Monday, 7 April 2008

Macro Level Trends – Eastern European Production – Battling Declining Conditions

Since the fall of the iron-curtain in 1989, throughout the decade prior to the new millennium (and the dawn of BRIC+ traction) auto-maker’s strategists and Boards were focused on the more easily obtainable promise offered by Central & Eastern Europe. Access to a massive population and low-cost production base spread across the new European entrant countries and Baltic states, demonstrated the shoots of new growth as Western European demand and capacity declined.

Thus VMs scoured Central & Eastern Europe to seek the best locations for trans-plant factories, requiring the right mix of: labour (skilled and non-skilled), component supply streams, local market (demand trends), geography (distribution networks), economic stability (good governance), taxation policy, any FX differential and of course economic aid via local government: either stemming from Brussels – in the case of European entrants – or ERB, or possibly the World Bank. Needless to say, each of the countries was keen to attract Foreign Direct Investment and so laid out their respective stalls to do so. For many the investments made by car companies represent the largest inward investments ever made, and had major trade policy consequences when seeking EU entry (ie Poland and European Commission)

Since those early days, we have seen the evolution of Eastern Europe as a new automotive production powerhouse come into play over the last 10 years of so, either via:

a) the green field factory developments of foreign VMs…
- Toyota-PSA (Czech Republic),
- Hyundai-Kia (Slovakia),
- Fiat-Ford (Poland)
b) the adoption and nurturing of local marques and factories…
- VW-Skoda (original in Czech Republic plus Sarajevo, Bosnia & India),
- Renault-Dacia ( Romania)
c) the creation of Joint Ventures…
- Renault Nissan-Avtovaz (Russia),
- ?-Zastova (Serbia)

[The forerunner of the business template perhaps being VW with its case study nurturing of Skoda]

From a governmental perspective, there was always a preference for FDI as independent ‘greenfield’ development (as with Toyota-PSA’s effort) since this was considered to attract funding for regional and state economic growth without divesting of state automobile assets. But in truth, those looking to invest (such as VW and Renault) considered M&A the only way forward both financially, politically, socially and commercially. Governments wanted to independently re-juvinate their own marques with technology transfer from western VMs, but that was only to be ultimately through integration

A recent report from Vienna’s Institute for International Economic Studies states that FDI within the 10 new EU countries rose from €24.5bn in 2000 to €61.7bn in 2007. Primary focus has been in locales such as the Czech Republic that to date has offered the right FDI criteria mix, but a mix of factors is starting to strain FDI fund levels and indeed starting those who previously invested as to whether to “twist” (carry-on investing), “stick” (hold-back) or even “leave the table” (look elsewhere). Those critical factors effecting Central and Eastern European industry are:

1. Emigration trends
2. Labour based Cost-Push Inflation
3. General Growth & Inflationary Pressures

Much of the workforce, not only the youth, keeps heading west seeking better pay (either for short or medium stays) or indeed new lives for themselves and children.
This has put a great pressure on indigenous and foreign firms when seeking additional or replacement labour. Indeed the old practice of replacing whole sheaves of the workforce after 2-3 years in order to contain costs is gone, instead firms having to offer job security and consistent pay-rises to try and keep labour as inflation rises.

Labour Costs
But the ‘inflation plus’, and beyond, salary offers simply aren’t useful when there’s an increasing shortage of workers to offer it too. And those that are skilled are consistently moving onto better paid work [Ironically, the short-termist attitude toward labour has been adopted by western industry as it seeks to depress costs vs the BRIC+ nations]. So the new EU countries are caught in the dilemma of facing a depleting workforce and increasing labour costs which undermines their FDI rationale…and foreign companies and ventures, like Toyota-PSA, are feeling the pinch and questioning their next strategic moves.

Growth & Inflation
Toyota-PSA has seen labour costs at its plant spiral 40% since the plant’s opening in 2004 on the back of an improving economy and labour constraint. Both initially wage-price inflation push and now the added headwind of rocketing food and energy prices are denting the new economies and seriously undermining both governmental and FDI confidence and sentiment. The IMF and S&P are both warning of a “hard-landing” in the Balkan and Baltic regions, especially so as the much needed FDI monies are greatly helping to off-set budget deficits that illustrate good fiscal governance. Without that, the newcomer EU countries will not be able to join the EU party and so once again there’s a loss of FDI confidence.

Under such increasingly harsh socio-economic conditions companies have to seriously consider their options. They recognise that although there may be a short to mid-term slow-down in economic expansion of the region, that the area is still ripe for continued growth, and so are keen to stay where possible - trimming costs and increasing productive efficiency. Thus there is a growing trend for auto-makers to follow the history of their western operations in automating as much as possible and farming-out the more intricate and labour intensive production activities to Tier1 and beyond suppliers, whether locally based or in Asia.

Automation in such tightening conditions is key and well recognised by VW-Skoda, “growth without growth” is how a former Skoda V-P describes the ideology; looking to capital investment projects to raise capacity and the all important ‘vehicles per employee’ measure that highlights the level of plant productivity.

This, as we know, has been the central story of industrialisation throughout history – labour intensive activities will always seek out, when the FDI criteria mix is right, those areas with ‘work-force elasticity’. As pressures build in the new EU countries and neighbouring Eastern regions, so those next in line areas are the likes of Belarus, the Ukraine and other ex Soviet CIS states.

Automakers well recognise that there is a re-run of the Eastern European story evolving today further East, as growing independent (but inter-connected) CIS states grow, their economies underpinned by massive oil industry revenues and reformed agricultural policies. And the CIS governors of course in turn well recognise that they are very well placed to ease the energy and food worries that plague the global economy.

Accessing those markets will be key, Kazakhstan perhaps the most important given its geographical and population size and the massive oil reserves that will serve the economy. And that’s why western media created that comedic ambassadorial character and cultural link called ‘Borat’.

So car-makers will be questioning themselves about the lessons learnt over the last decade in tapping into the Balkan/Baltic markets and moulding a copy+ initiative for the CIS that brings-forth new potential for names like Skoda, Dacia, Zastava, Lada etc etc.