Whatever Happened to Russia’s Silicon Valley?

James Appell

May 7, 2015

The Short Life and Speedy Death of Russia’s Silicon Valley

In the world of tech, six years is a long, long time. In 2009, the iPad was but a twinkle in Steve Jobs’s eye; 20 percent of the mobile phones sold in the United States were made by BlackBerry; and some of 2015’s finest procrastination tools — Instagram, Snapchat, even Candy Crush Saga — were still years away from release. It was in September 2009, against the backdrop of the world economic crisis, that the then-president of Russia, Dmitry Medvedev, unveiled an ambitious modernization program for his country.

Of the world’s major economies, Russia’s had fared the worst in the aftermath of the global downturn. GDP shrank by 7.9 percent across 2009, including a record 10.9 percent in the second quarter. Unemployment hit a peak of 9.4 percent in February of that same year. Going into the crisis, oil and natural gas had accounted for some two-thirds of exports. Many had already long recognized that Russia’s dependence on commodities exports was making it vulnerable, but Medvedev was the first Russian president to actively engage with the problem.

His solution was a set of reforms, sketched out in a 4,000-word treatise titled “Go Russia!” The reforms were designed to harness technology in order to equip Russia for the 21st century, and they covered industries ranging from nuclear power to space technology to pharmaceuticals. Medvedev’s reforms called for, among other things, a 40 percent reduction in Russia’s energy consumption by 2020, and the commercial generation by 2050 of power by thermonuclear fusion.

But the portion of Go Russia! that attracted the most attention, from domestic commentators as well as foreign analysts, focused on information technology. Medvedev proposed a raft of measures to stimulate IT innovation, from e-governance to education programs to the development of a national grid of supercomputers, whose rollout would begin immediately. The jewel in the crown, announced a few months later, was to be a $4 billion innovation center on a 600-acre plot in a suburb called Skolkovo on the outskirts of Moscow — “something on the lines of Silicon Valley,” as Medvedev himself put it, which by 2020 would house up to 50,000 researchers and technologists. Skolkovo would serve as an incubator for Russia’s start-up community, offering grants, education, and office space. Little by little, Medvedev would make his country — known mostly for oil and gas production and the mining of minerals and heavy metals — an attractive place for homegrown innovation and tech entrepreneurs.

“Our country has always had an abundance of innovative, progressive, and talented people,” Medvedev said in his 2009 State of the Nation address, two months after the publication of Go Russia! “They are the pillar holding up the innovative world, and we need to do everything we can to make these specialists want to work here in their own country.”

The program was met with some skepticism at home and abroad — theEconomist, for instance, called Medvedev’s plans “implausible.” But Go Russia! appeared to get off to a good start. The Medvedev government traveled abroad to champion its new favorite industry, negotiating a partnership between Skolkovo and the Massachusetts Institute of Technology, and securing financial support from Silicon Valley luminaries, including a $100 million investment from Cisco. Start-ups began flocking to the campus: It grew from 332 resident companies in 2011, to 793 a year later, to more than a thousand by 2013. Foreign capital flooded into Russia:Yandex, Russia’s largest search engine, staged its initial public offering on the Nasdaq exchange in 2011, raising $1.3 billion — at the time the largest dot-com IPO in the United States since Google’s in 2004. The 2010 IPO on the London Stock Exchange of Mail.ru, a major Russian Internet holding comprising social networking and gaming sites, was 20 times oversubscribed, according to insiders.

Today, precious little of that buzz remains. The political will and, more importantly, the financial capacity to encourage technological innovation are gone. Gone too is Medvedev himself, these days practically invisible outside Russia and eclipsed inside it, with President Vladimir Putin firmly back in the driver’s seat. Skolkovo was raided by anti-corruption agents in April 2013, after which several figureheads on the project were accused of misappropriation of funds. Although officials deny that the investigations were politically motivated, Skolkovo has tumbled down the government’s priority list: This year, the incubator was ordered to cut costs by 20 to 40 percent.

Medvedev’s baby blues

Among the country’s tech entrepreneurs and software developers — Medvedev’s “pillar holding up the innovative world” — the mood is gloomy. Many who’d been looking to set up shop permanently in the motherland are today seeking a way out. Meanwhile, with oil prices hovering around $60 a barrel and the Russian economy in tatters, Medvedev’s push to diversify from raw material exports looks as prescient as ever.

“I know five or eight companies who either are leaving or have already left,” said Anton Gladkoborodov, co-founder of Coub, a video-sharing platform and among the most successful companies in Moscow’s nascent tech scene. “If they open the borders and let people have visas, everyone will leave.”

Nina Zavrieva, co-founder of another Moscow start-up, Channelkit, a digital management tool with similarities to Pinterest, agrees.

“I know quite a few start-ups whose founders have moved to the U.S., to New York, San Francisco,” she said. “Even Ireland — there are programs and incubators there. People are proactively looking for opportunities outside of Russia.” Both Gladkoborodov and Zavrieva are planning their own exits. Coub already has office space in New York City; Channelkit hopes to relocate to the United States toward the end of 2015. And so the dream of a Russian “Silicon Steppe” looks to have died before it even began.

Exodus of tech

Official emigration statistics are always treated with a degree of skepticism in Russia; as one tech entrepreneur explained, if you’re leaving Russia for good, you tend not to tell the authorities. But the figures available point to a national brain drain.

The first eight months of 2014 saw more Russians leaving their country of birth than in any other year since 1999, the year before Putin first entered the Kremlin. The official figure, 203,659, is an increase of 80,000 over the previous year. The number of Russians successfully applying for the U.S. green card lottery nearly doubled from 2013 to 2014. All over social media, groups have cropped up with names like “Time to Go?” that offer advice to Russians looking to relocate. Statistics specific to the tech industry are hard to come by. But Tatiana Lysenko, a spokesperson for the Palo Alto-based American Business Association of Russian-speaking Professionals said, anecdotally, that “many Russian start-up founders are seeking to move their companies to Silicon Valley,” and cases of companies leaving for new pastures are plenty.

Luka is a restaurant discovery app powered by artificial intelligence and aimed at diners in the United States — it launched with listings for San Francisco. It’s set to challenge Yelp and Foursquare and is the brainchild of a Russian team headed by Eugenia Kuyda, a former editor at one of Moscow’s most successful lifestyle magazines. Last month, Luka was accepted into the California-based start-up incubator Y Combinator and is now based in Silicon Valley. Hopes & Fears, a lifestyle website founded in Russia, opened a branch in New York this year.Meduza, a Russian-language news website, last year moved practically its entire editorial team to Riga, Latvia. And Game Insight, a successful game developer, left Moscow in April 2014 to set up a new office in the Lithuanian capital, Vilnius.

Both foreign investors and homegrown tech companies point to a shift in the political mood, which had once looked so favorable for tech after Medvedev’s modernization initiative, as a major factor pushing them out of Russia. Medvedev was a self-described tech nerd: On a 2010 presidential tour of Silicon Valley he was in his element, setting up a Twitter account for the Kremlin and receiving apersonal demo of the as-yet-unreleased iPhone 4 from Steve Jobs himself. Two years later he goofed for the camera, looking like a kid in a candy store, as heposed alongside Facebook founder Mark Zuckerberg in Moscow.

But beyond the photo opportunities, Medvedev also seemed to understand the climate of tech innovation. In Go Russia! he talked of creating not just the financial and legislative conditions for IT companies to thrive, but also the democratic freedoms and open exchange of ideas necessary to stimulate inventiveness. Medvedev wrote that he was willing to enhance “fundamental political freedoms” for the sake of reform “even if the ruling class does not necessarily like this.”

That was not simply posturing, said Zach Witlin, a Russia specialist at political-risk consultancy Eurasia Group. “The essential premise — was Medvedev genuine? — is important in the sense that we are asking whether he wanted to bring about a truly free exchange of ideas and a liberal economy,” Witlin said. “I think he was more serious about getting these things done than was generally understood at the time. He was doing more than he was given credit for … but it wasn’t visible and wasn’t enough to overcome Russia’s structural issues.”

Looking back, Witlin argues, Medvedev’s approach to creating a liberal, tech-oriented society was “conventional” by Russian standards — a government-led megaproject without any particular grassroots initiative. That left both Medvedev and the Skolkovo plan straitjacketed, reliant on support from the very system of government that he was ultimately attempting to reform. “Medvedev has proved unable to escape gravity, the structure in which he has governed,” Witlin said.

Putin’s media power play

Meanwhile, Putin’s slow squeeze on Internet freedoms since his return to the presidency puts him further at odds with the IT and web services industry. Legislation passed in 2014 that calls for all Russian Internet user data to be housed on servers on the territory of the Russian Federation paves the way, some argue, for the Kremlin’s control of the “Runet,” as the Russian-language Internet is commonly called. Bloggers with more than 3,000 daily visitors need to register with the country’s media regulator. Meanwhile, major online platforms, including software development network GitHub and video-hosting site Vimeo, have been blocked in Russia — in some cases for seemingly arbitrary reasons, for hosting what the government says is extremist or terrorist material. That security services are playing a larger role in deciding how the Internet functions in Russia isn’t exactly inviting for businesses.

“It really changes the feel and perception of where Russia’s IT sector is moving,” Eurasia Group’s Witlin said. “If you contrast that with 2009 … it’s going to become a much more tense place.”

Those in the industry also say investment capital has all but dried up after Russia’s economically turbulent 2014. As Russia’s economy contracts — GDP was reported to have fallen 2.3 percent year on year in February — and the ruble readjusts to its new valuation (some 40 percent down against the dollar from a year ago), foreign investors are treading far more carefully. A 2014report by the research firm Rye, Man & Gor Securities shows a 9 percent drop in venture funding in the second quarter of 2014, compared with the same quarter in 2013, to $127 million, 39 percent of which was provided by the Internet Initiatives Development Fund, a state-run entity.

Luxembourg-based Mangrove Capital Partners, investors in the travel-booking site Oktogo and the online apparel retailer KupiVIP, suspended their Russian operations in October 2014, according to the Russian newspaperKommersant, though they did contribute to a small venture round of $5 million for Oktogo last month. Tiger Global Management and Bessemer Venture Partners, two U.S. funds, have also scaled back their presence. Bill Browder, CEO of Hermitage Capital Management, one of the largest foreign investors into Russia in the 1990s and 2000s, but now a noted critic of the Kremlin, believes state intervention in the Internet industry and issues with rule of law are to blame.

“It takes a risk-seeking person to devote their human capital towards technology to start with,” Browder said. “But what makes Russia so untenable is that there, if you have a successful venture, there’s the risk that someone will take it away from you.”

A risky bet

Other investors point to geopolitical instability in the region as the major risk factor. “Russia’s a large market; there are reasonably well-off consumers and a qualified labor force,” said U.S.-based angel investor Fabrice Grinda, whose portfolio of investments has included Russian start-ups Wikimart and Oktogo. “[But] all of the American investors that used to back Russian companies — Tiger Global, Bessemer — have got cold feet because of the conflict in Ukraine.”

Grinda himself has pulled back in recent years. Once, Russian companies represented 10 percent of his portfolio; last year, he says, they comprised 2.5 percent. Since Russia’s annexation of Crimea “there’s been a noticeable chill,” said Bill Reichert, managing director of Silicon Valley-based Garage Technology Ventures and at one time a venture advisor at Skolkovo. “I was going over [to Russia] once a year or so, but a combination of factors … has put a chill on the openness,” he said. “I think it’s going to be winter for cross-border activity in the venture high-tech space between the U.S. and Russia for an unfortunately long time. And it breaks my heart.”

In the short term, Russia’s tech sector will find ways to move forward. Several entrepreneurs and investors cited the devaluation of the ruble as presenting opportunities, with dollar investments now stretching nearly twice as far as they did a year ago. “It’s now significantly cheaper to live and develop here,” Channelkit’s Zavrieva admitted. But for most, the long-term prospects for tech in Russia are grim indeed.

Edward Shenderovich’s family immigrated to the United States from Russia in 1990, part of the wave of 1.1 million Russians who left — largely to Israel, the United States, and Germany — between 1989 and 2000. Shenderovich is now a tech investor and founder of the New York-based venture capital firm Kite Ventures.

“Life in Russia has become more difficult,” Shenderovich said. “People don’t see themselves being able to change the situation.… Technology entrepreneurs are generally forward-looking. They are enticed by the future, and in Russia the future is murky.”

His message to those with talent who remain in Russia is blunt: “If you don’t leave Russia right now, you must be crazy.”