Armenia2020 Presentation McKinsey Productivity

Armenia2020_presentation_Yerevan

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Pierre Gurdjian, André Andonian, McKinsey &CompanyPresentation on Armenia 2020 Conference

Yerevan, October 25, 2003

Key Levers for Productivity Improvement in Armenia


2

ARMENIA'S ECONOMY HAS RECENTLY GROWN AT HIGH RATES, HOWEVER IT STILL REMAINS WEAK BOTH IN ABSOLUTE AND RELATIVE TERMS

Nominal GDP 2002, USD billions

PPP GDP per capita 2002, USD

Real GDP CAGR1999 - 2002, percent

USAGermanyChinaIndiaRussiaTurkeyIsraelIranSingaporeRomaniaSlovenia

ParaguayAzerbaijan

GeorgiaArmeniaAverage

Source: Global Insight; EIU

36,14624,317

6,800

16,724

17,225

3,730

27,361

2,924

2,900

3,200

5,540

3,135

6,114

5,608

7.72

4.70

6.03

4.07

4.21

0.03

10.35

9.11

2.14

1.35

1.38

1.78

3.39

3.58

3.58

10,445.0

1,989.0

1,237.0

514.0

349.0

182.0102.0

91.0

88.0

45,0

21.0

5.4

6.2

3.4

2.4

8,280 4.19

3,850

Estonia

6.3 12,130 5.93


3

ARMENIA'S RECENT ECONOMIC GROWTH WAS LARGELY DRIVEN BY CONSTRUCTION AND RETAIL, FUELLED BY EXTERNAL FINANCING

*Without FDI, includes remittance, grants, concessionary lending and limited capital transfers

Source:McKinsey

As a percent of GDP

USD millions

Real CAGRPercent

7.8

3.6

7.3

23.0

12.3

5.3

7.8

97

Total GDP

Agriculture

Industry

Retail and wholesale

Transport and communication

Other services

Construction1,899 1,847 1,911

2,117

2,367

1998 1999 2000 2001 2002

External financing*

23.4 23.9 23.6 18.5 14.7


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ARMENIAN EXPORT HAS GROWN SIGNIFICANTLY TOO, ALTHOUGH FROM VERY LOW STARTING LEVEL AND ON A NARROW BASE

*On a net basis, given that the industry performs only intermediate processingSource:IMF,Armenia National Statistics Service, 2002

USD millions

Real CAGRPercent

12.6

60.1

34.6

16.0

3.0

7.0

3.4

Total exportsPrecious stones and articles*Food products

Base metals

Mineral and chemical products

Other

Textile and apparel

183

161

197

247

294

1998 1999 2000 2001 2002

Exports as percent of external assistance

Exports as percent of GDP

78

15 -6.9

Machinery & equipment

9.6 8.7 10.3 11.7 12.9

41.1 36.7 43.7 63.0 84.5


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FOUR DISTINCT MODELS CAN SERVE AS DEVELOPMENT PATTERNS

• Highly educated workforce

• Large Diaspora and foreign assistance

• Investment in education and science, but

• Chronic hostility with neighbors

• High rates of immigration, requiring extensive resources for job creation

"Israel" model

• Exploration of hydro energy resources

• Centralized (dictatorial) state

• Highly informal economy and weak rule of law

• Cheap labor and high reproductive rates

"Paraguay" model

• Integration to more developed EU

• Consistent economic liberalization

• Relatively cheaper, but productive labor

• Strong driving role of the private sector

• Investment in education

• Democracy and civil development parallel to economy

"Ireland" model

• Initially cheap labor

• Extensive investment in education

• Economic liberalization

• Strong role of the centralized state

• High rates of investment in infrastructure

• Large transit trade and intermediate processing

"Singapore" model

Source:McKinsey


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ARMENIA'S PROSPERITY LEVEL IN 2020 WILL STRONGLY DEPEND ON ITS CURRENT CHOICES

PPP GDP per capita/USD

1990 1994 1998 2002 2006 2010 2014 2018 2022

3,850

2,6902,120

4,460

5

10

15

Source:McKinsey

% Real growth CAGR, 2002-2022

Singapore model: Armenia becomes an integration champion and business hub for the region

12,560

8,340

6,600

10,340

5,040

6,1

9,2707,920

6,900

5,900

Ireland model: Armenia consistently integrates with European structures, attracts increasing foreign investment4,5

Israel model: Armenia relies mainly on Russia, sees slow growth of traditional sectors and little foreign investment

5,5806,040 6,410

2,6

Paraguay model: Regional and internal instability stalls growth, some traditional sectors decline due to increasing competition

4,8605,260 5,300 5,090 4,690

0,1


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THE WELL-BEING OF ORDINARY ARMENIAN CITIZENS WILL VARY EVEN MORE PRONOUNCEDLY DEPENDING ON THE CHOSEN PATH

Average nominal monthly salary,USD

2002 2020

50

100

600

Source:McKinsey

200

400

Paraguay model: No change for better•Average people barely make their basic ends•Unemployment is pervasive, especially in rural areas•Quality of education deteriorates•Population emigrates massively

6060

Israel model: Living like in a backward Russian province•Average Armenians work in small factories and shops •Some middle class emerges, mainly in Russian-owned industries•Quality of education like in Soviet times•Best and brightest still emigrate

120120

Ireland model: Living like in Eastern Europe•Average Armenians afford buying furniture and cheap cars •Large middle class emerges, both in foreign and local companies•Quality of education moves towards European standards•Emigration is reversed

260260

Singapore model: Becoming masters of own life•Average Armenians afford modern housing conditions •Armenia becomes predominantly middle class society•Quality of education is among the best in the world •Armenians return massively from Russia

460460

4545


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Labor productivity of Armenia's economic agents will be the main

engine for wealth generation

ACHIEVING THE AMBITIOUS GROWTH TARGETS WILL BE POSSIBLE THROUGH IMPROVING PRODUCTIVITY* OF ARMENIAN COMPANIES

*Productivity is defined as total value added divided by number of employees participating in value creationSource:McKinsey

Productivity

Greater surplus

Surplus distributed

Impact on economy

• Higher demand– Lower prices– Higher salaries– Net jobs created

• Higher investments– Higher profits– Higher demand

• Higher exports– Lower unit costs– Innovative

products

• Customers (lower prices)

• Employees (higher salaries)

• Owners (higher profits)

• Higher value added

• Lower labor/ capital expenses

• Growth in company x


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DRIVERS OF UNEQUAL ECONOMIC GROWTH

Must fix but far from enough

Much less important than suggested by conventional wisdom

• Macro-political economic instability

• Poorly educated workforce• Poor infrastructure• Rigidities in labour and capital

markets• Culture and religion

By far the most important barriers to higher economic growth in all studied countries

• Poor micro-economic policies

• Unequal enforcement of micro-economic policies

Source: McKinsey global institute, findings from 30 countries


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… WHILE ACHIEVING SIGNIFICANTLY HIGHER PRODUCTIVITY WILL BE POSSIBLE THROUGH FOCUSED INITIATIVES IN PRIORITY SECTORS

Negative(-5-0% CAGR)

High(5-10% CAGR)

Sector Employment growth potential*

Low(0-5%CAGR)

High(>10%CAGR)

Re

al

pro

du

cti

vit

y g

row

th p

ote

nti

al*

Mining1

Metals 2

Telecom 3

Tourism and restaurants 4

Construction5

Banking and insurance 6

Food processing7

Textile and apparel8

Industrial machinery9

Electronics and precision 10

Construction materials11

Health care 12

Retail and wholesale13

Jewelry and diamonds 14

Transportation15

1

12

13

3

15

69

5

8

7

10

11

4214

Low(0-5% CAGR)

Medium(5-10% CAGR)

16

Software and IT Services16

2003-2010

*Compared to current employment/productivity in the sector

Source: Team analysis; World Bank; UNDP


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Sectors with highest total growth potential

… WHILE ACHIEVING SIGNIFICANTLY HIGHER PRODUCTIVITY WILL BE POSSIBLE THROUGH FOCUSED INITIATIVES IN PRIORITY SECTORS

Negative(-5-0% CAGR)

High(5-10% CAGR)

Sector Employment growth potential*

Low(0-5%CAGR)

High(>10%CAGR)

Re

al

pro

du

cti

vit

y g

row

th p

ote

nti

al*

Mining1

Metals 2

Telecom 3

Tourism and restaurants 4

Construction5

Banking and insurance 6

Food processing7

Textile and apparel8

Industrial machinery9

Electronics and precision 10

Construction materials11

Health care 12

Retail and wholesale13

Jewelry and diamonds 14

Transportation15

1

12

13

3

15

69

5

8

7

10

11

4214

Low(0-5% CAGR)

Medium(5-10% CAGR)

16

Software and IT Services16

2003-2010

*Compared to current employment/productivity in the sector

Source: Team analysis; World Bank; UNDP


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Georgia

SOFTWARE AND IT SERVICES SECTOR: GDP* SHARE – NOMINAL

2,20

1,38

3,99

2,00

0,11

0,53

1,71

0,09 0,220,01

US Germany

Ireland Israel India Russia Estonia Armenia Iran

Percent

*GDP 2002 data consistently from Global Insight

Source:US Census Bureau, RUSSOFT, NASSCOM, Enterprise Ireland, IASH, Bitkom, ANCI, ASIROS, Bilisim, Datamonitor, Sanaray, Global Insight

Turkey

8.62

Software and IT Services sectorplays important role

in Armenia's economy

Western Countries

IT high growth countries

CIS countries

Neighbor countries


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ARMENIA IS ALREADY AT A GOOD STARTING POINT FOR GROWTH IN SOFTWARE AND IT SERVICES AS PRIORITY SECTORProductivity PPP - Percent of US level

*MGI values: Germany scaled with GDP PPP = 2.06, India and Russia from in-depth MGI studies**Ireland scaled with GDP PPP = 0.84; Israel playing equally on global market with US PPP=1, Armenia: Exports at PPP = 1.5, domestic at PPP = 5.6Source:US Census Bureau, RUSSOFT, NASSCOM, Enterprise Ireland, IASH, Bitkom, Datamonitor, Global Insight, MGI

10090

180172

44 3823

US Germany* Ireland** Israel** India* Russia* Estonia Armenia**

n/a

Western countries

IT high growth countries

CIS countries

Armenia with good performance given quite young and rather

fragmented sector


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50% value proportional to salary difference

BOTH FOREIGN SUBSIDIARIES AND DOMESTIC COMPANIES ALREADY REACH GLOBALLY COMPETITIVE LEVELS OF PRODUCTIVITY

*Including Armentel monopoly**Scarcity of experienced group leaders (project management skills)***Little incentive for value maximization due to predominantly one-person-ownership structure

Source:McKinsey, Company interviews

Programmingproductivity

Product generation and marketing/ sales productivity

Productivity split

1240

820

Armenia programming productivity

Tax, admin and regulatory issues*

Process management**and staff qualification

US programming productivity

Foreign owned companies

• Only comparison of programming productivity possible (at PPP) (further value creation steps executed abroad)

1515

2010

100

1510

15

Armenia programmingproductivity

Tax, admin and regulatory issues*

Product mix (small domestic market)

Strategic management (including ownership issues***)

Brandingdiscount

US total productivity

Domestically owned companies

• Comparison of total productivity (at PPP)

Armeniaproduct generation and marketing/ salesproductivity

Process manage-ment** and staff qualification

ESTIMATES

60%

40%


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LEARNING FROM SUCCESSFUL COUNTRIES IN SOFTWARE AND IT SERVICES SHOWS FOUR COMMON KEY FACTORS FOR GROWTH

Source:NASSCOM, Enterprise Ireland, IASH, McKinsey analysis

Attractforeigninvestment

Leveragecountryadvantages

Focus on target segments

Providegovernment support

India

• MNCs build offshoring credibility and skills, e.g., TI (1983), Citibank (1985), GE Capital (1996)

• Supported by strong industry association NASSCOM

• Talent – high quality, English speaking at low-cost

• Offshoreable segments, e.g., customized application development

• Offshored business processes

• Created Software Technology Parks (with optimal infrastructure)

• Subsidizing technical education• Provided fiscal incentives• Cooperated with NASSCOM

Ireland

• Large investments by Dell (exports of1 billion) built skills and reputation

• English speaking, low- cost talent pool

• Geographical proximity to EU

• Offshored business processes

• Created IDA*, an agency for attracting and facilitating overseas investments

• Provided fiscal incentives

Israel

• Microsoft’s first international center in Israel

• High quality talent (some immigrating)

• Sophisticated demand for security systems

• Strong R&D base• Assistance by Jewish

entrepreneurs

• Security software

• Creation of three-phase funding and support mechanisms for new companies

• High spending on R&D and education


16

TWO TARGET SEGMENTS HAVE BEEN IDENTIFIED AS MOST PROMISING IN THE GLOBAL EXPORT MARKET

Note:Size of bubble indicates global market size

Source:McKinsey

IT services

(Packaged) software

Attractiveness of industry segment• Global

market size• Market

growth rate• Industry

profitability

Armenia's ability to be a significant player(scale indicates "absolute" ability)• Technical skills• Customer relationship/marketing skills• Market concentration (only Packaged Software)• Language skills

Low

Low

High

2/10

17

5

22

13

4

18

9

83

12

146

7

21

15

111 19

20

16

High

IT consulting1

Systems integration2

Networking consulting and integration3

Customized applications development4

IT education and training5

Software support and implementation6

Hardware support and implementation7

IT outsourcing8

Network infrastructure management services

9

10 Processing services

Applications outsourcing11

Business Process Outsourcing (BPO) 12

Vertical business applications13

Cross industry business applications14

Consumer applications15

Information and data management16

Application design and construction tools17

Network management and security18

Systems management19

Operating systems20

Middleware and serverware 21

Embedded software22

Suggested first priority areas


17

FOUR ADDITIONAL SEGMENTS ARE IDENTIFIED AS SECOND PRIORITY TARGETS

Note:Size of bubble indicates global market size

Source:McKinsey

IT services

(Packaged) software

Attractiveness of industry segment• Global

market size• Market

growth rate• Industry

profitability

Armenia's ability to be a significant player(scale indicates "absolute" ability)• Technical skills• Customer relationship/marketing skills• Market concentration (only Packaged Software)• Language skills

Low

Low

High

2/10

17

5

22

13

4

18

9

83

12

146

7

21

15

111 19

20

16

High

IT consulting1

Systems integration2

Networking consulting and integration3

Customized applications development4

IT education and training5

Software support and implementation6

Hardware support and implementation7

IT outsourcing8

Network infrastructure management services

9

10 Processing services

Applications outsourcing11

Business Process Outsourcing (BPO) 12

Vertical business applications13

Cross industry business applications14

Consumer applications15

Information and data management16

Application design and construction tools17

Network management and security18

Systems management19

Operating systems20

Middleware and serverware 21

Embedded software22

Suggested first priority areas

Potential second priority areas


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A FOCUSED GROWTH STRATEGY COULD LEAD TO REVENUE GROWTH BY THE FACTOR OF 15 BY 2020

*Over next 8 years (higher growth phase)**About 500 computer science graduates annually, assumed from current base of 400Source:McKinsey

RevenuesUSD millions

Share of GDPPercent

EmployeesThousands

Share of workforcePercent

Comments*

High growth - 3I

40238

618

1,7

5,68,9

6,2

2,6

8,0

2002 2010 2020

0,200,41 0,54

• Average annual employee increase* of ~ 450 difficultto achieve (based on about 500 computer science graduates annually**, partly working as IT specialists in other sectors)

1,7 2,9 3,9

Medium growth

2002 2010 2020

• Average annual employee increase* of ~ 230 possible to achieve, seems balanced with IT specialists required in other sectors of economy

40 103 184

2,64,4 5,3

0,20 0,30 0,35

Slow growth

2002 2010 2020

40 64 78

1,7 1,9 1,9

2,64,1 5,1

• Average annual employee increase* of ~ 200 could underutilize pool of IT specialist graduates

0,20 0,28 0,34


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Government to continue and constantly coordinate education programs for all educational levels

1

Government to become lead user of IT and provide growth enabling conditions

2

Actively attract key global player to position Armenia on global IT map

3

Set up dedicated agency to support domestic companies towards international markets

4

Associations to increase coordination and intensify communication with industry

5

Domestic companies to more actively pursue domestic and export expansion options

6

THE STRATEGY FOR SOFTWARE AND IT SERVICES SHOULD CENTER AROUND SIX KEY ELEMENTS REQUIRED FOR LONG-TERM SUCCESS

Source:McKinsey

Leverage country advantages

Attract foreign investment

Focus on target segments

Provide govern-ment support


20

RECOMMENDATIONS ON ARMENIA'S GROWTH MODEL

Only "Armenia can do this"

Aspire for leadership

Export-led

Source: Team analysis

• Build your competitive position on unique strength of Armenian people, land and culture– Perseverance and excellence for new learning– Strongest tradition of arts and craft – Genuine and differentiated products and services

• Develop an export-oriented mindset– Adapt to foreign markets– Learn languages and travel– Compete globally

• Excel in the segments you chose to compete– Focus on attractive high-value niches– Measure yourself against best practices– Be open for global alliances

Documents

Armenia2020 Presentation McKinsey Productivity