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Russia’s online economy is booming and no one has really noticed. The traditional economy will be badly hurt this year by the double whammy of the oil price collapse and the coronavirus (COVID-19) epidemic, but the growth of online sales has almost completely ignored the multiple crises and continues to expand at double-digit rates. Indeed, if anything it has only accelerated.
Russia’s new economy has reached a critical mass, where the leading companies have gone from building up individual business lines to creating entire ecosystems. A period of consolidation has already started where billion-dollar deals and IPOs are being announced on a monthly basis and there is no sign of any of this slowing down any time soon.
But there is still a long way to go. Despite the progress, Russia’s new economy and its penetration still lag behind those of more advanced markets like the US and China. Russia’s e-commerce is still relatively underpenetrated, highly fragmented and there is a low share of multi-category players, say the experts.
“2019 e-commerce sales as a share of retail sales in Russia reached just 6% vs 8% in Poland, 15% in US and 28% in China,” said Oksana Mustiatsa, an e-commerce analyst with Sova Capital during a recent webinar dedicated to Russia’s online business. “Multi-category players accounted for less than 20% of the e-commerce market in Russia in 2019, vs 50% in US and over 70% in China.”
E-commerce’s share of retail won’t stay at 6% for long. Traditional retail sales have been walloped this year and have completely collapsed to never-seen-before lows during the lockdown that started in May. Sales bounced back strongly in the summer after the restrictions were lifted, which is one of the reasons Russia’s economy is doing better than expected in the second half of this year, but as the second wave of the pandemic began to build momentum rapidly in the last week of September, sales are already slowing again, according to the latest data from the Watcom Shopping index; the outlook for the rest of this year is poor.
The story with online sales is very different. There sales have been putting double-digit growth and the lockdown barely registered. Indeed, according to Sova Capital’s estimates, the coronacrisis will accelerate the switch to online retail, which will account for 9% of total retail by the end of this year and 20% of all retail sales by 2024.
“The step up from 10% of retail doing done online to 20% in just four years is an enormous change,” says Mustiatsa. “And it means there will be a consolidation in the sector that will end with two or three very large players.”
Russia’s advantages for a prospective e-commerce player is its widespread fast internet, the rapidly growing penetration of smartphones and its very large population; Russia already has more people online than the entire population of Germany.
The disadvantage is the country’s sheer size. The game is not just to be able to get goods ordered online to the customer, but to get them there quickly.
A survey made by Data Insights last year found that 40% of respondents said they would not order online if the terms of delivery were “inconvenient.”
“The geography of Russia has been more of a hindrance than a help so far,” says Mikhail Terentiev, Sova Capital’s head of research. “In Moscow you can promise to deliver goods in under 30 mins, but getting the same goods to some regional town or village is very hard and a lot more expensive. And most of the population live in the regions.”
Residents of Moscow and St Petersburg, Russia’s two biggest cities that have bigger populations than most Central European countries, have been spoiled with super-fast, super-efficient express delivery services, but in the regions delivery times can stretch into days. If the supplier is relying on the Russian post office then deliveries can take up to two weeks.
To get round the problem most Russian online stores have long ago committed themselves to building their own distribution systems. One of the reasons for the success of Russia’s market e-commerce market leader Wildberries has been huge investments it has put into its own delivery system. Ozon, one of the other biggest players, was a little slower to roll out a federation-wide distribution system, but it is closing the gap rapidly.
“One of the main obstacles for the growth of the Russian market in the past was the lack of sufficient logistic infrastructure, especially in Russian regions,” says Mustiatsa. “This why Russian online retailers have been increasingly relying on their own infrastructure.”
Hockey stick growth
E-commerce was already expanding at ten times the speed of the real economy before the coronavirus (COVID-19) pandemic swept through Russia, but it is growing even faster now.
While lockdowns forced people to turn to their computers and phones to buy groceries, one of the lasting changes will be the number of new customers the lockdown has brought into the market.
“You are not necessarily cannibalising traditional retail, but gaining new unique customers who have never shopped online before,” says Artur Galimov, a retail analyst at Sova. “That means online is also good for traditional retail chains that are adding online channels to their sales.”
Now they have the habit of shopping online these new customers are unlikely to go back to visiting bricks and mortar stores any time soon, say the analysts. This is a structural change in the way retail is done in Russia and is a permanent change.
“There is vast room for structural growth and market consolidation,” says Mustiatsa. “This year Russian online retailers received a boost from the lockdown. They e-commerce market could reach RUB2.5 trillion ($32.6bn) in 2020, with e-commerce penetration rising to 9%, according to Data Insight estimates. This effect is likely to be long-lasting due to the inflow of new customers into retail and the increase in the frequency of orders. The market should be able to grow at compound average growth rate (CAGR) of 3% or more for the next three years or so.”
Part of the change has been driven by the rapid growth of smart phone penetration. Internet speeds are fast in Russia, as most of the networks are relatively new and companies have gone straight to state-of-the-art solutions. Broadband use is widespread.
Russians have been trading in their dumb phones for smartphones, with sales of the latter continuing to grow in double digits. Today more than a third of all phone calls are made by one of the messaging services and the mobile phone operators made more money from data services than voice for the first time several years ago. Even the Moscow Metro is about to introduce face recognition technology to do away with tickets all together.
The switch from traditional bricks and mortar stores to “click-and-order” stores was always going to resemble a hockey stick. As Russian online pioneer Oskar Hartmann, the founder of online fashion store KupiVIP and an ethnic German born in Kazakhstan, told bne IntelliNews in a 2012 interview, once online sales move beyond the “consumer commodities” of airplane tickets and paying phone bills it still takes several years for punters to get used to buying other goods online.
Hartmann predicted in 2012 that “by 2020, the e-commerce economy should be of the order of $50bn to $80bn, depending on supply, and fashion sales will account for about $15bn of that." Not a bad guess. And if you take into account that the ruble unexpectedly halved in value in 2014 then this year’s online turnover is almost in the middle of Hartmann’s range in ruble terms.
Winner takes all
The business has now entered a new phase where being big has become a serious competitive advantage. E-commerce is becoming a winner-takes-all business with room at the top for less than a handful of multi-category players.
It costs a lot to set up an online business thanks to the costs of logistics, among other things. The only way to become profitable is to achieve a scale that allows the company to drive down these costs as a share of their turnover so that they can make a profit. This turning point is where the Russian market is now.
“We thing that large multi-category players like Ozon that have diversified production offerings and robust infrastructure are better positioned to benefit from the market structural growth and eventually gain market share from smaller mono-category players with sub-optimal logistics capacity,” says Mustiatsa. “And the market is ripe for consolidation.”
Analysts are very focused on Ozon at the moment, which at the start of October announced plans to IPO in New York. Sova Capital’s analysts believe the IPO could happen at the end of this year of the start of next year.
Ozon CEO Alexander Shulgin laid out the company plans to bne IntelliNews in an exclusive interview in September 2019 that predicted fast growth, and Mustiatsa also said she expects triple-digit growth for Ozon for the next couple of years.
“The volume growth this year will be up to 135% year on year to RUB190bn and it has potential to grow faster than the market this year,” said Mustiatsa.
Common middle ground
The acceleration of Russia’s online businesses has already challenged the traditional retail outlets, but many of them have embraced the new technology too and are becoming agnostic as to which channel they use to make a sale. It is telling that M.Video, Russia’s biggest purveyor of consumer electronics, already counts as the third-biggest e-commerce business in Russia, as its online sales have grown so fast in recent years. To bring the point home, M.Video became the fastest growing listed retailer in Russia in the third quarter of this year, posting a 25% y/y growth to RUB110bn ($1.4bn), while its sister company Eldorado reported 28% growth in the same period, compared to Russia's total retail turnover, which has contracted by 4.7% over the same period.
Traditional retail that doesn't make the change is in danger of getting left behind. The e-retailer Wildberries overtook the bricks and mortar franchise Sportsmaster as the biggest seller of clothes in Russia last year. It was the first time an e-commerce store became the biggest outlet for any product group.
Wildberries has been a smash success and saw revenues up 80% in the first half of last year to just under $1bn, while Sportsmaster, which has been around since the '90s, has seen sales stagnate.
On the other side of the fence the traditional retailers are also developing online aspects like Market Places. Detski Mir, Russia’s leading purveyor of children’s goods, is a prime example. Detski Mir has set up a market place that provides goods and services that are related to childcare such as paediatricians, nannies, babysitters, cleaners and the like.
Russia’s premier supermarket chain Magnit is also experimenting with online variants. Of course the chain long ago introduced a loyalty card to gather more information about the shopping habits of its clients, but now it is developing a “super App” that will integrate the whole range of shopping services from sending messages, to buying online and financial services.
“Magnit’s super App is still well behind those in China and Vietnam,” says Galimov. “China’s internet is more isolated from the rest of the world than Russia’s, where the ad space, for example, is much more competitive. It is easier in China to put all the stuff you need into one space. It's still early days for a super App in Russia.” But this might change too.
And X5 Retail Group, Russia’s leading supermarket chain, introduced a new strategy in the last week of October (see interview) that they are calling a “transformation”, as it will use technology to put the company at the start of the punter’s journey to buying groceries, not leave it at the end where it is now.
All these services are still in its early stages of development, but the traditional retailers and tech giants are building towards a common middle and eventually they will meet.
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