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Illicit alcohol in Russia ‘generally not affecting’ imported spirits

Recession and high taxes have driven increasing numbers of consumers towards illicit alcohol in a market where official volumes are down – yet prestige is making headway. Kevin Rozario asks how legitimate brands are handling the Russia conundrum.

Recession and high taxes have driven increasing numbers of consumers towards illicit alcohol in Russia

*This article was first published in the April edition of The Spirits Business

There remains a chill in the air for Russian spirits. The sector has endured sustained annual contractions in volumes since 2014, according to Euromonitor, and the market analyst forecasts further declines this year and next of -3.3% and -2.1% respectively, with the difference between 2018 and 2013 down a colossal -15.9%.

This looks bad, but the volume losses have been at the ‘value’ and discount end of the market, whereas prestige and premium lines have done much better, resulting in some uplift. In dollar terms, Euromonitor data shows that both the off-trade and on-trade have grown over the past three years, although the off-trade has done significantly better, climbing by 3% in 2016 compared with the on-trade’s relatively stagnant 0.8% rise. Within spirits, rum was the pace setter, followed by liqueurs and whiskies, then white spirits – predominantly vodka.

Long-lasting trend

Georgij Grebinskij, lead analyst at Euromonitor International, says: “If we look at sales of alcoholic drinks in Russia and per capita consumption, we observe a long-lasting negative trend.” He notes that in terms of per capita consumption, converted to pure alcohol, there was a substantial decrease from about 12.3 litres to 8.7 litres over the 2009-2016 period.

Grey-market channels, smuggling and ‘alternative’ alcohol have also been increasing in Russia, exacerbated by a stricter tax regime. “In the light of constantly growing excise duties for the majority of alcohol categories, consumers have been switching to illicit alcohol, such as counterfeit spirits and even surrogates,” notes Grebinskij. Surrogates are not alcoholic beverages but products such as cosmetics, for example, that may contain alcohol but are not made to be consumed, and therefore do not attract high taxes.

Economic woes

The rise of counterfeit alcohol has taken a significant toll on the market as the perfect storm of tax hikes, soaring inflation and lower incomes fuel demand for illegal products. A February report from Russia’s Ministry of Trade estimated that a whopping 70% of the alcohol market is illicit or counterfeit.

Euromonitor puts the illicit trade of vodka in Russia at around 30%-50% of total sales, so while the official data shows a decreased volume trend “we have rather observed a redistribution of spending from legal to illicit alcohol,” says Grebinskij. “Illicit trade and the fight against alcoholism stand behind the market dynamics, and while the statistical figures show a strong decline, these other factors hide the real picture.”

That fight is not easy, given that official sources put annual consumption of alcoholic surrogates at 170m-250m litres, leading to a recent spate of deaths. Drinks companies are concerned by the trend – but are aware, too, that, so far, not all brands or sectors are being directly affected.

Dmitry Kimelman, marketing director at Rémy Cointreau Russia, points out that the illicit alcohol problem is mostly relevant to the local vodka segment. Jevgeni Linko, export manager for Russia and CIS at Estonia’s Liviko agrees, saying: “Illicit alcohol is mostly affecting the cheapest categories of spirits and Russian-made spirits. Imports are not generally involved.”

Jägermeister’s Stefan Schneider

However, Moscow-based Oksana Pevtsova, vice president and managing director of Eastern Europe at Bacardi, notes: “Previously, it mainly affected local vodka producers, but bootleggers have started to counterfeit international brands, and the capacity is multiplying every year. We see an increasing number of cases of poisoning from products carrying internationally-known labels.”

Stefan Schneider, regional vice president of Eastern Europe/Pacific and global trade marketing at Jägermeister, adds: “Illicit alcohol sales negatively affected key official vodka producers, as most price-sensitive consumers were switching and volume decreased significantly. This also had some negative effect on imported spirits, as official vodka companies distribute international brands and, with lower market share, they had fewer resources to develop premium portfolio sales.”

Surrogates spectre

Pevtsova’s point about poisoning was underlined in December, when 74 deaths in the Irkutsk region were attributed to methanol poisoning from drinking bath lotion as a cheap alternative to regular alcoholic beverages.

The government has stepped up its counterfeit fight in response. Last year, there were attempts to improve transparency and control in the drinks industry, including the closure of factories making illicit spirits as part of an end-to-end monitoring of alcohol production under the EGAIS system. “This resulted in the growth of mainstream vodkas of compliant producers from Q2 2016 and a decrease of illicit spirits share,” says Schneider.

Pevtsova believes that multiple measures, “including balanced excise policy to encourage consumers not to consider counterfeit products during times of economic difficulty”, are the way forward. “If excise is reversed following the presidential order, we could see good news in favour of this fight,” she says. “For international brands, the impact on volumes is probably not that big, but there is an issue of public safety and the equity of our brands.”

Jim Beam is doing particularly well in Russia

So far, all the illicit switching has been manageable, helped, last year, by the fact that Russia’s fragile economy started to turn around. Dmitry Gorbanev, managing director of Maxxium Russia, the joint-venture distributor jointly owned by Edrington and Beam, says 2016 was better in terms of economic and consumer confidence.

“However, the market didn’t shown any change or improvement until recent quarters and the consumer confidence index only picked up in Q3, though retail sales were still in decline,” he says. Nevertheless the company’s own business grew in double-digits by volume and value last year, thanks its premium and super-premium focus, with the Jim Beam and Courvoisier brands doing particularly well.

Gorbanev believes consumers have become used to a “new normal” in terms of market conditions, and have redefined their own spending power. Kimelman, at Rémy Cointreau Russia, sums it up: “The Russian consumer was better adapted [in 2016 versus 2015] to the new economic reality and started to save less on entertainment – thanks more to psychological reasons than financial ones.”

Jägermeister’s Schneider says of 2016: “There was slight value growth [about +4%] driven by the rouble price increases of all major players, which was an attempt to compensate for margin losses after the rouble devaluation in 2015 to Q1 2016. In the on-trade, frequency and average transaction value went down, and only venues that provided better service or engagement at good prices were able to keep and grow their businesses.” Many other restaurants and bars have had to close.

Independent operators

The same dynamics were apparent in retail, where national chains were stronger than independent local operators. Linko from Liviko, whose main export to Russia is Vana Tallinn liqueur, says: “In the off-trade, most consumers are driven by price only – choosing supermarkets by the best price campaigns – whereas before they were also driven by added value or marketing campaigns.”

Schneider adds: “Another interesting trend is the fast development of specialised alcohol chains that offer good assortments or low prices in small shops, substituting local traditional shops and kiosks.”

The stabilising rouble is a good sign. Bacardi’s Pevtsova says: “Consumer confidence is still low by Russian standards, but a stronger rouble projects a better scenario for 2017, with real income flat or slightly positive for the first time in three years.” She adds that international travel – a key indicator of economic recovery – started to see growth in December 2016. So 2017 looks like it could be the year where better-tuned regulatory processes, an improving economy, higher consumer confidence, and a stable currency merge to drive the Russian drinks market forward. But along with these positive influences come other pressures.

Schneider says: “We expect more aggressive competition and investments from major companies, which will try to compensate for the declines during 2014- 2016 and try to grow either profits or market share. Jägermeister is gaining popularity, and all our major consumer metrics are improving, so we hope for another good year.”

Newcomers are also still knocking on the door. The UK’s Halewood Wines & Spirits is opening up in Russia and has confidence in the opportunities the market presents. Simon Roffe, Halewood’s managing director, Europe and global travel retail, says: “Our business is at a fledgling stage but our partners in Russia are upbeat about the potential for imported brands. There is evidence that the premium brands Russians enjoy when travelling overseas are becoming more evident in the domestic business.”

Rum was the spirits pace-setter in Russia

Pevtsova sees a definite switch back to imported labels. “In 2017, we expect some categories to get back to slight growth. Consumers are trading back up to international brands from local spirits. We expect that growth will start in large standard-price categories like vermouth, whisky, and the growing number of spice- flavour propositions. We will also continue to see a positive shift in trendy premium categories like super-premium vodka, gin and sparkling wines.” Kimelman agrees, and talks of “positive gearing in the premium segment” for imported brown spirits like Cognac, whisky (especially malts), brandy and others.

Yet, despite these welcome improvements, the Russian market will remain a tough nut to crack. Over the years, the country has introduced advertising bans, prohibited alcohol sales in particular types of outlets, and has outlawed products with certain packaging – the latest example was beer in PET bottles larger than 1.5 litres. As such, the volume trend is set to continue in a downwards trajectory.

Coinciding with this has been the general trend towards healthier lifestyles. However, this presents opportunities for brands to step up their ‘less but better’ campaigns and boost their premium ranges by encouraging Russians to trade up during nights out. It seems that in 2017, they may well be living it up that much more.

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