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Localization of industrial production of foreign companies in Russia

Government support as related to creation of favorable conditions for activity (discounted rate of tax, customs duty and so on) stimulates many international companies to enter Russian market not only as a provider but also as a producer. To a large extent it is achieved with the help of business (production) localization. Let’s speak about some advantages and disadvantages of such methods of localization as contract manufacturing, own production, joint-venture company.

Terms and notions

Import phase-out, localization and investment development seem to be the most frequently used words in Russian business community for the last three years since the middle of 2014 when economic sanctions were introduced against Russia because it had acknowledged the results of referendum in the Republic of Crimea, supported declaration of its independence and accepted it into the Russian Federation.

Measures and countermeasures taken in connection with the Ukrainian crisis in general positively influenced on state of Russian own industrial production, many experts note rise in light industry, agricultural plant, development of technology.

Besides technological development of Russian enterprisers, certain difficulties connected with the political situation which faces Russia gave an impulse to development of inner legislation, making important, timely and in some cases even proactive amendments to the federal legislation and other regulatory acts, strengthening of inner product market, finding out new potential foreign trade partners and new possible domestic market.

Government support as related to creation of favorable conditions for activity (discounted rate of tax, customs duty and so on) stimulates many international companies to enter Russian market not only as a provider but also as a producer. To a large extent it is achieved with the help of business (production) localization.

Localization generally is adaptation. Production localization is adaptation of a product or business solution known beforehand to the legislation of the country of operation on the one hand and on the other hand adaptation of legislation. There arises a need in flexible policy in the sphere of investment, creation and legislative recognition of new actual forms of legal cooperation. Together with new production there comes a new corporate culture, quality standards, product stock and this consequently develops and motivates Russian producers to raise own competitive ability.

Contract manufacturing

Localization by means of contract production is a kind of spreading of factory capacity point wise without own production, when the principle company has no space for own production or presents itself as a brand, name, idea and promotes its goods, works or services, raises attractiveness of its product, and actual manufacturing is carried out by other companies under the contract (in other words, by order).

Contract production may exist within the boundaries of one country or the whole world (extraterritorial localization).

Transfer of manufacturing of foreign product, imported to the Russian market, to Russia (localization according to the territorial characteristic) or arranging localization of their activity in this manner by domestic companies is convenient because Russian manufacturers, as usual, are ready to produce any volume of production for a customer, while China, for example, produces incomparably larger volume of one lot of goods. There are a lot of highly qualified and unique professionals of various kinds in Russia, however, there exist lack either of innovative solutions or high-technology equipment for self-sufficient development, so in this case contract production usually profitable for both sides of a contract. Localization results in additional saving of time and money due to absence of customs formalities, optimization of costs (payroll budget, production sites and facilities) due to possibility of the most profitable production location in small towns.

On the one hand it allows the customer company to get savings on manufacturing capacity maintenance, workers allowance and so on, that inevitably «loads» own production. And this in its turn allows to decrease direct charges under assessment of costs of the product for the ultimate consumer.

Localization depth may be different from development of a new product design concept, packaging and delivery to the ultimate consumer to complete production cycle with preparation of all necessary documents, permissions and licenses.

But on the other hand, this way of localization also has some disadvantages: there exist a risk of default of obligations performance for a customer, because manufacturer is just a contractor according to the contract, this is not his own production that can be effectively managed by it. Own production working at own capacity, internally financed as distinguished from contract production is more flexible, it is able to promptly respond to external changes and adapt to them, optimize own processes. For a foreign customer company there exist a risk of its technology disclosure to other companies that can start to manufacture analogues at own production that consequently may provide competition to the original product and detain its expansion at the relevant market.

Disadvantages for a manufacturer at contract production may consist in heavy expenses connected with logistics, generally undeveloped infrastructure in Russia, that eventually lead to increase of product cost, that decreases its market competitiveness, or - in the problem of undeveloped culture of consumption of any goods that can essentially make sales difficult.

Joint-venture company

Joint-venture companies are created for cooperation of companies remaining independent economic entities with an aim to expand production localization, to create new production for occupying new niches at markets, new markets. This is a good operating tool that was and remains in high demand all over the world.

In Russia the process of such alliances development has been gathering momentum from 2014 when applicable Russian legislation has started to change to mitigation of regulation in the sphere of corporate interaction between business entities. More and more Russian companies come to joint conduct of business, the flow of foreign direct investments in the form of creation of joint-venture companies with foreign companies has been increasing.

Joint-venture companies are created for long-term perspective as there takes place consolidation of independent production processes of companies, and this provides creation of a new production.

This strategic cooperation of partners allows to strengthen their positions at Russian market, to increase volume of production and make it better using accumulated advantages.

Along with this under such form of cooperation there exist certain problems, as for example, corporate management of a new joint-venture company is provided under the conditions of actually «two heads» presence. Coincidence of interests and shared objective for all participants, readiness to bear joint or proportional starting costs, ability to adapt to a new legislation, forming own infrastructure and so on are necessary for effective management of a new joint-venture company.

State interest

It should be mentioned that variety of legal instruments for structuring of relationship within an enterprise or with other enterprises by means of production localization provided with methods analyzed in this article - is a result of development of Russian civil legislation, particularly in the sphere of legal entities and liability law, state of economy, recourses, political relationship on the international stage and other objective constituents.

Although this activity is connected with considerable risks both for parties and for the state, it is characterized by long-term perspective of implementation, the state supports localization of industrial production of foreign companies in Russia. Russia is interested in a flow of foreign investments into its economy and creation of up-to-date progressive plants at its territory, increase of trust to quality of products by Russian manufacturers, new vacancies and effective competition creating, that positively influences interstate relations on the world stage.