The Moscow Times - June 17, 2002 - by Larisa Naumenko
With its wealth of computer programmers and solid reputation for scientific study, Russia has the potential to emulate some of India's success as a center of offshore software development. To achieve this, however, a lot will have to change.
It was during the twilight months of communism in 1991 that computer programmer Arkady Dobkin formed a small software company in Minsk. He then emigrated to the United States with plans to develop the business in his new homeland, but in December, the Soviet Union collapsed and so did the ruble, and Dobkin's firm of 25 people found itself out of action.
Dobkin quickly set back to work, teaming up with a specialist he knew from Minsk to start up EPAM. Today, the firm employs 350 people - although 50 of them are in its U.S. offices, all of EPAM's software developers are located back East (250 in Minsk and 50 in Moscow), making it an offshore outsourcing company.
EPAM now provides IT services to a number of international corporations, including Colgate-Palmolive, SAP AG and Halliburton Co. The company was selected as a finalist for research firm Aberdeen Group's Offshore Outsourcing Best Practices Report, published earlier this month."For me, it's the business of my life," Dobkin said.
With EPAM's sales of $9.5 million in 2001, the company seems to be a successful part of Russia's growing offshore software development market, but it's more than that. EPAM accounts for one-sixteenth of the total offshore programming market in Russia, which is tiny in comparison with India and China.
Russia's software outsourcing market had total revenues of just $154 million last year, according to Market-Visio/EDC research group.
India, meanwhile, is expected to gain $8 billion this year from the sector, up from $6.2 billion in 2001, according to the country's National Association of Software and Service Companies, or Nasscom.
The sector accounts for 16 percent of India's exports. Although almost half the size, China's software development market still pulled in $3.5 billion in 2001.
Offshore software development so far comprises a small percentage of Russia's $3.2 billion information technology sector, which accounted for a tiny 1.16 percent of gross domestic product last year, according to UBS Warburg.
And while Russia's offshore programming market is expected to grow at a rate of 50 percent per year and reach $348 million by 2003, according to Market-Visio/EDC, the demand for outsourcing IT services by corporations from the United States and Western Europe alone is expected to increase by 40 percent. Offshore outsourcing will soon make up 28 percent of companies' IT budgets, according to Forrester Research, and the number of offshore IT workers worldwide is expected grow from 360,000 now to more than 1 million in 2005.
It is now that Russia's IT companies should act to find a niche in the worldwide market, industry insiders say, but first they must solve some of the problems facing the sector.
Size Does Matter
Most of the country's software companies are relatively small. Only 31.3 percent of companies in Moscow, 13.6 percent in St. Petersburg and 15.4 percent in the regions had revenue of greater than $3 million, said Market-Visio/EDC.
The majority of the companies in St. Petersburg and the regions had annual revenues less than $750,000 and more than one-third of Moscow-based software companies did not cross that mark.
"It's hard for Russian firms with staffs of 100 people each to compete with Indian teams of up to 1,000 employees in offshore programming," said Andrei Sviridenko, CEO of Spirit, which specializes in licensed software.
"Russian companies need to grow to be able to compete with Indian companies. Small companies do not produce the impression of stability," Dobkin said.
Management and Teamwork
Russia's poor image abroad is another factor hurting the development of the country's offshore software companies, market players said.
"[Russia] is perceived by many as having an unstable economy and political situation, along with corruption and crime," said Alexander Yegorov, general director at Reksoft, a St. Petersburg-based company that recently signed a deal to produce software for Swisscom Mobile AG.
"When my sales people talk to a potential customer, they can spend 60 percent to 80 percent of their time selling Russia versus selling my company," said Andrei Konev, vice president at St. Petersburg-based Digital Design. Konev has worked with IBM, General Motors, Tetra Pak and other multinationals.
One of the ways companies can solve this problem is by setting up representative offices in countries with a large number of potential customers, industry players said."To find and keep international clients you should be on their side and speak their language," said Dmitry Loshchinin, managing director at Luxoft, one of Russia's leading software companies. "That means, at least, representative offices in the client's country and reliable partners in their countries that can handle what is called matchmaking."
"Often a big company without a U.S. office thinks that by sending a manager to the United States for a couple of weeks, they will be able to get a contract," EPAM's Dobkin said. "You can't work like that, you need to have real communication."
A lack of teamwork also hinders many software companies, and many rely solely on the abilities of individuals.
"We have a low level of management and insufficient culture of teamwork in software development," said Boris Pozin, director of the consulting and information systems development department at IT Co., a provider of business integration systems. "There's this idea that all programmers are geniuses and not team players. Indians are more modest and earn money through team work."
A lack of management is another weakness in the Russian software industry, Pozin said. "We always have everybody in the field working, and nobody has time or money to take care of organizing work and its quality," he said.
"Companies rarely suggest that their clients include a separate budget for managing projects," he added. "They should, and regular clients will agree to that. They will be surprised if companies don't do that."
Ranks and Taxes
Few Russian software developers have international certification and rank low on international systems used to gauge the efficiency of a company's software development process. There are currently two such systems: one is administered by the Swiss-based International Organization for Standardization, the other is the U.S.-based Carnegie Mellon Software Engineering Institute's Capability Maturity Model.
Russia has one company with the highest CMM level of five and two companies ranked at four, according to Software Engineering Institute. Meanwhile, there are 46 Indian companies with level five CMM and 28 level four CMM.There are 69 companies with level five CMM and 73 companies with level four worldwide.
"The more ISO- and CMM-certified companies there are in Russia, the faster we will be able to strengthen our position on the international market," said Taras Netrevozhko, development manager at Moscow-based Diasoft, which provides software products for finance companies.
"One of the main problems is a lack of government support in tax legislation and customs regulation," said Alexei Sukharev, president of Auriga, one of Russia's leading providers of offshore services.
The Indian government has played an important role in bringing India to its current leading position in the offshore programming market, he said.
The Economic Development and Trade Ministry drew up a list of initiatives in October 2001 to improve the IT sector, including the creation of tax free zones for IT companies and tax holidays.
However, the ministry said in May that more research into the industry is required to determine what offshore software development can bring to the economy and the government.
"The government should understand that software exports could very quickly become a significant part of the income to the country's budget," Reksoft's Yegorov said.
"At the moment, IT and telecommunications don't exceed 1.5 percent of the entire export volume."
More Than Just Science
Another major problem facing the Russian IT sector is a lack of proper education in information technology.
Russia has been praised for its high level of education in the sciences, and about 50 percent of all Russian students are enrolled in science-related programs, according to the American Chamber of Commerce. But only 250 out of some 1,000 higher education institutions train IT specialists, according to Microsoft Research.
The number of students in IT-related programs does not exceed 100,000 out of total 3.5 million students. Annually only 10,000 specialists in the IT field graduate from colleges and universities out of 186,000 that do have some basic IT preparation.
"The government should start caring more about reorganization of the education system as a whole and preparation of software developers in particular," said Igor Agamirzyan, head of relations with research institutions at Microsoft Research in Eastern Europe.
Russian universities offer an IT education solidly based in fundamental science, and gifted children are sought out for training in specialized schools. St. Petersburg State University won the ACM International Collegiate Programming Contest two years in a row in 2000 and 2001.
However, IT training programs in Russia do not conform with international standards, Microsoft Research said, and the quality of training is relatively low. A lack of teaching staff and insufficient number of graduating IT specialists, especially programmers, are other problems, Microsoft Research said.
Furthermore, no Russian university teaches an Association for Computing Machinery or IEEE-Computer Society "Computing Curricula 1991," a commonly accepted curriculum in IT fields.
To solve the industry's problems, companies themselves agree that they most join together. The national software development association Russoft was formed in September 2001 and now unites 50 Russian and Belarussian companies employing 5,000 software developers out of an estimated 30,000 programmers working in the two countries.
"Our goal is to turn from the industry of small individual companies into the industry of serious mature businesses that will be successful competitors in the international market," Russoft president Valentin Makarov said.
The association is often compared to India's Nasscom, which has more than 870 member companies and makes up more than 95 percent of revenues in the country's software industry.
Russoft's tasks include maintaining ongoing dialogue with the government in an attempt to create better conditions for operating IT businesses and promotion of the industry abroad. "The association will represent the interests of the entire Russian IT industry in the West," Makarov said.
The group helped organize the U.S.-Russia IT round table that took place in May in Moscow as part of a visit by U.S. President George W. Bush. The association will participate in a working group that was created at the round table to foster cooperation between Russian and U.S. IT companies.
It is difficult to enter highly competitive international markets, Makarov said, but to do this, Russoft organized two outsourcing summits in St. Petersburg in 2001 and 2002 to help draw attention to the Russian IT market.
About 450 participants from 30 countries gathered at the Second Outsourcing Summit in St. Petersburg earlier this month to discuss current issues in the industry. The summit also offered a chance for potential customers in the West to find partners in Russia. "We came up with the idea of the summit to help consolidate the industry," Makarov said. "Potential customers could see what Russia's technological opportunities are."
Russoft members could also use the association as a way to save money on training specialists and getting necessary international certification.
Although the need for such an association for a long time has been understood by many players in the IT market, Makarov said that there were some difficulties when Russoft was first formed. "Companies were cautious about each other because they thought each member would use the association only in the interests of their own company," Makarov said. "There was no mutual trust."
The situation is much better now, he said. "People have come to understand that companies need not fight against each other - they need to fight together."
Russian graduates of MBA programs in leading U.S. universities formed an organization similar to Russoft in January. The Russian Digital Alliance focuses on helping Russian companies enter the U.S. software products and IT offshore outsourcing markets. RDA also hopes to mitigate the worries of U.S. companies that are considering partnering and outsourcing with Russian companies.
"Russian companies need to have a clear development strategy to be able to enter American and European markets," RDA president Vadim Kapustin said. "There should be more people who can think strategically, who can divide the market into niches and see in which niches Russians can compete with Indians and in which ones it's already too late."
RDA was formed by "a group of enthusiasts" to help the Russian IT industry mature into an important part of the country's economy and to promote the interests of Russian companies, Kapustin said. "We invest our time in business opportunities."
In terms of offshore software development, Russia is a good choice, but U.S. companies are still unaware of what the Russian IT market has to offer, Kapustin said. "If you ask an ordinary American what Russia has, he will say, 'Oil, gas and the mafia.'"
The RDA is planning to organize events to increase such awareness among U.S. businesses. Meanwhile RDA's ambassador programs will search for U.S.-based representatives for Russian IT companies, and Russian graduates of U.S. MBA programs could fill those positions.
Choosing the Right Path
There is no doubt the Russian software industry has the potential to develop into a major part of the country's economy, and experts are now concerned about how the industry should evolve.
One development model, called the Indian model, focuses on pure offshore programming, or selling individualized services to Western companies. The second, often referred to as the Israeli-Scandinavian model, focuses on developing licensed software.
One inherent problem in Russia, said Spirit's Sviridenko jokingly, is the creativity of individual programmers.
"What they consider right may not be what they have been ordered [by a client] to do," he said.
Spirit was founded in 1992 and used to specialize in offshore services. The company switched to licensed software products in 1999 and has worked with NEC, Nortel Networks and Samsung Electronics.
Last year, Spirit partnered up with Texas Instruments, designer of digital signal processors. Spirit software will be used in TI processors used for cellphones, pagers, modems, soundcards, digital cameras and other equipment.
Sviridenko said that companies need to target global markets, specialize and find the right product niche. "The necessary condition for success is to enter the market with a professional partner, even better if it's the world leader in the chosen product niche," he said.
Alex Freedland, CEO of Mirantis, a U.S.-based company that specializes in providing offshore technology development centers, said Russian IT companies should focus on the software product model.
"We are counting on big Western companies gradually entering Russia as the market and skilled staff shortage grows, not with small projects that the current IT industry in this country is based on, but to open their development centers for long-term perspectives," Freedland said.
Russian IT entrepreneurs could learn how to successfully run their businesses at foreign companies' development centers and then set out on their own and promote their owned licensed software products, he said.
Several such development centers already exist in Russia. Motorola opened a software development center in St. Petersburg in 1997 that became a part of Motorola Global Software Group in 1999. Its 200 employees develop software for cellular network equipment and microprocessors and microcontrollers. The center cooperates with the city's universities to train IT specialists.
Another international IT major, Intel, opened a development center in Nizhny Novgorod in spring 2000. The center currently employs more than 200 specialists, and the number is expected to grow to 500 in the next few years. Russian students can apply for internships at the center.
Cadence Design Systems, which supplies electronic design automation products, methodology services and design services, earlier this year opened a development center in Moscow together with Mirantis. The two companies support the training of 20 specialists a year at the Moscow Institute of Electronic Technology to eventually work at the center.
Mirantis' Freeland believes that such centers and licensed software are the future of the country's software development industry that should steer away from individualized software solutions. "Russia doesn't have a chance in offshore programming and never will," he said.
However, Digital Design's Konev disagrees, saying that growing demand in the software solutions market allows for Russian businesses to find their niche.
"You can't come up with ready solutions for everything, and this is why customer-specific software development will always exist," he said. "[Digital Design] is gradually moving from services to products, but we do not consider it necessary to force this process."
A combination of the two models is the best, Reksoft's Yegorov said. "I don't understand why they have started to oppose these two business models," he said. "It's easier for offshore services companies to enter international markets because this model requires significantly lower investments, and one successful project leads to another one."
"The market is so diverse and the companies that can perform the required services or make products on demand survive and even become profitable," said IT Co.'s Pozin.
Which path the country's software companies should take is still up in the air, RDA's Kapustin said.
"We think the market will show where the demand is and what segment Russians are particularly successful in."
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