Enterprise Restructuring and the Role of Managers in Russia

Case Studies of Firms in Transition

Gary Krueger

• Publisher: Routledge
• Year: 2015
• eBook ISBN: 9781317471431
• Topic: Business
• Subtopic: Business General
• Index: Business

This book tells the story of what might have been considered an unlikely source of dynamic change in Russia - formerly state-owned manufacturing enterprises and their managers. Based on interviews conducted over a six-year span with managers at 47 manufacturing, light industry, consumer durable, and food processing firms in four Russian cities, the study documents the real world challenge of turning hidebound, often dysfunctional manufacturing operations into thriving companies. With analytical rigor and theoretical creativity, this work will dispel some common misconceptions about the Russian economy and make a contribution to the literature about management, company strategies, and corporate governance.

Part I

Legacy and Survival

1

RUSSIAN INDUSTRY’S SOVIET LEGACY

As the task of this book is to examine those forces that affect the likelihood of a formerly state-owned enterprise (FSOE) to restructure its activity, it is essential to investigate the degree to which FSOEs are distinct from their counterpart firms in functional market economies. Restructuring FSOEs requires knowledge of four elements: how far the FSOE mix of output deviated from that of a similar market-oriented firm; the stock of managerial and physical capital relative to that of a similar market-oriented firm; the flexibility, or asset specificity, of that physical and human capital; and the external pressures on the FSOE, such as domestic and foreign competition and threat of bankruptcy, to restructure.¹ Knowledge of these four elements would permit, in principle, identification of an enterprise’s restructuring propensity—the likelihood that a given enterprise will undertake proactive restructuring—as it undergoes the transition to market economy.

In this book I assume that, in general, the Soviet firm’s mix of output deviates significantly from that of a market-oriented firm and that the most important, and enduring, sign of FSOE restructuring is changes in its assortment (mix of output), including improvements in quality. Of course, in order to effect a change in its assortment, a firm needs to alter its internal operations, especially in managerial accounting, marketing, finance, labor relations, and ownership arrangements, including its governance structure. These changes are essential if the FSOE is to be profitable and sustain itself during the transition, but the changes in managerial practices per se, given the distance of the FSOE mix of output from that of a typical market-oriented firm, will not constitute effective or sustainable restructuring. In short, given the perceived importance of changes in the FSOE assortment, the interviews placed primary attention on document changes in the physical production of the FSOE before and after the dissolution of the Soviet Union. Secondary importance was placed on the associated changes in managerial practices necessary to effect and sustain changes in the firm’s physical production. After it became clear that particular firms were on sustainable trajectories, more attention was devoted to managerial changes, especially in these firms’ governance structures.²

This chapter describes the legacy of central planning and its impact on FSOE restructuring. Particular attention is given to the mix of output that a state-owned enterprise (SOE) was likely to have produced, as this is a primary touchstone of restructuring. I use the large body of literature on the former Soviet Union and some previously unpublished work on assortment planning under the Soviet system to show why Russian firms in some industries have survived, and in some cases flourished, while others have stagnated.

Once I have explained the need for changes in the FSOE assortment, I turn to asset specificity of physical and human capital, which is the factor that tends to have the next greatest impact on FSOE restructuring. More than the other factors that impact the FSOE propensity to restructure, asset specificity determines the actual out-of-pocket costs of restructuring. Skills acquired through intimate knowledge of, and experience with, a particular process, products, or materials may greatly diminish in value when changes in the product line are implemented. Under such circumstances, significant investment in new capital or in retraining may be needed in order to effect the changeover. Conversely, unspecific assets can produce a wide variety of products and processes and little or no cost is involved in the decision to change the mix of output or the production process. Imitating industrialization patterns in the late nineteenth and early twentieth centuries in the West, Soviet enterprises adopted asset-specific technologies in order to attain economies of scale at the expense of flexibility in the mix of output and in the processes used to produce it. This approach is directly opposed to developments in flexible manufacturing in the West that have reduced asset specificity of both human and physical capital.³

In heavy industry, enterprises in centrally planned economies produced a very narrow mix of output using highly specific physical and human assets. This narrow output mix resulted from three forces: the informational limitations inherent in central planning, managerial responses to the incentives of these informational constraints, and the rapid development of heavy industry in the 1930s, which sought growth in physical output at almost any price. The incentive regime established by this environment operated more or less unchanged for sixty years and it formed the basis of Soviet managers’ and workers’ human capital. An important aspect of this human capital was the near total absence of knowledge concerning money and finance as well as any financial infrastructure in the economy. The relative isolation of enterprises in the former Soviet Union (FSU) vis-à-vis their Central European counterparts was an additional obstacle to enterprise restructuring.

The Incentive Effects of Soviet Planning

The Monopoly Question

The key question in effecting Russia’s transition to a market economy is the external pressure on the firm.⁴ Monopoly power permits firms to delay restructuring, capture excessive rents, and to stifle new entry by encouraging government intervention in industry to regulate monopolistic behavior.⁵ Many aspects of the Soviet economy made a monopolized industrial structure desirable. The inherent logic of central planning, foreign trade policies, and the consequences of pervasive shortage contributed to a highly monopolized industrial structure in the Soviet period.

The monopoly question is central to the policy debate concerning the pace of reform. Observers as disparate as the American economist Marshall Goldman (1994) and former deputy primer minister Leonid Abalkin (1992) have argued that monopolization of the economy resulted in a perverse supply response in the which freeing of formerly state-owned firms from the plan led to higher prices and less output rather than stimulating supply. Kroll (1991) and Akhmeduev (1990) estimated that up to 80 percent of all products in the economy were produced by single producers. These numbers were calculated by simply counting the number of producers that produce a particular product, and they did not consider producers making very similar products that could credibly enter related markets.

A weakness of this approach is that it does not take into account, for example, whether or not the monopoly of freezer production by the Kishinev/Krasnoyarsk Freezer Association could be threatened by the several Russian producers of refrigerators.⁶ Brown, Ickes, and Ryterman (1993) and Joskow, Schmalensee, and Tsukanova (1994) favor the frequently used 4-digit Standard Industrial Classification (SIC) measure of monopoly, in which refrigerator producers and freezer producers would be considered in the same industry (SIC 3632).⁷ The industry-based measures of concentration find that relatively few SIC 4-digit industries were monopolized at the national level, although admittedly many firms did possess local monopoly power due to the relatively poor transportation and warehouse infrastructure of the Russian economy.

Central to the monopoly debate is the question of the appropriateness of using SIC 4-digit measures of concentration or more disaggregated product definitions. Given the tendency of enterprises to specialize along very narrow product lines, an assumption of those preferring the SIC 4-digit measures is that any firm in a 4-digit industry constitutes a competitive threat to other firms in the same industry that are producing a slightly different set of products. The appropriateness of the industry measure of concentration is determined by the credibility of other firms as potential entrants in adjacent product markets. Credibility of the threat of entry is directly related to the level of unrecoverable or sunk costs of entry into the new product line or exit from the old production. An absence of sunk costs requires a well-functioning capital market, including markets for resale of physical capital, while the contestable outcome additionally requires free flows of information in order that profit opportunities be known, and an adequate transportation and distribution network to facilitate entry. The assumption of no sunk costs also implies flexible human and physical capital, including the attitudes of management and labor.

How many of these assumptions are, at least partially, met in the Russian environment? Early in the transition, Russia’s transportation, distribution, and communications network was clearly insufficient to provide good access to all but a few locations such as Moscow and St. Petersburg and the adjacent oblasts. Since the mid-1990s, the communication and transportation situation has greatly improved; however, access outside of the Moscow/St. Petersburg corridor is cumbersome at best. With large numbers of buyers and sellers in Moscow, markets for physical assets, as well as for financial capital, function much more normally there than elsewhere. Moscow also supports a significantly robust secondary market for selling one’s “mistakes.” A priori we expect that firms in our sample from Moscow will behave more competitively than do their counterparts in the three outlying regions. Firms in the outlying cities enjoy a certain degree of local monopoly power and, therefore, are potentially more likely to delay restructuring. As we will see below, this expectation is indeed reinforced by the FSOEs in our sample, especially in Nizhny Novgorod and Novosibirsk, while FSOEs in the Tver region, located ninety miles from the capital, are clearly under the influence of Moscow.

The Enterprise Assortment

The propensity of an FSOE to restructure its operations is determined by the costs and benefits of doing so.⁸ How much restructuring is required by a typical former state-owned firm? Because this study has defined a large part of FSOE restructuring as taking the form of market-driven changes in the enterprise’s output assortment, it is necessary to examine in greater detail the system of product planning in the typical Soviet industrial enterprise in order to comprehend the magnitude of needed FSOE restructuring.

By western standards, a typical FSOE was large, produced a relatively few standardized products in large batches, and used a highly vertically integrated process. Measured in terms of employment, the average FSOE employed about 800 workers, compared to roughly 50 for the United States.⁹ This statistic, however, conceals the extreme skewness of the distribution of enterprise size in the Soviet Union. Very few small firms existed in the FSU; rather, the industrial landscape was populated by large numbers of medium-sized firms with 200 to 500 employees and a few very large establishments. The best known of these giants are the steel facility at Magnitogorsk, the Ural machine-building facility in Sverdlovsk, and the Kamaz truck factory. Most enterprises, irrespective of size, specialized narrowly along product lines and generally enjoyed at least some monopoly power in their local markets. Monopoly power was enhanced by pervasive shortages of most goods, and the supplier generally was able to dictate to its customers.

The narrow mix of output was the result of two forces: the informational limitations inherent in central planning and the development strategy adopted during the 1930s. In his study of the development of the machinery industry in the first five-year plan (1928–1932), Granick (1967, p. 37) found that a significant fraction of the growth in machinery during the 1930s was achieved through a severe restriction of the mix of output and numerous but relatively inexpensive inve...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Table of Contents
• List of Tables and Figures
• Foreword
• Preface
• Part I: Legacy and Survival
• Part II: Case Studies of Enterprise Restructuring
• Part III: Conclusions and Methods
• Appendix: Methods and Sample Characteristics
• Notes
• Bibliography