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Press about Auriga

May 31, 2002

Software outsourcing still faces hurdles

The Russia Journal,
Vladimir Kozlov

On the eve of the second Software Outsourcing Summit, which is scheduled to take place in St. Petersburg in early June, Russia’s software industry is struggling to establish a presence overseas. But it faces the aftershocks from the global IT industry’s plunge back to earth, market skepticism due to the obscurity and small size of most Russian software companies, and its own lack of sales and marketing skills.

Despite the hurdles, many domestic software companies and individual programmers are willing to try competing on foreign terrain, with the United States and northern and central Europe set as their main targets.

Analysts say the share of offshore software development in the total business of Russian programmers is likely to increase from 31 percent in 2001 to 35 percent in 2003.

There are about 100 companies that regularly develop software on order from foreign customers, according to a recent study by the Moscow research firm Market-Visio/EDC. There are also thousands of smaller companies and individual programmers in the industry, although analysts say the exact number is unknown.

Geographically, Russia has three centers of offshore software development – Moscow, St. Petersburg and Novosibirsk, a city in western Siberia. Most major universities that teach programming and computer science are located in these three cities, creating a talent pool for the IT industry.

Most Russian software developers with overseas clients are based in Moscow. The average number of employees at a software-development company in the capital is 45, compared with 30 in St. Petersburg and 35 in other Russian cities. In Moscow, the proportion of firms with a turnover of at least $3 million is just slightly more than 30 percent, compared with 13.6 percent in St. Petersburg and 15.4 percent elsewhere.

Despite its huge potential, however, Russia’s software-outsourcing industry has had a rough ride lately.

The bursting of the IT bubble on financial markets over the past two years was had a strong effect on Russia, said Anatoly Gaverdovsky, chairman of Moscow-based Vested Development Inc., or VDI.

"As soon as the IT boom was over and the crisis began, many small companies didn’t have any work and had to resort to slashing prices," he said. "As a result, companies are struggling for survival, with no cash to reinvest in development."

Alexis Sukharev, president of Auriga Inc., said the current market is lean for all software developers, including Russian ones, because of the drastic downturn in the global IT industry. Foreign tech firms are spending far less on development than in 2000 and 2001, which means local developers’ budgets are tighter than ever.

"Consequently, the world IT offshore-outsourcing industry did not grow during last year as fast as expected, and Russia is not an exception," he said.

Research backs Sukharev’s contention. According to Market-Visio/EDC, revenue in the domestic software-development industry last year was up 20 percent from 2000, to $154 million from $126 million – far less than the 50-60 percent rise that analysts had forecast.

"The Russian software market has slowed down, and significant growth is now out of the question," Gaverdovsky said. "Overall, the prospects are not rosy, but there is sustainable demand for IT products and services, and the sector could develop rather quickly, if properly organized.

"Russian companies need to look for niches in which they could specialize, gaining experience and stepping up quality so they could compete not only in price but also in other terms," he added.

Predictions are still optimistic. The Russian software-development industry could double its size by 2003, generating nearly $350 million in sales, analysts say.

Recently there has been a discussion about which model is more suitable for Russian offshore software developers – the Indian model, in which software companies or individual programmers work under contract for overseas customers, or the Israeli model, in which finished software products are exported.

Today, the Indian, or contract, model accounts for about two-thirds of all of Russia’s software exports, with the Israeli, or product, model making up almost 9 percent. The rest of Russia’s software exports – about one-quarter of the total – involve a combination of the two models.

According to Market-Visio/EDC’s research, about 60 percent of Russia’s offshore software developers say they have no plans to switch from the model they’re currently using.

"There is a lot of confusion now," Auriga’s Sukharev said. "People are saying that there are different models in the IT industry, product and contract models, Indian, Scandinavian, Irish, Israeli models, and then they give their recipes. Let’s make expensive products for the West rather than work on cheap Western contracts, or let Indians do cheap coding. Our niche is projects with dominant science/high-tech/math components."

Along with the debate over which production model best suits their industry, Russian development firms face many other challenges in their foray into markets overseas.

Among the most important, said Sukharev, is the need to establish and promote recognition of individual brands while drumming up interest in Russia as a potentially huge place for IT companies to outsource software projects.

"My encounters with people responsible for outsourcing at large and sometimes medium-size companies have shown that in many cases when they talk about offshore they think of India," the executive said. "Sometimes they would add the Philippines or China or someowhere else to their offshore list, but seldom Russia."

The relatively small size of Russian software firms, including the major players in the sector, also may cause some prospective customers to think twice before striking an outsourcing deal here.

"It is difficult – not impossible, but really difficult – to make a Fortune 500 company think of an offshore firm with fewer than 500 employees as a serious outsourcing partner," Sukharev said. "Industry consolidation is on the agenda, but it is difficult to achieve because of the mentality of the founders within the young Russian IT industry."

As for longer-term prospects, many industry insiders are more optimistic. "As for the next few years, I think that our prospects are good," Sukharev said. "We have the potential and the resources to get a much more sizable share of the market than we have now. A good legacy in the science and technology field, [Russia’s] strong and large educational system – these are the factors that are usually mentioned and they are really important in reaching that potential.

"But if we want to really increase our market share, we should understand that we have to follow the market rather than trying to find niches of perceived Russian dominance. Some industry insiders still believe in a good future for the segment."

Dmitry Loschinin, managing director of Luxoft, a Moscow developer that outsources for U.S.-based aerospace giant Boeing Co., among others, believes the sector can withstand the reduced demand and then grow rapidly.

"Today the Russian software development outsourcing market enters a stage of growth after the recent recession due to the economic downturn in the United States, the major consumer of outsourcing, which was aggravated by the tragedy of Sept. 11," he said.

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