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What are the advantages of the onshore business

05/ 12/ 2016

Andriy Drogalchuk, Financial Director Philips Ukraine

The foreign trade theory describes several options or schemes of foreign producers’ work on different markets. The choice of a working scheme depends on many different factors. Among the most important are:

  • market size and its potential profitability;
  • stability and civility of the market;
  • clarity of rules on the market, the number of risks, general business climate, safety and protection of the invested funds.

In this article I do not consider the choice of country to host the production capacities on its territory. The analysis of investment attractiveness of a country to contain production facilities in it is based on other factors that may differ significantly.

What are the advantages for the state from the onshore business, when a foreign company establish a subsidiary company that will work on themarket?

First of all, I want to note that when a foreign company takes a decision to establish a subsidiary company on Ukrainian market, it means that this foreign company determines for themselves this market as an important, interesting and worthy of investment. Thus, the foreign company recognizes that the advantages of the market may compensate for possible failures. Such recognition has pretty great practical importance and is key to investment. Moreover, I mean not only the direct or portfolio investments, but also and investments in a broad sense, namely:

1. investment in the country;

2. investment in infrastructure and business environment;

3. investment in the market;

4. investment in employees (human capital);

5. investment in the consumer;

6. social investment.

I’ll try to explain what is meant by these investments and to analyse what are the exact benefits to the country from working on its market of the foreign companies importing consumer electronics compared to other schemes of import.

1. Investment in the country

I’m sure that the main advantage of foreign companies is their investment in the country. Under the investment in the country, I mean not only direct or portfolio foreign investment, such as, for example, contributions to the statutory fund, purchase of movable and immovable property, etc. Of course, these types of investments are quite important, but, in my opinion, they are not major. I believe that the main contribution of foreign companies in Ukraine is in the following:

  • bringing of civilized business standards into Ukraine – namely, doing business legally, ethically, in compliance with all relevant laws, rules and regulations and, most importantly, doing business with payment of all required taxes and fees.
  • bringing into Ukraine of technical and technological innovations, new standards of management and doing business.

The first thing that Ukraine receives from the work of international companies is payment of all required taxes and duties. Ironically, seems that the foreign business is the biggest investor and patriot of Ukraine from the economic point of view. Due to payment of all taxes and fees, contributions to social funds and pension funds, etc., the foreign companies are the among the largest taxpayers in Ukraine.

According to data of the EBA Consumer Electronics Committee’s experts, the official importers of household appliances, only in 2015 paid about 12 billion UAH of taxes and fees to the Ukrainian budget. On the other hand, according to the State Pension Fund the average pension in Ukraine as of 10.01.2016 is 1745.5 UAH per month. Thus, we can summarize that 12 billion UAN of payed taxes and duties covered the pensions for 571,000 retirees. If we assume that the estimated level of “grey import” in the consumer electronics sector is 20%, the unpaid taxes could help to raise pensions by half to about 100 000 pensioners(!).

2. Investment in infrastructure and business environment

Activity of international companies has a significant impact on the development of infrastructure and business environment. An outside observer can consider rather a simplified situation. In particular, the official importer enters the market and contributes, for instance, only 100 000 Dollars of the statutory fund, which it spends at the beginning of its operations. What are the other investments in the infrastructure, in this case? However, things are not so simple. Entering into a new market, the international company requires all its suppliers to provide the standard high level of service quality. This creates a stable and long-term demand for high-quality warehouses, office and trading real estate, etc.

Such a long-term demand automatically creates a supply. Let’s have a look at the commercial real estate market. According to the open sources, the total supply of professional warehouses on the warehouse market of Kyiv and Kyiv region in 2005 was about 150 000 square meters (sq.m.). At the same time, in 2015, this figure rose to 1.73 million sq.m. Thus, there was an increase in 11 times(!). About 1.6 million sq.m. of professional storages were built during 10 years(!). Without prejudice to the role of Ukrainian companies, which also require storage services, I must say that foreign companies were the main drivers of demand for building the high quality professional warehouse real estate.

So, going with a quite small direct investment in 100 000 Dollars, the average foreign company creates additionally the investment demand for 5 000-10 000 sq.m. professional warehouse real estate and 300-1000 sq.m. office. Only the construction of these areas will cost about 2-4 million, and those funds will remain in Ukraine. In addition to construction of warehouses, there is a demand for high quality material handling equipment, trucks, furniture and more.

3. Investment in the market

Investments in the market make up a significant part of budgets of international companies-importers.The local importer is interested in a quick return of money. At the same time, international companies pay serious attention to support of a long-term image of their brands and the consumer awareness about their products. Companies invest into this support as well as in advertise of specific products. These resources will stay in Ukraine and will work for its economy.

Given the long-term approach, the amount of resources invested by foreign companies in the promotions funds far exceeds the amount of resources spend by local importers for the same purposes. The Ukrainian Advertising Coalition estimated that the volume of the advertising market in Ukraine amounted to about 9 billion in 2015. Huge part of these money was invested by foreign companies.

4. Investment in employees (human capital)

Technological progress is very fast in today’s world. States that 15-20 years ago were backward countries with a predominantly commodity exports, are producing today high-tech products for the whole world. For example, the automotive industry was created during the last 15 years in Slovakia. Currently, Slovakia occupies almost the first place in the world for release of cars per capita. It could not have happened without presence in Slovakia of at least part of the required skilled manpower. Consequently, availability of qualified personnel is one of the most important preconditions for investment in the country. Moreover, existence of high quality human capital is now the competitive advantage of each individual state.

Entering into the Ukrainian market the foreign companies are hiring the local employees and teach them in accordance to the standards of Western markets. Twenty years ago, it was difficult for foreign companies to find local technical specialists with knowledge of English. Today, specialists from Ukraine within multinational corporations are working not only in Ukraine but all over the world.

Moreover, foreign companies have high demands for suppliers, reporting documents (work according to International Financial Reporting Standards), organization of working processes in company. Thus, international importing companies usually have more people in staff, than local distributors. Thus, the payroll that remains in the country is much higher.

5. Investments in the consumer

As mentioned before, deciding to enter the market the international company usually adheres to a long-term approach. Thus, the end user is in the center of its attention. Re-purchase of this or another product depends on the customer satisfaction. Therefore, foreign companies investing in:

  • organization of service centers throughout the country;
  • “hotlines” to which the consumer can address any of the issues;
  • quality support of all warranty and post-warranty services (f.e. availability of spare parts warehouse, substitute products, etc.).

Thus, having bought a product in Ukraine the consumer would be able to fully protect his interests and would have the same rights for maintenance and replacement of defective goods as consumers in any other developed country. And this means that Ukrainians will have same standards as consumers in the EU and the USA. I am convinced that those consumers who have faced problems with returning to the store of defective goods, have felt the difference and understood the importance of the abovementioned standards.

6. Social investment

International companies have corporate social responsibility policies. In particular, for most international companies are essential such issues as: responsible attitude to society, where business is conducted, and to the environment, providing of charitable assistance to those who need it more, etc. Ukraine is not an exception. Many foreign companies permanently support local communities or sponsor hospitals, orphanages, and so on.

To summarize, the subsidiary company that work directly in a given country create much more added value in the chain between the production of goods and their sale to the final consumer, compared to the other business scheme, when the importer is a distributor.

I can make a very modest assumption that in investments in market, labor costs, real estate, etc., the difference is 5-7% of the cost of goods. Thus, it means that due to foreign companies in consumer electronics sector around 2 billion UAH are invested in Ukrainian economy each year. Together with the payed taxes of approximately 12 billion UAN in 2015 and created demand for thousands of meters of real estate – it is a significant resource that remains in Ukraine and works for its economy.

Moreover, if a foreign manufacturer didn’t enter into the market with a full subsidiary, evaluating it as risky, the chance to create in this country additional chain of added value (for example, powerful production) is small enough. How can we expect investment in manufacturing that could be estimated in millions of dollars, and creation of new jobs, if the company didn’t enter into the market with minimal initial investments in 50-100 thousand dollars? The question is rhetorical.

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