Consumer companies that source and manufacture products in Asia might do better to explore opportunities closer to the markets they want to serve. Research conducted over the past few years confirms that, contrary to popular belief, Central and Eastern Europe (CEE), especially Poland, offers features that make the region highly competitive with Asian countries.
– For many companies selling goods in Western Europe or North America costs are competitive with Asian countries
– CEE markets will continue to grow for at least the next several years
– CEE countries offer exceptional capabilities and productivity
– Several CEE countries offer business environments that are more favorable than Asian countries
Traditionally, companies have based outsourcing decisions on simple cost comparisons. Today, however, for many industries, the decision between CEE and Asia cannot be made on cost alone. Our research reveals that for many product categories sold into Western Europe or North America, total landed costs are essentially equivalent whether the product is manufactured in Asia or in CEE. In some cases, in fact, CEE countries have an actual cost advantage over Asia. In many other instances, the cost differential is small or negligible.
If the costs to serve Western European or North American markets from CEE or Asia are essentially equivalent, companies must look deeper into each product line to decide where to go. They should take into consideration a number of strategic factors, including the risk of port congestion, local market potential, opportunities for capitalizing on local talent, and the general business environment in each country, especially various kinds of business risk.
As we noted at the outset, CEE can be a highly competitive location for sourcing and production, in terms not only of total landed costs (which are lower in part because port congestion is slowing the Asian supply chain) but also of strong local markets, top-notch capabilities, and a favorable business climate. On a number of measures—the availability of skilled labor and qualified engineers, the competence of senior management, and various kinds of political and operational risk, CEE countries compare very favorably with China and other rapidly developing economies (RDEs) in Asia.
Many companies, of course, are already operating in CEE. Surprisingly, however, CEE’s share of production for Western European markets is lower than it should be, given the region’s relative advantages. Research suggests that misperceptions about the region, combined with the tremendous attention recently afforded China, have led some companies to ignore CEE and take much of their sourcing and manufacturing to Asia. An objective analysis of the CEE region, particularly as compared with China, suggests that those companies are overlooking highly desirable sourcing and manufacturing
Competitive Costs
Clearly, some RDEs have lower labor costs than others. But it is important to consider how large a factor labor is in each product.
Labor in CEE countries typically costs four to ten times less than in Western Europe. Even so, the cost of blue-collar labor in CEE is on average three times higher than in China. On the surface, that differential might appear to make a decisive difference in overall cost. In fact, however, it often works out to be nearly negligible. For instance, for a product whose labor content (direct plus overhead) amounts to 30 percent of its cost, the difference in total labor cost between manufacturing in China and in CEE amounts to less than 3 percent of total cost, and that’s before taking into account China’s transportation penalty.
Moreover, in the newly emerging CEE economies, such as Belarus, Romania, and Ukraine, labor rates are even lower than in the more developed CEE economies. Sourcing from these countries to serve Western Europe can be much more economical than sourcing from China and other Asian countries.
As companies recognize this opportunity, investment in the region is accelerating. Differences in labor costs between high-cost and low-cost countries will not remain constant, but the fundamental sources of advantage are likely to stay relatively fixed for many years. Nonetheless, companies that are designing global sourcing strategies would be prudent not to focus exclusively on one region but to manage their sourcing in classical portfolio terms, putting some in China and some in CEE. The question we are addressing here is which region to use to serve Western Europe.
A Way Around Port Congestion
Most materials from China enter Europe by ship, and most of Western Europe’s largest ports, which are operating nearly at capacity, are increasingly dealing with congestion, labor shortages, and strained networks. Although Far Eastern ports have been able to expand quickly enough to handle more shipments, European destination ports are constrained by stringent environmental and planning rules, which allow for only modest expansion at best. When you factor in transportation costs to Western Europe, along with the costs of labor, materials, and inventory, China’s cost advantage declines to 2 percent at most. In many industries, the CEE region actually has an advantage in total landed costs.
Total landed costs to Western Europe differ between CEE and China for 20 general product categories before supply chain variability is taken into account; when China’s longer lead-times and higher lead-time variability (both of which are increasing as a result of port congestion) are taken into account, CEE’s relative advantages become quite compelling. As stated above, it is important to understand for each product line, how different RDE locations affect cost, quality, lead-time, supply chain dynamics, and other factors.
As might be expected, China provides the largest share of imports into Western Europe in the industries where it is advantaged (although, as just noted, that advantage is quite small); in these industries, China’s share of imports amounts to almost 70 percent. However, even where CEE has a cost advantage vis-à-vis China, its share of imports into Western Europe is only 57 percent. Clearly, in bypassing CEE, companies are overlooking a cost-saving opportunity.
A Growing Market Opportunity
CEE represents an attractive and growing market opportunity. While the region is much smaller than China, with 380 million population versus 1.3 billion, it generates nearly the same GDP and nearly four times as much GDP per capita. CEE consumers represent a market that is only beginning to be tapped. Naturally, CEE is far from monolithic, as it consists of 14 national markets, each with its own language or languages and culture. Such variety no longer poses the significant challenges that it once did: many companies have learned to target regional sub-segments. For example, some beverage companies offer different brands of their products in different countries. They also offer different flavors to satisfy different national preferences. And some companies have addressed the diversity within CEE by choosing to focus on its five largest markets: Russia, Turkey, Poland, Czech Republic, and Hungary, which together represent almost $1 trillion of GDP.
Excellent Talent Pools
CEE provides a pool of skilled laborers and qualified engineers who are generally more educated than those in other RDEs.
In some CEE countries, levels of skill and training are competitive with those in more developed countries. Throughout the region, both the availability and the quality of the skilled work force are very high. Workers in CEE are also more akin to those in most multinational companies in terms of language, education, training, and culture than are workers in China. The percentage of the population that speaks English continues to increase and is particularly high among the labor pool of people under age 40. In the Czech Republic, for example, almost 15 percent of people aged 24 to 30 actively use English or claim knowledge of English equal to their knowledge of their mother tongue. German and French are also widely spoken.
A Favorable Business Environment
The major countries in the CEE region, such as Poland and the Czech Republic, compare favorably with China and other Asian RDEs in terms of various kinds of risk. Political, legal, and regulatory risks are currently significantly lower in these countries than in China.
So is intellectual property risk an area in which China is known to harbor a host of issues. Of course, intellectual property risk, like other elements of the business environment, varies greatly among CEE countries. Russia, for all its resources and large end-market potential, is comparable to China in terms of risk.
In contrast, the new European Union (EU) member states (including Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, and Slovenia) represent a more secure business environment, with regulations governing intellectual property rights being harmonized with EU standards. Infrastructure also affects the business environment. CEE can often offer much more convenient, faster, and cheaper communication links with Western Europe than can China.
The new EU member states will benefit not only from shorter transit times within the EU but also from significant investments in highway networks and other transportation infrastructure. And then there are other, less tangible but very important factors, such as the ease of managing plants that are in the same time zone as headquarters; the cost and the ease of travel back and forth between sites; and the efficacy of management across similar cultures.
Such factors are harder to quantify than labor costs and market growth rates, but they can have a disproportionate impact on RDE operations, sometimes determining the difference between success and failure.
Companies should take a portfolio approach to each sourcing decision, analyzing a variety of locations for each product line and carefully weighing all the factors that make up each location’s unique business opportunities and challenges. For most global companies, China is important as a market, a low-cost sourcing and manufacturing base, and a source of talent, and therefore should be taken into account. However, consumer companies designing RDE sourcing strategies specifically to serve Western Europe or North America owe it to themselves to give Central and Eastern Europe serious consideration as well.