With the greenback trading at historically low exchange rates against the euro, U.S.-based manufacturers have a significant competitive advantage when pursuing markets in the European Union. Twelve new countries will be added to the 15-member EU next year, adding another compelling reason for Corporate America to consider expanding its presence in Europe.

Yet, Europe is not unlike the territories Lewis and Clark set out to discover two centuries ago when it comes to setting up your business. Here are some of the practicalities and challenges of setting up and expanding business in Europe today.

THE SETTINGS: “ONE NATION, INDIVISIBLE? …”

Chances are that history offers no comparison for the process that has taken Europe from a set of belligerent countries to a political and economic union, with a common currency shared by around 80 percent of its 370 million people.

Certainly not when you consider that the process resulted out of voluntary choices, democratic decisions, and that it took less than 50 years to complete.

At times, however, the EU can be anything but united. With 15 members, discussions always run high. For example, when the southern countries advocated the participation of the EU in a Mediterranean trade block, the northern countries sought an expansion of the EU eastward. Policies also diverted on monetary issues, as only 12 out of 15 countries exchanged their own currencies for the euro. The recent discord on foreign policy regarding Operation Iraqi Freedom unveiled an even deeper divide.

But the 15 members must be credited for being able to work out their differences, creating a marketplace where regulatory principles and much of the local legislation is comparable, if not fully the same, stretching from the southernmost rock of Spain to the northernmost steps of Sweden (a distance comparable to that from Guatemala City, Guatemala, to Goose Bay, Canada).

The extent to which regulations are fully applied and legislation is enforced does vary from country to country, but the legal basis for business remains sound, offering a stability that is comparable to that of the United States.

Now, in come 12 new countries, which will join the EU next May. As a result, the EU’s population will rise to more than 440 million, a 25 percent increase. Yet, the newcomers will only account for 4 percent of the GDP of the extended EU. However, the GDP growth rates of the newcomers, estimated at 4 percent for 2003, almost doubles the 2.1 percent forecasted for the 15-member EU.

This bides good new for enterprise. There are compelling reasons to assume that the economic revolution of Poland, the Czech Republic and Hungary will serve as a template for the developments that will occur in other newcomer countries, be it that timelines will vary from one country to the other.

Yet, the ramifications of this expansion have only begun to surface. For one, the newcomers take a different view to the world, approaching it with open arms, more than the EU-15.

The support for central decision-making by a Brussels-based administration is another source for differentiation. Some of the prominent newcomers, such as the Czech Republic and Poland incline toward the federalist structure of which the UK has been a vivid proponent. This contrasts with the unionist vision that is shared by other nations such as France and Germany.

Such differences may slow down the creation of a fully harmonized and free market which business would like to see. The bottom line, however, is today’s Europe is tied together by joint economic interests and an adherence to free market principles, so it will get there eventually. Yet, it will be awhile before Europeans echo the pledge, “one nation, under God, indivisible. …”

INVESTMENT INTENTIONS: PRUDENT CONFIDENCE IN EUROPE

We recently surveyed the investment intentions of multinationals headquartered in Belgium and the Netherlands, including many operations of U.S. firms. The most apparent conclusions are:

Notwithstanding the current economic uncertainty, a large majority of business leaders (62 percent) will enact an expansion or growth strategy for their companies within the next three years;

In terms of geographical focus, Central and Eastern Europe is the area where most of the surveyed corporations (33 percent) expect the growth to materialize. Runners up are Southern EU (18 percent) and Northern EU (16 percent);

For many corporations (27 percent), distribution will be the main operation effected by tactical decisions for the next three years. Manufacturing operations also rank high, with 23 percent of the respondents expecting them to change;

Companies will seek to keep capital expenditures as low as possible, with the use of existing facilities as tactical priority for tackling the “New Europe.”

Another characteristic of the more than 100 executives that responded to the survey is that more than half of them (53 percent) envisage the tactical changes to occur between the next 12 and 24 months. The pace for expansion is on.

EUROPE'S GRAVITY POINT SHIFTS EASTWARD

Though U.S. companies continue to settle and expand businesses in Western Europe, the inbound U.S. investment flow has peaked in many countries.

Furthermore, the nature of the investment in these regions has also changed. If the period through the early 1990s witnessed many labor-intensive projects, followed by capital-intensive investments in the mid- and late 1990s, today’s projects tend to be more knowledge-intensive. In parallel, there is a significant relocation of business activities to Central Europe, or to areas even beyond such as Eastern Europe or Asia. This trend is apparent across most types of activities — manufacturing, R&D and back office.

Companies are lured to Central and Eastern Europe because of the reputedly low labor costs. There is truth to that. Labor costs in some of the candidate countries can be as low as 10 percent of those in, for example, Belgium.

There is more to labor cost, however. The right way to assess labor cost is to consider it as a function of such elements as productivity, worker motivation, number of shifts, absenteeism, pertaining regulations and local market conditions.

“Of particular concern is the overall productivity among regional manufacturers,” said Mark Walton, leader of Deloitte & Touche’s Central European Manufacturing Practice. “With an average turnover per employee of less than $80,000 (euro) in 2000, Central European companies rank below the global average of $180,000 (euro) per year and the world class standard of $222,000 (euro). Companies that are part of multinational organizations had average productivity of $120,000 (euro), compared with $65,000 (euro) for pure regional companies.”

Then labor cost is not everything and some of Europe’s newcomers are deliberately turning away from attracting low cost operations.

“The Czech Republic is certainly not the best country for all types of investment — we’re not anywhere near the cheapest location in Central Europe,” said Martin Cincura, managing director of CzechInvest’s Benelux operations.

He cited the case of Shimano, a Japan-based manufacturer of bicycle brakes and gears. Shimano set up assembly operations in the Czech Republic in September 2000, importing supplies from overseas. A typical “screwdriver plant.”

Cincura knows that this business is likely to eventually move to countries such as Bulgaria, Romania or Lithuania as Czech wages continue to rise. The solution is to anchor the operation by introducing its management to local suppliers. For this purpose, CzechInvest has eight, mostly technical, people whose sole focus is on supplier and joint venture opportunities. A service that is not uncommon for economic development agencies in Central Europe, yet quite rare among agencies in Europe’s western regions.

There is a lot that such people can mobilize. The Czech Republic, historically one of the most industrialized nations on the continent, can draw on a technology and innovation tradition, as well as a management culture that makes it a compelling market entry location for U.S. manufacturers, especially in the automotive and electronics industries.

Ingersoll Rand was one of the first companies to recognize this. It acquired an air conditioning business in the mid-1990s and shipped product throughout Europe from this base. By 2000, the company set up its first greenfield plant for its Torrington bearing business in the eastern Moravia region of the Czech Republic. In 2002, it opened another factory that manufacturers golf carts for markets worldwide. Local management realized these expansions.

One thing is clear: Central Europe entered the business location world with a splash. It is bound to cause damage to the established regions and cities that qualified as Europe’s hotspots and gateways for the past two decades.

Economic development agencies in Western Europe do not stand by idle. There is increasing attention for aftercare (servicing existing investments), paralleled by a strong focus on attracting businesses with high -value-adding activities, requiring a highly skilled and experienced labor force.

RISKS AND REWARDS

Business practices “out East” are indeed far less comprehensible and transparent than those to which companies are accustomed to in Western Europe. But businesses should make it their business to be wary of these differences and conduct a proper due diligence, rather than consider them as a showstopper.

In Romania, where corruption has deep roots, investors have overcome such factors by investing through joint ventures. The local partnership allows foreign companies to streamline business practices.

Some of the other challenges include:

A relatively unstable political situation and weakness of internal market;

Length of supply lines, both inbound and outbound;

Adapting U.S. practices to local circumstances, or even letting go of the known approach and trusting the judgment of local management.

There are positive developments. For example, future EU members can benefit from intensive and expert assistance on such matters as conversion of bankruptcy legislation, ownership of property, repatriation of profits or dividends, financial and banking system. This positively distinguishes these countries from other former Soviet satellites nations that are not currently listed for EU accession.

COUNCIL FROM THE LEGAL FRONT

“According to European Union institutions, the legal environment in the candidate member-states of Central and Eastern Europe qualifies as ‘in line with the European law,’” said Francesco Apruzzi, a lawyer with Laga & Philippe who specializes in assisting companies to set up business in Central and Eastern Europe. “Companies considering investing in this region should realize that this qualification only refers to the legal standards required for EU membership. The business community requires more than that.”

Apruzzi stressed that the legal environment of the Central European newcomers has merely been approximated to and harmonized with the EU law. Many steps need to be taken in order to achieve a uniform market from Portugal to Baltic States.

For the 2003 to 2006 period, the priority of the European Commission is the implementation and enforcement of Internal Market rules (e.g., technical requirements for products, consumer protection, public procurement rules, etc) making the free movement of services and goods into a practical reality in selected Central European countries.

Looking forward, Apruzzi said that, because of the ratification of EU Law and WTO rules, tax incentives, cash grants and other forms of state assistance favouring businesses will become the exception rather than rule in Central European countries.

THE CLUSTERS IN THE NEW EUROPE

Four country clusters have emerged in the New Europe (though generalizations are dangerous as regional business environments within these countries can vary significantly). Yet, we find the cluster approach quite useful to help companies visualize what is out there.

Cluster One consists of those countries where U.S. and other foreign businesses have long since set up activities and that have mature market and infrastructures.

Cluster Two groups countries that have made their mark as well, but tend to have lower factor costs and are continuously upgrading their infrastructure and talent pools. This cluster includes current and future EU members, such as Portugal, the Czech Republic, Hungary and Poland. The latter three started opening up their economies to Western enterprises in the early 1990s. As result, the “best deals” have long been signed and business opportunities have become more rare. Unemployment is rising in some of their key regions, giving cause to concern, as it puts pressure on the often fragile financial base of the new market economies.

Cluster Three countries are characterized by low labor costs and relatively limited foreign investment. This group includes both smaller nations, such as the Baltic States, but also vast territories with well-established international business centers such as Turkey. We expect these countries to constitute the “next wave”.

Cluster Four contains countries that are only beginning to figure on the maps of corporate location scouts. Labor costs tend to be very low, but this goes hand in hand with a relatively underdeveloped infrastructure and a business culture that is still quite remote from the Anglo-Saxon one.

Finally, we believe the Russian Federation is a league of its own, combining huge and highly developed metropolitan areas with extremely rural areas.

THE "LEAPFROG STRATEGY"

While dealing with more than 200 location projects each year, we are witnessing the emergence of a “leapfrog” strategy for Europe. If the “Old World,” as a whole, has seen manufacturing investment slide since the late 1990s, it is back on the map today.

Yet the location search area has changed unmistakably. Where the Czech Republic, France, Hungary, Poland, Portugal and the UK would be the usual suspects as potential locations for plants, corporate site selectors today rarely can get by without including such countries as Bulgaria, Romania, the Baltic States and Turkey. In an increasing number of cases, Cluster One and Two countries are not even considered as executives seek to leapfrog directly into Europe’s future hotspots.

This strategy has a wider support in Europe’s boardrooms than in the United States. U.S. entrepreneurs tend to be more cautious to consider the “next wave” locations. By contrast, their European counterparts tend to be more daring, thereby incurring the risks but also reaping the benefits of early market entry.

EUROPEAN MARKET ENTRY: KEY CONSIDERATIONS

Difficult enough on the domestic front, overseas investment introduces several additional considerations. Let’s look at five important considerations regarding Central European Market Entry.

PRODUCTS, MARKETS AND SUPPLY CHAIN

The fundamental question is” Does it make sense in terms of operating costs, service delivery, growth of new markets, to build new capacity?

Markets and the supply chain should fundamentally drive whether Central Europe makes sense for your business. For a cost-driven location decision, for example, low skills-based manufacturing, Cluster Three or Cluster Four countries might be very attractive for cost savings, though part of these savings will be offset by lower productivity, poor infrastructure, problematic logistics and political risk. For value-driven location decisions, such as high precision tools or research and development, going to the first wave of newcomers may be fundamental to tap into new sources of talent and intellectual capital.

TAX, FINANCE AND MONETARY STRUCTURING

Locating business abroad results in dealing with various tax authorities that can turn out into a costly business if the right strategy is not followed. Insight into tax regulations but often more importantly, understanding of the consequential tax authorities is key for defining an effective taxation strategy. For example, tax rulings may allow you to define your tax burden together with the pertinent tax authorities. How far you can go negotiating on your future tax bills depends on the eagerness of the local tax authorities to attract your business.

As companies grow more international, management must set up adequate transfer pricing structures. Transfer pricing enhances operational performances, minimizes the overall tax burden, improves cash flows, reduces legal exposures and increases earnings considerably. For instance, tax considerations define where to locate costs and profit centers. Also small and medium-sized enterprises have to review their fiscal structures if locating in Central Europe; transfer pricing is an issue to all transnational companies.

CONNECTIVITY AND COHESIVENESS

This can be one of the biggest barriers to remote investments where distance for the corporate center has big issues regarding organizational control. Though e-mail and video conferencing go a long way in capturing formal communications, they do not replace face-to-face and telephone communication; both travel and telephone charges build-up quickly and can become significant components of small company budgets.

TALENT AND WORK FORCE

Growing operations overseas can be led by indigenous personal of the host country, or relocating management from the home country. Though local management and supervisory personnel is critical to success, usually home country personnel must relocate for a time to startup operations and ensure that the continuity of the goals and culture of the company are maintained in the new environment.

Deploying executive-level personnel is a major expense, often much greater than planned. The average annual cost of relocating and supporting management personnel on foreign assignment can easily exceed three to four times the salary of six-figure U.S. incomes.

Costs include not only obvious factors such as moving households, traveling expenses and home sale assistance, but also fees for international schools, language lessons, costs to obtain visas and work permits, and tax equalization costs to minimize tax exposure to the foreign entity.

To lower these costs, some organizations have gone the route of short-term assignments, usually in the range of six months, where an executive may commute back and forth every few weeks, leaving the family at home. Such solutions can be much less expensive and disruptive.

Then there is the issue of local work force. Training varying and different cultures toward the workplace and regulatory environment regarding labor are essential considerations.

CULTURAL DIVERSITY

Locating an operation in Europe means that you have to be prepared to deal with cultural differences. Anyone will understand that running a business in Ireland requires a different approach compared with running an operation in Hungary, for example.

However, the general stereotypes pertaining to cultures are not sufficient. Look at Spain and Italy. Although both cultures appear very comparable from the surface, the way of doing business and managing an operation is totally different in both countries.

Formal hierarchical structures are common in Spain but obsolete in Italy. In Italy, informal networks play a crucial role. Ignoring these issues can be disastrous.

Furthermore, within most countries, as in the U.S., there are major cultural differences. Operating an operation overseas successfully calls for thorough investigation to insure that the decision is the right decision.

SELECTING YOUR LOCATION

From a decision-making viewpoint, the differences between Old and New Europe are significant. For one, the availability of reliable data sources is not on par, let alone comparable, with the United States. Then, the nature of the business environment in New Europe is much more dynamic and hence subject to almost constant change.

We find that companies often fail to fully realize the impact of these differences as they assess their European market entry options.

They tend to rely on “classic” site selection and business development concepts, which given the particularities of Central and Eastern Europe, do not necessarily produce the best results. Our key concern is that the “classic approaches” tend to inadequately cope with the uncertainty factor.

The combination of these ingredients, together with a thorough investigation of the local conditions, should help you avoid most pitfalls. Yet, we know that surprises cannot be avoided. Good or bad, they are a typical ingredient of upcoming economies leading to risk, and reward.

Yet, we are confident that Lewis and Clark took a significantly more daring step when they sailed up the Missouri River into an unexplored and mysterious territory, long before the days of high performance transportation and telecommunication equipment, and experienced location consultants.

Elias van Herwaarden and Larry Moretti are directors of Fantus, the specialist location and economic development practice of Deloitte & Touche. Van Herwaarden is based in Brussels, Belgium, and can be reached at evanherwaarden@deloitte.com. Moretti is returning to the United States to be based in New York, after a three-year stint in Europe. He can be reached at lmoretti@deloitte.c