Historically, the trend has been for western Europe to attract the lion’s share of this investment. However, in the past eight years, the flow of investment has shifted steadily eastwards: in the initial phases to the mainstream central European countries of Poland, Hungary and the Czech Republic but, in the run-up to the 10 accession states joining the EU in May 2004 and the subsequent period, the shift has been further east into Romania, Bulgaria and Russia.
Already, the EU accession countries and the rest of central and eastern Europe account for one third of all foreign investment projects into Europe, against a backdrop of rising investment into the region. In the short term (the next two to three years), this trend will continue and it would not be surprising to see these countries accounting for up to 40% of all investment projects into Europe in a few years’ time. Already, nearly 35% of companies identified by Oxford Intelligence’s CorpTracker product are declaring future investment plans for central and eastern Europe and in certain sectors this level is now at, or approaching, 50% of projects – notably in the automotive sector and general industrial sectors. The CorpTracker helps government agencies and service providers to locate companies with international location plans and fast track them into the market.
It is in the new technology areas, driven by research and product innovation, that ‘old Europe’ will continue to attract the bulk of investment. As each industrial sector or product matures, the drift eastwards will increase. This is because cost reduction continues to be the main driver for companies to maintain or increase margin. The business service sector will remain a major generator of jobs and investment in the West but, again, as these processes become established and mature, the drive to reduce costs will result in certain functions moving further east.
Medium to long term
In the medium to longer term (five to 15 years), there will be significant increases in investment into western Europe, as the two powerhouses of the Far East, India and China, move into a globalisation phase for their indigenous companies. This will follow the trend set by Korea and Japan in the 1980s and 1990s in their expansion drive to gain market share in Western economies.
The countries that will gain the manufacturing units of these companies are likely to be not only the newly-emerged central European markets, but also north African countries, such as Morocco, Egypt, Algeria and Tunisia. However, the establishment of technical support, sales, business support, research and development (R&D) and localisation, and key administrative and HQ functions will continue to focus on the key centres of western Europe. The UK will be best positioned to be the main recipient for this type of investor.
Looking at the type of activity on which the different markets can expect to compete, the CorpTracker database supports the shifts described above. Greenfield activity is increasingly moving eastwards, as are the lower-cost service functions. However, the higher-value activity, such as sales and marketing and technical support functions, are still strongly focused on old Europe.
The type of activity generated by the investing companies will vary considerably, depending on the sector in question. Comparing three important sectors for Europe – automotive, business services and medical technologies – highlights some key differences in investment activity. When looking at R&D investment, medical technology companies play an important role, while sales and marketing functions are much more significant in the business services area and far less important in the automotive sector.
The life sciences sector invests more in R&D than almost any other industry. Product development costs in the sector are spiralling, to the extent that it costs $500m-$800m to develop a new drug. About 90% of drugs in clinical trials never make it to the market; effective profitable product life cycles are shortening and governments are striving to keep healthcare costs under control against the background of an ageing population.
With cost being such an important factor, eastern Europe, and to some extent southern Europe, are well placed to pick up future investments in the biotech and medical technology sectors. The Czech Republic, Hungary and Poland are the prime candidates but there is also increasing competition from India and the Far East.
Western and eastern Europe are also likely to face increasing competition for clinical trials, not least because there are no longer enough potential patients in these markets. Clinical trials are therefore likely to become increasingly global, and Latin America and the Far East will play a growing role in the future. GlaxoSmithKline chief executive Jean-Pierre Garnier recently said: “There is no alternative to really streamlining research and development departments. We are trying to move 30% of our clinical trials to low-cost countries.”
R&D investment is critical in feeding the new product pipeline but there is a drive for greater efficiency in the process to increase success rates. Harnessing IT will be a critical success factor in drug discovery. In particular, bio-informatics will continue to be a huge growth sector. There has been a surge in the number of alliances between IT and life sciences companies. IT giants, such as IBM and Sun Microsystems, are investing heavily in tools for life sciences research and are emerging as a new type of competitive group in the industry. Locations with strong IT skills and IT infrastructure will become increasingly important. Established life sciences research clusters need to ensure that IT skills are developed to meet company needs.
The key factors in choice of R&D locations are access to skilled labour and high-quality academic facilities with a significant student base. Many regions across Europe have universities with excellent life sciences faculties, yet do not have significant medical technology industry clusters. International companies’ first choice would be to locate R&D facilities in the well-established European R&D clusters, such as Cambridge and Munich, because the skills are already there. As a result, the pressure is on other regions to develop their own medical technology clusters.
For the automotive sector, the relative importance of greenfield activity is clear to see. Over-capacity and consolidation are the catchphrases that continue to be associated with the automotive industry. It looks as though consolidation will continue for some years to come, as the sector hones itself down to what are likely to be 30 or so major players. But vehicle production is still viewed as one of the few industries that can bring major investment projects to a region, promising high project value, with substantial capital expenditure and high levels of employment. Countries worldwide are as eager as ever to attract automotive projects and companies have continued to announce and plan new investments throughout the year.
However, new investments in vehicle assembly and component manufacturing are becoming increasingly cost-driven, and companies are more and more likely to locate these projects in the world’s less developed markets. The most popular future locations for assembly and greenfield projects are likely to be in eastern Europe, South America, China and south-east Asia, which are competitive in terms of prices and offer high-growth markets. Western Europe’s share of these investments will naturally slide as a result.
Such has been the level of interest in the Chinese market, in particular, that while car sales in the country remain strong, over-investment is fast becoming an issue. The focus of some companies has moved on to new markets: Russia, India and Iran, where Renault, PSA Peugeot Citroën and Hyundai are already assembling cars.
North America, western Europe and Japan have not lost their appeal – industry presence remains a key requirement for new investments. But the opportunities for traditional automotive centres in these more mature markets will lie in high value-added facilities. They are seen as the key areas for investment in advanced technology and in projects involving more technically advanced vehicles. For these regions, the message is clear: there is still scope for volume car manufacturing but more so for higher specification vehicles.
Another effect of the move to cut costs has been a trend among vehicle producers to transfer critical activities to their suppliers. The result is that suppliers will have to increase their own investments hugely. It has been suggested that they will need to create 3.3 million new jobs worldwide by 2015 to accommodate this growth.
Shared service centres
FDI in the services sector has expanded rapidly in recent years. Unctad’s World Investment Report 2004 suggested that opportunities to attract FDI would be more prevalent in the services sector than anywhere else, especially in activities relating to the offshoring of services.
Traditionally, most services have been non-tradable, in that the transaction required buyers and sellers to be in the same place at the same time. Advances in information and communication technologies facilitate trade in services because they make it unnecessary for providers and users to be close to one another.
A recent trend in Europe has been a move towards sub-regional shared services centres, such as those serving the Nordic countries or southern Europe. Of the companies that now outsource overseas, many are opting for a two or three location strategy in an attempt to diversify risk. Other key future developments of the shared service centre business model are: the extension of the shared service centre model to a wider range of services; increased growth of outsourcing of basic transactional tasks; the development of low-cost offshore shared service centres; and the growth of virtual shared service centres. Support functions are also expected to evolve from existing shared service centres to become business service organisations, operating independently of the client business.
The selection of low-cost offshore locations does have a number of perceived drawbacks, including lack of European language skills and time zone remoteness from European business units. For some companies, the challenges associated with going offshore may be too great. High-profile reports of outsource U-turns by companies, such as Dell and Shop Direct, have dampened some enthusiasm for sending call centre work overseas.
In Europe, traditional sites for shared service centres have included Dublin, Amsterdam/ Rotterdam and south-east England. More recently, a new batch of cities has taken centre stage: Cork, Maastricht, Manchester, Glasgow and Barcelona. However, the most important trend – and a potential threat for western European regions – is the growing competition from eastern European countries and, increasingly, from offshore locations such as India, South Africa and Malaysia.
Focus moves east
The focus of attention now is on central and eastern Europe. Hungary is home to the shared service centre of the year (awarded to Diageo at the Shared Services Excellence Awards 2004). Prague and Krakow are also popular, and Slovakia, Bulgaria, Estonia and Romania are the up-and-coming locations of choice. The development of shared services in central and eastern Europe has been driven by cost, a good technical infrastructure, widely available language skills and membership of the EU.
In the call centre industry, India has been seen as a good location for large-volume capabilities but markets in South Africa, Botswana and eastern Europe are opening up. The Philippines and Canada also rank as good destinations for US English language calls. And there has been an increasing movement of US Hispanic outsourcing to Latin America, particularly the Caribbean, Costa Rica, Argentina, Chile, Venezuela and Panama.
The World Investment Report 2004 supports the view that FDI flows are set to pick up, particularly in Asia and the Pacific, and in central and eastern Europe. It confirms that prospects are particularly bright for services and for some industrial sectors, and for the relocation of a wide range of corporate functions. With this in mind, investment promotion agencies need to structure their incentives and targeting accordingly, if they are to meet the challenge of sustained competition for FDI.