With the lifting of sanctions against the Islamic Republic of Iran in January 2016, the country may finally be opening up its markets to the outside world, with several opportunities for both domestic and multinational manufacturers within the food and beverage industry.
The possibilities of a post-sanction Iran
Iran has much to recommend it. With a population of nearly 80 million and growing annually by 1.3%, it boasts a young population, with 63% of its population below the age of 34. In particular, the young in Iran are well-tuned to Western trends, primarily due to extensive travelling, high internet usage and interest in social media. Moreover, Iran is a huge economy with an extremely rich mining and energy base. According to industry sources, Iran has the 17th largest economy in the world, with a GDP of approximately US$430 billion in 2015, and is expected to grow between 1% to 2% over the next five years. Iran is also expected to achieve the second highest disposable income per capita in the Middle East, after the United Arab Emirates, illustrating the country’s high spending power.
Nevertheless, it is important to keep in mind that economic indicators, like high inflation and unemployment, continue to be problematic, with the official inflation rate at about 20%. This has led even loyal consumers to downgrade to cheaper alternatives of some consumer goods.
Despite this, the recent lift in sanctions is expected to offer new opportunities for foreign investors to enter the market, and which may help alleviate current economic concerns. There are two types of foreign investment laws. The first is the Foreign Direct Investment, where the investor must keep their money in Iran for a minimum of two years before they can take a principle out; however, they can take dividends in the interim. The second option, known as the FPI (Foreign Portfolio Investors), is where each investor can own up to 20% of a public listed company. If an investor wants to go above 20%, they must apply for a Foreign Direct Investment license.
In addition to foreign investment opportunities, Iran is a very tax friendly country, as there is no dividend tax for Iranian and foreign investments and no capital gain tax either. Consequently, the key investment methods, as well as the tax system, is a fruitful means in attracting potential foreign investors within the food and beverage markets and is likely to widen the brand portfolio in various categories that are already dominated by domestic manufacturers. According to official sources, post-sanction reliefs are expected to reap many rewards, as the Central Bank Governor of Iran has estimated that foreign direct investment into Iran is expected to reach US$50 billion in the forecast period as a result.
Equally, methods to facilitate the transfer of money are already taking place. With the lift of the economic sanctions, the Iranian banking system became connected to the SWIFT system again in March 2016, making money transfers more transparent and easier than before. During the sanction period, exchange houses were used to transfer money back and forth, which caused long delays in payments due to increased bureaucracy. Add to this, the high taxes that the government currently impose on imports to protect domestic brands in some food categories, for example the confectionery category, may change. Post sanction reliefs can lead to the potential for Iran to join the WTO (World Trade Organization), giving leverage to remove unreasonable tax implementations on multinational brands, which currently contributes to the price gap between domestic and multinational brands.
In addition, the currency exchange rate is gradually improving. In 2012 the currency rate to the dollar was three times the official rate. Now the gap between the free market rate and official rate has decreased to around a gap of 20%, according to industry sources, and this is likely to improve further as more multinational companies invest in Iran, stabilising import prices. For now though, it is recommended that multinationals send their money through the existing exchange houses until the two rates are unified, something that is expected to happen by the end of 2016. Following the high inflation in the country, as well as the declining purchasing power of its citizens over the past decade, this is one challenge that may take some time to alleviate in the short-term.
Implications for the packaged food market in Iran
Even under sanctions, Iran saw the highest retail value sales for packaged food in the Middle East, worth US$30.36 billion in 2015, according to Euromonitor International, with growth of 23% over the previous year. As a comparison, Egypt witnessed 16% value growth. Moreover, looking at per capita consumption, Iran has the third highest packaged food sales in 2015, and is expected to achieve the highest growth in the Middle East, with a 33% CAGR over the forecast period, following the improved economic situation.
Certain packaged food categories are dominated by domestic players more than others, and this often has to do with the tax on imports, making international brands more expensive than their domestic counterparts. This can make it difficult for multinational companies to compete in these categories, particularly as Iran is a price sensitive market. This can lead consumers to purchase less expensive brands, particularly for staples such as dairy, baked goods, confectionery and oils and fats. Equally, price control by the government on staple items can dictate which brands consumers end up buying. Domestic companies that lead the packaged food industry include Nami Nik Nahad Food Industries Co, Behshahr Industries Co, Kalleh Dairy Co and Pegah Dairy Co., and their success is due to strategies that focus on strong brand image, product diversification, innovation with new flavours and new packaging, strategic direction towards health and wellness, as well as a wide distribution network across main cities and the Northern regions.
Baked goods in particular will likely continue to be led by domestic companies, with Iran having great agricultural land to grow wheat in the West and Northwest of the country. Domestic production for categories such as bread is cheap and historically has been subsidised by the government. Though these subsidies have recently been removed, thereby making it more expensive for consumers, with raw materials easily available, local production for baked goods is still more profitable than for imported ones. The government also has an ongoing land redistribution program, making better use of agricultural land for food production in the country. Still, with Iran being the world’s largest producer of saffron rice, pistachio nuts, honey and spices, this local availability of raw materials has given domestic producers leverage in their production costs.
Like the baked goods, dairy production is led by domestic players, as Iranians seek freshness in these products. Eggs, butter, cheese and milk are a major part of the typical Iranian diet, alongside saffron rice. This goes to explain why domestic players in dairy such as Kalleh Dairy Co have dominated the category for so long. Also, In Iran, yoghurt is referred to as a miracle food and is used for treating many medical ailments and milk is commonly used in homemade traditional Iranian desserts. With leverage of cheap raw materials, domestic dairy companies are able to produce processed and unprocessed cheese at cheap rates, making it affordable amongst urban and rural areas in cities outside Tehran and Mashhad. These products are predominantly sold in independent small grocers.
Still, with strong partnerships amongst domestic and multinational players, this can change, benefitting both. For example, Behshahr Industrial, which dominates oils and fats, was able to leverage its local resources by merging with Savola Co a decade ago, which led to economies of scale and improvements in production facilities. Such joint ventures and mergers are expected to continue to leverage multinational expansion. Hence, for any multinational looking to penetrate the rice, nuts or honey markets, the company would need to partner with an existing producer or establish a local factory.
But there are some packaged food categories where multinationals dominate, though often these are niche categories, such as baby food milk formula, which also are expected to be among the fastest growing categories over the next five year. Such multinationals were able to succeed due to their financial investment in production, establishing their own local factories for their brands, avoiding issues like import tax.
As an example, of all of Nestlé Iran PJS Co’s brands, only baby food and bottled water are produced locally, while other brands are imported, thereby limiting their penetration in the country. For example looking at the chart below, Iran barely makes a dent in the overall global market (see red arrow), representing less than 1% value share and ranking 38th. Despite this, Iran is one of Nestlé’s biggest countries in the Middle East for milk formula and bottled water due to its local production of these products.
Future company strategies may need to focus on establishing additional local factories and expanding their existing distribution subsidiaries, avoiding the use of third parties in the country to reduce costs.
With an expected increase in international brand launches, consumer awareness is likely to increase as multinational manufacturers re-enter the market or introduce more products. Over the next five years, the key categories that multinationals should seek to invest in will be breakfast cereals followed by spreads. This will mainly be driven by the limited local resources within this category, and expected growing Western influence led by the demand for healthier eating habits following the support by the government to reduce obesity in the country.
For example, Tourang International Food Industries, which owns the Famila breakfast cereal, and Nesquik by Nestlé Iran PJS Co, were relaunched in 2015 after leaving the market years earlier, due to anticipation of sanctions being lifted. Nestlé Iran PJS Co started producing Nesquik flavoured powder milk in its factory in early 2016. The bulks of its products are imported and then are packaged inside the Iranian factory. In addition, Nestlé Iran PJS Co started to do the packaging for instant coffee. Danone Sahar also launched their brand Danone within cream in 2015, while previously the company was only present in baby milk powder and desserts in Iran.
Of course, for existing domestic companies the possible entry of multinational new comers and further expansion of the activities and brand portfolio of existing domestic manufacturers may pose a threat. Still it may bring scrutiny to their products, as some brands may need to improve quality standards and packaging of their products to remain competitive.
However, there are some benefits, as key domestic players such as Kalleh Dairy Co and Pegah Dairy Co will be able to import raw materials and export finished products without the need of unofficial dealers or the smuggling of products. This is expected to enhance the export market for local food and beverage companies, especially to some of their most profitable neighbours such as Iraq, Afghanistan, and other border countries like Pakistan.
Implications for the soft drinks market in Iran
Iran also has the second biggest retail value market for soft drinks in the Middle East, after Saudi Arabia, with value sales of US$2.8 billion in 2015. Juices dominate, primarily led by domestic manufacturers that include Alifard Co and Takdaneh Co, which have gained strong share in the country due to their low domestic production costs, making it hard for imported brands to compete. However, with sanctions lifting, as well as the joining of the Iranian banking system to the SWIFT process, this is expected to change, with more multinational brands expected, and an increase of competition within the country. These changes should also trigger stable multinational brand performance.
During the forecast period of 2015-2020, soft drinks retail value sales are expected to grow by a 32% CAGR, followed by Egypt at 16% and the United Arab Emirates at 8%.
Juice and carbonates dominate in Iran in retail value terms, the latter being led by Coca-Cola and Pepsi Co, where their concentrates are imported and produced in local subsidiaries under license of Koshgovar Mashhad Co. The carbonates category is expected to benefit from stable shelf space and product performance post sanctions. Other categories, such as bottled water and juices, in comparison, are dominated by domestic manufacturers such as Zamzam Beverage Co and Alifard Co. These companies are likely to face strong competition if more multinational manufacturers enter juices, or if existing multinational brands open more local factories, thereby reducing their costs.
With juices expected to see the highest value CAGR of 12% over the forecast period, this is expected to prove a high potential market for multinational companies to take on joint-ventures or introduce local factories following Iran’s incentives in cultivating fruit. Iran is the world’s leading producer of berries, and this is one ingredient that has become really popular amongst domestic companies in brands such as Sunich by Alifard Co. Hence the cheap raw materials and ability to grow berries in the country has helped keep production costs down for domestic manufacturers. Juice is also becoming a substitute to carbonates, with the growing health and wellness trend arising and governmental campaigns promoting obesity reduction. It is also worth mentioning that it is very common for Iranians to mix juice with alcoholic drinks at their homes. However, the potential for some regional companies to penetrate this category is likely to be limited, for example Almarai Co Ltd and Al Rawabi Co, with the conflict between Saudi Arabia and Iran at the moment. However, there is some potential for European brands to enter this market via joint ventures or using local production to try to be competitive in terms of pricing.
Furthermore, with the Iranian Government not investing much into the quality of water in the country, the necessity of quality bottled water will continue to feed into future demand. Existing multinationals were able to maintain their strong dominance in bottled water in Iran mainly due to their local production. Furthermore, domestic bottled water companies did not have the distribution leverage across the key cities such as Tehran, Mashhad and the North region that brands such as Damavad by Damavand Mineral Water Co and Nestle Pure Life by Anahita Polour Co had. Hence, multinational strategies will need to focus more on buying out stocks of domestic producers and leveraging local production. One of the best quality springs for mineral water in Iran exists in Polour Village and Damavand Mountain, which makes local production for multinational companies easier due to the wide natural resource.
Another way for bottled water companies to succeed is demand for small pack sizes. Currently these unique innovations are led by leading bottled water company Damavand, as this is the only company in Iran which produces bottled water in pack sizes of 1.5l, 500ml, 296ml, 250ml, while all other bottled water players, including Nestlé Pure Life, only sell 1.5ml and 500ml.
Changing distribution landscape
If Iran’s relationship with the US and the West continues to become more positive, then joint-venture schemes are likely to increase. This should result in the establishment of factory and production plants, as a lot of multinational brands get set to re-enter the market, with some domestic companies benefiting from a wider product portfolio, for example, Nestlé SA operating with Pegah Dairy. This could mean that domestic production of well-known multinational brands in the country could be established and can change the competitive environment, strongly challenging the dominance of domestic brands.
As such, the channel distribution landscape for food and beverage companies is likely to change. Currently, traditional grocery outlets dominate the landscape, representing 90% of the food and beverage sales in the country. An end to sanctions is expected to encourage rapid growth in modern retail channels, which is likely to encourage the popularity of hypermarkets at the expense and loss of independent small groceries. This will definitely challenge domestic manufacturers and benefit multinational brands, as modern retail channels give them a better opportunity to increase their product visibility and brand awareness.
The food and beverage landscape in Iran is expected to see drastic changes within categories led by domestic players; as existing multinational brands continue to import into the market with greater ease, their value share is expected to grow. Domestic manufacturers will face pressure from more imported brands, especially in categories where domestic manufacturers leverage the traditional channel landscape, such as juices and dairy. To succeed, multinationals will need to open up more local factories to remain price competitive, or create relationships with local players, for example the local production of Nestlé’s Maggi soup. Other manufactures are expected to form joint ventures, especially in categories that are dominated by domestic manufacturers. The threat of multinational penetration will also lead domestic players to adopt different management practices to reduce bureaucracy and maintain competition on a local and international basis.