If Russia were a business…

Francisco Navarro, Director, Global Corporation Center, EY and IE Business School

26 January 2015

Russia’s setbacks are a clear example of how it is no longer possible to compete with just one product. Raising barriers to entry requires large doses of technology and added value.

" It's only a small simplification, you see, to say that Russia doesn't so much have an economy as it has an oil exporting business that subsidizes everything else"
Matt O'Brien. Washington Post. 15/12/2014

If Russia were a company, we would see, from its balance sheet, that 60% of its output is related to oil. Having such a sizeable concentration of Russia PLC’s sources of wealth center on just the one product, without any major barriers to entry, puts its competitive edge at risk. If Russia were a business, it would find competing against other companies, such as Google, Apple, and Samsung, rather hard, since these companies are very well protected by very strong barriers to entry, built around their technological development. What’s more, these companies have gone beyond the boundaries of linear knowledge, into the exponential knowledge that shapes information technology so that they are increasingly distanced from potential competitors. Similarly, countries such as the US, Germany, Japan, or Israel, have grasped that the 21st century is all about complex knowledge and technology.

Businesses (countries) that compete with low added value products have to do so based on costs. That approach has been and continues to be the preserve of countries like Venezuela, Ecuador, or Russia. Their source of income does not rely on knowledge or technology, but on being in the right place at the right time. Where was Saudi Arabia back when Lawrence of Arabia was around? What was its standing in the international economy? What about Venezuela or Nigeria? Japan, for example, doesn’t have this problem, nor does Germany since, having not been blessed with oil they were obliged to raise their technological game. The US got in on the technological act, too, since despite being rich in natural resources, they were always quite clear about the need for products or services with an added value, as a means of setting up barriers to market entry.

In the case of Russia, they have the reserves to be able to meet their debts, which means they can pay their suppliers, for now. Average maturity on external debt commitments and the debt-servicing required to maintain the system have spiraled to some $273,000 million: 75% of current foreign reserves. Unless the situation changes, in the coming year, the risk of default will increase considerably.

Russia PLC’s suppliers and customers, however, can see that, in the short term, the business doesn’t have vast reserves on which to draw, which is starting to make them nervous. This nervousness is reflected in the fall in value of their currency. Last June, the price of a barrel of Brent Crude Oil stood at $115.71, while on December 16th 2014 it was down to $58.50. This dramatic drop poses a threat to a number of oil-producing countries’ profits. If they are to balance their budgets, Venezuela needs to sell a barrel for around $160, Russia for around $110, Saudi Arabia for around $90, and Kuwait for around $50.

In Russia’s case, the fall in prices is posing a threat to the ruble. As a result, its central bank has had to increase interest rates from 10.5% to 17%, to halt the decline of its currency. To make matters worse, Russia doesn’t exactly have the best image in geopolitical terms. Its recent actions in the Crimea and the Ukraine have led to distrust of the country, which has furthermore been affected by international sanctions.

In the future, I believe that the countries that will come out on top are the ones that are the most technologically advanced, which is not the case with Russia, Venezuela or Saudi Arabia. The 21st-century world is a network of markets in which every country offers its products and services, and it is the market that dictates prices, based on the added value or magic that companies have been able to attach to their products or services. It is a game that, thus far, Apple have played very well marrying, as they do, technology and what would appear to be magic in the eyes of potential customers. It is also in this marketplace that businesses (countries) create their image and their corresponding reputation. In the 21st century, there are countries that continue to be major players on the international scene. However, we can expect to see big changes in this area, because many have failed to understand that, from here on in, Lady Luck won’t be smiling on countries with the best natural resources, but on those with the technology and the most sophisticated knowledge.
 
 

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