The Russian Internet Economy

20.02.2013

While in 2011 the Internet economy accounted for just 1% of Russia’s GDP, it was expected to grow at a rate of about 30% in 2012. Russian IT companies are going global. Some Russian national giants are buying foreign assets and considering a gradual expansion into foreign markets.

The Russian Internet economy is demonstrating a substantial rate of growth, one that is significantly outperforming the rest of the domestic economy. According to joint research by the Higher School of Economics and the Russian Association of Electronic Communications, while in 2011 the Internet economy accounted for just 1% of Russia’s GDP, it was expected to grow at a rate of about 30% in 2012. According to BCG reports, the Internet contributed to 1.9% of Russian GDP in 2010, and is expected to grow by up to 2.8% by 2016. E-commerce, which combines retail and electronic payment systems, accounts for the large majority of the Internet economy, but other segments are also growing. Advertising is the fastest growing part of the Russian Internet economy, growing at a rate of 50% annually. 

The reasons for the growth are obvious: as IT and telecommunications infrastructure is developing steadily, more and more Russians are getting access to the Internet, via either a computer or their mobile devices. The country currently has more Internet users (in absolute terms) than any other European country. While currently 37% of the population is connected, the figure is expected to reach 71% by 2016, with 100 million Russians online. The country’s retail market is booming, fueled by oil and gas prices. 53% of Russians say they are Internet users and 39% of Russians use the Internet on a daily basis. According to the WCIOM national polling service, 29% of respondents have experience of online shopping, spending on average around US$210 online in the last three months of 2012 (double the figure for the same period of 2011).

Another reason the Internet economy is growing significantly faster than other industries is improving regulation. According to the Ease of Doing Business global ranking, Russia is ranked 121st globally. However, Russia’s main problems are international trade (162nd place), construction permits (178th place) and getting electricity (184th place). Registering a business, enforcing contracts, protecting property and paying taxes are ranked much higher, which essentially means that Russia's Internet businesses exist in a better regulatory environment than the rest of the economy. It is also worth emphasizing that Russia has no “Great Firewall” like China’s: Facebook, Twitter and YouTube are not banned.

According to the IT industry manager at the World Economic Forum USA Elena Kvochko, there are two main reasons why these companies are successful, apart from business efficiency. First, there is less regulation in the Internet market than probably in any other sector of the economy. That allows the best talent pool to be attracted and minimizes non-business-related expenses. Second, large Russian Internet projects, such as Yandex and Mail.ru, are often targeted at Russian-speaking audiences. Complicated Russian language semantics and Cyrillic spelling create a cultural competitive advantage for companies aiming at their local market, and they also arrived in the market first. Senior Partner of the Ward Howell international HR consultancy, headquartered in Moscow, Anton Derlyatka, says that “IT attracts the best people from all industries as it offers a lot of room for creative development. We have recently started a venture capital fund specializing in HR, called Talent Equity Ventures, and I can say that there are a lot of great projects combining HR and IT out there that can be globally competitive.”

There is also a relatively new phenomenon that has arrived almost unnoticed, but is becoming increasingly influential. Russian IT companies are going global. Some Russian national giants, such as Mail.ru and Yandex, are buying foreign assets and considering a gradual expansion into foreign markets. For instance, Russia’s most popular search engine Yandex made a foray into Turkey in September 2011. Many Russian startups are now aiming at the global market rather than the domestic. Increased ties between Silicon Valley and Moscow have encouraged IT entrepreneurs to apply for international venture capital support. Global venture capital funds are, of course, more interested in companies competing in the global market. Partially for that reason, young Russian IT companies are increasingly international in terms of their ambitions, business models and financing. According to Alexei Vorobyov, CEO of Usalytics, an Internet marketing startup company, there is more potential in the global market if you are competitive and ambitious enough to aim for it. “We can grow to become a US$50 million company in Russia. But why do that if we can just as well become a US$200 million company in the global market within the same timeframe, if we aim for that from the very start?”

As in many countries, in Russia financial and other support is easier to find the bigger you are. Foreign investors have been keener on Russia than foreign operators. Yandex raised US$1.3 billion when it was floated on the NASDAQ stock market 18 months ago; Mail.ru raised more than US$900m in London in November 2010. Western venture capitalists have bought stakes in the most promising e-commerce companies, including Ostrovok and Ozon. But local angel investors, who put money into the youngest companies, are far rarer than in America, Western Europe or China.

At some point of growth, Russian IT companies face a choice: they either have to offer domestic clients a wider range of services or expand into the international markets and stay focused on their essential value proposition. More and more Russian companies are choosing the second path, becoming “Russian Mittelstands.” The term comes from Germany where medium-sized technologically advanced companies compete for global leadership in very small market segments. There are many young talented IT teams in the Russian market that do not yet share that ambition. The Ministry of Communications and Mass Media is trying to support those companies. According to Deputy Minister Mark Shmulevich, improving conditions that allow Russian IT companies to expand internationally is one of the priorities of his work. “We see global growth not as an opportunity but as a necessity for those IT companies that are ready to compete globally. Actually, we see that the majority of the best early-stage companies are globally oriented from the very beginning, which is good. However, whenever they decide to start global expansion, they benefit if it is easy to work internationally from Russia, if they have easy access to knowledge on best practices in working abroad or, say IP right protection. Outstanding IT entrepreneurs from Russia have all it takes to become global leaders. We need to give them a hand”.

Internationalization is an obvious path for further development of specialized medium-sized globally competitive companies. However, there is a slight reluctance among the Russian leadership to support that policy as the Youth Affairs Agency and Ministry of Education and Science fears a brain drain. It is known that Russia can draw from a deep well of mathematical and scientific talent. Although the overall number of Russians in IT industries abroad is smaller than other nationalities, some representatives of the ruling elite are still cautious about Russian IT specialists moving to the West. However, IT professionals say that moving a company across borders, especially an IT company, is easier than moving a person. At some point in their development, many companies may consider relocating outside Russia, as conditions elsewhere may prove more favorable. In the end, the market does not always go where officials would like it to, especially in the free-spirited Internet. And there will be plenty of demand to meet at home.

The authors are laureates of the Valdai Club Foundation Grant Program. 

Views expressed are of individual Members and Contributors, rather than the Club's, unless explicitly stated otherwise.

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