Manufacturing strategies in Central Europe The challenge of

Manufacturing strategies in Central EuropeThe challenge of maturity

A white paper from

the Economist Intelligence Unit

sponsored by Oracle

© The Economist Intelligence Unit 2004 1

MANUFACTURING STRATEGIES IN CENTRAL EUROPE

THE CHALLENGE OF MATURITY

Manufacturing strategies in Central Europe: The

challenge of maturity is an Economist Intelligence Unit

white paper, sponsored by Oracle.

The Economist Intelligence Unit bears sole

responsibility for the content of this report. The

Economist Intelligence Unit’s editorial team

conducted the interviews, executed the survey and

wrote the report. The findings and views expressed in

this report do not necessarily reflect the views of the

sponsor.

Our research drew on two main initiatives:

● We conducted a series of in-depth interviews with

senior manufacturing executives at multinational

companies operating in Central Europe.

● We conducted an online survey in July/August 2004

of 98 manufacturing industry executives located

throughout the EU accession and candidate

countries.

The author of the report was Paul Lewis and the editor

was Denis McCauley. Mike Kenny was responsible for

design and layout.

Our sincere thanks go to the interviewees and survey

participants for sharing their insights on this topic.

October 2004

Preface

2 © The Economist Intelligence Unit 2004



Most manufacturing sectors in the new

European Union member states have been

transformed over the past 15 years by

foreign direct investment. Foreign-owned

companies now account for the vast majority of the

region’s exports and have underpinned these

countries’ economic growth.

EU accession is unlikely to herald a fresh wave of

investment into the region, however. Quite the

reverse, in fact. Central Europe’s structural allure as a

low-cost location is still impressive compared with

expensive West European markets but is under threat

from other, even cheaper locations.

Slovakia is currently the location of choice for many

manufacturers, for instance, but many firms are now

looking outside the current EU, particularly at

Romania. Although Ukraine and Russia are deemed by

many to offer too much operational risk, the latter in

particular is set to attract significantly more FDI over

the coming five years. China is another alternative for

many firms, though transport costs to the EU can

eliminate the wage cost savings.

Not all manufacturers are focused on the region’s cost

benefits, of course. Some are in the region mainly to access

the local market. Many more seek the double blessing of

both a low-cost base for export and penetration of the

domestic market (although this can be a difficult tightrope

to walk—rising wages may push up manufacturing costs,

but also increase consumer demand).

But as Central Europe becomes less able to compete

on wages alone, manufacturers’ strategies are maturing

in tandem. A survey of 98 senior manufacturing

executives in the region, conducted for this white

paper, shows that wage costs are a major issue but that

other preoccupations are coming to the fore:

● Consolidation. Manufacturers in our survey are

concerned primarily with consolidating their position

in the home markets rather than looking further

afield. 70% of respondents say that the former is

important, and a third say critically so. Similarly, the

need to build closer relations with existing customers

is critically important to 39% of respondents,

compared with only 19% who are critically concerned

with penetrating new customer markets.

● Cost efficiency. This is regarded as manufacturers’

greatest point of vulnerability. Local sourcing of

components is a good way to cut costs, but this

requires very close management of the local supplier

in question in order to get it up to the required quality

standard. Expansion of the automotive supply network

over the next few years may provide new sourcing

opportunities for other sectors.

● Customer relationships. Although cost efficiency

is the principal area of vulnerability for manufacturers

in the region, it is not the only source of competitive

advantage. Respondents also point to brand strength,

local knowledge, flexibility and innovation. Customer

servicing, sales and marketing and product

innovation are the main investment priorities for

survey respondents.

Manufacturing in Central Europe is entering a new

era. But these differences are narrowing, and as a result,

the preoccupations of manufacturers there are changing

and maturing—from a focus on cheap labour to one on

cost efficiency, from expansion to consolidation, and

from growth by acquisition to growth through careful

cultivation of customers and products.

Executive summary




The development of manufacturing over the

past 15 years in the Central European countries

that joined the European Union on May 1st

20041 has been startling and has largely been

driven by foreign direct investment (FDI). Entire

sectors have been transformed by the influx of foreign

capital and expertise from states of bankruptcy or

obsolescence into efficient export-driven industries.

Both investors and their hosts have reaped

rewards. Local enterprises have accessed modern

business skills, new technology, foreign markets and

money for investment. For their part, the investors got

a skilled and educated labour force, eager to learn

modern skills and at a fraction of the cost of their

western counterparts, as well as a market of 100

million consumers bordering the EU. Some 80-90% of

Hungary’s manufacturing exports is now produced by

foreign owned subsidiaries, and similarly high figures

apply to the Czech Republic, Slovakia, Estonia and

almost every other country in the region (with the

possible exception of tiny Slovenia).

Favoured manufacturing locations have shifted

between countries over time and will continue to do

so. Hungary was the preferred manufacturing site in

the early 1990s owing largely to its political stability,

but wage levels have since soared. Poland with its

significant domestic market took over during the mid-

1990s, attracting companies that wanted a piece of

the country’s roaring growth rates, until the economy

slowed in 1999. The Czech Republic became a brief

favourite around 2000, after it had ended its political

paralysis and began privatising key sectors. Today

Slovakia, an erstwhile political pariah with a small

domestic market, has become the new magnet for

export-oriented manufacturers, largely on account of

its reform-oriented government and the lowest wages

in Central Europe.

The most dramatic change in the region’s

manufacturing base, and a development that will

continue to shape the business environment and the

economies of the region for many years, has occurred

in the automotive sector. It has attracted the most

foreign investment of any manufacturing branch. The

key player has been Germany’s Volkswagen (VW) which

acquired Czechoslovakia’s Skoda works in 1991 and set

up a major greenfield plant near Bratislava as well as

an Audi engine plant in Hungary which supplies VW

world-wide. Fiat (Italy) and Daewoo (South Korea)

also acquired substantial plants in Poland, but both

ran into severe difficulties by the end of the 1990s. In

the last couple of years a joint venture of Toyota-

Peugeot (Japan-France) has set up in the Czech

Republic, while Peugeot and Hyundai (South Korea)

are both building major plants in western and central

Slovakia, respectively.

Although the automotive sector has in many ways

become the pre-eminent industry of the region,

foreign manufacturers have also transformed a wide

variety of other sectors. These include food and other

fast-moving consumer goods (FMCG) producers, such

as Nestle (Switzerland), Kraft Foods (US), Henkel

(Germany), Procter & Gamble (US) and Unilever

(Netherlands), which have bought or built scores of

manufacturing plants in Central Europe.

The steel industry, which is battling with over-

capacity and EU quotas, is currently being transformed

by foreign investors. Indian-run LNM Group—the

world’s number two steel company—recently took over

huge but underused steel capacity in Poland, the

Czech Republic and Romania; and Pittsburgh-based US

The end of transformation?

1 The Czech Republic,Estonia, Hungary, Latvia,Lithuania, Poland,Slovakia and Sloveniajoined the EU in 2004.Bulgaria and Romania arecandidate countries andare scheduled to join in2007.




Steel has turned around the Kosice steel plant in

Slovakia, which is now the US firm’s most profitable

unit and the country’s number two exporter behind

VW. Hungary, in particular, has enjoyed substantial

investment from electronics producers such as Philips

(Netherlands), Flextronics (US), Sony (Japan) and

many others, while Thomson (France) has transformed

the Polkolor TV-making operation in Poland. The

stories are endless.

A few local companies have survived the foreign

competition, though many do so as secondary or

tertiary suppliers to the foreign multinationals.

However, some local firms, notably in the

pharmaceuticals sector, have held their own. Zentiva,

a merger of Czech Leciva and Slovakofarma (with

investment and management brought in by US private

equity fund Warburg Pincus), is strong in its home

markets; Gedeon Richter remains a major player in

Hungary; and Slovenia’s Lek held off foreign

competition until 2001 when it was bought by Novartis

(Switzerland) for a hefty $1bn, to name some of the

few examples.

As far-reaching as the transformation of Central

Europe’s industrial environment has been, differences

between the newer EU members and the older ones

remain profound. Wage differentials, for example,

remain startling. As one engineering firm points out, a

German engineer may cost some $85,000 a year to

hire; a Slovak, given a few weeks training, will work

almost as effectively for $15,000.

Political stability can also not be taken for granted

in the region. The new and prospective EU member

states still struggle to form stable and effective

governments, as political parties continue to be built

around personalities rather than policies and the

persistence of extremist groups in parliament force

moderate parties to form ideologically incoherent

coalitions. Fortunately today, the consequence of

political immaturity and paralysis are not as

significant as they were in the mid-1990s when

policies on such weighty matters as privatisation, for

example, had still to be instituted. But in less

developed countries, such as Ukraine or the western

Balkans and more importantly Romania, the new

target location for several firms, such shortcomings

are as important as ever.

Day-to-day operational hassles are also ubiquitous.

These include: availability, flexibility, mobility and

cost of skilled labour; the state of roads, rail and

waterways; the quality of the local supplier base; the

fragmented nature of distribution systems; weak

brand loyalty; low, albeit rising, purchasing power;

overly-cautious banks; and national markets that are

too small to justify sizeable investments in advertising

or marketing. Added into the old mix of problems is

new competition from other EU players that is leaving

firms, particularly food and confectionery producers,

with wafer-thin profit margins. And while chronic

delays at customs—a consequence of low wages,

bribes, poor certification procedures and poor

training—have diminished with EU entry, such

problems persist in the Balkan states.




Contrary to widespread expectations, the EU's

enlargement will not lead to a fresh surge in

FDI into the eight new Central European

members. These countries have already largely

achieved the main benefits of integration for

investment. According to a survey of 98 senior

executives in the region conducted especially for this

paper, manufacturing strategies after enlargement

focus more on consolidation in existing markets rather

than expansion into other markets.

According to research conducted by the Economist

Intelligence Unit in its annual World Investment

Prospects report, Central Europe’s FDI boom has

peaked. A sharp decline in FDI inflows to the new EU

member countries in 2003 can be seen as a harbinger

of a trend that will lead to a lasting shift in the

geographic distribution of FDI in Central Europe.

Average annual FDI inflows into the new EU

member states in 2004-08 are forecast at some $20bn.

FDI is expected to peak in 2005-06 with the

completion of some major outstanding privatisations.

After that, investment will be dominated by re-

invested earnings and follow-on investment by

existing FDI ventures. The share of the new EU

members in the Central and East European regional

total is expected to decline to below 50%, compared

with a share of almost two-thirds in the pre-2003

period. Economies in the Balkans and the

Commonwealth of Independent States (CIS), such as

Ukraine and, especially, Russia, will increase their

share of regional FDI.

Over the medium term, FDI inflows to the new EU

member states are expected to recover from 2003,

However, the danger of diversion of cost-sensitive

Now the hard work starts

What approaches will your company take to drive growth over the next three years? Please rate the importance of the followingapproaches to your company's strategic goals on a scale of 1 to 5, where 1 is critically important and 5 is relatively unimportant.

(% respondents)

1 2 3 4 5

Critically Important Relatively

important unimportant

1. Achieving growth through mergers and acquisitions 6 24 15 27 28

2. Building closer relations with existing customers 39 33 17 9 2

3. Developing new products and services 38 40 15 5 2

4. Entering new alliance relationships 14 36 22 21 7

5. Entering new geographical markets 13 25 25 28 9

6. Focusing on/leveraging core products and services 20 47 26 5 2

7. Improving distribution channels 25 23 31 14 7

8. Increasing advertising and marketing spend 11 23 31 31 5

9. Penetrating new customers markets 19 29 30 21 1

10. Spinning off and/or starting up new companies 5 14 16 33 32

11. Improving use of IT to drive better overall business planning 16 28 29 19 7




forms of FDI to even cheaper destinations looms larger

than any promise of more relocation to these countries

of investment from the West.

For labour-intensive, export-led manufacturers, the

focus is now ruthlessly directed towards controlling

wage and salary costs. Over three-quarters of the EIU

survey respondents expect modest rises in labour costs

in the region over the next three years. Of course,

wages are not expected to catch up with average EU

levels anytime soon.

The constant worry, though, is pressure from yet

lower wage locations. As wages in Slovakia eventually

rise, and the business environment improves in poorer

countries such as Romania, with a market of 23 million

consumers and all-in hourly wage costs per worker of

under $1, the latter markets start to hit many

corporate radar screens. And unlike in yet cheaper

Ukraine, political risks in Romania appear to have

diminished appreciably—with EU accession set for

2007.

Of course, the importance of costs varies according

to the nature of the manufacturing operation. Low

wages are often a drawback for companies looking to

sell into the domestic market, because they imply low

purchasing power. Plenty of manufacturers—

particularly in the food, drink and other FMCG sectors,

which do not export their output—are not overly

concerned by wage and other costs. As one

pharmaceutical company puts it: “Wages costs are

small—we never measure the ratio of wages to cost of

FDI flows, 2002-08

2002 2003 2004 2005 2006 2007 2008

Central Europe

Inflows (US$ bn) 22.2 10.1 15.1 18.8 21.6 16.3 17.3

% of regional total 60.4 38.4 39.9 43.5 45.8 37.4 36.9

Rate of growth (%) 34 -54.7 50.3 24.7 14.7 -24.4 5.9

% of GDP 6 2.3 2.8 3.2 3.5 2.5 2.5

Balkans

Inflows (US$ bn) 4.2 6.6 5.7 6.2 6.5 7 7.4

% of regional total 11.4 25.2 15.1 14.2 13.8 16 15.8

Rate of growth (%) -6.5 58 -13.5 8.1 5 7.7 6

% of GDP 3.7 4.6 3.2 3.2 3.1 3.1 3

Baltics

Inflows (US$ bn) 1.4 1.4 1.6 1.7 1.9 2.1 2.2

% of regional total 3.8 5.3 4.2 3.9 4.1 4.7 4.6

Rate of growth (%) 21.4 -1.7 16.4 4.7 14.7 7 5.9

% of GDP 4.9 3.7 3.6 3.3 3.4 3.2 3

CIS

Inflows (US$ bn) 9 8.1 15.4 16.6 17.1 18.4 19.9

% of regional total 24.5 31.1 40.8 38.4 36.3 42 42.6

Rate of growth (%) 24.1 -9.4 89.6 7.9 2.8 7.3 8.6

% of GDP 2.1 1.5 2.3 2.3 2.2 2.2 2.2Source: World Investment Prospects




sales, only headcount to cost of sales”. Some FMCG

producers note that they sell more goods in wealthy

Slovenia than in the Ukraine, which is 25 times larger.

For firms focused on the domestic market,

distribution looms largest on their agenda. According

to Petr Sulc, CFO of Czech pharmaceutical firm Zentiva,

finding distribution partners who can get the drugs to

the pharmacies quickly and consistently is the big test

of business. Even small countries do not always have

the benefit of well-developed national distribution

networks, and local distributors still play a

disproportionate role in getting goods into shops in a

relatively limited geographic area. The only significant

development in this respect has come with the arrival

For Brau Union, which recently merged with

the Central European business of Heineken,

the much-heralded advantages of locating

in the region—EU accession and low

wages—come rather low down the list of

priorities. EU accession has brought

improvement in some areas, notably by

reducing corruption and improving the

legal environment, says Josef Nagl, head of

business development for Brau. But in con-

trast with manufacturers looking for a

cheap export base to western markets, Brau

is primarily seeking countries with strong

growth potential in themselves, not only in

which to sell its international beers, but

also to acquire and develop popular domes-

tic names.

The company is the market leader in

almost every country it enters, selling both

local and international brands in all of

Central Europe, as well as Romania,

Bulgaria, Croatia and Macedonia. In

Poland—its largest market—it has sales of

some €800m, accounting for 38.5% of the

beer market. In Macedonia it has a 73%

market share. The company’s strongest

competitive advantage is its brands.

International names such as Heineken and

Amstel represent some 10-15% of volume

sold in these markets, with local brands that

are equally famous in their domestic

markets, such as Zywiec in Poland, Zlaty

Bazant in Slovakia and the century-old

Steffl in Hungary, accounting for the rest.

Brau’s operating concerns therefore are

not directed at keeping labour costs down,

but at promoting its brands, finding and

developing a strong local management with

a good understanding of the consumer, and

getting beer to the shops and bars quickly

and cheaply.

Roughly three-quarters of Brau’s volume

goes to hypermarkets and small outlets,

with the rest going to bars and restaurants.

The biggest obstacles are the region’s

distribution systems, which almost

everywhere (with the possible exception of

Poland) are still poorly developed. Typically,

the manufacturer must deal with many small

distribution companies that each serve a

limited geographic area, and numerous

small, poorly-organised wholesalers. In

Romania, for example, a large part of a

distributor’s client base are kiosks. Building

up one’s own distribution system would

therefore give Brau, or any fast-moving

consumer goods company, a strong

competitive advantage, especially for a

product like beer which cannot travel too

far, says Mr Nagl. Hypermarkets are

admittedly now changing the distribution

environment, but these bring new problems

for the manufacturer, namely tougher

conditions and thinner margins.

As for expansion plans, market size is the

key factor to consider. Although Brau is

present in small markets, this is often the

result of having acquired an existing

brewery in a single deal. Its market

dominance in Macedonia, for example,

comes from having acquired Pivara Skopje

in the privatisation process in 1995, rather

than through long-term organic growth.

The fragmented Balkan markets would

normally hold little interest for the

company, not least because it is difficult to

sell a local brand across borders. It would be

impossible to sell its Croatian Karlovacko

brand, for example, in Serbia. Nationalism

can still play a big part in the choice of beer

drinkers, says Mr Nagl. And there are also

transportation problems in Southeast

Europe to consider. Such shortcomings are

only worth dealing with if the market

potential is big enough. Thus Heineken

Group is active in Ukraine and Russia, for

instance, where it recently acquired the

Shikhan and Volga breweries, making the

company the third largest beer producer in

the country.

Brau unbeaten




of major hypermarket chains, which often prefer to

sign international contracts with suppliers—and tend

to push very hard bargains.

But for some, costs are everything. “We count

pennies and minutes of production time”, says George

Varmuza, managing director for Central and Eastern

Europe at Emerson, an electrical goods manufacturer.

To take one example, Emerson might sign a lucrative

$500m, five-year deal to supply motors to Whirlpool

(US), but the agreed price will decline by a couple of

percentage points every year, irrespective of the fact

that input costs of copper or steel, to say nothing of

wages, may rise.

Emerson represents one extreme of the

risk/market/cost equation. The firm exports almost all

of its output from its factories in the Czech Republic,

Poland, Hungary and Slovakia. Although Emerson set

up a plant in Slovakia in the mid-1990s to supply the

Whirlpool washing machine factory in the eastern

town of Poprad, the decision to move in-country was

largely aimed at dodging the difficult customs regime

at the time. But Whirlpool Slovakia only accounts for

10% of Emerson’s sales of washing machine

components, while 100% of output from other

divisions is exported to Western Europe.

In its next step down the labour cost ladder,

Labour costs per hour (US$)

Country 1998 1999 2000 2001 2002 2003 2004 2005

Bulgaria 0.61 0.61 0.59 0.61 0.73 0.91 1.03 1.18

Czech Republic 2.05 2.09 1.99 2.19 2.73 3.41 3.88 4.63

Estonia 1.64 1.74 1.66 1.82 2.12 2.79 3.33 3.81

Hungary 2.03 2 1.91 2.27 2.95 3.8 4.37 4.94

Poland 1.96 2.38 2.42 2.77 2.86 3.14 3.36 3.78

Romania 0.65 0.55 0.56 0.58 0.64 0.8 0.95 1.08

Slovakia 1.58 1.44 1.41 1.42 1.66 2.19 2.6 2.91

Slovenia 5.29 5.29 4.78 4.91 5.44 6.79 7.71 8.53

Source: EIU CountryData

What does your company see as its greatest vulnerabilities? (Choose up to three) (% respondents)

Cost efficiency

Access to new markets

Efficiency in regulatory compliance

Sales/marketing strength

Innovation

Quality of customer service

Trading partner collaboration

Lean manufacturing and supply chain

Access to finance

Brand strength

Quality of workforce

Flexibility

Knowledge of local markets

Quality of product/service offering

Other

31

25

20

22

16

16

16

15

14

14

13

12

10

10

6




Romania therefore is now looking very enticing. But

“we won’t touch Ukraine now”, says Mr Varmuza. “We

are a conservative, Midwestern company.” For such

manufacturers, the cost-stability line appears to be

drawn west of the CIS and east of the former

Yugoslavia. Beyond Romania (or Bulgaria), a cost-

conscious, risk-averse company like Emerson is more

likely to look to China, where it is already one of the

biggest US investors with an $800m operation

employing 20,000 workers. But although wages there

are lower, transportation costs to Western Europe tip

the scales back in favour of staying in Central Europe

for the time being.

That balance is less decisive for Sony, which makes

TVs in Trnava, Slovakia and audio-visual equipment in

Hungary. Sony’s electronic goods are relatively light

and easily packaged, so China is a credible alternative

to Central Europe, even for supplying West European

markets. Werner Student, head of manufacturing in

the region for Sony, reckons that Romania, Bulgaria

and even Ukraine will inevitably become interesting

simply for reasons of lower wage costs.

Many manufacturers are increasingly focused as a

result on cost efficiency, the point of greatest

vulnerability in the minds of the survey respondents.

The automotive sector in particular has blazed a trail in

rationalising supply chain costs, bringing in hundreds

of its foreign suppliers to relocate in the region, while

attempting to boost the performance of locally-based

secondary or tertiary suppliers. Most manufacturers

have increased their local sourcing volumes, some to

almost three-quarters of their total inputs.

But even after 15 years of transition, firms still

report difficulties finding local enterprises that can

match global quality standards for the more

sophisticated components. Even low-grade

equipment, such as lathes, which are made locally,

often lack durability, while in some instances, key

pieces of machinery do not even exist in parts of the

region. The struggle to find cheap suppliers that can

deliver on time and to the required standard will

continue for many years, even within the new EU-10.




As competition from other locations heats up,

and as the region’s cost-based advantages

gradually erode, manufacturers in our survey

are concerned primarily with consolidating

their position in the home markets rather than looking

further afield. 70% of respondents say that this is

important, and a third say critically so. Expansion into

new markets is certainly on everyone’s radar screens—

with 63% saying that it is important to them—but it is

not critical. If they do expand it will most likely be into

one of the new EU member states, while a notable 22%

of respondents believe that Russia and the CIS hold

the brightest prospects.

The need to build closer relations with existing

customers is critically important to 39% of

respondents, compared with only 19% who are

critically concerned with penetrating new customer

markets. Asked to identify their competitive

advantages, survey respondents pointed to brand

strength (cited by 39% of respondents as their key

competitive advantage); cost efficiency (35%);

flexibility (33%); innovation (33%) and product

quality (33%).

Companies are prepared to put their money where

their mouths are. Asked to list their investment

priorities, they rated developing customer service as

the most important, followed by sales and marketing,

and product development. Interestingly, the benefits

of technology investments are expected mainly in

product quality and customer relationship

The changing agenda

What are your company’s investment priorities over the next three years? (Choose all that apply) (% respondents)

Customer servicing

Sales and marketing

Product development

Human resources/training

Information technology

Supply chain/logistics

Manufacturing

Regulatory management

General management

Finance and accounting

Other

58

57

49

51

44

32

26

21

15

11

5




management, ahead of lower costs.

The importance of finding and hiring strong local

management with a good understanding of the

mentality of the local consumer is central,

particularly where brands are involved. Central

European consumers still tend to look at where a

particular product has been produced rather than

simply relying on the quality of the brand name. This

may be a throwback to communist days when the

quality of a product could be determined by the

specific plant that made it. But it may also reflect a

more recent nationalist phenomenon, whereby

consumers seek western quality but only in locally

produced goods. Such nationalist sentiments have

diminished with EU accession but cannot be

dismissed, and they remain particularly potent in

Southeastern Europe.

Giving local units decision-making autonomy is

therefore important. One drinks firm executive neatly

sums up the division of responsibilities: “Local

managers can take 100% of the decisions on local

brands. These account for some 60-80% of our total

brand portfolio. But decisions on international brands

are centralised.”

Cutting costs and servicing the cus-

tomer are occupying more manage-

ment time in the expanded Europe

than implementing new EU rules and

regulations. The EIU survey shows

that no compliance issue stands out

as being particularly troublesome,

although the usual suspects—envi-

ronmental, competition, corporate

governance, product certification

and intellectual property issues—are

listed as the more challenging.

These issues are of less concern to

most big foreign manufacturers,

which have global resources to draw

upon and have made the necessary

capital investments from the outset.

Most manufacturers are relatively

sanguine, with 56% saying that that

they are already fully compliant with

EU legislation and most of the rest

reporting that they will be ready by

2006. But a few admit to struggling:

While half of respondents expect the

cost of compliance to rise slightly

over the next three years, a notable

17% fear a dramatic increase.

Local, small and medium sized

enterprises in particular worry not

only about the financial costs but

also the time spent sifting through

hundreds of regulations and trying to

implement those that apply. In

companies without specialised

departments dealing with

compliance, managers report

spending an average of 5-10% of

their time just on environmental

issues. One Hungarian chemical

company reports: “We are extremely

busy implementing the

environmental directives and are

trying to meet compliance targets.”

Without in-house departments to rely

on, firms consult a broad variety of

sources, including the EU, industry

associations, the business press and

consultancies, usually online.

Calm about compliance




If corporate structures are any guide, EU

enlargement has not closed the gaps between

Europe’s western and eastern halves. The new

member states are not yet seamlessly integrated

with the EU-15 in most manufacturing companies, and

probably rightly so. The disparity in wages and other

costs and the still different operating conditions

between east and west within the EU remain the

defining feature of this region and as a result the

corporate approach must be different, say managers.

But Central Europe cannot rest on its laurels as a

low-cost manufacturing location. FDI flows are already

down; competition from inside and outside the EU is

intensifying; and the bulk of survey respondents see a

trend of modestly increasing labour costs and

regulatory requirements.

There are still untapped markets for manufacturers,

of course. Pharmaceutical companies, for example, see

plenty of scope in the region to sell generic drugs. “We

are extending primary care [and] creating new

markets”, says Petr Sulc, the CFO of Czech drugs firm

Zentiva, who points out that western markets are just

as fragmented and far more competitive than those to

the east. But the region is maturing and

manufacturers must mature with it.

In the short term, that means a focus on core

markets and existing customers. Over the longer term,

it entails introducing higher value added activities

into the manufacturing mix. The wave of automotive

investments into the region is helping in this regard—

it has been accompanied by the arrival of hundreds of

international components suppliers, and also boosted

performance of local engineering firms. The ripple

effects may soon reach other manufacturing

industries. Sony (Japan), which makes TVs and video

recorders in the region, for example, has suggested

that it may reconsider its global sourcing strategy for

some electrical components as a result of the arrival of

new auto components suppliers. And companies such

as Emerson envisage the region’s new automotive hub

as a potential market in itself.

Look up

How do you expect labour costs in your industry to change over the next three years?

(% respondents)

They will fall dramatically 0

They will fall modestly 8

They will stay the same 10

They will rise modestly 76

They will rise dramatically 6

How do you expect the regulatory burden in your industry to change over the next threeyears?

(% respondents)

It will decrease dramatically 1

It will decrease modestly 11

It will stay the same 29

It will increase modestly 40

It will increase dramatically 17

Don't know 2




Appendix: Survey results

In July/August 2004, the Economist Intelligence Unit conducted an online survey of 98 manufacturing industry

executives located throughout the EU accession and candidate countries. Our sincere thanks go to everyone who

took part in the survey.

Please note that not all answers add up to 100%, because of rounding or because respondents were able to

provide multiple answers to one question.

Demographics

What branch of the manufacturing industry does your company represent? (% respondents)

Pharmaceuticals and biotechnology

Consumer goods

Automotive and transport

Chemicals

Electronics

Electrical engineering

Food and beverages

Machinery and equipment

Metals

Paper and packaging

Plastics

Textiles

Other

19

9

8

6

5

4

3

3

1

0

0

0

41


APPENDIX: SURVEY RESULTS



How many employees does your company have across all locations?

(% respondents)

Under 100 29

100-1,000 23

1,000-5,000 19

5,000-10,000 2

10,000-20,000 10

20,000-50,000 4

More than 50,000 12

In which country are you located? (% respondents)

Hungary

Czech Republic

Poland

Croatia

Lithuania

Romania

Slovakia

Slovenia

Bulgaria

Estonia

Latvia

Other

21

20

13

5

4

4

2

2

0

0

0

29





Which of the following titles best describes your job?

(% respondents)

CEO/COO/Chief executive/Managing director 31

Other manager 10

Director/VP of marketing 8

Other director/VP 7

CFO/Treasurer/Comptroller 6

Director/VP of sales 5

Supply-chain manager 4

Chairman/President 3

CKO/CIO/Technology director 3

Director of planning/manufacturing 3

IT manager 2

Director of research and development 2

Other 15

Where else in Central and Eastern Europe does your company have operations? (Choose all that apply) (% respondents)

Poland

Russia

Slovakia

Czech Republic

Romania

Hungary

Croatia

Ukraine

Bulgaria

Slovenia

Latvia

Turkey

Estonia

Lithuania

Other

56

55

53

55

44

43

41

39

36

35

34

34

33

33

21





Competitive challenges and corporate priorities

What does your company see as its main competitive advantages? (Choose up to three)

(% respondents)

Brand strength 39

Knowledge of local markets 37

Cost efficiency 35

Flexibility 33

Innovation 33

Quality of product/service offering 33

Quality of workforce 26

Sales/marketing strength 26

Quality of customer service 22

Access to new markets 16

Efficiency in regulatory compliance 12

Access to finance 7

Lean manufacturing and supply chain 6

Trading partner collaboration 3

Other 1

What percentage of your company’s turnover comes from your domestic market? (% respondents)

Less than 5% 18

5%-10% 4

10%-25% 11

25%-50% 9

50%-75% 16

Over 90% 25

75%-90% 17

Will EU enlargement benefit your company?(% respondents)

Yes 84

No16





What are your company’s strategic priorities after EU enlargement? Please rate the importance of each of the following on a scale of 1to 5, where 1 is critically important and 5 is relatively unimportant.

(% respondents)

1 2 3 4 5

Critically Improtant Relatively


1. We will seek to consolidate our position in our home market 29 13 28 14 6

2. We will seek to expand into other Central European EU member states 13 26 24 16 13

3. We will seek to expand into West European EU member states 7 20 22 23 15

4. We will seek to expand beyond the EU 15 18 18 12 25

What does your company see as its greatest vulnerabilities? (Choose up to three) (% respondents)

Cost efficiency

Access to new markets

Efficiency in regulatory compliance

Sales/marketing strength

Innovation

Quality of customer service

Trading partner collaboration

Lean manufacturing and supply chain

Access to finance

Brand strength

Quality of workforce

Flexibility

Knowledge of local markets

Quality of product/service offering

Other

31

25

20

22

16

16

16

15

14

14

13

12

10

10

6





What approaches will your company take to drive growth over the next three years? Please rate the importance of the followingapproaches to your company's strategic goals on a scale of 1 to 5, where 1 is critically important and 5 is relatively unimportant.

(% respondents)

1 2 3 4 5

Critically Important Relatively


1. Achieving growth through mergers and acquisitions 6 24 15 27 28

2. Building closer relations with existing customers 39 33 17 9 2

3. Developing new products and services 38 40 15 5 2

4. Entering new alliance relationships 14 36 22 21 7

5. Entering new geographical markets 13 25 25 28 9

6. Focusing on/leveraging core products and services 20 47 26 5 2

7. Improving distribution channels 25 23 31 14 7

8. Increasing advertising and marketing spend 11 23 31 31 5

9. Penetrating new customers markets 19 29 30 21 1

10. Spinning off and/or starting up new companies 5 14 16 33 32

11. Improving use of IT to drive better overall business planning 16 28 29 19 7

Which market offers the brightest prospects for your company over the next three years? (Choose one response)(% respondents)

The EU 45

Other 7

Other AsianMarkets 1

North America 6

China 19 Russia and the CIS22

Companies from which market pose the biggest competitive threat to your company over the next three years? (Choose one response)(% respondents)

The EU 52

Other 4

Latin America 1

Other Asianmarkets 5

Russia andthe CIS 9

China 9 NorthAmerica 12

India 7

How do you expect labour costs in your industry to change over the next three years?

(% respondents)

They will fall dramatically 0

They will fall modestly 8

They will stay the same 10

They will rise modestly 76

They will rise dramatically 6





How do you expect the regulatory burden in your industry to change over the next three years?

(% respondents)

It will decrease dramatically 1

It will decrease modestly 11

It will stay the same 29

It will increase modestly 40

It will increase dramatically 17

Don't know 2

What are your company’s investment priorities over the next three years? (Choose all that apply) (% respondents)

Customer servicing

Sales and marketing

Product development

Human resources/training

Information technology

Supply chain/logistics

Manufacturing

Regulatory management

General management

Finance and accounting

Other

58

57

49

51

44

32

26

21

15

11

5





Challenges of compliance

11. When will your firm be in compliance with the relevant areas of EU legislation - the acquis communautaire (excluding areas wheretransition periods apply)?

(% respondents)

We are already fully compliant 56

We will be in compliance this year 7

We will be in compliance next year 10

We will be in compliance in 2006 6

We will be in compliance later than 2006, but within five years 7

We will not be in compliance within five years 1

Don’t know 12

In which areas of your business do you expect to see the greatest benefits from your investment in technology? (Choose up to three) (% respondents)

Better quality of products and services

More successful customer relationship management

Lower costs

Improved sales and marketing

Improved knowledge management

Easier collaboration with partners and suppliers

Increased innovation

More efficient supply-chain management

Better financial management

Enhanced back-office systems and networks

Better control of regulatory issues

Increased productivity from mobile and remote workers

Other

47

41

30

39

29

28

27

26

23

19

13

7

0





13. What costs has compliance with the acquis entailed for your company?

(% respondents)

Insignificant 14

Modest 47

Substantial 19

Don’t know 20

14. How will your company’s compliance costs change over the next three years? (Choose one response)

(% respondents)

Compliance costs will fall sharply 2

Compliance costs will fall slightly 13

Compliance costs will remain the same 18

Compliance costs will rise slightly 49

Compliance costs will rise sharply 4

Don't know 14

What areas of the acquis have posed the biggest challenges for your company? (Choose up to three) (% respondents)

Environmental protection

Competition rules

Corporate governance/reporting

Product certification

Intellectual property

Consumer protection

Don't know

Taxation

Workforce representation

Workplace health and safety

Product liability

Product labelling and packaging

Customs and excise, import and export

Other

27

26

18

24

17

17

17

13

12

12

11

9

8

0





What are your company’s main sources of information on EU compliance issues? (Choose up to two) (% respondents)

EU

Consultancies

General business press

Local industry associations

Government

Country-based EU delegations

Trade press

Other

21

20

15

19

11

7

6

1

How do you access information on EU compliance issues? (% respondents)

Mainly throughprint media 9

A combination of all these37

Throughthird parties(i.e. legal firms)12

An even mixof print andonline sources20

Mainlyonline22

Whilst every effort has been taken to verify the

accuracy of this information, neither The Economist

Intelligence Unit Ltd., Oracle nor their affiliates can

accept any responsibility or liability for reliance by any

person on this white paper or any of the information,

opinions or conclusions set out in the white paper.

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Manufacturing strategies in Central Europe The challenge of

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