RUSSIA: Western Investment in Heavy Manufacturing

 

 

 

 

Global Initiatives in Management – Winter, 2001

  1. Carter Balkcom

Jeff Bougher

Michael Goldstein

 

  1     Introduction                                                                                                                               3

  2     Why Russia?                                                                                                                             3

  3    Problems Facing Business in Russia                                                                                           5

  4    Western Investment Strategies                                                                                                   7

4.1       Ford Motor Company....................................................................................................... 7

4.1.1        History of Ford in Russia........................................................................................... 7

4.1.2        Strategy after the fall of communism........................................................................... 8

4.1.3        Impact of 1998 economic crisis................................................................................. 9

4.1.4        Challenges................................................................................................................. 9

4.1.5        Other automotive players......................................................................................... 10

4.1.5.1     General Motors................................................................................................... 10

4.1.5.2     BMW................................................................................................................. 10

4.1.5.3     Japanese manufacturers....................................................................................... 11

4.1.5.4     Mercedes-Benz................................................................................................... 11

4.2       Caterpillar....................................................................................................................... 11

4.2.1        Caterpillar’s Products.............................................................................................. 11

4.2.2        The End of the Soviet Era........................................................................................ 12

4.2.3        Manufacturing in Russia........................................................................................... 12

4.3       Otis Elevator................................................................................................................... 13

4.3.1        History of Otis......................................................................................................... 13

4.3.2        United Technologies Corporation............................................................................. 13

4.3.3        Otis in Russia.......................................................................................................... 14

    5          Conclusion                                                                                                                       16


 

1         Introduction

Russia is an exciting place to do business in the future, but a hard place to do business in the present.  An expatriate American who had been working in Russia for the last eight years passed along the wisdom of this quote.  Though he could not remember its author, he was certain that it was first uttered around 1860.  Though much has changed in Russia in the last 140 years, this statement is still an accurate portrayal of the business environment today.  Even with all of the current problems in the country, western companies continue to attempt to enter Russia. 

This paper will focus on some of the reasons western companies are making the choice to have a manufacturing presence in Russia.  First will be a discussion of some of the reasons companies would want to be in the Russian market at all.  Next will be an overview of recent industrial history with an eye to highlighting infrastructure limitation.  Finally, an in depth investigation of  some of the strategies being used by western firms trying to penetrate the Russian market.  This section will include an analysis of the strategies, successes, and difficulties faced by three large U.S. firms; Caterpillar, Ford Motor Company, and Otis Elevator.  Though every company has different reasons for entry and different strategies, this paper will conclude with some general themes that run through the companies that are successful.

 

2         Why Russia?

            Russia is amazingly unique.  The country has the oil reserves of Saudi Arabia, the mineral reserves of South Africa, the timber reserves of the Amazon, the fertile farmland of the American Midwest, the inexpensive labor of Mexico or Malaysia, a population the size of Japan, a land mass almost the size of the U.S. and Canada combined, engineers and scientists that compare to any western country, but with a GDP roughly the size of Indonesia’s.[1]  Each of these reasons makes doing business in Russia attractive to a variety of companies. 

            Western companies engaged in the harvest of natural resources view Russia as one of the greatest opportunities still available.  Russia is thought to have some of the world’s largest untapped reserves of natural gas and oil.  Western companies such as British Petroleum[2] and Exxon Mobil[3] are investing in Russia to gain access to these oil fields.  These companies are looking for the oil itself as a resource, but building the infrastructure to drill for and transport the commodities to market are also drawing the attention of Western companies.  These include construction and oil filed equipment companies such as Halliburton[4], Schlumberger[5], Asea Brown Boveri[6] and McDermott International[7].

            Oil and gas are not the only natural resources that are highly sought after by western companies.  Russia also has vast resources of many other minerals.  It is estimated that Russia has 10% of the world’s copper reserves[8].  The country already produces almost 25% of the nickel and platinum supply, and over 40% of the world’s palladium[9].  The country’s gold reserves are considered one of the world’s largest, attracting investment by many western firms such as Western Pinnacle, High River Mines, Barrick, and Placer Dome[10].  Russia is also the 3rd largest producer of diamonds, which has attracted investment from DeBeers[11].

            Not all of Russia’s natural resources are under the ground, though.  Russia also has over 22% of the world’s forested area[12].  In the first six months of the year 2000, the timber and paper industry brought in almost US$145 million in foreign investment.  One of the largest investors is International Paper, which owns a controlling stake in a paper and pulp mill[13].  With a single investment in their Svetogorsk mill in 1999, International Paper turned Russia from a net importer to a net exporter of paper[14].

            Agriculture is another important industry to Russia.  Over 27,000 farms exist in the country, producing large amounts of grains, potatoes, sugar beets, and sunflower seeds.  Total farm production accounted for a GNP contribution of US$32.5 billion[15].  This has attracted investment from companies such as Cargill and IBP, a large beef processor[16].  Both companies have plants processing the food grown on Russian Farms.

            It is not just the resources themselves that are attracting western businesses.  US companies are also looking to provide the equipment with which these resources are harvested.  Companies such as Caterpillar and Ingersoll Rand have opened plants in Russia[17].  Other western manufacturers of oil drilling, mining, and agricultural equipment have at least a sales office in the country.

            Increasingly, Russia is also viewed as a source for inexpensive labor.  The wage rates in Russia are much lower than in Western Europe, so some companies are looking to use Russian labor to build products that are exported.  An example of a company doing this is Caterpillar.  They build large welded assemblies in a plant near St. Petersburg for shipment to plants in the west where labor rates can be 5 to 6 times as much.  Russia has almost 66 million people in their workforce with an unemployment rate of 12.4%[18].  There is also considerable underemployment.  Many of the shop floor workers at western firms are college graduates, and people with technical skills such as welding or tool and die making are also plentiful.

            Russia’s size also makes the country unique.  Russia is the largest country in the world, spanning 11 time zones.  Because of this size, huge opportunities exist in the expansion of the infrastructure for communications and transportation.  Lucent Technologies is one American company that has a manufacturing and sales presence in the country to take advantage of this opportunity.  They have manufacturing facilities producing digital switches for telecommunications and fiber optic cable[19].   Motorola also has a manufacturing presence in Russia.  A joint venture produces 2-way radio equipment and components for telecommunications[20].  Transporting people and ideas in a country this vast provides many opportunities.  A Ford plant currently under construction should be open by the end of 2001, and GM has announced a large joint venture with AvtoVAZ to start producing SUVs in Russia[21].  Both Pratt & Whitney and GE Aircraft engines have ventures in Russia to produce jet engines for passenger and cargo planes[22].

            Though other countries offer similar land and natural resources, Russia offers something that no other emerging market offers; vast intellectual resources.  Because of spending during the Cold War on education and the military related industries, Russian engineers and scientists are competitive with those from the west in many areas.  These include areas such as materials sciences, aeronautical engineering, computer sciences, and nuclear engineering.  Corning has chosen St. Petersburg as the location of one of its four research centers worldwide[23].  Many US based computer companies are starting to use Russian programmers in what is known as offshore development.  Companies such as Reksoft and Luxsoft hire Russian programmers to work on projects for western companies from offices in Moscow, St. Petersburg, or Novosibirsk at a fraction of the cost to employ a programmer in the west[24].  In the aerospace industry, Lockheed Martin’s International Launch Services uses Russian scientists and technology for many of the world’s commercial satellite launches.  Though the satellites might be western, they are launched into space from a site within Russia, and more than half of them are launched on Russian designed and built rockets[25].  

            Russia offers many possibilities to western firms.  In the last 10 years, many companies have begun the search for investment opportunities in the country.  But even with its abundance of natural and human resources, deciding to invest in Russia and building a successful business in Russia are very different accomplishments.

 

3         Problems Facing Business in Russia

While the business opportunities in Russia are appealing, many aspects of the political system and infrastructure act to thwart successful growth of the economy and thereby limit the potential of the economy as a whole.  In addition to the well-known issues of lack of land ownership, non-enforceable separation of the economic rights of management, majority and minority shareholders, stifling bureaucracy, corruption, and organized crime, the impact of the dilapidated physical infrastructure is often underestimated. 

The Soviet Union’s command-and-control economy was excessively focused on heavy industrial and military products.  The centralized nature of the production facilities coupled with the prolonged transition to a market economy resulted in staggering infrastructure problems that continue to impact Russia’s economy today.  The uncertainty of the early 90’s led to weak investment and resulted in an aging production base[26].  This trend was compounded by the incompatibility of the industrial base (both physical and managerial) with the expertise and infrastructure necessary to produce competitive consumer goods.  Existing production facilities were dedicated to specialized products and were not easily converted to consumer or export goods.  As seen in Figure AAA[27], investment in fixed capital goods dedicated to production plummeted precipitously throughout the 90’s.

The rapid decrease in capital investments coupled with the already weak infrastructure inherited from the Soviet Union led to a collapse in capacity utilization and a rapid aging of productive capital (See Figure 2 and Figure 3[28].).  The impact of failed privatization and massive capital flight only exaggerated these trends.

The Ministry of Industry claims that over 60% of the enterprises it formerly oversaw are no longer competitive and “have no prospect for a market presence without fundamental modernization”[29].  Even Russia’s traditionally powerful arms industry has shown great weakness.  While aviation was typically responsible for more than 50% of Russian arms exports, not a single MiG was exported in 1997.  This can be compared to approximately seventy MiG fighters valued at $2 billion that were exported between 1992 and 1997.  Hardest hit, as indicated in Figure BBB above, has been the light industrial sector.  As an example, three machine tools are imported for every one produced domestically, even though domestic machine tool capacity utilization is less than 20%[30].

It is estimated that to modernize Russia’s infrastructure would cost in excess of $2 trillion.  Assuming a growth rate between 6-8 percent per year, it would take Russia from 15 to 30 years to catch up to the West[31].  The catch is, this implicitly assumes a favorable business climate that would promote and support both foreign and domestic investment.  Fortunately, President Putin has taken steps to address many of Russia’s most entrenched problems.  Shortly after his election, Mr. Putin established the Center for Strategic Research (CSR) whose pro-market scholars have advanced a liberal, market oriented set of reforms.  Though there is not yet an official program, a working paper was leaked to the press recently indicates that a new focus on modernization will be pursued via elimination of exchange and trade restriction, broad deregulation of the economy to fight bureaucratic corruption, and private ownership of property[32].

Another major concern for multinational firms looking to invest in Russia is the crushing foreign debt.  With a GDP that ranks fourteenth in the world and major payments scheduled for 2001-2005, Russia’s near term fiscal stability is in question.  Annual debt payments on the existing $160 billion debt will amount to $12 - $17 billion per year between 2001 and 2005[33].  If these payments are demanded as scheduled, debt repayment would account for more than half the federal budget.  It is thus clear that existing debt must be rescheduled to give the Russia’s fledgling economy a chance to successfully restructure, but this again introduces significant uncertainty for international investors.

4         Western Investment Strategies

4.1      Ford Motor Company

All data from interviews with Len Meany, Vice President of Business Development for Emerging Markets, Ford Motor Company; and Henrik Nenzen, Director of Marketing for Russia, Ford Motor Company unless otherwise noted.

4.1.1        History of Ford in Russia

Ford Motor Company’s first influence on Russia dates back to 1929 when Henry Ford visited the country.  Soon thereafter AvtoGAZ, Russia’s first auto manufacturer, began churning out Model Ts from a factory patterned after Ford’s legendary River Rouge.  Throughout the 1900s GAZ licensed various Ford designs for production in its Novgorod facility, the latest being the GAZelle, a copy of Ford’s Transit multiple configuration van.  From 1997 to today, Ford has manufactured its own Transit and the European Escort in a Byelorussian joint venture with a dealer[34].

In the 21st century, Ford Motor Company plans to step up its investment in Russia via the construction of a $100M assembly plant for the Ford Focus compact car.  The facility, located in Vsevolozhsk in the Leningrad Oblast (a rural area outside of St. Petersburg), is a major rennovation of a former Russky Diesel defense equipment manufacturing plant[35].  The plant, with a capacity of 25,000 units, expects to roll the first Focus off of the line in October of 2001.

4.1.2        Strategy after the fall of communism

The Focus, an inexpensive compact vehicle and Ford’s latest “world car”, seems to be an excellent choice for manufacture in Russia.  As Ford studied the market, they found consumer tastes that are very similar to those of the rest of Europe, and they also found that Ford holds an image of quality.  These indicators drove the decision to build a Focus that is similar to that sold in Europe, with a few additions to suit the car better to the harsh Russian winter.

Ford was also driven to find ways to build the Focus cheaper.  They didn’t want to build a car that is inferior to the Focus built in the rest of the world, but they had to get the cost down to hit their desired price point of around $15,000.  Even this sticker can be as much as 5 times as much as a new Russian-built LADA from AvtoVAZ.  Ford is counting on Russians to recognize the superior quality of the Ford over the LADA, but the current economic conditions limit the number of people who are able to pay the premium.

Ford’s initial strategy with the Focus was to import the German-built vehicle with and pay a steep 30% import duty.  This resulted in a retail price of around $18,000.  According to Len Meany, Ford’s Vice President for Business Development in Russia, building locally becomes attractive for duties above 10% and Ford’s strategy to build in Russia is a reaction to those import duties

The uncertainty of the investment climate in Russia caused Ford to develop a strategy designed to mitigate the downside risk yet allow them to capture any upside.  Western firms have chosen several different methods for doing this, and Ford’s unique approach is based on minimizing the cost of the investment so that the company can afford to sit back and wait for the economy to recover over several years. 

The $100 million Ford is investing in Vsevolozhsk is a comparatively small amount for a full-service automotive assembly plant.  The company obtained the site and building for a very good price by exploring many different locations and choosing a municipality that was willing to offer significant incentives to locate[36].  Furthermore, Ford is developing a flexible plant that can take advantage of low cost labor today, yet is easily reconfiguable to a more highly automated layout in the future.  By choosing low-tech assemblymethodsand inexpensive equipment, Ford has minimized direct investment and kept equipment costs down.  Some examples of this are the decision for the cars to be painted by hand spraying and the joints to be manually welded.  In a typical plant, all painting and welding would be done robotically.  The result is a facility that will position Ford to take quick advantage of any improvements in the economy via flexible facility upgrades while allowing the company to wait for however long these improvements take to arrive.

4.1.3        Impact of 1998 economic crisis

The economic slide of 1998 has created significant challenges to Ford’s strategy in Russia.  The chief effect has been the fall in price of Russian-built cars; the cheapest sells for around $3,000.  The resulting 5-to-1 sticker multiple makes it difficult for Russians to justify purchasing the Focus.  The company’s Vsevolozhsk plant will have a capacity of 25,000 units per year, but 2001 sales are expected to be less than 1,000 units.

Ford has responded by cutting the original $150M plan to $100M and by applying some creative marketing techniques learned in other parts of the world.  One of these techniques allows groups of 20 or 30 customers to enter a 50-month financing program where each member contributes $300 per month.  And each month, two members of the group get a new Focus through a random drawing. 

4.1.4        Challenges

Ford Motor Company’s most critical current challenges in the former Soviet Union are product affordability (as described above) and maintenance of import rules.  The second concern is complicated by the huge gray market for new and used automobiles.  The gray market serves customer demand by illegally importing new or used vehicles from Europe with no duty or with a substantially lower duty.  This practice is a major concern for Ford because it is a large percent of the cars sold each year.  The lack of duty enforcement results in a much lower price on the gray market for vehicles similar to the Focus.  Table 1 illustrates the size of each segment of automotive sales.  Ford chose to establish a manufacturing presence in Russia as a direct result of import duties which the gray market so successfully avoids.

 

Segment

Annual Sales

Duties

NEW RUSSIAN

1,100,000

none

NEW NON-DOMESTIC

50,000

Fair Duties $3,000 and up

WESTERN USED GREY

400,000

Unfair Duties $0 - $1,000

NEW WESTERN GREY

50,000

Unfair Duties $0 - $3,000

Figure 4: Impact of Gray Automotive Market

 

Len Meany indicated that Ford’s manufacturing venture in Spain was very successful largely because there was a solid wall against illegally imported new and used vehicles.  He further indicated that the company had been successful in influencing the government to address the new-vehicles gray market.  He is confident that addressing the problem of gray imports will help create a market for the Focus and insure Ford’s investment.

Additional challenges faced by Ford include the artificially low cost basis of Russian firms and the lack of consumer financing for car purchases.  The first issue reflects the fact that the prices charged for domestic vehicles do not appropriately reflect the cost basis of those firms.  This is due to underdeveloped accounting practices that do not recognizing depreciation or the capital cost of their facilities and equipment. These firms simply inherited them from the government and consider them “free” assets.  The artificially low selling price resulting from these practices is difficult to compete against.  The second issue of lack of consumer financing is indicative of the Russian practice of purchasing everything in cash.  First, Russians are skeptical of banks because of the great losses in 1998.  Next, Russians are reluctant to disclose their earnings for the purposes of obtaining credit, since many do not pay correct income taxes.  Ford has attempted to circumvent these fears with the “Ford Plan” described earlier.

4.1.5        Other automotive players

4.1.5.1       General Motors

General Motors chose to enter the Russian market by taking a 41.5% interest in a joint venture with AvtoVAZ, Russia’s largest and most established automaker, and the European Bank for Reconstruction and Development (ERBD).  Under the terms of the joint venture, GM will invest $100M, while the EBRD contributes $40M.  AvtoVAZ will supply land, labor and the world rights to its Niva 2123, a newly designed SUV (Country Monitor, Feb. 2001).  This strategy gives GM access to the world’s largest automotive assembly plant in Togliatti (See Map 1 above) and to AvtoVAZ’s extensive dealer network.  According to David Herman, a GM vice president, the joint venture will give AvtoVAZ access to GM’s expertise in manufacturing and marketing, while providing GM access to low cost Russian engineering expertise and manufacturing labor.  AvtoVAZ has significant experience working with Opel and can supply lead engineers for $240 a month[37].  GM is targeting a capacity of 90,000 vehicles by late 2002 with a price under $10,000.  This strategy relies on AvtoVAZ’s management and engineering, but allows GM to significantly undercut Ford[38]. 

4.1.5.2       BMW

BMW currently assembles kits for  its 3, 5 and 7-series model sedans at a plant in Kaliningrad to avoid a portion of the import duty.  The $69 million plant had an initial target production of 900 vehicles per year with a goal of 2000 vehicles in 2001[39] , but has a capacity for 10,000 vehicles per year.  According to Heinrich Heitmann, one of BMW's managers[40] :

"This event is a witness of our belief in the future of Russia. With our work, we are setting an example for other investors and are showing how it is possible to achieve success quickly in this country."

Where Ford’s or GM’s image might be enhanced by selling vehicles manufactured in Russia, BMW down-plays the car’s assembly location.  It prefers that Russians associate the product with the German quality and engineering that is the foundation of its image.

4.1.5.3       Japanese manufacturers

Presently, Japanese manufacturers appear to be waiting for the dust to settle before entering an assembly or manufacturing venture there.  Japanese firms traditionally wait for other manufacturers to test emerging markets and then enter when the markets become profitable.

4.1.5.4       Mercedes-Benz

Russia has been a very profitable market for Mercedes-Benz since the fall of communism.  The S500 model was de rigueur for the wealthy class of “New Russians” who profited from the privatization[41].  DaimlerChrysler has no plans for operations in Russia.

 

4.2      Caterpillar

            Caterpillar has had a presence in Russia since even before the company existed.  Caterpillar was founded in 1925 with the merger of  two competing manufacturers; Benjamin Holt and Daniel Best.  Before the merger, both companies produced tractors for the Russian market.  Holt tractors were an important tool of the Russian Army during World War I[42]. 

After Caterpillar was officially formed, the company continued to supply tractors and equipment to the Soviet Union.  Along with tractors, the company also sold other farm machinery, logging equipment, and mining equipment to the Soviet Government.  Even during the Soviet era, Caterpillar had enough sales that a decision was made to open up a sales office in Moscow in 1973, thus becoming the first western company with a permanent presence in Soviet Russia[43].  Though Caterpillar was a leader throughout the world in farm and construction equipment, the focus in Russia was primarily the Mining and Oil and Gas sectors.  Domestic producers made very inexpensive tractors, but in equipment for the other sectors the government was willing to pay for quality and reliability[44].

4.2.1        Caterpillar’s Products

            Though Caterpillar started as a tractor manufacturer, their product offerings have expanded greatly over the years.  They currently manufacture and market many different products, with a strong customer base in Russia.  Caterpillar engines are supplied to AMO ZIL and Likino Bus Plant for use on their vehicles.  Caterpillar brand electrical generating stations, gas turbines, pipe layers, skidders, and wheel loaders are vital to Russia’s oil & gas and mining industries.  Throughout Russia, excavators, graders, dump trucks, and tractors are involved in construction projects.

            Russia is an important market for all of Caterpillar’s offerings.  Though the industries are still in their infancies, Russia has abundant oil and gas reserves that are soon to be tapped.  Their mineral reserves make them one of the most important mining regions in the future.  And with over 22% of the world’s forests, logging and forestry equipment also have huge potential markets.  It is important to Caterpillar to provide the equipment for this coming boom[45].

4.2.2        The End of the Soviet Era

            With the end of the Soviet Era, Caterpillar needed to make major changes in the way they conducted business in Russia.  Under the old system, all sales were done through a ministry in Moscow.  There were only 5 or 6 decision makers that needed to be contacted by Caterpillar.  But with the end of a planned economy came a decentralized decision making process.  Before, Caterpillar just needed to call on the Minister of Mining, but now they would have to call on hundreds of different mines and mining companies[46].   This change in the decision making base has led to a change in their distribution system.  Caterpillar distributed directly in Russia before, but by having to call on more companies in different regions, they changed to the strategy they employ elsewhere in the world; regional sales representatives.  They recruited 10 dealers from other parts of the world and convinced them to invest in regions of Russia[47].  These dealers have invested more than $30 million dollars and hired more than 400 employees to build their businesses, and Caterpillar showed their commitment to the importance of the Russian market by agreeing to build a manufacturing presence in country[48].

4.2.3        Manufacturing in Russia

            When the decision was made to start manufacturing in Russia, Caterpillar decided to form a joint venture with Karoski-Zavad, a Russian tractor company.  This venture started in 1994 under the name Nevamash.  It didn’t take long for the two companies to realize they were not compatible, so Caterpillar bought out the entire business in 1996.  But even after the acquisition, Caterpillar was not doing anything but some final assembly and repair parts[49].

            By the late 1990’s, Caterpillar made the decision to build a new factory in Russia.  They chose to locate in Tosno, a town about 40 km from St. Petersburg.   They chose the region for a number of reasons; large potential supplier base, quicker customs clearance, logistics hub providing rail and seaport, and educated and skilled workforce.  The new plant was opened in March, 2000[50]. 

            Caterpillar has a multi-part manufacturing strategy for its Russian operations.  The plant started out producing welded components that are exported to Caterpillar assembly plants in Europe.  This step in the strategy takes advantage of the inexpensive labor and the proximity to the European market.  It also establishes a presence in Russia.  This is the step in the process under which Caterpillar Russia is still operating[51].

            The next step in this strategy will be what they call Pin-on Assembly.  In this step they will do the final assembly of equipment in country.  At best case, they might start this step in 2002.  The third step in the process is full assembly.  In this step, they will add enough local content to the vehicle they can avoid import duties.  This is still years away.  The final step in their strategy will be to build specific factories that produce specialty products such as tractors, pipelayers, or wheel loaders[52].

            Caterpillar still has many ex-pats in its offices and plant, but the company has built a staff of well educated and motivated employees.  The entire management group is college educated, as are more than half of the shop floor employees.  They are making a transition from western employees to Russian leadership.

The Caterpillar plant in Tosno is operating at a profit, though it is still under capacity.  Having a plant in country has boosted the company image, but sales have been helped more by the presence of the new dealer network.  But investing US$50 million in a plant was needed to attract the investment from these dealers.  With these commitments, all parties understand that Caterpillar is investing in Russia for the long run.

           

4.3      Otis Elevator

            Otis Elevator may have the longest presence in Russia of any U.S. company.  An early Otis lift was installed in the Winter Palace in St. Petersburg in 1893[53].  During the communist era, Otis equipment was occasionally used on high profile or decorative products, but they had no real presence in the country.

4.3.1        History of Otis

            Otis Elevator was founded by Elisha Graves Otis in 1853.  The company was founded in New York City with his invention of a safety lifting platform.  At the time, only a few cities in the world had buildings tall enough to need elevators, so the company had expanded its sales presence to Paris, London, Tokyo, and St. Petersburg by the end of the 19th century.  The company continued to grow and innovate.  At the Paris World’s Fair in 1900, the company introduced a new product to the world known as an escalator.  The company remained independent until 1976 when it was purchased by United Technologies Corporation[54]. 

4.3.2        United Technologies Corporation

            United Technologies is one of the largest industrial products conglomerates in the world with sales of nearly $26 billion per year.  The company is made up of a number of distinct business units competing in very different industries.  Pratt & Whitney is one of the largest manufacturers of aircraft engines.  The Sikorsky group is the leader in the design and manufacture of helicopters, both military and commercial.  Carrier produces heating and cooling equipment.  Hamilton Sunstrand produces a wide variety of air compressors, pumps, power transmission equipment, and metering devices used in industrial applications[55]. 

Each business is run separately, with each making many of its own decisions about growth and corporate strategy.  Three of the divisions have included Russia in their plans; Carrier, Pratt & Whitney, and Otis Elevator.  Carrier has made the decision to partner with a Russian firm to handle the sales, service, installation, and parts for that market.  The joint venture is called Airconditioning & Heating International[56].  Pratt & Whitney has two different areas of interest in Russia.  The first is the sale of its jet engines.  They are producing engines for Russian aircraft design and construction bureaus to include on Russian commercial jets such as the Ilyushin IL-96 and the Tupolev Tu-144.  The second area is the production and export of rocket engines for use in commercial satellite launches.  The Russian designed and built Proton rocket engine is considered one of the world’s most reliable, and it is used to power most launches.  Besides its use in Russian rockets, the engine is used to power US made Atlas and Delta Rockets.  Pratt & Whitney is involved in a joint venture to produce these engines with Perm Motors[57].  The third United Technologies Company with an important presence in Russia is Otis Elevator, and the rest of this section will discuss the company’s history, strategy, and plans for the future.

4.3.3        Otis in Russia

As mentioned earlier, Otis Elevator had installed its first elevator in the Czar’s Winter Palace in St. Petersburg in the late 1900’s, but Otis did not have a presence in the country during the communist era.  In the late 1980’s, the company was in a push to expand its worldwide operations.  The decision was made to expand into many new countries.  In the early 1990’s, the company entered China, Russia, Korea, Ukraine, Poland, and Vietnam[58]. 

The market for elevators in the Soviet Union in 1989 was for about 20,000 new units per year, nearly all built in domestically.  In that year, Otis made the decision to enter this market.  In 1991, Otis announced the first step in their strategy with the start of construction of a plant in St. Petersburg.  The plant was to be completed in 1993.  To quickly gain market share, the company bought an interest in an elevator service company in St. Petersburg[59].  At the same time, Otis bought a stake in Moscow based elevator company MosLift.  Both of these acquisitions were made in 1992[60]. 

By the time Otis’s plant had opened, the situation had changed drastically.  The Soviet Union had broken apart, and much of the state sponsored construction stopped.  But Otis continued to invest in its facilities.  In 1993, Otis invested $695,000 in new equipment and construction for the MosLift venture, and in 1994 they invested an additional $495,000.  During these investments, the Russian side of the joint venture could not participate in the funding, which caused friction.  In 1998, the decision was made to split the venture into separate companies with the Russian firm keeping the name MosLift and the part owned by Otis would start operating under the name MosOtis[61].  The situation with the venture in St. Petersburg was the same.  Otis originally owned 55% of the venture, but by the late 1990’s they had acquired all but 2% which is still owned by the City of St. Petersburg[62].  All of the operations have now been folded under one organization, Otis Russia. 

The fall of the Soviet Union significantly changed the demand for elevators in the region.  The demand had been estimated at 20,000 per year, but after the collapse it fell to around 5,000 per year in Russia.  To serve the other countries in the region Otis also opened up facilities in Estonia and the Ukraine[63].  All of the other CIS countries are served by the closest office, but the demand in these other republics is minimal. 

Otis is the largest western employer of people from the former Soviet Union.  As of 1998, the company employed 14,000 people in the former Soviet Union countries[64].  In Russia, the company had three manufacturing plants; Moscow, St. Petersburg, and Scherbenko.  When production started, the company purchased 100% of its supplies from foreign firms, but today more than 60% of the components are purchased from Russian suppliers[65].  The components not purchased in Russia are safety and electronics components which come from Otis facilities in Europe. 

The majority of the Otis employees in Russia work for the service and installation part of the organization.  Even though the number of new elevators sold has fallen dramatically, all of  the existing units need to be maintained by professionally trained crews.  Otis Russia has been very successful in this area of business.   There are over 35,000 elevators under service contract in the country, and the revenue produced by this segment accounts for 55% of Otis Russia’s total revenues.  These service contracts are for products made by Otis and by their competitors[66]. 

Throughout the world, Otis has about 25% of the market share for elevators.  The main competition is from Kone(Finland), Schindler(Switzerland), Thyssen(Germany), and Mitsubishi(Japan)[67].  Competition is fierce throughout the world, but Otis is the only company that has entered the Russian market.  In Russia, Otis competes with domestic producers that are remnants of the Soviet planned economy.  The biggest of these is a plant in Belarus that was built to make 15,000 units per year.  This is the largest elevator plant in the world.  It is running far below its capacity, but keeps prices on the units very low.  Otis has trouble competing in the most price sensitive markets which are for low priced apartment buildings.  Otis is competitive in the government and the commercial and expensive residential segments.  Their share of the Russian market is about 20%[68].   In the low priced residential building segment, the form of payment is barter.  Instead of being paid for an elevator, the building contractor gives the company a few apartments as payment.  Otis does not have an interest in being in the real estate business, so they have avoided these types of deals[69]. 

Another area that Otis has found profitable is the modernization of older units.  This business represents 10% of Otis Russia’s revenues[70].  For the year 2000, Otis completed modernization projects on 1341 units in Russia.  These included improvements in appearance, safety, and reliability[71]. 

Otis Russia is now run entirely by Russians.  American citizens were involved in the startup operations and training, but none are still stationed in Russia.  The standards for size and speed of elevators is much different in the west than it is in Russia, so much of the engineering and design of the units are done in country.   Many of the employees are still sent to Connecticut to the Otis headquarters to go through a training program known as Otis University.  But even though the company is run entirely by Russian, the company is run like any other Otis facility in the world[72].

Walking through the Otis factories in Russia is impressive.  The plants are as clean and organized as the best western companies.  They have embraced Japanese Continuous Improvement techniques and terminology.   The plants have been trained and implemented improvements such as 5S(workplace cleanliness and organization), Kanban(inventory control system), and Kaizen.  The workers in the plants wear uniforms, and have meetings to go over charts and graphs posted with the plant’s performance data.  Each machine in the plant has a sign boasting the amount of money invested in the machine trying to instill a pride in company and workmanship[73]. 

Otis Russia is a respected supplier and neighbor.  Though it is not required in Russia, the company is changing their processes to reduce the amount of solvents Toluene and Xylene consumed.  They are using the same restrictions that would be in place if the company were in the United States.  Also, the company is ISO 9000 compliant, and it is pushing its local suppliers to do the same.  Already, 4 companies have reached the quality standard, and 10 other suppliers are in the process[74].

Otis has built an impressive business in Russia.  Using western management techniques, they have managed to provide a high quality product that can compete in a market that is typically driven by price.  Otis has maintained its profitability, even during the economic crisis of 1998.  They have a structure that will enable them to survive in the current tough economic climate in Russia, and they are poised for strong growth with an economic turnaround.  

5         Conclusion

Western firms have utilized a wide array of strategies to deal with the uncertainty that is such a part of doing business in Russia.  There is little doubt among the firms that we surveyed that recovery of the country’s economy will be a very gradual process, and no get-rich-quick opportunities are likely to exist in the short term.  We have examined how certain firms have invested in Russia to avoid import tariffs, others are utilizing and strengthening existing Russian brands, and still others are entering joint ventures with Russian firms.  The underlying concept of note is that all of these firms agree that there exists great potential in this market.  Firms like Nestle and Wrigley are positioned to capitalize on the market much sooner than those like Ford, General Motors, and Caterpillar.

The common threads among the strategies are that a) there is a talented and comparatively inexpensive work force available, b) the risk is great and must be hedged in some way, and c) the three firms of our focus represent the first ones of their industry to make a significant investment in Russia.  We have seen how all three firms find great technical skill in the labor force but very few sales and marketing skills.  We have also observed how each firm hedges the risk of investment – by minimizing the investment cost, by sharing the risk with a Russian partner, or by adopting a near-term export strategy.

As difficult as the Russian market has proved to be since the fall of communism, there are still firms willing to forge through it, learning as they go.