Making a building smart

I read a couple of interesting articles in Vedomosti about commercial real estate the other day. In one of them the authors advocated the idea of a new concept to be offered to buyers and tenants. Participants of the discussion spoke primarily about the redesigning of their existing projects.

From my personal experience I know that there are two main trends in commercial real estate tenancy. Trend 1 is ‘slicing’ space up into as many small rooms as possible and leasing each out at a price as high as possible. There’s good demand for small, 10-20 sq. m offices while supply is low.

Tenants come and go very fast; it’s next to impossible to remember all of them. The same office space may house pet stuff sellers yesterday; a lawyer’s firm today; and somebody else in a week. I regard this kind of tenancy as an Oriental bazaar where you’re fooled into buying goods at the highest price possible. This is business for quick money lovers: “I want it here and now.”

Trend 2 is offering big clients big office space on a long-term and moderate-rate basis. I think it’s a good strategy for you to move from one finished project to another with an eye to long-term and stable revenue.

When I was doing my Teledom business center project in Nizhny Novgorod, I ventured to ‘make the extremes meet.’ And I succeeded in doing that; today several companies rent one floor (within 700 sq. m), with most offices covering from 60 to 200 sq. m. Some of the tenants are ‘infrastructure’ firms important for the business center, including a restaurant, a dentist’s, a notary office, etc.

It’s worth mentioning here that at the time we launched the Teledom project Nizhny Novgorod hardly had any class-B office space, not to mention class A. When you consider a new business, assessing a local market and international best practices is one thing; forecasting trends is quite another. Construction of a class-A business center was a leap over the class-B step but we had to skip B not to be chronically lagging behind.

It was the time when business people would privatize buildings that Soviet-time research labs used to own, give them a face-lift, chop space into small offices and offer rooms for rent. The class-B era was looming as the next stage of commercial real estate development. We asked ourselves: why should we go where everyone will come soon? I came up with a concept that had its zest.

I decided to build a ‘smart building.’ I studied Russian and international experience and ordered design from a Moscow firm. It turned out that the cost of what the designer was suggesting was almost the cost of overall construction. This caused its payback period to skyrocket, too; in Russia’s instability doing a project with a ten or more year payback period is a losing strategy.

Scrapping the project looked like a logical move, but I decided to continue. I brought my own company, Internet Laboratory, into it; the firm made its own unique and less costly intellectual building system adapted to the needs of the future business center. I bet on less known but better-customized high-quality equipment.

Our ‘smart house’ developments have brought about a new business as the system can be easily tailored to an apartment, a cottage, a shopping mall or a residential complex. Unlike competitors we offer turn-key solutions including design, installation, FOCL, telephone gateways, high-speed Internet and cable TV. This Internet Laboratory initiative has made it possible to now use the system at many other projects.

The Teledom project was our attempt to peer far into the future and anticipate market trends. Being ‘smart’ the system is constantly developing.

To pull down and rebuild business centers from scratch or to renovate what is already available? This is a dilemma now faced by owners of land where ‘frozen’ factories stand. The owner of Danilovskaya Manufactura in Moscow took an unorthodox approach (see http://www.vedomosti.ru/newspaper/article/249607/ot_proletariev_k_dizajneram). He rebuilt some of his out-of-use parts of the factory to make a ‘loft quarter’ there. The guy was quoted as saying, “…this has wrought a unique atmosphere of working process where creativity is of value.”

A current office space glut in Moscow is apparently causing owners to ‘put a lovely face’ on offices to be specifically offered to professionals in creative sectors. In my opinion, the developer simply didn’t have enough long funds, which prompted him to launch an option that pays off fast. And he hit the mark!

However, it is service that makes commercial real estate business successful. I would also recommend that a developer bet on convenient location, availability of communications lines and the concept of prestige—this is what business people value.

Want to go global? Build up at home first—and innovate

According to a World Bank report, hi-tech products account for just 6.5% of Russia’s exports vs. just under 30% for China and the U.S. Sad stats for Russia, indeed. But should exports be the focus? Isn’t it putting the cart before the horse?

As is the case in a traditional commodity economy, Russian businessmen very often think in terms of exporting their products for sale abroad. With an innovation economy, however, it is first and foremost a domestic market that is the first buyer of innovation.

Historically, if you look at any other innovation-driven economy like the EU, Japan or the U.S., the first market has always been a domestic market which creates economies of scale. Local companies gear themselves up, take strong positions in local markets, build up their capital base and production know-how.

That forms the proper platform for exports of high technology all over the world. The Japanese built up their domestic automotive industry, filled it with high technology and then began exporting. The same with many other Asian economies.

So the problem for Russia is the lack of domestic manufacturing demand for innovation and modernized production mechanisms. Owners of new technology products feel they can’t make large enough profits through the domestic market so they immediately seek export markets. But the domestic economy of scale is not large enough. Therefore it is very hard for them to enter into markets such as America; they don’t have a large enough production base for their products within the Russian Federation.

The only way out here is if Russian managers and specifically the owners of Russian large-scale companies begin to buy Russian domestic technologies to use in their own companies. Once in some number of years the domestic market is substantial enough, this will form an outstanding foundation for Russia to begin exporting new ideas because they will already have been tested within the Russian market with quality control improved.

Domestic innovations ignored

Some fault Russian science for being in crisis and unable to supply new ideas. In my opinion, it is not the problem; and our readers responding to our recent poll obviously agree with me. Russian science has the greatest capabilities in the world. The problem is in the lack of commercialization opportunities; Russian science can’t identify local markets.

The real root of the problem lies in owners of this country’s large companies not buying domestic innovations to upgrade their assets. If they begin to do so, this will stimulate the entire development of this sector of the economy and will eventually create a terrific platform, from which Russia can not only export commodities but also high technology products—and not only in the defense sector but in regular consumer electronics, pharma or IT markets. These are significantly broader in scope across the entire planet compared to simply defense products, which are typically government-to-government purchases.

As soon as Russian industry begins to tap into global consumer markets, the scale for expansion is astronomical and can represent huge profits for Russian companies.

R&D neglected

There’s another serious snag that holds back Russia’s innovation drive.

If you look at the American market, for example, on average 3.5% of corporate turnover is returned in R&D investments. If you look specifically at the pharmaceutical or telecom sectors, 20-to-30% of turnover is plowed back into research and development. This allows companies to continuously improve efficiency and their competitiveness on a global scale.

As far as the stats I’ve seen, Russian companies, unfortunately, spend on average less than 0.5% of turnover on R&D across the entire economy. For large government-owned industries in the oil and gas sector, if I’m not mistaken, this is like 0.17%.

There’s no comparison with the amount of money that global majors like Exxon, Shell or BP reinvest in research and development. There’s no path to an innovation economy unless corporate Russia takes the lead in trying to catch up.

Business owners as a remedy to heal Russian societal divisions

Following the most recent congressional election the American nation is appallingly polarized. The G.O.P. is goading President Obama to “change course” and desperately wants to make him a “one-term president.” In Russia, a socio-economic rift has been tearing the fabric of Russian society already for two decades, with the mainstream parties and the opposition lambasting one another as “thieves and traitors.” Our two countries seem to be both living now in a time of deep-rooted divisions. But are these divisions of the same nature and equally insurmountable?

Looking at the election results in the U.S. I’m shocked at what a division in society exists. There are two sides of the American culture at the moment. One supports the Obama administration that wants to make a more integrated and inclusive society; those people are very much interested in work with the rest of the world, they are open-minded and very often quite liberal in their view of life. I would call them a progressive side of the American culture.

Opposing this is what I would call a conservative side. And, in my opinion, the division between these two has never been greater in the history of the United States. This is neither a North/South division nor ‘red’ states vs. ‘blue’ ones; this is about progressing into the 21st century or retrenching in order to hold onto past gains from the 20th century. It’s about the attitude of US citizens to our role in the world.

The two sides do not understand one another and can hardly collaborate politically or civilly to get things done any more. So I anticipate a very difficult two years for the American president to get new legislation passed.

When I think about this division in American society it troubles me greatly, and I also think about the division in Russian society and culture. But here the division is of a very different nature. This is more of a generational issue.

Russia, a commodity economy for a thousand years, has developed a certain socio-economic, demographic and geopolitical structure. That’s all very understandable, but I think equally understandable are the systemic barriers that this structure has erected, making it difficult to now create a modern, 21st century innovation economy. Historically, there has been a focus on short-term profit-taking, trading, high concentration of wealth in select hands and monopolization of industries.

The historical part of society that has underpinned this structure now lives side by side with another, very different side of Russian society, which are young progressive entrepreneurial innovators desperately trying to develop Russia into a modern-day global mover and shaker, using the power of brains and the power of intelligence in creating new solutions to global problems through technology.

I’m not saying these two groups in Russian society are necessarily fighting and creating a paralysis as in the United States, but they are very different. There’s nothing wrong with this cultural division; this is a difficult but normal transition Russia is going through on its way from a commodity economy to a modern innovation economy. The key challenge, however, is to ultimately find a middle ground.

In Marchmont we see our audience as business leaders, serial entrepreneurs and innovators. Why business leaders? Because it’s critical that this segment of society, the owners of industry, really have an ability to work between both sides of Russia’s culture. It’s the people who privatized and built industrial companies that now play the critical role in Russia’s development over the next 20 years; these are today’s Russian industrial drivers.

These individuals, now in their 40’s and 50’s, face a crossroads. In order to really make the final transition for Russia into a modern innovation economy the owners of industrial entities across the country, from the top oligarchs whose names you all know down to individual proprietary family-owned industrial businesses in each of Russia’s provinces, need to invest in modernization. Where do they stand?

If Russia’s industrial and manufacturing owners want to be competitive in a global economy and want Russia to be prepared for the WTO entry, they need to invest in themselves. If they do so, that will create a fantastic domestic market for new innovations. This in itself would give hope to young innovators and students and scientists that not only can their ideas be applied into a global market but they can and must be firstly applied within the Russian market and then exported—as is done in all other innovation economies. This will also make it more profitable for business angels to support innovation products.

The situation is a clear choice for me to see. If business owners decide not to invest in themselves, it will continue to restrict this innovation market in Russia. If they do decide to invest in themselves, it will rapidly accelerate Russia’s drive to being a real innovation economy.

The owners of industrial companies manufacturing and selling their products domestically and globally now have the future of this country in their hands; they have the power to support this innovation drive, thus bridging the generational societal gap that still exists. The older generation, people who have made their lives in the commodity economy, cannot change their mentality overnight.

I believe that the majority of our audience in Marchmont would agree with me, and I think that many of today’s business owners simply need to be encouraged and properly motivated with rational tax policies to initiate this process. Hopefully, the Skolkovo innovation city will start to create a new generation of laws and resulting success stories to show the way.

I’m optimistic about Russia

Returning to my own home country, the United States… Unfortunately, I’m not very optimistic. I think we’re in for a very difficult period and we’ll have to wait and see what happens in two year’s time with the next presidential election.

The divisions in American society tend to become greater every day, and I don’t think they will be resolved until we have leadership in the United States which fully understands the root-cause of the divisions and begins an effort to forge a new vision for the U.S. in the 21st century.

As far as Russia, I’m much more optimistic. I see signs every day that owners of companies are investing in themselves and supporting the development of innovation clusters through the creation of business angel clubs, new infrastructure, programs supported by the federal government including the Russian Venture Company, Rusnano and Skolkovo.

I think all these programs are now creating a critical mass of support moving Russia forward towards real long-term modernization. Unlike America I think the different sides in Russia will eventually converge creating a strong momentum pushing Russia forward.

Russia’s modernization from a bird’s eye view

I’ve been between places lately, doing business in Moscow one day and in Perm on another. Travel is always a good opportunity to give thought to things that matter…

Even with its own vast new gas reserves the U.S. is gearing up for an ambitious $5bn phase 1 of its Atlantic Seaboard offshore wind farms. I was wondering if Russia was ever seeing its place in this changing global energy paradigm.

In the current patterns of the global economic development I think it’s critical to work and find as many lower-cost alternative sources of energy as we can. If the U.S. government and private investors are going to develop these types of programs using advanced technology it will clearly help diversify their economy’s energy base.

As global economic developments transpire, certain costs will go up for certain technologies and commodities and other costs will go down for others. As there becomes a critical mass for solar technology, for example, with the Chinese producing a lot of solar panels, the costs to consumers will go down overtime. So to the degree that there are more countries getting involved in promoting alternative energy sources, the costs of those sources will go down and any given country will be able to have a portfolio of different sources.

If Iran, awash in oil, is extremely interested in developing nuclear energy, one has to ask the question: “Why is it so important for Iran to develop nuclear energy?” While there are clearly many alternative views to consider in answering this, it’s also clear that they, too, want to diversify energy usage inside their own country, being free, of course, to export their huge oil reserves around the world at the same time and generate as much profit as possible.

So, what’s good for one country is good for another country as well.

I think it’s absolutely not acceptable for Russia to ignore this global trend; and I’m glad that more than 60% of Marchmont website visitors answering the related poll questions share my view. It’s extremely important to also develop alternative sources of energy based on wind, solar, alternative battery and other ‘clean’ technologies. Looking at everything that Russia does to help support and promote its broad-based domestic energy industry I find it useful for this country; diversification will make it much stronger in the long run.

I reviewed Russian press last week and the following was a real eye-catcher—if not an eye-opener. Sberbank launched a year ago its Ideas Exchange project to encourage and pay for its own employees’ innovation ideas aimed at the bank’s operation optimization, and has now economized about $30m in cost-saving stemming from this program.

It is a very interesting initiative, I believe, and the fact that Sberbank launched it is an excellent example of how all companies in Russia should really view themselves and how they analyze their operating costs, their marginal profitability and the overall effectiveness of their business process.

If the owners of Russia’s industrial base really begin to look at their companies as an asset to be improved in its value rather than a source of free cash flows to milk, and begin to invest in the improvement of their companies’ performance and ultimate value, this will inevitably create, in fact, a very strong market for innovation projects in this country. This is an essential factor in building Russia as an innovation economy in the 21st century.

If Russian shareholders fail to understand this simple fact, the markets for innovation in Russia will continue to be sparse, with most innovators left to feel that the only markets that exist for their products are the EU, Asia or the U.S., and the results will show few projects will be commercialized locally.

To the degree other Russian companies follow Sberbank’s example and begin to invest in themselves and try to reward creative ideas, this will all certainly lead to an improvement in Russia’s development of an innovation economy.