Market Know-How: Meeting the Consumers’ Desires


Short of Shops

A survey by Moscow’s research institute for the general plan of the city’s development (NIiPI Genplana), commissioned by the Moscow Consumer Market Department, revealed 608 problem zones experiencing an acute shortage of grocery stores and household services companies. City hall has responded with an ambitious plan to build a chain of stores across the city, with a view to satisfying consumer demand in every part of Moscow.

By the year 2008, at least 1.2 million square meters of consumer goods enterprises, convenience stores and services companies are due to be developed in Moscow, in line with the plan. To that end, city hall has adopted a number of decrees laying down measures aimed at developing the enterprises and determining their location. The outlets are to measure 50 to 500sqm and cater for a radius of 150 to 500 meters, or at least 2,000 residents.

“We have adopted such a detailed plan to make sure that it will be implemented just as thoroughly,” says Svetlana Korolyova, deputy head of the Consumer Market and Services Department. “Today, the same product often sells at prices that differ by as much as 1.5 times across the city. As of 1995 prices in Russia have no longer been subject to any regulation, school catering and funeral services the only exception. We are in no position to tell entrepreneurs directly what prices they have to charge for their goods or services, but we can influence them by building a competitive environment.”

Moscow city hall has pledged to grant investors – to be selected through a tender – a deferment on payments for the right to enter into an agreement for the lease of a land plot (“purchase of the tenant right”) and to reduce rental rates for small businesses.

The Consumer Market Department notes that the network of neighborhood stores is being formed to augment the supply of stores and cafes already operating in residential areas. New stores will either be built from scratch (small detached properties) or operate on the premises of residential houses, occupying the first floors, basements or built-in properties reregistered as non-residential space.

Investors have shown a keen interest in the program, Korolyova says. The department has received plenty of applications from entrepreneurs. City hall, for its part, has urged private investors opening convenience stores in residential areas to honor their social responsibility, in particular, by accepting Moscow social cards that give their holders the right to discounts.

In order to ensure the welfare of Moscow’s residents, local government and business should join their efforts, Korolyova says. For example, by granting discounts to their customers the shop owners could take up 50% of the expenses, while the remaining 50% would be reimbursed from the city budget.

Small businesses account for 60% of the Moscow consumer market, city officials report. “But the future belongs to strong alliances, not to sole proprietors,” Korolyova is convinced. “Small proprietors could join and set up, say, chains of convenience stores.”

What’s a Convenience Store?

Market analysts describe convenience stores as retail centers or detached retail properties targeting inhabitants of residential areas within a 5-10-minute walk. They account for 80-85% of their customers. This sets out the framework for the key requirements such stores have to meet.

Convenience stores cannot be located next to metro stations or large transport routes. If they could, their audience would be much wider, and not just confined to the residents of the nearby residential buildings, Olga Yasko, head of the retail property market analysis group at Colliers International, says.

Marat Manasyan, managing partner at MovEstate, says that what appeals to customers about a convenience store is its proximity to their homes. “Convenience stores are frequented by residents of the neighboring buildings, shopping there is less time-consuming and takes less effort. Moreover, if properly managed, it can become a convenient socializing point, unlike the standard featureless format of hyper- and supermarkets.”

“A convenience store is perceived by consumers as a kind of a ‘family doctor’,” says Yuri Mereminsky, senior consultant at Leeds Property Group. “On the one hand, such stores face a variety of tasks, such as providing the customers with food, drinks, sanitary products and household goods, in other words, to supply them with a great range of items; on the other hand, their scope is limited, therefore the choice of goods is not as large as, say, in supermarkets, with only 3 or 4 brands of washing powder instead of 20.”

Where a convenience store is properly organized it will attract an influx of customers even if it is located in an out-of-the-way courtyard, Mereminsky insists, adding that transport accessibility does not play a major role for such stores because small trucks or vans do not need much space for maneuvering; nor is it important to ensure high visibility for the property – something retail operators attach great significance to.

At the same time, Manasyan notes that the store should not be located out of the way of pedestrian flows: “Even if the store is in the backyard it should be located on the path locals use to get to the nearest bus stop.”

Convenience stores fall into two categories, according to Olga Yasko. The first group consists of the outlets run by sole operators accounting for as many as 90-95% of goods turnover and space at such stores. As a rule, they offer a limited range of food products and household goods. The second group includes small retail centers with a variety of tenants.

But the development of such stores is fraught with many difficulties, she says. To begin with, the city government places special emphasis on the social responsibility of such businesses and tries to dictate price levels with the threat of administrative pressure. Secondly, their audience, limited as it is, demands a higher quality of service compared to large retail centers. Finally, the composition of tenants, the range of goods and services, and the quality of service remain unstable, which may undermine the store’s reputation.

Who’s in Charge?

That the city needs neighborhood stores is indisputable; moreover, these projects do not require huge amounts of investment, according to market consultants. The city center is especially short of such facilities, as are the southwestern and western areas of Moscow (the Central, Southwestern and Western Administrative Okrugs), experts agree. However useful and appealing such shops are to consumers, the sector remains the least developed.

Alexei Averyanov, general director at Vesco Consulting, is convinced that medium-size companies are likely to become potential operators in this market. “The program has the backing of the mayor’s office,” Averyanov says. “That may help solve numerous bureaucratic problems.”

In a move to encourage retail development, the federal lawmakers have made life easier for investors. As of this year, they are no longer required to commission a government examination of low-rise development projects (of up to 3 stories) and non-residential (non-production) developments measuring up to 1,500sqm, and no higher than 2 stories.

Yuri Borisenko, head of the Real Estate, Land, Construction department at the Vegas Lex law firm, says that provision is likely to produce a positive effect on the development of convenience stores and small shopping and leisure facilities: “Companies will report somewhat higher profits, as they will be required to get less permission from the authorities.”

“Retail property development is one of the most rapidly growing segments,” says Mikhail Gets, head of commercial real estate at Blackwood. “In the case of convenience stores, the returns can amount to 5% at worst, or reach 15-17% provided the store is successful.” Other experts agree in principle with the rate of return figures provided by Gets, adding that the average payback term for convenience stores is 3 to 5 years. But so far, few investors seem to have taken an interest in such returns.

“Large chains do not view the development of convenience stores as a priority,” Yasko says. “The efforts required to open and maintain such shops do not compare to the sales their other outlets can ensure. Major retail chains operate a variety of far more successful projects both in Moscow and the provinces.” At the same time, the market experts unanimously agree that retail chain operators are most likely to succeed in this sector.

Existing retail chains have already developed their own know-how and the specific requirements that don’t blend well with the restrictions imposed by city hall, Mereminsky says. For example, in line with the government program, convenience stores are small properties meant for retail use. They are also not as competitive as discount shops operating in the neighborhood.

In accordance with Moscow government decree No.865-PPM of Dec. 12, 2004, a trilateral social order agreement between a retailer, a prefecture of the administrative okrug where the outlet is located, and the district authority, shall stipulate for certain encumbrances, one of which being the retailer’s commitment to operate the property as a convenience store for a period of 25 years.

That is why it may be possible to build a new chain that would operate convenience stores across the city, adds Mereminsky. Such a chain, of course, is unlikely to satisfy the existing demand in full and new chains may also enter the market, merging their assets, or swallowing up existing street retailers.

Investors could begin by opening just a handful of shops – 3 to 10 – depending on their potential. Marat Manasyan puts the cost of an outlet of the DailyFood chain at approximately $140,000, providing the property is leased. Manasya’s company is a consultant for DailyFoods, a chain operating in a format close to that of convenience stores, measuring 100 to 150sqm. DailyFoods was launched in 2005 by Perekryostok’s board chairman Lev Khasis.

Pursuant to the strategic plans of the company, as declared on its official website, DailyFoods is set to open 700 outlets in Moscow and the Moscow Region, with annual goods turnover of no less than $700 million. Afterwards, the chain intends to enter the regional markets. By late December 2005, the company had already launched seven stores in the capital.

Retail property consultants are cautious in their forecasts for convenience stores and are not rushing to extol the format just to attract potential investors. Yulia Drovyannikova, retail real estate consultant at Jones Lang LaSalle, admits that major consulting firms take little interest in the segment. The Astera Oncor company, according to its head of marketing, Irina Kirsanova, is more interested in properties facing or situated close to large streets and thoroughfares where rentals are high, which means, the company gets higher brokerage fees.

In this case the interests of consultants and convenience store operators fail to coincide because convenience stores must be situated in the middle of residential areas. What may be regarded as an advantage, though, is that those firms secure good building plots and bank loans on favorable terms, Kirsanova says. “An investor acquires a share in a completed property, which he is free to rent out at market rates,” the analyst notes.

“Major retailers do not necessarily need support from the government in such matters,” says Gets. “In pursuit of the program to develop convenience stores, city hall ought to bet on medium-size and small businesses who really seek out our advice on the issue, and not on major operators.”

Despite all this, some major retailers have shown an interest in the format. The Borodino group, operating the Produktoria chain, joined the program in 2005. The holding has been cooperating closely with the city government, Vigen Avalyan, general director at Produktoria, says.

Produktoria’s outlets offer a range of goods manufactured at the company’s own production units making it possible to keep prices down. By late 2005 the chain operated a 10,000-square-meter distribution center, a wholesale-retail center and five outlets; by early March, five more outlets are to be launched. By 2007, Produktoria will be operating as many as 90 outlets inside and outside Moscow, Avalyan added.

One outlet, measuring approximately 250sqm, requires investment of between $250,000 and $500,000, according to Avalyan. The projected rate of return is 15%. The payback depends on how soon the chain wins the confidence of local residents. Produktoria pledges the best possible quality of service at the lowest possible prices.

Following the adoption of the government’s plan to promote convenience stores, new chains working in that format have begun to emerge in the city, Olga Yasko says. One of those is the Utkonos chain run by Novy Impuls (New Impulse). The first outlet was launched in the town Zelenograd, near Moscow. By the end of this year the company plans to open nearly 400 stores across the capital.

The key unit of the chain is the distribution center (measuring approx. 45,000sqm) from where the goods are shipped to the stores upon preliminary orders made by customers. They collect their orders on the following day. That makes it possible to save on the cost of retail space – Utkonos stores measure 200sqm on average. The company runs 66 outlets in Moscow.

It is also worth mentioning a few other major operators active in that segment, Yasko says. Viktoria Group runs a chain of 50 convenience shops named Kvartal (Quarter). Vega Plus has been developing a chain of neighborhood department stores under the name ABK (26 outlets of 200-350sqm each) since 1997. Garant Invest runs the chain Moi Magazin (My Shop), consisting of 9 outlets each measuring 400-600sqm. The group plans to increase their number to 50 by 2009.

Prospects and Estimates

Convenience stores are being forced to vie with projects already operated by large retailers. They, for their part, also diverge in their estimates of the smaller stores’ prospects. Alexander Barkhatov, chief spokesman for Perekryostok, says that while the company runs a number of Mini-Perekryostok stores it does not regard their development as a strategic objective. “That line of business has the right to growth,” Barkhatov says. “After all, Russia is following the example of Eastern Europe where smaller shops operate successfully alongside supermarkets.”

The development of neighborhood stores is a priority for Sedmoi Kontinent, the chain’s spokesperson, Dmitry Popov, reported. “We believe that format is one of the most profitable in retail. Investment is justified because positive economic results are expected in the near future.”

In 2003, Sedmoi Kontinent divided the chain into three formats: premium class Sedmoi Kontinent 5-star stores targeting high income earners, Sedmoi Kontinent supermarkets catering for a wide range of medium income customers and a chain of smaller convenience stores called Sedmoi Kontinent U Doma. Two years later, the company launched another format – a chain of Nash discount hypermarkets.

“In doing so the company seeks to strengthen its positions in retail by working with all consumer groups and targeting all groups of buyers. Moscow residents must be given the chance to shop in comfortable conditions, without having to go on time-consuming and tiresome trips to get to the nearest supermarket.”

Today, Sedmoi Kontinent runs 111 outlets, including 42 neighborhood shops. Next year, according to Popov, the chain plans to launch another 25 stores. “In order to find out which of them will operate as neighborhood shops you can have a look at last year’s statistical data: 11 of the 34 stores opened in 2005 have been operating in that format,” he says.

“While some Moscow districts – in prestigious as well as rundown parts of the city – suffer a shortage of retail outlets, other areas are saturated,” states Averyanov. “Otradnoye, for example, abounds with supermarkets and discount stores, with Perekryostok, Sedmoi Kontinent, Real, Paterson, Petrovsky, Avoska, Pyaterochka and Kopeika running stores there; in the neighboring district near the Voikovskaya metro station the only major operator present is Pyaterochka. Such densely built-up neighborhoods have virtually no vacant sites available for the construction of large supermarkets. The situation is the same in many other districts. Quite often, small neighborhood shops represent the only option for a retailer to launch operations in an area.”

Nevertheless, some of the discount chains, such as Kopeika, for example, do not consider that segment to be of interest, given all the encumbrances. Besides, mini-markets that meet the requirements for neighborhood shops may as well be regarded as such, with their goods being offered at lower prices. Incidentally, it is namely discount shops that are believed to be the most dangerous rivals for convenience stores. “Unfortunately, the [city hall] program targets, primarily, smaller shops while the smallest Kopeika outlet measures over 300sqm,” Maria Markova, public relations director at Kopeika, says. “Nonetheless, our discounters understand and work to meet the requirements of our customers, moving closer to their homes, acting as chain of shops next door, with goods available at affordable prices. Our mission is to be nearby, with new and favorable offers. And that is not just lip service – it will be that way as long as the demand exists.”