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Global Economic Report

Eastern Europe: The growth continues

By Greg Farnum

Europe today is making history with treaties, not tanks. It has opened new markets and transformed repressive societies through negotiations and the promise of economic growth, rather than through battlefield might. A powerful example of this is the recent series of accession treaties that have dramatically expanded the European Union. On May 1, 2004, accession treaties brought the former communist ruled lands of Poland, Hungary, the Czech Republic, Slovakia, Slovenia, Estonia, Latvia and Lithuania, along with Malta and Cyprus, into the EU. The treaties commit these nations to maintaining both a stable democracy with respect for human rights and a functioning market economy capable of competing within the Union. On Jan. 1, 2007, similar treaties went into effect for the former communist dictatorships of Bulgaria and Romania. The new EU has a population of 493 million, and its combined GDP of 11.6 trillion euro ($15.7 trillion) makes it the world's largest economy.

Here's another number to conjure with: 32.5 billion euro. That's the amount of direct foreign investment the ex-communist states of Eastern Europe received in 2006 alone. Low wages, high skill levels and the fact these nations are now part of the EU's single market have drawn numerous global manufacturers. This includes, notably, the auto industry: Hyundai, Kia, PSA Peugeot Citroen, Volkswagen and other car companies are building new assembly plants with a combined estimated price tag of over 4 billion euro. Existing plants are being upgraded. Suppliers are opening new facilities in the region almost daily.These companies are aided by the fact that Eastern Europe has a long manufacturing history, one which includes machine tool building, especially in Poland, the Czech Republic and Romania. Though primarily serving their local markets, each country also exports machine tools.

The European Union is meticulous about gathering statistics on its industries, but these statistics arent available for the Romanian industry since the country only joined the EU in March of this year. The statistics that do exist raise questions--supposedly the country produced precisely $59.3 million worth of machine tools in both 2006 and 2005. It's clear, however, that the industry is significant and eager to export, most of which is handled through Meximpex SA, located in Bucharest. Hydraulic press brakes, guillotine shears, and open-and-closed-bed hydraulic and mechanical presses are among the Romanian-made machine tools that Meximpex offers for export. These, along with metalcutting machines, can be viewed on the company's website: www.romanianbearings.ro. Meximpex also exports Romanian-made machine tool components, fasteners and bearings and imports Western machine tools and other industrial equipment.

Indicative of the internationalization of Eastern European industry is the fact that one of Romania's leading machine tool component firms is Wisconsin Precision Components. The company was known as Titan Componente de Precizie until it was bought by Wisconsin Machine Tool Systems of Brookfield, Wis., in 1999. It makes precision ballscrews up to 12 m long, sells them to local machine tool builders, and exports to the United States and Western Europe.

Poland's machine tool industry is larger, its product valued at over 200 million euro in 2005. (Figures given in euros include the value of components and tooling, as well as machine tools.) In the same year its machine tool imports came to roughly 600 million euro. The simpler and cheaper machine tools manufactured in Poland sell fairly well, both domestically and to foreign buyers looking for basic functionality at a low price. In recent years a number of Polish machine tool companies were acquired, in whole or in part, by Western firms.

The big player in the region in terms of machine tool production is the Czech Republic, the site of heavy manufacturing since the region was part of the Austro-Hungarian Empire. Fueled by rapid expansion in the automotive sector, local production hit 294 million euro in 2005 and consumption reached 387 million euro, up 25 percent from 2001. Large, mostly foreign-owned companies are the biggest consumers, but there is considerable demand from the country's many small and medium-sized enterprises.

Several of the nation's machine tool companies are internationally competitive, including OSO Olomouc (CNC knee-type milling machines), Skoda Machine Tools (CNC lathes), TOS Kurim, and ZPS. A builder of lathes and machining centers, ZPS produces more machines per year than all of the other Czech machine tool makers combined. This is in part because ZPS focuses largely on inexpensive vertical machining centers, many of which it exports to the rest of Europe and to the United States. The company has a U.S. office, ZPS-CNC USA Inc., in Wauconda, Ill.

The biggest supplier of foreign machine tools to the Czech Republic, and probably to the entire region, though figures on this are hard to come by, is Germany. Many German machine tool companies have offices in the country, and Trumpf has recently opened a production plant for laser cutting systems in Liberec. The German companies compete not on the basis of cost, but on quality, capability, proximity and reputation.

Outsourcing the outsourcing
Will Eastern Europe's cost advantage last? According to the Federation of European Employers, wages in the Czech Republic have risen 45.5 percent since 2002. In Hungary there has been a 70.1 percent increase. In Slovakia hourly wages have jumped 67.6 percent during this period. In Poland there has been a less dramatic but still substantial 29.8 percent increase. French wages, by comparison, have risen 17.9 percent during this period, and wages in the Netherlands have gone up 20.7 percent.

In addition, a new phenomenon has occurred: localized labor shortages. This has resulted from the fact that many thousands of Easterners have gone to Western Europe in search of higher wages, coupled with the rapid expansion of industry in the East. If this continues it may act as an upward pressure on wages.

Some firms have responded by looking further east for even cheaper labor. Delphi, for instance, has started investing in the Ukraine. Czech and Polish manufacturers have begun to explore cutting their costs by outsourcing some of their production processes to lower-wage countries. Eastern European die and mold makers, whose low cost has been seen as a threat to their Western European counterparts, are already seeing some of their work outsourced to India and China.

Nonetheless, it doesn't appear that capital is going to bypass Eastern Europe any time soon. Even with recent pay hikes, the average Czech worker still earns only 20 percent of what his counterpart in Germany makes. Add to this Eastern Europe's relatively high education and skill levels and its proximity to Western European markets, and it's a safe bet that the region will continue to see industrial growth for some time to come.

There is another factor that may act as at least a partial brake on oursourcing. CBI is an import promotion agency that is sponsored by the Dutch Foreign Office. As part of its work it monitors European markets and in its recently published survey, "The Engineering Products Market in the EU, 2006," it reported that China is looking less attractive to some European customers because of negative experiences in the past.

These include legal problems with industrial property rights; Chinese joint venture partners that bypass the agreed sales channels and offer the same products at lower prices to other outlets; bribery; and a quality that might be fine overall, but that can vary from shipment to shipment.

Eyes wide open
The CBI survey goes on to offer some practical advice to companies thinking of selling to European firms. The European market, and this includes its new Eastern members, are characterized by what CBI calls high logistic demands. That means lead times are short and becoming shorter, and delivery reliability must approach 100 percent. Suppliers are expected to be flexible and the response time following a request for a quote must be minimal and predictable. In order to consistently hit the mark in terms of delivery times and cost, they recommend using the services of a shipping agent with a proven track record.

The nature and extent of EU regulations regarding the packaging and labeling of products to be shipped can come as a surprise. While some Americans might find them cumbersome, they are designed to enhance conservation and safety and to ensure that products reach their destination in optimal condition. Armed with a little patience, anyone interested should be able to find the applicable packaging and shipping regulations on the Internet. The best place to start is the U.S. Commercial Service's Web site on its EU standards and regulations page. (The U.S Commercial Service also maintains helpful Web sites for Americans thinking of doing business in Eastern Europe, and these can best be searched for by name: "Doing Business in Poland" and "Doing Business in Hungary.") And if shipping from abroad, the CBI recommends using air freight whenever possible. Sure, it's expensive, but the value of a small engineered product is typically far greater than the air freight. Of course large or bulky shipments still need to be sent by sea.

When planning on selling into the region, designate someone to lead the Eastern European sales and marketing effort. In other words, make someone accountable. If an organization lacks experience in getting shipments through customs, it's important to gain that knowledge early in the process. Also, make sure that the executives and office personnel are aware of the export effort and, when relationships start to develop, be aware of who they might be dealing with. And of course responses to questions, RFQs and complaints must be prompt. All of this will take a concerted effort on the part of top management to initiate and maintain.

Scott Sneckenberger, senior manager at the accounting and consulting firm Plante & Moran LLP, Southfield, Mich., also has some advice for manufacturers wishing to do business in Eastern Europe, but his is of a more cautionary tone.

"Items to keep in mind when it comes to outsourcing products are logistics costs and total landed cost," stresses Sneckenberger. "Often we see clients and others enter into a contract with what they view as a low cost provider of a certain part in Eastern Europe. They say, 'Hey, this is great, I was paying a dollar for this part in the United States and I can get it for 42 cents in Eastern Europe.'"

In Sneckenberger's example, the U.S. customer figures that shipping this part will add an additional 20 cents to its cost. This, however, is typically figured on the basis of shipping a full container. In the real world, he says, manufacturers must often ship in containers that are only partially full, which raises the shipping cost of each part. "In fact, most of the time there is going to be a need to ship in a partial container, and this could bring the shipping cost up to 40 cents per part.

"So all of a sudden the cost is 82 cents instead of 42 cents," he explains. "And then if a hiccup occurs in the process, such as the part needing a little bit of rework because of an engineering change that occurred while the part was in a container crossing the ocean or a shipping delay causing you to have to order some expedited parts from a local supplier, all of a sudden you could be looking at additional costs instead of cost savings. We've heard companies say if that happens they will be able to bill for their extra cost. Well, that may be true and it may not be, but this is something that certainly should be considered. That's why we caution people to make sure you look realistically at the total landed cost and not just at the number that comes back on a per-part basis on an RFQ."

Sneckenberger also cautions clients who might be thinking of opening a plant in Eastern Europe. "They should be aware that the infrastructure in the former Communist countries of Eastern Europe is not advanced." This can be physical infrastructure like roads and airports, the banking system, or the legal and regulatory environment in which businesses operate. "The process of incorporation, for instance, and the process of hiring employees can be long and cumbersome. Similarly, the process involved in purchasing a plant or in getting permission to build a Greenfield plant will take a lot longer than it would here. There's a lot of red tape that you have to get through, and it can be frustrating, because it's not something that we typically see here in the United States, not anywhere near the extent that you see it in Eastern Europe.

"Their economic development folks are very good marketers," Sneckenberger continues, "but when it comes to putting the rubber to the road and making an investment, you need to be very patient and keep your eyes open." FFJ

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