Taking Hungary On A High Tech Ride

Contract manufacturer Flextronics dominates Europe from its old industrial heartland

As a manufacturer, Humphrey W. Porter cut his teeth on one of the toughest working environments around. Just when China was opening its doors to foreign investment in the early 1980s, Porter went to Hong Kong for Philips Consumer Electronics (PHG) to build up production of low-cost televisions on the Chinese mainland. Porter often had to spend hours criss-crossing the border. And his factories on the mainland were disrupted by frequent power shortages and bureaucratic wrangling with local authorities.

When Porter relocated to a much tamer Vienna in 1989, he may have expected a release from the rough-and-tumble Far East business world. But he quickly realized that for world-class manufacturers, the action would soon be in countries, such as Hungary, which were just then emerging from the collapse of the communist bloc. "It seemed like China all over again," he recalls, "only with better infrastructure, more skilled workers, and proximity to its main markets."

FLOW OF PRODUCT. Porter soon parted ways with Philips. But he has sunk deep roots in Central Europe. In the process, he laid the groundwork for what has become the Continent's largest electronics manufacturing operation. Today, the 55-year-old Briton is president of Flextronics International Ltd.'s mushrooming Central European operations, with plants in the Czech Republic and Hungary, and research operations in Austria. Pouring from these factories every day are thousands of Philips stereos, Motorola mobile phones, and Hewlett-Packard printers.

Porter's success in Hungary underscores how parts of former communist Europe are recapturing their natural place in the center of the continent's economy. At the same time, Flextronics' (FLEX) Hungary strategy is a thread in the larger tapestry of changes taking place in the global electronics sector. In a bid to boost return on capital and to speed the development of new products, U.S. and European electronics companies are contracting out more and more of their manufacturing. America's most competitive high-tech brands--bluechips such as Cisco Systems Inc. (CSCO) and Compaq Computers (CPQ)--rarely build their own gear anymore. Fewer and fewer premier U.S. manufacturers even own their own factories. But until recently their European and Japanese counterparts resisted spinning off production facilities. "They didn't want to give up control," says Porter.

Now, competitive pressures are forcing Europe's staid electronics brands--the likes of Bosch, Ericsson (ERICY), Nokia (NOK), and Siemens (SMAWY)--to outsource more. And Flextronics has shown enormous skill in mopping up their contracts. On the Continent, Flextronics controls roughly twice the manufacturing capacity of its six largest competitors combined. The upshot: Flextronics' European operations are growing by 50% a year and already generate about 40% of global revenue. "Flextronics has come out of nowhere," says Mike Hannon, an electronics manufacturing analyst for MHM, a Scottish consultancy. Its biggest move, he says, "was to invest in Eastern Europe before anyone else saw the potential."

Flextronics has come a long way since the early 1990s. As a struggling manufacturer based in Singapore, the company nearly went bankrupt making printed circuit boards. Now, it has blossomed into a global contractor producing $10.5 billion a year in electronic gizmos for the world's most famous brands. And according to the man responsible for this turnaround, Flextronics' Chairman Michael E. Marks, the company is on its way to $50 billion in sales by 2006 (page 148F).

If Flextronics pulls it off, Porter will garner much of the credit. When Philips sent him to Vienna, his assignment was to shut down the company's two stereo plants in Austria and move the production to Asia. Porter reckoned that Hungary would be a better solution. To be sure, Chinese wages were half of what manufacturers were paying in Hungary. But tariff and transport costs quickly did in that advantage. Electronics could be exported from Hungary to the European Union duty-free and could be delivered within a day by truck. In contrast, goods produced in China faced a 14% import duty and took weeks to reach the European market. Convinced that Hungary could compete with China, Porter began scouting around for sites to produce Philips stereos in 1991.

The Hungarian government was more than receptive. Back then, its foreign debt was high and its trade balance was deeply in the red. Inward investment looked like a panacea. In short order, Budapest privatized the massive state sector, including the state-run telephone and power companies, selling pieces to local and foreign investors alike. In China, Porter couldn't be sure the lights would stay on or the water would be clean. In Hungary, "I could get digital phone lines, good water, and steady electricity," he says.

Tax incentives played a crucial role, too. The government was quick to offer tax holidays and to set up free-trade zones, which meant exporting companies paid no duties on either the components they imported or on the finished goods they shipped abroad.

COMMUNIST HANGOVER. These up-front advantages, however, couldn't entirely offset the structural or human problems born in the communist era. In 1992, Porter located an abandoned electronics plant in the rural town of Tab. Under the communists, it had produced components for nuclear missiles. Now the town had 30% unemployment. "Everything was crumbling, so it wasn't ideal, but it was the best we could find," Porter recalls. Finding good managers and workers also proved a challenge. The technical level of Hungarian engineers was high. But accounting and other professional skills were in short supply. So it took Porter many years--and a series of foreign managers, some successful, others less so--before he could localize the management of the Tab plant.

The workers were simply out of practice. Although skilled, they were generally less than motivated. Under communism, workers would sometimes joke, "They pretend to pay us, and we pretend to work." These days, many line workers say the biggest difference is the speed of production. "Everything here goes so fast compared to before," says Jozsfue Konits, 48, who assembles fax machines.

Hungary's manufacturing expansion mirrors a larger economic expansion. In the first half of this year, Hungary's exports soared by 33%, to $12.5 billion, with manufactured goods accounting for 82%. And overall economic growth is approaching 6%. In the towns where Flextronics factories have been established, much of the old communist era grime has been washed away. Renovated buildings and bustling restaurants and hotels are the rule. Indeed, Porter's biggest problem these days seems to be coping with success. The renovated facility at Tab now employs 1,500 workers and labor is becoming a scarce commodity in the town.

So Porter has been opening other factories. The new Flextronics facilities in Zalaegerszeg and Sarvar are shiny turnkey operations, built on large new sites outside of the towns. Whereas Tab is a stand-alone operation, these new facilities are complete industrial parks, combining Flextronics' assembly operations with those of component suppliers and distribution partners.

Eventually, Porter knows he must move farther east. As he witnessed in China, rising wages are inevitable in such a fast-growth environment. Although the Hungarian government has kept labor costs low in U.S.-dollar terms by gradually devaluing the local currency, competition for workers is driving up costs. With the likes of Ford (F), General Electric (GE), and General Motors (GM) following in Flextronics' footsteps, Hungary has lately become the No. 1 destination for foreign companies in Central Europe. All told, multinationals have invested some $23 billion since 1989.

Porter is already looking farther afield. Flextronics is subcontracting some production to the Ukraine, where labor costs are less than one-quarter of Hungary's. And more factories are being built or renovated in Poland and the Czech Republic. For contract manufacturers such as Flextronics, the search for greater efficiency won't stop at any border.

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