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Pierre Gurdjian, André Andonian, McKinsey &CompanyPresentation on Armenia 2020 Conference
Yerevan, October 25, 2003
Key Levers for Productivity Improvement in Armenia
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ARMENIA'S ECONOMY HAS RECENTLY GROWN AT HIGH RATES, HOWEVER IT STILL REMAINS WEAK BOTH IN ABSOLUTE AND RELATIVE TERMS
Nominal GDP 2002, USD billions
PPP GDP per capita 2002, USD
Real GDP CAGR1999 - 2002, percent
USAGermanyChinaIndiaRussiaTurkeyIsraelIranSingaporeRomaniaSlovenia
ParaguayAzerbaijan
GeorgiaArmeniaAverage
Source: Global Insight; EIU
36,14624,317
6,800
16,724
17,225
3,730
27,361
2,924
2,900
3,200
5,540
3,135
6,114
5,608
7.72
4.70
6.03
4.07
4.21
0.03
10.35
9.11
2.14
1.35
1.38
1.78
3.39
3.58
3.58
10,445.0
1,989.0
1,237.0
514.0
349.0
182.0102.0
91.0
88.0
45,0
21.0
5.4
6.2
3.4
2.4
8,280 4.19
3,850
Estonia
6.3 12,130 5.93
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ARMENIA'S RECENT ECONOMIC GROWTH WAS LARGELY DRIVEN BY CONSTRUCTION AND RETAIL, FUELLED BY EXTERNAL FINANCING
*Without FDI, includes remittance, grants, concessionary lending and limited capital transfers
Source:McKinsey
As a percent of GDP
USD millions
Real CAGRPercent
7.8
3.6
7.3
23.0
12.3
5.3
7.8
97
Total GDP
Agriculture
Industry
Retail and wholesale
Transport and communication
Other services
Construction1,899 1,847 1,911
2,117
2,367
1998 1999 2000 2001 2002
External financing*
23.4 23.9 23.6 18.5 14.7
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ARMENIAN EXPORT HAS GROWN SIGNIFICANTLY TOO, ALTHOUGH FROM VERY LOW STARTING LEVEL AND ON A NARROW BASE
*On a net basis, given that the industry performs only intermediate processingSource:IMF,Armenia National Statistics Service, 2002
USD millions
Real CAGRPercent
12.6
60.1
34.6
16.0
3.0
7.0
3.4
Total exportsPrecious stones and articles*Food products
Base metals
Mineral and chemical products
Other
Textile and apparel
183
161
197
247
294
1998 1999 2000 2001 2002
Exports as percent of external assistance
Exports as percent of GDP
78
15 -6.9
Machinery & equipment
9.6 8.7 10.3 11.7 12.9
41.1 36.7 43.7 63.0 84.5
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FOUR DISTINCT MODELS CAN SERVE AS DEVELOPMENT PATTERNS
• Highly educated workforce
• Large Diaspora and foreign assistance
• Investment in education and science, but
• Chronic hostility with neighbors
• High rates of immigration, requiring extensive resources for job creation
"Israel" model
• Exploration of hydro energy resources
• Centralized (dictatorial) state
• Highly informal economy and weak rule of law
• Cheap labor and high reproductive rates
"Paraguay" model
• Integration to more developed EU
• Consistent economic liberalization
• Relatively cheaper, but productive labor
• Strong driving role of the private sector
• Investment in education
• Democracy and civil development parallel to economy
"Ireland" model
• Initially cheap labor
• Extensive investment in education
• Economic liberalization
• Strong role of the centralized state
• High rates of investment in infrastructure
• Large transit trade and intermediate processing
"Singapore" model
Source:McKinsey
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ARMENIA'S PROSPERITY LEVEL IN 2020 WILL STRONGLY DEPEND ON ITS CURRENT CHOICES
PPP GDP per capita/USD
1990 1994 1998 2002 2006 2010 2014 2018 2022
3,850
2,6902,120
4,460
5
10
15
Source:McKinsey
% Real growth CAGR, 2002-2022
Singapore model: Armenia becomes an integration champion and business hub for the region
12,560
8,340
6,600
10,340
5,040
6,1
9,2707,920
6,900
5,900
Ireland model: Armenia consistently integrates with European structures, attracts increasing foreign investment4,5
Israel model: Armenia relies mainly on Russia, sees slow growth of traditional sectors and little foreign investment
5,5806,040 6,410
2,6
Paraguay model: Regional and internal instability stalls growth, some traditional sectors decline due to increasing competition
4,8605,260 5,300 5,090 4,690
0,1
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THE WELL-BEING OF ORDINARY ARMENIAN CITIZENS WILL VARY EVEN MORE PRONOUNCEDLY DEPENDING ON THE CHOSEN PATH
Average nominal monthly salary,USD
2002 2020
50
100
600
Source:McKinsey
200
400
Paraguay model: No change for better•Average people barely make their basic ends•Unemployment is pervasive, especially in rural areas•Quality of education deteriorates•Population emigrates massively
6060
Israel model: Living like in a backward Russian province•Average Armenians work in small factories and shops •Some middle class emerges, mainly in Russian-owned industries•Quality of education like in Soviet times•Best and brightest still emigrate
120120
Ireland model: Living like in Eastern Europe•Average Armenians afford buying furniture and cheap cars •Large middle class emerges, both in foreign and local companies•Quality of education moves towards European standards•Emigration is reversed
260260
Singapore model: Becoming masters of own life•Average Armenians afford modern housing conditions •Armenia becomes predominantly middle class society•Quality of education is among the best in the world •Armenians return massively from Russia
460460
4545
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Labor productivity of Armenia's economic agents will be the main
engine for wealth generation
ACHIEVING THE AMBITIOUS GROWTH TARGETS WILL BE POSSIBLE THROUGH IMPROVING PRODUCTIVITY* OF ARMENIAN COMPANIES
*Productivity is defined as total value added divided by number of employees participating in value creationSource:McKinsey
Productivity
Greater surplus
Surplus distributed
Impact on economy
• Higher demand– Lower prices– Higher salaries– Net jobs created
• Higher investments– Higher profits– Higher demand
• Higher exports– Lower unit costs– Innovative
products
• Customers (lower prices)
• Employees (higher salaries)
• Owners (higher profits)
• Higher value added
• Lower labor/ capital expenses
• Growth in company x
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DRIVERS OF UNEQUAL ECONOMIC GROWTH
Must fix but far from enough
Much less important than suggested by conventional wisdom
• Macro-political economic instability
• Poorly educated workforce• Poor infrastructure• Rigidities in labour and capital
markets• Culture and religion
By far the most important barriers to higher economic growth in all studied countries
• Poor micro-economic policies
• Unequal enforcement of micro-economic policies
Source: McKinsey global institute, findings from 30 countries
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… WHILE ACHIEVING SIGNIFICANTLY HIGHER PRODUCTIVITY WILL BE POSSIBLE THROUGH FOCUSED INITIATIVES IN PRIORITY SECTORS
Negative(-5-0% CAGR)
High(5-10% CAGR)
Sector Employment growth potential*
Low(0-5%CAGR)
High(>10%CAGR)
Re
al
pro
du
cti
vit
y g
row
th p
ote
nti
al*
Mining1
Metals 2
Telecom 3
Tourism and restaurants 4
Construction5
Banking and insurance 6
Food processing7
Textile and apparel8
Industrial machinery9
Electronics and precision 10
Construction materials11
Health care 12
Retail and wholesale13
Jewelry and diamonds 14
Transportation15
1
12
13
3
15
69
5
8
7
10
11
4214
Low(0-5% CAGR)
Medium(5-10% CAGR)
16
Software and IT Services16
2003-2010
*Compared to current employment/productivity in the sector
Source: Team analysis; World Bank; UNDP
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Sectors with highest total growth potential
… WHILE ACHIEVING SIGNIFICANTLY HIGHER PRODUCTIVITY WILL BE POSSIBLE THROUGH FOCUSED INITIATIVES IN PRIORITY SECTORS
Negative(-5-0% CAGR)
High(5-10% CAGR)
Sector Employment growth potential*
Low(0-5%CAGR)
High(>10%CAGR)
Re
al
pro
du
cti
vit
y g
row
th p
ote
nti
al*
Mining1
Metals 2
Telecom 3
Tourism and restaurants 4
Construction5
Banking and insurance 6
Food processing7
Textile and apparel8
Industrial machinery9
Electronics and precision 10
Construction materials11
Health care 12
Retail and wholesale13
Jewelry and diamonds 14
Transportation15
1
12
13
3
15
69
5
8
7
10
11
4214
Low(0-5% CAGR)
Medium(5-10% CAGR)
16
Software and IT Services16
2003-2010
*Compared to current employment/productivity in the sector
Source: Team analysis; World Bank; UNDP
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Georgia
SOFTWARE AND IT SERVICES SECTOR: GDP* SHARE – NOMINAL
2,20
1,38
3,99
2,00
0,11
0,53
1,71
0,09 0,220,01
US Germany
Ireland Israel India Russia Estonia Armenia Iran
Percent
*GDP 2002 data consistently from Global Insight
Source:US Census Bureau, RUSSOFT, NASSCOM, Enterprise Ireland, IASH, Bitkom, ANCI, ASIROS, Bilisim, Datamonitor, Sanaray, Global Insight
Turkey
8.62
Software and IT Services sectorplays important role
in Armenia's economy
Western Countries
IT high growth countries
CIS countries
Neighbor countries
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ARMENIA IS ALREADY AT A GOOD STARTING POINT FOR GROWTH IN SOFTWARE AND IT SERVICES AS PRIORITY SECTORProductivity PPP - Percent of US level
*MGI values: Germany scaled with GDP PPP = 2.06, India and Russia from in-depth MGI studies**Ireland scaled with GDP PPP = 0.84; Israel playing equally on global market with US PPP=1, Armenia: Exports at PPP = 1.5, domestic at PPP = 5.6Source:US Census Bureau, RUSSOFT, NASSCOM, Enterprise Ireland, IASH, Bitkom, Datamonitor, Global Insight, MGI
10090
180172
44 3823
US Germany* Ireland** Israel** India* Russia* Estonia Armenia**
n/a
Western countries
IT high growth countries
CIS countries
Armenia with good performance given quite young and rather
fragmented sector
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50% value proportional to salary difference
BOTH FOREIGN SUBSIDIARIES AND DOMESTIC COMPANIES ALREADY REACH GLOBALLY COMPETITIVE LEVELS OF PRODUCTIVITY
*Including Armentel monopoly**Scarcity of experienced group leaders (project management skills)***Little incentive for value maximization due to predominantly one-person-ownership structure
Source:McKinsey, Company interviews
Programmingproductivity
Product generation and marketing/ sales productivity
Productivity split
1240
820
Armenia programming productivity
Tax, admin and regulatory issues*
Process manage- ment**and staff qualification
US programming productivity
Foreign owned companies
• Only comparison of programming productivity possible (at PPP) (further value creation steps executed abroad)
1515
2010
100
1510
15
Armenia programmingproductivity
Tax, admin and regulatory issues*
Product mix (small domestic market)
Strategic manage- ment (including ownership issues***)
Brandingdiscount
US total productivity
Domestically owned companies
• Comparison of total productivity (at PPP)
Armeniaproduct generation and marketing/ salesproductivity
Process manage-ment** and staff qualification
ESTIMATES
60%
40%
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LEARNING FROM SUCCESSFUL COUNTRIES IN SOFTWARE AND IT SERVICES SHOWS FOUR COMMON KEY FACTORS FOR GROWTH
Source:NASSCOM, Enterprise Ireland, IASH, McKinsey analysis
Attractforeigninvestment
Leveragecountryadvantages
Focus on target segments
Providegovernment support
India
• MNCs build offshoring credibility and skills, e.g., TI (1983), Citibank (1985), GE Capital (1996)
• Supported by strong industry association NASSCOM
• Talent – high quality, English speaking at low-cost
• Offshoreable segments, e.g., customized application development
• Offshored business processes
• Created Software Technology Parks (with optimal infrastructure)
• Subsidizing technical education• Provided fiscal incentives• Cooperated with NASSCOM
Ireland
• Large investments by Dell (exports of1 billion) built skills and reputation
• English speaking, low- cost talent pool
• Geographical proximity to EU
• Offshored business processes
• Created IDA*, an agency for attracting and facilitating overseas investments
• Provided fiscal incentives
Israel
• Microsoft’s first international center in Israel
• High quality talent (some immigrating)
• Sophisticated demand for security systems
• Strong R&D base• Assistance by Jewish
entrepreneurs
• Security software
• Creation of three-phase funding and support mechanisms for new companies
• High spending on R&D and education
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TWO TARGET SEGMENTS HAVE BEEN IDENTIFIED AS MOST PROMISING IN THE GLOBAL EXPORT MARKET
Note:Size of bubble indicates global market size
Source:McKinsey
IT services
(Packaged) software
Attractiveness of industry segment• Global
market size• Market
growth rate• Industry
profitability
Armenia's ability to be a significant player(scale indicates "absolute" ability)• Technical skills• Customer relationship/marketing skills• Market concentration (only Packaged Software)• Language skills
Low
Low
High
2/10
17
5
22
13
4
18
9
83
12
146
7
21
15
111 19
20
16
High
IT consulting1
Systems integration2
Networking consulting and integration3
Customized applications development4
IT education and training5
Software support and implementation6
Hardware support and implementation7
IT outsourcing8
Network infrastructure management services
9
10 Processing services
Applications outsourcing11
Business Process Outsourcing (BPO) 12
Vertical business applications13
Cross industry business applications14
Consumer applications15
Information and data management16
Application design and construction tools17
Network management and security18
Systems management19
Operating systems20
Middleware and serverware 21
Embedded software22
Suggested first priority areas
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FOUR ADDITIONAL SEGMENTS ARE IDENTIFIED AS SECOND PRIORITY TARGETS
Note:Size of bubble indicates global market size
Source:McKinsey
IT services
(Packaged) software
Attractiveness of industry segment• Global
market size• Market
growth rate• Industry
profitability
Armenia's ability to be a significant player(scale indicates "absolute" ability)• Technical skills• Customer relationship/marketing skills• Market concentration (only Packaged Software)• Language skills
Low
Low
High
2/10
17
5
22
13
4
18
9
83
12
146
7
21
15
111 19
20
16
High
IT consulting1
Systems integration2
Networking consulting and integration3
Customized applications development4
IT education and training5
Software support and implementation6
Hardware support and implementation7
IT outsourcing8
Network infrastructure management services
9
10 Processing services
Applications outsourcing11
Business Process Outsourcing (BPO) 12
Vertical business applications13
Cross industry business applications14
Consumer applications15
Information and data management16
Application design and construction tools17
Network management and security18
Systems management19
Operating systems20
Middleware and serverware 21
Embedded software22
Suggested first priority areas
Potential second priority areas
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A FOCUSED GROWTH STRATEGY COULD LEAD TO REVENUE GROWTH BY THE FACTOR OF 15 BY 2020
*Over next 8 years (higher growth phase)**About 500 computer science graduates annually, assumed from current base of 400Source:McKinsey
RevenuesUSD millions
Share of GDPPercent
EmployeesThousands
Share of workforcePercent
Comments*
High growth - 3I
40238
618
1,7
5,68,9
6,2
2,6
8,0
2002 2010 2020
0,200,41 0,54
• Average annual employee increase* of ~ 450 difficultto achieve (based on about 500 computer science graduates annually**, partly working as IT specialists in other sectors)
1,7 2,9 3,9
Medium growth
2002 2010 2020
• Average annual employee increase* of ~ 230 possible to achieve, seems balanced with IT specialists required in other sectors of economy
40 103 184
2,64,4 5,3
0,20 0,30 0,35
Slow growth
2002 2010 2020
40 64 78
1,7 1,9 1,9
2,64,1 5,1
• Average annual employee increase* of ~ 200 could underutilize pool of IT specialist graduates
0,20 0,28 0,34
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Government to continue and constantly coordinate education programs for all educational levels
1
Government to become lead user of IT and provide growth enabling conditions
2
Actively attract key global player to position Armenia on global IT map
3
Set up dedicated agency to support domestic companies towards international markets
4
Associations to increase coordination and intensify communication with industry
5
Domestic companies to more actively pursue domestic and export expansion options
6
THE STRATEGY FOR SOFTWARE AND IT SERVICES SHOULD CENTER AROUND SIX KEY ELEMENTS REQUIRED FOR LONG-TERM SUCCESS
Source:McKinsey
Leverage country advantages
Attract foreign investment
Focus on target segments
Provide govern-ment support
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RECOMMENDATIONS ON ARMENIA'S GROWTH MODEL
Only "Armenia can do this"
Aspire for leadership
Export-led
Source: Team analysis
• Build your competitive position on unique strength of Armenian people, land and culture– Perseverance and excellence for new learning– Strongest tradition of arts and craft – Genuine and differentiated products and services
• Develop an export-oriented mindset– Adapt to foreign markets– Learn languages and travel– Compete globally
• Excel in the segments you chose to compete– Focus on attractive high-value niches– Measure yourself against best practices– Be open for global alliances
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