Contracts Matter: Lessons on Unprotected Partnership Agreements from a Kazakh Entrepreneur

04.06.2021 | Zarina Bekbolat

This post is also available in Russian.

Valuable lessons come out of failures. Zarina Bekbolat, an entrepreneur from Kazakhstan, learned this firsthand when she left her stable career in auditing to go into business with her family. Though her family’s dairy distribution business experienced initial success, it eventually had to shut its doors after an important partner pulled out of a crucial contract. Her story reflects the challenges of entrepreneurs everywhere and shines light on the unique difficulties faced when starting a business in an environment without sufficient legal protection for contracts and agreements.

Kazakhstan’s economy has grown dramatically over the past twenty years. Its gross domestic product (GDP) alone has increased from $17 billion in 1999 to some $165 billion USD in 2020. Since 1999, the number of active companies has grown sixteen-fold, with the most significant increases seen in the trade, construction, education, telecommunications, and processing industries. In Nur-Sultan, Kazakhstan’s capital, the private sector is the largest employer, providing jobs for many of the capital’s residents and representing 55 percent of gross regional product (GRP). Private business accounts for more than half of tax revenues, the highest figure for any region of the country. To further grow GDP, the Kazakh government has launched programs, such as the Employment Roadmap, Business Roadmap, and Nurly Zhol (Bright Path) programs to support entrepreneurs. While these programs have seen some success through loan interest rate subsidies and guarantees, there are many remaining problems facing entrepreneurs that have yet to be addressed.

The Center for International Private Enterprise (CIPE) currently works in Kazakhstan on projects focused on private sector-led advocacy, business integrity, and good governance. Specifically, CIPE works with a group of organizations to strengthen corporate governance and business ethics practices of small and mid-size enterprises (SMEs). Zarina sat down with the CIPE’s Central Asia team to talk about her experiences, failures, and valuable lessons learned from starting a business in Kazakhstan.

With a strong will to succeed, honed organizational skills, and a knack for creative thinking, Zarina Bekbolat decided to start her own business in 2015. As an innovative thinker, she was always coming up with new business venture ideas, but never had the time the pursue them while she worked as an auditor. Finally, after five years of experience working at a major international audit firm, she was ready to take the plunge and follow her passions.

Tell us how you got started as an entrepreneur:

In 2015, I was working as a Senior Tax Consultant at Deloitte. I had five years of experience consulting on international and corporate taxation and customs and working on tax audits. That same year, my elder sister also moved to Nur-Sultan with her two small children. She possessed a breadth of experience, including ten years in sales, auditing, and finance for major companies. We each had our own goals and desires but were united by our boundless enthusiasm and drive to become more financially independent.

Where did your business idea come from?

We got the idea to form the family business when we experienced the high demand for dairy products in Nur-Sultan. As consumers of dairy products, we knew that the capital’s market offered a meager selection of dairy goods and that there was demand for larger, better selections. Later in 2015, we decided to negotiate with a major dairy producer in Ust-Kamenogorsk, our hometown, to buy their products to sell them to vendors in Nur-Sultan.

The dairy producers initially told us that they had already tried to market their products in Nur-Sultan, and that they ultimately had to close their branch there in 2012 because it was losing money. They did not initially express interest in opening any new branches, but eventually they told us they would consider a partnership based on a supply contract with prepayment and local pickup. We were provided the right to sell the goods within designated regions, but as there was no law to protect our rights, we all agreed to the partnership in good faith.    

What happened with your business?

With our initial capital investment, we began making the first shipments of products over the 1,100 km (684 miles) route from Ust-Kamenogorsk to Nur-Sultan. By this time, I had resigned from Deloitte, joined the family team with my sister, and the company was registered as a sole proprietorship in my name.

We began encountering problems right away. First, the product was not well-known in Nur-Sultan. Second, it was perishable and had a storage time of only five days, one of which it spent in transit. For these reasons, stores in Nur-Sultan refused to work with us. Yet, despite these initial challenges, our business took off after we designed a competitive sales strategy, created a diverse assortment of high-quality dairy products, and took advantage of the weak competitive environment.

Our initial capital investment was not sufficient to cover the first deliveries, but revenue was still growing rapidly. After our initial investment, we took out our first loan of $150,000 at a subsidized interest rate of seven percent under a government-supported, women-owned business program called the Free Enterprise Development Fund. These loans were available to women under the age of 29 who were registered as sole proprietors. We learned about the program from publicly available sources, and the process of obtaining the loan was straightforward, albeit lengthy, and took about three months. This money kept us going for the first few weeks, and revenue continued to grow. We repaid the loan after 18 months.

We had a small staff of about 13 employees. We rented 100 square meters of refrigerated storage space. We would often pack the products ourselves each night in the warehouse. If we did not manage to sell the goods within two days, we would sell them at street fairs and in courtyards on the weekends, even in the winter when it was -35 degrees Celsius.

In 2016, sales boomed to a net $1.4 million. There was no longer a need to spend money on marketing. Interest in our products spread quickly by word of mouth. Despite the short storage times, we could sell an entire trailer load in two days. We were making 12 to 13 deliveries per month. Major supermarkets began approaching us. However, despite all this success, we were experiencing a serious cash shortage and lack of funds to cover our budgeted expenses at the time.

As a result of our situation, we took another loan through a program of the Asian Development Bank at an interest rate of 14 percent. These were not long-term loans, but overall, it was successful. We even got an award and a bonus from the dairy producer for starting up quickly and then increasing sales in 2016.

By 2017, our yearly revenue had reached $4.5 million. We had proven ourselves to be serious partners and signed a seven-year supply agreement with the dairy producer. However, Kazakhstan’s law does not recognize the concept of a distributor agreement. Our agreement did not give us exclusive rights to sell the products in the northern region of the country due to the fact that exclusive right contracts are not allowed in Kazakhstan. Once the agreement was signed, the dairy producer started paying for the transportation costs, which led to a drastic rise in the prices for the goods. We had 44 employees at that time. Based on yearly revenue, our company moved from the category of a small business to a medium-sized business, with revenue of more than $2 million.

By 2018, other large companies began to appear in the market, leading it to become more saturated and competitive. Following the drastic increase in prices from the manufacturer, we witnessed several additional price increases that year. Additionally, the dairy producer began imposing sales targets on us. As a result, our products quickly became the most expensive on store shelves in Nur-Sultan. Sales volumes began to fall, and my company started losing money due to increased costs and lower sales. The dairy producer kept making money, while not investing in marketing or incurring any additional expenses. The terms of our arrangement with the dairy producer had become much less favorable, as we bore all the risks.

Our only option to stay afloat was to take out more bank loans with costly overdraft fees. We started to experience delays in paying the dairy producer for the goods. Vendors too owed us money and office expenses remained high.

In the early summer of 2019, the dairy producer terminated its supply agreement with us, citing a breach of the payment clause. Two weeks later, they opened their own branch office in Nur-Sultan. Due to business losses in 2018 and 2019, we were unable to pay off our loan with the bank and our indebtedness to the dairy producer. This led to litigation and attempts to declare the company as bankrupt. These attempts were eventually rejected.

What lessons can be learned from this experience?

The main risks our company faced were as follows:

  1. The partnership agreement. Matters involving distribution in Kazakhstan are governed by provisions of the civil law on purchase and sale agreements and supply agreements. Anti-monopoly restrictions and the way the courts apply the anti-monopoly laws place limits on arrangements for exclusive sales in such agreements. The inability to protect the rights of distributors in exclusive sales partnership agreements is one of the main risks of the distributorship business in Kazakhstan.
  2. Insufficient capital, cash flow problems, and lack of financing. I look back on this period like a rat race, where I worked tirelessly to obtain high-interest, short-term loans and pay off tranches, pay the factory for goods, and spent ample time at banks trying to resolve issues with the loans.
  3. Market factors, increasing competition, emergence of local manufacturers, and volatile rise in the dollar exchange rate. Since 2015, the exchange rate for the dollar has doubled, which results in higher product costs due to packaging, production, etc.
  4. The dairy business is complex. With short storage times, specific storage requirements, shipping products across distances exceeding 1,000 kilometers, and the high rate of returns from points of sale, it’s a hard business to succeed in.

The mistakes we committed in our business venture were as follows:

  1. We did not act quickly enough to lay the groundwork for the company to grow. On the contrary, we optimized our expenses on wages and office expenses. As a result, we lost sales and market share.
  2. My sister and I were too involved in the daily operations of the company. This led to delays in making decisions on larger problems.
  3. We lacked a marketing strategy. At first, we survived via word of mouth. But as new competitors appeared, this approach was no longer effective.

Despite the difficulties we encountered, my sister and I gained significant business experience. There were times of success and difficulties. To me, it was an invaluable experience. In the future, I would like to explore becoming a mentor for young entrepreneurs to help them avoid making the same mistakes my sister and I made. I would like to help people create new jobs and increase their income, while also creating projects to expand opportunities for people in Kazakhstan to bring their business ideas to life.

Entrepreneurial experiences like Zarina’s highlight the unique challenges facing small business owners in Kazakhstan, including access to finance and navigating nontransparent legislative environments. Without access to long-term, low-interest loans, and no way to appeal the termination of their distributer agreement or sue for loss of profit, Zarina’s business could not continue. Zarina’s experience demonstrates the need for ongoing collaboration between the public and private sector to address these systemic issues in order to create an enabling environment for businesses of all sizes in Kazakhstan.

Read more about CIPE’s work to enhance public-private dialogue and improve the business enabling environment in Central Asia here.