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Development of Small Innovative Companies in Zarechny to Serve the Russian Market

Yevgeny N.Loguntsev *
Zarechny Technopolis Development Fund

This report reviews the experience of Zarechny companies involved in innovation activity. Table 1 briefly presents information on the companies to be considered.

The main focus of this report is companies that provide an infrastructure for innovation activity. This category includes the first four examples cited in Table 1. In addition, typical examples of enterprises created to carry out innovation activity (the PGS and Ekorad firms) are also covered.

URALCONVERSION

The Uralconversion enterprise was created as one of the first open joint-stock companies in the city of Zarechny. Its initiators were employees of the Sverdlovsk branch of NIKIET (Scientific-Research and Development Institute of Power Engineering) who had worked together on projects connected with materials for use in the atomic power industry. The company's founding goals included facilitating conversion of research potential, performing research studies, and putting their results into actual production. The founders of Uralconversion included a number of former Soviet scientific-research institutes and design bureaus from Moscow, Yekaterinburg, Chelyabinsk, Tomsk, Kazakhstan, and Ukraine that had previously been involved in working on problems connected with reactor material development, including the Sverdlovsk branch of NIKIET. In addition, the group of founders also included the Zarechny City

* Translated from the Russian by Kelly Robbins.



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Page 79 Development of Small Innovative Companies in Zarechny to Serve the Russian Market Yevgeny N.Loguntsev * Zarechny Technopolis Development Fund This report reviews the experience of Zarechny companies involved in innovation activity. Table 1 briefly presents information on the companies to be considered. The main focus of this report is companies that provide an infrastructure for innovation activity. This category includes the first four examples cited in Table 1. In addition, typical examples of enterprises created to carry out innovation activity (the PGS and Ekorad firms) are also covered. URALCONVERSION The Uralconversion enterprise was created as one of the first open joint-stock companies in the city of Zarechny. Its initiators were employees of the Sverdlovsk branch of NIKIET (Scientific-Research and Development Institute of Power Engineering) who had worked together on projects connected with materials for use in the atomic power industry. The company's founding goals included facilitating conversion of research potential, performing research studies, and putting their results into actual production. The founders of Uralconversion included a number of former Soviet scientific-research institutes and design bureaus from Moscow, Yekaterinburg, Chelyabinsk, Tomsk, Kazakhstan, and Ukraine that had previously been involved in working on problems connected with reactor material development, including the Sverdlovsk branch of NIKIET. In addition, the group of founders also included the Zarechny City * Translated from the Russian by Kelly Robbins.

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Page 80 TABLE 1 Small Innovative Companies in Zarechny Company Founded Type Founders Maxi-mum Staff Present Condition Uralconversion 1992 SC 22 entities (research institutes, design bureaus, Zarechny City Administration) 27 Liquidated Zarechny Technopolis Development Fund 1993 SC Entities including Zarechny City Administration and private individuals 11 Consulting activity, regional development company Agropark 1993 CC Entities including Zarechny Technopolis Development Fund 21 Liquidated Technopark 1993 CC Entities including Zarechny Technopolis Development Fund 17 Offers support infrastructure for small business in Zarechny PGS 1993 CC Individuals and entities including Technopark 7 Monopolist in the Ural-Siberian region Ekorad 1992 CC Individuals 5 Liquidated NOTE: Enterprise types are listed as SC for Stock Company or CC for Closed Stock Company. Administration, a Yekaterinburg bank, and the Beloyarsk Atomic Power Plant. Uralconversion essentially worked on providing engineering support for several projects involving research and development for scientific products. The main such project involved developing, creating, and implementing “clean room” technology for the radioelectronics industry. Having received this major work order, the enterprise as prime contractor distributed subcontract orders to enterprises and institutions, with top priority in this subcontracting process going to the entities that were its founders. Preparatory work on the project was completed successfully; however, at that time the Ministry of the Electrical Industry found that it had exhausted its resources for continuing the work. The project was left uncompleted. No new projects were found to provide work for the enterprise's staff. With the onset of the Russian economic crisis and the total

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Page 81 curtailment of practically all types of production activity, the enterprise found itself in critical condition, and its founders decided to liquidate. The main problem the enterprise never managed to overcome was the lack of business activity in the science and technology sphere, a situation that is pervasive throughout Russia. The enterprise was unable to diversify its activities, although such attempts were repeatedly undertaken. The enterprise was also unable to enter the international market or the market for services for small businesses that were then operating in the sphere of science-intensive technologies. ZARECHNY TECHNOPOLIS DEVELOPMENT FUND The Zarechny Technopolis Development Fund was founded in 1993 in the form of an open joint-stock company. Its creation was initiated by the Zarechny City Administration especially to work on preparing and facilitating the Zarechny City Municipal Development Program. In essence, the fund was created as an analogue of the regional development companies, the experience of which is well known. One such example is the Tennessee Valley Industrial Development Association in the United States. The founders of the Fund include the Russian Ministry of Atomic Energy (Minatom), the government of Sverdlovsk Oblast, the Zarechny City Administration, the government of neighboring Beloyarsk Region, major Zarechny enterprises (including the Beloyarsk Atomic Power Plant and the Sverdlovsk branch of NIKIET), and the Department of Atomic Energy at the Urals Polytechnic Institute. In accordance with its charter, the development fund engaged in preparing municipal development programs for the city of Zarechny. In so doing, it provided a citywide infrastructure promoting the modern and coordinated development of the city's social and business spheres. As a result of the fund's work, the oblast government adopted and successfully implemented the Program for the Creation of Zarechny Technopolis. Other results included the preparation and coordination with federal ministries and departments of plans for the federal targeted program entitled Creating a Regional Research and Production Complex Zarechny Technopolis, which is included in the recently adopted Program for the Development of the City of Zarechny as a Science City. To implement this program, targeted funds have been allocated from the oblast government budget, along with investment tax credit funds from the federal budget and money from nongovernmental sources. One of the main focus areas for the Zarechny Technopolis regional industrial complex is innovation activity, not only in the science and technology sphere but also in the socioeconomic sector. To develop small business in the science and production sphere, the fund created two affili

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Page 82 ated structures, Technopark and Agropark, both of which are closed jointstock companies. More detailed information on the operating experience of these enterprises is presented below. The division of functions between these enterprises and the fund was determined by joint decision. Specifically, the fund deals with major regional development projects and works with state enterprises situated in the area. Technopark works with small-and medium-sized businesses and supports small projects in the production and scientific-technical spheres. Agropark deals with projects and enterprises connected with agricultural production and the manufacture of foodstuffs. Dividing the functions in this way has turned out successfully, at least with regard to operations involving small business. The main problem for the fund has been ensuring the availability of material support for its ongoing activities. This is a fundamental problem for all enterprises and organizations involved in innovation activity within an infrastructural unit. The real support that was obtained for innovation activity from the federal and municipal levels had to be directed only to actual project implementation. Expenses for preparing and promoting the projects could not be financed from budgetary sources. As yet, there is still practically no demand for consulting services in this sphere. Therefore, the fund was compelled to engage in various types of side activities to make it possible to carry out its function of providing an innovation infrastructure. The problem here lies in the constant danger that the enterprise will reorient itself toward more profitable commercial activities, leaving behind its innovation infrastructure functions. According to existing information on similar structures, the majority of them have either ceased to exist, as with Uralconversion, or are successfully operating in other more profitable fields of business. The fund managed to overcome this problem and still manages to do so as a result of constant interaction with its founders, who have an interest in the fund as an infrastructure. This is particularly true with regard to the Zarechny City Administration, which in practice assigns the fund responsibilities for a great number of issues regarding the management of development in the city. At present the situation is improving thanks to the economic upswing as well as the new demand for consulting services in the municipal management sphere, where socioeconomic and management innovations are vitally important, and in the newly invigorated sphere of scientific-technical innovations. The fund is actively developing both of these market niches. The second problem, which is connected with the first, is caused by the fact that the legal form of the joint-stock company is not in accord with the socially significant but essentially noncommercial nature of the work the company performs. This problem arose because at the time the fund was established, Russian legislation did not foresee such an entity as a nonprofit organization. In addition, the joint-stock company format has

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Page 83 some positive aspects in working with programs and with potential investors. This problem is being overcome by means of a decision of the shareholders that the fundamental goal of the enterprise is not making profit, but facilitating regional development. The third problem lies in the shortage of personnel who are trained and capable of working in an innovation infrastructure environment. This problem is being addressed by actively searching for potentially capable young people, who will subsequently receive on-the-job training at the fund by working there as experts on a part-time basis. The Program for the Development of the City of Zarechny as a Science City includes a special Personnel Bank project to promote broader searches for promising employees. The fourth problem involves the lack of legislation at the oblast and federal levels on matters connected with innovation-oriented development and merely development in general. These shortcomings are most acutely evident in the lack of legislation on development programs, intellectual activity, intellectual property, and rights to inventions made in the course of employment. AGROPARK The Agropark enterprise was created as a closed joint-stock company on the initiative of the fund to introduce new science-intensive technologies in agricultural production and foodstuff manufacturing. Its founders include a number of enterprises located in the city, including the Zarechny Technopolis Development Fund. With the help of the fund, the enterprise managed to obtain funds to create a number of new technologies and put them into actual use in the agricultural industry (the use of ozonators in the storage and processing of foodstuffs and the use of new types of equipment, for example, electric weeding devices). However, it turned out that there was insufficient demand for these technologies, and their implementation did not justify the funds invested. Attempts to diversify the activities of the enterprise were unsuccessful. As a result, the founders decided to liquidate the enterprise. TECHNOPARK The Technopark enterprise was created as a closed joint-stock company on the initiative of the Development Fund for the Support of Small Businesses Working with New Science-Intensive Technologies. In addition to the development fund, the founders of the enterprise included the Sverdlovsk Oblast government's Business Assistance Center and the experimental production branch of a scientific research and design institute of power engineering.

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Page 84 Successfully providing an infrastructure for small business and providing consulting and support services, Technopark fulfilled the functions of a municipal structure for the support of small business and took the lead in executing a program for the support of entrepreneur ship. At present, Technopark continues its small business support functions taking into account its enhanced capabilities in this regard. In 2000 the city administration leased production facilities to Technopark to be used as a business incubator. One problem encountered by Technopark during the initial stage of its operations was the insufficient volume of funds allocated in local and oblast budgets for the support of small business projects. The enterprise managed to resolve this problem by attracting funds from various, mainly nongovernmental, sources. A local bank and the local office of the Employment Fund were successfully recruited to participate in the specially prepared small business support program, and grants were also obtained to fund the program. The second problem involved a lack of projects concerning production, especially science-intensive production. To resolve this problem, Technopark worked with the development fund to launch a special effort to seek out and develop promising ideas. In essence, these actions were taken in strict accordance with generally recognized venture capital procedures. One example of a successful venture process is a project for creating an enterprise to manufacture test gas mixtures. The project has been taken from the idea stage to full implementation now that the PGS enterprise is operating successfully and producing a profit. The third problem concerned the discord between the joint-stock nature of the enterprise and the essentially noncommercial nature of its activities, just as was the case with the development fund. This problem is especially keenly felt in working with grants, which are usually awarded to nonprofit organizations. The problem was resolved by a special notation in the enterprise's charter documents stating that the fundamental goal of Technopark's activity is the development and support of small business and that the founders do not receive any profit earned, as these funds are entirely used for the company's stated goals. PGS The PGS enterprise was created on the initiative and under the patronage of Technopark for the manufacture of a science-intensive product, test gas mixtures. The founders of the enterprise were Technopark, the Laser Diagnostics Clean Technologies Technocenter, and a number of individuals, namely the inventors and implementers of the idea of producing such a product.

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Page 85 The idea of setting up such a production facility was born among Technocenter personnel who were working on problems connected with radiation-oriented materials science. The idea received the support of Technocenter management, but because of a lack of willingness to expand the effort, the idea was proposed for implementation on a venture capital basis at Technopark. Thanks to the efforts of Technopark, the idea was developed into a project, an enterprise was created, loans were secured to support its operations, and a project manager and staff were assembled. In its initial phase the enterprise received assistance in the form of administrative and accounting services. Today the enterprise has a monopoly on the production of test gas mixtures in the Ural-Siberian region. The enterprise's main problem was effective management oriented to the needs of the specific market. This problem was resolved by the selection of a trained Technopark staff member to become director of the enterprise and by his thorough preparation, including a period of study in the United States. The second problem that arose during the most difficult period of the economic collapse was the failure of customers to pay for the products they purchased from the enterprise. The problem was solved by establishing a system of surrogate means of payment (promissory notes) and by actively working to gain the greatest possible number of customers so as to require the least possible amount of payments in monetary form. The third problem is connected with contradictions between shareholders and managers of the enterprise regarding the targeted spending of profits earned. This problem has not been resolved. Moreover, the conflicts caused the managers to reregister the enterprise, and, as a result, the production facilities have essentially changed ownership. EKORAD The Ekorad enterprise was created on the initiative of employees of the Sverdlovsk branch of NIKIET as a closed joint-stock company for the development and manufacture of standard samples used for checking analytical instruments and monitoring the environment. The project participants were individuals involved in manufacturing such samples at NIKIET and workers from the All-Russian Scientific-Research Institute of Metrology and Standard Samples (VNIIMSO) who were engaged in developing standards and standard samples. The enterprise successfully began production of one type of standard sample with the support of the Sverdlovsk branch of NIKIET and VNIIMSO, which had an interest in such products. However, Ekorad was unsuccessful in launching full-scale production. Its losses accumulated, and the enterprise closed down. The

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Page 86 reason for the failure and the main problem was the lack of a trained manager who could organize production efficiently and produce specific science-intensive products. CONCLUSIONS An analysis of the experience of these and other enterprises makes it possible to draw conclusions on fundamental prospects for innovation activity and, in particular, venture capital activity under current Russian conditions. However, the specifics of this sphere superimpose particular conditions on organizational structures for the support of innovation and venture capital activity. It must be kept in mind that Russia completely lacks the innovation infrastructure that traditionally exists in the West. There are no venture capital funds. Such activity is prohibited for the pension fund. Banks do not engage in such activity because of the lack of the necessary normative documents. At the same time, a potential for such efforts does exist in the form of the scientific and technological developments that have been achieved at research institutes and universities. Potential investors have recently begun to appear; but to link these and other necessary elements, it is essential that raw ideas be developed into projects that are acceptable to investors. It is this work that is most required to add impetus to innovation processes. The function of developing ideas into full-fledged projects can only be carried out by specialized enterprises organized along the lines of venture capital funds. These enterprises must have connections and work experience in science and technology, and at the same time they must have experience working in business and interacting with investors. Only in this case will we see the formation of the only productive structure for the venture capital triangle (author of idea→enterprise supporting technology→venture capital enterprise) or venture rectangle (author→enterprise supporting technology→investor→venture capital enterprise). In cooperation with the Sverdlovsk branch of NIKIET and with institutes of the Urals Branch of the Russian Academy of Sciences, the development fund is currently working to establish venture capital procedures. Protocols have been signed with each partner regarding joint actions on the commercialization of ideas and scientific-technical developments not used by institutes in their primary activities. The institutes submit to the fund specially selected ideas of their employee-inventors, which are then developed into project form by the fund in collaboration with the inventors themselves. During this process, additional scientific and technological studies are conducted, the potential market for the product is researched, a business plan for the project is prepared, and investors are sought. Then, depending on needs and conditions, the project is either

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Page 87 transferred to a third party for implementation (in the mode of selling a business) or is carried out by the inventors themselves with the support of the fund and the institute. To increase the scale of these efforts, plans for financing the Project for Creation of a Regional Innovation Center are included in the draft Program for the Development of the City of Zarechny as a Science City. To make activities in this area more successful, the oblast needs to pass a law on innovation activity and establish a program for the development of innovation activity, including the creation of venture capital centers to provide an infrastructure for promoting innovations. Plans for such a concept of innovation activity have already been worked out, with the development fund being involved in this effort. At the federal level, a package of legislation is needed regarding innovations and the support they require. Drafts of such laws are at the Ministry of Industry, Science, and Technology and the State Duma. Efforts are needed to move them forward. In addition, initiating actions are necessary similar to those taken by the science ministry regarding innovative technology centers. However, it would be expedient to link such centers not with scientific institutions but rather with more flexible, active structures with more resources at their disposal. Such structures could be found in the boards of directors of Science City programs established at the time the programs are approved and their status is confirmed. The functions of establishing an innovation center or performing the functions of such a center should be recorded as mandatory state orders for each Science City. The functions of innovation centers could also be successfully carried out by Minatom cities regardless of whether they have been accorded the status of Science Cities or not.