mix of cars on the roads of Moscow is typical of the extremes that characterize the city:
a plethora of S-Classes, A8s and 7-Series rub shoulders with distressed Volgas and Ladas,
the motorized embodiment of the gray, featureless functionalism that characterized so much
of Soviet architecture and design. One face of Moscow is the new capital of conspicuous
consumption, with every kind of western luxury available at a price; the other is
pensioners on the streets begging for a few rubles because their pensions have not been
paid for months. While a $50,000 Audi TT was being sold on the show’s first day, two
men in the provinces were beaten to death with an iron bar for stealing 12 potatoes.

The roads are in a poor state, pockmarked
with seemingly bottomless potholes while now and then the road surface abruptly ends,
plunging down half a foot onto stretches of unsurfaced road. Lane markings in Russia
appear to be purely a matter of aesthetics, the Russian driver having embraced the central
tenet of the free market: every man for himself.

The financial crisis in Russia that culminated on 17 August 1998, when the Russian
government devalued the ruble and defaulted on its domestic debt, drew attention to a fact
that had been becoming apparent for some time: namely, that East Europe should not be
treated as a homogeneous zone. A clear economic divide has emerged between Russia and
other CIS countries like Ukraine and Belarus, that have pretended to carry out economic
reform, and the countries of central Europe that have actually carried it out. In the
reformed economies demand is expected to increase steadily as they grow in strength, while
vehicle sales in Russia were expected to collapse under the full force of the recession.

However, despite the turmoil of political,
economic and financial events in Russia since the August crisis, the basic desire of
Russian consumers to buy cars has remained unchanged. The automotive industry is still
coasting along, and the number of private cars on the roads is still growing. This, in
spite of the fact that more than one in three Russians – around 51 million people
– are living on the wrong side of the poverty line, which the government sets at the
equivalent of $34 a month. This phenomenon is the result of the fact that the market is
still responding to liberalization following the collapse of the Soviet system, under
which the market was distorted by an under-supply of Russian-made passenger cars for
domestic consumption and a gross oversupply of medium-range trucks.

The pattern of sales has now shifted. Sales of imported cars have slumped by up to 70%,
because the August 1998 crisis eroded many of the gains of the nascent middle-class, and
the ruble’s devaluation made foreign produced cars too expensive. (The ruble was trading
at around six to the dollar before the crisis; it is now around 25.) Ironically, Russian
automakers have benefited directly from Russia’s economic crisis. Pre-crisis, 80% of
the new car market was comprised of models costing less than $10,000; now, 90% of the
demand is for vehicles priced below $6,000 – essentially, the market covered by
Russian vehicles, which range in price from $3,000 to $5,000, compared to $7,000 to
$15,000 for a foreign car. Consequently, sales of domestically produced cars have
increased in the period January to June 1999 by 2.2% against the same, pre-crisis, period
in 1998.

Western manufacturers, however, are taking the long-term view of the Russian market, which
is not expected to reach 1997 levels of 981,887 units again until 2004. Despite the
collapse of pre-crisis bullish predictions about Russian market growth, western VMs are
still lured to Russia as one of the last untapped foreign markets in the world, and are
still going ahead with their plans to get a toehold in the Russian market for fear of
losing out to competitors if, and when, things improve. Volume goals and investment
commitments have been lowered, and model mixes revised downward, but no major investments
have been canceled due to the Russian implosion.

Even with revised production targets,
however, these ventures will still have to deal with two crucial, interconnected issues if
they are to be successful: price and localization. Although the Russian economy has
stabilized in 1999, helped by a rise in world oil prices, the gap between demand and
purchasing power is continuing to grow. With vehicles priced below $6,000 accounting for
90% of sales in 1999, western producers need to build models within this purchasing range
to meet volume targets. Alarmingly, most aim to build models that cost over $10,000. Even
these prices are based on the assumption that equipment and components can be imported
into Russian duty free, which in turn is based on the agreement that these ventures will
achieve a localization target of 50% within five years. Achieving this level will be
problematical. Local suppliers lag in productivity and quality, while foreign suppliers
are reluctant to locate in Russia without volume guarantees which manufacturers are simply
unable to give.

Ford announced the creation of Ford Vsevolozhsk, which will convert an existing defense
facility into an auto plant by 2000. The first phase calls for an investment of $150
million, with initial output of 25,000 vehicles and capacity to produce 100,000 units
annually. The plant is expected to become fully operational in 2001, and produce the five-
and four-door versions of the Focus. (The Focus five-door wagon will be imported, but
remains a future possibility for production at Vsevolozhsk.)

Ford’s optimism in proceeding with its
plans to manufacture in Russia is based on its view that "the crisis is a short-term
hiccup", a brave statement considering that after selling 5,072 vehicles in Russia in
1998, Ford’s sales for the first six months of 1999 were just 666 units. At start of
production the Focus will have 20-25% local content, but this level will have to be raised
to cut costs if the vehicles are to be affordable. Ford’s target is 50% in five
years. In April 1999, Ford Credit Europe, the banking arm of Ford Motor, announced the
establishment of a vehicle-leasing venture. Initially this will only be for corporate
clients but credit facilities will be extended to private customers by the end of 1999.
Ford will have to make full use of this to bridge the gap for consumers between its prices
and their purchasing power.

BMW. BMW, which has
recently started a production venture with Avtotor in Kaliningrad, used the show to raise
brand awareness and introduce the 5-Series, the model that will be produced in Russia.
Other models shown for the Russian market were the Z3 M Coupe, and the Land Rover
Freelander and Discovery. BMW will invest DM125 million in Russia over the next three
years in production and its own Russian distribution network. The company plans to
assemble 1,000 BMW 5-Series cars and 200 Land Rovers this year. With its first Russian
assembly line, it will be able to offer its vehicles 20% cheaper than imports, and hopes
the lower costs will help boost Russian sales. This strategy could backfire. BMW
purchasers in Russia are not bargain hunters, but conspicuous consumers intent on buying a
status symbol – part of the attraction of which is its high price. Luxury car sales
in Russia have tended to be immune to economic cycles. That this is so is attested to by
the fact that Mercedes sales this year (1439 units) have already surpassed figures for the
whole of 1998 (1361) — despite the recession.

Avtoframos, a 50-50 joint venture between Renault and the Moscow municipality, became the
first West European manufacturer to start production in Russia when it began assembling
Megane Classic kits from Turkey. The Megane’s price starts at $13,500. Avtoframos
originally planned to produce 2,000 units in 1998, 10,000 this year, and 65,000 by 2002
and 120,000 units in 2005. These plans changed after August 1998, and Renault has decided
to start assembling the cheaper Renault 19, also from Turkish kits, to sell for $7,500, a
price better suited to the current market environment.

SKODA. Skoda also had a
significant presence at the show, thanks to Skoda Auto Udmurtia, a joint venture between
Skoda and Izhmash, which plans to start assembly of the Felicia later this year. The
annual production goal is 80,000 units yearly, with 50% localization in five years.
According to the initial joint venture agreement, about DM500 million will be invested in
the project.

RUSSIAN VMS. Despite their
outdated models and poor quality, the Russians will continue to dominate their market for
some time to come simply due to price. Moreover, despite their financial difficulties,
Russian manufacturers are extremely resourceful and versatile, as illustrated by the
number of new models on display at the show. Particularly interesting is the way in which
Russian market trends shadow western fads, with the leading VMs offering their own MPVs
and SUVs. We noted similarities between the Russian and American markets in the prevalence
of automatics among the western imports and the clear preference for large, powerful

GAZ. GAZ, the strongest
domestic, had the largest of the Russian exhibits, with over 30 models displayed. Pride of
place was given to the new Volga 3111 sedan, the company’s first major introduction of a
new passenger vehicle in the 1990s. Compared with older Russian vehicles the 3111 has a
striking, sleek appearance and would not look out of place on western roads. With options
including imported technology such as air-conditioning, anti-lock brakes, central locking,
driver-side airbag and power steering, the 3111, scheduled to enter production early next
year 2000, is set to become the country’s most advanced production car ever.

Most of the space at the GAZ stand was
occupied by the GAZelle and Sobol LCV models. From a distance, these looked like simulacra
of the Ford Transit, but at close range one could see how GAZ is able to produce these
popular vehicles so cheaply: fit and finish fell drastically short of western standards.
GAZ is aware of its deficiencies, but without further investment is not in a position to
do much about it. In any case, Russian consumers do not particularly care; that these
vehicles satisfy a clear demand for cheap, practical LCVs is testified by the fact that
the GAZelle has probably been the most successful vehicle in post-Communist history.

Start of production at GAZ’s joint
venture with Fiat, Nizhegorod Motors, was delayed by the August 1998 crisis, and is now
set for next year. Planned investment has been cut from $850 to $500 million, and the
product profile will change. The Palio hatchback will replace the Siena as a cheaper
option in a lineup that will also include the Marea sedan and Palio Weekend station wagon.
Production is planned to start at 15,000 units, and eventually move to 150,000.

also had an impressive presence at the show and unveiled several new models, or at least
new derivatives of existing models – an impressive feat given the fact that due to
financial distress, it can dedicate only $200 from the sale of each car to R&D,
compared with the western figure of $800 to $1000. The most important of these new models
was clearly the Lada 1119 "Kalina", a four-door hatchback that looked
suspiciously like the Opel Corsa. The Kalina is to be VAZ’s offering for the small
car market, and VAZ, with big hopes for this car, intends to start producing the Kalina in
small batches late next year, ultimately raising output to 250,000 units annually.
However, in order to launch mass production VAZ says it needs around $2 billion. While VAZ
works to improve its finances, resolve its tax debts, and reduce its dependence on barter
(in 1998 barter accounted for 90% of its car sales and component purchases), it is
unlikely to obtain that kind of money without recourse to foreign capital.

announced at the show that it was close to a joint venture agreement with GM (absent from
the show, apparently in protest against the high exhibition charges). The deal will unfold
in three stages. Phase one sees VAZ assembling up to 30,000 Opel Astras, modified for
Russian conditions, in a plant constructed to allow expansion to an annual capacity of
85,000, even 150,000 units. GM assumes that the right price for the car in Russia is
around $10,000 and that output of 85,000 units could be reached by 2005. Phase two calls
for the production of 90,000 units of an un-named car, followed by 220,000 units of
another secret model in the final phase. Both of these models will be co-developed by VAZ
and GM.

While GAZ and AvtoVAZ have ridden the
roller coaster of market liberalization relatively successfully, maintaining profits,
updating their product lines and securing foreign partners, UAZ, Kamaz and ZIL –
former stars in the Soviet automotive constellation – have had a more difficult time.
All three have seen their traditional markets collapse and, handicapped by outdated
production facilities and severe financial difficulties, have struggled to adapt to the
new market.

UAZ, strongest of the three, was the main
supplier of military AWD off-road vehicles, and is trying to reorient its vehicles to the
civilian market. It unveiled two new prototypes at the show – the 3165, a hybrid AWD
MPV, and the 3162, a new aggressively-styled SUV.

Russia’s largest medium- and heavy-truck producer, increased its car assembly in order to
survive. Prominence at its stand was given to a facelifted version of the Oka minicar, the
diminutive vehicle that has largely saved it from bankruptcy. Small and spartan though the
car is, with a retail price of under $1,000, Kamaz cannot produce the 0.7L 33 HP minis
fast enough to satisfy demand.

ZIL, another major heavy truck producer,
has also had to diversify its product range to survive, moving towards the lighter end of
the market with its mid-sized Bychok vehicles. Intended to rival GAZ’s LCV lineup,
the Bychok, with its cumbersome retro-Soviet design, has not been able to offer much
competition, though it now accounts for the bulk of ZIL’s production.

As with the Hungarian bus company Ikarus,
these companies have resisted the need to restructure or seek foreign partners because
they believe that as "national champions" they were too big and important to be
allowed to collapse or fall into foreign hands. But since the market cares little for
"national champions" these companies must either find foreign partners or go

Edward Adderson, PricewaterhouseCoopers