Behind the Scenes of Import Substitution in Construction and Agricultural Machinery: Interim Results, Problems and Prospects

Grigory Bolotin, Chairman of the Board of the Machinery Cluster;
Mikhail Bolotin, expert in industrial machinery innovations;
Aleksandr Dmitriev, CEO of CHZSA LLC.

The situation in the road‑construction and agricultural machinery sector at the turn of 2023–2024 is widely known and needs no additional explanation. According to the Rosspetsmash Association, in 2023 the share of Russian producers in the construction machinery market fell by 6 % compared with 2022 to 16 %. In the agricultural machinery segment there was also a decline - from 61 % to 54 %. The market segments vacated by Western companies were instantly occupied by Chinese manufacturers, who are ready to keep increasing their share in all segments, including heavy‑duty equipment, pushing Russian producers out of these niches. This situation looks pessimistic, but details are crucial to gain a full perspective. First, we analyze the dynamics of Russian machinery market in order to understand how we came to the current situation and develop new approaches to avoid past mistakes. Second, by analyzing production chains we gain perspective on systemic problems of Russian producers, which needs to be addressed in order to development the whole industry further.

The beginning of the modern history of the machine‑building sector took place in 2008, when the global economic crisis demonstrated the failure of a domestic industrial policy. While government support focused entirely on preserving the stability of the financial system, companies in the real sector faced a simultaneous collapse in demand for their products and tightening requirements from the banking system. Meanwhile financing programmes for Western companies in Russia continued due to cheap funding from parent companies and export support from the countries where their production facilities were located.

Now this news is perceived quite differently, but back then in 2010-s, it was presented to the public as an unconditional step forward for the entire economy. Retail consumers certainly gained access to all consumer goods from developed markets. But Russian machine‑builders received a full set of Western competitors who possessed unattainable financial resources, including systemic export support from their governments, and a ready‑made wide product range with proven sales and service technologies.

With the dollar exchange rate at 25–30 rubles, Russian consumers could afford what seemed to be the most modern equipment, and adherence to WTO rules allowed foreign manufacturers to enter the Russian market almost unhindered using marketing strategy already deployed in other developing markets. The strength of Western brands combined with unprecedented investments in marketing and dealer network created the image of “always‑running” machines. Despite the presence of numerous service teams, indirectly indicating that Western equipment also broke down, foreign companies knew how to provide timely service and get their machines back on track.

Having studied the market, foreign companies began to create “production facilities” in Russia, which were in essence assembly shops with localization of secondary, simpler components that could be produced inhouse independently and without Russian suppliers. This was enough to convince most consumers that the producers had come to the Russian market forever and would remain with their loyal customers.

While Russian machine‑builders watched with interest how their Western colleagues worked with dealers and consumers, statistics already clearly indicated that growth of the construction machinery market was mainly due to the rise of imports, whereas Russian companies barely held their positions only in rare, unique niches and steadily lost ground in the mass market segments.

The first significant step to support Russian agricultural machinery production was the so so-called “Programme 1432”, under which since 2013 buyers of Russian equipment receive a price discount from 15 to 30 % funded by the government. The results of such strong support did not take long. Against the backdrop of rising subsidies under this programme — from less than 0.5 billion rubles in 2013 to nearly 16 billion rubles in 2017 — almost 80 % of manufactured agricultural equipment was sold under this programme, and the share of Russian producers in agricultural machinery increased from 24 % to 60 %, exceeding the critical level of 50 % in the third year of the programme.

Contrary to the WTO requirements, to reverse the negative trend across the whole range of machinery market, the “recycling collection fee” mechanism was introduced in the automotive industry. Amid WTO lawsuits from a key trading partner of those years — the EU — the mechanism for paying and compensating the fee was modified, but it survived and in 2015–2016 was also applied to construction machinery.

Along with other targeted measures, the negative trend was reversed, and many Russian producers began increasing production volumes, their market share, and even expanding the model range of their equipment. Some of the government support also went to local manufacturing sites of foreign companies, but overall demand for domestic equipment received a serious impulse.

Against this backdrop many Russian manufacturers, mostly traditional Soviet ones, were able to significantly improve their maintenance service quality, allowing them to approach the previously unattainable level of dealer and service networks of Western producers. Producers began creating new Russian machine‑building brands, trying to distance themselves from Soviet‑era stereotypes.

What is even more important, most Russian producers updated their product lines, taking a step towards consumers in terms of operator comfort, equipment performance and simplification of maintenance. Some consumers responded reciprocally, and, realizing that high‑quality Russian equipment cannot be as cheap as Soviet units, were ready to vote with their rouble for the domestic producer. The psychological price barrier was not removed, but at least shaken.

The largest group is represented by plants built and launched during Soviet times that survived various economic crises. As a rule, such producers make the same product as in Soviet times, with a slight (10–30 %) rollback to foreign components. Most producers were forced to switch to some imported components in order to ensure the level of performance required by consumers. Moreover, many Western components were supplied at quite affordable prices and virtually without restrictions. Many representatives of this group also departed from the original concept of full‑cycle production (when the equipment producer has the complete production cycle, including in‑house component manufacturing), because the volume of equipment produced was insufficient to maintain a rational economy of a full cycle manufacturing.

A small but administratively strong group of companies, usually part of the largest machine‑building holdings in Russia, which, using the SPIC mechanism (special investment contract), have the same preferences for the equipment they assemble from imported components as already localized producers. The essence of the SPIC mechanism is that equipment receives all the preferences as a Russian product first, and only afterwards does the producer have obligations to gradually localize it together with foreign partners. Without going into details of various projects, it is precisely the peculiarities of working with foreign, usually Western, partners that largely did not allow the full potential of SPIC to be realized as it was intended.

This group is represented predominantly by small producers that emerged mainly as dealer and service companies of large producers from Group 1. In that case, the products of Group 3 operate in the same niches as those of Group 1. Another way these producers appear is when small component producers grow into independent producers with their own final product in the form of a relatively narrow model range. In that case their equipment is usually from those segments that historically were not produced in Russia. In both cases companies have their own engineering departments; many have already built and are in the process of creating modern production facilities; and they typically have localization level above 50 %.

A relatively simple component, the cabin, is usually assembled by Russian producers domestically, unlike, for example, Western productions where cabs are often produced by independent specialized manufacturers.

Regarding diesel engines, at first glance the situation is most favourable, as there are two suppliers. However, closer examination shows that each supplier is a monopolist in its power segment. Lack of competition leads to expected result: a sub‑optimal ratio of price and quality.

Production of drive axles requires high competences in design and a modern and diverse machining shop. Only a few enterprises are capable of producing such components for their own needs, and only one plant supplies a small range of drive axles to the market for third‑party OEMs.

There has been no development and launch into production of new hydro‑mechanical transmissions for wheeled equipment in the last 30 years. Only two projects in this segment had been announced in the past year, but they cover just several types of equipment, and only one project envisages supplying transmissions to the market.

Hydraulic components are produced only by historically formed players whose production capacity are almost entirely loaded for special‑equipment needs, and the characteristics and cost of their civil products do not meet market requirements.

Competences in electronic components and control systems for various complex units, in particular transmissions, including hydrostatic ones, are held by just a few companies, but due to the deficit of domestic components such systems are based on imported components, and only the simplest types of control systems are supplied to the market.

The lack of guaranteed demand for components due to the small volume of consumption from OEM creates a disproportionate risk for any project to produce the components. Even if there is indicative demand for newly developed components, the volume of potential orders is insufficient for the payback of investments in new components production facility.

The main restraining factor is the almost complete absence of second‑tier suppliers — modern foundries that would supply quality casting, gear manufacturers, shafts and other parts required to modern components.

As a result, we observe stagnation in component production from a technological standpoint. And this problem affects producers of all types of equipment. Many Russian companies have capacities to produce components, but the quality of their products does not meet modern requirements. And this is a systemic problem for all three groups of final equipment producers, which we identified earlier.

In recent years we have observed periodic growth of the recycling fee on some types and power classes of equipment. However, the principles of this process are non‑transparent and for many, at least medium and small producers, are non‑predictable.

It is important to note that if the approaches to increasing the recycling fee were publicly known at least to the active players in the industry (there are not many fee recipients by different types of equipment — this is quite a limited number of companies), then producers would have more optimistic assumptions for their business plans, which in turn would encourage them to invest more aggressively. In reality until 2023 many small and medium market participants learned about the fee increase only from the mass media and already after the fact of its increase.

At the same time we observe quite an active position, often spilling into the public space, of other sectoral ministries and communities that are tied with consumers of construction and agricultural machinery. Their arguments are quite obvious: any increase in recycling fee will lead to a rise in equipment prices, which will cause growth in the cost of construction projects, extraction of mineral resources or agricultural products. Against the backdrop of a nationwide fight against inflation which is approaching double‑digit levels, this argument looks quite on trend, but in reality, is mostly populist.

The rise in the cost of construction projects due to higher equipment prices will likely amount to fractions of a percent, far behind other factors of exceeding the estimated cost. Moreover, the use of equipment in construction projects is not limited to its acquisition. In a more in‑depth analysis of the cost of construction and agricultural processes, it is also necessary to consider many other factors besides the purchase price of equipment.

For example, financial mechanisms for acquiring equipment. Western producers used to provide equipment with long‑term financial programmes with the cost of money significantly below the market rate. Asian producers do not offer such programmes, but instead they offer unreasonably long grace periods for their Russian dealers. But buyers of Russian equipment, on the contrary, have a whole range of programmes for subsidizing both the purchase price of equipment and the interest rate within various financial instruments, for example through the Rosagroleasing programmes.

Proper accounting of this type of preferences could significantly shift buyers’ priorities towards Russian equipment, if not for one systemic problem — funding limits for these programmes are not always available for the amount of equipment that buyers want to purchase.

Another factors - the so-called machine availability coefficient (or machine up-time) of the equipment, its productivity, maintenance cost and repair speed - come into play. As a result, if we count the total cost of ownership, Russian equipment often wins over imported equipment.

Another factor that plays against imported equipment from China is the peculiarity of self-declared technical characteristics of equipment. Except for a few expensive brands, the overwhelming majority of Chinese importers tend to significantly overstate technical characteristics of their equipment. For example, if a consumer needs to transport a load of three tonnes in a warehouse, he must compare Russian loaders of this payload with a whole bunch of Chinese equipment with a nominal carrying capacity of 4 or even 5 tonnes. They will practically do the same job. In fact these machines will correspond to the required carrying capacity of 3 tonnes, but consumers usually cannot check all the technical characteristics of equipment before purchasing,. At the same time, strict procedures for mandatory certification of equipment with verification of technical characteristics, as, for example, for automotive equipment, do not yet exist.

It is also important to separate short‑term and long‑term consequences. The absence of additional support for Russian producers today will bring small benefits to the construction and agricultural sectors — within 0.3 % of cost savings. However, after a few years, when Russian producers are again pushed into crisis, importers will simply raise prices and recoup all the lag in their profitability. The optimal balance between immediate benefits and long‑term consequences can be determined only by a carefully calibrated industrial policy.

In the open debate about the optimal level of state support for Russian producers between industry communities, it is also useful to refer to modern world practice. Against the backdrop of full‑scale tariff wars between the leading trading powers we have the opportunity to analyze what levels of protective tariffs are considered adequate in the modern deglobalizing world.

The brightest new tariff norms are represented in the electric‑vehicle market. The peculiarity of these markets around the world is that ten years ago they practically did not exist, as did producers of such equipment. And now there is both demand for such products and manufacturers that need to be protected. The similarity with our Russian reality is that it is necessary to protect domestic market exclusively from Asian producers, and more precisely — from Chinese producers.

Let us also examine what kind of tariffs are being introduced by the main proponents of free world trade who until recently dragged Russia into the WTO? For example, the United States has increased tariffs on Chinese electric vehicles to 100 %, and the European Union — to 48 %. For electric‑vehicle components tariffs range from 25 to 50 % — this way Western countries support the whole domestic chain of production of electric vehicles.

Against this background the currently existing “protective” measures in Russia look more than modest. For example, for forklift trucks with a lifting capacity of 5 tonnes, which are used mainly at strategic enterprises, the utilization fee amounts to 12 % of the sale price. Considering that Chinese equipment is usually in the low‑price segment, for the remaining small import of expensive Western equipment the tariff would be no more than 8 %. For more mass‑produced forklifts with a lifting capacity of 2 tonnes the tariff amounts to 14 %. Overall, across key product groups the size of the utilization fee generally does not exceed 10–15 % of the market price of equipment.

Obviously, compared to global trends domestic protective measures in Russia look extremely liberal. To analyze the potential effect of escalating financial support to domestic manufacturers we can refer to the results of Programme 1432, where an additional discount of 15–30 % allowed the share of Russian producers in the agricultural segment to increase by 2.5 times in just a few years.

On the other hand, the key argument in favour of gradual and careful increase of the recycling fee is the deficit of production capacities of Russian manufacturers. However, from the producers’ side the situation again looks different: if there is no confidence that the recycling fee is increased, then investments in expanding production capacities may not pay off.

It is extremely important to precisely determine the cause‑and‑effect relationships between the production of machines and components: to achieve import substitution in machines segment, it is necessary first to achieve import substitution of components for these machines. Currently, the SPIC mechanism suggests doing the reverse: first, the legal localization of machines, and only then the real localization of the components. But as practice shows, the second step does not always happen.

Moreover, support in the form of SPIC is available only to large companies and holdings. First, the SPIC mechanism is very complicated from an administrative point of view. Second, foreign partners that must be part of the mechanism, generally prefer to work only with the largest Russian companies. As a result, small and medium players have virtually no SPIC agreements, although the potential and flexibility of such manufacturers is often even higher than that of big players.

Key market participants — Russian OEMs — practically unanimously talk about the problem of the absence or high cost of Russian components. Essentially any producer — of automobiles, forklift trucks or combines — runs into the high cost of Russian components or absence of certain components.

In 2024 industry discussion has already focused on the problem of import substitution of components. Moreover, the situation is completely transparent, and it is now acceptable to talk about the systemic problem openly. For example, the leader of the Russian truck market — KAMAZ — represented by its director for development at the St. Petersburg International Economic Forum 2024 told the general public that materials in Russia cost more than ready‑made foreign solutions. “Today our metal price equals the price of a finished product abroad.”

The largest association of Russian producers of machinery equipment — Rosspetsmash — went further and published a comparison of the cost of gears produced in Russia and China, which along with housings are key components for such units as transmissions and drive axles. The higher (1.5x–2x) cost of Russian components is primarily due to the more expensive (2x–3x) preparatory stages — foundry and forging productions — and higher overhead costs that Russian producers face.

The task of reducing the share of overhead costs in the unit-cost of components has a fairly straightforward solution — increasing production volumes. However, the problem of high input cost of foundry and forging units, as we have already noted, require the highest technological competences and modern manufacturing equipment and technologies.

State support measures for component manufacturing have already been launched, but appear to be fragmentary, do not cover the entire supply chain of component manufacturing and do not fully stimulate serial production. In addition to subsidies for research and development and prototyping of individual components, the Technology Development Agency (ATR) established back in 2016 was relaunched in 2021 with the aim of providing large‑scale support for Russian component production. It is intended to finance a significant part of the costs for developing design and documentation for new components. However, this measure is more aimed at catching up, as it implies re‑engineering of previously supplied import components rather than developing new ones that could more fully satisfy the needs of Russian OEMs. This measure also does not support investing in production capacity, costs that far exceed the costs of design and pilot batches of components.

Over the last 35 years Russian machine‑building industry has experienced many ups and downs, but one thing has remained unchanged — at any moment the industry has operated under conditions of high uncertainty. For the long‑term success of the industry, a transparent industrial policy for the next 10–15 years is necessary.

Despite obvious potential of Russian enterprises to create new types of equipment, there are currently almost no specialized producers of such key units and components as drive axles, transmissions and hydraulic components, which would be oriented toward OEM market. This leads to dependence on Chinese suppliers, which in the context of tightening sanctions presents almost a 100 % risk of not receiving these components in the near future. Such dependence also creates significant limitations in the ability to design new products. Of course, there will always be loopholes through which sanctioned components can be imported. But, first, these components will be significantly, sometimes by multiples, more expensive; second, there will be no technical support from their producers; and, third, fewer intermediaries will want to take on the risks of secondary sanctions.

In order to reasonably restart import substitution, it is necessary first to nurture domestic component producers who are ready to supply components of the necessary technological level to any Russian equipment producers. If components are available to any equipment producer, there will be incentives to expand their ranges by designing new types of equipment in close cooperation with domestic component manufacturers.

In our opinion, the primary focus of industry participants, including the focus of government support, should be shifted from the sphere of producing finished machines to producing components and to second‑tier suppliers — primarily foundry and forging facilities. Supporting such projects, together with restricting measures on imported components, will make it possible, within 3–5 years, to form an internal market for components which will not only find application in already existing models of Russian machines, increasing localization levels, but will also create preconditions for the emergence of new Russian EOMs and the design of new types of equipment, which historically have been supplied to the Russian market from abroad.