By Alex Brownsell and Tom Bowker
IT Europa, November 16, 2007 As it rediscovers its swagger on the international stage, the Russian economy is booming and IT services continue to grow at an annual rate of up to 25%. The market is still small by west European standards but multi-national players like SAP, T-Systems and TietoEnator have all beefed up their Russian presence. The only question is, are these fairy tale market conditions sustainable? For years international IT firms have seen Russia less as a lucrative enterprise market where profits are ripe for the picking, and more as a centre for low-cost, high-skilled nearshoring. When IT Europa approached some of Europe's leading IT services players about participating in this survey, consensus seemed to suggest that Russia is not a priority market. For instance, T-Systems told us: "Russia is not a growth country for T-Systems in terms of new business. Our focus is on western Europe. St. Petersburg is solely an offshore location for T-Systems' systems integration business, for which we are currently seeking an international partner." Given the above comments, it comes as no surprise that the domestic IT services market is dominated by large local systems integrators such as IBS, Croc, TechnoServ and LANIT. In terms of scale, it is said that of the top 20 IT companies in Russia, only three are non-Russian (HP, SAP and IBM Global Services). Extend that to a top 30 and you find Accenture and Siemens IT Solutions and Services (SIS), but it nevertheless demonstrates how international players have struggled to make inroads into the Russian enterprise sector. Perhaps this has been due to a lack of motivation - after all, at an estimated EUR 36bn, the Russian ICT market is still playing catch-up with western Europe. But it appears that Russian enterprises are quickly improving their attitudes to IT. "Several years ago Russian providers focused solely at the US and European markets," says Arkadiy Dobkin, CEO at software solution developer EPAM. "Now the size and maturity of IT budgets of Russian companies, the number of deals, complexity of requirements and delivered solutions, as well as the attention paid and support lent by the government are approaching levels seen in the West." Dobkin attributes this change to the "Russian economy's dynamic and diversified industrial growth", and he is not alone in believing the economy is performing well. Dmitry Selitsky, project developer at Belarus-based ISV IBA Group, points to the "formation and advance of entirely new vertical sectors, the creation of new factories, expansion in the retail and logistic markets, and a shift to large and complex projects", although adding that Russia remains a "complicated and risky market." Of course, Russia continues to be a major centre for outsourcing from the US and western Europe, partly thanks to continuing low prices in comparison to increasing costs in India. But with ERP sales doing very well, up around 40% compared with 2006, it appears relations with international players are warming after an initially frosty Russian reception. For instance, SAP now leads the way in ERP sales ahead of US rival Oracle. Meanwhile, Microsoft has enjoyed remarkable revenue growth during 2007, up towards 300% on the previous year's figures - although this may largely be attributed to a crackdown on piracy and a subsequent influx of Windows sales. "Russia is by far our fastest growing market," says Jean-Christoph Berthier, marketing director at Microsoft Dynamics CEE. "This has been driven by the legalisation business and like any bubble it will burst, although we don't know when. We are investing massively in marketing, 34% of our entire budget into Business Solutions, so we can get that pay off once the bubble bursts." Boris Volpe, marketing director at SAP Russia, reveals that business in the first nine months of 2007 has growth considerably, and that the combined Russia and CIS region now stands as SAP's third largest market behind the US and Germany. It is also the fastest growing. "Overall the Russian economy looks healthy and inflation has stayed down," says Vope. He adds: "All of the industries have developed positively - retail, wholesale, utilities, construction, energy. There is a considerable cash flow into the country now. We expect ERP to grow even more - all enterprises, from oil and gas to coffee shops, have IT demands now." S&T CEO Christian Rosner agrees that SAP is doing well, but says it had to work hard to overtake Oracle. "It took a long time for the SAP market to get going. Oracle made a very strong start in Russia. This was unusual, as normally SAP was stronger in eastern Europe," he says. Rosner also believes there are opportunities for foreign IT services players to muscle in on the domestic scene. "The infrastructure business has been local IT services companies and international hardware guys, but for international systems integrators there is an opportunity to bring international skills. There are a lot of new business managers in Moscow, many of them Western, so there will be higher demands in IT skills and quality. "Although the take-up of outsourcing remains frustratingly slow, investment in IT infrastructure and business applications is keeping most Russian IT firms contented. Svetlana Vronskaya, marketing manager at software developer Reksoft, says: "The market is still very much dependent on the hardware sales which account for around 60% of it, but the IT services share is growing, too. Infrastructure has still been the major investments for Russian enterprises. Custom application development category accounted for a large share of IT services revenue last year, with system integration, support and installation following it." IBA's Dmitry Selitsky adds: "Customers are investing in the automation of their main business processes, especially banks, investment players and insurance companies. ERP systems are very popular, as well as document and workflow management systems, warehouse management systems and CRM. And there is also the latest love of the industry in Russia - SOA (Service Oriented Architecture)." An often-contentious issue among Russian IT commentators is the level of investment coming from the Kremlin. Poland-based research house PMR speculates that the government accounts for 22% of all IT spending in Russia, up 2% from 2006. But for some this is not enough. Back in April IT Europa spoke to Valentin Makarov, the president of the Russian Software Association (Russoft), and he criticised public sector involvement in IT. "There is a total absence of state support for international marketing and PR of our members and of the industry altogether," said Makarov. Reksoft's Vronskaya is reasonably pleased with govenment spending, although she admits much of the money is still being invested in hardware. "Serious investments in government IT infrastructure sped up over the last nine months with the government organisations becoming one of the largest client segments for ICT providers. It is hardware and front- and back-office applications that are in high demand here." Last month the authorities announced that on each Russian school computer it was to install open source software, but not many are getting carried away. Pawel Olszynka, head IT and telecoms analyst at PMR, describes it as a "reasonable plan, mainly because of potential cost reduction, problems with piracy and lack of funds for IT development in schools." But he warns: "There is a risk that, like many government plans, this one will remain on paper. We should wait a few months and observe how this project is going to be carried out in Tomsk region. Especially in Russia, there is always a danger, that such ideas have a propaganda dimension." Last year we mentioned that the authorities were attempting to stimulate growth in IT through a number of low-tax "Special Economic Zones" and "Technoparks", which were to be set up away from the economic centres of St Petersburg and Moscow. Sadly progress has been slow and many zones are simply yet to get going. But after much dithering by the Kremlin, local government bodies have taken control of IT company recruitment and the industry should see faster development with SEZs during 2008. The other big vertical sectors in Russia tend to be the industrial manufacturing space, financial services and the growing retail business. "Five years ago, retail was completely different in Russia," says MBS' Jean-Christoph Berthier. "Now it is all giant malls with Media Markt and others in the consumer electronics space. It is unbelievable, many have just started from scratch, and so now have a large need for IT." Rosner at S&T agrees: "There are opportunities in retail, both local and international retailers. Some local chains are developing, and they will want to bring the retail markets to more professional levels." Some Russian IT experts are also getting excited about the SME space. "SMEs in Russia have realised they need solid IT infrastructure, which wasn't the case two years ago," says Reksoft's Vronskaya. SAP's Boris Volpe sees increasing interest from SMEs, largely due to problems they are experiencing after strict government taxation enforcement. "The market is getting more consolidated. All business are being made to pay taxes now, so they need to invest in IT. One of the key drivers is that the business want to package themselves as an attractive M&A proposition."
Such levels of consolidation are yet to be seen in the local IT services sector. The big merger this year was between SAP specialist IBS Group and Oracle partner Borlas, which will produce the largest business application SI in Russia. "We have 22% of the business applications market and the nearest competitor has 5%," says IBS VP Eugene Peskin. Asked whether he sees any problems combining SAP and Oracle operations, Peskin says: "Some industries in Russia traditionally work with SAP, such as oil and gas, while some tend to choose Oracle, like the metal industry or energy companies. By combining we can offer a wider range of products and services." The acquisition of Borlas also places IBS in a position of authority with its vendor partners. SAP boss Boris Volpe admits the merger means it will need to try harder to gain IBS' attentions: "We are treating the deal neutrally, but the overall leverage of IBS has grown considerably. There is a threat as they also partner with Oracle and Microsoft Dynamics, so we need to fight more actively for their business" Software developer EPAM aquired local competitor Vested Development a year ago, while a recent Russoft survey suggested that up to 60% of members have increased their market position with M&A activity. But in general such consolidation seems restricted to smaller players; larger systems integrators have yet no need to pursue M&As, as the large growth rates in IT services provides enough business for all. For the time being, at least. Could the large internationals, such as HP Services, Accenture or IBM Global Services, prompt a bout of consolidation? Not likely, according to IBS' Eugene Peskin: "For the internationals, the only way into the top three is to buy someone. But they have probably missed the boat, as everyone is too expensive. From our IPO in Frankfurt we know that Russian IT services companies have a very high valuation." There is a chance that IBS may have set off a new phase of consolidation with its swoop for Borlas. Alexey Ananiev, chairman at rival SI TechoServ, recently told Russian news service Cnews.ru he is keeping a close eye on the situation. "A series of mergers have taken place this year on the part of those market players, which seemed absolutely self-sufficient a year ago. We are also working in the given direction, so I do not exclude we might announce several mergers up to the end of the current year." However, the most likely driver behind a fresh spate of M&As will be the dimishing resources in Moscow and St Petersburg. The latter, in particular, has attracted IT giants such as HP, EMC, Oracle, Microsoft and T-Systems in recent years and this is placing strain upon the employment market. Christian Rosner comments: "There are two places with a skills shortage - one is Moscow and the other is St Petersburg. In the regions you can still find skilled people, though if you need special industrial knowledge then you must train them." "There are still a lot of people coming through the univerisities, but there is a wage inflation of 10% to 15% in Moscow. In the regions this is less so," says Eugene Peskin. "We put a lot of effort into cooperating with universities and putting on special training programmes. I wouldn't say there are plenty of people, but if you compare it with the rest of Europe the situation is better."
Not everyone sees a problem - EPAM CEO Dobkin says that, "thanks to Russia's higher education system that is focused on science, maths and physics [...] Russia is fortunate to produce a significant number of IT graduates." And he too sees the potential of SEZs and Technoparks, which are set to create 75,000 new positions by 2011. IBS and its software vendor subsidiary Luxoft are in the process of creating a new operation in the city of Dubna, which is home to a scientific campus. By building apartments for prospective employees to live in, away from the high costs of Moscow, it hopes to attract graduates.
OUR ANALYSIS With strong growth and a burgeoning enterprise sector, Russia seems a great place to be right now. But annual growth rates of 25% in the IT services sector are clearly unsustainable - largely as many contracts involve legacy replacement. By 2011 the growth will drop to around 12%, but the more immediate problem is how to find sufficient resources in Moscow and St Petersburg. Local players have close ties with universities, so it may prove more difficult for international guys to get hold of the talent. |