People In The Know: The Logic of Development

The History of an Alliance

-How did it all begin? When and how did Skanska return to St. Petersburg?

Skanska arrived in St. Petersburg in 1994 having purchased the bankrupt Russo-Finnish firm Haka-Stroi, though the company first launched operations in Russia before the revolution. In the 1980s the company developed the Pribaltiiskaya Hotel. But it was in the year 1994 that Skanska arrived in St. Petersburg to do real business.

One of its first ventures was to establish jointly with the city authorities Skanska Development St. Petersburg. The city committee for property management (KUGI) held a 50% stake in the company.

The company focused on the development of commercial real estate and implemented three projects, including a business center on 8th Sovetskaya Street, Sweden House on Malaya Konyushennaya and an office center on Kazanskaya Street.

At the same time Skanska continued to pursue its core activities – offering construction services. Over 80 projects have been implemented in Moscow and St. Petersburg since 1994.

- At what stage did the interests of Skanska and Peterburgstroi meet?

Our company VMB – the title is an acronym of the initial letters of the names of the three founders – was registered in 1991. We launched two projects – a business center on Energetikov Prospket and a residential block.

We occupied only two floors in the business center, leasing out the remaining properties. Thus we started a property management business which we pursued in parallel with real estate development. It was not until later that we started spinning off subsidiaries and specializing.

In October 1995 we tried to work together with Sberbank [the state savings bank] and registered the company Sberbank-VMB-invest. In June 1997 Peterburgstroi was established. And in February 2002 the Skanska concern bought an 80% stake in Peterburgstroi. By the end of the year the deal was completed and the company was given the double name Peterburgstroi Skanska.

- Who initiated the deal?

The initiative came from Skanska. The firm had taken a strategic decision seeking to develop housing construction in Russia, with St. Petersburg chosen as the first stop. How was it to be done? It is possible to set up your own firm from scratch, to hire a director, etc. But Skanska’s executives decided that it would be more interesting and faster to find a local operator. They studied options. Incidentally, Skanska has been carrying out similar studies in Moscow. But they have still not found anything there.

- What criteria were most important when selecting a partner?

Transparency and readiness to learn. Readiness to work with Western experts, and an understanding of Western principles of doing business. Plus experience on the Russian market.

- Why did Skanska conclude that building a company of their own in Russia would take too long?

Perhaps, the reason is that the potential of Russia’s experts had long been undervalued.

- By Western companies?

Yes, and not only by Skanska. For instance, it was long believed that a Russian with a similar level of proficiency could be paid much less than a Western specialist. Today expatriates are only invited to do a little coordination work or to do some work that we have still not learnt to do technologically.

Local staff are cheaper anyway, even if the salaries [of locals and expatriates] are the same, as the company has to reimburse expat employees for visa arrangements, accommodation, daily allowances, telephone bills, and trips. A Russian expert, even if his salary is just as high, is still cheaper.

- What was the price paid by Skanska for the stake in Peterburgstroi?

That information is not subject to disclosure.

- Experts estimate it to be $3.5-4.5 million…

No comment.

Tactics

- At the present time does Skanska employ mostly foreign or local technical equipment and staff?

When Skanska had just started its operations here, of course, it employed a large number of expatriates, mostly Finns. Today, Skanska employs Russians, Swedes, Finns, as well as Spanish and Portuguese for its projects in Moscow. As for equipment, shortly after arriving Skanska launched a production unit in Olgino. Equipment brought there is available for purchase or hire.

Local construction firms of the old guard ask us if we have our own assets. We tell them that for us – like for other foreign companies – that is a question of tactics. We do not employ thousands of workers on a permanent basis and do not keep hundreds of equipment units and tens of thousands of square meters of production facilities listed among our fixed assets.

However, at least half of all the workers involved in the construction of the Finnish consulate, which was completed in the fall of 2004, were staff employees of Skanska.

- Does the company hire people for specific projects?

The general model used by Western construction firms is as follows. There are people involved in general management, accounting, finance, preparing tender offers, estimates, health and safety etc. Those are called ‘overheads’ as their pay is included in the overhead expenses. The other workers – foremen, engineers and laborers – are invited for specific projects.

Of course, if the company’s volume of orders is large, the most experienced and talented workers may be invited to work on other projects, too. Today Skanska has specialists who have been working in Russia for many years moving from one project to another. They are few in number. They are the most talented, competent professionals that the company wants to keep, sometimes even by paying them salaries even if they are not involved in any projects – an approach rarely practiced by Western firms.

Incidentally, at the end of 2004 we had a session of the House Building Association council where we saw executives of certain construction firms coming to the realization that firstly, keeping thousands of staff workers on permanent contracts and enormous production bases listed in the fixed assets is an incorrect Soviet-style approach, and secondly, that overhead expenses need to be cut.

Construction firms will have to be very flexible. Fixed assets are a weight that pulls you down. The logic is simple. Do we need equipment? No problem. The company has specialized units providing equipment, the rest can be hired. A unit involved in construction hires equipment from another unit that owns the equipment. Cost centers and profit centers must be clearly defined.

With everything in one heap it is impossible to assess the effectiveness of each unit, to understand where the company is making losses and where it makes money. At Skanska the head of a construction unit has no headaches. He simply files an application to our department stating what he needs. Then, there are options. There are things we are able to provide ourselves, the rest will be rented, here are the rates, go and rent it! If something is not available in St. Petersburg, [our unit in charge of equipment] is ready to bring it over from other subdivisions of Skanska in Finland or to rent from specialized firms.

Ideology

- What were the objectives set out by the new shareholders?

Well, of course, the main objective was profit. Speaking of the objectives given to the management, they included the fulfillment of the business plan we had presented.

The priority of the foreigners is to achieve our projected results. Figures, tasks and objectives are usually set by managers, not shareholders. Shareholders endorse them. The global goal was to become a leader on the St. Petersburg development market.

Skanska’s core business is real estate development. The firm launches a project, implements and then sells it. One company is rarely involved in diverse operations.

For example, construction of roads or engineering infrastructure installations differs greatly from hotel construction. Therefore, Skanska has a company involved solely in the construction of roads and infrastructure, as a contractor within the consortium. Then there is a company involved in civil engineering, which is a different type of business.

There are firms involved solely in development. Each company is an independent legal entity. Otherwise, overhead expenses mix and a conflict of interests between subdivisions arises. Most importantly, it is difficult to assess the result.

Therefore, each subdivision has to be specialized, it has to be possible to assess its performance, and the companies must be able to work independently on the market. Each subdivision must be absolutely independent. Such is the ideology.

What is a leader? A leader does not necessarily mean being the largest company. Unlike our rivals we have never sought to expand our share of the market, say, to 10%. Moreover, I would not try to increase it to more than 6-7%, even if favorable tendencies prevailed.

Judging by today’s volume of construction in the city, I think for us that figure stands at a maximum of 5%. I do not mean that being a large company is bad, but in terms of management it is difficult, if nothing else.

If the market goes down or is at a standstill, as was the case in the fall of 2004, for a large company it is not easy to quickly revise its tactics. It is not flexible. It is more vulnerable. Moreover, once a company becomes very large and wants to hold on to large volumes it is no longer able to “filter” projects so as to ensure the maximum effectiveness of each of them.

Now, a few words about the staff. Finding a 20-strong team of professionals is somewhat easier than a team of 200 people. That is why a leader, as Skanska sees it, is an efficient medium-size company involved solely in effective projects. We are opposed to the strategy of ‘working on turnover’ – a typically Soviet approach still practiced here – and subscribing to some projects in order to keep our market share. We do not need that.

A leader is an effective company that commissions a property on the date set. Last year we commissioned an apartment building on Krestovsky Island. I am very happy with it, not only in terms of the quality but also because we met all the deadlines. Two years ago we promised our clients that the property would be commissioned in the fourth quarter of 2004. On December 27 it was commissioned. Although, we had problems when the government revised the building rules and regulations (SNiP) connected to provisions on the development of territory.

And, regarding quality. Our shareholders made it clear that they would no longer put up with the kind of mess they had seen on our construction sites.

Specifics

- Are inspections a common occurrence?

During the first year of operations the board of directors, which really does work, gathered every 6-8 weeks. Four of the five board members are representatives of Skanska East Europe. I am also a board member. The board has set a number of quantitative and qualitative indictors, such as financial results to be achieved, requirements for project quality and project decision making to be met, performance requirements. The key principles are transparency, legality, and the inadmissibility of illegal or semi-legal payroll schemes.

Unlike some other St. Petersburg-based companies we simply do not employ any shady financial sources. Everything is legal. It is possible to run a test, to send an undercover agent to our sales department who would say he is ready to pay $1,000 officially and to add $300 in cash for a square meter. We won’t sell! Indeed, it turns out that we lose some potential buyers for expensive projects. We received offers for the building in Krestovsky from people willing to pay $750 officially and another $750 unofficially. But we can’t.

- Are Western shareholders aware that such an approach may hamper operations?

Perhaps they are aware, although not always. But they were brought up and educated differently. Finland ranks first on the list of least corrupt nations. Incidentally, in some countries with high levels of corruption companies like Skanska say: never mind the profits; we will not do business in that country.

- I thought Russian management was quite efficient, which implies doing business in such a manner as to ensure that a company always had spare cash for bribes…

No comment.

Besides, the shareholders set the task of obtaining a whole range of international certificates, including management quality, environmental protection, and labor protection by December 2004. And we did. No other construction firm in Russia has that many. This is not just a whim, it is really useful.

For instance, the corporate management standards provide new workers with quite a comprehensive description of how the company works, offering a detailed plan of action in every situation. Of course, those rules are not set in stone. Life is changing and we adjust.

At the same time, the Western approach has certain disadvantages. Many “Westerners” try to use some of their methods in Russia, failing to take local specifics into consideration. For example, when residential properties go on sale in Finland ads are placed mostly on the street, on billboards installed at the roadside and near the property in question.

There is almost no advertising on the radio and in papers because they do not want to waste money on ads that are not effective. In Russia, on the contrary, billboards are unlikely to attract more than 10-15% of our customers while the bulk of the information goes through papers and radio stations. But television ads are most effective. Thus, it turns out that the advertising budget here is much bigger.

Another example is that sales offices in Russia employ more personnel than in Denmark. With lending still underdeveloped in Russia, companies assume the role of banks, receiving contributions from investment shareholders and thus carrying out the functions of banks. Employees deal with the contracts as cash desk operators would, as well as registering titles and giving legal counsel. Every respectable firm in Russia offers such services. Because of that they have to hire and hold on to specialists.

Certain Western business models either work poorly in Russia or do not work at all. In the beginning almost every Western firm arriving in Russia encounters such problems. And the sooner the “Westerners” hire Russian managers, the better.

And yet, the advantages outweigh the disadvantages. Everything depends on the planning. If you plan cooperation with Western partners for a period of just two or three years, there will most probably be just as many advantages as there are disadvantages. By planning 7-10 years in advance the advantages become obvious.

Our Western partner has taught us planning. Reports and comparisons of plans with actual results is something we do every week and every month. The problem with many Russian firms is that they do not understand what kind of business they are in, what the economic situation is like, what they are running, what kind of project they are involved in. They do not have a feel for it. They go with the current, solving routine problems. The Western approach implies that the manager must have a clear understanding of what he is managing, what kind of business and project he is in, and know the actual liquidity of the company.

Every month Skanska Russia reviews projects, examines the situation on construction cites, the balance of revenues and expenses, current forecasts for the completion of projects, and sales. Each month it controls overhead expenses, cash flow statements, sales, the execution of previous decisions, new projects, the land bank. Once a month there is a market review.

Before the end of the quarter a fresh forecast for all the indicators is prepared. This is important. Shareholders want to have an in-depth knowledge of the situation. So, it turns out that a lot has to be kept under constant control on the local level, and to ensure that the system must work. And it works. It took us almost two years to build it.

Strategy

- Why did Skanska sell its office and residential projects on 8th Sovetskaya Street, Sweden House in Malaya Konyushennaya and the office center on Kazanskaya Street?

The sale was a result of a realistic Western approach. Some three or four years ago our head office looked into the amount of money invested in various projects around the globe and compared it to the size of the authorized capital, equity and current assets that could be spent on current projects.

The shareholders concluded that the company’s liquidity was not high and it would be quite risky to keep such large funds – some $3 billion – in investments. The average effectiveness or return on investment was quite low. It was far more profitable to recoup our investments and to spend the money on expanding the core business – participating in new projects and accelerating current construction projects.

That logic works not only in Russia but in any other country where Skanska has operations. They moved to get approximately $2 billion back over a period of two years. One ruble or one dollar invested in office buildings gives a return in 10-12 years, while one ruble or one dollar invested in the core business – construction – produces a much faster return. Tenancy is more profitable than ownership as long as there are large current assets, and less in the fixed assets. Herein lies the logic.

Then, the company determined which regions had the better prospects and were least risky for retail real estate development and for the development of office properties. The reason Skanska sold its projects in Russia is not that Russia is bad – some countries are worse – but that it was not included in the company’s priority list. The projects selected for sale were sold within 18 months.