Russia & Eastern Europe: Kings of the new Frontier

As vodka’s stranglehold loosens, Western brands are queueing around the Eastern bloc to tap into the region’s growth potential, reports Chris Mercer.

Czech Republic: Scotch imports are growing in the countries bordering eastern Europe

Would you rather be sipping an Irish whiskey in Sofia or sucking on a Mojito in Moscow? Perhaps you’d be more at home with a Scotch in Krakow, or even a Cognac in Kiev. The times they are a changin’ in Europe’s wild wild East.

The market in Eastern Europe can often look complicated and contradictory. Regulation, tax increases and economic instability have created a rollercoaster ride for alcoholic drinks firms of all categories. And, for Western spirits firms, that’s before grappling with the scale of unlicensed vodka production or the array of herbal liqueurs still favoured by many locals.

However, the figures for Eastern Europe show more consistency than you may imagine. As vodka’s hegemony continues to ebb, consumption of whiskies, Tequila, rum and Cognac is pegged for double-digit growth between 2012 and 2016, according to Euromonitor International forecasts.

A new generation of drinkers is getting to know a broader range of “Western” spirits in the bars of Eastern Europe’s great capitals. Of those spirits, Scotch whisky has made the biggest inroads into the region’s traditional vodka markets, but others are following in its slipstream.

Yves Schladenhaufen, international marketing director at Havana Club, says a new generation of trained bartenders in Russia provides opportunities for white rum. “Five years ago, we would have considered the cocktail scene under-developed, but that’s not the case any more,” he reports. Havana Club sales are growing in strong double digits in the region as a whole, albeit from a tiny base.

Signs of broadening consumer tastes come as distillers seek to extend their geographic reach. Russia is no longer the only game in town and Schladenhaufen points to Ukraine as a key Mojito market for Havana Club.

Ukraine’s spirits market is only about one third the size of Russia’s, but  opportunities are growing. Brandy and Cognac sales are set to rise by 24% over the next five years, according to Euromonitor, with Courvoisier one brand casting an eye over the Russian border. “Although on a smaller category base, Ukraine has followed similar trends to Russia,” says Courvoisier EMEA marketing manager, Nina Knezevic.

Inside the EU wall – another divider in this complex region – Diageo is reporting “amazing success” for Bushmills Irish whiskey in Bulgaria. This year, Bulgaria will also be Diageo’s global lead market for the Johnnie Walker “Keep Walking” project, which includes a big ad spend.

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However, of all the Eastern European spirits markets beyond Russia, few can match the profile of Poland. It is the European Union’s sixth most populous country, has fewer debt problems than most of its Western counterparts and is powered by an economy that has so far avoided recession. Poland’s total spirits market is predicted to expand by a relatively modest 3.7% up to 2016. Yet, as with Ukraine, a relatively flat performance for vodka and liqueurs mask stellar trajectories for other categories.

Whiskies lead the charge, with projected growth of 46%, to 22.1 million litres. “We will sell nearly 400,000 cases of Ballantine’s Finest this year in Poland, nearly ten times what we sold in 2005,” Chivas Brothers chairman and CEO Christian Porta told The Spirits Business. “If you look at Poland for Scotch whisky, without getting carried away, Poland today is what Spain was 25 years ago to a certain extent.”

Spirits other than whisky are also set to motor in Poland, with Tequila volumes tipped to jump by almost 50%, albeit to just 208,700 litres in 2016. Cognac and brandy volumes should increase by 17% to 6.5m litres over the same timeframe. That Diageo briefly flirted with the idea of buying Stock Spirits last year adds to the sense of anticipation in this market.

As for Russia itself, the country may have to share the spotlight these days, but its dominating aura remains intact. Sliding vodka sales mean overall spirits consumption will fall by 10% up to 2016. Yet, with a resultant market size of 1.5 billion litres, Russia will still account for half of all spirits volume sales in Eastern Europe.

All spirits companies aspiring to grandeur in Eastern Europe need to build presence in Russia. Volumes of whisky, Cognac (plus brandy), rum and Tequila are forecast to expand by 45.5%, 20%, 16% and 7.6% respectively in the country up to 2016. Some bright young things on Moscow’s club scene are even drinking imported vodkas, such as Grey Goose.

“The Russian economy is fast developing and once consumers start to enjoy some economic success they are quick to seek out quality international brands,” says a spokesperson for The Edrington Group, which has enjoyed success with The Macallan Scotch whisky in Russia.

International spirits still account for a small, and premium, proportion of Russia’s total market. However, emergent success at lower price-points suggests that Western distillers are becoming more embedded in Russia’s national culture.

Mixed response: bars are aiming to meet rising
consumer demand for cocktails in Eastern Europe

Diageo’s standard White Horse blended Scotch, for example, reported net sales up 15% in the first half of the firm’s 2012 fiscal year, following higher brand spend. Diageo’s MD for Russia and Eastern Europe, Stephen Morley, says White Horse is proving to be “the preferred choice for new whisky category drinkers from the emerging middle classes in Russian society”.

Meanwhile, Pernod Ricard is seeking to compete in the same territory via its Passport blended Scotch brand. Courvoisier reports good progress for its VS expression, while Olmeca vice-president Olivier Fages says Tequila is another category branching out from its premium focus.

Russia’s impending entry into the World Trade Organization club paves the way for lower import taxes, potentially making international spirits more competitive on price with local brands. Meanwhile, Russia’s government has set down a 30% year-on-year tax hike treadmill on alcohol until 2014 in order to raise prices for the cheapest vodkas (see box-out on page 20). It has also stepped up distillery inspections to curb a “grey market” of moonshine that is estimated to account for nearly a quarter of the total vodka market.

All of this could benefit imported brand owners, although Diageo’s Morley is hesitant about rejoicing in the government’s regulatory fervour. “There are a lot of restrictions which have already been enforced, as well as many more being considered,” he says. “In many cases they apply equally to domestic and imported brands.”

How are domestic vodka producers reacting to these challenges? Tougher government regulation is “driving smaller players to disappear”, says Tatiana Kormiltseva, analyst at Renaissance Capital. “The number of licensed players fell by 30% in 2011, and we’ve seen a sharp reduction in brands on the market.”

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However, many domestic brand owners remain in favour of the government’s policy. “Raising prices is necessary, because we can’t compete and the government should protect honest producers,” says Legend of Kremlin vodka export director, Ekaterina Egorova. However, Kormiltseva fears the government is forcing up prices too quickly. “The increase in excise tax shouldn’t be so high, otherwise the grey market will expand,” she warns.

Renaissance Capital expects the average retail price for a 0.5-litre bottle of vodka to hit RUB280-300 by 2015, more than double the current figure of RUB120-160. Faced with regulatory pressure, declining consumption and growing competition from imports, the domestic players that survive will be the ones embracing brand-building, with one eye on export markets.

“We must think not only about consumers in Russia, but also worldwide,” says Kirill Kirakozov, CEO of White Gold Company. The homegrown spirits company recently redesigned its Russian Gold vodka bottle. “Now it looks more fashionable and stylish, and the new logo makes it international,” the firm says, adding that it has also revamped bottle designs for its White Gold Original and White Gold Premium vodkas.

Russian heritage has become a strong marketing tool, and a reaction against Western faux-Russian brands. Legend of Kremlin, with its bottle a replica of a medieval Russian carafe, is another classic example. However, Kremlin’s Egorova cautions that, when it comes to brand-building, a lot of Russians still just don’t know how to do it. One of the biggest and most intriguing consolidation episodes in 2012 has been Russian Standard’s deal to bail out Central European Distribution Corporation (CEDC) in return for a stake of around 30%.

The deal brings Green Mark, Russian Standard and Parliament vodkas into the same orbit. Russian Standard gets greater access to Poland, while both companies will have more weight in Russia. For now, the deal terms state Russian Standard can only acquire up to 33% of CEDC, but this threshold may rise to 42.9% in the near term. “[Russian Standard owner] Roustam Tariko will push for more control, and likely a majority share,” Renaissance Capital’s Kormiltseva forecasts.

Indeed, Tariko has recently joined the CEDC board, and company chairman, president and CEO William Carey has stepped down from his position, with board director David Bailey taking over on an interim basis.

In a sense, this deal is a perfect example of Eastern Europe’s spirits markets coming of age via consolidation and brand-building, against a background of financial and regulatory pressure. There will likely be more to come, as both domestic governments and Western distillers seek to tame Europe’s eastern frontier.