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

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of products due to poor infrastructure, lack of resources and out-of-date equipment

(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.

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

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).

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-

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

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

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

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

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).

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.

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

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.

.

Appendices

Appendix a Mapa, Gupta, Phillips, 2001:10

Appendix b Mapa, Gupta, Phillips, 2001:11

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