The Human Capital Agenda in Russia and the CIS

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By: Ana Kekezi and Sergey Gadetsky

The Commonwealth of Independent States (CIS), according to the official description, is a regional organisation whose participating countries are the former Soviet Republics. It was formed during the breakup of the Soviet Union.

The CIS is a very loose association of states, and bears no resemblance to a federation, confederation or supranational organisation such as the old European Community. But the CIS is more than a purely symbolic organisation. With co-ordinating powers in the areas of trade, finance, law-making, and security, it is more comparable to the Commonwealth of Nations. Some of the members of the CIS (Armenia, Azerbaijan, Belarus, Georgia, Moldova and Ukraine) established the Eurasian Economic Community in May 2009 with the aim of creating a fully-fledged common market.

When Mercer refers to the CIS, in a business context, we are talking about the group of ex-Soviet Union countries that established their own market economies when the Soviet Union collapsed. Because these economies were all set up at the same time, we are able to make comparative studies and follow these countries' developments in the Human Resource arena. We currently have business activities in Russia, Ukraine, Uzbekistan, Kazakhstan, Georgia, Belarus, Azerbaijan, Moldova and Armenia.

The level of economic, social and cultural development varies between different countries in the CIS. Each country presents different challenges and opportunities for multinational corporations seeking to either gain a foothold or develop their business activities there. Its very variety makes the CIS an extremely interesting region to work in, as do the different views, ideas and expectations of increasingly sophisticated HR professionals. There is considerable variation between each country's approaches to HR strategy, but as well as being very demanding, HR teams are very eager to learn from best practice within and outside their market.

The economic backdrop
In terms of population size, the countries are ranked in the following order (according to 2010 official data):

Russia	139,390,205
Ukraine	45,415,596
Uzbekistan	27, 856,738
Kazakhstan	15,460,484
Georgia	4,600,825
Belarus	9,612,632
Azerbaijan	8,303,512
Moldova	4,317,483
Armenia	2,966,802

The rankings are slightly different when it comes to foreign direct investment (according to 2009 official data): Kazakhstan, Russia, Ukraine, Azerbaijan, Belarus, Georgia, Moldova, Uzbekistan, Armenia.

Kazakhstan enjoys the biggest investment because of the boom in the oil and gas sector, whereas Russia is attracting interest from foreign investors in other sectors such as FMCG and pharmaceuticals, as well as oil and gas.

In terms of cost of living, the comparison between CIS countries is calculated based on the base level of Moscow at 100% (according to Mercer's Cost of Living and Quality of Living surveys, March 2010).

Azerbaijan	93%
Kazakhstan	72%
Armenia	64%
Ukraine	64%
Belarus	61%
Georgia	61%
Uzbekistan	59%
Moldova	54%

Russia is by far the largest of the CIS economies, its GDP of US$1.2 trillion dwarfing the US$100 billion enjoyed by each of the next largest economies, Ukraine and Kazakhstan. However, GDP per capita in Russia is 5.65 times less than it is in the US.

CIS countries have been severely affected by the financial economic crisis over the past two years, with Ukraine and Armenia experiencing the biggest falls in GDP growth in 2009 – 13.5% and 15.6% respectively. But growth has returned this year, and the prospects for the next few years look promising: in 2012 most CIS countries are expected to see GDP growth of 5% or above, with Uzbekistan predicted to grow by 6.5%. In 2009 Russia's GDP fell by around 8%, and it is estimated to have reached 4% in 2010. If it sustains the same level of growth in 2011 it will recover its pre-crisis GDP level in 2012.

The difficult economic climate was reflected in inflation levels, which were relatively high in 2008 and 2009. For example, currency devaluation meant Ukraine was affected particularly badly, with inflation of 22% in 2008 and 16% in 2009.

In Russia, however, inflation expectations have been revised upwards from an expected 6% this year to 8%, owing to a summer drought. Average salary increases in Russia were 7.5% in 2009, compared to between 10% and 15% in Belarus, Kazakhstan and Ukraine. However, inflation in the CIS, including Russia, is projected to fall significantly this year – reflecting a return to economic stability – and should settle at more normal levels over the next couple of years, with salary increases following suit.

Labour market developments in Russia At the end of 2009 unemployment in Russia was above 8% of the economically active population. It has since fallen to around 7%, and is expected to return to the pre-crisis level of 5.5% at the end of 2011.

Employee turnover during 2008 and 2009 followed a typical 'crisis' pattern. In the pre-crisis year of 2008 'voluntary turnover' – people opting to change jobs – was higher than 'involuntary turnover' (companies needing to lose people). The pattern reversed in 2009 as individuals tried to keep their jobs while companies restructured to deal with the crisis. White-collar employees were most affected by the crisis – and it is no surprise that the most attractive career path at the moment is that of government servant.

However, involuntary turnover in 2009 was less dramatic than might have been expected, reflecting a more sophisticated approach to cutting employment costs than the blanket job losses common in previous recessions.

What's more, the fact that over 50% of firms plan to increase their headcount this year (with the same proportion having increased it last year) suggests a high degree of optimism about economic prospects in Russia. Only a very small proportion of companies plan to decrease headcount this year, but the number who are planning a headcount freeze has risen to over 40%, indicating ongoing caution in some areas.

The more cautious industries include retail, metallurgy, machine-building and construction materials, while industries actively attracting employees include IT, consulting, FMCG, pharmaceuticals, banking and construction.

Russia is currently suffering shortages of qualified engineers and sales people – jobs that Mercer research shows are critical to the success of many organisations. The difficulty of attracting and retaining engineering and sales skills will only intensify with demographic changes such as the declining and ageing population. By 2015 a more widespread gap between labour supply and demand is predicted, with unemployment only in areas where there is a structural mismatch.

The pros and cons of doing business in Russia

Pros

Growing economy with growing middle class
Easing inflation, though still high
Attractive amount of foreign direct investment
Nearly 100% literacy
Large labour force
Relatively skilled and relatively low-cost labour
Well-regarded medical, mathematical, scientific, and space and aviation research
Relatively low income tax and corporate tax rates
Opportunities for significant market growth

Cons

Many skilled employees, but not necessarily the skills needed in the market
Education systems not fully prepared for marketplace needs
Boom and bust economy
High wage inflation (10% – 11%)
Unstable regulatory environment with changing laws and decrees
Difficulties in restructuring workforce
Economic growth hindered by ubiquitous government red tape. Outdated government regulations affect many areas
Infrastructure (including power and energy sources) remains a bottleneck for the Russian economy

Developing HR practice in Russia and other CIS countries
CIS countries have gradually adopted more professional HR approaches, as multinational companies setting up operations in new CIS markets increasingly demand international consistency in compensation and benefits practice. So today, for example, companies in CIS countries are starting to participate in remuneration surveys and to use reliable and robust sources on which to build their compensation packages.

Another factor contributing to the spread of more 'professional' HR practice in Russia and the CIS is the growing mobility of HR personnel across borders, whether within the same company or to other organisations. CIS countries benefit from the injection of expertise and experience from outside their region, while heads of functions and top management in companies in the CIS – notably Russia, Ukraine and Kazakhstan – are seizing new opportunities to develop their experience outside the region.

The HR department in companies in many CIS markets is no longer simply an administrative function, often staffed by just one individual. It is now more complex, with sub-departments including compensation and benefits, recruitment, employee communications/relations, training and development, and payroll – as well as HR administration. However, in countries such as Georgia, Armenia, Uzbekistan and Moldova, the old model still persists, as it does among most local companies in all CIS countries.

Compensation trends overview in Russia and other CIS countries
Since 2008, there has been a shift towards a more centralised compensation and benefits approach by multinational companies in the CIS. But while this carries benefits, it also has a downside. Obvious advantages include consistent compensation and benefit analysis and strategy implementation. But disadvantages include a lack of local HR involvement in analysis and decision making, which poses the risk that the overall strategy doesn't take into account local market nuances, leading to poor 'fit'. What's more, local HR managers need to feel that their views are respected and reflected in local policy.

The proportion of base, guaranteed and variable pay is roughly the same in each CIS country, with employees at senior levels earning a higher percentage of variable pay than employees at more junior levels. But the differentiation between senior and junior levels when it comes to variable pay is quite small: even at top management level, the maximum amount of variable pay an individual can earn is 30%, according to Mercer's Total Remuneration Survey in 2010 and that's in just one country – Ukraine. In Russia, while the same trend applies in the consumer goods sector, the differentiation between senior and more junior levels is quite substantial in the financial services industry.

The overall picture in the region as a whole has remained largely unchanged for several years, but there are slight differences between the countries.

For example, at supervisory/specialist level, base pay comprises by far the largest component of the total remuneration package – typically around 90%. However, guaranteed pay represents about 10% of total remuneration among companies in Uzbekistan and Moldova, while companies in Belarus, Moldova and Ukraine award around 10% of total remuneration in variable pay.

At middle management level base pay again dominates remuneration packages, with guaranteed pay offered mostly in Uzbekistan and Moldova, and variable pay most common in Moldova, Ukraine, Kazakhstan and Belarus.

Among senior management base pay dominates, guaranteed pay is less common than at the two lower levels, but variable pay is higher – particularly in Ukraine, Moldova and Belarus, where it represents around 20% of the total remuneration package.

Even at top management level base pay is quite strong, guaranteed pay is virtually non-existent, but variable pay is higher than at other levels, especially in Ukraine (where it represents 30% of total salary), Georgia (nearly 25%), Kazakhstan (over 20%) and Moldova (20%).

Benefits trends overview in Russia and other CIS countries
The top benefits (over and above the statutory requirements) provided in CIS countries are private medial insurance, life assurance, travel insurance, additional paid sick and holiday leave, mobile phones, fully-funded training and education programs, meal allowances and company cars (the latter most commonly for sales, management and executives). However, in Moldova, Uzbekistan, Azerbaijan, Georgia and Armenia neither life assurance nor sickness benefits are common elements in benefits packages.

The most popular benefits in Russia are, in order, private medical insurance, mobile phones, training and education, compensation for business trips above statutory norms, and company cars. Benefits such as private pensions and flexible benefits are among the least prevalent.

Salary management policies and practices in Russia
According to Mercer's Total Remuneration Survey 2010, the average salary rise across all job categories in Russia in 2010 was 9%, compared with the forecast level of 10%. Caution is also evident in the fact that most organisations this year have targeted their pay at the median market level for all categories of jobs, including executives. The financial crisis prompted many organisations to lower compensation positioning for their executives from a level between median and upper quartile of the market to median. Consequently, the proportion of companies with median positioning for their executives increased from 35% in 2009 to 60% in 2010.

The compensation and benefits mix for sales and non-sales jobs across all levels is very similar. This suggests either that companies implemented non-aggressive variable pay schemes during the crisis, or that sales forces failed to achieve their targets. Mercer's survey also suggests that long-term incentive schemes are still under-developed and under-utilised in Russia.

The most highly-paid function in Russian companies is marketing, while the least well-paid is sales – particularly at senior level. The best-paid jobs in 2010 was head of sales and marketing, head of marketing, head of finance and accounting, head of manufacturing and head of regulatory affairs.

Average variable pay within short-term incentive plans for executive jobs fell from around 25% of the total remuneration package in 2009 to around 17% in 2010. While target bonus levels increased in 2010, the bonuses executives actually earned were lower than the previous year, again reflecting subdued business performance during the years 2008 and 2009.

The research shows a significant rise in the use of long-term incentives (such as stocks and shares) for CEOs and executives over the past three years.

Conclusion
The CIS is an attractive market for foreign investors. It is rich in mineral resources, has a large population and most people are well educated. There is, therefore, significant growth potential in terms of productivity, average income and, ultimately, spend per capita, all of which combine to drive attractive margins and return on investment. However, foreign investors also need to contend with the risks associated with red tape, an under-developed legislative framework, corruption and a dearth of local top management talent. Such things can, in the medium term, conspire to reduce hoped for margins and return on investment

Mercer works with an extensive range of clients in Russia and eight CIS markets – Ukraine, Uzbekistan, Kazakhstan, Georgia, Belarus, Azerbaijan, Moldova and Armenia. Mercer works in partnership with clients, helping them to keep up-to-date with HR practices and initiatives in their markets and to become 'employers of choice' by supporting the development and education of their HR teams.

About the authors:

Ana Kekezi is Mercer's Information Product Solutions Business Leader in the CIS. Based in Budapest, she can be reached at ana.kekezi@mercer.com.

Sergey Gadetsky leads Human Capital Solutions, Mercer's affiliate in Russia. Based in Moscow, he can be reached at sergey.gadetsky@hcsrussia.ru