First-person account of a joint venture in Eastern Europe.
First-person account of a joint venture in Eastern Europe.
Eastern Europe right now is like the Old West: you can't lose as longas you're willing to get your hands dirty
I think of myself as an entrepreneur who can move fast if I have to. I hate bureaucracy. I don't write memos or read them. I like face-to-face contact. In my spare time I race cars. This year I was a driver on the team that won the GTP [grand touring prototype] Camel Lights Daytona race. In some ways that may make me seem unlikely to put up with the mind-boggling bureaucracy of doing business in Eastern Europe. But I do like adventures, and this has been one.
In 1984 my company, Erie Scientific, bought a business in West Germany, which like our operation in the States manufactures microscope slides. Six weeks after the sale, the former owner bankrolled an employee who stole some of our equipment, went 800 meters down the street, and started up, even though we had a noncompete agreement. We've gotten bogged down in a lot of litigation over there. On top of that, wage rates in Germany are sky-high -- DM 25 ($15.13) an hour for semiskilled work, which includes benefits. The workweek is 36 hours and is probably going to 32. Workers get five to six weeks' paid vacation. Absenteeism at our West German plant is more than 10% -- daily.
I got so frustrated that I started thinking about moving. If I didn't do something, we would no longer be competitive in the West European market. Yet all the countries in Western Europe have these well-developed social-welfare states, which don't make it all that easy to do business. Wages are high, and productivity, while good, can't keep up with wage and benefit increases.
I even went so far as to mention my predicament to our doctor, who said, "Frank, I've got this patient who does deals all over the world. Why don't the two of you have lunch?"
We did, and he put me in touch with Leo Specht, a lawyer in Austria who specializes in helping Western businesses make contacts in the Eastern Bloc. At our first meeting Leo suggested Erie might like doing business in the Soviet Union.
"Why?" I asked.
He said, "Well, there's low-cost labor, and they need the commerce."
I asked, "How long do they work a day?"
He said, "Well, typically Soviet workers will work two hours a day. But if you pay them in blue jeans or food, you'll get them to work more because they won't have to stand in line so much."
I said, "Leo, I don't think I'm ready for this. Any other suggestions?"
He said, "I think I can do a deal for you in Hungary." He felt it was a relatively progressive place, and the laws covering joint ventures were more clearly delineated there than in the other Eastern European countries. So we paid Leo a fee to look for a partner that might do a manufacturing joint venture with us.
I sent an engineering group over there last August to take a look at what Leo had found -- the Hungarian Optical Works, whose acronym in Hungarian is MOM. MOM makes optics, laboratory equipment, surveying equipment -- some pretty sophisticated stuff. Unfortunately, it didn't have much business because its primary customer was the Soviet Union, and the Soviets aren't buying anything right now. MOM had some 6,000 employees and a piece of real estate in downtown Budapest that encompassed 10 city blocks. A lot of its buildings were empty and in complete disarray.
The engineers came back and told me that short of mental illness, there was no reason Erie should go into Hungary. The bureaucracy would be overwhelming. The process of trying to rig a building to meet our needs would be beyond belief. The workers just sat around all day. The feeling was that while it might be an attractive project to see what life might be like in the Eastern Bloc, maybe someone besides us should do it first.
When I told Leo that, he went berserk. "Your engineers have blinders on!" he said.
I said, "I have to admit it, Leo; this does sound kind of rugged."
He said, "You've got to come over here."
So I went over in October with my wife and our attorneys from the United States and Germany. We met in Vienna, where Leo had arranged for an airplane to fly us to Budapest. It was snowing that day. We drove out to the airport, and here's this single-engine plane sitting out on the tarmac. I turned to the pilot and said, "Does this thing have deicing equipment?"
He said, "No, but we'll fly low."
I told him firmly, "The only time I fly low is when I'm strapped into my race car. My wife and I are not getting on that airplane."
Leo flew, and we ended up renting a car and driving into Hungary, which has the most terrifying highway system I've ever been on. There are no traffic rules to speak of. The way I figured it, whoever is bigger and faster owns the road, and the rest of the cars, when they see someone coming, just get out of the way. We ended up driving half the way on the shoulder. So we arrived in Budapest relaxed and refreshed.
Our hotel lobby reminded me of the YMCA in Lexington, Ky. Leo had said we would like the hotel. I was not happy. The thing that struck me was how they were trying to appeal to Westerners. We had this little, tiny room, but it had a TV set that had ESPN, CNN, and HBO.
The next day we went over to MOM. The boardroom had these big red stars on the wall at one end -- awards from the Communist party. At the other end someone had written on a blackboard in English: "return on investment, return on assets, turnover, sales analysis" -- all these Harvard Business School buzzwords. I've been back to MOM four times since, and that blackboard and those words are still there.
I met the principals, and my attorneys and I started negotiating. Since I don't speak German or Hungarian, Leo and an interpreter conveyed my wishes. This was a unique deal, to say the least. MOM had no hard currency to speak of. Its contribution to the joint venture would be in the form of a building, which it would be responsible for fixing up to our specifications.
I was then taken on a plant tour. The engineering group we had sent over in August was right. This was like walking through a zombie movie. There were all these workers just standing around. One guy was reading the paper and eating some bread. He never even got off his butt when our group, which included the president of the company, came by.
So we got down to trying to negotiate this deal. We would bring in the machines, the money, and an American manager. We would choose workers from MOM's work force. They would provide us with a building totally rigged to our specifications. Erie and MOM would split the equity in the business, 50-50. Erie would get a royalty each month based on gross sales, and our German subsidiary could buy product from the joint venture at a discount. Erie would end up with about 65% of the profit. MOM would get the rest.
The deal was scheduled to close in early January. After the signing, we would send a manager over, and they would start work on the building with the idea that we would be in production by March 1. My engineers told me we'd be lucky to start by September.
The night before I was scheduled to fly over to sign the closing agreement in January, I got a phone call from Leo saying the Hungarians didn't know how they could go through with this. They didn't see how they could ever get their money back out. It was very frustrating. They didn't understand how businesses generate cash flow and money by selling things.
I knew they wanted us as partners. How could we get these guys over the hump? I thought about it and realized the only way they could get any confidence was if I made a gesture that showed how positive I felt about the joint venture. I decided to give them an advance against one-half of the first month's estimated profit, which was $8,000. Suddenly they were seeing hard currency. That $8,000 made all the difference. They signed, and our manager moved to Budapest.
In February we chose four Hungarian employees to send to our plant in West Germany for training. This was their first trip ever out of Hungary. They walked into the plant, and their immediate comment was, "This is slave labor. Never seen anybody work so hard in our lives." Our manager over there called and said, "Frank, I don't think this is going to work."
I said, "Gunter, give them a chance." Within a week we had a complete turn-around. I think the Hungarian workers realized they were there to prove a point -- they could work as hard as the Germans. They actually seemed excited by the opportunity.
Meanwhile, back in Budapest we were looking at a building with cracks in the walls and blown-out windows. Concrete was falling from the ceiling. We had some fairly sophisticated needs. We use oil-free and waterless compressors. We use special water to wash the glass. How could we possibly get this place in shape?
Our partners from MOM kept saying, "No problem."
Our engineers kept saying, "No way!"* * *
In March I went back to Budapest to get the keys to the front door and cut the ribbon. I got over there, walked in, and couldn't believe it. The job had been done to a T, a first-class renovation, with the machines in place and people ready to work. This was nothing short of a miracle.
The joint venture between MOM and us now has 35 Hungarian employees. The typical Hungarian, I've found out, works at a regular government job for eight hours and does nothing. He rests. Then he goes to work for several hours in some kind of underground entrepreneurial activity. We made it clear that the joint venture was to be the workers' primary source of employment, not a place of rest.
Paying double the going wage has helped there. Our workers take home around $60 a week. Then we put in an incentive over their base rate based on productivity. We've since boosted that. The tax rate in Hungary is incredibly regressive. So we're adding additional incentives in the form of food coupons and family vacations that the workers couldn't normally afford.
The joint venture has three managers. Number one is Guy Cosby, an engineering manager we sent over from our plant in Portsmouth, N.H. Numbers two and three are Hungarians; they came from the partner. The Hungarians get paid -- as executives -- $250 a month. I knew we had to increase their salaries dramatically because after we adjusted the hourly wage rate, they were making about the same as the hourly workers. But MOM didn't want to see their wages go up at the expense of profit distribution to the joint venture. So I gave them consulting agreements with Erie Scientific, and we doubled their salaries.* * *
The concept of privatization is still so new, there was a great deal of mistrust when we started as to why we were there. Basically, the thinking at MOM was we'll get these Americans in here as joint-venture partners. Then we can sell accounting to the joint venture; we can sell import/ export services; we can sell payroll services. We can make a fortune off this and keep our enormous bureaucracy intact.
Guess what? We ain't interested. For a while MOM kept forcing people on us, but we went out and got our own accountant, our own import/export department. We got our own banking. We pay our bills directly from hard-currency accounts. The joint venture is finally a stand-alone business as we had told them it had to be at the beginning. We had to be free from the bureaucracy. We took a stand, and I think our point of view is sinking in. MOM has become much more cost conscious as to what it's willing to lay off on the joint venture.
The most valuable outside contractor we've found so far is our cabdriver. This guy has gotten us trucks, helped us out with the bank, given us input on what employee benefits to offer. He says he'll find us distributors in Czechoslovakia and Yugoslavia. There are hundreds of people like him. These are the people you need to find to do business, because the basic relationships we take for granted just don't apply.
Customs officials, for instance, show up and have to examine every shipment. They expect a "gift." We've made it clear we are not in the gift business, and they don't come around anymore.
Our partner, MOM, could also go bankrupt. It's struggling right now, but it's also hustling. It's seeking other joint ventures. Hungary needs to keep creating joint ventures like ours that will pay people more money and generate some sort of positive cash flow for the country, because it is a huge foreign debtor. They say it will be a two-year process to turn the economy around. I hope they're right.
The joint venture is doing better than we expected. Labor productivity is ahead of budget. The quality is excellent. We even made a profit in the first quarter, and MOM has returned its $8,000 advance.
A country like Hungary right now is like the Wild West, and if you're willing to go over there and get your hands dirty, you can't lose. Go in, find a building with a phone in it, find a cabdriver, and tell him, "I want to be in business in 90 days."* * *
Frank H. Jellinek Jr. is the president of Portsmouth, N.H.-based Erie Scientific Co. The company, founded by his grandfather during the Depression, has revenues of more than $50 million.