James Silberman, Leland Cole, Charles Weiss Jr.
Published in the January/February 1996 issue of The International Economy magazine
Kharkiv The four week, springtime visit by two of the authors to the factory floors of 25 representative firms and farms, which operate 132 facilities and employ 67,000 workers in this major industrial city near the Ukraine-Russia border, raised questions of urgent geopolitical importance concerning current strategy for speeding the former Soviet Union’s transition to a market economy.
A “Weimar with nukes” scenario looms if consumers in these countries cannot foresee that free markets will soon improve their quality of life through productive jobs and affordable consumer goods.
We know of no comparably-detailed review of the managerial and technical capabilities of industry in Ukraine, for the enterprises we visited ranged in size from shops employing 60 workers to firms employing 18,000, and they covered the gamut of ownership patterns: largely private and privatized enterprises; joint stock companies; cooperatives; state enterprises in the process of privatization; and processing facilities of collective farms.
The study included an in-depth review of management; manufacturing equipment; products and operations; marketing procedures; employment and welfare; levels of output; business plans; and factors limiting expansion of output and reduction of costs. We also surveyed distribution channels including retail stores; small vendors and the markets; kiosks; street vendors; and stalls that constitute the black market. The study was funded by a grant from the Stella and Charles Guttman Foundation.
Due to the importance of consumer goods to the economic and political future of the country, we focused on companies producing basic consumer goods for the domestic market, especially foodstuffs (processed meat and sausage, dairy products, canned fruits and vegetables, edible oils, bread and biscuits) and garments (working clothes, man’s and women’s outer-wear, dress and casual clothing, shoes).
We also observed the products of converted defense manufacturing facilities, including consumer radio equipment, telephone systems, medical testing apparatuses, diesel engines and generators, small farm grain mills, small farm tractors, all-terrain vehicles, and household appliances. Ukraine was once one of the centers of “high-tech” military and aerospace production for the old Soviet Empire, so converted defense plants (many of which have long produced medium-tech consumer goods like television sets and automobile parts) are important assets to future industrial growth.
We were most surprised by the competence of the management located in the medium and large state enterprises, whether already privatized or in the process of privatization. According to received wisdom, such enterprises are considered to be “dinosaurs”, filled with antiquated equipment, managed by torpid bureaucrats, and producing goods of poor quality. Instead, we visited factories turning out serviceable although dated products and managed by former communist apparatchiks who were often superior in competence to many of the start-up entrepreneurs comprising much of the new private sector. The former apparatchiks were managing large, often highly-mechanized facilities with adequate administration of production, product, inventories, and receivables. Some of these enterprises date back as far as 1885 and have over the years successfully weathered major changes in product and output.
Also surprising was the fact that the privatization of Ukrainian industry, although now advancing, is not leading to an industrial economy producing consumer goods affordable to the ordinary Ukrainian citizen. To be sure, the better Ukrainian private entrepreneurs and privatized establishments we visited appear to be prospering and rapidly expanding. These private businesses are not, however, the harbingers of a new era that will improve the quality of life by bringing low-cost, domestically mass-produced goods to Ukrainian consumers. On the contrary, the new private firms are almost exclusively small cottage industries, which, like their large-scale counterparts, are producing high-cost products for the old nomenklatura and the nouveau riche.
There is little export-oriented outsourcing of the kind made familiar by the newly- industrializing countries of the Pacific Rim, despite the potential importance of such off-shore manufacture as a source of technology and of product and market information. Perpetually short of capital and of raw materials (with the exception of foodstuffs), these small firms reinvest profits back into the businesses, diversifying into new products for high-end local markets rather than expanding production of goods in order to lower costs and gain access to new domestic markets. The resulting diversification can be extreme. A small garment manufacturer we visited was expanding into sunflower oil extraction, animal feed production, flour milling, beverage distillation and manufacture of oil additives for paints. This trend to vertical integration and agglomeration of unrelated small-scale production lines will be difficult to reverse, and in the long run will minimize productivity and thus purchasing power.
If Ukrainian firms are to produce low-cost consumer goods for their own local market, they will first have to overcome their extreme insularity, a result of Ukraine’s isolation during the 70-year Soviet period. Except for garments and a few food products, we found little effort to reach for world competitive level product design and manufacturing performance. Western goods are readily available, but are not studied, adapted or copied, as they would be in the West or the Far East. Thus newly-designed Ukrainian products (medical equipment or telephone exchanges, for example) may be decades behind world standards in design and performance. Neither small entrepreneurs nor managers of large firms have a sense or how consumer products are designed, labeled, packaged or marketed in the West.
As a result, many domestic factories have been forced to reduce production, while consumer needs are increasingly met by goods imported from China, Turkey and Eastern Europe. While these products are often more expensive and of no better quality than Ukrainian goods, they have vastly better packaging and labeling and are therefore believed to be superior.
Nor did the enterprises we visited understand marketing requirements for export. A number of Kharkiv food and beverage products could be exported if they had better containers, labels, and packaging and if their manufacturers had a better understanding of Western purchasing and distribution practices.
In light manufacturing and defense conversion enterprises, the situation is even more serious. These firms have ample design engineering staff and adequate technical resources to improve their production methods, but many of their products are so outdated and poorly designed that they are unmarketable even in Ukraine. U.S. firms therefore are unlikely to find these firms to be attractive partners for joint ventures until they have redesigned their entire line of civilian products, including those still on the drawing boards. This problem is likely to defeat the efforts of the funds established by the US government in order to facilitate the conversion of Ukrainian defense industry to civilian purposes by encouraging their association with U.S. firms.
The persistent isolation from the West has also resulted in a costly misperception that new, preferably imported manufacturing equipment automatically results in increased productivity. Managers do not realize that overall productivity results from a myriad of small improvements in methods, processes, worker task design, product design, and cost control. Unaware of cost-benefit analysis and of the choices available to them, managers sometimes made costly mistakes in capital investments. Some plants even appeared to be over-equipped by Western standards.
None of the companies we visited showed any evidence of having received or benefited from any technical assistance from seminars or training centers, or from American or European consultants provided by external aid organizations. A few top and middle managers had made short trips to a single plant in the U.S. or Western Europe. Few had managed to observe facilities comparable to their own, nor had they gained an understanding of the role of product design, productive management, packaging or marketing in a form that they could understand and use.
The situation is discouraging; the mood of Kharkiv consumers is somber, resigned and pessimistic. The typical Kharkiv consumer has barely sufficient income to cover food and some clothing. The newly rich do not constitute a large enough market for volume production. But experience in Western Europe after World War II shows that the situation is far from hopeless.
The situation we encountered in Kharkiv in 1995 was in many ways similar to what one of the authors, Silberman, found on his first survey for the Marshall Plan to Western Europe in 1948 just after World War II. There, too, local producers had been long isolated form world trends in markets and technology, and many employed old-fashioned, small-scale technology to produce high-priced goods for the upper ends of local markets, ignorant of possibilities for mass production of consumer goods that would contribute to political and economic stability.
The present gap in product design and technology with that of the West is no greater than the gap that existed between British, German, and French enterprises and those of the U.S. in the late 1940’s and the 1950s. To overcome this isolation, the U.S. brought 24,000 Western Europeans (and later several thousand Japanese, Koreans, and Taiwan Chinese) on 1,500 carefully designed and supervised short-study tours to America, to see first-hand how manufacturing should be managed, and to learn about low-cost consumer goods they had never seen. These tours were followed up by several months of extension work by returned tour members in their own countries, and with technical services but very few consultants! from the U.S. to help in the absorption of the new ideas. By contrast, the visiting American and European consultant is the backbone of virtually all present programs of technical assistance to the entire former Soviet Union.
Silberman conceived and launched this program of study tours, which ran from 1948-61 and consumed just 1.5 percent of the funds of the Marshall Plan. With the aid of this technical assistance, the European productivity and marketing gap was largely closed in some five years or less and the product design gap within a decade.
Comparable progress can be made in the Ukrainian plants we visited and in Ukrainian industry in general, both large and small, if macro-economic conditions do not deteriorate further. Contrary to current strategy, there is no reason to dismiss the large Ukrainian plants as economically unfeasible dinosaurs to be excluded from technical assistance and destined for closure if they cannot succeed after privatization. These enterprises employ massive numbers of workers and will be the only firms with capacity to produce utility and heavy products for many decades to come. All the firms we visited demonstrated management potential to improve and a willingness even eagerness to participate in study tours. They are equipped to make notable improvements in product development, redesign, modernization and marketing, if exposed to the benefit of study tours devoted to management, production technology and marketing.
If Kharkiv industry is to improve its productivity and reorient itself to producing and marketing competitive, low-cost consumer products, it will have to be inculcated with a new and complex industrial and consumer culture. Even private firms have been isolated for so long that they cannot understand the advice of Western consultants, and they thus derive only limited benefit from the narrow exposure they receive from the internships and discussions with single firms and individual experts, which are the heart of present strategy.
This huge gap in knowledge can be overcome only by massive exposure of decision- makers in Ukrainian (and by extension, of former Soviet) industry to comparable industries and plants in the West. The managers of large enterprises in Kharkiv which provide the bulk of the consumer goods and the employment are able and receptive to new ideas but are extremely isolated. They understand production but not marketing or product design. They will learn quickly if they are brought to the U.S., Japan and Western Europe for structured exposure and studied observation, so that they can experience how a modern economy works.