CEE proceed with caution
A low-cost labour market on Europe’s doorstep, with 100 million consumers rapidly becoming wealthier and demanding higher-quality products, Central and
Eastern Europe holds promise both as a manufacturing base and as a market.
Rapid growth in gross domestic product is the single biggest driver of food and drink company interest in the central European region, both as a growing consumer market and as a source of lower production costs.
While personal incomes are markedly less than elsewhere in the EU, inhabitants of the newly acceded Central European EU states spend a much higher proportion – approximately one-third – of their income on food, with increasing demand for innovation and higher-quality products. This clearly marks them out as an attractive potential growth driver for food and drink producers.
Central Europe, however, is no instant goldmine. While the new EU economies of Poland, the Czech Republic, Hungary, Slovakia, Estonia, Latvia and Slovenia are all growing at a significantly faster rate than the EU average (see Table 1, page 23), it would still take the biggest of these, Poland, at least 25 years to catch up with EU per capita GDP. Average per capita GDP across all of the new member countries is $13,600 – around half of the comparable number in ‘old’ EU member states.
Labour for less
From a manufacturer’s perspective, lower personal incomes mean lower labour costs. According to online publisher MeatProcess.com, manufacturing wages averaged €618 per month in the accession states last year, compared to €3,385 within established EU states. Central European countries also tend towards longer working weeks, with a
higher proportion of wages linked directly to productivity.
From a production perspective, supply chain features within some markets are more attractive than others. Slovakian agriculture, for example, is dominated by large farms, making it easier to manage the supply of raw materials. This contrasts strongly with Poland, where farming is still highly fragmented.
Location, location, location
Selectivity is, therefore, the key word for producers considering a sustainable expansion strategy in the Central European region. “There is no doubt that the region represents a first-class opportunity for European food and drink producers, but for successful strategies, the devil will be in the detail, in terms of location, product, distribution and timing,” says Keith Ellis, head of food and drink at 3i.
What Alan MacKay, managing director, European buyouts, at 3i, calls “near-shoring” is one approach to supporting sustainability. Much of Central Europe borders on Western Europe, so production facilities in the four main economies – the Czech Republic, Poland, Hungary and Slovakia – can be used to produce goods for both markets.
Near-shoring could involve manufacturing of production machinery that might otherwise be sourced in Asia, or using the location advantages of Central Europe to service the wealthy 100km border strip, which includes large parts of Germany and Austria, with perishable goods.
A new phase of M&A
In terms of M&A activity, Central European food and drink companies are now entering what could be described as phase two of their post-communist development. Phase one was the mass privatisation drive that followed the collapse of the Berlin Wall and the subsequent acquisition of many privatised companies by Western multinationals.
Phase two is being driven by EU accession, the consequent reduction in risk (including, within a few years, foreign currency risk), and the opportunities offered by a market of more than 100 million people. Additionally, some of the nondomestic companies that bought whole privatised businesses in the early 1990s are now selling non-core subsidiaries.
In some sub-sectors of the industry – brewing in Poland, for example – there is little room left for further consolidation, with 90% of capacity owned by Carlsberg, Heineken and SAB Miller. In other markets, such as food retail, M&A activity is likely as local players and international groups compete for market share.
According to PricewaterhouseCoopers, food and drink was the second most active sector in terms of Czech M&A activity in 2004, with 17 transactions. Michal Wrzesinski of Rabobank in Warsaw points out that Polish M&A activity is picking up on the back of the accession story, with “quite a few newcomers, as well as companies strengthening their existing positions.”
Regional expansion
Not all of these companies are foreign. Wrzesinski cites Maspex, a highly efficient Polish domestic operator that now controls 40% of the local juice market and has interests in dried goods such as instant tea and pasta. Maspex’s annual sales revenues are in the region of €600m, and the company is expanding into other countries in the region, including the Czech Republic and Hungary.
One of Maspex’s key competitive advantages is a deep understanding of Poland’s local retail market, which accounts for as much as 70% of sales. In other Central European countries, supermarket-dominated distribution accounts for the bulk of sales: 70% in both Hungary and the Czech Republic.
According to 3i’s Olivier Le Gall, the number-one private equity opportunity in the region lies in supporting Western companies entering the market. For most of these, ‘follow the retailer’ is an optimum strategy. Aside from generating distribution efficiencies, this tactic can help to cement relationships between food manufacturers and the retail sector. “Retailers value the fact that manufacturers support them. This helps to re-balance the relationship between retailers and suppliers,” explains Le Gall.
Cautious optimism is the key to identifying and acting upon opportunities in the region. “The biggest challenge is sorting out the supply chain,” says Ellis. “A lot of producers are operating within closed shop co-operative structures, selling into retail co-operatives. More opportunities will emerge when these economies move further towards a more conventional business model. You have to be very selective, factor in the pace of change and recognise the co-op legacy. But against that, you also need to bear in mind the very rapid increase in incomes.”
A vision of the future
Dr Patrick Dixon, one of Europe’s leading futurists and business thinkers, is optimistic about the potential for food and drink companies in Central and Eastern Europe. But, he cautions that companies need to be aware of the long-term economic, social and political drivers affecting markets. Take the integration of the EU accession countries into the West. “The scale of the reconstruction effort to de-communise Central Europe is almost beyond comprehension and has been greatly underestimated,” he says. “Just look at how long it has taken Germany to begin to equalise lifestyles and opportunities following reunification.”
It is a common mistake to group the countries of the Central and Eastern European region together. Each is radically different – and any food and drink company wanting to succeed needs to fully understand the dynamics of each market and get under its skin. “Get out of the Hilton Hotel,” advises Dixon. “Find out where most people in the region stay when they travel. Go to a café and watch local people, see the reality of how ordinary people live.”
The real opportunity
But while the scale of the challenge is huge, so is the opportunity. Much of the region is still virgin territory for large food and drink companies. Economic growth rates are double the EU average (see Table 1, below) and there are opportunities for consolidation, economies of scale and sourcing of low-cost food products for local and Western markets.
“If you get it right, you could become the biggest retailer in a country like Poland, or the Ukraine, with maybe a 20% market share,” says Dixon. “The real pot of gold is there for those who can get inside the country and become part of it, rather than having a couple of token stores in the capital city. For food and drink companies, we are talking about building a dominant share of the wallet of every family in a rapidly developing country.”