What really is UkrOboronProm, the largest holding of state-owned defense companies?
Six months ago, we did not have an answer to that question. Society didn’t have it, the president didn’t have it, our military, partners and clients didn’t have it; the country didn’t have it.
Six months ago, I joined UkrOboronProm to provide an answer to this question and to start structural changes — reforms that will help Ukraine obtain a modern, high-tech state company in the defense sector.
Back in 2015, we in the Ministry of Economic Development and Trade initiated the corporatization of the largest state companies that are of strategic importance. UkrOboronProm was excluded from this process by a political decision of the country’s then-top leadership – it was too tempting not to benefit from illegal earnings in the super-profitable sphere, where everything is labeled as “top secret” and offers a vast field for abuse of office.
None of the state enterprises had to wait to be reformed as long as UkrOboronProm.
In 2019, I joined the supervisory board of UkrOboronProm to finally start the process of transforming this economic entity into a transparent and efficient company working for the state, not for those temporarily managing it.
In order to stabilize its work and quickly prepare for necessary transformations, I accepted the president’s proposal to become the general director of UkrOboronProm, to form a team and start the process of reforms. During the last six months, we have started to change UkrOboronProm, and it will never be the same again.
Here’s what we did so far:
- Hard reset of the team and relations with all regulators, including our number-one client – the Ministry of Defense;
- Audit of financial statements, including a comprehensive assessment of assets that in practice turned out to be liabilities;
- Established new procurement principles.
Together with the team, we assessed the condition of UkrOboronProm, which previously no one had done so carefully and meticulously, developed a strategy of transformation and formed a support circuit from key partners in government.
We expect the state to pay more attention to the transformation of UkrOboronProm, to support radical changes that will improve the capabilities of the entire defense industry.
What is UkrOboronProm?
The domestic heavy engineering industry is going through difficult times and needs systematic state support. This is particularly noticeable at UkrOboronProm, which consists of 137 enterprises, 21 of which are located in the occupied territories, 85 are financially unstable and eight are bankrupt.
The group has 68,000 employees, but revenue per employee is 5% of the global average in the industry. Even with Hr 4.2 billion (more than $171 million) in earnings before interest, taxes, depreciation, and amortization (EBITDA) in 2018, 90% of the group’s profit is generated by only about 10 enterprises.
Several thousand buildings and structures of UkrOboronProm are housed on 11.4 million square meters and 5,500 hectares of land, but most of this inheritance is excessive, costly and not involved in the production of military goods.
While competitors from neighboring countries (Turkey, for example) annually invest up to 25% of their revenue in research and development, our enterprises, unfortunately, feel absolute investment hunger and a complete lack of state support.
Due to the total lack of modernization and production influenced by the Soviet era, within a few years UkrOboronProm will lose competitiveness not only in foreign markets but also in Ukraine.
In order to reduce the technological gap and significantly upgrade production facilities to develop new products, I believe it is necessary to invest at least 10% of revenue, or $100 million per year over 10 years. Some of these funds will have to be raised by ourselves, including through the sale of surplus and idle assets that have not been used.
During the transformation period, the group urgently needs to write-off bad debts and introduce tax benefits, have a more flexible dividend policy, direct financial assistance and the opportunity to sell assets independently, freeing up and directing resources to modernization and new developments.
No major state-owned company in Ukraine has managed to get out of the difficult situation without state support: Naftogaz did so by raising tariffs on the population, Ukrzaliznytsia (the state railway) by raising tariffs threefold, while Ukrposhta (the state postal service) received compensation for unprofitable delivery of parcels to rural areas.
So what do we do in the meantime?
In 150 days, we were able to prepare the group for transformation and launch changes. We helped develop a property policy following the example of OECD standards – the first strategic document that answers the question: “Why does Ukraine need a state defense concern and what are its tasks?” We are waiting for the adoption of this document by the Cabinet of Ministers.
A bill to write off bad debts for Hr 4.4 billion has been developed and submitted to the Economy Ministry. This will help such enterprises as Malyshev Plant, Kharkiv Aviation Plant, Zirka and others to get out of a very difficult situation.
We applied business triage, analyzing the condition of each enterprise, its significance and role for the country’s defense and looked at exports and intellectual potential. As a result, we have three groups of enterprises, and for each of them we have a clear understanding of what to invest and develop and what to return to the state.
Only 27 companies in the concern have annual revenues exceeding $10 million. These companies generate 89% of total revenue. The overwhelming majority of the UkrOboronProm’s companies, huge factories in the distant past but quite small by today’s standards, will be more successful when consolidated around larger “colleagues.”
The group is no longer a closed club of traders of national interests. The human resources transformation of UkrOboronProm is almost complete.
We created conditions to attract professionals of a completely different level, quality and value. It is no longer a toxic place where no one wants to work. It is no longer a club exclusively for friends and relatives of the powerful. It is already an organization capable of attracting the former head of Microsoft in Ukraine and bringing top managers from Western Europe home, back to the country.
The entire top management of UkrOboronProm has been updated, as have the heads of large exporters. There have been and will be many people willing to put their protégés in key positions. And among such candidates, there are definitely no graduates from Western universities.
Such people want to earn money. Perhaps, by showing flexibility in this matter, the concern could get more support in certain circles. But neither I nor my team is ready to answer for such people.
Some eight large enterprises received new directors. Thanks to an open selection process, about 40 candidates applied for one position! A transitional Supervisory Board was also formed, which approved the corporate strategy, the plan of financial rehabilitation of enterprises and the reform of exporters.
Last year, the new team already managed to meet the demands of state defense orders and to win an important victory over a Russian subsidiary company, which through the courts tried to force one of the concern’s enterprises to pay off debt for military goods that were not delivered.
Without reforms supported by the state, UkrOboronProm will continue to increase debts rather than engage in enterprise development and innovation.
For example, without backing from the government, it is simply impossible to financially improve the enterprises.
First of all, we have to deal with unpaid wages. During UkrOboronProm’s first year of existence, there were already 27 enterprises with debts to their employees. And since then, this number has always exceeded 30. The salary issue has been brought under control. Today, the number of debtor companies has been reduced from 43 to 35.
After several years of decline, the concern’s arms and services exports grew by 19% to $908 million in 2019, compared to $766 million in 2018. The top importers of our products are India, Saudi Arabia, Turkey and other countries in Asia and the Middle East.
The most popular products are anti-tank missile systems, gas turbine engines and services such as repairs of Soviet equipment and modernization of aircraft.
Our export growth can potentially reach 30% in 2020 according to negotiations with dynamic key players.
A serious breakthrough in the export market is hindered by a modest list of modern products, a lack of financial instruments to stimulate exports as well as unhealthy competition among our own exporters.
To resolve this issue, UkrOboronProm has initiated changes in the work of exporters, aimed at improving coordination and cooperation by establishing a clear division of responsibilities.
During the transition period, four exporters will work on foreign markets instead of six, with no more than two in the same market. As a result of the changes, only two special exporters will remain in the long term with a rule: one country – one exporter.
The work of exporters is one of the examples of changes already introduced by the new team. The effect will be visible by the end of the year.
But UkrOboronProm also has made changes that one can experience right now. These are in procurement practices, traditionally considered the most corrupt. We proved that it is achievable to save money on state procurement.
At UkrOboronProm, the structure of procurement was transformed within several months. Since the beginning of 2020, procurements that exceed Hr 50,000 are now transferred to the Prozorro system. Previously they were held behind the closed doors.
Today in the Prozorro system, we have 2,430 tenders worth a total of more than Hr 1 billion. Savings this year have already amounted to Hr 120 million. For the first time, there has been centralized procurement of electricity and gas for the enterprises as well as audit services. For the third centralized procurement we managed to save more than Hr 60 million.
The figures clearly prove that Prozorro works if the system is implemented by a team with zero tolerance for corruption.
State defense orders
In 2019, the enterprises fulfilled 69 contracts for the development and manufacture of military equipment worth almost Hr 7 billion. The state order was 98% complete. The concern’s enterprises supplied almost 3,889 units of military equipment to the Ukrainian army and other security agencies, which is five percent more than in 2018.
Only due to well-coordinated work between all levels of power and the UkrOboronProm’s team was it possible to unblock the contract on BTR-4E manufacture and delivery (The BTR-4E is the export version of the BTR-4, an 8×8 armored vehicle personnel carrier (APC) designed by the Ukrainian company Kharkiv Morozov Machine Building Design Bureau.)
In addition, 1,048 units of repaired and modernized equipment were handed over to customers. The repair plan was 99% fulfilled.
We are looking forward to 2020 state orders. Unfortunately, the planning system and the old approaches have not yet changed, and UkrOboronProm as the largest performer of the state defense order, has no official information about the state’s needs from our products in 2020-2022.
From media reports, we learn that there is a lack of necessary financing for perspective rocket programs that are realized by UkrOboronProm, which is unacceptable! This is crucial for protecting Ukraine’s territorial integrity.
Planning and systematic approaches are paramount in the production process. Without it, it is extremely difficult to plan anything, and it disrupts cooperation with co-executing companies. It should not be like this.
At the beginning of the week, I visited one of the concern’s enterprises in Ivano-Frankivsk – called Karpaty. They produce wiring harnesses for the German car industry. The enterprise’s capacities have been used by the well-known American company Aptiv since 2007. Such cooperation allows the enterprise to estimate its workload until the end of 2026! And this provides stable work for its 3,600 employees.
UkrOboronProm is anxiously waiting for the adoption of the new law on defense procurement, which will allow planning for production for a longer period of time and will change the Soviet approach to pricing, which at the moment does not contribute to cost reduction.
UkrOboronProm’s new team managed to achieve these and many other results and small victories in six months. We were able to do all this without political interference or corruption scandals. This helped gain the support of partners from NATO countries and attract the best corporate governance and transformation consultants.
Now this reform must be implemented at both political and legislative levels, and within the group itself, to make the changes irreversible.
Aivaras Abromavicius is the general director of UkrOboronProm, a group of more than 100 state-owned defense companies producing military equipment, including advanced weapons systems.