“It helps that I have such a small company,” said entrepreneur Yury Sinodov, who has managed to keep government bureaucracy from consuming his online venture. Sinodov is the sole owner of roem.ru, an online blog journal similar to techcrunch.com. Unlike many other small- and medium-sized enterprises (SMEs), roem.ru has not faced pervasive corruption and government red tape, yet Sinodov has had to deal with stringent and inefficient administrative requirements that have adversely affected his business.

Small businesses operating in Russia may appear to face fewer administrative obstacles. In reality, however, they face increasingly difficult odds of survival when expanding their operations. At a 2011 rally in Moscow, private business owners said they were crippled by a lack of funding, corrupt courts and greedy officials. They gave Prime Minister Vladimir Putin a model of a sinking ship with the words “small business” etched on the side. These challenges stifle growth and the development of small business activities. Routinely, businesses face corrupt officials who have the power to deny licenses, permits, office space and access to supplies unless substantial “gifts” or bribes are offered.

Another small business owner, “Nikolai,” the entrepreneur of a baking company who asked to remain anonymous, has had “no choice but to raise prices to stay in business” due to legalized corruption practices. He has transitioned his Moscow regional-based baked goods company from the Soviet-centralized economy to the liberalized but unpredictable market economy that exists in Russia today. Armed with little more than smart intuition, he has balanced pressures from the market, creditors and corrupt government officials to keep his business afloat.

The Big Picture

SMEs are vital to the future of the Russian economy, even more so than in other countries. They are growing in Russia and are key to GDP and employment growth. According to data collected by Opora, a nonprofit devoted to SME development in Russia, there are currently about 1.6 million small and micro enterprises in Russia, a substantial increase since 2006. The number of SMEs grew by 7% between 2000 and 2005. In contrast, the number grew by 40% between 2005 and 2009. SMEs employ 17 million people, representing about 22.5% of the working-age population, and account for about 21% of GDP.

Although the number of SMEs in Russia is increasing, they face challenges, including an inaccessible credit environment and inefficient short-term government efforts to improve the business environment. The greatest threat to small businesses is the underdeveloped legal and administrative infrastructure, which is highly susceptible to corruption.

Even though the government passed new laws restricting the number of annual inspections for businesses and required that regulatory officials obtain prior approval from the prosecutor’s office to conduct said inspections, small businesses see the entire legislative apparatus as corrupt. Nikolai argues that “it is an attempt to ease things up; however, until the legislation in Russia changes from a system that authorizes government officials to manipulate the market to one that lets the market dictate the laws of supply and demand, the system remains flawed and highly inefficient.”

Nikolai views the government officials performing the inspections as extremely hostile, “regarding themselves as kings — we are nobody in their eyes, and they are the ones who do not produce anything for this society.  On the contrary, they actually impede the people who want to contribute.” In one instance, Nikolai needed an advertisement for one of his stores, which would normally cost around 10,000 rubles (roughly US$300) to construct and install. However, a special permit from the auto-regulatory police station was required, including a signature that cost approximately US$500.

“The consumers are the ones who are hit the most, as they end up paying the artificially inflated prices,” Nikolai argues. “No wonder Moscow has become one of the most expensive cities in the world. Corruption in Russia is practiced through official channels where bribes are legalized through a system of unfair practices that reduce producers’ profitability and completely destroy consumers’ surplus. Little can be done to impede this vicious cycle of corruption.”

Some outside observers note that Russia’s impending WTO accession has brought the legal and regulatory regime more in line with international standards. On the other hand, many see very little progress in the legal and regulatory environments. The World Bank’s 2011 Ease of Doing Business report places Russia behind other BRIC [Brazil, Russia, India and China] countries in several categories that rely heavily on legal and regulatory infrastructure, including dealing with building permits, trading across borders and protecting investors. In the report’s overall ease-of-doing-business measurement, Russia ranked 123 out of 183 countries.

In the case of Sinodov’s roem.ru, even though no corruption is involved, government inefficiencies and questionable services seriously impact the bottom line. As the sole full-time employee of his company, Sinodov is still required to pay all social security and benefit costs for his contracted (freelance) writers. He has spent nearly 10% of his time since he started the company in 2008 dealing with the tax matters and various reporting requirements.

The government has the right to freeze company bank accounts instantaneously, and without warning, if payment is not made on time. In one such instance, Sinodov’s company bank account was frozen for nearly a month. In a country where mail delivery is unreliable, an entrepreneur like Sinodov has only two options for dealing with the tax department: through postal couriers or in person. Because mail consistently arrives late or gets misplaced, entrepreneurs are forced to waste days dealing with administrative matters in person.

A Historical Perspective

Russia is fortunate to be one of the most resource-rich countries in the world. These resources, combined with an economically strategic position linking the Asian and European markets, ensure the country’s position in the global economy. Yet the country remains plagued by its massive land mass and crumbling physical infrastructure, its young bureaucracies carrying the vestiges of their Soviet predecessors, and the small groups of elites who hold economic power. Despite this, the SMEs have survived two economic crises and pervasive corruption, presenting Russia with an important growth opportunity. Furthermore, these businesses have the potential to be the key to innovation and diversification in an economy that neither fosters nor rewards innovations, among economic elites who are not incentivized to invest in new start-ups.

Nikolai started his company in the late 1980s as a cooperative that distributed a variety of baked goods to centrally controlled Soviet chain stores. Many newly minted entrepreneurs at that time had no professional business knowledge or training. This was their first experience with any type of market economy and their first chance to earn an actual profit. Most of Nikolai’s early decisions were based on intuition. He also faced several challenges along the way — e.g., finding rental space and acquiring capital to invest in refurbishing the cooperative’s production line. The only capital he had was some savings set aside from prior jobs, a used computer, energy and good health. Soon after the collapse of the Soviet Union, all of his partners decided to quit. They doubted that Russia’s environment would ever improve and sought stability by emigrating abroad. Nikolai decided to stay.

Prices for consumer goods were liberalized at the beginning of the 1990s. This step toward a market economy affected the survival of many small business ventures in Russia for whom that decade was an extremely challenging time. Inflation was rampant. It was unclear how much the cost of raw materials would escalate from day to day.

Nikolai was forced to become creative when the centrally controlled Soviet chain stores — the only retail chain in the country — collapsed along with the Soviet Union, making it difficult for entrepreneurs to sell their products. “My driver stormed into my office and told me that the stores would not take the bread or any of the baked goods we produced that day. I told him to take all the bread, put it in the back of his van and drive to one of the most crowded metro stops in Moscow. Imagine the middle of January, freezing outside…. When he came back, his face was bright red from the stringent cold but he was so exhilarated with joy; they had sold everything they had in the van.”

There was a constant rotation of labor: On Mondays, the employees could work as bakers, Tuesdays as drivers and Wednesdays as vendors near the metro. A majority of the revenue was reinvested immediately into the daily operations of the business, and a small portion was distributed among the employees as wages. Nikolai’s business was able to survive in a country that was on the brink of social and economic collapse; other businesses would not be as fortunate.

Nikolai learned the hard way that “private ownership is an illusion in Russia. At any time, the assets of any businessman could be seized without any explanation. Russia is still far from being a free country; there are always entrepreneurs who disappear … and there is no one who is held accountable for it.” The spirit of free enterprise was weak for many centuries in Russia, where a strong and merciless state restrained any action of disobedience or free will. “Currently, the risk in Russia is similar to, if not even worse than, what it used to be before.,” Nikolai adds. “In the early 1990s, the gangs of bandits that controlled most of the markets during the period of organized crime seemed to be more humane than the current government officials; they had a certain threshold that they abided by; now these corrupt clerks can take even the last piece from our mouths.”

The Future for SMEs

Prospects for small business development in Russia depend greatly on passing and implementing laws that improve the regulatory environment for SMEs. The country faces a self-imposed drought of talented individuals; with an aging population, too many bright and young individuals seek opportunities abroad. If and when changes do occur to ease the bureaucracy and minimize opportunities for corruption, things could improve. Currently, poor credit conditions make it difficult for all but the largest businesses to succeed.

The loss in motivation to pursue entrepreneurship has been one of the biggest problems affecting the state of small businesses in Russia. According to Ovanes Oganesyan, a Renaissance Capital analyst, potential entrepreneurs prefer working for large government organizations due to the relative stability and safety this provides. The risks associated with dealing with the government through private small business ventures set the tone for the future of SMEs.

Nikolai shares the sentiment that “there is a brighter outlook for larger corporations and big firms in Russia. During the Soviet Union, everything large was considered good. Now I see a similar mentality; small business entrepreneurs were always regarded with contempt and distrust in this society.” Oganesyan suggests that the government might dislike small owners because they are more independent, while larger state-owned firms need little convincing to support government policies. But many government-friendly big businesses have not turned out to be nearly as productive, profitable or innovative as the small businesses struggling to survive.

Until the day when corruption and credit obstacles are removed, Sinodov remains cautiously skeptical while reflecting on the future outlook of roem.ru. Due to an unstable income stream from ads, no access to capital and an even-more-unreliable government legal structure where “laws can be enacted at any moment and are constantly changing,” the future is bleak. In the meantime, Sinodov has learned to take matters into his own hands, to be pro-active and to live in the present as far as his business activities are concerned.

This article was written by Florentina Furtuna and Anna Ruvinskaya, members of the Lauder Class of 2013.