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Some examples of successful restructuring experiences

Edited by the Tacis Technical Dissemination Project Published by the European Commission

Published in December 1997

Copyright 1997 European Communities ISBN 92-828-2219-2

All rights reserved.

This publication may only be reproduced, distributed or transmitted, in any form, with the prior permission in writing of the European Commission, Directorate General IA, Tacis.

Enquiries concerning reproduction should be sent to the Tacis Information Office, European Commission, Montoyerstraat 34 3/88 Rue Montoyer, -1000 Brussels.

The findings, conclusions and interpretations expressed in this document should in no way be taken to reflect the policies or opinions of the European Commission.

Table of contents

What is Tacis?

Foreword

What is enterprise restructuring?

5

6

7

Enterprise restructuring and economic recovery

The different phases of enterprise restructuring Conditions for a successful enterprise restructuring 11

Acknowledge the need for restructuring

Recognise the need of outside assistance

A few cases illustrating various industries 14

Lessons learnt 17

Restructuring is a progressive process

Restructuring requires dialogue and communication inside the enterprise

Restructuring must present tangible results

Retraining of the staff creates new skills

Successful restructuring is a pre-condition to attract investment financing

Social assets, unused assets and redundancy have to be issued

Local consultants are essential Case no. 1 : Efremov synthetic rubber (EZSK) 22

The enterprise prior to restructuring

Diagnosis by the consultants

Recommendations from the consultants and their implementation

Situation of the enterprise after the TA project Case no. 2: Lutsk bearing plant 28

The enterprise before restructuring

The diagnosis by the consultants

Recommendations from the consultants and their implementation

Situation of the company after 6 months Case no. 3: Gavrilov yamskiy linokombinat 35

The enterprise prior to restructuring

The diagnosis by the consultants

Recommendations from the consultants and their implementation

Situation of the company in mid-1997 and perspectives

Table of contents

Case no. 4: Kiev sanitary engineering plant 39

The enterprise before restructuring

Diagnosis by the consultants

The recommendations from the consultants and their implementation

Situation of the company after six months Case no. 5: Carpaty Iviv furniture factory 46

The enterprise prior to restructuring

Diagnosis by the consultant

Recommendations from consultants and their implementation

Situation of the enterprise after the TA project Case no. 6: Akrikhin pharmaceutical company 53

The enterprise prior to restructuring

Diagnosis by the consultant

Recommendations from the consultants and their implementation

Situation of the enterprise after the TA project

List of NIS addresses for enquiries concerning TDP publications 60

Questionnaire 61

Acknowledgements We wish to thank the participation in the preparation of this brochure of: the Ukrainian Centre for Post Privatisation support in Kiev, and in particular its director, Mr Savruk Olexander the Russian Privatisation Centre in Moscow, its managers and Mr Jean Marie Roche the members of the consulting team of the Tacis project Post privatisation support in Ukraine Mrs Annie Cordet-Dupouy.

What is Tacis?

The Tacis Programme is a European Union initiative for the New Independent States and Mongolia which fosters the development of harmonious and prosperous economic and political links between the European Union and these partner countries. Its aim is to support the partner countries' initiatives to develop societies based on political freedom and economic prosperity.

Tacis does this by providing grant finance for know-how to support the process of transformation to market economies and democratic societies.

In its first five years of operation, 1991-1995, Tacis has committed ECU 2,268 million to launch more than 2,200 projects.

Tacis works closely with the partner countries to determine how funds should be spent. This ensures that Tacis funding is relevant to each country's own reform policies and priorities. A part of broader international effort, Tacis also works closely with other donors and international organisations.

Tacis provides know-how from a wide range of public and private organisations which allows experience of market economies and democracies to be combined with local knowledge and skills. This know-how is delivered by providing policy advice, consultancy teams, studies and training, by developing and reforming legal and regulatory frameworks, institutions and organisations, and by setting up partnerships, networks, twin-nings and pilot projects. Tacis is also a catalyst, unlocking funds from major lenders by providing pre-investment and feasibility studies.

Tacis promotes understanding and appreciation of democracy and a market-oriented social and economic system by cultivating links and lasting relationships between organisations in the partner countries and their counterparts in the European Union.

The main priorities for Tacis funding are public administration reform, restructuring of state enterprises and private sector development, transport and telecommunications infrastructures, energy, nuclear safety and environment, building an effective food production, processing and distribution systems, developing social services and education. Each country then chooses the priority sectors depending on its needs.

Tacis works with 13 partner countries (12 NIS and Mongolia):

Armenia Azerbaijan Belarus

Georgia Kazakhstan Kyrgyzstan

Moldova Mongolia Russian Federation

Tajikistan Turkmenistan Ukraine Uzbekistan

Foreword

Since 1991, useful work, in a variety of different forms, has been done to assist partner countries through the Tacis programme. In particular, practical field work, with more visible benefits, has been conducted on a more systematic basis since 1993.

A number of projects were successful in developing and testing possible solutions to help partner countries adjust to a market economy. The impact of these projects is not limited to the narrow geographical area in which they were implemented. Results will also benefit organisations and individuals in other regions.

The above is the main aim of the Tacis technical dissemination project (TDP). TDP selects projects with results that are worth disseminating, and develops material to facilitate the replication of those useful results. The content of this document is one such action.

TDP produces and disseminates various types of material documentation on comprehensive actions successful in facilitating adjustment to a

market economy tools to help individuals or organisations understand how they perform, and therefore

better enable them to adjust training materials to facilitate quicker adjustment as part of the process of change.

Documents edited by TDP are not coloured by a particular ideology or political doctrine, and they do not intend to prescribe any one solution to a problem. What is reflected are merely the results achieved in a given situation, and the details of tools used to good effect by local people in adjusting to their changing environment.

Replication of these results is possible, provided readers make an effort to adapt the contents to their local environment. Situations can be similar, but are seldom Identical.

This brochure was developed on the basis of the experience and results achieved by the project described hereafter.

Some information on the project Various Tacis projects have worked/are working on support to the restructuring of enterprises in NIS countries. This document draws particularly on findings from 4 Tacis projects in Russia and the Ukraine: Technical Assistance programme "EU12", Russia -1994/1996 - Consultant:

Arthur D. Little (Moscow) / Warburg / IDOM (Spain) Post-privatisation support for Russian pharmaceutical industry -1995/1997 -

Consultant: IDOM (Spain) and Boston Consulting Group (Russia) Support to the Restructuring of Selected Companies in the Textile Industry -

1994/1996 - Consultant Cast (Italy) Ukrainian Centre for Post-privatisation Support -1995/1997 - Kiev - Consultant:

Cllnvest consortium (France) with IDOM (spaln) and CEGOS (France).

Some information on this brochure Use The aim of the brochure is to provide references and help to enterprises'

managers and shareholders faced with similar difficulties as the ones which were plaguing the enterprise described in the presented cases.

Kxargets Any enterprises to be restructured, former state-owned companies,

restructuring and post-privatisation centres, training institutes.

Tacis would be happy to receive suggestions and comments on this document. Please complete the questionnaire at the end of the document and return it to a TDP distributor (see addresses on page 60).

What is enterprise restructuring?

Entreprise restructuring and economic recovery

Enterprise reform is a central and indispensable component of overall economic reform in countries of central and eastern Europe, and of recovery of growth. Unless enterprises become efficient and profitable, even well-designed and vigorously implemented macro-economic reforms will not result in a successful transformation of the economy (see Figure 1). Recent experiences, especially in Russia and Ukraine, indicate that the failure to implement enterprise reforms exposes governments to strong political and social pressures that can endanger the overall transformation process.

Figure 1: Enterprise restructuring and economic recovery

Macro-economic reforms

t Enterprise

restructuring

Economic recovery

Former State enterprises, even when privatised, are resilient to changes; they can hold the reform process and the State budget hostage. Privatisation programmes have somehow progressed (at a slower pace in Ukraine than in Russia), but the strategy for ownership reforms, and restructuring of enterprises has still to be defined. Restructuring of privatised enterprises has proved very difficult, especially when the ownership had been transferred to managers and employees.

There is a general agreement that enterprises cannot survive without restructuring. But how to implement It with success is very difficult. Furthermore, the business environment (taxes, laws and in particular bankruptcy laws, labour markets, trade barriers, etc.) is not yet positive, and does not provide incentives for restructuring. However, the depth of the economic crisis (the industrial production has continued to shrink in 1996 and in early 1997 in both countries) is the driving force behind restructuring, even if the business environment is not always positive. Most enterprises have seen their sales drop by a factor of 50 or more per cent if compared to 1990, and they understand that they cannot rely anymore on the State to save them. Many enterprise managers have dreamed of the white knight foreign investor, bringing money, but not interfering in the management. With time, hopes have faded, and managers and shareholders are now realistic. They recognise that they have to create their own future, and restructuring of their enterprise is going to be one of the first steps in this direction. This handbook aims at sharing the experience of a few companies which have started restructuring, and at identifying a few restructuring solutions which have proved workable in the Ukrainian and Russian contexts, and therefore can be applied to other enterprises.

Restructuring is not unique to Russia and Ukraine, and many western enterprises have been faced with similar (although sometimes less acute) problems especially in periods of deep market changes. The specificity of Russia and Ukraine is that most enterprises are in need of restructuring at the same time as the drastic change in environment has

8 What is enterprise restructuring?

affected all enterprises. In Europe, for example, after the oil crisis of the seventies, most energy intensive industries (e.g. cement, chemical industries, metal industries to name but a few) were deeply affected while others were unaffected. In the US, following the agricultural crisis of the seventies/early eighties, many agricultural machinery producers were in deep trouble, without market. A famous case is the International Harvester where several restructuring were attempted without success (the collapse of the agricultural machine market was not recognised and optimistic management thought the market would recover the following year while it continued to decrease for several years); their competitors took harsh measures and survived, while the famous International Harvester brand disappeared from the market. Another business schools classic case is the watch industry in Switzerland which was collapsing due to change of technology (cheap electronic movements versus expensive mechanical ones) and competition from new producers in the Far East. It was drastically restructured and revived thanks to a combination of the launch of new products (the famous SWATCH), focus on design and marketing for the higher end of the market, overall decrease of costs; and strong focus on branding.

The different phases in enterprise restructuring

Restructuring is a painful There are many ways to approach restructuring. It may encompass many aspects which but necessary adjustment can be addressed in parallel or phased depending on the situation of the enterprise, the process enabling enterprises to recover efficiency and competitiveness.

sector and the economic environment.

Restructuring may be costly and requiring new investments for modernisation, cost decrease and launch of new products. But certain phases of restructuring can be implemented rapidly1 using the only internal resources of the enterprises.

Restructuring is not continuously complaining about the current situation and hoping that God or somebody in the Centre will improve the situation. It is an active recognition of the problems faced by the enterprise, and a hands-on tackling of the necessary changes by the shareholders and the management team of the enterprise.

In the NIS context, once the diagnosis is completed, and that the enterprise strategy and the restructuring plan are agreed with the management and the shareholders, implementation of restructuring can be conceived around two main phases (see Figure 2): a first phase, articulated on urgent measures, alms at improving the overall situation of

the enterprise, improving the skills and the morale of the staff as well as the perception of the enterprise by outsiders. Through this phase, the enterprise improves its operations, and very Important, secures Its credibility towards outside financiers, thus increasing its chances to secure the necessary funding for new projects aiming at bringing new technologies, increasing production or reducing costs; all projects which are part of the second phase of restructuring. This phase generally requires low investment

a second phase builds on the improvements achieved during the first phase. It secures the future of the enterprise through the implementation of more ambitious projects requiring significant financing.

(1) Rapidly means within some 10 to 12 months.

What is enterprise restructuring?

Figure 2: The different phases in enterpr ise restructuring

First phase Organisational and managerial restructuring

Physical/assets and operational restructuring

Second phase Financial restructuring

Investment in new equipment

Investment in human resources

Later on Ownership restructuring

The initial phase may require very low investment of money, but high investment of the management to implement the required organisation changes. It can be implemented rapidly using internal resources of the enterprises.

The initial recovery phase

It usually addresses key weaknesses of former soviet enterprises entering the market economy, namely market and sales, finance, organisation, etc.

Organisational and managerial issues

The organisational and managerial issues Include the identification of the enterprise's core and optimal activities and markets, the analysis of weaknesses in all functions of the enterprise and the preparation of concrete proposals of remedies (at low cost and through redeployment of internal resources of the enterprise).

For example, actions on the following can bring very rapid visible results: management of cash flow cost reduction through identification of exaggerated high costs items and material

losses establishment of a sales force redirection of product mix, concentrating on core business for too diversified enter

prises, but more often widening the range of products offered as the former all-union enterprises which were part of a wider group of plants were producing a very narrow range of products, complemented by the production of other plants, today in other countries

lay-off of some of the redundant labour (while labour is still cheap in former soviet republic, it has nevertheless an important impact in certain industries. Moreover, it has an impact on the quality, and on the overall morale of the staff).

Physical/assets restructuring and operational changes

Very often enterprises are affected by a poor lay-out of the plant and by rigidities in production due to the tradition of long production batches.

Actions on the following will bring again visible results within a one year period: improvement to the lay-out of the plant (See Figure 3) spin-offs and disposal of non-operational assets (social assets, maintenance assets,...) modification of operations so as to decrease the standard time to change tools/ pro

duction initiation of a quality control process (the introduction of a full quality control process

will require a much longer time).

10 What is enterprise restructuring?

Figure 3: Example of lay out improvement in a mechanical plant of Lutsk (Ukraine)

Before restructur ing Production workshop of rough shaped rollers before restructuring

After restructur ing Production workshop of rough shaped rollers after restructuring

Tool storage

Cold stamping machine dedicated according to wire

diameters

I Spool holders

carousels Tool storage

tffir^) f^ THfr ifjPlT\i _

Strainer Cold stamping

machine dedicated according to wire

diameters

Storage of coils according to wire diameters

Container for collecting semifinished spools

The second phase builds on the improvements achieved during the first phase. It considers more ambit ious projects requiring significant f inancing.

The second phase of restructuring The second phase of restructuring addresses other aspects which may be initiated. financial restructuring

It is a necessary measure for enterprises overloaded with debts. However, creditors will not accept to initiate it in the absence of a credible plan for overall restructuring and recovery.

investments in new equipment

These investments may be financed through a variety of financial sources such as loans (but often difficult to obtain If the financial situation of the enterprise is poor), or investors (new share issues to existing shareholders, strategic Investors to bring both financial and business skills, and financial Investors). The Investment activity may also cover investments to obtain the certification for new standards.

investments in human resources

Investments in human resources are necessary, especially in the sales/marketing and finance areas (e.g. recruitment of a top salesman or a finance manager).

ownership restructuring

Ownership restructuring has been little seen so far in Russia and Ukraine, but it will probably become very Important In the future given the ownership structure resulting from privatisation in both countries. This may cover mergers with enterprises having complementary productions and markets, spin-off of unrelated activities, concentration of shareholders through various means.

11

Conditions for a successful enterprise restructuring

The business framework plays an important role to enhance the success of any restructuring as it provides incentives, positive or negative, which steer the restructuring process, especially in the case of defensive1 restructuring, which is a survival exercise. But even with imperfect market and unfavourable business environment, NIS enterprises may gain greatly from restructuring, and in countries like Russia and Ukraine, the incentives are sufficient (but more needs to be done to improve the business framework) to enable restructuring to take place. The most critical key to a successful restructuring is the commitment of the management and the shareholders. In the absence of such commitment, any attempt to restructure a company will quickly abort as the most important measures will not be taken by the management and the shareholders. But in addition to it, any attempt to restructure a company without having the people/workers on your side will quickly abort.

Acknowledge the need for restructuring The management group must recognise that the enterprise is facing a new challenge and/or is presenting symptoms of illness.

(1 ) Very often, in the western literature covering restructuring, restructuring of ailing industries facing hard competition from new entrants (e.g. shipyards, steel industry) is called defensive restructuring.

The manager and his team, as well as the enterprise shareholders have first to recognise that their enterprise is facing a new challenge (e.g. current or forthcoming competition, technological changes, loss of major markets) or that they have identified symptoms of illness (financial troubles for example) that they do not know how to solve without external assistance in a short period of time.

Problems vary with the type of industry (for example manufacturing, consumer goods products, process industries, etc.), the economic and social environment, the country as each of the former soviet republic has evolved differently since independence. But inheritance from the past soviet system indicates a few recurrent syndromes identified in many enterprises. Managers or shareholders must be convinced that they are not alone with the problems they are facing in their company.

Most of the time, in those enterprises that need to be restructured, some if not all of the following features can be found: there is no proper marketing/sales department, and the enterprise has difficulties to

understand who the client is and what he wants the financial strategy is non existent the enterprise lacks working capital and the absence of liquidity is blocking the re

covery of enterprise in the daily life of the enterprise, the manager decides on everything and does not del

egate the poor quality of products and no quality control process are hampering the cost of

products (very high reject rate) and the image and saleabillty of products the product design (especially for consumer products) is not matching the require

ments of clients

The manager and the shareholders of an enterprise in need of some sort of restructuring, may recognise themselves in some of the following statements and questions: - Yes, we know how to make product X, Y, Z, but our sales are dwindling and our financial situation is dreadful;

the salaries have not been paid for months; we have a huge debt to the budget - Why do we make these products today? Why are the customers willing (or not willing) to buy products , ,

from our factory? Where are our clients; and at which price they are willing to buy from us? - Where can I get raw materials at best price? - Why do we have so many rejects to achieve not even a good quality? - We do a lot of barter, but what is the financial result from this barter? - Investment is the only way to restructure the company.

12 Conditions for a successful enterprise restructuring

the management attitude (risk averse and lack of strategy) is inherited from the past the costing methodology prevents the enterprise from understanding the origin of high

costs and to compete on the market the burden of social costs is impacting the results of the enterprise the enterprise is undercapitalised and the shareholders cannot bring fresh money.

Recognise the need for outside assistance

Outside assistance (local or foreign) is necessary to accelerate the implementation of a restructuring programme.

Working with consultants is resource consuming for the enterprise.

The manager and his team and/or the shareholders have then to find an approach to design and implement the necessary restructuring. The assistance of consultants (local or foreign) may help accelerating the restructuring process, and this may be critical in certain cases when the enterprise competitive position is deteriorating. The consultants will act as catalysts, and will stimulate the recovery process of the enterprise. It is however crucial at this stage that any misunderstanding be eliminated so as to ensure smooth working conditions for the restructuring effort.

To maximise the advices provided by the consultants, the manager has to allocate one or several professionals to work with the consultants so as to help them to make the diagnosis as quickly as possible. The professionals will also gain an immense experience and they will later disseminate their know-how to their colleagues. They will be the pivotal team of the enterprise to implement restructuring.

What should the management expect from external assistance?

The consultants can help greatly in the elaboration of the diagnosis and in recommending measures to be implemented to improve the situation, as well as coaching during the implementation phase. Their knowledge of similar plants and enterprises in the West and in NIS enable them to diagnose the main issues very rapidly, and to explain what should be done to rectify the problems, why, and what kind of results could be expected.

They will help benchmarking the enterprise vis--vis its competitors. But in the most important phase, the implementation, the staff of the enterprise should be In the fore front, with the constant support of the consultants' team.

The consultants will bring support and vision to the internal task force. The consultants can help organise the effort, coach and train people, but the ultimate responsibility lies with the management of the enterprise, and with the shareholders If some of the problems have their roots within the management team.

The consultants can help the enterprise preparing for a partnership (financial partners, commercial partners), help Identify potential partners, and prepare the management for the negotiation covering a long list of complex Issues, and advising the management on how to deal with them.

But external assistance cannot solve all problems. Consultants do not know the enterprise better than its managers. Their role is summarised in Table 1.

Conditions for a successful enterprise restructuring 13

Table 1: Role of external assistance in the restructuring process

A consultant cannot: A consultant can: run the enterprise (for example be a sales representative for the enterprise, collect receivable) get money for the enterprise take strategic decisions on behalf of the enterprise

elaborate a diagnosis and recommend measures to improve the situation help benchmarking the enterprise vis--vis its competitors bring support and vision to the internal task force help the enterprise preparing for a partnership

14

A few cases illustrating various industries

The cases presented in the Table 2 (and detailed in the following chapters of this brochure) illustrate successful restructuring initiated with the assistance of Tacis projects. They cover different kinds of industry, which are affected by different problems, from more high tech pharmaceutical industries to mechanical industries. They cover enterprises of different sizes, in.Russia and in Ukraine, enterprises of different origins from all-union to local enterprises.

These cases are not necessarily a representative sample, but more a photography of enterprises which have succeeded to go through the post-Soviet storm and are now equipped to enter the market economy. The managers and the shareholders of these enterprises are willing to share their unique experience with their colleagues.

The diagnosis and the proposed remedies show a lot of similarities in each enterprise. Not surprisingly, marketing and sales s a problem in all enterprises. It is too early to speak of results as some of the projects have just been finished, while others finished more than a year ago. However, it is interesting to see that there are results, even when the prognosis was not very favourable at the onset of the project.

These cases demonstrate that there is no fatality, and that former soviet managers, with outside support, are able to turn around their enterprises in a year or so, and we are confident that they are continuing working on their enterprise to further improve their competitiveness, find partners and negotiate successfully with them.

Those cases for which we have an hindsight, such as Efremov, show that the restructuring has been instrumental in securing financing for additional investments at a later stage. Financiers are not rushing to a company, but want to feel secure that their investments will be repaid thanks to the good strategy and management of the company.

All the cases described in this brochures have been implemented in the framework of Tacis projects with the support of western consultants financed by the European Union, and respectively the support of the Russian Privatisation Centre in Russia, and the Ukrainian Centre for Post-Privatisation Assistance in Ukraine. Many different European consulting firms have worked on these projects, transferring know-how to enterprises and local consultants.

While the projects were slightly different in the two countries, the Russian approach being more focused on industry clusters, and direct transfer of know-how to enterprises of a given sector, and the Ukrainian approach being more focused on transfer of know-how to enterprises and to developing local consultants, the final results at the level of enterprises are very similar. As the problems encountered were very similar In different types of enterprises, and early results positive, it was decided to disseminate such results, so that other shareholders, managers and consultants can benefit from the experience of their colleagues from Russia and Ukraine.

Table 2: Summary of some successful TA restructuring projects

Company Country/Sector

Period of assistance by consultants

Main problems see below notes 1/ and 2/

Proposed restructuring strategy Main results

Efremov Russia/Rubber Sep. '94 - Dec. '95

Lustsk Ball bearings

Ukraine/ Mechanical industry

Feb. - Dec. '96

Gavrilov Russia/Textile Jul. '96 - Jul. '97

loss of market shares negative cash flow limited sales net-work

be one of the top key players on the European market of polybutadlene

certification with all main tire producers in the west

side products have been dropped recovery with profit in 1995 and 1996

good short term finance equity investment by EBRD of $38 million agreed in fall 1997

poor lay-out of the plant, does not allow for flexible production

no commercial department very limited range of products

become a full range supplier on the NIS market

get direct orders on the export market

secure agreements with some western producers

increase of sales for the first 6 months of '97 (plus 47% if compared to first 6 months of '96)

new flexible lay-out of the plant enlarged range of products

poor lay-out of the plant and very low productivity

no marketing and sales network

no capability for product development

become the Russian leader for linen products

compete effectively on International markets

significant increase in sales, both globally and per employee

development of new products development of sales network in Russia and of international contacts (participation to the Frankfurt fair)

negotiation under way for a new investment (in joint-venture) for the production of high count linen (about $6 million)

S

U i

S

Company

Kiev Sanitary Equipment

Carpaten

Akrlkhin

.

Country/Sector

Ukraine/ Construction materials

Ukraine/ Furniture

Russia/ Pharmaceuticals

Period of assistance by consultants

Feb. - Dec. '96

Mar. '96 - Jul. '97

Oct. '96 - Jan '97

Main problems see below notes 1 / and 2/

- outdated technology - no commercial/

marketing team - cash-flow difficulties - one customer represented the major part of the sales (90% In 1995)

- company technically bankrupt, with bank accounts blocked

- terrible quality/ design of products

- no commercial/ marketing team

- poor lay-out of the plant

- threat from Increasing western competition

- no understanding of cost - no sales and marketing

network - no product focus

Proposed restructuring strategy

- serve a wide array of customers, public and private, new or renovated buildings, with diversified modern products, easy to install

- design quality products for the medium/ lower end of the market

- decrease barter and recover a normal financial situation

- specialise production

- become effective producer of selected generic drugs; and increase Russian market penetration through alliances with western producers

Main results

- new product lines - commercial agreements with European partners

- diversification of sales in terms of products and clients with significant decrease of the weight of the public sector single customer (47% against 90%)

- quality has reached european levels

- new lay-out of the plant, - reduced production costs

(20 to 50% according to shops or machines)

- new sales team

- Increased sales - focused product portfolio - cost reduction and improved

competitiveness

c

1 / drop of sales has not been mentioned as it affected more or less all companies during the early period of the break-up of the former Soviet Union; similarly, even when not mentioned, the lack of marketing and sales net-work is common to all companies.

2/ non existent cost accounting was a problem in all enterprises.

17

Lessons learnt

Enterprise restructuring in NIS countries is addressing rigidities inherited from the past: in products design, production pattern, distribution, cost calculation, and also in approaching problems-

Short term actions are not sufficient, but the necessary step to ensure the success of the longer term restructuring.

(1) See the set of TDP brochures directed to SME, in particular -How to draw a business plan and -Manual on marketing practices.

Business managers and shareholders are key factors of change in NIS countries. The work with enterprises and the success of restructuring would extend beyond the individual cases and the initial results which have been achieved, and are reported in this handbook. It is evident that there is a burgeoning demand for restructuring, or more precisely for Improving the situation of enterprises which are faced with unprecedented problems.

A review of the above cases provides evidence of the impact and efficiency of restructuring, and also information on how it has been designed, implemented, and what are the early signs of recovery.

Restructuring is a progressive process

Once managers and shareholders have agreed that they want a restructuring, that they are ready to allocate resources to ensure its success, the real work can start.

The first step is to carry out a SWOT analysis' (Strengths, Weaknesses, Opportunities and Threats) or similar analytical grid to collect Information on sales, finance, production, personnel. This analysis is always supplemented by minute plant visits, face-to-face interviews and observations. Sometimes, the diagnosis is very quick, sometimes it takes a longer time if the company is important, active in many businesses, has several production sites, etc.

Recommendations will rapidly be formulated and in particular short term measures to be implemented immediately. For example cash stabilisation programmes have been implemented in Efremov (synthetic rubber) in Russia as well as in Carpaten (furniture) in Ukraine.

Short term actions on sales and market, finance, product design, quality, housekeeping, cost control, show results very rapidly.

New products developments, new markets, changes of strategy may require more time to be fully prepared, and also to be financed, but in a number of the above cases, in particular in light industries (textile, furniture, light mechanical industry), companies have been able to introduce new/improved products within a year.

The search for a partner is a longer term goal, as negotiation may take some time, and in many cases may be initiated only when the enterprise has regained a certain look. A very simple act of change is housekeeping. So many plants are full of pieces of metal, wood or junk; everything is rusting; nothing is clean. This can be changed almost overnight, and it will immensely improve the morale of workers.

An analysis of the examples provided in this brochure shows that it takes time to find real financial investors. For example, in the case of Efremov, the synthetic rubber company, the discussion with the EBRD started during the project, late '95, and the final agreement has only been signed in fall '97. Agreements with commercial partners are quicker (not necessarily easier), and examples both in Russia (Gavrilov) and in Ukraine (Kiev Sanitary Equipment) demonstrate that they are feasible within a couple of months.

The need of sequencing is critical in the case of NIS enterprises as they cannot generate quickly funding through the disposal of assets or shares as their western colleagues do. Announcements of sales of assets or divisions or subsidiaries are found every day in newspapers like the Financial Time or the Wall Street Journal, but such moves are difficult in Russia and Ukraine. But Russian or Ukrainian enterprises have shown that they have significant possibilities of productivity improvements and cost savings.

18 Lessons learnt

Restructuring threatens the status-quo. It has to be understood by everybody, from the management team to the workers.

Restructuring requires dialogue and communication inside the enterprise Restructuring implies a major change in the enterprise. This change has been and is still stressful, and it appeared that resistance to changes is building during the restructuring process. Even when the manager and the shareholders were willing and asking for restructuring, they have been faced with difficult decisions requiring sometimes an in-depth change of attitude. This has required a lot of communication and information from the consultants at all levels. In cases not reported In this brochure where the communication had failed, the restructuring process has aborted. Not only the consultants have to explain the whole process and explain it again to everybody', but the managers and the shareholders have to communicate and explain their strategy to the workers to ensure that they will support the effort, and not sabotage It. Through discussions with the consultants, visits to western plants and exchanges with western managers, very often the management team has rapidly understood the necessity of the actions proposed by the consultants, and their long term implications for the enterprise. Their European colleagues have often explained that they also had to go through restructuring, even if necessity is generally less drastic than in Russia or Ukraine. The Russian or Ukrainian managers have gained confidence In the proposed restructuring process, and were able to share this confidence In the future with their colleagues and the workers. Some of the cases highlighted above have gone through such an internal crisis, but all have succeeded to overcome It through dialogue and communication.

Restructuring threatens the status-quo as it requires changes from everybody. There is therefore a need for a very deep co-operation between the various actors to lessen tensions, and avoid misunderstandings. Explanations are needed not only at the level of the management, but also at the level of workers, for example to explain the background to changes in the production organisation to Improve productivity, to introduce a continuous quality control process which is not an ex-post reject of defective products. Also, as in most enterprises of the region, there is redundant labour, and lay-off plans, when necessary the restructuring process will have to be discussed with not only the workers, but the local community (municipality, region). This is also particularly true when the enterprise needs to get rid of social assets and services and to transfer them to the community.

Restructuring Issues can be exacerbated by certain forms of privatisation when managers and workers own a large part of the enterprise, and this is the case in many enterprises in Russia and Ukraine. The decision process is difficult, and through these privatisations, general manager have gained power. The workers cannot say much (despite their status of shareholders), and there is no more counterbalance from a power in the Centre. The chances of success of restructuring these types of enterprises lies mostly with the manager, who needs to have the intelligence to see that through this difficult process by which his power may be decreased, the future of the enterprise (and de-facto the future earnings of the manager) may be greatly Improved. Also the workers have to understand that even if they are no more part of the enterprise, the benefit from restructuring will bring them dividends in the future (the case of Lustk bearings is very illustrative of the dialogue with the workers to decrease the personel).

As said above, the key to a successful restructuring is motivation for changes, and setting-up joint task-forces between the outside advisers and the enterprise staff. This has been a constant feature jn all the cases presented In this handbook.

(1) The role of Russian and Ukrainian consultants is critical in this convincing.

Lessons learnt 19

Early signs of recovery are important to make the management team and workers move from a passive attitude to an active one.

Restructuring must present tangible results It is difficult to identify criteria to measure success in advance, but in the long term, financial sustainabllity and improved profitability are certainly one criteria or THE criteria. However deterioration of the overall financial situation may appear during restructuring due to the cost of certain measures (e.g. severance payments to redundant personnel, new investments, etc.) as it is the case during most restructuring everywhere. For example, as quoted in a European financial newspaper: the operational profit of company X shows a 60% Increased profit for the first 6 months of 1997, while the results are still negative due to restructuring costs. Prospects for 1997 are excellent

Early signs of recovery include increase of sales, in particular sales of new products, decrease of production costs, decrease of barter and receivable, Increase of cash flow to name a few. The cases presented in this handbook all show most of these positive indicators of success, which will enable the enterprises to build on their first effort. The value of shares is not yet an indicator in Russia and Ukraine given the lack of liquidity and transparency of the capital market. But it will certainly be an indicator in the future as it is in most western countries. Most companies with successful restructuring experience a significant increase in their share price. This is very important for the company which will need to tap the financial markets to finance development and new investments.

A very important aspect (although difficult to measure) gained through the restructuring process is the adaptation to the reality and change of attitude. Several cases describe companies where managers were frustrated, and the morale very low (the worst case was probably Carpaten in Ukraine). At the end of the process (in fact, it is a progressive change), the management team took risks, reacting to the market and the financial situation; the manager got feedback from the various members of his team. The sales manager (which did not exist as such before) got feedback from the customers who are happy or not happy with the quality, the quantity, the design. In other words, the management team and sometimes the workers have moved from a passive attitude to an active one.

The ultimate resource of the enterprise is the people. Training is essential in a restructuring process.

Retraining of the staff creates new skills

In all cases, one of the early diagnosis has been the lack of sales and marketing staff. Given the rigidity of the labour market where it is difficult to find good salesmen (the few specialists are quickly taken by joint ventures or foreign firms able to pay higher salaries), most enterprises have to Identify individuals within the enterprise, and to retrain them. It is not easy, and need certain precautions to be successful, but it works: the job description should be clear and precise, as well as the organisation and

responsibilities of the salesmen the search for internal candidates should be open to any employee of the enterprise.

The chief engineer is not necessarily a good salesman, but somebody in the design bureau, or in the administration may have some of the basic quality

the salaries and incentive schemes should be redesigned and include a significant part of bonuses

the new salesmen should be trained. They need to acquire certain basic skills, and this can be done either through a specific programme designed for the enterprise (a consultant or a business school may provide it), or through the attendance to short seminars organised by business schools for executives

it would be interesting for new sales and marketing men or women to meet some of their colleagues in Europe to understand how they work, and how they react in a given situation.

20 Lessons learnt

The retraining and change of attitude apply not only to sales and marketing men, but also to all the staff. The ultimate resources of enterprises are the people, educated, trained engineers, and workers, which will have to retool their approach to problem solving. Even companies without financial resources can implement some restructuring actions which will lead to an Improvement of productivity, of sales, of quality, if they retrain their staff. Initial and significant quality improvements can be rapidly achieved by training and by communicating with the workers.

A clearly defined vision of the enterprise and a credible business plan are necessary to attract potential partners.

Successful restructuring is a pre-condition to attract investment financing

Russia and Ukraine are part of the world economy and face competition. But they have advantages: large markets, not yet solvent, but which should enable a number of enterprises to have economies of scale and lower costs. Furthermore, Russian enterprises have access to cheap and good quality raw materials (wood, energy, metals for example). Of course, these markets will also attract competitors. In some of the cases presented above, the company has already found and negotiated with a partner. In the case of textile, a joint venture is under negotiation. The rubber company had already negotiated a joint venture, but was not capable to reap the fruit of the venture. Thanks to outside assistance, they were able to Increase the European sales through this venture, and later to secure a major financial deal (EBRD equity investment of $38 million). Some of the earlier restructuring cases have also ended with significant partnership negotiated with a foreign company (Russian furniture company).

In all companies, the restructuring has been effected in the framework of a newly defined vision of the enterprise. All the diagnosis work, and discussions with the management team, have led to the definition of a strategy. Such clear view Is essential to prepare a business plan, and at the end of the process, the management will be able to prepare a sound business plan, and more important a credible one to support its negotiation to obtain a credit or to solicit a financial investor. The company is in a position to present Itself in a better way to a potential partner; the activity is now focused and clear for an outsider; unrelated assets have been disposed off, the company knows its advantages, and also its weaknesses.

Social assets, unused assets and redundancies have to be addressed

Social assets are critical. But, in a market economy, a company has to focus on its core business.

While everybody recognises that the issue of social assets is critical and has to be addressed, it is beyond the capabilities of the external assistance to help divest them. But it can help divest some shops, for instance maintenance shops, which would be transferred for example to the workers, and assistance would be given to design the contract between the company and the new off-spring, and help focus the activity of the new off-spring. The Russian or Ukrainian companies have net only to dispose of social assets, but of assets not relevant to their core business. Most companies have already Initiated this process, and are moving towards a leaner company.

Redundancy is another issue. In practice, it is unfortunately less Important than it appears on the first sight. In many enterprises, workers have not been paid for some time, or many of them are In a sort of temporary or permanent leave. The Issue there, as Illustrated by the case of Lustk ball bearing in Ukraine, is to convince people that they would have a better future outside the company, and as shareholders, if the company improves, they may get benefits under the form of dividends. Of course, It is a question

Lessons learnt 21

of confidence between the management, and the workers. But important reductions of personnel can be achieved, and should be achieved as the structure of soviet enterprises was not designed for a market economy.

Local consultants are essential

The experience of the various pilot cases has shown that the role of local consultants has been critical to establish the confidence between the foreign consultants and the management of the enterprise. The local consultants have helped smoothing difficulties, especially in times of crisis. As mentioned above, the restructuring process is painful, and sometimes leads to tensions. The local consultants have had not only a cultural and psychological role, but have strongly participated in some phases such as sales and marketing retraining, financial control, etc.

The consultants mentioned in this handbook are not necessarily foreign consultants. From their dialogue with managers, restructuring concepts will be spread, and more enterprises will go through the painful, but rewarding process of restructuring.

The cases presented in details in the following chapters reflect different kinds of problems and different sectors of industry. The selection is not an exhaustive one, but it attempts to show how different enterprises can not only survive, but develop, if they recognise early enough their problems and address them.

To conclude, restructuring is not a mysterious and costly process, but an on-going effort that Russian and Ukrainian enterprises can initiate and master. The examples described in this handbook show that it is for all, and even in cases where results appear to be minimal, the efforts have been productive in the longer term.

20 Lessons learnt

The retraining and change of attitude apply not only to sales and marketing men, but also to all the staff. The ultimate resources of enterprises are the people, educated, trained engineers, and workers, which will have to retool their approach to problem solving. Even companies without financial resources can implement some restructuring actions which will lead to an Improvement of productivity, of sales, of quality, if they retrain their staff. Initial and significant quality improvements can be rapidly achieved by training and by communicating with the workers.

A clearly defined vision of the enterprise and a credible business plan are necessary to attract potential partners.

Successful restructuring is a pre-condition to attract investment financing Russia and Ukraine are part of the world economy and face competition. But they have advantages: large markets, not yet solvent, but which should enable a number of enterprises to have economies of scale and lower costs. Furthermore, Russian enterprises have access to cheap and good quality raw materials (wood, energy, metals for example). Of course, these markets will also attract competitors. In some of the cases presented above, the company has already found and negotiated with a partner. In the case of textile, a joint venture is under negotiation. The rubber company had already negotiated a joint venture, but was not capable to reap the fruit of the venture. Thanks to outside assistance, they were able to Increase the European sales through this venture, and later to secure a major financial deal (EBRD equity investment of $38 million). Some of the earlier restructuring cases have also ended with significant partnership negotiated with a foreign company (Russian furniture company).

In all companies, the restructuring has been effected in the framework of a newly defined vision of the enterprise. All the diagnosis work, and discussions with the management team, have led to the definition of a strategy. Such clear view is essential to prepare a business plan, and at the end of the process, the management will be able to prepare a sound business plan, and more important a credible one to support its negotiation to obtain a credit or to solicit a financial Investor. The company is in a position to present Itself in a better way to a potential partner; the activity is now focused and clear for an outsider; unrelated assets have been disposed off, the company knows its advantages, and also its weaknesses.

Social assets, unused assets and redundancies have to be addressed

Social assets are critical. But, in a market economy, a company has to focus on its core business.

While everybody recognises that the issue of social assets is critical and has to be addressed, it is beyond the capabilities of the external assistance to help divest them. But it can help divest some shops, for instance maintenance shops, which would be transferred for example to the workers, and assistance would be given to design the contract between the company and the new off-spring, and help focus the activity of the new off-spring. The Russian or Ukrainian companies have not only to dispose of social assets, but of assets not relevant to their core business. Most companies have already initiated this process, and are moving towards a leaner company.

Redundancy Is another issue. In practice, it is unfortunately less Important than it appears on the first sight. In many enterprises, workers have not been paid for some time, or many of them are in a sort of temporary or permanent leave. The issue there, as illustrated by the case of Lustk ball bearing in Ukraine, is to convince people that they would have a better future outside the company, and as shareholders, if the company improves, they may get benefits under the form of dividends. Of course, it s a question

Lessons learnt 21

of confidence between the management, and the workers. But important reductions of personnel can be achieved, and should be achieved as the structure of soviet enterprises was not designed for a market economy.

Local consultants are essential

The experience of the various pilot cases has shown that the role of local consultants has been critical to establish the confidence between the foreign consultants and the management of the enterprise. The local consultants have helped smoothing difficulties, especially in times of crisis. As mentioned above, the restructuring process is painful, and sometimes leads to tensions. The local consultants have had not only a cultural and psychological role, but have strongly participated in some phases such as sales and marketing retraining, financial control, etc.

The consultants mentioned In this handbook are not necessarily foreign consultants. From their dialogue with managers, restructuring concepts will be spread, and more enterprises will go through the painful, but rewarding process of restructuring.

The cases presented in details in the following chapters reflect different kinds of problems and different sectors of industry. The selection is not an exhaustive one, but it attempts to show how different enterprises can not only survive, but develop, If they recognise early enough their problems and address them.

To conclude, restructuring is not a mysterious and costly process, but an on-going effort that Russian and Ukrainian enterprises can initiate and master. The examples described in this handbook show that it is for all, and even in cases where results appear to be minimal, the efforts have been productive in the longer term.

22

Case n1 : Efremov synthetic rubber (EZSK)

Sector Country Activity Assistance period

Rubber industry Russia Polybutadiene rubber manufacturer September 1994 - December 1995

The enterprise prior to restructuring

Established in 1933, "Efremov Synthetic Rubber" (EZSK) was, in the soviet era, the world's largest polybutadiene rubber manufacturer with a capacity of about 250 Kt per year.

In 1994, production is running at best at a level of 5,000 t/month, 37% of which being exported to the West. With some 6,500 employees, the plant s a key job provider in the city of Efremov (40,000 inhabitants in the Tula region).

Following its privatisation in 1992, 19% of EZSK's capital is held by Kautschukgesellschaft, subsidiary of the German group Metallgesellschaft (Frankfurt). A Germany-based joint-venture owned 50% by EZSK and 50% by Kautschukgesellschaft is in charge of trading EZSK's production in the West.

EZSK provides social services to the population of Efremov: kindergartens, sanatorium, hospital and polyclinics including a pharmacy, sport and leisure complex, cultural houses, sports hall and a stadium, a summer camp for children and practical lectures for pupils binder school.

EZSK's sharehoding and participation in Efremov Kautschuk (Germany)

Kautschukgesellschaft (Frankfurt)

Efremov Kautschuk GmbH (Frankfurt)

7%

62%

2,4%

9,6%

Efremov's top management

Efremov's workers

Small investors

Tula Property Fund

Case n1 : Efremov synthetic rubber (EZSK) 23

Diagnosis by the consultants Sales-Markets In 1994 EZSK's product mix consists of core production (high molecular polybutadiene "solids", 93% of sales), related production (polybutadiene "liquids", 2% of sales, polyisobutylene) and other products (rubber hoses, Sipowder, PEbags, gases). The tyre industry is the main user of polybutadiene (87% of sales). Other users of Efremov's products are the plastic, railway brakes, abrasives, asbestos technical resins, food, baby pacifiers/teats rubber boats, varnishes/paints, roofing, construction and military sectors. The sold production of noncore products decreases sharply. In its shrinking domestic market, EZSK consistently loosing share (30% market share in 1994) to Voronesh Rubber Plant (VZSK) who holds a 70% market share. The main reason is the higher willingness of VZSK to trade on a barterbasis. Although the domestic market has a high potential in the mid to long term (when the automobile and tyre industry recovers), EZSK's revival is, In the short term, mainly dependent on its capacity to deliver on the western markets. The western market is dominated by Bayer. If all necessary actions are taken, EZSK will most likely double export tonnage by the year 2000. To this end EZSK needs to cope with western consumer's requirements. EZSK's position must be improved on 4 out of 6 key success factors in this market.

Positioning of EZSK on the world market

Key success factors

Price Quality Reliability Service/application technology Packaging Payment

Importance in Western Markets

XXX XXX XXX

XXX XX X

Positioning strong

A *

favourable

weak

A

+ Efremov (EZSK) Vorenesh Bayer

Although the quality of EZSK's polybutadiene meets western standards, and export markets have been developed successfully, some issues have to be addressed, in particular the improvement and the introduction of new grades of polybutadiene (like Cotype and Ndtype), the renewal of the domestic sales organisation and the securing of stable and affordable supply source for butadiene.

Finance EZSK is geared towards its production capacity of 250 Kt per year. Under the current market and supply conditions, if no restructuring is performed overall cash flow will remain negative. The "related production" does not even cover its direct costs.

24 Case n1 : Efremov synthetic rubber (EZSK)

Cash flow of EZSK in 1994

I Sales I Contribution Margini I Contribution Margin 2 ] Operating Result ] Cash Flow 1 I Cash Flow 2

V a V "1 w^

The losses from social services amount to 7% of overall annual revenues and severely hamper the cash-flow situation of EZSK.

Production

Although technology-wise EZSK is competitive on world wide markets, the production structure of EZSK is non-integrated, non-diversified and too large for present production levels. Focusing on core products (solid polybutadiene) should provide opportunities for optimisation of production layout and costs.

The three main areas for improvement are the following: present operations suffer from low capacity utilisation (50 vs. 250 Kt/y) resulting in

major inefficiencies: - organisational (room to discontinue one major production unit) - maintenance (generally room for improvement) - raw material and energy (potential to improve with centralised operations).

production capacity is being maintained for very low volume products that, therefore, cannot significantly contribute to the coverage of EZSK's fixed costs. Such activities should be either developed (investment) or discontinued: - Liquid polybutadiene (340 t/y vs. 5,000 t/y) - Polyisobutylene (500 t/y vs. 4,400 t/y) - Liquid Polyisobutylene (200 t/y vs. 3,000 t/y).

"non core" activities still operated: agrohoses, silica powder, PE bags should be discontinued. They dilute management's attention, without contributing significantly to EZSK's profitability.

Management / General organisation There is need and scope for major organisational restructuring, including the traditional segments. The plant presently employs 6,500 people, while social engagements account for 1,350 people.

Case n1 : Efremov synthetic rubber (EZSK) 25

The recommendations of the consultants and their implementation Based on the above diagnosis and following recommendations, mixed teams EZSK/ consultants were constituted and jointly searched for applicable practical solutions. A restructuring plan with targets, tasks, timetable, responsibility, budget and training needs has been developed to cover the immediate needs of EZSK.

Sales-Markets The development of sales to defend market leadership in domestic markets and to secure favourable market position abroad is the core of the strategy. This included the following tasks: - definition of a marketing/sales strategy - improvement of marketing and sales organisation (training, set-up of the marketing

and sales departments) - intensification of new product development activities.

Supply As raw materials represent 75% of the cost of production of polybutadiene, competitive and reliable supplies are key to EZSK's viability. Today's supplies come exclusively from Tobolosk petrochemical complex. Additional Russian supplies' have to be found. EZSK has to redesign the supply basis to ensure a constant supply of butadiene required on competitive price base. This required the following tasks: - definition of a multi source butadiene supply strategy - renegotiating actual contract terms - optimisation of logistic costs.

Finances The main objective was to introduce monitoring and liquidity control tools to support effective management decisions. This included the following tasks: - introduction of a computer-aided cost controlling system - development of liquidity management tools - leveraging on relationships with Kautschukgesellschaft to secure export credit facili

ties.

Production

Ensuring competitiveness by improving cost efficiency, plant reliability and product quality has been essential in the recovery of the company. The following actions were conducted: - restructure the operations (conserve or close down production lines) - improve the maintenance efficiency - study the feasibility of investments in utilities (energy, water,...) - introduce critical efficiency monitoring schemes.

(1) Given the cash-flow situation of EZSK, sourcing from western suppliers is not realistic.

Management /Genera l organisation

It was necessary to adapt the organisation to "core business" needs and rethink critical processes. The following actions were undertaken: - agreement on a common strategic vision - define and introduce the concept of profit and cost centres - design the future organisation structure (introduction of new functions such as sales

representatives, financial controlling and planning)

26 Case n1 : Efremov synthetic rubber (EZSK)

- streamline the key business processes - develop human resources - transfer social assets.

Situation of the enterprise after the TA project

Situation at the end of the consulting project a) Sales results and medium term perspective

In contrast to 1994, production of polybutadiene Is running at 9,000 / 10,000 tons per month (as opposed to 5,000 tons per month). Sales go predominantly to the West, Russian business being stagnant at 1,000 / 2,000 tons per month.

Business development by Kautschukgesellschaft during 1994 has paid off very well. EZSK Is now certified with all relevant tyre manufacturers in the West. Exports to the USA also work out financially.

In 1995 EZSK has not only generated a positive cash-flow (cash flow was negative in 94), but a gross profit of about 20% of sales, leaving the enterprise with a net profit of 10% of sales.

Medium term EZSK's sales are likely to stabilise, as 1995 production level reached a significant market share in western European market. Growth can only come from US market participation which is a function of US vs. European butadiene raw material prices and hard to predict (and exogenous factor for EZSK). Revival of the Russian market that would also boost EZSK's sales is even harder to predict.

b) Raw material supply

EZSK is now supplied under four contracts, only one of them having a hard currency element. EZSK's position is also helped by the much improved cash position.

c) Short term finance

Two important finance agreements at close to western market credit terms have been worked out during the TA project providing EZSK with a DM 25-30 million credit facility. This allows EZSK to finance export business both from the western border to customers and for the time from the product leaving the factory to arrival at the western distribution terminal.

This results in EZSK receiving cash payments for their export production once products leave the manufacturing production. General profitability and additional credit facilities greatly improve EZSK's purchasing position.

d) Long term finance

A $20 million investment plan Including plant efficiency Improvement, product and technology development, new product manufacturing and improved maintenance has been prepared by EZSK. Discussions are held with EBRD to finance the investment.

Case 1 : Efremov synthetic rubber (EZSK) 27

Situation two years after the end of the consulting project

At the end of 1997, EZSK employs 4,490 people and aims at progressively reducing this number to 2,500-2,800. Contrarily to VZSK, the enterprise transferred all social assets, has no debt to the budget and pays salaries on time. EZSK's fixed cost base has been reduced by 12-14% since 1995.

The cyclical Western European polybutadiene market, on which EZSK's performance is very dependent, decreased 15% in 1996. EZSK could not maintain its position. In 1996, exports to Western Europe decreased by 30%. This is mainly due to the increase of energy price, and the effects of the rouble corridor that weakened EZSK's competitive position in the export market.

Nevertheless, during this same period, EZSK auto-financed a $2.8 million investment to diversify its production and reduce dependence towards the tyre industry.

EZSK upgraded its production facilities to produce western standard quality high and low molecular polyisobutylene. This product is used in construction and isolation materials. As a result, the overall export figure for EZSK in 1997 is due to increase up to 72,000 tons (1995: 81,000 tons; 1996: 52,000 tons).

And the most significant results is the investment by EBRD. The Board of Directors of the European Bank for Reconstruction and Development (EBRD) has agreed to a syndicated equity investment of $38 million in EZSK, to be undertaken by the end of 1997. This process has been initiated by the consultants working with Efremov in 1994-95.

Project references Technical Assistance programme "EU12" Consultant Arthur D. Little (Moscow) / Warburg / IDOM (Spain) Supervision Russian Privatisation Centre Director of the Company Dr Igor Petrovitch Golberg

28

Case n2: Lutsk bearing plant

Sector Mechanical industry Country Ukraine Activity Manufacture of single-row and needle roller bearings Assistance period February - December 1996

The enterprise before restructuring

The Lutsk tapered roller bearing plant was founded in 1981. The company was specialised on the production of very large series of a short range of tapered roller bearings, mainly directed to the trucks, buses, tractors and farm machinery industries of the former USSR. Its clients were located all over the Union: Russia, Belarus and Ukraine. Lutsk Bearing Plant (LBP) was the youngest company of this sector in the USSR and the major bearings factory in Ukraine.

Since 1994 the enterprise had been transformed into an open Joint-Stock company. In 1995, the general meeting of shareholders had decided to make a second issue of shares, which was subscribed for only by a Swiss bank. The distribution of shares appeared as: 28.3% to the State Property Fund, 52.4% to the employees and former employees, 7% to the Pietet bank from Geneva and the remaining to small holders.

The company product range included 3 main categories of items: single-row tapered roller bearings of high load capacity, especially for heavy farm

machinery, tractors and trucks of middle range (8 to 15 tons), as well as buses and trolley-buses

needle roller bearings which are used in universal joints of cardan shifts and steering columns of automobiles

mass demand goods.

The diagnosis by the consultants

Sales/Markets The analysis of the sales of the past four years showed that sales were falling progressively down to 50% of the capacity: sales In Ukraine had been falling regularly, and there were little expectations of an

improvement because the production of the trucks, buses and farming machinery in Ukraine was in great difficulty, as well as the cars production

on a long trend since 1985, the production of heavy trucks had been slowing down in the USSR, whereas the production of cars had been stabilised around 1995 and was expected to re-develop around large Russian factories (VAZ, GAZ, UAZ, etc.). This had resulted in a severe drop in sales of LBP in the former Soviet Republics. Nevertheless, the decline in sales In other NIS countries stopped from 1994

the export market (outside the former USSR) was promising in terms of sales. Notably thanks to an agreement with a Slovak producer, LBP had started developing sales on this segment

this market picture has to be completed by the spare parts market. This market had a good potential, but to address it LBP needed to organise its network and to be able to develop a large number of product references.

Case n2: Lutsk bearing plant 29

Evolution of the sales

1992 1993 1994 1995

KEY SALES AND MARKET ISSUES: LBP has a very limited

range of products (mostly large diameter bearings)

NIS market remains the most relevant for the company within the middle-term period

vehicle producer in NIS reoriented to the light vehicles production which used more small diameter bearings

foreign market Is the only source of real cash flow for the company

commercial structure is not customer-oriented and market-drawn.

Consultants noticed that the factory had very little knowledge of its costs, especially in a period when a 30% use of the production capacities resulted in a very high level of fixed costs. These segments of the market had also varied characteristics in this respect: in the consultants' analysis, the export sales did not allow to cover the company's

overheads in a full cost calculation. Nevertheless they were the only cash resource of the company

the bearings were sold at higher prices on the NIS and Ukrainian markets, but on a strict barter basis. Nevertheless the higher margins on this market convinced the consultants to study carefully the evolution of NIS vehicles production.

Lutsk Bearing Plant Is operating in an world market characterised by a limited number of producers: a few world class ("quality/price") producers like SKF of Sweden, etc., and several "low price" producers in developing countries, some of them being linked by commercial agreements to western producers. Lutsk was unable to compete: in terms of quality with the quality/price competitors, although its prices were 80%

lower in terms of prices with low price competitors.

The commercial structure of the enterprise looked more like an "orders administration", having many difficulties in taking responsibility in terms of estimates and forecasts. It was not directed to the researching of new foreign markets, and as well unable to set-up an efficient client-supplier relationship with the major NIS clients.

The marketing department had been just established and had no input on enterprise commercial function at all.

Production

The production had been completed by automatic lines for forging, modern machine tools and robots for inner and outer races, and thermal treatment equipment. 50% of the equipment had come from Germany, the rest from Ukraine, Kazakhstan, Uzbekistan and Russia. Depreciation rate was about 50%.

30 Case n2: Lutsk bearing plant

KEY PRODUCTION ISSUES: high proportion of non-

flexible machinery structure and

centralisation of energy and process liquids distribution which led to increase cost

lack of the control over the production cost

environmental pollution and waste of energy

enormous size of the plant, its compartmentalisation and organisation of production in workshops, not on line

lack of quality control.

KEY FINANCE ISSUES: barter terms of payment high overhead and fixed

production costs high level of stocks impossibility to control

products profitability with company calculations

impossibility to determine real (free cash) profit with company financial information.

The factory was designed for the production of 10 million bearings but actually able to produce 7 million, and another set of up-to-date equipment for an additional capacity of 20 million bearings was ready to be installed, when the markets would rise again.

The actual production in 1995 consisted of 2.26 million tapered roller bearings and 1.13 million needle cardan bearings represents 24% of the theoretical capacity of the plant and 40% of the real capacity.

The production was characterised by a series of problems: quality issue: despite some attempts at launching the ISO 9002 certification process

(but without any organisational change) and conformity with ISO 355 for the dimensions of the needle roller bearings and ISO 492 for the accuracy, the global quality of the products was rather law and did not meet the export markets' requirements, out of NIS.

range of products: whereas every major producer of bearings was offering its clients a full range of bearings, LBP had 18 models on Its catalogue but was In fact producing only 11 of them. This made the competitive position of Lutsk even weaker. In order to become a major supplier of the main NIS automotive producers, the plant needed to Increase Its offer. In order to achieve this objective, It had to be considered that about 70% of technological equipment could be characterised by a lack In flexibility. Re-programming the equipment in order to produce smaller series took up to 2 days and caused very high losses.

production costs and price positioning: the very high proportion of Energy and utility in the cost prices (29%) was due to the bad shape of the pipes distributing cutting fluids and utilities, to the leaks and the inefficient monitoring of the heat treatment furnaces leading to a waste of gas. The quantity of defects, due to quality problems, was higher than in western competitors factories. The experts believed that a 20% reduction of cost prices could be obtained through investment in these areas.

Other fixed expenses, like administrative and production staff (personnel represents 17% In the full cost structure) in the context of a low use of the capacity, burdened the costs of Lutsk Bearing Plant.

Quality issues were also involved in the price positioning issue: the physical qualitative aspect of the outputs remained a competitive disadvantage on the export markets and under-pricing was the only means developed by the plant to sell its products, to compensate the low mage of the bearings.

Finance

Even though company had a profit of some $1,632,659 in 1995 it seemed to only appear in accountants' documents. There was no real cash flow because 65% of sales have been a barter-based sales. The lack of cash In the company made it difficult to pay the salaries (up to 5 months delay) and the taxes. It was all the more difficult to launch new productions, requiring the purchase of raw materials.

Management / General organisation

The organisation of Lutsk Bearing Plant was typical of a production-oriented company. The newly-created commercial and marketing department was still under the control of the powerful production director, which made it difficult to manage the production depending on commercial Issues.

The skills of the commercial and marketing department had still to be invested: for instance, export had always been managed by a Moscow-centralised export

organisation, and the skills for foreign trade were non-existing in Lutsk the newly-created marketing team was too numerous and had not a clear idea of their

mission.

Case n2: Lutsk bearing plant 31

KEY MANAGEMENT ISSUES: no controlling system traditional organisation

with main role of production departments

over-employment if compared with capacities being used

rather tense social climate.

Quality control systems were restricted to the production sphere: there were no indicators, no tools for motivation for the commercial and administrative staff.

The social issue was of importance in the company. The company had understood the necessity to decrease fixed costs, and started decreasing staff: individual companies were created by workers leaving the company with their equipment.

In addition, the company offered a full set of auxiliary services, delivered by 300 employees to the workers. They are a canteen, a recreation centre, an hospital, a greenhouse, a farm, etc. But some social assets had already been or were going to be transferred to external authorities (Lutsk city for instance) such as kindergarten or a hostel.

But it was clear that employment would have to be reduced further. This issue had raised the attention of workers and of the local opinion, LBP being the main employer of the region. Besides the traditional company trade union, Lutsk bearing Plant workers had formed another independent Union very active to protect employment and rights.

The recommendations of the consultants and their implementation The implementation of an action plan in Lutsk Bearing Plant, though the financial possibilities of the company were very limited and the social pressure was important, took place thanks to the fact that the management had been associated In the definition of the recommendations and were very active in their implementation. The company involved in the project its top management and decisions were taken rather rapidly.

Sales/Markets a) Strategy

In terms of marketing strategy, Lutsk Bearing decided to: become again a full range supplier for the main NIS clients (MAZ in Minsk, VAZ in

Nijni-Novgorod and others) and potential Ukrainian clients (Lviv buses factory, KrAZ through its joint-venture with Iveco). For this reason LBP improves the range of products and intensify the relationship with these clients

try taking direct contacts on export markets in order to get better margins intensify contacts with top western supplier and be ready to make trade agree

ments with them when the company would have regained market shares.

b) Actions

Strengthening the marketing team

This department was initially heavily staffed (40), and no clear organisation to approach markets and clients. A new commercial director was nominated and implemented an organisation by target client groups. In a second step, the key staff of the department received training from the consultants on the way to approach a client, manage the relationship, relate to the production and finance departments. This allowed progressively the marketing and sales aspect to become the power Centre of the company. The department started building a comprehensive client-supplier relationship with its key clients.

Strengthening distribution networks for the NIS

In order to achieve better sales in particular on the spare parts business, Lutsk Bearing Plant created a network of dealers in Russia and Ukraine. These dealers were trained by the consultants together with the company's commercial department. It was necessary to strengthen the barter department during the transition period. This action aimed at

32 Case n2: Lutsk bearing plant

continuing barter activity and increase the share on NIS market, though improving the quality of the barter contracts and final cash collection.

Research of direct clients

Previously, all export had been done through a Slovak company. Lutsk Bearing Plant and this company together were able to propose a full range of production to their clients. In order to Increase margins on export markets, the consultants advised to seek direct contacts with final customers, and started to take contacts together with the commercial team. Orders for small quantities were obtained and fulfilled. In order to export directly, It was also necessary to design a new packaging and a catalogue in several languages.

Production

a) Strategy

LBP decided to: modify the production management rule to reduce inventories improve quality using the equipment, purchased in 1991 in view of building additional

capacities and still in boxes, on the existing lines (this was a long decision process, because this additional capacity appeared to many managers as a legacy which should not be touched)

ensure a dominating position on the existing market, as It appeared that there was little hope for a recovery of the market.

b) Actions reorganise production into three types of products according to diameters of bearings

(this would integrate tools production and maintenance) re-engineering of workshops, with the redefinition of the role of workshop manager, to

produce the quality and the quantity necessary within a short delay re-engineering of distribution of energy and utilities to reduce their cost activation of the technical department to ensure the growth of the product range and

maximise the use of the available equipment improve quality department by better integration of laboratories and auto control strengthen the purchasing department directly linked to the top management.

Reorganisation of the production workshops

Before restructuring Production workshop of rough shaped rollers before restructuring

Out of order

equipment

Case n 2: Lutsk bearing plant 33

After restructuring Production workshop of rough shaped rollers after restructuring

Strainer Calibrator

Spool holders carousels Strainer

Calibrator

fct\ / j j fch /^fr\

Storage of coils according to wire diameters

Tool storage

Cold stamping machine dedicated according to wire

diameters

LZZICZI s Tool storage

Cold stamping machine dedicated according to wire

diameters

cziizzi rzzi Container for collecting

semifinished spools

Finance

Like in many restructuring projects, money was necessary to effectively restructure the company. In particular, developing each model of bearings required around US$ 100,000 in materials purchases. Therefore LBP had to find money inside the company: limited staff reductions allowed to reduce fixed costs the company sold old equipment, to Vietnam and Iran, and some of the new unused

equipment to western companies.

Management/general organisation

The simplification of the company structure and defeasance from auxiliary assets was continued under recommendations of the consultants. The cooperative, which produces the needle bearings (a totally different activity), the farms, etc. were transform