With the Western European economies in recession, what do such different industrial companies as Continental, Aker-Kvaerner, Landini, Renault, Timken or Honeywell-Garret have in common ? They opened shop in Romania, either by acquiring local companies or by investing in greenfield operations, being attracted by:

(1) Cheaper skilled labor
(2) More flexibility to restructure
(3) New markets

Cheaper skilled labor

• Romania can provide salary costs which are one third of the Central European level, while productivity is 50-65% of the productivity in Central Europe. Western-European metal-processing companies that we have assisted in moving operations to Romania, had an average burden rate (direct labor cost plus direct overheads) of EUR 40-60 per hour in their Western-European plants. Local companies we identified for subcontracting purposes had a burden rate of EUR 5-10 per hour. With investment in new equipment and management, productivity can reach Western-European levels while labor cost remains a fraction of the cost in Western or even Central Europe.

• Romania has a large pool of skilled engineers and workers specialised in metal-working industries. In addition, the current situation on the labor market provides employers with a strong bargaining position.

More flexibility to restructure

• With the wide-spread collapse of over-staffed state-owned industrial companies, the balance of power shifted progressively in favor of employers. Mass lay-offs initiated by the government were eased via the payment of substantial redundancy benefits. Private companies operated very much the same way. The focus in employers-unions negotiations around redundancies shifted largely towards the size of the redundancy package. This approach maintained the social peace for the past 3-4 years and there are no signs this is going to change.

New markets

• Romania's domestic market is increasingly attractive. The macroeconomic foundations are strong. The economy is in its third year of growth in the area of 5% p.a. Budget deficit was kept under 3% of the GDP. Inflation declined steadily and is to get to one single digit rate in 2004. Central Bank's hard currency reserves cover over four months of imports. The hard currency market is stable and liquid and the current account and the capital account have been fully liberalised, allowing the smooth repatriation of profits or investments. Romania's country ratings improved continuously and now they are generally at BB.

Apart from the Romanian market itself, Romania can be a springboard for exporting all over Eastern Europe and the Middle East. Romania has a reasonably good infrastructure, including the largest commercial port to the Black Sea in Constanta, at the end of the Danube Black Sea Canal. With the opening of the Rhine-Main-Danube canal, Constanta has a direct waterway connection with the North Sea.

1. RELOCATION - A LASTING COMPETITIVE EDGE

The current European economic environment, especially in the case of manufacturing companies, can be defined by:

• Recession. The euro-zone industrial producer price index decreased by 0.1% in June 2003 compared to the previous year. GDP increased by 0.1% in the EU15 during the first quarter of 2003.
  
• Cuts in capital expenditure. The capital goods industry takes most of the hit, with a 4.6% decline in the first half of 2003 vis a vis the first half of 2002. Construction also felt the pinch, with a 3.6% decline in the first half of 2003 vis a vis the first half of 2002. Durable consumer goods declined in the same period by 7.5%, which also triggers a decline in the consumption of intermediate goods.

In such a context, it is clear that:

• pressure on margins becomes a key feature of the game and
• ability to cut costs becomes the key to survival and continued profitability.

Relocation can be a major answer to such troubles, allowing:

• a solution to drastically cut operating costs while
• preserving quality in a country where restructuring efforts are easier to implement than in a Western European country and
• opening access to new markets that are still small but where growth rates outpace by far the rates in the more developed Euro-zone economies.

2. ROMANIA AS AN OPPORTUNITY

2.1. Labor cost and productivity

According to Eurostat data, productivity in the manufacturing industry has increased in Romania from 27.6% of the EU average in 1995 to 31.13% of the EU average in 2002. The productivity gain has been slower than in Hungary (which evolved from 53.8% of the EU average in 1995 to 64.4% in 2002) and Poland (from 37.16 to 48.3%) but faster than the Czech Republic (which rose from 53.6% of the EU average in 1995 to 56.34% of the EU average in 2002). The productivity gap can be largely explained by the huge gap in foreign investment between Romania, on one side, and Hungary or Poland, on the other side.

The average gross salary in the metal working industry in Romania, according to June 2003 statistics was EUR 159, i.e. a total average labor cost per month of EUR 217 (including charges paid by the employer). Despite the real terms increase in the real salary over the past four years, the average monthly gross salary in Romania still lags largely behind Central European countries - see chart below.

Source: National Institute for Statistics, Bucharest.

As the table above demonstrates, the gross salary in Romania is still around one third of the gross salary in Central Europe. Combined with an average productivity in the manufacturing industry around 60% of the level in the Czech Republic, 65% of the level in Poland and 48% of the level in Hungary, there is a clear low-cost niche in manufacturing a foreign company can take advantage of in Romania.

Western-European metal-manufacturing companies we have assisted in moving operations to Romania had an average burden rate (direct labor cost plus direct overheads) of EUR 40-60 per hour in their Western-European plants. Local companies we identified for subcontracting purposes had a burden rate of EUR 5-10 per hour. Among local companies we visited, productivity was 20-40% of the Western levels in companies at the lower end of the spectrum, while productivity in the companies at the higher end of the spectrum was 60-80% of the Western levels.

With Romania coming closer to the EU, the salaries will increase progressively. However, there is a generally shared opinion among policy-makers that increases in the minimum salary should only be accepted if supported by the necessary productivity gains.

2.2. Availability of well-qualified workforce

The low labor cost competitive advantage can be further stregthened by capitalising on the competence and skills available. The productivity gap vis a vis Central Europe is mainly the result of lower investment in technology and management in Romania vis a vis Central Europe. However, the numerous success stories clearly demonstrate that with good management and modern technology Romanian employees can achieve Western levels of productivity with a labor cost below Central Europe. This competitive advantage is best proven by the transfers of activity from both Western and Central Europe.

Before 1989 the whole industrial development of the country was strongly geared towards metal processing and manufacturing of mechanical products. Industrial complexes were created in all larger cities, with little consideration to efficiency. The upside of this effort is today's large pool of well-qualified workers and engineers who can adapt to modern technologies thanks to strong professional basics. Moreover, most of the large industrial companies were privatised and their employment declined drastically, therefore increasing the availability of qualified labor.

The existence of this large skilled low-cost labor pool was instrumental for the current wave of investments, especially in comparably more labor-intensive sectors.

Currently, one of the manufacturing sectors preferred by foreign investors seem to be car parts. This is partly the result of the acquisition of Dacia, the national car maker, by Renault. Dacia is to become the low price brand of the Renault group. Several dozen new car parts plants were launched by various international players during the past two years. With the acquisition of the national tractor maker by the Italian Landini, the entry of new car parts producers is set to continue - see footnote for an illustrative list .

Heavy engineering is another area of growing interest. Notorious examples are Trinity Industries who acquired the railway carriages in Arad, or the ball-bearings maker Timken , who acquired the heavy ball-bearings plant in Ploiesti. They have both achieved impressive productivity gains and moved volumes to their Romanian plants from both their Western and Central European plants. Also, almost all shipyards on the Danube have been privatised with foreign investors and the most significant steel pipes makers have been privatised and the remaining ones will be sold by the end of 2003.

The list of metal manufacturing sectors attracting investments could well continue with boilers, chemical equipment and various machine-tools. The main conclusion remains the availability of a large pool of labor able to produce metal-made mechanical products.

2.3. Cost of restructuring/redundancies

At the beginning of the 1990s, unions started from a dominant position, because the state was the only owner of the industrial companies.

With the wide-spread collapse of over-staffed state-owned industrial companies, the balance of power shifted progressively in favor of employers. Mass lay-offs initiated by the government were eased via the payment of substantial redundancy benefits. This model was widely used in the mining areas and in large manufacturing companies. The focus in employers-unions negotiations around redundancies shifted largely towards the size of the redundancy package. This approach maintained the social peace for the past 3-4 years and there are no signs this is going to change.

2.4. Transportation costs from Romania to Western Europe

The additional transportation determined by a location in Romania vis a vis Central Europe is marginal. An average quotation from a reputable forwarder for a 20 tons truck, going from Bucharest to Prague and from Bucharest to Paris was:

• Bucharest-Prague: EUR 1,450;
• Bucharest-Paris: EUR 1,750.

The very small difference between the two quotations, although the distance Bucharest-Prague is half the distance Bucharest-Paris, demonstrates that:

• the fixed costs dominate in the budget of the travel and
• the location of the plant in Romania vis a vis the Czech Republic would result in an additional EUR 15 transportation cost per ton only, in the case of products exported to Western Europe.

2.5. Access to new markets

Apart from a fast-growing domestic market, Romania can be a springboard for exporting all over Eastern Europe and the Middle East. Romania has a reasonably good infrastructure, including the largest commercial port to the Black Sea.

The telecom infrastructure is very modern and the management personnel available on the market is highly skilled and multi-lingual, with knowledge of English almost an implicit assumption.

2.6. Economic, political and institutional stability

• Growth was consistently high during the past three years. Romania has one of the highest annual GDP growth rates among EU candidate countries, in the range of 5%.
• Inflation has declined systematically, although it is still in the double digit area - the estimate for 2003 is approximately 15%.
• The Central Bank has a solid reserve, covering about 4 months of imports and for the past three years it has systematically been in a position of net buyer of hard currency. This allowed the liberalisation of the capital account and a stable and liquid foreign exchange market.Romania's ratings have progressively increased towards the safe area, as demonstrated by the table below.

Rating agency	Moody's	Standard &Poor's	Fitch	Japan Credit Rating Agency
Foreign currency bonds&notes	B1 Stable	BB Positive	BB Stable	BB
Foreign currency deposits	B2 Stable
L/T local currency sovereign rights		BB+Positive	BB Stable
S/T foreign currency		B Positive	B positive
S/T local currency	B1 Stable	B1 Stable	B1 Stable

Romania has experienced a progressive consolidation of democratic institutions. It became a mature democracy after the power has shifted already twice during the past eight years. The center-left government currently in power enjoys a stable majority in the Parliament. Even if power shifted again in the 2004 elections, the likely holder of the power would be a center-right coalition of two parties with a clearly liberal agenda agreed beforehand.

The government is strongly censored by a free press. The court system is mature and stable, although a certain number of corruption cases among judges have surfaced during the past years. The laws concerning dispute resolution and related procedures are well established in Romania. Generally speaking, any dispute can be solved either in court through the judicial system or by using the special procedure of arbitration, although arbitration can be used only for pecuniary disputes.

The planned EU accession set for 2007 has accelerated the modernization of country's legal system. Romania has to adopt the whole "acquis communautaire" before its accession. In the same time, after the invitation to join NATO, Romania has become an increasingly interesting target for foreign investment.

2.7. Bureaucracy and (Small) Corruption

Some of the problems which are still characterising an economy in transition and have a certain inpact on the business environment consists in a high degree of bureaucracy (as compaired to the other more "developed" central east European countries) and in the so-called small corruption. There has been significant progress in dealing with these phenomena, but this is still a problem that should't be neglected. However, the problems of small corruption and red tape can be reasonably dealt with (see the success stories which happened in Romania). Moreover, there is an increasing awareness at the level of the local political elites that more business is in their interest and, based on that, many of the potential hurdles created by red tape can be eliminated.

3. ABOUT US

LARIVE Group is a Dutch-based network of more than 30 partner organizations around the world, providing consulting services for business development. Its activity is focused on the emerging markets in Central and Eastern Europe and in the Asia-Pacific area. LARIVE Group provides a unique combination of experience in international business, in-depth knowledge of the local economies and solid connections in high potential markets.

LARIVE Romania provides a full package of business relocation services, ranging from:

• defining the strategy for entry
• partner search
• financial analysis and due diligence services
• advice on joint ventures or acquisitions
• executive search
• other implantation-related services.

Larive Romania is the Romanian branch of the Dutch-based consulting company Larive International BV. We are a provider of choice for a complete package of business relocation services to Western industrial companies that chose to move to Romania.

Larive Romania was involved in business relocations from Western Europe to Romania, that ranged from subcontracting to joint ventures and acquisitions. Notorious examples are partnerships such as:

• Fokker - Aerostar (production of plane parts)
• Campina - Covalact (production of yogurts)
• VNU - Pagini Aurii (production of business to consumer directories)

Our job is to save time and money for our clients, in the quest for the best strategic fit in one of Europe's most promising emerging economies.

For more information, please contact us: