04 January 2004 13:17
Five Percent More Room to Maneuver
Maxim Borisov
 The Russian government recently announced that the sales tax (Rus. NSP) will be eliminated in January 2004. This temporary tax was introduced in the summer of 1998 in order to make up for regional budget losses due to the five-percent reduction in the VAT. In addition, the sales tax replaced 16 various local taxes and duties that existed previously.
For almost five years, Russian retailers have been lobbying for an end to the sales tax, and in 2002 the government decided to eliminate it in 2004. However, the planned tax break came under fire this past May, when a group of Duma deputies representing the interests of local authorities tried to keep the tax (the OVR fraction headed by Moscow mayor Yuri Luzhkov was the strongest proponent of keeping the tax). In response, executives from a multitude of retail chains such as Kopeika, M.video, Sedmoi Kontinent, Snezhnaya Koroleva, Sportmaster, Perekrestok, Petrovsky, and Pyaterochka announced that they would cut prices by 5% if the tax was actually eliminated. This forced deputies to side with consumers, who are also potential voters, and the governmental bill was passed. The situation appears straightforward, but as January 1st approaches, the future of the price cut is looking more and more doubtful.
Differing degrees of sensitivity
The sales tax had a negative effect on the market for goods and services. Retailers were forced to raise prices and as a result lost a certain number of customers. “After the sales tax was introduced everyone raised their prices and sales declined, as consumers moved to wholesale-retail markets where prices stayed the same,” representatives of Tekhnosila Company told journalists.
The new sales tax had an even greater effect on those making and selling food products. “After the sales tax was introduced, the number of loyal customers stayed the same but the overall amount of an individual purchase in bedroom communities fell,” noted representatives of Sedmoi Kontinent. Retailers targeting less wealthy consumers were also hard hit by the tax. “When the tax was introduced, we were focusing on rather price-sensitive market segments, the mid- and lower-mid price range, which meant that higher prices led to a reduction in demand of 10-15%,” recalls Valeri Pokornyak, General Director of Altan, a manufacturer of flour and pasta products.
The market for specialty items reacted less extremely to the tax. For example, prices in Russian restaurants changed depending on their price category. “In expensive restaurants, the tax had no effect at all on prices, as other factors determine pricing policies, first and foremost their market position,” believes Vladimir Pavlov, owner of such restaurants as Konkord, Avtograf, and Pechki-Lavochki. “Mid-range restaurants automatically passed the increase on to their customers. Their bills had a separate item showing the sales tax.”
However, some mid-range and expensive retailers did feel the effects of the tax. “For Benetton’s price category, five percent does make a difference. For this reason, the introduction of the sales tax somewhat reduced demand,” says Andrei Grigoryev, who heads Benetton’s representation in Russia. Some companies immediately decided to swallow the cost of the sales tax. “The sales tax did not affect our demand because we decided not to raise prices. Instead we reduced our markup by five percent. For this reason, after the tax is eliminated our prices will stay the same,” says Arkadi Pekarevsky, owner of the Sela Company.
Thus, the sales tax first and foremost had a negative effect on companies targeting the mass market for everyday products. It had only a minimal effect on companies selling more expensive goods and services. At the same time, everyone knows that only the big retail chains actually pay their five percent, while open-air markets and small private stores don’t. For this reason, while some Duma deputies came out in favor of keeping the tax, many large retailers promised the government, which initiated elimination of the tax, to lower their prices by 5%. Finance Minister Alexei Kudrin recently reminded the big chains of their promises.
Selective reductions
The representatives of big Russian retailers insist they will keep their promises. However, as some observers have predicted, there won’t be any market-wide five-percent reduction in prices for goods and services.
Eliminating the sales tax will have no effect on the expensive segment of the consumer market, as prices depend first and foremost on brand positioning. “In expensive market segments, five percent more or less has little significance. Manufacturers of expensive products set their prices to a great extent based on their market strategy,” says Samvel Avetisian, Director of Marketing at Tinkoff. “For this reason the tax had no effect on the price of our beer, and its elimination won’t, either.”
On more sensitive mid- and lower-priced market segments, companies will lower prices very selectively. Most likely, only the companies who promised the Minister of Finance to lower prices actually will. “Prices in our stores will go down, absolutely,” Maria Markova reassured us. But even these companies will have varying approaches to the price cut. “Reducing prices after the tax is gone will not mean reducing prices overall,” explains Nadezhda Kiseleva of M.video. “The tax cut is more important for customers with limited budgets, which means we will lower prices on less expensive items. This type of item makes up around 80% of our product range, by the way. We will not reduce prices on things like plasma televisions and hi-fi equipment.”
In part, companies see the tax elimination as giving them more room to maneuver. “As you know, a lull hits retailers after New Years. The possibility of lowering prices could benefit both us and consumers. We are already holding sales and will continue them into the new year, thanks to the elimination of the sales tax,” says Elizaveta Totunova, Assistant to the Chair of the Board at Mir Company. Rosinter has similar plans: “The elimination of the sales tax will allow our company to be more flexible in its pricing. However, it will not mean lower prices on all our menu items. Prices will go down to differing degrees,” says Valeria Sulina, Director of PR at Rostik Group.
A substantial portion of companies on the consumer market see no reason at all to lower prices once the sales tax is gone, as they believe there are far more factors pushing prices upwards. “The end of the sales tax will have no effect whatsoever on our prices,” says Pokornyak at Altan. “First of all, we have moved to a different, more expensive market segment. Secondly, the price of grain on the Russian market is constantly rising and in this situation the only thing we can do for consumers is keep prices where they were.”
Only one company plans to use the tax cut to do what the government seems to have wanted: “The elimination of the sales tax will increase our turnover. During seasonal clearances, the reduced markup at Benetton usually equals 25-30%, which leads to an increase in turnover of 25-30%. That’s why I believe that when the sales tax is gone, prices will fall by 5% and turnover will increase by 5%,” states Andrei Grigoryev.
Judging by everything that retailers told us, if prices in stores do go down, they will only do so temporarily, and at some point prices will rise again. Companies on consumer markets have long focussed on how much customers are willing to pay. For example, the government announced that starting January 1, 2002, there would be a new 20% tax on medicine. By the end of 200, when pharmacies had already increased their prices by 20%, at the last minute the Duma reduced the 20% rate to 10%. Prices, however, stayed the same.
Lilia Moskalenko assisted in the preparation of this article.
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