Russia’s carmakers are coming out of hibernation, and as the market picks up, logistics providers must prepare for delivering to a domestic market beyond St Petersburg and Moscow, and keep the outbound logistics cost effective, writes Andrew Williams

In the wake of the boom years between 2006 and 2008 Russia’s car industry was virtually brought to its knees in 2009 as the twin blows of a global financial crisis and the disappearance of cheap credit saw sales cut in half. The severe contraction in the sector continues to this day with the latest figures showing that, overall, Russian car sales were down 34% in the first two months of the year, when compared with the same time in 2009.

After such a dramatic decline, there are now signs that the region is beginning to claw its way out of the difficult times. A gradual, if shaky, improvement in the global economic situation, as well as direct action taken by the Russian government, particularly in the form of a scrappage incentive scheme, is beginning to stimulate a steady growth in demand. The scheme offers up to 50,000 roubles ($1,600) to buyers trading in cars more than 10 years old and has been a modest success.

Following a period that saw a rapid reduction in the flow of imported cars, OEMs and LSPs are now keen to ramp up operations, encouraged partly by the increase in market demand and a residual excess of transport capacity following the boom and bust. However, there are some indications that the specific challenges facing LSPs operating in Russia may have changed since the boom years.

Customary problems
The most significant challenge for managing outbound logistics into Russia remains the customs and taxation system. The high level of customs duties means that cars imported from outside Russia are significantly less price competitive than those manufactured or assembled within the country. Some commentators predict that this could lead to a longterm downward trend in the volume of imported cars.

“The problem faced in importing cars is a high rate of customs and the high cost of deliveries, due to which imported cars cannot compete in price with the cars manufactured or assembled in Russia,” says Alexander Zhuravlev, CEO of vehicle logistics provider, Major Auto Trans. “Therefore, with the growth of car manufacturing at Russian assembly plants, the share of imports will drop,” he adds. Besides the distorting effect on competition, there are also signs that the customs and excise system, coupled with high rates of VAT on international transport, is negatively affecting other aspects of bilateral trade in the region.

“Customs and taxation issues directly influence the lead time on vehicles and thus overall customer satisfaction levels,” says Katariina Taimi, operations director at Avelon Autologistics.

There are indications that the situation is unlikely to improve over the next few years. Rather, it appears likely that the Russian authorities will seek to regulate automotive logistics more stringently. “The Russian government is paying more and more attention to the regulation of seamanship and port activities in both boundary and customs procedures. This particularly concerns the automotive industry due to the obligation to use specialized customs as excise customs,” says Konstantin Skovoroda, director of Russia Transport Lines.

OEMs must plan ahead
Another major problem has been the absence of adequate forecasting and planning by OEMs, which has been cited as one of the reasons that carmakers have found it difficult to react to changes in market demand in sufficient time. The absence of smooth delivery was a challenge when the market was growing and remains so today, particularly following the negative impact of the global financial crisis. In these changed circumstances, there is a danger that OEMs might be caught in a situation where they are unable to adapt and plan for longterm change in the Russian outbound logistics sector. The decrease in profitability in the logistics sector could also lead to serious underinvestment.

Branching out
Until now, outbound logistics operations have tended to be based in so called ‘base ports’ in Western Europe. However, it has been suggested that a significant opportunity for longterm development in this area lies in the potential for some of the leading carriers (such as Hoegh) to extend market coverage by opening offices in Russia. Following concerns voiced from some quarters that when complete built-up units (CBUs) have arrived in Russia they are sometimes vulnerable to damage in storage, it is also possible that further benefits may accrue if such relocations occur alongside compound improvements.

“Brokers should relocate their offices but compounds should also be developing at these points. Improvements have been made, but there is still a lot to do in terms of repairing damages occurring on the compound [so] this represents an opportunity to level the quality of services,” says Jean-Philippe Jouandin, supply chain director at Renault Russia. In terms of the existing infrastructure for importing vehicles it appears that, short of a few concerns about the Russian port infrastructure being rather limited for some ocean going vessels, operations are currently running relatively smoothly. In general, imported volumes are still considerably lower than the peak experienced in 2008, meaning that logistics providers have excess capacity. “As a result, the system is not currently under pressure,” says Jouandin.

Fools and roads
While the transport infrastructure is not a problem for most carriers bringing cars into Russia it could be said that the opposite applies for those seeking to distribute finished vehicles within the country itself. To begin with, it is undeniable that the long distances involved make it difficult to control vehicle transport in Russia.

“The main challenge lies in the size of the market. For domestic transport over long distances the main means of transport is the railway. Nevertheless, road transport is more flexible and is used for ongoing transportation even if the initial transport was undertaken by rail,” says Taimi. Despite the importance of road transport, the quality of many Russian roads is unsatisfactory. Large car compounds are practically non-existent in the regions and, quite often, obsolete vehicles are used for car transport. The main obstacle to car transport in Russia lies in the poor quality of the existing infrastructure.

“Bad road infrastructure is traditionally an obstacle for domestic distribution. I say ‘traditionally’ because this problem was mentioned even in the Russian classic literature. [In the] 19th Century the novelist Nikolai Gogol said that there were two problems in Russia: fools and roads. Nothing has changed in 200 years,” says Taimi. “There is an increasing lack of capacity, especially for quality car transporters on regional routes,” confirms Marc Brenneiser, CEO of Rolf Supply Chain Solutions.

Into the interior
Even though Russia is a very large country the average leadtime is still only around two days. This is mainly down to the complexion of the current market, and in particular the continuing dominance of the Moscow and St Petersburg regions. Some commentators predict that the largest proportion of any future growth in demand will come from smaller cities in the interior of the country. This development is likely to have three consequences. The first is that carriers will have to deliver more cars over longer distances. In principle, rail could be a good alternative to road for such long-distance delivery, but for that to happen the Russian rail system will need to improve its global performance.

“Rail is [currently] rather expensive but could be used as an alternative to trucking on longer distances,” says Tomasz Lis, from Hoegh Autoliners.

“My hope is that this [market] change will happen slowly alongside a fast improvement of rail, which could help us to smooth out this huge increase of transportation needs. For rail, I think that without a strong government involvement to develop rail transportation it will be difficult,” adds Jouandin. The second consequence of an upsurge in demand is that, to deliver to the smallest cities, trucks will have to use secondary road networks. As a result, this infrastructure will need to be developed to ensure adequate lead times and quality. In this respect, some predict that there are grounds for optimism. “Due to the growth of the share of Russian transportation, the infrastructure is being further developed: compounds are being arranged, carriers are renewing their fleet of vehicles, and they are taking measures to improve quality. I hope that the situation with roads will improve,” says Zhuravlev. The third consequence could be that an increase in the average lead time will lead to an increase in the global needs of transport capacities. Jouandin predicts that an increase of one day will bring about a requirement for a 50% increase in truck capacity.

“Since this mechanical increase will arrive at the same time as a market increase it will [lead to] some difficult changes for the global finished vehicles transport market,” he says. In spite of this challenge, however, there are signs that domestic logistics operators may be fairly well placed to respond to market changes over time. In most cases, those companies now have enough fleet to transport by road. “For domestic transportation it is also possible that other types of fleet, such as UAZ and KAMAZ trucks, could be used, which are tailored for transportation in severe conditions,” says Taimi. “Increasing local production also [allows] an increasing share of backloads,” adds Brenneiser.

Export from Russia
The Russian car industry currently exports very little by way of finished vehicles, with the majority of the very low volumes going to a few limited markets in Eastern Europe, Africa or Latin America. Nevertheless, some commentators predict that ongoing consolidation and integration in the sector will eventually lead to a modest increase in export activity. “Russia is becoming a part of [the] worldwide automotive industry and for sure the question about car export has to occur at some time. However, here we also meet the same challenge due to the inability of OEMs to react to market demands in time,” says Skovoroda.

Although exporting companies are likely to come up against a similar set of obstacles to those outlined above, at this stage it is difficult to arrive at an accurate picture of the challenges that will be faced.

“I think that carmakers, which have their assembly plants in Russia, are planning to manufacture cars for export, but it is difficult to speak about the challenges and opportunities of exports, as there is no clear understanding of the terms and volumes of car manufacturing for export,” says Zhuravlev. “I can only assume that the challenges will remain the same: roads, customs formalities, as well as the time and cost of car deliveries,” he adds.

In facing these challenges, though, some commentators have suggested that the Russia-based automotive companies should take advantage of some existing competitive advantages. To begin with, the industrial cluster around St Petersburg is well placed to become a hub for export activity because of its proximity to port facilities. A further significant opportunity, this time for foreign OEMs, lies in the possibility for them to extend the manufacture of their best-selling Russian models directly in Russia in a bid to avoid high import tariffs. “Combined with the Russian government’s support for the production of cars in Russia, with relatively cheaper production compared with western European countries, it is a good opportunity to shift sourcing of some models to Russia as the future export origin of brand new foreign brand cars,” says Lis.

A further advantage that could be enjoyed includes the possibility for operators to exploit the excess capacity liberated by the drop in the Russian market. Moreover, the development of a common customs area with Belarus, Kazakhstan and, possibly, Ukraine would be a good opportunity to reduce persistent concerns over high customs payments and taxes, especially as and when those markets increase again. “For Belarus and Ukraine , it is a good logistics opportunity to fill trailers on back flow from Western Europe imports,” says Jouandin.

Historically, Russian transport companies have a lot of experience of managing backward transport when they deal with cars imported into Russia. Currently, almost all transport is executed by fleets owned by Russian companies. “In this case Russian transportation companies have a clear advantage,” says Taimi.

After a bleak period for the Russian car industry, most analysts now predict a slow but steady recovery. However, those OEMs and LSPs expecting a gradual return to business as usual might be surprised to find that they may face a new and unexpected set of challenges. In particular, if emerging patterns of market demand break the traditional dominance of the Moscow and St Petersburg regions, they will need to develop a range of new capabilities in servicing customers located in smaller, and currently more remote, areas.