Russian start-ups hungry for risk, reward

(Moscow News – themoscownews.com – Nathan Gray – January 31, 2014) Entrepreneurship has become an object of intense focus in Russia since the crisis of 2008-2009, as debates continue over the pace and the progress of economic diversification.

The expansion of business accelerators and technoparks across the country has indicated the interest in fostering small and medium-sized enterprises. Events such as the Russian Start-Up Tour, which kicked off earlier this month in Tolyatti, Tatarstan, seek to offer a platform for networking and securing investments for innovative companies.

While government policy has in general had a good effect in laying a foundation for start-ups, for actual expansion, Russian businesses frequently have to look outside the country’s borders.

“The share of innovative start-ups is disappearingly small, and, at base, those who figure out a way onto the international market demonstrate success,” Alexander Chepurenko, dean of the department of sociology at the Higher School of Economics, told The Moscow News. “But in this case, a lot of them become successful [and] in fact leave the Russian jurisdiction – become a successful [business], but not a Russian [one].”

A need for demand

The problem, he said, is the need for a demand for innovative products, which can come in several ways: from the market, from large corporations that need products smaller firms can produce, or from the state, but the main direction of state support for start-ups has been the development of infrastructure.

The state сan foster demand that could lead to the growth of smaller businesses: Chepurenko offered the example of domestic aircraft production, where state demand could have a follow-on effect on other participants in the market, such as makers of aircraft technology selling to the larger manufacturer.

But the lack of knowledge on the part of large businesses in a resource economy of how to provide other products and services impedes the growth of domestic demand, and hence the growth of new firms to help respond to this demand, he added.

Foreign ties

International cooperation, meanwhile, is integral to the start-up sector that has probably benefited the most from state investment: IT.

“[Russians] have to rely upon somebody else’s experiences, because we don’t have enough of our own experience,” Igor Rozhdestvensky, CEO of the business incubator at Ingria Technopark in St. Petersburg, told The Moscow News. “We really want start-ups to go global, to start global operations.”

Residents at Ingria have traveled to countries such as South Korea, the United States and Israel to gain experience from start-ups and high-tech incubators abroad, but the dynamism of Russian IT is outstripping industries such as manufacturing, which are considerably lagging.

Comparing the state of Russian IT start-ups in 2010 and 2012 with that of American businesses, Rozhdestvensky identified sharp growth. In 2010, the amount of venture investment in Russia for 50 start-ups was $20 million – 50 percent from derivatives from the Russian Venture Company, the federal venture capital firm – while in the United States, it was $20 billion for 50,000 start-ups.

By 2012, the Russian amount had grown to $1 billion, with only 5 percent from RVC derivatives.

“It’s actually growing much more slowly than I would want, but the pace is incredible,” Rozhdestvensky said.

An industrial lag

The slower development of industrial start-ups in Russia is related to weak customer demand, said Timur Nigmatullin, an analyst at Investcafe.

“A slowing rate of GDP growth is now happening, and the demand of a broad customer base, including for products of machine-building, is quite weak,” he told The Moscow News. “Correspondingly, [there is] such a difference between the growth rates in IT and in machine-building.”

The simple difference in the facilities required to start a business in IT and the industrial sector can also contribute to the latter’s slower growth, as an industrial factory requires time to build.

Risky business practices can be a hallmark of IT entrepreneurship. The business model of Eviterra, the airline ticket sales website that collapsed in January after the ticketing subcontractor Avia Tsentr cancelled tickets Eviterra had sold to its own customers, is an instance of the risks involved.

Avia Tsentr did not receive money it had been expecting from the website, though bank closures over the holidays may have been behind the situation. The incident resulted in a fraud investigation against Eviterra, which is still in the early stages.

Max Krainov, executive director of Aviasales.ru, told Moskovskiye Novosti that Eviterra had sold tickets below the market price, hoping to profit from a high number of customers and resulting bonuses from airlines.

“I wouldn’t say that Eviterra was good, but they are not fraudsters,” Krainov said. “They simply gambled, and, unfortunately, let people down.”

“Innovative entrepreneurship is riskier everywhere, therefore inherently there is an innovative premium,” the HSE’s Chepurenko said. “This is a premium for high risk related to the higher uncertainty of a return, because there is still no market, still no customer, but it lies ahead to create it in fact, if we’re talking about innovative products.”

A checkered history

The inherent risk is a significant factor in limiting the growth of Russian entrepreneurship, since, despite the support for IT start-ups, there is less protection in case of failure than in other countries with more developed start-up cultures, Ingria’s Rozhdestvensky said. Many people still elect to go into the large state sector because employment there is “safer.”

An additional limitation is the cultural perception of entrepreneurship, which hearkens back to the Soviet period.

“Twenty-five years ago, throughout the Soviet time, [entrepreneurship] was considered a criminal offense, so the general public’s attitude is not too good,” Rozhdestvensky said. “It’s not enthusiastic, anyway, and this prohibits lots of people going into entrepreneurship.”