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Orica – The Russian Puzzle
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Orica Limited is a leading publicly-owned company with operations in more than 50 countries and is ranked among the top 40 companies listed on the Australian Stock Exchange.
Orica and its growth
Orica was formed when British chemical company ICI plc divested its Australian operations in 1997. Since then, Orica has pursued opportunities for organic growth, category expansion, mergers and acquisitions (including the acquisition of the global explosives interests of ICI Plc) that have marked Orica’s transformation into a global company. Orica today pursues a focused strategy targeted at the provision of services to mining, construction and infrastructure industries. It operations are conducted as three separate businesses - Orica Mining Services (OMS), Minova, and Orica Chemicals, each a leader in its chosen market.
Orica Mining Services (OMS) is the global market leader in the supply and servicing of commercial explosives and blasting systems to the mining, quarrying and infrastructure sectors. Commercial explosives, initiating systems and Blast-Based Services are its main offerings. The business is run globally with a presence in Australia, Asia, Europe, the former Soviet Union, Africa, the Middle East, North America and Latin America. Mining services contributed to 55% of the 2010 revenues.
OMS business activities are guided by three pillars:
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• Strategy - planning for business growth
• Efficiency – productivity improvements and capital management
• Culture – having common attitudes, behaviours and ethics.
Orica in Russia
Russia, the largest country in the world, has always been known for its vast abundance of natural resources including oil, natural gas, coal, timber and many strategic minerals. Almost 15 years ago, Orica Mining Services entered Russia to exploit the huge market potential by leveraging on its expertise in mining services and to take part in the rapid infrastructure development in Russia. The Russian market is operated as a part of the Commonwealth of Independent States (CIS) (Exhibit 1).
OMS recognizes the mining sector in CIS as one of the high growth areas. Currently, their strategic initiative for CIS is to aggressively grow through targeted selection of customers and markets. In implementing this strategy, OMS understands the need to take calculated risks by being quick and responsive. It can further leverage on its global business and differentiation through superior products, services and supply chain in achieving its goal.
Assessing the Russian Market
Today, OMS finds itself faced with a dilemma regarding their business operations in Russia. The market and geopolitical situation has changed over the years and the mining services industry has also transformed, with Russian mining companies internationalizing and also due to the increasing
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The strategy team of Orica Mining Services is assessing the Russian situation. It is critical for Orica to get an understanding of the complexities so that a strategic direction can be set for exploring specific opportunities in the Russian market. This would allow the management to allocate resources for exploring these opportunities more in-depth.
The team believes that an analysis of (western) MNCs would provide inputs to crack this case. The intention is to approach the “Russian Puzzle” by an analysis of entry and operating strategy of specific MNCs operating on the “Make-Move-Sell” model in the Business-to-Business industrial space, which Orica itself specializes in.
You have joined the Orica strategy team recently. The team is to provide an analysis and recommendations for the strategy to adopt in Russia. You may take the liberty to use secondary sources other than the information given, to accomplish the task.
Make – Move – Sell
The “Make-Move-Sell” model is based on manufacturing the products in the region not being reliant on imports, establishing distribution networks and selling through these networks to the customer. The OMS Strategy Team wants to explore firms in such industries – e.g. mining equipment and consumables, mining services, quarry and construction, oil and gas, general construction, heavy manufacture, public works. They intend to assess all aspects of a business case study for these firms.
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One such industry is the construction equipment industry. It has shown tremendous growth potential and, as a result, offers Western construction equipment companies enormous opportunities for growth and expansion. The construction and mining machinery market in Russia is expected to continue to grow strongly for at least the next 3-5 years. The Russian construction machinery market in particular was valued at $2.6 billion in 20071. The attitude of buyers towards foreign equipment has also been changing with the buyers now opting for imported machinery ensuring higher productivity and greater reliability, even at a higher initial purchase price. What has changed today when compared to the situation 10 years ago? With more demand for Western made heavy construction equipment, is there a secret formula to succeed and be sustainable in Russia?
Shifting our attention to the oil and gas industry, Russia happens to be one of the world’s “energy superpowers”. In terms of production, they are the largest in the world for oil - producing 12% of the aggregate volume. They are also the second largest producers of natural gas. However, there remain significant challenges in this industry. According to Swedish economist Anders Åslund2, corruption consumes a large share of the investments – as much as fifty percent in the case of energy giant Gazprom. The Russian section of Blue Stream pipeline was three times more expensive to construct per kilometer than the Turkish section of the same pipeline. With the once highly-productive fields in Siberia slowly being exhausted, there is a huge demand for investments for drilling and searching in the untapped regions. Is there a way for Western MNC’s to overcome the adversities and reap profits from this lucrative industry?
1 Robert Obekton, Richard Lucas. "The Russian construction and mining machinery market 2007," Russian Construction Review.
2 Keith C. Smith (October 2008). Russia and European Energy Security - Divide and Dominate.
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Maintaining corporate governance standards in the Russian market
For the strategic direction, OMS feels that maintaining corporate governance standards would also be another significant factor. For companies that wish to carry out their businesses in Russia, it is a lucrative market characterized by significant risks. In addition to the normal business and operational risks of starting or expanding business in a new country, companies have to also consider Russia’s increased risk of bribery and corruption.
The 2010 Corruption Perceptions Index (CPI)3 published by Transparency International indicates that conducting business in Russia carries a high risk of corruption. In the index, Russia was placed at 154 out of 178 countries, putting them into the top 25 countries with highest perceived levels of corruption. TI’s latest Bribe Payers Index, published in 20084, ranks firms headquartered in Russia as the most likely of the 22 top exporting countries to pay bribes. This problem was particularly pronounced in the industrial space. Oil and gas, heavy manufacturing, mining and construction were four of the five sectors in which companies were seen to bribe officials most frequently.
Several recent incidents illustrate the state of affairs in Russia and the difficulties in doing business there. In April 2010 German carmaker Daimler agreed to pay $185m to settle a US corruption case involving offences committed in Russia5. Just two weeks later, Hewlett-Packard, an American technology giant, came under the investigation carried out by Russian, German, and US authorities.
3 “Corruption Perceptions Index 2010 Results”.
4 Bribe Payers Index 2008:
5 "Foreign firms pledge not to give bribes in Russia". Rozhnov, Konstantin. BBC News, 21 April 2010 .
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Allegedly, the HP’s Moscow office paid $10.9m to the Russia’s Office of the Prosecutor General to ensure a $47.8m deal6.
Elena Panfilova, head of Transparency International in Russia, said that any company working in Russia could find itself in a situation when it did not want to give bribes but was forced to do so if it wanted to carry on doing business. In February 2010, Swedish furniture giant IKEA fired two top managers at its Russian subsidiary over a bribe paid to facilitate obtaining an electricity connection from Lenenergo, the state-owned St. Petersburg utility7. The difficulty they faced in getting a basic utility presumably contributed in their decision to withhold expansion outside the Moscow region8.
There is also significant concern about the role of politics in determining the fate of Russian businesses. In 2003 Yukos, one of the biggest and most successful Russian petroleum companies of that time was presented with a series of reassessed tax claims that amounted to $27 billion. At the same time, their assets were frozen by the government. Unable to pay these tax demands, the company went bankrupt and was eventually liquidated. However, Yukos claims its actions to have been perfectly legal at the time and that the the same tax reduction schemes were used by other oil companies in Russia. The underlying motives behind this affair have been analyzed by The Center for Eastern Studies to “the ruling class’ anxiety about a strong competitor and a desire to eliminate it and the wish to prevent an international investor from taking over a large shareholding of Yukos”9.
6 "U.S. Joins H-P Bribery Investigation". Crawford, David and Searcey, Dionne. The Wall Street Journal, April 16, 2010. .
7 “Russia’s top two IKEA execs sacked over suspected bribery”. Russia Today.
8 "Foreign firms bypass Russia due to rampant corruption". The Times. 08 Mar 2011.
9 "The ‘Yukos Affair’, its Motives and Implications". Centre for Eastern Studies. August 2006.
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The Assignment
In order to solve “the Russian puzzle”, the OMS strategy team wants to arrive at a list of key success and failure factors of operating in the Industrial B2B space in the CIS. The OMS strategy team has appointed you to deliver -
• A recommendation for a(ny) (Western) MNC in the industrial space to enter and operate in the Russian market.
• Key success and failure factors for such MNC’s (being a new entrant) operating under a ‘make, move and sell’ model in Russia.
• Assess 2 or 3 companies that are operating in this industrial B2B space; e.g. mining equipment and consumables, mining services, quarry and construction, oil and gas, general construction, heavy manufacture, public works. The assessment will address all aspects of a business case study. Present your recommendations along the lines of the assessment findings.
• Identify the “do's” and “dont's” (in the industries of choice) with focus also on upholding the companies own corporate governance standards in the Russian market.
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Exhibit 1
Exhibit 1: Orica Mining Services in CIS - 2010