Searching for a new future of Russian PE: What we should do in the fog?

Alexander Abolmasov Managing PartnerNRG www.nrgc.com C5 Private equity conference

2014 09 - 10 April 2014, Moscow,

Russia

February 13, 2014

TOP 100 Russian Banks profit

Just in February everything looked so positive…

Let’s focus on more positive issues

Main sources of value growth in Russia

1994-2007: Russian Economy

2007-2012: Specific niches/unique business models

2012-…: Effective management

Problems cannot be solved at the same level of awareness that created them.

Albert Einstein

The General Motors Management Style (1920s - …)

Strategy• Centralized operational decisions, but decentralized divisional

organization

Financial management• Control by setting quantitative targets for the divisions and

reporting back performance metrics• Decision making was based heavily on analysis of reported

managerial accounting data• ROI is the king

People Motivation • Performance based bonuses

Effective enough in a growing economy, but less effective in the crowded or low-growth marketplaces

What is effective management?

• Effective management system – keeps organization adjusting to unpredictable, dynamic conditions and satisfying customers

• Behavioral routine (skill), which helps to handle unpredictable and uncertain situations with confidence and effective action – competitive advantage

Startup management

• Need practices and principles geared to the startup context of extreme uncertainty

• In a startup, the product and customer are unknowns. We need a new definition of value for startups: validated learning about customers

• Case study: Begemot, Sovcombank

Traditional model(centralized functional hierarchy)

New model(decentralized leadership

network)

Changing leadership and structure

+ ROI-based decisions+ Mistrust and control+ Extrinsic motivation

+ Improvement Kata+ Employee development+ Intrinsic motivation

Change to what?

There are two different ways of working on the model – evolution and

transformation

Foundation

Time scale: organization's age

Low degree of decentralization/ empowerment

Differentiation phase

Integration phase

High degree of decentralization/ empowerment

Sustaining and deepening of the decentralized model, through generations

Pioneering phase

Bureaucratization through growing hierarchy and functional differentiation

Evolutionwithin the decentralizedmodel (culture of empowerment and trust)

Organizations with traditional models must eventually

transformthemselves

Transformation through radical decentralization of decision-making

Stagnationwithin the tayloristic model

Current Condition

Challenge

Vision

Toyota Kata Toyota strategy: “Survive long term as a company by improving and evolving how we make good products for the customer”

Non-Toyota thinking: normal daily management + improvement

Toyota thinking: normal daily management = process improvement

The Improvers

Process

The Improvers

“Everything deteriorates over time”

The second law of thermodynamics

Process

Success depends on your challenge

Shinichi Sasaki, former Toyota CEO

Toyota’s Vision for ItsProduction Operations

Zero defects 100 percent value added One-piece flow, in sequence, on

demand Security for people (no injuries)

“If you think it can be done or if you think it can’t be done, you will

be right!” – Henry FordChallenge

Mindset

“It can be done!”

Why?

Positive line of argument

Search for solutions

High probability of

success

“I told you: it can be done!”

“It cannot be done!”

Why?

Negative line of argument

Search for problems

Low probability of success

“I told you: it cannot be done!”

.

Brains are learning organs, so they reward us with joy when we learn

(for example by means of serotonin)

Brain activity measured using computed tomography, presented by Prof. Gerald Hüther at Production Systems 2009

“It cannot be done!”

“It can be done!”

Through frequent practice more electrical impulses are fired and synapses are

‘trained’ to perform better

Untrained synapse

Trained synapse

High electricalresistance

Low electricalresistance

changeable chemical bond

Regular Kata practice and coaching can change a conservative mindset into an open, ‘explorative’

attitude

Certainty Certainty

Explorative attitude of a kata novice

Conservative attitude (the norm)

Certainty

Explorative attitude of an experienced

kata practitioner

“I avoid it!”

“I’m OK

with it!” “I

like it!”

We are what we repeatedly do. Excellence, then, is not an act but a habit.

Aristoteles

Financial management

Traditional Budgeting Has Many Weaknesses....

Promotes centralization of decisions and responsibility

Motivates gaming the system• Conflicting purposes − target setting versus financial

forecasting• Not only a ceiling − also a floor for costs

Ineffective • Inflexible to changes in planning assumptions• Absorbs significant resources across the organization• Tends to make financial control an annual autumn

event

We Have Separated Performance Measurement From Financial ForecastingBroader Performance

Measurement

Balanced Scorecard

-Financial KPI’s-Non-financial KPI’s

+

Rolling Financial Forecast

-Rolling 5 quarters

-High level, few details

Better forecasting with less resources

Financial Budgeting

ToFrom

We Can Achieve What the Budget Did in a Simpler Way

The budget was used for: We achieve the same through:

High level financial and tax planning

Target-setting

Controlling fixed costs

Prioritising and allocating investment/project resources

Delegation of authority

Rolling financial forecasts

Balanced Scorecard

Trend reportingCost targets where and when neededActivity approachSmall projects - trend reportingMedium - Varying hurdle ratesMajor strategic projects - Case by case, the budget was never a tool ....Use existing mandates/authority schedules

The New Tools Cover What the Budget Did, but Also a Lot More

Controlling fixed costs-Activity accounting and product costing

- Improved cost understanding

- Product and customer costing

- Annual outlook

Balanced scorecard- Non-financial targets& measurements

- Link to strategy- Financial targets relative to

market

- Financial targets

& measuremen

t- Limited cost understanding

- Annual plan

BUDGET

Rolling Financial Forecast- Quarterly update- Rolling 5 quarters outlook

- Annual outlook

Investment management-Trend reporting & 5 quarter outlook

- Decentralised decisions

- Frames if needed

How Does the Manager’s Job Change ?

High degree of freedom in how to achieve challenging relative targets No detailed pre-approval of costs through a budget

Cost reports focusing on trends, projects and total cost levels. Less focus on the calendar year as reporting periodIncreased measurement of non-financial indicators supporting our strategy

No heavy budget process in the autumn, but more focus on costs and performance throughout the year

Increased responsibility and decision-making

More relevant cost information

Better but also tougher performance measurement

Better use of your time !

Motivation

1. Rewards PunishIncentives are ManipulativePunishment and Rewards are Two Sides of the Same Coin

2. Rewards Rupture RelationshipsForces People to Compete For RewardsDamages Relationships Between Managers and Employees

3. Rewards Ignore ReasonIncentives Are Easy Fix for Problems – Band Aid

4. Rewards Undermine InterestLimits CreativityIntrinsic Vs. Extrinsic MotivationPay-For-Performance Lowers Enthusiasm

Rewards Punish. Punishment blocks creativity.

What do you enjoy about work?

Typical answers given during brainstorming sessions:

- Overcoming challenges- Learning- Variety, trying new things- Team spirit, constructive exchange of ideas, sense of

belonging- Recognition and praise, celebrating successes- Seeing progress, improving, making a difference- Helping other people in their work- Scope for development, personal responsibility- Etc.

Pay Is Not A MotivatorEmployees Value Pay Less Than Most ExpectPaying More Does Not Mean Better Work

There is no combination of outcome metrics and incentive systems that by themselves will generate continuous improvement and adaptation.

And how could it? The people trying to achieve the quantitative targets are not taught or guided by any sort of improvement kata.

 Mike Rother, author of Toyota Kata

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