OTIS RUSSIA
Case Developed By
Dr. Julian E. Gaspar, Director
Center for International Business Studies
Lowry Mays College & Graduate School of Business
Texas A&M University
College Station, Texas 77843-4116
United States
and
Dr. Valery Katkalo, Dean
and
Dr. Andrei Panibratov
School of Management
St. Petersburg State University
St. Petersburg, Russia
January 2002
This case is prepared as a basis for class discussion rather than to illustrate either
effective or ineffective handling of a business situation. Support for this case was
provided by the U.S. Agency for International Development (USAID) through the
Eurasia Foundation in Washington, D.C. for which we are very grateful. We would like
to express our gratitude to the management of Otis, in particular, Messrs. Jeff Eaton, Kurt
Fruhbauer, Vladimir Marov, and Tom Whelan for their participation in discussions and
provision of materials without which this case study would not have been possible.
Copyright © 2002 by Dr. Julian Gaspar, Dr. Valery Katkalo, and Dr. Andrei Panibratov
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OTIS RUSSIA
I. Introduction
The days immediately following the August 1991 coup in the Soviet Union were
filled with decisions for Otis Elevator’s USSR team based in Paris, France. One member
of that team, Jeff Eaton, an MBA from the Sloan School of Management in MIT had
been recently promoted to the position of Deputy General Manager for the company’s
Leningrad Joint Venture. Jeff had been working for the last two years with George
Channin, who was the Senior Area Director for Otis operations in the USSR. Together
with a small team that included an industrial engineer and an elevator design engineer
they had been working to develop relationships with Soviet partners and customers while
shaping an evolving strategy that would need to be endorsed by senior Otis management
both in Paris and in Farmington, Connecticut, United States.
The headquarters for Otis operations in Europe, the Middle East and Africa was
called ETO (European and Transcontinental Operations) and was based in Paris. The
President of ETO was Pierre Fougeron who reported to the Otis Worldwide President
based in Farmington, CT named JP Van Rooy. George David who was at that time a
Senior Executive VP for United Technologies for the commercial businesses that
included both Otis and Carrier was believing that Otis had great potential in the Soviet
Union and was consequently very supportive.
By August of 1991 the Paris based USSR team also included Pierre Laboisse who
was a Director for Manufacturing and Sourcing, a project manager for Ukraine, a Deputy
General Manager for the recently signed Scherbinka Otis joint venture, a financial
manager for the USSR and two more project managers for joint ventures being negotiated
and for addressing sales and marketing and field operations issues.
On the second day of the coup the USSR team met in Paris to address the following:
• What would become of the two team members who were currently in Kiev with
whom we could not communicate?
• To what degree should we scale back our product strategy and our manufacturing
sourcing strategy?
• What impact would the coup have on the economy and our ability to develop local
suppliers? To what degree would this change our existing perspective of “make vs.
buy” in the USSR?
• Should we buy existing service companies right away to generate more immediate
earnings vs. growing our service base through the products we would manufacture
and install in the USSR?
• What about Russian partners and their roles? Do we need them? Want them?
When the USSR team began doing market research in 1989 they learned that in the
late 1980s, the market for elevators (lifts) in the former USSR was estimated to be about
40,000 elevators/yr. This was considered to be the world’s largest elevator market.
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During the same period of time the market in the North America was about
27,000units per year.
The majority of this demand was for passenger elevators in apartment buildings and
was driven by Mikhail Gorbachev’s goal that every family have their own apartment by
the year 2000. At that time, in large cities like Moscow and Leningrad, as many as 40%
of families lived in communal style apartments. This meant that from between three and
seven families might be sharing one kitchen and one bathroom.
II. Otis Elevator Company
Elisha Graves Otis initiated a new industry in 1852, when he invented the first
safety elevator in Yonkers, New York in the United States. A year later he founded Otis
Elevator Company, which was the first elevator manufacturer in the world. Over the past
century and a half, Otis has grown tremendously and has remained the global leader in
the elevator business.
Otis Elevator Company (see Exhibit 1: Otis), a wholly owned subsidiary of
United Technologies Corporation (see Exhibit 2: United Technologies Corporation), is
the world’s largest manufacturer, installer, and servicer of elevators, escalators, moving
walkways and other horizontal transportation systems. Otis sells approximately 50,000
vertical transportation systems annually – roughly 22 percent of the world’s new
equipment market – and employs nearly 63,000 people globally, of which 55,000 of them
are employed outside the United States. Elevator modernization is a $3 billion
worldwide market in which Otis is an active player. Over 22,000 Otis mechanics service
700,000 elevators, escalators and moving walkways worldwide. A comprehensive range
of maintenance, communications and service dispatching networks, which remain
unmatched in the industry, supports them. Indeed, Otis remains very much a global
company. Its products are offered in more than 150 countries and territories, and Otis
maintains manufacturing facilities in the Americas, Europe, Asia and Australia, and
engineering and testing centers in the U.S., Japan, France, Germany and Spain. (see
Exhibit 3:
Company Milestones).
Otis’ management considers servicing
elevators/escalators as one of the keys to the company’s success. Other factors that have
contributed to Otis’ success are:
Reliability: Otis products go through stringent quality control.
Service Agreement Options: Prices for maintenance services were based on the
type of service contract signed by the client, i.e. from full service, to service provided on
call.
Preventive Maintenance Agreements: To keep elevators operational at all
times, Otis also provides regular preventive maintenance of elevator equipment. While
using this service Otis will fix any problem with its equipment as well as those of other
manufacturers “on call” in the shortest time possible. Because of the numerous
components that go into assembling an elevator/escalator, Otis has developed an
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elaborate preventive maintenance service system that minimizes equipment breakdown
thereby keeping operating costs low.
Quality Service: Otis constantly upgrades its service quality by incorporating the
latest technology available thereby reducing elevator operating costs as well as
downtime.
In addition, Otis Elevator Company’s global success (see Exhibit 4: Key Success
Factors) can be attributed to the following factors:
Global Orientation: Otis is a company with operations spread all over the world.
In addition to sharing company ideals, Otis instills its global vision among employees.
This extends to approaches in service, engineering and manufacturing since resources are
shared globally by various divisions of the company.
Job Satisfaction: Otis strives for perfection in everything it does from
manufacturing to service. The company believes that each employee should be proud of
his work and do the best job possible. To achieve this goal Otis provides various
incentives that lead to job satisfaction.
Research and Development: Otis continuously tries to create better and more
efficient products that minimize total operating cost and are extremely competitive in the
marketplace. To achieve this goal Otis allocates significant amounts of resources
towards R&D.
Speed: Otis reacts fast to customer needs by adapting quickly to changing
environmental needs on a global scale.
III. Russia: An Economy in Transition
Centuries of repressive czarist rule followed by more than 80 years of
communism has left Russia ill prepared to meet the needs of a democratic free market
system. Nevertheless, in less than 10 years since the fall of communism in 1991, the
country has made relatively significant strides in developing some of the institutions and
infrastructure necessary for economic, political and social stability. While Russia’s
financial, legislative, judicial and executive institutions are largely being set up through
structural adjustment reforms (through IMF and World Bank loans), most of these
institutions are dysfunctional for practical purposes.
Manipulation and gross
mismanagement of institutions have led to a lack of transparency and steep operating cost
especially for foreign-owned businesses. Russia’s bureaucrats gobble up both money
and time. Reforming the post- communist system of government has been hard. For
Russia, a country that is almost unmanageably vast and has little experience in the rule of
law, private property or public participation, the task is awesome.
The early 1990s brought hyperinflation, and food panics (Lucas, E., A Survey of
Russia, The Economist, July 21, 2001). But there were also high hopes, fuelled by the
thought of vast quantities of underutilized brainpower and raw materials that were now
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joining the world economy. Some talked about a coming boom that might take Russia’s
per capita income above Spain’s by 2010. Such wishful thinking led to the financial
bubble of 1997-98, when hot money from abroad piled into weak stocks and bond
markets, culminating in the default, devaluation and banking collapse of August 1998.
So the main question before Russia is not whether the government and central bank can
manage the country’s finances sensibly, but whether Russia can become a long-tem home
to successful, competitive companies. In the early 1990s foreign investors where
cheated. Business basics such as contracts, proper book-keeping and customer
satisfaction were widely ignored. Barter was rampant.
The Financial Crisis of August 1998
An acute shortage of foreign exchange reserves caused by a worsening balance of
payments situation led to the collapse of Russia’s economy in August 1998 when Russia
was unable to service its large external debt. The causes of Russia’s financial crisis are
clear. As can be seen in Exhibit 5 and 6 (Russia: Key Economic Indicators), Russia’s
consistently large budget deficits were unsustainable . Fiscal deficits increased from 69.5
million rubles in 1995 to 147.6 million rubles in 1996 and 150.4 million rubles in 1997,
which led to the build up of short-term dollar liabilities that when coupled with falling
foreign exchange reserves led to debt service problems. Along with capital flight, the
level of foreign exchange reserves fell, which eventually led to the massive devaluation
of the ruble in August 1998. To shore up its finances, Russia was asked to reduce the
budget deficit by raising tax revenues and cutting government expenditures. To support
the restructuring of short-term debt and the new macroeconomic program, the IMF and
Western donors pledged a loan package of $17 billion. This did help stabilize the value
of the ruble and move toward greater market reform.
The crash of the Russian ruble and the subsequent economic collapse seemed to
confirm the worst fears about the country: It is too unstable to operate in Russia (NY
Times, May 1, 1999). While some foreign companies like Pizza Hut and Hershey pulled
out, others contemplating on entering Russia, just shelved their plans. Yet, a third group
of multinationals like Nestle, Lucent Technologies and Caterpillar deepened their
presence and increased localization. The key choice facing investors in Russia, just as in
the case of most large emerging market economies, is the short-term versus long-term
profit objective. This can only be answered by Russia itself. While Russia did reach an
agreement with the IMF on a $4.5 billion loan in May 1999 to prevent default on its debt
to the Fund, the jury is still out as far as honest implementation of IMF conditions and
reform program is concerned.
Even before the economic collapse of 1998, few foreign investors had the nerve to
invest in Russia. Most businesses, domestic and foreign were treated with indifference
by the government. They were burdened with onerous taxes, hostile and corrupt
bureaucracies and ever-changing, non-transparent regulations. That attitude has seeped
into the local level too. Yet, many multinationals realize that Russia, stable or not, is
ultimately too big a market to ignore. There is strong pent-up demand for quality
consumer and industrial products as Russians shy away from shoddy, unappealing
domestic goods. With the collapse of the ruble it became obvious to foreign investors
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that most Russians could ill afford imports and multinationals were forced to consider
localization. Local production made sense as it reduced foreign exchange risk, utilized
domestic resources and encouraged potential exports.
Recent Developments and Future Outlook
Experts argue that firmer stance is necessary since the chaotic liberalization of the
Yeltsin era. They believe that Russia is too big a developing nation to be governed
exactly like a western country. Democracy is fine in principle, but it must be managed.
To prevent chaos and gradually get people to respect the law, it is necessary to first
establish a sense of order and authority. Only a tightly run state can push through liberal
economic reforms, which in turn will create a strong middle class , which will eventually
become the foundation for a solid democracy and the rule of law. The changes
implemented so far have, however, done little to create the conditions for sustainable
development, i.e., efficiency, accountability and transparency. Most of the people in a
position to make changes are those who benefit from things staying pretty much the as
they are.
Change in Russia is only a matter of time. Yet, a recent survey of Russia by The
Economist (July 21, 2001) asks a thought-provoking question. Is Russia under President
Putin heading for regeneration, stagnation or decay? The survey argues that Russia is
going in all three directions at the same time. Most people who are knowledgeable about
Russia agree on the economic and political direction the country has to take: it must
embrace the free market system, private property, a stable convertible (at least in the
current account) currency, regular elections and freedom to travel. Reforming the post
communist system of government is hard. For Russia, a country that is almost
unmanageably vast and has little experience in the rule of law, private property, and
public participation, the task is awesome. Russia today is relatively calm both
economically and politically. Russians attribute this stability to Vladimir Putin, the
president whom they see as its architect. Unless this stability can be reflected in
sustainable economic growth stagnation or decay will be the result.
Russia’s new leaders have made three big changes in the way the country is run.
The first is to recentralize government, such as tax authorities, the security service, the
police, and the prosecutor’s office under the control of the Kremlin, which helps to
counteract local barons. The second big change has been to clamp down on tycoonpoliticians to curb fraud and embezzlement. The third change is referred to as political
“consolidation” – a political system that is recognizable to the West, but works from the
top down rather than from bottom up. Mr. Putin’s reforms appears to have made the state
a little stronger and quite a lot more stable, but not noticeably more efficient, and
certainly no more accountable or transparent --conditions necessary for sustainable
economic development. This is largely due to the fact that people in the position to make
changes are precisely those who benefit from things staying pretty much as they are.
Russia’s economy is still dominated by state-sanctioned monopolies in energy and
uncompetitive industries that receive various forms of state protection. The gas and
electricity monopolies are forced by the government to provide low-cost services to
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unproductive firms, which undermine the more-productive companies that do not receive
the same support. Combined with high tax rates, the implicit subsidies create a lack of
transparency in accounting practices and entail high social costs. In addition to
sustaining an inefficient arrangement in which businesses largely pay each other and the
government in kind rather than in cash, the Russian system breeds corruption and uneven
enforcement of tax laws, since most large firms negotiate their dues to the state.
The uncertainty and chaos occurring in Russia today largely reflect the drastic
changes in the economic and political landscape of the country since the fall of
communism in 1991.
Although almost a decade has passed since the monumental
change in the country, most Russian managers have not been able to adjust their mindset
to a free-market system. Nor have they had the time or inclination to acquire the business
skills (such as in accounting, finance, management, marketing, and operations) necessary
to function effectively in a free-enterprise system. The transition –from a passive order
taker to a more proactive business manager-- continues to be a challenge for most
Russian businessmen. In addition, American companies face legal and labor problems in
Russia with high turnover of key personnel. Despite the transition process, i.e.,
movement from the command economic system to one based on the free enterprise
system, Russia’s business culture is still heavily influenced by its national history and
totalitarian roots (mistrust stemming from the Stalinist era). Russian managers score low
in future orientation, low in uncertainty avoidance, and very high in “power distance” or
authoritarianism. The reason is not lack of intelligence, but a lack in those behaviors that
are linked to society-in-transition factors: uncertainty avoidance, human relations or
power distance.
Because of Russia’s vastness and diverse culture, there are at least three different
business cultures in the country. First, is the traditional culture --one in which
companies are quite successful under a paternalistic, state-run system. They are not
interested in any kind of social policy, and managers are more interested in prosperity
and survival of their business. Second, is the predatory culture --cheating on the state,
cheating on partners, and cheating on consumers. Here the rule is profiteering and
growth at any price with no role for business ethics. Finally, the socially responsible
culture --businesses that are trying to build loyalty and support of customers and
employees. One could argue whether these business cultures in Russia are a result of the
country's totalitarian past or a function of dysfunctional institutions and half-baked
economic reforms.
IV. Russia’s Elevator Industry
Russia, despite its economic malaise, is a big elevator market. The national
market for elevators (to be installed in green field projects) was $78.4 million in 2000, of
which Moscow was $37.2 million and St. Petersburg $8.5 million. In addition, 200
million rubles ($7.2 million) per year was spent on maintaining existing elevators and
another three billion rubles ($108 million) on replacing dysfunctional elevators that are
too old (Bratersky, A. Elevator Industry Seeks a Lift, The Moscow Times, August 4,
2000). In summary, Russia is among the top ten elevator markets in the world with a
demand of some 4,200 passenger elevators in 2000.
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Structure of Soviet (Prior to 1991) Elevator Industry
During the Soviet period, several government institutions handled all aspects of
the elevator business from manufacturing and installation to service. However, different
government agencies handled each of these functions independently. In a nutshell, the
industry was not integrated. The Soviet elevator industry consisted of several
hierarchically functional levels:
1. Elevator Production
Manufacturing operations were managed and supervised by Liftmash,
Mosstroikomitet, Lenstoikomitet, and the Ministry of Heavy Machine Building.
Liftmash was the leading enterprise responsible for manufacturing elevators in the Soviet
Union, and it reported to the Ministry of Construction and Road Building
(Minstoidormash). Liftmash’s Shcherbinka factory, located near Moscow, had 1,400
employees and operated four shifts. In 1989 the factory produced 3800 complete
elevators and 24,000 doors. Liftmash’s Sverdlovsk factory located in the Ural Mountains
has 820 employees and manufactured some 2,500 elevators a year by the end of the
1980’s. Liftmash’s other factories were in Armenia (Spitak), Belarus (Mogilev) and
Uzbekistan.
Mosstroikomitet (City of Moscow) included the Karacharovo facility with 1500
employees produced 6,500 freight elevators in 1989.
Lenstrokomitet is a major producer of various construction materials of which elevator
production accounted for 20% of its revenues. It had 1300 employees and built 500
elevators in 1989.
2. Elevator Installation
Elevators were installed by Moslift and Mosliftmontage of Moscow, and
Soyuzliftmontage, Liftmontage-I-Naladka, Trest No 27 (Leningrad), ect., of Leningrad
(present day St. Petersburg).
3. Elevator Service
Maintenance service was provided by Rosliftremont, Mosliftremont,
Soyuzliftremont, Liftmontage-I-naladka, RSU-3, RSU-4, RSU-5, and RSU-6 in
Leningrad. Similar companies provided elevator maintenance service for other regions of
the country. At the present time because of consolidation, only companies in Moscow
are still in business. They changed their names and have become less important than
during Soviet times. In addition, several new players have entered the elevator
maintenance service business, especially in St. Petersburg.
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Ministry of Construction and Road Building
Liftmash
Ministry of Heavy
Machine Building
Mosstroikomitet
Lenstoikomitet
Elevator installers, spare part suppliers and maintenance technicians
Russia’s Elevator Industry Since 1991
Since the fall of communism and break up of the Soviet Union starting in 1991,
there has been significant consolidation in Russia’s elevator industry. Several Russian
elevator manufacturing companies have either collapsed or merged/acquired by others.
In addition, in the service sector there has been some vertical integration. Instead of
having firms that dealt with installation or maintenance alone, several elevator service
companies have combined their installation and maintenance functions together. Still
others have fully integrated their operations to include elevator manufacturing,
installation and service. With the entry of foreign companies into Russia, the level of
competition has also increased.
A major source of concern to property owners is that some Russians try to strip
metal components and other easily removable parts from the elevators to sell them in the
market. For example, St. Petersburg’s city government spent some seven million rubles
in 2000 fixing elevators that stopped working because certain vital elevator components
were removed from government buildings and sold as scrap (Bratersky, A. Elevator
Industry Seeks a Lift, The Moscow Times, August 4, 2000).
There are only two domestic elevator manufacturers who could be considered as
significant players in Russia’s market. These local elevator manufacturers are
Shcherbinsky and Karacharovsky. Foreign brands include Schindler, Kone and Otis,
which is the only foreign company with domestic manufacturing facilities and fully
integrated operations. Shcherbinsky has about 20% of Russia’s elevator market
compared with Otis’s 15%. The key to Shcherbinsky’s success is price competitiveness
(company’s product costs half that of Otis elevator). Shcherbinsky produces some 1800
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elevators per year and has numerous customers in the CIS (Commonwealth of
Independent States).
The other significant domestic player in Russia’s elevator market is
Karacharovsky Elevator Factory, which produces around 2000 elevators annually and has
a very strong position in the Moscow market (around 80% of the buildings are equipped
with these elevators). Moslift, a Russian company, restructured since 1991, is
responsible for installation and maintenance of elevators. Liftremont currently provides a
complete range of service (maintenance, modernization, replacement, installation, and
commissioning) for Russia made elevators.
Liftremont is a competitor of Otis in the maintenance and repair sector of the
elevator business.
Liftremont does not manufacture elevators, but it provides
maintenance, and installation service. In 1993 its maintenance portfolio consisted of
1900 elevators of Russian and former Soviet Union origin. Today Liftremont’s
maintenance portfolio consist of around 9000 elevators and escalators. Liftremont is
considered the third largest elevator service company in the Moscow region.
Schindler (world’s largest escalator and second largest elevator manufacturer) of
Switzerland supplies imported elevators essentially to banks and offices. Since January
1997, Liftremont became the exclusive distributor for Schindler Group in Moscow and
Moscow region. Liftremont also provides service for elevators and escalators built by
Schindler. Schindler is striving to become the leading supplier (not of service) of
elevators and escalators in Moscow and the Moscow region. Schindler is a serious
foreign competitor to Otis in the Russian Market.
Kone of Finland sells its imported elevators to hotels and entertainment
complexes. Kone ships elevators from Finland and because of its proximity to Russia it
seeks to become a major player in developing Russia’s elevator market. Both Schindler
and Kone have their representative offices in Russia, and supply imported spare parts to
local dealers.
V. Otis in Russia
Otis’ relationship with Russia goes back over a hundred years (see Exhibit 7: Otis
Russia – Milestones) to 1893 when it first installed elevators in St. Petersburg during the
Alexander III period. Now, some 100 years later, the company has again returned to
Russia by establishing four joint ventures for the manufacture, installation, and
maintenance of elevators. During the 1991-1993 period, Otis built three factories in
Russia: one in St. Petersburg for manufacturing modern “Europe 2000” passenger
elevators and two in Moscow for manufacturing components and spare parts. The three
factories began operations in 1993. Otis is the only fully integrated (see Exhibit 8: Otis
Facilities in Russia) elevator company in Russia and it also services all brands of
elevators, domestic and foreign. Otis Russia now provides maintenance service for over
73,000 units and has some 4000 employees. With an initial investment of $50 million,
Otis set up its operations (see Exhibit 9: Otis Russia – Operations) in Russia by dividing
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the country into six operating areas (see Exhibit 10: Russian Regions). Each regional
branch offers fully integrated elevator installation and service.
Otis Russia – H.Q. Moscow
6 OPERATING AREAS/ REGIONS
MOSCOW
N.- WEST
CENTRAL
SOUTHERN
URAL
SIBERIA &
FAR EAST
Otis Russia’s strategy was to “think global and act local”, which meant
manufacturing most elevator parts locally and importing key technical components like
semiconductor control panels from abroad and assembling, installing and servicing the
elevators in Russia. Russia’s government appreciated Otis’s approach because of the
company’s long-term commitment to the country. Otis in Russia and Ukraine (one of the
largest former Soviet republics) combined has over 14,000 employees. The plants in
Russia and the one in Ukraine are integrated and manufacture major components for
elevators such as winches and door systems. Otis Russia started in 1993 by
manufacturing eight models of passenger elevators each capable of carrying a passenger
weight of 1000 kg. primarily for Russian apartments. These models are similar to those
built by Otis in Europe, but adapted for installation on standard Russian shafts. The
elevator doors and cabins are made of steel, which is fire resistant and meets European
safety standards. The elevators are designed to provide smooth and silent rides
contributing to passenger comfort. From a technical standpoint, Otis’ elevators are 10-15
years ahead of the competition. Today, over a hundred models are offered with different
car linings, e.g., Standard, Business and Deluxe as well as elevator cars with dual
entrances and hydraulic systems. As the first modern elevator manufacturer in Russia,
Otis introduced “vandal-proof” elevators along with microprocessors unlike the bulky
Russian systems. With a speed of 1.6 meters/sec. and telescopic doors, Otis elevators are
“state of the art” in Russia. Otis elevators are capable of operating over 17 floors and the
company is the recognized leader in elevator technology in Russia. Among Otis’ major
customers (see Exhibit 11: Otis Russia –Major Customers) are the Construction
Departments of Moscow and St. Petersburg, Russia’s Central Bank, and major
construction companies such as Skanska Oy, Alarko, Lemminkainen, Puolimatka, Soyak,
Gasprom and Lukoil.
Otis Russia has its headquarters in Moscow and has four companies with 34
branches (divisions) to serve Russia which is divided into six geographical regions:
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1)
2)
3)
4)
Mos Otis (with 5 branches),
Otis St. Petersburg (renamed “Otis Lift” in Summer 2001, with 4 branches),
Rus Otis (with 25 branches),
Shcherbinka Otis (an elevator component manufacturing factory)
OTIS RUSSIA
MOS OTIS
MOS OTIS
OTIS ST. OTIS ST. PETERSBURG
PETERSBURG
RUS
RUS OTIS
OTIS
SHCHERBINKA
SHCHERBINKA
OTIS
OTIS(component
(component
factory)
factory)
Because of regional differences (population, buildings, economic activity, ect.),
Otis Russia segmented the Russian market into six distinct operating regions. These
include: (1) Moscow city, (2) North-West Russia (including St. Petersburg), (3) Central
Russia, (4) Southern Russia, (5) Ural-Volga region, and (6) Siberia- Far East (see
Exhibit). In addition, all operations – engineering, manufacturing, sales, installation,
maintenance and modernization –are provided by three divisions of Otis Russia, viz., (1)
Mos Otis, (2) Otis St. Petersburg, and (3) Rus Otis. Shcherbinka Otis is essentially an
elevator components fabricator and supplier that was established to make operations
profitable. However, because of the artificially strong ruble, local components
sometimes were more expensive than comparable imports from Spain.
While some 35,000 elevators are serviced by Mos Otis in Moscow alone, Otis
Russia services some 74,000 elevators in the whole country. In August 2000, Mos Otis
was certified to have met Russian Standard of Quality similar to ISO 9002. Shcherbinka
Otis and Otis St. Petersburg received ISO-9001 certification in Summer 2001. Thus Otis
became the first elevator company in Russia to be certified for quality. It is Otis Russia’s
hope that the certification will help promote sales. All branches of Otis Russia generate a
lion’s share of their revenue and from technical maintenance. Otis Russia’s goal is
customer satisfaction. To fulfill this objective Otis Russia is dedicated to building quality
elevators and escalators that can be delivered at the building site on time for installation
to the customer’s total satisfaction.
Otis St. Petersburg
Otis St. Petersburg (see Exhibit 12: Otis St. Petersburg) is one of Otis Russia’s
four divisions that offer strong competition to the local elevator manufacturers. Otis
services every fourth elevator in St. Petersburg, although it installed only 475 of the city’s
55,910 elevators. Vladimir Marov, director general of Otis- St Petersburg, who has
worked in the elevator industry since Soviet times, believes that Otis’ success in the
Russian market it primarily due to the fact that Otis Russia is the first and only Western-
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style, full service elevator company in the country. Otis St. Petersburg has completely
integrated operations and it offers the customers delivery, installation, and preventive
maintenance service on a “turn-key” basis. Otis St. Petersburg services Russia’s
Northwest region including St. Petersburg, Leningrad area, Republic Kareliya, Pskov,
Novgorod, Murmansk, Arkhangelsk, and Vologda areas.
Otis St. Petersburg is a joint stock company (JSC) that is responsible for Otis
Russia’s elevator operations in North-West Russia. Otis St Petersburg has a
manufacturing plant and also provides elevator installation, sales, and service. In
particular, Otis St. Petersburg does the following:
.
Assists construction engineers in the layout necessary for elevator hoist ways
.
Clears Russian customs for imported elevator components
.
Manufactures and installs elevators on site for Gosgortechnadzor inspection
.
Provides maintenance service and modernization of elevators
Otis St. Petersburg was established in 1991 to meet the elevator need for new
construction as well as for the replacement market. With 470 employees, Otis St.
Petersburg is the only company that manufactures European standard elevators in Russia.
Since it commenced production in 1993, the St. Petersburg plant has shipped more than
3,000 elevator units to CIS (Commonwealth of Independent States) countries and other
Russian regions of which over 475 elevators have been installed in the North West region
alone. Otis St. Petersburg’s most important revenue generating activity is elevator
maintenance. Currently some 11,200 elevators are under Otis’ maintenance contract in
the North-West region of which 8,300 are in St. Petersburg alone. Elevator maintenance
is performed round the clock with the help of modern transportation, communication and
testing equipment. Otis’ maintenance network covers the whole city of St. Petersburg
and service is provided to all brands of elevators.
Otis St. Petersburg could also distribute elevators made at its European factories.
However, these elevators would be priced in dollars as compared with those built by Otis
in Russia that are priced in rubles and are correspondingly less expensive. Otis elevators
have been installed in such landmark buildings as “Nevsky Palace Hotel” and in banks
like “Credit Lyonnais”, “St. Petersburg Bank” and “Sberbank” among others.
VII. Otis Russia’s Performance
The economic crisis of 1998 had a severe impact on Otis Russia’s operations (see
Exhibit 13: Income Statement Summary) and (see Exhibit 14: Balance Sheet Detail).
The turbulence in Russia was a reminder that this transition economy is still a long way
to go to achieve a free-market system. Nonetheless, Russia is too important to ignore.
The prospect of Russian economic emergence led many U.S. firms like Otis to initiate
business operations in Russia, and trade and investment flows were expanding rapidly till
the 1998 financial crisis. It is likely that Russia’s growth and investment will resume
again, barring the advent of a hostile government.
A close analysis of Otis Russia’s income statement (see Exhibit 14) clearly shows
that gross sales of new elevators, spare parts and maintenance service grew rapidly,
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barring the lagged impact of the 1998 financial crisis on demand for elevators in 1999.
Gross sales more than doubled in 2000 over those in the previous year. An
interesting issue to analyze is how the three components of gross sales performed as it
offers some valuable sub-sector insights. While the gross profit margin remained
relatively stable over the 1997-2000 period, the cost of sales of new elevators, spare parts
and maintenance service rose at different rates, which reflects varying profitability of
Otis’ three operating segments. Otis Russia’s operating income improved significantly
since 1998 despite the fact that SG&A expenses as a percentage of total sales revenue
have dramatically increased since 1997.
Non-operating expenses, which consists
primarily of non-interest expenses (depreciation) were largely brought under control by
2000 and losses before taxes dropped from 130.5 million rubles in 1999 to 11.2 million
rubles in 2000. Overall, net loss after interest and taxes have declined from a peak of
153.1 million rubles in 1998 to some 68.5 million rubles in 2000. If this trend does
continue, Otis Russia is likely to show a turn around and become profitable in 2001.
An analysis of Otis Russia’s balance sheet (see Exhibit 15) indicates that the
company is relatively strong. However, there are a several areas of concern that Otis
Russia would need to address to improve its balance sheet and profitability. While Otis
Russia’s cash position was strong by 2000, its cash flow has been negative. The
allowance for bad debt does not appear to be under control and the trade receivable has
kept growing because of non-payment and arrears of government agencies. With the
collapse of the ruble in 1998, the construction industry almost came to a halt. Otis’
inventory level has been growing, which to an extent reflects unsold spare parts and work
in progress. A clearer picture emerges when the level of inventory is considered relative
to its total sales. A huge amount of money is tied up in construction in progress (CIP)
activities that are yet to come on stream and become productive. An interesting item in
the balance sheet to note is the level of long-term debt outstanding that was reduced from
200.8 million rubles in 1999 to 18.9 million rubles in 2000. At the same time the level of
inter company loan payable increased from 42.9 million rubles in 1999 to 463.5 million
rubles in 2000. Salary and benefits liabilities increased over 40 fold over the 1999-2000
period.
Since the collapse of the ruble in 1998, Otis Russia has taken a diverse set of
actions to stabilize output. Cities in northwest Russia ran up accounts payable of 40
million rubles to Otis Russia that before the crises were worth $7 million and after
August 17, when the ruble was devalued, the accounts payable was worth only $2
million. Soon after, Otis laid off about 10 percent of its St. Petersburg staff. In the fall of
1998 Otis St. Petersburg did not sell a single elevator, and the factory was idle for a
month. It also closed its maintenance offices in a few branches and was struggling to get
the city of St. Petersburg pay 23 million rubles in debt accrued before the crisis. “No one
had any experience with such a sudden fall, but we survived the best we could,” Mr.
Morov said. “The questions came up among our Otis leadership in the U.S. and Germany
about whether we should continue. And we decided we should, because the potential is
so big and things will calm down at some point.”
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Inadequate financial control coupled with Russia’s economic downturn led to
rising ruble debt and wage costs, which in turn led to lower sales and rising operating
losses. And internal audit of Otis Russia clearly revealed the strengths and weaknesses of
the company’s operations in Russia. Among the weaknesses identified in the audit were
poor price controls and poor management especially in the branches. Despite these
operational problems Otis Russia’s profit potential lies in its market for elevator service
(preventive as well as on call), and modernization (refurbishing) of old equipment.
Given Otis Russia’s extensive sales and service network in Russia, as well as it perceived
service quality, the potential for growth in sales and profitability appears promising.
After analyzing Russia’s economic crisis of 1998 and its impact on Otis Russia,
the company’s headquarters in the U.S. decided to restructure the Russian operations.
Otis Russia was to tighten financial operations of its branches and improve Otis’ national
image through even better service. To restructure its Russian operations, Otis Russia
sought and was provided $2.8 million loan from the company’s world headquarters in the
U.S. The basic terms of the loan were as follows:
.
Timely repayments of debt per repayment schedule
.
Better control of budget and operations in general
.
Better human resource management especially in the area of safety on the shop
floor
.
Ethical business practices
The real issue, of course, is how Otis Russia will perform in the future. Otis
Russia’s 1997-2000 financial performance is mixed. While the massive devaluation of
the ruble in August 1998 was the major external factor contributing to its poor
performance in 1998-1999, there are a number of strategic issues that the company needs
to address to recover from the ruble collapse and the subsequent slump in market (for
new elevators as well as maintenance service) demand. A financial analysis of the
company’s operations will be most helpful to determine Otis Russia’s future course of
action.
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Discussion Questions
1.
2.
3.
4.
5.
6.
7.
8.
Taking a long-term (10-15 years) view, does Otis’s strategy to enter Russia’s
elevator market make business sense? What was Otis Russia’s strategy to
begin with? What are the pros and cons of the strategy?
Russia is a transition economy. What are the major challenges that foreign
investors face while entering Russia? What is country risk in the Russian
context?
Given Otis’s corporate and historical background, what are the chances for
Otis Russia’s success? What are the reasons for this conclusion?
For businesses to be successful in a free-market democratic system, rule of
law, transparency, and disclosure are fundamental requirements. How does
Russia fare in this context? What is the direction in which Russia is moving?
Given the global opportunities available to Otis, is Russia a good choice?
What is Otis Russia’s competitive advantage in Russia’s elevator market?
Has the structure of Russia’s elevator industry changed for the better since
Soviet times? If so, how? Who are the winners and losers in the present
environment? What is the economic impact of developments in this sector on
Russia?
How does Otis’s strategy in Russia differ from those of its competitors? Who
are Otis’s major competitors, and why are they following strategies different
from those of Otis Russia?
A close look at Otis Russia’s financial statements (Income Statement and
Balance Sheet) for the 1997-2000 period provides interesting information.
How has Otis Russia performed over that period? Why? How did Otis Russia
react to economic developments in 1998?
What is the outlook for Otis Russia? Should Otis Russia shut its operations?
If not, why? Based on a detailed analysis of Otis Russia’s income statement
and balance sheet, devise a corporate strategy for the company’s management
that would strengthen Otis Russia’s financials.
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