The Russian Offshore Software Development Market

Dr. Susanne Sternthal

Soon after the Soviet system collapsed in 1991, “the end of history”1 quickly became the aphorism used to describe the seismic geo-political events of the time. More than ten years later, the revolutionary changes in information and communication technology industries (ICT) and the spawning of an expanding, and seemingly limitless cyberspace within the Internet have given rise to another adage: “the end of geography.” The Internet has surmounted many of the limitations of time and space that hampered the conduct of international business only a few years ago, and its potential cannot yet fully be grasped.

The ICT sector is among the fastest growing globally. More than $2 trillion was spent worldwide in 2000 and it has been estimated that these expenditures have been growing at about 8% annually during the 1990s, or more than twice the rate of the growth of the global economy.2 This has changed the conduct of business greatly, including a part of the ICT industry itself: offshore software development, that is, finding contractors or wholly-owned facilities abroad with lower labor costs to provide software programming and engineering services. Much in the way manufacturers began to relocate parts of their operations to Mexico, the Philippines and China in the 1970s and 1980s, some companies began to look at outsourcing their software development beginning in the 1980s. This market has been spurred further by the fact that by 2003, according to a U.S. Department of Commerce report, there will be some 1.4 million jobs in the ICT sector in the United States that will go unfilled.3

Until recently, the growing market of offshore software development has been dominated first and foremost by India, and to a lesser degree, Ireland and Israel. In recent years, however, Russia has made substantial inroads in the market for offshore software development. The Russian offshore software development industry is concentrated in the universities of three major cities: Moscow State University, St. Petersburg State University and Novosibirsk State University. Both St. Petersburg and Novosibirsk have formed consortia to promote their local software industries (Fort Ross Information Technology Services and Siberian Information Technologies Center, or SibIT, respectively). While India’s outsourcing market is more mature, having grown from $110 million in revenues in 1990 to about $6 billion in 2000-2001 (and accounts for more than 10% of the value of all Indian exports), Russia’s is expanding at a rate of up to 60% annually, having generated between $60 million and $100 million in revenues in 2000 (and where all of the information technology sector comprises only 0.61% of the economy). By the year 2003 Russia is expected to have about $500 million in offshore programming contracts, the vast majority of which will originate from Moscow, though the St. Petersburg market is quickly advancing.4

Why Russia?

What has drawn companies such as Boeing, Sun Microsystems, Intel and Motorola, among others to Russia? Lower labor costs are just part of the attraction. While a U.S. programmer earns $60,000 annually on average, his/her Russian counterpart earn about $10,000 a year (these wages are comparable to those earned by Indian programmers currently). The greater draw is that Russia is a gold mine of talent. The country has more personnel working in R&D than any other country and ranks third in the world (according to World Bank, UNESCO statistics) for per capita number of scientists and engineers, after the United States and Japan. Moreover, Russian scientists and engineers have been molded by their political and economic system (notwithstanding the transformations over the years) to be creative problem solvers. Some have come from the previously well-endowed military industrial complex and have skills using different technologies and working on complex projects such as satellite communications, nuclear rockets and power stations and the building of complicated control and monitoring systems for various energy and power projects. This depth of experience is what distinguishes Russian software engineers from their counterparts anywhere else in the world. The younger generation are naturals at computers and consistently win top awards in international math, engineering and programming contests.

This scientific and technical facility among Russian engineers convinced Motorola to open a St. Petersburg Software Development Group, which is one of 20 such global software development centers the company has. Motorola began working in Russia in 1993 with a small group of programmers in St. Petersburg. Its center finally was opened in 1997 with a staff of almost 200 software engineers, doubling in size in 18 months and the company expects to hire 300 more in the next two years. The software engineers at the St. Petersburg center work on a variety of projects that include: embedded software for operational systems and applications; behavioral models, simulation models and tools; embedded software for telecommunications; and Java technology for Motorola platforms. Even though Motorola also has well established centers in Hyderbad and Bangalore, India, where, together, it employs 700 developers, it is pleased with the high caliber of talent and motivation of the workforce at its St. Petersburg center, not withstanding the number of real obstacles of doing business in Russia.5

The Obstacles

Despite a good deal of progress, there are still a number of difficulties that face a prospective company interested in outsourcing software in Russia. Chief among these problems is Russia’s ill-defined tax and regulatory environment. Using the case of Motorola as an example once again, the company tempers its glowing report by candidly pointing out several “showstoppers” to its doing business in Russia. On the regulatory side the laws are arcane and customs regulations are extremely complicated. The same is true of the ambiguities in the tax law and the endless number of taxes: investment tax, capital tax, pay roll tax, excess wage tax, retroactive taxes and VAT. Motorola is negotiating with Russian tax authorities over the definition of a “software product” in its effort to try to get a VAT exemption on exported products. All in-coming equipment into Russia must conform to Russian standards and carry a conformity mark, indicating that the product has been tested and shown to conform to minimum safety and quality requirements. Because of these stringent regulations, Motorola’s equipment that is slated to be used solely for simulation and research purposes is waylaid for three or four months before the necessary paperwork certifying its safety and meeting Russian standards is completed.6

There are other problems. Though the quality of work of Russian software engineers is excellent, Russia does not have an independent certification organization that attests to their quality by providing CMM or ISO certifications, which verify that the software product meets international manufacturing quality control standards. In contrast, India has the National Association of Software and Service Companies (NASSCOM), which is one of the strongest industry groups in the world, and has successfully lobbied the Indian government for favorable tax and regulatory changes. Russian software developers are interested in forming a comparable organization, but it will take some time before it becomes effective. Some Russian software development companies, nonetheless, have sought to become certified and have acquired the international certifications.

The protection of intellectual property rights in Russia is a concern that is frequently raised. It should be noted at the outset, however, that there have been no problems with intellectual property rights in the area of offshore software development. Though piracy is a major problem with music, video, foreign-manufactured software and publishing products, no foreign company outsourcing software development in Russia has reported infringements in intellectual property. Though Russia has a legislative framework providing protection of various intellectual property rights that has been in place for many years, and though it belongs to most of the international conventions that protect intellectual property rights, Russia’s enforcement of these laws is inefficient and lax. The problem is not the lack of laws, but rather of a culture at large that traditionally has never placed much currency in the notion of intellectual property. In this regard, the nascent information technology industry in Russia, and the offshore software development sector stand apart. This area, over many others with which foreign investors are involved, enjoys a greater degree of transparency and has more of a “western bent.” The simple reason for this is that this budding sector of the Russian economy is dominated by young people who have not been tainted by the Soviet system. Computer savvy, curious and creative, this small sector of the population epitomizes the growing international tribe in the ICT field where the borders of geography, in their world and as they are defining it, do not exist.

Conclusion

At the present time, the offshore software development market in Russia is one of the most promising areas of Russia’s ICT sector (other than telecommunications) from the point of view of a foreign investor. But this is likely to change. Recognizing that its country’s future and economic development is inextricably tied with ICT, the Russian Ministry of Communications and Information Technology announced an ambitious $2.6 billion-program called “Electronic Russia 2002-2010” on July 5, 2001. The objective of the program is to have the Russian ICT sector account for 2 percent of the economy and have between $1 billion and $2 billion in ICT exports. The program will focus on easing the regulatory and legal environment, Internet infrastructure, e-government and e-education. The idea is to “wire” Russia so it can more actively participate in the international economy. The program seeks to increase the efficiency of the economy both in the public and private sectors, increase government transparency by transferring much of the state’s work online and facilitate the delivery of distance learning programs via the Internet. This program has been well received by the Russian and international business communities, and as it unfolds it will present many more investment opportunities in the fast-changing ICT field, further dissolving the boundaries between Russia and the rest of the world.

Notes

1. Francis Fukuyama, “The End of History?” The National Interest (Summer 1989).

2. Jose de la Torre and Richard W. Moxon, “Introduction to the Symposium E-commerce and Global Business: The Impact of the Information and Communication Technology Revolution on the Conduct of International Business,” Academy of International Business Journal of International Business Studies, December 22, 2001, No. 4, Vol. 32.

3. http://www.empowermentzone.com/itworker.txt, cited in Information Technologies and Telecommunications Committee of The American Chamber of Commerce in Russia, Whitepaper on Offshore Software Development in Russia, April 28, 2001, p.6.

4. Whitepaper on Offshore Software Development in Russia, p.5; Dr. Jan Dauman, “Software R&D Opportunities in Russia,” Software Development in Russia: Opportunity for U.S. Business, U.S.-Russian Chamber of Commerce of Boston conference, April 11, 2001.

5. Ibid., p. 27.

6. White Paper on Offshore Development in Russia, pp. 27-28; Marius Orlowski, “Setting Up a Motorola R&D Laboratory in Moscow,” Software Development in Russia: Opportunity for U.S. Business, U.S.-Russian Chamber of Commerce of Boston Conference, April 11, 2001.

Dr. Susanne Sternthal is the Business Development and Marketing Manager for the Russia and Central Asia Practice Group of Coudert Brothers. The views expressed in this article are hers alone.

Last Updated: June 6, 2002.
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