Captive R&D centers
Research and development (R&D) centers in Russia owned by foreign multinationals first began to appear in Russia in the 1990s. Debis (now T-Systems) was the first, opening in 1995, followed by Intel and Deutsche Bank in 2001, and Oracle (which now incorporates Sun Microsystems) in 2004. The trend continues with recent R&D centers being opened by Nokia and Microsoft. Currently the export volume of R&D centers is estimated to be around $380 million, demonstrating year-on-year growth of 9 percent.
Russia is regarded as a key destination for maintaining development units by major U.S. and European companies because of the high quality of Russian programmers and the lower costs of doing business. Companies that maintain captive R&D centers in Russia and continue to see the country as a strategic source of talent include:
- Allied Testing
- Design Systems
- Cisco Systems
- Columbus IT
- Deutsche Bank (the bank’s 2nd largest development center in the world is in Moscow)
- EGAR Technology
- Jensen Technologies
- LG Softlab
- Nival Interactive
- Nokia Siemens
- Quest Software
- Samsung Research Center
- Scala CIS
- Oracle (former Sun Microsystems)
- Tagrem Studio
The growth in exports from the R&D centers of foreign corporations increased by 12 percent in 2012 largely thanks to activities associated with the Skolkovo Foundation to reach a total volume of $500 million.
In 2012, international companies began implementing the previously declared plans for the creation of new R&D centers in Russia. Generally, these centers appeared thanks to the Skolkovo Foundation and the innovation center of the same name being built near Moscow. Residents of this center have already been given certain tax incentives for opening units there. The possibility of obtaining incentives (first of all, in reduced tax rates) supported an increase in the volume of investment by foreign corporations into R&D services in Russia.
Such influential corporations as IBM, Cisco Systems, Microsoft, and SAP were among the most active investors in the implementation of R&D in Russia during the last 2 years.
SAP, which opened a laboratory (SAP Lab) engaged in scientific research and innovative development at Skolkovo in 2012, plans to bring staff numbers at its research division up to 250 people by 2015. The company’s investment in R&D in Russia is expected to exceed 45 million euros.
In the spring of 2012, it was announced that programmers from Microsoft’s Moscow ERP system development center were engaged not only in product localization but also in the development of the company’s newest products. In addition, Russian staff provided development support for sophisticated Cloud Numerics functions for Microsoft. Microsoft identifies Cloud Numerics as being the first cloud development project at its center in Russia, which was created as a part of the agreement with Skolkovo. Microsoft plans to develop software in Skolkovo for face and speech recognition as well as software for multimedia data broadcasting. Staff numbers at Microsoft’s Russian development center are expected to reach 150 people by 2015.
EMC and Samsung have long operated R&D centers in St. Petersburg and Moscow, respectively. Both companies established additional centers at Skolkovo in 2012. EMC expects to employ 50 people at its development unit, which focuses on Bio-informatics, by 2015.
T-Systems, (a subsidiary of Deutsche Telekom), while expanding the number of developers at its St. Petersburg office also began operations in Voronezh, where they have begun to recruit programmers and to collaborate with Voronezh State University on a staff-training program. The T-Systems office in Voronezh opened in late 2012.
China’s Huawei Technologies announced plans to increase its R&D investments in Russia with an R&D division located in Samara that will focus on the development of cloud technologies solutions based on open source software.
Qualcomm, a US mobile microelectronics vendor, began sourcing a team to form the basis of its Russian development center in 2013. The company has said that it is interested in recruiting experts who have experience in application programming and digital signal processing.
Facebook is also considering the possibility of establishing an R&D unit at Skolkovo.
At the end of 2011, Cisco Systems announced the beginning of recruitment for a newly created affiliate, which is due become a resident of the Skolkovo innovation center.
Nokia Siemens Networks announced the opening of a new 4G mobile communication R&D center in Russia. The company has had Russian R&D subdivisions for a long time and actively cooperates with Russian universities.
The Intel Corporation is expected to increase its investments in its Russian R&D centers in connection with the signing of agreements with the Skolkovo Foundation.
We are aware of at least 40 captives located in Russia that employ over 6000 people. Because the amount of available data on captives from open sources is by and large negligible Software-Russia conducted interviews with a representative sampling of multinationals that maintain captive centers in Russia. Most of the units are located in St. Petersburg, Moscow, Nizhniy Novgorod and Novosibirsk.All of the companies surveyed are fully owned and operated by their parent organizations and claim workforces that range in size from 300 to more than 1000.
Primarily known for attracting IT firms which account for the majority of the country’s captive R&D units, Russia also attracts companies involved in finance, telecommunications and transport.
At Intel, for example, over 90 percent of the workforce is engaged in R&D. Oracle employs approximately 300 people in Russia split evenly between development and quality engineering — i.e. test engineers who develop test suites and test technologies that require advanced skill sets. Grigoriy Labzovsky director of Oracle’s High Technology Center, speaking of the country’s traditional strengths, revealed that Java technologies were among the main contributions made by the Russian center. “The company has been working on the Java Compatibility Kit since 1998 and has contributed to many other parts of Java including graphical libraries, numerous JSRs [Java Specification Requests] for mobile, Java virtual machines, etc. There is no single product that was developed entirely in one place — the company has always been a global team. We are lucky to work on technologies that millions of people use to build their products. The development of a technological platform is not the same as developing a product. The work is never finished and usually involves hundreds of people.”
In the financial sector, Deutsche Bank’s Global Execution Platform for stock trading was successfully implemented in all of the bank’s trading hubs from its Russian captive development center. In fact, many of Deutsche Bank’s projects developed in Russia have won accolades from Wall Street. In addition, of Deutsche Bank’s three main development centers — New York City, Moscow and London — Moscow has now expanded to occupy second place.
When asked why his company choose Russia over other locations, Deutsche Bank’s Mikhail Khassine remarked on “the high level of competence of Russian IT experts, their ability to learn quickly and their innovative thinking; all of which more than compensates for any lack of language skills or a knowledge of western culture and allows Russian-made software to compete successfully in any applied sphere.”
Oracle’s Labzovsky went on to say that “Russian specialists have a very profound technical background very good math skills and are loyal to the employer.” He also mentioned “The quality of the work and a decent level of English language skills.”
The top companies by employee numbers currently maintaining captive centers in Russia are: Intel, Motorola, Scala, Deutsche Bank, Borland, Oracle (incorporating Sun Microsystems), Quest Software (which gained a presence in Russia after acquiring Aelita in 2004) and Dell.
R&D Unit Formation
Typically there are two approaches to setting up a captive operation. The first is to build the development unit from the ground up. This is suited to organizations with the necessary resources, local expertise and market knowledge. The second is known as a Build-Operate-Transfer (BOT) approach where the parent company enters into a partnership with a third-party vendor to establish and stabilize the captive facility. A vendor is contracted for initial setup, staffing and operations of the captive development unit during a predefined period of time at the end of which ownership is transferred to the customer. The BOT option is best suited to organizations that do not have local expertise or extensive resources available. Sun Microsystems, for example, began life in Russia as Elbrus MCST a company set up in partnership with the Department of Computer Science at the Moscow Physical-Technical Institute and then spun off its own operations with the original company finally going on to become part of Intel. Sun was itself acquired by Oracle in 2010.
Of the companies surveyed, most built their Russian operations from the ground up. Intel, for example, began its Russian operations in 1991 by opening a sales office. A year later, it began to build contacts with Russian scientists working at the Arzamas 16 nuclear center. Gradually, as the number of contacts with Russian developers increased, so too did the number of contract-based projects. In 2000, this cooperation was leveraged into the company’s first R&D center and the opening of an office in Nizhniy Novgorod.
On why the BOT model doesn’t work for larger companies Igor Kaloshin, Operations Director for Intel Russia, expressed doubts over its benefits. “Does BOT have any advantages? It is hard to assert that unequivocally. Companies that wish to develop in emerging markets need to have access to relevant expertise. There should be a qualitative combination of incremental growth, which usually happens when cooperating with academic institutions and various business acquisitions.”
Advantages and Challenges
The chief impediment facing international R&D centers is the unresolved issue of administrative barriers to the import to Russia of hi-tech equipment for software development and testing. Customs duties are collected when importing equipment to Russia, which may be resolved by Russia signing an IT Agreement as part of Russia’s accession to the World Trade Organization.
The establishment of captive R&D facilities, however, still represents both a cost saving method for the delivery of sensitive functions close to core business that maintain operational control (as opposed to payroll and other non-core automated tasks, which are often more easily outsourced to a third-party) and a way to mitigate perceived risks associated with confidential business information.
Intel confirmed this by saying, “The protection of business information is a key factor. Intellectual property and core expertise are the two milestones.” While Oracle went on to say, “As a service provider the company secures sensitive business information that no one else can be trusted with.”
Most captive centers are set up as either Shared Service Centers (SSO’s) or product/service development units and generally operate on a pure cost model. But because these units are created specifically with cost savings in mind they can face top line financial issues and are increasingly beginning to turn toward Profit & Loss models. These can take the form of hybrid captive/outsourcer relationships where the parent company contracts an outsourcer to supply and manage programmers at the parent’s facility or the outright sale of their offshore operations to third-party vendors.
Several of the companies surveyed by Software Russia had first-hand experience of sales outright to a third-party vendor, which could signal an initial overconfidence on the part of the parent companies to run a business on the ground in another country. Michael Gromov, VP of Point-of-Production at T-Systems, said, “Our company experienced that in India. The decision was made in order to expand the possibilities of resource scaling. But in our center’s case it is hard to imagine that kind of scenario simply because there is no player on the Russian market whose capacity differs greatly from our own.”
Some of the issues that have lead to the sell-off of captive centers in India are lack of scale, higher than anticipated costs and elevated attrition rates. British Airways, GE, Deutsche Bank, Citigroup and Dell have all sold or spun off all or part of their captive center operations in India. The reasons for this are that beyond a certain size, the economics of captive centers are less than favorable. Cost structures of captives are typically 30–40 percent higher than third-party service providers and, with increased financial pressure, access to liquid funds and relief from the burden of running an offshore captive operation have begun to appear more attractive.
One reason why this hasn’t been seen as much in Russia is that many of the captive units located in Russia protect confidential information and processes which most companies are unwilling to outsource. Even in India, the segments of the business that are sold on are normally call centers and other non-core business processes.
Working in a different time zone from the parent company is as much of an issue for captive centers as it is in any offshore relationship. “Of course the time difference affects the working schedule of the center. The working hours were shifted to 11 a.m. to 8 p.m. so as to be in contact with New York for a longer period of time, but it wasn’t really difficult. It was enough to have three to four hours of interaction with New York to communicate effectively,” said Deutsche Bank’s Khassine, reflecting a common point-of-view on the matter.
Increased social security payments may also drastically increase the cost of doing business in Russia for these companies, although Intel’s Kaloshin remains positive. “It is not as crucial for the captives as it is for the outsourcers but increased social tax expenses also affect our business in a negative way. Financial indicators remain one of the most important factors in the decision making process, therefore growing expenses makes us less competitive with other emerging markets.” Oracle is not worried as it says it qualifies for the reduced payment of social taxes made available by the Russian government to alleviate the burden on IT-specific businesses.
Just as with any IT business, attrition rates can negatively impact a captive development unit’s productivity and raise costs. While some of the companies surveyed were unable to comment on their attrition rate, they all agreed that by using various motivational programs it is possible to retain talented employees and keep attrition under control— often by addressing issues related to corporate culture. According to Oracle’s Grigoriy Labzovsky “In relation to the parent company, the captive’s employees see themselves as legitimate global colleagues of the company.” Which goes a long way towards helping them retain top talent.
Expected Growth and Competitiveness
According to RUSSOFT and the company reports and forecasts of foreign-owned companies that maintain a presence in Russia, new hires for 2013 will remain flat or increase by relatively small margins. At the moment, captive R&D centers are not experiencing any shortage of manpower and are cautiously optimistic, as interviews with major companies with offices in Russia seem to confirm.
As a rule, the companies continue to routinely recruit new employees, increasing their staff numbers no more than by 5-10 percent a year. Only Deutsche Bank demonstrated a significant increase in activity — in addition to its Moscow development center it recently launched a similar location in St. Petersburg.
“Intel is a global company,” says the Director Operations at Intel Russia. “In Russia there are a large number of vertical divisions in the organization. Plans regarding growth and development are received from the head office, for the most part. Everything is taken into consideration: the reputation of the teams, the potential of the Russian market and the economic situation. For the last few years of the crisis there were hardly any signs of growth at all. But now a gradual resumption is clearly being seen. So far, there are no problems with finding enough people — maybe because no mass hiring is being done. It is safe to say that the rush for personnel seen in 2004–2005, when demand for programmers and engineers was greater than market’s capacity, is a thing of the past.”
Most of the surveyed companies foresee continued growth and development in Russia based on positive past experience. The combination of an extremely capable talent pool, intellectual property concerns, which have lead some to believe that having their own center helps to protect their unique IP assets, the prospect of tighter management control, the attraction of the potential cost savings to be had by doing things themselves and end-to-end process control all ensure that some companies will continue to maintain captive R&D units in Russia. This despot 205e the mounting evidence that the alternatives are no riskier and can often save significant expense and inconvenience.
Not all the heads of Russian R&D centers of corporations are fully satisfied with the business climate that exists in the country at the moment. All of them have expressed concern over the expiration of tax breaks on social payments for software development companies, which are currently set to end in 2014. They are also dismayed by the serious administrative barriers to the import of hi-tech equipment intended for software development and testing. The issue of hi-tech imports could be resolved by Russia’s joining the IT Agreement within Russia’s accession to the World Trade Organization, as long as Russia joins the co-signers of the ITA.
In order to maintain the current level of tax breaks on social security payments, it is necessary that the Russian government fulfill President Vladimir Putin’s directive of Feb. 17, 2012. In it, he charged the government with safeguarding the tax incentives for the foreseeable future and extending them to small business by lowering the minimum number of staff members necessary for qualifying for the incentive to 10. Despite the administrative impediments, however, not a single international company has pulled its software R&D out of Russia.
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