Russia is quickly getting to be one of the most important software markets in Europe.

In recent years, the software industry has been one of the most rapidly-growing IT subsectors in Russia with an annual average growth exceeding 18 percent. The software market reached the size of USD 2.5 billion in 2009. The market’s compound annual growth rate was 15.9 percent in the period of years from 2005 to 2009. The greatest sales results were demonstrated for business productivity and home computer applications. In 2009, these categories accounted for USD 589.6 million, or 23.6 percent of the market size.

The growth of the software market is expected to sustain itself in the next five-year term, with compound annual growth estimated at 11.6 percent. By 2015, the market is expected to reach USD 4.3 billion.

Overview

The pace of the Russian software market’s expansion slowed down considerably in 2009 from its previous 18 to 20 percent per annum. Market trends were reversed, and the industry contracted by almost one fifth of the total market size. Nevertheless, double-digit growth returned again in 2010. This year, the market is expected to grow by about one tenth of its 2009 value.

While the Russian software market in 2009 had the value of USD 2.5 billion, the size of the French market was USD 13.2 million, and the size of the German market was USD 19.8 billion.

The compound annual growth rates for the other two European markets were 4.5 percent for France and 3.1 percent for Germany.

Sales of general business productivity software and computer applications for home uses yielded the best results in 2009. Total revenues stood at USD 589.6 million, or 23.6 percent of the total market size.

Sales of network and database software totaled USD 536 million in 2009. The total market share in that segment was 21.5 percent.

Whereas the Russian software market is expected to reach the size of USD 4.3 billion by 2015, the French market is forecast to reach USD 15.1 billion (growing at 2.8 percent), and the German market is expected to expand to USD 23 billion (growing at 3 percent).  

Key market participants are IBM, Microsoft Corporation, Oracle Corporation, as well as SAP AG.

Market segments

Market shares for software in Russia were allocated in the following manner by volume of revenue: general business productivity: 23.6 percent; network and database management: 21.5 percent; cross-industry and vertical application: 21.2 percent; operating system software: 18.4 percent; other system software: 10.3 percent; other application software: 5.0 percent.

Analysis

The worldwide economic crisis produced significant negative consequences for the software industry leading to the decline witnessed in 2009. As the downward trends reversed direction in late 2009 and early 2010, the software industry once again became a very appealing market segment for foreign investors in Russia.  

Analysts have noted that switching costs could be quite large, especially for programs configured to perform a particular task of great complexity. The size of the workforce required for market participants to compete successfully is large, and employees must have high skills. The largest market players, including Microsoft Corporation and IBM, enjoy the benefits of greater diversification and have their proprietary developer training and certification. These companies often use custom-made equipment. Strong market expansion at the rate of 14.7 percent in 2010 and 10.9 percent in 2011 can accommodate IT newcomers and simplify their entry onto the Russian software market. At the same time, a number of subsectors are firmly held by existing companies that are unlikely to yield their ground. The danger of product substitution is significant, especially in view of the availability of a vast array of free software. Market competition is further curtailed as a consequence of the diversification of software manufacturers in relation to target end-users. 

According to Datamonitor, which analyzes business opportunities on the basis of the five main forces working on the market, the Russian software industry can be characterized as follows (on a 5-point scale): buyer power: 3-; supplier power: 3+; substitutes: 3+ ; market entry: 3+; competition: 3.

Buyers

Buyers on the Russian market come from a number of different categories and include private people, all kinds of commercial entities, as well as government establishments. Customers in the commercial sector include companies in the banking sector, retailers, transportation companies, IT firms, as well as medical service providers. These companies rely on sector-specific applications and often require that their employees or users be trained to use the particular computer programs. Because of the complexities of these applications, switching costs are high. At the same time, since most important customers are large businesses, the power of buyers is significant. The practice of industry consumers to unite in negotiating with software companies, which is widely used by the telecom sector, has caused buyer leverage to increase enormously. To protect against product substitution, software companies can artificially increase expenses involved in switching to third-party platforms by partnering with other market participants to ensure that their products are interoperable with different software solutions. As such, SAP’s business applications are quickly accessed through MS Office with the Duet application.       

Another danger to the market, mostly for the individual consumer category, is product substitution with free equivalent products. MS Office software can be replaced by OpenOffice.org, and MS Windows can be replaced by Linux. 

While open code programs are generally provided with no charge to the user, commercial vendors of open-source software continue to operate on the Russian market by providing technical support services. Since open-source software can be a perfect alternative to traditional programs, the ubiquity of open-source applications can make consumers more price-conscious.

A new trend emerging on the market is for users to subscribe to software-as-a-service. Since this type of an arrangement would involve smaller start-up costs, the availability of software-as-a-service subscription would also augment consumers’ sensitivity to price. Buyer power is thought to be moderate on the Russian market.

According to Datamonitor, the drivers of buyer power in the software market and their respective ratings (5-point scale) include buyer independence: 5; buyer

size: 3; financial muscle: 3; low-cost switching: 3; oligopsony threat: 1; price sensitivity: 4; product dispensability: 2; tendency to switch: 2; undifferentiated products: 3; backward integration: 1.

Suppliers

The software industry demands the employment of highly-skilled workers, who would be able to apply their knowledge in working with various computer programming applications and pieces of hardware equipment. The bottom line is that market success or failure will be determined by the level of proficiency of the programmers hired. Developer training offered by Microsoft is particularly designed to ensure that the personnel that will be engaged by a company wishing to enter the market has indeed acquired the high level of skill. 

Devices for inputting data, including hardware pieces, are frequently purchased from large manufacturers. These companies offer highly-specialized and well-differentiated products – resulting in considerable leverage that supplier can exercise. At the same time, the probability that the manufacturers of hardware components would go through forward integration into the software engineering sector is extremely small. Software development is a complex process requiring advanced know-how. Thus, in light of the totality of these circumstances, supplier power is rated as moderate. 

As a whole, the following factors are deemed relevant to determining supplier power (rated on a 5-point scale by Datamonitor): differentiated input: 5; forward integration: 2; importance of quality-cost relationship: 5; no substitute inputs: 5; oligopoly threat: 3; player dispensability: 3; player independence: 3; supplier size: 1; switching costs: 4.

Market newcomers

Engineering computer programs is a time-consuming job, and market success wholly depends on the mastery of individual programmers. Great attention is required for both recruiting a qualified labor force, as well as purchasing high-end equipment. At the same time, first-time market entrants should be particularly cautious about selecting which market subsector they would occupy. Companies long established firmly hold certain segments of the software market. As such, Microsoft occupies a nearly impregnable position in the operating systems sub-sector.

Additionally, access to networks facilitating the distribution of software application has become easier to obtain in the past few years with the growth in broadband online access. The new method of distribution now opens up the opportunities for software delivery in the absence of physical media. While Microsoft has become subject to anti-trust legal challenges in the U.S. over these innovative methods of software delivery, the area remains largely unregulated as far as the Russian software market is concerned.

Furthermore, since the market is simply inundated with new products, investment in research and development is considered critical. As a substitute, a big software engineering firm would be able to acquire the rights to intellectual property and proprietary knowledge of smaller companies by way of mergers and takeovers. Substantial outlays of capital are required in any of these circumstances. The hiring of highly proficient programmers can be problematic for smaller companies, since large market participants frequently offer developer training program and certification. 

Companies already on the market have strong positions as a result of their excellent awareness of the business needs of their customers. High expenses that would be associated with switching from one software solution to another also work to the disadvantage of non-incumbents.

Nonetheless, the likelihood of success for market newcomers is high. The factors affecting the performance of new entrants in the software market in Russia, according to Datamonitor, include distribution access: 5; incumbent acquiescence: 4; little IP know-how: 1; little regulation: 4; low fixed costs: 4; low-cost switching: 3; market growth: 5; importance of scale: 4; accessibility of suppliers: 3; undifferentiated products: 3; weak brands: 2.

Competition

Because of their high degree of specialization, software developers often have dominating position in particular areas. Oracle, for instance, centers on database applications and software that connects software components and their applications. Large market participants, such as IBM and Microsoft, are very diverse in the scope of their operations. These leading developers even produce hardware. IBM creates mainframe systems. Microsoft creates consumer electronics. Also, Microsoft’s and IBM’s target audience includes both private individuals and companies, while Oracle’s and SAP’s clients come exclusively from the business sector.

Such diversification has the effect of reducing rivalry because total revenues are protected from unexpected negative developments in any one subsector.   

Companies that have their own research and development centers in Russia are as follows: Alcatel-Lucent, Allied Testing, AVIcode, Cadence, Design Systems, Chrysler, Columbus IT, Dell, Digia, EGAR Technology, EMC, EMS, Ericsson, Google, Hewlett-Packard, Huawei, Intel, InterSystems, Jensen Technologies, LG Softlab, Motorola, NetCracker, Nival Interactive, Nokia, Siemens, Quest Software, RD-Software, Samsung Research Center, SAP, Scala CIS, SmartPhoneLabs, Sun Microsystems, Tagrem Studio, Teleca, and T-Systems.