The big move East

Frederick Metz Shepperd is managing director of the Quadral Group, a consulting firm with offices in Europe and North America.

Can experience along the borderland of Mexico and the US bring opportunities for family businesses in Europe to compete in the expanded EU? Frederick Metz Shepperd thinks so

Across Europe, family-owned businesses are sharing the same experience in meetings with their customers. The customer is establishing production in Slovakia and wants you to join them, there is a competitor to you that wants to supply from Asia with great pricing, or the customer has identified a new supplier in the suburbs of Warsaw, or somewhere in eastern Europe. Regardless, you are asked to supply from a low cost country and achieve a price level that cannot be accomplished with your current cost and operational structure in Germany, France, or elsewhere.

Family-owned businesses are under tremendous pressure to reduce costs and compete with production facilities of their larger competitors in China, India, or some location in the new countries of the EU, or beyond. How family businesses can respond to these pressures will be the crucial test for survival of the business in the future. However, in addition to the cost pressures, there are other serious questions in the big move east. Who will manage the new plant? Which engineer really wants to take his family to the border of the Ukraine? Which owner wants to send them?
 
There are many other pressures that are particularly hard for the family business owner. They may have a significant presence and responsibilities to the local community. The family has operated the business in the region for generations. Can you really be the one that pulls the plug? The children playing with your children, or grandchildren at school are the kids of your employees that may soon be without a job, if you make the decision. What's more, the move can only take place once. What if it is the wrong move? Family businesses cannot lose millions, then go somewhere else. You can only spend the money once.

East is East
These questions are not easily answered and the caution taken by family business owners and slowness of action may be just enough to allow the competition to take all the business and force the company to close its doors. No decision is also a decision.
 
The growth in eastern Europe is entering a new phase, just in time for family businesses.  Before, eastern Europe was only a place for the big companies with huge budgets. But now, the security and stability associated with EU membership is presenting opportunities for many mid-sized companies. But what track should they follow? What has been a proven model for success? There is one. The opening of borders between Germany and Austria with lower costs countries is creating a similar environment to the borderland area between the US and Mexico, which provides interesting practical solutions for family businesses.

Many family-owned businesses in the US have already been forced to move a significant portion of their business to Mexico, or elsewhere as a result of Nafta. They have met the Asian competition with this solution. In this case, the company establishes production in Mexico, along the border with the US. The plant manager, a family member, moves to the US side of the border, with the new team for production. They live in El Paso and the children attend US schools. They go to work in the morning, but the work is in Mexico. They come back at night, across the border and meet their family for dinner. The company profits from low cost production and a very satisfied management and technical staff. Over a five-year period, approximately 250,000 jobs were created in the El Paso-Ciudad Juarez region. The statistics prove the success of the model.

How does this apply to European expansion? Actually, quite well. Hourly costs in Mexico were 10% of costs in the US. Total hourly cost (with benefits,etc) in, say, Poland are around 25% those in Germany and other locations in the western Europe. In addition to cost savings, is the flexibility and motivation of the workforce. This combined with the developing new heart of Europe creates an opportunity that is not just a grab at low cost production, rather a very solid repositioning of the company for supply in a new, expanded Europe. One can blend the eastern production location with a technical and support operation just on the German side, with the home office remaining in the existing facilities back home.

A new heartland
"It is the new heart of Europe," says Prince Alexander von Sachsen, about the region of Saxony, areas of Poland and the Czech Republic. He may be right. The new centre of Europe is a line from Berlin, south to Vienna, going through Dresden. What were the centres of European industry in the 1800s are the new centres of industry in the 21st century.
 
Consider the automotive industry and the trend is clear. The new line East-West, particularly for automotive suppliers, is a line from Frankfurt, east through Dresden to Wroclaw, Poland and further. In fact, Deutche Bank estimates that by 2014, 3.5m cars (20% of the European automotive market) will be supplied from existing, and already announced carmaking plants in the new EU countries and 50% of the automotive suppliers in Germany will have to establish production capacity in the new EU countries. Others will follow.

Location along the border is a great position to move eastward and westward. The location of a plant on the Polish or Czech side of the border, and to have executive and technical staff living on the German side is an unusual concept. In Goerlitz in Germany, they go across the bridge and, in 10 minutes, are at their plant in low-cost Poland. The manager can even go home for lunch if he, or she, wants. Of course there is much more to this scenario. The company benefits from the infrastructure of Germany, the autobahns, the telecoms system, the stable legal climate, protection of intellectual property and a good lifestyle for technical staff and support. Yet, they also benefit from the low cost production in the expanded EU countries. It is the best of both worlds.

Of course, the model works for locations in Austria with plants in the Czech Republic, Slovakia, Hungary, or Slovenia as well. The key is to get the optimum lower production cost achieved by a mix of lower hourly costs and relatively high productivity. The second factor in the mix is the proximity to established western European rail and truck transportation for quick delivery to the western customers. Moving further east, there is an exponential increase in the time for transport to western locations. The roads are just not there and rail transport still lacks many of the rail infrastructure and electronic safety controls that could aid transit time westwards.

If the sole motivation is lower hourly costs, a move east is really a mistake. Be it long ago in Japan, more recently in Mexico, and now in China, and India, hourly costs will always rise as the economy develops and business invests. Low value production like wiring harness production is already heading to the Ukraine, Romania and other places further east. China presents an opportunity for low cost labour, but the costs for transport, oversight and quality control may exceed any savings from lower hourly costs. Further, what happens when a government company starts to supply a copy of your product, using tooling you supplied them at a fraction of the cost? Who do you sue? It's a hard lesson.

Happy families
Some family businesses have already made the move east, be it in eastern Germany, or in places beyond. The company Wago-Elwag, located in Wroclaw, Poland is a family business from Germany that partnered with a Polish company and now distributes to 14 countries from Wroclaw. "We are very friendly, strongly motivated and have companies that can be partners in business," says Adam Grehl, deputy mayor of Wroclaw. The City of Wroclaw also fits in with the 'twin plant' model from the US in the region near Dresden, with access from Poland both east and west.

The key for success in the East is innovation and the optimum production and supply solution for the customer. As customers go to the East, there is no other option than to follow. The location along the border provides family companies a new unique option to have the lower cost, access to the East and the West, while providing a good environment for senior managers, engineers and their families. In fact, for many German companies, going to the new borderland provides a unique opportunity to show others how they can stay in Germany and win the competition from the East. For all family businesses in Europe, it is a chance to reposition the company along the developing supply routes with a motivated, flexible and skillful workforce in the new, continental-wide Europe.