The Russian E-Commerce Market: Development & Trends. Liya Eijvertinya

The Russian E-Commerce Market: Development & Trends Liya Eijvertinya Center for New Media and Society New Economic School Российская экономическая школа July 2013

Poised for Growth: Context for Development E-commerce in Russia is about to take off. For years, Russia has been one of the world s most anemic online shopping markets. Even though the country has 140 million consumers, a series of economic, social, and political hurdles have prevented e- commerce growth. That is about to change, as more Russians come online and Russia s transportation and financial infrastructure continues to improve. As developed Europe continues to stagnate, Russia is now the industry s brightest star. Russia s e-commerce market is poised for rapid growth, but for companies to take advantage they will need develop innovative solutions to the challenges that make Russia s market unique. Search, payment, and delivery mechanisms will all look different on the RuNet as Russia s internet ecosystem is called than they do in developed markets. Detailed local knowledge will be key in overcoming the many hurdles that Russia s market impose. The companies that master these challenges, and find a way to tap Europe s biggest online consumer market, will reap rich rewards. Rising Incomes & Changing Demands While Russian politics and business can still be unpredictable, the life of the average Russian has become more stable and prosperous since the turmoil of the 1980s and 90s. Russian consumers are getting richer - GDP per capita based on Purchasing Power Parity has risen 40% over the last 5 years and almost 200% in the last 10 years. 1 In the 1990s, Russian GDP per capital dipped below overall world levels but has since risen to a level nearly twice that of world levels. While the Russian average is substantially below EU and US levels, the last decade has seen sizable growth. Furthermore, Russia is far ahead of the other BRIC nations with a GDP per capita that is twice as high as Brazil, the BRIC country with the next highest GDP per capital. While the extreme income inequality that exists cannot be ignored, the sheer magnitude of average growth explains the increase in demand for goods from abroad. $60,000 $50,000 $40,000 $30,000 $20,000 $10,000 $0 Comparative GDP per Capita, PPP (current international $) European Union USA Russian Federation World Source: World Bank Development Indicators 2

$25,000 BRICs GDP per Capita, PPP (current international $) $20,000 $15,000 $10,000 $5,000 $0 Brazil China India Russian Federation Source: World Bank Development Indicators As consumers become wealthier, they demand the same quality and variety of goods and services as are available in the West, which have not traditionally been available in Russia. Well-to-do Russians do much of their upper-market shopping abroad and have friends or relatives purchase goods for them on trips to Europe or America. The country s large size and fragmented infrastructure were previously unable to support the same range and quality of offerings as in the West, but as Russians continue to get wealthier and there is more demand for such products domestically, e-commerce companies see an opportunity to tap into a hungry market of customers that are ready to pay. Local Talent & Competitive Advantage As Russian consumers demand higher-caliber products, Russian businesses are coming up with their own innovative answers to Russian demand. These local businesses are able to draw upon the high education levels of the Russian population in providing innovative solutions. Over half of Russians have tertiary education, compared with an average of just 30% in the European Union, according the World Bank. Furthermore, the Russian labor force, on average, is much more educated than the labor forces of the other BRIC countries - tertiary education among the labor forces in Brazil, India, and China ranges from 8% to 10%. 2 In Russia, education enrollment levels continue to increase (see chart below). Current enrollment in higher education as a share of university-aged population is on average 15 percentage points higher in Russia than the EU average, promising a well-educated workforce in the future, too. A particular strength of the Russian education system has historically been math and science, which has resulted in widespread interest and skill in computer programming. Coupled with general education levels, the emphasis on technical subjects has provide a large pool of programmers and spurred the development of Russia s IT sector. So much so that many western companies are keen to hire programming talent from Russia. Besides the particularities of the physical retail Russian market, the Russian internet 3

100 90 80 70 60 50 40 30 20 10 0 Tertiary School Enrollment 3 (% gross) European Union Russian Federation Source: World Bank Development Indicators Rising Internet Use USA World predominantly uses the Cyrillic rather than the Latin alphabet. The prevalence of Cyrillic is so great that the Russian internet is often referred to as the RuNet - the language causes a dramatic degree of isolation from the greater worldwide web and poses another impediment to foreign entry. A prevalence of technical talent, unique characteristics of the retail market, and the isolation of the RuNet have allowed Russian e-commerce companies to maintain a 90% market share. 4 The result has been an e-commerce market dominated by Russian companies featuring a few strong foreign competitors with many more planning their entry in hopes of capitalizing on Russia s e-commerce potential. Russian companies are able to leverage their local market knowledge to create e-commerce solutions quicker and more effectively than foreign companies could ever hope. As will be shown below, creating inventive solutions to address the unique characteristics of the Russian market is no small feat and local companies thus have a leg up on their foreign competitors. In any economy, one of the most important drivers of e-commerce is the level of internet penetration. For the last 10 years, Russians have been rushing online in droves. In the near future, Russian internet penetration promises to catch up to the rates in developed countries. 90 80 70 60 50 40 30 20 10 0 Internet Penetration (% of population) 30 25 20 15 10 5 0 Fixed Broadband Internet Subscribers (% of population) European Union Russian Federation European Union Russian Federation World USA World USA Source: World Bank Development Indicators 4

28,722 23,917 22,410 19,350 12,006 6,404 6,371 5,034 5,027 4,743 3,772 3,476 3,336 2,598 43,021 39,357 52,448 61,345 In 2003, internet penetration was at just 4% of the population, and 5 years ago it was only 25%. In 2013, it is estimated to have reached 54% and is still growing, having increased by 15% from 2012 alone. Although this is still low compared to the rest of Europe, it is the highest level of internet penetration among the BRIC nations. In addition to speedy growth, Russia offers scale: Russia s internet market is the largest in Europe, with 61.3 million internet users in 2012. 5 This figure is expected to reach 86.3 million by 2015, as an additional 25 million Russians get online. 6 During the next half decade, Russia s annual growth in number of internet users will be larger than the entire population of many European countries. Russians already make up 15% of Europe s 408 million internet users and this share will grow substantially. 7 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 Internet Users in Europe, 2012 (unique visitors in thousands) Source: comscore More people with internet access means more people using the internet to Google, e- mail, tweet and shop. Social media has seen rapid growth in Russia: Mail.ru (which owns the popular social networking site Odnoklasniki), VK.com (dubbed Russian Facebook ), and Facebook.com all experienced growth in unique visitors of 17%, 19%, and 25% in 2012, respectively. Meanwhile, the top 5 Russian news and information sites averaged 20% more unique visitors last year than the year before. 8 As Russians spend more time online, they are not only finding out about products by searching for them directly, they are also seeing more targeted online advertising. The more time they spend on social networks, and the more information advertisers have about their interests, the more likely they are to buy online, too. E-Commerce Market Trends Despite the tremendous growth of the RuNet, and that Russia is catching up with European levels of social networking and search activity, e-commerce has lagged behind. Russia is not only behind Europe in measures of online shopping, it is behind the BRICS, too. By the end of 2012, only 26% of Russian internet users meaning roughly 1/8th of the population had bought something online (see chart below). 9 5

That is finally starting to change, as companies develop new ways of dealing with Russia s unique challenges. As Russian shoppers begin to buy online at similar levels as consumers in countries with more developed markets, this shift will create huge opportunities for online retailers. Online shopping currently makes up only 2% of Russia s retail market, far less than the global average of 6.5%. Russia is also significantly behind its BRIC counterparts where online sales currently account for 5% of total retail sales in both Brazil and China. However, online retail penetration is expected to more than double in the next few years, reaching 4.5% by 2015. In dollar terms, that means the e-commerce market will grow from $12 billion today to $35 billion by 2015 and $72 billion in 2020. 10 Nearly all of the benefits of this growth will accrue to Russian companies. Unlike e-commerce in many European countries, Russia s ecosystem will not look much like America s. Today, only a small percentage of e-commerce orders come from outside the country. Domestic companies have a 90% share of the country s e-commerce market and this figure isn t likely to change much. 11 Activities of Russian Internet Users, October 2012 (% of emarketer survey respondents) Finding information Communicating Having fun Following the latest news Finding/seeing any movies Finding/listening to any music Finding/buying any goods or services Understanding what is happening in the country and abroad Finding/buying any books Other Yet even as Russia s e-commerce market leaps forward, capturing the benefits of this growth will not be easy. The same factors that retarded the initial Source: emarketer development of e-commerce in Russia will challenge new entrants to the e-commerce marketplace, whether they are local or foreign. E-commerce companies must find a careful balance between adapting to Russians unique online habits while gradually working to acclimate Russians not only to the concept of shopping online, but also to the specific steps search, ordering, payment, delivery that accompany online shopping. The following sections will walk through each step of the online purchase process, highlighting the unique aspects of Russian e-commerce and the innovative steps some companies are taking to deal with them. 2% 26% 23% 21% 43% 39% 37% 47% 63% 75% 6

The E-Commerce Ecosystem: A Walk-Through Russians buying habits are often the reverse of Western shoppers. In developed countries, many people either shop completely online, or pick out clothing items in brick-and-mortar stores to verify size and quality, but return to their computers to make the actual purchase at a discount. Russians often do the opposite. They find items online and then visit a store to pay and pick up the item in person. The click-andcollect trend, where consumers buy online and then go to a physical location to get their goods, is catching on now in Europe and the US, but has been popular for a long time in Russia. Why are Russians online shopping habits so different? Shoppers in the West often go online to find low prices and avoid an unnecessary trip to the store. While the convenience of delivery is one of the main reasons for shopping online in the West, only 19% of Russian online shoppers cite this as a major draw. 12 Furthermore, Russian shoppers are more distrustful of product quality than consumers in the West and are largely willing to forego convenience to verify quality before buying. Although the convenience and price are important to Russian consumers, e-commerce will only work in Russia when it can convince consumers that its products are high quality and without defects. Variety matters, too: since the local retail market is still underdeveloped and the large physical size of the country makes it difficult to access all the goods that they would like, about a third of Russian consumers claim increase in product variety as their primary reason for shopping online. 13 On top of this, many Russians still do not have credit cards the payment system which works best for e-commerce in developed countries. Delivery is different, too. The postal system is famously unreliable and, even for companies that use private methods of delivery, Russians, as already mentioned, tend to be distrustful of buying items that they haven t been able to see and touch. When you leave a brick-and-mortar store in Russia, the cashier will open up your box to confirm that all the product parts are inside, and if you buy electronic goods, they will turn it on to verify that it works. Russians still expect similar verification with online shopping so e-commerce business models have to take that into account. While the Russian e-commerce market has many unique qualities, there are obvious similarities to more developed markets, too. The most important similarity is that the profiles of Russian e-consumers resemble those of e-consumers in the West. This is what allows for similar business models to be implemented in Russia. A survey of leading Russian e-commerce companies and consumers conducted by Morgan Stanley found that Russian consumer behavior has developed in a similar fashion to that of western e-consumers, just several years behind. 48% of Russian e-consumers made their first e-commerce purchase in the last two years and only 16% have been shopping online for more than six years. Meanwhile, only 10% of US online shoppers made their first online purchase in the last 2 years and 62% have been shopping online for over six years. However, the profiles of Russian and western consumers are comparable; just as in the US, online shoppers are more likely to be female and the average age of the online shopper is 44 in Russia versus 45 in the US. Additionally, shopping online is significantly more common among households with a higher income. 14 ` 7

Search & Support for E-Commerce E-commerce isn t just about dedicated e-retailers or about brick-and-mortar stores going online; search is a big contributor too. Search advertising is a significant driver of e-commerce growth, led by Russia-based Yandex. ComScore s study of internet usage in Europe found that the average number of searches per internet user in December 2012 was 118.2 in Russia versus an average of 138.4 in Europe. 15 This means that even though Russia s internet penetration lags behind Europe s, those who are connected use the web at comparable rates. A survey conducted by Morgan Stanley found that 87% of Russian e-consumers research purchases via search engines and 81% use them to compare prices. 16 Yandex and Google are in a constant turf war over search traffic, but Yandex has so far maintained a lead, with a 62% market share compared to Google s 26%. 17 Yandex accounts for 56% and Google for 38% of searches by Russian consumers prior to purchases (both online and offline). 61% of Russians who regularly shop online use Yandex, enabling a symbiotic relationship between search engine and online retailer. 18 As consumers increasingly rely on Yandex to research their purchases, they are exposed to more advertisements that bring Yandex revenue and allow it to gather more data. Yandex is used by 61% of Russians who regularly shop online, enabling a symbiotic relationship between search engine and online retailer. Currently, e-commerce accounts for 8% of Yandex s revenue, and the company is developing search and price comparison capabilities to further drive e-commerce growth. 19 Yandex.Market, which allows retailers to place items online and consumers to compare prices and review product ratings, has 13.4 million unique monthly visitors. 20 Although click-through rates for search advertising are currently a low 2%, Morgan Stanley estimates that they will increase 7-10% annually through 2015. 21 As more traffic and data paints a clearer picture of consumer preferences, online retailers will be able to better target ads and reach customers more effectively. The resulting feedback loop will encourage more people to search online and help both search engines and online retailers to expand. E-Tailers: Retailers & E-Commerce Whether or not a customer begins online shopping with a search engine, he or she will eventually end up in contact with a retailer, either directly through the retailer s website or through an e-marketplace. There two major obstacles for foreign e- commerce firms operating from abroad and selling to Russia: clearing customs procedures and overcoming logistical challenges in a large and unfamiliar country. As a result, Russian firms have been able to maintain a majority market share. However, foreign firms, enticed by the growth of internet usage and increased consumer demand and armed with lessons from previous firms attempts to enter Russia, are now aggressively planning their entry, ready to establish local operations and Russify their business models for the chance to get a piece of the growing market. 8

The Russian e-tailing market, largely dominated by fashion and electronics, grew 27% last year. Even more impressive, the home decor, children s goods, and sports & leisure purchases grew 40-50%. 22 Online purchasing habits of Russians in athletic apparel/ footwear and books were similar to those of western consumers. However, relative levels of online shopping for household items (appliances, furnishings, and home improvement products), personal care, and sporting goods were higher in Russia than in the West. The level of saturation in the e- commerce space varies greatly by sector. Cultural & Regulatory Differences Despite the growth of the e-commerce market, developing an e-commerce business in Russia is in many respects an uphill battle. The AT Kearney 2012 E- Commerce Index declares Russian e- commerce as a market characterized by hesitant shoppers. This means that the technological infrastructure is ripe for e- commerce expansion but consumers are hesitant to shop online due to insufficient consumer protection, delivery issues, and 2012 Growth by Sector Reflects Relative Market Saturation Growth Rate Sector Home decor & design Goods for children Sports & leisure Electronics Cosmetics Accessories Fashion Footwear Food Books & CDs Source: DHL & Data Insight Research 40-50% Faster than Market 25-30% Similar to Market ~20% Slower thanр Market < 5% Stagnation/ Decline different habits. 23 Russian government policy is partially responsible; while there are laws upholding the legality of electronic signatures for online transactions, digital consumer protection laws leave much to be desired. Many consumers fear they may be taken advantage of by rogue online stores and will have no method of recourse and are therefore wary of online shopping. Besides the procedural challenges related to ordering, payment, and delivery, which will be expanded upon in subsequent sections, e-commerce pioneers must work to change consumers negative associations with online shopping. These types of issues put more of the burden of attracting consumers on the e-tailers themselves via enhanced customer service, promotions, discounts for online payments instead of cash-on-delivery, and in-store pickup points. Educating Consumers Beyond the regulatory framework, some consumer skepticism about e-commerce exists for legitimate reasons while some is just due to lack of financial and technological literacy (resistance to credit card use and distrust of online merchants). Much more than in western countries with developed e-commerce systems, Russian e-commerce companies must not only work to optimize their processes and respond to consumer demands, they must convince consumers that it is worth their time and energy to shop online in the first place. Companies must devote resources to developing consumers trust and providing additional services and discounts that put consumers at ease in 9

order to convince them to trade their physical shopping cart for a virtual one. In developed markets, one of the main draws of online shopping is the ease of the experience, but all of the market-imposed impediments make online shopping in Russia far from a smooth process. As a result, retailers must put significant resources into managing the consumer experience, making it as stress-free and transparent as possible through readily available customer support, product reviews, and clear communication on deliveries. Russian Company Similar Western & Russian E-Commerce Companies AnywayAnyday Western Version Expedia/Kayak Industry Hotel & Arline Ticket Booking Avito Craigslist Classifieds Biglion Groupon Group Buying Game Insight Zynga Mobile Gaming KupiVIP Gilt Groupe Fashion LaModa ASOS Fashion Oktogo Expedia/Kayak Hotel & Arline Ticket Booking Ozon Amazon General Sapato Zappos Shoes Utkonos Wikimart Peapod/ NetGrocer ebay Groceries & Household Online Marketplace Similarities with Western Markets Many of the leading Russian e-commerce retailers are based on western business models adapted to the specifications of the RuNet and adjusted to Russian needs. As mentioned above, Russian e- consumer profiles are similar to those of western online shoppers. Therefore, Russian e-commerce companies have a good starting point of what can work for the Russian market and which basic business models can be adopted. Comparable western and Russian e- commerce companies are detailed in the table to the left. The best example of this is Ozon. Selling anything and everything with delivery to anywhere in Russia, Ozon is the Russian Amazon. In fact, just as Amazon purchased leading online shoe retailer Zappos, Ozon purchased Russia s largest shoe e- commerce company Sapato in 2012. While other companies were hesitant to enter the Russian market, Ozon set to work as an online only retailer with a business model similar to Amazon s, but adapted to the Russian consumer and to the country s logistical challenges. Over the last 5 years, it has proven itself to be the dominant e- tailer in the largest country in the world. Other noteworthy examples of Russian companies based on western models include Avito, the largest classifieds site in Russia; KupiVIP, Russia s answer to Gilt Groupe; and Biglion.ru, a Russian version of Groupon. 10

Market Dominated by Local Companies Despite Similarities Judging by the extensive list of Russian firms based on models similar to western firms, one might conclude that Russian e-commerce demands are very similar those in the West, and it would be easy for an established western firm to expand its operations into Russia but this is not so. While research by Morgan Stanley has found that Russian and Western consumers have similar profiles, there are important reasons that local companies have been able to beat out their foreign equivalents, even when foreign firms have deeper pockets. In some cases, local companies have remained dominant because more established western companies have not wanted to devote resources to entering the Russian market despite a perfect fit with their business model. As a result, local firms have been able to maintain dominance and, as the table below demonstrates, the top five most visited retail sites in Russia are all homegrown. The reasons for this center around logistical hindrances and the level of localization required to bring a western e-commerce business model to Russia. Much of what has made firms who have not shied away from the challenge successful is detailed in the ordering, payment, and delivery sections below. The rest is based on an understanding of the pace of Russian business and a network of the correct connections that enable their companies to navigate the Russian legal bureaucracy in a way that fosters growth. Top 5 Retail Sites in Russia Industry Total Unique Visitors (thousands) % Growth Average Minutes per Visitor Average Pages per Visitor Yandex.Market E-Marketplace 15,284 18 10.4 13 Ozon.ru General Retail 7,439 2 10.0 12 Svyaznoy Electronics 6,404 N/A 9.4 13 M.Video Electronics 5,314 27 14.0 21 Wildberries.ru Fashion 4,900 46 19.5 38 TOTAL 42,362 20 50.3 92 Source: comscore Ordering: Options Galore The usual process of online ordering is pretty standard: a buyer finds an item on a website that they wish to purchase, adds the item to their virtual shopping cart, places the order, and gets a confirmation e-mail. While Russian e-commerce ordering procedures are not as unique as payment methods (detailed below), there are some subtleties worth mentioning. With delivery services still subpar, many Russian consumers, especially those outside of the major metropolitan centers of Moscow and St. Petersburg, turn to online shopping not for the convenience of receiving their goods at home but rather to find the variety of products lacking in their local stores. Furthermore, despite the impressive growth in internet penetration in the last few years, Russian internet literacy still significantly lags behind the rest of Europe. As a result, Russian e-retailers have had to expand their ordering options to entice non-internet savvy consumers online. Besides just finding 11

the item and purchasing online, Russian consumers may not feel confident that they selected the order correctly or may need an assurance that their order has been submitted. While some e-retailers have assumed that Russian consumer habits will change in the near future, others, like Ozon, have coupled phone support with their standard online ordering processes. If consumers prefer, they can look up an item online and then call in the order, no matter how small. Furthermore, Ozon s policy is that each first time buyer receives a phone call confirming the receipt of their order (and then later another call once their order has been shipped). Buyers also have the option of receiving a phone call confirmation for all future orders if they so choose. While the expense of setting up a call center to make online orders or confirm order receipt might seem to negate the benefits of no-hassle online ordering, and likewise seem like an unnecessary expense, Ozon views it as a necessary step in attracting the big online consumer base and in tapping into Russians who are not yet online. As the Russian market develops and consumers become more comfortable with online shopping, phone support will likely decrease. In the meantime, Ozon s ability to cater to the Russian consumer is responsible for its unrivaled popularity among Russian e-consumers. According to a Morgan Stanley survey, 25% of online shoppers rank Ozon as their favorite online destination. 24 Payment: A Complex Web Cash-on-delivery is the dominant form of payment for Russian e-commerce purchases, with nearly 60% of online consumers still using cash to pay for purchases. 25 A major contributor to this is the extremely low level online banking penetration in Russia; the percent of people who use online banking is the second lowest of any country in Europe. Many Russians distrust online banking and prefer to deal in cash for all of their purchases. Unsurprisingly, this preference impacts how Russians pay for their e- commerce purchases even if they have joined the ranks of internet users and/or have ventured into the world of online shopping, may are still uneasy about using electronic payments. The last few years, however, and 2012 in particular, have seen promising growth in online payments. Web money has been the most popular method with debit cards and online banking following. The main provider of web money is Yandex.Money, a PayPal-like system accepted by many online and offline retailers alike. Online Banking Penetration Among Europe Countries, 2012 (% of population) Netherlands France Finland United Kingdom Sweden Poland Germany Spain Norway Denmark Belgium Turkey Austria Ireland Source: comscore Italy Portugal Russian Federation Switzerland 22% 19% 29% 25% 31% 41% 40% 37% 46% 44% 42% 52% 48% 56% 55% 54% 60% 66% 12

In 2012, about half of all online shoppers had used web money to pay for purchases. Credit cards have seen the most recent growth in usage compared to all other online payment methods. As of last year 74% of all Russians owned a credit card and 40% used their cards to make a retail purchase (online or offline), versus 27% the year before. 26 Currently, however, credit card usage is the dominant form of payment only for certain categories, such as travel, while cash-on-delivery is still the go-to method for the majority of the other e-commerce segments. Mobile and terminal payments have also become increasingly popular over the last few years. While both have seen impressive growth, the rise of payment terminals, in particular, demonstrates an ingenuous way of catering to the unique habits of Russian consumers. Spearheaded by a company called Qiwi, an extensive network of physical terminals allows people to feed cash into the terminals to pay not only for e-commerce purchases but also phone/electricity bills and bank loans. Furthermore, Qiwi allows individuals to combine the use of cash at terminals with prepaid cards and other electronic payment methods via their online accounts for a truly customizable payment experience. In this way, terminals have been able to bridge the gap between a population that distrusts online payments and businesses looking to tap into the efficiency of electronic payments. Terminals are gradually introducing Russians to the benefits of online payments and acting as a gateway to more sophisticated methods. 59% 58% Payment Methods of Russian E-Consumers (payment methods used, % of total online shoppers) 49% 49% 2009 20% 32% 27% 23% 2012 12% 11% Source: Morgan Stanley 0% 0% Cash on Delivery Web Money Debit & Credit Cards Bank Transfers SMS Payments Terminals In a survey conducted by Morgan Stanley, 67% of Russian consumers said that they would make more purchases online if payment options besides credit card were available. 27 This means that there is a huge market of consumers held back from shopping online by limited payment options, a lack of financial literacy, and general distrust of online payment. The offerings of e-commerce companies and the habits of potential consumers are likely to converge in the next few years. Online retailers are already offering more diverse payment options besides credit cards, such as web money, mobile, and terminals, and this trend will only increase. At the same time, Russian consumers will gradually increase their use of these more familiar payment methods over cash and finally warm up to the idea of credit card payment. 13

Delivery: The Logistical Jungle One might expect that demand for e-commerce services would be high in a country as expansive as Russia, because the vast geography makes it difficult to put physical stores in every town, limiting product choice in remote areas. Even in the dense urban centers of Moscow and St. Petersburg, product variety and quality is not equivalent to that of developed markets. However, the unreliability of the postal service and the subpar transportation infrastructure have significantly tempered the use of online shopping in Russia. One of the most problematic areas of the e-commerce ecosystem is package delivery. Russian logistics are notorious and the Russian post office is famously slow and inefficient. Russian logistic performance is not only well below western standards but also lags significantly behind the delivery and transport abilities of the other BRICs. In fact, one of the main reasons that Russians are so resistant to online shopping is the fear that their goods will get lost in transit. Even if the package is not lost, delivery generally takes much longer than in Europe or the US, especially for delivery outside major urban centers. 5 Russia's Relative Logistics Performance 28 (2012) (scored from 1 -low to 5 -high) 4 3 2 1 0 Overall Logistics Performance Competence and Quality of Logistics Services Russian Federation USA Quality of Trade and Transport-Related Infrastructure European Union World Ability to Track and Trace Consignments Frequency with which Shipments Reach Consignee within Scheduled or Expected Time Logistic Performance of BRICs (2012) (scored from 1 -low to 5 -high) 5 4 3 2 1 0 Overall Logistics Performance Competence and Quality of Logistics Services Quality of Trade and Transport-Related Infrastructure Russian Federation China Brazil India Ability to Track and Trace Consignments Frequency with which Shipments Reach Consignee within Scheduled or Expected Time Source: World Bank Development Indicators 14

In response, several of the most successful e-commerce companies like Ozon and Lamoda have developed their own delivery services. Those that do not have their own couriers will use other, more reliable services, like DHL and USPS if importing into Russia, or local courier services for domestic deliveries. Courier services were previously very expensive and had limited delivery networks, but prices have fallen and services increased so rapidly, that they are now a realistic option for delivery. In fact, private delivery companies and courier services are now the most commonly used delivery option among online retailers. Ozon s internally-developed courier service, O-Courier, has been so successful that other firms now use it for deliveries. Russian E-Commerce Delivery Methods, 2012 (% of e-commerce purchases) Establishing or subscribing to a niche courier service is expensive, but this 11% barrier enables companies that are willing to invest in delivery to carve out and 46% maintain a higher market share. The increased availability of private delivery methods is a welcomed development because, while 60% of the Russian e- commerce market by value originates in 33% Moscow and St. Petersburg, about half of Private Delivery/Courier Russian Post orders for goods come from outside the major urban centers. 29 Self-Pickup Outlets In-Store Pickup This figure is Other expected to keep growing since the dearth of product variety is more extreme outside Source: DHL & Data Insight Research of the cities and, as more People come online and discover e-commerce, online shopping will be even more of a go-to for those living in the Regions. Besides the reliability and speed of delivery, there are several important nuances to the delivery of e-commerce purchases in Russia. Some customers are not comfortable with deliveries coming to their homes, so many companies offer in-store pick ups (for traditional brick-and-mortar retailers that have moved into the online space) or set up drop-off points where people can retrieve their packages. Such methods are also popular among individuals who cannot be at home to wait for a delivery. Meanwhile, other consumers fall on the opposite end of the spectrum they are so distrustful of any product that they have not been able to examine that they refuse to pay until they have personally tested the good. Since the delivery point will be the buyer s first physical interaction with the product, many e-consumers demand to open the package and check the item for quality and/or sizing. As a result, many courier services will wait for the customer to turn on the device or try on a dress before receiving payment for the item. If the customer is dissatisfied, the delivery person simply takes the item back the customer has no obligation to pay. People often order multiple version of similar items with the express intent of picking out one and returning the rest. In fact, about 25% of purchases are rejected at the door. E-tailers have had to build sufficient scale to be able to support such buying habits while still making a profit. The distrust of e- commerce quality and the unreliability of delivery are two of the main reasons that cash-on-delivery is the principal method of payment in Russia. 8% 2% 15

Conclusion With an increasingly wealthy and internet-savvy population, Russia is a promising market for domestic and foreign e-commerce companies alike. Not only is the overall retail market expected to grow quickly, but the proportion of retail sales made via e- commerce is expected to increase substantially, too. Projections for Russian Retail Market Growth & Online Retail Penetration Overall Market Value $12B Online Market Value $670B 2012 Online Market Triples in Value 20% Growth of Overall Market $36B 2015 $800B Online Market Doubles in Value 30% Growth of Overall Market $72B 2020 $1030B Source: Morgan Stanley Note: Figure Not Drawn to Scale However promising forecasts may be, e-commerce companies with Russian operations must understand just how far Russian e-commerce lags behind other countries. Despite an impressive 54% internet penetration, only 26% of these internet users currently shop online and an even smaller proportion pay for purchases online. The main challenge for any companies part of the Russian e-commerce ecosystem is persuading consumers to buy into their online shopping models through advertising, promotions, etc or adapting their business models and catering to the preferences of Russian consumers. E-commerce companies operating in Russia must work hard to develop consumer loyalty through enhanced customer service, flexibility in payment, and quicker delivery options. Increased internet usage, demand for more product variety, and increased comfort with online payment will help e-commerce growth. But e-commerce companies who actively campaign to turn internet users into internet buyers and, even more challengingly, bring non-internet users to their online stores will be rewarded with a market share in the large and rapidly growing Russian e-commerce market. As the Russian e-commerce market matures and catches up with more developed markets, Russian companies will need to go beyond bringing new users to market and increasing purchase frequency. They will increasingly need to cater to the demands of more sophisticated e-consumers. According to ystats.com, upcoming trends in the global B2C e-commerce market include personalization and customization of sites to specific industries and individual user needs, proliferation of loyalty programs, adaptability to the 16

increased use of mobile for online shopping, and marketing strategies based around social media. 30 Even though Russian e-commerce has a long way to go before reaching developed world levels, the next generation of e-commerce techniques cannot be ignored as the Russian market has become increasingly competitive over the last few years. The firms that anticipate future global trends and accurately assess which new techniques best play to the idiosyncrasies of the Russian market will reap rich rewards. Endnotes 1 Based on World Bank s measure of GDP per capital, PPP (current international $), which is defined as GDP per capita based on purchasing power parity (PPP). PPP GDP is gross domestic product converted to international dollars using purchasing power parity rates. An international dollar has the same purchasing power over GDP as the U.S. dollar has in the United States. GDP at purchaser's prices is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products. It is calculated without making deductions for depreciation of fabricated assets or for depletion and degradation of natural resources. Data are in current international dollars. 2 World Bank Development Indicators, Tertiary School Enrollment 3 The World Bank defines Tertiary School Enrollment as Gross enrollment ratio is the ratio of total enrollment, regardless of age, to the population of the age group that officially corresponds to the level of education shown. Tertiary education, whether or not to an advanced research qualification, normally requires, as a minimum condition of admission, the successful completion of education at the secondary level. Data for Russia was not available after 2009 and therefore the graph is was cut off after 2009. 4 DHL, Uncover Russia: Logistics and Ecommerce Market, June, 3, 2013. 5 According to research by comscore published in Europe Digital Future in Focus, other sources place this figure closer to 70 75 million total internet users in Russia. 6 emarketer, Russia s Digital Ecosystem Shaped by Market Nuances, February 6, 2013. 7 comscore, Europe Digital Future in Focus 2013, March 2013. 8 comscore, Europe Digital Future in Focus 2013, March 2013. 9 emarketer, Russia s Digital Ecosystem Shaped by Market Nuances, February 6, 2013. 10 11 DHL, Uncover Russia: Logistics and Ecommerce Market, June, 3, 2013. 12 13 14 15 comscore, Europe Digital Future in Focus 2013, March 2013. 16 17 Bloomberg, Why Google Isn t Winning Russia, April 27, 2013. 18 19 20 17

21 22 DHL, Uncover Russia: Logistics and Ecommerce Market, June, 3, 2013. 23 A.T. Kearney, E-Commerce is the Next Frontier in Global Expansion, 2012. 24 25 26 27 28 The World Bank Logistic Performance Index ranges from 1 to 5, with a higher score representing better performance. Data is from Logistics Performance Index surveys conducted by the World Bank in partnership with academic and international institutions and private companies and individuals engaged in international logistics. 29 30 ystats.com, Recent Developments in Global B2C E-Commerce Markets, January 2013. 18