Something new is in the air in Europe: optimism. Growth of 2.8% rivals that of the U.S. Unemployment is falling. Exports are booming. Even in Germany, notorious for its pessimism, the spirits of both consumers and businesses are at all-time highs. Europe, famously hobbled by its rigidity, suddenly seems like a land of opportunity.
Don't bother thanking the politicians, though. In truth, not much progress has been made on political reforms. No, the biggest reason for the success can be found among the names in the European BusinessWeek 50, our annual ranking of the best-performing companies based on two core financial measures: average return on capital and sales growth over the past 36 months. From French steel tubing maker Vallourec (No. 1) to Spanish phone giant Telefónica (TEF) (No. 50), these companies have learned to confound the legendary disadvantages of doing business in Europe.
How do they do it? Pretty much the same way successful corporations worldwide have prospered. As a steelmaker in reform-resistant France, for instance, Vallourec would seem an unlikely candidate for the top spot. Yet it has flourished by getting rid of unprofitable businesses, shifting some production overseas, and becoming a provider of oil-field services as well as pipes. Variations on Vallourec's formula have been followed by dozens of European companies. By expanding abroad, they not only cut costs but also establish a natural hedge against the strong euro while gaining a foothold in emerging markets. By adding services, they avoid relying solely on low-margin commodity goods. "European companies had a very rough time in the last three or four years because of the dollar collapsing, which forced them to get very competitive," says Michael Sieghart, a European equity specialist at DWS, Deutsche Bank's (DB) fund management unit. "They mastered the challenge."
Few have done so more skillfully than Spain's Inditex Group (No. 7). Parent of cheap-chic fashion chain Zara, Inditex is growing at about a 20% annual clip and now has outlets in 64 countries. Inditex needs just two weeks to bring skirts, sweaters, and shirts from designer to store, allowing Zara to stay on top of fashion trends and keep shoppers coming back for the latest items. And Inditex is still expanding. It plans to open some 500 new stores over the next year, for a total of more than 3,400--making it an ever-stronger challenger to the likes of Gap Inc. (GPS) and Sweden's H&M Hennes & Mauritz.
No question, some of Europe's success is simply a result of a strong world economy. Many on the list sell energy, such as Norway's Statoil (STO) (No. 5), or serve the energy industry, like Sweden's Sandvik (SDVKY) (No. 23). Likewise, banks and financial-services companies have thrived from lively global stock markets, robust demand for financing, and the private equity boom. Barclays (BCS) (No. 18), UBS (UBS) (No. 42), and Man Group (No. 9), one of the world's largest hedge fund managers, are well positioned in private banking, asset management, and investment banking. "The winners [in banking] will have a strong position in each of these," says Barclays President Robert E. Diamond Jr.
Still, there's more to winning than riding the global economic boom. British mining company Rio Tinto (RTP) (No. 2), which has extensive holdings in Australia, used soaring copper prices to create a solid foundation for growth by making dozens of acquisitions to build share in China and other emerging markets. Last year alone it boosted capital investment by 56%, to $3.6 billion.
What's going on in Europe is not just a cyclical upswing. Unemployment, the region's most pressing economic and social problem, fell to 7.2% this spring from 8.9% in 2004, and it's still headed down. The drop exceeds what economists thought was possible, given generous welfare systems that discourage jobless people from looking for work and strong protections against dismissal that make employers think twice before taking a chance on a new hire. That helps explain why one of the star performers on the BW50 is in the business of providing temporary workers that bring greater flexibility in hiring and firing, Amsterdam-based Randstad Holding (No. 13). Another BW50 company providing a low-risk way to respond to fluctuating demand is British outsourcer Capita Group PLC (No. 17), which does customer service and back-office work for governments and private clients alike.
There's still plenty to do. Across Europe, numerous factors put the region at a disadvantage to the U.S. The Continent's universities are overcrowded, so they're not turning out the kind of qualified grads companies want. Its research institutes are underfunded. And unions such as Germany's IG Metall remain powerful obstacles to labor reform.
The real test of Europe's new dynamism will come when global expansion slows. Then Europe's companies will know if they've pushed hard enough to truly change. "Without innovation, you cannot create growth," says Manfred Wennemer, chief executive of German auto parts maker Continental (CTTAY) (No. 47), who makes a plea for faster government reform to keep the boom going. "If we relax and make no further adjustments, in five years we will be in the same mess we were in five years ago."