the Business School
Business School
Research Memorandum
37 • 2003
Managerial Responses to Transition in
the Russian Defence Industry
MARIANNE AFANASSIEVA
Centre for Regional Business Development
Research Memorandum
37 • 2003
Managerial Responses to Transition
in the Russian Defence Industry
MARIANNE AFANASSIEVA
Centre for Regional Business Development
The Business School, University of Hull,
Cottingham Road, Hull HU6 7RX
Email: [email protected]
ISBN 1 902034 309
1. Introduction
This paper is an attempt to look at issues of the Russian transition, using the defence industry
as an example. It is not surprising that ‘finding feet’ in a new discipline is proving to be quite
demanding. In a sense, this is a personal transition from an economics/political economy
viewpoint to a management studies perspective. It’s like having a split personality. One feels
very comfortable in a certain ‘comfort zone’ of one’s own developed approach, only to find
that it makes little sense, if viewed from a different, and moreover, a critical angle. Current
Russian reality is by no means conducive to any firmness of opinion on it, and to have to
challenge the comfortable unquestioned assumptions, makes the analysis even more difficult.
This is, however, a liberating experience.
The paper starts with a brief discussion of how managers operated and how
enterprises/factories behaved in the command administrative system of the Soviet Union and
analyses the legacy for contemporary enterprise adjustment. The third section deals with
managerial responses to the environment of transition, emphasising the conditions of
particular relevance to the Russian institutional arrangements. Some key findings from field
research illustrate the problems that managers face. Conclusions follow.
2. Legacy of the Managers Ways of Operation in the Command Administrative
System
In order to understand the underlying patterns of Russian managers' decision-making, it is
necessary to see in what kind of system the latter was shaped.
The pillars of the command administrative system were:
- directive central planning;
- highly centralised administration of producing units;
- state-fixed prices;
- rationing of materials and equipment;
- incentives geared to fulfil state plans.
Soviet management operated under a dual hierarchy, which paralleled every layer of line
management with Communist Party organs, step by step from top to bottom. Because of the
need to try to co-ordinate supplies and requirements as smoothly as possible, and to avoid
contradictory instructions, the system was a centralised one. Managers had always to look
upwards for their quotas, for adjustment to their quotas, and to negotiate their next quotas
(see Hickson and Pugh (1995)). So it was effectiveness (i.e., being able to meet planned
targets), not efficiency that was the main criterion of enterprise's activity.
Throughout most of the existence of the planned economy in the Soviet Union (from late
1920's) a principle of single responsible management (one-man-power) was essential. Under
this system the managing directors of Soviet enterprises (or factories) were solely and
personally responsible for every aspect of administration and production of their factories. As
Malenkov is quoted in Dewar (1945, p.45): "The factory director is fully responsible for the
state of the enterprise and for the order in production. His instructions must be carried out.
The director is responsible not only for the correctness of an order given, but also for the
timely and precise fulfilment of the order by the worker to whom it was given. It is
Research Memorandum • 37 • The University of Hull Business School
3
inadmissible to tolerate a situation where the director, in a desire to justify himself for bad
work, continuously refers to his orders not having been carried out, though they were issued
correctly and in good time. A director has to know his subordinates, has to check upon the
fulfilment of instructions given and has to replace workers who do not carry out orders, or
carry them out inaccurately, by more efficient workers".
The above seemed totally ‘normal’ in the Soviet reality, especially if one remembers that
Malenkov was a member of the Politburo and was in Stalin’s close entourage. Stalin,
incidentally, had a fairly reliable quality control method. For example, if his favourite dark
chocolate from the Moscow-based chocolate factory Rot Front had not been to his liking,
Stalin would order the factory director to be shot. It has to be said that here we do come
across a very worrying phenomena. If satisfactory performance is not achieved, there are two
possible scenarios: either, according to Malenkov, you have to get rid of the uncooperative
employee, or, according to Stalin, - the director. This may look ludicrous to us now, but it can
be ventured to suggest that this is but a grotesque caricature of organisational life.
The notion of control is not challenged, and accepted as given. The employee in the Soviet
system was not only contractually obliged to recognise the authority of superiors in
organisational hierarchies, but also legally obliged to work (apart from cases of disability,
injury, maternity leave, which were rigidly regulated, not working was illegal and punished
by incarceration). This legacy of institutionalised acceptance of authority for authority’s sake
can be viewed as very damaging during the development of a ‘new’ system of management.
There are two issues here. One is acceptance of authority for authority’s sake, which if one
takes a Russian perspective (of the times even before the 1917 Bolshevik Revolution) can
evoke a thought from Anton Chekhov. In an 1880 letter to his friend Suvorin, Chekhov refers
to squeezing the slave out of oneself drop by drop.1 He is pondering on the difficulty of this
process and the near impossibility to achieve individual personal liberty. At the risk of taking
the Chekhovian quote out of context, it is still appealing to draw on it as a reflection of the
human nature, especially in the Russian case.
‘Slavery’ can be interpreted as an organisational phenomenon. The potential of organisations
to be enslaving, oppressing is nothing new. This then makes it a more universal concept,
which might nonetheless, be filled with different contextually derived meanings. Applying it
to himself, Chekhov probably had meant his religious upbringing, shaping his personality. As
far as the Russian managers and employees are concerned, this (taken alongside the above
discussion) might indicate an alarmingly high level of subservience and compliance.
It can be put forward then, that the ‘new’ system of management, which is being developed
during Russia’s transformation, is not new at all. Along with paternalism, which is discussed
below, the ingrained control, supported by compliance and subservience, is carried into the
Post-Soviet reality. The rigid hierarchical and bureaucratised structured are hard to change.
This means that the transition from a planned economy to a market economy would be
merely a switch as far as control structures are concerned (because the latter are persevering).
This creates an easy opportunity for the workforce to be controlled as before and exploited to
the full in the capitalist system. In conditions of instability, insecurity and, generally, fear,
1
4
See http://www.samisdat.ru/3/311-696.htm, accessed on 04/07/01.
Research Memorandum • 37 • The University of Hull Business School
this willingness to comply and take almost anything will hardly be challenged. Even more so,
since “management is often depicted as a politically neutral process”, as stressed by Dispenza
(2000). Coincidentally, the example that Vincenzo Dispenza draws on is the case of the
Soviet Union during Stalin’s reign, when Soviet engineers (who were made managers)
“would not openly question the wider socio-political context of their work”.
It should be emphasised that management in Soviet-style organisations cannot be considered
separately from the worker collectives. Generally speaking, collectives are defined in
Vlachoutsicos and Lawrence (1996) as closely-knit work groups bound together by shared
values and mutual support. The management system of the Soviet enterprises was based on
"democratic-centralism". The latter was meant to create an ingenious balance of centralised
leadership and grassroots democracy. This balance was achieved by alternating clearly
defined phases of centralisation and grassroots participation. In the course of time the system
became bureaucratised: it was applied to decisions on an increasingly narrower range of
issues of decreasing general importance and its democratic phases became meaningless
rituals - however, it had a distinct influence in developing collectivist values.
Vlachoutsicos and Lawrence (1996) note that it comes ‘naturally’ to Russians to identify with
and behave according to these communitarian values. For example, collectives, in the face of
persistent shortages of goods, have traditionally been expected to be concerned about the
well-being of all their members in terms of the basics of life - housing, food, education,
medical care, job security. Directors feel a moral commitment but also heavy social pressure
to maintain job security and benefits for their members. Collectives will sink or swim
together. It is no wonder then, that paternalism played and still plays such an important role
in Russian enterprises.
It has to be recognised that the way privatisation was carried out in Russia has cemented the
previous de-facto control enjoyed by the top managers. This stems from the culture of
paternalism and delegation of the power of decision-making to top managers. The widespread adoption of the second option (51% of shares to management and workers) among the
three available privatisation options has resulted in the prevalence of insider ownership and
control. Insider control in Russia essentially means control by the directors and top managers
[see Blasi et al. (1997)].
The sense of responsibility on the part of the directors for the well-being of the whole of the
work collective may be considered as a positive aspect (as far as moving away from the
purely ‘economic’ analysis of the transition process2), were it not for the underlying
assumption that top managers know best what’s in the employees’ interest.
On the other hand, a negative aspect may be the blind faith in the top management on the part
of the workforce. This perpetuates inertia, a kind of zombie state, and shying away from
participating in the decision making process.
Let us summarise the activities of Soviet era managers. The job of Soviet managers was to
fulfil the plan established for their enterprises by responsible ministries under the centralised
direction of Gosplan's five-year plan. Each enterprise functioned under the jurisdiction of a
2
We shall return to explain this in the next section.
Research Memorandum • 37 • The University of Hull Business School
5
ministry, which provided the funds as well as the final plan for the operation of the
enterprise. Managers could request funds for research and development and equipment to
carry out their assigned plan, however, new equipment has been expensive and rare, with the
exception of supplies available to the defence industry. Enterprises associated with
ministries having the very scarce hard currency fared better than others did, which may have
allowed more efficient production or even some improvement in quality as a result of
purchasing Western equipment or technology. Some industrial enterprises also produced
consumer goods, almost exclusively for the domestic and Eastern European market.
Decades of meeting the plan have produced managers who function and are motivated only
by increasing units of production. The quality, cost, timeliness, and true need for their
products have not been very important criteria. And the production itself has been hampered
by chronic shortages of raw materials and by obsolete technology and equipment, as well as
by the desperate lack of motivation within the Soviet workforce. In this environment,
managers have not been able to develop the skills needed in a competitive worldwide
economy. Marketing and finance have been foreign concepts to them. Making deals to obtain
the needed raw materials was standard, and most production figures were reputed to be false.
Finally, the union representative and the Communist Party representative in the enterprise
have heavily influenced key decisions. And it goes without saying that many managers owed
their positions to the fact that they were members of the Party.
We must at this stage also mention the changes that happened during perestroika. The first
phase of transition can be dated from the perestroika-induced starting point of the
disintegration of the Soviet planning system with the 1987 Law on State Enterprise and the
Laws on Individual Labour Activity, 1987, and Co-operatives, 1988. These laws in principle
allowed individual enterprises to escape the straightjacket of the planning system,
particularly in wage setting and in the sale of above-plan output.
The major roles for the enterprises and managers under perestoika are contained in the Law
on the State Enterprise. Enterprises were expected to become self-sufficient and selffinancing - in short, profitable. Furthermore, they were expected to pay their debts on time.
These requirements should have been focusing managerial attention on the need for costconsciousness as well as the required measurement techniques.
With regard to product decisions, the enterprise law called for more autonomy for managers.
Markets for enterprise products were to be researched and some advertising was encouraged.
Direct relations between enterprise and customers were now permitted under some
circumstances. The autonomy granted by this law extended to relations with foreign firms,
when managers began to have the authority to negotiate directly with foreign firms regarding
imports, exports, and joint ventures.
It is important to point out that perestroika has brought substantial change to the jobs of
Soviet managers. They were expected to manage in a far more market-oriented economic
system. Unfortunately, developing ‘market-oriented’ incentives would not change the
relationships within organisations that we analysed above.
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Research Memorandum • 37 • The University of Hull Business School
3. Managerial Responses to the Environment of Transition
First of all in this section it is important to outline the conditions that have led to an industrial
decline in the beginning of the Russian transition. We shall follow Nove (1996) in his
explanation of this phenomenon:
1) The consequences of political disruption. This includes the collapse of COMECON, which
deprived some industries of markets and others of supplies. The former Soviet Union
depended on these countries for various industrial components, medical drugs and consumer
goods. The disruption of the Soviet Union had similar deleterious effects.
2) The consequences of institutional disruption. Management (and bureaucrats) found
themselves in a situation with which they were unfamiliar, with the disappearance of the
system to which they had been accustomed. Market-type institutions were still in process of
formation. Management had not developed marketing skills, the necessary information flows
were missing or inadequate, the legal structure all too often ambiguous or confused, 'market
culture' lacking. All in all, the moral, institutional, and legal infrastructure of markets was
still in process of formation.
3) The consequences of inherited structural distortions. The Soviet economy was heavily
'slanted' toward the military-industrial complex, and the end of the arms race led to an
immediate fall in output of military end-products and of inputs for these products, while
'conversion' required time and scarce resources. The heavy-industry sector was
overdeveloped, based on artificially low-priced energy and materials, transported long
distances. There were serious deficiencies in infrastructure. There were some of the world's
worst cases of atmospheric pollution. This called for a major redistribution of resources to
previously neglected sectors, but meanwhile output would fall in those sectors which were
plainly uneconomic on the new circumstances (there were cases where, if evaluated in world
prices, the net product was negative, i.e., the value of inputs exceeded the value of output).
4) The effect of deflation on consumer demand. A decline in real incomes has been
significant. This has had the effect of increasing the share of income devoted to food and a
corresponding fall in demand for manufactured consumer goods and durables. There was also
a fall in demand for the more expensive foodstuffs, such as sausage. So the fall in
consumption was due partly to the fall in purchasing power, which was also a cause of the
drop in output. Price relativities have been greatly affected by the elimination of most
subsidies. Thus in Russia the (official) prices of bread and meat multiplied a hundredfold
between 1990 and the end of 1992, while the average incomes rose roughly twenty-fold in
the same period.
5) The consequences of (premature?) currency convertibility and import liberalisation.
Consumer goods production is seriously affected by the citizens' preference for goods
imported from the West.
6) The consequences of the collapse of investment. Investment has fallen very sharply,
despite the urgent need for restructuring and conversion, and this naturally is associated with
a fall in demand for machinery, building materials and other investment goods. Foreign
investment can only partially fill the gap.
Research Memorandum • 37 • The University of Hull Business School
7
7) The consequences of 'marketisation' of formerly state-sponsored services. For example,
medical services, education, culture, crèches, holiday homes and scientific research have all
been cut back or partially put on a commercial basis. Hence in Russia the steep decline in
many of the 'services' components in GNP.
If we look at the conditions underlying enterprise behaviour in Russia it is important to
consider the institutional framework of the present Russian society. As North (1990) stressed,
"both what organisations come into existence and how they evolve are fundamentally
influenced by the institutional framework; in turn they influence how the institutional
framework evolves".
The institutional framework is defined by Davies and North (1971) as "the set of fundamental
political, social and legal ground rules that establishes the basis for production, exchange
and distribution". Essentially, institutions are the rules of the game, as North (1990) points
out, that the institutional framework provides, thus serving as constraints to regulate
economic activities in a society. Institutions include any form of constraint that human beings
devise to shape human interaction. Institutions can be formal, informal, or either. Formal
constraints include rules that human beings devise, informal constraints include conventions
and codes of behaviour. Institutions also may be created or may evolve over time.
At this stage it might be worthwhile to have a broader look at the transition debate. After 10
years of transformation in Eastern Europe one cannot help admitting that this debate is
dominated by economic considerations of efficiency and is still ideological by nature. The
neo-liberal agenda promotes private property rights as one of the main institutions that the
transition economies are deemed to need in order to develop successfully [see World Bank
World Development Reports, especially, World Bank (1996)]. The notion of the superiority
of capitalist institutions has been taken full-heartedly on board by the transition economies.
It is not the aim of this paper to give an in-depth critique of this. What is relevant here,
however, is that the discourse on Market has been substituted for the discourse on Plan. As
has been highlighted above, during Soviet Union’s existence the system became
bureaucratised. It can be added also that commitment and loyalty at the workplace has been
ensured in the first instance by the commitment to the communist ideals (Stakhanovites, etc.),
however, enthusiasm does not prove to be a lasting stimulus. Indeed, when the common
cause has eroded, it was fear and oppression that were the only ways to ensure compliance
and loyalty. From then on control is enforced, ingrained, and becomes a tradition.
Sticking to the received wisdom of not challenging the assumptions behind institutional
economics analysis Kochevrin et al. (1994) note that the ideas of institutional efficiency and
institutional choice are especially important in the case of transitional economies where their
relevance and potential impact could be much greater than elsewhere.
If we turn our attention to the transforming institutions in present-day Russia, we see the
influence of the legacy of the ways of operation in a planned economy. One should remember
that certain "quasi-market" institutions had existed in the administrative command system. It
is well known that a shadow economy had been operating in parallel to the "main" economy
in former socialist countries. The shadow market had played an important stabilising role.
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Research Memorandum • 37 • The University of Hull Business School
The inevitably arising in the CPE production disbalances had been levelled out by the use of
informal quasi-market rules periodically by all economic agents, including state enterprises.
As a result, a whole spectrum of informal institutions has evolved: institutions of the ‘black’
market, institutions of the ‘grey’ market (e.g., ‘tolkachi’, who had been ensuring the supply
of the most sought after resources and those in shortage to the state enterprises).
Oleinik (1997) argues that it is not enough just to legalise these institutions in order to create
efficient institutions of a market system in Russia. It is necessary to understand primarily
what is the market code of conduct. In an ‘ideal’ market setting a market agreement should be
based on a minimal level of mutual trust. Other essential norms mentioned by Oleinik, are
sympathy and empathy, which are connected to a complex of norms of rational behaviour.
Finally, interpretative rationality, being the ability to predict the actions of other participants
of the transaction, and also the ability to convey one's own intentions to them, is an important
factor of the relations of trust.
By comparison, it is interesting to examine the existing norms of quasi-market behaviour
fixed in informal institutions in the Russian society. The level of trust in the Russian society
is alarmingly low - only 35% of respondents gave a positive answer to the question whether
they trust people in general (33.3% is the calculated benchmark of the marginally acceptable
level). This survey was conducted in autumn 1996 among 404 respondents in Moscow and
Nizhni Novgorod by a group of researchers from the Russian Academy of Sciences Institute
of Comparative Politology.
And this is not surprising since, as Kornai (1990) noted, that it is not mutual trust but mutual
suspicion that had been spread in a society, where mechanisms of bureaucratic co-ordination
had dominated: no superior had been fully sure of the loyalty of his /her subordinates, and the
whole society had been pierced through by the superior-subordinate relationship.
However, another figure from the same survey gives a slightly puzzling picture. 65% of the
respondents stated that they base their relations with people on trust. The following
explanation, i.e., that trust is personified and relations of trust are limited to a circle of people
that know each other well, primarily relatives, clarifies the seeming contradiction with the
above figure.
Kholodkovski (1998) also stipulates that ‘close’ relations, i.e. between relatives and friends,
are prevalent in the Russian society. Personalism, preferring private relations to non-private
ones, or universal norms, is running through the Russian society on different levels - from
business and official relationships to ‘charismatic’ politics. This is the principal reason for
the low authority and weak efficiency of the law, official channels of interaction, and their
substitution or duplication by personal relations.
The conclusion that one comes to based on Oleinik (1997) is that the informal norms of
behaviour dominating in the Russian society are insufficient to a large extent for the market
transactions to take place. Trust and relations based on sympathy, are personified and
localised. The prospects for their development are directly related to the emergence of formal
institutions.
Research Memorandum • 37 • The University of Hull Business School
9
The described above norms of behaviour in the Russian society are an answer to the
underdeveloped market infrastructure. Ickes et al. (1997) have analysed the components of
the latter and why it is underdeveloped. Their account includes the following institutions as
constituting the market infrastructure:
"One subset of institutions that is most pertinent comprises those firms engaged in the
production of information services, whose products are integral to the process of search. For
example, it includes firms that engage in wholesale and retail trade, marketing, and
telecommunications. Another subset includes institutions that are integral to the process of
bargaining - in particular, legal institutions, including law, lawyers, institutions for private
arbitration, courts, and their more informal alternatives".
These authors contend, basing their conclusions on a survey of Russian firms conducted in
1992 - 1994 that the quality of information services in Russia is poor and had declined during
the survey's period. Physical infrastructure and financial institutions had also declined in
quality, as had the reliability of all forms of transport. Another revealing fact, in accordance
with our analysis above, was that Russian firms admitted that personal connections are the
most important method for finding new customers.
As far as the legal framework is concerned, Hendley et al. (1997) came to the conclusion that
Russian enterprises make little use of law and legal institutions in structuring their
relationships, reflecting the fact that the legal system in Russia does not adequately support
transactions.
Hendley et al. (1997) also stress that "formal contracts are used, but as a matter of routine
rather than strategy, the form of the contracts changing little in response to circumstance".
It is not, thus, the formal contracts that govern transactions, but informal institutions are used
instead. Gutnik (1996) points out in this connection that contractual relations in Russia are
constrained by uncertainty and risks coming from insufficient availability of information.
Contracts are more or less based on trust and on mechanisms of responsibility. If one reneges
on an agreement, it is not legal liability that is feared but the loss of business partners' trust,
cornering out of the market, and eventually bankruptcy. In constantly changing economic
conditions contracts are necessarily incomplete, full information is never available. More so
in the Russian transforming economy, where a contract is based only on key points and on
final results, as a rule.
McMillan (1995) notes that despite the absence of laws of contract and courts able to enforce
them in Eastern Europe and Russia, business deals are made and workable substitutes for
institutions familiar to a market economy arise in transition economies. The substitutes for
legal contract enforcement include reputational incentives, repeated games and privatised
coercion.
It should be emphasised that when it is difficult to write complete contracts [because of
bounded rationality combined with complexity and uncertainty, according to Williamson
(1985)] markets break down and market failure leads to increased integration. In the
transition case of Russia, where markets are almost absent, as we have seen, moves towards
integration are even stronger, resulting in reluctance to restructure and break up large
enterprises.
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Research Memorandum • 37 • The University of Hull Business School
High transaction costs, which according to Gutnik (1996) are determined by the uncertainty
of economic conditions and unreliability of suppliers and customers, are close to blocking a
normal process of economic transaction in the Russian economy.
Hendley et al. (1997) give a very useful summary of the implications of an insufficient role of
legal institutions for Russian economic performance:
"First, a large proportion of transactions appears to be based on ties inherited from the
Soviet times. Second, firms are forced to rely on prepayment, often in combination with
barter, as the preferred method to ensure that purchasers fulfil contracts. Such payment
terms impose large transaction costs and do little to build confidence in the legal system.
Third, semi-legal or illegal enforcement methods are common, with their associated social
and economic costs. Fourth, there seems to be a dearth of complex transactions between
enterprises - that is, transactions involving long-term agreements for the exchange of highly
differentiated products. It is possible that many potential transactions simply do not take
place, with adverse consequences for economic growth".
Bearing in mind all these conditions it is interesting to see what adjustment strategies the
defence enterprises are adopting. The defence sector in Russia post 1991 was put in such a
situation when the usual conditions of defence sector operation were drastically changed.
With the demolition of the administrative economic system rigorous administrative coordination is no longer present. However, the market in Russia is still underdeveloped.
Defence enterprises have been forced to face the fact that the government can no longer be
the main buyer of their products, defence orders have collapsed, and the problem of
‘marketisation’ has arisen.
Since conversion as a state programme did not bring any tangible results due mainly to lack
of funds for different conversion projects, defence enterprises started to find ways to survive
chiefly by means of diversification (and this is what is meant by ‘marketisation’).
According to Ekspertnyi Institut (1996), Russian defence enterprises adjust by using various
routes. These are analysed below. Privatisation was the main reason why this was possible.
As noted by Filatotchev et al, the privatisation programmes had an impact on both the
internal and external dimensions of Russian enterprises. The programme introduced a new
structure of corporate governance for firms. This process involved market reform designed to
replace the ‘soft’ penalties and rewards for performance imposed by the State (often seen as a
lender of last resort) with a ‘harder’ regime. In practice, however, the initial effect of
privatisation was a simple transfer of enterprises to the private sector, but their transformation
was into competitive companies was yet to be resolved. During the period of central
planning, state ownership created a corporate governance problem because the government,
as an absentee owner, failed to monitor management adequately (see Filatotchev et al
(1996)).
A discussion of privatisation in greater detail is not feasible at this stage. Here we shall just
mention that there were strategic enterprises, which were prohibited from privatisation. The
rest have either privatised according to the privatisation programme or were granted special
permission by the Government. In many cases privatisation meant, however, corporatisation,
Research Memorandum • 37 • The University of Hull Business School
11
i.e. creation of joint-stock companies but with the state retaining control. However, those
enterprises that had restrictions on privatisation began to develop new organisational schemes
for their transformation.
It should be pointed out that the legacy of the old system of operation when the defence
enterprises had many different functional departments including R&D facilities and also
social amenities hinders their successful functioning in new conditions. This dictated the
necessity to give more freedom to the departments and divisions of enterprises, because the
predominant logic was that ‘everybody should be surviving on their own’.
In the next part we shall outline the general trends of this adjustment process.
One direction of transformation goes along unbundling of large multifunctional enterprises.
The other direction of transformation goes in the opposite direction of creation of new
corporate structures that integrate inter-related production cycles.
This process took mainly the form of the creation of a network of small firms (malye
predpriyatiya) around the large enterprises. As a rule, the small firms were created a-new
with the enterprises own assets and with private persons’ resources, or using the enterprises’
divisions as a base.
The problem that can be identified here was that in many cases most of the profitable
activities of the enterprise were spun-off but the costs and overheads from maintaining the
unprofitable parts of the enterprises and the social sphere would be written off to the
enterprise as a whole. So the profits would actually be in those small companies and going to
the people who were organising them. In many cases these would be the top managers of the
enterprise, because they would be able to shift around the enterprise’s assets.
This development was also noted by Stark (1996), namely that "assets are distributed to the
satellite companies around the main company and debts are centralised, increasing the
enterprises' chances of inclusion in the government-funded debt consolidation". Although
David Stark made his conclusions based on Hungarian experience, it holds true for the case
of Russia as well. In Russia writing off of liabilities to the enterprise as a whole effectively
means centralisation of debts so that the state would have to take care of it.
Vinslav (1996) stressed other negative implications in the form of creation of favourable
terms for these small enterprises, when they are established at loss-making enterprises with
the losses of the small enterprises being transferred to the losses of the main enterprise.
However, the positive effect of the small enterprise development concerns the fact that these
entrepreneurial ventures make efficient use of the capacity, which is under-utilised by the
main enterprise.
Apart from the mentioned possibilities of siphoning off the profits, the development of small
enterprises in this case signifies an important type of restructuring whereby the principal aim
is to maintain the core production and personnel through making the fixed capital available to
be utilised by the small enterprises, simultaneously re-directing all the cash flow to the latter
from the main enterprise (see Vinslav (1996)).
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Research Memorandum • 37 • The University of Hull Business School
Coakley et al. (1997) have noted from their case study research that many workers have
become entrepreneurial by launching “side businesses” from the shop floor in order to
survive. The authors identify this process as a de facto trend in defence conversion, being
radical decentralisation and the creation of associations and networks of ‘spin-off’ work
groups with new definitions of a strategic mission.
There are several types of reorganisation that were tried by defence establishments. These are
the leasing of an enterprise’s divisions from the enterprise; the creation of daughter
companies based on an enterprise’s divisions; the transformation of the enterprise into a
holding company.
Leasing of an enterprise’s divisions from the enterprise means that enterprise divisions are
organised into separate companies using outside funds (either of private persons or other
organisations) which sign lease agreements with the enterprise as the owner of assets. Newly
created companies can also lease assets from the enterprise. A problem with this variant of
transformation is that the separate companies have enough independence to actually pursue
their own economic interests and break the technological cycle if they had a part in it. So
only those departments should ideally be transformed according to this variant, which have a
closed production cycle or supply some services and have limited relations with other
divisions of the enterprise in terms of production.
The creation of daughter companies should also be based on those divisions that do not
contribute to the core production. Independent firms are created in the form of daughter
companies (either like joint-stock companies or limited liability companies) with the
controlling package of shares retained by the enterprise. The advantage of this form is that
operational decision making is left to the daughter companies but control is maintained
through the controlling package of shares. The latter ensures that the enterprise as a whole
still functions as one system. However, the mechanism of such control is not well developed,
so the disadvantages are the same as in the case of lease agreements.
The transformation of the whole enterprise into a holding company presupposes the creation
of several independent join-stock companies based on the enterprise and the creation of a
new company that would have the controlling packages of the shares of these joint-stock
companies. This variant offers the advantage of separating defence and civilian divisions, so
that the civilian ones could be more effective in attracting private investment because they
would be independent legal entities.
As far as the operation of holding companies is concerned, there is no experience as to how
they should operate in the specifics of the Russian economy. The mechanism of management
of controlling packages of shares is not well developed. On the one hand, the financial
controls on the operating companies are weak. On the other, the financial flows within the
whole holding company structure are not regulated and could be inefficient.
This process is happening in some defence establishments, which are trying to diversify into
new product lines having been faced with drastic reductions in military orders. The problem,
which then arises, is how to organise these new activities. Most likely diversification would
lead to decentralisation of operational decision making and a shift towards holding
companies or divisionalised companies.
Research Memorandum • 37 • The University of Hull Business School
13
According to Bernstein (1994), the relative values of organising along functional lines as
opposed to multidivisional organisation will shift. However, the lack of development of new
skills (e.g., marketing, cost accounting, etc.) would have to be provided in a centralised
fashion.
In addition to the above, Kuznetsov (1996) from his sample of 24 case studies of defence
enterprises has identified four types of adjustment strategies:
- sustainable real adjustment (long-term-oriented turnaround): management perceives that
certain segments of the enterprise are potentially quite competitive and that it is bound to
remain the effective owner of the enterprise even after privatisation because of pervasive
scarcity of managerial expertise;
- fragile real adjustment (the attempt to maintain all parts of the enterprise): management's
strategy is to maintain all technological and human capabilities of the enterprise, this strategy
is financially unfeasible;
- sophisticated rent seeking (extraction of rents from enterprise assets): management is
motivated to extract high personal rents from lucrative segments of the enterprise and then
either retire or set up a new private venture not necessarily related to the production line of
the enterprise;
- traditional rent seeking (reliance on the government): management follows ‘fly-by-night’
strategy with exclusive reliance on government assistance and favours.
Fragile real adjustment was spread among two-thirds of the sample in 1993, but starting from
middle 1994 private rent seeking has become more common. About a quarter of Kuznetsov's
sample have become social protection units with the main aim to maintain the social
infrastructure and employment. On the other hand, sustainable adjustment has become more
widespread, with managers searching for strategic investors and becoming more active in
layoffs. The conclusion that is put forward is that the adjustment dynamics appear to have
their own logic and inertia and are quite independent of variation in both policy and
economic environment.
4. Key findings from the author’s field research
During field research carried out in 1995-1996 with follow up interviews in 1998 five
defence companies in Kirov (North-Eastern Russia) were visited. All of these exemplify the
problems of conversion and adjustment to the new environment of evolving market relations
in Russia. The situation that the visited enterprises found themselves in is not unusual for
most of the defence enterprises.
The ambiguous position of the state vis-à-vis many such enterprises is reflected in the fact
that on the one hand, some defence plants (including two of the visited ones) are not allowed
to privatise and on the other, the state orders have completely stopped and cannot support the
military content of the production which is deemed to be of strategic importance. This
contradiction forces the defence enterprises into a state of limbo, not being able to pursue the
profitable opportunities whilst being tied down by mobilisation capacities that have to be
14
Research Memorandum • 37 • The University of Hull Business School
kept up and uncertainty about the state resuming its military orders. In most cases military
production is sustained by export contracts.
Another common problem is the mobilisation capacity in the enterprises. It should be stressed
that mobilisation capacity has been maintained on all Soviet defence enterprises due to the
militarisation of the Soviet economy. It used to be a great burden on the overall costs.
However, a positive development has been made possible in making them independent of the
core production. The cost of the modernisation capacity maintenance goes to their own
account, so that it is not included in the overheads.
However, the management has developed an active policy of expanding the range of products
and support in introducing different organisational innovations. In many cases the top
management encouraged the production shops to form separate agreements on joint activity
with the enterprise as a whole. Consequently, the shops were transformed into limited
liability partnerships with their own accounts. The enterprise as a whole contributed assets to
the partnerships, the sale of products was made the responsibility of the partnerships. The
main idea behind this development was to create partnerships that at least in the beginning
didn't have an overhang of the debts that have been plaguing the enterprise. Debts incurred by
the newly formed partnerships were to be accounted for in their own accounts. The formation
of these structures was to encourage a more efficient operation of the shops.
The creation of limited liability partnerships, co-operatives and joint stock companies within
the framework of the enterprise has had a positive effect on finding new markets for
products. The most important characteristic of these was the initiation of a management
approach, which is totally new as compared to operating in the Soviet economy. Previously,
in the Soviet era, production had precedence over sales and demand. Most managers were
engineers and any new product was technology-driven rather than demand-driven. The idea
of first assessing the demand for a good was alien in the command-administrative system, but
it also has rolled over into the transition period, to re-iterate the point we have already made
above.
However, the top management in the visited companies have insisted on making the
companies’ shops and divisions self-sufficient so that they try to find markets for their
products as much as possible on their own. A co-ordinating and supporting role in marketing
was of course maintained by the newly created marketing department. It has to be noted,
though, that the mechanisms of a miniature capital market style resources re-allocation could
not operate since the profitable divisions tended to keep their profits fully.
Defence enterprises are struggling both with the uncertainty of the emerging market and the
uncertainty of state policy towards the defence sector. It is difficult to base long-term
sustainability on short-termism, which is (surprisingly) exercised not by the managers of
enterprises but by the state.
Another problem that is highlighted by the companies visited is the problem of maintenance
of the social sphere. It is widespread among not only defence enterprises but also most of the
large enterprises in Russia.
Research Memorandum • 37 • The University of Hull Business School
15
One has to remember that the role of the enterprise in a Soviet economy was not merely of a
production unit. An enterprise had a social function, enterprises have been often situated in
especially remote areas or under-populated areas, or areas with predominantly agricultural
populations. On the one hand, enterprises have had an aim of increasing the worker
population in the above areas cementing the support for the Communist Party. On the other
hand, this worker population had to be provided for by an extensive network of social
amenities to keep the employment at enterprises attractive.
It should be pointed out that defence enterprises had a superior social sphere provision to
keep the most talented engineers and workers. In a system where the development of private
provision is developing but very slowly and mostly in rich trading and financial centres such
as Moscow, St. Petersbourg and other large cities, and where the income to afford these is
possible to earn also in such cities, maintaining an already existing network of social
amenities to sustain the work force takes on a whole different meaning. The question at hand
is whether to sustain a way of remuneration that the work force is accustomed to and values
or to separate the social sphere, commercialise it, so that the same social amenities would be
available for a ‘market’ rate which would not be affordable by a work force which is
underpaid in monetary terms and whose wages are often delayed by months reflecting the
acute liquidity problems that many enterprises face.
The visited enterprises still maintain the social sphere and even if they wanted to ‘unburden’
themselves from it, the local authorities would have no funds to take it on. In conditions of
uncertainty mentioned above the slow process of reorganisation that is happening is aided by
the workforce being sustained by the enterprise's social sphere in cases of cash flow
difficulties and the process of searching (which takes time) for new opportunities which are
still not exhausted.
5. Conclusion
Our analysis of the role of managers in the Soviet era and during the transition in Russia has
led us to believe that the legacy of operation in the command administrative system is still
apparent. This has been an obvious obstacle as far as economic considerations are concerned.
However, a more important aspect of this legacy is the unwillingness of transition economics
discourse (which is still dominating in countries of Eastern Europe, especially the former
Soviet Union) to recognise the prospects of increased exploitation of the workforce within
the developing organisational setting. Is an opportunity being missed to let organisational
development evolve into something else?
16
Research Memorandum • 37 • The University of Hull Business School
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18
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