- Effects on Business
There are both positive and negative affects that relocation can have on businesses. These will now be identified and discussed.
- Benefits
Low Costs
Lower cost is the main reason why companies choose to relocate in the first place. These can be divided into production costs and employment costs.
Many suppliers to automotive companies are pushed into keeping costs as low as possible, therefore, making parts cheaper to buy and increasing profit margins. Whilst squeezing margins, this can also have a positive effect on suppliers to become more efficient. One method is for the supplier to also relocate. Another option for companies would be to switch to local suppliers. Production costs are lower in these countries because of exchange rates since these members are yet to adopt the Euro. Relocation would also mean that companies can avoid import tariffs and other related costs, and therefore increase profit margins.
Employment costs not only include wages, but also healthcare benefits and pensions. Since the introduction of the Euro, it has been easier to compare employment costs across Europe. The Euro is the single currency for 12 of the 25 current member countries and so employers are able to monitor employment cost differentials more easily. Labour costs are roughly one fifth of those in the richer parts of Europe. The graph below compares the employment costs within the EU with key competitor countries:
Figure 2 – Comparison of Employment cost
It can be seen that Estonia, Slovakia and Latvia are the cheapest when comparing employment costs within the European Union. Costs are significantly lower than China, but are double the costs in India. If companies pay out lower wages and benefits, its profit margins increase as well as the overall profits of the company. Eastern European countries have a lower wage cost, because there is a lower standard of living and have less developed economies.
Location
Eastern Europe is a key location into potential new growth markets. Originally these production plants were set up to satisfy local demand, as Western European markets became over saturated. With an increase in the growth of these economies, the standards of living are on the increase and therefore consumers can have more disposable income. Eastern Europe is also very close to the west and therefore production can also service these markets.
Labour Pools
Since the fall of communism these countries have experienced a high unemployment rate due to the shortage of jobs and excess labour. This was due to the government controlling resources and the lack of foreign investment. There is therefore a large willing labour pool that are flexible in terms of working hours, which companies are able to exploit. Most employees are willing to work 40-42 hours per week and there are quite often a lot fewer holidays available. Whereas in Western Europe there is often generous overtime or nightshift benefits that are considerable disadvantages to companies. The sudden boom of growth has not been confined to manufacturing but also to all sectors, and there are potential signs of labour shortages, even though unemployment levels are still at around 11%. Companies have taken measures in spite of this concern. For example, Elcoteq started transporting 150 workers from Narva (northeast region of Estonia) to work at its big mobile-phone plant in the capital, Tallinn.
Incentives
There are two main methods of incentives, indirect or direct. Indirect incentives are generally tax breaks or exemptions. However, over the last few years flat tax is becoming more popular. Flat tax, in relation to corporate tax, means that there is only one single rate that all companies pay regardless of the level of profits. This system has proven popular in Slovakia, who introduced the system in 2003, with a rate of 13% on corporate profits and personal income. Slovakia also offers ten-year tax breaks of up to 50% for a minimum of €1.2 million invested. A flat tax is considered beneficial to the country as it reduces the incentive to avoid paying taxes; companies are more willing to pay taxes and less likely to hide profits. It can also lead to more foreign investment because the treatment is more attractive than companies’ home countries. UK, France and Germany are examples of many states that still impose tax brackets.
Direct incentives include grants and subsidies. These are offered by governments to companies in order to help offset the risk and costs involved in creating a new production plant within their country. However, the EU has limited the value of subsidies offered to countries. For example, the Czech Republic offers incentives of up to 50% of eligible costs for job creation and training/retraining programmes. The minimum investment volume is equivalent to between €3 – 6 million.
Additionally, the EU itself has provided the new member states with almost €22 billion in order to help automotive manufacturers to construct new production facilities. The incentive limit varies for large companies, but is between 20-50% of eligible investment costs. For small to medium enterprises (SMEs), this threshold can be as high as 50%.
- Drawbacks
There are however drawbacks in relocating to Eastern Europe, which will now be discussed:
Redundancies
As automotive companies shut down production plants, it is causing many employees to become redundant. This has angered many trade unions believing it to be “unfair” to its members since they cannot compete against the attraction of lower costs in Eastern Europe. It may also be hard for these former employees to find new jobs because of lack of skills and qualifications.
By relocating to Eastern Europe, many companies would prefer to take over existing plants and factories as this would mean a saving in cost, however in doing this, it would lead to redundancies in the former staff that worked there before. This is due to Western European companies bringing in new technology to the existing “old” Eastern European factories. With newer technology, efficiency is improved and more and more work is carried out by robots and computers. Because of this, less human employees are needed; meaning those that are nearer the unskilled end of the workforce will be most definitely made redundant. Even though the new companies will probably try to retrain the existing workforce to be up to date with using the new technology, less people are required to operate the machinery. As people are made unemployed, this will cause bad relations with trade unions, causing more unnecessary problems for companies. If they are unlucky, the trade unions may make the problem bigger and ask for compensation as well as making bad publicity for the company. This could seriously affect the future of the company in that particular country or even neighbouring countries.
Regulation
Another drawback would be regulations. By relocating to Eastern Europe, some countries may have certain regulations which may hinder the progress of companies. This may include regulations to do with taxes incurred due to movement of labour or capital, or certain restrictions for new companies entering their market. Regulations do not just include the Eastern European country’s regulations, but also include those in the EU. An example of this would be the Working Time directive. This was brought into effect in 1993 and was concerned with how many hours were allowed for each person to work in a week. This was set at 48 hours due to health and safety regulations, however there were agreements called “opt-outs” which workers could sign to be able to work more than 48 hours (in certain circumstances). Due to this restriction on man hours, companies would have to structure their staff so as to optimize their workforce to be more efficient. In 2003, there were 2 court rulings which stated that when doctors were “on-call”, they were considered to be on “working time”. This caused problems as countries had to raise their spending in the health sector. This may cause problems for companies because if they had a lot of machinery, they would therefore have technicians “on-call”. If the same thing happens to technicians as did to the doctors, companies would have to raise their costs to gain 24-hour technical support for their machinery.
Limitation of growth
Although there is huge potential growth, currently the significance of these markets is limited by substantially lower wages and purchasing power. Most consumers in these markets prefer to purchase second hand cars as brand new ones are often unaffordable. Now much of production is exported and is used to supply Western Europe. Output in this region, however, is only at three million cars per annum and quite low compared to total output in Europe of eighteen million. Although in the last five years output has grown by 27%, compared with little or no growth in the traditional areas of Europe. Therefore, although the future prospects are more certain, currently this market is still under-developed.
Insufficient infrastructure
When relocating to Eastern European countries, most of the time companies will be building on Greenfield sites (69% of the time – see graph below). This is due to the countries having insufficient infrastructure. This would be another cost that a company would have to take on if they so wish to move to that country. They would have to weigh out the options between the cost of building a new plant in a less developed country or taking over an existing plant in a more developed country.
Figure 3 – Greenfield versus Brownfield sites
Language Barriers
Moving to Eastern Europe would mean moving to a different country. This can be a major problem for companies if they were to employ local workers and/or use local suppliers. Even though English is the universal language used, it would still be hard to communicate if both sides were not fluent in it. Because of this, it may cause misunderstandings, which could end up costing the company financially and may potentially damage relations with other firms.
Insufficient management capabilities
Due to the distance from the home country and Eastern European country, it is not always possible to keep checks on the new plant. To combat this, companies would have to employ trustworthy and reliable managers to look over all the workings of the new plant. However, problems include whether to send employers from their home country abroad or to hire local people. The problem with sending their own workers abroad would be that there may be certain legal or tax problems that may waste companies’ time and money. However, with hiring local managers, there is the problem of trust and whether he/she is capable to do the job, as the company would not have any knowledge of the employees’ previous experience.
Transferability of profits
One major problem is the transferability of profits. This is transferring profits from an Eastern European country back to the home country. Most of the time it is relatively simple; however there are some countries that require a submission of resolution on requisition of profits or the companies have to register transfers with authorities. This could hinder the company’s progress and cause unexpected costs to occur through the regulations and the time taken for the profits to be transferred. It could result in double taxation, which is where a company is taxed by its home country and by the country it operates under. This can decrease profits and increase the bureaucracy that companies must face. Although, this is becoming less of a problem as the number of double tax treaties between countries are increasing. For example the UK has by far the most with over 100 Double Taxation Conventions.
Collaboration
When moving to a new country, it would be wise to maybe think about collaborating with local partners so as to obtain information on the market status in that particular country. However, it was found that 65% did not (see graph below) and decided to relocate by themselves. This would not be very advantageous as without collaboration, the company would be missing out on valuable benefits such as financial incentives given to those companies who collaborate with local groups, access to important local networks to help build up a customer base quicker, valuable information on the area to help with the building of infrastructure and possibly a local workforce, meaning cheaper labour and lower costs. However, even if companies do cooperate with local groups there are dangers of finding the right partner and the reliability of local companies.
Figure 4 – Whether companies should collaborate with regional partners or not
Others
Other problems include things such as corruption (which is possible in very under-developed countries), the degree of local influence (meaning how strong the community is within that country and whether it will affect the plant in any way) and quality control (as it is hard to keep quality at the same level as in the home country because the companies are running on lower costs than before).
- Implications
Political
There has been strong opposition from some Western European countries (mainly France and Germany) against relocation of many companies. This has been due to the fact that these countries are home to many of the best-known brands such as Volkswagen and have the biggest economies in the EU. They have also opposed the movement of labour across borders from Eastern European countries. It would mean that there are high job losses, increasing unemployment levels, which already stand at a high percentage, and is a sign of the economic difficulties within these economies. Additionally, relocation marks France and Germany’s lack of competitiveness.
Avoiding Tariffs
By relocating to Eastern Europe, companies tend to move to countries within the EU, so as to avoid tariffs. As the EU is a customs union, all countries in the EU can have the benefit of no internal tariffs with a common external tariff. With no internal tariffs, the company can freely move their capital and labour across borders into other member states. This makes the prospect of relocating to Eastern Europe even more desirable as labour is relatively cheap and the costs are very low to start up a plant compared to in their home country.
Language barriers
To avoid language barriers, companies could send their own employees to the Eastern European countries and keep the company culture that they had in their home country. Even though it would be more expensive, the company could do this initially to help train or retrain the staffs that are there, so as to get them updated with the company values and objectives. This way, there would be less redundancies and protect the companies from trade unions.
Suppliers
A way that suppliers could keep their customers would be to relocate where their customers move to. This way, the company would still use the supplier (as they would know each other already, making things easier and run more smoothly) and the supplier would not lose its customers. It is not uncommon for suppliers to follow companies to other countries, and it would be easier now as it would be cheaper to move to Eastern Europe from Western Europe. With no internal tariffs, the suppliers would get the same benefits as the companies and be able to freely trade and move their labour and capital across borders. There is however the additional start-up costs associated with relocation, which would affect the supplier in the short-term.
- Conclusion
Based on performance on the global automotive market, it can be concluded that the European automotive industry is competitive. However, success in the future is clearly not guaranteed. Japanese manufacturers are equally strong in investing in automotive innovations and US producers are taking advantage of not only the large home market but have also pursued internationalisation strategies for years. There has been a sharp decline in the competitiveness of the EU as a whole and this trend must be reversed. In order to improve the automotive sector, the European Commission set up CARS 21 in January 2005 in order to improve the regulatory framework within EU. The work by this body can be divided into four distinct areas; better regulation, competitiveness, environment and road safety. This is one of the methods of increasing the competitiveness. Nevertheless, the automotive industry is facing rising costs. For example, there is pressure for automobiles to become more environmentally friendly and the reduction of emissions. Companies are beginning to research new ways to combat emission levels, but this comes at a high price.
Therefore, in order to reduce costs many automotive companies must relocate and it is believed that this trend will increase in years to come as automotive companies struggle to retain margins. There has been some opposition from France and Germany against this. However, the main objective of expansion of the EU is to create a single European market, which can remain competitive in international markets and that can benefit from fewer trade boundaries internally. Full integration cannot exist without full cooperation between member states. Otherwise the EU as a whole cannot be successful and harmonisation cannot move forward.
Bibliography
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http://www.emcc.eurofound.eu.int/content/source/tn04005a.html?p1=sector&p2=Motor
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Ernst & Young study: Automotive manufacturing in Western Europe Under Threat? Automotive Industry Making Inroads into Eastern Europe and China
European Foundation for the Improvement of Living and Working Conditions report: Trends and drivers of change in the European automotive industry: Mapping report
