OVERVIEW OF THE FOOD-PROCESSING INDUSTRY IN THE NIZHNY NOVGOROD OBLAST

Prepared by Alexander Gordienko
BISNIS Representative
Nizhny Novgorod, Russia
November 1998

This report will survey the food-processing industry in the Nizhny Novgorod region. It will also highlight the local impact of the financial and economic crisis in Russia on this sector.

The food-processing industry accounts for 7- 8 percent of the of the overall production volume of all industrial sectors. Local food-processing companies produce such goods as canned fish, meat products, sausage, butter, milk products and cheese, canned vegetables, bread products, confectionery products, margarine, alcoholic and non-alcoholic beverages.

Source: Nizhny Novgorod Regional Statistics Committee

Market Assessment

With 3.72 million consumers, the Nizhny Novgorod region represents a good market for food products. A number of surveys conducted by Russian independent research companies report that Russian consumers spend over 50 percent of their income on food. Therefore, the prime factor for families with low or average income is pricing. The staples which Russian families would like to have for regular consumption include: bread, milk and dairy products, sugar, salt, pasta and grains, sunflower/vegetable oil, meat and meat products (including canned meat), fresh/frozen/canned fish, and tea/coffee. As for vegetables, Russian families tend to buy them (beet-roots, carrots, onions, cabbages, potatoes) in big quantities during the harvest time, or to grow them on their land plots and store them in cellars of out-of-town cottages (dachas), garages etc. Prior to the financial crisis in Russia in mid-August, the share of imported food in the regional market reached 40-45 percent. It varied from chicken legs and butter to sauces and ketchup. Products were imported, mostly, from Western Europe. Local consumers were fairly receptive to imported goods. However, they gradually were beginning to shift their preferences to domestically produced food, especially regarding meat/meat products, dairy products, and fish. Arguments espoused by the population to support this change in purchasing habits included: a) locally made food products are produced for immediate consumption, contain natural ingredients, lack artificial flavors or preservatives; b) local sanitary and hygiene supervision bodies have a tighter control over quality of local products and compliance with Russian standards. After the collapse of the Russian banking system, the distribution of imported goods was paralyzed and Western suppliers stopped or postponed most of their shipments to Russia due to payment problems and concerns involving either Russian banks or their Russian partners. The local population was frightened by the unstable and uncertain economic situation and quickly began hoarding basic food with a long shelf life from stores and open markets (grains, pasta etc.). The slump in the regional food-processing sector in May and June, when production output declined by 35 percent, was followed by a hectic growth due to the demand for food generated by the Russian financial crisis. In order to prevent a shortage of food in the region, and thus social unrest, the local authorities issued guidelines to local food producers/distributors not to ship food out of the Nizhny Novgorod region. Moreover, the Price Control Department of the local government announced likely sanctions to wholesalers/retailers for any unjustifiable price increases. Price increases were permissible when raw materials/semi-finished products/ingredients were imported from abroad. In spite of all efforts of the local government to regulate prices, they increased up to 50 percent within a few weeks from the beginning of the crisis. The price increases ranged from 30 percent to 200 percent, depending upon the product. Generally, merchants felt they could not miss this opportunity to earn additional profit on the excessive demand created by the crisis, especially since the demand was very likely to end as abruptly as it began.

Prices of imported food products strictly follow the US$/RUR exchange rate in the regional market. Over the past 2 months the ruble depreciated threefold. However, salaries of the overwhelming majority of Russians have not been indexed accordingly. Thus, the purchasing power of thousands of people has diminished dramatically. The following table covers current retail prices of some foods in Nizhny Novgorod on average:

The conversion rate on November 30th, 1998 is RUR17.5 per US$1.

The local authorities have taken, and continue to take, efforts to keep the prices of bread and bread products at the pre-crisis level. These efforts have included preferential energy rates being given to bakeries to reduce the cost of baking, as well as providing bakeries with pre-crisis priced grain and flour. However, as a result of the current considerably higher costs of flour and other ingredients (yeast, sugar) prices are predicted to rise 15-20 percent in the immediate future.

Competitive Situation

Some of the larger regional food-processing companies include the Butter Factory (Nizhny Novgorod), Arzamas Liquor Distillery, Nizhny Novgorod Champagne Factory, Vermani Pasta Company, the Volga Beer Brewery (Nizhny Novgorod), Sormovo Confectionery Factory (Nizhny Novgorod), Nizhny Novgorod Meat and Sausage Company NIKO, Nizhny Novgorod Company of Dairy Products, Lindovskaya Poultry Farm, and the Meat-Processing Company (Dzerzhinsk).

Established in 1898, the Nizhny Novgorod Butter Company is one of the largest Russian producers of butter, margarine and mayonnaise. It employs over 1,000 workers. The company's management has a reputation in the region as being committed to success and progressive in outlook. The Butter Company is under a restructuring program now, with the goal of making its products exportable and competitive in Western markets.

The Volga Beer Brewery has been operating since 1959. It is one of the largest beer breweries in the Russian Federation, with a capacity of approximately 10 million dl per year. The company produces 10 brands of beer which are marketed not only within the Nizhny Novgorod region, but also in neighboring regions.

The Nizhny Novgorod Champagne Company was formed in 1940. It is a producer of high-quality brut, dry, semi-dry, semi-sweet and sweet champagne of various brands. Some of these have received awards and prestigious prizes in competitions in Europe, including France and Germany.

The Nizhny Novgorod Pasta Company VERMANI was established 60 years ago. It produces assorted types of pasta (macaroni, vermicelli) from hard species of wheat. In order to raise the quality of its products, VERMANI has recently purchased Italian-made equipment.

The Nizhny Novgorod Meat and Sausage Company NIKO is a leading regional company which processes cattle and poultry and makes over 150 kinds of sausage. The company has its own network of retail stores in Nizhny Novgorod.

Established in 1984, the Nizhny Novgorod Company of Dairy Products employs over 400 workers. Its product line includes a broad line of milk, yogurt, cheese, butter, and children's foods.

The Lindovskaya Poultry Farm is the largest producer of broiler chicken parts and meat in the Nizhny Novgorod Oblast. In 1995 the farm received a Dutch technical assistance grant totaling US$2 million to purchase modern equipment and to restructure the enterprise.

The majority of food-processing companies operating in the region are based in the city of Nizhny Novgorod. One of the criteria which was taken into consideration before constructing medium- or large-sized food processing companies in the Soviet era was the size of population in an area, as well as the proximity to sources of produce. Such large regional cities as Dzerzhinsk, Arzamas, and Pavlovo basically have small- and medium-sized food-processing companies with less than 100 employees. They market their food products locally and also supply them to the regional capital (Nizhny Novgorod).

According to the Nizhny Novgorod Regional Statistics Committee, in 1997 14,752 small-scaled businesses were in operation in the Nizhny Novgorod region, 38 percent of which were involved in general wholesale/retail operations (including food products), food-processing and food-related businesses. In excess of 70 percent of small-sized businesses are based in the city of Nizhny Novgorod. In order to promote and develop small business locally, small business support organizations of the regional government lease out GAZ(Gorky Automobile Plant)-made small-sized trucks, as well as equipment. Trucks are mainly utilized for the delivery of foods. Out of 16 equipment sets provided to entrepreneurs, use of leased machines has ranged from the production of bread products and ice-cream, to pelmeni (ravioli) production, as well as for product packaging.

Each large- or medium-sized company which operates in a specific food-processing subsector is confronted by common problems. One of them is a shortage of working capital. Due to the Russian crisis, numerous payments have been delayed or frozen. Barter operations and offsets make-up to 70 percent of deals. Long-established relationships between food-processing companies and farms have been disrupted or wrecked. Furthermore, large food-processing companies frequently have not been able to quote a fair price to farmers due to currency instability and cash-flow problems. This has resulted in the establishment of many small-scaled food-processing firms which are more flexible in pricing and terms of payment and are able to offer more beneficial terms of collaboration to farmers.

According to the Nizhny Novgorod Region Customs Office, in September imports to the Nizhny Novgorod region dropped considerably in comparison to the same period of last year. Shipments are still coming in, but as per contracts which were concluded before the August crisis in Russia.

Western food-processing companies which have established their production facilities locally are not numerous, but they do include such multinational corporations as Coca-Cola and the Spanish company PASA (Galina Blanca soups). Another large international company, Pepsi Cola, has a distribution center in Nizhny Novgorod. They were all affected by the crisis but responses have varied. For example, one of the major regional foreign investors temporarily halted production in Nizhny Novgorod. To reduce costs, many have also laid-off some staff, mainly consisting of those involved in auxiliary functions. A few weeks before the crisis in Russia, the Spanish company PASA (above) began producing dried soups and chicken broth cubes in the city of Bor (a US$15 million investment project), just a few kilometers from Nizhny Novgorod. To make their products more competitive and raise sales, the Spanish company is reviewing the possibility of replacing a high percentage (80%) of imported components and ingredients with Russian ones. Replacing imported packaging materials with Russian ones is another method some of the foreign investors are considering to reduce cost further.

One Italian company, Parmalat, has decided to suspend a US$16 million investment project in the Nizhny Novgorod region until the economic situation in Russia stabilizes. It had planned to produce packaged milk and juice in the regional city of Bor.

Best Sales Prospects

The following food products have fair sales prospects:
dairy products with 5-15 percent of the import tax rate, meat products, including canned meat (5-15 percent, but not less than 0.4 ECU per kg), fish products, including canned fish (15-30 and over 30 percent for fish delicacies).
In order to stabilize the situation in the Russian food market, to increase the food supply and to attract more importers, on October 15, 1998 the Russian Government issued a decree which extends the list of food stuffs subject to a reduced VAT sales tax rate (10 percent in place of the regular 20 percent) and canceled an additional 3 percent import duty imposed earlier on imported foods. The list of foods receiving preferential rates includes such products as meat and meat products, milk and dairy products, eggs, vegetable oils, seafood, and baby food.

Market Access

Many long-term Western exporters stopped or postponed their operations in Russia due to the financial crisis. As soon as the economic situation stabilizes and the banking system recovers, Russia and its regions will regain their past status as a good prospective market for foodstuffs with fair to high growth potential. Over the past few years many local consumers have developed preferences for and learned to appreciate the imported foods available. An impressive variety of foods have been available in local stores until recently, and although still present, this variety has noticeably diminished. One of the consumer groups which has been affected by the crisis in the least negative way is the high-income consumers. They have continued to show preference towards expensive Western-made products and delicacies, even now. The tremendous ruble devaluation, fluctuations of the US$-RUR exchange rate and the collapse of the banking system have painfully struck the Russian middle- class and upper middle-class. They will certainly buy imported food but in much smaller quantities. Such factors as international shipment costs, customs taxes and duties, and local transportation and overhead costs will definitely make imported foods less competitive compared to locally produced products. Categories of customers with low income will stick to Russian-made food because of its lower price. If a U.S company decides to step into the regional food market via a local distributor, it is advisable to bear in mind the following:

1. Establish a business relationship with a local food distributor with long experience in this business area.
The company should be licensed to perform foreign economic activities and be certified for this type of business operations. It is also important to find out how the Russian company is going to distribute products locally. Distribution channels are structured in a number of ways. There are 10-12 large local food distributors and they own or lease spacious warehouses with product display facilities with up-to-date equipment. They serve retailers from Nizhny Novgorod and other regional cities. Most also operate chains of stores in different areas of the city. Large-sized distributors have been pursuing ambitious expansion strategies with the goal of establishing their presence in neighboring regions. In the past, the majority of large food distributors were interested in marketing large quantities of imported food as cheaply as possible. The critical factor for them was pricing, at times at the expense of quality. However, a few were also distributing exclusive and expensive products that were not sellable in large volumes, but did fill a certain market niche. The typical pre-crisis selection of foods consisted of 2,000-2,500 brands. Smaller distribution companies use basements of commercial and residential buildings for wholesaling food products. In this case, the variety is limited to items which do not require expensive equipment and strict storage conditions (beverages, confectionery, chewing gum). In addition to regular stores and supermarkets, other clients of wholesale companies include open markets and kiosks, as well as mini-markets. There are more than 8 open markets throughout Nizhny Novgorod that are owned by the municipality. Spaces are rented to retailers, the majority of which are sole proprietors. The selection of goods include food and non-food products (clothing, footwear, personal care items, etc.). Food is represented by, but not limited to, fruits, vegetables, grains, meat, sausage, dairy products, fish, canned edibles, pasta, bread products, confectionery and others. Open markets are appealing to all groups of local consumers. Prices of food are 10-25 percent lower than in regular stores. It is also possible to bargain prices of such products as fruits and vegetables. Kiosks and mini-markets form another group of retail outlets. Their typical food range is comprised of such products as beverages and confectionery products.

2. The Russian company should be involved in the process of obtaining all necessary local certificates for sales of imported foodstuffs. It should provide as much assistance as possible in correctly completing the necessary customs declarations. This point is very important, as failure to do so could easily entail stringent penalties and subsequent losses, perhaps including forfeiture of the goods in question.

3. When negotiating payment terms with a Russian partner, it is recommended to U.S. companies to quote prices in a U.S. dollar equivalent and insist on advance payment, at least during the first few shipments before the relationship matures. There are a number of local banks (for instance, Nizhegorodpromstroibank, NBD bank, Sberbank - Nizhny Novgorod) which have emerged from the financial crisis in relatively decent shape. They all have direct correspondent relationships with U.S. banks and are able to wire transfer money to the U.S. within 1 or 2 days.

Investment Incentives

In March, 1998 the Nizhny Novgorod regional legislature passed a law On Governmental Support of Food-Processing Companies in the Nizhny Novgorod Oblast. Under this law investors will be exempt from the profit and property tax payments which are made to the regional treasury. They will also be exempt from the road tax. These tax breaks will be applicable to investment projects with a total value of not less than 6 million rubles. Investors are required to sign a multilateral investment agreement with the regional Administration, as well as the Administration of the respective sub-region of the region (the rayon). These tax incentives will be effective during the time-line specified in the agreement.

Trade Promotion Opportunities

Nizhny Novgorod has a large exhibition center, Nizhegorodskaya Yarmarka. It arranges exhibitions year round for short intervals (usually 5-7 days). Foreign companies are welcome to participate and exhibit their sample products. Next year exhibitions dedicated to food and the food-processing industry will be held in mid-April and mid-November.

Key Contacts:

1. Department of Foreign Economic Relations and Resources, Nizhny Novgorod Oblast Administration, (investment projects) Tel: (8312) 39-19-12, Fax: (8312) 39-04-50

2. Department of Economics and Forecasting, Nizhny Novgorod Oblast Administration,(investment projects) Tel: (8312) 39-07-91, Fax: (8312) 39-01-86

3. Nizhny Novgorod Exhibition Center (Nizhegorodskaya Yarmarka), Tel: (8312) 345-489, 345-590, Fax: (8312) 345-674, E-Mail: yarmarka@yarmarka.ru

4. ALLIANCE company, (food distributor) Nizhny Novgorod, 603057, ul. Beketova 5, Tel: (8312) 62-11-77, Fax: (8312) 62-36-15, 33-65-92

5. Sladkaya Zhizn (Sweet Life), (food distributor) 603002, Nizhny Novgorod, ul. Kanavinskaya 5, Tel: (8312) 44-55-56, Fax: (8312) 44-56-25

6. Negotsiant (diversified company, including food distribution), Nizhny Novgorod, ul. B. Pokrovskaya 14-16, Tel: (8312) 33-34-31, 33-40-01, Fax: (8312) 33-01-94

7. Nizhegorodsky Dairy Products Company, Nizhny Novgorod, 603309, ul. Larina 19, Tel: (8312) 66-91-37, Fax: (8312) 66-74-76

8. VERMANI (pasta), Nizhny Novgorod, 603600, Pr. Gagarina 34, Tel-Fax: (8312) 65-66-23

9. Sormovo Confectionery Factory, Nizhny Novgorod, 603003, Pl. Bazarnaya 10, Tel-fax: (8312) 23-11-15

10. Nizhny Novgorod Meat-Processing Company NIKO, Nizhny Novgorod, 603141, ul. Geologov 1, Tel-Fax: (8312) 66-17-54