Restructuring Soviet Enterprises: Challenges and Solutions

IMGXYZ436IMGZYXOn December 6, 2005, the Carnegie Endowment for International Peace hosted a meeting entitled “Restructuring Soviet Enterprises: Challenges and Solutions” with Oleg Deripaska, Chairman of the Board of Basic Element. Anders Aslund, Director of the Carnegie Russian and Eurasian Program, chaired the session. Deripaska’s remarks are summarized below.

Deripaska devoted his talk to the Gorkovskiy Avtomobil’nyi Zavod (Gorky Automobile Factory), known in Russia by its acronym, GAZ. When Deripaska acquired GAZ in 2000—seven years after privatization—it didn’t resemble a western business at all. Instead the haphazard privatization had left it looking like a self-contained colony. GAZ owned two large hospitals, nine schools, 16 kindergartens, several roads, a law office, and a police station. Four hundred thousand people lived in GAZ-owned apartment buildings. The firm was extremely vertically integrated. Said Deripaska, “They would receive a lump of iron ore and produce a car.”

GAZ also faced cultural problems with its workforce. Low wages led many workers to steal from the firm. “[The employees] could steal more than their monthly salary in one shift,” said Deripaska. Many employees were not really focused on their jobs. Deripaska compared their old working conditions to slavery, noting that many employees relied on their gardens for food. “We tried to focus people on their main job,” he said.

In the first phase of restructuring GAZ laid off 25 thousand superfluous workers and implemented a new production system. This enabled the firm to boost both efficiency and wages while cutting expenses. GAZ also improved quality control and transferred non-core assets, like the hospitals, to the city of Nizhniy Novgorod. Deripaska set up a modern distribution and marketing network with dealerships throughout Russia and the former Soviet Union. As a result of these initial efforts GAZ went from a $160 million loss in 2000 to an $8.7 million profit in 2001.

In the second phase of restructuring Deripaska and GAZ management made radical changes to the production process. They continued to reduce staff. Remaining employees were given narrowly defined tasks. Management set daily quotas, increased the speed of the conveyor belts, and began delivering parts to workstations on a just-in-time basis. Between 2003 and 2005 production rose approximately 50 percent and the average wage rose from $150 to $295. The Volga sedan, which had ferried Soviet officials for decades, received a much-needed makeover and GAZ rolled out several new vehicles.

Today GAZ is entering a new, more difficult phase. Deripaska stressed for the need to develop research and engineering capabilities in order to create competitive new products. GAZ hopes to increase its exports from 45 thousand vehicles in 2004 to 90 thousand by 2008. The firm will also expand into automobile components. Deripaska plans to introduce international standards for corporate governance and accounting prior to an IPO in 2007.

Deripaska said no good deed goes unpunished in transforming a former Soviet enterprise into a viable modern business. In the mid-1990s the European Bank for Reconstruction and Development (EBRD) gave GAZ a loan. “They did this for no reason, in my opinion, just to do something to help,” said Deripaska. Following Deripaska’s purchase of the company, the EBRD demanded repayment on the second day of operations. “When it was bankrupt no one would take an interest,” said Deripaska, “But when we stepped in and it was our company, a huge number of creditors immediately approached us.”

Q&A

Q: The state is making a comeback in the economic sphere. As perhaps Russia’s biggest businessman, what do you expect?
Deripaska: No change. Through we have high capital cost, Russia is still becoming a market economy. The government has amassed a lot of rent from the raw materials sector. They’re like kids: when they get a new toy, they play with it, and then get bored and give it back. Russia had too many academics in the beginning and not enough people with even one day of business experience.

Q: You mentioned working with Sergei Kiriyenko in Nizhniy Novgorod. Can you comment on how his work there has prepared him for his new post as head of RosAtom, or on his agenda?
Deripaska: He understands the microeconomic issues. It’s easy to talk about the macroeconomy. He understands what’s going on at the business level and what management can achieve. He knows what help is needed, not just slogans. Russia is going to implement a new nuclear program. I went to Moscow State University in physics, by the way, and it’s time for Russia to decide what to do in the nuclear sphere: the program for research, and for the military. Who is our customer? I see no problem with the past. [In Russia Kiriyenko is popularly associated with the default of 1998.] It’s always tough when you have a past that you can’t change.

Q: How will WTO accession affect the Russian auto industry?
Deripaska: We must understand where Russia can be competitive. Right now Russia is not prepared to negotiate properly. It took China 15 years to accede and they had a better bureaucracy. For our company nothing will happen. We’re giving up on passenger cars. For the whole industry it’s not an issue of tariffs, but of monetary policy. Russia has high capital costs and interest rates. The ruble is strengthening. Tax policy will also be important. Will we have tax incentives for industry? Otherwise Russia will have a problem. There are no alternative jobs if a factory like ours closes.

Q: Can you comment on your new educational project with the Plekhanov Academy in Russia?
Deripaska: At first we had no horizontal relations between departments. Employees didn’t treat everyone as a customer. Quality control was hard. A bad press form would lead to bad stamping and a bad product, but no one complained. The problem is cultural, but also educational. We are trying to help educational institutions address this problem. We contribute to the Moscow State University Business School. Plekhanov is a huge organization with representatives across Russia and the CIS. We are trying to focus them on the demands of industry.

Q: As your company [Basic Element, the parent company of GAZ] becomes more international, will you adopt international corporate governance standards? Will there be an IPO?
Deripaska: We already have strong corporate procedures inside the group. But we are a private company. An IPO won’t mark our business as successful or not. Many private companies do better than public ones. We will consider an IPO if the management sees the need for capital. We won’t use it as an exit strategy.

Q: A recent article said you’re planning to fund a Washington think tank that would express Kremlin-friendly views. How do you see your role? How much will you contribute?
Deripaska: That report is incorrect.

Q: What are the strong and weak points of RusAl? [RusAl is Russian Aluminum, another of Deripaska’s businesses.]
Deripaska: The one uncertainty is how the government restructures certain state monopolies: RAO UES [electricity] and the railways. RusAl has no other vulnerabilities. By 2011 it will be the leading company in this industry. Of course this depends to some degree on the development of China and India.

Summary prepared by Matthew Gibson, Junior Fellow with the Russian and Eurasian Program at the Carnegie Endowment for International Peace.