Russians go west in search of vodka gold

At first glance, the future might not look too bright for Russian vodka companies. Faced with a declining domestic market and increasing competition from international players such as Diageo and, especially, Ukraine’s Soyuz-Victan and Nemiroff, it is hardly surprising to see them looking abroad to potentially lucrative export markets such as the US and the UK.

However, those markets are already crowded, with strong, established brands at every price-point, ranging from core products such as Smirnoff to the rising tide of super-premium vodkas such as Grey Goose, Ketel One and Absolut’s Level.

Despite this, the picture is complicated, and there is good reason to believe that some Russian brands will triumph: the opportunities of a still fragmented local market, and Russian vodka’s unrivalled heritage and reputation for authenticity are strong cards.

Home thoughts: Russia’s fast-changing market

Russia remains a vast vodka market – easily topping 1.8 billion litres in 2005 – but considering that until a few years ago it was above two billion litres, the decline becomes apparent.

The future looks even less rosy: sales are expected to fall by almost 25% over 2005-10, to well below 1.5 billion litres. The loss of volume is merely a reflection of the dramatic changes sweeping through the market, however – changes which will benefit those companies that are dynamic and daring enough to invest in their products.

Illegal vodka still accounts for an estimated 40% of total market volume, in addition to the legal market volume, most of it sitting at prices of US$1.50 a bottle or less. Given the fact that no taxes are paid on these products – not to mention their potentially devastating effects on health – it is hardly surprising that the Russian Government has taken steps to eradicate them.

The new duty stamp scheme currently being introduced has been botched in its implementation – distilleries were silent for weeks earlier in 2006 as companies waited in vain for the new stamps to arrive. Ironically, this led to a short-term increase in demand for illegal vodka, as legitimate stocks ran short. This resulted in an estimated loss in tax revenue for the government of US$8 million a day.

The principle behind it is to stop small, fly-by-night operators from being able to set up at will, offering greater opportunities to legitimate businesses. “The Russian government is taking steps to control fraud,” explains Igor Rogovchenko, export sales director of Green Mark producer Russian Alcohol Group (RAG). “That will give us more opportunity to grow.”

Consolidation follows

RAG provides an excellent example of a new, more efficient and dynamic approach in today’s Russia. It is an incredibly fragmented market, with only Kristall and Veda holding volume shares of more than 2.5% in 2004 – although that picture is changing rapidly.

RAG’s 2005 figures show Kristall with a near 7% share, and Veda with just over 5%, followed by RAG, which has overtaken OST to take a share of almost 4%. The projections are even more dramatic, however: RAG forecasts its share to be almost 7% in 2006, taking the lead, then building to 10% by the start of 2007.

How is this possible? For one thing, RAG now exclusively produces its own brands, whereas an estimated 90% of Kristall’s production is contract. Most of RAG’s production is in the low premium segment, with the Green Mark brand – now claimed to be the best seller – growing from 1.3 million cases in 2004 to five million cases in 2005. “It’s a very interesting point in the Russian market,” says Rogovchenko. “Interest is shifting to more premium brands, and we are trying to fill this niche.”

The company is also building a new distillery to cash in on the huge volumes below US$2.00 a bottle – which the new legislation should theoretically open up – and also has ambitious plans for exports.

If RAG is the most dramatic example of what might be achieved by Russian vodka producers, others are also investing in the market’s future. New Muscovy Company’s Ivan the Terrible brand (Ivan Grozny in Russia) is ironically a Russian-produced brand previously only available internationally.

Now it is entering the Russian market, targeting the still small but rapidly-growing on-trade sales, explains New Muscovy’s Dimitry Chebotarev. “We are not after big volumes at all. We just want to be seen – because it’s where we come from, so we should be present.”

The brand already has associations with top restaurant owner Stepan Mikhalkov, and has run bartender master classes. Chebotarev acknowledges, however, that building a cocktail culture – even in Moscow – is a long-term process.

There are also threats to the new breed of Russian producers. As the market develops and gradually becomes more Westernised, foreign brands are sure to make inroads. Diageo recently established a marketing and distribution vehicle with A1 Group, which sees the multinational take control of the fast-growing Smirnov brand.

There are even greater threats closer to home. Ukrainian vodka producers Nemiroff and Soyuz-Victan have enjoyed huge success in Russia recently, partly helped by tax breaks. In particular, these Ukrainian brands are strong in the super-premium segment. However, all international brands are potentially vulnerable to rises in import duty – although relatively low, these have increased four-fold recently. Soyuz-Victan got around this problem, however, by building a distillery in Russia.

In conclusion, there are opportunities for all in Russia – both Western and domestic brands, and particularly premium products – as the historically high amount of illegal vodka decreases, disposable incomes increase, and Westernisation continues.

East meets west: Russian vodka’s export niche

In looking abroad for growth, Russian vodka needs to expand its horizons beyond traditional destinations such as the CIS states and Israel, where many brands remain strong for historical reasons.

Continued strong growth is expected in Western Europe – particularly the UK and Germany, which are predicted to grow by 21 and 16 million litres respectively over 2005-10 – as well as North America. However, these are markets filled with products desperate to prove a point of difference to the consumer.

Fastest Growing Vodka Markets 2005-2010
millions 9 litres cases
United Kingdom2.4
Euromonitor International

Russia’s USP, however, is a strong one: heritage and authenticity. In an environment almost totally devoid of provenance, the country’s vodka-making history and rules governing the purity of the production process are strong positives.

Parliament vodka plays up its 18th century production process, in which milk is used to remove unwanted particles (followed by multi-stage purification). “The complicated nature of the process and its cost make it very difficult to produce, so not many people use it now,” says vice-director Alexei Yuriev.

Parliament is already making inroads abroad. It is strongest in Russia, where it sells 25 million bottles a year, and the manufacturer has also started targeting the brand at Russian ex-patriots in Germany. The manufacturer now has a contract with major distributor Drinks & Food, and is entering major retail chains, with projected sales of 1.5 million bottles in 2006.

Other brands use the pull of Russian cultural associations, most obviously Legend of Kremlin, a vodka produced via an offshoot of President Putin’s administration. Presented in a hand-decorated bottle, and so far only available in small quantities, the brand has found success as a corporate gift – a bottle was presented to the G8 leaders as a Christmas present – but is targeting export growth in 2006.

Beluga vodka takes the luxury theme still further. A byword for the conspicuous consumption of Russia’s new hyper-rich, Beluga Gold costs EUR80.00 per bottle wholesale, and is produced using a painstaking, 6-month long process. Much sought-after (Roman Abramovich reportedly bought 1,000 bottles), it is unlikely to be a great export driver because of its rarity.

However, little brother Beluga Silver (EUR30.00 per bottle wholesale) has a production run of 20,000 bottles a month, and is likely to be a greater export product for producer Atreum.

Denis Borodin of Atreum says that Europe interests the company most, particularly because of a tie-in with the Caviar House chain. With regard to other countries, he added: “The US is seeing a boom in Russian vodka, so they are asking us about it. In Japan they know our vodka, but it is not a priority. They want volume we cannot provide.”

Tough times ahead

Whether Russia can convert Western audiences to the indigenous habit of drinking vodka neat and with a meal is open to question. Even without this cultural phenomenon, the country’s increasingly dynamic producers clearly have something new to offer the still growing vodka markets of the west.

Russian companies’ trump card is that Russia is still viewed as the spiritual home of vodka by many (although Poland’s producers may argue). The new packaging for “ex-Russian” brand Smirnoff Black, for example, plays up its Russian heritage.

Whatever the prospects for Russian vodka companies in the near future, the smart money will be on those brands which use authenticity and provenance to offer something new and interesting to the world’s vodka markets.