[pic]

ConocoPhillips – Final Report

MBA 808 – Moscow May 1, 2008

Scott Legler Erin Osborn Greg Whitehorn

Introduction

The ConocoPhillips and LUKOIL joint venture provides great insight into doing business in Russia. The Russian economy continues to grow as companies domestically and internationally find success in an emerging market once filled with corruption and instability. Through an analysis of the ConocoPhillips and LUKOIL joint venture one can see the opportunities available for those companies who are able to enter this market. ConocoPhillips provides lessons learned and a six-step approach for a successful joint venture business in Russia. ConocoPhillips also provides insight into many of the challenges still facing those who desire to do business in Russia. They prove that with a will to confront and determination to overcome these challenges, business in Russia can prove to be quite profitable.

Background

ConocoPhillips

ConocoPhillips is the third largest energy company in the U.S. Based on market capitalization; it is surpassed in size only by U.S. oil giants Exxon Mobile and Chevron. ConocoPhillips is headquartered in Houston, TX and employees over 32,000 people worldwide in forty countries. According to its website “ConocoPhillips is known worldwide for its technological expertise in reservoir management and exploration, 3-D seismic technology, high-grade petroleum coke upgrading and sulfur removal.” The four core worldwide activities of ConocoPhillips in the oil and natural gas industries are: • Exploration and Production

• Refining, Marketing, Supply, and Transportation

• Natural Gas Gathering, Processing and Marketing

• Chemicals and Plastics

ConocoPhillips’ 2006 sales were $188.5 billion with net income of $15.5 billion, an increase of 14.9 percent over the previous year’s net income. With 12 U.S. refineries, the refining capacity of ConocoPhillips is 2.7 million barrels per day. It sells petroleum at 10,600 U.S. retail outlets under the brand names 76, Conoco, and Phillips 66. Top competitors for ConocoPhillips include Exxon Mobil, BP, Shell, and Chevron.5

Conoco was founded in 1875 when Isaac E. Blake began providing kerosene to a small town in Utah. Phillips Petroleum Company was founded in 1917 by two brothers, Frank and L.E. Phillips, who had already achieved great success in discovering oil in Oklahoma. Both companies went on to become giants of the U.S. oil industry in the 20th century. The rich histories of these two companies spanned the Great Depression, two world wars, and the oil crisis of the 1970’s. During this time, each company faced challenges such as downsizing, oil price fluctuations, and attempted acquisitions by hostile firms. Over time, Conoco became known as a leader in technology with a large global presence while Phillips came to be regarded as a powerhouse of innovation, research, and development. This reputation for innovation began early in Phillip’s history, and in 1975 the company was granted its 10,000th patent.5

In May 1998, Conoco became an independent company again after 18 years as a subsidiary of Du Pont. An IPO soon followed to sell Conoco to public investors. The IPO was valued at $4.4 billion and was the largest in history. At the turn of the century, Phillips was expanding by making many acquisitions including the purchase of ARCO Alaska for $7 billion. In November 2001, Phillips and Conoco reached an agreement to merge forming “the sixth-largest publicly traded oil company in the world and the third-largest in the United States.” 5 The largest publicly traded oil companies at the time of the merger can be found in Exhibit 1.

Though Conoco was purchased by Phillips, the merger of the two companies was viewed as a merger of equals. The two companies meshed well, but found that their very different cultures determined the way the two companies approached new ventures. Conoco was the more aggressive of the two companies. It was one of the first companies to enter Russia getting a foothold there in 1989 before the fall of the Soviet Union. Conoco also had experience as a first mover in other risky environments such as Iran and Venezuela. Phillips, on the other hand, tended to employ a less aggressive strategy of waiting before moving into emerging markets. While Conoco had a history of moving quickly into a new market and doing a small deal to get a foothold there, Phillips would wait and enter a market by doing a large deal only when it was comfortable.

LUKOIL

LUKOIL is the largest oil company in Russia accounting for 19 percent of Russia’s oil production. The natural gas monopoly Gazprom is the only Russian company that is larger. LUKOIL is an integrated company focused on the extraction, production, refining, and sales of oil products. The company operates throughout Russia and has operations in 30 other countries. In addition to Russian operations, LUKOIL has oil exploration and production activities in Kazakhstan, Azerbaijan, Uzbekistan, Egypt, Iran, Iraq, Colombia, Venezuela, and Saudi Arabia. In the past few years, LUKOIL has expanded greatly by making acquisitions as it tries to restructure from a centralized, bureaucratic organization to a decentralized firm that can compete in the global energy market.

LUKOIL’s annual sales for 2006 were $68.1 billion with a net income of $7.48 billion. This represented a 16.2 percent growth in net income for the year. LUKOIL currently owns over 5,700 gas stations and 8 refineries. LUKOIL's own facilities refined over 350 million barrels of crude oil in 2006. In 2007, crude oil output of LUKOIL was estimated at 1.96 million barrels of oil per day, an increase of 1.6 percent over the amount of crude oil output for 2006. LUKOIL employees approximately 148,000 people worldwide. Its top competitors are BP, Gazprom, and Rosneft.4

After the fall of the Soviet Union, the oil industry was one of the first industries called on to privatize its assets. In 1992, the government required three major state-owned oil companies, Langepasneftegaz, Uraineftegaz, and Kogalymneftegaz, to merge. A year later these merged companies became known collectively as LUKOIL, adopting LUK from the first initials of each company. Several other large oil companies were also formed by the government at this time, but LUKOIL was the largest. The first president of LUKOIL was appointed by Boris Yeltsin at the time of its formation. LUKOIL went public in 1994 and the following year the company began to rapidly expand.4

Russian Oil Industry

Russia has one of the largest oil industries in the world and the country’s current economic boom is largely based on the output of this industry. Russia’s annual oil production is surpassed only by that of Saudi Arabia. Russia is, therefore, the largest non-OPEC oil producer in the world and second largest overall. In addition, Russia has the largest reserves of natural gas in the world and is the world’s largest exporter of this resource. Russia is second only to the United States in world coal reserves. With proven oil reserves of some 60 billion barrels, Russia is currently ranked 8th in the world in oil reserves. Russia is the second largest exporter of oil in the world with approximately 12 percent of world production and exports. Russian oil production in 2006 averaged about 9.7 million barrels per day which was a 220,000 barrels per day increase over 2005.1

The economy of Russia has grown at a rate faster than all other G8 nations each year for almost a decade. This is largely due to the volume of oil exports and the high price of oil on the world market. Estimates from the World Bank and IMF indicate that 20 percent of Russia’s GDP of $1.7 trillion in 2005 came from the oil and gas industries. According to the Energy Information Administration’s analysis, “Russia’s economy is heavily dependent on oil and natural gas exports, making it vulnerable to fluctuations in world oil prices.” In 2004, the Russian government established a stabilization fund which was estimated to be worth almost $80 billion dollars by the end of 2006. The purpose of this fund is to lessen the risk of Russia’s dependence on oil exports for economic stability. Over two-thirds of Russia’s export revenues are from raw materials such as oil, natural gas, minerals, and metals.1 The Russian government benefits from high taxes on energy extraction and exports, but such taxation could slow the growth of oil production in the coming years.

ConocoPhillips and LUKOIL Joint Venture

Overview

On September 29, 2004 ConocoPhillips and LUKOIL formed a strategic alliance. The alliance involved ConocoPhillips becoming an equity investor in LUKOIL and the creation of a joint-venture with the purpose of developing resources in Russia’s Timan-Pechora oil and gas basin [ see Exhibit 2]. Another objective of the joint venture was to seek the rights to develop the West Quam oil field in Iraq. The agreement resulted in ConocoPhillips’s purchase of 7.59 percent of LUKOIL’s authorized and issued ordinary shares held by the Russian government and came at a price of $1.988 billion ($30.76 per share). The initial Shareholder Agreement between the two companies allowed for ConocoPhillips to increase its total ownership in LUKOIL up to a total of 20 percent, which it did by the end of 2006. The Shareholder Agreement also limits ConocoPhillips’ ability to sell LUKOIL shares for a period of four years.6

The joint venture between LUKOIL (70 percent interest) and ConocoPhillips (30 percent interest) allowed ConocoPhillips to partner in the development of LUKOIL’s reserves in the northern Timan-Pechora area (north of European Russia). ConocoPhillips paid LUKOIL more than $370 million for a 30 percent interest in the resources, an additional payment for its 30 percent share of working capital and its 30 percent share of LUKOIL’s capital investments in the fields.

Reasons

Although foreign investors are now allowed to start wholly foreign owned firms in Russia, joint ventures represent the most popular method of foreign direct investment in Russia. Carl Fey names the following in his article “Success strategies for Russian-foreign joint ventures”:3

• Russian partners can provide country-specific knowledge and valuable help in navigating through Russian bureaucracy.

• Joint ventures often receive lower prices for services than wholly-owned foreign firms.

• The risk of starting to do business in Russia can be shared between two or more firms.

• Russian partners can often provide access to prime real estate.

• From the Russian partners' perspective, IJVs help them to:

o Obtain needed starting capital;

o Learn Western management practices;

o Develop leading-edge technology; and

o Gain assistance in marketing products in the West.

The LUKOIL/ConocoPhillips joint venture was a strategic move for both companies. LUKOIL had understood the benefits of a joint venture relationship with a western company as a way to share knowledge crucial to its future success. It attempted a similar joint venture with BP which did not prove to provide the expected benefits. After discussions with the leadership of ConocoPhillips, LUKOIL knew that this experience would be much different.
In a press released distributed on the day of the agreement the following were listed as the “strategic rationale” for the transaction 6: [pic]

Foreign companies such as ConocoPhillips have much to gain with a partnership with a Russian oil company. Leaders in both companies understood that, to sustain production, they must continue to “go greater distances, operate in more difficult geographic and surface environments and build more complex and highly integrated delivery systems.”7 To accomplish these objectives, the companies must obtain the technology, personnel and additional capital. Joint ventures such as this one allow companies to address the cost and the risk while finding the most effective solutions. It is estimated that the world will need $8.2 trillion oil and natural gas development investment over the next two decades according to the International Energy Agency. Russia alone will need a staggering $38 billion in investments each year.2 Companies such as LUKOIL are seeking foreign companies to serve as sources of some of that capital. On the technological front it is imperative for Russia to be able to extend the lives of producing fields through higher efficiency and improved recovery. Although Russia has experience facing these challenges, working with international oil companies gives it access to a much broader array of potential solutions.

Outcome

In 2006 LUKOIL began development drilling in the Yuzhno Khylchuyu field in Russia’s Timan-Pechora basin. Ninety development wells are in operation as of the first half of 2008. LUKOIL also agreed to purchase from ConocoPhillips 376 retail fueling stations in Europe. The two companies are also jointly pursuing opportunities both in and outside of Russia. As a part of this alliance, the companies have launched an employee exchange program to share best practices. During the last two years about 30 LUKOIL and 18 ConocoPhillips employees have taken part in this program in the upstream, downstream and corporate services areas.11 The combined efforts in the Timan-Pechora venture have resulted in a reduction of the number of drilling pads from ten to three – while at the same time doubling peak production, reducing environmental impact and improving development economics saving more than $500 million. 2 The benefits to ConocoPhillips also included increased revenues. Twenty percent of LUKOIL’s production and 30 percent of the joint venture profits goes on its books. It has already seen over $11.5 billion in revenue as a result of the joint venture.

ConocoPhillips understands that entering a joint venture is not an easy task and shares its lessons learned and the best practices of its successful joint venture.

Six Principle of Success

[pic]

ConocoPhillips has developed six core principles that have been, and continue to be, keys to the success of its joint venture in Russia. The first principle is to always partner with a good company. There are many companies in Russia that would love to receive the backing of a large multinational company; however, many are not good corporate citizens and can cause trouble that would be a liability for an American company. LUKOIL is a good corporate citizen that has helped develop the areas in which it operates in addition to actively participating in various charity and community service projects. ConocoPhillips is able to support these efforts and gain positive PR through the joint venture actions in Russia.

The second principle is to align interests with the local company. Instead of just trying to focus on projects that serve ConocoPhillips, the joint venture is aimed to improve both companies. There is a strong recognition that what is good for the part is good for the whole; meaning that when LUKOIL receives a benefit, ConocoPhillips also benefits. This mentality also reduces any power struggles that would result from the two companies fighting for projects that would only benefit themselves.

The third principle is to design transactions to share knowledge. This increases communication flow between the two companies and allows them to learn and adopt the best standards for each situation. When ConocoPhillips first entered Russia, it had to teach LUKOIL how to improve its operational efficiency, the quality standards of its refining outputs, and occupational safety of the facilities. LUKOIL had to introduce and adapt the ConocoPhillips culture to Russia and teach the ConocoPhillips managers the proper way to get business done in a country that is leery of outside influence. Several years after the initial lessons have been learned, the two companies still have a great deal of knowledge to be shared.

The fourth principle is to pursue big opportunities that benefit both companies. If only small interests were at stake, both sides would begin to wonder if they could go at projects on their own and be successful. By focusing on the big stakes, the joint venture is constantly looking at ways to learn from one another and receiving a larger reward for the cooperation and sharing of resources.

The fifth principle is to work on projects that will lead to multiple opportunities. ConocoPhillips and LUKOIL look to find projects that will generate future opportunities for the joint venture, such as in Turkmenistan and other former-Soviet bloc countries. Without an end-game in mind, the two companies constantly look for rewarding projects and ways to improve their operations.

The final principle is to work well with the government. Paying taxes, being transparent, and obeying the laws is just the start of this principle. ConocoPhillips has sought to seek government involvement and approval in all of its negotiations and dealings in Russia. This helps ease the concern of a foreign company “raiding” the natural resources of the country. By being open, ConocoPhillips has eased concerns and tensions which have resulted in quicker government approvals on projects, leases, and business dealings. By following these six principles, ConocoPhillips has thrived in an environment where many other foreign companies have floundered. It has positioned itself to be favored by Russian business and government when it comes to outside oil and energy companies.

Logistic and Operational Issues

Russia poses several major challenges to businesses and industries that operate in many places across the country. One of the main issues that ConocoPhillips faced when it moved into Russia was a lack of reliable transportation. Russia’s transportation network consists of 10

• 738,000 km of paved roads • 133,000 km of unpaved roads • 87,157 km of railways • 244,826 km of pipelines
For comparison, the United States (about 2/3 the land area of Russia) has 226,612 km of railways, 6,430,366 km of total roadways, 793,285 km of pipelines. There are many areas in Russia that are inaccessible for common transportation vehicles. There are towns that are only accessible through rail or ice roads during the winter. ConocoPhillips and LUKOIL must develop a logistics system that can supply the oil fields being developed with proper personnel and supplies, as well as transport oil and refined products to markets or ports to be exported. The joint venture must make investments into roads and railways to service new locations that they wish to develop and maintain existing roads that suffer from neglect. ConocoPhillips must also find transportation firms that can safely and reliably haul, by rail or truck, products and supplies point to point within the country. Delays in receiving supplies cause delays in profit realization; common operating strategies such as JIT or VMI break down if materials cannot be delivered at the right place, at the right time.

ConocoPhillips managers in Russia were shocked when they dove into the operational practices at LUKOIL. What they found was a decentralized free-for-all that lacked major coordination or collaboration that formed the basis of operations in the US. For example, across the terminals in LUKOIL, there were no transfer pricing for other LUKOIL terminals or divisions; each individual plant and terminal was only concerned with its own profit and sales, not for the company as a whole. Most of the business practices have their roots in Soviet methods. It has been difficult for ConocoPhillips to implement changes in operational practices because it cannot quickly change practices that are part of the corporate culture. One project that ConocoPhillips would like to implement in the joint venture is to develop a consolidated procurement group; however, local managers want to keep control of their operations and have resisted. Another factor that makes it difficult for a simplified sourcing strategy is the vast distances between plants, terminals, and fields; one source might be cheaper for the Moscow/St. Petersburg/European region, another for the central/Siberian region, and yet another on the Pacific coast/Far East region. ConocoPhillips must take care to work in all transportation costs when costing out bids submitted by suppliers.

Another area in operations that has been improved is the attention to quality in the refining process. Russian companies produce low-grade (low octane) gasoline and have difficulty exporting it abroad. There are two ways to obtain an octane rating for gasoline, the Research Octane Number (RON) and the Motor Octane Number (MON). The United States uses an average of the two numbers, the (R+M)/2, method; the average octane rating in the US is 85. In Europe, they use the RON method and deliver an average octane rating of 95 (the 85 octane in the US is comparable to a 91 or 92 octane in Europe). The average Russian octane level is 80 RON, well below the quality demanded by the largest gasoline importing countries around the world. By improving the processing method and quality at LUKOIL refineries, the joint venture can improve the octane and export the gasoline to more countries. ConocoPhillips goal is to help create an efficient, reliable logistics network to reduce costs and increase the flexibility of the joint venture to quickly respond to new opportunities across Russia and the region. LUKOIL’s refineries can increase capacity and sales opportunities by implementing more stringent quality controls on the refining processes and reduce costs by adjusting practices to bring them in line to achieve success for the company as a whole rather than the current decentralized, individual plant mentality.

Production Sharing Agreements
Production sharing agreements are contracts that outline how a private company will use a natural resource and repay the owner of the resource. These agreements are used extensively in the oil industry throughout the world. These are used extensively in developing countries because they limit the risk for the country. A standard PSA arranges for the private company to have the right to develop a potential field. The private company is given the rights to all revenues from the oil that is first produced to offset the cost of the initial investment; this is called cost oil. Once the private company’s costs are recovered from the initial capital expenditures to develop the field, any oil production after this is called profit oil. The revenues from profit oil are split between the private company and the owning country. The terms of a PSA can cover a wide range of topics, such as requirements to use local labor or sourcing, environmental regulations, tax shelters, and international arbitration conditions12. ConocoPhillips spent two years negotiating the PSA agreements for the joint venture with LUKOIL. Complications arose because the Russian government wanted to assure that the state oil companies would not be harmed by this joint venture and that the venture would benefit the Russian people and economy.

Challenges of Doing Business in Russia
As mentioned there are many benefits for entering into a Joint Venture with a Russian company. However, there are also many challenges to doing business in Russia as well. By knowing what the potential challenges and putting plans in place to address them, a company such as ConocoPhillips can overcome these challenges and take full benefits of the benefits of a joint venture.
One challenge faced by companies doing business in Russia is the language barrier. Russian is not spoken widely around the world. Further, the Russian language is one of the more difficult languages to learn because it uses the Cyrillic alphabet not the more common Latin alphabet. Therefore, most internationals doing business in Russia are not able to speak or understand the language-- at least not right away. Those who do learn the language, through engraining themselves in the culture, still struggle in situations where detailed and technical information is being discussed. This of course makes it very difficult to participate in essential business tasks such as negotiating, networking, developing solutions to business problems and building relationships necessary to be successful.
The language challenge was one faced by ConocoPhillips from the very beginning when negotiating the terms of the joint venture. In negotiating the JV agreement, tensions were very high, trust was very low and neither company was getting what they wanted. This was the case until ConocoPhillips brought in a native speaker of the language who also understood the Russian culture. From this situation, it learned that interpreters are not the solution. Interpreters are usually not effective because they often do not understand the business aspects of the transactions. The slightest detail which can easily be lost in translation could greatly impact the outcome of the discussion causing additional tensions amongst the individuals involved or at worst millions of dollars. ConocoPhillips has learned the need for hiring those who understand the business and speak the language. Not only will an individual like this be able to understand the business jargon of that particular business, but she will also understand the cultural nuances required to do business in Russia.

Another obvious challenge of doing business in Russia is the political environment. Companies must be savvy in Russian politics and know how to get things done in a highly bureaucratic and sometimes corrupt political environment. However, the corruption does seem to be improving. As mentioned by various business leaders of international corporations doing business in Russia, most US companies refuse to pay the once required bribes to get business done. This is not to say that bribery is not prominent. Many smaller companies continue to pay bribes in order to stay competitive with the larger international companies. Those companies which are most successful are those that are able to build relationships with the Russian government and other prominent figures in Russia in order to get ahead without wavering on their ethical standards. As mentioned in the six steps to success, one way that ConocoPhillips has met this challenge is making sure that the projects it chose to work on in the joint venture are big enough that they get the attention from the President and the other leaders required to get things done. As a result, international business has actually led to a decrease in the amount of corruption. This trend will continue to strengthen the Russian economy and hopefully provide a more predictable business environment.

A history of corruption, suspicion, and distrust paired with the difficulty in communication found in a joint venture with a Russian company can result in an environment with huge barriers for obtaining trust. For ConocoPhillips and LUKOIL there is the added element of competition which adds to the lack of trust.

Having trust is essential in a joint venture like the ConocoPhillips LUKOIL venture because the key benefit is the ability to learn best processes from each other. It is the concept that two heads is better than one. However, if there is no trust, information will not be shared and the benefit will not be realized.

ConocoPhillips employees taking part in the employee exchange program are essentially there to act as consultants to LUKOIL -- to share best practices and give advice. The lack of trust between the Russian employees and leaders in the LUKOIL Company made this sharing of best practices impossible from the onset because they would not share information. This information wall prevented the progression that LUKOIL or ConocoPhillips desired as a result of the joint venture. ConocoPhillips dealt with the lack of trust in a couple of ways. First of all, it overcame the language barriers by having native Russian speakers on staff to help overcome any trust issued resulting from a miscommunication. Further, it reiterated to the LUKOIL leadership that ConocoPhillips employees were there to help them. Because of the ownership that ConocoPhillips has in LUKOIL, ConocoPhillips shares in both LUKOIL’s successes and failures. ConocoPhillips has to be successful in honoring the integrity of information provided by LUKOIL. The ConocoPhillips employees working on behalf of LUKOIL cannot give confidential information to either side. Any misstep in this area would have grave consequences for the joint venture and could stifle any future projects for the two companies. While the trust issue has not fully been overcome the two companies have made huge strides and continue to develop the trust necessary for success.

One of the largest challenges facing companies doing business in Russia is the shortage of talent. Unlike many other companies, the talent shortage is not a result of a lack of education. On the contrary, Russians are highly educated, with a literacy rate of over 99 percent. With a declining population and a growing economy, Russia actually “suffers” from low unemployment. Low unemployment contributes to the country’s high inflation and cost of living. This high cost of living creates additional challenges for bringing in talent. Many companies in the US look to internationals to fill the talent gap especially in the highly technical positions such as engineering. With the high cost of living found in Moscow, companies struggle to find internationals who will work for the wages they are willing and able to pay. Most internationals couldn’t afford to live in a city with such high living expenses. Further inhibiting the use of internationals to fill the shortages in talent is the language barrier. With few people speaking the language it further reduced the ability to use international talent.

ConocoPhillips has an advantage over many other companies looking for talent because it has the resources available to attract the best Russian talent as well as the ability to pay for expatriates to live in Moscow. Obviously the oil companies such as ConocoPhillips and LUKOIL have this luxury not available to some of the other businesses struggling to develop a plan for talent.

While ConocoPhillips is in an industry which helps attract the best and brightest talent into the organization, it too faces the challenges of the talent shortage. If companies are unable to find the talent they need to grow their business, the Russian economy as a whole will suffer and that will affect everyone. The outlook for the economy is currently bright. The price of oil is rising and the economy and political hurdles dismaying international companies from doing business in Russia are improving. This progress however, will be stifled if companies cannot find the talent to grow with their business. It is apparent that all companies believe that talent is one of the biggest challenges their company is facing and will continue to face in the future. Few, however, have truly put plans in place to make sure that it does not cripple their business. This issue could make or break the ability for Russia to emerge and become a successful international market.

Cultural Differences

All companies that do business in foreign countries must contend with cultural differences. These cultural differences are most challenging in countries that are in a process of major transition. This is clearly seen in Russia, a country that continues to transition from a planned economy and authoritarian government to a more capitalist and democratic system. The complexities of Russian culture and language can create tremendous challenges for American managers who find themselves responsible for managing new ventures there. David Ysebaert, an American who currently works with both ConocoPhillips and LUKOIL in Moscow in the role of Downstream Advisor to LUKOIL, described in detail the differences he has found between American and Russian culture. These cultural differences have shaped the way ConocoPhillips does business with LUKOIL. Such differences yield useful insight to those who are new to the Russian business world.

Fatalism

Fatalism is the belief that free will does not exist, but rather all things happen in the only possible way they can. This belief is often summarized in the phrase, “what will be, will be.” Fatalism has been an integral part of Russian history and culture, and evidence of this can be found in Russian literature, religious tradition, and governmental practices.9 The deep belief that an individual does not ultimately have control over her future has profound effects on the behavior of the Russian people. Mr. Ysebaert gave the example of Russians frequently not bothering to use seatbelts when in a vehicle because they believe that if it is their time to die, then it will happen regardless of their actions. In work environments and public places, safety hazards are not flagged or blocked off as they are in the U.S. The attitude is that each person is responsible for her own safety in all situations. This is a very foreign attitude for American businesses that are accustomed to doing business in the environment of the Occupational Safety and Health Administration (OSHA). In the United States, governmental organizations and businesses actively work to ensure the safety of workers to avoid injuries and lower costs. Because Russia does not have a legal environment that includes widespread personal injury lawsuits, government and businesses in Russia leave safety to the responsibility of the individual. Some American firms that have rigorous safety requirements may have difficulty adjusting to this environment. In a larger sense, this Russian belief that the individual lacks control over events and circumstances could cause American firms to view the Russian workforce as unmotivated and not willing to “do what it takes” to accomplish business objectives.

Employment Status

Employment with a Russian worker is established through a contractual agreement. Under this agreement, the employer has certain obligations to the employee including guaranteed employment for the length of the contract. This contractual system makes it very difficult for a firm to terminate an employee for poor performance. Thus, if a Russian worker is dissatisfied with their employment, they may respond by consistently underperforming. This employment arrangement could be very frustrating for a Western manager who has operated under an at-will employment system in which either party can terminate the relationship with no liability.

Another element of Russian employment practices that could lead to great frustration for Western managers is that Russian workers are usually not expected to exceed their planned performance objectives. Russian companies offer no rewards or bonuses for doing so. American managers observe a lingering practice from Soviet times in which Russian workers avoid exceeding expectations. By meeting, but not exceeding the rigid requirements of their plan, Russian workers avoid having increasingly higher expectations demanded of them and their group in the future. Again, this causes a clear difficulty for American businesses that are driven to constantly exceed performance expectations and reward those who do so.

Decision Making

The ConocoPhillips team in Russia has noted an important difference in the way Russian workers use data to make decisions. A tremendous amount of data is collected by Russian firms such as LUKOIL, but American managers feel this data is rarely converted to useful information or knowledge. While Americans often make decisions with an incomplete picture and defer to the Pareto principle which states that 80 percent of effects come from 20 percent of causes, Russians labor over detailed calculations to account for every ruble before reaching a decision. An American firm that is eager to strike quickly and take action may find that this style does not work well in Russia where large amounts of data must be gathered before taking any course of action. Additional problems can arise if the data that is gathered is used to justify not taking action or making a decision.

Another critical difference in Russian business is a reluctance to make decisions at lower levels. Again the centralized, planned management style that Russians are accustomed to often discourages subordinates from taking on the responsibility of decision making. When Americans negotiate or work with Russian counterparts, they are likely to hear, “I have to check with my boss” before an answer or decision is made. The practice of delaying decisions as well as the general reluctance of Russian business people to make decisions, leads to higher costs and can have an impact on the ability of American firms to get things done when operating in Russia.

Team Work

Further cultural differences are found in the way that Russians work in teams. As already mentioned, Russians have a dependence on rigorous accounting and data collection. While Americans may see such practices as unnecessary, the situation is worsened by the fact that many Russian teams or departments do not freely share the data and records that they collect. Mr. Ysebaert described Russian business units and departments as “silos of information” in which information only flows up and does not get dispersed across the different units. This, of course, leads to redundancy as groups employ high numbers of analysts and accountants to gather data that may have already been recorded by another group.

American managers note the challenges of dealing with these inefficiencies when working with Russian teams. Additionally, Mr. Ysebaert stated that when working with Russian teams one often hears “one hundred reasons” why something cannot be done. The impact of Russian cultural behaviors regarding decision making and teamwork can be staggering when it is viewed from the perspective of an American manager. It seems that tremendous resources are devoted to gathering exhaustive data that is often unnecessary, costly, redundant, and, in the end, often used by Russian managers as a means to justify not taking action.

Individualism

For centuries, Russians have endured great hardship and difficulty by depending on their group or community for survival. Therefore, it is not surprising that today’s Russian culture ranks high on Hofstede’s scale of collectivism.8 Individualism, on the other hand, is highly discouraged and often punished in Russia. Russians seek to blend into the crowd and do less to differentiate themselves. This varies greatly from the behavior found in a highly individualistic society like the United States where people are rewarded for standing out and being noticed.

Generation Gap

Extreme variation is seen between the older and younger generations in Russia. Mr. Ysebaert described the older generation, which was raised under the Soviet regime, as being more traditional and regimented. Under Communism, everything was planned; therefore, many older Russian managers see their primary roles as monitoring and controlling. Older Russian managers often have little involvement in the business activities. Instead, they use the data that is given to them to develop detailed plans and monitor those below them in the organizational structure. It is the responsibility of those at the lower levels of the organization to meet these plans. This is a sharp contrast from the more decentralized Western management style in which lower level employees are empowered to make decisions that are not prescribed to them in a plan.

In contrast, Russians in their twenties are embracing change and open to Western influences in business and education. Mr. Ysebaert described this generation as the “professional Russians”. These individuals are more likely to have been exposed to various business training and education. They work hard to further their careers, and they are viewed by Westerners as more open than the older generation. This often means that younger Russians are willing to openly share information that older Russians would protect. Young professionals in this group are more status conscious and materialistic than their parents. These attitudes certainly provide the younger generation with the motivation needed to excel in their career development. As a result, many younger Russians are choosing not to seek the safety and security of lifelong employment with one company as older Russians often do. Instead, they are being lured to competing firms by the prospect of greater pay and more rapid advancement. In a very competitive labor market, younger Russians are often willing to select their employer based on who is the highest bidder.

ConocoPhillips seems to highly value its colleagues in LUKOIL who fall into this young professional category. As the Russian workforce gains more and more skilled professionals of the younger generation, foreign companies doing business in Russia will benefit from their skills and work ethic. Such a workforce is also a great strength to the Russian economy in general. Throughout Moscow, exceptionally young managers can be found in key leadership positions. This younger generation has great power to shape and influence Russia’s economic future. This may explain why optimism, a cherished value in the West, is becoming more common among these young professionals. The economic strides that many young professionals are making have caused them to challenge the traditional Russian belief that individuals have no control over their circumstances. These young business leaders express great certainty that Russia will continue to improve economically and that the future is to be anticipated with great hope. This optimism is yet another reason why the younger generation of Russian professionals is such an attractive workforce for American companies operating in Russia.

Conclusion

The ConocoPhillips and LUKOIL joint venture is an ideal case study from which to learn about the benefits and challenges of a joint venture and doing business in Russia. In researching both companies and their path to becoming a successful joint venture, one learns of the challenges faced and how they were able to overcome them. Companies thinking about entering into a joint venture situation or into the Russian market can learn from the ConocoPhillips Six Steps to Success as they design their strategy and business plans. They can see that business in Russia can be done without being corrupt and that the challenges, once a reason to shy away from doing business in Russia, can be overcome. Entering the market with an open mind, determination, and patience for the challenges ahead will enable other companies to find the win-win situation achieved by the ConocoPhillips and LUKOIL joint venture.

Exhibit 1

Ranking of Publicly Traded Oil Companies – 2002

|International Companies |Daily Production |Reserves |
| |(thousand bpd) |(million barrels) |
| | | |
|ExxonMobil |2,496 |11,823 |
|Royal Dutch Shell Group |2,220 |10,133 |
|BP AMOCO |2,018 |7,762 |
|ChevronTexaco |1,751 |8,668 |
|TotalFINA Elf |1,597 |7,231 |
|ConocoPhillips |682 |4,632 |

Data sources:

SEC Reports. Data include Proved Reserves of Condensate, Natural Gas Liquids and Crude Oil.

Exhibit 2

Map of the Timan-Pechora Basin

[pic]

Works Cited

1 April 13, 2008. www.eia.doe.gov/emeu/cabs/Russia/Oil.html

2 Berry, Bill. “Remarks by Bill Berry in Moscow State Institute of International Relations.” October 22, 2007. www.conocophillips.com.ru/news.remarks. January 31, 2008.

3 Fey, Carl. “Success strategies for Russian-foreign joint ventures.” Business Horizons, Nov-Dec. 1995.

4 April 13, 2008. Hoovers Online. premium.hoovers.com.proxy.lib.ohio-state.edu

5 January 31, 2008. www.conocophillips.com

6 January 31, 2008. www.lukoil.com/press

7 Mulva, Jim. “Oil of Russia: The present and the Future.” July 30, 2007. www.conocophillips.com. January 31, 2008

8 Naumov, Alexander. Puffer, Sheila. “Measuring Russian Culture Using Hofstede’s Dimensions.” International Association for Applied Psychology 2000.

9 Thelen, Shawn. Coulson, Kevin. “Russian National Character: An Application of Clark’s Comprehensive Framework.” Marketing Management Journal, Spring 2002.

10 www.cia.gov/library/publications/the-world-factbook/index.html

11 http://www.conocophillips.ru/project-russia/luk-cop/index.htm

12 Dr. Irina Paliashvili. “The Concept of Production Sharing”. 1998. http://www.rulg.com/documents/The_Concept_of_Production_Sharing.htm

-----------------------
Benefits of Joint Venture for ConocoPhillips:

• Further exposure to Russia’s vast resource potential, where LUKOIL has leading positions in reserves and production.

• an expected meaningful increase in its oil and gas reserves at an attractive cost, as well as access to possible substantial future reserve additions

• experience in cost-efficient development of Russian reserves and associated best practices,

• a direct participation in world-class oil projects in the northern Timan-Pechora region, and an opportunity to potentially participate in the development of the West Quran field in Iraq, as well as opportunities to leverage production knowledge and technology to improve the operations in both projects

• Added shareholder value through additional earnings. The investment was expected to be accretive to ConocoPhillips’ 2005 earnings per share, based on First Call consensus estimates.

Benefits of Joint Venture for LUKOIL:

• An affirmation of its status as Russia’s leading international oil and gas company, and a global energy player.

• management experience in the international energy business from a trusted long-term partner

• accelerated growth and improved efficiencies through exposure to global best practices and technology and involvement of the best human resources

• increased resources for accelerated development of projects, both in Russia and internationally

• Growth in LUKOIL’s net income and shareholder value through efficiencies and other benefits of this partnership.

Six Principles of Success

1. Always partner with good companies

2. Align interests with the local company

3. Structure transactions to share knowledge

4. Pursue big opportunities that benefit both companies

5. Do things that will lead to multiple opportunities

6. Work well with the government