Marketing U.S. Cosmetics in the CIS

CE last year introduced an American CEO to a Russian entrepreneur. The two joined forces to sell cosmetics in the Commonwealth of Independent States. The Hazel Bishop line, manufactured by a subsidiary of Continental Health Affiliates, is even sponsoring a beauty contest. Who will be the first queen of Russian Red Lipsticks?

June 1 1992 by Sergei Glushko And Robert M. Donnelly


How do you make the transition from Marxism to a market economy in a country where the currency is virtually worthless, commercial technology is sparse, distribution systems are almost nonexistent and management talent is far from world class? That is the question I face as CEO of Kharkov, Ukraine-based Effect, the third largest manufacturer of perfumes and cosmetic products in the Commonwealth of Independent States.

In seeking to capitalize on a market of 290 million people with a pent-up demand for almost everything, we’ve begun the process of privatization, introduced our employees to Western-style marketing and accounting, streamlined our workforce and product lines and contracted with key suppliers of raw materials outside the CIS. But perhaps most important, we’ve launched joint ventures with Swedish and American partners to sell cosmetics and facilitate other deals.

RISKY ENVIRONMENT

Following below is an account of Effect and its fledgling Western ventures. I hope it will prove instructive to other Western entrepreneurs hoping to do business in the CIS over the next several years.

Of course, newcomers to the business environment in the former Soviet Union continue to face considerable risk. There’s still political turbulence here, the ruble isn’t convertible, and as yet, there’s no more than a bare-bones legal infrastructure in place. Nonetheless, innovative businessmen are finding plenty of ways to turn a profit. In the process, they are imparting considerable management expertise and helping us to become better partners.

One thing is for sure: Even in the midst of chaos and confusion, deals are being done. In the absence of an established business law, hordes of Western lawyers have descended on the CIS and are drawing up contracts ranging from short-form agreements for the sale of commodities to more complex contracts for joint ventures. Those favoring a rapid transition to a free-market economy obviously are not waiting for the legal system to catch up. Russian entrepreneurs are being forced to go ahead of the law.

A NEW GOLD RUSH?

The pioneers in this new environment-which originated under the glasnost policies of Mikhail Gorbachev, the former Soviet president-were Western multinationals looking for big deals. Some, like AT&T, continue to buy stakes in emerging commonwealth enterprises. In fact, the giant telecommunications company just took a 39 percent position in a new company that will build, own and run the Ukraine‘s long-distance telephone network. Its partners are Dutch PTT Telecom (10 percent) and the Ukrainian Government (51 percent). AT&T plans to pay for its share by providing switching equipment. Some of the company’s profits will come from hard currency payments on calls made into the Ukraine over the new network.

But many larger companies got cold feet, watched their early deals go awry, or were caught in the turmoil that last year swept away even Gorbachev himself. Typical deals now are smaller, simpler and easier to finance. Some shell-shocked veteran observers liken the business climate in the CIS to the U.S. “gold rush” of the 1800s. Some pioneers and entrepreneurs willing to take a risk are coming up big.

MOVING AHEAD

When Gosplan dissolved some time ago, I latched on with Effect. I began as an engineer, but later worked my way up to foreman, superintendent, managing director-and eventually “CEO.” Effect has annual sales of around 250 million rubles (roughly $3.3 million). On average, it produces 800,000 items a day at a price of three rubles apiece.

Effect was part of the initial American-Soviet Trade Consortium. And with Johnson & Johnson, a member of the American Trade Consortium, it was one of the first joint ventures in the Soviet Union. In retrospect, it is clear the initial attempt by large American players to gain a toehold in our market was not feasible partly because of the lack of an infrastructure needed to sustain free-market enterprise.

On the lookout for new partners, I attended a meeting early in 1990 sponsored by Unilever N.V., the diversified Dutch multinational with more than $30 billion in annual sales. While at the meeting, I established a relationship with Emile Wolters, president of Parfusale ab in Uppsala, Sweden, an entrepreneur active in the worldwide cosmetics marketplace. This relationship led to another meeting, this one between the Swedish entrepreneur and his American associates. Subsequently, a new U.S.-based joint venture company, Peremena Russo-America, was formed. Co-author Bob Donnelly and I were both among the partners in this agreement.

Having established a vehicle to transact business outside of the Ukraine, I now had a base on which to build the Effect business. Then, in the Fall of 1991, Chief Executive editor J.P. Donlon introduced me to Effect’s first real American partner, Jack Rosen, CEO of Continental Health Affiliates in Englewood Cliffs, NJ. Rosen is also president of Hazel Bishop Cosmetics. We held initial discussions and compared notes on the business practices in our respective markets.

Ultimately, we agreed to market Hazel Bishop cosmetics in the CIS through the Effect distribution system.

Initially, Continental Health cracked the Russian market in 1991. The company had established a partnership with Sana Medical, a French-Soviet joint venture, through which it markets health products in Russia. When we met, however, Rosen told me his company was looking to further position itself and create brand identity in a giant market at a crucial juncture in history.

Hazel Bishop, a maker of mass-market brands in the cosmetics industry, markets its products in some 20,000 retail outlets. In Russia, we selected a mix of cost-competitive products that would appeal to Russian buyers. In deciding on an appropriate marketing strategy, rather than repackaging the line’s products, we decided to keep them “as is.” That’s because American goods have upscale appeal in the Commonwealth. And cosmetics are particularly image-sensitive.

Hazel Bishop’s “Commonwealth” line is shipped to our Kharkov factory for distribution to major cities in Russia and the Ukraine. The products are manufactured in the U.S., but Rosen of Continental Health hopes to gradually shift production to our factory. He will provide the necessary raw materials until our local resources become more reliable.

Meanwhile, to introduce the cosmetics, we kicked off a Russian beauty contest supported by advertising on Soviet television and posters in retail outlets. To begin the competition, we invited Russian women to send us their photos and tell us why they would like to become a model and spokesperson for “Russian Red Lipsticks.” We’ll announce the contest’s winner later this year.

It’s too early to get an accurate gauge on the size of the market here for Hazel Bishop products. But early returns have been encouraging: Some 25 percent of the initial shipment was sold in Moscow shops in just 10 days.

The financial arrangements in the cosmetics venture work this way: Rosen’s contribution comprises inventory and promotional dollars-from which he garners a profit in rubles. He leaves those rubles in the CIS to reinvest in additional promotional materials, packaging and inventory. The idea is to boost sales prospects in the CIS and prepare for the eventual export of Effect-manufactured cosmetics to the U.S. (Peremena already has spoken with a major U.S. retailer about that possibility.) The rubles will also be used to fund the beauty contest and thereby to gain market recognition for Hazel Bishop cosmetics.

Parfusale’s Wolters, who owns a 25 percent stake in Peremena, supplies raw materials for products made by Continental Health/Effect. Wolters, of course, derives a share of the joint venture’s profits.

VISION QUEST

In the wake of the disintegration of the Soviet Union, there are many other things Effect is doing to remodel itself along Western lines and gain a competitive advantage. We are now:

Privatizing the company.

In the Ukraine, there are two types of property. One is so-called republican property that belongs to Republic of the Ukraine. The other is municipal property, the property of local councils and other authoritative bodies. After the disintegration of the Soviet Union, Effect’s management team converted the company’s assets to municipal property of the City Council. This enabled us to carry out privatization directly through these local bodies, with whom we were well acquainted.

Our next step was to establish a joint stock company in which all employees would be eligible to become shareholders. If a privatization law is passed this year, as expected, Effect will lease the plant back from the City Council. When the company turns enough profit, the joint stock company will buy the plant.

The first phase is now complete, and the new company is leasing the plant. We hope to purchase the assets from the City Council in two years.

Streamlining and retraining our workforce.

Effect is moving to reduce the number of workers from 1,000 to 800 and to reorganize its workforce into more efficient units.

It is also attempting to train workers in the ways of a market economy. Many people accustomed to working in a command-style economy are not motivated. Until recently, the average Russian worker toiled in antiquated facilities and tried more to avoid work than to do it.

As a result, the first task of any manager in the new market economy is to sort out who can be motivated and who cannot.

In fact, we may be able to take our cues from several large American firms that have successfully trained and motivated Russian workers. Of course, it is a great advantage if you have clean facilities and modern equipment, as do McDonald’s, which employs 1,100 people in its Moscow restaurant, and Johnson Wax, which employs 350 workers at a liquid detergent and shampoo plant in Kiev.

But Russian entrepreneurs are also watching closely a Polaroid factory in Obninsk, Russia. This isn’t a new factory, but rather a small section of an older factory building. Most of the original workforce has been released, and replacements have been handpicked by a Russian-American joint venture management team. The new workers are motivated by better working conditions and benefits. Under the new system, the more these workers produce, the more they earn. That’s the best motivation for workers anywhere in the world.

Targeting valuable assets.

As part of the lease-back agreement, our management team has the option to select only the most “modern” assets. The rest of the assets will be held by the City Council as part of the new administration’s policy to promote capitalism.

Trading company products to procure housing, clothing, food and pharmaceuticals for employees.

To be sure, this is a concession to the old way of doing things. We are aware that barter removes valuable goods from the marketplace and slows the process of transformation. But for now, our ability to provide our workers with hard-to-get goods is a valuable motivational tool. In a sense, it is among the few “benefits” we are in a position to offer.

Aggressively seeking foreign partners willing to invest valuable hard currency or raw materials and negotiating to try to sell some of our products through partners into Western markets.

Moreover, there are other ways we are restructuring Effect. We are contracting with fewer companies and seeking new sources of raw materials outside the Commonwealth. On the marketing side, we are reducing the number of our product lines from 60 to 40. We have also drawn up a financial plan based on Western-style accounting.

LEARNING THE ROPES

I believe that joint ventures are perhaps the best way for a Western concern to test the waters in the new Commonwealth. The Hazel Bishop experience is a case in point. A local joint venture partner knows the lay of the land and provides an entree into the internal network of contacts in Russia and the other former republics. But of course, the helping hand works both ways: As much as foreign investors need someone to guide them through the maze, entrepreneurs in the Commonwealth need desperately to learn the ropes of a market economy from their partners.

In plotting joint ventures in the CIS, both Russian and American partners have to listen and learn. Further, we must be aware that just as with other global markets, the Commonwealth has a variety of cultures, each of which may require tailored marketing strategies. We must put into action the Western expression “think global, act local.”

The risk may seem great, but for those with a long-term mentality, the rewards can be even greater. The CIS is the largest untapped market in the world. Robert S. Strauss, last year appointed U.S. Ambassador to Moscow, said in a recent interview, “If I was 40 years old and had $100,000-and I wanted to turn it into $10 million-I would invest in the former Soviet Union, because it will eventually become a booming economy.”

Effect, and thousands of other CIS companies in industries across the board, hope that the West hears and heeds the ambassador’s advice.


Sergei Glushko is managing director and chief executive officer of Effect, the third largestmanufacturer of cosmetic products in the Commonwealth of Independent States. Robert M. Donnelly is honorary chairman and managing partner of New York-based consulting firm Alpha International Management Group. He is also a partner in Peremena Russo-America.