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RUSSIA WARMING TO DEVELOPMENT

By Susan Thorne

In typical European style, Moscow’s Marina Rosha has a hypermarket, shops and a cineplex.

Russia may have led Eastern Europe during the Cold War, but it has surely lagged its former protégés in the development of Western-style shopping. Shopping centers of many descriptions, tenanted by a variety of domestic and foreign retailers, sprouted quickly in Poland, Hungary and Czechoslovakia following the fall of the Iron Curtain in 1989, but that is only now beginning to happen in Russia.

Russia’s development fell victim to the rampant corruption and lawlessness that peaked in the financial crisis of 1998 and 1999; the Russian stock market crashed, the ruble plunged, and personal incomes fell by half. But relative political stability has returned, the economy is recovering, and employment and consumer spending power are on the rebound, creating an attractive emerging market ripe for shopping center development. Now new centers are multiplying rapidly in Moscow, and the Russian retail revolution is picking up speed at last.

Moscow offers a particularly tempting prospect for shopping center developers. The capital city has Europe’s largest concentration of people — 8.5 million inhabitants, versus the London area’s 7 million — and its per capita spending power is three times higher than in other parts of Russia. Although the average annual income in Moscow would only buy $7,000 on the world currency market, that amount represents significant purchasing power in Russia and is catching up with levels in Eastern Europe. Russians also enjoy a much higher level of discretionary spending relative to total earnings than Westerners because of low housing costs, a low household savings rate and the lack of a personal income tax.

“Out of $100 you earn, 85 percent is typically spent in shops, compared with 50 percent in Europe,” said Michel Pascalis, managing director for Central and Eastern Europe at Jones Lang LaSalle’s Moscow office and chairman of the newly formed Russian Council of Shopping Centres. Food accounts for half of all retail spending, Pascalis said, and for the city’s fashion-conscious populace, apparel is the second-highest category. Appliances and televisions are other big sellers.

There is strong demand for Western retail offerings, only partly being met by the players already in place. They include Adidas, Benetton, Ecco, Levi Strauss, Mango, Mex, Mothercare, French apparel retailer Naf Naf, Nike, Promodes, Reebok and Tommy Hilfiger, as well as such luxury names as Armani and Hermès. Roughly 20 new international brands have opened stores in the past year, according to Natalia Oreshina, who heads the retail division of Moscow real estate consulting firm Stiles & Riabokobylko. Moscow shoppers would respond well to Western-style store concepts and Western retail merchandise, Oreshina speculates.

“We need new formats which are bigger and offer more choice within the store,” she said. “At present, people are buying in relatively small shops.” (A substantial amount of retail purchasing still takes place in open-air street markets too.)

Ramstore-1 in Kuntsevo, built by Turkish developer Ramenka, draws 8,000 shoppers daily. It contains 70 stores, some foreign.

Moscow acquired a limited amount of downtown shopping center space during the 20th century, mostly in the form of such high-profile fashion galleries as the 35,000-square-meter (376,670-square-foot) Manezh Square, near the Kremlin; the 63,000-square-meter Smolensky Passage; and the 10,000-square-meter Petrovsky Passage. A symbolic sign of the times was the conversion of the famous state department store GUM, a Moscow shopping tradition since 1887, which is now a 30,000-square-meter mall arcade with 185 specialty retailers, including many Western brands.

In the past two years, the shopping center sector has moved into high gear and expanded into the suburbs, where about half of development is being undertaken by foreign players, including Ramenka, a company formed by three Turkish firms to develop retail in Russia. According to research by Stiles & Riabokobylko, 14 new shopping centers (for a total of 190,000 square meters of gross leasable area) opened in 2001, bringing Moscow’s total supply of mall space to 431,000 square meters. A doubling of that space to over 900,000 square meters is projected by year-end 2002, when there will be 53 centers of various sizes in the Moscow area.

One major addition is the Mega mall now being readied by Ikea (see story, Ikea spares no expense for Moscow’s Mega Family Centre), which will bring 150,000 square meters into the market in one stroke. But a sizable share of the growth in 2002 and 2003 will be contributed by hypermarket centers (grocery hypermarkets with adjacent specialty store galleries), a ubiquitous format elsewhere in Eastern Europe. This year French grocery chain Auchan opened its first hypermarket-anchored center here, and German retailer Metro is expected to launch two. Over the past five years, Turkish development firm Ramenka has opened three regional centers ranging from about 23,000 square meters to roughly 66,000 square meters and anchored by Ramstore brand hypermarkets. An additional five or six such projects are planned for the next few years, including one at 111,500 square meters. Pascalis noted that there is room for 20 to 40 hypermarket centers in the Moscow area and said he wouldn’t be surprised to see Tesco, Carrefour and even Wal-Mart operating in Russia within a year. “They are all considering Moscow’s potential,” he said.

Foreign companies operating in Moscow find the environment encouraging from a commercial point of view, though cumbersome administrative processes can make for slow going. Getting a building permit can take as long as six to 12 months, for example. But the city of Moscow officially supports shopping center development as a source of tax revenue and environmentally friendly employment, and regional officials have allocated 20 sites on the city’s outer ring road for shopping center and leisure development.

Mete Doguoglu, deputy managing director of Ramenka, describes the business and legal environment as “difficult and challenging,” but says his company has nonetheless managed to flourish on Russian soil since 1997. Tom Lange, marketing director for Ikea’s operations in Russia, says Russian authorities required that Ikea produce at least 30 percent of its merchandise sold in Russia at a Russian plant. Mega is doing well, he said. The two stores already operating in the Moscow area (the company’s biggest worldwide) have three times the sales level of Ikea’s stores in Eastern Europe.

One issue on the minds of Westerners contemplating the Russian market is the high level of organized crime and general lawlessness, which was given such wide publicity in the global media a few years ago. Sources interviewed for this article unanimously describe the situation as greatly improved, however, and note that security issues do not present an unassailable obstacle to Western businesses.

“Things do not change overnight — to say that there is not corruption would not be true,” Pascalis said. “We always have these questions.” But, he added, Russia’s portrayal in the media is darker than the reality. “When people arrive in Moscow for the first time, they are always surprised by the wealthy, developing city.”

Ramenka has built several retail complexes in Moscow besides Ramstore-1.

Russian companies are important participants in the shopping center boom and are adding new formats. Moscow-based management and development company PMCo (Public Management Co.), for instance, which opened the 16,000-square-meter Global City on Moscow’s southern outskirts in 2001, has an upcoming project called Crossroads. The project will feature such names as Naf Naf, Swatch, Baskin-Robbins, Sbarro and sushi and Russian restaurants. PMCo is also at work on an eight-floor entertainment center project to open in late 2003, which will feature Russian electronics retailer Titanic Records.

Moscow has a way to go before it catches up to the retail supply levels of neighboring countries. At present, there are about 50 square meters of shopping center space per 1,000 inhabitants, compared with 365 square meters in the East European capitals, according to Stiles & Riabokobylko. Vacancy rates are at about 2 percent to 3 percent, while annual shopping center rents per square meter have reached $1,000 to $1,600, although these have dropped back to about $750 as competition has increased, according to Pascalis. With 50 new Moscow area centers anticipated by the end of 2020, the competition will sharpen further, forcing rents to drop more, said Oleg Planovoy, general director of PMCo. That will lengthen the time needed for investors to recover their investment from two or three years currently to between five and seven years, he said — a state of affairs that he compares to recent developments in Poland. All of which suggests the window of opportunity may be narrowing soon. Planovoy suggests that the new Russian Council of Shopping Centres, formed this past summer, could regulate the supply of new centers to avoid such problems as building them too close to each other (an arrangement that in the United States would certainly invite scrutiny from antitrust authorities).

Opportunities for shopping center development in Russia don’t stop with Moscow, of course. Russia’s national population is 144 million, and there are 13 cities besides Moscow with populations over 1 million that could provide substantial customer markets. To date, there is no significant modern shopping center development outside the capital, but Alexey Panfilov, chairman of Garant-Invest, a leading Moscow-based commercial bank, says that Western-style centers will probably be seen in the larger regional cities within the next year or two. Oreshina notes that international brand merchandise is being sold outside Moscow, but Western retail franchise stores are almost entirely limited to Moscow at present.

Ikea may be the first to venture into the regions on a major scale. The retailer recently announced plans to open one or two stores in St. Petersburg and another in Yekaterinburg in 2004 to 2005, and it is possible that these could eventually form the basis for subsequent mall development. This was the pattern for Ikea’s two Moscow malls, in each of which an Ikea store was built first to generate shopper traffic, with a mall subsequently constructed around it. Ikea is also reported to be investigating market opportunities in other large Russian cities, such as Kazan, Nizhny Novgorod and Ufa.

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