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Entrepreneurship in the Russian Service Sector: Trends and Developments

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In a market economy, the service sector across many industries is driven by entrepreneurship translating into powerful driving forces of motivation and competition (creative destruction). Under the post-Soviet transition the service sector in Russia is one of the most dynamic sectors of the national economy. There are strong indications of positive entrepreneurial developments in such segments of the service sector as construction and home improvement, real estate, wholesale and retail trade, banking, insurance, hospitality, tourism, and other industries. The paper identifies current patterns and trends, motivations and obstacles for entrepreneurship in the Russian service sector. It focuses on high propriety sub sectors in the service sector that are highly attractive for entrepreneurs and factors making those sub sectors particularly attractive; geographic, demographic and other factors affecting demand for services; major obstacles in the service sector affiliated with entrepreneurial business venture start-ups; key governance and support factors on the part of local and federal government; and finally common patterns of decision making in entrepreneurial business venture start-ups.
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Zagreb International Review of Economics & Business, Special Conference Issue, pp. 1-19, 2008
© 2008 Economics Faculty Zagreb
All rights reserved. Printed in Croatia
ISSN 1331-5609; UDC: 33+65
Entrepreneurship in the Russian Service Sector: Trends and
Developments
Dmitry Shtykhno*
Anatoly Zhuplev**
Abstract: In a market economy, the service sector across many industries is driven by
entrepreneurship translating into powerful driving forces of motivation and competition
(creative destruction). Under the post-Soviet transition the service sector in Russia is one of
the most dynamic sectors of the national economy. There are strong indications of positive
entrepreneurial developments in such segments of the service sector as construction and
home improvement, real estate, wholesale and retail trade, banking, insurance, hospitality,
tourism, and other industries. The paper identifies current patterns and trends, motivations
and obstacles for entrepreneurship in the Russian service sector. It focuses on high propriety
sub sectors in the service sector that are highly attractive for entrepreneurs and factors
making those sub sectors particularly attractive; geographic, demographic and other factors
affecting demand for services; major obstacles in the service sector affiliated with
entrepreneurial business venture start-ups; key governance and support factors on the part of
local and federal government; and finally common patterns of decision making in
entrepreneurial business venture start-ups.
Keywords: Russia, entrepreneurship, service, trends, business start-up
JEL Classification: L800,L260
Introduction
Economic growth and development in many advanced nations around the world are
increasingly dependent on the service sector often contributing 65-75% to the overall
economic wealth. With ‘smoke stack’ industries gradually relocating to less
developed nations their economic role in advanced countries tends to diminish. The
service sector becomes particularly important since many nations strive to move up
1
* Dmitry Shtykhno is at Plekhanov Russian Academy of Economics, Moscow, Russia.
** Anatoly Zhuplev is at College of Business Administration, Loyola Marymount University,
Los Angeles, USA.
the value creation chain in their effort to operate in the knowledge-based industries.
Typical examples include software development, imaging, entertainment, and
communications to name a few. In addition and beyond economic forces driving
entrepreneurial developments there are also strong impacts of service-oriented
culture and entrepreneurial tradition. A share of the GDP generated by the Russian
service sector in 2006 was 55.8% compared to 69.1% in Germany, 69.2% in Italy,
73% in Japan, 77.2% in France, and 78.2% in the USA (CIA, 2007).
Historically, small business has been a relatively self-contained economic activity
focused on local markets and needs. Its capital has been limited, and the owner and
manager have often been one and the same. Such enterprises have been operating in
market segments that have not been served by big corporations. They paid taxes, did
not need large-scale government support, and have had limited cooperation with each
other.
Today small and medium enterprises (SMEs) play an increasingly important
institutional role in developed economies since their significant contributions to both
economic welfare/ development and employment due to their high adaptability to
local conditions, independent decision-making process, quick and flexible response
to market changes, and low start-up capital requirements. Neace (1999) observes that
‘Long-term success in economic development, particularly in developing economies,
depends to a significant degree on a growing network of small entrepreneurial
enterprises . . . and human capital in the person of an entrepreneur.’ Their
contribution is not just economic, as Neace also stresses the role of entrepreneurs as
agents for creating social capital in emerging economies.
Besides that, the SME’s fundamental role in economic development stems from
cushioning the impacts of structural reforms by providing alternative employment
and - especially important in Russia’s case – because it ‘helps to reduce an emerging
market economy’s vulnerability to external shocks by providing a domestic engine
for growth’ (Economist Intelligence Unit, 2004). Financial dislocations and
collapses of the 1990s and extremely poor legal environment in Russia did not allow
for any meaningful growth of SMEs in service industry until deregulation started in
2001.
By 2005 Russia’s GDP in real terms reached almost 90% of the pre-reform level
of 1990. But this fact conceals wide variations across sectors and regions. Value
added in manufacturing was less than 70% of the Soviet maximum. The oil and gas
sector reached its pre-reform level of output. And services — trade, transport,
communications, and finance—exceeded it.
Currently, under the second stage of the post-Soviet transition the service sector in
Russia is one of the most dynamic sectors of the national economy, next to the oil and
gas extraction. While there are some recent trends pointing out to the rebirth of
government capitalism and increased state control over the Russian economy, there
2Dmitry Shtykhno and Anatoly Zhuplev
are also strong indications of positive entrepreneurial developments in the service
sector in such fields as construction and home improvement, real estate, wholesale
and retail trade, banking, insurance, hospitality, tourism, and other industries.
As of recently, Russian economic growth has been primarily driven by the
production of non-tradable services and goods for the domestic market. The 2006
was marked by the continuing trend in the high growth of the construction and retail
trade sectors. In January - October 2006, compared to January - October 2005, this
growth constituted 13.2% in the construction sector, 12.5% in retail trade, and 2.5%
in transport. In contrast, these indicators for the same time period were 1.3% for
agriculture, 2.2% for extraction of mineral resources, 4.7% for manufacturing and 5.1
for electricity, gas, water production and distribution (Russian Economic Report,
2006).
Roots and Prevalent Types of Russian SMEs
Russia’s entrepreneurial potential stems from vast supplies of natural resources and a
well-educated population. Ageev, Gratchev & Hisrich (1995) see Russian
entrepreneurship: ‘on the leading edge of radical economic and political
transformation of the society that should lead to new business developments, and
improved quality of life’.
Traditional fields of small business activity are small-scale and individual
production of goods, retail trade, hotel and food services, construction,
transportation, and health care. As Khodov (2003) notes, ‘this is the first type of small
enterprises, a necessary step in the initial accumulation of capital and spread of
market relations’. The distinctive features of this group of SMEs are as follows: their
business is typically based on accumulated family capital; it depends primarily on
local resources and focuses on local markets; and there is no capital diversification
into other industries/types of activity or other regions. This category of SMEs was
completely destroyed in Soviet Russia in the course of socialist transformation
followed the 1917 Bolshevik Revolution and replaced by local industry and
consumer cooperatives. Khodov argues that ‘the resurrection of local independent
business is slow and difficult, not only because of the shortage of capital and low
solvent demand in the Russian countryside but also because of the lack of acceptance
of the concept of entrepreneurship by the social consciousness, which is stuck in
traditional and socialist ideas of equalization in distribution’. The existence of this
type of SMEs is subject to local natural conditions (local types of agricultural
production and natural resources like climate, recreational areas etc.), consumer
preferences, and traditional local specialization in the nationwide context. The
prospects for the development of these types of enterprises depend on the growth of
Entrepreneurship in the Russian Service Sector: Trends and Developments 3
the local population’s purchasing power and the development of tourism. As the
pattern of the local population’s consumer needs and consumption changes, the
composition of local small business also changes.
Another type of small and medium-sized business is the suppliers of parts and
services for large enterprises. This type has been facilitated under the Soviet Union
economic framework with its centrally planned economy where industries and large
enterprises of high national strategic priorities have been planned and managed on
the federal level whereas SMEs serving some of their needs have been under local
jurisdiction and management. The development of this type of business in the
post-Soviet period in the 2000s is fostered by new forms of commerce, especially
franchising. In Russia, such enterprises are not numerous so far but obviously have
huge potential, as the robust growth and increase in the efficiency of the domestic
economy require a deeper division of labor and broad development of consumer
services both in range and scale.
Priority Subsectors
The Russian Federal Service of State Statistics (FSSS) reports that there are 7.2
SMEs per a thousand of population in Russia (FSSS, 2008), while in some European
Union countries this figure it is significantly higher - close to 45, 49.6 - in Japan and
74.2 in the U.S. In total, by the end of year 2006 there were almost 1 million small
businesses in Russia.1More than 50% of the SMEs are located in the Central and
North-Western federal districts, among them 25% are located in the capital city of
Moscow. Small business is still underdeveloped in the Far Eastern (4.8%), Ural
(6.7%) and Southern federal districts (9.7%). About 46% of all small business
enterprises in Russia operate in wholesale and retail trade and food service, about
11% - in construction service and about 14% - in production industries. Figure 1
shows detailed breakdown of SME by industries.
The latest Global Entrepreneurship Monitor (GEM, 2006) survey that covered 42
countries worldwide suggests modest level of entrepreneurial development in Russia
(Table 1 provides key comparisons of entrepreneurial activities in Russia with other
countries).
It is reasonable to expect that in an economy with severe deficit of consumer
goods and services like the post-Soviet economy of Russia a booming growth of
entrepreneurial activity would take place particularly in retail trade and service
industries.
In a contemporary Russia, the primary users of various services are middle age
well-paid professionals from 30 to 44 years old, followed by young employees from
25 to 29 years old.
4Dmitry Shtykhno and Anatoly Zhuplev
Figure 1: Distribution of SME in Russia in 2006, % of the total number of SMEs.
Source: Federal Service on State Statistics, 2008
Table 1: Prevalence Rates of Entrepreneurial Activities: Russia versus Other
Countries
Nascent
Entrepreneurial
Activity
New Business
Owners
Early-Stage
Entrepreneurial
Activities
Established
Business Owners
Russia 3.5% 1.7% 4.9% 1.2%
China 6.7% 10.5% 16.2% 9.0%
Germany 2.9% 1.7% 4.2% 3.0%
Italy 2.2% 1.4% 3.5% 3.0%
Japan 1.6% 1.4% 2.9% 4.8%
USA 7.5% 3.3% 10.0% 5.4%
Source: Global Entrepreneurial Monitor, 2006
As most service sectors are still undeveloped and are in dire need of advanced
expertise Russian consumers often have high regard for Western service quality,
brand name and often choose a service from a Western provider or provider with a
Western service component. At the same time there is a growing awareness among
Entrepreneurship in the Russian Service Sector: Trends and Developments 5
Russian entrepreneurs that service industry has a strong potential as well as growing
demand from Russian consumers for locally produced and branded services.
Russian service industry related newspapers like ‘Economics and Life’ and
‘Financial Newspaper,’ as well as professional service industry magazines like
‘Services and Prices,’ ‘Tourism: Practice, Problems and Perspectives,’ ‘Restaurant
News,’ ‘Hotel,’ point out to the following service subsectors that are in high demand
and thus most attractive from a business development standpoint:
consumer services (barber shops, house cleaning/renovation, baby sitters,
courier service, etc.);
food services (full service, fast-food, catering, food delivery, and take-out
services in restaurants);
financial services (leasing of equipment and insurance);
health care;
advertising;
accommodation (hotels, motels, vacation houses, resorts);
entertainment (aqua-parks, amusement parks, bowling/snooker clubs, night
clubs, sport centers, etc.);
tourism (travel agencies, tour operating, excursion bureaus, local sightseeing);
educational/training services;
information and telecommunication services (internet providers, computer
services, cable TV, VoIP).
It is necessary to mention that in Russia consumer services and entertainment are
the only two subsectors in the service industry where the market share of SMEs is
dominant mainly due to short payback periods.
Recent Legislative Initiatives and Reforms in the SME Sector
During Vladimir Putin’s first term as President numerous laws have been adopted to
improve the business climate in Russia, particularly to ease the start-up and operating
conditions of SMEs. Legislation has been introduced to streamline the number and
extent of inspection procedures that firms are subject to, the licensing of various
economic activities, the taxation of small firms and the registration of new
businesses. Legislative reforms have facilitated improvements in SME practices, but
not as great or as steady as they should have been.
Russia’s tax system was overhauled in 2001, with a view of simplifying it and
easing the fiscal burden on companies and individuals. The corporate tax standard
rate is currently stands at 24% (reduced from 35% in 2001). It is comprised of a 17%
6Dmitry Shtykhno and Anatoly Zhuplev
regional tax, 5% federal tax and 2% local tax. That corporate income tax favorably
contrasts with China’s 33%, Germany’s average 38.3%, Italy’s 33%, Japan’s 30%,
and US’ 35% (Worldwide-tax.com, 2008).
Another reform that has had positive impact was the introduction of a simplified
tax regime for SMEs in July 2002. SME growth, especially in the service sector, has
been significantly restrained by the tax burden that the government had imposed on
them. Since 2002, firms with fewer than 100 employees and a turnover of under 15
million rubles2can choose between paying the less onerous of two taxes: either a 15%
flat tax on profits, or a 6% flat tax on turnover (compared to the 24% profit tax
imposed on larger firms). Eligible firms are also exempt from VAT, sales tax,
property tax and payroll tax. A survey conducted by the Moscow-based Center for
Economic and Financial Research (CEFIR) has found that firms that had switched to
the new small-business tax regime on average considered it a real improvement on
the standard taxation arrangements3(Economist Intelligence Unit, 2004).
A ‘one-stop shop’ approach to business registrations was introduced by the
Ministry of Economic Development and Trade in 2002.
According to the CEFIR survey, licensing used to be a big problem, and has been
identified by SMEs as the main obstacle to small enterprise growth in Russia before
2004 when the number of commercial activities requiring a license was significantly
reduced.
To facilitate and support SME innovations the Foundation for Assistance to Small
Innovative Enterprises (FASIE) was created in 1994 by the Russian government. The
funding provided by the government comprises 1.5% of the total federal
expenditures for non-defense related R&D. FASIE supports small innovative
companies through open competition. Proposals for financial support prepared by
innovative companies are submitted to peer review by external reviewers from the
science and business sectors (including representatives of banks and venture and
investment funds). FASIE’s financial share in the winning projects cannot exceed
50%, and the companies retain their rights to their intellectual property created in the
projects. FASIE provides support only to projects included in a list of
government-approved critical technologies.
As illustrated by Bortnik (2004), in the late 1990s, FASIE has began increasing its
support for companies at the seed and start-up stages, obviously a riskier strategy.
The change was stimulated not only by stabilization of the general economic
situation but also by the fact that the FASIE’s financial resources have been growing
larger. In addition, repayment of the FASIE’s earlier loans has stabilized and
provided additional funds. In 2003, FASIE initiated a program called START to
support start-up companies. About half of the FASIE’s budget has since been
devoted to the START program (from $10 million when the FASIE was started in
2003 to approximately $15 million in 2006). In its composition and instruments the
Entrepreneurship in the Russian Service Sector: Trends and Developments 7
program resembles the American SBIR program. The first results show that about
20% of supported firms managed to find investors and thus get FASIE’s funding for
the second year. Although $15 millions is a very limited amount for SME funding in
such a large economy as Russia, this is a rather encouraging result showing that there
are quite a few technology-intensive goods and services created by SMEs with high
commercial potential.
The Russian government continues its effort in strengthening and creating new
initiatives to support innovative and commercially promising developments in
smaller firms. Such measures include more effective infrastructure (technology
parks, incubators), centers that offer specialized services, and financial support for
small firms and start-ups.
Obstacles in SME Start-ups and Operation
In the late 1990s, starting-up and operating SMEs in Russia have been prone to the
following major obstacles in the service sector (in descending order of importance):
taxation system that restrains growth of the business (more than 40 different
taxes and obligatory payments to be met by small businesses totaling up to 90%
of company’s profit);
• lack of finance and credit facilities (because of high interest rates, an
unrealistically high collateral requirement and a lack of long-term financing
availability);
state credit lines requirements (legal need of support by federal budget of small
businesses’ requirements for external funding, obligation to collateralize up to
50% - 70% of the total project value, and maximum project duration and
repayment term limited to two years);
impoverishment of the population severely limiting effective demand;
obsolete equipment and limited availability of new one for small-scale
production;
lack of knowledge about economics, management and business procedures;
lack of insurance services for small business;
bureaucracy and administrative barriers (red-tape);
corruption and racket;
lack of incentives for long-term business (Polonsky, 1998).
As already mentioned, due to numerous legislative initiatives many of these
problems have been solved, but some of them are still in place and even have
worsened.
8Dmitry Shtykhno and Anatoly Zhuplev
Table 2: World Bank Rating of Doing Business in Russia for 2007 and 2008
Ease of... Doing Business 2008 rank Doing Business 2007 rank
Doing Business (overall) 106 112
1. Starting a Business 50 45
2. Dealing with Licenses 177 172
3. Employing Workers 101 102
4. Registering Property 45 44
5. Getting Credit 84 156
6. Protecting Investors 83 81
7. Paying Taxes 130 126
8. Trading Across Borders 155 155
9. Enforcing Contracts 19 19
10. Closing a Business 80 81
Notes: (1) Ratings are given out of 178 countries ranked in the order of descending ease of doing
business in a country. (2) Doing Business 2007 rankings have been recalculated to reflect changes to the
methodology and the addition of new countries.
Source: The World Bank Group, 2007
The latest World Bank data on doing business in Russia (World Bank Group,
2007) presented in Table 2 provide good illustration of the recent changes. Under the
World Bank methodology all rankings and values are calculated for a limited liability
company located in the peripheral urban area of the country’s most populous city.
The company is 100% domestically and privately owned and has 50 employees all of
whom are nationals. This methodology is completely suitable for our analysis but
allows for detection of some significant changes in the business environment.
As follows from Table 2 Russia’s overall rank in the World Bank survey
improved from 112 in 2007 to 106 in 2008. The most dramatic improvement in the
World Bank ranking for Russia comes in the ‘getting credit’ category where Russia’s
ranking improved by 75 positions from # 156 in 2007 to # 84 in 2008. In the
‘Employing Workers’ and ‘Closing Business’ Russia’s ranks improved by one in
each category. While there were no change in the ranking for the ‘Trading Across
Borders’ and ‘Enforcing Contracts’ categories, unfortunately a number of Russia’s
rankings worsened: ‘Starting a Business’ and Dealing with Licenses’ by 5 ranking
points each, ‘Paying Taxes’ by 4 points and ‘Registering Property’ by 1 point. These
rankings reflect overall positive changes in the SME legal environment and other
Entrepreneurship in the Russian Service Sector: Trends and Developments 9
improvements. Although paying taxes is still a complicated issue according to the
World Bank, it is not a case for SMEs in the service sector that usually employs no
more than 10-15 persons. Difficulty of dealing with the licenses can be explained by
complicated and unclear procedure of getting license for those types of business that
require a license, but after 2004 their overall number has decreased. Comparing
Russia with the region suggests that for the majority of the World Bank survey
indicators Russia’s performance in similar with the region or better. The detailed
breakdown of the World Bank data is shown in Appendix 1.
The World Bank data on doing business still does not include ranking of business
transparency where Russia’s situation remains problematic. According to the
Business Monitor International’s (2007) Transparency International survey Russia’s
record on transparency remains poor. Its world rank in 2007 was 143/179 with a score
of 2.3 (International Corruption Perceptions Index - CPI - ranges between 10 –
highly clean to 0 – highly corrupt4). Russia’s 2007 ranking actually drastically
worsened compared with 2006 when it was 121/163.
Decision-Making Patterns in SMEs
The majority of small business people in Russia have never received any formal
business education. Some of them have gained their experience while working in the
informal (underground) economy and still often rely on the same well-tested
practices. There is an obvious need for business education that to certain extent is
fulfilled by business courses and seminars offered in major cities by governmental
and private educational institutions. Business education is becoming more popular,
although its need is still sometimes acknowledged out of politeness or political
correctness rather than in real belief. Russian economic reality is full of examples
where success has no correlation with business education.
An earlier conducted survey (OECD, 2003) reported that 52% of small business
directors attended business seminars, particularly for training in bookkeeping and
taxation. The survey respondents reported that the factors preventing them from
undertaking training included lack of money (1/3 of respondents) and unwillingness
by management to release people from work (1/6 of respondents). Entrepreneurs in
the service industry have been facing a problem of finding qualified personnel when
starting up a new enterprise during the past five years, suggesting that there may be a
growing demand for training.
At the same time it is noticeable that Russian entrepreneurs are quick learners. For
example, a few years ago some common concepts of the international hospitality
industry like ‘international operator,’ ‘royalty fee,’ ‘management contract’ etc. were
not clear to Russian operators and partners; today they are able to deal with
10 Dmitry Shtykhno and Anatoly Zhuplev
international management companies and learn how to manage international mergers
and acquisitions (Antel, 2006). In major cities (Moscow, Saint-Petersburg,
Novosibirsk, Yekaterinburg) a new trend appears: young (under 30) generation of
entrepreneurs expresses strong demand for business education, eager to invest time
and money, and often combines professional full or part-time education with distant
business education.
To illustrate some patterns of decision-making in entrepreneurship in the service
industry it is necessary to provide background information explaining the attitude of
the Russian society towards employed in service industry. In the Soviet Union the
service industry was neglected for political reasons, and consequently it was difficult
for the sector to attract a high-quality workforce. As a result, even now service sector
entrepreneurs and employees are sometimes regarded as ‘either mafiosi or as
incompetents who do not have the necessary intellect for more prestigious careers’
(Jallat, Shekshnya, 2000). The service industry was among the first to benefit from
economic liberalization. Unsatisfied and inexperienced thus unexacting customer
was ready to get almost any kind of service offered. Besides that, people from
pensioners to government officials shared the same opinion that creating and running
a service business was a simple task that did not require specific skills, preparatory
work such as marketing research or value chain planning, or previous experience. All
those circumstances negatively affected the level of quality of services and the entire
entrepreneurial climate in the service industry. Jallat and Shekshnya (2000)
identified five categories of entrepreneurs in the service sector in the
Post-Communist Russia, as shown in Table 3.
Despite of a change in mentality, many people consider working in the service
sector to be on a par with being a servant with a sort of derogatory connotation
attached. Still there is some lack of quality consulting services for small businesses in
the service sector, especially those focusing on local markets afar from large cities.
Under the rising consumer power and growing experience the demand for knowledge
and practical skills in such issues as service delivery design, customer complaint
handling, service quality, analysis of customer needs and so forth is to be taken into
account on common basis. So far the Federal Government also has not gotten to a
point of concern with the provision of consulting services and instead often prefers to
rely on ‘heavy’ methods like credits and subsidies in steering small businesses in the
desired direction, while some local governments, like in Moscow and St. -Petersburg,
started providing information and sometimes business consulting services to
potential entrepreneurs in specific fields which are particularly important for the
cities.
Entrepreneurship in the Russian Service Sector: Trends and Developments 11
Table 3: First Categories of Service Entrepreneurs in the Post-Communist Russia
Categories Origin of Business Sector
1. Former managers of
State-owned companies
Privatization of existing
organizations
Retail trade, banking, public
catering, hospitality
2. Former ‘cooperators’
Cooperatives turned into private
companies Acquisition of existing
organizations
Retail trade, public catering,
education, software development
3. ‘Deal genius’ Creation of new structures Wholesale trade, banking, finance
4. Professionals Expansion of individual activities
into a business
Software development, education,
consulting, medical care
5. Soviet era entrepreneurs/ black
market masters
Legalization of underground
businesses
Acquisition of existing
organizations
Creation of new structures
All
Source: Jallat, Shekshnya, 2000.
Another pattern of SME decision-making process that has been identified in
interviews with entrepreneurs in the service industry is that even in regions where
small business is well developed, small business people are not among major
consumers of specialized information services (databases and online consultancies
on various aspects of small business start-ups and operations). This area remains
unnoticed by governmental agencies responsible for the development of small
business and is not financially attractive by large commercial providers. Only in
Moscow the situation is different, where local government supports about 40 web
sites with information tailored to small business.
A specific aspect of Russian entrepreneurship in the service sector is the growing
number of female entrepreneurs (Wells, Pfantz, Bryne, 2003). In fact, 60% of female
entrepreneurs in Russia are in the service sectors (that includes business services,
finance, insurance, real estate). Although over half of them draw financing from
private sources such as personal savings, friends and family, and 92% of them have
rated capital availability as a problem, female entrepreneurs respondents demonstrate
striking optimism: 42% expressed an optimistic or a very optimistic outlook of the
Russian economy for the next few years and 58% expressed an optimistic or a very
optimistic outlook for their own business.
12 Dmitry Shtykhno and Anatoly Zhuplev
SMEs in the Service Sector in Moscow
Russian government’s development plans for tourism identify Moscow, the Moscow
region, St. Petersburg, Kaliningrad and the so called ‘Golden Ring’ cities as major
tourism centers and priorities for development. Investment in the development and
modernization of the tourism infrastructure is considered the backbone of the future
market growth. Domestic tourism will be increasingly emerging as the basis for
tourism development and is expected to increase its share in the overall tourism
revenue.
The growth of sales at Russian cafés and restaurants has averaged about 8% a year
since 2000. The restaurant business in Moscow is one of the fastest-growing
segments of the city’s rapidly expanding economy. A growing middle class is
creating a solid customer base, with the result that numerous restaurants and cafes are
opening or expanding, and purchasing equipment and supplies. Over the last ten
years the number of food service companies in Moscow has almost doubled and
today reaches some 10,000 enterprises with total capacity of almost 700,000 seats.
Coffee shops have seen some of the fastest growth, expanding in excess of 20% per
year.
As communicated by the Minister of the Moscow government responsible for the
development of consumer goods and services, professor of the Plekhanov Russian
Academy of Economics Vladimir Malyshkov, Moscow government supports small
business in the following ways: provision of credit on favorable terms, granting
subsidies, subventions and guarantees of small business loans to financial
institutions, joint financing, leasing of equipment at convenient terms, and
establishing attractive rental rates. There are more than 20 governmental agencies
and designated organizations in Moscow that support small business. For example,
the Financial Assistance Foundation established by the Department of Consumer
Goods and Services of the Moscow Government in 2005 provided financial help to
the following small business recipients in their first or second year of operation
(Malyshkov, 2006):
43 retail trade companies - for about 5.5 million rubles (US $ 200,000);
18 food service companies - for about 2.5 million rubles (US $ 90,000);
44 consumer service companies - for about 6 million rubles (US $ 215,000).
As for the accommodation subsector in services, the Moscow city government
considers switching an emphasis from the development of four- and five-star hotels
to building a network of medium-class hotels to cater for guests with average
incomes. The city is planning to build up to 40 two- and three-star hotels in the next
Entrepreneurship in the Russian Service Sector: Trends and Developments 13
decade in order to boost the incoming tourism. It is expected that small business
entrepreneurs will be interested in the development of the small budget hotels.
The least developed subsector of the service industry in Moscow as well as in
Russia as a whole is consumer services (hair/beauty salons, tailoring, laundry, repair
workshops, photo studios, cleaning service, etc.) It can be explained by lack of
support and governance in earlier years when free market forces pushed out or
completely destroyed such services due to their low profitability. Currently, there are
about 7,000 companies providing consumer services but customers often complain
both about lack of these services and their poor quality. It has forced the Moscow
Government to develop and start implementation of a special program to facilitate
priority growth of this subsector in 2007-2008. Being a capital city, Moscow often
creates a pattern that is followed by other large Russian cities if it proves successful.
Conclusion
As the Russian fledging service sector is gaining momentum in contributing to the
nation’s economic wealth and dynamics in the post-Soviet transformation its share in
the nation’s GDP remains relatively modest at 55.8%. That compares to 69.1% in
Germany, 73% in Japan, and 78.2% in the USA, leaving significant room for growth.
Over half of SMEs are located in the Central and North-Western part of Russia
with Moscow and St. Petersburg remaining major hubs; remote areas located in the
Far Eastern, Ural and Southern federal districts continue to be underdeveloped.
Above 46% of all SMEs in Russia operate in the wholesale and retail trade and food
services, about 11% - in construction and about 14% - in manufacturing industries.
Legislative and administrative reforms over the past few years have streamlined
and improved situation in taxation, registration, financing and other crucial
components closing the gap in SME environment between Russia and other
countries. Meanwhile, many problems, such as restraining taxation system, limited
SME access to financing, low consumer spending power among general population,
lack of SME training, non availability of business services and other problems,
remain.
The stage of ‘wild business’ in the post-Soviet transformation appears to have
passed and now entrepreneurs as well as the society as a whole increasingly need
transparent rules and business relations in business transactions and the overall
business environment. Macro-economic environment as well as government efforts
in streamlining legal environment contribute to the continuing increase in
entrepreneurial potential of the Russian service sector.
With consumer spending as a primary growth driver in the current economic
development Russian service providers continue to benefit from high demand and
14 Dmitry Shtykhno and Anatoly Zhuplev
robust customer confidence. Despite some decline in purchasing power, because of
the weak dollar, from those employees whose salaries are nominated in US dollars,
the Russian consumer remains unsatisfied while both real disposable income to keep
rising and substantial consumer credit expansion taking hold.
Although a lack of support of the Federal Government to SME’s ‘soft’ issues still
remains in place, many local governments, especially those in capital cities, adopted
special programs in assistance and support of SME start-ups, and the service sector is
among top government priorities.
The growth in entrepreneurial activity along with other positive trends in Russia’s
service sector is expected to continue suggesting positive future outlook in this sector
translating in improvements in volume, range and quality of services.
NOTES
1Throughout the 1990s – 2000s, the universal definition of SMEs in Russia has undergone several
changes. In terms of economic dimensions, the latest law divides all enterprises in the economy into two
categories: small enterprises and large and medium enterprises. Small enterprises are classified by the
Federal Law ‘On the State Support of Small Business in Russian Federation’ # 88-FZ of 14 June 1995
into three groups: individual entrepreneurs without legal status, farm enterprises, and small enterprises –
legal entities. The Law determines small enterprises - legal entities as having: no more than 25% of the
state, municipal, public and religious organizations or charitable funds’ ownership in their charter
capital and not exceeding the following limits in annual number of employees: 100 persons in industry,
construction and transportation, 60 in agriculture and R&D areas. Russian law does not define a specific
category of medium-sized enterprises
2The exchange rate as of January 27, 2008 was 1.00 USD= 24.4990 RUB; or 1 RUB = 0.04081 USD
(Universal Currency Converter, 2008)
3Some experts point out that small and individual enterprises in Russia have not become the engines of a
healthy economy. Instead of fostering growing companies Russia has fostered the creation of a vast
number of very small businesses comprising the ‘kiosk economy.’ This ‘kiosk economy’ of micro
businesses employs a quarter of the population but comprises a disproportionately small share of GDP
and the tax base. Other than providing employment, these businesses add little to overall wealth creation
and the majority of them are unlikely to make the transition to mid-size businesses because it will
require massive advances in business education, regulatory environment, court system, financing, and
other components of the business infrastructure. The current Russian legislation and regulations press
small business to be very small. In drafting the small business legislation the government decided to
offer tax breaks and a friendlier business environment only to those companies that it considered as
economically less significant for the budget. Thanks to government reforms, small enterprises are now
easy to start and accounting requirements as well as taxes are minimal. While this is a great step forward
it has not led to a critical growth of medium enterprises because of the low cut-off limit for use of the
simplified system of taxation and the abrupt and hugely punitive cost of moving to the regular tax
system. Small businesses that do well under the protection of the simplified system of taxation are often
not large and strong enough to survive the full weight of Russian taxation and accounting requirements.
Many businesses that grow too large to use the simplified system find that they do not have sufficient
resources to thrive without it and find their growth stunted. Additionally, the burdens of compliance and
Entrepreneurship in the Russian Service Sector: Trends and Developments 15
making advance tax payments are often more destructive to growth than the actual increased taxes
themselves (Firestone, 2005).
4In contrast, the #1 Denmark had a 9.4 CPI score.
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Entrepreneurship in the Russian Service Sector: Trends and Developments 17
Appendix 1: World Bank Rating of Doing Business in Russia 2008 breakdown
Aggregated Index Indicators Russia Region OECD
Starting a Business
Procedures (number) 8 8.8 6
Duration (days) 29 26.2 14.9
Cost (% GNI per capita) 3.7 11.1 5.1
Paid in Min. Capital (% of GNI per capita) 3.2 45.3 32.5
Dealing with Licenses
Procedures (number) 54 24 14
Duration (days) 704 251.3 153.3
Cost (% of income per capita) 3788.4 628.4 62.2
Employing Workers
Difficulty of Hiring Index 33 36.3 25.2
Rigidity of Hours Index 60 51.4 39.2
Difficulty of Firing Index 40 32.1 27.9
Rigidity of Employment Index 44 40.0 30.8
Nonwage labor cost (% of salary) 31 25.4 20.7
Firing costs (weeks of wages) 17 26.1 25.7
Registering Property
Procedures (number) 6 6.2 4.9
Duration (days) 52 92.4 28.0
Cost (% of property value) 0.3 2.4 4.6
Getting Credit
Legal Rights Index 3 5.6 6.4
Credit Information Index 4 3.4 4.8
Public registry coverage (% adults) 0.0 2.4 8.6
Private bureau coverage (% adults) 4.4 15.4 59.3
Protecting Investors
Disclosure Index 6 4.9 6.4
Director Liability Index 2 3.8 5.1
Shareholder Suits Index 7 6.3 6.5
Investor Protection Index 5.0 5.0 6.0
18 Dmitry Shtykhno and Anatoly Zhuplev
Paying Taxes
Payments (number) 22 46.3 15.1
Time (hours) 448 451.5 183.3
Profit tax (%) 14.0 11.2 20.0
Labor tax and contributions (%) 31.8 28.7 22.8
Other taxes (%) 5.7 10.8 3.4
Total tax rate (% profit) 51.4 50.8 46.2
Trading Across
Borders
Documents for export (number) 8 7.0 4.5
Time for export (days) 36 29.3 9.8
Cost to export (US$ per container) 2050 1,393.4 905.0
Documents for import (number) 13 8.3 5.0
Time for import (days) 36 30.8 10.4
Cost to import (US$ per container) 2050 1,551.4 986.1
Enforcing Contracts
Procedures (number) 37 35.9 31.3
Duration (days) 281 443.0 443.3
Cost (% of claim) 13.4 22.7 17.7
Closing a Business
Time (years) 3.8 3.2 1.3
Cost (% of estate) 9 13.7 7.5
Recovery rate (cents on the dollar) 29.0 28.9 74.1
Note: (1) Ratings are given out of 178 countries in order of decreased ease of doing business in a
country. Source: The World Bank Group, 2007
Entrepreneurship in the Russian Service Sector: Trends and Developments 19
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Enhancing Russia's Competitiveness and Innovative Capacity. The World Bank document
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Desai Raj M., Goldberg I. (2006), Enhancing Russia's Competitiveness and Innovative Capacity. The World Bank document.
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Firestone, J. (2005). 'Why Institutional Investors Should Care About SMEs' (2005), Russian Investment Review, http://www.russiainvestors.com/contents/index.html, accessed December 10, 2005