still rapidly expanding market, three main problems remain for western firms on the ground - finding qualified staff, dealing with rising costs and managing distribution.

For most firms, the first of these issues has been the biggest headache in the last couple of years, executives say. Whereas for several years after the 1998 crisis recruitment was relatively straightforward, demand for good people now far outstrips supply. Moscow staff are particularly demanding when it comes to wages, as inflation on many goods in the capital is nearer 20% per year than the countrywide official statistic of 10%.

One Western CEO who laments the falling quality of university graduates says his company is scouting for talent in Russian regions where it would not have looked just a few years ago. The managing partner of a large consultancy says his firm spends more time on training people in Russia than anywhere else in the world.

"Most firms could double staff tomorrow if they could find qualified people," says one expatriate manager.

"The biggest challenge in the company internally is human resources," says another country manager. "The demand for talent is increasing, but supply is dropping."

The company is always looking for new ways to attract and keep the right people, he says, including finding Russians working abroad to bring back to Moscow, and sending company representatives to MBA schools around the world to recruit students. "There is a trend of bringing experts back to Russia," he notes.

Some Western companies are also returning to the policy of filling middle-management positions with expat staff, who are often cheaper to employ than locals.

Bought and paid for

Strategies in the battle to keep staff include introducing performance-related pay, and moving some staff to regional cities where salaries are lower. Setting up branches in the provinces also means lower office rental costs and the ability to expand outside Moscow.

Meanwhile, rising costs in other areas are also affecting foreign firms' profit margins. Two areas of particular concern are office rental and advertising.

Moscow's real estate speculation boom means commercial property has become almost prohibitively expensive, and this has led some firms to consider buying their own office space rather than rent. Office space currently costs over $4,000 per square metre in central Moscow, and this is expected to continue rising. With most companies taking on more and more staff, the need for more space becomes particularly acute.

TV advertising costs are expected to rise by at least a quarter both this year and next year. The Russia country manager of a large international industrial firm notes that companies are developing other and tools such as digital and phone advertising and events marketing to offset the rising costs.

The other major issue, distribution, is one that affects firms increasingly as the scale of their business expands into more regions. "The next challenge is distribution," says one country manager. "We are facing gigantic transformation in distribution in the next five to 10 years."

Logistical problems in the regions

Local distributors are becoming more expensive, and many firms have been trying to implement their own distribution chains to offset this. Given the difficult logistical issues involved in moving goods around Russia, however, more firms are considering as an alternative buying the distributors they have worked with. Those that decide to stick with external distributors increasingly look to place one of their own employees with the distributor to keep an eye on operations.

Compliance considerations are another issue here – under US and European anti-corruption legislation, companies are obligated to keep track of how their local partner firms are operating, and can face liability in their home jurisdictions if they are compliant in corruption. Greater control over these entities is, therefore, becoming increasingly important.

Most foreign executives see these problems as part and parcel of doing business in a rapidly growing market and one country manager sums up the current optimism by noting that that, whereas 10 years ago Russia was his worst performing market, it is now a contender for cover story on the company's annual report.

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