Russia Ripe For IT Reformation

Twice the size of the US, spanning 8,000 miles and 11 time zones, Russia is the world's biggest country. But we all know size isn't everything. The country's IT market is valued at just one-sixth that of the UK's and 1bn euros a year less than neighbouring Sweden, despite housing 15 times the population. Blame can be attributed to decades of economic stagnation and underinvestment, but the root of Russia's problems are being left in the past as the country leads Europe's IT renaissance with exponential annual growth rates. Both private and public sector enterprises are investing at record levels, and the current IPO craze is stimulating demand for levels of corporate glasnost and perestroika that Gorbachev only dreamed of. But as the market begins to mature, can the local providers keep hold of the spoils as the international contingent advances? Is the country primed for consolidation? And will the market forever be shackled by institutionalised corruption? IT Europa investigates...

While most European IT markets are only just beginning to thaw from a recession longer than a Siberian winter, Russia is currently enjoying white-hot growth that was unimaginable a decade ago. Eugene Peskin, VP marketing at 4,000-strong Russian IT group IBS, explains: 'The IT services market is growing at 25pc a year in revenue terms, but we saw our services arm grow by more than 50pc in 2004.'

With annual growth rates sky-high it is easy to forget the total Russian IT market will be worth just $9.2bn (7.6bn euros) this year, according to research firm IDC. Hardware sales are again stealing the show, booming 23pc to $5.8bn (4.8bn euros). 'Every year analysts claim software and services spend will overtake hardware sales, but we are still waiting for it to happen,' continues Peskin. Yet software investment will peak 76pc year-on-year to $1.6bn (1.3bn euros) over the course of 2005, and while IT services spend registers at a meagre $1.9bn (1.6bn euros), an annual sales spike of 26.4pc makes it the fastest growing services sector in Europe. Svetlana Vronskaya, corporate communications director at 250- strong services and software developer Reksoft, is optimistic the enterprise IT market growth is sustainable: 'We expect dynamic growth of more than 20pc for at least the next four to five years,' she says. Given economic prosperity the envy of Europe, you would be forgiven for assuming winning business in the booming Russian IT services and software market is akin to stealing candy from a baby. But Sergey Rasskazov, country manager at 500-strong HP Russia, is keen to highlight that the acceptance in the value of IT services is 'still very low'. He continues: 'Enterprise accounts - which typically make annual sales in excess of $500m (414m euros) - still prefer to spend IT services budgets on products. It is up to the vendor community to address and change business attitudes.'

One Russian source reckons this may be easier said than done, claiming IT investment falls short in corporate priorities behind nurturing relationships with the government and local tax authorities. 'To be a large, successful business in Russia, special relationships must be built with all the legal and financial authorities,' he says. 'It means IT investment will never fulfil its potential, but that's how business works here.'

As in all developing markets, the competitive landscape is dominated by indigenous players, but Peskin suggests that the market leaders are beginning to pull away from the pack: 'Within five years the market will be a lot less fragmented,' he says. 'Russian vendors are still the strongest although the internationals, especially IBM and HP are catching up fast. SBS has also done well in the past year, moving from a top 30 to a top 10 vendor after focusing on winning contracts with German-speaking Russian clients.' Arkadiy Dobkin, CEO at leading software developer EPAM, admits IBM and HP are now more 'visible' competitors but both still rely on hardware sales to bring home the bacon. 'Neither are major players in the services space where Russians dominate,' he claims.

Sergei Yaskevich, general manager of IBM Global Services' 400-strong Russian operation, confirms that the national vendors remain the market's trailblazers. 'It is still easier for the locals to win business as they have the best contacts and established histories with the majoraccounts,' he says. 'Locals are also more flexible in their Ts and Cs than the international vendors and offer an end-to-end service that includes hardware, software and integration.'

But Rasskazov at HP reckons the internationals play a bigger part than the locals give them credit for: 'We have been very successful over the past 10 years by focusing on mission critical services and software support. Many Russian vendors only work in the simple system integration and break-fix areas, but we lead the way in more advanced projects.' He continues: 'It means we work more closely with Russian vendors than in other markets as they provide the simpler IT services and customer contacts.'

Michael Ivanov, research analyst at IDC Russia claims the internationals made considerable marketshare gains last year, but they still face the same challenges as other vendors. He adds: 'In addition to issues of security and transparency, there is a talent war going on, where vendors readily poach the best IT staff from competitors, making it hard to build up a solid pool of workers who know the clients and how best to address their needs.' Yaskevich at IBM claims Big Blue is growing 'quicker than the market average' and that its infrastructure solutions and maintenance services are most popular. He admits that, like HP, Big Blue has a greater reliance on its partners in Russia than in other European markets. 'The majority of IBM's hardware sales goes through partners which is not typical,' he claims. It emphases how important strong relationships are with local vendors, but despite the rise of the internationals, Yaskevich concedes that old attitudes may turn against them: 'IBM is seen as a big, powerful US brand which works in our favour in most markets. But this may well work against us in Russia and limit our success.'

Whether international or indigenous, all vendors operating in the Russian market are benefiting from the widespread adoption and implementation of ERP systems and the rise of IT outsourcing. 'SAP is very strong and MBS is having success at the lower end of the enterprise market,' explains Peskin at IBS. The vendor works with both software giants but claims database heavyweight Oracle is beginning to break into Russia: 'Oracle has made good progress over the last two years and while we don't work together, it is winning some sizeable deals.'

But Boris Volpe, marketing boss at the 500-strong Russian office of SAP, claims the German ERP giant boasts a 40pc share of the enterprise software space. 'Oracle is our number one competitor but it is a distant runner-up, holding less than half of the marketshare we do,' he claims. 'Its engagement model is quite different too as we have many experts based in Russia, while it has limited in-house resources and has to rely heavily on partners.'

The most important software market development over the last year has been the rapid evolution of complex projects. Peskin explains: 'We are now implementing contracts that were unthinkable five years ago, and the more complex the solution, the better the margins.' He cites one recent contract win to implement an SAP ERP solution to a major Russian bank that had significantly increased its workforce and resources after several sizeable acquisitions. 'These projects are important to all vendors, but the real value is only achieved when you implement several similar solutions at the same time. This is how to really utilise core capabilities,' he adds.

While ERP software is being ubiquitously adopted, most sources reckon Russia is still not ready for CRM or SCM applications. 'Even the most advanced telcos are not looking at CRM yet as they are faced with more pressing issues,' reckons one source. 'Elements of SCM are being investigated in some quarters but it is not a universal trend.' However, Dobkin at EPAM, reckons demand for other applications is rising. 'SCM and CRM are very closely related to ERP in Russia as the market is relatively young, but as more Western companies enter the country, other solutions will grow in popularity.' Vronskaya at Reksoft, agrees: 'IT services spending will concentrate in the areas of ERP systems and document management systems for the moment, but BI and CRM will become important trends given time.'

Government to halt IPO IT services frenzy?

The E-Russia initiative and the stability of the country's main industry pillars are vital to the development of a mature Russian IT services market. But one other driver, which has received little attention in comparison, is the number of Russian companies that have recently decided to become publicly-owned. In fact, Russian companies have raised more than $4bn (3.3bn euros) through IPOs in the last year (predominately on the London and New York exchanges where backers are keen to invest in one of the few remaining booming economies), compared to just $1.3bn (1.07bn euros) raised in the previous decade.

Consequently, as with any public company, rigorous accountancy practices and other corporate streamlining procedures take on a higher significance, and require the specialist skills of IT and management consultancies and software vendors. Boris Volpe, marketing boss at SAP, explains: 'IPO activity has been a significant driver for SAP's growth in Russia, and while companies wanting to go public aren't required to implement ERP systems by law, they want to streamline business processes and effectively manage their operations which is exactly what we offer.' SAP has more than 90,000 users in Russia and the CIS, and saw annual sales leap 26pc last year to $125m (104m euros).

Alexandre Gorine, managing director at 260-strong Accenture Russia, explains IPO interest is fuelling the surge in demand for business consultancy services: 'Many Russian companies are interested in floating but most understand they are not ready to do so. We advise them on becoming more transparent, implementing corporate governance procedures and updating software systems, all of which are designed to make it more attractive to investors.' However, he warns that time may be running out for those Russian companies wanting to list on a foreign exchange: 'The government may put obstacles in the way of national companies going public on foreign markets to keep investment within Russia,' he claims. 'Officially there are no laws that prevent a company from listing outside Russian borders but I wouldn't be surprised if this happens.' He adds that there has been much debate within government organisations and the national press: 'I am sure it is only a matter of time before the government intervenes.'

Having previously avoided IT services like the plague, the Russian public sector finally appears to have broken with tradition to catch up with the technological advances made by the private sector since state-owned enterprises were sold in the early 1990s. Yaskevich at IBM claims oil and gas are still the biggest verticals for IT investment, and that telco and banking are also 'investing heavily', but he bets that the public sector will be the key vertical to watch in the coming years: 'Money is being put aside for IT infrastructure investment although we are still waiting for exact contract details,' he says.

Vronskaya at Reksoft adds that Russian IT services spending is primarily generated from just four sectors, of which the public sector is now included: 'Financial services, manufacturing, government and telco investment are responsible for 65pc of the total IT services market,' she says. 'Over the past two or three years the public sector has become an increasingly important client since the government launched the E-Russia program.' The eight-year initiative, which was launched in 2002, centres on getting four key areas online - regulatory and legal, internet infrastructure, government and education - at a cost of $2.6bn (2.15bn euros). Peskin at IBC explains: 'The government has changed its outlook and realised progress must take place. While it is still early days, some proposals are being put in place.' He cites the example of a new passport programme that includes biometric data for added security. While no details have emerged, this tender is sure to be lucrative given the country is home to nearly 150 million people. As is par for the course across Europe, outsourcing is Russia's hot topic and all the IT market's major players are delighted by its arrival. Yet despite the various proclamations, there appears to be a slight uneasiness over whether the market is really ready for such an advanced IT service. Rasskazov at HP explains that although a market driver, outsourcing is far from a mainstream activity: 'There is a lot of talk but very little activity and it is worth remembering Russia is still a very young and inexperienced market,' he says. 'We need to bring the issue of outsourcing front and centre and start a debate on why it is in the best interests of Russian enterprises to consider this option. There is a lot of potential interest but it's up to the vendors to stimulate demand.'

But Alexandre Gorine, managing director at Accenture, reckons vendors will have little say in its adoption: 'Outsourcing is still not on the agenda for the majority of companies as it is often a tool used to reduce costs. While Russian businesses continue to make huge profits they will not be interested in what outsourcing has to offer.' He reckons that outsourcing will only become widespread in a market downturn, but nevertheless, Accenture has already taken steps to capitalise on the potential trend: 'Vendors that want to be big outsourcing players must make preparations now. It will be these companies that win the massive contracts,' he says.

The market may be maturing but the consensus from the major players is that any serious consolidation is still a long way off. 'Other sectors have seen a lot of M&A activity but there has been very little in the IT market by comparison,' explains Peskin. 'The market remains extremely fragmented and only in the past year have we seen any minor consolidation.' The reason for the lack of M&A activity is simple. There are huge IT market territories that are still relatively uncharted which ensures, in the short term at least, there is enough business to go around. 'It makes more sense strategically and financially to grow organically and recruit more workers, especially when this country has such high educational standards, than find a target, make the acquisition and integrate,' continues Peskin. 'We will see some minor activity over the next three to five years but nothing that will reshape the competitive landscape.' He concedes the only scenario in which this would change is if a major international player wants a short-cut into the market and has the resources to acquire one of the big nationals, but admits this is 'fairly unlikely'. Rasskazov at HP agrees that the market is too immature for notable consolidation, and points out an absence of global systems integrators in the country. 'International SIs are still biding time before entering Russia, but it is too early to say whether acquisitions will be a viable strategy,' he says. The only acquisitions I have seen are among very small local players.'

However, as is the way in a market with more angles than a hexagon, Gorine at Accenture believes consolidation is imminent. 'Some companies are employing the services of management consultancies to become more attractive to potential suitors,' he says. Meanwhile, Elena Klyueve, international marketing director at St. Petersburg-based services outfit Digital Design, adds another twist 'Consolidation doesn't always focus on acquisitions, and I expect strategic partnerships to become even more significant. It allows two companies to utilise each other's strengths while adding value to clients.'

While the internationals grow in strength, local businesses look west for investment, and demand for advanced IT services gathers momentum, one aspect of the Russian market harks back to its darker days -corruption. One Russian source is quick to rubbish the government's latest attempts to stamp out the corporate corruption culture that has dominated Russia since time immemorial. 'Corruption is more evident now than a year ago despite the government claiming it is taking steps to eradicate it,' he claims. 'Whenever it launches an anti-corruption initiative, illegal activity goes through the roof.' As with all illicit activity, the extent and impact on the market is practically immeasurable, but our whistleblower is happy to speculate. 'The prevalence of kickbacks that completes a contract agreement is one way of measuring corruption and I'm hearing rumours that this trend has grown twofold in the last two years,' he says. 'It's strangling the growth of our market but with so much money flooding into the country, no one really cares.'

While both Rasskazov at HP and Volpe at SAP swear blind they have never witnessed any bribery or corruption first-hand, one high-profile Russian vendor reckons it's not just the local players that are involved in dodgy deals: 'I am hearing charges that implicate the big western European and US companies,' he says. 'It seems that even the foreign players have discovered the most effective way of doing business here.'