Historically a laggard in the e-commerce world, Russia is showing signs of life. But challenges remain.
While the internet has now penetrated much of the global economy, there remain significant disparities within emerging markets, particularly Russia. Historically, e-commerce penetration rates in Russia have lagged global and emerging market peers as the market faced challenges caused by the sheer geographical size of the country and its fragmented population. As a consequence, large investments in fulfillment centers and infrastructure were required to support sector growth and help nurture consumers’ behavior towards e-commerce.
Despite these challenges, there are reasons to believe that the market may be close to a turning point. The country now has the required infrastructure in place to enable growth, and as the digital economy matures, consumer behavior is changing. Russia’s 80% internet penetration is higher than China and smartphone ownership at 65%, is on par with most emerging market peers. Furthermore, the announcement of a number of high-profile partnerships in 2018, including Aliexpress, the joint venture between Alibaba and Mail.Ru, is likely to help to drive the sector forward. That being said, e-commerce in Russia currently makes up just 2% of the total retail market (excluding intangible merchandise), which stands in stark contrast to China and Brazil, where e-commerce penetration is substantially higher, at 17% and 5%, respectively.1
INTERNET VS ECOMMERCE PENETRATION: 2017
Lack of a Dominant Player
Traditionally, countries with a more established e-commerce sector normally have one dominant player. For example in the U.S., 63% of e-commerce sales are generated by the top 5 players, with Amazon alone accounting for almost half. Likewise in China, the top 5 companies by market share account for 83%, with Alibaba controlling 57%. In contrast, the Russian market is highly fragmented, with the top 5 accounting for only 27% of the market. Two companies, Yandex Market and Alibaba’s Tmall platform, each take a 10% share.2 This fragmented market in Russia presents an opportunity for one company to dominate, in our view.
To capture this opportunity, companies will either need to grow domestically, such as Ozon, where the order and fulfillment, including last mile delivery, happens in Russia; or the growth will have to come via cross-border trade, where orders are fulfilled outside of Russia and delivered via national operator Russian Post. China dominates cross-border volume, accounting for 90% of purchases, with the majority of transactions taking place via Tmall. Despite making up the lion’s share of volume, Chinese cross-border trade accounts for only 50% of transactions by value, however. This trend for lower priced items is important, in our view; it forms habits for online shopping and attracts new investments into the sector.
In our view, Yandex and Mail.Ru appear best positioned to capitalize on this opportunity and become established market leaders. Yandex has a potential source of future financial backing via their joint venture with the state’s largest lender, Sberbank, which has already yielded Yandex.Market, a popular comparison website. Furthermore, the company’s search engine, which is the largest in Russia, can drive traffic toward their e-commerce offerings. Mail.Ru’s joint venture with Alibaba marries the latter’s experience in e-commerce while leveraging consumer data from Mail’s 90 million users to target customers more effectively and grow the platform.
Despite these partnerships, questions remain over the future path of the industry. Yandex Market has been unable to grow its platform away from its core business, and it is uncertain that state-owned Sberbank can tolerate sustained monthly losses without damaging public opinion. A widely dispersed population in Russia adds to high delivery costs and long delivery times, and it remains to be seen whether firms will commit the required investment in fulfillment centers, which are essentially vast warehouses, or if the larger operators, such as Aliexpress, will build on their cross-border strength and aim to boost revenue through that channel. While these challenges are significant, however, we believe that the foundations are in place for companies to take advantage of the market opportunity in a sector which may be poised for substantial growth.
At Barings, we aim to capitalize on secular changes like the opportunity in Russian e-commerce across a variety of strategies including in our Global Emerging Markets (GEMS) portfolios. By combining a top-down analysis of macroeconomic and technological trends with fundamental, bottom-up security selection, we aim to pick the companies that will be the key beneficiaries of changes like these over the long term.
1. Morgan Stanley: Russia eCommerce: Last but not least, September 2018
2. Morgan Stanley: Russia eCommerce: Last but not least, September 2018