Journal of World Business 38 (2003) 182203

Strategies for political risk mediation by international rms in transition economies: the case of Bulgaria
Elena Iankova*, Jan Katz
Johnson Graduate School of Management, Cornell University, Ithaca, NY, USA

Abstract As foreign investors have entered the transition economies of central and eastern Europe, they have had to deal with signicant political turbulence and ambiguity. To create an environment that is more amenable to their businesses, the investors have pursued political risk management strategies. An analysis of those strategies in Bulgaria was undertaken on the basis of indepth case-study research of American Standard, Metro Cash&Carry, and the Bulgarian International Business Association (BIBA), which represents many international rms in regard to political risk management in Bulgaria. The analysis shows that companies are pursuing two strategiesa low involvement strategy, in which companies, often working as part of a consortium, devote limited resources to mediation of a narrow set of political concerns, and a high involvement strategy, in which companies develop a diverse network of government, business, and public partners who can help them to mediate the political environment broadly. Investment intensity, a possible explanation of the different choice of strategy is considered. # 2003 Elsevier Inc. All rights reserved.

1. Foreign investors and political risks in transition economies Though the transition economies in Eastern Europe have opened to foreign investment, few have implemented political, legal, and regulatory systems that provide a comfortable and predictable business environment. While political factors are not the sole determinants of investment decisions of multinational corporations (MNCs), they are a serious concern because of the potential impact on protability (Aharoni, 1996). Political risks arise from both governmental and societal sources (Ting, 1988: 16). Governmental risk concerns the chance that ofcial government decisions and activities adversely affect capital or prots
Corresponding author. E-mail addresses: eai1@cornell.edu (E. Iankova), jhk14@cornell.edu (J. Katz).
*

(Fatehi-Seden & Sazadeh, 1989; Formica, 1996; Kobrin, 1979; Robock, 1971; Schmidt, 1986). Governmental risk can be extreme, as with conscation and nationalization, or it can have temporary or more marginal effects as with exchange controls, local content regulations, etc. (Monti-Belkaoui & Riahi-Belkaoui, 1998; Kennedy, 1988). Governmental risks can also indirectly affect business by creating a problematic environment, as when bribery and corruption are common. Societal risk arises from the political action of non-governmental organizations. Examples include violence, revolutions, coup detats, civil wars, ethnic or religious conicts, terrorism and civic disobedience, strikes, national boycotts of rms, and other forms of industrial protest (Ting, 1988: 14). Even in a country with relatively mature political institutions and public interest groups, the political environment is complex (Coplin & OLeary, 1976). In a transition economy, where institutions are still developing, the spectrum of potential risks is even wider.

1090-9516/$ see front matter # 2003 Elsevier Inc. All rights reserved. doi:10.1016/S1090-9516(03)00018-X

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To deal with the political turbulence and ambiguity, foreign investors therefore develop political risk assessment and management strategies. The diversity of potential political risks and differences in company exposure to risk make selection of an appropriate political risk management strategy complex. Have companies pursued different strategies to manage the highly complex political environment and if so, why?

2. Determinants of political risk management strategies Further complexity in the political risk equation exists because varying corporate entry strategies and industries cause different political risk exposures. As a result, the political risk management objectives of rms can be very different. Some rms have minimal asset exposureeither because they operate solely as distributors, with rented space, short-term contracts, and imported goods or because their assets are insured by guarantees abroad. If those rms are in relatively low-prole industries, they may operate easily with minimal political risk exposure and so, little consideration of political risk management. Other rms have very extensive exposure. Some make long-term investments in production facilities and source products locally; they establish elaborate distribution systems and advertise to increase consumer awareness of their products. For some rms, risk exposure may even exceed loss of local assets or loss of local sales if operations are integrated with those of other countries. Companies with internationally integrated production systems, for example, risk disruption of business worldwide if one manufacturing plant is lost. For those rms, exposure to political risk is more obvious as is the need to manage that exposure.

The selection of optimal political risk strategies becomes difcult both because of the variation across political environments and because rms vary in their exposure to those environments. Given the complexity of both the political environment in transition economies and the variance in the exposure of investing rms, we could imagine different strategies for political risk mediation to arise. According to Gladwin and Walter (1980) rms should vary in the amount of resources they should be willing to devote to political risk management depending on their risk exposure. Those that have limited exposure should seek low cost strategies and those with more extensive exposure should choose more resource-intensive strategies. The link between political risk exposure and political risk strategy can be seen as a specic case of the resource dependency framework (Pfeffer & Salancik, 1978). That framework posits a link between environmental dependence and the need for the organization to develop means to effect a better corporate-environment t. The greater the impact of other organizations or environmental conditions on the corporation, the more signicant its need to ameliorate environmental effects. That can be done through the creation of interorganizational ties that provide competitive advantages or eliminate potential threats or by efforts to change the environment to make it more amenable to corporate needs, by direct or indirect lobbying, for instance. Typically the resource dependency framework is used to address marketing and strategic issues, but the concept applies equally well to the political risk environment. In that context, rms with relatively limited political risk exposure can choose a low involvement strategy that includes little interchange with the environment. Firms with extensive exposure can choose a high involvement strategy that includes substantial interaction with other actors and the environment (see Box 1).

Box 1. Low involvement strategy and high involvement strategy Low involvement strategy Conditions for selection Limited investment (assets at risk) Narrow political risk concerns (e.g., only trade regulations or financial legislation) High involvement strategy Significant investment Wide political risk concerns (market, trade, employment, financial, etc. issues are all relevant)

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Little risk of spillover effects to other markets if situation worsens Characteristics of strategy Mediates political risk through a coalition of similar companies

High risk of spillover effects if situation worsens (e.g., loss of supply from manufacturing facility will affect sales elsewhere) Mediates political risk through a coalition of local stakeholders (e.g., unions, community organizations, local government), in which political, social and economic actors are drawn into a network Political influence at varying levels by combining the political resources of local and national organizations Works intermittently, being activated when a relevant political issue comes to the fore Hopes to create a more stable political environment in general

Focus on national level policy (government bureaucrats and parliament members) Constantly active, developing position papers and interacting with government and parliament officials Hopes to create a regulatory and legal framework that benefits business

3. Types of political risk management strategies 3.1. Low involvement strategy There are a number of alternatives for low-cost risk management, including reducing costs by linking with other organizations that have similar goals in trying to avoid political entanglement altogether. The former uses the common strategy of gaining scale economy to achieve cost reduction. In this case, rms with similar objectives form coalitions to gain scale in information gathering and action. Several scholars have pointed out that joint venture partners are a common method of expanding political risk management capabilities (Bradley, 1977; Delios & Henisz, 2000; Hennart, 1988; Teece, 1992). For wholly-owned operations, coalitions with other similar-interest companies can be formed (Coplin & OLeary, 1976). For example, rms interested in decreasing import tariffs might join together to share the costs of a lobbying strategy rather than each making the effort independently. The low resource strategy leads rms to simply avoid the appearance of political activity (Gladwin & Walter, 1980) in the hope that they may not be the target of political action. That strategy is only viable if a rm does not want to effect change in the political system. The common theme of both strategies is that they are low involvement for the rm, requiring few resources for their execution.

The less resource-intense choice, the low involvement corporate strategy, mediates political risk through a coalition of similar companies, all with similar expertise and objectives and all acting with a single voice. Firms pay an annual membership fee and managers may choose to act on various coalition committees that develop position papers and interact with high-level government bureaucrats and parliament members. Its focus is national level policy, where the coalition hopes to create a regulatory and legal framework that benets business. Companies involved in this strategy expend few resources, but have potential for return only in regard to general business issues, such as national tax policy or labor law revision. Firms with limited political risk exposure, for example because they have less equity in the market (as with trading rms) or because their equity investments are guaranteed outside of the market (as with many banks) are likely to pursue this less resource-intense corporate strategy. 3.2. High involvement strategy Companies with high political risk exposure, however, should be willing to expend greater resources and develop a more elaborate strategy because they can expect to affect the political environment in ways that provide adequate return on their efforts. The idea of a network is still appealing, but instead of a coalition of similar parties to gain scale, this network would be of

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diverse parties to gain scope. Consumer groups, labor unions, creditors, environmental and other public interest groups, government agencies, etc. are all potential network members (Coplin & OLeary, 1976; Delaney et al., 1999; McCahery & Vermeulen, 2001; Vogel, 1978). The high involvement strategy thus creates a network of local, regional, and national stakeholders, including political, social and economic actors. Through frequent contact and communication, the network acts as an information gathering device and a mechanism to work with potential sources of political risk to reduce the likelihood of actions in conict with company objectives. When these groups goals are aligned with the rm, they can supply diverse information leading to better management decisions and use their diverse contacts to make the environment more amenable to the rm. Even when those groups are not aligned with rm objectives, maintaining communication within the high involvement network allows rms to better predict risks and negotiate settlements that reduce the impact of political actions (Gladwin & Walter, 1980). This strategy provides opportunities for political inuence at varying levels and in regard to a wide variety of issues, with substantially greater sensitivity to the specic needs of the rm. Further, it can address political problems that cannot be solved through changes in the regulatory framework, for example civil unrest. These strategies are not mutually exclusive; a rm can choose to participate in both. The limited-resource and the high involvement strategy are actually two sides of a spectrum with rms able to move incrementally throughout the range. Firms that have developed high involvement networks may agree to participate in low involvement consortium because they see those as simply another node in their network. In addition, rms can transition from the low involvement to the high involvement strategy as their level of involvement in or sophistication regarding an environment increases. A rm devoting very limited resources to political risk management may thus develop a link to a community organization or a direct link to a government agency and begin to slide toward the high involvement strategy. In general, though, we would not expect a low risk exposure rm to choose a high involvement strategy because of its high resource cost. Also, high exposure rms may not choose to participate in low involve-

ment strategies because they may pursue different objectives. For example, a large number of importers involved in a corporate coalition encourages focus on lowering import tariffs, even in exchange for the creation of other taxes, such as export fees or higher corporate tax rates. A foreign company that has invested in local manufacturing, particularly if the output is in part destined for export markets, would be unlikely to support those political objectives. Furthermore, there is evidence that rms select across those based on the extent of resource commitment to the marketforeign rms with substantial long-term equity commitments in the market including manufacturing, distribution, and sales activities would likely choose the broad-resource-intensive strategy. Other rms, particularly those with limited exposure, choose a more focused-low-cost strategy.

4. Methodology To illustrate the two political risk management strategies, we will examine the emerging business networks in Bulgaria, a transition economy in southeastern Europe. The focus on Bulgaria, which is in an early stage regarding foreign investment, allows us to identify the initial development of foreign investors political risk strategies and ascertain the reasons for divergent strategic choices. Bulgaria is also a good case because it provides insight into the type of turbulent economy that is the destination of much new investment. Historically, investment in turbulent countries was limited to a few industriesextraction, construction, and some lending. Recently, there has been a broadening of investment as rms sought low wage manufacturing sites, consumer products companies expanded beyond traditional mature markets, and service rms, such as consultants, rushed in to support the other investments. Between 1990 and 2000, the stock of foreign direct investment (FDI) in the least developed nations rose more than fourfold, from $8.3 billion to $34.9 billion (UNCTAD, 2002). With the opening of markets in Eastern Europe, FDI stocks in that region rose from $3 billion to $124.7 billion during the same period (UNCTAD, 2002). A look at political risk management strategies in Bulgaria suggests that rms have chosen to pursue

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various combinations of strategic paths for political risk mediation. We have done two in-depth case studies in Bulgaria. The rst describes Metro Cash&Carrys activities through the Bulgarian International Business Association (BIBA), and illustrates the low involvement strategy. Though there are some manufacturers that belong to BIBA, membership is primarily comprised of large trading and service rms, which have lower political risk exposure, despite the fact, as will be noted below, that 55% of foreign investment is in manufacturing. The second case study describes American Standards linkages with several government and public groups to manage its complex political environment. It illustrates the high involvement strategy, which is appropriate for American Standards extensive investment in Bulgaria. The two companies highlighted in the cases here, simply illustrate close approximations of the two ends of the spectrum with one rm, Metro Cash&Carry pursuing a very limited-resource strategy and American Standard illustrating use of a high involvement network. The Metro Cash&Carry case is based on several visits to one of the Soa stores, and an interview with the companys executive director E. Abadjiev. Additional information was gathered through the companys Internet resources. Extensive interviews were also conducted with the BIBA leadershipits two executive secretaries since 1999, I. Derilova and N. Babev. The BIBA secretariat also provided all the necessary information on its activities, including copies of the annual White Papers and the government response to them, where available. Our case study on American Standard is based on several visits to American Standards subsidiary in Bulgaria, Vidima, starting from July 1999. Interviews were conducted with the executive director of the company, V. Kanev, and several other representatives of the management. Archival and current economic data available from American Standard was used as well. Interviews were held with the Mayor of Sevlievo Y. Yovkov as well, to examine the extent of local community outreach of the company. Analysis of all reports on American Standard that appeared in the Bulgarian media since the entry of the company in Bulgaria was also conducted. Interviews with BIBA representative regarding American Standard were also included in the methodology.

As background for the political risk strategy argument, the foreign investment situation in the country is rst described. That will be followed by an analysis of the political risk management strategies of the two rms and on multi-rm organization in Bulgaria, as mentioned above, and a discussion as to why various strategies were selected. The nal section of the paper discusses conclusions and managerial implications adequate for foreign investors operating in the transition economies of central and eastern Europe.

5. The foreign investment situation in Bulgaria Since it began its transition in 1989, Bulgaria has attempted to move to a market economy and meet the criteria for EU membership through the use of foreign aid and capital investment to overcome domestic crises. To this point, capital inows have not been adequate to reach the national objectives. Although the country was not directly involved in the Balkan conicts of the 1990s, its economy and emerging businesses suffered the consequences of political instability in the region, causing reduced investor condence, postponement of needed structural reforms, and general economic malaise. In addition, Bulgaria still lacks political and legal transparency and suffers from too much corruption, making the country unattractive to many foreign investors. Compared to other central and eastern European applicants for EU membership, Bulgaria occupies the last but one place (before Romania) in terms of GDP per capita6,500 Euro in 2001, compared with the frontrunners Slovenia (16,000 Euro), the Czech Republic (13,300 Euro) and Hungary (11,900 Euro). Accordingly, its GDP per capita as a percentage of the EU average is also one of the lowest (second after Romanias)28, compared with Slovenias 69, the Czech Republics 57 and Hungarys 51 (see Table 1). Bulgaria is also at the bottom in terms of FDIa total of 1.15 billion Euro by the end of 1998, only 138 Euro of FDI per capita. At the same time Hungary, the frontrunner in terms of FDI inows, was able to attract 14.9 billion Euro of FDI, or 1,473 Euro per capita for the same period (see Table 2) (European Commission, 1999: 4243). Investment of external capital signicantly lags domestic investment. The share of FDI in the overall

E. Iankova, J. Katz / Journal of World Business 38 (2003) 182203 Table 1 Macroeconomic indicators for CEE countries (2001) Country Population (millions) 2001 7.9 10.2 1.4 10.2 2.4 3.5 38.6 22.4 5.4 2.0 GDP Euro billion PPP 2001 51.5 136.0 13.4 121.3 18.1 30.3 355.5 132.2 59.7 31.9 GDP per head Euro/PPP 2001 6,500 13,300 9,800 1,900 7,700 8,700 9,200 5,900 11,100 16,000 GDP per head as percent of EU average (PPP) 2001 28 57 42 51 33 38 40 25 48 69 GDP growth (%) 2001 2.0 1.1 5.2 4.5 6.1 3.6 4.2 1.0 3.3 4.2

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Inflation rate (%) 2001 annual average 7.4 4.5 5.6 9.1 2.5 1.3 5.3 34.5 10.8 (2000) 8.6

Bulgaria Czech Rep. Estonia Hungary Latvia Lithuania Poland Romania Slovakia Slovenia

Source: European Commission, Towards the Enlarged Union. Strategy Paper and Report of the European Commission on the Progress towards Accession by Each of the Candidate Countries, Brussels, October 2002, pp. 9698.

investment process in the country3.3% of GDP in 1998 and 6.1% in 1999 has been far behind the level of domestic investment (15.1% and 17.1% for the same years) (CSD, 2001). Despite the absence of signicant wealth domestically, local businesses still invest more in business growth than do foreigners, further indicating how unattractive the market appears to be to foreign rms. Despite the low investment numbers, the last decade has seen several major multinational companies establish subsidiaries in BulgariaAmerican Standard, Shell, Danone, Nestle, METRO and others. FDI came through

both privatization and greeneld investments (see Table 3). Thirty-two percent of the total foreign investment into Bulgaria is accounted for by privatization deals. The number could have been higher, but foreign investors have shown little interest in the big debtridden agships of the socialist economy. Some of those were sold for 1 BG Lev (approximately U.S.$ 0.50) plus assumption of debt and guarantees of new investment. It does not appear that privatization will play a much greater role as a channel for FDI inows because there is little left to privatize. By 2000, more

Table 2 Foreign direct investment in CEE countries, 19891998 Country Hungary Poland Czech Rep. Romania Slovenia Latvia Slovakia Bulgaria Estonia Lithuania Total FDI by 1/1/99 (Euro million) 14,902 13,439 8,396 4,023 1,062 1,413 1,137 1,147 1,224 1,394 EU share in total FDI percent (total CEE 79%) 80 75 78 90 100 88 82 84 62 58 Total FDI per head (Euro) 1,473 347 863 178 531 565 210 138 844 376 FDI in 1998 (Euro million) 1,517 5,888 2,230 1,820 137 178 223 325 504 847 FDI per head in 1998 (Euro) 150 153 217 80 69 71 41 39 348 229

Source: European Commission, European Union Enlargement: A Historic Opportunity, Brussels, 1999, pp. 4243. Based on: EBRD Report on Transition (update 1999); Report on Investment in the World (UNCTAD, 1998)data up to 1/1/98 (including 1997). Note: Conversion of 1998 EBRD data at rate of 1 Euro $1:121 and 1997 UNCTAD data at 1 Euro $1:134.

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Table 3 Foreign direct investments in Bulgaria by year Foreign direct investment inflows by years Year Volume in USD (m) Privatization 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Total 22 134.2 26 76.4 421.4 155.8 226.7 366 19.2 1447.7 Other
a

Number of employees Total by years 34.4 102.4 210.9 162.6 256.4 636.2 620.0 818.8 1001.5 688.5 4531.7 1,715 3,052 4,269 5,646 6,168 5,503 6,226 4,845 5,153 9,089 51,666

34.4 80.4 76.7 136.6 180 214.8 464.2 592.1 635.5 669.3 3084.0

Source: Bulgaria 2002 Business Guide: Legal, Tax and Accounting Aspects (Soa: Bulgarian Foreign Investment Agency, 2002, p. 18). a Greeneld investment additional investment in companies with foreign participation reinvestment joint ventures 2001 preliminary.

than 76% of the assets dened for privatization have been transferred to the private sector and the remaining 400 enterprises were expected to follow in 2001. The lack of transparency and corruption of the Bulgarian economy can be seen in the privatization process. Forty-eight percent of privatization deals between 1997 and 2000 have been managementemployee buyouts (MEBOs), which are entitled to a ten year deferred payment scheme with grace period. Initially MEBOs were intended to provide private investors when there was a lack of traditional investor interest. Over time, however, MEBOs have increasingly been used as a cover for third party interestspolitical/ business networksto buy public assets inexpensively and with little capital invested initially (CSD, 2001). Greeneld investment has been dominated by small- and medium-sized enterprises (SMEs), though in the last few years, large companies have appeared, such as the German retail chain METRO, Liebherr (Switzerland, heavy equipment manufacturing), BILLA (Austria/Germany, hypermarkets), American Standard (USA, bathroom ttings). As assets for privatization are now limited, greeneld investment seems likely to rise further. Germany and Belgium have been the unchallenged leaders in FDI in Bulgaria (see Table 4). Italy has been the second trade partner of Bulgaria but until 2000 it was at the bottom of the list15th. Then Unicredito

Italiano bought the largest Bulgarian bankBulbank, and Italy jumped to third position making its trade and investment presence more balanced. In terms of numbers of investments, 91 of the biggest 152 investors have been companies based in the EU (CSD, 2001). There is a 77% concentration of capital in the top 10 countries in 2001, $3,473 million. The sectoral distribution of FDI has changed as major privatizations overwhelm earlier patterns. Manufacturing has shown consistent investment and remained in rst place among sectors since 1995. By 2001 foreign investments in manufacturing reached $2,184 million, almost half of total FDI. With the privatization of Bulbank in 2000, the nancial sector captured the second investment spot, with total investment of $830 million. Trade has attracted $704 million and telecommunications is in fourth position with $244 million in investments (see Table 5). As noted previously, few privatizations are left after 2002 and so, we would expect to see more consistent trends in investment by sector after that. In its Program People are the Wealth of Bulgaria presented to parliament at the end of October 2001, the new government of Simeon Saxecoburggotski promised to attract $1 to $1.2 billion FDI annually in 20022005. Foreign investment remains a key aspect of Bulgarias growth model. A declared commitment of the government is to create an environment that is

E. Iankova, J. Katz / Journal of World Business 38 (2003) 182203 Table 4 Bulgaria: foreign direct investments by countries in USD million, 19922001

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Source: Bulgaria 2002 Business Guide: Legal, Tax and Accounting Aspects (Soa: Bulgarian Foreign Investment Agency, 2002, p. 18).

friendly to Bulgarian and foreign investment and to the balanced development of small, medium and big business. The government declared that it would stick to clear rules and offer incentives to local and foreign capital while it abides to the principles of the market economy. This suggests room for corporations to effect a political/regulatory system that is amenable to business needs.

6. Political challenges to foreign investors in Bulgaria Until 1997, Bulgaria did not have a clear and precise legislation on foreign investments. In October 1997, however, the Foreign Investment Act (FIA) brought the legal framework for foreign investment into full compliance with the accepted international standards

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Table 5 Bulgaria: foreign direct investments by sectors in USD million, 19922001

Source: Bulgaria 2002 Business Guide: Legal, Tax and Accounting Aspects (Soa: Bulgarian Foreign Investment Agency, 2002, p. 18).

and created a liberal foreign investment regime by regional standards. Under the Act, foreign and local investors are entitled to equal treatment. No minimum investment is required for classication under the FIA and 100% foreign ownership is permitted, with the exception of direct foreign ownership of land. The FIA also provides for liberal exchange controls and does not restrict prot and capital repatriation except where enterprises are acquired in foreign debt-for-equity swaps. It permits expropriation only after fair compensation is paid. Despite the institution of a liberal business environment from a regulatory standpoint, problems clearly persist. The initial strong legacy of the planned economy (Jones & Miller, 1997; Spenner et al., 1998), and fragile political arrangements favored the growth of illegal economic activities (Bogdanov & Stanchev, 1997), corruption and extortion (IME, 1996; Stanchev, 1995), extensive state involvement in economic and business activities (Bogdanov, 1998; FED, 1999; IME, 1996a; Kabakchieva & Dimitrov, 1998; Stanchev, 1999), and the possibilities of coalitions of rent-seeking elite obtaining political power (Jackson, 2002). Throughout the Bulgarian transition business issues have been revisited frequently by governmental ofcials. Each change in governmentnine since 1989 saw waves of politically motivated campaigns against company directors, often carried out with the support

of labor unions. Those campaigns led to the frequent dismissal of top executives of state-owned enterprises, creating turbulence in companies being readied for privatization. Major tax laws were changed 66 times between 1990 and 1999 with implementing rules changed 43 times in the same period. The Personal Income Tax Law of 1950 was changed 19 times after 1990; seven of these were in 19961997 (FIAS, 2000: 4). Political risk is ever present, as managers can never be certain of the permanence of any political action. Additional uncertainty arises because no regulations or institutions exist in some business areas while too many exist in others. Holes in the system arise as outdated laws are eliminated before the adoption of new laws. The Personal Income Tax Law of 1950 for example was abolished in 1997, though a new law was not completed in 2000 (FIAS, 2000: 45). On the other hand, Bulgaria had 79 registration regimes, 119 allowance regimes and 49 license regimes along with 579 regulations in 1999 (Stanchev, 1999). This is, to a certain extent, inevitable in a country in transition. Further, in the rush to pass new legislation in the pursuit of EU accession requirements and general policy reforms, implementing regulations seem to be falling behind (FIAS, 2000: 5). Still, this leads to a high degree of uncertainty, both for investors and for responsible civil servants. Partially because of the uncertainty, the administration fails to provide help

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in the interpretation of new legal provisions. Corporations are therefore left on their own to gather information and determine the means of compliance. Finally, the existing court system is seen as inefcient and not in a position to handle the caseload and administrative tasks it is charged with. As one investor had pointed out, going to court would be his last choice to ght for his rights (FIAS, 2000: 5). A survey of the judicial system in Bulgaria conducted by the World Bank reveals several inherent weaknesses, including understafng, low salaries, potential corruption, insufcient training mechanisms, and overly complex legal procedures (The World Bank, 1999). Weak oversight and an ambiguous legal system have resulted in the proliferation of tax violations and the development of informal and grey economic activities. According to ofcial estimates, the private sector accounted for 25% of GDP in 1994, but when activities outside of the government tax base were included by the International Bank for Reconstruction and Development (IBRD), the private sector was seen to contribute 50% of GDP. IBRD data further indicate that at least 90% of prots in the economy accrued to the informal private sector (UNDP, 1997). Private sector illegalities are compounded by public sector corruption, which is generally perceived as the abuse of public power for private gain. Bulgarian corruptionsimilar to other central and eastern European casesis fostered by three major factors: monopoly (the continuing power of the state in the economy and other sectors of social life), excessive discretionary power (i.e., the lack of clear administrative rules and regulations), and lack of accountability (i.e., poorly functioning or absent watchdog agencies) (Elliott, 1997). Together the illegal private systems and corrupt public system create signicant uncertainty for legitimate rms. Several forms of corruption were identied in a 1999 survey of 130 Bulgarian businesses including 17 foreign rms (part of a broader World Bank survey carried out in 20 CEE countries) (Hellman et al., 2000). Companies reported that people bought parliamentary votes, presidential decrees, and court decisions. Bribes could be paid to public ofcials to avoid taxes and regulations. The survey did not clarify whether payments were a corporate strategy or whether extortion occurred. Those rms that paid bribes, frequently or always, indicated the following distribution of bribes

for services: licenses (22.6%); connection to public services (17.7%); taxes (14.1%); courts (13.6%); customs (11.9%); health/re inspectors (8.2%); government contracts (6.6%); inuence on legislation (2.8%); and other (2.6%) (Hellman et al., 2000: 36). Questionable practices that effected business indirectly were also found in the survey. Respondents reported that the Bulgarian National Bank mishandled funds and that patronage (dened as public ofcials hiring their friends and relatives to ofcial positions) was common (Hellman et al., 2000: 20). The survey found though that illegality was pervasive in the business environment of Bulgaria. To reduce the questionable practices, the government is currently discussing a new law on lobbying that is intended to increase transparency and reduce the likelihood of bribery and corruption. If this law is implemented, it will create a major change in the businessgovernment relations in Bulgaria and improve conditions for foreign rms, which tend to be less familiar with appropriate relations or constrained legally (as with the US Foreign Corrupt Practices Act) from participating in such relations. Another pervasive and difcult to manage concern is the conduct of the state in its capacity of corporate shareholder and the resulting control over major economic activities. The dual role of the state as a regulator of the economy and shareholder in privately traded companies is inevitably generating internal conicts and often leads to a politicizing of purely economic issues. This often lowers corporate efciency and induces decisions determined by non-economic factors. Public servants participating in company governing bodies tend to exert a dominating and, sometimes, unsuitable inuence on managers. Important decisions, such as election of boards, amendments of bylaws, and management of assets, are often affected by the state through this particular channel. Several non-governmental organizations signicantly affect the business environment as well. The Bulgarian Labor Code of 1986 introduced works councils at the rm level, providing labor organizations with an impact on rm strategy. Until the collapse of the Zhivkov regime in 1989, this system actually provided only a modest degree of worker involvement (Petkov & Thirkell, 1989). Afterward, however, the Code was not signicantly changed, and workers and unions have become key players in the emerging business environment.

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E. Iankova, J. Katz / Journal of World Business 38 (2003) 182203 Table 6 Factors inuencing initial investment decisions in Bulgaria (KPMG Survey 2000), in percent 1. Customer base in the region 2. Former business contacts 3. Emerging market 4. Strategic geographic location 5. Lower labor and non-labor costs 6. Skilled labor 7. Stable political environment 8. International competitive pressure 9. Good local market 10. Lack of competition in the country 11. Availability of capital equipment 12. Proximity to home operations 13. EU membership prospects 14. Availability of raw materials 15. NATO membership prospects 16. Tax incentives 18. Favorable foreign investment law 19. Positive regulatory environment 20. Funding accessibility 21. Inexpensive land 42 40 38 36 36 26 18 18 17 14 13 13 6 6 3 1 1 1 0.1 0.1

A survey of 371 Bulgarian manufacturing establishments in the period 19891992 carried out by Jones (1995) reveals that, while modest in the initial years of transition, employee involvement was clearly increasing. Through their involvement in national political talks with the government and emerging business associations in the initial years, trade unions acquired overwhelming employee representation powers (Thirkell & Tseneva, 1992). Politically motivated strikes and other forms of industrial unrest were a frequent phenomenon during the initial years of transition. Not unrelated, all international nancial institutions in Bulgaria for the purpose of granting loans for economic restructuring requested the consent of the unions on preserving social peace during the duration of the loan agreements (Iankova, 2002). Business groups also have their own political power. A survey of Bulgarian business organizations reveals the tight link between business and political institutions. In 1995, more than 80% of business leaders interviewed by the Institute for Market Economy believed that in Bulgaria a business association should be committed to a political party, in order to achieve its goals (Bogdanov & Stanchev, 1997). Public interest groups have also arisen and those attempt to effect the business environment either directly or indirectly. Ekoglasnost is composed of citizens with an interest in environmental issues, such as pollution control. Ekoglasnost was responsible for the rst public demonstrations in Bulgaria prior to 1989. Their objective is to foster enactment of regulations supportive of a sustainable environment, which obviously would affect manufacturing rms. Womens groups, groups advocating for the disabled and elderly, and other groups are being created and beginning to ex their political muscle (Iankova, 2002). While this means that the sources of political risk are expanding, it also means that the range of external entities to form a political risk management network is growing. Proper management of the environment, while complex and costly, can therefore provide a signicant return to the rm.

Source: KPMG. Foreign Investors in Bulgaria. Survey 2000 (KPMG: Soa, 2000, p. 17).

7. The business perception of the political challenges In terms of determinants of FDI in Bulgaria, a 2000 survey on foreign investors in Bulgaria conducted

by KPMG1 distinguishes between three groups of factorsfactors inuencing the companys initial investment decision; factors of signicant importance for running the companys local operations; and critical factors for future foreign investments. While respondents rate political risk as the seventh most important factor inuencing the companies initial investment decision (Table 6) (KPMG, 2000: 17), it is fourth most important in affect on the companies local operations in (Table 7) (KPMG, 2000: 18) and most important in inuencing corporate decisions about future investments (Table 8) (KPMG, 2000: 21). The impact of political factors on investment patterns emerges even more clearly if we look at the barriers to foreign investments in Bulgaria listed by the surveyed companies. Four of the top ve barriers are a direct consequence of political and policy factors: cumbersome bureaucracy (considered the most serious problemreported by 86% of respondents), the incoherent and unstable legal system
Two hundred and thirty companies were surveyed including the top 140 foreign direct investors identified by the Bulgarian Foreign Investment Agency.
1

E. Iankova, J. Katz / Journal of World Business 38 (2003) 182203 Table 7 Factors of importance for running local operations in Bulgaria (KPMG Survey 2000), in percent 1. Skilled labor 2. Lower labor and non-labor costs 3. Customer base in the region 4. Stable political environment 5. Emerging market 6. Good local market 7. Strategic geographic location 8. Former business contacts 9. Lack of competition in the country 10. International competitive pressure 11. Availability of capital equipment 12. Availability of raw materials 13. Proximity to home operations 14. EU membership prospects 15. Positive regulatory environment 16. NATO membership prospects 17. Funding accessibility 18. Favorable foreign investment law 19. Tax incentives 20. Inexpensive land 47 35 28 21 17 15 15 15 13 13 8 8 7 6 4 4 3 3 1 1

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Table 9 Barriers to foreign investments in Bulgaria (KPMG Survey 2000), in percent 1. Cumbersome bureaucracy 2. Incoherent and unstable legal system 3. Limited purchasing power 4. Corruption 5. Excessive taxation 6. Lack of infrastructure 8. Lack of experienced managerial staff 9. High investment risk 10. Crime 11. Limited borrowing options 12. Technological backwardness 13. Inflation 14. Currency instability 15. Other 86 75 68 63 54 38 32 29 28 28 24 12 8 10

Source: KPMG. Foreign Investors in Bulgaria. Survey 2000 (KPMG: Soa, 2000, p. 21).

Source: KPMG. Foreign Investors in Bulgaria. Survey 2000 (KPMG: Soa, 2000, p. 18).

Table 8 Factors of importance for future foreign investments in Bulgaria (KPMG Survey 2000), in percent 1. Stable political environment 2. Skilled labor 3. EU membership prospects 4. Strategic geographic location 5. Tax incentives 6. Favorable foreign investment law 7. Customer base in the region 8. Positive regulatory environment 9. Lower labor and non-labor costs 10. Emerging market 11. Good local market 12. NATO membership prospects 13. International competitive pressure 14. Funding accessibility 15. Availability of capital equipment 16. Availability of raw materials 17. Lack of competition in the country 18. Inexpensive land 19. Former business contacts 20. Proximity to home operations 39 38 35 35 33 32 28 26 26 24 24 19 17 10 8 7 6 4 4 3

(75%), corruption (63%) and excessive taxation (54%) (Table 9) (KPMG, 2000: 21). Nikolay Marinov, Director of the Bulgarian Foreign Investment Agency, conrms that political factors are signicant obstacles to his agencys task of attracting foreign investment. Bureaucratic red tape, ambiguous legislation, and frequent changes in legislation are consistently sited by foreign investors as problems (Standart, May 29, 2002). The political environment clearly is of concern to foreign investors and we would therefore expect most to make some effort to mediate political risks.

8. The low involvement strategy: Metro Cash&Carry and the Bulgarian International Business Association Metro Cash&Carry Bulgaria is a constituent part of sseldorf, Germany, Metro Metro AG. Based in Du consists of the following chains: Metro Cash&Carry wholesale hypermarkets, Real retail hypermarkets, Extra (a chain of smaller supermarkets in Germany), Media-Saturn group in Metros electronic business, and Praktiker, Metros do it yourself markets. During the recent years, Metro has grown through take-overs and been completely restructured. It has expanded from being a cash and carry wholesale company to being Germanys largest retailer, Europes second

Source: KPMG. Foreign Investors in Bulgaria. Survey 2000 (KPMG: Soa, 2000, p. 19).

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largest commerce company, and, according to some accounts, it is the second largest retailer in the world after Walmart. The Cash&Carry business is the core business of Metro AG. It offers under the label of either Metro or Makro a broad and deep food assortment with special emphasis on fresh products and a broad non-food assortment for general business supply to professional customers and institutional bulk buyers. Metros assortment comprises about 20,00030,000 non-food articles and about 10,00015,000 food articles, always adapted to the local demand. Cost reductions are passed on to the customers as price advantages. Due to its wide assortment variety Metro Cash&Carry is able to offer its professional customers what they need under a single roof and is therefore a exible, rst-degree purchase source for them. The Cash&Carry business is also by far the largest and most international business of Metro AG. Metro Cash&Carry wholesale hypermarkets are present in 22 countries with a total of 384 Metro and Makro markets (in Europe, the Makro cash and carry markets belong to Metro). Cash&Carry employed an average of 64,662 workers (full time equivalents). With over 38 billion German Marks (close to U.S.$ 20 billion) in 2001, Metro Cash&Carry brought 44.4% of the total Metro AG turnover. Metro opened its rst cash & carry hypermarket/ megastore in Soa in March 1999. Metro was expected to carry a wide variety of direct-imported and locally produced consumer items. By 2002, Metro had built one additional store in Soa, and others throughout the country, in the larger cities of Plovdiv, Varna, Bourgas, Russe, Stara Zagora, to a total of seven. Metro is predominantly a retailer. It does not have its own production system, except for the production of small amounts of barbeque meat balls for distribution in its stores. Each country, including Bulgaria, is managed by a local management team. The basic management idea is Our customers are our partners. Our customers pick the goods they need for themselves in the store, pay and take away the goods in their own vehicle: CASH & CARRY. This has a number of advantages for the customers: very favorable price/performance level; large food and non-food assortment under one roof; immediate availability of goods in both, large and small quantities.

The rm discusses the political conditions in the country on a regular basis. According to its managing director E. Abadjiev, we talk a lot about the political situation in the country and discuss political risks. But our general approach is to mind our own business and not interfere in politics. Our business is not politics. Metros direct outreach to the local communities is not big, although the company considers its support for the development of the local national economy to be signicant. We support the development of the economy in several ways: (1) our investment in Bulgaria per se; (2) we create new jobs; (3) we create opportunities for our suppliers to grow with us (these are mostly local suppliers although some foreign are also used)they enter the global markets together with Metro; (4) we create opportunities for a lot of entrepreneurs to develop their small businesses. These are owners of hotels, restaurants, bars . . . there is always the option for them to nd fresh food in the Metro stores; and (5) we have participated everywhere in the building of infrastructure accompanying our stores in Soa, Varna, Plovdiv, Burgas, Russe, and Stara Zagora. Metros aim in the area of employment relations has been: Friendly and well qualied employees. Special educational and training programs support this. Labor relations at Metro have normally been correct, although major problems have been encountered in many countries. In 1999, at a meeting between Uni Commerce and the responsible personnel directors of Metro AG and all its chains, the company afrmed its full respect for workers and trade union rights, including the right to organize. With the support of the two German Uni Commerce afliates DAG and HBV, an organizing campaign was launched in Poland, the Czech Republic, Slovakia and Hungary. The pilot project with Uni Commerce afliate the Solidarity trade union in Poland has been successful, several new Metro trade union locals have been established, and it is now being expanded to the other countries. The Metro AG personnel management has intervened several times in Poland, in favor of the right to organize. They also participated in the European social dialogue round table meeting in Warsaw in 1999, reiterating their commitment to respect workers rights. Metro Bulgaria does have direct contacts with various government ofcials from the national government and local government authorities, despite its

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general policy of restraint from direct involvement in the government decision-making process. These contacts were much more intensive at the time Metro entered the country in 1999. There were meetings with then Prime Minister Ivan Kostov, with the Minister of Finance Muravey Radev and the deputy ministers of nance, the Head of the Main Tax Directorate, and the Minister of Labor. The Law on Foreign Investments allows special institutional help for the investors accomplishing an investment project acknowledged by the Council of Ministers as priority one. At the request of the investor, the Foreign Investment Agency may propose to the Council of Ministers to form an interministerial group, comprising representatives of ministries and agencies concerned, in order to provide institutional support for appointed investment projects acknowledged by the Council of Ministers as priority investment projects. Based on the institutional support mechanism, the Council of Ministers set an interministerial group in 2000 in order to coordinate the institutional help to the greeneld investment project of Metro Group in Bulgaria. Currently Metro does not hold regular meetings with politicians. There are though direct contacts with deputy prime minister and Minister of Economy Nikolay Vassilev. Also, in November 2002 the CEO rber met with of Metro AG, Dr. Hans Joachim Ko Bulgarian President Georgi Parvanov during Parvanovs ofcial visit to Germany. Metro Bulgaria became a member of the Bulgarian International Business Association soon after its entry, actually when the rst store was opened in Soa. However, BIBA membership was not included in the entry strategy of the company. The entry strategy has been a pure strategy for a trading company. Everywhere in the world, Metro AG aims to become a member of representative organizations of business in the eld of trade. In this way Metro aims at inuencing the process of legislation drafting and securing better conditions for the development of trade and the retail sector. BIBA was perceived as such a representative organization of business in Bulgaria which has been visible in the country in summarizing and formulating, representing and defending the interests of foreign investors. Overall, BIBAs lobbying activities and high visibility in the country are the reason for Metro to decide to become its member.

BIBA was founded in April 1992 as a non-prot organization bringing together many of the largest foreign investors in the country. The founders of BIBA were British Gas, the Bulgarian-American Enterprise Fund, International Computers Limited (ICL), Pricewaterhouse, Rank Xerox, Shell Bulgaria and the ITT Sheraton. BIBAs objectives are: to represent the inter` -vis ests of the international business community vis-a the Bulgarian authorities; to improve the business and investment climate in Bulgaria; to function as an information exchange tool; to pool the know-how and expertise of its members on doing business in Bulgaria and place it at the disposal of its members; to encourage the commitment of its members to the advancement of the Bulgarian society; to assert a new culture and new business ethics as well as international standards and quality of performance.2 BIBA changed dramatically in 1997. According to then BIBA executive director Iliana Derilova, BIBA was just a club before 1997, with no signicant impact on society. Committees were very small and they did not interact with many outside the group. The change was actually initiated by the new Bulgarian government following the dramatic economic and nancial crisis in the country in the fall of 1996, and the creation of a currency board in 1997. As a result, BIBAs current organization reects both company and government needs. Not surprisingly, BIBA is one of the most inuential non-governmental organizations in Bulgaria. Its membership has grown steadily, from 7 founding members in 1992 to 170 members in 2001. Members represent more than 20 countries, including some supranational organizations such as the European Bank for Reconstruction and Development. BIBA generally focuses on common problems that foreign investors encounter in Bulgaria. Specic company problems can be brought to BIBA, but only to request that BIBA organize meetings between the company and government agencies. Individual company problems are typically resolved directly between the company and relevant agencies. Overall, contacts between Metro and BIBA are organized through ve major channels. First, Metros managing director is a member of BIBAs Board of
2 Statute of the Bulgarian International Business Association (Sofia: BIBA, 2000, p. 3).

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Directors, and participates in its regular meetings. Second, there is a exible email connection among Executive Board members. A lot of questions are discussed over the email. Third, Metro participates in BIBAs general meeting which convenes once a year. Fourth, Metro has representatives in all BIBA committees. These are Metro specialists on the particular thematic topics of each committee, such as the Head of the Financial Department, the Chief Accountant, etc. Finally, Metro participates in the preparation of the BIBA annual White Paper, in its part on trade and trade legislation. Through active lobbying activities, BIBA members, including Metro, mediate political risk and inuence Bulgarian public policy at all levels. BIBA maintains a regular dialogue with the Bulgarian government, the Bulgaria Investment Forum, and international nancial institutions. It holds monthly meetings with Bulgarian ofcials and regularly meets with representatives of international nancial institutions. Increasingly, as its current executive director N. Babev notes, BIBA is consulted by government ofcials on issues of EU accession and harmonization of Bulgarian legislation with the European common law. BIBA was a member of the Consultative Council on Foreign Investment to the Prime Minister created by the Kostov cabinet, and is also a member of the recently created Council on Economic Growth to the Council of Ministers within the new Saxecouborggotski government. The Council is, according to Metros managing director Mr. Abadjiev, a forum where BIBA can be heard. It comprises the basic ministers (of nance, economy, etc.), and representatives of the business community in the country BIBA, the Bulgarian Chamber of Commerce, the Bulgarian Industrial Association, the Union of Employers and the Vazrazhdane Union of Private Producers. The Council holds meetings every week under an agenda that has been distributed in advance. Overall Mr. Abadjiev perceives the Council as a exible instrument for the synchronization of the interests of the state and the business community: Here our interests coincide. BIBA is also one of the co-founders of the Bulgaria Economic Forum and is represented in the forums Board of Directors. BIBA also maintains regular contacts with other national business consortiums such as the Bulgarian Industrial Association and the Bulgarian Chamber of Commerce and Industry. It has an agreement with the Bulgarian Industrial Associa-

tion to use the latters permanent seat at the National Council for Tripartite Cooperation as a channel for the resolution of some societal problems of the political environment such as industrial unrest. During the June 2001 parliamentary election campaign, BIBA members met with the ve largest political powers in the country. The foreign companies heard the parties economic platforms and provided feedback. The economic program of the winning political party, the National Movement Simeon II, was based on three business sourcesthe Velikden For Bulgaria strategy, the Agenda 2005 of the Union of Employers, and BIBAs annual White Paper. After the new government took ofce, BIBA communicated with the new Prime Minister, Simeon Saxecoburggotski, requesting a set of measures for the establishment of an ethical and sustainable business environment. Foreign investors urged for zero tolerance, high nes and punishment for companies that evade taxes. They also requested changes in creditor/debtor regulation. As for whether Metros expectations were met by BIBA: it can always be more and better, according to Mr. Abadjiev. Our expectations from BIBA are not only in regard to how BIBA represents our interests, but also how well it is heard by politicians and the public. BIBAs voice is thus best heard through its annual White Paper, prepared since 1996 and ofcially presented to the Bulgarian government and international institutions. The document renders an in-depth analysis of the investment and business climate in the country and sets out recommendations for improvement of the national legislation initially in the areas of nancial services, tax regime, privatization, manufacturing, logistics and distribution, IT and telecommunications, and personnel (see Table 10 for an account of the evolution of BIBA White Paper chapters since 1998). In preparing the annual editions of the White Paper, BIBA operates on the basis of permanent committees. Their aim is to identify problems of common concern, analyze various legislative issues, and formulate BIBA ofcial statements. Since 1997 BIBA incorporates the following six committees: Tax and Duties Committee; Banking and Finance Committee; Privatization Committee; Personnel Management Committee; Trade and Distribution Committee; and Industrial Committee. The committees meet regularly depending on the concrete issues. All committees prepare draft chapters of the White Paper and

E. Iankova, J. Katz / Journal of World Business 38 (2003) 182203 Table 10 Evolution of BIBA White Paper chapters 1998 1. Financial services Banking Bank privatization Equipment leasing Capital markets 2. Tax regime 3. Privatization 4. Manufacturing 5. Logistics and distribution 6. Telecommunications 7. Personnel 1. Financial services Banking Financial sector privatization Capital markets Insurance Pension funds Equipment leasing 2. Tax regime 3. Privatization 4. Manufacturing 5. Logistics and distribution 6. Telecommunications 7. Personnel 1. Financial services Banking Capital markets Insurance Pension funds Accountancy and corporate governance 2. Tax regime 3. Privatization 4. Manufacturing 5. Advertising 6. IT and telecommunications 7. Personnel 1. Financial services Banking Capital markets Insurance Pension funds Accountancy Financial leasing 2. Tax regime 3. Industry operations 4. Advertising 5. IT and telecommunications 6. Personnel

197

1999

2000

2001

distribute them among all BIBA members (Table 11). The papers must be approved by the Board of BIBA before ofcial distribution.

The 2000 White Paper showed a change in focus no longer concentrating on legal basics, but instead on more detailed issues in a way more amenable to the government. In part, this was due to the closer collaboration between the BIBA committees and relevant government agencies during preparation of the document. This years White Paper is a boring document there are no scandals in it, remarked then BIBA President John Munnery when presenting the Paper to the Prime Minister. However, the 2000 White Paper did note the slow implementation of regulations essential to a healthy business climate. Investors are concerned that legislation continues to hit targets outside the original ones and demand regulations providing clear interpretation of laws. The White Paper also recommends that more attention should be paid to small- and medium-sized Bulgarian enterprises, which are becoming more important as a source of investment, now that the big privatizations are drawing to a close. The government has increased its response to the White Paper. In February 2001 the Prime Minister Ivan Kostov presented the President of BIBA with an ofcial set of answers to all problems identied in the 2000 BIBA White Paper. The 55-page document contained positive answers to about 5560% of all issues raised in the White Paper, according to BIBAs then President Mr. John Munnery. Thus according to BIBA information out of a total of 153 proposals, the governments response was Yes to 67 of them; No to 57; Yes, but17; To be discussed 2; Already in place1; and No comment9 (BIBA News, MarchApril 2001: 2). A more detailed account of the proposals and the government response reveals a very similar picture (see Table 12). The highest acceptance rate was in the area of manufacturing (81% of all proposals) followed by nancial services (62%). The sensitive issues of tax regimes and privatization had a low acceptance rate, of 16% and 26%, respectively, but many of these proposals were accepted with some reservations (29% of the privatization proposals and 22% of the tax regime proposals). Accordingly, the proposals rejected at the highest rate were in the areas of advertising (83%), tax regime (62%), and information technology and telecommunications (50%). BIBAs political management, then, occurs at the highest national level and does appear to affect national legislation of relevance to member rms. Actions are

198 Table 11 BIBA committees Committee name Personnel Management

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No. of members 42

Tasks Maintain relations with the Ministry of Labor and Social Affairs Discuss legislation on social and health contributions Prepare the BIBA Salary Survey Prepare the personnel chapter of the annual White Paper Maintain relations with the Ministry of Finance Discusses issues related to the national tax regime Prepare the tax section of the annual White Paper Discuss banking, capital markets, insurance, pension fund issues Prepare the Financial Services Chapter of the annual White Paper Discuss legislation in regard to trade, distribution, marketing, and advertising Prepare the logistics and distribution chapter of the annual White Paper Focus on internal (e.g., economic stability) and external issues (e.g., EU accession) that affect the manufacturing sector Prepare the manufacturing chapter of the annual White Paper Discuss issues related to privatization Prepare the privatization chapter of the annual White Paper

Tax & Duty

33

Banking and Finance Trade and Distribution Industrial

29 23 16

Privatization

15

not rm-specic, however, so only general political issues can be mediated through this mechanism. It is possible that committee members develop useful ties with government ofcials during their regular meetings and that those ties may be used to mediate rm-specic risks. Firms such as American Standard, that developed close government ties during privatization or through other mechanisms, could use those instead.
Table 12 BIBA 2000 White Paper on foreign investment in Bulgaria Issue areas BIBA recommendations

Aside from the national government links, BIBAs only connections are with other business consortia and international nancial institutions. They do not communicate on a regular basis with other potential sources of political risk, such as public interest groups or local governmental authorities. Companies with extensive exposure, for example those with substantial manufacturing operation or with particularly politically

Government response Accept 18 3 7 2 3 3 5 9 13 1 5 7 (62.1%) Accept with some reservations 4 2 1 1 7 10 1 1 2 (13.8%) Reject 7 4 1 2 20 16 2 5 6 5 (24.1%)

Financial services Banking Capital markets Insurance Pensions funds Accountancy and corporate governance Tax regime Privatization Manufacturing Advertising IT and telecommunications Personnel Total

29 3 11 5 6 4 32 35 16 6 12 14 144 (100%)

(15.6%) (25.7%) (81.3%) (16.7%) (41.7%) (50%)

(21.9%) (28.6%) (6.2%) (8.3%) (14.3%)

(62.5%) (45.7%) (12.5%) (83.3%) (50%) (35.7%)

58 (40.2%)

25 (17.4%)

61 (42.4%)

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sensitive businesses, would need to seek out other political risk management strategies if they wanted complete coverage. This political risk strategy requires the devotion of few corporate resources, but it also provides only narrow political risk management. For the payment of an annual fee (committee participation is optional), the company gains information about national level political action and has the opportunity to ask BIBA to arrange meetings with government ofcials if necessary. For rms with limited or relatively specic exposures, this level of political risk management may be adequate. Ergo, it is not surprising that the membership of BIBA is distributed as it is. Despite the fact that 55% of foreign investment in Bulgaria is industrial investment, only 23% of BIBA members are manufacturers. This is not a function of the relative size of investment of members, by the way. Many of the largest investors in Bulgaria are BIBA members, but they are banks, which have very specic political concerns, or trading companies, that are also primarily concerned with narrow, national level issues. Some of the manufacturers that have broader exposure and like American Standard, probably developed political risk management contacts through other means seem to have opted out of the organization. Given that the cost of entry into BIBA is so low, however, it would not be surprising if every rm joined the organization. The only signicant deterrent to membership would arise if a companys operations place it at odds with the bulk of BIBA members in political terms. For example, American Standard has more extensive assets in place and operates in a very different region than most other BIBA members. As a result, it may see inconsistencies between its own objectives and those of other members and so chose not to participate. That may have been the case for other manufacturers as well.

9. The high involvement strategy for political risk mediation: the case of American Standard American Standard Inc., based in the United States, specializes in manufacturing and sales of plumbing xtures, air conditioners, sanitary and industrial ttings and bath accessories. It rst invested in Bulgaria in 1992 making the country one of its key low-cost

production sources to supply Western European markets. Production of porcelain bathroom xtures (e.g., toilets, sinks, baths) is a labor-intensive process and transfer to a low wage country was necessary to improve margins and remain competitive. Bulgaria was a strategically situated country with lower labor costs, providing easy access to crucial markets in Western Europe, the Middle East, and elsewhere in Eastern Europe, with labor costs only about one-tenth of those in Western Europe. American Standard entered gradually, developing expertise before making signicant investments (Tagliabue, 2001). The group initially formed a joint venture, Vidima Ideal, in 1992, to make bathroom and kitchen ttings in Sevlievo, a small city in central Bulgaria. The partner, Vidima, was founded in 1934 and then nationalized under state socialism. Vidimas product line was very similar to that of American Standard. When the company was privatized in 1996, American Standard purchased a 77% stake for $5.4 million. Turnover has risen from $8.5 million in 1992 to $68 million in 2001. Approximately about 96% of the companys output is exported to Western Europe.3 In 1996 American Standard opened a second, porcelain plant in Sevlievo under the Ideal Standard name. In May 2001, two new plants were opened in the village of Gradnitsa. One, called Vidima-2, produces lowvalue sanitary ttings, for export through Europe. The second, called Vidima-3, produces deluxe brass casings, for worldwide export. The company has also made non-production investments in the local community (such as the construction of the luxury four-star Sevlievo Plaza hotel and the installation of gas utilities in the Sevlievo region). By 2001, American Standard was the 12th largest foreign investor in Bulgaria. According to Vassil Kanev, CEO of one of the Bulgarian units, the companys total investment in Bulgaria had increased to $96 million by 2001. As a result of this entry strategy, American Standard carries signicant political risk exposure. In addition to the potential for losing its assets in place, a range of political actions could disrupt production or directly disrupt export, thereby harming the companys operations in Western Europe and to some extent worldwide. As well, the extensive operations including all
3 Sinking a Big Investment. Financial Times, March 8, 1999; and company data.

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facets of business, can be affected by a wide range of regulatory changes and also non-governmental actions (e.g., protests). To respond to these diverse political risks, American Standard developed a high involvement strategy. We can tentatively identify four elements of this strategycoalition of suppliers; contacts with the national government; contacts with local stakeholders; and relations with employees. First, American Standard has become a magnet for foreign investment. Though the company has about 50 suppliers locally, it also relies heavily on Western suppliers for products not available locally. As a signicant buyer, American Standard has been able to force suppliers from Germany, Austria, Spain and Italy to open operations in Bulgaria to ensure rapid and dependable supply. One major supplier, Gruppo Minerali of Italy, which provides some of the 600 tons of raw materialsclays, sand and the likethat the porcelain factory consumes every week, is already building a processing plant in Sevlievo. They will provide all the materials American Standards works in Bulgaria and Germany need. Though primarily driven by a need for production efciency, this strategy also produces general goodwill with local and national government ofcials who recognize the need for investment and also, a coalition of companies ready to act in unison on political issues. Second, American Standard has pursued direct contact with the national government. These contacts have two major goalsmanagement of day-to-day needs, such as license and certicate requirements, and political risk mediation, as with lobbying activities to effect preferred tax and customs policies. These contacts were developed by the local Bulgarian management in the early post-privatization years, when the political system was particularly ambiguous. Executives worked to maintain their government contacts, illustrated by frequent visits by government representatives to the plants. To support these government contacts, American Standard has sponsored non-business activities that show the government in a positive light. For example, in October 1998, American Standard Companies sponsored a path-breaking conference in Bulgaria on government transparency and accountability. American Standard not only provided the funding, it also participated actively in the conference, demonstrating how a partnership between a government with reformist intentions, a think tank, and the corporate

sector can help develop strategies to improve governing institutions and democratization. The conference was entitled Foreign Investments, Transparency, and Economic Growth. Speakers included, among others, then Prime Minister Ivan Kostov and the president of American Standard Companies. American Standard was able to expand on the positive public relations aspect of the conference for the Bulgarian government, by drawing in the U.S.-based National Endowment for Democracy and the U.S. embassy in Soa. A third coalition building strategy used is to develop strong relationships with local stakeholders. American Standard is one of the few foreign investors that are not centered in the capital Soa but in a remote area. The Gabrovo region is fth in the country in terms of foreign investment. The company is recognized as a major force for development to this struggling region on the edge of the Balkan Mountains. The company renovated the old Vidima plant and brought in new technologies to the region. Employment expansion has also been a benet for a variety of local stakeholders. Jobs at the plants are so plentiful that workers have to be bused in by the company from towns as far as 35 miles away. This benets not only local government agencies interested in development, but also nascent local business that supply and support workers, local cultural and recreational organizations that benet from the growth in wages, etc. The creation of local ties has been strengthened through network action to ensure long-term investments in local communities. The company has worked with other local stakeholders to improve local social services, such as health care, education, communications, commercial networks, sport and recreation, and others. American Standard has provided substantial nancial assistance, helping to pay for the extension of gas lines and ber optic cables to Sevlievo, making donations to the hospital (U.S.$ 70,000), supporting two technical schools for ceramics and metal processing; and supporting local sport clubs. The company also provides English language education for more than 400 students in Sevlievo. In 1999, the company opened the citys rst hotel, the 40-room four-star Sevlievo Plaza. Again in 1999, Sevlievo even got its own customs ofce, mainly to handle the companys shipments. In addition, Gradnitsa, 12 km from Sevlievo and site of the new plants, is the only Bulgarian village with gas supply and optic-ber telecommunications.

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It thus enjoys all advantages of this connection: instant on-line access to the rest of the world and videotelephony. Local government agencies and other organizations have played a role also to ensure that the projects move forward (licenses, designs, links with other regional governments, etc.) and found other sources of capital when necessary. As a group, the network created an environment that is more attractive as a business center. In fact, the goal of the Vidima management is to turn the city and the region into a center of aristocratic sports such as motorcycling, golf, hunting and shing. Not accidentally, Vasil Kanev, the CEO of Vidima was awarded the prestigious distinction Mr. Economy 2000, for turning Sevlievo into a dream city. American Standards fourth coalition building strategy has been the creation of strong ties with its unions, employees and related workers in the region. The company directly employs about 3,350 Bulgarians and indirectly employs about ve times that many, including truck drivers and construction workers. The average salary in the company is $175 to $220 a month, which compares well to the countrys national average wage of $100. American standard has invested in improving work conditions, remuneration and social services for its employees, and helped to improve human resource practices and labormanagement relations in general. This has clearly helped the company avoid labor friction, which has been common nationally; it has never faced a strike action. Work conditions have been improved through signicant investments. These include the supply of safety devices for the workers and the workplace, and the introduction of new technologies with safer parameters for the workplace. Social benets are higher than the average for the country. The company covers transportation costs, health care, catering, including free food and beverages, and some discounts for the families of retired workers. Human resource management groups main priority is the development of a new type of work culture that increases productivity and quality and develops entrepreneurial thinking and personal identication with the company. There are two trade unions in Vidima (Confederation of Independent Trade Unions in Bulgaria or CITUB, and Podkrepa Confederation of Labor) and most of the employment benets have been negotiated into the companys collective agreement. Prior to American

Standards entry in 1992, relations with management had been institutionalized with a joint labormanagement Commission for Social and Economic Partnership. Upon acquisition, the company accepted that structure. The commission is comprised of eight management members and eight union members (ve seats for CITUB and three for Podkrepa). It has three co-chairs: the CEO of Vidima and the leaders of the two unions. The commission discusses and approves the minimum and average wage for the company, and related skill levels and personnel categories. Any individual wage disputes are also discussed in this commission. Collective agreements with the trade unions are concluded on a regular annual basis but they are discussed twice a year for amendments which gives a lot of exibility in labormanagement relations.

10. Conclusion and managerial implications In our review of political risk mediation strategies in Bulgaria, we found that two strategies were pursued a low-investment strategy and a high involvement strategy. The former used a network of similar companies that worked on issues of common concern with a relatively narrow range of political entities. The latter created a broad network of diverse participants to gather information and potentially assist in the mediation of risks. The rst strategy, typied by BIBA, is particularly suited to companies with more limited exposure to political risk, either because of limited investment or due to the narrow nature of business risks. The strategy requires minimal resources and returns few, but potentially valuable contacts with senior government ofcials. Because of the limited resources necessary to pursue this strategy, we would expect many members who pursue the high involvement strategy to also participate in the low involvement strategy. On the other hand, companies with extensive political risk exposure may have concerns that put them at odds with the bulk of corporate strategy members and so, they may choose not to participate. American Standard, for example, initially was a member of BIBA but later decided to leave the coalition. The second strategy, typied by the network established by American Standard, is well suited to companies with extensive exposure to political risk in

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the ambiguous and changing business environment of Bulgaria. The strategy requires substantial resources to establish and maintain. In return, however, the rm gains information and expertise of a wide variety of actors. When members of the network have common political objectives, they can form a stronger coalition for political action. Even when members do not have common objectives, the communication channels developed with this strategy make it more likely that political risks can be avoided through early contact and negotiation (Gladwin & Walter, 1980). It is clear that political risk assessment and management responds to standard economic pressures on businesses. As companies enter and expand into new markets, they must nd the means to manage turbulent political environments without creating systems that are so elaborate that they force the company into a nancial loss. All of the strategies that were found in Bulgaria allowed companies to leverage the resources and skills of other actors to efciently manage their political environment. In the Metro/ BIBA case, rms pooled resources to gain scale. In the American Standard case, the company was able to use the knowledge, skills, and networks of many external organizations to manage its particularly complex environment. Managing political risk alone is probably not a viable strategy because of the very high costs, even if the same ends could be achieved. As private investment in the Bulgarian economy continues and ages, it is likely that we would see development of even more elaborate and overlapping political risk management strategies. In long-term industrialized, capitalist societies, there are a host of political risk management channels including industry consortiums, regional consortiums, temporary businessgovernment working groups, etc. The value of looking at the Bulgarian business system is that we were able to consider political risk management at a time when there were limited business institutions and so, more clearly see the pursuit of different strategies. References
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