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Russian mobile operators divide opinion with move to retail

28 мая 2009

Russian mobile phone operators are rethinking their sales strategies as many of the independent retailers that sell their subscriptions are close to bankruptcy.

Handset dealers mushroomed across Russia in recent years, but half of their profit came from the commissions paid by operators for each new subscriber. The over-leveraged retailers had very little power in negotiating these fees and, last autumn, they were squeezed by both creditors and suppliers.

That enabled Russia's second-biggest operator OAO Vimpel Communications to pick up half of retail giant OAO Euroset. No. 1 provider OAO Mobile TeleSystems has also been buying up indebted chains.

These deals bring the Russia market closer to Europe's, where operators own most of their sales outlets. But analysts disagree on what the changes mean for MTS and VimpelCom; a fall in profitability or a more refined sales strategy.

"The operators should never have got into the retail business," said Evgeny Golossnoi, a telecoms analyst with investment bank Troika Dialog, arguing that their business model has been stronger than the one in Europe.

Early this year, MTS bought the Telefon.ru and Eldorado chains, taking the total number of stores it runs to 2,600, and Golossnoi estimates the cost of operating a larger retail chain could knock 4% percentage points off MTS's operating profit margin.

In order to avoid this, VimpelCom has kept its stake in Euroset just below 50%, but many analysts expect that the operator will eventually take control of the retailer.

MTS has been working hard to bring its newly-acquired businesses to their break-even points, Chief Executive Mikhail Shamolin said on Friday when the company announced first quarter results. He said, however, that the operator didn't buy the retailers for their profits.

In emerging markets, operators typically offer low call prices but avoid direct distribution costs by selling most of their contracts through independent retailers, says Nomura telecoms analyst Viktor Shvets.

He estimates that around 80% of Russians now use mobile phones and says that when penetration reaches this level operators seek closer relationships with their subscribers in order to sell them additional services.

"What's happening in Russia (with operators expanding in retail) will happen in all emerging markets," says Shvets.

But not all analysts welcome the change.

"I don't see why mobile operators should own retailers; there are no real synergies," says Konstantin Belov, an analyst at Moscow-based brokerage UralSib.

Belov said it isn't necessary for operators to run their sales outlets, but that once one of them has started to do so, the others have to follow in order to avoid losing subscribers.

MTS was in talks to buy Euroset last summer, before VimpelCom took its stake, and the chief executive of the winning bidder, who has now stepped down, had publicly expressed his concerns over MTS's courtship of the sector's biggest sales outlet.

"While we would have preferred to maintain the status quo regarding mobile retailers, it became clear that this would not happen," said former CEO Alexander Izosimov said after the deal.

By contrast, MTS wanted to own more of its sales outlets, saying that the company could sell additional services in these stores and prevent its own subscribers from signing up to rival networks at independently-owned stores.

Russia's three national operators have relied on independent retailers to bring them new subscribers and accept payments from users on "pay-as-you-go" deals.

But these retailers make profits from signing up new subscribers, and their sales people promote the networks that pay the biggest commission, encouraging visitors to sign up even if they already have SIM cards and only came in to top up their accounts.

This sales model partly explains why so many Russians have more than one card - there are 190 million active subscriptions for a population of 140 million - it is cheap to buy a new SIM card and vendors are incentivized to sell as many as they can.

MTS's Shamolin recently complained about this, saying that Russian operators have been paying independent retailers to sign up new subscribers who don't want the SIM cards and leave the network, known as churning, after a few months.

Around a quarter of Russian SIM cards are discarded every year, and Shamolin describes this as "artificial churn" arguing that most of these cards represent secondary subscriptions bought by people "who are looking for a better deal and are being stimulated by the dealers."

"That is essentially a dealer commission and overall acquisition cost without creating any value in the market," says Shamolin, who wants to save this expense by running more stores under MTS's own brand.

Salaries for sales consultants and rent for shop space may weigh heavier on MTS's statement of costs than the dealer commissions that they replace, but investors will welcome the extra expense if it makes subscribers spend more and stop switching networks.


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