Drive for the east

Can Eastern Europe's force in manufacturing be sustained?

Production of passenger cars is currently growing faster in Central and Eastern Europe than in any other region of the world.

Western Europe will see its passenger car manufacturing output rise by a meagre 2 per cent between 2002 and 2012, while North America will fare much worse with a fall of almost 15 per cent, according to the Global Insight consultancy.

By contrast, Eastern Europe will register a production increase of 154 per cent in the same period.

However, only a relatively small part of that phenomenal growth can be attributed to rising indigenous demand. With the exception of Russia - which is fast-approaching annual car sales of two million units, rivalling the size of Europe's biggest markets - the rest of Eastern and Central Europe's car-production clusters are acting mainly as export hubs.

In particular, the Czech Republic and Slovakia have in recent years emerged as the recipients of significant foreign investment. European, Japanese and Korean car makers, together with many of their key suppliers, have opened factories in these two countries, with three-quarters of their output for export. According to consultants Ernst & Young, this picture clearly indicates that these companies are using the region predominantly as a low-cost manufacturing base close to Western Europe.

Apart from government incentives, one key reason for foreign car makers' investment in the Czech Republic is the country's long tradition of automotive engineering. Skoda, still the nation's bestselling car brand, built Central Europe's first car there in 1897.

Auto giant Volkswagen pioneered the era of foreign involvement in the Czech Republic in 1991 when Skoda officially became a subsidiary of the German group. More recently, in 2005, the TCPA consortium of Toyota, Peugeot and Citroën started assembling their own models at their new plant in Kolin near Prague. Collectively, they built almost 300,000 units in 2006, producing the Toyota Aigo, Peugeot 107 and Citroën C1.

Auto-dependent

Hyundai will be the next auto-maker to open a manufacturing facility in the country. It will be located near the city of Ostrava and reach full operational capacity in 2011. By then, the Czech Republic will have the capacity to produce over 1.2 million passenger cars per year.

However, an Ernst & Young report compiled at the end of last year, 'The Central and Eastern European Automotive Market', claims that a number of Czech politicians have started to ask whether the nation's high dependency on the automotive industry could eventually become a risk. They have a point: over 16 per cent of the country's GDP and as much as 19.7 per cent of its exports in 2005 came from the auto industry.

"Such concerns are already starting to impact incentive packages offered to suppliers that want to follow Hyundai," the report says.

For the time being, though, the strategy of using Central and Eastern Europe as a low-cost manufacturing and export hub remains firmly in place.

Apart from the Western European car makers mentioned as operating in the Czech Republic, plants owned by Suzuki in Hungary, Fiat in Poland and Turkey, and Renault in Russia, Slovenia and Turkey, are all set to produce significantly more vehicles in the region than the region will demand from them during 2008.

US group Ford, which last year assembled 170,000 cars in Russia and Turkey, recently acquired a former Daewoo factory in Craiova, Romania, where it will invest $2.6bn over the next five years to increase annual production to 300,000 units in the region. The plant's output is expected to include a new small car targeted at the European market, a sector which Ford currently addresses with its Fiesta model.

There are a number of manufacturing sectors that would struggle to achieve growth in Europe without the healthy margins they are expected to achieve in Central and Eastern Europe.

This is particularly evident in areas where infrastructure is involved. Demand for electricity, for example, is surging in all EU accession states, where the need to upgrade dilapidated power generation plants is opening a significant market for equipment vendors in this sector.

An outdated power station isn't just a problem because of its inefficient operation at a time of spiralling energy prices; once a country becomes an official member of the EU, strict regulations on carbon emissions kick in, forcing local utilities to invest in more efficient power-generation technologies.

Apart from manufacturers of gas and steam turbines, automation and control equipment makers are also set to cash in from this trend. "Central and Eastern Europe offers some great revenue possibilities for air pollution control equipment manufacturers," says Jonathan Robinson, an analyst with Frost & Sullivan Energy and Power. "After relatively patchy growth and insubstantial revenues in the 1990s, European expansion, economic growth and power sector reform have really driven this market forward, providing good opportunities in most states in the region."
The sealant products sector will also see a compound annual revenue growth rate of 8 per cent until 2013 in Eastern Europe, says Frost & Sullivan.

The main end-user segments for flexible sealants vary depending on individual countries. In Russia, for example, the fastest-expanding application sector is construction, while in the Czech Republic and some neighbouring countries automotive applications dominate.

Opportunities have also opened up for manufacturers of uninterruptible power supply equipment. The dangerous combination of robust economic growth and unreliable power grids has led thousands of financial institutions, hospitals, manufacturing facilities and corporate offices to turn to back-up power and power protection systems to guarantee continuous and safe operation of key assets such as electronic equipment.

These electronic assets are increasingly coming not from China, as one might expect, but from within the region itself. Figures from Frost & Sullivan suggest that electronics manufacturing services will grow in Eastern Europe from $9bn in 2006 to around $24bn in 2013.

"The need to maintain profit margins in the face of declining pricing trends and high competition has made low-cost manufacturing a necessity," says Frost & Sullivan analyst Santosh Kumar. "This is encouraging the continuing migration of manufacturing processes in the electronics industry to low-cost Asian countries and, lately, to Eastern Europe."

Mobile phone makers are also turning to Eastern Europe. In February this year Nokia, the world's largest handset maker, opened a new plant in Romania, the company's 11th around the world.

It cost €60m to build and employs 500 workers. It joins another factory Nokia was already operating in Central and Eastern Europe, located in Komarom, Hungary. Between them and Nokia's two other European facilities in Finland and Germany, the phone maker will increase its production capacity targeted at supplying Europe, the Middle East and Africa.

Eastern Europe's mobile communications market, which in 2006 had a penetration rate of just under 88 per cent, is expected to reach 100 per cent penetration before 2011, according to Frost & Sullivan estimates.

The first country to surpass 100 per cent penetration (more than one mobile phone per person) was the Czech Republic, in September 2004. In the Czech Republic, Romania, Poland and Bulgaria, the percentage of mobile data revenues compared to traditional voice revenues is fast catching up with the same levels enjoyed by Western European operators.

Achilles heel

However, the labour force, that most vital of manufacturing resources that has helped attract billions of dollars of foreign investment into Central and Eastern Europe, could be on the verge of becoming the region's Achilles heel.

While the workers are still highly skilled - a key factor in attracting foreign manufacturing firms - wage costs are rising and the labour force is shrinking, as hundreds of thousands of unemployed and low-earning skilled workers have emigrated to richer nations in Western Europe in search of better living standards.

The shortage is becoming particularly acute in those markets where large automotive clusters have been established, such as the Czech Republic and Slovakia, prompting car makers and their suppliers to compete between them for trained local workers.

And, when local workers just aren't there to be found, companies are being forced to recruit them from other areas of the country, from neighbouring countries, or even from different continents. Poland, for example, has issued special work permits for citizens of Ukraine, Belarus, Uzbekistan and Tajikistan, while young qualified Chinese and Indian employees have been approached to help ease skills deficits in its electronics and construction industries.

It is a delicate situation, and one that threatens to put a brake on the vital flow of fresh foreign investment. As Ernst & Young points out in its recent report on the region's automotive market, since 2005, when Hyundai announced plans to open a factory in the Czech Republic, "no further decision by a vehicle manufacturer has been made to build a production plant in the Central and Eastern European region - except for Russia".

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