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Page 190

Steps Being Undertaken by the Snezhinsk City Administration to Support Small Innovative Companies

Andrei G.Kruglov *

Snezhinsk City Administration

One way or another, the progress of all civilizations has always been connected with new technologies and goods based on new knowledge. It is commonly said that innovations lie at the foundation of development. In the twentieth century, the role of innovations especially increased in the evolution of society. Today it is universally clear that only by relying on knowledge can any state succeed in solving its internal problems and satisfying the needs of society as well as winning the competitive struggle for world markets for products, technologies, and services.

The paradox of the development of the Soviet scientific-technical sphere was that an immense number of research discoveries were never implemented in practice. As a result, a country that possessed a powerful scientific-technical complex produced civilian products that were uncompetitive on the worldwide market. Individual scientists and scientific collectives had no economic incentives to turn their research results into competitive products in demand on the market. The well-being of scientific organizations has almost no relation to the results of their work.

In our view the innovation policy of the state must play the leading role in the formation of the country's economy. The effectiveness of this policy determines the ability of domestic manufacturers to incorporate new ideas, work actively, and above all compete successfully in the world market. Therefore, the current status of innovation activity and the problem of promoting innovation processes in our country are more urgent today than ever before.

* Translated from the Russian by Kelly Robbins.



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Page 190 Steps Being Undertaken by the Snezhinsk City Administration to Support Small Innovative Companies Andrei G.Kruglov * Snezhinsk City Administration One way or another, the progress of all civilizations has always been connected with new technologies and goods based on new knowledge. It is commonly said that innovations lie at the foundation of development. In the twentieth century, the role of innovations especially increased in the evolution of society. Today it is universally clear that only by relying on knowledge can any state succeed in solving its internal problems and satisfying the needs of society as well as winning the competitive struggle for world markets for products, technologies, and services. The paradox of the development of the Soviet scientific-technical sphere was that an immense number of research discoveries were never implemented in practice. As a result, a country that possessed a powerful scientific-technical complex produced civilian products that were uncompetitive on the worldwide market. Individual scientists and scientific collectives had no economic incentives to turn their research results into competitive products in demand on the market. The well-being of scientific organizations has almost no relation to the results of their work. In our view the innovation policy of the state must play the leading role in the formation of the country's economy. The effectiveness of this policy determines the ability of domestic manufacturers to incorporate new ideas, work actively, and above all compete successfully in the world market. Therefore, the current status of innovation activity and the problem of promoting innovation processes in our country are more urgent today than ever before. * Translated from the Russian by Kelly Robbins.

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Page 191 Present worldwide practice indicates that many problems related to research and innovation activity (lack of investments due to the “scientific risk,” selection mechanism for promising areas of scientific research, targeted funding system, sufficient conditions for free creative self-realization, etc.) were successfully resolved over the course of decades in other countries by means of sharing the costs for scientific and innovation-oriented research between the state and private sector. The greater the attention paid by the state to creating scientific-technical potential, the more major companies spent on research and development efforts. Therefore, state funding takes on even greater significance in our country, as there are practically no investments from the commercial sector for this purpose, thus depriving the country of an important funding source. Regarding Chelyabinsk Oblast in general, it has been established that investments in small businesses are recouped two to three times faster than investments in large industrial enterprises. According to statistical data, labor productivity in small businesses is 50 percent higher in monetary terms than the average for the oblast. The development of small business can solve the employment problem, as this sector is more dynamic in job creation. Furthermore, the cost of job creation in the small business sphere is several times less than in large enterprises. Meanwhile, small business also solves the problem of filling the market with consumer goods and services, improving the quality of life for citizens, and promoting the political stabilization of society. Despite the fact that small business is one of the most important economic sectors and its development affects the development of our region and Russia in general, the oblast government and the Chelyabinsk Oblast Legislative Assembly do not pay enough attention to issues connected with small business development and support. There are numerous problems affecting this sector: administrative-bureaucratic obstacles, the poorly developed nature of oblast-level legislation on small business, the tax burden, the cumbersome accounting system, the lack of the necessary social protection for owners and employees of small enterprises, the absence of financing in the oblast budget for small business support. All of this has a negative impact on the dynamics small business development. Thus, the lack of regional investments in small business development in our oblast represents a serious financial and economic oversight on the part of the oblast administration. As for the Snezhinsk city government, the city administration and Snezhinsk City Council have chosen their own way of developing the innovation activities of small business. On the whole, small business support is provided in three main areas: regulatory, financial, and organizational.

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Page 192 REGULATORY SUPPORT Regulatory support includes the adoption of laws and regulations that promote the efficient functioning of the system. In 1999 the Targeted Comprehensive Program for the Support and Development of Small Business in Snezhinsk for 2000–2001 was prepared. The Regulation on Investment Activity in the Closed Administrative-Territorial Zone of the City of Snezhinsk was adopted in Snezhinsk City Council Resolution 30, dated March 13, 2000. Taking into consideration the recommendations of the Snezhinsk Entrepreneurs Association, the Snezhinsk City Council issued Resolution 93, dated June 28, 2001, which included a series of measures focused on small business development in Snezhinsk. Following are some extracts from the Regulation on Investment Activity in the Closed Administrative-Territorial Zone of the City of Snezhinsk: “This Regulation was developed to create incentives for organizations and individual entrepreneurs to make long-term investments…. The main objectives of promoting and creating incentives for investment activity include creating new production facilities in the city and preserving existing ones, creating additional jobs, increasing the employment rate among citizens, and augmenting the city budget with increased tax revenues. Our policy of attracting and allocating investment funds is based on the principle of providing investors with an economic interest in creating new production assets and establishing new production facilities in the closed city of Snezhinsk through various forms of support provided by local government agencies.” To varying degrees, these documents highlight the top priorities for small business development in the city. These priorities include expanding the production of competitive science-intensive products; accelerating the transfer of technologies to the production sphere; developing a technology transfer support infrastructure; creating employment opportunities for highly qualified engineers, technicians, researchers, and specialists; and promoting small-scale industrial manufacturing and the production of consumer goods that can replace imports. In addition, various forms of support for small- and medium-sized business were defined and adopted. This support includes investment tax credits, additional local tax exemptions, loans (credits) and loan guarantees on preferential terms, other nonfinancial privileges (municipal orders on preferential terms, assistance in business infrastructure creation, leasing or sale of municipal lots and nonresidential buildings that have been placed in municipal ownership according to established procedure), and cofounding of economic organizations, with part of the shares of the new companies becoming municipal property.

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Page 193 FINANCIAL SUPPORT Taking into consideration the shortage of budget funds, the main emphasis in small business support has been placed on developing advanced methods of raising nonbudget resources. The Municipal Fund for the Support of Small Business was created by Resolution 774 of the Snezhinsk City Mayor, dated October 3, 1995. The Municipal Nonbudget Fund for the Socioeconomic Development of Snezhinsk was established by Resolution 100 of the Snezhinsk City Council, dated June 23, 1997, and Resolution 470 of the Snezhinsk City Mayor, dated June 24, 1997. These funds are noncommercial organizations, and profit-making activity is not their main goal. The main objectives of the funds are as follows: (1) facilitating the implementation of state policy in Snezhinsk regarding the formation of market relations on the basis of small business support, and (2) developing competition by attracting and efficiently using financial resources to implement targeted programs for the support and development of small business. The primary areas of the funds' activities are the following: participation in the development, expert review, competitive selection, and implementation of municipal programs focused on small business support and related projects in the small business field, including demonopolization of the economy, development of competition, satisfaction of the goods market, and creation of new jobs participation in the formation of a market infrastructure providing equal conditions and opportunities for small business operations support for entrepreneurial innovation activity, stimulation of the development and manufacturing of fundamentally new types of products, assistance in putting new technologies and inventions into practice assistance in attracting domestic and foreign investments to pursue top-priority objectives in creating a competitive environment and developing small business To achieve their primary objectives, the funds are involved in the following activities: accumulating monetary resources (nonbudget) providing financial assistance in conformity with Russian law on a free and paid basis to develop competition and increase the goods available on the market serving as a guarantor for the obligations of small businesses

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Page 194 sharing in the foundation and operation of economic entities financing activities focused on providing training, retraining, and professional development for employees of small enterprises, supporting new economic structures, and protecting the rights of consumers funding scientific research, scientific and practical conferences, symposiums, meetings, and exhibitions, including international ones organizing activities focused on attracting and efficiently using funds provided by domestic and foreign investors collecting and processing legal, patent, licensing, and other information of interest to small business entities; studying domestic market conditions; providing consulting and organizational-methodological assistance in the development of programs and projects in the small business sphere forming creative collectives, expert councils, and commissions, including those involving foreign specialists sending specialists for training, retraining, and professional development, including to programs abroad Because the financial resources available to the two Snezhinsk municipal funds differ substantially, there has been a sort of “unspoken” division of responsibilities between them. The Municipal Nonbudget Fund for Socioeconomic Development focuses its resources on supporting and developing medium-sized businesses, while the Municipal Fund for the Support of Small Business provides assistance to small businesses, as its name would indicate. For the sake of clarity, Table 1 presents quantitative data and the volumes of financial resources provided by the Snezhinsk municipal funds in 2000–2001 for supporting and developing small- and medium-sized businesses, including those involved in innovation activity: In addition, the Snezhinsk City Administration participates in the foundation of economic entities, with a portion of the shares of the new enterprises being secured under municipal ownership. The following organizations may be cited as examples: Bars-70 The city administration is one of the founders of this limited liability company. The main activities of the organization include developing, designing, manufacturing, and assembling filters, ventilation systems, and air regeneration systems. The company has developed its own original ionizing, power-supply, and precipitation units that differ from foreign models. A patent search has been conducted regarding these issues. A number of technical features require more comprehensive patent research in order to secure patents.

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Page 195 TABLE 1 Support for Small- and Medium-Sized Businesses in Snezhinsk Funding Sources Number of Projects Total Amount of Financing Municipal Nonbudget Fund for the Socioeconomic Development of Snezhinsk 20 71,802,000 rubles Municipal Fund for the Support of Small Business 70 17,737,000 rubles In addition, Bars-70 has obtained a loan in the amount of 2,448,000 rubles from the Municipal Nonbudget Fund for the Socioeconomic Development of Snezhinsk to develop promising areas of activity. Spectrum-Conversion Research and Production Enterprise The focus of this limited liability company involves organizing and carrying out work in industrially promising fields of geological and geotechnological research in the development of the mining potential of the Urals and other Russian regions. The company also pursues research and production activity concerning the development and application of new technologies in production; the implementation of scientific-technical achievements in the mining and processing of precious and rare stones and metals; and the development and application of low-waste, environmentally clean, and resource-saving technologies. Spectrum-Conversion is currently carrying out the following innovation projects: organization of serial production of high-temperature electric heating devices creation of a production facility for improving precious stones organization of production of traffic safety equipment and devices using super-bright diodes At the time of its foundation, the enterprise had authorized capital stock of 6,506,000 rubles, with 99.88 percent belonging to the City Administration Committee for Property Management. In addition, Spectrum-Conversion received 10 million rubles in loans from the Municipal Fund for the Support of Small Business. ORGANIZATIONAL SUPPORT In 2000, with the active support of the Foundation for Russian-American Economic Cooperation and the U.S. Department of Energy,

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Page 196 the Snezhinsk City Administration and the Snezhinsk City Council established the Snezhinsk International Development Center (IDC) Foundation. The IDC is a nonprofit organization with the following main areas of activity: promoting a favorable investment environment in the closed city of Snezhinsk aiding in the search for investors for industrial diversification projects and assisting with market analyses organizing training for employees laid off from nuclear enterprises providing information to enterprises about access to financial resources to fund projects and activities helping to identify and create new favorable economic opportunities in the closed city of Snezhinsk providing consulting and informational support for the investment activities of state and municipal enterprises and private businesses and in the preparation and development of promising technologies and production facilities providing assistance in developing and conducting expert reviews of investment projects and programs aimed at supporting the economy in the closed zones helping local government agencies to develop investment stimulation programs, strategic plans, and development concepts rendering information and consulting services to businesses and local government agencies in the field of investment opportunities On October 24, 2000, a conference for entrepreneurs entitled “Small Business in Snezhinsk: Problems and Prospects” was held in Snezhinsk. Having heard and discussed the reports and presentations made by local government leaders, representatives of municipal nonbudget funds, other city organizations and institutions, entrepreneurs, and small business managers, conference participants stated that the city has created a functioning system for providing financial support to small business. At the same time the current climate is not sufficiently favorable for the development of business, including innovation-oriented business. Many entrepreneurs gave pessimistic forecasts regarding their further business prospects. The lack of funds and production facilities is urgently felt. Existing “administrative barriers” also hinder business development in the city, and owing to a number of objective reasons, these barriers are much stronger in the closed zones than in other cities and regions of the oblast. Interest rates are still rather high for small business, and having collateral or a guarantor is an obligatory condition for obtaining loans, which limits credit opportunities for businesses at the start-up or expansion stage.

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Page 197 Entrepreneurs at the conference made the following suggestions: Snezhinsk local government agencies should provide for increased credit resources at the municipal funds in order to reduce interest rates for small business. A venture capital loan mechanism should also be developed. The possibility of using city funds to construct office and production space for start-up companies should be considered. Unfortunately Russia is ill prepared to initiate efficient development of the venture capital business, and Snezhinsk is no exception. Those with financial resources are scarcely starting to realize that investing for a period of several years is the norm, and moreover it can be profitable. The country lacks the necessary number of managers for new venture companies, though this problem is slowly being resolved. There are legal problems, mainly in the sphere of taxation. A system for the interaction of inventors and investors has not yet been worked out, and there are many issues of an infrastructural and psychological nature. For instance, it is no secret that inventors have little concept of the structure of costs required for product development and marketing. Many years of statistical data indicate that development costs rarely exceed 25–30 percent of total costs even in developed countries where skilled labor commands very high wages. About another third of the total costs goes for setting up full-scale production, and the same amount for marketing operations regarding product promotion and distribution. In Russia, development costs are usually lower, but promotion costs and costs of organizing full-scale production are higher because production lines are worn out and almost 100 percent of the necessary equipment must be purchased. Inventors and investors are not yet ready to compromise. Inventors are hardly willing to prepare serious business plans, including assessments of the market and product prospects based not on speculative conclusions but on market facts. Investors are reluctant to consider projects when the business plan is not yet complete. Current tax legislation also presents a big problem in the development of the venture capital business. If as a result of budget shortfalls we cannot provide effective support for technology-oriented business now, as it is done in the developed countries, which have two-stage grant systems, then at least we need to introduce tax benefits regarding stock investments in projects. At the very least, this should be done for the companies that are commercializing the newest Russian technologies. A high-tech project is not a bakery that can pay back investments a week after its equipment has been installed. Here we are talking about three or four years or more. Therefore, certain special conditions should be created for such projects:

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Page 198 Venture investors must take on many more functions connected primarily with establishing and developing business processes in the company in which they invest, so they should be compensated for this in the form of more favorable partnership conditions. Many projects do not pay proper attention to the issue of creating incentives for investors. Mainly, they emphasize the technical advantages of the product. When resources are in short supply, it becomes more important to join several similar projects separately developed by various participants into one larger project that could include all their best features. Solving the problem of finding potential participants and forming a single overall project would substantially increase the chances of the project's success. Loan financing will play a significant role for projects that have reached the stage of commercial implementation and are looking to expand. Accordingly, many projects should be adapted with an eye to the specific requirements of lending organizations. Thus, we should place special reliance on efficient, nonstandard solutions, which have often led to success in many undertakings. One such nonstandard solution could be the creation of innovation centers or business incubators, that is, appropriate facilities used by their owner to provide entrepreneurs with the following services on mutually beneficial terms: long-term rental of office and production space a range of services to facilitate innovation and economic activity The goal of such a business incubator is to promote the preservation and development of scientific-technical potential by supporting the innovation process carried out by entrepreneurs at its facilities. It may also be said that the majority of innovation projects are sufficiently well elaborated from the technical standpoint. However, the following general defects are noted: no clear market positioning of products and company trademarks and no qualitative comparative analysis of competitors unresolved intellectual property and patent protection issues, in many cases At the same time, one of the most substantial factors hindering the development of innovation-oriented business lies in the undeveloped nature of the information infrastructure focused on serving the interests of both investors and entrepreneurs. In conclusion, I would like to add that the investment policy of Snezhinsk local government is aimed at supporting and assisting small

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Page 199 business, not creating it. The Municipal Fund for the Support of Small Business has conducted a sociological study entitled “Focus on the Small Business.” Based on the results of this study, specialists reached the following conclusion: “Entrepreneurs are rather well informed about available municipal forms of small business support, but in fact almost none of them ever use this information in practice.”