Confidence ‘not dramatically’ eroded in Russia

Faced with a dark market and a tumbling rouble, international drinks companies are looking to brown spirits to make headway in Russia and Eastern Europe.

The spirits market in Russia and Eastern Europe has encountered substantial headwinds in recent years

*This article was first published in the August 2015 issue of The Spirits Business magazine

The emerging market transition from local to international spirits was progressing well in Eastern Europe until President Putin kick-started a new Cold War.

“Russia is isolated and its economy is in tatters,” declared Barack Obama in his State of the Union address in January this year. With the rouble in free-fall, down by a half against the dollar in six months, and a slump in world oil prices, he clearly had a point. If Russians were seeking solace in hard liquor, it was in illicit vodka at the expense of domestic brands, while fewer can afford international spirits with average real incomes down by a tenth last year.

“In Russia we are operating in a challenging environment of macroeconomic decline, currency volatility and consumers trading down,” says Diageo’s MD for the region, Svetlana Naumova. “While our performance continues to be impacted by these external factors, it remains an attractive emerging market for Diageo.” A week after Obama’s address, the BBC were reporting a 17% drop in the company’s Scotch whisky sales in Russia in the second half of 2014. Johnnie Walker Red Label is still the leader within the Scotch category however, and White Horse gained share.

Western sanctions

For all his rhetoric, Obama was really boasting of the impact of Western sanctions – something President Putin has shrugged off. Cyril Claquin, Pernod Ricard’s CMO for Eastern Europe and Russia, talks of “a big, black media war between the two countries,” and adds: “Of course the overall economy has slowed down if you consider the GDP figures, but we’re not in disaster mode. It was expected the Russian economy would collapse and consumers would panic and lose confidence about everything.” Instead, he has been impressed by the resilience of ordinary Russians while the rouble, helped by firmer energy prices, has managed to bounce back somewhat.

“The premium whisky market is growing steadily by 8% in the off-trade in the year to date,” claims Claquin, which sounds extraordinary when other indicators like new car sales crashed 42% in April compared to 12 months earlier. He credits two main factors: “The first is that consumer confidence has not eroded as dramatically as we expected, and secondly the market is very much fed by very aggressive promotions from almost all players.” In other words, international producers are having to fund their market share through the bottom line, which may prove hard to sustain. According to Claquin, Jameson is second only to Johnnie Walker in Russia’s premium whisky category, and though volumes are flat, it managed to grow its share by 0.5%.

Diageo launched its Russian-distilled Shark Tooth rum in Russia in 2013

Consumer sensitivity

His opposite number at Campari, Cesare Vandini, concedes “the last 18 months have been less brilliant than usual” in Russia, and that “consumers have become more sensitive to promotions”. Yet as for the impact of the exchange rate, he says: “It’s partly absorbed with entry-level brands, but the rouble devaluation is fully visible in premium categories.” Nevertheless, he agrees with Claquin that brand owners are being “very aggressive” on price. Those with volumes to defend must either discount heavily or risk haemorrhaging sales to rival imported brands or Western look-alikes.

In July, the Russian news agency RBC reported on the surging popularity of domestic “whiskey and rum substitutes” which sell for at least a third less than their cheapest foreign equivalents. The report cited Vadim Drobiz, director of the Research Centre for Federal and Regional Alcohol Markets, who said that prices for imported spirits were up 20-25% this June compared to 12 months earlier. Two years ago Diageo launched its Russian-distilled Shark Tooth rum to recruit consumers into the category where they could trade up to Captain Morgan. “It offers the taste and emotional benefits of an imported brand, but, at an accessible RUB 300 (£3.40), it’s towards the top end of local vodka,” Russell Jones, Diageo’s then marketing director for the region, told SB last year. Today Shark Tooth is snapping at the heels of Bacardi and Captain Morgan, and is the third biggest rum in Russia according to Diageo.

Local vs imported

The Moscow Times recently reported that Russia’s biggest vodka producer, Sinergia, has retaliated with its own brands – Captain Gin and Captain Rum, which the paper claimed contained no rum at all. Diageo is probably not desperately worried, and Svetlana Naumova says that “among imported spirits, rum is the fastest growing category and Captain Morgan is gaining momentum”. Meanwhile, encouraged by the success of Shark Tooth, Diageo launched a “premium spirits drink with Irish whiskey” called Rowson’s Reserve last year, priced at a competitive RUB 500 (£5.60).

Somewhat confusingly, it’s the same trademark as a popular Indian whisky owned by the company. Either way, Jameson appears unfazed by this budget “Irish” competitor. “It’s a totally different price position,” says Claquin. “It’s for a different consumer, for cheap vodka switchers.” He believes the transition from local to international spirits – a dynamic that drives the industry’s faith in all emerging markets – will continue in Russia, though at a slower pace. His colleague, Nick Blacknell, international marketing director for Havana Club, reckons: “The old model is not as clear cut as it once was; there’s a bit more back and forth between local and international brands.”

But he remains confident things will pick up and says: “The presence of rum bars, tiki bars and cocktail bars all bode well for international rum brands.” Havana Club has always been available here thanks to the country’s ties with Cuba and is apparently benefiting from a nostalgic glow among Russian consumers.

Russian consumers are developing an interest in independent, “craft” brands

Craft movement

The trend towards “craft” and brands that are perceived as more authentic and local is happening among millennial consumers in Russia just as in the West. This is something brand owners need to be aware of, reckons Blacknell, who says: “We used to promote Havana Club with Coke, but we’ve now moved to local, high-quality soft drinks.”

Meanwhile, Russian distillers have been learning from their Western counterparts about premium branding and packaging. They will have to try harder than Captain Rum, and Claquin believes their cause is not helped by the image of cheap vodka that so dominates the domestic market. The government has been ramping up taxes to curb alcohol abuse and this narrowed the price gap with entry-level imports and gave a massive boost to the domestic moonshine industry. As a result future tax hikes may be frozen, or even reversed.

In the background lurks the threat of sanctions on foreign spirits, though so far Russia has only banned Western foodstuffs in a tit-for-tat move in June last year. “There have been lots of rumours and counter rumours,” says Stuart Thompson, area director for Eastern Europe at Ian Macleod Distillers. After 10 years in the job, he claims nothing would surprise him. At Campari, Cesare Vandini accepts that sanctions are possible, but argues they would be counterintuitive. “If the alcohol policy of the Russian government is to support the move from quantity to quality, sanctions on imported spirits wouldn’t help.”

No more ambivalence

Not that the State is always logical, and there are other ways to interrupt trade like the arbitrary imposition of a new tax stamp. Meanwhile, there seems more ambivalence among consumers to international spirits than in the past, reckons Blacknell: “There’s certainly not the unquestioning acceptance that the more expensive and ‘Western’ a brand the better it is.”

Spirits in the rest of Eastern Europe, with the obvious exception of Ukraine, appear unscathed by events in Russia. Richard Hayes, Stock Spirits’ sales and marketing director, claims there has been “no measurable impact on consumer confidence” or “on the overall spirit market’s performance”. With its “millionaire” brands like Zoladkowa Gorzka and Lubelska vodka, Stock is the leading player in Poland and the Czech Republic. Thanks to a 15% tax hike in January 2014, vodka slumped 4.9% (AC Nielsen) in the Polish off-trade in the same year. This year to May, the decline has slowed to 2.6%, “so the indications are that the vodka market is in recovery,” says Hayes.

In his key markets in the region, local brands have an 80-90% share, and he reckons the shift to internal spirits is “typically less than 1% per annum”. The latter are impeded by issues of affordability, the fact that much of Eastern Europe is a dark market, and that local producers are breaking into what were historically seen as international categories.

Yet whisky, particularly Scotch, is doing well in Poland and Euromonitor predicts it will hit 31.6m litres by 2019, a 50% hike on 2014. Thompson was delighted by the number of 20-30-year-olds at a recent Polish whisky festival, and the fact that a third of them were women. He wonders if, ironically, vodka is now perceived as something of an ‘old man’s drink’.