This is an article I wrote that was published in CFO Magazine in June 2011. Enjoy!
A publicly traded software company took a common approach when it first decided to expand into Europe: it located in the United Kingdom with the expectation of managing all European operations from there. The company hired 12 people over eight years there before finally deciding to pull the plug on this operation, which generated disappointing revenue and market share, along with unnecessary costs such as company cars and personal assistants.
What went wrong? The approach wasn’t all bad. For one, the company didn’t try to manage overseas operations from the United States, a budget-saving effort that almost inevitably fails. Assuming it was setting up a foreign office, Europe is a logical place to start, since it has many legal and cultural similarities to the U.S. And the UK certainly has some advantages as a landing spot. In fact, 44% of U.S.-based executives would consider the UK as a prime location for future investment, in large part due to common language, according to a recent survey by the Institute of Chartered Accountants in England and Wales, compared with 38% considering all other European countries.
But too often, companies choose a country for their foreign operations without enough careful thought. Language and ease of doing business are important factors, but they shouldn’t be the only drivers of where to locate. In fact, defining — and locating in — the true target market, rather than swinging wide at an entire continent, has some unbeatable advantages.
Now, four years after pulling out of Europe, this software firm is moving back to the continent, but this time with a different strategy that includes hiring locally instead of consolidating all employees in one region. The firm has hired a local business-development professional in the Netherlands and is in the process of hiring experts in Germany. They will also hire in the UK, but this time, the UK folks will only focus on the UK market.
How can your firm make the right location decision the first time around? Consider and weigh all of the following points, rather than just one or two:
1. Core Customer Base
Pinpoint the location of your core potential customer base. Sometimes, the answers are obvious. If you sell into the car manufacturing industry, perhaps Germany would be a good choice for you. If you sell into the fashion industry, your choice is likely more focused on Italy or France. In other cases, finding the core customer base is a discovery process, and you may need to adjust course along the way. Many countries have a chamber of commerce or a representative organization in the U.S. that can be helpful in the process. You should also look at where your competitors are, or companies in related industries. Strategic partners in your home country who have already established an overseas presence can also help you get quick traction, just to name a few.
Where is your best and most qualified talent pool? Most likely the employees you want will be located in the same region as your core customer base and may come from a customer you want to sell into or from a competitor. One client, for example, is trying to hire an employee from SAP in order to build business in Germany. In general, local people know their market, and they have an existing network, which you can leverage. They can also provide realistic perspectives on how long it will take for you to recoup your investment. Local partners can also help you with the local marketing plan, and they can steadily help you build your brand, just to name a few.
Those are also some of the reasons why managing all operations from one location often fails. Europeans tend to be nationalistic and prefer to do business with someone within their own country. Having a Brit manage Germans works if the Brit speaks German, understands the culture, and makes a real effort to integrate. If you have a Brit who treats others like Brits, it can be problematic.
3. Legal structure and regulatory climate
Is a permanent establishment easy to set up or does it require specific, local expertise? More important, can it be done within your deadlines and your budget? In the unfortunate case of having to let staff go for any reason, can this be done in a reasonable and fair manner, or do laws and regulations make it a difficult and costly process? For example, though the Netherlands is a fairly easy place to establish an office, and can be a friendly place to do business, these factors are often overshadowed by what are perceived to be unreasonable protectionist employment laws and regulations surrounding employee warnings, sick leaves, and terminations. If a company is not properly prepared, staffing issues cannot only be time-consuming, they can be a nightmare. However, if your core customer base and talent pool are located in the Netherlands, these issues will likely be secondary considerations.
4. Preliminary tax considerations
While this factor shouldn’t drive the whole decision, it is an important one to consider. Some countries require a much higher annual financial base to conduct business due to tax, regulatory, and customary requirements. The first type of tax you’ll likely need to consider is the VAT (value-added tax), which is similar to sales tax in the U.S. Most European countries allow you to recoup the VAT paid on business-related expenses like hotel rooms and car rentals, but in some countries, like France, there are significant limitations on what you can reclaim. Payroll taxes can also vary quite a bit. In France, employers can pay the equivalent of 45.2% of an employee’s wages toward social security and wage tax; rates in the Netherlands, for example, are marginal. You may also want to look at tax issues that will crop up as sales grow, such as how different countries handle transfer-pricing issues.
5. Cultural differences
Never underestimate the power cultural differences might have on your efforts to be successful. At one point, I was working in Japan, Germany, and the US on similar projects — establishing critical strategic-partner contracts — but at very different paces. In the U.S., we were able to close partner contracts rather quickly, as we normally worked directly with management. In Germany, we worked with management but they typically sent the contracts to their lawyers for review toward the end of the process. In Japan, we worked with people who reported to management, and even after management got the contract, they would spend more time mulling over the terms and conditions than their German and U.S. counterparts. Then, at the end of each step of the process, they sent it to legal. In the end we were successful but it took a year — yes, a year — to close the contract in Japan that would have taken us a month to close in the U.S.
Off the List
Of all the factors to weigh, you might have noticed that I did not mention language. The perception of language as a barrier is just that, a perception. English is an accepted business language in Europe, so don’t let it be a major deciding factor. If you find yourself faced with a situation where the people you are working with have no or limited English, there are in most cases local partners who could help you.
The first foray outside the U.S. is never easy for a business, but taking the time to properly look for the right location and having an open mind can improve your odds of success.