Russia currently has some of the world’s most valuable Internet companies, but also faces a number of daunting challenges – such as the need to rebuild relations with the West and prevent the nation’s best and brightest from taking their talents abroad.

Moscow-based Yandex Company office. Photo: TASS

The recent World Startup report that ranks 50 countries by the value of their leading online businesses – where Russia ranked 6th globally – coincided with the first official recognition of the importance of the online sector of the Russian economy. During a meeting with key figures of the Internet industry last week, President Vladimir Putin estimated its size at 8.5 percent of the country’s GDP.

It is definitely interesting to attempt to model the future development of this segment, especially against the background of international competition. Is Russia likely to go up the list, stay in its current place or cede ground in the rankings to rivals?

This last possibility started to look like a viable scenario in view of recent political developments. The deterioration of Russia’s external relations puts pressure on the more globalized of the companies to consider what could be best described as “business emigration” (as demonstrated by the recent cases of Luxoft and Game Insight). Moreover, the growing attention on the Internet from top policy makers in the country may involuntary put a check on the growth of the domestic market – and thus contribute to the desire of local companies to seek their fortunes elsewhere. 

Russian online giants in the World Startup report

Let us first re-examine the data from the World Startup report. The official ranking is based on the value of the country’s most valuable Internet company. In the case of Russia, this happens to be Yandex. It is interesting to add a look at a country’s #2 and #3 companies, mostly to see how established is its Internet economy. Such reassessment puts Russia one position higher, and it’s not just an exercise in vanity.

Consider that the place of South Africa is determined almost exclusively by the value of one company, Naspers (which by the way holds substantial assets in Russia in the form of shareholding in and direct ownership of Slando and Avito). The country’s second and third most valuable online businesses are worth a mere $90 million and $48 million, respectively, definitely not to be compared to Russia’s ($8.2 billion) and VKontakte ($2.5 billion).

Together with Yandex, the three Russian companies have a combined market cap of approximately $26 billion – still just about one half of the market cap of Naspers, and even less than Korea’s leader Naver, but some $10 billion ahead of the closest competitors, Australia and the UK. And there are valuable contenders beyond the Top 3 – like Tinkoff Bank, which rightfully insists on positioning itself as an e-business, currently valued at nearly $1.5 billion on the London Stock Exchange.

The future outlook also seems at least stable for the Russian online giants. It is highly unlikely that any of them will move out of the country tomorrow – or any time in the foreseeable future. And, while no business is fully immune from threats and challenges, on the domestic market the situation currently looks quite like “business as usual.”

Providing the right environment for online entrepreneurship

Yet, on the long-term horizon, Russia can’t take things for granted. At the moment, Russia is enjoying the fruits of favorable coincidence of circumstances that occurred at the beginning of development of the Internet business here in the late 1990s, including the availability of highly skilled computer talent and the relative smallness of the local economy of those days, which kept it off the radars of the international majors for enough time to permit the emergence of strong local players in almost each and every market niche. When foreign competition came in the mid-2000s, those players stood resourceful and strong, due to being organically grown and strategically ambitious to face the challenge.

To keep the momentum, it is essential that Russia continue to provide the right environment for online entrepreneurship. And while one cannot move a Yandex out of the country, the situation may be radically different for a promising start-up of several dozen people. If such a company has a product that can be marketed globally, there are almost no barriers to re-locating or re-launching it in almost any given point on Earth.

Two important “anchors” can keep Russian online entrepreneurs in Russia. One is the local market and the other one is the access to the unique ecosystem of computer software development, which consists of the large number of specialists, having not only coding skills, but also good fundamental education in mathematics and physics together with enough of the talent in complementary areas like graphic design, all of them coming at a cost which is still very competitive internationally.

Two other integral parts of the ecosystem are the Russian technical universities which are now largely restructuring their curriculum to meet the modern demand for IT specialists and a number of industrial research clusters created across the country back in the Soviet era. 

The ecosystem factor is most important. With all the development of the mobile, social and digital technologies that theoretically enable location-agnostic collaborative work of project teams, the reality is that face-to-face participation is important at crucial decision-making moments. The issues of knowledge transfer – building teams that can become a company’s strategic asset, not just a bunch of freelancers on a gig – also are most effectively handled via personal contact. But with time people will be acquiring more and more of the competences of remote collaboration and even coaching.

Closing a gap between Moscow and the “regions”

The means of mobile communications are increasingly broadband and reliable and the project management techniques are quickly developing in line with them. Thus, in 5 or 10 years, having full access to the Russian ecosystem of software specialists may not necessitate any physical presence of business management in Russia. “Virtual off-shore employment” starts to take off via various communities of freelancers and one day may pose a serious threat for the local companies.

The resource pool of internationally competitive talent is not at all infinite. Russian regions may generate a larger supply (in the Soviet times the engineering centers were deliberately spread across the country), but generally they lack the "soft skills" – like complex collaborative problem-solving – to provide quality input into the projects with potential of becoming international “value champions.”

From what we can observe now, there is a serious competence gap between Moscow and the “regions” (with St. Petersburg falling somewhere in between), a gap which has been growing over time, although there are standout exceptions to the rule, like Prognoz from Perm. The only possible answer is “education through experience” or, at least, the simulation of experience.

The recent advances of international MOOCs – massive open online courses – can be instrumental in bridging the gap. But then another challenge will emerge, since the best regional talents tend to base their career strategies on a physical proximity to the “center.” This provides not only better wages, but also professional growth and a radically different quality of everyday life.

Yet once you have hit the road, there is no reason to stop half-way, and the question is: Will Moscow and St. Petersburg win the competition for being the place of final destination for the specialists in global demand – against a Prague, a San Diego or a Sidney?

I’d say that the Russian high tech future is largely linked to the capabilities of radically boosting the quality of the country’s “regional” living environments. Unless a Perm, a Surgut or an Irkutsk become the places really attractive (as judged against a global list of options) for modern residence of a highly skilled international professional, the “brain drain” will continue to be one of the regretful, yet unavoidable phenomena in Russia.

Corporations can play a role here – it may be too long to wait for the thorough modernization of a whole town, but one can afford designing and implementing of a “mini-West” in an office environment, styled, for example, to the model of Google’s offices, with top-notch catering, recreation, fitness and even childcare facilities for employees.

Challenges that e-companies face in Russia

As for the “home market” factor – we can expect some turbulence here as well. Certainly, Russia is already Europe’s biggest Internet market by number of users – about 62 million people, yet with some important room for growth (as the potential Internet population is probably 100 – 110 million). The question is how one can monetize this vast audience in the context of global trends.

The World Startup report states that two sub-segments of the online industry currently generate the top performing companies – the search engine sector and the media and communications sector (social networks fall here). In the first one, Russia is clearly unique in the non-Asian world, having the local brand not just holding the No. 1 place on the market against Google, but also doing this with definite “gusto.”

Yandex is nothing like a merely surviving upstart: It invents top-notch services, expands internationally and is not afraid of getting into direct competition with established players (as demonstrated by the launch of the analogue of the popular Foursquare geolocation service a few days ago).

But the market of “search” is monetized essentially through small ads from millions of enterprises across the country, and this model can be vulnerable in view of the overall economic situation. Sales will hardly contract, but slowing down from high double-digit growth to something much more modest may be a realistic scenario. This will have negative consequences for the company’s valuation. (See more on the strategy at Yandex and the challenges it faces here).

Another star market of the World Startup ranking is the media and communications market (which includes, as noted earlier, the social networks). This is also the one that is having the most complex relationship with Russian politics. Here, the investors’ perception is that policy makers too often get too preoccupied with the issues of control over the content of users’ political loyalty (this was largely the interpretation of the change of management in VKontakte, the Russian social market leader).

The danger for the business can come through the apathy of consumers as it is diversity (and even conflict) that generates attention, involvement – and monetization. Once again, there is no serious question of contraction of sales – but in the world of valuation by investors, it takes all the running you can do just to remain in place. Slowing down may lead to negative consequences.

Two segments were designated in the report as the global growth drivers, B2B and SaaS (software-as-a-service), and here the Russian practices and beliefs seem to be strong barriers to development. Russian B2B purchases tend to fall out of the global trends. Corruption does play a role, but more important are the issues of a “competence gap” with the regions that we touched above.

While the HQs of the key businesses are located in the “center” they buy for the specifications of the regional “field operations.” Statistically, we end up with hugely disproportional investment into hardware (up to 65 percent, about twice more than the global average) and underinvestment into services and consulting as compared to the developed economies. Ironically, this structure of corporate purchases concentrates the demand precisely in the area where Russia is least competitive internationally.

As for SaaS – which is largely just another way to say “cloud” – our cultural obsession with “security” means that this is largely a non-starter. Well, everyone needs and wants to be secure, but the Russian approach is never about reasonable assessment of risk. It seeks the elimination every theoretical possibility of “wrong doing” – and after this throws in a couple of additional security procedures, just in case.

Within such an approach anything which resides on someone else’s servers can never be trusted. It is only the bravest of the small business which dare not to get mesmerized by “questions of security” – as demonstrated by the growing popularity of services like Knopka (developed by it offers an innovative view on the outsourcing of business bookkeeping). However, it is really doubtful that SaaS will grow into a strong market in Russia in segments other than end-consumer applications or very targeted technical systems (where it is sometimes the supplier who dictates the modus operandi).

So when Russian companies develop an effective SaaS product – there are enough of examples – they look to target it on the exports markets, such targeting immensely puts them into the risk zone for “business emigration.”

In summary, Russian’s tech leaders have done a remarkable job of transforming the scientific and technical legacy of the Soviet Union into modern business assets. Yet it looks like now we are approaching the point where this same legacy becomes a barrier to future development. To move forward, we need to re-structure and reconsider the type of mindset required for the digital world.

Overcoming the limits of your own mindset is the greatest possible challenge, and this is precisely the issue if we speak about nurturing and accelerating the further development of Russia’s innovative online businesses. We need to build better living environments, acquire new competencies (which can go against our own educational background) and throw away some cultural beliefs that seem so obvious to us right now.

Can we do it? Insightfulness, tact and business pragmatism are required for anyone attempting to influence and shape the process.

The opinion of the author may not necessarily reflect the position of Russia Direct or its staff.