Article in the Zemlya Kstovskaya newspaper — 28 April 2013

28 April 2013
 April 28, 2013
On 27 April 2013 the article about the Mercury Group ‘You may ignore changes, as survival is not an obligation’ was published in the Zemlya Kstovskaya newspaper.
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You may ignore changes, as survival is not an obligation

– The Mercury Group of Companies was brought to your attention for the first time in 2010 when a new team of young professionals was appointed by former OJSC Agat Plant after its bankruptcy.

Please find below the interview with Kirill Alexeevich Lisin, the General Director of Mercury holding:
I have the pleasure of interviewing you Kirill Alexeevich again, about two years after our last conversation. What about the holding? Fundamental changes seem to have been made
?
Naturally, the changes that have been made are significant, however the principles remain the same. The holding still carries out 4 main activities and includes 3 core companies different in functions but similar in ownership and organizational structures:

– production of vehicle spare parts (crankcases, change gear levers, braking cylinders, etc..) by MetKon LLC;

– production of van fittings and components by AgatSpetsKomplekt LLC;

– production of tools, die tooling and die sets by AgatSpetsKomplekt LLC;

– electric power (Energosistemy LLC).

As to the electric power we are focused on the maintenance of the existing status quo and providing a safe and secure energy supply to municipal buildings and our own production facilities. May I remind you that almost half of Kstovo including infrastructure facilities such as Kstovo water and wastewater treatment plant are supplied with electric power that passes through our substation Rubin. We successfully perform this social function.

Our main investment priority today is what we call production. Significant changes have been made in this section.

Could you please tell me a little bit more about this?

During the last interview I told that GAZ Group is our core partner in the production sector. By now, we have successfully overcome any hostility in our business relationships with this enterprise which has ‘accumulated’ at the AGAT Plant due to heavy debts and poor quality. You might as well say that we have established a mutually beneficial and lasting partnership with Gorgy automobile plant and now we are taking part in its new strategic project on start-up of  the GAZel NEXT production.

It is clear that cooperation only with one major Russian vehicle manufacturer has increased the business risks of our enterprise, which forced us to solve the complicated problem of diversifying production. It should be noted that we have solved this problem successfully. Over the past three years, we have modified and upgraded the existing equipment fleet and have purchased six new machining centres. All machines are made in foreign countries (South Korea, Japan and Germany). Due to this, we have succeeded in expanding the production capacity and established relationships with the German company KNORR BREMSE, through which we supply our products to the largest manufacturing plants in Russia including KAMAZ, Yaroslavl Motor Plant, PAZ, Russian-American joint venture CUMMINS – KAMA. Apart from the purchase of new equipment, we have introduced a number of innovative process solutions which allowed us to greatly benefit at the expense of increased competitive advantages for our products. Thus, we produce compressor crankcases for KNORR BREMSE twice as fast as our competitors due to the use of progressive tooling.

To turn to the equipment I have talked about, I can say that in former times we purchased new equipment at least every six months for different purposes apart from vehicle spare parts production, but let me tell about this a little later.

Do you expect the investment rate to stay static?

– Yes, certainly. Today our strategic objective is the expansion into new markets. In the nearest future, we plan to enter into the Russian railways and aviation industry market.

That is great. Did it allow you to increase sales?

– Yes, the sales of this group have increased about three times. A source of our pride is the production of spare parts and fittings for vans. We have become the largest manufacturer in Russia for this sector and have seen the distance between our rivals behind us increase. I would like to note that when we entered the market our output in this sector was not more than 1.5 – 2 million rubles per month. We made overtures for our development direction with difficulties for a long period of time. For example, we tried to cultivate the market of fittings. Finally, we have found the development path and in the second half of the previous year we increased sales up to 10 million rubles and now we maintain this value.

Does it mean that your company has increased sales of fittings by more than five times

– Yes, it does. However this would not yet be sufficient. At the end of the year we plan to gain 20 million rubles from monthly sales in this area. We have already developed a new product line – stainless steel fittings. There are no analogues available yet on the Russian market. We will be the first manufacturers of the same. However, we now lack facilities to serve this purpose, that is why we plan to arrange van furniture and fittings production to another workshop at our site in May. Currently, we are finishing the repair work – the repair of the building was expensive.

It is interesting. Indeed, you do not seem to be troubled about increased competition on the part of western manufacturers as a result of Russia having entered the WTO. Can Russian manufacturers compete with China?

– Yes, you are right. There are such risks. Unfortunately, today prices of Chinese products are lower than those made in Russian.

What does price determination depend on? Is it due to the low cost labour in China?

– I do not think so. Recently I have been on business trip in China. There I was told that salary played an important role in the 1980s and in the early 1990s.  But at the beginning of the 2000s the Chinese government started to pay more attention to increasing the standard of living. Surely, China’s cost of labour tends to be lower than those in the industrialised western countries. It should be noted that today, wages of Chinese workers are almost equal to those of Russian workers. That is why some foreign economists say that some enterprises now arrange their business in other Asian countries, such as Vietnam, to minimize the cost of labour. Of course, the personnel in these countries is less competent and less qualified, therefore in foreseeable future, China will be our major competitor, we also may face more competition in our sector from Turkey and countries of South Europe (Spain and Italy) which has always set the tone for fittings production.

So, you mean that wage is not a competitive advantage of foreign made products? Then, what is a competitive advantage? Cost of metal?

– I doubt if this is true. Of course, the cost of metal in China is 10-15% less, but the cost of product does not exceed 12%. Furthermore, the delivery from China (customs fees, customs VAT, and transportation expenses) increases the cost of a product by 2 times. In my opinion the key problem has its roots in the Russian economy in general.

– Will you spell it out to me in a more detailed way, please?

– I would like to draw attention to two factors:

– firstly, Russian money is very expensive – high interest rates including short term revolving loans. An investment loan rate in Russia is 15-20% per annum, and in China – 5-7%. At that, earning power of the banking sector is estimated at billions and has topped record levels for many years.

– secondly, there are very high taxes in Russia.

As to taxation in Russia, the rate of social expenditures (together with contributions to accident insurance fund) amounts to about 31% of the wage budget plus VAT.

– What has that to do with VAT?

– VAT as you know is a value added tax. What is the base of VAT to be paid by an enterprise? Bank interest, profit rate, and, primarily, salary budget. Contributions to salary budget (as opposed to expenses on materials) in no way decreases VAT. All that can be concluded from hence is, that the more actively a company carries out a social mission, the higher salary it pays to its employees and the more employees work with it the higher taxes it has to pay. In fact, the company shall pay to the State budget at least 49% of the total salary budget amount. Invisible hand of the market (according to Adam Smith) and visible hand of the State appear to force enterpreneurs to be involved in trading or services rendering not in production. Taxes on sale and resale are much lower. That is why Russian companies direct their efforts at trade and most often at ‘shade business’, ‘grey market’ and ‘hidden wages’. Unfortunately, our State voices concerns over the transfer of capitals from Cyprus in preference to developing domestic economy effectively.

– These are dark and dismal prospects before us.

– In fact, it is not so. In my opinion, this attitude of the State towards the production sector and the overall condition of the Russian economy is another challenge that makes my work more interesting and more effective. The solution is performance improvement, decrease of expenses and positive changes. What is different is that currently changes are being made in order to survive, but it’s OK. According to one of the most famous American economists, ‘guru of quality’, Edward Deming “you may ignore changes as survival is not an obligation”. We change ourselves!

– Could you please give examples?

– During the production of vehicle spare parts we successfully implemented mechanisms of the TOYOTA production system which have been used by western countries for a long period of time. Basic ideas of the TOYOTA production system may be externally simple, but focused, hard work is required. The basic idea is to analyze any process, identify faults and eliminate them to improve efficiency. For example, two machines in the workshop are located so far apart and an employee is to spend 10 seconds on movements between these machines during the production of each item – an outside observer thinks that these losses are not big. Suppose an employee is to produce 500 items per shift which means that he/she is to make 500 round trips, i.e. total losses per shift will amount to 5,000 seconds or 1.38 h (17% of working time). Therefore, if we place two machines close together we will improve efficiency by more than 17%! It is a simple example, but if we look closely at any process we may discover tens of such elements which in the aggregate may contribute to significant improvement in efficiency. Example in practice: 6 employees were involved in the production of 43 crankcases for GAZ Group (spare part for GAZ 3307, 3309), machines were strewn across the workshop, much time was spent on non-productive hand work and movements. We have analyzed the process, grouped machines successfully into so called work cells, normalized work and decreased the number of employees involved in work at this site down to two persons, i.e. we increased efficiency by 3 times!

– And what about employees taken off the process? Do you rationalize the production system?

– Never. I have already said that significant growth rates in the production output are observed. Please note that the number of employees engaged in production activities increases, i.e. we transfer persons ‘taken off the process’, as you have said, to other production sites. Moreover, as we do this, we increase the salary paid to our employees. Coming back to 43 carters, I would like to say that we increase salary of the employees working in this cell from 13,000 rubles up to 18,000 rubles.

– Does it allow you to enter into price related competition with foreign made products?

– Yes, surely. The approach described by me is universal and can be applied to any process, for example, quality control. Earlier we carried out full quality control of the products produced to prevent defects being identified by our customers. However, if there are tens of thousands products produced human factor is an unavoidable expedient in this case and even after carrying out full quality control, defects can be detected by customers. Once we being governed by western experience asked ourselves: why do we produce defective products in general? After that we tried to pay attention to the process itself: if it allows to produce defective products, there is a lack of stability which makes it impossible to control the process and produces good and poor quality products. If we eliminate these factors and normalize the process, full control will be unnecessary. We can just carry out regular checks of the process parameters instead, which will allow us to decrease costs of a production unit by the reduction of the number of employees involved in the quality control department, exclusion of expenses on complaints, etc.

That is why today the management of expenses is our priority. This also requires relevant approaches to pricing.

– Please explain what you mean.

– The question is what we should do with indirect expenses. Let me give you a simple example. Imagine a product sold at a competitive price of 10 rubles. Imagine that we produce 2 pieces. Direct expenses (salary + electricity +materials + tools) on our piece amount to 7 rubles and other indirect expenses – 7 rubles. According to standard approach all indirect expenses relate to the goods produced. It means that an original cost of one piece is 10.5 rubles – output will be a loss if the product is sold at a competitive price. What manufacturers do further? Most commonly they try to increase the price, but such an increase results in the decrease of a production output (one piece is produced instead of two) and administrative expenses are paid in terms of this decreased output though such expenses. In fact, this remains the same, which leads to increase in the original cost (14 rubles instead of 10.5 rubles). What should we do in this case? Increase price? Another approach (with the same results): abandon the product.

What approach should we use? We should sell product at a market price (no more no less). When estimating an original cost, sales margins should only be taken into account. If there are such, we will benefit from the production of a product. In case sales margins do not cover overall expenses on the site, we should increase production output while at the same time improving efficiency. If there are no sales margins, we should work with the original cost reasonably. Purchasing chipper materials is not a way out. I must say that any decrease in expenses on materials or tools can have negative effects (for example, an increase in defective products). Quality matters must therefore be taken seriously before decreasing expenses on materials. In some cases expensive materials would be found more beneficial.

– Please sum up what has been said. What are the methods of the site development?

– I would like to stress one more time the fact that there are some problems connected with the Russian economy in general. However, it is another challenge that we should take up and find an adequate way out. High bank interest on evergreen loans? Decrease the amount of finance necessary to replenish working assets. This can be achieved by reducing resources that appear to be dead weight or frozen assets. For this purpose, you need to be involved in the process.

High original cost? Improve technological processes decrease expenses.

The main objective of Russian business as a whole and our company, in particular, is reasonable management of expenses, an increase in production output and process improvement. The tools required to make all these changes are well known, amongst them is the experience of Japanese companies. We are to study and adopt good professional practices and continue to develop. Changes are a way out.

-The approaches you have described appear to be innovative ones. What is the attitude of the company management and shareholders to the changes you are making?

There is no denying that any innovative positive changes can be made only with the support of the owner. And I would like to thank the shareholder of our plant Alexander Vyacheslavovich Shulik for giving credence and providing us with the opportunity to implement the policies I have talked about.

I also wish to express special thanks to the company management without which development is impossible and which generates a great number of innovative ideas. I’d like to make a pointed reference to merits of E. V. Aleshina, Head of the Production Systems Department, N. M. Fokeeva, chief of tool making facilities, N. A. Malitskaya, chief engineer, V. M. Kitova, chief industrial engineer.

 Read the original article in Russian scaled