Arcady Khotine starts every morning with an old-style soviet. Over breakfast he, his wife, and his daughter?all partners in Arcadia, Inc. ?inull over what another day of offshore software development holds in store.

Mr. Khotine is at the center of one of Russia's fastest-growing industries. Famed for its top-notch engineers, some of the West's biggest software houses now rely on companies like Arcadia and Typhoon Software, also of St. Petersburg, to develop software and Internet tools for them. Not only can these bigger firms outsource the most complicated pieces of their work, but they pay a small fraction of the going rate in the U.S.

"With communication tools like the Internet, Western firms can access talent around the world," says Mr. Khotine. "Here in Russia, we have some of the best, cheapest talent around."

Indeed, analysts estimate that dozens of companies in St. Petersburg and more in Moscow are lining up to otter services. Arcadia came early to the business, and is considered one of tile best.

Mr. Khotine, a veteran in St. Petersburg's old state-run technology machine, scooped up some of the best and brightest engineers to work with him. Years of avid English reading had prepared him to start contacts with bigger Western contractors. What began as a $50 contract sealed via the Internet in 1993 has blossomed into hundreds of thousands of dollars in 1997 revenue, a staff of 40, and six or so major, steady clients.

The young industry faces challenges, though. Enlarging the client base is difficult because customers?reluctant to admit to farming out work?won't make recommendations. Mr. Khotine's solution: recruiting a U.S.-based partner to operate Planet Software, a Gainesville, Florida, enterprise concentrating solely on building up Arcadia s business.

What Western companies like to do, though, is send headhunters to shop for local talent. Mr. Khotine, unable to beat Western salaries, has lost engineers to bigger players. So he plans to try a training-center approach: He'll teach engineers, putting them to work on a Western contract in Russia for several years, and then place them with the client overseas.

"We get some contracts, and Western companies get better trained engineers," explains Mr. Khotine. "We have to turn our disadvantages into benefits."