Russian Internet: Great Potential Is Pushing Expansion

With its vast distances, highly educated population and desperate need of a modern communications system, Russia would seem the perfect place for the Internet to take hold. But while much of the Western world jumped online in the 1990's, Russia, embroiled in political turmoil and growing poverty, missed the revolution.

In the last two years, however, as the Russian economy has posted its strongest growth in almost two decades, Russian Internet companies have grown rapidly, and the number of Russian Internet users has increased more than 50 percent, to about four million.

And already, the Western model of mergers, revampings and layoffs is increasingly the rule, in part a result of the fallout from the global technology meltdown.

The Internet in Russia, known as Runet, is still in its infancy, with only 2.5 percent of the country's population online — at work, home or perhaps a cafe — at least once a week, according to the telecommunications ministry. That is less than one-tenth the portion of United States households with Internet access, according to Nielsen/Net Ratings.

This, analysts say, just means there is a lot of room for growth. Some forecasts predict that Russia will have almost 11 million Internet users, nearly 8 percent of the population, in 2003.

While Russians have access to the broader Internet, analysts say that most spend most of their time online within the Russian- language portions of the network, where e- mail addresses and Web sites are denoted by the suffix .ru —hence Runet.

Foreign investors, including Delta Capital Management, have led the way in financing the growth so far, but Russian investors have also plunged in. The Russian government is trying to help, too. The telecommunications ministry recently announced a $30 billion plan to modernize the country's telecommunications sector over the next decade, with Internet development a top priority. Half the money will come from the state; the government hopes to entice the private sector, especially foreign companies, to invest the other $15 billion.

"We welcome Russian and foreign capital, and there will be no limits on foreign investment in Russia's telecommunications sector," the telecommunications minister, Leonid Reiman, said in February.

Of course, given the country's entrenched corruption and ever-changing legal system, investing in Russia is always risky. Beyond that, analysts say, it is hard to find viable Internet projects run by capable and responsible entrepreneurs.

"Everyone in Runet dreams of doing an I.P.O. as in the West, but they believe this to mean some rich sugar daddy comes along with a bag full of dollars and that they need not be accountable for this investment," said Daniil Dougaev, an independent Internet analyst and former chief editor of the online publication, Internet.ru, which is owned by the country's leading portal, Port. ru.

Delta Capital is among Port.ru's backers. It also administers the U.S.-Russia Investment Fund, which is based in New York and was established by Congress in 1994 with $440 million of grant money for Russian ventures. Delta was part of a consortium of investors that paid $2.5 million last year for about a 9 percent stake in Port.ru; it plans to invest more in the Russian Internet industry. "Internet capacity is low in Russia; it is underdeveloped; and we believe it can only grow," said David Jones, president of Delta Capital. "Russia has been affected by the informational technology bust in America, but in the long term, we're very optimistic."

That battering of technology stocks, along with increased domestic competition, is pushing the Russian industry's major players to combine and revamp. In February, for example, Port.ru merged with a leading Internet holding company, netBridge. Shortly afterward, it laid off almost half its 170 employees and announced that it would shift its focus from developing new projects to achieving profitability and improving customer service.

Persuading users to take advantage of more Internet services has been tough. Runet users have access to the entire World Wide (news/quote) Web, but they spend most of their time surfing the free entertainment sites and sending free e-mail using Web sites and services operated by Russian companies. Although e-commerce, including business to business and other paid services, has been disappointing even in Europe and the United States, it has encountered additional obstacles in Russia.

"E-commerce and B2B virtually don't exist in Russia, totaling about $30 million annually," said Andrei Braginski, a telecommunications analyst at Renaissance Capital, an investment bank in Moscow. "Most portals and sites are not profitable but make money through advertising, which is growing, but was about $3.2 million in 2000."

Some investors think business-to-business commerce is the best bet. "Unlike in the West, where consumer Internet was a very visible part of the phenomenon, at least initially, consumer Internet in Russia is lagging behind for several reasons," said Boris Jordan, an American businessman who heads the Sputnik Group, a Moscow-based private investment company. Last year, the group created a venture through which to invest up to $50 million in high- technology enterprises.

The impediments, Mr. Jordan said, include an antiquated and overburdened telecommunications infrastructure, a lack of credit cards for online payments, expensive or unreliable delivery of goods and a small online advertising market. "Therefore, we feel that business-to-business Internet has a much better chance of becoming commercially significant."

Internet service providers have had some success luring customers by decreasing rates sometimes by almost half — unlimited monthly service can go for about $20 a month — and by allowing users to buy prepaid Internet access cards, say for 5 or 10 hours. Though the economy is growing, most people earn the equivalent of just $50 to $100 a month.

Still, Andrei Bogdanov, a senior analyst at Alfa Bank in Moscow, said: "People have underestimated the country's regions, thinking people there are too poor. But people in Russia are highly educated and want to get online and be a part of the worldwide flow of information." Alfa recently paid $110 million for a controlling stake in Golden Telecom, one of the country's largest Internet and telecommunications providers.

Indeed, the number of Internet users in Russia's far-flung regions is growing rapidly. Though Moscow and St. Petersburg, with about 12 percent of the country's population, account for 35 percent of total Internet users, that proportion is down from 50 percent a year ago.

"There is little of everything in Murmansk," Yuliya Chernova, 21, said of the Arctic Coast city where she lives. "But with the Internet, I have access to all the world can offer."