Magazine

Cutting Their Losses


David N. Farr, chairman and chief executive of St. Louis industrial group Emerson Electric Co., keeps a close eye on Europe. That makes sense. The region accounts for about one-fourth of Emerson's (EMR) $15.6 billion revenues and 16% of its worldwide assets. But more and more, Farr is discouraged by what he sees. Western European sales have been flat for months, as corporate customers delay purchasing the power networks, air-conditioning systems, and other big-ticket capital goods Emerson sells. Come to think of it, there hasn't been much life in these markets for years. "The European economies have continued to weaken and weaken," Farr laments. Even worse, a strong euro and stringent anti-layoff laws make it tough to trim costs.

Now, Emerson has had enough. It has halted new investment in Western Europe, while pouring money into faster-growing, more lightly regulated economies in the old Soviet bloc. Vacant jobs in Western Europe are not being filled. "As we need more capacity, we're putting it in Eastern and Central Europe," says Edward L. Monser, Emerson's chief operating officer.

It's hardly news that Western Europe is a tough place to do business these days. Growth for the euro zone economy is forecast to be below 1.5% this year, less than half the rate in the U.S. and Asia. Unemployment averages 8.9%, retail sales are sagging, and euro zone manufacturing production shrank in April. High oil prices only add to the gloom. U.S. multinationals from McDonald's (MCD) to Caterpillar (CAT) to Wal-Mart (WMT) complain that their European operations, particularly in Germany, are dragging down companywide sales and profits.

TROUBLING CONTRAST

But as Europe heads into a fifth year of economic anemia, some U.S. multinationals are finally concluding that a robust recovery won't arrive soon -- if ever. Like Emerson, they're scaling back longstanding operations and diverting investment to more promising venues. Until now, many U.S. companies have hesitated to reduce European payrolls because of local laws requiring cumbersome, expensive layoff procedures. But more and more are concluding that it's worth the trouble. IBM (IBM) says that the bulk of the 10,000 to 13,000 worldwide job cuts it announced on May 5 will be in Western Europe, while the company is hiring in Hungary and Slovakia. General Motors Corp. (GM) plans to eliminate up to 12,000 Western European jobs by 2006, even as it expands manufacturing in Poland.

The big numbers tell the story most clearly. Foreign direct investment in the European Union's 15 longstanding member countries fell almost 50% in 2004, to $165 billion, with every one of the EU's major economies except Britain posting a decline. By contrast, in the eight Central and Eastern European countries that joined the EU last year, foreign investment rose by one-third, to $36 billion. Foreign direct investment in the U.S. also rose sharply last year.

Of course, the U.S. is losing manufacturing and service jobs to lower-wage countries, too. And European companies are doing plenty of offshoring themselves. A survey by Woodlands (Texas)-based consulting firm TPI found that European companies accounted for 49% of all major outsourcing contracts last year, ahead of U.S. companies, which had 44%.

But the malaise in Europe is far more pervasive than any dislocation in the U.S. While sales of consumer-goods companies such as Kraft Foods Inc. (KFT) and Colgate-Palmolive Co. (CL) are strong stateside, they're sagging in Europe as consumers turn to cheaper private-label brands stocked by fast-growing discount chains such as Germany-based Aldi Group and Lidl & Schwarz. Sara Lee Corp. (SLE) recently announced plans to sell its European packaged-meat business, which is fighting stiff competition from discounters. Ad spending is weak, too. Paris-based advertising giant Publicis Groupe (PUB) says its first-quarter European revenues grew only 1.8%, compared with 4.8% in North America and 7% in Asia. After first-quarter advertising lineage at The Wall Street Journal's European edition plunged 20.6%, owner Dow Jones & Co. (DJ) announced plans on May 9 to trim staff in Europe and Asia and switch to a tabloid format in both regions.

Despite the prolonged slowdown in Europe, no U.S. company with global ambitions can afford to turn its back completely on a region that has 380 million consumers and boasts its own stable of world-class corporations. "You have to fish where the fish are," says Stuart Wilson, Kraft's vice-president for strategy in Western Europe.

That explains why some American corporations are fighting hard to win back European consumers. McDonald's Corp., which on May 8 announced that same-store sales declined 0.7% in Europe during April, has slashed prices in Germany while running an advertising blitz for new menu offerings in Britain. Wal-Mart Stores Inc. has struggled to make headway against established German retailers. Now it is building a state-of-the-art distribution center in the western German city of Bingen.

Still, the broader numbers look worrisome. "It is not a stampede," says Dirk Schumacher, a Frankfurt-based economist for Goldman Sachs & Co. (GS). "But some [companies] are saying: 'We can't afford another five years of this."'

That's what Emerson execs have concluded. While the company's sales are set to stagnate in Western Europe, they're expected to climb at least 20% this year in Eastern Europe, where Emerson has opened 10 plants in the past five years, for a total of 28 in the region. More flexible labor regulations and weaker unions are another of Eastern Europe's attractions, Emerson President James G. Berges says. "I hate to say this, because we've got terrific German, French, and Italian companies and people, but you hate to hire people in those countries because the cost if you ever have to [lay them off] is so enormous."

How bad could the pullback get? A recent survey by Boston Consulting Group showed that one in five U.S. companies with operations in Germany is planning to relocate some activities to lower-cost, less regulated countries. Although Germany and some other nations have moved to relax labor regulations, the reforms don't go nearly far enough to make them competitive with Eastern Europe. Among the corporations that are most likely to flee eastward: automobile and auto parts companies and makers of appliances and furniture, says Kevin Waddell, a Warsaw-based partner in Boston Consulting. Looks like Emerson will have plenty of company.

By Carol Matlack in Paris and Michael Arndt in Chicago, with Adrienne Carter in Chicago


Silicon Valley State of Mind
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