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STUDENT EXAMINATION NUMBER Y1401956
MODULE NO: MAN00018M _________________
MODULE TITLE: International Business strategy
Module Tutor: Prof. Teresa da Silva Lopes ______________________
Essay Title: MNE’s in the high-risk market: P&G and Coca-Cola entering post-communist Russia.
Word Count: 3286
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Introduction: Benefits and Risks of the Russian market
The collapse of the Soviet Union had changed Easter European political and
economic landscape in the early 90’s.Communist dictatorship and centrally planned
economy that previously prevented MNE’s from entering the market (and gave no
country-specific advantage according to Rugman’s framework) were replaced by
multiparty democracy and open market (Johanson et. al.,2006:181). Sudden market
liberalisation that enabled pricing to be “determined by market forces has had profound
effects on both cost and revenues for firms” (Ibid). It also gave private companies
freedom and incentives to compete and co-operate, as well as, freely decide on how
and where to do business (Ibid). From the former Soviet Union countries, Russia was
the largest republic (51% of the former Soviet population) with the highest market
potential (Morgan, Thorpe, 2001:32).New policies introduced by Boris Yeltsin were
created to attract private enterprise and foreign investments; however, they resulted in
hyperinflation and vast opposition (Shleifer A., Treisman D., 2005). Nevertheless,
abundant natural resources, educated labour force, and huge population of consumers
with increasing income and diversifying tastes created favourable conditions for foreign
MNE’s to invest into the liberalised market (Mapa et al.,2001:9).
Newly opened immense and untapped Russian market offered international firms
a “proverbial gold rush following its initial opening” (Beckes, Izergina, 2012) because
local Russian companies failed to satisfy the increasing demand on quality and variety
of products due to poor infrastructure, lack of resources and out-of-date equipment
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(Ibid). Exposure to global mass media and expansion of tourism changed Russian
ideological patterns towards foreign culture and products (Morgan, Thorpe, 2001:32).
Companies like Procter and Gamble and Coca-Cola quickly recognised the potential
and long-term benefits and entered this market to capture a competitive and “first mover
advantage” (Hooper et. al., 2001).
However, as in every transition economy, Russian market turbulence that had led
to changes in “demand, product obsolescence, growing competition, and the
appearance of new products and technologies” also presented a high risk environment
for potential foreign investors (Johanson et. al., 2006; Beckes, Izergina, 2012, Mapa et.
al., 2001). “Transition economies are characterised by high transaction cost due to
opportunism and the lack of property-right-base legal framework, a stable political
structure and strategic factor markets” (Johanson et. al., 2006:181). The defining
features of the post-Soviet Russian market in transition are ‘political uncertainty’ and
‘economic turmoil’; they fostered bureaucratic obstacles and corruption and created
difficulties for Coca-Cola and P&G at the point of entry. Additional economic problems
like demand levels outstripping supply, emergence of grey markets, and “transportation
and logistics infrastructure constrains” also created high-risk environment for the two
multinationals (Morgan, Thorpe, 2001:30). Stephen Hymer (1960) mentioned these
imperfections in the market and noted that if there are advantages despite these
imperfections there is rationale for operating in unfamiliar foreign market. This essay
mainly focuses on financial and political risks the two MNE’s had to overcome and the
strategies they used to overcome these risks; however, it also mentions competitive risk
in the face of corruption and operational risk connected to taxes and infrastructure.
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Procter & Gamble’s entry into the emerging Russian market.
Ranked number 41 in the list of World’s Most Reputable Companies by Forbes
(2014) and recognized as number one most admired company in soaps and cosmetics
industry by Fortune (2014), Procter & Gamble Co is the world’s largest consumer-goods
manufacturer with $84.74 billion in sales as of May 2014 (Forbes). Founded by William
Procter and James Gamble in 1837 and based in Cincinnati, small American candle and
soap company has grown into a multinational corporation with the strongest product
portfolio of trusted, quality, leadership brands sold in over 180 countries (P&G history,
P&G annual report, 2014:12). Now P&G has around 118,000 employees and 137
manufacturing facilities worldwide in over 40 countries (P&G Annual report, 2014:16).
P&G expanded its international presence mainly through acquisition of local
companies and manufacturing facilities or by setting up foreign subsidiaries (Rugman,
Collinson, 2012:273). In 1991 P&G entered Russian market through FDI and joint
venture. The “major untapped market of the next decade” was strategically important to
P&G because locally produced goods had poor quality which meant lack of local
competition (Backes, Izergina, 2012). P&G quickly realised that entering the Russian
market with the vast population of potential buyers and establishing relationships there
first will give the company competitive advantage and tremendous revenue in the future
(Ibid). On the other hand, right after the fall of the regime there was no real demand on
products, because the shift from planned economy was not fast enough, so, according
to Vernon’s Product Life-Cycle Theory (1966) P&G had no incentives to produce in this
market at an early stage or charge high prices for their newly introduced products; the
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company had to wait until the customers had gotten used to the new market framework
of supply and demand.
As a first step to internationalisation, P&G entered through a joint venture by
forming a partnership with St. Petersburg University to get local talent and gain insights
into the Russian market and to develop a distribution system which was critical to the
company’s success. Then, P&G opened a plant and established a subsidiary to ensure
local production and operation (Pepper, 2012).
P&G’s main strategy is to produce regional brands to develop regionally. R&D
and high sensitivity to the changing economic and political environment is the forefront
of P&G’s strategy (Davey, Sanders, 2012). The company mainly expands its product
portfolio through acquisition of locally trusted brands and then re-markets them to
deliver to the local consumer (Rugman, Collinson, 2012: 273). When Procter & Gamble
was expanding into Eastern European markets the company had international division
structure arrangement (Ibid). It was simple and centralized enough to keep control over
the international operations in a highly risky and unstable turbulent market which was
left without any infrastructure after the fall of the Soviet Union (Johanson e al.,
2006:180). Due to political uncertainty and economic turmoil giving more autonomy in
decision-making to the regional management was too risky (Backes, Izergina, 2012).
One central point of decision - making was crucial to keep control over the overseas
operations in that region which gave P&G an easy way to withdrawal from the market in
case of failure. In addition, this structure helped develop a ‘’cadre of internationally
experienced managers’’ for the Russian (international) division by overseeing local
talent development (Rugman, Collinson, 2012:278).
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When P&G was expanding into Russia the market was in transition and
characterised as turbulent (Johanson, et. al., 2006:181-2). On top of political instability,
contradictory judiciary system, arbitrary tax code, inflation, extensive use of barter
payments, lack of corporate governance and massive corruption there was a distribution
and supply chain coordination problem (Ibid, Casson, Lopes, 2013:389). After the
collapse of the Soviet Union where government used to control the product distribution,
Eastern Europe was left without a distribution system. This risk was the main barrier of
entry for Procter and Gamble, so, P&G created its own distribution operations and
called it the McVan model (Dyer et. al., 2004). P&G signed agreements with 32 regional
distributors and 68 subdistributors that were committed to distributing only P&G
products within their territory in return for “vans, working capital, and extensive training”
that P&G provided (Kotabe,Helsen,2011: 617). As a result, McVan distribution system
gave P&G “coverage of some 80 percent of the population at a time when most
multinationals were still restricted to marketing in the two main cities of Moscow and St.
Petersburg” (Arnold D.,2003:3). This bold and risky approach of investing into a
distribution network development in a county with no infrastructure gave P&G a
competitive advantage in the largest country in terms of area (Arnold, 1998: 616-17;
Kotabe, Helsen, 2011:617). “By tackling the issue head-on rather than waiting for the
enabling condition to develop, P&G gained huge leads in market share in many
categories” (Arnold D.,2003:3).
Coca-Cola’s entry into the emerging Russian market.
The Coca-Cola drink was invented by John S. Pemberton in1886 and became a
“largest-selling soft drink in the world” (Rugman, Collinson, 2012:4). Now, the Coca-
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Cola Company is the world's largest non-alcoholic beverage company that
manufactures retails and markets over 500 brands (Coca-Cola Company, 2009).
Ranked number four in World's Most Valuable Brands list by Forbes (2014) the Coca
Cola Company is a globally renown leader in a non-alcoholic beverage concentrates
and syrups segment with a 46854 $ million revenue (Fortune,2014). Headquartered in
Atlanta, Georgia the company operates as a franchise system that sells its products to
local bottlers that are authorised to manufacture and distribute Coca-Cola products.
During internalisation into the Russian market Coca-Cola had a global area
structure which was typical for a business with “diverse geographic areas” (Rugman,
Collinson, 2012: 287). It is a good structure for consolidating regional expertise in a
subsidiary country like Russia where local culture is most important (Blanchard, 2006,).
“A global area structure is commonly used by MNE’s” like Coca-Cola “that are in mature
businesses and have narrow product lines that are differentiated by geographic area”
(Rugman, Collinson, 2012: 280). This structure also worked well in the economies of
scale such as Russia and gave the company production cost advantage (Ibid, 281).
The Company had a “global view and global strategy” (Rugman, Collinson,
2012:15). In the 90’s the company was restructuring towards decentralisation; however,
in 1991, when Coca-Cola was entering the Russian market, it still had a rather
centralised decision - making and standardised operating practices which were more
risk-free when operating in a turbulent Russian market (Rugman, Collinson, 2012:431).
Later on, in order to meet local needs and facilitate national responsiveness the
company gave their international partners and local managers some authority in
decision- making. “The Coca-Cola Company has a corporate (Head Office) segment
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that is responsible for giving the Company an overall direction and providing support to
the regional structure” (Business Case studies,2014). Satisfaction of local tastes gave
strong competitive advantage to the company (Rugman, Collinson, 2012: 281).
To enter the Russian market Coca-Cola used ‘voluntary heavy initial investment
strategy’ that presupposes company’s optimistic view of industrial or consumer market
and availability of resources (Morgan, Thorpe, 2001:36). The company used FDI as the
main strategy because their market share objective was of first or early mover. Also,
according to the Dunning’s Eclectic Paradigm, Coca-Cola possessed ownership
advantages in a form of their unique product, a location advantage because of Russia’s
expanding market with cheap labour and extensive natural resources ( infrastructure
was the main problem prevented by the company before the entry), and even
internationalisation advantage that the company achieved through unique strategies
and communication with local authorities an firms (Fabri, Zekhni,2002: 291).
Consequently, all three categories were fulfilled, so, FDI was a rational choice even
though it reduced strategic flexibility, produced high risk and extensive global
competition (McCarthy, Puffer 1997; Morgan, Thorpe, 2001:35). Such heavy investment
is appealing given the commercial potential and lack of local competition in the market
but it is only appropriate for long term return (Morgan, Thorpe, 2001:37). “Cola could not
ignore the Russian market because their main worldwide opponents were already in
position, and to leave entry until the economic situation had stabilized could have been
too late” (Ibid, 43).
Internationalising into the Russian market was strategically important for Coca-
Cola in order to compete in the world’s market share with Pepsi - the main rival that
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successfully entered the Russian market in the 60’s and established a counter-trade
agreement with Stolichnaya vodka. Coca-Cola tried the same approach during the
Soviet regime but was unsuccessful in its first attempt due to tactical and operational
difficulties, as well as, its American imperialism brand image (Ibid, 38). The fall of the
regime meant that Coca-Cola had an opportunity to try again. Pepsi is always a
“potential threat to Coca-Cola and the reason why defensive strategies are now being
put at place” (Ibid, 43). Coca-Cola’s expansion strategy was “through a variety of entry
modes, including joint ventures, acquisition of existing Russian plants and greenfield
investments in the construction of the plants” (Mapa et. al.,2001:11) (appendix a). This
multiple entry strategy played a “key factor in the success of Coca-Cola’s entry into
Russia” (Ibid).
Coca-Cola was aware of the barriers to its Russian expansion and had
undertaken strategic actions to overcome these barrios. The main risk for entry was the
operational risk. There was no adequate transportation, distribution or infrastructure
system. So, Coca-Cola’s direct investment strategy started with “building an
infrastructure for soft drink production” (Ibid, 13). Then the company made joint venture
agreements with Pepsi’s bottlers so that they would also produce for Coca-Cola. The
most crucial in developing countries is finding reliable high-quality suppliers for inputs,
as well as, getting production and distribution infrastructure local as soon as possible
(bid). After creating the production and distribution base, the company “sought to
expand horizontally” and established headquarters in the two central cities of Moscow
and St. Petersburg (Morgan, Thorpe, 2001:38). Second phase was acquisition of
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bottling companies and building their own production plants. Coca-Cola also attracted
its established foreign bottlers to enter Russia and produce exclusively for the company.
The Coca-Cola Company used the rare multi-local approach: localised its
operations as much as possible and used local partners and suppliers in order to
support economic growth and gain Russian government’s support, thus, reducing the
political risk and “debilitating effects of the Russian taxation system” (Morgan, Thorpe,
2001:39, Mapa et. al., 2001). As a part of the strategy, the company had gathered an
exceptional managerial team from the US “to ensure successful entry and post-entry
developments” and train Russian employees that struggled with marketing knowledge
and concepts (Morgan,Thorpe,2001:41-42).In order to overlook operations in Russia,
Coca-Cola created information system network to ensure overall efficiency and
coordination between the plants (Ibid).
In a post-communist Russia political and economic risks were understood by
Coca-Cola and the company entered Russian market to deliberately overcome them
(Mapa et al., 20001:17). “Instead of being deterred by exorbitant taxes, enormous
bureaucracy and systemic corruption, Coca-Cola accepted that these problems were
part-and-parcel of doing business in Russia and that the company would need to
develop a strong relationship with the Russian government if it was to overcome these
challenges” (Ibid, 1). Lack of stable legal mechanisms and corporate governance and
arbitrary Russian tax system increased investment risks. Extensive regulation and
barter payments imposed by the government also created financial and political
difficulties for MNE’s at the point of entry. Country’s inexperience with private land
ownership discouraged foreign investments (Ibid,6-8). “Key component of Coca-Cola’s
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entry strategy into Russia was to convince the Russian government that the company
would provide positive spill over effects for the local economy”(Ibid, 15) (appendix b).
To win the support of the government in order to gain acceptable conditions of
entry the company formed alliances with local companies, which helped Coca-Cola to
successfully negotiate a two-year tax exception from the Russian Federal government.
This has helped Coca-Cola to invest heavily in plant facilities (Morgan, Thorpe, 2001).
The company chose to fight with corruption and stick to internal code of ethics and
worked with partners that supported this integrity. Because the Russian legal system
was still influenced by the corrupt government, Coca-Cola insured itself with an in-
house legal team. In addition, Coca-Cola introduced tax reforms and land leasing
practices to the government in order to build plants. “In 1991 Coca-Cola became the
first Western Company in Moscow to lease land from the state” and in 1994 the plant in
Moscow was opened (Ibid, 41). In 1995 Coca -Cola expanded into St. Petersburg with
the greenfield strategy but experienced problems with local infrastructure surrounding
the bottling facility. The company negotiated a deal with the government in which “it
received tax rebates covering capital costs for infrastructure improvements” (Mapa et.
al., 2001:12).
Overall, Coca-Cola’s objectives were to localise production and develop flexible
supplier networks. The company succeeded to do so because it also contributed to the
recovery of Russia’s economy by investing capital, creating jobs, training work force and
sourcing 80% materials locally, thus, creating demand for local materials and services
(Ibid). By balancing both domestic and international interests Coca-Cola was able to
reduce financial risks connected “shifting taxes and import duties “(Ibid, 4).
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Conclusion
Procter & Gamble and Coca-Cola recognised recently liberalised post-communist
Russian market potential, as well as, the high risk when entering and operating in such
highly turbulent market. Both MNE’s used preventing and mitigating strategies before
entering the market and when expanding their operations in Russia. Since both
companies entered Russia in 1991, their challenges and strategies when dealing with
high risk environment were similar: main risks involved political instability and corrupt
government sceptical of foreign investors, as well as, absence of any infrastructure like
supply chain and distribution system. The challenges were quiet serious, so, both
companies used a mixture of entry modes like joint venture as a first stage and then FDI
in P&G’s case, and joint venture as a first stage, and acquisition and FDI as a second
stages in Coca-Cola’s case. Both companies entered through joint venture first in order
to create their own distribution system and overcome this economic challenge before
initial entry. Then, they both established their own plans and local subsidiaries to ensure
local operation.
Both companies were not looking for short-term success, so they invested
heavily into the distribution system and gained competitive advantage by having
coverage in one of the biggest countries in the world. Thanks to the firm-specific
advantage of P&G and Coca-Cola both firms could afford heavy investment in a high
risk environment because they had resources and experience to deal with it. Despite
the heavy investment companies entered gradually through multiple entry modes and
with multi-local strategies. Partnering with the authorities and local firms was a big part
of it.
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Both companies localized the operations and worked with local partners in order
to gain insights into the market and establish relationship with the Russian government
in order to get beneficial conditions for their business. This gave Coca-Cola and P&G
production cost advantage. They also developed local talent that knew the Russian
market and could use Western business practices.
In order to prevent the distribution problems, P&G developed the McVan
distribution network by working with local companies. Same did Coca-Cola, - signed
agreements with local bottlers and private firms. P&G focused more on satisfying local
taste by adapting or purchasing local products while Coca-Cola localised the marketing
strategy of its standardised product to the Russian customer. Also, Coca-Cola seems to
have had more risks that involved Pepsi as a main competitor and Russian government
that imposed taxes and limited access to resources. It’s defensive strategy involved
negotiations with the Russian government in order to get adequate conditions for
building plants.
Russian market was strategically important for both companies. Thanks to the
early mover advantage P&G monopolised its niche and won a significant amount of the
Russian market share. Coca-Cola defended its leading position from Pepsi and won
Russian consumers with higher quality of the product because, unlike Pepsi, Coca-Cola
could easily control the quality of the product produced in its own facilities (Morgan,
Thorpe, 2001:42). The entry modes and risk prevention and mitigation strategies P&G
and Coca-Cola used ensured the leading position for the two MNE’s in the Russian
market up until now. However, they are facing political and economic risks again
connected to Western sanctions against Russia. Coca-Cola HBC announced fall in
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volume sales connected to deterioration in Russia (Nimmo K., 2014). Moscow is
planning to freeze the assets of American and European companies operating in Russia
in response to Western sanctions (Kollewe J.,2014). I would suggest the two MNEs use
their old strategies and come up with new beneficial deals for both Russia and
multinationals in order to prevent the Russian government from taking drastic
measures.
.
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Appendices
Appendix a Mapa, Gupta, Phillips, 2001:10
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Appendix b Mapa, Gupta, Phillips, 2001:11
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