**COUNTRY COMMERCIAL GUIDE--RUSSIANFEDERATION**

**FISCAL YEAR  2000**

 

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**IV.  MARKETING U.S. PRODUCTS AND SERVICES**

 

 

U.S. businesshas dramatically increased its activity in Russia since the collapse of theSoviet Union.  Membership in theprivate-sector American Chamber of Commerce in Russia (Amcham) grew from a fewdozen companies in 1994 to roughly 500 by 1999, making it the fastest-growingU.S. business chamber in the world during this period.  Amcham, with chapters in Moscow andSt.Petersburg and more than a dozen member-led committees, has worked closelywith the U.S. Commercial Service and private-sector associations in bringingpolicy issues to the attention of the U.S. and Russian governments to encourageimprovement of Russia’s commercial climate, and in calling U.S. companies’attention to overlooked opportunities in regions beyond Moscow. 

 

On anaccumulated basis, America remains the largest single-country investor inRussia, but ranks behind the EU as a whole in investment in, as well as inexports to, Russia.  In 1998,Germany was the largest source of foreign portfolio investment into Russia(attributable to Ruhrgas’ large investment in Gazprom), while the U.S. remainedthe largest source of foreign direct investment (see Appendix D).  In fact, Russia has received relativelylittle foreign direct investment compared with, for example, Central Europe orChina.  Most firms have decidedthat early returns are not great enough to compensate for high start-up costsand perceived risks.  With fewexceptions, U.S. firms investing in Russia describe their decision to do so asstrategic, based on the promise of long-term position rather than short-termsales.

  

WesternEurope's share of exports to Russia parallels its share of direct investment inRussia:  in each case, it accountsfor around a third of the total. The U.S., on the other hand, accounted for only 6 percent of Russianimports but contributed 35 percent of direct investment in 1998.  Overall, there is a contrast betweenthe trade-oriented policy of Western European firms toward Russia and theapproach taken by U.S. firms.  Someof this is due to Europe’s proximity and the logistical advantages thisconfers.  However, anecdotalevidence suggests that U.S. firms have been less active than their European competitorsin taking advantage of opportunities and in marketing and building distributionnetworks at regional levels in Russia.

 

**Distribution and Sales Channels******

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Companiesoperating in America are accustomed to well-defined distribution channels, relentlesscompetition, and strong advertising budgets.  Firms in Russia, by contrast, encounter erraticdistribution, unpredictable (but often tough) competition, and word-of-mouthmarketing.  Although Russia boastsincreasing numbers of joint ventures and Western-style stores in major cities,most goods distribution -- especially outside of Moscow and St. Petersburg --takes place through less formal channels. Penetrating these channels is often the key to success or failure for anAmerican company operating in the Russian market.  Western companies which have succeeded have done so througha combination of improvisation and innovation, combined with a substantialinvestment of time and a tolerance for early mistakes.  U.S. companies with a long-term marketdevelopment strategy may find regional markets well worth exploring, becauseanecdotal evidence indicates that European products are increasingly showing upunchallenged in Russia’s regional markets.  

 

## Use of Agents and Distributors / Finding a Partner

 

Bothexperienced exporters and those with less well-developed agent selectioncriteria are well-advised to cultivate personal, ongoing relations with agents,to proceed gradually, and to retain a fall-back position should a relationshipsour.  Experience has shown thatperhaps the riskiest strategy is to visit Russia only once or twice, select anagent and grant him exclusive representation, then move quickly to consignmentor credit sales without establishing a solid track record, especially withregard to payments.

 

To succeed,U.S. companies must consider a variety of local and regional distributionalternatives.  In a few productcategories (e.g., apparel, packaged foods, and alcoholic beverages), foreignsuppliers can choose from a small but growing number of existing Russiandistributors.  These Russian agentscan help the foreign supplier by placing its products on store shelves,handling customs and transportation matters and conducting advertisingcampaigns.  Most of  recently-formed Russian distributorsare small-volume operations with experience limited to the main cities ofMoscow and St. Petersburg or other regional centers. 

 

Over the lastfour years, many foreign manufacturers of consumer appliances and durables havemoved away from using official distributors.  These companies typically have replaced agency agreementswith their own representation in major cities.  They then sell directly to Russian importers, who takepossession of goods outside Russia (in Finland, for example) and import for theirown account.  This affords themanufacturer greater control over prices and distribution, while avoidingpotential tax and customs liabilities, as well as the uncertainties of thelocal commercial environment. 

 

Meanwhile,other foreign companies have decided that the reputation of their firm andbrands could suffer if they fail to ensure compliance with Russian customsregulations by acting as the importer-of-record (and in fact, some U.S.companies have met trouble as a result of false invoicing and otherirregularities commited by their intermediaries).  Firms which opt for direct exports will likely face lowerearly returns, due to reduced sales owing to duties and higher landed costs.  However, for those determined to builda strong presence in Russia, this policy may be seen as an investment that willultimately pay reputational dividends.

 

In theaftermath of the 1998 financial crisis, many Western firms selling in Russiahave pared back their distribution networks, focusing products and resources onthose distributors who were able to maintain sales and payments while cuttingloose those who performed less well. This strategy is designed mainly to cut medium-term costs during aperiod of depressed sales, although it could slow companies’ efforts to expandinto regional markets. 

 

The U.S.Department of Commerce provides assistance to U.S. companies seeking Russianpartners, agents or distributors through the Agent/Distributor and Gold Keyservices offered by the Russia-based offices of the U.S. Commercial Service,and also through the “Search for Partners” program of the Department’s BusinessInformation Service for the New Independent States (BISNIS).  Contact information for these officesis found in Chapters IX and XI.

 

**Direct Marketing**

 

In Russiancities, telemarketing and fax marketing to business customers is common but notparticularly effective.  Bycontrast, person-to-person direct marketing works well (e.g., in the health andbeuty products markets).  Otherdirect marketing channels (e.g., catalogs, internet and regular mail) remain intheir infancy.  Many shippers arereluctant to send goods without prepayment, especially those who were burned bynon-payments during 1998’s freeze-up of the banking system.  The base of customers with credit cardsremains very small, and although it is expanding, this remains a key constrainton the growth of catalog and online business.  However, since catalog businesses avoid high costs of retaildistribution in Russia, they have potential for higher profit margins, and thismarket segment should heat up in coming years.    

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**Joint Ventures and Licensing**

 

Jointventuring demands meticulous planning and sustained commitment from U.S.partners.  In most cases, otherforms of alliance, in which the U.S. partner retains managerial control, arepreferable.  JVs in which foreignpartners hold minority stakes are quite dependent on the good intentions oftheir Russian majority-owners. Recent experience shows that foreign minority shareholders face seriousdifficulty in protecting their interests in Russian courts.   

 

Usually,foreign firms have established JVs to market goods, and sometimes tomanufacture.  Goods made and/ordistributed successfully by U.S.-Russian JVs range from soft drinks, ice creamand cigarettes to elevators, oil, sport-utility vehicles and jet engines.  Some firms choose to create a JV tocapture lower local cost structures, in effect running their business as aRussian would.  High taxs anduncertainty in Russia's legal environment are barriers to greater reliance onJVs as a form of market entry by U.S. suppliers. 

 

One advantageof a JV is that it can help a U.S. firm gain a measure of Russian identity,which can be useful in a culture where many still view foreigners withsuspicion.  Political pressure ismounting in Russia for domestic-content mandates for key sectors orlarge-scale  procurements.  For example, some planned foreigninvestments in the oil industry may entail contractual commitments to use 70percent or more Russian-sourced goods and servics.  Firms that can creatively help oil producers meet theserequirements may be in an advantageous position to serve this industry.

 

The jointventure concept is often viewed differently by the  Russian and American partners.  U.S. companies, especially smaller ones, often view JVs as ameans of securing a local partner with experience selling in the Russianmarket, and may agree to a JV as the price for this expertise.  Many Russian managers, on the otherhand, view a foreign partner chiefly as a source of working capital, andproactive local market development may not be a high priority.  While there are many examples ofsuccessful JVs in which both partners’ goals have been met, ceding managerial oversightover any aspects of a JV to a Russian partner who does not share the U.S.investor’s objectives invites trouble. U.S. firms should thoroughly explore whether a Russian potential partnershares priorities and expectations before making financial or legalcommitments.  

 

A mistakethat often has led to commercial failure and, in some cases, bitter legaldisputes, is for an American to strike a JV agreement with a Russian partnerafter a limited history of cooperation, and then return to the U.S. as an“absentee” partner in the expectation that the Russian partner will manageday-to-day operations, implement a business plan, and wire home the American’sagreed-upon share of the profits on schedule.  This is a recipe for disaster.  Any firm that undertakes a JV in Russia should be ready toinvest the constant personal attention of American managerial staff to keep thebusiness on-course, both before and after the venture has achieved commercialsuccess.  

 

Licensing ofU.S. technology for production in Russia outside the context of joint ventures remainsrare.  Chief hurdles whichlicensing arrangements must overcome include concerns over quality levelsattainable by Russian facilities in the absence of significant investments inretooling, uncertain intellectual property protection (especially in thesoftware industry, where potential for licensing is otherwise high) anddifficulty in receiving regular payments on-time.  In the opposite direction, Russian companies generally areeager to license their technologies to foreign companies in exchange for thecash infusion this brings.  In1998, one major American chemical manufacturer signed a $40 million agreementwith a Russian chemical firm to license Russian chemical technology.  Again, computer software is an areawith high potential for this avenue of cooperation.  

 

**Establishing an Office; BusinessStructures**

 

Registrationof foreign businesses in Russia is regulated by the 1991 law on foreigninvestment, as well as the Civil Code and other legal acts.  **Branchoffices** and**accreditedrepresentative offices** are both legally distinct from full-fledged Russiancorporations, which may be established by foreign firms in Russia either as **joint-stock companies** with partialRussian ownership, or as **wholly-ownedsubsidiaries** of the foreign firm. Foreign ownership can legally be as high as 100 percent, except incertain sectors where foreign stakes are restricted by law (e.g., asdefense-related enterprises, where foreign ownership cannot exceed 25 percent).

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**--Branch Offices:**Branches are not consideredindependent legal entities, and cannot make a profit in Russia.  Branches of U.S. companies cannegotiate or market on behalf of American firms based outside Russia, providingbusiness support or promotion services to the parent company in the U.S., butcannot turn a profit in Russia. Setting up a branch may be worthwhile if a foreign company has justbegun pursuing business in Russia and is in the process of exploringopportunities and making initial contacts in the market.  Many large U.S. firms now active hereoriginally began their Russian operations as locally-established branches.  Keep in mind that the term “branch”under Russian law refers to a specific type of corporate structure.  U.S. firms should not use the term“branch" with registration authorities if the purpose is in fact toregister as a full-fledged company.

 

**--Accredited RepresentativeOffices:**Likebranches, accredited rep offices are not independent legal entities, and cannotearn profit, in Russia.  Afteraccreditation is obtained from an appropriate Russian government agency (seeChapter XI for contacts), the office should be registered with the Moscow orSt. Petersburg registration chambers if based there, or with other localregistration chambers in other cities. Advantages of an accredited office include annual (rather than monthly)reporting requirement for some activities (including some tax payments), andgreater leeway in issuing invitations for U.S. partners to visit Russia onbusiness visas.  Up to five foreignemployees may work with an accredited office of a foreign company.  Offices are usually accredited forterms of from 1 - 3 years.  Theaccreditation could be provided by several Russian government agencies andministries supervising the industry in which a company operates, including theState Registration Chamber, the Central Bank, Ministry of Trade, Ministry ofFinance, or Chambers of Commerce and Industry of Moscow or of the RussianFederation.  Accreditation is more time-consuming(2-3 months) and expensive than establishing a branch office.  Accreditationfees vary from $1,000-1,500 for one year to $3,000-3,500 for three years.

 

**--Full-fledged companies** operating in the oil &gas or coal-mining sectors as well as businesses investing over 100,000 rubles(about $ 5,000) as charter capital are to be registered with the StateRegistration Chamber (SRC), which since September 1998 has been underjurisdiction of the Ministry of Justice. Other businesses should be registered with regional registrationchambers (or city registration chambers, if established in Moscow and St.Petersburg).   

 

Apartfrom registering businesses, the SRC also provides accreditation service torepresentative offices of foreign companies in Russia.  The Chamber maintains a State Registerof Companies with Foreign Investments registered in Russia, the ConsolidatedState Register of representative offices of foreign companies registered inRussia, and the State Register of branches of foreign companies in Russia.  Registration with the SRC serves tocertify the companies' legal status at the federal level.  The Chamber also registers liquidationsof businesses having foreign capital. Companies with foreign capital may be established in a form of a jointstock company or a limited liability company.  Minimum authorized capital of a limited liability company is100 minimum monthly wages (as of this moment, - 8,300 rubles or about $400) and1,000 minimum monthly wages for a company with Russian partner(s).   

 

Registrationis supposed to take from 21 days to a month, but in practice, due to backlogsat registration offices, often takes longer.  Registration entails obtaining first a temporaryregistration certificate, then a permanent one.  To receive a temporary registration certificate, a foreigninvestor should submit required documents and have fifty percent of theauthorized charter capital deposited in a Russian bank account. (The remainingfifty percent should be received in the company's bank account within a yearafter the registration for the registration to remain valid).  Within 45 days after receiving thetemporary registration, the investor should register with the StateRegistration Chamber and Russian tax authorities.  After this is done, a permanent registration can begranted.  While the officialregistration fee is low (4 minimum monthly wages, or 332 rubles or about$14.5), the actual cost may include other expenditures such as documentpreparation and legal counsel. U.S. Commercial Service offices can provide additional details onregistration requirements, but we strongly recommend that firms also seekprofessional legal advice when registering in Russia. 

 

**Sales Factors**

 

U.S. firmsgenerally find success by choosing their sales targets carefully.  Because a lack of capital and poor cashflow are typical of Russian businesses, many firms find it expedient to rankpotential customers based on their ability to pay.  Possible candidates for export sales include:

 

-    Russian enterprises thatexport for hard currency;

-    development projects financedby Western sources;

-    Russian enterprises withgood domestic cash flow;

-    regional governments innatural resource-rich areas;

-    the Russian federalgovernment;

-    major modernizationprojects by Russian enterprises;

-    the general Russianconsumer market; and

-    the upscale (albeit narrow)"new Russian" market.

 

**Advertising and Trade Promotion**

 

Advertisingthrough TV, radio, print and billboard media, nine years ago a novelty inRussia, is now ubiquitous in the consumer goods and financial servicemarkets.  A number of Western aswell as Russian advertising agencies are active here.  Russian advertising regulations are not well-developed,however, and most advertising costs are not tax-deductible in Russia as in theWest (although draft legislation under consideration in the Duma as of thiswriting may allow a measure of deductibility for advertising as soon as 2000,if enacted in 1999).  Both foreignand domestic firms frequently advertise in commercially-oriented newspapers andjournals in Russia. Industry-specific trade journals offer good marketing venues (e.g.,Russian-language computer industry magazines).  Among the more popular general-interest publications are:

 

--DeloviyeLyudi          (monthly journal,Russian-language)

--Izvestiya                (daily paper,Russian-language)

--Kommersant               (daily paper,Russian-language)

--DelovoyMir              (daily paper,Russian-language)

--Ekonomika iZhizn        (weekly paper,Russian-language)

--BusinessMN              (weekly paper, Russian-language)

--MoscowTimes            (dailypaper, English-language)

--MoscowTribune           (daily paper,English-language)

--MoscowBusiness Guide      (monthlybus. directory, English) 

--DelovoiPetersburg       (daily paper, Russian-language)

--St.Petersburg Times      (daily,English-language)

--Sevodnya                (daily paper,Russian-language) 

 

Tradeexhibitions, numerous in Moscow and St.Petersburg, and increasingly common inother cities, can help U.S. suppliers find potential buyers and distributors,and are among the best ways for companies initially entering the Russian marketto meet a large number of potential customers or partners.  U.S. companies sometimes makesubstantial off-the-floor sales at Russian exhibitions.  Representatives of regional governmentsand state enterprises from remote, poorly-supplied areas of Russia often visittrade exhibitions in major cities to purchase goods for their region orenterprises.  A list of major tradeexhibitions is found in Chapter XII.

 

**Product Pricing**

 

Pricecompetition in large Russian cities is often muted.  The ratio of retail outlets per capita in Moscow or St.Petersburg is a fraction of that in, e.g., Warsaw or Budapest, so thatcompeting stores often are not near enough to one another to offer consumersreal choices.  Collusion byorganized crime is also allegedly a factor.  Regional markets are also notable for few alternatives inoutlets and weak competition on price among analogous products.  While markets for a given import inMoscow or St.Petersburg may boast access to several competing imports anddomestic brands, heavy advertising, consumer awareness and widespread pricecompetition, the market for the same product in Novosibirsk or Perm may differmarkedly.  Weakness of pricecompetition among similar goods does not mean, however, that high-cost itemswill fare well where lower-quality but cheaper substitutes are available. 

 

**After-Sale Service, Training andCustomer Support**

 

After-salesservice, training and customer support can be a major competitive advantage --or disadvantage -- for U.S. firms entering the Russian market.  Russian manufacturers even today areknown in Russia for their almost complete lack of attention to post-saleservice.  For many lower-costitems, Russian buyers, especially in rural areas, are accustomed to buying moreof an item than they need, in order to have a ready supply of spares or partsfor do-it-yourself repairs. Similarly, Russian buyers of sophisticated equipment of all types --from computers and process controls to medical equipment to mining equipment --are keenly interested in training, as their employees may never have usedparticular products or brands before. U.S. firms able and willing to offer even rudimentary training andsupport for products, particularly in remote sites, can gain a big advantageover competitors.  Conversely,companies not willing to make this commitment may find themselves at a distinctdisadvantage to European or Far Eastern companies, whose proximity alreadyaffords them advantages in providing training and service. 

 

**Selling to the Government**

 

A law onfederal procurement, adopted in May 1999, provides that foreign firms mayparticipate in public tenders if the product is not produced in Russia or ifRussian production is considered to be economically unprofitable.  Regional or local authorities arepotential customers for U.S. suppliers. (For example, the federal Health Ministry and some of the more than 90regional administrations often buy supplies to distribute to hospitals andclinics under their jurisdiction.) While local governments now receive much-reduced federal subsidies, theyhave more flexibility in making purchasing decisions based on local factors andcontacts.  Overall, however,Russia’s current fiscal situation limits the role of public-sectorcustomers.  Some depressed regionsare even worse off than the federation government in terms of spending ability.

 

**Taxation**

 

Russian andforeign products alike face a 20-percent Value Added Tax upon sale in Russia(although a lower VAT of 10 percent applies for a few basic food items andchildren’s necessities).  Regionalor municipal taxes may also apply to transactions for some goods and services,and federal excise taxes are particularly stiff for alcohol and tobaccoproducts.  

 

Companieswhich move beyond strictly exporting into the realm of direct investment aresubject to a wide, rapidly-changing array of taxes at federal and locallevels.  Russian tax laws andregulations are often ambiguous and inconsistently interpreted by authorities.  Western firms are often surprised tolearn that many business deductions common to the U.S. or EU do not existhere.  With proper documentation,U.S. firms may be eligible for exemption from some Russian taxes on incomewhich is also taxed in the United States, under a bilateral treaty on avoidanceof double-taxation.  Althoughforeign firms have successfully appealed tax disputes to the courts, officialshave been slow to honor court rulings. Penalties for underpayment can be draconian (often assessed at 100percent or more of the total tax due), and a company's accounts can be frozenrelatively quickly.  Regulationsand officials who enforce them often do not differentiate between criminalintent versus honest errors when levying penalties.

 

Most of PartOne of Russia's new four-part tax code was implemented on January 1, 1999.  Provisions thus implemented includenarrowing the list of permissable types of taxes at various levels (other typesof taxes are, by implication, prohibited).  Major federal taxes include VAT, excise tax, corporateprofits tax, capital tax (essentially on interest and dividends), socialbenefits fund taxes, customs duties and individual income tax.  Permissable regional taxes includecorporate property tax, real estate tax, road tax, sales tax, gaming taxes, andregional licensing fees. Permissable local taxes include land tax, individual property tax,advertising tax, inheritance and gift tax, and local licensing fees.  

 

Othersignificant changes resulting from enacted provisions of part one include somebeefing up of taxpayer rights vis-a-vis tax authorities.  Taxpayers are now entitled to writtenclarifications on tax questions from tax authorities, the number of times taxpayerscan be audited for the same tax issues is limited, and tax authorities aretheoretically liable for losses caused by any wrongdoing on their part.  In addition, enacted provisions of partone permit a regional level investment tax credit of from two to five years.

 

EffectiveApril 1, 1999, Russia's corporate profits tax rate was reduced to 30 percentfrom 35 percent, a move long called for by many foreign and domestic investors(although the aforementioned lack of deductions results in a high portion ofincome subject to tax).  A morecontroversial proposal to reduce the more easily collected VAT to 15 percentwas vetoed by President Yeltsin amid concern that this would hamstring one ofRussia's few effective revenue sources without resulting in any compensatingincrease in tax compliance.

 

In 1998-1999,Russia’s drive to crack down on tax deadbeats and boost collections underpressure of Russia’s budget deficit has spawned numerous anecdotal accounts ofwhat Western firms regard as harrassment by federal and local tax inspectorsand Russia’s Federal Tax Police. Firms are advised to familiarize themselves with Russian taxregulations, and companies with tax questions should seek the counsel ofprofessional tax specialists who are experienced in Russia.

 

Besidescorporate taxes, U.S. businesspersons working in Russia are subject to Russia’spersonal income tax, depending on the nature of their income and the durationof their work in Russia during a given tax year.

       

**Need for Local Attorneys, Accountantsand Other Services**

 

In Russia,commercial regulations are contained in thousands of presidential, governmentaland ministerial decrees.  Often,these decrees and laws overlap or conflict.  Determining tax obligations is a tedious task.  Russian accounting rules differmarkedly from Western standards, and while the Russian Government has madecoversion to International Accounting Standards a priority, the process is atan early stage.  U.S. firms shoulduse experienced, locally-based (Western or Russian) specialists familiar withissues faced by Western firms operating in Russia.  The Commercial Sections at the U.S. Embassy and consulatesmaintain and can make available upon request lists of local attorneys andaccounting firms.  

 

Whileprofessional services in Russia are expensive, companies which shun thisinvestment from the outset of their work here do so at their own peril.  In Russia’s commercial arena, when taxand legal problems are concerned, an ounce of prevention can be worth a poundof cure.  Seeking seasoned adviceearly on can save both aggravation and money down the road.    

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