Market Know-how: Illogical Logistics

The long road to the shop

Logistics are part of a big chain: customs, storage, stock-taking, the delivery of goods and so forth which is built, to put it mildly, not ideally. "Because of an undeveloped system of rendering logistics services retailers suffer,” says Irina Kanunnikova, director of the Union of Small Russian Chains. “They have to bear unjustified operational charges, and as a result the price of goods for the end user increases." According to her, Russia is one of those countries where the rules of concluding external economic contracts allows for the correction of prices by up to 30% to take into account logistics. In other words, this is how much retailers lose because of the imperfection of modern logistics.

Retail loses a lot to intermediaries. If a chain of deliveries could be limited to one manufacturer, one logistics company and one retailer, expenditures could be seriously optimized. But at the moment there are too many intermediaries in this chain – logistics companies and distributors, Kanunnikova notes. And even large players often carry out some kind of cargo handling operations before the goods are delivered to a destination point, essentially making the process more expensive. Often they choose the nearest warehouse rather than the one they need.

At the moment there are no operators in the market that work across the whole territory of Russia, Kanunnikova assures. There are operators who allocate certain zones. For example, FM Logistics works in the Northwest and the Ural Mountains. Others take the south of Russia. Accordingly, a retail chain that works in different regions has to conclude contracts with different operators. This reduces the volume of orders and seriously increases expenditures, the expert considers.

A roundabout way

At the moment delivery is carried out as in the Soviet saying: "We deliver everything to Moscow and then people deliver it other places themselves." "The main problem in Russia is distance and insufficiently developed transport infrastructure," says Polina Vinokurova, PR manager of Natsionalnaya Logisticheskaya Kompaniya (National Logistics Company). "Logistics is centralized, freight traffic goes through Moscow and St. Petersburg," adds Roman Burtsev, partner at Knight Frank.

According to the Ministry of Economics of the Moscow region, transport infrastructure in the Moscow region provides transit for more than 35 million tonnes of exported and imported cargo. More than 28 million tonnes of this are delivered to Moscow just to be sent further to other regions of Russia. According to forecasts, imported cargo transited through Moscow in 2010 will be up to 60-65 million tonnes. Minister of Transport of the Russian Federation Igor Levitin stated in the mass-media that 60% of all cargo imported to Russia is for the capital. The Moscow transport hub works like a transit center, distributing streams of cargo to other regions of Russia. The largest international transport corridors pass through the center.

For example, a center for imported cars on Leningradskoye shosse in the area of Chernaya Gryaz, where cars wait to be custom cleared and because of this there are constant traffic jams here.

Active development of the warehouse segment leads to additional loading on the weak transport network. The government of the Moscow region considers the present development of the market of transport-logistics services in the region as "unsystematic" and "chaotic". "If the negative tendencies that have developed are not reoriented by the state and socially significant development goals are not regulated by the state, the construction of the Central Ring Road and other large infrastructural development projects of the Moscow transport hub planned by the government of the Russian Federation and the Moscow region, will have practically no effect," it is noted in an order of the Moscow region’s government (No. 884/36 dated September 18th, 2006).

At the moment the only centralized logistics structure in the Russian Federation is the rail system. But even the rail system cannot help the development of those regions where there is no railway or debugged system of automobile or river logistics or modern warehouses, sums up Konstantin Korolev, general director of Smart Property. "Even Chinese goods are delivered to most of the country by sea and very often not directly, but through Finnish or Baltic ports," he complains.

You are not welcome here

According to Korolev, investors only go to the regions they know. Participants of the IV annual conference on the warehouse real estate market, organized by Knight Frank (September, 2008), have decided that only four regions are attractive for investment: Moscow, St. Petersburg, Yekaterinburg and Novosibirsk. The majority of other cities where logistic complexes have been announced, in the opinion of experts, are overestimated. In some cities, for example in Kazan, there is already an overabundance of Class A warehouses. Premises with high rent rates, according to Burtsev, are still vacant.

Nevertheless besides the afore mentioned cities, developers are also developing in Rostov-On-Don, Nizhny Novgorod, Krasnodar, Samara and Volgograd. When developing regional projects, they choose cities with a population of more than one million people, located near the main transport channels.

The requirements in regard to location significantly limit the geography of projects. The site should be located either in the surburb of a city or not further than 15km from it and has to join a national highway. The site should also have a railway. Unfortunately, there are not a lot of suitable sites. Usually no more than five in a region, assures Nikolai Ditsman, head of the marketing department at Evrasia Logistics. Not all of them are vacant. Also, sites bought for the construction of logistics parks, as a rule, are agricultural-purpose land. Changing the purpose of the land increases the time it takes to realize a project. Sergey Tchernyshev, general director of Ruuki Rus, notes that because of various delays to a project they are put into operation no earlier than 2.5 years after they started. Even though construction itself takes no more than three months.

The plot, according to Ditsman, should also be rather large. The company builds complexes on no less than 100,000 sq.m. "In warehouses the numbers are as follows: for 5,000 sq.m of premises 1 hectare of land is needed," he says. Accordingly, the minimum size of a suitable plot is 20 hectares. The average plot bought by the company for construction, as a rule, is 50-70 hectares. He estimates the cost of construction of such complexes as follows: if the project is on an area less than 30,000 sq.m construction will cost $1,700-$1,800 per sq.m. If the area of the project exceeds 100,000 sq.m construction will cost on average $1,100-$1,400.

A deficit without supply

In 2008, according to Knight Frank, demand is expected to be at the level of 2.5 million sq.m, and there will be no more than 700,000 sq.m in operation.

"The profitability of warehouse projects is about 12%. Accordingly, investments into them were made by a residual principle," Omar Gadzhiev, managing partner at Panorama Estate, explains.

Nevertheless Evrasia Logistics consider warehouse real estate one of the most attractive for investments. Competition is low compared to other segments, and increased popularity guarantees demand. According to Evrasia Logistics, rental rates have grown 30% this year. In 2007 rental rates (excluding taxes, municipal payments, etc.), according to Evrasia Logistics, stood at $120-$130 per sq.m a year. Today they have risen up to approximately 100 euros. And by the end of this year the company expects them to increase to 120 euros per sq.m a year.

In 2008, according to Russian Research Group, there was more than 1.376 million sq.m of warehouses on the Russian market. Evrasia Logistics has already built about 540,000 sq.m in Moscow. In November 2007, the first 500,000 sq.m (the first and second phase) of Severnoye Domodedovo (in the Moscow region), the largest industrial-logistics complex in Europe were put into operation. Its total area will exceed 1.1 million sq.m. The company is also present in Yekaterinburg (85,000 sq.m), St. Petersburg, Kazan, Novosibirsk and Volgograd. The company has plans to enter the markets of Krasnodar, Rostov-On-Don, Samara, Ufa, Chelyabinsk, Omsk, Krasnoyarsk, Saratov, Kiev, Dnepropetrovsk, Odessa, Istanbul, Ankara and Izmir.

With your own power

The lack of development of the logistics market has led some companies to start creating their own logistics divisions. But this variant does not suit everyone. "If the turnover of a company is less than $100 million a year it simply cannot make such expenditures," considers Tchernyshev. The largest expenses on logistics are on power supply and the communications of a warehouse complex. And if there are no railway tracks then it is necessary to lay them. Construction of such a track, by his estimations, depending on the cargo, can cost $1 million per km.

The expert estimates that connection of power costs $1,500 per kw in Moscow and $1,000 per kw in St. Petersburg. "It is easy to calculate, for example, how much it will cost for a warehouse with refrigerating equipment with a capacity of no less than 500 kw,” says Tchernyshev. It may be necessary to install X-ray equipment for scanning transport units (cars and wagons). This costs about 1.2 million euros and is not made in Russia.

Some large manufacturers and retailers decide to develop their own regional logistics networks, but there are just a handful of such companies, Burtsev summarizes.

For example, the Russian division of Finnish company Ruuki Rus has its own logistics department, created in 2006. The total expenditures on the construction of two of its own complexes, and creating and developing infrastructure, according to Tchernyshev, were more than 10 million euros. The company constructed five logistics complexes last year: 50,000 sq.m in the Moscow region, two logistics complexes in the Rostov region and one in Kaluga. The company is building another complex measuring 100,000 sq.m in St. Petersburg near the airport. Tchernyshev says the construction of logistics complexes in Samara, Saratov and Rostov are at the negotiation stages. The company also has its own transport department and delivers about 50% of its production itself to customers. Only one of its warehouses - in Odintsovo - is rented.

Ruuki Rus thinks that its own logistics is economically justified. Especially for the realization of import-export operations. "By our calculations, we save about 2.5 million euros a year in comparison with using external providers," Tchernyshev says. In his opinion, it has also been possible to significantly improve service by reducing delivery times. Effective logistics improves competitiveness in distant regions, allowing to offer prices for production comparable to the prices of local manufacturers, and thus increasing sales volumes, the top-manager sums up.

Tikkurila is also building its own logistics complex in Novosibirsk. Within its structure will be a modern, paint factory, general and customized warehouses, offices, etc.

One of the largest retailers - X5 Retail Group - also has its own complexes. Diksi, a group of companies that owns a chain of food stores created a logistics division practically right after it started its retail business. With its own warehouses and transport with highly centralized deliveries it can optimize operational costs and, accordingly, offer retail buyers goods at a lower price, says Fedor Rybasov, vice-president of the company. At the moment Diksi is completing the construction of a new distribution centre measuring about 35,000 sq.m in the Serpukhov area of the Moscow region. Having its own logistical complex allows it to reduce delivery times 2-3 times, Rybasov notes, and that is especially valuable for perishable products. It also allows for an increase in the assortment of goods in shops. Ideally the company wants to reduce the number of its warehouses because of high costs, slow turn over, etc. It is impossible to have a warehouse in every village – nobody wants that, says Vinokurova.

Only large chains and manufacturers can afford their own logistics departments.

Korolev is assured: for the majority of companies, logistics is a non-profile business demanding separate investment, management, research, training, etc. Often it is simply unprofitable. It is one matter to provide delivery to all shops in one city or area but a completely different question to do the same across the whole country. The services of external logistics companies are not cheap. Employees of logistics companies on the condition of anonymity have told us that retailers spend up to 30% of the margin of the final cost of a product on their services.

To improve the existing system, long term and inexpensive financial resources, preferences for leasing companies to deliver specialized warehouse equipment, qualified and trained personnel, modern warehouse complexes and state support in terms of legislation are necessary, lists chairman of the board of directors of Smart Logistics Group Vladimir Yelin.