“Hot spot” articles are designed to showcase an emerging economy or a particularly interesting economy, with emphasis on that market’s most pressing human capital challenges. In this article, Sergey Gadetsky and Larisa Muravska discuss the current economic and human capital trends in Russia. Gadetsky leads Human Capital Solutions, Mercer’s affiliate in Moscow, and Muravska leads Mercer’s Information Product Solutions business in Eastern Europe and the Middle East.

Q: What are some of the key human capital challenges facing organizations in Russia today?

Sergey Gadetsky : There are several forces that together are posing significant challenges for organizations in managing their human capital. First, Russia still has high inflation – about 12 percent annually. That’s making it difficult for companies to manage merit increases and to reward for performance, because they are also having to make significant cost-of-living adjustments.

Second, the economy is growing at the same time that our population is shrinking – it has decreased from 148 million people in 1991 to about 142 million today. This means that employers are facing an employee-driven labor market and high employee turnover. A few years ago, for example, the average turnover for companies in Russia was 10 to 15 percent annually. Now it’s common to see 20 to 25 percent turnover. And considering that the economy is growing and many companies are expanding their operations and increasing their head counts, you can imagine how challenging it is to recruit enough people each year, particularly highly skilled, well-educated employees.

These labor market realities are driving large salary increases. Each year, average salaries are increasing by 10 to 15 percent. For established economies, this rate of increase is unheard of. Moreover, many employees are taking advantage of the tight labor market by changing jobs frequently in order to negotiate higher salaries. For highly skilled employees, these increases can be 50 percent to 300 percent. Top executives can sometimes double or even add another zero to their salaries.

Trade unions are also playing a role in driving salaries up. They have become stronger and more active as a result of changes to the economic system beginning in the 1990s, particularly in the St. Petersburg area, and are pushing for salaries to reflect the high inflation.

Finally, distortions within the Russian educational system are causing human capital challenges. While the educational system of the Soviet Union was quite strong in preparing people for the technical fields and fundamental sciences, changes in the Russian economy now require a different focus in education. But the educational system has not changed enough with the economy and isn’t yet preparing the required number of people with the management and innovation skills demanded by industry. As a result, many companies can’t find proper specialists for their positions.

Larisa Muravska: I would add that with the changing economy, vocational education has deteriorated in Russia. We have an abundance of institutions training people at very high technical levels, but not many people receiving the type of vocational training often needed by industry. That’s why engineering and manufacturing companies are seeing a shortage of highly skilled blue-collar workers and technicians.

Q: Are the challenges different for companies that are based in Russia compared to companies that are expanding into Russia?

SG: The challenges we listed earlier are common to all companies. But there are additional challenges facing multinationals that are expanding into Russia. First, these companies have difficulty finding employees with the language skills they need. Because multinational companies are already quite active in the market, most of the employees who speak English, for example, are already employed by multinationals.

Second, Russian companies find it much easier than newcomers to deal with the huge geographical span of the country, as well as differences across the country. It is a major challenge for international companies to establish a network in such a big territory.

Third, it is very difficult to attract people, particularly in such a tight market, if you are not known. Russian companies enjoy a stronger employer brand than many multinationals. When a new company comes to this market, it needs to establish a brand name to attract the best talent.

Fourth, it can be a challenge for multinationals to understand Russian culture and Russian realities. For example, if a company that is accustomed to annual salary increases of 3 to 4 percent comes to this market, it may have difficulty understanding and managing expected merit increases of up to 15 to 20 percent in Russia.

Finally, multinational companies often come to this market anticipating that they will find high-caliber local management talent. Given that the Russian economic transformation started 20 years ago, these companies expect to find a new generation of local Russian top executives. But it is much more difficult than they expect. The distortions in the educational system and some cultural aspects have resulted in a situation where expatriates still fill most top management positions at multinationals and also at some local companies.

Q: What are companies doing to address these challenges?

SG: The most simple and straightforward way that companies are addressing these challenges is simply to raise salaries to retain employees. When companies want to recruit high-caliber, talented people, it is not unheard of for them to offer employees up to 10 times their current salaries. Companies recruiting top management are also paying signing bonuses and are offering some quite good allowances, including housing, a car with driver, and club memberships.

Another retention strategy used mainly by Russian companies is to elevate the employee’s title. Because Russian culture puts such emphasis on titles, this can be effective even in the absence of salary increases.

Some companies are also addressing these challenges by working to strengthen their employer brand, providing employees with career development opportunities and challenging assignments. However, this is a longer-term strategy, since changing the brand cannot be done overnight.

Q: How long can the market sustain raising salaries? Does anyone see the situation changing soon?

LM: As long as inflation and the cost of living remain high in Russia, we expect that salaries will continue to increase at a faster rate than is usual in the more mature economies. At some point, salary increases will become overwhelming and companies will stop paying them, but that hasn’t happened yet. This kind of salary growth is typical for fastgrowth markets, such as China and Romania, where you have supply and demand issues for labor.

But you have to consider the starting point. Russian salaries are low, especially for lower-level jobs. Even with annual increases of 10 to 15 percent, labor costs in Russia will still not reach the level of labor costs in the Western economies for another decade. The exception to this is top executive jobs, for which salaries are already at the level of Western European countries. 

Q: Are HR departments equipped to deal with these challenges?

SG: Some HR departments are better prepared than others. I would say that HR people in multinational companies, with systems and methodologies cascaded from headquarters, are better equipped than the local companies to deal with these challenges.

Some Russian companies are trying to catch up, but their interest is driven less by an understanding of the benefits and value of proper HR management and more by the belief that, in establishing HR systems, the companies will be more highly valued as they prepare for an IPO.

Q: What do companies need to do differently if they want to be successful in managing human capital?

SG: Our first recommendation to most companies is to establish basic HR systems and management. In many companies, management of HR processes is still chaotic and ad hoc, which makes it difficult for these companies to deal successfully with all of the human capital challenges they face.

Second, companies need to establish meaningful salary bands. In Russian companies especially, we find that top management is overpaid, while lower-level employees are underpaid with respect to the market. If companies were to establish salary bands and make HR systems much more transparent to employees, they could reduce turnover substantially.

Third, companies that want to succeed in attracting and retaining people should put more emphasis on developing an organizational culture and management style that is caring of employees.

Fourth, given the turbulence of the labor market, companies should be prepared to deal with high turnover. They need well-designed recruitment plans and succession plans, for example.

Finally, organizations need to establish cultures in which people focus on the long term. Today, most Russian companies do not offer long-term incentive plans, for example. With the establishment of these plans, they could induce a longer-term mentality and do a better job of retaining top executives.