Transforming Russian Enterprises:
Performance, Ownership, and Management

The privatization process in Russia has brought extensive change across most firms. While some firms have improved and more have failed, many are still struggling ten years after the passage of the privatization law.

Mismanagement and corruption are major barriers to improvement in many firms. What can we learn from firms which are over coming these barriers? What is the best strategy for removing these barriers for even more firms?

The data suggests that a powerful anti-corruption strategy is broad-based employee participation in ownership and decision-making that also leads to improved performance.[1]

Summary

Prepared by The Kennan Institute

“Enterprise transformation is one of the keys to rapid and equitable economic development,” stated John Simmons in a Kennan Institute lecture at the Woodrow Wilson Center. Simmons, President of Participation Associates, discussed how an early amendment to the privatization law and the lack of enforcement of shareholder rights has limited the growth of many businesses in Russia. However, Simmons also described how a growing number of mid-sized companies have challenged the 1992 law and successfully transformed into broad-based, employee-owned businesses. He concluded by explaining the importance of federal support for these “protest enterprises,” and outlined ways in which Russian business and political leaders could more effectively encourage enterprise transformation.

According to Simmons, an amendment to Russia’s privatization law helped increase mismanagement and corruption throughout the country and limited the desired rate of improvement in management and ownership practices. He explained how the amendment, which was drafted as an executive order by Anatoli Chubais, then Minister of Privatization, disenfranchised employee shareholders in the selection of directors and effectively transferred control of a firm’s assets to a small group of outside shareholders. While the June 1992 law permitted employees to buy up to 80% of the shares of their companies, the amendment allowed a small group of outside shareholders to appoint two-thirds of a firm’s board of directors, regardless of what percentage of shares were owned by the employees. Simmons pointed out that the executive order was never effectively challenged in court because underpaid judges were easily swayed by bribes from minority shareholders.

Simmons observed that despite the obstacles established by the privatization law, many firms have made significant changes to avoid the problems of corruption, mismanagement, and “predatory privatization.” He described how some Russian business leaders have created more employee involvement by introducing shared decision-making teams, gain-sharing of profits and offering broad ownership of shares to employees. In other cases, employees of “protest enterprises” locked out plant management or threatened to strike unless a Western style of increased participation in management and ownership was introduced. He estimated that over 40 protest enterprises currently exist in Russia, but noted it is hard to measure because the media rarely covers them.

Simmons stressed that in order to enhance and sustain the growing productivity of restructured firms, changes are needed in the national economic policy. He noted that political leaders have shown an increased understanding of the anti-corruption effect of broad-based employee ownership, and, recently, the Russian Duma passed a law legalizing broadened ownership. Simmons suggested, however, that the government must provide more support by creating a regional model that can be used to support the transformation of small and medium-sized businesses.

Simmons concluded by offering several recommendations for implementing enterprise transformation throughout Russia. He stated that in order for enterprise transformation to be successful, it is imperative that President Putin follow through on his campaign promise to radically reduce corruption. Simmons also noted that government leaders must strengthen or develop adequate institutional mechanisms, like the protection of shareholder rights, which encourage transformation, realizing that immediate rewards may not occur. He also called for increased cooperation among international agencies, government officials and non-government organizations in supporting increased employee participation and ownership. Finally, business, labor, and government leaders must communicate the results of successful transformations in both the local and national media.

Background

The purpose of my talk today is to provide some windows into the transformation of Russian enterprises. It should help us better understand strategy for accelerating enterprise transformation in the future.

In the 1970s I worked on policy and project planning at the World Bank. In the 1980s my work as a consultant to the private sector focused on the creation of high performance organizations in the United States and abroad. In 1988 I was invited by the Russian government to visit some pilot firms in order to help forecast the impact of the New Law of Enterprises that had begun to free firms from Ministry domination.

Since then I have worked with people from over 200 Russian firms. I have coached CEOs, trained work teams in problem solving, and taken enterprise leadership teams on month-long study tours abroad. A Russian-American team has studied seventeen firms to better understand the problems and opportunities for transforming and has published two books plus articles on transformation. My most recent project was a new partnership with ten firms in the Volgograd region, the governor of the Region, and the World Bank.

Protesting Privatization

Ten years ago the Duma passed the privatization law, launching the world’s most comprehensive privatization process. While some firms prospered, most have not. While some analysts believe that the best measure of economic results in Russia is a GNP driven by natural resource prices, Moscow construction, and criminal transactions, some oblast governors prefer to measure economic results in terms of the percentage of employees who are getting paid for their work, new jobs created, and an increase in tax revenues.

Governors often see their firms stripped bare of their equipment, and 40% of their people living at or below the poverty level. Even worse, they see corruption spreading to more and more small and medium sized firms. Governors are beginning to see the advantages of the Chinese model of privatization which emphasizes employee and community ownership.

One piece of the problem came from an early amendment to the privatization law. Another is the lack of enforcement of shareholder rights. Together they assured that the original intent of the Yeltsin administration would be achieved: to transfer the assets of the state to a small group of outside shareholders.

One amendment helped open the floodgates of enterprise bribery and corruption across the country, and denied any possible accountability to the majority of shareholders. The amendment was an executive order, drafted by Anatoly Chubais, minister of privatization, and signed by President Yeltsin. They had to use an executive order because they knew that the Duma would never approve their idea.

You may recall that the June 1992 law permitted employees to buy up to 80% of the shares in their own company if they would agree to pay full value of the shares. This required a vote of the majority of the firm’s employees. The law also offered the option of getting non-voting shares, which would also provide dividends, at no cost. Chubais expected that most workers would prefer to get free shares; instead the employees at 83% of the firms voted to pay full value. This created broad employee ownership of Russian firms.

At the more profitable firms, however, workers and managers had already begun to see mafia members visiting the director. They did not want to yield control of their firm to criminals. A majority of the shares would give them a majority on the board of directors.

The Executive Order required that outside shareholders had the right to elect two thirds of the board of directors, even if the employees controlled 80% of the shares. This order violated the contract established when the employees bought their shares; it included the right to vote their shares for the board. This order was never effectively challenged by law suits. The bribes employee litigants could offer the judge making the decision and earning about $30 per month, paled in comparison to the size of the bribes from their adversaries.

As a result of this executive order the foxes got the right to guard the hen house and oversee the pillage of many firms for the coming years.

Illustrations: Protest Firms

For the past ten years, readers of the Russian press, Business Week, and The Financial Times – have been treated to the often deadly theatrics of the struggle among the Russian oligarchs, and some brave, but often naïve, foreign investors, over the crown jewels of Soviet firms.

Across Russia, however, there is another struggle taking place in some firms. It is a quiet struggle far from reporters or television cameras, that could affect the performance of Russian firms and the economy for decades to come. It is not a struggle that the Oligarchs and their government partners would like to become a model for the firms that they own.

Have any of you heard about the “protest movement”? The 1998 Law on Peoples Enterprises? Have any of you had the opportunity to visit any of these firms?

Yasnogorsk

Four years ago, a group of twenty workers and managers hid themselves one night at the Yasnorgorsk Machine Tool Plant, near Tula, southwest of Moscow.[2] Most of the 4000 employees had not been paid for over a year, yet the plant continued to sell the large coal mining machines they made that worked at the face of the mine, and took them three months to build. They had begun to wonder who was buying the equipment.

That night they were armed with machine guns and clubs. At midnight a large flatbed truck drove in, and the driver and several men on the truck used a forklift to load a mining machine on the truck. Sitting in the cab next to the drivers seat they saw Vladimir Chernov, the General Director of the plant. He was stealing the machine in order to sell it.

Outraged, the employees locked out the plant administration. At the end of a six-month legal process they prevented him from returning and replaced the board of directors. Back wages were paid, a 50% raise in wages was granted, and the employees took a greater role in decision-making, including voting their shares to select a new board. Despite the 1993 executive order, Yasnogorsk was one of the first successful takeovers of a large plant that started with the action of locking out the General Director.

Ryazan

The Ryazan textile plant has about 290 women who make military uniforms and clothes for export.[3] When the Ministry of Defense couldn’t pay for their uniforms in 1997, the firm went into bankruptcy. Thirty five percent of the employees were fired, and some people were not paid regularly. While employees owned 51% of the shares, they had no representatives on the board of directors.

The board planned to liquidate the firm in March 1999, and started to tear it down. The women used fire engines to block the way of the demolition equipment into the compound, and the confrontation lasted three months. The textile employees were supported by employees of other firms in the town as a show of solidarity. A court ruling found mismanagement on the part of the Director General, including selling the warehouse without the required inspection of inventory.

As a result the employees negotiated changes with the General Director who did not leave. They wanted and got the payment of back wages, substantial independence from the parent plant, increased wages by almost 100%, increased the participation of employees in decision making, and began hiring new workers.

Tutayevsk

In the Yaroslavl region 500 miles northeast of Moscow, the Tutayevsk Motor Plant makes eight-cylinder engines for automobiles.[4] While the General Director stripped the company of its assets from 1993-96, the company experienced a steady decline in sales. Seven thousand employees worked without pay.

The employees decided they had had enough. They got the approval of the shareholders and they took over the daily management of the plant. They changed the General Director to someone who was more participative in his management philosophy. In the four years since then, sales have improved, old customers have returned, and wages are regularly being paid.

Tutayevsk was another one of the first of 40 firms in Russia now called protest firms. While the protest firms hold out some hope for stopping corruption and mismanagement from the bottom up, they are the exception rather than the rule in Russia today. They are like a light hidden under a bushel basket.

These firms have suffered a virtual communications blackout. No one hears or reads about them in Russian or international media. The last things the oligarchs want people to see are the happy faces of employees who have just replaced their bosses.

Members of the Duma think that the “protest firms” are so important that two years ago they established The Center to Study of Protest Firms.

Illustrations: High Performance Firms

Now here are three firms that have radically changed their results and the way they are managed, but are not protest firms.

Elinar

Recently the Board of Directors of the MacArthur Foundation visited Elinar, a company located in Atepsevo, a village 100 km south of Moscow. The 1000 employee shareholders have transformed Elinar, a typical manufacturing firm which made insulation for industrial motors.

By 1993 demand for their product had declined by 80%. Bankruptcy was next. Then Igor Kuimov, the General Director, made a study tour to Ohio sponsored by the Ohio Employee Ownership Center and funded by the MacArthur and Eurasia Foundations. He learned that for employee shareholders to be effective owners, they needed to participate in decision making, not just take orders. In Ohio he developed a vision of what a high performance firm looked like, and got the confidence to try it out. When he returned, the employees began to reorganize and start new businesses ranging from a bakery to an auto repair shop. They even found new customers and uses for their insulation.

When relatives of Elinar employees from a nearby bankrupt collective farm asked them for help, Elinar did a financial analysis and saw a possibility. They gave them stock in Elinar in return for the farm’s 30,000 acres and 800 employees. In 24 months Druzba was the top Russian producer in the Moscow poultry market. They had started using self-managing work teams and paying bonuses based on gain-sharing methods. Three years later foreign investors added $20 million to expand their production.

Although not publicized in the media, the word of Elinar’s success spread. So many people from around the country came to see Elinar’s success that they had to stop taking visitors two years ago. Ninety percent of the shareholders are employees in the firm and farm. They vote to select the board which selects the General Director.

Energia

Ten years ago, 10,000 employee owners at Energia in Voronezh made only military aircraft and they had no orders for new planes. No one expected them to survive. Five years later they had fully converted to non-military production, and the workforce of 7,000 was starting to grow again. Since privatization, employees have owned the majority of the shares, and fully participate in the plant redesign.

Konfil

Four years ago, the 500 employees at Konfil, a chocolate candy company in Volgograd, voted to become a closed stock company and a People’s Enterprise. They felt that the change would help prevent a hostile take over by criminal elements. Since then, sales have increased, along with employee participation in decision-making. Three years ago, a second shift began operating, and when I visited the plant in December 2000, a third shift had gone into operation.

Four years ago the Duma passed a law to create Peoples’ Enterprises where employees own at least 75% of the voting shares, and to help prevent a hostile takeover by outside investors. Eight weeks ago the Duma passed another law that encouraged the sale of the shares that the government holds to the employees in firms where the employees already hold 51% of the shares. Today about 25% of the joint stock companies formed under the privatization law have majority employee ownership. This new law could quickly expand the number of closed firms with broad-based employee ownership.

What do we learn from these six cases, windows into ten years of privatization?

Some Observations

The Duma members began to see the anti-corruption effects of broad-based employee ownership.

1) In Russia, the privatization law has failed to create the desired rate of improved management and ownership practices in small and medium sized firms compared to similar practices in some Eastern European Countries and China. Corruption and mismanagement, termed “predatory privatization” by some Russian analysts, is the hallmark of too many firms.

2) To overcome these problems, some Russian firms have developed new approaches to management and ownership that are getting results. Most firms have had little or no help from consultants. Mainly on their own they are discovering practices of high performance management.

3) The strategies of these emerging excellent Russian firms build on the best practices of high performance firms in the Asian Rim, Europe and North America. Best practices include a focus by all the employees of the firm on the customer, quality improvement, self-managed teams, shared decision making, gain sharing and broad-based employee ownership of shares.

4) To enhance and sustain the growing productivity of these firms, and spread the results across eleven time zones, changes in economic policy at the national and regional level are needed.

5) Also needed is a model that can be used by governors in regions that are ready to spread the experience of these newly emerging high performance Russian firms.

World Wide Shift in Management Strategies

One key point about all these firms whether they are protest firms or not, is that they moved from the Soviet model of authoritarian management with a focus on production volume to a more participative strategy of management focused on improving customer satisfaction and product quality. It is the same shift that we have observed in European firms beginning with co-determination in the German Coal and Steel Community in 1950. There half the board of directors is selected by labor, and the other half by management. The shift to participative management and governance extended first to Japan in the 1950s and then to the rest of Europe, Australia, Scandinavia, and North America in the 1960s, 1970s, and 1980s.

Trying to stay competitive is the reason for the shift across the world to a focus on quality and participation. It is a better way of managing because it gets better results more quickly and at less cost. Participation in decision-making and ownership releases the untapped energy and creativity of each employee in ways that produce steady increases in productivity.

Peter Senge at MIT, calls organizations that utilize these paradigm shifts – learning organizations. Tom Peters, the McKinsey consultant and author, has made a small fortune by discussing their results. In the past fifty years participation in management and ownership has accelerated productivity improvement and contributed to the steady expansion of the GDP of a growing number of countries.

Eight years ago, Alan Blinder, former Vice Chairman of the Federal Reserve and Economics Professor at Princeton, and Laura Tyson, former chairman of the President’s Council of Economic Advisors and Dean of the School of Business at the University of California, Berkeley, wrote a book confirming the productivity effects of these high performance strategies, Paying for Productivity.

Many of you know that the main components of these strategies are:

· All employees focus on raising the quality of their products and services;

· Ownership of shares for all employees and participation in corporate governance;

· The introduction of team work where teams hire and fire their own teammates even in union companies;

· Removing levels of middle management to speed up communication and decision making, and reduce costs;

· Sharing the gains from productivity increases as often as monthly with all the employees as financial incentive.

In a growing number of these firms, most of the employees are voting shareholders. In American firms like United Airlines or the People’s grocery chain, they are the majority shareholders. In most countries in Western Europe the law requires that employees hold up to 50% of the seats on the boards of directors of firms larger than 500 employees.

These management and ownership methods that form international best practices are beginning to reshape performance in Russian firms.

But let’s back up to get some historical perspective. In Russia, the process of developing a post-Soviet management paradigm goes back more than 13 years and includes two Gorbachev-sponsored laws. In the 1970s some firms had been experimenting with new methods for quality improvement. The New Law of Enterprises went into effect in January 1988 providing some freedom from the ministries. The Leasing Law of 1989 offered additional autonomy from the Soviet management system as it enabled firms to get full control of their assets by leasing them from the state.

Both these laws were cancelled by the Yeltsin government in 1992. It was estimated that 10,000 medium-sized firms took advantage of the leasing law to jump-start privatization. A Russian/American team that I was on wrote a book about these firms, Transforming Russian Enterprises, published in 1995 in the US and 1996 in Russia.

These laws and the results that firms got from them was the subject of a debate I had with Anatoly Chubais on Channel 2 in March, 1992, two months before the Duma vote on the privatization law. They were also the subject of a memo on privatization that I was asked to write for President Yeltsin, in which I pointed out the potential for corruption of the privatization process. The memo was leaked to Rossikaya Gazeta, and published three weeks before the vote on the law in the Duma.

Which brings us up to today. In summary, here are the key problems.

Problems at the Enterprise level

• Gross mismanagement and corruption among the leadership of too many firms;

• Employee shareholders with little or no influence because shareholder rights are either ignored or not legally protected;

• Harassment of firms by the tax authorities;

• Inadequate banking facilities and borrowing conditions that are too expensive;

• Up to 80 percent of the fixed assets of a firm may be obsolete and have not been upgraded in 30 years;

• Unmotivated and apathetic workers compared to their counterparts in Russia and abroad firms which use the high performance paradigm. Since macro economic polices are such a barrier to improving firm-level productivity, company leaders need to rely even more heavily on mobilizing the energy and creativity of workers to achieve and sustain improvements in productivity;

• The Government may own up to 20% of the shares in privatized companies, but does not participate in the governance of these companies;

• Government policies and practices, including the new labor code, discourage management practices that have transformed Western and Asian-run firms. These practices are: labor-management cooperation, and employee participation in management, governance or ownership;

• Most General Directors lack a powerful vision of the high performance firm;

• Opportunities do not exist for General Directors and their executive teams to visit other successful firms in Russia and abroad in order to understand the best strategies for transforming their firms;

• If they do have a vision of what they could become, they lack opportunities to learn the strategies and techniques for achieving their vision.

On September 9, 1999 the Russian Government issued an Executive Decree. It stated, “the real institution of private property had not been created in Russia, and the rights of shareholders were not protected.” Finally someone noticed that the horse was out of the barn and decreed it to be so!

So what do the Russian workforce, their General Directors and their potential partners in the Government do now?

Rethinking Transformation

Experience from the first decade of privatization has demonstrated several points:

· While the introduction of the market is having a positive impact with some firms, ten years of data suggest that the rate of progress is not adequate for them to catch up to the firms in their industry which are their benchmarks in Asia and North Atlantic;

· A small but growing number of Russian managers and workers see value in high performance strategies and tools for transformation;

· Some of them discovered some components of these strategies without any help;

· They implemented higher practice strategies and got bottom-line results, despite a hostile environment which includes crime, corruption, and government harassment.

Partnering A New Paradigm

Where is the pressure to transform low-performing firms going to come from, especially in firms with corrupt leaders or governance?

The success of protest firms and peoples enterprises provides important data. When the institutional infrastructure doesn’t exist (e.g. judicial, regulatory, insurance, securities, banking, etc.), look for alternatives within the firm itself.

This solution empowers the stakeholders to take responsibility for the future of their firm. When the infrastructure of the state cannot cope with the demands of the new economy, the stakeholders of the firm can be encouraged to improve the quality of management, governance, and ownership. Empowering the stakeholders was the policy that Joseph Stiglitz proposed for Russia in the summer of 1999 while chief economist for the World Bank. He didn’t know that protest firms had already been practicing it for several years.

Stiglitz asked: Who are the people most hurt by corruption and mismanagement at the enterprise level? They are the stakeholders who have the most to lose if the firm fails. They include the employees, shareholders, customers, suppliers and the community in which the firm is located.

In the protest firms the stakeholders finally began to ask themselves: Was the government going to help them? No. Government representatives at every level had either been bribed by illegal owners and asset strippers or felt powerless to intervene.

From Policy to Practice: A Vision for a New Partnership

The vision for a new kind of partnership is simple: Develop a partnership between a governor and an international agency. The two partners help a small number of firms in a region become models of high performance practice. Encourage the firms to open their doors to visitors, and share the knowledge which they have learned. Help them start a profit center in their firms to sell their knowledge by consulting to their neighbors.

In 1999 the governor of Volgograd and the World Bank Institute began a project to implement such a vision. The key design principals were:

• The strategy of the World Bank Institute and its partners for enterprise improvement recognizes that Russia lacks institutional support and national and regional leadership for reform;

• Apply good models for enterprise reform: build on what is working in Russia now, and what is aligned with international best practice;

• Identify Russian and international partners who can help firms implement the models for reform.[5]

Model for Accelerating Enterprise Performance

The components of the model are research-based best practices. They include:

• A business planning process that helps assess the firms’ governance, management and ownership needs and opportunities;

• Workshops and site visits that provide information and skills related to high performance systems and Russian firms;

• Study tours to foreign firms following the World Bank’s Kazakhstan Study Tour Model;[6]

• Networking among the Volgograd firms to share and learn from each other;

• Identifying workers and managers to become region wide trainers from the firms that emerge as the best examples;

• Communicating the results to other firms;

• Helping the best firms to set up consulting profit centers in order to assist other firms;

• Encourage the local institutes, the Open University, and the local university to provide support and continuous evaluations;

• Consider additional proven components like anti-corruption measures, low cost long-term finance, possibly through credit cooperatives, and a program to identify and remove policy barriers to firm development.

These components shape the model used to develop and spread innovation in Japan, Germany, Sweden, the USA and other countries in the past 50 years. The Marshall Plan includes some of these components.

Implementing this model in Russian regions would help accomplish three goals:

1) Accelerating the rate of enterprise improvement;

2) Improving the content of the high performance model and its implementation within a region;

3) Training the staff needed to expand to other firms within and across regions.

Next Step: A Turnaround Strategy

In conclusion, most medium-size Russian firms with 500 to 10,000 employees face an uncertain future that could have a powerful, negative effect on the growth of the economy.

If medium size firms do not have corruption or mismanagement now, they soon could. The steady spread of corruption into medium-size firms threatens to destroy an increasing number of firms, jobs, and one-company towns across Russia.

The protest firms, the People’s Enterprises, and firms like Elinar and Energia are examples of what could spread instead.

An effective turnaround strategy – top down and bottom up – should have at least six components:

From the top down:

1. Political will: President Putin carries through with his campaign promise to rid the country of corruption. He should use all the available tools he has to do it.

2. Institutional infrastructure: the inadequate institutional mechanisms and policies are either strengthened or developed, while recognizing that it could take 20 years or more to begin to feel their integrated impact. The 1992 Executive Decree should be cancelled and shareholders rights strengthened.

3. Support Best Practices: Government, international agency and, their organizations support to the expansion of employee participation in improving quality and ownership.

4. Communicate the results: use the media and key organizations to get the word out across the country.

From the bottom up:

1. Empower stakeholders: use multiple methods to empower the stakeholders. Broad employee ownership is perhaps the most cost-effective anti-corruption tool. Local and regional officials should personally lead study tours to people’s enterprises and with each other.

2. Continuous improvement: governors and mayors should evaluate the merits of the Volgograd model for creating and sustaining high performance firms in their jurisdictions and improve the model.

The cycle of mismanagement, corruption and destruction of both physical and human capital needs to be turned around. The lessons from the firms we have studied suggest that the people closest to the problem, who have had the most to lose, are the best place to deal with it. They need to be supported and recognized for their success. To do this they need effective partnerships. These six components of a turnaround strategy would help reverse the negative aspects of the privatization law. Such a strategy could reshape enterprise performance and economic development for decades to come.

Bibliography

Blasi, Joseph R., Maya Droumova, Douglas Kruse. “The Privatization of the Russian Economy.” Cornell University Press, Ithaca and London, 1997

Blinder, Alan & Lacera Tyson. “Paying for Productivity.”

Brady, Rose. “Kapitalizm: Russia’s Struggle to Free Its Economy.” Yale University Press, New Haven, 1999

Broadman, Harry G. “Seeds of Corruption: Do Market Institutions Matter?” World Bank

Bulavka, Ludmila and Jacob Keremetsky. “Leadership Makes the Difference at Iskitim Limestone Quarry.” January 16, 2002