Road to success in central and eastern Europe not always simple

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Last week, Sony announced it was to close its factory in the Budapest suburb of Godollo after 14 years and concentrate production of DVD and Blu-ray players in the Malaysian capital, Kuala Lumpur.

The closure, which will cause the loss of 540 jobs in December, is a sign of the fierce competition for cheap labour that is seeing the central and eastern European countries losing ground in the battle to attract the multinationals of tomorrow.

Kalman Kalotay, an economist at the United Nations Conference on Trade and Development in Geneva, points out that, with the specific exception of Russia, countries from the emerging Bric economies have few compelling reasons to be in the central and eastern European region.

“You start by asking why a company might want to invest in a location,” he says, listing the hunt for natural resources, the desire to establish a new strategic foothold, a desire for cheaper labour and familiarity as motivations. “India and China are all over resource-rich companies,” he notes.

As far as conquering new markets is concerned, he points that only Poland, with its 40m population, is large enough to be worth the attention of a company with a China-sized domestic market. “The partial exception is if they are using CEE as a base from which to sell to the entire EU,” he adds.

And, as Sony’s example shows, eastern Europe remains cheap from a German perspective, but not when compared with the fast-developing economies of south-east Asia.

Add to this Brazilian and Chinese investors’ lack of familiarity with the region, and the obstacles to establishing a bridgehead east of the Danube look high indeed.

But there is an exception. “Almost any decent-sized city in eastern Europe has a Chinese population,” Mr Kalotay notes. Numbers are hard to come by, but some estimates put the number of Chinese in Hungary as high as 30,000. Yet in spite of their entrepreneurial nature, many are simply selling cheap goods to price-sensitive consumers at market stalls – a factor that does not show up in many statistics.

The experience for many Bric nations investing in emerging Europe is varied. Here, we profile three companies that decided to establish divisions in Hungary: two success stories and one example of the problems faced by other Bric countries seeking to expand into a central or eastern European country.

McNally Bharat, India

For an Asian company looking to expand abroad, the countries of central and eastern Europe can seem small, with their modestly sized consumer markets, expensive and with labour costs far higher than in much of south-east Asia, or very distant and alien.

But in certain circumstances, there can be a compelling investment case. For South Korea’s Daewoo Heavy Industries, which bought a shipyard in the Romanian Black Sea town of Mangalia, the presence of infrastructure on a scale that would have been prohibitively expensive to build from scratch was compelling. Whereas for McNally Bharat, the Indian engineering group, the appeal of investing in Hungary was a company with unique expertise and knowledge.

“We work in an extremely specific area,” says Karoly Horvath, managing director of EWB Energy, which McNally Bharat bought from Austrian owners in 2000. “We have expertise in ash handling – in getting rid of the ash that is a by-product of coal-burning power stations.”

EWB has a heritage going back to the 1950s. It started as a specialist department in the then-communist country’s central energy planning office, and is one of only a handful of companies in the world with the engineering expertise to design the networks of sluices, pipes and conveyors that clean the ash out of coal power stations. The cleaning process helps power stations run more cleanly – a key benefit for India, where 75 per cent of electricity is generated by power stations powered by relatively poor quality coal reserves – and allows the ash to be recycled for use as an ingredient in cement manufacture.

The company is now fully owned by McNally Bharat. Its 15 employees receive roughly 20 per cent of their commissions from their Indian parent, and have to use their own resources to compete for contracts on the world market for the remaining 80 per cent of their business. “A big contract can be worth €30m ($37m, £25m),” says Mr Horvath. The company had revenues of €4.6m last year, earning profits of 13 per cent – a high profit ratio by Hungarian standards.

McNally Bharat’s investment came out of a desire to gain access to EWB’s know-how during the country’s energy boom at the turn of the millennium, allowing its engineers to gain training expertise in the field. Links between the two companies began in the early 1990s, with a project to clean up an Indonesian power station.

“I must have gone to Jakarta 20 times that year,” says Mr Horvath. “We remain valuable to them, though. We continue competing on the world market, at standards just as high as our west European or Korean competitors, and we send the profits back to India.”

But he admits that it was EWB’s extremely specialised skills that made it valuable to McNally Bharat. “If it was just about general engineering, they wouldn’t need us. Indian engineers can do anything that Hungarian engineers can do, but we have very specific knowledge.”

Hankook, Korea

Barely an hour south of Budapest, Dunaujvaros was created to be Hungary’s new socialist city in the 1950s.

As part of a programme of reconstruction after the war, the then-communist government decided the country was in need of a giant steelworks to speed up its economic development.

A site by the Danube was chosen for plentiful access to water, and a town was planned to house the thousands of workers who would stoke the furnaces of the Danube Ironworks. Sztalinvaros, as it was christened, was to be a showcase, with fountains and public art adorning dazzling example of socialist realist architecture. The town boomed, and by the 1960s, Dunaujvaros (Danube New Town), as it was renamed, had roughly 60,000 inhabitants.

In the 1990s, however, as demand for lower-quality east European steel fell, the town fell on hard times as the steelworks passed through a succession of owners, and the workforce was slashed.

It was into this depressed atmosphere that Hankook, a South Korean company that is the world’s seventh-largest manufacturer of automotive tyres, arrived as a saviour in 2007.

The €550m plant that was established now amounts to 13.7 per cent of the company’s global production and employs almost 1,300 people – a substantial proportion of its overall workforce of 14,000.

The plant was designed as part of the company’s move to improve its position in the European market, where it had been falling behind. According to Hankook, the push into the European market was part of a strategy to establish it as a “leading global company” and improve awareness of its brand in Europe.

At a stroke, supply chains and delivery times to a key automotive market were cut. Before, the company needed 45 days to deliver tyres from its plants in South Korea and China to Europe. The Dunaujvaros plant reduced this to seven. Beyond the obvious advantages of having a manufacturing base inside the EU, the company also noted it was attracted by the presence of abundant qualified labour in the city.

For Hankook, the strategy was a success, and further investment has followed. It set up a rubber technology department at the local college, and has more recently invested in training courses at schools in the surrounding county.

Apollo Tyres, India

The logistical attractions of a central European location within the EU have lured many investors to the region, though not all have met with the same success, and unanticipated political risks can derail the best-laid plans.

Last year, India’s Apollo Tyres chose Gyongyos, a town to the north of Budapest, as the location for its first European plant. Central and local government both boasted of their coup in snatching the investment from Slovakia, Hungary’s arch-rival for foreign investment. The €200m plant, which was to have been the country’s first outside India and South Africa, was to have been coupled with a research and development centre, carrying out the kind of high-value activities that central and eastern Europe sometimes struggles to attract.

However, the company ran into fierce local opposition. Neeraj Kanwar, the company’s chief executive, issued a statement saying he did not wish to divide the community and abandoned the investment, later opting to buy a bankrupt tyre manufacturer in the Netherlands.

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