with Mikhail Shapiro, General Manager, Danfoss Russia
Can you firstly introduce the footprint of Danfoss in Russia and elaborate on the growth path the company has experienced in this market?
Danfoss Group has two entities in Russia, which altogether amount to 800 people and roughly EUR 200 million in turnover. The largest entity deals with both production and sales, which includes technical support and logistics for instance. In terms of production, this entity manufactures roughly 20 percent of our actual sales here. The second smaller entity engages more in local production and deals with the sales of its entire production volume. All our business in Russia relates to heating, refrigeration and frequency converters, which reflects our activities at headquarters level. In Russia, however, the volumes may differ in the sense that our volumes are higher for products and solutions related to heating. The second biggest business area is refrigeration. Our business of frequency converters (drives) makes up the smallest –yet very promising– business area.
Why is this such an interesting area now?
Russia hosts large volumes of industrial activities of various types. From a certain perspective, these can all be considered as gold mines due to their lacking modernization. We currently see a situation where the market dictates the price pressure. Ongoing privatization has been forcing the industry to look at how they could reduce cost and how they could save energy. Frequency converters, in turn, require only a limited amount of investment while the payback periods can be as short as one or two years. It really is the most effective way for a commercial enterprise to reduce cost and increase competiveness in quality. These drivers have generated an increased interest in our products.
Russia does score poorly in terms of energy intensity. In your view, what factors brought the country in the current situation?
The cost of resources has always been a very small proportion of the cost of goods manufactured in Russia. For this reason, the attention was never drawn to energy efficiency. Another element was the fact that Russia had numerous state companies, which were driven by different targets and objectives. Back then, profitability was not always the main driver and competition levels were different than today. Now that many of these companies have been privatized and now that they actively need to compete with new entrants in the market, price levels have dropped and a focus on profitability has gained increasing momentum. Danfoss can help companies with this.
While it seems that there is a certain push coming from the private industry now, one can imagine that the government still plays a role too. When you say that you help these companies, do you also foresee a role for Danfoss to change the perception towards energy efficiency in Russia?
This drive is overall supported by government, but by itself if it is decisive,- can be questioned. As many enterprises and big holdings –such as Sibur, Gazprom, etc.– have been fully or partly privatized, they have become increasingly interested in raising profitability levels. In many cases, private companies are driving such demand.
Danfoss comes into play as a provider of energy-saving activities and solutions, be it in heating, refrigeration or frequency converters. We are ready to help our customers to evaluate different proposals to increase efficiency. We will first do a technical audit of their applications in order to provide them with a solution that not only consists of a product but of a turnkey package. To implement such solutions we use several partners across the Russian territory.
While it is easier to communicate in the private sector, it is much more complex to do so in a public or municipal context. Whereas private companies mostly focus on increasing profitability, the interests of municipal entities are more complex than that. For some of those, an increase in profitability may result in reduced subsidies. As a result, their targets are more on the technological side, where one would for example look at gaining better control and easier management over the distribution of heat. Obtaining guarantees and approvals are a number of other factors that complicate the implementation of proposals at municipal level, even though they may benefit the area significantly.
Would you say that there are also regional differences in this respect, both in terms of market potential as well as in ease of implementation? Perhaps there are also differences from a legislative point of view?
Rather than in legislation, there are differences in regional leadership. Some regions in Russia have strong leaders that enforce decisions far easier and quicker than elsewhere. In Tatarstan, for instance, we have seen a strong drive towards energy efficiency and strong subsequent results.
Generally speaking, longer chains of decision-making create more resistance. Some district heating companies, for instance, tend to focus on the decrease in turnover that will be caused by greater energy savings. In other cases, they take an active role in leading this process by –for example– providing additional services to regain this loss in turnover. These regional differences generally do not only depend on local characteristics, but also on the vision and strategy of local leaders. We have seen very prominent people that are ready to spend significant efforts in long-term thinking and investment strategies.
You approached this market through an extensive network of distributors. In September 2012, several of them were invited to Denmark to talk about how their performance could be further improved. What were some of the highlights that you could take away to the Russian market?
Historically, Danfoss has been a first mover in this market which has enabled the company to build a very strong distribution network with the best local companies. Still today, we try very hard to keep these companies in our network. We are experiencing growing competition today and are trying to stay attractive to them. At the same time, we want these companies to stay competitive and operate professionally. We assist them in reducing costs and implement the right business models. We can not only help in creating their strategy, but also in building it year-on-year.
It is interesting how you mention that Danfoss tries to stay attractive for the distributors. Does the power sit with them?
The power sits on both sides. We do have certain power on our side but do not wish to overplay this either. Our view is that our distributors should see the value of our cooperation. From a competitive perspective, the products of different manufacturers have become increasingly similar. For this reason, we do not only see the need to differentiate through products but also through other business aspects.
Business processes can perhaps be less easily copied than products. In what ‘softer aspects’ do you see Danfoss Russia standing out?
We maintain a strong focus on technical support to help develop our partners and create more business for them. We work very closely with them and work on several aspects, by reducing their delivery times, loads, working capital, and so forth. We have built several systems around these areas to create a sustainable competitive business.
You previously mentioned that 20 percent of the goods sold are being manufactured in Russia. Can this number grow and if so, will additional investments be required?
So far, Danfoss has invested roughly EUR 50 million in our facilities here, including production, logistics, premises, and so forth. Our local production capabilities were initially integrated by assembling components here. To some extent, it showcased that we were able to become a local producer here in Russia although the initial purpose was to support our marketing activities. Due to the initial small scale, this process was rather uneconomical at first.
Now, we are looking at ways to make our assembly activity economically interesting. This is difficult to do so for mass products, which is why we try to find more specialized products to assemble here. I am a strong proponent of producing a number of our products –such as heat exchangers and steel valves for district heating– here in Russia. At the same time, we try to find capable suppliers in Russia that can provide quality components to us too. We are now evaluating our different options but it is my view that we can produce in Russia in a competitive manner, just like many of our competitors have managed to do.
The Group recently opened a new research center in Denmark. Do the Russian operations have the potential to contribute to the R&D capabilities of the Group worldwide?
We plan to open an R&D department here in Russia and have already developed some of our new products here, using the experience and knowledge base of our local people. Whereas many of these projects will first be sold in Russia, they can offer great potential. To leverage these R&D capabilities, we are in the process of establishing an agreement with the Skolkovo innovation center. Under this agreement, our current department of 15 people will move to Skolkovo to work on innovative capabilities such as project modeling, software development, and so forth.
You have already received various awards for your performance in Russia, including ‘HRH the Prince Consort’s Medal of Honour’ from Denmark in 2009 and the national business award ‘Captains of Russian Business’ in 2012. What do you now envision for Danfoss Russia in the next few years?
Our main goal is to keep our advanced position in the Russian market. We will continue to do everything to keep that position. A big part of the business we do today is not commercially oriented. It would be great if this sector would be more commercially driven in the future, which will be the only way for end users to really start benefitting from our solutions. Energy-saving should become a business in Russia, not only in the commercial sector but also in the municipal niche.
Would you like to add a final message?
Overall, those companies that wish to come to the Russian market should do so with a long-term focus and great patience. One cannot get immediate returns if one wants to really achieve something here. Danfoss commits to this view in Russia.