Corporate Strategy in Post-Communist Russia

Mikhail Glazunov

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781317352600
• Edition: 1
• Topic: Sciences sociales
• Subtopic: Études ethniques

Russian businesses in the post-Soviet period have been noted for their unusual, sometimes allegedly corrupt, business practices, and for their role in the enrichment of oligarchs. This book, which includes a wide range of case study examples, and which draws on the author's first-hand experience of running a Russian company, argues that a key to understanding contemporary Russian business is the importance of arbitrage, that is the ability to take advantage of price and cost differentials in different markets. The book argues that the conditions for such arbitrage advantages are often created by businesses which have special links to particular institutions; that arbitrage benefits are not available to all businesses in a sector, thereby providing unfair competitive advantages to some businesses; and that businesses' overall activities are often distorted by this system. The book includes an analysis of a wide range of different types of arbitrage activities in action.

1 Demarcation of arbitrage

DOI: 10.4324/9781315665603-2

The chapter considers the idea of corporate strategy as a process of arbitrage between markets where diverse types of asymmetry – economic, cultural, administrative and geographical – are exploited by corporate managers. The scope for arbitrage includes the differences that exist between countries and regions. Also, the chapter considers arbitrage as strategy apart from traditional generic strategies such as cost leadership and differentiation.

Definition of strategy

According to the traditional definition, strategy is the direction and scope of an organisation over the long term, which achieves an advantage in a changing environment through its configuration of resources and competences with the aim of fulfilling stakeholder expectations (Johnson et al. 2013). In addition, strategy should help to the company to address the following questions: Where should the company compete? How could the company achieve and maintain an advantage? What capabilities, assets, structures and culture do companies need to implement the strategy? How can the company change?

Porter (1980) offers a strategy typology, and these strategic alternatives are labelled generic because theoretically any type of business can implement them, whether it is a mining company, a high-technology firm or a public organisation. According to Porter's approach, a company's positions itself in its industry relative to competitors, suppliers and customers, and as a result of positioning, presents a suitable choice of generic strategies of low-cost production, product differentiation or specific focus. In addition, firms’ own choices of generic strategies have to bring them into line with all the other firms that operate along the value chain, as these initiatives impact on the company's performance.

Simplifying, the profit of a company is the difference between its revenues and the cost of units multiplied by the number of units sold. Consequently, companies can achieve high profitability (in Porter's terminology, competitive advantage) through attaining low costs and large quantity of sold units (cost leadership strategy) or by distinguishing their products from those of competitors (differentiation strategy). Later, Porter added a focus strategy, which suggests that a company may choose to focus on a narrow rather than a wide-ranging scope of products. By accepting and effectively realising one of these generic strategies, a company can produce higher earnings than the industry average (Porter 1985).

Porter notes that a company should select a strategy in order to operate in attractive industries, in which it can use its generic strategy and achieve higher profit than that of an average firm in the same industry. However, there is a problem with the determination of an industry average firm. It is quite difficult to identify the average firm in the car industry, for example, which includes Kia, Mercedes and Tesla Motors. Moreover, employing Porter's approach it is often impossible to find a single strategy for a large company. For example, the car manufacturer Mercedes produces the SLS AMG Roadster which costs £176,950 and this model competes with Ferrari; but on the other hand Mercedes also makes A and B class cars which compete against the mass products of VW or Ford, so it remains an open question as to which generic strategy will be optimal for Mercedes. The calculation of an average strategy from SLS AMG Roadster and A class is the same as the calculation of the average temperature of patients in a hospital: there is a lot of information, but not enough practical sense. Many companies are conglomerates and operate in different, unrelated industries or markets. As a result, a company needs to employ different generic strategies in one segment, where it uses a differentiation strategy, from those in another, where it uses a cost leadership strategy. This approach contradicts Porter's idea that a company has to employ one or other generic strategy across the area of the market served. Moreover, Porter's idea about one generic strategy for a company is inappropriate for highly diversified corporations.

Porter's concept of generic strategies also has other shortcomings. For example, the concepts of differentiation and cost leadership have many similarities: in the differentiation strategy we need to remember cost price; but in the cost leadership strategy we should not forget about quality standards. Also, cost leadership does not always bring more benefits than the second or third place in the industry, perhaps outperforming the leader in other parameters such as return on capital employed. In addition, there are difficulties because of the contradictory requirements for the organisation of activities, which includes each of the generic strategies.

Relatively similar generic frameworks for gaining competitive advantage have been offered by numerous researchers. For example, Treacy and Wiersema (1995) offer a framework where a company usually can choose to accentuate one of three strategies: product leadership, operational excellence or customer intimacy. Thompson and Strickland (2003) suggest a slightly different classification model from Porter, which comprises a strategy of cost leadership (cost reduction, which attracts a large number of buyers); a strategy of broad differentiation (giving goods specific features that attract a large number of buyers); a strategy of optimum cost (great value for customers through a combination of lower costs with broad differentiation); and a focused strategy based on low cost (low costs and a narrow segment of buyers).

Mintzberg (1988) offers a classification of generic strategies founded on differentiation by price; by image, which refers to generating an individual image for a product through marketing; by support, which suggests providing a unique service during or after the sale of the product; by design, offering products with exclusive features, design configurations and quality based on high reliability, durability and performance; and finally non-differentiation, in which a firm emphasises none of the differentiation dimensions. Analysis of the above papers allows the allocation of a series of generic business strategies: cost strategies, differentiation strategies, focus strategies, and a hybrid strategy which refers to the simultaneous aspiration of cost leadership and differentiation.

However, these models concentrate effort mainly on a company's external competitive environment and do not look inside the company context. As a result, supplementing Porter's work, resource-based theory has been created (Barney 1991). The resource-based approach considers a company as a set of tangible and intangible resources such as company assets, capabilities, organisational processes, knowledge and other elements. These resources allow it to develop and implement a competitive strategy. There are different types of company resources: financial, human, organisational, etc. The firm's task is to acquire the most important key resources that will be a source of sustainable competitive advantage. A company has a competitive advantage when it creates value for customers using a strategy that is not used by its competitors. Sustainable competitive advantage exists when none of these competitors can receive comparable benefits from existing policies.

The resource-based perspective highlights the need for a fit between the external market context in which a company operates and its internal capabilities. Resources are stocks of available factors, which belong to or are controlled by firms; capabilities are the capacity of firms to deploy these resources (Amit and Schoemaker 1993). This approach suggests that a company's unique resources and capabilities provide the foundation for strategy and permit a company to take advantage of its core competencies to exploit opportunities in the external environment.

Within the framework of this approach, Barney (1991) determines four characteristics (‘VRIN characteristics’) of key resources of a company. They must be valuable (the company's ability, using the resources, to realise opportunities and neutralise the threat of the environment); rare (the rarity of the resource is defined by the level of its employment among competitors); inimitable (resources must have several distinctive features that do not allow competitors to make similar use of them); and nonsubstitutable (no similar resources exist that could be used by competitors as an alternative).

Arbitrage

Arbitrage is one of the popular ideas of modern economics, implementing the law of one price and keeping markets efficient. According to the law of one price in a competitive market, if two assets have equivalent risk and return, they should sell at the same price. If the price of the same asset is different in two markets, there will be arbitrageurs who will buy the asset cheaply and sell in the market where it is expensive. In traditional meaning, arbitrage involves the simultaneous purchase and sale of the same or an analogous security in two different markets for profitably different prices, and continues until prices in the two markets reach equilibrium (Sharpe et al. 1998). Of course, an object of arbitrage may be assets of a different nature, such as securities, currency, commodities or derivative forms in order to take advantage of differing prices.

Miyazaki (2007) notes that arbitrage is a fundamental category of contemporary economics and an ordinary trading strategy of investment banks. He describes the difference between arbitrage and speculation. Speculators gamble on the future movement of prices and take risks, whereas arbitrageurs profit by identifying current price differences and search to eliminate risk.

Presently, arbitrage is used relatively widely and it can be protracted to numerous markets and apparently mispriced assets, goods and services, as well as various kinds of transaction (Miyazaki 2013). For example, the financial crisis of 2008 was attributed to a practice known as ratings arbitrage (Nocera 2009). Nocera employs the example of the huge multinational insurance company AIG. The company was rated AAA, which meant ratings agencies such as Standard & Poor's (S&P) supposed its probability of defaulting was extremely small. Therefore the company was able to borrow more inexpensively than other companies with lower ratings. The London division sold credit default swaps (CDS).These exotic instruments acted as a form of insurance for the securities. As a result, the company mortgage-backed securities were also rated AAA. The technique of using the rating was arbitrage. Nocera (2009) notes that Wall Street carried out these operations easily due to the transferred risk of default from banks to AIG, and the AAA rating made the securities attractive for the financial market. Certainly, AIG had profitable fees and it was naively thought that the market would grow forever. CDSs were not regulated and were not considered as a conventional insurance product; as a result money was not reserved for losses. When housing prices fell and there were losses, the company was in trouble. One can see that AIG arbitraged rating by employing a loophole in the regulations –in this case Nocera (2009) recommends that instead of the term ‘loophole’, one could use the less well mannered but possibly more accurate term ‘scam’.

Ledyaeva et al. (2013) looked at the issue of why Russian companies invest in offshore jurisdictions and why these companies reinvest capital back to Russia, with its uncooperative institutional environment, instead of using it in more stable economies. In their study they utilised another concept, institutional arbitrage, which means a situation where a company is presented with opportunities to use dissimilarities between two institutional environments (Boisot and Meyer 2008).

Golikova et al. (2013) determined that the Russian institutional environment, which drives companies to escape to a foreign country, also makes available opportunities for institutional arbitrage. This is demonstrated by possibilities to establish in foreign jurisdictions, which are targeted by Russian customers seeking a secure location for their capital abroad or support services for their international trade. As a result, understanding of the Russian institutional environment together with the opportunity to run one's business within the European regulatory framework gives a competitive advantage for Russian-owned companies.

Huang (2003) also notes that institutional arbitrage is used where companies from emerging economies search for institutions capable of maintaining global operations, establishing particular parts of their operations in developed economies. He offers the example of an institutional arbitrage operation where Chinese local companies transfer assets out of China and then return, assuming the likeness of foreign investors. A similar strategy was realised by South Africa's companies SAB-Miller and Anglo American, which relocated their headquarters to London, fearing the uncertainties associated with changing authorities in the 1990s (ibid.).

In the case of Russia, the protection of property rights in EU countries, and the benefits given to foreign companies in Russia beyond those with Russian owners, can reduce the exit costs of business. Therefore one can use the term ‘institutional arbitrage’ for Russian companies taking advantage of inexpensive institutions outside Russia; in other words, Russian business exploits the differences between various institutional arrangements functioning in different states.

A cycle from Russia offshore and back to Russia is example of an institutional arbitrage operation. Travelling in a foreign country may amplify a company's business capability when returning to Russia, as the company can capture benefits of the same legal and economic protections outside Russia enjoyed by foreign companies operating there. Also, the round-trip company has the ability to protect against the deviant behaviour of government and domestic business partners. Therefore round-tripping can be a considered a global business strategy (Ledyaeva et al. 2013).

Initially arbitrage as a concept was seen as a purely economic phenomenon rather than a technical method, but currently the concept of arbitrage is used comparatively extensively. It has become a more complex phenomenon, capturing the areas of culture, law and politics. For example, in late 2013 the Russian government decided to invest $15 billion in Ukraine's sovereign Eurobonds, and shortly afterwards the government purchased the first Ukrainian Eurobond tranche valued at $3 billion with a two-year maturity, a coupon rate of 5 per cent annually and coupon payments twice per year (TASS 2015). Russia could not invest the other $12 billion in Ukraine's bonds due to a change of power in Kiev. The Ukrainian Eurobond issue prospectus includes covenants providing that Ukraine must meet all obligations on its sovereign debt. Moreover, one covenant says the Ukraine should not permit its debt-to-GDP ratio to rise beyond 60 per cent (ibid.).

However, after the crisis of the Ukrainian economy in 2014, the Russian government received an opportunity to use this debt as a tool for causing the collapse of the Ukrainian economy. Gelpern (2014) termed this contract arbitrage. She notes that Russia is the principal holder of Ukrainian bonds due for repayment in the period of the term of the newly approved International Monetary Fund programme, and these Russian bonds can be used to apply political power over Ukraine and give it additional influence in any debt negotiations. One can see that buying assets (in this example bonds) can give additional future political benefits which can be transferred, under certain circumstances, to arbitrage profit.

Arbitrage as strategy

Recently, a new prospect of corporate strategy as a process of arbitrage between markets has been shaped. Ghemawat (2003) suggests a new perspective on arbitrage as an element of corporate strategy, where arbitrage is not cheap capital or labour; rather the scope for arbitrage is the differences that persist among countries. Distance between countries impacts on doing business in a new market because costs and risks result from barriers created by distance.

Arbitrage benefit from the influence of physical distance on transportation and communication costs. It has been the essence of trading throughout history – buy or produce goods in a place where they are very inexpensive and sell them in another place where there is a high willingness to pay. A good example of such geographic arbitrageurs is the Honourable East India Company, which took advantage of huge i...