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Vietnam’s Macroeconomic Environment: FDI Paving the Way for Growth

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2013 was the sixth consecutive year since Vietnam first witnessed macroeconomic instability. With high inflation levels, a collapse of the banking system, and relatively lower growth levels compared with its Asia-Pacific peers, the economy faced immense pressures. However, thanks to continuous efforts by the government to uplift the economy as well as the presence of several inherent benefits that Vietnam offers to foreign corporations, the economy has been resurging, largely on the back of soaring FDI.

Vietnam has faced several economic pressures since 2008, which resulted in high levels of inflation, stagnated growth, and a crumbling financial system primarily led by rising bad debts and loss of liquidity. This also brought a negative impact on the real estate sector and its periphery industries. Over the past few years, the country has struggled to find its ground and has undertaken several policy measures to instigate investor interests. In fact, the Vietnamese government is largely focusing on increasing FDI investment levels and exports as the key tools to pull its economy out of stagnation.

The government made substantial moves with regards to economic policies. These initiatives, which led to a boost in the country’s FDI in 2013, included:

  • Equitization of 573 state-owned enterprises (SOEs), wherein foreign investors are eligible to hold stake in SOEs with few conditions

  • Tax allowance that reduces corporate income tax from 25% to 22% from January 2014 and further to 20% in January 2016

  • The approval of a scheme to enhance FDI management in Vietnam

These efforts by the government appear to have started yielding results, as the registered FDI rose by 95.8% to US$13.1 billion during the first 10 months of 2013, and the disbursed FDI rose by 6.4% year-over-year to $9.6 billion for the first 10 months of the year.

In addition to these initiatives, the government has stepped up to strengthen the country’s banking sector since 2012. Over the past two years it has significantly reduced average lending rates, equitized four state-owned commercial banks, and set up Vietnam Asset Management Company, a state-owned company created solely to purchase bad debt from existing banks in order to clear their books. This company purchased bad loans worth about US$1.6 billion in 2013. In an effort to further speed up the restructuring of the banking system, the government announced that it would increase the allowed limit for foreign strategic investors to invest in a domestic financial institution from 15% to 20% in February 2014.

VietnamInvestmentEnvironment


The government efforts to stimulate FDI have also been supplemented by the existence of several positive intrinsic factors that Vietnam boasts off. The country remains an attractive investment destination thanks to its abundance of natural resources and cheap labor availability (according to JETRO report, monthly pay for general workers in Vietnam is about 32% of levels in China, 43% of that in Malaysia and Thailand, and 62% of that in Indonesia). The country also offers a young and dynamic consumer base domestically, as well as favorable conditions and location to supply within the subcontinent. It also enjoys a stable political environment, a significant advantage over several of its neighbors.

The resurfacing of negotiation talks regarding Vietnam becoming a member of The Trans-Pacific Partnership (TPP) is also positive news for the export sector, which is expected to receive a significant boost with the signing of the agreement (especially in the area of garments, footwear, and wooden furniture). This will also ease investment inflow in Vietnam from other TPP members.

Backed by the aforementioned factors and a robust young population, several sectors in the country are registering a double digit growth and intensified attention from foreign investors.

  • Vietnam’s aviation sector, for instance, is expected to be the third-fastest growing sector globally with regards to international travel and freight, and the second-fastest with respect to domestic travel in 2014.

  • The electronics sector has also witnessed keen interest from foreign players. Nokia, a leading telecom handset player, opened its first factory in Vietnam in 2013. Samsung and LG have announced plans to build factories in the country primarily for export purposes.

  • Retail, consumer goods, and tourism are some of the other best performing sectors with strong growth potential in the near future.

  • Moreover, in anticipation of the TPP agreement, Wal-Mart is also exploring investment opportunities in Vietnam that would entail sourcing of several products, such as clothing and footwear, entertainment, home appliances, toys and seasonal goods.


It is clearly visible that Vietnam is on the right path of growth and expansion, nevertheless, there is still a long way to go. While the FDI levels rise, the government has to channelize this investment to develop support industries and high-quality workforce to sustain growth. Moreover, while Vietnam enjoys abundant natural resources and cheap labor that attracts FDI, these factors remain exhaustible, especially in the light of new investment hotspots (such as Myanmar) emerging. Therefore, in addition to just focusing on economic policies, Vietnam must work towards creating better investment climate to lure FDI. The country’s legal framework still presents several hurdles to foreign investment and the country ranks very poorly on the global corruption index (114 out of 177 countries). While it is almost certain that Vietnam will continue to see an inflow of foreign investments, it is to be seen if it can use this to achieve sustainable growth for its economy.

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Mongolia – Mining in China’s Backyard

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MongoliaMining

Mongolia, uninteresting and perhaps almost forgotten to the rest of the world until just recently, has turned out to become of the world’s largest untapped mining centers. The country houses minerals worth over US$ 1 trillion, thanks to which it has the potential to become one of the most prosperous economies in the East. We take a closer look at Mongolia’s potential, its background, most relevant advantages, and challenges that continue to put a brake on the country’s development. Read Our Detailed Report.

 

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How To Confuse The Consumer – Organic Cosmetics or ‘Organic’ Cosmetics?

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Despite the ongoing crisis, there is a continuous interest in green, environmental, and health-centered benefits across consumer products, including personal care. While organic personal care and beauty products markets have been growing in several geographies, they are still a fraction of the overall cosmetics industry. Industry experts expect organic personal care and beauty products to continue on its growth trajectory; it might, however, be hampered by consumer’s increased scrutiny and lack of trust in the authenticity of organic claims.

Cash-stripped consumers do shop less and trade downwards in some of their purchasing choices, however, still remain under the universal pressure to stay young and to fit in the general convention of beauty, allowing the cosmetics and personal care markets to do pretty well. The ever existing need to beautify oneself, satisfy vanity, or to heal personal insecurities, had led to a healthy growth of beauty and personal care industry worldwide during the pre-crisis years. Despite the current slowdown, Euromonitor estimates the beauty and personal care market to grow 5% annually to reach US$562.9 billion by 2017, with the US sales alone accounting for US$81.7 billion.

The industry has not remained untouched by the widespread trend of going green, and natural and organic cosmetics segments have seen some good growth rates even amid crisis. Transparency Market Research estimates that the global demand for organic personal care products was about US$7.6 billion in 2012, with anticipated CAGR of 9.6% by 2018, when it is expected to reach US$13.2 billion. While this might be still a fraction of the overall beauty and personal care industry, the growth is promising, especially that more and more consumers express strong interest in organic cosmetics in hopes of their more beneficial or at least less harmful effect. The interest in organic cosmetics is particularly strong in a few developed countries, led by the USA, Japan, and Germany; however, other developed and developing markets are also exhibiting the trend. It is believed that, over long term, there are even greater opportunities in markets across Eastern Europe, China, Brazil, Mexico, or India, where health awareness is increasing, purchasing power is growing, and ‘going green’ trend is catching up. As a result of these opportunities, makers of organic and natural personal care products proliferate, led by names such as The Body Shop, Burt’s Bee, Dr. Hauschka, Weleda, Bare Escentuals, Herbal Essences, or Aveeno.

However, organic beauty and personal care products industry has its own dark face, and while the growth is promising, there are a few issues challenging the overall market growth.

If it quacks like a duck, is it… ‘organic’?

In several markets (probably most of them), many organic products are not organic at all. While certain level of organic regulation and certification has been achieved in the food industry, personal care industry lags far behind. Therefore, large part of cosmetics, despite having some natural or plant-derived ingredients, is made with synthetic and petrochemical compounds. Further, several of those naturally grown, supposedly organic ingredients, in reality are grown on soil that was treated with fertilizers and pesticides, thus has barely anything to do with organic – pesticides’ harmful effects can be transferred to end products, and further to consumer’s skin. The reason for such dishonesty is not hard to guess: truly organic products are far more expensive at each stage, from product development, to raw material sourcing, to production, as well as distribution, as their short shelf-life is a real challenge for both producers and retailers.

Producers benefit from lack of legislation, as they can put an ‘organic’ label on products with some (even marginal) natural content while using synthetic ingredients to achieve better product properties. However, such practice will harm the industry over long term, since it will destroy overall consumer trust and dilute the differentiation of genuine organic products. Legitimate organic cosmetics have to compete with conventional ones labeled as ‘natural’ or ‘organic’. It is fair to say that the ‘evil’ cosmetics producers just take advantage of the lack of law that would clearly regulate when a cosmetic product can and cannot be called ‘organic’. Organic personal care products are not government-regulated and no global or universal standard has been developed so far.

 

‘Organic’ Legislation Gap

The USA has not introduced any regulation that would control the use of ‘organic’ in labeling of personal care products. While USDA regulates organic agricultural products, which might also be used as ingredients in cosmetics (e.g. honey, cinnamon, avocado), it does not have authority over the production and labeling of cosmetics and personal care products as such. Therefore, if a cosmetic product’s ingredient is plant-derived but is not a food ingredient (e.g. plant-derived essential oils), it does not fall under jurisdiction of USDA, and producer’s claims go unregulated. At the same time, USDA issues certifications under the USDA National Organic Program, however it just allows cosmetics to be certified organic, it does not require it.

Similarly in Europe, there is no clear regulation on the types of claims. There are certain private organization certificates, such as Ecocert, which help guide consumers through the plethora of claims on labels. However, no legislation has made it mandatory for cosmetics producers to obtain such certification, therefore, ‘organic’ claims can still be made. The EU recently introduced new EU Cosmetics Regulation, which imposed uniform rules for all cosmetic products, including “Common Criteria” that identify principles for cosmetic product claims. However, organic cosmetics still lack regulatory definition, leaving an open gate for greenwashing.

Greenwashing in the spotlight

With increasing confusion about what really is and is not organic, several organizations and campaigns are pointing fingers at industry cheaters, calling for stricter regulation preventing false claims, and these organizations’ voices are increasingly audible. Drives such as The Campaign For Safe Cosmetics by a coalition of several organizations or Coming Clean Campaign by Organic Consumers Association, point out that governments do not regulate cosmetics industry for safety, long-term health impacts, or environmental damage they cause, and that producers label their health and beauty products falsely as ‘organic’. While these efforts have not led to fundamental changes in legislation, one goal has been achieved: consumers are increasingly aware that the word ‘organic’ on the label does not guarantee organic content. Moreover, consumers learn how to scrutinize the real-deal brands and differentiate them from the ones that just greenwash their products’ image. Just this year, some voices were raised indicating a slowdown in organic beauty products sales. It appears, that while market and consumer trends do remain favorable, the claims on organicity of such products do not convince consumers. Simply put, consumers no longer trust that ‘organic’ means really organic, and that such products can meet their expectations, especially given their higher price.

‘Organic’ or ‘with natural ingredients’?

The inclination to natural content in consumer personal care products is nothing new. However, with the overall confusion of what can and cannot be rightfully called organic from regulatory point of view, there is another issue – lack of clarity on the consumer side. Organic products are not always differentiated in consumer minds, and they are thrown in the same bag with all ‘free from parabens’ or ‘with natural ingredients’ products. This is not the same as a truly 100% organic product, made with organically grown, pure ingredients, with traceable and certifiable organicity of all raw materials used. Still, organic cosmetics marketers have not been able to define clear positioning for their products yet, and they seem to have settled for the word ‘organic’ do the job for them. Yet for many consumers, ‘organic’ and ‘with natural ingredients’ seem almost the same, and they perceive such products as alternative, artisanal, rather than luxury or aspirational, resulting in their lower commitment to purchasing choices remaining only within the ‘organic’ category.

The overall natural cosmetics market, with its organic segment, is growing, and several market leaders have managed to establish a reasonably strong position (while some brands, such as Herbal Essences or Aveena, still being a target of awareness and integrity campaigns). At the same time, there have been several failed attempts to bite a share in the organic sales cake – including Clarins shutting down its Kibio brand or L’Oréal’s Sanoflore brand’s unsatisfactory performance, with some less significant brands exiting the market within a couple of years of launching. The market is quite competitive and not easy to get to, and will be subject to increasingly tightening regulation, though it remains unknown when a truly, organic-oriented regulation will be introduced. Till then, it is up to individual consumers’ to understand the ingredients and research into particular producer’s practices to understand whether they really buy what they think they buy.

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E-commerce in China – Intensive Competition In Spite of Low Penetration

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In the concluding article of our E-commerce Challenges in the BRIC series, we highlight the challenges faced by online retail companies in China. While China is one of the rapidly growing online retail markets, we discuss how aspects such as growing local competition, infrastructure deficiencies, issues with online security for buyers, and heavy dominance of price-based competition hinder the expansion of e-commerce in the country.

Given the Chinese economic growth story, good performance of its e-commerce market comes as no surprise. Exploding middle and upper class, rapidly growing disposable incomes, rising internet penetration, fascination with foreign brands and mobile solutions, all add up to a perfect scenario for online retail to flourish.

According to McKinsey & Company, China’s online retail market, estimated at US$210 billion in 2012, is the world’s second largest market after USA. It is expected that by 2015, it will reach US$305 billion and surpass the US market, having grown at a CAGR of around 34% during the 2010-2015 period. With the size of even up to US$650 billion by 2020, the momentum is expected to continue, especially that industry analysts emphasize that in China’s case, e-commerce has strong effect of generating additional consumption, and not only drives change of sales channels from the otherwise existent off-line sales.

Thanks to the favorable dynamics, Chinese e-commerce has been named the most promising destination for online retailers, which found reflection in China’s first position in AT Kearney’s 2012 E-commerce Index. Unlike in other markets, Chinese e-commerce space is dominated by virtual market places, where a plethora of merchants sell their products, without the need to invest in opening and managing own online stores. However, aspects such as these, along with other specific characteristics of the market, make doing e-commerce business in China a challenge.

China e-commerce

The Challenges

  • Strong and consolidating position of local players – the Chinese e-commerce market is dominated by Alibaba’s consumer-serving arms: consumer-to-consumer e-commerce platform, Taobao, and business-to-consumer marketplace, Tmall, which together account for close to 90% market share. Several local and foreign merchants, such as Microsoft, are increasingly joining Tmall and other e-marketplaces (as opposed to opening own online stores) to sell their products online to Chinese consumers, which leads to further consolidation of Alibaba’s position in the market. While the market is growing and space is expanding to absorb new entries, such strong and established local players are a significant challenge for newcomers, as well as existing online retailers.

  • Dominance of price-based competition – despite strong local players both in the field of direct online retailing as well as e-marketplaces, majority of them do not offer any particular differentiating factor or unique proposition. However, what makes competing with them particularly difficult is their ability to slack the prices and enter into price competition. With price being the key platform of competing, achieving profitability is very difficult, or even impossible, for instance, for retailers who sell imported products subject to high import duties.

  • Considerable infrastructure deficiencies – Infrastructure woes are a common challenge affecting e-commerce markets developing across all BRIC markets, including China. Only metropolitan areas have sufficient infrastructure to ensure that product delivery can reach in time (and reach at all). In rural areas and locations far from main hubs, there is no guarantee the orders will reach the customer, as the road infrastructure and delivery services tend to be non-existent or fragmented. The infrastructure issues are often indicated as the biggest challenge that hinders realization of the country’s full e-commerce potential, as online retailers are not able to control and improve the entire supply chain. This challenge is particularly difficult, given the already high expectations of Chinese online consumers, who not only expect wide selection and attractive prices, but also excellent and fast services, including short delivery times.

  • Insufficient security solutions for consumers to shop online – despite numerous industry analysts agreeing that the market will continue to grow with large numbers of consumers joining the online shopping crowd, there is a common consensus that security-related risks in China are still significant. This includes issues such as product quality, payment security, information security, consumer rights protection, illegal transactions, etc. All of these aspects still significantly impact consumer trust, deterring many of them from shopping online. Also, e-commerce providers have little control over these risk factors, as the security of online payment is handled by a third party. Cash-on-delivery method is not very popular due to other risks (robbery, fraud, etc.), which drives some e-commerce companies to partner with security services providers or to double the number of own couriers sent to deliver the order and collect the payments, to eliminate fraudulent activities (which generates considerable costs).

  • Low internet penetration in rural areas of the country – while the overall internet penetration is increasing, majority of this growth occurs in urban and metropolitan areas. Currently, it is estimated that not more than 35% of Chinese population uses internet, a ratio below levels in many developing countries. As large proportion of Chinese consumers is still located in the countryside, the internet usage growth confined to the cities limits the internet user base growth for the time being. Moreover, rural-based consumers are not very likely to start using the internet and build an interest in online shopping very soon. Therefore, e-commerce players are challenged with having their customer base currently limited mostly to tier 1 to tier 3 cities.


E-commerce in China is booming, in spite of several teething problems around infrastructure, online and offline security, and low internet penetration. The bigger challenges, however, impact new entrants, which are faced by a highly intensive competitive environment and a market driven purely by price competition. E-commerce will continue to grow in China; there is no question about it. The pace of growth will depend on how the market environment changes to mitigate the risks emanating from the current set of challenges.

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Wind Energy in South Korea – Aiming High

SouthKoreaWind

Over the past couple of years, South Korea has undertaken considerable efforts to research and develop renewable energy generation across technologies such as fuel cell, solar, wind, geothermal heat, and tidal power. While supporting growth in several renewable energy sectors, the country has focused on expanding wind power generation in particular, given Korea’s access to strong and steady winds due to its long coastal line and mountainous terrain, as well as relatively well developed wind power technology and related skill set. We take a look at current state of affairs in the renewable energy sectors in Korea as well as the development of wind energy capacity goals set by the country’s government.

Read Our Detailed Report.

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Mexico’s Energy Reforms – The Balancing Act

Mexico’s president Enrique Peña Nieto seems to be a man on a mission. Since his term started in July 2012, he has worked towards weeding out the inefficiencies and monopolies plaguing several sectors in Mexico and has received much appreciation for that. But this time, has he gone too far? With Pemex being Mexico’s much-guarded jewel, the attempt to bring in private investment seems much more ambitious than the previously introduced overhaul in the labor laws and telecom sectors.

President Enrique Peña Nieto took a bold step in June 2013 by reforming the country’s quasi-monopolistic telecom sector, voicing his seriousness about bringing real changes to Mexico’s economy by tackling inefficiencies and welcoming foreign investment. While the results of the telecom reforms remain yet to be seen, he has moved to an even more ambitious project – to allow foreign investors to enter Mexico’s energy sector, which has been closed to private participation since 1938.

Pemex, which is the world’s 10th largest oil producer, has been a government monopoly for over 75 years. The country’s oil output has been falling since 2004, as a result of its inability to explore unconventional (deeper) sources driven by lack of investment and outdated technology. It is expected that if further exploration is not undertaken, Mexico will become a net energy importer.

To combat this, the president sent a bill to congress that aims to end the state’s 75-year old monopoly over the energy sector. According to the proposed bill, private oil exploration companies would gain access to the Mexican oil reserves under profit-sharing contracts for upstream oil and gas development (exploration and production).The bill also cover reforms regarding the restructuring of Pemex to make it more transparent and accountable.

The bill also encompasses reforms in the electricity market, wherein it looks to allow private participation in electricity generation, while maintaining transmission and distribution under state control. While few amendments to partially allow private participation in the electricity sector have been introduced in the past, they have left much to be desired. The current amendments only allow private companies to generate or import electricity for self-supply or to undertake cogeneration. In addition, Independent Power Producers that produce less than 30 MW of electricity and exclusively sell to the state-owned Comision Federal de Electricidad (CFE) or export to other countries are allowed to generate electricity under the existing amendments. As against the state-owned CFE choosing the players from which it would like to purchase electricity, these reforms would boost competitiveness in the sector by establishing an independent system wherein power generator participation would be decided based on lowest generation costs.

These reforms are expected to boost investments in the oil sector by about US$10 billion per annum. Further, an influx of investments is expected to help Pemex offset its current US$60 billion debt. In addition, they are also expected to bring down electricity prices in the country (which are 25% higher than that in the USA), boost employment, and strengthen the participation of renewable energy in the energy mix primarily underpinned by private participation in electricity generation.

While these reforms spell out immense benefits for Mexico’s economy, their implementation and outcome are a different story altogether. The Mexican population that applauded and supported the government through the education and telecom reforms, is now much less convinced regarding this arm of reforms. Mexicans have for long considered Pemex to be symbol of their national independence and the oil found beneath Mexico’s soil and water, a part of their national heritage. Moreover, March 18th – the day when president Lazaro Cardenas nationalized the country’s oil industry in 1938 is celebrated proudly as a national holiday. Unlike the case of the previous successful reforms, the government faces much opposition from the leftist groups. However, with full support for the reforms from Peña Nieto’s Partido Revolucionario Institucional (PRI) and the Partido Acción Nacional (PAN) parties, which control more than two-third seats in congress, there are strong chances of this proposed law becoming a reality.

The bill also falls short from the point of view of leading global oil exploration companies. While the reforms give foreign companies access to extract and exploit oil, share risks and profits, they would not be able to have a share in the resources. This makes the Mexican agreements far less lucrative for large oil players when compared with proposals offered by neighboring oil-producing countries, such as Brazil and Columbia, which allow the producers to own a certain amount of oil in their books. Thus, although leading oil companies, including Shell, Chevron, BP, and Exxon Mobil have welcomed the wave of reforms in Mexico, their participation will largely depend on the nature and attractiveness of the final profit-sharing agreements.

Therefore, while these reforms look at altering history, it remains extremely premature to predict their outcome. These reforms run the risk of offering ‘too much’ from the eyes of the Mexican public or ‘too little’ from the point of view of resource-hungry energy companies and can only be a success if they manage to find the perfect balance between both the stakeholders. Thus, the key question that remains is not regarding the approval of reforms, but if these reforms will actually manage to stir foreign investment into the Mexican oil sector.

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E-commerce in India – Unfavourable Business Environment

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In Part III of our E-commerce Challenges in the BRIC series, we highlight the challenges faced by online retail companies in India. Unfavorable business environment, profitability issues, consumer’s set notions on shopping are some of the key aspects that we discuss, in order to better understand where India stands in the e-commerce space.

Despite India being a rightful member in the BRIC group from the economic development point of view, in terms of e-commerce development, the country is typically not clustered together with Brazil, Russia and China. In AT Kearney’s 2012 E-commerce Index, India was not ranked at all, and the market is described as lacking the necessary technology to connect vast numbers of potential users to the internet, and extremely poor infrastructure preventing reliable delivery and returns. Opinions, however, are divided. According to McKinsey & Company, India indeed does have problem with low internet penetration and significant infrastructure barriers, but these issues are challenging, not disabling, e-commerce market.

Currently, Indian online retail accounts for around 1% of India’s overall retail market, according to Euromonitor, and is estimated to reach about US$1.3 billion in 2013. This might be far behind the market size of other BRIC countries, however, looking at the anticipated CAGR of 34% between 2005 and 2015 to reach over US$2 billion with expected share in overall retail to increase to 8%, it appears that the Indian market does have opportunities to offer. Some forecasts indicate a considerably more intense growth, even up to US$15 billion by 2017. The varied forecasts show how big of a question mark the market and its growth trajectory are.

One thing appears to be true though – despite still being a comparatively small market, potential long term growth might turn India into an attractive destination, with current internet users expressing strong interest in online shopping.

The market has the potential to accelerate, however, currently several challenges hinder its growth.

India e-commerce

The Challenges

  • Very low internet penetration – it is estimated that the internet penetration is about 12.5% of the population, far less than in any other BRIC country. Existing connections are largely characterized by low average broadband speed and unstable, often interrupted signal, which results in high online transaction failure rate. None of the Indian economy’s favorable economic developments, such as growing incomes and rapidly expanding middle and upper class, will translate into flourishing e-commerce market until larger proportion of Indian population is online and has access to reliable, fast connection.

  • Infrastructure and logistics inadequacies – given India’s vast size, order delivery is and will continue to be a problem, as the country is not able to develop road infrastructure at a pace fast enough to meet the demand, therefore is postponing investments in infrastructure in rural and remote areas (where majority of Indian consumers are based). Large part of investment in the e-commerce market goes into warehousing infrastructure, inventory management, in-house logistics and delivery logistics, as currently only in tier-1 cities (and in a few tier-2 cities), e-commerce companies can ensure relatively timely and safe order delivery. Infrastructure issues significantly affect the online shopper’s willingness to shop regularly, and many of them abandon their online baskets after seeing the estimated time of delivery. From the e-retailer’s point of view, all these issues generate additional costs, as they either develop own delivery capabilities or partner with several delivery services providers (who often also lack delivery management technology such as fleet or parcel tracking). Overall, it is estimated that the logistics costs in India are among the highest in the word, primarily due to large proportion of poor quality physical infrastructure.

  • Strong off-line shopping culture – traditional, often small, local retailers for years have been part of the shopping landscape, becoming the synonym of shopping experience for Indian consumers. While this is changing with proliferation of malls and organized retail, those local shops still are a tough competition for potential online stores, especially that they have managed to build lasting, often personal relations with customers in their community. These traditional shops are located in the customer’s immediate neighborhood, with some of them offering free delivery, which makes online shopping advantage of purchasing from home much less relevant. Further, consumers’ familiarity with traditional, off-line shopping makes them wary and distrustful of online shopping, due to a range of reasons: the products cannot be touched and felt, e-commerce and online consumer protection laws are yet to be developed in India, and online payments security is still far from perfect.

  • Challenge with achieving profitability – given the nascent stage of e-commerce development in India and the overall high price-sensitivity of Indian consumers, fierce price competition (or even price wars) have been present in Indian e-commerce space. Players attempt to outbid each other with lower price, to the extent that some of them offered prices below their cost. Players’ profitability has also been compromised due to the need to invest and develop overall e-commerce ecosystems, and attract customers to the very concept of buying online. This resulted in the market being plagued with profitability issues, even for the market leaders such as Flipkart, Jabong, or Myntra, with several market exits by players who were not able to continue operations in such unsustainable way. Over time this will lead to higher consolidation in the market, as further companies decide to exit, while the stronger ones (probably with better financial backup) survive and acquire smaller players –more than half of e-commerce companies are expected to disappear over the next 6-8 months. These developments might put a brake on price reductions, but will continue to make it difficult environment for new market entrants.

  • Dominance of cash-based transactions – cash payments by far dominate in India, estimated at 80-90% of all payments and more than half of online transactions. The use of credit cards has been constant over past years, estimated at around single digit percentage share of population using a credit card. The use of debit cards has increased, and currently some 200-250 million issued cards, however, majority of Indians are still uncomfortable with this way of payment, and often do not feel the need to use it. While cash-on-delivery could be an option here, e-commerce thrives in environments with high use of electronic money. For the time being, cash-on-delivery is quite popular, however, it is risky and costly for e-retailers, as they have to finance the purchase and delivery till they receive the payment, and as many as 45% of orders are rejected without paying, generating costs. In attempts to rationalize costs to deal with profitability issues, online retailers will have to start promoting higher use of electronic payments, however this might mean losing a considerable customer segment of shoppers who will continue to be interested only in cash transactions. Therefore, few players are likely to decide to make such a bold move, and cash payment will continue hampering e-commerce market growth and negatively affect players’ bottom line.


India’s e-commerce market faces a mix of common challenges which exist across the BRIC countries, and inherent issues pertaining to unfavorable business conditions. Consumer culture and infrastructure issues aside, the fact that the market has to compete almost exclusively on price is hurting the current breed of players, and perhaps forcing potential new entrants into re-thinking their business models. The market is plagued with logistical nightmares, in spite of the fact that it only caters to a minuscule proportion of the potential customer base. In view of the challenges, it is no wonder that there are such divergent perspectives on e-commerce’s growth potential in India.

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Part I of the series – E-commerce in Brazil – Marred By Political and Social Influences

Part II of the series – E-commerce in Russia – Strong Impact of Consumer Culture

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E-commerce in Russia – Strong Impact of Consumer Culture

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Part II of our E-commerce Challenges in the BRIC series brings us to Russia, a market with significant growth opportunities which are impacted by customer’s traditional retail perceptions and infrastructure woes.

With a share of only 1.9% held by online sales in total retail sales, it would appear that Russian e-commerce market is almost irrelevant. However, the strong growth dynamics promising an average annual growth rate of 35% and a market size of US$36 billion by 2015, give a good context of the scale of opportunities. International online retailers are increasingly eyeing the Russian market with a view of capturing the growing e-commerce consumer base; however, some of the global giants, such as eBay or Amazon, still lag behind strong local competitors, such as Ozon.ru.

Opportunities are many, considering that already in 2011, Russia overtook Germany to become the market with the highest number of internet users, as well as the fact that it is Russia that prides the highest per capita income amongst all BRIC countries (with per capita income at PPP of US$17,700, compared with Brazil’s US$12,200, India’s US$3,900, and China’s US$9,100). However, as many e-commerce entities operating in this market have already discovered, Russian market is challenged by its own set of issues that hold back the market to expand even faster.

Russia e-commerce

The Challenges

  • Inadequate infrastructure – similar to many other developing countries with vast territories, Russia has by far insufficient and inadequate infrastructure, a fact that negatively affects delivery times, safety of cargo, and generally prevents the e-commerce market from developing to its full potential. Russia’s major transportation method is railway and road. With insufficient and outdated rail infrastructure, as well as bad or non-existent road network, paired with long distances required to cover in this large country, deliveries outside metropolises such as Moscow or Saint Petersburg often take a week to reach the online shopper. Also, on the online retailer side, delivering orders to customers across this huge country, particularly without a reliable national post system, generates significant costs and considerable time issues. Several larger players that have sufficient financial resources at hand need to invest in building own delivery networks and infrastructure wherever possible, as such services are not commonly available due to lack of specialized, reliable third party providers. This is, however, often impossible for smaller players or newcomers to the market, as it requires substantial investment.

  • Try-it shopping attitude – Russian shoppers often like to treat online shopping as ‘try-at-home’ service. They order many products, try them out at home, with the assumption that they might keep just few or even none of them. This requires online retailers to be rather flexible with product return options, and create process that allow for quick and efficient dealing with rejected products and cash refunds. This shopping attitude also results in retailers having relatively high inventory level, as well as devoting considerable time and resources to deal with orders that will eventually not generate revenue for them, as it is estimated that one in four deliveries of online purchases in Russia is refused and returned by the customer. Further, the infrastructure problems and lack of reliable public postal system clash with the try-it shopping attitude, as it makes it difficult for online customers to return purchased products, making them hesitant to shop online.

  • Cash payment shopping culture – credit and debit cards are not widely used by Russian shoppers, on the back of distrust towards safety of advance online payments and honesty of online retailers, as well as requirement for special card authorization before a purchase (online payment cannot be completed within a few clicks). This has led to high dominance of cash-on-delivery payment, which currently accounts for about 80% of online sales of products such as clothes, shoes, and electronics. Online retailers must cater to this demand, which requires them to finance product delivery while receiving payment later, leading to problems with cash flow and returns/rejects. Further, online retailers often incur additional costs of employing own team of cash couriers. While the use of debit and credit cards will increase, the process will be rather slow and long, as apart from developing reliable and safe online payment systems, a considerable cultural change to cash-oriented mindset in customers must occur.

  • Strong local competition – this is a challenge for newcomers to the Russian e-commerce market, especially foreign players. While it is still in early stages of development, there are several strong and successful local players (e.g. Ozon.ru, KupiVIP, Lamoda, Utkonos, Svyaznoy, X5, Wildberries.ru), who know how to navigate through nuances of online retail in the country, and enjoy strong, often loyal customer base. Ozon.ro is the unquestionable market leader, with grounded position, large customer base, own logistics arm, and wide offering, resulting in its extremely good performance (revenue hike of 91% in H1 2012 to US$232 million, expected to reach US$1 billion in 2014). Local competitive landscape is also infused with a number of smaller retailers that focus on narrower product categories, providing broad offering with a given category, e.g. consumer electronics provider Citilink or car spare parts store Exist.ru.

  • Consumer nationalist inclinations demanding localization – while many Russians appreciate foreign trends, there is a strong sense of nationalism that makes Russian shoppers less accepting and more likely to reject foreign influences and brands, if they do not localize their offering and do not provide fully Russian-language experience. This might pose a challenge for foreign e-commerce entities, expecting to transplant their business and operating models directly to the Russian market.

 

Russia’s e-commerce market is heavily influenced by customer mindsets and attitudes, which are still based on traditional shopping experiences, thus acting as hindrance to the pace of online retail growth. Inadequate and inefficient infrastructure has also played its part in creating challenges that result in cost and operational losses to existing players, and scares new entrants from investing in this space.

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E-commerce in Brazil – Marred By Political and Social Influences – read the first part of our E-commerce Challenges in the BRIC series.

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