Restructuring Eastern European manufacturing: the case for Poland

by Kevin McDonald
Kellogg World, summer 1990

Kevin McDonald is a management consultant based in Newton, Massachusetts. For the past seven years, he has advised managers and directors of both Fortune 500 companies and new ventures on corporate strategy and productivity. In March 1990, McDonald testified before the Subcommittee on European Affairs of the Senate Foreign Relations Committee (led by Senator Joseph Biden) concerning U.S. economic assistance to Poland. This article is based on that testimony.

On January 1, 1990, Poland lifted price controls, as part of an attempt to transform from a controlled economy to a market economy literally overnight. Several weeks later, I arrived in Warsaw at the invitation of the Ministry of Foreign Relations. The purpose of my visit, which was supported by a grant from the United Nations Development Program, was to determine how key Polish companies could restructure their business to compete in a market economy.

Although I am not an expert on Poland, I have extensive international business experience and was able to analyze Polish factories in operation in terms that are relevant to factories in any country.

I visited eight companies that were selected on the basis of their exposure to Comecon markets or their high level of employment in Poland. The firms I visited manufacture three broad categories of products: large machines, including farm equipment, construction equipment, and electric power transmission equipment; electronics, including computers, printers, and telephone switches; and clothing, including winter coats and shoes. In each case, I met with management and toured a factory.

My impression of these companies can be summarized in several dimensions. The product assets of the factories are good. The plant and equipment are generally adequate, though not always modern. In many cases, workers perform highly skilled operations. In addition, a number of the products represent good value from a customer’s point of view. For example, a simple but well-made trench coat is exported to West Germany for $15 wholesale; a small tractor sells for $4,000 wholesale, versus about $6,000 for a similar model made in Asia and sold in the United States.

On the debt side, production is often highly inefficient. Many companies are overextended vertically; they product some parts that they could purchase more cheaply from outside suppliers. For example, a shoe company makes cardboard boxes for shipping its product and runs a printing plant to label the boxes. Management is clearly unable to use the box and printing assets to their full potential while also directing the shoe business.

This extreme vertical integration is a legacy of the communist economy, where process 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. If a company had to purchase a part, management would generally carry a high inventory of the item. For instance, an electronics firm I visited keeps a five-month supply of simple items such as screws and washers.

The environment has changed dramatically with the new economic program. Because of a tight credit policy and free-market pricing, the shortages have disappeared. Goods are now widely available, though often at much higher prices than before. In addition, dollars can be readily obtained with zlotys, giving manufacturers access to reliable suppliers outside Comecon. But despite this new opportunity to outsource, thus far, Polish companies have retained their old practices. In particular, they lack the information needed to determine which parts to make or buy:

• They do not know their costs by component or by process step and thus have nothing to compare with an outside supplier’s price; and
• They have not established a world-wide network of potential suppliers; therefore, they do not know the lowest price they would pay for a component.

Similarly, some factories lack procedures that western companies typically use to increase output, such as controlling quality throughout the plant rather than just the subassembly stage or final assembly; giving workers decision rules to permit rapid decision-making at the source of a problem or an opportunity; and offering compensation based on performance (except in the case of piece work).

The current crisis

Polish companies are facing an enormous crisis. An expected but unfortunate side effect of the stabilization program begun in January is that the traditional markets for Polish products have contracted rapidly. The Polish market is depressed, as the domestic prices for most goods have risen to the level of world prices, putting them beyond the reach of most Polish consumers. In addition, tight credit has restricted borrowing capacity.

Sales to the Soviet Union are also declining significantly, as economic problems within the USSR lead to a shortage of Soviet goods, such as oil, that the Poles wish to buy. At the same time, the Soviets are negotiating aggressively to reduce the price they pay for Polish goods.

Thus the desirability of exports to the Soviet Union has diminished. Poland expects to reduce exports to the USSR by up to $1 billion from 1989 levels.

The contraction of traditional markets exposes another deficiency of Polish companies - marketing. In the shortage economy that ended just two months ago, Polish companies paid little attention to 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. For example, a Polish farm equipment manufacturer used to sell all its output in Poland through a government agency. In January the agency was disbanded. Now the manufacturer has no idea where its products are needed, what features are preferred, and what price/volume trade-offs could be made. Nor does it know how to do market research to answer its questions.

The situation is worse in foreign markets. Many Polish companies have sold to the West, but they have done so indirectly, through trading bureaucracies. As a result, they have had virtually no contact with western managers or factories. Now they have the right to export directly, but their isolation prevents them from seeing opportunities or even requesting assistance or collaboration, as in a joint venture.

For example:

• A computer company that is uncompetitive with its entire product line could make power supplies, a labor-intensive component of the computer that is increasingly produced by low-cost labor in Asia. The market for personal computer power supplies is highly visible - at least $2 billion - but from inside Poland.
• Domestic demand for the output from Polish garment makers has plunged since January. Those same companies have historically sold 10 to 30 percent of their production in Western Europe, but they lack the necessary representation to increase significantly their sales in the West on short notice. As a result, they will lay off possibly half the industry’s workers.

The plight of the garment industry illustrates a great irony about the crisis of Poland’s transition to capitalism. The irony is that many Polish factories could inexpensively and, in some cases, quickly redesign their products to meet western requirements. Yet finished goods are piling up and workers are losing their jobs, mainly because the Poles lack information and managerial experience.

The transition to a market economy has reached a crucial point. The program is successful on a macroeconomic level, for instance in terms of price stability. Yet the next few months could be devastating to many Polish companies. Indeed, liquidity is becoming a widespread problem. Working capital is supporting high inventory levels, and interest rates are currently more than 10 percent per month. As a result, many companies with valuable production capacity will soon go bankrupt in their effort to join the market economy. That is, unless they receive large-scale assistance from potential partners, suppliers, customers, and investors in the West.

Assistance needed

Polish companies need assistance in a broad range of activities, including the following:

• Finding potential partners to license technology, help modify a product line, jointly manufacture a product, market Polish-US products, and invest in Polish companies;
• Locating reliable, low-cost suppliers for Polish firms;
• Training management in production scheduling, purchasing, inventory management, quality control, market research, sales and service, distribution channel management, organizational design, compensation, accounting for cost control and financial analysis, and information management;
• Developing a long-term strategy, particularly for big investment decisions;
• Selling uneconomical assets;
• Defining immediate sales opportunities;
• Implementing a new sales plan.

The striking thing about Poland, which has more than 7,000 companies, is the scale of assistance needed. Trying to provide western strategic and operational support to so many companies is unprecedented, and the urgency of the need makes the task even larger.

An opportunity for U.S. business

The United States has a unique opportunity to create linkages between American and Polish businesses and generally to increase U.S. business activity in Eastern Europe. The field is wide open, and assistance now could 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 United States could establish a base of operations for serving European markets and defending American markets from Asian imports. What Polish companies need most are managerial assistance and information, the likes of which are readily available from American manufacturing and service firms.