Valentin Makarov, president of RUSSOFT, an association that represents the interests of Russia’s software development sector, recently presented some impressive statistics to the Association of European Businesses: in 2007, information technology (IT) in Russia experienced 46% growth, to top $2.3 billion; revenues in 2008 will likely exceed three billion dollars; Russian programmers are among the world’s most highly educated and qualified.
Makarov gave his presentation at Moscow’s glistening President Hotel, owned and operated by the Presidential Administration. Yet the government-supplied meeting room, which boasted a state-of-the-art sound system, had awful acoustics. The grand, marble and polished-wood lobby, which can be spacious and welcoming (in a Brezhnevian, “Welcome to Vegas” sort of way), was only accessible through a crowded and disorganized security checkpoint.
In short, the event was a microcosmic reflection of the reality that is Russian IT outsourcing. American and European firms are providing the bulk of contracts generating growth in Russia’s fast-growing IT sphere. Yet clumsy governmental actions prevent Russian IT from reaching its full potential.
Kiosks and Graduates
When DHL began looking for ways to improve its remote-drop off points with a specialized electronic kiosk, they selected Cyphermint, a company that specializes in kiosks, to develop the units for them. Cyphermint, though now headquartered in New York, started in Russia and still does much of its product development in St. Petersburg. Its original product was developed for a Russian bank that needed an electronic transfer system that was impenetrable, even to Russian hackers – known to be some of the world’s most ingenious (just ask Estonia). The result was a program called “PayCash,” which has now been in use around the world for a decade. DHL’s new kiosks are now appearing in Walgreens and OfficeMax locations throughout the U.S.
IT outsourcing is an industry born of globalization and modernization. Given the ease of sharing bits around the globe via the internet, software programmers in Bangalore, Boston and Bratsk can work together seamlessly. And non-software companies can meet their proprietary programming needs by contracting with more competitive offshore companies, as in the case of DHL and Cyphermint.
Yet it is not simply a question of cost. In fact, the average price difference between outsourcing to a small company in rural America and outsourcing to a company in Russia is growing less by the day. Companies continue to outsource to Russia because companies there are better suited to handle large, complex problems and exploding demand, and because local high-skilled labor is insufficient to meet exploding local demand.
The global IT market has grown 250% over the last half-decade, from $162 billion in 2002 to $408 billion in 2007, according to the Gartner research agency. The U.S., which is the world’s largest purchaser of IT services, simply does not produce enough programmers to keep up with demand. The American IT industry copes by luring about 50% of its programmers from other fields – even though these workers do not hold degrees in IT. Every year, the U.S. also imports thousands of highly skilled immigrants to help fill the gap. Yet this is still insufficient. So U.S. companies outsource programming work to companies overseas.
Raw Material
Russia graduates nearly a quarter million highly-trained IT specialists per year, according to Auriga Research. Most hold advanced degrees: 88% claim specialist (five-year) degrees and 66% hold masters (six-year) degrees, according to a 2006 study by Kominfo Consulting. UNESCO further reports that nearly 50% of Russians graduate with science degrees – the highest percentage in any software-exporting country.
Russian IT companies have built their businesses based on this educated work force and they market their services using Russia’s reputation as a scientific leader – as the nation that launched Sputnik, put the first man in space, and has long rivaled the U.S. as a nuclear power.
Most Russian software developers started in the 1990s, in the grey area of the Russian economy that formed as perestroika took hold and the Soviet Union crumbled. Many were founded by academics that began offering outsourcing services from their university offices, as a way of surviving when inflation decimated the value of their state-issued paycheck. Other developers started as “unofficial” businesses in cramped residential apartments.
Even in these rag-tag early stages, Russian developers impressed most American observers.
Fred Anderson, for example, founded a successful telecom company in Russia in 1991 called Direct-Net Telecommunications. He recalls, in his recent, self-published memoir, Walking on Ice, a 1992 meeting with a collective of young programmers: the room was a mess of “computers, wires and gadgets,” yet “young people spending their Saturday night late at an office suggested the vision and dedication needed to spark change. I knew then that, whatever happened, Russia would be all right.”
Daniel Satinsky, Russia country manager of the tech company York Group, first became involved in Russian IT in 2000. At that time, he said, the average Russian outsourcing company had already grown to employ 60-120 people. They “were almost completely oriented towards customers in the U.S. and Europe” and “sold their services on a value proposition that combined relatively low wages with a very high level of mathematical and scientific skills… [emphasizing] their creativity and flexibility in solving higher level problems.”
Richard Golob founded GGA Software Services in the early 1990s, after the Boston-area software company he was a partner in hired a Russian émigré and began outsourcing to groups in St. Petersburg. He echoed Satinsky’s observation, that “the skill set of our colleagues in St. Petersburg was superb, and the price was impressively low. I realized that I was participating as a client in the upcoming new trend of offshore outsourcing.”
Headquartered in Boston, GGA maintains development centers in St. Petersburg and specializes in IT solutions for scientific problems. Among other projects, it has developed molecular modeling software for chemists; software that can look for “target signals” in the extensive and often messy numbers contemplated by scientists who study natural systems; artificially intelligent data analysis algorithms that can analyze investment data for financial risks.
By harnessing a talented labor pool and by effectively marketing themselves, Russian developers now command a growing share of the global IT outsourcing market. In fact, a sort of maxim has formed since Russia entered the market: If you have a big project, go to the Indians. If you have a very urgent project, go to the Chinese. But if you have something very challenging that needs to be done right, you want the Russians. Or, as Steve Chase, president of Intel Russia, said in a Fortune article last year, “We commit difficult problems to engineers in the USA. If the task is very labor-intensive, we assign it to the Indian specialists. If the problem cannot be solved, we offer it to the Russians.”
Still, while Russia is climbing up in the world IT outsourcing market, according to data from XMG, its $2.3 billion in annual sales pales in comparison to leaders India ($34.1 billion) and China ($13.1 billion), and is well below even Malaysia ($3.6 billion). And, while every country competes with all comers for clients, the main challenge facing developers everywhere is getting enough labor to fill demand. Russia’s outsourcing market has grown by over 40% per year for several years, yet its IT labor force is only growing 10% annually.
Julia Vasiliyeva, human resources director for software developer Auriga – Russia’s first successful IT outsourcer, confirmed that the industry is experiencing a labor crunch. To recruit and retain top talent and thereby to achieve stable growth, Lashkova said, requires creativity and significant financial investment. In addition to paying above-market wages (which are growing at 10% per year), Auriga has added perks such as health care, subsidized English lessons, and even fitness club memberships. Headquartered in Moscow, Auriga also actively recruits new labor from across Russia, paying for plane tickets and some relocation expenses.
The company has also implemented many “western-style” HR policies still rare in Russia. For example, Auriga has done away with dress codes, allows its employees to telecommute, and has adopted a policy of promoting almost exclusively from within. Many of the company’s project managers and executives were originally programmers. These policies and perks have allowed Auriga to stay at the low end of the 5-16% annual attrition rates that typically affect Russian software developers.
Meanwhile, demand from local clients is rising, bringing staffing challenges of its own. Russia is in the midst of an internet boom, with 40 million internet users and counting. As a result, most Russian developers consider the local market to be as important as the U.S. market – which has traditionally been their major revenue source. Certainly the Russian market is closer and easier to reach.
IT Territory is a case in point. The Moscow-based firm specializes in gaming and graphics, and their original business plan included offering outsourcing services, while developing and marketing their own internet-based games. Yet, as the company’s online games gained in popularity (now with more then 6 million users), the company found it less profitable to devote resources to outsourcing. They have largely left the outsourcing business, but continue to grow as a company (in the process consuming more of Russia’s limited supply of programmers).
Staff is also being purloined by major research and development (R&D) centers. Hewlett-Packard, IBM, Microsoft, Sun Microsystems, Google, and Intel have all opened R&D centers across European Russia in the last few years. These firms can also use their multinational muscle to leapfrog into the Russian marketplace, hiring scores of programmers at a time. Google is a signal example.
Strangely enough, search engine leader Google, which has a Russian-American as one of its founders, was slow to modify its search engine to handle the unique grammar and variations of Russian-language search terms. As a result, Yandex – a search engine developed by Russians for the Russian market – has long held the lion’s share of the Russian search market.
Two years ago, Google was looking at ways to improve its Product Search tool (then known as Froogle). This service locates products for sale on websites around the world and presents the results in a standardized format, with a picture, a product description, and the price. Initially, Google relied entirely on product information data streamed to its service in a format it specified. But this limited results to, by some estimates, just 10% of all online shopping sites. Expansion to include more stores required “crawling technology:” scanning hundreds of non-standardized web pages to accurately extract prices, pictures, and product descriptions from each. It was a task many thought could only be efficiently performed by humans. Yet programmers at the Russian company Dulance came up with a crawling program that was far more effective than anyone else had yet achieved.
So in 2006 Google bought Dulance, gaining not only the unique crawling algorithms, but also the team of programmers that created them. It then put the head of Dulance in charge of Google’s Russian development operations. Last year, Google’s share of the Russian search market increased by 7.4 percent, rocketing it to second place, behind only Yandex (which gained a much smaller 3.1 percent). Google has since expanded its Russian development operations to include two centers staffed by more than fifty programmers.
Other Obstacles
In a 2005 report by A.T. Kearney, Russian IT outsourcing potential got high marks for its financial structure and for the quality of its human resources, but low marks for business conditions, leading to an overall global ranking of 27 out of 40 destination countries. This underscores what may be the biggest problem facing this sector, aside from a limited labor pool. In Russia’s rapidly growing economy, double-digit annual inflation is ruthlessly accelerating labor and overhead costs, particularly in Moscow; an over-regulated and often corrupt business environment straps businesses in red tape and extra “expenses;” and a falling dollar and strengthening ruble has disproportionately upped the cost of Russian services to American clients.
GGA’s Golob said he is confident, despite these challenges, that Russian outsourcing is holding onto its market position. “Once a corporation makes an investment in building a partnership with an outsourcing company in a particular country such as Russia to undertake highly sophisticated projects,” he said, “it does not quickly dissolve that partnership to experiment in another part of the world.”
Most in the industry, however, agree that actions taken by the Russian government are not helping Russian outsourcers achieve their full growth potential. Doug Mow, Senior Vice President of Marketing for Exigen Services, noted that “other governments have used tax benefits to build industries and education programs to create capacity.” He also said that Russia must face up to “other issues regarding business practices and perceived international issues like IP theft… on a country vs. country level, Russia has to step up if it wants this to be a strategic industry for growth.”
One strategy India and China have successfully implemented is “special economic zones” (SEZ), which receive tax breaks and government help in infrastructure development. Russia has tried many times since the early 1990s to develop SEZs, but never with any notable success. Most recently, a 2005 federal law offered packages of tax breaks for up to 20 years to companies that build facilities in four new “technical-innovation” SEZs (in Zelenograd, St. Petersburg, Dubna and Tomsk; there are also other SEZs, with other aims). While the government has allocated about two billion dollars for infrastructure development, enterprises are expected to contribute half of the SEZ’s development costs. So far, reception to the SEZs has been lukewarm at best, if only given the logistical and financial obstacles to moving a company to a special zone. But the idea of tax breaks is also problematic. Some businesses claim that accepting such breaks only results in visits by tax auditors.
That the government has been so lax in its protection of foreign or domestic intellectual property rights is also a hindrance. The difficulty American music companies faced trying to shut down the Russian site allofmp3.com is a cautionary example. Although the site was selling unlicensed, copyrighted material for years, Russian courts, until recently, consistently ruled in favor of the site. The blind eye that local authorities turn (notwithstanding show-raids on random vendors) toward grey- or black-market sellers of software underscores the low priority Russia has fixed for intellectual property – the stock and trade of IT.
Despite these challenges, no one is pessimistic about the prospects for Russian IT outsourcing. Most companies in the industry are planning for growth. Industry forecasts predict that Russian IT exports will rise by at least 30% in 2008.
RUSSOFT’s Valentin Makarov, at his President Hotel presentation, said that government inefficiency won’t seriously hold back Russian IT outsourcing. “We will just not grow as fast as we could,” he said. “But we will go on without them.”
York Group’s Daniel Satinsky, who is also president of the US-Russia Chamber of Commerce of New England [disclosure: the author of this article is in the employ of USRCCNE], was similarly optimistic and underlined the positive effect outsourcing has had for the Russian economy as a whole. “Outsourcing companies will prove to have been a training ground for a whole generation of entrepreneurs and software executives in a wide range of tech areas,” he said. “This is because they have been trained to be oriented towards international markets and to be customer focused, which are skills that are in short supply in Russia. Furthermore, they have had to conduct business in English and in accord with international business practice, which gives them entry into international technology markets in a broad way.”
And, as in any business, getting a foot in the door is the first step. RL
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