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Center aids Russian defense workers by courting U.S. high-tech business

Stanford -- Twenty-three Russian engineers, who once wrote computer programs for the Soviet military, are due to deliver their first commercial compiler software to a Silicon Valley contractor in January. The engineers take turns working on three Sun Microsystems work stations and sleeping in cots in their workroom because this is a make- or-break situation for them.

In Saratov, Russia, meanwhile, 13,000 defense workers managed this year to pay off their debt to the government, secure suppliers and get enough new contracts to ensure their plant's survival into 1993. They are scheduled to take formal ownership of the Saratov Aviation Plant - including their town's hospitals, schools and apartment buildings - on Feb. 6.

Both groups of Russian defense workers have been aided by teams of Americans put together by Stanford University's Center for International Security and Arms Control. Dozens of executives from American and Russian firms involved in such business projects were brought together by the center, along with government officials and researchers from both countries and China, for a four-day conference Dec. 1-4 in Palo Alto.

Stanford's role as a facilitator of Russian defense industry conversion to civilian profit-driven companies has been funded since early 1990 by the Carnegie Corporation of New York.

Approximately 200 people attending the Stanford conference discussed and debated what is needed next for successful conversion. Many attended to try to arrange business deals. (Other republics of the former Soviet Union were discussed, but the focus was on Russia's 80 subdivisions, where much of the former Soviet Union's research and development was concentrated.)

Russian executives and their American counterparts listed many obstacles to working together, not the least of which is poor telecommunications between the two countries. Alexander Lebedev of the Khrunichev Corp. drew knowing laughter from the audience when he bragged that he was the only one present with fax and phone technology to know what was really happening at the People's Congress of Deputies meeting running simultaneously in Moscow.

"Intellectual property protection is a huge problem for us," said Victor Turin of TsAGI, the Russian equivalent of NASA. Because Russia has no workable intellectual property laws, he said, "we have to protect ourselves by using world markets. This is an extremely painful problem for us. The other problem is hyperinflation."

Hyperinflation, along with a reduction in government subsidies and defense orders, has forced companies to lay off workers, take out loans with interest rates over 100 percent and to insist that buyers of their products pay up front in cash.

Despite many disagreements about how to solve these problems, there was almost total unanimity at the Stanford meeting on two things:

  • Converting Russia's defense industry to civilian production as quickly and competently as possible is crucial to preventing social upheaval and collapse of the fledgling democracy there.
  • It cannot be done without Western market-oriented technology companies working directly with Russia's high-tech defense sector.

Devising new ownership patterns - as well as management, marketing and financial accounting capabilities - are linchpins to success, speaker after speaker from both countries said.

The international weapons market is drying up, but conversion of Russia's defense industry "is doomed to failure if we do not have real economic success" with civilian products, said Ronald F. Lehman II, director of the U.S. Arms Control and Disarmament Agency.

Added William Perry, co-director of the Stanford center, and former U.S. undersecretary of defense: "Their defense industry has the best trained managers, the best equipment and facilities, the best of everything. Therefore, I would argue that converting the defense industry in Russia is not an option. It is a strategic imperative."

Russia's is the biggest defense conversion ever undertaken, Perry said. About 25 percent of the Soviet Union's population was dependent upon the military-industrial complex for its income, and the Russian government is trying to reduce the defense sector's share of the gross national product to 5 percent within two years.

In comparison, the United States proposes to decrease its defense spending from 6 percent of its gross national product to 3 percent over six years. That is "a serious problem for the workers and companies involved" but not an insurmountable problem for the U.S. economy, Perry said.

President-elect Clinton has proposed using excess U.S. defense capacity to rebuild the U.S. infrastructure. That raises many implementation problems, Perry said, but they pale in comparison to the conversion issues facing Russia.

China has been able to convert its defense industry's output from 90 percent military-related production in 1979 to 70 percent civilian production in 1991, Perry said. He called this a dramatic shift but said it was too early to assess whether China's more recent attempts to compete on international civilian markets would be successful.

Russia has neither the U.S. civilian sector to hire away the best defense workers for market-oriented work, as was the Bush administration policy, or the command organization of China to keep workers busy on domestic civilian production, Perry said.

He urged the Russian government to place orders with defense enterprises for such infrastructure needs as communications, transportation, housing, energy and food-processing systems. Russia also should "spin off" independent stock companies - smaller teams of workers and managers with the expertise to develop more competitive commercial products, starting first with products for Russian markets.

These smaller, independent units will be more likely to "attract Western joint ventures who have assets of capital, marketing expertise and an understanding of Western financial accounting methods," he said.

"Designating defense companies to produce infrastructure products will be inefficient, but compared to what? First of all, you do not have the hard currency available to buy this infrastructure in the West. Secondly, it will be less inefficient than to have these plants build unneeded weapons."

Several of the Russian plants represented said they had already spun off some teams who operate independently with their own banking accounts. Most said they hope, however, to keep the large organizations together, and they believe they have developed technologies that could compete internationally if they had the other resources necessary to enter the marketplace.

"We lack experience in the marketing and commercialization of our high technology," said Vasily Bakhar, vice president of Vympel Interstate Joint Stock Corp., which was established as a joint stock company this year. A designer and manufacturer of missile, space control and radar systems, Vympel has 59,600 employees in three republics: Russia, Belarus and Ukraine. The company's scientists and engineers are developing telecommunications systems, radars for air traffic control and other uses, monitoring equipment for industrial wastes and medical equipment, he said.

"We can develop this equipment to Western standards, but we believe it will be better if we can combine the best technology of both," Bakhar said.

Vympel is working on becoming a privately held company with assistance from Stanford and a U.S. consulting firm, he said. It also has an agreement with a consortium of American companies who want to market an air traffic control system that will compete with that offered by European manufacturers. It needs strategic alliances with other Western companies if it is to keep its work force intact, he said.

German, French and Japanese firms have moved faster than Americans to take advantage of Russian joint venture opportunities, many Russian and several U.S. speakers said. American firms have sent thousands of visitors to the former Soviet plants this year, but they have expressed more fear of the political instability, speakers said.

"We are always being pressured by Japanese and European companies, despite the fact that we would prefer to work with American partners," said Turin of the TsAGI aerospace center, which needs investments of $5 million to $50 million over one to two years to develop and test each of the civilian applications it has identified for its technology.

"American companies tend to be more risk averse and lack patient capital compared to competitors internationally," said Kathryn Wittneben, who researched American business involvement in the former Soviet Union for the American Committee on U.S.-C.I.S. Relations.

U.S. high-tech companies told her, Wittneben said, that the Russian defense industry offers technology and well-trained technical employees who will work at lower labor costs. The firms who have made deals, she said, first identified a technology that linked to their own and then made agreements that met the quick, hard cash needs of the Russians.

One of the big fears expressed at the conference was a "brain drain" of the best Russian resources.

The American firms "prefer to hand-pick the best employees to work with" through contracts, leases and joint ventures, Wittneben said. "Unfortunately, that doesn't fit the broader government definition of defense conversion as finding employment for defense workers [overall]."

In addition to cash, the Russians need to learn about marketing, financing, accounting and management, which can be done only through working relationships with people who have done those things, many speakers said.

Spending hours and hours trying to get the employees of one plant to understand that "stock is not a piece of paper with a fixed value," John Battilega, vice president of Science Applications International Corp., said he came to understand that "assimilation of basic economic concepts at a depth necessary won't come quickly."

"You can start a [privatization] process guided by definitions and formulas, but as you handle the problems as they come, you have to have an economic sense, and it isn't there. American companies have a high-leverage role simply by working with them. I would advocate a [government] policy promoting and creating a sister-company approach over a long period of time."

Economic understanding varies from one site to another, speakers said, but Russian managers have learned to become fast-moving problem solvers, speakers said. "They have a 'damn the torpedoes' attitude," said Battilega about the executives he works with at the Saratov plant.

One speaker compared the situation to the "Wild West" and another said to expect a few Western style "ghost towns" in Russia in places where capitalistic conversion will fail.

The U.S. government was the most consistently mentioned "obstacle" at the conference. Representatives of American firms who were trying to contract labor, license technology or form joint ventures complained about a lack of coordination among federal agencies, as well as the absence of aid or incentive programs. Export control procedures and even paperwork related to travel to former Soviet bloc countries were described as inhibiting.

Other problems include the lack of a central banking system in Russia, laws protecting intellectual property and a social safety net. Many of the Russian enterprises own hospitals, housing and other social assets that are not directly related to their bottom lines, but there is no structure for reorganizing those social assets.

Some American defense contractors are concerned that they will jeopardize business with the Department of Defense if they work with Russian defense enterprises, and others don't trust the U.S. Department of Commerce's information on technical opportunities in Russia because it was gathered initially for intelligence rather than business reasons, Wittneben said.

After years of the Cold War, it is difficult to adjust one's thinking, conceded William Walster, a manager of Sun Pro Systems, a division of Sun Microsystems.

When he got a call last summer from the Stanford Center for International Security and Arms Control, Walster said, the title of the organization made him think he was in trouble with the U.S. government. He had just returned from Russia, where he had signed contracts with a defense company to hire software engineers.

"I thought, 'What have I done now?' " he said. "I was scared. I really was. I made them send me all kinds of papers and articles before I was reassured."

Dave Bernstein, the co-director of the Stanford center's conversion project, wanted to offer Walster the center's help in making the project work, and eventually provided teachers for training sessions that Sun held for its Russian contractors in the Silicon Valley.



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