Miloš
The economic crisis that began in 2014 hit the Russian mechanical engineering industry hard. Compared to 2008, the situation for enterprises was complicated by political sanctions against Russia. On one hand, the twofold drop in the ruble became a positive factor, increasing the cost of similar foreign machines and reducing competition in the domestic market for domestic producers. On the other hand, imported components, on which the production of Russian equipment heavily depends, became more expensive. The cost of mechanical engineering products rose. Manufacturing plants became concerned with import substitution, but so far this task has not been solved.
Another negative factor was the decline in economic needs. With the exception of orders placed by the military-industrial complex and state corporations, the rest of the market slumped sharply. Total demand for the products of mechanical engineering companies decreased more than it did in 2008.
Unlike our enterprises, foreign companies quickly reoriented and began to additionally stimulate demand for their products in Russia by introducing new financial services. They began providing buyers with unprecedented discounts, long-term interest-free installments, leasing, and practicing other methods to stimulate purchasing activity.
In the crisis situation, domestic companies chose different tactics. A number of enterprises (for example, a crane manufacturing plant in Chelyabinsk) diversified sharply, changing their assortment and concentrating efforts on exports and working with key clients. However, most mechanical engineering companies preferred to sharply reduce the amount of products manufactured, focusing on various ways to optimize expenses and reduce costs.
One of the enterprises caught in the whirlwind of these economic events and experiencing the negative consequences of the crisis was the Mashinstroy holding (name changed).
About the company
The Mashinstroy production holding has a long history and tradition. It includes production enterprises, a design bureau, and its own sales unit. The holding produces tractors, municipal equipment, bulldozers, and special-purpose equipment for the military-industrial complex with a fairly wide range of modifications. It is one of the few mechanical engineering companies in Russia that has preserved the engineering competencies and production base necessary for producing modern products.
Sales Market
Mashinstroy works with customers from Russia and small developing countries, to which sales are carried out largely through political channels. The competitive environment in which it offers its products is not very saturated. On one hand, there are Western manufacturers, whose equipment, after the fall of the ruble, exceeds the cost of similar products from the holding by 30% or more; on the other, there are Chinese plants, whose equipment is lower in quality and currently not widespread in Russia.
Management
The mechanical engineering holding consists of a number of independent enterprises located in different regions of Russia. They are managed by a management company located in Yekaterinburg. The powers of plant directors are limited to solving only operational issues. All strategic tasks are formed in the management company. In most cases, all communications between enterprises were also carried out through the management company.
The formalized development strategy of the mechanical engineering holding became irrelevant under the current conditions. A new anti-crisis strategy has not been adopted. In this situation, each head of an enterprise within the holding independently seeks solutions to exit the crisis.
Finances
A high level of fixed costs remained in the holding. At the same time, product output dropped sharply, leading to a fall in turnover and profitability. High indebtedness and the inability to take new bank loans increased the need for working capital. For this reason, the deadlines for several contracts were missed. Against this backdrop, financial flows decreased even further.
Personnel
As a result of the reduction in production volumes, salaries fell in most divisions of the holding. Key specialists began to resign. The level of motivation and engagement of personnel dropped sharply. Gradually, some enterprises began switching to a part-time work week, which served as another push for the resignation of several important specialists.
Products
The range of products is quite wide: municipal, agricultural, quarry, and construction equipment. In addition, a number of enterprises have competencies in producing military equipment. The engineering company constantly develops new equipment, including innovative types. New modifications of existing products are constantly being developed, and models that have proven themselves in the market are being updated.
General Situation
Starting from 2014, the situation in the holding has been constantly deteriorating. A shortage of working capital makes it impossible to ensure the deadlines for existing contracts. Despite the demand for the holding’s equipment, the ability of the enterprises to meet the needs of the mechanical engineering market has also decreased. Parallel to this, the capacity of the Russian market is shrinking.
In the absence of an actual strategy in the field of sales and marketing, a large amount of work-in-progress has accumulated, which, against the backdrop of a shortage of working capital, further exacerbates the situation of the mechanical engineering holding.
With rapidly falling turnover, the holding’s fixed costs remained at the previous level for quite a long time. Profitability began to drop rapidly, going into the negative within a year. Having a large loan portfolio, the holding began to delay loan payments. Delays in salary payments appeared in each of the business units at the enterprise.
Questions
- What solutions do you see for bringing the Mashinstroy holding out of the crisis?
- How should these solutions be integrated into the overall development strategy of the holding?
Answer
1. What are the downsides of this type of enterprise organization, such as a holding? First and foremost—transfer pricing. The owner of a holding always has the temptation to sell the products of one of their enterprises to another of their enterprises not at a market price, but at an undervalued one. What does such a protectionist policy lead to? Exactly the same thing that protectionism at the state level leads to. The holding’s enterprises become less competitive compared to their direct competitors in the global market, as they may not care much about sales. Why bother if the buyer is “one of their own”? They will buy anyway.
During a period of economic growth, this all seems like trivia, but in a crisis, there are no trivialities.
Thus, the first and obvious direction of optimization is increasing the autonomy of the holding’s enterprises.
2. A crisis is always characterized by a decrease in the share of CAPEX and an increase in the share of OPEX in enterprise budgets. So, the second obvious direction of optimization will be reorienting from the finished products market to the production of spare parts, warranty and post-warranty service; as for finished equipment, the goal should be not so much to fight for the shrinking Russian market as to push into the global market with all possible strength.
3. A strong point of Russian mechanical engineering is still a fairly powerful design school. It makes sense to negotiate with the Chinese about production in China based on Russian projects. Yes, this means that the holding’s design units act directly to the detriment of the production units. From the perspective of social obligations, it is not very “comme il faut” to reduce labor-intensive production, but from the perspective of the holding owner, developing a potentially more high-margin research and design direction is certainly profitable.
4. When the price of labor drops even further compared to the Chinese, production in Russia can be resumed, and “made in Russia” mechanical engineering products can be sold in the Celestial Empire, which sounds fantastic for now, but the Russian leadership is confidently moving the country in exactly this direction. Of course, this will mean the entry of Chinese comrades into the capital of the corresponding enterprises of the holding. It is also possible that the enterprises could be offloaded to them entirely, and even for a relatively decent price. Of course, this move might not work, because you never know exactly when the state will decide to tie the hands of a drowning man, imagining he actually intended to save himself. However, this caveat applies to absolutely any step taken by a legal business, so it is not necessary to repeat it every time.
5. A lack of working capital means that strategic investors must be sought. For this, it may be necessary to take some of the holding’s enterprises public through an IPO, which, in essence, would mean their exit from the holding while the current owner retains, say, a blocking package of shares. In return, refinancing, a change to more effective management, and involvement in new technological and sales chains could give these enterprises a development impulse, and for the current owner, mean a transition from losses to profits.
