U.S. corporations have been in Europe for decades. Even today, with the lure of China and the continued popularity of Mexico, Europe ranks third as the region where U.S. companies are considering an expansion.
By 2005, this interest equated to an accumulated investment of more than $964 billion (U.S.) supporting more than 3.6 million jobs. Much of this amount relates to expansions or relocations of existing European operations, of which Western Europe takes 70 percent for its account.
The location dynamics clearly show that a large group of companies already located in Western Europe are moving eastward, as is their related investment package. The three economic tigers — Poland, the Czech Republic and Hungary — are key destinations, with more than $1.1 billion invested in 2004 alone, an increase of 20 percent from the previous year. Moving east is a natural for those companies already present in Europe, and they can capitalize on years of experience in dealing with Europe’s fragmented and diversified markets.
| But what if you are contemplating your first expansion into Europe? What are the fundamentals to keep in mind? |
But what if you are contemplating your first expansion into Europe? What are the fundamentals to keep in mind? Here are some key features of Europe today and practical guidelines for companies that are new to the “Old World.”
Europe and the Global Imperative
The key attraction of Europe today is its consumer market. The 25 member-nation European Union (EU) has a population of 457 million and a combined gross domestic product (GDP) of nearly $14 billion (U.S.) — $29,687 (U.S.) per capita. Add to that the key markets of countries applying for the EU — including Romania, Bulgaria and Turkey (a population of 168 million and an estimated GDP $481 billion U.S.) — and you’ll find that, by size, the market tops that of NAFTA. GDP-wise, it is more than three times the size of India.
For U.S. companies, European market access is relatively easy in comparison to other global regions. On one hand, this is the result of EU policy-making, which seeks to promote free trade globally and to dismantle distortions to competition within the EU member-nations. The other contributing factor is that consumers in Europe share the same cultural roots as their U.S. counterparts and are accustomed to buying internationally.
Then there is the euro, the common currency for 12 countries. These countries include the original 15 EU member-nations, except for the United Kingdom, Sweden and Denmark. The new member-nations are preparing to change their currencies. The conversion is set for 2010.
The euro has become a stronger currency compared with the U.S. dollar since becoming a trading currency in 1999. For numerous Asian markets, the euro has pushed the dollar off its throne as a trade currency. One can only state that if by 2010 about 20 EU countries adopt the euro and the European economy continues its steady growth, the euro will become the global trade currency.
Not Only Milk and Honey
Notwithstanding the common market across the EU, companies still experience differences, administrative delays and barriers to free trade. True, these are being tackled by EU officials, but the process is not likely to be accelerated now that 25, rather than 15, countries need to agree to harmonization measures and implement the ensuing legislation.
Newcomers to the region should realize this and be prepared to work in an environment that sometimes appears to integrate at different speeds. During the past several years, the member-nations have experienced difficulties in reaching a consensus on issues related to country deficit, agriculture, free movement of labor, structural incentives, etc. These difficulties are somewhat slowing the total unification of the EU and the related consumer market and economic growth that an ideal EU could offer.
As for the euro, some view it as a mixed blessing as its strength damages the export competitiveness for companies that basically buy and produce on a euro cost basis. Numerous European-based companies focusing on an export policy have suffered from the strong euro. On the other hand, the potential of the new EU consumer market is such that in the future, one will see these companies only exporting to EU countries and not outside the EU.
Locating Your Expansion
Before engaging in the site location process, it is critical that newcomers address some fundamental questions. The answers will drive the strategy and set the search area for your successful expansion into Europe.
For example, expansions that are predominantly sales-oriented tend to locate in the well-established business centers of Western Europe, or close to the manufacturing hotspots of Central Europe. These proven locations offer an experienced and international-business-oriented talent pool, combined with a good business environment and accessibility. Key destinations include the metropolitan areas around London, Amsterdam, Brussels, Paris, Frankfurt, Prague, Budapest and Warsaw.
Interestingly, Switzerland, though often seen as a high-cost country, offers good and affordable conditions for such operations as well. Key locations are found along the Geneva-to-Zurich axis.
If your first requirement is to set up a distribution operation in Europe, your markets and clients will determine your search area. That said, there is a compelling concentration of logistics and distribution expertise and service providers around Europe’s main ports, such as Antwerp, Frankfurt, Hamburg, Paris-Roissy Airport, Rotterdam, Schiphol, not to mention regional platforms such as Barcelona (Spain), Marseilles (France) and Gdansk (Poland), and the rapidly emerging logistics centers in the western portion of the Czech Republic, Hungary, Southern Poland and Bucharest (Romania), where U.S.-based developer Prologis recently established a new logistics park. A key tactical decision will be whether to outsource distribution. Europe offers a long tradition and very effective solutions in this area.
| For manufacturers, the center of gravity is clearly Southern Poland, the Czech Republic, the Republic of Slovakia, Hungary and Romania. |
For manufacturers, the center of gravity is clearly Southern Poland, the Czech Republic, the Republic of Slovakia, Hungary and Romania. It’s not just the lure of low labor costs alone that leads these areas to benefit from a surge in foreign-owned plants across many industrial sectors. The quality of the labor market, in terms of skills, attitudes and sheer numbers is probably equally, if not more, important.
It goes to reason: The cost advantage will erode over time (though probably not for the next five years), calling management to build on other sources of competitive advantage. Human capital tends to be the better choice.
That said, Western Europe should not be discarded for manufacturing. It still offers deep skill pools, technological prowess, an established infrastructure and developed clusters that newcomers, and particularly niche players, can turn to for success.
In this context, France, Germany and the UK are still favorite destinations.
As R&D operations tend to follow production, it is not surprising to see that an increasing number of international companies are setting up R&D and high-tech activities in Central Europe, though Western Europe still takes up the larger share of such expansions.
Key factors to consider here are the attitudes and skill levels of the local talent pool. Yet even more important is probably the overall R&D cluster and the extent to which you, as a newcomer, can easily access the knowledge and testing capabilities of universities or dedicated research institutions.
Hotspots or Under-the-Radar Locations
There are many reasons why new entrants rightfully focus on Europe’s hotspots for their initial European expansion: excellent infrastructure and operating environment, high quality labor, most of which already have some experience working for large multinational companies in the location, and professionally minded authorities that already have an abundant experience with providing services to first-time companies.
Yet the success of these regions also leads to challenges. Just consider higher wage escalations and a tougher search for finding adequate personnel.
Corporate planners have realized this and are today — just like they did in Western Europe in the 1970s through 1990s — venturing into Central Europe’s secondary cities, opening up new frontiers and locations.
Brno, the Czech Republic, offers a good example. If the city was barely noticed (under the radar) just five years ago, its infrastructures, resources and astute economic developers turned it into a hotspot, where today the likes of Lufthansa and Credit Suisse have located. These companies successfully operate businesses that cater to the needs of their clients throughout Europe.
Admittedly, a location strategy based on an under-the-radar location is not for everybody. For one, it calls for a “leap frog strategy,” whereby a company is prepared to accept a certain level of initial hardship to obtain a level of competitiveness and stability that is increasingly difficult to find in most of the hotspot areas. But the strategy also has its benefits. Just consider wage and real estate costs that are up to 20 percent lower than the hotspots and a far better situation regarding the viability of educated labor.
There is of course a downside to starting out in an under-the-radar location. Real estate is still developing and Class A office space is scarce, there is a lack of managerial skills, and there is a limited international community resulting in a shortage of native-speaking foreigners.
How to Proceed?
The process of choosing the most adequate location for an expansion is, on one hand, straightforward because it is about an elimination of options beginning with an adequate initial site location search area. On the other hand, it can be very complex as many different factors need to be compared, typically requiring information that is not readily available, from unbiased sources.
Certainly, local and national investment promotion agencies can be a starting point for your data gathering, but given their vested interest in attracting your business, you should reach out to independent sources as well.
When embarking on the location journey, our first questions to the client are always:
* Do you clearly know what your goal is?
* Are the future processes clearly defined?
Once these questions have been answered, the real work can begin.
| A company that seeks to start its first expansion in Europe should start off with an initial search area of between 12 and 15 locations, depending on the scale of the project and the level of understanding that management has about Europe. |
A company that seeks to start its first expansion in Europe should start off with an initial search area of between 12 and 15 locations, depending on the scale of the project and the level of understanding that management has about Europe. This initial search area is then typically analyzed on about 50 criteria, selected in function of the project’s drivers and characteristics, leading to the list of potential sites being pared to six to eight locations.
A subsequent round of analysis involving field visits should then eliminate locations and result in a short list of two to three locations. The analyzed criteria should include political stability; labor-related criteria (availability, education, language skills, etc.); and operating and working environments. In parallel to the qualitative analysis, there should be a cost estimate during the first five years for each location covering the key cost factors for your project (labor, utilities, leases, logistics, taxation, etc.) and the real cost escalations that can be expected.
In our view, job creation and investment incentives should be considered for the finalist locations only. They are the cherry on the cake. However, there are increasingly fewer cherries to go round.
The EU’s legislative bodies have since long ruled that financial aid to companies is, in principle, illegal as it is seen to distort fair competition. There are exceptions to these rules, allowing public authorities to support job creation and investment in regions that are considered to be economically weak from an overall European perspective.
Yet, even in those regions where you may apply for financial support, the actual amount you may be granted for your startup will often be low. That said, there is a multitude of incentive programs available (think of training and research support, or incentives toward environmentally friendly technologies, for example) and it would be wrong not to explore how your company could benefit from them.
In sum, Europe still offers significant room for expanding your business. Location-wise, the options come in a large variety and are geographically spread. The process of selecting the location that works best for you should not be taken lightly. After all, the decision you are about to take will impact your business for at least the next five years, and it may actually make it or break it.
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