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Country Commercial Guides for FY 2000: Russia Report prepared by U.S. Embassy Moscow, Released July, 1999 Note*

IV. MARKETING U.S. PRODUCTS AND SERVICES

U.S. business has dramatically increased its activity in Russia since the collapse of the Soviet Union. Membership in the private-sector American Chamber of Commerce in Russia (Amcham) grew from a few dozen companies in 1994 to roughly 500 by 1999, making it the fastest-growing U.S. business chamber in the world during this period. Amcham, with chapters in Moscow and St.Petersburg and more than a dozen member-led committees, has worked closely with the U.S. Commercial Service and private-sector associations in bringing policy issues to the attention of the U.S. and Russian governments to encourage improvement of Russia's commercial climate, and in calling U.S. companies' attention to overlooked opportunities in regions beyond Moscow.

On an accumulated basis, America remains the largest single-country investor in Russia, but ranks behind the EU as a whole in investment in, as well as in exports to, Russia. In 1998, Germany was the largest source of foreign portfolio investment into Russia (attributable to Ruhrgas' large investment in Gazprom), while the U.S. remained the largest source of foreign direct investment (see Appendix D). In fact, Russia has received relatively little foreign direct investment compared with, for example, Central Europe or China. Most firms have decided that early returns are not great enough to compensate for high start-up costs and perceived risks. With few exceptions, U.S. firms investing in Russia describe their decision to do so as strategic, based on the promise of long-term position rather than short-term sales. Western Europe's share of exports to Russia parallels its share of direct investment in Russia: in each case, it accounts for around a third of the total. The U.S., on the other hand, accounted for only 6 percent of Russian imports but contributed 35 percent of direct investment in 1998. Overall, there is a contrast between the trade-oriented policy of Western European firms toward Russia and the approach taken by U.S. firms. Some of this is due to Europe's proximity and the logistical advantages this confers. However, anecdotal evidence suggests that U.S. firms have been less active than their European competitors in taking advantage of opportunities and in marketing and building distribution networks at regional levels in Russia.

Distribution and Sales Channels Companies operating in America are accustomed to well-defined distribution channels, relentless competition, and strong advertising budgets. Firms in Russia, by contrast, encounter erratic distribution, unpredictable (but often tough) competition, and word-of-mouth marketing. Although Russia boasts increasing numbers of joint ventures and Western-style stores in major cities, most goods distribution -- especially outside of Moscow and St. Petersburg -- takes place through less formal channels. Penetrating these channels is often the key to success or failure for an American company operating in the Russian market. Western companies which have succeeded have done so through a combination of improvisation and innovation, combined with a substantial investment of time and a tolerance for early mistakes. U.S. companies with a long-term market development strategy may find regional markets well worth exploring, because anecdotal evidence indicates that European products are increasingly showing up unchallenged in Russia's regional markets.

Use of Agents and Distributors / Finding a Partner

Both experienced exporters and those with less well-developed agent selection criteria are well-advised to cultivate personal, ongoing relations with agents, to proceed gradually, and to retain a fall-back position should a relationship sour. Experience has shown that perhaps the riskiest strategy is to visit Russia only once or twice, select an agent and grant him exclusive representation, then move quickly to consignment or credit sales without establishing a solid track record, especially with regard to payments.

To succeed, U.S. companies must consider a variety of local and regional distribution alternatives. In a few product categories (e.g., apparel, packaged foods, and alcoholic beverages), foreign suppliers can choose from a small but growing number of existing Russian distributors. These Russian agents can help the foreign supplier by placing its products on store shelves, handling customs and transportation matters and conducting advertising campaigns. Most of recently-formed Russian distributors are small-volume operations with experience limited to the main cities of Moscow and St. Petersburg or other regional centers.

Over the last four years, many foreign manufacturers of consumer appliances and durables have moved away from using official distributors. These companies typically have replaced agency agreements with their own representation in major cities. They then sell directly to Russian importers, who take possession of goods outside Russia (in Finland, for example) and import for their own account. This affords the manufacturer greater control over prices and distribution, while avoiding potential tax and customs liabilities, as well as the uncertainties of the local commercial environment.

Meanwhile, other foreign companies have decided that the reputation of their firm and brands could suffer if they fail to ensure compliance with Russian customs regulations by acting as the importer-of-record (and in fact, some U.S. companies have met trouble as a result of false invoicing and other irregularities commited by their intermediaries). Firms which opt for direct exports will likely face lower early returns, due to reduced sales owing to duties and higher landed costs. However, for those determined to build a strong presence in Russia, this policy may be seen as an investment that will ultimately pay reputational dividends.

In the aftermath of the 1998 financial crisis, many Western firms selling in Russia have pared back their distribution networks, focusing products and resources on those distributors who were able to maintain sales and payments while cutting loose those who performed less well. This strategy is designed mainly to cut medium-term costs during a period of depressed sales, although it could slow companies' efforts to expand into regional markets.

The U.S. Department of Commerce provides assistance to U.S. companies seeking Russian partners, agents or distributors through the Agent/Distributor and Gold Key services offered by the Russia-based offices of the U.S. Commercial Service, and also through the "Search for Partners" program of the Department's Business Information Service for the New Independent States (BISNIS). Contact information for these offices is found in Chapters IX and XI.

Direct Marketing

In Russian cities, telemarketing and fax marketing to business customers is common but not particularly effective. By contrast, person-to-person direct marketing works well (e.g., in the health and beuty products markets). Other direct marketing channels (e.g., catalogs, internet and regular mail) remain in their infancy. Many shippers are reluctant to send goods without prepayment, especially those who were burned by non-payments during 1998's freeze-up of the banking system. The base of customers with credit cards remains very small, and although it is expanding, this remains a key constraint on the growth of catalog and online business. However, since catalog businesses avoid high costs of retail distribution in Russia, they have potential for higher profit margins, and this market segment should heat up in coming years.

Joint Ventures and Licensing

Joint venturing demands meticulous planning and sustained commitment from U.S. partners. In most cases, other forms of alliance, in which the U.S. partner retains managerial control, are preferable. JVs in which foreign partners hold minority stakes are quite dependent on the good intentions of their Russian majority-owners. Recent experience shows that foreign minority shareholders face serious difficulty in protecting their interests in Russian courts.

Usually, foreign firms have established JVs to market goods, and sometimes to manufacture. Goods made and/or distributed successfully by U.S.-Russian JVs range from soft drinks, ice cream and cigarettes to elevators, oil, sport-utility vehicles and jet engines. Some firms choose to create a JV to capture lower local cost structures, in effect running their business as a Russian would. High taxs and uncertainty in Russia's legal environment are barriers to greater reliance on JVs as a form of market entry by U.S. suppliers.

One advantage of a JV is that it can help a U.S. firm gain a measure of Russian identity, which can be useful in a culture where many still view foreigners with suspicion. Political pressure is mounting in Russia for domestic-content mandates for key sectors or large-scale procurements. For example, some planned foreign investments in the oil industry may entail contractual commitments to use 70 percent or more Russian-sourced goods and servics. Firms that can creatively help oil producers meet these requirements may be in an advantageous position to serve this industry.

The joint venture concept is often viewed differently by the Russian and American partners. U.S. companies, especially smaller ones, often view JVs as a means of securing a local partner with experience selling in the Russian market, and may agree to a JV as the price for this expertise. Many Russian managers, on the other hand, view a foreign partner chiefly as a source of working capital, and proactive local market development may not be a high priority. While there are many examples of successful JVs in which both partners' goals have been met, ceding managerial oversight over any aspects of a JV to a Russian partner who does not share the U.S. investor's objectives invites trouble. U.S. firms should thoroughly explore whether a Russian potential partner shares priorities and expectations before making financial or legal commitments.

A mistake that often has led to commercial failure and, in some cases, bitter legal disputes, is for an American to strike a JV agreement with a Russian partner after a limited history of cooperation, and then return to the U.S. as an "absentee" partner in the expectation that the Russian partner will manage day-to-day operations, implement a business plan, and wire home the American's agreed-upon share of the profits on schedule. This is a recipe for disaster. Any firm that undertakes a JV in Russia should be ready to invest the constant personal attention of American managerial staff to keep the business on-course, both before and after the venture has achieved commercial success.

Licensing of U.S. technology for production in Russia outside the context of joint ventures remains rare. Chief hurdles which licensing arrangements must overcome include concerns over quality levels attainable by Russian facilities in the absence of significant investments in retooling, uncertain intellectual property protection (especially in the software industry, where potential for licensing is otherwise high) and difficulty in receiving regular payments on-time. In the opposite direction, Russian companies generally are eager to license their technologies to foreign companies in exchange for the cash infusion this brings. In 1998, one major American chemical manufacturer signed a $40 million agreement with a Russian chemical firm to license Russian chemical technology. Again, computer software is an area with high potential for this avenue of cooperation.

Establishing an Office; Business Structures

Registration of foreign businesses in Russia is regulated by the 1991 law on foreign investment, as well as the Civil Code and other legal acts. Branch offices and accredited representative offices are both legally distinct from full-fledged Russian corporations, which may be established by foreign firms in Russia either as joint-stock companies with partial Russian ownership, or as wholly-owned subsidiaries of the foreign firm. Foreign ownership can legally be as high as 100 percent, except in certain sectors where foreign stakes are restricted by law (e.g., as defense-related enterprises, where foreign ownership cannot exceed 25 percent).

--Branch Offices: Branches are not considered independent legal entities, and cannot make a profit in Russia. Branches of U.S. companies can negotiate or market on behalf of American firms based outside Russia, providing business support or promotion services to the parent company in the U.S., but cannot turn a profit in Russia. Setting up a branch may be worthwhile if a foreign company has just begun pursuing business in Russia and is in the process of exploring opportunities and making initial contacts in the market. Many large U.S. firms now active here originally began their Russian operations as locally-established branches. Keep in mind that the term "branch" under Russian law refers to a specific type of corporate structure. U.S. firms should not use the term "branch" with registration authorities if the purpose is in fact to register as a full-fledged company.

--Accredited Representative Offices: Like branches, accredited rep offices are not independent legal entities, and cannot earn profit, in Russia. After accreditation is obtained from an appropriate Russian government agency (see Chapter XI for contacts), the office should be registered with the Moscow or St. Petersburg registration chambers if based there, or with other local registration chambers in other cities. Advantages of an accredited office include annual (rather than monthly) reporting requirement for some activities (including some tax payments), and greater leeway in issuing invitations for U.S. partners to visit Russia on business visas. Up to five foreign employees may work with an accredited office of a foreign company. Offices are usually accredited for terms of from 1 - 3 years. The accreditation could be provided by several Russian government agencies and ministries supervising the industry in which a company operates, including the State Registration Chamber, the Central Bank, Ministry of Trade, Ministry of Finance, or Chambers of Commerce and Industry of Moscow or of the Russian Federation. Accreditation is more time-consuming (2-3 months) and expensive than establishing a branch office. Accreditation fees vary from $1,000-1,500 for one year to $3,000-3,500 for three years.

--Full-fledged companies operating in the oil & gas or coal-mining sectors as well as businesses investing over 100,000 rubles (about $ 5,000) as charter capital are to be registered with the State Registration Chamber (SRC), which since September 1998 has been under jurisdiction of the Ministry of Justice. Other businesses should be registered with regional registration chambers (or city registration chambers, if established in Moscow and St. Petersburg).

Apart from registering businesses, the SRC also provides accreditation service to representative offices of foreign companies in Russia. The Chamber maintains a State Register of Companies with Foreign Investments registered in Russia, the Consolidated State Register of representative offices of foreign companies registered in Russia, and the State Register of branches of foreign companies in Russia. Registration with the SRC serves to certify the companies' legal status at the federal level. The Chamber also registers liquidations of businesses having foreign capital. Companies with foreign capital may be established in a form of a joint stock company or a limited liability company. Minimum authorized capital of a limited liability company is 100 minimum monthly wages (as of this moment, - 8,300 rubles or about $400) and 1,000 minimum monthly wages for a company with Russian partner(s).

Registration is supposed to take from 21 days to a month, but in practice, due to backlogs at registration offices, often takes longer. Registration entails obtaining first a temporary registration certificate, then a permanent one. To receive a temporary registration certificate, a foreign investor should submit required documents and have fifty percent of the authorized charter capital deposited in a Russian bank account. (The remaining fifty percent should be received in the company's bank account within a year after the registration for the registration to remain valid). Within 45 days after receiving the temporary registration, the investor should register with the State Registration Chamber and Russian tax authorities. After this is done, a permanent registration can be granted. While the official registration fee is low (4 minimum monthly wages, or 332 rubles or about $14.5), the actual cost may include other expenditures such as document preparation and legal counsel. U.S. Commercial Service offices can provide additional details on registration requirements, but we strongly recommend that firms also seek professional legal advice when registering in Russia.

Sales Factors

U.S. firms generally find success by choosing their sales targets carefully. Because a lack of capital and poor cash flow are typical of Russian businesses, many firms find it expedient to rank potential customers based on their ability to pay. Possible candidates for export sales include:

- Russian enterprises that export for hard currency; - development projects financed by Western sources; - Russian enterprises with good domestic cash flow; - regional governments in natural resource-rich areas; - the Russian federal government; - major modernization projects by Russian enterprises; - the general Russian consumer market; and - the upscale (albeit narrow) "new Russian" market.

Advertising and Trade Promotion

Advertising through TV, radio, print and billboard media, nine years ago a novelty in Russia, is now ubiquitous in the consumer goods and financial service markets. A number of Western as well as Russian advertising agencies are active here. Russian advertising regulations are not well-developed, however, and most advertising costs are not tax-deductible in Russia as in the West (although draft legislation under consideration in the Duma as of this writing may allow a measure of deductibility for advertising as soon as 2000, if enacted in 1999). Both foreign and domestic firms frequently advertise in commercially-oriented newspapers and journals in Russia. Industry-specific trade journals offer good marketing venues (e.g., Russian-language computer industry magazines). Among the more popular general-interest publications are:

--Deloviye Lyudi (monthly journal, Russian-language) --Izvestiya (daily paper, Russian-language) --Kommersant (daily paper, Russian-language) --Delovoy Mir (daily paper, Russian-language) --Ekonomika i Zhizn (weekly paper, Russian-language) --Business MN (weekly paper, Russian-language) --Moscow Times (daily paper, English-language) --Moscow Tribune (daily paper, English-language) --Moscow Business Guide (monthly bus. directory, English) --Delovoi Petersburg (daily paper, Russian-language) --St. Petersburg Times (daily, English-language) --Sevodnya (daily paper, Russian-language)

Trade exhibitions, numerous in Moscow and St.Petersburg, and increasingly common in other cities, can help U.S. suppliers find potential buyers and distributors, and are among the best ways for companies initially entering the Russian market to meet a large number of potential customers or partners. U.S. companies sometimes make substantial off-the-floor sales at Russian exhibitions. Representatives of regional governments and state enterprises from remote, poorly-supplied areas of Russia often visit trade exhibitions in major cities to purchase goods for their region or enterprises. A list of major trade exhibitions is found in Chapter XII.

Product Pricing

Price competition in large Russian cities is often muted. The ratio of retail outlets per capita in Moscow or St. Petersburg is a fraction of that in, e.g., Warsaw or Budapest, so that competing stores often are not near enough to one another to offer consumers real choices. Collusion by organized crime is also allegedly a factor. Regional markets are also notable for few alternatives in outlets and weak competition on price among analogous products. While markets for a given import in Moscow or St.Petersburg may boast access to several competing imports and domestic brands, heavy advertising, consumer awareness and widespread price competition, the market for the same product in Novosibirsk or Perm may differ markedly. Weakness of price competition among similar goods does not mean, however, that high-cost items will fare well where lower-quality but cheaper substitutes are available.

After-Sale Service, Training and Customer Support

After-sales service, training and customer support can be a major competitive advantage -- or disadvantage -- for U.S. firms entering the Russian market. Russian manufacturers even today are known in Russia for their almost complete lack of attention to post-sale service. For many lower-cost items, Russian buyers, especially in rural areas, are accustomed to buying more of an item than they need, in order to have a ready supply of spares or parts for do-it-yourself repairs. Similarly, Russian buyers of sophisticated equipment of all types -- from computers and process controls to medical equipment to mining equipment -- are keenly interested in training, as their employees may never have used particular products or brands before. U.S. firms able and willing to offer even rudimentary training and support for products, particularly in remote sites, can gain a big advantage over competitors. Conversely, companies not willing to make this commitment may find themselves at a distinct disadvantage to European or Far Eastern companies, whose proximity already affords them advantages in providing training and service.

Selling to the Government

A law on federal procurement, adopted in May 1999, provides that foreign firms may participate in public tenders if the product is not produced in Russia or if Russian production is considered to be economically unprofitable. Regional or local authorities are potential customers for U.S. suppliers. (For example, the federal Health Ministry and some of the more than 90 regional administrations often buy supplies to distribute to hospitals and clinics under their jurisdiction.) While local governments now receive much-reduced federal subsidies, they have more flexibility in making purchasing decisions based on local factors and contacts. Overall, however, Russia's current fiscal situation limits the role of public-sector customers. Some depressed regions are even worse off than the federation government in terms of spending ability.

Taxation

Russian and foreign products alike face a 20-percent Value Added Tax upon sale in Russia (although a lower VAT of 10 percent applies for a few basic food items and children's necessities). Regional or municipal taxes may also apply to transactions for some goods and services, and federal excise taxes are particularly stiff for alcohol and tobacco products.

Companies which move beyond strictly exporting into the realm of direct investment are subject to a wide, rapidly-changing array of taxes at federal and local levels. Russian tax laws and regulations are often ambiguous and inconsistently interpreted by authorities. Western firms are often surprised to learn that many business deductions common to the U.S. or EU do not exist here. With proper documentation, U.S. firms may be eligible for exemption from some Russian taxes on income which is also taxed in the United States, under a bilateral treaty on avoidance of double-taxation. Although foreign firms have successfully appealed tax disputes to the courts, officials have been slow to honor court rulings. Penalties for underpayment can be draconian (often assessed at 100 percent or more of the total tax due), and a company's accounts can be frozen relatively quickly. Regulations and officials who enforce them often do not differentiate between criminal intent versus honest errors when levying penalties.

Most of Part One of Russia's new four-part tax code was implemented on January 1, 1999. Provisions thus implemented include narrowing the list of permissable types of taxes at various levels (other types of taxes are, by implication, prohibited). Major federal taxes include VAT, excise tax, corporate profits tax, capital tax (essentially on interest and dividends), social benefits fund taxes, customs duties and individual income tax. Permissable regional taxes include corporate property tax, real estate tax, road tax, sales tax, gaming taxes, and regional licensing fees. Permissable local taxes include land tax, individual property tax, advertising tax, inheritance and gift tax, and local licensing fees.

Other significant changes resulting from enacted provisions of part one include some beefing up of taxpayer rights vis-a-vis tax authorities. Taxpayers are now entitled to written clarifications on tax questions from tax authorities, the number of times taxpayers can be audited for the same tax issues is limited, and tax authorities are theoretically liable for losses caused by any wrongdoing on their part. In addition, enacted provisions of part one permit a regional level investment tax credit of from two to five years.

Effective April 1, 1999, Russia's corporate profits tax rate was reduced to 30 percent from 35 percent, a move long called for by many foreign and domestic investors (although the aforementioned lack of deductions results in a high portion of income subject to tax). A more controversial proposal to reduce the more easily collected VAT to 15 percent was vetoed by President Yeltsin amid concern that this would hamstring one of Russia's few effective revenue sources without resulting in any compensating increase in tax compliance.

In 1998-1999, Russia's drive to crack down on tax deadbeats and boost collections under pressure of Russia's budget deficit has spawned numerous anecdotal accounts of what Western firms regard as harrassment by federal and local tax inspectors and Russia's Federal Tax Police. Firms are advised to familiarize themselves with Russian tax regulations, and companies with tax questions should seek the counsel of professional tax specialists who are experienced in Russia.

Besides corporate taxes, U.S. businesspersons working in Russia are subject to Russia's personal income tax, depending on the nature of their income and the duration of their work in Russia during a given tax year. Need for Local Attorneys, Accountants and Other Services

In Russia, commercial regulations are contained in thousands of presidential, governmental and ministerial decrees. Often, these decrees and laws overlap or conflict. Determining tax obligations is a tedious task. Russian accounting rules differ markedly from Western standards, and while the Russian Government has made coversion to International Accounting Standards a priority, the process is at an early stage. U.S. firms should use experienced, locally-based (Western or Russian) specialists familiar with issues faced by Western firms operating in Russia. The Commercial Sections at the U.S. Embassy and consulates maintain and can make available upon request lists of local attorneys and accounting firms.

While professional services in Russia are expensive, companies which shun this investment from the outset of their work here do so at their own peril. In Russia's commercial arena, when tax and legal problems are concerned, an ounce of prevention can be worth a pound of cure. Seeking seasoned advice early on can save both aggravation and money down the road.