Large Companies Amount to 55% of Russian IT-Export

According to Russoft research presented at the Russoft Forum being held in St. Petersburg the software export capacity and software development services amounted to $ 1,495 in 2006.
Source: CNews Jun 22, 2007
55% of the export was carried out by large companies (more than 120 people), 10% - by middle-size companies (from 35 to 120), 8% - by the small ones (less than 35), 5% - universities, 3% -informal developers units and 19% - foreign companies software development centers. Russoft mentioned the significant increase of the ready-made software stake in the overall export bulk as one of the main 2006 trends.

Source: http://www.russoft.org/

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Add Russia to ITO “Favorites”

To outsource or not to outsource is not a question any more. The tricky point is where to outsource.

At the Gartner Outsourcing Summit in Dallas in mid March 2007 it was reconfirmed that offshoring is no longer that India-centric as before, and is going more and more global with emerging destinations trying to adopt India’s success model. By 2012, India's dominant position will be significantly diluted by effective alternative destinations, the so-called challengers. At present smaller market players with relatively limited resources try to gain competitive advantage by narrowing their services specialization. Given that cost reduction is no longer the most powerful incentive to go offshore, the market repartition may be explained primarily by the need of the client companies for certain business drivers, specific expertise and niche skills, as well as “follow-the-sun” delivery.

To be more precise, the challengers’ group currently includes the Philippines (9%), Canada (8%), Brazil (8%), Mexico (4%), whereas India, China, Russia make the leading trinity. Interesting are the changing preferences of the clients regarding ITO destinations. As the outsourcing needs are permanently upsurging among US and Western Europe’s companies, offshoring activity in Eastern Europe could triple from 2005 to the end of 2008, McKinsey predicts, and Russia has already become the industry engine.

Niche skills in demand
Taking into account the narrowing specialization of ITO destinations, it’s getting evident that there are no universal vendors: IT is the industry where Jack-of-all-trades can by no means be good at everything. This underlies multi-sourcing and multi-vendor trends, which mean transformation of sourcing strategies making them better thought-out, better corresponding to business goals, and thus more effective.

A recent research titled “Adopt Disciplined Multisourcing in Your Organization” by Gartner shed light upon this trend: according to the analysts by 2010, organizations that continue to apply outsourcing as an ad hoc solution to tactical business problems will be dissatisfied with the performance of their contracts more than 70% of the time. Market leaders will instill disciplined multisourcing as a core competency for successful business operations.

Lack of multisourcing management discipline will result in large-scale business disruption among buyers, suppliers and their value chains. In other words, CIOs can no longer use outsourcing in an ad hoc way and enjoy success. What they need to do is to think twice on how to best tie outsourcing strategy with their business one, to shape their needs clearly, and find the best skilled labor for each particular task choosing from a number of destinations.

Growth catalysts.RU
Named one of the 3 IT outsourcing global leaders by Gartner, Russia gets into gear making over 40% leaps forward annually. Below is a chart from the Third Annual Survey on Russian Exports of Software by the Russian Software Developers Association (RUSSOFT):



The fact that the total value of its IT market grew 25 times (from 550 mln to 13.6 billion) over the last 7 years speaks for itself. The IT export-oriented outsourcing industry grew nearly same fold up to 1.5 bln at present, with 5.8 bln by 2009 billion forecast by IDC Group and 10 bln by 2010. And it’s only for a start!

Russian ITO market is growing rapidly and is expected to keep pace adding 40-45 percent in 2007, according to neoIT. It’s quite likely that it will even accelerate and exceed the forecast rate as Russia is project by project proving its first-class services thus attracting more and more customers. Important to note is that what Russia is respected for is complex software engineering capabilities, which require special skills, agile mind, and talent. A 2006 study by the FCREUE, the Haas School of Business, and the University of California at Berkeley showed: "In terms of education and experience with complex software development tasks, Russian programmers likely outrank all others."

The study mouths the unanimous opinion of analysts. Another one by Ernst&Young focused on skills and training of Russian IT workforce and here is the summary table:

	Russia	India	Israel	China	Ireland	Singapore	Malaysia	Mexico	Philippines
Skills & Training	A+	A	A	B	B	B	C	C	C
Source: PRTM (Pittiglio Rabin Todd McGrath), Ernst & Young

Selecting a Local Provider

Though the Russian IT industry has been growing fast, it is still pretty young, and many emerging providers are inexperienced and not known abroad. So, it is critical that customers visit a provider's office or delivery center. This allows establishing personal contact with the possible provider, get acquainted with its workflow, facilities, etc. They must also ask for client references. Moreover, with dozens of newborn providers emerging each year in Russia, mid-size and large market players seek merger opportunities to gain more weight. 2006 and 2007 have seen several deals, in particular Exigen Services merger with StarSoft Development Labs; Bulgaria-based Stone Computers joining IBA Group; and EPAM Systems acquisition of VDI.

The education in Russia, and former USSR region as a whole, is one of the strongest growth supporting elements. The Soviet Union bequeathed to Russia a world-class education system with a strong emphasis on science and mathematics. Forrester characterizes Russian engineers as “exceptionally well educated developers who can perform extremely complex jobs, and a great understanding of engineering and financial services domains are core strengths of Russia’s outsourcing industry”.

Despite being almost 80 percent smaller by population, Russia produces the same 200,000 of graduates capable of entering the IT sector as India does, according to Microsoft Research, and 20 times more scientists per capita, according to Forrester. Whereas India as well as China often tries to achieve higher quality of work increasing the number of the employees involved, Russia has a different quality-quantity ratio. So there is nothing surprising that namely Russians win various professional programming competitions, whereas Indians often have to cherish hopes for the podium.

Significant for outsourcing engagements are also foreign language skills, which are still to be improved in Russia. India is a bit ahead in this issue, but these calculations must be taken with a pinch of salt. English fluency is among the top priorities in the current school and college+ education, and the picture looks much more optimistic now than 5 years ago. It’s also necessary to note that it’s not only English that Russian IT specialists know. Growing is the number of German-speaking people which is good news for Western Europe and additional market opportunities for Russian vendors.

Another key consideration for companies seeking offshore partners is employee attrition rate. Vendor’s labor force stability crosses out one bullet on the client’s risk list, that is, the quality is unlikely to fall off and there’s no need to overstaff the project which does reduce costs. Not only skilled programmers does India lack, but also experienced middle managers, said recently Gartner analyst Frances Karamouzis. Currently Russian ITO providers can boast 3-4 percent attrition rate versus India’s 30+. Does this make sense? You bet!

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Far-reaching designs with rapid returns

Much time has been lost and Russia has to play catch-up with India. True. And the more is done to acсelerate this process, the better. You may ask what effort is made now in high-tech industry. They say government support is small compared to that in India. However the lack of it can be already removed off the hurdle top-list for Russian IT sector development.

Russia's over-dependence on the raw materials has much been criticized both in the West and locally. After his visit to Bangalore in 2004 inspired by the impressive results of the transformed Indian economy, Vladimir Putin instructed the government to elaborate and enact the measures that would help create favorable conditions for exporting IT services in order to diversify the economy by unlocking the country's significant intellectual potential through entrepreneurship and investment in non-energy-related research and development.

As a result a number of government initiatives and projects have been proposed and planned for implementation in the very near future. For instance, the Ministry of Information Technologies and Communications (ITC) has already started the work to create a dedicated authority - Federal Agency for IT Exports Development. The agency will analyze the exporting potentials, provide marketing support and conduct PR activities.

A dedicated Russian Investment Fund for Technologies and Innovations is being created by the ITC Ministry in compliance with the instruction of President Putin and is expected to become completely private by 2010 with the state's share in the fund making up around 25 percent by the end of 2007. International IT corporations participate as co-investors, and some of the British and American financial institutions representatives who invest in IT and know the Russian market perfectly well are ready to make financial contributions.

Importantly, Russian software exports are exempt from VAT payments, whereas Forrester predicts some problems for Indian companies in the near future: the tax-free status of software firms in India comes to an end in 2009, and there is a powerful political coalition which plans to oppose to the renewal of such regime. It took pretty a while for the Kremlin to grasp the necessity of suchlike amendments, but since January 1, 2007 IT companies enjoy these remission which enabled them to increase investments into business development and push up their production volumes.

Another frequently mentioned trouble of Russian high-tech industry is infrastructure underdevelopment. In absolute figures it looks pessimistic for the post-industrial US and Western Europe. Experts say Russia lacks PCs per capita, roads, broadband is still costly, and so forth. In a recent Gartner’s study entitled “Best Practices in Offshore Outsourcing” they figured out what level of risks several popular ITO destinations have. Russia’s overall climate was rated “good” with “poor” infrastructure spoiling the bright picture. However it must be noted that telecom is developing rapidly and already now Russia possesses a good quality and reliable telecommunications infrastructure, including physical and power infrastructure. Interestingly, that of India also leaves much to be desired and was rated “fair”.

Are there any measures taken to improve the situation? Sure. Over a dozen of industrial technoparks in the areas of the cities with largely unused human resources and scientific potential are being developed. As a result, 19,000 jobs are to be created by 2008, and 75,000 by 2011. As stated in the program adopted by the government in March 2006, such parks shall be set up in all over Russia – in Moscow, St. Petersburg, Tyumen, Nizhniy Novgorod, Kaluga and Novosibirsk regions, and in Tatarstan. Intensive construction operations are to be launched within the next year, and in two more years time the parks will start to look for investors. At present several technoparks are already being engineered and constructed in St. Petersburg which is set to be one of the most technologically packed zones in Russian IT. In addition, the Novosibirsk region authorities have passed the decision to initiate a large-scale construction of a technopark located in the vicinity of Academgorodok (Academic Town).

Project of the technopark in St.Petersburg (source: CNews)

Russian ITC Minister Reiman said at CeBIT 2007 in Hannover, Germany – the world’s largest IT and Telecom tradeshow – that the annual production output of these techparks may exceed 4 billion dollars. He also pointed out that as far as the Russian industry develops, it may raise 40 billion dollars in revenue by 2010.

Legislation is viewed as another Achilles’ heel of Russia. Intellectual property protection is what Russia is criticized for, but here 2 points should be kept in mind.

First, in terms of legislation much is done to improve intellectual property protection. Russia’s IT Minister Reiman said Russia will step up its fight against IP violations as part of effort to gain admittance to the WTO. Second and most important, leading Russian vendors seek stable relationships with customers and therefore do put special attention to security. The primary areas they try to cover in their IP protection policies are NDAs, additional employee confidentiality contracts, project related IP protection and document control.

Credibility witnessed
What do you know about doing business in Russia?

The media sometimes speculate on this topic and continue to insinuate some distrust flair about the business climate and dealing with the Russians. Recently an analyst from Gartner commenting on Russian ITO trends said that it could take years for Russia to overcome the common perception of being a difficult place to conduct business. However a closer look at the situation makes it clear that experiences and impressions differ and it’s not that risky and insecure to partner with ex-Soviets.

The American Chamber of Commerce in Russia (http://www.amcham.ru/) recently released their special report prepared in cooperation with Ernst & Young and the RUIE Expert Institute for AmCham‘s 8th Annual Investment Conference. It states that “2006 proved one of the most successful for Russia over the last 16 years. The country is steadily developing and exceeds many transition economies in growth rate.” The Russian government demonstrates understanding of still existing economic problems and heads at solving them within a short-term period. In general, the situation in the Russian financial system may be described as stable. It demonstrates growth in aggregate assets and intensification of market trade, says the report. World business leaders like General Motors, Toyota and Ikea understand this very well, and Russia is now enjoying a foreign direct investment upsurge, with $17 billion entering the country in 2006.

These rapid changes in Russian economy, in general, and IT industry, in particular, are witnessed by American companies conducting business there. Russia is a reliable trading and business partner, and a vast market with broad opportunities. According to a recent American Business in Russia Survey by AmCham “92% of U.S. companies in Russia believe that continued commercial engagement with Russia is positive for American business”, and 86% believe that Russia’s upcoming membership in the WTO will bring new opportunities for them. President of the AmCham in Russia Andrew Somers calls Russia ”an engine of growth for American companies”. For instance, Kirill Korniliev, Country General Manager, IBM East Europe/Asia (IBM in Russia & CIS), says: “In 2006 IBM's business in Russia grew by over 20%, and in the most recent quarter (Q4 2006), IBM's growth in Russia exceeded 38% – faster than in China, India or Brazil.”

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Next move to Russia

A whitepaper titled “Russia as offshore software development location: should you consider this your next move?” by IDC provides a deep insight into Russian IT industry basing the research on in-depth, executive-level interviews with 20 Western European and US companies that have used Russian software and services companies for delivering on offshore development projects.

The thorough analysis proved that crucial for customers is the ability of Russian vendors to deliver on high-end, technically complex projects, strong technical skills, understanding the business needs of the customer and translating these into the final product. American organizations often perceive Russia as being a closer cultural fit than e.g. India, China, and the Philippines, states the study. This together with time zone fit and acceptable cost makes up the group of softer factors, less important but still influential.

The study also found that for custom application development engagements, customers value the ability of Russian companies to tackle non-standard tasks, which are essential for trouble shooting and product development. These findings are also in line with neoIT’s estimations that Russian vendors create a differentiator from lower-priced offerings from Indian companies by focusing on top-notch software and embedded software product development.

Selecting a local vendor
However there are a number of issues one needs to keep in mind when engaging with a Russian vendor. Russian IT industry has been growing fast but from a nascent stage. It’s still pretty young and many of the emerging vendors are unknown abroad and yet inexperienced. It doesn’t mean you should shun them: just weigh the pros and cons.

Here some recommendation may be useful. First of all, customers are advised to visit a vendor’s office or delivery center. This step allows establishing personal contact with the possible provider, get acquainted with its workflow, facilities, etc. Second, it’s always good and convenient to learn by others’ experience, so asking for references of the vendor’s clients does sound sensible.

Still Russia lacks promotion on the world market and this used to impede its stepping out from the shadow of India. Nonetheless the situation is changing. RUSSOFT joining the majority of domestic vendors holds annual Forums (this year held in St. Petersburg on June 20-23) which have become the mouthpiece for the whole industry, including many local vendors, not only market leaders (see the chart) but also smaller companies each having something unique to offer.

Company Staff Revenue, $ mln
EPAM Systems 2,700 80
Luxoft 2,220 68
IBA Group 2,000 61
Exigen Services 1,800 55
Reksoft 350 11.4
Top Russian ITO companies, 2006 (Source: “Russia as offshore software development location: should you consider this your next move?”, IDC)

Not only locally is more and more consideration given to Russian high-tech players, but also globally. It’s no wonder that there was so much hype around Russia at this year’s CeBIT which welcomed 77 nations and Russia as “guest star”. With top state authorities opening the event, Russia nearly doubled the number of its representatives vs. last year and made the top 5 list of largest exhibitors.

Consolidating to boost scalability
Together with the whole IT industry growing are local vendors, too. The majority of serious market players report 40-60% annual growth in 2006. This stands for organic growth, however non-organic one derived from acquisitions and mergers is also a factor.

Recently analysts noticed definite consolidation trends within global IT outsourcing industry. With constantly intensifying competition between the vendors it’s getting more and more evident that the bigger the company, the easier it is to win contracts and gain credibility.

On the wave of hot discussions on outsourcing contracts failures clients have become more careful in vendor selection. Although the major reason for unlucky outsourcing engagements is considered to be lack of communication between the parties, certain dependence between the size of the vendor company and the success of the deal exists. Larger vendor aim at expanding their presence as many countries within their target markets as practical in order to make communication with the clients easier. This increases the client’s chances to find a vendor’s office onshore or nearshorе, and gives additional time and cost advantages. Understanding the necessity to increase communication and having better opportunities to do it, clients are likely to choose a 2,500 – 3,000-strong vendor with offices in at least 5-8 global locations vs. a smaller and geographically more limited ones (other things being equal).

Global market trends have reached Russia as well. With dozens of new-born vendors emerging each year, mid-size and large market players seek merger opportunities to gain more weight. 2006 and already 2007 have seen several deals, in particular 1,800-strong Exigen Services merged with StarSoft Development Labs, Bulgaria-based Stone Computers joined IBA Group, EPAM Systems acquired VDI. Particularly the latter merger was a milestone for the industry as it solidified EPAM’s leadership in the vast CEE region, making the combined company the largest in headcount (2800+ at the moment), the most regionally diversified (20+ offices in 7 countries), and broadest service line.

These and most of other smaller deals have similar root causes. Vendors seek rolling out operations in new markets, expanding onsite, onshore, and nearshore presence, access to richer talent pool with unique expertise and specific skills. Interestingly, new target market spot include Russia itself, too.


On the right way
Russia’s domestic demand for IT services is going up fast. In their BRIC’s analysis Goldman and Sachs forecast that by 2050 the Russian economy overtakes that of Germany, France, Italy and the UK, automatically becoming a huge target market for IT services. While the majority of projects today are coming from the US or EU, in the future more and more IT services will be requested by Russian local clients.

Though some analysts predict a downturn in the amount of outsourcing deals and offshoring activities, others stay optimistic. Eastern European countries are poised to take more offshoring business, however, due to their attractive regulatory environments as well as close proximity and cultural ties to Europe, according to a study by the Economist Intelligence Unit (EIU). As far as Russian vendors are concerned, they feel pretty secure against possible business activity slump thanks to their target markets’ stability and, most importantly, to their focus on complex projects which can be developed best of all by the Russians.

Given all these factors, it’s evident that Russia is unlikely to fall out of favor as an ITO destination. The country has already entered the market in a big way and is unlikely to leave the road!

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