The countdown for enlarging the European Union is about to end. On May 1, the Old Continent will don formal attire to mark the introduction of ten new members and the creation of The Europe of 25. However, the good news also has some negative aspects, including greater competition for companies from the West. Lower salaries, tax incentives and community funds are the principal tools new member-states will deploy in order to attract investment and grab market share from Western companies. In their study, “Business Strategies: The economic impact of enlarging the European Union,” professors Lluís G. Renart and Francesc Parés of the IESE business school at Spain’s University of Navarre analyze four ways companies can transform the looming dangers of European expansion into new business opportunities.
With the arrival of ten new member-states from Eastern Europe – Estonia, Latvia, Lithuania, Poland, the Czech Republic, Slovakia, Hungary, Slovenia, Cyprus and Malta – the Europe Union will expand by 20%, both in size and population. In terms of economic wealth, however, the growth will amount to barely 6%. This imbalance reflects the lower productivity and living standards of the new member-states. According to Eurostat, the gap that separates the rich countries of the EU from its newest members is enormous; the per-capita GDP of new members is barely 33% of the average of the fifteen earlier members.
To overcome this gap, a large part of EU funding and community-aid programs will be earmarked for Eastern Europe, with the goal of balancing the poles [of wealth and poverty]. Other EU member-states will lose subsidies they have been receiving. “There are two large categories of assistance – first, ‘integration funds’ for regional policy; and second, funds for agricultural policy,” notes Renart. “EU regions are classified in three levels, comparing their development with the overall community average in terms of GDP. For example, the per-capita income in Extremadura (a region of Spain) is 60% of the European average. With the arrival of 10 countries with lower income, some regions will lose the right to receive integration funds, because the overall [EU] average will now drop and they will wind up being above it.”
About half the EU budget is devoted to common agricultural policy, and that fact has drawn criticism from numerous quarters. “Although it won’t happen right away, in the mid-term agricultural policy funds will not increase, at least in the best case scenario. In the worst case, it is possible that funding will decline,” explains Renart. This would affect countries such as Spain, Portugal and Greece, which are net recipients of such funds.
These are not the only obstacles that companies in the fifteen earlier member-states will have to overcome if they are to maintain their current competitiveness. Companies are carefully considering the possibility of relocating their production centers in Eastern Europe. Many fear that there will be a massive exodus of multinationals. Lower wage rates are the main reason cited. According to Eurostat, the average hourly wage in industry and services in old European member-states is seven times higher than in the new states. In countries such as Spain, this gap is only four-to-one, but it continues to be large enough for production to relocate.
As a result, the best-developed countries [of Western Europe] will have to redesign their strategies for competing. They will have to depend less on manufacturing processes and think less about wage costs. Little by little, low-wage manufacturing is already becoming the exclusive territory of emerging economies. As Renart notes, “The leaders will be those companies that carefully analyze the new competitive environment. They will respond with strategies that generate new opportunities for creating value and growth.” Already Germany and France have transformed themselves, leaving behind low-cost manufacturing in favor of a new model based on intellectual capital and [high value-added] services.
Taking the Next Steps
Companies must overcome fear of globalization, Renart and Parés assert. Their report focuses on Spain and, particularly, on the Autonomous Community of Catalonia, but “you can extrapolate from the conclusions to the rest of the companies in Europe, recognizing that there are differences between various governments,” notes Renart. Overcoming fear and opening yourself to new markets means viewing the EU’s expansion not as a threat, but an opportunity for expanding your business. There are four approaches to doing this: Going to the countries of the East to sell; going East to buy; establishing alliances with companies in those countries; and pursuing a defensive strategy that involves analyzing which products or services could be most vulnerable to the impact of the EU’s enlargement.
“Research on export development and globalization shows that companies normally begin [to globalize] by exporting to countries that are closer to them, from a psychological point of view,” Renart and Parés state. “That means that few companies [from Western Europe] that have never exported – or that export rarely – will begin their export campaign by selling to countries of the East. Do not forget, these countries are not well known by business executives – in large part because they were isolated for years, when communists ruled them. Moreover, many of their languages – Polish, Hungarian, and so forth – are not well known by [Western European] business people.”
As a result, many Western companies do not plan to start by competing in the new member countries. They prefer to compete in countries closer to their home base, or in countries that are closer in cultural or linguistic terms. For example, Spain has close ties in Latin America, and Portugal has close ties with Brazil.
Nevertheless, companies should consider selling in the new EU member states, the authors recommend. To be sure, the products and services that Western companies offer may be too high-end or too expensive, given the local buying power. “However, in such a case, consider selling to those sectors that are most demanding in quality and that have the greatest buying power. For example, in the case of industrial products, you might sell to companies owned by – or linked to – Western multinationals. Other possibilities include designing, producing or selling products whose quality and price are better suited to purchasing power levels in the East,” the study notes.
Each of these approaches involves a different strategy. On the one hand, you might establish commercial pacts with one or many local distributors. To the degree that sales develop, the distributor could support you with local advertising and marketing. You can also consider the advisability of establishing a logistical framework that allows you to serve your distributors more rapidly. “When you achieve a certain level of sales, it makes sense to think about creating your own subsidiary in a specific country. In some cases, it could even make sense to establish a production subsidiary, with the double goal of better serving local customers and serving customers in other countries in the East,” adds Renart. “For example, you could devote time and resources to penetrating Poland and Hungary, realizing that you could also be using those two countries to enter markets in Ukraine and Russia. Or, you could use Cyprus as an operating base for penetrating markets in the Near East, such as Syria, Jordan and Lebanon.”
Knowing How to Make Friends
The lower wage rates in Europe’s new member-states can also provide an opportunity to “go there and buy raw materials, or buy half-finished materials, parts and components. You could even study the possibility of purchasing finished and half-finished products, both branded by the manufacturer, or branded by the importer,” the study notes. This strategy can be especially attractive if you import products from a country already recognized worldwide for its quality [in a product sector], such as crystal from Bohemia and beer from the Czech Republic.
Plasticos Taya, a Catalonian company, provides a good case study. “The company moved into Romania in 1991. Now it is the majority shareholder in a plastics factory that has a high percentage of Romania’s domestic market; it exports an additional 30% [of its production] to France and, from there, it re-exports to France and Portugal.” Using this approach, Plasticos Taya sells products in four different markets, but its manufacturing costs are much lower than costs in Western Europe.
“There’s another thing companies should not forget: The EU’s expansion will lead to an improvement in the quality of life in the new member states,” Renart and Parés assert. “That, in turn, will raise salary levels there. For example, Hungarian salaries increased by 11% during 2002, according to the International Herald Tribune. The prospect of rising salaries could have an impact on some companies that manufacture or buy low-tech products; that is to say, the kinds of products that depend on low wages and are price-sensitive. Some companies could prefer to focus their manufacturing and purchasing strategy on other developing countries that are not expected to join the EU. For example, they could look to North Africa or East Asia, particularly China.”
A third strategy is to establish alliances with companies from Eastern countries. “Finding an ally allows you to make things together, more quickly, more cheaply, and with less risk. That way, you might find a Polish ally for going into Russia.” Although there is no standard model for creating alliances, “many writers agree that alliances wind up being unstable and of limited duration. So companies that get involved should already be thinking about what they will do if the alliance dissolves. This model is especially compelling for small and midsize companies that don’t have sufficient resources to go it alone in a new market.”
Knowing your adversary
“A fourth strategy, aimed at avoiding problems, involves looking at [Eastern] countries as potential competitors that can do you harm. A defensive approach, it focuses on discovering the main dangers that can come from the expansion [of the EU], such as the lower prices in the East,” notes Renart. That way, you can choose the business sector where you are likely to be most competitive, while abandoning others or transforming your company.
“Products that are most sensitive [to competition from the EU’s new members] are products where labor costs represent more than 30% of the total manufacturing cost. In addition, they are products that are relatively easy to manufacture – i.e. that have low technology, little innovation, and little design. They are also products where there is a relationship between volume, weight and price that allows them to be transported over long distances,” note Renart and Parés. Mauro Guillén, a professor at Wharton business school, expressed a similar view in a recent article published by UKW. Guillén recommends investing in human capital and infrastructure to manufacture higher value-added products – or to manage a transformation into providing high-value services. “For example, instead of manufacturing video recorders, [you might] create labs that design them, or manage the way they are marketed,” Guillén wrote.
In Guillén’s view, the sectors most affected by the enlargement of the EU will be “assembly industries, such as auto parts, electronics, machinery, furniture, toys, and so forth. On the contrary, I don’t believe that there will be an impact on continuous processing industries – such as petroleum, chemicals, metals, cement and glass manufacturing.”
Another potential danger for Western companies is the business strategy that Eastern companies will pursue after the EU’s expansion. “Some [Eastern] companies can defend their positions in smaller markets because of traditions involving their local brands. They can exploit their ability to adapt their products to local tastes. They can make low-priced products thanks to lower wage rates, and purchase local raw materials. They can use consolidated local channels of distribution. On another level, some companies can compete in other countries surrounding Eastern Europe – and, in some advanced cases, they can even compete in Western markets.”
Renart and Parés believe that exporters from Eastern countries will play an outstanding role in “exporting primary materials, intermediate products and components – not [exporting] finished products or their own brands.”
Fiscal incentives established by governments of the new member-states to attract investments can also play a role. Ireland provides a model worth remembering. Anticipating the change that would occur when Europe expanded, Ireland devoted a large part of its resources to raising its professional standards a decade ago. Ireland devoted more funding to Research and Development, and enhanced its role in the information technology sector. As a result, Ireland achieved the goal of maintaining its position as an attractive country for multinationals.