Part I: The Start-up of Russia. The Startup of Start-up Communities: The Power of Clones in Russia—& Beyond

Thomas Nastas, a member of Marchmont's Advisory Board, is presenting his series of blog postings on start-ups and start-up communities in Russia and beyond.

Last time I introduced the questions as topics for answers in this five part post series:

1.)   What is the ‘spark’ that ignites the startup of start-up communities?

2.)   How does the ‘start-up’ of startup communities differ—emerging markets vs. developed countries?

3.)   Why is the US entrepreneurial model of experimentation, trial and error and pivoting a death sentence for entrepreneurs in the emerging markets? And what you can do about it.

4.)   How does the culture of risk and failure in emerging markets impact investor DNA—what they finance and what they won’t

5.)   What is Clonentrepreneurship, where is it spreading from and to, and why is it a model for more—innovation, startups, and venture investment?

I conceived this series for StartUp Communities, the blog of venture investor Brad Feld (Foundry Group, Boulder, Colorado, co-founder of Tech Stars, blogger Feld Thoughts).

Subjects covered in this post include:

1.)   First—Three Definitions

2.)   The Russia Tech Scene

3.)   Growth in Russia

4.)   What Changed for Growth to Emerge

5.)   The Spark that Ignited the Start-up of Russia

First—Three Definitions

You might be unfamiliar with this phase ‘start-up community.’ So here’s a short intro to what it is and why it’s important to every country on Planet Earth.

A start-up community is a place where entrepreneurs with ideas come together to start new companies, and can actually find the money and the talent to get their start-ups financed, staffed and launched.  Most start-up communities offer appealing lifestyles, are cool places to live, to work, to have fun and do more—faster.  Over time as more and more start-ups are created and financed, an entrepreneurial ecosystem takes root with success begetting success leading to a thriving start-up community.

In the world of venture capital (VC), entrepreneurship and start-up creation, Silicon Valley is the quintessential start-up community in the United States, with the MIT/Boston area as #2.  The term start-up community can be attached to a country as Dan Senor and Saul Singer did in their 2009 book Start-Up Nation: how Israel became a start-up ecosystem with sixty-three publicly Israeli companies traded on the NASDAQ stock exchange in the United States, more than any other foreign country.

Start-up communities attract and breed entrepreneurs.  Entrepreneurship drives economic growth and development, new jobs and of course, wealth creation. It’s this prosperity that cities, states, regions and countries around Planet Earth are trying to create, attempting to replicate—duplicate, to get things going; for their survival and renewal, by inspiring wannabe entrepreneurs to take the leap into the unknown and supporting resident entrepreneurs.

I craft two other phrases in this series, Clonentrepreneurs and Clonentrepreneurship; words put together from Clone-Entrepreneurs and Clone-Entrepreneurship (but without the hyphen).

Clonentrepreneurs are entrepreneurs that clone a business idea or a business model of a company and implement it too, sometimes with improvements, sometimes not.  While the word clone may be a 21st century phenomena, clones have been around a long, long time.  Over the years these two companies have taken different paths to growth, but over 100 years ago it was “Coke or Pepsi?”

The Russia Tech Scene

Startup Genome recently published research on the most active start-up ecosystems around the world. It listed Moscow as #10.

It’s great to see Russia’s largest city rocket into this spot, given that in 2001 less than $100 million/year was invested in Russian seed and early stage tech vs. billions of dollars of private equity money invested in fast moving consumer goods, real estate, construction, wholesaling, retailing, natural resources and other sectors that lifted a post-Soviet economy into the 21st century.  Ten years ago only a handful of emerging growth tech companies existed in Russia including Yandex, Ozon, Mail.ru, Abbyy and Kaspersky to name five.  The first three served primarily the Russian speaking market, the last two—international customers around the world.

In the latter half of the decade, innovation became a priority of the Russian Government to diversify the economy from oil/gas with its investments in the Russian Venture Company (fund-of-funds with ? $1 billion under management) and the Russian Corporation of Nanotechnology (Rusnano, ? $10 billion under management, making fund, project and international investments in nanotech). Even with these efforts, the needle of tech investment crept up ever so slowly to $200 million ± 10% for seed and early stage investments in all sectors.

But everything changed in 2010; investment in seed, start-ups and early stage companies more than doubled from 2009 and in 2011, doubled 2010 results.  In 1Q 2012 the top Internet 10 investments raised over $80 million. Some pundits claim that investment will exceed $1 billion by end of 2012.

What caused this acceleration in investment in just two years, and what are the take-ways for your start-up community; to increase the # of start-ups in your country and entrepreneurs making the commitment to new projects, the amount and velocity of venture money invested with the ‘Scaling Up’ of entrepreneurship, risk-taking and innovation for more?

Growth in Russia

Certainly as the Russian economy rebounded from the lows of the global financial crisis, consumers and businesses were in the mood to spend. Russians increasing lived and breathed on-line with entrepreneurs serving up Internet models to capture their eyeballs and wallets.

Online video advertising in 2011 doubled to $37 million from $15 million, Russian contextual advertising jumped to $430 million in the first half of 2011, an increase of 60% from 2010, Russian Internet advertising clocked in at $1.4 billion, up 56% from 2010 with display (banner) advertising’s 2011 spend up 45% to $510 million from 2010.  GP Bullhound an investment bank based in the UK estimates that only 18% of the 53 million Russian internet users shop online, with online advertising consuming only 9% of Russian ad budgets.

All of this growth translated into increasing revenues for Internet and Web companies with Forbes.ru listing the top 30 Russian Internet companies by their 2011 sales.

Such growth attracts investors as honey lures bees.  But it’s the nature of the deal flow that better explains the huge jumps in VC investment in less than two years and the wave of new entrepreneurs doing start-ups.

What Changed for Growth to Emerge

2010 was a ‘tipping point’ for the start-up of Russia through two liquidity events and underlying forces in the country. First was the acquisition of the Russian Groupon clone called Darberry by Groupon.

From their formation in February 2010 to its purchase by Groupon in August 2010, Darberry showed the investment path for entrepreneurs and investors in Russia, business models with a real shot at attracting capital.  While a handful of clones existed in Russia, Darberry’s sale was a major inflection point for more Russian entrepreneurship.

The second event was the minting of a few billionaires and dozens of new millionaires from the IPO of Mail.ru (valuation—$5.71 billion, November 2010).  After this new wealth splurged on cars, clothes, homes and travel, it financed new start-ups.

Since these liquidity events, dozens of new start-ups raised hundreds of millions of dollars in 2010, 2011 & 1Q2012 with capital invested by new Russian funds formed to finance mainly e-commerce, social and gaming startup clones with US and European venture capitalists co-investing since they had experience with these business models in the West.

Prior to 2008 the Russian tech scene had no role models, no ‘mojo’ and little connection to the world other than oil/gas.  It was widely known that Russia had deep human talent in mathematics and the physical sciences, yet few knew the route to exploit these assets for commercial ventures.  Some took the path of outsourcing (India model) or system integration to build enterprises like Luxoft, IBS and TerraLink to name three.  A few others walked a different road like Acronis and Parallels:  creation of gamechanging technology for global customers (Israeli model) with R&D conducted in Russia and headquarters located in the United States.

Neither of these endeavors generated the velocity of new start-ups being formed nor an explosion of venture capital investment.  Yet if these were not the paths forward for the creation of a start-up community, then what was—since there was no clarity to what business models would capture the wallets of Russian customers and the cash of Russian investors?

The Spark that Ignited the Start-up of Russia

Certainly the creation of several dozen angel investors with tech experience was an impetus to the start-up of Russia as the market lacked ‘smart’ money. But that money has to find a home, and that’s where clones showed the way forward.

Darberry demonstrated that cloning established Western Internet business models and localizing them for the domestic market captures growth. While profits eluded Darberry, it scaled quickly with revenues multiplying exponentially day-by-day.  This was the signal that Russian investors needed to open their pocketbooks and finance the start-up of Russia.

From Sept. 2010-2011, 20+ new start-ups and development stage companies raised over $400 million.

New capital continues to flow into clones.  KupiVIP (clone of USA shopping club Gilt Groupe, itself a clone of French deep discounter Vente-Privée) grew from launch (October 2008) to $200+ million revenue by 2011 with $65 million of new capital raised in 1Q 2012.  In May 2012, Avito.ru, the Russian clone of Craigslist raised a whopping $75 million.

Ok, so, uhm—what’s so revolutionary about entrepreneurs cloning the ideas of others and investors financing the start-up of clones?

For Next Time—Part II:  The Cultures of Risk

To answer this question I’ll examine how the cultures of risk—developed vs. developing countries—impact the DNA of investors and their willingness to finance seed and early stage tech business models, with some investors ‘buying’ opportunity while others ‘buy’ risk.  A preview of the subjects in Part II:

1.)   The Cultural Divide:  What Investors ‘Buy’

2.)   What Investors Fear

3.)   The Culture of Venture Capital:  Friend or Foe?

You're welcome to send comments, opinions and questions directly to Tom at mailto:Tom@IVIpe.com . We also encourage you to visit his personal website.

Regional innovation clusters: the art of knowing one’s strengths and interacting with neighbors

In assessing Russia’s regional innovation potential I can point out some developments which show that the regions are starting to really differentiate themselves.

For example, Nizhny Novgorod is developing its own concept of innovation cluster here with the advancement of techno-parks such as Sarov and Ankudinovka, its incubators, Lobachevsky University, etc. This region is really beginning to develop its own strategy.

I can say that Penza has also developed a terrific approach towards commercialization of early-stage technologies. They’ve built, I believe, two very strong techno-parks; one is fully operational and the other is coming on-line a bit later. And there are perhaps seven different incubators in the Penza region which are now operational. I can see that the administration has developed a focused approach to developing an innovation cluster system in Penza. Historically, Penza was a very strong region in systems integration and developing a lot of key technologies that might have been synthesized from other regions of Russia and then brought into the Penza region to create end products. So, Penza is now strategizing to take advantage of its historical roots and strengths in that area. I would be looking out for Penza over the next three years to really emerge as one of the key systems integration and manufacturing innovation clusters.

From my perspective, another highly attractive innovation cluster is being formed in the Kaluga region, and specifically I may point to the city of Obninsk where a pharmaceutical and biotechnology cluster is quickly emerging with tens of millions of dollars of investment coming from Western pharmaceutical giants and into the Obninsk area. Local companies such as Medbiopharm and others are actively working to develop that region as a biotech cluster.

I think the development of these differentiated innovation clusters is a very positive signal for Russia because historically you don’t want to just grow each cluster in an identical way. Each region has its own history; each region has its own education and geography and culture. Therefore each region in Russia should be developing its own strategy and prioritization of infrastructure investments. Some regions have significantly more scientific potential than others; other regions have very solid manufacturing background; others are very strong in R&D.

In beginning to assess the innovation potential of different regions I would begin to look at them in a broader context. Not just how many projects they are producing which are classified as innovation-driven—but what the strategy of the governor of a region is in differentiating his region from other regions, and how the administration is initiating contact on a horizontal level from one region to another. Because clearly there’re technologies being developed in Nizhny Novgorod which could use the strengths of partners from Tomsk Polytechnic University, for example, or Akademgorodok in Novosibirsk.

The world is both horizontal and vertical. And what about Russia?

If you look at the innovation cluster system in the United States, you’ll see that there’re certainly vertical relationships between the Washington-based government departments (Department of Defense, Department of Energy, Department of Science), which are pouring about $50bn worth of annual subsidies into fundamental science and R&D around the country, and regional university centers. But simultaneously, there’re horizontal efforts for different regional universities to collaborate between themselves. That system is very strong in the United States, in the UK, in Japan, and in many countries in the European Union.

The vertical relationships already have existed for decades in Russia; this is a very vertical, top-down driven system. But what I’ve seen emerge over the last three years is the development of horizontal relationships between universities from completely different regions—especially as they tackle versatile hi-tech problems which require different scientific disciplines, ranging from mathematics to cybernetics, to nanotechnology and IT. As the global level problems show themselves to be quite complex, Russian university and R&D teams need to actively accelerate their relations with other teams across the country that could collaborate to help create real products. And I see this development happening.

Reaching out to one another

I attended a Seliger event recently doing a master-class with students. I was there at the invitation of the Hi-tech Techno-park Association of Russia which brings together 19 techno-parks across the country. Absolutely fantastic event! I met a lot of different directors and administrators from different techno-parks and I can say there was a very high-level dialog between people from completely different regions who have not previously really interacted together on a horizontal level. We all talked about common problems and how we might collaborate to overcome administrative and financial barriers in order to really reach the process where we can commercialize technologies.

So from my standpoint, I’m very optimistic that Russia’s starting to develop these horizontal relationships between regions and between individual R&D centers and techno-parks and incubators within these regions. It’s great to see that the top-down sort of stimulation through vertical budget relationships is now being matched with horizontal work between scientific teams. And that’s a very good signal that shows me that the basis of Russia’s innovation economy is finally beginning to take root.

Introduction: the Startup of Start-Up Communities; the Power of Clones in Russia—& Beyond

Marchmont Advisory Board member, and internationally respected expert in early stage technology commercialization, Thomas Nastas, is preparing a series of blog postings that reflects his view of the history and trial and error based development of Russia’s start-up community. We are glad to offer you this time the intro to the series. Other postings will follow.

What are the elements of a start-up community?  What can you do to startup a start-up community in your city, or help it do more—faster?

Venture investor Brad Feld (Foundry Group, Boulder, Colorado, co-founder of Tech Stars, blogger Feld Thoughts) writes about these subjects in his other blog StartUp Communities with his new book titled ‘Startup Communities: Building an Entrepreneurial Ecosystem in Your City,’ to be published in the fall of 2012.

If you don’t know Brad, he was and remains the protagonist and instigator that transformed Boulder from a sleepy Rocky Mountain hippie town into one of the most vibrant entrepreneurial tech start-up communities in the United States.  It is his individual contributions to this success that makes Brad’s advice sought by investors, government policy makers and entrepreneurs from around the world.

Recently Brad accepted my offer—I contribute a post on the startup of Russia to StartUp Communities.  As I started writing, one subject led to another, with the result too much for one individual post.  Over the next few weeks I’ll upload the content as a series of posts for you:  the investor, the entrepreneur, the Government policy maker, staff of international development finance institutions.

In this series I answer five questions:

1)   What is the ‘spark’ that ignited the start-up of Russia?

2)   How does the ‘start-up’ of startup communities differ—emerging markets vs. developed countries?

3)   Why is the US entrepreneurial model of experimentation, trial and error and pivoting a death sentence for entrepreneurs in the emerging markets?

4)   How does the culture of risk and failure in emerging markets impact investor DNA—what they finance and what they won’t?

5)   What is Clonentrepreneurship, where is it spreading from and to, and why is it a model for more—innovation, startups, and venture investment?

There is much happening in Russian cities like St Petersburg and Novosibirsk as two regional hubs of innovation and entrepreneurship.  Even so, I’m confining my discussion to Moscow since what we are seeing in the Russia capital is being replicated in other cities in the Russia Federation, only to a lesser degree.

Here’s a preview of the topics in each post.

PART I:  THE START-UP OF RUSSIA

First—Three Definitions
The Russia Tech Scene
Growth in Russia
What Changed for Growth to Emerge
The Spark that Ignited the Start-up of Russa

PART II: THE CULTURES OF RISK

The Cultural Divide:  What Investors ‘Buy’
What Investors Fear
The Culture of Venture Capital:  Friend or Foe?

PART III: THE POWER OF CLONES

Growth and Innovation in the Supply Chain
Sidestep the Obstacles that Impede Scaling Up
The Controversy of Clonentrepreneurship: Cloning the Idea or Hatching a Start Up?
The Spread of Clonentrepreneurship

PART IV:  THE QUEST FOR GROWTH

Clonentrepreneurship or Alternative Paths to the Start-up of Start-up Communities?
Change the Culture to Make Amazing Things Happen

PART V:  CLOSING REMARKS

The Start-up of Your Start-up Community
Links: Evolution of Runet (Russia Internet) & the Russia Tech Scene

I hope that these subjects will help you to ‘Scale Up,’ more entrepreneurship, more investment and more tech start-ups in your country, with Russia as one experience to learn from.

How might this happen you ask?

Frequently a mismatch exists in the business models that entrepreneurs launch in the emerging markets and what local investors finance.  Struggling to raise money, entrepreneurs label capital as risk adverse with investors blind to potential, seeking guarantees and sure things.  Investors respond that entrepreneurs of venture stage companies fail to transform potential into paying customers fast enough and in the volumes needed for the business to scale.  Add in their need to generate a rate of financial return required for their own survival, and it’s logical why local investors in the emerging world finance expansion stage companies.

This conflict spills into the public stage with Governments called to action.  They conceive and invest taxpayer money to catalyze an early stage tech venture capital industry to fill market voids.

What happens next is perplexing to the creators of these investment schemes.

These new funds have a mandate to invest in venture stage tech companies, but they behave differently in execution. They invest in tech, but at the growth stage of company development, not at the startup stage.

But what if seed and early stage business models exist with the revenue growth characteristics of expansion-stage companies?  If such business models do exist, what are they? Can they impact the DNA of local investors to risk and catalyze investment at the earliest stages of company formation?  And can they spark the start-up of a startup community? While such business models seem to be an illusion and counterintuitive to the natural evolution of market development, I explain in this series that such models do in fact exist in Russia—& beyond.

For Next Time—PART I: THE START-UP OF RUSSIA

Subjects I discuss in Part I:

1)   First—Three Definitions

2)   The Russia Tech Scene

3)   Growth in Russia

4)   What Changed for Growth to Emerge

5)   The Spark that Ignited the Start-up of Russia

Reactions & opinions welcome in the comments box or send directly to me at mailto:Tom@IVIpe.com.

You may also want to visit Tom's personal website.