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INTERNATIONAL JOURNAL OF BUSINESS, 4(2), 1999 ISSN:1083-4346
Russian Mass Privatization: What Has Been
Achieved?
Trevor Buck, Igor Filatotchev, Mike Wright, and
Vladimir Zhukov
In countries of the former Soviet bloc, the economic aims of industrial
privatization beyond mere ownership change include shifts in managerial
strategies to reflect market imperatives and ultimately to improve enterprise
performance. New strategies involve business turnaround, at first through
retrenchment, or reactive restructuring. When stability is achieved, second-
stage strategies involve long term, deep restructuring in a recovery phase,
involving investments in new products and processes. Extensive research on
Russian privatization has so far yielded little evidence of progress in these
respects, but ignores the important, counterfactual question, ‘What would
have happened without mass privatization?’ For a realistic evaluation of
Russian reforms and their consequences, comparisons are made with Belarus,
another former republic of the USSR, with some political and economic
reforms but hardly any privatization. This comparison indicates that
privatization in Russia has been a relative success.
I. INTRODUCTION
The break-up of the USSR after 1991 was followed by extensive economic
reforms in most republics and countries of the former Soviet bloc. In Russia
itself, prices were substantially liberalised, more openness to international trade
and capital flows was achieved, and the State gradually withdrew from playing
a dominant role in the governance of industrial enterprises. In particular, the
privatization of Russian industry gradually accelerated after 1992, with the
exception of certain ‘strategic’ firms in the defence and natural resource
sectors. By the beginning of 1997, 123,000 formerly State-owned enterprises
had been privatized, and about 70% of Russia’s GDP was accounted for by the
private sector, according to the European Bank for Reconstruction and
Development (EBRD), 1997, p195. Budget constraints have hardened
somewhat with the withdrawal of the State as lender-of-last-resort, new private
Trevor Buck, Leicester Business School, De Montfort University, U.K. Igor
Filatotchev, Mike Wright, and Vladimir Zhukov, Business School, University of
Nottingham, U.K.
Copyright?1999 by SMC Premier Holdings, Inc. All rights of reproduction in any form reserved.
24 Buck, Filatotchev, Wright, and Zhukov
business start-ups have proliferated and a new breed of Russian entrepreneurs is
emerging (McCarthy et al., 1997).
At the same time, however, many changes in Russia appear to have
been superficial. Although the natural resource-based sectors have spawned
over two hundred quoted companies on the Russian Trading System, and
competition in many markets is fierce between new private companies,
especially outside the manufacturing sector, in other areas progress has been
slow. The EBRD (1997, p15) describes Russian State credit and subsidy policy
towards industry as only ‘moderately tight’, and although bankruptcy
legislation has been introduced, enforcement has been weak. The ‘unofficial’
economy still is estimated to be 41.6% of Gross Domestic Product (EBRD,
1997, p74), and shares in privatized firms, as the result of a ‘giveaway’ share
distribution, mostly have fallen into the hands of incumbent enterprise
managers and other employees rather than outside investors (Filatotchev et al.,
1996). Although outsiders often can overcome barriers to share trades imposed
by enterprise incumbents, a number of studies of Russian privatized firms have
failed to identify any significant improvement in their performance that can be
attributed to outside ownership and improved corporate governance
(Filatotchev et al., 1996, Blasi et al., 1997, Earle & Estrin, 1996).
Although some reactive, short-term restructuring has been found in
privatized firms as they have reduced employment and capacity (Filatotchev et
al., 1996, Earle & Estrin, 1996), there has been no significant increase in
investments in privatized firms to achieve deeper restructuring, and in
particular, no significant inflow of foreign capital for direct investment (as
opposed to portfolio investment).
For example, in the period 1989-95 Russia had cumulative inward
foreign direct investment (FDI) of US$3,900 million (mostly in the natural
resource sectors) while China attracted $121,700 million (International Bank
for Reconstruction and Development, IBRD, 1996a, p64). Even in per capita
terms, Russia in 1995 attracted FDI of $1.10 per person compared with $18.20
for China (United Nations Conference on Trade and Development, 1997,
pp348-350). In terms of foreign trade, China’s total 1995 exports were
$149,000 million of which 81% were manufactured goods (IBRD 1996b,
p110), while Russia exported $81,000 million, mostly raw materials and fuels,
with machinery and manufactured goods providing only 8% (EBRD 1997,
p65).
In other words, compared with China, Russia’s economic reforms have
failed to attract foreign investment and consequently have failed to produce a
manufacturing sector that can compete significantly on world markets.
INTERNATIONAL JOURNAL OF BUSINESS, 4(2), 1999 25
A gloomy outcome indeed at a national level for Russia, but what if
privatization never had happened or had been more half-hearted, and what
would have been the situation at the enterprise level?
These important, though hypothetical, questions imply the
counterfactual analysis identified with Fogel (1964). It is impossible to answer
them with any econometric authority, given the number of uncontrolled
variables involved, but it is possible to make informed judgements by using
comparisons between Russia and a country like Belarus. Belarus was also a
republic of the USSR, sharing a rather similar economic, political and social
environment. After 1991 however, Belarus introduced fewer economic reforms,
and substantially omitted privatization from its policies.
In contrast with Russia, the European Bank (EBRD, 1997, p154)
reported that in 1997 the private sector in Belarus accounted for only 15-25%
of GDP. In 1993, about 8,500 State enterprises (10% of the total) were slated
for privatization, but in early 1997 only 24% of this original target had been
privatized. At this time, all privatizations were halted, and none have occurred
since 1996. Indeed, some companies have even been renationalized. The
International Monetary Fund (IMF) and World Bank (IBRD) have both
withdrawn their support for the Belarusian economy, and the EBRD (1997,
p155) reports continued extensive State intervention in the setting of industrial
price and production targets. One third of industrial enterprises are loss-making
but virtually none has been closed, and the State continues to give financial aid
to priority enterprises through tax and import duty concessions and through
directed credits (EBRD, 1997, p155). For example, budgetary subsidies in
Belarus amounted to 3.4% of GDP in 1995 compared with only 1.3% in Russia
(EBRD, 1997, p83). Thus, employment levels have been sustained above
Russian levels, and some reactive restructuring avoided, but at the expense of
deeper reform. Inward FDI has been low even by Russian standards, and indeed
UNCTAD (1997, pp340-350) calculates that with the exception of Somalia and
Sierra Leone (which both had negative inflows), Belarus had the lowest per
capita FDI inflow in the world in 1995, at $0.40 per person, compared with
Russia’s $1.10. Current trends suggest that even the unfortunate records of
Somalia and Sierra Leone may be under threat from Belarus. Given a
comparable geographical location and sharing a common, recent, political and
economic history, it is seriously suggested that Russia without a privatization
programme could have followed the Belarusian path.
It appears therefore that comparative enquiries into managerial
priorities and strategies in Russia and Belarus may be instructive in order to
answer the counterfactual, ‘what if...?’ question for Russia. The next section
discusses business turnaround as a result of short-run retrenchment and long-
run recovery strategies, and then reviews survey responses from managers in
26 Buck, Filatotchev, Wright, and Zhukov
privatized firms in Russia and Belarus in this context, supplemented by one
Russian and two Belarusian case-studies. It concludes with some comments on
the merits of Russian mass privatization and implications for investors from the
West.
II. BUSINESS RETRENCHMENT
Although the collapse in industrial and final consumer demand in the former
USSR after 1991 was massive, individual firms in the West also have had to
face up to similar disasters. For example, the ‘peace dividend’ of the 1990s has
meant the cancellation of military orders and market collapse for many
weapons manufacturers in the West; the demand for British coal virtually
disappeared with the discovery of North Sea gas; and the birth of the PC has
had enormous implications for typewriter builders and for the printing industry.
Faced with market collapse, the continued procurement of labour,
capital and material supplies cannot be sustained without soft loans and/or
grants. Western academics, for example Robbins & Pearce (1992) and Pearce &
Robbins (1993), have observed that a successful transition to changed market
circumstances can be achieved only in a sequence of steps after first ‘stopping
the bleeding’ (Bibeault, 1982). Together, internal and external factors
determine the severity of the enterprise crisis, and, unless soft credits are
available, a retrenchment phase follows, when the main objective is to get
control of cash flows and achieve a position of stability. Such retrenchment
comprises current cost reduction (including reductions in the labour-force)
and/or asset reductions (capacity reduction or plant closure), depending on the
severity of the situation. This is analogous to the ‘reactive’ or ‘shallow’
restructuring in economic transition described by Earle and Estrin, (1996). Only
if retrenchment policies achieve stability can the next decision-point be
reached: whether to enter a recovery phase, which amounts to ‘deep’
restructuring, involving entrepreneurial decisions concerning new capital
investments.
III. LONG-TERM RECOVERY
The direction of new strategies such as diversification, refocusing on core
competencies, acquisitions, and the adoption of new technologies may vary
from case to case, but they all have one thing in common: a need for new
investment and for the funds to finance that investment. An enterprise in
economic crisis is unlikely to be able to generate funds internally, though some
diversified firms may be able to sell or spin-off activities to raise funds for new
INTERNATIONAL JOURNAL OF BUSINESS, 4(2), 1999 27
projects. With these exceptions, recovery must involve shareholders and/or
outside lenders.
In the former USSR, long-term loans are unlikely from a banking
system that prefers, for pragmatic and legal reasons, to keep its assets liquid.
Investment banks may be a source of long-term loans, but they will probably
demand an equity stake, too, in order to protect their investments with a degree
of control. Where States are themselves in budget crises, they cannot consider
any loan finance for industrial investment, and this emphasises the conclusion
that shareholders are the most feasible potential source of funds for recovery
strategies.
Shareholders who are enterprise incumbents are unlikely sources of
significant amounts of restructuring finance. In any case, existing managers and
other employees are stakeholders in firms even before they obtain shares (Buck
et al. 1998), and with dual roles as employees and shareholders they are likely
to inhibit the very short-run cost and asset reduction policies that can achieve
stability as a prerequisite for deeper restructuring. (Although employee
ownership in the former Yugoslavia was associated with over-investment, this
was a result of State loans being the dominant source of investment finance, see
Buck, 1982, 77-123).
This leaves outside shareholders as the major potential source of new
investable funds, including financial institutions, venture capitalists and
strategic investors as well as individual outsiders. Besides looking at the
underlying asset value of the enterprise and earnings prospects, the time-
horizons of outside investors are crucially influenced by the tradability of
shares. Freely tradable shares give outside investors infinitely long time-
horizons, since the value of shares reflects the present value of all future
expected dividend streams, but any attempts to limit the tradability of shares
must increase the reluctance of outsider investors to finance long-term
restructuring programmes. In the former USSR, stock trading restrictions can
deter outside shareholders, thus placing a new emphasis on short-run
turnaround and the internal generation of funds for recovery investments.
In order to provide estimates of the extent of turnaround responses in
terms of retrenchment and recovery in privatized firms in two countries from
the former USSR subjected to massive economic crisis, the authors carried out
extensive surveys in Russia and Belarus, reported below.
28 Buck, Filatotchev, Wright, and Zhukov
IV. RETRENCHMENT AND RECOVERY IN RUSSIA AND BELARUS
Managerial attitudes and strategies in Russia and Belarus were estimated
through direct questionnaire surveys of enterprise directors during the first half
of 1997, after piloting a survey instrument in Moscow and Minsk. Useable
responses were obtained from 106 privatized industrial firms in Russia and
from 91 in Belarus. Rather than focus on the dynamic, new private start-up
sector, and natural resource-based firms, a decision was made to study the
industrial heartland of the former USSR: her manufacturing industry, where the
need for business turnaround is most pressing. Although this sector has the
reputation of being entrepreneurially inert, it employs a majority of the former
USSR’s workforce, and its future has enormous implications for political
stability. To illustrate the current importance of this sector, the average
employment of firms in the sample was 1,044 in Russia and 1,157 in Belarus.
The surveys were conducted approximately 4.0 years and 2.5 years after
privatization in the two countries, respectively. In each country, a random 5%
of returns were checked by at least two of the authors personally visiting
companies for face-to-face interviews with senior managers, to check the
accuracy of questionnaire responses.
The contrasting economic policy stances of the two States surveyed are
reflected in their different average industrial ownership structures in privatized
firms (Table 1). In the few firms that have been privatized in Belarus, the State
in 1997 still holds an average 12.1% of voting shares (versus 6.3% in Russia)
and ‘insiders’ hold 67.9% (versus 55.4% in Russia). Within these dominant
insider ownership groups, managers have a smaller average holding of 12.2% in
Belarus (versus 17.1% in Russia), and other employees’ shareholdings are
correspondingly more significant. Importantly, private ‘outsiders’ now have
38.3% of Russian shares compared with only 20.0% in Belarus.
These shareholdings are reflected broadly in Board representation in
both countries and have great significance in the determination of company
strategies. The picture presented by Table 1 therefore suggests that in Russia
weaker employee ownership, together with higher stakes for managers and
outsiders, may be expected to produce short-term turnaround strategies that are
not so favourable towards the immediate concerns of employees (current wages
and employment). Eventually however, recovery strategies may be more
realistic in Russian companies, where employees have smaller proportions of
total shares.
INTERNATIONAL JOURNAL OF BUSINESS, 4(2), 1999 29
Table 1
1997 distribution of voting shares (%) in sample of privatized firms, Russia and
Belarus
RUSSIA BELARUS
Managers 17.1 12.2
Other Employees 38.3 55.7
(Total ’insiders’) (55.4) (67.9)
Trading Partners 4.0 3.5
Investment Funds 3.5 1.7
Banks 1.8 0.5
Private Individuals 13.7 9.9
Holding Companies 1.9 1.2
Foreign Investors 0.6 1.7
Other Organisations 12.8 1.5
(Total ’outsiders’) (38.3) (20.0)
The State 6.3 12.1
TOTAL 100.0 100.0
A. Business Retrenchment in Russia and Belarus
Although realistic measurement of the size of the collapse of sales was not
possible in a period of hyper-inflation which affected sectors differentially, the
overall predicament of Russian and Belarusian privatized firms is reflected in
managers’ responses to questions about the average competitiveness of their
products. In these two countries that are increasingly open to competition from
imports, fewer than 25% of managers estimated that their products were
competitive on world markets in terms of product price, design, quality,
packaging and after-sales service, with the last reckoned to be most deficient in
both countries.
In such a situation of deep crisis, with over-manning and with large
average debts to the State, suppliers and banks, and faced with the prospect of
further sales decline in the face of import competition, business turnaround is
required, with an early emphasis on ‘stopping the bleeding’ before
reconstructive surgery is considered. In Belarus, with a higher proportion of
shares held by employees with short-term needs and held by the State, and with
relatively fewer outside investors, it could be expected that managers would be
30 Buck, Filatotchev, Wright, and Zhukov
generally less able to reduce costs in the short run than would managers in
Russia.
This was found to be the case. Focussing on the 1995-97 period, the
weighted average reduction in employment in Belarusian privatized firms was
reported to be 14.8%, as opposed to 23.0% in Russia. In order to get some
impression of the continuing extent of over-manning in 1997, we asked
managers to estimate the desired level of employment compared with the
current actual level. The average Belarusian response was 97%, as opposed to
85% in Russia, indicating that Belarusian managers were still relatively
reluctant to concede the need for employment reduction in a situation requiring
business retrenchment.
Table 2
Mean values of directors’ strategic priorities
(Average responses on a seven-point Likert scale, where 1=unimportant, 7= very
important, etc, to the question, ‘What importance do directors give to the following
strategies?’)
RUSSIA BELARUS
Retrenchment Strategies:
Monitor cash flows 6.1 5.9
Seek new domestic markets for existing products 5.7 5.3
Recovery Strategies:
Marketing and Advertising 4.1 5.5
Seek new export markets for existing products 2.7 5.6
Develop new products for domestic markets 5.2 5.9
Develop new products for export markets 3.0 5.4
Monitor IRR on investments 3.7 5.4
Seek new investors 4.4 5.1
INTERNATIONAL JOURNAL OF BUSINESS, 4(2), 1999 31
Managerial priorities in relation to different retrenchment and recovery
strategies in 1997 are shown in Table 2. The first thing to notice is that
Belarusian managers absolutely fail to distinguish short-term and long-term
priorities: in the middle of a business crisis, they consider each of eight
strategies to be worth at least an importance rating of five on a seven-point
scale. The significance of this failure of senior managers to establish any
priorities is emphasised by Peters and Waterman (1995, p307):
“The organization gets paralyzed because the structure not only does
not make priorities clear, it automatically dilutes priorities. In effect, it
says to people down the line: ‘Everything is important: pay equal
attention to everything.”
Conceding that Belarusian managers consider every strategy to be
important, they fail to give retrenchment strategies the higher priority that
Russian managers appropriately provided, instead giving each short-term
variable related to current cash-flow a lower value than do Russian managers.
Although Belarusian managers’ previous responses in relation to their products’
lack of a competitive edge on world markets revealed the infeasibility of
expanding exports of existing products, the fourth row of Table 2 still shows
that they still entertain dreams of expanding export sales for existing products,
all in the middle of a short-term crisis requiring retrenchment actions.
Such dreams persist even in the dire circumstances of one privatized
firm in Minsk, Belarus:
B. Case Example 1
Ribocomplex is one of the least fortunate privatized firms in Belarus, as a sea-
fish processor in a country without access to the ocean. It is confronted not
only with the break-up of the USSR and its main suppliers in the Baltic states
but also with the exhaustion of Baltic Sea fish stocks. Although it had a
workforce of 1,200 in 1993, since privatization in 1995, there has been no
further reduction in its labor force of 296. The pre-privatization retrenchment
occurred through attrition as a result of low wages, rather than from conscious
company strategy. Wages are one-third lower than at Kommunarka, (Case 2,
below). It sells its entire output to the Russian market.
The factory was a depressing sight for the authors in April 1997, with
workers huddled in about 10% of the total factory area, processing only a token
quantity of fish. It would appear that with the breakdown in supplies of raw
fish, the antiquated plant is doomed as a fish-processor, and in its existing
32 Buck, Filatotchev, Wright, and Zhukov
function can only be preserved as a large refrigeration facility, with even fewer
jobs than at present
Still the managers dream that their premises and plant are an
attractive target for foreigners. As a fish-processing plant, the managers
estimate that they would require only $0.7 million of new investment to achieve
world standards, assuming raw fish supplies could be obtained.
After so-called privatization in 1995, the State had 84.5% of the voting
shares, with employees holding the other 15.5%, but by January 1997, the State
was left with 26%, employees 38%, managers 1.5% and ‘friendly’ outsiders
34.5%.
In 1995, there was a takeover raid. A brokerage company, ‘Ramos’,
was hired by ‘European Style’, a joint venture operating in the fish industry
that wished to acquire Ribocomplex’s refrigeration capacity. It bought 36% of
the shares, but was only able to register 22% before the company’s General
Director instructed the so-called ‘independent’ company operating the share-
register to stop all transfers.
Late in 1997, employees and managers at Ribocomplex were confident
that a team of investigators from the President’s office would recommend
renationalization of the company to preserve the few jobs that have survived so
far.
This case emphasises the business crisis in the most unfortunate
privatized firm in Belarus. The harsh conclusion is that fish-processing is no
longer feasible at Ribocomplex. Even further retrenchment, with the focus on
refrigeration services is the only practicable strategy, and any State ’rescue’ can
only be financed by taxes on more successful private businesses.
By comparison, post-privatization Russian managers are more
commercially and entrepreneurially aware, recognising the high priority that
should be given to realistic and urgently needed short-term strategies of
monitoring cash flow and seeking to increase domestic sales. In this context, it
may be that the weaker ownership position of non-managerial employees in
Russia compared with those in Belarus may in the end enable managers
themselves to acquire more shares and to implement turnaround strategies. 30%
of Russian managers reported that they had already purchased or intended to
purchase shares from employees, as opposed to only 13% in Belarus. There is a
rather different privatization situation in Russia:
C. Case Example 2
INTERNATIONAL JOURNAL OF BUSINESS, 4(2), 1999 33
GAZ (Gorky Avtomobil Zavod, now the Nizhny Novgorod Automobile
Company) has faced a turnaround crisis less severe than most Russian
privatized firms. It was founded in 1930 with the support of a then-friendly US
government and the Ford Motor Company: its first product was a version of the
Ford ‘Model A’ truck in 1932.
Upon privatization in 1993, it became an enormous employee-manager
buy-out, and, in late-1996 when one of the authors visited, it had managed to
maintain its workforce at 106,000, but this included workers in every kind of
social infrastructure operated by GAZ, from fish farm to schools and hospitals.
Incumbent managers and other employees were hostile to any outside investor
who might impose a strategy of retrenchment in relation to direct production or
infrastructure workers, and no foreign motor manufacturer was prepared to
pay a price for GAZ control if these social liabilties were included.
Nevertheless, 20% of GAZ’s shares had fallen into the hands of
outsiders plus 13% with senior managers and 67% with other employees, and
half of the outsiders’ shares (i.e. 10%) could be traded reasonably freely on the
Moscow capital market. The remaining 90% of shares (80% inside-held shares
and 10% with so-called outsiders) could only be sold to a private company
owned and controlled by the GAZ chairman.
Dominant incumbent ownership was reflected in control of the
company’s Board, though the State was also represented in the form of the
Nizhny Regional Administration and the State Property Committee, which
oversaw the privatization process. This State involvement evidently gave the
company certain privileges such as the non-payment of taxes and access to
State credits, which have enabled it to avoid employee retrenchment even
though certain elements of the product range have been abandoned.
Specifically, the production of medium trucks (401,500 in 1993) had been
virtually abandoned by 1995 in favour of the Gazelle range of light trucks,
probably financed out of plowback profits accumulated with the support of the
State. The Gazelle trucks (73,000 produced in 1995) and the Volga saloons
(157,000 in 1995) are currently the backbone of GAZ, but their design and
build quality are not competitive internationally.
Although GAZ’s Russian market is stable for the moment and no
immediate retrenchment strategy is needed if the local authorities assume
responsibility for social infrastructure, managers and other employees now
seem to be aware of the need for outside investors and new products, and in
1998 are prepared to enter joint venture agreements in which foreign strategic
partners do not assume a share of GAZ’s infrastructural burden. In early 1998,
an agreement for a $1,450 million joint venture with Fiat was nearing
completion for the assembly of Fiat models by GAZ.
34 Buck, Filatotchev, Wright, and Zhukov
Although GAZ is in a relatively favourable position of stability
compared with other Russian privatized firms in manufacturing, it seems that,
five years after privatization, GAZ senior managers have grasped the need to
establish priorities and cut production and employment where products have
poor trading prospects, to achieve short-term stability before embarking on
recovery investments with foreign investors. Such business recovery is the
subject of the next section.
D. Business Recovery in Russia and Belarus
Although the majority of managers in privatized firms in Russia and Belarus
have faced a demand collapse and have recognised the uncompetitive nature of
their existing products, probably few privatized firms in Russia and Belarus
have restored business stability yet, or reached a decision-stage at which
recovery strategies should have a high-priority, as at GAZ. Recognising the
seriousness of their problems in regard to global competitiveness, Russian
managers on average calculated that investment spending on new premises and
re-equipment needed to achieve world standards was of the order of
$65.9million per enterprise: a totally infeasible amount in the short-term.
Belarusian managers estimated a requirement of $11.1million per firm.
However, in these desperate circumstances, Russian managers have focused on
short-term retrenchment strategies, while Belarusian managers unrealistically
dream of new investors and investment (Table 2).
Outside investors arguably represent the only realistic long-term source
of new funds for investment on a large scale. Although 56% of Russian and
68% of Belarusian managers consider that their firms are attractive investment
targets for outside investors, Russian and Belarusian managers alike cited the
State and retained enterprise earnings as their most likely actual sources of
funds - clearly inconsistent with the sums quoted previously as necessary to
achieve competitiveness. This disregard for outside investors is based on a fear
that outsiders will urge drastic business retrenchment strategies.
The extent of this hostility to outsiders was slightly lower in Russia, in
that ‘only’ (sic) about two-thirds of managers would try to prevent an outside
accumulation of shares, while in Belarus the response was about three-quarters.
The concrete effect of this hostility to outsiders is that privatized firms in
Belarus (and to a lesser extent Russia) have adopted a strategy of blocking the
transfer of shares and strategic control to outsiders, usually by
administrative devices. Such actions have already been alluded to in relation to
Ribocomplex, above. Since technically they are unlawful, it was not possible to
conduct formal surveys into the phenomenon, but a third case is relevant
INTERNATIONAL JOURNAL OF BUSINESS, 4(2), 1999 35
regarding recovery strategies and barriers to externally-imposed strategies, like
Case 1 from Minsk in Belarus:
E. Case Example 3
The Kommunarka confectionery company is one of the most fortunate and
prosperous privatized companies in Belarus. Since privatization in 1993 it has
managed to increase its sales, production capacity and labor-force, thanks to
its products. These comprise sweets, chocolates and biscuits, which are still
popular in Belarus and Russia despite the availability of Western imports. The
local markets favour plain chocolate and a distinctive form of packaging,
providing Kommunarka with a niche market, which it has fostered with
consistent production and a stream of new product variations. It exports 70%
of its output to and imports 73% of its inputs from Russia. Short-term
turnaround strategies have been unnecessary. Indeed capacity has been
increased by 20% since privatization. Wages average about $170 per month.
Kommunarka estimates that to compete on world markets, it would
need to invest around $30 million over five years, but it has no plans to do this.
Nevertheless, it claims that it is an attractive target for foreign investors. Its
current strategy is to develop new products for the domestic and Russian
markets and to improve packaging. This requires investment in machinery, but
the directors have no intention to allow outsiders to acquire shares and control.
Although directors hold only 4% of voting shares, employees have 65%, the
State 2.5%, and ‘friendly’ outsiders 28.5%, all believed to be under the control
of individual directors. The directors control the Board, with six directors out
of nine. (Employees nominate two directors and the State one.) All are anxious
to prevent outsiders from buying shares and registering them.
During 1997, the government of Belarus issued a decree requiring that
all privatized firms must have their share registers kept by an independent
book-keeper, in the case of Kommunarka by the joint-stock company
Agorkapital. Unfortunately, the subsequent transfer of Kommunarka’s register
and its computerization now means that share registrations take two months
rather than the previous two days. Also, share dealings are forbidden for ten
weeks before a General Meeting and for ten days afterwards. Agorkapital
levies a transfer charge on buyers of 100,000 Belarusian rubles per share,
about ten times the face value of each share. Taken together, these restrictions
restrict stock tradeability and deter outside investments.
Without outside injections of funds, it seems unlikely that Kommunarka
will be able to finance significant investment programmes in the future to
protect even its niche market from firms in Russia and other countries.
36 Buck, Filatotchev, Wright, and Zhukov
The hostility shown towards outside investors in Kommunarka and
other in privatized firms in Russia and Belarus effectively rules out most long-
term investments for business recovery, despite the fact that outsiders already
have obtained one to two-fifths of all shares (Table 1). It may be that managers
themselves will be the ultimate sources of limited recovery strategies as well as
of turnaround. On the basis of Western evidence in relation to management
buy-outs, however (Wright et al. 1994), it seems likely that managers wishing
to preserve their equity positions in the firm but also to raise outside funds must
be prepared to submit themselves to extensive monitoring by outside investors
who wish to prevent current consumption by managers and employees of funds
intended for long-term investment. The local power of enterprise managers is
reflected in the finding that since privatization the General Director had been
replaced in 37% of Russian firms and in only 25% in Belarus.
V. CONCLUSION
Although the shortcomings of Russian economic reforms have been widely
recognised and criticised in this paper and elsewhere, it seems likely that
political realities after the break-up of the USSR in 1991 produced a reform
package as market-oriented as was practicable at the time. At least the
distribution of shares at privatization to favor enterprise managers and other
employees sustained support for the government throughout the regions of
Russia, and enabled the government to push ahead with other reforms, which
have resulted in significant political and press freedoms and less hostility
towards private business and foreign traders and investors. Without such a
Russian privatization programme, even though flawed, the results would have
been similar to those in Belarus.
In Belarus, privatization favouring the interests of the State and
enterprise employees was strangled at birth. The outcome is a populistic
dictatorship that seriously constrains press freedoms and the activities of private
business, and which continues to be dominated by insiders and the State, (Table
1). In May 1996 all private firms in Belarus had to re-register and seek
permission to carry on in business, and about one-third (30,000) of all
companies were instantly liquidated (EBRD 1997, p155), some because the
State’s inspectors considered them insufficiently profitable! Private banks were
instructed to make directed credits to favoured enterprises and the State
arbitrarily seized a proportion of the hard-currency balances of private firms to
relieve its financial crisis. In December 1997 a presidential decree introduced a
‘golden share’ for the State in any future privatizations, which effectively rules
out any foreign participation, since the State can veto any turnaround strategy
proposed for the firm. Aggregate economic statistics are regularly massaged
INTERNATIONAL JOURNAL OF BUSINESS, 4(2), 1999 37
(mostly by enterprise managers anxious to demonstrate their ‘achievement’ of
fictitious plan targets), and international agencies such as the IMF and IBRD
have withdrawn from the country both their offices and financial support.
This focus on Belarus has been deliberate in order to make judgements
on the ‘what might have been’ counterfactual position in Russia. It is not
unrealistic to argue that a similar scenario could have developed in Russia in
the absence of its mass privatization programme, which seemed from a distance
to be seriously flawed. Without this programme it seems unlikely that in 1998
in Russia there would be a proposed joint venture (JV) between GAZ and Fiat
in Nizhny Novgorod, a JV between Renault and Moskvitch in Moscow, and
Ford’s JV with Russky Dizel near St. Petersburg, all in one industry: motor
manufacturing. The positive results of shock therapy now are beginning to
show.
Generally, however, apart from portfolio investment by financial
institutions from the West, mostly in natural resource-based companies where
share values are backed with physical reserves, Western investors have voted
with their feet and have made few direct investments in either Russia or
Belarus, preferring to concentrate on other emerging markets like China. In
1999, Western entrepreneurs are aware of the continuing hostility they face
from enterprise incumbents in the heartland of Russian and Belarusian industry,
in privatized manufacturing companies. This hostility has undoubtedly
contributed to the national crisis which developed in Russia and Belarus late in
1998, with insiders’ immediate self-interests prolonging the admitted lack of
competitiveness of local industry, which in turn has contributed to a balance of
payments crisis and a massive State budget deficit from shortfalls in enterprise
tax payments.
Still, in Russia mass privatization was achieved, even if imperfectly.
Outside ownership in the survey sample averaged 38.3% in 1997, up from
33.2% in only two years from 1995, and by 1998 there were signs that
enterprise incumbents, in some firms at least, appreciate the danger of
continuing to be uncompetitive internationally, appreciating the danger of even
further retrenchment without outside investment.
In Russia, mass privatization and the subsequent evolution of privatized
firms by mid-1998 created a climate that had begun to bear fruit. Ironically,
however, progress in companies admitting outside investors for the purpose of
financing recovery investments may now be swept away in a new national
economic crisis, for which more defensive companies are partly to blame.
Nevertheless, without its mass privatization, Russia could already have
followed the path of Belarus in its struggle with Somalia and Sierra Leone to
the bottom of the pile in terms of foreign direct investment.
38 Buck, Filatotchev, Wright, and Zhukov
REFERENCES
[1] Bibeault, D. (1982) Corporate Turnaround. McGraw-Hill, New York.
[2] Blasi, J., Kroumova M., and Kruse D. (1997) Kremlin Capitalism.
Privatizing the Russian Economy. Cornell University Press: Ithaca, N.Y.
[3] Buck, T. (1982) Comparative Industrial Systems: Industry under
Capitalism, Central Planning and Self-Management. Macmillan:
London.
[4] Buck, T., Filatotchev, I. and Wright, M. (1998) Stakeholders, Agents and
Corporate Governance in Russian Firms. Journal of Management
Studies. 35, 1, 81-104.
[5] Earle, J. and Estrin, S. (1996) Employee Ownership in Transition, pp1-62
in Frydman, R., Gray, C.W. and Rapaczynski, A. (eds.) Corporate
Governance in Central and Eastern Europe. Central European University
Press, Budapest.
[6] European Bank for Reconstruction & Development (1997) Transition
Report 1997: Enterprise Performance and Growth. EBRD, London.
[7] Filatotchev, I., Hoskisson, R., Buck, T. and Wright, M. (1996) Corporate
Restructuring in Russian Privatizations: Implications for US Investors.
California Management Review, 38, 2, 1-19.
[8] Fogel, R.W. (1964) Railroads and American Economic Growth: Essays
in Econometric History, John Hopkins Press, Baltimore, MD.
[9] International Bank for Reconstruction & Development (1996a) Trends in
Developing Countries. IBRD, Washington, DC.
[10] International Bank for Reconstruction & Development (1996b) World
Development Report: from Plan to Market. IBRD, Washington, DC.
[11] McCarthy, D., Puffer, S. and Naumov, A. (1997) Partnering with
Russia’s New Entrepreneurs. European Management Journal, 15, 6, 648-
657.
[12] Pearce J.A., II and Robbins, K. (1993) Toward Improved Theory and
research on Business Turnaround. Journal of Management Studies. 19,
3, 613-636.
[13] Peters, T.J. and Waterman, R.H.Jr. (1995) In Search of Excellence.
Harper Collins, (paperback edition), London.
[14] Robbins, D.K. and Pearce J.A., II (1992) Turnaround: Retrenchment and
Recovery. Strategic Management Journal.13, 4, 287-309.
[15] United Nations Conference on Trade & Development (1997) World
Investment Report. United Nations, New York and Geneva.
INTERNATIONAL JOURNAL OF BUSINESS, 4(2), 1999 39
[16] Wright, M., Thompson, S. and Starkey, K. (1994) Longevity and the
Life-Cycle of Management Buy-Outs. Strategic Management Journal,
15, 2, 215-227.
doc_334090001.pdf
Our paper about russian mass privatization what has been achieved.
INTERNATIONAL JOURNAL OF BUSINESS, 4(2), 1999 ISSN:1083-4346
Russian Mass Privatization: What Has Been
Achieved?
Trevor Buck, Igor Filatotchev, Mike Wright, and
Vladimir Zhukov
In countries of the former Soviet bloc, the economic aims of industrial
privatization beyond mere ownership change include shifts in managerial
strategies to reflect market imperatives and ultimately to improve enterprise
performance. New strategies involve business turnaround, at first through
retrenchment, or reactive restructuring. When stability is achieved, second-
stage strategies involve long term, deep restructuring in a recovery phase,
involving investments in new products and processes. Extensive research on
Russian privatization has so far yielded little evidence of progress in these
respects, but ignores the important, counterfactual question, ‘What would
have happened without mass privatization?’ For a realistic evaluation of
Russian reforms and their consequences, comparisons are made with Belarus,
another former republic of the USSR, with some political and economic
reforms but hardly any privatization. This comparison indicates that
privatization in Russia has been a relative success.
I. INTRODUCTION
The break-up of the USSR after 1991 was followed by extensive economic
reforms in most republics and countries of the former Soviet bloc. In Russia
itself, prices were substantially liberalised, more openness to international trade
and capital flows was achieved, and the State gradually withdrew from playing
a dominant role in the governance of industrial enterprises. In particular, the
privatization of Russian industry gradually accelerated after 1992, with the
exception of certain ‘strategic’ firms in the defence and natural resource
sectors. By the beginning of 1997, 123,000 formerly State-owned enterprises
had been privatized, and about 70% of Russia’s GDP was accounted for by the
private sector, according to the European Bank for Reconstruction and
Development (EBRD), 1997, p195. Budget constraints have hardened
somewhat with the withdrawal of the State as lender-of-last-resort, new private
Trevor Buck, Leicester Business School, De Montfort University, U.K. Igor
Filatotchev, Mike Wright, and Vladimir Zhukov, Business School, University of
Nottingham, U.K.
Copyright?1999 by SMC Premier Holdings, Inc. All rights of reproduction in any form reserved.
24 Buck, Filatotchev, Wright, and Zhukov
business start-ups have proliferated and a new breed of Russian entrepreneurs is
emerging (McCarthy et al., 1997).
At the same time, however, many changes in Russia appear to have
been superficial. Although the natural resource-based sectors have spawned
over two hundred quoted companies on the Russian Trading System, and
competition in many markets is fierce between new private companies,
especially outside the manufacturing sector, in other areas progress has been
slow. The EBRD (1997, p15) describes Russian State credit and subsidy policy
towards industry as only ‘moderately tight’, and although bankruptcy
legislation has been introduced, enforcement has been weak. The ‘unofficial’
economy still is estimated to be 41.6% of Gross Domestic Product (EBRD,
1997, p74), and shares in privatized firms, as the result of a ‘giveaway’ share
distribution, mostly have fallen into the hands of incumbent enterprise
managers and other employees rather than outside investors (Filatotchev et al.,
1996). Although outsiders often can overcome barriers to share trades imposed
by enterprise incumbents, a number of studies of Russian privatized firms have
failed to identify any significant improvement in their performance that can be
attributed to outside ownership and improved corporate governance
(Filatotchev et al., 1996, Blasi et al., 1997, Earle & Estrin, 1996).
Although some reactive, short-term restructuring has been found in
privatized firms as they have reduced employment and capacity (Filatotchev et
al., 1996, Earle & Estrin, 1996), there has been no significant increase in
investments in privatized firms to achieve deeper restructuring, and in
particular, no significant inflow of foreign capital for direct investment (as
opposed to portfolio investment).
For example, in the period 1989-95 Russia had cumulative inward
foreign direct investment (FDI) of US$3,900 million (mostly in the natural
resource sectors) while China attracted $121,700 million (International Bank
for Reconstruction and Development, IBRD, 1996a, p64). Even in per capita
terms, Russia in 1995 attracted FDI of $1.10 per person compared with $18.20
for China (United Nations Conference on Trade and Development, 1997,
pp348-350). In terms of foreign trade, China’s total 1995 exports were
$149,000 million of which 81% were manufactured goods (IBRD 1996b,
p110), while Russia exported $81,000 million, mostly raw materials and fuels,
with machinery and manufactured goods providing only 8% (EBRD 1997,
p65).
In other words, compared with China, Russia’s economic reforms have
failed to attract foreign investment and consequently have failed to produce a
manufacturing sector that can compete significantly on world markets.
INTERNATIONAL JOURNAL OF BUSINESS, 4(2), 1999 25
A gloomy outcome indeed at a national level for Russia, but what if
privatization never had happened or had been more half-hearted, and what
would have been the situation at the enterprise level?
These important, though hypothetical, questions imply the
counterfactual analysis identified with Fogel (1964). It is impossible to answer
them with any econometric authority, given the number of uncontrolled
variables involved, but it is possible to make informed judgements by using
comparisons between Russia and a country like Belarus. Belarus was also a
republic of the USSR, sharing a rather similar economic, political and social
environment. After 1991 however, Belarus introduced fewer economic reforms,
and substantially omitted privatization from its policies.
In contrast with Russia, the European Bank (EBRD, 1997, p154)
reported that in 1997 the private sector in Belarus accounted for only 15-25%
of GDP. In 1993, about 8,500 State enterprises (10% of the total) were slated
for privatization, but in early 1997 only 24% of this original target had been
privatized. At this time, all privatizations were halted, and none have occurred
since 1996. Indeed, some companies have even been renationalized. The
International Monetary Fund (IMF) and World Bank (IBRD) have both
withdrawn their support for the Belarusian economy, and the EBRD (1997,
p155) reports continued extensive State intervention in the setting of industrial
price and production targets. One third of industrial enterprises are loss-making
but virtually none has been closed, and the State continues to give financial aid
to priority enterprises through tax and import duty concessions and through
directed credits (EBRD, 1997, p155). For example, budgetary subsidies in
Belarus amounted to 3.4% of GDP in 1995 compared with only 1.3% in Russia
(EBRD, 1997, p83). Thus, employment levels have been sustained above
Russian levels, and some reactive restructuring avoided, but at the expense of
deeper reform. Inward FDI has been low even by Russian standards, and indeed
UNCTAD (1997, pp340-350) calculates that with the exception of Somalia and
Sierra Leone (which both had negative inflows), Belarus had the lowest per
capita FDI inflow in the world in 1995, at $0.40 per person, compared with
Russia’s $1.10. Current trends suggest that even the unfortunate records of
Somalia and Sierra Leone may be under threat from Belarus. Given a
comparable geographical location and sharing a common, recent, political and
economic history, it is seriously suggested that Russia without a privatization
programme could have followed the Belarusian path.
It appears therefore that comparative enquiries into managerial
priorities and strategies in Russia and Belarus may be instructive in order to
answer the counterfactual, ‘what if...?’ question for Russia. The next section
discusses business turnaround as a result of short-run retrenchment and long-
run recovery strategies, and then reviews survey responses from managers in
26 Buck, Filatotchev, Wright, and Zhukov
privatized firms in Russia and Belarus in this context, supplemented by one
Russian and two Belarusian case-studies. It concludes with some comments on
the merits of Russian mass privatization and implications for investors from the
West.
II. BUSINESS RETRENCHMENT
Although the collapse in industrial and final consumer demand in the former
USSR after 1991 was massive, individual firms in the West also have had to
face up to similar disasters. For example, the ‘peace dividend’ of the 1990s has
meant the cancellation of military orders and market collapse for many
weapons manufacturers in the West; the demand for British coal virtually
disappeared with the discovery of North Sea gas; and the birth of the PC has
had enormous implications for typewriter builders and for the printing industry.
Faced with market collapse, the continued procurement of labour,
capital and material supplies cannot be sustained without soft loans and/or
grants. Western academics, for example Robbins & Pearce (1992) and Pearce &
Robbins (1993), have observed that a successful transition to changed market
circumstances can be achieved only in a sequence of steps after first ‘stopping
the bleeding’ (Bibeault, 1982). Together, internal and external factors
determine the severity of the enterprise crisis, and, unless soft credits are
available, a retrenchment phase follows, when the main objective is to get
control of cash flows and achieve a position of stability. Such retrenchment
comprises current cost reduction (including reductions in the labour-force)
and/or asset reductions (capacity reduction or plant closure), depending on the
severity of the situation. This is analogous to the ‘reactive’ or ‘shallow’
restructuring in economic transition described by Earle and Estrin, (1996). Only
if retrenchment policies achieve stability can the next decision-point be
reached: whether to enter a recovery phase, which amounts to ‘deep’
restructuring, involving entrepreneurial decisions concerning new capital
investments.
III. LONG-TERM RECOVERY
The direction of new strategies such as diversification, refocusing on core
competencies, acquisitions, and the adoption of new technologies may vary
from case to case, but they all have one thing in common: a need for new
investment and for the funds to finance that investment. An enterprise in
economic crisis is unlikely to be able to generate funds internally, though some
diversified firms may be able to sell or spin-off activities to raise funds for new
INTERNATIONAL JOURNAL OF BUSINESS, 4(2), 1999 27
projects. With these exceptions, recovery must involve shareholders and/or
outside lenders.
In the former USSR, long-term loans are unlikely from a banking
system that prefers, for pragmatic and legal reasons, to keep its assets liquid.
Investment banks may be a source of long-term loans, but they will probably
demand an equity stake, too, in order to protect their investments with a degree
of control. Where States are themselves in budget crises, they cannot consider
any loan finance for industrial investment, and this emphasises the conclusion
that shareholders are the most feasible potential source of funds for recovery
strategies.
Shareholders who are enterprise incumbents are unlikely sources of
significant amounts of restructuring finance. In any case, existing managers and
other employees are stakeholders in firms even before they obtain shares (Buck
et al. 1998), and with dual roles as employees and shareholders they are likely
to inhibit the very short-run cost and asset reduction policies that can achieve
stability as a prerequisite for deeper restructuring. (Although employee
ownership in the former Yugoslavia was associated with over-investment, this
was a result of State loans being the dominant source of investment finance, see
Buck, 1982, 77-123).
This leaves outside shareholders as the major potential source of new
investable funds, including financial institutions, venture capitalists and
strategic investors as well as individual outsiders. Besides looking at the
underlying asset value of the enterprise and earnings prospects, the time-
horizons of outside investors are crucially influenced by the tradability of
shares. Freely tradable shares give outside investors infinitely long time-
horizons, since the value of shares reflects the present value of all future
expected dividend streams, but any attempts to limit the tradability of shares
must increase the reluctance of outsider investors to finance long-term
restructuring programmes. In the former USSR, stock trading restrictions can
deter outside shareholders, thus placing a new emphasis on short-run
turnaround and the internal generation of funds for recovery investments.
In order to provide estimates of the extent of turnaround responses in
terms of retrenchment and recovery in privatized firms in two countries from
the former USSR subjected to massive economic crisis, the authors carried out
extensive surveys in Russia and Belarus, reported below.
28 Buck, Filatotchev, Wright, and Zhukov
IV. RETRENCHMENT AND RECOVERY IN RUSSIA AND BELARUS
Managerial attitudes and strategies in Russia and Belarus were estimated
through direct questionnaire surveys of enterprise directors during the first half
of 1997, after piloting a survey instrument in Moscow and Minsk. Useable
responses were obtained from 106 privatized industrial firms in Russia and
from 91 in Belarus. Rather than focus on the dynamic, new private start-up
sector, and natural resource-based firms, a decision was made to study the
industrial heartland of the former USSR: her manufacturing industry, where the
need for business turnaround is most pressing. Although this sector has the
reputation of being entrepreneurially inert, it employs a majority of the former
USSR’s workforce, and its future has enormous implications for political
stability. To illustrate the current importance of this sector, the average
employment of firms in the sample was 1,044 in Russia and 1,157 in Belarus.
The surveys were conducted approximately 4.0 years and 2.5 years after
privatization in the two countries, respectively. In each country, a random 5%
of returns were checked by at least two of the authors personally visiting
companies for face-to-face interviews with senior managers, to check the
accuracy of questionnaire responses.
The contrasting economic policy stances of the two States surveyed are
reflected in their different average industrial ownership structures in privatized
firms (Table 1). In the few firms that have been privatized in Belarus, the State
in 1997 still holds an average 12.1% of voting shares (versus 6.3% in Russia)
and ‘insiders’ hold 67.9% (versus 55.4% in Russia). Within these dominant
insider ownership groups, managers have a smaller average holding of 12.2% in
Belarus (versus 17.1% in Russia), and other employees’ shareholdings are
correspondingly more significant. Importantly, private ‘outsiders’ now have
38.3% of Russian shares compared with only 20.0% in Belarus.
These shareholdings are reflected broadly in Board representation in
both countries and have great significance in the determination of company
strategies. The picture presented by Table 1 therefore suggests that in Russia
weaker employee ownership, together with higher stakes for managers and
outsiders, may be expected to produce short-term turnaround strategies that are
not so favourable towards the immediate concerns of employees (current wages
and employment). Eventually however, recovery strategies may be more
realistic in Russian companies, where employees have smaller proportions of
total shares.
INTERNATIONAL JOURNAL OF BUSINESS, 4(2), 1999 29
Table 1
1997 distribution of voting shares (%) in sample of privatized firms, Russia and
Belarus
RUSSIA BELARUS
Managers 17.1 12.2
Other Employees 38.3 55.7
(Total ’insiders’) (55.4) (67.9)
Trading Partners 4.0 3.5
Investment Funds 3.5 1.7
Banks 1.8 0.5
Private Individuals 13.7 9.9
Holding Companies 1.9 1.2
Foreign Investors 0.6 1.7
Other Organisations 12.8 1.5
(Total ’outsiders’) (38.3) (20.0)
The State 6.3 12.1
TOTAL 100.0 100.0
A. Business Retrenchment in Russia and Belarus
Although realistic measurement of the size of the collapse of sales was not
possible in a period of hyper-inflation which affected sectors differentially, the
overall predicament of Russian and Belarusian privatized firms is reflected in
managers’ responses to questions about the average competitiveness of their
products. In these two countries that are increasingly open to competition from
imports, fewer than 25% of managers estimated that their products were
competitive on world markets in terms of product price, design, quality,
packaging and after-sales service, with the last reckoned to be most deficient in
both countries.
In such a situation of deep crisis, with over-manning and with large
average debts to the State, suppliers and banks, and faced with the prospect of
further sales decline in the face of import competition, business turnaround is
required, with an early emphasis on ‘stopping the bleeding’ before
reconstructive surgery is considered. In Belarus, with a higher proportion of
shares held by employees with short-term needs and held by the State, and with
relatively fewer outside investors, it could be expected that managers would be
30 Buck, Filatotchev, Wright, and Zhukov
generally less able to reduce costs in the short run than would managers in
Russia.
This was found to be the case. Focussing on the 1995-97 period, the
weighted average reduction in employment in Belarusian privatized firms was
reported to be 14.8%, as opposed to 23.0% in Russia. In order to get some
impression of the continuing extent of over-manning in 1997, we asked
managers to estimate the desired level of employment compared with the
current actual level. The average Belarusian response was 97%, as opposed to
85% in Russia, indicating that Belarusian managers were still relatively
reluctant to concede the need for employment reduction in a situation requiring
business retrenchment.
Table 2
Mean values of directors’ strategic priorities
(Average responses on a seven-point Likert scale, where 1=unimportant, 7= very
important, etc, to the question, ‘What importance do directors give to the following
strategies?’)
RUSSIA BELARUS
Retrenchment Strategies:
Monitor cash flows 6.1 5.9
Seek new domestic markets for existing products 5.7 5.3
Recovery Strategies:
Marketing and Advertising 4.1 5.5
Seek new export markets for existing products 2.7 5.6
Develop new products for domestic markets 5.2 5.9
Develop new products for export markets 3.0 5.4
Monitor IRR on investments 3.7 5.4
Seek new investors 4.4 5.1
INTERNATIONAL JOURNAL OF BUSINESS, 4(2), 1999 31
Managerial priorities in relation to different retrenchment and recovery
strategies in 1997 are shown in Table 2. The first thing to notice is that
Belarusian managers absolutely fail to distinguish short-term and long-term
priorities: in the middle of a business crisis, they consider each of eight
strategies to be worth at least an importance rating of five on a seven-point
scale. The significance of this failure of senior managers to establish any
priorities is emphasised by Peters and Waterman (1995, p307):
“The organization gets paralyzed because the structure not only does
not make priorities clear, it automatically dilutes priorities. In effect, it
says to people down the line: ‘Everything is important: pay equal
attention to everything.”
Conceding that Belarusian managers consider every strategy to be
important, they fail to give retrenchment strategies the higher priority that
Russian managers appropriately provided, instead giving each short-term
variable related to current cash-flow a lower value than do Russian managers.
Although Belarusian managers’ previous responses in relation to their products’
lack of a competitive edge on world markets revealed the infeasibility of
expanding exports of existing products, the fourth row of Table 2 still shows
that they still entertain dreams of expanding export sales for existing products,
all in the middle of a short-term crisis requiring retrenchment actions.
Such dreams persist even in the dire circumstances of one privatized
firm in Minsk, Belarus:
B. Case Example 1
Ribocomplex is one of the least fortunate privatized firms in Belarus, as a sea-
fish processor in a country without access to the ocean. It is confronted not
only with the break-up of the USSR and its main suppliers in the Baltic states
but also with the exhaustion of Baltic Sea fish stocks. Although it had a
workforce of 1,200 in 1993, since privatization in 1995, there has been no
further reduction in its labor force of 296. The pre-privatization retrenchment
occurred through attrition as a result of low wages, rather than from conscious
company strategy. Wages are one-third lower than at Kommunarka, (Case 2,
below). It sells its entire output to the Russian market.
The factory was a depressing sight for the authors in April 1997, with
workers huddled in about 10% of the total factory area, processing only a token
quantity of fish. It would appear that with the breakdown in supplies of raw
fish, the antiquated plant is doomed as a fish-processor, and in its existing
32 Buck, Filatotchev, Wright, and Zhukov
function can only be preserved as a large refrigeration facility, with even fewer
jobs than at present
Still the managers dream that their premises and plant are an
attractive target for foreigners. As a fish-processing plant, the managers
estimate that they would require only $0.7 million of new investment to achieve
world standards, assuming raw fish supplies could be obtained.
After so-called privatization in 1995, the State had 84.5% of the voting
shares, with employees holding the other 15.5%, but by January 1997, the State
was left with 26%, employees 38%, managers 1.5% and ‘friendly’ outsiders
34.5%.
In 1995, there was a takeover raid. A brokerage company, ‘Ramos’,
was hired by ‘European Style’, a joint venture operating in the fish industry
that wished to acquire Ribocomplex’s refrigeration capacity. It bought 36% of
the shares, but was only able to register 22% before the company’s General
Director instructed the so-called ‘independent’ company operating the share-
register to stop all transfers.
Late in 1997, employees and managers at Ribocomplex were confident
that a team of investigators from the President’s office would recommend
renationalization of the company to preserve the few jobs that have survived so
far.
This case emphasises the business crisis in the most unfortunate
privatized firm in Belarus. The harsh conclusion is that fish-processing is no
longer feasible at Ribocomplex. Even further retrenchment, with the focus on
refrigeration services is the only practicable strategy, and any State ’rescue’ can
only be financed by taxes on more successful private businesses.
By comparison, post-privatization Russian managers are more
commercially and entrepreneurially aware, recognising the high priority that
should be given to realistic and urgently needed short-term strategies of
monitoring cash flow and seeking to increase domestic sales. In this context, it
may be that the weaker ownership position of non-managerial employees in
Russia compared with those in Belarus may in the end enable managers
themselves to acquire more shares and to implement turnaround strategies. 30%
of Russian managers reported that they had already purchased or intended to
purchase shares from employees, as opposed to only 13% in Belarus. There is a
rather different privatization situation in Russia:
C. Case Example 2
INTERNATIONAL JOURNAL OF BUSINESS, 4(2), 1999 33
GAZ (Gorky Avtomobil Zavod, now the Nizhny Novgorod Automobile
Company) has faced a turnaround crisis less severe than most Russian
privatized firms. It was founded in 1930 with the support of a then-friendly US
government and the Ford Motor Company: its first product was a version of the
Ford ‘Model A’ truck in 1932.
Upon privatization in 1993, it became an enormous employee-manager
buy-out, and, in late-1996 when one of the authors visited, it had managed to
maintain its workforce at 106,000, but this included workers in every kind of
social infrastructure operated by GAZ, from fish farm to schools and hospitals.
Incumbent managers and other employees were hostile to any outside investor
who might impose a strategy of retrenchment in relation to direct production or
infrastructure workers, and no foreign motor manufacturer was prepared to
pay a price for GAZ control if these social liabilties were included.
Nevertheless, 20% of GAZ’s shares had fallen into the hands of
outsiders plus 13% with senior managers and 67% with other employees, and
half of the outsiders’ shares (i.e. 10%) could be traded reasonably freely on the
Moscow capital market. The remaining 90% of shares (80% inside-held shares
and 10% with so-called outsiders) could only be sold to a private company
owned and controlled by the GAZ chairman.
Dominant incumbent ownership was reflected in control of the
company’s Board, though the State was also represented in the form of the
Nizhny Regional Administration and the State Property Committee, which
oversaw the privatization process. This State involvement evidently gave the
company certain privileges such as the non-payment of taxes and access to
State credits, which have enabled it to avoid employee retrenchment even
though certain elements of the product range have been abandoned.
Specifically, the production of medium trucks (401,500 in 1993) had been
virtually abandoned by 1995 in favour of the Gazelle range of light trucks,
probably financed out of plowback profits accumulated with the support of the
State. The Gazelle trucks (73,000 produced in 1995) and the Volga saloons
(157,000 in 1995) are currently the backbone of GAZ, but their design and
build quality are not competitive internationally.
Although GAZ’s Russian market is stable for the moment and no
immediate retrenchment strategy is needed if the local authorities assume
responsibility for social infrastructure, managers and other employees now
seem to be aware of the need for outside investors and new products, and in
1998 are prepared to enter joint venture agreements in which foreign strategic
partners do not assume a share of GAZ’s infrastructural burden. In early 1998,
an agreement for a $1,450 million joint venture with Fiat was nearing
completion for the assembly of Fiat models by GAZ.
34 Buck, Filatotchev, Wright, and Zhukov
Although GAZ is in a relatively favourable position of stability
compared with other Russian privatized firms in manufacturing, it seems that,
five years after privatization, GAZ senior managers have grasped the need to
establish priorities and cut production and employment where products have
poor trading prospects, to achieve short-term stability before embarking on
recovery investments with foreign investors. Such business recovery is the
subject of the next section.
D. Business Recovery in Russia and Belarus
Although the majority of managers in privatized firms in Russia and Belarus
have faced a demand collapse and have recognised the uncompetitive nature of
their existing products, probably few privatized firms in Russia and Belarus
have restored business stability yet, or reached a decision-stage at which
recovery strategies should have a high-priority, as at GAZ. Recognising the
seriousness of their problems in regard to global competitiveness, Russian
managers on average calculated that investment spending on new premises and
re-equipment needed to achieve world standards was of the order of
$65.9million per enterprise: a totally infeasible amount in the short-term.
Belarusian managers estimated a requirement of $11.1million per firm.
However, in these desperate circumstances, Russian managers have focused on
short-term retrenchment strategies, while Belarusian managers unrealistically
dream of new investors and investment (Table 2).
Outside investors arguably represent the only realistic long-term source
of new funds for investment on a large scale. Although 56% of Russian and
68% of Belarusian managers consider that their firms are attractive investment
targets for outside investors, Russian and Belarusian managers alike cited the
State and retained enterprise earnings as their most likely actual sources of
funds - clearly inconsistent with the sums quoted previously as necessary to
achieve competitiveness. This disregard for outside investors is based on a fear
that outsiders will urge drastic business retrenchment strategies.
The extent of this hostility to outsiders was slightly lower in Russia, in
that ‘only’ (sic) about two-thirds of managers would try to prevent an outside
accumulation of shares, while in Belarus the response was about three-quarters.
The concrete effect of this hostility to outsiders is that privatized firms in
Belarus (and to a lesser extent Russia) have adopted a strategy of blocking the
transfer of shares and strategic control to outsiders, usually by
administrative devices. Such actions have already been alluded to in relation to
Ribocomplex, above. Since technically they are unlawful, it was not possible to
conduct formal surveys into the phenomenon, but a third case is relevant
INTERNATIONAL JOURNAL OF BUSINESS, 4(2), 1999 35
regarding recovery strategies and barriers to externally-imposed strategies, like
Case 1 from Minsk in Belarus:
E. Case Example 3
The Kommunarka confectionery company is one of the most fortunate and
prosperous privatized companies in Belarus. Since privatization in 1993 it has
managed to increase its sales, production capacity and labor-force, thanks to
its products. These comprise sweets, chocolates and biscuits, which are still
popular in Belarus and Russia despite the availability of Western imports. The
local markets favour plain chocolate and a distinctive form of packaging,
providing Kommunarka with a niche market, which it has fostered with
consistent production and a stream of new product variations. It exports 70%
of its output to and imports 73% of its inputs from Russia. Short-term
turnaround strategies have been unnecessary. Indeed capacity has been
increased by 20% since privatization. Wages average about $170 per month.
Kommunarka estimates that to compete on world markets, it would
need to invest around $30 million over five years, but it has no plans to do this.
Nevertheless, it claims that it is an attractive target for foreign investors. Its
current strategy is to develop new products for the domestic and Russian
markets and to improve packaging. This requires investment in machinery, but
the directors have no intention to allow outsiders to acquire shares and control.
Although directors hold only 4% of voting shares, employees have 65%, the
State 2.5%, and ‘friendly’ outsiders 28.5%, all believed to be under the control
of individual directors. The directors control the Board, with six directors out
of nine. (Employees nominate two directors and the State one.) All are anxious
to prevent outsiders from buying shares and registering them.
During 1997, the government of Belarus issued a decree requiring that
all privatized firms must have their share registers kept by an independent
book-keeper, in the case of Kommunarka by the joint-stock company
Agorkapital. Unfortunately, the subsequent transfer of Kommunarka’s register
and its computerization now means that share registrations take two months
rather than the previous two days. Also, share dealings are forbidden for ten
weeks before a General Meeting and for ten days afterwards. Agorkapital
levies a transfer charge on buyers of 100,000 Belarusian rubles per share,
about ten times the face value of each share. Taken together, these restrictions
restrict stock tradeability and deter outside investments.
Without outside injections of funds, it seems unlikely that Kommunarka
will be able to finance significant investment programmes in the future to
protect even its niche market from firms in Russia and other countries.
36 Buck, Filatotchev, Wright, and Zhukov
The hostility shown towards outside investors in Kommunarka and
other in privatized firms in Russia and Belarus effectively rules out most long-
term investments for business recovery, despite the fact that outsiders already
have obtained one to two-fifths of all shares (Table 1). It may be that managers
themselves will be the ultimate sources of limited recovery strategies as well as
of turnaround. On the basis of Western evidence in relation to management
buy-outs, however (Wright et al. 1994), it seems likely that managers wishing
to preserve their equity positions in the firm but also to raise outside funds must
be prepared to submit themselves to extensive monitoring by outside investors
who wish to prevent current consumption by managers and employees of funds
intended for long-term investment. The local power of enterprise managers is
reflected in the finding that since privatization the General Director had been
replaced in 37% of Russian firms and in only 25% in Belarus.
V. CONCLUSION
Although the shortcomings of Russian economic reforms have been widely
recognised and criticised in this paper and elsewhere, it seems likely that
political realities after the break-up of the USSR in 1991 produced a reform
package as market-oriented as was practicable at the time. At least the
distribution of shares at privatization to favor enterprise managers and other
employees sustained support for the government throughout the regions of
Russia, and enabled the government to push ahead with other reforms, which
have resulted in significant political and press freedoms and less hostility
towards private business and foreign traders and investors. Without such a
Russian privatization programme, even though flawed, the results would have
been similar to those in Belarus.
In Belarus, privatization favouring the interests of the State and
enterprise employees was strangled at birth. The outcome is a populistic
dictatorship that seriously constrains press freedoms and the activities of private
business, and which continues to be dominated by insiders and the State, (Table
1). In May 1996 all private firms in Belarus had to re-register and seek
permission to carry on in business, and about one-third (30,000) of all
companies were instantly liquidated (EBRD 1997, p155), some because the
State’s inspectors considered them insufficiently profitable! Private banks were
instructed to make directed credits to favoured enterprises and the State
arbitrarily seized a proportion of the hard-currency balances of private firms to
relieve its financial crisis. In December 1997 a presidential decree introduced a
‘golden share’ for the State in any future privatizations, which effectively rules
out any foreign participation, since the State can veto any turnaround strategy
proposed for the firm. Aggregate economic statistics are regularly massaged
INTERNATIONAL JOURNAL OF BUSINESS, 4(2), 1999 37
(mostly by enterprise managers anxious to demonstrate their ‘achievement’ of
fictitious plan targets), and international agencies such as the IMF and IBRD
have withdrawn from the country both their offices and financial support.
This focus on Belarus has been deliberate in order to make judgements
on the ‘what might have been’ counterfactual position in Russia. It is not
unrealistic to argue that a similar scenario could have developed in Russia in
the absence of its mass privatization programme, which seemed from a distance
to be seriously flawed. Without this programme it seems unlikely that in 1998
in Russia there would be a proposed joint venture (JV) between GAZ and Fiat
in Nizhny Novgorod, a JV between Renault and Moskvitch in Moscow, and
Ford’s JV with Russky Dizel near St. Petersburg, all in one industry: motor
manufacturing. The positive results of shock therapy now are beginning to
show.
Generally, however, apart from portfolio investment by financial
institutions from the West, mostly in natural resource-based companies where
share values are backed with physical reserves, Western investors have voted
with their feet and have made few direct investments in either Russia or
Belarus, preferring to concentrate on other emerging markets like China. In
1999, Western entrepreneurs are aware of the continuing hostility they face
from enterprise incumbents in the heartland of Russian and Belarusian industry,
in privatized manufacturing companies. This hostility has undoubtedly
contributed to the national crisis which developed in Russia and Belarus late in
1998, with insiders’ immediate self-interests prolonging the admitted lack of
competitiveness of local industry, which in turn has contributed to a balance of
payments crisis and a massive State budget deficit from shortfalls in enterprise
tax payments.
Still, in Russia mass privatization was achieved, even if imperfectly.
Outside ownership in the survey sample averaged 38.3% in 1997, up from
33.2% in only two years from 1995, and by 1998 there were signs that
enterprise incumbents, in some firms at least, appreciate the danger of
continuing to be uncompetitive internationally, appreciating the danger of even
further retrenchment without outside investment.
In Russia, mass privatization and the subsequent evolution of privatized
firms by mid-1998 created a climate that had begun to bear fruit. Ironically,
however, progress in companies admitting outside investors for the purpose of
financing recovery investments may now be swept away in a new national
economic crisis, for which more defensive companies are partly to blame.
Nevertheless, without its mass privatization, Russia could already have
followed the path of Belarus in its struggle with Somalia and Sierra Leone to
the bottom of the pile in terms of foreign direct investment.
38 Buck, Filatotchev, Wright, and Zhukov
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