What 1992 means to small and midsized businesses.

There is much that is not yet known about the single European market scheduled to emerge by the end of 1992. The European Community is still in the process of creating the unified market and many of the most complex issues have not yet been resolved.

However, even at this early stage, it has become clear that a single European market will change the way many American businesses operate. The economic statistics are staggering. The unified EC market will include more than 320 million people and have a gross national product of over $4 trillion; if sales by subsidiaries are considered, bilateral trade with the United States will be worth over $1 trillion annually.

DEALING WITH A COMPETITIVE

EUROPE

American business owners should keep in mind one of the prime reasons the EC decided to band together to form this immense market. The member nations wanted to build industries with world-class products that can compete globally with U.S. and Japanese companies. Thus, U.S. companies that concentrate exclusively on domestic markets soon may find themselves saddled with heightened competition from European corporations. Such giants as Siemens and Philips already have announced programs to enter U.S. markets more aggressively.

The logical move for American companies faced with increased competition at home is to expand their horizons and move into overseas markets. In many respects, a unified European market is an inviting target. Instead of 12 different sets of customs laws and regulations, industrial standards and exchange rates, there will be only one--allowing businesses to simplify production methods, transport goods faster and less expensively and develop unified marketing strategies. Mergens and acquisitions in Europe have been booming as European companies position themselves for 1992 by reaching for markets outside their home countries. For 1989 alone, 1,276 European cross-borden aquisitions, valued at $56.6 billion (45.3 billion ecu) were reported by European Deal Review. This consolidation of European companies creates additional potential customers for American companies.

EUROPE FOR THE EUROPEANS?

Against these attractions, American business owners looking for entry into the EC market should realize that, to some extent, the goal may be to protect the European market for European companies. The EC did not plan the unified market to be dominated from abroad.

This is not to say the concept of "Fortress Europe" has any real merit. EC exports account for almost 20% of world trade and approximately 22% of its combined gross domestic product. Therefore, the EC cannot afford to follow a protectionist policy that would invite reprisals. Nevertheless, it will follow policies that will support the development of industries it consideres important to its well-being. Willy De Clerq, the EC's top trade official, put it blunty when he said, "1992 means one thing--opportunity first and foremost for Europeans. There should be no surprise about this." An American banker with an EC operation seconded the notion when he said, "They aren't trying to force us out but they're sure not making it any easier for us, either in Europe or in the United States."

Even at this early stage, evidence abounds that the EC is willing to take a hard-line stance when its own interests are at stake. The European Parliament's action to limit the amount of foreign television programming that can be broadcast within the EC is one example of a protectionist move. A draft directive on telecommunications procurement requiring that EC companies be preferred and that 50% of the value of all bids be derived from EC sources is another piece of evidence.

WHERE MIDDLE MARKET

COMPANIES STAND

In the United States, the principal impact of 1992 will be felt by small and midsized companies. The large multinational corporations that intend to be involved in the European market are already there and adjusting their production and marketing operations to meet the unified market. As examples, Coca-Cola, H.J. Heinz, Colgate-Palmolive and IBM have announced reorganizations of management or marketing responsibilities to develop a European, rather than national, strategy in time for 1992.

In contrast, even though the Small Business Administration estimates that 50% of the value of U.S. exports comes from businesses with fewer than 500 employees, these small and midsized companies usually work through foreign distributors. They rarely establish a physical presence overseas. This type of arrangement could pose two distinct problems after 1992.

1. A U.S. exporters could find its European distributor has decided to take advantage of the unified market and sell a European competitor's product instead of the U.S. product.

2. An exporter to the EC will not enjoy the benefits of the unified market available to companies manufacturing products in an EC country. Unlike that for EC-made products, there is no requirement that a product imported into one EC country be accepted by other EC countries. One small business exporter of electronics products to the United Kingdom expressed her doubts by saying, "Right now, I'm uncertain about what will happen after 1992. I'd like to expand into other EC countries but I'm not sure I'll be able to keep the markets I already have under the new rules."

ESTABLISHING A PRESENCE

There are three ways for a U.S. company to enter the EC. It can open its own plant in an EC country, acquire or merge with an EC company or establish a joint venture with an EC partner. Of the three, the joint venture arrangement appears to have the most appeal for a typical middle market company. It allows the parent company to establish a presence in the EC without surrendering control of the basic operation.

When Tony O'Reilly, chairman and chief executive officer of H.J. Heinz, was questioned about the best way for a small company to enter an overseas market, he said, "Before you move into a new market, you've got to learn everything possible about your potential customers. When you get there, you've got to produce quality products at the lowest possible cost. And after that, you've got to market your products in the most effective way possible. All three of these efforts are enormously expensive. A joint venture combining American production know-how and European marketing expertise could cut these costs and improve the chances of success."

There is one further reason for an American company to opt for a joint venture arrangement over the formation of an overseas subsidiary. The EC has not yet defined a local company. It is widely expected the definition will include all companies incorporated in the EC, including subsidiaries of U.S. companies. However, the definition could be narrowed to exclude companies owned and controlled outside the EC. In such a case, joint ventures still would be considered local companies, but subsidiaries would not.

UNRESOLVED ISSUES

One of the principal reasons for establishing an early presence in the EC is the possibility that all established companies would be grand-fathered if a restrictive definition of a local company is adopted. In addition, there are a number of important policy issues that must be resolved before it will be possible to develop detailed business plans for dealing with the EC market.

* Reciprocity. Under the EC reciprocity principle, the EC gives access to foreign suppliers on the same terms their country gives access to EC companies in the same industry. This sounds fair but no one knows what it means yet. There are two possible interpretations. In one, the EC will give foreign companies access to EC markets equivalent to that given to EC companies, if the foreign country allows EC companies to compete on the same terms as its domestic companies. In the other, EC companies will be allowed to operate in a foreign country in the same manner that the foreign companies operate in Europe. But a foreign company operating in Europe must follow the laws of its home country.

The dispute over reciprocity in the banking industry demonstrates how difficult these issues can become. An EC proposal suggested U.S. banks would be allowed full access to the EC market only if EC banks were allowed to operate in U.S. markets in the same way they did in their home countries. Noting that U.S. banking regulations differ substantially from European regulations (European banks, for instance, have broad investment banking powers), U.S. trade officials objected vehemently. The EC has retreated some but still insists U.S. banks will not be given complete EC access unless European banks are given equivalent access to U.S. markets.

Whatever the outcome, the EC has served notice that it intends to use reciprocity as a wedge to open doors to foreign markets for its products and services. This is an additional reason to expect intensified European competition for U.S. domestic markets.

* Local content. U.S. Secretary of Commerce Robert Mosbacher once said, "While I do not foresee a Fortress Europe, it would be naive to believe there will not be a few strongholds here and there."

Local content restrictions require that a manufacturer add a minimum amount of value to a product in the EC for it to be given an EC label. The restrictions are designed to prevent the spread of the Japanese method of overseas assembly, where Japanese parts are assembled in a foreign assembly plant. The requirements for added value can take many forms.

Lately, however, the restrictions may have exceeded their original goal. For instance, a rule on semiconductors requires that the most costly and sophisticated part of the manufacturing operation, known as the diffusion process, be used to determine the country of origin. Thus, a U.S. semiconductor manufacturer selling to the EC either must relocate manufacturing operations there or face a 14% import duty. Potentially, these requirements could be applied to finished products that contain semiconductors, including computers and automobiles. In the meantime, the fallout has been bad enough. One small semiconductor marketer who sold to France said, "It wipes me out. If they don't change the rule or I don't find another market, I'm out of business."

* Government procurement. One of the objectives of unification was to open up the $600 billion government procurement market to foreign businesses. However, until now, this goal has been difficult to accomplish. Most government contracts still are awarded to domestic suppliers with ties to the purchasing agencies of the EC nations. Even if the bidding process opens up, proposed regulations in some of the more important areas, such as telecommunications, energy, water and transportation, would require as much as 50% local content.

MUCH TOO IMPORTANT

TO IGNORE

How long it will take for the EC to resolve the issues discussed above, and perhaps as many as 50 other difficult issues, is open to conjecture. Many may not be decided until well past the 1992 target date. However, one thing is certain--the birth of the world's largest market is too important to ignore. It will offer many new opportunities but it also will bring with it aggressive new competition. The only possible way for small and midsized business owners to prepare for both is to keep informed on all aspects of the market's development.

GENE R. BARRETT is a news editor of the Journal.

Mr. Barrett is an employee of the American Institute of CPAs. His views, as expressed in this article, do not necessarily reflect the views of the AICPA. Official positions are determined through certain specific committee procedures, due process and deliberation.