The Skolkovo Innovation Cluster: Russian reality or mirage?

Case Study

This case was written by Arnould P; Barthalon N; Bheemaiah K; Dhatt K; Sandey O; Sudhir K, Tripathi A, under the supervision of Professor Mark Esposito, Grenoble Ecole de Management. It is intended to be used as the basis for class discussion rather than to illustrate either effective or ineffective handling of a management situation. This case was compiled by published sources.

2012, Grenoble Ecole de Management & Lab-Center for Competitiveness. No part of this publication may be copied, stored, transmitted, reproduced or distributed in any form or medium whatsoever without the permission of the copyright owner.

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Introduction

Inthelightoftheeconomicturmoilthathasaffectedtheglobaleconomy,thereisaneedforimprovingbusinessmodelsandgovernmentalpolicies.Thisrealizationhasinstilledageneralbelief that innovation and competition are themain drivers for improving not only thenational economy but also the global economy. Encouraging ideas and allowingentrepreneurstocomeupwithnewproductsandnewwaystoperformexistingactivitiesisneeded.Enhancementscanbemadeinallspheresofaneconomywiththegoalofanequaldistribution of wealth in foresight. One way tomake headway towards this goal is thedevelopmentofclusters.

A cluster is a group of companies or institutions from a specific sector that areinterconnected geographically. The threefold effect of clusters to increase productivity,createopportunitiesforinnovationandstimulatecompetitionalsodiminishesobstaclesfornewfirmstoenter.The improvementsmadeonamicroeconomic levelbyacluster leadtomacroeconomic prosperity. As this trend is slowly finding its feet on a global scale,governmentsaretakingstepstoencouragethegrowthofclusters.A prime example of this phenomenon is the Skolkovo Innovation Center,which is beingnurturedbytheRussiangovernment inanattempttoreestablish itselfasaglobalpower.Whatsetsthisclusterapartfromotherestablishedordevelopingclustersisthefactthatitisamulticlusterencompassingfivesectors.TheinvestmentsmadebytheRussiangovernmentand a number of foreign investors are slowly establishing Skolkovo as an innovation andtechnologyhub.ThisprojectalsoreflectsRussiasdesire to transform itself fromanaturalresourcebasedeconomytoatechnologicalbasedone.However,inordertogainfurtherinsight,itwouldbeessentialtounderstandthecountry,itsobjectives, iteconomicperformanceandthereasonsleadingtothedecisionof launchingaproject of thismagnitude. This will also help us explore the feasibility of the project and thechallengesthatitmightface,amongotherthings.

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RussiasOverallBusinessEnvironmentandPolicyGeographySpreadacross9 time zones,Russia isgeographically the largestcountry in theworld. It islocatedbetweenEuropeandAsiaandmostof itspopulation isconcentrated in theareassurroundingMoscow, itscapital.Russia isboundedonthenorthandtheeastbytheArcticandPacificoceansand itborders14countriesAzerbaijan,Belarus,China,Estonia,Finland,Georgia,Kazakhstan,Latvia,Lithuania,Mongolia,NorthKorea,Norway,Poland,andUkraine.

The country has awide variety of landforms, including arctic deserts, tundra steppe andforestandboastsofawealthofnaturalresourcesincludingoilandgas.i

EthnicGroupsandLanguagesThemajority of the population is Russian by ethnicity, however, about 120minor ethnicgroupsexistandhence,over100 languagesarespoken.The largestoftheseethnicgroupsare the Tatars, Ukrainians, Chuvash Bashkir Chechens and Armenians each of theseminoritieshasoveramillionmembers.Accordingtotheconstitution,theofficiallanguageoftheRussianFederationisRussianbuttherepublicsareallowedtoestablishtheirownstatelanguages.Onlyafewoftheselanguagesaretaughtinschools.Sincethe1990stherehavebeenseveralclashesbetweencertainethnicgroupsandtherestofthecountrybecauseoftheirdesiretoobtainmoreorcompleteindependencefromRussiaiiiii.

ReligionsAlthoughthecountryhasnoofficialreligion,thetraditionalreligionsareRussianOrthodoxChristianity, Islam, Buddhism and Judaism.Of these, RussianOrthodox Christians are thelargestgroupbutinthepresentday,therearelargepopulationsofnonpracticingbelieversandnonbelievers.ivvvi

RegionalInteractionRussiahas leveragedon itssizeandpositionby formingseveralalliancesorarrangementswithitsneighbors.

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TradewithE.U:TheRussianFederationisoneofthekeytradingpartnersoftheEuropeanUnion and trade between the two economies continues to grow rapidly. The EuropeanUnionisRussiasmaintradingpartner,makingup47.1%ofitstradeincomein2010.GoodsimportsfromtheEUtoRussiaamountedto86Billionin2010whileRussiasgoodsexportstotheEU inthesameyearsummedto159Billion.RussiasexportstotheEUaremainlyenergyandmineral fuelproducts.Furthermore,75%ofFDIstocks inRussiaoriginate fromtheEUmembers,makingtheEUthemostimportantinvestorinthecountry.vii

CommonwealthofInternationalStates(CIS):TheCISisaregionalorganizationthatwas formed in 1991 andwhosemembers are 11of the countries that resulted from thebreakupoftheSovietUnion.Ratherthanserveasacustomsoreconomicunion,thepurposeoftheCIS ismore in linewithpromotingcooperation incertainareas includingtrade, legalissuesandsecurity.However,over theyears,certain firmeragreementsandorganizationshaveemergedbetweenmemberstatesviii.

CISFreeTradeArea:TheideaofafreetradezonebetweenthemembersoftheCIShasbeen around since 1994 but no firm agreementwasmade until 2011when 8 of theCISmember states (Russia,Ukraine,Belarus,Kazakhstan,Kyrgyzstan, Tajikistan,Moldova andArmenia)finallysignedtheagreementix.

State Customs Union: In July 2010, a customs union and common economic spacebetweenRussia,BelarusandKazakhstancameintoplace.Theaimofthismovewastoboosttrade and investment flows between thesemember states. Although the agreement hasbeenratifiedbythethreenations,severalunresolvedissuesrelatedtotherefusalofRussiatoremoveexportdutiesonitsoilproductsstillexistx.

In2012,Kyrgyzstanappliedto jointhisunionand it isexpectedthatthismovewill leadtoother Central Asian countries such as Tajikistan, Turkmenistan andUzbekistan to join aswellxi.

EurasianUnion (EAU): The EAU is a proposed common economic space and customsunionbetweenRussiaandthepostsovietstates.ItwillbeanextensionofthecurrentthreestateunionwithBelarusandKazakhstan.Plans for thisunion includeacommoncurrency,politicalintegrationandeconomicintegration.ThisunionisoneofthemajorprojectsofMr.

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Putin,theCurrentPrimeMinisterandPresidentElectxii.

PolicyChoicesxiiiOneofthecharacteristicsoftheRussiangovernment isthestability intermsofpolicyandleadership thathaveexistedsince1999.VladimirPutinwaselectedPresident in1999andhassincespentclosetothreetermsinpower.In2008,whenDmitryMedvedevwaselectedaspresident,heappointedPutinasPrimeMinister.Followingtheelectionsin2012,Putinissettoserveonemoretermaspresident.Thesuccessoftheregimehasbeenevidentintheprogressandstabilitythatthenationhasundergone.

KeyreformsdatingbacktowhenPutincame intopower in1999 includearestructuringofthe tax structure and property ownership rules. Business licensing and registrationprocedureshavealsobeenmademoretransparentwiththeaimofreducingthepossibilityofcorruptionoccurring.

Since the early nineties, Russia has transformed from a socialist regime to amore openeconomy. International integration is one of the strong focus points for the currentgovernmentandRussias increasedmembershipof international communities suchas theG8anditsleadingpositionintheBRICgroupareexamplesofthisfocus.InareassuchasR&Dandenergy,RussiahasformedseveralbilateralallianceswithIran,Japan,ChinaandtheUSA.Forexample, in2010,Russia initiatedanagreementaimingtoboostcooperation inenergydevelopmentintheMiddleEastandEasternSiberia.

Russiasmainexportisoilandseveralpoliciestoreducethedependenceoftheeconomyonthissingleresourcehavebeenput inplace.These includecreditsforcertainexportersandtax reforms, including tax breaks. The construction of special economic zones and tradeareashasboostedthemanufacturingandITsectorsinthecountry.TheITmarketinRussiaisnowthefastestgrowinginCentralandEasternAsia.

Duringthenineties,Russiasawanincreaseinthepovertylevelandthenumberofalcoholordrug related problems. This and the poor shape of the national healthcare system haveincitedthegovernmenttoputpoliciessuchastaxbreaksforbusinessesoperatingwithintheeducationandhealthcaresectorsinplace.

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FollowingthebreakupoftheSovietUnion,therewasareduction inthepopulationofthecountry.Toattractworkers,Russiahasafairlyrelaxedimmigrationpolicy.Thisisoneofthecontributingfactorstotheincreasedattractivenessofthecountrytoforeigninvestors.

There are certain issues revolving around the effectiveness of some of the policiesmentionedincludinghighlevelofcorruptioninstaterunagenciesandcrimeinthesociety.Astudyperformedby theWorldBank showed thatalmost80%ofbusinesses inRussiapaybribes to state agencies. Inefficiency also arises from the lack of clear allocation ofresponsibility amongst the government owned organizations, which in turn complicatescoordination.

Programstosolvethecorruptionproblemincludereformsinthelegalsectorssuchasspecialtrainingforjudgesortheprocurementoflegalassistancefromothercountries.

GeneralDiamond

1. FactorConditionsRussiahasoneofthemosteducatedpopulationsintheworldwithaliteracyrateof99.2%xiv.In addition, the university system has been undergoing several consolidation reforms inorder to weed out the substandard institutions and improve the overall quality ofeducationxv.Russiausedtoberenownedforitsstrongfocusonscienceandtechnologyandthis is reflected in the education systemxvi. However, in the area of business education,Russian institutions are considered as lacking innovation andmotivation.Many qualifiedRussian students leave thecountry to followother,betterqualitymanagementeducationprogramsxvii.

Withregardstothesizeoftheworkforce,thelenientimmigrationpoliciesinplacemakeupfortherelatively low lifeexpectancy(66.5years), lowfertilityratesandtheextremelyhighdeathrate.Russiahasthesecondhighestdeathrateintheworld.xviii

Russiahasawealthofnaturalresources.Itistheworldstopoilproducerandistheworldssecond largestoilexporter.Althoughothernatural resources includenatural gas, timber,mineralsandmetals, itcanbesaid that theeconomy isoverlydependentonoil revenuesandthismakesthecountryvulnerabletoglobaloilpricefluctuations.xix

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Historically,Russiahasbeenheavilyinvolvedinspacetechnologies,however,inthepresentage, ithas lost itsedgeand is found lacking in theareaofbasic research. Inaddition, theregistrationofpatentsislowandpiracyisrifexx.

2. DemandConditionsWith increasing regional integration including the creation of the customs union withKazakhstanandBelarusandtheproposedEurasianUnion,thesizeofthemarketaccessibletoRussia is set tocontinue increasing.ThesuccessofPutins regimeand thesurge in theglobaloilpriceshaveresultedintheemergenceofthemiddleclassinRussia.Localdemandhasbecomestrongerand tasteshavestarted tobecomemoresophisticatedascustomershavethe incometoaffordmorehighendgoodsandservices.TheGDP (PPP)percapitaofcitizenssawan increaseof83%between1999and2009.However,this increasehasbeenfairlyunequalamongstthedifferentregionsinthecountry.xxi

3. RelatedandSupportingIndustriesFollowingthebreakupoftheSovietUnion in1991,therewasa largefocusonthedefenseandmanufacturing industries.However, itwasnotuntil1999thatthese industriesevolvedtobecompetitiveonan internationalscale.Mainareasof interest includedchemicalsandpetrochemicals, metallurgical, machinery construction, transportation equipment, andshipping. Evidently, the country has built up industries to take advantage of its naturalendowments. Inaddition, someother seeminglynonrelated industrieswerecreatedwiththe aimof supportingother areas, such as themachinery industry,whichprovidesotherindustrieswiththeequipmenttheyrequiretooperate.Servicesareanupcomingareaoftheeconomy.In2009activities,includingsales,advertising,tourism,financialservicesandretail,summedupto58.4%ofthenationalGDP.

4. Structure,StrategyandRivalryRussia has emerged from a periodwhen themajority of enterpriseswere owned by thegovernment.In2003,stateownedenterprisesrepresented64%ofbusinessesbutby2006,this figurewas cut down to about 30%. State ownership is concentrated in the fuel andenergy,militaryandindustrialsectors.Therearealsosignificantlevelsofstateownershipinthemanufacturing,metallurgy,chemicalandpetrochemicalandbankingindustriesxxii.

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Accordingtothe2012DoingBusinessRankingbytheWordBank,Russiaisplaced120thoutof 183 countries in the Ease of doing business. Factors such as the large amount ofbureaucracy, tedious procedures to start businesses, difficulty in obtaining credit anddifficultywithobtainingconstructionpermitscountagainstRussia.Russiahasthepositionoflastplacewithregardstotheeaseofgettingelectricity.

Thehighlevelsofcorruptionthatexistinthecountryresultinunfairnessindoingbusiness.Inordertospeedupcertainprocesses,stateofficialshavebeenknowntoacceptbribesfromcompanies.

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AnillustrationsummarizingtheaforementionedcomponentsoftheNationalDiamond:RussiasOverallEconomicPerformanceThePostSovietUnionSincethedissolutionoftheSovietUnion,theRussianeconomyhasexperiencedtremendouschanges, transferring from a centrally planned socialist structure to a more open andintegratedmarket.During this transition, Russiawent through a time of economic chaos

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with a loss of approximately 30% of its real GDP, massive capital flights ($150 billionbetween199299)aswellasextremeratesofinflation(2000%in1992,800%in1993),whichreduced the averageRussiansdisposal incomeby25% (in real terms)xxiii.Althoughmajoreconomic reforms based on large prioritizations or price liberalizations had beenimplemented inordertomodernizetheeconomy,variouscombinedcomplications ledtoaseriousfinancialcrisisin1998.Thesalientfeaturesofthecrisisincluded:

- The failure to implement fiscal reforms to reduce the accumulation of shorttermborrowings,whichwerefinancingbudgetdeficits(reached9.8%ofGDP).

- Russias dependence on oil and other commodities to earn foreign currencies whichnegatively impacted the countrys foreign currency reserves and capacity to defend theRublewhenthesecommoditiesworldpricesplummeted.

- TheAsiancrisisthatincreasedRussianTreasuryBillprices.Thiswasduetoinvestorsfeartoholdriskyshorttermsecurities.

TheNewRussiaIn 1999, President Yeltsins low popularity and poor health, combinedwith the ongoingeconomiccrisis,forcedhimtogiveuphisseattoVladimirPutinwhoisknownforbringingbackbettereconomicconditionsandstabilitytoRussia.Overtheperiod19992008,RussiasGDP increased on average by 6.9% per year (Exhibit 1), unemployment decreased from12.6% to6.3%,andaverage realwages increasedby10.5%peryear.AdditionallyRussianexports dramatically increased by 525%, which logically improved the countrys tradesurplusxxiv.

This revivalwas partly due to Putinswill to rationalize the governments revenues andexpenditures,toimplementstructuraleconomicreforms(taxations,bankandlabormarkets)and to integrate the country within the modern global economy. Negotiations for thecountrys accession to theWTOwere kept in thebackgroundof these reforms. It is alsoimportanttonoticethatbecauseoftheboominglobalcommoditiesprices,theimportanceofnaturalresourcesintheRussianeconomyhasalsobeenoneofthemajorgrowthfactors.However, in 2008 and 2009, the global economic crisis hit the reviving country, slowingdown theongoing growth. Serious capital flightsmade theRussian stockmarket collapseandadramaticfallinglobalpricesofcommoditiesaccentuatedthenegativetrendwhichled

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Russiatohavea7.9%GDPgrowthin2009xxv.

After the crisisMeasuringRussias current economic situationon aMacroandMicroeconomiclevel:

Macroperformance:

GDP:In2011,Russiahadthe7thlargestGDPintheworld,reaching$2.38trillion,howeveritsGDPpercapitawasranked70thwith$16,700.TheRussianservicessectoraccountedfor58.9%oftheGDP,37%forthe industryand4.2%fortheagriculturesectorxxvi.Despitethecrisis,theRussianeconomybouncedbackquicklyandsawitsGDPgrowingby4.3%in2010and2011.However, forecastspredicted thatRussiasGDPs longtermannualaveragegrowthwouldremain modest due to weak institutions and declining demography. The EconomistIntelligenceUnitpredictsthatbetween2011and2030thegrowthwouldapproximatelybe3.6%xxvii. Exhibit (2) shows the contribution of GDP towards the countrys growth incomparisontoothercountries.

Inflation:

With a decline from 85% in 1998 to 9% in 2006, Russia appeared tomanage its priceinstability.However,due to rising international food andenergyprices, the inflation ratereached15% in2008xxviii.Despite adecreasing trendbetween2008 and2011 (Exhibit3),inflationremainedveryhighandevenhigher than theauthorities targetrangeof67%bytheendof2011.In2011theinflationratereached8.9%,whichwas2pointsabovethe2010inflationrate.TheIMFhasadvisedamoreflexibleexchangerate,asanimprovedmonetaryframework could contribute to lowering inflation (weakening of the currency is slowingdisinflation)xxix.

Currency:

In1998,Russia implementedafloatingruble,whichwasofficiallynotpeggedtoanyothercurrency. However, to guide its daily exchange rate policy, the Russian central bank()targeteditscurrencysexchangerateagainstits /$ currency basketxxx. However, Russian monetary policies are frequently altered

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becausetheexchangerateremainsveryvolatileduetohighfluctuationincommodityprices(e.g.oil)andthedebtcrisisinEurope.Forinstance,in2011,theRublestronglyappreciatedbecause of surging oil prices, but in the second half of 2011, due to uncertain globalattitudes,thecurrencysignificantlydepreciatedreachinganexchangerateof28.35RublesperUSdollarxxxi.

Fiscalstability:

Itisimportanttonoticethatin2009Russiasfiscalanddebtoutlookswerelesspressingthaninothereconomies,owingto lowdebtandfiscaldeficitstoGDPratios(exhibit4).In2011,despite the fact that the public debt increased to 8.7% of GDP, the fiscal outcomewasactuallypositiveas thebudget returned tosurplusesdue tohigheroilandgasprices.Thebudgetwasexecutedwithasurplusof0.4%(revenues:$382.8billion,expenditures:$376.2billion)againstadeficitof3.6%in2010xxxii.Despiteseriousfiscalconsolidation,thenonoildeficit is lesssolid. BasedontheofficialRussianamendedbudget,thenonoildeficitwassupposed to reach 11% of the GDPxxxiii. This fiscal stability and sustainability have to beperceivedwith prudence due to the countrys strong dependence on natural resources,which makes it vulnerable to fluctuations in global commodity prices. The future oilembargoeswhichwillbe imposedon IranbytheUSandEurope,however,willstrengthenthepositionofRussiaintermsofbeingasupplierofnaturalresources.

Employment:With75.41millionworkers,Russiawasranked8thintheworldin2011withregardsofthesizeofitslaborforce.In2010,9.8%ofworkerswereintheagriculturesector,27.5%intheindustrysectorand62.7%intheservicessector.Since1999,theunemploymentratehas largelydecreasedandreachedarateof6.8% in2011(Exhibit6).Theoverall labormarketsufferedduringthecrisisin2008,howeverthesituationisnowimproving.Althoughthenationalrateisacceptable,itremainsextremelyunevenataregionallevel.In2010theunemployment rate inMoscowwasclose to1.6%,andclose to2.6% inSt.Petersburg. Incontrast,insomeregions,therateremainedveryhighorincreasedduringthesameperiodforinstance,itreached49.7%theIngushrepublicxxxiv

Exhibit5:Regionswithhighestunemploymentrates,2010

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Microperformance

Trade:In2011,Russiaexportswereworth$498.6billionanditsimportswereworth$310.1billion this logicallyprovided thecountrywitha large trade surplusxxxv. Industries suchastransportation equipment, electronics, chemicals and machinery were performing well;nevertheless this performancemeasurement is largely based on a narrow product base,dominated by natural resources (mostly petroleum and gas Exhibit 7). In fact, the tradebalanceperformance is strongly linked toGlobal commodityprices.xxxvi(Exhibit8).Naturalresourcesrepresented90%ofRussianexportsin2011.

ThelackofdiversificationinRussiacanbemostlyexplainedbytwofactors:

A. Exporters incapacitytoremain inforeignmarkets:For instance,between1999and2009,only57%ofexportattemptssurvivedmorethan2years (Exhibit9),which islowerthantheperformanceofmostoftheBRICcountriesxxxvii.

B. Themodestdomesticcompetitionconstrainsthepossibleexportperformance:Thisisexplainedbyhigh levelsofstatedownedcompanies,stateaids,whichcontributetolowerproductivity.

ItisworthnotingthatRussiaisintheprocessofintegratingwiththeWTO.Itisexpectedtoratify the agreement by July 2012. Thiswould largely force the domestic companies toimprove their competitiveness, but will also provide them with more internationalopportunities.

FDI:

Even though the level of inward FDIwas very volatile during the global economic crisis,Russiahasexperiencedasteady increase in thevalueofannual inwardFDIbetween2006and 2012 (Exhibit 10). In 2010, 54% of FDI was aimed at creating projects in themanufacturing sector (e.g. automotive, chemicals, food industry and mineral products).However,significantpartoftheseprojectsconsistedofRussian flightcapitalgoingbacktothe Russian economy. For instance, foreign fund inflows accounted for $114.7 billion in2010,butFDIonlyrepresented$13.8billionofthisamountxxxviii.

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Education:

In 2008 around 8.1million studentswere enrolled in the 1108 Russian higher educationinstitutions.AlthoughRussiausuallyspendsasmallerportionof itsbudgetoneducationascompared with highincome countries, it allocates the same percentage of its GDP ascountries with similar economic development. The impact of this spending, however,producessimilaroutcomesasindevelopednations.(Exhibit11)(Exhibit12)xxxix.

GlobalCompetitiveness:

In the 20112012 Global competitiveness report, Russia was ranked 66th out of 142countries,and recentlymoved from the stage2ofdevelopment (Efficiencydriven) to thestage3(Transitiontoinnovationdriven)(Exhibit13).Howeverthecountrydropped3rankssincelastyear,whichaccordingtotheWorldEconomicForum,isduetolackofprogressinthe institutional framework (RuleofLaw,ProtectionorPropertyRights,FunctioningoftheJudiciary), thedomesticcompetition (RestrictionsonTrades, InefficientMonopolyPolicies,FewLargeCompanies)andthestabilityof itsfinancialmarkets,reduceRussiascapacitytobenefit from itsmain strengths. Indeed, it stillhas ahigh capacity for innovation (ranked38th),alargegrowingmarketsize(8th)andasolidHighereducationsystem(27th)xl.

TheSkolvovoCluster

HistoryoftheSkolkovoProject:Aftertransforming itselffromaplannedtoamarketeconomy,Russiahasenjoyedbuoyantgrowthfor2decades.The2008economiccrisisledtothecountrysfinancialsectorsufferingablow asoilprices collapsed,which led to theunderstanding that therewas aneed forgrowth inentrepreneurial industriesand lessdependenceonnaturalresources.This ledtothedevelopmentoftheSkolkovoproject.

In November 2009, the Russian government announced the creation of a new facilitydedicated to advancement of technology in a cluster within the areas of InformationTechnology, Biomedical Technology, Energy Efficient Technology, Space Technology andTelecommunications, and Nuclear Technology. To harbor this cluster, Skolkovo, a region

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approximately40minutesfromMoscow,wasselected.ByconstructinganewhighwayandupgradingtherailwaylineslinkingSkolkovotothecapital,theprojectwillbeabletoupholditsisolationfromamajoreconomiccenter,butstillremainwithinreach.

Theprojectaimedtoattractthebestscientistsfromabroadandatthesametimetopreventabraindrainofhome grown scientistsmoving abroad.Anestimated$2billionwouldberequiredforthefirstthreeyears,andthetotalestimatedcostwascalculatedtobe$6billion.Initially, thestatewouldprovide funds toprivatecompanies tohelpstartnewschemes,acommonpracticeinmostcountries.

TimelineoftheSkolkovoproject:

20094th Quarter: Dmitry Medvedev makes it known to the Russian Assembly that thegovernment intends to create a center of innovation to promote the discovery of newtechnologieswhichwouldbringtogethercompetingorganizationsandresearchinstitutions.The center was modeled on Silicon Valley in the United States. Leading businessmanVladislavSurkovistogoverntheprojectscreation.

20101stQuarter:Skolkovo is chosenas the location for theproject tobeestablished.As theprojectneededtobeconstructedinarelativelyshortperiodoftime,itwouldbeabletotakeadvantageof itsgeographicalproximitytoMoscowbybeingwithinaccessofmaterialsandthelaborforce

2ndQuarter:ViktorVekeselburg,alsoaleadingbusinessfigureisappointedasheadoftheSkolkovoInnovationCentre.ThishelpedtoestablishalinkwiththebusinessworldinRussia.3rdQuarter: For the Skolkovoproject to gain international acknowledgment,promotionandmarketingbytherightcompanywereimperative.Maxmakers Ltd., from Switzerland, are chosen to be the creators and facilitators forintelligible monitoring systems and State Unitary Enterprise. Mosgorgeotrest was the

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engineering research company chosen for surveying. The Skolkovo Innovation center isacceptedbythestate.4thQuarter:ConstructionoftheSkolkovoprojectisinitiated.AnagreementisformedwiththeFederalMigrationServicetoallowforeasierproceedingsforworkvisarequirementsforforeignnationalsworking in Skolkovo.A subdivisionof the FederalMigration ServicewascommissionedtobebasedinSkolkovoitself.Cooperation agreements were entered into with the Microsoft Company to promoteresearch in collaboration with Russian universities and with the planned SkolkovoTechnological University. Nokia would also collaborate with Russian universities withresearchand formpartof theglobal innovationnetwork.The IntelCorporation signedanagreementwhichfocusedonresearch.20111stQuarter:Amomentousoccasion for theproject,with theSkolkovo InnovationcenterbeingunveiledattheWorldEconomicForum,Switzerland.Anofficewasopened inSiliconValleycomprisingofSkolkovo,theRussianVentureCompanyandRUSNANO.

2ndQuarter:AnothermilestoneisreachedfortheprojectasTheSkolkovoOpenUniversitybeginsoperations.Theeducationsectoroftheprojectflourishesfurtherwiththesigningofan agreement between theMassachusetts Institute of Technology (MIT) to assist in thecreationoftheSkolkovo InstituteofScienceandTechnology.TheEricssonCompanywouldalso contribute towards theprojects infrastructure, research anddevelopment andworkcloselywiththeSkolkovoUniversityofTechnology.AnagreementissignedwiththeMinistryof Transport, Innovation and Technology of the Republic of Austria, enabling ties withAustrianbusinessesandeducationalfacilitiestoo.

Innovations intheareaofhealthcarearestrengthenedbyagreementsigningsbetweenthefoundationwithJohnsonandJohnsonandJanssenPharmaceuticals.Anew60millionEurosresearchfacilityistobefundedbyboththeSkolkovoprojectandSiemens

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3rd Quarter: The third quarter sees yet another milestone achieved with the SpaceTechnologies and Telecommunications cluster beginning operations. A division of theRussian Emergencies Ministry is established within Skolkovo to provide a securityinfrastructure for theproject. Further tieswithRussianMinistries included an agreementwiththeChamberofAccounts.

Cooperation agreementswere signedwith theUnited Kingdom business community andeducationaltieswereestablishedwithinthefieldofresearchwithCambridgeUniversity.

4thQuarter:TheSamararegionalgovernmententersintoanagreementwiththeSkolkovoprojectestablishingfuturetiesthatwouldbenefittheregionalongsidetheprojectitself.Thisshowsthespillovereffectthattheprojecthas.ItisannouncedthattheSkolkovoUniversityofTechnologywouldcommence in2012attracting itsworkforce fromStanfordUniversity,Harvard andMIT. The first official programwould begin in 2013with research programsstarting in2014.CiscoSystemsenters intoagreementwith theprojectat theCiscoExpo,2011,heldinMoscowtobeginitsoperationsin2012.

TheClusterToday:

ThecompaniesthatwillmakeuptheclusterarehandpickedbytheSkolkovoFoundationbyarigorousandcompetitiveprocess.The initiativenowhas422companies.Thebreakupofthese422companiesisgivenbelowxli:

ITCLUSTER BIOMEDCLUSTERENERGYCLUSTER

SPACETECHNOLOGIES&COMMUNICATION

NUCLEARTECHNOLOGIES

CLUSTER142 116 109 28 27

ITCluster:ThegoaloftheITclusteristodevelopinnovativeandstrategicpathwaysintotheITsectorinRussia. The cluster houses a wide range of diverse companies who specialize in searchsystems to advanced cloud computing systems. There are over a 100 companies in thiscluster and this number is growing.Within the framework of goal in place, threemainobjectiveshavebeenidentifiedfortheITclusterxlii:

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1)TofocustheresourcesandskillsintheITsectorToachievethisgoalanexpertboardpanelwithworld class scientists, researchers and innovatorsof the IT industryhasbeensetup.ManyMemorandumsofUnderstanding (MoUs)havebeensignedwithmajorplayersof the IT industry (CISCO,Microsoft, Intel,Nokia SiemensNetworks, Siemens andHoneywell).AlsoJointProgramsandcourseswiththetopinstitutesoftheRussianAcademyofsciences (Kotelnikov InstituteofRadioEngineeringandElectronics,Lebedev InstituteofPhysics,KeldyshInstituteofAppliedMathematicsetc)havebeeninitiated.

2)ToprovideaplatformforITinnovations

Educational contests have been arranged for children with the aim of fosteringinnovationinthem.

A joint grant program along with Microsoft to encourage startups has beendeveloped.

A global innovation competition, the I Prize, is held regularly in partnershipwithCisco

3) To develop Innovative IT systems in the vital sectors of the RussianeconomySystemssuchas theMinistryof InformationTechnologyandCommunications,Rosneft,MinistryofEducationandScience,MinistryofEconomicDevelopmentandTrade.InOctober2011,theSkolkovofoundationtook13startupstotheSiliconValleyasapartofaroadshowandtheinitiativewasamassivesuccess.TheyrangedfromavarietyofdifferentIT sectors such as location services, visual search, mobile, 3D animation, data analysis,games, New Generation Search engines, Advanced Digital image processing techniques,Mobile Applications, Advanced IT security systems, Cloud computing, IT in education,medicineandhealthcareandGreenIT.

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BiomedicalCluster:TheBiomedicalclusterinitiativeisfosteredinordertodevelopthegloballeadersinthelifesciences industry. The cluster encompasses of around 150 companies with cuttingedgetechnologiesandworldclassinfrastructurexliii.Thisclusterfocuseson4significantsectorsoftheindustry:

Clinical medicine and healthcare: The aim is to bring in innovations in thedevelopment and implementation of the Russian technologies and to gain the industrialknowhowfromabroadinareasincludingInnovativehealthcaremethods,technologiesandcustomizedmedicines.

Biomedical and life sciences: The foresight of this is to transform the Russianpharmaceutical sector froman infancy stage toanactuallydeveloped stage.Keyareasoffocusinthisregardincludeinnovativepharmaceuticalse.g.AnticancerdrugsandAntiviraldrugs.

Bioinformatics: The goal is tonurture thedevelopments in the areasof infrastructure,computingtechniques,knowledgemanagementandplanningofclinicaltrialsthroughdataanalysisandcomputersimulateddrugdesign,forexample.

Industrial biotechnologies: The purpose of this is to develop new expansions in theproduction ofmedicines, bioremediation and development ofwaste processing systems.Crucial target sectors include Bioremediation, biodegradation and ecology andenvironmentalprotection.EnergyCluster:TheEnergyclusteraimstodevelopinnovativesolutionsintheEnergysectorfocusingmainlyonreducingtheenergyconsumptionbyindustries,households,publicutilitiesandmunicipalservices. The goals of this cluster are broadly classified into two categories EnergygenerationandEnergyConsumptionxliv.

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Targetareasrelatedtoenergygeneration:

Advanced solutions for the improvement and enhancement of the disposal of thesecondaryheatfrompowerplants.

Enhancedefficiencyintherenewableenergysources. Materialsandtechnologiesfocusedondecreasingheatlossesduringenergytransfer

(superconductivitytechnologies,adaptivenetworks,energytransfersafety).

Targetareasrelatedtoenergyconsumption:

Solutions for the integrated use of energy sources and electricity including theconsumptionoftherelatedgas.

Engineeringsolutionsandmaterialsaimedatenhancingtheenergyefficiencyoftheindustry in the fields of metallurgy, oil and gas etc. and augmenting the energyefficiencyofbuildingscomprising insulation,energyefficientwindows, internal lightingwithlightdiodes,andexternallightingwithdischargelamps.

There are many key projects that are underway at present (Development of low andmedium capacitywind generators, Sewage processing operations, development of a newresearchcenter forresearchandproductionof innovativesemiconductormaterialsbasedupon thinfilm concepts). Few associates in this cluster are the Center of InnovationDevelopmentSTM,MetakonInnovationCompany,KyumodulLaboratoryLLC,OptoganLtd.,RUSAL Engineering and Technological Center, and AdvancedMagnetic Technologies andConsultation.

SpaceCluster:TheSpaceand theTelecommunicationsclusteraims toboostRussiascompetitiveedge inthe respective sectors and expected total volume is estimated to be around 300 billiondollars.TheSpaceindustryhasbeenanintegralpartofRussiaformanyyearsnowandhashad a global impact. This cluster is intended to provide the impetus for developinginnovative processes in spacecraft designs and to diversify the industry in many otherrealms.The initiative focuseson twomaindomainsSpace forEarth (SpaceApplications)

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and Earth for Space (Aerospace technologydevelopment anddiversificationof the Spaceindustry).

Thedirectionofthiscluster issplit intotwomaincategories,onebasedonPriorityandtheotherisaGeneraldirectivexlv.

Priorities:

Space Spaceprojects formissionoriented systems, Functional Space technology,InvestmentprojectsforindustrialspaceexpertiseandAerospaceprojects.

TelecommunicationsMobilecommunications, Innovativecommunicationprojects,Investmentprojectsfordevelopmentprojectsineducationandinformation.

StrategicDirectionsandPriorityAreasofDevelopmentPassedonDec62011,thisinitiativeaimsinformulatingguidelinestoensuretheclustersdirectivesaremet.

OtherDirections:

Earth to Space Space Telecommunications, Technologies and Softwaredevelopmentforspacenavigation(GPS,GLONASS),Spacetourism insuborbitsandPilotedmissionexperiments.

Earth Space Space radio electronics, R&D for rocket and space engineering,Advanced jetpropulsion techniques,Studyofhypomagneticeffectson thehumanbodyandotherbiologicalspeciesonlongrangemissions.

The New Space Economy Pilot projects in upstream segments, EURussiapartnership formodernization,BusinessProjects fororbitalandsuborbital tourismandinthefieldsofremotesensingandsatellitecommunications.

Developing a Legal Framework to govern the commercial activities in space andtelecommunications.

Someofthekeyplayers:

TheSpaceclusterhasbeenarevelationamong theSkolkovoclustergroupand thesizeoftheclusterisrapidlygrowing.ManynewimplementationsandinitiativeshavebeendevisedinordertofosterthedevelopmentoftheclusterandoneofthemwastherecentSkolkovo

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Roadshow on the Space Cluster. The show beamed in Russias partnershipwith the UKfocusingmainlyupon thehigh technology companies inRussia.PartneringwithUK SpaceAgency, RAL space and ISIC, the cluster is cultivatingmany of the local startups in theindustrytoalargeextentingatheringinnovation.

NuclearTechnologyCluster:Thisclusternotonly intendstoshapeupthenucleartechnology inRussia,butalsoaimsatcreatinginnovativebreakthroughsinthefieldanditsassociatedprocesses.DuringtheSovietUnion,nucleartechnologywascomprisedofprocessesbasedonnuclearphysics,chemicaltechnologies, fluid and thermodynamics. Over time these technologies have significantlyimproved and proved the basis formany vital creations in a variety of fields. Themostimportantbreakthroughs in this sectorhavebeen the radiationcontroland technology.Anumberofhighlyadvancedequipmentsandengineeringcreationshavebeenmaterializedupontheseconceptsinthelikesofatomicreactors,particleaccelerators,lasers,microwavetechnologies,neutrongenerators,particleand radiationdetectorsetc. In thispresentera,these technologies have been implemented not only in themilitary and the engineeringfieldsbutalsoextensively in themedical field for treatingdeadlydiseases (Cancer,MEMSbasedsurgeries)andalsointhefieldsofgeophysicsxlvi.

TheNuclearTechnologyclusteraimsinpromotingtheseaspectsofthefieldbyencouragingR&Dbypartneringwithworldleadersandqualifiedscientistsalongwiththemanystartups,whicharewithinthecluster,tocomeupwithnewscientificinnovations.

Thenuclear technology clusterwill alsohave its ramifications in noncommercial sectors,suchas:

Inradiationtechnologyintherealmofbeamacceleration. Constructionofmaterialpropertiesforecastinganddiagnosing. CreationofcompactXraylasersbasedonlaserplasmaacceleration. Virtualtechnologiesspecificallyin3Dvisualizationandsupercomputingcalculations.

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KeyPlayersInTheCluster

SkolkovoInstituteofScienceandTechnologyInstitute(SkolkovoTech)

TheaimofSkolkovoTech istocreateaclassofstudentswhocancomeupwith innovativesolutions that address the critical and vital areasof science technology and innovation inRussiaandtheworld. InJune2011,MITandSkolkovoTechannouncedthattheywouldbecollaboratingwith each other in an effort to increase international cooperation in highereducation, researchand innovation at SkolkovoTech.This3yearagreementalsoaims todevelopanewgraduateresearchuniversitybothinRussiaandtheUSinordertobreaknewgrounds in the fields of teaching, research, innovation and entrepreneurship. This is acompletelynewmodelforRussiasetupwithseveralcriticalgoalsinmindxlvii:

FosteranewenvironmentofInnovationacrossthefieldsofScienceandEngineering. Integrateanecosystemof innovationandentrepreneurshipwithintheuniversity in

bothformalandinformaleducation. Createaworldclassresearchuniversitythatcanattracttalentfromvariouscountries

apartfromRussia.

SkolkovoTech intendstooffer5Mastersand5Ph.Dprogramsspecifically inthefieldsofinteresttotheclusterInformationScienceandTechnology,EnergyScienceandTechnology,Biomedical Science and Technology, Space Science and Technology, and civilian NuclearScienceandTechnology.

15 Research centerswill be associatedwith the university, each focusing on a particularresearchmission.Thestudentsoftheuniversitycancarryouttheirresearchwork inthesecenters in their respective fields of expertise. The key partners of the clusterswill alsofeatureapartoftheirresearch inthese labs incollaborationwiththeuniversitysongoingresearchtopics.

IntellectualPropertyCenter

ThisarmoftheSkolkovoFoundationdealswith issuesofIntellectualPropertyRights inthecluster.HeadedbyVitalyKastalskiy,Managerof the IntellectualPropertyDirectorate, thefollowingaresomeoftheservicesofferedxlviii:

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ConsultingandmanagementofIPrights(IPR)ofthevariousparticipants. FilingnewapplicationsandinitiationsforIPR. Submission and management of projects to the Federal Service for Intellectual

Property,PatentsandTrademarksRegulations(Rospatent)togetpatents,copyrightsandtrademarksetc.

Managementofclaims,draftsandrefiling,includingprecontractualwork.

TheSkolkovoFoundationBoardandOtherInvestors

DmitryMedvedevheadstheBoardofTrusteesoftheSkolkovoFoundation.ThefoundationisresponsibleforallthemajordecisionsoftheSkolkovo Innovationcenteranddecidesonthekeyplayersofeachsector.TheSkolkovofoundationreceivesover50applicationseveryweekandtheboardselectstheprojectswhichareeligibleforagrant.Theselectioncriteriaare based on certain requirements to dowith the quality and intensity of the particularproject.Researchgrantsrangingbetween1.5millionRUR300millionRURaregivenouttotheparticipantsoftheclusters.Untiltoday,thefoundationhasissuednondilutivegrantsofaround6.3billionRURandhasbeensupportedbyseveralthirdpartyfinancingsourcesforanamountover4.4billionRUR.

Venturecapitalistsarethekeyplayersinthiswholeinitiativeandtheboardensuresareturnon investment for all the investors. In addition to venture capital, cofinancing programscombined with low tax rates and smooth business regulations have been developed.Additionalbenefits in the formofaccreditationsareoffered toventure capitalists this inturnallowsthemtoapplyforresidencewithinSkolkovoundercertainconditions.

Thecurrentnumberofventurecapitalists is34andthisnumber isgrowing.ThisbringsthetotalamountavailabletotheSkolkovofoundationtoover$430million.

CustomsandFinanceCompany

Skolkovosscustomsand financecompanyknownasTFKSkolkovowassetup in July2011andwasadded to theRussianFederationRegisterofCustomsRepresentativesonAugust2011.Thecompanyxlix:

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Manages the customsoperations related to the transferofgoods importedby theparticipantswithintheSkolkovoproject.

Processesdocumentsrelatedtothecustomauthorities. Consultsandassistswithrespecttocustomsrelatedissues,VATandimportcustoms

tax. Deliverstransportanddispatchservices.

ClusterDiamondAlthough the conceptof theSkolkovo cluster iswell foundedandhas received significantfinancialaidfromthegovernmentcoupledwithFDI&thirdpartycofinancing,anendeavorofthismagnitudeisboundtobefraughtwithcomplicationsintermsoftheexecutionofitsstrategy.

FirmStrategiesandRivalries:Inordertoattractandretain international intellectualcapital,theSkolkovoprojectwillbelocatedinthemiddleofafreeeconomiczoneandwillthereforebenefitfromauniquelegalframework in Russia. Since Russia is disreputable for having a legislation that hindersinnovation,RussianauthoritiesandtheSkolkovoFoundationhaveagreedonasetofrulesthat would clearly distinguish Skolkovo from the rest of Russia. Two federal laws wereadoptedonSeptember28,2010:theFederalLawNo.244FZtheSkolkovoLawandtheFederalLawNo.243FZtheLawonAmendmentsl.Provisionsofthesetwolawsdealwith:

Tax and other fiscal incentives (No VAT and corporate profits tax in the first tenyears),

Use of foreign workforce, customs regulations, regulation on land use anddevelopment,

Highereducation,healthcare,advertisingandinsurance.

However,thesettingupofaneconomiczonedoesnotonlyrequirelawsthatareconvenienttobusiness,itmustalsoensurefirmswillingtoinvestthattheirinterestswillbeprotected.ThispromptedPresidentMedvedevtoannounceanimprovementoftheRussianintellectualproperty rights law inApril2011and thecreationofan Intellectualproperty rightscenter

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withintheSkolkovoInnovationCenterli.Also,theSkolkovoregionwillbefreeoftheRussianGovernmentjurisdiction,withitsownGovernment&legislationtherebydeemingtoattractforeigninvestments.

SincetheSkolkovoproject istransforming fromtheconceptualizationphase,analyzingthecompetition among local rivals ispremature.However, analyzing the statuses of the firststartups in thisprojectandhow theywillbe supportedcanassess the scaleof the futurecompetition. In 2011, the Skolkovo Foundation selected a group of 330 startups andprovidedthemabout$190milliontohelpthemturntheirinnovativeideasintobusinesses.This example clearly highlights the fact that the local customer needs will bemet andcompetitionwithineachclusterwillbeinnovationdriven.Nevertheless,thefundingsystemof the foundation shouldprogressivelydiminish, allowing venture capitalists to step in astheyhavebeendoingintheSiliconValley.

Indeed,inthelongrun,startupsneedtobeindependentfromstatefundingandtherefore,the foundation signed an agreement with 22 major Venture Capital funds, who havecommitted themselves to provide $265million to local startups in the next five yearslii.Thus,thecompetitionwillnotonlytakeplacebetweenthebigplayersbutalsoatthestartuplevelsincethelatterwillhavetovieforfunds.

Demandconditionsforfirms:Eachclusterisexpectedtogenerateaninnovationecosystem,whichimpliesthatacompanythatbelongs toagroupofcompaniesora sectorwill find its individualbusinessactivitiesbeingaffectedbythebytheactivitiesofthewholegroup.Therefore, localdemandwillbecreatedexnihiloandshouldbecomemoreandmoresophisticatedasnewpartnershipsaresigned between the Skolkovo innovation center and themajor players of the respectiveindustries.AsparticipantcompaniesinSkolkovogenerateanorganicgrowthwiththeirownsupply anddemand, firms in the clusters should be sufficiently innovative to have needswhich firms located elsewherewill not have at the same time. Collaborationwithin theclusterswillbeofgreat importance inSkolkovoscaseliii,especiallyas thebusinessculturewillbecreatedsimultaneously.

Firmswillfinditeasiertoexchangetheirrespectiveneedsbecauseoftheirproximitytoeachother.Theconcentrationof international intellectualcapital turnsout tobeaprerequisite

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for entering into very specialized segments. The outcome of cooperation shall spur newinnovationdrivensolutionsthatwillsellathomeandabroad.For instance,thebiomedicalclusterisexpectedtoprovidesolutionsinBioinformaticswhereitwillattempttomodelbiomolecular structures to design drugsliv and in industrial Biotech where it will focus onindustrialdrugproductiontechnologieslv.

A great clout will be given to entrepreneurs in the form of grants from the Skolkovofoundation,especiallyforthosewithbreakthroughinnovations.Inthe20112013period,$1billion are to be given to startups selected by the Skolkovo foundationlvi. Thus the localdemandforinnovativesolutionsshallremainstrongovertime.

RelatedandSupportingIndustries:Each ecosystem thatwill be created by the associated clusterwill utilize local suppliers.ExpertsspecifictoeachclusterwillselectallthemembersoftheSkolkovoInnovationcenter.Therefore,thisprocessofselectionallowstobettermeettheneedsofthecompaniesthatare already a part of the project. As of April 2012, 422 companies have committedthemselves to theSkolkovo innovationCenter:116 in theBiomedicine technologycluster,109 in the Energy efficient technology cluster, 142 in the IT cluster, 28 in the Spacetechnologyclusterand27inthenucleartechnologycluster.Highernumbersofapplicationswouldmostlikelyleadtothepresenceofhighlyinnovativecompaniesoperatingwithintheclusters. Considering the number of applications received (50 each week), Skolkovoscredibility is increasing and thus is bound to attract some of the most innovative andaccomplishedcompaniesaroundtheworld.

Theinterconnectionbetweenthe5majorclusterswillcreatesubclusters.Forinstance,theIT clusterwill be useful inmanaging the residential and social infrastructurewithin theSkolkovo Township. Similarly the Energy efficient technology cluster would turn theeconomyintoaGreenEconomywithnewinnovationsthatleadtosmarter&lowerEnergyconsumption. The nuclear technology clusterwill serve themilitary purposes aswell asmedical purposes. Indeed, in order to treat certain diseases, there has been a growingdemandforradiation&laserdiagnostics.Thus,thebiomedicalclusterwillbeintandemwiththenuclearclustertosuchpurposes.

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FactorConditions:Large companies are willing to invest in Skolkovo because of the idea of bringing theirresearcheffortsclosertotheirpotentialproductandservicemarkets.Thepotentialofthisproject in terms of human resources, capital resources, physical infrastructure,administrative infrastructure, information infrastructure and scientific and technologicalinfrastructureisindeedappealingandinvestorfriendly.

Forthispurpose,abrandnewcitywiththeSkolkovoInnovationCenterhasbeenbuiltinthesuburbs of Moscow offering modern physical infrastructure. Along with, an urbandevelopment firm, Siemens has aided to build this city by applying sophisticatedconstruction methodologies and relying on energy efficient solutionslvii. The SkolkovofoundationisinchargeofalltheadministrativetasksoftheSkolkovoInnovationCenter.

IdentificationofStrategicIssuesAndConstructingPartsOfTheDiamond:

1)ContextforfirmstrategyrivalryThecurrentinvestmentmodelcanposeathreattotheSkolkovoinnovationcenterbecauseitisessentiallydependentonthefundsoftheRussiangovernment.Inordertofosterarisktaking culture as in the Silicon Valley, the goal of the center should be to becomeindependent of state funding and should support a market approach to innovation.EntrepreneursknownfordynamicinnovationsareslowlygrowinginnumberintheSkolkovoinnovationcenter.ObserversexplainthisfactbythelackofentrepreneurcultureandskillsinRussia. The Russian government supports the startups through the funds given by theSkolkovo foundation.Thisapproachto innovation isclosertoatopdownapproachthanabottomupapproachwhichadvocatesanorganicgrowth.Theproblemliesinthefactthatitdoesnotprepare startups to the scenario inwhich theonly sourceof funding isventurecapitalists. The role of the government is pivotal at the early stage of development ofclusters, however no communication has been made around the transition from statefundingtoprivatefundingandwhethertheRussiangovernmentexpectsanyfinancialreturnfrom the grants given to companies so far. Therefore, this may be deemed as unfaircompetitionforventurecapitaliststhatexpectafinancialrewardforeach investmenttheymake.

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2)Factorconditions:In theearlystageof theSkolkovo innovationcenter,attractingWorldclassdignitariesandtalented nonresident Russians in the field of Science & Technology will be the mainchallenges in terms of human capital.According to independent reports, 80 000 Russianscientists leftthecountryshortlyaftertheendofthecoldwar.Duringhisterm,PresidentMedvedevreceivedanopen letterfromRussianscientistswhohavemigratedtowarnhimabout thisbraindrainand theeventualdeathof science inRussia if the current situationremains unchangedlviii. Therefore, even if prominent foreign scientists agree to join theSkolkovoinnovationcenter,therewilllikelybeaninitialshortageoflocalscientistscapableofbuildingontheideasofforeignresearchersandscientists.

Thesettingupofaneducationalsystemthatcanmeetthedemandoflocalandforeignfirmscan be deemed the second challenge that the Skolkovo foundation needs to take intoconsideration.TheSoviet legacy intermsofhighereducationdidnotfit inwellthemarketeconomy,mainly because of a difference in ideals: initiative, competition, autonomy andresponsibilitylix.However,aseriesofeducationalreformshavebeenundertakensince2001and improvements have been made in the following fields: institutional organization,infrastructure, personnel policy, content standards, educational system and qualityassessment.

Theinformationinfrastructurewillhavetobeastransparentaspossible,sothattheRussiangovernmentshallnothaveanycontrolonthe flowof informationrelativetotheSkolkovoinnovation center.This isofgreatconcern forpotential investorswhowillhave toobtainreliable informationwhen decidingwhether or not to invest in the Skolkovo innovationcenter.

The issue of capital flight needs to be addressed as foreign firms and the Russiangovernmentcantbetheonlyonesto invest intheclusters.Venturecapitalist investmentsneedtobeencouragedandmeasurestodosohavebeensuccessfulintheshortrun.

3)Relatedandsupportingindustries:Several innovation ecosystems are supposed to coexist in the new city of Skolkovo.Althoughthereareclearexamplesofhowsomeclusterscanbecomplementary(Forex.the

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IT cluster integratedwith all the other clusters), severalquestions need to be answered:Should therebeaprioritizationof theclusters in termsof financing?Howcan therebeabetterintegrationoftheclusters?HowimportantisthespaceclusterforthemodernizationfortheRussianeconomy?Towhichextentcanconfidentialactivitiessuchasthedefense&militaryprojectsof thenuclearclusterbeopen to foreign scientistsandcompanies?Howcan the Skolkovo foundation retain companies after the VAT and corporate profits taxexemptionperiodends?lx

4)Demandconditions:AnimportantissuetoconsiderinthecaseoftheSkolkovoinnovationcenteristheabsenceofclaritywhen itcomes tocommercial issues.Althoughanarrayofpartnersandprojectshavebeen inplacewithin the clusters, it remainsunclearonhow the findingsof variousinnovationswould be translated into products and how firmswill collaboratewith eachother to launch such innovative products and solutions. There has been hardly anycommunicationbetweenthefirmsinvolvedinthefiveclustersuptilldateandmostpartnershave signed to run projects on their own based on the negotiations with the Skolkovofoundation.

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TheSkolkovofoundationwantsthe5clusterstobecompetitiveonaglobalscaleandatthesame time to help modernize the local economy. This means that a local demand forproductsoftheSkolkovoinnovationcentermustemergeandinturn,triggeraselfsustainedgrowth tocreateaneconomicdevelopment.Thegrowthshouldnotonlybe fueledby the

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government demand but also by private companies and individuals who believe in thequalityof theproducts& services from theSkolkovo Innovationcenterandalso from theparticipantswithinthecluster.

RecommendationsfortheSkolkovoClusterBasedonthefactsthatwehaveexploredinthecluster,ouranalysisregardingthesituationinRussia,thescopeoftheprojectandtheglobaltrendofinnovation,wehavecomeupwiththefollowingrecommendations.Asthedifferentiatingfactorwithrespecttothevariousrecommendationsistimebased,therecommendationshavebeencategorizedintolongtermandshorttermrecommendations.Longterm:

1. FosteringLocalCompetitionandForeignCompetition:In order for the cluster to grow and have a dynamic effect on the economy, localcompetition has to be increased within the economy. The arrival of foreign firms willdefinitely improve thenatureof competitivenesswithinRussia,but it isvital for the localfirmstogrowfirstandcompeteinordertoavoidbeingtakenoverbyforeignfirms.

Onepossiblewaytoaddressthisissueisbycapitalizingonthecountryslargemarketsize.Alargemarketsizeraisesproductivityasitenablesbusinessestorealizeeconomiesofscale.Alargemarket sizehas alsoother advantages, inparticularhigher attractiveness to foreigninvestors, which brings many spillover effects such as transfer of management andtechnologicalknowhow.Bybringinginmoreoutsidecompetitors,localcompetitionandtheforeigncompetitioncanbeincreasedatthesametime.Onewayoffacilitatingthistransitionis to reduce export tariffs. Taxation distorts competition and disincentivizes investment.This isaproblemfacedbyRussianexporters.Russiascoreshighwhen itsexporttariffsarecomparedwithother countries (5.7percent, corresponding to the102nd rankoutof125countries).Inaddition,joiningtheWTOwillenablethecountrytoreducethesebarriersandfurtherdevelopexports.

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2. CapitalizingOnTheCISFreeTradeAgreement.Buildingupfromtheabovepoint,onewayoffurtherincreasingthemarketcap,istobenefitwiththeCIStradeagreement.ApointtobetakenintoconsiderationisthefactthattheCISpossessesnominalpowers intheareasoftrade, finance, lawmakingandsecurity. IfRussiacanrecognizetheopportunityinvolved,thenextstepasanimprovementtotheCIScanbemadewithrespecttoIPRandthushelpingpromotedomesticentrepreneurship.Forthistooccur,theDumahastopasslegislationintermsofimprovingthestructureoftheCIStoonethat resembles thatof the EU.By copying this framework, there couldbe an increase inRussiaspowers and at the same time, theunionwillbemademore legitimate as itwillinvolvemore countries.Thiswill in turn increase trade, foster theexchangeof ideas andbolster innovation and entrepreneurship. Thus the Skolkovo mindset will no longer berestricted tooneparticularareabutcanbeseen todevelopandbranchout intodifferentsectorsofbusiness.

The EU regulations that can be adapted to Russia include the antimonopoly regulation,industrial regulation and trade regulation. There aremany limitationswith regulations inRussia,oftenassociatedwithalackoftotallegislationtheimportationofthebestEuropeanUnionlegalpracticeswouldallowsignificantprogressinaddressingtheseissues.

Stepstobetakentoaidinthisdirectionwouldbe:

DirectcontactbetweenRussianandEuropeanbusinessandpublicorganizations Moredirect interaction amongEU agencies (governmentbodies), and theEU as a

whole,withfederalauthoritiesinRussia.

3. PrivatizedBankingSectorinSkolkovo:OneideaworthconsideringisdevelopingabankingsectorinSkolkovo.Thiscouldconsistofsubsidiaries or branches, branches thatwould be able to deliver services tailored to theneedsofentrepreneurs.Similaritiescanbedrawnwiththecurrentbankingsituationnoticedin theUS.Reasons foradopting thisoutlookare twofold.Firstly if studentsor innovatorscomeupwithentrepreneurialideastheywishtopursue,byhavinglocalizedaccesstofundsatreduced interestrates,theycanhavetheresourcestopursueanddeveloponthe idea.

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Thiswillhelpboostinnovationeveninsmallsizedprojects.Inaddition,theRussianfinancialandbanking sector is inefficient in termsofavailabilityaswellasaffordabilityof financialservices, having a ranking of 92nd and 109th, respectively. Therefore, Skolkovo canwelcomeforeignbankstowork incollaborationwith localbanks.Thisgivesthe localbankscompetition, increasesthepossibilityofmergers, increasestheconsumercapofthebanksandultimatelyprovidestheentrepreneurseasieraccesstofundsthatwillpushinnovation.

4. SkolkovoandTheRussianMilitary:Forthelastfewyears,armiesaroundtheworldhavebeendownsizingtheirtroopswiththeaimofreducingspending.ThisisevidencedbycasessuchasthesharingofaNavybetweentheUKandtheincreasinglystringententryrequirementstoenlistinmostEuropeanarmies.The trendbeingnoticed is thatmilitariesacross theworldaregettingmore sophisticatedwithgreaterdependenceonsmartwarfareandtechnologies,ratherthanonpersonnel.

Russia isnoexceptiontothistrend.With its largeexpenditureonthecountrysmilitary, interms of share of GDP, Russias expenditure on the procurement ofweapons, scientificresearchandthetestingofmilitaryequipmentfornationaldefenselagsbehindonlytothatoftheUnitedStates.

Skolkovocouldcapitalizeon thisbystarting toconsider tying innovativeprojectswith thecountrysmilitaryindustrialsector.Historyhastaughtusthatdemandfornationalsecuritycreates increaseddemand for resultsofboth fundamentalandapplied science,aswellashightechproduction.Theseareintertwinedwithstimulatinginnovation.ItshouldbenotedthatthiswouldallowSkolkovoaccessto funds fromthissectoraswell.Furthermore,withthe largenumberof foreign investors and theendof animosities, further cementedwithpeace treaties and trade agreements, the threat of hostility is drastically reduced. It isbelievedthatamovementinthisdirectionwillalsoallowdefenselogisticcompaniessuchasAssaultandEADStoconsiderSkolkovo,thusattractingmoreinvestors.

5. BoostingEntrepreneurship:Russianeedstopromotedomesticentrepreneurshipsothat localbusinesscansupporttheforeign firms and act as local suppliers. Instilling trust in local entrepreneurs, that theirbusinessandideasarelegallyprotectednotonlyinSkolkovobutalsoinRussia,isthewaytogo.Thisshallbejustoneofthemanystepsthatneedtobetakentoimproveitsrankingin

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theEaseofdoingbusiness index. Inaddition, thegovernmentneeds toreducered tapeand shoulddo itsbest tobolsterdomestic companiesand integrate themwith themajorfirms thatmakeSkolkovo theirnewhome in thecomingyears.This integrates the foreignfirms better in the business ecosystem, develops domestic business scenario and alsoincreases the exit cost for the foreign firms forcing them to stayput even in the faceofeconomicadversity.

6. UtilizingtheSkilledWorkforce:Russiahasoneofthebesteducatedpopulationsintheworldwithalmost100%literacyrate.However, the productivity of this educated work force has reduced drastically over thedecades.TherehasbarelybeenanygroundbreakingresearchortechnologicalimprovementinRussia,whichwasonceperceivedasoneofthemosttechnologicallyadvancedcountriesin direct competition with the USA. To give the Skolkovo cluster a jumpstart, thegovernmentisattractingforeignresearchersandlaureatesbyprovidingthemheftybenefits.Butnotmany topnotch scientistswouldbewilling to come toRussia for something thatlookspromisingotherissuessuchasadjustmentissuesandculturaldifferencesmayhindertheirlongtermstayinthecountry.Thus,theaimshouldbetofosterhomegrowntalentinthe long run. The government should therefore provide incentives to low earning youngindividualstoenterintobothbusinessandtechnicaleducationsotheycancontributetothegrowingneedofskilled labor inthecluster.Peoplewithonlyabachelordegreeshouldbegiven incentives topursuemastersdegreesand theneitherchoose toworkorenter intoresearch.Further,onewaytoattractworldclassscientistsisbycollaboratingwithbignamesintheeducation industry,andprovidingthem incentivestochooseRussiaovertheirhomecountrytoconductresearchin.

7. InvestmentModelSelection:TheSkolkovoprojecthasbeen subject to criticismby thepressandmediabecauseof itsinvestmentmodel.Severalarticleshavebeenpublishedciting that thecurrent investmentmodelemployedbythegovernment is inappropriateand ismoreofatopdownapproachfrom the government. This allegedly undermines the role of investment bankers in thedevelopmentofthecluster.Webegtodifferonthisallegationandbelievethattogetthecluster up and running it is appropriate to adopt a topdown approach in the short run.Although, eventually in the longer run the government needs to step back and slowly

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introduce the investmentbankers in themix. This shallwelcomemore andmore foreigninvestmentinthelongerrun.

8. ImprovingPublicHealthcare:Russiahaspretty low lifeexpectancyrateduetoalcoholismandthefragilities in itshealthinfrastructure.Russiashouldinvestinimprovingpublichealthandshouldtrytodeveloptheinfrastructureforthesameandshouldaimatprovidingbettermedicalaidtoallitscitizens.Bydoingso,itisnotonlytakinggoodcareofitscitizensbutisalsoprovidingbettervalueformoneyforinvestors.

ShortTerm

9. ReducingTheEconomicDisproportionAndHighUnemploymentRate:Russia suffers with a high economic diversity with more than a 40% difference inunemploymentrateindifferentpartsofthecountry.Onewayofapproachingthissituationis by increasing the powers and the legality of the CIS. This way we can offer moreopportunitiestothoseunemployed.The factthatthere isacommonlyspoken language isalreadyaplus.

Another point to be considered is that despite the positive development over the pastdecade,thegapbetweenRussiaandOECDeconomies intermsofGDPpercapitaremainssizeable, amounting to about 47 percent. Although some structural factorssuch asdemography, the employment structure, and the number of hoursworked per persondonate toclosing thegap, the largedifference inprosperity isattributed todifferences inlaborproductivity.According to theWorldEconomicForum, laborproductivity inRussia isless thanhalf thevalueachievedbyworkers intheOECDmemberstates.Stepsshouldbetaken to address this issue. A work ethicmodelmore similar to European orWesterncountriescanbeadoptedbyorganizations inorder to realize theweakpointsof the localpractices.Amixofthe localandforeignpracticescouldthen leadtothecreationofanewworkmindsetmoretailoredtotheRussianculture.

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10. MisuseOfSkilledLabor:Thereductionofthemanufacturingsectorsisaprocessthatmosttransitioneconomieshaveundergone. However, the decline of Russianmanufacturing beyond the initial transitionperiod isaworrying trend.While thenumberof jobs inmanufacturinghasdeclined,employment in the government sector has grown. This indicates that the government ispartaking in the redistribution of resources rather than creation of value. It is of vitalimportanceforthegovernmenttorealizetheimpendinglimitationitiscreatingbyfollowingthispath.Onewayofsolvingthisproblemwouldbetousetheirhighlyeducatedworkforce.Therearemorequalifiedpeople inRussiathantheotherBRICcountries.ThisgivesthemahighpotentialfordevelopingR&Dactivitiesandhighendmanufacturingandservicesectors.Hence the regime should focusmoreon theseareasandprovide jobs in these sectors inordertodiversifyandavoidthecurrenttrenddecliningvaluecreation.

Also a number of studies show that thewaning inmanufacturing sectors is due to thecombinationofanincreaseinrealwagesandinadequaciesofthebusinessclimate.ThisputsRussiaatadisadvantageinternationally.AlthoughproductivityinthecountryishigherthaninIndiaandChina,highRussiansalariesmeanthatforeachdollarofwage,aRussianworkeryieldshalftheoutputofhis/herpeers.ByadoptingCompetitivenessenhancingreformsasstated above,willhelp advance thebusinessenvironment, increaseefficiency, andutilizemanufacturingoutputbetterwithinternationalwageproductivityratios.

11. ReducingTheLanguageBarrierThelanguagecanbeabarriertoattractingforeigninvestorsandhumanresourceintoRussiaconsideringthefactthatmanystatesareallowedtohavetheirownregionallanguages.Thisshallnotbeaproblemaslongasthereisoneofficiallanguage,preferablyEnglish.AsofnowRussianistheofficiallanguageandRussianisnotamongoneofthemostpopularlanguagesin theworld. (ranked8th/10most spoken languages in theworld;Russian 146million)lxiThustheGovernmentshouldincludemandatoryEnglishlessonsfromjuniorschooltoensurethat all citizens have a sound knowledge of the most global language. Further it isunderstandable if Russia wants to keep Russian as their official language tomaintain auniquenational identity. Insuchcasetheyshouldworkwithtwoofficial languagesRussianandEnglishtobemorecompetitiveonaglobalscale.

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12. LeveragingOnItsOilReserves:Russiashouldrealizeitsbargainingpowerintermsofoilreserves,whichitcurrentlyexportsheftily,majorlytotheEU,tofundalionsshareofthegovernmentsexpenditures.Russiaisthebiggestexporterofmineralfuels,distilledproductsandoil intheworld.Lookingatthecurrentstateofworldaffairs,thisaspectisofastoundingimportanceforRussia.InJanuary2012,theEUagreedtolevyanoilembargoonIranwhichcomesintoeffectfromJuly2012.Thisbanwas approved in the lightof an allegation that Iran isbuildingnuclearweaponswhich it intends touse in thenear future. Thus,Russianowhaseven greaterbargainingpowerandcanuse itsoilreservesasa leveragingtool inordertostrikedealswiththeEUand the US to further invest in the Skolkovo project. This could be in the form of newtechnologies to help increase the oil extraction process fromwells or bywelcoming oilcompaniesbasedintheEU/UStomakeinvestmentsinSkolkovo.Although,Russiaisobligedto selloilandenergy to someEUnationsaspartof theEuropeanUnionRussiaCommonSpaces agreement it should bargain to export less and rather invite EU based firms toestablishproductioninSkolkovoandusetheenergylocally.

13. ROI:There is a lack of clarity regarding the returns the governmentmightwant on its initialinvestment into various new projects within Skolkovo. This is discouraging manyentrepreneursfrom investingorsharingtheir ideasopenly.Thus,thegovernmentneedstobemoretransparentinitsapproachintheshortrun.

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EXHIBITS

Exhibit1 19922008AnnualGrowthofRealRussianGDP(in%)Source:CRSconstructedfromdatabytheEconomistIntelligenceUnitExhibit2 ContributiontoGDPGrowth

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Exhibit3 RussiaInflationExhibit4 PublicDebtComparisons

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Exhibit5: UnemploymentRatesWithinRussia

Exhibit6:19992010:RussianMonthlyUnemploymentRateDynamics

,

Source: World Bank estimates based on Rosstat data.

Figure 1.8: Unemployment Hotspots: Regions with highest unemployment rates, 2010, in percent

Sources: Rosstat, World Bank staff calculations.

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Exhibit7: OilandGasDominateRussiasExportsSource: TheWorld Bank : Russian Federation: Export Diversification through competition and innovation:Overview.April2012

Exhibit8 OilPricesandTheTradeBalance

Source: CBR and World Bank staff estimates.

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Gas

Other exports

Petroleum

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Exhibit9: BRICExportRelationships

0.2

.4

.6

.8

1

0 5 10Analysis Time

Russia BrazilChina India

Survival Rate 1999-2008

Source: TheWorld Bank : Russian Federation: Export Diversification through competition and innovation:Overview.April2012

Exhibit10: RussiasPositioninTheGlobalEconomy

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Exhibit11: OECDPartnersBasedOnEducationExpendituresExhibit12 RussiasPublicSpendingonEducation

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Exhibit13: GlobalCompetitivenessIndex

Source:WorldEconomicForum:TheglobalcompetitivenessReport20112011Exhibit14: Summaryofthemulticluster

Source:http://themoscownews.com/infographics/20110829/188975599.html

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Exhibit15: SkolkovoValueChain

Source:http://www.kooperationinternational.de/fileadmin/cluster/moskau/Skolkovo_Sitnikov_USRBC.pptExhibit16: SkolkovoDevelopmentMasterPlan

Source:http://www.kooperationinternational.de/fileadmin/cluster/moskau/Skolkovo_Sitnikov_USRBC.ppt

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Exhibit17: Foresights

Source:http://www.sk.ru/Model/AboutFund/Clusters/BioMed.aspx

Exhibit18: InvestorsinTheBMTClusterinSkolkovo

Source:http://www.sk.ru/Model/AboutFund/Clusters/BioMed.aspx

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Exhibit19:NuclearClusterPriorities

Source:http://www.sk.ru/Model/AboutFund/Clusters/NuclearTechnology.aspx

Exhibit20:MapofRussia

Source:CIAFactbook

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