Corporate Transformation in Russia's Emerging Multinationals

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Corporate transformation in Russia’s emerging multinationals

A report from the Economist Intelligence Unit Sponsored by Ernst & Young Shaping up Corporate transformation in Russia’s emerging multinationals

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.

Executive Summary

The phenomenon of the “emerging Russian being forced to introduce more transparency, improve multinational” is now well-established. Companies like reporting procedures, and get corporate governance Gazprom, Rosneft, and Lukoil feature regularly in the right. Acquisitions and establishment of operations in world media and their actions are watched closely by western markets have also forced these companies to both business and political leaders around the globe. play by western business rules. Recent years have seen these firms embark on an aggressive expansion binge, but behind the scenes ● Reforms are not purely being forced upon the they have also been active in trying to transform Russian multinationals: senior executives with whom themselves from former state-held behemoths (in we spoke for this report confirmed that corporate some cases) or cobbled-together holdings into more transformation efforts are not being made just as effective, efficient, and profitable companies. A closer pre-IPO window dressing. In most cases executives look at the internal reform efforts of these mega-firms understand that the long-term competitiveness of reveals several key themes: their firms will depend upon meeting or beating global best practices in operations, governance, and finance. ● Reform is indeed happening, if at a slow and uneven pace: the biggest Russian firms, with the ● Image is still a problem: many senior executives most contact with the outside world, have been very around the world are still either wary of or openly active in corporate restructuring, implementing uninformed about the actions of Russia’s biggest modern, best practice corporate governance systems, firms. These companies have a big image problem upgrading internal processes and procedures, and to solve, and it’s not just a case of prejudice: building environmental sustainability into their Russian executives need to become more open to businesses. Firms that are closer to the state, not communicating with the business world. surprisingly, tend to move more slowly in this regard. ● There’s still a long way to go: Impressive ● Change is being driven in part by funding progress has been made, but the emerging Russian requirements: As the biggest Russian firms run into multinationals are still emerging. Substantial room constraints on internally-funded investment, they are for improvement still exists, which presents an increasingly looking to western capital markets for opportunity for these firms to continue their vault into financing. In order to minimise their cost of capital the upper echelons of the global business world, if on these markets, the Russian multinationals are they choose to take it.

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Introduction

While the largest multinationals from India and China The emerging Russian multinationals at a glance have been household names for some time, a new Company Sector Employees 2006 Revenues class of emerging Russian multinationals has moved (US$M) onto centre stage, catching the rest of the business Lukoil Oil & gas 148,500 67,684 world off guard. These firms span a wide spectrum OAO Gazprom Oil & gas 432,000 64,100 from unwieldy state-owned giants like Gazprom and Rosneft Energy 70,000 33,099 Rosneft to private companies which were built on Severstal Metals and mining 100,000+ 12,423 assets snapped up in contentious loans-for-shares Norilsk Nickel Metals & Mining 96,193 11,550 auctions in the 1990s, and they have been on a well- Evraz Group Metals and mining 110,000 8,292 documented spending spree in recent years, acquiring MTS Telecommunications 24,125 6,384 assets (sometimes controversially) in Europe and the UC Rusal Metals and mining 100,000+ 6,650a US, as well as closer to home in Russia’s near abroad. Vimpelcom Telecommunications 21,300 4,870 a 2005, estimate, Rusal only (pre-merger) Crossing borders has not been easy, and the Source: company annual reports, SEC filings, websites. 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 are beginning to make more concerted efforts to Sistema, a holding company active in technology, transform themselves from their current state— banking, tourism, and real estate, put it at the St. cumbersome, inefficient, and misunderstood—into Petersburg International Economic Forum in May modern organisations capable of competing and 2007: “This is an extremely difficult process. We are winning in the global marketplace. entering the highest league, and of course we are The response is not just in reaction to the bad press making mistakes, and of course we are getting flicked these companies are getting. As the biggest Russian on the forehead.” firms reach the limits of what they can achieve via In response, Russia’s largest multinational firms internally-funded investment, they are increasingly looking to external sources of finance to fund their Domestic companies in Fortune Global 500, 2006 aggressive expansion strategies. And these sources of funding come with strings attached—in the form China of requirements to increase transparency, provide more financial information, and adopt international India business standards and practices.

Russia These firms are currently at various stages in the process of adopting global corporate best practice and Brazil international standards for corporate governance, but

0 5 10 15 20 they are all planning continued aggressive expansion Source: Economist Intelligence Unit. abroad and need to raise their game fast.

This paper will examine what the new class of and systems, and adoption of internationally accepted emerging Russian multinationals is doing to get their approaches to corporate sustainability. We argue organisations in shape to take the fight directly to that much remains to be done to achieve parity with their western competitors—mergers and acquisitions, established western competitors, but that the reform corporate restructuring, introduction of corporate process is a real phenomenon and one that will governance systems, revamping of internal processes continue.

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Transforming Russia’s multinational corporations

M&A, JVs, and cross-border have produced a windfall of export earnings and left cooperation these firms cash-rich and in a buying mood. This rapid earnings growth, along with robust macroeconomic While the behind-the-scenes corporate modernization growth, has also trickled down into rising incomes activities of the emerging Russian multinationals may for a growing Russian middle class, which has in turn not be well-documented, their increasingly confident boosted the performance—and ability to invest—of forays into both emerging markets (including financial services, consumer-goods, and technology Russia’s backyard CIS countries) and even the more firms as well. sophisticated markets of Europe and the US has made Russian companies have for years been active in front-page news, and forced western rivals to take the CIS countries, leveraging common language, note. According to M&A Intelligence, a Moscow-based similar business practices, and trade and other links consultancy, last year Russian companies completed established in former Soviet Union times to build almost 100 cross-border mergers and acquisitions market share in and extract natural resources from worth some $15bn. The most well-known and Russia’s near-abroad. Russian companies account for controversial of the Russian firms venturing abroad over a third of all foreign direct investment in the CIS is gas giant Gazprom, which has gained control over countries. This investment is led by the oil and gas assets in the CIS and eastern Europe which allow it sectors, but telecommunications, financial services, to exert major influence over the supply of gas to and consumer companies are also heavily active in the western Europe. region. In contrast to the prevailing view in the global Many Russian emerging multinationals are now media, though, aggressive corporate expansion looking further abroad, re-tracing the steps of Soviet abroad is not solely the purview of the biggest state enterprises, which were active in the Soviet firms, nor those most closely-linked to the Kremlin, Union’s former spheres of influence, ranging from and in most cases is based on purely commercial Asia to Latin America and Africa. These firms are motives. Russian companies like Lukoil, UC Rusal, now using the skills built up in both the challenging and Severstal—all highly active in overseas M&A—are domestic Russian market and the still-undeveloped all several steps further removed from the state than CIS to venture into far choppier waters—including Gazprom, while smaller Russian multinationals such places few Western companies are willing to go. as the telecommunications company MTS and food Currently, the international presence of Russian manufacturer Wimm-Bill-Dann are barely more than telecommunications companies, including MTS and a decade old and are less central to the Kremlin’s VimpelCom, is largely limited to the former Soviet economic strategy. republics. As opportunities in this expanded home For the largest Russian energy and natural market become harder to come by, though, they resources firms, years of high global oil and suggest they are considering entering markets like commodity prices, accompanied by exceptionally high North Korea and Afghanistan to sustain growth demand from both emerging and developed markets, beyond 2009.

Perceptions towards BRICS economies (% respondents comfortable working in each country) US UK France Germany 45

0 Brazil China India South Africa Russia Source: Datamonitor.

“We will be ready to look at markets that are riskier, deals). The thwarted deals included five by Gazprom, the markets that, in the mind of western companies, three by Lukoil and two by Severstal, with the biggest are taboo,” Alexander Izosimov, chief executive being Severstal’s $13bn bid to buy Luxembourg-based of VimpelCom told reporters in June 2007. Media steelmaker Arcelor. reports have suggested that Altimo, the telecoms During the same period, companies from the arm of billionaire Mikhail Fridman’s Alfa Group Middle East lost just $18bn worth of deals in Europe conglomerate, has been in talks to buy into Iranian and North America. mobile phone company Iraphone. Political considerations have worked against While Russian multinationals hold a commanding Russian firms in recent cross-border bids. Reports in position in the CIS and operate comfortably across early 2006 that Gazprom was considering a bid for a range of emerging markets, their experiences the UK’s Centrica raised such concerns within the UK entering the developed western markets have been government that then-Prime Minister Tony Blair was more mixed. This experience has been in large part compelled to issue a statement officially confirming driven by ongoing concerns over transparency and that the government would not actively block a bid. corporate practice, but the circumstances have been Severstal’s bid to takeover Arcelor, the Luxembourg- made more difficult for Russian firms by the rise in based steelmaker, in 2005 drew a sharp response from political tensions between the administration of European politicians and the company was eventually Vladimir Putin and the US and Europe. thwarted by a rival bid from Mittal Steel. The troubles Russian firms have accessing Political sensitivities are even greater in the developed markets are encapsulated in figures former communist countries of eastern Europe. Steel from M&A Intelligence on failed cross-border deals. and mining company Evraz Group bought the ailing Between January 2006 and January 2007, the Vitkovice Steelworks in the Czech Republic in 2005. It Moscow-based consultancy reports that Russian was the group’s first international purchase and the companies failed to clinch 13 foreign deals with a total memories of the two countries’ common communist worth of $50.2bn (well ahead of the $15bn in closed past complicated the bid.

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“We faced serious challenges [in this acquisition],” for the first time, Mr Deripaska’s automaker GAZ will says Irina Kibina, vice-president for corporate affairs get access to Western technologies and automotive and investor relations at Evraz. “All the memory, all expertise, while Magna secure a well-connected local the fears, they are still alive. Besides, it was our first partner in one of the world’s fastest-growing car international acquisition and we were just learning markets. how to do it right.” When oil company Lukoil realized it needed a Inexperience is only half of the problem, though— strategic partner to become a truly global company, it Russian firms (and Russia itself) currently suffer formed an alliance with Conoco Philips. In 2004, the from a very poor image within the global business U.S. major took a 7.6% stake in Lukoil and later raised community, according to numerous studies including it to 20 percent. Through the deal, Lukoil gained several from the Economist Intelligence Unit.1 access to advanced technology and management The news for Russian multinationals trying to get know-how as well as more funds to develop costly into western markets has not been all bad, though. projects, while Conoco secured access to the Russian Evraz has since gone on to conclude a string of firm’s significant oil and gas reserves in Russia. acquisitions, including the highly-publicised purchase of Portland, Oregon-based Oregon Steel Mills, which was completed in January, 2007 despite concerns Corporate restructuring that U.S. antitrust authorities might not approve the While expansion abroad has provided the emerging purchase due to Evraz co-owner Roman Abramovich’s Russian multinationals with vital access to ties to the Kremlin. technology, management practice, and markets, these While Russian firms’ efforts to transform themselves firms have also recently begun looking inward, in an via acquisition have been met with some backlash, a attempt to unlock value for shareholders and prepare more collaborative approach has reaped rewards for for flotation on western stock markets by adopting a number of big Russian firms in potentially sensitive best corporate practices, streamlining operations and industries. The most successful of these firms are reorganising unwieldy corporate structures. For many increasingly seen as credible business partners and of these companies, such internal transformations are important vehicles for access to the big Russian home being undertaken for the first time. market and the country’s vast natural resources. The rush of consolidation in the wake of the In a sign of the immense importance of the country’s transformation from communism to market to the global energy sector, when the Russian capitalism—combined with already complex government effectively forced the UK’s BP to sell its relations between industrial firms and the financial stake in the TNK-BP joint venture to Gazprom in early sector—meant that many of the largest Russian firms 2007, the two firms virtually simultaneously signed a now have convoluted management and ownership new memorandum of understanding to create a long- structures, and often consist of loosely-organised term alliance and jointly invest in projects in Russia amalgams of assets with little synergy between them. 1. See The Russians are and abroad. Not surprisingly then, unwinding these complex links Coming: Understanding Russian Multinationals, In May 2007, a unit of Oleg Deripaska’s holding is often the first order of business for Russian firms 2006 (Economist Intelligence Unit, company, Basic Element, agreed to invest $1.54bn looking to increase their attractiveness to western sponsored by Rusal) and Hidden Gem: Perceptions into Canada’s Magna International, North America’s investors. of business opportunity and risk in Russia, 2007 second-largest auto parts maker. Under the deal, Norilsk Nickel was Russia’s first publicly traded (Economist Intelligence Unit, sponsored by Clifford which brought Russia fully onto Detroit’s radar screen company to spin off a unit. The unit, Polyus Gold, was Chance)

spun off to elevate the value of the nickel company’s tended to come quicker to privately-owned Russian gold assets in 2006. “The task was complicated multinationals rather than state-owned companies. because nobody in Russia had done it before,” In the latter, increasing shareholder value is less of said Andrei Bugrov, managing director of Interros, a primary concern, as government owners provide billionaire Vladimir Potanin’s holding company that some buffer against the pressure to clean up their acts includes Norilsk Nickel and Polyus Gold. “Now we have brought by initial public offerings. an asset valued at around $8-9bn that never existed At Gazprom, the bigger issue is that the company before.” is headed in the opposite direction: while Lukoil Norilsk Nickel is now gearing up to spin off its endeavours to divest non-core businesses, Gazprom energy assets by early next year, in a move which has gone on a global buying spree. Gazprom assets it hopes will create an energy company with an now range from a host of gas units to Gazprom-Neft estimated value of $7-8bn. (formerly known as Sibneft) to Gazprom-Media, Lukoil was one of the pioneers in corporate the gas giant’s media arm, which includes Izvestia reorganization—the firm’s restructuring programme newspaper, NTV television channel and several radio began in 2002. It has disposed of an array of non-core stations. and underperforming assets, and reduced the number While Gazprom has without doubt become a major of separate legal entities within the company from force in the global economy, this strategy does bring an astounding 700 to 380 between 2001 and 205, some complications. “The fact that the state considers according to company data. The management has it not just a company but a ‘corporate Russia’, in which also been ruthless in eliminating inefficiency in the you can stick everything from gas and oil to energy organization—Lukoil shut over 1,500 low production to media assets and whatever else you please very wells in 2004 and 2005. much limits the freedom of its managers, if they have In 2006 billionaire Alexei Mordashov reorganised any at all,” says Igor Belikov, director of the Russian his Severstal group of companies, removing a Institute of Directors. corporate CEO in the group’s main production company, OAO Severstal, and consolidating other metal and mining assets. In 2006 and 2007, Mr Corporate governance and Mordashov also disposed of his holdings in several transparency non-core businesses in the transport and automotive Attention to transparency and adoption of corporate industries. governance standards are relatively new phenomena To manage its multiple assets efficiently, within the aspiring Russian multinationals. In Russia, in 2004 Rusal divided its companies into five these firms’ monopolistic market positions and divisions, including engineering and construction, close ties with the government and the presidential raw materials, packaging and aluminium (Rusal administration have tended to obviate the need for added a sixth division, energy, this year). After the transparency and best corporate practices. However, restructuring, strategic plans for Rusal’s companies as they become increasingly active in foreign markets, are now set at the division level. “The restructuring and subject to the legal and regulatory requirements helped us to integrate SUAL and Glencore assets more of those markets, they are facing more pressure effectively after the merger,” says Vera Kurochkina, UC to conduct business in a transparent fashion and Rusal’s director for corporate communications. adopt accepted corporate governance structures and As a rule, market-oriented restructuring has processes.

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An important new driver of change is the scrutiny Information disclosure in Russia’s largest firms Russian firms will face in the run-up to public offerings Most disclosed Least disclosed on western stock exchanges. As companies evolve, the Ownership structure Amount and nominal Number and names of value of issued common shareholders who own need to open up, take on board independent directors stock and other shares— more than 10 percent of and introduce other reforms often comes gradually. 100 percent stock—21 percent Fundraising requirements speed up those processes. Shareholder rights Detailed press-releases Code of business conduct about latest corporate and ethics—13 percent “If you need to expand, then you also need to raise events—97 percent more long-term funds,” says Eric Rasmussen, director Financial information Name of auditor— Policy of auditor rotation— for the corporate sector in Russia at the European 100 percent 0 percent

Bank for Reconstruction and Development. “And it Operational information List of types of Reporting of social is a fact of life that modern funding sources push activities—100 percent responsibility—3 percent companies to adopt more transparency.” Detailed information about investment plans for next Karl Johansson, managing partner for Russia and year—30 percent CIS at Ernst & Young, agrees. “Financial resources may Information about board of List of board members— Terms of contract for help you to a certain point, but they won’t keep you directors and management 100 percent general director— competitive,” he says. “If you’ve got regulators and 1 percent potential investors looking at your operations, you Remuneration of board Decision-making on Details of remuneration of members and top managers remuneration for board top managers—16 percent will need to improve your financial transparency.” members—67 percent Established in 1992, Evraz went from an obscure Source: Standard and Poor’s, 2006. 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 is the chair. The company also set up audit and switching to international financial standards; putting remuneration and nomination committees and in place a seven-member board of directors, including introduced an internal audit, which reports to the three independent directors; and establishing board. In a sign of the ground yet to be made up, strategy, audit and remuneration committees. however, quarterly financial reports—a staple in The company also adopted information disclosure western markets—have just been started this year. But procedures and rules preventing insider trading. the firm’s management is clear that the listing played In 2006, Greenleas International Holding Limited, a key role. “Corporate governance is a powerful tool which is associated with Millhouse Capital, controlled in mergers and acquisitions. Your stock becomes your by billionaire Roman Abramovich, acquired a 40% hard currency,” says Andrei Laptev, head of strategic stake in the company. The structure of the board planning department at Severstal. was changed and grew to 9 members, including It’s not just a listing that makes the difference three directors representing Greenleas and three though—as the largest Russian firms develop deeper independent directors. Earlier this year the board relationships with the world’s largest companies and approved three codes: the codes of ethics, business operate across markets, they are increasingly beholden conduct and corporate governance. to those companies’ and countries’ standards for Severstal went public in 2006. Its 10-member corporate behaviour. “Whether you are listed or not, board of directors has been reformed to include when you become a global company your clients five independent representatives, one of which include the world’s largest companies, and they will

check your environmental activities, your financial Mikhail Fridman’s Alfa Group holding company practices and all those basic principles that comprise recently rebranded its Alfa Eco business as Alfa1, in an corporate governance, before they ink a contract with effort to shed its murky image (the company has been you,” points out Ms Kurochkina of UC Rusal (which is involved in a series of controversial acquisitions). gearing up to go public in the near future). Tightly held companies are reforming much UC Rusal has a 12-member board, including two slower. Billionaire Viktor Vekselberg’s Renova group independent directors that joined the board in the end of companies was established 17 years ago but it has of 2006. Ms Kurochkina describes the transformation yet to bring in independent directors. However, the which the merger has underpinned: “According to our logic of growth and the company’s move into the partnership agreement with SUAL and Glencore, the heart of developed markets is adding more urgency company is to get two more independent directors by to transparency and reform efforts. Last year, Renova year’s end.” She goes on to point out that “in 2006, bought a 10.25% stake in Swiss semi-conductor maker, boards of directors were also established within the Oerlikon, while Vekselberg’s SUAL joined forces with company’s divisions.” Swiss commodities trader Glencore and Rusal. Altimo, the telecommunications firm, recently Just a year earlier, Renova set up a special set up a heavy-weight, London-based international unit within the group, the Institute of Corporate advisory board to beef up its international corporate Development, to tackle issues related to reputation, governance practices, and Lukoil has worked closely government relations, corporate social responsibility on corporate governance and practices in conjunction and management of personnel. Within the past two with its strategic partner Conoco Philips. years, the Institute has helped establish boards With some companies moving forward faster of directors in all companies of the holding and than others, the range of practices in disclosure and introduce internal procedures to run their work. Board information sharing is wide among major Russian committees for strategy, compensation and audit are firms (see table 1). As a rule, listed companies are now being put in place. more transparent and have better reputation than “We may not be ready yet to invite independent their non-listed counterparts in Russia. This is best directors—this is a job for tomorrow,” said Oleg seen at conglomerates like Sistema and Alfa Group, Alekseyev, director of corporate projects at the where publicly traded companies coexist with less Institute. “At a private company, there is always the transparent private units. possibility of a [strategic] decision being made on the “We have seen such groups,” said Rufat basis of the main shareholder’s position.” The Renova Alimardanov, a senior investment officer in group has, however, begun inviting outside experts manufacturing sector for IFC in Central and Eastern to join board committees, says Mr Alekseyev, and it Europe. “Obviously, there is more disclosure of is working on building a full-fledged best practice information by listed companies within the same corporate governance system “with all the necessary group. Typically, there is a transfer of knowledge internal procedures and consultative and advisory and management skills within such groups, which bodies.” positively affects more closely-held entities.” But introduction of boards and board committees Such co-existence can sometimes be difficult for does not automatically lead to better business investors to stomach, and concerns from investors and behaviour. Adoption of codes and establishment of business partners can force internal reform of such various committees under the boards of directors can companies’ less transparent elements. Billionaire often amount to window dressing and have little effect

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on the decision-making process—especially in the long-term competitiveness of these companies. Many archetypal Russian case in which a single shareholder of the Russian multinationals inherited Soviet-era exerts overwhelming influence within the board. plants, as well as employees with a Soviet mentality. According to a 2006 report by Standard and Poor’s At such enterprises, quality control has historically (S&P), Russian companies often work to become just been lax and safety standards have sometimes been transparent enough for an IPO or a Eurobond sale. The ignored to increase production. average transparency score assigned by S&P to the This is changing, if slowly. “We’ve sorted out a lot largest Russian companies has hardly budged in the of problems with quality, and improved our product last two years. portfolio,” says Ms Kibina, Evraz vice-president. For the time being, this may not matter too much: “Everything is not perfect yet but is much better than some among the Russia-focused financial community two years or a year and a half ago.” feel that companies in Russia are enjoying a period However, the adoption of international health and of such an unprecedented financial strength that safety standards can sometimes be merely cosmetic. stakeholders often turn a blind eye to questionable “Formally, there is certification but in practice those corporate practices. requirements are often not followed,” said a corporate “There are lots of problems with Russian development manager at a major Russian metals companies,” says James Beadle, a portfolio manager company. “I think this is the case with many Russian at Pilgrim Asset Management. But “there is so much companies.” money flowing around the world that asset managers Russian firms are also beginning to understand have—for the moment at least—ceased to worry about the importance of the softer elements of corporate good or bad management or governance.” strategy, especially given the poor image of Russia as If most private companies are at least taking steps a market and Russian firms as a whole (a 2006 survey to improve their image, Russian state-owned energy of senior executives around the world by the EIU found giants Rosneft and Gazprom don’t seem too bothered. that 72% of respondents do not yet regard Russian “Rosneft is the least understandable company from companies as world-class competitors). the point of view of its strategy and structure, to say Between 2003 and 2005, Alfa Bank, part of the nothing of the corporate governance,” according Alfa Group holding company, had two brands: Alfa to Mr Belikov of the Russian Institute of Directors. Bank and Alfa Bank Express. “Our research showed, “They think they took on board one independent however, that the two brands decreased total brand director and that’s enough,” he said in reference to recognition, so a decision was made to merge the Rosneft’s independent director, Hans Jorg Rudloff, brands” in 2005, says Natalya Orlova, chief economist the chairman of Barclays Capital. 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 People, product, process between corporate lending divisions and investment While financial restructuring and introduction of banking departments to fuel cross-selling of banking modern corporate governance structures are helping products, according to Ms Orlova. to make the new Russian multinationals more The Russian multinationals have also moved attractive to potential western investors, changes on aggressively to bring in top managers from around the ground—to business processes, human resource the world. This rise in demand has created a severe systems, and internal controls—are also crucial to the shortage of top quality managerial talent in the

Russian market—especially at the highest levels—and logistical complexity of communicating across 11 time has in turn driven white-collar wages up substantially zones have all weighed against efficient corporate in the past several years. This has forced the leading information-sharing in the largest Russian firms. Russian multinationals to rethink their compensation Managers at Wimm-Bill-Dann decided to tackle systems, moving away from pay policies that have this issue in the beginning of 2006 by launching tended to reward longevity and preserve egalitarian quarterly “town hall meetings,” during which the pay structures toward more incentive-based and management shares information with employees flexible compensation options. Like so many about the company’s achievements. Senior executives others, this trend is also underwritten by financing for the country’s largest food manufacturer have also requirements: Mr Potanin, the Interros president, taken an “internal road show” to the regions in which recently pointed out: “The higher the managers’ the company operates to communicate the company’s motivation, the more attractive the company is in the strategy and goals to key managers operating in eyes of investors.” Russia’s periphery. Telecoms company MTS has recently adopted a “Now we’ve decided it should become a regular management motivation and retention plan for its 420 thing and the management of the entire company top and middle managers, linking their compensation should at least once a year visit the regions and directly to share price performance. The management communicate with the people,” says Mr Anisimov. estimates that the programme will cost approximately $150 million, depending on share price movements. In 2007, dairy and food manufacturer Wimm-Bill- Corporate social responsibility and Dann began a stock appreciation rights (SAR), or environmental sustainability “phantom stocks” programme in an effort to tie down The concept of corporate social responsibility is the company’s top-performing managers. “When a slowly gaining traction among the leading Russian person realizes that his income will directly be tied companies. The biggest companies played a large up to the company’s long-term financial results, social role in the previous system, often providing then he has an incentive to continue his work at the schooling, healthcare, and entertainment in company for a longer period of time,” said Dmitry communities in which they were the dominant (or Anisimov, chief financial officer at Wimm-Bill-Dann. only) employer. These activities were largely divested The programme so far covers just a handful of top after the privatisation of the 1990s. More recently, managers, but Mr Anisimov suggests that it may be these firms have come to grips with the fact that expanded to cover the mid-level management in the they face a major image problem both at home and future. abroad—domestic public opinion has been wary of Evraz introduced a stock option programme in 2005 the motives and disapproving of the methods of the and has since reviewed it on a yearly basis to include “oligarch” class since the 1990s. more managers, while Renova set its first three-year The Russian multinationals have in the past stock option programme in 2006. responded with flashy public relations campaigns—in Another recurring problem in the Russian corporate a widely publicized move, Viktor Vekselberg bought world is poor internal communication. A culture of back the tsar’s Faberge Eggs in 2004. However, the decision-making taking place among small groups of adoption of new legislation governing corporate senior executives (or by a single “oligarch” leader), philanthropy and efforts by groups like the combined with Byzantine corporate structures and the International Business Leaders Forum (IBLF) and the

12 © The Economist Intelligence Unit 2007 Shaping up Corporate transformation in Russia’s emerging multinationals

Learning from the to deal with adverse conditions are constrained by insufficient other emerging and an instinctive understanding knowledge of foreign languages. of how to thrive in challenging Poor English language skills mean multinationals business environments. Like other many senior Russian executives emerging multinationals, Russian in the country’s multinational firms are also good at selling to low- companies cannot negotiate directly income consumers and dealing with with partners and clients, participate In many ways, Russia’s emerging antiquated logistics and distribution in interactive sessions and multinationals are similar to those networks. roundtables with their foreign peers, from China, India, and Latin America. Nonetheless, compared to their or communicate with media. The Brazilian mining company CVRD multinational peers in the other Indian firms also have the is the world’s largest iron-ore pro- BRICS countries, Russian firms are advantage of having worked within ducer, having acquired the Canadian relative late-comers to the global established western legal and mining company Canico in 2005 and business world and there is much financial frameworks for some time. Inco, a Canadian nickel producer that Russian firms can learn from the While Russian companies are moving the following year. Gerdau, a steel more battle-hardened multinationals fast to adopt international financial producer from Brazil, has purchased of the other BRICS countries. The reporting standards, these changes companies in Colombia and North battle over Luxembourg-based will take time to become ingrained America, and in 2006 purchased two steel company Arcelor in 2005 in managers’ thinking and corporate Spanish companies. In both cases, provided one example of Russian culture, according to Karl Johansson these firms faced exchange-rate firms’ weakness in corporate of E&Y: “Indian companies have a appreciation and high interest rates communication. It came as little competitive edge primarily because at home, and faced an array of trade surprise when Russia’s Severstal the framework of English law and barriers to operations in the US and lost out to Mittal Steel in its bid to English financial reporting has been Europe. Like their Russian counter- purchase the European steel giant in there for the last hundred years, and parts, they found foreign expansion 2006. At the time of the bid, Mittal so it’s more embedded in the way the most effective way of getting had a well-established presence in business is done.” around these constraints. The true Europe and had launched a charm Russian multinationals can also multinationals operating in the offensive, communicating its plans learn lessons from leading global BRICS countries (with the exception and intentions directly to the Chinese manufacturers, which have of South Africa) are largely, like in stakeholders. Severstal had kept also been able to build profitable Russia, in natural-resources-based largely silent. partnerships with western suppliers industries, such as oil and gas, steel Indian executives benefit from and joint-venture partners. Midea and mining. understanding of the English Holding, one of the country’s largest Like companies in Latin America, language, and the “multilatinas” manufacturing companies, has Russians are quick decision makers of Latin America have the natural developed deep relationships with and seize opportunities fast. Because advantage of a common regional a handful of major distributors in both the so-called “multilatinas” language. Russian firms have a the US (including Home Depot and and the Russian companies have had similar advantage in Russia’s near- Wal-Mart) to drive an export-led to go through a series of economic abroad, but when moving outside doubling of pre-tax profit in the past crises, they share both an ability the CIS many Russian executives five years.

Why is your enterprise interested in environmental issues? responsibility programme, which will touch upon (% respondents) everything from social, labour and environmental This is part of your basic values and issues to relations with different stakeholders, corporate principles including the state and local communities. This is part of your regional and social policy MTS hopes to decide on its corporate social It helps increase exports and access responsibility strategy by late summer or early important foreign markets fall. Andrei Terebenin, vice president for corporate It helps increase market share communications at MTS, says “we feel responsible as It increases production because it allows for a more efficient use of resources there are 50 million people behind us in Russia alone.” It's a requirement of key shareholders, Mr Terebenin adds that his company’s philanthropy consumers and clients This is a useful marketing strategy that and community projects also directly support the helps the company stand out bottom line, being designed to retain subscribers by It helps attract foreign investment involving them in the company’s feel-good activities. This is your area of expertise (you sell The Russian multinationals, many of whom ecological goods and services) inherited Soviet-era plants, are also putting in place 0 102030405060 Source: WWF. new equipment and earmarking budgets to help protect the environment. According to a recent study National Council on Corporate Development (chaired by the World Wildlife Fund’s Trade and Investment by Mr Potanin of Interros) to establish standards Programme, the largest multinational companies in for corporate practice have seen corporate social Russia are leading the way—the study claims that, “a responsibility efforts taking on more conventional close correlation exists between the environmental forms in Russia. This year, Mr Vekselberg’s Renova responsibility of companies and their level of group of companies—in a much quieter move—made integration into the international economy.” a decision to establish a corporate charity fund. Of the 70 companies surveyed in the study, “Shareholders got together and agreed that they will including Gazprom, Severstal and AvtoVAZ, 60% said channel 10% of their profits into charity projects,” that attention to the environment was part of their says Mr Alekseyev, director of corporate projects at corporate values, while a third suggested that it would Renova’s Institute of Corporate Development. help increase exports and foreign market access. In Philanthropy in Russia is still a tiny fraction of the same survey, 80% of responding firms said their corporate giving in countries like the United States organisations had specific budgets for environmental but foundations are growing and quickly adopting protection, 58% publish regular environmental clear and open procedures to select recipients and sustainability reports, and around half are involved in assess their work. Around ten Russian endowments an eco-labelling scheme. have been registered in Britain, according to Renova’s The problem remains acute, though. According to Mr Alekseyev. Alistair Schorn, a trade and investment programme Renova also took the decision to join the Global manager with WWF in South Africa, “in terms of gross Compact, a United Nations initiative to improve domestic product versus amount of carbon dioxide business practices in human rights, labour, the damage, Russia is not generating a lot of economic environment and anti-corruption. In addition to activity for the pollution it creates.” He notes that, financial reports, the group this year plans to publicise “there is a declining trend but Russia is still much for the first time a report on its corporate social higher than other BRICS countries.”

International lenders such as the EBRD and the and IFC stepped in to help, said Rufat Alimardanov. IFC are actively supporting the biggest Russian Unfortunately, it’s often cheaper for businesses to companies’ efforts to become greener. OMK, one of pollute and pay up rather than buy modern equipment Russia’s leading producers of steel pipes, recently and adhere to strict nature conservation policies— received a $60 million loan from IFC for increasing and “Some Russian companies prefer to pay fines for not modernization of its pipe manufacturing capacities complying with the local environment standards and is investing even larger amounts to phase out rather than invest large amounts in modernisation. It outdated polluting open-hearth furnaces by 2012. just costs them less,” says Mr Alimardanov. OMK had long planned to install such new equipment

The future of today’s Russian multinationals

What does the future hold for the emerging class of Real GDP growth Russian multinationals? The answer will depend on a (%) Russia World combination of external and internal factors. 7 On the external side, the omens look relatively good. 6 Russia’s buoyant economic expansion of recent years looks set to cool slightly as oil prices recede, but real 5 GDP growth will remain over 4% per annum well into 4 the next decade. Fiscal surpluses and a strong rouble will help underpin moderate disinflation and overall 3

macroeconomic stability looks like a solid bet for the 2 foreseeable future. This will help underwrite increasing consumer confidence, which along with strong GDP 1

growth should see household consumption per head 0 2006 2007 2008 2009 2010 2011 more than double in US dollar terms from 2006-2011. Source: Economist Intelligence Unit. The uncertainties surrounding the presidential succession after Vladimir Putin steps down in 2008 present some risk to these companies, and their deterioration in relations between Russia and the senior management teams may face shake-ups as the West—should this slide continue, the reception facing political elite re-aligns itself in the post-Putin era. In leading Russian companies as they attempt to break the long term, though, this is unlikely to cause a big into western markets could become even chillier than shift in corporate strategy for most of the emerging it is today. Russian multinationals. More worrying is the steady The much bigger question, though, will be how

Tomorrow’s emerging practices than today’s top tier—but top 500 companies within the next leaders because most of them are outside decade. resources-based industries and are Seventy Russian companies have active within Russia only, few in the been invited to join this initiative While the best companies do care West know about them. and around 25, including banks, about corporate standards, the West The World Economic Forum (WEF) a logistics company, a trading often judges Russian business on is launching a new project to groom company, a heavy industry company the practices of some of its most such companies—it calls them “the and a major foreign car importer, controversial and combative compa- New Champions”—which are expected have joined so far, suggesting that nies with a global reach. At the same to become the next generation of the country’s next wave of “emerging time, there are a growing number of multinationals. These companies have multinationals” will hail from a much smaller, second-tier Russian com- a growth rate of more than 15 percent broader range of sectors than does panies that boast better business and are expected to join the global the current crop.

16 © The Economist Intelligence Unit 2007 Appendix: Survey results Shaping up: Corporate transformation in Russia’s emerging multinationals

far these companies go internally. The largest Household consumption Russian companies have come a long way in terms (Per head, US$) of corporate transformation and the adoption of 8,000 international business standards. Managers in these 7,000 firms are increasingly realising that the introduction 6,000 of new ways of doing business is crucial not just 5,000 in order to make their companies more attractive to western investors but also to ensure long-term 4,000 competitiveness—this explains why the changes being 3,000 made in these companies sometimes even exceed the 2,000 minimum requirements of European stock exchanges. 1,000 Nonetheless, much remains to be done. Command- style management is still not uncommon in the 0 2006 2007 2008 2009 2010 2011 largest companies and it will take time for this to be Source: Economist Intelligence Unit. replaced by modern methods of management and intra-firm communication. The recent trend to retain talented employees with the help of short-term and Because of high staff turnover and cultural factors, long-term motivation programs will help attract top training and retaining of personnel is considered to management talent, but more can be done to bring be an unaffordable luxury at some companies—this compensation and career development practices into too will need to change if Russia’s multinationals line with best global practice. The largest Russian expect to compete with global leaders in the long run. multinationals show a solid understanding of and Human resources departments still tend to play a very concern for environmental best practice, but studies limited role in supporting professional development, suggest that most companies can do much more to and formal staff development plans are the exception switch from “end-of-the-pipe” practices of polluting rather than the rule. and cleaning up to pre-emptive measures.

Conclusion

The pace and emphasis of corporate transformation factors are also at work. in Russia’s emerging multinationals varies from As the emerging Russian multinationals expand company to company, but there is little doubt that a their operations into more markets, they face new sets broad process has begun and is gathering momentum. of stringent regulatory requirements, along with the Reforms are indeed happening, and they are, for the need to conduct business in a manner in keeping with most part, driven by real commercial imperatives. accepted values and practices in the west. As these Russian mega-firms seek to continue More broadly, though, senior leaders of the expanding, they are increasingly facing the need more advanced Russian multinationals are now to look for external sources of funding to support accepting that the long-term competitiveness of their their growth strategies. The requirements that organisations (and in some cases the viability of their come with those sources of funding—for improved own personal fortunes) will depend upon their ability transparency, better reporting, tidier environmental to match or better financial, human resources, and and social practices, and more efficient processes and strategic planning practices of their competitors from structures—are a key driver in the process, but other both the west and other emerging markets.

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