Gorbachev, Turnaround CEO

No one, not Joseph in Egypt or Alfred Sloan, has ever faced a managerial challenge as far-reaching as the one Mikhail Gorbachev has set for himself. In his own writings and speeches the Soviet economy comes across as a huge, failing industrial corporation whose workers are demoralized and whose managers are complacent about everything but privilege. The Soviet Union, Inc.’s monopoly in its domestic market has produced a vaguely equal distribution of security, but not enough wealth to be worth distributing; in international markets, it can barely hold its own against Singapore. For 70 years, Gorbachev laments, no fundamental alternatives to the Soviet system of planning could be openly advocated. Marxism-Leninism—or, in Gorbachev’s view, a perverted form of it—stifled entrepreneurship and innovation by disallowing private enterprise and enrichment. International competition was dismissed as imperialist encirclement. Gorbachev, then, has undertaken not only to change the course of the ship of state but also to provide new maps, install a new navigation system, introduce a new theory of command, and gradually replace the crew. Has there ever been a turnaround effort like it? Obviously Gorbachev’s challenge warrants the attention of American managers, and not only because a good many American businesses could use some perestroika themselves. Reform in the Soviet Union may eventually mean new commercial opportunities for U.S. companies and new competition—in world markets as well as in military and diplomatic spheres. Soviet efforts are intriguing for the way they reveal fundamental principles of production in an age of computer-driven technology. Whether he succeeds or fails, Gorbachev’s effort represents a serious experiment in administrative reform, one that promises to exploit general management principles that are familiar to any executive—incentives, accountability, pride, quality. Not long ago the Soviet economy was growing so rapidly, Nikita Khrushchev boasted that by 1970—1980 at the latest—the Soviet economy would overtake and surpass that of the United States. The economic situation began to deteriorate sometime in the mid-1960s. And by 1979, during the last four years of Leonid Brezhnev’s rule, output in important industrial sectors like steel and coal actually began to fall. The year 1979 also marked the beginning of a series of seven poor harvests, leading to the imposition of food rationing in several of the more hard-pressed regions of the country. By 1982, GNP growth had fallen to .7 % and, for the first time ever, the growth of per-capita income actually dropped. Brezhnev’s death in November 1982 and Yuri Andropov’s succession brought a halt to the decline. A former head of the KGB, Andropov moved to restore discipline and order; 1984 proved that intimidation can, by itself, produce some impressive gains (see the table). But they didn’t last long. Production in major industries dropped again under Chernenko, and when Gorbachev assumed control, Soviet GNP was growing at half the 5.3 % average for the period 1966 to 1970. (Gorbachev himself has acknowledged that “the national income in the past four five-year plans stagnated and actually fell in the early 1980s.”) Soviet Union, Inc.: Annual Report 1982–1986 (January–February Production as a Rounded Percentage of Preceding January–February) Sources: Ekonomicheskaia Gazeta, March 1982, March 1984, March 1985, March 1986. The decline in Soviet GNP was even more serious than it appeared because Soviet economists routinely factor in production that is nothing but waste. Every time a Soviet factory produces a ton of steel or a pair of shoes, economists assume consumption, investment, or capitalization and GNP is increased. The same procedure applies in the West. But if those shoes are never consumed or if the steel is junked, economists fail to take account. Some factories in the Soviet Union have had quality rejection rates as high as 70 % . And Gorbachev himself noted wryly that many Soviet steel factories used to send products from the factory floor “directly to storage.” Indeed, Soviet factories require three times more coal to produce a dollar’s worth of gross domestic product than West German factories need. What accounts for all this waste, poor quality, and misallocation of resources? How could Soviet economic growth be so impressive in the early years of the Soviet regime and be so unimpressive now? According to Gorbachev, the secret of past Soviet economic success is precisely the source of its current problems—a centrally planned economic system, commanded from Moscow since the early 1930s. There is Gosplan, the state central planning organization; Gossnab, the Soviet central supply agency, which allocates imports and assigns output targets for Soviet factories; and Gosbank, the state bank. There are collectivized peasant farms under state control. As part of previous efforts to generate quick economic growth, the central planners set individual factory and farm targets in terms of quantity of output: tons, units, or meters. When a factory produced heterogeneous items, targets were set in terms of gross ruble value of output. Generally, the higher the percentage increase in output over the preceding period, in units of production or rubles, the higher the factory bonus. For years this system worked well enough. The Soviet Union was so short of products that managers at all levels of decision making focused mainly on quantity. If quality suffered in the process, this seemed a small price to pay: the priority was to ensure survival. But once basic needs were met, and as high-technology products flooded the international market, quality became increasingly important. If anything, central planning exacerbated the problem. Soviet planners have always found it difficult if not impossible to control quality from the center. Gosplan and Gossnab took responsibility for product quality away from managers and operators in making them subject to rough quantitative targets. A factory could look good on paper however shoddy its products. Indeed, who cared if products actually sold? In the Soviet Union’s command economy, prices were calculated on a cost-plus basis: the higher the input costs, the higher the final price. Where profit was but a minor consideration for the factory manager, little emphasis was given to controlling costs—any American defense contractor will tell you why. And since big factory bonuses depended on high gross ruble value of output, the Soviet managers were keen on designing products with excessively large quantities of raw materials, which is why Soviet products have tended to be so large and heavy. The same kind of wastefulness has plagued agriculture. Soviet officials report that as much as 20 % of Soviet crops rot in the field each year, amounting to a loss of billions of dollars in convertible currency—the approximate value of the agricultural products the Soviet Union has had to import. Since agriculture amounts to about 20 % of the Soviet GNP, compared with only about 3 % for the United States, improvement in this sector is critical to Soviet development plans. But it is not just a question of crop spoilage. That which doesn’t spoil seems increasingly inadequate. Soviet reluctance to raise retail prices on food staples has led to serious economic distortions—bread prices have not changed since 1955! The widening gap between wholesale grain and retail bread prices has encouraged wily Soviet peasants to buy up as much as 15 % of the bread that is baked and feed it to livestock. In time, the failure of the Soviet economy to respond to consumer need and market disciplines began to take its toll. Frustrated by the poor quality of the goods offered them, workers became less and less willing to work hard. As one worker expressed it: “If they will only pretend to pay us, we will only pretend to work.” Gorbachev lectured the employees of a television plant in Vladivostok in July 1986: “You produce television sets that stop working in 13 to 15 minutes; yet you are upset at the way construction workers build—the roof leaks and so forth.” It’s a caviar and sturgeon predicament. The advent of high technology has made Soviet bureaucratic planning glaringly inept as well as ponderous. Today, industrial management must be responsive and technically sophisticated; those who lag even momentarily risk falling behind a whole generation of producers. Product life cycles are now shorter, markets are more specialized, and, in an age of personal computers, a tremendous premium is paid to entrepreneurship, independence of mind, quick communication, shared learning—attributes alien to the Soviet economy and, indeed, Soviet society. Back in the 1960s, industrial societies emphasized steel and standard machine tools. Industrial prowess and economic strength were measured not by how sophisticated the country’s computers were but by how large steel and machine tool production was. Once the basic technology in these sectors had been mastered, it could be used over and over again without much change. Gosplan could thus set plans for five years at a time and not have to worry about changing innovation. Today the situation is very different. Products and production processes change from year to year. But the new technology is raising other, even more important problems for the Soviets. PCs can function not only as management tools but also as printing presses and electronic mail systems. Can the Soviet government encourage managers to avail themselves of the PCs, printers, copiers, and modems that make possible computer-integrated manufacturing and yet stifle the political individualism that accompanies the new technology? Can a police state govern the new industrial revolution? It was only a few years ago, after all, that my own use of a Xerox machine in the Moscow offices of an American company prompted a KGB warning that the machine would be confiscated if it was used any further for non-business purposes. It is in this context that Gorbachev has campaigned for glasnost, for more openness. Curtailing the KGB’s interference in intellectual and artistic life was, for him, merely a consequence of curtailing its interference in the economy. His first task was to improve worker morale. He visited many outlying towns and cities—some of which had never seen a czar, let alone a Communist party general secretary—and urged people to work harder. He told them the country would face a crisis if they did not do their best. And he extended his promotion effort to the media, using television, radio, and newspapers to spread the word and rally support. Then came the crackdown on alcoholism. The sale of alcohol was banned before 2 p.m. and the number of liquor outlets was sharply reduced. This had an immediate impact. Sales of alcoholic products fell 37 % in 1986, which in turn produced a decline in highway accidents (and, arguably, in the rate of divorce). More important, worker productivity rose and product rejection diminished. Unless workers had considerable foresight, they had to be sober at least until 2 o’clock in the afternoon. As it happens, the emphasis on discipline and the crackdown on drinking were particularly important in increasing the production of petroleum. In late 1983, oil production began to drop, and by 1985, output for the year was down 3 % . Gorbachev flew out to the main production fields in Western Siberia and spoke out for better quality and against vodka. He followed up his visit by firing local party officials and petroleum managers. One year later, production was up by 3 % . But Gorbachev’s exhortations proved to be only a short prelude to more comprehensive action. In late 1986, he began sketching out a series of proposals for reform—revolutionary in scope, “counter revolutionary” by Soviet tradition—that culminated in the program he presented to a plenum of the Central Committee of the Communist party in June 1987. For the first time a Soviet leader proposed something more than just a refinement of centralized bureaucratic planning. Rather, he offered the rudiments of a market approach. Gorbachev intends to diminish the role of administrative decision making and central planning. This means shrinking the control that Gosplan has exercised over the ministries. Under the new proposals, Gosplan’s and Gossnab’s power will be reduced; they will command the production and allocation only of priority goods like steel, coal, oil, and other icons of the old five-year plans. Government needs will be met by the issuance of state orders. The goal is to reduce the number of state orders to such heavy industries to somewhere below 30 % of their total output, though at present the average remains around 90 % . While reducing the power of Gosplan and Gossnab, Gorbachev seeks to enhance the functions and decision-making powers of managers in the producing enterprises. As of January 1988, economic decision making was officially decentralized. By law, enterprises producing 60 % of industrial production are now self-financing; they must fund not only their current operations but also their future growth with their own profits, depreciation, or, if need be, repayable loans. They can no longer count on subsidies from the state budget. Enterprises that operate in the red will be declared bankrupt and closed down. Managers in these enterprises now have more power to decide what to produce. They determine their own production targets in response to market demand and, within limits, make their own wage decisions, award bonuses, hire, and even fire. According to Gorbachev’s program, prices for raw materials will vary more nearly according to supply and demand. Goods will no longer be priced on a cost-plus basis, though pricing will remain under strict government control until 1990. This means that if all goes as planned, goods in short supply—e.g., meat, televisions, fashionable clothes, for which there are always long lines—will be priced higher. The new pricing mechanism may lead to temporary inflation, but higher prices and higher profits should stimulate factories to boost production, which in turn should lead to shorter lines and lower prices. (That is the theory.) At the same time, prices of goods for which there is little demand will drop, depleting the shelves and forcing reduced profits and production cutbacks. Presumably, cutbacks will generate a wave of employee layoffs, something rare in Soviet enterprises. Gorbachev has authorized 100 of the largest Soviet enterprises and 21 ministries to engage in foreign trade on their own. According to the July reforms, most imports and exports (which have had to go through the Ministry of Foreign Trade in the past) may be negotiated directly between Soviet traders and foreign partners. This change should lead to greater responsiveness on the part of Soviet exporters. It should also increase the exposure of Soviet producers to world competition. After 60 years of self-enforced isolation, the Soviet Union finds itself with one of the world’s most protected economies. Gorbachev seems determined to bring the Soviet Union up to world competitive standards in technology and product quality. As of this writing, Gorbachev and his advisers are calling for convertibility of the ruble and even for Soviet participation in the General Agreement on Tariffs and Trade, the International Monetary Fund, and the World Bank. Incidentally, what counted to Soviet citizens in the past was not how many rubles they had but how many allocation or ration coupons they had been authorized by Moscow. To make the shift to market forces more stringent, Gorbachev has ordered the establishment of wholesale warehouses that will sell production materials to ruble holders. The decision to authorize creation of joint ventures on Soviet territory with foreign partners—especially from the capitalist world—is another part of Gorbachev’s effort to expose Soviet industry more effectively to the currents of world technology. The reforms allow foreigners no more than 49 % of the equity in such ventures, and Gorbachev has insisted that both the president and chief operating officer of any joint venture be Soviet citizens. There are other restrictions. Strict rules discourage the repatriation of profits and limit sales by jointly owned companies in the Soviet market. Yet we should not underestimate the ideological and economic significance of these proposals to cooperate with Western and Far Eastern multinationals. Unlike Lenin, whose national economic policy he admires, Gorbachev has not justified readmitting foreign investors with the notion that two steps forward require a step backward. For Gorbachev, this is entirely a step forward. Another step forward is Gorbachev’s decree legitimizing private enterprises. He has imposed strict limits, however, on what new enterprises may do and when. Expected to keep the business a family affair, they cannot hire employees. Moreover, unless the entrepreneurs are pensioners or students, they can operate their business only after they have finished their regular work. Yet the decision to unleash private initiative suggests that Gorbachev wants to harness energies previously thought a corrupt quest for personal wealth. Enrich yourself, Gorbachev echoes Adam Smith, and provide the economy with more goods and services. He hopes that money will become more meaningful if there are more goods and services to buy. To accelerate the drive toward quality, Gorbachev has sent out quality inspectors to 1,500 of the Soviet Union’s largest factories. These inspectors have the power to reject newly produced goods and to deny bonuses to managers as well as laborers. This corps of gospriemka has had an impact. Production has fallen at many Soviet factories, but quality has improved. Finally, and perhaps most radically, Gorbachev has advocated the election of managers and shop foremen by enterprise employees. His proposal suggests that candidates even nominate themselves by secret ballot, though in large factories a labor collective is to be elected from worker ranks to make the actual decision. The point of this reform is to generate loyalty and a greater sense of participation in the workplace. If Gorbachev’s proposals make sense on paper, they are, not surprisingly, exceedingly controversial. Indeed, his proposals are so far-reaching that they threaten almost everyone in the society: workers will have to work harder or face pay cuts or even discharge, managers may be voted out of a job, ministers and bureaucrats may lose their offices (and limousines and special government stores). Gorbachev’s dilemma is that having moved too fast for his critics, he may be unable to move fast enough for his plan to succeed. If he had decided to approach reform more gradually, he might have avoided alienating so many people at once. But then he would not have been able to demonstrate that experimentation and disruption are worth the effort. To quiet detractors, Gorbachev must now prove that his reforms have produced results at least in the construction of housing and the availability of better quality consumer goods. Will workers work harder if they do not see more abundant and more desirable goods to buy with the money they earn? Can factories produce more and better goods without worker involvement? If the workers decided to work harder, would they not find themselves frustrated by the ill-designed machinery they work with? “Men make history,” Karl Marx wrote, “but not just as they please.” Gorbachev has little time to resolve a whole series of managerial dilemmas—dilemmas that would baffle even the most resourceful leaders. If I were his consultant, I’d advise him to face certain problems squarely and I’d offer some possible solutions. If Gorbachev is to eliminate what he says is a 70 billion ruble ( $ 110 billion) annual subsidy on consumer goods, he will have to increase housing costs 20- to 30-fold, and meat prices 3-fold. As the Polish leadership would affirm, such price hikes can be politically explosive. Indeed, when meat prices in the Soviet Union were raised in 1962, riots ensued that had to be put down by Soviet troops. An increase in unemployment might produce the same result, which is why Gorbachev has been attacking economists who have warned that meaningful reform will necessitate a minimum unemployment rate of 2.5 % to 3.5 % —a projection he may actually believe. How can Gorbachev rid the economy of unproductive workers and products and at the same time stimulate the production and invention of new and more desirable goods? Recommendation: A switch from central planning to the market will be disruptive no matter how carefully considered the transition. But the Hungarians and the Chinese have been somewhat more successful than the Poles, say, in getting over the hump. First, they combined their price increases with wage supplements, particularly for the lowest paid workers and pensioners. Second, they moved quickly to unleash private-sector and peasant initiatives. In China, the peasants were, in effect, decollectivized. The state retained ownership of the land but the peasants were allowed to contract with the state to use the land for long periods and grow what they wanted without being told what, when, or how. Similarly, the Chinese government relaxed control over small businesses producing consumer goods and services other than food. Admittedly, prices rose. But so did output, and price increases soon leveled off. Almost everyone’s standard of living improved enough to dispel much of the grumbling. Gorbachev, like Deng, should insist on more liberal conditions for those willing to set up private businesses, including less red tape and permission to hire non-family members—something not now permitted. Private businesses may help to absorb some of those workers laid off by the closing of bankrupt factories. At the same time, the state will have to move quickly to upgrade its employment offices and to create a computerized job bank. The Soviet people have accommodated themselves to the principle that income for most working people will be relatively equal. An exception has always been made for party officials, who have had access to special shops, clubs, cars, and resorts. Nevertheless, conspicuous consumption has always been associated in the public imagination with illegal dealings in the second economy or the black market. Indeed, the state finally closed down a private taxi cooperative in Krasnoyarsk because the drivers were obviously earning too much money. Gorbachev’s dilemma: How can he successfully promote an “enrich yourself” mentality after so many years of opposition to it? How will ideological conservatives accommodate themselves to income differentiation? Recommendation: Brave as he has been, Gorbachev has not faced up to the ideological implications of what he is doing. Gorbachev will have to curb some of the grosser disparities in income, but he must defend openly the social benefits of private gain. An increase in consumer well-being, driven by entrepreneurship, will do much to intimidate ideological hard-liners. It matters not whether the bear is red or black, only that it knows how to find honey. Gorbachev has to stop the practice of lifting Soviet workers’ wages faster than productivity. But as he cuts wages, worker morale and product quality will decline. Sending state inspectors to the Soviet Union’s largest factories to reject poor-quality goods is not the answer. In Western economies, poor-quality goods are flushed out of the market because no one buys them. That is a risky and time-consuming strategy in the Soviet Union, however, where goods have been in chronically short supply. How can Gorbachev improve quality and do it quickly using market techniques? Recommendation: Competitive pressure for improved quality can be accelerated if Gorbachev hastens the growth of expanded private business. Soviet consumers will pay a premium for quality, especially for such products as jeans, stereos, and televisions. Gorbachev should let small, private manufacturers fill the niche. He should also introduce a system of redress for those who have purchased poor-quality items, so that consumers become the inspectors. The penalties should be lost profits. To give the Soviet Union a more democratic economic system, Gorbachev has called for the secret election of not only factory managers but also shop foremen. If they have their own political mandate, will the shop foreman respond to orders from the factory manager? Where will their loyalty lie? How can Gorbachev stimulate a sense of partnership among workers without destroying necessary managerial prerogatives? Recommendation: Keep the elections for factory and farm managers, but do not extend the election process to lower ranking supervisors. Gorbachev should also set up crash training programs for industrial managers, who must now come to terms with greater uncertainties and a potentially more restive work force. Indeed, he has begun to move in this direction—training programs have been instituted and Western business schools and corporations have been asked for assistance. In March, for instance, the Harvard Business School and the USSR Research Institute of External Economic Affairs in Moscow began a cooperative research project aimed at developing guidelines for joint venture enterprises in the Soviet Union. Gorbachev is hoping that joint ventures will help the Soviet Union master high technology and boost its exports. But Soviet conservatives are insisting on a host of cumbersome restrictions. At this writing, only 21 joint ventures have won official approval, all of them minor in scope and involving low—certainly not high—technology. The most sophisticated is a factory producing process equipment in the energy industry. More typical are the timber operations in Siberia, a hotel, an Indian restaurant, and two Pizza Hut outlets in Moscow. It is a different matter, though, to attract more sophisticated undertakings as long as the foreign partner is unable to exercise quality control or repatriate profits. Gorbachev’s dilemma: How can he obtain the infusion of the technology he wants and needs without risking an ideological backlash? Recommendation: By all means keep tight controls on those efforts that do not involve sophisticated technology transfer, like timber operations. But Gorbachev should allow high-technology companies to repatriate convertible currency, even if they generate no exports. At the very least, such ventures will permit import substitution—in computers, copiers, and so forth. Gorbachev abolished the Ministry of Foreign Trade in January, thus allowing enterprises and ministries to contract for their own imports and exports directly. He has also said the ruble should be convertible. But if the terms of trade for Soviet individuals and enterprises are liberalized, can the Soviet Union avoid large trade deficits? How, then, to protect the value of the ruble? Recommendation: An increase in the trade deficit is unavoidable. Gorbachev should gradually broaden the number of industries that are exposed to competition, and he should also determine a schedule for the devaluation of the ruble. Such measures can only help improve quality, and they may boost exports of Soviet commodities like timber and oil. The keystone of Gorbachev’s reform is contraction of Gosplan. As long as the authorities in Moscow can disburse favors, even their informal phone calls to managers will be treated with deference, regardless of market conditions. Gorbachev’s dilemma: Can he reorient the managerial class so that it feels empowered to ignore those at the center? Recommendation: There is no way to empower all managers without undermining the center. As a start, all ministries should be abolished and personnel decisions decentralized. As long as any exist, they will be tempted to interfere unduly. Gorbachev should trim Gosplan’s power back so that it somewhat resembles Japan’s MITI. It should be a coordinator of long-range planning and a facilitator of long-term capital investment, but not a center dictating to company managers. Gorbachev will have to make some tough choices in the months ahead. Like other executives around the world, he has discovered that upending a system that has resisted change for so many years is not easy. As he himself has put it, his restructuring program has meant that there are many “who have had their toes stepped on.” For Gorbachev the big question is whether he can withstand the political criticism that will inevitably come with the administrative steps he must take to succeed. But can anything short of radical restructuring, leading to some quick economic successes, stifle criticism? The second most dramatic thing about Gorbachev’s challenge is that nothing will sink him more assuredly than halfway measures. The most dramatic thing is that he knows it.

Gorbachev, Turnaround CEO

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