11 December 2007
The Latest Challenges to Doing Business in Russia
The Latest Challenges to Doing Business in Russia
by Renee Stillings
Alinga Consulting Group, Partner
Corruption and bureaucracy have been the focal point of nearly every article addressing the subject of doing business in Russia. While these are still "live" issues, a new complaint has moved solidly to the forefront of the frustrations facing entrepreneurs and big business alike Ц the escalating costs of doing business.
The two major expenses driving this inflation are sky-rocketing commercial rent and rising labor costs. As these two are the major expenses for service-sector businesses, it is the service sector, which is the driving force of most modern economies, that is being hardest hit by rising costs.
These concerns have become a central point of conversation between business owners and top managers, leading to an increase in the number of local seminars and articles attempting to either present solutions or to minimally provide management with support in arguing their budget request with a home office that is likely to be shocked by the numbers.
Lease Rates Heading North
Nearly every foreign business owner can tell of at least one nightmare situation with a commercial landlord. While many western-managed Class A properties are somewhat immune to this (perhaps due in part to the power of their tenants), it is the rare landlord who fulfills most of his/her side of the contract. Moreover, rental contracts in Russia are usually biased toward the landlord.
As a result, tenants very frequently find themselves looking for new premises after an unexpected or especially large demand for increased rent or after frustration in waiting for property upgrades. However, finding a better situation can be extremely difficult in Russia's current real estate market. Centrally located, Class A property can run $2000 and more per square meter ($186 per sq ft) per year. Bidding wars are not unusual and most other classes of property are seeing equal pressure.
I recently visited a small company providing IT services from an office located about 40 minutes by metro from Moscow's city center. The trip would probably take about two hours by car these days. The nature of their business does not require fancy office space, but conditions are dismal. They are operating out of an old Soviet research center. While the building has obviously been wired for reliable, high speed Internet, most of the fixtures, and even the paint in some cases, are Soviet-era. The entry system, which requires forms and waiting in line is also antiquated and obviously not designed for businesses hoping to regularly entertain foreign clients. The rent for their space was raised by 250 percent in the past year. This money did not lead to desperately needed renovations, and I knew better than to even ask to use the restrooms. The point is, for a small business, a hike of 2.5x is painful and at this point even if they said no and tried to find other premises, they'd likely be hard-pressed to find more competitively priced office space. More importantly, they have to pass these increased costs on to someone Ц including me as a client.
A rent budget increase of 50% is a common complaint for those facing a move now and for prime properties, a 2-3x increase is not unusual, especially for those who have had long-term leases (signed post-1998) that are now coming to and end. Some businesses are even finding that after they move, landlords are asking for rent increases within the first few months. Those staying put are often facing the maximum rent increase allowed by the lease.
The Labor Problem
Management is faced presently with two major issues in the labor force: the battle for highly qualified specialists and the cost-to-productivity ratio.
The battle for top specialists has become ruthless. Recruiting companies are very busy these days with headhunting. Professionals already receiving top salaries at multinational corporations are being stolen away, often by Russian majors, lured by dramatic salary increases and perks. It used to be that the professional would look at these offers with skepticism, questioning the reputation or stability of most Russian companies. Now, they do not worry as much and instead look at the cost-of-living, which is also rising dramatically, especially in major cities. The situation has gotten so bad that many companies are afraid to let their specialists be quoted in articles or to send them to conferences or other events where headhunters or competitors may be lurking.
Parallel to this, much of the labor market has become "spoiled." Salaries are steadily increasing but productivity levels are not. At the current salary levels, business owners and management are becoming increasingly sensitive to productivity levels and attempting to demand more work ethic and more productivity from their highly paid employees. At the same time, there is the sense of having very little choice in the current market.
Interestingly, foreign-owned companies in particular seem to be looking more closely at hiring and importing foreigners, now that Russian salaries are roughly on par with those of foreigners in many sectors. Foreigners coming from countries known for higher productivity levels and initiative are especially attractive Ц minimally in the hopes that they can set an example. Young foreigners eager to gain experience in Russia's developing market, are finding work Ц particularly in sales, client relations, business development, and marketing.
A Market Correction?
Most do not have high hopes for a market correction anytime soon. Barring a significant drop in oil prices, there is nothing to indicate that the Russian economy and money supply will slow. As such, any correction will likely have to be driven by increased supply.
In the commercial real estate market, a lot of new properties are slated to come online in the next few years. This may result in some stabilization of pricing.
The labor situation will likely not improve significantly for the next few years due to simple demographics: the birthrate declined drastically during the unstable 1990s. This generation is now just beginning to enter university, and will, in a few short years, translate into fewer new entrants into the workforce.
In the meantime, landlords and recruiters will continue to enjoy the current windfall.
About the Author
Renee Stillings is co-founder and a partner in Alinga Consulting Group - a Moscow-based consultancy providing audit, accounting, legal, and HR services. Previously she worked in the Russian financial markets, co-founding a small Moscow-based brokerage. She is also director of The School of Russian and Asian Studies (SRAS). Founded in 1995 to promote and organize educational programs in the Former Soviet Union, SRAS also provides a wealth of information for students, teachers and travelers on its website She graduated from Boston University with a B.S. in Biomedical Engineering and has studied Russian language at Moscow State University. Renee is fluent in Russian and has traveled extensively in the Former Soviet Union.