James M. Silberman, Leland M. Cole
Introduction and Survey Characteristics
1. Under the auspices of the Cincinnati-Kharkiv Sister City Project, a team of two industrial specialists, conducted an in-depth investigation of those industry sectors in Kharkiv vital to the maintenance of living standards and to the employment prospects for the largest enterprises in the city. The work was funded by the Stella and Charles Guttman Foundation. The survey covered in-depth reviews of management, manufacturing equipment, and operations; business plans; output levels; product analysis; marketing procedures; employment and welfare; and factors inhibiting increased output and lower production costs. The objective of the survey was to assess both the existing managerial and technical capabilities of industry, and the possible relevance of a specific form of study-tour based training program based on the successful Marshall Plan technical assistance programs.
2. The team spent some six months in preparation reviewing available economic data from Ukraine and Kharkiv and conferred with officials of the USAID, the World Bank, and foundations active in the CIS. Documentation was obtained on past USAID technical assistance efforts, the recent World Bank-funded study tour experience in Kazakstan, and on new support programs for private enterprise. A large group of U.S. firms with international operations was visited for comparison purposes. The Ukrainian survey took place from May 2 through May 31, 1995.
3. The broad industrial sectors selected for the study included: (i) basic consumer goods, in light of their importance to the economic and political future of the country, namely foodstuffs (processed meat and sausage, processed dairy and oil products including cottage cheese, edible oils, margarine, cheese, sour cream, and bread and biscuit baking) and garments (working clothes, men’s and women’s outer-wear, dress and casual clothing, and shoes) and (ii) civilian goods output resulting from conversion of defense manufacturing facilities, to assess the impact of conversion to date (including consumer radio equipment, medical testing apparatus, diesel standby units, small farm grain mills, small farm tractors, all terrain vehicles, and educational aids). Distribution channels were also surveyed including retail sales establishments, small vendors, and the gray and black markets.
4. A representative sample of enterprises was sought with the help of the Kharkiv Department of Economic Development (DED), the Department of Foreign Economic Relations, the Kharkiv International Department, USAID, and both Kharkiv and international investment banks. The sample spanned the range from small to very large enterprises; and included wholly private ventures, recently privatized state companies, joint stock companies, cooperatives, state enterprises, and processing facilities of collective farms. Some 25 enterprises were surveyed, which operated more than 130 plants and employed more than 67,000 workers. With respect to private enterprises, the sample included a somewhat larger share of successful ones.
5. Virtually all of the enterprises were “insider” or management controlled, and appeared fiscally conservative. No unsustainable wage increases were reported. Inventory levels also appeared reasonable as were receivables. Labor appeared to be shed appropriately to contraction of production. In fact, due to production stoppages, a number of manufacturing enterprises were not in operation at the time of our visit, for various reasons. Some lacked material and packaging supplies. Others lacked replacement parts for equipment. Many faced declines in demand due to competition of imported goods. In some cases the firms were seeking alternate products for their firms. It also was evident in other firms that workers had been called-in to man a single production line for the benefit of the survey team.
6. Finally, regarding the stated normative objective of the survey, a surprising knowledge of the Marshall Plan existed in the Kharkiv area, despite the Soviet-era ban in the 1950s on participation in Marshall Plan aid and technical assistance. There was a general familiarity with the impetus which the Marshall Plan technical programs had given to European recovery; in one case, extensive studies even had been made and a book published on the subject. This knowledge of past technical assistance to Europe contributed a valuable acceptance by Kharkiv industry and management to the objective of this study.
7. Detailed visits to enterprises in Kharkiv revealed a snapshot picture of Ukrainian industry, struggling to adjust to harsh new conditions. The following paragraphs outline some of the most striking findings, including a continuing isolation from market practices prevalent in the West and the Far East, an alarmingly high level of industrial integration, an absence of outsourcing, and extremely primitive marketing practices. A surprising finding based on visits to several extremely large state enterprises is that there appears to exist substantial management potential in these firms, in spite of very severe product knowledge and design gaps. The type of mind set change facilitated by Marshall Plan-type study tours seems very relevant to help address these shortcomings.
8. Legacies of isolation. There was no evidence in any of the companies visited of technical assistance or benefits gained from American or European consultants provided by external aid or training programs. Nor was there any evidence of management, marketing or product design know-how transmitted by the above channels from the West. For this not-insignificant array of Kharkiv industry and agricultural product enterprises, it was as though the isolation during the Soviet era command economy period still persisted.
9. A significant number of the top and middle managers had visited the U.S. or Western Europe at one time or another, but few had succeeded in seeing comparable facilities as theirs, nor had they gained an understanding of the role of product design, production management, packaging, or marketing in a form that they could utilize. Their short visits to a single plant abroad had little or no major beneficial impact on their production or costs.
10. There was a surprising insularity that has carried over from the isolation of the Soviet period. Although there were readily available examples of consumer goods from the West, they were not studied or examined for the purpose of incorporating features, design elements, or material and labor savings as has been the practice in the West and Far East. There was little effort to reach for world competitive level product design and manufacturing performance with the exception of the garment industry.
11. The persistent isolation from the West has resulted in a costly lack of knowledge of comparative equipment from competing suppliers and a consequent inadequate understanding of cost benefit ratios in equipment acquisition. Poor and costly choices are often made by companies. Most companies have not learned that overall productivity is the result of a myriad of small improvements in methods, processes, worker task design, product design, and cost control. Ukrainian firms appear to identify productivity with machinery and equipment and believe that once new equipment is acquired, high productivity will result. Some plants even appeared to be over-equipped by Western standards.
12. Finally, the isolation from a market economy has resulted in a widespread confusion between money prices and real prices (defined as the number of hours worked to buy a unit of product). Often establishments feel they have achieved market performance if their money prices for products reach equivalent levels to those of the West. In real terms, however, prices of both essential and consumer goods are often many times higher than those of the West. The avenue to reaching equivalent real prices to those of the West is not well understood.
13. Excessive integration. Private enterprises today in Kharkiv are repeating the pattern of either vertical integration or the disparate accumulation of facilities for a wide range of products, characteristic of industry during the Soviet era. Firms were moving into new products, sometimes with little or no access to expert technology. This dynamic venture growth into related or new areas of production was unusual even in European and U.S. experience. For example, a large shoe company expanded into banking, insurance, garments, and was poised to go into beverages and sausage production. A small garment manufacturer was installing a sunflower oil extraction plant and was undertaking production of animal feed, flour milling, distilled beverages and oil additives for paints. A diversified meat, fish, and dairy processing firm was expanding into cattle feeding, hog breeding, and grain storage. It may be understandable that companies with funds to invest seek readily available markets and equipment for new avenues of production. However, this results in firms becoming involved with excessive spans of technology and management supervision, with production often locked in high cost low volume batch type output. There is little understanding that lowest real costs can only be achieved as in the West by maximum investment and large scale production of single or closely related products.
14. The survey indicates that the prevailing private enterprise and privatization trend to vertical integrated plants or disparate agglomeration of product outputs will in the near future create problems of crisis proportions. Product supplies eventually may become more readily available, but real costs will be frozen at high levels compared with industry in the West and Far East. Once this pattern of vertical or disparate production is firmly established it will be difficult to correct. It may be acceptable or necessary at present, but Ukrainian industry must soon understand the high costs of this pattern of production. Perhaps one of the most direct ways to convey an understanding of the relationship of high productivity output to low real prices is by a mass exposure of Ukrainian entrepreneurs and managers to Western and Far Eastern production practices.
15. Lack of outsourcing. Outsourcing has been one of the most important means whereby the developing and often primarily agricultural economies of the Far East and Asia have obtained world level technology and production performance during the past 30 years. Fueled by the enterprise and funds of the overseas Chinese, materials, equipment, machinery, and product models were sent by the West for outsourced manufacture. This process had a powerful impact on the developing industries, and brought with it all the disciplines and understanding of modern, world level production efficiency and competitive costs. In contrast, in Kharkiv, only one company surveyed manufacturing garments was producing to outsourced orders from the U.S., Canada, and France, and these orders accounted for 90% of their output. The company received patterns, yard goods, and labels plus findings and was able to achieve levels of productivity to compete with other countries for their orders.
16. Outsourcing can be spread to various other Kharkiv light manufacturing industries, and may answer some of the problems of material and key equipment shortages. For example, Hong Kong companies often ship equipment together with materials in garment industry outsourcing. This also may be part of the answer to defense industry conversion, but substantial technical assistance steps will be needed to initiate and accelerate the process.
17. Weakness in marketing. A lack of packaging materials, product labels, containers, and efficient packaging equipment has severely retarded the domestic growth and export potential of many, perhaps most firms. In virtually all enterprises visited there was at all levels of management an almost total lack of understanding of marketing requirements for export. A number of Kharkiv products in the food and beverage fields have excellent prospects for export. Impediments included appropriate containers, labels, and packaging; and even more seriously a lack of knowledge of Western purchasing and distribution practices. This persists despite visits by Kharkiv managers to the West.
18. Products from Eastern Europe and the West with attractive packaging have given the Ukrainian consumer a belief that imported products are superior, even at higher prices. The problem is even more serious in light manufacturing and defense conversion enterprises. Many of the civilian products now made are seriously outdated and unmarketable even in Ukraine, and few of the defense firms have the potential for large scale production which can employ the numerous displaced workers. Only by a thorough study of Western and Ukraine markets can these industries develop competitive products with a promise of large scale production and employment. If effectively assisted, the small container and packaging industry could act as a catalyst for consumer acceptance of Ukrainian products and for export growth.
19. Challenges of conversion. Three very large state or former state enterprises employing until recently a total of 41,000 employees were visited. Comprehensive discussions were held with management, research and marketing executives and an examination was made of their heavy industry products and their civilian consumer goods both in development and in production. Some of the firms date back to 1885 and the early 1900s and they have survived decades of drastic product manufacturing changes. Over the years, they have been involved in a wider range of manufacturing technologies and products than in most Western companies.
20. Far from being characterized as “Dinosaurs,” deserving of little or no technical assistance and destined for closure, these large enterprises are characterized by a gap in product design and technology (with that of the West today) no greater than the case of British, German, and French enterprises (with that of the U.S. in the late 1940s and 1950s). With the aid of Marshall Plan technical assistance the European productivity and marketing gaps were closed in some five years or less and the product design gap within a decade. There is no reason to believe that comparable progress cannot be made in these large plants unless the macro-economic conditions deteriorate further. Even with the persistence of present fiscal restraints, these large plants can make notable improvements in product development, redesign, and modernization and in marketing, with the help of management, technical and marketing-type study tours.
21. All of the above firms showed management potential to accomplish the above improvements, and a willingness, even eagerness, to participate in such study tours. Since conversion is the objective of Nunn-Lugar funds, and assistance the objective of the Western NIS Enterprise, Defense Enterprise, and Ukrainian Funds, we believe that widened product redesign will be necessary before U.S. firms find association with these large Kharkiv enterprises attractive. These large Kharkiv firms have the drafting and engineering resources to upgrade their present conversion product models. They also appear to have machine tooling and assembly line resources for initial small scale output, a necessary beginning stage.
22. Given the massive employment of these large enterprises, and their unique capacity to produce utility and heavy products which cannot be matched by private enterprise for many decades to come, it is difficult to argue that study tour assistance should not be extended to this sector. The long isolation of these firms from the West has left such a severe product knowledge and design gap, that only widespread contacts with Western firms can begin to remedy the problem. No level of U.S. consultant services in situ can conceivably accomplish this remedial change.
23. Inattention to distribution and consumer markets. Moving from the sphere of the enterprise to that of the consumer, wide ranging talks with a cross-section of Kharkiv residents revealed an almost somber sense of resignation and pessimism. Much of the consumer’s existence is lived at the edge, with barely sufficient income to cover food and some clothing. With the gray markets (the main source of goods for all but the wealthy) continuing to be filled with lower cost clothing from Turkey and the Far East, the consumer appears to have little faith that Ukrainian industry can supply comparable goods except in the distant future. This in effect places producers out of touch with consumers, with Kharkiv production continuing in high cost, high priced, consumer goods. There appears to be no break in this cycle, with Ukrainian producers refusing, or being unable, to make a beginning in mass output of low cost products which are within the expendable resources of the lower income groups. The same situation is true to a lesser extent with processed foods. Although somewhat more affordable, the real cost of processed food is several times that of Western Europe and the U.S. Were it not for urban family gardens and a return to a type of Ukrainian village existence, the mass of the population could not survive.
Recommendations for Technical Assistance
24. While the better private entrepreneurs and privatized establishments covered in the survey appear to be expanding with vigor, the trend to vertical integrated operations and multiple small scale manufacturing of disparate products will freeze future output and living standards at relatively high real cost products to the consumer. This situation is believed to be critical. Based on what we have seen in Kharkiv, one of the most effective means to turn around the direction of new investment in the longer run appears to us to be through mass visitation of entrepreneurs and decision-making managers to comparable Western companies through the Marshall Plan-type study tour approach.
25. Short term visits by individuals or apprenticeships to the U.S. have not accomplished this in the past and cannot in the future. Nor can U.S. consultants turn around the production and investment practices in a foreign firm into directions the owner and managers do not understand. Furthermore, consultants to individual firms will not turn around a whole industry. To orient Kharkiv industry in the high productivity practices of U.S. industry and the marketing know-how which achieves new low cost products desired by consumers is to inculcate Kharkiv industry in a new complex industrial consumer culture. This requires mass exposure and studied observation by Kharkiv industry decision makers in comparable industries and plants.
26. The only proven technical assistance method to accomplish this is the Marshall Plan type study tour approach. It has been proven in Western Europe and has been proven as modified for CIS nations in Kazakstan, where two pilot study tours are being followed by ten additional study tours, financed by Kazakstan under part of a World Bank loan.