Macroeconomic Overview
Russian macroeconomic trends, including the overall growth in the economy and in the markets in which the Group operates, influence the Group’s results of operations.
|
Year ending 31 December |
|
2009 |
2008 |
2007 |
| GDP Growth in percentage (GDP on constant prices) |
-7.9 |
5.6 |
8.1 |
| GDP Growth in percentage (GDP on current prices) |
-5.4 |
24.6 |
23 |
| Inflation, average consumer prices (percentage change) |
11.6 |
14.1 |
9 |
| Unemployment rate in percentage |
8.4 |
6.4 |
6.1 |
Sources: International Monetary Fund, OECD
Between 2002 and mid-2008, the Russian economy benefited from exports of oil and oil products, natural gas, other natural resources and commodity products and high oil, gas and commodity prices on international markets. Domestic economic growth during this period also contributed to growth in Russia’s federal budget surplus, which has been a significant factor behind federal government spending and the development of Russia’s infrastructure. These factors resulted in a 29.7 % increase in US$ terms of the Russian IT spending in 2007, as compared to 2006, and a 22.9 % increase in US$ terms in 2006, as compared to 2005, according to IDC. With the onset of the global financial crisis in mid-2008, these trends have reversed, causing massive cutbacks on IT spending in Russia and globally. Whereas, according to IDC, the Russian IT spending slowed in 2008, however still showing the growth of 9.5% year-on-year, in 2009 it contracted 42% year-on-year in US$ terms. See Russian IT Market.
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IT Market Structure
Generally, the IT Market consists of three segments: hardware and peripherals, IT services and software. The Group primarily operates in the IT services and software segments.
IT Services Sectors
According to IDC, IT services worldwide comprise the six major sectors as set out below. In practice, the distinction between the sectors is not rigid and there tends to be an overlap of products and services among certain of the sectors. Furthermore, IT projects typically involve the delivery of services across a number of the sectors. IDC characterises the major sectors in IT services as follows:
- IT consulting. Services in this sector primarily involve the development of IT strategy and IT maintenance planning. Examples of IT consulting include IT operations assessment, determining the best technology to meet a company's order fulfilment requirements, IT design and architecture and IT supplier assessment. Worldwide leaders in this sector in terms of number of projects and number of consultants include Accenture and CSC.
- System and network integration. Services in this sector include the planning, design, implementation and project management of IT solutions tailored to clients' specific technical or business needs. Such services typically involve systems and custom application development and implementation as well as network planning, design, installation and configuration. These projects typically involve different platforms and technologies, and the IT services contractor is responsible for integrating the relevant hardware and software within the client's IT infrastructure and may act as reseller of that hardware and software. BearingPoint and Sapient are among the leading international service providers in this sector in terms of number of projects and number of consultants.
- Application development. Services in this sector relate to the design and creation of software. The sector breaks down into two sub-sectors: Application Consulting and Customisation which involves the customisation and enhancement of packaged software applications for specific business requirements of clients; and Custom Application Development which involves developing and maintaining bespoke software applications and interfaces for the specific business requirements of clients. BearingPoint and Accenture are among the major international providers in this sector.
- IT outsourcing. This sector of IT services covers a wide range of services, involving the long-term management, enhancement, maintenance and operation by a third-party of all or a part of a client's IT functions, infrastructure and applications (excluding business processes outsourcing). EDS and IBM Global Services are among the major international providers of outsourcing services. This sector also includes Offshore Software Development. See also "– Offshore Software Development”.
- Support and installation. This sector includes the installation, configuration and maintenance of hardware and software. Service providers in this sector also render ongoing customer support and distribute new product releases and updates. Some of the global hardware and software producers, such as HP and Oracle, are among the leaders in this sector.
- IT training and education. Services provided in this sector cover training for all IT products, with a particular focus on packaged software and data communication. This sector also includes training in IT technical skills and professional IT certification.
The Group operates in all of the above sectors, except for IT training and education, whereas systems integration applications development and IT outsourcing, namely outsourcing of software development, are the major segments for the Group.
Software Market Sectors
According to IDC, the worldwide software market consists of the following primary sectors, based on software functionality:
- System infrastructure software. Such software focuses on managing the computer resources for the end user or enterprise (including network management), storage, improving security, and operating hardware on which applications are built.
- Application software. Application software includes consumer, commercial, industrial, and technical programs and codesets designed to automate specific sets of business processes in an industry or business function, to make groups or individuals in organisations more productive, or to support entertainment, education, or data processing in personal activity. The application sector includes the consumer, collaboration, content, and enterprise applications subsectors; the enterprise applications market, in turn, consists of the enterprise resource management, supply chain management, operations and manufacturing, engineering, and customer relations management software.
- Application development and deployment software. This sector includes software, tools, and development environments used by developers, business analysts, administrators, and other computer professionals to create, deploy and manage both Web-based and traditional software applications Selling licences remains the key driver for software revenues. This revenue stream is also complemented by maintenance and subscription sales. IDC gives the following definitions for these revenue streams:
- Licence revenue includes revenue collected for software licences, either limited term (lease) or perpetual, that include licences for new installations of a software product, licences for additional software options, changes to existing licences permitting more users or more computer system resources to be used by the licenced software; such changes are often necessitated by server upgrades or staff increases or conversions of licences that result in incremental additional revenue such as conversions from a fixed number of users or processors to a site or enterprise licence.
- Maintenance revenue consists of fees charged for continuous improvement of the software by repairing known faults and errors and/or enhancing and updating the product, as well as for technical support. It typically includes version upgrades, the automatic delivery of bug fixes and patches, and basic telephone support, all of which are normally delivered during a fixed, renewable term of service.
- Subscription/other software revenue consists of fees to use software products and to receive maintenance and support for those software products for a limited period of time. Subscriptions consist of bundled software and services where the fair value of the licence fee is not separately determinable from maintenance/support. This category also includes software lease or rental revenue. Through its IT Services segment, the Group is involved primarily in system infrastructure and enterprise applications software, while Group’s Online Software Delivery business is active in all software sectors.
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Russian IT Market
General Information
In the last two decades, the Russian economy has undergone fundamental structural change from a centrally planned to a market based economy. Prior to these changes, IT spending by Russian companies and government agencies was significantly lower than in more developed economies. These fundamental structural changes to the Russian economy have led Russian companies and government agencies to seek increased efficiency in their operations through the use of IT and, as a result, investment in IT services and products has increased substantially since 2002. These factors have caused the Russian IT market to develop rapidly. In addition, the proliferation of multinational companies in Russia has brought with it higher standards of business operations and processes, which rely heavily on IT systems and technology.
From 2001 until 2008, when the worldwide economic crisis broke out, the Russian IT market developed rapidly at a compounded annual growth rate (CAGR) of approximately 34 % (IDC). According to IDC, the IT spending in Russia had declined from 2008 to 2009 by 42% (in dollar values) to USD 14.5 Billion. Another market agency, Linex, estimates that Russian IT market had declined by 26% (in Rouble terms) to RUB 459Billion in 2009, as compared to RUB 620Billion in 2008. However, not all market segments were equally affected by the crisis. According to IDC and Linex, the hardware segment saw the steepest drop, falling 38% from RUB 407Billion in 2008 to RUB 252Billion in 2009, with its share in the overall IT spend in Russia in 2009, however, still remaining the largest and making 55%. Such change in the hardware sector was primarily due to aggressive cost-cutting strategies of the companies whereby new hardware purchases were one of the primary budget line items sacrificed. The IT services, which substantially grew from 2005 to 2008, were able to limit to some extent their sales deterioration in 2009 by existing contracts. Nonetheless, the IT services segment which accounted for 30% of the IT spend in 2009 dropped by 12% year-on-year in Rouble terms, and by 31% in US dollars (according to IDC). The software segment, having a share of 15% in the overall IT spending in 2009, had a slight decline of 8% in 2009according to VTB Capital. The overall decline in Russian domestic IT services and software segments was partly offset by the increase in software and services exports (by 13% in US$ terms in 2009, according to VTB Capital) as numerous Western companies reduced their software developer staff as part of cutting personnel costs and contracted external specialists for software developing projects. This turned to be advantageous mostly to Russian and Eastern European developers who were able to capture business resulting from Western companies staff reductions that also affected the higher ranking companies within the sector.
In the global context, the Russian IT market remains underdeveloped compared to those in Western Europe and North America, with the Russian IT spendings in 2009 being at the level of 1.2% of the GDP, whereas the average worldwide IT spendings made 2-2.5% of the GDP in 2009.
IT spendings as percentage of GDP in 2009:
This results in Russian IT investments accounting for a very low portion (roughly 1%) of the worldwide IT spendings.
Furthermore, the structure of the Russian IT market is still dominated by hardware which accounted for more than a half of IT spend in 2009, as opposed to the more developed European countries where the share of hardware supplies is less than one third of total spend.
The charts below represent the value of the Russian IT market, in US$ and as a percentage of the Russian GDP, and the Russian IT spend per segment in 2003-2009, respectively.
Russian IT Market in US $ billion and as % of GDP, 2001-09
Russian IT spend b/d, 2003-09 (US $) 
According to VTB Capital estimates, the Russian IT market will see a slow growth in 2010 reaching RUB 524 Billion (US$ 18.3 Billion) followed by a medium term recovery starting from 2011. These projections are based on the assumptions of GDP growth at the level of 4.9% year-on-year in 2010 and a moderation of GDP growth to 4.0% year-on-year in 2011 as well as growth of other macroeconomic indicators. Given that the IT market started recovering at the end of 2009 and that the IT markets tend to recover more quickly than the economy in general after crises, it is estimated that the IT market might perform close to GDP growth, but is still unlikely to reach 2008 levels in 2010.
Russian IT Services and Software Market Sectors
The dominant segment of the Russian IT market has traditionally been the hardware & peripherals segment with a share of approximately 55%, followed by IT services and software with the respective shares of approximately 30% and 15% in 2009. This breakdown is the opposite of that in developed European countries where the biggest segment is IT services (49%), followed by hardware (30%) and software with approximately 20% (Source: IDC).
The charts below show the IT spendings structure by country in 2009 and 2008, respectively.
IT spending structure by country 2009
IT spending structure by country 2008
Comparing the 2008 and 2009 results, IT service and software in Russia gained substantial market share as the hardware spendings dropped significantly within this period. However, the Russian IT market and the mix of spendings are still immature and the market’s focus on IT hardware investments reflects the relatively early stage of IT development in Russia. The main reason for this is that business (government) consumers or state-controlled companies are still mostly concentrated on very hardware-intensive ‘automating’ processes. In contrast to European developed countries IT investment in Russia is not yet playing a major role in enhancing competitiveness and efficiency. Due to decades of IT underinvestment, the hardware focus is particularly pronounced.
The Russian IT services market dropped by 12% year-on-year in Rouble terms and by 31.2% in USD terms in 2009 (according to IDC), still demonstrating its resilience (compared to overall IT market in Russia, which declined by 42.1% in 2009) and continued demand for IT services despite the crisis. The total revenue for IT services market in Russia amounted in 2009 to USD 3.6 Billion (IDC). According to VTB Capital’s estimates, the segment is expected to grow by 14% and 18% year-on-year (in Rouble terms) in 2010 and 2011, respectively, with its market share remaining at the level of approximately 30%. According to IDC, the IT services segment is forecasted to grow 7.9% and 14% year-on-year (in USD terms) in 2010 and 2011, respectively, with a forecasted compound annual growth rate of 16.3% for 2010-2014.
Within the Russian IT Services market, three segments major for the Group are showing the following trends:
- According to IDC, the Russian systems integration market amounted to USD 1.1Billion in 2009, which represented 31% of total IT services revenue. It is estimated that, with the Russian IT services spend becoming more mature in the next years, the market for other types of services will grow faster than for systems integration services as the market share of the related hardware segment will decline. However, on the Russian market there is still a high level of legacy software developed by the in-house IT workforce and the companies seeking to adopt new software will usually need to upgrade both their hardware and operational systems at the same time. This generates additional revenue stream for system integrators. Besides, they are often involved in integrating old hardware and software systems with the new ones.
- The application development market in Russia is estimated by IDC at USD 986 Million in 2009, being the most negatively affected by the crisis with a 34% drop compared to 2008. The forecasts suggest that the key drivers for this sub-segment in the next few years would be the replacing of legacy IT systems, and the demand for customised solutions to create competitive advantages for the enterprises.
- IT outsourcing market in Russia is estimated by IDC at USD 480 Million in 2009. Although the Russian outsourcing services have intensified in the past few years, due to the crisis the number of new large outsourcing projects has decreased. The crisis has nevertheless resulted in the increase in Russian software and services exports (by 13% in USD terms in 2009, according to VTB Capital) as numerous Western companies reduced their software developer staff as part of cutting personnel costs and contracted external specialists for software developing projects.
The Russian software market, according to VTB Capital’s forecast, is likely to see growth of 18% and 22% year-on-year (in Rouble terms) in 2010 and 2011, respectively, whereas its market share is not expected to change dramatically being at the level of 16% both in 2010 and 2011, compared to 15% in 2009. It is estimated that the demand for software in the Russian IT market will be driven by, among others, decreasing level of piracy, the decreasing cost of hardware, accounting changes leading to standartisation and customisation of nearly all business and operational processes, regulatory changes regarding intellectual property rights protection, etc.
The top five IT service providers in Russia are locally based. Russian IT service providers have local expertise which enables them to closely work with domestic customers on their IT projects, especially in the government sector and for geographically diverse Russian corporations. Russian companies therefore often act as general contractors in large governmental or defence related projects, with international vendors as subcontractors.
The table below shows, top five Russian IT services providers, ranked by market share in 2009:
| IBS |
6.4% |
| CROC |
5.7% |
| Technoserv |
5.3% |
| LANIT |
4.9% |
| EPAM Systems |
3.6% |
Source: IDC
Tax Incentives for the IT sector
Until 1 January 2010 IT companies were eligible for a reduced rate of the unified social tax if software accounted for at least 90% of turnover, where foreign companies accounted for over 70% of revenues and the companies employ on average 50 people. Unified social tax was as a rule charged on the basis of a company’s employment expenses, such as salary payments, bonuses and other employee benefits. Effective 1 January 2010 the unified social tax was abolished and replaced with insurance contributions payable by the taxpayer to various social insurance funds. The aggregate rate of social insurance contributions is currently 26% and will increase to 34% from 1 January 2011. The incentives provided to IT companies in respect of the previous unified social tax have not been carried over to the new system effective from 1 January 2010, which resulted in an increasing tax burden for IT companies that had previously been eligible for the benefits. In February 2010, the Russian President proposed a cut in the aggregate rate for innovative companies (including the IT sector) for the following 10 years up to 14%. The tax policy approved by the Russian government in May 2010 for the period of 2011-2013 already contains as one of its objectives a reduction in the aggregate rate of insurance contributions by up to 14% until 2020 inclusive for certain categories of innovative companies. Initially the target group includes innovative companies previously entitled to tax incentives in connection with the unified social tax. However, it cannot be ruled out that a temporary reduction may also be granted to other innovative companies, which are not defined at present. While it remains unclear at present whether such amendments will be enacted and when this will happen, it is likely that the contemplated changes may be adopted before the end of 2010, with retroactive effect from January 2010.
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Software Development Outsourcing
Structurally, software development outsourcing is attributed to the outsourcing sector of the IT services market (IT Outsourcing, or "ITO"). It belongs to the Enterprise Application Outsourcing, which represents a significant part of the ITO Segment.
The Worldwide Software Development Outsourcing Market
Worldwide IT outsourcing spending by segment in 2009:
Source: Gartner
Unlike domestic outsourcing (for example, IT infrastructure outsourcing and business applications outsourcing), offshore programming used to be physically provided in countries with a lower cost of services and/or a higher availability of professional staff (including the experts with deep industry domain knowledge and/or experts in complex software programming projects).
Major providers of offshore software development include companies from India, China, Russia, Eastern Europe and the Philippines.
The global offshore programming market was estimated at US$65 Billion in 2009, according to VTB Capital. On the supply side, Indian offshore programming service providers dominate the programming market with a 72%. market share in 2008, whereas Russia’s market share made only 3 % as estimated by VTB Capital.
Global ITS´exports by country in 2008.
According to Gartner in, 2008-2009, the outsourcing market showed resilience despite the severity of the economic downturn.
The worldwide ITO market has shown the greatest resiliency in the IT professional services market. Despite the difficult global economics of 2008 and 2009, the ITO market declined by 5.1%, compared to discrete/project services, which declined by 4.7%. The five-year compound annual growth rate (CAGR) is forecast to be 4.3% for the ITO market; in contrast, discrete/project services are forecast to have a 2.6% five-year CAGR. As a result of the worldwide economic downturn, and CEOs' top priority to reduce costs of IT, outsourcing's key value proposition focused on its ability to help reduce costs. In 2009, the worldwide outsourcing market was, in particular, defined by slowed demand for all services because of IT budget declines, market uncertainties or unique business challenges.
North America represented the most mature and largest market for ITO services, with 44% of worldwide spending, followed by Western Europe (31%) and Japan (12%). Organisations in these regions continued to sign outsourcing deals, yet the following key trends dampened spending in these regions:
- Outsourcing decisions were being made by (or influenced by) senior business executives, such as the CEO or COO and, increasingly, the CFO, who often works hand in hand with procurement.
- Executives considered outsourcing to cut costs and stabilise IT performance and were strong outsourcing promoters; there was less likelihood of outsourcing budgets being frozen when the CFO was a lawyer.
According to Gartner forecasts for the next few years for Europe, in this competitive economic environment ITO will be an ideal driver for additional services selling, such as IT consulting and development and integration. This is especially true as an increasing number of deals focus on transition and transformation of the IT environment. ITO deals often have a transformational objective that requires consulting and system integration capabilities. A number of key European markets, such as Belgium, the Netherlands, the Nordic countries, Germany and France are increasing their adoption of ITO services. Most European companies in the aforementioned countries are new first-time outsourcers (which means the growth of the outsourcing market and fast market recovery possibility). The U.K. remains the most progressive country in the region in this regard, in terms of both volume and maturity, with many second- and third-generation deals being signed.
Gartner expects that the largest segment of IT Outsourcing market will be Development and Integration (software development outsourcing is a significant part of this segment).
Worldwide IT Outsourcing spending forecast by segment in 2001 - 2013.
Gartner also believes that the worldwide ITO market will almost recover in 2010 since IT Outsourcing is now in great demand as cost reduction tool for corporate IT.
ITO worldwide growth rates in US$ in 2001-2012.
Russia and CIS Software Development Outsourcing Services
General
According to the independent researches of RUSSOFT, the key industry association of software outsourcing providers from Russia and the CIS, Russian offshore programming market amounted to approximately US$3 Billion in 2009, an increase of 13% from the 2008 level, out of which Russian IT services exports accounted for approximately US$2.2 Billion and packaged software exports accounted for approximately US$800 Million. Around 50 per cent of the demand for Russian offshore programming is U.S. driven.
Key analysts such as Gartner, Forrester, IDC reported Russia as well positioned destination to gain a significant share in the global software development outsourcing market.
According to a VTB Capital, the Russian offshore programming market should increase by 24% to US$3.71 Billion in 2010.
Russian offshore programming market developments in 2002-2009.
According to RUSSOFT, in the past years software development outsourcing providers were selected as strategic suppliers by many worldwide market leaders, in particular Deutsche Bank, UBS, IBM, Dell, Credit Suisse, Boeing, Citibank, Alcatel-Lucent, Avaya, Nortel, Areva, T-Mobile, Rockwell Collins, Fujitsu Siemens, SAP, Coca-Cola, GoodYear and others.
While the share of Russian service providers in the global offshore programming market is not so high, Russian offshore programming providers are becoming increasingly attractive to customers as an alternative to Indian service providers and as partners in complex engineering projects which demand high level of engineering skills and deep industry domain knowledge –as well as high level of software development project management skills.
According to RUSSOFT, Russian and CIS based software outsourcing suppliers are often selected when the outsourcing project has complex engineering tasks, such as non-standard requirements, a need for long-term expert team, research and prototyping, or alternative sources of service.The competitive advantages of Russian and CIS suppliers include highly educated, broad-minded and motivated engineering teams, that thrive on challenge; low attrition rate and commitment to long-term collaboration; top-notch engineering skills sprouting from the widely acknowledged Soviet scientific educational; price effective alternative.
Software Development Outsourcing Market Segments by Services
Outsourcing services of software development exported from Russia and CIS can generally be structured by the following Services Segments:
Software Development Services, including
- Application Software Development:
Outsourced engineering excellence to build a solution tailored to meet any specific business requirements
- Software Architecture Services:
Planning and strong technological expertise as part of sound IT strategy, including the strategy of core software products architecture development in order to achieve become critical has peak efficiency and rapid growth in a cost-efficient manner requires careful planning and strong technological expertise.
- Performance Engineering:
Careful design, industry-standard development practices thorough functional testing to fully solve performance problems of core software products whic are difficut to diagnose and expensive toresolve by in-house IT forces.
- Software Quality Assurance:
Assuarance software code quality and full spectrum of independent testing solutions.
- IT Infrastructure Management:
Design, building and improvement of customer’s IT infrastructure to monitor the conditions of customer’s network, enabling the customer to avoid or resolve potential problems.
Product Engineering services include just a software product or a product combining hardware and software among other
product specification and mock-ups development
product design development
product engineering services
product enhancement services
product maintenance services
product support services
performance engineering for the product
performance testing for the product
Consulting services, including
- IT Strategy Consulting
If core software products play a definitive role in the customer’s business, then appropriate long-term IT strategy become the key element for the business success. Software development partners (especially in case of so called built-to-order software solutions) can help to develop such a strategy for the customer.
- Software Process Consulting
Software development partners can ensure effective software engineering and business processes used in design and development of the software and IT systems which are essential for the customer.
- Data Security Consulting
Nowadays companies increasingly face internal and external threats to network infrastructure, critical information theft risks, exposing of sensitive client data and the loss of important corporate information. Software development partners can help clients create a blueprint of powerful security systems that effectively guard against data losses, preempt and mitigate risks while ensuring regulatory compliance according to the highest industry standards.