The todays and tomorrows of Russian e-business life

Issue Number: 
181
Author: 
By SVETLANA PIROZHKOVA / Business analyst at Deloitte & Touche C.I.S.
Published: 
2001-03-30


Russia's interest in the Internet economy continues to grow. Factors such as the high capacity of the Russian market, availability of skilled labor and relatively low wages in the country, as well as low product prices, give hope for rapid growth in e-business.

Despite these favorable prerequisites for further progress in e-business, the sector's development is proceeding with a lot of difficulties and is being hampered by numerous obstacles.

Among other barriers, the legal environment is a significant roadblock to the growth of e-commerce, both globally and in Russia. The Russian government is responding to this by attempting to resolve some key issues.

An issue that is being tackled by many major countries in the world is the use of electronic signatures. According to existing Russian law, parties can enter into a standard contract (signed and stamped) that declares they will conduct further business by electronic means. Thus, the ability to agree to the way in which further transactions are conducted exists and allows the protection of e-commerce transactions under contract law. Unfortunately, this does not help Internet businesses with numerous customers engaging in a limited number of purchases. Due to Russia's legislatively backed tradition of issuing stamped, signed contracts for all business transactions, it would appear to be difficult to shift to the use of a purely electronic agreement between parties. As proof of this unfavorable finding, the draft law on electronic signatures was rejected in its first reading and will require some modifications before being reconsidered.

Another bill, The Law on e-Trade, submitted to the State Duma lower house of parliament at the beginning of March, focuses on extending the provisions of contract law contained in the Civil Code to electronic transactions.

This rather broadly written draft first attempts to define electronic trade through a long, but not exhaustive, list of possible transactions. The only truly restricting provision of the definition is that e-trade must be related to commercial activity.

The draft law also says that compulsory components in an electronic contract should include the technology used in concluding a contract, signing procedures, terms of reference to other electronic documents, access procedures and storage procedures. These compulsory terms are defined as substantial and their violation would mean that a contract has not been concluded.

A final point of note is that the law does not stipulate the necessity to license e-trade. Considering the substantial number of licensing requirements in Russia, this is a step in the right direction. But to prevent your early elation, I should remind you that this law hasn't yet passed and is currently being reworked.

Another painful issue that stirs the minds of the Internet community is e-business valuation.

The specifics of the e-business industry make traditional valuation approaches useless. The market-valuation approach (basing a company-value definition on comparisons to other firms of similar parameters) doesn't work with Internet firms because valuing an Internet company is a lot like valuing Dali pictures against Michelangelo frescoes – each Internet deal is equally unique.

The assets-based approach fails because tangible assets of most Internet companies are very modest. If a company sells information or access to some resources, or even software, it normally doesn't have huge stocks of goods and consumables in warehouses, own machinery, means of transportation, etc.

Discounted-cash-flow (DCF) models are based on calculations of today's value of future incomes, and their application is impossible with those Internet companies that suffer substantial losses and have no prospective of earning any profit in the near future.

Determining the fair market price of Russian Internet resources is even more complicated than valuing their Western analogues.

First, the Russian Internet sector is a "start-up" market and there is no wide set of contracts to be studied; there is no balance of supply and demand and the number of declared sellers, buyers and intermediaries is insufficient to make predictions or extrapolations and assess trends.

Second, traditionally for Russia, the information business-acquisition price is not revealed; the services of professional appraisers are not always enlisted and PR issues make buyers and sellers announce imaginary contract prices to attract attention to their projects.

Besides the described general limitations for the Internet economy's evolution, there also exist numerous country-specific factors that slow down the coming of the New Economy to Russia.

The first one to mention is Russia's underdeveloped infrastructure, especially in the fields of telecommunications and finance. On average, there are five Russians for every phone line in the country and, in some rural areas, the ratio of people to phone lines is as high as 10 to one. Insufficiency of telephone lines multiplied by the relatively small number of PCs in the country and high connection costs result in an extremely low Internet penetration rate of about 2.5 percent. Poor logistics systems, especially in the regions, contribute to Russian e-business market backlog.

Another important feature of today's Russia is deep mistrust of the domestic banking system following its near-collapse in 1998. Absence of unified payment systems, which would be trusted and accepted by both buyers and sellers, and the extremely low penetration rate of credit cards together with the general unwillingness of users to provide credit-card details when shopping or making other transactions online attests to a dangerously low development level of financial and transactional sectors.

Weak consumer purchasing power is a well-known problem not only in Russia and the former U.S.S.R., but also in all the emerging economies of Eastern Europe and Latin America. Weak consumer purchasing power that is driven by high unemployment levels, low wages, and low living standards constrains the development of Internet business, especially its B2C sector.

The great benefits promised by the Internet to small businesses remain almost unexplored in Russia. The reason is simple: Businesspeople don't want their businesses to be "transparent."

The idea that a lot of Russian companies deal in "black cash" and resort to revenue understating and tax evasion isn't going to surprise anyone. Doing business on the Internet can deprive these firms, which abuse lax laws, of these "efficient" methods of money-making and they are not willing to give up their income.

WHAT'S AHEAD?

For a few years, online business in Russia was a kind of wishful thinking rather than a real opportunity. However, recent studies show facts that are likely to encourage investors into translating their ambitious plans into life.

The International Data Corporation (IDC) compares Russia's Internet economy to its counterpart in United States during the mid-1990s and predicts that 9.4 million Russians will gain Internet access by 2004. This will mean an Internet penetration rate of 10.5 percent, up from 2.5 percent in 2000.

According to Brunswick Warburg, the compounded annual growth rate (CAGR) of e-commerce from 1999 to 2003 will be 253 percent, with the B2B sector enjoying revenue of $4.25 billion in 2003 with a CAGR of 245 percent over the 1999-2003 period. But it is B2C that should experience truly dramatic growth — a CAGR of 316 percent although its revenues in 2003 should be somewhat more modest, at $900 million, up from $3 million in 1999.

As for Internet advertising, by the end of 2003, will triple to reach $150 million, with $30 million in 2001 and $70 million in 2002.

Among the factors that could lead to formidable growth, four are particularly worth mentioning.

(1) The number of PCs in the country is expected to increase from 1.1 million computers sold in 1999 to 2.5 million in 2003.

(2) Experts also anticipate Internet access costs reduction, which includes not only Internet-service-provider (ISP) fees, but also fixed phone-line rental charges. Some experts predict Internet access charges will more than halve by 2003. That is, if the Internet user pays for service at all, as some analysts anticipate that free Internet access will soon expand in Russia.

(3) With the appearance of the first online payment systems, Russian Internet users gained an opportunity to more actively participate in e-commerce, and today's trend is toward unification of online transactional mechanisms and their general acceptance by Internet users.

(4) Currently, the main Russian Internet players are merging and acquiring the most promising projects in different Internet segments such as Golden Telecom (NASDAQ: GLDN) which started as an ISP and currently owns the Moscow Web-design studio Fintek, and the well-known Russian portal Referat.ru. The current trend toward diversifying Internet activities reflects that Russia is one of the strongest in the market.

SUMMARY

Many experts believe that e-business will be one of the most important economic tools of the 21st century, both globally and in Russia. The numerous obstacles that hold the industry back – imperfection of the legislative base, absence of e-business valuation methodologies, Russia's infrastructure immaturity and weak purchasing power of the population – will be gradually lifted.

However, to become a strong "new economy" player Russia needs to speed up. It is already two to four years behind the United States in terms of Internet business development. Of course, two to four years' lag time is nothing compared to the almost 50-year development gap observed in other economic sectors.

But the pace of e-business sector evolution dictates that Russia apply all efforts to create a favorable environment for further development of Internet and e-business. And it is more than evident that if Russia doesn't catch up with the rest of the Internet-advanced world in the near future it will be much more difficult (if not impossible) to integrate into the "new economy" later.


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