By JOHANNES HUTH, TOMAS KUBICA Nov 02, 2014
4. Unlocking the Global Marketplace
Notwithstanding significant obstacles, we believe that the CEE region has the necessary fundamentals to develop into a thriving region that can produce successful global players across sectors. There are a number of initiatives and focus areas for the public sector and for companies that could help develop a more constructive environment for nurturing CEE champions; we include some of those as suggestions below.
a. Priorities for the Public Sector
Notwithstanding significant hurdles, we believe that the CEE region has all the necessary fundamentals to develop into a thriving region that can produce successful global players across sectors.
While the success or failure of an enterprise should be determined by the forces of the free market, government policies and actions can also have a strong impact on the general entrepreneurship, business, and investment climate of a country. As articulated in the EBRD’s Transition Report 2013, many CEE countries are at risk of getting “stuck in transition” due to slow progress on strengthening economic institutions, driving structural reforms, investing in education and human capital, and promoting economic inclusion.16 In addition, regrettably, several countries in the CEE region fall toward the bottom of rankings for corruption and ease of doing business. These national considerations can easily deter potential international business partners and also hinder the effective formation and functioning of the domestic market, and therefore should be a subject of broader and much-needed government attention.
The public sector can play a unique role in creating conditions to enable CEE companies to grow beyond their region, to go above and beyond the critical political and macroeconomic considerations necessary for local market development. Experience from other countries points to several practical government-led initiatives that can help propel global CEE champions:
i. Creating a Business- and Entrepreneurship-Friendly Environment
Governments can meaningfully improve the business environment by establishing a business-friendly legal, financial, and tax framework. The ease of doing business differs radically across CEE – while the Baltic countries are ranked among the top 25 countries in the world (ranks 17-24, which represent top ~13% out of 189 ranked countries), most of the CEE countries are ranked 45-75 (top 25-40%), with Bosnia and Herzegovina closing the CEE list at 131.17 The most often cited complications include setting up a business, dealing with construction permits, paying taxes, and protecting investors.
Corruption is another complication that makes it difficult for young businesses to succeed against more established players, which may at times ‘bend’ the rules of the game. As mentioned by some local entrepreneurs, in certain sectors, for example construction and healthcare, the high degree of perceived corruption may deter new entrants who wish to play fair from even entering and competing. Transparency International ranks CEE countries roughly in the middle of the pack in its corruption perceptions analysis: Estonia is ranked #28, indicating lowest corruption in the CEE, followed by Poland at #38, Czech Republic at #57, and lastly Albania at #116.18 According to a Eurobarometer survey carried out in 2013, corruption is perceived as a widespread issue across most CEE countries, with all, except for Estonia, being worse than the EU average.19
Entrepreneurship in CEE does not always carry the best reputation. Historical corruption and privatization issues have resulted in suspicion, often combined with jealousy, about entrepreneurial success stories. Students and young professionals do not generally yearn to start their own businesses. The perception is changing, as evidenced by the Czechs voting into power last year a new party led by a high profile entrepreneur and more recently the Slovaks electing an entrepreneur-turned-philanthropist as their president, but the progress appears slow and uneven to many. Governments could more proactively drive the improvement in the public perception of the entrepreneurial career path through deliberate advocacy and targeted education initiatives.
Estonia provides an example of how countries can propel improved governance and entrepreneurship with the use of modern technology. The Estonian government bet on technology and digitization when upgrading its infrastructure in the early 1990s and thus leapfrogged the paper era. Today, 98% of bank transfers in Estonia are done online, 25% of people vote over the Internet, and health records are stored in the cloud.20 It takes on average 15 minutes to register a company and five minutes to file an annual tax return online, enabled by digital signatures and online background checks. This investment in technology also helped to drive down corruption in Estonia and encouraged a culture of entrepreneurship. Estonia benefits from the highest number of startups per capita in the world, and high-tech industries account for about 15% of GDP.21
ii. Providing Targeted Financial Support
There are mixed views on the benefits of governments providing direct financial support to the private sector. National governments across CEE support local startups through direct investment, often in the form of low-interest loans or free grants, frequently subsidized by EU funds. While those funds provide capital to the often needy startup community, they also can push out the initially more expensive but also more value-adding VC funding, which in addition to capital for growth, can also provide advice and coaching to new entrepreneurs.
Proven areas suitable for government funding include university research, education projects (as further described below), and projects aimed at strengthening physical and digital infrastructure. Investments in national and international highways, fast broadband, and mobile networks all benefit the private sector, as well as society at large, making it more efficient and competitive in an international setting.
In Israel, the government launched the Technological Incubators Program, which oversees technology ideas before they are ready for private investment. The Israeli government has also partnered with the U.S. government to set up the BIRD (Binational Industrial Research and Development) Foundation, which seeks to partner Israeli technology companies with U.S. corporates with sales and distribution networks, to create mutually beneficial joint ventures. CEE governments could consider establishing similar programs to help prepare early-stage companies for private funding as well as establish links with foreign governments and the international business community.
iii. Establishing Regional Technology Clusters
According to the cluster theory first laid out by an economist Alfred Marshall in 1890 and later popularized by Michael Porter in 1990, companies and whole industries can develop faster if they are concentrated in the same area, facilitating the exchange of information, experience, innovation, and talent. The most famous clusters are Silicon Valley (technology), London and New York (finance), and multiple Chinese provinces (low-cost manufacturing).
Due to its low-cost labor advantage, stable investment environment, and central geographic location, the Czech Republic and Slovakia have developed an automotive cluster with many international automotive manufacturers, suppliers, and service providers setting up their local operations. Low-cost manufacturing is not an attractive and sustainable business niche, however. Its focus on low value-add production (with engineering, research and development often located abroad), and low labor cost advantage provides only a temporary edge, which is gradually being eliminated by higher economic growth and convergence.
We believe that one of the CEE’s competitive advantages is a large pool of high quality technical and information technology (IT) talent, and many of the current CEE global champions have succeeded thanks to tapping into this. The region’s governments could thus facilitate the creation of national technology hubs, connecting their universities, research centers, corporations, startup incubators, and local investors. Governments could support the hub with initial funding and mobilizing state-owned universities and publicly-funded research institutions, which would subsequently attract the private sector. National technology hubs could then be linked across the region to create a CEE technology network, forging relationships across the region. An internationally recognized CEE technology hub would in turn attract more international investors and also help prevent the outflow of the most talented entrepreneurs and engineers abroad.
Well-connected and integrated venture hubs and technology clusters have played an important role in creating thriving entrepreneurial ecosystems in Israel, the Nordic countries, and in other areas of Europe. There are 20 accelerators in Israel, out of which 18 are technology focused.22 In addition, the country has lured many global corporates including Google, which in 2013 unveiled Campus Tel Aviv, a hub for developers and entrepreneurs, and Microsoft, which in 2006 launched the Israel Research & Development Center as an expansion of the technology activities the company had run in Israel since 1991. The Swedish venture landscape is equally buzzing. SUP46, a meeting place for startups and investors launched in 2013 and whose partners include the Swedish government, is on a mission to make Stockholm the world’s number one startup city. STHLM Tech Meetup, a regular event for the Stockholm technology community, has more than 2,000 members23 and Sting, which describes itself as an ecosystem for startups in Stockholm, provides business development support including a business incubator, an accelerator program, and an international network of investors. Europe boasts several other notable technology hubs, including London, Berlin, Paris, Amsterdam, Barcelona, and Helsinki, which are often connected through personal, business, or investment relationships.
iv. Creating Conditions for the Return of the Lost Talent
To address the brain drain of many of its most talented citizens, governments can support international opportunities for its citizens while also making it more attractive for people to return home. Many young Scandinavian professionals leave their countries to spend the early part of their careers abroad but return home to settle down, attracted by the favorable social system and work-life balance, bringing back with them their valuable international experience.
Many of the initiatives already mentioned – strengthening the business environment or creating leading regional technology hubs – can help in reducing the outflow of local talent abroad as well as luring talent back. However, more can be done to send a positive signal to diaspora members that they are welcome to return. Estonia launched a targeted campaign, “Talents, come home,” in 2010 to appeal to young professionals who had left the country. It offers practical information for the return back home, and it collects and advertises attractive job positions for people with international experience.
Developing a corrective brain drain strategy is not only about convincing talented citizens to return home; equally important and beneficial for the countries is fostering strong relationships with and among their citizens when they are abroad. Emigrants can support their home countries by establishing business links or cooperation opportunities in the fields of culture, arts, or research and development. Tomáš Červenka, a Cambridge-educated Chief Technology Officer at London-based technology company VisualDNA, has recently set up an IT development center in his native Slovakia to leverage the local IT talent and have an opportunity to spend more time in his home country. There are many formal and less formal events being organized for expatriates to strengthen their links to their home countries and establish relationships among themselves.
v. Increasing Education Quality
The quality of education in CEE is generally considered good, yet with significant variations across countries. While Estonia, Poland, Slovenia, and the Czech Republic rank above the OECD average in secondary level math and science, Albania, Bulgaria, Montenegro, Romania, and Serbia fall well below the average.24 At the tertiary level, technical faculties focused on IT, engineering, and mathematics have a strong reputation internationally. In 2013, 16 out of the 24 finalists of Google’s annual Code Jam programming competition were from CEE. In 2014, computer science students from three CEE universities (University of Warsaw in Poland, University of Zagreb in Croatia, and the Comenius University in Slovakia) won silver and bronze medals at the ACM International Collegiate Programming Contest, a prestigious international programming competition with ~2,300 participating universities from 94 countries.
There are two areas where CEE education systems lag behind international best practices. First, while students are generally well equipped with hard skills, there is limited focus on soft skills development. CEE teaching methods are generally based on listening to the teacher and memorizing facts, rather than students working in teams to come up with their own solutions, presenting them in class, and thus building important social and communication skills and self-confidence. Second, although improving, basic entrepreneurship education and training is largely non-existent at primary and secondary level. It is also very limited at university level, being largely restricted to business faculties only and often completely missing from technical schools. Junior Achievement, a U.S. non-profit organization which focuses on ‘turning kids of today into entrepreneurs of tomorrow,’ has made great progress in this regard across multiple CEE countries, but the rollout is still limited.
There is no doubt that CEE students can be competitive at the international level. To sustain and further improve this position, universities, which are generally publicly funded and do not charge tuition fees, need to receive adequate financial support to invest in research and development and equally important, is to attract and retain quality professors who often prefer more lucrative careers in the private sector at home or abroad. Well-funded and resourced universities are more likely to attract the highest caliber professors, generate research breakthroughs for commercialization, and encourage the best students, who are often lured out of the country by generous scholarships to foreign universities and research centers. In addition to government money, universities can explore research partnerships with the private sector, which could provide additional sources of funding while offering students relevant work experience. Finally, with technology advancement, there are numerous online and technology-enabled educational methods, including distance learning and massive open online courses (MOOCs), which can bring quality content and instruction to students irrespective of their location.
b. Priorities for Companies
The public sector can contribute to creating a favorable business environment, but it is the private sector that will successfully drive international growth. We have summarized below a few lessons observed among other CEE champions as well as from our experience.
i. Building on Competitive Advantages
Successful global companies often rely on building a business around the strong competitive advantages of their respective regions. For example, U.K.-based school operators have expanded internationally into Europe, Southeast Asia, and Latin America, leveraging the strong reputation and brand of U.K. education. Many Africa based companies have integrated themselves into the global agricultural and horticultural supply chain, leveraging the region’s unique climate, labor costs, and demographic dividend.
Swedish companies have recognized that succeeding with mainstream products outside of their domestic markets is more difficult. By the time they develop a tailored product, international markets are saturated. The most successful companies have thus focused on niche sectors, in line with their competitive advantage, where they can differentiate from lower-cost players. For example, Sweden’s Sandvik has focused on high-end engineering machine tools, while Volvo Trucks specialized in high-quality heavy trucks. Both are successful companies that benefitted from Sweden’s engineering tradition and which have been able to carve out strong global positions.
CEE countries also have competitive advantages. For CEE as a region, notwithstanding country-to-country variations, the main differentiating factors include a large pool of high quality technical and IT talent, engineering, and industrial heritage, strategic location between major consumer markets, lower labor costs, and in some cases (Poland and Serbia, for example) arable land. Many local companies have leveraged these advantages to build truly global players; good examples are CEE antivirus companies, which benefit from the large availability and high quality of IT talent.
ii. Thinking Globally
The target market for many CEE companies should not end at national, regional, or European borders; the entire world is their potential marketplace. From our experience, in many industry sectors, especially technology, it is easier to think globally from the very start, rather than focus on the local market first and then try to expand. Successful technology leaders from the CEE region – AVG, Eset, Sygic, and Telerik – started developing their products with a global customer in mind.
For Israel or Scandinavia, global citizenship is part of their cultures. Extensive travel, study or work abroad programs, and English language fluency all contribute to fostering a global outlook and perspective. Similarly, when it comes to business, Israeli and Swedish entrepreneurs, cognizant of their small home countries, target the U.K., Germany, and the U.S. as their priority markets from the beginning.
Thinking globally does not mean spending time and resources on international expansion before the business model is established but rather by adjusting the company’s mindset, internal and external communication, and business strategy with a global marketplace in mind. This is where market fragmentation within CEE and Europe more generally may be an advantage: local entrepreneurs in CEE gain experience by dealing with different countries, cultures, and languages early on, in contrast to their U.S. peers. Some specific suggestions for adopting a more global approach include:
- Developing an internationalization strategy: CEE companies may want to identify priority international markets, based on expected product and service demand, competition, and market size, and develop a go-to-market approach for each priority market. Targeting B2B customers or finding distribution partners may be an easier way to break into new markets to establish a presence, rather than focusing on a direct greenfield business to consumer (B2C) strategy;
- Catering products to the customer base: Different countries have different preferences. Slovenian multi-channel retailer Studio Moderna, backed by a group of growth equity firms, found that an important component to its international success has been its strategy to tailor products and marketing to the specific needs of each local market. The business now operates in 21 countries across Europe;
- Adapting positioning, marketing, and communication: CEE companies may wish to think about international, easy-to-pronounce product brand names, develop a company website and marketing materials in multiple languages, avoid culturally-biased or sensitive advertising, and make cultural adjustments where appropriate. Showing the international customer case studies can establish higher comfort in the company’s ability to serve them globally, regardless of location or origin. Marking products ‘Made in the EU’ can – for some CEE countries – be a potentially strong advantage versus other non-EU low-cost competitors;
- Opening offices in the global centers: We see many CEE companies opening small representative offices in major global cities to be closer to their customers and add to their global image. Relationships with international customers, media, or investors develop faster with face-to-face meetings; being in the same time zone as important contacts also makes the interaction easier. It is important to avoid incurring high fixed costs; one or two salespersons and a local address may suffice. As an example, a Czech social analytics company, Socialbakers, opened a small London office with a public relations person and a small sales team, allowing it to gain greater customer, media, and investor visibility, while the large majority of the staff remained in the Czech Republic; and
- Hiring staff, especially in sales, with international background and experience: CEE companies should think about looking for people with study and work experience abroad, or expatriates living in the country, building a global outlook, international cultural awareness, and language capabilities early on.
iii. Pursuing Inorganic Growth Options
Many entrepreneurs focus exclusively on organic growth to scale their business. We agree that growing customers in a cost- and capital-effective way should be the priority, but we also believe that there can be significant benefits from pursuing inorganic growth opportunities. Completing targeted acquisitions can bring access to new international markets and customers, improvements in technology, extensions to existing product portfolio, and the addition of new management talent. From our experience, smaller acquisitions often result in higher synergies, lower execution risk, and easier integration, compared with large transformational mergers.
Another avenue to consider is establishing partnerships with selected international distribution or manufacturing partners, who can bring the required knowledge and experience to enter the international markets. This would involve giving up some economic benefits, but it may allow the companies to scale more quickly and at a lower risk.
It is important that inorganic growth options complement the overall business strategy. For example, KKR previously invested in BMG Rights Management, a music rights business, in a 50/50 joint venture with Bertelsmann, a leading German media conglomerate. KKR and Bertelsmann supported the business through its industry knowledge, contacts, and experience. During the four-year ownership, BMG had completed seven acquisitions, which was a major contributor to its overall growth.
iv. Strengthening Corporate Governance and Management
The CEE business environment and corporate governance best practices are less developed compared to Western markets. Many successful CEE businesses are still led by their founders, who are approaching retirement age and have often not adequately prepared their companies for eventual succession. Bringing the founder’s children to the business is often the most obvious and frequent way for ensuring continuity in the business, but that may not always be a viable or preferred option.
Retaining and empowering professional management can solve succession issues, as well as bring new perspectives and ideas to the business. Bringing in new management or developing internal candidates well ahead of the founder’s eventual retirement to provide sufficient time for training, hand-over, as well as assessment of the new hires, is typically a good way of de-risking management transition.
Even if there are no succession issues, significant benefits can be accrued from bringing new talent to the executive management ranks or to the boardroom as non-executive directors. For example, SBB/Telemach Group, a leading provider of pay television and broadband services in the countries of former Yugoslavia in which KKR recently invested, added to its advisory board Boris Nemšić, a Bosnian/Croatian/Austrian national and a former CEO of Telekom Austria and VimpelCom, who is an expert on the Balkan region and telecommunication industry. Well-selected additions can benefit a business by sharing best practices from their prior experience, contributing their industry contacts, and providing a more independent sounding board for new ideas and initiatives. Well-designed incentive schemes with equity upsides are often necessary to attract high caliber candidates and retain them for the long term.
v. Exploring Different Capital Alternatives
In order to fund international growth, execute on potential acquisitions, or bring in new talent, companies may need to re-examine their funding sources. Reliance on savings or self-generated profits is a suitable option in many situations, which may result in lower risk and full equity retention by the original founders. However, in faster changing sectors, more significant investments may be required to be able to differentiate oneself from the competition. With increasing globalization, CEE companies are no longer only competing against each other but also need to keep pace with the international developments.
Finding a strong financial partner, which can support the company by injecting capital and also through its know-how and international contacts, can lead to a potential “win-win” situation. A well-selected financial sponsor can help the founder and management team to professionalize the organization, enter new markets, bring industry and regional expertise from other investments, and open up its network of contacts for potential customer, supplier, or partnership opportunities. Private equity backing has stood behind many of the CEE international successes, including AVG, a leading antivirus provider from the Czech Republic or HTL-Strefa, the world’s leading producer of personal lancets and pen needles for people with diabetes from Poland.
In addition to considering partnering with a financial sponsor, companies may also wish to explore other financing alternatives to fund their growth and potential acquisitions. In today’s environment, debt financing (both bank loans and public bonds) is relatively cheap and can provide companies with sufficient capital for international growth as well as acquisitions. In some cases, and despite their somewhat mixed reputation, EU’s structural funds, aimed at reducing regional disparities between EU regions, can be an attractive alternative for funding expansion projects, especially for developing new infrastructure or employing more people. Funding from a development bank, such as EBRD, can be another attractive alternative, especially in the less developed countries of the CEE region.