`All Simple Production Will Go East'

It was an unlikely courtship. As communism collapsed in Eastern Europe, Asea Brown Boveri, the Swedish-Swiss giant known for its production efficiency, wooed a near-bankrupt engineering company in northern Poland. The takeover target--125-year-old Zamech--was a Western manager's nightmare: bloated payroll, bad worker attitudes, and poor-quality goods.

That was two years ago. Now, under ABB management, Zamech is churning out profits. Its orders are up 50% this year despite a severe recession in Poland. But most important, while the quality at Zamech is nearly up to Western levels, the components it makes cost as little as half as much as those produced at ABB's German factories. That's giving ABB a potent competitive edge, which it's using to snatch bids for gas turbines, generators, and similar equipment from such rivals as General Electric Co.

More and more European and American companies are betting big on turnarounds such as Zamech's--not just in Poland but also in neighboring Hungary and Czechoslovakia. The newcomers are attracted by the region's hottest resource: cheap labor. They're out to create something akin to Mexico's maquiladoras, the border plants used mostly by U.S. companies to cut production costs. Wages in the former communist bloc are one-tenth or less of those in the West (table, page 122G). And there's an added bonus: Skills and education levels are close to those in Western Europe.

HUGE WAVE. Setting up shop in the East is a key part of the huge wave of corporate restructuring now washing over Europe. Eastern Europe has become a survival play for some companies, and for others, such as auto makers, a strategic weapon in the all-out battle for global market share. "All simple production will go east," says Jorg Schill, who recently retired as CEO at Berlin machinery maker Deutsche Babcock Borsig. It's already happening in glass, machinery, chemicals, consumer electronics, furniture, and paper.

Europeans see the low-cost production platforms and access to new markets as a bulwark against Japan. State-of-the-art factories are likely to offset the Asian threat in such industries as autos and machinery. They may even give Europe the chance to stage a comeback in consumer electronics.

But there's a downside: Investment in the East will drain jobs from Western Europe. The West's investment in the region now totals a modest $7 billion, but experts forecast that as much as $20 billion could flood in during the next four years. As money flows eastward, exports to the West are already rising. And the European Community agreements with Poland, Hungary, and Czechoslovakia that now curb imports will be phased out over the next 5 to 10 years. "These countries will absorb a considerable part of the manufacturing base of Western Europe," says Martin Creydt, president of United Technologies Automotive in Paris.

Most Western executives think the payoffs are worth the dislocations. Volkswagen, General Motors, and Fiat have rushed east to build ultra-efficient factories. GM's engine plant in Hungary already ranks as one of the company's most efficient operations. All three carmakers are planning to weave the new factories into their networks. VW plans to sell a third of its Czech-made cars locally, a third in the rest of Europe,and the remainder in Asia and the U.S.

French electronics giant Thomson is another pioneer. It's shifting all production of 14- and 20-inch TV tubes to Poland to compete with Asian rivals. "Poland offers us the same costs as Thailand," says Bernard Varaut, chairman of Thomson Polkolor, the Warsaw TV-tube maker that Thomson bought last year. Thomson has invested more than $100 million in the venture. Already, Varaut says, quality has reached Western levels, with a rejection rate of under 1%--down from a disastrous 33% a year ago.

FIELD TRIPS. It's more than just the big guys going east. Threatened by low-priced Asian imports, many owners of Germany's Mittelstand, or midsize companies, are also driving their Mercedes and BMWs over bumpy roads in search of factories to buy. German machine-tool maker Maho, for example, is shifting a considerable chunk of its production from western Germany to Budapest, where total costs are 35% to 40% lower.

One of the toughest tasks is teaching East Europeans the meaning of competition. Procter & Gamble Co. is working a metamorphosis among workers at Rakona, its Czech detergent company, by sending them to Western P&G plants for training. Rakona's local boss is off on a two-year stint in Cincinnati, while dozens of others--from managers to secretaries--have been sent on temporary assignments throughout Western Europe. Although the step is costly, "you have to do it to get to Western levels of productivity and performance," says William D. Harter, P&G's general manager in Prague.

While positioned primarily to export, many investors are reaping bonus gains as local markets develop faster than expected. Western aid programs have fueled investment with hefty infrastructure loans for everything from cellular-telephone networks to oil pipelines. Belgian glassmaker Glaverbel was surprised by a sharp rise in orders from the Czech auto and construction industries at its $150 million joint venture called Glavunion Ltd. in the Czech town of Teplice. "New markets in the East are the ultimate prize for investors," says Luc Willame, Glaverbel's CEO.

Despite the region's lures, Western investors still bemoan the trials of operating in the East's new democracies. Negotiating with government officials, company chiefs, and union leaders can rack up stratospheric travel bills with little to show for the money spent. "It's a $100,000 chip just to play, and there's no guarantee you'll walk away with a deal," says Stephen Frater, managing director of Cohfin, a Hungarian affiliate of Italy's De Benedetti Group. Other problems range from a shortage of qualified suppliers to office rents in Prague and Warsaw that rival those of New York.

What's more, revamped labor unions are clamoring for Western-style wages. Even though Skoda-VW workers earn 20% more than the average Czech, the union is demanding lockstep increases that would bring wages at Skoda much closer to Germany's. "Linking Skoda to one of the greatest Western European companies should bring corresponding salaries," says Zdenek Kadlec, head of Skoda-VW's union.

STRIKE. Nobody expects the benefits of low wages to last forever. Western companies see a 10-to-15-year window of opportunity. But if workers' demands push wages up too quickly, as in eastern Germany, investors could balk, slowing recovery in the East significantly. An eight-week-old Polish strike for higher wages, for example, is delaying Fiat's planned $2 billion investment in auto maker FSM.

But most companies that have been operating for more than two years in Hungary, Poland, or Czechoslovakia say labor unrest there is unusual. East Europeans are generally happy to earn above-average wages and work with new technology in a secure job. "Our factory is cleaner, and the jobs are better," explains Adam Kulesza, a union leader at Zamech who has been able to buy a color TV, a video recorder, and new furniture with his earnings. If such enthusiasm can be nurtured, the East could turn out to be a powerful competitive force for Western Europe's restructured and rejuvenated corporate giants.

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