Mercedes Seeks Security in Russian Government Contracts

PHOTO by Ruslan Shamukov / TASS
Mercedes-Benz invests in manufacturing in Russia

Mercedes-Benz plans on investing in manufacturing in Russia and securing the status of an exclusive government contract supplier. In the face of economic recession, the company hopes to ensure a guaranteed level of demand. The official statement from the German car manufacturer claims that government contracts previously accounted for only three percent of its sales. However, given the current economic crisis, experts believe that Mercedes needs to secure support from public officials.

The German company is hoping to sign a so-called Special Investment Contract (SIC) with the Russian government. These plans were relayed to Gazeta.ru by Alex Uchenov, Director of the Strategic Development and Project Management Department at the Russian Ministry of Industry and Trade during a conference of the Franco-Russian Chamber of Commerce and Industry (CCI France Russie).

Future Cooperation

An SIC is an agreement which can last for up to ten years. By signing it, commercial entities agree to certain responsibilities, such as localisation of production, the development of technology, bringing new manufacturing and goods to the region and creating jobs. In turn, the government guarantees the companies preferential treatment on the federal (national) and regional levels. Potential benefits include tax breaks and less stringent administrative procedures. Uchenov added that the list of advantages will grow too. The minimum investment to enter this kind of contract is 750 million roubles ($11.8 million).

Another perk the SIC provides is the chance to be appointed as the sole provider of certain goods to governmental and municipal bodies. However, in order to qualify for such a status, a company needs to invest at least three billion roubles ($47.4 million). Experts believe that this is what investors are really interested in.

It should be noted that this condition only holds true for new investments – in other words, existing projects and previous investments are not taken into account. Gazeta.ru was the first to report Mercedes-Benz’ plans for Russia, as quoted by sources in the Industry Development Fund (IDF). The Ministry of Industry and Trade stated that Mazda has already signed a similar deal. The company has focused on exporting engines, which are being manufactured in Russia’s Far East. Hyundai is also considering a similar agreement: the Korean company is looking into ramping up manufacturing in St. Petersburg and increasing the localisation of its models. Gazeta.ru also discovered that Avtotor, an automobile manufacturing company located in Kaliningrad Oblast, Russia, is also considering signing an SIC.

The total volume of the five SIC deals currently being processed by the Ministry of Industry and Trade is around 20 billion roubles ($315.5 million), Uchenov told Gazeta.ru. The IDF and Ministry of Industry and Trade both noted that negotiations with Mercedes-Benz were quite protracted – each condition can be discussed for up to six months. However, both agencies now hope that they’re in the final stretch. Mercedes-Benz Russia was unable to respond.

Mercedes 2
Russian Presidential envoy to Russia's Southern Federal District Vladimir Ustinov (L) and Russia's Prime Minister Dmitry Medvedev pictured in a car after inspecting the construction site of a bridge across the Strait of Kerch linking Crimea to mainland Russia

From Localisation to Official Support

Ekaterina Evdokimova, managing partner of GDP Quadrat (an investment services company), said that building a car manufacturing plant from scratch requires massive investment, as much as €200-300 million. “The situation requires a clear understanding of the payback period. When consumer demand is declining, business planning becomes difficult due to the situation's high volatility,“ Evdokimova told Gazeta.ru.

“Therefore a SIC, which guarantees steady demand for ten years, is a very useful tool of business planning, allowing the accurate calculation of a project's payback period. As Daimler is a public company, the issue of business planning becomes a key factor when taking stockholders into consideration,” the expert added. Kirill Yakovenko, an analyst for Alor Broker, notes that localisation has little effect on sales in premium and luxury markets. The price difference stemming from import duties on assembled cars is not a key factor which prevents the target audience from making a purchase.

“However, lack of localisation is a major obstacle if we’re talking about government contracts,” he said. Mercedes-Benz is the leader in the premium sector of the Russian automotive market, and has yet to lose its position, regardless of the ongoing economic recession, notes the analyst. Despite falling sales over the last two years, the company’s competitors have to deal with the same issues. In Q3 2016 Mercedes sold 24,000 cars – 5,000 more than BMW and almost 9,500 more than Audi.

“It should be noted that Mercedes-Benz is the only one of the ‘Three Germans’ of the premium market which had negative sales dynamics (-7.7%). During the same period, BMW and Audi sales grew by 3.4 and 7.6% respectively. I don’t think this is due to lack of localisation and a lack of access to government contracts: it’s about pricing and demand shifting to cheaper models offered by the competitors of Mercedes-Benz,” Yakovenko added. As far as the luxury segment is concerned, Mercedes-Benz has nothing to worry about. The S-Class Maybach controls over half of the market and sold 447 units in the first seven months of 2016.

Yakovenko believes that Mercedes-Benz will not launch Maybach production in the Moscow region. There simply is no demand for luxury cars from the public sector. Government procurements are made public and are strictly scrutinised; moreover, luxury items purchased using public funds are often the subjects of public outcry. The bottom line is that Maybach are unlikely to sell any cars to government fleets.

“Regardless, the company will most likely launch S-class production in Moscow region – probably of the S-400. Other models will most likely be chosen based on the private demand for them: SUVs and sedans. I believe the C-class, GLA and GLS are prime candidates,” declared the analyst. The head of retail sales at SOLID Asset Management Company, Sergey Zvenigorodsky, told that Mercedes wants to secure its place as a government supplier as otherwise it risks it being overtaken by Korean companies, such as Hyundai with its Genesis models.

The expert notes that the presidential fleet will be extremely limited, whereas there are thousands of public officials who require a premium car, so there will be no competition. “I think Mercedes has an investment programme; its experts evaluated the potential of the Russian automotive market and decided to focus on localisation. All the major manufacturers have already invested hundreds of millions of dollars in localisation. Although their production facilities are not fully operational at the moment, they will reap the fruit of their investment within two to three years. Meanwhile, other manufacturers will have a hard time breaking into the market. Automotive localisation in Russia is quickly developing, so you need to jump on the bandwagon or lose the Russian market,” Zvenigorodsky explains.

Jan Madeja, President and CEO at Mercedes-Benz Russia, previously told Gazeta.ru in an interview that only three percent of sales were provided by the government. “Of course, they generally purchase expensive cars,” he said, adding: “But these orders are not the key component of our profits. Our brand and reputation requires top management of largest companies to choose Mercedes-Benz. Still, it’s only a small part of our business.” Moreover, Mercedes-Benz had a lot of concerns regarding the framework conditions of the agreement.

“The so-called SIC will only come into force in 2019. I think that we need to start construction now if we want to build a factory by then. But that’s the problem. The government needs to settle on the benefits and advantages for manufacturers. The talks are constructive and professional, but complicated. For us this is a strategic issue – where to produce which cars and with which partners. I hope we will soon work it out and present the rest of the project to the government, so it will be green-lit.” Madeja told Gazeta.ru.

Author: Alina Raspopova