S t a n f o r d U n i v e r s i t y C I S A C Center for International Security and Arms Control The Center for International Security and Arms Control, part of Stanford University’s Institute for International Studies, is a multidisciplinary community dedicated to research and train- ing in the field of international security. The Center brings together scholars, policymakers, scientists, area specialists, members of the business community, and other experts to examine a wide range of international security issues. CISAC publishes its own series of working papers and reports on its work and also sponsors a series, Studies in International Se- curity and Arms Control, through Stanford University Press. Center for International Security and Arms Control Stanford University 320 Galvez Street Stanford, California 94305-6165 (415) 723-9625 http://www-leland.stanford.edu/group/CISAC/ Contents Acknowledgments iv Executive Summary v I Introduction 1 Section One: Case Studies II The Central Aerohydrodynamic Research Institute (TsAGI) 9 III ELVIS+ and The Moscow Center for SPARC Technology (MCST) 28 IV Impuls 45 V The Mashinostroenie Enterprise 59 VI The Saratov Aviation Plant 79 Section Two: Analysis VII Privatization at Four Enterprises 111 VIII Organizational Restructuring 137 IX Principal Differences in Accounting Systems in Russia 163 and the United States X Reallocation of the Social Services 183 XI Conclusion 207 Glossary 216 1 Acknowledgments Many people have contributed to this report, and still more have contributed to the research leading up to it. In writing this report, we have not attempted to reach consensus among the authors on the interpretations to be drawn from the data. The executive summary, introduc- tion, and concluding chapter contain my own conclusions, which at times are different from those of the authors of the individual chapters. Any errors are entirely my own. The research on this project has been performed over the past four years primarily by researchers at the Center for International Security and Arms Control (CISAC), its two subcontractors, Science Applications International Corporation and the Foundation for Enterprise Development, and consultant Tatiana Krylova of Moscow State University. Assistance was also provided by members of the Center for Conversion and Privatization and Russia’s Economic Reform Foundation. Jeffrey Lehrer and Elaine Naugle are research assistants with the CISAC Project on Industrial Restructuring and the Political Economy in Russia. Former research assistant Tova Perlmutter has returned to school as a Ph.D. candidate in American history at the University of Michigan. Research associate Michael McFaul is spending 1994-95 heading the Moscow office of the Carnegie Endowment for International Peace; he will return to Stanford in the summer of 1995. In addition to the contribution of Stanford researchers, the case study on the Saratov Aviation Plant was written by John Battilega, corporate vice-president at Science Applica- tions International Corporation, and the chapter on accounting was written by Tatiana Krylova, associate professor, Finance and Banking Department of the School of Economics, Moscow State University. We wish to acknowledge Yevgeniy Kuznetsov, of the Institute of Economic Forecasting, Russian Academy of Science; Tatiana Krylova of Moscow State University; S. V. Malakhov, Yu. G. Gritsin, N. Shmeleva, and A. Radygin of the Institute for the Economy in Transition; John Battilega of Science Applications International Corporation, and David Binns of the Foundation for Enterprise Development who provided valuable reviews of the report. In addition to their research and writing, Matthew Bencke, Jeffrey Lehrer, Elaine Naugle, and Tova Perlmutter assisted greatly with the review and editing of the report. Megan Lauppe was indispensable in her editorial support. Preparation of this report was funded by the United States Agency for International Development through the Eurasia Foundation. None of this effort would have been possible without the support of our research by the Carnegie Corporation of New York. Finally, and most importantly, we wish to thank the general directors and staffs of the enterprises that we have studied, including those not covered in detail in this report. They have devoted many hours to our cooperative efforts. They are the ones who have to carry out this incredible transition and build the industries of the future. The rest of us only study it and try to assist as we can. David Bernstein, editor iv Executive Summary David Bernstein I. Introduction Because of the Soviet Union’s heavy emphasis on military prowess and capability, the military-industrial sector in the Soviet Union (and Russia) was larger than its counterparts in other industrialized societies. In addition to military equipment, it produced almost all civilian products with technology content such as appliances, electronic equipment, and aircraft. With the ending of the Cold War, support for the military production from this sector was radically deemphasized. The necessary adjustment of the military enterprises to this demand shock has been embedded in far more comprehensive economic reforms. As the country has moved to a market economy and privatized much of its economic potential, the managers of the enterprises have found it necessary to convert most of their output to nonmilitary products and services as well as to restructure the enterprises. In going through this major transition, the challenge for Russian defense enterprises, and for the state, has been to address several partially conflicting and interdependent goals, including: • To redistribute ownership from the state to managers, employees, and outside inves- tors. • To utilize the assets of the enterprises to increase efficiency, revenue, and profits from both state and nonstate customers. • To maintain operational control of the enterprises in hands sympathetic to the contin- ued operation of the enterprises. • To provide employment and social services for the employees. • To remove the burden of support from the state and impose hard budget constraints. • To maintain the technological and industrial base required for national security. v • To reduce the degree of industrialization and militarization of industry and thereby increase both the civilian production and service sectors of the economy. • To liberalize prices. • To demonopolize the supply chain. The three major areas of restructuring are (1) the relationships of the enterprises with their owners, (2) the internal organization and operational procedures of the enterprises, and (3) the relations between the enterprises and the employees. The degree of success of the national economic reform program and the health of the economy will depend substantially on the degree of success of the defense enterprises in utilizing their residual assets (human, technological, and physical) to generate profitable economic activity. This report deals with this economic transition, primarily at the enterprise level. We have met the directors of more than forty defense enterprises and worked with approximately ten of them in considerable detail and six in more detail, having spent between one quarter and one person year with managers from each of the six. Notwithstanding this amount of contact, there are still problems with the reliability of our data. The researchers in our group do not always agree on some aspects of the situation at a given enterprise, and of course many of the conditions are changing over time. This coupled with the absence of periodic financial reports complicates the data gathering and evaluation process. (The last data for this report were collected in early September 1994.) We have not attempted to reach consensus on all aspects of the data, and hence different views are expressed by the various contributors. The report contains case studies of these six enterprises as well as cross-cutting chapters on four critical aspects of enterprise restructuring—privatization, organization, accounting, and social services. These have emerged as the key factors governing the strategies of the enterprises, and they will be some of the primary determinants of the success or failure of an enterprise. In analyzing the factors that will determine the success or failure of the transition at a given enterprise, we find it impossible to isolate individual factors, such as leadership, product line, markets, and foreign investors that combine to determine success or failure; they are interdependent. Therefore we do not expect to be able to draw precise conclusions about the relative importance of these key factors, nor do we expect the relative importance to be the same for all enterprises. By success we mean transition to a sustainable, and ultimately profitable, enterprise functioning in a market economy. The market economy does not yet exist in Russia; many of the military-oriented enterprises have not as yet been permitted to privatize; those that have privatized and converted are still undergoing many changes; and the political environment has not yet stabilized. Therefore it is not yet realistic to deem any enterprise successful. The most that one can do is note the success or failure of interim operations, restructuring steps, and strategies. The degree of success to date is not necessarily the indicator of long-term success. Although profitability will be a primary long-term indicator of success of any business, short-term financial performance is not a very good