Going to Russia is

Worthwhile Despite the Risks

In spite of numerous risks and difficulties, Johnson Controls is convinced that investment in the booming Russian market is worthwhile. “Go East, but go now” is the call to further companies to conquer the Russian market.

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1 Introduction

The Russian Federation (Russia) is the largest of the individual states formed by the break-up of the former Soviet Union. It has a population of over 142 million inan area of 17 million km2 – an area 48 times larger than Germany. Its favoura-ble economic conditions are attractive to the automotive sector; the collapse of Communism, orientation towards a mar-rrket economy, many potential consumers with a lot of catching up to do, recovery from the crises of the 1990s, a high level of education, increasing per capita in-come, low vehicle density, high average age of existing vehicles, a competitivelandscape that is not yet well-developedin international terms, and an interest in Western products are all factors, amongothers, that favour business relation-ships with Russia.

However, business operators shouldnot forget that Russia is still recovering from the legacy of over seven decades of central economic planning, which is re-flected on both a macro- and micro-eco-nomic scale with political, legal, techno-logical and cultural aspects. A number of reforms have taken place in the move to-wards a market economy and democracy since 1990, but this mindset has not yetbecome fully established in all of thecountry’s institutions and individual ap-proaches. The process of democratiza-tion has also suffered a loss of credibility as a consequence of Putin’s centraliza-tion measures.

2 Geographical Expansion

Many sectors, including the automotivesector, have had to deal increasingly withsaturated domestic markets and increas-ing production costs. One solution for increasing profits or new growth or forencouraging corporate survival is geo-graphical expansion into attractive mar-rrkets. Thus, many well-known OEMs havealready become established in Russia.

In early 2005, Johnson Controls fol-lowed its customers with plants in St. Petersburg and Togliatti, Figure 1. The plant in St. Petersburg supplies the local market with Ford Focus seat systems, Figure 2, Figure 3. In the fall of 2006, thecompany joined forces with the Russian firm Ladaplast in a joint venture in Togliatti to produce seat covers for well-known national and international car manufacturers for the Russian market, Figure 4, Figure 5. A local presence is an important precondition for supplying car makers more efficiently and morequickly. This is emphasized by the credo that car makers have had for many years, “Build your cars where you can sell them”.

The same also applies to the futureEuropean market. This has been recog-nized in Russia – a market in which ma-jor car makers have been busy for years.A leading automotive manager has re-cently identified current growth rates of 230 %. Experts are talking about morethan three million new cars coming onto the Russian market no later than 2013.

The Author

Heinrich Fiedler is General Manager

& Director Finance

Russia & Turkey at

Johnson Controls in

St. Petersburg (Russia).

Figure 1: Assembly area for the front seat of the Ford Focus

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3 Market Potential

Specialists in the field have observed theinteresting phenomenon that local man-ufacturers, with their Ladas and Volgas,are stagnating. It has been estimated thatmarket share for these companies will fall from 50 % in 2008 to about 30 % by 2013.The volume of the forecast growth will come, no doubt, from the foreign OEMs. The fact that the cars are very old also contributes to the positive sales forecasts: in 2005, 50 % of private passenger vehicles were more than ten years old, and 29 % were five to ten years old. In addition, the vehicle density in 2007 was only 188 cars per 1000 inhabitants. This is well behindGermany, for instance, at 565.

Good growth in average purchasingpower supports the car makers’ profit expectations and the public’s desire to own new cars. The IMF forecasts that av-erage per capita income in Russia for2008, based on purchasing power parity,will be USD 15,000, or about 45 % of the EU average.

4 Supplier Network

Johnson Controls demonstrated goodtiming when it followed the car makersin their eastward move. The St. Peters-burg plant produces and supplies 80,000 seats for the Ford Focus every year. This figure will increase to 100,000 in the coming year.

When other OEMs start production, the need for locally supplied parts will in-

crease dramatically. Partnerships betweenlocal manufacturers and international partners will be the result. Local car mak-kkers will break away from their vertical sup-ply structures. Old structures from the So-viet era are still in place: 80 % of localmanufacturers produce in-house or by means of closely interlinked companies whose structures are often difficult to iden-nntify. However, it is foreseeable that a largenumber of development and production activities within the Russian car market will also be outsourced in future, bringingthis volume onto the market as well.

We must always bear in mind thatRussia is not a low-income country. It has a poor infrastructure, to some extent,long transportation distances and high customs duties, which are further argu-ments against manufacturing in Russia for export. For this reason, Johnson Con-trols and its Russian locations manufac-ture exclusively for the Russian market and the CIS states.

5 Market Conditions

Although recent legislation has adjustedsignificantly to the demands of a free

market economy, there are still problems at a practical level with differing and sometimes arbitrary interpretations of the law. There are also a great number of authorities involved in the approvalprocess. It is therefore essential to engagespecialists who are most familiar withthe local circumstances because, very commonly, regulations are interpreted on an individual basis and often quite differently in the various regions. In ad-dition, everything must be precisely doc-umented. However, these difficulties canbe overcome or at least reduced to a toler-rrable level with the right planning and the help of specialists.

The notion that everything in Russia is associated with vodka and bribery is mere prejudice. The possibility that thesemay occasionally speed some things upcannot be ruled out, but this is not a val-id criterion for Johnson Controls.

There are also various forms of assist-ttance and incentives depending on theregion involved, and the same applies toinvestments. However, approval process-es take time, and a large number of indi-vidual steps are unavoidable. Everythingis checked manually, and everythingmust start again from the beginning if

Figure 2: The seat cushion of the Ford Focus front seat is fitted with a coverFigure 3: A worker at the JIT factory fits the seat cover on the already assembled backrest of the front seat using an upholstering machine

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only a single error is found. The contra-dictory regulations constitute a particu-lar challenge: a decision regarding fireprotection that is taken today may berendered invalid from the perspective of environmental protection tomorrow. Inorder to avoid sanctions for breachingregulations, it is essential to carry out re-quirements accurately in practice. Greatstore is set on the correct form of addressin official letters. If an incorrect title isused, you can guarantee that the letterwill be returned unanswered after alengthy period.

Nevertheless, the Russian market needs foreign investors, and companiessuch as Johnson Controls need their sup-pliers because there are not enough com-ponents, modules and raw materials,such as special steels for the car makers. In addition, more than half of Russia’sindustrial facilities have an expected use-ful life of over twenty years, and more than 70 % of the facilities are obsoleteand no longer competitive. The country’scontinuing positive economic develop-ment since 1999 is therefore not basedon an increase in industrial production,but on increasing prices for raw materi-als on the energy market, which thecountry has in abundance.

6 Developing the Supplier Structure

Johnson Controls has been performingstrategic market analyses on the Rus-sian market since 2004. 160 local sup-

pliers have been analyzed, 83 of themin accordance with Johnson Controls’ standards. The result speaks for itself:three supplier contracts are currently in place, and there are 22 further po-tential suppliers. These figures reflect the general situation in the supplierindustry: in general, the car makershave few suppliers. The reasons are ob-vious. Inadequate capital endowment of local suppliers, obsolete plant and production technologies, hardly any in-house development, lack of exper-tise, innovation and quality manage-ment, and the associated overpriced products speak for themselves. As aconsequence, many components stillhave to be imported. The Russian gov-ernment is encouraging imports with a wide range of concessions, but oncondition that the share of local man-ufacture is gradually increased. Besidesthe challenges represented by the in-adequate supplier basis, the increasing demand for specialist personnel andthe associated problems are also grow-ing in significance.

7 Employment Market

The particular advantages offered by Rus-sian employees are their ability to be en-thused, great willingness to learn and good theoretical education. However, it must not be forgotten that, for seven dec-ades, collective goals came before indi-vidual goals and there was little identifi-

cation between individuals and company requirements. Now there are no longerany collective plans to be satisfied andemployees are gradually adopting mar-ket economy thought patterns and arelearning, for example, to assume more responsibility and improve their timemanagement.

Poor job loyalty is creating increas-ing challenges for business operators in the context of demographic changes. Itmust be understood as a problem inconnection with the prevailing short-age of skilled labour. The populationgrowth rate fell by 3.7 % in 2007. By 2020, the working age population willhave fallen from 90 million to 77 mil-lion. A steadily falling unemploymentrate is aggravating this trend: unem-ployment has already fallen from 8.3 % to 6.0 % between 2004 and November2007. Moreover, universities are not yetproviding education in line with indus-try requirements.

The company is countering this with close co-operation. A trainee programmeprovides 12 to 18 months of practicaltraining for potential managerial staff inthe company. This is an investment in the future. Because there is already vig-orous competition in the market for spe-cialist personnel in the automotive sec-tor, Johnson Controls has introducedfurther measures to encourage loyalty tothe company, including collective activi-ties such as sleigh rides, family after-rrnoons, fitness studios, kindergartens andmedical care.

Figure 4: Setting the assembly line for the front seat frame of the Ford Focus

Figure 5: The welding cell worker at the JIT factory removes the welded metal frame from the robot welding cell

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