A Gleam of Hope for Russia Inc.

Productivity is exploding, and foreign capital may follow

Peek inside the Cherkizovsky meat-processing plant, and you'll see red sausages streaming from sparkling machines made in Germany. In another wing, turkey and ham are processed and packed into brightly colored, vacuum-sealed packs. Such scenes might seem prosaic in Chicago or Cologne. But in Russia, this is a scene from the economic revolution. Thanks to $20 million of investment in new product lines and equipment, the Cherkizovsky group, which includes eight other meat-processing plants and chicken farms across Russia, boosted productivity by 21% in 2001. And the modern packaging lets the company charge higher prices. "People are ready to pay more for quality," says Cherkizovksy's president and majority owner, Igor Babayev, 52. Nearly bankrupt in 1998, Cherkizovsky last year notched profits of $35 million on sales of $350 million.

Cherkizovsky is far from unique. Russian industry has ratcheted up productivity gains of 31% since the August, 1998, collapse of the ruble, according to a recent study by Peter Boone, head of research at Moscow brokerage Brunswick UBS Warburg. That's an astounding record, and one that could help Russia attract the foreign investment it needs.

Even Karl Marx understood that productivity is the crux of capitalism. It's hourly output per worker, and for years before and after the collapse of the Soviet Union, Russia's workers were at the bottom of the league tables. Training was poor, motivation lousy, factories antique. Without better productivity, Russia couldn't generate the extra capital needed for more investment, or produce the returns that would attract outside capital. "Labor productivity and efficiency levels have been Russia's biggest problems since the Soviet era," says Ruben Vardanyan, CEO of Troika Group, a Moscow financial services firm.

Even today, most of the country's plants perform dismally. But at least some Russian executives--mainly owners of privatized companies--are realizing that to make money, you have to spend money. Windfall gains from high oil prices, along with a renewed taste for Russian-made goods after devaluation pushed up the price of imports, have helped CEOs find the dough.

Leading the pack is Russia's No. 2 oil producer, Yukos, where productivity has doubled since 1998, thanks to a $1.3 billion investment in new fields and technology. Yukos has cut costs per barrel from $7 in 1998 to less than a third of that. Profits climbed 48% in 2001.

Food processing is not far behind oil. Since 1998, Russia's leading beer companies, Baltika Brewery and SUN Interbrew, have raised productivity by 58% and 72%. Baltika, majority-owned by Britain's Scottish & Newcastle and Denmark's Carlsberg, spent $20 million last year on software to improve distribution. Net income grew 54%, to $128 million. Petrosoyuz Industrial Group of St. Petersburg has kicked Unilever Group's Rama brand out of the top spot in the market for spreadable butter after buying Western equipment five years ago. Now, H.J. Heinz Co. and Kraft Foods Inc. are talking to a newly profitable Petrosoyuz about a strategic investment.

The biggest productivity gains have been made at privatized companies. Mammoth state-controlled enterprises such as Gazprom and Unified Energy System have been slow to make changes. It costs state-run oil company Tatneft $4.5 to produce a barrel of oil, double what it costs Yukos. Still, more and more Russian managers are getting the message. Consultancy firm McKinsey & Co. has doubled the number of employees in its Moscow office since 1998 to cope with growing demand for advice on how to raise productivity. And boosting productivity means deploying capital. "There will be no further growth without investment," says Christof Ruehl, chief economist at the World Bank in Moscow.

That's a point well understood by President Vladimir V. Putin. He's doing everything in his power to make Russia more attractive to foreign investors, including cutting taxes, beefing up disclosure rules, and lobbying to get Russia accepted into international trade organizations. But the best thing he could do is privatize more state companies--and force them to be productive to earn profits.

By Catherine Belton in Moscow

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