Acquisition Strategies in European Emerging Markets

Acquisition Strategies in European Emerging Markets

Also by Klaus E. Meyer INVESTMENT STRATEGIES IN EMERGING MARKETS (co-editor with Saul Estrin) DIRECT INVESTMENT IN ECONOMIES IN TRANSITION

Also by Saul Estrin FOREIGN DIRECT INVESTMENT IN CENTRAL AND EASTERN EUROPE (co-edited with Kirsty Hughs and Sarah Todd)

Acquisition Strategies in European Emerging Markets Edited by

Klaus E. Meyer and

Saul Estrin

Selection and editorial matter © Klaus E. Meyer and Saul Estrin 2007 Individual chapters © contributors 2007 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1T 4LP. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2007 by PALGRAVE MACMILLAN Houndmills, Basingstoke, Hampshire RG21 6XS and 175 Fifth Avenue, New York, N.Y. 10010 Companies and representatives throughout the world PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St. Martin’s Press, LLC and of Palgrave Macmillan Ltd. Macmillan is a registered trademark in the United States, United Kingdom and other countries. Palgrave is a registered trademark in the European Union and other countries. ISBN-13: 9781403998545 ISBN-10: 140399854X This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data Acquisition strategies in European emerging markets/edited by Klaus E. Meyer and Saul Estrin. p. cm. Includes bibliographical references and index. ISBN 140399854X 1. Investments, Foreign“Europe, Eastern“Case studies. 2. Investments, Foreign“Europe, Central“Case studies. 3. Consolidation and merger of corporations“Europe, Eastern“Case studies. 4. Consolidation and merger of corporations“Europe, Central“Case studies. I. Meyer, Klaus E., 1964 II. Estrin, Saul. HG5430.7.A3A26 2006 338.8’309437“dc22 2006046406 10 9 8 7 6 5 4 3 2 1 16 15 14 13 12 11 10 09 08 07 Printed and bound in Great Britain by Antony Rowe Ltd, Chippenham and Eastbourne

Contents List of Tables, Figures and Appendix

x

Acknowledgements

xii

Notes on the Editors and Contributors

xiii

List of Abbreviations

xiv

PART I

FDI IN EUROPEAN EMERGING ECONOMIES

1 Introduction: Acquisition Strategies in European Emerging Markets

3

Klaus E. Meyer and Saul Estrin Introduction Context Acquisitions as a strategy of entry and growth Acquisitions and public policy The design of the study Structure of this book

2 Institutional Contexts and FDI Trends in European Emerging Economies

3 4 6 7 8 9

11

Camilla Jensen Introduction The re-emergence of market institutions Location advantages Trends in FDI inflows Conclusion

3 The Changing Patterns of Foreign Direct Investment: Survey Insights

11 12 16 20 24

27

Klaus E. Meyer, Delia Ionasçu, Przemysław Kulawczuk, Anna Szcze´sniak, Zoltán Antal-Mokos, Krisztina Tóth and Valdone˙ Darškuviene˙ Introduction Survey methodology The foreign investors Entry strategies Performance Conclusion

27 27 28 31 36 38 v

vi Contents

PART II 4

ACQUISITIONS: BUSINESS STRATEGY AND ECONOMIC POLICY

Acquisition as an Entry and Growth Strategy

43

Klaus E. Meyer Introduction Entry strategies Acquisitions as an entry strategy Acquisition targets Conclusion

5 Synergy Management in Acquisitions

43 45 49 54 57

58

Krisztina Tóth Introduction Theoretical perspectives Comparative case analysis: synergy management Case conclusions Acquisition experience

58 58 60 63 65

6 M&A in Mobile Telephony: Industry Dynamics

72

Jamie Anderson and Zoltán Antal-Mokos Introduction Challenging the vertically integrated European MNOs Fixed-mobile convergence Emerging industry, emerging markets, mergers and acquisitions The European MNO organizational challenge Conclusion

7 Institutional and Regulatory Barriers to Foreign M&A in Central Europe

72 73 75 78 80 83

84

Mieczysław Bak, ˛ Przemysław Kulawczuk and Anna Szcze´sniak Introduction Privatization policies Administrative barriers Administrative burdens on greenfield entries Conclusion

8 Acquisitions, Institutions and Policy

84 84 87 91 93

94

Saul Estrin and Klaus E. Meyer Introduction Evaluation of the local business environment Institutions moderating acquisition strategies

94 96 102

Contents vii

Enterprise restructuring The impact of foreign investments on the local environment Conclusion

PART III

107 110 112

CASE STUDIES

9 The Evolution of the Hungarian Mobile Communications Market and T-Mobile Hungary

117

Zoltán Antal-Mokos and András Bauer Introduction The emergence of the mobile communications market: 1990–93 Growing in duopoly: 1994–99 Three-player competition: 2000–05 Conclusion

117 118 119 125 131

10 The Purchase of a Monopoly: France Telecom Acquires TPSA

133

Przemysław Kulawczuk Introduction The firms Entry Integration and restructuring of the acquired firm Performance Conclusion and interpretation

11 Building Strategic Alliances to Maintain Independence: Bank Millennium and Banco Comercial Português

133 133 137 139 144 145

147

Anna Szcze´sniak Introduction The two firms Industry: Polish banking sector BCP’s entry Restructuring of Bank Millennium S.A. Subsidiaries Conclusion

12 Building Profit from Losses: K&H and ABN AMRO

147 148 150 151 154 159 160

161

Krisztina Tóth Introduction The firms Fit between the merging firms Acquisition strategy and negotiations Integration Evaluation of the merger

161 161 165 168 169 173

viii Contents

13 Creating a Nordic Bank: SEB-Vilniaus Bankas

176

Kristina Šimkute˙ Introduction Banking crisis of 1995–96: Lithuania The firms Entry Local environment Integration and restructuring of the acquired firm Performance Post-entry developments Conclusion

14 The Emergence of the Central European MNE: MOL

176 176 178 185 185 185 187 188 189

190

Zoltán Antal-Mokos and Krisztina Tóth Introduction Central Eastern European oil industry The firms Fit between the merging firms Acquisition negotiations Integration and restructuring Evaluation of the acquisition

15 Growth through Multiple Acquisitions: Carlsberg Breweries in Poland

190 191 192 195 197 199 202

203

Mieczysław Bak ˛ Introduction Local environment: the Polish beer market Acquired firms Investment in modernization Employment Carlsberg’s strategy in Poland Human resource development Cost reduction Financial results Conclusion

16 Purchase the National Brand No. 1 to Rescue Entry Strategy? The Acquisition of Wedel by Cadbury-Schweppes

203 204 205 208 209 209 213 214 215 215

217

Przemysław Kulawczuk Introduction The firms Entry

217 218 223

Contents ix

The environment Integration and restructuring of the firm Conclusion and questions for future research

17 Early Entry and Aggressive Growth: Kraft Foods Lietuva

224 225 230

232

Valdone˙ Darškuviene˙ Introduction The firms Fit between the merging firms Acquisition strategy and negotiations Integration Post-entry development Conclusion

232 232 234 236 238 240 241

Case Sources and Notes

242

References

247

Index

254

List of Tables, Figures and Appendix Tables 1.1 Case study framework 2.1 General indicators of institutional changes in the accession countries 2.2 Business enterprise perception indicators 2.3 Corporate, value added and wage taxes 2.4 Weighted FDI in EEE 2.5 FDI Stock by major sectors and industries 3.1 Sample FDI characteristics (percentage of affiliates) 3.2 Market focus of affiliates (percentage of sales) 3.3 Distribution of affiliates by entry mode (percentage of affiliates) 3.4 Corporate performance 4.1 Overview of case studies 4.2 Entry strategies of the case firms 4.3 Entry modes of the case firms 4.4 Typology of acquisition strategies for emerging economies 4.5 The role of acquired firms in acquisitions 5.1 Achieving synergies: main questions in the acquisition process 5.2 Three Hungarian case studies 5.3 Realizing synergies: three Hungarian case studies 7.1 Administrative procedures in business creation in 2004 8.1 Investors’ evaluation of local resources 8.2 Evaluations of the institutional environment 8.3 Institutional influences on establishment of the FDI 8.4 Post-acquisition restructuring 8.5 Spillovers 10.1 Comparison between FT and TPSA 10.2 Financial data of TPSA 11.1 Bank Millennium Group: financial data 12.1 Main indicators of the merged banks 1998–99 12.2 Comparison of the two banks 13.1 SEB Group’s account data, 2001–04 13.2 Players of the Lithuanian banking sector, 1997, 2nd quarter 14.1 Key financials of MOL and Slovnaft, 1998–99 (USD million) 14.2 Planned and realized synergies (USD million) 15.1 Market shares: leading beer manufacturers in Poland (%) x

8 13 14 19 22 24 29 32 34 37 44 47 50 53 55 60 61 63 91 97 100 103 108 111 136 144 158 165 166 178 184 195 201 205

List of Tables, Figures and Appendix xi

16.1 Wedel SA: financial performance prior to acquisition by CS 16.2 Shop presence of Cadbury and Wedel brands in northern Poland, November 2003 17.1 Kraft General Foods International, Inc. and Kaunas Confectionery

222 227 235

Figures 1.1 2.1 2.2 2.3 3.1 3.2 4.1 5.1 8.1 11.1 11.2 12.1 13.1

Net FDI inflow per capita in accession countries GDP per capita (2003) and average real growth rates FDI inflows, 1989–03 Estimated FDI by mergers and acquisitions and other entry modes Sales in domestic market, initial year Entry modes over time Entry strategy as a package of decisions Potential and realized synergies in the analyzed cases Conceptual framework for this chapter BM structure: pre-transformation BM structure: post-transformation Organization of the integration process Market shares of the major banks in Lithuania, 2001

5 17 21 23 34 35 46 68 95 155 156 171 187

Appendix 5.1 The Wallis–Elender deal

70

Acknowledgements This research project has been an international collaboration between scholars at the time based at Copenhagen Business School (CBS) in Denmark with the Baltic Management Institute (BMI) in Vilnius, Lithuania, the Institute for Private Enterprise and Democracy (IPED) in Warsaw, Poland and BUESPA (now Corvinus University) in Budapest, Hungary. We thank all contributors not only for timely delivery of their chapters but for their direct and indirect contributions to the overall aims of the research project. Many ideas developed in Chapters 2 to 8 originally emerged in discussions in this team. The Center for East European Studies (CEES), and especially its director Niels Mygind, provided a conducive research environment that enabled and facilitated this project. Yen Thi Thu Tran and Kristina Šimkut˙e provided excellent research assistance, and Tina Pedersen made an invaluable contribution by language-editing the text and thus helping us to communicate the insights from our work. We wish to thank the Danish Social Science Foundation (SSF) for financial support for this project (Grant no. 24-01-0152), without which the project would not have been possible. The grant was competently administered by the staff at the Department for International Economics and Management at Copenhagen Business School. The UK Department for International Development (Grant no. DfID/ESCOR R7844) supported the study on Egypt, India, South Africa and Vietnam used as a benchmark in this project, and insight from this earlier project have informed the current project. Saul Estrin acknowledges support from the Adecco Professorship in Business and Society. Permission to reprint Table 13.2 has been kindly granted by SEB Vilniaus Bankas; all other figures are the authors’ own design. Klaus E. Meyer Saul Estrin

xii

Notes on the Editors and Contributors Editors Klaus E. Meyer is Professor of Business Administration at Reading University Business School, Reading, England, and Copenhagen Business School, Denmark. Saul Estrin is Adecco Professor of Business and Society at the London Business School, England.

Contributors Jamie Anderson is Senior Lecturer in Strategy and Innovation at the European School of Management and Technology, Berlin, Germany. Zoltán Antal-Mokos is Associate Professor of Strategy at the European School of Management and Technology, Berlin, Germany. Mieczysław Bak ˛ works at the Institute for Private Enterprise and Democracy, Warsaw, Poland. András Bauer is Professor of Marketing at Corvinus University of Budapest, Hungary. Valdone˙ Darškuviene˙ is Associate Professor of Finance at Vytautas Magnus University, Kaunas and Baltic Management Institute, Vilnius, Lithuania. Delia Ionasçu is Assistant Professor of Economics at the Copenhagen Business School, Denmark. Camilla Jensen is Associate Professor at the Copenhagen Business School, Denmark. Przemysław Kulawczuk works in the Department of Economics at the University of Gdansk and Institute for Private Enterprise and Democracy, Warsaw, Poland. Anna Szcze´sniak works at the Institute for Private Enterprise and Democracy, Warsaw, Poland. Kristina Šimkute˙ is a Research Assistant at the Copenhagen Business School, Denmark. Krisztina Tóth is Senior Assistant Professor at the Corvinus University of Budapest, Hungary.

xiii

List of Abbreviations 2G 3G ABN ADSL AMRO ATM BBAG BBG BBH BCP BG BIG BM CEO CS DB DSL EBIT EBITDA EBRD EEA EEE EU EUR FDI FT GBP GDP GDR GFCF GPRS GSM hl HR HUF ISDN IT KBC K&H

Second Generation/Digital Mobile Third Generation/Digital Mobile Algemeine Bank Nederland Asymmetric Digital Subscriber Line Amsterdam-Rotterdam Automated Teller Machine Brau Beteilungs Aktien Gesellschaft BIG Bank Gdanski ´ S.A. Baltic Beverages Holding Banco Comercial Português Bank Gdanski ´ S.A Bank Inicjatyw Gospodarczych S.A. Bank Millennium S.A. Chief Executive Officer Cadbury-Schweppes Deutsche Bank Digital Subscriber Line Earnings Before Interest and Tax Earnings Before Interest, Tax, Depreciation and Amortization European Bank for Reconstruction and Development European Economic Area European Emerging Economies European Union Euro Foreign Direct Investment France Telecom Great Britain Pound Gross Domestic Product Global Depository Receipts Gross Fixed Capital Formation General Packet Radio Service Global System for Mobile Communications hectolitres Human Resource Hungarian Forint Integrated Services Digital Network Information Technology KBC Bank & Insurance Group Kereskedelmi és Hitelbank Rt. xiv

List of Abbreviations xv

LTB LTL ¯ LŽUB MHB MHz MMS MNC MNO MVNO M&A n.a. NBP NOM OECD PLN SAB SDI SEB SEB VB SEK SIM SMS SOE SWIFT TPSA UMTS URT URTiP USD USSR VAT VB VoIP WiFi WLAN WTO

State Savings Bank (in Lithuania) Lithuanian Litas State Agricultural Bank (in Lithuania) Magyar Hitelbank Rt. Megahertz Multimedia Messaging Services Multinational Corporations Mobile Network Operators Mobile Virtual Network Operators Mergers and Acquisitions not available National Bank of Poland Niezalezny ˙ Operator Mi˛edzystrefowy Sp. z o.o. Organization for Economic Cooperation and Development Polish Zloty South African Breweries Serial Digital Interface Skandinaviska Enskilda Banken SEB Vilniaus Bankas Swedish Krona Subscriber Identity Module Short Message Service State Owned Enterprise Society for Worldwide Interbank Financial Telecommunication, Global Interbank System Telekomunikacija Polska S.A. Universal Mobile Telecommunications System Urz˛ed Regulacji Telekomunikacji Urz˛edu Regulacji Telekomunikacji i Poczty United States Dollar Union of Soviet Socialist Republics Value Added Tax Vilniaus Bankas Voice over Internet Protocol Wireless Fidelity Wireless Local Area Network World Trade Organization

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Part I FDI in European Emerging Economies

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1 Introduction: Acquisition Strategies in European Emerging Markets Klaus E. Meyer and Saul Estrin

Introduction The nations of central and eastern Europe have joined countries in Asia and Latin America as emerging economies. Many countries in the region have transformed their economic systems from socialism to capitalism in fifteen years, starting with the fall of the Berlin wall on 9 November 1989 and culminating, for ten of them, in membership of the European Union (EU) on 1 May 2004. However, these ‘European emerging economies’ (EEE) are unusual among emerging economies due to their entrenched communist legacy, and recent deep and rapid institutional change. Thus, they were not market economies and were essentially closed to international business until 1990. However, by the time of EU membership, they had developed market-oriented institutions, largely private ownership of firms, (almost) free access to international markets, and the shared legal framework of EU member countries. Despite their volatile environments, they had also attracted investors willing to take the risks in the expectation of fast future market growth or reduced production costs. Foreign direct investment (FDI), and acquisitions in particular, have played an important but complex role in the restructuring and upgrading of local firms and industries in these economies (Meyer, 2001b; World Bank, 2004). Since the start of the transition process in 1990, mergers and acquisitions have become an important feature of business life in EEE. An increasing share of FDI into emerging economies is in the form of acquisitions rather than greenfield projects (UNCTAD, 2000), and EEE have been participating in this global trend. In the early to mid-1990s, acquisitions mostly took the form of foreign (or domestic) investors taking over state-owned firms as part of the privatization process. By the end of the decade, the picture became much more diverse as foreign investors acquired stakes in previously privatized firms, took over entrepreneurial firms, or bought out their joint venture partners. At the same time, domestic firms entered the stage, not only as targets, but as acquirers as well. The focus shifted from privatization agencies 3

4 Introduction: Acquisition Strategies

to private equity and the emerging stock markets (for example, Antal-Mokos, 1998; Uhlenbruck and De Castro, 2000; Meyer, 2001b; Estrin, 2002). The resulting patterns of business relationships are crucial for the ways in which these countries economically integrate into the European Union. This study explores the increasingly diverse and complex strategies of acquisitions in three transition economies and analyzes its drivers and consequences. The focus is primarily on international acquisitions; that is, acquisitions across borders, though Chapter 5 by Tóth also incorporates domestic mergers. We investigate the strategies of foreign investors acquiring businesses in EEE using a multi-method approach with an enterprise survey (Chapter 3) and case studies (Chapters 9 to 17). Ten EEE have become members of the EU or are expected to join within the near future: Bulgaria, Estonia, Czech Republic, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia. In this study, we focus on three transition countries that have received significant FDI flows, but which also reflect the diversity of the region: Hungary, a relatively small but more developed economy which was an early-leader in attracting FDI; Poland, the largest EU entrant, which faced inflation and debt problems at the start of transition but has since grown very quickly and became a strong second mover, receiving a boost of FDI in the mid- and late 1990s; and Lithuania, a very small Baltic economy which reformed quite slowly and was a relative latecomer, attracting significant FDI only after shedding the legacy of having been part of the Soviet Union. We use the survey and the case study findings to develop recommendations for businesses considering international acquisitions in the region, as well as for policy makers (Chapters 4 to 8).

Context Figure 1.1 illustrates the net FDI flows to the three countries of this study, along with the average for the ten EEE, using net per capita inflows to account for the different sizes of the countries (Poland has 38.5 million inhabitants, Hungary 10.1 and Lithuania 3.5). In contrast to declines in worldwide FDI flows (UNCTAD, 2005), the average FDI inflow to our sample economies continues on an upward trend, though there were temporary setbacks in 2003, especially in Hungary. The year-on-year data for individual countries show a large volatility due to the weight of large projects, so the leading positions have changed frequently. Hungary was an early leader due to its FDI-oriented privatization programme in the early 1990s, and we observe peaks in the years of the largest privatization deals. Other counties mainly opened up to FDI only after privatization in the early 1990s, and so only gradually increased their FDI receipts. Thus, in 2005, FDI was spread more evenly across the region, with the Czech Republic and Slovakia taking the lead in recent years. Outward FDI from EEE has also increased from very low levels, especially in Hungary where it exceeded inflows in 2003

Klaus E. Meyer and Saul Estrin 5 500 400

US$ per capita

300 200 100 0 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 –100 –200 Hungary

Lithuania

Poland

EEE average

Figure 1.1 Net FDI inflow per capita in accession countries Source: Own calculations based on data from EBRD (2005).

generating a net outflow of FDI capital. Once again, this is driven by a few large investments, notably the acquisitions by the oil company MOL in Slovakia and Croatia (see Chapter 14), and a major acquisition by OTP, the largest Hungarian bank, in Bulgaria. But there have also been withdrawals of FDI projects, especially in labour-intensive industries. Institutional development has been at the heart of the transition process and has also shaped the pattern of FDI in EEE (Campos and Kinoshita, 2003; Bevan et al., 2004; Meyer and Peng, 2005). The role of institutions is thus an important theme throughout this study; not least the EU accession which presents a major institutional change that builds on earlier radical transformation of the legal framework. With both investment diversion and investment creation effects, the net effect of EU integration on FDI is theoretically ambiguous (Baldwin et al., 1996; Buch et al., 2003). In particular, reduced administrative barriers were expected to facilitate pan-European integration of business operations, which would generate some new FDI projects, but also the closure of certain small operations serving local markets. Secondly, more small and medium-size firms were expected to seek to serve markets in accession countries. Third, liberalization and privatization of sectors such as telecommunications and banking creates major opportunities for FDI in service industries; and fourth, accession countries would participate in the merger and acquisition activities of European multinational enterprises (MNEs) (Meyer and Jensen, 2005). In the early years of economic transition, several surveys investigated the pattern (Meyer, 1995) and strategies of FDI (OECD, 1995; Meyer, 1998; Pye, 1998). Fewer studies assess FDI in the later stages of transition. Disdier and Mayer (2004) find that locational determinants of FDI are converging with

6 Introduction: Acquisition Strategies

those in Western Europe. Yet, unit labour costs continue to be an important determinant of FDI (Bevan and Estrin, 2004), which is more typical for FDI in emerging economies. In fact, we know surprisingly little in detail about how FDI has evolved during the transition. How are patterns of foreign acquisitions changing the completing of privatization? Are patterns of FDI converging with those of other emerging economies? Is a unique east European pattern of FDI emerging, or are variations within the region just a large as between central and eastern Europe and, say, East Asia? These are the issues we seek to address using our multi-method approach.

Acquisitions as a strategy of entry and growth International acquisitions in EEE raise many research questions of concern to businesses. The unusual context and its rapid change force businesses to adapt their strategies. Yet, it is not well understood in which ways firms are adapting, and how such adaptation would influence corporate performance and interactions with the host economy. We focus on three aspects of entry strategies: resources, control and time. An FDI entails the transfer of resources from the parent to the new affiliate, and their combination with local resources, notably in an acquired local firm. Moreover, it stipulates an arrangement for sharing control, mainly based on equity contributions but also with other mechanisms. This study aims at refining the typology of entry modes to incorporate the post-entry dynamics with respect to control and resource contributions. Moreover, we consider the impact of alternative ownership and governance arrangements, and of resource transfers between parents and affiliates. The determinants of entry mode include institutional variables, such as competition policy, profit repatriation, protection of property rights, taxation and other aspects of government intervention. These factors affect investors’ preferences via transaction costs in pertinent markets. The second group of determining variables arises from the resource endowment of the entering multinational firm, potential local acquisition targets, and the local economy in general. However, the initial set-up of an FDI may change quickly. Control arrangements are known to be unstable, especially in ‘staged acquisitions’ (Antal-Mokos, 1998; Meyer and Tran, 2006), and the role of the parent in affiliates in EEE changes with the progression of economic transition (Steensma et al., 2005). Rapid resource upgrading or replacement can create brownfield projects; that is, acquisitions in which the acquired local firm is only a minor part of the new affiliate (Meyer and Estrin, 2001). This longitudinal process of developing FDI operations in volatile host economies provides opportunities to investigate processes of strategy evolution over time, and the interaction of environmental and strategic change (Meyer and Gelbuda, 2006).

Klaus E. Meyer and Saul Estrin 7

We draw on both a resource-based view and transaction cost analysis when analyzing entry strategies. Resource acquisition and absorption is of crucial importance for enterprise transformation in central and eastern Europe (for example, Kogut, 1996; Lyles and Salk, 1996; Uhlenbruck et al., 2003) and, thus, for the process of post-acquisition integration and restructuring (Meyer and Lieb-Dóczy, 2003). Transaction costs in transition economies are crucially influenced by the incomplete and evolving institutional framework governing market relationships (for example, Swaan, 1997; Peng, 2000; Meyer, 2001a). Investors use and adapt acquisitions to achieve specific goals with respect to resource access and internalization of markets in different contexts.

Acquisitions and public policy Policy makers in both host and home countries are concerned with FDI and international acquisitions for a variety of reasons (UNCTAD, 2000). FDI creates spillovers for the local economy, and empirical evidence suggests that, on average, they are positive in central and eastern Europe. However, they are more likely to occur in the form of vertical rather than horizontal spillovers (Javorcik, 2004), and they may be dependent on specific features of the recipient firms (Konings, 2001; Sinani and Meyer, 2004) and be limited to local communities of interrelated firms (Jensen, 2004). The impact of FDI varies with the characteristics of the project, the investor’s entry strategy and the local business environment (Meyer, 2004). From a theoretical perspective, the impact of FDI differs between advanced and transition economies due to, among other factors, the technological gap, quality of resources in local firms, and development of the regulatory and institutional framework. Empirical studies have addressed differences between acquisitions and greenfield investment in OECD countries, but no systematic evidence exists for less advanced economies. The World Investment Report 2000 (UNCTAD, 2000) infers that the long-term impact of FDI established by different entry modes would not differ systematically and substantially by most criteria. However, due to path dependency of networks and competence development, acquisitions tend to retain and develop existing supplier links and, as a consequence, continue to share technology with local partners. In the short term, a number of impact parameters (technology transfer, technology spillovers, R&D, employment quantity and quality, exports and imports, and competition) may differ considerably depending on the specific circumstances of the investment project. For instance, acquisitions may lead to the upgrading of skills such that facilitate the production of higher quality products demanded by consumers in the West. However, crucial for such an assessment of the impact is the counterfactual ‘What would have happened to the firm without the acquisition?’ As this scenario is hard to establish

8 Introduction: Acquisition Strategies

on an aggregate level, we combine case and survey methodologies. As part of this research, we thus consider not only the benefits to the investors themselves, but the ‘societal performance’ of FDI; that is, its positive and negative spillovers.

The design of the study This study investigates the aforementioned issues by using a multi-method approach, combining a questionnaire survey with case studies. In addition, the country teams prepared background reports that informed the design of the study and the interpretation of the data. We also aim to analyze EEE in the broader context of emerging economies elsewhere in the world. We have, therefore, replicated parts of our earlier study (Estrin and Meyer, 2004) which focuses on similar issues in a different set of countries: India, Vietnam, Egypt and South Africa. For example, the current survey uses the same definitions of FDI and is sampled over a Table 1.1 Case study framework Services

Manufacturing

Telecom

Banking

Food and Beverages

Intermediate products

Final products

Poland

FT/TPSA (fixed line)

BIG Bank (banking)

—

—

Hungary

T-Mobile/ Westel (mobile) —

K&H/ABN Amro (banking) SEB/Vilniaus Bank (banking) —

Carlsberg (brewing) Cadbury/Wedel (confectionery) —

MOL ∗ (oil & gas)

—

Kraft (confectionery)

—

—

Heinz (ketchup)

—

BacardiMartini (spirits) —

Packaging (packaging)

GlaxoSmithKline (pharmaceuticals) —

Lithuania

Egypt

ECMS (mobile)

India

—

ABN Amro (banking)

South Africa —

ABN Amro (banking)

Vietnam

—

—

Carlsberg (brewing)

Behr (automotive suppliers) ABB (electrical components)

Note: ∗ This case refers to an acquisition in Slovakia by Hungarian MOL. Source: For Egypt, India, South Africa and Vietnam: Estrin and Meyer (2004).

EST (electrical equipment) Honda (motorcycles)

Klaus E. Meyer and Saul Estrin 9

comparable base population, and a number of the central questions in the survey instrument are identical. This allows us to make direct comparison with many of the patterns emerging over all seven countries – three in Europe, two in Asia and two in Africa. The main results of the survey study, and details of the methodology, are reported in Chapter 3. Our research partners in the three EEE countries conducted a series of case studies following a common case framework. The cases follow a common structure based on a common set of issues that were to be investigated in each case. They have also been selected so as to cover similar industries in the three European countries and, to some extent, to facilitate comparison with cases in our earlier study (Estrin and Meyer, 2004). This study design greatly assists in the interpretation of the cases and we summarize the choice of cases in Table 1.1. Thus, we actually have the same investor in three cases; that is, Carlsberg (Poland, Vietnam), France Telecom (Poland, Egypt) and ABN Amro (Hungary, India and South Africa). These cases illustrate in particular how the same MNE may operate differently in different business environments.

Structure of this book The book is structured as follows. In Chapter 2, Camilla Jensen sets the context by outlining the main trends of FDI in CEE in the context of a changing institutional context. Chapter 3, by the team that implemented the survey study, introduces the main results that emerged from the questionnaire survey of over 500 foreign investors in the region. The second part of the book contains our interpretations of the cases and data collected for this research. In Chapter 4, Klaus E. Meyer reviews all the case studies to analyze how multinational firms use acquisitions in EEE to pursue entry and growth strategies. This chapter highlights some critical variations in acquisitions that have not yet been properly explored in the literature. Chapter 5 by Kristina Tóth analyzes the synergies aspired to and achieved as a result of acquisitions in three Hungarian case studies. Chapter 6 by Jamie Anderson and Zoltán Antal-Mokos moves the level of analysis to industry, and discusses the role of acquisitions in the process of industry creation, consolidation and maturity. In Chapter 7, Mieczysław B˛ak, Przemysław Kulawczuk and Anna Szcze´sniak explore how institutional frameworks and government policy have affected inward FDI and acquisitions in particular. Part II concludes with a review by Klaus E. Meyer and Saul Estrin of the impact of national policy and EU enlargement on FDI and acquisitions in the cases and the survey. The third part of the book reports the actual case studies in Hungary, Poland and Lithuania. Because, as we will show in Chapter 8, industry factors can be as important as country specific characteristics, the sequencing is based on sector rather than country. Thus, we start with FDI in

10 Introduction: Acquisition Strategies

telecommunications in Hungary (Chapter 9) and Poland (Chapter 10). This is followed by cases in banking in each of the three countries (Chapters 11 to 13). Chapter 14 reports the special case of a major Hungarian outward FDI in the oil refining industry. Finally, three cases explore investment in beverage and confectionary industries in Poland (Chapter 15 and 16) and Lithuania (Chapter 17). These original case studies contain rich details that have informed our interpretative chapters, and that we hope will also stimulate further research as well as management practice.

2 Institutional Contexts and FDI Trends in European Emerging Economies Camilla Jensen

Introduction Since 1989, the European emerging economies (EEE) have not only experienced massive changes from within their societies, but also remarkable changes in their interactions with the world economy. By 2003, they have, as a group, converged with worldwide average levels of foreign direct investment (FDI) (UNCTAD, 2004b). At the beginning of the 1990s, most EEE expressed their wish to join the European Union (EU). They were to be admitted to the EU as soon as their internal economic development progressed to an appropriate level, and when the EU institutions and the European Acquis had been sufficiently amended to allow for enlarged membership. In terms of real integration, the opportunity to join the EU, together with the geographic placement of the transition countries, drew a new dividing line through Europe. This line has followed the borders of the new EU since May 2004. However, Bulgaria and Romania have the prospect of becoming members in 2007. This chapter focuses on the relatively homogenous group of transition countries, and their external and internal transition process – namely, the ten accession countries (Bulgaria, Estonia, Czech Republic, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia) out of the larger group of 27 transition countries covered by the European Bank for Reconstruction and Development (EBRD). Except for the three Baltic countries, these countries were never formally part of the Soviet Union, but acted as buffer states between the Soviet Union and Western Europe. They were socialist economies only from 1945 to 1989. The chapter lays out the context for the foreign investments and acquisitions that are investigated throughout this book. The main purpose is to explain the overall trends of FDI inflows up to the 2004 EU enlargement. 11

12 Institutional Contexts and FDI Trends in EEEs

The chapter first outlines the relationship between the institution building process of installing a well-functioning market economy and FDI. I then review the traditional location advantages that may attract FDI to these host countries, before discussing recent trends in FDI inflows.

The re-emergence of market institutions During the socialist period in central and eastern Europe, fundamental institutions (such as coordination mechanisms, information flows, ownership and incentives) were different from those of a market economy (Gregory and Stuart, 2004). The transition process was to recreate market-supporting institutions within the economic sphere, establish markets as the principal means of coordination with information flows decentralized to firm level, private ownership, and the alignment of incentives with rational economic behaviour and calculation. This process is often described through four different reform elements: liberalization and stabilization, privatization, supporting institutions, and reinsertion in the world economy.

Liberalization and stabilization The first element relates to the liberalization of the economy from the former system and the introduction of stabilization policies to reduce the instability that follows liberalization. Table 2.1 shows the progress of the different reform elements through the transition period. The EBRD’s Transition Index is a weighted index that measures liberalization and small scale privatization. In most accession countries, a critical mass of liberalization was attained between 1994 and 1996. Only some countries lagged behind the others, including Bulgaria and Romania. Liberalization, as such, does not make transition countries attractive to foreign investors (Spar, 1993; Meyer, 1995). Business looks for a certain level of macroeconomic stability, stability that could not be offered by many countries during the initial transition period. Inflation, in particular, was a major source of instability and risk, given the general institutional void and instability that arise from the liberalization policies (Mygind, 2000). Furthermore, most transition countries were hit by at least two to three consecutive years of GDP decline (Milanovic, 1998). Romania and Bulgaria were more severely hit in this aspect and, hence, worse off in terms of reintroducing economic stability into the new, market-based economy. Not until the end of the early transition period (1994–96) did the accession countries start to attract significant foreign investment (Bevan and Estrin, 2004). The exceptions were the pioneering investors attracted by the potential for high returns and undeterred by the risks. In addition, some large multinationals invested heavily in pursuit of first mover advantages (Jakobsen, 2006). However, macroeconomic instability relating to the transition process and institutional changes continues to be among the main

Camilla Jensen 13 Table 2.1 General indicators of institutional changes in the accession countries Country

EBRD’s Transition Index ∗ 1989 1996 2004

Bulgaria Czech Rep. Estonia Hungary Latvia Lithuania Poland Romania Slovakia Slovenia

1.0 1.0 1.0 1.7 1.0 1.0 1.7 1.0 1.0 2.3

3.0 3.9 3.8 3.8 3.7 3.7 3.9 3.0 3.9 3.9

4.0 4.3 4.2 4.3 4.3 4.3 4.3 4.0 4.3 4.2

Private Sector Share of GDP 1994 1996 2004 40 65 55 55 55 50 55 35 55 30

55 75 70 70 60 70 60 55 70 55

75 80 80 80 70 75 75 65 80 65

Openness (export +import/GDP) 1989∗∗ 1996 2004 15 15 10 31 10 10 15 9 15 n.a.

97 86 107 69 74 98 42 53 101 93

82 113 125 109 79 97 41 67 130 96

Notes: ∗ Various indices on different aspects of transition are published regularly by the EBRD in their Transition Report (EBRD, various years). The general transition index reported here is a composite index including both liberalization and small scale privatization. It was the first index to be calculated on a regular basis and, hence, the only one that has been estimated as far back as 1989 (Falcetti et al., 2002). ∗∗ The figures are estimates based on EBRD (1994) and SMFA (1991) data, and include only trade between transition and OECD countries (marked-based trade) in 1989; 1989 is comparable to subsequent columns in the sense that they all measure marked-based trade. Sources: EBRD (1994; 2003; 2004); Falcetti et al. (2002); SMFA (1991).

concerns of investors in the region even 10–15 years after the first reforms were introduced (see Table 2.2).

Privatization The second element of the reform programme concerns the privatization process – the conversion of ownership from state to private interests. Table 2.1 shows progress with these reforms in terms of the private sector’s growing share of GDP over the transition period. Countries that privatize more rapidly often attract FDI sooner for several reasons. One reason is that privatization is necessary before investors can have even rudimentary information about industry-level issues, such as likely competitors in local markets, and potential acquisitions or partners (Meyer, 1998). Another reason is that the method of privatization is important, as it provides an initial basis for merger and acquisition opportunities in the region (EBRD, 2003; Carstensen and Toubal, 2004). In fact, countries using direct sales methods that include foreign investors in the bidding process, such as those used in Hungary and Estonia, are more likely to attract considerable FDI early in the transition process (Kalotay and Hunya, 2000). However, investor-unfriendly methods, such as widespread voucher programmes or management and employee buy-outs, may have delayed

14

Table 2.2 Business enterprise perception indicators Is the following factor an obstacle to your operations (percentage of respondents considering the factor to be a moderate or major obstacle is shown)? Slovenia Poland Hungary Czech Republic Slovakia Romania Bulgaria Latvia Lithuania Estonia 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Access to financing Cost of financing Telecommunications infra Electricity infra Transportation infra Access to land Tax rates Tax administration Customs and trade reg. Business licensing and permits 11. Labour regulations 12. Skills and education of workers 13. Economic policy uncertainty 14. Macroeconomic instability 15. Functioning of the judiciary 16. Corruption 17. Street crime 18. Organized crime 19. Anti-competitive practices 20. Contract violations 21. Title and leasing of land

Source: World Bank (2002).

250 399 27 21 43 133 373 187 101 181

538 746 164 144 148 156 836 678 458 288

408 448 72 64 108 60 632 376 236 192

459 514 100 112 145 239 601 526 265 325

470 506 83 147 165 230 553 400 341 359

537 639 149 192 184 208 761 530 294 424

624 636 128 164 128 100 632 324 20 348

318 336 119 108 102 125 648 654 358 233

185 340 170 135 80 250 765 505 225 215

259 318 106 147 147 88 441 188 147 241

176 240

504 356

232 372

250 347

283 270

243 306

192 240

233 369

245 235

200 635

426

834

444

526

659

698

816

676

630

483

367 325 176 75 69 335 335 53

764 446 466 434 312 592 466 176

432 128 224 148 108 420 296 40

500 247 262 287 182 481 553 224

735 494 471 265 229 400 412 124

804 486 529 325 247 533 506 173

696 376 516 388 384 528 384 144

494 130 273 256 130 262 403 125

515 355 370 335 200 305 415 210

394 212 165 265 94 471 382 124

Camilla Jensen 15

merger and acquisition opportunities after privatization has been completed, as seen in the Czech Republic (EBRD, 2003; UNCTAD, 2004b).

Supporting institutions The third element of the reform package is the building of institutions to support the emerging structures, such as market-based coordination and newly acquired ownership rights. The fundamental institutions of market economies need supporting institutions to help formulate the rules of the game, including competition rules, banks, stock exchanges and a system of property rights. The development of these supporting institutions is often tantamount to the evolution of FDI in transition economies over time (Bevan et al., 2004). Furthermore, these institutions influence subsequent decisions, such as to scale up investment commitments, or to reinvest profits (Meyer and Jensen, 2003; 2005). However, cases often show that the quality of, and experiences with, regional-level institutions are at least as, or more, important than on the general national level (Meyer and Nguyen, 2005). Typically, the national level is associated with the capital cities of these countries and, in reality, there may be enormous in-country differences in the transition countries. The quality of institutions or their level of development in terms of being pro-market oriented is not always as important as the stability of the new institutions. This emerges quite clearly in World Bank research on the business environment in the EEE (Table 2.2). Economic policy uncertainty is the highest scoring factor among aspects of the new business environment and institution building that investors perceive as an obstacle to their operations in the transition countries.

Reinsertion in the world economy The liberalization of foreign trade, the introduction and stabilization of a free and convertible exchange rate, and membership in international institutions are encompassed by the fourth element – reinsertion in the world economy. Unlike the other elements, reinsertion goes beyond national economic relations to the relationship between the transition process and the country’s ability to attract FDI and develop exports. The evolution of openness towards world markets during the transition is shown in the last three columns of Table 2.1. The FDI-attractive frontrunners are the countries that, according to their trade openness ratios, are the most outwardly-oriented. However, the problem of two-way causation arises, as FDI is a major catalyst of trade flows during transition, with up to 80 per cent of trade being conducted by foreign investors in these countries (Jensen, 2002). The numbers for Poland and Romania are not quite comparable to those of the other countries due to their much larger populations (as a basic rule, smaller economies are more open).

16 Institutional Contexts and FDI Trends in EEEs

Regarding membership in international institutions, the group of countries is quite homogenous, as they have undergone a very similar transition process with respect to their integration into the world economy (Spar, 1993; EBRD, 2003). Here, as with other aspects of reform, there is the tendency for lead, middle and lagging groups among the ten accession countries. Leaders in terms of starting the EU accession process, obtaining World Trade Organization (WTO) membership and obtaining Organisation for Economic Cooperation and Development (OECD) membership are the largest attractors of FDI in the region: Estonia, Hungary, the Czech Republic and Poland. The middle group includes Latvia, Lithuania, Slovakia and Slovenia. These countries are not yet members of the OECD and typically applied later for EU membership. The lagging countries are Romania and Bulgaria, which still await final admission to the EU and are not prospective members of the OECD.

Location advantages The reform factors discussed above are specific to countries undergoing fundamental institutional changes. As the accession countries’ institutions start to resemble those of a well-functioning market economy, these transition factors will phase out as the main determinants of FDI inflows. But more traditional factors are also relevant; that is, fundamental location factors such as those associated with market size, natural resources, factor cost and skills (Dunning, 1992), and other location factors such as investment incentives. These factors must be expected to take on more importance as the transition draws to a close (Campos and Kinoshita, 2003; Bevan and Estrin, 2004; Carstensen and Toubal, 2004; Disdier and Mayer, 2004).

Market size and growth Survey evidence points to the very important role played by market-seeking motives in the region (Meyer, 1998; Holland et al., 2000; Resmini, 2000; EBRD, 2000). The market size and market growth potential can therefore be seen as fundamental explanatory factors behind the accession countries’ ability to attract FDI. Countries offering the highest level of wealth and the highest growth rates, including the largest local market (Poland), are also the main attractors of FDI in absolute terms (see Figure 2.1). Econometric studies find that the absolute GDP level is a relevant explanatory factor (Resmini, 2000; Bevan et al., 2004; Carstensen and Toubal, 2004; Bevan and Estrin, 2004). National market size in terms of population must be expected to become less important as an argument for locating in a specific market. With the establishment of free trade agreements (Europe Agreements) between the EU and individual accession countries, market access is no longer a main issue

Camilla Jensen 17 16,000

6

14,000

5

12,000 4

10,000 8,000

3

6,000

2

4,000 1

2,000 0

ia en

lic ub

Sl ov

ry C ze

ch

R ep

ni a

ga H un

to Es

ak

ia

d Sl ov

Po

la n

ni a ua Li th

La

tv

ia

ia R om an

Bu

lg a

ria

0

GDP per capita, 2003 (USD) (left axis)

Average real GDP growth, 1995–2004 (%) (right axis)

Figure 2.1 GDP per capita (2003) and average real growth rates Sources: EBRD (2003; 2004).

(Meyer and Jensen, 2003). Furthermore, with the increasing regional integration among the accession countries themselves (such as the Baltic Free Trade Area and the Central European Free Trade Area), access to regional markets across central and eastern Europe is also becoming fairly free. In terms of market access, each of the ten accession countries offers increasingly equal opportunities over time – with the exception of the lower wealth and lower apparent growth potential of Bulgaria and Romania. However, proximity to customers and suppliers may still be important arguments, underpinning the relevance of local purchasing power as a location advantage. Emerging industry clusters, such as those in the automobile industry, may therefore play a bigger role in defining market-related location advantages in the future (Disdier and Mayer, 2004).

Natural resources For most of the EEE, natural resources associated with primary production are not important determinants of FDI inflows, except in some countries of the former Soviet Union (Meyer and Pind, 1999). Natural resources associated with land, oil and other minerals are not important natural endowments except in the Baltic States, and even there, they have not become important targets for FDI (Lovino, 2002). The only major natural resource that attracts FDI under the resourceseeking motive in accession countries is the abundance of labour in the EEE. However, a simple cheap labour argument may be somewhat overstated in the general public discussion of location advantages sought by investors.

18 Institutional Contexts and FDI Trends in EEEs

This observation is supported by survey evidence (Meyer, 1998; Holland et al., 2000; EBRD, 2000) and by econometric studies (Carstensen and Toubal, 2004; Bevan and Estrin, 2004). Certainly, factor costs play a central role in some cases and have some influence on the location decisions of multinationals (Lankes and Venables, 1996). However, it would not be appropriate to infer that cheap labour was the main location advantage of the region. Firstly, wages and productivity are highly correlated in Europe, and within EEE in particular. For example, Slovenia has the highest wages and the highest labour productivity amongst EEE, while Bulgaria and Romania have low productivity and low wages. Thus, the lower wages are a general reflection of the fact that productivity is much lower, in part due to the lack of both capital and knowledge in production. The situation in foreign subsidiaries often varies widely. FDI typically achieves considerably higher productivity, with typical productivity levels between those realizable in the home country and generally prevailing in the host country. At the same time, foreign subsidiaries pay wages above the average local level (Hunya, 2002), which diminishes the unit cost advantage. However, the realization of productivity advantages through the transfer of technology is not automatic, and requires considerable effort and time. This is, in part, reflected by the rather poor performance of some subsidiaries in EEE, especially in their early life cycle. Furthermore, FDI does not favour the lowest wage countries, but rather the opposite. The comparative survey evidence pointing to the less important role of factor cost as an investment motive may also be explained by the fact that many potential investments based on factor costs do not generate internalization advantages. Hence, firms may opt for other modes of sourcing the lower factor cost, such as outsourcing contracts or processing trade, as is seen in the textile and garment industry.

Human capital Related to factor costs, are qualitative factors and strategic considerations with respect to the local labour force. The role of skills and human capital poses a challenge to traditional location theory, such as the Heckscher–Ohlin theorem of comparative advantage, due to the lack of consideration for differentiated factors of production and the increasingly ‘created’ nature of the asset base. The motive of seeking human capital abroad is viewed more as strategic asset seeking than as basic resource seeking (Dunning, 1992), although both aspects could be involved simultaneously. For instance, many investors seek relatively skilled labour at competitive cost. At the beginning of transition, certain industries or sectors often exhibit a high human capital potential; for example, in certain areas of the food and chemical industries or in terms of general engineering skills (Orazem and Vodopivec, 1997). The generally high level of education in central and eastern Europe, including the skills acquired during socialism by some professional groups, created a location advantage for investors at the beginning of

Camilla Jensen 19

transition (EBRD, 2000). In this respect, the emergence of industry concentrations or clusters should play a significant role in terms of making human capital an increasingly important location advantage in these countries over time. On the other hand, concerns are often raised about the lack of human capital and skills in other areas, especially with respect to certain areas of service and creative industries, and general management skills.

Taxation and other location factors A more recent trend in transition countries is the widespread use of specific incentive packages targeted at foreign investors (UNCTAD, 2003). This trend is common during the later stages of the transition and in the run-up to EU accession. The most prominent policy tools during the late 1990s and early 2000s included a substantial lowering of Corporate Income Taxes (see Table 2.3), coupled with the incentive programmes that aimed to attract greenfield investors to the specific country or specific regions within each country (UNECE, 2004). By 2005, all accession countries were partaking in this type of location competition, at least in part because the underlying location advantages are so similar in the region, making it difficult for the countries to differentiate themselves on other factors. In addition, FDI is considered to be a panacea to economic growth and the governments in EEE are unable to identify other policy alternatives. These policies involve potential beggar-thy-neighbours politics that may ultimately result in a ‘race to the bottom’. Ultimately, the tax base of

Table 2.3 Corporate, value added and wage taxes (%) Country

Bulgaria Czech Republic Estonia Hungary Latvia Lithuania Poland Romania Slovakia Slovenia EU-15

Corporate tax 1999 325 35 26 18 25 29 34 38 40 25 32

Corporate tax 2004 195 28 26 18 15 15 19 25 19 25 29

Indirect (VAT) 2004 20 19 18 25 18 18 21 19 19 20 20

Wage taxes ∗ 2003 42 48 35 46 33 34 46 54 51 38 n.a.

Note: ∗ Compulsory social contributions where the EE employer typically pays around two thirds of the contribution. Similar contributions have been abolished in most EU countries and are instead included under personal income taxation. Sources: UNECE (2004); Ernst & Young (2004).

20 Institutional Contexts and FDI Trends in EEEs

accession countries may be diluted to the extent that it poses a threat to other important location factors, such as education and infrastructure, which need financing through taxes. At the same time, successive rounds of corporate tax cuts (often coupled with very generous tax holidays or subsidies) tend to cause indirect erosion of other aspects of location advantage in the region. For instance, such actions create upward pressures on gross wages through the heavier taxation of wages and high indirect taxes (see Table 2.3). In fact, the present state of tax laws and administration appears to be more of a perceived investor barrier than an opportunity or advantage, according to World Bank research on the business environment in the region (Table 2.2). Whether the incentive programmes even have the short-term effects that governments hope for – namely, to attract a larger number of investors to a particular country (Beyer, 2002) – is also questionable. However, Carstensen and Toubal (2004) find that the tax rate is an important location determinant.

Trends in FDI inflows Figure 2.2 shows FDI inflows into accession countries since the beginning of liberalization in 1989. Aggregate flows are modest until about 1995, yet the countries with early take off in FDI inflows (Hungary, Estonia, the Czech Republic and Poland) also sustained large inflows throughout the transition period (Table 2.4). However, some latecomers to the FDI process eventually turned into considerable recipients, such as Slovenia. Annual FDI flow data are not always the best type of data for analyzing and understanding the relative differences across countries because inflows do not take country size into account, and do not always reflect a general trend. Especially in the case of EEE, large privatization-related projects may cause substantial volatility in FDI flows (Meyer, 1998). Table 2.4 shows the cumulative stocks of the accession countries and smoothed inflow averages in terms of different country weights, making the data easier to compare both across countries and over time. This demonstrates that having built up a stock early on makes it easier to sustain inflows. There is, therefore, a clear tendency for cumulative effects in the investment process in the EEE. However, when controlling for country size, Poland no longer remains as one of the major recipient of per capita FDI, but only ranges ahead of Romania and Bulgaria (column 3). Although transition countries have caught up with the world average, their per capita stock is much lower than per capita stock within the EU (Table 2.4, column 1). This difference may, in large part, be explained by the lower level of development in the transition countries (Dunning, 1992; Disdier and Mayer, 2004). The per capita income in transition countries typically ranges from lower middle income to middle income, placing

Camilla Jensen 21 10000

9000

8000

7000

FDI inflows, mio USD

6000

5000

4000

3000

2000

1000

0 1989

1991

1993

1995

1997

1999

2001

2003

Poland

Lithuania

Hungary

Romania

Bulgaria

Estonia

Slovakia

Latvia

Slovenia

Czech Republic

Figure 2.2 FDI inflows, 1989–03 Source: UNCTAD (2004a).

these countries between the developing and developed countries. The data suggests that the Czech Republic, Hungary and Estonia would be the first to converge with the EU average. However, the increase in per capita stocks within the EU during the same period is remarkable. This also partly explains why the transition countries have not been able to catch up so quickly. The next columns of the table take different aspects of development, such as economic size (GDP) and capital endowments (Gross Fixed Capital Formation (GFC)), into account and suggest a somewhat different picture. These weights indicate that FDI plays a much larger role in the economic development of transition countries than among the western EU countries. This is especially true when weighing FDI stock in terms of the GDP of each country. The difference in dependence on FDI for capital build up (new

22 Institutional Contexts and FDI Trends in EEEs Table 2.4 Weighted FDI in EEE Country

Per capita stock, USD

Stock in GDP, %

2003

2003

6515 39838 46507 42915 13610 5849 18978 21450 14435 14171 87780

291 450 776 518 249 234 315 156 351 272 328

Bulgaria Czech Republic Estonia Hungary Poland Romania Slovakia Slovenia Latvia Lithuania EU-15

Flow in GFC, % (annual average) 1998–03 377 310 296 254 159 159 246 87 171 201 235

Source: UNCTAD (2004b).

investments) is actually narrowing when EU member and EEE are compared over the periods 1992–97 and 1998–03. With respect to the latter indicator, there is quite strong convergence caused mainly by the increasing role of FDI in terms of new capital formation within the EU-15 countries in recent years. Another aspect of cumulative causation for FDI inflows over time relates to the relative importance of greenfield and acquisition entry modes (Meyer and Estrin, 2001). This is illustrated in Figure 2.3 with respect to FDI stocks at the end of 2003. In the early 1990s, countries such as Hungary and Estonia launched large-scale privatization programmes that involved foreign investors, while also attracting increasing amounts of greenfield investments. On the other hand, in the Czech Republic, greenfield investments dominated the beginning of the transition period due to the prevalence of the voucher scheme privatization, and there was an opposing trend for increasing amounts of FDI to come through more conventional acquisitions that only indirectly related to the privatization process. However, the general trend is that acquisitions, whether directly or indirectly related to privatization, play a major role in explaining why these three lead countries receive a much greater amount of FDI than other accession countries. Hence, privatization-related institutional set-ups, including emerging institutions surrounding the systems of property rights and corporate governance, are very important determinants of FDI flows into the transition countries.

Investment activities Table 2.5 shows the pattern of FDI in terms of industrial sectors: primary, secondary and tertiary. The data substantiates the argument that FDI into

Camilla Jensen 23 4500 Estonia Other FDI, USD per capita

4000 3500 Hungary

3000 2500

Czech Republic

2000 1500 Latvia

1000

Slovenia

Lithuania Poland

500

Slovakia

Romania Bulgaria

0 0

500

1000

1500

2000

M&A sales, USD per capita Figure 2.3 Estimated FDI by mergers and acquisitions and other entry modes Source: UNCTAD (2004b).

accession countries differs from the normal composition of FDI into other countries at a comparable level of development. For instance, the primary sector is less important than in other transition countries, say, Russia and Kazakhstan. Secondly, the service sector plays a surprisingly large role in these inflows (UNCTAD, 2004b). Several reasons may explain these large differences from more traditional developing countries and transition countries. First, the transition countries are emerging out of an economic system where investment in services (and in many of the customer-oriented and professional services, typically the domain of the private sector), is hugely underdeveloped or, for many core products, entirely absent (Kornai, 1992). Modern banking and consultancy services are examples of the latter. Services are also important in these FDI statistics because of the way that subsidiaries are categorized. Many investors may be manufacturers in their home countries, but when they undertake market-seeking investments only involve minor aspects of their value added activities (such as sales); these are typically categorized as trade services. Table 2.5 indicates that trade services is the second most important industry in terms of attracting FDI to the region. Services may also be dominant in transition countries for reasons related to the privatization of these activities in the absence of capable domestic investors. This explains the dominance of foreign investors within financial intermediation and banking since the mid- to late transition period. Finally,

24 Institutional Contexts and FDI Trends in EEEs Table 2.5 FDI Stock by major sectors and industries Country

Primary Manufacturing

Services

Total

Trade Financial Transport Subtotal Bulgaria Czech Republic Estonia Hungary Latvia Lithuania Poland Romania∗ Slovakia Slovenia

1 1 1 1 1 2 1 4 1 0

28 33 17 37 17 31 40 19 47 41

20 10 15 12 18 18 12 55 13 8

23 20 30 11 15 16 23 N/A 6 21

1 13 17 9 7 9 10 8 12 N/A

71 66 82 62 82 67 59 77 52 59

100 100 100 100 100 100 100 100 100 100

Note: ∗ Data for Romania is only available as number of subsidiaries. Sources: UNCTAD (2004a) (for data for Hungary and Romania) and National investment agencies: www.unctad.org; http://investbg.government.bg; http://www.investinestonia.com; http://www. czechinvest.com; http://www.liaa.gov.lv/eng/invest/, http://www.lda.lt/; http://www.paiz.gov. pl/index/; http://www.sario.sk/; http://www.investslovenia.org/

services may also be quite attractive given the participation of the accession countries on the internal market since May 2004. Expectations may have led investors to anticipate potential scale and efficiency-seeking advantages to locating service activities in these countries (Meyer and Jensen, 2003). In all countries, manufacturing is an in-between sector, with FDI inflows at about 40 per cent, with the notable exceptions of Estonia, Latvia and Romania where manufacturing FDI only covers 20 per cent of total stocks. Countries such as Poland, Slovakia and Slovenia are recipients of more manufacturing FDI, which may be due to different priorities in the privatization of firms within service and manufacturing activities in these countries. Unfortunately, comparable industry-level data within manufacturing is only available for a few countries. For those countries where such data is available, either food, automobiles or both are the lead manufacturing industries in terms of FDI, whereas the role of light industries (textiles, wood and paper processing) typically declines over time (UNCTAD, 2003). This confirms that other entry modes, such as subcontracting, are more prevalent in the light industries where proprietary knowledge (technology) related to production per se is quite small.

Conclusion In many ways, FDI has been the main driving force of the external transition process in the transition economies, both with regard to shaping

Camilla Jensen 25

institutional changes initiated within each country and with respect to each country’s orientation and priorities in the regional, EU and global economy. This raises new questions about the relationship between the local institutions and international investments, with the present chapter focusing on institutional changes as a determinant of FDI inflows into the transition countries. During the early and mid-transition process, determinants of FDI inflows are difficult to separate from the pace and orientation of the reform process in each country. Even in 2006, the effort to build market economy institutions continues to play an important, yet perhaps somewhat different, role towards attracting FDI to the transition countries. The evidence shows a strong macroeconomic convergence of the region’s FDI trends in terms of the level of development or income (with respect to relative shares of FDI, dependence on FDI and inward/outward mix). This places the transition economies somewhere between the developed (high income) and developing (low income) countries. Many microeconomic peculiarities of FDI into the accession countries are evident. Some of these are relatively uncontroversial, such as unusually large shares of acquisition projects explained by the massive privatization process. Another such element is the unusually strong orientation of investors towards services, which is partly explained by the structural misfit between incomes and sector weights caused by socialist production planning. Other microeconomic peculiarities based on the fragmented available evidence stand out as more controversial or unresolved. For example, the relative importance of different types of location advantages (virgin markets or cheap labour costs) in relation to investor motives for entering the region have been somewhat unequally treated by different authors. However, the available survey evidence points to a general predominance of the market-seeking motive throughout the transition period. Many investors who focus only on cost factors in relation to their investment decision often adopt other modes of entry, such as outsourcing production to the EEE. This may be one important explanation for why the cost motive is not considered very important when foreign direct investors are surveyed. Another reason may also be the strong correlation between motives and sectors sought, where service-oriented FDI, in particular, involves the market-seeking motive (UNCTAD, 2004b). In this sense, EU enlargement offers new challenges for research with respect to changing motives as both location and internalization advantages are altered. The EEE countries are likely to become increasingly diverse while moving towards the institutional convergence of a market economy, in part because of institutional differences that will ensue and in part because of the increasing importance of the true asset base of each country. Some countries, such as Hungary, Slovenia and the Czech Republic, are

26 Institutional Contexts and FDI Trends in EEEs

likely to move note swiftly towards their long-term potential and away from their present static location and comparative advantages. Other countries have a considerable way to go to complete their upgrading processes, including the Baltic States, Slovakia and Poland, while Bulgaria and Romania continue to face many fundamental issues, both transitional and developmental.

3 The Changing Patterns of Foreign Direct Investment: Survey Insights Klaus E. Meyer, Delia Ionasçu, Przemysław Kulawczuk, Anna Szcze´sniak, Zoltán Antal-Mokos, Krisztina Tóth and Valdon˙e Darškuvien˙e

Introduction The questionnaire survey conducted for this research project shows crosscountry differences in the patterns of foreign direct investment (FDI), in the motives for and performance of investment, and in investors’ assessments of the local business environment. Following a brief introduction to the survey methodology, we discuss the investors and review their entry motives, entry modes and performance. Generally, we find fewer changes in entry pattern over the period of the 1990s than expected, but also uncover some interesting differences across the three countries in our study, and between European emerging economies (EEE) and other emerging economies.

Survey methodology Local research teams in the three East European economies administered the survey in 2003 during the run-up to EU membership. The research teams met three times, once in Budapest and twice in Copenhagen, to coordinate the research, to discuss the research questions and to design the common research instruments. During these meetings, a common research instrument was developed, which was translated into local languages where appropriate. The sample framework and some of the questions have been designed to replicate Estrin and Meyer’s 2004 study, which was conducted in India, Vietnam, South Africa and Egypt. This allows for an analysis of the pattern of FDI in EEE with respect to other parts of the world, and to identify EEE specificities among the emerging economies. The survey’s base population includes all FDI into each country between 1990 and 2000, where the FDI involves at least ten employees and foreign equity participation of 10 per cent. We have constructed the base population in each country from multiple, locally available databases, to obtain as complete a picture of FDI as possible because complete databases of FDI projects in these countries do not exist. In Poland and Hungary, all firms with 27

28 The Changing Patterns of FDI: Survey Insights

complete addresses, and in Lithuania a random sample of 500 companies out of a base population of 1389 were contacted. Respondents to the questionnaire are chief executives or close associates knowledgeable about the firm. Researchers followed up with telephone calls and personal interviews to secure high return rates, chasing potential respondents until a previously agreed target number of replies was achieved. We have thus obtained replies from over 500 foreign investment firms including 200 in Poland, 225 in Hungary and 107 in Lithuania. This represents, respectively 10 per cent, 11 per cent and 22 per cent of the firms contacted. These return rates are, however, lower estimates as the databases often included only very imprecise information about the firms. Thus, the contacted firms included many firms that were not actually operational (especially in Poland) or not actually foreign-owned (in Hungary), and thus did not reply; however, theoretically these firms should not have been in the base list. Relative to the base population of all foreign investors, our sample represents about 10 per cent in Poland, and a higher proportion in Hungary and Lithuania. In the three countries, official statistics use different definitions or they are not published at all, so an assessment of the representativeness of our data is difficult. To the extent that we can benchmark our data to official statistics, both data sets show similar tendencies, albeit our data may overstate some differences between the three countries. We are fairly confident that the Polish and Hungarian data are a close representation of the underlying base population of foreign investors. In the case of Lithuania, the data need to be treated with more caution as our sample under-represents investors from the USA and investments where the foreign investor holds only a minority stake.

The foreign investors Table 3.1 depicts the distribution of sample firms across broad categories of industries. Services account for more than 60 per cent of the total number of projects in EEE. However, in India, South Africa, and Vietnam, investments in manufacturing prevail over investments in other sectors. This reflects the attraction of various service sectors in EEE, where there was a considerable need to catch up in the early 1990s, and where EU association and later preparation for accession opened the market to a much greater extent than in other emerging economies. Lithuania received a particularly high share of FDI in services as the local market is too small to attract production aimed only at the local market and because Lithuania’s geography provides opportunities for transport and energy services related to business with Russia and Belarus. Hungary and Lithuania still have a high share of FDI in trade and other services, which includes the sales operations of companies exporting to these countries. Since manufacturing projects are, on average, larger and more capital intensive than FDI in the service sector, the distribution of

29

Table 3.1 Sample FDI characteristics (percentage of affiliates)∗ By sector Agriculture, mining and construction Light manufacturing Heavy manufacturing Chemicals Transport, communication and utilities Sales (retail and wholesales) Services (business, financial, hotels and others) Total Number of observations

Hungary Lithuania Poland Egypt

India

South Africa Vietnam

5.5

7.6

4.8

15.3

2.7

3.7

5.9

10.1 27.2

22.6 2.8

15.6 21.5

18.0 14.7

19.2 29.3

36.4 12.4

34.3 20.7

7.8 7.4

0.9 16.0

6.5 9.1

8.7 3.3

13.8 2.7

3.7 9.9

15.4 6.5

24.9

27.4

14.5

6.7

0.5

1.9

0.6

17.1

22.6

28.0

33.3

31.9

32.1

16.6

100 217

100 106

100 186

100 150

100 188

100 162

100 169

By country of origin North America Europe Central and eastern Europe Germany Nordic Other W. Europe East Asia, includes Japan Middle East/North Africa Other (including Australia) Total

Hungary Lithuania Poland Egypt 10.8 4.7 20.7 18.8 84.0 492.5 76.1 43.8 1.9 17.0 1.6 1.4

India 32.8 48.5 0.8

By number of employees < 50∗∗ 51–100 101–250 251–1000 More than 1000 Total Median no. employees Median capital stock∗∗∗

South Africa Vietnam 22.4 4.7 56.5 14.8 0.0 0.6

31.9 6.1 44.1 0.5

17.0 41.5 17.0 0.9

28.8 13.0 32.6 1.1

2.8 4.9 34.7 3.5

14.2 3.0 30.6 15.7

11.2 9.9 35.4 17.4

1.8 1.8 10.7 78.1

0.0

0.0

0.0

33.3

2.2

0.0

0.6

4.7

1.9

2.2

0.7

0.8

3.7

1.8

100

100

100

100

100

100

100

Hungary Lithuania Poland Egypt

India

South Africa

Vietnam

51 19 14 15 2 100 48

48 22 7 14 9 100 60

24 17 24 23 13 100 140

38 19 18 18 6 100 73

46 18 19 16 1 100 56

31 23 16 20 10 100 90

24 24 20 27 5 100 127

0.70

0.35

0.62

1.45

0.69

1.67

1.2

Notes: ∗ Columns may not add up due to rounding. ∗∗ The sampling criterion required that the firms had at least 10 employees at some stage. They may well have less than 10 employees in any specific year. ∗∗∗ Median capital stock: median size of fixed capital stock in USD million.

30 The Changing Patterns of FDI: Survey Insights

affiliates across sectors may be different when the industries are ranked by capital investment. Manufacturing FDI is, to a large extent, focused in the heavy industry and chemicals sectors in Hungary and Poland, but these sectors are particularly under-represented in Lithuania. In contrast, Lithuania receives more investment in the light industry sector and far less in chemicals and heavy industry than any of the benchmark countries. This includes textiles and food processing, industries where cheap labour or access to agricultural products are key competitive advantages. Lithuania, therefore, seems to receive the less sophisticated parts of the industrial value chain, where offshoring of production from Western Europe is particularly important. For services, we observe major FDI variations in the financial sector, where the regulatory framework is particularly important in shaping business opportunities and risks. Over 10 per cent of foreign investors went to the financial sector in Poland and Lithuania, presumably due to their earlier privatization policies. In contrast, Hungary only began large-scale privatization of the banking sector in 2003 when Erste, an Austrian bank, bought Postbank. The second part of Table 3.1 reports the pattern of foreign investment by country of origin. Research in the early 1990s pointed to the importance of proximity for FDI in EEE (Meyer, 1995), but this was widely believed to be a transitory phenomenon. Our data show that the pattern persists and may even have become stronger. Multinational enterprises (MNE) from Western Europe are the most important investors in EEE, which corresponds to the role of Asian investors in Vietnam and Arab investors in Egypt. European investments account for almost 95 per cent of all FDI projects in Lithuania, out of which a remarkable 16 per cent originate in other EEE countries – including the Baltic states and Russia. The importance of Western European partner countries can be explained in part by geography and cultural familiarity: • In Lithuania, 42.9 per cent of the parent companies originate from Nordic countries • In Poland, both German (29.5 per cent) and Nordic (13.7 per cent) parent companies are important • In Hungary, 30.7 per cent of investing firms are German. However, the phenomenon is not unique to Europe. In Vietnam, Taiwanese investors are the largest group followed by Korean and Japanese, while Egypt attracts investors from across the Middle East. Thus, distance to the investment location continues to be important for international business, especially for small and medium-size enterprises. The geographic position of EEE in Europe holds, theoretically, considerable potential for American or Asian investors aiming to serve western European markets. EEE offer relatively low cost production sites within the EU (or tariff free zones prior to May 2006). In particular, businesses wishing to

Klaus E. Meyer et al. 31

establish new production sites in Europe and not face the costs of closing down existing operations would have been expected to take advantage of these conditions. However, our data suggests that there has been no rush to ‘enter fortress Europe through the back door’, with the exception of some well known examples, such as Daewoo in Poland, which was ultimately unsuccessful. The importance of North American investors varies among the three EEE. In Lithuania, only 2 per cent of investing firms originate from this region, while this share is as high as 20 per cent in Poland. American investors are perhaps focused on large markets and have only secondary interests in smaller markets, such as Lithuania, which may otherwise be served by exports from affiliates in other European countries, such as Poland. Their share in the other emerging economies underlines the global importance of North American MNE – except, for political-historical reasons, in Vietnam. The third part of Table 3.1 shows FDI project patterns by size, as measured by employment in the year preceding the survey. Note that firms had to have at least ten employees at some point in time to be included in the base population. About one third of the foreign owned subsidiaries in Hungary, Lithuania and Poland have started with less than ten employees, but these firms exceeded the ten employee threshold by the time of the survey. In terms of the number of employees employed by the company, affiliates are in a range similar to those of the other emerging economies. However, in Poland, more than 60 per cent of the surveyed foreign subsidiaries in Poland had more than 100 employees by 2001 and almost 12 per cent had more than 1000 employees. Considering the capital stock, the median projects in the EEE sample are smaller than those in the benchmark countries. Overall, Table 3.1 suggests that FDI in the accession countries is mainly driven by European economic integration and the creation of pan-European business operations and, to a lesser extent, by the integration of EEE into the global economy and into the supply chain of MNE. The relatively easy access from Western Europe may, in particular, facilitate FDI in service industries and the establishment of small operations.

Entry strategies The changing business environment in terms of resource endowment and institutional frameworks would be expected to lead to changing FDI patterns. However, FDI patterns are more stable than we expected. Firstly, we expected an increasing integration of EEE into global trade, and that initial market seeking FDI would give way to more FDI serving both local and export markets. Table 3.2 shows the market orientation of the foreign investors. In the three EEE, foreign affiliates produce mostly for local markets. The main investment motive in these countries is therefore market seeking, as seen in the other emerging economies, except Vietnam. The majority of

32

Table 3.2 Market focus of affiliates (percentage of sales) Market focus

Percentage of sales exported of which Regional markets EEE Europe outside EEE Global market Other affiliates

Poland initial 2002

Lithuania initial 2002

Hungary initial 2002

Egypt initial 2000

India initial 2000

S.Africa initial 2000

Vietnam initial 2000

19

27

33

36

30

35

23

26

36

37

19

25

51

50

15

20

27

28

19

23

10

12

6

7

4

10

25

24

5.5 9.2

7.3 12

7.5 19.5

8 19.8

4.5 14.5

5.9 17.1

– –

– –

– –

– –

– –

– –

– –

– –

1

2

2

3

3

3

10

10

20

20

11

12

20

20

3

6

4

5

8

9

3

4

11

10

4

3

6

6

Klaus E. Meyer et al. 33

investors thus appear to be initially attracted by the large domestic market, but develop the export potential of their operations later; a result consistent with Meyer (1998). Interesting differences emerge between the three EEE. Foreign affiliates in Hungary and Lithuania export more than Polish affiliates, presumably because the Polish domestic market is much larger with 38 million potential consumers. However, over time, Polish affiliates increased the share of sales exported, thus diminishing this differentiation. The high export orientation of Lithuanian firms may, in part, arise from the small size of the domestic market, as MNE often serve markets in all three Baltic States from one FDI operation. Unlike the four other emerging economies, the share of exports to global markets from Poland, Lithuania and Hungary is very small – less than 3 per cent compared to 10 per cent to 20 per cent in the four benchmark countries. The bulk of Polish, Lithuanian and Hungarian exports went to other European markets, and the share increased over time. Exports to other EEE were low initially but grew faster than the exports to other destinations. Exports to other affiliates of the investing MNE are reported separately. They are important for some firms, but account for less than 10 per cent in all countries except India. Hence, we observe the accession countries being integrated with the EU economy through trade, and that they are less directly integrated with the global economy, as was already suggested based on the pattern of countries of origin. These data also allow for the possibility of EEE producing products that are exported to world markets via western European parent firms. Often EEE operations may produce components that contribute to products that are finalized in, say, Germany, and then sold worldwide. In this way, component exports from EEE contribute to Germany’s leading position in world exports. To examine differences between early and late investors, the share of domestic sales in the initial year of operation by year of entry is plotted in Figure 3.1. A trend only emerges in Hungary, as sales on the domestic market in the initial year fell from 97.6 per cent for investors arriving in 1991 to 56.7 per cent in 1997, after which the export propensity stabilized at over 60 per cent. No clear trends emerge in Poland or Lithuania. The outlier observation for 1993, where 40 per cent of sales from new investors in Lithuania were exports, may be due to the brief period when newly independent Lithuania was perceived as a basis for exports to Belarus and Russia. However, due to the disappointing economic performance of its Eastern neighbours, Lithuanian’s eastward exports did not thrive as expected. In EEE, acquisitions are a major mode of FDI, which distinguishes this region from other emerging economies (Table 3.3, Figure 3.1). Only South Africa had a similarly high proportion of foreign investment in the form of acquisitions, presumably due to the availability of attractive acquisition targets and the development of markets for corporate equity (Estrin and

34 The Changing Patterns of FDI: Survey Insights 100% 80% 60% 40% 20% 0% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Hungary

Poland

Lithuania

Figure 3.1 Sales in domestic market, initial year Note: Percentage of sales in the domestic market in the initial year of operations. Only years with more than five observations in the respective country are reported.

Table 3.3 Distribution of affiliates by entry mode (percentage of affiliates) Sector Greenfield Joint venture (JV) Acquisition Partial acquisition

Hungary Lithuania Poland Egypt India South Africa Vietnam 43 23 25 9

40 19 30 11

42 20 21 16

46 37 5 12

35 53 4 7

31 23 31 14

56 32 2 11∗

Notes: Column total = 100 +/− rounding. ∗ Vietnam: partial acquisitions were defined as JV where local firms transfered part of the existing operation to the newly created JV.

Meyer, 2004). The percentage of acquisitions in EEE is still less than in South Africa. Among the EEE, Poland received the least FDI in the form of acquisitions, which may be due to a privatization policy that relied less on FDI. EEE were highly industrialized – arguably over-industrialized – prior to transition, making acquisition targets available in principle. However, local firms typically needed major investment and restructuring, which created major barriers to acquisition entry (Meyer, 2002; Uhlenbruck, 2004). In the absence of equity markets, privatization programmes served as a substitute market for corporate equity in the early to mid-1990s. Conventional acquisitions (private owners to private owners) increased in the late 1990s. Thus, opportunities for acquisitions have been available and facilitated the inflow of FDI. Even so, greenfield investments outnumber acquisitions in all three central and eastern Europe countries. Compared to other emerging economies, few foreign investors enter the three countries by joint venture (JV). In fact, JVs account for only one in five FDI projects. Foreign investors in Egypt, India and Vietnam have higher

Klaus E. Meyer et al. 35

preferences for partially owned subsidiaries than the preferences seen in EEE and South Africa. These include two thirds of conventional joint ventures and one third of partial acquisitions; that is, foreign investors taking an equity stake in an existing company. The share of partial acquisitions is higher in Poland, presumably because of the chosen privatization methods. Some of these patterns may be attributable to differences in the cross-sector distribution of FDI among the seven countries. While JVs may have been particularly common around 1990, the preferred mode of entry quickly shifted to full foreign ownership (Meyer, 1995). We expected that the share of joint ventures and partial acquisitions would diminish further as institutional obstacles were removed. However, the survey data show considerable volatility during the 1990s, without a clear trend. Figure 3.2 shows the changing pattern of entry modes over time, as percentages of all FDI in the respective country in the same year. While there has been some decline in FDI with partial ownership over time, this decline has been fairly modest and rather volatile. Moreover, there has been no clear shift away from acquisitions following privatization. Instead, the share of acquisitions increased in Poland and Lithuania during the final years 100%

80%

60%

40%

20%

0% 1991

1992

1993

1994

1995

1996

Joint venture Partial acq. Figure 3.2 Entry modes over time

1997

1998

Acquisition Greenfield

1999

2000

2001

36 The Changing Patterns of FDI: Survey Insights

covered by this study. This may reflect the second round of privatization, where foreign investors acquire firms privatized earlier to domestic owners. The phenomenon is described in detail in our Polish case studies of Carlsberg (Chapter 15) and Cadbury (Chapter 16). The persistently high proportion of acquisitions has important implications for future FDI expectations, and the impact of FDI on the local economy. Future acquisitions will depend on the supply of attractive target firms. As privatization programmes come to a close, FDI may decline unless private firms emerge as attractive FDI targets. In terms of impact, acquisitions make a major contribution to restructuring efforts in the region, but they do not add new capacity, new clusters, or new employment. In addition, contrary to expectations and despite considerable governmental efforts to create new industrial zones (Mallya et al., 2004), greenfield investment in the region does not increase.

Performance Foreign investors flocked to central and eastern Europe in large numbers: but were they successful? Investors were asked to assess their own performance using two different benchmarks: their expectations (on a scale from 1 to 7), and their peers in the local industry (on a scale from 1 to 5). These are appropriate measures of subsidiary performance given the problems associated with financial data on the subsidiary level, which is usually kept confidential. Most, but not all, scores are above the midpoint of the respective scale, suggesting that investors are moderately satisfied with their FDI performance. In all countries except Hungary the profitability of the subsidiary is the weakest performance indicator, both in terms of having met expectations, and in terms of return on assets and return on sales relative to other firms within the industry (Table 3.4.). This is an important result because it holds true across such a diverse set of emerging economies and for two very different measures of performance. Foreign investors may be fairly successful in managing their operations and their marketing in emerging economies, but still find it difficult to make satisfactory profits. The long-term motivation of sacrificing short-term profits to achieve a long-term market position may play a role. However, this can only be part of the explanation because the majority of investors in the survey have been in the market for more than five years, by which time investments are expected to generate profits. Comparing the results between countries, the margin of difference between the performance measure and the other items is less in central and eastern Europe, which suggests that a lack of profits may be less of a concern in central and eastern Europe than elsewhere. On the other hand, investors in Vietnam are least satisfied with their profitability (relative to other scores), possibly due to administrative obstacles to business.

Klaus E. Meyer et al. 37 Table 3.4 Corporate performance

Relative to expectations∗ Productivity Profitability Revenue growth Domestic market share New product development Average (first 3) Relative to the industry∗∗ After tax return on total assets After tax return on total sales Firm total sales growth Overall firm performance and success Productivity Average

Poland

Lithuania

Hungary

Egypt

India

South Africa Vietnam

549 489 506

451 446 460

519 500 536

535 457 478

545 460 460

538 485 527

481 370 423

520

472

494

485

496

535

429

537

460

439

n.a.

n.a.

n.a.

n.a.

5.14

4.52

5.18

4.90

4.89

5.17

4.24

350

305

354

n.a.

n.a.

n.a.

n.a.

357

305

347

n.a.

n.a.

n.a.

n.a.

375

325

371

n.a.

n.a.

n.a.

n.a.

375

334

386

n.a.

n.a.

n.a.

n.a.

400 3.72

331 3.20

380 3.68

n.a. n.a.

n.a. n.a.

n.a. n.a.

n.a. n.a.

Notes:∗ 1 = performance expectations not met at all, 7 = performance expectations entirely fulfilled. The data for the four emerging economies have been rescaled from a 5-point Likert scale to a 7-point Likert scale. Domestic market share is only reported for firms that do not export all of their output. ∗∗ 1 = lowest 20 per cent, 5 = top 20 per cent.

Among the three central and eastern Europe countries, foreign affiliates in Lithuania lag behind the performance of Hungarian and Polish affiliates, both relative to investors’ expectation and relative to industry performance. This might be caused by industry effects (a high share of investors in service sectors) and country-of-origin effects (a high share of investors from other central and eastern Europe economies). Affiliates in Hungary and Poland also outperform foreign affiliates that were set up in Egypt, India and Vietnam, and are on par with the performance of South African affiliates. (These direct comparisons of Likert scale scores across countries, however, need to be considered with caution, as cultural differences may inhibit equivalence: that is, consistent interpretation of the scales across countries.)

38 The Changing Patterns of FDI: Survey Insights

Polish respondents gave the highest scores for productivity, followed by market share, while Hungarian affiliates perform best in terms of revenue growth followed by productivity. In Lithuania, the scores for different performance indicators vary little. The positive assessment of labour productivity in Poland may be a result of the rapid employment restructuring and increase of manufacturing output. Between 1995 and 2001, the manufacturing output per Polish employee increased by 68.1 per cent in constant prices (Statistical Office of Poland, 2003). Apparently, Polish affiliates seem more oriented towards local markets. Their performance in terms of domestic market share scores higher than the performance of Lithuanian and Hungarian affiliates and Polish firms are more successful in developing new products, which are more likely to be sold in the local market, than the foreign affiliates in Hungary and Lithuania.

Conclusion This study confirms that the EEE share many features with other emerging economies, although there are also important qualitative differences. Commonalities include a strong presence of investors from nearby countries and many small investment projects that may attract few headlines but, in aggregate, make a substantial contribution to international business relationships. In these countries, with the exception of Vietnam, FDI is predominantly driven by market seeking motives, with 63 per cent to 75 per cent of output being sold on the local market (Vietnam: 50 per cent). Moreover, across countries, investors are moderately satisfied with most aspects of their operations, but may still find it difficult to generate satisfactory profits. However, there are also important differences. Exports from FDI operations in central and eastern Europe are primarily oriented towards Western Europe, with less than 3 per cent aimed at global markets. The global export motive is more important elsewhere, reaching 20 per cent in India and Vietnam. The entry mode pattern also varies considerably as a result of both the institutional environment and the attractiveness of local firms. South Africa is an outlier among emerging economies, with an unusually high share of acquisitions due to its developed capital markets and strong indigenous firms. In central and eastern Europe, acquisitions account for a much higher share than in Egypt, India or Vietnam. Interestingly, the pattern persists even as the major privatization wave comes to an end. Thus, conventional private-toprivate acquisitions replace privatization related acquisitions. Joint ventures are less common in central and eastern Europe than in the other emerging economies, but their share is, surprisingly, persistent over time. The patterns observed in this study suggest that the forces of European integration are driving this trend:

Klaus E. Meyer et al. 39

• The main countries of origin continue to be neighbouring north and western European countries • Most investors are market seekers, which in turn further integrates markets within the enlarged EU and provides consumers with increasingly similar product and brand portfolios • To the extent that FDI operations export, these exports go towards western Europe, while only 3 per cent are sold in global markets. In central and eastern Europe, FDI has been largely driven by business strategies that integrate operations and markets across Europe. This has resulted in stable or increasing FDI flows in central and eastern Europe at a time when FDI worldwide is declining. Overall, FDI in central and eastern Europe is driven by economic integration across Europe, even well ahead of the political union accomplished in May 2004. This integration is likely to continue, especially if the current uncertainty and instability of the regulatory environment stabilizes. However, one driving force of FDI in the 1990s – the privatization process – is coming to an end. It resulted in a higher share of FDI by acquisition than in other emerging economies. To sustain the high levels of FDI inflow, central and eastern European economies must therefore develop attractive private firms worthy of being acquired, or attract more greenfield investment.

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Part II Acquisitions: Business Strategy and Economic Policy

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4 Acquisition as an Entry and Growth Strategy Klaus E. Meyer

Introduction Multinational corporations (MNC) use acquisitions to pursue strategic objectives. In emerging economies, these objectives often relate to the establishment of a position in a new market or the strengthening of a position in a consolidating market. Organizational forms are selected and customized to match objectives with the prerogatives of the local environment. Consequently, entry modes – acquisitions, in particular – exhibit a great diversity that would be masked in aggregate data from official statistics (Chapter 2) or even in survey data (Chapter 3). Our case studies illustrate the diverse forms of acquisition by which firms pursue their strategies in the idiosyncratic context of each emerging economy. This chapter analyzes international acquisitions from the perspective of the specific foreign investor, its global strategy and its strategic adaptation to the local context. The main focus is on three research questions: Why do firms enter or grow by acquisition? What new forms of acquisitions are they developing? What are the underlying strategic objectives? I thus aim to provide a deeper understanding of strategies in emerging economies, and the specificities and communalities of business strategies within European emerging economies (EEE) and other emerging economies. In addition to analyzing the case studies in Chapters 9 to 17 of this book, I set them in a broader perspective by making comparisons with similar case studies in our earlier research project (Estrin and Meyer, 2004). Tables 4.1 lists the cases in this book along with cases in Egypt, India, South Africa and Vietnam. The acquisitions in the case studies are large and, in themselves, important for both the multinational investor and local stakeholders. Each acquired operation had, at the time of the takeover, between 700 and over 68,000 employees. Most investors originate in western Europe, which reflects the strong role of west European businesses in the EEE (Chapter 3). All investors focus on local markets – some sell to private consumers, while others, notably the banking and telecom companies, also sell to corporate customers. None 43

44

Table 4.1 Overview of case studies Foreign investor

Industry

Motive for entry∗

Poland Poland Poland Poland Hungary Hungary Slovakia Lithuania Lithuania Egypt Egypt

Cadbury Schweppes, UK Carlsberg, Denmark France Telecom, France Banco Commercial Portugues, Portugal KBC, Belgium and ABN Amro, Netherlands∗∗ Deutsche Telecom (T-Mobile), Germany MOL, Hungary SEB, Sweden Kraft, USA France Telecom, France GSK, UK

Confectionery Brewing Telecom Banking Banking Telecom Oil and gas Banking Confectionery Telecom Pharmaceuticals

Egypt

Heinz, USA

Food

India India India S. Africa S. Africa S. Africa

Bacardi-Martini, USA Packaging, n.a. ABN Amro, Netherlands Behr, Germany EST, USA ABN Amro, Netherlands

Beverages Manufacturing Banking Manufacturing Manufacturing Banking

Vietnam Vietnam Vietnam

Carlsberg, Denmark ABB, Sweden Honda, Japan

Brewing Manufacturing Motorcycles

Local individuals Local individuals Local individuals and businesses Local individuals and businesses Local individuals and businesses Local individuals and businesses Local individuals and businesses Local individuals and businesses Local individuals Local individuals and businesses Medical practitioners in Egypt and export Arab-wide individuals and restaurants Local individuals Local businesses Local individuals and businesses Global MNCs (local and export) Worldwide, mainly businesses Local businesses and individuals, global customers. Local individuals Local state-owned firms Local individuals

Notes: ∗ =Motive in terms of main group of targeted customers. ∗∗ =Merger between two foreign-owned affiliates with respectively 2700 and 2100 employees. n.a. = Data not available. Source: For Egypt, India, South Africa and Vietnam: Estrin and Meyer (2004).

Entry year 1998 1996 2000 1998 2000 1994 1999 1998 1993 1998 1981, 1997 1992

Employment 12502003 14292001 681002000 65572001 48002000 n.a. 75401999 9001998 7001995 1700 1057 200

1998 mid-1990s 1920, 1998 1999 2000 1995

n.a. n.a. n.a. 1081 450 3502000

1993 1996 1996

3401995 4701998 n.a.

Klaus E. Meyer 45

of the EEE cases has a substantive export orientation, as customers outside the host economy are, at best, of secondary importance. This reflects the general pattern of FDI in the region, especially for the industries we have selected. Food and beverage products typically face high transportation costs and are therefore not heavily traded on an international level. The banking and telecommunication sectors usually require a presence close to the customer. This chapter explores why and how foreign investors have used acquisitions to establish and grow market positions in EEE. The next section discusses entry strategies and sets acquisitions within the context of the firm’s strategy. Thereafter, the varieties of acquisitions are explored to develop a richer and more differentiated classification of entry modes. I then discuss how they are being implemented.

Entry strategies An entry strategy involves a complex set of decisions to position an operation in its market. The scholarly literature has focused in particular on entry mode decisions; namely, the choice between acquisition and greenfield entry, and the decision over the foreign ownership stake in the operation. However, the entry mode decision forms part of a broader set of decisions. Firms may decide to enter a particular region or country, and then develop, compare and assess alternative scenarios for in-country location, timing, mode and other key variables. Most scholarly interest has probably focused on entry modes: export, contractual cooperation, or FDI (Young et al., 1989). Furthermore, direct investors have to decide on their share of equity ownership (Hennart, 1988; Meyer, 2001a), and whether to invest in a greenfield project or acquire an existing firm (Hennart and Park, 1993; Barkema and Vermeulen, 1998). The choice of entry mode is interdependent with other decisions. For example, if timing and speed of entry are crucial – as they are for those pursuing a first-mover advantage – an acquisition or a joint venture (JV) may offer quick market access. On the other hand, acquisitions pose greater challenges in terms of marketing, logistics and human resource management, as the acquired firm’s personnel, routines, and local brand names have to be integrated with the investor’s global operations. Entry strategy is, therefore, a multidimensional construct. Any decision on one dimension has not only to take account of decisions made for other dimensions, but also consider the implications of each decision on the other dimensions. The weight attributed to different aspects of entry strategy decisions varies across firms with different investment objectives. It is therefore useful to think of ‘entry strategy’ as a package of interrelated strategic decisions. Figure 4.1 illustrates this idea. The design of an entry strategy requires strategic decisions over location, entry mode, timing,

46 Acquisition as an Entry and Growth Strategy

Local environment

Corporate strategy

Location • Country • Within country

Logistics • Transportation • Coordination

Entry Mode • FDI vs non-equity • Ownership and control • Acquisition vs greenfield

HRM • Knowledge management • Expatriation • Remuneration

Timing • First mover advantages • Acceleration

Marketing • Global, local or multi-tier branding and processes

Figure 4.1 Entry strategy as a package of decisions

marketing, human resources, logistics, and possibly other aspects of business. Entry decisions are motivated by the investors’ global strategy, yet they have to relate this global strategy to the specific local environment, which may require considerable adaptation. For expansion strategies, the same considerations apply, except that certain parameters are given by the existing operations, and changing them may involve considerable sunk costs. Despite the multidimensionality of entry and expansion strategies, most scholarly research to date has taken a theory driven approach, applying existing theories to partial aspects of entry decisions. This approach implicitly assumes that other strategic decisions are exogenous – for example, timing and location are assumed to be independent of mode choice. However, this is a rough simplification that is not supported by case evidence. For instance, mode choice decisions may, in some cases, precede locational decision but follow locational decisions in other cases. The case studies demonstrate interesting similarities and differences in various aspects of entry strategy, although this study focuses on one entry mode, acquisition. The variation of timing, location and marketing is depicted in Table 4.2.

Timing The timing of the acquisitions in this study was driven by market considerations: all case firms were either involved in early mover advantages or in industry consolidation on a national level. Market seeking foreign investors aim to be at the top of their industry or market segment, as this allows

Klaus E. Meyer 47 Table 4.2 Entry strategies of the case firms Case

Timing

Cadbury-Schweppes Unsatisfactory performance of the existing subsidiary Carlsberg Fast 3rd

Location

Marketing

Partner location and existing Greenfield location

Focus on acquired local brand, withdrawal of global brand

Partner location, but closing smaller operations Partner location

Three tier branding (global/national/local)

France Telecom

1st

BCP

Early

KBC/ABN Amro

T-Mobile

Unsatisfactory performance of the existing subsidiaries 1st

MOL SEB

1st 1st

Partner location Branches in the entire country

Kraft

1st

Initially partner location

Partner location, nationwide branch network Unchanged from pre-merger locations

Partner location

Initially local brand, replaced several years after initial entry Development of brand jointly with the foreign investor n.a.

Local brand replaced 10 years after initial entry by global brand n.a. Local brand for 5 years, then co-branding Global and local brands

Note: n.a. = information not available.

for the generation of substantially higher profits. However, the dynamics vary across industries. The early movers include first movers, such as France Telecom, T-Mobile, MOL or SEB (Table 4.2). Others entered the host country shortly after the first mover in the industry, aiming for a strong market position before the first mover had a well-established position. For instance, Carlsberg entered Poland later than key competitors Heinecken and South African Breweries, but acted soon after these first movers to build a strong market position. Early mover advantages have similarly been important in the case studies in Vietnam (ABB, Carlsberg), India (Bacardi) and Egypt (ECMS, Heinz). Foreign investors that do not achieve a strong market position with their initial investment often end up with a small operation and unsatisfactory

48 Acquisition as an Entry and Growth Strategy

profitability. From such a position, they can either move forward aggressively, or cut their losses and exit. The case studies show several ways in which foreign investors aim to strengthen their position, including taking advantage of another foreign investor’s intention to exit the market. Cadbury had a small greenfield operation, but its own brands failed to make major inroads with Polish consumers. At the same time, PepsiCo redesigned its global strategy and wished to exit confectionery manufacturing in Poland, although the operation itself was performing successfully. Cadbury’s struggling Polish subsidiary then took over PepsiCo’s successful one, and obtained a strong market position. Carlsberg engaged in a series of smaller acquisitions a few years after its initial entry, thereby participating in the rapid concentration process in the Polish brewing industry. Both ABN Amro and K&H in Hungary were dissatisfied with their market position and decided to merge their local operations. In India, ABN Amro grew by taking over the retail banking operations of Bank of America, which divested from India. In South Africa, ABN Amro took over smaller operations or created JVs to expand into other segments of finance. The strengthening of a secondary market position thus emerges as a major strategy motivating acquisition, in addition to first mover or fast follower. Acquisitions are used to implement an aggressive entry strategy – providing a strong foothold – or to strengthen a position in the local market at a mature stage. The only case that does not fit this pattern is the acquisition of South African Ziton whose superior fire detection technology strengthened the global capabilities of the acquirer EST. In emerging economies, however, this technology seeking motive is an exception.

Location and marketing strategies All of our EEE cases focus on selling products in the local market, but their marketing and branding strategies vary. Acquisitions are often used to access local brands and distribution channels, and these marketing related objectives have also been important in the cases studied here. Firms selling products with global brands, on the other hand, may serve the market through exports or by setting up a greenfield plant. The cases suggest that foreign investors targeting private consumers primarily use dual branding strategies, with one or more brands for the local mass market, plus an international brand serving the premium market. Over time, the relative emphasis between local and global brands may shift (Meyer and Tran, 2006), but this varies across industries. Brewing, confectionary and banks rely on local brands, while the telecoms move to global brands after a transitional phase. Most remarkably, Deutsche Telecom replaced its well-established Hungarian brand ‘Westel’ with its ‘T-Mobile’ brand ten years after the initial entry. The reasons for such a shift may be the maturing of the local market, the convergence of consumer spending patterns, and the increased integration of operations across national borders, in particular as EEE countries become members of the EU.

Klaus E. Meyer 49

The intra-country location is often linked to the existing location of the acquired firm. Thus, in contrast to greenfield operations, acquirers have only a few degrees of freedom when it comes to locational choice. If they wanted to change the location of certain units of the acquired operation, they may face considerable resistance from the workforce. We noted two motives for foreign investors to change the location of local operations. First, they may wish to consolidate operations and increase economies of scale if existing operations are highly fragmented with multiple production sites, or if multiple smaller operations have been acquired (see the Carlsberg Poland case). Such a consolidation may take the form of heavy investment in a selected site to increase its productivity and scale economies. Minor operations are then used as supplements for peak demand or speciality products, and phased out over time. Second, national headquarters can be moved to the capital of the country, as in Poland where foreign investors prefer to establish themselves in Warsaw. An exception to this trend is Cadbury, which moved its Polish headquarters from its greenfield site to Wedel’s existing operations to facilitate the integration process. Foreign investors’ preference for the capital city may arise from the need to access important networks in both business and politics. Moreover, the capital may offer better living conditions for expatriates and a better infrastructure. In Poland, Warsaw’s centrality is also advantageous in terms of reaching markets in all parts of the country. This discussion of other aspects of the entry strategy illustrates both the subtleties of entry strategies, and the motivations for using an acquisition to achieve strategic goals. Building an early market position or strengthening an existing one are important motives. Hence, access to marketing-related assets is also important to acquisitions. On the other hand, intra-country location seems to be of secondary importance for acquirers.

Acquisitions as an entry strategy The cases present a large range of strategies and organizational arrangements, although all constitute a form of acquisition (Table 4.3). Many deals were very complex and, in fact, difficult to trace. To review these different methods of implementing an acquisition strategy, I propose new classifications and point to strategies that, while presumably common, have not received due attention in the scholarly literature. The first observation is that large acquisitions in EEE are rarely one-off deals where one owner hands over 100 per cent ownership and control to another for a cash payment. Cadbury’s takeover of Wedel from PepsiCo seems to be an exception, but even this deal was made possible by PepsiCo increasing its ownership stake to be able to sell the company outright. The normal pattern seems to be a gradual changeover of ownership for a variety of reasons related to both the seller and the buyer. Initially, the foreign investor often acquires a

50

Table 4.3 Entry modes of the case firms Foreign investor

Acquired firm

Type of firm

Mode

FDI ownership

CadburySchweppes

Wedel SA

Initially greenfield, then acquisition

100%∗

Carlsberg

Okocim and three others

Firm previously privatized by staged sale to another foreign investor Privatized firms with local and foreign shareholders

France Telecom

TPSA

BCP

BIG Bank

Multiple acquisitions, partial and staged patterns, later merged. State-owned Partial, by enterprise bidding for privatization tender Private bank, Partial growing acquisition, domestically by following a acquisitions hostile battle between investors

Initially: 21.6%, 2005: 100%

Two privatized foreign-owned firms

KBC: 59.01%, ABN: 40.23% Other: 0.76%

KBC & ABN Amro (Hungarian affiliates) T-Mobile

Westel

MOL

Slovnaft

SEB

Vilniaus Bank Domestic and foreign financial investors Kaunas State-owned Confecenterprise tionery

Kraft

Merger of two FDI operations built by acquisitions New business Initially developed by a consortium, then state-owned acquired by enterprise buying out other foreign partners Privatized, Stepwise, initial insider owned entry by bidding firm for a private tender

Initially: 33.93%

2000: 15% 2002: 50%

1994: pyramid structure∗∗ 2005: 100% 1999: 36.2% 2003: 72.4%

Stepwise via the stock market

1998: 35.8% 2000: 97.7%

Stepwise as part of privatization process

1993: 67.0% 2003: 90.1%

Notes: ∗ Previous owner PepsiCo had acquired Wedel in stages over seven years, increasing its equity stake from 40 per cent to 100 per cent. ∗∗ Deutsche Telecom owned 50 per cent in Magyarcom, which owned 59.58 per cent in MATÁV, which owned 51 per cent in Westel.

Klaus E. Meyer 51

stake in the existing firm, usually with the intention of increasing ownership later. The partial ownership is the start of a process aimed at achieving full ownership and control. It may therefore be appropriate to describe these acquisitions as ‘staged acquisitions’ rather than as ‘partial acquisitions’. The increase of the foreign investor’s equity stake may be pre-planned at the outset or occur in response to changes in the environment. Like JVs, partial acquisitions are potentially subject to many conflicts that require compromises among shareholders, and the ownership structure is rarely stable. In some cases, the temporary nature of the shared ownership structure is already reflected in the initial control arrangements, with the acquirer allotted key positions on the board. For instance, in the case of MOL/Slovnaft, the tender specified that the strategic investor would receive 50 per cent of management control along with 36.2 per cent of equity. On the other hand, many local stakeholders expected the firm to retain its national identity and predominantly local control, which is reflected by local scholars and journalists at the time of the initial investment. Interviews at corporate headquarters tend to point in a different direction – ex post managers tend to emphasize that they prefer full control over their operation and that sharing ownership is second best option. The causes of the staged nature of acquisitions in our cases are mainly related to the supply side; that is, the sellers willingness and ability to sell the company. Theoretically, buyers may also prefer staged ownership implementation, as the continued involvement of the previous owner may also be advantageous for the acquirer (Meyer, 2002). If the state or an influential local conglomerate shares the risks as well as the profits, they may also help alleviate potential interference by bureaucrats. Networks with authorities are important in many emerging economies and shared ownership may align the interests of the local community with the prosperity of the business. Moreover, staged acquisition stretches the financial commitment over time, which can be an advantage for financially constrained investors. However, such motives are not apparent in our cases. Where firms were bought from a privatization agency, the tender conditions have stipulated the equity stake available for sale, or the agency has implicitly or explicitly favoured tenders by consortia with local participation. These constraints have been particularly evident in the telecommunications industry. For instance, France Telecom acquired its initial stakes in both Poland and Egypt through a privatization agency tender and Deutsche Telecom initially entered Hungary through a partial acquisition of MATAV, the local telecom operator. Partial tenders also occur for private businesses, as seen in the case of Slovakian Slovnaft, which was eventually entirely taken over by Hungarian MOL. Why are sellers, and privatization agencies in particular, interested in selling a firm in a staged manner, at least when it comes to large firms? First, governments may wish to retain some influence over privatized firms

52 Acquisition as an Entry and Growth Strategy

to secure certain political objectives, such as to secure employment or the continuation of a local brand. Second, staged sales might generate higher revenues if it is hard to establish the true value of a firm at the outset. This would be a major concern in highly uncertain environments, such as those that characterized the EEE in the 1990s. When the foreign investor later acquires the outstanding stock, a better valuation may be available to strengthen the seller’s bargaining position. Privatization agencies have often placed part of the equity on the stock exchange, either through an initial public offering or through variants of voucher privatization. At the same time, a substantive bloc of shares is usually sold to a ‘strategic’ foreign investor. Wedel was initially sold to PepsiCo of the USA and Okocim to Brau & Brunnen of Germany. Gradually, foreign investors then acquire stock from the minority shareholders and eventually delist the firm from the stock exchange. In the case of Wedel, PepsiCo acquired the remaining outstanding shares in order to sell the company to Cadbury. With Okocim, there was an additional complication in that Carlsberg bought out Brau & Brunnen in 1996, and then gradually increased its equity stake in Okocim to 100 per cent over the next eight years. Foreign investors may prefer to buy out minority shareholders in their subsidiary for several reasons. Decision-making processes are easier if there are no minority stakeholders to consult, and the operation can also be more easily integrated into global organizational structures. For example, production can be moved between countries, as was the case with Carlsberg. Moreover, less information needs to be provided to the public and crucial data can be kept confidential, out of sight of competitors (and, unfortunately, also scholarly researchers). In addition, unified accounting and financial management may reduce capital costs. Finally, full ownership may make it easier to sell major units of the business, or the entire business, to third parties, as happened when PepsiCo sold Wedel. An alternative scenario can be seen in the case of BCP, where the staged acquisition of BIG Bank occurred via the stock exchange and involved a hostile battle between several potential acquirers. Here, the pace of acquisition was driven by the interplay between the unwanted suitor, Deutsche Bank, and the local management and its favoured investor, BCP. Each aimed for a controlling equity stake, but only for a price reflecting the value of the firm. The local management’s own initiatives and politicking played an important role, as did court decisions concerning the interpretation of corporate governance and takeover legislation. In some countries, ownership restrictions defined by law may explain why foreign investors hold only minority stakes in their local affiliates. As ownership restrictions are relaxed, foreign investors increase their equity stake. This appears to have played a role in, for example, India and Vietnam, but it does not seem to be of major importance in EEE as most ownership restrictions were removed in the early 1990s.

Klaus E. Meyer 53

Staged acquisitions thus emerge as a major type of acquisition in EEE. Table 4.4 presents staged acquisitions along with other modes of entry that we have observed in the region. Multiple acquisitions are probably the most aggressive entry strategy observed in emerging economies. In fragmented markets, a single acquisition may not suffice to attain a strong market position, especially when Table 4.4 Typology of acquisition strategies for emerging economies Description

Purpose

Drawbacks

Staged acquisition

Occurs in several stages with the foreign investor acquiring only an initial equity stake and gradually increasing it to 100 per cent.

Staged acquisitions allow the continued involvement of previous owners when they are unwilling to sell outright or enhancing legitimacy with local consumers.

Shared control as a source of conflict; uncertainty over eventual full takeover.

Multiple acquisition

Entry by acquiring several independent businesses and subsequently integrating them.

Through multiple acquisitions, global players can build a strong nationwide position in a traditionally fragmented market.

Simultaneous integration of multiple acquisitions is challenging

Indirect acquisition

An acquisition outside the focal market of a company that also owns an affiliate in the same emerging economy.

The prime objective of the indirect acquisition may be outside the country. Rarely, the affiliate may be a strategic asset sought by the acquirer.

The local affiliate may or may not fit with existing local operations.

Brownfield acquisition

An acquisition in which the acquirer invests subsequently more resources, such that it almost resembles a greenfield project.

Brownfield acquisitions provide access to crucial local assets under the control of local firms that are, in many other ways, uncompetitive.

Postacquisition investments may exceed the price originally paid for the acquired firm.

Joint venture

A new company with two or more parents sharing control and contributing resources.

Accessing local resources without taking responsibility for an entire existing company.

Shared control as a source of conflict.

54 Acquisition as an Entry and Growth Strategy

targeting the mass market where economies of scale and market power are important. Still, foreign investors would normally aim to become a leader in the local market. Multiple acquisitions can, therefore, build a strong nationwide position in a market that traditionally has been highly fragmented, and provide a portfolio of local brands that serves multiple regional or niche markets. Consequently, an acquisition is often only a small building block of the envisaged new operations in an emerging economy. For instance, Carlsberg engaged in three further acquisitions in Poland following its initial investment in Okocim, becoming part of the rapid concentration process within the Polish brewing industry (Meyer and Tran, 2006). Multiple acquisitions, however, pose additional challenges in terms of the integration of the acquired businesses. These may include the concentration of head-office functions in one location – foreign investors often prefer the country’s capital – and the construction of new production facilities that realize economies of scale and apply the latest technology. Organizational integration may also transcend national borders; for instance, with integrated logistics and production capacity sharing between multiple brands. Deep restructuring is also at the core of brownfield acquisitions, acquisitions where the post-acquisition investment replaces major parts of the original operation, so that the new operation almost resembles a greenfield project. Some firms in emerging markets require such extensive restructuring that foreign investors essentially replace all resources except for a few sought after assets, such as local brand names, licences or distribution channels. Meyer and Estrin (2001) first observed this phenomenon in acquisitions related to the EEE privatization process but later found it in other emerging economies (Estrin and Meyer, 2004). Foreign investors are willing to shoulder the burden of transforming uncompetitive enterprises if the perceived value of the key assets exceeds the restructuring costs. By combining aspects of traditional acquisitions and greenfield operations, brownfield investments provide an aggressive route into a market. Indirect acquisitions occur as a by-product of an acquisition in a different country. In rare cases, the operation in an emerging economy is actually the strategic asset that inspired the third-country acquisition. An indirect acquisition may be a short cut to gaining market share quickly, especially if the acquired firm has strong global and local brands. At the same time, complex negotiations with authorities and labour unions are bypassed. If, on the other hand, the global merger or acquisition had entirely unrelated objectives, local synergies may be limited and operations may have to be run as separate business units.

Acquisition targets The details of an acquisition depend not only on the wishes of the acquirer, but also on the resource endowment, ownership and bargaining position

Klaus E. Meyer 55

of the target firm. For instance, aspects of acquisitions vary across different types of pre-acquisition owners: privatization agencies rarely sell large companies in one-off deals, but frequently retain a government equity stake for a limited period of time. With dispersed and diverse owners, acquirers almost inevitably buy their respective shareholdings in a sequential manner (as with Carlsberg Poland and MOL Slovakia). However, domestic entrepreneurs may also retain a partial stake for a while, as seen in the case of SEB. With a single foreign owner controlling 100 per cent of the equity, the deal is straightforward, with the business changing hands for cash, as when Cadbury Poland acquired Wedel from PepsiCo (Table 4.5). An interesting phenomenon emerged in the late 1990s in the EEE, known as second-round privatization. Some of the ownership arrangements that emerged from the initial privatization proved to be instable, especially when employee owners sold out to managers and to outside investors, facilitating a process of ownership concentration (Jones and Mygind, 1999; Kalmi, 2002). With the exception of SEB’s acquisition of Bankas Vilniaus, our cases of acquisition from private owners actually concerned firms that were, at least in part, owned by other foreign investors who had, in turn, acquired their stake in the privatization process: Carlsberg acquired its initial stake from Brau & Brunnen, Cadbury acquired full ownership from PepsiCo, Deutsche Telecom bought out its consortium partners, and KBC/ABN Amro merged their Hungarian operations. Slovnaft was privatized to domestic owners before it was taken over by MOL. Of our cases, only SEB acquired a private business that was newly created in the early years of economic transition. How are these second-round privatizations different from an acquisition of a state-owned firm directly from the state, as in the cases of Kraft or TPSA? In Table 4.5 The role of acquired firms in acquisitions Type of acquisition

Full

Staged

Partial

Previous owner

Foreign investor

Domestic private

State-owned firm

Behr, SA ABN Amro, IN Cadbury, PL Carlsberg, PL ∗∗ T-Mobile, HU ∗∗

EST-Ziton, SA GSK (APIC), EG

–

GSK (ABI), EG Packaging, IN ABN Amro, SA SEB, LIT ∗∗ MOL, Slovakia Bacardi-Martini, IN

ABB, VN BCP, PL Kraft, LIT

KBC/ABN, HU

∗

∗∗∗

ECMS, EG TPSA, PL

Notes: ∗ These companies were previously privatized to foreign investors, and then merged. ∗∗ Previous owners included both domestic and foreign shareholders. ∗∗∗ 33 per cent employee-owned, 67 per cent state-owned.

56 Acquisition as an Entry and Growth Strategy

second-round privatization acquisitions, the foreign investor does not have to deal with the complexity of privatization negotiations, which can often become highly political, especially for large or high profile firms. This reduces negotiation costs and uncertainty. However, they may still have to engage in deep restructuring if the inheritances from the central plan regime dominate the acquired organization. In some cases, such as Wedel, the first private owner engages in deep restructuring, which lowers the burden for the second buyer. Second-round privatizations are normal business transactions that bring in investors who best know how to manage the operation. Still, these transactions seem unpopular among local policy makers who are used to having an influence on business, and they may receive negative commentary in local media, especially if they are accompanied by a reduction in or reorganization of employment. Acquisition targets also vary in terms of what they contribute to the MNC. A variety of resources are crucial in inducing the acquisition. Keeping in mind that some resources, including human resources, can be bought or hired on markets, the local firm must possess organizationally embedded resources that are not available in an unbundled form to become the target of an acquisition. Our cases suggest that these resources are typically related to assets that ease access to local consumers, such as local brands and distribution channels (as in the brewing and confectionary industries), or operating licences and existing customer bases (as in the telecommunications and banking industries), and other business networks. Motives for seeking a local partner are, therefore, largely related to intangible assets, as we would expect in western Europe, which suggests a convergence of business strategies. In some cases, the local firms also contribute valuable physical assets such as real estate or distribution infrastructure, but these seem less common than in the other emerging economies studied by Estrin and Meyer (2004). Human capital is presumably also very important, especially with respect to managerial teams, or specialist or technical staff, yet the case studies do not explore this aspect in great detail. There is no indication of local firms in EEE contributing resources that enhance the investors’ global competitiveness, as seen in South Africa. However, in some industries we do see the emergence of pan-European patterns of competition with strategic interdependence among different markets in EEE, as is evident in the telephone industry. In the case of MOL’s acquisition of Slovnaft, the competitive dynamics between MOL and ÖMV both aiming to become the industry leader in the central European region have been a major driving force and strengthened MOL as a regional player. Finally, acquisitions are not necessarily initiated by the acquirer although they have to fit with the acquirer’s global strategy (Graebner and Eisenhardt, 2004). The management of a strong local firm may take the initiative to find the foreign investor they want – one who will provide what local management seeks, such as high degrees of strategic autonomy and fresh

Klaus E. Meyer 57

resources. In fact, financially constrained but otherwise competitive firms are most likely to search for a new home within a multinational firm. For example, the management of BIG Bank in Poland brought in a ‘white knight’ to prevent takeover by an unwanted suitor, and thus became an affiliate of BCP instead, presumably with a higher degree of autonomy and unchanged local management. The strategic issue is then to find and negotiate with a strategic investor, rather than being (passively) selected by an MNC as an acquisition target.

Conclusion Despite the diversity of industries, the cases have two common features: the acquisitions are large projects, and they aim at establishing or strengthening the investor’s market position. Consequently, they illustrate the variety of ways in which multinational investors can implement an acquisition strategy. Given the variety, it is hard to generalize, but it appears that all of the cases roughly follow the following steps: • • • •

Envisage the market position that the firm would like to attain Identify one or more target firms that may help attain this position Find ways to acquire control over the sought resources at acceptable costs Implement the strategy, over a period of several years if necessary, and flexibly readjust to changes in the environment.

The case discussions raise many issues for future research. First, the cases point to the interdependence of entry mode decisions and other aspects of entry strategy, especially timing and intra-country location. This interdependence is not yet well understood. Second, we observe a diversity of acquisition modes. Researchers may want to investigate under which circumstances investors choose a certain mode. In particular, why do investors accept partial ownership in acquired firms, and how do they manage their subsidiaries under this circumstance? Third, how do acquisitions vary for different targets? In particular how does the identity of the seller affect the negotiation and integration processes? Finally, acquisitions of firms where employees hold a substantial share, a common phenomenon in some EEE, may pose particular challenges for both the employees as owners and the foreign investors. These challenges need to be explored.

5 Synergy Management in Acquisitions Krisztina Tóth

Introduction Acquisitions are often motivated by expected synergies, but these synergies are frequently not achieved in practice. Synergy management, which aims to implement goals established when signing the acquisition agreement, has an essential role in the acquisition process. Synergy concerns the value creation resulting from effective collaboration between companies, business units or resources. This chapter differentiates between internal and external methods of achieving synergies. Internally, the issue is how to enhance collaboration between organizational units in a multi-business company. Externally, the challenge is to make the most out of the combination of two previously independent companies. The unit of analysis in this chapter is the acquisition agreement itself. This chapter is organized as follows. First, the major research streams on this topic are compared. Then, three Hungarian case examples are analyzed from different perspectives before conclusions are drawn from both theoretical and practical angles. This chapter draws extensively on Tóth (2004) and the cases of K&H–ABN Amro (Chapter 12), MOL (Chapter 14) and Wallis– Elender, which is summarized in Appendix 5.1.

Theoretical perspectives Synergy realization in mergers and acquisitions (M&A) differs from everyday synergy management (or parenting) activities in multi-business companies, because the former involves two different companies with different resources, cultures and organizations. Therefore, M&A entails major changes in both organizations and can even set new strategic directions (Goold et al., 1994). Focusing on the additional synergy management arising from a merger or acquisition, the M&A process can be described from three points of view. First, financial research on acquisitions centres on how share price is affected when the deal is announced. Share price increase is the result 58

Krisztina Tóth 59

of synergy effects, which are distributed between the target and bidder companies, although target shareholders usually receive all or most of the gain (Bradley et al., 1988). According to the financial approach, one of the most important factors influencing shareholder value creation is the price paid for the target. An accurate estimation of the synergy potential is, therefore, necessary to avoid overpayment and corresponding losses. The higher premiums paid in hostile takeovers mitigate the future benefits of the transaction (Eccles et al., 1999). In general, the processes of integration and synergy realization remain in a black box for financial analysts. Second, when we look at the strategic management literature on diversification, we come one step closer to uncovering how synergy is realized in acquisitions. The key to achieving synergies is that the two companies must be related, given the assumption that related diversification results in higher synergy potential than unrelated diversification. Consequently, rather than measuring the value creation potential of a deal, the level of strategic relatedness between the firms can be used (Markides and Williamson, 1994). However, research on whether industry or firm-specific factors influence value creation in diversification is inconclusive (Rumelt, 1991; McGahan and Porter, 1997). Third, new insights can be gained by narrowing the level of analysis to firm resources. The main issue is to uncover how the resource base and core competencies of the company can be strengthened via external growth if internal (or organic) development would take too long or if the capabilities necessary for achieving competitive advantages are hard to imitate (Grant, 1991). The organizational approach proposes that it is advisable to look into the organizational design, human resources management practices, and organizational culture of the target to ascertain whether the two companies will be able to cooperate (Cartwright and Cooper, 1992). Thus, the need for organizational autonomy ultimately affects the approach to integration and synergy realization (Haspelagh and Jemison, 1991). From an integration point of view, friendly takeovers hold the promise of greater synergy realization, as the constructive atmosphere of negotiations has a positive effect on the process of combination by diminishing the extent of cultural conflicts (Hitt et al., 1998). In summary, management of the factors influencing synergy is central to the acquisition process – from planning to target selection to negotiation to integration. This is both an external process aimed at the company to be acquired, and an internal process focused on the resources within the acquirer. Table 5.1. compares the three approaches for each stage of the acquisition process. This chapter takes an organizational approach and a managerial perspective, using qualitative case analysis, to investigate how synergy realization can be maximized in acquisitions.

60

Synergy Management in Acquisitions

Table 5.1 Achieving synergies: main questions in the acquisition process Financial approach

Strategic approach

Organizational approach

Acquisition strategy and target selection

How to find positive NPV projects? (Free Cash Flow Theory)

How to find a target with a strategic fit?

Due diligence and negotiations

What is the value of the target? What is the synergy potential? What is the premium paid, and how is wealth distributed between target and bidder? How does the paying method affect valuation? How much synergy is realized?

What is the extent of strategic relatedness between the companies?

How to eliminate resource gaps in order to strengthen and develop core capabilities? What is the relative resource position of the companies and how does it affect synergy potential? Will there be any obstacles in realizing synergies (cultural differences, lack of resources)?

Integration

Has the competitive position of the merged companies been enhanced?

What organizational and managerial actions help effective resource combination and synergy realization?

Comparative case analysis: synergy management Three case studies were conducted in 2004 to investigate the synergy realization process in mergers and acquisitions in Hungary. Both primary and extensive secondary sources were used to gather information on the acquisition process. The cases were selected to represent three acquisition types (horizontal, vertical, conglomerate) and different motives. The cases differed in terms of industry and ownership background, as shown in Table 5.2. However, all three seller companies suffered from financial distress and urgent liquidity problems. All three cases also involved cross-border features, especially regarding the owners’ nationality, although the oil industry transaction was the only case in which international integration and cross-border coordination took place. In terms of the length of the acquisition process, the conglomerate transaction took the shortest length of time from acquisition decision to completion of integration. In the other two cases, a slower, staged acquisition process was followed that gradually increased the stake in the company together

61 Table 5.2 Three Hungarian case studies K&H–ABN Amro

Industry Type of acquisition

Deal motives and characteristics Banking Oil and gas Horizontal Mainly vertical

Acquirer

MNE

Acquirer’s motives

Industry consolidation, larger market share MNE

Seller

Seller’s motives

Geographic scope

Decision Negotiations

Integration

MOL–Slovnaft

Hungarian privatized company Economies of scale, international growth option Local management (who privatized the company) Bank pressure to stop a loss-making operation

Exiting an unprofitable operation, change in CEE strategy Cross-border Cross-border (both (ownership) ownership and and domestic location) (location) (EEE company (MNE sells to sells to EEE MNE, but company) only the Hungarian branches merge) The acquisition process 2000 1999 August 2000– Nov. 1999–Mar. November 2000 2000 From January Staged acquisition: 2001 Mar. 2000: 36.2 until June per cent 2003 Nov. 2002: 67.8 per cent Jan. 2004: 100 per cent (full integration)

Wallis–Elender

IT Conglomerate (but horizontal on the divisional level) Local private conglomerate Strengthen the IT subsidiary, full scale web services package MNE

Cut losses after the IT bubble burst

Cross-border (ownership) and domestic (location) (MNE sells to EEE company, but only the Hungarian subsidiary)

2001 Spring 2001–Oct. 2002 From Jan. 2002 until Aug. 2003

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with the level of integration. Negotiations were smoothest in the horizontal case, where the two foreign MNEs quickly agreed upon transaction terms. According to the mainstream literature, related acquisitions have more synergy potential than unrelated acquisitions since there is more overlap between the companies. However, managing a conglomerate involves strengthening a business area, so scale economies were also present in the IT industry case, as were company-level synergies coordinated by corporate headquarters. Therefore, unrelated acquisitions are not always inferior to horizontal cases. The process view of acquisitions states that value creation is influenced by activities throughout the acquisition process, including the due diligence and negotiation phases. Careful preparation and planning proved to be beneficial in all three cases – top management teams sometimes even ‘over-planned’ in order to reduce uncertainty as well as legal and managerial risks. The detailed action plans reduced the time necessary to achieve integration milestones and increased employee commitment to changes. Such large-scale changes were not possible without structural support, leading to the establishment of temporary structures to coordinate synergy realization efforts and administer changes. As a key practice, mutual task forces (transition teams) prepared the integration project according to relevant functional areas and customer groups. Team members came from both organizations and helped implement integration plans through knowledgesharing, learning and contact-building. Familiarization was a gradual process that proved to be the most effective solution to knowledge transfer problems and cultural differences. Although realizing the synergy potential of the ‘soft’ side of collaboration was not possible without ‘hard’ factors, tight financial control and reporting systems were the most important early implementation of the joint cooperation. IT systems played a significant role in supporting merged operations (mainly in the banking industry case), while IT integration problems also took time to solve, thereby inhibiting adaptation to competitor moves and changes in customer needs. Obstacles to synergy realization belong mainly to the soft, hard-toquantify factors, such as hidden HR costs resulting from low employee morale, distrust and uncertainty. Some of these problems can be solved by clear communication and senior management support, but external changes are harder to manage in a newly formed merged organization where processes and routines are to be mutually developed. During the evolutionary period, synergy scepticism can also be present, which is often the result of exaggerated expectations and forced collaboration. For the corporate parent, the challenge is to find the right balance between strictly controlled shared services and motivation factors that enhance voluntary collaboration between different business units. Table 5.3 lists managerial practices observed in the three case studies.

Krisztina Tóth 63 Table 5.3 Realizing synergies: three Hungarian case studies K&H–ABN Amro

Main fields of synergy potential Preparations before the integration

Structural support Managerial actions to maximize synergy realization Inhibiting factors and problems during the process

MOL–Slovnaft

Synergy potential Branch closures All major areas: Broadening of the logistics, finance, HR, product portfolio production, corporate Finances services Legal preparation Handling corporate (joint governance issues management) Setting up functional Feasibility study task forces Synergy realization Integration Slovnaft Portfolio Office (project Management (project organization) organization) Quick decisions Thorough preparation Careful timing of Clear goals and actions communication IT systems Tight financial integration control Changes in Changes in the management environment Uncertainty Distrust Decrease in Cultural differences employee moral

Wallis–Elender

IT infrastructure and support Customer network Moving to the same office building Early integration of management Wallis Management Academy (corporate shared service) Building personal relationships Management pool Solving liquidity problems Changes in the strategy Synergy scepticism Exaggerated expectations

Each of the three transactions met the original objectives and realized significant synergies. On this basis, managers evaluated each transaction as successful, despite the fact that unexpected problems had to be solved and that some of the expected synergy potential was not realized. In 2005, K&H Bank introduced a new image campaign and reinforced its market position. The MOL Group fortified its market position by capitalizing on its tight integration with Slovnaft, and pursued ambitious expansion plans by acquiring stakes in Croatian and Romanian oil companies and entering into negotiations with Polish and Serbian companies. The Wallis conglomerate changed its IT strategy and sold its IT portfolio (including Elender) at a premium to a major competitor.

Case conclusions Implications for theory development Synergy management practices focus on eliminating potential problems in the acquisition process while easing the collaboration – and realizing synergies – between the two companies. The cases have various theoretical implications for resource transfers, acquisition experiences and processes.

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Resource transfer The heterogeneous resource endowments of companies may contain similar and complementary elements (Wernerfelt, 1989). The synergy effects emerging from the combination of similar types of resources primarily decrease costs through the exploitation of scale economies. The identification and quantification effects that arise due to differences between merging companies are much more complicated because the cooperative advantages are complex, making it difficult to estimate their impact on revenues. Synergies emerging from complementary resources are more valuable for the merged company due to the fact that knowledge and capabilities can be created that can only be copied and acquired by competitors with much difficulty (Harrison et al., 1991). If the necessary resources exist within the organization, other factors can still impede transfers. One reason can be a lack of motivation of the parties involved in knowledge transfers, as illustrated by synergy scepticism in the conglomerate case study. This calls the attention to further human resources management tasks, including the introduction of compensation and performance evaluation systems that inspire cooperation (Anslinger and Copeland, 1996). However, further investigation is necessary into whether complementarities or similarities are more beneficial in a transaction, and also the most effective ways to encourage voluntary collaboration between units. The factors behind the acquisition and target selection criteria are the functions of the relative resource position of the given company. Both the acquirers and the acquired companies try to eliminate relative weaknesses by deploying the resources of the other party. If we examine the motivations of the acquiring companies in the case studies compared with the resource positions of the companies in the transaction, we find elements in all the three types of acquisition that can eliminate the resource gaps and strengthen the core capabilities. • The most overlaps and the fewest advantages emerged from the asymmetric position that appeared in horizontal acquisitions. An example is the establishment of the IT system, where the weaker position of K&H Bank was improved by the experience of ABN Amro. • In case of vertical acquisition, different positions are seen at several points along the value chain. MOL’s relative weaknesses in refining and production were properly supplemented by the strengths of Slovnaft in these areas. Company documents showed that realized synergies coming from these fields were the largest. • The fewest overlaps occurred in the case of conglomerations. The relative weakness of Wallis (its lack of experience in the IT industry) was demonstrated by the unfavourable market position of its own company, Webigen. To strengthen its IT subsidiary, the company obtained managerial capabilities and knowledge by retaining Elender’s CEO.

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On the other hand, complementarities make analyzing the resources that are transferred to the parent company necessary: • In the horizontal case, complementarities appear within the different resource types due to the considerable overlaps. Specifically, the product structure, sales network (the network of branches) and the customers of the two companies properly supplemented each other. • The most complementary matches are seen in the vertical case. They emerged at different points of the value chain (for example, in refining and wholesale trade), and were also related to functional and general management capabilities. • In the case of conglomerates, the transfer of financial and general management capabilities was possible. In all three cases, the parent company’s capital injection was one of the very first steps – most frequently in the form of equity increase. This is not surprising given the poor financial situation of the targets. Cash injection provided latitude and a scope for action within the integration of the operations. At the same time, covering the costs of the integration (HUF 10.3 billion the case of K&H Bank) was necessary. The main return in the conglomerate case was the financial synergy of the cash pool system, while in cases of related acquisitions, operational improvements were more typical. The transfer of managerial capabilities was intense in all three cases in the form of the exchange of experience and the sharing of knowledge. In all three cases, the capability to manage the acquisition process acted as a threshold condition without which synergies would not have been completely realized.

Acquisition experience Studies of the relationship between acquisition experience and deal performance show that the more experience an acquirer has, the more successful the acquisition can be (Barkema and Vermeulen, 1998). Although this statement can be best examined using quantitative methods, we found counterexamples in the cases presented here. In the horizontal case, the idea to merge bank affiliates in Hungary first developed in the foreign parent company. The merger can therefore be regarded as a reaction to local market challenges, especially since the parents did not merge their other foreign subsidiaries. The parent companies were already experienced in acquisitions, but only the Belgian KBC had experience in this region, making this area new to the others, including ABN Amro Bank, whose withdrawal can be regarded as a failure. General acquisition experience is, therefore, not sufficient in this case, as regional experience would have been essential to manage the Hungarian acquisition. For MOL, the acquisition of Slovnaft was the first opportunity to gain experience that

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could be consciously utilized in the future. As such, the acquisition of Slovnaft was an invaluable experience for MOL. The plans and intentions for growth constituted an essential part of the strategy. MOL can now rely on its tried and tested methods for implementing its acquisition strategy and avoiding certain mistakes. For Wallis, acquisitions are the primary means of growth – the group has more than 100 affiliated corporations, making Wallis an experienced acquirer. Still, not all of its transactions are successful from the management point of view, which raises certain issues in terms of the size and diversification of the group. The company divided its investments into sub-holdings in order better to manage and utilize the synergy potentials between investments. However, the attention and energy of senior management is still torn in many directions, making the introduction of other coordinating mechanisms necessary. Communicating the goals of the acquisition supports efforts to integrate the acquired companies into the group and avoids the uncertainty that would hinder the cooperation of the companies. In summary, the clear formulation of the acquisition strategy and goals obviously increases the probability of success, together with the inclusion of local, country-specific knowledge in the case of cross-border transactions. This aspect proved to be more decisive than rich acquisition experience.

Acquisition process Formulating the goals of the acquisition also supports the selection of the target company and makes it easier to decide whether a possible acquisition matches the long-term expectations of the acquirer and fits the strategy of the company. The process of acquisitions frequently involves the phenomenon of ‘opportunism’ – the utilization of possibilities even they are not included in the original strategy (Haspeslagh and Jemison, 1991). In the cases examined, the financial problem of the targets served as just such an opportunity, which resulted in the seller’s willingness to cooperate with prospective buyers and eased the way for synergy realization. Accordingly, there was no classical target selection process – rather the acquisitions served as a way for the troubled companies to find a suitable new parent. Successful acquirers properly react to these obvious possibilities. ‘Opportunism’ is, therefore, a dynamic capability that subsequently influences the acquisition strategy. In other words, opportunism exerts an effect on the realized strategy as an ‘emerging’ element, as in Mintzberg’s concept. Integration is the last and, at the same time, the most complex phase of acquisitions. In terms of the case studies, the typology recommended by Haspeslagh and Jemison (1991) could not always be used. The integration approaches do not exclusively depend on the need for strategic interdependence and organizational autonomy – legal limitations also have a role either during the negotiations or as a result of the external, legal rules of competition. These marginal conditions influence management’s decision

Krisztina Tóth 67

as to which approach to apply. In this case, the selection of an integration method is not conscious or carried out by predetermined guidelines, but always reflects the solution that seems best at the given moment. At the same time, the type of the acquisition does not necessarily determine the integration approach to be applied, as this choice is influenced by management’s ideas about the role of the target company in the company strategy.

Measuring synergy Despite the expected difficulties of quantifying synergies in practice, this is not the primary problem related to synergies in the minds of managers. In fact, they trace operationalization through the introduction of strict financial control systems with regular reports and discussions, which forces employees to define synergy. This works in most cases, and is the general reason for the underestimation of realized synergies. However, there are also uncertainties because managers are not able to connect all efficiency improvements to functional areas in the reports, especially when the performance improvements are the result of a solution that has emerged from the common thinking of several organizational units. The synergies arising from the sharing of ideas and knowledge cannot be planned in advance and their quantification is only possible after the event. Therefore, synergies emerging through the sharing of knowledge are those non-forecast performance increases that produce ‘unexpected’ results. Managers try to determine the degree of such performance increases afterwards. Therefore, synergy potential cannot be measured completely. In addition, synergy potential estimations always depend on the evaluator who explores and analyzes the possibilities. Distorting factors related to bounded rationality arise, which are classified into the categories of managerial mistakes made during the estimation of synergy potential (Collis and Montgomery, 1995; Goold and Campbell, 1998). The change of performance is a realized synergy indicator that can be applied, but it is very difficult to separate other (environmental) effects that influence the change in performance. In some cases, the expected result is not achieved despite careful planning and obvious synergy potential. The lost value is unexpected, often arising from unexpected problems that affect management (as with some technical problems in the joint MOL–Slovnaft case), and cannot be included in the category of managerial or forecast mistakes.

Implications for managerial practice According to Collis and Montgomery (1995) the realization of synergy potential can be set back by a number of managerial mistakes. Managers tend to underestimate the difficulty of transferring special resources from one field to another. Additionally, they have a tendency to ignore the limits of adaptation to new markets and consequently fail to give a realistic estimation of synergy potential. Overestimation by managers of their own capabilities and

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failing to define of factors of success in the targeted industry leads to a similar result. In these circumstances, management tends to believe it has acquired a resource of value to the company, but since industry-specific factors of success are ignored, the resources they acquired may be of no value to their corporation. Managers often overlook the hidden acquisition costs – dissynergies – in the integration process, which can be indicated by an increased fluctuation in the workforce, a decrease in productivity or an increase in the number of consumer complaints. The overestimation of benefits and the underestimation of costs usually accompany one another, and can in turn be complemented by the false supposition that all required know-how is available within the organization (Goold and Campbell, 1998). When trying to make an empirical evaluation of the merger synergies in the cases examined here, we found that corporate documents do not provide a guarantee that all real factors are known. In the communication of the results, favourable effects are often exaggerated, while unfavourable effects are marginalized. Still, the magnitude of the data can properly refer to the achieved results; although the presentation of the difficulties in achieving synergy is probably not complete since informants focus on positive results. When comparing the expected synergy potentials to the degree of synergy realization in the three cases, we get several different pictures (see Figure 5.1). In the Wallis case, the synergy estimation exceeded the synergies that could have been realized. On the other hand, MOL was able to realize more synergies through the acquisition of the Slovnaft transaction than it had planned in advance. In the merger of K&H and ABN Amro, the synergy expectations and the realized synergies were similar, so that no sudden change occurred in any direction. Figure 5.1 allows us to consider two possibilities when quantifying synergies. On the one hand, the overestimation of synergy potential has a greater

Realised synergy

MOL–Slovnaft

K&H–ABN Amro

Wallis–Elender

Synergy potential Figure 5.1 Potential and realized synergies in the analyzed cases

Krisztina Tóth 69

effect on the realized synergies than the degree of overestimation, since the excessive expectations and the lag of results generate processes that further impede realization. On the other hand, when estimating synergy potential, several factors may arise that could not be identified in advance. In fact, the overestimation of synergies is more dangerous than underestimation, assuming that excessively low expectations may decrease the necessary motivation. The formulation of realistic expectations is easier when the activities of the two companies are similar with many overlaps, as cooperation is then carried out in areas known by both parties so that the expected effects can be better calculated. This concept might explain why, in the case of the two banks, the goals set in advance could have been practically reached, although no unexpected or new results emerged. In sum, when discussing other factors influencing the degree of realized synergies, we find similar elements in different types of acquisitions. In all three cases, senior management’s attention is a vital supporting factor and, in all cases, differences in organizational cultures emerge as hindering factors. These are, therefore, remarkable factors that require attention, regardless of the degree of relatedness of the acquisition. Based on this research, two things seem important for supporting the work of the managers. First, synergy scepticism should be dissolved by communicating realistic expectations to all parties involved. Effective communication plays a role in the reduction of uncertainty, because if members of an organization are well-informed, the potential for a positive reaction is much greater than when employees speculate on their own (Buono and Bowditch, 1989). Frequently, a wave of the hand is the reaction to the mention of ‘synergies’, because the concept is trite and different experiences have led to the spread of synergy scepticism. Doubt, on the one hand, is useful because it limits overestimations when evaluating synergy potential; on the other hand, it is damaging because the motivation of those participating in the realization of synergy is decreased. Therefore, publications should describe both successful and unsuccessful cases. Second, factors supporting the realization of synergies need to be acknowledged, taking practical experience into account. Therefore, the training of the executives of the companies concerned has to have a role in company policy.

70 Appendix 5.1 The Wallis–Elender deal Period

Events

2000: Acquisition strategy

Wallis Rt. pursues an investment strategy of acquiring topperforming companies that have the potential to become market leaders in their respective fields. Wallis Rt. had been interested in entering the IT sector long before the acquisition. According to CEO Gordon Bajnai, ‘We have seen opportunities in the IT sector long before, and we came along step by step, but we would invest in firms only in those cases when there is a certain confidence in the management. If it is not the case, despite the market attractiveness, we would not invest.’ The creation of the IT portfolio started in 2000 with the establishment of Webigen Rt. This was the first occasion when the two owners, Wallis Rt. and PSInet Inc., were in touch with each other. The internet and web service providing the activity of Webigen Rt. was under Wallis’ top management’s profit expectations so Wallis Rt. proceeded with a portfolio restructuring by detaching the advertising branch. Improved results were expected from the value chain restructuring and the delivering of a complex service package. The relationship between Webigen and the former parent company remained close, making PSINet Magyarország Kft an important strategic partner. In addition, the employees knew each other very well. Meanwhile, the IT boom started to fade, which created problems for PSInet Inc., the world’s biggest internet provider, and its competitors. A wave of bankruptcies raged during the summer of 2001. Wallis’ attention turned towards PSINet Magyarország Kft. because of its market potential as well as its talented and charismatic management. Additionally, the weakened situation of the foreign owner favoured Wallis’ bargaining position when it came to a possible acquisition of Webigen. Furthermore, the firm fitted perfectly with the existing Wallis portfolio. Negotiations with PSINet were delayed because the firm did not want to sell one of the two profitable subsidiaries of the European division separately. It therefore had to wait for the English–Israeli consortium to take over the European division so that the negotiations could be restarted. This meant a half-year delay relative to the initial schedule. The purchasing price was not public information, but it is known that the previous owners took back their shares at a lower price than they had originally sold them.

2001: Target selection

2001 Spring–2002 October: Negotiations

71 The parties were represented by one or two persons each. PSINet was represented by Dr. János Kóka, Vice President of PSINet’s European division and responsible for business development. At the same time, Dr. Kóka was co-founder of Elender. Negotiations were also carried on between Wallis and the former owners (Gyula Lepp and János Kóka) in order to set the ownership shares. The situation was described by CEO János Kóka as follows: ‘Wallis fought for every per cent, meaning that they also considered the firm a good investment.’ Finally, Wallis Rt. acquired 77 per cent of the shares. 2002. January– 2003. August: Integration

The integration process started before the negotiation closed. Both companies (Webigen and PSINet Magyarország) moved to a new office building owned by Wallis. In this way, the staff worked practically in the same room. In February 2002, a strategic agreement was reached concerning the cooperation. Nevertheless, the official discussions aimed at a partnership between the two companies at that time. On 7 October 2002, the deal was signed. The integration of the management had already started. János Kóka fulfilled his duties as president of Webigen Rt. starting December 2001. Gábor Ormossy, Webigen’s former financial and business development vice president,became the CFO of the co-owned firm. The merger of the two companies created the opportunity to operate more efficiently and to reduce costs. The number of employees first increased 10 per cent because of the new duties and return of expatriates from PSINet subsidiaries abroad. Then, in 2003, 10 to 15 employees (out of 100) were fired. The first step in the integration was to solve the liquidity problems and to introduce Wallis’ controlling system. The human resource management tasks were then defined. The sales organization was merged as well, but only minor restructuring was needed due to previous cross-selling activity. This department was simplified by dividing the customers into groups. The consolidation of the infrastructure (IT, telecom) also occurred without problems. The integration process is considered complete, although differences in the organizational cultures still persist. It is expected that these will be progressively dissolved through collaboration.

6 M&A in Mobile Telephony: Industry Dynamics Jamie Anderson and Zoltán Antal-Mokos

Introduction The European mobile telecommunications industry has evolved rapidly over the past decade (Gruber, 1999; Sabat, 2002). From a niche service targeted at business users and wealthy individuals, mobile voice has become a mass market proposition with penetration rates in many markets exceeding 90 per cent. Mobile Network Operators (MNOs) have evolved from offering basic voice connectivity to data (Short Message Service (SMS) and Multimedia Messaging Services (MMS)), and multimedia. The industry has been through a transition, focusing initially on network rollout, quality of connectivity and customer acquisition towards customer retention and segmentation, operational efficiency and diversification into increasingly sophisticated service provisioning. More recently, some operators have moved to complement ‘traditional’ mobile network connectivity (Global System for Mobile Communications (GSM) and Universal Mobile Telecommunications System (UMTS)) with fixed network propositions such as Wireless Fidelity (WiFi) and voice over Internet protocol (VoIP). This chapter discusses strategic trends at the industry level. Going beyond micro issues such as segmentation and service proposition development, which have obsessed many MNOs, the focus here is, firstly, on technologydriven evolution of the value chain and, secondly, on the impact of fixedmobile convergence. Shaping the context for strategies of European MNOs, these key trends pose scale and scope challenges. Cross-border mergers and acquisitions, briefly reviewed in the third section, have apparently been a favoured strategy option for European MNOs to cope with these challenges, while M&A itself intensifies another challenge, that of strategic management of operations, the topic of the fourth section. This chapter, therefore, also provides an industry background to the cases in Chapters 9 and 10 on T-Mobile Hungary and France Telecom’s acquisition in Poland, respectively. 72

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Challenging the vertically integrated European MNOs One of the critical issues confronting MNOs has been the evolution of the mobile value chain. The industry has been evolving from vertically integrated structures towards increasingly unbundled models, driven by two key motivating factors: gains from specialization driven by differences in the evolving knowledge bases along the value chain, and latent gains from trade emerging from capability differences between specific firms in the industry (Anderson and Williams, 2004). In the early days of the mobile industry, technologies, business processes and channels to market were not yet established. While companies such as Nokia and Ericsson were developing the network infrastructure and handset hardware to support the infant industry, such companies did not typically extend their roles into network management. These were the days of vendors selling ‘boxes’ and base stations to end clients, who would then be responsible for network roll-out and management. Mobile network operators such as Vodafone, Orange and T-Mobile employed dedicated armies of network engineers to build and manage the industry infrastructure. Network quality and geographic ‘footprint’ were critical sources of competitive advantage. Network coverage and capacity management were focused on voice-based services, which accounted for almost 100 per cent of customer demand up until the late 1990s. Similarly, while vendors provided handsets they did not typically support these handsets with extensive technical support. Again, this often fell to the network operators themselves, seeing the emergence of (voice-focused) service organizations and supporting call centres. In many European countries, the network operator also controlled the distribution channel, managing everything from supply chain strategy to sales and marketing. Operators acquired broad retail footprints, as well as extensive agency networks, and frequently worked with vendors to build and manage their own billing systems and other supporting technologies. Simultaneously, many operating companies built direct sales forces to service the important business segment. MNOs even built and managed their own billing systems because vendors were not yet delivering the breadth of ‘off the shelf’ software and services required. To deal with the rapid growth of the industry during the 1990s, mobile operating companies needed to build highly integrated operations. Mergers and acquisitions, then, were playing a role in both obtaining new functional capabilities and enlarging the pool of voice subscribers so as to recoup investments. One of the key drivers for value chain unbundling in the mobile industry lately has been the emergence of technological standards in maturing formats (voice, SMS, wireless application protocol, 1.x), not only for network infrastructure, but also for billing enablement, IT and other business critical processes. The interfaces between 2G (second generation/digital mobile) access networks, operations and business support system components and

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subsystems have become increasingly standardized and reliable, in many ways reducing operational complexity and change. Furthermore, as both vendors of and customers for core industry technologies such as networking equipment have faced difficult economic times as the 2G industry has matured, some have looked for vendors to extend their role into value-added services rather than simply selling technology ‘products’ to clients. As the core technological components of the 2G industry have become modularized, and vendors with core competence in network infrastructure design and maintenance have looked to diversify their service offerings, it has become questionable whether network operators are best positioned to be the most efficient managers of their own networks. Recent industry entrants, widely known as Mobile Virtual Network Operators (MVNOs) have been radical in their approach to the typical industry value chain. There are a range of MVNO models, but a key similarity for all MVNOs is their typical lack of ownership of network infrastructure. The services offered by an MVNO are therefore to a degree dependent upon the commercial agreement with the MNO and the amount of infrastructure controlled. The typical MVNO market entry strategy is to own as little infrastructure as possible, and so MVNOs usually provide basic voice and data (SMS) services as the primary offering, operating over an established 2G network with spare capacity. This is typically where processes, interactions, costs structures and use cases/scenarios have stabilized to an extent where commercial agreements and service level agreements give a high level of confidence in the management of outputs to the MVNO, and a high degree of confidence in margins and utilization impact for the MNO. Both parties operate within acceptable risk/reward areas in foreseeable cost structures. ‘Pure MVNOs’ are only typically found in European countries where there is strong national regulation to overcome the incumbent MNOs’ reluctance to form such arrangements, and where a business case can be created that justifies the initial capital cost. But this situation is changing, with regulators placing increasing pressure on incumbents to provide access to their network infrastructure for new entrants. Virgin Mobile is the most often quoted MVNO, a 50:50 joint venture between Virgin and German mobile operator T-Mobile. Its product is therefore quite integrated with T-Mobile’s UK service (formerly One2One) with billing and customer service provided by T-Mobile. Virgin Mobile has been successful due to Virgin’s very strong brand and distribution channels, and its ability to integrate mobile telephony with Virgin’s other products and services, while owning virtually no network infrastructure. It has been the fastest growing mobile service operator in the UK since 2001. Another fast growing MVNO is Telmore, a Denmark based service provider. Telmore is an Internet enabled company with an aggressive price strategy targeted at the ‘low-end’ segment. Like many low-cost airlines, it offers

Jamie Anderson and Zoltán Antal-Mokos 75

a basic service and primarily deals with customers over the web. It has no high-street shops, nor does it own a network; it resells airtime on a network owned by TDC, Denmark’s incumbent. Customers check their balances via text messages. There are no subscription fees or paper bills. Telmore acquired 450,000 customers after less than three years on the market, and reached more than 500,000 customers by the end of 2004, moving past Telia as the fourth largest mobile network operator in Denmark. Telmore had captured 7 per cent of the Danish market for voice, and 15 per cent for data. The company achieved this growth with fewer than one hundred staff, which compares to some national MNOs in Europe with roughly the same number of customers but up to ten times the employee headcount. Orange France had more than 6500 employees in call centres alone at end 2003 (Anderson, 2005). MVNO entrants such as Telmore have recognized that value chain integration is no longer crucial for a company’s success in the mobile industry, and by aggressively lobbying regulators these upstarts have been able to gain access to industry ‘subsystems’ such as network infrastructure. Telmore has also taken advantage of the fact that as incumbent network operators have moved to bring more and more sophisticated services to market they have overshot the needs of many customers. And to deliver all things to all customers, most of these incumbents (both large and small) have built high-cost and bloated organizational structures spanning the breadth and width of the value chain. In this respect, a company such as Telmore is a classic disruptive innovator. The current strategies of many mobile network operating companies may then be misguided. They continue to target virtually all customer segments, and to pursue a single brand, integrated business model, despite the fact that the past conditions that required integration across network and services provisioning for competitive advantage have shifted. Interestingly, the entry of MVNOs can also be a motive for M&A. The largest Danish incumbent, TDC, bought a 20 per cent stake in Telmore in early 2003, acquiring the remainder of the company in early 2004, while the number two MNO Sonofon (itself acquired by Telenor in 2003) acquired a smaller Danish MVNO, CBB Mobil (Anderson, 2004a). It remains to be seen how TDC and Sonofon will develop their daughter MVNO businesses, but the challenges for an incumbent in integrating a disruptive innovation are well known (Chariotou and Markides, 2003).

Fixed-mobile convergence At the same time that value chain evolution is pushing mobile network operators across Europe to focus on vertical specialization and outsourcing, another factor is starting to reveal itself: fixed-mobile convergence. Driven by customer demands and emerging IP based technologies, fixed-mobile

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convergence will also introduce new dynamics that will potentially transform the European mobile telecommunications industry, and may trigger some M&A deals as well as internal organizational changes. (Latest developments in the case on T-Mobile Hungary and Deutsche Telekom as described in Chapter 9 may just be an example of this.) Over the past decade, a range of technologies have evolved to deliver communication and data services to consumers over fixed and mobile telecommunications networks. But these services have become communications and content islands, separated by a range of service delivery platforms and a lack of common standards. Customers have had fragmented communications lives, with services often provided by two or more vendors enabling access to mobile voice telephony and mobile multimedia, fixed Public Switched Telephone Network, voice services, fixed VoIP services and fixed multimedia services. Customers have received multiple bills from multiple vendors, or from different divisions of ‘integrated’ telecommunications companies, have juggled different fixed and mobile telephone numbers and voicemail services, and have had to deal with multiple messaging applications such as SMS and email. Customer services, and sales and marketing activities have also been fragmented, with many operators having separate retail channels and service centres for fixed and mobile services. It has been difficult to transfer multimedia content, address books and contact lists between different network platforms and the devices offered by different fixed and mobile network vendors. From the customer’s perspective then, fixed-mobile convergence is very simply the desire for a unified voice and multimedia service experience, with simplified billing and a single point of contact for vendor service. Terminal device convergence and service convergence are evolving to deliver a unified end-user experience, and the evolution of open standard operating systems and application engines are driving standardization in the mobile handset industry in a similar manner to the evolution of standards in the world of IT. Beyond device standardization, network convergence will dissolve the barriers that currently separate today’s network islands. The technologies are in place and there is agreement on the core technology standards that will deliver end-to-end solutions – Session Initiation Protocol and IP Multimedia Subsystem protocol. From an operator’s perspective, the network convergence goal will be to integrate today’s separate circuit and packet switch core networks to a unified core network that supports existing access technologies in both the fixed and mobile domains (Anderson, 2006). The implications of fixed-mobile convergence are clear: it will become increasingly difficult to survive as a pure play fixed or mobile operator, and operators pursuing fixed or mobile only propositions are likely to be squeezed into narrow market niches. This does not mean that these

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focused firms cannot be profitable. But the difficulty of building a significant and broad market presence as a pure play mobile network operator has already become apparent in Australia, where MNO Vodafone has found it difficult to grow profitably in the face of established competitors Telstra and Optus which provide bundled fixed-mobile propositions. Typically positioned as number one or two in its other markets, Vodafone has been unable to break out of third position in Australia, and has acquired predominantly prepaid customers at the lower end of the market. Some operators, such as Deutsche Telekom, France Telecom and Telefonica, have both the fixed and mobile network assets to deliver converged fixed-mobile propositions to customers in some markets but, as the planned integration of T-Mobile Hungary into Magyar Telekom might prove (see Chapter 9), there will be a significant organizational challenge in reintegrating what have become increasingly autonomous operational divisions. Deutsche Telekom is perhaps uniquely positioned within Europe in this respect, having retained its own ICT systems integration organization, T-Systems. Other firms, such as British Telecom (BT) have divested mobile networks or, in the case of companies such as Vodafone, are pure play MNOs, and therefore do not have the full spectrum of network components to deliver converged solutions to end customers. In a converging world, mergers and alliances of fixed and mobile network operators are likely to intensify, reversing the trend begun more than ten years ago to separate these businesses – witness the mid-2004 alliance for fixed-mobile propositions between BT and Vodafone, and the 2006 acquisition bid for Virgin Mobile by ntl. If successful, the Virgin acquisition would make ntl a ‘four-play’ provider – adding mobile services to the TV, broadband and fixed-line phone services already offered. Value chain evolution and vertical specialization will become even more critical as the network layer is broadened to cover multiple access technologies sitting on an IP backbone, and services and applications are developed using common technological standards. The management challenges of integrating different fixed and mobile networks across different European operating countries to deliver fixed-mobile convergence cannot be underestimated, either. In some countries, operators will have both fixed and mobile networks. In others, the industry is likely to see a patchwork of alliances and partnerships to deliver converged solutions. Fixed-mobile convergence is a given in Europe, but it will take time to achieve. The challenge for telecommunications companies with both fixed and mobile networks will be to integrate organizational silos and develop compelling service propositions that eradicate communications and content islands. For pure play fixed or mobile network operators, the objective will be to avoid being squeezed into potentially narrow niche segments (unless this is an acceptable outcome of a focus strategy), and this will require either mergers and acquisitions or alliances.

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Emerging industry, emerging markets, mergers and acquisitions The total transaction value of M&A activity in Europe increased fivefold between 1995–99, with the telecom industry at large and mobile services specifically being a key area of European mergers and acquisitions. Overseas, one could see a similar trend: consider WorldCom’s takeover of MCI Communications for USD 41.9 billion in 1997, SBC’s acquisition of Ameritech for USD 62.6 billion in 1998, the deal between AT&T and MediaOne with a transaction value of USD 49.3 billion and Quest taking over US West for USD 56.3 billion, both in 1999. Clearly, this is an industry where ownership changes, including cross-border deals, have played a key part in the strategies of all the MNOs with an aspiration to grow beyond their ‘traditional’ markets, to build, defend or refine their business models, and to acquire skills, resources and customers (Trillas, 2002). Potential scale and scope economies and the need to cover enormous capital costs relating to investments in new technologies and licences have been driving cross-border transactions. As perhaps the most remarkable example, witness Vodafone’s transactions with AirTouch, Verizon (former Bell Atlantic), and Mannesmann (Anderson et al., 2003), which have been front-page news due to their size, but represented only a few of the deals the British firm have made throughout the years on its non-organic path to become the leading global mobile service provider. Other examples include France Telecom’s acquisition of Orange, and Deutsche Telekom’s deals with VoiceStream and Powertel (USA). Acquisitions also reflect changing market conditions throughout the telecommunications sector. As markets revealed the first signs of becoming more and more saturated around the end of the 1990s, managements reverted to deals as a way to achieve growth. The search for new markets and synergies, and the desire to develop regional footprints resulted in large industry players snapping up smaller ones in an industry where, in 1999, there were 45 mobile players in 15 EU member states. Some deals, however, seem to have been driven by defence motives of mid-size players (Dutch KPN might be an example) in the hope that with an increased size chances to become targets would reduce. Not only may large competitors play a significant role in some local markets, however. Telenor, for example, was the leading provider of mobile telecommunications in Norway as of the end of 2004, but it also held interests in mobile operations in 11 countries, many of which were emerging markets, including principal investments in Sonofon in Denmark (100 per cent ownership, 1.3 million subscribers), Pannon GSM in Hungary (100 per cent, 2.77 million subscribers), DiGi.Com in Malaysia (61 per cent ownership, 3.24 million subscribers), Kyvistar in Ukraine (56.5 per cent, 6.25 million), GrameenPhone in Bangladesh (62 per cent, 2.39 million), and ProMonte GSM in Montenegro (100 per cent ownership, 0.28

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million subscribers), with another five equity participations in Europe and Southeast Asia (Telenor ASA, 2004). The number of subscriptions in Telenor’s international mobile operations, calculated on the basis of proportionate ownership interest in each company, was 22.1 million at 31 December 2004 and 13.2 million at 31 December 2003, indicating significant growth opportunities for a mobile service provider in emerging markets. For another example, France Telecom has also been active in emerging markets, as its ownership position in MobiNil (Egypt) indicates (Estrin and Meyer, 2004). As a result of the collapse of share prices in March 2000, a rediscovered importance of profitability, a weak Euro, practices of competition authorities and, following the UMTS tenders in several countries, the dismal financial state of firms have all contributed to the subsequent slow-down of M&A activity, while the need to reduce indebtedness prompted some firms to realign their business portfolio by selling some of their interests, such as Deutsche Telekom divesting its stake in the cable business, Telecom Italia selling its interest in Telekom Austria, and BT selling its shares in Japan Telecom. This was the time when some global telecommunications service providers sold their investments in central and eastern Europe, often completely withdrawing from a region or a national market. Others opted for different solutions to the problem of indebtedness; for example, amongst other measures France Telecom put a great emphasis on reducing operating costs (the budget of Orange was cut by 25 per cent), while Deutsche Telekom issued 30-year corporate bonds. Even in the ‘post bubble’ period, in a year starting from 1 April 2000, there were 139 deals in the telecommunications sector in the German speaking countries of Europe, signalling the significance of M&A in this industry, even in tough economic and financial conditions (Andersen, 2001). The mobile segment accounted for one third of this activity, with two thirds of these made across borders. Fixed line companies were especially prominent acquirers of mobile firms. Some companies continued their expansion by making further acquisitions; Vodafone, for example, increased its stake in Dutch Libertel, bought up the rest of the Swedish mobile telephone service provider Europolitan, and also acquired the outstanding 39 per cent stake of Portuguese Telecel, to name but a few of its moves. In the years 2000–03, Deutsche Telekom was active as an investor in central and eastern Europe (Listing Prospectus, 2003; Karnitschnig, 2004), most importantly adding to their existing interests in Hungary by acquiring stakes in Hrvatski Telecom (Croatia), Polska Telefonia Cyfrowa (Poland), Slovak Telekom (including mobile service provider Eurotel, Slovak Telekom’s joint venture with Atlantic West B.V.), and in the Czech Republic, where T-Mobile International holds 92 per cent of Cmobil, which in turn owns an equity interest of 61 per cent in RadioMobil, a mobile network operator with about 3.5 million subscribers (as of the end of 2002). Elsewhere in Europe, the most significant acquisition by Deutsche Telekom (through T-Mobile International) was the stepwise takeover of Ben Nederland.

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Strong profits and cash flows, cheap credit, a strong Euro, an increased activity of private-equity firms, coupled with Europe-wide ambitions of key industry players may fuel another M&A wave in the telecom sector in the years to come. TIM Hellas was recently bought, for example, by two private-equity firms, Vodafone spent more than USD 4 billion for control over mobile operators in Romania and the Czech Republic, Telefonica acquired O2 , and France Telecom bought control in Spain’s Amena in 2005 (Rosenbuch, 2005). France Telecom (with Orange in its court already) and Telefonica Moviles of Spain are seen as great consolidators in western Europe – in a race with Vodafone for economies of size and scale. Deutsche Telekom is likely to continue with its strategy to build a leading position in central and east European markets, where there are still more growth opportunities, and assets are typically valued lower than in western Europe. Behind these giants, there are others who seem to follow similar ‘consolidatorstrategy’ at a regional level, one example of which may be Orascom Telecom (a member of the Orascom Group in Egypt) which had become one of the largest GSM network operators in the Middle East, Africa, and Indian subcontinent as a result of acquisitions and tenders by 2001 (Estrin and Meyer, 2004), and recently bought a stake in Hutchison Telecom to extend its ‘fastgrowing emerging-markets story’ to India and Southeast Asia, also with an eye on Vodafone as the global leader to catch up with (Reed, 2005).

The European MNO organizational challenge A major organizational issue confronting many mobile network operators across Europe has been the need to reap the scale and scope benefits of the merger and acquisition activity that continues to drive the industry. At the same time, regional and international operators will also need to remain responsive at the local level in the face of national operators and niche competitors such as the MVNOs. In Europe, emerging pan-regional MNOs have typically grown through a mixture of organic growth, and merger and acquisition, but with M&A often being the preferred method of expansion. For example, Vodafone exploded in size to more than 100 million customers between 1999–2003 as it acquired Mannesmann in Germany, and swallowed or obtained significant equity stakes in a number of other small and not so small operators. The rationale for this merger and acquisition activity in Europe, as we have already noted, has typically related to economies of scale and scope – scale economies through volume for infrastructure, information technology and handset procurement (particularly with the expected roll-out of third generation networks), as well as savings in the overall cost of running networks, and scope in terms of reducing cost per unit. Other highlighted benefits are roaming advantages, marketing synergies, customer services, regulatory relations, and increased depth of management expertise. Indeed, there has been

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no shortage of potential benefits identified in the deals made by Vodafone, and others emerging international and regional players such as T-Mobile (Deutsche Telekom) and Orange (France Telecom). But there are also challenges in moving away from national operating structures – not least the fact that those network operators acquired are highly autonomous and often successful companies with their own organizational structures, operational processes and business cultures. While the limitations of being an exclusively local (usually national) mobile network operator have become increasingly apparent as debt, market saturation and technology evolution have adversely impacted smaller European MNOs, it should not be ignored that national network operators have some unique strengths. Companies such as Optimus in Portugal, Omnitel (now Vodafone) in Italy, and WESTEL (now T-Mobile) in Hungary have been recognized for their innovation in responding to local needs, and developing product and service propositions well suited to local consumers. And herein lies one of the challenges for the emerging international and panregional competitors – while the development of coordinated cross-border corporate organizations offers many advantages in terms of economies of scale and scope for elements such as network, technology platforms and brand, there is also a risk of these scale and scope advantages being delivered to the detriment of local responsiveness. The issue of local responsiveness did not emerge as a challenge when companies such as Vodafone and Orange managed their operating companies in a ‘multinational’ manner, with a degree of centralized financial control and (sometimes) brand management – but little operational control. However, as these autonomous multinational structures are replaced with more centralized approaches there is a real risk that this shift of power might result in decreasing motivation and an inability of operating companies to respond to local market needs. As any marketer knows, standardization often fails to satisfy, and there is a risk of market insensitivity when strategy making becomes detached from the end customer. Furthermore, as the larger MNOs attempt to make the shift from decentralized decision making to a more centrally coordinated strategy, we are witnessing conflict with local management teams – as demonstrated by a number of senior country-level resignations from the larger Europe-based groups in recent years. Why might this be the case? Often, these local executives reject the scale–scope argument in favour of their own experience and knowledge of the local market, and they deeply resent functional expertise being shifted from their local operation to the headquarters organization. A particular problem is often the lack of due process on behalf of the headquarters’ executive management team, with the rationale for centralization of particular functional activities not clearly articulated to the country managers. Were this to be followed by simply drawing all power to the home country headquarters and downsizing centres of excellence and innovation in the operating companies,

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then headquarters would become the fountain of all functional strategy – everything from supply chain management to marketing – with the local operations simply acting as implementers, usually with some local sales and promotional activities delegated grudgingly. A more enlightened approach is to avoid this highly centralized structure and adopt what is termed a ‘transnational’ organizational model (Bartlett and Ghoshal, 1987), although recent developments suggest that this approach is the exception rather than the rule for the cross-border consolidators in the mobile industry (Anderson et al., 2004). In the transnational organization, management aims to identify and leverage expertise from across the organization, rather than centralizing control and expertise at the headquarters. Duplication is avoided, but centres of excellence are distributed rather than centralized. Furthermore, in the transnational organization, different operating companies are managed differently – some centrally and some as largely autonomous entities. As indicated by the organizational practice of Hutchison Whampoa with its launch of ‘3’ in the United Kingdom, Italy, Sweden and other markets, this approach aims to allow a company to respond to different strategic requirements for each of its businesses and, in essence, provide a balance between international or regional scale and scope, and responsiveness to divergent local market needs. While some elements of the Group’s strategy in areas such as brand, network procurement and handset vendor management is highly centralized, many operating decisions in areas such as the marketing mix and multimedia content partnerships are local. Furthermore, Hutchison actively works to transfer personnel and knowledge between its operating entities, with no one country operation seen as the hub for all functional expertise (Anderson, 2004b). Vodafone has also, to an extent, taken the transnational route, with many centres of excellence sitting outside its Newbury HQ – for example, the Group’s Global Products and Services arm is based in Düsseldorf. But to achieve this more transnational dynamic, Vodafone has had to make significant investments in changing organizational processes and culture to become more conducive to information and resource flows. T-Mobile (Deutsche Telekom) and Orange (France Telecom) appear to have moved increasingly towards the centralization of knowledge and skills. The weaknesses of purely local or decentralized multinational structures are easily identified – efficiency penalties, poor flow of knowledge and information, and needless duplication – but these structures also offer advantages in terms of the ability to differentiate and respond to unique local customer preferences. Highly centralized structures might offer advantages of scale and scope, but the trade-off is all too often a one-size fits all approach that leads to excessive standardization and local market insensitivity. The development of a transnational approach will be much easier for a greenfield player like Hutchison ‘3’ than it will be for established MNOs with

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their legacy organizational structures, processes and people, but few new entrants will have the resources or bravery to launch cross-border mobile start-ups. The incumbents who are able to strike a balance between scale and local responsiveness are those most likely to enjoy the greatest success moving forward.

Conclusion The mobile telecommunications industry has rapidly evolved, forcing executives to focus on management of the value chain, the implications of fixedmobile convergence, and strategic coordination across borders. Value chain design should be recognized as a strategic activity that will determine the fate of MNOs, and of future profits and power distribution in the industry: putting in place the resources, structures and processes to deliver a transnational solution will require management commitment. Fixed-mobile convergence is an inevitable outcome of emerging customer needs, but will require dramatic change by fixed and mobile telecommunications companies alike. The European mobile industry has seen significant changes over the past decade, and the coming decade will witness no fewer transformational shifts. As the European mobile industry continues to evolve, merger and acquisition activity is likely to intensify. Cross-border consolidation is an inevitable part of industry maturation, and although it might take some years for truly global competitors to emerge, we have already seen the rise of international and pan-regional competitors such as Vodafone, T-Mobile, Orange and Hutchison ‘3’. With consolidation gathering pace, one of the key priorities for growing MNOs will be the development of transnational organizational structures that are both internationally or regionally integrated and locally responsive.

7 Institutional and Regulatory Barriers to Foreign M&A in Central Europe Mieczysław B˛ ak, Przemysław Kulawczuk and Anna Szcze´sniak

Introduction The governments of most central European countries considered the privatization of state property to be an important instrument in introducing market rules to the economy. Despite general consent that privatization facilitates the development of market economies, countries differed in their adaptation of particular privatization methodologies and in the pace of privatization. Generally, central European countries’ privatization policies facilitated foreign mergers and acquisitions, although there were some differences between countries. This chapter reviews and critically evaluates the governmental policies adopted in the European emerging economies, with a special focus on the case of Poland. The next section reviews privatization policies and their impact on acquisition opportunities, which is followed by a discussion of administrative barriers to acquisition and greenfield entrants.

Privatization policies In Poland, of the approximately 8000 state-owned business units in 1990, 7165 were privatized by the end of 2004. The main methods of privatization were: partial or total sale of the company stock (1555 firms), mass (coupon) privatization (512), privatization through debt conversion (15), direct sales of state-owned enterprise (SOE) assets (2090), liquidation (1852), and inclusion of state-owned farm assets within the Agricultural Estate Fund (1654); with, in some cases, multiple methods being applied to the same firm. By 2004, over 80 per cent of the state property units earmarked for privatization were sold. The majority of privatization cases were executed in the form of direct or indirect acquisitions by domestic or foreign owners. According to Lewandowski (2001), mergers and acquisitions in Poland related to privatization differed in many ways from typical transactions on the private market. 84

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He lists the following differences between traditional acquisitions and privatization acquisitions: • Different representation: the process of asset sales is organized by state bureaucrats rather than by private owners • The new owner in privatization acquisitions must accept social and capital investment obligations, which increases the cost of acquisitions • Managerial freedom is reduced in privatization acquisitions due to the acceptance of existing obligations • In privatization acquisitions, formal limits are placed on such aspects as further stock transfers, branding policy, and withdrawals from the stock exchange • Privatized acquisitions are politically sensitive due to the changes in government and resistance to privatization from different social groups Under Polish privatization law, sales of SOE assets required employees’ consent. Usually employees managed to achieve job guarantees for two or three years and compensation for job cuts. The obligations that had to be accepted by the investors and the performance of different groups of stakeholders during privatization significantly influenced the withdrawals of foreign investors from Poland (B˛ak et al., 1998). Moreover, the stakeholder groups may have had different interests in privatization (Meyer and Jensen, 2005). When the privatization of SOE had two stages, primary privatizations were altered in favour of employees and company managements (that is, employee and management buy-outs – about 10 per cent of all privatization cases). Secondary privatizations changed the ownership structure in favour of strategic branch investors. In this secondary phase of privatization, limitations and obligations towards employees were usually relaxed. In their privatization policies, state governments tried to combine two main goals. The fiscal goal was to receive the maximum income from privatization, while the industrial policy goal was to provide sound strategic management for privatized companies, which would facilitate their future development. In the majority of cases, these goals could be achieved simultaneously but fiscal orientation generally made it difficult to obtain a high level of capital investment from a new investor. Therefore, the synergy effects of privatization acquisitions in Poland were usually delayed by approximately three years due to the social obligations investors had to accept. In numerous cases, such a delay was not observed due to substantial compensations for earlier job cuts offered by the new investor, although this increased the acquisition cost. In Lithuania, the privatization process was organized in two rounds. During the first round (1991–95), state property was sold for investment vouchers that were distributed to Lithuanian citizens. State property was sold through open and closed submissions of shares (2928 enterprises), auctions

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(2726), and best business plans tenders (12), as well as for cash (48). In the second round of privatization (1996–99), 1053 units were sold through public auctions, 26 units through the public sale of shares, 24 through public tenders and 16 through other methods (LFMI, 2000). Despite the fact that privatization goals were not laid down in Lithuanian law, the State Property Fund, responsible for privatization process, declared several goals: • • • • •

To To To To To

privatize state property for the maximum price ensure a transparent, high-speed privatization process avoid aggravating unemployment problems ensure large investments create conditions for the development of capital markets.

Lithuania’s privatization policy had to combine numerous contradictory goals (such as a maximum property sales price that was contrary to maximum capital investment). The Lithuanian Free Market Institute notes the possibility that foreign acquisitions may inhibit the formation of local capital, because they would transfer profits abroad (for example, via transfer prices) and exploit the low financial capability of local investors. In Lithuania, as in Poland, the privatization agency had to operate under budgetary pressures, which increased the pace of privatizations and made acquisitions by foreign companies more attractive. In general, the more ambitious the privatization target, the faster the foreign acquisition. The pace could also influence prices for state assets or capital. One important factor in privatization negotiations was the costs of job guarantees for employees. In Hungary, the privatization process was faster and shorter than in Poland or Lithuania. By 1998, Hungary had completed most of its privatization process, and had transferred about 35 per cent of corporate ownership to foreign owners, which was a far higher proportion than any other central European country at the time. The privatization policy of the Hungarian government stressed the necessity of integrating the national economy with transnational companies. Prior to the Second World War, the majority of manufacturing companies in Hungary were foreign-owned and the 1990s privatization round recreated this situation (Mihaly, 2000). The fast pace of privatization facilitated the inflow of FDI. In this regard, Schwartz and Haggard (1997) observe that privatization strategies may encourage FDI by making terms of ownership relatively attractive to prospective foreign investors. Privatization strategies that tend to encourage FDI are unrestrictive, and strategies that tend to discourage FDI are restrictive. They therefore suggest that voucher and institutional privatization approaches tend to restrict FDI, while direct sale and public tender privatization approaches tend to be relatively unrestrictive to FDI

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flows. They also suggest that national privatization strategies are the second important element, after geography, in determining FDI flows. Schwartz and Haggard’s observations are directly applicable to Hungary. Hungary only used a form of mass privatization in relation to key industrial and service assets, and focused its privatization efforts on direct sales to strategic investors. The majority of state industrial assets were sold off by auction (mainly to local buyers in small privatizations), and through direct sales to local or foreign investors via public competition, public tender, private placement of shares and public stock offerings on the stock exchange. Compared to other central European countries, this policy was effected in a relatively short period of time. Hungarian authors such as Antal-Mokos (1998) have expressed concerns that large scale privatization is negatively affected by organizational politicking, drawn out privatization processes, and a lack of transparency. Voszka (1999: 15) notes that the changeable and mixed nature of privatization in Hungary has made it difficult for participants to evaluate the process and has led to a certain lack of transparency. On the other hand, the flexible and pragmatic approach has offered good opportunities to several groups of investors. It also contributed to the significant expansion of the private economy. Secondly, the speed of the privatization has been influenced both by the methods and associated decision making mechanism. In some countries, voucher schemes that aimed to speed up the process may in fact have slowed down privatization because it created a high level of uncertainty for the pertinent firms over who their new owners would be, and whose objectives they were thus to follow. In summary, the privatization policies of the EEE countries created a good climate for foreign acquisitions. The application of mass privatization delayed M&A opportunities, while the direct sales of companies and capital privatization facilitated M&A. The major problems for foreign investors in privatized companies were investment obligations and job guarantees, both of which significantly increased costs, delayed synergy results and reduced short-run profits. In the long run, these problems were overcome in the majority of cases and the acquisitions were successful.

Administrative barriers Although most of the central European countries joined the EU in 2004, numerous administrative barriers to foreign direct investment still existed. Barriers to FDI can be discussed in two dimensions: specific administrative barriers to mergers and acquisitions, and barriers related to capital investment processes and site development. All of these barriers are inter-related,

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as barriers to greenfield investment may turn investor attention to M&A and vice versa.

Ownership restrictions European emerging economies seemed to be very supportive of the mergers and acquisition process in the years before accession to the EU. According to PricewaterhouseCoopers, the EEE M&A market’s total value in 2000 (a peak year) was USD 17 billion (PricewaterhouseCoopers, 2001). The total number of M&A deals was 791 in 2000, which was a 33 per cent increase over the previous year. Countries like Poland, the Czech Republic and Hungary had to lift restrictions to foreign capital flows in accordance with an OECD condition for entry condition. By 2000, most of the restrictions were removed. Despite the lifting of restrictions, some institutional barriers still existed, which disturbed the free flow of capital. One restriction of this kind was the direct determination of the maximum foreign share in a company’s stock, which affected a number of industries. In Poland the stake of non-resident investors in TV or broadcasting stations could not exceed 49 per cent. In Hungary, ownership of civil aviation, defence and broadcasting companies was restricted until 2002. The ownership of farmland was also limited to Hungarian citizens. During the 1990s, Lithuania imposed restrictions on foreign ownership in the defence, manufacturing, and media industries. However, restrictions on media ownership were lifted in 1999. As accession to the EU came closer, the number of ownership restrictions within the EEE decreased significantly. After 2004, restrictions on foreign ownership were regulated by accession treaties with the EU, although they did not necessarily address investors from outside the EU. In addition to the business areas mentioned above, foreign access has been heavily regulated for markets such as pension funds and legal services. Upon joining the EU, European emerging countries had to lift most of the restrictions on businesses established by citizens of other EU countries. However, restrictions do persist with respect to non-EEE citizens, even if they are legally operating in another EU country. This might have been important when managers of large companies were hired using self-employment contracts. This, of course, did not seriously affect the inflow of foreign capital or mergers and acquisitions, but disturbed everyday management of foreign affiliates. When joining the EU, the European emerging economies created a much more privileged position in this area for nationals from the European Economic Area (EEA) than for non-EEA residents. However, this aspect only indirectly disturbs the mergers and acquisitions process.

Discretionary administrative practices Central European M&A are most influenced by the discretionary practices of regulating agencies within the legal framework, which in turn does not directly create any obstacles to international M&A. A typical example of the

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impact of such discretionary practices on the M&A process is the requirement that all mergers in the pension and banking industries must have an administrative permit. Poland serves as an interesting example in this area. In banking activities, business permits were issued by the National Bank of Poland (NBP). In general, NBP did not created any problems for M&A between banks in Poland. However, it used its discretionary licensing policy over foreign applicants to resolve the poor condition of various banks to protect them from bankruptcy. For a foreign bank to obtain a licence, they were required to acquire such a bank. When foreign financial institutions applied for a licence to conduct business in Poland, the NBP would indicate which banks had to be acquired by the foreign bank first. Such practices were understood to be a condition of trade for market entry for the benefit of the local banks. This policy was evaluated as effective and protected Poland from significant bankruptcies and financial crisis, although it created significant costs for newcomers. NBP’s policy resulted in numerous spectacular mergers on the Polish financial market, with NBP’s most important tool being the laws increasing capital requirements for banks. Those rising requirements caused the number of cooperative savings banks to be reduced from over 800 to about 500 between 1998–2004, mostly through the M&A process. Merger permits were issued by the Commission of Banking Supervision, which is formally an independent institution but is actually associated with the National Bank of Poland. While NBP’s policy encouraged consolidation in the banking sector, the situation was the opposite for pension funds. The Supervisory Commission of Insurance and Pension Funds was the governmental agency that issued permits for M&A in the pension funds market. When a pension funds reform was introduced in Poland in 1999, 21 pension funds were created. These were managed by financial institutions which had to comply with severe capital requirements. Given the lack of local capital, most funds were managed by foreign financial institutions. Of the 21 pension funds created in 1999, several small funds had poor opportunities for development. The Commission intended to provide competitive market conditions, leading it to oppose acquisitions and reductions in the number of market players. However, two processes occurred that affected the development of the Polish pension fund market. The first was that institutions who managed funds outside of Poland merged, creating a situation in which two funds could be managed by one financial institution. The second process was the loss of economic logic behind very small funds. The Commission agreed to mergers only in extreme situations and refused to issue permits based on business development reasoning. The number of mergers was four in 2001, one in 2002 and one in 2004. The last permit for a merger was issued in 2002, and since then the process of mergers has been blocked by the discretionary policy of the regulator. There were still 15 pension funds in Poland in 2005.

90 Barriers to Foreign M&A in Central Europe

Detailed administrative approaches and the monitoring of small M&A deals Competition law influences the process of M&A in central European countries more than in countries with mature markets. All European emerging economies try to follow the competition laws and practices established by the European Commission, but these countries operate with narrow, and sometimes undeveloped, markets. As a result, some applicants for M&A permits seem to be treated more severely by EEE regulatory agencies than they would be in other EU countries. In Poland, the Office for the Protection of Competition and Consumers requires that companies wishing to undertake the M&A process submit a brief describing the market concentration in all cases where the annual turnover of the companies participating in the M&A is over EUR 50 million. Such a brief must also be submitted when the amount of stock to be purchased will exceed 25 per cent of total shares. This brief is submitted only when the total market share of the companies exceeds 20 per cent. The President of the Agency makes his decision based on this brief. These regulations follow EU requirements, but on small markets they can influence very small deals. However, there are no observed cases of prohibitions to copy M&A deals that have taken place abroad in Poland, which raises the question of whether such a procedure is necessary in the case of small deals. Polish regulations concerning the acquisition of stock in publicly traded companies are more severe than those seen in non-EEE European Union countries. Most non-EEE EU regulations require permits when the capital or voting rights held by the investor exceeds 20 per cent, 33 per cent or 50 per cent. In Poland, requirements for submitting briefs begin when 2 per cent of voting rights will be affected in publicly traded companies. Permits from the Commission of Securities are required when this amount passes 25 per cent. As permits are not required for cases involving 0 per cent to 25 per cent of voting rights, a question arises as to the reasoning behind this procedure. Gradual increases in shareholding are heavily monitored in Poland by the Securities Commission, which imposes severe penalties for not submitting a brief at the appropriate time. However, such a detailed approach to submitting briefs could constitute a financial trap for investors not deeply engaged in the local securities market.

Costs of administrative procedures Morisset and Neso (2002) list the 26 administrative procedures most commonly affecting FDI in developing countries (including central Europe). Similar methodology was adopted by the World Bank (2005). Important issues arise when analyzing the cost of administrative procedures in business creation. The total business creation administrative cost can be measured by the number of administrative procedures, the time required to fulfil them,

M. B˛ ak, P. Kulawczuk and A. Szcze´sniak 91 Table 7.1 Administrative procedures in business creation in 2004 EEE countries

Number of procedures

Time (number of days)

Monetary cost (% per capita income)

11 10 6 7 8 10 5 10

32 40 52 18 26 31 28 61

103 108 229 176 37 206 74 123

Bulgaria Czech Republic Hungary Latvia Lithuania Poland Romania Slovenia Source: World Bank (2005).

and the corresponding monetary cost. The summary of World Bank measurements is presented in Table 7.1. Morisset and Neso find that access to land and site development are the sources of longest delays in most countries [32 surveyed]    Although business registration appears not so costly relative to land access and site development, there is a wide dispersion across countries. There are no systematic correlations between the number of procedures and their cost (both monetary and in time), suggesting that the number captures the government’s willingness to protect their citizens (the public interest theory of regulation), while cost may reflect the ability of a few privileged groups to capture those rents (the public choice theory). (Morisset and Neso, 2002: 19) In light of these conclusions, mergers and acquisitions provide less bureaucratic procedures and regulations for market entry by foreign investors than greenfield aspects, including access to land and site development.

Administrative burdens on greenfield entries Before joining the European Union in 2004, the European emerging economies were still in the process of building a modern system of business location and spatial planning. Their regulations aspired to copy western regulations, but their execution was relatively weak. A typical example of complicated and sometimes confusing systems of regulations is the Polish case, although similar problems were seen in other EEE countries as well.

Regulatory aspects Greenfield investment is normally preceded by the examination of possible locations in potential countries. Investors wish to obtain information on

92 Barriers to Foreign M&A in Central Europe

construction types and their corresponding possible locations, including the proposed location of manufacturing, the acceptable size for buildings, planned infrastructure investment, and specific environmental regulations. Investors are also interested in possible access to technical infrastructure. Such information should be available through regional plans and municipalities. In Poland, municipalities are obliged to elaborate local spatial plans because of the Law on Urban Planning. Such elaboration is expensive and most municipalities only expand upon the plans for relatively small areas of their territories. Therefore, as a rule, plans are not available, leading investors to request information on the conditions for a planned investment, which generally take several months to obtain. While construction permits in Poland are issued by counties, general investment conditions are issued by municipalities. The lack of spatial plans enables municipalities to maintain some decision-making power. The 2003 Law on Urban Planning obliged municipalities to coordinate local spatial plans with investment plans. However, investment plans were not prepared in a large number of municipalities and investors are, therefore, not aware of when planned infrastructure investment will be completed. The Law on Urban Planning also requires also that, in lieu of local spatial planning, investment conditions could be issued for new investments only, and that these must match the constructions and functions of the buildings on neighbouring plots. This aspect implies that, for example, plots next to an area that hosts a gas station can only host similar services unless there is an elaborate spatial plan that provides for a different opportunity. Such regulations complicate the process of meeting the conditions for greenfield investments.

Administrative and procedural issues Administrative barriers to locating new investment arise from the division of responsibilities between different levels of administration in Poland. Investors are obliged to contact municipality and county administration. Municipalities are responsible for spatial planning but do not issue construction permits. On the other hand, counties issue construction permits but are not responsible for spatial planning. Since 2003, this situation has created serious delays in the investment process. Investors looking at urban areas were in a relatively good position, as most of administrative decisions in these areas are issued from a single office. This discourages investors from locating construction outside large cities. Moreover, administrative procedures and specific legal regulation of site development create serious problems throughout central Europe, not only in Poland. In Slovakia, the government concluded an agreement with a foreign car producer in 2004 that provided for the transfer of land for a greenfield investment before the land had been purchased from local farmers. The farmers did not agree to the prices proposed by the government and

M. B˛ ak, P. Kulawczuk and A. Szcze´sniak 93

demanded a purchase price three times higher than the price that was offered. As a result, a forced purchase was considered by the government, causing the greenfield investment to be seriously delayed. The shortage of transparent and working rules in relation to site development and land transfers disrupted greenfield investment in the region and indirectly facilitated M&A. Despite problems with greenfield entries, they were successful in the majority of cases, but required more time and investor patience than M&A. Greenfield entries were also hampered by the possibility of protests from environmental organizations. Although many organizations really care for environment, some of them specialize in opposing investment projects, especially foreign investment. Accordingly to the Polish media, the Association ‘Friendly City’ in Lodz obtained PLN 2 million (EUR 500,000) from a French investor to stop opposing the construction of a new shopping centre. Investors facing significant delays in their investment process were sometimes forced to pay the organization in order to stop protests. In general, regulatory execution in central European countries did not appear to be mature and cases of legal system abuse, by interest groups in particular, are numerous. The influence of such environmental organizations was severely restricted in 2003, and these organizations cannot influence the investment process once the construction permission has been issued.

Conclusion In summary, M&A entry encountered fewer discretionary administrative practices than greenfield entry in European emerging economies. M&A entry requirements in EEE were similar to those seen in developed countries, dealing with competition law and public securities law. Their function was much more advanced than the functioning of construction laws, spatial planning or land transfers, which strongly affected the opportunity for greenfield investment. The privatization policies of EEE facilitated M&A but the cost of privatization deals were raised by job guarantees costs and capital investment obligations. Despite the fact that most EEE intended to implement site development solutions similar to those used by their western neighbours, the execution of laws was poor and created different opportunities for discretionary practices, including corruption and legal abuse. In addition, M&A were easier in terms of the ability to purchase real estate, especially for investors coming from the European Economic Area. Normalization in this area was also a factor facilitating FDI flows into the EEE.

8 Acquisitions, Institutions and Policy Saul Estrin and Klaus E. Meyer

Introduction Foreign investors and local institutions have a great influence on each other. Foreign investors adapt to requirements imposed on them by local institutions, and adapt to local market conditions that are shaped by local institutions. However, foreign investors directly and indirectly influence local institutions through their interactions with local businesses, individuals and policy makers. This is a two way process; local policy makers in turn aim to influence institutions, notably the legal framework, in ways that influence the patterns of foreign investment and its interactions with local stakeholders. The result is a complex interaction between economic agents, including foreign investors, political agents and the institutional environment governing them all, which we try to represent in Figure 8.1. This chapter traces these interdependencies in European emerging markets (EEE), as they emerge from both the survey and the case evidence. All of these elements are fundamentally influenced by the fact that the three countries, and therefore their institutions and business environment, are in the process of transition from communist planning to free markets planning, as well as having recently joined the European Union (EU). Many analysts consider institutional development as a precondition for private investment. This view has been given a theoretical grounding by proponents of the ‘new comparative economics’ (Djankov et al., 2003), as well as the institutional perspective in international business strategy (Peng, 2003; Meyer and Peng, 2005). This literature takes us beyond the traditional concerns about exchange rate risk or the threat of expropriation, to consider the range of institutions in terms of the ‘rules of the game’, as outlined by North (1990). Institutions are seen as crucial because they underpin the market economy, with property rights, the legal system and the level of corruption being given particular emphasis, especially in emerging economies. Thus, institutions have been identified as determinants of FDI both worldwide (Globerman and Shapiro, 2003) and in CEE (Brenton 94

Saul Estrin and Klaus E. Meyer 95

Institutional framework (rules of the game)

Strategies of MNEs

Acquisition projects

Local firms and individuals

Policy makers

Figure 8.1 Conceptual framework for this chapter

et al., 1999; Bevan et al., 2004). Moreover, local resource endowment, especially human capital and the supply of intermediate goods, are also crucial for many investors. International institutions and independent agencies have taken upon themselves to provide information on these issues, including the World Competitiveness Report, concerning the general business environment and policy regime, and Transparency International, which focuses on corruption. Their annual reports provide information on the relative attractiveness of alternative host economies for FDI in terms of a large variety of measures of institutional development, and also act as a spur to governments to improve the institutional environment relative to competitor economies seeking MNC investment. For transition economies, specific information about the relevant aspects of institutional development is compiled in the annual EBRD Transition Reports, and in World Bank (2004). Both sources suggest a substantial improvement of their respective indicators in recent years. This is expected to make the business environment more attractive for both domestic businesses and for foreign investors (Djankov et al., 2003; World Bank, 2004). However, the process of institutional change, even when the moves are in the ‘right direction’, also creates obstacles to business. There are several reasons for this. A new institutional framework cannot be created overnight. Even where rules and regulations are implemented swiftly, as in East Germany in 1990, informal institutions such as procedures and value systems change only gradually. Elsewhere, institutional development has been a gradual process of adjusting the legal and regulatory framework, with repeated changes and fine-tuning. This is not only because of the complexity of changing the economic system, and a natural desire to approach things cautiously. The concept of transition was a new one in the early 1990s, and even if there was consensus about the end point, in terms of creating a Western-type market economy, the path was not well understood and

96

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subject to considerable experimentation (see Estrin, 2002). This implies that institutions during periods of transition will necessarily be unstable, which creates higher transaction costs for businesses to operate through market mechanisms (Swaan, 1997). Firms may be driven to rely relatively more on informal mechanisms of exchange, such as business networks rather than arm’s-length market transactions (Peng, 2003), and they have to be flexible to adapt to changing circumstances (Uhlenbruck et al., 2003). Hence, although we would expect the recent institutional change to favour the growth and prosperity of business in the long run, we might actually observe short-run effects that inhibit the efficiency of the economy. In fact, the evidence gathered in this research project does highlight the costs and risks for business created by institutions ‘in transition’. While one would expect that these will be overcome once the period of institutional change has been completed and the business environment becomes stable and predictable once again, the survey and cases instead highlight the problems as well as the opportunities created for business by the transition process. In the next section, we review how foreign investors responding to the questionnaire survey view the local environment in our transition economies. We find that despite broad improvements on key indicators, they report that increasing complexity and high instability of the legal and regulatory framework inhibit their businesses. The responses also suggest that labour markets may be beginning to tighten in Hungary, which may influence the future pattern and scale of FDI. We then investigate institutional influences in the case studies, and find that many of the regulatory issues affecting the acquisitions are industry-specific, somewhat in contrast to countries such as India and Vietnam, where both industry-specific and FDI-specific regulatory issues were of major concern to investors. However, the privatization process and its legacies distinguish EEE from other emerging economies. Finally, we review the impact that the case studies have on the local environment, which provides a basis for discussing whether and how the regulatory framework may be modified to enhance received benefits for the host economy.

Evaluation of the local business environment Official reports generally report an improvement of the business environment (EBRD 2004; World Bank, 2005), yet how do foreign investors themselves evaluate the local business environment in the accession countries? We asked respondents to evaluate various aspects of the local business environment on a scale from 1 to 5, at two points in time: the initial year of operation and at the time of the survey. Table 8.1 shows respondents’ evaluations concerning two important aspects of the local business environment that greatly reflect the underlying institutional arrangements; namely, the quality and availability of human

Saul Estrin and Klaus E. Meyer 97 Table 8.1 Investors’ evaluation of local resources Poland

Lithuania

Hungary

Initial 2002 Change Initial 2002 Change Initial 2002 Change Human capital∗ Executive managers Professionals Operational managers Skilled non-managers Low cost, low skill Mean

3.18

3.86

0.67

3.38

3.57

0.19

3.50

3.77

0.27

3.41 3.50

4.18 4.11

0.78 0.61

3.67 3.73

3.81 3.86

0.15 0.13

3.82 3.73

3.95 3.76

0.13 0.02

3.83

4.30

0.47

3.98

4.31

0.33

3.81

3.66

−015

4.51

4.72

0.21

4.49

4.96

0.46

4.16

3.84

−032

3.69

4.23

0.55

3.85

4.10

0.25

3.80

3.79

−001

2.45

2.54

0.09

2.17

2.66

0.49

2.97

3.20

0.23

2.58

2.62

0.05

2.29

2.78

0.49

3.03

3.24

0.21

2.71

2.81

0.10

2.65

3.06

0.41

3.19

3.46

0.27

2.73

2.84

0.11

2.57

2.96

0.39

2.99

3.26

0.28

2.62

2.63

0.01

2.35

2.76

0.40

2.83

3.17

0.34

2.62

2.69

0.07

2.41

2.84

0.44

3.00

3.27

0.27

∗∗

Local industry Quality and range of products Quality and range of services Management capabilities Marketing capabilities Level of technology Mean

Notes: ∗ Human capital was rated on a 5-point scale, where 1 = never available, 5 = readily available. ∗∗ Local industry was rated on a 5-point scale, where 1 = Local industry far inferior to your firm, 5 = Local industry stronger than your firm.

capital, and the capability of domestic industry; for example, as suppliers. The upper part of the table refers to the availability of different categories of labour, by qualifications, in the three host economies. Across all countries, the ratings for all five labour categories (from executive to unskilled) are above the midpoint of the scale at 3.0, suggesting that employees can ‘sometimes’ to ‘mostly’ be recruited. Moreover, the scarcity of labour increases with the qualification levels, with executive managers being far more difficult to find locally than low cost, low skill labour. Thus, initially, the foreign investors come in, and labour scarcities increase monotonically with qualification in each country. These observations in EEE correspond to the pattern that we observed in Egypt, India, South Africa and Vietnam (Estrin and Meyer, 2004). However, market pressures are seen to have begun to play a role by 2002, at least in Hungary, with labour scarcities for particular labour types emerging; for example, for operational managers and skilled workers.

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The general improvement in the business environment is indicated by the perceived improvements in labour availability in every category and in almost every country. Thus, the general trend over time is an improvement of the availability of labour, except for two categories in Hungary. By 2002, all labour categories except executive managers are ‘mostly’ available (above 4) as against only 1 (low cost, low skill workers) initially. According to our respondents, the situation has not improved quite so much in Lithuania, with only skilled and unskilled worker categories scoring over 4 by 2002, though there was improvement in labour availability in every single category. However, labour availability on average declined in Hungary for our respondents, with no category being above 4. This was despite some improvement in the situation for executive managers and professionals, and arose because of a decline in the perceived availability of low cost, low skill workers. Thus, in Hungary, we observe a paradox: many FDI projects were initially motivated by cheap labour, but unlike in other transition economies, respondents see the shortage of cheap labour as a constraint. Low cost workers are becoming scarcer while executives become more available, such that the evaluations show smaller margins in the year 2002 than at the time of investors’ initial entry. This suggests the emergence of a shortage of unskilled labour as the economy advances with economic development and EU accession. No such tendencies emerge in Poland or Lithuania. In Lithuania, in contrast, availability of low skilled staff has improved while executive managers continue to be harder to recruit. The large margin of improvement in labour availability in Poland, as seen from the corporate perspective, may be explained by the sharp increase in the unemployment rate from 10.4 per cent in 1998 to 17.5 per cent in 2001, reaching 20.4 per cent in 2004. Unemployment grew despite the significant growth rates of GDP achieved by Poland in this period, and this probably reflects the high degree of labour hoarding in the communist era and the gradual shake-out of labour associated with privatization and the resulting imposition of harder budget constraints, as well as restructuring to satisfy new domestic demand and trade patterns in anticipation of, and subsequent to, EU membership. The perceived unfavourable development of some elements of labour supply in Hungary may come as a surprise to observers with a west European perspective, where the relocation of production is of major concern to both business communities and policy makers. However, Hungary was one of the earliest reforming economies, and was the recipient of very considerable FDI flows in the early to mid-1990s, until other locations such as the Czech Republic and Poland began to catch up (see Chapter 1, Figure 1.1). It is interesting that FDI to Hungary has been declining in recent years, perhaps because businesses are aware of growing labour shortages as reflected in our survey. Unit labour costs are an important concern to some foreign investors (Bevan and Estrin, 2004) and relocation of production using semiskilled or low skilled labour may thus seek locations other than Hungary

Saul Estrin and Klaus E. Meyer 99

as labour supply shortages constrain future FDI. However, our findings may also reflect economic progress and upgrading of the labour force to higher qualification levels, which may in the future make Hungary attractive for more sophisticated types of operations. As can be seen in Table 8.1, foreign investors have a lower opinion of domestic firms than they do of labour availability; on average, managers of foreign affiliates perceive the local inputs as being of medium or low quality (between 2 and 3). The quality and range of products are the most problematic items in all three countries, followed by the level of technology. Management and marketing capabilities receive very slightly more favourable ratings, which may be surprising given the low esteem of EEE management in the early 1990s, but the levels are so low and differences so slight that one cannot draw strong conclusions. However, there is some variation across countries and over time. In all respects, foreign investors give the most favourable assessment to Hungarian firms, and scores there have also been improving over time in every category. Lithuania ranks the lowest when foreign investors first arrived, but improvements have been more pronounced so that by the year 2002, Lithuania ranked slightly higher than Poland for all local inputs. The situation in Poland was fairly poor in all categories, and has hardly changed at all over time. These are interesting findings because they suggest that the domestic business environment – for example, in terms of supply chains, customer orientation and quality of service – lag behind western standards in all three countries. This is an issue that potential investors need to take into account when considering the mode of entry, since it favours greenfield over acquisition or joint venture, and suggests that reliance may have to be placed on western sources of inputs if quality and standards are to be maintained. If the supply of domestic resources in these transition economies is relatively more limited, investors have to rely relatively more on their own resources, or those that can be purchased from established sources. It may also make multinational operations in these economies more expensive to run, and therefore limit the flows of investment. Finally, the modest, at best, rate of improvement of the respondents’ perception of local firm quality, should be worrying for governments in these economies, since it suggests that despite the relatively high FDI inflows, the spillover benefits for the domestic firms have so far been modest. The authorities may wish to consider policies that increase the rate of spillovers, as well as creating an environment in which the capabilities of domestic firms to improve themselves are enhanced. We now turn to the attitudes of the respondents in our survey to the institutional environment itself. Their evaluation varies considerably according to the indicator of institutions under consideration. We asked respondents if they agree that various aspects of the institutional environment cause costs or delays to their business, and the findings are reported in Table 8.2. We report responses on nine questions related to the state of institutions

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Acquisitions, Institutions and Policy

Table 8.2 Evaluations of the institutional environment State variables (a) Frequent changes of rules and regulations cause substantial costs and/or delays (c) The procedures for registering the business and obtaining business licences cause substantial costs and/or delays (d) The procedures for obtaining access to utilities such as electricity, water and so on cause substantial costs and/or delays (e) The customs procedures cause substantial costs and/or delays (g) The tax assessment and payment procedures cause substantial costs and/or delays (i) In our industry, it is important regularly to obtain information on forthcoming changes in the law (j) In our industry, it is important regularly to obtain information on forthcoming changes of regulation or decrees issued by government (m) In our industry, it is important to maintain close personal contacts with key officials at local level (n) In our industry, it is important to maintain close personal contacts with key officials at national level Mean of the above Change variables (b) Changes of rules and regulations are less frequent now than when the foreign investment was first established (f) The customs procedures affecting our industry cause fewer costs and/or delays now than when the foreign investment was first established (h) The tax assessment and payment procedures cause fewer costs and/or delays now than when the foreign investment was first established Mean of the above

Poland

Lithuania

Hungary

4.17

3.64

3.51

3.66

3.31

2.78

2.60

2.79

2.62

3.33

3.15

3.12

3.42

3.35

3.13

4.32

4.10

4.18

4.26

4.16

4.16

3.02

3.33

3.33

2.86

3.18

3.03

3.52

3.45

3.32

Poland

Lithuania

Hungary

2.33

2.80

2.74

2.71

2.74

3.01

2.44

2.74

2.74

2.49

2.83

2.74

(for example, impact of rules and regulations, customs procedures, tax), on three questions related to the stability of the intuitional environment (for example, whether the negative impact of customs, tax and so on is

Saul Estrin and Klaus E. Meyer 101

increasing or declining), and on two related to social responsibility (for example, environment). There is a lot of variation across the three categories and within each category, though many ratings are around the midpoint of the scale, 3.0, reflecting partial agreement with the statements. However, respondents in all three countries considered it important to stay informed about both legal and regulatory changes, with scores over 4.0 for all countries. Moreover, they are concerned about the costs caused by the frequency of changes in laws and regulations, especially in Poland. Between 1999 and 2001 the Polish government introduced reforms in the area of social security, health care and the pension system, as well as in the legal forms of enterprises and while reforming the public administration. These reforms aim to bring Polish law in line with EU legislation. However, according to a Polish expert interviewed for this research, ‘this has at least tripled reporting obligations of enterprises and created an unimaginable mess at the beginning of the implementation process. The paperwork of Poland’s private enterprises in 2004 reached a level last seen when leaving the communist regime in 1990.’ (see also Chapter 7). Asked about specific institutions, respondents indicate moderate concern about customs and tax procedures, as well as (excepting Hungary) procedures for registering the business. However, access to utilities is seen as less problematic, if we use the midpoint of the scale (3.0) as a cut off. Similarly, personal contacts with officials are considered only moderately important. Since this question is often used as indicator of corruption, we may infer that foreign investors do not appear to face bribes as a major obstacle to business. Across countries, Polish respondents appear more concerned about procedures, while in Lithuania and Hungary investors are more concerned with maintaining personal contacts, which is consistent with case evidence (Antal-Mokos, 1998). To investigate the institutional change, we moreover asked foreign investors whether they observe an improvement in the business climate over time (Table 8.2, lower part), based on three change variables that correspond to items in level questions. Given the widely reported progress of institutional development (EBRD, 2005), we expected that our respondents would, at least on average, report that institutional improvement would facilitate their business and reduce costs. However, the scores are all below 3.0 (except Hungarian customs), suggesting that on average respondents see little improvement of the institutional environment. These contrast with the widely held believe that EU accession would enhance the institutional framework. Overall, these data suggest that rather than the state of laws and regulations, their frequent change is of concern to business, although it presumably generally makes the business environment more business friendly. Thus, the evolution of the legal framework remains a major concern because of the uncertainty and transaction costs associated with legal changes. This indirectly supports Swaan’s contention that the transition process

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Acquisitions, Institutions and Policy

itself raises transaction costs during the period of institutional change (Swaan, 1997). However, these transitional obstacles appear to have persisted longer than Swaan envisaged. Businesses may thus prefer an imperfect institutional framework to institutions that are supportive to business but change frequently and unpredictably. Moreover, the accession to the EU may not have made things simpler, at least initially. From the mid-1990s, our three countries were embarked on a lengthy process of altering their laws and regulations to conform to the acquis communitaire of the European Union. This meant, in effect, that they altered their domestic laws, including those concerning business, to ape the legislation of the EU. As has been noted by the World Bank (1996), in situations when the policy-making process is immature and it is hard to evaluate the correct sequence of reforms, the political process of reform can be eased greatly by the adoption of an already fully developed legal and institutional framework. However, as Estrin and Holmes (1998) note, although the concept of European Union membership was crucial in maintaining the momentum of reform, and the idea of obtaining an institutional framework from elsewhere as a package is speedy and attractive, the acquis communitaire may, in many of its details, have not been the ideal structure to adopt for economies in transition. This is because European institutions were designed to serve more developed economies, and countries with a more sophisticated administrative apparatus. Thus, many of the new rules may have acted to add to the complexity of the legal framework, rather than to reduce it. Moreover, at least during the preparation phase, the process of EU Accession may have raised rather than lowered transaction costs, even where they open new business opportunities and create a fairer, more level playing field for competition; for instance, for public sector tender processes. Thus, our respondents suggest that businesses are concerned not only with the quality of institutions but also with their complexity as well as with their stability and predictability.

Institutions moderating acquisition strategies The development of the institutional environment has also directly influenced some of our acquisition case studies by creating particular sorts of opportunities for acquisitions and by shaping their implementation. Table 8.3 summarizes the relevant institutions and their impact. The first three groups of companies comprise the cases of investments into Poland, Hungary and Lithuania respectively, while the latter four remind readers of the findings from our previous studies in South Africa, Vietnam, India and Egypt respectively. When we look at the ways that institutions shaped foreign direct investment in our previous selection of cases in emerging markets (Egypt, India, South Africa and Vietnam), one is left with the overwhelming impression

103 Table 8.3 Institutional influences on establishment of the FDI Firm

Institutions influencing FDI

Impact on business strategy

Cadbury Carlsberg

None apparent Privatization to domestic owners Privatization tender, Telecom liberalization and regulation, ambiguity of the law and ineffective implementation by regulator and courts Government equity stake in major banks, privatization of competitors, regulation of takeover battles, court handling of dispute between shareholders None apparent Telecom liberalization and tenders for mobile phone licences to be issued Privatization to previous domestic owners, utilities liberalization and regulation Banking sector regulation, competition law (special exemption negotiated) Trade liberalization, privatization laws: initial insider ownership, then sale to foreign investors Industrial policy to attract FDI to this sector None reported Financial sector deregulation FDI laws FDI laws, public sector procurement FDI laws, tariff barriers, fiscal incentives, local content requirements State-level regulation of alcoholic beverages industry

– Entry opportunity (indirect effect)

France Telecom

BCP

K&H/ABN Amro T-Mobile

MOL

SEB

Kraft

Behr EST ABN Amro SEAB ABB Honda

Bacardi-Martini

Entry timing and dynamics of competition, especially of entry; ability to maintain monopoly position

Entry timing and dynamics of the takeover battle

– Entry timing, consortia arrangements

Entry timing and dynamics of competition

Need for local partner, possibility of acquiring second local bank Entry timing, initial ownership, serving multiple countries from one plant Motivated the FDI – Entry timing and dynamics of competition Need for local partner Need for local partner May have motivated the FDI, the choice of partner, local sourcing Limited foreign ownership, 74 per cent

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Acquisitions, Institutions and Policy

Table 8.3 (Continued) Firm

Institutions influencing FDI

Impact on business strategy

Packaging

General FDI liberalization

ABN Amro

Financial sector deregulation

ECMS MobiNil

Telecom privatization, liberalization and regulation Regulation of pharmaceuticals industry: drug approval, pricing, intellectual property rights Licensing of food products, investment incentives

Timing of entry, initial sharing of equity Timing of entry, sharing of equity for some units, dynamics of competition Timing of entry, design of the bid for ECMS, dynamics of competition May have motivated initial tariff jumping FDI

GSK

Heinz

No clear impact

that most country specific economy-wide institutions did not play a significant role. Thus, while the literature has tended to stress issues of property rights weakness and policy uncertainty at the national level, these do not appear to have influenced behaviour greatly in our cases, except perhaps with respect to FDI laws themselves in India and Vietnam. Rather, the crucial aspects of the institutional environment for our investors was sectorspecific, and concerned the particular regulations governing behaviour in the domestic industry in question; for example, financial or telecoms regulation. In this respect, though the FDI projects were to emerging markets, many of the institutional issues in our cases were either the consequence of liberalization or issues resulting from aspects of sector-specific regulations that might also, in principle, be germane in cases of FDI to developed countries. There are several possible reasons for this finding. Firstly the major impact of deficiencies in the institutional environment may be felt in the number of firms that ultimately decide to enter the country. All the economies represented in the bottom half of Table 8.3 have only attained, at best, modest FDI flows, and it is notable that most of our cases concern firms that are very large and highly international in their chosen sectors. Thus, the institutional structures may operate as a filter to screen out potential foreign investors that would be unable or unwilling to operate in such environments. This selection effect would imply that, even though the firms that have chosen to enter do not appear to be greatly influenced in their strategies by the institutional environment, this will not apply to the firms that did not choose to enter and so one should not conclude that the institutional environment is irrelevant to investor strategies.

Saul Estrin and Klaus E. Meyer 105

The same selection factors may also influence the character of the firms that choose to enter. It is notable that the investors in the bottom part of Table 8.3 are mainly, though not exclusively, large multi-national corporations with considerable experience of operating in a variety of institutional settings, including emerging markets. These are rarely their first experiences of investing in emerging markets and, as the literature cited at the start of the chapter notes, there are similar issues of weak property rights enforcement, corruption and policy uncertainty in many developing countries. Moreover, most large investors have put into place management systems and human resource management policies that facilitate their operation in environments where institutions are less well developed. Finally, the debate about the impact of the rules of the game has followed North (1990) in stressing the distinction between formal and informal institutions. In the emerging market context, where formal institutions are likely to be weaker, one expects a relatively greater role for informal institutions; for example, networks and social capital. However, we find surprisingly little reference to such phenomena in our cases. The likely reason is that the large MNCs that are the subject of most of our cases do not operate in, and are not greatly affected by, the informal system of networks and relationships that permit the market economy to function in environments where the other mechanisms to enforce property rights and lower transactions costs are only partially available. Foreign subsidiaries are constrained by their size, their visibility and the governance pressures placed upon them by their head offices to operate largely within the formal economy, and to function within the formal rules. This suggests that as foreign owned firms contribute an increasingly important share of the economy, an important spillover could be a strengthening of the institutional structure of the economy as a whole. With this background, we can now consider the upper part of Table 8.3, and the influence of the institutional structure in our three EEE on the foreign investors in the nine cases presented in this book. The process of transition is somewhat different from the general liberalization of the business environment that has characterized emerging markets in the past fifteen years. First, the bulk of ownership in most emerging markets has always been private, though state ownership has been more widespread in some countries; for example, Vietnam. However, in the EEE, almost every firm was stateowned and therefore transition itself is largely defined by the speed and scale of the privatization process. This has meant that most transition economies, including the three covered in this book, needed to create privatization agencies to dispose of the huge number of privatization targets in every industry. This contrasts with most other emerging economies where, though there have often been privatizations, they have largely been restricted to the utility and telecoms sectors where state ownership predominated. As a result, foreign firms seeking to enter the EEE have been spoilt for supply of potential acquisition targets (though, of course, the number of firms that foreigners might have found acceptable to purchase was probably smaller).

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The excess supply of acquisition targets has probably acted to lower the price of acquisition of existing firms relative to other entry modes, and therefore to encourage relatively more acquisitions. This is despite the fact that the planning system led state-owned firms to hoard labour and to operate at low levels of productivity and efficiency, so that enterprises acquired by foreign investors typically require very significant amounts of labour shedding and restructuring. We return to this issue in the following section. It is therefore unsurprising that we observe in the upper part of Table 8.3 that privatization was the main institutional feature in almost all our transition cases. This is true in utilities and telecoms (for example, France Telecom (FT) or T-mobile), but also in the banking (BCP), food and drink (Carlsberg, Kraft) and the oil industry (MOL). Thus unlike in our other emerging market cases, we do identify a common institutional characteristic influencing foreign direct investment into EEE – privatization – and this is an important factor as a direct consequence of the transition process itself. The cases suggest that privatization does not merely open up opportunities for foreign investment and perhaps bias the entry mode in favour of acquisition. Thus, privatization methods have direct effects illustrated in the cases by shaping the way foreign investors take over local state-owned firms. However, the cases illustrate also important indirect effects. Our cases suggest that the dynamics of the privatization process and the subsequent development of competition are very important. Privatization determines what kind of firms and ownership structures are created, and this indirectly influences possible future M&A. The regulatory laws on mergers and acquisitions, and their implementation by competition authorities are also important as they may inhibit M&A, or lead to important divestments in the context of acquisitions. For instance, Carlsberg was requested to divest a brewery in Lithuania when, subsequent to its merger with Norwegian Orkla, the two intended to integrate their respective Lithuanian operations, Baltic Beverage Holdings and Carlsberg-Švyturys. Playing by the rules of competition law can be of crucial importance in the context of oligopoly, such as ¨ MOL and OMV. However, in emerging economies, competition law is often ambiguous and not implemented very effectively. Foreign investors may use ambiguities in the legal framework and inexperienced (or locally biased) courts to their advantage so as to protect their position contrary to the spirit, if not the letter, of the laws aimed at liberalizing markets. Arguably, this was the case when (the partially French-owned) Polish Telecom protected their quasi monopoly position in fixed line telephony, and when the management of BIG Bank used legal tricks to survive a hostile takeover battle with Deutsche Bank. In contrast to, for example, India and Vietnam, FDI-specific legislation does not appear to have played a major role in EEE, perhaps because of the overwhelming drive to privatize and the resulting need for large scale FDI.

Saul Estrin and Klaus E. Meyer 107

Also, national treatment may have been implemented to a larger extent, in part due to the process of Accession to the EU. Though formal accession was only in 2004, countries seeking membership had to begin to adjust their institutions up to eight years earlier, and governments that were thinking ahead to the process might have tried to ensure a level playing field for foreign investors for almost the start of the transition process. Thus, we can confirm the conclusion from our earlier emerging market study that national institutional factors were not a dominating influence in our cases, probably for the same reasons as those outlined above. However, another important observation from Table 8.3 is that the relevant formal institutions are often specific to the sector of industry and they especially influence the timing of entry, with secondary influences on, for instance, location and ownership arrangements. This observation applies in particular to the telecommunications and banking sectors, where regulation is essential due to inherent sources of market failure due to information asymmetries, network externalities and the potential for monopolistic market positions. Liberalization of an industry has also been important in terms of creating opportunities for entry. With limited numbers of operating licences, entry into the mobile phone industry can occur either by acquiring an incumbent operator or by bidding for a new licence. The mobile telephone industry is a good example of the important role of policy in shaping the pattern of foreign entry (Chapter 6). This can be illustrated by a simple comparison of the investment by FT in Poland and in Egypt. In Egypt, FT acquired Egyptian Company for Mobile Telephony (ECMT) through a consortium of foreign and local partners in 1998. FT took the leading position in the consortium with 51 per cent of shares that, in 2001, increased to 71 per cent. The mobile business was developed almost from scratch and the number of subscribers increased from 80,000 in 1998 to over 2.6 million in August 2003. The market functioned as a duopoly, with Vodafone being the only competitor. In 2002, the Egyptian Regulatory Authority issued a third licence for mobile telephony with the intention of granting one to Telecom Egypt, a fixed line state monopoly.

Enterprise restructuring The transition process favoured FDI via acquisition but the legacy of most firms from the planning era was of inefficiency, over-manning and poor management, especially with respect to financial control and marketing. On the other hand, local observers are often very concerned about negative side effects of post-acquisition restructuring and integration into the multinational enterprise. In particular, they fear the loss of autonomy of the MNE subsidiary and the downsizing of employment. We summarize the main aspects of post-acquisition restructuring in our nine transition cases in Table 8.4, focusing on employment and the autonomy of the

108 Table 8.4 Post-acquisition restructuring Firm

Employment

Employment adjustment process

Subsidiary role/autonomy

Cadbury

1997:1100 (Wedel) 2003: ca 1250

Carlsberg

2001: 1429 2004: 1051

Minor adjustment in the Warsaw plant, 3 employees moved to Wroclaw Employment restructuring in each acquired firm, and reduction of production sites

France Telecom

1999: 2000: 2002: 2003: 2004: 2001: 2002: 2003: 2000: 2003: n.a.

Emphasis on the local brands at the expense of the acquirers global brands. Initially high autonomy but highly integrated after weak performance, additional acquisitions and buy-out of minority shareholders High degree of autonomy in early years

BCP

KBC/ABN Amro T-Mobile

71600 68100 41000 37000

∗

6557 5046 4426 4800 3897

∗∗

MOL

1999: 7540 2003: ca 6000

SEB

1998: 1999: 2002: 2005:

Kraft

Before: 947 After: 780

900 1905 1877 1464

Very radical downsizing with generous packages for departing employees Moderate downsizing

High degree of autonomy

n.a.

n.a.

Growth of the telecom business, but downsizing of MATAV the (related) fixed net operator

Initially highly independent; after Deutsche Telecom acquired full ownership, tighter integration and global branding. n.a.

Employee rotation programme, top management and key positions taken by MOL managers. Growth followed by a period of downsizing (after acquiring another local bank) Gradual reduction of employment

n.a.

n.a.

Notes: ∗ According to the Financial Times, Jan 20, 2004, France Telecom decided to lay off over 14,000 employees worldwide, mainly in France and Poland. ∗∗ 4800 was the combined workforce of both firms prior to the merger.

Saul Estrin and Klaus E. Meyer 109

subsidiary post-acquisition. Our cases suggest that there is some substance to the concerns about restructuring and local autonomy, though such policies were probably a necessity for survival in these former state-owned firms. As one would expect in transition economies, we observe a common trend of reduced employment in most cases. For example, FT embanked on radical employment restructuring and cut the labour force by almost half in four years, though offering a very generous redundancy package. However, the decline in employment in the subsidiary should not be equated with net employment loss for the host economy because, in many cases, companies were spun off or units were subcontracted. Moreover, the opening of the industries to competition also allowed the entry of new firms in some cases, so even sectoral employment may not have fallen in total. For example, in consumer goods manufacturing, there is a global trend from employment in the manufacturing process to increased employment in sales and distribution. These operations may be independent, thus leading to a notional decrease of employment in the brand manufacturer, but not necessarily leading to a decline of employment economy-wide. The phenomenon is not specific to EEE, nor is it directly related to mergers and acquisitions – though a takeover exposes the need for restructuring, and thus lay-offs. In the early 1990s, foreign investors into EEE tended to avoid acquisition targets with major restructuring needs, in part because of the negative publicity associated with laying off large numbers of people. This was particularly true when the foreign firm was entering the market to win a domestic market share, because the restructuring and protests about unemployment and layoffs might tarnish the brand. However, restructuring in domestically owned firms had become very common in the countries covered by our study by the late 1990s, and also the economies themselves were growing sufficiently quickly that there were fewer public concerns about the social effects of layoffs. In part, as a result, contractual clauses that required foreign investors retain a certain number of employees over a certain time period, which were very common in the privatizations of the early 1990s, have become much less frequent now. The opportunity to implement radical change in the acquired operation and, thus, to adjust employment, is an important motive for foreign investment in the first place. The Indian case studies pointed to major obstacles arising from the protection of labour, which in turn inhibited acquisitions (Estrin and Meyer, 2004), and labour regulations may be an obstacle to restructuring in many other emerging markets. However, it is an important finding in most of our cases that such obstacles are of minor concern in EEE, where a broad social consensus now recognizes the need for fundamental change in the structure of the economy. This is despite accession to the EU, whose members typically accord a high degree of social protection to employees. In this respect at least, the transition economies may have been wise not to implement in full the social and labour regulations of the more

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Acquisitions, Institutions and Policy

developed EU member states. An exception in this respect is Poland, where labour unions have traditionally played an important role in firms and in the politics of the country. The authority of unions was further enhanced by the role that the Solidarity Union played in bringing down the communist regime in 1989, and the position of its leader, Lech Wałesa, as the first post-communist president of the country.

The impact of foreign investments on the local environment We argued above that, not only were the pre- and post-acquisition strategies of investing firms shaped by the local institutional environment, but that the environment itself might be influenced by the foreign investment process. In this final section, we explore evidence for this proposition from the cases. Our discussion is organized around Table 8.5, which summarizes the influence of foreign investors in four main areas: on the local industry (horizontal influences), on other firms (vertical influences), for consumers and on the public sector. We discussed the perception of our respondents concerning the capabilities of local industries in the second section. The most significant influence of foreign investors, both horizontally and vertically, appears to be through the enhanced competition. In almost every case, successful restructuring was a precursor to improved competitiveness, with an impact on the domestic market and, in some cases, also on international trade. Though we have little direct evidence on this, one can presume that the greater productivity of the foreign subsidiaries increased the competitive pressure on domestic competitors, leading to a spillover effect throughout the industry as the other firms either raised their game in response or exited the industry, thereby raising the level of productivity on average. One can presume similar effects would also have worked vertically as a result of the increased pressures on suppliers downstream, and through the improved quality of service upstream which is noted in many of the cases. This form of spillover benefit through competitive pressure and ‘creative destruction’ seems to be much more common in central and eastern Europe than in the other emerging markets of our earlier study (Meyer and Estrin, 2004), and may be particular to the transition environment, where foreign owned firms spearhead the restructuring that would otherwise be hard to obtain by relying on domestic owners. More specific spillovers appear to be of some significance in infrastructure related service industries such as banking and telecom, though the precise form and impact is dependent on regulatory issues. However, in market oriented manufacturing FDI, they seem much less recorded and the case authors rarely identify specific evidence of either positive or negative spillovers. Thus, while we hear evidence of plants being upgraded, and the provision of higher quality products to local consumers, reports of benefits to

Saul Estrin and Klaus E. Meyer 111 Table 8.5 Spillovers Firm

To local industry (horizontal)

To other industries (vertical)

To consumers

To the public sector/ government

Cadbury

–

–

–

Carlsberg

Competition in a foreign dominated industry Technological progress, new services

–

Better quality of consumer goods with local brand name Better quality of consumer goods

France Telecom

BCP

Competition

New technologies and new services slower than elsewhere Improved banking services

K&H/ Converting two ABN Amro loss making firms into one profitable one, competition T-Mobile Competition between those winning the tenders MOL Survival of the only firm in the industry SEB Dominant competitor

Better services (but market power)

Kraft

–

Early restructuring of a local SOE, competition

Improved banking services

Arguably better quality of consumer services Better quality of consumer services Improved quality of services

–

Financial revenues from privatization –

–

Improved quality of services

Improved quality of services

–

Improved quality of services

Improved quality of services Better services (but market power) Improved quality of consumer goods

–

–

Financial revenues from privatization

suppliers or customers are generally cursory. Nonetheless, consumers benefit in all cases from the availability of consumer goods of enhanced quality. The cases show that acquired firms do improve services, but it is worth exploring whether this is necessarily an outcome of foreign investment. The foreign investor contributes financial resources, knowledge and the latest

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Acquisitions, Institutions and Policy

technologies to enable upgrading of the services. However, local observers are not always convinced of their positive impact. As Kulawczuk discusses for the case of FT taking over Polish Telecom (Chapter 10), the foreign investor came in for substantial criticism for not adopting new technologies as quickly as was expected, especially those related to Internet connectivity. Analysis of this sort cannot be conclusive however; we do not know what would have happened without FT’s involvement and there were no other bidders at the time the takeover was agreed. It is doubtful that the Polish state would have been able to provide the necessary financial resources to accelerate technological progress. Moreover, with the burst of the Internet bubble, investment in IT businesses worldwide was downscaled. Thus, while FT may have disappointed some local customers, it is not clear what scenario would have secured larger investment in new telecommunications infrastructures. Finally, the cases confirm the budgetary advantages to the governments of acquisition by foreign firms. Transition economies typically face severe budgetary pressures because of the need for state and institution building in an environment where the culture of tax payment by individuals rather than firms is relatively recent. Thus, several of the privatizations in our cases (for example, in telecoms) provided welcome budgetary relief. Moreover, the government sector presumably benefits, in all cases, from the increased tax revenues as a result of increased economic activity.

Conclusion The business environment, as seen from the perspective of managers in MNE, is improving, but not at the pace one might have expected. The change indicators on local firms and human capital are overwhelmingly positive but small, and there is evidence that in Hungary, at least, labour supply shortages are beginning to appear. Particularly interesting are the views of our respondents on the institutional environment. The instability and uncertainty associated with the introduction of new (and hopefully superior) rules and regulations emerge as major obstacles, and respondents only partially agree that the business environment has made any improvement. Institutional change creates costs and risks, even if it is moving in the direction of a more market friendly environment. This confirms Swaan’s (1997) concern about increasing transaction costs during transition, and indirectly Peng’s (2003) concern about increased usage of informal mechanisms of coordination during periods of transition. Future research may take up these observations and investigate not only how present institutions affect business, but also how instability and unpredictability of rules and regulation inhibit business. As a policy implication, these results warn that political debates over details and delays may undermine the overall objectives of reform, and suggest that comprehensive institutional reforms should have lead times that allow business to prepare.

Saul Estrin and Klaus E. Meyer 113

Notably, businesses have to develop the ability to deal with frequent institutional change, which underlines the crucial importance of strategic flexibility as a means to secure the long-term success of business in transition economies (Uhlenbruck et al., 2003). Future research should therefore explore stability and the complexity of institutional frameworks as determinants of businesses development, and FDI in particular. Many of the benefits that host economies may receive from FDI arise from their direct and indirect effects on industrial restructuring and competition. These benefits are, however, often associated with less welcome employment adjustments, and create challenging priority conflicts for policy makers. In the EEE, where privatization set the context for many acquisitions, this policy conflict between modernization and concern for individual workers unable to perform in the modernized economy has been particularly pronounced.

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Part III Case Studies

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9 The Evolution of the Hungarian Mobile Communications Market and T-Mobile Hungary Zoltán Antal-Mokos and András Bauer

Introduction Foreign direct investment, and acquisitions specifically, have played a central role in the transformation of the Hungarian mobile communications industry. In particular, foreign acquisitions by consortia and the gradual buy-out of small local and foreign co-owners contributed to the consolidation of the industry, both in Hungary and worldwide (see also Chapter 6). In only a decade, the industry and its players have gone through tremendous changes, making it almost impossible for the developments to be covered comprehensively and in depth here. Therefore, we focus mainly on the voice segment of the industry, and investigate the gradual transformation of the market leader, WESTEL, which was stepwise acquired and then integrated and rebranded as T-Mobile Hungary by a global player in the industry, Deutsche Telekom. This chapter tells the story of WESTEL as much as it charts the path of the industry from its emergence in the early 1990s to its maturity phase only a decade later, and the intensifying competition between players. The evolution of the industry can be divided into three phases. The first phase started with the first tender and the creation of a joint venture by a consortium of foreign and local investors becoming the sole supplier. The second phase started in late 1993 with the introduction of the GSM standard. Following several years of duopoly, the third phase saw the entry of a new competitor, Vodafone, in 2000. Thus, in less than a decade, foreign investors in the industry had gradually acquired control over the local operation, while industry dynamics shifted from growth to price competition in saturated markets (Bauer, 2004). The third level at which our story unfolds is, therefore, that of ownership changes. Deutsche Telekom made its first investments in the industry at the time of the GSM tender, teaming up with the US based co-owner of the formerly sole mobile service provider to obtain a GSM-licence, and also acquiring a major stake in MATÁV when the local incumbent was partially 117

118 The Hungarian Mobile Communications Market

privatized at about the same time. Other foreign companies, quite a few of them, joined forces with local firms to create a competitor in the mobile business. A third player appeared only when a tender for mobile business on 1800 Megahertz (MHz) was called in 1999. Vodafone’s entry also signalled an era in which competition on the local market was even more evident as the cross-border strategy of expanding multinationals that were seeking long-term competitive positions in a dynamic industry, amid industry reconfiguration, M&A frenzy and technological innovation. Chapter 6 provides a brief look at this broader context for this case.

The emergence of the mobile communications market: 1990–93 Hungary, as all EEE, had been lagging behind the developed world in phone penetration. In 1990, only one in ten households in the country had a phone (about one fifth of the European average), with rural areas being hit the most by the shortage of connectivity. The average waiting time for a fixed phone line was over six years. Economic reform opened the doors to the importing of more liberal technology and the introduction of modern mobile technology. Els˝ o MagyarAmerikai Rádiótelefon Kft. (Ltd) was established in 1989 as a joint venture of US West (a Baby-Bell company from Colorado, USA) and the Hungarian Post and Telecommunication Company. It was renamed to WESTEL even before launching its service, and used the only available analogue technology, Nordic Mobile Telephone at 450 MHz. This technology had proven to be robust, and did not require highly sensitive technology. Following some organizational changes, Mr. András Sugár became Chief Executive Officer (CEO) of the WESTEL at the end of 1991. Public reaction to the new service had been frenetic. The lack of fixed lines had created a very strong need. Before opening for business in October 1990, the company had already generated, without any advertising, a waiting list of 3000 customers. Word of mouth had been driving expectations. Customers were not deterred by horrific prices, either. The price of a handset and the one-off joining fee equalled the price of a mid-range car. By the middle of 1992, more than 20,000 customers had joined the service and the major performance indicators had been growing rapidly. The initial market plan, which had estimated a maximum of 30,000 customers during the whole lifetime of the service, proved too conservative, and management had found US West’s financial approach rather over-cautious. Nevertheless, the whole business plan (including capital expenditures) had been based on these moderate estimates. Maximization of assets was the name of the game. Later, the company managed to raise new capital and went on increasing geographical coverage. In 1992, the management launched an ‘affordability’ campaign with the goal of lowering entry barriers for customers. Teaming up

Zoltán Antal-Mokos and András Bauer 119

with a leasing finance company, clients could lease equipment and pay the joining fee in three instalments. It was also in 1992 that the first marketing breakthrough in coverage development was introduced: the island-like, isolated territorial coverage of major cities, instead of developing continuous coverage along the major freeways. Despite the fact that users in these towns could only use the services locally, this move resulted in high brand loyalty. Consumers started to utilize the service up to its full potential more and more during 1993. Consequent to market development and the decreasing need to educate potential customers, advertising emphasized the basic benefits of mobility and usage less and less. Early customers represented all kinds of walks of life in Hungary. The entrepreneurial spirit was strong and these customers appreciated the major benefits of mobile services: accessibility and communication. They had soon realized that a mobile phone not only gave them high visibility and prestige, but it also supported their business opportunities. The first customers driving large western cars were followed by less affluent, but still strongly business minded customers. The end of the first phase coincided with the partial privatization of MATÁV, which itself had been established as a result of splitting the Post (Héjja, 1996; Reg˝ os, 1996; Danis, 2001). MagyarCom, a 50:50 per cent consortium of Deutsche Telekom AG (itself state-owned at the time, with partial privatization in the pipeline) and Ameritech International Inc. acquired management control over MATÁV by paying USD 742 million for 30.2 per cent of the stock and a USD 133 million fee for the concession, while the Hungarian State and Privatization Holding Company contributed USD 400 million of the purchase price paid by MagyarCom back to MATÁV to provide it with the capital to expand the telephone network.1 The concession agreement also granted MagyarCom exclusive service rights for a period of eight years. An additional 37 per cent was acquired for USD 852 million in December 1995. As a consequence, Deutsche Telekom rapidly established strong ownership positions in the booming Hungarian telecom sector in general, as well as in the mobile segment in particular, the latter being exercised through MATÁV’s stake in WESTEL, and through MATÁV’s dominant position in a new GSM operator.

Growing in duopoly: 1994–99 The Hungarian government settled on the GSM standard, and announced two concessions for service to be started in 1994. This created a new situation for WESTEL. Not only was it going to lose its monopoly, but the magnitude of the required investments was also at a different scale. The sales network, distribution system, brand awareness, technical staff and, quite importantly, the accumulated market knowledge were all assets on which the company could capitalize, but there was no compatibility between the GSM and the Nordic Mobile Telephone systems. New competitors were expected

120 The Hungarian Mobile Communications Market

from Scandinavia, then arguably the most developed region of the mobile world. Expectations regarding market size had also been quite different; GSM seemed to offer much greater opportunity. It was obvious that WESTEL would vie for one of the new concessions. Due to legislator will, a new legal entity was established, separated from the existing service provider but allowing for the sharing of some marketing and infrastructural assets. On 27 October 1993, WESTEL Mobile Telecommunication Co. Ltd (the ‘new’ WESTEL 900) was founded by MATÁV Rt.(43.6 per cent), US West (later renamed MediaOne, 41.9 per cent), WESTEL Rádiótelefon Kft. (the ‘old’ WESTEL 450, 9.5 per cent), and the International Finance Corporation (5 per cent). The owners and the management also separated the two WESTEL companies through different positioning, styles and advertising. WESTEL 450 was positioned as a Hungarian company providing comprehensive national coverage (on the basis of an outgoing technology), while the WESTEL 900 brand was strongly European and high-tech. Mr. András Sugár, whom many in the business regard as a charismatic leader, switched from WESTEL 450 to the new firm and became CEO, working with an initial team of about twenty people, including Messrs Zsigmond Bodnár CFO, and János Winkler who joined them later as CMO. As of summer 2005, this was still the team at the helm. Another consortium of European telecoms and some Hungarian companies founded Pannon GSM in October 1993. Leading consortium members were Sonera, TeleDanmark, Telia, Telenor ASA, and KPN. Thus, a newly founded WESTEL 900, and a new service provider, Pannon GSM, won the 900 MHz GSM tender with the concession for providing mobile communications services in the next 15 years that could optionally be extended with a period of a further 7.5 years. The concession agreements were signed on 4 November 1993, and the two companies launched service in March 1994. There was an immediate race between WESTEL and Pannon for coverage and quality of voice and service. Despite having been in the mobile phone business for three years, for WESTEL to build a GSM service proved a major challenge in technical complexity, size and financial magnitude. WESTEL had selected Ericsson to build its GSM system. Financially, forecasts in the early business plan for GSM called for 230,000 customers in 15 years. Funds were allocated accordingly, and the company had to upgrade its plans constantly. The challenge was tremendous: balancing profitability and growth simultaneously, in a rapidly growing market with large investment needs. Despite the major investments in equipment and the concession fees, WESTEL became EBITDA positive in the first year of its operations and profitable in 1995. For Pannon GSM, building the business was even more testing, a real greenfield venture to start from scratch. Nokia had been selected to build

Zoltán Antal-Mokos and András Bauer 121

the network. The two companies had maintained strong ties in other areas, as well, and Nokia handsets helped the customers familiarize with the new GSM service provider. Both competitors developed several special applications for business customers in terms of content, sales and customer service. Owing to its early start with WESTEL 450, WESTEL 900 enjoyed an advantage in the business segment. In terms of headcount and revenues, individual consumers represented the majority of the market. The consumer base of the two companies had differed greatly at the beginning, but one could already discern many similarities, (for example, in age distribution of consumers) by 1999. Both companies developed products to strengthen the club-feeling; consumers received discounts for calling one or two selected numbers within the company network. Handsets played an important role in the service experience, owing to their capabilities and image. Major innovations in service typically required new phones. It was unclear, however, to what extent service providers should follow a handset subsidy policy, a common practice in many countries with the notable exception of Scandinavia, which in the past had helped in boosting demand and accelerating acceptance of novel services. WESTEL did not subsidize handsets until 1996. Subscription services certainly provided excellent opportunities to crosssell, providing content or other products to the customers. These services also offered opportunities to upgrade, and to establish loyalty programmes that were to become an important factor in consumer retention. WESTEL created its loyalty programme quite early. For a post-paid consumer, prices include entry fees (with handset and SIM card), fixed subscription and usage fees, the latter depending on call volume, timing, destination, and additional services to which the customer subscribed. Most of these fees were typically parts of a bundled service package, representing an often unsolvable puzzle for the consumer. This was, in part, also due to the consumers’ limited ability to assess and predict their own call patterns and usage of services. Competitors were using a variety of tariffs, and prices were changing quite often, making price comparisons quite difficult. The Hungarian consumers were highly sensitive to prices around the mid-1990s as real incomes were sinking. Mobile phone companies introduced promotions to boost sales. One of these promotional actions delivered a major breakthrough for WESTEL in attracting customers. In May 1996, the company launched its first major promotion bringing entry barriers down to an unprecedented low. In a period of only 12 days, WESTEL 900 sold more subscriptions than WESTEL 450 had done in three years. This event also created major support for WESTEL as a firm that stood by its promises. The company had ordered only 13,000 promotional handsets, but it received around 50,000 orders. Subscriber Identity Module (SIM) cards also ran out of stock. Customers were then given vouchers,

122 The Hungarian Mobile Communications Market

which they could exchange for handsets and SIM cards at the promotional price when these became available. The ‘Santa Claus in the Summer’ promotion campaign was then repeated twice during the year. Handset promotions became a norm, without which it was unlikely to achieve significant market growth. Pannon GSM followed suit, quite reluctantly at the beginning, even questioning whether such handset support was lawful. A further pricing move was associated with network capacity utilization. Zone pricing was one way to channel consumer demand away from highly used time zones, thus reducing the likelihood of congestion and the need to develop a peak capacity network. WESTEL had spent large amounts on developing its own customer database, gaining knowledge of its consumers that was useful in introducing a package with lower rates after 4 pm, a move that Pannon GSM soon followed. Mobile service providers typically used multiple channels, including a direct sales force mainly for business customers and indirect channels to reach individual buyers. WESTEL’s distribution had always been outstanding; in 1994, the company enjoyed benefits from its exclusive relationship with the FOTEX Group, the first modern retail chain in Hungary. For reasons of building its image and its need to gain first-hand consumer information, WESTEL also opened its own showrooms, very much in line with general industry trends as noted in Chapter 6. Pre-paid was another set of services. This was a different challenge for product developers, since these products had to be standardized and sold in mass channels. Pre-paid services were introduced to the Hungarian market in late 1997, and they have continued to be a major source of head count growth ever since. Pre-paid services represented a paradigm shift in distribution. There was less information required for consumer identification, and consumers had to have broader access to both product packages and refill or ‘top-up’ cards. WESTEL started to sell through mass retail outlets, such as hypermarkets. In 1999, one could already buy pre-paid cards at around 1500 gas stations and newspapers stands, and it was possible to top-up these cards at ATMs. Pannon GSM needed more time to build up its distribution system due to its market entry mode and strategy. It could not rely on an existing sales network and did not have access to the best wholesalers. The company contracted with independent dealers, and started to establish its presence by building showrooms. However, it did not follow WESTEL’s downtown location strategy. Creating a distribution system in a changing environment represented a major challenge, and the company had to restructure its dealerships to achieve homogeneous service quality regardless of location. In the early 1990s advertising was very modest; WESTEL 450 could capitalize on the simple availability of the service. Advertising’s role in the first years was to educate customers about basic product features, use opportunities, and coverage. Later, the two competitors chose different strategies:

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WESTEL relied on its strong technical heritage and wanted to build a high-tech, modern image. Pannon GSM, as a newcomer, had to introduce itself to the Hungarian public and selected ‘The Top Line’ positioning. Its first advertisements had strong association with the mobile phone itself, emphasizing Nokia handsets. The company decided to use a combination of the red-white-green national colours and even emphasized the word ‘GSM’ in its name. Later, it ran a successful advertising campaign, which added prestige to the company image. Advertising spending increased tremendously parallel to subscriber growth and new product introductions. Until the end of 1997, the time when the pre-paid brands (DOMINO for WESTEL and Praktikum for Pannon) were introduced, the two companies had pursued somewhat different schedules in their campaign activity. WESTEL had used the first half of the year for product-specific promotions and then added image campaigns, while Pannon GSM had promotions throughout the year and combined it with alternating image campaigns. With the introduction of the new pre-paid brands, the firms reacted to the changes in market segmentation. The pre-paid brands received intense image support, mainly at launch periods, and they were less connected to the main corporate image. In 1998, both companies launched new products; WESTEL introduced the GoldCard loyalty programme for its highly valued customers, while Pannon GSM focused on the pre-paid Praktikum product features. Heavy promotions and advertising campaigns supported the new products. With higher and higher penetration, emphasis was thus shifting from network development and coverage to customer segmentation and product development, pricing tactics and promotions, distribution and advertising so as to generate further growth. Competition was not cut-throat; players could occasionally avoid rather than generate confrontation. In addition to boosting sales by new customer acquisition, competitors were paying more and more attention to customer retention, but the market was far from being saturated yet. At the same time, product and technology developments also promised further long-term opportunities. In 1999, tender calls for Third Generation (3G) service were already being drafted elsewhere in Europe. A new vision for the whole industry seemed to take shape (Handley, 2001; Karli et al., 2001). The two competitors approached the new millennium with a significantly altered ownership structure. During the 1990s, WESTEL’s ownership structure had simplified to MediaOne (former US West, later merged with AT&T) holding 49 per cent and MATÁV (with Deutsche Telekom in the background) holding 51 per cent. Indeed, ownership was changing in a clear direction, one that had already been discerned by industry observers when, in the second phase of MATÁV’s privatization in the mid-1990s, the idea of the state selling another significant stock to Magyarcom had been favoured

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against other privatization options. Most importantly, MediaOne pulled out of Europe, selling its central European wireless businesses, including its stake in the two WESTEL companies, in late 1999 to Deutsche Telekom (Cambridge Telecom Report, 1999). As we have noted, MATÁV had by then been privatized, with almost 60 per cent held by Magyarcom (Deutsche Telekom and Ameritech, the latter being acquired by SBC Communications Inc. in 1999) and with about 40 per cent of the stock being publicly traded on the Budapest and the New York stock exchanges. In 2000, Deutsche Telekom bought out SBC’s 50 per cent stake in MagyarCom and thus increased its ownership in MATÁV to almost 60 per cent, further strengthening its control over WESTEL, too. Consolidation of WESTEL’s ownership – as a part of the restructuring of Deutsche Telekom’s holdings in the Hungarian telecom sector – reached its conclusion in 2001, when Deutsche Telekom sold its shares in WESTEL to MATÁV for EUR 920 million, financed from a medium-term euro loan provided by Deutsche Telekom itself at an interest rate of LIBOR + 50bp.2 At the same time, MATÁV assumed a new role in the Deutsche Telekom Group, by taking control of MakTel in Macedonia in early 2001.3 This was at the approximate time when Deutsche Telekom’s expansion in central and eastern Europe was taking further steps through acquisitions in Slovakia, Macedonia, the Czech Republic and Croatia, and overseas, by acquiring VoiceStream for almost EUR 60 billion (now T-Mobile USA) and Powertel in 2001 (Deutsche Bank, 2001; Rathe, 2001; J.P. Morgan, 2002). Throughout the 1990s, the ownership structure, as well as the management, of Pannon GSM had also been changing.4 As of the end of 1997, there were still Hungarian firms amongst the owners (MOL Rt. with a stake of 8.65 per cent, Antenna Hungária 1.25 per cent, and Wallis Rt. 0.24 per cent). In 1995, equity was raised twice, and Telia sold off in 1996. By November 1998, all the Hungarian partners of the original consortium were bought out by the foreign owners through their wholly owned subsidiaries (thus abiding to the letter of the law, which required them to maintain a minimum of 25 per cent of the Hungarian shareholding). As of the end of 1998, ownership was split between KPN Telecom BV (27 per cent), Telenor Invest (23 per cent), Sonera Holding NV (21 per cent), TeleDanmark A/S (4 per cent), Media Tel Holding (15 per cent), PTT Telecom Hungary (3 per cent), TeleDanmark Hungary (3 per cent), Telenor Hungary (2 per cent), and Sonera Hungary (2 per cent). In effect, through direct and indirect holdings, Dutch KPN controlled about 45 per cent of the stock, while Norwegian Telenor and Finnish Sonera together held almost 50 per cent. KPN then sold its shares (while retaining its interests in other segments of the Hungarian telecom industry), and by February 2002 Telenor had become the 100 per cent shareholder by paying EUR 1002 million for 74.2 per cent of the stock it had not previously owned. Due to the lengthy process of ownership changes, Pannon was also a company that had several CEOs over the years.

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Three-player competition: 2000–05 The late 1990s witnessed growth in the telecom business worldwide. Stocks were high as well as expectations for growth in an industry with a penetration of about 33 per cent in Europe, on average, in 1999. Governments cashed in, too, milking new revenue sources from providing new concessions. At about the same time, cross-border acquisitions fostered global consolidation in the telecom sector. Vodafone had become the world’s largest cellular company with the completion of the acquisition of AirTouch. It had multiple majority and minority stakes in different European and international service providers. The company was the first to offer cellular mobile services in Europe and initiated technical and business innovations early on. It was a low cost service provider in Europe and an initiator of the pre-paid product, and used second-based billing. The Hungarian government had decided years before to open the 1800 MHz frequency for mobile communication and also offered a 900 MHz GSM concession for a third player. The two incumbent GSM companies could also bid for the 1800 MHz licences, but they had to start their service a year later than the third player so as to provide the new entrant with a level playing field. In the meantime, the incumbents had to provide national roaming opportunities for the new entrant on a commercial basis. In early July 1999, the winner was announced: a consortium of Vodafone-AirTouch, RWE Telliance (belonging to the German energy giant RWE, who had considerable business in Hungary), Antenna Hungária (the national broadcaster, diversifying into telecommunications at the time), and Magyar Posta (the Hungarian Post), with holdings of 50.1 per cent, 19.9 per cent, 20 per cent and 10 per cent respectively, through a joint venture which was incorporated under the name of VRAM Rt. The consortium concluded before Mannesmann (soon acquired by Vodafone) and decided to operate under the Vodafone Hungary company name. The consortium had to pay around USD 200 million, while the two incumbents had to come up with a further USD 46 million each. In the run-up period to the tender, the two Hungarian incumbents were busy executing their business plans. The first nine months in 1999 brought major product innovations and new pricing schemes to the market. Both companies created preferred number programmes as a loyalty scheme and as a way to increase traffic, and they started to offer handsets capable of operating at both 900 and 1800 MHz frequencies. WESTEL allowed SMS services with pre-paid cards and increased the availability of pre-paid products in mass distribution and gas stations. In January 1999, new post-paid and pre-paid service packages were introduced on the basis of an analysis of its extensive customer database. In turn, Pannon GSM decided on a major step by introducing second-based billing (as opposed to an ‘impulse’ of a

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minimum of 30 seconds). The company was also believed to be introducing VoIP (Voice over Internet Protocol) for international calls soon. All of these moves lowered the cost to the consumers but had a negative impact on profitability, but in different areas of the two companies. By this time, WESTEL had stabilized its leading position, reached the magic number of 1 million customers before the end of 1999 and had a 55 to 60 per cent market share over the years, also enjoying profitability, while Pannon had 40 to 45 per cent of the market. This was when Vodafone was about to enter and carve out its share. Until October 1999, little was known about its plans as to how large a share it wanted to acquire and what exactly its market entry strategy was going to be to achieve that share. The Hungarian government officials had great expectations from the change in market structure, hoping for major price reductions and an increase in service quality. The latter was due to the opportunity to offer a service on the less congested 1800 MHz frequency. Industry observers pointed out, however, that technical service quality had already been very high in Hungary, often better than in other European countries. It was also noted that Vodafone, while it would need considerable time to build its own network coverage, could use the network of the two incumbents, thus being able to offer total coverage from the first moment of its operations. This was a rather unique situation in Europe. Vodafone announced that the company was going to offer competitive prices, use the technical services of Antenna Hungária, utilize the Hungarian Post network (more than 3200 offices covering the whole country) for selling certain products, and initially employ around 350 people. Billing was to be undertaken by Panafon, the Greek member of the Vodafone Group. Vodafone forecast further growth in the Hungarian market, predicting 1.8 million customers by the end of 2000, of which Vodafone aspired to about 10 per cent (Czágler, 1999; 2000). From 2000 to 2004, the Hungarian mobile landscape was coloured with intensifying competitive action by all the players. New post- and pre-paid packages, discount schemes and Internet based online customer services were introduced. Technology based innovations, such as GPRS, Wireless Local Area Network, and 3G handsets became available. WESTEL was the first to offer MMS even worldwide, and was working hard to stay at the forefront of innovation.5 Its service profile was also becoming more and more international; for example, customers could use GPRS and MMS roaming in Germany with T-Mobile from 2002. It was only from 2003 that Vodafone began more aggressive marketing behavior, which some industry observers had expected to see earlier. Pricing became a central competitive weapon (Reznák, 2005). In August 2003, WESTEL publicly criticized Vodafone’s radical price competition and its related market communication policy, arguing that a downward spiral of price dynamics could lead, given the firms’ effort to maintain profitability, to

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a slow-down of research and development. At about the same time, Pannon discontinued its second-based billing, which was believed to have caused it significant financial stretch, considering that about half of the calls had reportedly been shorter than 35 seconds. Instead, it introduced billing on the basis of 30 second units, while decreasing per minute fees by 25.7 per cent in various tariff packages.6 Both firms were quick to react to Vodafone’s socalled ‘Vitamax Uno’ tariff. Indeed, 2003 brought more significant changes than ever since the entry of Vodafone: competitors reacted to each other’s moves more and more rapidly, since competition had by then reached a stage where results could only be achieved at the expense of others. In the meantime, Vodafone Group gradually increased its stake in its Hungarian subsidiary. On 23 January 2003, the Group purchased the 15.565 per cent interest of RWE Com GmbH & Co. OHG for an undisclosed cash consideration, thus achieving an 83.8 per cent stake in VRAM Telecommunications Limited, now called Vodafone Hungary Mobile Telecommunications Limited. Options were granted to Antenna Hungária Rt. over certain of the shares acquired from RWE, representing a maximum interest of 3.89 per cent. All of these options expired on 9 October 2003, unexercised. On 10 June 2003, the Group further increased its stake in Vodafone Hungary to 87.9 per cent by subscribing for Antenna’s share of an issue of ‘C’ shares. Antenna’s call options over Vodafone Hungary ‘C’ shares, relating to three equity injections between 2001 and 2003, expired on 9 October 2003, unexercised.7 Intense competition continued in 2004. In the consumer voice market of the telecom sector in Hungary several competitive pricing actions followed each other in rapid sequence. From 1 January, WESTEL introduced nonlinear pricing, with the first few minutes charged at higher and later minutes at lower per minute fees, thus encouraging customers to conduct longer calls. This was not only a threat to mobile competitors (particularly Pannon’s corresponding tariff package), but also challenged fixed line, with the associated marketing communication suggesting that long calls were, for the first time in the history of telephony, no longer the realm of the traditional fixed line network. Vodafone came to market with its new tariff only a few days later, changing its ‘VitaMax City’ package, which now offered a lower per minute fee, but charged on longer units. This followed the trend of the previous year: a decrease in the charge per minute amount was attractive for communication, while it could be compensated for financially by using longer charging units. In this case, this meant an increase from 30 seconds to one minute. At the time, this meant the best rate for an off-peak call within any mobile network (but not for calls that ended in fixed line). Similar or lower tariffs by competitors were only available within their own network, and only after 10 pm. The next month, Vodafone innovated its customer acquisition practice by applying viral marketing, turning all its customers into potential retailers

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who could earn significant discounts for acquiring new Vodafone post-paid subscribers. It was then Pannon’s turn to please the customer. The company was the first to introduce a post-paid tariff with the same rate per minute, regardless of time-zone and network direction. The rate was lower than WESTEL’s corresponding tariff – introduced in January – but it did not include off-peak discounts and minutes deductible from the monthly subscription fee. Vodafone responded only one week later, by announcing its ‘Europe’ tariff, which offered a low flat rate to all Vodafone networks and any fixed line networks within the European Union and Romania. The subscription fee was relatively high, but more than 50 per cent was deductible. Vodafone clearly built on its international image, emphasizing its global power. At the same time, this move also represented a strong attack on fixed line tariffs internationally, and even locally. Soon afterwards, the company also introduced, for the first time in the mobile market and with intense market communication, the ‘VitaMax Duo’ tariff, with discounts for subscribers who received incoming calls that originated from other mobile networks. This move was clearly aimed at acquiring not only new subscribers, but also at migrating its existing customers to the new tariff and thus generating higher traffic. Over these months, WESTEL, the market leader with a well-known and highly valued brand, was busy with preparing to rebrand itself to T-Mobile Hungary. We should again note that by this time MATÁV, the direct owner of WESTEL, was already controlled by Deutsche Telekom. Deutsche Telekom’s wholly owned subsidiary in the mobile communications business, T-Mobile, was founded in December 1999, and was comparable in size to Vodafone Group; they had 109 million and 139 million subscribers in the third quoster of 2004, respectively. The company clearly wanted to establish itself as a worldwide competitor matching Vodafone, the global leader, in terms of subscribers and use of innovative technologies. The T-brand was applied to all subsidiaries of Deutsche Telekom. Repainting the WESTEL flags, however, did not seem to result in WESTEL being perceived as a subsidiary of a global company. While Pannon had built an image of a domestic firm, and Vodafone had clearly acted as a truly global player irrespective of local market differences, T-Mobile appeared as a member of a group that was implementing a ‘global’ approach. The rebranding process was carried out in one month, starting on 3 May when WESTEL was officially renamed T-Mobile, and was completed on 5 June 2004, when most of the mass brand promotion events took place. This day was also marked with a new ‘T-Mobile Relax’ tariff family, modelled after the same post-paid packages of the mother company, and offering deductible monthly subscription fees. ‘Relax’ also intended to pick on Vodafone Europe, as it offered – with an additional package – the facility to make international calls to 29 countries (EU, USA, neighbouring countries) at local Relax rates.

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Exactly two weeks later, Vodafone sent a strong message to T-Mobile when it launched Vodafone 150, 250, 500, a tariff family with the same structure, but at lower rates. The market launch of the new tariff was promoted with strong market communication, including direct comparisons with Relax. As a prompt response, T-Mobile modified the Relax rates from 1 July, only four weeks after their introduction, lowering most of the applicable rates but not going under the Vodafone levels. Pannon followed suit ‘only’ some weeks later by starting Pannon 50, 150, 250, 500 and 1000 minute tariff packages – but it did so by coming up with the lowest rates available at the time, and offering a greater choice to the customer, particularly with the 50-minute package for low traffic users. This also meant a significant decrease of the entry barrier for the customer; one could have a post-paid subscription for only HUF 1800 (remarkably, exactly the same amount that the lowest tariff of MATÁV, the fixed line operator), which was entirely deductible. One would assume that Vodafone could simply not afford to be perceived as second to Pannon in the tariff race. Only 12 days later it launched tariffs with 90 and 800 minutes deductible, thus opening to both sides of the market. It was then hard to tell the customer anything with a novelty value in terms of entirely deductible packages. Pannon, therefore, chose a different route when it made a completely new move and launched a fee reducing scheme. It calculated two bills for the subscribers of the applicable tariffs: one that the customer ordered when subscribing to the tariff, and another with the next higher monthly subscription fee and with lower per minute charges. Whichever was the better for the customer was then actually invoiced. Soon afterwards Pannon also modified its ‘Horizont Extra’ tariff, indicating a further move towards lower segments of the market. Vodafone appeared to protect the lower segments when, on 13 September, it launched a new tariff in the pre-paid market called ‘VitaMax Joker Plus’. Within its own network, customers could make weekend calls at a rate of only HUF 9, as a direct reply to the same within network, weekend rate of the Pannon Happy package. In only one week, Pannon reacted by reducing per minute rates for its pre-paid product ‘Praktikum’ to HUF 29. In addition, it also offered 50 per cent discounts for the users of SMS and MMS services for two months with strong marketing communication. While the campaign lasted, one could send an SMS at a rate of HUF 9 and an SMS at HUF 25, which were significantly lower than the rates of the competitors. Vodafone promptly responded with a new pre-paid ‘VitaMax Uno Plus’. It mimicked the structure of Pannon’s tariff, offering the same rate in every direction and in every time zone, but it was cheaper by HUF 2 per minute. Since the launch of the Relax tariff family and the subsequent competitive duel between Pannon and Vodafone, T-Mobile had noticeably stayed away from the escalating price game. It also refrained from attacking – by prices or market communication – fixed line, which may also be attributed to the interests of its mother company, MATÁV. Apparently, it was rather emphasizing the war on the front of customer relationship. Its loyal customers,

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those with Gold and Platinum cards, could obtain a flat rate deductible tariff for a prespecified amount of call time, in addition to their existing low rate subscription package. Pannon appeared set to protect its position on the pre-paid market by whatever means. It offered new buyers of ‘Praktikum’ pre-paid cards free calls for 120 minutes between 27 November and 31 December 2004, or free SMS and MMS. It took a really well informed and sophisticated customer to follow all the events of 2004. Nevertheless, churn – customers deserting a provider in favour of another – had become a major issue for competitors at an admitted level of 10–5 per cent. It should also be noted that Vodafone and Pannon slowed down their price rivalry towards the end of the year and none of the competitors blasted a true tariff bomb before Christmas, apparently trying to minimize the chance of an escalating price war. In early 2005, only modest price competition was expected for the year. Competitors were believed to be gearing up to face new challenges, including the implementation of 3G technology and the increasing common threat, and opportunity, of VoIP. Overall, market shares had stabilized. T-Mobile could maintain its market leadership, albeit slowly losing share since 2002. Pannon served one third of the market, whereas Vodafone had reached a 20 per cent share at the end of 2004, and had maintained it since then. With the year of 2005, T-Mobile Hungary reached the end of an era. Following the rebranding in the previous year, one of the key issues now appeared to be integration, in terms of organization and management, as well as in terms of synergies with other lines of business of the MATÁV Group. Considering the latter, a precarious question was the decline and low profitability of the fixed line business. Also in this year, MATÁV was rebranded; the firm itself was renamed Magyar Telekom in May, and all of its businesses took Deutsche Telekom’s ‘T’-brands. Thus, the former MATÁV Wireline Services became T-Com, Hungary’s leading ISP, Axelero Rt. as MATÁV’s subsidiary in the Internet business was repainted as TOnline, while T-Systems and T-Kábel were formed from MATÁV Business Services and MATÁVKábelTV, respectively.8 The Group was also faced with some serious challenges, as thousands of customers dropped their subscriptions to fixed line telephony, and financial results looked grim. Following the latest trends of the industry (as noted in Chapter 6), its future strategy seems to place more emphasis on broadband, and on complementing ‘traditional’ mobile network connectivity (GSM and UMTS) with fixed network propositions such as WiFi and VoIP. Whether in the light of the trends ‘one-brand integration’ strategy is a misguided effort or a key to gain positions in the early days of the 3G era remains to be seen. With these issues in the background, it was announced in early September 2005 that Mr. Sugár, long-time CEO of WESTEL 450, WESTEL 900, then

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T-Mobile Hungary, would leave the firm on the next day as a result of disagreement with the owners concerning future directions, and his position would be filled, on a temporary basis, by the Chairman of the Board; that is, the CEO of MATÁV. While at Christmas 2005 radio listeners could still frequently hear Seasons’ Greetings sponsored by ‘T-Mobile Hungary Részvénytársaság’ (joint stock company, Inc.), the firm as a legal entity was already planned to be aligned with the global structure by merging into Magyar Telekom.9

Conclusion While the fight for market share remains at large, the equity transformation process has almost been completed. Vodafone’s last Hungarian co-owner was acquired in 2005 (Antenna Hungária was eventually privatized by Swisscom taking control of the firm). As the Hungarian mobile communication industry has matured, T-Mobile and Pannon GSM are 100 per cent controlled by one of their initial foreign investors (Deutsche Telekom and Telenor, respectively), and Vodafone maintains a majority in the ownership of its Hungarian subsidiary. While other segments of the communication industry have not been covered in this chapter, it should be noted that a few other foreign firms have also built significant ownership and competitive positions in fixed line communication, cable, and internet services. The parallel stories of the competitors in the industry sheds some light on the effect that ownership arrangements and changes may have on competitive strategy. WESTEL’s ownership was rather concentrated from the beginning, and its management was leading the firm throughout the emergence, growth, and early maturity phases of the industry. It was often driving change in the industry that was just taking shape, and even if it may not always have been the first to introduce an industry innovation, it has been recognized as typically the fastest to take commercial advantage. Pannon GSM’s experience indicates that dispersed ownership and management fluctuation may slow down decision-making and reduce risk taking, and can contribute to the firm being a follower, at least in a dynamic industry such as mobile communication. The experience of the Hungarian mobile telecom industry illustrates the role of international mergers and acquisitions in the transformation of a whole industry from its emergence to consolidation. One characteristic of the process to be noted is that initial positions, typically attained through privatization deals, do not necessarily determine long-term competitive dynamics. In the first half of the 1990s, several foreign and even indigenous firms carved out a share of the cake, both in terms of ownership and market share; yet, in a relatively short period of time, the mobile communication sector has consolidated with a handful of strong industry players remaining.

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Consolidation in the industry is clearly embedded in the broader context of increasingly globalizing competition. On the one hand, this has influenced local developments, as exemplified by the pull out of US-based firms from their Hungarian businesses as a part of a broader move to refocus globally. On the other hand, Deutsche Telekom’s stepwise acquisition of key firms in the Hungarian telecom sector should be understood as one integral part of the German firm’s large-scale international strategy.

10 The Purchase of a Monopoly: France Telecom Acquires TPSA Przemysław Kulawczuk

Introduction France Telecom (FT) acquired Telekomunikacja Polska S.A. (TPSA) in 2000, just before the economic slow down and a worldwide crisis in the telecommunication market. Despite the unfavourable timing, the acquisition appears to have been managed quite successfully under regulatory conditions that protected against entry in the core business, fixed line telephony. Thus, one might argue that FT bought a monopoly, which raises an interesting question: What was really bought: a telecommunication company or the monopoly? The case describes activities undertaken by two companies. Yet, at the time, FT was itself owned 55 per cent by the French state. Thus, in the background of this case lurk two governments of countries that retain negative prejudices and stereotypes about the each other. Since both governments have some influence over their state telecom operators, it was ultimately the French government who invested in restructuring TPSA. Moreover, the French state had to invest EUR 9 billion in 2003 into the restructuring of FT. This raises an additional issue: Can a firm be privatized by sale to another state company? This question received affirmative response in the juridical system of Poland, but what are the economic implications? A third issue raised in this case is: Can deep organizational restructuring be implemented by a company that itself requires major restructuring? Again, the answer is positive. The mixed French–Polish management implemented a successful employment reduction plan, which at this scale may not have been feasible in the French parent company.

The firms Investor: France Telecom The history of FT dates back to 1889 when the first private telephone company in France was nationalized, and joined with the national postal service. Henceforth, telecommunication and postal services were provided 133

134 The Purchase of a Monopoly

by one national organization. In the 1970s, a specialized department for telecommunications was created separate from postal services, which in 1988 became a company called France Telecom (FT). In 1991, FT became an autonomous provider of a public service. In 1996, it was turned into a public limited company, subject to French corporate law, but with additional requirements arising from its status as a majority state-held company and the French telecommunications regulatory regime. In an initial public offering, in 1997, equity in FT was offered to the public, and shares were traded on the stock markets in Paris and New York. In 2000, FT launched its Internet subsidiary, Wanadoo, on the Paris stock market and acquired the British mobile telephone operator Orange to become the second largest European player in the mobile telephone industry. At that time, FT employed 220,000 employees and was one of the most indebted firms in the world, with debt reaching EUR 70 billion. FT offers five lines of products: voice and data services, broadcast services, network services, internet, and mobile telephone services. Voice and data remain the primary source of revenue, thanks to the fixed line network. In broadcast services, FT, with its subsidiary GlobeCast, provides a range of services including professional broadcasts, Internet delivery via satellite, and TV channel distribution. In Internet services, FT reached the number three position in Europe in 2001 via its subsidiary Wanadoo, which had over six million subscribers. Wanadoo provides Internet access, Intranet solutions, website creation and hosting, and related services. The network services of FT were merged with Global One and Equant, which were present in 220 countries and territories, and provided services for 75 of the 100 largest corporations in the world. Moreover, with the acquisition of Orange, FT became the second largest European operator and leader in France and the United Kingdom in mobile telephony. In the late 1990s, FT grew through an aggressive international acquisition strategy. In May 2000, FT and the Vodafone group signed an agreement for the purchase of 100 per cent of the share capital of Orange, the largest acquisition in the history of telecommunications. Several other major full or partial acquisitions occurred in 2000 and 2001: Global One, Equant (54.27 per cent), Wind (18.9 per cent), TPSA (25 per cent in 2000, increased to 33.93 per cent in 2001), Spanish Indice Multimedia (86.71 per cent), British Freeserve as well as a UMTS mobile telecommunications licence in Germany.10 As a result of this acquisition drive, FT became one of the world’s leading telecommunications carriers, with more than 111.7 million customers on five continents and consolidated operating revenues of EUR 46.6 billion in 2002. On 30 June 2002, international business accounted for 41 per cent of FT’s consolidated revenues. Its customer base outside France grew rapidly. For instance, the number of fixed subscriptions in Europe other than in France rose from 2.5 million to 13.8 million with the acquisition of TPSA. FT intended to build a strong European position as a leading telecommunications company by expanding, especially in neighbouring countries and

Przemysław Kulawczuk 135

in central Europe. Central Europe was considered one of the most promising markets because of a low coverage of telecommunication services and, therefore, a high growth potential. In 1997, Poland had 197 telephone subscribers per 1000 inhabitants, while France had 595. In the next three years, the number of fixed line subscriptions in Poland increased from 7.6 million to 10.9 million.11 Poland thus seemed to be an ideal direction for expansion. The difficulty in understanding the FT strategy in Poland is the fact that FT was (and still is) a state controlled company with 55 per cent of shares in the hands of the French state. Due to the lack of liquidity in the stock market at the time, the ownership structure could not be immediately changed, even if the French government had wanted to privatize FT entirely. The radical restructuring of TPSA, including cutting employment by 50 per cent within four years, was fortunately not negatively received or associated with the French State. One could argue that the restructuring happened despite, rather than because of, the state ownership.

Acquired local firm: TPSA The development of TPSA can be divided into three stages: 1992–98 – a treasury owned corporation, 1998–00 – partial privatization, and 2001onwards – an FT member group. TPSA was established in December 1991 as a result of the division of the state enterprise Polish Post, Telegraph and Telephone into two companies: Polish Post SA and Polish Telecommunication SA (TPSA). In 1998, TPSA was partially privatized and a part of its stock was offered on the Warsaw Stock Exchange. It was also offered on the London Stock Exchange in the form of GDRs. Up to 1998, the history of Polish telecommunications (apart from mobile telephony) was essentially the history of TPSA, with only a marginal role for small competitors. In the 1990s, the telecommunication market was undergoing rapid growth; the number of served fixed telephone subscribers increased more than three times within 12 years from 3.3 million to 10.8 million. The market share of TPSA for fixed line telephony fell from 100 per cent in 1992 to about 91 per cent in 2001, while smaller providers rarely reached 10 per cent. The most important competitors to TPSA were Telefonia Dialog and Netia Group. Dialog had got about 350,000 subscribers in 2002 and was active mainly in the Lower Silesia area. Netia held about 342,000 fixed lines at the end of 2002, and was active in other important regions in western Poland and Warsaw. Other important players in the market were operators belonging to the Elektrim Telekomunikacja Group with about 100,000 clients. The situation was different in the mobile telephony market, which experienced a rapid growth in the late 1990s. TPSA and FT jointly created the mobile phone operator Centertel, which held 100 per cent of the market until 1995. The company used the commercial brand ‘Idea’. In 2000, PTK Centertel acquired a licence for new generation of mobile telephony UMTS,

136 The Purchase of a Monopoly

originally planned to be launched in 2004, but postponed until 2006 with the agreement of the Polish government. PTK Centertel is owned 66 per cent TPSA and 34 per cent FT.12 In mid-2003 it had over 5 million mobile subscribers out of 16 million througout Poland. In a dynamic, frequently changing market, PTK Centertel was the largest pre-paid services provider, holding about 30 per cent of the market share. In the Polish mobile phone market, the major competitors held roughly similar market shares. In addition to PTK Centertel, these were Polska Telefonia Cyfrowa, an Era network operator belonging to the Elektrim Telekomunikacja Group and Deutsche Telekom, and Polkomtel, operating under the name Plus GSM.

Fit between the two firms The two firms, FT and TPSA, were similar in terms of their product range and the basic services they provided: fixed telephony, mobile, telecommunication, Internet services, radio services. The pace and advancement of introducing new products were similar; however, FT was leading by at least one year in the field of introducing the most new technologies. As a result of extensive capital investment in TPSA in 1990s, the technology differences between FT and TPSA in 2000 were not substantial. FT was substantially bigger than TPSA (Table 10.1): by employment more than three times; by assets about 14 times; by sales more than eight times. However, TPSAs main problem was over-employment. Despite the fact that Polish telecom was continuously profitable, the number of fixed telephone lines per one employee only reached 140 in 2000, while most European telecom operators reached between 200 and 300. This lower labour productivity led to the expectation that major restructuring would follow acquisition by FT. The organizational culture of both firms also appeared to be similar. Both were joint stock companies, both had to face all the requirements of securities commissions yet, in both, the majority owner was the state. However, the scale of operations of TPSA was limited to Poland, so that the Table 10.1 Comparison between FT and TPSA Item Assets (EUR billion) Sales (EUR billion) Short term liabilities (EUR billion) Net income (EUR billion) Employment (thousand)

FT

TPSA

129 336 586 37 220

9 40 16 06 68

Note: The numbers for TP were calculated taking the exchange rate EUR 1 = PLN 4. Source: FT and TPSA annual reports.

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Polish company arguably had a narrower vision of the industry than FT. As a majority state-owned company, TPSA was under constant pressure from politicians. This especially influenced human resources management, including the expectation of employment for persons related to the winner of political elections. For example, the former government spokesman was engaged on the TPSA board. FT was less affected by pressures of this nature. In both firms, labour unions played an important role. However, the Polish unions were ineffective in preventing job losses, while the opposite would hold true of their French colleagues. Both firms faced similar problems: danger of over-investment, enormous increase in debt (mostly denominated in market bonds), and strong pressure from clients to introduce new products and services. Moreover, FT knew the organizational culture of TPSA as a minority shareholder of PTK Centertel. FT had spent eight observing years how Polish managers operated and how the Polish Telecom market operated.

Entry Privatization related acquisition The entry of FT was preceded by a privatization process in the form of a public offering on the Warsaw Stock Exchange. The privatization of TPSA started in 1998, when 1.4 billion TPSA shares were admitted for public trading; 210 million shares were sold, which constituted 15 per cent of the company’s initial capital. The same year, the company’s shares were first listed on the Warsaw Stock Exchange and its GDRs on the London Stock Exchange. The government intended to sell between 25 to 35 per cent of the TPSA stock to a strategic investor. The largest interest in buying TPSA stock was expressed by FT and SBC Communications, one of the smaller ‘Baby Bell’ companies operating regional and local services in the USA, and a strategic investor in Danish telecom, the operator TDC. The two bidders were similar in size; however, SBC Communications was wholly privately owned and more profitable than FT. Besides FT and SBC Communications, other firms indicated moderate interest, including British Telecommunications, Deutsche Telecom, US West, and Belgacom. However, there is no evidence that they submitted any written offers. The change in the Communications Act of 1999 removed the 51 per cent share threshold in TPSA to be held by the Treasury, which permitted the sale of stock to foreign investors. In 1999, the ministry announced a tender for the purchase of TPSA stock and only FT and SBC Communications took part in negotiations. After initial rounds of negotiations, SBC Communications withdrew from the tender and FT became the only bidder. FT placed an offer for a 30 per cent package of TPSA stock for USD 3.5 billion at the price of PLN 24.5 per share. Moreover, FT demanded full operational control over the company as well as a guarantee from the Treasury, and compensation

138 The Purchase of a Monopoly

for the possible unfavourable changes in Polish telecommunication law.13 However, the Treasury rejected the FT offer and the tender was declared to be unsuccessful. In 2000, the Treasury announced a new tender. Only FT placed an offer and, after a round of negotiations, the parties concluded an agreement. The consortium of FT and Kulczyk Holdings purchased 35 per cent of TPSA stock for PLN 38 per share (13 per cent more than the price of a TPSA share on Warsaw Stock Exchange at that time). The investors gave a 40-month guarantee of employment and promised to maintain a high level of capital investment. They were obliged to maintain the ‘national character of TPSA’ and not to withdraw the company from the Warsaw Stock Exchange. The Treasury promised to sell the consortium an additional 16 per cent of the stock at a later time. Moreover, the Treasury promised to provide TPSA with a licence for UMTS (however, paid in equal market conditions), and delayed the liberalization of the telecommunication market by one year. As a result, FT paid PLN 38 per share rather than the PLN 24 offered in 1999, but it received much more in the sense of control over the company and security for future operations in Poland. The purchase price was extraordinarily high for Poland. The ownership structure was as follows: FT, 33.93 per cent; Treasury, 14.48 per cent; Kulczyk Holdings, 13.57 per cent; GDR holders represented by the Bank of New York, 9.99 per cent; and other investors, 28.03 per cent. The government gained PLN 18.6 billion (EUR 4.5 billion) and FT gained the largest telecommunication operator in central Europe.

Local player in the consortium: Kulczyk Holdings SA The main local player in the acquisition of TPSA by FT was Kulczyk Holdings SA. Kulczyk Holdings is a privately owned company that became one of Poland’s largest private capital groups in the 1990s by acquiring various businesses and developing them within its holding structure. Kulczyk was an attractive partner for the Treasury in privatization processes. Accordingly to the company website, in the 1990s Kulczyk invested over 1.5 billion in Polish firms and it has ‘made an essential contribution to ventures and projects of strategic importance for the economic and civilization growth of Poland’.14 The largest affiliates in Kulczyk Holdings S.A. include TUiR WARTA S.A. (second largest Polish insurance company), Kompania Piwowarska S.A. (largest beer producer), Autostrada Wielkopolska S.A. (motorway ownership), Euro Agro Centrum S.A., Skoda Auto Polska S.A. (car imports and manufacturing), PTE DOM S.A. (pension fund), and POLENERGIA S.A (energy sector). The role of Kulczyk Holdings in most privatization projects was to leverage foreign capital, take the Polish co-owner position and, after some time, partially or wholly withdraw from the investment with earned income. Kulczyk seems to be merely a comfortable intermediary for the government

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and for some acquirers. Kulczyk played a role of a facilitator when the government could not sell the property directly to the investor or when there was no investor. As an investment company, Kulczyk Holdings SA was expected to withdraw from TPSA when beneficial for its own ends.

Regulatory context The development of TPSA after its purchase by FT was strongly dependent on the regulatory environment. On the fixed line telephony market, TPSA was a national monopolist and enjoyed benefits connected with this position. The regulatory environment in Poland was shaped in closed connection with the sale of Treasury stock to FT. During the first privatization tender, it was revealed that FT strongly demanded that the privileged position of TPSA be prolonged in the future, which would imply delaying liberalization of the telecommunication market. FT demanded compensation for the change in Polish telecommunication law should it weaken the position of the company.15 After the successful conclusion of the negotiations between FT and the Treasury, nothing further was said on the matter, but there is a linkage between the preparation of the new telecommunication law and the privatization of TPSA. Thus, on 21 July 2000, the new Telecommunication Law was accepted and, on 27 July 2000, the national telecommunication operator was sold. The new legislation removed discretionary licences for performing most telecommunication services and replaced them with permits, which were always granted after the applicant had performed the necessary requirements set up in legislation. The new legislation allowed for the effective blocking of the entry of newcomers on the market by the monopolist. The position of TPSA was not explicitly privileged, but the national regulator was not equipped with the tools to enforce laws if dispute should arise with such a dominant player in the market. The right to appeal to the Court was mostly used by TPSA to delay market changes. The issue of legal obstruction of the regulator’s decisions by TPSA (before and after the FT takeover) will be discussed below.

Integration and restructuring of the acquired firm The most important issue after FT’s takeover of TPSA was the restructuring of employment. TPSA’s staff at the end of 2000 was 68,100 employees, which was considered too high. Another important issue for TPSA in restructuring was reducing the burden of financial costs arising from the high level of investment.

Employment restructuring The privatization agreement between the Treasury and FT provided a 40 months employment guarantee, which was half what had been demanded

140 The Purchase of a Monopoly

by the labour unions (84 months). The privatization agreement allowed TPSA to fire employees before the 40 months’ term but, in this case, those fired were entitled to compensation that was, on average, approximately PLN 23,000, an amount equal to one-year’s average salary in Poland. It was expected that some employees would want to leave TPSA in order to receive compensation, and TPSA created a special fund for compensation amounting to PLN 300 million. In 2001, employment restructuring was subject to lengthy negotiations between the board and the unions. Unions demonstrated, protested and wrote petitions, but these actions were not effective in blocking restructuring. The most important factor weakening the position of the unions was the very low labour productivity. In 2000, there were only 161 fixed telephone lines per employee, while in the most efficient telecom operators in Europe these indexes were between 507 and 669 (for example, Swedish Telia, Dutch KPN, Spanish Telefonica). Even in the Hungarian MATÁV, one employee served about 300 lines.16 Most TPSA employees acknowledged that the reduction of employment levels could not be avoided. In 2002, a major programme of ‘out-placement’ was introduced. Of 57,700 employees that remained at the end of 2001, more than 11,000 were designated for the programme. Another ‘Labour for Employment’ programme was implemented between July and December 2002. It aimed to transfer network maintenance to independent companies, who would thus also take over the relevant employees. To select the companies for the programme, TPSA opened a tender aimed at firms that were the subcontractors of TPSA. In the second half of 2002, the programme included 6500 employees, of whom 5400 accepted new work offers. TPSA concluded three years’ contracts with subcontractors, who took over staff and gave job guarantees up to February 2004 (18 months). The departing employees received compensation up to 80 per cent of the compensation for employees who did not participate in the programme. In 2002, the average compensation amounted to PLN 38,000, much higher than in 2001. The employees who left TPSA received wages, on average, 16 per cent lower than in TPSA. Accordingly to TPSA officials, the programme introduced in 2002 was aimed at creating a positive image for the company, not only among the public, but also among departing personnel. Perhaps the reason was the difference in the average compensation (PLN 38,000 versus PLN 23,000). As a result of the restructuring, the number of TPSA employees declined from 68,000 at the end of 2000 to 37,000 in mid-2003. The radical downsizing programme in the Polish affiliate was seen by some observers as an example that the mother company might follow suit in its French operations, which were equally subject to over-employment.

Capital investment Capital investment was a critical factor for TPSA’s development. When the number of TPSA fixed line subscribers reached a level close to ten million,

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traditional TPSA operations reached their capacity limits. The level of capital investment was regulated by the privatization agreement, which provided PLN 27 billion over a period of seven years. However, this sum was provided in TSPA’s investment plans before acquisition and the earlier plans were only accepted by FT. A three year investment plan for the years 2002–04 provided for PLN 13 billion over the four year period,17 compared to PLN 17.4 billion in the preceding three year period.18 Thus, the level of capital investment decreased after privatization, which could be partly be explained by reaching maximum fixed line network density and by recession on the telecommunication market. The investment guarantee was an important element of the privatization agreement between the Treasury and FT. The agreement did not define the directions of technological developments. At the end of the 1990s, TPSA was a relatively well equipped company with modern network technologies. However, the acceleration of technological change in the late 1990s required substantial investment. In view of the difficult economic position of the mother company, the TPSA board opted for the development of cheap and easy services, especially dial-up access to Internet. Since ISDN and DSL were not widely offered, their prices were significantly higher in Poland than in Germany and in France.

Exploitation of benefits arising from dominant position of TPSA The dominant role of TPSA in Polish telecommunications received considerable media scrutiny. Many authors describe TPSA as ‘monopolistic’ with negative connotations, as associated with ‘compulsory’, ‘dishonest’ or ‘unfair’. However, up to the beginning of 1990s in the majority of countries, telephony was a natural monopoly comparable with utilities such as water supply and sewage treatment. De-monopolization of this sector became possible due to technological changes in 1980s and the 1990s. The Polish Law on Communication and then the Telecommunication Law of 2000 shaped the economic situation of TPSA. Independent telecom operators could receive licences for local telephony building their own networks. A new law liberalized the long distance market from 1 January 2002, and the international markets starting from January 2003. Despite this formal liberalization of long distance and international markets, few substantial changes were observed in the market. In 2002, TPSA held a 90.7 per cent share in local markets traffic and a 96.8 per cent share in long distance traffic.19 The liberalization of the long distance market in 2002 was largely unsuccessful, the main reason being the regulations of the new telecommunication law, which did not favour TPSA but also did not contain regulations to enforce liberalization in practice. A typical example was the problem of collecting due amounts for long distance calls. Contrary to Germany, where

142 The Purchase of a Monopoly

the owner of the local loops (mostly DT) is obligated to collect payments in favour of all service providers, Polish law did not contain such a regulation. This situation created a strong conflict between an independent operator, Niezalezny Operator Miedzystrefowy (NOM), and TPSA. NOM introduced long distance services before liberalization on basis on licence, but TPSA refused neither to inform NOM who subscribers were, nor to collect dues from clients. The regulator obliged TPSA by his decision to bill services and issue invoices in favour of NOM. TPSA lawyers at once appealed this decision to the Anti-Monopoly Court. Moreover, TPSA tax lawyers found that Polish VAT legislation does not allow the issuing of invoices in favour of another firm. NOM offered first services in July 2001; in November 2001 started an advertising campaign but, on 11 April 2002, signed an agreement on the connection of two networks and on the rules on payment and billing. This means that for more than ten months NOM did not receive due revenue from clients. This was a strong warning for the others. The TPSA legal strategy was very effective. The poor execution of the new telecommunication law and the weak position of the regulator (URT and later URTiP) meant that TPSA could effectively block the liberalization process. In March 2002, the president of URT imposed a huge penalty on TPSA amounting to PLN 300 million – a sum that had never been imposed on any company in Poland before. A penalty was imposed for not performing the decision of the Minister of Communication obliging TPSA to cooperate in launching the services for NOM (technical issues, billing and payment issues). TPSA immediately appealed to the Anti-Monopoly Court. The President of URT, K. Ferenc, maintained that ‘operations of TPSA which harm the competitor operators are done on purpose and make the real competition impossible at the long distance market’.20 The number of claims of independent operators against TPSA increased after starting their operations. In May 2002, Mr W. Grabo´s was appointed as new president of the regulatory office, and immediately withdrew the penalty. In return, TPSA withdrew its writs against URTiP from the court. The philosophy of the new president was mostly based on dialogue and argumentation instead of legal fights, as had previously been the case. TPSA, however, did not change its tactics of questioning all URTiP decisions that could create real competition. After six months, URTiP had to return to legal battle with TPSA. One year was lost in the creation of real competition on the market. The penalty was withdrawn by the new president of the regulation office (URTiP), who was appointed by the new left government. This withdrawal occurred after massive critiques by TPSA lawyers against URT (the previous regulator) but before the court decision concerning TPSA’s appeal against the penalty. Why was the penalty for the obvious disrespect for the law withdrawn? Did TPSA and FT influence the Polish government? These questions cannot be fully answered because the privatization agreement between FT

Przemysław Kulawczuk 143

and the Treasury is kept confidential and the public does not know what really was agreed. TPSA used the slow operation of the Polish Courts as an effective weapon against the regulator. When URT or URTiP decisions were made, TPSA questioned them, appealed to the court and had at least several months for the preparation of a defence line. The Polish Anti-Monopoly Court is a Department of the Warsaw District Court, a court considered to be one of the slowest in Poland. The operation of courts in Poland is mostly based on the letter of law (what is written) not on the purpose of law (why it was written). Numerous regulations are contradictory, and tax law is in considerable disarray. The execution of the law depends very much on the decisions of judges who very often do not have the knowledge on the regulation of telecommunication markets and practices in this area in different countries. For example, the Anti-Monopoly Court decided that the local loop owner could not issue an invoice that would contain services of the other operators – VAT law does not foresee such a possibility. This decision was completely against the practice in other countries. Summing up, TPSA has very effectively defended its position on the fixed line market mainly by using legal tools.

Organizational changes after the acquisition Organizational changes in TPSA started well before the acquisition by FT. In 1998, first preparations took place to change the regional structure into a product based one. The main idea was to distinguish main service areas and offer them on the basis of product groups. In 2001, the TPSA group was officially established, and strategic management would henceforth take a group perspective instead of simply coordinating different entities. The new management also changed the demand for labour and allowed for extensive outplacement programmes. Most services connected with network maintenance and expansion were transferred to external contractors. Sales and service telephone centres were located in several places in the country, replacing the previously spread out services throughout Poland. It allowed for better control and efficiency of the access to the customer and economized the consumption of work. Technical problems that arose at the beginning of this service in 2003 were mostly eliminated by mid-2004. The restructuring of TPSA resulted in significant organizational changes. The most important was changing the regional management structure into a functional division including: retail, business, multimedia, and customer relations. The greater part of customer contact was moved from Customer Service Offices to a so-called ‘blue’ telephone 0-800 line, which significantly reduced the labour intensity. The acquisition of TPSA by FT speeded the transformation in the direction of a modern client group oriented division. After radical reduction of the labour force, TPSA more than doubled its labour productivity.

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TPSA was not integrated into FT’s internal structure. The privatization agreement obliged FT to maintain the ‘national character’ of the Polish telecommunications operator. FT may have liked to consolidate the TPSA Group and eliminate entities that were not profitable enough or generated losses. For example, in mid-2004 TPSA wanted to withdrew from WP, a lossmaking internet portal. FT declared its intention to change its local mobile brands to Orange, which may seem a risky strategy as the local brand, Idea, gains market share in Poland. Yet, with increase of the FT shareholding in TPSA, the organizational ties of the TPSA Group with FT will increase. In June 2004, TPSA changed its logo and introduced the symbol ‘&’, which identifies the FT Group.

Performance Table 10.2 presents financial and market performance data for TPSA, illustrating that the financial position of TPSA is much better than the mother company, FT. In 2003, the TPSA debt received a Standard & Poor’s rating BBB, in comparison to the BBB- of FT. This success was based mostly on the operation of TPSA in the area of the fixed telephone market and introducing new services in the area of mobile telephony. TPSA did not incur losses in any year between 1996–01. Probably the main reasons for the satisfactory financial results are the reasonable level of investment, the strategy of preventing extensive price competition in the fixed line market, and efficient employment restructuring. During a serious financial crisis, FT, considered withdrawals from certain investments, but TPSA was never considered as a candidate for FT withdrawal, contrary, for example, to the German FT affiliate Mobil Com, which was left alone when in serious financial crisis. Table 10.2 Financial data of TPSA 1997 Employment (thousand) Sales (PLN million)∗ Fixed line Mobile Net income (PLN million) Assets (PLN million) EBITDA/sales (%) Return on assets (%) Return on equity (%) Long-term debt/equity (%)

1998

8,317 829

10,127 956

441 99 103 42

383 83 70 79

1999

2000

716 14,020 12,384 1,066 1,249 26,467 395 89 107 102

681 15,879 14,678 1,553 1,979 32,914 382 94 138 105

2001

2002

577 41.1 17,324 18,001 15,448 15,040 2,367 3,460 629 840 34,819 36,899 331 79 44 105

Note: ∗ Differences between total sales and the sum of sales in fixed line and mobile are due to eliminations and other business. Source: TPSA, annual reports, various years.

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This performance must be seen in the context of the global changes and challenges that FT faced during 2000–03. When FT built its European position, its financial standing declined significantly. In 2001–02, the total collapse of FT even seemed possible. In 1999 and 2000, acquisitions were made at the height of stock market euphoria. Yet, FT incurred substantial losses when the speculative bubble in technology stocks burst and the global economy slowed down. In 2003, the French government, owner of 55 per cent of the company stock, provided a subsidy of EUR 9 billion to FT. Without this aid, the cash flow situation of FT might have become extremely difficult. At the end of 2002, FT was the most indebted company in the world. Its stock was valued at EUR 18 per share, 37 per cent less than at the first public offering in 1997. In spring 2000, the price per share had been EUR 219.

Conclusion and interpretation The case study illustrates that the introduction of modern management can significantly speed up corporate restructuring. Internationalization of TPSA with mixed Polish–French management helped to reduce employment. The techniques of employment reduction invented and implemented in Poland could be also useful in other FT units, including the mother company. TPSA, as opposed to FT before and after privatization, happened to be much more financially conservative and the value of bad investment in comparison to FT, was very low. TPSA concentrated on the basic activities, which generated stable income, and was very reluctant to introduce services or technologies that may be difficult to sell or commercialize. This conservative policy was not changed even after FT’s takeover of TPSA. Moreover, TPSA adjusted the level of capital investment to real market needs, while facing pressure from the market to deliver new products. This careful and moderate policy concerning investment and technology helped the company to maintain profitability at all times, before and after privatization, and sales grew year by year. Positive financial results were achieved, even in the years 2000–03, despite the significant costs of employment reduction compensation. It was expected that profits would increase significantly after completing the restructuring process. TPSA and FT managed to maintain the market position in Poland, using not only management techniques but also with legal tools. The functioning of the juridical system in Poland is considered to be one of the most challenging in Europe. TPSA continued questioning nearly all the regulator’s decisions that would extend competition on the telecommunication market. Of absolutely benefit (from TPSA’s point of view) was the introduction of a new Telecommunication Law in 2000, which contained non-precise, partial and questionable regulations. In numerous cases, TPSA did not respect valid

146 The Purchase of a Monopoly

regulator’s and court’s decisions, and the regulator decided to impose a spectacular penalty of PLN 300 million on TPSA. Another conclusion can be made from a customers’ point of view. TPSA and FT have a very poor reputation among clients, especially young and educated people, and cannot expect a high level of customer’s loyalty when the real competition comes. The successful development of mobile services was based on local brands Idea (post-paid) and Pop (pre-paid), which are sold by PTK Centertel, a company which is not necessarily perceived as associated with TPSA and FT. Changes in TPSA offers in the fixed line market are sometimes perceived as differentiation, not as new products. The price policy of TPSA sometimes uses its monopolistic position. Although services did not improve, prices rose significantly after the acquisition by FT (for example, subscription fees from PLN 25 to 35 plus 22 per cent VAT). Another typical practice was the reaction to partial liberalization. When the government liberalized the given market (for example, for long distance calls), TPSA significantly reduced prices shortly before the liberalization to make business more difficult for potential competitors. In a monopolistic market, TPSA was able to maintain the high prices regardless of real costs and international prices. Between 1994 and 2002, TPSA held prices for international calls constant, and as a result, in May 2002 Poland had the highest purchasing power adjusted rates of all OECD countries for individual subscribers.21 Another difficult aspect of TPSA changes after acquisition by FT was product quality. TPSA introduced new technological developments too slowly, especially Internet technology (B˛ak et al., 2000). It seems that significant errors were made in this area. Initially, after FT’s takeover of TPSA, it was assumed that broadband Internet access would be too expensive for Poles and this was why dial-up access would be developed. As a result, TPSA kept prices for DSL technology at very high levels. Besides DSL, TPSA’s dial-up Internet access was of very poor quality. The unsatisfactory evaluation of TPSA from the point of view of customers is not the only fault of FT and TPSA managements. They did not have to work harder to attract clients because there was no real competition on the fixed line market. This was caused by unclear governmental policy towards the liberalization of the telecommunication market. Very weak execution of the law and poor functioning of the court system in Poland were additional factors which effectively allowed TPSA to keep the monopoly. On the mobile market, more competition existed than on the fixed line market, and the subsidiary of TPSA–FT achieved a real success, despite oligopolistic competition.

11 Building Strategic Alliances to Maintain Independence: Bank Millennium and Banco Comercial Português Anna Szcze´sniak

Introduction The case of Bank Millennium shows how the top management of a Polish bank remained relatively independent by finding a sympathetic foreign investor. This alliance was created in reaction to an attempted hostile takeover by a major global player. The spectacular fight for the bank attracted considerable attention from the Polish business community. The case thus shows how a local firm can find partners when its business models are clear and promising. The case reflects the consequences of the rapid development of BIG (Bank Inicjatyw Gospodarczych), as Bank Millennium was formerly known, under the leadership of a dynamic management team led by bank President Boguslaw Kott. BIG was created in the early 1990s by large, state-owned enterprises (98 per cent), and private investors (2 per cent). This public– private affiliation became burdensome for the bank, which was frequently accused of doing private business with public money. The bank was later privatized through public offerings, and the state enterprises lost their majority holding in the bank’s equity. Throughout the 1990s, the small bank grew thanks to its dynamic management, and took over the Lódzki Bank Rozwoju S.A. in 1993. This spectacular acquisition put BIG on the national stage; Mr. Kott’s team took over the seventh largest state bank in Poland, although BIG was considerably smaller. It was the only case in Poland of an acquisition of a large state bank by a small, private financial institution. The ambitions of Kott’s team were high but it was in danger of gradually losing control. Deutsche Bank Polska S.A. acquired significant stakes in BIG’s equity. However, the management of BIG Bank Gdanski managed to defend its position with the help of a foreign partner, Banco Comercial Português (BCP). The battle with Deutsche Bank (DB) was turbulent, unclear and ambiguous from a legal point of view. At some stage, BIG had two different management boards at the same time. Finally, following a court decision, Deutsche Bank withdrew its takeover bid and Kott’s bank was 147

148 Building Strategic Alliances

overtaken by BCP. The name of the bank was soon changed to Millennium Bank. It became the new private bank in Poland after 1990, the first listed Polish bank, and the first Polish bank to acquire another bank.

The two firms The investor: Banco Comercial Português Banco Comercial Português was founded in 1985 as a limited liability corporation. BCP is a leading financial group in Portugal with headquarters in Lisbon, and one of the top 100 banks in Europe. In 2003, the mission of the bank was to contribute to the development of the financial system and of the Portuguese economy – through a comprehensive offer of innovative, personalized financial products and services conceived to meet the overall financial needs and expectations of various market segments, with a very high degree of quality, innovation and technological leadership of its value proposals, both on domestic market and in those geographic markets in which it does business either autonomously or through subsidiary financial companies.22 BCP has been the most internationally oriented Portuguese bank, and in March 2006 it made an offer for domestic rival Banco BPI, which if successful, would make it Portugal’s largest bank. BCP reached market leadership through the integration of services, cross-selling of financial services, utilization of the newest operating technology and innovative marketing. In 2003, BCP had 17,827 employees, total assets of EUR 66 billion, and a domestic network of over 1100 retail outlets. BCP is listed on the New York, Frankfurt, London and Amsterdam stock exchanges; strategic objectives include leadership in quality, innovation and technological development; the Bank has emphasized its capacity for innovation and contributed to the modernization and development of the Portuguese financial industry. The BCP Group is a diversified financial conglomerate offering a wide variety of banking and related financial services, both in Portugal and internationally. BCP has adopted a sequential approach to the various segments of the market. Following a preliminary analysis of the attractiveness and profitability of each segment, the bank would create a full range of products and services for various segments of customers, each with its own brand.23 The company’s major activities include deposit services, loans, custody of securities, treasury services, foreign exchange transactions and money market operations. The BCP Group is also involved in related financial services, including life insurance and non-life insurances, asset management, investment and pension fund management, medium and long-term credit, specialized credit (leasing and factoring), mortgage loans, consumer credit,

A. Szcze´sniak 149

organization of capital market operations, corporate finance, company valuations, venture capital financing, brokerage and property management.24 The BCP Group operates in Asia, Europe, North America, and South America. In recent years, it focused mainly on selected business areas and geographic markets, aiming to take advantage of distinctive competitive advantages in the local markets. Internationalization strategy has thus focused on European markets with high growth potential – Poland (Bank Millennium) and Greece (NovaBank). In the Iberian market, BCP Group and Bank Sabadell established a strategic cooperation agreement in 2000 with a view to pursuing and developing joint initiatives on ‘e-banking’, which includes the ‘Managerland’ Iberian portal. At the same time, the BCP Group developed autonomous operations in countries with historical relations with Portugal or substantial Portuguese communities. These included BCM (Macao), BIM Group (Mozambique), Banque BCP (France and Luxembourg), BPABank (UAE) and SottoBank (Canada).25

The acquired local firm: Bank Inicjatyw Gospodarczych BIG Bank Inicjatyw Gospodarczych S.A. was created in 1989 as a nationwide, universal commercial bank offering its services to individual clients, small and medium-size companies and corporate clients. In 1990, BIG was the first bank to issue shares by public offering. During the same year, it opened a stockbroker office and started leasing activity. In 1991, BIG issued the first VISA card in Poland, and in 1992, BIG became the first bank to be quoted on the Warsaw Stock Exchange. In that year, BIG acquired Lódzki Bank Rozwoju S.A., which was the first acquisition of a private bank in Poland for over 50 years. In 1995, BIG S.A. bought its first stake in privatized Bank Gdanski ´ S.A., and in 1997, the two banks merged, creating BIG Bank Gdanski ´ S.A. (BBG). Both financial institutions complemented each other: BBG had the stronger position on the capital market, while Bank Gdanski ´ specialized in servicing small and medium enterprises as well as private customers.26 The synergy gains of the merger were clearly visible in 1999. BBG employed 5100 persons in March 1998, which number fell to 4300 in June 1999. At the same time, net profit grew from PLN 67 million to PLN 93 million and the group’s share of the banking services market in Poland increased from 3.9 per cent to 5.2 per cent. In 1999, BBG was listed on the London Stock Exchange. From the outset, BIG had few retail outlets, but the acquisition of ŁBR and BG provided BIG with many retail outlets in central and northern Poland and, thus, access to thousands of customers. Since its inception in 1998, BBG had always been a private bank in which the state never held more than 2 per cent of equity. The shareholder structure had continuously changed. To prevent a dominant influence from a foreign investor, the BBG board did everything to

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disperse the stock as much as possible. In 2000, American, Dutch, French, Portuguese, German, and even Japanese banks owned small packages of BBG stock, as did the Polish insurance company PZU (Powszechny Zakład Ubezpieczen ´ S.A.). Public opinion has often linked BIG with the political left, as Mieczysław F. Rakowski (the last prime minister of the ‘older regime’) was considered its ‘godfather’ at its creation in 1989. State banks from that time were said to support the left.27 However, the bank’s connections with a wide variety of politicians came to light during the various takeover manoeuvres. According to the press, Mr. Kott (formerly director of the Foreign Trade Department in the Ministry of Finance), Mieczysław F. Rakowski and Aleksander Kwa´sniewski established the Foundation of Sailoring Development, which in turn was co-founder of the Interster company. Interster was accredited by the Physical Culture and Sport Office, of which Aleksander Kwa´sniewski was chief. Interster and several big state companies (including PZU and Polish Mail) were founders of BIG S.A., providing it with an initial capital of 1 billion ‘old’ PLN, worth PLN 100,000 in today’s currency.28

Firm compatibility BCP and BBG appear to be compatible in relation to the range of services offered, but BCP offered many new services that were lacking in the BBG product portfolio. Given BBG’s pursuit of rapid development, BCP was an attractive partner to which intensive development could be linked, although technological standards differed. BBG was a nationwide bank and its services were directed at the Polish market. These activities focused on various objectives, covering inter alia arranging funds and facilities for its own or its customers’ purposes, servicing trade transactions, participating in international foreign exchange and money market operations, and trading on equity markets. The bank cooperated with nearly one thousand correspondent banks in countries of significance to Poland’s foreign trade. The most important relations were those with eastern and western Europe, as well as China and the United States.

Industry: Polish banking sector In 2002 and 2003, the Polish banking sector suffered due to the general economic situation in the country. Two consecutive years of increasing unemployment, weak economic growth and the insignificant progress in reforming public finances had a negative influence on banks. In 2002, the unemployment rate exceeded 20 per cent and productivity no longer grew faster than unit labour costs. Inflation decreased to a record low level of 0.8 per cent in December 2002, and domestic demand and individual consumption also reached record low figures. The budget deficit increased to 5.1 per cent of GDP in 2002. The monetary policy became less restrictive

A. Szcze´sniak 151

with eight successive basic interest rate reductions, moving the rate from 6.75 per cent to 4.75 per cent. As a result, the interest rate for savings accounts fell, on average, from 2.4 per cent to 0.5 per cent, and for longterm deposits from 8 per cent to nearly 5 per cent. The profitability of savings declined even more as a new 20 per cent tax on interest income was introduced. The amount of funds in long-term deposits declined by 12.3 per cent between November 2001 and November 2002. The economic slowdown decreased demand for loans from both the corporate sector and households, and the two disappointing years deteriorated the quality of bank credit portfolios.29 Polish banks had, for several years, been subject to internal restructuring. In 2002, the number of commercial banks in Poland diminished from 71 to 62, mainly due to consolidation. No major changes were seen in the banks’ ownership structure, as the State Treasury continued to control seven banks. The number of active private banks dropped from 62 to 52. The number of banks with a majority of capital in Polish hands fell from 16 to 7. Among foreign-owned banks, two started activities, two closed down and one lost its legal status. In addition, 650 cooperative banks were present in the market in 2002, most of which were savings banks. Fifteen banks were listed on the Warsaw Stock Exchange. In 2002, the state-controlled banks still accounted for 25.3 per cent of the total banking sector assets, 21.4 per cent of loans to non-financial customers, 30.5 per cent of deposits to non-financial customers and 14.8 per cent of total core and supplementary capital. On the other hand, foreign investors controlled 45 commercial banks, which accounted for 67.2 per cent of bank assets, 62.2 per cent of deposits from non-financial customers and 70.5 per cent of total loans. The year 2002 saw, for the third consecutive year, a decline in employment in commercial banks from 138,822 to 131,874. The main reasons for this reduction were: consolidation; the introduction of modern, centralized IT systems; the development of electronic banking; and cost cutting in response to increased competition and unsatisfactory earnings. FDI in the Polish banking sector reached PLN 6.7 billion in 2002, so that the proportion of the total banking capital held by foreign investors increased to 60.5 per cent. At the end of the year, foreign investors from 14 countries were present in the Polish banking sector, including Allied Irish Bank Plc, ING Group NV, CITIBANK, ABN Amro-Bank, Bayerische Hypo-und Vereinsbank AG, Deutsche Bank, and UniCredito Italiano.

BCP’s entry After BIG took over Bank Gdanski, ´ it became clear that it would be difficult to control the bank without the assistance of a major capital investor. BCP learned that BBG was looking for a strategic investor that would allow BBG

152 Building Strategic Alliances

to develop according to its own vision. BCP was an expansive bank that had eliminated competitors from its domestic market. A representative of the BBG board presented the bank to BCP partners. In 1998, BBG and BCP initiated their cooperation when they started to create a modern network of retail banking services – Millennium – with over 300 branches serving more than 800,000 customers. In 2001, the two companies launched a special network to serve the affluent customer segment, known as Millennium PRESTIGE. The key factors behind BCP’s decision to invest in BBG were BBG’s access to the local markets and the need to improve the efficiency of its global network. A qualified workforce and low labour costs were not important to BCP. The most crucial factors for success during the first two years of operation were licencses, distribution network and trade contacts. BCP acquired shares of BBG gradually. However, the acquisition of shares accelerated in 1999 and 2000, when BCP purchased a strategic block of BIG Bank Gdanski ´ S.A. shares. This process was triggered by DB, which tried to acquire BBG. It was a dramatic and controversial situation, but the BCP bid allowed BBG to avoid being acquired by DB. The vicious fight for BBG began in February 1999, when American investment fund Templeton and Dutch ABN Amro filed a motion at the BBG general shareholders meeting. At the time, 24 per cent BBG stock was held by BBG subsidiaries, who would vote with the management in shareholder meetings – a practice legal in Poland but not in many other countries. Templeton and ABN Amro, who owned over 10 per cent of BBG stocks, demanded that this practice be ended. Yet, the BBG board refused, thus cementing the dominant position of insiders. However, the foreign stockholders did not accept this decision and thus a dispute began over who would control nearly one quarter of BBG and, consequently, the entire bank.30 BBG President Bogusław Kott stated many times in press interviews that the BBG Group could develop without an active investor’s support. Therefore, BBG traded its own stock through subsidiaries subordinated to the board. Such an arrangement was the most comfortable and left the BBG board in control. In March 1999, Bank Rozwoju Eksportu – a bank backed by the German Commerzbank – acquired an additional 3.3 per cent of shares, increasing its stake in BBG to 5.4 per cent. It announced that it treated the investment as a portfolio investment, but did not exclude the possibility of becoming a strategic investor later. Only one day later, Banco Comercial Português, the loyal partner of BBG, informed the public that it had increased its equity stake from 4.99 per cent to 5.4 per cent. The BBG share price increased about 200 per cent over the course of one and half months – from less than PLN 3 to over PLN 9 per share. The turnover grew to the highest point ever seen in the six-year history of the Warsaw Stock Exchange. On one day, more than 5 per cent of BBG shares had changed owners, accounting for half of the day’s turnover at the Exchange.

A. Szcze´sniak 153

In first ten days of April 1999, 20 per cent of bank shares changed owners. Sellers included the Bank of New York, which reduced its commitment from 22.9 per cent to 13.7 per cent, and – to the surprise of many observers – the Templeton Fund, which sold the majority of its stake in BBG, a stake which went from 8.3 per cent to 0.45 per cent on 6 April 1999. At the time, the statutes of BBG had forbidden any shareholder from having more than 15 per cent of the vote at the general shareholders meeting, regardless of the size of his or her holdings. At the beginning of 1999, DB started taking control of BBG, and passed this information to the public, which dissatisfied the BBG board. DB announced simultaneously that its potential partner – BBG – was careful in the development of Polish banking and that DB wanted to undertake this matter in negotiation with BBG board. DB was already interested in BBG when BBG took over Bank Gdanski ´ two years earlier, an interest which President Kott ignored. By April 1999, DB had 9.9 per cent of BBG shares and wanted to become the strategic investor in BBG. Later, DB obtained permission from the Bank Supervisory Committee to hold 25 per cent of equity. At the end of February 2000, the German bank owned 13.23 per cent of BBG shares, and asked the Bank Supervisory Committee for permission to increase its stake to 33 per cent. DB affiliated companies administered one third of the bank’s shares, including a stake obtained through a controversial transaction undertaken in secret by DB representatives with the president of PZU, a large state-owned insurance company in the autumn of 1999. Meanwhile, the BBG board adopted a very shrewd line of defence. The board did not want to take stockholders’ preferences into account in the future and announced its intention to sell 24 per cent of shares before the planned meeting on 5 May. In the meantime, a consortium of Eureko and BBG committed to purchasing the 30 per cent of PZU shares from the state (PZU in turn owned 7 per cent of the BBG shares) to prevent DB from taking over the company.31 On 28 January 2000, the general shareholders’ meeting took place. During the voting for the dismissal of the Supervisory Board, which would enable DB to take control of the company, the PZU representatives abstained and, by doing so, acted in the interest of DB. The abstention of PZU allowed representatives of the German bank to dismiss the BBG’s Supervisory Board and call for a new one. President Kott protested, pointing to the commercial code, and demanded that the general meeting be continued on 11 February 2000. The BBG general shareholders meeting was interrupted and the new president Hubert Janiszewski called together a meeting of the newly elected Supervisory Board. Thus, at this time, there were two Supervisory Boards, two Management Boards and two Presidents. Władysław Jamrozy, ˙ the president of PZU, declared that he had voted according to instructions received from the Ministry of the Treasury. Several hours later, the Minister of Treasury

154 Building Strategic Alliances

(Mr. Emil W˛asacz) accused him of lying and stated that the President of PZU had voted in defiance of instructions.32 The members of the PZU board lost confidence in the majority owner (the Ministry of the Treasury) and were therefore hung in the carrying out of the board’s duties. The Securities Committee suspended the institutional trading of BBG shares on the Warsaw Stock Exchange. At that time, BCP possessed almost 15 per cent of BBG shares.33 On 4 February 2000, the District Court in Warsaw cancelled the resolutions of the BBG General Meeting of Shareholders enacted on 28 January 2000; namely, those concerning the dismissal of Supervisory Board members and the election of the new Supervisory Board.34 After that judgement, DB stopped its fight for BBG and sold its shares to BCP, which increased its share of BBG, gradually becoming a partner and strategic investor. The ‘hostile takeover’ by DB caused political turmoil. Politicians’ statements related to the matter led to widespread belief in an unclear connection between politics and business, perhaps bordering on corruption.35 In November 2001, BBG’s main shareholders were: BCP (19.98 per cent), Achmea Holding NV (9.99 per cent), Eureko (9.99 per cent), Carothers Trading Limited (8.99 per cent), Priory Investment Corp. (8.18 per cent), INEC Services (5.85 per cent), and M+P Holding S.A. (5.40 per cent).36 In 2001, BCP increased its stake to 46.18 per cent, and did so again in 2002, raising it to 50 per cent. BCP appointed BBG’s top management and made key strategic and operational decisions. In January 2004, Bank Millennium’s ten-member Supervisory Board included three BCP representatives and one representative of another shareholder. The eight-person Management Board also included three BCP representatives. Mr. Kott retained his position as Chairman of the Management Board.

Restructuring of Bank Millennium S.A. BBG and BCP began cooperating in 1998, when they started creating a modern network of retail banking services – Millennium. Although this was a common effort, Millennium was modelled after Portuguese solutions. However, BBG remained independent under the leadership of Mr. Kott and was not absorbed by BCP.37 Bank Millennium’s (BM) vision was to become as one of Poland’s leading banks with activities based on three strategic pillars: the best banking standards; leading-edge technologies; and a central European partnership with BCP, BM’s strategic shareholder. The basis of the cooperation between BCP and BM lies in their common strategy, and their skills in implementing this strategy in an open and competitive European market. They also share similar perceptions of challenges and tasks standing before the Polish financial services market. Both

A. Szcze´sniak 155

banks want to accomplish essential qualitative changes to bringing BM up to the European level of bank services. The stability in shareholder interests following the acquisition of BBG by BCP allowed for the restructuring of BBG. The next factor necessary to this process was the merger between BBG and its subsidiary BIG Bank S.A. in January 2001. At that time, BBG began developing and implementing a comprehensive programme for the restructuring of the ‘merged bank’. The programme was named a ‘Strategic position of the BIG Group on the financial services market’ and encompassed all organizational units of the Group. The programme included the support necessary to establish a nationwide financial group providing a full range of financial services through a network of high-tech branches and automated distribution channels. Before the merger between BBG and BIG Bank S.A. there was no coherent customer segmentation, no IT systems, product distribution networks or trademark registration (see Figure 11.1). This changed significantly following the acquisition, and again following the merger of BIG BG and BIG Bank. A period of implementation of the strategic change program for BBG came in 2001. The programme implemented a modern business model, along with a method of activity and business strategy, reformed infrastructure, support services and a back office. In addition, it enhanced the bank’s capital base. The transformation programme assumed that after the implementation of a single, unified operating system and the creation of a centralized

Segment

Branches

IT systems

Brand

Small business and corporate banking

Retail banking

Millennium

Retail branches BIG BG old/new

ZORBA

ICBS

Millennium

Corporate branches BIG BG

Bank Gdanski

BIG Bank Gdanski

Figure 11.1 BM structure: pre-transformation Source: Based on BIG Bank Gdanski ´ S.A. Annual Report, 2001.

BIG BANK

2 business units

5 branch types

IBIS

3 IT systems

BIG BANK

4 brands

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settlement system (a central back office), the BM Group would simplify its customer service. The creation of new business lines and a modified customer service organization would enable the cross-selling of products by individual networks and the development of bank assurance products. At the same time, the bank developed automated distribution channels, which were offered to customers from all market segments, and the bank’s offering was supplemented by specialty offers from BM Group companies (leasing, brokerage, and factoring services), as described in the next section. In 2001, the new focus on customer segmentation as the core strategy element was implemented. As a result, five business lines were established, each with a specialized sales network, product range and marketing function. Millennium PRESTIGE provided private banking services for affluent customers. Millennium served individual clients. Millennium Biznes served small firms, and Regional Corporate Business Centres serve medium-sized and large businesses. Finally, the Strategic Customers Unit was responsible for cooperating with firms with the largest potential and importance for the bank. In 2002, the bank completed the major portion of its restructuring activities and implemented its new organizational structure (see Figure 11.2). The implementation of new market segmentation and a new operating system,

Private banking

Corporate Banking

Central unit strategic customers 17 Outlets Bank Millennium PRESTIGE Affluent banking

300 Outlets Millennium Individual customers

Phone banking

Electronic banking

Organizational units

10 Microregional Business Centres Bank Millennium Mid-corporates 154 Outlets Millennium Business Small businesses

Internet banking

External Operators

Figure 11.2 BM structure: post-transformation Source: Based on Bank Millennium S.A. Annual Report, 2002.

PZU Sales network

Distribution channels

A. Szcze´sniak 157

along with the centralization of support functions and the reorganization of the sales network, was completed. All customer accounts were transferred to a uniform, centralized, modern IT system – ICBS. During this process, 875,000 customer accounts were transferred to the new operating system, and 214 traditional outlets of the bank migrated to the new operating system. In addition, the transfer of data from 72 servers was automated. The unified IT system required total reorganization of the branch network. Unprofitable branches were closed and new ones were set in areas of considerable business potential. On 31 December 2002, the bank served customers through: • • • • •

300 branches of the Millennium network, 17 branches of Millennium PRESTIGE (private banking), 10 Macroregional Business Centres (corporate banking), 26 Regional Operating Centres (corporate customers), and 25 service outlets (corporate customers).

The most significant task of the transformation process was the implementation of the advanced operating platform for servicing both individual and corporate customers, which encompassed banking in all business lines under one uniform operating system. Moreover, the organizational change required the creation of a cross-selling culture within the BM Group. On 8 January 2003, BIG Bank Gdanski ´ S.A. changed its name to Bank Millennium S.A. This operation signified the end of a basic stage in the bank’s new development strategy. The bank’s new image and brand supported its sales networks and led to intensified marketing. At the beginning of 2003, the first measurable effects of the restructuring programme were apparent. One clear change was the growth of the mortgage loan business and the cross-selling of various products (insurance, leasing, factoring and investment funds). The programme also allowed for the comprehensive review of the cost base and the launch of a number of cost reduction projects. There were also visible changes in the employment structure, as described below. In total, the restructuring programmes reduced costs by 16.4 per cent in 2003. Moreover, 2003 brought the visible effects of the Bank’s business stimulation programmes. Unfavourable trends in net interest income, commission income, and customer funds were reversed. In 2003, non-personnel costs were 16.8 per cent lower than at end of 2002. The most significant reduction came in IT and telecom costs, and in administration.38 At end of 2003, the Millennium Group employed 4426 persons, compared to 5667 employed by the company at the end of 2001 – a reduction of 33 per cent. Over the same period, BM’s total assets declined slightly from PLN 19,926 million (EUR 4634 million) to PLN 19,283 million. In 2003, the Bank Millennium Capital Group posted a net profit of PLN 40.9 million. In the medium term from 2004 to 2005, the BM Group aimed

158 Building Strategic Alliances Table 11.1 Bank Millennium Group: financial data

P&L account (PLN million) Net interest income Net commission income Other non-interest income Total costs Net provisions Net profit Ratios (%) Net interest margin Cost to income ratio Return on assets Return on equity Capital adequacy ratio

2003

2002

5580 2070 1763 9005 1394 409

6693 2265 5010 1 0782 3372 1791

2003 37 872 02 23 1226

2002 43 722 09 115 1066

Source: Bank Millennium Annual Report 2003.

for a 20 per cent rate of return on equity. The financial results of the Bank Millennium Group are presented in Table 11.1. The transformation programme also required employment restructuring and human resource development. In 2001, the bank undertook several initiatives to prepare staff for new positions and tasks in accordance with the new bank marketing strategy. New remuneration, incentive and training schemes were also implemented. In 2002, the bank implemented an extensive training programme and reallocated a number of its human resources. The bank’s intent was to provide its workers with steady access to current knowledge of banking services and products through both external and internal training courses. In total, 2041 employees were trained and prepared to work in the new customer service system, while 5451 participated in related courses. Formal performance appraisals were introduced to facilitate promotion decisions and to enhance employee development.39 The transformation programme resulted in a material improvement in staff effectiveness and an adjustment in the number of employees to reflect the new bank structure. The number of workers decreased by 23 per cent. On 31 December 2002, the Millennium Bank Group employed 5892 workers, of which 846 were under termination. In financial year 2003, personnel costs had fallen by 18.6 per cent and the Millennium Group employed 4426 persons (a decline of 25 per cent over the previous year). Bank Millennium had a headcount of 3977 persons (a decline of 26 per cent).40 The effect of joint planning between BCP and Bank Millennium allows for the exchange of experiences, knowledge, technology and staff. At the end of February 2003, two Polish managers worked for BCP Group in Portugal and

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Macao, and about 20 Portuguese middle-and high-level managers worked in Poland. BCP expects the role of Polish managers to increase in the BCP Group management team. In fact, Mr. Kott became a BCP board member, initiating a closer cooperation between the banks.41

Subsidiaries Bank Millennium has several subsidiaries serving specific segments of the financial market. These include:42 BEL Leasing Sp. z.o.o. Established in 1991, BEL Leasing is one of the leading leasing companies in Poland. With 160 employees, the company held an 8 per cent market share in 2002, a number that had increased from 4.5 per cent in 1999. As of 31 December 2002, the company serviced 7622 clients and 14,737 leasing contracts, and the value of engaged capital in active contracts amounted to PLN 1285.5 million. Following the Bank Millennium strategy of cross-selling, BEL Leasing initiated programmes in 2002 to increase the volume and efficiency of sales conducted by the bank’s advisors in other units. To achieve this goal, the company introduced cross-selling within the sales chains of the bank and BEL Leasing. Moreover, during 2002 the bank’s advisors were regularly trained in the field of leasing. As a result, cross-sales rose by 300 per cent in 2002. Millennium Dom Maklerski S.A. was established as the bank’s brokerage office in 1990. In May 2003, Millennium DM S.A. was one of the largest brokerage enterprises in Poland with equity of PLN 80.86 million. In terms of turnover in the general and block shares markets, Millennium DM ranked fourth among Polish brokerage houses. In 2002, its share of equity trading on the Warsaw Stock Exchange was 3 per cent, and its share of the futures market reached 4 per cent. Millennium DM actively participated in the primary and secondary securities market, holding some 52,000 investment accounts. The company introduced a state-of-the-art Internet site that gave customers instant access to both brokerage services and a database about the capital market. Millennium DM employed 150 people. Forin Sp. z.o.o. offered factoring services. In 2002, Forin concluded 560 factoring contracts, and turnover reached PLN 1.7 billion, a 29 per cent increase over 2001. At that time, Forin became the second largest factoring firm in the country with a market share of 16 per cent in 2002 and 62 persons on staff. Millennium Towarzystwo Funduszy Inwestycyjnych S.A. is an investment fund company operating under the Securities and Exchange Commission. In 2002, its market share amounted to 2 per cent with 11,000 customers and total assets of PLN 338.2 million.

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Conclusion The success of Bank Millennium’s restructuring appears obvious. The bank is becoming one of the leading banks in Poland, operating according to European best practices and using state-of-the-art technology. The bank is a key partner of its strategic shareholder BCP in central and eastern Europe. The alliance gives BM access to vital knowledge of modern financial services. BM remained a nationwide bank, developed and reorganized its sales network and modified its thoughts about concrete customer services. Many new BM outlets were placed conveniently for individual customers with suitable opening hours. The new BM layout was associated with a new brand and improved quality. The bank’s transformation programme improved the range and quality of its products, and also raised the standard of services, all with the aim of gaining new customers and obtaining a larger market share of banking services. Undoubtedly, a new organizational culture was transferred from BCP to BM and to BM subsidiaries. It is only possible to speculate what would have happened if the bank had not had a strategic partner in BCP. BM would probably have been acquired by another foreign bank, but the board would not have saved its position. In 1999, BBG’s board had a choice between a Portuguese bank and a German bank, but fiercely opposed the DB’s overtures. We can only speculate that the acquisition of BIG by BCP turned out better for the bank’s position and that this variant was better for BBG’s board. It is hard to say today what position BBG would gain if DB had decided its fate. Following BCP’s entry, BM became a bank with a wide range of high quality services, an extensive network, and a management style incomparable to that seen in BIG three or four years earlier. Many fields of activity were firmly established at the bank, costs were under control, and programmes of reduction were started. However, customer complaints about the poor service of the bank were heard and ‘propaganda of success’, despite unsatisfactory results, is visible. More time is needed to better estimate how the cooperation between BCP and BM strengthened the Polish bank, but BCP clearly helped modernize and develop Bank Millennium and its subsidiaries.

12 Building Profit from Losses: K&H and ABN AMRO Krisztina Tóth

Introduction In 1999, the Hungarian banking industry had around 40 market players, a large number for the relatively small market. The consolidation of the industry began at the end of the 1990s with the merger of Kereskedelmi és Hitelbank Rt. (K&H) and ABN Amro (Magyar) Bank Rt., which was one of the first significant transactions in this sector. The importance of this merger is highlighted by the fact that the fusion was not the usual consequence of an international merger of two foreign banks, but focused only on the Hungarian subsidiaries. This horizontal merger of the banks was a friendly transaction that was set up through the agreement of the management and owners of both parties. The merger was announced in 2000 and, by the end of 2002, the integration was almost completed. This integration period is the subject of this case-study (I do not discuss the embezzlement scandal which broke in 2003 and its implications on market performance). In the next section, the main actors – the foreign parent companies and their local subsidiaries – are introduced, as are changes in the ownership structure and business strategy. Discussion of the merger process follows, and then the results of the fusion are presented in the light of the realized integration and an analysis of the synergy potential.

The firms KBC Bank & Insurance Group KBC Bank & Insurance Group was established in 1998 following the merger of three Belgian financial institutions: Kredietbank, Cera Bank, and ABB Insurance. The Group employs 44,000 individuals and caters to nine million customers. The third largest bank in its home market, KBC, has a strong market position in Flemish areas, with 20–25 per cent of the banking business and 10 per cent of the insurance business in these areas.43 The Group is present in over 25 countries but is not a global player. Expansion into 161

162 Building Profit from Losses

the growth countries of European Emerging Economies (EEE) is central to corporate strategy. Therefore, KBC invested in Hungary, the Czech Republic, Slovakia and Poland. Through its subsidiaries, the Group serves 4 million customers in the EEE region. In an interview with Figyel˝ o (a Hungarian economic weekly) KBC President Remi Vermieren said: Becoming an important actor in the EEE region was an early objective of KBC because we see considerable financial and growth potential in this region. In global terms, KBC is not really a significant company, but it is strong enough to gain a notable position is this market.44 In the years ahead, KBC plans to concentrate on overall growth and cost reduction in the banking business, which is to be achieved through downsizing, IT cuts and further optimization of the branch network.

Kereskedelmi és Hitelbank Rt. Kereskedelmi és Hitelbank Rt. (K&H) was founded on 1 January 1987 as a result of the establishment of a two-tier banking system in Hungary. The Bank took over the management of 51 branch offices and the accounts of 2400 legal entities (mainly from the food industry) from the National Bank of Hungary. In 1996, K&H took over IBUSZ Bank, its fully owned subsidiary, primarily engaged in retail banking. As a result, a large universal bank, which administrated the country’s second largest branch network, was born. In 1997, the privatization of the bank began with the assistance of EBRD. The winner of the tender was the consortium formed by the Belgian Kredietbank and British Irish Life, which acquired 23.1 per cent of the shares, and the Bank’s financial position was consolidated through capital expenditures amounting to USD 60 million. In 1999, KBC Bank increased its interests in K&H Bank by acquiring half of the shares (9 per cent) owned by the EBRD. The other half was acquired by the Portuguese Espirito Santo Group. Thereafter, KBC sought gradually to increase its holdings in K&H. The next opportunity occurred when the State Privatization Company sold its shares, amounting to 30.6 per cent of total shares. Following two weeks of intensive negotiations, KBC purchased the State shares for a price of 120 per cent of their valuation. The bank continually expanded its branch network and developed a broad credit card portfolio, but these efforts were not seen in the results. In 1999, the bank registered the highest deficit in its history, amounting to HUF 10 billion, which was three times higher than the previous year. The lack of capital was induced by inefficient functioning and the need to make provision for liabilities and charges. The Belgian owner sought to compensate for the shortage while, at the same time, it tried to buy out the Hungarian state. Earnings growth was under the inflation rate, which forced management to introduce several constraints, including the limited use of company cars

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and mobile phones. As a result of such cost cutting measures and the partial replacement of the management team in early 2000, the bank became profitable. As it gained trust in the Hungarian operation, the foreign owner made further investments in the bank. The ownership structure changed when KBC increased its stake in Kereskedelmi és Hitelbank to 98.51 per cent in February 2001. At that time, KBC acquired Irish Life’s 17.9 per cent stake as well as the 7.33 per cent stake held by Espirito Santo Asset Administration Ltd.

ABN AMRO Bank ABN AMRO, the result of the 1991 merger of Algemeine Bank Nederland (ABN) and Amsterdam-Rotterdam (AMRO), is a leading player in private banking in the Netherlands. In 1999, the bank was ranked third in Europe and sixth in the world.45 ABN AMRO is a prominent international bank, with over 700 branches in 80 countries, that sees the EEE region as a strategic market for growth. In conjunction with the liberalization of the banking sector throughout the 1990s, ABN AMRO entered in the region through quick acquisitions. The establishment of the Hungarian subsidiary and the acquisition of the local Magyar Hitelbank Rt. (MHB) were the first steps. ABN AMRO’s first acquisition target in the region – MHB – had already begun restructuring the customer portfolio and the organization by benchmarking both local and international best practices. As a result, ABN AMRO had to offer a 222 per cent premium on the shares to obtain ownership. The objective was to learn how to operate in this special market and to gain competitive advantages. ABN AMRO planned to take part in the privatization process in Bulgaria, Czechoslovakia, and Romania. The MHB situation provided an opportunity to find out how to deal with the state as an owner and to learn how to restructure a company with underdeveloped technology and services. ABN AMBRO’s other desire was to challenge the largest bank in Hungary – OTP – by quickly acquiring a market share. The subsidiary did not realize the expected results and registered only losses. Despite the continuous capital injections and various development efforts, the Hungarian operations were not successful. One possible explanation could be the fact that ABN AMRO had just started to build universal bank operations and used the Hungarian operation as a testing ground. Despite the losses, ABN AMRO was optimistic and adopted a long term strategy. In 2000, the opportunity to merge ABN AMRO Magyar with K&H Bank arose, with ABN AMRO as minority owner. Mr. Jan Koopman, Senior Executive Vice President of ABN AMRO, said: This potential partnership with KBC confirms ABN AMRO’s commitment to Hungary and is expected to ensure sustainable profitability. In addition, this strategic step is in line with the global restructuring process ABN AMRO is currently undertaking to increase shareholder value.46

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The new strategy led ABN AMRO to focus on three selected business areas (retail clients, corporate and private clients, and asset management), and to rethink its international investments. The focus on the EEE region shifted as a consequence of changes in top management. The evaluation criterion for the affiliates became strict profitability, meaning that units making losses had to be sold, allowing the bank to retreat from unprofitable markets.

ABN Amro (Magyar) Bank Rt. With a Hungarian presence dating back to 1993, ABN AMRO Bank substantially expanded its Hungarian operations by acquiring Magyar Hitelbank Rt. (MHB) in 1996 for HUF 35 billion. Furthermore, by 1995 MHB’s management had already begun restructuring (efficiency improvements, renewal of the loan portfolio, development of banking technologies, employee training), making MHB a good target. On 1 January 1998, ABN AMRO (Magyar) Bank Rt. was established following the merger of ABN AMRO’s two Hungarian subsidiaries. The primary objectives of the newly formed bank were to maintain the institution’s position and to increase organizational flexibility. ABN AMRO’s objective was to compete with the market leader, OTP Bank. After acquiring MHB, one of ABN AMRO’s main tasks was to unify the information networks. Over 40 different computer systems needed standardization, which required major investment. Given the goal of becoming a universal bank, further investments were made in the opening of 33 new branches, and introduction of new credit and debit cards. In addition to the high costs of these developments, new marketing campaigns meant significant expenses for the company. Despite these efforts, ABN AMRO Magyar Bank ranked sixth in Hungary in 1999. The bank operated inefficiently, the operation costs exceeded the interest income, and losses arising from an oversized real estate portfolio were significant. After three consecutive years of deficits, the bank had accumulated losses of HUF 15 billion by 1999.47 In November 1999, the parent company invested HUF 10.5 billion in order to avoid a capital loss, and constraints were introduced to improve cost efficiency. To analyze the reasons for this failure, one should consider several issues. On the one hand, most MHB managers left the company after privatization, taking their local expertise and experience with them. Although the programme for restructuring had been started, it would only be finalized by the high-priced expatriate managers. A former manager of MHB said that ‘the new management made childish mistakes’.48 On the other hand, the continuous mistakes that occurred due to deficiencies in the electronic systems provoked a massive withdrawal of clients. Despite aggressive advertisement campaigns, the number of new clients increased very slowly and the performance evaluation system did not motivate employees (fixed salary proportions were between 80–90 per cent). In addition, the development of the branch network and the creation of a new image were expensive,

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and adjustment of the book value of the oversized real estate portfolio to reflect market prices along with bad credit placements aggravated the bank’s financial situation. For these reasons, the intervention of the parent company was absolute necessary to ensure that the bank’s subscribed capital would not exceed equity capital. Therefore, at the end of 1999 subscribed capital was increased to the same amount (around HUF 15 billion) as the expected deficit. In addition, the foreign owners decided to search for a partner in order to get out of the disadvantageous middle bank situation.

Fit between the merging firms Table 12.1 compares the two merged bank’s performance indicators prior to the merger, at which time both companies were in a difficult situation. In fact, without the merger K&H Bank would have contravened the law governing loan institutions, as its equity was HUF 1 billion less than the subscribed capital. Table 12.1 illustrates that both institutions had problems and that their market share decreased due to intensified competition. In 1999, the two banks ranked at the bottom among the Hungarian banks in terms of losses, and only third and fourth in terms of total assets. The amount of their losses in 1999 accounted for two thirds of the total deficit accumulated by all commercial banks in Hungary. The most prominent problem was the decreasing cost efficiency within ABN AMRO resulting from major expenditure for modernization and expansion, as well as serious management problems. Another side to the situation is illustrated by a customer survey about bank services. The results of the survey showed that, in addition to banking costs, good service levels and correct assistance are the main consideration when it comes to selecting a bank. From this point of view, both K&H and

Table 12.1 Main indicators of the merged banks 1998–99

Total assets (mn HUF) Market share (%) Equity (mn HUF) Earnings after taxes (mn HUF) Cost-to-revenue ratio (ratio of operation costs to gross revenue)

K&H 1998

1999

ABN Amro 1998

1999

515,980 8 32,399 −2,890 90.8

544,964 7.5 22,283 −9,847 102.7

373,886 5.8 33,311 −3,590 115.5

407,043 5.6 38,758 −15,389 150.9

Source: HGV (Hungarian Business Journal) compilation based on bank information, 12 August 2000.

166 Building Profit from Losses Table 12.2 Comparison of the two banks Aspect

K&H

ABN Amro

Strategy

Strengthen the presence in EEE market (KBC) Expand branch network

Organization

Privatized state-owned bank

Management

Expatriates Changes in management

Resources

Good position at consumer clients in credit card business Important corporate clientele Branch network Losses

International growth strategy (ABN AMRO) Compete with OTP Become a modern, universal bank Acquisition and restructuring of MHB Rt. Expatriates Management failures, wasteful spending Leading product development in personal loan area Successful life-insurance and leasing firm Up-to-date electronic system Losses

Results

ABN AMRO were well qualified, which meant that the banks’ services were capable of bringing over new clients. Table 12.2 shows that the partners had complementary products, but from organizational and management points of view, the merger was risky and entailed significant financial difficulties. However, it could be seen that without a concise integration plan the merging parties would not have been able to realize the obvious synergy potentials. It stood out as a major task to integrate the two banks’ information systems, which had been at the core of operations. Further challenges emerged from streamlining the branch network and the organizational structure. On the human resources side of the integration, the differences in company cultures and management styles also had to be dealt with. We can conclude that, despite some dissimilarities, these were two similarly sized companies (employees at K&H: 2700, at ABN AMRO: 2100; total assets HUF 545 and 407 billion respectively; number of branches 116 and 104 respectively) with comparable market positions and international experience merged. One of the main motives behind the fusion was the opportunity to become a leading, cost efficient, profitable bank. Merging the two middle-sized banks was the fastest way to reach critical mass and to realize the various objectives. In the light of the combination of benefits, the most important requirement was to exploit the economies of scale. According to an employee, the banks were ‘too big for being a small bank but too little for being a large bank’. The conditions needed to create a top-ranking bank had been set from organizational and product portfolio points of view. The sum of the main

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indicators showed that the new bank would occupy a stronger position in the market – with HUF 1000 billion total assets, the new K&H could become the second leading financial institution in Hungary. According to Remi Vermeiren, Chairman of KBC Bank, the main potential for the merger resided in achieving a stronger market position.49 Reaching critical mass is essential for the optimal use of a branch network and for achieving an efficient return on investments. According to the plans, the growth of the new bank’s market share from 15 per cent to 20 per cent would permit efficient operations. On the basis of the year 2000 results, profit was expected to grow by around 15 per cent in 2001, with a corresponding 5 per cent savings in costs. If synergy effects were included, the costs of the merger were estimated to be around HUF 9.8 billion.50 One of the most important opportunities related to the joint use of resources was the exploitation of economies of scale. Upon examining the synergy potential in each functional area, we can see that both revenue enhancing and cost reducing synergy effects are possible. However, significant financial resources and time would be needed to exploit all potentials. • Benefits from economies of scale Around 40 branches out of the 220 could be closed. These would mainly be branches in the same location or close to each other, and would create considerable savings. As a result of clientele growth, the average unit costs (administrative costs) would decrease. • Product development A complementary product portfolio could be achieved. With regard to retail banking, K&H was well-known in the bank card business and housing loans, while ABN Amro had the advantage in consumer and small enterprise loans. The knowledge accumulated in these areas could be amalgamated, which could trigger a reciprocal learning process resulting in a shorter period being required to develop innovative products. From another point of view, the amalgamated product range would cover the clients’ needs and the demand for new products could decrease, meaning that development costs could be reduced as well. • Marketing and sales The merger could enhance the accessibility of the extended branch network and the automated bank tellers. By means of an extended product portfolio and improved service levels, the merged bank could attract more clients through costly marketing activities. K&H’s clientele could be extended by taking over the administration of large multinational customers from the parent company. • Finances The stronger financial position would allow higher loan limits. The bank could therefore bring over additional corporate clients and finance bigger projects. Furthermore, the risk of losing authorization when the value of equity capital falls under the subscribed capital could be reduced. Through reinforced financial power, the bank could stabilize its position and, in turn, attract more clients and increase infrastructure related activities.

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Given these synergy potentials, the merger decision was justified. The only question was how to manage the merger project, which was one of the largest in the history of the Hungarian banking sector. A chronology of the integration process from an organizational point of view is, therefore, discussed in the next section.

Acquisition strategy and negotiations Growth through acquisition was a strategic priority for both banks. The region was a key market and both KBC and ABN AMRO took the advantage of privatization opportunities. Both parent companies had previous acquisition experience, although the MHB acquisition was the first step in EEE region for ABN AMRO. KBC already had acquisition experience in the field of privatization in the Czech Republic and Slovakia. One central issue is why ABN AMRO decided to withdraw from the Hungarian market. The reasons might be based on financial and profitability aspects; namely, in the fact that the Hungarian subsidiary could not realize the expected results despite the successive capital injections. KBC, smaller in international terms than ABN AMRO, was interested in the deal because the bank expected to strengthen its position in the region and in Hungary through the merger. KBC most likely proposed the merger idea to ABN AMRO when the former became aware of the record making deficit of the Hungarian subsidiary. In the comments of Mr. Herman Agneessens, Managing Director of KBC, we find references to strategic intent: ‘We are very pleased with this unique opportunity, where two investors from the EU are willing to join forces for a value-creating project. Moreover, this merger would strengthen KBC’s position as one of the leading investors in central Europe.’51 One particularity of the deal is that the parent companies did not merge – the combination affected only the subsidiaries. Previously, the overall phenomenon in the Hungarian banking sector was the fusion of Hungarian subsidiaries as a result of a merger between foreign parent companies. The K&H deal was the first sign of intensified competition in the local market, since the consolidation of the sector began at this time. As part of the agreement, KBC gradually increased its ownership in K&H, first buying out the State Privatization Company, and then the Irish and Portuguese investors. The intention to merge was not made public until the official announcement on 9 August 2000, when the parties had started the negotiation process. Accordingly, the merger came as a surprise to the market. A Merger Committee was created, with members from the top management of each bank. The merger was expected to be completed, in legal terms, by 1 January 2001, with the unified bank’s name remaining Kereskedelmi és Hitelbank Rt.

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According to initial plans, KBC Bank would own 66 per cent, ABN AMRO Bank would own 33 per cent, and the corporate and private owners would own 1 per cent. Under the initial agreement, the ownership structure would have reflected the two banks’ market values. In the negotiation process, ABN AMRO aimed to take a back seat to avoid losses on its previous investments (between HUF 50 and 60 billion). Therefore, ABN AMRO wanted to keep the value of its subsidiary as high as possible. Consequently, ABN Amro (Magyar) Bank was valued HUF 90 billion while K&H Bank was valued at HUF 60 billion. This was an overvaluation as, according to the analysts, the total value should have been between HUF 120 and 130 billion. The equity capital of the banks was not a good indicator for determining the ownership ratios either – ABN Amro had HUF 38 billion in equity capital while K&H had HUF 22 billion. In order to determine the correct ratios, both banks were valued by auditors and the Boston Consulting Group. A feasibility study was made on the grounds of the audited balance sheets and income statements for the first half of 2000. KBC and ABN AMRO made their decision based on this feasibility study. The feasibility study elaborated on strategic issues as well, including market position, competitiveness and predicted performance of the merged bank. Recommendations were formulated for integration with regard to organization, operations, costs of integration and timing. However, the negotiation process was much more difficult and time consuming than expected. Finally, in return for majority ownership, KBC increased its invested capital by HUF 10 billion. Therefore, 60 per cent of shares were owned by KBC and 40 per cent by ABN AMRO. The parties had to agree on the future of 15 other subsidiaries as well. With the exception of ABN AMRO’s car fleet management company and its life insurance subsidiary, as well as KBC’s non-life insurer, the parties reached an agreement to merge all of the Hungarian subsidiaries. Mébit, ABN AMRO’s most successful subsidiary with a 4.5 per cent market share in the life-insurance market, was sold separately. The final decision to merge was taken on 7 November 2000, a few weeks later than previously planned. The process of obtaining authorization from the State Supervision of Financial Institutions (PSZÁF) body and the Company Court of Hungary then began in parallel with the detailed planning of the integration process.

Integration Following the merger announcement, a special unit – the Integration Office – was established and made responsible for integration coordination. When the general meetings of the two banks convened simultaneously on 15 January 2001, the new Managing Board was formed. In this way, the management of the two banks united before the legal merger on 8 February 2001. The joint management set-up enabled preparations for

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integration to begin and cross-selling of each other’s products could also be started. The first step in the integration process was to create an organizational structure for the merged bank. The size of the bank doubled, not only in terms of total assets, but also vis-à-vis clients and products. The key employees from the two banks worked together on several integration projects. Integrated products, price policies and processes for different functions (such as procurement and human resource management) were developed. Common rules of confidentiality were built up, and client contracts and brochures were modified. Reporting systems were also harmonized. The most extensive organizational task was the integration of the IT systems. In fact, more than 100 employees worked on the IT harmonization project under the coordination of the Integration Office. At the annual general meetings, shareholders gave their final approval for the merger and on 1 July 2001 the Company Court of Hungary registered the new merged bank. Thus, the new K&H was established, with a 59.01 per cent share held by KBC, a 40.23 per cent share held by ABN AMRO and 0.76 per cent of shares held by small stockholders.52 Those small stockholders unwilling to keep their shares were bought out with a premium above the nominal value of the share price. From that time on, the integration process went quickly – plans were implemented, new rules were put in force, new departments were set up, and branches were merged. The Integration Office coordinated more than 130 projects. By the time of legal merger, 14 projects had been completed. The final step of the integration – total IT harmonization – was completed in mid-2003. According to official press releases, the integration process was exemplary, and was completed almost one year ahead of schedule. Throughout the integration process, important managerial tasks had to be resolved. The parent companies assisted with the feasibility study and the official announcement of the merger, but they were not involved in the execution of the integration process. The management of the whole integration process was handled by the local representatives. The quality of a merger can be measured by the number of customer complaints. With the exception of some minor problems (such as limited availability of automated bank tellers), there were no significant customer complaints after the merger. That was due to the fact that one of the most essential aspects of the integration management was to avoid generating disadvantages for clients. Therefore, client account numbers, contracts and bank cards remained unchanged. Figure 12.1 shows the organization of the integration process. Around 150 simultaneous projects had to be managed. The head of the Integration Office reported directly to the CEO, which indicates the importance given to the integration process. The Integration Office had between 15 and 20 staff members, headed by Csaba László, the Vice-President of K&H at the time.

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Managing Committee

Integration Director Central Programme Management Support Programme Manager (1, 2 . . . n)

IT Integration Committee IT Programme Management

Executive Committee Support Project 1

IT Project 1 Business Support

Project . . . n

IT Project . . . n

K2 Project Manager K2 Project 1

K2 Project . . . n

Figure 12.1 Organization of the integration process Source: Tóth (2002), Appendix No.1: 96.

According to the initial plans, the integration was to be finished by the end of 2002. There were 15 project areas: Corporate Business, Corporate Risk Management, Consumer Business, Consumer Risk Management, Back Office, Communication, Controlling, Accounting, Human Resources, Internal Audit, Legal, Treasury and Market Risk-Management, Network and Segmentation, Regulation and Project Management, Real Estate and Procurement, IT. The different areas indicate the priorities that ruled the Integration Office’s activity: client management, internal operations (differentiated by functional areas), and supporting activities. Overall, the merger changed each functional area. The main responsibilities of the Managing Committee were to establish the merger’s objectives, evaluate reports on the integration and to make decisions in problematic situations. The Integration Director was responsible for the execution of the integration, paying special attention to budget control. The Programme Managers supervised their own projects and cooperated with each other. Executive Committee Support was responsible for resource needs and for communication with the Managing Committee. This group’s responsibility also included conflict management, decision making and motivation.

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The whole integration process was aided by Central Programme Management Support. This department oversaw the entire administration and documentation of the integration, as well as the coordination of the monitoring and reporting systems. As the chart indicates, IT tasks were very important and complicated. Of 131 projects, 58 were purely IT related, which explains the need for this area’s separate management. IT Project Managers were supervised by the IT Integration Committee, being composed of top managers, the Integration Director and external consultants. Project K2 was responsible for developing an integrated IT system for the merged bank. Given its importance, K2 was a stand-alone project separate from the other IT projects. According to the Integration Director, the most difficult issue was workforce reduction.53 As a consequence of branch fusions, around 1000 employees had to be fired. The branch fusion was particularly stressful in the countryside, because finding a job in the financial sector is difficult outside Hungary’s capital. At the middle-management level, approximately 130 persons were made redundant. The remaining managers were selected for positions based on internal applications, with the help of external consultants. Although the positions were supposed to be equally divided between the two banks’ managers, some had the impression that K&H employees were favoured in the selection process. In spite of top management’s denial of such favouritism, this situation draws the attention to the typical ‘we– they’ conflict that had to be considered. In September 2001, the integration process was somewhat affected by the ¨ the President of unexpected, indefinite holiday leave taken by Tibor E. Rejto, K&H. The presidency was taken up by Ludo Jacobs of Belgium. Later, Tibor Draskovics, Vice-President of K&H, was fired because ‘he had a different vision about the future of the bank’.54 In spite of widespread speculation, the owners’ trust in the president of K&H was steady, and he returned at the end of the year. According to the Integration Director, the president’s holiday did not really disturb the integration process because most of the duties regarding the integration had been completed by the Integration Office.55 The president had been involved only when an important decision had to be made. In terms of various approaches to integration, the present case is an example of integration by absorption, which is typical for horizontal mergers (Haspeslagh and Jemison, 1991). When executing the merger, the major managerial task was to promote rationalization and to exploit economies of scale. The instruments of structural coordination (projects and committees), as well as strict technocratic coordination (regulations, cost-control and reports), accelerated the integration. The coordination tools relating to personnel were applied mostly in the process of management selection, at which time instruments for conflict management and motivation were also probably applied. In several official statements, the President of K&H

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emphasized the importance of reciprocal learning (’applying best practices’) and harmonizing the different organizational cultures.56 Cross-employment was applied from the beginning in order to facilitate cooperation. Through teamwork, active management control and support, the harmonization was continued (see Executive Committee Support). However, many key employees abandoned the organization because of the instability induced by restructuring. This suggests that, from an organizational culture point of view, the integration was not completed and was likely to take longer than the integration of the IT systems. By 2003, only the formal tasks of the merger were finished.

Evaluation of the merger The merger can be evaluated by comparing the relevant fiscal results of the banks in 2000 with the post-fusion results. The synergy that appears immediately after the combination is the improved market position through growth in size: 500,000 consumer clients and 76,000 corporate clients guaranteed the merged entity 15–16 per cent of market share. Therefore, the new K&H ranked second in the retail segment and first in corporate segment. Client migration was insignificant at 0.5–1.0 per cent in contrast to the expected 3–4 per cent, which also indicates the low degree of inconvenience felt by the clients. With total joint assets of HUF 1100 billion, the new K&H became the second largest bank in Hungary, although its total asset amount was only 60 per cent of the total assets owned by OTP. The quality of the credit portfolio improved to the point that the percentage of non-problematic credits increased to 92.9 per cent, compared to 83.5 per cent average in the sector.57 Nevertheless, it is hard to get a clear picture from accounting figures alone, because K&H’s 2001 income statement is based on Hungarian accounting principles, and therefore shows different numbers than the evaluation based on the international standards. While the first showed an HUF 3.6 billion deficit before taxes, the latter showed profits of HUF 3.8 billion due to the HUF 6.4 billion of goodwill and the different evaluation of the securities. Thus, the official declarations provided the results according to international accounting standard principles.58 In addition, the 2001 income statement was overloaded with the merger’s expenses. The bank was motivated to obtain a transparent picture of the combination effects no later than 2002. In the last quarter of 2001, the bank accounted the costs of lay-offs and the provisions for future staff reductions as a single expenditure. The costs of rationalizing the real estate portfolio and contract withdrawals, as well as the depreciation of the IT systems and other equipment, were also included on the financial statements. Altogether, the costs totalled HUF 10.3 billion. As the legal merger occurred during the year, the 2001 results showed the total results of K&H’s annual and ABN AMRO’s second half results.

174 Building Profit from Losses

According to the press release of 22 April 2002, the IAS balance sheet of 2001 showed the following improvements over K&H Bank’s and ABN Amro Magyar Bank’s results one year earlier: • Operating profits improved from a deficit to an HUF 8.9 billion profit • The expenses/income ratio decreased 24 per cent • The loan portfolio grew by more than 8 per cent, while deposits grew by 9 per cent • Income grew by 12 per cent • Operating expenses were cut by 14 per cent because of the synergy effects • The number of consumer and medium-enterprise clients grew more than 4 per cent, while the number of large corporate clients increased by 7 per cent. Further profit growth could be seen by comparing the results of year 2002 with 2001. After-tax profit rose to HUF 11.3 billion, the bank’s total assets grew to HUF 1232 billion. In addition, the bank’s operating income grew by 53 per cent, while its operating expenses rose by 22 per cent.59 The latter indicates that increasing market performance came at a considerable expense. However, the first half results for 2002 showed a 1.4 per cent decrease in operating costs although by the end of the year these costs had grown. The underlying reasons were probably the high costs of product development and service improvements, as well as the costly integration of IT systems. In 2002, product development and the introduction of new products enjoyed an active and successful year. In the summer of 2002, K&H Bank was the first bank in Hungary to issue microchip based bankcards. The K&H Ingatlanalap (real estate fund) and Employee Benefit Package were also novelties on the market. K&H was also the first bank to launch Private Banking Services, while sales on its telecom related Mobilinfo product grew 45 per cent. Also in 2002, the reduction of the workforce went according to plan. The number of branches decreased to 163, and employed 3897 persons.60 In addition to improvements in efficiency, the Bank planned to raise its return on equity to 20 per cent by 2003. While return on assets was 6.7 per cent in 2001, during the first half of 2002 it grew to 12.7 per cent. However, whether this pace of growth would be enough to achieve the ambitious objective was unclear. In spite of this fact, CEO Tibor E. Rejto¨ was pleased with the merger’s results and declared that the key issues of a successful merger are quick decision making and the existence of a separate integration office.61 When comparing the results with the original plans, an ambivalent picture of the merger’s success emerges. The legal side of the merger caused a half year delay. However, integration was completed ahead of schedule. While

Krisztina Tóth 175

the costs of integration exceeded the planned amount by HUF 0.5 billion, performance was improved by considerable income growth. Although costs remained unpredictable, the indicators of efficiency (the expenses/income ratio) indicated a better situation than had existed before the merger. The overall conclusion is that the bank’s competitiveness and profitability increased considerably through the merger. With its strengthened market position and more effective operations, K&H Bank could ensure its position in the competitive market. If we evaluate the merger using only one indicator – profits – the results show that these two companies, which had previously been making losses, became profitable after the merger.

13 Creating a Nordic Bank: SEB-Vilniaus Bankas Kristina Šimkut˙e

Introduction This case describes how Skandinaviska Enskilda Banken (SEB) Group acquired Vilniaus Bankas (VB) in Lithuania in 1998. SEB entered the Lithuanian banking sector with the wave of privatization in 1998, when the government adopted the strategic foreign investor approach. Foreign investors therefore acquired Vilniaus Bankas, the State Savings Bank and the State Agricultural Bank. SEB was the first to enter the market and acquire VB. The other two banks were privatized later: the State Savings Bank was privatized in 2001 by the Swedish bank Hansabank, and the State Agricultural Bank was privatized in 2002 by the German bank Nord/LB. SEB’s entry into Lithuania was part of the company’s strategy to establish a presence in the Baltic States and thereby cover the entire Nordic region. This entry was seemingly induced by competitors’ moves in the Nordic region. In 1998, the Swedish bank Swedbank obtained over 50 per cent of the shares of the Estonian bank Hansabank, which had subsidiaries in both Latvia and Lithuania. In 2001, after SEB acquired VB, the Swedish-owned Hansabank privatized the State Savings Bank, the second largest bank in Lithuania, the country’s banking industry then being clearly dominated by the Swedish capital. However, Swedish dominance in the industry was mitigated in 2002, after German bank Nord/LB privatized the State Agricultural Bank. By entering the emerging banking market, SEB brought a strong capital base and had an opportunity to expand its existing product portfolio as well as leverage its investments in IT. The bank therefore managed to perform successfully despite a great uncertainty in the Lithuanian banking sector, which had just recovered from the crisis of 1995–96.

Banking crisis of 1995–96: Lithuania The crisis was a result of a weak Lithuanian banking sector that was still in its infancy and, therefore, did not have strong regulatory mechanisms. After 176

Kristina Šimkut˙e 177

breaking free of the iron grip of the former Soviet Union in 1991, Lithuania had to transform the banking sector from a mono-bank to a two-tier banking system. The country had to establish and organize its own central bank, put the legal framework in place for a future independent banking industry, and start the privatization of all state-owned banks. The banking systems and skills, which had been developed under central planning, bore little resemblance to those that these countries needed (Hansson and Tombak, 1996). This was, therefore, a momentous task, particularly in light of the fact that the country initially suffered from hyperinflation and had very limited currency reserves. The Lithuanian banking crisis began two years after the Estonian banking crisis (in 1992) and just few months after the crisis in Latvia (at the beginning of 1995). The first negative signs in the sector cropped up at the beginning of 1995, when several small commercial banks failed and were liquidated. A few months later, two privately owned and medium-sized banks – Aurabank and Vakaru˛ Bank – ran into difficulty and called for government help (Hansson and Tombak, 1996). The crisis erupted at the end of the year, after the central bank discovered that two large private banks, Innovation Bank and Litimpeks, together controlling 19 per cent of total banking assets at the end of 1995,62 were insolvent. The banks had been run into the ground by mismanagement, bad lending decisions, and fraud (Jones, 1997). Having learned important lessons from the recent crisis in the other two Baltic States, Lithuanian authorities reacted very quickly and decisively. The early step to close the banks pre-empted massive outflow and plundering of funds. However, the government’s decision to compensate household deposits up to a maximum of LTL 1000 (USD 250) each placed large debt service burdens on future budgets and the balance of payments. The crisis had a significant impact on the further development of the banking industry and the entire financial system of the country. First, it delayed the planned privatization process of state-owned banks until 1998. The three largest state-owned banks in Lithuania were the State Savings Bank, the State Commercial Bank and the State Agricultural Bank. In 1997, the state still controlled the majority of bank institutions, which together amounted to 75 per cent of all banking deposits in Lithuania (Jones, 1997). The stateowned banks, although large and with an extensive branch network, could not compete effectively with the private banks, so overall picture of the sector suffered. Second, the crisis significantly contributed to the consolidation of the Lithuanian banking sector. In 1993, Lithuania had 27 banks, a number that dropped to 13 in the aftermath of the banking crisis and remained the same at the end of 2001. At the end of 2005, there were ten commercial banks operating that held a licence from the bank of Lithuania.63 The industry sustained high concentration rates: in 2003, the top five banks accounted for 99 per cent of the entire sector, while the top three accounted for about

178 Creating a Nordic Bank

80 per cent.64 Finally, the banking crisis contributed to the development of equity markets. Lithuanian authorities sought to diversify financing sources in order to allow enterprises access to funds when bank lending ended. However, equity and bond markets in the Baltic area, including Lithuania, still remain underdeveloped and the financial systems of the Baltic States are primarily bank based. At the end of 2000, Lithuanian government securities dominated the market, accounting for about 95 per cent of the total. Securities issued by corporations amounted to 5 per cent.65

The firms Investor: SEB Group SEB was formed in 1972 through a merger between Stockholm’s Enskilda Bank and Skandinaviska Banken. Stockholm Enskilda Bank was founded in 1856, at the time when Sweden shifted from being an agricultural society to an industrial society. The bank followed the growing industrial companies into the world markets and became a leading bank for internationally oriented Nordic companies during the twentieth century. Skandinaviska Banken was started in 1864 in Gothenburg, Sweden. Soon after establishment, it became a prominent corporate bank with a well-developed network of branch offices throughout Sweden. The two banks merged in order to strengthen their position among corporate clients and to meet competition from the major international banks. In 1972, the newly formed SEB bank had 6730 employees and 393 branches, along with a well-established customer base and good relationships with many of Sweden’s biggest companies.66 Following the merger, the newly formed bank undertook an extensive expansion strategy. At the beginning of 2005, SEB had a total of 670 branch offices around Sweden, Germany, the Baltic countries and Poland, with more than 5 million customers.67 As indicated in Table 13.1, by the end of 2004 Table 13.1 SEB Group’s account data, 2001–04 Financial results/ratios

2001

2002

2003

2004

Number of full-time employees (average) 19,618 19,003 18,067 17,772 Assets (SEK million) 1,163,315 1,241,112 1,279,393 1,591,318 Net profit (after tax) (SEK million) 5,051 5,318 5,704 6,590 Average equity (SEK million) 44,292 45,696 46,182 49,863 Earnings per share (SEK million) 7.17 7.60 8.22 9.69 Return on equity (%) 11,9 12 12.3 13.2 Return on assets (%) 0.43 0.44 0.45 0.46 Cost/income ratio 0.73 0.69 0.67 0.67 Source: SEB Group’s Financial Reports (2002) and (2004) http://taz.vv.sebank.se/cgi-bin/pts3/pow/ wcp/sebgroup.asp?website= TAB2&lang=en

Kristina Šimkut˙e 179

the Group’s total assets amounted to SEK 1591 billion and the number of full-time employees was nearly 18,000. The SEB Group’s vision is ‘to become a leading North-European Bank, based upon long-term customer relations, competence and e-technology’.68 Its strategy is to keep building upon the group’s traditional factors of strength as a financial partner for companies and financially active, demanding, private individuals. According to the SEB Group’s Financial Report (2000),69 the major customer segments targeted by SEB are international companies, growth companies and financial institutions. SEB occupies a leading position as a bank for companies and institutions in both Sweden and the rest of the Nordic area. SEB views high growth companies as a very important market, since they maintain considerable business potential in terms of volume and often expand with the help of their own capital resources. This focus results in an increased demand for knowledge and competence on the part of the financial partner. SEB’s long tradition as a bank for Swedish multinationals has led it to develop a series of products and services that can be used by large and small companies in the Nordic area and the rest of Europe. In terms of business diversification, SEB mainly concentrates on banking activities. The belief that being profitable is more important than being big has led the bank to focus on its profitable activities and to become less diversified. SEB sold off its office properties, the industrial and marine business area, and the non-life business of Trygg-Hansa after 1998, and acquired ABB Investment Management as well as strategic blocks of shares in banks in all three Baltic States, thus reinforcing the bank’s platform in northern Europe. SEB’s global strategy aims at being familiar with local markets and close to customers. The main core capabilities of SEB are its resources and its network of contacts as an international bank. SEB positions itself as being ‘more local than the international banks – and more international than its local competitors’.70 It is represented in some 20 countries around the world and aims to pursue a single SEB culture within the overall group. In early 2005, the bank’s markets included Sweden, Denmark, Norway, Estonia, Latvia, Lithuania, the Ukraine and Germany. The Group also had a presence in Poland, where it owned 47 per cent of BOS´ Bank, and throughout the rest of the world, including interests in Singapore, Russia, the USA, Spain, Great Britain, France, Switzerland, Luxemburg, Brazil and China. SEB established representative branches in Germany and Poland already in 1990, but in 2000 it purchased the German bank BfG, and increased its ownership of the ´ Northern Europe continues to account for the greater part Polish bank BOS. of SEB’s business, with Sweden generating 45 per cent of income in 2004, followed by Germany (30 per cent) and other Nordic countries (11 per cent). SEB’s motive for entering the Lithuanian market and acquiring VB in 1998 was its strategic wish to establish a foothold in the Baltic region, and to

180 Creating a Nordic Bank

meet the increased client activities in these countries. The presence of SEB as a European bank was important, since the Baltic countries were showing strong economic growth and had substantial export/import business with the Nordic countries, Great Britain and Germany. The Managing Director of SEB Baltic Holdings AB, Mats Kjaer, who was responsible for SEB’s involvement in the Baltic region, argues: For us, the Baltic nations are not only the new market. Through the three Baltic banks we can offer our existing customers a broader service base. The Baltic nations were reconstituted only a few years ago and at that time the banking systems were also privatized in the three nations. This is a young banking market and has established a good form in a short time.71 At the time of the acquisition, SEB acknowledged its need to make more ‘stringent demands as regards gaining insight into economic conditions and financial systems of the emerging countries in order to promote the creation of more stable institutions in these economies’.72 The bank assumed it was a task for the international organizations, in cooperation with national central banks. If not, the whole international financial system was seen to run the risk of damage due to lack of trust and poor functionality. SEB entered the three Baltic countries simultaneously, using the same mode of entry. Currently, SEB has three subsidiary banks with approximately 4000 employees in total and more than 2.1 million customers in the Baltic region.73 All three banks have strong positions in their markets, both in terms of total size, and deposits and lending. EeSti Ühispank was the second largest bank in Estonia after Hansabank, Latvijas Unibanka was third in terms of size and first in terms of deposits and lending. Vilniaus Bankas was the biggest bank in Lithuania and the market leader regarding deposits and lending. EeSti Ühispank and Vilniaus Bankas were privately owned and quoted on national stock exchanges, whereas Latvijas Unibanka was a governmentowned bank.

The acquired local firm: Vilniaus Bankas The bank was established in the beginning of 1990 under the name of Spaudos Bankas AB. It was one of the first non-state, commercially oriented banks intended to finance payment operations by certain publishing companies. The founders were mainly local and government-owned companies, who were represented on the supervisory board. In 1991, the bank’s name was changed into Vilniaus Bankas. In 1992, the Central Bank of Lithuania granted VB a licence to carry out a broad range of international banking activities in Lithuania, in addition to its domestic banking operations.

Kristina Šimkut˙e 181

VB started setting up the international contacts necessary for future growth. In 1993, the bank was accepted into the International Payment Card Association Visa International and issued the first payment card, Visa Classic. At the end of the year, the bank joined the Global Interbank System, SWIFT. From 1993, VB prepared its financial statements and, as from 1994, its shares were listed on the official list of the newly established Lithuanian Stock Exchange. VB’s overall strategy was very strongly oriented towards building and strengthening its national network. In 1995, the bank established two subsidiaries to provide new services; namely, The Financial Brokerage Department and VB Leasing. During the same year, the bank installed the first ATM in Lithuania that could accept Visa cards. Vilniaus Bankas’ ownership structure has been changing over time and the Bank has been owned not only by local, but also by international investors. In 1995, despite the bank crisis, Vilniaus Bankas attracted the first foreign investors – international investment funds – and as a result increased its shareholder equity to LTL 42 million. In 1996, the bank successfully placed an LTL 60 million share issue on the Luxemburg Stock Exchange and increased shareholder equity to LTL 102 million through a Global Depository Receipts (GDRs) issue. In 1997, among the major foreign investors of Vilniaus Bankas’ share capital were: holders of GDRs (Depository Bank – Bankers Trust): 54.8 per cent, Swedfund Financial Markets: 9.7 per cent, holders of VB shares (Custodian Bank of Bermuda): 6.6 per cent, DEG (Deutsche Investitions-und Entwicklungsgesellschaft mbH): 3.9 per cent, and CIBS Oppenheimer: 3.6 per cent.74 In 1995, VB also implemented major changes and improvements within the organizational structure and the development of business processes. World Bank EC PHARE sponsored the technical assistance programme, Twining, implemented together with ABN AMIRO bank. The programme aimed at providing expertise and know-how to the growing Lithuanian financial sector. Consequently, based on ABN AMRO bank recommendations, VB reorganized itself and streamlined its operations in accordance with general western banking principles. In 1998, the bank signed a major cooperation agreement with the two other Baltic banks: EeSti Ühispank and Latvijas Unibanka. The banks agreed on strategic cooperation in providing cross-border customer service, joint investments and development projects, syndicates and interbank funding. Such cooperation between the institutions was seen to enable the banks to focus on their fast growing domestic financial services markets, and targeted projects in the neighbouring countries.75 However, at the end of 1998, SEB entered the Baltic banking industry and signed an agreement with the three banks, including VB, that allowed SEB to become the major shareholder. From its establishment in 1990 until its acquisition in 1998, VB rapidly developed and emerged as the second largest bank in Lithuania. VB’s total

182 Creating a Nordic Bank

assets were LTL 3.7 billion (SEK 7.5 billion) in 1998 and the number of employees exceeded 900. The bank had 14 branch offices and cooperated with the Post Office in another 150 offices. At that time, VB’s market share of total deposits was 21 per cent, and the bank was responsible for 26 per cent of lending. The bank mainly focused on the corporate market, but was also expanding to the household market. In 1998, the bank reported a profit of LTL 59.8 million (SEK 121.5 million) and was the most profitable bank in Lithuania.76

Fit between the two firms Before entering the Baltic market at the end of 1998, SEB was involved in seven main business areas: Retail Distribution, Financial Services, TryggHansa, SEB Asset Management, SEB Trygg Liv, SEB Merchant Banking and Enskilda Securities. Retail Distribution was a business area encompassing all of SEB’s various ‘shops’ for private individuals, small/medium-sized companies and municipalities; the branch office network; the Telefon Bank and the Internet Office for private customers and companies. This business area also included production companies – units for credits, investments and payments. Financial Services comprised SEB Kort, SEB Finance (leasing and factoring), SEB Securities Services (custodial services), and SEB Företagsinvest (venture capital). Trygg-Hansa offered all types of non-life insurance to private customers and small/medium-sized companies. SEB Asset Management was comprised of all active management of securities portfolios within the Group, including mutual fund activities and management of the total assets emanating from the Group’s life and non-life insurance operations. In addition, the section handled portfolio management for institutions, private individuals and the ‘private bank’ SEB Kapitalförvaltning. The SEB Trygg Liv business area offered life insurance and pensions, unit linked insurance, endowment assurance, and such welfare products as compensation for private health care and rehabilitation to private individuals and companies in the Nordic area. SEB Merchant Banking comprised all activities aimed at large Nordic multinationals and institutional investors, as well as large international companies. Enskilda Securities functioned as an independent investment bank within the SEB Group, primarily acting on behalf of Nordic companies and institutional investors in the Nordic Region, Europe and the USA. According to group’s Financial Report (1998)77 , the largest contributions to the total Group’s income were generated by Retail Distribution (30 per cent) and Merchant Banking (29 per cent). Asset management and financial services accounted for 13 per cent each. Trygg-Hansa accounted for only 10 per cent of total Group revenue and exhibited low profitability, making it a business that SEB planned to sell in 1998.

Kristina Šimkut˙e 183

SEB maintained its expertise within a number of cutting edge areas and made heavy investments in qualified advisory services for both companies and individuals. The Group had extensive experience and was innovative in terms of technology. SEB had close to 150 years of experience acting as a financial partner for companies and private individuals. At the same time, the SEB Group had invested heavily in modern technology in order to be able to offer customers increased freedom of choice, accessibility via the Internet, and staffed telephones and call centres that stayed open around the clock. After entering into the agreement with VB, SEB indicated its intention to restructure the bank. SEB defined the areas it would cultivate in VB, including the development of products, competence, and IT. VB was to become as modern as Swedish banks, with an entirely new infrastructure. SEB’s aim in acquiring VB and the other two Baltic banks was two fold: to increase the distribution of SEB’s own savings products and corporate services, and to help the Baltic Banks develop products for both private individuals and companies in the Baltic market. SEB’s role in the bank restructuring process is reflected in the following statement made by the Managing Director of SEB Baltic Holding AB, Mats Kjaer: Of course, we do not want to ‘brand’ SEB on anyone. Each bank is independent and listed on the local stock exchange. They must work in the local markets to be able to grow in them. Each one works in its own culture. We must recognize the big differences between the nations. Estonia, for example, is very advanced in IT and technology and has a welldeveloped Internet bank. In Latvia and Lithuania, not even 50 per cent of the population has bank accounts yet. But developments are taking place very rapidly. When you look at future expansion in Europe, the Baltic nations and Poland are expected to have the best growth.78

The industry When SEB acquired VB in 1998, the global financial sector in Europe was characterized by several trends that indicated economies of scale and the deregulation of the industry. First, due to globalization and more intense competition, the financial sector experienced accelerating consolidation. Bank and insurance companies accounted for close to one third of the total volume of mergers and acquisitions in Europe in 1998.79 Second, several new players had been appearing in the market. Third, the borderlines between banks and life insurance companies had been blurred – the financial products offered by banks and insurance companies had converged. Finally, transaction volumes had increased and new products had been created. The Internet provided customers with new opportunities to compare the services, prices

184 Creating a Nordic Bank

and performance of financial companies. This stiffened competition within all areas of banking activity. Furthermore, differences existed between SEB’s home markets in northern Europe. Essentially, Sweden and the other Nordic countries were deregulated and mature markets with a few, large domestic banks and insurance companies. Foreign financial groups and domestic niche players were tough competitors. The German banking market was still fragmented, and government guarantees and regulations have restricted competition within a number of areas. The Baltic countries and Poland were growth markets with great demand for loans and a growing interest in mutual fund savings, life insurance and related services. In general, the Baltic economies remained very strong in 2002, when compared with most other countries. Domestic demand was very high, which had positive impacts upon the three SEB subsidiary banks in Estonia, Latvia and Lithuania. SEB’s new markets in the Ukraine and Russia also had very promising growth potential. The main players of the Lithuanian banking sector and their results in 1997 are presented in Table 13.2. VB, at that time, was the largest private bank in the country. Hermis Bankas, established as a private bank in 1991, occupied the second position after the VB. LTB (the State Savings Bank) was the largest state-owned bank, as well as the oldest bank, tracing its history ¯ (the State Agricultural Bank) was the second largest State from 1919. LŽUB bank, which was started in 1988 after the transformation of the Lithuanian ¯ unit of the Agro-Industrial Bank of USSR into a universal bank. Snoras, Ukio Bankas and Šiauliu˛ Bankas were medium-sized private banks. Litimpeks was one of the private banks that faced a threat of bankruptcy in the crisis of 1995–96; however, it temporarily evaded bankruptcy by collecting the badly needed new capital and receiving new owners.

Table 13.2 Players of the Lithuanian banking sector, 1997, 2nd quarter

Vilniaus Bankas Hermis LTB ¯ LŽUB Snoras Litimpeks ¯ Ukio Bankas Šiauliu˛ Bankas

Loans/dep. (%)

Net profit (LTL thousand)

Total assets (LTL thousand)

8988 7491 3722 9557 743 6424 5676 8968

34 248 20 025 27 376 13 239 1 088 532 568 336

2 189 056 1 452 048 2 801 665 1 403 282 594 207 286 436 195 880 120 749

Source: VB Vilfima Equity Research (1998): ‘Lithuanian Banking Sector’; reprinted with permission.

Kristina Šimkut˙e 185

Entry SEB’s initial entry into the Lithuanian market took place at the end of 1998. SEB bought 4.8 million shares through direct issue at a price of LTL 46 per share. In addition, SEB bought 570,000 shares on the market. By the end of the year, SEB owned 35.8 per cent of the shares and votes in Vilniaus Bankas – a total investment of SEK 474 million. SEB also entered into a shareholder agreement with Swedfund Financial Markets AB, which owned 9.7 per cent of the shares and votes in Vilniaus Bankas, on 31 December 1998.80 During 1999, SEB gradually increased its ownership in VB so that by the end of the year it held 40.8 per cent. By December 1999, VB was not yet consolidated into SEB, but was reported on a profit participation basis. In 2000, SEB made a cash offer to acquire all remaining shares, and, by the end of the year, SEB owned almost 100 per cent of the bank shares.81 The same was true with the two other Baltic banks. At that time, all three banks were completely integrated within the SEB Group, and were free to use SEB products and its international network.

Local environment Banking activities in Lithuania are mainly monitored and controlled by the central bank. A modern anti-trust law has been introduced, which is well enforced. Local authorities have not refrained from controlling, and even challenging, leading international investors if their behaviour is deemed to be out of line with local legislation. The law is based on EU guidelines and was last revised in 2001. Under this law, VB clearly has a leading market share. However, following the bank’s merger with Hermis Bankas in 1999, the anti-trust authorities have rarely approached VB, as its growth has been achieved organically.

Integration and restructuring of the acquired firm In early 1999, SEB’s Baltic engagements were assembled within SEB Baltic Holdings. SEB established an operative representative and several board representatives in each of the Baltic banks. As the Managing Director of SEB Baltic Holdings AB, Mats Kjaer, states: It is important that the product knowledge and banking experience that we have can be transferred in a good way. Therefore, we have an experienced management person based in every bank and a person in Sweden for each bank, who are responsible for product transfer and development. Competence is also transferred via trainee and training programmes and a number of very well-trained young people are already in place.82

186 Creating a Nordic Bank

SEB planned to reduce the number of employees in VB as a result of restructuring and technical development. In 1998, the VB Group employed over 900 employees. However, when Vilniaus Bank acquired Hermis Bank in 1999, the total number of employees increased to 1905.83 Due to the 2002 restructuring, the number of employees was reduced to 187784 and, at the beginning of 2005, the number of employees was 1464.85 After SEB acquired the majority of VB shares at the end of 2000, VB was able to access cheaper financing resources and, at the same time, provide cheaper credit to the market.86 VB also started introducing new information technologies and launched several new products. For example, the bank launched its e-banking services in September 2000, and had 11,000 customers at the end of the year.87 The new banking system allowed clients to pay for their utility services as well as buy and sell securities. At the end of 2001, the number of VB Internet users amounted to over 50,000. During 2002, this number doubled, reaching 117,000 customers by the end of the year. In 2003, the bank expanded its e-banking services into several areas such as the mobile banking system, an Internet investment management system, a phone banking system, and an Internet banking system. VB also introduced a range of new banking services, including life insurance packages. However, due to limited purchasing power, this service remained rather small and appeared to be a segment with limited business potential. In 2001, VB launched new saving services by offering ten SEB governed security funds with different risk and profitability levels. VB also became the leader of the third pillar pension funds markets. In 2004, Lithuania introduced its first three-tiered pension system. VB took an aggressive approach in this small but very promising segment and, over a period of three months, VB Investment Management became the market leader. Finally, SEB Vilniaus Bankas Group developed a strong position in the Lithuanian mortgage, leasing and private wealth management sectors. In 2003, Vilniaus Bankas was renamed SEB Vilniaus Bankas (SEB VB). At the beginning of 2005, the SEB Vilniaus Bankas Group included SEB Vilniaus Bankas and its network of 17 branches, 40 sub-branches and seven subsidiary companies: SEB VB b¯ usto bankas AB (Mortgage Bank), SEB VB gyvybes ˙ draudimas UAB (Life Insurance), SEB VB investiciju˛ valdymas UAB (Investment Management), SEB VB lizingas UAB (Leasing), SEB VB nekilnojamasis turtas UAB (Real Estate), SEB VB rizikos kapitalo valdymas UAB (Venture Capital), SEB Vilfima (Corporate Finance). Finally, as a member of SEB Group, VB has also expanded through acquisitions. At the end of 1999, VB acquired 91.8 per cent of Bankas Hermis’ share capital. This aggressive step was a response to increasing competition in the Lithuanian banking industry. After the acquisition, VB became the second largest bank in the Baltic States and a clear leader in the Lithuanian market, with its assets increased by 66 per cent, from 3318 million Litas in 1999 to 5511 million Litas in 2000.88 The main goal of acquiring Hermis

Kristina Šimkut˙e 187

was to strengthen VB’s position in the retail banking sector and to offer new services.89 Last, but not least, Vilniaus Bankas developed its business in the eastern European markets by acquiring Bank Agio of the Ukraine in January 2005.

Performance Before its acquisition in December 1998, Vilniaus Bankas reported a profit of LTL 59.8 million and was the most profitable bank in Lithuania.90 During the next several years, the bank’s profitability maintained stable growth, and its net profit grew continuously from LTL 59.8 million in 1998 to over LTL 132.2 million in 2003.91 In 2001, VB still occupied a leading market position in deposit, loan and asset markets. The second and the third positions in the Lithuanian banking market were occupied by Hanza-LTB and ¯ respectively (Figure 13.1). LŽUB During the first year after acquisition, many of SEB’s corporate customers in the Baltic countries realized the advantages offered by SEB’s presence. SEB clients with business in Lithuania and other Baltic States were able to use the services of the same bank. ‘Cooperation between each respective local bank and the rest of SEB has been successful, which has led both to more business and increased customer satisfaction. Many companies have now discovered that they can manage their banking business within Northern Europe through one single bank.’92 VB made substantial investments in new IT systems that were of crucial importance to Lithuania’s European Union membership, which began 45 40

42.4 39.7

39.8

35

31.6

30

26

25 17.9

20 15

12.4

14.5

17.3 16.2 12.2

10

6.2

7.9

10.1 5.8

5 0 Vilniaus Bankas

Hansa-LTB Deposits (%)

LŽUB Loans (%)

Bankas Snoras Assets (%)

Figure 13.1 Market shares of the major banks in Lithuania, 2001 Source: Based on Vilniaus Bankas Financial Report, 2001.

Other

188 Creating a Nordic Bank

on 1 May 2004. VB successfully faced this challenge by adopting new e-banking systems that were capable of using International Bank Account Numbers (IBANs) in compliance with the European Union standards, and by launching multi-currency accounts. VB’s successful performance is also reflected in its ratings and acknowledgements. In 1999, just a year after SEB acquired a stake in Vilniaus Bankas, Standard and Poor granted it a BB- rating, the highest rating given to the country’s banks. The agency acknowledged the bank’s good position in the local market, its strong financial base and SEB’s positive role. According to the agency, SEB’s solid capital base and well-managed, diversified lending policy helped Vilniaus Bankas to avoid the Russian crisis.93 At the time of writing, the senior debt rating of SEB VB is the highest investment grade rating (A) among Lithuanian commercial banks. Furthermore, it became the only Lithuanian member of the international settlement and clearing system, Euroclear. Global Finance, Euromoney, The Banker and other prestigious international publications and institutions have, for the last several years, named Vilniaus Bankas the ‘Best Bank in Lithuania’. As far as it concerns the present competitive situation in the sector, the three largest banks, according to their assets, were AB VB, AB Hansa Bankas and AB Bankas Nord/LB Lietuva. In 2004, the asset market share of the three largest banks (AB VB, AB Bankas Hansa Bankas and AB Bankas Nord/LB Lietuva) contracted from 71.1 per cent to 67.6 per cent. Vilniaus Bankas lost the largest part of the market share – 3.67 per cent over the course of the year. Nordea Bank Finland Plc Lithuania Branch increased its market share by 1.61 per cent, AB Sampo Bankas by 1.61 per cent and Vereins-und Westbank Ag Vilnius Branch by 1.53 per cent.94 This indicates that concentration of the banking industry in Lithuania is contracting and the smaller industry players are increasing their market shares.

Post-entry developments SEB’s stake in VB has had some adverse effects on the legal and regulatory environment of the country. In order to promote foreign investment, the Lithuanian government has granted VB a 6-year profit tax holiday with 0 per cent profit tax for the first three years and a 50 per cent profit tax tariff discount for the next three years. SEB and the Lithuanian Finance ministry signed this agreement to cover the period 1998–03. In return, the bank promised to invest the value of the saved profit tax in the development of new technologies and the creation of 300 new workplaces.95 However, the number of employees actually has been declining since 2000. This has been mainly due to the constant shareholder pressure to reach higher efficiency. Furthermore, after SEB acquired a stake in VB, VB announced acquisition of the second biggest bank in the country – Hermis Bankas – in 1999. Even though Lithuania’s market concentration regulations did not allow these

Kristina Šimkut˙e 189

two banks to join, the Central Bank granted the merger licence. The Central Bank’s adjustments to the regulations in this case were based on the rapidly changing bank market conditions in the country: Hansabank was making aggressive moves on the market, Norddeutsche Landesbank Girozentrale was planning to open affiliates and other foreign banks were starting operations.

Conclusion The conditions of SEB’s entry into the Lithuanian banking industry at the end of 1990s were quite uncertain. The Lithuanian banking sector was very young and therefore did not have well-established regulatory mechanisms. Furthermore, the sector had just recovered from the crisis of 1995–96. The uncertain situation in the industry made foreign investors cautious when it came to investment decisions. SEB was among the first foreign investors to enter the Lithuanian banking industry. Despite the existing uncertainty in the emerging Lithuanian banking sector, there were also promising prospects of success. First, VB at that time was the biggest and the most profitable bank in Lithuania, and thus a good partner for SEB. Second, SEB had a good opportunity to leverage its existing product portfolio by expanding it into the Lithuanian banking sector. For example, the SEB services forming the greater part of the total Group’s income were Retail Distribution and Merchant Banking. At that time, the retail banking sector in Lithuania was underdeveloped and was expected to grow in coming years. Corporate banking, even though quite competitive, had a strong demand for new and more complicated products. Third, SEB could offer VB a depth of expertise in technology, for which was a great need at that time. Last, but not least, SEB brought a strong capital base that allowed VB to face the increasing competition in the sector. In 1999, VB acquired Hermis Bankas, the second largest bank in Lithuania, and strengthened its market position in the country and the Baltic region. SEB acquisition of VB proved to be successful, since the bank has demonstrated a very good performance until now. However, the increasing competitive situation in the Lithuanian banking market raises the question of whether SEB VB is able to sustain its growth and strong market position. As was presented in the case, in 2004 the concentration of the industry began to contract, and VB lost the largest portion of its market share to the smaller market players.

14 The Emergence of the Central European MNE: MOL Zoltán Antal-Mokos and Krisztina Tóth

Introduction The oil industry is dominated by multinational corporations that are constantly looking for growth options. In this global industry, the products are standardized and the majority of the markets are saturated, leaving companies constantly searching for growth options. The projected growth for gasoline demand indicates that the only growth markets can be found in central eastern Europe. The consolidation in these markets has already started – the 1990s witnessed many mega-mergers between multinational companies in the sector. The question still remains as to who will emerge as a major player in the central and eastern Europe region. While the big multinational companies are present in Europe, they are not strong in these growth markets. Their position is therefore challenged by the emergent eastern counterparts, such as MOL Plc. Moreover, the financial markets value growth is creating a constant pressure for companies to create value by acquisitions. In the oil industry, some firms specialize in a specific stage of the value chain, while integrated oil companies deal with all stages of the chain, from exploitation to refinement to distribution. The case analyzed here takes place in this vertically structured industry. MOL Rt., the Hungarian integrated oil company, aims for a regional leader position. It has therefore procured the majority of shares in Bratislava based Slovnaft, a company specialized in refinement and distribution. The importance of this case is emphasized by the fact that this transaction is the biggest outward Hungarian foreign direct investment project as well as the most important foreign direct investment into Slovakia so far. The period investigated in this case begins in 1999, at time of the tender offer on Slovnaft, and ends at the beginning of 2003, when MOL Rt. doubled its former 36.2 per cent ownership in Slovnaft and became the largest shareholder. By November 2003, MOL had acquired 98.4 per cent of the 190

Zoltán Antal-Mokos and Krisztina Tóth 191

shares. According to the board’s August 2003 decision, the two companies were totally integrated as of 1 January 2004.

Central Eastern European oil industry The central eastern European region consists of Austria, Hungary, Slovakia, the Czech Republic, Romania, Poland, and the former Yugoslavian countries. Although there were some similarities between these countries’ oil industries, there were several differences in the markets. Prior to the turn of the century, the socialist countries regarded the oil industry as strategically important, and each of them strove to build its own independent refining infrastructure and logistics network, resulting in remarkable redundant capacities (such as 20–30 per cent overcapacity in refining) in the region. Consequently, the various markets could not reach critical mass and efficiency. Furthermore, in contrast to other industries, the national oil companies were not specialized but focused on the entire value chain. One of the main reasons for the lack of specialization was the fact that they had no physical connection, such as pipelines, between them and, once pipelines were built, each country was supposed to obtain its raw materials only from the Soviet Union. The only alternative pipeline for procuring raw materials remained the Adrian pipeline. After the transition, the countries tried to ease this defenceless position, but the situation did not really change. Despite their similar past, there were differences in their local environments as well: • In 2003, the national oil companies were at different stages of their privatization and restructuring. • The artificially centralized old socialist companies had different levels of vertical integration. In some countries, the gas, petrochemical, and energy sectors were connected to the oil industry, while in others they were separate. • The countries had different levels of economic development. Austria was a member of the EU while the others were not, and there were variances in the development of the capital and financial markets. • State regulation also differed. Price liberalization, taxation, obligations for service and storage influenced the profitability of the companies. From the beginning of the privatization process, it was clear that the region’s national oil companies were not at all competitive in the unifying markets. There were two ways to grow: organic growth by obtaining financial sources to restructure the organization, increase efficiency, and build existing markets; or external growth through acquisitions. Since the firms had to

192 The Emergence of the Central European MNE

reach critical mass over a relatively short period, only inorganic growth seemed viable, laying ground for mergers and acquisitions in the region. Due to the special ownership structure and state dominance in the sector, acquiring companies in the region was possible through privatization. However, privatization in the region was far from smooth. Companies for sale were often in very bad condition, with obsolete machinery, technology and processes. The prospective buyers looked for cheap buys, while governments looked for fast money, meaning that firms were often sold at a ‘discount’ price. The transparency of the privatization process was not satisfactory, with political cadres sometimes gaining unexplained advantages. All of these facts led to the public’s hostile reaction to privatization attempts. Privatization in some countries has not yet finished – state ownership had just been gradually decreasing, influenced by domestic political changes.

The firms MOL Rt. Magyar Olaj- és Gázipari Rt. (Hungarian Oil and Gas Plc) is Hungary’s leading oil firm and Hungary’s largest company in terms of net income. MOL’s establishment was a result of the transformation of state-controlled OKGT (National Oil and Gas Trust) into a company limited by shares. Early on, the company experienced the challenges of the market economy. Starting in 1991, the company was subject to several reorganization projects, through which it increased its international competitiveness. In this effort, the company separated its upstream and downstream businesses and created profit centres for the different segments. SAP and control systems were introduced and costs were cut significantly at the refineries through the application of the Total Operational Performance concept. As a result, the number of employees was decreased 50 per cent from 40,000 to 20,000 by 1993, partly through outsourcing. The fuel stations were modernized and the whole redistribution network was redesigned to meet strict quality and efficiency targets. Simultaneously, the privatization process started, resulting in a gradual decrease of the government’s equity stake in the company. The shares were acquired by international and domestic investors, with the Hungarian state reintaining 25 per cent of the shares plus one vote in the company in 2002, and 12.5 per cent plus one vote as of February 2004. The company was present in the following business areas: • • • • •

Research and exploration (upstream) Refining (importing and processing crude oil) and wholesale Retail (fuel stations and shops) Gas (procurement, transport, wholesale, underground storage) Petrochemicals (producing and selling olefin, polyolefin products).

Zoltán Antal-Mokos and Krisztina Tóth 193

Furthermore, a corporate services unit dealt primarily with the coordination of non-core businesses, including the general administration of acquisitions and investments prior to their integration with the specific business areas. In 1995, new top management was appointed. The focus in the new management’s strategy was internationlization. First, MOL wished to counterbalance the decrease in domestic reserves and to promote independence from raw material suppliers through research and exploration in Africa and Asia. Second, the company registered its first affiliate in Romania and started to build its own retail network. Third, despite the high entry barriers (such as taxes), MOL entered the wholesale segment in neighbouring countries. Due to its special features (mature markets, limited growth possibilities, increased competition, intensified pressure for economies of scale, consolidation), some forecast that MOL could itself become an acquisition target if its growth objectives were not reached. Thus, thoughts concerning possible acquisitions popped up before any official announcement of the new strategy. In addition to the organizational restructuring, important changes occurred in the strategic area. In February 1999, another set of new top managers took over. The young and charismatic leader, János Csák, became Chairman of the Board and initiated a strategic change. Mr. Csák called for more aggressive market behaviour in regional expansion. MOL’s Board therefore made the following decisions: • To divest of non-core businesses to free capital • To sell the Asian and African exploration properties, using the proceeds to buy oil fields that had already been explored (this move was widely criticized) • To cut costs by decreasing the number of employees from 20,000 to 12,000 • To implement a flexible organizational structure through a process-based structure – business unit executives were delegated to top management • To implement vertical integration for petrochemicals, as resources were not sufficient to open up to the energy sector. Four companies were identified in the growth strategy as potential partners: Croatia’s INA, Poland’s PKN, Slovnaft in Slovakia, and Petrom in Romania. PKN was too big for MOL at the time and starting growth through a neighboring country was felt to be more logical. In Romania, where MOL had already had 34 fuel stations, the economic climate was very unfavourable, with a 10 per cent luxury tax and 6 per cent extra customs tax levied on fuel. The first available target was the neighbouring Slovnaft. MOL’s management took immediate advantage of the tender announced in November 1999. Since then, strengthened by Slovnaft, MOL has acquired 25 per cent of the shares plus one vote in the Croatian INA, expanded its retail network

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in Romania, and a future partnership with the Polish PKN Orlen is expected. Furthermore, the company is interested in acquiring the Czech and Serbian oil companies in the future.

Slovnaft The history of the Slovakian national oil company dates to 1895, when the first mineral oil refinery was constructed in Bratislava. During the 1960s, Slovnaft grew from being just a refinery into a refinery and petrochemical complex, enriching the range and quality of its products. In the 1990s, Slovnaft was transformed from a state enterprise to a joint stock company. The privatization process was finished at the beginning of 1998 with Slovintegra and Slovbena (owned by the management, employees and investors) having become majority shareholders. As a result of the development process, the Bratislava refinery became one of the most up-to-date refineries in Europe. Oil extraction was not one of the activities, as the crude oil was acquired from the market. Slovnaft had significant capacities in the plastics and petrochemical industries, with 80 per cent of market share in the domestic market. The company had a strong wholesale market position in the Czech Republic (approximately 25 per cent in diesel and 15 per cent in gasoline) and 360 retail stations in four countries (Slovakia, Czech Republic, Poland, and the Ukraine). Slovnaft – already transferred into the hands of management and employees – was meant to be a good investment for MOL. Several factors increased the attractiveness of Slovnaft. First, the company had a modern refinery that conformed to EU standards. Second, the Czech and Slovak markets showed further growth potential, since an increasing number of vehicles was expected. Third, of the available potential partner companies from the region (PKN, Petrom, INA, OMV, Slovnaft), only the North–South expansion seemed to be practicable. Finally, the privatization of the Croatian company had been delayed by political reasons; that is, the only potential target for MOL remained Slovnaft. Table 14.1 shows Slovnaft’s performance indicators. As the figures indicate, that company was in a difficult situation: MOL was three times bigger in size in terms of sales and employees, but the debts were almost the same. Slovnaft’s intense development increased its need for credits, creating financial difficulties. Consequently, bank pressure resulted in a call for tender in order to attract capital. The share package offered for tender a strategic investor 50 per cent participation in the management of the company. The winner of the tender was MOL, acquiring 36.2 per cent of the shares. On 31 March 2000, Slovnaft signed the agreement for a strategic partnership with MOL. According to this agreement, MOL would have had the option to acquire a further stake in the company after two years, thereby becoming the majority owner. By the end of the process, MOL would have all of the shares.

Zoltán Antal-Mokos and Krisztina Tóth 195 Table 14.1 Key financials of MOL and Slovnaft, 1998–99 (USD million) MOL 1998 2 958 528 −190 338 −39 235 2 835 661 20 460

Indicators 1999 3 158 576 −223 353 −104 287 2 949 654 18 938

Sales EBITDA D&A EBIT Net financial expense Net income Total assets Net debt Employees

Slovnaft 1998

1999

1 031 163 −49 114 −87 2 1 496 566 7 742

1 043 129 −66 63 −128 −60 1 389 564 7 540

Source: MOL investor presentation www.mol.hu

Mr. György Mosonyi’s (CEO) statement in a leading economic weekly illustrates the importance of the Slovnaft deal for MOL: MOL’s ownership in Slovnaft and the regional partnership with Slovnaft is of historical significance. If we are successful, we can prove to the financial institutions that an initiative from a central European country can really work. Thus, by strengthening trust it is possible to move forward. If we are not successful, this window of opportunity will be closed in front of us.96

Fit between the merging firms The comparison of the two companies makes the motivations behind the partnership clear. MOL’s financial aid and management capabilities were beneficial for Slovnaft, while Slovnaft’s existing resources and market position were attractive to MOL. Moreover, the growth in size and market power backed up MOL’s further regional expansion plans in line with its declared strategic intent. The refinery overcapacity that caused problems for many other companies in the region was not a problem for MOL and Slovnaft, since the Danube (Hungary) and the Bratislava (Slovakia) refineries had 80 per cent and 95 per cent capacity utilization respectively. The profile of the two refineries was different – MOL focused on diesel and Slovnaft on gasoline production. MOL defines synergy as follows: ‘Synergy is the opportunity to increase efficiency through the partnership of two firms.’97 Synergy potentials were identified by functional areas. Slovnaft’s value for MOL was defined by the calculation of the combination’s financial effects (cost reduction, revenue growth) minus the necessary expenditures.

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Business synergies • Optimization of refinery production According to the production optimization model, the refineries from Bratislava and Hungary sent components to each other to enhance capacity utilization. The results were cost reduction and income growth due to the increased quality of products (shift towards more value-added products). The sharing of knowledge between specialists was realized in the course of joint problem solving. • Linking logistics networks The common transportation system implied better capacity utilization and, consequently, cost reduction, which would be enhanced by the countries’ accession to the EU in 2004. • R&D The shared use of R&D instruments, as well as the common expenses for technology, led to cost reductions. More new ideas emerged in product development. • Coordinated sales and marketing By introducing a mutual fuel card, sales increased and customers could use the same card at both MOL and Slovnaft fuel stations. Furthermore, eliminating the geographical overlap allowed rationalization of the wholesale markets (for example, both MOL and Slovnaft had wholesale firms in Austria). The introduction of the single channel approach was a primary marketing objective.

Operational synergies • Procurement, investments The company’s bargaining power with suppliers increased due to the increased volume of the orders that allowed for a better procurement price. The growth in size and production, in addition to better capacity utilization, improved returns on major investment projects. • Systems and processes Capitalizing on the more efficient corporate governance practice of MOL, the board and management of Slovnaft could work more efficiently. In addition, better decisions might have been taken. The introduction of Key Performance Indicators allowed for the close monitoring of Slovnaft’s activities.

Financial synergies • Finance MOL’s experience in debt management was beneficial to Slovnaft. Traceable benefits could be gained if Slovnaft applied MOL’s financial management practices. For example, the merged company could take advantage of a tax reduction due to Slovnaft’s deficit. In addition, earnings could be realized by divesting unrelated units. Renegotiated and rescheduled credits, as well as savings gained from an earlier execution of debts, resulted in an unexpected improvement of financial results. • Corporate services Cost reductions could be achieved by more efficient organization of supporting activities. These might include using the same inventory policy, harmonizing the IT sourcing and servicing, using

Zoltán Antal-Mokos and Krisztina Tóth 197

common regulations for legal issues, and sharing contacts and administrative processes.

Other synergies • Management Management synergies were considered to be as important as financial synergies. In an investor presentation, the Slovnaft transaction was defined as value enhancing because MOL’s expertise in cost cutting could be applied to Slovnaft’s operations, and revenues could be enhanced due to the improved strategic position. The synergy potential that resided in management and experience sharing was difficult to measure. An employee rotation programme was launched, while the top management and other key positions taken by MOL employees provided the opportunity to exploit knowledge sharing. Through the Slovnaft acquisition, MOL gained substantial experience in managing a crossborder acquisition, an experience that could be beneficial in the further realization of its regional expansion strategy. Synergy potentials were not only examined in order to calculate the bidding price. Rather, synergy planning and monitoring is a yearly activity. In the planning system, synergies are defined as ‘benefits’; it is possible to monitor their realization and to make corrections after confronting the realized results. One might say that the MOL–Slovnaft deal can be characterized by a permanent search for synergy potentials, and by firm and systematic synergy realization and control. In fact, synergy expectations are incorporated into business plans. Further savings are expected following the completion of the integration. For 2005, synergies were estimated to amount to USD 70 million.

Acquisition negotiations Negotiations began following the official call for tenders. The other bidding ¨ companies were the Austrian OMV, the Russian Lukoil and the Polish PKN. The pre-selection was done based on three major conditions: the intended share ownership, proposed options for the future, and modernization and development strategies after the acquisition. The bidding companies were offered insight into Slovnaft’s confidential information in order to compile the offer. Severe confidentiality agreements were therefore signed by the parties. The evaluation of the offers was based on the following criteria: strategy, technology and finance. MOL’s experts had access to Slovnaft’s data and evaluated the company’s business and financial value, and opportunities to increase efficiency and synergies. Later in the process, the company’s value was defined using a financial model,

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using the help of external consultants ( J.P. Morgan). As a result, MOL knew its maximum price during the negotiation process. Between the preliminary and binding offers, figures could be modified based on further market and profit information. In the detailed offer, predefined topics were to be discussed: how the petrochemical plants were to be developed, how the petrol distribution network was to be expanded (five new tank stations and 15 refurbishments were the minimal requirements), and methods of operating the refineries at maximum efficiency. These issues were analyzed by the MOL experts. During the process of bidding, analyzing and negotiation, MOL was represented by a team of 10–20 experts. Several weeks after the submission deadline, Slovnaft’s management and consultants evaluated the offers. Consequently, the detailed negotiation process started with the most favourable bidder, which was MOL. The negotiating teams (consisting of three persons from each company) were comprised of each party’s top management. Special attention was given to the balance of MOL’s professional experience, leading the company to delegate top executives from its strategic, legal and functional areas. By this time, there was already no going back in the process. Nevertheless, a chance to raise the bidding price was still available. The refining of the contract and clarification of various sub-sequences followed, with special attention paid to the organizational plan. Although MOL acquired only a share of 36.2 per cent, it had 50 per cent of the Board seats and key positions. In fact, MOL controlled four out of the eight available seats in both top management and the board. A three quarters majority was required when responding to strategic questions during the first two-year period. This could easily have brought deadlock. Other organizational questions were answered as well – the 40 key positions were shared 50–50 per cent. These agreements were set into contractual form. The negotiation process was closed and the contract signed with all due ceremony. The events were announced in press releases, while other tasks were undertaken to finalize the deal. Among these were the financial closing, the production of delivery-reception documents, the compilation and control of liquidity and property lists, the transfer of the negotiated price, and settling on the ownership structure. The new management was elected at Slovnaft’s extraordinary general meeting, with effect from 20 December 2000. The Hungarian, Czech and Slovakian Competition Offices needed to approve the deal, which took six months, after which the agreement was final. The value of the transaction was USD 262 million, realized in the form of capital increases (USD 150 million) and share subscriptions (USD 112 million). In addition, MOL acquired an option to become the majority shareholder of Slovnaft after two years.

Zoltán Antal-Mokos and Krisztina Tóth 199

Integration and restructuring Integration began in May 2000, following the signing of the partnership agreement. Special functional task forces were highlighted in order to define future duties. The integration was, however, partial in that the two firms remained separate legal entities – MOL had only acquired an initial equity stake of 36.2 per cent. The mutual work began in early 2001. Slovnaft Portfolio Management Department was formed within MOL in order to support and coordinate the integration, and to represent MOL in the relationship with Slovnaft. This unit was also responsible for synergy realization. The department, formed by four or five experts, prepared materials for board meetings, business plans and different reports, ensuring strong financial control over Slovnaft’s activities. With the coordination of Slovnaft Portfolio Management, 100 teams were working on the integration process, involving 600 people from all over the organization. In November 2002, MOL agreed to increase its shares in Slovnaft to 67.8 per cent, while the Slovakian partner gained about 10 per cent of MOL shares. Further savings were expected thereafter, but the questions of how to achieve the ambitious goals and which organizational structure would best serve the realization of synergies were still open. The integration project started at the beginning of 2003. According to the preliminary schedule, the plan of cooperation had to be ready by the end of March. The first phase of the project was to be closed on 4 August, when the board was to agree on the organizational concept. The reorganization tasks – regardless of the level of integration – had to be completed by the end of the year because, according to the plans, the new Group structure would start operating on 1 January 2004. For the board, an important condition was to finalize the organization concept by assigning specialists to each task, and defining the responsibilities, new processes and supporting systems. The MOL–Slovnaft joint task forces were busy analyzing possible alternatives for the new structure. The functional task forces were formed by specialists from specific areas, who contributed many new ideas. The final decision was that the management of different areas was to be divided between Bratislava and Budapest following integration. The Slovakian and Hungarian employees had worked together on several projects since 2000, which supported the integration process. The integration process was further helped by consistent project management. Employees were informed of plans and expectations through personalized mails, the company newspaper, newsletters, the intranet, and CEO messages in an effort to facilitate the acceptance of changes. Language courses and specialized training for Hungarian expatriates were organized, but the mutual language of communication was English. One of the biggest challenges to integration was the conflicts arising from the different organizational cultures. For example, MOL employees were

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much more critical, while Slovnaft employees were characterized by the firm execution of commands. MOL was considered to be five to seven years ahead of Slovnaft in terms of its professional organizational structure, culture and management effectiveness. The conflict was later prolonged by the necessary workforce reductions at Slovnaft – over a three-year period, the number of employees decreased from 8000 to 6000. Slovnaft employees felt they were the losing party despite the fact that board seats were equally distributed between the two firms and that several key positions were held by Slovnaft managers. From MOL’s point of view, the positive communication of a friendly partnership was important in terms of external stakeholders, because different national cultures and political factors had a great influence on the company’s value.

Changes in both organizations In the meantime, a new Chairman/CEO was appointed to MOL – Mr. Zsolt Hernádi who continued the work of his predecessor and further streamlined the hierarchical levels of the organization to enhance value creation. In the retail and wholesale segments, micro-matrix structures were applied to enable the company to react to different customer needs, while the rest of the organization remained simply linear-functional. Mr. Hernádi wanted MOL to become sales oriented rather than production oriented, and he commented on this change as ‘instead of talking about barrels, we began to talk about dollars’. In 2002, Hernádi and his team reinforced MOL’s primary strategic objective of growth through acquisitions. They intended to launch a new project that would result in a USD 175 million decrease in operational costs by 2005, with a corresponding workforce reduction of 2500 employees. In early 2002, Slovnaft also started streamlining its operations and divesting non-core subsidiaries, while integrating its retail affiliate, Benzinol, into the organization. Management formulated a new sales strategy and started modernizing fuel stations, retaining the Slovnaft design and logo. All accounting services were outsourced to Accenture, which was MOL’s accounting services provider. The Business Restructuring and Value Oriented Organization Project was initiated to restructure the organization to fit the new streamlined operations and business processes to achieve a projected savings of SKK 1.7 billion. Accordingly, between 2003–05 Slovnaft’s workforce would be reduced by 27 per cent (1000 employees).

Performance The fulfilment of synergy potentials was permanently monitored and controlled by specialized task forces. In 2001, Slovnaft registered the highest profit in its history (SKK 3.2 billion). This resulted from two contradictory effects. On the one hand, the unfavourable market conditions and an unexpected technical shortfall reduced the probable profit. On the other hand,

Zoltán Antal-Mokos and Krisztina Tóth 201

the new integrated purchasing, logistics and sales system, together with the financial restructuring, produced better results. The result of these two effects was the realization of the synergy plans. The extent of synergy realization exceeded expectations, leading management to modify the plans upwards, starting in 2003. Nevertheless, there were some goals that could not be achieved. These were analyzed by functional areas and, based on the conclusions, action plans were defined. The same method was used for analyzing emergent synergies. The unrealized synergies included: • Logistics: modest transportation overlaps • Retail: introduction of the mutual fuel card was postponed because of technical barriers. Later, approval of the retail strategy was delayed. Some synergies that succeeded beyond expectations were: • Marketing: the single channel marketing approach • Finance: renegotiated and rescheduled credits, as well as savings. The regular follow-up on synergy realization enabled immediate action. In addition, each synergy area had its own responsible person and a sponsor. The reports followed the same structure and also considered market changes that influenced synergy realization. Consequently, action plans could be prepared for the future. Although the plans remained unchanged throughout the year, changes could be clearly defined at the end of the year and implemented in the new plans. If we analyze the synergies by functional area, most were realized in refining activities (21 per cent of total synergies), which indicates that the main motivation behind the acquisition was verified. Common marketing resources, experience sharing and geographical proximity were the other contributing factors to wholesale (13 per cent of total synergies) and retail (7 per cent) synergies. Altogether, business synergies accounted for 50 per cent of the realized synergies. Financial synergies constituted 15 per cent of total realized synergies while corporate services contributed with 10 per cent. Table 14.2 presents the synergy realization in figures:

Table 14.2 Planned and realized synergies (USD million)

Planned Actual Source: Tóth (2004).

2001

2002

2003

11 15

28 45

64 90

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Evaluation of the acquisition If we consider the realized synergies, the price paid for Slovnaft was a good one. As the integration continued, further synergies could be developed. The integration process cannot be evaluated without taking synergy management processes into account; the projects launched for synergy realization were integration projects as well. Integration was supported by consistent project management. Management controlled the entire integration process, starting with goal setting and ending with accurate implementation. The Slovakian and Hungarian employees had worked together since 2000, long before the full integration took place. The fact that they knew each other facilitated the common work. Board seats were equally distributed between the representatives of the two firms and several key positions (mainly in refining activities) were assigned to Slovnaft managers, which facilitated the cross-organizational integration. Further on, partnership is to be emphasized through the company’s communications. In order to decrease the ‘we–they’ conflict, a new common company identity is going to be formed. The positive communication of a friendly partnership is also important from external stakeholders’ point of view, as different national cultures and political factors have a great influence on the company’s value. Strict plans and continuous teamwork facilitated synergy realization. In this process, the main problems were quantifying synergy potentials and realized synergies. According to the head of Slovnaft Portfolio Management ‘it is almost impossible to overestimate the synergies’ because in realizing the objectives, further possibilities might emerge. Management evaluates the acquisition as very successful – in addition to the good results, the collaboration positively affected both companies and the merged company avoided a crisis situation. This case illustrates the process of symbiotic integration, because the demand for strategic dependence was as important as the need for organizational autonomy. The parties not only aimed at exploiting the reciprocal benefits, but also at promoting a mutual learning process. The interaction between the two companies has gradually increased, with the continual objective of stimulating knowledge transfer and the integration of the results into the new systems. Overall, the acquisition and successful integration of Slovnaft was an important learning process for MOL, through which the company gained essential experience for future growth and acquisitions. MOL experienced revolutionary changes allowing it to develop from a state-owned enterprise into a regional MNC aiming at central and eastern European dominance. While the process has certainly not been without its difficulties, MOL’s culture has changed to incorporate the international experience necessary to international growth.

15 Growth through Multiple Acquisitions: Carlsberg Breweries in Poland Mieczysław B˛ ak

Introduction Carlsberg is one of the world’s leading companies in the production, marketing, and distribution of beer and related products. Its origins date back to 1847, when Jacob Christian Jacobsen started his first brewery in Copenhagen, Denmark. In 1970, Carlsberg merged with another famous Danish brewery, Tuborg, to create the Carlsberg Group, which sells over 79 million hector litres (hl) of beer and 21 million hl of soft drinks worldwide each year. The Group has grown mostly through expansion in foreign markets and runs 67 breweries in 40 countries. Since the 1990s, Carlsberg Breweries have been very active in the European emerging economies (EEE) as well as in Asia (Meyer and Tran, 2006). The region plays a special role in the company’s investment strategy. In addition to a variety of holdings in Poland, Carlsberg owns 50 per cent of Baltic Beverages Holdings (BBH), 40 per cent of Panonska Pivovar d.o.o. in Croatia, 50 per cent of OAO Vena in Russia, 59 per cent of Shumensko Pivo AD, in Bulgaria, and 67 per cent of Pirinsko Pivo AD, also in Bulgaria. In January 2002, BBH acquired 70 per cent of the shares in the Voronezh Brewery (Russia), which later increased to 83 per cent. In January 2003, Carlsberg breweries increased its shareholding in Pirinsko Pivo to 94.5 per cent. Carlsberg is further expanding through BBH in the Ukraine and other countries of the former Soviet Union, and utilizes its Polish experience when purchasing strong local brands in other EEE countries. The company’s strategy is to offer strong local brands alongside its global product (Carlsberg). Carlsberg transfers new technologies and modernizes local breweries to bring them up to the Group’s standards. Despite this intense involvement abroad, most research and development is conducted in Copenhagen. R&D activities are an integral part of Carlsberg A/S, and the company holds a special place in the history of business financed research. The group runs its own research centre, founded in 1976, but with a history dating back to 1876. It is financed partly by the Carlsberg Group and partly by external 203

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sponsors. Its main task is to provide group breweries with new technology and research related to plant and yeast biochemistry and molecular biology. Its studies of barley, malt and yeast involve such disciplines as conventional breeding, genetics, microbiology and biotechnology. It is also involved in quality control, and works on the comprehensive, molecular definition of beer quality based on contemporary biotechnology.

Local environment: the Polish beer market Poland consumed 27.26 million hl of beer in 2002, making it the tenthlargest beer consumer in the world.98 Simultaneously, the Polish market for beer is growing rapidly, as beer is gradually replacing other alcoholic beverages, especially vodka. In 1990, beer constituted only 24 per cent of alcohol consumed, but by 2000 this amount had increased to 52 per cent, in part replacing consumption of higher alcohol liquor. These changes were related to the promotion of a new lifestyle and the perception of beer as a drink for young, energetic people. The new lifestyle was mostly related to the advertising of beer in the mass media and the fact that the advertising of stronger drinks was not allowed. From 1993 to 2001, the average annual growth rate of beer consumption was over 9 per cent. In 2001, the rate of growth fell to 0.5 per cent, in part due to an increase in the excise tax to EUR 22.5 per hl, (compared to only EUR 9 per hl in Germany). Also, the industry’s access to media was restricted, though these restrictions were partially revoked in 2003. Despite these obstacles, the consumption of beer increased from 30 litres in 1993 to 68 litres in 2003. Of the Polish population 60 per cent are regular beer drinkers,99 making Poland the fifth-largest beer market in Europe, after Germany, the United Kingdom, Russia and Spain. The Polish beer industry was one of the first industries to be privatized, a process that began in 1990. Large foreign investors started entering the Polish ˙ market three years later, when Heineken invested in Zywiec. A year later, South African Breweries (SAB) invested in Lech Brewery in Poznan, ´ creating ‘Kompania Piwowarska’. The Polish beer market was relatively dispersed until 1997, and the largest company had only a 17 per cent market share. In 1998, Heineken undertook the first mergers and acquisitions in Poland, purchasing three new breweries and increasing its market share to 38 per cent. Carlsberg, which entered the Polish market in 1996 with its investment in Okocim, purchased three other breweries in 2001. In 1999, a new investor, BBAG (Austria) entered the Polish market by purchasing Van Pur Brewery, and then purchased Kujawiak and Browary Warszawskie in 2000. In 2003, Kompania Piwowarska (SABMiller) acquired 98.8 per cent of Dojlidy Brewery from Radeberger Gruppe for EUR 35 million, strengthening its position in eastern Poland and taking the lead position in Poland with a 35 per cent market share.100 At the same time, Heineken purchased BBAG,

Mieczysław B˛ ak 205 Table 15.1 Market shares: leading beer manufacturers in Poland (%) Group name

1998

1999

2000

2001 2003

˙ Heineken Zywiec Kompania Piwowarska (SABMiller) Carlsberg Okocim

38.5 19.9 17.3

36.7 22.7 16.7

30.9 29.0 15.8

31.8 31.4 13.2

37 34 14

Note: Carlsberg data include Kasztelan, Bosman and Piast breweries before they were acquired by Carlsberg. Sources: Polski Rynek Piwa (2002) Rynki Alkoholowe, no. 3/2003; and Prusek, T. (2004) ‘Piwny Rynek 2003’, 21 January, www.gazeta.pl

reducing the number of main competitors in the Polish beer market to three, which today manufacture over 80 per cent of all beer in Poland (Table 15.1). The brewery industry in Poland has access to a plentiful supply of human resources. Brewery engineers are trained in agricultural colleges, polytechnic universities, and universities. Raw materials, in terms of agricultural products and water of good quality, are available. These aspects facilitated the fast development of the beer sector in Poland. The further development of the Polish beer market may be hampered by high duties. In the future, Poland might face a situation similar to that seen in Denmark, where the excise tax for beer reaches EUR 36.14 per hl. In Denmark, an estimated 20 per cent of beer consumed is individually imported from Germany. After joining the EU, the individual import of alcoholic beverages into Poland became easier. The Polish excise tax is over two times higher than in neighbouring countries, which may limit the development of local industry. The situation facing the Polish beer market in 2004 was even more difficult as the excise tax was increased to EUR cents 9.3 per 0.5 litre bottle, while in Germany it is EUR cents 3.9 (the excise tax for a 0.5 litre, a bottle of beer in Poland is currently PLN 0.43, compared with 0.18 in Germany, 0.20 in the Czech Republic, 0.20 in Slovakia and 0.21 in Lithuania. In Denmark, excise taxes reach PLN 0.72).101 Foreign-owned breweries were thus considering relocating part of their manufacturing to neighbouring countries.

Acquired firms In 1996, Carlsberg began investing in Poland by acquiring over 30 per cent of Okocim Brewery. Okocim’s history in beer manufacturing was even longer than Carlsberg’s. The first Okocim brewery in Brzesko was established in 1845 by Jan Goez of Bayern. At that time, the town was part of the AustroHungarian Empire. The company mission was to produce ‘The Best of the Best’. In 1860, Okocim produced 18,000 hl of beer and over 40,000 hl in 1880. Prior to World War I, the brewery was one of the largest beer manufacturers in the Austro-Hungarian Empire, brewing over 400,000 hl of beer.

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The Goetz family, who owned the brewery until 1939, was also active in Polish political life. Jan Albin Goetz II became Chairman of the Polish Parliamentary Club in the Austrian Parliament and, later, Senator of the Republic of Poland following Polish independence in 1918. During World War II, the brewery was owned by Germany. After the war, Okocim was nationalized and became a state-owned enterprise. In 1950, the company manufactured 350,000 hl of beer, barely equal to the 1911 level. In 1969, breweries in J˛edrzejów and Kraków were merged with the Okocim enterprise. During the transition from a centrally planned to a free market economy, Okocim was one of the first Polish companies in Poland to be privatized through the Warsaw Stock Exchange. On 25 October 1990, the company was converted into the joint stock company Okocim Brewery SA. Further privatization was postponed until 1992, given the need to settle with the heirs of Jan Goetz.102 In early 1992, an A series of shares was issued and the stock was introduced on the Warsaw Stock Exchange: 2.8 million shares (62.96 per cent of total stock) were sold through an initial public offering. The management board, following the terms of the privatization agreement, purchased 16,800 shares (0.6 per cent of distributed stock) and held an option to purchase 67,000 more shares before December 1996.103 Okocim’s privatization was combined with investments in modern production lines. In 1991, Okocim was the first brewery in Poland to introduce beer in cans. A year later, equipment for distributing beer in steel containers was purchased. In 1994, the modernization of the brewing department and the purchase of fermentation tanks with automatic controls made Okocim the most modern brewery in Poland. Prior to its acquisition by foreign investors, Okocim was the leading brand in Poland with relatively modern equipment. Germany’s Brau and Brunnen GmbH purchased 25 per cent of Okocim B shares in 1994. As a part of the restructuring process, the brewery in J˛edrzejów was sold and, simultaneously, a brewery in Chociwie was purchased. Brau and Brunnen held an interest in Okocim for only two years. In April 1996, a new series of shares (C) was issued, 31.6 per cent of which were purchased by Carlsberg A/S, while the German investors withdrew completely. The purchase of Okocim was the first step towards developing the Carlsberg Group in Poland. In August 2001, Carlsberg Okocim SA and Carlsberg Breweries A/S concluded contingent share–purchase agreements with Bitburger Brauerei Th. Simon GmbH and Bitburger GetraenkeVerwaltungsgesellschaft mbH, the respective owners of 99.77 per cent and 99.39 per cent of the initial capital of the Bosman Brewery and Kasztelan Brewery companies. In April 2002, both breweries were incorporated into the Carlsberg Okocim Group for a total purchase price of PLN 220 million (approximately EUR 52 million).104 Carlsberg entered the Polish market relatively late compared with its main competitors, Heineken and SAB, which entered the market in 1995. By 1996,

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the attitudes of Poles towards beer drinking were shifting and it was anticipated that Poles would eventually consume a similar amount of beer per capita as consumers in Germany, the Czech Republic, and the UK. After purchasing Okocim, Carlsberg had a relatively small market share of only about 7 per cent, compared to Heineken’s 17 per cent. Following its main competitors, the Danish company then chose to acquire strong regional breweries, owned mostly by private investors. In 2002, Carlsberg Breweries A/S acquired Dyland BV, the owner of over 98 per cent of Browary Piast’s initial capital. Previous cooperation between Carlsberg Okocim SA and Browary Piast was based on two agreements made in February 2002. Under the distribution agreement, Carlsberg Okocim would purchase products manufactured by Browary Piast and include them Carlsberg Okocim’s product line, thus reselling them as commercial goods. According to the cooperation agreement, Carlsberg Okocim would support the sales of Browary Piast’s products, and the organization of the company’s product marketing services, packaging equipment maintenance and logistics.105 The Bosman, Piast and Kasztelan breweries were each privatized in different ways. Originally, the Kasztelan brewery in Siepc was leased to its employees, before it was later purchased by Bitburger. The Piast Brewery was sold to a German citizen – a co-owner of a small company ‘drink-service’, and was later acquired by the Dutch holding company Dyland BV. The Bosman Brewery was sold to an individual, before it was acquired by Bitburger. The privatization process of these breweries raised many concerns. The State Controller’s Office reported that during the privatization of Bosman, not all bidding companies had an equal chance and that the final price was not optimal. Also, the first private owner of the Piast brewery did not meet all of the requirements of the privatization agreement.106 All breweries acquired by Carlsberg were recently modernized and had a strong regional position. All breweries also had a very long tradition of beer brewing. Piast was established in 1893 and Bosman in 1848. The purchase of these additional breweries in 2001 marked the true beginning of the Carlsberg Okocim group in Poland, with Carlsberg holding a 14–16 per cent market share. In addition to acquiring companies, Carlsberg increased its shares in Carlsberg Okocim, reaching 50.1 per cent in May 2001. According to Polish Securities Law, Carlsberg was then obliged to make a public tender for all outstanding shares in Okocim. Carlsberg offered PLN 16.25 per share, a price that represented a premium of 36.1 per cent over the average price of the preceding six months. The Carlsberg offer was approved by the Security Commission on 16 May 2001, and it enabled Carlsberg to increase its shareholding to over 50 per cent. In December 2002, Carlsberg Breweries A/S acquired an additional 9.9 per cent of Carlsberg Okocim SA from Bitburger, increasing its holding in the company to 71.47 per cent. Simultaneously,

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Carlsberg declared that it had no intention of delisting Carlsberg Okocim from the Warsaw Stock Exchange before 2005.107 During the first half of 2003, Carlsberg’s holding in Carlsberg Okocim increased to 74.97 per cent. In 2003, 10 per cent of the Okocim shares were owned by Bitburger Getranke, 5.85 per cent by the Industry Development Agency (which belongs to the state treasury), and 9.18 per cent by minor share holders, including the Danish Investment Fund for central and eastern Europe.108 During the second half of 2003, Carlsberg continued purchasing Okocim shares, including 4 per cent of shares from Bitburger for USD 8.4 million. At the end of 2003, Carlsberg announced a call for purchase of Okocim shares at the fixed price PLN 25.50 (approximately EUR 6) per share, through which it purchased 2.3 million shares, increasing its shareholding to 92.97 per cent.109 In March 2004, another call for purchase was announced at similar price (PLN 25.50) and the company declared its intent to purchase the remaining 2,019,975 shares. By the end of 2004, Carlsberg owned 100 per cent of Okocim and withdrew the company from the Warsaw Stock Exchange. Carlsberg had full control of the company, and the withdrawal from the stock exchange allowed Carlsberg to reduce the amount of financial information it would have to provide to the public.

Investment in modernization Carlsberg’s continual increase in its share of Okocim Brewery was combined with company modernization. In 1999, the Danish investor implemented a new ‘High Gravity Brewing’ method, which increased brewery efficiency. Later, in 2001, the group invested PLN 74 million (EUR 17.6 million) in the modernization of Okocim.110 By 2002, Carlsberg had in total invested USD 103.5 million in Poland. Another EUR 20 million were invested in the modernization of the breweries in Brzesko and in Szczecin in 2003, and nearly USD 40 million in the Sierpc Brewery in 2004.111 In 2001, as a part of the Group’s reorganization, the head office of Carlsberg Okocim was moved to Warsaw. This move affected the management board, as well as the sales, marketing, supply chain, human resource, and finance departments. In 2002, Carlsberg Okocim SA began conducting purchasing, logistics, sales, marketing, distribution and finance activities on behalf of all of the Group’s organizational units in Poland. Manufacturing functions were concentrated in three production plants: the Okocim, Bosman and Kasztelan breweries. In 2002, the Carlsberg Okocim Group nearly doubled its sales and reported a profit of PLN 2.8 million, a significant improvement over its PLN 30 million loss in 2000. In 2003, the company increased sales from PLN 1014 million to PLN 1093 million, but reported a loss. According to the company management, this was mostly caused by the high costs of restructuring the Kasztelan and Bosman breweries.

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In the late 1990s, brands of the Carlsberg group lost their market position due to the fast growth of competitors Heineken and SAB. Tyskie Beer, owned by Kompania Piwowarska (SAB) held 7 per cent of the market in 1998 and ˙ 18.4 per cent in 2000. In the same year, Zywiec (owned by Heineken), observed less spectacular, but still substantial, growth from 9 per cent in 1998 to 11.8 per cent in 2000.112 At the same time, Okocim’s market share fell from 8.3 per cent in 1998 to 5.9 per cent in 2000. However, the modernization of the brewery and the new marketing strategy resulted in the rapid recovery of the brand. In 2001, Okocim was the fastest growing brand in Poland, and Carlsberg regained market share through a series of smaller acquisitions.

Employment The restructuring process, the modernization of the breweries and the implementation of new technologies resulted in a decrease in employment. When the Carlsberg Okocim Group was created in 2001, it employed 1429 people, yet this was reduced to 1055 by early 2004.113 The decrease in employment within the group was the continuation of ongoing processes in the acquired companies. Prior to the Carlsberg acquisition, the Bosman Brewery decreased employment from 314 to 297 persons,114 while the Kasztelan Brewery decreased employment by 100 persons after joining the Group.115 Modernization and increased efficiency also resulted in decreased utilization of supplementary breweries with outdated technologies. For example, the Kraców brewery was closed in 2001. Furthermore, Carlsberg began outsourcing some of the services, leading to a further reduction in employment.116 Employment reductions were eased through assistance to laid-off workers. For example, Kraców employees could participate in new skills training provided by the Group. The reduction in employment also had a significant impact on the increase of salaries. In the Bosman Brewery alone, the total amount of compensation increased by 7.5 per cent in 2001, in of spite a staff reduction of 5.4 per cent.117

Carlsberg’s strategy in Poland Carlsberg’s strategy in Poland is ‘to be the fastest growing profitable beer company fighting for a leading position’. To execute this strategy, Carlsberg implemented significant changes in its product portfolio, focusing on the most promising brand and reducing the overall number of brands. In addition, new brands were introduced during 2002 and 2003. In most cases, only two leading beers were selected from each brand for continued manufacture. Carlsberg then changed some of the brand names and the production methods, focusing on improving the product and package quality. Simultaneously, the Group focused on ways to increase the volume of Carlsberg beer sold in Poland.

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During the consolidation process, major emphasis was placed reducing the number of local brands and replacing existing brands with new ones. Carlsberg divided the brands into two groups: the main brands (Okocim Jasne Pełne, Okocim Mocne, Karmi, Carlsberg), and the supporting brands, which include acquired regional brands.118 Decreasing consumer interest in Okocim Premium led to its replacement with the new Okocim Jasne Pełne. In general, Carlsberg aimed to adjust its new products to consumers’ preferences, leading to the introduction of the Pełne. Thus, the Group’s portfolio included four national brands in 2003: Carlsberg, Okocim (Okocim Jasne Pełne and Okocim Mocne), Karmi, and Volt (Volt Original and Volt Mocne). In addition, Carlsberg maintained five regional brands: Kasztelan (Kasztelan Jasne Pełne and Kasztelan Mocne), Bosman (Bosman Full and Bosman Special), Piast (Jasne Pełne and Piast Mocne), Ksi˛az˙ (Ksi˛az˙ and Wrocławski Full), and Harna´s, a new brand added in 2003. The discontinuation of the production and sale of selected brands, and the restructuring of the product portfolio in 2002 did not have a negative impact on sales volumes. In fact, in 2002 sales increased by 2 per cent. Following the restructuring process, the Carlsberg Group was the fastest growing beer manufacturer. During the first 6 months, beer sales in Poland increased by 4 per cent, while Carlsberg increased its sales by 6 per cent, Kompania Piwowarska by 5 per cent of and Heineken-Zywiec by 4 per cent.119

New marketing strategy The restructured distribution system came into effect in 2002. New sales teams were built from the basis of the most effective staff members from Okocim, Bosman, Kasztelan and Piast. The number of directly serviced retail points of sales, including bars and restaurants, increased to 28,000, with marketing efforts focused on two brands – Carlsberg and Okocim. At the regional level, the Group focused on strengthening the position of Kasztelan, Bosman and Piast in their respective home markets. Furthermore, in 2002, Carlsberg Okocim launched a new sales strategy based on independent distributors who sold the full range of the Group’s products. Emphasis was placed on closer cooperation with distributors, improved service quality and joint market initiatives. To improve cooperation with wholesale distributors and commercial chains, a new network of distribution warehouses was established, which in turn led to the closure of premises at Cz˛estochowa, Kielce, Torun ´ and Łód´z. Lastly, a new IT system improved document flow and centralized inventory management. In both 2002 and 2003, the Carlsberg brand was the prime focus of promotional campaigns, especially on TV. These marketing efforts increased the sales of Carlsberg beer in Poland by 671 per cent in 2002. The brand’s availability improved and its pricing strategy restructured to be competitive with local brands. The Danish-style packaging was replaced with 0.5 litre bottles in a special carton, which were more familiar to Polish consumers, as well

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as new multi-packs. Distribution channels were reviewed and the brand was made available in most important supermarket chains. Carlsberg also introduced special motivational measures for all employees involved in the project.

Strengthening selected national brands The Carlsberg Group also shifted its communication strategy for the Okocim brand towards focusing on a single image for the entire brand. Prior to the creation of the Carlsberg Group, local brands purchased by Carlsberg were distributed in cans or in so-called ‘Euro standard’ returnable bottles. These bottles were replaced with the customized ’okocimska’ bottle. The new packaging, with its attractive graphic design, enhanced the brand’s prestige and helped to attract new consumers as well as retain existing ones. Intensive advertising activities accompanied the launch of the Okocim Jasne Pełne brand, the most eye-catching of which was the TV advertising campaign linking the beer brand’s name to values that bring Poles together. Okocim Jasne Pełne was also advertised in magazines and the daily press. During the summer season, promotional activities were conducted at points of sale under the ‘Okocim Days’ scheme. Consumers who purchased two bottles of the advertised brand were offered, free of charge, a small bottle of Okocim Jasne Pełne. The purpose of this was to encourage the potential consumers to sample the new brand. The product itself was awarded the highest score in the Polish beer ranking held by ‘Gazeta Wyborcza’, the largest Polish daily newspaper, an award that was extensively communicated in advertisements in turn. In 2002, the Carlsberg Group focused a significant portion of its marketing efforts on the brand ‘Volt’, an inexpensive beer targeted at the younger generation. The company managed a rapid increase in the brand’s points of availability from 33 per cent in January to 64 per cent in December. Another important step in Volt’s image repositioning was a new design and packaging. The Group introduced a series of three types of cans, which contributed to the promotion of the brand’s value. New methods of promotion were introduced, including new point of sale material that primarily targeted youth. Attractive prizes, such as multimedia laptops and CDs, attracted public interest. Consumer promotions established Volt’s presence in the media and advertising spots were broadcast on nationwide radio stations. Carlsberg’s second communication channel was selected press titles created for active youth, where advertisements were placed referring to the brand’s value and the promotions available. The Carlsberg Group also effectively responded to the increasing interest of the Polish consumers in the ‘strong beer’ segment, meaning those beers with an alcohol level of approximately 7 per cent. Competing with Heineken Zywiec-Group and Kompania Piwowarska in 2002, the Group decided to

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increase the size of its cans. Consequently, Okocim Mocne became the first beer in the Polish market to offer consumers ‘15 per cent more’ in a taller than standard can. In late 2002, the Okocim Mocne brand was supported with a tactical TV advertising campaign that helped it regain market share. At the same time, the group launched a new, strong brand – Volt Strong, a variation of Volt beer. Positioned similarly to Volt Original in the lower priced sector, Volt Strong offered high quality with a characteristic sweet flavour at a competitive price that, combined with its very attractive and dynamic packaging, generated high consumer interest. In the same segment, Carlsberg offered two regional brands; ‘Piast Mocne’ and ‘Kasztelan Mocne’. The Carlsberg Group emphasized leveraging market niches, particular those in the non-alcoholic beer category. Primarily, the Group focused on Karmi beer, which resulted in a sales growth rate of 23 per cent in 2002. The success of the marketing campaign arose from the consistent and multidimensional promotions, combined with a two-year programme concerning the improvement of brand manufacturing and quality. The increased sales of Karmi beer could be attributed to the nationwide TV advertising campaign, conducted under the ‘We know what’s good for us’ slogan, designed specifically to attract women. This effort included a promotional campaign in commercial chains known as ‘Karmilanie’, beer sales with bonuses in the form of elegant gifts, and the modified graphic design that enhanced the feminine brand image. Advertising materials were also prepared for retail outlets stressing the brand’s lightness and femininity. In the summer months, Karmi was sold in kegs from Karmi sandwich bars. The new promotional strategy of the Carlsberg Okocim brands included a strong emphasis on hotels, restaurants, coffee shops, and outlets, where promotional activities were conducted involving regulars in games and competitions with prizes. The participating premises were provided with glasses and umbrellas bearing the company logo. Some were also equipped with beer garden furniture.

Building local brands Efforts to strengthen the position of the national brand, Carlsberg, were combined with the development of regional brands. For example, Kasztelan, the strongest regional brand, recorded a 5 per cent sales growth in 2002. The product was recognized by beer experts at the Łód´z Beer Festival and during the ’Chmielaki’ competition, where Kasztelan Jasne Pełne was awarded a gold medal and Kasztelan Mocne a bronze medal. Bosman, another of the Group’s regional brands, focused on strengthening its position in the local market. Intensive marketing efforts targeted consumers from north-western Poland. Promotional and advertising efforts helped to strengthen Bosman’s position, supporting its marine, regional image through a strong presence in the local media (TV, radio, outdoor and press), and through sponsored events, and consumer and commercial

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promotions held at retail points of sale and hotels, restaurants, coffee shops and outlets. The strategy was effective, as reflected in the 4 per cent sales increase in 2002, despite a substantial narrowing in the distribution area. In April 2002, two products, Piast Jasne Pełne and Piast Mocne, were launched under the Piast brand. Both replaced existing brand varieties. The relaunch of the Piast brand involved an altered graphic design, new labelling, a corporate ’okocimska’ bottle, an improved recipe, a new price structure, and a new, consistent marketing strategy. At the same time, Carlsberg Okocim retained the Ksi˛az˙ and Wrocławski Full brands. The Piast brand is the region’s pride and a symbol of the best in Lower Silesia. The campaign supporting the launching of the new Piast brand was conducted under the ‘Piast Piwo Zdolnego S´ l˛aska’ (Piast Beer from Talented Silesia – a play on words, in Polish ‘from Lower’ = ‘Talented’) slogan. During the course of the campaign, Piast received strong support from regional media across retail channels for which new consumer and commercial promotions were developed.

Human resource development The company’s main objective was to create a world class team, composed of highly qualified, ambitious, motivated and open minded people, oriented towards constant development. Carlsberg strongly emphasized the development of a transparent organization within the company, reflecting the responsibilities of all staff members. The reorganization of human resources was started in the Brzesko Brewery (Okocim) and was then continued in the Bosman and Kasztelan breweries. After these areas were addressed, the process of building a single organizational structure within the Group began in the second half of 2001. During the same year, Carlsberg started introducing ‘management by objectives’ systems for top and medium level managers. Clear descriptions of yearly objectives and individual tasks allowed for improvements in the company’s strategic objectives. Carlsberg also supported the development of individual skills through the training of staff members. Training topics included implementation of new computer software, financial management, negotiations skills, time management, strategic management, and presentation skills. Internal and external communication was also heavily emphasized. Within the framework of internal communication, the flow of information to each employee was improved. Information on implemented changes in terms of restructuring reached all brewery employees. This information exchange reduced the scale of possible fears related to such aspects as the stability of the work place, and possible changes in tasks and obligations. Today, internal communication is assured through the corporate newsletter, and e-mails from management. Meetings with management were organized, at which staff members were

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informed of changes through presentations or films created specifically for this purpose. The company’s human resource development activities focused also on improving sales efficiency. The HR Department developed a system to evaluate the competencies of sales staff, assuring market success was based on such competencies. Carlsberg built short-and long-terms development plans for all staff members within the sales and marketing departments.120

Cost reduction An important element of the restructuring process and the move to improve Group operations was the reduction of operational costs. When the group became fully operational in 2002, the company managed to lower substantially the ratio of ‘cost of goods sold’ to net revenue from 36.1 per cent in 2001 to 35.2 per cent in 2002. The cost of sales as compared to net revenue dropped significantly from 50.5 per cent in 2001 to 39.3 per cent in 2002. The ratio of selling costs to net revenues decreased due to such organizational changes within the Group as the centralization of purchasing and administrative functions, and the establishment of a shared sales and distribution network. The Group significantly reduced general management costs from 18.5 per cent in 2001 to 13.7 per cent in 2002. The implementation of a new IT system and the introduction of consistent procedures allowed for better and more flexible management of the logistical processes within the Group. Substantial savings were generated in strategic inputs and materials purchasing. Production planning functions were integrated and systematized. Thus, production capacity was more effectively utilized by all the breweries within the Carlsberg Okocim Group. The strategic, long-term approach to the issue of cost reduction also took account of investment projects. The process of beer bottle and crate standardization was continued within the Group. When extending the Brzesko brewery, new fermenting tanks were commissioned and a test run of the new brewing facility was begun. The consolidation involved the standardization of analytic methods for beer inspection, materials, inputs and process flows. Following optimization, changes in technological processes, and the application of new operating methods, production costs were reduced. The integrated production planning functions allowed for flexible management of the area in question. The expansion of the Brzesko brewery, as well as the upgrade of the draught lines at the Bosman and Kasztelan breweries, led to a more economic utilization of production capacity. In April 2002, the modernization of Okocim brewery in Brzesko was finished and the brewery was prepared to produce 2 million hl of beer, compared to only 1.5 million in previous years.

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Financial results The last publicly available financial data for Carlsberg Okocim relate to 2002, which is just prior to the Group’s withdrawal from the stock exchange. Asset values in 2002 reached PLN 901,248,000 (EUR 214,582), representing a 106 per cent increase over the corresponding 2001 figure. This increase reflects the execution of the purchase agreement whereby Carlsberg Okocim SA acquired the Bosman and Kasztelan breweries. On 31 December 2002, the ratio of fixed assets to total assets stood at 66.2 per cent. Despite the restructuring process and organizational changes related to building the Carlsberg Group in Poland, the company earned a profit in 2002. Following its EUR 4.2 million loss in 2001, the company improved efficiency, reduced production costs, and ended the year with a profit of EUR 630,000. The profit arose despite significant increases in financial costs related to the acquisition of the Kasztelan and Bosman breweries. The positive financial result in 2002 showed that the process of building the Carlsberg Group in Poland was relatively swift and that the restructuring measure significantly improved the efficiency of the Okocim Brewery. Simultaneously, the Carlsberg Group became the smallest significant player on Polish market. Mergers and acquisitions are likely to continue on the Polish beer market, as large beer manufacturers are currently interested in the Perła Lublin and Brok Strzelec breweries. The extent to which Carlsberg Okocim will be able to participate in the acquisition of new breweries and strengthen its market share is unclear.

Conclusion Carlsberg applied mixed control modes in Poland, where it aimed to become a major player in the beer market. Carlsberg decided to take control of two breweries, Kasztelan and Bosman, through the acquisition of, respectively, 99.77 per cent and 99.39 per cent of their initial capital. Simultaneous control over the Piast Brewery was gained through the purchase of 81 per cent of the Dutch holding company, Dyland BV, the owner of 98 per cent of Piast stock. This acquisition gave Carlsberg control over two Piast Breweries, a malting plant and two distribution companies. On the basis of agreements between Piast and Carlsberg Okocim, Carlsberg purchased Piast products and placed them in its distribution network. Control over Piast gave Carlsberg direct access to the Lower Silesia region, characterized by a strong beer culture and relatively high consumption. Piast went through a restructuring process similar to those experienced by the remaining three Group breweries. The marketing and sales functions were centralized in Group headquarters. Furthermore, Carlsberg participated in the second round of privatization, allowing it to avoid complex negotiations with public authorities and labour unions.

216 Growth through Multiple Acquisitions

Like its competitors, Carlsberg developed its market position through mergers and acquisitions. It did not have a spectacular success like Tyskie beer, which nearly tripled its market share within two years. Although Okocim was the fastest growing brand in Poland in 2001, the growth was not sufficient to regain the market position it held in the late 1990s. The acquisition of the Bosman and Kasztelan breweries, with a combined market share of 5.3 per cent, and the control of the Piast brewery, with its 3.2 per cent share, made Carlsberg Okocim’s total share of the Polish beer market about 15 per cent in 2001 and 14 per cent in 2003. The acquisitions gave Carlsberg Okocim critical mass in the Polish market, thus enabling it to establish an efficient national distribution and sales force, and to introduce a new branding strategy that positioned Carlsberg as a strong international premium beer, and Okocim as the strongest national brand, supplemented by a number of strong regional brands. The Group’s position relied on restructuring measures, which include a reduction in management costs, achieved through the centralization of the marketing and sale functions, the reduction in local brands, and a focus on selected strong brands. Restructuring was conducted in three main areas: the product portfolio, the distribution system, and the compatibility of manufacturing plant with new technology. This restructuring and modernization allowed significant reductions in costs, making Carlsberg Okocim a profitable company.

16 Purchase the National Brand No. 1 to Rescue Entry Strategy? The Acquisition of Wedel by Cadbury-Schweppes Przemysław Kulawczuk

Introduction Cadbury-Schweppes (CS) first entered Poland in 1993 by establishing a greenfield operation. In 1998, it accelerated its market penetration by taking over an old established Polish confectionery manufacturer that had been owned by PepsiCo for six years. Subsequently, CS developed its brand portfolio with a strong emphasis on local Wedel brands, even to the extent that the global Cadbury brands received less marketing support than before. The acquisition thus illustrates the power of loyalty to local brands, and how this loyalty can modify the global strategies of international companies. The case took place in the context of the change from a grey socialist coupons market providing, monthly, two bars of chocolate per person in 1985, when adult customers could exchange the 200-grammes of chocolate for a bottle of vodka or two bottles of wine, to a competitive, consumer oriented market with the largest chocolate manufacturing capacity in the European Emerging Economies (EEE) in 2002. The histories of the two companies, Cadbury and Wedel, developed along fairly similar lines during early stages of their life. Both started in the nineteenth century as small private firms specializing in chocolate manufacture, and both developed significantly in their national markets (UK and Poland) until the Second World War. After 1945, they went in different directions. While Cadbury enjoyed the operation in the real market, Wedel was nationalized and changed its name into 22 lipca (22 July) to honour the proclamation of the Manifesto on 22 July by Poland’s Liberation Committee associated with Soviet allies. Despite the change of company name, the factory still marked its products ‘22 lipca, formerly E. Wedel’. Thus, the tradition and brand loyalty to Wedel products was kept alive in Polish society. 217

218 Purchase the National Brand No. 1?

After the fall of communism, all major chocolate producers were sold to international companies. The only exception was 22 lipca, which had again adopted the old name Wedel SA. Poland’s treasury preferred not to lose this famous national brand, and in 1991 sold 40 per cent of equity stock to a non-chocolate manufacturer, PepsiCo. After six years, PepsiCo withdrew from the investment and CS purchased most Wedel brands. CS had originally entered Poland by building a large greenfield factory near Wrocław, in the south-west of Poland in 1993. On this basis, it had built a significant presence in Poland before acquiring Wedel. Why, therefore, did Cadbury purchase Wedel? To the surprise of local observers, two to three years after the Wedel purchase in 1998, Cadbury products disappeared from sales outlets in Poland, while the range of Wedel products expanded. Apparently, strong national brands can replace international brands, even for a company pursuing a global brand strategy. This chapter explores the dynamic development of the CS expansion strategy in Poland. Two features make the case particular interesting. First, contrary to common patterns, the acquired local brands replaced the investor’s own brands. Second, one foreign investor took over the generally successful operations of another foreign investor.

The firms Cadbury-Schweppes In 1824, John Cadbury opened a business in Birmingham that dealt with selling foods and drinks, including hot chocolate. Cadbury invested considerably in shop display, which attracted the attention of the crowds. In 1866, the company created a recipe for instant cocoa. In 1904, Cadbury introduced a new, creamy, milk chocolate called Dairy Milk, thus challenging leading Swiss chocolate manufacturers. Cadbury began overseas investment in 1922 when its first overseas factory was build in Australia.121 An important step in the history of the company came in 1969 with the merger with Schweppes, which specialized mainly in soft drinks and was a PepsiCo franchise operator in the UK. However, in 1986 Cadbury changed alliances and began cooperation with Coca Cola. Also, it purchased Canada Dry and Dr Pepper and became the third-largest soft drinks company in the world. Explaining these moves, the chairman of the company Sir Adrian Cadbury, emphasized that ‘he had bought and sold businesses with the sole objective of building up its brand strengths in line with the Group’s declared aims’ (Eccles and Stoll, 1991).

Global strategy Cadbury-Schweppes Plc is an international company with headquarters in Great Britain. The company is a public limited company and thus focused

Przemysław Kulawczuk 219

on growth of shareowner value. It aims to achieve this objective with the following strategies:122 • Focusing on core growth markets of beverages and confectionery • Developing robust, sustainable market positions which are built on a platform of strong brands with supported franchises • Expanding market share though innovation in products, packaging and route to market where economically profitable • Enhancing market positions by acquisitions or disposals where they are on strategy, value-creating and available. The CS group is focused on the beverages and confectionery businesses, two closely related consumer markets, and manages an extensive portfolio of brands. CS and its subsidiaries manufacture and distribute branded beverages and confectionery, and related foods, in almost 200 countries throughout the world.123 In confectionery, CS had manufacturing facilities in 25 countries and marketed a broad range of chocolates and sugar confectionery brands over 170 countries in the form of bars, blocks, bagged products, rolls, boxed assortments, chocolate eggs and novelties. Products were sold through groceries, confectionery outlets, garage forecourts, convenience stores and kiosks. In principal markets, products were sold through CS’ own sales and distribution organizations. It is important to underline that a significant part of sales was through super- or hypermarkets and chain stores. This distribution channel seems especially important in countries that reshaped their shopping networks, such as EEE. In beverages, CS operated primarily as a licensor, selling concentrate and syrups to independently-owned bottling and canning operations, to whom it also provided marketing support and technical monitoring. The beverages operations had bottling and partnership operations in ten countries and licensed their brands in a further 21 countries around the world. CS beverage products were sold to consumers through many different outlets, ranging from grocery stores to garage forecourts and fountain equipment, and leisure, food and entertainment venues. As for confectionery, in markets such as Poland, large supermarkets were the main distribution channels. Beverages sales are to some extent seasonal, with peaks in the summer months and before festive seasons such as Christmas.

The brand value concept Brands constitute a particular value for CS and it is necessary to understand the philosophy of the company. Quotations from official company documents illustrate this philosophy:124

220 Purchase the National Brand No. 1?

Whether on the commercial side developing and extending brands, working in operations, in procurement or manufacturing, communicating with our consumers or selling, at Cadbury-Schweppes we are in the process of creation. It is essential to be innovators in product research and development in our supply chain, and routes to the market, with consistent investment to guarantee unique taste, quality and value. Working together at Cadbury-Schweppes we deliver growth by working together to leverage our strengths around the globe driving existing brands and creating new ones is at the very heart of our business.  Brands are the essence of our relationship with customers. Values that we communicate and instil in our products over time make them into brands. Brands that people consume all around the world in their millions. The role those brands play in our consumers’ life is what distinguishes them from competitors’. Whether it is Dr Pepper in the US or Cadbury’s Dairy Milk in the UK, these relationships are very special.  How consumers feel about our brands. Liking is not enough, that’s why we use love as quintessentially powerful expression of the way people feel about Cadbury-Schweppes brands, capturing the affection, the importance, the character, the unique relationship that customers have with them. Our customers can be anybody, from any age, anywhere in the world. Our consumers’ needs have to be met, and it is then the relationship they have formed with the brand through experience and implicit trust in quality and taste determines and drives the purchasing decision. This philosophy is based on strong emotional attachment of customers to Cadbury’s brands, connecting these brands with pleasure, and the belief of the company management in the creative power of building brands that people love. Such a philosophy is included in the reports distributed to general public. The strategy of the CS is mostly based on a global approach with specific modification for industries where brands had unique and emotional value (Bartlett and Ghoshal, 1989). It means that brands themselves have value and a uniform branding policy is contrary to this concept. The application of the CS strategy in Poland is evidence that simple thinking in categories of cost reductions through excluding the local brands and promoting international brands does not always prove to be efficient. Sometimes national brands have stronger power than international brands. The company adopted three fundamental models of the confectionery business (market entry modes). The description of these models is included in the company reports.

Przemysław Kulawczuk 221

In confectionery we have increasing presence in not just chocolate but also sugar and, more recently, chewing gum. We have three basic models of development of our business: (1) the first where our brands have been sufficiently long and well established to give what we call ‘first mover’ advantage (markets such as the UK and Australia); (2) the second where we seek to transfer this model into relatively undeveloped markets through greenfield ventures (such as China and Poland) and; (3) the third where our current brands are not sufficiently well known and markets are mature, we acquire business to create critical mass (such as France and Argentina).125 These words were written in 2000, reflecting the company’s official strategy. As will be shown below, CS shifted its Polish operations after the acquisition of Wedel from an unsuccessful operation in model 2 category to a successful one in model 3.

Acquisitions and disposals Acquisition and disposals played an important role in CS both before and after the Wedel acquisition. Developing strong market positions requires, in the company concept, building a platform of strong brands supported by franchises. Especially interesting seems to be the approach to acquisitions and disposals: The strong positions we enjoy in most of our markets have been achieved by a combination of organic growth, but also acquisition and disposal. We have sought to dispose of lower earning or disadvantaged assets and used these funds to acquire higher growth potential businesses which also strengthen our existing positions. We have been able to do this and simultaneously achieve a higher price earnings multiple for those business we sold than those we have bought. In this way our restructuring of the portfolio seeks to create value for our shareowners. Our overall portfolio now comprises a series of businesses which are much more competitively advantaged than they were four years ago.126 In addition, CS also raised funds from the market through selling brands with lower market potential in over 160 markets, especially in the area of beverages.

Wedel SA Wedel had over 100 years of tradition which developed from a small family firm founded by Karol Wedel in Miodowa (Honey) Street in Warsaw. Information on recent history is scarce. When the company was sold to Cadbury in 1998, Internet sources in Poland were still rare. After 1999, the company had been withdrawn from the stock exchange and Cadbury-Wedel thus had

222 Purchase the National Brand No. 1?

no legal obligation to publish operational or financial data. It is sometimes mentioned that results were good (2001) or that the company had to face difficult market conditions (2000). However, Wedel is acknowledged as one of the then most advertised brands in Poland, and one of the largest payers for advertising. In 2003, marketing spending for Wedel brand advertising was estimated between PLN 80–100 million. The most recent available balance sheet refers to 1996 and 1997 and is provided in Table 16.1. The data show that Wedel sales in 1997 reached PLN 829 million, equivalent to USD 234 million. (The exchange rates of PLN to USD were 2.47 on 1 January 1996, 2.86 on 1 January 1997, 3.53 on 1 January 1998. On 22 November 2003, the exchange rate was 3.91.). The data contain information on all the companies of the then Wedel holding company, including Frito Lay (crisps) and Syrena Ltd (sugar confectionery). The data may reflect the preparation for the sale of the company. The goodwill was expanded to cover the value of Wedel brands to sell them more easily without too much tax. Significantly increased management costs may represent higher costs, but they might also indicate extraction of profits before the disposal of assets, and the size of these costs might not be easily accepted by regular shareholders. However, such moves in the balance sheets and profit and loss statements would not have been possible if PepsiCo had not been the majority owner. The increase of management costs reduced operating profit significantly. The financial data presented above may not represent the real financial situation of Wedel but may indicate how effectively PepsiCo could take cash from the company. Also, shortly before selling the assets of Wedel, PepsiCo decided to pay themselves an additional dividend of PLN 8 million. It is very important to underline the fact, that Wedel was very profitable for PepsiCo. The share prices rose over ten times while the exchange rates of foreign currencies increased by a little more than three times. Both parties to the deal, PepsiCo as seller and CS as buyer, considered the disposal of Wedel as good business. PepsiCo developed the company substantially

Table 16.1 Wedel SA: financial performance prior to acquisition by CS

Net sales Operating profit Management costs Assets Goodwill Capital equipment Equity

1996

1997

650 60 69 435 1 256 356

829 21 108 1 206 493 441 393

Source: Monitor Polski No. B-322: 14–16.

Przemysław Kulawczuk 223

and earned handsome profits, yet it had limited knowledge of the confectionery industry, which limited its ability to stay ahead in an increasingly competitive industry. Cadbury-Wedel on the other hand had gained market leadership in the Polish chocolates industry, and according to market researchers AC Nielsen attained a 27.9 per cent market share in 2001, followed by Stollwerck (20.3 per cent), Kraft Foods (15.6 per cent) and Nestlé (11.3 per cent).

Entry CS selected Poland as its manufacturing base for the region in 1993. CS had a choice between three modes: exporting from another European operation, acquiring a local Polish company, and establishment of a greenfield plant. Export was ruled out due to the high import tariffs at the time, and substantial transportation costs in the industry. CS evaluated alternative entry strategies, and decided to start a greenfield investment in Kobierzyce, near Wrocław. The initial assessment of potential acquisition targets noted many problems; overstaffing or lack of investment, were found to be common across all of them. However, one of the Cadbury managing directors frankly admitted in 2004: ‘In that time [1991] we simply offered too low price to Poland’s Privatization Agency for Wedel. This is why PepsiCo won. We did not assess the Wedel assets as worth spending USD 25 million (GBP 15 million) for 40 per cent of its stock’. Seen in retrospect, the initial due diligence may have undervalued the firm, as CS later paid a much larger amount for the – by then, restructured – company. At the beginning, the greenfield investment appeared to be quite successful. The company received a welcoming reception from the local community and built a modern factory with capacity to serve the whole central European market. The street name where company was located was changed into Czekoladowa (Chocolate) and the Company address was at number 1. The main reasons for CS investment in Poland were the growing potential of domestic and regional markets, low manufacturing costs, the very supportive approach of local government and relatively very friendly regulatory environment in Poland in the early 1990s. At the same time, other leading international companies opened or acquired manufacturing capacities, including Nestlé, Stollwerck, Kraft Jacob Suchard and Fazer. In addition, local private or privatized companies offered local brands such as Wawel, Mieszko and Jutrzenka, which were mostly at lower price levels. The leading position with the largest market share was occupied by Wedel. Wedel had been privatized in 1991 with an initial price of PLN 18 per share. From 1991 to 1998, when the company was withdrawn from the Warsaw Stock Exchange, the share price rose to PLN 194.39 per share – over ten times

224 Purchase the National Brand No. 1?

higher than the initial price. The treasury sold 40 per cent of the company stock to PepsiCo before entering the Warsaw Stock Exchange. PepsiCo was considered to be a very aggressive investor with plans to develop a Polish market for salted snacks, but without serious ambitions to introduce its own brands in the area of confectionery. Thus, the treasury anticipated that PepsiCo would be interested in developing Wedel brands, which expectation came true. After six years, PepsiCo decided to withdraw from the confectionery market. The first step was to withdraw Wedel SA from the Warsaw Stock Exchange. The task was transferred to Wojciech M¸adalski, the marketing director of Pepsico, who worked in the London Office on the Development Strategy for Europe, North Africa and Middle East. His idea was to purchase all stock from the Warsaw Stock Exchange, and sell the company, probably to one of the industry leaders. In early 1998, PepsiCo announced a call for purchase of Wedel stock and managed to collect 98.9 per cent of all traded stock. The purchase was effected at the price of PLN 200 per share. Finally, on 16 April 1998 Wedel SA was withdrawn from the public. PepsiCo’s strategy was to partition the company into product divisions and sell each part separately. Wedel was converted into a holding company which could sell subordinated firms. In December 1997, Leaf acquired sugar confectionery manufacturer Syrena Sweets Ltd, while a few months later Danone purchased chocolate biscuits producer Delicja Ltd. In autumn of 1998, PepsiCo announced a call for offers for Jedyna Ltd, the manufacturer of chocolate confectionery that also owned the main asset, the Wedel brand. CS purchased the assets of Jedyna for GBP 76.5 million, expecting that the acquisition of the Wedel brand and chocolate confectionery business would give it a leading position in the developing Polish chocolate market with, initially, a 28 per cent share. Based in central Warsaw with one factory, the business had sales of GBP 80 million and employed around 1100 people. Announcing the acquisition, Ian Johnston, Managing Director of CS Confectionery, said: ‘The combination of Cadbury and Wedel puts us in a strong position to generate added value for the group in this large developing market. The Wedel trade mark is a powerful asset representing high quality, good value chocolate and is a good fit with our existing Cadbury operation.’127

The environment Although the business environment in Poland in the late 1990s has often been considered deficient and less than conducive for international business, none of these concerns appear to have had a significant impact in the case of CS. The legal and regulatory environment did not create any serious problems for selling company assets. It seems that accounting rules in Poland supported the changes described in the case study. Neither were there any

Przemysław Kulawczuk 225

problems with the withdrawal of Wedel from the Warsaw Stock Exchange; however, it created some kind of shock for some investors. It was the first withdrawal of this size from the Warsaw Stock Exchange, though it was followed by other cases of foreign investors withdrawing their Polish operations from the stock exchange; for instance, the case of Carlsberg Okocim (see Chapters 15). Trade unions activities in the confectionery industry did not reach the aggressive forms observed in other industries in Poland, such as mining, and labour relations cannot be considered as any barrier. There is a good supply of professionals in this sector. To some extent corruption may be a minor problem, but in the 2004 opinion of Cadbury-Wedel managing director Peter Knauer it does not reach any level comparable with Russian problems in this area (He was a managing director in a Russian CS factory in Chudowo before taking over as managing direct in Poland). Moreover, the accounting, tax and legal environment gradually reached levels similar to the other EU countries.

Integration and restructuring of the firm After buying the chocolate factory assets, CS created Cadbury-Wedel Ltd by merging Cadbury Poland Ltd with Wedel SA. This changed the competitive position of CS on the Polish market significantly. Before the acquisition of Wedel assets, Cadbury Poland was fighting to achieve a significant market share – with, however, limited success. Yet, the purchase of Wedel more than tripled its market share to 28 per cent in 1998. Before 1998, Cadbury was selling its own brands in Poland aiming at the premium segment with high price levels, thus distinguishing itself from mass market brands dominating the market with inexpensive products. The fast development of hyper- and supermarkets offered new avenues to sell cheap products. Cadbury confectioneries were perceived as too expensive for these stores, yet they did not have the prestige of, for example Lindt in luxury food stores. Thus, Cadbury had serious problems with positioning its products in the Polish market. As a result, the manufacturing base in Poland operated below full capacity. The acquisition of Wedel may thus be seen as response to the ineffective market strategy of Cadbury in Poland. Polish customers preferred the Wedel brand, and Cadbury realized that it should change the name of its company in Poland to Cadbury-Wedel Ltd. From the beginning, Cadbury realized that the real value of the acquisition of the Wedel factory was in the brands, not in the factory itself. According to Poland’s Businessman Magazine in 2002, the Wedel brand has been the best Polish brand in three areas: positive knowledge, utilization potential and image value. This brand value has been confirmed by other research. A representative survey of polling company PBS Sopot in April 2002, across 500 customers, revealed that Wedel is considered as Poland’s best brand by 28 per cent of

226 Purchase the National Brand No. 1?

the Polish population. The second-best brand achieved nearly four times less indication (8 per cent). Similarly, the potential of Wedel brands was shown in a survey by Claritas Polska on customers’ preferences across 1.2 million customers on goods and services in 2001. Accordingly to the Claritas survey, 27 per cent of the Polish population bought Wedel products, 24 per cent KJS products and 21 per cent Stollwerck chocolate confectionery (such as Alpen Gold). Different segments preferred different products. Young, well- situated people bought the brands Cadbury, Lindt and Ritter Sport. Elderly people bought Polish brands: Goplana, Wawel. Children bought cheaper brands (Alpen Gold, Terravita, Baron, Kinder Surprise). All groups, however, bought Wedel as being a universal brand that was associated with high quality and a reasonable price. Cadbury exploited the Wedel brand value by further reinforcement in an advertising campaign, and extended its presence in hyper- and supermarkets. It was supported by more than double marketing expenditure. The visible role of Cadbury brands in advertising in the Polish media almost disappeared. Cadbury-Wedel used a strong TV campaign supported with press presence and numerous customer competitions. Wedel became one of the ten most strongly advertised brands. Evidence of the strategic shift of promotional efforts from Cadbury’s own brands to Wedel brands is not directly available. The company does not give information on the sums spent on marketing individual brands. However, the effect of the promotional effort can be indirectly evaluated by the presence of flag brands of Wedel and Cadbury in leading retail shop networks or supermarkets. Table 16.2 reports the presence of Cadbury and Wedel flag brands in northern Poland in November 2003. Shop inspection reveals that leading Cadbury brands have a low key presence on shop shelves in leading chain stores in northern Poland. They are usually positioned on lower shelves that would be less accessible to potential consumers. In only one shop chain, Polish-owned Bomi, were Cadbury brands easily accessible to clients and positioned on the same shelf as Wedel. Cadbury Picnic wafer was accessible with difficulty, being almost invisible. In wafers, dominant positions were taken by Prince Polo, made by KJS (also an acquired Polish brand of Olza Cieszyn). It seems that Cadbury brands occupy less accessible and lower prestige positions. It reflects the small turnover of goods. Cadbury’s chocolates were available only in three locations and the number of brands had never exceeded three positions. Unlike Cadbury’s original brands, Wedel brands were present in all locations. Only in one location there was only one Wedel chocolate product, but in all locations Wedel pralines (Ptasie Mleczko) were present. Wedel products occupied the most easily accessible shelves in all locations and were usually much better displayed than the other products, or at least at the same level. In comparison with other market competitors (Nestlé, KJS, Stollwerck), the visibility of Cadbury’s original brands was poor, much worse than the

Przemysław Kulawczuk 227 Table 16.2 Shop presence of Cadbury and Wedel brands in northern Poland, November 2003 Wedel’s Comments Cadbury’s Cadbury’s Wedel’s Luksusowa Ptasie Dairy Milk Picnic Chocolate Mleczko Wafer (pralines)

Chain

Type

Tesco (British)

Hypermarket

N

A

A

A

Geant (French) Auchan (French)

Hypermarket

N

N

A

A

Hypermarket

N

N

N

A

Carrefour (French)

Hypermarket

A

A

A

A

Bomi (Polish)

Hypermarket

A

N

A

A

E-Discount Supermarket (German)

N

N

N

A

Lewiatan (Polish)

Store

A

A

A

A

˙ Zabka (Polish)

Store

N

N

A

A

ABC (Polish)

Store

N

N

A

A

Lower shelves for Cadbury Picnic Wedel main display Only one Wedel brand (strawberry chocolate) 3 brands of Cadbury’s chocolate – lower shelves 3 Cadbury’s brands chocolate on the same shelf as Wedel 5 other Wedel chocolate brands offered Only one Cadbury’s chocolate brand available Majority of Polish branded Chocolate Majority of Polish Branded chocolate

Source: Based on author’s own shop inspection on November 22 and 23, 2003 (after the start of the Christmas season) in the Gdansk Metropolitan Area. A = available, N = not available.

local Polish competitors such as Terravita or Baron Milan Co. These seems to be no effort to place original Cadbury’s brands on the best shelves, and there is a scarcity of original Cadbury’s products in stores. This observation was confirmed by Cadbury-Wedel managing director Peter Knauer in January 2004: ‘There is no promotional support for original Cadbury brands in Poland. We support only Wedel brands.’

228 Purchase the National Brand No. 1?

Interesting information can be drawn from chocolate labels. CadburyWedel labels indicate the place of manufacture: (1) when a product is produced in an old Warsaw plant, this plant is mentioned as the place of manufacture; (2) when a Wedel branded product is produced in a Cadbury greenfield factory near Wrocław, both addresses are mentioned with Wrocław indicated as the place of manufacture. Thus, part of the Wedel brands manufacturing was moved from Warsaw to Wrocław, and plants originally built for production of Cadbury brands also produce Wedel brands. In fact, they can produce all brands and they may produce different brands for different markets. Observation of Cadbury-Wedel advertising shows that only Wedel brands are promoted, while Cadbury brands are completely invisible. This was confirmed by the company. As it was mentioned before, Cadbury-Wedel business is driven by the promotion of brands. Without a drive to push Cadbury brands, there is no sales growth in these brands. Accordingly to the CS Interim Report 2003,128 marketing expenditures accounted for 11.8 per cent of sales in the first part of 2003, compared to 11.4 per cent in 2002. This information does not correspond with the 19.4 per cent ratio for the whole 2000 or 18.1 per cent ratio for the whole 1999.129 It shows that, in the second half of the year, marketing expenditure is approximately three times greater than in the first. The sales are driven by strong promotional campaigns. If the campaign only promotes Wedel brands, other brands (such as Cadbury brands) may disappear from the market. This is the reason for the very weak presence of Cadbury’s brands in Polish chain stores. It may constitute indirect evidence that Cadbury withdrew from promotion of its original brands in favour of Wedel brands in Poland.

Why did Cadbury move away from its own brands? Again, it was difficult to find the answer in the company. The Cadbury-Wedel managing director Peter Knauer maintained that: ‘Wedel brands had higher market potential and we supported the most promising brands’. Below, there are some possible answers which offer supplementary explanation: • The price positioning of Cadbury’s brands was poor (in fact, prices for Cadbury’s brands were not seriously higher but they were considered to be more expensive) • The product, despite its excellent quality, created an unnecessary barrier between clients and the company (too expensive and too British, instead of British adapted to suit Polish tastes) • It was easier to sell Wedel brands than Cadbury’s • It was cheaper to promote Wedels’ brands to receive sales • The efficiency of selling Wedel brands was significantly higher • It is easier to sell Polish brands in Poland.

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It seems that CS benefits from cultivating traditions that are based on national or regional cuisine. Why are Poles strongly tied to national food brands? There is a strong feeling that Polish products are healthier because foreign foods contain chemical additives and customers in Poland cannot control this. Second, consumers prefer brands associated with Polish values, traditions and history, or with an ethos of family, children and home. ‘Support your local sheriff’ or ‘Buy Polish’ ideology also has some importance. The mix of these reasons create a domination by national brands that appears difficult for outsiders to overcome. It is good for CS shareholders that the company changed its strategy in Poland and began to consider Poland as a growing market with some features characteristic to mature markets, including loyalty to traditional brands. The exploitation of something that is known to everybody is easier than creating something new and artificial for customers.

Further consequences of restructuring The employment at Wedel plants in Poland at the time of acquisition was roughly 1100 employees. At the end of 2003, the total employment in the Warsaw and Wrocław plants was approximately 1250 persons – of this 912 were employed in Warsaw. Employment at the Warsaw plant decreased by approximately 200 employees (circa 20 per cent) within four years. Most of this decrease was natural personal movement, but there were also some reductions in the level of employment at Warsaw. After the merger with Cadbury Poland Ltd, the management of the company was moved to Warsaw. The two plants have significant cost differences and the Wrocław plant produced confectionery significantly more cheaply. Some production was moved to Wrocław, which enabled the cutting of labour costs in Warsaw. Wages in Warsaw were significantly higher than in Wrocław due to the long service of Wedel employees. When employment had to be cut, employees were offered compensation or the opportunity to move to Wrocław. Only three of them accepted that offer, as the situation in the labour market is much better in Warsaw than elsewhere in Poland. There were serious fears about reduction in the number of workplaces in Warsaw. Unions demanded confirmation from management of job stability, but management made no promises. As explained by Peter Knauer,130 Managing Director; the company is located in downtown Warsaw on the left bank of the river, in the Praga quarter which changed its spatial function from a manufacturing zone into an office and residential area. ‘I cannot promise that in 100 years’ time the company location will be constantly in the same place. ‘It is however possible to assume that within 10–15 years the spatial function will change and the city authorities will be interested in moving manufacturing companies out of the city.’ At the end of 2003, there were no plans to close the Warsaw plant and move production to Wrocław. In the words of Peter Knauer, ‘now we are

230 Purchase the National Brand No. 1?

using our full capacities in two plants. Why we should move production from here?’ However, the Wrocław plant operates more efficiently, which constitutes a serious challenge for the unions in Warsaw. The trade union Solidarity even started a campaign to secure that manufacture of Wedel brands would not be moved outside Warsaw. The company management and unions agreed to exchange information and avoid any sudden moves. Organizational changes after acquisition were mainly connected with the better allocation of human resources. Some manufacture was moved to the Wrocław plant and most of the management functions were transferred to Warsaw. These moves reduced white collar employment in Wrocław and manufacturing employment in Warsaw. The majority of managerial functions were moved from Wrocław to Warsaw, apart from those affecting manufacturing processes. The company has still its own marketing department in Warsaw, which plays a critical role in the implementation of company strategy on the Polish market.

Results of operation after acquisition The first year after acquisition was very dramatic in terms of financial results for Cadbury-Wedel in Poland. In 1999, the company reported PLN 92 million losses (USD 1 equalled to approximately PLN 4). In 2001, the profit reached PLN 35 million and in 2002 it amounted to PLN 23.5 million. Profit, however, is not necessarily the best way to measure the company’s financial performance with regard to the possibility of using transfer prices. According to the same report, the ratio of marketing expenditure to sales increased from 7 per cent in 1999 to 19 per cent in 2002.131 Before leaving Wedel, PepsiCo reduced its marketing efforts, but the situation changed after, as the new owners increased the ratio of marketing expenditure to sales to the average CS level (approximately 19 per cent).

Conclusion and questions for future research 1 The case study shows that global strategy does not necessarily require the supporting of international brands in order to do business on national markets. Sometimes, it is obviously better to support acquired national brands because it is much more profitable. When do local brands have stronger potential than international ones? 2 It is necessary to have regard for local traditions and feelings because consumers may have an emotional attachment to products. It seems that Cadbury Schweppes really understands the importance of national brands. The better for Cadbury that it managed to withdraw from the difficult and problematic strategy of promoting unknown brands in favour of something that had real value for many people. What managerial culture should be connected with a shift of strategy?

Przemysław Kulawczuk 231

3 Cadbury presents itself as having an outstanding managerial culture. However, researchers note a serious problem with the transparency of company operation at regional levels. Financial information is not obvious and not easily accessible. How thoroughly should shareholders and the public be informed about changes in development strategy at subsidiary level? 4 Businesses such as Cadbury are less connected with quality and value comparisons but are strongly driven by marketing. Each product marketed should be customized to the culture of the host nation. Is it possible to customize global strategy formats to national characteristics? 5 There are some nations that cultivate tradition more strongly, celebrate history, and appreciate a family atmosphere than other. These issues are all emotionally driven. Cadbury successfully exploited the potential connected with these positive emotions. Should MNEs rethink their strategies in the Russian and Chinese markets? 6 It is interesting that some Polish-owned companies have names that reflect history; for example, Mieszko, the prince who introduced Christianity, and Wawel, the castle in Kraców with the graves of Polish kings. Such companies are loved by elderly people. Should this aspect be taken into account if we consider the growing number of elderly people in Europe’s population? 7 Was the acquisition of Wedel brands the rescue for Cadbury-Schweppes’ development strategy in Poland? Does it mean that the previous CS strategy was a mistake? What elements of the previous strategy were mistaken and what were correct?

17 Early Entry and Aggressive Growth: Kraft Foods Lietuva Valdon˙e Darškuvien˙e

Introduction The case of foreign Kraft Foods Lietuva illustrates the peculiarities of FDI at the beginning of the transition period – a time when FDI was highly dependent on the privatization process, and the development of a new market economy. Kraft Foods International’s acquisition of Kaunas Confectionery in 1993 was the second-largest foreign capital investment at that time in Lithuania, with the largest being the acquisition of Lithuania’s tobacco industry by Philip Morris, which belongs to the same parent company as Kraft Foods. Kraft Foods pursued an ambitious global growth strategy, aggressively moving into the European emerging economies (EEE) after the breakdown of the Soviet bloc. After the acquisition, the new Kraft Foods Lietuva thoroughly modernized its processes and brought in new management. The company was strengthened by new, market oriented structures as well as the creation of strong brands in both local and regional markets. Kraft Foods Lietuva successfully implemented its parent company’s expansion strategy for the EEE.

The firms Kraft Foods International In 1989, Philip Morris combined Kraft Foods and General Foods to form Kraft General Foods, the largest food company in the USA. For overseas operations, Kraft General Foods International was established. Strong revenues inspired accelerated growth by acquisition. In 1990, Kraft General Foods International acquired Swiss Jacobs Suchard for USD 4.1 billion, making the company number one in the European roast and ground coffee market and a leader in confectionery. Acquired brands included Carte Noire, Grand Mere and Jacobs coffee and Suchard, Milka, Toblerone and Cote d’Or 232

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chocolates. In 1992 alone, Kraft made fourteen acquisitions worldwide. This aggressive policy continued when moving into the newly opened central and eastern European market in 1992 and 1993. Kraft acquired five confectionery companies in the area: Csemege in Hungary, Figaro in Slovakia, Kaunas in Lithuania, Olza in Poland and Republika in Bulgaria. The acquisition in 1993 of both Freia Marabou, Scandinavia’s premier confectioner, and Terry’s of York, the UK’s major confectioner, brought Kraft the Daim, Japp, and Twist confectionery brands as well as Estrella snacks. Kraft’s multinational strategy was oriented towards the creation of relatively independent regional and local units. Kraft markets fast-moving consumer goods within a wide product portfolio: coffee, cheese, confectionery and dressings. In line with other global competitors in the food and beverage industry, Kraft built its success around fast-selling brands that are instantly recognizable to consumers, and has created one of the most powerful brand portfolios in the history of the food industry. Kraft holds the number one market share position in 22 out of its 25 top categories in the USA, and in 19 out of its 25 country categories internationally.132 Kraft views successful food product marketing as connecting with people in a personal way, offering services such as health and wellness information, or online meal planners. Moreover, Kraft’s intensive R&D focus on food quality and safety is seen as a major competitive advantage. Kraft aims to be at the forefront of industry innovation. Changes in consumer views of snacks, along with the increasing consumer orientation toward healthy food, has had a major impact on the food industry. The declining consumption of chocolate in developed countries, and innovations in the ‘food-on-the-go’ sector in terms of healthier products, pushed food companies to introduce new products and change their product mix. Due to its aggressive expansion, Kraft needed restructuring and concentration into strategic activities to maintain its global position. In 1994, the company laid off 6000 employees globally and closed ten enterprises in Europe.

Kaunas Confectionery Lithuania’s largest chocolate and confectionery firm – Tilka – began operating in Kaunas in 1921. After nationalization in 1940, the company continued operating in the old premises until new production facilities with expanded capacity were built in 1969 in the city suburbs. Kaunas Confectionery became one of the strongest food manufacturers in the former Soviet Union, distinguished by its new technologies, high quality and excellent tasting products, which included a variety of candies, assorted chocolate sweets, moulded chocolate and layered caramel, nougat bars and biscuits. In 1969, Lionginas Turauskas took over as company director, and modernized and expanded its product lines. In the middle of 1980s, the company began manufacturing a product line similar to Mars. By 1989, the company produced 22,645 tons

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of candy, of which approximately 40 per cent was exported to Russia and the Ukraine. After Lithuania regained its independence, employees became interested in the acquisition of company shares. Kaunas Confectionery was one of the first companies to go through the first stage of privatization. In 1991, the biscuit line of the business was transferred to former owners, and the state-owned company was transformed into a limited liability company with company employees acquiring, by voucher, 33 per cent of shares for 267 thousand Lithuanian talonas (average annual ratio 53.7077 talonas/USD at the time). The head of the Supervisory Board, Gintaras Rimšelis, became the new director of Kaunas Confectionery and led the company through the subsequent challenging restructuring process. The company experienced severe disruption due to the break from the old Soviet markets. Since 1991, the company had virtually no export sales. Total sales declined by approximately 10–15 per cent annually, up to 8614 tons in 1992. A highly inflationary economy (1163 per cent in 1992) and a weak currency brought enormous price increases for raw materials. Costs, moreover, increased due to non-utilised capacity (as high as 45 per cent), and forced the company to raise prices. On the other hand, a solid basis was laid to improve financial status, and the profit margin rose to 33.8 per cent in 1992. The company did not experienced any losses from bad debt, because the majority of customer payments were made on delivery or with bank guarantees. Another major concern was the low book value of fixed assets, inherited from the Soviet accounting system. After being revalued twice on orders from the Lithuanian government – by 2.2 in 1991 and by 5.0 in 1992 – it was still considered to be understated. The management of the company undertook internal reorganization, with major technological departments and workshops reporting to a Production Director, while purchasing and sales related departments reported to a Commercial Director, and accounting, economics, personnel and foreign relations departments reported directly to the CEO. The workforce was reduced from 947 to 780 employees. Special efforts were made to retain the skilled workforce, of which 69 per cent held university degrees or specialized or secondary education. However, the workforce remained relatively old, with 38 per cent being over 50 years of age. In the spirit of ‘social equality’, the increase in salaries and bonuses for executive officers and managers was controlled, being only three times higher compared with the workers’, and no dividends were paid. Salaries and wages were controlled by stabilizing the ratio of direct labour cost to sales.

Fit between the merging firms Both the acquirer, Kraft General Foods International, and the acquired local company, Kaunas Confectionery, operate in the food processing industry.

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Many industry features are relevant to both of them: low barriers to entry, the threat of substitutes, supplier power, trade barriers, strong brand value and innovations, population growth and resource depletion, long-term health problems, obesity and diet trends. However, an analysis of the strategic fit between the two firms shows major differences. The product range and technology had little similarity prior to the acquisition. Kraft General Foods International was geographically diversified and had a wide range of products. Furthermore, the company was a subsidiary of Philip Morris Companies, a global holding company (later renamed Altria). Kaunas Confectionery manufactured and sold confectionery in the local market and in other former Soviet markets. The two companies’ geographical markets and types of customers were hardly similar, and the two companies were not direct competitors. The manufacturing and financial position of the acquired business was much weaker, and the company had no international brands. While Kaunas Confectionery had strong general production and commercial managerial capabilities, marketing skills had to be established. However, budgeting and financial forecasting were made with very short-term goals; thus, a financial management unit that could be integrated in the global structure of parent company had to be established. The company lacked hard currency for further investments and product development, because bank loans, especially long-term ones, were unavailable due to huge interest rates at the time. The comparison between the two firms is provided in Table 17.1.

Table 17.1 Kraft General Foods International, Inc. and Kaunas Confectionery

Strategy

Organization

Leadership

Resources

Performance

Kraft General Foods International, Inc.

Kaunas Confectionery

- Regional leadership through acquisitions - Long-term growth - Continual organizational reforms

-

- Reorganization and change management expertise - Strong financial approach (shareholder view) - R&D, global brands - Global market leader - Horizontal integration - Strong financial performance

Avoid hostile takeover Long-term: retain markets Short-term: liquidity Management structure and functions reorganized before acquisition - Management and employee ownership - Stakeholder view - Production-oriented - Former Soviet Union’s most up-to-dated confectionery - Experience in eastern markets - Domestic market leader - Liquidity problems - High profitability

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At the time of the acquisition, Kraft was oriented towards market expansion. Its main motives for Lithuania were: access to local markets; access to a highly educated, lowcost workforce; the need for a central European location with a well-developed infrastructure; and access to the former Soviet Union. The high profitability of Kaunas Confectionery’s products, successfully implemented internal reorganizations, as well as low value of fixed assets in place facilitated the deal. Synergy potentials were identified by functional areas, especially in R&D, and the brand strategy was oriented towards creating and maintaining strong local and regional brands.

Acquisition strategy and negotiations Kraft’s global strategy and the development strategy of Kaunas Confectionery defined the acquisition process. For both companies, the acquisition made it possible to take advantage of the opportunities arising from the initial Lithuanian privatization round (1992–93). However, both companies had different starting points. The acquisition’s timing coincided with fierce global competition in the food and beverage industry, which led to consolidation through mergers and acquisitions. As a result, a few global players with a similar market share dominated the top end of the market, while a large number of small and medium-sized companies remained. This provoked a struggle for market leadership, leading to intense rivalry. With market maturation and the slow down of growth in developed countries, global strategies were oriented towards increasing market shares in emerging economies. Kraft General Foods International pursued growth through acquisitions. Kraft Jacobs Suchard, its subsidiary in Europe, was one of the first food companies to enter the EEE after 1990. By 1993, the company had experience in the region through its acquisition and restructuring of two factories in the region; namely, Figaro in the Slovak Republic and Szemege in Hungary. The acquisition was driven by several major factors. The opening markets of the former Soviet Union, with a population of over 200 million, and unsatisfied demand for confectionery products offered vast opportunities for growth. The fact that the confectionery industry in the former Soviet Union was highly concentrated and dominated by a few large factories offered several investment mode options for analysis. When investing in Lithuania, Kraft could benefit from the experience of its sister company, Philip Morris. This experience was particularly important in assessing the risks of investing in a transition economy and participating in the privatization process at such an early stage. Philip Morris had invested in the Lithuanian tobacco industry, an investment that proved to be economically viable. This experience encouraged Kraft to investigate investment in another Lithuanian company. The Kaunas agreement was the first sign of the intensified interest of global players in the EEE.

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Kaunas Confectionery’s strategy for both the acquisition process, and its short- and long-term goals, was determined by the challenges of transition. Due to production oriented management, efficient equipment was already in place, as was a highly skilled labour force. On the other hand, the company did not possess certain vital functions, such as marketing, which had not been needed in a centrally planned economy. As the Lithuanian economy broke from the former Soviet Union, distribution ties were broken, leaving the company short on liquidity and forcing management to develop a new strategy quickly. The company had already undergone the initial stage of privatization, with the active participation of management and employees. The privatization laws of 1990 and 1991 favoured employee ownership schemes, so 33 per cent of the company was owned by insiders in 1993. However, 67 per cent of company shares remained under state ownership, making the company vulnerable to hostile takeovers. In an interview with the author, Managing Director Gintaras Rimšelis argued that he saw a clear threat of takeover by local industrial investment groups with possible negative consequences, including a threat to the company’s existence. He stated that: ‘The solution was seen in bringing in a strong foreign investor, which served a function of a white knight in a possible takeover, as well as to solve liquidity problems, and possibly to maintain our local market position and to grow internationally. The dilemma was – either we manage to jump into the boat and float in the new competitive world, or we are left overboard.’ The initial privatization in Lithuania focused on insider ownership, and thus did not generate any cash inflows for the government. Yet, the start of the Russian economic blockade forced the Lithuanian government to look for sources of cash inflows into the state budget. In February 1992, the government listed the companies to be privatized for hard currency. The management of Kaunas Confectionery successfully lobbied to be included on the list. KPMG, which was the first of the five largest global consultancies to open an office in Lithuania, performed a feasibility study and searched for investor candidates. The tender was announced in the international press in April 1993. Given the urgency, confidential negotiations began with several companies, including Kraft General Foods International, in June 1993. The negotiation process was extremely short. The company’s management initiated the sale and received support from the State Privatization Agency. Following the approval of the Lithuanian government, the agreement to sell the company was signed on 5 October 1993. Kraft General Foods International acquired state-owned shares (67.2 per cent of total issued capital), for which it paid USD 37 million to the State Privatization Fund. According to law, the transaction was closed within 45 days. As part of this deal, a subsidiary, Kraft General Foods Lietuva, subsequently named Kraft Jacobs Suchard Lietuva, was established with Gintaras Rimšelis as Managing Director. The parent company approached employees with an offer to sell shares at triple

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the price compared with the price paid to the state. The share repurchase deal ended successfully with 99.03 per cent of the equity of the acquired company concentrated in the hands of the parent company.

Integration After the acquisition, the parent company invested in the renovation of manufacturing facilities, upgrades of managerial capabilities, and, most importantly, the creation of local or regional brands. The Lithuanian company became a regional business unit, expanded its production function and created a strong marketing function. A regional trade structure and information system was developed. Some of the functions, such as R&D, logistics and finance, gradually became integrated with other business units in other European countries. Initially, the parent company provided a vital working capital injection, while later on investments were mainly financed by internally generated cash flow. The physical reorganization of the company also began. Though the management and other employees were highly qualified and labour costs were extremely low, the total number of employees was gradually reduced. The parent company established a pension fund, supporting long-time employees on their retirement. At the time of acquisition, the Lithuanian company had separate production facilities for chocolates and other confectioneries. Natural products were traditionally used for manufacturing, leading to high quality products. The company produced chocolate sweets, chocolate tablets and boxes of assorted chocolates. In 1994, the product range was reduced by more than 50 per cent. ‘We choose quality, not quantity’ became one of the company’s slogans. The parent company allowed use of its know-how and resources, such as R&D facilities in Switzerland for joint development of new recipes, and new product brands were offered. Market research showed that Lithuanians had a low consumption of chocolate and sweets. The company therefore started introducing brand names: Kar¯ una (for dark chocolate products – the most popular), Princas (for milk chocolate products), and Karališkas. In 1998, the company expanded its Lithuanian product lines, and introduced the chocolate bars Rikis, Kopos, Gama, Kauke, ˙ and Pauze. ˙ Later, several chocolate bars from the Mania brand, as well as Fregata, Bingo, Siesta and 3bit were introduced, as was Kar¯ una with fillings. Products sold under Kar¯ una and other brand names became market leaders on the local and east European markets. The chocolate confectionery brands became synonymous with quality and part of everyday life in Lithuania, Latvia, Estonia, Belarus and Russia. Further development of Kraft Foods Lietuva followed the diversification strategy of the parent company. Introduction of new products started with imports, which were followed by local manufacturing and, later, export sales.

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The Kaunas company began importing coffee and snacks, and selling them on the local market. In 1994, the company started importing Jacobs coffee from Germany. In 1996, imports of Estrella crisps from Sweden started, expanding rapidly and taking over 45 per cent of the market by the following year. In 1997, the company began importing ketchup and salad dressings, and introduced four types of Milka chocolate. The success of Estrella crisps eventually led to a production site in Kaunas. In 1999, LTL 40 million were invested in ‘Estrella’ crisps production facilities, producing the first Kraft Foods crisps outside Scandinavia. The company uses a special species of potato grown in Lithuania, and the project created (directly and indirectly) about 300 jobs. Over the next two years, Kraft Foods Lietuva invested LTL 5 million in eight homesteads. Subsequently, Estrella crisps made in Lithuania were exported to Scandinavia, Bulgaria, Latvia, Estonia, Belarus, the Ukraine, Russia and Kazakhstan. By the end of 2001, exports of Estrella crisps reached 40 per cent of total production. By introducing these products, Kraft Foods Lietuva succeeded in somewhat narrowing the gap in the product line between the acquiring and the local company. Following the acquisition of the Lithuanian company, Kraft Foods International reinvested USD 15 million in the improvement of production processes and technologies, a sales distribution system, and advertising. The investment achieved remarkable results in production and sales, and boosted the company to a market leading position in chocolate and chocolate confectionery. In 1997, USD 1 million was invested in a new production line for jams and jelly. In line with Kraft’s common objectives, the Lithuanian subsidiary started applying Genetically Modified Organisms and Good Manufacturing Practices standards and quality assurance programmes. In 1998, Kraft Foods Lietuva received ISO 9001 quality certification for its confectionery production line, which was followed by ISO 9002 quality certification for the crisps production line. By 2003, the major Lithuanian products were confectionery, coffee and snacks – over 140 products under more than 60 brands. The dark chocolate brand Kar¯ una took over about 40 per cent of the chocolate market and was declared to be the ‘best known’ brand in the Baltics in 1999, 2000, 2001 and 2004. The company reoriented its production by decreasing the number of assorted chocolates as well as chocolates in boxes. Though sweets accounted for 70 per cent of total sales in 2002, their profitability lags behind coffee. The least profitable product is crisps, which account for the largest sales volumes. The Lithuanian company continued to extend its product lines, especially in the snack category, and Kraft started employee training programmes. As a result, highly skilled managers and a skilled labour force emerged. The company in Kaunas innovated products that were later brought to other companies owned by Kraft Foods International. By implementing this policy,

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the parent company managed to create employee loyalty. The Managing Director, Gintaras Rimšelis, was named entrepreneur of the year 2002 in Lithuania. As a result of the integration and restructuring, the Lithuanian company became one of the largest companies in Lithuania in terms of sales and net profit. Sales reached LTL 250 million in 2002. In comparison, operations in the first post-acquisition year amounted to LTL 106 million, with 100 per cent of sales in the domestic market. With the increase in exports, sales started expanding quickly. The company was severely affected by the Russian economic crisis in 1998. In 1999, its sales dropped sharply, but recovered in 2000 after the company stopped sales to the Russian market. In 2003, 45 per cent of sales went to the regional markets (central and eastern Europe). The number of employees decreased by about 100 (14 per cent), while sales doubled between 1995–2003. In 2005, the Kaunas company started manufacturing a few international confectionery brands for USA and EU markets. In April 2000, the parent company changed the subsidiary’s name in accordance with the strategy of Kraft Foods International. The Lithuanian subsidiary was renamed as Kraft Foods Lietuva. During the following years, the remaining management- and employee-owned shares were sold to Kraft, with less than 0.5 per cent of shares staying in the hands of a few former employees or their successors in 2005.

Post-entry development Kraft Foods has several key points in its strategy: global competition through regional growth, increasing long-term competitiveness through global and regional brands, and increasing shareholder value. Kraft Foods pursued a multinational strategy with relatively independent regional or local company units, while the strategy blended with elements of a transnational corporate policy. Optimization of regional capacities, cost cutting, and consolidation on a regional and global scale became major issues.133 In 1995, Kraft General Foods was reorganized in the North American market, renamed Kraft Foods and structured around product groups. Kraft General Foods International was renamed Kraft Foods International and organized geographically. Additional acquisitions included shareholdings in different regions of the world, spurred by the mentality ‘bigger and broader is better’. When Kraft took over Nabisco in 2000, Kraft Foods became the world’s second-largest food company, with activities concentrated in the North American market, and an increasing focus on Europe – especially the east European markets, South America and Australia. The Nabisco brands were successfully integrated into the Kraft Foods business worldwide. In 2001, Philip Morris Companies conducted an Initial Public Offering of shares in Kraft Foods. At the same time, Philip Morris Companies (later renamed Altria) remained the largest shareholder.

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Central and eastern Europe was one of the most important regions for growth. In 1993, the same year as the Lithuanian acquisition, Kraft acquired Olza in Poland and Republika in Bulgaria. In the Ukraine, Kraft acquired a confectionery in 1994 and the snacks business, Mova, in 1999. Kraft entered the Russian market by opening a representative office in Moscow and then a coffee packaging business in 2000. After acquiring the Polish and Russian businesses from the German company, Stollwerck, Kraft Foods became the second-largest confectionery producer in Russia, with several well known local brands. The coffee businesses were strengthened by the acquisition of Nova Brasilia in Bulgaria and Nova Brasilia, Classic Brasilier and Prestige in Romania. The strong financial position of the company is indicated by its key financial ratios.

Conclusion The Kraft General Foods International acquisition of the Kaunas Confectionery was only the second acquisition in Lithuania. In terms of investment volume, it was the second-largest foreign investment into Lithuania, following Philip Morris. After Kraft entered Lithuania, its production facilities were increased and the distribution network was expanded. In 1995, Kraft Foods Lietuva created a distribution network in Estonia, followed in 1996 by Latvia, and later by Kaliningrad and Belarus. Following such developments, Kraft Foods Baltics was established in Kaunas for producing, importing and distributing the whole range of products. General Manager Gintaras Rimšelis was appointed Chairman of the Board, Managing Director for the Baltics. The company established job training programmes where employees work directly with representatives of Kraft Foods International. Many former employees of Kraft Foods Lietuva are employed in Kraft regional companies in the USA, EU, Switzerland, Norway and Russia. As the success of those programmes is highly ranked, one can conclude that no major cultural conflicts occurred. Fierce global competition between multinational fast-moving food companies forced structural changes in Kraft Foods International. Standards based production and management procedures were introduced, production of global and regional brands was relocated, and individual business units were combined into transnational clusters. Information systems and technology competence centres were established in Kaunas to provide global services to Kraft Foods International.

Case Sources and Notes

1. MATÁV (2000) SEC Form 20-F, Annual Report for the fiscal year ended 31 December, Washington, D.C. 2. MATÁV becomes the 100 per cent owner of WESTEL (2002), CRM Today, 2 January 2002. 3. MATÁV (2003) SEC Form 20-F, Annual Report for the fiscal year ended 31 December, Washington, D.C. 4. Communication Authority (various years) Ownership structure of the Hungarian telecommunications market, Budapest; Pannon GSM (1997) Annual Report, Budapest; and Telenor ASA (2001) SEC Form 20-F, Annual Report for the fiscal year ended 31 December, Washington, D.C. 5. European Quality Award (2000; 2001) submission documents by WESTEL. 6. Gazdaság, N. (2003) ‘A Pannon is csökkenti az árait – Megsz˝ unik a másodperc alapú számlázás’ (Pannon reduces its prices, too – Second-based billing discontinued), 18 August 2003: 5. 7. Vodafone Group plc (2004) Annual Report for the year ended 31 March 2004. 8. A nagy T-hadm˝ uvelet (2005) ‘Interjú Straub Elekkel’ (The big T-move – Interview with Elek Straub), 9 June, Menedzsment Fórum, [www document] http://www.mfor.hu and T-Brands Boost Magyar Telekom (2005) Supplement, Budapest Business Journal, July 11–17: 2. 9. A helyes válasz: fúzió (2005) ‘Straub Elek a Magyar Telekom körüli változásokról’ (The right answer: merger – Elek Straub on the changes at Magyar Telekom), Magyar Nemzet, 24 October: 12. 10. France Telecom Annual Report (2002): 72–80. 11. Main Statistic Office Yearbook (2001): 417 and 703. 12. ibid. 13. http://www.teleinfo.com.pl/ti/2000/01/to2.html 14. http://www.kulczykholding.pl/ 15. Oferta France Telecom – odrzucona (The FT Offer rejected) [www document] http://www.teleifo.com.pl/it/2000/01/t02/html 16. Rozmowy TP S.A. ze zwi˛azkami zawodowymi (Talks of TPSA with labour unions) [www document] http://telefon.gsm.pl/ 17. http://tp-ir.pl/tpsa/ 18. TPSA Annual Report (2001): 6 (supplement). 19. TP S.A. Wyniki (2002), Przewidywania 2003, (TP S.A. Results 2002, Forecasts 2003), 4 April 2003, [www document] http://www.tp-ir.pl/ 20. http://www.urt.gov.pl/urtip/6/tekst/sp 21. Ocena liberalizacji poł˛acze’n mi˛edzynarodowych (Evaluation of Liberalization of International Connections), Ministry of Infrastructure, (2003) [www document] http://www.mi.gov.pl/ 22. http://www.bcp.pt 23. ibid. 24. http://www.nyse.com/listed/listed.html 25. http://www.bcp.pt

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Case Sources and Notes 243 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42.

43. 44. 45. 46.

47. 48.

49. 50. 51.

52.

53. 54. 55.

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244 Case Sources and Notes 56. In the first quarter operating results grow more than 250 per cent at K&H, Press Release 28 May 2002 [www document] http://www.khb.hu/index. khb?p=print&id=OTMx and The Kereskedelmi és Hitelbank fulfils its annual plans, Press Release, 5 September 2002 [www document] http://www.khb.hu/ index. khb?p=print&id=MTA2MQ%3D%3D 57. Egy fúzió eredményei (The results of a fusion) [www document] http://www.privatbankar.hu/html/bank/kommentar.php?kommentar= 2554. 58. Washio, A.G. (2002) ‘Banks upbeat about 2002 amid consolidation, government changeover’, Budapest Business Journal, 27 May–2 June: 19. 59. K&H Bank held its annual shareholders’ meeting, Press Release, 23 April 2003 [www document] http://www.khb.hu/index.khb?p=print&id=MTE5OQ%3D %3D. 60. Annual Report (2002), Central Europe [www document] http://newkbcpdf.kbc.be/Financial_Information/ kbc-jv-en-2002-centraleurope.pdf 61. Mong, A. (2002) ‘Egy csésze kávé – Rejtö E. Tibor. Figyelö’ (A cup of coffee with Tibor E. Rejtö – interview), 16–22 May: 13. 62. Bank of Lithuania Monthly Bulletin 1996: 1. 63. A List of Credit Institutions, Bank of Lithuania (2005) [www document] http://www.lb.lt/banks/Default.asp 64. Capital Markets and Financial Intermediation in the Baltic States, International Monetary Fund (2003) [www document] http://www.imf.org/external/pubs/ ft/scr/2003/cr03115.pdf 65. ibid. 66. SEB Group’s history (1972) ’Merger with Skandinaviska Banken’ [www document] http://swp2.vv.sebank.se/cgi-bin/pts3/pow/wcp/sebgroup.asp? website= TAB1&lang=en 67. SEB Group’s Financial Report (2004) [www document] http://taz.vv.sebank.se/ cgi-bin/pts3/pow/wcp/sebgroup.asp?website= TAB2&lang=en 68. Ibid.: 6. 69. SEB Group’s Financial Report (2000) [www document] http://taz.vv.sebank.se/ cgi-bin/pts3/pow/wcp/sebgroup.asp?website= TAB2&lang=en 70. SEB Group’s Vison and Strategy [www document] http://taz.vv.sebank.se/cgibin/pts3/pow/wcp/sebgroup.asp?website= TAB1&lang=en 71. SEB Group’s Financial Report (1998): 55, [www document] http://taz.vv.sebank. se/cgi-bin/pts3/pow/wcp/sebgroup.asp?website= TAB2&lang=en 72. ibid.: 6 73. SEB Group’s Financial Report (2004) [www document] http://taz.vv.sebank.se/ cgi-bin/pts3/pow/wcp/sebgroup.asp?website= TAB2&lang=en 74. Lithuanian Banking Sector, VB Vilfima Equity Research, VB Vilfima, 1998, Lithuania. 75. EeSti Ühispank History (1998) [www document] http://www.seb.ee/index/1305 76. SEB Group’s Financial Report (1998) [www document] http://taz.vv.sebank.se/ cgi-bin/pts3/pow/wcp/sebgroup.asp?website= TAB2&lang=en 77. ibid. 78. ibid.: 55. 79. ibid. 80. SEB Group’s Financial Report (1998) [www document] http://taz.vv.sebank.se/ cgi-bin/pts3/pow/wcp/sebgroup.asp?website= TAB2&lang=en 81. SEB Group’s Financial Report (2000) [www document] http://taz.vv.sebank.se/ cgi-bin/pts3/pow/wcp/sebgroup.asp?website= TAB2&lang=en

Case Sources and Notes 245 82. SEB Group’s Financial Report (1998): 55 [www document] http://taz.vv. sebank.se/cgi-bin/pts3/pow/wcp/sebgroup.asp?website= TAB2&lang=en 83. Vilniaus Bankas’ Financial Report (2001) [www document] http://www.seb. lt/lt/wcp/seblt.asp?lang=en&website=TAB+4 84. Vilniaus Bankas’ Financial Report (2002) [www document] http://www.seb. lt/lt/wcp/seblt.asp?lang=en&website=TAB+4 85. About SEB Vilniaus Bankas [www document] http://www.seb.lt/lt/ wcp/seblt.asp?lang=en&website=TAB+4 86. Majauskas, M. (2002) ‘SEB Perima Vilniaus Bank˛a. I˛sigyjes Vilniaus Banka, SEB Ketina Aktyvinti Savo Veikl˛a’, Verslo Žinios, 154, rugpj¯ ueˇio 30 d.: 3. 87. SEB Group’s Financial Report (2000) [www document] http://taz.vv.sebank.se/ cgi-bin/pts3/pow/wcp/sebgroup.asp?website= TAB2&lang=en 88. Bank of Lithuania Monthly Bulletins (2000) and (2001), [www document] http://www.lb.lt/eng/institutions/operations.htm 89. Augaityte, ˙ I. (1999) ‘Naujos Vilniaus Banko Paslaugos’, Verslo Žinios, 223, gruodžio 8 d.: 9. 90. SEB Group’s Financial Report (2000) [www document] http://taz.vv.sebank.se/ cgi-bin/pts3/pow/wcp/sebgroup.asp?website= TAB2&lang=en 91. Vilniaus Bankas’ Financial Report (2003) [www document] http://www.seb.lt/lt/ wcp/seblt.asp?lang=en&website=TAB+4 92. SEB Group’s Financial Report (2001) 27, [www document] http://taz.vv. sebank.se/cgi-bin/pts3/pow/wcp/sebgroup.asp?website= TAB2&lang=en 93. Majauskas, M. (1999) ‘Agentûra Bankus I˛vertino Skirtingai’, Verslo Žinios, 125, birželio 30 d.: 8. 94. Operations of Credit Institutions, The Bank of Lithuania (2004) [www document] http://www.lb.lt/eng/institutions/results2004.html 95. Bankui - Mokesˇciu˛ Lengvata, Verslo Žinios, 123, birželio 23 d. (2000): 3. 96. Figyel˝ o (2002), 29 August: 43. 97. Interview with Dr. Ferenc Dénes, Head of Slovnaft Portfolio Management. 98. Prusek T. (2004) ‘Piwny Rynek 2003’, 21 January [www document] www.gazeta.pl 99. Rynek piwa w Polsce (2002) Kompania piwowarska. 100. Polish Press Agency, 4 February 2003. 101. Akcyza Piwa w Polsce, Zwi˛azek Pracodawców Przemysłu Piwowarskiego (2003) and Gazeta Prawna, 19 March 2004. 102. Informacja o wynikach kontroli przekształcen ´ własno´sciowych, NIK (1999). 103. ibid. 104. Polskie perły s´wiatowych koncernów, Rzeczpospolita, 20 January 2003. 105. Carlsberg Okocim S.A. Annual Report (2002). 106. ibid. 107. www.cws.huginonline.com/Q/111/PR2000105 108. www.gielga.onet.pl, July 2003. 109. Carlsberg wezwał do sprzedazy Okocimia, [www document] www.breinwet .com.pl 110. Polskie perły s´wiatowych koncernów Rzeczpospolita, Ekonomia i Rynek, 20 January 2003:1. 111. Parkiet, 2 February 2004. 112. Przeobrazenia ˙ Polskiego Przemysłu Piwowarskiego, Rynki Alkoholowe, 6/2001. 113. Serwis finansowy Money pl., 30 March 2004. 114. Carlsberg-okocim prospekt emisyjny, 8 rozdz (2003). 115. Sierpeckie Rozmaito´sci, 1/2002.

246 Case Sources and Notes 116. 117. 118. 119. 120. 121. 122. 123. 124. 125. 126. 127. 128. 129. 130. 131.

132. 133.

Carlsberg-Okocim, Sprawozdanie z działalno´sci remitenta, Warszawa, 2002. Prospekt Emisyjny Carlsberg-Okocim, 8 rozdz. 2002. Prospekt Emisyjny Carlsberg Okocim, 2002 part 1. Press release of Employers Association of Beer Industry in Poland, PAP, 14 January 2003. Carlsberg-Okocim, Sprawozdanie z działalno´sci emitenta, Warsaw 2002. http://www.cadbury.com.pl/. Cadbury Schweppes Annual Report and Form 20-F 2000: 1. Cadbury Schweppes Annual Report and Form-20-2001. Working Together to Create Brands People Love, Cadbury Schweppes Annual Review and Summary Financial Statement 2002. Cadbury Schweppes Annual Report and Form 20-F-2000. Cadbury Schweppes Annual Report and Form 20-F-2001. Cadbury Schweppes to acquire Poland’s leading chocolate company, press release, 7 September 1998. Working together to create brands people love, Cadbury Schweppes Interim Report 2003: 7. Cadbury Schweppes Annual report and Form 20-F-2000: 11. Interview with Peter Kanuer, 26 January 2004. Cadbury Schweppes Zamyka 30 Fabryk, Likwiduje 5.5 tys. Etatów (Cadbury Schweppes closes 30 plants, liquidates 5,500 Workplaces), Rzczepospolita, 28 October 2003. http://www.kraft.com. Kraft Foods, EWC case study [www document] http://www.eurofund.eu.int.

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Index ABN AMRO 47, 48, 50, 152, 163–4, 181 K&H merger 48, 103, 108, 161–75; synergy management 60–5, 68 ABN AMRO (Magyar) Bank 163–5, 169 absorption, integration by 172–3 acquisition experience 65–6 acquisition process 66–7 acquisition targets see target firms administrative barriers 87–91 administrative burdens on greenfield entries 91–3 costs 90–1 discretionary practices 88–9 monitoring of small deals 90 ownership restrictions 88 procedures 92–3 advertising 122–3 Agneessens, H. 168 AirTouch 78, 125 Ameritech 78 Anti-Monopoly Court (Poland) 142, 143 AT&T 78 Australia 77 autonomy 107–9 Baltic countries 11–26 passim banking 180, 181, 184 see also Lithuania Baltic Beverages Holdings (BBH) 203 Banco Comercial Português (BCP) 47, 50, 52, 103, 108, 147–50, 160 investment in BBG 151–4 see also Bank Millennium Bank Agio 187 Bank Gdanski ´ 149 Bank Millennium (BM) 147–60 investment of BCP in BBG 151–4 restructuring 154–9 subsidiaries 159 Bank Rozwoju Eksportu 152

banking 183–4 ABN AMRO and K&H 48, 103, 108, 161–75 Lithuania 176, 184; banking crisis 176–8; see also SEB-Vilniaus Bankas Polish banking sector 150–1; business permits 89; see also Bank Millennium BBAG 204 beer industry 204–5 see also Carlsberg BEL Leasing 159 BIG Bank (Bank Inicjatyw Gospodarczych) 50, 52, 57, 106, 147, 149–50, 155 see also Bank Millennium BIG Bank Gdanski ´ (BBG) 149–50, 155, 157, 160 BCP investment in 151–4 see also Bank Millennium Bitburger Brauerei Th. Simon 206 Bitburger GetraenkeVerwaltungsgesellschaft 206 Bosman brewery 207–10, 212–13, 215, 216 brands beer: national 210, 211–12; regional 210, 212–13 Cadbury-Schweppes: brand value concept 219–21; Cadbury brands in Poland 226–7; move away from own brands 228–9; promotion of Wedel brands 228; Wedel brand 225–7 Kraft Foods Lietuva 238 Brau and Brunnen 206 British Telecom (BT) 77, 79 brownfield acquisitions 6, 53, 54 Bulgaria 11–26 passim, 241 business enterprise perception indicators 12–13, 14 business environment, local see local business environment

254

Index 255 business permits 89 business synergies 196, 201 Cadbury-Schweppes (CS) 47–9, 103, 218–21 acquisition of Wedel 50, 108, 217–31; move away from own brands 228–9 acquisitions and disposals 221 brand value concept 219–21 entry into Poland 218, 223–4 global strategy 218–19, 230 capital injection 65, 140–1 Carlsberg 47, 48, 50, 103, 106, 108, 203–16 acquired firms 205–8 cost reduction 214 employment 209 human resource development 213–14 investment in modernization 208–9 performance 215 strategy in Poland 209–13; local brands 210, 212–13; marketing 210–11; national brands 210–12 case studies 117–241 acquisition targets 54–7 acquisitions as an entry strategy 49–54 entry strategies 46–50 institutions moderating strategies 103–7 restructuring 107–10 spillovers 110–12 synergy management 58–71 CBB Mobil 75 Centertel 135–6, 146 central eastern European oil industry 191–2 centralization 81–2 chocolate 218, 225–8, 238, 239 Commission of Banking Supervision (Poland) 89 competition 110, 111 competition law 90, 106 complementarities 65 confectionery 218, 219 Kaunas Confectionery 233–4; see also Kraft Foods Lietuva see also Cadbury-Schweppes

conglomerates 61, 64–5, 66 consumers 110–11 control 6 corporate services 196–7, 201 corporate taxes 19–20 costs of administrative procedures 90–1 reduction by Carlsberg 214 country of origin 29, 30–1 crisps 239 cross-selling 157 Csák, J. 193 customer complaints 170 customer segmentation 156 Czech Republic 11–26 passim Delicja 224 Denmark xii, 74–5, 78, 205 Deutsche Bank 147–8, 152–4 Deutsche Telekom 48, 77–80 Hungarian mobile telephone sector 117–18, 119, 124, 128, 132 see also T-Mobile direct sales privatization 84, 86–7 discretionary administrative practices 88–9 disruptive innovations 75 distribution 122 see also logistics diversification 59 divisional structure 143 domestic sales 33–4 Draskovics, T. 172 Dyland 207 e-banking 186–8 EBRD Transition Index 12–13 Transition Reports 95 economies of scale 80–1, 166, 167 economies of scope 80–1 Eesti Ühispank 180–1 Egypt 8, 44, 107 survey findings 27–39 passim Egyptian Company for Mobile Telephony (ECMT) 107 employment restructuring 107–9 ABN AMRO–K&H merger 172, 174 BM 158

256 Index employment restructuring – continued Cadbury-Wedel 229 Carlsberg 209 SEB-Vilniaus Bankas 186 Slovnaft 200 TPSA 139–40 enterprise restructuring see restructuring entry modes 33–6, 38, 45–6 entry strategies 45–54 acquisitions as entry strategy 6–7, 33–6, 38, 49–54 location 47–9 marketing strategies 47–9 survey insights 31–6, 38 timing 46–8 environmental organizations 93 Ericsson 73 Estonia 11–26 passim Estrella crisps 239 Europe, FDI from 29–31, 39 European integration 38–9 European Union (EU) 3–4, 107 accession countries and FDI trends 11–26 institutional framework 102 ownership restrictions and joining 88 expectations 68–9 experience, acquisition 65–6 exports 239 market orientation 31–3, 38 feasibility study 169 Ferenc, K. 142 finance 167 financial approach to acquisitions 59–60 financial synergies 196–7, 201 financial services 23, 24 see also banking firm size 29, 31 fit between merging firms BCP and BBG 150 FT and TPSA 136–7 K&H and ABN AMRO 165–8 Kraft Foods Lietuva 234–6 MOL and Slovnaft 195–7 SEB and Vilniaus Bankas 182–3 fixed-mobile convergence 75–7, 83

foreign direct investment (FDI) 4–6, 11–26 administrative barriers see administrative barriers flows 4–5, 20–4 location advantages 16–20 privatization and 13–15, 22, 25, 86–7 re-emergence of market institutions 12–16 survey and changing patterns of 27–39; entry strategies 31–6; foreign investors 28–31; performance 36–8 Forin 159 formal institutions 105 Foundation of Sailoring Development 150 France Telecom (FT) 47, 77, 79, 80, 103, 133–5 acquisition of Orange 78, 134 acquisition of TPSA 50, 108, 112, 133–46 entry into Poland 137–9 investment in Egypt 107 frequency of changes in regulations 100, 101–2 ’Friendly City’ Association 93 GDP 16 per capita and average real growth rates 17 weighted FDI 21–2 Germany 184 global strategy 218–19, 230 Goetz, J.A. 206 government policy 7–8, 84–93 administrative barriers 87–91 administrative burdens on greenfield entries 91–3 privatization policies 84–7 government sector 111–12 Grabo´s, W. 142 greenfield investments 22, 34, 35, 36 administrative burdens on 91–3 Cadbury Schweppes in Poland 218, 223 gross fixed capital formation (GFC) 21–2 growth strategy, acquisitions as 6–7 GSM standard 119–23

Index 257 Haggard, S. 86–7 handset subsidies 121 Hansabank 176, 188, 189 Heineken 204–5, 206, 207, 209 Hermis Bankas 184–9 Hernádi, Z. 200 horizontal acquisitions 61, 64–5 horizontal spillovers 110–11 human capital 18–19, 46 development in Carlsberg 213–14 foreign investors’ evaluation of 96–9 Hungary xii, 4, 8, 22, 23, 44 ABN AMRO and K&H 48, 103, 108, 161–75 evaluation of local business environment 96–102 passim FDI 11–26 passim; flows 4–5, 20–4; survey insights 27–39 passim mobile communications market 117–32; duopoly 1994–99 119–24; emergence 1990–93 118–19; three-player competition 2000–05 125–31 ownership restrictions 88 privatization policy 86–7 synergy management 60–71 Hutchison Whampoa 82 importing 238–9 INA 193 incentives 19–20 India 8, 44, 109 survey 27–39 passim indirect acquisitions 53, 54 industrial sectors FDI flows 22–4; survey insights 28–30 institutional environment 104, 107 informal institutions 105 Innovation Bank 177 institutions 5, 94–113 enterprise restructuring 107–10 evaluation of local business environment 96–102 impact of foreign investments on local environment 110–12 importance of institutional development 94–5 institutional environment 99–102

moderating acquisition strategies 102–7 re-emergence of market institutions 12–16, 25 supporting institutions 15 integration 66–7 ABN AMRO-K&H merger 169–73 Cadbury-Wedel 225–30 FT acquisition of TPSA 139–44 Kraft Foods Lietuva 238–40 MOL-Slovnaft acquisition 199–201, 202 SEB-Vilniaus Bankas 185–7 international institutions 16 Interster 150 investment plans 92 investment synergies 196 Jacobs, L. 172 Jacobs Suchard 232, 236 Janiszewski, H. 153 Jasne Pełne brand 211 Jedyna 224 Johnston, I. 224 joint ventures (JVs) 34–5, 38, 53 Karmi beer 212 Kar¯ una brand 238, 239 Kasztelan brewery 207–10, 212, 215, 216 Kaunas Confectionery 50, 232, 233–4 see also Kraft Foods Lietuva KBC Bank and Insurance Group 47, 50, 108, 161–3, 168–9 Kereskedelmi és Hitelbank (K&H) 162–3 merger with ABN AMRO 48, 103, 108, 161–75; synergy management 60–5, 68 Kjaer, M. 180, 183, 185 Knauer, P. 225, 227, 228, 229–30 Kompania Piwowarska (SABMiller) 204–7, 209, 210 Koopman, J. 163 Kott, B. 147, 150, 152, 153, 154, 159 KPN 124 Kraft Foods 240–1 Kraft Foods Baltics 241 Kraft Foods International 240–1

258 Index Kraft Foods Lietuva 50, 103, 108, 232–41 acquisition strategy and negotiations 236–8 firms 232–4 fit between the merging firms 234–6 integration 238–40 post-entry development 240–1 Kraft General Foods International 232–6, 240 Kulczyk Holdings 138–9 labour, cheap 17–18 Latvia 11–26 passim Latvijas Unibanka 180, 181 Law on Urban Planning (Poland) 92 Lewandowski, M. 84–5 liberalization 12–13 Poland and telecommunications 141–2 Lithuania xii, 4, 8, 44 banking sector 176, 184; crisis of 1995–96 176–8; see also SEB–Vilniaus Bankas evaluation of local business environment 96–102 passim FDI 11–26 passim; flows 4–5, 20–4; survey insights 27–39 passim Kraft Foods Lietuva 50, 103, 108, 232–41 ownership restrictions 88 privatization policy 85–6, 234, 237 Litimpeks 177, 184 local brands 210, 212–13 local business environment banking in Lithuania 185 evaluation of 96–102 impact of FDI on 110–12 Poland 224–5 local industry foreign investors’ evaluation of 97, 99 impact of FDI on 110–11 local responsiveness 81–2 local spatial plans 92 location Cadbury-Wedel 229–30 entry strategies 46–9 location advantages 16–20, 25 Lódzki Bank Rozwoju 149

logistics 46 synergies 196, 201 long distance calls 141–2 loyalty programmes 121 M¸adalski, W. 224 Magyar Hitelbank (MHB) 163–4 Magyar Telekom 130–1 MagyarCom 119, 124 management synergies 197 managerial capabilities, transfer of 65 managerial practice, synergy management and 67–9 Mannesmann 78 manufacturing 8, 24, 28–30 market growth potential 16–17 market institutions, re-emergence of 12–16, 25 market orientation 31–3, 38 market share 37, 38 banks in Lithuania 188 market size 16–17 marketing 167 Carlsberg’s strategy in Poland 210–11 entry strategies 46–9 synergies 196, 201 MATÁV 119, 123–4, 128, 130 MCI Communications 78 MediaOne 78, 123–4 micro-matrix structures 200 Millennium DM 159 Millennium Towarzystwo Funduszy Inwestycyjnych 159 Mobil Com 144 mobile network operators (MNOs) 72–4 mobile telephony 72–83, 107 challenging vertical integration 73–5 emerging industry, emerging markets 78–80 fixed-mobile convergence 75–7 Hungary 117–32 organizational challenge 80–3 Poland 135–6 mobile virtual network operators (MVNOs) 74–5 modernization 208–9

Index 259 MOL 47, 103, 192–4 merger with Slovnaft 50, 51, 108, 190–202; synergy management 60–6, 68 monitoring small deals 90 Morisset, J. 90, 91 Mosonyi, G. 195 multiple acquisitions 53–4 Carlsberg in Poland 203–16 Mygird, Niels xii Nabisco 240 National Bank of Poland (NBP) 89 national brands Carlsberg 210–12 Wedel 222, 225–8, 230 natural resources 17–18 negotiations ABN AMRO and K&H 169 Kraft Foods Lietuva 236–8 MOL-Slovnaft acquisition 197–8 Neso, O.L. 90, 91 Netia Group 135 network convergence 76 new product development 37, 38, 167, 174 Niezalezny Operator Miedzystrefowy (NOM) 142 Nokia 73 Nord/LB 176, 188–9 North America 29, 31 ntl 77 Office for the Protection of Competition and Consumers (Poland) 90 oil industry 191–2 see also MOL Okocim 50, 52, 204–8, 216 Carlsberg’s strategy 210–12 employment restructuring 209 modernization 208–9, 214 performance 215 one-brand integration 130 openness 13, 15 operational synergies 196 opportunism 66 Orange 78, 82, 134

Orascom Telecom 80 Organisation for Economic Cooperation and Development (OECD) 16 organizational approach to acquisitions 59, 60 organizational culture 199–200 organizational structure BM 155–7 changes in TPSA 143–4 K&H 170 mobile telephony 80–3 MOL and Slovnaft 200 see also restructuring ownership restrictions 88 Pannon GSM 120–31 partial acquisitions 34–5, 49–51 Pederson, Tina xii pension funds 89 Pepsico 48, 49, 217, 218, 222–3, 224, 230 per capita stocks 20–1, 22 performance ABN AMRO-K&H merger 173–5 Cadbury-Wedel 230 Carlsberg 215 Kraft Foods Lietuva 240 SEB-Vilniaus Bankas 187–8 Slovnaft 200–1 survey insights 36–8 TPSA 144–5 permits 89 Petrom 193–4 Philip Morris 232, 235–6, 240 Piast brewery 207, 210, 212–13, 215, 216 Pirinsko Pivo 203 PKN 193–4 Poland xii, 4, 8, 44, 49, 110, 184 Anti-Monopoly Court 142, 143 banking sector 150–1; business permits 89; see also Bank Millennium beer market 204–5; see also Carlsberg Cadbury-Schweppes: acquisition of Wedel 50, 108, 217–31; entry 218, 223–4 Commission of Banking Supervision 89

260 Index Poland – continued evaluation of local business environment 96–102 passim FDI 11–26 passim; flows 4–5, 20–4; survey insights 27–39 passim FT acquisition of TPSA 50, 108, 112, 133–46 government policy 84–93 passim Kraft Foods 241 Law on Urban Planning 92 Office for the Protection of Competition and Consumers 90 Supervisory Commission of Insurance and Pension Funds 89 telecommunications legislation 137, 139, 141 Polish Telecom 106 post-acquisition restructuring see restructuring Powertel 78 pre-paid services 122, 123 pricing mobile telephony in Hungary 121–2, 126–8, 129–30 TPSA 146 primary sector 23–4 privatization 35–6, 38–9, 105–6, 192 and FDI 13–15, 22, 25, 86–7 FT acquisition of TPSA 137–8 Kaunas Confectionery 234, 237–8 MOL 192 policies 84–7 Slovnaft 194 privatization agencies 51–2, 55 process synergies 196 process view of acquisitions 62 procurement 196 product development 37–8, 167, 174 product quality 146 production, optimization of 196 productivity 18, 37, 38 profitability 36, 37, 173, 174 promotion campaigns 121–2, 123 public policy see government policy public sector 111, 112 public tender privatization 86–7 PZU 153–4 Quest

78

redundancies 172 reform process, elements of 12–16 regional brands 210, 212–13 regulation greenfield investments 91–2 Poland: FT acquisition of TPSA 139; TPSA and use of legal tools 141–3, 145–6 see also government policy reinsertion in the world economy 15–16 Rejtö, T.E. 172, 174 related acquisitions 62 research and development (R&D) 196, 203–4 resource-based view 7 resources 6 acquisition target’s contribution 56 synergy management and resource transfer 64–5 restructuring 107–10 Bank Millennium 154–9 Cadbury-Wedel 225–30 Kraft Foods Lietuva 238–40 MOL acquisition of Slovnaft 199–201 SEB-Vilniaus Bankas 185–7 TPSA 139–44 retail/sales shop presence of Cadbury and Wedel brands 226–7 synergies 196, 201 revenue growth 37, 38 Rim˘selis, G. 234, 237, 240–1 Romania 193–4, 241 FDI 11–26 passim Russia 241 SAB 204–7, 209, 210 SBC Communications 78, 137 scale, economies of 80–1, 166, 167 Schwartz, A. 86–7 Schweppes 218 see also Cadbury-Schweppes scope, economies of 80–1 SEB-Vilniaus Bankas (SEB VB) xii, 103, 108, 176–89 entry 185 firms 178–82 fit between the two firms 182–3 integration and restructuring 185–7

Index 261 local environment 185 performance 187–8 post-entry developments 188–9 second-round privatizations 55–6, 85 selection of target firm 66 services 8 FDI patterns 23–5, 28–30 impact of foreign investment on local environment 110–12 share price 58–9 Simkute˚, Kristina xii Skandinaviska Banken 178 Skandinaviska Enskilda Banken (SEB) Group 47, 50, 176, 178–83 see also SEB-Vilniaus Bankas skills 18–19 Slovakia 11–26 passim, 92–3 Slovenia 11–26 passim Slovnaft 194–5 acquisition by MOL 50–1, 108, 190–202 small deals, monitoring 90 soft drinks 218, 219 see also Cadbury-Schweppes Solidarity 110, 230 Sonofon 75 South Africa 8, 44 survey 27–39 passim spillovers 7–8, 110–12 stabilization 12–13 staged acquisitions 49–53 ˘ UB) ¯ State Agricultural Bank (LZ (Lithuania) 176–7, 184, 187 State Savings Bank (LTB) (Lithuania) 176–7, 184, 187 Stockholm Enskilda Bank 178 strategic approach to acquisitions 59, 60 strong beers 211–12 Sugár, A. 118, 120, 130–1 Supervisory Commission of Insurance and Pension Funds (Poland) 89 supporting institutions 15 survey 8–9, 27–39 entry strategies 31–6 foreign investors 28–31 methodology 27–8 performance 36–8 Sweden 184

symbiotic integration 202 synergy management 58–71 comparative case analysis 60–3 implications of case studies 63–9; acquisition experience 65–6; acquisition process 66–7; managerial practice 67–9; measuring synergy 67; resource transfer 64–5 MOL acquisition of Slovnaft 202; potentials 195–7; realization 201 potentials and ABN AMRO-K&H merger 166–8 theoretical perspectives 58–60 Syrena Sweets 224 systems synergies 196 T-Mobile 47, 50, 74, 82, 103, 108, 128–31 target firms 36, 54–7 selection 66 taxation 19–20 beer 205 SEB-Vilniaus tax holiday 188 TDC 75 technological standards 73–4 GSM 119–23 Telecom Egypt 107 Telecom Italia 79 telecommunications 51 fixed-mobile convergence 75–7 FT acquisition of TPSA 50, 108, 112, 133–46 see also mobile telephony Telefonia Dialog 135 Telefonica Moviles 77, 80 Telekomunikacja Polska S.A. (TPSA) 135–6 acquisition by France Telecom 50, 108, 112, 133–46; exploitation of benefits arising from TPSA’s dominant position 141–3 Telenor 78–9, 124 Telmore 74–5 Templeton Fund 152, 153 terminal device convergence 76 TIM Hellas 80 time/timing 6, 46–8

262 Index trade 13, 15, 31–3, 38, 238–9 trade services 23, 24 trade unions 110, 140 Tran, Yen Thi Thu xii transaction costs 7 transnational organizational model 82–3 Transparency International 95 transport services 24 Tuborg 203 Turauskas, L. 233 22 lipca see Wedel typology of acquisition strategies 53–4 Tyskie Beer 209, 216 Ukraine 241 URT (later URTiP) 142–3 US West 78, 118 value-added taxes 19 value chain 73–5, 83 Verizon 78 Vermieren, R. 162, 167 vertical acquisitions 61, 64–6 vertical integration 73–5 vertical spillovers 110, 111 Vietnam 8, 44 survey 27–39 passim Vilniaus Bankas (VB) 50, 176, 180–2 see also SEB-Vilniaus Bankas

Virgin Mobile 74, 77 Vodafone 77–80, 82, 134 Hungary 117, 118, 125–30, 131 VoiceStream 78, 124 Volt brand 211, 212 Voronezh Brewery 203 Voszka, E. 87 voucher privatization schemes 84, 85, 86, 87 wage taxes 19, 20 wages 18 Wałesa, L. 110 Wallis-Elender deal 70–1 synergy management 60–4, 66, 68 Wanadoo 134 Wedel 52, 221–3 acquisition by Cadbury-Schweppes 50, 108, 217–31 WESTEL 50, 117–32 World Bank 90–1, 95 World Competitiveness Report 95 world economy, reinsertion into 15–16 World Trade Organization (WTO) 16 WorldCom 78 ˙ Zywiec

204, 209