Ukraine’s tech ecosystem equation: Product + Outsourcing = ?

Ukraine’s tech ecosystem equation: Product + Outsourcing = ?
Credit: IDCEE

Although many countries across the world strive to build a Silicon Valley of their own, regional technology business ecosystems are all very different, and are likely to remain so. It’s very interesting to observe how each country’s history affects the way startups and bigger companies grow and coexist on the market.

In Ukraine, a country of  great technological talent that has historically been linked with outsourced software development, the startup movement only gained momentum around seven years ago. Since that time, the local tech community has been discussing the struggle between product companies and offshore developers. The startup proponents would argue that outsourcers are killing the country’s potential, while their opponents would reply that they are creating a basis upon which entrepreneurs can build.

Earlier this year, Ukraine Digital News together with other local industry players released two reports—The Dealbook (PDF) and IT Ukraine (PDF)—that shed some light on both parts of the ecosystem and add some perspective to the country’s technology business landscape. (Full disclosure: I was involved in working on The Dealbook.)

More than 25 years into Ukraine’s independence and a few years into the startup boom, what has the country achieved so far?

Outsourcing and R&D

According to a conservative estimate, Ukraine’s IT services export reached $2.5 billion in 2015. The bulk of this was accounted for by its more than one thousand IT service companies that employ north of 90,000 people. The largest include EPAM, SoftServe, Luxoft, GlobalLogic, and Ciklum, each boasting between 2,000 and 4,000 engineers.

The report has it that the war in the East of the country and the economic and political turmoil hasn’t made a serious negative impact on the work of the existing IT service companies. However, there have been reports of some of them moving closer to the country’s western borders. The unstable situation also supposedly prevents the industry’s active growth.

Be that as it may, the outsourcing software development industry in Ukraine isn’t likely to shrink, as the talent pool here isn’t running dry any time soon. The number of people working for the top five outsourcers has more than doubled over the past five years, reaching some 32,000 specialists, according to a study conducted by DOU.ua.

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The salaries of programmers, although not rising significantly over the past couple of years, are still among the highest in Ukraine. A middle-level JavaScript coder in Kyiv can expect to take home in the region of $1,800 a month, a C#/.NET specialist $1,900, and for Java developers the amount rises to $2,000.

In most cases, this is much more than a local bootstrapping startup can afford. Nonetheless, more and more tech professionals are trading higher earnings for the risk and excitement of starting their own companies.

Startups taking over

After the turbulence of 2014, in which the total amount of funding received by Ukrainian startups shrank by 55 percent, last year showed a 237 percent year-on-year growth to the record-breaking $132 million. To put the number in a subregional context, it’s about 17 percent more than Estonian startups received the same year. The population of Estonia, however, is just 1.3 million people, while Ukraine’s is 45 million.

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Nevertheless, the Ukrainian tech scene’s achievements in times of trouble are admirable. According to UADN’s report, more than 40 percent of all the deals on the market in 2015 were made or led by foreign investors, who have kept faith in the country’s entrepreneurs.

Among the companies that raised the most were the Ukrainian-Danish outsourcing software developer Ciklum, the country’s biggest online retailer Rozetka, the popular photo stock Depositphotos, and Ukrainian-American pet gadget startup Petcube.

“Creating an enterprise software startup with a team of 20 people working for at least two years requires at least $10 million in the US,” wrote Andrey Kolodyuk, the founder and managing Partner at AVentures Capital. “In Ukraine, the same team for the same time span will cost 10 times less. Just think about it. It is possible to raise $1 million in the US, develop the product here and then return with the developed product to sell it in the US.”

Predictably, about nine out of 10 funding deals on the Ukrainian VC market are made at the seed stage. Access to capital for later stages is a universal issue for most Eastern European startup ecosystems, and startups that have survived long enough usually prefer to look for “smarter” money on the better developed markets.

Friends or foes?

Different players within  Ukraine’s tech ecosystem have varied opinions on whether the outsourcing software development industry can or can’t coexist with that of entrepreneurship and startups.

“The market is skewed because of the outsourcing software development industry,” said Igor Zhadanov, founder and CEO of Readdle in an interview for the report. “On one hand, this industry actually created the Ukrainian market, but on the other, it now suppresses its growth.

“I respect the outsourcing software development business and know that it’s very difficult to build and maintain. But a team of 20 talented engineers working in this industry would have a potential equal to their company’s profit margin. But if we talk about a product that this team could potentially build, the difference is huge.”

Not everyone agrees that the “outsourcers” are the enemy of the local startup ecosystem.

“I used to think that outsourcing hinders the development of startups, but now as I’ve dug deeper into it, I can see two important things,” said Denis Dovgopoliy, the founder and managing partner of GrowthUP, one of Ukraine’s few remaining startup incubators. “The first one is that outsourcing isn’t for everyone. For many creative software developers it’s hard to just sit and work on a product they don’t really understand. In the end, they become bored and end up joining a startup, bringing their experience, understanding, discipline, and coding standards from the outsourcing industry.

“The second thing is that many people who reach their career ceiling in the outsourcing industry may join or launch startups. These are mostly senior developers or project managers, who directly interact with clients and understand their problems. At some point, they get ready to take on creating a product to solve these problems. That’s why I think that outsourcing is the base upon which a number of strong startups will be built within the next few years in this country.”

Katherine Kostereva, the founder of one of Ukraine’s success stories, BPM Online, is convinced that it’s the people’s mindset that makes the ecosystem thrive or fail.

“What does it take to develop a highly competitive product and a successful IT company? You need to have a strong entrepreneurial spirit, first of all,” she said. “You need to be brave, believe in your idea, and make it happen. How would outsourcing software business stop you from doing that?”

If the cautious optimists are to be believed, Ukraine’s tech scene is about to make the major transformation into a product-focused ecosystem.

“One way or another, we will make a leap from outsourcing software development to product economy,” said David Braun, CEO of TemplateMonster. “It has already happened in the game development industry. Up next is the Internet of Things, because Ukraine still has a huge number of engineers who are good with hardware and can build stuff.”

This post is part of our contributor series. It is written and published independently of TNW.

This post is part of our contributor series. The views expressed are the author's own and not necessarily shared by TNW.

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