Russia Information Technology Report Q2 2008

Market Overview Against the backdrop of increased funding for ambitious government IT infrastructure plans, and an oil- fuelled spending boom, Russia has the potential to become one of the largest IT markets in Europe. BMI has upwardly revised its Russian IT market CAGR to 21% for the period until 2012. The total size of the IT market is now predicted to increase from US$13.1bn in 2007 to around US$31.3bn in 2012.

Accelerating growth in computer sales in 2007 after strong growth in 2006, and immense potential for IT investments by Russia's traditional industries, all provide strong grounds for optimism.

The general economic context should be favourable, with high oil prices still above their long-term trend level, and real wages showing significant gains. The political context now also appears more stable, and it is estimated that the Government has as much as US$350bn in reserves for investment to apply IT to improving areas such as education, healthcare, defence and the power sector. Increased funding has also been announced for the ambitious series of IT-oriented 'technoparks', and laws are being passed to provide tax and other incentives for companies specialising in IT.

The wild card is possible WTO entry, which would likely boost the hardware sector through cuts in taxes on imports. In any event, much will depend on the government's ability to maintain an environment conducive to further development, including an effective customs regime, low import duties, and generally transparent business environment.

Industry Developments The Russian government's spending on IT projects is expected by BMI to accelerate over the next two to three years. The Electronic Russia programme is projected to generate around US$2.4bn in spending by 2010. Meanwhile, the government's flagship 'technology parks' programme is expected to receive an additional US$850mn in investment, up from US$140mn in 2006-2007.

The Russian government is currently reviewing draft Ministry for IT and Communications (MITC) policy guidelines for the 2008-2010 period. In August 2007 the MITC submitted a report for the period 2008- 2010 which looks at ways of spending its budget more effectively. The key priorities in the ministry's proposed agenda are developing a competitive IT and domestic ICT equipment sector, increasing product turnover rates and developing IT service capabilities.

In a boost to domestic computer production, the Russian Minister of Economic Development and Trade Elvira Nabiullina has promised to eliminate the 10% duty on imported computer parts. In October 2007, duties on most types of processors were waived. Under the latest proposal, memory cards, microprocessors, cables and other parts that are currently subject to 5-10% duties will be exempted.

Competitive Landscape With PC sales growing at a double-digit CAGR over the last few years, local brands and assemblers still dominate the market. Although difficult to estimate, the share of multinationals may account for less than 10% of total sales once grey market sales, thought to be increasing, are taken into account. HP is thought to have around half. Other players include Lenovo and Dell, although Lenovo has been losing share since its buyout of IBM's PC division in 2005.

For the most part, multinational players serve mainly the government and corporate segments, leaving the retail sector primarily to domestic companies. Given the trajectory of the market most foreign vendors have still enjoyed rapid revenues growth, with leading vendor Acer expecting revenues of more than US$1bn in 2007 in the CIS markets.

Many Russian vendors are showing greater ambition to build market share. Kraftway has recently built a PC plant in Obninsk, which is expected to product 500,000 computers in the next year. Kraftway has seen steady growth on the Russian consumer market recently, and expects to eventually expand production to 3mn units a year.

Hardware Driven largely by notebooks, computer sales grew strongly in 2007. The true numbers are hard to ascertain because around 20% of PCs sold in Russia are self-assembled. BMI estimated that the hardware market grew from around US$5.5bn in 2006 to US$6.9bn in 2007. The main driver is falling prices, but growing internet penetration is now becoming an additional factor in some areas. Service providers are therefore joining forces with electronics retailers to benefit from the chain. Most recently Sky Link, the largest CDMA provider in the CIS, announced a joint initiative with retail electronics giant Eldorado on co-operation. Under the agreement, Eldorado will sell notebook equipment preinstalled with high speed modems supporting Sky Link's datacoms and internet access services.

In February 2007, the MITC launched a new 'computer for every home' programme. With average monthly earnings at around the US$400 level, inhabitants of the remote regions will be able to order computers at a set price of around $300-350, at least 10% below the lowest market prices. Russian as well as foreign manufacturers may participate in the scheme, and schools are also permitted to take advantage of the programme to acquire computer equipment. Hardware spending CAGR in the next five years will be in the region of 13%.

Software SAP has announced that it is to open a new software development centre in Russia to improve access to customers over the next two to three years. The domestic software market was worth US$1.4bn by the end of 2007. Although Russia has the fifth-highest software piracy rate in the world (87%), BMI expects that government efforts to strengthen IP protection as part of WTO entry will see this decrease closer to average Eastern European levels, boosting the market to US$2.6bn by 2010. In addition, the rapid growth of internet penetration is stimulating demand for security solutions, while there is growing demand from the corporate sector for enterprise resource planning (ERP) and customer relationship management (CRM) applications. The corporate market is moving beyond demand for single function applications such as accounting, to broader solution packages, and not only large and medium but also smaller enterprises offer potential for development.

The small business market is emerging as the primary battle ground for enterprise application vendors in the Russian market, with local companies emerging to challenge the multinationals. While market leaders SAP and Oracle primarily focus on the large Russian organisational sectors, the rise of local companies such as automation-management software vendor IC has been fuelled more by concentrating on smaller Russian businesses, which have traditionally considered such applications beyond their means. Now SAP in particular is starting to develop an interest in the small business market.

Services Russia's IT services sector is growing, from a low base, with BMI calculating a value of about US$2.8bn in 2007, up from US$2.2bn in 2006. The IT services sector is expected to grow at a CAGR of 22% in the period up to 2012. Russian vendors continue to dominate the market, with companies such as Croc (the market leader), R-Style, Open Technologies, Borlas, Optima and Lanit all in the top ten, along with HP. Other foreign vendors such as IBM, SBS and Logica-CMG are also winning significant contracts, however, and the market remains diffuse, with the top 40 companies accounting for less than 50% of spending.

Special Focus: Techno Parks The 'technopark' programme is the government's flagship policy for development of the IT sector. A new phase of funding for 2008-2010 worth some US$850mn has recently been announced. For details see the 'Industry Developments' section of this report. The main construction phase began in 2007, with a federal budget of around US$74.68mn initially assigned for the project, which is being co-ordinated by the Federal Agency for IT (see below).

The 'technoparks' were initially intended to be exclusively 'IT Parks', but are now open to enterprises in other sectors such as nano- and bio-technology, as well as Information Technology. A plan was approved in March 2006 to construct the parks in seven regions, and it is expected that the parks will employ 19,000 people by 2008 and 75,000 by 2011. Investment will be US$985mn, and the Russian IT Minister predicts that the output of the technoparks will be US$749mn by 2008, reaching US$4.4bn by 2011.

Intra-departmental wrangling over budgets has caused some delays to the project, and to get the programme approved the sponsoring MITC had to make several compromises with the economic development and trade ministry. State financing is expected to make up only around 20% of the funds required by the programme, which overall are likely to exceed RUB100bn. Another proposal floated at one stage - for tax breaks - was not included in the current programme. Each of the technoparks will have a management company and a board, which will include members of the federal and regional executives and IT entrepreneurs.

E-Readiness The government's ambitious policy is that every locality in Russia should be provided with fixed line telephony infrastructure, cell phone coverage and internet by 2015. According to the ministry's target, every populated area in the country should be provided 'irrespective of its economic 'weight' and population'.

The internet penetration rate per unit of population was estimated by BMI to have reached around 21.4% by end 2007, representing around 30mn internet users, up from 26mn users in 2006. By the end of 2007, BMI estimates that there will be around 23mn broadband users, mostly DSL.

Russian IT and Communications minister, Leonid Reiman, has described the 'digital divide' as a very challenging issue for all Commonwealth of Independent States (CIS) countries, and one that the Russian government was seeking to overcome. Out of 150,000 populated settlements in Russia, 40,000 towns and villages do not have telephone services, but according to Reiman, there will be no neighbourhoods without telephone services left in Russia by 2008.