Changes and challenges in a larger EU
Elsevier Food International Vol.7, No.2, May 2006 Pascal Kuipers
On 1 May 2004, the European Union witnessed its biggest enlargement ever with the entry of ten new member states, bringing the total number of EU countries to 25. Expansion into the Central European region (Poland, Hungary, Czech Republic and Slovakia) also means the addition of well-developed but still growing retail markets.
The 15-member EU has expanded with ten new members, eight of which are former centrally-led economies situated in Central and Eastern Europe that have transformed themselves into market economies in just over a decade. With the EU expansion, however, the Central and Eastern European region will see a division into EU and non-EU states, with significantly different paces of development in the years to come. Hungary, Poland, the Czech Republic and Slovakia will develop further to – supported by the EU – become at par with the other EU member countries. On the other hand, Russia and the Balkan countries (with the exception of the small but well-developed Slovenia that also joined the EU) will not enjoy EU support.
“In 2004, the separation of the region Central and Eastern Europe into EU and non-EU states will impact significantly on logistics, income growth, pricing strategies and parallel distribution possibilities,” says Richard Lucas, managing director of PMR, a Kraków (Poland) based market researcher/consultancy specialised in the CEE region. Despite the rapid economic development of the four Central European countries that joined the EU in May, Lucas thinks that powerful and distinct regional characteristics remain in place, which differentiates these markets from those of the higher income countries.
Increasing affluence
“Low income per capita reduces the possibilities for consumers to do their weekly shopping in one go,” says Lucas. “And those who may be able to buy more, often live in small and overcrowded apartments with reduced storage capacity and none or limited freezer space. Another aspect impacting purchasing patterns is low car ownership, which further reduces the number of people who can buy products in volume.”
This, however, does not necessarily make the new Central European EU member states an underprivileged region. Quite the contrary, as many multinational retailers have been flocking to these markets since the mid-1990s.
In its recent survey on Central Europe and Russia, the UK-based think tank for the food and grocery industry IGD, refers to a EU study which estimates that enlargement could increase the GDP growth of the accession countries by 1.3 to 2.1 percentage points annually. For the existing 15 EU members the GDP increase would be 0.7 percentage points on a cumulative basis over the period between 2000 and 2009. “This would particularly benefit retailers and suppliers operating in the accession countries, where a high percentage of the newly-generated wealth would be spent on food and increasingly non-food items,” says IGD.
PMR’s forecasts for household consumption and spending in the four Central European states up to 2007, confirm this pattern of increasing affluence. The share of food, beverages and tobacco in total household spending will go down whereas sales of refrigerators, washing machines, passengers cars and especially PCs are bound to increase (see table X). This will surely affect purchasing patterns. It is, however, unrealistic to expect that – despite the soaring sales of PCs – online shopping will gain momentum in this region in the near future.
Subsistence economy
“Rural and urban lifestyles and income levels are extraordinary different,” is another regional characteristic of the CEE countries that Lucas mentions. “Internet shopping, on-line financial services and western ways of life co-exist uneasily with 19th century style subsistence farming in much of the region,” he says. “Formats such as semi-organised open air markets, so-called ‘suitcase trading’ and kiosk retailing sometimes have no ready equivalents in Western Europe and can be a significant part of the economy in some Central European markets.”
“If you look at size, quality and numbers of state-of-the-art retail outlets, standards in the four Central European markets are similar to what can be seen in Western Europe,” says George Johnstone, partner with PricewaterhouseCoopers in Budapest, Hungary. “Especially in the large cities, open air markets are of less and less importance. In Warsaw and Budapest they are rapidly declining in numbers. In the countryside, however, things are totally different. Especially in Poland differences between cities and the countryside are profound. The countryside has really been bypassed by economic development and Poland’s rural economies function merely on subsistence level. One third of the Polish population is still employed in agriculture. In Hungary and the Czech Republic these levels are much lower. Compared to these countries, Slovakia has higher shares of people depending on agriculture but not as high as in Poland. Especially in eastern Slovakia, rural economies are persistent.”
Bizarre rules
“Legislative instability whether by design or incompetence creates challenges for retailers and producers throughout the region,” is a further characteristic feature of the CEE region, according to Lucas. “Goods with barcodes still had to be individually priced for years. This legislation for consumer protection was finally changed, provided that retailers had sufficient price look-up terminals in store. This provoked a lot of confusion. The same holds true for the Ministry of Finance’s ‘fiscal cash register’ legislation, aimed at avoiding tax evasion. Companies installing cash registers needed to send their employees to the Ministry to be approved and the retailer needed to keep records along with the installer right down to the level of the guy who did the installation. Only this specific person was allowed to install – or replace – cash registers for retailers. These regulations, however, caused huge problems when personnel working for installation companies quit. In such cases it made it impossible for retailers to renew or relocate cash registers. This is one of the many tight regulations in Poland, which create a major headache to companies. This situation of bizarre regulations hasn’t got better either. This year I came across an ice cream factory, which could not export to the UK due to a lack of Polish veterinary approvals. The EU and the UK authorities, however, already gave their approval.”
“Bureaucracy is a common feature across all Central European countries,” says Johnstone. “You can also call it ‘less coherent central decision making’. This particularly holds true for Hungary and Poland. Slovakia and the Czech Republic have been more successful in breaking this down.” Johnstone stopped short from calling it corruption. “No, that’s not the case. It’s more an unwillingness by authorities on different levels to make a decision,” he says. “But corruption as such is more prevalent than in Western Europe, though it’s not excessive. It’s merely petty corruption with which citizens have to deal with in their day-to-day lives.”
Lobbying with legislative authorities happens in the CEE region just as it happens in Western Europe. “The political controversies that sometimes face big retail chains have arrived with a vengeance in the region,” says Lucas. “Small local retailers are lobbying with their local politicians just as their counterparts do in the West to protest against the arrival of new hypermarkets with their low prices, economies of scale and aggressive purchasing practises.”
“Here in Hungary legislation is beginning to prevent retailers from selling under the purchasing price,” says Johnstone. “This aims to protect the whole market. The retail sector is less organised in its protest. More pressure comes from the more populist agricultural sector. Poland has more restrictive legislation when it comes to the accessibility of retail sites.”
Pricing dilemma
The final characteristic Lucas mentions is pricing. “The price sensitiveness of many consumers is remarkable,” he says. “Pricing strategies have had to evolve very rapidly. In the first years after the introduction of the market economy it was feasible to achieve premium pricing compared to the rest of the world in some post-communist economies. Increasing competition and local producers who pack and promote their products in a similar way with their international peers, however without premium pricing, led to international brands being cheaper in the CEE region than elsewhere.”
This leads to a pricing dilemma for suppliers. “The pricing strategy of international suppliers of consumer goods is challenged and this will intensify with accession to the EU,” Lucas says. “Those who produce locally, such as Smithfields Foods who are aggressively investing in Central European production, are well placed to compete with increasingly well-organised local suppliers who have lower costs and aggressive pricing strategies. This, however, impacts their ability to sustain pricing variations across the EU. Retailers’ global and European buying teams, however, are increasingly questioning why money currently being made in grey parallel markets should be ‘left on the table’.”
The dilemma of suppliers being squeezed between international retailers and local low cost competitors is not easy to address. Lucas: “Achieving market leadership in Central and Eastern Europe may undermine margins in richer countries, while harmonised pricing leaves CEE markets wide open to local competition and private labels.”
“Price levels will increase but there will not be necessarily a harmonisation to one EU-25 level,” says Johnstone. “Within the EU-15, there have always been disparities between countries. GDP levels in Greece or Portugal are for instance 75 per cent of the average EU-15 level, while this average level ranges much lower than GDP levels in specific regions within the EU, such as the metropolitan areas of London and Paris. There is certainly a potential for parallel trading. Differences in tariff rates may well be used by governments to attract business to the country.”
“Prices in Central Europe may rise following single market entry, meaning that suppliers and manufacturers will have to make strategic decisions as to where Central Europe fits into their pricing strategies, e.g. whether current price corridors should shift,” reads the IDG survey. “Increased parallel trading by retailers – which is entirely legal within the EU – is likely to affect pricing decisions. Retailers may also benefit from the reallocation of supplier/distributor contracts from existing member states following the removal of duty rates to accession countries. Savings can be invested in marketing support, be divided among manufacturers, distributors and retailer, or be used to lower prices to benefit the consumer.”
| Slovakia | 2002 | 2007 | Exp. growth |
| Food, bev. & tobacco (%household spending) | 29.1% | 28.6% | -0.5% |
| Refrigerators (per 1,000 people) | 83.3 | 103.3 | 24% |
| Washing machines (per 1,000 people) | 51.6 | 61.4 | 19% |
| Passenger cars (per 1,000 people) | 296 | 442 | 49% |
| PC's in use (per 1,000 people) | 154 | 314 | 103% |
| Poland | 2002 | 2007 | Exp. growth |
| Food, bev. & tobacco (%household spending) | 29.4% | 27.8% | -1.6% |
| Refrigerators (per 1,000 people) | 2.8 | 3.4 | 21% |
| Washing machines (per 1,000 people) | 20.9 | 26.8 | 28% |
| Passenger cars (per 1,000 people) | 261 | 309 | 18% |
| PC's in use (per 1,000 people) | 89 | 185 | 152% |
| Hungary | 2002 | 2007 | Exp. growth |
| Food, bev. & tobacco (%household spending) | 31.8% | 28.9% | -2.9% |
| Refrigerators (per 1,000 people) | 45.4 | 55.5 | 22% |
| Washing machines (per 1,000 people) | 23.8 | 30.6 | 29% |
| Passenger cars (per 1,000 people) | 247 | 323 | 31% |
| PC's in use (per 1,000 people) | 117 | 212 | 81% |
| Czech Republic | 2002 | 2007 | Exp. growth |
| Food, bev. & tobacco (%household spending) | 28.9% | 26.4% | -2.5% |
| Refrigerators (per 1,000 people) | 43.5 | 52.6 | 21% |
| Washing machines (per 1,000 people) | 25.7 | 32.4 | 26% |
| Passenger cars (per 1,000 people) | 323 | 329 | 2% |
| PC's in use (per 1,000 people) | 161 | 307 | 91% |
Source: www.polishmarket.com
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