September 19, 2013 12:08 am

Growth will depend on invention and imagination

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Skype offices in Tallin, Estonia©Eyevine

Wired for business: Skype, which has its head office in Tallinn, has a significant research presence in the Czech Republic

In communist times, smog-spewing heavy industries were the driving force of central Europe’s economies. Over the past two decades that engine has been replaced first by modern factories, largely built by foreign investors, and then by office parks filled with white collar workers.

Growth in the future is likely to come from places such as the slightly tatty building in Prague’s Smichov district, which houses Node5, a high-technology accelerator accommodating 21 new companies – many just a few months old. Inside, a fashionable fixed-wheel bike leans against a post, and small groups of people huddle around computer terminals. “Czechs are known for being amazing engineers and developers,” says Lukas Hudecek, chief executive of Node5.

Similar places are springing up across the region, catering to the growing interest of young entrepreneurs in starting up their own tech businesses. The rise of a central European start-up culture – still a pale imitation of the more developed formation of new high-tech companies in the US and the UK – is part of a broader trend across the region, as central and eastern Europe starts to put more emphasis on spurring innovation.

A large part of the economic growth of the region over the past two decades has stemmed from the marriage of cheap but highly qualified labour with modern technology imported from more advanced economies.

The result has been the success of ventures such as Volkswagen’s enormous factory on the outskirts of Bratislava, or the echoing 16 hectare Swedwood plant in northern Poland that makes furniture for Ikea shops around the world.

As salaries across the region slowly rise towards western levels, and technology advances rapidly – from replacing horses with tractors to building factories – the scope for quick catch-up growth is eroding. That means the countries of the region will have to do less copying and more inventing and creating of their own.

A deep rethink of society is required, starting with education. At present, CEE schools produce a healthy number of literate and numerate graduates, as seen by the region’s steady march up international education rankings. Indeed, the latest index of education attainment produced by Pearson, the global education group that owns the Financial Times, has Poland in 14th place, above Germany and the US. The region’s technical universities produce highly skilled engineers and programmers. It is this legacy, dating back to communist times, that inculcated Victor Kislyi with the skills to build Wargaming, one of the world’s most successful online gaming companies.

“In many ways I am a child of the Soviet education system,” he says from the headquarters of his company in Minsk. Last year, it reported €218m in revenues from a game in which players take part in online tank battles.

Many universities, however, still produce many more budding journalists, advertising specialists and sociologists than engineers. “We’re having a problem with finding the right people,” says Artur Wiza, spokesman for Asseco, a Polish IT company that is one of Europe’s largest business software providers. “If universities could train more IT specialists, we’d hire them all.”

Local universities have been reluctant to adopt the more entrepreneurial model common in the US. Central European professors still focus on publishing and staying within academia rather than co-operating with business or looking to found companies based on their own inventions.

Finance remains a problem. Most of the CEE countries spend significantly less on research and development than the EU average of 2 per cent of gross domestic product. The Czech Republic and Estonia at 1.6 per cent come reasonably close, while the likes of Bulgaria and Romania lag far behind.

How the money gets spent on R&D differs. The private sector may dominate in western Europe but, in CEE, governments take the lead, which often means funds are used less efficiently. Part of that is the legacy of past foreign investment, where companies built factories in Hungary, Poland and Slovakia, but tended to keep lucrative and highly skilled research jobs in their home countries.

That is slowly changing. Global tech companies such as Google and Samsung have built up substantial research facilities in Poland. Skype, the Microsoft-owned internet phone service developed in Estonia, has a significant research presence in the Czech Republic.

As local companies grow, they are increasing R&D spending. The bulk of research is being done by industrial companies such as Pesa, the Polish train maker, which recently won a €1.2bn contract to supply locomotives to Germany. The Czech Republic has chosen nanotechnology, while Slovakia has an incentive to focus on the car industry thanks to the auto plants that dominate its economy.

So far, IT receives a much smaller piece of overall R&D expenditure but many governments aim to boost investments by venture capital funds and to direct EU money, especially from the EU’s Jeremie programme, towards start-ups.

“This attracts a lot of criticism, sometimes for good reasons,” says Barnabas Malnay, director of Mobility and Multimedia Cluster, a non-profit Budapest events organiser. “There are a lot of very strict regulations as to how to spend that money, but it has made the whole concept of [venture capital] famous here, and [fuelled] a huge wave of enthusiasm among young people to become entrepreneurs.”

While more cash is available than before, a growing problem is the actual creativity of the start-ups themselves. Many of the incubators opening across the region are filled with teams of young programmers working on local versions of popular social networking sites such as Groupon, the daily deals company, Facebook, the social network, and yet more smartphone apps rather than coming up with original concepts.

“There are a lot of start-ups in the Czech Republic, but they are not coming up with useful ideas. They are trying to copy US projects,” says Pavel Zima, general director of Seznam, the leading internet portal in the Czech Republic.

Seznam and other IT companies such as Asseco and Techland, the games maker – both in Poland – and Czech and Slovak antivirus firms such as Eset and Avast Software trace their roots to the early 1990s. This was when the region’s workforce earned very low wages compared with their western counterparts, and markets were national and fragmented.

Janusz Filipiak, head of Comarch, a Krakow-based business IT firm, recalls paying programmers €150 a month. Nowadays, a Polish programmer can expect to earn closer to $50,000 a year – about a third of what their counterparts in California can earn, says Adam Kicinski, chief executive of CD Projekt, a Polish games maker.

The internet has eroded the advantages of having a large national market – it does not matter if a start-up is in Tallinn or Tel Aviv, the global market is the same. This helps companies from smaller countries, as they have less expectation of prospering within smaller domestic markets, while firms from larger countries such as Poland often try to grow domestically first, which can make international expansion more difficult later on.

“The region has actually produced a good number of highly successful companies that are relevant globally,” says Marcin Hejka, managing director for the region at Intel Capital, the venture capital arm of the US technology company. “If you look at the consumer internet segment, the two largest companies are both Russian – Yandex and Mail.ru. In terms of software successes, we have a number of companies that have reached or are approaching billion-dollar valuations.”

New start-ups are counting on help from the earlier generation of successful local companies, but the US and UK culture of wealthy founders offering advice and investments to a new generation of entrepreneurs has yet to take root in Prague and Warsaw.

“That American fashion of meeting and talking with young people with ideas hasn’t really taken off here,” says Pawel Marchewka, founder and chief executive of Techland.

“I had thought about it, but I’m busy with the development of our company. I haven’t seen any really innovative ideas come to me, and I haven’t really gone to incubators.”

Local start-ups often find that while they have the technical skills to create the product, their marketing, design and sales abilities are lacking, which is pushing some entrepreneurs to look for talent in the UK and the US.

The path from scrappy incubator to profitable and fast-growing business is long and tricky. Those who succeed, however, could provide the foundations for central and eastern Europe’s transition from a region reliant on cheap labour to one in which creativity and innovation will drive closer economic alignment with western Europe.

Additional reporting by Neil Buckley and Kester Eddy

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