Obuv Rossii puts shoe on right foot

By bne IntelliNews May 21, 2013

Ben Aris in Moscow -

When the Soviet Union fell in 1991 and the borders were thrown open to consumer goods, the first thing to arrive from the West, predictably enough, was cigarettes. The second was good shoes.

Shoes are important in Russia. The bad weather means you notice the quality of shoes very quickly, especially in the spring when the roads are awash in freezing slush. Everyone scrimped and saved in the midst of the economic chaos that followed the end of communism to buy at least one decent pair of shoes.

Anton Titov was still a kid when the Soviet empire collapsed, but his father was clearly an enterprising man. A retired soldier, Titov senior in 1993 started importing quality German shoes from Westphalia and opened a store in his native Novosibirsk in Siberia. The shoes flew off the shelf and the company, called Westfalika, soon made enough money to buy a factory at the cost of $500,000 - an enormous sum in those days - to make its own quality shoes.

Titov junior, 16 at the time, helped out with the business as a sales manager, eventually going on to become the head of marketing. "It was a university," says the ebullient Titov, who is still only 34 today. "There was no brand awareness in those days, no real competition. The only real problem was getting hold of enough shoes and selling them fast, as we had over 100% inflation but we had to pay for the imports with Deutschemarks," says Titov, adding that the biggest sellers were high-heeled ladies' shoes and boots for winter.

Making money was not a problem, but holding cash was due to the hyperinflation. Business in Russia became a perpetual motion affair where the fleet-of-foot (excuse the pun) were the most successful.

Oddly enough, Russia's 1998 financial crisis was actually a boon for Westfalika, as the four-fold devaluation of the ruble reduced the cost of its locally produced shoes compared with the imported competition. "In 1998, the cost of shoes was half that of the cheapest Chinese imports," says Titov.

By this time, 70% of Westfalika's inputs were Russian, including the leather, soles and the insoles of its shoes. Prices stayed low for at least another year and the company couldn't make shoes fast enough to meet demand. Using the extra money, Westfalika expanded again. It opened dozens of new stores and even bought an Italian factory that had gone bankrupt due to the effects on the rest of Europe of the Russian crash, as well another factory in Belgium and a sheep fleece factory in Russia that makes the warm lining for winter boots.

Rise of China

Business continued to flourish until about 2003 when things began to change very fast, says Titov. China's meteoric rise was well underway and starting to impact the Russian market. The Chinese had always sold cheap, poor-quality shoes to Russians, but as they began to assimilate western technology the quality of their shoes rose rapidly - but prices didn't. "The cost of production started to rise rapidly in Russia and soon was at the same level of the international producers. We needed to change strategy," says Titov. "We were like a Soviet factory, doing everything in the process ourselves. It was not effective anymore as the market had changed."

Titov wanted to move production to China, but his father was not interested. So Titov struck out on his own and set up the shoe retail chain Obuv Rossii, selling the Westfalika brand. "It was a small operation. In the first year we opened five shops and sold 40% of the family's shoes and the rest were imports. The biggest problem we had was finding capital to grow. There were no bank credits then, but as I knew all the suppliers I could get materials and products on credit," says Titov.

In 2004 and 2005 Titov opened 10-15 stores a year, but by 2006 with 45 stores he had maxed out the credit available from suppliers. It was this year that he flew to Beijing to find producers and the same year his father closed down Westfalika as it was no longer profitable. The young Titov took over many of its stores that still trade under the name. "We made lots of mistakes in the next few years as the price of experience is high, but we eventually found good partners in China," says Titov. "The key was to control the quality of the materials."

The Chinese don't argue about price, explains Titov, as if you push down the price, all they do is skimp on the quality. And most of his competitors from Russia in China were pushing for the lowest prices they could find. Titov didn't haggle, but insisted on having his own quality inspectors visit the factory floors. "Our priority was to control the quality of the materials in the factory and half the factory owners wouldn't agree to letting our inspectors in," says Titov.

Obuv Rossii's success is built on concentrating on the mid-range price group; the cheap end of the market is flooded with Chinese shoes and the top of the market is out of the reach of most Russians in the regions, even if Titov could technologically produce them. And his insistence on quality has paid dividends. Typically, a contract with a shoe factory in Italy allows for a 3% return rate of the shoes; Obuv Rossii had a return rate of just 0.8% over the last five years out of sales of 1.5m shoes a year.

With its new cheaper suppliers in China, the company grew fast in the boom years to reach over 200 shops in 60 cities of Russia by the time the 2008 economic crisis struck. The company is the largest player on the mid-price market in Russia and had sales over $110m in 2012 and $160m in 2013. According to Discovery Research Group, the total volume of the mid-price segment in 2012 was $10.5bn, accounting for 35% of the entire footwear market. "We have been growing at about 40-50% a year over the last three years," says Titov. "The shoe business has been growing extremely fast in general and is now the third largest retail segment in a market worth a total of $25bn."

Hard financial times

The company's biggest problem remains financing its rapid expansion. For a mid-sized company based primarily in Russia's far-flung regions, it remains very hard to raise debt from banks. In 2007-2008, Titov broke new ground in Novosibirsk by issuing $23m worth of three- to six-month credit notes to fund buying stock for the shops that was entirely bought by 28 small regional banks. But when the 2008 crisis arrived this debt nearly killed the company off. "We were lucky that the crisis struck in the autumn, the shoe sellers' high season, as everyone is buying boots for the winter," says Titov.

As the economy went into meltdown, shoe sales remained exceptionally strong that year. Confusion reigned after Lehman Brothers collapsed in September, as the Kremlin remained in denial and the state television was reporting the crash as "America's problem". The government assumed that its $600bn in hard currency reserves was enough to protect Russia from the storm, so Russian businesses were getting mixed messages. It wasn't until about February the next year that the government realised the impact the crisis would have on Russia and started to withdraw its support, sending the economy into a tailspin. "Long before then, we were already closing stores, some of which we had opened only a few months earlier, cutting costs, renegotiating rents and pulling in all the cash we could," says Titov. "We decided we had to pay off our $23m credit notes by December."

By the start of 2009 when most other businesses were just starting to go into crisis mode, Obuv Rossii was already through the worst. It started the spring season with dramatically lower costs and no debt at all. By the summer of 2009, on the back of strong sales - the population was largely unaffected by the crash and incomes have continued to rise throughout the current troubles - Obuv Rossii was opening new stores again and back into expansion mode, while the rest of the country's companies wallowed in misery. "In the autumn of 2009, going into high season the other companies had not bought enough shoes as they didn't know what was going to happen next, but we started our own credit scheme for customers to keep sales levels high," says Titov.

Shoes are not a big-ticket item, but because the winters are so cold people, and especially mothers, are willing to pay for a good pair of warm boots. The cost of about $100-150 for decent boots is not that much, but as mothers typically buy for the family, four sets of boots will eat up most of an average salary in one month. Obuv Rossii came to the rescue with a credit scheme that spreads the payments over the whole winter and was enormously popular. In 2012, half of the sales were made on credit, or $50m, and the company is expecting this to rise to $85m in 2013. The local banks were a bit non-plussed by this idea. "Why offer your customers credits when they can come to us and get a credit card?" the banks asked. Titov explains that people still don't trust banks in Russia, as they have lost money with them too often. However, they do trust shoe shops, as the deal is clear: they want to buy shoes and we give credit to buy them. "No trickery involved," says Titov.

And the Russian retail borrower remains very reliable: Titov's non-performing loan rate on these credits has been a mere 1.2% - better than the 4-6% most banks have to deal with. "Besides, the banks don't like to lend less than RUB50,000 ($1,666), whereas we typically lend RUB5,000."

The Magnit of shoes

Obuv Rossii is now hitting its stride. The Russian economy may be slowing, but people will always need shoes and consumer spending is stable or growing. The next stage is to expand the business and open more shops and become the "Magnit of shoes", following in the footsteps of Russia's super successful supermarket chain.

In addition to Westfalika, a mono-brand in the middle-price segment, the company is also developing the Peshekhod chain, a multi-brand footwear supermarket, and the fashion brand Emilia Estra, which offers inexpensive accessories. "We want to open 100-120 shops a year and get to 650 shops in the next five years, growing the revenues from $160m to $800m over the same period," says Titov.

Most of this will be done through organic growth. "Over the next five years, we will place an emphasis on the development of Westfalika in the shopping centre format. This will allow us to expand the consumer base of our brand by attracting the attention of younger and more active customers," says Titov.

He estimates he needs to invest $200m over the next few years. The company has already issued its first ruble bond on the Moscow Exchange worth RUB700m ($23m) in 2011, but plans to issue another RUB6bn in three tranches over the next five years with the first bond offering of RUB1.5bn due this year. There could be an eventual IPO too. "We may IPO eventually, but on the Russian exchanges," says Titov. "Some say that we should look at London's Alternative Investment Market (AIM), Warsaw or Hong Kong, but we are a Russian business with Russian customers and so the natural place to float our shares is where people understand our business and our market - in Russia."

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