How To Get Into Gear For 1992

April 1 1990 by Sir Michael Butler

What should a U.S. CEO make of these European developments? Will “1992″ change his industry, affect his markets? The answer, for a large number of U.S. companies, will be yes to both questions, especially in those industries where a global market of industrialized countries is emerging. Mergers and acquisitions (M&A), joint ventures and strategic alliances are changing the face of European industry. Competition will be more intense. Many more European companies are beginning to treat Western Europe as a single market and to operate throughout all of Europe. Most observers agree that economic growth in Western Europe will be considerably higher in the 1990s than in the past 20 years, with deregulation and increased competition providing a spur to a new dynamism.

Western Europe is going to be an exciting place to be. Unless the U.S. Congress initiates a process of protectionist action and counteraction, which Europeans fear hut do not really expect, U.S. CEOs need not suffer from anxiety that there will be a fortress Europe. But there will continue to be disputed European/ U.S. trade issues and protectionist pressures. These issues will require skillful handling on both sides of the Atlantic.

TREATY OF ROME

One issue that is giving rise to lively debate is public purchasing. Around 16 percent of European Community’s (EC) gross domestic product is accounted for by public purchasing, due to be opened to free competition over the next few years. European companies argue that either the U.S. and Japanese governments must be persuaded to open up their public purchases to European companies, or European companies should be given purchasing preference (as opposed to non-European multinationals with subsidiaries in Europe, since the U.S. government does not treat the American-based subsidiaries of European companies as American).

This argument may not prevail. Article 58 of the Treaty of Rome says that any company, no matter where its ultimate ownership lies, must be given equal treatment with European companies. Non-EC companies rely on this Article when making European acquisitions.

Non-European companies have been slow to join the growing movement to restructure European industries. Japanese companies, for example, have made acquisitions in the U.S., but have barely begun to make them in Europe. The number of European acquisitions in the U.S. since 1986 has far outnumbered U.S. acquisitions in Europe, despite some increase in the latter in 1989.

Many U.S. companies already are well established in Europe. For instance, IBM and Ford have long operated throughout Europe with few European companies able to emulate them. In contrast to the 1950s and 1960s, the 1980s saw U.S. firms beginning to expand overseas and not just in Europe. With Eastern Europe opening up, and Western Europe growing fast, the 1990s will once again see the U.S. targeting Europe.

With the exception of the U.K., European firms are very different from U.S. firms. In Great Britain, 80 percent of the economy is in the hands of listed (public) companies, while in Germany, 80 percent is in the hands of private companies. More than 90 percent of the M&A deals done in the EC in 1987 and 1988 concerned private companies.

M&A BARRIERS

The hostile takeover bid, as common in the U.K. as it is in the U.S., is virtually unknown in Denmark, Germany and Italy; it is extremely rare in Holland and Belgium; and an infrequent innovation of the second half of the 1980s in France and Spain.

A recent consultant’s report on the obstacles to takeovers in the member states of the EC runs three lengthy volumes. They include many devices illegal in the U.S., as well as family holdings, cross share holdings between companies and bank share holdings. But the least destructible barriers are purely cultural. The German CEO, for example, simply does not accept that the management of his or his friends’ companies needs to be subject to the threat of a hostile takeover to keep them on their toes. Indeed, they regard the susceptibility of British companies to takeovers as a result of the defects of the British economy.

This does not mean that there are no transactions taking place. Companies frequently come up for sale, only because of succession problems. In West Germany, for example, 10 percent of the owners of companies are age 65 and over; and 26 percent are between 55 and 64 years of age. And the number of cross-frontier transactions is growing fast. In 1984, there were a total of 209; in 1988, there were 792, far more still in 1989.

Mergers and joint ventures are beginning to transform the industry, with General Electric of the U.K., once very skeptical of the process of European integration, well in the lead.

IDENTIFYING TARGETS

The real problem for a U.S. CEO is identifying good targets; the number of intermediaries engaged in M&A is quite small, and the private seller seldom advertises his company as being up for grabs. Intermediaries are much more willing to discuss strategic alliances and cross share holdings-though these may lead to an outright sale or a common earn-out-than they are to put their company on the auction block.

The EC countries will remain distinctly different throughout the 1990s. The non-European CEO should not take the plunge without first seriously studying each country. Taxes will be slow to level out-corporate tax in Germany is more than 50 percent higher than in the U.K. Wage levels will remain widely spaced. Bureaucracy is still a major obstacle to profitable business in some countries. The objectivity of accounts varies widely. National characteristics are still powerful influences. To an Italian, for instance, no deal is complete without a “combinazione”; to a Frenchman, the opposition is always engaged in a conspiracy; to a Belgian, it is the duty of his negotiating partner to compromise, even if it means compromising his principles; to a Spaniard, his pride must be protected at all costs.

The diversity of the effects of “1992″ in different industries is striking. The only generalization that can be made is that there will be more competition. Consider a few different sectors: banking and investment services, information technology (IT), telecommunications, pharmaceuticals and road transport.

BANKING AND INVESTMENT SERVICES

Once the key directives have been adopted and then implemented (target date 1 January 1993), a banking license in any member state will permit the company in question to operate anywhere in the Community, and to offer its services to companies in other member states without having to establish itself there. An Italian company will become free for the first time to undertake its foreign exchange or interest rate hedging operations in Paris or London; a Danish bank will not have to seek permission from the Bank of France to open up in Paris. Unit trusts authorized in any nonmember state can already be sold Community-wide.

Once the remaining exchange controls are removed, any European citizen will be able to open a hank account anywhere in the Community. The effects will be profound in countries where no one in living memory has been able to legally take his money out without having to fill out endless and often mindless forms.

From the point of view of the economy, it may be the steps that firms take in anticipation of 1992 that will have the most important immediate effect. Already major Spanish, Danish and Dutch banks have merged. Others have formed strategic alliances and large cross share holding groups are being formed under the leadership of Deutschebank, Suez, Banque Paribas and San Paolo. Twenty-five years after the signature of the Treaty of Rome, the European banking scene was very little changed. In 1993, it will be transformed.

IT AND TELECOMMUNICATIONS

The official program of liberalization of telecoms has been long delayed by old-fashioned nationalist reflexes. An agreement on the first steps has now been reached, however, and it is reasonable to think that it will go a long way in the end, perhaps stopping short of full blown competition on the basic telephone network. Apart from some fields of public purchasing, the computer sector is already open (and IBM is the biggest computer company in almost every European country).

It is the preparatory steps that firms are taking which are moving the industry most. The 12 main European IT firms have formed a powerful lobby, accepting worldwide, open competition, insisting on worldwide open standards, arguing for an equivalent opening up of public purchasing in North America and Japan and, above all, initiating with the EC a common program to build a “European Central Nervous System” of electronic data interchange (EDI) and other computer networks to serve the single European market in the 1990s.

PHARMACEUTICALS

Pharmaceuticals is an idiosyncratic industry. Most large European firms, like their U.S. counterparts, are multinationals. Still, we are miles away from seeing a single European market. Progress seems likely, by one means or another, toward gradually eliminating the present need to seek drug approvals in each of the 12 member states.

But there are still no signs of a breakthrough on the issue of pricing. At present, because of different systems in each country for reimbursing citizens for expenditure on medicines, prices differ widely (up to 8 or 10 times difference for some drugs), from one country to another. Many governments fix prices in negotiation with firms; the outcome is often influenced by whether a firm manufactures, or undertakes some of its R&D expenditure, locally.

This situation cannot last. Already, “parallel imports” are causing problems. When the internal frontiers of the Community are abolished, the firms will have no choice but to press vigorously for movement toward a common European price. What will happen to national reimbursement systems then?

ROAD TRANSPORT

This is an idiosyncratic industry of a different kind. National markets have been protected by a system of quotas and licenses. Trucks have frequently had to return empty because they were not allowed to pick up loads in other countries. No wonder there are almost 50,000 firms in the industry.

Even here, at last, the single market is on the way. Tentative steps have been agreed on toward abolishing quotas and licenses and permitting “cabotage.” Already some of the bigger firms are on the acquisition prowl. This is one of the industries where the forthcoming period of restructuring will be traumatic. By the mid-1990s, the number of firms may be reduced to a tenth of the present figure.

In many of the industries that are going “global,” powerful European firms will emerge. Much of the action now going on in the fields of strategic alliances, joint ventures, and M&A is consciously designed to enable European companies to compete better with their rivals from North America and the Far East. Suddenly, after 30 years of a most uncommon market, government has awakened to the benefits of free competition. The European Commission is cracking down on subsidies, state aids and cartels. Though her European policy is behind the times, Mrs. Thatcher’s free market philosophy has won the day in Western Europe, even in countries with nominally “socialist” governments, such as France or Spain. Its consequences will often be profound.

LOOKING AHEAD

Now is the time for U.S. CEOs to take a long, careful look at this new Europe that is emerging. They need to find out what is going on in their industry, to understand the single market legislation recently passed, and to learn about what’s ahead. They need to assess the restructuring that is beginning in many EC industries.

This is not an easy task. So many people have piled into the “1992″ knowledge industry in the past three years-consultants, lawyers, public relations specialists, stockbrokers, analysts, and merchant bankers, among others. The quality of the advice offered varies from nothing to expert. Yet, it is hard to do without expert advisers.

My advice to British CEOs-and it applies to North American CEOs as well-is to begin preparing for 1992 by appointing a bright, young director or senior executive to travel to Brussels and other capitals, talk to representatives from the U.S. Chamber of Commerce in Brussels, meet with Commission officials and talk to journalists and other contacts in the industry. Once the appointed executive has surveyed the scene and presented his ideas, the director or CEO can then determine which of the expert advisers, if any, he will choose to help lead his firm into 1992.

Sir Michael Butler joined Hambros Bank Limited in 1988 and was appointed a director of Hambros PLC and executive director of Hambros Bank Limited. He served as permanent representative to the European Community from 1979 to 1985. He is a director of the Wellcome Foundation, chairman of ICL’s European Strategy Board, and chairman of the City of London Europe Committee under the auspices of the British Invisible Exports Council. He is the author of Europe: More Than a Continent, for which he won the 1987 Adolphe Bentinck Prize.