Slide1: Pierre Gurdjian, André Andonian, McKinsey &Company Presentation on Armenia 2020 Conference Yerevan, October 25, 2003 Key Levers for Productivity Improvement in Armenia


ARMENIA'S ECONOMY HAS RECENTLY GROWN AT HIGH RATES, HOWEVER IT STILL REMAINS WEAK BOTH IN ABSOLUTE AND RELATIVE TERMS: 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 CAGR 1999 - 2002, percent USA Germany China India Russia Turkey Israel Iran Singapore Romania Slovenia Paraguay Azerbaijan Georgia Armenia Average Source: Global Insight; EIU 36,146 24,317 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 1,237.0 514.0 349.0 182.0 102.0 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


ARMENIA'S RECENT ECONOMIC GROWTH WAS LARGELY DRIVEN BY CONSTRUCTION AND RETAIL, FUELLED BY EXTERNAL FINANCING: 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 CAGR Percent 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 Construction 1,899 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


ARMENIAN EXPORT HAS GROWN SIGNIFICANTLY TOO, ALTHOUGH FROM VERY LOW STARTING LEVEL AND ON A NARROW BASE : 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 processing Source: IMF,Armenia National Statistics Service, 2002 USD millions Real CAGR Percent 12.6 60.1 34.6 16.0 3.0 7.0 3.4 Total exports Precious 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 7 8 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


FOUR DISTINCT MODELS CAN SERVE AS DEVELOPMENT PATTERNS: FOUR DISTINCT MODELS CAN SERVE AS DEVELOPMENT PATTERNS Source: McKinsey


ARMENIA'S PROSPERITY LEVEL IN 2020 WILL STRONGLY DEPEND ON ITS CURRENT CHOICES: ARMENIA'S PROSPERITY LEVEL IN 2020 WILL STRONGLY DEPEND ON ITS CURRENT CHOICES PPP GDP per capita/USD Source: McKinsey Real growth CAGR, 2002-2022


THE WELL-BEING OF ORDINARY ARMENIAN CITIZENS WILL VARY EVEN MORE PRONOUNCEDLY DEPENDING ON THE CHOSEN PATH: 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 45


ACHIEVING THE AMBITIOUS GROWTH TARGETS WILL BE POSSIBLE THROUGH IMPROVING PRODUCTIVITY* OF ARMENIAN COMPANIES: 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 creation Source: McKinsey


DRIVERS OF UNEQUAL ECONOMIC GROWTH: DRIVERS OF UNEQUAL ECONOMIC GROWTH Must fix but far from enough Much less important than suggested by conventional wisdom By far the most important barriers to higher economic growth in all studied countries Source: McKinsey global institute, findings from 30 countries


… WHILE ACHIEVING SIGNIFICANTLY HIGHER PRODUCTIVITY WILL BE POSSIBLE THROUGH FOCUSED INITIATIVES IN PRIORITY SECTORS: … 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) Real productivity growth potential* Mining 1 Metals 2 Telecom 3 Tourism and restaurants 4 Construction 5 Banking and insurance 6 Food processing 7 Textile and apparel 8 Industrial machinery 9 Electronics and precision 10 Construction materials 11 Health care 12 Retail and wholesale 13 Jewelry and diamonds 14 Transportation 15 1 12 13 3 15 6 9 5 8 7 10 11 4 2 14 Low (0-5% CAGR) Medium (5-10% CAGR) 16 Software and IT Services 16 2003-2010 * Compared to current employment/productivity in the sector Source: Team analysis; World Bank; UNDP


… WHILE ACHIEVING SIGNIFICANTLY HIGHER PRODUCTIVITY WILL BE POSSIBLE THROUGH FOCUSED INITIATIVES IN PRIORITY SECTORS: 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) Real productivity growth potential* Mining 1 Metals 2 Telecom 3 Tourism and restaurants 4 Construction 5 Banking and insurance 6 Food processing 7 Textile and apparel 8 Industrial machinery 9 Electronics and precision 10 Construction materials 11 Health care 12 Retail and wholesale 13 Jewelry and diamonds 14 Transportation 15 1 12 13 3 15 6 9 5 8 7 10 11 4 2 14 Low (0-5% CAGR) Medium (5-10% CAGR) 16 Software and IT Services 16 2003-2010 * Compared to current employment/productivity in the sector Source: Team analysis; World Bank; UNDP


SOFTWARE AND IT SERVICES SECTOR: GDP* SHARE – NOMINAL : Georgia SOFTWARE AND IT SERVICES SECTOR: GDP* SHARE – NOMINAL 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 Western Countries IT high growth countries CIS countries Neighbor countries


ARMENIA IS ALREADY AT A GOOD STARTING POINT FOR GROWTH IN SOFTWARE AND IT SERVICES AS PRIORITY SECTOR: ARMENIA IS ALREADY AT A GOOD STARTING POINT FOR GROWTH IN SOFTWARE AND IT SERVICES AS PRIORITY SECTOR Productivity 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 = 5.6 Source: US Census Bureau, RUSSOFT, NASSCOM, Enterprise Ireland, IASH, Bitkom, Datamonitor, Global Insight, MGI US Germany* Ireland** Israel** India* Russia* Estonia Armenia** n/a Western countries IT high growth countries CIS countries


BOTH FOREIGN SUBSIDIARIES AND DOMESTIC COMPANIES ALREADY REACH GLOBALLY COMPETITIVE LEVELS OF PRODUCTIVITY: 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 Programming productivity Product generation and marketing/ sales productivity Productivity split Armenia programming productivity Tax, admin and regulatory issues* Process manage- ment** and staff qualification US programming productivity Foreign owned companies Only comparison of programming productivity possible (at PPP) (further value creation steps executed abroad) Armenia programming productivity Tax, admin and regulatory issues* Product mix (small domestic market) Strategic manage- ment (including ownership issues***) Branding discount US total productivity Domestically owned companies Comparison of total productivity (at PPP) Armenia product generation and marketing/ sales productivity Process manage-ment** and staff qualification ESTIMATES


LEARNING FROM SUCCESSFUL COUNTRIES IN SOFTWARE AND IT SERVICES SHOWS FOUR COMMON KEY FACTORS FOR GROWTH: LEARNING FROM SUCCESSFUL COUNTRIES IN SOFTWARE AND IT SERVICES SHOWS FOUR COMMON KEY FACTORS FOR GROWTH Source: NASSCOM, Enterprise Ireland, IASH, McKinsey analysis Attract foreign investment Leverage country advantages Focus on target segments Provide government support


TWO TARGET SEGMENTS HAVE BEEN IDENTIFIED AS MOST PROMISING IN THE GLOBAL EXPORT MARKET: 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 8 3 12 14 6 7 21 15 1 11 19 20 16 High Suggested first priority areas


FOUR ADDITIONAL SEGMENTS ARE IDENTIFIED AS SECOND PRIORITY TARGETS: 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 8 3 12 14 6 7 21 15 1 11 19 20 16 High Suggested first priority areas Potential second priority areas


A FOCUSED GROWTH STRATEGY COULD LEAD TO REVENUE GROWTH BY THE FACTOR OF 15 BY 2020: 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 400 Source: McKinsey Revenues USD millions Share of GDP Percent Employees Thousands Share of workforce Percent Comments* High growth - 3I Average annual employee increase* of ~ 450 difficult to achieve (based on about 500 computer science graduates annually**, partly working as IT specialists in other sectors) Medium growth Average annual employee increase* of ~ 230 possible to achieve, seems balanced with IT specialists required in other sectors of economy Slow growth Average annual employee increase* of ~ 200 could underutilize pool of IT specialist graduates


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


RECOMMENDATIONS ON ARMENIA'S GROWTH MODEL : RECOMMENDATIONS ON ARMENIA'S GROWTH MODEL 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