The reasons behind the stagnation of Russia’s luxury market

Crocus City Mall – Moscow’s latest luxury shopping mall

The apparent calm following the re-election of Putin as Russia’s President for a 6 year term, earlier this month has been failing to provide a stable economic environment, maintaining a sense of nervousness for both Russian and foreign investors. The assassination of 46 year old furniture tycoon Mikhail Kravchenko by Russian mafia earlier this week, has once again instilled fear among nationals and foreigners alike, proving to be a vivid reminder of Russia’s never ending meddling of politics in business.

The politics of fear and censorship dominate all Russian industry sectors, with luxury being no exception. From hospitality, where major international hotel operators face huge losses unable to open brand new hotels ready for business to international luxury jewellery brands which are forced to operate under the rule of a single retailer, nowadays, all luxury sectors are directly or indirectly affected by the Russian way of doing business, which concentrates power in fewer and fewer hands, almost with no exception linked to politics.

But probably the most disturbing aspect is the way international luxury brands have given in to the Russian practices for fear of losing their business. For those few international luxury brands which have decided to take matters in their own hands, reality is proving increasingly painful. The most evident such example is of international luxury fashion brands which have had the courage to part ways with their former exclusive franchise partners, struggling to operate directly.

The insane level of rents for commercial real estate, the maze-like business administration practices(accounting, logistics etc), the lack of experienced luxury retail personnel (hence the growing salaries) and the constant corruption at all levels, from customs, local fiscal authorities, municipalities – are just some of the challenges which have brought these major international luxury to a point of hardly breaking even, in a market which many stubbornly compare to Brazil and China, there being no term of comparison.

I wonder whether a major international luxury brand has had no other choice in China or Brazil but to have to open stores in an unsuitable retail complex in exchange for a downtown space, ideal for a flagship, just because the respective space owns the retail complex. Mentioned should also be made that Russia provides yet another paradox, where the owner and developer of luxury commercial real estate is often a luxury retail operator, especially in franchising. That is why, in many situations these days, international luxury brands have been forced to accept dealing with the same ”partner”, one of three which dominate the entire market, the only change being the type of agreement.

What used to be distribution or franchising agreements have now turned into lease agreements. This would not be detrimental, unless the respective real estate owner and developer would not push the limits in terms of feasibility of rents, bringing luxury brands to a corner situation. However, despite the dramatic situation, none of the players involved wish to openly discuss matters, for fear of losing their business. Needless to say, even the so called ”independent” Russian media finds itself in a situation where it has no choice but to turn a blind eye, for fear of losing advertising revenues, regardless of whether these are paid by the luxury brands themselves or by their local franchisees.

There is no simple way out and in many cases, there is no way out, as major international luxury companies cannot just cease operations in Russia, for two reasons – losing the prospective potential of the market, especially in terms of size and secondly because of the reputation damage this may bring. It is too early to predict, but we might see, in the not so distance future, major luxury brands now operating directly returning to franchising and exclusive distribution. Such a scenario could also be the case even for international luxury brands which have production facilities in Russia, especially in the auto sector.  

Oliver Petcu