Challenges for Entering Eastern European Markets
Given that countries in the CEE region are all moving at their own pace in developing new markets, trading across the region is a complex activity and requires a deep knowledge of the local markets.
—Claudio Capozzi
Overview
As the developed Western economies still try to recover fully from the global financial crisis, Eastern Europe, a part of the world often neglected by investors and business leaders, has been showing impressive growth and maturity, both economically and politically. Stock markets in Bulgaria and Romania, for example, have appreciated significantly over the past year, and improving infrastructure coupled with still relatively cheap labor provide an attractive environment for investments in the manufacturing and service sectors.
Recent political unrest in some countries of the region, however, threatens to stymie the economic progress and has reminded investors of the inherent risk that such high-return opportunities tend to carry, along with other factors discussed in this chapter, which should be seriously considered.
Even when bound by the ideology and strong embrace of the Soviet Union, eastern European countries differ widely, both economically and culturally. Additionally, as discussed throughout this book, the former USSR’s varying levels of economic commitment to each country, mostly born out of different strategic priorities, led to uneven infrastructure investments and industrial development. Even today, this developmental disparity is still evident.
Another important factor is the historical and cultural perspective that each country and its people possess. An investor would be well advised to seek trusted, and if possible local, advisers with a keen understanding of each country’s culture and history. Failure to grasp local customs can be a pitfall when investing in any part of the world, but one would be hard pressed to find a place where such knowledge is more important than Eastern Europe.
On the political side, newly elevated activists supported by democracyhungry populations, along with some freshly repainted old-regime politicians, dominated the initial scrambles for power in these countries. After the early victories by the new but inexperienced leaders, however, the former communist figures, well groomed for political survival through the decades, have emerged as major players in many of these countries.
In addition, despite their relative stability and impressive growth, the global financial crisis that started in 2007 continues to ripple through these countries, and their ongoing struggle to adapt to new ways of doing business still bears watching, as does the potential for renewed political turmoil. In our experience teaching this topic, consulting for several multinational corporations (MNCs) around the world, and being a practitioner ourselves, we find that eastern European markets are not easy to enter, despite the many government incentives already discussed throughout this book. Hence, entering these markets can be a complex endeavor, but the rewards can be immense as well.
In some countries, government interference, backward infrastructure, political instability, work-skill mismatch, and even lack of skilled workers, require a lot of patience, perseverance, and specialized assistance. Opportunities in eastern European markets, therefore, come with their own set of challenges.
Emerging economies, in particular these eastern European transition economies, have also experienced large-scale structural change, in their case from the agricultural to the industrial sector. They are also often characterized by strong growth of the public sector, leading to a high share of employment in public activities often under the clientelistic control of ruling parties; a strong growth of informal sector; and a rapid demographic transition leading to a rapidly expanding and youthful population.
The modern urban sector employs relatively skilled labor, which attracts rural migrants with inadequate skills in search of higher wages, which leads to an oversupply of unskilled workers. The demographic transition leads to large numbers of young educated people in the labor market and high youth unemployment and consequently results in an oversupply of people with secondary education and skills. In addition, emigration of skilled workers (also known as brain drain) reduces the supply of skilled workers in the domestic economy, which typically also leads to shortages of highly skilled people.
The role of the state in these economies can be an important determinant of appropriate matching of skills supply and demand. Take South Korea, Singapore, and Taiwan, for example, which joined up policy making enabled developmental states to anticipate future skills needs since the state was also involved in the very industrial policies, which generated the demand for skilled labor.1
Yet, although the integration of economic and skill formation policies in South Korea and Taiwan through modified forms of state planning was initially relatively successful, the power of the state to compel employers to train their workers gradually waned.2 The state-directed policy eventually came under pressure to reform although the state retains a role in steering these economies. Kuruvilla et al.3 argued that Singapore’s successful national skills development model has the potential to move constantly toward higher skills equilibrium, but they question the long-term sustainability of the model and whether it is transferable to other developing countries. Recent research by Özsagir et al.4 has shown a positive relationship between the extent of vocational training and the index of industrial production.
Skill Mismatches
Skill mismatches and skill shortages have become a priority concern for policymakers in many countries, especially since the onset of the global economic crisis and its intensification through the crisis in the eurozone. Endogenous growth models emphasize that human capital is a key resource for growth.5 In fact, skill mismatch has an adverse effect on the efficiency of labor markets, particularly in transition economies, raising unemployment above the levels that could potentially be achieved given the level of aggregate demand. Efficient matching would reduce frictional and structural unemployment and ensure that vacancies are matched to workers with appropriate qualifications and skills.6
For instance, often the lack of specialized education of the workforce tends to translate into thwarted growth being curbed by the lack of a skilled workforce. According to models of endogenous growth,7 the skill levels of the workforce, particularly in transition economies, are an important driver of economic development. This is partly due to different patterns of structural change and partly associated with demographic factors. Countries with high population growth rates may experience oversupply of educated school-leavers; countries with falling populations may experience undersupply of both skilled and unskilled workers. There is also evidence of gender-bias mismatch in these markets. Among the main challenges to the development of effective skill-matching systems and its corresponding policy design in transition countries are the weak capabilities of government institutions including the employment services, underfunding of state-provided training services, slow reforms of the education systems, and low level of in-house training by employers.8
Most eastern European countries have experienced volatile labor markets for many years. Although unemployment rates were on a falling trend till 2008, long-term unemployment has been persistently high in many countries, as shown in Table 5.1, leading to a corresponding obsolescence of skills among a large section of the workforce. After almost a decade of sustained economic growth, the global economic crisis brought about an abrupt reversal of fortunes and began to increase in most countries of the region.9 Long-term unemployment in the region is a serious problem, especially affecting older workers with obsolete skills. Youth unemployment is generally high,10 particularly in countries with a rapidly growing population. On the demand side of the labor market, many old largescale industries declined or closed down, while most new jobs emerged in the service industries among which a range of new skills are needed.11 Regional mismatch also emerged as a specific problem due to the collapse of industries in peripheral areas and mono-industrial towns.12
Table 5.1 Unemployment rates for eastern European countries
Country |
Unemployment rate |
Last updated |
Previous % |
Highest % |
Lowest % |
Albania |
17.5 |
Sep, 2015 |
17.3 |
22.3 |
12.1 |
Bosnia and Herzegovina |
42.81 |
Oct, 2015 |
42.97 |
46.1 |
39.03 |
Bulgaria |
9.9 |
Nov, 2015 |
9.5 |
19.27 |
4.68 |
Croatia |
17.7 |
Nov, 2015 |
17.2 |
23.6 |
12.2 |
Czech Republic |
5.9 |
Nov, 2015 |
5.9 |
9.69 |
0.09 |
Estonia |
5.2 |
Sep, 2015 |
6.5 |
20.1 |
0.5 |
hungary |
6.2 |
Nov, 2015 |
6.4 |
11.8 |
5.5 |
Kosovo |
35.3 |
Dec, 2014 |
30 |
57 |
30 |
Latvia |
9.7 |
Sep, 2015 |
9.8 |
20.7 |
5.4 |
Lithuania |
8.4 |
Nov, 2015 |
8.3 |
15.3 |
2.7 |
Macedonia |
25.48 |
Sep, 2015 |
26.84 |
37.3 |
25.48 |
Montenegro |
16.35 |
Nov, 2015 |
15.67 |
31 |
10.2 |
Poland |
9.6 |
Nov, 2015 |
9.6 |
20.7 |
0.3 |
Romania |
6.7 |
Nov, 2015 |
6.8 |
8.1 |
5.4 |
Serbia |
17.3 |
Sep, 2015 |
17.9 |
25.5 |
13.3 |
Slovakia |
10.8 |
Nov, 2015 |
11 |
19.79 |
7.36 |
Slovenia |
11.7 |
Oct, 2015 |
11.5 |
15.5 |
6.3 |
Source: tradingeconomics.com
Education System
Education systems in many transition countries are still characterized by poor quality and irrelevance of much education provision in the region.13 It is increasingly been recognized that curricula inherited from the previous communist system were unsuited to the development of a service-oriented post-Fordist14 market economy and have not been upgraded sufficiently to reflect the new occupations that have emerged in the service sectors and in high technology industries. Skills that are taught in vocational education institutions tend to be too specialized in obsolete occupations. Education methods often outdated and dependent on rote learning, based on memorization techniques and repetition rather than problem solving. There is generally a deficit of education in transferable skills (so-called “soft skills”).
Skills produced by the education system are often no longer demanded in the labor market. A recent study of the development of skills mismatches in Eastern Europe found that
even when people hold the correct qualification for an occupation they may not necessarily have the skills needed to effectively perform the job and satisfy employer expectations. Rapid technological and economic change makes difficult to predict what types of skills will be needed in the near and more distant future and what kinds of new jobs will appear.15
Moreover, because of structural change, it seems that skill mismatch is a more permanent phenomenon in eastern European markets than in the advanced economies resulting in high levels of long-term unemployment, and that skills mismatch increases with the age of workers, rather than falling as it does in the developed economies.
Economic Restructuring
Skill shortages and surpluses of various types are challenges for eastern European countries as a consequence of economic restructuring. The process of economic transition involved a simultaneous process of job destruction and job creation in which unskilled workers lost employment disproportionately as the skill content of blue-collar work increased due to technological change.16 Newly created jobs typically require different types of skills to those that have been destroyed. This process of restructuring and the expansion of demand for new skills have often taken place more rapidly than the education and the training system has been adept at leading these skill shortages.17 Figure 5.1 provides a sample of a handful of eastern Europeans countries, depicting the proportion of business organizations reporting that an inadequately educated workforce is a major or very severe obstacle to the firm, in percentage points.
Figure 5.1 Proportion of firms reporting that an inadequately educated workforce is a “major or very severe” obstacle to the firm (%)
Source: BEEPS Survey 2010, European Bank for Reconstruction and Development (EBRD).
Legal Framework and Trading Policies
Other challenges that arise are legal frameworks with regard to trade policies, which may be absent or underdeveloped, or tendencies for political paternalism or blatant interferences, especially in those countries that have not yet joined the European Union (EU), such as Albania, Armenia, Belarus, Bosnia and Herzegovina, Kosovo, and Macedonia, to name a few.
All EU countries, for example, do not recognize Kosovo’s independence, although a surprise Serbia-Kosovo deal, brokered by EU High Representative Catherine Ashton in 2013, paves the way for its eventual EU membership. The other Western Balkan countries have all been told that they can one day follow Croatia into the EU, as long as they make progress on democratic and economic reforms. Moving closer toward the EU implies meeting the criteria and conditions for each stage. These relate to the Copenhagen membership criteria18 and the stabilization and association process,19 including on regional cooperation, good neighborly relations, and full cooperation with the International Criminal Tribunal for the former Yugoslavia (ICTY).20 The Western Balkan countries need to effectively address the priorities set out in their accession or European partnerships. The pace of each country’s progress is determined by its own achievements in this respect.
As for most industrialized countries, trade volumes increased significantly in the period after World War II, trade has been identified as one potential culprit for the worsened position of low-skilled workers.21 Trade is thought to have affected the demand for low-skilled workers in two ways. It is thought to have reduced the relative demand for low-skilled labor and to have made the demand more responsive to changes in the price of low-skilled labor. Both effects would reduce the relative wages of low-skilled workers in economies with flexible labor markets. In economies where labor market rigidities prevent wages from falling, an increased relative unemployment rate of low-skilled labor may result. Country-specific labor-market characteristics would thus have an important effect on whether and to which extent relative wages or trade or both affect the relative unemployment rates.
With strong increases in skill inequalities over the 80s and part of the 90s and continuing integration of economies around the world, trading in emerging markets, particularly in eastern Europe, where some markets are very well developed and worker’s skills are high, versus other markets in the region lacking both. We’d argue that there is potentially negative effect of trade with developing countries in Eastern Europe on low-skilled workers in industrialized countries.22
Public administration in eastern European economies has much to be desired, although overall it ranks much better than Brazil, Russia, India, China, and South Africa (BRICS) and other leading emerging market blocs. The Doing Business 201523 study by the World Bank, which ranks economies on their ease of doing business on a scale of 1 to 189, where a high ease of doing business ranking means the regulatory environment is more conducive to the starting and operation of a local firm.24 As depicted in Table 5.2, the study ranks Macedonia 12th, Lithuania 20th, and Latvia 22nd as the easiest countries of doing business in Europe and central Asia, out of 189 countries, while ranking Kosovo 66th, Bosnia and Herzegovina 79th, and Albania 97th. The discrepancy between the first three and the last ones are remarkable. By comparison, the study ranks Brazil 116th, Russia 51st, India 130th, China 84th, and South Africa 73rd, respectively, out of 189 countries.
Table 5.2 Ascending list of most ease of doing business countries in Europe and central Asia
Economy |
Ease of doing business rank |
Macedonia, FYR |
12 |
Lithuania |
20 |
Latvia |
22 |
Georgia |
24 |
Armenia |
35 |
Romania |
37 |
Bulgaria |
38 |
Croatia |
40 |
Kazakhstan |
41 |
Belarus |
44 |
Montenegro |
46 |
Cyprus |
47 |
Russian Federation |
51 |
Moldova |
52 |
Turkey |
55 |
Serbia |
59 |
Azerbaijan |
63 |
Kosovo |
66 |
Kyrgyz Republic |
67 |
Bosnia and Herzegovina |
79 |
Ukraine |
83 |
Uzbekistan |
87 |
Albania |
97 |
Tajikistan |
132 |
Source: World Bank (2015).
Does all this mean that foreign investors should avoid trading with or investing in eastern European markets? On the contrary, however, any organized program of opening up to eastern European markets must include specialized expertise, on-the-ground knowledge, local partnerships, and, most of all, patience.
Why Multinationals Fail in Eastern European Markets
Pacek and Thorniley25 identified an exhaustive range of factors contributing to the failure of companies from advanced economies into eastern European markets. These factors may be divided into external and internal factors and almost all are related to strategic and leadership issues.
Leaders fail to consider eastern European markets as an integral part of strategy and acknowledge that such markets need to be approached with a distinct set of criteria for judging progress and success.
Top leaders fail to commit sufficient resources to get businesses established and growing in eastern European markets, or acknowledge that it is never a short-term affair.
MNCs fail to appoint a head manager for eastern European markets and often assign this responsibility to an international manager who is responsible for markets in both advanced and emerging markets. The problem with this is that operational approaches are distinct in each of these markets, as evidenced in Table 5.3.
MNCs fail to understand that business is driven by heads of regions and business units rather than by heads of functional areas. While the former has a focus and appreciation for the eastern Europe economies, the latter tends also to be interested in advanced markets.
MNCs do not acknowledge that eastern European markets operate under distinct business models and structures, and often merely transfer practices tested in advanced economies without considering adaptation.
The board members of many MNCs have limited diversity in terms of culture and ethnic background and do not develop sufficient appreciation for the peculiarities of the eastern European markets.
MNCs underestimate the potential and often early competition from smaller international and domestic companies, thus never accepting that they may be destined as a follower in eastern European markets.
Economic and political crises also exist in eastern European markets, as discussed earlier, and have a significant impact on business performance. Top managers need to understand this, be prepared to adapt and introduce new tactics rather than changing strategy, which despite having short-term success, tends to be the wrong approach in long term.
MNCs get alarmed by short-term slippages and cut costs to attain favorable temporary results, yet this is likely to have a structural impact on strategy implementation and long-term results.
MNCs set unrealistic targets to achieve, which leave managers with limited maneuvering space and short-lived careers.
MNCs fail to recognize that entering the market early is fundamental in establishing networks, developing brands, and learning the larger context from which it will operate.
Senior leaders fail to recognize that developing a network of reliable contacts often requires establishing friendships with locals, which requires time and visibility in eastern European markets.
MNCs fail to empower regional and country managers and delegate decision-making power to local managers.
Foreign companies fail to recognize that eastern European markets are more price-sensitive and often stick to their pricing structures instead of adapting to local sensitivities.
International firms fail to recognize that their product portfolio is not tailored to the lower and middle segments of emergent markets and do not develop innovations that are context oriented.
Foreign companies underestimate the competition from local companies in emergent markets, which gradually move up from lower to upper segments. Local companies understand better than anyone about local markets, sometimes employ dubious practices, and often have the support of local governments.
One of the largest obstacles that foreign companies face may be the unwillingness to change long-standing business practices.
Another challenge is to appoint senior managers who are not familiar with the local market, culture, and language in emerging countries.
The fact that demand is volatile and unpredictable in emerging and frontier markets may discourage multinationals, which often expect reliable market information.
The failure factors are numerous and diverse but as Pacek and Thorniley noted, it all boils down to a lack of adequate market entry preparation. Preparation requires companies to continuously research the external environment and know how to use internal resources to take advantage of opportunities. Hence, a preliminary audit that focuses on external and internal factors is essential. The external factors may be examined by posing questions concerning the market, the political environment, the economic environment, and the business environment, as depicted in Table 5.3.
Table 5.3 External factors and sample questions
Understanding the market |
|
Market potential |
|
Understanding local consumers or customers |
|
Reaching the consumer or customer |
|
Competition |
|
Lessons learned by noncompetitors |
|
Local culture |
|
Understanding the political and economic environment |
|
Economic outlook |
|
Political outlook |
|
Government policies |
|
Understanding the business environment |
|
Finance |
|
Labor market |
|
Taxation |
|
Legal environment |
|
Bureaucratic obstacles to business |
|
Crime and corruption |
|
Infrastructure |
|
Foreign trade environment |
|
Cost of building a business and brand |
|
Table 5.4 Internal factors and sample questions
Resources |
|
Products |
|
Organization |
|
Risks |
|
By the same token, the internal factors must inquire about resources, products, organization, and risks, as depicted in Table 5.4.
Having done a preliminary external and internal audit, managers need to prepare a business proposal describing what to do, how to do it, by when, and resources required. Businesses must then ask themselves whether there are similar or better opportunities available in other eastern European markets. How then, can we compare the potential of different eastern European markets?
Ranking Eastern European Markets
According to the GlobalEdge26 team at the International Business Center (IBC) at The Eli Broad Graduate School of Management, Michigan State University, in the state of Michigan, United States, there are three main reasons why eastern European markets are attractive. They are target markets, manufacturing bases, and sourcing destinations.
As manufacturing bases, they present advantages such as low wages, high-quality labor for manufacturing and assembly operations. Slovakia has been the world’s largest producer of cars per capita27 with currently three automobile assembly plants in the country, including Volkswagen’s in Bratislava, PSA Peugeot Citroën’s in Trnava, and Kia Motors’ Žilina Plant, and by 2018, Jaguar Land Rover is set to open the country’s fourth automobile assembly plant in Nitra.28 The Czech Republic’s long and rich scientific traditions, with research based on cooperation between universities, the Academy of Sciences of the Czech Republic and other specialized research centers often bring new inventions and contributions to market, including, but not limited to, the modern contact lens, the separation of modern blood types, and the production of Semtex plastic explosive. Several MNCs are already present in Lithuania, including PricewaterhouseCoopers, Ernst & Young, Societe Generale, UniCredit, Thermo Fisher Scientific, Phillip Morris, Kraft Foods, Mars, Marks & Spencer, GlaxoSmithKline, United Colors of Benetton, Deichmann, Statoil, Neste Oil, Lukoil, Tele2, Hesburger, and Modern Times Group.
From Indicators to Institutions
It is common wisdom that size and growth potential are the two best criteria to select an eastern European market. Not so for Khanna and Palepu29 who argue that the lack of institutions, such as distribution systems, credit cards systems, or data research firms, is the primary factor to consider when entering into an emerging market. The eastern European markets are no different. For them, the fact that eastern European markets have poor institutions, thus, inefficient business operations, present the best business opportunities for companies operating in such dynamic markets. However, the ways businesses enter into eastern European markets is different, and are contingent upon variations presented by the institutions and the abilities of the firms.
Khanna and Palepu point out that the use of composite indexes to assess the potential of emerging markets, as executives often do, has limited use in eastern European markets because these indicators do not capture the soft infrastructures and institutions. These composite indexes are useful in ranking market potential of countries when and only these countries have similar institutional environments. When soft infrastructures differ, we must then look at the institutional context in each market.
Best Opportunities Fill in Institutional Voids
From an institutional viewpoint, the market is a transactional place embedded in information and property rights, and eastern European markets are a place where one or both of these features are underdeveloped.30 Most definitions of eastern European markets are descriptive based on poverty and growth indicators, and their stage as a transition economy. In contrast, a structural definition as proposed by Khanna and Palepu points to issues that are problematic, therefore allowing an immediate identification of solutions. Moreover, a structural definition allows us not only to understand commonalities among eastern European markets but also to understand what differentiates each of these markets. Finally, a structural approach provides a more precise understanding of the market dynamics that genuinely differentiates eastern European markets from advanced economies.
To illustrate, let us contrast the equity capital markets of South Korea and Chile. According to the International Finance Corporation (IFC) definition, South Korea is not an emerging market because it is an Organization for Economic Co-operation and Development (OECD) member; however, when we look at its equity capital market, we notice that until recently it was not functioning well. In other words, it has an institutional void. Chile, on the other hand, is considered an emerging market in Latin America but it has an efficient capital market; thus no institutional void appears in this sector. However Chile has institutional voids in other markets such as the products market. Similar factors exist among eastern European countries that are already members of the EU versus those that are not.
Strategy formulation in eastern European markets, therefore, must begin with a map of institutional voids. What works in the headquarters of a multinational company does not per se work in new locations with different institutional environments. The most common mistake companies do when entering eastern European markets is to overestimate the importance of past experience. This common error reflects a recency bias: a person assumes that recent successful experiences may be transferred to other places. A manager may incorrectly assume that the way people are motivated in one country would be the same in the new country (context). It may be assumed that everyone likes to be appreciated, but the way of expressing appreciation depends on the institutional environment. Khanna and Palepu point out that the human element is the cornerstone of operating in new contexts. Ultimately, human beings, who provide a mix of history, culture, and interactions, create institutions.
In short, based on Khanna and Palepu’s institutional approach to eastern European markets, it is necessary to answer several questions, including but not limited to:
Which institutions are working and missing?
Which parts of our business model (in the home country) would be affected by these voids?
How can we build competitive advantage based on our ability to navigate institutional voids?
How can we profit from the structural reality of eastern European markets today by identifying opportunities to fill voids, serving as market intermediaries?
Strategies for Eastern European Markets
The work of Khanna and Palepu indicates that there are four generic strategic choices for companies operating in emerging markets, which also applies for eastern European markets:
Replicate or adapt?
Compete alone or collaborate?
Accept or attempt to change market context?
Enter, wait, or exit?
Eastern European markets attract two competing types of firms, the developed market-based multinationals and the emerging market-based companies. Both bring different advantages to fill institutional voids. MNCs bring brands, capital talent, and resources, such as the case of several ones based in Lithuania, whereas local companies contribute with local contacts and context knowledge. Because they have different strengths and resources, foreign and domestic firms will compete differently and must develop strategies accordingly. Table 5.5 summarizes the strategies and options for both MNCs and local companies.
Table 5.5 Responding to institutional voids
Strategic choice |
Options for MNCs from developed countries |
Options for eastern European market-based companies |
Replicate or adapt? |
|
|
Compete alone or collaborate? |
|
|
Accept or attempt to change market context? |
|
|
Enter, wait, or exit? |
|
|
Source: Khanna and Palepu (2010).
Anand P. Arkalgud31 provides a good example of how companies fill institutional voids. Take the example of India, where road infrastructure is still underdeveloped in terms of quality and connectivity. Traditionally Tata Motors has been the dominant player in the auto industry but when it started to receive competition from Volvo in the truck segment and by Japanese automakers in the car segment, Tata responded. It created a mini-truck that not only provided more capacity and safety than the two- and three-wheeled pollutant vehicles used to access market areas but also an environmentally sound vehicle, one that could easily maneuver U-turns in such narrow streets.
Another case in India involved Coca Cola, who discovered that their beverages were being sold “warm.” Coca Cola realized that it needed a solution to sell its product “chilled.” The reason for the warm bottles was electricity supplies in these remote locations, which was unstable especially in summer periods. Thus the company developed a solar-powered cooler and partnered with a local refrigeration company.
Tarun Khanna and Krishna Palepu propose the following five contexts as a framework in assessing the institutional environment of any country. The five contexts include the markets needed to acquire input (product, labor, and capital), and markets needed to sell output. This is referred to as the products and services market. In addition to these three dimensions, the framework includes a broader sociopolitical context defined by political and social systems and degrees of openness. When applying the framework, managers need to ask a set of questions in each dimension. An example of these questions is indicated in Table 5.6.
Labor Markets
How strong is the country’s education infrastructure, especially for technical and management training? Does it have a good elementary and secondary education system as well?
Do people study and do business in English or in another international language, or do they mainly speak a local language?
Are data available to help sort out the quality of the country’s educational institutions?
Can employees move easily from one company to another? Does the local culture support that movement? Do recruitment agencies facilitate executive mobility?
What are the major post recruitment-training needs of the people that multinationals hire locally?
Is pay for performance a standard practice? How much weight do executives give seniority, as opposed to merit, in making promotion decisions?
Would a company be able to enforce employment contracts with senior executives? Could it protect itself against executives who leave the firm and then compete against it? Could it stop employees from stealing trade secrets and intellectual property?
Does the local culture accept foreign managers? Do the laws allow a firm to transfer locally hired people to another country? Do managers want to stay or leave the nation?
How are the rights of workers protected? How strong are the country’s trade unions? Do they defend workers’ interests or only advance a political agenda?
Can companies use stock options and stock-based compensation schemes to motivate employees?
Do the laws and regulations limit a firm’s ability to restructure, downsize, or shut down?
If a company were to adopt its local rivals’ or suppliers’ business practices, such as the use of child labor, would that tarnish its image overseas?
Table 5.6 Framework to assess institutional voids
Institutional dimension |
Questions |
Product markets |
|
Capital Markets
How effective are the country’s banks, insurance companies, and mutual funds at collecting savings and channeling them into investments?
Are financial institutions managed well? Is their decision making transparent? Do noneconomic considerations, such as family ties, influence their investment decisions?
Can companies raise large amounts of equity capital in the stock market? Is there a market for corporate debt?
Does a venture capital industry exist? If so, does it allow individuals with good ideas to raise funds?
How reliable are sources of information on company performance? Do the accounting standards and disclosure regulations permit investors and creditors to monitor company management?
Do independent financial analysts, rating agencies, and the media offer unbiased information on companies?
How effective are corporate governance norms and standards at protecting shareholder interests?
Are corporate boards independent and empowered, and do they have independent directors?
Are regulators effective at monitoring the banking industry and stock markets?
How well do the courts deal with fraud?
Do the laws permit companies to engage in hostile takeovers? Can shareholders organize themselves to remove entrenched managers through proxy fights?
Is there an orderly bankruptcy process that balances the interests of owners, creditors, and other stakeholders?
Political and Social System
To whom are the country’s politicians accountable? Are there strong political groups that oppose the ruling party? Do elections take place regularly?
Are the roles of the legislative, executive, and judiciary clearly defined? What is the distribution of power between the central, state, and city governments?
Does the government go beyond regulating business to interfering in it or running companies?
Do the laws articulate and protect private property rights?
What is the quality of the country’s bureaucrats? What are bureaucrats’ incentives and career trajectories?
Is the judiciary independent? Do the courts adjudicate disputes and enforce contracts in a timely and impartial manner? How effective are the quasi-judicial regulatory institutions that set and enforce rules for business activities?
Do religious, linguistic, regional, and ethnic groups coexist peacefully, or are there tensions between them?
How vibrant and independent is the media? Are newspapers and magazines neutral, or do they represent sectarian interests?
Are nongovernmental organizations, civil rights groups, and environmental groups active in the country?
Do people tolerate corruption in business and government?
What role do family ties play in business?
Can strangers be trusted to honor a contract in the country?
Openness
Are the country’s government, media, and people receptive to foreign investment? Do citizens trust companies and individuals from some parts of the world more than others?
What restrictions does the government place on foreign investment? Are those restrictions in place to facilitate the growth of domestic companies, to protect state monopolies, or because people are suspicious of multinationals?
Can a company make greenfield investments and acquire local companies, or can it only break into the market by entering into JVs? Will that company be free to choose partners based purely on economic considerations?
Does the country allow the presence of foreign intermediaries such as market research and advertising firms, retailers, media companies, banks, insurance companies, venture capital firms, auditing firms, management consulting firms, and educational institutions?
How long does it take to start a new venture in the country? How cumbersome are the government’s procedures for permitting the launch of a wholly foreign-owned business?
Are there restrictions on portfolio investments by overseas companies or on dividend repatriation by multinationals?
Does the market drive exchange rates, or does the government control them? If it’s the latter, does the government try to maintain a stable exchange rate, or does it try to favor domestic products over imports by propping up the local currency?
What would be the impact of tariffs on a company’s capital goods and raw materials imports? How would import duties affect that company’s ability to manufacture its products locally versus exporting them from home?
Can a company set up its business anywhere in the country? If the government restricts the company’s location choices, are its motives political, or is it inspired by a logical regional development strategy?
Has the country signed free-trade agreements with other nations? If so, do those agreements favor investments by companies from some parts of the world over others?
Does the government allow foreign executives to enter and leave the country freely? How difficult is it to get work permits for managers and engineers?
Does the country allow its citizens to travel abroad freely? Can ideas flow into the country unrestricted? Are people permitted to debate and accept those ideas?
Conclusion
Entry mode32 is determined by product, market, and organizational factors. In regard to products and services, MNCs need to know whether the nature and range of the product or service, along with available marketing strategies, will require any adaptation. If so, they should consider a partner in the eastern European country they plan to enter. Usually a higher level of control and resource commitment in the foreign market is required for new or wider product offerings as well as higher levels of adaptation. When taking into account market factors, managers need to consider physical distance and experience, as well as identify appropriate marketing strategies and distribution channels, and priorities in revenues, costs, and profits.
Organizationally, major concerns are communication with foreign operations and control of overseas activities. One particular concern in foreign markets is the control of assets. Firms will prefer to internalize activities where there is a higher chance of opportunism by the partners in those markets.
For eastern Europe in particular, the region is poised for further growth, but some major obstacles remain on the road to prosperity. Chief among them are social and economic tensions between ethnic groups, which can create problems ranging from labor markets conflicts to security risks for local businesses. Such dynamics are a special concern during periods of economic distress, high unemployment, and political unrest— known causes of nationalistic, antioutsider fervor.
The role of Russia is another concern. After the Soviet Union’s fall, eastern Europe began shifting its allegiances to the West. With Russia struggling through its own economic problems at the time, it seemed likely that the realignment would endure. Today, trade with the West is up and several countries in the eastern European region are members of NATO and the EU.
But Russia should not be underestimated. It still plays an important role in the economies of eastern Europe. And Vladimir Putin has been frank about his ambition to create a Eurasian economic union, composed mainly of former Soviet states, as a counterweight to the EU. The long-term possibility of new realignments, this time toward the East, cannot be dismissed.
A case in point, most recently, the developments in Crimea have shown that despite years of change and effort toward global integration, Russian strategic goals in the region should not be overlooked. Putin’s rule, reminiscent of the iron hands that governed Russia during the Soviet era, coupled with those weakened by the Great Recession in the West, is a recipe for a meal that’s only served very cold.
Russia’s annexation of Crimea, and even more importantly, the inability of the West to do much to prevent it, shows the complex political and economic relations in the region and the political, and military, power that Russia still holds. The brazen move by President Putin is a source of much anxiety in eastern Europe, particularly by neighbors of the big superpower, Poland being one of them. Several of the eastern European countries are NATO members, which eases a bit worries of invasion, but Russia remains a strong business partner to much of Europe and especially to countries from the former eastern European bloc, and economic sanctions against Russia would surely be felt and have a lasting effect across the continent.
3 Kuruvilla, Erickson, and Hwang (2002).
4 Özsagir and Bayraktutan (2010).
6 Petrolongo and Pissarides (2001).
7 Endogenous growth is long-run economic growth at a rate determined by forces that are internal to the economic system, particularly those forces governing the opportunities and incentives to create technological knowledge.
12 Bornhorst and Commander (2006); Newell and Pastore (2006).
13 Sondergaard and Murthi (2012).
14 Post-Fordism is the name given by some scholars to what they describe as the dominant system of economic production, consumption and associated socio-economic phenomena, in most industrialized countries since the late 20th century.
18 The Copenhagen criteria are the rules that define whether a country is eligible to join the European Union. The criteria require that a state has the institutions to preserve democratic governance and human rights, has a functioning market economy, and accepts the obligations and intent of the EU.
19 In talks with countries that have expressed a wish to join the European Union, the EU typically concludes Association Agreements in exchange for commitments to political, economic, trade, or human rights reform in that country. In exchange, the country may be offered tariff-free access to some or all EU markets (industrial goods, agricultural products, etc.), and financial or technical assistance.
20 The International Tribunal for the Prosecution of Persons Responsible for Serious Violations of International Humanitarian Law Committed in the Territory of the Former Yugoslavia since 1991, more commonly referred to as the International Criminal Tribunal for the former Yugoslavia (ICTY), is a body of the UN established to prosecute serious crimes committed during the Yugoslav Wars, and to try their perpetrators. The tribunal is an ad hoc court, which is located in The Hague, Netherlands; Debating Europe (2014).
21 Other factors that affect wage and/or employment inequalities are migration, technological change and changes in the skill distribution of the labor force.
23 The World Bank (2015).
24 The rankings are determined by sorting the aggregate distance to frontier scores on 10 topics, each consisting of several indicators, giving equal weight to each topic. The rankings for all economies are benchmarked to June 2015.
26 Based on GlobalEdge. http://globaledge.msu.edu/mpi
31 Arnand Prasad Arkalgud (2011).
32 http://globaledge.msu.edu/reference-desk/online-course-modules/market-research-and-entry