Season of the Forecasts that Came True

If we try to analyze the development of the Russian market of air conditioners for the last five years, we have to añknowledge that the season that has just ended was the most “quiet” when sales volumes and all the trends have been in good agreement with our forecasts (see “Climate World” ¹29 and ¹30).

Destined to Growth

The structure of the Russian market of RAC/PAC air conditioners, evolved by the end 2004, looked the way that the following season's sales were destined to growth. The practice of the many previous years showed that the segments of corporate orders and higher-class housing stimulate market even in spite of cool summers. At the same time, the share of split systems in mass housing proved to be quite negligible in 2004, and even its further dwindling due to cold summer countrywide would nor result in overall market shrinkage.

That is why the lowest expansion of sales of split systems that could be expected in 2005 was 15%, and the highest, in case of heatwave all over European territory of Russia, – 35-40%. If demand reached the latter estimate it could have meant shortage of equipment and available installers.

The reality for 2005, as it often happens, was right between the two extreme estimates. The season's start was characterized with brisk market to the extent that the things took the turn to the highest estimates. The suppliers were not prepared for hot May which resulted in stockout for some brands – the phenomenon unheard of since spring 2003. In the event of hot June the market could face an acute and all-embracing stockout especially when conservative orders for the coming season of majority of suppliers are taken into consideration.

As a result, a number of companies rushed second orders. But June happened to be cool on the major part of Russia. None the less, the market moved ahead by inertia during the first half of June, and manufacturers of equipment were kept busy. July did not bring the expected heat and there appeared a threat of unprecedented in-stock balances by the end of the season.

Russia. Sales dynamics of air conditioners for standard housing in 1994-2005
	Window type Mobile Split systems
Chart 1

But hot August and prolonged heatwave, practically till the end of September in southern Russia (with temperatures at and above 30 C), came to rescue. The sales there jumped 35-40%. The main push was provided by owners of standard housing, who abstained from buying equipment for a couple of previous years (see Chart 1). Unlike in earlier years hot weather did not provoke higher demand for window-type air conditioners. Their appeal to house owners continued to decline (see Chart 2).

Russia. Share of different types of air conditioners installed in housing in 1994-2005
	Window type Mobile Split systems
Chart 2

At the same time, in the northern regions of European Russia August was quite warm but not hot. Average day temperatures that summer were 1.5? C above normal, but there were no hot days. In Moscow day temperatures were never above 30? C, and there were not more than 3-4 nights when people could feel need for air conditioner to sleep comfortably. As a result, the sales of split systems for standard housing were neither bad nor good and sales growth in northern and central European Russia was only 15%/

The total sales of split systems in Russia grew about 26%, while sales of window-type air conditioners marked time and stayed at the level of the previous year. It is quite logical to postulate some changes in the total structure of the Russian market taking into consideration the decisive role of southern regions in the final growth rate.

In the first place, southern Russia is a mass market for inexpensive equipment. It is no surprise then, that the share of economy class brands (mainly of Chinese origin) on Russian market as a whole grew from 17 to 22%.

In the second place, south of Russia is the area were the positions of trading houses are somewhat stronger. And 2003-2004 were not the best seasons for these outlets because of cool summers and low demand from owners of standard housing. But in 2005 they managed to get back own and practically to double their sales. That is why the share of Korean brands in the last season (unlike in 2004) did not DROP.

In the third place, in spite of the faster growth of sales in the south, the share of window-style air conditioners in overall air conditioner sales DROP ped again, this time from 26% to 22%.

Great Scale Redistribution

Analysis of trends in Russian economy in the last 3-4 years shows a clear tendency towards integration of businesses. In place of small shops there appear chains of supermarkets. Drugstores, cellular-communications salons, movie theatres – in each of the branches several monopolists capture a lion's share of the market.

In climatic business the process goes on since 2003. Namely that season faced the most important development that became the watershed between two epochs – market saw the last of deficit. Before that year the working capital slightly above $ 100,000 (the price of one container of split systems) would suffice to start one's own supply business. From summer 2004 on, climatic market is characterized by overstocking. Dealers then received a chance to pick and choose with what brands and what suppliers to work. It became obvious that only suppliers able to maintain constantly the full inventory of the whole range of equipment could stay competitive. For brands with wider nomenclature of equipment, warehouse inventory had to be (at the lowest) around 1,500 split-system units. With the present level of profitability of wholesale trade, working capital turnover should be 2.5-3 times a year. That meant that the sales volume should be 4,000-5,000 units. It was found out that only 15-16 distributors could meet the challenge. They expanded their joint share of the wholesale market which is about 75% now.

Other suppliers were forced to move to some narrower segments (PAC, VRF) or to concentrate on industrial climatic equipment (central systems, ventilation). The second choice for smaller distributors was to make their warehouses easily accessible for each other. One jointly used warehouse with 1,400 units in it is a far cry from two separate warehouses with 700 units in each of them. Joint warehouse programs allow forming a balanced assortment that could be of interest to dealers, unlike in the case of smaller warehouses with possible gaps in availability of PAC equipment or multi-split systems.

We see quite similar situation on the level of separate cities. There are several major companies (1-2 or 10-15, depending on the size of the market) in any city that expand their sales and grow successfully. As far as the rest of the local aircon community is concerned, we see shrinkage in size of small and medium companies. Their number goes up while turnover per company goes down. Diminishing profitability of air conditioner market will inevitably lead to extinction of significant number of dealer companies.

Some companies have already “immaterialized”. They have no office, and what is left of them is, in fact, their director with a mobile phone. Redundant and now “free lance” installers work for several such “bodiless” companies. By the way, the freelancers have settled the problems of trading houses with equipment mounting. They were not forced to ask favours of specialized companies, as earlier, since unemployed technicians lined up in front of their doors. Thus we have a system crisis of the branch on hand which will inevitably result in fewer players on all strata of distribution system and stabilization of the market.

What to be expected

The above mentioned tendencies will stay on in 2006. The major distributors will grow further, making a place too hot for less successful ones. Trading houses will probably again face huge unclaimed in-stock balances and suffer losses. Sales of equipment for standard housing will grow insignificantly in 2006 even in case of hot summer. Sales explosion of 2005 in this segment stemmed from deferred demand. Many potential buyers of 2003-2004 abstained from purchase because of cool weather. Namely this group of people pushed the sales in trading houses. By 2006 this potential will be exhausted, but household equipment shops (habitually basing their plans on the latest achievements) will, in all probability, order much excess stocks.

Average growth rates will gradually diminish. In a number of regions (south of Russia, Samara Region, Moscow, Yekaterinburg) the market has approached the saturation point and will stabilize in the nearest 3-4 years at 130-160% of the present sales volume. The growth rates later on will not be above 5-7%. With the passage of time the growing part of sold equipment will be needed for replacement of obsolete equipment. If in 2005 about 7-8% of sales went for the above mentioned purpose, it is expected to be around 12% next year.

This trend has a number of important consequences.

In the first place, it provides a big advantage for the companies expanding repairs and servicing of equipment lines since in majority of cases namely these companies are going to replace the old equipment.

In the second place, the share of expensive, prestigious equipment is substantially higher in “second” sales. People who tried any piece of equipment, as a rule, will not agree to anything lower in class. So, in medium-term outlook one can expect a slow but steady growth of the share of sales of Japanese equipment. And a number of Korean and Chinese brands will probably try to raise their image to “premium” level.

One can state with a degree of certainty that after 2005 season there will be no new players and no new capital flow to Russian air conditioner market. Quite the opposite. The profitability in distribution has DROP ped to the extent that there is an outflow of capital to other branches of economy with substantially higher profitability.