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Page 200

The Role of Foreign Partners as Investors or Customers in the Development of Small Innovative Firms

Igor I.Rakosei*

Obninsk City Administration

Throughout the world, attracting external companies, including those from abroad, is regarded as a key resource for regional economic development. At present, conditions have developed in Obninsk such that they could serve as a sufficient stimulus to attract foreign strategic investors and partners. The creation of those conditions was facilitated by the following factors:

  • long-standing scientific contacts between Obninsk research institutes and international organizations and foreign scientific centers in various fields

  • focused efforts to search for partners, as well as support of projects having high priority in terms of their importance for economic development

  • long and fruitful cooperation with Oak Ridge, Tennessee, as our sister city

  • positive experience cooperating with the Eurasia Foundation on diversified efforts to support market-oriented economic reforms in Russia

  • successful teamwork on Tacis Program projects

  • participation in the project entitled “Technological Cooperation Between Kaluga Oblast and the Netherlands”

Of course this list of factors is not complete, with the most important factor being the Program for the Development of Obninsk as a

* Translated from the Russian by Kelly Robbins.



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Page 200 The Role of Foreign Partners as Investors or Customers in the Development of Small Innovative Firms Igor I.Rakosei* Obninsk City Administration Throughout the world, attracting external companies, including those from abroad, is regarded as a key resource for regional economic development. At present, conditions have developed in Obninsk such that they could serve as a sufficient stimulus to attract foreign strategic investors and partners. The creation of those conditions was facilitated by the following factors: long-standing scientific contacts between Obninsk research institutes and international organizations and foreign scientific centers in various fields focused efforts to search for partners, as well as support of projects having high priority in terms of their importance for economic development long and fruitful cooperation with Oak Ridge, Tennessee, as our sister city positive experience cooperating with the Eurasia Foundation on diversified efforts to support market-oriented economic reforms in Russia successful teamwork on Tacis Program projects participation in the project entitled “Technological Cooperation Between Kaluga Oblast and the Netherlands” Of course this list of factors is not complete, with the most important factor being the Program for the Development of Obninsk as a * Translated from the Russian by Kelly Robbins.

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Page 201 Science City, which was adopted by the legislature and is now being implemented. Under the program, a set of measures is being carried out to attract foreign companies, including the following specific activities: creating a portfolio of investment proposals preparing specialized informational materials about Obninsk intended for foreign companies interested in establishing or expanding their business in Russia marketing the city of Obninsk to help promote it on the Russian and international markets preparing documentation on industrial sites available in Obninsk and on other resources required for foreign companies to establish their businesses Unfortunately the city's authority to grant tax breaks is quite limited. The only considerable tax benefit available under the present tax law is that regarding the profits tax. Preferential rates on all of the other taxes paid to the city treasury are so small as to make any talk about their attractiveness meaningless. If the project happens to be of a clearly regional character, however, the situation could become more attractive as a result of additional concessions on taxes payable to the oblast. Thus, the maximum special exemption for the property tax (50 percent of which goes to Kaluga Oblast and the other 50 percent to the city) can be 100 percent. For the land tax (50 percent remains in Obninsk and 30 percent goes to Kaluga), it will be 80 percent. With the standard rate of 24 percent for the profits tax, the tax benefit for it could reach 68.7 percent (2 percent goes to Obninsk and 14.5 percent to Kaluga). Other measures within the city's powers include reducing the rate for land rental or making buildings with the required infrastructure available on advantageous terms. At present, 13 joint ventures and 11 businesses with 100 percent foreign capital are operating in the city. As a rule, these are small businesses. Their activities are rather diversified, including the production and bottling of mineral water (the POLLO firm), ketchup production (MOSSPOL), footwear manufacturing (the Shafran limited liability company), medical technologies and pharmaceuticals (Vienna-Obninsk Biomedical Laboratory, the German Intensive Therapy Clinic, Mir-Pharm), and others. In addition there are a number of Russian firms operating in Obninsk that fill orders for foreign customers, including such high-tech firms as Eridan, Ekon, Converscenter, and Theseus. Both positive and negative experience has been accumulated in the implementation of international projects in the city. I shall cite two ex

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Page 202 amples of successfully operating high-tech companies whose experience should be studied and replicated. Cyco Software is the world's leader in the development of AutoCAD and office automation systems. The company, which began operations in 1987, has now developed the most advanced of modern software products. Cyco is a multinational corporation with its headquarters in the Netherlands and branches all over the world. Located in Atlanta, Georgia, Cyco International is responsible for sales, marketing, and technical support in the Americas, Asia, and Australia. The Cyco-Europe branch handles sales, marketing, and technical support in Europe, the Middle East, and Africa. Finally, Cyco has created a center for technology development in Russia in Obninsk called Cyco-Russia. Cyco-Russia's history began in the early 1990s. Cyco Software management first visited Obninsk in 1991. They had received information about the city from the Netherlands Ministry of Economic Affairs and from some of their friends who had high-tech business contacts with a subsidiary of the Russian State Research Center Institute of Physics and Power Engineering (IPPE). Cyco Software managers were looking for new ways of improving the company's performance by involving professional programmers from Russia. In the unstable economic conditions of the early 1990s, doing business in Russia seemed very risky, but such factors as the availability of a highly skilled workforce and relatively low costs compared with Western countries tipped the balance. Cyco gave trial projects to a few Russian programmers, and the results were very good. So Cyco realized that it had found the right people in the right place. That was how their cooperation began. The Cyco-Russia company was founded in 1994. The partnership has proven mutually beneficial. The Dutch company recruited highly qualified Obninsk programmers at relatively low salaries and in this way solved its human resources problem. In turn, the city acquired a new stable and disciplined taxpayer in the Cyco-Russia company, and Russian specialists got jobs in their fields appropriate for their high qualifications. Today Cyco-Russia is a full-fledged high-tech company with several dozen employees. Thanks to the high quality of their work, Cyco-Russia's specialists are increasingly relied upon by the Dutch partners, with the company taking on an increasing number of projects as it develops and grows. The Obninsk City Administration appreciates the fact that the Dutch company invested in the city's economy during such a difficult period, so it is now giving Cyco-Russia its full support and assistance. It should be mentioned that the creation of companies like Cyco-Russia is entirely in keeping with the Program for the Development of Obninsk as a Science City. The key idea of the program is to minimize the

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Page 203 dependence of the city's economy on the federal budget. Obninsk is striving to commercialize its scientific and economic potential by stimulating modern production and services. Meanwhile, preference is given to developing small- and medium-sized high-tech businesses. Cyco-Russia can serve as an example of real international cooperation in the high-tech field and a graphic demonstration of the potential for successful investments by foreign companies in Obninsk. Another example of successful cooperation is the firm SSI/Russia, which was registered in Obninsk in July 1993. The company's full name is “Subsidiary of the California Corporation SSI/Russia.” The company was organized on the initiative of former IPPE employees Yury Belogortsev and Alfred Mirzagitov. In early 1992 Yury Belogortsev won a contest organized in Moscow by an American foundation supporting beginning Russian entrepreneurs. Contestants who passed all three rounds of the contest were given the opportunity to go to the United States for a one-month internship in an American company. That was how Yury Belogortsev got to know George Rothbart, president of the California company Software Science, Inc. In the process of learning more about the work of the American company, the first contract was signed, and it was carried out so successfully that the Software Science management decided to open a new branch using a team of programmers from Obninsk. As a result, SSI/Russia, a business with 100 percent foreign capital, was incorporated. The firm is engaged in the development of different software products used in the following areas: database management systems office applications software for end users (shrink-wrap software) telecommunication systems based on Transition Control Protocol/ Internet Protocol (TCP/IP), including wireless technologies online data acquisition and processing systems web sites, including e-commerce sites Since the firm was founded, it has been oriented entirely to the American market. All products and systems have been developed for American companies and individuals, and the parent firm in California is responsible for routine contacts with customers and technical support for its software products. The use of the entire spectrum of modern telecommunications technologies, such as the Internet, IP-telephony, remote paging, and cellular telecommunications helps to eliminate any inconveniences related to the two companies being in different time zones and located so far apart. In fact, the company takes advantage of the 11-hour time difference in solving urgent problems for clients—for example, work on those

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Page 204 problems can go on 24 hours a day. This is particularly important for online projects, such as one of the most popular American sites for selling cars, www.carsmart.com. The project is the pride of the company. It was developed for the AIN Corporation, starting from scratch in 1996 and continuing with site maintenance over the past five years. In January 2000 the project was bought by AutoByTel for $20 million. Other examples of successful projects include the following: a real-time system for tracking financial transactions of ticket vending machines and gauging passenger flows in San Francisco subway stations (the customer was Bay Area Rapid Transfer) a worldwide technical support notification system for the Amdahl Corporation unique radiomodems with automatic packet routing (Dynamic Forward Routing) for the firm CommUniqueWireless There have been a number of problems (organizational, technical, personnel related) encountered during the formation and development phase at this company. ORGANIZATIONAL PROBLEMS It was hard to overcome the differences in business models of the American and Russian enterprises, with each having different accounting systems and different business cultures. Added to that were difficulties that are very hard to explain to the American partners, such as frequent changes in tax legislation, bureaucratic hindrances in the economy and customs procedures, and so on. It would take quite a while to list all the problems and ways of solving them, especially considering the specifics of the type of production involved (e.g., the nonmaterial nature of the end product, which led to certain conflicts with tax inspectors who could not understand how work could be sent over the Internet without making out customs declarations and so forth). In addition mention should be made of the rather heavy demands made of workers at the subsidiary with regard to their knowledge of the English language, as all correspondence, negotiations, and software systems development is done in English. TECHNICAL PROBLEMS The first technical problem was poor communications channels between Russian and American partners, including mail, electronic communications, and transportation. All of those problems were gradually resolved as the market economy developed in Russia. As a result, we now have a very good system for accessing the Internet (Obninsk has a fiber

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Page 205 optic network for Internet access with 4.5 Megabit bandwidth), a reasonably good mail service (DHL, FedEx), and conventional ways of solving transportation problems (provided that you have a visa, you can get to the customer within 48–72 hours). PERSONNEL-RELATED PROBLEMS In 1993 it was not at all difficult to find a skilled programmer for a specific project. Today the search could take a good deal of time owing to easier access to the European and North American job markets, as well as the influence of Moscow, the nearby megalopolis. Nevertheless, Obninsk still has considerable intellectual resources for handling most software development problems. In its early days the subsidiary employed four programmers, but now the number of employees ranges from six to eight depending on the volume of work. The subsidiary operates steadily, and personnel turnover is low. In the near future, SSI/Russia will be considering options for expanding cooperation with information technology companies in Europe in order to diversify its market and smooth out workload fluctuations caused by the American market. The availability of highly qualified personnel with the necessary skills and knowledge, the absence of language barriers in communications not only among management but also with rank-and-file workers, and accessible opportunities for familiarization with current experience all contributed to the success of the companies mentioned above. And yet we also have an example of how a well-prepared major investment project was ruined by the unprofessional actions of regional politicians. During 1995–1998, work was done to promote a major Russian-Dutch agrarian project involving the creation of Protva-Agro, a sales and service company that was registered in Obninsk in 1998 (its initial capital was about 25 million new rubles). The project was supposed to introduce modern agricultural technologies for growing crops in the Obninsk area as well as create a specialized sales network. Implementation of the project would have helped to create new jobs not only in the cultivation and sale of agricultural produce but also in the necessary processing infrastructure. The financing plan amounted to more than $10 million in foreign investments (about $4 million from the World Bank for a period of 10 years and about $6 million in the form of a loan from a Dutch bank guaranteed by the Netherlands government). It had been fully worked out and approved by all interested organizations. Unfortunately, in May 1998 the Kaluga Oblast Legislative Assembly refused to serve as a guarantor of the project, thus causing it to be completely shut down and, in the

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Page 206 process, undermining the image of Kaluga Oblast as a region capable of attracting foreign investments. Another international project should also be mentioned. In February 1999 the Regional Agency for the Promotion of Investments and Technologies (RAPIT) was founded in Obninsk as a component of the international project entitled “Technological Cooperation between Kaluga Oblast and the Netherlands.” This project represents a joint initiative of the Netherlands government, the Kaluga Oblast government, and the Obninsk City Administration. The Netherlands is represented by a number of Dutch companies that had won the right to implement the project in a 1998 tender announced by the SENTER Agency of the Netherlands Ministry of Economic Affairs. The main goals of the project were to support the development of small- and medium-sized high-tech enterprises in Kaluga Oblast and to establish mutually advantageous business contacts between enterprises in the Netherlands and Kaluga Oblast. These goals are in complete accord with those of the program to develop Obninsk as a science city. POSITIVE RESULTS For the first time, we have succeeded in establishing long-term business relations with the investment institutions of the Netherlands. This partnership offers good prospects for the further cooperation with the International Science Cities Foundation (ISCF), which is engaged in providing venture financing for Russian high-tech companies and fostering the further development of joint enterprises that have received financing. Other opportunities involve continuing business contacts within the “business-to-business” project and attracting the Dutch-American Investment Fund SEAF to Obninsk. This activity is supported by the authorities on both sides—the Obninsk City Administration and the Netherlands government via the SENTER Agency. This creates the most favorable conditions and guarantees, which is undoubtedly important in securing high-risk start-up financing for newly created enterprises. Despite the difficulties in the initial phase, the past three months since the arrival of a new team in RAPIT have seen the completion of a plan for the investment of Dutch capital in Russian-Dutch joint ventures, taking into account the particularities of Russian and Dutch legislation. Since June 2001, two joint venture agreements have been concluded. Entrepreneurs from Obninsk, Balabanovo, and Maloyaroslavets have submitted preliminary applications and business plans for five new projects, including the following: Tandem—painting chambers for vehicles; Winter Harvest—mobile greenhouses with new technology for vegetable growing; Cartridge Plus—refilling of all types of cartridges, and so on.

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Page 207 RAPIT would not like to restrict its activity only to collaboration with the Netherlands, so it is expanding the bounds of its contacts. For example, preparatory work is already under way to identify investment opportunities in Oak Ridge, Tennessee. NEGATIVE EXPERIENCE Because of the lengthy procedures for project financing, the ISCF was not able to finance all the projects as planned in the project terms of reference. The scope of RAPIT's activities has been limited primarily to Obninsk. The effort to create a business incubator in Obninsk was launched only in the final stage of the project. Despite the very careful selection of RAPIT staff (four persons), the team disintegrated by spring 2001. Having acquired new knowledge and skills and having completed training in the Czech Republic and the Netherlands, they essentially split into two groups. This was largely due to the unconstructive and generally willful actions of the former director of RAPIT, who was not able to establish a normal working relationship with the representative of the Dutch consortium. This situation could not fail to affect the quality of the staff's work and their relations with the Dutch partners. Even so, there is a positive aspect that speaks to the level of training of the staff. One of the staff members who left RAPIT, Andrei Perekhrest, is currently the director of Cyco-Russia, while another, Oleg Shershakov, is a senior manager with the financial company StoraEnso. However, even the negative results have positive significance, as they represent important lessons from which the correct conclusions must be drawn. The new RAPIT staff has made a thorough analysis of the agency's activities during the first two years of its operations. Serious corrections have been made, taking into account the negative experience and the mistakes that were made. PROSPECTS RAPIT participates in the implementation of the Program for the Development of Obninsk as a Science City. The directors of the program have approved projects involving the joint participation of RAPIT and the Franco-Russian Institute of Business Administration (FRIDAS) in developing the international marketing plan for Obninsk and creating the website “Investors Guide.” An application is being prepared for participation in a joint project entitled “Development and Creation of a Package of Presentation and

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Page 208 Informational Materials Aimed at Attracting Foreign Investments to Obninsk on the Basis of Analyzing and Adapting the Experience of Oak Ridge in Promoting Itself in the Innovation Technology Market.” A public relations project on the development of the Obninsk investment infrastructure using the technopark model is also being prepared. There are opportunities for participation in the selection and placement of small innovation-oriented enterprises in the business incubator. A joint project is being prepared for collaboration between the Chambers of Commerce of Obninsk and Oak Ridge. It would be wrong to say that joint enterprises and firms with 100 percent foreign capital contribute substantially to the city's economy. We are still in a preliminary phase. Of course, the legislative basis for stimulating foreign investments must first of all be strengthened at the federal level. At the same time, the city is doing a great deal in this area within the scope of its authority, as you have heard. We hope the number of positive examples of international cooperation will increase with each passing year.