By JOHANNES HUTH, TOMAS KUBICA Nov 02, 2014
2. Key Challenges
There are several obstacles that CEE companies must overcome to expand successfully beyond their home markets. While some challenges are structural and difficult to change (e.g. smaller, fragmented markets), most are linked to the more nascent stage of these countries’ respective economies and free market development. Such factors include more limited financing alternatives, less mature corporate governance practices, brain drain, low entrepreneurship recognition, and a lack of global outlook. As countries in CEE develop further, globalization continues, and generations turn over, we believe those difficulties can be largely overcome or mitigated and conditions for local entrepreneurs thereby improved.
a. Fragmented Markets
As countries in CEE develop further, globalization continues, and generations turn over, we believe many of these difficulties can be overcome and conditions for local entrepreneurs thereby improved.
CEE companies face significant challenges in reaching a large number of customers. While the large size of the U.S. enables growth companies to scale up fast in a single-language market, the fragmented nature of the markets across CEE means rolling out a cross-border business, even through consolidation, often remains a slow and challenging process.
EU members benefit from a largely harmonized legal framework, but certain barriers continue to hinder international growth: uneven sector developments in different EU markets, small populations, different currencies (outside of the Eurozone), and multiple languages, cultures, and customer tastes. Dealing with disparate tax regimes is also cumbersome.
Such a broad range of differences across CEE highlights the importance of having an adaptable business model that can be tailored to the specific needs of each country. For instance, certain products, particularly those aimed at consumers (rather than business to business, or B2B), may only sell well in a handful of countries. Creating a large, international business which relies on meeting the needs of different countries can be difficult, time consuming, and costly.
b. More Limited Availability and Acceptance of Financing Alternatives
The relatively short private sector history in CEE also means a less developed understanding and utilization of different financing sources by companies there. Banks have been the traditional funding alternative for CEE companies, but bank loans are often inaccessible, and sometimes not advantageous, for earlier-stage companies that need them most. Non-bank financial institutions emerged in the 1990s, but given their poorer risk management and more aggressive practices, many ended in bankruptcy. Public markets are generally under-developed in CEE (with Poland being a notable exception), with the total market capitalization of the region at ~$340 billion, or only ~23% of GDP, compared to 63% of GDP in the Euro zone.12
Private equity and growth capital is generally available in CEE, but it is less widespread compared to Western European markets. The CEE region represents only 2% of total European private equity activity, compared to 8% of GDP.13 CEE entrepreneurs are often resistant to raising equity from third party investors, often due to wariness of losing some autonomy, even if the new capital and fresh ideas would help the company accelerate its growth. Consequently, international investors, especially those focusing on providing growth capital, are less present, discovering the region only gradually. Venture capital and seed financing, from local venture capital funds, angel investors, or accelerator platforms, are relatively more advanced, as young entrepreneurs have a more open approach to raising external financing and accelerating growth.
Improved access to and familiarity with different financing sources would allow companies to grow faster and consequently attract even more capital to the region – reinforcing a positive virtuous cycle.
c. Less Mature Corporate Governance Practices
Entrepreneurs in CEE have typically not been accustomed to fully-developed corporate governance best practices. Many family businesses have only recently started professionalizing their management teams and few companies have invited non-executive members to bring fresh perspectives to their boards. In time, efforts by the EU to raise governance standards across the continent should benefit the CEE ecosystem through enhanced transparency and more effective board representation. Greater diversity and higher corporate governance standards are also likely over time to lead to more innovative, better-run, and more transparent businesses.
d. Brain Drain
CEE is renowned for its technology expertise, due largely to the popularity of studying engineering – an educational background shared by many of the world’s most successful entrepreneurs and businesspeople. However ‘brain drain’ is a concern, whereby, many of the most talented engineers leave the region to pursue advanced studies or higher-paid, more entrepreneurial opportunities abroad. Only a small proportion of this talent finds its way back home.
This trend, in turn, has contributed to a lack of well-known entrepreneurial role models in the region to inspire the next generation. In addition, the founders of large and successful companies in CEE do not tend to seek public profiles, despite the success they achieved. Many of the most talented students or entrepreneurs thus think about moving abroad and succeeding away from home, rather than developing international businesses from their own countries.
e. Low Interest in and Recognition for Entrepreneurship
A long tradition of engineering and technical expertise means CEE ought to have a wealth of innovative entrepreneurs. However, unlike in other regions where entrepreneurs are highly regarded, many young professionals in CEE do not set up their own businesses. A positive exception is the Baltic region, where entrepreneurship has gained significant traction in recent years. In our view, slow progress in other countries may be explained by several reasons:
- First, as previously mentioned, the current generation did not grow up with local entrepreneurial role models. Indeed, before the end of communism in 1989, there were hardly any private companies whatsoever;
- Second, the public reputation of entrepreneurship is rather mixed in CEE, where post-communist privatization processes often rewarded politically connected insiders. Entrepreneurship often has a negative association with corruption and achieving success in a relatively short period of time is often viewed with suspicion. Negative public perceptions of entrepreneurship also seem to be an issue across numerous EU countries, not only CEE. According to a recent European Commission survey, more than half of respondents in the EU believe that entrepreneurs ‘think only about their own pockets’ and ‘take advantage of other people’s work,’ compared with less than one third in the U.S.;14 and
- Third, entrepreneurs in CEE are concerned about not succeeding and subsequently suffering from a public stigma of failure. By contrast, in the United States, failure is often considered a badge of honor. An entrepreneur who saw his startup collapse and moved on to succeed with a new venture or in a more traditional corporate career is seen as more experienced, more driven, and resilient. This fear of failure is a Europe-wide issue; according to the same European Commission survey,15 50% of respondents in the EU said the risk of failure would deter them from starting their own businesses, compared with only 28% in the U.S.
As a result, the best students in CEE are often attracted to corporate, banking, or consulting career, rather than setting up their own businesses. Attracting high caliber employees to startups is even more challenging since the experience and reward is perceived as too low and the risk too high.
f. Lack of Global Perspective
Entrepreneurs in CEE often see themselves and their businesses as part of CEE or perhaps Europe more broadly but rarely as part of the global business system. CEE companies tend to benchmark themselves more to local or regional peers than to best practice global competitors. That said, the younger generation is increasingly connected to the international markets (by often studying or working abroad), has more international connections, and is able to speak fluent English, while older generations often lag behind in those respects.
Also, CEE companies often need to fight negative perceptions or misconceptions from potential Western customers or business partners. Regional companies are perceived as less experienced in dealing with international clients, and products with CEE origin are often seen as of lower quality compared to Western equivalents (this is more applicable to consumer goods and less so for technology products). Some CEE companies have adopted international names or branding and started selling to international markets from foreign subsidiaries to circumvent this problem.