How to Manage a Venture in Eastern Europe

by Kevin McDonald

This article was published in the Wall Street Journal Europe on May 10, 1993. The article was adapted from "Why Privatization is Not Enough," published in the May-June 1993 issue of the Harvard Business Review.

Most Western businesspeople believe that privatization is the key to salvaging state-owned enterprises in Eastern Europe. According to the conventional wisdom, privatization invariably improves corporate governance, management, and performance. My experience with dozens of companies in Eastern Europe, mostly in Poland, has convinced me that this is an incomplete truth and, like a runway that is a bit too short, extremely dangerous.

The reality is that making a state-owned industrial firm competitive is a colossal task. In most cases, it requires an infusion of new management, or experienced shareholders who can upgrade management. Without such support, Eastern European companies tend to operate along the lines learned in the days of central planning, insider control, and relentless focus on production. But when these same enterprises receive support from strong, capable - most often Western - shareholders, they have shown that they can perform to international standards.

The difficulty of transforming a state-owned enterprise into a viable company is illustrated by the French electronics giant Thomson, which has recently completed a turnaround of the Polish enterprise Polkolor, a producer of picture tubes for color television sets. When Thomson in effect acquired Polkolor through a joint venture in May 1991, the latter was insolvent and had halted production. There were still 4,500 employees on the payroll, but no cash to pay them. Polkolor urgently needed better management and the things good management can create or attract - skills and procedures, productive work attitudes, and capital.

Step One: Troubleshooting

For example, although Polkolor did highly skilled work in the preparation and assembly of parts and materials - work requiring extensive quality control - the defect rate in the final product was 12%. There was no way the enterprise could overcome its troubles without tremendous operational and financial restructuring.

Thomson agreed to invest $35 million and to pay one year's full salary for the 1,000 employees whom the new, more efficient enterprise did not need. The Polish government agreed to convert old bank credit into equity in the joint venture and to let Thomson import components duty-free.

Thomson's managers identified two sources of Polkolor's operational difficulties. One was cultural: employees lacked a sense of responsibility to the organization and to themselves. They viewed a job as a necessary evil and felt unmotivated to work productively or carefully. Absenteeism was high and concern for quality was lacking. There was little interest in the performance of the firm as a whole and no feeling of team spirit.

The second was structural: Polkolor lacked basic tools for measuring quality and tracking inventory. Its solution to customers' problems was to accept returned merchandise and write it off.

Thomson attacked the problem of morale and commitment by providing employees with leadership, exposure to Western companies and cash incentives. It installed Western managers in eight out of 12 top management positions, with seven of the eight speaking Polish fluently. It sent Polish managers and workers overseas for training and conducted over 10,000 man days of training in the plant-not counting daily English lessons for all employees. It also raised salaries by an average of 122%, to a level 60% above the national median.

Thomson addressed the quality problem in two ways. First, management introduced new quality control procedures, recordkeeping, and technology. Second, the firm adopted new productivity targets and began posting employees' accomplishments on bulletin boards.

To be sure, there were problems along the way. Thomson had to replace more than 8,000 square meters of broken glass and 100 kilometers of pipe in the factory itself. It also had to scrap a $6 million furnace bought by Polkolor just one year before the joint venture was formed.

Nevertheless, he operational results have been dramatic. The overall defect rate is now approximately one out of 200, which is lower than Thomson in Europe or the U.S., and comparable to quality rates in Japan and Korea. The company has also improved product safety and has greatly reduced inventory. What's more, the plant has gone beyond its initial role of assembling imported components. It now manufactures the most difficult parts of the picture tube, and has become Thomson's sole supplier of picture tube masks.

The joint venture has also achieved impressive financial milestones in just 16 months of operation: sales have doubled, and exports to the West have reached 60% of output - from nothing two years ago. Production is now 1.2 million tubes per year versus a peak of 700,000 before Thomson came on the scene - despite a 25% reduction in personnel. The joint venture generates a large operating profit and paid $10 million in taxes last year. None were paid by the former state-owned enterprise.

As a result of all these changes, morale is markedly higher and the rapport between managers and workers is good. By last fall, absenteeism had dropped to 3%, compared with 7% to 11% at Thomson's facilities in France and the U.S.

The effort required to turn Polkolor around is not unusual in the East. Janusz Dabrowski, an economist at the Gdansk Institute in Warsaw who has carried out a study of 11 Polish privatizations, insists that dominant shareholders such as Thomson are the key to improving corporate performance: "The reason is that there is new capital investment, access to new markets, and influence on management and the organization of the enterprise."

Unfortunately, the flip side is all too easy to find. There are countless examples of firms either kept in state hands or sold to employees or quasi-state agencies without bringing in new management or retraining existing management. They will remain industrial dinosaurs.

One such case is Krosno Glass Works (Huta Krosnienskie Huta Szkla), which was privatized by an initial public offering in 1991. Krosno employs 4,800 workers in six plants in southeastern Poland, generating revenue of approximately $35 million a year. The company exports 50% of its output to 25 countries. Most exports are sold through Minex, a formerly state-owned foreign trade organization that was recently bought by employees.

Krosno's shares were sold to inactive investors with no involvement in the glass industry outside Krosno. The Government of Poland now owns 35% of Krosno, small investors hold 28%, the Polish Development Bank has 15%, the foreign trade company Minex owns 10%, and 7,000 current and former employees hold 12%.

Since privatization, Krosno's revenues have fallen dramatically, mainly due to the global recession. Sales' are down for all products except hand-blown glass, now the company's only profitable product line. Management's principal response has been to fire one-third of its employees, without making a significant effort to increase sales. Indeed, the company does not even have a product catalog.

Misguided, Management

A former sales manager blames management for making obvious mistakes: "Management should have added capacity in hand-blown glass, but they do not know how to raise capital. So instead they laid off as many people as they could, Some of the people they laid off now make hand-blown glass in competition with their old employer! Meanwhile, Krosno did not fire enough workers to become profitable; the company still operates two plants that are clearly losing money. So management has continued losing money and has also put new competitors in business!"

The board's only response so far has been to replace the company's president twice in two years - first with an outsider and then with a 30-year company veteran - to no avail. All three of the men who have led the company over, the past two years were trained and seasoned in the communist environment, which emphasized production and labor,


Kevin McDonald
25 years of experience in investment banking, consulting, private equity, and international business
Michael Lehner
In the high technology field for 30 years, as an operating manager, consultant, venture capitalist, and investment banker
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