Troika Potato Chips 1

St Petersburg, Russia

Case Description This two part case provides students with the opportu­nity to evaluate the attractiveness and fea~ihility of entering the potato chip business in St. PE'tershurg. Russia, based on the information and analysis present­ed in a business plan document, and then prE'~ents a savvy Western investor's perception and as~e~sment of that business.

Case (A) presents the business plan itself, along with a background note on Russian culture.

Case (B) presents an assessment of this plan by a mt~n­aging director of a British-owned, Moscow-based ven­ture capital fund who is reviewing it to decirle if he wants to invest in this start-up venture to produce pota­to chips for the St. Petersburg market and surrounding region.

Given the different tone of the second case, which largely summarizes the view and opinion of a Westerner in Russia, Case (B) endeavors to encapsul<~te the "wisdom of experience" of an experienced Western investment professional who outlines his rules of thumb for dealing with Russian entrepreneurs seeking invP.st­ment, and offers specific recommendations for forE>ign investors who are endeavoring to work with Ru~sian entrepreneurs.

Project Summary The proposed project envisions the establishment of a new enterprise that will produce high-quality, competi­tively priced potato chips in the town of Komt~rovo, not

far from St. Petersburg. The initiators ht~ve formed a separnte legal entity ct~lled ''Troika" spedfict~lly for the purpose of renli7.ing thP. project. The potr~to chip~ will be c;olrlunrler the "Troika" brr~nrl nt~me.

The Russian initiators hope to attr<~ct tin outside eqtrity investor r~nrlaJ~e the invP'itPrl funrl~ to purcht~~e special­ized, high-quality, imported procP~sing equipment that will enable them to produce and package world-clnss potnto chins to be c;old through both whoiP.salers and retailers in the region. The finanrial rE'Quirements for thP. reali7r~tion of the ahnve project nre: nn equity investmPnt of $RO':J.fi00 for the purchase of imported produrtion enuinmP.nt. and a c;hort-term credit of $nfi.OOO for str~rtup cnpital.

The prep<~rntory stage has been completed. and practi­cally nil key asner.ts have hPen worked out by the ini­'tiators. The Pnterpric;e has t~cq.Jired a production site (building t~nd land) t~nd <1 spedali;,:ed potato stort~ge fadlity. With thP pmchac;e and instt~llation of processing equipment. nnd a compiPte renovr~tion of the prorluc­tion sitP, production can bPqin. A prPiiminnry agree­ment to pt arrhnc;e enuiomP.nt hils been rPnC'hPd with a Outrh firm mnc;idPrPd <1 lendinq prorlurer of food pro­cesc;ing eqtaioment.

Tbe Focus of this Case In performing their <~nt'lly~is, students should focus more on thP qut'llitativP, rt~ther than q11antitative issues of the cac;P.. In evt~luntinq pntP.ntinl projects in Ruc;,c;ia and othPr dP.velnning countriP~. the quality of mnnngement takec; prPrP.rlenre over finnnrinl projertionc; il~ the most

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TEACHING NOTES

important factor. Because the instability of the Russian market makes long-term planning virtually impossible, most Russian entrepreneurs regard the business plan as a formality in attracting foreign capital rather than an actual blueprint for running their business. Therefore, the student, as a potential investor, should concentrate on those sections of the business plan which give some indication of management's style and degree of profes­sionalism. These sections deal with marketing research, risk assessment, and project planning.

Position in Course This case could be used as a teaching tool in courses on managing in developing countries, entrepreneurship or venture capital investing.

This case should:

1. Give an appreciation for the cultural aspects of doing business in Russia.

2. Provide experience analyzing an actual business plan and making an investment decision.

3.111ustrate the specific challenges facing investors in developing countries.

Questions for Discussion 1. Discuss some of the positive attributes of this

project.

2. Discuss some of the negative attributes of this project.

3. Based on the business plan, what can be said about the initiators?

4. What additional information would you request from the initiators?

5. Should the investment be made 7

Salient Points Indications of insufficient preparation on the part of the initiators:

• Further information revealed that the potatoes supplied by Komarovo were inappropriate for

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potato chips. Suitable potatoes are not grown in the vicinity and would have to be supplied by an outside producer, leaving Komarovo uninterested in involvement in the project since it would no longer have a steady buyer for its potatoes. Costs of purchasing potatoes outside the region and trans­porting them to the processing plant were not accounted for, and they would certainly increase the cost of production. Furthermore, potatoes suit­able for potato chips do not hold up well in trans port.

Students will not know this from reading the case. However, as potential investors, they should reque-;t an expert opinion about the viability of using the supplied potatoes for producing chips.

• The partners are not willing to make a significant equity investment into the enterprise. This is an indication that they may not have a sufficiently serious attitude toward the project.

It may also indicate that they have no cash, which is not negative in itself. However, the contributed assets are overvalued and highly illiquid.

• Assets offered by the partners are overvalued and illiquid.

The assigned values seem arbitrary since there were no licensed appraisers in Russia at the time the case was written. Furthermore, real estate is a highly illiquid and problematic asset.

• Certain legal questions are not sufficiently addressed. Presently, one cannot have 100% own­ership claim on a piece of Russian real estate. Also, the land on which the building is situated is still considered state property. Real estate laws in Russia are rarely defined and very confusing. Therefore, these sorts of questions have to be examined very carefully.

Students may not know the intricacies of Russian real estate laws, but they should be able to identify this as a salient yet vague point, since real estate forms the bulk of the initiators' contribution to the project. Initiators should have anticipated this ambiguity and provided some additional information regarding legal issues.

Evidence of Inexperience in General Management

• Sales are projected to be $1 million/year, while advertising expenditures are estimated to be S 15,000/year. It is unlikely that this amount will be enough to realize brand recognition and sales of that enormity.

• Sensitivity analysis should have been performed and provided to the investors.

• Troika projects to capture 5% of the local market selling 300 tons of chips per year. This puts the total market at 6,000 tons per year, which is obviously an exaggeration (1 kg of chips per person). Further­more, the marketing research indicates that only about 60% of the population consumes potato chips on a regular basis.

• The business plan does not indicate how the prod­uct will be sold. We only know that one of the partners has access to a local distribution network. It seems that the initiators have very little experi­ence in wholesale on such a scale.

Evidence of lnexperience in Financial Management

• Cash flows are not discounted.

If some students attempt to do an NPV analysis, discuss how they would choose a discount rate and adjust for inflation.

• The proposed exit strategy indicates that the initia­tors do not take into account that the investor will require a minimum 30% annual return on his money, which seems fair considering all the specif­ic risks of the project and the general risks of invest­ing in Russia.

TROIKA POTATO CHIPS

The initiators estimate the annual return on investment to be roughly 24%, which is the ratio of the average annual dividend to total investment.

General Comments about Business in Russia

• The project or enterprise is only as good as its man­agement team. Laws and cash flows change quick­ly and unexpectedly in Russia, though management does not. A good manager is someone who has operated a successful (profit-making) business through the recent economic transition; someone who can react quickly to changes; someone who understands the system but is also outside of it; someone whose livelihood depends on the business he is managing.

• Organized crime groups perform two important functions for business in Russia. First, they provide the business with protection against other criminal structures. Second, they enforce contracts, especial­ly the repayment of credit. It makes no difference whether the credit is obtained by an individual or a corporate entity with limited liability; the individ­ual who signed the promissory note is personally responsible for repayment. The individual risks all personal property and ultimately his life if repay­ment is not made. In Russia, bankruptcy offers no protection from creditors.

NOTES

1. This case was written by Gene Gutenberg of Cornell University. It is intended as a basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation.

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