Armenia Competitiveness Fund Preliminary Report: Summary of research todate and design thoughts

1
Armenia Competitiveness Fund Preliminary
ReportSummary of research to-date and design
thoughts

• Prepared for Discussion Purposes
• by Aslan Global, Inc.
• September, 2005

2
The Competitiveness Imperative

• Competitiveness has emerged as the leading
  framework for the economic development of nations
• Originated with Professor Michael Porter
• Led President Reagans Economic Competitiveness
  Council
• Founder of The Monitor Group, inspiration
• Strategy advisor to dozens of nations, both
  developed and developing
• Created Institute for Strategy and
  Competitiveness at Harvard
• Kaia Miller
• 10 year ongoing collaboration with Professor
  Porter and his Institute
• Monitor, Onthefrontier, Aslan Global
• Direct experience in El Salvador, Venezuela, the
  Middle East (Palestine, Israel, Jordan, Egypt),
  Rwanda, Bangladesh, Mozambique, Nigeria, Romania,
  Zambia, Dominican Republic, Brazil
• 4 years active participation in Armenia, Armenia
  2020
• McKinsey Global Institute
• Premier advisor to nations on competitiveness
• Working in Armenia, Armenia 2020 since 2002
• Completed assessment of sector productivity,
  detailed analyses of IT and Tourism, additional
  sectors ongoing
• Porter/Miller and McKinsey provide world-class
  foundations to develop the Armenia
  Competitiveness Fund strategy

3
Agenda

• The Challenge
• The Case for an Armenia Competitiveness Fund
• What is Competitiveness and How Is It Created?
• Why a Competitiveness Fund Makes Sense Now in
  Armenia
• The Vision for the Armenia Competitiveness Fund
• Critical Design Issues for the Armenia
  Competitiveness Fund
• Discussion and Recommendations
• Lessons Learned from Other Initiatives
• Selected Armenian Initiatives
• Selected non-Armenian Initiatives

4
Armenia Competitiveness FundThe Challenge

• There are dozens of channels through which funds
  and support are flowing to Armenia and being used
  in various aspects of development, some more
  effective than others.
• Diaspora, development agencies and donors, other
  foreign investors, Armenian government
• In recent years among most donors and
  philanthropies there has been a trend away from
  humanitarian only support to include economic
  development support, particularly support for
  private sector enterprise development
• The current efforts are not linked to any
  national vision or economic development plan and
  are insufficient to achieve the dramatic
  increases in productivity and prosperity that
  Armenians both in Armenia and in the Diaspora,
  desire.
• There is little coordination among the disparate
  sources of support and the hundreds of projects
  underway
• Even successful efforts are realizing only
  incremental results
• There is an emerging sense of urgency among
  wealthy Diasporans to devise an economic
  development strategy with a strong focus on
  business development that will have real,
  dramatic and sustainable results.
• Wealthy Diasporans who have contributed
  significant funds want to have confidence that
  Armenia will have the support it needs longterm.
  They want real impact and regenerative
  investments.
• The central challenge is to develop an effective
  mechanism to pool external funds and other forms
  of support, link the mechanism to a sound,
  comprehensive, national economic development
  strategy embraced by relevant groups in Armenia,
  and achieve dramatic and sustainable results
• Desired results would focus on creating truly
  successful companies, attractive jobs in Armenia,
  and ultimately prosperity creation consistent
  with the ambitious levels articulated by
  Armenians in the Armenia 2020 visions.

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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
600
Singapore model Becoming masters of own life
Singapore model Becoming masters of own life
460
460
460
460


Average Armenians afford modern housing
conditions
Average Armenians afford modern housing
conditions


Armenia becomes predominantly middle class society
Armenia becomes predominantly middle class society


Quality of education is among the best in the
world
Quality of education is among the best in the
world


Armenians return massively from Russia
Armenians return massively from Russia
400
Ireland model Living like in Eastern Europe
Ireland model Living like in Eastern Europe
260
260
260
260


Average Armenians afford buying furniture and
cheap cars
Average Armenians afford buying furniture and
cheap cars


Large middle class emerges, both in foreign and
local companies
Large middle class emerges, both in foreign and
local companies


Quality of education moves towards European
standards
Quality of education moves towards European
standards


Emigration is reversed
Emigration is reversed
200
Israel model Living like in a backward Russian
province
Israel model Living like in a backward Russian
province


Average Armenians work in small factories and
shops
Average Armenians work in small factories and
shops


Some middle class emerges, mainly in Russian
-
owned industries
Some middle class emerges, mainly in Russian
-
owned industries
120
120
120
120


Quality of education like in Soviet times
Quality of education like in Soviet times
100


Best and brightest still emigrate
Best and brightest still emigrate
Paraguay model No change for better
60
Paraguay model No change for better
60
60
60


Average people barely make their basic ends
Average people barely make their basic ends
45
45
50


Unemployment is pervasive, especially in rural
areas
Unemployment is pervasive, especially in rural
areas


Quality of education deteriorates
Quality of education deteriorates


Population emigrates massively
Population emigrates massively
2003
2020
Source
Armenia 2020/McKinsey
7
Agenda

• The Challenge
• The Case for an Armenia Competitiveness Fund
• What is Competitiveness and How is it Created?
• Why a Competitiveness Fund Makes Sense Now in
  Armenia
• The Vision for the Armenia Competitiveness Fund
• Critical Design Issues for the Armenia
  Competitiveness Fund
• Discussion and Recommendations
• Backup Lessons Learned from Other Initiatives
• Selected Armenian Initiatives
• Selected non-Armenian Initiatives

8
Competitiveness is Productivity

• Competitiveness is productivity
• It is determined by the productivity with which a
  nation uses its human, capital, and natural
  resources
• Productivity sets a countrys standard of living
  (wages, returns to capital, returns to natural
  resource endowments)
• Productivity depends both on the value of
  products and services (e.g. uniqueness, quality)
  as well as the efficiency with which they are
  produced
• It is not what industries a nation competes in
  that matters for prosperity, but how firms
  compete in those industries
• Productivity in a nation is a reflection of what
  both domestic and foreign firms choose to do in
  that location. The location of ownership is
  secondary for national prosperity
• The productivity of local industries is of
  fundamental importance to competitiveness, not
  just that of traded industries
• Nations compete in offering the most productive
  environment for business
• The public and private sectors play different but
  interrelated roles in creating a productive
  economy

Source Michael E. Porter, Institute for
Strategy and Competitiveness, Harvard University
Any project focused on building competitiveness
is ultimately focused on increasing productivity.
Labor productivity, for example, is one key
indicator that should be used to measure the
performance of any competitiveness initiative.
This can be measured at company, cluster and
national levels.
9
Competitiveness is ProductivityNational
Determinants of Productivity and Productivity
Growth
Macroeconomic, Political, Legal, and Social
Context for Development
Microeconomic Foundations of Development
Quality of the Microeconomic Business Environment
Sophistication of Company Operations and Strategy
Source Michael E. Porter, Institute for
Strategy and Competitiveness, Harvard University

• A sound macroeconomic, political, legal, and
  social context creates the potential for
  competitiveness, but is not sufficient
• Competitiveness ultimately depends on improving
  the microeconomic capability of the economy and
  the sophistication of local companies and local
  competition
• A competitiveness initiative needs to have
  components that ensure upgrading of both
  company-level strategies AND of the business
  environment.

10
The Microeconomic Business Environment
Context for Firm Strategy and Rivalry

• A local context and rules that encourage
  investment and sustained upgrading
• e.g., Intellectual property protection
• Meritocratic incentive systems across all major
  institutions
• Open and vigorous competition among locally based
  rivals

Factor (Input) Conditions
Demand Conditions

• Sophisticated and demanding local customers
• Local customer needs that anticipate those
  elsewhere
• Unusual local demand in specialized segments that
  can be served nationally and globally

• Presence of high quality, specialized
  inputsavailable to firms
• Human resources
• Capital resources
• Physical infrastructure
• Administrative infrastructure
• Information infrastructure
• Scientific and technological infrastructure
• Natural resources

Clusters of Related and Supporting Industries

• Access to capable, locally based suppliers and
  firms in related fields
• Presence of clusters instead of isolated
  industries

• Successful economic development is a process of
  successive economic upgrading, in which the
  business environment in a nation evolves to
  support and encourage increasingly sophisticated
  ways of competing

11
Productivity Growth in Companies Drives the
Economic Growth for the Country
While looking at economic growth opportunities
for the country, we focus on labor productivity
of its economic agents as the main engine for
wealth generation
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
Surplus distributed Customers (lower
prices) Employees (higher salaries) Owners
(higher profits)
Greater surplus Higher value added Lower labor/
capital costs
Productivity growth in company X
Source McKinsey Report for Armenia 2020
Productivity is defined as total value added
divided by number of employees participating in
value creation
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Microeconomic Competitiveness and GDP Per Capita
1999 GDP per Capita
Current Competitiveness Index (CCI)
Adjusted for Purchasing Power Parity
Source Porter, Michael E. The Current
Competitiveness Index Measuring the
Microeconomic Foundations of Prosperity. The
Global Competitiveness Report 2000, New York
Oxford University Press, 2000
14
Cluster Development in Emerging EconomiesSome
Principles

• Improving the general business environment is
  essential, but cluster development is needed to
  attain middle-income levels
• Developing economies should upgrade traditional
  clusters including agriculture, never abandon
  them
• Recruitment of foreign direct investment should
  focus on existing and emerging clusters, not
  generalized appeals
• Incentives should be weighted toward training,
  infrastructure, and other areas that upgrade the
  cluster versus general subsidies and tax
  holidays
• Existing MNCs can become nodes for cluster
  development
• The best way to retain companies is to make them
  part of a cluster to support higher local
  productivity
• Free trade zones should be organized around
  clusters, and regulations designed to encourage
  linkages with the local economy
• A formal structure for cluster development is an
  important component of economic development
• Private sector led
• Government convening and participation
• Seed funding for cluster assessment and the
  formation of cluster-based industry groups

Source Michael E. Porter, Institute for
Strategy and Competitiveness, Harvard University
15
How Clusters Can Fit into a National Economic
Development ProgramExample El Salvador
National Plan
EL SALVADOR 2021
Other Clusters
Coffee Cluster
Apparel Cluster
Handicraft Cluster
Emigrant Cluster
Electronics Cluster
Export Promotion
Investment Promotion
Technological Capabilities
Regional Agenda
Sub-national Agenda
Business Climate / Cross Cluster Issues

• Legal Reforms / Deregulation and Facilitation,
  etc.
• Institution building, capacity building,
  innovation potential, productive private-public
  dialogue
• Social investments geared toward increasing
  productivity

National Competitiveness Program
Source Adapted from the National
Competitiveness Program in El Salvador
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Clusters Include Companies, IFCs and
Government Example The California Wine Cluster
Winemaking Equipment
Grapestock
Barrels

State Government Agencies (e.g., Select Committee
on Wine Production and Economy)
Bottles
Fertilizer, Pesticides, Herbicides
Caps and Corks
Grape Harvesting Equipment
Growers/Vineyards
Wineries/Processing Facilities
Labels
Irrigation Technology
Public Relations and Advertising
Specialized Publications (e.g., Wine Spectator,
Trade Journal)
Tourism Cluster
California Agricultural Cluster
Educational, Research, Trade Organizations
(e.g. Wine Institute, UC Davis, Culinary
Institutes)
Food Cluster
Sources Michael Porter / Institute for Strategy
and Competitiveness at Harvard. California Wine
Institute, Internet search, California State
Legislature. Based on research by Harvard MBA
1997 students R. Alexander, R. Arney, N. Black,
E. Frost, and A. Shivananda.
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Agenda

• The Challenge
• The Case for an Armenia Competitiveness Fund
• What is Competitiveness and How Is It Created?
• Why a Competitiveness Fund Makes Sense Now in
  Armenia
• The Vision for the Armenia Competitiveness Fund
• Critical Design Issues for the Armenia
  Competitiveness Fund
• Discussion and Recommendations
• Backup Lessons Learned from Other Initiatives
• Selected Armenian Initiatives
• Selected non-Armenian Initiatives

18
The Need for a Focus on Building Competitiveness
in Armenia
Armenian Real GDP per capita, 19902005 (2004,
2005 estimated)
CAGR 19902003 -3.5 19932003 7.1
GDP per Capita (Constant Armenian Drams)
Although growth rates in Armenia have been
impressive over the last decade, the sources of
growth are unsustainable, including large
infusions from the Diaspora and international
institutions. To sustain the growth, Armenia must
invest in supporting and creating successful
companies and increasing labor productivity or
competitiveness.
Note CAGR represents Compound Annual Growth
Rate Source Aslan Global Report for Armenia
2020, IMF World Economic Outlook September 2004
19
Armenias Recent Economic PerformanceA Closer
Look at Recent Drivers of Growth (USD Millions)
Real CAGRPercent
Nominal CAGR Percent

• Armenia experienced robust growth, which was
  driven by construction, retail and services
  largely boosted through generous external
  financing
• Armenia's tradable sectors performed worse than
  the average economy, with price deterioration
  resulting in almost no nominal gains in four years

7.8
5.7
USD millions
2,367
2,117
3.6
-1.7
1,911
Total GDP
1,899
1,847
7.3
4.3
Agriculture
23.0
19.7
Industry
Construction
12.3
9.9
Retail and wholesale
5.3
15.1
Transport and communication
7.8
5.5
Other services
1998
1999
2000
2001
2002
External financing
1998
1999
2000
2001
2002
As a percent of GDP
23.4
23.9
23.6
18.5
14.7
Source McKinsey Report for Armenia 2020
Without FDI, includes remittance, grants,
concessionary lending and limited capital
transfers
20
Composition of Armenian PPP GDP, 2001
GDP at PPP, without informal sector, USD millions
GDP at PPP, with upper estimate of informal
sector, USD millions
GDP at PPP, with lower estimate of informal
sector, USD millions

• Sectors

• Armenian economy is heavily dominated by six
  basic sectors-agriculture, energy, food
  processing, construction, retail and personal
  services
• Tradable and higher value-added services sectors
  are weak, which results in lower quality of total
  output and limited wealth creation
• For the same reason, pricing level in economy is
  depressed real economy, at PPP prices, is
  estimated to be 5 times larger than the nominal
  one without structural improvements, the
  discount will persist in the foreseeable future

Agriculture
Energy and utilities
Mining and Metals
Construction materials
Chemical
Industrial machinery
Electronics and precision
Jewelry and diamonds
Food processing
Textile and apparel
Other manufacturing
Construction
Retail and wholesale
Tourism (Hotels/restaurants)
Telecom
Transportation
Banking and insurance
IT/Software/Scientific research
Other professional services
Personal/communal services
Health care and social services
Education and culture
Government and defense
10,618
13,211
14,163
Total
Source McKinsey Report for Armenia 2020
Armenian Statistics Yearbook 2001 IMF
interviews, team estimates
21
Armenias Recent Export PerformanceUSD Millions
Nominal CAGRPercent
12.6
294
60.1
247

• Armenia's export sector outperformed the rest of
  the economy however its share is still rather
  small
• 2 segments diamond and food processing
  accounted for more than 70 of export growth
  since 1998
• In terms of impact on economy, export revenues,
  although growing, are still behind external
  financial assistance

Total exports
34.6
197
Precious stones and articles
183
16.0
161
Food products
Textile and apparel
3.0
Base metals
7.0
Mineral and chemical products
Machinery and equipment
3.4
-6.9
Other

• 1998

• 1999

• 2000

• 2001

• 2002

Exports as percent of GDP

• 9.6

• 8.7

• 10.3

• 11.7

• 12.9

Exports as percent of external assistance

• 41.1

• 36.7

• 43.7

• 63.0

• 84.5

On a net basis, given that the industry
performs only intermediate processing Source
McKinsey Report for Armenia 2020 IMF,Armenia
National Statistics Service, 2002
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Increasing Focus on Economic Development Among
Donors, but Lack of National Strategy and
Coordination

• Early focus in many organizations on humanitarian
  relief has given way to increasing focus on
  economic development
• Ex USAID and CAPS 17-20mm Competitiveness
  Project focused on clusters and business
  environment
• Armenia 2020 focused on economic development,
  including cluster development
• Increasing interest of organizations such as AGBU
  and Assembly to support economic development
  oriented activities
• Dozens of organizations are contributing to
  Armenias economic development, but there is
  little coordination of strategies and activities,
  and lack of leadership from within Armenia,
  particularly from the Government
• Plans for a national economic development plan
  have fallen short of expectations
• UNDP oversees foreign donor coordination efforts
  which are reportedly weak
• The number of local NGOs has increased
  exponentially since independence, but activities
  often focus on fund-raising rather than economic
  development
• Several attempts have been made to start programs
  focused on company-level support, with mixed
  results
• Attempts now defunct
• Lincy SME Loan Programs
• Armenian SME Investment Fund (w/IFC)
• Programs still in operation
• Armenian Business Corporation 1994 (w/revised
  business model and significantly reduced in scope
  after bankruptcy in 1999)
• Izmirlian-Eurasia Small Business Loan Program
  1995
• BSTDB-IF JV Financing Facility
• Little specific focus on improving clusters or
  the business environment
• Some preliminary analyses done by Armenia 2020
  through McKinsey

23
Increasing Focus on Economic Development and
Companies, but Gap in Clusters and Microeconomic
Environment
24
Emerging Focus on Industry Cluster Development in
Armenia

• A Beginning
• Increasing awareness / visibility of clusters and
  competitiveness in Armenia over the last several
  years
• Government and USAID recently initiated a cluster
  program as part of the CAPS Project
• Several cluster projects expected
• Armenia 2020 initiated strategic analyses of the
  business environment and several clusters
• Tourism completed jewelry, healthcare and others
  proposed

• Future Priorities
• Link programs focused on companies to cluster
  development
• Include a robust cluster development program as
  part of a comprehensive national economic
  development strategy linked to an articulated,
  ambitious vision
• Training for cluster members, facilitated
  strategic processes, targeted investments by
  companies, IFCs and local and national
  governments
• Increase local leadership and initiative (private
  sector and government participation in and
  leadership of cluster strategy development and
  strategic implementation)
• Institutionalize the cluster process and make it
  open to any cluster able to organize and commit
  itself to a rigorous change process
• Design mechanisms for ongoing Public / Private
  Sector Dialogue to guide investments in the
  overall Business Environment

25
Company-focused Initiatives to-Date are
Insufficient to Achieve the Desired Prosperity
Levels

• Failed Initiatives
• Armenian Business Corporation 1994-1999 Goal
  unifying the efforts of the Diaspora to assist
  the development of private business in Armenian
  and improve the social climate in the country.
  Activities Loans to local businesses of which
  many went bankrupt leading to bad loans
• Armenian SME Investment Fund with IFCtarget of
  15mm from Diaspora never reached
• High levels of direct company support unallocated
• All but 20mm of the 170mm Lincy program
  originally established for company support
  redirected to infrastructure
• Small programs relative to ambitious national
  goals
• Black Sea Trade and Development Program-Izmirlian
  Foundation 4mm joint-finance facility for SMEs
• Izmirlian-Eurasia Small Business Loan Program
  highly successful (particularly among poultry
  producers), but small (3mm Izmirlian
  contribution)
• ABC1999-2003 New business model--Businesses
  willing to undertake an equity JV in which ABC
  was majority owner. 7 JVs fruit / vegetable
  processing, gas stations, potato production,
  stone mining, law office
• No program focused on investing in companies in
  targeted, high potential industry clusters or
  linked to an articulated national vision and
  strategy

26
Agenda

• The Challenge
• The Case for an Armenia Competitiveness Fund
• What is Competitiveness and How Is It Created?
• Why a Competitiveness Fund Makes Sense Now in
  Armenia
• The Vision for the Armenia Competitiveness Fund
• Critical Design Issues for the Armenia
  Competitiveness Fund
• Discussion and Recommendations
• Lessons Learned from Other Initiatives
• Selected Armenian Initiatives
• Selected non-Armenian Initiatives

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The Armenia Competitiveness Fund Vision Four
Primary Activity Areas

• Equity/Debt Investments
• Direct investments in existing private companies
  and start-ups in Armenia in targeted industry
  clusters
• Management of funds to-be-invested

• Investment Banking Services
• Mergers and acquisitions
• Strategic partnerships
• Potentially partner with existing investment
  banking firm to provide these services (e.g.
  Ameria, Troika Dialog)

• Cluster Competitiveness Strategic Advisory
  Services
• Management consulting and support services
• Talent pool
• Potentially partner with existing Armenian or
  international consulting firms to provide these
  services (e.g. McKinsey)

• Grant Program
• Direct grants for productivity growth
• Cluster-level benefit multiple companies in a
  cluster (e.g. industry experts, research,
  institutes, etc)
• Regional / national level benefit all companies
  (e.g. infrastructure, policy, etc.)

Key objectives of the Fund are to make strategic
investments to achieve rapid and dramatic growth
in targeted industry clusters that will allow
Armenia to achieve the ambitious levels of
prosperity articulated in the Vision 2020
process. The vast majority of these investments
will be direct equity investments in companies in
Armenia, supported by critical related services
strategic advisory services, investment banking
services and a direct grant program.
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The Armenia Competitiveness Fund VisionHigh
Level 10 Year Plan
Year
1
9
7
8
6
5
4
2
3
10
Clusters 1, 2
Cluster Strategy Development
Investments and Support
Strategy Update
Growth Phase
Realization of Gains
Clusters 3. 4
Cluster Strategy Development
Investments and Support
Growth Phase
Strategy Update
Realization of Gains
Clusters 5. 6
Cluster Strategy Development
Investments and Support
Growth Phase
Strategy Update
Realization of Gains
Target clusters will undergo a four-phase / 5
year development strategy Phase OneStrategy
Development Phase TwoInvestments and Support
Phase ThreeGrowth Phase FourRealization of
Gains. The first 2 clusters will begin to
realize gains in Years 4-5. With 2 additional
clusters initiated every 2 years beginning in
year 2, each subsequent year a new cluster will
enter the Realization of Gains Phase. At least
every 5 years, each pair of clusters will undergo
a Strategy Update Exercise. By the end of 5
years, there will be 3 robust clusters realizing
strong growth, and by the end of 10 years there
will be 7.
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Agenda

• The Challenge
• The Case for an Armenia Competitiveness Fund
• What is Competitiveness and How Is It Created?
• Why a Competitiveness Fund Makes Sense Now in
  Armenia
• The Vision for the Armenia Competitiveness
  Fund
• Critical Design Issues for the Armenia
  Competitiveness Fund
• Discussion and Recommendations
• Backup Lessons Learned from Other Initiatives
• Selected Armenian Initiatives
• Selected non-Armenian Initiatives

30
What Are the Challenges that Could Inhibit
Success?
31
Armenia Competitiveness FundSeven Critical
Design Areas
Interface with Contributors

• Whom to target (Diasporans, international
  organizations? Other individuals?
• Communication strategy

Collecting the inputs
Financial Structure
Governance
Investment Strategy
Support / Performance Measurement
Managing the organization

• Transparency, accountability, objectivity, trust
• Organizational Structure
• Hiring and Compensation

• Key performance indicators
• Accountability for company performance

• Priority clusters
• Allocation of funds among equity investments,
  grants, consulting and investment banking

• Type of fund
• Size / per cluster
• Distributions

Interface with Armenian Government
Interface with Other Development Players
Coordinating strategy with other players

• Coordinating with ongoing projects e.g. USAID,
  UNDP, World Bank, IMF, MCA, other bilaterals,
  Diaspora orgs., NGOs, etc

• Coordinating / ensuring relevant investments in
  upgrading the business environment
• Ongoing private-public sector dialogue

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1. Interface with Contributors

• Fund will target interested Diasporans who share
  the vision of what Armenia needs to achieve its
  desired levels of prosperity
• Consider setting minimum investment levels
• Fund is open to other investors (e.g.
  non-Armenians, international institutions, etc.)
  providing there are no constraints on the use of
  the funds
• Key indicators will be defined to include not
  only traditional fund performance indicators, but
  competitiveness and productivity indicators at
  the company, cluster, regional and national
  levels in Armenia
• Contributors will receive regular communications
  on the performance of their investments.
• Contributors will have the opportunity to sit on
  the Board of the fund, potentially through a
  system of rotating seats.

33
2. Financial Structure

• Initial Fund Size 200mm to cover the first two
  sets of cluster.
• Average of 50mm per cluster. The larger the
  cluster and the higher the potential growth rate,
  the bigger the allocation. This is aggressive
  but feasible given current levels for the first
  two cluster targets
• Software 110 companies today with total
  estimated revenues 40mm and 2600 employees. The
  McKinsey high growth scenario reflects growth 25
  per year or total revenues of 238mm by the year
  2010.
• Tourism Total 2002 revenues of 80mm and 23,000
  employees, with a high growth scenario expected
  level of 300mm by 2010 with 50,000 employees
• Consider having a pre-set management fee (e.g.
  2) to cover the Funds operations, salaries and
  bonuses
• Consider allowing contributors to direct their
  investments into specific clusters or types of
  activities
• Ideally they would be encouraged to contribute
  to the general fund
• Fund founders will need to decide what to do with
  the gains. Options include
• Create an evergreen fund in which gains are
  reinvested into existing or new clusters. This
  releases some pressure on ongoing fundraising.
• Distribute gains directly to investors. This
  infuses a disciplining mechanism into the fund
  and a stronger incentive to make gains.

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2. Financial StructureFund Management Fee
BenchmarksPreliminary

• Mercer Management study of institutional asset
  management fees
• December 13, 2004 report
• 2,000 firms surveyed in 8 regions around the
  world UK, Europe, US, Canada, Asia, Japan,
  Australia and New Zealand
• Main findings
• Highest fees are charged in asset classes with
  the greatest potential to add value emerging
  markets equity is the most expensive
• Fees for equity strategies vary significantly
  between regions Asia has highest fees while
  Canada has lowest
• Fees are consistently higher for small cap equity
  products than large cap products
• Emerging market equity
• Small cap equity products are consistently more
  expensive than large cap equity products, and
  there is no discernible difference in fees
  between style (e.g. core, growth and value). In
  the US, for example, small cap fees range between
  0.82 (82bps) and 0.88 (88bps) for a 50m
  segregated mandate. In contrast, large cap fees
  vary between 0.55 (55 bps) and 0.58 (58 bps)
  for the same size fund.
• Emerging markets equity is the most expensive
  regional asset class, with median fees for a 50m
  segregated mandate at 0.95, or 95 basis points
  (bps), decreasing slightly to 0.9 (90 bps) for a
  75m fund.

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3. Governance

• The Board
• 10-12 Board members. Consider including major
  contributors as well as key outside experts on
  clusters and competitiveness (e.g. Michael
  Porter, Diana Farrell-McKinsey, etc).
• Limited terms with possible renewal to ensure
  openings for others interested over time and to
  encourage Board Members to create value for the
  Fund or not be renewed
• Minimal or no compensation for Board members,
  funded out of management fees
• Consider having a separate Advisory Board without
  the ability to vote or make decisions, but
  enabling the Fund to have a flexible group of
  experts to consult on critical issues. Could
  include Government officials
• Offices New York and Yerevan. Consider offices
  outside Yerevan in a couple of target regions
• CEO
• Characteristics high-caliber investment expert,
  philanthropically-minded, linkages with Armenia /
  some interest in Armenia
• Compensation Salary and bonus paid out of a set
  management fee at slightly below market rates for
  top-level fund managers in New York (arguably
  there are psychic rewards to this Fund as opposed
  to other more mainstream funds).
• Conduct research to determine appropriate levels
  and structure of package
• Must be willing to spend a lot of time in
  Armenia, particularly during the first years
• Managers
• Characteristics / Responsibilities
• Number of managers estimated 3-5 per cluster
  overseeing 5-10 investments
• Compensation Salary and bonus paid out of a set
  management fee
• Conduct research to determine appropriate levels
  and structure of package
• Must be located in Armenia
• Support / Other staff as necessary
• Functional Administrative staff (HR, IT, etc)
  based in NY with counterparts in Armenia when
  necessary

36
GovernanceFund Manager Compensation
Benchmarks--Preliminary

• RESULTS OF 1999 COMPENSATION SURVEY OF
  INVESTMENT MANAGEMENT PROFESSIONALS RELEASED BY
  AIMR AND RUSSELL REYNOLDS ASSOCIATES
• Key Findings
• Investment management professionals employed by
  mutual fund organizations typically earn 24 more
  than their counterparts in insurance companies,
  banks, investment advisors and securities firms..
• The 1999 median total compensation for investment
  professionals at mutual fund companies is
  expected to be 196,000, followed by investment
  counseling firms and securities broker/dealers at
  185,000, insurance companies at 150,000, banks
  at 128,000, plan sponsors /endowments
  /foundations at 104,200 and lastly pension
  consulting firms at 95,000. The 1999 median
  total compensation for all survey respondents is
  expected to be 150,000.
• Portfolio managers and analysts focusing on
  global or international investing generally earn
  more than their domestic counterparts.
• In fact, the expected 1999 median total
  compensation for a portfolio manager of domestic
  equities is 153,000 and for global equities it
  is 211,000. In 1999, a portfolio manager of
  domestic fixed income is expected to earn
  158,000, while a portfolio manager of global
  fixed income is expected to make 185,000.
• Those serving institutional clients are generally
  rewarded with higher median total compensation
  than those working with a high net worth client
  base.
• Bonuses are given on the basis of
• an organization's overall business performance (a
  factor in the bonus determination of 60 percent
  of those surveyed)
• an individual's own investment performance (45
  percent)
• an organization's investment performance (42
  percent)
• an individual's business development performance
  (40 percent).
• Debra J. Brown, an executive recruiter in Russell
  Reynolds Associates' Investment Management
  Practice, notes, "Incentive compensation is most
  significant at mutual fund firms and securities
  broker/dealers, accounting for roughly half of
  the median total compensation at these
  organizations. This finding is consistent with
  their pay-for-performance cultures and the trend
  towards greater differentiation in remuneration."

37
Investment StrategyTarget Investments

• Clusters
• Clusters 1-2 Tourism, IT
• Clusters 3-4 Banking, Jewelry
• Clusters 5-6 Food Processing, Electronic and
  Precision
• Clusters 7-8 Metals, Health Care
• Grants
• Non-company-specific cluster enhancing
  investments (e.g. training, consulting, market
  research and outreach, etc.) identified in the
  Strategy Development Phase
• Business Environment labor protection, private
  ownership, tax policy, management capability,
  cluster specific investments to benefit multiple
  companies, cross-cluster investments to boost
  productivity. Identified in the Strategy
  Development Phase.

38
17 SECTORS OF ARMENIAN ECONOMY WERE SELECTED FOR
INITIAL
PRODUCTIVITY ANALYSIS
Selection criteria

Services and products marketable

Growth potential in productivity and/or
employment

Potential for exports

Relative comparability with US
17 Sectors covered
5 Sectors not covered



Agriculture
Chemicals
Textile and apparel



Energy, gas and water
Mining and minerals
Retail and wholesale



Education, science, culture, arts
Metals
Tourism and
restaurants


Government and defense
Materials

Banking and insurance


Other manufacturing and services
Construction

Health care

Industrial machinery

Communication

High
-
tech equipment

Transportation

Jewelry and diamonds

Software and IT

Food processing
Services
Source
Armenia 2020/Mckinsey Report
39
Armenia 2020 Research Highlights Guiding
Potential Investment DecisionsEmployment and
Labor Productivity of Selected Armenian Sectors,
2001
Share in employment Total employment 1,264
thous. Percent
Real productivity at comparable prices Percent of
US sector productivity
Nominal labor productivity USD per employee
Sectors

• Mining

• Metals

• Jewelry and diamonds

• Telecom

• Tourism and restaurants

• Construction

• Banking and insurance

• Food processing

• Textile and apparel

• Industrial machinery

• Electronics and precision equipment

• Construction materials

• Health care

• Retail and wholesale

• Transportation

• IT software

Total
Average for economy 1,690
Average for economy 11.5
Source McKinsey Report for Armenia 2020
Armenian statistics Yearbook 2001 IMF U.S.
Census Bureau Team estimates
40
Armenia 2020 Research Highlights Guiding
Potential Investment DecisionsEstimated
Employment / Productivity Growth Potential of
Selected Sectors
2003-2010
High(gt10CAGR)
1
Mining
12
2
9
Metals
6
3
3
10
Telecom
8
16
13
4
Tourism and restaurants
15
7
5
Construction
4
14
2
Medium(5-10 CAGR)
1
6
Real productivity growth potential
Banking and insurance
11
7
Food processing
5
8
Textile and apparel
9
Industrial machinery
10
Electronics and precision
11
Construction materials
Low(0-5CAGR)
12
Health care
Negative(-5-0 CAGR)
High(5-10 CAGR)
Low0-5 CAGR)
13
Retail and wholesale
14
Jewelry and diamonds
Sector Employment growth potential
15
Transportation
16
IT software
Compared to current employment/productivity in
the sector Source McKinsey Report for Armenia
2020. Based on team analysis World Bank UNDP
41
(No Transcript)
42
Armenia 2020 Research Highlights Guiding
Potential GrantsUniversal Productivity
Constraints Across Selected Sectors
1
Small domestic market
Unequal income distribution of population/ Low
purchasing power
2
7
3
2
4
Country risk and cost of credit
17
4
Low salaries/ wages
5
5
Legal protection of labor
High
6
15
State ownership
12
11
7
Inefficient private ownership
7
8
19
3
16
8
1
10
13
Tax enforcement
The estimated impact of the constraints on
overall productivity
14
3
9
9
Tax policy
10
Efficiency of public administration
18
6
11
Corruption/ Abuse of power
12
Low
Expensive land transportation
13
Trade with neighbors
14
Competitive intensity
0
15
Privileges to businesses
Low
High
gt20 years
5-10 years
10-20 years
16
Informality
17
Medium-term adjustment capability
Management capability
18
Labor trainability
19
Obsolete Assets
As a share of productivity gap
Source McKinsey Report for Armenia 2020
43
Armenia 2020 Research Highlights Guiding
Potential Grants Required Microeconomic and
Institutional Reforms

• Microeconomic diagnostic focusing on major
  sectors of economy
• Development of major initiatives in each priority
  sector
• Development of major initiatives across all
  sectors of economy
• Building public-private consensus on major reform
  priorities

• Reform regulatory framework for natural
  monopolies (e.g. power transmission, airports,
  water, rail, mining)
• Set and enforce standards in sectors with
  asymmetry of information issues (e.g. education,
  healthcare)
• Improve standards in banking sector and drive
  towards further consolidation

• Reform the public administration
• Reform tax, corporate and labor market regimes to
  reduce the burden on lawful players
• Drive towards equal enforcement of simplified and
  less restrictive laws and regulations

• Remove regulatory entry barriers (e.g. telecom,
  aviation) to best practice companies
• Eliminate formal and hidden privileges, reinforce
  competition and bankruptcy laws
• Improve entry conditions in nascent sectors (e.g.
  non-bank financial services, high-tech)

Source McKinsey Report for Armenia 2020
44
Typical Needs Resulting from Cluster Strategies

• Successful cluster processes will identify
  several needs to make the clusters competitive
  that the Armenia Competitiveness Fund could
  consider addressing
• Company Specific Support
• Direct financing / investment for companies
  growth strategies
• New start-ups
• Management personnel / advisors (marketing
  advice, market research, financial management,
  etc., capable employees)
• Cluster-specific Support
• Outside experts, advisors
• Marketing outreach such as participation as a
  cluster in international trade shows and cluster
  marketing materials
• International networking
• Training and research institutes
• Infrastructure investments specific to the
  industry cluster
• Cross-cluster Business Environment Support
• General infrastructure investments that benefit
  multiple clusters (roads, airport, etc)
• Legislation support
• Relevant government agency strengthening (e.g.
  ADA)
• Customs
• International trade negotiations and trading
  partnerships
• Trade delegations to neighboring countries

45
5. Support / Performance Measurement

• The Consulting Services division of the Armenia
  Competitiveness Fund Structure will provide
  needed support to client companies and help
  ensure the success of the investments
• Investment funds can be earmarked for desired /
  necessary support
• The investment banking arm will identify
  potential partners, mergers and acquisitions
• The grant program will expedite critical cluster,
  regional and national level investments that are
  necessary, in coordination with the Government
  and other donors to avoid duplication of effort
• Key performance indicators
• Individual client company performance
• Profitability and profitability growth
• Total revenues and revenue growth
• Labor productivity (revenues / employee)
• Cluster performance
• Profitability and profitability growth for client
  companies
• Total revenues and revenue growth
• Labor productivity (revenues / employee)
• Regional / National performance
• Profitability and profitability growth for client
  companies
• Total revenues and revenue growth
• Labor productivity (revenues / employee)
• Consider early indicators prior to realization of
  growth and gains

46
6. Interface with the Armenian Government

• Coordinate Grant Program Activities with
  government to avoid duplication and maximize
  impact
• E.g. the Armenian Development Agency (ADA)
  sponsors period trade shows, leads market
  development delegations abroad and other
  activities that Fund clients could benefit from
• Discuss plans with key government officials
  before initiating the Fund to gain support and
  address any possible concerns
• Consider including a government representative on
  the Board, or as part of an Advisory Board to
  ensure continued coordination and connection to
  the countrys emerging national vision and
  comprehensive economic development strategy

47
7. Interface with Other Development Players

• Foster productive relationships with relevant
  donors and NGOs working toward similar goals
• UNDP is the local Donor Coordinator and holds
  periodic meetings of donors
• Refer clients to donor programs that might
  provide additional support
• E.g. CAPS program for specific clusters
• Training programs
• Outside industry experts
• Others
• Coordinate Grant Program Activities with donors
  to avoid duplication and maximize impact
• Ensure transparency and openness to the degree
  possible

48
Agenda

• The Challenge
• The Case for an Armenia Competitiveness Fund
• What is Competitiveness and How Is It Created?
• Why a Competitiveness Fund Makes Sense Now in
  Armenia
• The Vision for the Armenia Competitiveness Fund
• Critical Design Issues for the Armenia
  Competitiveness Fund
• Discussion and Recommendations
• Backup Lessons Learned from Other Initiatives
• Selected Armenian Initiatives
• Selected non-Armenian Initiatives

49
Izmirlian Foundation

• Est. 1994 by family of Swiss-Armenians
• Headquartered in Geneva
• Mission Improving the lives of Armenians
  throughout the world

• Izmirlian-Eurasia Small Business Loan Program
• In 1999 Izmirlian contributed 3mm to existing
  Eurasia program
• Eurasia managed the program
• Up to 2 yr loans and 125k for Armenian SMEs
• Loans made in partnership with 3 Armenian banks
  which changed over time
• Rate set at 15 Eurasia received 5, bank
  received 10
• Prospective borrowers submit application jointly
  evaluated by Eurasia and bank
• Borrowers subjected to monthly or quarterly
  monitoring by both bank personnel and Eurasia
  employees
• Banks and the Izmirlian shared the non-payment
  risk --50 each for loans made with Izmirlian
  funds
• Results by year-end 2003
• Less than 1 of loans past due
• Less than 5 of loans written off
• 20 of loans made to repeat borrowers
• Noted for contribution to the poultry industry
• Changes in 2003-2004 Finance Company
• The 2 foundations planned to establish a finance
  company owned 50 by each
• Bypass banks At some point banks have to . . .
  make their own loans and not use our money.

• Black Sea Trade and Development Bank Izmirlian
  Foundation Joint Finance Facility
• In 2003 Izmirlian and BSTDB each contributed 2mm
  to launch a joint finance facility for Armenian
  SMEs
• Provide loans in dollars or euros for capital
  expenditures and working capital requirements
• 125k 500k
• Maximum term 5 years
• 12 interest rate (vs. 18 average lending rate
  in-country)
• Financial returns to Izmirlian used to support
  philanthropic activities in Armenia
• Netherlands Management Cooperation Program
  audited companies and offered technical
  assistance through retired executives

Source Gillespie and Andriasova, Diaspora
Support for Business Development in Armenia
50
Lincy Foundation Loan Programs for Armenia

• Foundation est. by Kirk Kerkorian, an
  Armenian-American billionaire and philanthropist
• Late 1990s visited Armenia and was asked by the
  government to assist the homeland
• In 1998 a loan program to assist SMEs was signed
  by Government, Central Bank and Lincy Foundation
• 100mm 6 year loan without interest to government
  from Lincy
• Government proposed and administered the original
  organization of the project
• Government would loan to Armenian banks at no
  more than 3 per annun
• Banks would provide qualified businesses with
  loans
• 100k - 1mm loans at no more than 15 interest
  rate
• Firms had to be majority-owned by Armenian
  citizens
• Government created a project implementation
  office and a special commission to approve loans
• No Lincy employees involved but frequent Yerevan
  Los Angeles communication
• When commission approved a loan, the request
  would be presented to Lincy to assure projects
  met criteria est. by US IRS (no arms or hazardous
  materials, environmentally safe production, etc)
• 2000-2001Government went back to Lincy concerned
  that it was too much money. New MOU
• 95mm direct grant for infrastructure
• 45mm SME loan program
• 30mm for loans or equity investments in majority
  foreign-owned companiesbypassed banks and
  government was in charge of loaning this money
  directly
• Results
• 45mm SME loan program

Source Gillespie and Andriasova, Diaspora
Support for Business Development in Armenia
51
Armenian Business Corporation

• 1991 Government invited 600 Armenian
  businesspeople from Diaspora
• Est. Armenian Business Forum
• Use members to mobilize charitable funds for
  Armenia and seek foreign investors
• We were working with the local government
  knowing that only 20 of the humanitarian
  assistance was reaching the people. ABF tried to
  bring investors . . . None of them succeeded.
  They all lost their shirts and returned because
  of strong Mafia thief organizations.

• ABC 1994-1999
• 1994 President asked for help to pull Armenia out
  of depression
• ABF created Armenian Business Corporation (ABC)
• ABF became inactive
• ABC registered as a for-profit ordinary
  joint-stock company
• 32,000 shares / total capitalization 320k
• Participants were all members of ABF and came
  from 17 countries
• Goal unifying the efforts of the Diaspora to
  assist the development of private business in
  Armenian and improve the social climate in the
  country
• Activities
• Loans to local businesses of which many went
  bankrupt leading to bad loans
• Shareholder in 2 privatized SOEs

• ABC 1999-2003
• 1999 desire to liquidate full time managing bad
  loans
• Shareholders exited at small loss, down to 821
  shares
• Hovsep Seferian new president
• New business model
• Businesses willing to undertake an equity JV in
  which ABC was majority owner
• if they want to steal, they steal their own
  funds.
• When approached for financing ABC would
• Determine if there was a market
• Site inspection
• Business plan approved by managing committee
• New LLC established to implement project
• Day to day business left to minority partner
  w/recognition that ABC could change management
• 2001 listed on Armenian stock exchange
• SEC presented obstacles but ABC persevered
• By end 2003
• 10 employees and 251 owners
• Assets exceeded capitalization, company
  finalizing application to issue new shares to be
  sold in Armenia and Diaspora at a premium

Source Gillespie and Andriasova, Diaspora
Su