outside in one new message intelligent life transform · one new message is social media really the...

One new messageIs social media really the

saviour of business?

Outside inThe rise and rise of public-to-

private equity deals

Health checkTaking the temperature

of pharma in CEE

Intelligent lifeHow Russia’s “innovation

city” will inspire the region

Insight for CEE’s business leaders

Bridging the gapSpecial report: Building CEE’s future fabric

Transform Issue 6/Autumn 2010

Adviser of the Year

to Private Equity

in Central & Eastern

Europe

www.pwc.com/cee/private-equity

unquote” has named PricewaterhouseCoopersAdviser of the Year to the Private Equity industry in Central & Eastern Europe.

The unquote” CEE Private Equity Awards recognise excellence in the CEE private equity market. In a highly challenging environment over the past year, we were among a few select firms that still managed to achieve above-par success.

PricewaterhouseCoopers helps more private equity houses to realise the unique investment opportunities in Central & Eastern Europe than any other adviser in the region.

For more information please contact:

CEE Private Equity LeaderMike WilderTel: +48 22 523 [email protected]

Czech RepublicMiroslav BratrychTel: +420 251 15 [email protected]

PolandJoanna SimonowiczTel: +48 22 523 [email protected]

RussiaJonathan ThorntonTel: +7 495 232 [email protected]

© 2010 PricewaterhouseCoopers. All rights reserved. “PricewaterhouseCoopers” refers to the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity.

3

F R O M T H E C E O

As trusted advisers to leading

businesses across the globe, we at PwC

often experience first hand the game-

changing events of the corporate world.

The global economic downturn has

led to a ‘brave new world’ that we and

our clients operate in now. In CEE the

financial crisis has had an added potency, offering, as it does,

a new perspective on the region’s honeymoon with capitalism

after so long under socialism.

The financial crisis doesn’t mean the end of capitalism but it

does mean a fresh start. This amounts to a new economic

environment, intensified by the greater immediacy of climate

change, new technology, tougher competition, increased

regulation, demographic issues and government involvement

in the economy.

These factors make it

imperative to transform

our businesses and

reinvent ourselves.

Inventiveness and

innovation will be key to

any business’s success

in the post-crisis future.

We ourselves in PwC

CEE are undergoing a process of change, setting a bold vision

of our future firm and articulating the changes necessary to

realise that vision.

The core principle of this vision is to enable our clients, to

help them prepare for and profit from the new era. This issue

of Transform magazine features a number of fascinating

organisations, businesses and leaders, all grappling with

today’s complex issues and turning them into opportunities.

I hope these stories provide some food for thought and help

you build a resilient business for the future.

PricewaterhouseCoopersCENTRAL AND EASTERN EUROPE

CEO:Mike Kubena

MANAGING PARTNER ADVISORY: Mark Okes-Voysey

MANAGING PARTNER ASSURANCE: Rick Munn

MANAGING PARTNER TAX & LEGAL SERVICES: Steven Snaith

PwC CONTRIBUTING EDITOR: Donall O’Shea

COVER IMAGE: PHOTOLIBRARY

Brave new world

Mike Kubena

pwc.com/transform

Inventiveness and innovation will be key to any business’s success in the post-crisis future

06 UpfrontAwards spotlight the response of Czech entrepreneurs to the financial crisis; call for Hungary’s SSCs to develop beyond the capital; PwC Russia launches technology and innovation centre; new man at the top at PwC Czech Republic; PwC forms JV with operations management consultancy firm; PwC wins Adviser of the Year award for private equity in CEE

10 CommentDemographic dilemma

Aging and declining populations are presenting major socioeconomic and business challenges for the CEE region

4

CONTENTS

CAPITAL PROJECTS AND INFRASTRUCTURE

12 IntroductionActivity in CEE’s capital projects and infrastructure sector is on the rise. PwC partner Tibor Almássy sets the scene

13 Managing the unmanageable

New energy infrastructure is a high priority in CEE. To achieve success, cooperation between the public and private sectors is key

16 The nuclear optionNuclear power is making a comeback in CEE. But CEE governments and energy companies first need to navigate a number of hurdles

19 The ride aheadPwC’s Mark Okes-Voysey calls for the creation of a new government body to oversee Russia’s infrastructure shopping list

20 CEE on the move?Private public partnerships could be the answer to CEE’s transport infrastructure needs, provided best practices are adopted

13 2025 Comment

Roadside assistanceeEncouraging local production could provide the required boost to get Russia’s car market motoring again

26 Micro-businessesSmall, and perfectly formed

Micro-businesses are contributing to the growth of several CEE economies – however, government support for them is vital

30 Company profileForging ahead

Polish copper mining company KGHM sets out plans for major global growth

34 InnovationMind and matter

Why a new knowledge city could put Russia on the innovation map

38 Climate changeLighting the way

Regulation and taxation can help CEE make its economy greener, but how?

26

Published by Bladonmore (Europe) Ltd T: +44 (0)20 7631 1155 E: [email protected]

5

42 Pharmaceuticals Healthy prospects

The international pharma industry has already shown a commitment to CEE. What can governments do to deepen that relationship?

46 Private equityPublic to private

Why the number of public-to-private transactions is on the rise in CEE

50 Social networkingTotally wired

It is time that companies recognised the business potential of social networking sites

54 Data centreA focus on economic facts and figures from across the CEE region

The potential of social networks was recognised only half a year ago. Now big companies use Facebook applications

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42

50

30

46

34

EDITOR: Eila Madden MANAGING EDITOR: Sean Kearns SUB-EDITOR: Lynne Densham ART EDITOR: Ivelina Ivanova PRODUCTION MANAGER: Andrew Miller PUBLISHER: Siân Mansbridge

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Upfront >>>Upfront >>>

“Crisis”, as the proverb goes, “is opportunity” – a maxim that the Czech winners of the

“In Defiance of Crisis Awards” would agree with. The 10 winners (see box below) of the inaugural awards for small or medium-sized privately owned businesses were recognised at a June ceremony at PwC’s offices in Prague, for their creativity and innovation in response to the financial crisis.

Working with the Czech Chamber of Commerce, PwC Czech Republic was the main expert partner for the awards, devising the methodology used to assess applicants’ online award submissions. PwC partners visited the shortlisted companies to interview the company owners. Petr Zmátlík, director in assurance at PwC Czech Republic,

coordinated this process, while PwC Czech Republic managing partner Jirí Moser oversaw PwC’s involvement in the project and presented the awards.

Travel company Exim Tours, the overall winner, was recognised for its decision to focus on high-end customers which helped stabilise demand, for its investment in the development of its employees to secure high-level customer care, and for implementing an online booking system that helped cut costs. Exim also won the education and travel award category.

More than 30 companies were shortlisted for the 10 category awards, with a panel of four judges making the decision in consultation with an expert company advising in each category. At the awards ceremony, all the companies involved were invited to vote for the most inspiring project, with the winner – co-owner of Rodinný pivovar Bernard, a beer company that launched a new, non-alcoholic plum beer to the market during the financial crisis – picking up his award at the end of the evening. "We see the award as a recognition that all the activities we undertook were successful and correct," said Stanislav Bernard. "Consequently, we have introduced another new product to the market – a non-alcoholic beer called Bernard's Clear Head Sour Cherry."

The ultimate aim is to use the top ideas as best-practice models for other small and medium-sized companies in the Czech Republic, where SMEs account for a large proportion of the economy. The SME sector is credited with having helped the country weather the financial crisis better than many other EU economies.

For more on SMEs, see p.26.

Czech awards recognise SME innovators

AND THE WINNERS ARE…

Main winner Exim ToursMost inspirational project Rodinný pivovar BernardConstruction and engineering Isolit-Bravo Education and travel Exim Tours Food and beverages Rodinný pivovar Bernard Healthcare Linet IT WBI Systems Manufacturing/industrial products 5M Mechanical engineering, electro Zikmund electronics Professional services Moris design Transportation and telecommunication Dial Telecom Trade TPT Coating

Jury Petr Kužel, president, Czech Chamber of CommercePetr Zmátlík, director, assurance, PwC audit, Czech Republic Jindrich Soukup, vice rector, University of Economics, Prague, Czech Republic Pavel Finger, financial director, CCB – Czech Credit Bureau

Best in class: Exim Tours executive director Romana Slížková accepts

the main winner’s award

ˇ

ˇ

Hungary should develop the infrastructure and living standards of a second city beyond its capital, Budapest,

if its shared service centre (SSC) sector is to continue thriving, says Gyula Bunna, a director in PwC Hungary’s advisory practice.

Hungary’s SSCs should branch out from Budapest

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TIME TO REBOOTHUNGARY’S SSC SECTOR AT A GLANCE PwC has launched a Center for Technology and

Innovation (CTI) in Russia, in response to Russian President Dmitry Medvedev’s call for more high-technology businesses in the country.

The CTI opened in October last year and aims to provide leading-edge research on technology trends and encourage the exchange of talents between Russia and the US – the centre is modelled on PwC’s existing CTI in San Jose, California and the two centres will work closely together.

“By talking to Russian stakeholders, companies and the government, we identified a number of areas where we could concentrate our expertise. These included government policy on stimulation and innovation, building innovation clusters and regions and investigating how technology can help small businesses,” explains Ekaterina Shapochka, a PwC director in Russia.

The centre has already published a Russian edition of the Global Technology Forecast. Having initially translated the quarterly PwC publication into Russian, the CTI in Russia then went a step further. “We involved Russian experts and interviewed Russian companies to gain their perspective on global technology trends,” says Shapochka. “It’s a very interesting platform, where we are bringing political and technological cultures closer together.”

So can Russia lead the way in developing innovative technologies, in line with Medvedev’s call to action? “The combination of good financial investment, a clear strategy and the necessary resources means the country has every chance of success,” she says.

The CEE state is already a location of choice for multinational companies that want to set up SSCs specialising in transaction-based work in support functions such as human resources and finance.

A recent market intelligence survey conducted by PwC – the first of its kind in the Hungarian sector’s 10-year history – revealed that the country’s 80 centres collectively employ 30,000 people, and the various taxes that the industry pays account for 1.2% of the central state budget.

The survey found that 80% of the SSCs that were assessed are currently in the expansion phase of their life cycle, with their well-established operations enabling them to shift focus towards high-end, value-added activities such as customer service and treasury support. That expansion could potentially create more than 2,000 extra jobs within the next two years.

Cost arbitrage and a highly educated talent pool are two of the main reasons attracting investors to Hungary, but Bunna believes current costs are not as cheap as they used to be.

“Today, from a simple cost arbitrage viewpoint, Hungary is not the best location,” he says. “However, we are seeing more and more SSCs come to Hungary because they feel it’s a safe place to be.”

Hungary should not rest on its laurels, however. To maintain its cost arbitrage advantage, Bunna believes that in the next two years the country should build up the image and infrastructure of one secondary city so that it can still offer investors the winning combination of lower costs and strong infrastructure.

Contribution to central state budget

1.2%Predicted job creation

more than

2,000 new jobs in the next two years

Number of SSCs

more than 80

Employees with university or college degree

more than 80%

Total number of employees

30,000

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Upfront >>>

Domestic companies in the Czech Republic can expect a charm offensive from PwC after the firm there

appointed its first ever Czech national as country managing partner. Jirí Moser, a lifelong PwC employee, took over the role from Stephen Booth in the spring. We spoke to him about his plans for the Czech practice.

What is the significance of a Czech national heading PwC Czech Republic?The Czech economy is quite open. Of the top 200 companies here, 70%-80% of them are multinationals. In the past, the management of these companies was foreign but as the business community matures, we are seeing more and more Czech managers. I’m the first Czech national to lead PwC in the Czech Republic. The biggest advantage is that I understand the culture and speak the local language.

How will you build on your predecessor’s success?We are currently very strong in all three lines of service – assurance, advisory, and tax and legal services. What we need to do is find new opportunities in the market and grow the business – hopefully by building relationships in the local market. So we will carry on with the good stuff that has been done in the past and just take it one step further.

What are your short-term goals for the Czech practice? As well as implementing PwC’s global and regional strategies, we need to develop a specific action plan for the Czech market. We will also focus on

New leader for PwC Czech Republic

developing specific industry solutions for our clients. We have identified nine industries that we want to focus on, including the public sector and energy.

And longer term?We did a CEO survey among 70 companies operating in the Czech market. Combined with responses from PwC’s global CEO survey, the feedback indicated that the economy should stabilise and be growing in somewhere between six and 12 months’ time. We have to position and prepare ourselves for times of growth. In five years’ time, we want to be at least 50% bigger than we are now.

Do you foresee any challenges in trying to achieve these goals?The biggest challenge is the development of our people. We need to create a culture of success, develop our key talent and really think about how to train the whole firm.

Should clients and colleagues expect to see a change in the way the Czech firm is run now?What I really want to do is raise our profile in the local community, both personally and as a practice. And then in line with the global strategy, we want to change our culture to be more client-orientated, more collaborative and more orientated towards success.

In five years’ time we want to be at least 50% bigger than we are now

MOSER’S RISE THROUGH THE

PWC RANKS

2010 Appointed country managing partner for PwC Czech Republic

2006 Becomes advisory leader for PwC Czech Republic

2002 Appointed leader of the Performance Improvement business unit across CEE

2001 Makes partner and becomes leader of the Performance Improvement Group in Prague

1995 Moves to the UK for a year and a half-long secondment in PwC’s London office

1994 Joins PwC (then Coopers & Lybrand) in Prague after gaining a PhD in scientific computations

ˇ

PwC has launched a new venture to help manufacturing clients across CEE cut costs and improve operational

efficiency on the factory floor. New services offered by PwC Operational Excellence – a subsidiary set up in partnership with manufacturing consultancy Competitive Capabilities International (CCI) – will help clients save as much as 2%-3% of annual revenue every year.

The new venture will offer manufacturing clients access to TRACC – an integrative improvement management solution developed by CCI to drive continuous improvement in manufacturing processes. It is particularly effective when applied to processes where downtime or a shutdown would cause major difficulties.

“TRACC is primarily a repository of best practices built up over 20 years from 1,000 companies,” says Andrew Friars, managing partner, advisory, in PwC Poland. It is already used by several leading companies, including SABMiller, Coca-Cola and DuPont, across 55 countries.

PwC Operational Excellence is expected to revolutionise the way PwC can help manufacturing clients to improve performance.

“Traditionally in the manufacturing sector we have had a limited set of offerings to take to our clients,” says Friars. “Typically, we have done work around tax, finance and the supply chain, but the

majority of their cost base isn’t in the back office, it’s on the factory floor. As we are developing our consulting business, we are building capabilities around performance improvement processes such as LEAN and Six Sigma. We want to take our clients to world-class excellence where they will have integrated these improvement initiatives across their entire value chain. The TRACC solution focuses on continuous improvement by driving change, reducing cost and increasing capacity in the biggest cost base of the business.”

Friars says market response has been positive and a pipeline of opportunities is developing. Future plans include adapting TRACC for back office processes (including HR and admin, supply chain and sustainability) and non-manufacturing industries.

PwC has been named Adviser of the Year at the third annual unquote” CEE Private Equity Awards.

The award was made following a vote by readers of unquote” and, according to Kimberly Romaine, editor-in-chief of the private equity news site, PwC came out “heads above” its competitors in the poll.

“We allowed the CEE readership of unquote” to decide on the winner and PwC came out heads above,” she said.

Mike Wilder, the leader of PwC’s transactions group in CEE, collected the award on behalf of the firm at a ceremony in London on 20 May, following the unquote” CEE Private Equity Congress.

“PwC has been in the region longer than most, so pretty much anybody who does private equity in CEE will have worked with PwC,” added Romaine, explaining why PwC had fared so well. “Knowing and working with the major players, they’ve obviously worked on the largest and most significant deals in the region.”

Although the event has been running for several years, it was the first time that an Adviser of the Year category had been included. However, Romaine said the success of the category means that it will be included again in next year’s event. Words by Dominic Dudley

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Clients on TRACC to improve performance on factory floor

Adviser of the Year win at private equity awards

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Demographic dilemma

CEE is facing the biggest population decline in the world. As governments harbour ambitions for strong economic growth, how should they respond to this demographic time bomb?

Demographic trends matter, and they matter a lot in CEE. While the world as a whole is in the middle of rapid population

growth, the opposite is true for the majority of CEE economies. For these countries, this will represent a formidable challenge in the coming years.

CEE countries stand out when it comes to population decline. The most recent United Nations’ (UN) population projections (World Population Prospects: The 2008 Revision) lists the 10 countries in the world where population is due to rise most rapidly over the next 40 years and where the declines are expected to be greatest. Including Russia, all 10 countries in the latter category are in the CEE region (see table opposite).

Nor does it end there. As George Magnus, UBS’s senior economic adviser, put it in his book The Age of Aging: “Of the top 25 population shrinkers by 2050, 18 are found behind what used to be called the Iron Curtain …The populations of the countries in Eastern Europe that have joined the European Union and those of the Baltic republics and the Balkans will typically experience falls of between 10% and 30%.”

Why are CEE countries apparently locked into long-term population decline? The two driving factors in what the UN describes as the

“demographic transition” of Eastern Europe are sharply declining fertility rates and greater longevity. The two are related: the former reduces the natural increase in the population directly, while the latter means that an increasing proportion of the population is beyond child-bearing age.

AGING TRENDAccording to the UN: “This aging trend is the consequence of demographic transition, which is when populations progress from premodern regimes, where both mortality and fertility are high, to postmodern regimes, where both mortality and fertility are low. The cause of the transition lies in the control of epidemics and contagious diseases, which eventually contribute to lower mortality, and in the processes of modernisation, which leads to lower levels of fertility.”

In the half century from 1950, fertility rates in CEE countries, which were not high to begin with, more than halved, in the majority falling well below replacement rates. In many cases, fertility rates are merely half of that level. At the same time, longevity increased

by an average of a decade for

David Smith has been economics editor of The Sunday Times since 1989, where he writes a weekly column.

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COMBATING POPULATION DECLINE

With the United Nations forecasting an 18% drop in Russia’s population by 2050, to 116 million, President Dmitry Medvedev must have welcomed the news announced early this year that the population has grown. The Russian health ministry revealed a 1.5% rise in the number of births in the first quarter of 2010 – the first such rise in decades.

Dramatic population declines have been recorded each year in the post-Soviet years in Russia, causing concern for successive governments. In 2006, then president Vladimir Putin asked the Russian parliament to develop a plan to increase the country’s birth rate, labelling the population decline “the most acute problem of contemporary Russia”. In response, a new law was introduced, paying $10,000 to a child on their third birthday. The policy had the immediate effect of increasing births in 2006 to 2007 by 130,000. This small rise has continued, with 2.8% more babies born in Russia in 2008, compared to the previous year.

In neighbouring Poland, the government has introduced measures aimed at encouraging Poles to return. In 2008, it abolished a rule which meant migrant workers were liable to pay taxes both in Britain and at home. When Prime Minister Donald Tusk was elected in 2007, his policy platform included a pledge to encourage migrant workers to return. The government has advertised its pro-return policies in the British press, in a bid to persuade some of the hundreds of thousands of workers who moved to the UK when it opened its borders to Eastern European workers in 2004, to return home.

C O M M E N TC OC O MM MM E NE N TT

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C O M M E N T

men and 12 years for women. The other big factor is migration.

“The big story in the ex-Communist world is people,” wrote Edward Lucas of The Economist. “Too few are being born… And tens of millions have changed country.” Estimates by the World Bank suggest that between 5% and a third of the working-age populations of CEE economies are making a living elsewhere. The impact of this is not all one way. The World Bank has been developing a databank to monitor flows of remittances. These flows of the proceeds of higher wages back to countries of origin are an important economic bolster. Whether they make up for the loss of the most

productive part of the population is another matter.

Population decline for CEE economies means a rising dependency ratio and slower long-run

The second policy thrust is to try to reverse migration flows, replacing significant net emigration with net immigration. Again, to an extent this should be a natural effect of rising prosperity. Particularly for those economies that have entered the EU, the lure of higher wages and living standards for CEE workers has been powerful. Some of these migration flows partly reversed themselves when the financial crisis struck previously vibrant labour markets.

The third broad approach is to squeeze longer working lives out of the existing population, by encouraging people to stay in the workforce longer.

Fortunately, there has been

plenty of scope for doing this. In the Communist era people expected to retire in their fifties in most CEE economies. In the two decades since the collapse of Communism, significant pension reforms have taken place, which include the development of private or organisation-based pensions. In parallel, retirement ages have been raised, typically to 62 but in some cases higher. Romania, for example, is moving to a common retirement age of 65 for both men and women in 2015.

Aging and declining populations represent a formidable challenge for CEE countries. In most economies, policy is responding to this challenge. It will not, however, be easy. ■

PREDICTED POPULATION DECLINE ACROSS CEE

Country 2009 population (million)

Expected 2050 population (million)

% decrease 2009-2050

Georgia 4.3 3.3 23

Moldova 3.6 2.7 25

Lithuania 3.3 2.6 21

Ukraine 45.7 35 23

Bulgaria 7.5 5.4 28

Belarus 9.6 7.3 31

Latvia 2.2 1.85 16

Romania 21.3 17.3 19

Russia 141 116 18

Hungary 10 8.9 19

Poland 38.1 32 16

Slovakia 5.4 4.9 9

Slovenia 2.02 1.95 3

Czech Republic 10.4 10.3 1

Source: United Nations

Countries with the biggest proportionate population decline in the world

economic growth, a key component of which is rising

population. Pressures for higher age-related public expenditure increase inexorably. Aging populations tend to have high levels of saving and low levels of discretionary spending.

THREE-WAY SOLUTIONWhat can CEE economies do about their declining populations? There are only three broad policy responses to the situation. One is to attempt to increase fertility rates, essentially by encouraging women to have more children. It is possible, but not guaranteed, that rising prosperity will have this impact, essentially because families will be able to afford to have more children. Running against this is the fact that, in most Western economies, rising prosperity is associated with smaller families.

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12

Among the challenges facing CEE economies, perhaps none is greater than the development of their aging

infrastructure and the capital projects required for an efficient economy. It is probably the largest single critical success factor needed to close the gap between standards of living in East and West.

During the last 20 years, the transition to market economics and democratic principles has been key to CEE’s social development. The next stage of economic development cannot be attained without significant investment in infrastructure, be it roads, power plants, airports or pipelines. Unless this funding is forthcoming, an entire generation could miss out on the benefits of economic growth and the social and developmental rewards of efficient economies.

The paradox is that the challenge is not so much economic as it is

political. The time frame required for such investments is greater than many government cycles, and the temptation to think short term and satisfy immediate social concerns – given tight monetary constraints – is always a barrier to progress.

However, there are increasing signs across the region that many if not most countries have realised that, regardless of political nuances, long-term investments in infrastructure cannot be delayed any longer. Ambitious programmes have been announced by governments in Russia, Poland and Romania, to name just a few. But there are lessons to be learned from public private partnership structures and other tools that the Western economies have utilised – and careful implementation is required.

This special report explores these areas in detail, shedding light on the risks and rewards of investing in capital projects and infrastructure.

Special report C A P I TA L P R O J E C T S A N D I N F R A S T R U C T U R E

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Tibor Almássy, Partner, Capital Projects and Infrastructure CEE, PwC

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Managing the unmanageable

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P E C I A L R E P O R TC A P I TA L P R O J E C T S A N D I N F R A S T R U C T U R E

New energy infrastructure will play a critical role in the economic development of CEE. The investment opportunities are vast, but the risks can also grow to giant proportions without close scrutiny and active management

WORDS: DAWN COWIE

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The cost of keeping the lights on in CEE over the next 25 years is

estimated at $3.3trn, according to Lights Out?, a World Bank report. Without this investment in infrastructure, the region faces energy shortages that will constrain economic development.

Almost all of the funding for new infrastructure is expected to be provided by private investors. A main task for CEE governments is to create the right regulatory environment to ensure energy companies and investors feel they can earn appropriate returns.

Higher country risk and more volatile capital markets have prevented energy companies from identifying as many profitable investment projects as pre-crisis, according to Peter Mohnen, chief financial officer of E.ON Hungária. That said, E.ON has invested in two long-term projects in Hungary during the crisis: a combined-cycle power plant and the extension of its gas storage capacity.

The World Bank report advocates progressive taxation, where public authorities make a positive economic rate of return on projects, while also ensuring the profitability of projects after tax for private investors.

AGREEING A CONTRACTGovernments also have a crucial governance role to play in ensuring projects are managed effectively, and delivered on time and budget. Creating clear lines of accountability at the contract stage is essential.

“A power plant is an incredibly complex product and therefore the customer-supplier relationship is not simple. It is not like buying

200,000 nuts and bolts,” says John Wilkinson, PwC’s head of forensics and disputes in Russia. His team specialises in analysing the causes of delays and offers advice on how to design bespoke governance systems. “The customer often cedes responsibility to the supplier to deliver the project and what is missing on the supplier side is ongoing communication and project management with the customer’s involvement.”

There comes a point when the customer does not understand why the terms of the project have changed or the costs have increased. From a supplier’s perspective, the greatest risk is to overpromise but underdeliver. If a supplier’s contract sets out requirements that are too specific, the slightest problem could result in the contract being terminated. PwC

is working for a contractor in this position. “Our client didn’t pay enough attention to his contract requirements, and didn’t

keep his client informed about delays, which led to

the termination of the contract. Before they go into litigation,

we are carrying out critical path analysis so that he can explain his position,” says Anthony Morgan, forensic services partner at PwC in London.

GOVERNANCE ROLECreating a sound governance framework is the best way to ensure that problems do not escalate out of control. At E.ON Hungária, every project has standard milestones and its status is monitored monthly at company level and more frequently at a regional level. For cost overruns, the project manager has to request additional budget and go through an approval process, says Mohnen.

When developing a monitoring framework, it is important to bear in mind that no two capital projects are alike. “The logistics involved in building a power station in a remote location in Siberia are different from building a similar plant 50 miles from Budapest,” says Wilkinson. For example, there will be costs associated with transporting the workforce, challenges getting work permits and a different pay structure.

It is important to complete a scoping exercise to identify the factors that could introduce delays. This includes everything from harsh weather to the insolvency of a supplier. “There could be hundreds of factors so it is important to appoint a risk manager who understands what the main risks will be and then engages with the

There is a lot of room for improvement in the economics of running projectsTIBOR ALMÁSSY, PwC, HUNGARY

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customer and supplier to define an efficient means of managing these,” says Wilkinson.

However, the risk review does not have to be incredibly complicated. It could be as simple as a 30-minute, monthly review of the engineering cost sheets with the customer and supplier to ensure they are in line with expectations on both sides.

BUILDING UP EXPERTISEFor public sector organisations that have several energy projects in the pipeline, this could be a good opportunity to build up their governance skills. People are often the biggest risk on a project, says Doug Downing, partner and leader of IT services for CEE at PwC. “It is important to assess whether you have the right skills in place and whether your business partners have put enough expertise and knowledge into the project. If they have not, how will you deal with that?”

Another important factor is to ensure that you have the right IT in place and avoid complexity – having too many different systems and a lack of integration can be a classic cause of problems. Partners on a project have to work towards the same objectives, on the same schedule. Employing a turnkey contractor, responsible for overseeing the whole project, can help prevent it fragmenting into 50 different pieces.

Cost overruns on big capital projects can be eye-wateringly large so every stakeholder has to be aware, and slightly afraid, of the consequences if things go wrong. “You have to make risk a point of pain for everybody involved. An engineer looks at the risk differently from the IT guy and the finance guy, but they all have to understand that it is important,” says Downing.

The financial crisis has focused minds on how to produce large capital projects that are economically viable. Today energy companies have to back up their investments with corporate guarantees because banks are not willing to provide off-balance-sheet finance for projects. “Energy companies are building up portfolios of projects that make more financial or economic sense, rather than looking at each power plant as a one-off,” says Tibor Almássy, a partner at PwC in Hungary.

This is starting to have a knock-on effect on the governance of projects. “Typically, when new power plants have been built in the past, the whole process from design to delivery has been project managed to achieve an optimal result from an engineering and technical perspective,” says Almássy.

By contrast, the next generation of energy infrastructure needs to be built using a better system for assessing and allocating risk over the life cycle of each project. “There is a lot of technical expertise in the industry, but there is also lot of room for improvement in the economics of running projects. This requires modelling to be done to get the right balance between the commercial risk, financial risk and the technical specification of the project,” he adds.

Common goals and effective cooperation between the public and private sectors will be critical if the region is to meet its energy infrastructure needs over the next 25 years. If the right lessons are learned, it should be possible to shrink the unmanageable to more manageable proportions. ■

Dawn Cowie is a freelance business and finance editor and writer.


Natalia Sherbakova, a PwC partner, says tax

issues should be high on a risk manager’s list

in Russia

Uncertainty about the macroeconomic outlook and the increasing volatility of capital markets means that risk management is a much higher priority for infrastructure investors than before the financial downturn. Tax issues related to infrastructure projects should be as high on the radar as any other risks. For example, is an investment structure, particularly a holding structure, tax efficient?

Such questions are especially important when choosing a jurisdiction for joint ventures and consortiums, as well as the financing of projects. Loan financing can often lead to negative tax implications, which can be avoided through careful consideration of all the possible options.

Delays in the recovery of VAT related to construction costs can also lead to significant cash-flow issues. Structuring construction contracts in a way that minimises these delays can improve the cash-flow position of a project.

Regulations in some Russian regions provide for tax incentives for investors, particularly investors in energy projects. Normally, the incentives include exemption from property tax and a reduction of the profits tax rate for a certain time period. At investment stage, it is important to review the regional regulations to take advantage of tax incentives.

The Russian government has recently been promoting public private partnerships (PPP) as an efficient tool for the development of infrastructure projects. Careful analysis of PPP agreements is needed to ensure that payments and other conditions of the agreement are clear and beneficial from a tax standpoint. Experience shows that the young and developing PPP regulations can create uncertainty about how regional tax authorities will interpret the tax treatment of PPP agreements, particularly where there are contradictions with federal laws.

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The nuclear option

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Nuclear power is the answer to many energy challenges in CEE, but to deliver a successful build, a number of hurdles need to be jumped

WORDS: SCOTT PAYTON

Why are governments and energy companies across CEE

turning to nuclear power to solve their energy problems? Apart from offering a means for countries to diversify their energy mix, reducing their reliance on oil, gas and other fossil fuels, nuclear power also provides countries with a way of increasing energy generation capacity without increasing carbon emissions.

As a result of these attractions, many CEE states are drawing up and implementing plans to deploy a new generation of nuclear power plants. “All the big energy players in the region are talking about nuclear – though not all of them are acting yet,” says Piotr Luba, a Poland-based PwC partner. (See map opposite for more details.)

Despite the advantages of nuclear power projects, the process of developing, deploying and maintaining nuclear power plants presents unique and formidable challenges. What are these challenges – and how can they be overcome?

CHALLENGE 1: FINANCE“Most governments cannot finance nuclear power projects on their own, so substantial private sector investment is required, from private equity, via banks, to

bonds,” says Tibor Almássy, a PwC partner based in Hungary.

This reliance on private money means that world-class project management processes are of paramount importance. Particularly in the current economic climate, a huge amount of work on risk allocation and planning is needed at the outset of a project to give financial backers comfort. However, nuclear power projects are not necessarily more expensive than alternative energy infrastructure projects such as clean coal. If anything, nuclear power can be lower cost than such an alternative.

So how do CEE states plan

to fund their new nuclear energy projects? In Romania, the financing of two new nuclear reactors –

projected to cost around 4bn – is very much a multipartite

effort. Vasile Iuga, country managing partner of PwC Romania, explains: “The government decided to set up a joint venture with SNN, the country’s public nuclear utility, to complete both units. This joint-venture company,

EnergoNuclear, would be an independent power

producer, with SNN operating and maintaining the two

units. Twelve potential investors were selected from 15 initial bidders, and in November 2007 binding offers from six companies were accepted: ArcelorMittal, CEZ, Electrabel, Enel, Iberdrola and RWE Power.” Progress is being made, with EnergoNuclear now officially launched.

CHALLENGE 2: TIME FRAMESThe sheer length of time that a nuclear power plant takes to complete is a further complication. “Experience shows that the time between an initial policy decision by a state to consider nuclear power up to the start of operation of its first nuclear power plant will be at least 10–15 years,” Iuga explains. “These are highly expensive projects that need a sustained financial effort and

CEE’S NUCLEAR PIPELINE

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the mobilisation of vast resources over a lengthy period of time.” Again, as nuclear programmes are a highly complex undertaking, watertight project, process and systems management is part of the solution.

CHALLENGE 3: SKILLSScarcity of people with the required expertise is another hurdle. “There are not currently enough nuclear scientists around, and there are not yet enough people going to university to study nuclear science,” explains Almássy. On top of this, the latest nuclear technologies are very different from 20th-century ones, and there have been relatively few new projects in the past two decades – which means that much of the nuclear skills base is not equipped to handle the requirements of running modern nuclear power plants.

Part of the solution to plugging this skills gap is embarking on joint ventures with overseas energy organisations that have built up more recent experience of nuclear power projects. General Electric, Mitsubishi and EDF are participating in discussions regarding potential projects in Poland, for example.

CHALLENGE 4: LOCATION AND PUBLIC SUPPORTIt is quite difficult to find a location offering three important things required for a nuclear project: a sufficient water supply, proximity to the existing national grid infrastructure and distance from centres of intense public opposition to nuclear power plants.

The choice of site for Romania’s Cernavoda plant illustrates other considerations that need to be made. The location was chosen

due to the geological structure of the soil, the low seismic activity of the region that is generally safe from the earthquakes that affect the south and east, and the availability of the water supply from the Danube.

How much of a problem is public opposition to nuclear power in the CEE region? In Poland, public attitudes are relaxing as people see nuclear as an effective channel for bolstering energy independence and reducing reliance on fossil fuels, says Luba. “However, if you ask: ‘Do you want a nuclear power station to be built

15km from your home?’ it will remain a huge issue.”

The solution, he says, is for governments and energy companies to engage in an open discussion with citizens. With carbon emissions and energy security continuing to rise up the agenda, and with many power stations entering the last stretch of their life cycles, it is a discussion that should happen sooner rather than later. ■

Scott Payton is a regular contributor to numerous publications including Spectator Business, The Spectator and Financial Management.


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RUSSIA

Plans to increase nuclear power generation from 16% to 25%-30% of total energy mix by 2030 by building 26 new reactors.

CZECH REPUBLIC

Six existing nuclear reactors generate about one-third of the country’s electricity. Czech utility EZ issued a tender last year to build two new nuclear reactors on the existing Temelín site. The winning bidder is expected to be announced in 2012.

ROMANIA

Two nuclear reactors already operational, generating almost 20% of the country’s electricity. Government has “well advanced” plans to build two more through public private partnerships.

Four existing nuclear reactors generate more than one-third of the country’s electricity. The Hungarian parliament has expressed “overwhelming support” for building two new reactors.

ESTONIA

In February 2009, the government approved plans to build a nuclear power plant by 2023.

POLAND

State-owned Polska Grupa Energetyczna plans to develop two nuclear power plants that together will generate around 6,000MW as a first stage of nuclear development.

LITHUANIA

Plans to build a new nuclear reactor to replace the Ignalina nuclear power plant, which was closed in December 2009.

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HUNGARY

Adviser of the Year

to Private Equity


Europe











pwc.com/transform

The ride aheadIt is time to establish a credible new body to help deliver Russia’s infrastructure needs

The growing demand for infrastructure worldwide continues to put pressure on public budgets, especially

in countries with fiscal deficits. Higher energy prices as well as demographic, social and environmental concerns also add to the strain on public finances.

The drivers for investment may vary from country to country but demand continues to rise. The UK and US need significant investment to upgrade or replace aging infrastructure, while other economies are aggressively focused on building new infrastructure to facilitate economic growth.

Russia faces the same challenge as most large economies at the moment – how to upgrade its infrastructure in order to provide high-quality public services and remain competitive in an increasingly global economy. It is difficult to source accurate data but informed sources have quantified infrastructure plans in Russia. The numbers are staggering. Current plans call for 17,000km of new roads, 3,000km of new railroads and more than 100 airport runways. They also call for expanding annual port capacity by 400m tons of cargo.

This is one of the world’s largest infrastructure shopping lists and only covers some of the headline requirements. In 2007 the then President Vladimir Putin announced that $1trn would be spent on infrastructure by 2020, with a third coming from the federal budget and the rest from

Mark Okes-Voysey is managing partner of PwC’s advisory practice in CEE.

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“non-budgetary funds and companies”. In September 2009, President Dmitry

Medvedev reiterated the Russian Federation’s commitment to using private finance, stating that the government “cannot allocate budget funds to all the projects that it needs to support, that is why we [the government] need public private partnerships (PPP)”.

How can Russia successfully meet its PPP demands over the coming decades? The government may consider constructing a credible administrative framework empowering one government body with the legislative authority to originate and implement PPP projects. This body – which could be called “Infrastructure Russia” – should be able to resolve issues as they arise on projects. It should provide a new strategic focus across the range of infrastructure sectors, assessing how infrastructure investment is planned, prioritised, financed and delivered.

Responsibilities of Infrastructure Russia should include:● Developing a strategy for the country’s

infrastructure over the next five to 50 years

● Identifying and attracting new sources of private sector investment in infrastructure

● Prioritising the government’s investment in infrastructure

● Supporting the delivery of major infrastructure projects and programmes, helping to build stronger infrastructure delivery capability across government.

Infrastructure Russia’s first role should be to publish an infrastructure plan with a focus on PPPs. This publication should: propose suitable sectors for PPP; give plans for PPP within individual states; suggest legislation and regulations to promote and monitor PPP projects; and initiate the drafting of model or standardised PPP project agreements. It would be solely responsible for these areas and should provide a coherent message for the advancement of PPPs in Russia. The Russian PPP market is evolving. In today’s globally competitive market, it is important for Russia to develop the frameworks fundamental to the success of its market, so that it can compete for investment. ■

This is an edited version of an article that first appeared in Law and Management XXI Century magazine, published by the Moscow State Institute of International Relations.


20

CEE on the move?

Following decades of underinvestment, CEE’s transport infrastructure is in need of upgrading to enable the region to continue to develop economically. Not only are there domestic imperatives for getting networks up to scratch, but commitments have also been made on a pan-European level: the

Trans-European Networks (TEN-T) initiative, which seeks to ensure that integrated road, rail, water and air travel networks are in place across the European Union (EU) and beyond, was enshrined in the Treaty of Lisbon in 2007.

There is little available data on how much will need to be spent to bring the region’s roads, railways, ports and airports up to Western European standards, although PwC estimates put the figure at around 500bn over the next 20 years.

So where will the money come from? Following the financial crisis, many of the region’s public finances are in poor shape. Hungary, Latvia and Ukraine have needed support from the EU and International Monetary Fund to restore financial and economic stability. Other countries are in better shape, but still have to manage public resources more carefully than in the past.

The answer may well be private capital through public private partnerships (PPPs). PPPs have already been used in a number of transport infrastructure projects in the region to varying degrees of success, yet the financial crisis appears to have sharpened governments’ focus on involving the private sector. Estonia, for example, is soon to launch a tender M

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CEE badly needs improved transport networks to foster further economic development. Public private partnerships are one way of funding this, but success depends on careful planning and structuring

WORDS: VICKY MEEK

for a 170m road project. And Latvia is extending its PPP programme; it has already launched a tender for its first PPP road pilot project, the 140m E77 Riga-Senite stretch, and the opening of bids is expected on 30 September 2010.

SETTING A GOOD EXAMPLEOne project that has already got off the ground and that other countries can learn from is Slovakia’s R1 Expressway project. This 52km dual carriageway, which connects the towns of Nitra and Tekovské Nemce, is the country’s first major motorway PPP project to reach financial close. The fact that the project reached this stage is remarkable because of its size – at more than 1bn, it is large by any standards – and, because the government did not have to give financial guarantees, an achievement in today’s market.

According to Karel Kolár, director in the infrastructure team in PwC’s Czech Republic office, several factors were in place that contributed to the success of the process. These included the involvement of international advisers from the start and the use of standard legal documentation where possible. Another factor was the decision to use availability payments (where the government pays according to the availability of specified services, encouraging repairs to be made during off-peak hours) rather than tolls or shadow tolls (where the government pays according to traffic volume). “The whole approach to the project was very sensible right from the beginning which meant that when the financial crisis hit we were in good shape to deal with it,” he says. The government also took a pragmatic stance

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Newer countries to PPP will have to adopt the standards of more developed markets if they are to have any success in getting projects financed and completed

NICK ALLEN, PwC

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over the difficult financing environment. Instead of cancelling the procurement when market debt terms altered after the appointment of the consortium, it agreed to most of the increased terms in return for improvements in refinancing contracts.

FLIGHT TO QUALITYYet attracting international finance in the first place will not be easy in the current climate. Over the short term, there has been a flight to quality among investors. “At the height of the PPP boom, two to three years ago, there was a lot of money chasing deals, and governments could afford to be demanding and innovative,” says Nick Allen, a PwC partner specialising in infrastructure finance.

“Now private capital is a more scarce resource, it is tending to go to less risky markets and less risky projects. This means the countries newer to PPP, like many in CEE, will have to adopt the standards of more developed markets if they are to have any success in getting these transport projects financed and completed,” he says.

It will be a steep learning curve for many countries. While some, such as Poland and Hungary, have a track record in PPPs, others have no such

experience to draw on. As a result, many countries are not prepared for the complexities involved in ensuring projects are bankable, negotiating with the private sector and with understanding which risks can and cannot successfully be transferred.

One of the main factors for governments is risk allocation. For some, PPPs are attractive because they help shift liabilities off the balance sheet. Yet past experience shows that projects can fail to get off the ground if governments seek to transfer too much risk. “Payment mechanisms have been a particular problem,” says Marzena Rytel, director of the transport, infrastructure and public sector team in PwC’s Warsaw office. “This is especially so when governments try to transfer demand risk and traffic levels turn out to be too low to provide adequate revenue for the private operators. There is a temptation to shift as much risk as possible to the private sector – that makes negotiations difficult, and in the market at the moment, deals will fail because of it.”

THE POLITICAL DIMENSIONThe other key issue is politics. With elections every four years or so and the fact that many CEE countries

have coalition governments, the commitment to see projects through to close is often absent. “Political instability or a lack of support for projects will make banks run away,” says Werner Weihs-Raabl, head of infrastructure finance and public sector at Erste Group, the Austrian bank. “Even if you make it to the next round, there is a risk that an incoming government will cancel the process, leaving you with millions of euros in sunk costs.”

Elections in the Czech Republic, for example, have cast doubt on whether planned projects will go ahead. “There is still a bit of uncertainty about how things will evolve,” says Kolár. “The parties currently in talks to form the new government mentioned transport infrastructure as one of the priorities including transport PPP, which is a good start. What is not

UNDER CONSTRUCTION: A sample of traditional PPP projects in CEE

Country Project Procurer Project details Size ( m) Likely timetable

Czech RepublicHighway PPP programme

Ministry of Transport DBFO (Design, Build, Finance and Operate) schemes to be considered

Minimum 500 each

Project procurement potentially from end 2010 to 2013

Hungary FEREX railway linkMÁV Zrt; Ministry of Transport and Economics

Railway link between Ferihegy airport and Budapest city centre

200 Under investigation

PolandHigh-speed train line

Polish Railways

Construction of new high speed railway, connecting western Poland with the country’s capital. Private sector involvement under analysis

4,000Project in preparation phase – likely to be operational in 2020

RomaniaSibiu-Pitesti highway (116km)

CNADNR (National Company for Motorways and National Roads in Romania)

Public debates on the environmental impact of the motorway in December 2009. The traffic study has been finalised

3,500, according to the feasibility study

Not yet clear

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INTERNATIONAL BEST PRACTICE

PPP projects need to meet international best practice standards if they are to get off the ground these days, particularly if they rely on international funding as most do. The key ingredients for success are to:

● Invest time in project preparation, including economic feasibility studies and environmental impact assessments, as well as land acquisition and necessary public sector permits for zoning and construction

● Ensure projects provide value for money. PPP projects should be underpinned by the concept that involving private partners offers at least as much value as traditionally procured and financed projects rather than solely viewed as a means of shifting expenditure off the government’s balance sheet

● Make the procurement process transparent and open to competition. Any hint of corruption or a bias towards local advisers or developers will deter international and experienced players

● Use "standard" international documentation wherever possible as this gives comfort to developers and funders that they are entering contracts they are familiar with and understand

● Ensure risks are shared appropriately between the public and private sectors. Attempting to transfer too much risk to the private sector will either increase financing costs or deter international capital completely. For example, availability payments provided by the public sector for road use are far more palatable to the private sector than demand-based payments

● Hire international advisers with experience of established markets. This assures good-quality advice and lends projects credibility with potential funders.


very helpful, though, is that they would prefer PPP with demand risk to be borne by the concessionaire.” Recent elections in Slovakia may pose similar question marks over some proposed PPP projects.

One other problem CEE has faced in recent times has been getting finance for larger projects. Some governments are now splitting them into smaller, more bankable and more manageable phases and these seem to be getting a better reception in international markets. “Governments need to think about smaller projects,” says Weihs-Raabl. “This will help restore trust with developers and banks and once that has happened, the region can

start thinking once more about bigger projects.”

Provided governments are willing to learn lessons from the past, the prospects for transport PPPs in the region seem bright. With so much investment required in the infrastructure, capital will need to be sourced from the private sector. And while the financial crisis may have parked some projects that have failed to raise funding in recent times, over the longer term, those that are prepared to follow best practice standards and stay the course will find interest aplenty. ■

Vicky Meek is an award-winning business and finance journalist.

Political instability or a lack of support for projects will make banks run away

WERNER WEIHS-RAABL, ERSTE GROUP

Adviser of the Year

to Private Equity


Europe











pwc.com/transform

Roadside assistanceEncouraging local production will help get Russia’s automotive industry back on the road to recovery

T he global downturn was slow to hit the Russian car market. Few anticipated that, when it did, Russia’s slump would turn

out to be around twice as severe as any market in the world and that unit sales in 2009 would fall by about 50% from 2008 levels. First half figures from 2010 show a market continuing to struggle to recover, with overall unit sales little better than the previous year, at the height of the crisis.

Producers of foreign brands in Russia are outperforming the market with an impressive 32% growth in unit terms and a dramatic 62% increase in dollar terms compared to the first half of 2009. However, much of this performance is down to import substitution – the additional $1.6bn spent on locally produced foreign brands has been offset by a $1.2bn fall in spending on imports.

Despite the dramatic fall in demand from 2008 to 2009, the 15 or so major OEMs (original equipment manufacturers) that have invested in car production in Russia are sticking to their plans. Peugeot/Mitsubishi have gone ahead with the launch of production at their factory in Kaluga, joining Volkswagen. At an estimated cost of 450m, this is currently the second highest value of investment behind Volkwagen. Both are set to be eclipsed by the planned 2.4bn Sollers/Fiat investment in Tatarstan.

Providing in excess of three million unit annual sales, the Russian market could

Stanley Root is automotive industry leader and a partner at PwC in Russia.

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just about accommodate its unusual profile of so many foreign players, each of which is hoping to outdo its competitors in a race to carve out a long-term, sustainable share of the market.

However, with demand falling, many OEMs are struggling in the short term to cope with lower than planned levels of production. Those that have hedged their bets with a balanced strategy of local production and continued import are having to rebalance heavily in favour of the former as the demand for expensive, hard currency imports shrinks.

Current market conditions may discriminate against imports, but two major factors inhibit the growth of local production – the relatively low quality of

auto components manufactured in Russia and the very low levels of unit demand from any one Russian automotive factory for any one component.

The Russian government’s 10-year strategy for the automotive industry highlights the need to attract significant amounts of foreign investment into local car parts production, but given the problems this part of the industry faces, investors are unlikely to commit without significant government support.

There is a more fundamental challenge – setting up and running a medium-sized business is not a process undertaken lightly in Russia. And yet worldwide, the car parts industry has its roots in an extensive, complex and energetic network of SMEs.

During the past two years, there has been a growing realisation at all levels of the need to tackle these issues if Russia’s strategic engineering capability is to be preserved. Regional administrations such as Kaluga and Tatarstan are making

strenuous efforts to attract foreign investment by streamlining

the processes of doing business within their territories.

At stake is the country’s ambition to modernise its economy and secure long-term employment and wealth for its citizens. It is now understood that the high-tech engineering

skills that are essential to the automotive sector are

equally central to the overall modernisation of the economy. ■

C O M M E N T

The skills that are essential to the automotive sector are equally central to the overall economy

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Small, and perfectly formed

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Some parts of Eastern Europe escaped the recession – one possible reason is the growth and strength of the region’s micro-businesses

WORDS: CHRISTIAN DOHERTY

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The owner of the micro-business should spend their time running the business and not filling in forms

STEEF KLOP, PWC, CZECH REPUBLIC

While the developed economies of Western Europe and the US have spent the past

few years looking nervously at growth statistics, trade figures and share prices, some countries have escaped the worst of the global financial crisis.

Indeed, many countries in CEE have continued to post healthy growth figures. For example, Kosovo last year recorded 4% GDP growth, which this year is forecast to be 5%-6%, compared to growth of less than 1% in the UK (see box on p.29). This can in part be explained by structural advantages, principally less consumer indebtedness and less exposure to the international financial system, while the region’s reliance on its small and micro-business sector is another key factor.One-fifth of Macedonia’s economy is in the ‘grey market’, according to the CIA Factbook, illustrating how much micro-businesses on the fringe of the economy contribute in terms of employment and wealth creation.

“There is a positive correlation between the number of SMEs [small and medium-sized enterprises] in a country – including start-ups – and economic growth,” says Peter Jungen, president of the SME Union, an organisation that lobbies for small business at a European level.

While the positive role of SMEs is well documented, what exactly is a

micro-business? In a 2009 report, European SMEs under Pressure, the European Union describes them as employing between five and 10 people, and says they “are most prominent in construction, hotels and restaurants, business services and parts of retail and wholesale trade, and are heavily orientated towards the market for domestic consumption”.

WIDE SPREADIn CEE, micro-businesses are mainly found in consumer businesses, services industries, technology and the entertainment and media sectors.

Karel Havlícek, vice president of the Association of Small- and Medium-Sized Enterprises and Crafts in the Czech Republic, says the Czech SME sector, traditionally strong in the automotive and mechanical engineering sector, has recently recorded a surge in innovative sectors such as biomedicine and nanotech.

Whatever the sector, micro-businesses are embedded in the fabric of Eastern Europe’s economies. Thousands of micro-businesses grew up during the 1990s, in the years following the fall of Communism. But as their numbers have grown, so have the obstacles they face, such as lack of government support at both national and EU level. However, as Steef Klop, private company services leader – CEE at PwC in Prague, points out: “In the CEE region, it seems that micro-businesses flourish despite

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government policy, not because of it.”

Jungen agrees. “If they thrive, it’ll be purely down to them and will have nothing to do with the advice they’ve received from Brussels. In terms of governance and putting in new ideas and promoting micro-businesses by providing incentives or role models to mentor, there’s not very much coming from Brussels.”

REDUCING RED TAPEIn Jungen’s view, the main problems are both administrative and financial. Research backs this up. According to the World Bank’s Doing Business 2010 survey, Eastern Europe has the worst ranking of any region in terms of procedures to follow and the time it takes to complete a simple administrative task. For example, acquiring a construction permit takes on average 264 days in Eastern Europe, compared to 157 days in the OECD member states.

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CRISIS IS OPPORTUNITY

Micro-businesses and SMEs across CEE appear to be navigating the downturn more effectively than larger corporates. Czech company WBI Systems is a case in point.

Set up a year ago, the SME provides IT solutions and services to Czech and Slovakian companies using Microsoft and IBM technologies. Within just six months of start-up, WBI had managed to build a team of 35 IT consultants working across four branches.

“We took the [financial] crisis as an opportunity for growth and expansion,” says WBI owner Robert Paskovský. “Thanks to the crisis, we were able to skim top IT experts from the market – something that we would not be able to do in a time of economic growth.”

WBI’s IT solutions, designed to save time, money and other resources, have been in particular demand during the downturn. Paskovský hopes the company will be profitable by the end of the year.

Now, WBI has been recognised for its achievements by the Czech Chamber of Commerce. The company won the IT category of the Chamber’s inaugural “In Defiance of Crisis Awards” (see p.6).

Many believe that this lack of attention and assistance must be tackled, on both a national and European level. But what can governments and European agencies do to foster micro-businesses? “First, pay attention to them and second, lower the administrative burden they face,” says Klop. “In my experience of working with micro-businesses, although they are small, they still have a lot of mandatory forms to fill in, and in that respect there’s usually no difference between micro-businesses and SMEs, and the mid-market.”

Jungen has spent the past 10 years advocating the rights of smaller businesses. “What’s needed in these countries is the introduction of one-stop government agencies for SMEs and start-ups. So that means that the founder of a new firm only has to deal with one government office, maybe on a regional level. And that office will deal with all issues to do with SMEs – permits, licences, tax and so on,” he says.

In Bucharest, the authorities are planning to establish such an office. However, across the region, the range of measures enacted to help

In terms of governance and putting in new ideas and promoting micro-businesses, there’s not very much coming from Brussels

PETER JUNGEN, SME UNION

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ONE TO WATCH

Kosovo’s diverse economy has helped insulate it from the worst of the recession. Indeed, Robert Wright of Austria’s Raiffeisen Bank, the country’s second largest lender, recently told The Banker that Kosovo’s economic profile was the engine of its resilience. “Industry is micro,” he told the magazine. “So you do not have a dependency on a handful of large corporates, and the risk is diversified across thousands of small micro-businesses.” It is therefore of little surprise that the country’s leading bank is part of ProCredit Group, an institution made up of 21 financial institutions operating in transition economies and developing countries in Africa, Latin America and Eastern Europe, and which has grown up on the back of its lending to SMEs in these regions. Kosovo’s micro-businesses have also been helped by the millions of dollars of overseas aid that flooded into the country when Kosovo declared its independence in 2008. A substantial proportion of that aid took the form of small business loans, which enabled the active small business sector to grow faster.

micro-businesses flourish is narrow. Access to finance has been limited as European banks retrench after the credit crisis. Until that changes, small and medium-sized firms will struggle to access loans to expand their companies.

In response, some governments have lowered taxes to help companies struggling with cash flow. One of the most popular measures has been the introduction of flat tax rates. Within days of taking power in April, the new Hungarian government proposed a series of sweeping tax reforms, the central plank of which was the introduction of a flat income tax of 16% and a corporate tax of 10% for SMEs. Similar flat tax regimes in Slovakia and Romania have resulted in higher budget revenues because the lower rate reduced tax evasion.

“Currently six out of the eight former Communist countries that joined the EU have a flat tax so that is very positive,” says Jungen. In his view, there are some clear regional differences in the levels

the small businesses in them, are very conservative. That means that they had more financial reserves than the bigger companies. They were better prepared to cope with the downturn when it hit. Normally small family businesses are looking beyond the next quarter earnings, and are more focused on the long term and therefore build up reserves for the bad times.”

However the CEE economies develop over the next two years, it is clear that micro-businesses will be crucial to any success in the region. Having played such an important role in sustaining the region’s economies during the recent downturn, the owners of micro-businesses will be hoping their governments support them in the years to come. ■

Christian Doherty is a financial journalist, specialising in corporate governance, risk and accountancy issues.

of understanding of the issue. The countries of the western Balkans, for example, get mixed reviews. “Serbia is still dominated by state-owned businesses, but Macedonia is racing ahead and they have a great understanding of the importance of SMEs and micro-businesses. But Serbia and Croatia are still finding it hard to make that leap and change their economy.”

The Czech government’s support of the SME sector is also relatively strong. A recent survey of the European Association of Craft, Small and Medium-Sized Enterprises (UEAPME), the largest European employers’ association, evaluated governments’ compliance with the EU Small Business Act, and the Czech Republic came top.

“I’m not saying it is the best marketplace here, and as an association of SMEs we have to continuously put pressure on the state, but in comparison to the rest of the world, the conditions here are not at all bad. Joining the EU helped our companies a lot, namely to those orientated towards exports,” says Havlícek.

Poland has long been one of the leading CEE countries for micro-business, along with Romania. But in some countries such as Ukraine, Hungary and Belarus, the focus remains on attracting large multinationals to the country more than developing indigenous small firms.

CONSERVATIVE OUTLOOKWhatever the country, there is little doubt that micro-businesses have enjoyed an easier time than their large corporate counterparts. But size alone cannot explain that statistic, as Klop says: “I think those countries that were less affected by the financial crisis, and by extension

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Forging ahead By the end of the decade, Polish copper

mining firm KGHM plans to be a “major global company”. Geographical and product diversification are just part of how CEO Herbert Wirth intends to get it there

WORDS: DOMINIC DUDLEY

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year we have PLN1.6bn worth of investments planned and, after the first half of the year, there are no risks as far as achieving those plans is concerned,” says Wirth.The strategy, which Wirth is leading, is the latest in a series of evolutions of KGHM. Its history dates back more than 50 years to December 1959, when the Minister of Heavy Industry formed the state-owned Lubin Mine Company to exploit copper deposits, which had been discovered in the region two years earlier.

In 1961, the company’s name was changed to Copper Mining and Smelting Industrial Complex, or Kombinat Górniczo-Hutniczy Miedzi (KGHM) in Polish. In September 1991, it was transformed into a joint stock company, KGHM Polska Mied , and in July 1997 it listed its shares on the Warsaw Stock Exchange.

The government remains the largest single shareholder in the company, with a 32% holding.

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KGHM is a company in transition. From its base in Lubin, in the southwest of Poland, the business

is aiming to become a globally significant copper producer while also moving into new industries in its home market. The company, whose accounts will be audited by PwC from 2010 onwards, is already one of Europe’s largest copper producers and is planning to increase its copper production by 40% to 700,000 tonnes a year. But it also wants to earn as much as 30% of its revenues from outside its core sector by 2018.

The most significant target for diversification is power generation and supply. Last year, KGHM bought stakes in wind farm operator Biowind and thermal energy firm WPEC in Legnica, and in June this year it bought a stake in Tauron Polska Energia. KGHM has set itself the target of controlling 3% of the Polish energy market by 2020.

Diversification is just one element of a broad growth strategy, which KGHM set out in 2009 and which also includes improving its productivity, developing new minerals resources and enhancing its in-house skills.

“The most important event of the past few years was setting the company’s strategy focused on innovation,” says KGHM’s president, Herbert Wirth. “If KGHM does not change, we will witness a constant increase of costs.”

In all, the company plans to invest PLN19.8bn ($6.2bn) in this strategic overhaul. It invested PLN1.2bn last year and will spend even more in 2010. “This

MINING COREThese days the KGHM group contains more than 30 subsidiaries ranging from health services firm MCZ to tourism company Interferie and the Zagł bie Lubin football club. Between them, they employ some 28,000 people. Notwithstanding the unusually diverse nature of its subsidiaries, the core of the company remains very firmly in the mining and refining of

The outlook for demand is positive and the supply side looks even better

HERBERT WIRTH, KGHM

copper and precious metals, from what is the largest single deposit of copper in Europe.

The company operates three mines – Lubin, Rudna and Polkowice-Sieroszowice. The copper ore extracted from them is transported to processing plants where it is enriched to produce copper concentrate. That is sent to the company’s smelters where it is refined into anode copper which is refined into copper cathodes. From these cathodes, wire rod and round billets are produced.

The copper production process leads to a number of other products. Most importantly, the anode slime from the refinery is used as a raw material for the extraction of precious metals, including silver and gold. Other by-products include lead, nickel

This year’s publication marks our seventh annual survey of the top 40 mining companies by market capitalisation, provides a comprehensive analysis of the financial performance and position of the global mining industry and also discusses current trends in the global mining industry.

pwc.com/mining


CEE Mining Leader John Campbell Tel: +7 495 967 62 79 [email protected] Global Mining Leader Tim Goldsmith Melbourne Tel: +61 3 8603 2016

[email protected]

Mine Back to the Boom…Review of global trends in the mining industry – 2010

© 2010 PricewaterhouseCoopers. All rights reserved. “PricewaterhouseCoopers” refers to the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independant legal entity.

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sulphate, copper sulphate and sulphuric acid.

The environmental impact of these processes is potentially huge, but KGHM has invested heavily to try to minimise the danger. It has three industrial waste-water treatment plants and has built desulphurisation and dedusting plants.

“In the past, copper smelting in particular had a significant impact on the environment,” says Wirth. “As a result of long-lasting ecological investments, the emissions into the atmosphere have been visibly reduced. The impact of the company on the natural environment is relatively small.”

As well as 502,500 tonnes of refined copper, KGHM produced 1,203 tonnes of silver and 814kg of gold last year and posted a profit of almost PLN2.5bn ($797m). The profits were lower than in previous years, but still impressive.

“The financial crisis that started in the second half of 2008 caused huge turbulence on the commodities markets,” says Wirth. “Copper prices declined from almost $9,000 a tonne to $2,800 a tonne within half a year.” The price is still well below its peak, at less than $7,000 a tonne.

TACKLING TURBULENCEKGHM was able to ride out the storm due to hedging against price swings and the depreciation of the zloty against the US dollar.

“KGHM systematically hedges copper prices, aiming to lower its

exposure to the market risk,” explains Wirth. “The frequency of our activity in this area grows when prices are higher. Pre-crisis copper price levels allowed us to build a substantial hedging position at satisfying levels.

“Another issue was that the Polish zloty depreciated significantly, which constituted strong support for the price of copper in Polish zloty.”

The effects of the financial crisis continue to be felt in markets around the world, but Wirth is optimistic about the long-term future for the copper industry and KGHM’s fortunes.

“The outlook for demand is positive, and the supply side looks even better,” he says. “China, which consumes more than 40% of global copper production, should maintain a high and stable pace

of growth. The needs coming from the country’s industrialisation are huge, and the demand in developed countries is improving and should maintain moderate growth in coming years.

“On the supply side, mines globally face lowering ore grades and infrastructure problems such as groundwater shortage in Chile or energy constraints and political instability in Africa. Some planned mine projects were withdrawn or postponed in 2008 and 2009 due to limited access to financing.

“All these factors mean that the market for refined copper in the coming years should be balanced or in temporary deficit, which will provide significant support for the copper price,” says Wirth.

To make the most of this opportunity, the company needs to find and develop more copper resources, and much of the growth in this area is likely to come from beyond the Polish borders. In June 2009, KGHM set up a joint venture with German firm HMS Bergbau to search for and extract deposits of copper and other metals in Saxony, Germany. This was followed, in May 2010, by an agreement with Vancouver-based Abacus Mining & Exploration Corporation to develop a copper and gold scheme known as the Afton-Ajax project in British Colombia, Canada.

KGHM is the ninth largest producer of copper in the world and the second largest producer of silver. The plans it has in place mean that, over the short term, it will improve its competitiveness, but in the longer term it could transform itself into something far more impressive.

“By 2018 or earlier, I see KGHM as one of the major global companies with assets in several countries,” says Wirth. ■

Dominic Dudley is a former deputy editor of MEED.

KGHM POLSKA MIEDZ IN FIGURES

2006 2007 2008 2009 2010*

Sales (PLNm) 11,670 12,183 11,303 11,061 11,736

Net profit (PLNm) 3,605 3,799 2,920 2,540 2,898

Average copper price (PLN/tonne) 20,866 19,739 16,754 16,112 18,090

Unit cost of refined copper (PLN/tonne) 8,185 9,313 10,797 9,750 11,503

*budget Source: KGHM

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Russia is well known for its engineering excellence, scientific achievement and educational prowess. Now, it is planning to harness these skills in an all-purpose city

west of Moscow in an effort to emulate the success of high-tech ‘knowledge cities’ around the world. President Dmitry Medvedev recently pushed a parliamentary bill through the State Duma formally establishing Skolkovo Innovation City (SIC), a high-tech research hub, already known as ‘Russia’s Silicon Valley’.

Moscow has allocated R25bn ($800m) to the creation of Skolkovo, with construction to begin in early 2011. Project officials have identified five ‘priority spheres’: energy, information technology, communication, biomedical research and nuclear technology. Skolkovo will be declared a special development region with its own police force, tax structure, patenting authority and customs bureau. A bill added to the draft document will permit tax exemptions over a certain period for firms setting up shop in Skolkovo, a tax moratorium on research equipment and, for selected companies and industries, a moratorium on sales tax.

According to Alexander Ordinartsev, a partner at PwC in Moscow, the financial crisis triggered the creation of the new innovation city, after the fall-off in national earnings from energy sources in late 2008 and 2009. “The country could not

be sustainable if it just relied solely on oil and gas, so this is a way of speeding up the creation of innovation cities in Russia,” he explains.

Ordinartsev notes that Skolkovo is just the start. SIC will ultimately become an “umbrella model” for regions across Russia as they aim to boost economic growth. Towns such as St Petersburg and Novosibirsk are hoping to build their own high-tech research hubs in the future.

Creating a compelling destination for foreign professionals is an important objective for Russia. A recent survey found that just 7% of foreign professionals would be willing to relocate to the country, putting Russia in 32nd position globally. SIC, it is hoped, will also reverse an almost-terminal brain drain.

TYPE TWOKnowledge cities such as Skolkovo are famously difficult to get right. Broadly speaking, they come in two guises. Under type one, local or central authorities build basic infrastructure, pare down any restrictive rules on start-up firms and, where necessary, capitalise new corporations directly or via growth funds. This type can mainly be found in the ‘developed’ or fast-developing world, where authorities largely leave local companies to their own business. California’s Silicon Valley is the most obvious example, but such technology clusters, or mini-knowledge cities, exist around Stockholm, Paris, Munich, and Cambridge in the UK. M

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Wrapping a new innovation cluster in a legal and regulatory protective shield could help put Russia on the map of world-leading knowledge cities

WORDS: ELLIOT WILSON

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Mind andmatter

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education system. However, Russia can still do more to further build foreign companies’ confidence.

Moscow has taken a softly-softly approach to Skolkovo, wrapping the new development zone in a protective shield, allowing companies to grow by themselves. Bo Parker, a partner in PwC’s US firm, says: “This new effort strikes me as demonstrating that Russia’s leaders are learning from their experiences and that each step along the way will demonstrate what they need to do to make Skolkovo successful.”

Skolkovo will have other benefits for a country that wants to move beyond a one-dimensional economy based on basic energy and mineral extraction. President Medvedev has ambitions to develop and create an economy that values the mind as well as physical labour. That, as much as anything, will help stem the brain drain. Russian entrepeneurs have long chosen to seek their fortunes elsewhere, particularly in the US. It is notable that one of the most successful Russian business expatriates, Google co-founder Sergey Brin, found both fame and fortune in the first knowledge city: California’s Silicon Valley.

A LITTLE PATIENCEMany countries have tried and failed to emulate one of the world’s most extraordinary wealth-generating machines. What few realise is that Silicon Valley was created by mistake rather than design. And that the most challenging aspect of creating a working knowledge city is that it often takes decades to develop fully.

When a group of scientists known as the ‘Traitorous Eight’ left Shockley Semiconductor Laboratory in 1957, they did more than tear the beating heart out of California’s first maker of intelligent chips. They also created what we know today as Silicon

China now boasts 20 SEZs, each generating tens of thousands of jobs for labourers, engineers, chemists and scientists. Indeed, the model has proved so compelling that it has been copied far and wide, in countries including Poland, Ukraine, Russia and Kazakhstan.

SOFTLY SOFTLYSkolkovo itself falls firmly into the category of a type two knowledge city. Russia’s central authorities have approached the issue of creating a new knowledge city with forethought. Many foreign corporations are attracted by Russia’s vast resources, sizeable population and excellent higher

The second type is a far trickier beast. Mostly found in emerging nations, for this model to become successful several key ingredients are needed. A friendly business environment, protection of intellectual property and a fair and balanced corporate arbitration system are directly relevant. More general but equally important are a trustworthy police force, transparent public institutions and a government willing to tackle corruption.

One country that has implemented these elements, creating a legion of knowledge cities in the process, is China. Thirty years ago, its economy was underdeveloped and the nation was emerging from a protracted, painful period of internal and external conflict. Early on in China’s post-isolationist life, its leader Deng Xiaoping realised the extent of central and regional hostility towards capitalism. But also recognising the need for capital creation to yank the country out of poverty, Deng set about permitting the creation of greenfield regions.

The first of these Special Economic Zones, or SEZs, was established in 1980 in Shenzhen, a capital-hungry town in southern China. The model quickly spread:

I’m optimistic that the people who recognise the importance of these frameworks aren’t asleep at the wheel BO PARKER, PwC, UNITED STATES

KNOWLEDGE SHARING

Several emerging economies have succeeded in building knowledge and technology centres either by accident or design:

● Taiwan and Singapore replaced Silicon Valley as the world’s pre-eminent chipmakers in the 1980s

● Israel has become a global hub for water technology and biotechnology

● Casablanca in Morocco has become Africa’s leading technology hub, recently welcoming American computer maker Dell as its latest blue-chip tenant

● South Korea’s ICT sector, already large, is still growing fast

● Abu Dhabi’s Masdar City is expected to become a global hub of renewable energy

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Valley, transforming a pot of venture capital provided by a farsighted investment banker, Arthur Rock, into a multi-million-dollar enterprise – Fairchild Semiconductor.

No one ‘designed’ Silicon Valley. It merely grew, first providing semiconductors to the world, then, when the chipmaking industry moved to the Pacific Rim, branching out into internet portals, biotechnology and, more recently, low-carbon energy and fuel sources.

As PwC’s Parker notes, when it comes to Silicon Valley the local government’s role has been somewhat light. “Private initiative has been the dominant driving force. Silicon Valley has nice weather, two large research colleges, a big community with a high tolerance for business failure and the recycling of local entrepreneurs with serial ability that leads to strong management capabilities.”

He adds: “A typical mistake is to look at that and to try to recreate all of that in a greenfield. If you go back to the beginning of Silicon Valley, what happened there was a lot of happenstance and a lot of luck. Those who built the first company got lucky when they got money from a single man.”

ROLE MODELDeliberate creations can be equally successful, however. Malaysia’s Multimedia Super Corridor has become a haven for fast-growing technology and biotech firms. “Malaysia has created a comfortable environment for big companies. In 20 years there will be successful big Malay companies with global standing [as a result of the supermedia corridor] and people will attribute it to the fact that people made a decision to build the local project,” says Parker. And Malaysia

is not the only emerging economy to have effectively deployed a knowledge city model (see box).

Several emerging economies have managed to rid themselves of an economic environment hostile to entrepreneurs and capital with the aid of knowledge cities. In China, a legion of knowledge cities dotted around the country showed Chinese workers and investors that capital could, when used correctly, be a force for good.

The big question when it comes to Skolkovo is whether Russia will be able to do the same thing. The

new project has made all of the right noises. It plans to build new infrastructure, train and deploy its own police force, roll out research and design credit, impose a period of tax forgiveness of investors and protect intellectual property.

“What makes me somewhat optimistic is that the people who recognise the importance of these frameworks aren’t asleep at the wheel,” says PwC’s Parker. “I think they are trying to create an environment where normal commercial risks are the only ones that exist.” ■

Elliot Wilson is an associate editor of Spectator Business and Hong Kong’s Asiamoney magazines.

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Lighting the way

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Businesses in CEE are ready to move to a low-carbon economy – they just need governments to take the leadWORDS: CONRAD HEINE

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A time of economic recession brings many challenges, not least of which is making tough decisions about what to prioritise and what to put on the back burner. Concern for the environment and the effects of climate change

have tended to fall into the latter category. Despite the economic slowdown leading to some reduction

in the rate of emissions generated, climate change remains no less an urgent issue. Businesses the world over realise this and expect to have to deal with it. Indeed, they are impatient to do so and expect a lead from governments. Such awareness is not simply about a green agenda, says Mark Schofield, global leader of PwC’s Sustainability and Climate Change Tax Network. “It is also about cost savings. Businesses are looking to maximise their efficiency.”

BE PREPAREDAppetite for Change, a recent report published by the PwC network, examines attitudes in the international business community towards environmental regulation, legislation and taxes. It found that many of the almost 700 executives in 15 countries polled expect climate change to alter the way they conduct business in the next two to three years, both through developing strategies to deal with the problem and because of regulatory and policy changes. Business leaders realise, the findings suggest, that a lack of preparedness on these fronts could severely affects firms’ ability to remain competitive.

In CEE countries, these needs and realisations remain no less acute. Most of the countries have struggled with a Communist legacy of heavy industrial development, and then with a post-Communist legacy that prioritised playing economic catch-up with the rest of Europe.

Now, the wider narrative of climate change and energy security needs has meant that governments in the region need to move their economies in a low-carbon direction. That primarily means a move towards renewable sources for energy generation.

Countries in the region are generally at a “relatively early stage of the debate”, says Schofield. Consumer demand for change in the region is less than in Britain or the US, for example. Martin Scott, a PwC director in Prague, concurs: “Many regions in CEE still have significant social and economic challenges to deal with, which pushes carbon and sustainability down the priority list.”

That said, some governments have made more progress than others. European Union (EU) member states, for example, are already bound by the EU’s “20-20-20” targets, by which countries are obliged to reduce greenhouse gas emissions by 20% of 1990 levels, increase generation of renewable energy by 20% and cut energy consumption by 20%, all by 2020.

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the green agenda to change the way they do business over the next two to three years.

So what of the tools available to governments? For the main potential policy instruments – regulation, market-intervention tools such as carbon taxes and emissions trading schemes and subsidy tools, such as incentives to use or invest in clean energy – support from business is varied. In the Czech Republic, 47% of businesses surveyed were supportive of emissions trading as a policy instrument, while only 25% supported carbon taxation. In Russia, the equivalent figures were 67% and 74%. In terms of incentives to become carbon neutral, 68% in the Czech Republic and 90% in Russia agreed they were a good idea. But in all cases, willingness and support was tempered with caution about consistency by, and between, governments.

SIZE MATTERSPwC’s Schofield also points out that the effectiveness of the tool depends on the size of the business. “Cap-and-trade works quite well for larger businesses, but for small businesses carbon taxes work better.”

Countries that are already EU members are taking a lead in encouraging renewable energy initiatives. To meet the common targets, the Czech Republic has established a strong legislative framework including, in 2005, a renewable energy sources act that sets targets for usage of renewables for energy generation and motor vehicles. Other countries have made similar moves – in 2007, Bulgaria introduced legislation requiring energy suppliers to purchase all renewable energy generated locally at guaranteed prices, and has introduced credit lines to encourage business to take up renewable energy.

The Czech Republic has made use of two tools to encourage the take-up of renewable energy for power generation:

This does not just affect states that are already members, but those that aspire towards membership: Ukraine and Croatia among them.

PROMISING SHIFTCountries are taking action. Poland has traditionally made use of its abundant supplies of coal for energy generation. In 2009, it produced 56.4 million tonnes oil equivalent of the fossil fuel, far more than any European country bar Russia. Yet the European Bank for Reconstruction and Development (EBRD), which is advancing the development and financing of renewable energy projects in the CEE region through its Renewable Development Initiative, says Poland is making a tentative but promising shift towards renewable energy sources.

The country has established a target of 7.5% of energy from renewable sources by 2010 and 14% by 2020. Lack of enforcement makes these targets more symbolic than actual for the moment, but the EBRD points to the promising investment environment, combined with strong economic growth that this fosters. Meanwhile, utilities are required to purchase electricity from renewable sources, although prices are unregulated, and the EBRD has great hopes for the development of wind energy.

Poland encapsulates both the problems and potential in CEE in terms of shifting to low-carbon generation. Poland’s politicians realise the importance of the issue, and the resources exist, but government leadership on this front is as yet tentative. Yet the signs are that businesses in CEE are ready and willing to accept a political lead.

Among the countries surveyed in Appetite for Change, 54% in the Czech Republic felt the lead should come from government rather than business whereas in Russia this figure rose to 63%. In both countries, a significant proportion of those surveyed expected

Cap-and-trade works for larger businesses, but for small businesses carbon taxes work betterMARK SCHOFIELD, PwC

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EU grants for the construction of renewable energy power plants, and incentives for the purpose of green energy support, namely, the “guaranteed purchase” and the “green bonus”. With the former, if an energy generator applies for it, a company providing energy to the consumer must buy the renewable energy produced at a price set by the government regulator. The latter fixes minimum prices for renewable energy, encouraging companies to sell it or use it for their own operations.

Outside EU targets, the motivating factors for governments come down to perception of need for energy and ability of current supply sources to meet that demand – a factor that has motivated Poland but explains why Romania has been slower in the take-up of renewable sources. Beyond the EU, Ukraine’s fears about rising gas prices and the security of supply have motivated

regulatory innovations to encourage renewables there.

The need to move towards renewable energy brings with it business opportunities, especially in markets such as real-estate development. Peter Burnie, a PwC partner based in Belgrade, points to a PwC report on foreign direct investment (FDI) into CEE in 2008-09 that showed a general halving of FDI into the region but a rise of 35% to 40% in alternative investment. This, he suggests, is down to government support.

GET ON BOARDScott points to the risks of not getting on board. “Internationally, the carbon-trading market is becoming bigger and more sophisticated as, for example, banks take on carbon credits as collateral,” he explains. “As the numbers get bigger, so does the risk. Businesses in CEE need to be

on board, and understand the market to minimise their risk as well as to take advantage of opportunities.”

Overall, expectations of business and government policies are set in a low-carbon direction in CEE, even in the face of economic slowdown.

For Schofield, the implications of a lack of action on the part of CEE governments are severe: “In the long run, a shortage of natural resources means these economies will simply become less competitive and miss out on any gains in terms of skills learnt.”

With renewables offering investment promise, there is a rare opportunity for government and business to work together for long-term change. But what is needed is a willingness by both parties. While government action is necessary, businesses in CEE and elsewhere must ensure their own rhetoric is matched by action too. ■

Conrad Heine is a freelance writer on the environment, business and politics.

PWC GLOBAL ENVIRONMENTAL TAX AND REGULATION MONITOR SERVICE

PwC has recently launched a new monthly newsletter – the Global Environmental Tax and Regulation Monitor, which is available to clients on a subscription basis. The service is targeted at all those with responsibility for (or involvement in) setting and managing company environmental policy and strategy, including those with responsibility for tax. The newsletter combines policy, tax and legislative updates with analysis and insight from PwC experts in sustainability and climate change.

Mark Schofield, global leader of Sustainability & Climate Change Tax at PwC, says: “As momentum gathers behind climate change, this presents businesses with a range of new opportunities and risks. Whether they are looking for cost-savings, competitive advantage or simply to comply with new taxes and regulations that are evolving, we can help. The Global Environmental Tax and Regulation Monitor will help businesses get up to speed quickly with global trends and developments in climate change related policy, and stay ahead of the curve.”

Sign up to the newsletter at: http://pwc.co.uk/eng/issues/environmental_tax_newsletter.html

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Healthy prospects

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A thriving generics market has put CEE on the map for pharma players seeking new markets for manufacturing, R&D and clinical trials. The region’s governments should get into shape to maintain the industry’s vitality

WORDS: KIMBERLY ROMAINE

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P H A R M A C E U T I C A L S

When the European Union expanded its borders in 2004 to cover numerous CEE economies, many of these countries brought with them

ageing healthcare systems where inefficiency was the norm. However, in a 2005 report called Prescription for Growth, PwC predicted that CEE’s low-cost base and talented workforce would ultimately act as pulls for a resource-intensive pharma sector. The experience of the past five years has borne this out, and today the region has a very different story to tell.

Not only have global pharma players been making strategic acquisitions, but private investors have found plenty of growth companies to back (see box, ‘Financial boost’). CEE is also fast becoming a hub for clinical trials and the manufacture of generic drugs. The industry’s prospects are healthy, but a friendlier regulatory environment and better overall government support could guarantee an even better future.

LOCAL ADVANTAGEThe international pharma industry has already shown a commitment to the region. France’s Sanofi-Aventis and Indian pharma Ranbaxy have both gained footholds in CEE through acquiring local players, but they are just two of many global pharmas to do so; in fact, most local players are now tied to foreign pharma companies.

A major plus point for local players is their unrivalled market knowledge. “Many people lump CEE together as one market, but the region is really quite diverse, with very different systems and opportunities,” says Peter Koetsier, general manager of the Polish subsidiary of US pharma Bristol-Myers Squibb. “Understanding the nuances between countries is a real challenge for industry players.”

Here is where local players take the lead, says David Wake, a partner in PwC Hungary: “Regional pharmas know their space, unlike many multinationals, who eye up the area but may struggle to get a real foothold.” He points to the example of Hungary’s Gedeon Richter, which has

successfully expanded east: sales to Russia in the first quarter of 2010 were up 55% to 63.3m.

Many global pharmas have been enticed to the region by CEE’s activity in the clinical trials and generics markets. “The benefits clinical testing can bring are often underestimated by governments,” says Koetsier, who believes governments could do more to attract this kind of business to their countries. “An increase in trials is good news for the region as they bring with them additional scientific and medical expertise – and

can reduce cost burdens for governments.” This is because most new products trialled offer the best standard of care – a plus for patients – which is paid for by the sponsor company. Trials also bring state-of-the-art processes and fresh job opportunities: for staff to conduct the tests, and enter and analyse the data.

The more that governments realise how these benefits can add up, the more likely they are to compete to attract multinationals to set up trials. This is happening in R&D, with Hungary and the Czech Republic particularly strong, says Tunde Kis, a senior manager in PwC Hungary’s advisory practice. “There has long been pharma-friendly legislation such as non-refundable subsidies and tax breaks [in Hungary],” says Kis. “Local businesses with a base in Hungary can reduce their taxes for R&D development, such as purchasing equipment, building new facilities and employing people.” She points to Hungary’s new

Understanding the nuances between countries is a real challenge for industry players

PETER KOETSIER, BRISTOL-MYERS SQUIBB

PwC partner Alina Lavrentieva offers an

update on the Russian pharma sector

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government and its promise to make R&D a “key area”. Slovakia held elections in June and it too may look to offer competitive incentives to attract investment.

Poland’s pharma industry is also benefiting from a friendly environment. Its clinical trials market is set to grow by 5% this year to 170m, according to research by PMR, a market intelligence firm.

Why is CEE “on its way to becoming a hub for clinical trials”, as Wake describes it? For starters, the number of healthcare professionals compares favourably with Western Europe, and is far higher than in emerging markets, according to the PwC report Prescription for Growth. Additionally, there are a growing number of patients eager to benefit from innovative drugs that may not yet be available to them via conventional means.

GENERICALLY SPEAKINGLimits on spending have led to CEE’s second growth area in pharmaceuticals – the cheaper generic drugs market. “A unique feature of CEE is

a strong presence of local manufacturers supplying local ‘branded generics’ that are well established in particular markets,” says Mariusz Ignatowicz, PwC’s pharma tax leader for the CEE region.

In 2002, Poland’s generics accounted for over two-thirds of prescriptions, versus just a fifth in Western EU states. This was not just down to frugalness: patents were largely non-existent until the fall of the Iron Curtain, just as new drugs were extremely limited. The market for generics has grown particularly fast since 2009, when the crisis drove up demand even more for cost-effective alternatives.

Though it is a high-volume game, it is a low-margin one. This is due to government-imposed price controls, which often set a price that patients will pay pharmacies based on the cheapest available drug. This has led to players competing on discount, rather than price, meaning some drugs are sold below cost.

WORSE STATE“Conditions for CEE generics producers are less attractive than they used to be,” says Joanna James, managing director at Advent International, a private equity firm that has invested in CEE’s pharma sector. “Governments post-crisis are short of cash and the drugs reimbursement budget is a prime target for cost-cutting.” This is a budget that sees governments put select drugs on a list and determine what price the government is willing to pay the suppliers. Although price ceilings

may deter some players, opportunities now abound for

The Russian pharma market has witnessed significant changes in the past couple of years. The landscape is now set to alter again, as the government implements healthcare reforms, increases its influence over the prescribing of pharmaceuticals and looks to bring in tighter restrictions on promotional activities. Among the key drivers are changes in the state regulation of prices for vital pharmaceuticals, specifically, changes in the registration of maximum prices of pharmaceuticals of Russian and foreign manufacturers, and setting maximum wholesale and retail mark-ups for manufacturers’ actual prices.

In essence, based on these regulatory mechanisms, it is assumed that pharma manufacturers will be able to set prices for pharmaceuticals in a way that corresponds to manufacturers’ functions and the risks they bear. As a result, a number of large pharma groups – Nycomed, Berlin-Chemie and Novo Nordisk – have announced plans to build pharma factories in Russia.

Distributors and pharmacies need to think about how to finance their expenses and ensure their businesses’ future growth in conditions where statutory maximum mark-ups apply. In such conditions, distributors represented by foreign producers’ subsidiaries will inevitably be faced with a choice of whether to carry out a wide range of loss-making activities, or gradually reject such a model and concentrate on functions directly associated with the distribution of pharmaceuticals. In our view, the majority will choose the second option, meaning manufacturers themselves will have to take on the marketing and promotion of their own pharmaceuticals. Here they may hire the distributors to provide this for a fee.

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P H A R M A C E U T I C A L S

generics manufacturers. Patents, introduced in the early 1990s, were for 20 years, which means many drugs are about to come off patent. According to Ignatowicz: “This should ignite an explosion in the number of generics of lucrative therapeutic drugs.”

Global players have been getting ready for this moment. Sandoz, the generics arm of Novartis, bought Slovenian pharma Lek in 2002. GlaxoSmithKline announced in 2005 that it would create a major distribution centre in Poznan, Poland.

GOVERNMENT ACTION Andrew Friars, managing partner for advisory with PwC Poland, agrees with Ignatowicz that the pharma market is poised for significant growth, but says: “There is also a high likelihood of increased government intervention and regulation.” This is largely because of the need to watch costs. “This will have serious impact for all players including (particularly) the generic manufacturers. Some players will not survive and/or will exit,” he adds.

This may be due to pricing pressure. Shortly after EU accession, the Czech Republic began to regulate prices. More recently, Romania’s government has tinkered with pricing regulation, but despite this, the domestic market is growing quickly, according to Koetsier.

Cost controls continue to make their way throughout CEE, such as decreasing statutory prices/margins, introducing risk-sharing measures and forcing generic prescriptions. But this won’t deter major players, says Ignatowicz: “The ever-growing demand for innovative treatment, as well as an aging population combined with increasing per capita spending, help to keep the region attractive for pharma investors.”

Next on the region’s list should be biotech, says Kis: “CEE is considering

coming into this area. Biotech could become much bigger in CEE, but its governments must be heavily involved, cooperating with pharma companies to lure them to CEE.”

A global appetite for investing in CEE’s pharma sector clearly exists. If CEE governments can resolve pricing issues, and get more enthusiastic about the clinical trials market, the region’s low cost base and talented workforce could help it become a much bigger player in the

global pharma market. ■

Kimberly Romaine is editor-in-chief of unquote”.

FINANCIAL BOOST

The allure of CEE is not limited to multinational pharma companies – financial investors are also attracted to the promise of healthy returns.

One of the biggest names in CEE pharma, Zentiva, is a case in point. In 1998, global buyout house Warburg Pincus acquired the Czech government’s 67% stake in Leciva, as Zentiva was then known, as part of a privatisation. Under Warburg’s financial firepower, new products were launched and Slovakopharma added on. In 2004, Warburg floated the business on the Prague stock exchange, not only making a sizeable return on its investment, but also marking the exchange’s first substantial flotation since it resumed trading in 1993. Zentiva’s business is made up of 73% branded generics, 10% in-licensed pharmaceuticals and 13% over-the-counter drugs. Its success and product mix caught the eye of global pharma giant Sanofi-Aventis, which acquired a 20% stake in the business in early 2006, and then in June this year

announced that it is buying Zentiva for around $2.6bn in cash.

CEE’s newest member states in the Balkans also offer growth prospects. In 2003, private equity firm Advent International delisted Terapia, then Romania’s second largest pharma maker, from the stock exchange in a $49.5m deal. The financial partner began consolidating the domestic market through bolt-on acquisitions, and three years after Advent’s investment, Indian pharma Ranbaxy took hold of Terapia, whose sales and Ebitda had more than doubled to $75m and $26m respectively.

Proving there is still goodness in the Romanian market, Advent is pursuing another success story with Romanian generics pharma manufacturer and distributor LaborMed, which develops new products through R&D, in-licensing and acquiring dossiers. As a result of the buyout, a new CEO was brought on board from Polpharma, one of Poland’s biggest players.

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P R I V AT E E Q U I T Y

For most private equity firms in CEE, when they deal with stock markets it is usually to exit from their investments. But that has been changing in recent months, with a notable if small trend of investment firms

looking to local exchanges as a source of new deals.Among them, EQT completed its public tender

offer for the shares in HTL-Strefa, a Polish developer of specialist medical equipment, in November 2009, which allowed it to move ahead with plans to take the company off the Warsaw Stock Market where it had been listed. In February this year, Advent International concluded a successful tender for the shares of Polish educational publisher WSiP and completed steps to take the company private. Advent International has also bought a majority stake in Devin, a soft drinks company, which is expected to be delisted from the Bulgarian Stock Exchange by mid 2010.

These are not the first examples of such deals, known as public-to-private or take-private transactions – as long ago as August 2003, Advent bought Romania’s second-largest pharmaceuticals manufacturer Terapia through a public-to-private deal – but there have never been as many at one time as in the past few months.

“The interest in these types of deals has been huge,” says Joanna Simonowicz, a partner in PwC Poland, which has provided financial, tax and commercial due diligence services on a number of public-to-private deals in CEE in recent months. “Only the most sophisticated private equity houses can do it. However, to the extent you can do it, these companies are usually well run with good management.”

GOOD HUNTING GROUNDSFor private equity houses, the depressed nature of the stock markets makes them worthwhile hunting grounds. There can also be clear benefits for the target companies in moving off the exchanges, as it means their management teams can focus on developing the business rather than being distracted with having to deal with analysts and others. “Traditionally, 20 years ago the reason why you’d take these companies S

UP

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CEE’s private equity sector shows signs of maturing as some investors look to the stock markets for targets

WORDS: DOMINIC DUDLEY

The interest in these types of deals has been huge. Only the most sophisticated private equity houses can do it

JOANNA SIMONOWICZ, PwC, POLAND

private was because you felt these companies were undermanaged,” says José-Miguel Gaspar, private equity chair at Essec Business School in France.

“You still get some of those, but that rationale for a deal is becoming less frequent. From the 1980s to now, there has been a lot of professionalisation of management teams, so the rationale now is mostly about increasing the growth potential of these companies. Also, being public brings significant costs: compliance costs, the cost of maintaining a structure for investor relations, the management time dedicated

to talking with analysts and institutional investors like mutual funds and pension funds. So the management team will just say: why should I waste my time on this instead of developing the business?”

The strength of the management team at the target company is critical for a deal, says Monika Morali-Efinowicz, managing director and head of Advent’s Warsaw office. “They are very well placed to recognise the optimum way for their company to go forward and to recommend whether their business should be run privately or not.” But it is not always easy to push through a public-to-private deal, and it can end up being far more expensive than other types of deals.

POTENTIAL BARRIERSThe biggest potential barrier is existing shareholders, who may be reluctant to sell at the deflated prices most attractive to private equity buyers. You need a large proportion of the shares before you can force the more intransigent shareholders to give up their stakes to allow you to delist the company – known as a ‘squeeze out’ or compulsory purchase.

“There’s a wide range of shareholders involved in a public-to-private deal and it can be very time-consuming,” says Rod Ball, research fellow at the Centre

unquote” has named PricewaterhouseCoopers Adviser of the Year to the Private Equity industry in Central & Eastern Europe.




Adviser of the Year to Private Equity in Central & Eastern Europe

For more information please contact

CEE Private Equity LeaderMike WilderTel.: +48 22 523 [email protected]


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49pwc.com/transform

P R I V AT E E Q U I T Y

for Management Buy-out Research (CMBOR). “Often you can get counter bids so it can be quite an expensive way of doing things. There are a lot of regulations involved and it can be quite an arduous process.”

Persuading reticent shareholders can involve paying a high premium for their shares, although some recent deals in CEE have involved a relatively modest mark-up. Advent offered PLN17.15 for each share in WSiP in January 2010, 6.5% more than the trading price of PLN16.10 the day before the deal was announced. EQT paid an even smaller premium of 2.7% for shares in HTL-Strefa, offering PLN13.71 per share compared to the previous closing price of PLN13.35. In contrast, the average bid premium in the UK – by far the most active market in Europe for such deals – was 45.3% in 2009, says CMBOR.

The difficulties only mount if a company has a listing on several

stock markets, as the rules for take-private transactions can differ in each market.

Chris Mruck, managing partner at Advent and co-head of its CEE investment activities, says: “Acquiring publicly listed companies can be more complicated than acquiring private ones. This is mainly due to limitations on, for example, the information a listed company can disclose to an interested party. The only thing I would say is that it gets easier with practice.”

For private equity firms that need to raise debt for deals, the weaknesses at European banks do not help. Typically a buyout might rely on up to 60% debt, which can be difficult to secure in today’s market, although some firms are finding novel solutions. Such

considerations, along with the cost and complexity of public-to-private deals, mean they are still relatively unusual in CEE. But they have long been a part of the private equity industry in other markets, where firms have decided that the gains from such deals can make the extra effort worthwhile.

THE PICTURE ELSEWHEREOne of the largest buyout deals of all time, the £11.1bn purchase of Alliance Boots by Kohlberg Kravis Roberts & Co. in June 2007, was a take-private deal. The deal helped ensure the public-to-private market in the UK hit record levels that year, with 24 deals worth £19.5bn, according to CMBOR. However, the number and value of deals have declined steadily since then. In the first three months of this year, there were four deals worth just £62m in total.

In CEE, deals are likely to remain at low levels and, even if the current momentum is maintained, they will

continue to be a minority area of private equity activity. In more mature markets, such deals generally only account for 3-4% of deal volumes, according to Ball, even if at times they can account for as much as 40% of the total values of deals.

Nonetheless, it is a welcome addition to the range of deal

sources for the private equity industry in the region and a further indication of the sector’s growing maturity. Once stock market activity picks up, they will even be able to think of selling the companies back to the markets a few years later.

As Gaspar points out, “Companies that were bought in public-to-private deals tend to be larger and, being large, an equity listing is one of the most important ways to exit.” ■

Dominic Dudley is a former deputy editor of MEED.

ABRIS CAPITAL AND THE CATALYST MARKET

With bank finance so hard to raise in today’s market, it can pay to explore different avenues. For Abris Capital Partners, a Warsaw-based firm which focuses on mid-market deals, that meant turning to the Catalyst bond market in Poland.

Abris used the market to help finance its acquisition of fleet management firm Masterlease Polska from GMAC Financial Services in April. As part of the deal, Masterlease issued PLN534m worth of corporate bonds to institutional investors.

“We tried to raise finance with banks but there wasn’t enough interest to make us confident we would be able to do it,” says Paweł Gieryn ski, a partner at Abris. “But there

is some liquidity in the market and it mostly comes from institutional players.”

It was the first time the market had been used to finance a private equity deal, and more deals could follow.

“The deal was unique from the point of view of how they financed it,” says Paul Gleeson, a partner at PwC Poland, which provided financial, tax and commercial due diligence on the transaction. “It will provide private equity buyers with alternative ways of financing deals where bank finance is hard to come by.”

“I am aware of other discussions going on so I’m pretty sure there will be some other transactions,” adds Gieryn ski.

Totally wired

50

Some parts of CEE

are exploiting the business potential of

social networks better than others. It’s only a matter of time before the cautious

catch up

WORDS: CHARLES ORTON-JONES

51pwc.com/transform

S O C I A L N E T W O R K I N G

Social networks seem to baffle and annoy businessmen. Mobile phones they love. Google they get. Understanding AdWords and search engine optimisation (SEO) is compulsory in the internet age. But leave a

meeting to check your Facebook account and you’ll face a chorus of derision. It is as though social networks are leisure tools. No serious exec would be caught using one.

So here’s the reality check: social networks are the future of business. They are more important than mobiles or search engines. If you do not understand the landscape of social networks, you are a dinosaur facing extinction. To crush any lingering doubts, reflect on the fact that Facebook recently overtook Google for traffic in the United States. Furthermore, Facebook is growing at 185% to Google’s 9%. It has more than 500 million members and is almost certain to reach 1 billion.

Convinced? Then you’ll be eager to learn more about these networks, such as who uses them, who does what to whom on them, and where the dollar signs are located.

THE RISE OF FACEBOOKThe first lesson is that Facebook rules. This is true across CEE. Not everyone realises this – many executives still believe the old social networks, which sprang up across CEE over the past decade, are the ones to watch.

Here’s what happened. Until a year ago, each country in CEE had its own national champions. Lithuania had One, a site for friends to stay in touch. The Czech Republic had three sites battling it out: Spolužáci was the place where old classmates got in touch; Libimseti had a dating angle; and Lidé.cz was the all-purpose network. In Hungary, iWiW gained total dominance.

Facebook was a late entrant into Europe – not surprising since it was founded in 2004. The drip-drip of media coverage marvelling at Facebook’s ascendancy in Western Europe started to influence consumer behaviour. In 2009, Facebook gained traction and grew exponentially. In the Czech Republic in the past six months it has grown from 1.6 million to 2.8 million users, a third of the entire population. Traffic to the three native networks is now a fraction of what it was.

Facebook is now number one in 21 of the 27 European Union member states. The exceptions are Latvia, where Draugiem is number one, but may be toppled within a year; Hungary, where iWiW is so dominant that Facebook can’t seem to get started; and Poland, home to the well-funded, well-run Nasza-Klasa.

Founded in 2006, Nasza-Klasa means “our class” in reference to its original mission of connecting old school friends. It has 11 million members, meaning that anyone IS

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seeking to talk or market to Poles needs to know about it. But Facebook is likely to overtake Nasza-Klasa, just as it has done with other networks across the continent. Today, Facebook has 4.5 million Polish members and search requests for the term Facebook outstrip searches for Nasza-Klasa tenfold. The future is not hard to predict. In fact, Facebook is now either number one or destined to be number one across the world.

A MARKETING REVOLUTIONThe rise of Facebook has meant businesses across CEE are waking up to its immense possibilities. Unlike the local networks it is replacing, Facebook offers more than mere banner ads. In the Czech Republic, for example, there are examples of viral marketing, consumer interaction and brand initiatives as impressive as anything in the US. The foremost Czech expert on Facebook is Jan Rezab, who has a string of technology start-ups under his belt, including Candytech, a

Facebook marketing firm and Facebakers.com, a statistics portal specialising in Facebook data.

Rezab evangelises about the business impact of Facebook. “It’s been amazing. Let me tell you one story,” he says. “There is a guy outside of Prague who changes car tyres. His business has a Facebook page with only 140 friends. He did a status change offering 15% discount and immediately got seven clients out of that. Think about what that means. He advertised for free using Facebook and made money from it. The whole marketing campaign took 10 minutes.

“Businesses across the Czech Republic are doing the same thing. The most popular radio station, Evropa 2, uses Facebook for their requests. They used to say ‘Call us’, then ‘Email us’. Now they say ‘Facebook us’.”

Candytech works with the largest companies in the Czech Republic to create Facebook campaigns. Clients include Tesco, GE Money Bank and Peugeot. Rezab

He advertised for free using Facebook and made money from it. The whole marketing campaign took 10 minutes

JAN REZAB, CANDYTECH AND FACEBAKERS

52

ARMENIA1 Facebook2 Odnoklassniki3 Vkontakte

AZERBAIJAN1 Facebook2 Odnoklassniki3 Disput.az 4 VKontakte

BELARUS1 VKontakte2 Facebook3 vk.com

BOSNIA AND HERZEGOVINA1 Facebook

BULGARIA1 Facebook2 Aha.bg 3 Mail.bg4 Elmaz

CROATIA1 Facebook2 Forum.hr

CZECH REPUBLIC1 Facebook2 Lide.cz

ESTONIA1 Facebook2 Orkut3 Odnoklassniki4 VKontakte

HUNGARY1 iWiW2 Facebook

KAZAKHSTAN1 VKontakte2 Facebook3 Odnoklassniki

LATVIA1 Draugiem.lv 2 One.lv3 Facebook4 Odnoklassniki 5 Boomtime.lv

LITHUANIA1 Facebook2 One.lt3 Draugas

MACEDONIA1 Facebook

POLAND1 Nasza-klasa.pl2 Facebook3 GoldenLine

ROMANIA1 Facebook2 hi5

RUSSIA1 Mail.ru2 VKontakte 3 Odnoklassniki4 Facebook

SERBIA AND MONTENEGRO1 Myspace2 LinkedIn

SLOVAKIA1 Facebook2 Porada.sk

UKRAINE1 VKontakte2 Odnoklassinki3 vk.com

CEE’S TOP SOCIAL NETWORKS*

* Social networks are listed in the order they appear in each nation’s list of most visited websites Source: Alexa.com

explains: “For example, Peugeot wanted to increase the number of Czechs asking for a test drive. We created a quiz which guessed your mental age. The age it discovered was always lower than your real age, which people loved. They showed their friends and 200,000 people downloaded the application. At the end of the quiz there was a statement that if users liked the game, they would love the new Peugeot model. We had 1,300 test drives resulting, a huge success for Peugeot.”

You’ll find a similar culture in Poland. The best-known marketing

company for Facebook campaigns is Agencja Społem, based in Warsaw. It maintains Facebook pages for the likes of Nike Poland and television channel TVN. A recent project for Milka chocolate on Facebook involved a vote for where the firm should spend 1m złoty earmarked for environmental projects. “We got 22,000 votes from Poles who wanted to get involved,” says Agencja Społem spokesman Jakub El Mahdi.

El Mahdi says that although Facebook is growing fast, Nasza-Klasa still has a lot to offer: “It is for people who want to meet their

old school friends. It doesn’t have the same functionality as Facebook. It is worth knowing about because everyone is there, with 11 million accounts. If you want to market in small cities, it is maybe better. But it isn’t cheap to buy advertisements on Nasza-Klasa.”

A recruitment site in Poland is worth a mention too. GoldenLine is a recruitment-based site like LinkedIn. El Mahdi says: “GoldenLine is used by headhunters, so it can help to have your CV on it. It is popular for Polish professionals. If you want to recruit a Polish executive, it can be a good place to start looking.”IS

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Over the border in Lithuania, the situation is identical. Facebook is a major part of the marketing mix for firms of all sizes. In fact, Vilnius is home to Kitoks.com, a Facebook Preferred Developer, one of just 10 outside the US.

“The potential of social networks was recognised only half a year ago. Now many Lithuanian companies introduce themselves on Facebook.com. Big companies and famous brands use Facebook applications,” says Kitoks.com founder Tomas Kacevicius. He points to brands such as Svyturys beer and Pigu.lt, the nation’s biggest online store, which have both established powerful Facebook presences.

NETWORKS UNDER FIREHe says the national social networks are suffering. “The popularity of One and Draugas decreases because of Facebook growth. Moreover, the audience of One is mostly under 18 years old. Facebook.com consists of older users. Needless to say, this makes Facebook.com more attractive for brands and business. There are 672,740 Lithuanians on Facebook and two-thirds of them fall in the range of 18-35 years old.”

Trends move fast. Kitoks.com itself is only two years old. “Our first Facebook application was developed one-and-a-half years ago. It was a novelty in the Lithuanian IT market – only 80,000 Lithuanians were on Facebook. Now half of all internet users are on Facebook.” In Romania, Estonia, Bulgaria, Slovakia and the Balkans, the situation is similar.

The frontier is Ukraine, Russia, Kazakhstan and Moldova. Here

the appeal of Facebook clone VKontakte and classmates site Odnoklassniki mean Facebook itself is rather pointless. VKontakte has 42

million users, with 17 million unique users logging in each month. The webmail service Mail.ru offers a social network extra, My World, which boasts 15.6 million unique users a month and Odnoklassniki 15 million. By contrast, Facebook has only 1 million Russian users.

Nick Wilsdon, the British chief executive of Moscow-based internet marketing agency E3Internet, says the Russian social networks are just as good as their Western counterparts. “VKontakte has the same functionality as Facebook,” he says. “You can programme applications in a variety of languages, whereas Facebook has

just one. Applications are popular. The game Happy Farmer has 6 millon users. Major brands, such as Standard Vodka, have a presence, marketing to consumers and to wholesale distributors. It really is very similar.”

Wilsdon moved to Russia in 2005, so he can compare the UK and Russia. He believes the major difference is the sophistication of business usage. “There aren’t many internet marketers in Russia. There tend to be a lot of one-man-band firms.” Russians firms are also slow to capitalise. “International firms here realise the value,” he says. “The approach of native Russian firms lacks rigour. For example, there are a lot of banner ads and SEO, but often without tracking. You really need to monitor every campaign and every rouble you spend.”

This point is emphatically endorsed by Alexander Repiev, founder of the Repiev School of Marketing and Mekka Consulting. “Many employers are suspicious of social networks. They don’t like employees using them and they aren’t sure how to use them to market their products.” This, he says, is partly due to the low status of marketing in Russia. Social networks are still not considered respectable tools, he adds: “It is too early to say that social networks are used by the majority of businesses in Russia, or that those who use them use them expertly.”

This will change. Analysis by Moscow management consultants J’son & Partners suggests usage of social networks in Russia will double by 2013. Membership will increase 40% year on year.

The phenomenon of social networks is just getting started. ■

Charles Orton-Jones is a freelance business journalist, specialising in entrepreneurship and small businesses.

The potential of social networks was recognised only half a year ago. Now big companies use Facebook applications

TOMAS KACEVICIUS, KITOKS

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For a decade, the Heritage Foundation has produced an Index of Economic Freedom, in collaboration with The Wall Street Journal. The index uses 10 benchmarks of economic freedom to gauge the success of a country. These freedom categories include business, trade, fiscal, investment, property and labour.

While Hong Kong tops the global index of 179 countries, Estonia scored the highest of the 25 countries in the CEE region, with its economy ranking as the 16th freest in the world. Its overall score of 74.7 is well above both the regional and global average. Georgia and Lithuania took second and third places respectively, while Montenegro was the highest climber this year, rising from 94th place last year to 68th place in 2010.

The 2010 Index of Economic Freedom

COUNTRY RANK 2009 RANK 2008 RANKEstonia 16 13 12

Georgia 26 32 32

Lithuania 29 30 26

Czech Republic 34 37 37

Slovakia 35 36 35

Armenia 38 31 28

Latvia 50 45 38

Hungary 51 44 43

Albania 53 62 56

Macedonia 56 78 71

Slovenia 61 68 75

Romania 63 65 68

Montenegro 68 94 -

Poland 71 82 83

Bulgaria 75 56 59

Kyrgyzstan 80 74 70

Kazakhstan 82 83 76

Croatia 92 116 113

Azerbajian 96 99 107

Serbia 104 109 -

Bosnia & Herzegovina 110 134 121

Moldova 125 120 89

Russia 143 146 134

Uzbekistan 158 148 130

Ukraine 162 148 133

Source: The Heritage Foundation

Source: Global Innovation Index Report 2009-2010

Measuring the levels of credit provided to the private sector, through loans and trade credits, is a tool for gauging the volume of financial resources available to companies looking to expand. While the credit to the private sector in the world’s most developed countries is typically more than 100% of GDP – the US is placed third in the Global Innovation Index Report for 2009-2010 with 210.07% – Estonia is the highest-ranked Baltic state, in 29th place with 96.11%.

Domestic credit to the private

sector – the Baltic states

% of GDP

96.11%

Estonia

88.67%

Latvia

60.31%

Lithuania

0

10

20

30

40

50

60

70

2006 2007 2008

Source: The World Bank

Of the 25 CEE countries, Slovakia exports the highest volume of goods as a proportion of its gross domestic product (GDP), at 83% in 2008. By sub-region, however, the Baltic states perform the strongest, with the value of goods and services exported in 2008 worth 58.5% of the region’s GDP. The Balkan states were the weakest performers in 2008, with a score of 37.8%.

Export of goods and services in CEE

%

Baltic states Balkan states Central Europe & Russia Central Asia & the Caucasus

Data centre >>>

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To discuss how Outlook can address your company issues, contact [email protected].

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ContactsCHIEF EXECUTIVE OFFICER

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This publication has been prepared as general information on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, neither PricewaterhouseCoopers nor Bladonmore accepts or assumes any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

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Stefan Weiblen

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SLOVENIA

Francois Mattelaer


UKRAINE

Boris Krasnyansky

[email protected] +380 44 490 67 72

UZBEKISTAN

Abdulkhamid Muminov

abdulkhamid.muminov@ uz.pwc.com

+998 71120 6101

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