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Innovation Strategies of Emerging Russian Multinational Companies

Sergey Filippov

Delft University of Technology (The Netherlands)

Alexander Settles

Higher School of Economics (Moscow, Russia)

Prepared for an international conference

‘Re-Assessing Emerging Market Multinationals’ Evolving Competitive Advantage’

(Cambridge, UK, 25-27 March 2011)

Date: 14-03-2011

Abstract

The paper explores innovation strategies and processes in emerging Russian multinational companies. Innovation is a major driver of corporate growth and determinant of competitiveness of western multinationals. Emerging Russian multinational companies have started to realise the value creating aspects of R&D and innovation. They devise various innovation strategies ranging often leading to acquisition of technology-intensive firms in advanced economies. Russian firms are unique since they operate in a society with a strong scientific tradition inherited from the Soviet system with limited success in translating these scientific inventions into innovative products. The paper provides an inventory of such strategies and provides empirical evidence to exemplify them. Finally, managerial and policy implications are formulated.

Key words: innovation, Russia, multinationals, acquisition, FDI

1. Introduction

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Innovation is universally recognised as a competitive advantage and a key driver of the growth of multinational companies. Presently, innovation is not limited to western multinationals, emerging multinational companies start realising the strategic value of innovation too. As a vivid indication of the importance of this topic, in April 2010, The Economist published a special report on innovation in emerging markets, titled ‘The world turned upside down’. The report states that the emerging markets are developing their own distinctive management ideas, not simply imitating the western. It urges to recognise that the emerging world, long a source of cheap labour, can be a source of disruptive innovation as well.

Among emerging multinationals, Russian companies represent an interesting case. Russia has inherited the Soviet science and technology (S&T) complex that enjoyed leadership in many technological domains. However, the institutional collapse after the break-up of the Soviet Union has had a profound effect on innovation, science and technology. Dependency of the contemporary Russian economy on the international commodity markets is often acknowledged. The exports of oil and natural resources make up to 80 per cent of all Russian exports. Likewise, many emerging Russian multinational companies operate in the natural resources sectors.

Diversification of the national economy remains a top priority for the Russian political leadership. Russian president Dmitry Medvedev has consistently called for the ‘modernisation’ of Russia’s economy and appealed to Russian companies to design and implement innovation strategies.

Despite the general interest to this topic and its relevance, the role and place of innovation in emerging Russian multinationals remain under-researched (with some exceptions, e.g. Podmetina et al, 2009). The objective of this paper is to fill this gap. We seek to explore the nexus between innovation and internationalisation of Russian companies. More globally, we aim to reflect whether innovation represent a firm specific advantage - competitive advantage for Russian emerging multinationals. As the conventional wisdom about EMEs especially those from Russian fail to innovate even with the extensive state support of state corporations, scientific institutes, and now technology parks. While there is a lack of innovative activity of Russian based firms there are firms that operate both in the Russia market and internationally that have attempted to acquire technology assets or create innovative capacity in Russia. For example in the telecommunications industry Russian firms have developed significant competitive advantage in their home market and have extended these advantages to other emerging markets especially in the area of the former Soviet Union.

Innovation capability is often measured by patenting activity (Acs and Audretsch, 1989); however in the Russian context patents do not always provide meaningful representations of innovation process, as the efficiency of R&D measured by patents is low. Other standatd measures of innovation are not always readily available in Russia. Therefore, the paper relies on secondary data and circumstantial evidences.

The paper is structured as follows. Section 2 provides a theoretical background by reviewing academic literature on a number of relevant topics, such as emerging multinational companies and firm-specific advantages, innovation and internationalisation of R&D and absorptive capacities. Section 3 sets the context by providing a macro-view on innovation in Russian, the strategic intentions of the government’s policies and innovation in Russian (domestic) companies. Section 4 examines the interplay between innovation and internationalisation. Section 5 provides critical reflections and conclusions.

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2. Theoretical background

2.1. Emerging multinational companies and firm-specific advantages

The rise of multinational companies originating from emerging economies has attracted a lot of attention among the business and economic literature. We start review of this literature by looking at the classic theories of internationalisation.

The ‘eclectic paradigm’ originally proposed by John Dunning (1981) yielded many useful insights that have informed subsequent research; it represent the most influential approach to study the international activities of multinational companies. This eclectic paradigm can be considered as an ‘envelope’ for the existing theories of internationalisation, with the addition of a new attention to the locational choice of investments (Dunning, 2000). Besides, according to Dunning (2006), the eclectic paradigm can be easily adapted to include new features emerging from the recent developments in globalised markets. In its essence, the eclectic paradigm postulates that the decision of firms to expand their activities abroad via FDI can be explained by three different advantages. Ownership (O) advantage represents the ownership of specific resources to be exploited externally. Location (L) advantage depends on the characteristics of the host country and opportunities it offers. Internalisation (I) advantage depends on the opportunity to internalise firm-specific advantages rather than to exploit them on the markets through other transactions.

Another fundamental contribution by John Dunning (1993) is a widely used typology of motivations drawing FDI. They are: (1) resources-seeking investments aimed at accessing unique resources specific to foreign locations (e.g. natural resources), (2) market-seeking investments aimed at entering new markets, (3) efficiency-seeking investments pursuing an efficient specialisation of firms, and (4) strategic asset-seeking investments aimed at augmenting the set of proprietary resources of firms.

The key precondition to become engaged in foreign investments is that a firm must possess some unique competitive advantage, or firm-specific advantages (FSA). The multinational company needs to build on some type of FSA that, at the simplest level, is nonlocation-bound, i.e., easily transferable across borders as an intermediate product. It can be either a functional, production-related proprietary asset, typically technological, manufacturing or marketing know-how, or an organisational capability to efficiently coordinate and control the multinational company’s asset base. Hence, the FSA concept covers a very broad set of unique company strengths (competencies and capabilities). The importance of FSA transfer to explain performance of the multinational company has become a pivotal in the international business literature (Rugman and Verbeke, 2001).

Alan Rugman also identifies country specific factors (CSA). The CSAs are the location-bound, exogenous factors in a multinational company’s home-market. The CSAs result from the home country’s economic and institutional environments, such as labour force, factor endowments, government policies, national culture, productive reputation, or institutional framework. In fact, both FSA and CSA can be related to the O and L advantages of the OLI framework.

The OLI framework originally designed to explain internationalisation of companies from western economies does not directly address the pattern of internationalisation of firms from less advanced (or emerging) countries. Essentially, companies from emerging economies might not possess the same competitive advantages as companies from advanced economies

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do. As Goldstein (2007: 81) argues, ‘If they invest abroad, it is not on the basis of ‘O’, and the parameters that determine the degree of ‘I’ in their foreign operations are different’. These firms internationalise in order to get access to the strategic resources abroad they need. This idea is consistent with the classical Dunning’s typology of FDI motives. UNCTAD (2006) identify resource-seeking, market-seeking and efficiency-seeking factors as the main reasons for outward FDI from emerging countries to the emerging / developing countries. On the contrary, strategic asset-seeking motives are dominant for outward FDI from emerging economies to developed countries.

Reflecting on CSA, the domestic environment may be an important advantage for emerging multinationals, such as the low cost of factors (Barnard, 2008; Cuervo-Cazurra, 2007) and the monopolistic power at home (Andreff, 2002). The CSA may serve as a push factor; for instance, home country government policies may create a favourable framework for outward FDI.

Last but not least, cultural and psychic proximity (in line with the tenets of the Uppsala Model) is an essential factor is internationalisation of firms from emerging economies. Aykut and Goldstein (2006) report that that emerging multinationals successfully acquire companies in their home region since they are able to rely on cultural and ethnic affinities. In the same vein, Barnard (2008) shows that in knowledge-intensive services cultural and geographical proximity represent for emerging multinational a source of advantage over developed country multinationals.

2.2. Innovation and internationalisation of corporate R&D

The previous section outlined lack of ownership advantages as a reason for firms from emerging economies to internationalise. Strategic asset-seeking motive, entailing acquisition of technology-, or R&D-intensive firms, appears as dominant for expansion of emerging multinationals to developed countries.

A parallel trend is internationalisation of corporate R&D function when multinational companies engage in R&D at foreign locations. Motives, or location-specific factors, are divers – from characteristics of local or national markets to the properties of national or regional innovation systems. Establishing a presence in a foreign knowledge-intensive location is not a guarantee of success, and location-specific factors cannot be automatically captured (Narula and Zanfei, 2005). Tapping into localised knowledge base require strong linkages that are expensive and time-consuming to develop (Narula, 2002).

If the location-specific knowledge is internationalised by a foreign subsidiary, it is essential that it is then transferred to other units of the multinational company. Narula and Zanfei (2005:334) point out, ‘It is not sufficient for foreign affiliates to internalise spillovers if it cannot make these available to the rest of the MNE’. The multinational company must be able to co-ordinate and balance its structure, and stimulate and facilitate knowledge flows. As Narula and Zanfei (2005:334) claim, ‘a dispersion of R&D activities across the globe require extensive complex coordination if they are to provide optimal benefits. Such co-ordination requires expertise, managerial and financial resources’.

In its turn, the organisational structure is highly linked to the technological and sectorial nature of the company. Therefore, technological and sectorial differences can account for some of the differences of patterns of internationalisation and organisational structural adaptation (Narula, 2002).

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A related question is the nature of technology involved, as it can explain specificities of internationalisation patterns. Technologies can be analytically split in two categories – mature or immature. In Narula’s (2002: 796-797) words, mature technologies ‘evolve slowly and demonstrate minor but consistent innovations over time. The technology is to a great extent codifiable, widely disseminated, and the property rights well-defined. Competition shifts towards price, economies of scale and downstream activities in order to add value, as the original product is priced as a commodity. On the other hand, immature technologies, widely present in emerging sectors, change rapidly and are difficult to codify.

The sectoral differences, or systematic knowledge base variations between industrial sectors is a classic argument (Pavitt, 1984). Understanding the specificities of involved knowledge bases is crucial in order to understand the prospects for, and challenges involved in, creating corporate learning networks that span different locations, and the need to link up involved knowledge actors.

Many emerging economies operate in mature technologies and low-tech sectors, and competition indeed shifts towards the price. For example, as shown by Barnard (2008), emerging multinationals tend to concentrate their M&A activities in low-tech traditional industries in which they have accumulated capabilities over time and in which they enjoy competitive advantages (compared to western multinationals) such as capital-intensive production, scale economies and assembly-based mass production.

2.3. Absorptive capacity – can emerging multinationals learn from their international investments?

The ability for emerging market firms to learn from their international technology acquisition remains unclear. The historical expansion of R&D activities of multinational companies from developed economies into new markets was shaped by a firm’s ability to transfer their R&D capacity into new situations to take advantage of localisational benefits for R&D, to access lower cost of labour for highly skilled workers, or to tap into country specific capabilities not available in the home country. In the case of emerging multinationals, especially those from Russia, it is unclear whether these firms have the know-how to benefit from their investments in developed market technology assets. The assumption has been to acquire developed market technology leaders and then transfer the technology to the Russia operations. Since multinational companies have been able to transfer their technologies to the Russian market it assumed that Russian may merely buy the technology and transfer it.

A firm’s ability to learn from it subsidiaries or cross border acquisitions is a function of its absorptive capacity. Cohen and Levinthal (1990) define absorptive capacity as the ability to exploit external knowledge which is predicated on its prior related knowledge built on an understanding of the most recent scientific or technological developments. This prior knowledge provide a framework for the firm to recognise the value of new technologies, knowledge or management innovation and apply them for profitable ends. Absorptive capacity is the moderator between firm level R&D spending, technology opportunity and appropriability of innovations for commercial uses. In the case of post-acquisition innovation performance the level of absorptive capacity will determine whether technology-seeking investments will pay off for emerging market firms.

The extant research in developed market firms indicates that learning from acquisitions is difficult as previous results indicate that in developed market that post-acquisition innovation performance has suffered (Hitt et al., 1994, 1996; Hoskisson et al., 1994; Ahuja and Katila 2001). A deeper understanding of the value of technology seeking behaviour was examined

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in the chemical industry by Ahuja and Katila (2001) where they found that the relative size of innovation output mattered. Innovation activity went up in the post-acquisition period when the absolute size of the knowledge base was large but was reduced when the relative size of the knowledge base was high. In case where firms try to absorb their target’s knowledge when the knowledge base is relatively large to their existing knowledge base this reduces innovation. Firms that purchase relatively large knowledge bases and those in unrelated fields have fallen into ‘competency traps’ (Levinthal and March, 1993) wherein they are able to properly utilise the innovation capacity of their acquisition. The extension of this model and results to emerging market firms brings into doubt about whether emerging multinationals will be able to integrate the existing technology competence of acquired firms into their home-market based operations.

3. Context: Innovation in Russia

3.1. Macro-view and public policy

The Soviet leadership regarded the S&T complex as a matter of national priority; and it was particularly crucial in the defence sector. The innovation was assessed from a technological, not economic perspective. Therefore, it is unsurprising that the situation in other sectors of the Soviet economy was rather disappointing. The command economy was inherently resistant to innovation. Introduction of innovation and new technologies would lead to (short-term) disruption of the existing structure. Because Soviet enterprise directors were not interested in profit maximisation, innovation and following reorganisation were considered as a burden. As Berliner (1988: 639) describes it, ‘management must always regard innovation as a secondary and potentially threatening activity’.

The transition to a market economy has not improved the situation, and even worsened it in many respects. While elimination of the command economy was a necessary condition for resistance to innovation to disappear, yet it was not the sufficient one (Berliner, 1988).

In the volatile transitional environment of the 1990s, innovation receded into the background. Most enterprises were struggling for survival in the new economic conditions, and innovation was perceived as luxury, a risky investment which would pay off in the long term. The situation has not radically changed in the 2000s. The potential for technology and innovation to drive Russia’s productivity growth is severely limited by several factors, such as a weak regulatory environment, weak intellectual property rights protection, low levels of collaboration between public and private sectors, and inadequate technological infrastructure.

The private sector remains reluctant to innovation, however. Apart from aforementioned problems, the fundamental issue is the structure of the Russian economy. It is heavily dominated by extractive and energy industries where the potential for innovation is limited by definition. In contrast, R&D-intensive sectors such as biotechnologies and electronics are under-developed.

The problem is recognised by the Russian leadership and the utmost attention is given at the top political level. The Governmental Commission on High Technologies and Innovations was established in 2007, and since March 2010 it is headed by the Prime Minister Vladimir Putin. Two years later, in May 2009, the Commission for Modernisation of and Technological Development of Russian Economy was established; it is headed by the President Dmitry Medvedev. The Russian government started to allocate funding to innovation through a number of state corporations, such as Rosnano (nanotechnologies),

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Rosatom (nuclear technologies), Rostekhnologii (hi-tech industrial products for civilian and military purposes), etc. In February 2011 the Russian government presented a draft of the National Innovation Strategy 2020. It aims to increase the number of Russian companies conducting technological innovations up to 40-50 per cent, and for Russia to reach some 5-10 per cent of the global market of high-tech products and services.

The landmark project of the Russian president is Skolkovo innovation centre, a planned high technology business area to be built near Moscow and which is meant to become Russian Silicon Valley. The site is intended to be an ultramodern complex created to encourage technology-based companies and start-ups. The objectives are to stimulate Russian innovation system by creating a springboard to globalise Russian businesses and localise international R&D activities, facilitate development of new high-tech businesses, new high-tech products and services, and to attract foreign talents.

Despite all the energetic actions undertaken by the Russian political leadership, the actual situation remains disappointing. A vivid indication is a session of the Presidential Commission for Modernisation and Technological Development held on 31 January 2011. In the beginning of 2010, the Russian president Medvedev requested the top management of large state-owned companies to design innovation programmes and increase funding of innovation. As it turned out, only one third of companies had designed such programmes, let alone increased funding.

At the session, the president regretted poor progress in modernisation, in spite of massive investment. ‘Today we have investment and money, though not huge, for innovations projects, but still have practically no innovations’, the president stated. ‘There are very few hi-tech products which could compete at the world market’, he emphasised. The president named companies performing badly in terms of innovation, ‘There is another issue I would particularly like to address: almost none of the state-owned companies have people among their top executives specifically responsible for innovation... I won’t name companies that are doing better right now, but I will name the companies whose R&D spending is very low. … These include Rosneft, IDGC Holding, Sovkomflot, and Aeroflot. .. it’s just unacceptable. Corporations must dramatically increase R&D spending; moreover, they must work together with research centres, and this should also be an obvious step’ (Medvedev, 2011).

It shows that the heritage of the soviet administrative style is still very dominant, at least in relation to state-owned corporations. In these companies innovation is something not driven by market forces but enforced administratively, whilst the company management perceives it as a burden.

3.2. Innovation in private Russian companies

Innovation in Russia tends to be concentrated in large companies, possessing sufficient financial, human, intellectual resources for it. The strategic value of innovation and R&D in large Russian companies has been realised only recently. This phenomenon has been of limited relevance in Russia in the period of economic transition in the 1990s, when the economy was characterised by low investments in R&D. The reason is that R&D and innovation were not among the priorities of Russian companies. The main goals of most companies at that period were acquisition of state assets in controversial deals, struggle for a market share, corporate restructuring and consolidation. Investment in R&D did not generate immediate profits and therefore were considered uneconomical. The focus was on reform the enterprises to bring immediate returns through efficiency, adoption of international management practices, and imitation of technology utilised by international competitors.

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Russian companies started their internationalisation in the 2000s. While outward FDI were recorded since the early 1990s, it was rather a ‘capital flight’ than distinctively designed internationalisation strategies and establishment of a network of overseas subsidiaries. Roughly at the same time, many large Russian companies showed a growing interest in financing R&D and creation of in-house R&D departments.

International growth of some firms’ was strongly biased towards the former Soviet republics of the Commonwealth of Independent States (CIS) or Eastern European countries, yet other emerging Russian multinationals started investing in all regions (Asia, Africa and Latin America) and particularly advanced economies of Western Europe and North America. It is expected that access to western technologies and know-how has become a distinctive driver of this expansion.

Vahtra (2010) aims to depict the scope and potential impact of outward R&D-related FDI by Russian companies. The study concludes that the evidence of R&D investments by Russian companies remains notably scarce. One of the explanations is that many emerging Russian multinationals are concentrated in the low-tech and natural resource-based industries, and the share of high-tech sectors in Russian economy is marginal. Specifically, only few financial-industrial conglomerates account for significant R&D-related FDI. Moreover, even this small share of R&D-related FDI does not always prove to be successful. Skolkovo Research (2009) identifies ‘unsatisfactory knowledge transfer’ as one the six key operational challenges faced by Russian multinationals (along with inappropriate organisational structure, low brand recognition and so on).

In contrast to the EU’s Community Innovation Survey, Russian authorities do not systematically measure innovation activity of businesses. One of the latest private initiatives is a comprehensive report compiled by the New Economic School and PricewaterhouseCoopers Russia timed to the commencement of St Petersburg’s 2010 International Economic Forum. The survey provides a comprehensive account of innovation in 100 large companies, with annual turnover exceeding $ 100 million and mostly privately-owned. The survey results show that innovating companies are the largest ones, especially foreign subsidiaries and those present on the global market, i.e. Russian multinationals. Overall, in the period of 2008-2010, 39 per cent of companies introduced innovative products, 73 per cent – innovative technologies, 66 per cent – innovative business processes, as stated by the respondents. One-third of companies believe that they introduced globally innovative products, technologies and business processes (‘new to the global market’). In terms of expenditures on innovation, 64 per cent of respondents indicated ‘R&D’, 52 per cent – ‘procurement of machinery and equipment’, and 40 per cent – ‘staff training and development’. According to the survey, Russian multinational companies implement new technologies and business processes as often as international companies (subsidiaries of multinational companies operating in Russia).

While this survey is based on self-assessment and self-reflection of respondents, it is however evident that the need for innovation and breakthroughs at the global level are recognised by the leadership of Russian companies. In analysing data from Russian firms it should be noted that innovation has come to have a very broad meaning in Russia and to Russian businessmen and policy makers. Therefore it should be recognised that innovation in Russian may mean any management, operation, or production technology or technique adopted to improve efficiency of the firm.

These findings are broadly consistent with the survey among executives on the role of innovation in emerging economies of Brazil, China and India conducted by the Boston Consulting Group. Among the main conclusions are that innovation is becoming a priority in

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emerging economies, and companies’ willingness to spend on innovation and their satisfaction with the return on innovation spending are inching higher (BCG, 2010).

The actual numbers of R&D expenditures are in contrast with these intentions though. Russian multinational fall back on R&D expenditures in comparison to multinationals of other BRIC economies. In our analysis we rely on the R&D Scoreboard annually published by the UK’s Department for Business Innovation & Skills (Table 1).

Table 1 Investment in R&D by Russian companies: Global look

20062005/06

20072006/07

20082007/08

20092008/09

20102009/10

Number of global companies in the Scoreboard 1250 1400 1000 1000

Russian companies in the Scoreboard Gazprom Gazprom

Gazprom AvtoVAZ Sitronics

Gazprom Lukoil

Gazprom AvtoVAZ

Lukoil

Total R&D investment, £m 132.63 254.70 367.82 520.54 683.16

as % of sales 0.5 0.6 0.7 0.3 0.6

as % of operating profit 1.4 1.6 2.2 1.4 2.8

R&D Investment per employee, £’000 0.3 0.6 0.6 0.9 1.1

Memorandum (number of companies and total R&D investment)Brazil 3

448.023

674.815

983.483

1546.116

1263.99

China 5608.87

7765.66

9991.91

122411.73

164595.84

India 3155.08

7268.17

15751.94

7721.59

121066.02

Source: compiled from respective annual editions of the R&D Scoreboard published by the UK’s Department for Business Innovation & Skills

Among 1000-1400 (depending on the year) global companies in the Scoreboard, with the highest R&D investments, Russia is consistently represented by only one company – Gazprom. Among others, the carmaker AvtoVAZ, oil and gas producer Lukoil and the microelectronics company Sitronics. In total, the amount of R&D investment by Russian firms in the Scoreboard increased from £132.6 million in 2005/06 to £683.2 million in 2009/10. Likewise, there has been a trend in increase of these expenses as a proportion of operating profit. Nevertheless, performance remain disappointed if measured in terms of R&D intensity (R&D as a proportion of sales) which remains at 0.5-0.6 per cent. In 2009/10, this indicator stood at 3.6 per cent on average for all companies in the Scoreboard. Companies in the life sciences sector have R&D intensity as high as 10-15 per cent. An explanation, already aforementioned, is that Russian companies such Gazprom and Lukoil operate in low R&D-intensive sectors as such.

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Comparison with other emerging multinationals (from BRIC economies) is illustrative. Judged by the amount of companies in the Scoreboard and the sum of their R&D investment, there is a continuous upward trend. Chinese companies are leading – in 2009/10, 16 largest R&D spenders invested more than £4.5 billion. Chinese multinationals virtually doubled their R&D investment compare to 2008/09. On the background of other BRIC companies, performance of Russian companies is disappointing as they are clearly lagging behind.

3.3 Russian Firms Innovation to Compete with Developed Market Firms

The emergence of a middle-income country middle class in Russia has greatly expanded the market size for consumer goods. DMME rushed into the market in the 1990s and early 2000s overwhelming the domestic manufactures of consumer durables, electronics and fast moving consumer goods (and created new market segments where Soviet and Russian producers had not previously provided goods). There are some Russian firms that have been able to innovate to create products that are more affordable for the Russian consumer by making products that fit the “good enough” for local consumers

An example of a successful Russian firm in the consumer durables and electronics market is VITEK. The firm began as importer of foreign brands and had developed a clear understanding of the market place. In 1999 immediately after the financial crisis of 1998 the firm took advantage of the withdrawal of foreign brand operations in Russia to launch its own brand. Now it has over 650 models of audio, video and home appliances in 60 product categories and a network of over 350 service centres. The success VITEK can be traced to its extensive distribution network, the brand and pricing strategy, service centre geographic distribution across Russia and effective use of Russia based and outsourced manufacturing. The challenging Russia environment drove VITEK to develop a local approach to import, distribution, and after-sales services to capture the mid and low range market for appliances in the Russian market.

4. Interplay of innovation and internationalisation

In this section we aim to examine the interaction between internationalisation of Russian companies and the role of innovation in it. The literature has shown that technological resources can significantly influence the internationalisation and international activities of firms (Brock and Jaffe, 2008; Rodriguez and Rodriguez, 2005). More specifically, the interplay between internationalisation and innovation was raised by several scholars. For example, Saarenketo (2004) argues that internationalisation is compulsory for firms in some high-tech sectors that have only a few potential domestic clients. In line with this, Kafouros et al (2008) claim that firms need to be sufficiently present in several markets to capture the fruits of innovation. In other words, these authors present internationalisation as a necessary condition for innovation. Other authors, as Kylaheiko et al (2010), position innovation and internationalisation as a trade-off and classified firms according to their degrees of internationalisation and innovation.

Considering the specific context of internationalisation of Russian companies, two types of this process can be identified – ‘domestic’ and ‘global’ internationalisations. The former means entering nearby (less advanced) markets such as CIS countries. In contrast, the latter implies internationalisation to more advanced western markets. In terms of the role of innovation in internationalisation, we identify two types – innovation-driven and innovation-

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seeking internationalisation. The first type means internationalisation underpinned by strong ownership advantages in innovation. In turn, the second type means obtaining access to innovation as a strategic motive of internationalisation. These approaches are visualised in Table 2.

Table 2 Interplay between internationalisation and innovation

‘Domestic’ Internationalisation (to neighbouring markets / CIS)

‘Global’ Internationalisation (to the west)

Innovation-driven

Russian companies possess advanced technological competences and offer new innovative solutions in less advanced markets (innovation is not necessarily ‘new to the world’).

Russian companies internationalise globally using innovation as a source of competitive advantage.

Innovation-seeking

Russian companies internationalise by seeking innovation and technological competences in nearby markets.

Russian companies internationalise to acquire innovation and knowledge abroad, and compensate for the weaknesses of the Russian national innovation system.

‘Domestic’ Innovation-driven Internationalisation

‘Domestic’ innovation-driven internationalisation can be observed in CIS countries. Russian companies internationalise using products and services not necessarily new to the global market, yet new to the host country.

Russian firms in the mobile telephony industry have been very successful implementing the local optimizer strategy (Ramamurti, 2008) of creating services for low and middle income customers both in Russia and the CIS states. The examples of Vimplecom, MTS, and Megafon expansion into the ‘near abroad’ and frontier markets has been a successful strategy of apply technology solutions developed in the Russian market to these emerging and frontier markets. Vimplecom during the 2000s entered markets in Russia, Ukraine, Kazakhstan, Uzbekistan, Tajikistan, Georgia, Armenia, Kyrgyzstan, as well as Vietnam and Cambodia. MTS has similar operations in Ukraine, Uzbekistan, Turkmenistan, and Armenia and Megafon in Tajikistan, Abkhazia and South Ossetia.

Mobile telephony is a rapidly changing high technology industry with demanding customers. The markets are heavily regulated with substantial barriers to entry that must overcome through relationships with government regulators. Russian mobile phone operators have been able to partner with handset providers and producers of the cellular network technology to provide competitive networks to meet the cutting edge technology demands of its customers while providing service at reasonable cost for low to medium income customers. MTS is also owned by the Sistema holding company and partners with Sitronics on the development of new equipment and network systems.

It should be noted that the expertise, technology and innovation that drive expansion of Russian telecommunication companies to the CIS countries were originally developed in collaboration with western partners. For Russian telecommunications companies such as

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MTS and VimpelCom foreign expertise in the telecommunications sector has become indispensable for performance improvements, and they have chosen alliances and partnerships with foreign companies, technological leaders, as a way to access the latest technologies. They could not integrate any former state-owned research institutes. Both telecommunications companies were newly established and did not inherit any research institutes since such labs for mobile telephony did not exist in Soviet times. Moreover, Russian research institutes did not possess competence in the new telecommunications technologies rapidly developing in the West. Acquisition of a western company was also troublesome (as the number of such companies on the market is limited). Both MTS and VimpelCom entered in partnerships with Ericsson and other leading technology companies. Strategic alliances and partnerships serve as means for Russian firms to access technology know-how of developed market firms at a time when these firms do not have the internal R&D capacities to create the own technology advances. As Russian firms grow and internationalise it is expected that they will also follow the path of major multinationals to increase such activities to gain technology advances.

Further, CIS countries may be used as a testing ground for new innovative products or services before they are offered on a wide-scale in the home country. For example, in April 2006 a Belarusian subsidiary of a Russian telecommunications company MTS (part of the Sistema JSFC), in partnership with Siemens, launched a trial area of 3G communication network in the capital Minsk. As the trial proved to be successful, MTS announced the launch of 3G in its home market Russia in the second half of 2008, or early 2009 (in partnership with Ericsson). Similarly, with its launch in Ukraine in 2007, MTS became the first operator in the CIS region to offer Blackberry enterprise services to its subscribers. MTS intends to launch similar services back in Russia in 2008.

‘Domestic’ Innovation-Seeking Internationalisation

A somewhat less common scenario in relation to the nearby markets is the ‘domestic’ innovation-seeking internationalisation, whereby Russian companies start internationalisation from entering nearby markets and obtaining domestic innovative firms/organisations. Because generally the nearest markets possess lower technological capabilities than in the home base, Russian companies would rarely employ such strategy. It is however cannot be completely ruled out. Many Russian companies seek to re-establish their value chain in the CIS countries broken up with the collapse of the Soviet Union. In this respect, the drive of Russian companies into CIS countries can be explained not only by efficiency-seeking motives, but also by the asset-seeking ones. Several examples support this claim. Russian holding company ‘Elektrozavod’ acquired former state-owned research institute of transformer equipment in Ukraine. Likewise, OMZ (Uralmash-Izhora Group), a large Russia heavy industry and manufacturing conglomerate, acquired control over the Ukraine-based Central construction bureau ‘Korall’ (an offshore drilling platforms and crane ships designer) in 2002-2003. In both cases, these foreign R&D divisions became integrated in the corporate networks of the acquirers.

‘Global’ Innovation-Seeking Internationalisation

‘Global’ innovation-seeking internationalisation is a distinctive and very common strategy. Russian companies internationalise into advanced markets with the strategic intention to acquire advanced technology and know-how. As Dunning (2006) suggested multinationals from emerging economies might start internationalisation with advanced economies in order to improve their ownership advantages, in this case, technology base and innovativeness.

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Still, they might have a prior internationalisation experience. Below are several examples of Russian companies acquiring strategic assets in advanced economies.

In mature industries such as metals and mining emerging market firms can be viewed as ‘global-consolidators’ (Ramamurti 2008) that leverage their low-cost production FSA to acquire assets internationally. These firms have been able to utilise what Ramamurti (2008) refers to as ‘production and operational excellence’ and ‘privileged access to resources and markets’ to compete effectively with western multinationals. In the case of Russian firms that fit these criteria such as major metals firms such as Evraz Group, Novolipetsk Steel, Evraz Group, RUSAL, Servestal, and NLMK have made international investments to consolidate production and build market share, open up new markets, and to acquire new technology assets. While the metals industry has a comparative low R&D intensity (Cohen & Klepper 1992) and is not either a medium or high technology industry according to the OECD classification scheme the technology utilised by Russia-based firms significantly lagged western market EMEs in the same industry. During the commodities boom of the mid-2000s the metals market firms went on an acquiring spree to diversify the location, resource and market assets as well as self-report technology asset acquisition process to capture a greater share of the value created in the final product.

One example of a Russian company that reported the acquisition of technology related assets is Evraz Group. This multinational company employs approximately 110,000 people across four continents and has become a dominate player in steel, steel products, and vanadium. Unlike many resource based firms from Russia Evraz is based on a private firm that was a metal trading company that acquired production assets. Its expressed strategy is to develop a cost-efficient integrated mining and production manufacture of end user steel products. The firm has attempted to build on it lead in the Russia market in railway and construction steel products markets and acquired the US based Oregon Steel Mills in 2007 as means to gain access to new technology for rail production. The acquisition of the US based Claymont Steel in 2008, the Canadian based plate and pipe firm IPSCO Inc. 2008 and the Highveld Steel and Vanadium Corporation in 2007 further expanded the reach of the firm to North America and South Africa while diversify its technology base to serve the Russian market as a provider of rails to Russian Railways, construction steel to growing construction market, pipes for the oil and gas industry, and alloys for the production of medical equipment and airplanes.

The weakness in connections between the Soviet era R&D centres and production facilities has meant that Russian firms have had to look abroad for advances in technology. Also the weak inter-firm rivalry characteristic in natural resource industry and the markets for these products has not provided the competitive pressure to create new innovations in production or product development. With the cash resources that Evraz and other firms had available in the mid-2000s these firms attempted to compensation for their “unbalanced” diamond in the domestic market by acquiring firms or starting greenfield developments in competitive markets.

Other examples can be cited. For instance, the acquisition deal of Kvaerner Process Technology, a UK-based entity of the Norwegian multinational company Kvaerner ASA, by the oil company Yukos in November 2001 for €112 mln. In May 2007, the Basic Element Holding acquired a 10% stake in the German construction company Hochtief Aktiengesellschaft. Later that year, in April, Basic Element acquired a 25% stake in the Austrian construction company Strabag SE, through a subsidiary company Rasperia Trading Ltd, for € 1.05 billion.

Considering the engineering sector, the large Russian conglomerate, the Renova Group, acquired two Swiss engineering companies. Both investments are particularly important as

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they offer Renova access to new technologies that may be used on the Russian market. The first acquisition was the Swiss engineering company Sulzer AG. Sulzer’s activities include machinery, equipment, surface technology and thermal turbo machinery. Another asset is the Swiss company OC Oerlikon, the leader in the market of semiconductor and vacuum technologies, manufacturing of textile machinery and data storage technologies. Besides, the company develops innovation technologies in outer space exploration, solar energy, laser and nanotechnologies.

Acquisition of foreign assets is recorded not only in the resource-based and manufacturing sectors, examples can be found in such R&D-intensive sector as biotechnology. For example, on 18 August 2009, Human Stem-Cell Institute, Russia’s largest bank of umbilical chord blood, acquired a 25 per cent stake (€ 1 million) in Germany’s SymBioTec GmbH, a developer of treatments for cancer. The Russian company gained access to the latest biotech competences.

Not all acquisitions have been successful, and have not reached the intended results. The acquisition of LDV, a British van producer, by the GAZ Group in 2006 is illustrative. GAZ aimed to adapt the British van for emerging markets; it would allow GAZ to leapfrog the technological divide and boost its competitive advantage. However, three years later (in early 2009), GAZ abandoned its plan as it could not adapt the design of LDV’s product and it announced the intention to create a new van model on its own (Skolkovo, 2009).

CTV, a Russian equipment manufacturer acquired Silvatec, a Danish producer of forestry machines. The company intended to scale up production of Silvatec’s harvesters and forwarders, and customize them for the Russian market. As the acquirer realised, the engineering at Silvatec was done on an ad hoc basis, not as a consistent system. CTP had to bring standardisation in engineering processes; and only after that it was able to benefit from R&D capabilities of its new subsidiary (Skolkovo 2009).

These examples show that the acquisition of a technology-intensive company is only an initial step. The challenge is how to codify and benefit of the knowledge and competences embedded in a newly established subsidiary. Furthermore, the mother company should be able to receive and integrate this knowledge, in other words, it should possess a certain level of ‘absorptive capacities’.

‘Global’ Innovation-driven Internationalisation

Last but not least, it is global innovation-driven internationalisation. It is inherent to most western multinationals, entering foreign markets using their Ownership advantages that can be a unique technology or know-how. Most Russian multinationals operate in the resource-based and low-tech sectors, and it hence this scenario is hardly applicable. However, several examples can be found in the IT sector.

Russian firms that have expanded into western market in search of innovation resources are engaging in the practice of ‘global’ internationalisation as a means to rebalance their competitive resources and to gain access to R&D and know how to absorb new technologies. An example of this strategy is the Russian company Sitronics a company involved in the telecommunications industry, information technologies, system integration and consulting, and the development and production of microelectronics. Sitronics is part of the Russian conglomerate Sistema was established through the merger of the JSC NIIME & Micron and the Czech manufacturer of telecommunications equipment and software STROM Telecom. The Russian part of the firm was a privatized state concern connected to a Soviet era institute.

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This born global firm established in 2002 has been focused on the Eastern European, Eurasian and developing country markets. The firm invests heavily in R&D and out of 10,000 employees approximately 3,500 work directly on R&D activities. Its network of R&D facilities connects Russian and Ukrainian specialists with Czech, Slovak, and Greek facilities. Through this network the firm has been able to create commercially viable patents and other intellectual property.

Sitronics capitalizes on the unused and low cost research capacity in Russian and Ukrainian research centres and through private ownership and the use of modern management techniques has been able to reorganize the innovation system within the firm. The solving of the ownership problem that faces many Russian firms was accomplished through the privatisation process and then later listing on the Russian markets and then in 2007 on the London Stock Exchange. With outside investors including 17.55% in a free float and 3.07% held by EBRD the firm has outside pressure to increase shareholder returns and through EBRD advice on how to enter and be successful in the international marketplace. There are non-Russians on the board of directors and all members of the top management team either have education from abroad or have worked abroad. They also have strong links to the Russian and Eastern European telecommunications industry having served in top management teams in mobile phone operators or at competitors of Sitronics.

The R&D activities are of high priority to Sitronics and in the 2008 Annual Report the firm reported a series of research partnerships with major Russian research institutes. The R&D results for 2008 were two patents and eight patent applications pending. By combining research activities in Russia and international development and production activities Stironics has been able to overcome the institutional weakness to innovate in the Russian market. To overcome institutional rigidities inherent in the Russian business environment Sitronics was established as a separate company within the Sistema business group. Instead of in-house the development of new mobile phone technologies within MTS (Sisema’s group mobile phone provider) the founder and board of directors of the Sistema group decided to separate the R&D and high technology production into its own entity that can be transparent to remainder of the group. The adoption of different system of human resource management and incentive plan by Sitronics allowed the tailoring of the motivation of employees to the technology innovation market.

Overall Sistema is Russia’s leading consumer focused technology group. As part of its long-term corporate strategy, the company began establishing R&D centres in each of its main businesses in 2006. The centres are to engage in the development and introduction of new technologies for the operating companies in their businesses area. On the corporate level, Sistema has created a Department for Innovation Projects to identify and coordinate priority R&D projects for each business area and the corporation as a whole. This office will maintain a single database of on-going innovation projects and house a special service to ensure the corporation's intellectual property rights are protected in Russia and internationally. In 2006, the strategy was successfully implemented in the telecommunications business area, where all R&D centres were unified in a single structure, Intellect Telecom. In 2007 Intellect Telecom focused on developing R&D and technical strategies and solutions for products and services for Sistema’s telecommunications companies. Also during 2007, a concept was developed for the creation of an R&D centre for the Radar and Space business (Sistema, 2010).

Kaspersky Lab is a Russian computer security company, founded in 1997, offering anti-virus, anti-spyware, anti-spam, and anti-intrusion products. The company was founded with virtually zero investments and presently, Kaspersky Lab is a privately held company headquartered in Moscow with regional offices in India, Germany, France, the Netherlands,

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the UK, Poland, Romania, Sweden, Japan, China, South Korea, and the USA. It provides antivirus software for leading global corporations such as Microsoft, IBM and Cisco. Further, in 2010, it released technology that protects mobile devices without straining their batteries, ingeniously spreading the power burden throughout a cluster of phones that share the security system.

Another example, also in the IT sector, is ABBYY, a software company that provides optical character recognition, document capture and language software for both PC and mobile devices. The company is headquartered in Moscow and distributes its products worldwide. Its development history is virtually identical to the Silicon Valley model for advanced technology companies. A group of students at the Moscow Institute of Physics and Technology, one of the Russia’s leading research universities, got together to form a software company led by its current chairman David Yang. Their first product was Russian-English dictionary software Lingvo in 1989. Since then the company has grown by producing an ever-wider range of products. Today, ABBYY is a leading provider of document conversion, data capture and linguistic technologies, in over 130 markets worldwide. It has over 900 employees in nine offices across the world – Russia, Ukraine, Cyprus, Germany, the UK, the US, Japan and Taiwan.

5. Analysis and conclusions

The paper examined internationalisation of emerging Russian multinationals in conjunction with innovation and technology. Russia has a rich history and legacy of breakthrough inventions, and science and technology. However, with the collapse of the Soviet Union and command economy, the S&T sector suffered substantial (financial, human and intellectual) losses. Besides, the fragmentation of the S&T sector itself as well as its disconnection from business poses a great challenge for Russian firms. Russia’s potential country-specific advantage in science and technology is not easily transferred to internationalising companies.

Most Russian multinational companies operate in resource-based, low-tech sectors where the need for innovation and new product development is limited. Innovation in low-tech industry primarily takes the form of concrete problem-solving, according to customer requirements and within certain pre-defined budget constraints; that can be viewed as incremental innovation. Overall, innovation in these companies is rarely perceived as a source of competitive advantage.

In certain industries there are clear advantages that Russian firms can gain through innovations that they have developed to overcome weak institutions, operating in an economy outside of the WTO, geographic distances and climatic conditions, and other cultural factors of the Russian business environment. These innovations that have given Russian firms significant competitive advantage in their home market have been able to be extended in other emerging markets with similar institutions or business environments. In the telecommunications and natural resource sectors Russian multinationals have been able to tap into this ability to conduct “reverse innovation” to be competitive against DMME. It should be noted that the “innovations” created by Russian multinationals are not always viewed as positive as their FSA may be related to how well they can influence government decisions, clear their goods through customs, reduce the cost of labour, etc.

The interplay between internationalisation and innovation is equivocal. Innovation is used as a competitive advantage facilitating internationalisation, but only in specific sectors (such as IT and software development) and mostly in the neighbouring CIS countries. At the same

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time, innovation-seeking ‘global’ internationalisation emerges as the main form of this nexus. Russian firms increasingly acquire technology-intensive assets abroad (in advanced markets).

The market motive can be considered as the prime driver; and technology and knowledge is regarded through the in-house competencies of the target asset. Through these acquisitions, Russian companies aim to foster their innovation and technology base and execute international expansion strategy. That creates potential for positive technology and knowledge spillover effects. However, the majority of Russian multinational companies are in the resource and low-tech sectors. Therefore, the actual contribution of these acquisitions (and potential spillovers) to development of high-tech sectors and enhancement of technological capabilities remains contentious.

State support for innovation in Russia is strongly voiced. Russian leadership political consistently expresses the need to modernise the Russian economy and to diversify it away from reliance on commodities. Similarly, state-owned corporations are instructed to design and fund innovation programmes. It seems that innovation is politically imposed, and is not perceived as a source of competitive advantage for these companies.

Overall, as innovation is becoming a critical factor of firms’ competitiveness and the international expansion of emerging multinationals (including Russian firms) is on the rise, the interplay between innovation and internationalisation of companies from emerging markets will remain a promising avenue of research.

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