CEE Change: Central & Eastern Europe Makes Waves

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Nearly two decades removed from the fall of Communism, Central and Eastern Europe is transforming into a pivotal global logistics hub. Czech it out.

The fall of the Berlin Wall in 1989 served as both a literal and symbolic catalyst for Communism's decline in Europe and the emergence of social and economic freedom throughout Eastern bloc countries.

While change wasn't immediate, civil revolution sparked a domino-like sequence of events as Romania, Poland, Hungary, East Germany, and Czechoslovakia's Communist regimes capitulated to populist demands.

In concert with Soviet leader Mikhail Gorbachev's appeal for glasnost (openness) and perestroika (restructuring), material and immaterial walls crumbled, border restrictions eased, and political asylum seekers flooded out of Eastern Europe.

When the Soviet Union finally collapsed in 1991, Eastern Europe was already well on its way to reconstruction.

Now, nearly two decades removed, roles have reversed—economic freedom has paved the way for foreign enterprises to circumvent the crumbling debris of communist blockades and make inroads into Central and Eastern Europe (CEE).

While cultural integration is ongoing, and to some extent still an obstacle to growth, the region's capacity for trade and potential as a pivotal global logistics hub is nonetheless readily apparent.

Political, economic, and social reform, as well as widespread accession into the European Union (EU), have yielded increasing private and public investment and attention from both European and U.S. interests.

The relatively quick economic turnaround for countries such as Bulgaria, Czech Republic, Romania, Slovakia, Poland, Estonia, and Hungary have many observers optimistic about CEE's growth potential and its position in the broader global supply chain.

Individually, each country is still mapping out a political course for the future; collectively as a region, and with the EU's financial and leadership support, CEE is already making waves the world round.

"Joining the European Union is more than an accelerator," notes Stathis Karaplios, principal consultant for PMR Consulting, a Krakow, Poland-based firm. "Integrating low-cost economies into richer areas causes many economically important changes: the growth rate accelerates; investment surges sharply; gaps close; entrepreneurs get rich; investment is sucked in; and labor, capital, and goods flow across borders.

"Rapid change means that buyers need to pay attention and get regular updates in order to keep abreast of the emerging sourcing opportunities," Stathis suggests.

Indeed, paying attention to CEE's growth is no longer a problem. The difficulty now for many businesses and other countries competing for foreign investment is keeping pace with the region's perestroika.

The Lure of Consumption

The CEE's grand reawakening and the pervasive forces of globalization have together created a welcome environment for enterprising businesses worldwide.

"As wages in Western Europe increased and borders disappeared there has been a steady migration of labor-related activities into Eastern Europe—countries such as Hungary, Poland, Slovakia, and even as far east as Turkey," says Erik van Egmond, managing director, Penske Logistics Europe.

Penske Logistics Europe, a third-party logistics provider primarily engaged in the automotive, pharmaceutical, and chemical industries, has had a foothold in Europe since 1997. It currently manages more than 1,000 employees across the UK, Netherlands, Slovenia, and Slovakia, among other areas.

Cheaper labor has become a recurring concern for European companies and economic development consortiums alike, especially as more light-tech manufacturers routinely move operations eastward.

The pitch for many U.S. companies is that Europe-at-large is a growing consumer region, so locating manufacturing, procurement, and distribution activities on the periphery of this boom market better positions them to move product to buyers.

A Buyer's Market

"Companies see an opportunity coming out of the oppression of communist regimes," says Friedrich Macher, regional manager for Switzerland-based 3PL Kuehne + Nagel. "Consumers now just want to buy things, creating a huge demand for goods. They want a higher standard of living; therefore private consumption is driving fast growth."

As a country's selling power grows, consumer goods industries follow, suggests Macher. He points to Poland as one example where the national economy is approaching western standards in terms of luxury goods consumption.

Third-party logistics providers that have deep roots in Eastern Europe, the Commonwealth of Independent States (CIS), and the Balkans are quickly becoming hot commodities. For Kuehne + Nagel in particular, the fast-moving consumer goods industry fits well with its value proposition.

"With K+N's local distribution power, we go east and companies follow," Macher says.

Changing consumption patterns in Western and Eastern Europe, as well as globalization trends, have inevitably rationalized the balance of manufacturing and logistics-related activities across Europe, where the West traditionally held a monopoly.

The majority of manufacturing activity will leave Western Europe and move eastward, van Egmond predicts, with some Penske Logistics Europe customers indicating they will move 40 percent of all product from CEE within the next few years.

The obvious reason for the shift is labor costs, which Macher estimates are 40 percent less in CEE than elsewhere in Europe. Location is also a likely factor.

"Central and Eastern Europe is close to mature markets in the European Union, allowing just-in-time deliveries that are not possible from China," says Libor Krkoska, senior economist for the European Bank for Reconstruction and Development (EBRD).

The London-headquartered EBRD is currently the largest single investor in the Eastern European and Balkan regions, and mobilizes significant foreign direct investment beyond its own financing.

"The local workforce also demonstrates a high skill level relative to wages, as a result of historical strengths in technical education," he adds. "Proximity to final customers and high technical skills are valuable in low-volume, high-specification manufacturing that may require frequent discussions with customers."

Elsewhere, the retail sector has been exploding across Central and Eastern Europe, driving significant expansion in distribution and warehousing activities related to consumer goods.

Real estate investment potential in warehouse facilities is increasing, especially in areas located near large consumer markets.

"South-eastern Europe and the CIS also face significant demand for warehousing for agricultural products," Krkoska notes. "The EBRD has financed warehouses and distribution centers across the region, with the activity shifting from an initial focus on Central Europe (Prague, Warsaw and Budapest) toward South-eastern Europe (Bucharest, Sofia), and the CIS (Kiev, Moscow, St. Petersburg).

"It is encouraging to also see demand for warehousing in regional cities in Russia and Ukraine," he adds.

Most of the major capitals in the CEE—Prague, Warsaw, Bucharest, Moscow, and Kiev—can serve as ideal distribution and logistics hubs in the coming years, Krkoska says.

"Other areas—Belgrade, for one—have the potential to become major redistribution points as well, if the necessary investment is in place," he notes. "The redistribution points, however, do not have to necessarily be located in the capitals.

"Other major centers—such as St. Petersburg and Poznan—are starting to emerge or are likely to emerge in the future due to large investments."

Even still, where some Western countries are losing manufacturing capacity to CEE, equal opportunity exists to leverage existing space, labor, and transportation infrastructure to create distribution and warehousing facilities that can fill that economic void.

Paving the Way

Outsourcing manufacturing to CEE makes sense only if the logistics and transportation networks exist to support product movement to market, says Kristof Vanfleteren, country manager Eastern Europe, for Eurinpro, a logistics real estate business headquartered in Mechelen, Belgium.

CEE has the potential to become a pivotal transportation crossroads, given its central location within Europe.

"Central European transition countries are located on the crossroads between East and West Europe, as well as North and South Europe, allowing shipping centers based there to access customers across Europe," says Krkoska.

"The EU accession of 10 transition countries—eight in May 2004 and two in January 2007—also removed borders between most of the countries in the region, significantly speeding shipment time between the new EU member states and the 15 original EU members," he adds.

One major obstacle to locating operations in Eastern Europe, however, is its underdeveloped transportation infrastructure. Highways have generally been limited in Eastern Europe, though roads in Poland and Hungary almost meet western European standards.

On the rail freight side, progress has been even more stifled. Railroads in Eastern European countries operate at about 50 percent of where they should, says Krkoska, because of poor investment and maintenance.

As a result, intermodal capabilities are limited and most gross tonnage—ideal cargo for rail—still moves via truck.

EU Drives Transport Improvements

Over-the-road transport remains the mode of choice within the region and the greatest challenge moving forward is expanding road capacity.

The EU has been a key driver in infrastructure improvements, investing money in projects that facilitate local transportation development and create better synergies across borders.

"EU funds, as well as innovative ways of financing such as toll roads, have allowed local governments to significantly increase the length of local motorways and to construct new ones," says Krkoska. "The EU serves as the largest trading partner in Eastern Europe, as well as its major source of foreign direct investment."

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