By Alexander Egorov, CEO, Reksoft
Outsourcing Strategist, May 17, 2007 The ICT industry is the fastest growing industry in Russia and one of the most buoyant, dynamic and diverse in the world. Russia is currently in its fourth consecutive year of high double digit growth and is poised for a period of boom from 2007-2010. The country is well in the process of upgrading requisite infrastructure, and making legal and policy provisions for its ICT industry.
"Russian ICT Industry - On a Stable High Growth Trajectory", December 13th, 2006
Frost and Sullivan As a recent study by Duke University and Booz Allen Hamilton concludes, offshoring "is now a strategic imperative of competing for talent globally". With this shift in the perception of offshore outsourcing away from a mere costs-saving initiative to a means of raising competitiveness through secured access to the necessary qualified resources, and ultimately - faster time-to-market, we have seen more European and North American enterprises looking for alternative destinations for sending work offshore. With the rising general concern over India's high attrition rates and the clearly swelling costs of engagement, India sets new challenges for companies involved in IT operations in the country. From Buenos Aires to Manila there has been a thorough search of better prices, resources, location and culture proximity, and knowledge. Many such pilgrims ended up in Eastern Europe, having found the region to offer a skilled labour pool, plus a pronounced cost savings advantage. Still only a 1 % share of the global offshoring market, Eastern and Central European countries present an attractive option, especially to Western European enterprises, due to geographic proximity, reduced communication and travel overhead, and the ability to support European languages. Although Eastern Europe traditionally markets itself as an integrated region, each single outsourcing destination within it differs: from Hungary to Romania, from Czech Republic to Poland, from Lithuania to Slovakia. Besides some of the ex-Soviet republics (Byelorussia, Ukraine) position themselves as parts of the Eastern European region (although they lack both the large pool of IT professionals and the political stability). Each of these locations puts forth an offer, but altogether, they should be viewed as separate destinations with their own pluses (e.g. good BPO options) and minuses (limited workforce and rising prices). I, however, have a strong feeling that even with all the visible benefits that the CEE region can offer, only Russia has the sufficient potential for becoming a 'leading' destination in the future. Already, Russia is ranked 7th in the volume of outsourcing contracts globally. There are a few theses to support the unique positioning of Russia as a major outsourcing location in Eastern Europe. - The IT Labor force in Russia is larger than in all other EE countries combined, with 'guaranteed' long-term cost advantage.
Although McKinsey in its "Time to Go East" white paper reports that the offshoring activity in Eastern Europe is expected to reach over 100 thousand FTEs in 2008, it is by far less than what Russia can boast already (see table 1). The quality of technical skill and education of the Russian IT workforce is certainly the country's advantage. According to the World Bank statistics, Russia has more personnel working in R&D than any country in Europe, and ranks third in the world for per capita number of scientists and engineers. Needless to say that such a solid base explains the permanent victories of Russian students in the annual ACM programming contests. The number of graduates ready to enter the IT industry is estimated as 246'000 per annum which is more than twice as much as in the Eastern European countries and the Baltics together. Meanwhile, the industry utilizes just about 10% of this output, which secures the growth potential. No clear plans for EU accession guarantee that the Russian cost advantage will stay relevant in the long term. And joining the WTO will not affect this sector of the economy much. The year gone has left a strong sense of the fact that Russian vendors are leading in Eastern Europe, both in terms of size and capabilities. The top Russian players (10-12 companies) are getting to be more mature, thus widening the gap between themselves and the rest of domestic competitors. There is a clear sense of differentiation in the leaders' strategic positioning. Staying competitive in the long run calls for above-average growth rates, which organic growth can not secure. With this in mind, the M&A mood is now in the air with more Ms than As expected. With the outsourcing market of one billion USD in volume for 2005, Russia is expected to grow at the rate of 30% in the next three years and thus surpass the whole of Eastern European outsourcing produce. As Pascal Matzke of Forrester Research pointed out, Central Eastern Europe is getting stronger, but advantages will be short-lived due to a number of risk factors such as the lack of national champions, absorption of the local talent by global providers and wage inflation which has already hit the large metropolitan areas. This gives the Russian players a chance to take over Eastern Europe in the global outsourcing marketplace. - Whereas prices are lower than with Eastern European providers, the total cost of engagement (TCE) is lower than with most Asian suppliers.
Hosting a development center in St. Petersburg or Moscow means easy communication and commuting. At the same time, the cost of developing software in Russia incurs fewer costs than software development in Eastern Europe (see table 1). Both of these factors make for a lower total cost of outsourcing engagements for customers. Table 1 | | Baltics | Eastern Europe | Russia | | Labour pool (FTEs) | 40'000 | 45'000 | 246'000 | | Average salary in IT (EUR) | 2000 | 2500 | 800 | | Hourly rates (EUR) | 40-60 | 40-60 | 18-30 | | Volume of ITO market (EUR) | 800 mln | 800 mln |
- Russia's improved economic landscape makes the country attractive for investment and a huge market with vast potential.
In 2005 the Russian Federation was acknowledged by the Economist Intelligence Unit as the most promising market in Eastern Europe. The reality of Russia's steady economic growth is also recognized by such credible sources as the World Bank and UNESCO, indicating that the country's macroeconomic climate has surely reached the threshold of fertility. The economical performance of the Russian Federation over the last five years is more than impressive. According to the estimates of the World Bank Economic Unit, in the time span between 1998 and 2005, Russian GDP grew by an estimated 48 percent, while the real income of population went up by 46 percent. The country achieved an unprecedented macroeconomic stability along with strong budgetary and current account surpluses. This fact was also confirmed by upgrades in the international credit rating that Russia received in 2005 and 2006. January and October of last year have seen Standard and Poor's and Moody's awarding Russia an upgraded investment rating, respectively. Fitch upgraded Russia's sovereign rating in August 2006 to 'A-'. Standard and Poor's has placed the Russian debt the equivalent of one level higher in its 'BBB-' category. In its annual foreign direct investment rating in 2005, A.T.Kearney moved Russia from the 11th to the 6th position in the index of the most attractive countries for investment. The booming domestic ICT industry ($12 bln according to IDC) reflects this economic growth and contributes to further development of modern infrastructure in the country. Another Russian trend that is worth to be mentioned is the occurrence of FDIs into Russia-based IT services companies. We have witnessed the Nordic investment into the St.Petersburg-based Reksoft in November, funds coming to Epam Systems in February and acquisition of Nizhny Novgorod's Telma by a Swedish system integration house. The Nordic Venture Network visit to Russia in April and the creation of a state-managed investment fund with a special focus on IT - all serve as evidence to the rising attractiveness of investing into Hi-Tech Russia. - The Russian government has gotten serious about its support to IT companies and introduced a series of measures to facilitate the development of the IT industry in the country.
Along with the overall favorable initiatives brought up by the government for the whole high-tech sector (which include the development of a number of technoparks around the country, the federal law "On Special Economic Zones in the Russian Federation"), the achievements so far include one of the most useful and fast-paying law on the industrial VAT exemption for IT services companies (effective from January, 2006). On August 11, 2006, the Russian Prime Minister Mikhail Fradkov signed the law launching the venture fund with a special focus on ICT industry. The Ministry of IT and Telecommunications lobbied for the IT find creation to ensure that the sector does not remain underfinanced compared to other high-tech sectors. The State Duma of the Russian Federation has finally passed the long-awaited law on tax incentives for export software development companies based in Russia. The law will come into effect on January 1st, 2007. According to the new legislation, companies engaged in software outsourcing activities will get a major tax relief due to the reduced unified social tax paid per employee. And on top of that, the Ministry of IT and Communications announced in August of 2006 that it created the Federal Agency of Software Exports support. The main goal of this entity will be to promote the software outsourcing sector in the global marketplace through the support of special events in the target markets as well as to raise the public awareness of the opportunities available through cooperation with Russian ESPs. - The maturing Russian domestic market brings new opportunities to both Russian ESPs and international companies.
The ICT Industry is growing fast and according to the estimates of the Ministry of IT and Communications, it has reached the volume of $40 billion in 2006, demonstrating a five-year CAGR of 21.8%. As the IT sector becomes more mature - the segment by segment growth pace changes too. IT Services are getting more and more important, diminishing the share of Hardware (32.5% and 56.5% of the IT market size, respectively). The growing market is a huge opportunity for IT Services providers since they have a chance to offer more sophisticated services up the value chain thus strengthening their own positions. In the mid-term this will lead to a situation when Russian ESPs will offer services such as systems integration to international customers. On the other hand, the notably growing demand for IT services on the Russian market attracts foreign IT vendors, and they admit that Russia is one of the most lucrative marketplaces for their services and products, SAP, Hewlett-Packard, Microsoft and IBM are just a few examples of successful ventures in Russia. - Russia has a slightly different set of offering being well suited for high-end software R&D, and product development.
Russia will most likely never outperform India in the cost aspect, but the combination of a vast human force potential and the ability for creative thinking and strong technical background allows Russia to do product design and R&D better than any other country on the market. The clients that already chose Russia as an outsourcing destination over closer Eastern European regions are the best proof: Deutsche Bank, Fujitsu Siemens Computers, Nokia, Siemens, TietoEnator, T-Mobile and T-Systems. Read the inaugural issue of Outsourcing Strategist magazine online. |