International investors are looking closely at Russia. If you are, you might want to wait until there’s a Russian entrepreneur next door. Or you might not.
Russia is an almost incomprehensibly large country. Stretching eastward from Europe across 11 time zones and almost 17 million square kilometres, it is roughly twice the land size of China or the US. It has an estimated population of 145 million (July 2005), roughly half the population of the US and about a 10th of that of China.
Are Russia’s vast size and its relatively small and declining population a hindrance or an advantage?
In terms of economic growth, technology development and FDI, it is a considerable hindrance. One reason is that the extreme distances of the Russian Federation make communication, much less collaboration, a serious challenge. Another is the vast areas where there are no people or cities: much of eastern Russia is uninhabited.
Since 1724, Russia has had an interesting way of overcoming these challenges. In that year, Peter the Great set up a vast and far-flung system of institutes and research facilities to provide a highly collaborative and interconnected network of scientific and technological hubs, compartmentalised according to discipline: the Russian Academy of Science (RAS).
The RAS helped the former Soviet Union to compete against the US for almost 50 years. Without the military developments emanating from the RAS over the decades, the Soviets would not have kept up. The pure science and technology behind these military developments has been harnessed and readied for commercial purposes. However, a startling development has hurt Russia: there is nowhere to go.
That is the case internally, at least. There is little indigenous venture capital, a general misunderstanding of the power of entrepreneurship, intense hatred of anybody who is financially successful and, lastly, although the Russian government talks a reasonably good game in its public statements, it is prone to overregulate, overtax and underprotect its burgeoning small business sector.
Slanted playing field
Russian businesses and entrepreneurs are expected to survive pretty much alone and to overcome the slanted entrepreneurial playing field. This environment could help to create some of the world’s most robust entrepreneurs – if they can survive the start-up and infancy phases to begin earning some revenues.
There are many successful businesses inside Russia and a few successful ones operating outside the country. But there are nowhere near as many operating inside Russia as there are, say, in Japan, Germany or the US. If the natural resource-based, formerly privatised, now partially renationalised oil and gas companies are excluded, the figure is even smaller – they make up a huge share of the Russian economy.
There are only three possibilities for a Russian entrepreneur, scientist or businessperson with ambitions of fame, wealth and glory:
- They can remain inside Russia and strive to build their business domestically.
- They can try to establish their business at home initially, then move to a European country in a ‘stepping stone’ strategy for leaving Russia altogether.
- They can focus on starting and building their business entirely abroad.
An inordinately high percentage of foreign-educated entrepreneurs never return, and if they do, they do not conduct their businesses in Russia. One reason for this is that once they have tasted the competitive and success-oriented pleasures of the capitalist west, few want to face the much harsher and more difficult business environment in Russia.
The reason why this dynamic is so important in terms of inward investment is that there is a direct correlation between the number of exiting entrepreneurs, scientists and students, and the investment opportunities remaining in any particular country suffering a brain-drain.
The Irish example
The Republic of Ireland in the early 1990s is a good example. Suffering 19.8% unemployment, its economy was teetering on the brink of disaster (many would say it had already teetered too far).
Enter the EU with funding galore for Ireland, just in time for the Irish to execute a coup de grâce. Understanding that bright Irish minds were accustomed to getting themselves educated in Singapore, Stockholm or San Francisco, then not returning to Ireland, and knowing the difficulty of breaking a long-held tradition, the Irish did the only thing they could. They made returning to Ireland highly attractive from an employment, economic, career and entertainment standpoint. A revitalised economy, invigorated employment market and the establishment of quality nightlife areas such as Temple Bar in Dublin completed the transformation.
Russia could and should do the same. This is an important investor scenario that must be understood before investing in any region.
One man provides an excellent example of the migratory path that many Russians must take to make anything of themselves, their technology or their business ambitions. He is Dr Valentin Gapontsev, founder and CEO of IPG Photonics. He worked for many years in the RAS Institute of Radio Electronics, specialising in laser technology and could have ended up working his whole life in those austere halls. Instead, in 1991, he started up his company, then called NTO IRE-Polus, in a basement of a small research facility outside Moscow.
The upsides of Mr Gapontsev remaining in Russia and trying to build a flourishing business were few. The downsides, however, were significant. He got no help from the government, unlike an entrepreneur in the UK, US or Asia might have. There were no tax incentives, no incubators, no public-sector/private-sector initiatives and no government-influenced environments for entrepreneurial development.
So Dr Gapontsev made a momentous decision to expand his company outside of Russia. In 1992, he won a development contract with an Italian company, which gave him an insight into the opportunities available. Next he worked with a German company, which led to his setting up a facility in Germany in 1994.
Between 1993 and 1999, IPG Photonics, headed by Dr Gapontsev, developed, modified and increased the power of fibre lasers, which are set to be a major innovation in industrial sectors as diverse as medicine, telecoms, construction and underwater welding. Few other than Dr Gaponstev could foresee that this new fibre-laser technology would represent a threat to legacy laser systems such as CO2 and YAG.
In 2000, almost $100m in investment capital for IPG Photonics flowed in from Merrill Lynch, Apax Partners, TA Associates, Marconi and Robertson Stephens to help fund company growth, and to allow Dr Gapontsev to adopt vertical integration and begin manufacturing IPG’s own laser diodes and fibre products. These risky decisions turned out to be IPG’s only saving grace when, shortly into 2001, the telecoms crash took place and the company lost 60% of its business virtually overnight due to the sector’s troubles.
Today, Dr Gapontsev and IPG Photonics have a thriving global business based in the US city of Oxford, Massachusetts. Revenues for 2005 were $96.5m, a solid 59% increase over 2004, and although the private company does not disclose profits, margins are reportedly quite good.
The future for IPG is bright: it owns more than 65% of the skyrocketing fibre-laser market, which is growing at a robust 53% year-on-year and fast replacing obsolete laser technologies. It employs more than 800 people worldwide and counts Boeing, Sony, Nissan, Gillette, Lucent, Siemens and Nasa as flagship customers.
Dr Gapontsev took his early invention of a 4-watt fibre laser to a 36-kilowatt monster. In 1990, he was already talking about a 100kw model, which many laser scientists dismissed as almost impossible to build. He insists that 100kw models are on the way.
The company has maintained some operations in Russia since its inception and still has more than 240 employees there. However Dr Gapontsev and IPG Photonics are only one example of entrepreneurial migration from Russia – unfortunate for Russia’s economy but fortunate for the final destination’s economy.
The exception that proves the rule is Roustam Tariko, founder of the Russian Standard brand of vodka and banks. Mr Tariko has been called the ‘Russian Richard Branson’, and has been the rare subject of two INSEAD (the France-based business school) case studies, proving it is possible to succeed in Russia with proper determination and stamina.
Just as Ireland had to find a way to stop the haemorrhaging of its native intellect to other lands, Russia needs to approach this problem with the same intent and urgency.
Russia possesses a depth of technological, scientific and commercial talent but the big problem is that it is not working this homegrown brain-power to its advantage.
There is a similar paradox for foreign investors. They can take a high risk by crossing the Russian border and seeking out these rare gems or they can wait until the gems arrive in the west and put their money in with a higher degree of safety.
Bill Robinson is a business commentator specialising in technology and marketing issues.