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Comment of Tim Demchenko, Global Head of Private Equity and Special Situations at VTB Capital, to Financial Times online

2 August 2012

A menu for success in Russia

By Courtney Weaver

When McDonald’s opened its doors in Soviet Moscow in 1990, the US fast- food group received a welcome fit for The Beatles.

On the first day of operations, customers lined up outside in frigid February temperatures and waited up to four hours just to enter the Pushkin Square restaurant. A total of 30,000 people went on the first day.

Working in the restaurant proved nearly as popular. After McDonald’s advertised in the local newspaper, about 25,000 applied to work as cashiers, cooks and cleaners.

Two decades later its fast-food competitors are trying to re-create the magic of the initial success of McDonald’s in Moscow, piling into Russia and setting up outposts as far afield as Irkutsk in Siberia and Vladivostok on the edge of the Pacific Ocean. Since 2010, Cinnabon, Burger King, Dunkin’ Donuts and Wendy’s have entered Russia at speed. Now the competition is intensifying.

Burger King recently announced it would increase its 64 locations to several hundred by 2017 together with a new partner, VTB Capital, the state-owned investment bank. Doughnut chain Krispy Kreme has said it will be working with Arkady Novikov, a restaurateur better known for posh eateries both in Russia and London’s Mayfair district. The first Moscow Krispy Kreme is expected to open this year.

The new entrants arrive as chains that have been in the Russian market a little longer – KFC, Subway, and McDonald’s – are launching aggressive expansion campaigns that put them in cities up to seven time zones fr om the Russian capital.

US fast-food giants expanding into emerging markets is not new, but the effect in this case has been dramatic for a country that has typically been considered “second or third priority” for multinationals after China and often Brazil, says Sergei Plykine, a director at Boston Consulting Group’s Moscow office. “It took time for McDonald’s to develop the [Russian] market, and it took time for the others to realise that the market was there,” Mr Plykine says.

By trying to enter the market early – McDonald’s started talks with the Soviet government as far as back as 1976 – the restaurant group formed a close relationship with the Soviet and then Russian governments and with Russian consumers, a strategy its competitors found hard to replicate.

Nor was it deterred by Russian volatility. During the 1998 debt crisis, Pizza Hut, another early entrant, scaled back its operations, while Dunkin’ Donuts, which arrived in 1996, left until 2010.

The decision to see out the debt crisis and the fall of the Soviet Union paid off for McDonald’s in the long run, while the interim volatility was enough to deter competitors.

Today the Russian market may not offer the same scale as China. But it does offers a more upmarket clientele, says Jeffrey Welch, vice-president Krispy Kreme. “You do look at when the middle class and purchasing power start growing when deciding when to enter the market.”

For Cinnabon, this means the company can charge about 20 per cent more for its classic pastry than it would in the US, which helps offset import costs.

At the recent opening of its third location in Vladivostok, an industrial city of 600,000, a dozen customers were nibbling on pastries and sipping coffee within a couple hours of the store opening. “A lot of people complain that they are losing their figures – but they come just the same,” laughs Maria Antiforova, the local manager. “There are people who come here every day. We are in shock.”

Mike Shattuck, president of Focus Brands International, Cinnabon’s parent company, says that while Cinnabon’s customers in the US usually take the pastries away, in Russia the outlets are seen as sit-down cafés, with most customers preferring to eat in. “Our operation hours tend to be longer [in Russia]. We see a lot more full-meal type purchases,” Mr Shattuck says.

Mr Plykine says: “Unlike most western countries, for a lot of Russians going to a fast-food joint is almost like going out to a restaurant. It’s a celebratory thing.

“Even if you look at McDonald’s, Burger King, KFC, they always have a peak in sales over the weekend. That’s why the average [bill] is high. People just buy more, and go in with larger crowds,” he says.

To adjust to this, most fast-food groups in Russia try to make restaurants places where people want to sit down with their families, including making their menus more diverse.

Cinnabon Russia, for instance, offers not just its well-known pastries but full meals: sandwiches, Russian blini, and beer – the latter two being exclusive to Russia. The average bill in the chain’s restaurants is about 50 per cent higher than its global averages.

The growth in Russians travelling overseas has enhanced foreign fast- food brands’ appeal. Mr Shattuck says customers know Cinnabon from their favourite tourist destination – Dubai – while Tim Demchenko, head of private equity at VTB Capital, says Russians are increasingly receptive to western brands. The Russian fast-food market “is approximately 50 per cent captured by international, well-known brand names. The percentage could reach 75-80 per cent of the market over next few years, and then M&A activity will ramp us as well,” he says.

Western brands face little competition from local players. “There have been attempts to take the Russian cuisine and adapt it . . . But I haven’t seen many successful examples,” Mr Plykine says. “You don’t eat hamburgers at home. Wh ereas with [Russian] pancakes you are comparing fast food pancakes with the pancakes you eat at home and they are obviously inferior.”

The western fast-food groups’ rise has not pleased everyone. This month Gennady Onishchenko, Russia’s chief public health official, denounced Mc­Donald’s after a customer reported finding a worm in a chicken sandwich. “I would like to remind our fellow citizens that hamburgers, even without worms, are not a good choice of a meal for residents of Moscow and of Russia. This is not our food,” Mr Onishchenko sniffed in a radio interview.

McDonald’s has weathered the incident, denying the presence of any “foreign objects” in its food, and is choosing to focus instead on its expansion to Irkutsk and Vladivostok, which takes it east of the Urals for the first time in its 22 years in Russia.

And, while it may not have a fan in Mr Onishchenko, McDonald’s got a boost earlier this year from Igor Shuvalov, Russia’s powerful first deputy prime minister. “We have no McDonald’s in Vladivostok and I would like it to appear there,” he told the company’s vice-president in February.

For Russia’s fast-food market, the golden arches are still ahead.

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