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Regular version of the site

Monitoring Development of the Intellectual Service Sector

2010

The results obtained in the course of the project show that in 2010 the sector of intellectual services started to show a positive trend.

After the downturnin 2009, most companies of the sector have recovered from the crisis (Figure 1):

Figure 1. Output of the intellectual service sector

 

Growth YoY

TOTAL

Advertizing services

Marketing services

Audit services

IT-services

Recruitment services

Engineering services

Financial services

Legal services

Development services

Design services

2009

-12.5%

-17.2%

-15.2%

-12.8%

-9.3%

-14.3%

-19.8%

-5.2%

0.1%

-17.8%

-14.3%

2010

3.2%

0.0%

2.6%

-0.6%

9.0%

4.3%

-3.9%

12.7%

9.4%

-2.3%

-0.3%

Source: surveys of intellectual service companies

 

The data in Chart 1 demonstrate that many segments of the sector posted positive growth rates. The continued output contraction is registered primarily in the construction-related companies (engineering and development). It is known that the construction industry in general has great inertia, as it was affected by the crisis more slowly than the others; but the crisis for it is more prolonged, and recovery is taking longer. Therefore, the downturn in related intellectual services will also last longer. However, the companies representing this segment are optimistic for the medium-term, noting that before the crisis, the construction industry was the most active consumer of intellectual services - in 2007, 57% of sector companies took advantage of these services. The rebound in construction is expected to bring a revival in the related segments of the intellectual service sector.

Other segments that displayed negative growth rates in 2010 (audit and industrial design) attribute their poor performance primarily to the fact that many Russian companies continue to see such services as “luxuries” - indeed, the survey showed that demand for these services  depends on income, i.e. the revenues of companies-consumers, and the value of the correlation coefficient is above average for the sector. Thus,  expenses for these services amid crisis-related output fall are the first to be reduced.

This conclusion is indirectly confirmed by the fact that the services that show the least dependence on the turnover (i.e. perceived as “vital”), suffered very little in 2009 and significantly increased in 2010. This group includes, in the first place, financial and legal services.

The results of sector monitoring show that the erosion of the policies, which were dominant before the crisis, registered in 2009,  was not overcome in 2010. In pre-crisis years, most companies had a clearly defined target strategy, while during the crisis, intellectual service providers had not yet grasped the optimum strategy. The state of strategic management in the sector is best characterized by the words of experts: “they are trying everything”. This is especially notable in the area of pricing strategies (Chart 2):

Chart 2. Quantitative characteristics of demand, 2010 on 2009

 

TOTAL

Advertizing services

Marketing services

Audit services

IT-services

Recruitment services

Engineering services

Financial services

Legal services

Development services

Design services

Change in the number of customers (+ growth,

- decline)

2.4%

-5.9%

5.9%

-1.9%

6.5%

5.3%

-8.2%

5.6%

10.3%

4.2%

-2.4%

Change in order value

(+ growth,

- decline)

0.8%

6.2%

-3.1%

1.3%

2.3%

-1.0%

4.7%

6.8%

-0.8%

-6.2%

2.2% 

Source: surveys of intellectual service companies

 

Chart 2 shows a full range of pricing strategies:

 - attempts to win over customers through lowering service prices (marketing, HR consulting, development, legal services),

- attempts to offset the contraction in actual demand volume (turnover) by rising prices for the remaining customers (gross) (audit, engineering, industrial design),

- attempts to increase revenue due to low demand elasticity (financial services).

Amid non-obvious optimal pricing strategy, companies that provide intellectual services are beginning to make greater use of non-price competition factors. We noted a significant increase in an attraction to innovative behavior. In 2010, as compared with 2009, more and more companies relied on innovations as the main way out of the crisis (Chart 3):

Chart 3. Propensity to innovate in 2010

Propensity to innovate during the crisis

2009, %

2010, %

We excluded innovations from our priorities for the crisis period

12.9

7.2

Significance of innovations for our company has subsided during the crisis

8.7

10.8

The crisis made no difference to innovation policy of our company

43.2

40.2

During the crisis, significance of innovations for our company increased

25.1

26.3

Our company considers innovations to be the main way out of the crisis

10.2

12.3

Chart 3 indicates that in 2010 as compared with 2009, propensity of intellectual service providers to innovate increased.

 

During the crisis, product innovations that are considered to be the main tool of non-price competition came to the fore. The share of innovation products in  output during the crisis is  growing rapidly (Chart 4):

Chart 4. Share of innovation products in total output of the intellectual services sector, %

Year

Share of innovation products, %

2008

9.2

2009

15.1

2010

19.9

 Source: surveys of intellectual service companies

 

The propensity to  technological innovations, which was the most important area of innovation activity before the crisis, weakened during the crisis, and in 2010 the situation didn’t change compared with 2009. Providers of intellectual services attribute this fact to the expense of technological innovations and very long (compared to other innovations) payback period.

However, it is unlikely to lead to a substantial reduction in the role of the intellectual services sector in technological modernization, as capital intensity of these services is quite low, and the main productive resource is skilled labor (accounting for 50-70% of costs). Therefore, physical capital plays a significant role only in the production of those services that are associated with a material product (engineering and IT-services). Thus the fluctuations of investment in technological innovations do not have a significant impact on the role of the sector as a whole because of the low base effect.

Organizational innovation almost lost their significance during the crisis although, according to the experts, almost all companies work in this area. This apparent paradox is resolved quite simply: organizational innovation during the crisis has been greatly downgraded for the majority of producers, as they are reduced to various cost savings (cost cutting) using the easiest ways (moving the office away from the center, lower advertising costs, payroll cuts etc.). It is clear that the significance of these activities for market success is small, although they are performed in one form or another by all providers.

Therefore, the main source of innovation activity because of the crisis became product innovations, i.e.  innovations  directed  at consumers. In this sense, the healing effect of the crisis in the sector of intellectual services is more important than for the economy as a whole - services that suffered from inefficient demand became unnecessary, and the spread of noncompetitive products  virtually ceased due to the crisis. Strengthening of  non-price competition, also stirred by the crisis, established product innovativeness as a key competitive advantage.

Apparently,  intellectual services providers are adequate in their assessment of the crisis shifts, as the level of business sentiment in 2010 compared with 2009 has increased across the market, except for the development of HR services.

Strengthening of business confidence weakened the desire for external support: in 2009, when one third of the companies acknowledged the need for direct government support, while in 2010, 42% of executives said that they need minimum state support (“it’s sufficient if the state doesn’t get in our way”). Another 22% believed that it was sufficient for the government just to create a general environment for business (intellectual property rights protection, improving legal framework etc.). And only a third of producers insisted on the need for the state’s active support for sector companies.

However, in 2011, the outlook can change for the worse. Executives of sector companies have serious concerns about the increase in payroll taxes to 34% as planned for 2011, which means for the companies using the general tax regime an increase of the payroll tax burden by 1.3 times, and for those who use simplified taxation (there is a large number of those in the intellectual services sector, especially in the legal sphere) – by more than three times. Given the fact that in the production of intellectual services, the share of value added is over 60%, and it is almost entirely produced by highly-qualified and therefore highly paid professionals, the growth of social taxes will be a significantly heavier burden than in industrial sectors where wages account for 10-12%. Intellectual services providers do not rule out that in 2011 they will have to shift the focus to such “innovations” as “gray” salary schemes and tax reporting distortions. This will not only weigh on the overall business climate in the sector, but may also undermine its innovation potential.


The project results in three articles.

1. M.E. Doroshenko. Innovative Potential of the Intellectual Services Sector in Russia. Foresight, 2011, No. 4 (forthcoming).

2. Marina Doroshenko and Dmitry Vinogradov. External Benefits from Knowledge Intensive Business Services: Evidence from Russia. In: RESER 2011 Productivity of Services Next Gen - Beyond Output / Input. Conference Proceedings. Walter Ganz, Florian Kicherer, Alexander Schletz (eds.). Hamburg: Fraunhofer IAO, 2011

3. Marina Doroshenko. How Knowledge-Intensive Business Services Upgrade their Customers: Evidence from Russia. In: Exploring Knowledge-Intensive Business Services. Ed. by Eleonora Di Maria, Roberto Grandinetti, and Barbara Di Bernardo. Palgrave, 2012 (forthcoming)

Publications:


Дорошенко М. Е. Инновационный потенциал сектора интеллектуальных услуг в России // Форсайт. 2011. Т. 5. № 4. С. 50-65.