Marco Breu, managing partner of McKinsey & Company Vietnam, and Diaan-Yin Lin, partner offer an analysis of reform measures regarding state-owned enterprises in Vietnam
State-owned enterprises (SOEs) account for around 30-40 per cent of Vietnam’s GDP. These companies, controlled by the government or a government agency, often struggle to meet the private sector’s performance levels, and potential profits remain unrealised. During the current downturn, some SOEs, even as they face increased pressure to become more efficient, have been called on to support government stimulus plans through higher spending and job retention.
Nonetheless, our research and experience show that notwithstanding the constraints of the public-sector model and the tough economic times, these enterprises can significantly improve their performance.
Even in normal times, for example, the average return on assets at state enterprises in China was less than half that of the private sector, a McKinsey study showed a few years ago. One reason is that many such companies, in China and elsewhere, are shielded from competitive pressures, but other factors contribute greatly as well. State enterprises often juggle multiple, unclear, or conflicting financial and social objectives, such as providing blanket, low-cost telephone service. Political interference can prompt decisions that threaten a company’s financial goals. Finding talented workers at all levels is a problem too. The best and brightest gravitate toward a more lucrative private sector and the tenure-based promotions common at SOEs can conceal their best internal talent.
Yet, there is hope. Some SOEs in emerging markets are closing the gap with their private-sector competitors. Petronas, the state-owned energy company in Malaysia, for example, began an operational excellence campaign focusing on improved technical capabilities and a more effective working culture at its plants. After five years, the initiative delivered upward of $1 billion in savings and new revenues. What’s more, the company’s operational effectiveness, judged by a metric combining utilisation, quality, and performance, is now in the industry’s top quartile. While these better-performing companies draw from well-known best practices in the private sector, they also concentrate on three areas of specific importance in the public sector. These are clarifying objectives and securing an explicit mandate, focusing scarce resources on areas with the highest financial impact and redefining the talent proposition. Governments play a big role in creating the right environment for SOEs to excel.
Creation of a government-holding company
One option that has been used effectively by some governments to enhance the efficiency of SOEs is the creation of powerful government holding companies (GHCs), such as Singapore’s Temasek, Malaysia’s Khazanah Nasional Berhad and Kazakhstan’s Samruk-Kazyna to oversee the state’s portfolio in ways that insulate corporate managers from political influence or control and thereby pushes performance standards.
Successful GHCs have an effective governance structure, people with the right skills and critically, a clear mandate and the political support they need to implement and enforce change in SOEs. GHCs typically require three components to be in place. First, they need a powerful board that reports directly to the highest level of government, president or prime minister, and consist of key government officials such as ministers of finance, economy, and industry, as well as respected leaders from the private sector. Second, the CEO or leader of the GHC needs to have a clear mandate and the personal skills to drive change. Third, the organisation must have sufficient autonomy to hire, fire and incentivise its employees and be shielded from any backlash against politically unpopular decisions. Without these sources of internal and external strength, most GHCs are unable to execute the difficult but unavoidable choices necessary to position the government’s portfolio for growth.
Clarify objectives and secure an explicit mandate
Too often, SOEs operate with limited transparency, revealing little information beyond their general mandate. One reason may be that their objectives are unclear or conflicting, but the lack of transparency can also reflect a desire to avoid comparisons with the private sector, or inexperience with clear, concise corporate communications. Leading SOEs can openly proclaim their objectives and clarify the tradeoffs between their financial and social goals when they negotiate a transparent mandate with the government and other stakeholders. In practice, that kind of transparency involves explicitly establishing financial objectives as the primary goal and setting both aspirational targets and minimum expectations, such as covering the cost of capital.
The experience of developed economies provides some guidance. In Sweden, for instance, the national rail operator was told to match industry standards for returns on equity (13 per cent), interest coverage (2:1) and minimum debt-to-equity ratios (1:1). Also, nonfinancial social objectives, such as maintaining employment or offering universal service, should be identified, quantified, made transparent, and, where feasible, explicitly financed. The leaders of state enterprises must not only have the freedom to pursue these explicit objectives but also receive support publicly. An agreement between the leadership and government officials on the scope for action is often helpful.
Focus scarce resources for highest financial impact
Even with transparent agreements, SOEs have some important challenges. Public scrutiny and the pressure to deliver quick results and avoid missteps is intense. Wholesale changes can upset workers and raise the level of political risk. Leadership talent is scarce, and few people have experience executing change programs. As a result, judicious SOEs tend to begin their change programmes by concentrating on a few areas that promise to have the greatest financial impact rather than embarking on a broad agenda that could fail for lack of resources. This focus also limits the possibility that divergent, and possibly conflicting, stakeholder interests will distract a company’s leaders from their core tasks. Executives must choose their targets carefully. To emphasize urgency and plow through the bureaucratic inertia that’s common in state enterprises, it will often be necessary to establish special, CEO-sponsored teams that can bypass unnecessary management layers.
The chief executive of the Indonesian state oil company Pertamina, for example, created breakthrough teams he monitored closely to speed up high impact projects. Starting with about a dozen initiatives, the programme has since been expanded to encompass the entire organisation, generating about $285 million in earnings before interest, taxes, depreciation, and amortization (EBITDA) in just over two years. For many companies, departments (such as procurement) that control big budgets and are prone to political interference (or that need to balance social objectives) often benefit from the increased focus such teams create. By focusing on a select group of business units, CEOs can channel disproportionate investment to the areas with the highest potential.
Some CEOs even go so far as to separate from their core organisation the areas with the highest potential. Such isolation can create room for these businesses to build decisive, performance-based cultures and to become models for the entire organisation, potentially leading the way to broader cultural change. To help focus on high-priority areas, leaders at state companies must also examine noncore activities and assets and, wherever possible, terminate, franchise, outsource, or shed them. Divestment of public assets can be sensitive and usually requires approval on many levels, but executives have found creative ways to expedite the effort. The commodities company cited earlier, for example, transferred the running of its shipping fleet to an international partner. This move, which required no ownership changes or headcount reductions, saved the company tens of millions of dollars in less than six months, primarily thanks to the partner’s better discipline and operating practices.
SOE reform in Vietnam
Given the economic weight the SOEs bear in the Vietnamese economy, reform of the ownership and management incentives for public enterprises can be an important institutional vehicle for improving productivity and growth. Vietnam’s SOEs continue to lag both private sector companies and multinationals on efficiency. They face many of the same challenges that SOEs face in other parts of Asia. One measure of how productively a company invests is the incremental capital output ratio (ICOR), the amount of investment needed to generate an additional unit of output; the higher the ICOR, the poorer is the efficiency of the capital invested. The average ICORfor Vietnamese SOEs is 1.62, they need $1.62 in capital to generate one additional dollar of output. That compares with the average ICOR we calculate in Vietnam for multinational corporations of 69 cents and for private companies as a whole of just 47 cents, a gap that differences in the underlying sector cannot explain.
Boosting the productivity of SOEs is particularly important in the transportation, storage, and telecom industries, all of which have significant growth potential but where SOEs control 60 per cent of the domestic market. Raising the capital efficiency of Vietnam’s SOEs would contribute a great deal to boosting economy-wide capital efficiency.
Vietnam has already embarked on an important journey towards reform of its SOE sector. It has already established the State Capital Investment Corporation (SCIC) in 2005 with a mandate to facilitate the reform of SOEs and to improve the efficiency of the economy’s capital utilisation.
SCIC could look at how other GHCs have organised and equipped themselves internally and what levers they have used to improve the performance of their SOEs. As individual Vietnamese SOEs strive for enhanced efficiency, the experience of others, including in clarifying their objectives, better focusing and leveraging their resources and developing world class operating practices will provide valuable lessons.