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Vestas in Russia

Essay Topic:

Vestas in Russia Introduction For my exam project in International Business Environment I have chosen to write about the Danish cooperate Vestas Wind Systems A/S (referred to as Vestas throughout the paper). Vestas is the world’s largest producer of wind turbines and in addition to this it is also the leading company when it comes to green technology regarding wind energy . Vestas not only serves the Danish domestic market, but the company is also present on several foreign markets in other parts of Europe, Africa, Asia, Australia and North and South America.

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With over 22. 00 employees spread over 35 countries Vestas is categorized as being a multinational cooperation. As for the market of entry I have chosen The Russian Federation (referred to as Russia throughout the paper). Vestas has not yet entered the Russian market so my exam project will be a hypothetical one. One could question why a global actor like Vestas not already has entered a market with so big opportunities as Russia, but along with visions for great profit comes the reality of great risks and challenges as well. Russia is a vast market for windmills taking the size of the country and the climate debate into perspective.

The country is the fourth largest consumer of electricity in the world , but lack of technology hinder Russia to produce it in a climate friendly way. The relevance of a successor to the Kyoto Protocol is at its highest and Russia has expressed great will to find sustainable solutions for its large electricity consumption. Companies capable of exploiting such market are in position for massive gains. This is however easier said than done. Denmark and Russia differ on several aspects of their countries’ structures and Danish companies planning on doing business in Russia hence carefully have to consider these differences.

In this paper I will first describe and motivate the entry strategy of Vestas by using John Dunning’s OLI-framework . In this context I will argue why more advanced forms of FDI (Foreign Direct Investment) are appropriate for Vestas when entering Russia. Furthermore I will analyze the differences between Vestas’ home market conditions in Denmark, and the conditions of the target market, Russia, regarding adjustments in the marketing mix. To illuminate this section I will use E. Jerome McCarthy’s principle of the four P’s .

Lastly I will summarize the above mentioned and discuss the best internationalization strategy for Vestas. Vestas’ competitiveness In order to describe and motivate the entry strategy of Vestas I will outline the advantages based on John H. Dunning’s OLI-framework. Although Vestas already has expanded into many different countries with regards to different culture, political systems and business systems it is not always suitable to use the same entry strategy although the firm is the same in every case. O – Ownership advantage: Vestas’ competitive advantage

The O in Dunning’s OLI-framework of specific advantages deals with the Ownership advantage. To expand into new markets Vestas has to be in possession of something that gives the company an advantage compared to its competitors. Vestas has a clear ownership advantage first and foremost in form of its technology and know-how. Denmark has exploited wind energy since 1850s with the purpose of making agriculture more efficient. In the beginning of the 1970s the oil crisis influenced Denmark as well, and to avoid another economic breakdown the Danish government searched for an alternative energy industry.

Vestas had already done R&D (Research and development) and tried out the construction of windmills since 1971. However they first entered the market in 1979 with a licensed windmill. In the development of the required technology, subsidy from the government and research on RISO (The National Laboratory for Sustainable Energy) has had a vast significance for Vestas, enabling it to play the leading role it does today. Besides the support from the government, Denmark has a highly skilled labor force, which of course also adds to Vests’ ownership advantage.

Nevertheless as Lars Andersen (Managing Director of Vestas’ Sales) mentions, it is not only the technology and the skilled employees that give Vestas an ownership advantage: “However, it also has to do with our ability to deliver on time, the fact that things work from day one, and, in particular, the fact that we fulfill customers’ expectations for a good, reliable return on their investment. In other words, we are not simply selling a wind turbine…” Vestas does not only manufacture and sell the wind turbines, it also provides installation and subsequent after-sales-service, which not many Russian competitors can match.

Vestas is, in addition to the above mentioned, a multinational company with more than 30 years of experience and is therefore in a greater position than later emerged firms. Vestas is on top of this a world-known and respected brand with focus on quality and is represented in 35 countries spread out all over the world. The company has the largest market share, 24,8% , of the global market, which again places Vestas in a favorable situation when it comes to taking advantage of for instance the experience curve. L – Location advantage

The L in Dunning’s OLI-framework deals with the location advantage. Saying there should be an advantage for Vestas for doing business in Russia as a location for export or more advanced forms of FDI. Russia is geographically an enormous country (covers over 17 million square miles) and includes areas with a very low population density. These areas have great potential for windmill parks and the coastal areas of the Pacific and Arctic Oceans, the vast steppes and the mountains are the areas of highest potential.

On the other hand it would also be favorable to place the wind energy system in regions where there is an existing power infrastructure and major industrial consumers. Areas, which fulfill these requirements, are the steppes along the Volga River, the northern Caucasus Mountains and various locations in Siberia including the Chukotka Peninsula in the Magadan region . Chukotka Peninsula is especially to prefer, because of its already existing hydropower stations, which could be used to compensate for the possible intermittent wind power.

Another location advantage for Vestas is the fact that the Russian population is the fourth largest consumer of electricity in the world. Hence there is a demand for Vestas’ products and in particular when taking the Russian will to reduce greenhouse emission into consideration. Russia is willing to play an active role regarding the improvement of the global heating problem. The country has already reached its commitment stated in the Kyoto-protocol, but the Russian president Dmitri Medvedev declares that Russia “would try to reduce greenhouse emissions by 25% by 2020. ” The quotation signals a will from the government o find more sustainable solutions for production in Russia, and because Vestas does “business to business” and “business to government” commerce, it is of great importance with prospect for government interest and support. In this setting it is worth mentioning that The Ministry of The Russian Federation has published “The 2020 Energy Strategy”, which describes how to reach the new goal by prioritizing, among other things, ecological energy security through energy policy. In addition to the above-mentioned advantages of Russia as a location for Vestas’ expansion come the possibilities of reducing the overall production costs.

As it is with most emerging markets, like Russia, wages are lower than in more developed markets like Denmark. Hence by moving production to Russia Vestas would be able to compete on both quality and price, although their main focus most likely would be on quality . The location advantage is even greater when taking into consideration that there are no real national or international competitive competitors settled in the market yet, hence there is a possibility of a first mover advantage for Vestas as well.

Notable is nevertheless also the risk for a first-mover disadvantage in terms of costs and risks when preparing the market for the ‘new’ product. I – Internationalization advantage If Vestas expanded into Russia it would strengthen its position of being “No. 1 in Modern Energy”, which was Vestas’ slogan before the recent switch to: ”Wind. It means the world to us”. Furthermore if Vestas gained the first mover advantage it would give the company control over one of the worlds biggest markets. The internationalization advantage is gained in form of a proper entry mode.

The chosen entry mode is of great advantage if it is selected in accordance to Vestas’ now described ownership advantage and Russia’s location advantages. Vestas’ main ownership advantage is their know-how and technology while the location advantage of Russia primarily are the huge market possibilities and the government’s positive attitude towards renewable energy sources. What remains is, which type of entry mode that exploits both Vestas’ ownership advantage and Russia’s location advantage?

Would licensing or exporting be the best-suited entry mode or should Vestas take greater risks and do more advanced FDI? Vestas wants to keep their know-how, but by pursuing a licensing entry mode, spillovers will occur. Vestas would have little control over production, giving possibilities for competitors to emerge and quickly become as efficient as Vestas. Exporting is neither a favorable entry for Vestas. The transportation costs are extremely high, when it comes to the final products. Each piece of the windmill weights approximately 250 tons and thus not suited for export.

Other obstacles for the export as an entry mode are the protectionist policies and Russian trade barriers as for instance high tariffs. Vestas would have to pay up to 20% tariff + an additional charge (Value Added Tax) of another 18%, making a total of 38% for exporting its products into Russia. Russia ranks 162 out of 183 countries on the list of ease to do cross border trading with. To compare, Denmark ranks 6 which means that the products produced expensively in Denmark becomes more expensive by being exported to Russia.

This situation will of course change if Russia gets its membership in the WTO, but this is not yet achieved. To sum up Vestas needs to move in with plants in Russia and with more advanced FDI to protect its know-how asset and to stay competitive. There are two options for this being either a joint venture or a wholly owned subsidiary. The most obvious solution would be the wholly owned subsidiary, where Vestas could protect its know-how by owning 100 % of the stocks. On the other hand there is a time perspective to consider as well.

Siemens, one of Vestas German competitors, have recently announced plans on moving into the Russian market on a large scale . Setting up a wholly owned subsidiary as a green field venture takes a lot of time and the alternative of an acquisition is not an option since Vestas has core values and does not want to take over existing operating routines and enterprise culture. Another aspect, which is important to these considerations, is the fact that corruption and bureaucracy, which makes connections and personal relations very important for success, mark Russian business.

Setting up a joint venture with a local firm solves this problem for Vestas, since Vestas would benefit from the partner’s country specific knowledge of culture, language, political systems, business systems and local connections. A joint venture is at the same time a less risky (capital vise) and less time-demanding entry mode, than a wholly owned entry mode, which Vestas needs to take into considerations in order to prevent falling behind Siemens. The major disadvantage of choosing a joint venture is of course the risk of spillover, eading to future competitors. On the other hand it is possible to construct the joint venture to minimize this risk. Vestas needs to engage in a joint venture where it owns the majority of the cooperation and thus is able to remain control. One might argue that it would be difficult to find a company, which would accept to own minority of the joint venture, but taken the undeveloped market into consideration, it should not be a huge problem. There are only a few local firms in the windmill industry in Russia.

All of these would most likely be interested in boosting their profit (value creation) and it is not an unattractive offer to join the world leading windmill cooperate in a first mover attempt with prospect of a significant future market share in the Russian market. The joint venture and expansion of Vestas would also have to be on a large scale to be able to capture demand, establish a strong brand name and realize economies of scale. This would no matter what be an ideal opportunity for any local producer in Russia, although they would have to accept Vestas owning the majority of the joint venture.

Differences and adjustments There are several aspects where the Russian market conditions differ from the Danish market conditions. These are necessary to look at in order to outline the needed adjustments for Vestas’ marketing mix. Differences in market conditions When comparing Russia and Denmark regarding the ease to do business in, it is very clear that there is a vast gap between the two. According to a survey by The World Bank, Denmark ranks 6 whereas Russia ranks 120 out of 183 countries (1 being the easiest country to do business in).

I could therefore point at several diverging market conditions, but because of limitations of this paper I have chosen to focus on the following four: Infrastructure, climate, GDP per capita and the level of corruption. One might argue that ‘climate’ is not of great importance when speaking of market conditions, but in my opinion it is a very significance factor in this case concerning the marketing mix, which I will elaborate on in the following section. Infrastructure is important for Vestas when it comes to distribution of the company’s products.

When looking at infrastructure in Russia and Denmark the most noteworthy factor is distances and terrain. Russia is the largest country in the world covering 11 time zones and it does not entail deep analysis to conclude that it requires great coordinated logistic to create a well functional infrastructure. This has for several of reasons not yet succeeded for Russia and the country’s infrastructure is hence very fragmented. An uneven terrain with low population density and nature impediments as rivers and mountains has hindered buildings of proper roads and connections, which have a great influence on Vestas’ ease of doing business.

Because of the enormous extent of Russia, the climate varies a lot from the coasts to the mid-country and from the west (Europe side) to the east (Asian side). The temperature fluctuates between the extremes of -65 °C in the winters and +40°C in the summers. The wind is an important factor to look at in this case as well, because Russia possesses areas with all degrees (categorized as: Low, medium and high) of wind power. The climate differences is thus of great importance regarding Vestas’ product differentiation. Moving focus to the more economic orientated difference in market conditions is the GDP per capita (PPP).

Russia’s GDP per capita is low compared to Denmark’s. According to the ranking done by International Monetary Fond, Russia ranks 51 in contrast to Denmark’s ranking as 17th . This means that Russian consumers, including the government and large enterprises, have less purchasing power compared to the Danish consumers. Little purchasing power could be an obstacle for Vestas. If consumers don’t have much money to spend, they would most likely not have the mental surplus to think of the environmental dimension by burning fossil fuels.

If generating electricity the cheapest and easiest means exploiting fossil fuels, this is what they will do. However higher purchasing power (higher GDP per capita) results in the means to be able to prioritize such things as future global environment. Looking at the energy produced in Russia, over 60% of the electricity generated is based on gas- and coal power whereas less than 1% of the electricity generated is based on renewable energy production . In contrast stands Denmark, where wind power alone in 2008 generated 18,9% of the Danish electricity demand .

The growth in GDP per capita in Russia was before the economic crisis, around 7-8% . This is promising for Vestas as a continuous high growth in GDP per capita means a more developed economy, higher purchasing power and therefore increased interest in products like the ones Vestas offers. The fourth difference I have chosen to outline is the high level of corruption in Russia. Russia ranks number 146, whereas Denmark ranks number 2 (1 being the less corrupt) in the Corruption Perceptions Index (2009) made by Transparency International.

Vestas has no power to end corruption by itself, so instead it should focus on how to deal with it in business situations. Adjustments in marketing mix: The four P’s I will use E. Jerome McCarthy’s principle of the four P’s: Place, Product, Price and Promotion to analyze the needed adjustments for Vestas’ marketing mix. The four differences (infrastructure, climate, energy production and level of corruption) described in the previous section are all differences that affect these adjustments. The ”p” concerning the place (distribution) deals with how to get the product to the consumer.

It would be obvious to discuss adjustments to retail concentration, channel length, channel exclusivity and channel quality, but selling Vestas’ products is not like selling jeans or other regular consumer goods. There is no distribution channel, or at least it is very short, because Vestas sells directly to the customer, being government or large enterprises. However the undeveloped infrastructure, as outlined as a big difference between the Danish market conditions and the Russian market conditions, is of great importance for Vestas’ delivery to its customers.

Vestas’ products require stable roads (due to heavy weight and size) and connections to the best set-up areas. The infrastructure is best around Moscow and St. Petersburg, due to big business, but this is not necessarily the best location for Vestas’ production. As mentioned before the best set-up areas are the vast steppes along the Volga River, the Caucasus Mountains and locations in Siberia. In Denmark Vestas can easily get around to all parts of the country, but Russia’s huge distances and the uneven terrain in many areas do acquire adjustments.

Vestas carefully have to reconsider where to place the facilities of production to minimize transportation costs, and not to forget, maximize availability. This might require compromises in form of set-ups in optimal and less optimal wind areas. To do this Vestas has to deliver wind turbines that also are able to exploit the low winds and Vestas thus has to adjust its products to the Russian climate conditions. Other adjustments are necessary for the turbines to manage the before mentioned freezing winters with temperatures down to -65 °C and the hot summers with temperatures up to +40°C.

The turbines should be able to function all year round to be attractive to customers. Vestas has to differentiate the turbines to match these standards compared to the standards in Denmark, where weather conditions don’t differ as much. In other words, Vestas’ product differentiation is necessary to encounter pressure for local responsiveness and thus reach its customers. The customer segment that Vestas tries to reach is a narrow segment consisting of the government and maybe a few other large enterprises, which would be interested in promoting a green profile.

The government and the large businesses would, as most customers, be concerned about price. To match Russia’s rank regarding the low GDP per capita, Vestas would have to make an adjustment in form of lower prices. Price is however not the main focus for Vestas . Quality and safety is their top priority, but of course they would be able to take advantage of the lower labor costs in Russia and thus lower the overall production costs. Vestas could however use strategic pricing in form of experience curve pricing to gain market share and relations to the large customers before competitors emerge.

This could be rewarding because of the promising growth in Russia’s GDP per capita, which presents better future market conditions for Vestas’ products. Vestas should at the same time stress that setting up windmills is an investment that might require lots of capital as a starting point, but in the long-term perspective it would be worth it. Today Russia is self-sufficient in terms of energy . However the supply of fossil fuels is diminishing and the demand for it is increasing. Investing in wind power would be a possible way for Russia to stay self-sufficient in the future.

Left remains the question of how to communicate all this to Vestas’ customers? When choosing a promotion strategy Vestas has to adjust its approach to the above described high level of corruption. One way of doing this is by having the right connections; knowing the right people. As previous mentioned I would suggest Vestas to pursue an entry mode of a joint venture and thereby gain the advantage of local relationships, which could help Vestas to get around the bureaucracy. On the other hand it is of paramount importance that Vestas ‘stay clean’.

If Vestas in any way gets associated with any form for corruption, it will have tremendous consequences not only for the domestic market, but also for the global market that Vestas operates in. In accordance to the entry mode I would suggest Vestas to practice a push strategy. It would be a waste of resources to communicate through mass media to vast private consumer segments, to which Vestas’ products have no interest. Vestas’ communication should be directly orientated at the small customer segment, previous outlined.

Personal selling, exploiting the local partner’s ability to speak the local language, perhaps supported by additional informative products to be handed out and an enlightening webpage is the best way for Vestas to reach its potential customers. Vestas’ internationalization strategy In the last part of this paper I will sum up and describe the best internationalization strategy for Vestas when entering the Russian market. Throughout the paper I have concluded that now is a good time for Vestas to enter the Russian market, because of prospects for government interest and support and no real competitors settled in the market yet.

Hence Vestas has an opportunity for a first-mover advantage, but only if they enter the market on a large scale. Entering on a large scale is associated with greater risks and costs, but taken the growth in GDP per capita and the decreasing amount of fossil fuels into considerations, it is most likely that Vestas in the long-term perspective will secure massive gains from having established the contacts and its own brand in an early phase.

I have already argued that I find a joint venture the most appropriate form of entry mode for Vestas. Forming a joint venture with the right partner, a partner that has agreed to Vestas’ way of doing business e. g. no corruption, is the best way to remain in control, but still benefit from local knowledge, which is of great value because of the different market conditions compared to Denmark. Due to these different market conditions, Vestas also has to adjust its marketing mix.

The most important adjustments would be: Reconsideration of production locations concerning infrastructure impediments, product differentiation and the use of a push communication strategy with help from the chosen partner’s local advantages. There is no doubt about the difficulties a global actor faces. A company like Vestas carefully needs to consider every aspect of a business opportunity to prepare for an expansion into a new market.

Vestas operates all over the world where it has to respond to pressures for local responsiveness and pressures for cost reductions. There is a pressure for local responsiveness in Russia due to the geography and the political system. The question is, if this pressure is low or high? I would categorize it as being in between. The pressure is not low since the expansion requires considerable adjustments in the marketing mix, but the pressure is on the other hand neither as high as pressure for local responsiveness for e. g. lothes or cars. Concerning the pressure for cost reduction it is necessary to take a look at Vestas competitors in the Russian market. At the time being, there are not many, but as mentioned before Siemens is planning on moving in. In addition to this, many Asian competitors have emerged in China as well and might constitute future competition. I would therefore say that pressure for cost reduction in Russia at the time being is low, but in the near future this pressure will definitely increase due to the above explained.

Vestas could enter with a location strategy or an international strategy, in accordance to the low pressure for local responsiveness, but if the company wants to prepare itself to face upcoming aggressive competitors it might be strategic wise to enter with a transnational strategy already at this point. Pursuing such strategy will as well benefit the information flow between Vestas subsidiaries and between the subsidiaries and the home country, which is necessary for sharing one of Vestas’ core competences: know-how.

If Vestas not only is able to take advantage of the outlined possibilities but at the same time adjust and respond to the described impediments, it has great opportunities to grasp large profits and at the same time remain competitive in perspective of the Russian market as well as the global market. References The paper is based on classes in International Business Environment plus the beneath listed Book: Hill Charles WL, International Business: Competing in the Global Marketplace, 8th edition