INVESTMENT:Setting up a business in eastern Europe is an attractive prospect, but there can be challenges along the way

EUROPEAN UNION accession, greater market access and financial assistance, a young and educated society, fast economic growth and investment incentives are all factors behind the increasing attractiveness of eastern European countries for Irish companies.

The term "eastern Europe" is commonly used to refer to the countries of the old eastern bloc, but many countries are now referred to as being a part of central, rather than eastern, Europe - Vienna for example, is actually east of Prague.

In 2004, a host of countries including Poland, Hungary and the Czech Republic acceded to the European Union, while in 2007 both Romania and Bulgaria left their Communist past behind to become a part of the single market, opening up these markets for Irish companies.

To date, Enterprise Ireland (EI) has assisted some 664 Irish projects across the EU accession states, Russia and the Ukraine, and currently employs some 35 people focused on the region.

Giles O'Neill, regional director for EI in Germany, central and eastern Europe, Russia and CIS, says that it's a combination of costs and closeness to markets that is attracting Irish companies to the region.

He says that Irish companies are initially attracted to the "more westernised countries" such as Poland, the Czech Republic and Hungary, with Poland the most popular destination for Irish companies.

Over 150 companies currently export to Poland, of which half are in industrial markets, including electronics, engineering and lifesciences; one-fourth are in software, services and emerging sectors; and one-fourth are in food and consumer retail markets. Exports from Ireland to Poland have grown from €16 million in 1989 to €292 million in 2005.

Hungary and the Czech Republic are also popular, with more than 100 Irish companies exporting to each country. Like Poland, half of all exports to both countries are in industrial markets.

However, O'Neill says that the agency is also seeing an "awful lot of interest" in Romania, following a visit for Irish companies organised by Enterprise Ireland to the country last year.

"In terms of timing, it's a good time to go there as things are busy, particularly on the construction side as they are drawing down EU structural funding," he says. "They also need a lot of support services to help them do what they want to do." Over the period 2007-2013, Romania will draw down some €28 billion in EU structural funds.

Joe Tynan, a partner in PricewaterhouseCoopers in Dublin says that Irish companies started in Poland, "but as they get more comfortable in eastern Europe, they are now gradually working their way east towards the Ukraine, Bulgaria, Romania and Russia".

He says that the further east you go the more difficult it can be but that it has potentially greater cost benefits.

Irish companies seem to be attracted to the east by a number of factors. Costs are obviously a major reason in some companies' decision to locate, or re-locate, operations to eastern Europe. Annual salaries in the more westernised countries such as Poland and the Czech Republic still remain less than €10,000, while the further east you go, the lower the costs. In Romania, annual salaries average just €3,600.

"We'll see Irish companies using eastern Europe to lower their own costs rather than specifically to access the local markets. Rather they'll use it to access western European markets and to supplement their own staffing skills and to reduce their costs," says Tynan.

EI also helps Irish companies who have been manufacturing in Ireland but are finding it difficult to meet the price points.

"We're not really that interested in talking to Irish companies that are going to shut up shop in Ireland and set up a manufacturing facility somewhere else because its cheap," O'Neill says. "If, however, as part of an overall plan to grow the Irish business production has to re-locate, then we would help them and advise them and point them in the right direction."

It wasn't lower costs however that attracted construction firm Kingspan to the east in the late 1990s - market potential was the driving factor.

"Kingspan saw the infrastructural opportunities 10 or 12 years ago and knew that with the 10 accession states, the potential for infrastructure development was and continues to be huge. It is much better to supply from Poland to the Ukraine rather than from Ireland," says Paul O'Gorman, commercial director for Kingspan's panel division in continental and eastern Europe.

The firm opened its first sales office in the region in Poland in 1997, followed by a production plant in the Czech Republic in 1998. The firm subsequently bought a company in Poland around 2003 and built a green field plant in Hungary two years ago.

Today it has a significant footprint in the region, with four production plants focusing on insulated panels and external cladding in eastern Europe and 17 sales offices in 17 countries right across the region, including Estonia, Romania, Ukraine and Belarus. The company employs about 600 people in the region.

O'Gorman says that its strategy is very simple. "We build local plants in the region which service the host country and then surrounding countries.

For example the Polish plant supplies Poland, plus Belarus and parts of the Ukraine, while Hungary services its home market, plus Romania and the former Yugoslavian countries," he says.

"Our method is very simple. We do extensive research before we enter a market, to see general macro trends and see who the competition is. We then open a sales office, and then grow rapidly.

"But we use different routes to market in the different countries as the people are different, the regulations are different. Our approach to Poland would be very different to our market approach to Serbia."

However, while the region does present plenty of opportunities for Irish companies, it is not without its own specific difficulties.

O'Gorman cites the range of languages - at least 17 - the firm has to deal with on a daily basis as being a major difficulty, as well as the different regulations from country to country. However, he adds that this is getting better as more countries join the EU.

Tynan concedes that it can be a difficult place to do business. "It is very bureaucratic," he says, "and they have concepts in eastern Europe that we wouldn't have here. For example,you need licenses to do business and these need to be very specific.

"Some companies make the mistake of going for very broad licenses, but they then need numerous different trade licenses. In Ireland, if you set up a company, you typically set up the charter of that company to be very broad. In eastern Europe you've got to be very specific - if you say you want to do something you've got to apply for the licenses to do that."

Another issue is the requirement to have resident directors. "In the Ukraine you require a resident director and if anything goes wrong that director has full responsibility. It can be quite difficult to get someone who will be director of a subsidiary."

Tynan says most Irish companies try and have an Irish person to act as director, but they need to be local tax resident or else the firms try and identify a local they're comfortable with, such as a senior employee, who may have worked for the firm in Ireland and are looking to move back home.

He also cites the difficulties involved with basic things such as setting up a bank account, which necessitates a certificate of absence of criminal record. "There is no question of going into a bank with your passport and utility bill and walking out half an hour later with a bank account. It just doesn't happen like that," he says.

Another problem is what the authorities in some of those countries see as being taxable income. "When you set up a bank account, you'll want to put money into it to start doing your business, but if you put that money into an account, it will be treated as taxable income," Tynan says.

Other problems which may arise include the considerable compliance requirements. "In Poland you must have original documentation, you can't just copy it.

"If you can't produce original documentation, then you can't claim a deduction," Tynan says which can make claiming back business expenses difficult.

And of course there are major differences from country to country. "You can't say Poland is the same as Serbia - each and every country has its own culture and its own way of doing business," says O'Gorman.

"But as a general rule," he adds, "there has been tremendous progress in all of the countries, just at different paces. Bureaucracy is significantly less than it was, but there are worlds of difference between Poland and the Ukraine. In general, the further east you go, the greater the bureaucracy."

Another issue is a lingering Communist mentality. With the fall of the Berlin Wall not yet 20 years old, it is unsurprising that while eastern European countries have made massive leaps forward to become free market economies, remnants of the old Communist regime linger.

Tynan gives the example of settling your tax bill. "Once you've agreed your tax bill, the authorities have power to go in and take the money directly from your bank account," he says.

Seán Melly, who set up telecoms firm Etel in Prague eight years ago, sees it in terms of mentality. "If you met people over the age of 45-50, you would almost be assured of this communist reaction to things, whereas if you dealt with younger people, they were looking to shake off the shackles of communism."

Another example cited by Melly is a lack of commerciality. "There is a general tendency in the region, even now, for people's skill-sets to be very strong in engineering and very weak in sales and marketing, although you would see it less with the younger people.

"There is a mentality that if you build something, be it a product or a service, then you don't really have to work to sell it. Our idea on the other hand is that you might be a third of the way there, but that at least two-thirds of the effort goes into selling and keeping the customer happy."

So what should you do, if you're a company thinking of setting up an operation in the east? "Do your research, do lots of research," says O'Gorman, and he recommends that interested companies make use of the information available, especially from sources such as EI.

"Preparation is key," says Tynan. "Most companies presume it will be like Ireland but it's not, it's very very different. You can get a lot of advice from EI and advisers, but you need to have a good understanding of how it is going to work.

"How are you going to operate a business which may be 3,000 miles away from your home operation? Some of these companies are quite small, and you're effectively talking about running it as an MNC."

EI offers a range of services to help Irish companies evaluate and enter export markets and to expand international sales. But O'Neill says that one of the more important services they offer is the validation of opportunities.

"A firm might come in and say, 'I hear there's an oppportunity in Poland, someone has told me'. We can then go and test those theories, and if we believe there is a market for a product or service we will identify potential buyers, and feed this information back to the company, along with identifying the ideal distribution channels."

He also says that the agency will put companies which are looking to establish manufacturing operations in the east in touch with the local IDA, such as Czech Invest in the Czech Republic which may offer grant aid. "All these countries are very agressive and proactive about attracting investment," says O'Neill.

O'Gorman also highlights the importance of employing local people.

"One of the key things we do is have the business run by local people. A Ukrainian will understand cultural differences much better than an Irish person," he says.

If your company is looking for very skilled staff, Tynan recommends linking up with a university, either by sponsoring a seat in the college or by working closely with a relevant faculty.

The fall of communism and preparation for accession to the EU meant that for many central and eastern European states, the late 1990s was a time of de-regulation - and with de-regulation, came opportunity.

Identifying the potential in the telecoms sector was Irish entrepreneur Seán Melly, who had previously experienced success in the sector in Ireland through the sale of his first venture, TCL Telecom, to multinational giant MCI Worldcom in 1997.

Following the sale, Melly stayed on to run the business across western Europe, which gave him an understanding of what was going on in most markets, including those in central and eastern Europe.

During this time he helped to seed finance a telecoms start-up operation in Prague, in the Czech Republic. When this business started to grow, he left his job to develop the business full-time, and it became the start of Etel, which offered voice, data and internet services.

Etel's first full year of business was 2000, and the firm soon settled on a business plan of developing from the Czech Republic to Poland, Hungary and Slovakia, and at a later date into Austria.

"We knew what we wanted to roll out, which was half the battle but the challenge then was all the other issues," says Melly, who adds that the major difficulty for the firm was the fact that the telecoms industry was highly regulated and government-controlled.

A quarter of his time in the early days was spent on regulatory matters, securing whatever licences he could, and looking to develop the business within the restrictions of those licences.

"But the difficulty was also the opportunity, as larger companies wouldn't have been willing to go in and do what we had done," says Melly.

He found the EU Competition Authority quite helpful in prising open the door into securing licences and dealing with quasi-political issues, as the markets they were looking to trade in were only getting used to issues to do with impending membership of the EU.

Bureucracy and local legislation was another problem.

"Yes, bureaucracy was a huge issue, almost for the sake of bureaucracy," he says. "I remember when we set up the business in Poland, there was a requirement at the time that you couldn't own the majority of a business: 51 per cent had to be owned by a Polish person. But, like everything in these countries, there's a problem and a solution for it, and so you got around it by coming to an agreement with a partner in your law firm, who would become the 51 per cent shareholder, and you would have an agreement to buy him out at certain stages.

"We had to do all those sort of things, things you would never encounter in the western world," he adds, although he concedes that since this time the region has become much more business-friendly.

During his years with Etel, Melly lived in Dublin, but travelled every week. "Back then, I know it's strange now, but back then going to Prague was exotic. You couldn't get direct flights and the international business presence there was much less obvious. It had more of a pioneering, entrepreuneurial flavour, rather than the big companies you see there today."

Etel's general policy was to hire local staff, and Melly says that it was critical to have the right local managing directors, who had a strong appreciation for the western approach to business and who had one foot in the local markets, and one foot in international markets.

Etel's initial financing was transacted in the west, although later on, Melly says that the firm started raising funds out of Vienna, Austria, which he says offers an important dynamic to the region. Professional advice also came from large global groups which had a presence in some of the cities in which Etel operated.

Over a period of seven years, Melly and his team developed the company to a stage where it employed about 500 people across the region, and was doing approximately €140 million a year in recurring revenue.

He sold the business last year to Telecom Austria for just over €100 million.

BUSINESS TIPS
Dos
Do your research
Do talk to companies in your sector who have set up there
Do take advantage of resources
Do employ local people to head up operations

Don'ts
Don't expect it to be like Ireland
Don't underestimate the bureaucracy of countries in the region
Don't expect countries in the region to be very similar to each other
Don't expect the region to be more backward than Ireland