Alex Brownsell, Leo King
IT Europa, November, 16, 2006 The Russian IT market has seemed on the cusp of explosive expansion for many years. Annual growth of 25pc must be put into context - Russian IT is valued at less than EUR 10bn. It is smaller than markets such as Spain, Sweden and Switzerland, and a sixth the size of a mature market like the UK. But with IPOs the must-have accessory for any forward-thinking Russian company at the moment, greater adherence to international business regulation is helping to drive the industry forward. And it was only a matter of time before the Kremlin got involved - for better or worse... Much like hearing the parable of the hare and the tortoise for the umpteenth time, the Russian IT market is a tale of the inevitable. Everyone knows the end already: Russia will expand beyond all of its CEE neighbours, then western Europe, and eventually the majority of global players. But it is a painstakingly slow process, as Europe's old juggernaut gradually gathers momentum. The IT market in Russia has been enjoying annual growth of around 25pc (depending on who you listen to), with the latest research in June by analyst IDC valuing the industry at EUR 9.4bn. The majority share of the market still belongs to hardware sales, but IT services and software developers are slowly but surely catching up. In the meantime the Russian government is doing its bit to rebalance the deficit. From January 2006, all IT services companies operating in Russia secured exemption from industrial VAT payments. Furthermore, software developers for whom 70pc of sales comes from foreign clients - in other words, those involved with offshore software outsourcing - have been allocated a reduction in social tax payments. Svetlana Vronskaya, director of corporate communications at offshore software developer Reksoft, is confident this will be the first of many tax breaks for IT companies. 'There has been much discussion in the industry as to why only outsourcing companies are getting the benefits, but I think this will be the first step of many,' she says. The government had to pass the first bill, and I believe there will be more.' Yet they may not be of use to everyone in the market, claims Arkadiy Dobkin - CEO of software giant EPAM. 'I do not think that these incentives will make much impact on the local market,' says Dobkin. He continues: 'It is mostly for making the local IT companies more competitive on the global market. It follows what has happened in other countries, like Ireland and India.' The past year has seen many attempts by the Russian authorities to stimulate growth in the IT market. The Ministry for Economic Development and Trade has launched Special Economic Zones (SEZs), locations build by the government for IT firms. The ministry also threw in the sweetener of reduced profit and transport taxes, should you agree to move out to the SEZs. Confusingly, a rival ministry (for Information Technologies and Communications) has established a handful of Technoparks. Similarly they are built by the authorities and offer low rent, although they are being set up away from the economic hubs of Moscow and St Petersburg. 'Both initiatives are generally positive,' says Vronskaya. They reflect the small portion of attention that the government has paid to Russian IT industries, since January 2005 when President Putin visited Bangalore in India. The problem is that neither is really applicable for IT software companies, more for hardware companies. No software developer will want to set up 50-60km outside of St Petersburg, it is much easier to stay in the city.' Russian giant IBS Group has located its offshore software development wing, Luxsoft, at the SEZ in Dubna. Eugene Peskin, executive VP at IBS, tells IT Europa: "We will gladly be the anchor for the SEZ. Having reductions in social tax certainly does help us to compete with the Indians and the Chinese in the Outsourcing." Alexandre Gorine, managing director at 320-strong Accenture Russia, believes the IT parks will cause talent wars among competitors. The problem with Technoparks is that they will cause a huge battle for the best people, which will drive up costs,' he says. 'We prefer to go to other towns where there are fewer competitors.' Many in the IT industry remain dissatisfied with the government. Boris Volpe, marketing director at SAP's 400-strong Russian operation, says ministers should turn their attention to driving up demand for advanced software solutions. 'I think the government needs to alter its position in several ways. First of all it needs to become the number one customer for companies like us. The investment so far has been very mild, to put it lightly,' he says. 'It should concentrate its efforts on the demand side, not the supply end. In Russia corporate corruption is rampant and current transparency measures are just not adequate. Russian business practices need to improve, there must be a level of corporate governance.' Ah, corruption. You never get far in Russia before you encounter the C-word. As ever with Russia and the CIS countries, there is no real consensus as to the level of corporate corruption still in existence. Eugene Peskin puts simply: 'Corruption is still here, and it is going to be much longer before it goes away.' But Sergey Komyagin, general director at 100-strong S&T Russia, disagrees. The problem seems to be overestimated,' he says. 'All good local commercial customers like banks and retailers pay serious attention to this issue. IT people in these companies prefer to involve the reliable and experienced IT providers. This is another reason why international IT companies working by international rules are an attractive prospect.' This time last year, Russian companies were announcing IPOs in droves and it was the single biggest issue influencing the market. Fears that the government would intervene and prevent companies listing abroad have thus-far proved unfounded, and the increasing globalisation of Russian business has been good news for the IT channel. Eugene Peskin says that the attraction of IPOs is helping improve the level of data management in Russian businesses: 'Lots of companies are interested in IPOs, but with international business regulations you must publish results. There is no way you can do this using Russian software or home-made systems, so you must buy state-of-the-art software products. This is partly why there is still lots of activity with ERP, and lots of attention to planning and keeping records.' Software vendors have also noticed a gradual change in client habits. Boris Volpe says that SAP, which registered revenues of 127m in Russia in 2005, is supplying more data management products than previously. 'Most big guys and even mid-market guys are looking at IPOs, so they must comply with international corporate requirements. Master data management (MDM) has been popular, with companies making the transition to centralised data management. There has also been CRM demand, as businesses - especially retail banks - are in a fight for customers,' he says. Meanwhile, EPAM's Arkadiy Dobkin claims that the IPOs are a sign of a more progressive Russian economy, last year lots of retailers were looking at IPOs, so they needed better IT services. But it is not just IPOs that are causing the changes, it is a sign that companies in Russia have become more mature and that the leadership has become better,' he says. A newly internationally-focused Russian business environment has opened up new verticals to software developers and IT services groups. The traditional big customers - oil and gas, telecom, financial services and the public sector - are still around, says HP Service Russia's general manager Sergey Rasskazov. 'Older verticals, such as financial services, have stabilised. There are no new banks, but there are still consolidation and improvement projects. And we're seeing growing activity in the public sector,' he says. But it is new opportunities that are exciting IT companies. 'Retail is a booming sector right now, especially for ERP systems,' reveals Reksoft's Svetlana Vronskaya. Eugene Peskin agrees: 'We do see a rising demand from retail, and we are working with a number of major retailers. This would have been impossible a year ago.' A lucrative vertical yet to emerge, according to Alexandre Gorine, is the insurance industry: 'There are areas where there has been very little development, such as insurance, and I fully expect those to grow. Insurance companies use cheap, basic software and I think there is huge potential.' Meanwhile, Boris Volpe says that smaller Russian companies are also seeking advanced software solutions. 'I think that new industries are showing up. The construction industry is enjoying a housing boom in Russia, so anything to do with construction development and the production of construction materials is big. They have started to think about customer management. Earlier SMEs have used basic software, but there is now considerable demand from these guys as they want to improve their position,' says Volpe. But despite the hype, Russian IT companies have not yet jumped en masse upon the IPO bandwagon. 'IPOs have not made a big difference yet,' says Vronskaya. 'Two IT companies - Compulink and IBS - have made announcements to list in 2007. But I don't think many will follow in the next couple of years. Especially with the Government initiatives, many companies have enough money to do what they need to do.' Andrey Konyaev, head of PR at 1,000-strong IT services giant TechnoServ, is equally dismissive of IPOs. 'We do not intend to list on foreign stock exchanges in the near future. TechnoServ enjoys confident development, so we do not see the need for abrupt listings. The main goal is to make the company more effective,' he says. So if Russian IT companies are not desperate to look abroad to boost business, what of the international IT service groups operating in the Russian market? Russia is notoriously supportive of domestic companies and less accepting of their overseas counterparts. However, S&T's Sergey Komyagin says international companies have found a way to improve their standing: 'International companies, those operating in western Europe and Russia, prefer to deal with international players to cover different countries from the single point of contact. The level of this business becomes significant,' he says. This is particularly true when it comes to outsourcing market Russian companies have been reluctant in the past to outsource their IT maintenance. Only last year, Accenture Russia's managing director Alexandre Gorine told IT Europa: 'Outsourcing is still not on the agenda for the majority of Russian companies.' Reminded of this comment, he laughs, 'Here in Russia everything happens so fast, one year here is like ten years in western Europe!' According to Goring, a year later outsourcing is on the brink of a boom. 1 think the situation is changing rapidly. We have our first contracts. These contracts are small, but we want to build up our facilities. There is huge potential in this market and we want to become the market leaders,' he says. 'Being an international company gives us a huge advantage,' reveals Gorine. 'Companies know about our outsourcing centres in Bratislava, Lodz, Riga and Prague, and work with Accenture there. This helped get a contract with a big international airline company. By February next year we want the centre operating, but we are going to build it up step by step.' A burning question, however, still remains unanswered: is the Russian IT market finally approaching maturity? Perhaps, if one takes into account the top 100 Russian IT companies chart, as compiled by local analyst house CNews. It calculates that in 2005, the top 20 Russian IT companies enjoyed some 73pc of all business done by the top 100. As the biggest companies get bigger, it can only be a matter of time before they start to look greedily at smaller competitors. 'We believe that the market will soon begin to mature,' says Eugene Peskin, confirming that IBS is approaching the point of consolidation. 'We are beginning to see mergers and acquisitions happening, and we are looking at possible acquisitions ourselves.' Indeed, IBS subsidiary Luxsoft was involved in a merger with US-based IT consultancy ITCI in May this year. Furthermore, in April Swedish consultancy Teleca acquired top Russian software vendor Telma. But TechnoServ's Andrey Konyaev is less convinced that this amounts to a trend: 'We do not yet see any serious reason for an increase in the number of M&A deals. The market is still growing by up to 30pc each year, so it should still be regarded as a developing one,' he says. General consensus amongst analysts states that growth in the Russian IT market should continue at the current 25pc mark for at least the next few years. Vronskaya at 350-strong Reksoft is confident that 2007 will be another good year for the IT services companies. 'I think in 2007 there will be a trend for IT services and system integration companies getting more and more of the market pie. But it will take years to catch up hardware,' she says. SAP's Boris Volpe claims that, for the market to really push forward, more must be done to appeal to SMEs: 'For the next three-to-five years I think the growth will continue. But significant work has to be done, especially with SMEs, to convince them that they need more hi-tech products, not some locally produced software.' And Vronskaya has a final warning for the industry, lest anyone think that the next 12 months should be plain sailing for Russian IT companies: The most critical issue for the next year is the government and its initiatives. It will be good if they keep doing things with tax, but there is a danger if they do things at a political level. The IT industry is trying to fight for a better image for Russia and there is a danger that the government could damage that.' OUR ANALYSIS The best news to come out of Russia this year is that of new emerging verticals, such as large-scale retailers. Without fresh customers the IT market is in danger of stagnating, so it's vital that the industry moves beyond traditional verticals like financial services. The other big news, of course, is the increasing activity from the Kremlin. Tax breaks are very welcome for an industry still working to overcome market scepticism, and it is important that the government continues to act if Russia wants to keep up with the other big developing economies, China and India. A general election is scheduled for 2008, and there is a real danger that public sector investment will dry up to fuel election campaigns. At this stage in the development in the IT services market, losing an investor like the government would be a terrible blow. |
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