Management Briefs Laptops from Lapland: Economist September 1997
Acer Computers decided to enter the Russian market by selling from Finland. This is the first in a series of articles on the difficulties of penetrating emerging markets
THE Finnish border with Russia near Vyborg lies a mere 200 kilometers (124 miles) by road from the Russian city of St Petersburg, and 1,000 kilometers from Russia’s capital, Moscow. The route is Russia’s shortest one to the West, and so is favored by people trading in expensive and perishable goods. The border divides two different worlds: the orderly calm of Finland and the feral badlands of Russia.
The old customs terminal on the Petersburg road was the stuff of Finnish drivers’ nightmares. It would take them ten minutes to clear formalities on the Finnish side-and ten hours to clear the Russian ones, if they were lucky. Waits of several days were possible. A new Russian terminal opened in February has cut the waiting time to a more reasonable hour or two. But beyond lies a Russia where criminal gangs prey, potholes gape, and the next place southbound for a decent cup of coffee is Turkey.
In the past three years more than 50 Finnish trucks have been hijacked between Vyborg and Moscow, two drivers have been killed and two have gone missing. The attentions of the traffic police are a mere inconvenience by comparison. They stop trucks for imagined infractions of obscure laws, and are easily bought off with a few dollars or the chance to pilfer from a load.
Slow and dangerous as it may be to move goods in by road from Finland, it is less slow than any other route, and less dangerous than stockpiling expensive goods in Russia. This comparative advantage has turned Lappeenranta, on the Finnish side of the border, into a boomtown for the trucking and warehousing industries. The town exemplifies the way much of Russia’s new wealth is being captured by cities and countries outside its borders that offer more security.
When Acer Computers, a Taiwanese firm, decided in 1995 that it needed to “localize” assembly of its computers for a growing Russian market, it was Lappeenranta, rather than Russia, to which it turned. Last year, Acer was, by its own reckoning, the world’s fifth biggest maker of personal computers. Though founded in Taiwan, it has its headquarters in Singapore. In 1993 it wanted to establish a permanent presence in the Russian market, starting with a representative office. It dispatched a young marketing specialist, Steve Kuzara, who hired two local staff and started signing up local distributors.
In the final quarter of 1993 Acer sold about $2m-worth of computers in Russia, shipping them from Taiwan via Western Europe. In 1994 it recorded full-year sales of $22m. The growth continued into 1995: though a softening of the market was apparent by the end of the year, Acer’s sales still almost doubled to $42m, and its office in Russia grew to 30 staff.
Acer believed it could do even better in Russia if it assembled computers locally, instead of shipping them in from distant plants. Shorter lead-times between assembly and delivery would allow its computers to be priced more competitively: component prices tend to fall with time, so more recently made computers tend to be cheaper. Acer could also adjust its specifications more readily to match local demand.
In principle, local assembly was an Acer specialty: by 1995 it already had some 30 factories worldwide, to which it was adding at the rate of four a year. But Mr Kuzara worried that the logistical difficulties of trying to set up and run any sort of assembly business within Russia would overwhelm all but the most experienced and hardy investor.
One thing to fear in Russia was the tax code-a collection of more than 4,000 legal documents so contradictory and ill-drafted that it was impossible for any firm to obey it in full, and easy for a company to be slapped with a bill for more in tax than it grossed in sales. Dealing with the tax bureaucracy could become a near full-time occupation for a law-abiding chief executive. So long as Acer operated purely as a representative office in Russia, it was covered by much more modest reporting requirements, and could concentrate on building its brand.
Setting up any sort of factory or warehouse business would mean managing the risks posed by the organized and disorganized crime ubiquitous in Russia, where even small retail stores often have guards armed with automatic weapons. It would mean seeing off rent-seeking bureaucrats who viewed foreign investors as especially easy and rewarding prey. In fact, investing directly in Russia was so difficult and dangerous that few Russians were willing to do it.
Finland, with its law-abiding business environment and highly developed infrastructure, offered a vision of everything Russia was not. Valuable goods that went into airport cargo terminals also came out again. Public utilities worked. The law of contract counted for something. There was even a special customs regime tailored to firms trading with Russia, allowing them to bring in goods from outside the European Union and re-export them to Russia with a minimum of formalities. Foreign investment trends reflected this benign regime (see chart).
A government agency, the Invest in Finland Bureau, showed Acer around and introduced it to Finnish firms that might help it settle in. Acer struck up a partnership with Wilson Finland, a subsidiary of a Swedish-owned international freight firm, which was a big carrier of goods between Finland and Russia and stood to benefit from the business Acer would create. Wilson helped Acer negotiate attractive terms for a light industrial building in Lappeenranta, and put up some of the capital.
The contracts for Acer’s new factory were signed in October 1995. It was designed to make 7,000 units a month, working a single shift-enough to accommodate Acer’s most optimistic projections for Russian sales growth until at least the end of 1996. Bulky and low-value components would be shipped by sea from Asia, a journey of more than a month; but the vital organs of the computer, mainly microprocessors and hard-disk drives, could be flown in from Asia and the United States within a few days of being ordered. A computer taking shape on the production line at Lappeenranta could be on sale in Moscow two weeks later.
The key to Acer’s strategy was a plan to sell its computers to Russian distributors “at the factory gate” in Finland. Across the border within Russia, Acer’s Moscow representative office would be on hand with support and advice. But it was for the distributors to arrange import procedures, and to cope with customs formalities and border taxes on the computers to which they held title.
This division of labor allowed Acer to reconcile the contradictory imperatives confronting it in Russia. As a high-profile international company it insisted on squeaky-clean observation of all laws and regulations in the countries where it operated; but any importer who paid Russia’s full panoply of tariffs and taxes on his goods, and waited dutifully in every line, would be beaten out of the market by other importers who did not. So Acer let its distributors worry about the routes and wheezes for clearing customs. In a quite literal sense, these would be none of Acer’s business.
An incidental benefit of assembling in Finland was that it would give Acer’s computers more appeal for some Russian consumers. The Russian computer trade divided computers into “white” ones, made in Europe or America; “red” ones, assembled in Russia; and “yellow” ones, from Asia, rated somewhere in between. “White” computers were popularly supposed to be the best made, and commanded a premium in the shops. Finnish assembly would make Acer more of a “white” brand and less of a “yellow” one.
Such were the considerations that encouraged Acer to opt for Finland. And such is Finland, everything went according to plan. The first computers emerged from Lappeenranta at the start of 1996, and they were brought into Russia by the half-dozen main distributors with which Acer had established close ties. It also happened that events at another foreign computer firm, IBM, were meanwhile confirming the wisdom of Mr Kuzara’s strategy.
IBM had gone the other, braver, route to building its Russian business. In 1993 it had elected to assemble its computers in Russia, upgrading a relatively modern production line installed by the Soviet authorities in the dying months of communism at a town near Moscow called Zelenograd.
To encourage IBM, the federal government had promised it exemption from import duties on the components it would need to bring in. But Russia’s parliament opposed the deal, and duties were levied on IBM all the same.
Worse, IBM found itself competing against Russian importers of finished computers to which the government itself had granted tax-exempt status. These importers could undercut IBM in the Russian market, even on its own-brand products. In February 1996 IBM decided to halt its assembly operation. It made only the briefest of public statements, but its actions passed a damning verdict on the conditions prevailing in Russia for foreign direct investment.
The climate for foreign investment has not improved notably since. In February this year Ben & Jerry’s, an American ice-cream maker, walked away from a Russian joint venture because it could not afford the management time needed to deal with the Russian authorities and with a troublesome local partner. In March America’s General Electric said that it would shut down a distribution subsidiary in Russia after tax officials sequestered its bank accounts, claiming money the firm says it had already paid.
In April the St Petersburg fire inspectorate said that it would close a Coca-Cola bottling plant and halt construction of two neighboring factories for other American firms unless it was given $1m to build a new fire station. (The St Petersburg argument was something of a collector’s item: the fire department argued that alarm and sprinkler systems in the factories did not “correspond” to Russian standards-which was true, in that the systems exceeded those standards. A St Petersburg official conceded that Russian fire legislation was “almost impossible to follow”, and that he did not know “of a single site where all the conditions set by the fire code were followed”.) Murder and mayhem also remain a contingent hazard: in July Motorola’s country manager was shot dead in Moscow, apparently by a professional killer.
All this would seem to suggest that Acer’s decision to invest in Finland was the right one, despite local labor costs being ten times higher than in Russia. That is not to say, however, that everything in Russia has worked out quite as Acer expected.
The autumn of 1995, when the Taiwanese decided to invest in local assembly, was also when the growth rate of its sales in Russia peaked. The full-year sales of $42m were slightly less than the high-end hope of $50m penciled in at mid-year. In 1996 Acer managed little or no growth at all in sales. Market conditions suggest it may manage growth of 20-30% in 1997.
Acer cannot blame the market for its recent disappointments. Overall demand for personal computers in Russia remained strong in 1996: it grew by 15% in volume terms and a third in value terms (see chart). That growth was captured by new Russian computer firms that had no alternative to assembling their computers locally, and that knew how to work the system in ways denied less sure-footed foreign firms.
These young computer firms now represent arguably the most dynamic part of Russian industry. The new market leader, VIST, did a brilliant job of building its brand between 1993 and 1996, advertising heavily and establishing distributors and service centers across Russia. VIST and the other local firms dealt foreign brands a double blow: they took away sales, and they forced importers to slash their once-fat margins. Consumers began to trust “red” computers more readily, and grew less willing to pay more for “white” and “yellow” computers.
In the meantime, the foreigners were also hurt by another change in the market. The parlous state of Russian public finances meant there were precious few new orders from the public sector, the main buyer of foreign computers; the market growth came in sales to households, which opted for Russian brands. The upshot was that local assemblers ended the year with a market share of about two-thirds-reversing the balance with imported brands that prevailed when Acer came into the market in 1993.
Acer was not alone in underestimating the growing strength of Russia’s indigenous computer industry. Might a joint venture in Russia have been a better move? Perhaps, but joint ventures in Russia have proved among the unhappiest ventures of all, with destructive arguments between partners a seemingly inevitable part of the learning process on both sides.
The decision to assemble in Finland, as a low-risk route to expanding Russian sales, still offers a model of its kind. It recognizes that Russia, for the next couple of years at least, is not a market like any other, but a place in which many things are simply too dangerous or difficult for all but the most massive and ironclad of foreign firms to attempt. There need be no shame in admitting as much, and in sitting (and siting) out this particular phase of Russia’s transition in a convenient country nearby.
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