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Eastern Europe: tread softly, joint venturer.

Eastern Europe: tread softly, joint venturer Perhaps the most exciting development in the business world in the last year has been the flow of Western cash and business interests into Eastern Europe and the Soviet Union. Seeking to gain from labor wage rates half those of Western Europe, some large Western European and North American companies have gone to Eastern Europe to produce low-cost products. And, with a total economy of $3.5 trillion and almost twice as many consumers as the U.S. (440 million inhabitants), this new market is inducing many Western companies to develop detailed strategies on how to do business there.

Not surprisingly, the number of international joint ventures has rocketed. According to the latest reliable figures, released in February, Western firms have joined in over 1,000 joint ventures in the U.S.S.R., compared with only 162 in 1988. In Hungary, there are now over 600, compared to 150 two years ago. And Poland has seen an increase from 26 joint ventures in 1988 to over 400.

Multinationals from every major country have established joint ventures in Eastern Europe. France's Pechiney will manufacture aluminum tubes in East Germany; Japan's Suzuki will make cars in Hungary; Korea's Daewoo Electronics will produce microwaves in Hungary; Gillette will manufacture razor blades in the U.S.S.R.; and West German firms, Siemens among them, have inundated East Germany with investment dollars and joint-venture proposals.

As with any investment, however, doing business in Eastern Europe has considerable risk. Much has been learned in the last six months about how Western firms can mitigate these risks through careful planning and thorough analysis.

Location, location, location

Top firms are learning that choosing the right country in which to do business is just as important as choosing the right joint-venture partner. This is so because in Eastern Europe the environment in which a firm does business has a tremendous effect on the success of a venture.

Eastern European countries differ in a number of respects:

* Their standing with Western banks and, therefore, their access to capital for development.

* The speed and stability of their economic reform.

* The sophistication and reliability of their infrastructure, particularly in telecommunications and transportation.

* The convertibility of their currency.

* Their willingness to allow repatriation of profits and capital investment.

* The degree to which their government bureaucrats become involved in business decisions.

In the euphoria of the last few months, many Western firms have assumed that they can assess a joint venture in Eastern Europe in much the same way they assess a joint venture in the West, which principally is to analyze the strengths and weaknesses of the firm with which they want to link. In making this assumption, these companies have not thoroughly assessed the six criteria above. The result, in several cases, has been a bad business decision.

Companies investing in Eastern Europe must assess both the attractiveness of a country's business environment, as measured by the six criteria, and the attractiveness of its business assets, as measured by the existence of export-oriented businesses in the investor's industry and the history of entrepreneurship in the country and the industry.

The chart on page 14 shows a relative ranking of the eight Eastern European countries on these two dimensions. (Please note that the chart analyzes the business asset attractiveness of each country overall, irrespective of industry. Any company wishing to apply this model should tailor the analysis of business asset attractiveness to its particular industry.) The graph on page 16 plots the relative overall attractiveness of the countries.

The following analysis, which explains briefly why countries are ranked as they are, provides a useful context in which to place a more tailored assessment.


"Limited potential"

Business environment: Bulgaria benefits from having little foreign debt, but it has not passed progressive economic reform packages. Many believe that old-line Communists still control political power in the country.

Infrastructure in the country is very weak; there is no currency convertibility; and it is impossible in many cases to repatriate profits. Plus, the government is highly bureaucratic.

Business assets: Bulgaria has the world's largest forklift truck manufacturer--Balkan Kar--and the world's fourth largest tobacco crop. Apart from these industries, however, there is little that is attractive.

"We are literally begging for investment," says Bulgaria's Commercial Counsel to the U.S. Embassy, Dimiter Karamfilov. But there is little history of entrepreneurship in the country.


"Great expectations--slower


Business environment: After an initial head start with President Vaclav Havel's very successful U.S. trip last winter, Czechoslovakia has cooled somewhat in the eyes of Western businessmen.

The country still has many positive qualities. Its foreign debt is trading at par, making it an attractive area for commercial loans from Western banks. In addition, the country's infrastructure is solid, with 50 percent more phones there than in most other Eastern European countries.

Nevertheless, economic reform has been slower than expected. Currency convertibility does not exist. Western firms can repatriate hard currency exports but not the profits they make in Czechoslovakia. And, finally, the government bureaucracy has been more difficult in approving deals than expected.

Business assets: Czechoslovakia has a long history of business success. The Koda Works in the Sudetenland has been a strong industrial and engineering concern since before World War II. But much of the country's property and equipment and many of its plants are outdated.


"Ahead of the pack"

Business environment: East Germany must be evaluated in a different context from its Eastern European neighbors because of the tremendously positive effects that German reunification will have in the region. Reunification makes Western banks much more likely to make commercial loans to the country, and economic reform is likely to be stable since conservative West Germany has controlled the process.

Though the infrastructure in the country is poor, steps have been taken to improve the situation. A French firm will help remodel the country's telephone system, and West German banks are sending prefabricated bank buildings into East Germany fully equipped with satellite-accessing telephone and facsimile lines.

The East German currency became fully convertible in July of 1990 and ceased to exist. Western firms doing business in Eastern Germany will be able to repatriate profits 100 percent. And government influence in business decisions has already declined substantially.

Business assets: Equally attractive is East Germany's history of effective business dealings with the West. The region's ties with West Germany are well known, with 58 percent of its export earnings coming from trade with West Germany. The region was also a relatively productive and entrepreneurial area before World War II.

All of these factors make East Germany the most attractive country in which to do business in Eastern Europe. The situation is somewhat akin to doing business in West Germany, but at a much reduced capital cost.


"Reaping the benefits of 20

years of reform"

Business environment: Hungary faces problems with Western bankers because the country has substantial outstanding debt. Nevertheless, banks are reassured by the speed of economic reform in the country. Hungary has by far the most liberalized joint-venture laws: foreign companies are allowed to own 100 percent of their businesses, and they are permitted to repatriate 100 percent of foreign and domestic profits.

The country's infrastructure is strong by Eastern European standards, with the second highest number of cars and phones in all of Eastern Europe (17 telephones per 100 people).

True currency convertibility still does not exist, although recently the official rate of exchange for the dollar was only 30 percent below black-market standards, which is good for Eastern Europe.

Finally, government bureaucracy is less of a problem in Hungary than in almost all of its counterpart countries, largely because of the economic reforms that have been in place since 1968.

Business assets: Hungary has always had a strong history of entrepreneurial business activity, and has had the largest percentage of export earnings outside of Yugoslavia. When East Germany is excluded, 80 percent of the cash value of Western investment in Eastern Europe in the last year has taken place in Hungary. Among U.S. firms participating in Hungary have been General Electric, General Motors, and Digital Equipment.

Clearly, Hungary has become an attractive location for Western business, especially for those Western firms that have limited access to the superior East German market.


"Success of the government

program will tell all"

Business environment: Because old commercial loans to Poland are trading at 15 cents to the dollar as of mid July, Western bankers shy away from the country.

Economic reform is increasingly unstable. As of June, Solidarity leader Lech Walesa was challenging the government of Tadeusz Mazowiecki for going too slowly with economic reform. Meanwhile, Finance Minister Leszek Balcerowicz was jeered in Gdansk by grass-roots Solidarity members who thought the economic program was going too fast. As industrial production has plummeted almost 30 percent, Poland may soon face unemployment as high as 15 percent. These figures, previously unheard of in Poland, can only create further dissension and greater instability.

In addition, the infrastructure is one of the poorest in Eastern Europe, with only seven phones per 100 people and nearly no chance to make a call to the West.

Currency convertibility is still in question, and foreign firms can repatriate only 15 percent of earnings made in Poland.

Perhaps worst of all, Poland suffers from a stifling government bureaucracy in which many old-time Communists are still in power. This has led to a continuation of central planning policies that wreaked havoc on the country's economy in the first place. Recently, the Polish Council of Ministers constructed a list of "Priority Sectors for Investment by Companies with Foreign Participation."

"This measure smacks ominously of our old five-year plans," says Andrzej Wroblewski, the editor of Gazeta Bankowa, Poland's leading financial magazine.

Business assets: Business investment in Poland is somewhat attractive for one main reason: labor wage rates are extremely low, in some places 40 percent of the levels in Hungary. Unfortunately, few firms have export earnings or dealings with the West, and the Polish market is not large enough to support major business activity by itself. In addition, the history of entrepreneurship in the country has always been low.


"Living with the ghost

of Caesescu"

Business environment: Though Romania has perhaps the best historical relationship in Eastern Europe with Western bankers (almost all of the country's debt has been repaid), few bankers want to venture into the region.

Romania's major problem is its continuing political strife. Political dissension between ruling government forces and the opposition will wreak havoc with the stability of the country, making business conditions difficult.

Other drawbacks are a poor infrastructure, with little being done about it; non-existent currency convertibility and repatriation of profits; and a considerable level of government bureaucracy.

Business assets: All of Romania's most attractive industries, such as petrochemicals, exist under more stable conditions in other countries of Eastern Europe. The country has never had a significant entrepreneurial class.


"The new China"

Business environment: Western banks are wary of doing business in the U.S.S.R. because of the country's dire economic situation and its history of reneging on loans. In addition, economic reform in the country is spotty and inconsistent, with Gorbachev pushing to build a market-oriented economy but insistent on using central planning methods to achieve it. Many economists doubt he will succeed.

The country has tremendous infrastructure problems, especially with communication and transportation east of the Urals, where much of the country's natural resources are located.

Many economists have begun to question the ability of the government to make the currency convertible or to afford profit repatriation. And a meddlesome and unwieldy government bureaucracy has tormented Western business in the past.

Business assets: One statistic indicates the difficulty of doing business in the U.S.S.R. According to White and Case, the international law firm, only 5 to 15 percent of joint ventures with Western firms are currently operational.

To some, the U.S.S.R. is beginning to resemble a "new China." It is considered to have great economic potential but is not close to realizing this potential. Just as China failed to become an economic juggernaut within a decade of Nixon's 1972 trip, it is perhaps unrealistic to expect the U.S.S.R. to play a significant role in global business for quite some time.


"Huge political risk"

Business environment: The business environment in Yugoslavia is quite difficult to deal in. To begin with, Western banks have cooled considerably to the country, with the nation's debt trading at 63 cents to the dollar as of mid July.

More important, the speed and stability of economic reform is vastly overshadowed by the possibility that the country could splinter into several different republics. All Yugoslav companies concede that such a development would be disastrous. Says Leonel Lukic, deputy managing director of Oktobar 14, Yugoslavia's largest manufacturer of construction equipment, "As a Serbian firm, we would lose 25 percent of our revenues immediately, because it would be difficult for us to sell into the republics of Slovenia and Croatia."

In addition, the country's currency is not convertible. Few foreign or Yugoslav banks will convert the dinar into hard money.

One positive sign is that Western firms have been allowed to repatriate more domestic profits and are allowed to control their boards of directors through non-Yugoslav citizens. In addition, the country's telephone system works well. Unfortunately, most of this good news is of lesser importance than the bad news.

Business assets: Yugoslavia has a history of export-oriented, entrepreneurial business activity, mostly because the Communist party in the last 40 years has interfered less with business there than in the other Eastern European countries. In addition, Yugoslavia is the only Eastern European country aggressively attacking the problems of excess labor that plague the entire region, and the government is backing companies that apply austerity measures.

Nevertheless, Yugoslavia should be approached with extreme caution, unless a business firm is convinced that the threat of secession in the country will cool.

Takeaway points

In conclusion, Western firms should approach the Eastern European market with great care. Firms should not seek to link with only the best firm in Eastern Europe; rather, they should choose the combination of the best firm and the easiest environment in which to conduct business.

In addition, Western firms should compare any opportunity they have in Eastern Europe against similar opportunities in other less-developed areas of the world, such as Thailand, Indonesia, or Brazil. Firms should not rush into Eastern Europe simply because the region has recently opened up. Instead, they should view the recent events in Eastern Europe as giving them more options to access new markets and to build low-cost products.
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Title Annotation:Special Report: International
Author:LaFollette, Charles McHugh
Publication:Financial Executive
Date:Sep 1, 1990
Previous Article:Unlocking the value in your IS department.
Next Article:Prospering in the European Community: three EC initiative to ensure it.

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