Is Eastern Europe the new China?
Countries in the former Soviet bloc are fast gaining ground as sourcing destinations for procurement professionals in Western Europe, according to many commentators.
Once upon a time not so long ago, China was flavour of the month as a fantastic source of cheap goods and services. India, in particular, was the place to go for low-cost IT and other services. China – and India – were seen as the best bets for bargain basement sourcing. The novelty, though, seems to be wearing off.
Increasingly, the advantage of low costs is being set alongside other factors, and deals available now seem less attractive. Instead, many procurement leaders are thinking that they should be looking to Eastern Europe as the sourcing destination of choice.
Sven Marlinghaus of Germany-based consultants, BrainNet, deals with many high-profile clients who source from countries in the former Eastern bloc. Interest in the region is growing, he says, as China’s sparkle fades. “It’s increasing this year and we’re pretty sure trading volumes will increase between at least 15 per cent and 20 per cent in the next five years,” he says. “All our clients are asking us to look at sourcing from Eastern Europe. They’re saying China is not everything. There’s a sourcing market right next door which we want to explore before going further afield. Now that the hype has died down, people are saying that not everything is better in China.”
The consensus appears to be that China will continue to be good value for some simple, high volume items and that India will remain a good source of some services, particularly IT, but that Eastern European countries have advantages in other categories. For low-volume goods – large machine parts, for example – the costs of setting up production in the Far East are almost certainly not economically viable. If you are making several thousand pieces it could make sense to go to China, but otherwise there may be better deals available in, for example, Poland, Romania or the Czech Republic.
Crucially, the risks of losing intellectual property in China, particularly, are still very high. According to Marlinghaus, this remains a very serious issue: if you go to China, it is very likely your goods will be copied by producers with no real notion of copyright.
“It’s a very serious issue in all industries where you have patents and complex intellectual property,” he says. “There are no laws in place and you don’t have any rights. They only let you in if you share your IP. Things might get a little bit better – the Chinese people are not stupid and they know if they don’t improve, people won’t invest there – but they want to become the leaders and they will do anything to get the IP they need.”
Similar problems may arise in Eastern Europe, Marlinghaus says, but it’s much less likely. And with several Eastern European countries now members of the EU, there are legal safeguards. A related problem is that for many well known Western European companies, consumers may take exception if they believe components are being sourced elsewhere at low cost. A consumer might be happy to pay two or three times more for a refrigerator or dishwasher with a high-value European brand name on it rather than one made in the Far East. But if they realise most of its components, or even the whole unit, is sourced from China, it may lose its appeal.
Eastern Europe – the players
Hungary
High growth rates especially in electronics, automotive and steel. High education levels are spurring research and development in, for example, ambient intelligence. German and English widely spoken.
Czech Republic
The most popular location in Eastern Europe for offshoring. Production of cars and automotive components account for a fifth of industry and are gaining ground, but focus of new investments is shifting from production activities to services.
Poland
Major investors are Japanese companies, mainly from the electronics or automotive industries. So-called business process outsourcing centres are gaining importance. Growing industries are renewable energies, environmental projects, logistics and services.
Slovakia
Manufacturing is growing fast, particularly machining, building, automotive, electronic, plastic and construction materials. Slovakia offers low taxes, relatively low wages and high productivity.
Slovenia
Wages in Slovenia are relatively high but so is productivity. Infrastructure and language skills are very good. Slovenia has low corruption. Industry is growing rapidly especially in machine building, chemicals and electronics.
Bulgaria
Very low relative wage levels coupled with high growth rates. Many companies have announced modernisation and expansion investments. In 2007, investors were especially interested in the energy and water supply and distribution.
Croatia
Leading industries including metals are attempting to improve competitiveness. Corruption remains a problem.
Baltic States
Language skills are good, especially English and Russian. Important industries include metal and machine building industry, telecommunications and IT software and services. All Baltic states have high growth rates.
Romania
High growth rates. Main industries include automotive, chemicals, machining and electronics. The IT sector is growing fast.
In terms of the logistics, the countries of Eastern Europe may be a much stronger option than China or India, simply because they are much closer. “You don’t want millions of dollars floating for six weeks on the ocean when you can receive them from an EU-member country in Eastern Europe in just two or three days,” one procurement expert said.
Sourcing from China or India is, it seems, really only about low labour costs. If the procurement professional is looking for more than cheap labour, Eastern Europe has significant advantages.
India remains a useful source of some services – its people are better educated than in, for example, the Czech Republic. But ironically, India’s success is in some ways its undoing – the very attractive rewards on offer has brought with it problems of loyalty, as skilled young people feel able to take advantage of a new-found mobility in the labour market.
Sridhar Vedala, director of global sourcing at EquaTerra, believes the advantages of sourcing from Eastern Europe have been exaggerated. In the fields of IT and BPO in which he mainly deals, China, and particularly India, remain extremely strong – and are getting stronger, he says. Business between Western European companies and these two countries has grown substantially in the last year, he adds, and shows no signs of weakening.
Many European companies, he says, are sourcing from the countries of the old Eastern bloc, but on a much smaller scale compared to trade with India and China. The reasons for this are clear. First, the cost benefits of Eastern Europe are much less impressive than those obtainable in the East. Typically, Sridhar says, India and China offer prices 85 per cent lower than those available in home countries, compared with only 50 per cent in Eastern Europe.
The advantage is diminishing, he acknowledges, but only by about one or two per cent annually, while for Eastern Europe the savings margin is shrinking much more rapidly. This is mainly because several of the countries involved – Poland, Romania and Bulgaria, for example – are recent members of the EU. While this brings some administrative advantages, it has also had an impact on labour costs which are rising to meet those of their EU partners. And, at the same time, the availability of skilled labour is in increasingly short supply as good quality personnel take advantage of their new mobility and leave their home countries for more lucrative pickings in Germany, the UK or other EU countries. Deals with India, says Sridhar, are getting bigger, often amounting to $250 million or more, while those with Eastern European suppliers usually remain below that range.
They tend to be small-scale operations involving perhaps 30 or 40 people. Secondly, according to Vedala, the higher education systems of India and China are huge powerhouses of highly-skilled talent compared to the relatively modest outputs achieved by Eastern European institutions. China is turning out something like three or four million graduates every year, and India is producing about 1.5 million, compared to about 50,000 each in most Eastern European countries. This means, of course, that skilled labour is not only more easily available, if necessary, at short notice, but that its sheer abundance means it will continue to be relatively much cheaper.
Finally, the availability of labour not only with the marketable skills but with some experience is limited in Eastern Europe, as a product of the fact that most of these countries are fairly new to the outsourcing business compared to their oriental counterparts.
“It’s not hard to find an experienced workforce when setting up a business in India,” says Vedala. “But in Eastern Europe it is much more difficult. They just don’t have the resources. Eastern Europe is a useful hub but doesn’t really compare with India and China as a sourcing destination. “Someone who is looking for language skills and proximity might use an Eastern European supplier, but they would be much less likely to use it for large-scale deals where you don’t want to take a lot of risks. China, and especially India, are still excellent sources of services at a much lower price, and will continue to be so. There is no chance of them being eclipsed in the foreseeable future.”
Malgorzata Sculz, Accenture manager in Warsaw, says China and India remain very attractive sourcing destinations for many commodities such as electronics and engineering parts. But they are not as attractive as they were just a couple of years ago. “Companies are no longer focused just on cost,” she says. “China offers very attractive prices and a very large pool of suppliers. India has started to become attractive to the automotive industry. But the thinking in Western European and global companies has changed. They have started to think not just about cost advantage but also about time to market, innovation and quality.
“Chinese companies, in particular, are no longer perceived by many multinational and Western companies as offering the complete solution as they might have been not long ago. “The reason for the change of heart is fairly simple: most Western companies have started to deal with Eastern countries in the past ten years – and especially in the last five years when interest in low-cost country sourcing has really become the hot topic in procurement circles and found it to be a positive experience.
Eastern and Central Europe, in comparison, are becoming more attractive, because of the relative proximity, high standards of technical training, greater cultural affinity and, especially in the case of those countries that are now members of the EU, the relative lack of business and legal barriers to doing business.
China and India, says Sculz, while still excellent sourcing destinations for some commodities, are no longer seen as the procurement Eldorado they once were. “Conditions have not really changed, but companies have gained much wider knowledge of these countries,” Sculz says. “Ten years ago not many companies were working with Asian suppliers, but now most global multinationals have at least some experience of sourcing from Asia and, particularly, China. “They’ve learned from their own experience and they’re stepping back. They know there are much bigger factors to take into consideration, not just fantastic prices.”
- Source: European Leaders in Procurement, Thursday January 31 2008