A report from the Economist Intelligence Unit
Sponsored by Ernst & Young
Preface
Corporate transformation in Russia’s emerging
multinationals is an Economist Intelligence Unit white paper sponsored by Ernst & Young. The Economist Intelligence Unit bears sole responsibility for this report.
Our editorial team conducted the interviews and wrote the report. The findings and views expressed in this report do not necessarily reflect the views of the sponsors.
The research for this paper was conducted in June 2007. The author of the report was Anna Smolchenko, and the editor was Matthew Shinkman. Mike Kenny was responsible for design and layout. Our thanks are due to all interviewees for their time and insights.
The phenomenon of the “emerging Russian
multinational” is now well-established. Companies like Gazprom, Rosneft, and Lukoil feature regularly in the world media and their actions are watched closely by both business and political leaders around the globe.
Recent years have seen these firms embark on an aggressive expansion binge, but behind the scenes they have also been active in trying to transform themselves from former state-held behemoths (in some cases) or cobbled-together holdings into more effective, efficient, and profitable companies. A closer look at the internal reform efforts of these mega-firms reveals several key themes:
● Reform is indeed happening, if at a slow and uneven pace: the biggest Russian firms, with the most contact with the outside world, have been very active in corporate restructuring, implementing modern, best practice corporate governance systems, upgrading internal processes and procedures, and building environmental sustainability into their businesses. Firms that are closer to the state, not surprisingly, tend to move more slowly in this regard.
● Change is being driven in part by funding requirements: As the biggest Russian firms run into constraints on internally-funded investment, they are increasingly looking to western capital markets for financing. In order to minimise their cost of capital on these markets, the Russian multinationals are
being forced to introduce more transparency, improve reporting procedures, and get corporate governance right. Acquisitions and establishment of operations in western markets have also forced these companies to play by western business rules.
● Reforms are not purely being forced upon the Russian multinationals: senior executives with whom we spoke for this report confirmed that corporate transformation efforts are not being made just as pre-IPO window dressing. In most cases executives understand that the long-term competitiveness of their firms will depend upon meeting or beating global best practices in operations, governance, and finance.
● Image is still a problem: many senior executives around the world are still either wary of or openly uninformed about the actions of Russia’s biggest firms. These companies have a big image problem to solve, and it’s not just a case of prejudice:
Russian executives need to become more open to communicating with the business world.
● There’s still a long way to go: Impressive progress has been made, but the emerging Russian multinationals are still emerging. Substantial room for improvement still exists, which presents an opportunity for these firms to continue their vault into the upper echelons of the global business world, if they choose to take it.
Executive Summary
While the largest multinationals from India and China have been household names for some time, a new class of emerging Russian multinationals has moved onto centre stage, catching the rest of the business world off guard. These firms span a wide spectrum from unwieldy state-owned giants like Gazprom and Rosneft to private companies which were built on assets snapped up in contentious loans-for-shares auctions in the 1990s, and they have been on a well- documented spending spree in recent years, acquiring assets (sometimes controversially) in Europe and the US, as well as closer to home in Russia’s near abroad.
Crossing borders has not been easy, and the Russian billionaire owners of these firms often voice complaints that their companies face various barriers and wrestle with bad press and prejudice in the West.
As Vladimir Evtushenkov, the core shareholder of AFK Sistema, a holding company active in technology, banking, tourism, and real estate, put it at the St.
Petersburg International Economic Forum in May 2007: “This is an extremely difficult process. We are entering the highest league, and of course we are making mistakes, and of course we are getting flicked on the forehead.”
In response, Russia’s largest multinational firms
are beginning to make more concerted efforts to transform themselves from their current state—
cumbersome, inefficient, and misunderstood—into modern organisations capable of competing and winning in the global marketplace.
The response is not just in reaction to the bad press these companies are getting. As the biggest Russian firms reach the limits of what they can achieve via internally-funded investment, they are increasingly looking to external sources of finance to fund their aggressive expansion strategies. And these sources of funding come with strings attached—in the form of requirements to increase transparency, provide more financial information, and adopt international business standards and practices.
These firms are currently at various stages in the process of adopting global corporate best practice and international standards for corporate governance, but they are all planning continued aggressive expansion abroad and need to raise their game fast.
The emerging Russian multinationals at a glance
Company Sector Employees 2006 Revenues
(US$M)
Lukoil Oil & gas 148,500 67,684
OAO Gazprom Oil & gas 432,000 64,100
Rosneft Energy 70,000 33,099
Severstal Metals and mining 100,000+ 12,423 Norilsk Nickel Metals & Mining 96,193 11,550 Evraz Group Metals and mining 110,000 8,292
MTS Telecommunications 24,125 6,384
UC Rusal Metals and mining 100,000+ 6,650a Vimpelcom Telecommunications 21,300 4,870
a 2005, estimate, Rusal only (pre-merger) Source: company annual reports, SEC filings, websites.
0 5 10 15 20
Domestic companies in Fortune Global 500, 2006 China
India
Russia
Brazil
Source: Economist Intelligence Unit.
Introduction
This paper will examine what the new class of emerging Russian multinationals is doing to get their organisations in shape to take the fight directly to their western competitors—mergers and acquisitions, corporate restructuring, introduction of corporate governance systems, revamping of internal processes
and systems, and adoption of internationally accepted approaches to corporate sustainability. We argue that much remains to be done to achieve parity with established western competitors, but that the reform process is a real phenomenon and one that will continue.
M&A, JVs, and cross-border cooperation
While the behind-the-scenes corporate modernization activities of the emerging Russian multinationals may not be well-documented, their increasingly confident forays into both emerging markets (including Russia’s backyard CIS countries) and even the more sophisticated markets of Europe and the US has made front-page news, and forced western rivals to take note. According to M&A Intelligence, a Moscow-based consultancy, last year Russian companies completed almost 100 cross-border mergers and acquisitions worth some $15bn. The most well-known and controversial of the Russian firms venturing abroad is gas giant Gazprom, which has gained control over assets in the CIS and eastern Europe which allow it to exert major influence over the supply of gas to western Europe.
In contrast to the prevailing view in the global media, though, aggressive corporate expansion abroad is not solely the purview of the biggest firms, nor those most closely-linked to the Kremlin, and in most cases is based on purely commercial motives. Russian companies like Lukoil, UC Rusal, and Severstal—all highly active in overseas M&A—are all several steps further removed from the state than Gazprom, while smaller Russian multinationals such as the telecommunications company MTS and food manufacturer Wimm-Bill-Dann are barely more than a decade old and are less central to the Kremlin’s economic strategy.
For the largest Russian energy and natural resources firms, years of high global oil and
commodity prices, accompanied by exceptionally high demand from both emerging and developed markets,
have produced a windfall of export earnings and left these firms cash-rich and in a buying mood. This rapid earnings growth, along with robust macroeconomic growth, has also trickled down into rising incomes for a growing Russian middle class, which has in turn boosted the performance—and ability to invest—of financial services, consumer-goods, and technology firms as well.
Russian companies have for years been active in the CIS countries, leveraging common language, similar business practices, and trade and other links established in former Soviet Union times to build market share in and extract natural resources from Russia’s near-abroad. Russian companies account for over a third of all foreign direct investment in the CIS countries. This investment is led by the oil and gas sectors, but telecommunications, financial services, and consumer companies are also heavily active in the region.
Many Russian emerging multinationals are now looking further abroad, re-tracing the steps of Soviet state enterprises, which were active in the Soviet Union’s former spheres of influence, ranging from Asia to Latin America and Africa. These firms are now using the skills built up in both the challenging domestic Russian market and the still-undeveloped CIS to venture into far choppier waters—including places few Western companies are willing to go.
Currently, the international presence of Russian telecommunications companies, including MTS and VimpelCom, is largely limited to the former Soviet republics. As opportunities in this expanded home market become harder to come by, though, they suggest they are considering entering markets like North Korea and Afghanistan to sustain growth beyond 2009.
Transforming Russia’s multinational corporations
“We will be ready to look at markets that are riskier, the markets that, in the mind of western companies, are taboo,” Alexander Izosimov, chief executive of VimpelCom told reporters in June 2007. Media reports have suggested that Altimo, the telecoms arm of billionaire Mikhail Fridman’s Alfa Group conglomerate, has been in talks to buy into Iranian mobile phone company Iraphone.
While Russian multinationals hold a commanding position in the CIS and operate comfortably across a range of emerging markets, their experiences entering the developed western markets have been more mixed. This experience has been in large part driven by ongoing concerns over transparency and corporate practice, but the circumstances have been made more difficult for Russian firms by the rise in political tensions between the administration of Vladimir Putin and the US and Europe.
The troubles Russian firms have accessing developed markets are encapsulated in figures from M&A Intelligence on failed cross-border deals.
Between January 2006 and January 2007, the Moscow-based consultancy reports that Russian companies failed to clinch 13 foreign deals with a total worth of $50.2bn (well ahead of the $15bn in closed
deals). The thwarted deals included five by Gazprom, three by Lukoil and two by Severstal, with the biggest being Severstal’s $13bn bid to buy Luxembourg-based steelmaker Arcelor.
During the same period, companies from the Middle East lost just $18bn worth of deals in Europe and North America.
Political considerations have worked against Russian firms in recent cross-border bids. Reports in early 2006 that Gazprom was considering a bid for the UK’s Centrica raised such concerns within the UK government that then-Prime Minister Tony Blair was compelled to issue a statement officially confirming that the government would not actively block a bid.
Severstal’s bid to takeover Arcelor, the Luxembourg- based steelmaker, in 2005 drew a sharp response from European politicians and the company was eventually thwarted by a rival bid from Mittal Steel.
Political sensitivities are even greater in the former communist countries of eastern Europe. Steel and mining company Evraz Group bought the ailing Vitkovice Steelworks in the Czech Republic in 2005. It was the group’s first international purchase and the memories of the two countries’ common communist past complicated the bid.
0 5 10 15 20 25 30 35 40 45
Perceptions towards BRICS economies (% respondents comfortable working in each country)
Brazil China India South Africa Russia
Source: Datamonitor.
US UK France Germany
“We faced serious challenges [in this acquisition],”
says Irina Kibina, vice-president for corporate affairs and investor relations at Evraz. “All the memory, all the fears, they are still alive. Besides, it was our first international acquisition and we were just learning how to do it right.”
Inexperience is only half of the problem, though—
Russian firms (and Russia itself) currently suffer from a very poor image within the global business community, according to numerous studies including several from the Economist Intelligence Unit.1
The news for Russian multinationals trying to get into western markets has not been all bad, though.
Evraz has since gone on to conclude a string of acquisitions, including the highly-publicised purchase of Portland, Oregon-based Oregon Steel Mills, which was completed in January, 2007 despite concerns that U.S. antitrust authorities might not approve the purchase due to Evraz co-owner Roman Abramovich’s ties to the Kremlin.
While Russian firms’ efforts to transform themselves via acquisition have been met with some backlash, a more collaborative approach has reaped rewards for a number of big Russian firms in potentially sensitive industries. The most successful of these firms are increasingly seen as credible business partners and important vehicles for access to the big Russian home market and the country’s vast natural resources.
In a sign of the immense importance of the market to the global energy sector, when the Russian government effectively forced the UK’s BP to sell its stake in the TNK-BP joint venture to Gazprom in early 2007, the two firms virtually simultaneously signed a new memorandum of understanding to create a long- term alliance and jointly invest in projects in Russia and abroad.
In May 2007, a unit of Oleg Deripaska’s holding company, Basic Element, agreed to invest $1.54bn into Canada’s Magna International, North America’s second-largest auto parts maker. Under the deal, which brought Russia fully onto Detroit’s radar screen
for the first time, Mr Deripaska’s automaker GAZ will get access to Western technologies and automotive expertise, while Magna secure a well-connected local partner in one of the world’s fastest-growing car markets.
When oil company Lukoil realized it needed a strategic partner to become a truly global company, it formed an alliance with Conoco Philips. In 2004, the U.S. major took a 7.6% stake in Lukoil and later raised it to 20 percent. Through the deal, Lukoil gained access to advanced technology and management know-how as well as more funds to develop costly projects, while Conoco secured access to the Russian firm’s significant oil and gas reserves in Russia.
Corporate restructuring
While expansion abroad has provided the emerging Russian multinationals with vital access to
technology, management practice, and markets, these firms have also recently begun looking inward, in an attempt to unlock value for shareholders and prepare for flotation on western stock markets by adopting best corporate practices, streamlining operations and reorganising unwieldy corporate structures. For many of these companies, such internal transformations are being undertaken for the first time.
The rush of consolidation in the wake of the country’s transformation from communism to capitalism—combined with already complex relations between industrial firms and the financial sector—meant that many of the largest Russian firms now have convoluted management and ownership structures, and often consist of loosely-organised amalgams of assets with little synergy between them.
Not surprisingly then, unwinding these complex links is often the first order of business for Russian firms looking to increase their attractiveness to western investors.
Norilsk Nickel was Russia’s first publicly traded company to spin off a unit. The unit, Polyus Gold, was
1. See The Russians are Coming: Understanding Russian Multinationals, 2006 (Economist Intelligence Unit, sponsored by Rusal) and Hidden Gem: Perceptions of business opportunity and risk in Russia, 2007 (Economist Intelligence Unit, sponsored by Clifford Chance)
spun off to elevate the value of the nickel company’s gold assets in 2006. “The task was complicated because nobody in Russia had done it before,”
said Andrei Bugrov, managing director of Interros, billionaire Vladimir Potanin’s holding company that includes Norilsk Nickel and Polyus Gold. “Now we have an asset valued at around $8-9bn that never existed before.”
Norilsk Nickel is now gearing up to spin off its energy assets by early next year, in a move which it hopes will create an energy company with an estimated value of $7-8bn.
Lukoil was one of the pioneers in corporate reorganization—the firm’s restructuring programme began in 2002. It has disposed of an array of non-core and underperforming assets, and reduced the number of separate legal entities within the company from an astounding 700 to 380 between 2001 and 205, according to company data. The management has also been ruthless in eliminating inefficiency in the organization—Lukoil shut over 1,500 low production wells in 2004 and 2005.
In 2006 billionaire Alexei Mordashov reorganised his Severstal group of companies, removing a corporate CEO in the group’s main production company, OAO Severstal, and consolidating other metal and mining assets. In 2006 and 2007, Mr Mordashov also disposed of his holdings in several non-core businesses in the transport and automotive industries.
To manage its multiple assets efficiently, in 2004 Rusal divided its companies into five divisions, including engineering and construction, raw materials, packaging and aluminium (Rusal added a sixth division, energy, this year). After the restructuring, strategic plans for Rusal’s companies are now set at the division level. “The restructuring helped us to integrate SUAL and Glencore assets more effectively after the merger,” says Vera Kurochkina, UC Rusal’s director for corporate communications.
As a rule, market-oriented restructuring has
tended to come quicker to privately-owned Russian multinationals rather than state-owned companies.
In the latter, increasing shareholder value is less of a primary concern, as government owners provide some buffer against the pressure to clean up their acts brought by initial public offerings.
At Gazprom, the bigger issue is that the company is headed in the opposite direction: while Lukoil endeavours to divest non-core businesses, Gazprom has gone on a global buying spree. Gazprom assets now range from a host of gas units to Gazprom-Neft (formerly known as Sibneft) to Gazprom-Media, the gas giant’s media arm, which includes Izvestia newspaper, NTV television channel and several radio stations.
While Gazprom has without doubt become a major force in the global economy, this strategy does bring some complications. “The fact that the state considers it not just a company but a ‘corporate Russia’, in which you can stick everything from gas and oil to energy to media assets and whatever else you please very much limits the freedom of its managers, if they have any at all,” says Igor Belikov, director of the Russian Institute of Directors.
Corporate governance and transparency
Attention to transparency and adoption of corporate governance standards are relatively new phenomena within the aspiring Russian multinationals. In Russia, these firms’ monopolistic market positions and close ties with the government and the presidential administration have tended to obviate the need for transparency and best corporate practices. However, as they become increasingly active in foreign markets, and subject to the legal and regulatory requirements of those markets, they are facing more pressure to conduct business in a transparent fashion and adopt accepted corporate governance structures and processes.
An important new driver of change is the scrutiny Russian firms will face in the run-up to public offerings on western stock exchanges. As companies evolve, the need to open up, take on board independent directors and introduce other reforms often comes gradually.
Fundraising requirements speed up those processes.
“If you need to expand, then you also need to raise more long-term funds,” says Eric Rasmussen, director for the corporate sector in Russia at the European Bank for Reconstruction and Development. “And it is a fact of life that modern funding sources push companies to adopt more transparency.”
Karl Johansson, managing partner for Russia and CIS at Ernst & Young, agrees. “Financial resources may help you to a certain point, but they won’t keep you competitive,” he says. “If you’ve got regulators and potential investors looking at your operations, you will need to improve your financial transparency.”
Established in 1992, Evraz went from an obscure trading company to a major mining and steel giant in less than 15 years. Major changes to its corporate structure took place on the eve of an initial public offering in London in 2005. Preparatory work included switching to international financial standards; putting in place a seven-member board of directors, including three independent directors; and establishing strategy, audit and remuneration committees.
The company also adopted information disclosure procedures and rules preventing insider trading.
In 2006, Greenleas International Holding Limited, which is associated with Millhouse Capital, controlled by billionaire Roman Abramovich, acquired a 40%
stake in the company. The structure of the board was changed and grew to 9 members, including three directors representing Greenleas and three independent directors. Earlier this year the board approved three codes: the codes of ethics, business conduct and corporate governance.
Severstal went public in 2006. Its 10-member board of directors has been reformed to include five independent representatives, one of which
is the chair. The company also set up audit and remuneration and nomination committees and introduced an internal audit, which reports to the board. In a sign of the ground yet to be made up, however, quarterly financial reports—a staple in western markets—have just been started this year. But the firm’s management is clear that the listing played a key role. “Corporate governance is a powerful tool in mergers and acquisitions. Your stock becomes your hard currency,” says Andrei Laptev, head of strategic planning department at Severstal.
It’s not just a listing that makes the difference though—as the largest Russian firms develop deeper relationships with the world’s largest companies and operate across markets, they are increasingly beholden to those companies’ and countries’ standards for corporate behaviour. “Whether you are listed or not, when you become a global company your clients include the world’s largest companies, and they will Information disclosure in Russia’s largest firms
Most disclosed Least disclosed Ownership structure
Shareholder rights
Financial information
Operational information
Information about board of directors and management
Remuneration of board members and top managers
Source: Standard and Poor’s, 2006.
Amount and nominal value of issued common stock and other shares—
100 percent
Number and names of shareholders who own more than 10 percent of stock—21 percent Detailed press-releases
about latest corporate events—97 percent
Code of business conduct and ethics—13 percent
List of types of
activities—100 percent Reporting of social responsibility—3 percent Detailed information about investment plans for next year—30 percent Name of auditor—
100 percent Policy of auditor rotation—
0 percent
List of board members—
100 percent
Terms of contract for general director—
1 percent Decision-making on
remuneration for board members—67 percent
Details of remuneration of top managers—16 percent
check your environmental activities, your financial practices and all those basic principles that comprise corporate governance, before they ink a contract with you,” points out Ms Kurochkina of UC Rusal (which is gearing up to go public in the near future).
UC Rusal has a 12-member board, including two independent directors that joined the board in the end of 2006. Ms Kurochkina describes the transformation which the merger has underpinned: “According to our partnership agreement with SUAL and Glencore, the company is to get two more independent directors by year’s end.” She goes on to point out that “in 2006, boards of directors were also established within the company’s divisions.”
Altimo, the telecommunications firm, recently set up a heavy-weight, London-based international advisory board to beef up its international corporate governance practices, and Lukoil has worked closely on corporate governance and practices in conjunction with its strategic partner Conoco Philips.
With some companies moving forward faster than others, the range of practices in disclosure and information sharing is wide among major Russian firms (see table 1). As a rule, listed companies are more transparent and have better reputation than their non-listed counterparts in Russia. This is best seen at conglomerates like Sistema and Alfa Group, where publicly traded companies coexist with less transparent private units.
“We have seen such groups,” said Rufat Alimardanov, a senior investment officer in manufacturing sector for IFC in Central and Eastern Europe. “Obviously, there is more disclosure of information by listed companies within the same group. Typically, there is a transfer of knowledge and management skills within such groups, which positively affects more closely-held entities.”
Such co-existence can sometimes be difficult for investors to stomach, and concerns from investors and business partners can force internal reform of such companies’ less transparent elements. Billionaire
Mikhail Fridman’s Alfa Group holding company recently rebranded its Alfa Eco business as Alfa1, in an effort to shed its murky image (the company has been involved in a series of controversial acquisitions).
Tightly held companies are reforming much slower. Billionaire Viktor Vekselberg’s Renova group of companies was established 17 years ago but it has yet to bring in independent directors. However, the logic of growth and the company’s move into the heart of developed markets is adding more urgency to transparency and reform efforts. Last year, Renova bought a 10.25% stake in Swiss semi-conductor maker, Oerlikon, while Vekselberg’s SUAL joined forces with Swiss commodities trader Glencore and Rusal.
Just a year earlier, Renova set up a special unit within the group, the Institute of Corporate Development, to tackle issues related to reputation, government relations, corporate social responsibility and management of personnel. Within the past two years, the Institute has helped establish boards of directors in all companies of the holding and introduce internal procedures to run their work. Board committees for strategy, compensation and audit are now being put in place.
“We may not be ready yet to invite independent directors—this is a job for tomorrow,” said Oleg Alekseyev, director of corporate projects at the Institute. “At a private company, there is always the possibility of a [strategic] decision being made on the basis of the main shareholder’s position.” The Renova group has, however, begun inviting outside experts to join board committees, says Mr Alekseyev, and it is working on building a full-fledged best practice corporate governance system “with all the necessary internal procedures and consultative and advisory bodies.”
But introduction of boards and board committees does not automatically lead to better business behaviour. Adoption of codes and establishment of various committees under the boards of directors can often amount to window dressing and have little effect
on the decision-making process—especially in the archetypal Russian case in which a single shareholder exerts overwhelming influence within the board.
According to a 2006 report by Standard and Poor’s (S&P), Russian companies often work to become just transparent enough for an IPO or a Eurobond sale. The average transparency score assigned by S&P to the largest Russian companies has hardly budged in the last two years.
For the time being, this may not matter too much:
some among the Russia-focused financial community feel that companies in Russia are enjoying a period of such an unprecedented financial strength that stakeholders often turn a blind eye to questionable corporate practices.
“There are lots of problems with Russian
companies,” says James Beadle, a portfolio manager at Pilgrim Asset Management. But “there is so much money flowing around the world that asset managers have—for the moment at least—ceased to worry about good or bad management or governance.”
If most private companies are at least taking steps to improve their image, Russian state-owned energy giants Rosneft and Gazprom don’t seem too bothered.
“Rosneft is the least understandable company from the point of view of its strategy and structure, to say nothing of the corporate governance,” according to Mr Belikov of the Russian Institute of Directors.
“They think they took on board one independent director and that’s enough,” he said in reference to Rosneft’s independent director, Hans Jorg Rudloff, the chairman of Barclays Capital.
People, product, process
While financial restructuring and introduction of modern corporate governance structures are helping to make the new Russian multinationals more attractive to potential western investors, changes on the ground—to business processes, human resource systems, and internal controls—are also crucial to the
long-term competitiveness of these companies. Many of the Russian multinationals inherited Soviet-era plants, as well as employees with a Soviet mentality.
At such enterprises, quality control has historically been lax and safety standards have sometimes been ignored to increase production.
This is changing, if slowly. “We’ve sorted out a lot of problems with quality, and improved our product portfolio,” says Ms Kibina, Evraz vice-president.
“Everything is not perfect yet but is much better than two years or a year and a half ago.”
However, the adoption of international health and safety standards can sometimes be merely cosmetic.
“Formally, there is certification but in practice those requirements are often not followed,” said a corporate development manager at a major Russian metals company. “I think this is the case with many Russian companies.”
Russian firms are also beginning to understand the importance of the softer elements of corporate strategy, especially given the poor image of Russia as a market and Russian firms as a whole (a 2006 survey of senior executives around the world by the EIU found that 72% of respondents do not yet regard Russian companies as world-class competitors).
Between 2003 and 2005, Alfa Bank, part of the Alfa Group holding company, had two brands: Alfa Bank and Alfa Bank Express. “Our research showed, however, that the two brands decreased total brand recognition, so a decision was made to merge the brands” in 2005, says Natalya Orlova, chief economist at the bank. Other changes included creating a unified client data base to develop Alfa Bank’s retail services.
The bank is now aiming for higher cooperation between corporate lending divisions and investment banking departments to fuel cross-selling of banking products, according to Ms Orlova.
The Russian multinationals have also moved aggressively to bring in top managers from around the world. This rise in demand has created a severe shortage of top quality managerial talent in the
Russian market—especially at the highest levels—and has in turn driven white-collar wages up substantially in the past several years. This has forced the leading Russian multinationals to rethink their compensation systems, moving away from pay policies that have tended to reward longevity and preserve egalitarian pay structures toward more incentive-based and flexible compensation options. Like so many others, this trend is also underwritten by financing requirements: Mr Potanin, the Interros president, recently pointed out: “The higher the managers’
motivation, the more attractive the company is in the eyes of investors.”
Telecoms company MTS has recently adopted a management motivation and retention plan for its 420 top and middle managers, linking their compensation directly to share price performance. The management estimates that the programme will cost approximately
$150 million, depending on share price movements.
In 2007, dairy and food manufacturer Wimm-Bill- Dann began a stock appreciation rights (SAR), or
“phantom stocks” programme in an effort to tie down the company’s top-performing managers. “When a person realizes that his income will directly be tied up to the company’s long-term financial results, then he has an incentive to continue his work at the company for a longer period of time,” said Dmitry Anisimov, chief financial officer at Wimm-Bill-Dann.
The programme so far covers just a handful of top managers, but Mr Anisimov suggests that it may be expanded to cover the mid-level management in the future.
Evraz introduced a stock option programme in 2005 and has since reviewed it on a yearly basis to include more managers, while Renova set its first three-year stock option programme in 2006.
Another recurring problem in the Russian corporate world is poor internal communication. A culture of decision-making taking place among small groups of senior executives (or by a single “oligarch” leader), combined with Byzantine corporate structures and the
logistical complexity of communicating across 11 time zones have all weighed against efficient corporate information-sharing in the largest Russian firms.
Managers at Wimm-Bill-Dann decided to tackle this issue in the beginning of 2006 by launching quarterly “town hall meetings,” during which the management shares information with employees about the company’s achievements. Senior executives for the country’s largest food manufacturer have also taken an “internal road show” to the regions in which the company operates to communicate the company’s strategy and goals to key managers operating in Russia’s periphery.
“Now we’ve decided it should become a regular thing and the management of the entire company should at least once a year visit the regions and communicate with the people,” says Mr Anisimov.
Corporate social responsibility and environmental sustainability
The concept of corporate social responsibility is slowly gaining traction among the leading Russian companies. The biggest companies played a large social role in the previous system, often providing schooling, healthcare, and entertainment in communities in which they were the dominant (or only) employer. These activities were largely divested after the privatisation of the 1990s. More recently, these firms have come to grips with the fact that they face a major image problem both at home and abroad—domestic public opinion has been wary of the motives and disapproving of the methods of the
“oligarch” class since the 1990s.
The Russian multinationals have in the past responded with flashy public relations campaigns—in a widely publicized move, Viktor Vekselberg bought back the tsar’s Faberge Eggs in 2004. However, the adoption of new legislation governing corporate philanthropy and efforts by groups like the
International Business Leaders Forum (IBLF) and the
Learning from the other emerging multinationals
In many ways, Russia’s emerging multinationals are similar to those from China, India, and Latin America.
The Brazilian mining company CVRD is the world’s largest iron-ore pro- ducer, having acquired the Canadian mining company Canico in 2005 and Inco, a Canadian nickel producer the following year. Gerdau, a steel producer from Brazil, has purchased companies in Colombia and North America, and in 2006 purchased two Spanish companies. In both cases, these firms faced exchange-rate appreciation and high interest rates at home, and faced an array of trade barriers to operations in the US and Europe. Like their Russian counter- parts, they found foreign expansion the most effective way of getting around these constraints. The true multinationals operating in the BRICS countries (with the exception of South Africa) are largely, like in Russia, in natural-resources-based industries, such as oil and gas, steel and mining.
Like companies in Latin America, Russians are quick decision makers and seize opportunities fast. Because both the so-called “multilatinas”
and the Russian companies have had to go through a series of economic crises, they share both an ability
to deal with adverse conditions and an instinctive understanding of how to thrive in challenging business environments. Like other emerging multinationals, Russian firms are also good at selling to low- income consumers and dealing with antiquated logistics and distribution networks.
Nonetheless, compared to their multinational peers in the other BRICS countries, Russian firms are relative late-comers to the global business world and there is much that Russian firms can learn from the more battle-hardened multinationals of the other BRICS countries. The battle over Luxembourg-based steel company Arcelor in 2005 provided one example of Russian firms’ weakness in corporate communication. It came as little surprise when Russia’s Severstal lost out to Mittal Steel in its bid to purchase the European steel giant in 2006. At the time of the bid, Mittal had a well-established presence in Europe and had launched a charm offensive, communicating its plans and intentions directly to the stakeholders. Severstal had kept largely silent.
Indian executives benefit from understanding of the English language, and the “multilatinas”
of Latin America have the natural advantage of a common regional language. Russian firms have a similar advantage in Russia’s near- abroad, but when moving outside the CIS many Russian executives
are constrained by insufficient knowledge of foreign languages.
Poor English language skills mean many senior Russian executives in the country’s multinational companies cannot negotiate directly with partners and clients, participate in interactive sessions and
roundtables with their foreign peers, or communicate with media.
Indian firms also have the advantage of having worked within established western legal and financial frameworks for some time.
While Russian companies are moving fast to adopt international financial reporting standards, these changes will take time to become ingrained in managers’ thinking and corporate culture, according to Karl Johansson of E&Y: “Indian companies have a competitive edge primarily because the framework of English law and English financial reporting has been there for the last hundred years, and so it’s more embedded in the way business is done.”
Russian multinationals can also learn lessons from leading global Chinese manufacturers, which have also been able to build profitable partnerships with western suppliers and joint-venture partners. Midea Holding, one of the country’s largest manufacturing companies, has developed deep relationships with a handful of major distributors in the US (including Home Depot and Wal-Mart) to drive an export-led doubling of pre-tax profit in the past five years.
National Council on Corporate Development (chaired by Mr Potanin of Interros) to establish standards for corporate practice have seen corporate social responsibility efforts taking on more conventional forms in Russia. This year, Mr Vekselberg’s Renova group of companies—in a much quieter move—made a decision to establish a corporate charity fund.
“Shareholders got together and agreed that they will channel 10% of their profits into charity projects,”
says Mr Alekseyev, director of corporate projects at Renova’s Institute of Corporate Development.
Philanthropy in Russia is still a tiny fraction of corporate giving in countries like the United States but foundations are growing and quickly adopting clear and open procedures to select recipients and assess their work. Around ten Russian endowments have been registered in Britain, according to Renova’s Mr Alekseyev.
Renova also took the decision to join the Global Compact, a United Nations initiative to improve business practices in human rights, labour, the environment and anti-corruption. In addition to financial reports, the group this year plans to publicise for the first time a report on its corporate social
responsibility programme, which will touch upon everything from social, labour and environmental issues to relations with different stakeholders, including the state and local communities.
MTS hopes to decide on its corporate social responsibility strategy by late summer or early fall. Andrei Terebenin, vice president for corporate communications at MTS, says “we feel responsible as there are 50 million people behind us in Russia alone.”
Mr Terebenin adds that his company’s philanthropy and community projects also directly support the bottom line, being designed to retain subscribers by involving them in the company’s feel-good activities.
The Russian multinationals, many of whom inherited Soviet-era plants, are also putting in place new equipment and earmarking budgets to help protect the environment. According to a recent study by the World Wildlife Fund’s Trade and Investment Programme, the largest multinational companies in Russia are leading the way—the study claims that, “a close correlation exists between the environmental responsibility of companies and their level of integration into the international economy.”
Of the 70 companies surveyed in the study, including Gazprom, Severstal and AvtoVAZ, 60% said that attention to the environment was part of their corporate values, while a third suggested that it would help increase exports and foreign market access. In the same survey, 80% of responding firms said their organisations had specific budgets for environmental protection, 58% publish regular environmental sustainability reports, and around half are involved in an eco-labelling scheme.
The problem remains acute, though. According to Alistair Schorn, a trade and investment programme manager with WWF in South Africa, “in terms of gross domestic product versus amount of carbon dioxide damage, Russia is not generating a lot of economic activity for the pollution it creates.” He notes that,
“there is a declining trend but Russia is still much higher than other BRICS countries.”
Why is your enterprise interested in environmental issues?
(% respondents)
Source: WWF.
This is part of your basic values and corporate principles This is part of your regional
and social policy It helps increase exports and access important foreign markets It helps increase market share It increases production because it allows for a more efficient use of resources It's a requirement of key shareholders, consumers and clients This is a useful marketing strategy that helps the company stand out It helps attract foreign investment This is your area of expertise (you sell ecological goods and services)
0 10 20 30 40 50 60
International lenders such as the EBRD and the IFC are actively supporting the biggest Russian companies’ efforts to become greener. OMK, one of Russia’s leading producers of steel pipes, recently received a $60 million loan from IFC for increasing and modernization of its pipe manufacturing capacities and is investing even larger amounts to phase out outdated polluting open-hearth furnaces by 2012.
OMK had long planned to install such new equipment
and IFC stepped in to help, said Rufat Alimardanov.
Unfortunately, it’s often cheaper for businesses to pollute and pay up rather than buy modern equipment and adhere to strict nature conservation policies—
“Some Russian companies prefer to pay fines for not complying with the local environment standards rather than invest large amounts in modernisation. It just costs them less,” says Mr Alimardanov.
What does the future hold for the emerging class of Russian multinationals? The answer will depend on a combination of external and internal factors.
On the external side, the omens look relatively good.
Russia’s buoyant economic expansion of recent years looks set to cool slightly as oil prices recede, but real GDP growth will remain over 4% per annum well into the next decade. Fiscal surpluses and a strong rouble will help underpin moderate disinflation and overall macroeconomic stability looks like a solid bet for the foreseeable future. This will help underwrite increasing consumer confidence, which along with strong GDP growth should see household consumption per head more than double in US dollar terms from 2006-2011.
The uncertainties surrounding the presidential succession after Vladimir Putin steps down in 2008 present some risk to these companies, and their senior management teams may face shake-ups as the political elite re-aligns itself in the post-Putin era. In the long term, though, this is unlikely to cause a big shift in corporate strategy for most of the emerging Russian multinationals. More worrying is the steady
deterioration in relations between Russia and the West—should this slide continue, the reception facing leading Russian companies as they attempt to break into western markets could become even chillier than it is today.
The much bigger question, though, will be how
Tomorrow’s emerging leaders
While the best companies do care about corporate standards, the West often judges Russian business on the practices of some of its most controversial and combative compa- nies with a global reach. At the same time, there are a growing number of smaller, second-tier Russian com- panies that boast better business
practices than today’s top tier—but because most of them are outside resources-based industries and are active within Russia only, few in the West know about them.
The World Economic Forum (WEF) is launching a new project to groom such companies—it calls them “the New Champions”—which are expected to become the next generation of multinationals. These companies have a growth rate of more than 15 percent and are expected to join the global
top 500 companies within the next decade.
Seventy Russian companies have been invited to join this initiative and around 25, including banks, a logistics company, a trading company, a heavy industry company and a major foreign car importer, have joined so far, suggesting that the country’s next wave of “emerging multinationals” will hail from a much broader range of sectors than does the current crop.
The future of today’s Russian multinationals
0 1 2 3 4 5 6 7
Real GDP growth (%)
Source: Economist Intelligence Unit.
2006 2007 2008 2009 2010 2011 Russia World
far these companies go internally. The largest Russian companies have come a long way in terms of corporate transformation and the adoption of international business standards. Managers in these firms are increasingly realising that the introduction of new ways of doing business is crucial not just in order to make their companies more attractive to western investors but also to ensure long-term competitiveness—this explains why the changes being made in these companies sometimes even exceed the minimum requirements of European stock exchanges.
Nonetheless, much remains to be done. Command- style management is still not uncommon in the largest companies and it will take time for this to be replaced by modern methods of management and intra-firm communication. The recent trend to retain talented employees with the help of short-term and long-term motivation programs will help attract top management talent, but more can be done to bring compensation and career development practices into line with best global practice. The largest Russian multinationals show a solid understanding of and concern for environmental best practice, but studies suggest that most companies can do much more to switch from “end-of-the-pipe” practices of polluting and cleaning up to pre-emptive measures.
Because of high staff turnover and cultural factors, training and retaining of personnel is considered to be an unaffordable luxury at some companies—this too will need to change if Russia’s multinationals expect to compete with global leaders in the long run.
Human resources departments still tend to play a very limited role in supporting professional development, and formal staff development plans are the exception rather than the rule.
0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000
Household consumption (Per head, US$)
Source: Economist Intelligence Unit.
2006 2007 2008 2009 2010 2011
The pace and emphasis of corporate transformation in Russia’s emerging multinationals varies from company to company, but there is little doubt that a broad process has begun and is gathering momentum.
Reforms are indeed happening, and they are, for the most part, driven by real commercial imperatives.
As these Russian mega-firms seek to continue expanding, they are increasingly facing the need to look for external sources of funding to support their growth strategies. The requirements that come with those sources of funding—for improved transparency, better reporting, tidier environmental and social practices, and more efficient processes and structures—are a key driver in the process, but other
factors are also at work.
As the emerging Russian multinationals expand their operations into more markets, they face new sets of stringent regulatory requirements, along with the need to conduct business in a manner in keeping with accepted values and practices in the west.
More broadly, though, senior leaders of the more advanced Russian multinationals are now accepting that the long-term competitiveness of their organisations (and in some cases the viability of their own personal fortunes) will depend upon their ability to match or better financial, human resources, and strategic planning practices of their competitors from both the west and other emerging markets.
Conclusion
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