In general, the Russian economy is a mess: Industrial production is half what it was in 1991, the transition to a market economy has gone badly, the ruble has collapsed, many giant enterprises are in desperate straits, unemployment and poverty are ubiquitous.
And yet, some Russian businesses are actually making money. Some are even thriving. Though criminals and corrupt government officials frustrate entrepreneurs all over the country, some manage to evade or ignore them. The experiences of the few who are succeeding provide some hope for Russia's future, and also some powerful lessons in why that hope remains so remote.
Consider the adventures of Andrei Mladentsev. Four years ago, when he was 26 and flush with cash earned as a successful trader on Russia's first stock exchange, Mladentsev engineered the takeover of the 75-year-old pharmaceutical factory in Nizhny Novgorod. By his own account, the acquisition was touch-and-go for many months. The Soviet-era management, many local officials and the local mafia were eager to see it fail. [Story, Page H11.]
Four years later, with the help of a variety of Western accountants, lawyers, advisers and investors, Mladentsev is presiding over the re-creation of Nizhpharm, hoping to make it the most modern manufacturer of pills, ointments and suppositories in Russia. Helped by the enterprise's strong cash flow (some of its ointments and suppositories are old favorites on the Russian market) and by a $10 million investment backed by the European Bank for Reconstruction and Development (a critical contribution in this capital-starved country), Mladentsev and his band of mostly boyish colleagues are thriving.
They are rebuilding their enterprise, putting a modern, Western pharmaceutical manufacturing facility inside the walls of a typical old Soviet factory--not a face lift, but a replacement of the innards. The workmanship of the new, all-white and sanitary manufacturing facilities is far higher than the old Soviet norm, as is obvious on the stairs between the floors of the factory, where--in contrast to the shiny new facilities--the concrete is crumbling.
Only two of the half-dozen key members of Nizhpharm's management team are over 40, both engineers working in production. They all share a combination of infectious enthusiasm and determination.
The boss likes being the boss. In the executive dining room he not only eats lunch, he presides, clearly the dominant figure in the room. With a foreign visitor present, his colleagues seem reluctant to speak up. The big boss is a Russian tradition, though Mladentsev says he models himself unabashedly on Western examples.
The night before the key 1995 meeting at which he won control of Nizhpharm, Mladentsev recounted, he watched--again--"Wall Street," the Oliver Stone movie depicting '80s greed. Michael Douglas plays the fabulously successful, shamelessly amoral Gordon Gekko, master of the universe and the stock market. "This movie played a big role in my life," Mladentsev said. He realized Gekko was "a negative hero," but nevertheless Douglas's portrayal "inspired me."
"And I can tell you," he added, "the violations [of law and stock-trading rules] that occur in Russia . . . are much worse than Gekko's!"
Thus inspired, Mladentsev won the vote of Nizhpharm's employee-stockholders that gave him control of the company. Difficult choices arose at once. A large distributor of pharmaceuticals in Moscow sent a representative to congratulate Mladentsev on winning control and told him his work was now done. The distribution firm would provide all necessary raw materials and sell everything the plant could produce; in return the distributor would pay a 20 percent profit margin and pay it in cash so taxes could be avoided, plus another 5 percent in hard currency deposited in a bank account overseas.
Mladentsev refused the offer. "I've decided that I can only feel secure in Russia if I obey the law," he said. "I don't have family in the [government] administration, I don't pay bribes." His goal was to transform Nizhpharm into an up-to-date enterprise.
Ultimately he retained an Austrian bank as financial adviser, and on its advice he hired Baker & McKenzie, the huge, international American law firm, to do legal "due diligence." He hired KPMG, the giant American and international accounting firm, to do a full audit that would provide a basis for seeking a foreign investor. He retained the Intermatrix Group, a consulting firm based in London, to help devise a long-term business strategy.
His choices have paid off so far. Sales are up, profit margins are 50 percent to 60 percent, Mladentsev said, and prospects are excellent. His and his partners' original investment of about $1 million is today worth at least $10 million, according to calculations made by the Intermatrix Group. Nizhpharm got the foreign investor Mladentsev wanted, Quadriga Capital Russia, an affiliate of the Frankfurt investment firm Quadriga Capital, which was hired by the European Bank for Reconstruction and Development to administer a regional investment fund in this part of Russia.
Direct foreign investment in Russia is paltry, for understandable reasons. Many foreigners have been badly burned here, and the lack of legal standards and enforcement makes every investment a risk. But the ERBD is backing direct investment as a matter of policy, supported by the rich industrial nations.
Quadriga Capital, run here by an American named Kendrick White, organized a $10 million direct investment into Nizhpharm. In return it got 25 percent of the company's stock and two seats on its eight-member board of directors. Most of its investment is coming in the form of European pharmaceutical-manufacturing equipment.
Nizhpharm's experiences illuminate nearly every aspect of the perils of entrepreneurship in modern Russia. They demonstrate that Russia has gone through wrenching economic changes that at least make experiments such as Nizhpharm possible, but these changes do not yet constitute a sustainable market economy. Everything is different than under communism, but not everything is better.
Politics provides the context for these changes, to the exasperation of many businessmen. National leaders in Moscow and former local leaders in Nizhny Novgorod talked up reform and took the steps that made it possible for Mladentsev and his partners to take over Nizhpharm as a private business, but they have left the reform process in limbo.
The parliament in Moscow, the Duma, has never passed a law enabling Russian businesses or individuals to own land, so no Russian entrepreneur or business has clear title to the ground under their enterprises. Local authorities can't keep their hands off businesses, so Nizhpharm has to pay a tax of a half a percent of all money it invests in the business to support the Nizhny Novgorod fire brigade.
The chairman of another successful enterpreneurial venture described the political problem in philosophical terms. Pavel P. Dudnikov, chairman of Wimm-Bill-Dann, a manufacturer of milk products and fruit juices that cannot yet match booming sales with booming profits, pointed to Russia's reluctant embrace of capitalism in a conversation in his elegant Moscow office: "Society hasn't yet come to a consensus [in support of private enterprise], and people like us [entrepreneurs] aren't universally admired, nor do we seem to qualify for protection from the government."
In the absence of consensus, Dudnikov said, Russia still doesn't have "a full infrastructure or all the needed laws" to support a real market economy. "This government has no program, no strategy, no tactics," he said.
In practice, government action is as likely to frustrate business as to support it. Nizhpharm regards state authority as potentially hostile--and actually hostile in the case of a local official who guided government funds to a competing drug firm. (According to Mladentsev, the father of a local health official was involved in the competing company, a fact that has now prompted a criminal investigation.) Jan Daumann, Nizhpharm's British business consultant, said it was part of the company's strategy to try to insulate Nizhpharm from outside influences of all kinds.
But that isn't always possible. Nizhpharm has to operate in an environment where there is no reliable source of credit, for example. Russian banks are really speculative enterprises that rarely provide traditional support for businesses such as loans or lines of credit. "The whole world lives on credit," complained Viktor Asadullin, Nizhpharm's production director, "but we can't get credit." Nizhpharm finances investments from its own cash flow, and now with the $10 million investment by Quadriga Capital.
And Nizhpharm has to live with the Russian tax code, a bewildering hodgepodge that is more likely to discourage business than to provide incentives for investment and growth. Pharmaceutical companies are blessed with an exemption from Russia's 20 percent value-added tax (VAT), usually applied to all wholesale and retail transactions. It doesn't apply to drugs. But it does apply to Nizhpharm's purchases of machinery. Mladentsev said he has to earn 150 percent of the cost of every new investment so he can both pay for it and the taxes on it. (Under the tax law, VAT does not have to be paid on the machinery acquired in Europe with Quadringa's $10 million investment in Nizhpharm.) Other countries with VAT give credits to companies that make capital investments, but not Russia. Profits are highly taxed, so many companies lie about them. Nizhpharm officials say they are trying to be honest.
Nizhpharm has made a virtue out of the fact that outsiders were able to seize control of Soviet enterprises under the government's privatization program, but other companies have suffered from patterns of absentee ownership that this created. A good example is the Vermani noodle company in Nizhny Novgorod, whose former director, Vladimir Kuzmin, is now a production executive at Nizhpharm.
Vermani's absentee owners, the Alfa capital group and the Inkombank in Moscow, insisted that it sell its production at fixed prices to a distributor Inkombank helped set up, thus limiting Vermani's profits. When the ruble tumbled last August, Inkombank went bust. Vermani could no longer service a $1 million debt it had incurred (from its co-owner Alfa) to buy new equipment, because Vermani owed dollars but could only sell pasta for rubles. Its current director, Viktor Golovachev, painted a grim picture of the company's prospects in an interview here. His predecessor, Kuzmin, predicted the company would have to be sold to get a fresh start.
Russian businesses have to cope with criminal elements and in many cases have succumbed to them. Mladentsev told a harrowing tale of his own run-in with local mafiosi on the eve of his successful takeover of Nizhpharm. Five Mercedes-Benzes drove up to his home in Nizhny Novgorod and a gang of local vodka makers piled into his living room. They told him they had their own candidate for director of the company who would offer himself for election at the stockholders meeting the next morning. They told Mladentsev that, for the sake of his health, he should support their man.
"And I explained to them that they couldn't win with just my votes," because he controlled only 24 percent of the stock, Mladentsev recounted. "You'll just elect the old director" by forcing a split among supporters of change in the company's management, he told them. "Moreover, if you make me do this, I will go right to [local government authorities] and give evidence against you. You can't kill me before the meeting because only I can vote my shares, and right after the meeting I'll go to the [authorities] and you won't be able to get me."
"So they said, 'Well, what can you suggest?' I said we had a vacancy for a chief engineer--if I won the election we could meet to discuss the job of chief engineer." His visitors agreed. Later, when he was director, they proposed someone for that job. Mladentsev by then had hired "security" for the factory. (Mladentsev provided no details about this security. Many companies depend on a "roof," as the Russians call it--an organization, often extra-legal or outright criminal, that offers protection from gangsters for cash.) He told the vodka makers he had already picked a chief engineer but needed an assistant engineer. He actually hired the man his visitors proposed but fired him after a month for poor performance. Since then, he said, the vodka distillers have left him alone.
For Mladentsev, foreign advisers and investors have provided an antidote to negative Russian influences. He said his eagerness to get a foreign partner to invest in Nizhpharm stemmed less from a need for capital than his perceived need to bring Western-style discipline, accounting and quality control to his company. He has made three trips to the United States for training of various kinds, from which he concluded that American individualism and civic consciousness--both rare in Russia, he said--contributed significantly to national well-being.
Now Mladentsev and his colleagues have adopted a foreign standard by which to measure the next stage of their efforts. They are determined to make Nizhpharm the first Russian pharmaceutical firm that fulfills the European standards for "good manufacturing practice" of pharmaceuticals, a rigorous set of rules to assure quality and cleanliness. Foreign connections are important to many successful Russian businesses. Often the most important foreign ingredient is equipment. All of Nizhpharm's new manufacturing equipment comes from Western Europe, mostly Italy. Wimm-Bill-Dann, the large milk and juice maker, imports equipment from Scandinavia, Germany and other foreign sources. Igor Skvortsov, 35, who won control of a stuffed-animal factory in the tiny town of Mstyora, 75 miles west of Nizhny Novgorod, said he is saving money to buy new sewing machines from Japan or Germany.
Raw materials often have to be imported also. The giant American firm Cargill Inc. provides many of the juice concentrates used by Wimm-Bill-Dan. The company is trying to generate local production of tomato juice to reduce its dependence on foreign supplies. Nizhpharm has to import 70 percent of its raw materials for pharmaceuticals and has plans for purifying domestically produced chemicals to make them usable in its production lines.
Since the collapse of the ruble last August, Russian producers have a huge advantage over importers, whose prices quadrupled overnight. The opportunities that have opened for import substitution have helped sustain a modest revival of manufacturing in Russia this year.
Mladentsev and his colleagues want to ride this wave to success and wealth. "It's the project of our lives," Mladentsev said. His understanding with Quadringa Capital foresees taking the company public in three to five years. According to the business plan, sales in 2003, measured in dollars, should be five times what they are today. The goal, Mladentsev said, is that the company be worth $250 million by 2003.
Can their dreams come true? "There's no human brain big enough to know what will happen in Russia in 10 years," observed Oleg Krylov, Nizhpharm's director of human resources. So what is his own sense of Nizhpharm's future possibilities? "I'm here," he replied. "That's my answer."
Mladentsev listed the factors he sees influencing the company's future, most of them beyond his control. Quality of management was one he could influence. The others were the political situation in Russia, the evolution of the ever-changing tax code, the stability of the ruble, and the reliability of the government as, at worst, a neutral factor in Nizhpharm's prosperity.
"Now I spend a lot of time praying about the situation in Russia," he said.
Here are other members of Andrei Mladentsev's team who are working to revitalize Nizhpharm:
Fresh-Faced, Fresh Start
Yuri Gaisinki, 30, was one of the three original partners who bought shares in Nizhpharm in 1994 and 1995, making possible Andrei Mladentsev's takeover of the firm. This year he joined the company as its finance director. "I see big potential for myself, working in the real sector, doing real things," he said.
A professional water polo player in his early 20s and a mechanical engineer by training, Gaisinki got a correspondence-school degree in finance three years ago. Now's he's a master of the Microsoft Excel spreadsheet. Calling up several Excel files on his desktop computer, Gaisinki showed a visitor how Nizhpharm keeps its books identically in English and Russian. He showed a "conservative budget" for the current year, calling for $16.5 million in sales. A more hopeful budget projected sales worth $21.8 million.
Sales in 1998 totaled $21.4 million, but that figure hides a complicated story. For the first eight months of the year the Russian ruble was worth about 16 cents. Then the August financial collapse sent it reeling -- to 4 cents by year's end. So if Nizhpharm can sell as much in dollar terms this year as last, that would represent, roughly, the tripling of sales revenue measured in rubles. And this is possible.
Gaisinki is proud that Nizhpharm is able to pay its workers every month (many Russian businesses have failed to meet payrolls and owe enormous back wages) and has gotten almost entirely out of barter trade. Many Russian businesses swap products and services as a way of overcoming chronic cash shortages or to hide taxable income. Nizhpharm has reduced barter transactions to 8 percent of total turnover.
Gaisinki has enjoyed helping Nizhpharm's employees learn entirely new ways of thinking about their business, from accepting accounting standards that put value only on sales, not on production (the measurement that mattered most in Soviet times) to convincing them that marketing is a legitimate way to spend money.
Oleg Krylov, 35, Nizhpharm's human resources director, moved from Moscow -- where he worked for an Irish company -- to come to work in Nizhny Novgorod in March. He grew up here and his parents still live in Nizhny, which made it easier for him to consider leaving the capital. He got the job by responding to an ad Nizhpharm put in The Moscow Times, an English-language paper.
Krylov began his working life as a navigator in the Soviet merchant marine, then got a business degree in Riga, Latvia, in the early 1990s and moved into personnel work. At Nizhpharm he manages the careers of 680 employees, which puts him on the front line of one of the firm's biggest challenges: converting the many workers who grew up in a Soviet enterprise into productive employees of a private company. "The major problem is the mentality of the workers," he said. The Soviet system "poisoned people's attitudes toward the enterprise," and his challenge now is to create a sense of collaboration. "I try to reassure them that this is a team effort that will bring team rewards."
Will it be necessary to fire a lot of the old-timers? "That is a very difficult question," Krylov replied. "We have to be very flexible," seeking to maximize profit but also to recognize the past contributions of loyal employees. His big concern is middle management. He hopes he can teach his middle managers new ways of doing their jobs. "I try to convince them that I'm not a purely Western-style manager who thinks everything they do is wrong," Krylov said. "I try to reassure them."
The old man of the management team is Viktor Asadullin, 51, the general director responsible for production. A shipbuilding engineer by training and experi-ence, he spent 20 years in a military plant here. (Nizhny Novgorod, known as Gorki in the Soviet era, was a center of military industry.) He came to Nizhpharm as its chief engineer and enjoyed rebuilding the operation. "It was in bad shape," he said. Working for a man who could be his son doesn't seem to bother Asadullin: "I've learned a lot from our young colleagues."
Learning about the market economy has been a priority for him. He's been reading widely and taking courses when he can. During an interview he was carrying an underlined copy of the Russian edition of the Guide to Good Manufacturing Practice for Medicinal Products.
He's proud of the many changes the new management has already made, from redoing all the packaging of Nizhpharm drugs to installing the first equipment enabling the firm to make "hard" tablets as well as "soft" ointments and suppositories. The biggest challenge is "to alter the psychology of the people working here," he said. "In the old days the workers saw themselves as one thing, the firm as something else. Now we have to make the connection, so people realize `If I do well, my firm does well.' "
"We have a lot of wonderful people," Asadullin said, but he also offered a reserved prognosis: "Generally speaking, it could take two generations to really change people's outlook."
At 43, Vladimir Kuzmin, Nizhpharm's chief engineer, is already a veteran of the privatization wars. He was the director of the Vermani pasta company in Nizhny Novgorod in the mid-'90s and tried to make it a modern, profitable enterprise under difficult absentee ownership. Eventually the owners fired him, and he was thrilled to be invited to come to work at Nizhpharm, where he finds the owners much more congenial. "There the bosses always said `can't, can't, can't.' Here they say `do it, do it, do it,' " Kuzmin said.
What he's doing is presiding over the ambitious effort to build a sanitary pharmaceutical-manufacturing facility up to the highest international standards. He has visited firms in the Czech Republic, Poland and Germany to see how it's done. "It will be at least as good here," he promised.
Kuzmin is responsible for the installation of new equipment: Czech wall panels, Italian and German machinery, Austrian air conditioners, Japanese water-treatment equipment. "Unfortunately, our country isn't producing these things," he said.
He, too, sees worker psychology as a key issue, but he is optimistic. "There's a whole new attitude. Before, you'd make a mistake and. . .," he said, using his hand to make an erasing motion, describing the traditional Soviet cover-up. "But not now. Now you get it right."
Nizhpharm's marketing director is Alexander Andreyev, 40, whose willingness to work for the company is a source of special pride to his colleagues. Andreyev was hired from Moscow, where he had a big job working for Danone, the French yogurt company. Leaving rich and bustling Moscow for the relative backwaters of Nizhny Novgorod is a big step in today's Russia, one few Muscovites would consider.
The Danone job -- vice president for business development -- lost its appeal for Andreyev after the currency crash of last Aug. 17 -- "the blackest day of my life," he called it. Faced with the overnight quadrupling of its hard-currency costs and prices, Danon told him he would have to fire all the people he had recently hired to his new unit of the company.
When he came to visit Nizhpharm, Andreyev said, "to my surprise, I felt a certain pride that something this good could be done in Russia." He decided to plunge in.
Andreyev has an MBA from the Moscow affiliate of California State University at Hayward, where he learned the modern marketing concepts he wants to use "to move Nizhpharm from a product-oriented company to a market-oriented company." He is trying to teach his new colleagues how they can strategically reprice their products to gain maximum advantage, either by boosting market share in important niches or by exploiting product popularity to increase profits.
Next he hopes to "completely rebuild the sales department." The idea of creating a team of creative, energetic salespeople is a new one in Russia; Andreyev says he is excited to try it. "Honestly speaking, I don't see any obstacles to making this a great success," he said.
Business: One of the 10 biggest drug-manufacturing companies in Russia; its products include pills, ointments and suppositories.
Based: Nizhny Novgorod, Russia
1999 revenue (projected):
1998 revenue: $21.4 million
Chief executive: Andrei Mladentsev
Web address: www.nizhpharm.ru
CAPTION: An ointment-tube filler in the Nizhpharm pharmaceutical plant at Nizhny Novgorod, where standards are far higher than under the old Soviet system.
CAPTION: Western-style marketing is evident in this publication by pharmaceutical firm Nizhpharm.