K.White book

Innovation for Business: a 21st Century Development Model for Russia

Part V

A four-point plan to help Russia reinvent itself

What does Russia need to do to establish itself as a leading innovation economy in the world? In my opinion, there are four basic criteria, which should be explored to determine Russia’s competitive advantages, if any.

To create an innovation economy there must be

(i) a culture of innovation.

(ii) a full range of infrastructure and support

(iii) a full range of financial resources

(iv) a dynamic living eco-system of new open business creation which has access to capital and global know-how in commercializing new and innovation solutions to global problems.

Culture of Innovation

Russia has a very strong culture of innovation. In the last one hundred years, many international innovations were created by Russian people or people of Russian descent who were educated in Russia. An academic study should be made of this position. From my own anecdotal experience, there are many innovations which came from America, Germany, Israel or Japan, which actually were ideas created by Russian national expats that left Russia to live in foreign countries where they could develop their ideas and effectively earn income from their innovations.

Russia is inherently a very creative society. It has every potential to be a leading innovator and creator of new ideas. This is a fundamental competitive advantage of Russians internationally.

I remember asking a leading founder of one of the top Silicon Valley companies who was visiting Nizhny Novgorod several years ago about how he compared software programmers from America, from China, from India, and from Russia. This is what he said:

“Well, effectively I can say that American software programmers are some of the best in the world but they are extremely expensive and, on top of that, very capricious individuals. They are not very easy to deal with.

Considering China, our company has not experienced a high level of new R&D developments from our partners in China. However, the Chinese are extremely good at taking an existing technology and improving upon it. Furthermore, China is skilled at mass-produce products at a very low-cost. It is potentially very profitable for us to work in China.

In India, our company must create very structured sets of instructions for our programmers. We must give them the exact detail of the desired end result, when we need it, and under what budget. Indian software programmers are excellent in their work, and the job gets done at a lower-than-expected cost and on time, or even ahead of schedule. However, we do not outsource creativity or R&D work to India. We instruct them to do precise contract work according to very specific instructions.

With Russian programmers, basically we take our toughest problems, and ask two Russian programmers to come in and talk with us. They may look a little scruffy, with hair uncombed and a disheveled look. However, we explain to them our programming challenge on a blackboard, they take notes, and then leave. We do not see them for two or three weeks. I am told by my supervisors that the two have been drinking coffee for 24 hours a day and smoking cigarettes in the corridor. In three weeks, they are back in my office. They look horrible, but they explain to me on that same blackboard that the root of the problem is three levels deeper that we thought. They then conclude by explaining the solution.”

This skill is a major Russian competitive advantage in this 21st century world. The Russian education system can produce some of the best minds in the world at solving some of the toughest problems. Russia should be using this competitive advantage to its own national advantage.

With these intellectual skills, Russia can change its image to the entire world. Russia has an opportunity in the 21st century to bring its intellect and expertise to the table at the highest level, with the Americans, English, Japanese, Germans, and others, and work at an absolutely equal level in solving global problems.

Infrastructure and Support

Twenty years ago upon my arrival to Russia, infrastructure was in a very difficult condition. Even ten years ago, Russia was in a very serious predicament as far as its infrastructure. However, over the last five years, many infrastructure problems are being addressed.

There’s a huge amount of work yet to be done, but the government today is taking the profits from oil and other natural commodity markets and reinvesting them in the development of special economic zones, new techno-parks and business incubators and municipal infrastructure, which is helping to develop the innovation economy.

As an example, the Russian Government is supporting the Russian Venture Company (RVC). This is the organization that is creating a number of programs designed to bring the risk barrier down so that private Russian investors are more incentivized and motivated to invest in Russian technology and innovation.

The RVC now is creating a number of different funds that are able to co-invest with investors and allow investors to take a higher rate of return at the end of the project when the project is profitable and sold. This is a huge benefit to be used to motivate and encourage Russian investors to risk their private savings in supporting innovation projects.

Unfortunately, not many have taken advantage of the RVC yet, but the funds are now actively working and investing in projects. The RVC examples established over the past two-to-three years are going to be very successful and show other Russian investors the way forward.

The Russian Venture Company has also developed a number of partnerships with different programs, such as its Venture Partner program. These partnerships are becoming effective in lowering risks and encouraging private investors to take greater risks in domestic investment projects.

As another example, the Rusnano technology corporation has been created and is led by Anatoly Chubais. Rusnano is a government-owned corporation set up in 2007 to develop Russia’s nanotechnology potential and tap into the world market of nanotechnology products.

The individuals who work in this project come from experienced background of venture capital, private equity, banking and international financial markets. They are very competent, very confident, and are developing a number of programs that are specifically addressing the systemic problems in Russia.

Russia faces a lack of business angel investors. However, Rusnano together with the RVC is absolutely supporting the development of the new RuBAN business angel network, Russia’s first NGO set up by private (business angel and PE) investors seeking the fostering of innovation culture and looking for promising venture projects across Russia’s regions.

The Russian Government is pouring money back into infrastructure and is helping to develop risk reduction mechanisms to encourage entrepreneurs to invest in themselves and to invest in new innovation projects.

Other examples include Russia’s network of Special Economic Zones, which includes a specific Hi Technology zone just outside of the city of Tomsk in Siberia. Other regions are following; it’s clear that the infrastructure is developing in this country and will soon reach a critical mass.

A Full Range of Financial Resources

Regarding the range of financial sources, Russia has not yet completed the development of a strong financial system in this country. Specifically, business angel investors are too few to establish a solid foundation on which the rest of the system must develop.

A number of professional venture capital fund managers cast about for projects around the country, as well as many world class private equity funds based in Moscow. Additionally, international and domestic banks and many other financial intermediaries are active; all built on top of some very effective and useful government technical assistance programs, such as the Bortnik Fund.

But to effectively build an innovation economy, there must be numerous Russian investors at the earliest seed capital and start-up phase: money coming into projects before the commercialization strategy is really understood for those products. Business angel investors nurture young, aggressive innovators and scientific minds that are creating new innovation ideas. But those innovation ideas need business experience in order to succeed.

Business angel investors bring to the table money, of course, but most importantly their experience. Russia faces another systemic challenge here, as the first generation of business angel investors who developed their career in the market economy, creating their own businesses from scratch, are just maturing into Smart Money angel investors, ready to morally and financially support the next generation of innovators.

Only a handful of such people exist in Russia today. They must be encouraged with incentives and Western know-how to properly channel their own experience and wealth back into Russia’s emerging new innovation economy.

Numerous wealthy individual Russian investors exist in the nation, who made their money through any combination of privatization, real estate, or commodities trading deals. Others became wealthy riding the topsy-turvy swings of the Russian stock markets, or perhaps simply by being in the right place at the right time and having the right government connections.

Whatever the case, while many who have made substantial wealth through lucrative transactions, few who have made serious money by building businesses from the bottom up, with bootstrapping and 24/7 work routines.

Smart Money experience is not profound yet. Only today are the first generation of entrepreneurs – individuals that started their business twenty years ago, grew that business, found investors, found strategic partners, developed the production of their products to sell in Russia or export into the world, and then maybe sold their companies - investing in the next generation of projects.

This should be a cyclical process, with each new generation of successful entrepreneurs investing in a next generation. Because the number of such individuals is far too small in today’s Russia, an answer must be developed which uniquely addresses this Russian problem.

The Russian Venture Company and Rusnano are working on developing earlier stage seed funds and infrastructure funds to bring earlier stage money into companies. The government has already experimented with such approaches, such as the Bortnik Fund. This well-known fund was a pioneer in Russia, and its concept should be repeated a thousand times around the country. Each major city should have fifty different funds operating in competition with each other and stimulating the young generation of innovation entrepreneurs to create new ides in which the funds can invest.

Unfortunately, Russia is still very far away from this vision. A typical city in the United States - such as Chicago – holds hundreds of different investment funds focused upon different areas of technology; private equity, venture capital, and of course, business angel investors. The same type of financial structure is repeated in New York, Boston, the Silicon Valley, all across the U.S., the Euro zone, England or Japan.

Mature economies must have a very deep and rich financial infrastructure in order to remain competitive and attract the best and brightest from around the world to come, live, work, and get rich. Russia is only beginning to develop this system. To succeed, the country must work harder to improve its competitiveness and retain its “best and brightest” in Russia.

Nonetheless, the system today is like “night and day” compared to its appearance five years ago. The country is laying the right foundation for attracting Russian investors to come into this market and risk their investment capital in early stage technology. Over the next twenty years, the evidence should show if this system is working correctly.

A Dynamic Living Ecosystem of New Open Business

The next stage on the path of commercialization is to assure business developers understand commercialization strategy.

The process begins by developing a first prototype; then identifying another investor to help move to a next level prototype; then testing and validation and market studies to develop a business plan to attract a Private Equity investor to secure credit from banks; then acquire higher levels of private equity funding to continue expanding; and ultimately moving to an Initial Public Offering (IPO) to go national or international with product sales.

The overall process may take five, ten, fifteen, maybe twenty years from start-up to IPO. However, any major global company today probably went through this exact same process, such as Google, Apple, Yandex, Facebook, or Cisco Systems. The path each company took is clear and understandable. A business angel investor’s main responsibility is to help the leaders of the invested project fully understand this process and prepare for it properly.

An investment project’s commercialization strategy is like a roadmap. For a journey from Moscow to Vladivostok, one would not jump in a car and leave without a map. A map is needed to make decisions as to where to turn left or right, or where to get gas or other help along the way. Without that map, one cannot explain the journey to anyone else.

Likewise, if an innovator cannot explain to an investor the development process of the project or the new innovation of his young company, the investor is not going to invest. So, a path to commercialization is simply a mechanism to explain to an investor how the company will develop from one stage to the next.

Hi-tech innovation entrepreneurs won’t be able to do that unless they understand their market. As a business angel I advise you: be market-driven. When the first investor listened to Sergei Brin speak about his Google idea in a caf?, what did the investor do? He gave Mr. Brin a check for a hundred thousand dollars because as a Smart Money investor he understood the difference between just a change and a market disruption.

In order to understand the market impact of your product, you must understand who’s going to buy your product. Is your product a niche industrial product? Or are you going to develop a license on a new evolutionary change? Know the market potential, be aware of your valuation—and be prepared to explain the path to commercialization to each and every level of potential investment along the way.

For example, angel investors place much importance on the innovator’s motivation to work 24/7 to develop the project. The angel investor may make an investment decision based on his intuition.

As the project progresses, a professional private equity firm is not going to base its decision upon an investment officer’s intuition; the firm is going to conduct due diligence. The firm will want to look at cash flow statements and financial projections; it will read the 200-page business plan to understand if all the risks in the proposition have been addressed.

If the company approached a public offering, hundreds of pages of documents on financial due diligence, accounting due diligence, international reporting, etc. are required.

At every level of the company’s development, the innovator must be prepared to speak to that level of investor. This is the path to commercialization, and this is what business angels need to explain to innovators.

20 Aug '10

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