the challenges of enlargement sme growth strategies in central...

The challenges of enlargementSME growth strategies in Central Europe

A report from the Economist Intelligence Unitsponsored by Oracle

© The Economist Intelligence Unit 2004 1

The challenges of enlargement

SME growth strategies in Central Europe

The challenges of enlargement: SME growth strategies in

Central Europe is an Economist Intelligence Unit white

paper, sponsored by Oracle.

The Economist Intelligence Unit bears sole

responsibility for the content of this report. The

Economist Intelligence Unit’s editorial team executed

the online survey, conducted the interviews and wrote

the report. The findings and views expressed in this

report do not necessarily reflect the views of the

sponsor.

Our research drew on two main initiatives:

● We conducted an online survey in March/April

2004 of 147 senior executives of small and mid-

sized firms distributed throughout the accession

and candidate countries of Central Europe.

● To supplement the survey results, correspondents

for the Economist Intelligence Unit also conducted

in-depth interviews with senior executives at small

and mid-sized enterprises in Bulgaria, the Czech

Republic, Hungary and Poland.

May 2004

Preface

2 © The Economist Intelligence Unit 2004



The enlarged European Union market is now a

fact. Conventional wisdom suggests that small

and mid-sized enterprises (SMEs) in Central

Europe, burdened by more onerous

compliance requirements and menaced by new

competition from West European firms, will struggle in

this expanded marketplace. But the 147 SME

managers surveyed for this Economist Intelligence

Unit white paper, sponsored by Oracle, tend to see

enlargement in a rosier light, with most expecting at

least modest revenue growth as a result of

enlargement and significant benefits to the regional

business environment.

Some will not survive, of course. Almost half of the

SMEs covered in our survey are not yet compliant with

industry-specific EU rules and those that consider

themselves ready for the new environment may not be

in as good a position as they think. For these firms

there is still a window of time in which to take remedial

action, but it is diminishing.

Among the key conclusions of this report are the

following:

● Competition will intensify at home, but most

SMEs believe they are ready to cope. Managers

are confident they will cope with tougher

competitive conditions in their core markets, and

are looking forward to a more stable business

environment. Overall, most SMEs expect to receive

a modest boost to sales from enlargement,

although confidence that new export

opportunities will help to compensate for any

losses at home may be misplaced.

● Access to finance will remain a growth

constraint. SME managers cite access to capital

and exposure to financial risk as two of their most

glaring weaknesses, and these will restrict growth

of exports and local sales. EU membership will help

financing conditions improve over time, but credit

will remain tight in the short term in most

accession countries.

● Labour costs will come under growing pressure.

Cost efficiency based on low wages is perceived as

the main competitive advantage of most Central

Europe SMEs. Wages are already rising, and entry

to the EU internal market will only add to the

upward pressure. Managers will need to constrain

wage growth, but to avoid accelerated erosion of

their cost advantage they will also need to find

savings in other areas, such as the supply chain.

● Improving customer retention is the top

strategic priority. “Secure the home base” is the

watchword of SME managers in Central Europe,

mindful of the arrival of tough new competition in

their home markets. Improving customer

relationship management is how they aim to

achieve this—60% of survey respondents listed

this among their top three priorities—and

investment in IT systems figures prominently in

these plans.

● There remain alarming knowledge gaps among

SMEs on enlargement. Central European

governments and industry bodies have not been

effective in educating SMEs on the requirements,

risks and opportunities of EU accession. Over 50%

of survey respondents rate their knowledge of

compliance requirements as average, fair or poor.

Many know little or nothing about EU structural

funds, for example.

Executive Summary




● Secure the base first. New market

opportunities are alluring and should not be

missed, but be sure of your core customer base

first. Gaining better knowledge of, and

improving communication with, your key

customers must become routine practice, not

remain episodic initiatives.

● Invest in your staff. The internal market

should ultimately enhance labour mobility,

making it easier to switch employers. Wages

and benefits are important to retain good staff,

but so are intangibles, such as training,

recognition, ability to provide input and

responsibility.

● Knowledge is power. Don’t assume that

compliance with EU rules equals readiness.

Update your knowledge about operating

requirements and conditions. If local information

sources are lacking, check with EU agencies or

relevant Europe-wide industry associations.

Learn whether your business may be able to tap

EU financing vehicles and how to apply.

● Don’t count on low labour costs indefinitely.

Economic development tends to erode such

competitive advantages over time. Seek

efficiencies in other cost areas, but in the

longer term quality, reliability and customer

service will need to be equal or better than that

of your competitors.

● Invest in technology, but wisely. CRM, sales

force management and other IT systems can

provide an advantage, but only when utilised

effectively. Don’t invest in IT without training

staff in how to use it and adapting business

processes and organisational structures

accordingly.

● Watch your rear. Some competitors in your

domestic market or further east in Russia and

Ukraine operate in a better cost environment

than you. Their product quality, marketing and

distribution channels will improve over time.

Don’t underestimate them, even if they’re

outside the EU.

Six key messages for SMEs




Key points

● Managers of small and mid-size firms in Central

Europe still display alarming knowledge gaps

regarding the requirements, risks and

opportunities of EU accession.

● Most SMEs in the region expect to be compliant

with the relevant acquis by the end of 2004, and

the costs of compliance are manageable.

As of May 1st 2004 the European Union

numbers 25 countries and 454m people.

Although transition periods in various

compliance areas will delay completion of the

full internal market for a few more years, crunch time is

here for the companies of the EU’s eight new Central

European member states.* (If things go smoothly for

candidate countries Bulgaria and Romania, D-day for

their firms will be January 1st 2007).

Conventional wisdom has it that the new market

conditions will be unforgiving for Central Europe’s

companies, and particularly so for its small and mid-

sized enterprises (SMEs). The 1990s brought an

explosion in their number throughout the region. By

2001, according to Eurostat, registered micro, small

and mid-size firms numbered nearly 2.2m in the eight

accession countries of Central Europe, 99.7% of the

total number of firms in the region**. The SME sector,

including micro-enterprises, employed two-thirds of

the region’s employees, or 36% if micro-enterprises

are excluded.

Numerous they may be, but many are poorly

endowed and inward-looking. Starved of finance and

operating in adverse, often crime- and corruption-

ridden environments, a vast number failed to survive

the post-socialist transition. Now comes another

hugely significant test. Are they truly ready to operate

in the enlarged EU? Can they compete successfully for

customers in the more developed EU markets? Can

they protect their core markets at home from new,

well-endowed west European entrants? If yes, how do

they plan to achieve this?

This report will show that SME managers in the

accession and candidate countries are reasonably

Ready or not

0

20

40

60

80

100

Poland Czech Rep Estonia Latvia Lithuania EU-15

Micro Small Medium Large

Source: Eurostat

Size breakdown of enterprises in selected European countries, 2001

(%)

*Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, and Slovenia.

**SMEs in Europe—candidate countries: Data 2001, Eurostat, 2003.




A total of 147 executives from 12 Central and

Eastern European countries participated in the

survey. Poland and Hungary provided the largest

number of respondents, but managers from all the

Central European entrants were represented in

proportions that broadly reflect their population’s

weight in the group of eight countries.

Senior-level executives dominated the group of

respondents. Over three in ten were chief

executives or chairmen of their firms, while another

30% were senior directors of departments or

functions.

Financial and professional service firms were

well represented in the survey group, as were

telecommunications, IT, and pharmaceuticals and

healthcare firms. The other respondents were

distributed fairly evenly among the manufacturing,

retailing, transport and primary industry sectors.

Who took the survey?In what country are you located

(% respondents)

Lithuania 3

Slovenia 9

Other 9

Poland 37

Hungary

16

Czech Rep

10

Slovakia 5Estonia 6

Latvia 5

Which of the following titles best describes your job?

(% respondents)

CEO/COO/Chief executive/Managing director 27

Other manager 25

Chairman/President/Vice-president 7

CFO/Treasurer/Comptroller 7

CKO/CIO/Technology director 6

Director/VP of marketing 6

Director/VP of sales 4

IT manager 4

Director of planning/manufacturing 1

Supply-chain manager 1

Other 10

Source: Economist Intelligence Unit survey, March–April 2004

confident about surviving in the enlarged EU

marketplace. Perhaps the most encouraging result of

our survey is that nearly all our respondents—97%—

are looking forward to enlargement. The majority say

they are now or will soon be compliant with industry-

specific operating standards, which is also

encouraging. At the same time, SME managers

understand that enlargement will ratchet up

competition in their markets to a substantial degree,

and that they’ll need to do everything possible to

protect their customer base.

Information gaps

During the long run-up to accession, the European

Commission, local EU delegations and accession

country governments organised numerous conferences,

seminars and training programmes designed to

enlighten managers of Central European businesses on

the requirements and challenges of EU entry.

At the same time the new entrants’ governments

managed to transpose most of the acquis

communautaire—the body of EU legislation regulating




wide swathes of economic and social activity—into

domestic law. In their turn, companies of all sizes and

across all industries have been required to comply with

industry-specific areas of the acquis covering issues

ranging from product certification to data protection.

The fruits of these efforts are becoming visible. Half

of the survey respondents expected their companies to

be compliant with their industry-specific acquis by

May 1st 2004, and most of the others expect to

become compliant by the close of 2004 or by the end

of their respective transition periods.

Despite fears to the contrary, moreover,

compliance appears to be a manageable cost burden

for SMEs. A 2003 progress report produced by

Eurochambres, the umbrella network of EU national

chambers of commerce, suggested that the all-in cost

of implementing the company acquis was less than

€500,000 for most SMEs, and no higher than €1.5m.

The largest proportion of survey respondents expect

enlargement to lead to only a modest rise in costs over

the next three years.

Even so, with enlargement now a reality, the

majority of SMEs still display alarming knowledge gaps

regarding EU accession and the compliance process

relevant to their industries. Over 50% of the managers

we surveyed characterised their knowledge of

compliance requirements as average, fair or poor.

Central European governments and industry bodies

do not appear to be effective in educating SMEs about

enlargement. The vast majority of executives in our

survey source their key information about accession

and compliance issues online, many of them from EU

websites. Others turn to the EU delegations in their

home countries. Very few, however, cite local sources

such as industry associations or chambers of

commerce.

This lack of knowledge extends to the availability of

EU structural funds. Two-thirds of SME managers do

not intend to seek EU help in financing investments or

operations. Few financial and professional service

When will your firm be in compliance with the acquis (excluding designated areas where transition periods are in effect)?

(% respondents)

We will be in compliance on May 1 2004 52

We will be in compliance during 2004 29

We will be in compliance in 2005 4


We will be in compliance within five years 5

We will not be in compliance within five years 0

Don’t know 10

How would describe your level of knowledge of the accession-related compliance requirements for your firm?

(% respondents)

Excellent 6

Good 42

Average 34

Fair 8

Poor 9





firms would qualify for structural funds in any case,

but several interviewees in other industries were not

aware of their availability or of how to apply for them.

According to Attila Molnar, managing director of

Hungarian management consultancy Strategia, there

is a lack of professional guidance on the application

process: “SMEs don’t know how to get started [in

applying for EU funds]; they are unfamiliar with even

the most basic concepts.”

Are you intending to apply for EU structural funding after accession?

(% respondents)

No: 67

Yes: 33





The impact of accession

Key points

● Despite fears of tough new competition in their

home markets, SME managers in Central Europe

are optimistic about revenue growth prospects.

Tight financing and poor knowledge of export

markets will defeat the growth plans of many firms,

however.

● SME executives are hopeful that accession will

bring improvements to the macroeconomic and

business operating environment.

● Low wage costs—currently local firms’ chief

advantage in EU markets—are expected to come

under increasing pressure. Managers will need to

adjust to remain cost-competitive.

For companies of all sizes, multinational,

regional or local, EU enlargement is mainly

about competition—the allure of it and the

fear of it. Competition not just for customers,

but also for employees, capital and other resources.

The outlook of SME managers in Central Europe differs

little in this area from their counterparts at large

firms: accession will be a two-edged sword, with

intensified competition from abroad balanced by

welcome expansion of their own markets.

Andrzej Kuzmicki, chief executive of Gaia, a small

Polish underwear producer, reflects on the EU

challenge: “On the one hand, more Western

companies with enormous capital and strong

marketing prowess will arrive. On the other hand, a big

new market is opening up for us, full of customers with

larger household budgets than we’ve known before.”

On the whole, SME managers in Central Europe are

sanguine about what awaits them in the EU’s internal

market. Concerns about the pressures of new

competition are real, but managers seem surer of their

ability to survive than was perhaps the case in previous

years. They expect to benefit not only from new export

opportunities but also from improved home market

conditions, resulting from foreign direct investment

and from a more stable business environment. Their

chief worry is how to battle effectively with savvy,

resource-rich west European firms, while their main

competitive advantage—low wage costs—comes under

increasing pressure.

In this regard, compliance with the acquis is a

baseline, nothing more. Forward-looking firms with an

eye on new markets have gone beyond regulatory

requirements to invest in more ambitious upgrading of

systems. Take Poland’s Mackowy dairy, based in the

Gdansk region, which has invested Zl100m (€23m)

over the past five years not only to make the existing

plant and systems compliant but also to expand

capacity for export.

Competition: the riskAsked to name the three main risks of enlargement to

their firm, nearly 70% of SME executives in our survey

cited increased competitive pressures, by far the most

pressing concern. Needless to say, the threat is

primarily perceived to emanate from well-endowed

and battle-hardened west European firms that will

now find it easier to operate in the SMEs’ local

markets.

Economist Peter Mihalyi of the Budapest-based

Central European University, worries that, even in




service industries, large west European firms will in

many cases push Hungarian service providers out of

the local market. “The local providers will have to

become franchise partners of these chains,” he

suggests. For SMEs in the manufacturing sector it will

be still tougher: Mr Mihalyi believes such small firms

will only manage to stay afloat by becoming suppliers

to the multinationals.

For Bulgaria’s Kiril Vutev, co-owner of meat

producer Tandem-V, Western supermarket chains are a

particular bugbear: “No producer can operate in the

market without meeting supermarkets’ demands for

lower prices, discounts, extended payment periods

and longer shelf life of food products”.

But it’s not only the large players, many of whom

have been operating in Central European markets for

at least a decade, that local SMEs need to worry

about. Smaller Western firms will also turn their

attention to the market—a recent KPMG survey of

middle-market companies in the UK showed that 35%

of respondents believe that Central Europe will

become a much more significant market for their

products and services. These new competitive

pressures are compounded by the new EU-mandated

public procurement rules. Public tenders will now

need to be advertised, large ones at a Europe-wide

In your view, what are the main risks of enlargement for your firm? Please choose the top three risks.

(% respondents)

Increased competitive pressures 68

Rising wage pressures 52

Tighter regulations and higher compliance burden 42

Greater difficulty attracting and retaining talent 35

Risk of being acquired 19

Fewer corporate customers because of consolidation 19

Greater pressure for corporate transparency 12

Unemployment caused by restructuring and bankruptcy 11

Inability to manage start-ups, alliances and acquisitions 6

Other 6

What do you see as the greatest source of competitive threat to your business over the next five years? Please choose the top three threats.

(% respondents)

Multinational companies 73

SMEs in Western European EU states 34

Competition from outside Europe 31

Existing local SMEs 29

Large local firms 29

SMEs in other Central European EU states 25

Start-up local SMEs 16

SMEs in non-EU Eastern European countries 8





Construction companies should be some of the

biggest beneficiaries from Czech accession to the

European Union but many small firms fear it could

bring more threats than opportunities. MAO, a

construction firm based in Kladno, 25km west of

Prague, is a good example: it is looking to take

advantage of the increased EU structural funds

devoted to the Czech Republic, but it also fears

greater competition after EU entry, particularly in

its core business of public sector contracts.

Large international construction firms such as

Sweden’s Skanska are already present in the Czech

market. But MAO fears that EU membership will also

encourage small west European companies to enter

the market, creating much greater competition.

“EU entry will be a signal for foreign SME

construction firms to enter,” says Otto Tlusty,

MAO’s 39-year-old chief executive and co-owner.

“The good news is that not just construction

companies will enter—the market as a whole will

get bigger.”

MAO is particularly worried about the impact of

new EU rules on public procurement. Sixty percent

of MAO’s work is conducted for municipalities, for

which it builds council offices, schools, sewage

treatment plants and similar structures. Such

contracts are typically awarded after municipalities

request bids from a small group of firms they

already have experience with.

Following the recent, belated passage of EU-

mandated public procurement legislation, all

tenders of more than Kc2m (€61,000) now require

an advertised open tender, while tenders of more

than €5m require a formal advertisement at the

European level. Moreover, foreign construction

firms without a Czech unit will now be able to

compete in all tenders. MAO fears therefore that

there will be much greater competition for public-

sector contracts. “Our only advantage lies in low-

cost labour,” says Mr Tlusty, who estimates that his

wage costs are around a quarter of those in

neighbouring Germany and Austria, giving him a

cushion against incoming rivals.

One upside to EU membership could be the

opportunities to win contracts in western Europe.

Yet MAO—which employs 130 full-time workers and

had a turnover of Kc260m last year—will not even

bother seeking contracts there. “We only cover

central and western Bohemia, we don’t even cover

the whole of the Czech Republic yet,” says Mr Tlusty.

Apart from greater competition, MAO does not

expect much to change with EU membership. MAO

building sites passed EU-standard safety

inspections, for example, without any problems.

“There was a time when I was afraid [of

enlargement], but as I found out more I haven’t

found any important problems I have to solve,” says

Mr Tlusty.

Czech Republic: Building for the future




level, and since bidders will not require a local

presence, competition for even local government

contracts can now come from any corner of the EU.

Competition: the opportunityDespite fiercer competition, executives are confident

they will be able to compete in a tougher but larger

domestic market. Otto Tlusty, CEO of MAO, a Czech

construction firm, welcomes the likely expansion of

demand for construction services that the entry of new

west European firms will produce. A large number of

the managers we surveyed similarly look forward to

opportunities arising from EU customers investing

directly in their home markets.

Others believe they’ll be able to compensate for

setbacks at home by tapping new markets opened by

enlargement. Andrzej Grzegorzewski, chief executive

of Kolastyna, a Polish cosmetics firm, looks forward to

a significant boost in exports—already 15% of his

sales—following the opening of Poland’s borders. The

harmonisation of certification procedures—now only

one certificate is required for the entire EU—removes a

major obstacle to doing business further west.

For Corin, another Polish underwear producer, open

borders mean direct sales to boutiques and shops. “Up

till now, we needed to have an in-country distributor

because an EU-based boutique owner didn't want to

deal with customs procedures,” explains CEO Mariusz

Hanczka. “Now that will change”. Maciej Szymanski of

Poland’s Ster, which manufactures bus seats, also

In your view, what will be the main benefits of enlargement for your firm? Please choose the top three benefits.

(% respondents)

Improved regulatory environment 50

Increased macro-economic stability 50

Easier access to markets of existing EU member states 47

More customers investing directly into Central Europe 37

Access to EU structural funding 30

Greater business opportunities through more outsourcing to Central Europe 24

Greater business opportunities through higher public spending 22

Higher consumer spending 21

Improved transport and telecoms infrastructure 20

Cheaper sourcing of inputs 9

Other 6


Data for 2004-2007are EIU projectionsSource: National statistical offices

0

1,000

2,000

3,000

4,000

5,000

Czech Rep Hungary Slovakia Poland Bulgaria Romania

Foreign direct investment

€ per head, 2001-2007

2001 2002 2003 2004 2005 2006 2007




welcomes the ability to certify his products wherever

in the EU conditions are most amenable. “I’ll no longer

be subject to the loose legal interpretations of Polish

officials,” he says.

SME leaders in the accession countries are

expecting significant indirect benefits from

enlargement too. More important to them than export

opportunities, structural funds and higher public

spending are improvements to the regulatory

environment and enhanced macroeconomic stability.

In many ways, SMEs in this region have been more

vulnerable to bureaucratic caprice and red tape than

large firms, lacking the latter’s lobbying clout,

resources and connections. From obtaining operating

licences to getting products certified to registering a

new office, delays and unpredictability tend to hit

small firms heavily, and most managers expect

enlargement to change things for the better.

“There will be fewer new domestic regulations

introduced, so the conditions of running a business in

Hungary and the other accession countries will be

more predictable,” says Janos Nemes, president of

Euromedic Hungary, a regional healthcare services

provider. “That’s an enormous advantage compared to

the current situation.” Chavdar Selveliev, owner of

Bulgarian frozen food producer Magre, also thinks

accession will squeeze out the criminal sector in his

domestic industry, although bureaucratic corruption

will take longer to uproot.

All in all, most executives in our survey expect

enlargement to have a positive impact on their firms’

sales revenue, with 64% anticipating a modest boost

and 13% expecting robust revenue growth. Given that

they rated easier access to EU markets as one of the

Economist Intelligence Unit business environment rankings, Central & Eastern Europe

1999-2003 Total score 1999-2003 Global rank Grade 1999-2003 2004-08 Total score 2004-08 Global rank Grade 2004-08

Azerbaijan 4.46 56 Very poor 5.37 51 Poor

Bulgaria 5.29 43 Poor 6.15 39 Moderate

Czech Republic 6.5 31 Good 7.3 25 Good

Hungary 6.62 29 Good 7.19 28 Good

Kazakhstan 5.01 49 Poor 5.3 53 Poor

Poland 6.42 32 Moderate 7.07 29 Good

Romania 4.84 53 Very poor 5.81 47 Moderate

Russia 4.93 52 Very poor 5.83 46 Moderate

Slovakia 5.78 34 Moderate 6.6 34 Good

Ukraine 4.32 58 Very poor 5.32 52 Poor

World average 6.39 – Moderate 6.86 – Good

Note. Qualitative grades are assigned according to the following scale: very good, score more than 8; good, 6.5-8; moderate, 5.5-6.4; poor, 5-5.4; very poor, less

than 5. Global rank is out of 60 countries.

The business rankings model measures the quality or attractiveness of the business environment in the 60 countries covered by the Economist Intelligence Unit

using a standard analytical framework. It is designed to reflect the main criteria used by companies to formulate their global business strategies, and is based not

only on historical conditions but also on expectations about conditions prevailing over the next five years.

The model examines ten separate criteria or categories, covering the political environment, the macroeconomic environment, market opportunities, policy

towards free enterprise and competition, policy towards foreign investment, foreign trade and exchange controls, taxes, financing, the labour market and infra-

structure. Each category contains a number of indicators that are assessed by the Economist Intelligence Unit for the last five years and the next five years. There

are 70 indicators in total.

Source: Economist Intelligence Unit




top three benefits of enlargement, it is fair to

conjecture that most expect exports to deliver a large

impulse to sales growth. Indeed, 60% of SME

managers see exports contributing an expanding

share of their firms’ turnover over the next three

years, and 24% of them expect this share to grow by

more than 10%. Equally noteworthy is the fact that

only 9% fear a decline in revenue from enlargement,

further evidence that SMEs are confident of being able

to compete in the new environment (see box on p.14).

A note of caution is in order, however. As noted

earlier, many SMEs remain surprisingly ill-informed

about the requirements and consequences for their

firms of EU accession. For some, a belief that they can

compete at home with stronger, nimbler rivals and

can tap EU export markets may be rooted more in

hope than reality. Mr Molnar of Strategia 21 is

dismissive of Hungarian SMEs’ ability to prepare for

What impact do you expect enlargement to have on your revenues over the coming three years?

(% respondents)

It will produce modest growth in revenues 64

Revenues will be flat 14

It will lead to robust growth in revenues 13

It will lead to a modest decline in revenues 8

It will lead to substantial decline in revenues 1


Which of the following aspects of business do you regard as strengths and weaknesses of SMEs as they seek to take advantage of thegrowth opportunities of an enlarged EU?

(% respondents)

Strength Weakness Neutral

1. Cost efficiency 61 23 16

2. Quality of customer service 57 22 20

3. Quality of product/service offering 44 22 33

4. Knowledge of local market 82 7 10

5. Access to technology 22 46 31

6. Information on opportunities in new markets 27 41 30

7. Access to right channels to market 25 42 32

8. Brand strength 16 54 29

9. Sales/Marketing activities 23 44 33

10. Quality of workforce 47 20 32

11. Innovation activities 44 28 27

12. Ability to comply with changing regulatory environment 31 36 31

13. Risk management and corporate governance 16 45 38

14. Access to capital 19 53 28

15. Exposure to financial and credit risk 11 55 33





Since its establishment in 1997, Mirai Interactive

has been growing at a steady pace. The full-service

digital communications agency currently employs

around 30 people and made it to Deloitte &

Touche’s regional “Fast 50” list of up-and-coming

technology firms in both 2001 and 2002. Last year,

it posted a turnover of Ft150m (€590m), a 50%

increase over the previous year. Mirai has designed

local websites for the likes of Unicef, British

American Tobacco Hungary, McDonald’s Hungary,

Ikea, Interbrew and OTP Bank.

Neither a traditional web design firm nor an

advertising agency, Mirai works closely with clients

and their contracted advertising, media and PR

agencies. The agency offers digital solutions

ranging from standard branding and corporate

communication sites to more innovative ideas. “We

try to stay one step ahead of the market, so we can

lead clients in the direction that new technology is

taking,” says Peter Szilagyi, the company’s

managing director.

EU entry will mean an expanding market for

Mirai, says Mr Szilagyi. “For us, EU accession will

bring more opportunities than risks, since in our

field—interactive communications services—

distance from the client is not an obstacle,” he

adds.

In the first phase, the company is eyeing growth

in Central Europe but it hopes to tackle EU markets

further west afterwards. “Our goal is to provide a

regional service for multinational clients, and to be

able to offer that service to EU-based clients

entering the accession markets.”

Value for money is the chief advantage companies

like Mirai can offer to EU clients, believes Mr

Szilagyi. “We’re able to provide the same quality

service for a much cheaper price,” he says. “The

challenge is getting the service to market and selling

it. Establishing direct relations with customers is

difficult, but we can prepare for that.”

For now, Mirai is still in the planning phase, and

hopes to launch its offensive in the second half of

2004. “We have to learn about market processes

and scout for potential partners, and our

experience will show whether we can actually

access EU markets,” Mr Szilagyi says. The plan also

includes expansion—both in terms of workforce and

of revenue—in line with the pace of previous years.

Establishing affiliates elsewhere in Central Europe

is also a possibility.

“It’s important for us to actively develop our

contacts with potential target markets, and we’ll

see afterwards whether we need to establish offices

in the targeted countries,” Mr Szilagyi says. “We’re

lucky because our production work can be done

from a distance. I don’t expect fundamental

changes from EU entry, only that our work will

become easier and simpler in the long run.”

Hungary: Expanding horizons




enlargement. “Most small enterprises have no

concept, no strategy for the future … Many see no

further than the next day.”

Many SMEs undoubtedly lack some of the muscle

needed to breach new export markets. Asked to

identify their strengths and weaknesses in an

enlarged EU, the survey group rated local market

knowledge and quality of customer service as two of

their key competitive advantages. Fair enough for the

local market, where their edge comes from knowing

and serving their own customers better than

newcomers. But these assets cannot easily be

extended to foreign markets, where sales and

marketing activities and distribution channels will be

of much greater importance. Many more of our

respondents rated these as weaknesses for SMEs

rather than strengths.

Cost efficiency is widely regarded as another great

competitive strength of SMEs in the region, both in

local and export markets. That’s why more than half

the managers we surveyed are worried about upward

pressure on wages as a result of enlargement. Overall,

57% of our survey group expect that their costs will

rise after enlargement. And many believe that wages

will be an important driver of cost increases.

Mr Szymanski of bus seat producer Ster expects his

products to become more expensive due to increased

raw material and wage costs. He’s trying to keep a lid

on the latter: “The question is whether we will be able

to balance rising costs through advanced

What impact do you expect enlargement to have on your costsover the coming three years?

(% respondents)

It will lead to a modest rise in costs 47

Cost levels will be flat 22

It will lead to modest cost savings 18

It will lead to substantial rise in costs 10

It will lead to significant cost savings 2


Source: Economist Intelligence Unit

60

80

100

120

140

160

180

Bulgaria Czech Rep Estonia Hungary Latvia Lithuania Poland Romania Slovakia Slovenia

Bulgaria Czech Rep Estonia Hungary Poland Romania Slovakia Slovenia

Average real wage index, in local currency

(1996=100)

Average labour cost per hour

(€)

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

0

1

2

3

4

5

6

1995 2000 2005

Wage and non-wage labour costs; data for 2005 are EIU projectionsSource: National statistical offices, central banks




technologies, better work organisation and higher

productivity. I ask my staff: ‘Do you want to have

higher wages but an unstable future, or lower wages

and employment in a stable company?’”

Also likely to scotch many SMEs’ expansion

hopes—particularly in regard to exports—is

restricted access to financing. Company executives

cited access to capital and exposure to financial and

credit risk as two of their most glaring weaknesses as

they enter the EU. Poor access to external financing,

and the high cost of financing when it is available,

are significant constraints on increasing both

exports and local sales.

The Western banks that have established

themselves throughout the region have proven

extremely cautious in extending credit to local firms,

particularly SMEs. Local commercial banks have been

more generous, but they are less stable than their

foreign counterparts and their lending practices and

criteria are more erratic. As for start-up and early-

stage expansion capital, family savings and loans from

friends remain the principal source of funding,

especially for small and micro-enterprises.

Over the long term, EU membership will bring

greater stability, predictability and liquidity to

accession countries’ banking sectors, in turn

improving financing conditions for SMEs. In the short

term, membership will also open some new financing

doors, for example in the form of EU structural funds.

As we noted in the previous section, however, two-

thirds of the managers we surveyed have no plans to

apply for EU funds anytime soon.




Key points

● Improving customer relationships in their core

markets is SMEs’ chief imperative and investment

in this area is a top priority.

● Spending on CRM and sales force management

systems is likely to feature heavily in SME

investment plans in the accession countries over

the next three years.

● Faced with upward pressure on wages, managers

will look to control costs in other areas; many will

also fight an uphill battle to retain qualified staff.

Consonant with their belief that enlargement

will open new customer markets for them,

survey respondents are keen to maximise

growth potential. Favoured strategies include

moves to expand production capacity—like the

Mackowy dairy in Poland, cited earlier—to develop new

products and services and to rethink distribution

channels.

But anxious about the day they will begin to

compete on equal terms with west European firms,

SME managers’ deeper instincts still appear defensive.

Asked about their company’s chief strategic priority

after enlargement, the resounding response of our

survey group was to consolidate their position in the

home market. Expansion into other European markets

ranked far lower as a priority.

The approaches they are adopting in order to

mitigate keener competition centre around improved

customer service and other efforts to solidify

relationships with key customers. Two of the top three

areas of SME spending in Central Europe will be

sales/marketing and customer service; the third is

technology investment, much of which is expected to

be allocated to CRM and sales force management

systems. Our surveyed executives expect improved

customer relationship management to be the area of

their business to benefit most from IT investment.

Cost focusCost reduction also figures prominently among SME

managers’ priorities. Aware that low production costs

may be their only real competitive advantage vis-à-vis

west European counterparts, local executives are keen

to protect it. Waldemar Pawlak, CEO of Poland’s Plast-

box, a plastic packaging firm, plans to cut his 190-

strong staff by 20% in order to remain competitive. At

the same time, like other Polish firms, he intends to

relocate some production capacity to Poland’s eastern

regions, where labour is less costly, and also to set up

shop in neighbouring Ukraine, where it’s even

cheaper.

Few expect to benefit indefinitely from the region’s

low wage levels, so while trying to keep a lid on wage

inflation, many are looking to reduce costs in other

areas. Supply chain management is one additional

SME strategies

What are your company’s strategic priorities after enlargement?

(% respondents)

We will seek to consolidate our position in our home market 61

We will seek to expand into other Central European EU states 25

We will seek to expand into West European states 24

We will seek to expand beyond the EU 13

Other 4





Until recently, the Mackowy dairy in Poland’s northern

Gdansk region had not attracted the attention of EU

importers. It does not specialise in long-life products such as

cheese and powdered milk, which EU customers have

traditionally bought in Poland. Exports have been tiny,

accounting for only about one percent of annual turnover of

Zl108m (€24.5m).

But in the last six months Mackowy has seen a burst of

interest from EU buyers. “There has been nothing like it

before,” says Teresa Krystman, CEO of 19 years’ standing. She

attributes the increased interest to the opening of borders.

“It will be faster and easier to transport goods over our

western border, and that generates interest in our short-life

products such as yogurts and desserts.” As a result, Ms

Krystman has already signed one contract with Swedish

buyers and is also negotiating with Italian ones.

Mackowy has been five years in preparation for EU

accession. It received certification for ISO 9001 in 2000 and

for HACCP, the main food industry standard, the following

year. It has invested Zl100m in a thorough-going plant

modernisation, and in the process expanded production

capacity beyond the needs of a regional producer. “Buying

machines, we would think in terms of tomorrow, not just the

present day,” explains Ms Krystman. Only a fraction of this

investment has been covered by EU funds. “They came in too

late and we couldn’t wait”.

The dairy now processes 60,000 litres of milk annually and

this year Mackowy expects exports to rise fivefold. But

despite increased foreign interest, Ms Krystman does not

plan to concentrate on exports only. “I don't want to

increase exports at the cost of local clients. The local market

is the assured market. Export contracts are always limited in

time, and who knows what will be next.”

Catering to foreign tastes will bring change, however. The

firm’s product range is becoming more diverse, which could

allow it to tap niches in the domestic market. For example, its

new Swedish customers have ordered cream in large 0.5l

packages, which Mackowy had not previously produced. In

May the dairy will begin delivering the new packages to the

Swedes and will also introduce them to the domestic market.

“We hadn’t previously noticed that there is demand for such

large package sizes,” said Ms Krystman.

Accession could bring an increase in Mackowy’s prices in

domestic and export markets. The EU’s regulated prices for

milk and sugar are much higher than those in Poland. Ms

Krystman hopes that higher production and sales volumes

will allow her to limit price rises and thus balance the impact

of increased ingredient costs. Nonetheless, the dairy’s prices

could rise by 3%-5%.

Ms Krystman believes the firm’s local reputation for

quality is the only way to beat Western competition, which is

able to spend heavily on promotion. Mackowy has specialised

in health-conscious products such as reduced-lactose milk,

of which it is the only producer in Poland. She also counts on

experience. “We have survived very difficult times. We had to

modernise quickly and at the same time fight foreign

competition with know-how we didn’t have. For example,

they knew that you don’t make money on milk but on yogurts

and desserts. But how could we, a 30-year-old regional

company producing for local residents, refuse to sell milk to

our customers? We took a hard beating but we are up and

running. That's why I don’t fear the EU.”

Poland: Cream on top




A radiant future in 2007 assuming on-schedule accession?

For Bulgaria, the hopes invested in EU enlargement are high

indeed. Listen, however, to two veterans of post-communist

business in Bulgaria, who have built successful food-

processing firms, are active industry association leaders and

are, one way or another, very EU-oriented. They certainly

welcome EU entry, but also have few illusions about its likely

impact.

Kiril Vutev is co-owner of one of Bulgaria’s leading meat

processors, Tandem-V, founded back in 1993 and now

purveying sausages, mince, packaged meats and other meat

products to a wide variety of outlets in Bulgaria. He’s also

president of the Association of Meat Processors of Bulgaria

(AMPB), which has 150 members and is working hard to

inform its members of EU requirements, via manuals,

seminars, training, liaison with state officials, and

participation in working groups.

Mr Vutev has put his money, €4m of it, where his mouth is.

This was the cost of Tandem-V’s modern, meat-packing facility

commissioned three years ago. It’s licensed for EU exports

and it’s getting its meat from EU-compliant slaughterhouses.

All in all, therefore, Tandem-V is ready for the EU.

But it’s not yet exporting to EU countries, due to what Mr

Vutev labels “health protectionism”. For instance, EU

regulations forbid imports of meat from pigs that have been

vaccinated against swine fever. This keeps out products from

Bulgaria, where vaccination is vital in a country so close to

Asia, from where birds and insects can transmit the disease.

Moreover, prior to accession this requirement will also be

extended to the domestic market. The result, he thinks, will

be that Bulgaria’s pigs will quickly be devastated by swine

fever. Meat producers will likely do what Tandem-V plans and

shift away from pork towards beef and veal, along with

chicken and turkey.

What about other firms in his industry? Some firms are just

ignoring requirements, planning to work on in the old way

until the last permissible moment—and expecting to be

closed thereafter. Some are ignoring requirements on

different assumptions: they think a compromise will be

reached between now and January 2007.

Others are trying hard, though. This, one gathers,

includes all or most of the 150-odd members of Mr Vutev’s

association. Perhaps 10% are already EU-compliant,

suggests Mr Vutev. As to those who will be ready on time, he

hazards a guess of 50-60%. Others will be closed, mostly

because they won’t be able to afford the necessary

investment.

More optimistic about sales prospects in current EU

countries is Chavdar Selveliev, owner of Magre, which

produces frozen fruit and vegetables. Active on the

Bulgarian market for more than a decade, Mr Selveliev has

seen a steady increase in sales of a product historically new

to the country, and he is now eyeing west European

markets. He notes that several Bulgarian companies are

already exporting frozen fruit and vegetables for packaging

by EU companies and sale under those companies’ brands.

Mr Selveliev wants to take a different route, maximising

margins and value added by selling “gourmet products” in

the EU under the Magre brand.

Compliance with EU standards is more problematic. A

planned €5m investment in a farm cooperative with a state-

of-the-art processing facility and cold storage units will help

meet EU requirements, but the plan languishes for lack of

financing.

Bulgaria: Longer to wait and farther to travel




Which of the following areas are your critical investment priorities over the next three years?

(% respondents)

Sales and marketing 59

IT 56

Customer servicing 50

Product development 33

General management 25

Supply chain/logistics 17

Finance & accounting 14

Manufacturing 9

Other 4


area of cost attention, to judge by our survey group’s

responses.

SME managers are also clearly concerned about

their ability to attract skilled staff, and recognise that

they will need to spend more to keep them. A

significant number expect to be devoting an

increasing chunk of their budgets to staff

compensation and benefits. Mr Szymanski of Ster fears

that some of his 170 highly qualified employees could

be snapped up by EU firms. Hoping to keep wage

growth in check, he plans to offer them foreign

business trips, including six-months stints in the

United States, and to set up an in-house design and

construction training centre. Training, foreign

business trips and other benefits in return for wage

restraint? It’s sounding more like the EU all the time.

Conclusion

SME executives in Central Europe almost uniformly

perceive EU enlargement as a positive development

that will have salutary effects on their countries’

economies and business environments in the years to

come. There’s relatively little grumbling from this

quarter about stringent compliance requirements or

unfair competition. As for how their own companies

will fare, the attitude is similarly upbeat: few expect

windfalls and most expect to face challenges in core

markets, but almost all believe they’ll be able to

weather any storm.

After all, the “big boys” from western Europe have

been operating locally for a decade or more. In retail,

services, manufacturing and construction, small and

mid-size firms in Central Europe have had time to

adjust to the often major changes in supply,

distribution, marketing and quality that foreign firms

have brought.

But there’s no room for complacency. SMEs’ cost

advantage will be eroded as wages creep upward.

Legal barriers that kept some local market competition

in check will disappear. Their best employees will be

tempted by perceived greener pastures of west

European firms. The strategic focus most SME

managers espouse on shoring up existing customer

relationships is well-advised.

Forward-looking SMEs are already planning

initiatives to survive and thrive in an expanded EU, but

many of their brethren are less prepared. The early

post-accession years will reveal no small number of

firms who only paid lip service to customer retention

and who mistook achieving compliance with EU rules

with acquiring competitive advantage. For these firms,

welcoming though they are of EU enlargement, the

new marketplace will be a daunting environment.


Appendix: Survey results




In March/April 2004, the Economist Intelligence Unit conducted an online survey of 147 executives of small and

mid-size firms operating in 12 Central European countries. Our sincere thanks go to everyone who took part in

the survey.

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

provide multiple answers to one question.

Demographics

What industry are you in?

(% respondents)

Financial services 15

Professional services 15

Telecommunications 12

Technology 9

Pharmaceuticals 8

Consumer goods manufacturing 5

Healthcare 5

Transport 5

Energy (including oil & gas) 4

Automotive 2

Consumer goods retailing 2

Mining & metallurgy 2

Agriculture 1

Coal & steel 1

Tourism 1

Other 14

How many employees does your company have across all locations?

(% respondents)

Under 50 37

50-200 13

200-500 14

500-800 7

800-1000 2

Over 1,000 27





Which of the following titles best describes your job?

(% respondents)

CEO/COO/Chief executive/Managing director 27

Other manager 25

Chairman/President/Vice-president 7

CFO/Treasurer/Comptroller 7

CKO/CIO/Technology director 6

Director/VP of marketing 6

Director/VP of sales 4

IT manager 4

Director of planning/manufacturing 1

Supply-chain manager 1

Other 10

What percentage of your company’s turnover comes from your domestic market?

(% respondents)

Less than 5% 16

5%-10% 4

10%-25% 5

25%-50% 6

50%-75% 15

75%-90% 11

Over 90% 44

Are you in favour of EU enlargement?

(% respondents)

No: 3

Yes: 97

In what country are you located

(% respondents)

Lithuania 3

Slovenia 9

Other 9

Poland 37

Hungary

16

Czech Rep

10

Slovakia 5Estonia 6

Latvia 5





The impact of EU enlargement

What impact do you expect enlargement to have on your revenues over the coming three years?

(% respondents)

It will produce modest growth in revenues 64

Revenues will be flat 14

It will lead to robust growth in revenues 13

It will lead to a modest decline in revenues 8

It will lead to substantial decline in revenues 1

What impact do you expect enlargement to have on your costs over the coming three years?

(% respondents)

It will lead to a modest rise in costs 47

Cost levels will be flat 22

It will lead to modest cost savings 18

It will lead to substantial rise in costs 10

It will lead to significant cost savings 2

In your view, what will be the main benefits of enlargement for your firm? Please choose the top three benefits.

(% respondents)

Improved regulatory environment 50

Increased macro-economic stability 50

Easier access to markets of existing EU member states 47

More customers investing directly into Central Europe 37

Access to EU structural funding 30

Greater business opportunities through more outsourcing to Central Europe 24

Greater business opportunities through higher public spending 22

Higher consumer spending 21

Improved transport and telecoms infrastructure 20

Cheaper sourcing of inputs 9

Other 6





In your view, what are the main risks of enlargement for your firm? Please choose the top three risks.

(% respondents)

Increased competitive pressures 68

Rising wage pressures 52

Tighter regulations and higher compliance burden 42

Greater difficulty attracting and retaining talent 35

Risk of being acquired 19

Fewer corporate customers because of consolidation 19

Greater pressure for corporate transparency 12

Unemployment caused by restructuring and bankruptcy 11

Inability to manage start-ups, alliances and acquisitions 6

Other 6

What strategies do you plan to adopt to mitigate the risks that enlargement poses to your business? Please choose your three mostcritical strategies.

(% respondents)

Extra effort to protect relationships with key customers 54

Improved training programmes for staff 45

Cost savings through implementation of more efficient supply-chain management 35

Implementation of new or improved risk management policies and systems 27

Enhanced compensation and benefits for staff 26

Initiatives to move higher up the value chain 26

Cost savings through automation of manufacturing processes 22

Defensive alliances with partners 22

Introduction of more transparent accounting and governance processes 10

Lower pricing 10

Outsourcing to lower-cost countries outside the EU 9

Other 4





Which of the following aspects of business do you regard as strengths and weaknesses of SMEs as they seek to take advantage of thegrowth opportunities of an enlarged EU?

(% respondents)

Strength Weakness Neutral

1. Cost efficiency 61 23 16

2. Quality of customer service 57 22 20

3. Quality of product/service offering 44 22 33

4. Knowledge of local market 82 7 10

5. Access to technology 22 46 31

6. Information on opportunities in new markets 27 41 30

7. Access to right channels to market 25 42 32

8. Brand strength 16 54 29

9. Sales/marketing activities 23 44 33

10. Quality of workforce 47 20 32

11. Innovation activities 44 28 27

12. Ability to comply with changing regulatory environment 31 36 31

13. Risk management and corporate governance 16 45 38

14. Access to capital 19 53 28

15. Exposure to financial and credit risk 11 55 33

Complying with which areas of the acquis communautaire, the body of EU laws and regulations, represents the greatest challenges foryour firm?

(% respondents)

Competition rules 35

Product certification 31

Taxation 31

Product standards 30

Intellectual property 27

Product liability 26

Workplace health & safety 26

Environmental protection 24

Corporate governance/transparency of accounting 24

Customs & excise 11

Other 4





When will your firm be in compliance with the acquis (excluding designated areas where transition periods are in effect)?

(% respondents)

We will be in compliance on May 1 2004 52

We will be in compliance during 2004 29



We will be in compliance within five years 5

We will not be in compliance within five years 0

Don’t know 10

How would describe your level of knowledge of the accession-related compliance requirements for your firm?

(% respondents)

Excellent 6

Good 42

Average 34

Fair 8

Poor 9

Are you intending to apply for EU structural funding after accession?

(% respondents)

No: 67

Yes: 33





What do you see as the greatest source of competitive threat to your business over the next five years? Please choose the top three threats.

(% respondents)

Multinational companies 73

SMEs in Western European EU states 34

Competition from outside Europe 31

Existing local SMEs 29

Large local firms 29

SMEs in other Central European EU states 25

Start-up local SMEs 16

SMEs in non-EU Eastern European countries 8

What are your company’s strategic priorities after enlargement?

(% respondents)

We will seek to consolidate our position in our home market 61

We will seek to expand into other Central European EU states 25

We will seek to expand into West European states 24

We will seek to expand beyond the EU 13

Other 4

How do you expect the share of turnover coming from exports to change over the next three years?

(% respondents)

It will increase by more than 10% 24

It will increase by 5-10% 21

It will increase by up to 5% 14

It will remain unchanged 36

It will fall by up to 5% 2

It will fall by 5-10% 1

It will fall by more than 10% 0

Which of the following areas are your critical investment priorities over the next three years?

(% respondents)

Sales and marketing 59

IT 56

Customer servicing 50

Product development 33

General management 25

Supply chain/logistics 17

Finance & accounting 14

Manufacturing 9

Other 4





In which areas of the business do you expect to see the greatest benefits from your investment in technology over the next three years?

(% respondents)

More successful customer relationship management 43

Better quality of products and services 43

Lower costs 40

Improved sales and marketing 37

Improved knowledge management 30

Enhanced back-office systems and networks 24

Increased innovation 23

Easier collaboration with partners and suppliers 17

More efficient supply-chain management 15

Better financial management 14

Increased productivity from mobile and remote workers 9

Other 1

Which approaches will your company take to drive growth over the next three years?

(% respondents)

Building closer relations with existing customers 60

Penetrating new customer markets 58

Developing new products and services 54

Entering new alliance relationships 32

Improving distribution channels 23

Entering new geographical markets 22

Focusing on/leveraging core products and services 17

Increasing advertising and marketing spend 13

Achieving growth through mergers and acquisitions 9

Spinning off and/or starting up new companies 4

Whilst every effort has been taken to verify the

accuracy of this information, neither the Economist

Intelligence Unit Ltd. nor the sponsor of this report

can accept any responsibility or liability for reliance by

any person on this white paper or any of the

information, opinions or conclusions set out in the

white paper.

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