A Polish Odyssey: A Vanderbilt alumnus advises Poles on the switch to a free market

by Kevin McDonald

Kevin McDonald, A'78, is a management consultant with his own firm based in Newton, Massachusetts. He is currently living in Warsaw and serving as intemational coordinator of the Task Force on Company Assistance created by the new Polish government. At Vanderbilt, he was a Grantland Rice Memorial Scholar, a Senior Scholar, and a Henry Luce Scholar, and he also directed the Appalachian Student Health Coalition.

In May of this year I took a Polish garden trowel to a hardware store near my home in Newton, Massachusetts. The shopkeeper's face spoke volumes about Poland's postwar period and its near term potential. The merchant could scarcely believe the quality and low price available from some random factory in Poland. His reaction illuminated the economic opportunity Poland has missed since the war, including needless sacrifices of income, security, and health. His response also reflected the great potential Poland has to gain ground quickly.

This year has been an odyssey for me. In January, I was living comfortably in a Boston suburb advising U.S. corporations on strategy and factory operations, as I had been doing for seven years. I had no expectation of making a dramatic change. By May, however, I had moved with my wife and daughter to Warsaw in response to the deputy prime minister's request that I manage his program of helping Polish companies to enter the world economy. Along the way, I had an unusual opportunity to see the pioneering nation of Eastern Europe as it made the initial transition from a controlled economy to free enterprise.

That transition began with the stroke of a pen. On January 1, the Government of Poland (recently elected in place of the communists) introduced the most radical economic reform ever attempted in modem history. In an effort to break the hyperinflation that ran at an annual rate of 2000 percent in late 1989 and to end the chronic shortage of goods throughout Poland, the government instituted several measures, including: convertible currency, free trade (in most product categories), tight monetary policy (high interest rates), and an end to most subsidies and price controls. The new government was confident its new policies would work. The slogan of the program was "No experiments" - reflecting the will to emulate successful Western economies without any tinkering.

The program has proven to be a success, but the initial results were not clear. Unfortunate but anticipated side effects were evident from the outset. Prices jumped about 80 percent in the first month. (Inflation was reduced to 5 percent per month by February.) Goods returned to the shelves in abundance, but demand for the goods dropped, driven down by limits on wage growth and by high interest rates (36 percent per month, reduced to 5 percent monthly).

It was against this background that I received a telephone call from Warsaw on January 7. The call was from Professor Jeffrey Sachs, the economist from Harvard University who advises the Solidarity Government. The precipitating event was an emerging trade problem with the Soviet Union. Demand in the U.S.S.R., Poland's main trading partner, was falling rapidly, as the Soviets were facing bottlenecks in the production of goods such as oil and gas that have traditionally been bartered for Polish merchandise. Polish factories needed large alternative markets instantly. The Ministry of Foreign Economic Relations wanted an outside opinion on what resources would be required to reorient Polish trade. I agreed to fly to Poland in early February under the sponsorship of the United Nations Development Program.

I was immediately surprised upon reaching Warsaw. The taxi driver made an impression that was soon to be reinforced by many other people. The cabbie was sober about the timing of economic improvement: "We aren't going to have a miracle. We should give the program six months without interruption. Then we ought to have some signs of progress." The basis for patience was a historical perspective: "This government has not created the problems. It is trying to fix the mistakes made by the communists over the last forty-five years."

My first stop was at a factory miking a peripheral product for computers, mainly for the Soviet market. The company's plant and equipment were fairly modem and potentially competitive in a number of applications. On the other hand, the company’s current product was not suitable for Western markets. The design was out of date and the price was not low enough to offset design limitations. Thus the company's response to declining Soviet demand could take the form of a joint venture utilizing Western technology or diversification into other products.

A few things were particularly striking about how the company was run. To begin with, the firm was very extended vertically. It produced all its components except the semiconductors and some screws and washers. By contrast, an American firm would typically buy more components and produce only those parts in whose production it had an economic advantage over competitors. Other Polish companies I visited later made this difference even easier to see. One shoe company not only makes shoes but also produces its own electric power, boxes, and labels, and operates a trucking fleet, retail stores, and a loan office. A company making wheel rims raises hogs for workers to eat during the lunch hour.

This extreme vertical integration is a legacy of the communist economy. In the communist regime, prices were set centrally as a markup over cost. Capital came from the government primarily through low-cost loans. The combination of controlled prices and easy credit led to a situation of excess demand relative to supply and thus to massive shortages throughout the production chain. To minimize exposure to the erratic supplies of other firms, Polish enterprises integrated vertically. When a company had to purchase a part, it generally would carry a large inventory of the item. For instance, the first company I visited had kept a five-month supply of screws and washers.

The environment was changing even as I spoke with the Polish manufacturers. The new policies of free market pricing and high interest rates were eliminating most shortages. In addition, convertibility of the zloty was creating access to reliable suppliers outside the East Bloc.

Yet despite the new opportunity to outsource, Polish firms faced difficulties in trying to take advantage of the worldwide market. In particular, they lacked and still lack the information necessary for determining which parts to make or to buy. In many cases, they do not know their costs by component or by process step. Thus they have nothing to compare with the price of an outside supplier. Moreover, they have not established a worldwide network of potential suppliers. Accordingly, they do not know the lowest price they would have to pay for a component.

A second characteristic of the computer peripherals firm was its isolation from Western companies. Historically, foreign contacts were the exclusive province of foreign trade offices. Such firms had a monopoly over the export and import of particular goods. These offices vary in quality, and they have an enormous task in attempting to find new markets and suppliers in the West. They clearly are not able to make the massive extent of connections necessary. Since January 1, Polish manufacturers have been free to trade internationally without assistance from the trading organizations. Yet in most cases they do not know whom to call or even how to initiate contact. Unfortunately, Poland does not have a telephone culture. They are much more familiar with exchanges by telex. Poles are not particularly comfortable cold-calling or conducting business by phone the way Americans do.

A third characteristic was the firm's under-developed skill in marketing. In the shortage economy that just ended, Polish companies paid little attention to sales and marketing. Production was concentrated on functional items with few variations, and price subsidies created demand for almost all that was produced, regardless of quality or features. On this basis, investment in marketing was unnecessary. Thus even companies with tens of millions of dollars in sales might have only one or two people in sales and marketing.

I reported these observations to the Ministry of Foreign Economic Relations. The ministry itself was worthy of note. To my surprise, the government officials were very well versed in international economic theory. Any expectation that economics is a misunderstood subject in Poland is unfounded, at least on high levels in the new government. One minister explained that Poland has always been more free intellectually than other East Bloc nations. In addition, the Poles have historically placed a higher value on intellectual achievement than on material or physical accomplishments. This view is believeable after a meeting with the new Ministry of Foreign Economic Relations.

The ministry was extremely interested in acting to prevent a trade crisis based on declining Soviet demand. Indeed, the minister asked if the problems could be solved that very month! This was clearly not the old bureaucracy slowing down progress. The solutions at the factory level are by no means available in a few weeks, but they will be reached the soonest if the pressure from the top continues to be forceful.

My trip resumed with a tour of seven more plants. The companies I was directed to meet were selected on the basis of their exposure to East-Bloc markets or their high level of employment in Poland. These companies were producers of large machines (for agriculture, construction, and electric power transmission), electronics (computers, printers, and telephone switches), and garments. In each case I met with top management and also toured a factory.

Most of the management teams I met were acutely aware of the impending financial pressure. Both fixed costs and variable costs had soared since January 1, driven by a surge in the prices of energy, credit, and materials. This rise in costs, along with the withdrawal of government subsidies, would force companies to increase sales dramatically just to break even. Unfortunately, traditional markets remained unpredictable.

Perhaps because of this pressure, there was a great deal of enthusiasm about Western management. Exactly what constituted Western management was not always articulated. Rather, it was viewed as a black box whose contents could make a big difference in the efficiency of virtually any company. Whatever was in that box was something the Poles needed.

A shoe company I visited reflected this sort of interest. At first the management was suspicious of me, even though I was accompanied by someone from the Ministry of Industry, and I explained my intention of trying to assist the firm. The director of the company asked for my passport. Taken aback, I offered the passport along with my check book, photographs of my twenty-month-old daughter, and the keys to my home in Newton. The atmosphere quickly improved as we discussed the company's problems, and by the end of the evening we were in the executive dining room exchanging toasts on behalf of Polish-American friendship and a future world in which American-style management and Polish shoes would cover the globe.

I reported my complete findings to the Ministries of Finance, Industry, and Foreign Economic Relations, and I accepted an invitation to return a few weeks later.

Back in the U.S., my next step was to testify before the Senate Foreign Relations Committee. In a meeting of the Subcommittee on European Affairs chaired by Senator Joseph Biden, I described the condition and needs of Polish factories. It is actually a sad commentary that after eight factory visits, I was the ranking expert in the U.S. concerning Polish manufacturing.

I was able to make a few general observations for the Senate to use in planning foreign aid. The first was that Polish factories had significant potential based on several things: their installed capacity, which in many cases was at least adequate; their experience producing goods with large markets; and their low wages - sixty cents per hour on average, including all benefits This potential is reflected in some Polish goods currently exported to the West. For example, a simple but well-made trench coat, without lining, is exported to West Germany for $15, and a small tractor is sold in western Europe for about 30 percent less than a comparable model from Korea and Japan. An important consideration for the Senate was that Poles are not likely to compete directly with U.S. manufacturers. Rather, given their low wage rates, the Poles will probably confront producers from Asia that displaced U.S. manufacturers years ago.

The second point was that Polish firms face urgent problems. Polish managers are coping simultaneously with two enormous challenges - the instantaneous switch to capitalism and also a deep recession. They have not encountered either condition before. Thus at the factory level, Poles are not prepared for what they must do; they do not know where to turn; and they have very limited time. The Polish government will not intervene to save inefficient producers.

An additional point was that the U.S., can help significantly. What Polish firms need most urgently is information- about what market opportunities to pursue and what procedures to use inside the factory walls. This kind of information is purchased regularly by American companies of all sizes. It is also available indirectly through joint ventures and license arrangements.

The final point was that offering such assistance on a large scale would be in the American interest. Well-designed aid to Polish enterprises would undoubtedly lead to linkages between U.S. and Polish business and more generally increase U.S. business activity in eastern Europe. This field is still wide open, and timely assistance from the U.S. could certainly enable U.S. firms to participate in Poland without any disadvantage relative to competitors from western Europe or Asia. Such linkages would be mutually beneficial. Poland could achieve its transition to a market economy. And the U.S. could establish a base of operations for serving European markets and also defending American markets from Asian imports.

A proposal for a $100 million fund for such assistance was viewed with some interest by the Subcommittee but not taken up by the Senate. The opposing argument was that the U.S. does not have an extra $100 million available. This argument assumes that the revolution in eastern Europe has been completed - that free enterprise and democracy have triumphed and their future is secure. It does not reflect the Poles' point of view, that they are still in the trenches and they are a great distance from the economic goal that justifies the dislocation they are now undergoing.

Developing a workplan was the purpose of my next trip to Poland, in March. In particular, I was asked to help define more precisely where a restructuring effort should begin and how to proceed. I took three American colleagues with me - Susan Smith, Jack LeVan, and Leon Sandler. We visited twenty-seven companies and refined the observations of the previous trip.

By this time there was public interest in our activities, so we went on primetime television to explain our mission. I summarized our impressions up to that point. After the filming, the cameraman said, "Please come back. We need your positive attitude." An unexpected feature of the broadcast was the display of my business card on the screen for a minute or two. The Producer erroneously thought I wanted a lot of referrals. The next day my wife received a request for a joint venture with a Polish engineering firm, which I politely declined.

The television show revealed another difference between Western and Polish businesses. The day after the show, I visited three factories. In each case, someone approached me and said he recognized me from the news program. Such recognition would not have occurred in the U.S. I realized that at least until January, a managerial job in Poland was a political job. Accordingly, managers stayed informed by following political news. The most efficient medium in Poland is the television. Thus, every factory manager has a television set in his office. I cannot remember ever seeing a television set in an American executive's office.

Near the end of this trip, I was asked by Mr. Leszek Balcerowicz, the deputy prime minister and driving force behind the new economy, to return again. Factory restructuring was clearly a priority for the new government, and the work was in need of coordination. I agreed to play such a role. Our resources would initially be fifty industry experts who would be sent by governments in Western Europe and North America. In addition, the United Nations Development Program and the Government of Turkey later agreed to provide cash to support the operation. The Polish Council of Ministers (the equivalent of our cabinet) created the Task Force on Company Assistance to receive these resources officially and to draw support from relevant ministries.

This coordination task posed a great challenge: how to use very scarce resources efficiently. There are eight thousand companies in Poland. The question of how to leverage fifty people in this context is not trivial. In a commercial setting, a consulting group does not face this question. Instead, it works for almost anyone who can pay the requisite fee, and it adds capacity to meet demand. By contrast, we were under pressure to have an impact with a small amount of fixed capacity. This pressure would force us to specify which problems the industry experts would be asked to solve, what sort of people actually were needed, and how long they should expect to work on a given project. To the extent possible, we also would need to supervise the foreign experts and assist enterprises with the implementation of any recommendations made.

Planning this program required two more trips to Poland, in April and May. The German Marshall Fund of the United States generously supported my work associated with this planning and these trips. During this phase of the work, our planning capability was expanded by the arrival of two more Americans - Steve Buckley and Jim Van Bergh - and a U.S. resident from the U.K., Sherry Agar. The group visited more factories and brainstormed into the night both in Poland and in the U.S. Three-and-a-half months after my first landing in Warsaw, we developed a plan, in collaboration with the Poles, for efficiently assisting Polish factories.

We decided to try several approaches, so we could compare results and use them to allocate resources in the future. One approach is to provide sales and marketing assistance to entire industries. In this activity we would work with foreign trade offices that represent a broad line of products from Polish suppliers. Another approach is to work directly with selected enterprises on both sales problems and operational matters (e.g., cost reduction). Enterprises receiving direct assistance will be either candidates for privatization or prospective candidates. A third approach is to create in-depth profiles of firms that need a foreign partner and assist the firms in the search process. The fourth approach is to provide essential business training on national television.

Identifying products with export growth potential (for our first approach, above) required several steps. The first step was to sort Polish companies according to the ease with which they could divert capacity from old markets to new ones. This criterion reflects the drop in demand in traditional markets. The most flexible enterprises make such products as metal components, hand tools, pottery, garments, and shoes. From this group we identified firms that have exported enough to the West to prove their capability. We selected companies that have concentrated their exports on one or two Western countries only, implying the potential to enter other Western markets if supported properly. We narrowed the group even more in some cases based on customers' reactions to product samples.

The main barrier at this point was administrative. We needed a bank account so we could begin using our money. The Polish government has made it difficult even for government offices to set up new accounts, presumably to minimize embezzling. After weeks of slashing red tape, my counterpart of the task force called me from Warsaw in an elated state to declare victory. "There is only one problem," he finally added. "We can put the money into the account, but we can't take it out."

The Polish government officially launched the program with a national television program in late May. In this inauguration, we introduced one additional activity. Polish companies have tremendous excess inventory remaining from the old days of easy sales. They need to liquidate raw materials and finished goods to escape from the burden of high interest rates. A great deal of this inventory represents marketable merchandise. On national television, we invited Polish manufacturers to describe their inventory to us so we could create a catalog and market it around the world. It is likely that bargain hunters will be attracted.

In the final days of May, my wife and I packed up our house and boarded the plane for Warsaw. On the plane, I felt a surge of optimism as I recalled the merchant's reaction to Polish garden tools. My wife Diana, an art historian, reflected on the prospect of working with museums in Warsaw. Our daughter Samantha was entertained merely by the airplane ride. She will probably be the first of us to speak Polish. She may also be the first to read an account of Polish history that has a happy ending.