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In June 1992, the United States and the Russian Federation declared
their intention to make cooperation in advancing defense conversion a high priority. Both countries recognized that Russian defense conversion was key to building a more economically prosperous world and assuring world peace. Among other things, they agreed to facilitate the exchange of information on conversion enterprises and to disseminate that information to potential business partners. The Russian Defense Business Directory was designed as a first step towards meeting that commitment.
This Directory furnishes Russian industry with basic information about American interest in investing in Russian Defense Industry. The Directory is intended to help Russian industry that may warrant further exploration with American enterprise managers. The Defense Conversion Subcommittee will continue to issue updates and compile additional or updated information on these enterprises and comparable information on additional enterprises.
"Defense conversion", from the U.S. point of view, is the transfer of defense production capabilities to non-defense production, either non-defense industrial products (e.g. pumps and valves) or consumer goods. However, according to the Defense Conversion Law, the Russian Federation has a much broader definition, which includes the possibility of a plant maintaining its defense production while expanding its non-defense production for other purposes, including the generation of hard currency exports. (See section C.1.a. for a discussion of this issue.)
The former Soviet Union developed an immense defense industrial base with enterprises scattered throughout the various republics. About 70% are located in the Russian Federation. Russia contains more than 100 major final assembly plants; thousands of subsystem, component, and materials producers; and more than 1,000 military research, development, and test facilities. Russian defense industry employs some five to seven million workers, out of a total industrial labor force of 25 million. In addition to producing weapons, the defense industry has long been a large producer of civilian goods, producing all of the former Soviet Union's radios, televisions, VCRs, most of the refrigerators and washing machines, as well as a large share of the country's production equipment.
Defense enterprises in the former Soviet Union differ from their Western counterparts in several ways. They tend to be larger than plants in the West which produce similar items. The plants typically include on-site facilities for much of the component fabrication, which in the West would be subcontracted to other companies. Former Soviet defense enterprises also have traditionally had infrastructure responsibilities not found in the West, including schools, housing, and other social and cultural services. In addition, because central government organizations historically assured that defense enterprises received priority access to available supplies, investment, engineers and distribution of production, the enterprise managers never learned to fend for themselves.
At the June 1992, Bush-Yeltsin Summit, a Joint Russian-American Declaration on Defense Conversion was announced which sets forth measures that the United States and Russia will take to facilitate bilateral cooperation in the conversion effort (See Chapter Four-RECENT BILATERAL AGREEMENTS).
Thus far, progress in defense industry conversion has been minimal. Many defense enterprises are on the brink of collapse, due to cuts in weapons orders and insufficient funding to shift to civil production. Defense enterprises continue to be stymied, as they have been for the past three years, by a vast range of problems with respect to conversion. Most plant managers are faced with implementing massive structural changes in the management and operation of their plants and relationships with suppliers. The majority are having limited success, given their lack of expertise with the new products, the chaos in the economy, their lack of skill in dealing with a quasimarket environment, the difficulty of establishing new supply chains, and the lack of Western investment or domestic financial support for costly re-tooling. Meanwhile, defense plants have built up huge bank debts, as well as debts to other enterprises, while attempting to meet their payrolls and continue operations.
Russian leaders recognize the high cost of conversion, but do not have the investment resources available to assist defense enterprises undergoing conversion. Although their expectations have dropped considerably in recent months, Russian leaders continue to count on western investment and foreign assistance to increase civilian production in defense enterprises. In the meantime, however, the Russian Federation is pursuing arms sales as a means to earn hard currency-partially to finance defense conversion.
Many Russian defense enterprises now are preparing for privatization. The Russian Federation will retain possession of those weapons production facilities it deems critical to future weapons production, but the government is encouraging all defense enterprises undergoing conversion, and some of those which are not, to privatize. Although the government also has the right to retain ownership of a significant portion of the shares in privatized defense enterprises, a number of large defense enterprises-and former defense enterprises-are slated to begin the privatization process this year. An important side-effect of the privatization process in the defense sector has been the creation of numerous small and medium-size private companies from the bodies of large defense enterprises. (See Chapter Six for a summary of the Privatization program.)
There are numerous studies and case histories available for the Russian businessman considering American investment. Therefore, the following discussion only highlights some of the more significant generic barriers to doing business in Russia. The discussion is designed to alert the individual to some of the factors that he or she should address when developing a proposal.
Good business practices require careful evaluation of all the elements; detailed knowledge of whom one is doing business with, and a clear understanding of the risks. This is especially true in the constantly evolving Russian commercial environment. The U.S. Russian Bilateral Investment Treaty (BIT), ratified by the U.S. Senate on August 11, 1992, is intended to alleviate many of these generic obstacles. (See Chapter Four for details on the BIT).
During the U.S.-Russian Business Summit, the Commerce Department established a business information service "BISNIS" to assist with the investment process. Palms & Company is in communication with BISNIS. In addition, the U.S.-Russia Business Development Committee includes five additional working groups to foster increased commercial cooperation between U.S. and Russian firms. These working groups include: Foreign Trade Regulations, Investment and Commercial Projects, Industrial Cooperation and Trade Promotion, Business Facilitation, and Standards. Palms & Company collaborates and cooperates with these groups on behlaf of its Russian clients.
Authorities commonly cite infrastructure problems in the areas of telecommunications and transportation as major obstacles to doing business in Russia. Although Western firms have announced plans to assist in the development of a modern telecommunications system in Russia and the other Newly Independent States (NIS), communications limitations will continue to hamper business activity for some time. Transportation systems in Russia are inadequate, both for the distribution of goods and services, as well as the movement of people.
Among the most serious obstacles inhibiting Western investment is the chaotic situation in government regulations affecting business. Although the Russian legal system has abandoned many of the rules and procedures of the Soviet system, it has not yet developed all the laws and institutions necessary for a market economy to function, such as guarantees and definitions of property rights. Today, there are bodies of conflicting, overlapping, and rapidly changing laws, decrees, and regulations affecting both domestic and international commerce. As a result, these laws are inadequately communicated, understood, and enforced. Therefore, Russian businessmen are should expect negotiations for capital to include concurrence agreements from various Ministries of the Russian government to satisfy their American co-investors.
The legal obstacles have little to do with local government regulations, but rather with the overall economic and legal policy of the Russian Federation. One of the most pressing concerns for Western investors is property ownership. Existing Russian laws on ownership prevent Western investors from purchasing land or buildings. Without definitive ownership rights, some Western firms have declined or even refused to do business.
A second issue confronts Western firms interested in exporting goods to Russia-an evolving tariff policy. The export of services is usually not affected by tariff policies because they are generally an intangible product that does not pass through Customs. Effective September 1, 1992, imported goods are no longer duty free, but are subject to a 15% tariff for most products, except for duties on alcoholic beverages and some luxury goods, now levied at rates ranging from 20% to 50%. However, some types of food, medicine, medical supplies, and printed matter have now been given duty-free status. There is also a Value-Added Tax (V.A.T.) levied on imported items at a rate of 20%, with some relief afforded food and other necessities. Exports from Russia to the West are taxed at a rate as high as 61 percent of the value of the goods. Thus, Russia is hardly an example of a nation where one would import materials, use inexpensive but high-quality local labor for assembly or manufacture, and then export finished goods. There is some discussion in the Russian Supreme Soviet about both property laws and tariff laws, but immediate relief on either matter is not expected. This will require discussion.
Russia's financial instability, ruble inconvertibility and skyrocketing inflation, along with its underdeveloped banking system, constitute other serious barriers to investment. These issues have also greatly impeded and complicated the ability of western firms to repatriate profits. It is advisable to discuss payment options and profit repatriation strategies prior to investment. Palms & Company offers advice to Russian companies about methods and techniques for barter and countertrade transactions that can be used as an alternative to receiving payment and income, given that Russian enterprises frequently lack hard currency.
Maintaining adequate sources of materials and supplies will be difficult in light of Russia's current political and economic climate, particularly in view of the breakdown of the distribution system throughout Russia and the NIS. Although supply problems did exist under the command system, defense facilities could seek help from their ministries and other bureaucratic oversight organizations when problems arose. Now that the command system has broken down, supply disruptions have increased and managers are generally on their own to devise solutions. One production shop at an aviation plant reported that deliveries of a critical type of metal had been halted for six months. In addition, the dissolution of the Soviet Union has impeded and sometimes halted the delivery of supplies from other NIS countries.
These problems have been recognized by both the Russian leadership and the U.S. Government, and are to be worked on as a result of the recent bilateral agreements.
Other obstacles faced by many Western companies engaging in trade and investment in Russia include the lack of a business culture and misunderstandings on the part of Russians regarding Western companies. Many Russians lack even a basic knowledge of how markets operate, from the role of profits to proper business ethics. Russians often view Western firms as having very deep pockets. As a result, U.S. companies may find themselves significantly overcharged for services. In addition, this kind of business environment engenders illegal activity of every sort, including fraud. Russian companies must avoid help American to avoid such problems.
While more aptly characterized as a benchmark for, than as an "obstacle" to, increased trade, Russian businesses must understand and comply with various U.S. laws when structuring business deals. For example, U.S. law provides for the protection of American manufacturers from unfair foreign trade practices. Manufacturers who believe that foreign competitors are "dumping" merchandise in the United States or are being subsidized by foreign governments may file for relief with the U.S. Department of Commerce's International Trade Administration (ITA) and the U.S. International Trade Commission (ITC).
"Dumping" generally refers to the selling of goods in the U.S. market at prices lower than the prices at which comparable goods are sold in the domestic market of an exporter. These sales must cause or threaten material injury to a competing U.S. industry. "Subsidies" are direct and indirect grants on the production or export of goods. They may occur in many forms, including direct cash benefits, credits against taxes, and loans with artificially low interest rates.
The U.S. antidumping legislation provides for duties to be levied on goods "dumped" on the U.S. market in order to discourage the sale of merchandise in the United States at "less than fair value" where such sales cause or threaten "material injury" to a U.S. industry. For more information, contontact Palms & Company.
Although the Russian Federation is pinning a great deal of hope on Western investment to help fund the defense conversion program, serious problems hinder the efforts of Western investors who want to work with Russian defense enterprises. Some of the problems are caused by confusion over who is authorized to make decisions over enterprises and sometimes lack of interest on the part of some local enterprise managers. Misunderstandings between Western firms and Russian enterprise directors have fueled the spread of rumors and convoluted excuses to explain apparent failure. The problems discussed below are representative of those affecting all Russian defense enterprises.
The Russian Federation is drawing nearer to the establishment of a basic military doctrine. Until it completes this task, however, military planners cannot determine which weapons systems will be required, and consequently, which defense enterprises will continue to produce military goods. While many enterprise managers recognize that they will fill few, if any, defense orders, some do not yet know if they will be permitted to fully convert production.
In March 1992, President Yeltsin signed a law on defense industry conversion the "Russian Federation Law on Conversion of the Defense Industry in the Russian Federation" (hereafter Conversion Law). It states that the main principle of defense conversion is to use the high-technology capability of defense industry to manufacture products capable of competing on the world market. This principle appears contrary to Western expectations of defense conversion-production of non-defense industrial products and consumer goods for consumption within Russia.
The Conversion Law also contains social protection provisions in the event of large-scale unemployment as the defense sector downsizes. Workers who are laid off because of conversion, and have worked in the defense sector for at least 15 years, are entitled to retain their access to the social, medical, and housing services provided by the defense plant. This section of the law is an attempt to smooth over the inevitable disruption of employment as defense facilities are reorganized or shut down altogether. This provision in the law may be unaffordable to Russian employers
The ultimate authority to approve or disapprove a deal with a Russian defense enterprise depends on the situation of a given enterprise. The central government previously had responsibility for all such actions because, through the former Ministry of Industry, it owned nearly every defense enterprise in Russia. Today, however, the lines of ownership are not so clear. Privatized enterprises have the right to make their own decisions and other defense enterprises now are at least nominally the property of the Russian State Property Committee. Russian companie sshould present clearly the lines of their authority to any American investor.
During the Geonomics Institute seminar attended by U.S. and Russian government and industry representatives in October 1992, the suggestion was made on more than one occasion to have the Russian participant in a business transaction be responsible for obtaining the necessary Russian government approvals. Lacking guidance from the central government, defense industrialists as well as local and regional officials, are increasingly asserting their own autonomy and independently seeking foreign aid and investment. Regional and city governments and defense industrial managers and apparatchiks have created defense conversion support groups and have increased their role as players in the conversion process. Clearly, Russian industry must be trorough in presenting such matters to American investors and ensure that they have consulted will all the applicable, and ultimate authorities.
These layers of authority have presented formidable obstacles. For example, according to a senior manager at the Svetlana Production Association (a large military-industrial enterprise located in St. Petersburg), negotiations with the U.S. firm Batterymarch Financial Management had gone well and they had expected to sign an agreement early in 1992. However, according to an official in the former Russian Ministry of Industry, the deal fell through because the Russian Federation refused to approve it. In addition to the State Committee on the Defense Sectors of Industry, other Central government authorities involved in conversion policy include: the Ministry of Economics, Ministry of Foreign Affairs, Ministry of Foreign Economic Relations, Ministry of Higher Education and Science, the Interdepartmental Committee on Conversion the Supreme Soviet Committee for Conversion and Ministry of Defense. Palms & Company can help Russian industry obtain solutions to these questions and convince American investors that the questions have been corectly settled.
The ultimate success of conversion will depend on the ability of enterprise managers to break with past practices. Defense enterprise managers will find that most of the management practices developed under the planned economy of the former Soviet Union will be of little use in a market economy. Managers were primarily concerned with meeting a production target assigned by central planning authorities, who judged performance by indicators such as percentage of plan fulfilled or actual output level. Such criteria caused distortions and inefficiencies as managers sought to maintain output at the expense of quality, investment in new technology, and labor efficiency.
Most defense plants have remained afloat by relying on Central Bank credits and by running up inter-enterprise debts. Inter-enterprise debt came about when enterprises that were unable to sell their goods ran up debts with their suppliers.
This created a chain reaction of unpaid debts that reverberated throughout the entire industrial sector. According to Russian statistics, around five trillion rubles in credits were issued in 1992. The defense industrial sector was a major recipient of the credits. Inter-enterprise debt for the Russian economy as a whole increased sharply in the first half of 1992, rising from less than 40 billion rubles at the beginning of January to around three trillion rubles at the end of June. The Russian Federation tried to eliminate the debt by establishing a commission that arranged for the cancellation of mutual debts and provided funds to enterprises to pay off outstanding debts. However, inter-enterprise debt has since expanded to many trillions of rubles because the Central Bank continued to jump credits and loans into struggling enterprises.
Russia's bankruptcy law, passed by the Supreme Soviet in November 1992, went into effect on March 1, 1993. The law establishes the legal framework for reorganizing or liquidating bankrupt enterprises through Russia's arbitration courts. Enterprises are defined as insolvent if they have defaulted on debt payments for a period of three months. Although the law provides arbitration court judges the necessary levers to carry out bankruptcy proceedings, the courts face numerous hurdles, including a lack of experienced and qualified judges, and a shortage of funds. Moreover, the government has yet to attempt to implement the law.
Some defense industry managers and workers are still resistant to the idea of conversion. The Russian Federation is determined to continue some military production, albeit at a greatly reduced level, and some enterprise managers hope to gain those contracts and continue to produce military hardware, thus avoiding conversion. Others are not convinced that conversion is necessary, believing that Russia eventually will abandon defense conversion and economic reform and that they again will be required to produce weapons. Commercial investment requires agreement about such policies.
In addition, some defense industry employees oppose conversion because defense production facilities have traditionally been viewed as the more prestigious sector of the economy. Conversion to civilian production will cut into their wages, bonuses and awards. Nevertheless, their resistance has weakened over the past few years as
the special privileges associated with defense work-higher wages, special bonuses, and awards-have disappeared. Recently, in fact, wages at many defense plants have become lower than those at other industrial enterprises.
Another aspect that could cause problems in the conversion process is the possibility of unemployment and displacement of persons caused by the downsizing of defense industry. Since the Russian Federation previously adhered to a policy of near full employment, they have little experience with the large scale demands associated with retraining and job placement of defense industry employees.
There are three major infrastructure issues which serve as barriers to defense conversion: 1) social services associated with employment; 2) difficulty in industrial conversion; and 3) environmental and occupational safety hazards.
Besides providing employment, defense facilities also have been responsible for supplying numerous other social infrastructure benefits including: housing, schools, day care, medical, and other community support functions. Many enterprises have been kept in operation through subsidies because of the social necessity of these services. Currently, some regions are in the process of transferring responsibility for such services to the local government, although plant managers often feel responsible for their workers and have been reluctant to give up responsibility for these services-particularly since local authorities are struggling to find a way to finance them. The Privatization decree instructs Russian enterprises not to include social and cultural infrastructure items when placing a value on the enterprise's assets.
Conversion projects may continue to provide employment for a number of these people, but a significant portion are at risk of losing not only their jobs, but also their basic needs (i.e., shelter). Due to the housing shortage, as well as the lack of private housing market, many Russians have no means of finding alternative housing. Again, defense facilities will be particularly hard hit because of the number of employees that they currently sustain. Thus, Russian businesses need to be aware of and learn about these potentially overriding considerations for Americans in developing conversion proposals, and to includeperhaps provisions for temporarily sustaining certain aspects of the social support system.
A second physical infrastructure barrier to defense conversion is the conversion process in and of itself. The experience of defense industry enterprises around the world indicates that attempts to retool military production lines to produce civilian goods are frequently unsuccessful. In the United States when defense orders fall, defense firms usually become smaller or go out of business. Commercial markets are significantly different from the defense customers that managers have learned how to satisfy in such areas as cost and quality requirements, maintenance and service, marketing and supplier networks, the length of production runs, and the demands for technology. People, physical equipment, buildings, and land are flexible and adaptable; institutions, management, and organizations are rigid.
The general assessment of several experts on Russian defense conversion is that it will be difficult to convert an entire existing facility to civilian production at one time. Potential joint venture partners and other investors may be more successful in targeting a specific portion of the production line or "corner" of the plant for a project. Some have even suggested that successful conversion would involve establishing a new organization or building a new facility near the existing one and staffing it selectively from the existing enterprise. Decisions on how to structure a specific transaction, how to finance it, (e.g., pursue a joint venture, acquire an equity interest in the enterprise, lease the facility), and where to market (e.g., for the Russian industrial and consumer market, for export to foreign markets) are matters to be negotiated by Palms & Company for the Russian clients who are a party to the transaction and it should be determined what the Russian Federation will allow in the case of heretofore state-owned enterprises.
A third infrastructure factor would be the current and looming environmental and occupational safety hazards associated with many defense facilities. Defense plants have a disproportionate share of heavy industrial waste problems, and many sites are already severely contaminated. American firms may not want to become responsible for the extremely high cost of cleaning up these sites. In addition, they may not want to expose their workers to the potentially harmful side effects of these polluted environments.
In recent months, a host of American investors have come to Russia to explore possibilities for investment or cooperation with local defense enterprises. However, few deals have actually been concluded. Problems between American investors and Russian defense enterprise directors stem from a number of factors, some related to the expectations of American investors and others related to the expectations-or lack thereof-of Russian managers. Sharply conflicting expectations surface when American investors run across enterprise directors who have no interest in conversion projects or foreign cooperation in general. According to articles in the Russian press, some enterprise directors are not interested in conversion projects at all because they expect a return to the "old days" and want to be prepared again to produce arms. American firms interested in these facilities will probably wait new management.
Russian officials, both from the government and from defense industry, take great pride in the capability and advanced technology of Sovietdesigned weapons. Russians typically regard their defense industry as the most technologically advanced sector of the economy and as capable of matching or exceeding the West. As a result, Russian defense industry managers generally seek Western investment to help them produce a high-tech product-most likely closely related to their previous military production-for export. Western businessmen, on the other hand, are more likely to be interested in a project to produce civilian goods for the sizeable Russian market and frequently regard Russian technology as considerably out-of-date.
Another source of conflicting expectations surfaces when Western firms appear, in Russian eyes, to be going after the "crown jewels" of a particular enterprise. Several Russian enterprise directors and academics believe that Western businessmen are interested only in stealing their advanced technology and state secrets rather than engaging in real cooperation. Thus, Russian companies will find that suspicion regarding American motives can harm negotiations. In a typical scenario, a Western firm will propose a joint venture with a profitable division of an otherwise-unprofitable enterprise. Some enterprise directors balk at this approach because it would mean sharing managerial control of this division with the new joint venture. According to a Committees of Industry representative, some managers are refusing to relinquish control over their best divisions because they would be left managing a struggling complex of little real value. The enterprise director prefers to talk about deals with his less-attractive divisions in hopes of boosting their value. The Western investors, not surprisingly, are less interested in such proposals. Compromises must be designed by Palms & Company.
Despite these obstacles, deals can and are being made, but successful negotiations require imagination, persistence, and demonstrations of confidence and genuine interest in mutual benefits. Russian businessmen need to understand yet quickly get beyond, certain stereotypical criticisms: Russian enterprise managers frequently complain that American businessmen are interested only in "kicking the tires" rather than discussing business deals seriously; on the other hand, Western businessmen complain that the Russian "projects" they are asked to invest are merely thoughts or concepts at best.
Palms & Company can help Russian businesses learn about American enterprises and identify those of interest. Before travelling to America however, the Russian companies might well want to communicate their interest to Palms & Company in a business plan providing the detailed information typically required before businesses and financial institutions in the West engage in serious negotiations, and to present these to American investors. If the enterprise has not yet prepared such a plan Palms & Company can help it to do so. Once business plans have been prepared, Russian enterprises can more reasonably anticipate serious business discussions, particularly with the Western firms that will have previously noted their interest.
The progress toward increased trade with Russia gained through the agreements reached at the Summit meetings in which Dr. Palms participated are enhanced significantlyby several positive factors concerning the Russian marketplace. First, the sheer size and scope of the Russian market provides opportunities for a wide variety of products. The total Russian population is approximately 150 million. It is well known that Russian consumers have long been deprived of many basic consumer goods. Although defense conversion may not provide immediate availability for some of these products, the channeling of industrial productivity to non-defense related items will provide a myriad of opportunities for a variety of Russian businesses. Second, by Western standards, the Russian labor force is generally considered to be well-educated and the defense industries have extremely well qualified, technical personnel. In addition, labor costs are relatively inexpensive for the level of education associated with work performed in high-tech defense sectors. Third, Russian defense enterprises have an over abundance of plant capacity. Excess plant capacity resulting from severe cutbacks in defense orders, has left many plants under-utilized, providing a commercially attractive aspect to an otherwise negative infrastructure outlook. Defense plants also tend to have some of the most sophisticated manufacturing equipment available in Russia.
In 1990, the Department of Defense and the Department of Commerce co-chaired an Interagency Technology Assessment Group (ITAG) to develop a list of technologies where it was then estimated that the former Soviet Union led western accomplishments. The technologies were measured in scientific (mathematical or physical) terms, or in business terms (cheaper to manufacture, less labor-intensive, etc.), or both.
To emphasize that there are wide-ranging opportunities for those who persist in working through the obstacles discussed above, listed below are the technologies identified in the ITAG report, Soviet Commercial Technologies.
Chemical/Allied Products (SIC 28)
Derived from Soviet Commercial Technologies, Interagency Technology Assessment Group, U.S. Department, Office of Foreign Availability, September 1990.
Fabricated Metal Products (SIC 34)
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