Western Capital Tests East Europe
Three companies, by different roads, try to turn minefield of obstacles into gold mine of profit. RISK AND REWARD
AFTER a Digital Equipment Corporation team surveyed investment possibilities here last year, it took home an alarming report: Digital's computers were being cloned illegally by state-owned Hungarian computermakers. The delegation's recommendation was even more startling: It advised a joint venture with the culprits. "The situation is a bit Kafkaesque," concedes Yves Sarrazin, general manager of Digital's Country Development Group. "But in a strange way, you could say our three companies had a good 'fit.' Our partners understand Digital."
For large Western companies like Digital, East Europe's attractions include low wage rates, an educated labor force, and above all, a pent-up market of nearly 140 million consumers. But foreign investors must traverse a maddening minefield of explosive financial, legal, cultural, and political obstacles. Emerging from more than four decades of communist rule, the region's economies struggle under bloated bureaucracies, archaic financial systems, outdated trade rules, and primitive roads, phone systems, and factories.
These immense problems have not crushed investor enthusiasm. Nearly all West European and about half of United States and Japanese large-scale companies plan to invest in Eastern Europe over the next five years, according to a survey published recently by DRT International, a New York accounting firm. The survey polled 128 West European, US, and Japanese companies with annual revenues or assets exceeding $1 billion.
"The results lead us to believe that investment commitments of anywhere from $42 billion to $50 billion may well be on the drawing board for the next five years," says Thomas Presby, a DRT managing partner.
Three examples - the Digital joint venture plus a start-up and a takeover - illustrate the opportunities for foreign investors in Eastern Europe, and also the patience and persistence that are required.
Jean-Louis Vuille slumps back in his chair, surrounded by the mess of moving boxes. Tetra Pak, a Swiss food packaging company, announced a project for a $48 million factory at the beginning of 1990. Since then, Mr. Vuille says he has struggled to get construction started. It took him more than six months just to get a telephone, he complains. "We call the Ministry of Telecommunications and they say, 'It'll be there tomorrow,' " he recalls. "The next day, there's nothing."
Retraining a local labor force that grew lazy under communism has proved difficult. For most of its operations worldwide, Tetra Pak hires local managers. But in Hungary, it had to import six executives on costly expatriate salaries. Miguel Fresquet, marketing manager, says he even has trouble finding skilled secretaries.
"You get lots of people trained to serve only coffee," he moans. Three secretaries are needed to do the job of one.
Hungary began introducing market mechanisms into its state-dominated economy more than two decades ago, long before any other East European country. It was the first East European country to permit majority control of local companies by Westerners and the first to allow 100-percent foreign-owned subsidiaries.
But start-ups such as Tetra Pak remain rare. A big gap exists between what the law permits and what foreign investors can do in practice. Most investors prefer to enter a joint venture with a local partner who knows how to deal with the cumbersome bureaucracy.
"I don't know many foreigners who own 100 percent," says Zoltan Gombocz, Hungary's secretary of state for trade. "Foreigners just seem more comfortable sharing the risk."
For Tetra Pak, however, the joint venture route proved impossible. "We saw every cardboard factory in the country and none suited us," Vuille says.
Vuille expects the new factory, finally begun last September, to be operating by the beginning of 1992, producing 800,000 cardboard containers a month for juice and milk. Most Hungarian juice and milk is now sold in unwieldy plastic bags. Tetra Pak's cardboard cartons are cheaper and preserve the product longer.
"Even if the general economic situation in Hungary is confused, we should be OK," says Sabine Kouzinger, the company's East European director. "People can be rich, poor, feeling good or feeling bad, but they always need juice and milk."
Unlike Tetra Pak, Digital had no problem setting up its office. One of its Hungarian partners, Szalmak Computer Technology, cleared a floor in its building and offered 1,000 square meters of space. Digital's new offices are spartan, painted in drab communist gray and furnished with old-fashioned desks, bulky chairs, and aging sofas. But they came with telephones already installed.
Though Tetra Pak found it hard to hire competent Hungarian secretaries, Digital is pleased with Hungarian computer scientists. The satisfaction, ironically, stems from Hungarians' experience cloning Digital machines.
Until 1979, Digital, based in Maynard, Mass., sold its computers to Hungary through a sales agency based in nearby Vienna. But after the Soviet invasion of Afghanistan, Washington tightened export rules to Eastern Europe. Digital stopped selling its computers to Hungary.
So the Hungarians began cloning them. "We weren't copying out of revenge but out of necessity," explains Ferenc Bati, Digital Hungary's president and a former Szalmak employee.
US export rules on computers to Eastern Europe were relaxed last year. The problem for consumers is financing. With a $20 billion foreign debt, Hungarians simply don't have the hard currency to buy expensive machines.
Still, Mr. Sarrazin says sales are better than expected. He has just decided to double Digital's initial investment in Hungary and expand from 40 to 80 employees.
Digital's easy-going approach didn't suit Britain's Telfos PLC. Since buying 100 percent of the Hungarian locomotive-maker Ganz-Mavag in December 1989, Telfos's managers have renamed the company Ganz-Hunslet, cut the work force from 1,200 to 800, and reduced annual operating costs by more than $1 million.
"When I arrived, my department numbered 58 people," recalls Stephen Kostyal, the Canadian finance director. "Today we have 18 people and we accomplish four times as much."
Rather than tracking expenses with quarterly reports, Mr. Kostyal's department issues monthly ones."We were all frightened by the new owners," says Szuszana Szopori, an accountant. "Now even though some of us still are frightened of losing our jobs, we've learned to work together."
Ganz-Hunslet's production facilities, most of them only a decade old, were in decent shape. Shop-floor morale, by contrast, was terrible. New managers handed out colorful blue, red, and yellow uniforms. They forbade wearing worn jeans and torn shirts on the factory line. Autonomous working groups were created to encourage individual responsibility.
"The mentality's totally changed," says Gabor Szabo, production manager.
The changes are visible in the bottom line. Kostyal and his fellow expatriate managers say they have turned a bloated company losing $3 million a year into a winner that earned $3 million last year. The company is eying contracts in Egypt, Brazil, Syria, and Malaysia.
The phone rings.
"It's our man in Malaysia," whispers Kostyal. "There's a contract out there for 200 cars."
As he listens, a small smile breaks out across his face. "Great news," he says, putting down the receiver. "We're the low bidder."
For Stephen Kostyal, the moral is clear. "This place is a gold mine," he says. "You just have to know how to mine it."