risks and opportunities in eastern europe

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514 EMJ VOL. 8 NO. 4: December 7990 Reinhard Hijnerberg Director, EA P Europai’sche Wirtschaftshochschule, Berlin R* emhard Hiinerberg believes there are exciting and profitable business ventures possible for foreigners in Eastern Europe, and he traces the reasons for these. But factors remain in the situation in this region which coynsel strict caution on the part of the foreign investor. There is no doubt that the changes in the former Eastern bloc countries are the event of the year. The media are full of it and politicians and economists surprised by the speed of change and its far-reaching implications. But the process appears unstoppable. Although Gorbachev said to Honecker about this, “those who start late will be punished by events”, the opposite could also be true. Being too hasty in joining in it all could prove risky. The following article focusses on the implications for Western companies, although it is also of interest for Eastern bloc enterprises wishing to survive. Main Developments and Facts The list of changes in Eastern Europe since Autumn 1989 is dazzling (see Table 1). A common feature is unrest following Gorbachev’s new policies of liberalisation in the Soviet Union. Some East European governments, like Hungary, were more willing to liberalise than others e.g. Rumania. Yet @her Member States of the East European bloc have a long way to go - including the Soviet Union itself. The Communist system broke down in Eastern Europe for several reasons. The main one is the dreadful lack of economic progress in the countries concerned. Although East European countries rank high in a world league, and even East Germany beats some weaker EEC members, daily life in East Europe is markedly inferior to that in the West - especially in consumption, health and environment. Easterners saw the apparently better life-style in Western Europe through visits and on TV. Western Europe has consistently underestimated the frustration of Eastern Europe’s population as workers and consumers. Also, the real economic performance of the Soviet Union compared with the USA (as measured by CIA figures), has been over-valued (see Table 2). Such comparative figures are unreliable anyway - sometimes they are influenced by propaganda and sometimes the technical measures differ. The conversion of local currency is another snare. A better comparison is of labour productivity. Because of out-of-date machinery, low investment and meagre incentives, labour productivity in the East is well below that of Western Europe; in East Germany it is around 40% of West Germany. East European countries are heavily in debt, which will delay their recovery and probably require Western aid (see Table 3). Poland leads the league table of debtors. Despite all the talk about East-West economic relations in Europe, they have a long way to go. But there is much potential. West Germany dominates the current scene in terms of trade - in 1988 it accounted for 38% of the total volume of trade East-West in Europe, with Italy, France and UK next, trailing at 17%, 15% and 9% respectively. Details for West Germany’s trade with Eastern Europe are shown in Table 4. But changes are taking place. The number of East-West joint-ventures is increasing. In the whole Eastern Bloc,

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514 EMJ VOL. 8 NO. 4: December 7990

Reinhard Hijnerberg Director, EA P Europai’sche Wirtschaftshochschule, Berlin

R* emhard Hiinerberg believes there are exciting and profitable business ventures possible for foreigners in Eastern Europe, and he traces the reasons for these. But factors remain in the situation in this region which coynsel strict caution on the part of the foreign investor.

There is no doubt that the changes in the former Eastern bloc countries are the event of the year. The media are full of it and politicians and economists surprised by the speed of change and its far-reaching implications. But the process appears unstoppable.

Although Gorbachev said to Honecker about this, “those who start late will be punished by events”, the opposite could also be true. Being too hasty in joining in it all could prove risky.

The following article focusses on the implications for Western companies, although it is also of interest for Eastern bloc enterprises wishing to survive.

Main Developments and Facts

The list of changes in Eastern Europe since Autumn 1989 is dazzling (see Table 1).

A common feature is unrest following Gorbachev’s new policies of liberalisation in the Soviet Union. Some East European governments, like Hungary, were more willing to liberalise than others e.g. Rumania. Yet @her Member States of the East European bloc have a long way to go - including the Soviet Union itself.

The Communist system broke down in Eastern Europe for several reasons. The main one is the dreadful lack of economic progress in the countries concerned. Although East European countries rank high in a world

league, and even East Germany beats some weaker EEC members, daily life in East Europe is markedly inferior to that in the West - especially in consumption, health and environment. Easterners saw the apparently better life-style in Western Europe through visits and on TV.

Western Europe has consistently underestimated the frustration of Eastern Europe’s population as workers and consumers. Also, the real economic performance of the Soviet Union compared with the USA (as measured by CIA figures), has been over-valued (see Table 2). Such comparative figures are unreliable anyway - sometimes they are influenced by propaganda and sometimes the technical measures differ. The conversion of local currency is another snare.

A better comparison is of labour productivity. Because of out-of-date machinery, low investment and meagre incentives, labour productivity in the East is well below that of Western Europe; in East Germany it is around 40% of West Germany.

East European countries are heavily in debt, which will delay their recovery and probably require Western aid (see Table 3). Poland leads the league table of debtors.

Despite all the talk about East-West economic relations in Europe, they have a long way to go. But there is much potential. West Germany dominates the current scene in terms of trade - in 1988 it accounted for 38% of the total volume of trade East-West in Europe, with Italy, France and UK next, trailing at 17%, 15% and 9% respectively. Details for West Germany’s trade with Eastern Europe are shown in Table 4.

But changes are taking place. The number of East-West joint-ventures is increasing. In the whole Eastern Bloc,

HijNERBERG: RISKS AND OPPORTUNITIES IN EASTERN EUROPE 515

Table 1 Steps to freedom in Eastern Europe

Albania May 1990:

Bulgaria 10 June 1990:

Czechoslovakia 24 November 1989: 29 December 1989: 819 June 1990:

East Germany 18 October 1989: 9 November 1989: 1 December 1989: 18 March 1990: 2 July 1990:

Hungary 20/21 February 1989: 23 October 1989: 25 March 1990:

Poland 4118 June 1989: 24 August 1989:

31 December 1989:

27 January 1990:

Romania 22 December 1989: 20 May 1990:

Soviet Union 13 November 1989: 7 February 1990: 15 March 1990:

Source: Der Tagesspiegel, Nr. 1569, 15 May 1990

start of first steps of a liberalization process

first free democratic elections

retreat of government election of Have1 for president first free democratic elections

dismissal of Honecker opening of Berlin wall dropping the monopoly of power by the Communist Party first free democratic elections monetary union between East and West Germany

dropping the monopoly of power by the Communist Party declaration of the “Republic of Hungary” first free democratic elections

first free democratic elections election of Mazowiecki at first Bon Communist Prime Minister declaration of the “Republic of Poland” and dropping the monopoly of power by the Communist Party dissolution of the Communist Party

overthrow of Ceausecou first free democratic elections

law on freedom of journey and emigration dropping the monopoly of power by the Communist Party election of Gorbachev for president

Table 2 Comparative GNP, USA and USSR

USSR

CIA estimate

abs per capita abs

2690 9310 1450

all figures in Billion US $

USSR estimate

per capita abs

5020 5170

US

per capita

20780

Table 3 Net Debt Position of Eastern European Countries

Bulgaria 10.0 1.2 8.8 CSFR 7.2 1.5 5.7 GDR 21 .o 9.9 11.1 Hungary 20.0 1.2 18.8 Jugoslavia 19.0 3.9 15.1 Poland 40.4 3.5 36.9 Romania 0.4 1.1 -0.7 USSR 45.0 15.2 29.8

Gross debts

Assets Net debts

Source: Wirtschaftswoche, Nr. 15, 6 April 1990, p 112

the number registered rose from 165 to 3500 between early 1988 and early 1990. The Soviet Union has 1500 registered and Hungary 700 (although only 10% may be considered firm in the former case). Well-known names like GEC, General Motors and Suzuki have set up in Hungary.

West German companies dominate East Germany. By April 1990, 150 companies had concluded 1100 co- operation contracts with East German partners. For example, Siemens with Robotron (in computer software), Volkswagen with Ifa (to produce cars), Lufthansa with Interflug (airlines) and inter-bank co- operation are among the better-known names. But East Germans are also worried - is this a sell-out to the East?

516 EMJ VOL. 8 NO. 4: December 7990

Table 4 West German-East European Trade

West German Exports West German Imports

Country 1988 1989 change 1988 1989 change

(O/o) (O/o)

USSR 9423.8 11528.1 + 22.3 6877.7 8391.9 + 22.0 Poland 2889.1 4470.4 + 54.7 2911.8 3584.0 +23.1 Hungary 2759.5 3651.2 -I- 32.3 2262.6 2676.6 + 18.3 CSFR 2438.6 2734.4 + 12.1 2200.4 2493.3 + 13.3 Romania 572.3 583.9 + 2.0 1388.9 + 10.8 Bulgaria 1565.1 1471.3 -6.0 321.8 327.0 + 1.6 Albania 37.8 78.3 + 107.1 53.8 61.5 + 17.3

Total 19686.2 24517.6 + 24.5 16017.0 19073.0 + 19.1

Share of total 3.5 3.8 3.6 3.8 West German foreign trade

(O/o)

Source: Wirtschafrswoche, Nr. 15, 6 April 1990, p. 92

Rapid progress has been made in the setting up of retail distribution systems in the East by Western companies - the field has enormous potential. Table 5 shows the current state of play:

Yet, in general, Western managers are still cautious about doing business in the East. Even now many plans and projects are only on paper and actual results are thin on the ground.

The remainder of this article looks at the opportunities and risks for Western companies in this region and makes specific prescriptions for succeeding in making money in Eastern Europe.

Opportunities

They are exciting:

l There is a huge pent-up consumer demand, from daily foodstuffs like yoghurt to consumer durables like cassette recorders. Consumer goods are lacking in quality and simple quantity.

A number of West German firms have realised this opportunity; for example, the Hamburg Spar AG, in co-operation with the former State distribution organisation HO (Handelsorganisation), has opened Western-style supermarkets in some East German cities with much success. Other Western firms, especially those with saturated domestic markets, should follow suit - the marketing requirements do not need to be overly-sophisticated.

West European suppliers stand first in line to meet demand in the East for total company restructuring. Industrial groups in the East are facing a real struggle for survival in the transition from planned to market economies. Either a far- reaching re-equipment has to take place or close co-operation with Western partners is necessary to guarantee a flow of know-how and Western materials

The public sector in the East has to be rebuilt almost from scratch. Most cities are falling apart, from Leipzig to Leningrad; buildings are crumbling, streets need repairing, railways are slow, hospitals primitive and telephones nightmarish.

The Service sector, including tourism, banking, insurance, consulting, advertising, market research, auditing and training is chronically underdeveloped.

Risks

These are significant and rather qualify the positive allure of the opportunities listed above. The future for Western companies in Eastern Europe is unpredictable and the following specific risks should be taken into account:

l Great political instability, especially in the Soviet Union, which may affect other Eastern European countries.

HijNERBERG: RISKS AND OPPORTUNITIES IN EASTERN EUROPE 517

Table 5 West German Retail Operations in Eastern Europe

Country Food/restaurants Clothing/footwear Electrical/photographic Other

Soviet Union Asko (W. Germany) Baginski (W. Germany) Herlango (Austria) Bloomingdale’s Dr. Octker (W. Germany) Quelle (W. Germany) Eastman Kodak (USA) (USA) Baskin-Robbins (USA) Salamander (W. Germany) Computerland (USA) Alphagraphics (UK) McDonald’s (USA) Alain Manoukian (France) Rastile International lkea (Sweden) PepsiCo (USA) Christian Dior (France) (Venezuela) Starup (Brazil) Alfa Beta (Greece) Benetton (Italy) Pukeva (Finland) Goodys (Greece) Stefanel (Italy) Aer Rianla (Ireland) Delhaize (Belgium) Coppernob (UK)

Jindo (S. Korea)

Hungary Asko (W. Germany) Tengelmann (W. Germany) Billa (Austria) Wiener Holdings (Austria) McDonald‘s (USA) Burger King (UK) Andre Trade (Switzerland) Nestle (Switzerland) Mercasa (Spain)

Adidas (W. Germany) Neckermann (W. Germany) Quelle (W. Germany) Levi Strauss (USA) La Redoute (France) Benetton (Italy) Pop 84 (Italy) Marks & Spencer (UK)

Siemens (W. Germany) Hertie (W. Germany) Herlango (Austria) Avanti (Austria) Niedermeyer (Austria) INKU (Austria) Philips (Austria) Julius Meinl Walter Nettig (Austria) (Austria) Sony (Japan) MetrolHuma

(Austria) lkea (Sweden)

Bulgaria Asko (W. Germany) Quelle (W. Germany) Sandra (Italy) Lee Cooper (Italy)

Glaoudalos (Greece)

Poland Julius Meinl (Austria) Leclerc (France)

Czechoslovakia Julius Meinl (Austria)

Romania Leclerc (France)

Puma (W. Germany) Quelle (W. Germany) Benetton (Italy)

Bata (Switzerland)

Hertie (W. Germany) lkea (Sweden) Affelow (France)

Source: Price Waterhouse The Economist, 7 April 1990, p. 84.

l Includes joint ventures under negotiation

l The current and prospective economic framework is deteriorating. For example, State-owned companies in the Soviet Union, after years of meeting their debt repayments promptly, are falling behind. Suppliers of steel alone are waiting for outstanding payments of 200 million. Liberalisation is actually accelerating this process as suppliers can negotiate business agreements without the State co-ordinating currency flows.

Forecasts for the Eastern economies are dark - high unemployment, inflation and company failures. East Germany is certain to succeed; Czechoslovakia maybe; but question marks hang over Hungary, Poland and the rest.

l Much of the necessary legal framework for

business is lacking in Eastern Europe, and this will hamper the development of market economies. For instance, property rights are not guaranteed, prices not freely determined, local currencies not freely convertible and joint venture laws rigid.

l Transport and telecommunications are very undeveloped and constrain normal business. Computer support, like databases, is similarly lacking.

l Many State-owned industries are in virtual collapse and beyond repair or restructuring. Even the Soviet oil industry is experiencing declining production and cannot fulfil long-term contracts with countries like Czechoslovakia, Hungary and Poland. Even in East Germany, which is currently

518 EMJ VOL. 8 NO. 4: December 7990

undergoing more radical change than the other East European countries, two-thirds of industry, from shoes, cars, food and distribution to electronics and agriculture, is unable to stand up to Western competition.

Western companies may believe the lack of competition in most of East European industry should create opportunities for them, but they should recall it also means a lack of potential partners, State interference and a very long period of restructuring.

Financial restrictions are severe. Local currencies and not convertible so counter-trade is common. There is likely to be increased demand for financial aid from the West or international organisations.

Perhaps the biggest barrier to the liberalisation of the Eastern economies and therefore to Western companies is a deficiency of trained managers who possess a “capitalistic” mode of thinking. Market- orientated thinking about prices, costs and quality and management techniques cannot be acquired in a short period of time. It will remain a problem for a long time to come. Consumers in the East are similarly afflicted with a lack of appreciation about how market economy mechanisms work.

The former East European bloc of countries which hitherto offered relatively safe although rather unprofitable business opportunities, has broken up with uncertain fragments. Currently, it is difficult to identify the right organisation and the right people. The terrific pace of events has caused fast turnover of responsibilities and made personal contacts uncertain. The sheer number of people one may have to talk to now makes it easy to get confused. Now, 25,000 companies in the Soviet Union negotiate their import/export business individually, whereas not so long ago the Foreign Trade Bank of the USSR did nearly everything.

Steps to be Considered

Western companies should make deliberate efforts to be coolly analytical as far as their decisions about Eastern Europe are concerned. This should counteract the alternate euphoria and pessimism that has characterised views of this region in recent months.

Even before they start any venture in the East, Western companies should establish the strategic direction they wish to follow. This advice is based on an understanding of the current competitive situation. Multinational companies may be forced, by competition, to take an interest in Eastern Europe.

However, this region is much less monolithic than the other great trading areas of the world - the USA, Japan and the European Community. Hungary, Poland and Czechoslovakia may be considered as one segment, Bulgaria and Romania another, and the Soviet Union a third. If the present disintegrating tendencies in the last cannot be stopped, even this country may be subdivided.

East Germany is also somewhat different. It offers excellent opportunities for pilot projects because of its links to West Germany and is thus a good springboard for business in other parts of Eastern Europe. A recent survey showed that West German companies would prefer to do business in East Germany to Ireland, Portugal or Greece.

Western markets are tending to saturation and Eastern Europe may provide an outlet. Nonetheless, one should bear relative size in mind - East Germany has a population approximately the same size as that of the Land North Rhine-Westphalia.

It might be thought that certain supply-side factors such as low wages, investment incentives and tax cuts would help companies looking for business in Eastern Europe. But these attractions can be transitory or at least erratic and may even be outweighed by disadvantages elsewhere. At the present time Hungary probably offers the best investment conditions of all East European countries, for example, attractive tax concessions, joint ventures with a high proportion of foreign equity permitted and the possibility of share ownership of Hungarian companies. But this kind of encouragement may soon become the norm elsewhere in this region.

After a foreign investor’s initial decision to go ahead, his next step is to decide which country and region, type of investment, customer, product range and distribution network to invest in. This means scrutinizing all external factors like legislation and consumer habits which could affect business activity now or in the future. For long-term commitments, the political and legal background will probably make it necessary to seek partners. It is clearly advisable for major projects to be preceded with a feasibility study, but surprisingly, 40% of all German joint ventures in the Soviet Union go ahead without such studies.

Given the risks described above, it may be best to try to obtain a strategic option in this region without investing too much. Many of the joint ventures in the Soviet Union are of this “sleeping” kind, with investment in each totalling less than one million transfer roubles. This approach allows the investor to gain experience and contacts and collect information with a lower risk of failure. In places like Warsaw and

HijNERBERG: RISKS AND OPPORTUNITIES IN EASTERN EUROPE 519

Budapest it has become easy to gether know-how since many consultants and specialists are now gathered in such places. It goes without saying that there is still all the information agency advice offered by Chambers of Commerce and literature sources in the West. In West Germany today it is as easy to obtain information on Eastern Europe as it is on the European Community.

It is quite clear that business decisions by foreigners in Eastern Europe should be even more cautious than usual and not neglect any factors which could affect the outcome of their investment.

REFERENCES

Dickey, Alan (1990) “Going out of the window”, Euro- Business, Vol. 1, No. 7, April, pp. 14-17

Schneider, Dieter J.G. (ed.) (1990) Das Sowjetunion-Geschtifi, Wiesbaden

“Dann bricht alles zusammen”, Spiegel, No. 19, 1990, pp. 18-26

“The grim reality”, International Management, April 1990, pp. 24-32

“The Soviet Union” (Financial Times Survey), Financid Times, 2 March 1990

“Die Kunst des Mikado” (Wirtschaftswoche Special), Wirtschuftswoche v. 6.4.1990, pp. 89-131