I Will Get to the Bottom of This!

Seems like American jurisprudence and righteous indignation are combining to shake some long-held brand images to their very core. Oh, and don't forget a healthy dose of Russian intrigue. All these dubious qualities intensified by the presence of large amounts of alcohol and money.

That is, specifically, a court case in California seeking $1 million in damages (and presumably a cease and desist order) for labeling Stoli as Russian vodka when its actually made in neighboring Latvia. Friendly American consumers seeking to improve relations with Russia have been hoodwinked since 2001 by the French/Latvian axis. Check out the article at MosNews.

Its interesting that there's a battle over the actual origin when it seems that the premium vodka market has already moved well beyond that. Ketel, Chopin, Absolut, Grey Goose - basically every successful recent market entrant - are all made far from Russia. And that hasn't really been much of an issue for consumers.

And Smirnoff, the industry giant in sales, hasn't had anything to do with Russia since 1917.

Vodka is an interesting consumer good, since it is driven nearly all by marketing. For example, the legal definition according to the Bureau of Alcohol, Tobacco, Firearms and Explosives is a neutral spirit "without distinctive character, aroma, taste or color." Vodka manufacturers (except for one or two boutique houses) purchase already distilled neutral spirit, and do a modicum of filtering and flavoring before bottling. The value add is in small variations from the raw material and differentiation from other brands, with much more effort put into designing packages and clever ads.

So back to Smirnoff. You don't buy a Smirnoff Cosmopolitan and expect to pay $12 for it like you do when you order Grey Goose. And yet, an exhaustive survey by the NY Times (Jan 26, 2005) editors for the Dining Section - with help from professional bartenders - placed Smirnoff squarely at the top of a list of 21 vodkas. Something similar happened in 2003 at an industry event in San Francisco. All by way of saying that if you use your vodka in mixed drinks like the vast majority of Americans, you are pretty much guaranteed not to notice a difference in taste.

So smile the next time the poser next to you at the bar orders a $10 Grey Goose and Tonic. Or, order one yourself if you're with very shallow people.

You can read the NY Times article at the Smirnoff site. You'll have to "prove" you're of legal drinking age by entering your date of birth on the main page. Don't worry if you can't subtract 21 from 2005 easily, the pulldown menu of years goes all the way back to 1900.

Out of the Frying Pan and Into the Fire

Mercer published a new list of the most expensive cities in the world. Mercer is to expensive cities as Forbes is to rich people or that Mr. Blackwell guy is to fashionable celebrities. Here are some of the top contenders for 2005.

1 Tokyo

2 Osaka

3 London
4 Moscow
5...6...7...8...9...

13 New York City
15 St. Petersburg, Russia

My previous rationale for this statistic when talking about Moscow was to put the data into context. Mercer is looking at common prices for expat packages, with certain standards of quality, size, etc. For example, the price in Moscow for a European-renovated apartment that would be comparable to living arrangements in Paris, or NYC, or London, etc. That sort of apartment is in pretty short supply in Moscow - so they tend to be very expensive. In effect, the normal standard of living measured by Mercer is actually available to only the richest class in Moscow, and the premium pricing shouldn't be any surprise. Overall, the supply/demand imbalance is really a distortion of the true price structure of a city.

As noted, that was my previous rationale. A rationale that disappeared in a small puff of white smoke when my landlord submitted the paperwork to convert my rental apartment to condo. The initial offer to sell to me values my apartment at $2000 per square foot. With a top-end at $2500 per square foot.

The rationale that replaced the old one is not very encouraging. Its a realization that I evidently enjoy living in exactly those places that are in the crux of the imbalance. So what if Moscow is overly inflated for purposes of the Mercer list? I'm going to be living in the very midst of that exact neighborhood. Just as I apparently live in the midst of one here.

Stupid well-developed sense of entitlement.

So just look at the faulty nature of my logic if reflected on my situation at home. Sure, I'd say, way out in Brooklyn is much cheaper since it doesn't fall prey to the supply/demand problems and premiums associated with living in Manhattan. The apparent cost of living in New York, therefore, is inflated by this distortion. But I didn't choose to live in way-out Brooklyn. I chose to live on 57th Street in Manhattan. While there may very well be distortion in true prices, it definitely defines my reality.

And will likely continue to define my reality even in Moscow.

The truth is I don't have to worry too much. The fellowship is picking up living expenses and providing a very generous stipend. I just have to not pretend to be a billionaire oil baron, and I should be alright.

Thoughts on Capital Allocation and What I Want To Do in Russia.

“Economic growth should be a national idea, and it should be generated not by the extraction of mineral resources but by the development of innovative industries,”

Vladimir Putin -22 May 2005

"...over the next few years the country's economy will not be able to ride the oil engine anymore. So the issue of new, innovative sources for [economic] development becomes crucial for reaching the social targets set and ensuring a decent position for Russia in the world."

German Gref, Minister of Economy - 16 June 2005

I've been thinking about the Russian economy quite a bit during the research phase of what I want to do for the professional assignment part of this fellowship. Oil is currently getting all the attention, and the country's prosperity is certainly largely a function of >$50 a barrel crude. Russia’s giant oil companies already command hefty market capitalizations. Indeed, the largest components of the RTS exchange already have demonstrated access to global capital. Adding to that market cap is helpful to a degree, but the benefits to the companies and the general economy are at best an indirect function of the secondary marketplace.

The real engine of sustainable economic growth has to be developed outside of commodity markets. I believe that Messrs. Putin and Gref are looking into the future and getting nervous. Broad-based prosperity can only continue long-term if other industries are born. Russia should be using the oil windfall as capital for development of emerging industries. If Russia were a company, we'd say it should milk its cash cow and redeploy the capital into new ventures.

Certainly, Russia is making some of the right moves. It's using oil profits to pay down its debt and to boost foreign currency reserves. But the government needs to follow up on Putin's and Gref's comments by creating a more hospitable environment for small and medium (non-oil) businesses.

I'm fascinated by this turning point in the development of the Russian economy, and I would really like to get a much closer look. So, private equity, venture capital, and the IPO functions of investment banking are the main areas for me to explore as a professional assignment. All these capital allocation functions are vital ways that small and mid-sized businesses get funded in a critical period of their growth cycle. Jobs get created, social welfare increases, economic and legal frameworks are born, people gain experience in professional workplaces and eventually start their own businesses, and the national economy is founded on more solid bedrock of many stakeholders creating their own futures. In short, it may be the birth of a virtuous circle.

Of course, a statement as simple as that is obviously complicated in a place like Russia. Only days before my first conversation on professional assignment interests, The Carlyle Group abandoned its efforts to raise $400 million for a Russia-dedicated fund. They even went so far as to pull the plug on the Moscow office. Now, Carlyle is a successful private equity firm - but their real core competency is as a fundraiser. They've been able to tap nearly bottomless pools of capital for funds all over the world. And a relatively modest $400 million fund for Russia completely stymied them. Hmm.

That would seem to have put the kibosh on the Private Equity idea, but several other pieces in the news point to a slightly rosier picture. In February, Barings Vostok raised a $400 million fund. Alfa Capital announced its participation in a $180 million fund as of April. And last but not least, Delta Private Equity Partners raised a $120 million fund the same week Carlyle called it quits. Perhaps there's hope after all.