- Email: [email protected]
Plant location—The international perspective
Plant Location-The International Perspective James
C. Leontiades*
appraisal. Such models are only useful as long as their underlying assumptions are valid. The initial assumptions they make about the real world are crucial to their effectiveness. It is just these, however, which are now changing and throwing doubt on current practice.
Current events in Europe and elsewhere are bringing about far reaching changes in the global business environment, forcing companies to re-examine their basic strategies towards plant location. The companies which have adopted the most sophisticated techniques with theirgreater reliance on highly structured inputs are those which most urgently call for re-appraisal. Such models are useful only as long as their underlying assumptions are valid. The author points out that while there are no easy prescriptions for dealing with the problems in developing a successful location strategy, an awareness of the most prevalent pitfalls would be of considerable advantage.
C
URRENT
EVENTS
IN EUROPE
AND
ELSE-
where are bringing about far reaching changes in the global business environment, forcing companies to re-examine their basic strategy towards plant location. The emergence of a greatly expanded Common Market, reduced tariffs towards the developing non-industrial nations, together with improved transportation technology are only some of the recent innovations causing decision makers in multi-national corporations to review their procedures for locating optimal investment sites abroad. Even those firms which have already implemented the latest in capital budgeting, linear programming and mathematical modelling techniques are encountering ,difficulty adjusting their procedures to the new business situation. in fact, it is the more sophisticated techniques with their greater reliance on highly structured -nputs which most urgently call for rec) Copyright
James Leontiades,
1974.
*Dr. Leontiades is Professor of Management E.I.A.S.M. He was formerly on the staff Manchester Business School.
70
at of
Consider the typical situation of Company X which is attracted by the growing Eureopean market and has decided to study the feasibility for a new plant designed to service this growing potential. The company proceeds to gather information on the nature and distribution of the potential market, European wages and productivity, European site costs, building costs, local regulations, investment incentives and government attitudes and restrictions. These, together with facts which may be peculiar to Company X’s individual circumstances, will then be weighted and analysed to determine the feasibility of alternative European plant sites. This procedure, which worked well enough in the past could prove dangerously misleading today. A number of companies are discovering that the best place for their ‘European plants’ may be in Asia, Africa or Latin America. The tacit link between the target market and rhe new plant built to service that market has been broken. New plants are going up in diverse corners of the developing world aimed at the European market but making full use of the lower wages available elsewhere. Satellite or runaway plants as they have been called are often associated with U.S. companies fleeing U.S. wage rates to produce abroad for the U.S. market. Yet, as a practical matter, planning plant locations for the new EEC will have to take into account the competitive threat by this new possibility. An impressive list of leading European companies are already showing the way: 0 Germany’s Rolleiwerke camera company has set up three subsidiaries in Singapore to export its products on a worldwide basis. Volkswagon’s
Mexican plants produce parts which are exported to Europe as well as the U.S. Besides Rolleiwerke, Grundig, Bayer, Hoechst and Siemens have also joined the move to Singapore. Britain’s Plessey Instruments has set up plants in Malta, Portugal, Barbados and Singapore, to produce a wide variety of products for northern as well as southern European markets. Olivetti supplies its worldwide needs for desk calculators from Latin America. Renault, Mercedez Benz and Fiat are starting operations in Eastern Europe which are scheduled to produce components for Western European markets. Philips, the Dutch firm is setting up a major industrial base in the Far East to supply European and other markets. Corporate Planners have their work cut out for them. As the wage gap between the industrial countries and the developing countries which are potential sites for such plants continues to grow (see Figure 1) so will the need to take into consideration, more explicitly than heretofore, the feasibility of plants completely disassociated from the markets they are aimed at. This will involve such hard to predict variables as future wage rates, union activity, local incentives, development of free trade zones and other incentives, transportation costs and future tariff movements. WHICH
COMMON
MARKET?
Despite the growing importance of satellite plants, most companies building new plants for the Common Market will continue to locate within the enlarged communities tariff barriers-but what are these? Before even beginning to calculate the trade offs between plants located in one EEC country or another, companies must first determine the outlines of the new tariff structure which defines the Common Market. This will not be as simple as it
LONG
RANGE
PLANNING
(Dollars
per
Hour
40
More
will have several levels of membership (see Table I). First, there will be the full members, i.e., those that take part in all of the economic and political aspects of the group as set out in the Treaty of Rome. On this level, we may expect tariff free trade of industrial products within an
Paid in U.S.)
g
z
increasingly
Singapore
Taiwan
Thailand
El Salvador
Guatemala
South
Figure
Korea
1. Widening
Wage Gap. Amount by which U.S. Wages Exceed CDC’s. 1964 (shaded) and 1969 (unshaded).
Source: Derived from United
Nations
and International
those
Labor Office data.
Note: Wage differentials shown refer to average hourly wages paid in manufacturing. paid by satellite plants may be significantly higher.
might seem. The community long ago outgrew the six country members that signed the Rome treaty. It is not a matter of six or even ten countries which must be considered but the 55 or so countries which have associated themselves with the community as it has developed. The community has proved to be a very dynamic organisation, continually growing in terms of membership and continually altering the ties linking one member to another. It is safe to assume that within the lead time necessary to construct a new plant and make it operative (34 years) it will have altered still further. What is needed then is not so much a definition of present tariff barriers as a projection of future barriers. What will the Community look like 10 years from now-that is the question which plant location must take into consideration. It is a crucial question whose answer will seriously influence the decisions made for this part of the world. The new Common Market now emerging
FEBRUARY,
1974
of selected
Actual wages
homogenious
industrial
frame-
work of laws governing mergers, competition and industrial standards. Closely associated with these countries will be the important group referred to in Table 1 as ‘Free Trade Associates’. The national markets represented here will be virtually a part of the ‘Common Market’ as regards industrial trade. Corporations planning their future exampansion strategy must consider the present and future interrelationships between these two groups. If history is any guide, the two will move even closer together eventually forming a single industrial market of 16 countries and a population of over 300 million people. This is not to deny that real differences in taxes, social policies and location incentives will persist for at least another decade. It is this mixture of commonality together with key areas of national difference, the precice combination changing over time, which represents perhaps the major planning challenge of the new EEC. The other two levels of EEC membership are comprised of less industrial countries. Level III countries have a number of differing treaty relationships with the Level 1 group which vary from one Level III country to another. In general, these offer the possibility of preferential access to EEC markets for the products of these countries
Table 1. EEC Structure.
Levels of Membership*
Market
I. Full Members: Belgium, France, Italy, Netherlands, Luxembourg, W. Germany, Britain, Denmark, Ireland
Free trade in industrial and agricultural products. Progress toward reduction of legal and monetary differences together with free movement of capital and labour.
I I. Free Trade Associates: Austria, Finland, Sweden, Portugal, Norway
Free trade in industrial products between each other and countries in Group I.
Switzerland,
Iceland,
I I I. Mediterranean Associates: Israel, Tunisia, Morocco, Algeria, Libya, Malta, Greece, Turkey, Egypt, Cyprus, Spain IV. Developing Countries Associates: Senegal, Malim, Niger, Ivory Coast, Dahomey, Togo, Cameroon, Chad, Central African Republic, Congo, Madagascar, Burundi, Rwanda, Somalia, Mauritania, Upper Volta, Gabon, Kenya, Tanzania, Uganda, Nigeria. Gambia, Ghana, Malawi, Sierra Leone, Botswana, Lesotho Swaziland, Mauritius, F&V, Tonga, Western Samoa, British Commonwealth Islands in the Carribean, Pacific and Indian Oceans *Those with membership
pending
are italicized.
Relationship
Selective reductions in trade barriers between countries at this level and those in Groups I and II. Developing preferential
countries whose goods have access to Common Market.
while permitting access to their own markets for Level I exports in certain product categories. Level IV countries enjoy preferential access for many of their products (primarily agricultural products and raw materials) into Level I. In the past they have also offered entry into their markets at a preferential rate for exports from Level I, though future prospects for such ‘reverse preferences’ are in considerable doubt as of this writing. Nevertheless, the affiliation of this important group of countries within the EEC presents major opportunities for the supply of certain products produced in these countries on a tariff free basis to plants located in Level I. Looking further into the future, there is little doubt that the affiliation of these last two groups with the EEC will open up additional possibilities. Particularly, it may be expected that some of the Level III group will apply for Level II membership, joining the industrial free trade area while offering substantially lower wage costs to plants located there.
the move to acquire foreign production facilities within the new tariff free area. The dominant motivating factor here is a perceived need to be closer to the market. With the British initiated expansion, the EEC will take on the dimensions of a true mass market. The more competitive situation this implies is already putting pressure on consumer oriented companies to emphasize a number of marketing variables which, although sometimes omitted from formal calculations, are nevertheless assuming an increasingly important role. Delivery Time
Shorter delivery times are becoming an ever more important competitive variable. The wider choice of consumer products made available by the lowering of trade barriers has meant the long patient European consumer, no longer has to wait as long for producers to supply his needs. The pressures on delivery times gives advantage to local investment facilities over imports with their generally longer waiting period.
THEORY vs. PRACTICE
Market Feedback
The enlarged EEC brings together Europe’s two major industrial centres, the northern European industrial complex beginning with Hamburg in the north and extending south through the Ruhr, Belgium and on towards Paris, together with the British industrial complex. This poses a special problem. Theoretically, the removal of tariff barriers now taking place between these two industrial concentrations would seem to strengthen the case for exporting from one to the other, i.e. if you have a plant in one of the member countries(Leve1 I or II, seeTable 1) exports would seem the logical way of reaching the new markets opened up by the enlarged community, rather than investment in new plants and facilities. It is strange therefore, that one hears so much emphasis on the latter. One finds an increasing number of firms which have historically relied on exports to reach other members of the enlarged community now turning toward direct investment just when the barriers to such exports are being lifted. British Leyland, for example, which has historically relied on exports to reach Continental markets has prepared for British entry into the Community by embarking on an accelerated program of plant acquisition and expansion. The same pattern is to be found in a number of corporate areas, including breweries, food companies and electronics. The rapid pace of merger negotiations and agreements with Continental firms is still another aspect of
Company facilities located near the final consumer provide a better ‘feel’ for the market. Rapidly changing product requirements are behind the efforts of some companies to establish a local presence.
12
Government Sales
For many products sold directly to governments, it is still true that the company which wishes to sell in a particular country must produce in that country. Current EEC efforts and statements point in the opposite direction, but experience has shown that it will be many years before the plans to eliminate this bias can provide a basis for action. Control
Difficult to pin down, but nevertheless vital, is the added control over marketing strategy which the firm with its own locally owned facilities is able to exercise. One of the areas of greatest upheaval currently is the conversion from reliance on import agents to wholly or partly owned sales agencies. In short, plant location is becoming an integral part of the corporate marketing mix. As such, its adjustment to the new
business environment frequently calls for more not less expansion within local European market areas. FOREIGN
EXCHANGE
Expected rate fluctuations are yet another factor encouraging some companies to
move abroad. The EEC has been notably unsuccessful in eliminating or significantly moderating exchange rate fluctuations. Prospects for the future on this score are not optimistic. Regardless of progress in other areas, trade within EEC member countries is still ‘foreign trade’ as regards currency considerations. This will continue to be the case until some distant date when national sovereignty over monetary matters may be yielded to a central EEC authority charged with managing what will in effect be a single Common Market currency. Until then, exchange rate fluctuations will continue to become more, not less important. Since the formation of such a group is directed towards the increased exchange of products among member states, exporters find that their investment abroad in terms of promotion expenditures, distribution facilities and inventories rapidly increasing. The most successful exporters assume the greatest risk. Resort to forward cover, effective in short term situations, is no solution here. For it is the exporters market position which represents his most important investment and this cannot be hedged. Any change in exchange rates is bound to exert an impact on the foreign cost structure of his products within 3-6 months. True, this presents the possibility of gains as well as losses. Ultimately, however, each company in question must ask itself what business it is in. Does it’s competence lie in manipulating different currency positions or is it based on certain skills and transferable assets? If the latter, the prospect of eliminating foreign exchange rate risk by locating within the target market represents a consideration that will have to be balanced against other possibilities, such as locating in low wage countries. BACKDOORS
OF EUROPE
Although great strides have been made toward eliminating government differences between one member of the Common Market and another, the distinctions which remain are substantial. Differences in wages, regional incentives and other regulations continue despite statements and efforts to the contrary. Careful investigation of those areas sometimes referred to as ‘backdoors’ has proved worthwhile for a substantial number of companies. Moreover, there is no short term prospect that these preferential regions will be eliminated. Areas such as the Channel Islands, Ireland, the North of England and the Italian Mezzogiorrno, will continue to offer distinctive advantages in terms of taxes and wage differentials
LONG
RANGE
PLANNING
which the prospective investor cannot afford to overlook. Investment incentives offered to companies locating within their jurisdiction by different local and regional governments will continue to play a major role. Management must exercise considerable judgement in evaluating the different types and amounts of incentive. Although the stated EEC policy is to standardize such aid and to reduce discrepancies in locational incentives among member countries, in practice the implementation of this objective will be extremely difficult to enforce. Incentives to companies locating in specific areas may take a bewildering variety of forms, including programs such as labor training and housing which are also frequently encompassed by national programs outside the scope of the Commission. There is no substitute here for on the spot investigation and talks with local officials.
industrial and less polluted Moselle region. Other companies similarly situated have not always publicized their decisions, but there is little doubt that this factor is playing an ever larger role in corporate expansion considerations. The lead here is being taken by local national) (i.e. authorities. Holland, Germany and France, within the Community, have instituted specific pollution control programs. Since such measures were not anticipated by the Rome treaty, legislation at the Community level has been slower in reaching implementation. However, programs now in process leave little doubt that this will be a major future area of EEC initiative, particularly with reference to plants located in the Rhine basin and along other major commercial waterways. The increasingly onerous cost penalties on plant connected pollution will provide still another incentive for location in less congested regions.
ENVIRONMENTAL
A FRENCH
CONSTRAINTS
One of the most important influences determining new plant location stems from the current wave of concern over the question of pollution and associated environmental problems. The full impact of this phenomenon is only now emerging in the form of action and proposed EEC legislation but its impact on industry is already much in evidence. A West German electronics firm recently decided to cancel its proposed plant in the Saar basin and locate instead in the less
CALIFORNIA
Looking toward the more distant future, one can detect signs of substantial change in the industrial geography of Europe. As Professor Ode11 of Rotterdam University points out, the basis for the present distribution of European industry is being eroded. The present heavy concentration toward the north is largely due to the location of coal and steel deposits there. However, with the energy switch toward gas and oil and the diminished emphasis on heavy metals the rational for this Table
Change
Factor
Present
Situation
northward bias is rapidly disappearing. Will industry continue to concentrate in the north? For the near and middle term future the answer is positive. Having established a comprehensive infrastructure of transportation, communication and skilled labour, rapid change appears to be out of the question. Yet, it would be foolish to overlook the vast potential of Southern Europe as a new centre of industrial concentration based on the more advanced technologies. Particularly for those companies which require a high proportion of highly skilled manpower, i.e. electronics, scientific instruments, etc. the milder climate and outdoor life style of Southern Europe are likely to prove as attractive to the more mobile European of today as they have in the U.S. There is no shortage of indications that this is already happening. To sum up, a number of forces are at work on the European scene which may be depended upon to drastically effect strategic planning of corporate facilities. Greater Geographic Flexibility
The growing freedom to locate production facilities in distant parts of the world while transferring the finished product to the market place is a phenomenon which has already critically influenced the competitive position of many firms. Its impact will no doubt vary from one industry to another, but it would be dangerous to assume that its effects were limited to electronics and, office equipment.
2.
Future
Outlook
Planning
Implications
1
Movement of plants to low wage countries
A few major European firms have established satellite plants for European markets
Sizable trend toward satellite plants, particularly in Eastern Europe
Plants established outside target markets, especially in labour intensive, high value to weight ratio type product
2
Tariff barriers
EEC tariff preferences extend to over 50 countries
European wide free trade in most industrial products
Tariff preferences obtained outside “EEC member” countries opening up new locational opportunities while maintaining EEC preference
3
Marketing benefits of plant location
Influence of marketing variables now more important than wages and other cost elements for many firms
Development of European mass market conditions and competition
More emphasis on facilities investment versus exports in consumer oriented industries. Less emphasis on import agents
4
Regional differences
Substantial differences remain in regional aids, wages, taxes
Gradual elimination of regional differences, but some will persist
Regional differences will continue to influence locational cost picture
5
Attitude towards environment
National and ad hoc measures influencing plant location and pollution control equipment in new plants
Regional legislation defining pollution and other environmental standards
New element raising plant costs in more highly industrial areas
6
New energy sources
Traditional sources, located in Northern European countries still provide the bulk of industrial energy.
Shifting emphasis on oil, nuclear fuel and other forms of energy largely independent of geographic constraints.
Greater freedom to locate areas calculated to attract the most valuable resources of the futurehuman technical and managerial.
FEBRUARY,
1974
13
Automobiles, machine tools, all types of mechanical as well as electrical appliances are suitable candidates. Within the EEC, the affiliation of what we have termed here as Level 111 and Level IV countries presents additional incentive in this direction. Shyting
Trade Barriers
Although there have been temporary setbacks, the downward movement in tariffs and other trade barriers is another important force. Momentum toward a broader more homogeneous market may be expected to continue. The influence here is often toward the side of greater reliance on exports from the home market, but this is not always a dominant consideration. For the broader, more competitive, tariff free area also places a greater emphasis on marketing factors and the marketing effect of exchange rate fluctuations. Environmental
Constraints
Pressures to decrease pollution within the factory as well as in the market place have already taken hold within the EEC. Management, which has generally proved willing to cooperate with such measures must still consider the cost implications and their variability within the EEC. Government
Subsidies and Taxes
Paradoxically, government taxes and various types of subsidies are becoming more important even as they are being reduced. Once of little interest to companies operating largely within their national market, they are becoming increasingly relevant in the new, more mobile business environment of the EEC. Where and how to expand plant capacity is only one aspect of the more general strategy problem posed for management by the changing business environment. None of the preceding comments should be construed as an argument against due consideration of other strategy alternatives -particularly exporting. The latter has already proved to be the source of dramatic sales gains for those firms abandoning (some of them for the first time) the notion that exports comprise a residual market.
14
They have found that pruning and cultivation of previously neglected export agents and outlets can yield surprising dividends. The more basic issue goes beyond the export/foreign investment trade-off. Logically prior to this are a number of decisions bearing on the company’s basic competitive reaction toward the forces set in motion by the widening of the market place. Faced with membership in the Common Market, corporate attitudes in the U.K. vary from “protect the home market” to “let’s get the other fellows customers.” The precise point a company chooses along this spectrum will be a function of its perceptions and priorities. The former reaction is probably the most common and most dangerous, since the pressure of the forces set loose by EEC membership is entirely in the opposite direction, toward market interpenetration. Also, the effort required to stop foreign producers from acquiring even a small segment of the home market can be disproportionate to results. Whatever stance the company chooses, whether defensive or aggressive, the impact of the EEC will be to vastly complicate managements strategy task to the benefit of those companies which can master the new environment and the detriment of others. No easy prescriptions can be offered for dealing with these new complexities. However, many firms would deal more competently with both new and more familiar problems by keeping in mind the most prevalent pitfalls in formulating their expansion strategy. These may be categorized under the following headings: Tunnel Vision
By arbitrarily directing expansion to one part of the world rather than another, management runs the risk of suboptimizing. The key word here is ‘arbitrarily’. Through tradition, precedent or simply management bias, there is a distinct tendency in many companies to focus expansion in a particular part of the world. Often, this is rationalized in terms of some corporate advantages or expertise. This is legitimate enough, where such geographic advantage
in fact exists. However, all too often the evident bias reflects institutional or other factors which have long disappeared. The concentration of British investment in the Commonwealth countries is one example. The factors which once conditioned such expansion have long since altered-yet many British firms have been slow to reflect such change in their expansion strategy. Only a careful weighing of the trade offs between alternatives in all parts of the world can serve as a basis for rational decision making in today’s environment. Passive Planning
Perhaps the most prevalent and painful mistakes begin as a response to outside initiative. Despite all the emphasis given today to Forward Planning and associated skills, I am personally convinced that most expansion takes place as a response to external demands to “look at this part of the world.” A foreign government wants new corporate facilities to alleviate a local labour condition, or an export agent asks that a new plant be built to produce the product in his territory. All legitimate requests and the source of many profitable ventures, but the company that simply reacts to initiatives of this nature has in effect abdicated control. Static Strategy
Whatever else may be said about the emerging foreign business environmentit does not present a static situation. Yet, many companies proceed with expansion abroad as if this were indeed the case. The problem this generates are most obvious with reference tocontractualcommitments. All too often, companies distribute their agencies abroad on a basis of assumed perpetuity of present conditions, with no provision for termination or review of contract. Having sprinkled the globe with long term commitments, they then find alternative arrangements either extremely costly or impracticable. Today’s fast moving international markets require that company strategy anticipates fundamental change at the outset. Any particular corporate configuration in world markets must be regarded as a phase in an evolutionary process whose future character istics are anticipated today. ??
LONG
RANGE
PLANNING
C. Leontiades*
appraisal. Such models are only useful as long as their underlying assumptions are valid. The initial assumptions they make about the real world are crucial to their effectiveness. It is just these, however, which are now changing and throwing doubt on current practice.
Current events in Europe and elsewhere are bringing about far reaching changes in the global business environment, forcing companies to re-examine their basic strategies towards plant location. The companies which have adopted the most sophisticated techniques with theirgreater reliance on highly structured inputs are those which most urgently call for re-appraisal. Such models are useful only as long as their underlying assumptions are valid. The author points out that while there are no easy prescriptions for dealing with the problems in developing a successful location strategy, an awareness of the most prevalent pitfalls would be of considerable advantage.
C
URRENT
EVENTS
IN EUROPE
AND
ELSE-
where are bringing about far reaching changes in the global business environment, forcing companies to re-examine their basic strategy towards plant location. The emergence of a greatly expanded Common Market, reduced tariffs towards the developing non-industrial nations, together with improved transportation technology are only some of the recent innovations causing decision makers in multi-national corporations to review their procedures for locating optimal investment sites abroad. Even those firms which have already implemented the latest in capital budgeting, linear programming and mathematical modelling techniques are encountering ,difficulty adjusting their procedures to the new business situation. in fact, it is the more sophisticated techniques with their greater reliance on highly structured -nputs which most urgently call for rec) Copyright
James Leontiades,
1974.
*Dr. Leontiades is Professor of Management E.I.A.S.M. He was formerly on the staff Manchester Business School.
70
at of
Consider the typical situation of Company X which is attracted by the growing Eureopean market and has decided to study the feasibility for a new plant designed to service this growing potential. The company proceeds to gather information on the nature and distribution of the potential market, European wages and productivity, European site costs, building costs, local regulations, investment incentives and government attitudes and restrictions. These, together with facts which may be peculiar to Company X’s individual circumstances, will then be weighted and analysed to determine the feasibility of alternative European plant sites. This procedure, which worked well enough in the past could prove dangerously misleading today. A number of companies are discovering that the best place for their ‘European plants’ may be in Asia, Africa or Latin America. The tacit link between the target market and rhe new plant built to service that market has been broken. New plants are going up in diverse corners of the developing world aimed at the European market but making full use of the lower wages available elsewhere. Satellite or runaway plants as they have been called are often associated with U.S. companies fleeing U.S. wage rates to produce abroad for the U.S. market. Yet, as a practical matter, planning plant locations for the new EEC will have to take into account the competitive threat by this new possibility. An impressive list of leading European companies are already showing the way: 0 Germany’s Rolleiwerke camera company has set up three subsidiaries in Singapore to export its products on a worldwide basis. Volkswagon’s
Mexican plants produce parts which are exported to Europe as well as the U.S. Besides Rolleiwerke, Grundig, Bayer, Hoechst and Siemens have also joined the move to Singapore. Britain’s Plessey Instruments has set up plants in Malta, Portugal, Barbados and Singapore, to produce a wide variety of products for northern as well as southern European markets. Olivetti supplies its worldwide needs for desk calculators from Latin America. Renault, Mercedez Benz and Fiat are starting operations in Eastern Europe which are scheduled to produce components for Western European markets. Philips, the Dutch firm is setting up a major industrial base in the Far East to supply European and other markets. Corporate Planners have their work cut out for them. As the wage gap between the industrial countries and the developing countries which are potential sites for such plants continues to grow (see Figure 1) so will the need to take into consideration, more explicitly than heretofore, the feasibility of plants completely disassociated from the markets they are aimed at. This will involve such hard to predict variables as future wage rates, union activity, local incentives, development of free trade zones and other incentives, transportation costs and future tariff movements. WHICH
COMMON
MARKET?
Despite the growing importance of satellite plants, most companies building new plants for the Common Market will continue to locate within the enlarged communities tariff barriers-but what are these? Before even beginning to calculate the trade offs between plants located in one EEC country or another, companies must first determine the outlines of the new tariff structure which defines the Common Market. This will not be as simple as it
LONG
RANGE
PLANNING
(Dollars
per
Hour
40
More
will have several levels of membership (see Table I). First, there will be the full members, i.e., those that take part in all of the economic and political aspects of the group as set out in the Treaty of Rome. On this level, we may expect tariff free trade of industrial products within an
Paid in U.S.)
g
z
increasingly
Singapore
Taiwan
Thailand
El Salvador
Guatemala
South
Figure
Korea
1. Widening
Wage Gap. Amount by which U.S. Wages Exceed CDC’s. 1964 (shaded) and 1969 (unshaded).
Source: Derived from United
Nations
and International
those
Labor Office data.
Note: Wage differentials shown refer to average hourly wages paid in manufacturing. paid by satellite plants may be significantly higher.
might seem. The community long ago outgrew the six country members that signed the Rome treaty. It is not a matter of six or even ten countries which must be considered but the 55 or so countries which have associated themselves with the community as it has developed. The community has proved to be a very dynamic organisation, continually growing in terms of membership and continually altering the ties linking one member to another. It is safe to assume that within the lead time necessary to construct a new plant and make it operative (34 years) it will have altered still further. What is needed then is not so much a definition of present tariff barriers as a projection of future barriers. What will the Community look like 10 years from now-that is the question which plant location must take into consideration. It is a crucial question whose answer will seriously influence the decisions made for this part of the world. The new Common Market now emerging
FEBRUARY,
1974
of selected
Actual wages
homogenious
industrial
frame-
work of laws governing mergers, competition and industrial standards. Closely associated with these countries will be the important group referred to in Table 1 as ‘Free Trade Associates’. The national markets represented here will be virtually a part of the ‘Common Market’ as regards industrial trade. Corporations planning their future exampansion strategy must consider the present and future interrelationships between these two groups. If history is any guide, the two will move even closer together eventually forming a single industrial market of 16 countries and a population of over 300 million people. This is not to deny that real differences in taxes, social policies and location incentives will persist for at least another decade. It is this mixture of commonality together with key areas of national difference, the precice combination changing over time, which represents perhaps the major planning challenge of the new EEC. The other two levels of EEC membership are comprised of less industrial countries. Level III countries have a number of differing treaty relationships with the Level 1 group which vary from one Level III country to another. In general, these offer the possibility of preferential access to EEC markets for the products of these countries
Table 1. EEC Structure.
Levels of Membership*
Market
I. Full Members: Belgium, France, Italy, Netherlands, Luxembourg, W. Germany, Britain, Denmark, Ireland
Free trade in industrial and agricultural products. Progress toward reduction of legal and monetary differences together with free movement of capital and labour.
I I. Free Trade Associates: Austria, Finland, Sweden, Portugal, Norway
Free trade in industrial products between each other and countries in Group I.
Switzerland,
Iceland,
I I I. Mediterranean Associates: Israel, Tunisia, Morocco, Algeria, Libya, Malta, Greece, Turkey, Egypt, Cyprus, Spain IV. Developing Countries Associates: Senegal, Malim, Niger, Ivory Coast, Dahomey, Togo, Cameroon, Chad, Central African Republic, Congo, Madagascar, Burundi, Rwanda, Somalia, Mauritania, Upper Volta, Gabon, Kenya, Tanzania, Uganda, Nigeria. Gambia, Ghana, Malawi, Sierra Leone, Botswana, Lesotho Swaziland, Mauritius, F&V, Tonga, Western Samoa, British Commonwealth Islands in the Carribean, Pacific and Indian Oceans *Those with membership
pending
are italicized.
Relationship
Selective reductions in trade barriers between countries at this level and those in Groups I and II. Developing preferential
countries whose goods have access to Common Market.
while permitting access to their own markets for Level I exports in certain product categories. Level IV countries enjoy preferential access for many of their products (primarily agricultural products and raw materials) into Level I. In the past they have also offered entry into their markets at a preferential rate for exports from Level I, though future prospects for such ‘reverse preferences’ are in considerable doubt as of this writing. Nevertheless, the affiliation of this important group of countries within the EEC presents major opportunities for the supply of certain products produced in these countries on a tariff free basis to plants located in Level I. Looking further into the future, there is little doubt that the affiliation of these last two groups with the EEC will open up additional possibilities. Particularly, it may be expected that some of the Level III group will apply for Level II membership, joining the industrial free trade area while offering substantially lower wage costs to plants located there.
the move to acquire foreign production facilities within the new tariff free area. The dominant motivating factor here is a perceived need to be closer to the market. With the British initiated expansion, the EEC will take on the dimensions of a true mass market. The more competitive situation this implies is already putting pressure on consumer oriented companies to emphasize a number of marketing variables which, although sometimes omitted from formal calculations, are nevertheless assuming an increasingly important role. Delivery Time
Shorter delivery times are becoming an ever more important competitive variable. The wider choice of consumer products made available by the lowering of trade barriers has meant the long patient European consumer, no longer has to wait as long for producers to supply his needs. The pressures on delivery times gives advantage to local investment facilities over imports with their generally longer waiting period.
THEORY vs. PRACTICE
Market Feedback
The enlarged EEC brings together Europe’s two major industrial centres, the northern European industrial complex beginning with Hamburg in the north and extending south through the Ruhr, Belgium and on towards Paris, together with the British industrial complex. This poses a special problem. Theoretically, the removal of tariff barriers now taking place between these two industrial concentrations would seem to strengthen the case for exporting from one to the other, i.e. if you have a plant in one of the member countries(Leve1 I or II, seeTable 1) exports would seem the logical way of reaching the new markets opened up by the enlarged community, rather than investment in new plants and facilities. It is strange therefore, that one hears so much emphasis on the latter. One finds an increasing number of firms which have historically relied on exports to reach other members of the enlarged community now turning toward direct investment just when the barriers to such exports are being lifted. British Leyland, for example, which has historically relied on exports to reach Continental markets has prepared for British entry into the Community by embarking on an accelerated program of plant acquisition and expansion. The same pattern is to be found in a number of corporate areas, including breweries, food companies and electronics. The rapid pace of merger negotiations and agreements with Continental firms is still another aspect of
Company facilities located near the final consumer provide a better ‘feel’ for the market. Rapidly changing product requirements are behind the efforts of some companies to establish a local presence.
12
Government Sales
For many products sold directly to governments, it is still true that the company which wishes to sell in a particular country must produce in that country. Current EEC efforts and statements point in the opposite direction, but experience has shown that it will be many years before the plans to eliminate this bias can provide a basis for action. Control
Difficult to pin down, but nevertheless vital, is the added control over marketing strategy which the firm with its own locally owned facilities is able to exercise. One of the areas of greatest upheaval currently is the conversion from reliance on import agents to wholly or partly owned sales agencies. In short, plant location is becoming an integral part of the corporate marketing mix. As such, its adjustment to the new
business environment frequently calls for more not less expansion within local European market areas. FOREIGN
EXCHANGE
Expected rate fluctuations are yet another factor encouraging some companies to
move abroad. The EEC has been notably unsuccessful in eliminating or significantly moderating exchange rate fluctuations. Prospects for the future on this score are not optimistic. Regardless of progress in other areas, trade within EEC member countries is still ‘foreign trade’ as regards currency considerations. This will continue to be the case until some distant date when national sovereignty over monetary matters may be yielded to a central EEC authority charged with managing what will in effect be a single Common Market currency. Until then, exchange rate fluctuations will continue to become more, not less important. Since the formation of such a group is directed towards the increased exchange of products among member states, exporters find that their investment abroad in terms of promotion expenditures, distribution facilities and inventories rapidly increasing. The most successful exporters assume the greatest risk. Resort to forward cover, effective in short term situations, is no solution here. For it is the exporters market position which represents his most important investment and this cannot be hedged. Any change in exchange rates is bound to exert an impact on the foreign cost structure of his products within 3-6 months. True, this presents the possibility of gains as well as losses. Ultimately, however, each company in question must ask itself what business it is in. Does it’s competence lie in manipulating different currency positions or is it based on certain skills and transferable assets? If the latter, the prospect of eliminating foreign exchange rate risk by locating within the target market represents a consideration that will have to be balanced against other possibilities, such as locating in low wage countries. BACKDOORS
OF EUROPE
Although great strides have been made toward eliminating government differences between one member of the Common Market and another, the distinctions which remain are substantial. Differences in wages, regional incentives and other regulations continue despite statements and efforts to the contrary. Careful investigation of those areas sometimes referred to as ‘backdoors’ has proved worthwhile for a substantial number of companies. Moreover, there is no short term prospect that these preferential regions will be eliminated. Areas such as the Channel Islands, Ireland, the North of England and the Italian Mezzogiorrno, will continue to offer distinctive advantages in terms of taxes and wage differentials
LONG
RANGE
PLANNING
which the prospective investor cannot afford to overlook. Investment incentives offered to companies locating within their jurisdiction by different local and regional governments will continue to play a major role. Management must exercise considerable judgement in evaluating the different types and amounts of incentive. Although the stated EEC policy is to standardize such aid and to reduce discrepancies in locational incentives among member countries, in practice the implementation of this objective will be extremely difficult to enforce. Incentives to companies locating in specific areas may take a bewildering variety of forms, including programs such as labor training and housing which are also frequently encompassed by national programs outside the scope of the Commission. There is no substitute here for on the spot investigation and talks with local officials.
industrial and less polluted Moselle region. Other companies similarly situated have not always publicized their decisions, but there is little doubt that this factor is playing an ever larger role in corporate expansion considerations. The lead here is being taken by local national) (i.e. authorities. Holland, Germany and France, within the Community, have instituted specific pollution control programs. Since such measures were not anticipated by the Rome treaty, legislation at the Community level has been slower in reaching implementation. However, programs now in process leave little doubt that this will be a major future area of EEC initiative, particularly with reference to plants located in the Rhine basin and along other major commercial waterways. The increasingly onerous cost penalties on plant connected pollution will provide still another incentive for location in less congested regions.
ENVIRONMENTAL
A FRENCH
CONSTRAINTS
One of the most important influences determining new plant location stems from the current wave of concern over the question of pollution and associated environmental problems. The full impact of this phenomenon is only now emerging in the form of action and proposed EEC legislation but its impact on industry is already much in evidence. A West German electronics firm recently decided to cancel its proposed plant in the Saar basin and locate instead in the less
CALIFORNIA
Looking toward the more distant future, one can detect signs of substantial change in the industrial geography of Europe. As Professor Ode11 of Rotterdam University points out, the basis for the present distribution of European industry is being eroded. The present heavy concentration toward the north is largely due to the location of coal and steel deposits there. However, with the energy switch toward gas and oil and the diminished emphasis on heavy metals the rational for this Table
Change
Factor
Present
Situation
northward bias is rapidly disappearing. Will industry continue to concentrate in the north? For the near and middle term future the answer is positive. Having established a comprehensive infrastructure of transportation, communication and skilled labour, rapid change appears to be out of the question. Yet, it would be foolish to overlook the vast potential of Southern Europe as a new centre of industrial concentration based on the more advanced technologies. Particularly for those companies which require a high proportion of highly skilled manpower, i.e. electronics, scientific instruments, etc. the milder climate and outdoor life style of Southern Europe are likely to prove as attractive to the more mobile European of today as they have in the U.S. There is no shortage of indications that this is already happening. To sum up, a number of forces are at work on the European scene which may be depended upon to drastically effect strategic planning of corporate facilities. Greater Geographic Flexibility
The growing freedom to locate production facilities in distant parts of the world while transferring the finished product to the market place is a phenomenon which has already critically influenced the competitive position of many firms. Its impact will no doubt vary from one industry to another, but it would be dangerous to assume that its effects were limited to electronics and, office equipment.
2.
Future
Outlook
Planning
Implications
1
Movement of plants to low wage countries
A few major European firms have established satellite plants for European markets
Sizable trend toward satellite plants, particularly in Eastern Europe
Plants established outside target markets, especially in labour intensive, high value to weight ratio type product
2
Tariff barriers
EEC tariff preferences extend to over 50 countries
European wide free trade in most industrial products
Tariff preferences obtained outside “EEC member” countries opening up new locational opportunities while maintaining EEC preference
3
Marketing benefits of plant location
Influence of marketing variables now more important than wages and other cost elements for many firms
Development of European mass market conditions and competition
More emphasis on facilities investment versus exports in consumer oriented industries. Less emphasis on import agents
4
Regional differences
Substantial differences remain in regional aids, wages, taxes
Gradual elimination of regional differences, but some will persist
Regional differences will continue to influence locational cost picture
5
Attitude towards environment
National and ad hoc measures influencing plant location and pollution control equipment in new plants
Regional legislation defining pollution and other environmental standards
New element raising plant costs in more highly industrial areas
6
New energy sources
Traditional sources, located in Northern European countries still provide the bulk of industrial energy.
Shifting emphasis on oil, nuclear fuel and other forms of energy largely independent of geographic constraints.
Greater freedom to locate areas calculated to attract the most valuable resources of the futurehuman technical and managerial.
FEBRUARY,
1974
13
Automobiles, machine tools, all types of mechanical as well as electrical appliances are suitable candidates. Within the EEC, the affiliation of what we have termed here as Level 111 and Level IV countries presents additional incentive in this direction. Shyting
Trade Barriers
Although there have been temporary setbacks, the downward movement in tariffs and other trade barriers is another important force. Momentum toward a broader more homogeneous market may be expected to continue. The influence here is often toward the side of greater reliance on exports from the home market, but this is not always a dominant consideration. For the broader, more competitive, tariff free area also places a greater emphasis on marketing factors and the marketing effect of exchange rate fluctuations. Environmental
Constraints
Pressures to decrease pollution within the factory as well as in the market place have already taken hold within the EEC. Management, which has generally proved willing to cooperate with such measures must still consider the cost implications and their variability within the EEC. Government
Subsidies and Taxes
Paradoxically, government taxes and various types of subsidies are becoming more important even as they are being reduced. Once of little interest to companies operating largely within their national market, they are becoming increasingly relevant in the new, more mobile business environment of the EEC. Where and how to expand plant capacity is only one aspect of the more general strategy problem posed for management by the changing business environment. None of the preceding comments should be construed as an argument against due consideration of other strategy alternatives -particularly exporting. The latter has already proved to be the source of dramatic sales gains for those firms abandoning (some of them for the first time) the notion that exports comprise a residual market.
14
They have found that pruning and cultivation of previously neglected export agents and outlets can yield surprising dividends. The more basic issue goes beyond the export/foreign investment trade-off. Logically prior to this are a number of decisions bearing on the company’s basic competitive reaction toward the forces set in motion by the widening of the market place. Faced with membership in the Common Market, corporate attitudes in the U.K. vary from “protect the home market” to “let’s get the other fellows customers.” The precise point a company chooses along this spectrum will be a function of its perceptions and priorities. The former reaction is probably the most common and most dangerous, since the pressure of the forces set loose by EEC membership is entirely in the opposite direction, toward market interpenetration. Also, the effort required to stop foreign producers from acquiring even a small segment of the home market can be disproportionate to results. Whatever stance the company chooses, whether defensive or aggressive, the impact of the EEC will be to vastly complicate managements strategy task to the benefit of those companies which can master the new environment and the detriment of others. No easy prescriptions can be offered for dealing with these new complexities. However, many firms would deal more competently with both new and more familiar problems by keeping in mind the most prevalent pitfalls in formulating their expansion strategy. These may be categorized under the following headings: Tunnel Vision
By arbitrarily directing expansion to one part of the world rather than another, management runs the risk of suboptimizing. The key word here is ‘arbitrarily’. Through tradition, precedent or simply management bias, there is a distinct tendency in many companies to focus expansion in a particular part of the world. Often, this is rationalized in terms of some corporate advantages or expertise. This is legitimate enough, where such geographic advantage
in fact exists. However, all too often the evident bias reflects institutional or other factors which have long disappeared. The concentration of British investment in the Commonwealth countries is one example. The factors which once conditioned such expansion have long since altered-yet many British firms have been slow to reflect such change in their expansion strategy. Only a careful weighing of the trade offs between alternatives in all parts of the world can serve as a basis for rational decision making in today’s environment. Passive Planning
Perhaps the most prevalent and painful mistakes begin as a response to outside initiative. Despite all the emphasis given today to Forward Planning and associated skills, I am personally convinced that most expansion takes place as a response to external demands to “look at this part of the world.” A foreign government wants new corporate facilities to alleviate a local labour condition, or an export agent asks that a new plant be built to produce the product in his territory. All legitimate requests and the source of many profitable ventures, but the company that simply reacts to initiatives of this nature has in effect abdicated control. Static Strategy
Whatever else may be said about the emerging foreign business environmentit does not present a static situation. Yet, many companies proceed with expansion abroad as if this were indeed the case. The problem this generates are most obvious with reference tocontractualcommitments. All too often, companies distribute their agencies abroad on a basis of assumed perpetuity of present conditions, with no provision for termination or review of contract. Having sprinkled the globe with long term commitments, they then find alternative arrangements either extremely costly or impracticable. Today’s fast moving international markets require that company strategy anticipates fundamental change at the outset. Any particular corporate configuration in world markets must be regarded as a phase in an evolutionary process whose future character istics are anticipated today. ??
LONG
RANGE
PLANNING