Annex Bulletin 2006-13                               March 20, 2006

An OPEN client edition

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Updated 7/12/06, 1:30PM PDT; adds Boeing in Russia...

In Search of Next Global "Holy Grail:" Destination CEER [Central, Eastern Europe & (Greater) Russia]

Go East, Young Man!

Region's 400 Million People Produce $3.6 Trillion GDP; CEER Growing Four Times Faster Than EU!

Economist Research Report: Eastern Europe to Benefit from Outsourcing at India's Expense

"Go East, Young Man!" (speech, May 2006)

Boeing Also Goes East to Russia

SCOTTSDALE, Mar 20 - As America opened its western frontiers, some 150 years ago, "go West, young man!" was the destination slogan for the bold fortune seekers.  No longer.  "Go East, young man!" (or woman) is where the current road signs to riches point.

"There is a small but close-knit group of us ex-pats here in Moscow," a young American told this writer over drinks at Moscow's prestigious "Metropol" hotel on a cold and snowy night in late February.  "We all came here for the same reason... better opportunities to make money.  We think this is the new frontier."

The enterprising investment banker in his early thirties has even learned Russian so as to better explore his gold mine.  "I could never make the kind of money I am making here in Moscow back in the States," he added.

And if that's what a young man thinks who has an MBA and an undergraduate Ivy League degree on his resume, and who hails from one of the "blue blood" East Coast families, then you'd better believe that serious western money is either already here, in Moscow, or will soon follow.

Already, there are 2,500 banks in this country.  Most of them are growing in double digits.  The big ones are swallowing the smaller fish like the whales eating the minnows.  New businesses are opening their doors at a rate of 30% to 50% per year.  They are all frantically building their infrastructures for competitive advantage. 

America - at the turn of the century last?  No, Russia today.  A real gold mine.  In more ways that one.  Especially when it comes to human talent.  This vast region, that encompasses Central, Eastern Europe & (Greater) Russia (CEER) and stretches through 11 time zones, is a home to some 400 million people, and is seven times bigger than the European Union (EU)...

... where 390 million people are crowded in 20 countries and toil in largely stagnant economies. 

In fact, the CEER GDP growth is more than four times higher than that of the EU; 1.8 times that of the bustling U.S. economy; and almost 2.5 times faster than that of Brazil, for example, another enterprising developing country.

But the CEER region's most important asset are its people.  We have been saying that for years over and over again, such as in our October 2004 report, "To Russia with Love and $$$," from which we bring you the following chart...

The chart ranks the most attractive countries in the world in terms of the percentage of university educated people relative to the GDP per capita (in other word, the "best bang for the buck" when it comes to high education talent).  Six of the top 10 nations, led by Ukraine, Belarus and Russia, are from the CEER region.  The "Old Europe" countries - Germany, Norway, Belgium, Netherlands... along with Japan, are in the cellar of the list.

We said that just as China has become a global factory, and India's the world's "help desk," this "New Europe," the CEER countries, will be the next global R&D lab.  Among other things.  Lest we forget, Russia is also the world largest source of natural fuels.  Which helps fuel all that banking and SMB (small and medium size business) growth.

CEER's "Renaissance II" Accelerates in 21st Century

No surprise there.  Ten years ago, we traveled through Eastern Europe and Russia on another research mission whose purpose was to determine if this market may ever become a Mecca for western investors.  Our conclusions in the affirmative were summarized in the report “Eastern Europe’s ‘Renaissance II’; a Taiwan Next Door” (June/96).  We pointed out, for example, that the top six Eastern European economies even back then were growing nearly four times faster than the "G6" (the world's top developed countries - see the chart).

For the next 10 years or so, western investors largely ignored this gold mine of economic and human assets.  Even as late as September 2005, prestigious global economic organizations, such as the Geneva-based World Economic Forum, (see "New 'Drang Nach Osten'," Sep 2005).  While paying lip service to Russia's economic potential, they favored the Old Europe in their investment recommendations.

We said contemporaneously such opinions, best described under the "Ignorance is bliss!"-label, are based on old Cold War biases, and are thus worthless in today's economic environment. We reconfirmed such a conclusion a month later in our own analysis of global investment opportunities (see "Yin-Yang Pacific Tsunamis," Oct 2005).  

And now, after this writer's latest whirlwind tour of Eastern Europe and Russia, we can tell you with reasonable certainty that those who continue to ignore this vast market will be doing it at their peril...

...especially if one considers the fact that five of the top 10 countries with the most attractive corporate and personal tax rates are also from the CEER region, starting with Russia and Hungary, that top the list.  Once again, "Old Europe" and Japan are at the bottom of the tax attractiveness ratings.

Summary & Outlook

To summarize, Eastern Europe & (Greater) Russia's 400 million people represent the world's greatest pool of human talent at still affordable rates.  They are destined to become the next "Global R&D Lab."

And even though the area is still in an embryonic stage of economic development, relative to its potential, its aggregate GDP growth rate is already more than four times that of the EU, 2.4 times that of Brazil, and 1.8 times that of the bustling U.S. economy.

The underpinning of the economic potential in many CEER countries, especially in Russia, the world's largest source of natural fuels, is the energy sector.  Its earnings then help fuel the growth in the banking and SMB segments, which is expanding at mid-double digit rates.

In short, "go east, young man!" (or woman) - is the next global investment destination (from a western point of view, of course).  Those who choose to ignore it, will miss the next gravy train.  Prescient prioneers, such as the young American banker at the Hotel Metropol and his ex-pats friends, will only have more left over to divide among themselves.  

"First to the girl, to him the bride" - is an old East European proverb.  "First come, first serve" would be the American equivalent.  And the Russians are already serving their guests on gold-plated settings at an increasingly crowded table.

Happy bargain hunting!

Bob Djurdjevic

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Moscow Photo Gallery

GUM is a huge indoor shopping mall across the Red Square from the Kremlin.  It dates back to pre-communist era. 

This is a picture of Metropol's main dining room - one of the most beautiful restaurants I have ever seen anywhere in the world.  In fact, it almost feels like an insult to call it a restaurant.  I had visions of the grand balls in tsarist time taking place at this very spot, with wigged and powdered gentry dancing to Bach and Vivaldi music.

"Turandot" is a new Russian restaurant on Tverskaya Boulevard (the theater and arts district).  Once again, the word "restaurant" does not fit the ambiance.  For this was a 30,000-square foot mini-Versailles, created in the Baroque style by 500 Russian artists who worked for seven years on the project.  They used some real antiques but mostly created new art and made it look like antiques.  Ever heard of a $70 million-restaurant?  I had not.  That's how much the owner, a wealthy Russian of French descent, spent on the Turandor.

The entire time we had spent at "Turandot," a quartet, seated in the middle of the restaurant under that dome (above), played beautiful 18th century classical music.  All staff were also dressed in the period costumes.

Here's the maitre d', for example, at one of "Turandot's" many private dining rooms.  He gave this writer and a Russian friend from the arts world a tour of the place.  One felt as if one were on a movie set rather than in real life.

And that's also Moscow today... showing off its nouveau artistic splendor in a "Renaissance II" version of Russia's renewal.

To see more of this writer's personal Moscow pictorial travelogue, click here.

Eastern Europe to Benefit from Outsourcing at India's Expense

SCOTTSDALE, June 1 - A new report just-released by the Economist Intelligence Unit (EIU) confirmed our prediction from three years ago that a shift in global investments would happen from India to Eastern Europe and Russia (see "A Passage to India," July 2003, "To Russia with Love and $$$," Oct 2004, "Go East, Young Man!," Mar 2006).  As expected, the labor costs in India are starting to rise, making the Eastern European market more attractive for offshoring.  Plus Eastern Europe is a closer cultural fit to western corporate market, as the EIU survey showed, according to a May 31 Reuter's report.

Having just returned from a speaking tour of Russia and Eastern Europe (Poland, Czech Republic), we can personally vouch for the validity of this conclusion based on my meetings and discussions with business people in those countries.  In Poland, for example, we even saw an example of reverse outsourcing.  An Indian firm has decided to outsource its IT to a Polish data center because of the higher quality of IT professionals in that Eastern European country.

To check out the prepared text of this writer's May 25 speech delivered at an IBM Innovation conference in St. Petersburg, Russia...

Click here to view SPEECH TEXT (PDF)


Click here to view SLIDES (PDF, 2MB)


But India's Software Business Booming

But a shift in new global investments from India to Eastern Europe does not mean a lack of growth for Indian-based operations.  On the contrary.  India's software services sector is likely to grow by more than 25% in 2006/07.  But a shortage of talent and weak infrastructure remain concerns, according to a Reuters' June 1 report, filed from New Delhi.  And even the impressive 25% growth rate represents a slowdown from that of a year ago (33% for the 12 months prior to March 2006).

The National Association of Software and Service Companies (NASSCOM) said large contracts worth a combined $100 billion were coming up for grabs over the next two years, pointing to a vast and yet untapped market for Indian software companies which have so far sealed mainly low-value deals, the Reuters report said.

"India's strength has emerged through large client wins, cross-border mergers and acquisitions, and the movement of the industry towards a stable pricing model," said Kiran Karnik, president of New Delhi-based NASSCOM.  Growth forecasts ranged between 25% and 28% for the year to March 2007, he said.

The sector, which receives up to 70% of its revenue from the United States, saw a 33% rise in service exports to $23.6 billion for the year to March 2006.

The number included sales of $6.2 billion from the booming back-office sector, which provides services such as payroll accounting, and managing voice and data call centers.

The declining growth in the forecast for 2006/07 reflects the expanding base, Karnik said.  He added that the sector would have to overcome several problems, including inadequate quality and skills of graduates, rising salaries and weak infrastructure, which resulted in frequent power outages.

To read the rest of the report, CLICK HERE.

Boeing Also Goes East to Russia, in Pursuit of "Brains of Gold"

SCOTTSDALE, July 12 - IBM is not the only major multinational company that is taking seriously the concept of going east to outsource its R&D to Russia (see above "Go East, Young Man!" report and speech).  Boeing, the world's second largest defense contractor with a $16 billion+ IT services business (see "From Defense to Services," Feb 2006), is already in Russia doing the same thing.  Big time.

Some 1,200 Boeing contractors across Russia's aerospace industry work double shifts in their hi-tech cubicles, designing plane parts and offering technical solutions for the U.S. aerospace giant, the Reuters wire service reported from Moscow earlier today.

"We definitely pioneered intellectual services in Russia, and this means Russia can sell not just oil, gas or metals," said Sergei Kravchenko, head of Boeing in Russia and the post-Soviet Commonwealth of Independent States.  

"Our engineers are an elite with brains of gold, and you just can't do the job without superb education and experience," added Timur Dyablov, a director at the Boeing Design Center. "This is not India or China -- you cannot just show a specimen and say 'manufacture this'. Ours is a sophisticated engineering process."

No wonder that Intel and mobile phone maker Motorola have also already opened research labs in Russia.

As Russia gets set to host for the first time ever the prestigious "G8G8 2006 Summit" next week in St. Petersburg (July 15-17 - click right on the logo for a detailed agenda), and aspires to gain a membership in the WTO (World Trade Organization), its integration in the global business economy is already a reality, as these R&D projects with America's IT and telecom giants attest.

Russia's decade-old bid to join the WTO could clear its last major hurdle if presidents George W. Bush and Vladimir Putin sign a deal as expected, when they meet in Russia on Friday (July 14), on the eve of the G8 summit.  Such an agreement will be an anti-climax.  It will merely acknowledge the reality on the ground, despite the U.S. vice president Dick Cheney's recent saber-rattling (see "Tricky Dickey Is Back: Dick Cheney Lambastes Russia", and "Putin Responds: Washington Coddling Up to China," May 2006).

Meanwhile, Boeing, IBM, Intel, Motorola, etc. are here to stay... the politicians' rhetoric notwithstanding.  That's because Russia is offering them the largest carrot of any country in the world - its brain power.

"We don't design airplanes in any other place outside the U.S. at the level that we design them at the Russian design centre," Boeing's Kravchenko said. "Moscow is the biggest engineering centre that we have outside Seattle."

Boeing plans to invest $27 billion in Russia over the next 30 years. This includes $18 billion in purchases of titanium, a lightweight metal used in aircraft construction, and $5 billion to be spent on design and engineering.  Now, that's putting its money where the politicians' mouths are going to be.

The trade also cuts both ways.  Russian airlines are Boeing's big customers.  Its planes make up 81% of the foreign aircraft fleet in Russia and the CIS, according to Reuters. 

After a possible U.S.-Russian trade deal in St. Petersburg, Boeing could sign a contract to sell 22 'Dreamliner' B-787 jets to Russian flag carrier Aeroflot. The American multinational is competing for the $3 billion order with Europe's Airbus' A-350 model.

The fact that Russian engineers are working on the B-787 at the Boeing Design Center in Moscow may well be the swing factor in the deal.  If so, chalk up another reason for the "Go East, Young Man!"-approach.


To read the rest of the Reuters report, CLICK HERE.

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For additional Annex Research reports, check out... Annex Bulletin Index 2006 (including all prior years' indexes)

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Volume XXII, Annex Newsflash 2006-13
March 20, 2006

Bob Djurdjevic, Editor
(c) Copyright 2006 by Annex Research, Inc. All rights reserved.

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