Reference no: EM133237207

Carlsberg faces political risk in Russia (Case Study) - Provide a critical analysis & summary on case below:

In the early 1900s, Danish businessmen were rushing to invest in Russia, building cement plants, slaughterhouses and engine factories. Their advanced technologies gave them competitive advantages in the vast Russian market that gradually opened up to foreign investment. Then came the revolution of 1917 and all was lost as factories were expropriated.

For the next seven decades, Russia was under Soviet rule and, with very few exceptions, closed to foreign investors. When Soviet rule came to an end in 1990, Dan-ish businesses - led by shipping company Maersk, pump maker Grundfos and building materials giant Rockwool - began setting up operations in Russia. Carlsberg was particularly successful, building a mar-ket share of 38% in the Russian beer market; their Baltica brands achieved market shares of 49% in the mainstream segment and 37% in the premium seg-ment. As part of its commitment to Russia, Carlsberg sponsored the national hockey league and the Sochi Olympic Games. Thus Carlsberg earned about 35% of its global revenues in Russia in 2013.

The success in Russia, however, exposed Carlsberg to the economic and political volatilities of Russia. In the 1990s, while Russia was experimenting with democ-racy, the economy had collapsed; by official estimates GDP fell approximately 40%. In the early 2000s, the economy was recovering at 7% annually, but remained highly volatile. Russia was highly dependent on exports of oil and gas and thus on the world market prices of these commodities. Moreover, as Russia became richer and stronger (thanks to high oil prices), the government became more assertive vis-à-vis foreign businesses, for example putting pressure on foreign oil companies such as BP to reduce control over their operations in Russia. While brewing is not a particularly sensitive activ-ity, institutional changes still had a profound impact on Carlsberg.

Russian leaders, from the czars to Boris Yeltsin, periodically tried to convince Russians to drink less alcohol, especially vodka. Vladimir Putin made a fresh attempt by increasing alcohol taxation, and in consequence the beer market shrank. Moreover, new laws banned TV, radio and outdoor advertising and prohibited the sale of alcohol at non-stationary kiosks, which traditionally accounted for 26% of the off-trade (i.e. not in restaurants, clubs, or hotels) sales of beer in Russia.

These institutional changes had a profound impact on brewers like Carlsberg. First, the demand surged ahead of the deadline of the new taxation as people stocked up their supplies, only to sharply drop in the next quarter as people destocked their supplies, creating challenges for logistics. Second, market-ing resources had to be reallocated to, for example, in-store displays and channel marketing. Third, con-straints on sales channels and advertising shifted the pattern of demand, leading to a drop in sales, espe-cially in the economy segment. The economic crisis further reduced the demand for beer, especially in the premium and super- premium segment. By early 2014, capacity utilization in Carlsberg's Russian breweries dropped to below 60%.

In 2014, Carlsberg was hit by the deteriorating Russian economy, worsening political relationships between Russia and the EU, and the collapse of the rouble. The trade sanctions introduced by the EU did not hit Carlsberg directly, because most of the beer it sold in Russia was brewed in Russia. Yet the economic crisis did: beer consumption dropped (especially of the more expensive brands), and the value of its Russian investments depreciated when the rouble dropped in value. Thus every time there was bad news from Russia, Carlsberg's share price took a hit; in the sec-ond half of 2014, Carlsberg shares lost 20% of their value. Even so, Carlsberg remained committed to the Russian market, hoping for economic recovery, even though it reduced overcapacity by closing two brewer-ies in early 2015. Yet, the situation did not improve. The Russian econ-omy grew slowly, the currency was weak and the gov-ernment periodically introduced new restrictions on the sale of alcohol, such as a ban on 1.5 litre beer bottles. The beer market shrank by about 5% in 2017. Thus, in 2018, Carlsberg took a write-off of €650 million on its Russian operations. Carlsberg's early success in con-quering the newly opening Russian market had become an ongoing liability weighing on the overall profitability of the company.

Questions:

1. Why is investment in Russia considered risky?

2. Why do Western European MNEs invest in Russia, despite the political risks?

3. If you were a board member of Carlsberg, would you vote 'yes' or 'no' for a new project to acquire a local company in Russia?