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Russia’s Crony Capitalism and its influence on

transferability of practices

A study of business systems

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Russia’s Crony Capitalism and its influence on

transferability of practices

A study of business systems

Author: Rozemarijn Jager

Student number: 1001108

Date: March 10 2003

Place: Groningen

Faculty of business

1st supervisor and reviewer: Kees van Veen

2nd supervisor: Luchien Karsten

2ndreviewer: Bram Neuijen

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At Cebeco International Projects (which is now called Matrix), I was appointed to conduct a research, which initially seemed very interesting and challenging. By the time I started the research (2 months later), and during the first several months, the (by the management desired) focus of the research kept changing slightly and resulted in a, for me, not sufficiently satisfying research. I tried to make the best of it and kept looking for interesting angles to add, but it became very clear to me that Matrix was not interested in this. That is why, in consultation with my first supervisor Kees van Veen, I decided to finish the company’s research as soon as possible and than add a literature study on to it in order to get the desired depth. The result for Matrix was a strategic marketing plan, considering several product- market combinations. Russia is Matrix’s largest market and I spent some time there during my research. During this stay, I was considerably impressed (read shocked) by the great difference, as compared to the Netherlands, in the way businesses deal with their environment and so became interested in exploring this more. With the experiences I had in Russia in the back of my mind, Kees van Veen mentioned the concept of business systems to me, which made the pieces of the puzzle fall in place. And so I started my literature study. What was toughest on me during this literature study was trying not to get carried away and let it get too broad. While exploring literature on the subject, I encountered tons of interesting subjects that I would have loved to add on to my research and explore further. Unfortunately, I set myself a time-limit for writing my dissertation, which I did not want to exceed to too great an extent. Due to this, I was forced to make many delimitations and focus on the most ‘central’ subject.

The result is a study of the composition of the business system in general, the Russian business system in particular, and an exploration of the implications of the nature of this business system for the transferability of practices. For enabling me to establish this, I want to thank Kees van Veen and Luchien Karsten, my supervisors at the university. I want to thank Bram Neuijen as well, for jumping in as a second reviewer.

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In writing this report, three objectives were pursued:

1. Developing an integrative framework for analysis of a society’s business system, based on literature available on this topic

2. Putting the developed integrative framework into practice in describing the business system prevailing in Russia

3. Discussing the influence of this business system on the entry mode decision.

This led to the formulation of the following problem statement:

What approach should be used by an organization intending to operate in the Russian market, so that it can best deal with the Russian environment?

The research –and sub- questions emanating from this were:

1. What kind of business system prevails in Russia?

1.1 What are the relevant characteristics of a business system?

1.2 What do these relevant characteristics look like for Russia?

2. What recommendations can be given, based on the analysis of the business system, regarding the way in which foreign operations should be set up and managed for an organization intending to operate in ‘the’ Russian market?

2.1 Which factors influence the international transferability of organizational practices?

2.2 What do these factors look like for a Dutch firm intending to extend its operations to Russia?

The general intention of this study was thus to give insight in issues companies have to deal with when internationalizing. This was done by critically looking at literature available on the subject, based on which a framework was developed. The framework developed can be used as a basis for the analysis of any country’s business system and could be an important tool in co-determining a firm’s entry mode.

The dominant business system prevailing in Russia can be analyzed by looking at characteristics of major institutions. Major institutions can be divided into background and proximate institutions.

Background institutions date back to the pre-industrial society, while proximate institutions can again be divided into two sorts. The first considers the process of industrialization and the second considers more recent events, like large-scale political changes.

The institutional characteristics stemming from the pre-industrial background- and proximate industrialization institutions result in the establishment of a business system; the embodiment of actual relations. Distinct characteristics of hierarchy-market organization are established that do not change easily.

On top of this, proximate recent event institutional changes can add nuances on to this more permanent business system. These recent event institutional changes can be described through looking at a country’s general rules. These general rules are constructed by the contemporary dominant group in society and entail the design of property rights, governance structure and rules of exchange.

The currently dominant business system can be described as Mafia capitalism; getting wealthy not by working hard or investing, but by using political connections to get state property on the cheap in privatizations. These new oligarchs, able and willing to exert immense political and economic power, are large conglomerates controlled by the founder. These conglomerates have developed with considerable state backing, the oligarch maintains good relationships with government officials and is able to exert great influence on this same government. Their diversification can be considered opportunistic since these oligarchs engage in whatever business, as long as they think they can make money in it.

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uncertainty, this is solved by vertical and horizontal integration in Russia. Because of lack of trust and the absence of a reliable legal system in Russia, alliances are replaced by ownership structures. If a firm cannot trust a supplying firm, they can just buy one and the need to rely on legal means of protection will be eliminated because both stages of the transaction will be controlled by the same parties, greatly diminishing the incentives to cheat. Barter is another way of arranging a transaction in such a way to minimize the possibilities for a contracting partner to breach. Barter was first engaged in by tolkachi and the importance of barter as a method to mediate transaction gives firms an incentive to produce a wide array of goods, as this will expand their opportunities for barter. As a result, conglomerates have been forming in Russia. Because of the internalization of activities emanating from the institutional structure, firms arise that are very diverse and independent of other large conglomerates. So, a wide variety of economic activities is coordinated through authority hierarchies.

Within large conglomerates, employees are very dependent on the employer and work groups do not have high levels of task autonomy. Labor turnover is normal and unions do not have a lot of influence.

The dominance of the state is an important feature of the economic system in Russia.

It seems clear that many characteristics of the oligarchy can be traced back to historical regimes.

Historical insecurity and dependence on central officials and leaders, coupled with traditional conceptions of authority, both of which were reproduced and reinforced by the Tsarist regime and the communist regime represent the main features. These factors have resulted in personal trust and loyalty being very highly valued by business owners and typically restricted to family members and close personal associates. Lack of strong institutional trust mechanisms inhibits the development of impersonal authority and trust relations within firms and leads to extensive reliance on personal networks between enterprises. Personal business networks lower the risks of dealing with strangers and save transaction costs on information. A business network can be defined as a stable and relatively closed set of interpersonal links between regular business partners. Russian businessmen have become more selective in dealing with other agents in recent years. Personalism thus pervades both internal and external relations of authority structures, which encourages strong central and personal control of a wide range of economic activities.

Based on this outcome, recommendations were formulated regarding the optimal strategy for a Dutch organization intending to operate in ‘the’ Russian market. The transferability of the practices of the Dutch firm depend on three things:

1. The homogeneity and cohesion of business system characteristics in the originating economy 2. The homogeneity and cohesion of institutions and business systems in the host economies

3. The relative strength of the multinational firm in particular host economies and of the local institutions most related to particular procedures and characteristics

Dutch firms are in general not expected to be able to export their successful ways of operating to Russia, because of the highly cohesive and homogeneous Russian society as opposed to the more pluralist Dutch society. Where market institutions are more pluralist, novel procedures and ways of working are easier introduced, whereas in a society where a particular business system is integrated and cohesive, the more difficult it will be to alter established procedures and rationalities. The fact that Matrix’s home-economy sector is very strong worldwide, implies that transfer of practices to the host- economy is simplified somewhat, but to what extent cannot be indicated.

The dependence of particular managerial practices on the strength of the local institutions most closely connected with them implies that, while introduction of some practices is easy, the introduction of others is expected to be hard. Before I will specify these, it has to be said that in general it is hard for a Dutch firm to introduce novel practices in Russia because of the lack of similarity of institutions.

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strong position), it seems relatively easy to introduce novel working practices. The introduction of novel managerial roles, on the other hand, will be hard since patrimonialism, which lay at the foundation of the distinct Russian managerial role, is central to the Russian business system. In this section, the conclusion is however drawn that it is too simple to assume that practices can just be singled out and considered in that way. A strong interrelatedness of practices has to be taken into account when looking at transferability.

Another important difference between the Dutch and the Russian way of economic organization is the extent of diversification. Diversification is important in Russia for maintenance of the very important personal networks.

Thus, since there is a much greater looseness of fit between the elements of the Dutch system, it is much more vulnerable to ‘becoming unlocked’. The tight integration in the Russian case, makes the system much more stable and able to withstand the potential dislocating effects of changes in markets and technology.

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Introduction ______________________________________________________________________ 1 Part I Objectives and introduction to literature _______________________________________ 3 1.1 Objectives and problem statement ___________________________________________ 3 1.2 Method and process _______________________________________________________ 3 1.3 Introduction to literature ___________________________________________________ 4 1.3.1 Whitley ________________________________________________________________ 4 1.3.2 Fligstein _______________________________________________________________ 5 1.3.3 Complementarity ________________________________________________________ 7 Part 2 The Russian business system_________________________________________________ 9 2.1 Relevant characteristics of a business system _____________________________________ 9 2.1.1 Key characteristics of the pre-industrial situation______________________________ 11 2.1.2 Key characteristics of industrialization and institutional developments ____________ 11 2.1.3 General rules ____________________________________________________________ 11 Part 3 Relevant characteristics of Russian society_____________________________________ 14

3.1 Characteristics of pre-industrial Tsarist situation______________________________ 15 3.1.1 Political system _________________________________________________________ 15 3.1.2 Economic system _______________________________________________________ 16 3.1.3 Legitimacy ____________________________________________________________ 16 3.1.4 Village & family organization _____________________________________________ 16 3.1.5 Relevant characteristics __________________________________________________ 17 3.1.6 Conclusion ____________________________________________________________ 18 3.2 Industrialization _________________________________________________________ 19

3.2.1 Political systems ________________________________________________________ 20 3.2.2 State-business relations___________________________________________________ 21 3.2.3 Relevant characteristics of industrialization ___________________________________ 24 3.2.4 Conclusion ____________________________________________________________ 25 3.3 Business system __________________________________________________________ 27

3.3.1 The nature of firms as economic actors ______________________________________ 27 3.3.2 Market organization (inter firm relations)_____________________________________ 28 3.3.3 Firm type (authoritative coordination and control systems) _______________________ 29 3.4 Conclusion ____________________________________________________________ 30 Hierarchy-market relations in Russia: the oligarchy___________________________________ 30 3.4 General rules ____________________________________________________________ 32

3.4.1 Dominant groups and market institutions in the Russian society ___________________ 32 3.4.2 Property rights__________________________________________________________ 33 3.4.3 Governance structure ____________________________________________________ 34 3.4.4 Rules of exchange_______________________________________________________ 34 3.4.5 Conclusion ____________________________________________________________ 34 Part 4 Recommendations ________________________________________________________ 38

4.1 Transferability of practices ________________________________________________ 38 4.2 Application _____________________________________________________________ 39

4.2.1 The Dutch business system ________________________________________________ 39 4.2.2 The facilitating factors ___________________________________________________ 40 4.3 Conclusion ______________________________________________________________ 41 Recommendations for setting up and managing foreign operations _____________________ 41

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Introduction

‘When the driver of a Dutch truck with flowers is in line at the Russian border, he discovers that the temperature in his trailer is rising too fast. To prevent his valuable load from ruining, the takes out the perishables. Without knowing it, he breaks the Russian customs rules. The truck as well as the load is seized directly. During five months, the exporter negotiates with customs concerning the level of the fine. Then, the Russians one-sidedly determine the fee to be 80.000 dollar. At the same time, they put the truck and trailer for sale. The exporter does not know any better than paying the fee. The same night that he pays the fee (cash of course), the truck and trailer are, inscrutably, sold. Yield: 20.000 dollar, one sixth of the book value. The customs authorities argue that their actions are rightful, because the law determines that they can undertake action fifteen days after the announcement of the sale. Load gone, truck gone, trailer gone. But that is not all. In the Netherlands the exporter has to pay a large penalty because he cannot produce certain documents, which have been held back by the Russians. On top of this, he has to pay extra rent for the trailer: 600 dollar for each week between the seizure and the forced sale. At that time, the damage already added up to 400.000 dollar.

At his wits’ end, the exporter turns to a public prosecutor in the particular district. He hopes to be able to prosecute the customers’ authorities, but the court of justice states that the only thing that could them be reproached was that they let the sale take place a day earlier. ‘

(Terterov: 2001)

The above story is a somewhat extreme example, but in essence is similar to what I encountered during my stays in both Russia and Kazakhstan for Matrix. A totally different way of doing business from the one in the Netherlands is dominant there. But why is that distinct way the most dominant and how should Matrix deal with this? These were questions that were on my mind and these same questions functioned as a foundation for this study and resulted in the following problem statement:

What approach should be used by an organization intending to operate in the Russian market, so that it can best deal with the Russian environment?

Kees van Veen drew my attention to Whitley’s work on East Asian business systems. A business system can be described as the dominant form of hierarchy-market organization in a society and deals with the following questions; how are activities to be coordinated, how are markets to be organized and how are economic activities within authority hierarchies to be structured and controlled?

In that work Whitley describes the dominant business systems in Japan, Korea and China and attempts to describe the characteristics of the historical path that led to the establishment of these distinct business systems. Next to this, Whitley has also edited a work on European business systems, but no research was yet conducted on Russia or other Former Soviet Union countries. Besides Whitley, Fligstein’s work on the social structure of markets is another main point of departure for this study.

The general intention of this study is thus to give insight in issues companies have to deal with when internationalizing. This is done by critically looking at literature available on the subject, based on which a framework is developed. The framework developed can be used as a basis for the analysis of any country’s business system and could be an important tool in co-determining a firm’s entry mode.

More specific this study considers Russia. As it is one of the few real ‘growth markets’ in the world, the FSU seems to be a very attractive area to do business in nowadays, and more and more organizations are exploring this area. Before a firm enters a new market, however, attention should be paid to the local way of economic organization as this might greatly differ from the home country’s way, which again can have a great impact on the firm’s success. The distinct ways of economic organization are dependent on the society’s social institutions; they are socially structured. In order to explore the consequences that the Russian business system might have for a foreign firm’s operations there, a framework for the analysis of a business system will be developed, which will subsequently be applied to Russian society.

The study is divided into four parts. The first part deals with the objectives of the study, the problem statement resulting from this, a discussion of the methods and process and an introduction to the

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The second part deals with the identification of the elements out of which a business system is made up. Key characteristics of major institutions during different periods are identified and a framework is developed.

Subsequently in part three, the filling in of the relevant characteristics of the Russian society is dealt with. In the first paragraph of part three, major institutions of pre-industrial Russia are described, resulting in relevant characteristics. In paragraph 3.2, major institutions in the Russian society under industrialization are described, again resulting in relevant characteristics. Based on these two chapters, the business system prevailing in Russia is described in paragraph 3.3. This is followed by a description of the general rules in society; dominant groups that are responsible for construction of property rights, governance structure and rules of exchange, which adds a nuance onto the business system described in paragraph 3.3.

In part four, the influences that the business system in Russia has for a Dutch firm intending to operate there, are discussed. This is done by first exploring the factors of influence on the transferability of practices. After first considering the Dutch business system, these general factors are then applied to the Dutch-Russian situation. Based on this, recommendations for setting up and managing foreign operations are formulated and illustrated by looking at Matrix’s practices.

To finish the study off, a general conclusion and discussion can be found in part five, integrating literature and practical matters.

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Part I Objectives and introduction to literature 1.1 Objectives and problem statement

In conducting this study, I have three objectives:

1. Developing an integrative framework for analysis of a society’s business system, based on literature available on this topic

2. Putting the developed integrative framework into practice in describing the business system prevailing in Russia

3. Discussing the influence of this business system on the entry mode decision of a Dutch firm In order to reach these objectives, the following problem statement is formulated to steer the research:

What approach should be used by an organization intending to operate in the Russian market, so that it can best deal with the Russian environment?

Research questions:

1. What kind of business system is prevailing in Russia?

2. What recommendations can be given, based on the analysis of the business system, regarding the way in which foreign operations should be set up and managed for an organization intending to operate in ‘the’ Russian market?

Subquestions:

1.1 What are the relevant characteristics of a business system?

1.2 What do these relevant characteristics look like for Russia?

2.1 Which factors influence the international transferability of organizational practices?

2.2 What do these factors look like for a Dutch firm intending to extend its operations to Russia?

1.2 Method and process

This study is intended to provide an insight in issues that companies have to deal with when internationalizing their operations. I intend to establish this by critically looking at literature available on the subject first. By critically looking at, and comparing different authors, a well-founded framework for analysis of business systems can be developed. This framework will subsequently be filled in by making use of literature available on the topics to be explored. Through this, a complete analysis of the Russian business system will be created, after which the implications of the discrepancies as compared to the Dutch business system will be underlined. The process will thus look as follows:

Sub questions 2.1 & 2.2 Sub question 1.2

Sub question 1.1

Identification of relevant characteristics Critical

exploration - and comparison - of relevant literature

Development of a framework for analysis

Filling in of this framework for Russia

Comparison with the Dutch situation and discussion of the implications of this for internationalization

Research question 1 Research question 2

Part 2 Part 3 Part 4

Part 1

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1.3 Introduction to literature

Whereas many discussions of market economies used to assume that they were all basically the same, there is now an increasing awareness of the variety of institutional arrangements found in different market economies and of their influence on firm structures and behavior.

Cultural and institutional relativists (such as Granovetter, 1990; Maurice et al.,1986) regard differences in social conventions, rationalities and moral codes to be strong enough across societies that they generate highly distinctive forms of successful business organization and practices which are specific to their context. Variations in institutional contexts are seen as directly affecting the nature of market processes and the way in which economic success is achieved. This has as a result that the sorts of business structures and practices that become established, and remain dominant, in a particular context reflect the specific features of that context.

Economic rationalists, on the other hand, consider competitive practices to be so strong that efficient forms of business organization and ‘rational’ strategic choices quickly dominate market economies irrespective of cultural and institutional variations. Thus differences in beliefs, preferences and expectations are essentially irrelevant to economic outcomes in this view.

Altogether it is becoming widely accepted that different kinds of business environments generate different kinds of managerial structures that are equally successful in world markets. Market processes and the outcome of firms’ decisions vary significantly between their institutional contexts and depend, among others, upon the beliefs, priorities and understandings of those responsible for controlling and directing economic resources (Whitley, 1992a: 7). Specific institutional arrangements generate specific forms of authority relations, control mechanisms and taskdivision in leading organizations in a society.

This means that different institutional contexts will encourage different forms of business and market organization to become established. If these distinctive contexts are particularly cohesive, quite distinctive kinds of firms and ways of organizing relations between them will characterize them. Thus, different kinds of business- and market organization develop and dominate different market economies as a result of major variations in social institutions, constituting distinctive business systems. When a company intends to enter a new market, a consideration of the prevailing business system in that specific society would be highly recommended.

Since I try to avoid creating a completely holistic view of the business system, I will be using two main sources of theory; Whitley and Fligstein. These two authors represent different points of view in their work. Whereas Whitley’s approach entails mainly macro-processes, Fligstein’s mainly considers the micro-processes. I will first discuss both of their approaches after which I will explore the extent to which the two approaches are complementary in the following section.

1.3.1 Whitley

A business system, as Whitley defines it, is ‘the distinctive configuration of hierarchy-market relations in which firms function as economic actors through their authoritative coordination and direction of human and material resources’ (Whitley, 1992a: 22). Variations in major social institutions, such as cultural patterns and those governing access to economic resources, result in significant differences in the ways that market economies are organized. This organization of the economy is of influence on key characteristics of firms, which leads to the establishment of distinctive business systems in different economies. Once established, these business systems develop interdependencies with their institutional contexts through which they were established so that major changes in business system characteristics are unlikely in the absence of substantial alterations in related institutions. Different societal contexts thus have encouraged and constrained the development of dominant hierarchy-market configurations there. These dominant characteristics occur across industrial sectors and areas of the economy and are often reproduced in newer industries, thus implying the society-wide importance of key institutions in these contexts.

Whitley thus states that a business system is something to be considered on a society-wide level, generating distinct forms of business across sectors. In this study I therefore focus on providing an analysis of these society wide characteristics. I would like to describe Whitley’s approach as a historical approach since he describes how a society’s historical trajectory and the development of nation-wide institutions can lead to variations on a contemporary sector-level. Whitley however focuses only on historical events, where I am of the opinion that more recent nation-wide events also

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1.3.2 Fligstein

Fligstein, in his economic sociology of capitalist societies, focuses on markets; industries and not societies as a ‘market’ as I am interested in in the first place. His approach also focuses on contemporary characteristics as opposed to Whitley. Due to this, I got the idea that there might be several parallels between the way in which Fligstein considers industries, and the way in which the national market can be considered like I intend to do. Fligstein’s more contemporary focus then might complement Whitley’s historical focus. For this reason, I will start looking at the characteristics of industries (the terms sector and industry will be considered mutually exchangeable) described by Fligstein and study whether I can extrapolate them to societies.

‘The economic sociology is a study of how the material production and consumption of human populations depend on social processes for their structure and dynamics’ (Fligstein, 2001: 6). The sociology of markets thus concerns the structuring of production, a way of economic organization.

Within this area, different (but related) focuses can be identified:

a. A focus on macro processes, which entails the comparison of the organization of national capitalisms. Examples of this level are; trying to understand the development of third world societies, examining the processes of globalization, or studying the market transitions from socialism.

b. A focus on micro processes, which entails studying the formation of a particular market or industry and the emergence of social structures that affect firms’ strategy, structure or labor market practices. Many markets have complex and stable social structures based on repeated interactions of buyers and sellers and on the status and reputation of market participants.

Firms again have very different internal configurations that reflect these social processes.

The macro-process approach thus considers the emergence of a national capitalism, while the micro- process approach considers the establishment of a sectoral social structure. Macro processes naturally enable micro processes as the macro processes entail the establishment of the national capitalism. The national capitalism creates a framework within which social structures within industries can be established. The national capitalism therefore can be seen as an ‘umbrella social structure’ for industries within one society; a national social structure.

As mentioned before, I would like to explore whether Fligstein’s contemporary focus on micro processes can fill up the ‘gap’ of Whitley’s historical focus on macro processes. Thus, can a focus on the formation of a particular industry and the emergence of social structures in that industry provide characteristics for considering the contemporary ‘national social structure’ and the emergence of social structures within this national ‘market’; the society? In order to be able to regard this, I will turn to the elements of social structure.

Social structure

There are four types of rules relevant to producing social structures in markets and therefore relevant to be considered in analyzing the market:

1. Property rights 2. Governance structures 3. Rules of exchange

4. Conceptions of control

The rules relevant to producing social structures can be divided into actual relations and general rules.

‘The general rules are rules, both formal and informal, about organizing economic activities that provide the social conditions for economic exchange and allow for the production of new markets’

(Fligstein, 2001: 11); property rights, governance structure and rules of exchange. These can be described as specific understandings about the way a particular market works.

The division of property rights is at the core of market society. Property rights define who is in control of the capitalist enterprise and who has rights to claim the surplus. The division of property rights makes the firms possible in the first place, allows investment to occur, and constrains and enables managers and workers. ‘In places where firm property rights do not exist, investment is haphazard and the economy is operated at the point of the barrel of a gun’ (Fligstein, 2001: 240).

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Rules of exchange define who can transact with whom and the conditions under which transactions are carried out.

Actual relations among parties result in local understandings, which are called ‘conceptions of control’.

Fligstein states that conceptions of control reflect market-specific agreements between actors in firms on principles of internal organization, tactics for competition or cooperation, and the hierarchy or status ordering of firms in a given market. These three elements seem to be borrowed from Whitley’s definition of a business system. Conceptions of control are stated to be both historical and cultural products. ‘They are historically specific to a certain industry in a certain society. They are cultural in that they form a set of understandings and practices about how things work in a particular market setting’ (Fligstein, 2001: 35).

In the following figure, a suggestion of the similarities and overlaps of the approaches of both authors is pictured:

Figure1.2 Whitley and Fligstein, an integrative framework

Thus, Whitley focuses more on the macro-processes, looking at the history of a society and the results of this for the institutional structure in which the business system is embedded. Fligstein, on the other hand, focuses more on the micro-processes, considering the contemporary industries and from this, drawing conclusions regarding the conceptions of control. Because he considers the characteristics of industries and subsequently talks about dominant characteristics for the society, I would like to describe Fligstein’s approach as a contemporary approach.

As can be seen in figure 1.2, Fligstein’s conceptions of control seem to entail the same concept as Whitley’s business system, eventhough the different authors use different angles in describing it.

Adding on to this, as mentioned before, in his description of the concept, Fligstein uses a strikingly similar definition as Whitley does of a business system. Also, on page 83 of Fligstein (2001), for example, the Keiretsu structure in Japan is described as a set of conceptions of control (the dominant conception of control), while Whitley classifies this as a business system. In my opinion they are discussing the same concept from different viewpoints. In Fligstein, the Keiretsu structure is described from the viewpoint of an industry, while Whitley considers a higher level of aggregation; the society.

Therefore, in the figure above, an ‘=’ sign should be added between the business system and conceptions of control. This results in a business system, covering both the society- and the industry level.

This is supported by a statement by Fligstein, describing that a ‘lock in’ can occur for a given conception of control across many industries, if these solutions are sufficiently general (2001: 87). This illustrates that he perceives the general rules in a industry as generating a conception of control. This conception of control can become the dominant conception of control for the entire society if it is general enough.

Industry Micro

Business system (Whitley)

Conceptions of control (Fligstein)

-Property rights -Governance structure

-Rules of exchange

Society

Macro Institutions/ history World/ society

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Fligstein also states that distinct national cultures of control can develop at the moment of entry into capitalism. ‘These national ways to legally control competition are inscribed in the institutions of the state and in the ways that firms pursue their tactics in markets’ (2001: 87). Thus, what Fligstein calls a national culture of control is equal to what Whitley calls a business system and from now on, the term business system will exclusively be used.

1.3.3 Complementarity

In my opinion, the two approaches are complementary in the sense that the business system can be approached from two sides; historical practices and contemporary practices, which coincides with a focus on respectively actual relations and general rules. Fligstein’s following quote illustrates this; ‘The historical problem of producing stable capital, labor and product markets eventually required governments and the representatives of capital and labor to produce general institutional arrangements around property rights, governance structures and rules of exchange for all markets in capitalist societies. Within markets, cultural and historically specific rules and practices came to govern the relations among suppliers, customers and workers (conceptions of control)’ (2001: 27).

This illustrates that general rules are created at the micro-level, while actual relations are created at the macro-level. These actual relations, in my opinion, are too much described from the micro-level by Fligstein, since they originate out of historical macro-processes. There is a lack of depth in his discussion of the macro-level. Despite his focus on the micro-processes, however, he does not consistently stick to the level of aggregation of industries. His description of dominant groups in society and their implication for market institutions, for example, is country-level and will be looked at next.

Configuration - dominant groups and market institutions -

Whitley states that ‘market processes and the outcome of firms’ decisions vary significantly between their institutional contexts and depend, among others, upon the beliefs, priorities and understandings of those responsible for controlling and directing economic resources’ (1992a: 7). Therefore, it is important to figure out who is responsible for controlling and directing economic resources.

Fligstein states that in order to define the forms of economic activity that exist in a given society, it is necessary to think systematically about how government capacity and the relative power of government officials, capitalists, and workers figure into the construction of new market rules. Thus, in order to be able to give a good description of the general rules in a society, one has to attempt to identify the relative powers of the three groups.

‘The roles of the different groups are not fixed once established and along with a change in roles, a change in institutional context can occur. Most market institutions are the outcome of political struggles whereby one group of capitalists captured government and created rules to favor themselves over their political opponents. Market institutions therefore mainly arise during moments of the formation of transformation of political or market fields. In these moments, actors become self-aware and engage in new forms of interaction to produce new arrangements. Because they try to forge new understandings, their interests and identities are in flux. They try to figure out what they want, how to get it, and how to get along with others that might want other things. Actors modify these understandings in the practice of interacting with other groups and create new practices. But these new practices are often laid down along lines set by existing understandings’ (Fligstein, 2001: 27). Thus, general rules are constructed by dominant groups, but are often laid down along lines set by the actual relations, established through a historical process.

A moment of market transformation, as recently occurred in Russia, is a very suitable moment to observe the general rules in society since through these radical changes, a new configuration is established.

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In order to clarify the previous discussions, connections between different concepts and authors are depicted in the following figure.

Figure 1.3 Complementarity of Fligstein and Whitley’s approaches

A question remaining unanswered here, however, is the significance of focusing on either sectors or societies. I will try to deal with this question now. To start of with, Whitley argues that business systems can develop at different levels. As a particular hierarchy-market organization, a business system can develop wherever dominant social institutions and cultures are sufficiently integrated and mutually reinforcing to generate separate patterns of economic organization which reproduce themselves as effective socio-economic structures (Whitley, 1992b: 268). This could be on a national, sectoral or cultural level. Requirement is, however, that key institutions exist at that level. The institutions responsible for the establishment of a particular business system can be divided in background and proximate institutions, which will be discussed in detail later. One thing I want to say about them here is that it is unlikely for these to develop for particular sectors since the background institutions are to a great extent dependent on cultural background. Fligstein, in my opinion, neglects this and instead focuses to too great an extent on the micro processes.

Whitley states the following: ‘Sector and industry specific ways of organizing firms and markets are not derived from distinctive background institutions. Instead these are better conceived as distinct business ‘recipes’ which summarize dominant beliefs of industry leaders about effective business behavior rather than broad systems of firm-markets relationships coordinating economic activities throughout an economy’ (Whitley, 1992b, p. 270). The patterns of economic organization, described as business systems by Whitley, are the outcome of processes operating at quite general levels of social organization. Sector-specific ways of organizing will only become established if distinctive social institutions exist to structure them within each sector. Sectoral differences develop, but are often combined with cross-sectoral similarities regarding authoritative coordination and direction of human and material resources.

Besides this, Whitley states that the level at which distinctive forms of economic organization should be analyzed, depends on the characteristics that are of interest. In the case of this study, it is the broad pattern of forms of economic coordination and control, which is considered interesting and will be dealt with in the remainder of this report.

Social structure/ Institutional context

General rules:

Configuration

-property rights -governance structure

-rules of exchange

Actual relations

= Business system

= Conceptions of

control

Contemporary processes Historical processes Whitley Fligstein

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Part 2 The Russian business system

In the previous part, the complementarity of the approaches of the two authors was explored and it was concluded that they are complementary to each other in the sense that the viewpoints taken in order to describe the business system differed and add on to each other. Whitley focuses on the macro-process and a historical approach in describing the business system, while Fligstein focuses on the micro- process and the contemporary market processes in describing the business system. In order to give a most complete analysis of the business system prevailing in Russia, I will therefore use both approaches. The way in which I will do this answers sub-question 1.1 and is described next, by indicating the relevant characteristics of a business system.

2.1 Relevant characteristics of a business system

The basic characteristics of business systems across market economies can be divided under three headings (Whitley, 1992a: 242):

1. Economic actor -- What sorts of economic activities and resources are coordinated and controlled by authority hierarchies, and how and by whom is discretion exercised over them? Key characteristics are the following:

- extent of authoritative control over economic activities - extent of managerial discretion from owners

- variety of activities controlled through authority hierarchies - extent to which strategic changes are incremental or discontinuous - firm independence and mutual separation.

2. Inter-firm relations – How are cooperative and competitive relations between such authority hierarchies organized? Key characteristics are the following:

- level of market organization within and between sectors - significance of intermediary coordinating organizations - basis of inter-firm commitments.

3. Firm-type – How are resources and skills organized and directed within dominant authority hierarchies? Key characteristics are the following:

- degree of integration and interdependence between activities - impersonality of authority and subordination relations - integration of formal authority with technical superiority - centralization of decision making and control

- specialization of tasks, roles and skills - distance and superiority of managers

- employer commitment to employees and organization-based labor system.

The three elements of the business system are closely interconnected, since the ways in which resources are managed reflect differences in their diversity and type, just as market relations are interdependent with strategic preferences and patterns of managerial recruitment and promotion (Whitley, 1992a:18). The characteristics I listed here, are derived from Whitley’s discussion on business systems in East Asia. In Whitley’s later book, European business systems, he slightly changed the characteristics, but these are mainly superficial changes in wording and I decided to stick to the first

‘list’.

As explained before, a particular hierarchy-market organization develops because of a society’s distinct institutional environment, made up out of actual relations and general rules. Major institutions that structure and enable different business systems to develop and become established, can be divided into two groups:

1 The immediate, proximate institutions, established currently and in the recent past 2 The institutions more distant in origin, which are more indirect in their impact

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The explanation of the meaning of proximate and distant institutions however differs between the two books written by Whitley that I considered. In his ‘first’ book, on East Asian business systems, the proximate institutions are described to be ‘the structure and policies of the state, the nature of the financial system and its role in economic development and the education and training system’

(Whitley, 1992a: 16). The more distant institutions are here described to be ‘those which developed during industrialization, and, where this was relatively recent, those which were important in pre- industrial periods and influenced the particular patterns of industrialization that occurred’. Thus, the more distant institutions concern both the pre-industrial period and the process of industrialization, while the proximate institutions are not elaborated upon.

In his ‘later’ book, on European business systems, proximate social institutions are described as often being a product of the industrialization process itself and frequently developing with the formation of the modern state. As well as reflecting particular features of the pre-industrial political and economic organization, these proximate social institutions are also the result of more recent events such as large- scale political changes. Proximate institutions thus concern the more immediate business environment.

Background social institutions are described as those underpinning the organization of all economic systems and forming the background to industrialization and the development of modern market economies. Background institutions thus concern general patterns of trust, cooperation, identity and subordination in a society. Thus, the background institutions concern the pre-industrial period, while the proximate institutions concern the industrialization process and more recent events.

The two descriptions differ slightly and in order to avoid confusion, I will elucidate on the way I chose to interpret the two terms. I will mainly stick to the second interpretation by considering background institutions to be the pre-industrial institutions, which influenced the process of industrialization.

Proximate institutions, on the other hand, will be considered to consist of two parts; the institutions developed through the process of industrialization, plus the ones as the result of more recent events.

These two parts of proximate institutions will not be considered as one influence and in order to clarify this, I attempted to depict it in the following figure:

Figure 2.1 Institutional environment

While the background institutions and the proximate institutions that developed during industrialization have a quite definite influence on the establishment of the business system, proximate institutions that developed during more recent events are considered to only add nuances onto the established hierarchy-market organization.

Thus, referring back to figure 1.3, actual relations stem from the combination of particular features of the pre-industrial society and the society during industrialization which, in turn, partly result from the features of the pre-industrial society. On this, general rules exert an influence, stemming from more recent events. This brings me to the formulation of the following sub-sub questions, together constituting research question 1.1:

1.1.1 What are the relevant characteristics of the pre-industrial situation?

1.1.2 What are the relevant characteristics of industrialization?

Background

Proximate - industrialization

Business system

Proximate – more recent events Proximate –

more recent events

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2.1.1 Key characteristics of the pre-industrial situation

Characteristics of the pre-industrial situation that are of influence on the characteristics of the business system are (Whitley, 1992a: 166):

- The level of trust between business partners and non-kin

- The extent of collective loyalties and commitments beyond families

- The degree of formalization and depersonalization of authority relations and administrative procedures

Background institutions thus involve those covering trust relations, collective loyalties to non-kin, individualism and authority relations.

2.1.2 Key characteristics of industrialization and institutional developments

Characteristics of the industrialization process that are of influence on the characteristics of the business system are (Whitley, 1992a: 163):

- importance of state approval and support - bargaining power of firms

- dependence on banks - state risk sharing - encouragement of large firms - dependence on intermediaries - strength of organized labor

- urbanization and concentration of workers

‘Proximate institutions concern the availability of, and conditions governing access to, financial and labor resources, together with the overall system of property rights and political control (political, financial and labor systems)’ (Whitley, 1992b: 269). Considering merely the above characteristics can not complete the description of these institutions. More proximate institutional developments have to be considered as well: the general rules in a society.

2.1.3 General rules

As was described in the introduction of literature, general rules exert an influence on the business system; they add nuances. In order to be able to give a good description of the general rules in a society, the relative powers of the different groups in society have to be identified; state, capitalists and workers. A moment of market transformation, as recently occurred in Russia, is a very suitable moment to observe the general rules in society since through these radical changes, a new configuration was established. Governments and the representatives of capital and labor produced general institutional arrangements around property rights, governance structures and rules of exchange are for all markets in Russian society. These can be described as specific understandings about the way a particular market works.

Thus, in order to improve the understanding of the business system on a more detailed level, the configuration in society has to be described, as well as the property rights, governance structure and rules of exchange that emerged out of the recent transition.

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In the following figure, the composition of the business system once again is depicted, as well as the positions of the sub-subquestions dealt with above.

Figure 2.2 Business system and position of sub-subquestion

The identification of key characteristics of a society that are of influence on the elements of the business system prevailing in such a society leads to the figure depicted on the next page, which will be filled in for Russian society in part three.

Social structure/ Institutional context

General rules:

Configuration

-property rights -governance structure

-rules of exchange

Actual relations

= Business system

= Conceptions of

control Proximate institutions

-more recent events

Proximate institutions -process of industrialization

Background institutions - pre-industrial society

1.1.1

1.1.3 1.1.2

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Figure 2.3 Key characteristics for analysis of a business system

A conceptual model covering the problem statement can now be designed and looks as follows:

Characteristics pre-industrial situation

Business System

=

Conceptions of control

-Level of trust between business partners and non-kin

-Extent of collective loyalties and commitments beyond families

-Degree of formalization and depersonalization of authority relations and administrative procedures

Economic actor -Extent of

authoritative control over economic activities

- Extent of managerial discretion from owners -Variety of activities controlled through authority hierarchies - Extent to which strategic changes are incremental or discontinuous -Firm independence and mutual separation

Inter firm relations -Level of market organization within and between sectors

-Significance of intermediary coordinating organizations -Basis of inter-firm commitments

Firm type

-Degree of integration and interdependence between activities -Impersonality of authority and

subordination relations -Integration of formal authority with technical superiority

-Centralization of decision making and control

-Specialization of tasks, roles and skills

-Distance and

superiority of managers -Employer commitment to employees and organization-based labor system

Characteristics of

industrialization

-Importance of state approval and support -Bargaining power of firms

-Dependence on banks -Encouragement of large firms -State risk sharing

-Dependence on General Trading Companies -Strength of organized labor

-Urbanization and concentration of workers

Configuration

-Property rights -Governance structure

-Rules of exchange

1500

2003 Market

transition

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Figure 2.4 Conceptual model and positioning of sub-, sub-sub- and research- questions The upper box represents research question 1: What kind of business system is prevailing in Russia?

The lower box and the arrows in between the two boxes represent research question 2: What recommendations can be given, based on the analysis of the business system, regarding the way in which foreign operations should be set up and managed for an organization intending to operate in

‘the’ Russian market?

The Netherlands’ business system will be used as the basis for exploring the influence of the nature of both business systems on the transferability of practices. The Netherlands’ business system will be considered as a black box, since it was adapted from an existing article and it thus is the result that is regarded and not the processes that led to this.

Initially, I wanted to present a conceptual model in the first part of this study, but this was not possible Social structure

General rules

Business system

Transition Industrialization Pre-industrial society

1.1

1.2

2.1

2.2

1.1.3 1.1.2 1.1.1

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