Building local brings dramatic changes to a market soon to be the biggest in Europe
MOSCOW, 16 JUNE 2011: Profound transformation is underway in the Russian automotive market. As a result of the shift to local manufacturing and sourcing, and rapidly growing sales, the opportunities and demand for logistics services are significant, especially as growth spreads to the regions outside Moscow and St Petersburg. But, as ever in a country which is still developing a modern economy, investment in infrastructure and new equipment is needed, along with even-harder changes to the processes of Russia’s customs authorities.
Carmakers, tier suppliers and logistics providers from across the industry gathered in Moscow this week for the 6th annual Automotive Logistics Russia conference, where they heard that 2011 car sales are above previous expectations.
Spurred on by high oil prices – in Russia a boost not a dampener to the economy – sales have jumped some 60% in the first five months compared to 2010. also helping has been what VW’s head of group service Jan Bures described as a “very clever and very well-thought out” government plan for scrappage incentives, which directly benefit domestic manufacturers but which appear to have added momentum for all brands.
End of year forecasts call for sales in the range of 2.2m-2.5m, which though up from the 1.9m in 2010 would still be well below the pre-crisis peak of more than 3m light vehicles bought in 2008. Nevertheless most predictions, including those of Volkswagen, Toyota and the Association of Russian Automakers (OAR), are for the market to continue to grow for the rest of the decade, and to surpass the previous peak by 2015. By that time Russia will have overtaken Germany as the largest market in Europe.
Decree 166 drives the changes
The composition of the new 3m plus market will look radically different from the former peak. Alexey Serezhenkin, deputy executive director of the OAR, reminded delegates that 2008’s sales included most of the 2.5m vehicles imported that year (the total includes used vehicle imports). In contrast, by 2015 the association forecasts a total of just 856,000 imports (with only 5% representing used cars), or less than a third of the total annual market.
That shift up in domestic production – a 50% increase to around 2.4m units per annum by 2015 – is part of the very specific agenda of the Russian government to build the country’s manufacturing base. It has consistently raised tariffs on imported vehicles as well as increased localisation targets for foreign manufacturers. The latest targets set this year – known in shorthand as ‘decree 166’ – brought signed commitments from most major carmakers (with the notable exception of Toyota) to raise local production in exchange for preferential duty rates.
Indeed, VW’s Bures was presenting to the conference in place of his boss, country head Marcus Osegowitsch, who on the first day of the event was signing a new jv agreement under decree 166 with Gaz, in the person of its chief executive and former-GM logistics chief Bo Andersson, to build 100,000 cars per year in Nizhny Novgorod.
Decree 166 stipulates that by 2015 foreign OEMs must produce at least 300,000 vehicles per year in Russia (up from the former minimum of 25,000) in return for exemption of duty on parts imports. At the same time, localisation rates for components sourced within Russia, or within countries of the Customs Union established last year (with Belarus and Kazakhstan), must reach 60% for assembled cars and 30% for engine components.
GM takes on a more Russian flavour
Such targets are a dramatic step up on existing production rates for foreign carmakers in the country. Excluding joint ventures, their plants have tended to be relatively small scale, including the St Petersburg facilities of Toyota at a 20,000-unit per annum capacity, Nissan at 50,000 units, and GM at around 60,000 (though rising to 95,000 next year). Slightly larger plants include Renault’s 100,000 unit Avtoframos plant in Moscow, and Volkswagen with an 180,000 unit-capacity plant in Kaluga, southeast of Moscow.
GM Russia’s Peter Layer, head of purchasing and supply chain, revealed that the carmaker will meet its target of 350,000 vehicles locally produced by expanding its St Petersburg plant to 230,000 units and its GM-Avtovaz plant in Togliatti to 120,000 units (from 98,000 currently). GM will also continue to use contract manufacturers in the country, including Avtotor in Kaliningrad and Gaz in Nizhny Novgorod. Engines and gearboxes will be built for the Chevy Niva and the Lada 4×4 to increase the local supply base.
Layer told LSPs present at the conference that these volumes require a strong commitment from both inbound and outbound providers. “I’ve been with GM for six years [in a career spanning Korea to Detroit],” he told delegates, “and Russia is undoubtedly the most ‘interesting’ and challenging market in which I’ve worked. 100% of those challenges are due to logistics.”
Layer estimated that Russia’s current car carrier fleet for road transport is short of nearly 2,000 trucks, and added: “To expand as we have planned in Russia, we need all of you [logistics providers] to invest in the market. We can’t make or sell cars without you,” he said.
VW wants to get local
Other carmakers at the event echoed GM’s ambitions. Volkswagen’s Bures revealed that the carmaker had just started a third shift at its plant in Kaluga, which brings the factory close to its full capacity, and confirmed that VW Russia will be increasing its control over the distribution of other brands. “I can confirm the rumours. By July we will also be representing SEAT – and taking responsibility for its logistics – and we are currently in talks with Bentley and Lamborghini,” he said.
The challenges facing VW Russia include the low proportion of local suppliers compared with the company’s other global production locations. In Russia the local share is just 38%, said Bures, compared to 78% in Brazil, 86% in India, 88% in Eastern Europe and 94% in China.
He acknowledged that the low levels of localisation are partly a reflection of scale (VW produces about 2m cars per year in China), but also said that sourcing costs for Russian-based material are often quite high. In that sense, logistics costs could be a competitive edge for suppliers looking to meet VW’s expanding purchasing in Russia.
Bures also pointed to the capacity constraints in finished vehicle distribution. As well as a transport capacity shortage “of about 30%,” he said that increased road closures and stress on infrastructure was common across the country.
Can infrastructure keep up with Renault?
The complaints about infrastructure were common. GM’s Layer pointed out that the country has only about 755,000km of paved motorways, about 1/5th the amount in the US (which is only half as big in area) and the same amount as Germany (which is 48 times smaller than the Russian Federation). Rail infrastructure is also inconsistent, with relatively few of the automotive clusters having railheads.
Other speakers expressed their worries, and the OAR’s Serezhenkin saw little improvement before 2015. “Financing for road building has actually been decreased in the federal budget,” he reported.
That will likely cause further congestion and lead to more difficulties as carmakers expand their use of road freight. The Renault Nissan Alliance is yet another carmaker with plans to increase production, to 350,000 units and beyond in the next two years. The company’s supply chain director in Russia, Jean-Philippe Jouandin, told delegates that capacity between the Nissan plant in St Petersburg, the Renault factory in Moscow and the ‘B0 line’ coming on-stream in 2012 at the Avtovaz factory in Nizhny Novgorod, would grow to 200,000 units this year from 112,000 in 2010, before rising to 350,000 units by 2013.
He said that increasing localisation – currently at 53% for Renault but rising to a planned 74% –would greatly increase the demand for inbound truck capacity. The 20 local suppliers that the company used in 2010 required around 160 trucks per week from St Petersburg, Moscow, Yaroslavl, Nizhny Novgorod and Togliatti. Meanwhile the Alliance’s 30 suppliers in 2011 have increased truck usage to 330 per week, and by 2013 Jouandin anticipates that 60 suppliers will nearly treble truckloads to 900 per week.
“We have to ensure that our supply chain and logistics providers will be ready for this growth,” he warned.
But even while the Alliance has a relatively high level of localisation compared to some other foreign OEMs, Jouandin gave details of the complexity in managing imported material. For Renault Nissan it comes from a range of different points in Europe and Asia: from its crossdock in Turkey 120 containers per week are sent to Russia on a mix of sea and rail transport; 120 containers are sent from its crossdock in Romania, including two block trains per week; 300 containers arrive each week from the Alliance’s parts consolidation centre for Asia, which includes material from Japan, China and Thailand; and finally the Alliance sends 15 trucks directly from France each week.
Jouandin said that the drive for localisation provided the opportunity to dramatically lower inbound logistics costs. But for outbound, he said Renault Nissan is seeing price rises for truck transport of 80% from a baseline at the beginning of 2008. Compared to the crisis levels of 2009 and 2010, prices had trebled.
Tier suppliers arrive, slowly
Up to now, a relatively small number of tier suppliers have built factories in Russia. One that is doing more to localise is the fuel system manufacturer, Inergy. In 2009, the company opened its first Russian plant in Vladimir City, about 200km east of Moscow and roughly equidistant between the capital and Nizhny Novgorod. Igor Matrosov, supply chain manager, told the conference that the company was looking to begin a second production line or open a second plant near to one of the country’s automotive clusters.
But although Inergy is now making 200,000 fuel tanks per year in Russia, it in turn uses a large share of imported material – roughly 50% of content – from logistics centres in France and Romania. Inergy relies on delivery duty unpaid incoterms, leaving logistics responsibility in the hands of its suppliers. “This is easier for us since we don’t incur additional expenses if something happens at the road side or at the border,” he said.
He wanted more collaboration with other tier suppliers. Until Inergy reaches a larger scale it will be difficult to localise components such as fuel pipes, for example.
The customs maze
Matrosav also touched on one of the biggest challenges for any company, that of clearing imported material through customs. Holds for three days or longer bring high storage costs, while random checks require Inergy’s logistics providers to open up a container or truck and count every single one of the several thousand parts contained inside.
Ever a complex, cumbersome and expensive process, speakers at the conference demonstrated again how critical it is to work with experts who can navigate the “idiosyncrasies”– in the words of Priority Freight’s country chief Alexander Rogan – of Russian customs. “Unless you’re willing to invest millions of dollars (to manufacture) here, then you will pay a lot,” he said bluntly.
Wilhelmina Shavshina, legal director at DLA Piper, is an expert with a close understanding of the customs authorities. In a detailed but very important presentation to delegates, she gave some insights into ever-changing procedures. An example is from the new Customs Union with Belarus and Kazakhstan. It offers opportunities for both exports and parts sourcing – localisation requirements, for example, can be met through material from these countries. The union is open to other countries, she noted, including those from the EU, and Ukraine is also said to be interested.
However, the union’s ‘exceptions’ and confusing rules reveal that the tri-lateral agreement still maintains some bi-lateral elements, a small example of which is Russia’s free trade agreement with Serbia that has not been extended across the union.
Shavshina outlined a maze of complicated procedures that importers need to follow to avoid certain tariffs and inventory taxes, including a ‘free warehouse’ procedure that might be an alternative to carmakers that did not sign decree 166. However, the implication was that the authorities can change procedures quickly, leading to considerable confusion.
She did express hope that reform was coming, however. At the prompting of Prime Minister Vladimir Putin, the Ministry for Economic Development is investigating ways that customs might become friendlier to business. The day before the conference Shavshina had been at the ministry, where she and a consulting team had presented a list of 75 business-relevant problems. “We only discussed one third of them, but I can already see a breakthrough,” she declared.
Toyota import strategy
Since Toyota has not signed decree 166, it will retain an import strategy for the Russian market – and thus have to deal more with the vagaries of customs for finished goods. But it is not planning to miss out on market growth. Fumitaka Kawashima, senior director responsible for sales, logistics and dealer development, said that Toyota plans to expand sales from 90,000 in 2010 to 120,000 this year, and will exceed 200,000 by 2013. Given its small St Petersburg plant, most will be imported from global Toyota production centres in Japan, the UK, Turkey, France and South Africa.
Toyota currently relies on the Baltic ports, making use of the Fishery port in St Petersburg as well as Ust Luga. As of this summer Toyota will have eliminated use of offshore ports, which in the past included the Finnish port of Hanko and even Gdansk in Poland.
Kawashima revealed plans for further significant changes to the OEM’s Russian import and distribution network. They include the use ports on the Black Sea as well as in the Far East. There are currently no well-developed facilities in the Black Sea, he said, “but we think this would be a very good option for Turkey. We are looking very seriously for terminal partners in the region, as well as in the Far East.”
Toyota would also like to expand its use of rail. It currently moves some 85% of imported volume by truck, and has only recently begun to move the other 15% by rail, notably from Ust Luga to the Ural region and to Siberia. The OEM has also begun trials with the RailTransAuto (a finished vehicle rail operator at Ust Luga that is half-owned by the Russian Railways state monopoly) to assess how to respond to the temperatures of a Siberian winter. “If we have a positive result, then we will expand the use of rail for this area,” he said.
Toyota would like to increase the movement of SUVs, in particular, by rail, but Kawashima pointed to a lack of closed rail wagons.
He also gave delegates an update from Japan, where the earthquake has cost the company at least two months of constrained production. By the fourth quarter of 2011 Japan will be back to full speed, he said, which is when logistics capacity issues will hit Russian operations. Kawashima’s colleague Olga Valieva, senior manager for vehicle logistics, warned that ports and onward distribution restrictions will be “severe” for the company, and added her voice to the message to LSPs. “We are relying on logistics providers to step up their investment and meet the market demand,” she said.
The second day of the conference featured more detailed working sessions, including breakouts for presentations and questions on finished vehicle logistics, service parts logistics and packaging, followed by a series of round tables for even closer discussions.
Some delegates, including Toyota’s European (excluding Russia) head of logistics, Levent Yuksel, attended just for that day.
The sessions on finished vehicle logistics did show that investment in road distribution is taking place, albeit at a pace slower than desired by carmakers. Alberto Picco, from trailer manufacture Rolfo, unveiled his company’s new model dedicated to the Russian market, the Blizzard 3. He said that Rolfo planned to extend its summer production and keep the line open during August to meet anticipated demand. Anna Vorobjeva, logistics director for MAN Russia, said that she expects sales of about 6,000 trucks this year in Russia and CIS countries, about 10% of which would be car carriers.
But simple capacity shortage is not the only disruptive factor in outbound logistics. Not helping in 2010, for example, was the end-year sales rush at a time when cars were stranded in compounds buried under piles of snow.
Russian ports on the rise
As Toyota’s plans for Russian ports demonstrate, the scenario for vehicle imports has changed considerably since before the financial crisis. The opening of Ust Luga, along with several terminals at St Petersburg, has repatriated the majority of imports at the expense of Finnish and other Baltic ports. Alexander Goloviznin, deputy general director of Ust Luga, said that vehicle imports were expected to reach 160,000 this year, and that the terminal continues to add capacity. As well as Toyota, it is used by Kia where RTA is the main operator, and will this year see Toyota trialling rail shipments to Kazakhstan.
The Russian ports still lag behind their Finnish competitors on price, service and storage space, however. Toyota’s Valieva said that Finnish ports continue to act as a benchmark, even though they are no longer being used. She said that Russian ports tend to focus on earning their margin by throughput, moving vehicles quickly through the terminals, rather than by offering competitive storage options or added value services.
“Right now what exists in the Russian ports is very simple,” she said. “We see PPO (post-production options and installations) at the ports to be within our strategic scope, and we would like to see this developed.”
“That could include simple tasks like installing audio options, or more complex work such as air conditioning. But we have not yet decided what the full scope of the PDI (pre-delivery inspection) or PPO operations should be for Russia.”
Ust Luga’s Goloviznin explained that the difference with Finnish ports stemmed from the fact that his facility was developed and financed largely by private money, in contrast to Finland’s municipal ports.
He could only go on to comment that while Ust Luga could not offer storage rates as competitive as those in Finland, savings are made by cheaper onward transport. And that Ust Luga would be willing to develop PPO services if it had commitments from its customers, including Toyota.
Quality must match quantity
Along with capacity, quality of service was the important theme for the finished vehicle logistics sessions at the conference. Ekaterina Makarytcheva, head of logistics for Citroen, showed slides illustrating the results of snow – including damaged gearboxes and clutches – as well as extreme inefficiencies, including the time it took to free cars from the snow and the difficulty of identifying which models were on a compound.
“I’m making a specific call to providers and compound operators to come up with solutions to protect these vehicles during winter,” she said. “We also need to establish a clear process for dealing with the damage. Often the (damaged) vehicles arrive at the dealership and the burden of repair falls on the dealer because the compound or transport provider won’t take responsibility.”
These concerns are universal. Alexey Tenkov, head of outbound for GM Russia, noted that, despite harsh winters, all storage was done in open compounds which appeared to be unprepared for ice and snow.
Providers in the room challenged GM and Citroen to pay more for covered storage or additional damage-protection, and both said that they were “open” to such discussions. But Tenkov warned that GM expected its vehicle compounds to be total service centres rather than glorified parking lots.
“We believe that the rates we are paying should include more than simple storage,” he said.
Minnows and giants
Logistics as a competitive advantage for both inbound and outbound applies to newcomers too. John Mylonas, the former GM executive who was instrumental in starting the OEM’s production in Russia, outlined his plans for a new factory in Tartarstan for a completely new Myla Motors SUV/crossover brand to launch this November.
He told delegates that logistics was the single most important factor in running an efficient assembly operation.
His extremely lean operations – an investment of €30m will produce 40,000 cars a year, expanding to 80,000 for another €10m – will be built around a just-in-time, pull supply chain, he said. Mylonas contrasted that with the €775m which Jan Bures revealed that VW had invested in Kaluga.
“You are a giant and I am a minnow. But logistics will be my advantage over you,” he quipped.
Wide area challenge for the aftermarket
Service parts logistics are always going to be challenging in a country which is 10,000km from west to east, and which has almost twice the land area but half the population and a quarter of the car ownership per head of the USA.
Added to that, some two thirds of car sales have up to now been made in the Moscow and St Petersburg conurbations, leaving the remainder to be even more thinly spread across the rest of the country.
But it is the regions that are driving the growth in car sales. In the special break-out session on service parts held during the conference, Anna Blumkina, spare parts & accessories director for Renault Russia, revealed that the OEM has aggressive plans to expand its dealer network in cities of less than 750,000 people. At the end of 2010 it had only eight such outlets in the 107 towns and cities of between about 150,000-750,000 population (though near-universal coverage of those bigger).
In this expansion, she believes logistics can be a differentiator. “Alongside the evolution of a modern dealership network comes a rise in customer expectations,” she said. “It is very important to match the expectations (of parts availability) that we have created.”
In a clear signal of intent, she added: “We believe logistics today is a time of investment into the so-called ‘dead zones’ where delivery is problematic. In such a vast country, parts delivery to dealerships will be a key factor in competition between OEMs.”
That meant she was lukewarm to the idea of finding efficiencies through sharing networks with other OEMs. They too are embarking on regional expansion, and given that large dealerships owned by companies like Major Auto Trans are multi-brand, this could lead to parallel deliveries to the same location.
As for logistics collaboration between production and service parts, Anna Klinskova, sales & marketing director in Russia for Kuehne + Nagel said there was no call for it and little was going on, and anyway that “the initiative has to come from the OEM”.
“If we as an LSP find a synergy, we inform the client….for free,” she added.
Blumkina echoed the absence of collaboration. She said there is no regular contact between the production and service parts logistics functions at Renault Nissan, and only a once per year get-together for purchasing transport capacity. The Renault plant in Kaluga currently has tenders out for both logistics types, she noted, but ‘they come from different parts of the company and their concepts of network are very different”.
There are other specifically Russian challenges to service parts logistics, said Klinskova. The cost of running distribution warehouses is higher because, by law, they cannot limit their liability. The grey market is buoyant, and in a country where it can take I4 days to move parts from the western centres to Vladivostok (it takes three days by air), these competitors will be tackled only by improved availability rather than by price. Finally, security measures like screening staff, using whole metal trucks for high value parts, and the low use of GPS for tracking, add to the challenges.
But it would be wrong to say that specialists in the sector are not responding. The chairman of this conference session, Michael Hess, who is director of international business development at Tablogix, the Russian market leader in service parts logistics with 80,000 sq m of warehouse space serving 300 dealers, revealed that his company had won an award from Ford last year for operating its best spare parts warehouse in Europe.
Return to customs for packaging
The clear advantages of returnable packaging have delivered only modest gains to date in Russia, according to Michel Kutin, automotive sales director in Russia for packaging provider Schoeller Arca. These products have been introduced into the country only in the last 10 years, he said, and have just 5% of the use being seen in Western Europe.
There are reasons. Among them is the size of the country, which makes pooling centres for washing and re-cycling packaging harder to justify. The complexity of customs regulations also plays its part, for example the detailed article listings reuired for individual models of packaging which are temporarily imported and then re-exported. Gefco’s Stanislav Morosov, the company’s customs’ expert, was quizzed on some of the excruciating detail by Haluk Asar, an assistant general manager at Ford Russia, including about the regulations which apply to metal skids for painted car bodies and to racks for engines.
Nevertheless, there are some factors in favour of returnable packaging, said Gefco’s commercial director for Russia, German Suvorov. Responding to a question from Honda, he noted that low Russian exports of manufactured goods mean that freight rates for the round trip back to Europe are extremely low.
anyway, wooden packaging (including pallets) presents its own problems for customs. Absorption of water in the varied climatic conditions can lead to changes in weight which are significant in its description, and throw up discrepancies which need to be explained.
There could be a breakthrough
The overall theme of Automotive Logistics Russia 2011 was ‘The great Russian breakthrough” for logistics. Perhaps that might have put it too strongly. But this year’s conference did reveal an industry of rising unit sales, rising logistics prices, and increasing logistics success, from ports to warehousing. Even customs might soften its business approach.
So despite the wariness which stems from the boom-to-bust crash of 2009, and the fact that challenges of geography and climate will not go away, there is good money being made today in Russia. And unless all the predictions for continuing-high oil prices are plain wrong, money to be made tomorrow as well.
Just like the spending that made a luxurious venue for the conference out of the Stalin-era Hotel Ukraine, which is sited across the Moscow river from the White House parliament building, so the right amount and location of investment in Russian automotive logistics could pay off for years to come.