By JOHANNES HUTH, Tomas Kubica Nov 02, 2014

Twenty five years after the fall of the Berlin Wall, the broader Central and Eastern Europe (CEE region) is once again a flashpoint of global geopolitics. With heightened tensions surrounding Ukraine and Russia, the risk perception of CEE has increased in the eyes of many international observers and investors alike.

That perspective ignores the tremendous progress CEE countries have achieved in their governance, economies, and institutions over the past quarter century. We believe that investors would be well-served to adopt a more constructive view in looking at CEE: as a region that has achieved notable albeit uneven gains over the last 25 years, is largely converging with the rest of Europe, and could serve as an incubator to thriving, competitive companies.

Where the CEE region is still underdeveloped, however, is in its ability to develop true CEE ‘champions’ – firms that succeed both at the national or regional levels and in the international marketplace.

In this KKR Global Institute paper, we discuss why we are optimistic about the prospects for the CEE countries and how companies in this region can overcome some of the common obstacles they face. Our observations are based on extensive dialogue with CEE entrepreneurs and companies to understand their aspirations and concerns. In our view, this dialogue has made clear that there is real potential for CEE to be on the global map as an attractive, highly investable region and that global investors can positively contribute to the internationalization of local champions by providing growth capital, experience, and networks.


1. Introduction: A Compelling Region

Central and Eastern Europe (CEE)1 is home to world-renowned talent even though the world does not always recognize its origin. Insulin, modern contact lenses, parachutes, the Rubik’s Cube, Skype, and several of the world’s leading computer anti-virus companies all originated in Central and Eastern Europe.

Those significant achievements illustrate the potential for CEE to make valuable contributions to the global marketplace and also highlight the need for companies and investors to pay close attention to the region. While historically often overlooked or considered too risky by many investors, the region has come a long way since the fall of communism. A majority of CEE countries have become members of the European Union (EU), the North Atlantic Treaty Organization (NATO), and the Organization for Economic Cooperation and Development (OECD), and the general political, economic, and business environment has improved significantly.

CEE is not uniform; there is significant variation and fragmentation within the region. Population sizes range from Estonia, with only 1.3 million inhabitants, to Poland, a country of nearly 40 million people. Eleven countries are members of the EU, all having joined in the past decade; six are candidates at varying stages of accession and displaying varying degrees of determination. CEE countries also differ in overall governance, institutional strength, and business climates. Understanding these differences is critical for investment and business success in the region.


Exhibit 1

Countries of Central and Eastern Europe


Notwithstanding intra-regional variations, from an investor perspective, the CEE region offers an attractive set of fundamentals:

  • The CEE region has significant scale. Its combined population exceeds 100 million, and last year’s gross domestic product (GDP) of about $1.4 trillion was larger than that of the Nordic region2 at $1.2 trillion and approximately the same size as Spain, the thirteenth largest economy in the world;3
  • The CEE economies have performed relatively strongly by most measures. CEE real GDP growth rates4 over the last 15 years have outperformed those of the Eurozone, with an average annual growth rate of 3.1% between 1999 and 2013, compared to 1.1% in the Eurozone. Going forward, as shown in the chart below, the IMF forecasts real GDP at purchasing power parity (PPP) to grow in CEE on average by 1.4 percentage points higher than that in the Eurozone. The government debt is at approximately 50% of GDP in CEE, compared to around 100% in the Eurozone area and the U.S.;5

Exhibit 2

IMF Projected Real GDP Growth Rates at Constant Prices (PPP Exchange Rates)

Source:IMF WEO April 20146, Haver, Data as of 9/4/14
  • CEE countries’ existing (and for some, forthcoming) memberships in the EU, OECD, and NATO have created a more stable and integrated economic market. While there is still work to do to integrate markets and regulations, most visibly in the energy sector, the countries are converging with Western Europe. Slovakia, Slovenia and Estonia have already adopted the euro as the single currency, with other CEE countries expected to join the Eurozone in the next decade. The political environment has been largely constructive with the embrace of pluralistic, multi-party democracy following the collapse of communism – a historic achievement – although, notably, in a few countries in CEE, these gains are coming under pressure from corruption, populism, and backsliding on judicial independence, rights protection, and free press. Broadly, however, legal, regulatory, and business conditions have advanced and standardized considerably across CEE, which has been shaped by the common EU acquis adopted as part of EU accession for some in CEE;6

    Insulin, contact lenses, parachutes, matches, the Rubik’s Cube, and more recently Skype and several of the world’s leading computer anti-virus companies all originated in Central and Eastern Europe

  • The CEE, because of its location, is ideally situated for building trade links between Western Europe, the Middle East, and Asia. The region has access to the Adriatic, Baltic, Black, and Mediterranean Seas and has significantly improved road and rail infrastructure in recent years and has become deeply integrated with pan-European transport corridors;
  • The region benefits from a well-educated and inexpensive workforce with particular strengths in technology and engineering. From 2001 to 2012, the percentage of the CEE7 labor force with tertiary qualifications increased by ~11 percentage points to 24%, versus an increase of ~7 percentage points to 29% in the Eurozone. The average wage in CEE is less than one third of that in developed Europe;8 and
  • CEE also enjoys increasingly supportive tax regimes with favorable corporate tax rates ranging from 10% in Bulgaria to 22% in Slovakia, compared with ~30% in Germany and an OECD average of more than 24%.9

While the region exhibits several positive characteristics and some notable achievements, the global success of CEE companies lags on average behind those in other European and international markets. For comparison, Israel and Sweden, two countries with relatively small populations (both less than 10 million), have each produced more global companies than the entire CEE region combined. To illustrate, there are just 11 CEE-based companies listed on NASDAQ compared with 62 from Israel.10 In the Global Forbes 2000 list, there are ten companies from all of CEE (seven from Poland, two from Hungary, and one from the Czech Republic), compared to 26 from Sweden alone.11

Exhibit 3

Fortune 2000 companies for different European countries

Source: Forbes Global 2000, http://www.forbes.com/global2000/list

With such attractive market fundamentals, why does the CEE region have so few global champions? What are some of the lessons from other countries that could be applied to CEE? And, what can we learn from some of the true CEE success stories, which, despite the odds, have managed to flourish internationally?

In order to attempt to answer these questions, we have drawn upon our institutional knowledge of having evaluated investment opportunities in the CEE region and across Europe, as well as extensive dialogue with entrepreneurs and CEOs of the region’s leading companies, regional experts, and other government officials. In this paper, we review the key challenges CEE companies face in penetrating the global markets. We then offer a set of considerations for the public sector and aspiring CEE companies, identifying potential ways to tackle those challenges. We aim to draw lessons from CEE champions as well as pan-European KKR portfolio companies that have succeeded internationally.

We have not attempted to cover either the region’s macro-economic or geopolitical situation in depth; our aim is to provide a ’battlefield’ business perspective based on our experience. We neither have nor offer all the answers, but we hope our observations can contribute to the debate among private and public stakeholders in CEE on how to propel private sector champions and, thereby, accelerate growth of the region.