Three Critical Ingredients for Success in Foreign Investment in Russia

The recipe for a successful foreign investment project in Russia may have a number of ingredients, but three are critical. In fifteen years of advising a variety of clients on hundreds of projects in the former Soviet Union, we have witnessed exceptionally high failure rates. Of course, a business fails for many reasons: bad concept, no market, poor execution of the concept, inappropriate personnel, etc. However, in Russia the failure rate has been compounded by political, economic and social instability, profound differences between Russian and Western business practices, a Russian bureaucracy that strangles commercial activity and widespread corruption associated with that bureaucracy. To be successful the basics must be in place: good concept, strong market, proper execution, the right people; but the specific challenges of Russia require focused, persistent initiatives in three key areas.

Choose Your Partner Well

The single best predictor of success in a foreign investment project in Russia is the quality of the Russian partner. Indeed, it is no exaggeration to state that behind every successful foreign investment in Russia is a quality Russian partner. The difficulties of successfully operating a business in Russia over a sustained period are simply too great to be overcome without such a partner.

What makes a quality partner? In our experience, it is a combination of effectiveness, integrity, cooperation and transparency. Having “political clout” may be helpful, but it is vastly overrated (and often ephemeral) as many disappointed Western companies can confirm. Effectiveness means that the partner must be competent at the business and able to navigate the byzantine Russian bureaucracy successfully. This navigational function requires the right combination of assertiveness and obsequiousness to handle sensitive encounters with bureaucrats. Integrity is obvious; the partner must be honest in its dealings with the foreign partner and not yield to the temptation to pay bribes. Cooperation means that the Russian partner must be looking for ways to build the relationship with the foreign partner for the greater good of their joint venture business and also that the Russian partner is willing to learn from the foreign partner. Transparency requires that the Russian partner be willing to share information and assist in operating the business in a way that promotes openness between the parties. Clearly, these qualities are best cultivated by a foreign partner willing to demonstrate them graciously to the Russian partner.

How does one find a quality partner? Our experience teaches us that the peculiarly Russian features of the answer to this question involve a combination of trial and error, patience, and a commitment to developing the personal side of business relationships. It is also quite appropriate (and, indeed, often a necessity) to do background checking on a proposed partner. This includes obtaining references, the best being from other foreign companies that have worked with the Russian partner. This also includes, in many cases, hiring a private investigation firm to interview law enforcement officials, check registration and tax records, and confirm the reputation, expertise and experience of the potential partner. While many foreign business people find such private investigatory work objectionable, the difficulty in obtaining reliable public information about proposed Russian partners makes these investigations a vital component in due diligence. Many times investigations that we have arranged have revealed important information that disqualifies a potential Russian partner, such as ties to organized crime, involvement in illegal activities that have attracted the attention of tax or regulatory authorities, a pattern of cheating business partners, or corrupt ties to Russian government officials.

Once the background investigation is complete and reveals no such problems, work should begin on developing the relationship. Under no circumstances should the foreign partner be in a hurry to develop the relationship. The seeds of failure are sown in haste. To our knowledge no one has suffered ill consequences from being patient and methodical in selecting a partner.

Building the relationship with a Russian partner is intensely personal. Officials at all levels of the foreign company should be involved in cultivating relationships with their counterparts within the Russian organization. Russians value the personal aspects of the relationship far more than Westerners tend to do, and success requires that proper attention be given to this aspect of the relationship.

The foreign partner should also focus on the educational aspects of the relationship. Almost certainly the foreign partner’s background, training, experiences and interests have been vastly different than his or her Russian counterpart. Much of the development of the relationship should be focused on familiarizing the Russian partner with the values and goals of the foreign partner and practical issues, such as how the business is operated in the West, what the appropriate measurements of that business should be, and how legal compliance is accomplished.

What we have learned about the importance of partners should not go unheeded by companies that establish wholly-owned subsidiaries or do not have a Russian partner in a traditional sense. The same principles identified above apply where the “partner” may be a key supplier of raw materials to the Russian business owned by the foreign company or a key distributor of products from that business. In many circumstances local governmental authorities, particularly in regions outside of major metropolitan areas such as Moscow and St. Petersburg, should also be considered in some sense “partners” by the foreign investors.

Think Broadly and Take Nothing for Granted

The establishment and implementation of a foreign investment project in Russia requires that the foreign investor think broadly about the entire range of business activities and take no aspect of those activities for granted. Every facet of how the business is conceived and operated in Russia must be well understood by the foreign investor, starting from the most basic questions of supplying the business (power, water and other utilities as well as ingredients or raw materials). Shame on the American businessman who established a joint venture to produce ice cream in Moscow only to learn that one of the required ingredients he had assumed was available — skim milk — was unheard of in Moscow in the early 1990s. Among the due diligence issues for the well-prepared American aluminum producer was how to acquire control of a regional power plant to ensure an adequate supply of electricity for the aluminum smelter.

Equally critical is control over the sale and distribution of products. The baby food manufacturer must take steps to ensure that products are not stolen by employees or sold at deep discounts for cash by those employees out of the back door of the plant. What a surprise to a major American company to learn that its joint venture partner, who had been left to run the business, had hired representatives of the Russian mafia to collect bills – and that they deployed the strong-arm tactics one would have expected.

No company has done this better than arguably the most successful foreign investor in Russia, McDonald’s. McDonald’s exercised control over all aspects of the business to ensure quality from beginning to end. Especially impressive has been their vigorous training program that has produced hundreds of young Russians who understand the importance of prompt, friendly customer service.

The foreign investor must also understand cash flow in the business, the Russian accounting rules applicable to the business, the regulatory regime and the interactions with the bureaucracy responsible for that regulatory regime. Cash flows are a particular concern, since Russian currency laws continue to restrict the remitting and receiving of payments, particularly in foreign exchange. U.S. oil and gas companies can attest to the myriad of overlapping, confusing and contradictory regulations which govern exploration, development and production operations in Russia. Many such regulations contemplate practices that are dramatically different than internationally accepted practices for such operations. Many American companies that fail to understand the interactions between the business and the bureaucracy, and the potential for corruption in those interactions, have suffered the consequences under the U.S. Foreign Corrupt Practices Act.

These issues should ideally be addressed prior to making any legally binding commitments. One of our clients learned to its dismay that the manufacturing operations being conducted by an apparently reputable, potential Russian partner were “legal” only because the Russian partner had not disclosed the ownership of two affiliated companies to the Russian authorities. To make matters worse, upon further due diligence the client learned that the

Russian partner kept a “reserve fund” of cash to bribe governmental officials if questions were raised. Serious potential liability would have resulted if our client had already acquired the business.

Participate in the Business in a Consistent, Focused Way

The third critical ingredient for success is for the foreign investor to place a competent, mature, stable senior employee, with appropriate authority and support, on the ground in Russia. The employee must become completely immersed in the business. In fact, it is not advisable to consider a joint venture or any substantial investment without a willingness to arrange for such an employee to be resident in Russia indefinitely or at least until appropriate Russians can be trained and the trust developed to allow them to run the business successfully.

Countless tales of woe abound as Americans recount experiences with Russian partners left alone to run their jointly-owned businesses who bribe officials, maintain multiple sets of books and records, enter into self-interested transactions, commit the business to liabilities it cannot meet, or engage in activities totally unrelated to the business plan. One Russian partner appeared on our doorstep with a request that we advance a bribe on behalf of a major American company to the Russian registration authorities. Another Russian partner diverted resources from a manufacturing facility to operate a car repair shop on the plant site. Another built titanium sailboats for wealthy Russian oligarchs instead of power generation equipment the Russian partner had agreed to construct. The list goes on.

This ingredient requires the foreign investor to appreciate how vastly different the Russian business culture is from the business culture developed in more market-oriented Western democracies. Basic Western business values like communication, cooperation, transparency, efficiency, training, quality control, etc. are frequently missing in Russian business experience and must be taught patiently but persistently. The foreign investor’s employee on the ground must become familiar with the propensity of many Russians to avoid compliance with law or indeed any cooperative contact with law enforcement or other government officials. It is critical to understand and anticipate the tendencies of many Russians to compromise through corruption in order to get by. The foreign partner’s on-site employee must also know how Russian managers address personnel, financial disclosure, tax reporting and customer prey on businesses with foreign investments. Disgruntled Russian partners have also been successful at mobilizing local law enforcement officials to take action against their foreign partners, which often allows such Russians to circumvent the normal dispute resolution mechanisms in their joint venture documentation and put enormous legal and political pressure on their foreign partners.

None of these vitally important pieces of information can be conveyed in a series of brief meetings at the commencement of the project. The foreign investor simply must ensure that its own personnel learn these lessons by direct experience and focus on developing appropriate connections between the foreign investor’s values, principles and standards and those of its Russian counterpart.

Concluding Remarks

The consequences of serious consideration of these three ingredients are obvious. Their proper implementation involves great time and expense, making successful investment projects quite difficult for small to medium-size companies. Moreover, the process involved in following our counsel undermines any effort to get rich quick in Russia. Almost always the road to success is longer and the costs greater than originally anticipated. As Russia continues to stabilize politically, economically and socially, opportunities for foreign investment should increase, but the importance of including our three critical ingredients in any “recipe for success” will not diminish for some time to come.

Mr. Dean was at the time and is now partner with Coudert Brothers. He founded Coudert Brothers’ Moscow office in 1988 and heads the firm’s Russia practice. Coudert Brothers was the first Western law firm to establish an office in Moscow.

Last Updated: June 6, 2002.
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