Return to Home Page 1997 Joint Ventures between Russia and the United States By Paul Herbig** INTRODUCTION Perhaps the most important foreign policy question of the 1990s is how the United States and the new independent states of the former Soviet Union can work together to strengthen the process of economic restructuring in the former Soviet Union republics. While economists and policy makers continue to sift through the many possible approaches to this issue, business people on both sides have pushed ahead to explore the limits of present legal and economic structures in Russia. As a result, increasing attention is being given to a uniquely challenging and potentially rewarding mechanism for international economic cooperation, the joint venture. A joint venture can be attractive to an international marketer when (1) it enables a company to utilize the specialized skills of a local partner; (2) it allows the marketer to gain access to a partner's local distribution system; (3) a company seeks to enter a market where wholly owned activities are prohibited; and (4) when the firm lacks the capital or personnel capabilities to expand its international activities otherwise. (See Table 1) U.S. companies are finding joint venture choices limited in the markets of the new republics of the former Soviet Union for several reasons: Difficulties in assessing profitable and legal opportunities in a non-market economy, lack of some managerial and technical skills in these new republics, absence of necessary infrastructure, uncertainty about inputs, currency conversions, and pricing (since all purchases within Russia are still required to be handled in rubles. Note this changes day to day . Sales denominated in dollars are still allowed though discouraged and unpopular), tend to complicate and delay investment decisions. (See Table 2) Numerous legal methods of joining companies together exist, but the joint venture form is essentially a merger or partnership of two or more participating companies that have joined together to increase profits through improved marketing, financing, and/or managerial know-how. Three definite factors are associated with joint ventures: (1) there is an acknowledged intent by the partners to share in the management of the joint venture; (2) joint ventures are partnerships between legally incorporated entities such as companies, chartered organizations, or governments (not between individuals); and (3) equity positions are held by each of the partners. RUSSIAN JOINT VENTURES The Russians are enthusiastic about joint ventures because they allow access to western technology, management and marketing expertise, and hard currency. Russia is in poor economic shape, with its gross domestic product plunging 50 percent since late 1991 (Rosett, 1994), a still too high military budget absorbing too much GNP, a 1994 national deficit of nine percent, which is proportionally higher than that of the U.S. (The Wall Street Journal, April 19, 1994) and an annual inflation rate approaching 100 percent (but still an improvement over the 1993 rate of 800 percent). (The Wall Street Journal, July 11, 1994). Many U.S. firms have been put off from investing due to the economic mess, the pervasive bureaucracy, the growing crime problem (with "protection" payments to the mafia necessary for survival), and the ever-changing legal and political landscape. U.S. corporations with an understanding of business in Russia can negotiate successful joint ventures with Russian organizations. The principles of establishing a joint venture include minimizing risk while setting an acceptable return. This includes avoiding areas with a high risk of violence, evaluating the charters of potential partners, and finding a partner with a compatible corporate philosophy. Western companies with current technology, tested distribution systems, and marketing schemes can generally profit by providing their assets to a Russian company with ancient technology and little to no distribution or marketing systems. The oil industry is one example. Negotiations are hampered by the Russians’ lack of understanding of free markets, the stifling bureaucracy, and their lack of capital. U.S. business people seeking a joint venture should be prepared to spend at least one year and $100,000 before getting a signed agreement (Cooper, 1990). As reflected in Table 3, as the negotiations commence, U.S. representatives attached the most importance to management and control issues. On January 1, 1989, a new law about business enterprises affecting joint ventures came into operation. The opportunities for joint ventures have been broadened: with the permission of the Ministry of Finance and the Ministry of Trade it is now possible to form enterprises completely owned by foreign investors. Foreign participants in joint ventures can now be private individuals, not just legal entities. Table 4 shows conditions of development and activities of joint ventures in the Russian Union.4 Although this was an initial step to encourage foreign investment, several more laws (sometimes conflicting) have been passed since that time. For example, in May 1994, President Boris Yeltsin signed six decrees designed to boost the disappointing level of foreign investment by easing taxes on joint venture manufactures and abolishing the export licensing and quota system (The Wall Street Journal, May 24, 1994). Fifty percent of the joint ventures in the former Soviet Union have formed in the areas of engineering, the manufacture of computer programs, informational consulting, and project construction activities as seen in Table 5. These joint ventures are in sectors of the economy that do not require substantial start-up investments. U.S. companies so far tend not to participate in spheres that may require a lengthy period of time before becoming profitable. Americans have been hesitant to invest heavily in joint ventures in Russia or the other republics. An exception is U.S. West, who is planning to increase its presence in Russian economy by helping the country improve its telecommunications infrastructure. The firm plans to help finance three international gateway switches. U.S. West is also planning to enter into a joint venture to implement a cellular system in Moscow. The firm is aware of the Russian's political and economic risks, which have caused other Western firms to avoid doing business there. U.S. West President and CEO Richard McCormic believes that the benefits of the investment outweigh the risks. U.S. West is planning to invest approximately $18 million in Russia between 1991 and 1993.5 Increased investments in the Russia’s telecommunications infrastructure will improve communication for the Russians and remove a tremendous barrier in day to day business operations, especially for international communication where domestic international calls must be requested 24 hours in advance. THE FUTURE OF JOINT VENTURES American vendors need to understand the business dynamics of the former Soviet Union when attempting to exploit the vast market potential of the new republics. Those considering doing business should avoid making judgments based on the portrayal in the U.S. media. Every purchase should be made to count; Russia should not be used as a dumping ground for obsolete hardware. It is important to establish contact with companies and organizations that create and support user groups in the former republics (Amdilyan, 1992). Effective distribution channels are vital; several U.S.-based distributors have established a presence in Russia. Seminars, road shows and presentations are valuable tools for educating the CIS market. Presidents, CEO's and chairpersons make good corporate ambassadors to the CIS. Pricing policies need to be flexible, especially if products are sold for hard currency. The U.S./Russian Information Institute has been established through a joint venture agreement signed by a Minnesota consortium of academic and business groups with a former Russian think-tank. The institute will help North American business firms pursue trade and investment opportunities in the former Russian Union. The Russian partner in the venture is the Russian Institute of World Economy and International Relations, a part of the Russian Academy of Sciences (Robinson, 1992).. An increasing number of joint ventures are anticipated and joint agreements like this one will aid interested partners in their efforts to identify and pursue marketing opportunities in the Russian Union. American business firms were the largest investors in Eastern Europe and the former USSR in the first quarter of 1992, surpassing their German and Italian counterparts. Both in terms of the number and value of deals, U.S. companies emerged on top of the investor list. American firms pumped in a total of $1.1 billion during the period, up from $819 million in the fourth quarter of 1991. Among the U.S. firms, electronic companies have been the most active group in terms of acquisitions, joint ventures and new start-ups. This increase in investments by American businesses in the first quarter of 1992, surpassing German and Italian counterparts, tends to reinforce the future potential of U.S. joint ventures in the former Russian Union. CONCLUSIONS It is too early to determine to what extent foreign and Russian investors in Russian-based joint ventures will be able to realize their respective objectives. However, it is already clear at this point that many of the foreign investors attracted to the Russian Union are either incapable of or unwilling to provide the know-how and capital that the Russian Union government had hoped for in relaxing its joint venture legislation. Thus, caution regarding partner selection, an advice so frequently extended to the foreign investors, should just as well guide the host firms. Russian firms will do well to examine the available resources and know-how of their prospective foreign partners as well as looking at the record of those firms in establishing and managing joint ventures in other countries. At the same time, Russian firms should seek an independent evaluation of their assets prior to the joint venture negotiations, so as to receive an adequate equity representation in the venture and assure sufficient investment on the part of the foreign partners. Foreign partners in Russian joint ventures will have to take this reality into account. Russian companies will tend to be more suspicious of the motives of foreign firms, if they are not world-renowned firms, they will have to acquire the Russians trust prior to and throughout the negotiation process. A significant investment in employees, and particularly managerial work force will become essential. Foreign investors taking this long-term approach may be eventually rewarded for their efforts. Table 1 Advantages of Joint Ventures Shared Market Risk Reduced Political Risk and Discrimination Access to Market Knowledge Access to Technology, Products, Trademarks, etc. Access to Marketing Network, Distribution Systems, etc. Reduced Investment Requirements Access to Experienced Labor Force Access to Suppliers Tax Advantages Reduction/Exemption of Import Duties on Commodities for Production Requirements Access to natural resources Table 2 Disadvantages of Joint Ventures Loss of Control, which may result in: Conflicts over Dividends Objectives Conflicts over Marketing Objectives Conflicts over Production Objectives Conflicts over Financial Objectives Conflicts over Personnel Objectives Conflicts over Supplier Objectives Conflicts over Transfer Prices Conflicts over R & D Efforts and Costs Limitations on Profits Contributions to Joint Venture can become Disproportionate Complexity of Procedures for Conducting Negotiations in Creating a Joint Venture Difficulty in finding the authority figure--licensing, patents, etc. Tax Laws change often Quotas on exports are often changed whenever Russians feel exploited (which is often) Ever-changing political landscape--Example is the recent decree making pre-1993 issued rubles worthless. Table 3 Important Issues of U.S. Negotiators in Joint Ventures Mean (Scale = 1-5) Most important issues Management Structure 4.1 Management Control 4.0 Capital Contribution 4.0 Allocation of Profit 3.9 Important issues Supply of Material Ownership Shares Calculation of Profit Less important issues Quality Assurance 3.3 Licensing 3.0 Housing Arrangements 3.0 Not important issues Obtaining Credit 2.6 Salaries of Workers 2.6 Use of Technology 2.6 Table 4 Conditions of Development and Activity of Joint Venture in CIS 1. Type of enterprise Undefined by law; in practice, companies with limited responsibilities, consortia, associations, trade houses, bands 2. Conditions and Permission of higher requirements for authorities or permission establishment of of Russian Ministers of joint ventures the Republic formal permission 3. Limitations None on the forms of activities 4. Maximum time Undefined for examination of joint venture application 5. Organization Ministry of Finance responsible for joint venture registration 6. Limits on share of Up to 100% foreign partners 7. Participants Russian and foreign legal persons 8. Minimum investments None 9. Use of property Can be leased 10. Protection of State guarantees based on property intergovernmental agreements on investment protection 11. Definition of Balance profits - payments taxable profits to reserve funds - payments to development fund 12. Taxation of profits 30% with 2-year maximum delay of payments after declaration of profits 13. Limitations on profit None transfers and withdrawals 14. Additional taxes on 20% can be lowered or exempted profit transfers abroad 15. Other taxes Income taxes 16. Permission for foreign Not required currency transactions 17. Credit requirements Credits obtained in in local and foreign Vnesheconombank, bank currency specializing in foreign currency transactions, or in foreign banks with permission of Vnesheconombank 18. Fund types Reserve fund until it reaches 25% of charter capital. Contributions of any size before taxes 19. Current type of Ruble (can be in other currency bookkeeping purpose as auxiliary measure) 20. Dependence on the Independent state plan 21. Supplies from the Based of agreements, payable local sources in rubles or hard currency 22. Distribution and sales Market prices, ruble and hard inside the country currency 23. Foreign trade Permission after registration with Ministry of Foreign Economic Relations or through import/export organization 24. Customs fees Foreign contributions, imports of materials and equipment for joint venture's production is duty free 25. Employment of Allowed foreign nationals 26. Wages Local partner in rubles. Foreigners in rubles or in foreign currency or by agreement 27. Labor relations Act independently, make their own decisions concerning labor. Creation of union of JV workers 28. Management One of two positions: chair limitations of the board, or general manager, can be held by foreign partner Table 5 Joint Venture Specialization Sphere of Activity Number of JV's Percentage Total 1447 100 Fuel and energy complex 16 1.11 Metallurgical complex 21 1.45 Chemical - lumber complex 97 6.70 Heavy machinery 91 6.29 Production of personal computers and software 208 14.37 Construction and building materials 117 8.09 Transportation and communication 27 1.87 Agro - industrial complex 91 6.29 Trade and public food services 71 4.91 Tourism, hotels, transportation 87 6.01 health and medical care 56 3.87 Education 2 .14 Light industrial manufacturing 53 3.66 consumer goods 123 8.50 Film and video 34 2.35 Concert activity 22 1.52 Printing and publishing 43 2.97 R & D 71 4.91 Engineering 58 4.01 Consulting and intermediary services 149 10.30 Personnel training 10 .69 REFERENCES Amdilyan, Levon (1992), Some tips on dealing with the new Russian Union. PC Week 9/44 (Nov. 2): 81. 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