School alumnus, and winner of the School’s Accomplished Entrepreneur Award, Ian Zilberkweit went from being a Director in HSBC’s Corporate Finance Group to growing one of Russia’s largest bakery café chains.
Russia’s tough, but not how you’d think
When business people think of Russia, probably the first word that comes to mind is corruption. But that’s not the real problem for a small consumer led business like ours that’s seeking to grow – it’s the lack of a developed SME infrastructure, other small businesses like yourself who you can contract services out to, so you don’t have to do it yourself.
So it might seem alien, but for us the way of growing a chain of bakery cafés involved such things as buying a bespoke bakery of our own, becoming the main food supplier for a famous coffee chain and setting up our own construction and design company, employing its own architects and lawyers. We didn’t quite have to become candlestick makers, but we weren’t far of.
To examine why this happened, let’s take a couple of steps back. Why did we decide to take the Le Pain Quotidien (LPQ) brand to Russia in the first place? First of all, I was involved in building LPQ’s franchise in the UK and Ireland, when a friend suggested doing something similar in Russia. And the more my Russian partner, Gogar Gargossian, and I explored the idea, the more it made sense.
It was the middle of Russia’s big mid-2000s economic boom, and we saw huge potential in Russia for a quality bakery café, something no one else was doing, serving the need of a growing middle class for inexpensive city dining.
Russia has always had a big bread culture, but the traditional artisan way of baking bread, the way your Russian babushka (grandmother) would make it, fell out of practice completely in the Soviet era. Then the emphasis was on quantity, not quality, on feeding the burgeoning city populations. Instead of quality baking, bread became a mass-produced, low-quality factory product.
We saw the LPQ formula – high-quality bread baked traditionally, used to make tartine sandwiches, alongside nourishing salads and soups, and good coffee – as one that would work here. And we’ve been proved correct – now we have 47 shops in Moscow and St Petersburg
But how we got there was anything but conventional. And our pioneering progress actually contains a few important lessons for companies seeking to succeed in Russia.
Our first challenge, as I said earlier, was finding reliable – and affordable – suppliers. In Russia, we found, these simply don’t exist, by and large. Local contractors are either highly unreliable or very expensive. Those that are good charge a big premium for reliability.
One illustration of this was how we built the interiors of our shops. In London, for example,you would just outsource work to a contractor, but in Moscow that doesn’t work: work is either hideously expensive or late – or both. Trust is expensive, and all the rest are cowboys.So we ended up creating our own construction company, embedded inside LPQ, with 20 people, including two architects. We make the furniture ourselves from local products – we found 50-year-old wooden railway carriages that provided just the right kind of wood, and it works fine.
But it’s an indication of our difficulties that to get it right, we had to learn how to do it ourselves.
Money in the bank
Now we come to our biggest challenge, which has been capital. This we’ve learned the hard way, unfortunately. Initially we did very well, growing the chain of cafés to the point when it was time to look for an investor. We needed £2m. It was 2008, and the market was just about to collapse. This was when I committed a cardinal sin: I waited, instead of clinching a financing deal.
We thought we’d found the perfect investor for £2m, so we stopped talking to other people who were interested. But when the markets tanked, the deal evaporated and the money never arrived. It was simply that this successful self-made Russian guy, who was worth £500m, couldn’t be bothered to follow through with a deal he’d signed. He didn’t even return calls or emails – he just walked away, because he could.
The lesson is that if there’s a decent deal, take it today. And the thing you have to remember about Russia is that a deal isn’t a deal until the money is in the bank. We lost three years, we couldn’t raise capital – no one was putting money into Russia – and it took until December 2012 to recover from this, when we received a capital injection of £4m.
So how did we get around this problem? Bizarrely, the solution was in the tough market conditions themselves: other people, including our competitors, had got into more trouble than we had. As they faced a cash crunch, they had to sell up. This meant we were able to acquire four competitors for shares, paying hardly any cash. As a result, we got a lot of good, second-hand equipment for making our products.
But the biggest break was the failure of a supermarket chain, which went bust leaving a brand new, state-of-the-art bakery, 30 miles outside Moscow, on the hands of real estate developer Fleming Family & Partners. We were able to get a very reasonable 20-year lease on the property (we later bought it) and this facility now forms a big part of our core assets. This bakery is at the heart of how we turned around the business. Buying only raw ingredients, we are now able to make all our 400-odd products locally – and this makes a huge difference.
We are able to offer what other suppliers were not – a good-quality bakery and good products at reasonable prices. This has led one leading coffee chain to rely on us for virtually all of its food products – a whole other third-party business we never anticipated when we came to Russia.
The acquisitions and the factory had a transformational effect on our business. And the lesson is clear: we had to focus on making more from what we had, rather than relying on an injection of capital to build.
An all-Russian workforce
Another challenge has been training up our people, and building a good management team. On the surface, it looks as if business in Russia should be profitable because labour costs are lower. But the problem is that, particularly in our industry, service quality is lower too.
During the Soviet era (and for a while afterwards, to be honest) there simply was no tradition of good quality service in restaurants. For the enthusiastic young people we wanted, it often didn’t seem like a good career option, as some of them wanted to start their own small businesses.
London is different – there you have an abundance of people for all different kinds of roles, from waiting staff to accountants and managers.
In Russia, it’s very difficult to find people with more than five years’ experience in this line of work – in part, because the number of network operators is limited, and also because the financial crash in the late 1990s caused horrible disruption to businesses and to the training of people working in marketing, accounting and senior management of small companies. In London, those people are lining the streets – but not in Moscow. So, as a result, you have to ‘double up’ – employ more staff, in part to check on other staff. And we had to hire people with very little experience and train them on the job.
But we have succeeded in building up a good team now – and it’s based purely on Russians, not foreigners. There are no foreigners working at LPQ in Russia, apart from myself and Grogar, the General Director. The other 1,000 people – 700-800 of whom are in retail, while 150 are involved in bakery production and transportation – are all Russian.
We are also finding that loyalty and honesty among employees counts for much more in Russia, and the up-and coming people in our company are young: most senior managers are in their early-to-mid-30s.
Shop within a shop
The other two key challenges were the cost of rent and ingredients. Rent for our cafés in Moscow is higher than in London – in one key measurement: you get fewer sales per square foot than in London. So rent is higher as a percentage of sales.
One of the reasons for this is the under-supply of retail space. Traditionally, from Soviet times, the ground floor of buildings was occupied not by retail (there were hardly any consumer goods to buy) but by apartments.
So the money you might save from lower labour costs in fact disappears. It doesn’t go into the company but straight to the landlords: it’s literally classic rent-seeking behaviour.
One of the solutions to this problem came, again, from the difficulties other Russian companies were facing. Because it’s so hard to find good quality, decently priced bread and other baked goods, a leading supermarket chain, Perekryostok (Crossroads), approached us with the proposal to set up shops within- shops: bakeries inside their supermarkets.
This is clearly a win-win, and now accounts for the biggest number of our shops: 30 out of 47 are now under the Nash Khleb (our bread) brand in Perekryostok supermarkets.
We got this business because we had established ourselves as a bakery of quality. We were reliable, and this is what you look for in Russia: not perfection (you’re never going to find that), but a reliable partner you can trust.
Production facilities the key
The last, perennial problem we had to solve was the cost of ingredients – as a really high proportion still have to be imported.It may seem bizarre for a country so huge as Russia, but sourcing good quality ingredients, from greens to quality cheeses – can be a nightmare. Even after seven years working in Russia, we still find that 50 per cent of ingredients in summer have to be imported, and that rises to 70 per cent in winter.
In addition, there are big transport costs, and customs costs that are passed on by suppliers to us and our customers. An example of this was the Cheesecake Crisis of 2012. For some months, Kraft’s Philadelphia cheese – the basic ingredient for all good-quality cheesecake – had been hit with an import ban. That meant that nowhere in Russia could you make good quality cheesecake. There was some stuff called cheesecake with much poorer quality ingredients, but not the proper stuff. So we had to take it off the menu.
The only ways that we keep our food costs under control are to keep searching hard for locally sourced ingredients, and to buy only raw ingredients and make all products ourselves from scratch. Every soup every croissant has been made in house.
The result is that we are now a very highly vertically integrated company in Russia – which an equivalent café bakery chain in the West of our size would not be. This is paying off, however, in that we are increasingly becoming a key supplier of quality food products to supermarkets and coffee shops. So we have achieved our goals, to provide a great café experience and good quality food, while being in the top two premium bakers and a supplier of quality foods to leading caterers.
In short, we are where we wanted to be. It’s taken us three years longer than it should have done, but in the process we’ve learned some other ways to grow the business that can only stand us in good stead for the future.
Ian Zilberkweit is President and co-founder of NX Bakery Group (incorporating Nash Xleb, Le Pain Quotidien and Breadway).