Preface	Background	Agribusiness in Russia	Collectivized Agriculture
Agricultural Reorganization	Nizhni Novgorod	Economy	Agribusiness in Novgorod
A.O. 'PRAVDA'	Description of the Farm	Research on Pravda	DISCUSSION ISSUES
Price Disparity	Distribution Channels	Human Resources	Integration and Diversification
QUESTIONS	Exhibits 1-7	Exhibits 8-15	Exhibits 16-22

PREFACE

Just a few months ago Anatoli Shamin was promoted to Head of the Kniaginino Raion (county) administration. This was a very special day for him -- a payday. It took him more than twenty years of hard work and intensive study to go from car technician assistant to his present position. After he graduated from Gorky College of Autotransportation with a specialization in industrial engineering, Shamin decided to advance his education and enrolled in Gorky Agricultural Institute (now known as Nizhni Novgorod State Agricultural Academy). He later continued his study in the graduate school of the same institute. In 1992 Shamin received his Master of Science in Economics. Such an advanced degree combined with extensive work experience gave him great leverage for further career promotions. Right after graduation Shamin was appointed by the government as director of the collective farm "Pravda," which was subsequently reorganized into a joint-stock venture with the same name. As a result of his innovative approach to farm management, shareholders of the newly reorganized farm elected Shamin as chairman of A.O. "Pravda." Since then and until his recent promotion Shamin worked as senior manager-supervisor at A.O. Pravda. He oversaw all operations run by the farm and initiated many creative ideas that facilitated Pravda's growth. In 1996 Shamin was rewarded by the Government of the Russian Federation with a medal "For Excellent Service to the Country." (Exhibit 1 contains Shamin’s professional biography)

Since he has moved on, Anatoli Shamin is now wondering who the new manager will be and how the farm will operate strategically to maintain its successful growth and become profitable.

Since the dissolution of the Soviet Union in 1991, Russia and the 11 other newly independent states (NIS) have made progress, albeit somewhat erratic, toward economic reform, the institution of free markets, and open attitudes to foreign investment and trade. Each of these countries is pursuing an agenda of political and economic reform, although the pace of implementation varies in each. The majority of these economies are now experiencing decreases in output, rising unemployment, rampant inflation, and rapidly decaying infrastructures.

The process of reorganizing these nations' economies around market-driven structures is incomplete. Although much property and means of production have been returned to private hands, most economic indicators remain weak. Economic production in these countries fell sharply subsequent to the mass movements for independence. In some cases, they have begun to rebound. Most significantly, the sharp contractions appear to be letting up. Economic stability is improving.

Russia has been one of the most successful of the NIS in pursuing economic reforms. By tightening monetary policy, Russia has reduced inflation from about 20 percent monthly to an estimated current rate of 10 percent. It also made remarkable progress in privatizing its public sector. An estimated 60 percent of the Russian workforce is now employed in the private sector, and nearly 70 percent of industrial firms have sold some shares to the public. Privatization has expanded to include particularly attractive investment targets, such as Aeroflot, the United Utility of Russia (national electric utility), and Gazprom (gas production). This process is expected to continue in the foreseeable future.

Despite these reforms, Russia's GDP is still declining. In recent years, the annual decline has been as great as 15 percent and as low as three percent. However, these official data significantly undercount the services sector, where many Russians hold second jobs. Good news is that real disposable income is growing each year, sometimes by as much as 12 percent. Some companies producing consumer goods are experiencing increases in sales.

Russia's economic reforms will likely have some positive official results. Bringing down inflation is a high priority of the government, but this may be difficult to achieve. The Russian budget deficit is expected to continue to be high--up to 10 percent of GDP. Reducing this figure by half within a two-year time frame is the Russian government’s goal. The decline in output is likely to slow, while real disposable income will continue to rise. The future of the ruble will remain largely dependent on the rate of inflation. In the short term, the ruble's stability will depend on the central bank's willingness to support it.

The agriculture industry has always played an important role in the Russian economy. In the pre-perestroika period this sector of the economy produced approximately one-third of the country's gross output while simultaneously engaging one-third of its workforce and investments. The principal objective of the State regarding this sector was the growth of agricultural production by means of new technologies in cattle breeding and plant growing. This task was organized and carried out through consistent development of specialized production on the industrial base of collective (kolkhozy) and state farms (sovkhozy).

There were 12,800 collective farms and 13,000 state farms in 1991. Collectivized farming has traditionally supported the social infrastructure of rural Russia. Each farm comprises a community, providing the social benefits of housing, roads, gas and electric utilities, childcare, clinics, public cafeterias, recreational centers and other public facilities.

The property of a collective farm belongs to the members of the collective that runs the farm, while the state owns the property of a state farm. Previously, the government controlled the distribution and price of inputs to production and set output prices for both types of farms. In essence, the only practical difference between collective and state farms was the form of property ownership. State and collective farms differed substantially from farm businesses in market economies in that they employed many more workers and were often engaged in rather diverse production, unlike the small, more specialized farms of the central U.S., for example.

Compared to crop yields in more developed countries, yields for most crops in Russia remain low. The food system is characterized by low productivity, lack of technology and farm implements, high levels of post-harvest waste, quality problems, poor sanitary conditions and distorted prices. Since the state set both input and output prices, it had the ability to determine farm enterprise profits. By manipulating price, the state could make a farm profitable or unprofitable. As in the western context, profitability measured the value of output compared to the value of inputs, providing a general measure of economic performance. In 1990, for example, (using the prices set by the state), the average profit margin for farm enterprises was approximately 37%. Only about 3% of Russian farms were unprofitable in 1990.

However, for all the profitability of these farms, the real-life disparity was glaring. The agricultural distribution system was grossly inadequate. Consumers experienced huge shortages of meat, butter and other foods, long lines in stores, and limited distribution in many Russian cities.

Despite the high level of investment and planning the output of the agriculture industry was poor. It became increasingly evident that the system of centralized planning had failed and could not increase the efficiency of agricultural production.

The overriding reason for the inefficiency of Russian agriculture was the absence of private ownership of land and other means of production on state and collective farms. Crop yield levels, livestock production and farm technology were far behind those of countries with well developed market economies.

The facts of price liberalization and inflation that come with economic transition have resulted in families spending a large percent of household income on food. This figure was at 39% in 1990 and rose to 46% in 1993. The nature of the problem has shifted; whereas before consumers went without and couldn’t find the produce they sought, currently, even if food is available, it is not affordable.

The reorganization of the farming system was a sweeping agricultural reform movement introduced after the end of Soviet power. The change was manifested by and large in the transformation of collective and state farms into joint-stock companies, associations and cooperatives.

Macroeconomic conditions for these farms have changed radically with the power shift. This has created new problems for farm managers and aggravated existing ones. Prices that were once set by the government have been partially or fully liberalized. As a result, inflation has increased and labor conditions have worsened. The former system of State purchasing and distribution that was in place has collapsed, rendering the supply of agricultural produce dependent upon the spontaneous market mechanism. Goods that are produced do not necessarily find their way to consumers.

Agricultural reorganization has had a positive influence on individual economic initiatives. The development of individual and small business is an important step in the reorganization of agricultural production.

The Russian word "nizhni" means "lower" in English. "Novgorod" is a combination of the root "nov" meaning "new" and the word "gorod" meaning "city." Hence "Nizhni Novgorod" translates roughly as "Lower New City." In the ancient chronicles it is written that Nizhni Novgorod was founded in 1221, although some historians consider it to have been established earlier. The city's founder, Prince Yurii Vsevolodovich, may have named it thus in hopes that the glory of this fortress-town would rival that of the great city of Novgorod in the north of Russia.

Two major European rivers -- the Oka and the Volga -- flow "down" to their confluence at Nizhni Novgorod, located about 400 kilometers east of Moscow (See Exhibit 2). The city's favorable geographic location at the intersection of these two rivers transformed it into a major commercial center by the beginning of the 19th century. Nizhni Novgorod thus became an immense transport and economic hub and earned itself the title of Russia's "pocket book." The famous Nizhni Novgorod trade fair, which began in the 16th century, became the largest show of its kind in pre-Soviet Russia and one of the most important centers for wholesale and retail activities.

The Nizhni Novgorod oblast^* is located in the center of the European part of Russia. The total geographic area of the Nizhni Novgorod oblast is equivalent to a combination of Belgium, Luxembourg and Denmark and its climate is temperate with cold winters and warm summers. The oblast has a population of 3.7 million people -- about 2.1% of the population of Russia -- about half of which live in the capital city of Nizhni Novgorod. The population of the city makes it the third largest in Russia, just behind Moscow and Saint Petersburg.

The Nizhni Novgorod oblast ranks seventh in terms of population and shares the seventh spot with the Samara oblast in terms of industrial production. In 1995 the rural population comprised approximately 22.5% of the whole oblast population of the Nizhni Novgorod oblast (Exhibit 3). The oblast covers an area of 74.8 thousand square kilometers; it has 47 administrative districts, 25 cities, 71 towns and 519 small villages.

The Nizhni Novgorod oblast does not have substantial reserves of natural resources, except for salt and peat deposits and its forests. Machine building is the largest sector of the oblast's diverse industrial base. Defense enterprises account for approximately one-third of oblast production, while other local industries are automobile manufacturing, shipbuilding, glass making, chemicals, oil and timber processing, pulp and paper production, and production of instruments and gauges. The economy of the Nizhni Novgorod oblast is extremely dependent on supplies of metal, fuel, energy, and raw materials for its chemical industry. Supplies of at least thirty types of products are crucial to the oblast's economy, including raw materials for the chemical industry.

Shipments to other Russian territories from the Nizhni Novgorod oblast include metal cutting machinery, presses, automation devices, trucks, buses, cars, oil products, steel and grain. The list of international trading partners is growing; presently the oblast trades with Finland, Germany, Israel, Great Britain and the United States. The oblast imports high levels of consumer goods and computer equipment, while exporting glass, diesel fuel, electronics and cars.

There are over 5,000 small businesses in the Nizhni Novgorod oblast, making up about half of overall economic activity. Significant growth has occurred in retail trade, food processing and light industry. In 1993 alone over 100 small bakeries, creameries and sausage factories and mills began operation.

The Nizhni Novgorod oblast is the most economically progressive and reform-minded oblast in the Volga Region and as such functions as the unofficial but spiritual leader of change. Boris Nemtsov, governor of the oblast, has advocated an ambitious program of privatization that has been implemented with the assistance of the International Finance Corporation (IFC). The critical areas that have been addressed are the retail and service sectors, trucking and distribution, and collective farming. Through privatization of these industries individuals become responsible for their livelihood and experience change first hand. For example, through the Voucher Privatization Program the factories of Nizhni Novgorod were transferred from state ownership to the general population using privatization vouchers.

Oblast agriculture is representative of Russia's non-black earth territories. Many big collective farms have been and are increasingly becoming vertically integrated. Reform is taking place as a result of the Agricultural Land Privatization Program, under which former state and collective farms are being privatized to form new private farms.

Approximately 39.5% of the oblast’s total land is classified as agricultural land. Of this area, over 2.1 million hectares are farmable land and 820,000 hectares are pasture and hayfield (this is about 1.4% of Russia’s total agricultural land). The main crops are grain crops (for feed purposes), potatoes, vegetables, sugar beets, flax (2.3% to 2.6% of total crop production in Russia). (See Exhibits 4a and 4b for summaries of oblast crop areas and crop yields)

The largest area of agricultural production is the livestock industry (65% of gross agricultural output). In 1995, production of the livestock industry included about 1,850,000 tons of meat (sold after slaughter) or 1.8% of total livestock production in Russia. Also included are more than 1 million tons of milk or 2.6% of total dairy production in Russia (Refer to Exhibit 5 for data on oblast livestock and poultry productivity).

As a whole, the agriculture of the Nizhni Novgorod oblast supplies its population with potatoes (including sales outside of the oblast), vegetables, dairy products and meat. As for wheat and sugar beets, it supplies less than 50% of the population’s needs.

In 1995, there were 254 collective farms, 25 state farms, 487 joint-stock companies, 3,696 private farms and 344 auxiliary farms engaged in agricultural production. The dynamics of the agricultural gross product from 1987 to 1995 in the Nizhni Novgorod oblast are illustrated in Exhibit 6 (in comparable 1983 prices). Before 1992, changes in the agricultural gross product were explained by changes in the weather conditions. The recession in agricultural production beginning in 1992 is explained by changes in Russia’s political and economic conditions. However, the situation in the agriculture of the Nizhni Novgorod oblast is almost the same or even better than in the neighboring regions and in Russia overall (See Exhibits 7a and 7b).

Pravda is located in the regional center of Kniaginino in the Nizhni Novgorod oblast. The farm’s agricultural products include grain, milk, chicken and pork. Steer of the "elita" and "elita-record" breeds are raised there and then sold.

Pravda also has significant food processing and trade operations. The sausage operation produces 3.5 tons per month of seven varieties of sausage as well as 200 kilos per month of pressed meat. The flourmill produces 50 tons per month of dough and 8 tons per month of cereals. Non-alcoholic drinks are produced at the rate of fourteen thousand half-liter bottles per month. Pravda’s dairy facility outputs 200 kg of butter and 300 kg of cream daily (See Exhibits 8-12).

The farm’s produce is sold both through its own network of regional stores as well as wholesale to distributors. In general, Pravda’s management is open to pursuing partnerships in the areas of raw materials, packaging and ingredients. Payment for Pravda’s commodities and services is flexible and management will consider barter deals in addition to other forms of reimbursement.

Pravda was reorganized in October of 1992 as a closed-type agricultural joint-stock company. Its charter, consisting of 23 sections, is summarized in Exhibit 13.

In December of 1995 Albert Buzin and a group of investigators were developing methods of effective management for Russian farms. Buzin’s company, CC "Consultation NM," was specifically engaged in research on two farms, "sovkhoz Kamenskii" in Bogorodskii region of the Nizhni Novgorod oblast and A.O. "Pravda" in Kniaginino region, with the aim of increasing the farms’ operational efficiencies. As a result, a demonstration model for one business unit of A.O. "Pravda" was developed.

This model included the following components as methods for reorganization of the business unit:

• Preservation of the organizational structure of the enterprise
• Privatization of business capital in the form of share capital
• Privatization of business unit and work team capital
• Introduction of the concepts "unit labor cost" and "sales per unit of labor"
• Estimation of the economic level of jobs, business unit activity breakdowns, business units themselves, the farm’s business taken as a whole and the level reached
• Agreement between business units, their components and separate job categories about the distribution of cash inflows based on sales of the business unit’s production
• Implementing a system of checks for interim payments to settle accounts within the enterprise
• Training business unit staff in the use of programs for economic analysis of the business unit’s activity
• Development of programmatic methods for record-keeping and economic analysis under the new working conditions

While managers of privatized farms realize the need to minimize operational costs and respond to market prices, they are often at the mercy of monopolistic buyers. The command system nurtured a legacy of bilateral monopoly situations in which few sellers face few buyers. In fact, many of the large state monopolies are still in existence. Because of this, operating efficiencies that might have occurred do not, due to lack of competition. These monopolies can raise prices to punitive levels, making it very difficult for firms doing business with them. It is common for both buyers and suppliers to try and manipulate prices by distorting the market. The resulting state of affairs is one with quantity reductions at each stage of food production, processing and distribution. These phenomena are symptoms of severe market inefficiencies that can potentially wreak havoc in localized markets.

After the breakup of the Soviet system Pravda faced the problem of finding its own distribution channels without government support. The main difficulty in establishing relationships with distributors was the inability of most of the latter to pay on delivery or close to that time in cash. Since Russian banks managed risks due to inflation and the unstable economy by offering very high interest rates, potential buyers of agricultural commodities preferred barter deals to financing activities. Besides high interest rates there was an absence of the hedging tools that farmers could use, which put agricultural production in the range of the most risky areas of business.

Additionally, some difficulties of distribution were caused by the underdeveloped transportation system, which often limited a company's ability to ship a product within a certain range of distance or location. Delays in rail transport could be significant and cause losses due to product spoilage. The transportation of agricultural output on trucks owned by private farms is now an issue. Transport capacity often exceeds the peak-load period associated with harvest. The government has enacted equipment taxes and value-added taxes that make the determination of optimum transportation inputs and minimum costs more difficult. Storage of produce and inventories are also components of this distribution problem.

Privatized farms are often faced with the problem of having too many employees. Those employees that leave the enterprise tend to be among the more productive and entrepreneurial. Management feels a social responsibility to provide jobs; at the same time it must find ways to match labor with output, provide incentives to increase productivity, and attract more qualified workers.

Traditionally, each collective farm had a government-fixed budget and one's salary was not tied to one's performance. This led to a large number of underutilized workers in the enterprise. Since Pravda went public and the budget is now approved at the stockholders' annual meetings, it cannot afford to employ superfluous workers. On the other hand, all employment opportunities in the surrounding villages fully depend on Pravda. Therefore, each laid-off worker will most likely have to find a job in another area and move out, which is almost unacceptable by many village residents (especially the older ones) due to very deep historical and traditional roots. The majority of the population lives in the same area where it grew up.

Another reason for the farm employing a large number of workers is the poorly developed technology used in Pravda’s operations. These operations are very labor intense. As a result of not being able to cut costs on volume of workforce Pravda economizes on wages. Currently, the wages of Pravda’s employees vary from 370,000 rubles to 420,000 rubles per month, depending on each business unit. This translates as an average of about $80 per month, which is much lower than the average wage in urban areas. Since many enterprising youths find career opportunities in urban areas more attractive, Pravda has difficulties with retaining a young, competent labor force.

In years prior to the 1990s A.O. "Pravda" operated to meet government-placed orders. The farm had its own infrastructure (albeit poorly developed), which included educational and recreational facilities for the use of the local community as well as a few local stores, gas stations etc. All of these business units were government profit units with employees hired and paid by the state. After the reorganization of A.O. "Pravda" the employees had to assume some social responsibility previously born by the state pertaining to the maintenance and constant improvement of the local area's infrastructure.

Because distribution channels for non-processed agricultural products were not widely available Pravda had to find a way to sell the output from its operations. Pravda's management thought the best way to meet the farm's capacity was to expand by integration of its operations toward the demand end of its distribution chain. By processing its product further Pravda ads value to it and can more easily expand its distribution channels by diversifying its product line. Besides improvement of its distribution Pravda can also better manage the risk due to unstable prices for agricultural commodities. Additionally, in case of a local crop failure Pravda can now use the excess capacity of its processing units to meet orders from outsiders. However, there were some important pitfalls of the integration. First of all, Pravda did not have expertise in food processing and had to take a certain risk due to the inexperience of the staff in this area. Secondly, Pravda deviated from its core business, which was much more significant in scale compared to the newly introduced business units.

Due to rapid changes in the so-called "equality status" of Russian society and its significant division into extremely rich and extremely poor social classes, the latter characteristically expresses a tremendous level of anger towards and jealousy of those who have managed to succeed. In order to smooth out such negative attitudes on the part of the local residents A.O. "Pravda" takes responsibility for the well-being of the local community by providing it with jobs, locally produced products at discounted prices and improved housing. Since the farm's dilemma of how to handle the human resource problem mentioned above while also creating a positive image in the community is well known, the local residents are very supportive of ideas to establish additional business units in the area from an employment and tax standpoint. Many managers of large privatized farms, Shamin included, have expressed the opinion that although such business units often operate close to the break-even point, the fact of being socially responsible is profitable in the long run.

As a result of forward integration, A.O. "Pravda" launched following businesses:

• Milk processing
• Flour mill
• Non-alcoholic beverages
• Sausage factory
• Convenience stores
• Gas stations

1. What steps must be taken toward the development of a business communications infrastructure in Russia that will foster competition? How should Pravda operate until a legal apparatus is established that is capable of enforcing efficient contracts?
2. How can Pravda use existing distribution channels in new economic conditions and develop new flexible channels that are more oriented to consumer demand?
3. How can Pravda address the human resource problems of matching labor with output, incenting workers to be productive, and retaining a skilled labor force?
4. Should Pravda continue to integrate forward or centralize its operations based on its core competencies?
5. Is there a role for promotion and advertising to play in Pravda’s future development?
6. Analyze Pravda’s organizational structure (Exhibit 16). Is it suitable for a focus on markets and growth in sales?
7. Use the financial information provided by Pravda (Exhibits 17-19) to prepare a U.S.-formatted balance sheet, income statement, and cash flow analysis. Exhibits 20-22 contain U.S. formats for farm financial statements.