BEMM160 Group members Sarah Naylor Sen Zhai Ka Ki Tsang Phatiphat Tanasuwanthan 580005089 610009431 610044810 590070608

Critical analysis of the Ukraine market for further investment by Deutsche Brauerei company

Introduction

This report aims to analyse the attractiveness of the Ukraines market for

further long-term capital investment in a brewing capacity by Deutsche

Brauerei (DB). DB first invested in the Ukraine in 1998 with Ukraine

consumers accounting for most of the unit growth in Deutsches sales over

the past three years (Deutsche Brauerei 2007) and thus this suggests

potential for future investment. A detailed analysis of the weaknesses and

strengths, and also risks and opportunities is needed in order to decide on

any structural changes and cultural changes needed if implementation is to go

ahead.

PESTEL

Political:

Since 1991, the Ukraine has declared itself independent from the Soviet

Union and preceded a constant political and legal reform for the past 20 years

and has now achieved a better stable political status since Viktor Yanukovych

won the presidential election in 2010. In order to support its economic growth

by foreign investment, the parliament has passed legislation that endows

foreign investors the right to purchase property and businesses, to repatriate

profits and revenues, and to receive compensation if the business or property

is nationalized by the government (DATAMONITOR, 2010). Furthermore, the

Ukraine entered into World Trade Organization in 2008 and intends to join the

European Union by 2015. Its corporate income tax rate in the Ukraine is a flat

25% which is lower than in Germany or other Europe countries. These factors

are all attractive to potential investors however; informal economies and

corrupt practices are widespread in the Ukrainian workplace (Rogers,

Williams 2008) with the Orange Revolution anti-corruption campaign in 2005

having minimal impact (Neutze, karatnycky, 2007).

Economic

Before 2008, the inflation rate increased steadily but saw a dramatic increase

in 2008 which was detrimental to the Ukraine economy. However in 2009

there was a substantial decrease and a decreasing tend is expected to

continue

to

approximately

8%

by

2013.

(DATAMONITOR

2010).

Consequently, despite the current high inflation, the decreasing trend of

inflation will be attractive to potential investors.

Figure 1 showing the consumer price index and CPI-based inflation in Ukraine from 2002 to 2013

Figure 2 showing the GDP and GDP growth rate from 2003 to 2013

Figure 3 showing percentage of population living below $1 a day (absolute) from 2000-15

From 2003-2008 there was a reasonably steady economic growth which then

suddenly dropped in 2009 (Figure 2) and the unemployment rate increased

dramatically. These changes were caused by the global recession in 2009 but

the worst is potentially over with an expected increase in GDP rate until 2013

(Figure 2). The governments response to this negative economic impact was

to raise the wages of certain public-sector workers and draft a 2010-11 budget

proposing a minimum hourly Ukraine wage. The resulting decrease of the

percentage of the population living below $1 a day (DATAMONITOR 2010)

indicates that the residents income would increase from 2010-15.

Social

The population of the Ukraine has seen a steady decrease since 2001 which

would be seen as disadvantageous to companies wishing to invest further.

However, the sex ratio shows 1.06 males to every female which is favorable

as statistically males consume more alcohol than females with men

accounting for 64% of alcoholic drinks consumption in comparison to 36% for

women and men accounting for 71% of beer consumption (Humphries 2010).

Moreover, the amount spent on alcoholic drinks has increased by 1% from

2001 to 2011 and the consumption of alcoholic beverages increased

substantially in 2007 and has continued to increase steadily since 2001

(Barnes Report 2011)

10

Figure 4 showing the total mid-year population (Absolute) in Ukraine from 200015

11

Figure 5 showing the fertility rate (Absolute) in Ukraine from 2000-15

12

Figure 6 showing the death rate (Absolute) in Ukraine from 2000-15

13

Figure 7 showing the spending pattern of citizens in the Ukraine in 2001

14

Figure 8 showing the spending pattern of citizens in the Ukraine in 2011

15

Country Statistics - Alcoholic Beverages, Total Retail Sales, Volume(Absolute)

16

Figure 9 showing Alcoholic beverages, Total Retail Sailes, and Absolute Volume in the Ukraine

17

Technology

Since the fall of the socialist regime in 1991 the countrys telecommunications

has developed rapidly. For instance the mobile growth rate had reached more

than 180% in 2006. The Ukraine has weak internet penetration when

analyzed by European standards however, the dramatic increase of internet

access of residents since early 2000 indicates that internet advertising is more

convenient and useful in the 21st century Ukraine. (Market Research report

2011)

Environmental

18

According to U.S. Department of Agriculture (USDA), recent climate change

together with new crop varieties and better technology could increase crop

yields in Ukraine significantly (Impacts of Climate Change in Ukraine, 2010).

Furthermore, the development of biotechnology in the Ukraine allows

enhanced efficiency of barley production and thus a stable production supply.

(DATAMONITOR 2011)

Legal

The Ukraine is set to integrate into the European Union in the near future,

having already undertaking an obligation to gradually harmonize its legislation

19

with European Union laws pursuant to Article 51 of the Treaty on Partnership

and Co-operation between Ukraine and the European Community and their

Member States of 14 June 1994, (The New Legal Frame work).

The main legal framework of foreign investment in Ukraine is the Law on the

Foreign Investment Regime, which provides equal business conditions for

national and foreign investors. It endows foreigners with the rights to invest in

the Ukraine to the same extent as Ukrainian legal entities and individuals.

However, it should be noted that there are still some restrictions in place in

certain areas. E.g. publishing and broadcasting (Deloitte, 2009)

20

Swot analysis

DB prides itself on quality and thus a key strength of it is that is has the

benefit of their brewers expertise which makes it possible for them to gain a

competitive advantage over rival companies. However, despite its apparent

popularity, DB has only five distributorships. This weakness might result in a

lack product availability within the Ukraine especially if production was to

increase in the case of further investment.

Enhanced technology for the production of barley may lower Ukraine

production costs in the long-term compared to Germany. Furthermore, Table 1

21

below shows that German beer companies are considered the best beer

producers from a consumer viewpoint which suggests that consumers would

respond well to the marketing of new beer products by DB.

22

Ukraine has an informal economy with an inflation rate higher than 10 %. If

prices rise at a faster rate in Ukraine than in Germany then that will affect the

exchange rate and transaction costs as the purchasing power of each

currency has changed. Furthermore, the fact that it enforces corrupt practices

may lead to increased overhead costs from bribery. Increased investment

interest in the Ukraine market increases both the level of competition and the

overall marketing costs which is consequently detrimental to all beer

companies in the market.

Since Ukraine customers are brand conscious, they are more inclined to buy

famous brand products. If DB cannot operate efficiently and reduce

23

manufacture costs then the selling price will be high and will not be able to

compete on the same level as those famous brands. Consequently, these

may all be threats to the company in terms of establishing itself successfully

within the Ukraine market. (Swift 2010)

Five porters analysis

Buyers:

Buyer power is weakened by the fact that the Ukrainian consumer is brand

conscious. Ukrainian consumers consider Country-of-origin to be less

important than quality, taste, brand and availability and thus loyalty to local

24

beers is feigning whilst demand for foreign beers increases. Moreover, due to

the Ukraine having a lower average standard of life, compared to other

European countries, and the previous years recession, Ukrainian consumers

will appeal to a lower-priced market. The Ukraine beer market is vast though

so consumers are able to switch to brands best suited to their preferences at

different economic times (Khmelnytska, Swift 2010)

Suppliers:

The Ukraine, as a nation of substantial beer consumption, has many suppliers

of the input goods and resources required for beer production i.e. malted

25

grain, hops and apples. Thus there is a low switching cost for companies

wishing to change suppliers within the Ukraine. At the same time, some

companies, with the specific aim of maintaining unique quality and taste, have

their own raw material manufactory which consequently reduces suppliers

bargain power.

New entrants:

The Ukraine has a relatively large population (some 48 million) and a large

and increasing demand for beer with beer import increasing by 63% over

2010. This makes it an attractive, but competitive, market for the major

26

international brewers. Moreover, the Ukraine implements policies to integrate

European and domestic regulations creating a similar economic situation to

that of other European countries and consequently making it easier for

European countries to invest in the Ukraine. (Pivnoe-delo 2011)

Substitutes:

There are a number of beverage substitutes to beer, such as wine or soft

drinks. From the chart below, we can see that non-alcoholic beverage sale

volume has been increasing for the past several years. Children prefer to

27

Beverage and adults are more like wine and beer. There are no switching

costs and many different beer brands for consumers to choose from..

Figure 10 Country Statistics - Non-Alcoholic Beverages, Retail Sales, Total Value (Absolute) (Datamonitor 2011)

28

Rivalry:

80% of the marketplace is controlled by the Big Eight brewers whose brands

are well positioned on the market, and whose output and sales far exceed the

industrys average. This makes them strong competitors for any new brewers

entering into the Ukraine marketplace. (Foodmarket 2011). Quality is no

longer the key characteristic of the product, but rather company image and

brand popularity thus companies should be innovative and create new brands

to meet customers demands.

29

Part b)

Corporate culture:

The Ukraine market has a different organization and corporate culture than

that of Germany. Germany operates a family oriented business compared to

the Ukraines market-oriented subsidiary business which is ultimately

inflexible enforcing bootstrap operations.

The specific advantages of family business, unity and commitment, ensure a

competitive advantage to achieve market expansion in the Ukraine as long as

the balance between family interests and business development is

30

maintained. (Gallo and Cappuyns, 2004). For instance since family members

are different from employees, they may have different assessments and goals

within the company which may cause uncertainty as to the companys actual

goals which would be detrimental to business development and productivity

and upset the balance. Thus previous generations knowledge and cultural

information should continue to be acknowledged in order to maintain and

improve the business reputation long-term (Academy of Entrepreneurship

2004). They should continue to take advantage of the ensured commitment to

the businesses success when run by family members but the negative effects

such as reluctance to punish employees for wrong-doings because of the

31

family tie and the disinclination of older generations to trust younger

generations.

The balance of the shareholders and business interests is important to control

when moving into the Ukraine. For instance, the fact that business is

controlled by family shareholders with more than half retired and relying on

dividends for the rest of their life, means consideration of what is a suitable

dividend

percentage

for

satisfying

both

shareholders

and

company

development is important. This could be a big issue as it may result in conflict

between the businesses two vested interests: management and its

32

shareholders. (Worldpress 2011). Moreover, DB should establish strong

distribution networks to guarantee vast product availability. As Ukraine

distributors are small businesses with little room for capital increase

individually, DB can increase the time allowed for credit repayment, as there

is opportunity for longer credit repayments in the Ukraine compared to

Germany, which would help to build strong relationships with numerous

distributors, thus enhancing their reputation. (Rise 2007)

High gearing is dangerous for the volatile revenues in the Ukraine. The

gearing ratio for the Ukraine is extremely high which suggests narrow profit

33

margins in the future. Setting up the Ukraine subsidiary independently but

having DB buy minority stakes in the company may resolve this issue. DB

would have a shareholding of less than 50 per cent of the Ukraine companys

equity capital and thus it would have to deduct earnings (or losses)

attributable to minority. There will be reduced risk because they then become

a national, rather than international, company. Thus they wont be targeted by

Governments in the long term as there are trends towards nationalistic

government in the Ukraine i.e. with parties like our Ukraine and Pro Ukraine

potentially putting foreign companies at a disadvantage. (Smartcompany

02/12/11)

34

Organizational structure:

The best organizational structure would then be divisional which divides

employees and resources along divisional lines. So DB would be at the top of

the hierarchy and on the next level it would be split geographically into

Germany and the Ukraine. These divisions are created as self-contained

units, so the German and Ukraine divisions are distinctly separate, each with

their own separate functional departments for distribution, production etc. The

advantages of this are that each unit will be small and tuned into its

environment and thus will be responsive to change and flexible in an unstable

35

environment. Furthermore it fosters concern for customer needs and ensures

excellent communication across functional departments. However there is

potential for duplication of resources across divisions, resulting in lost

efficiency and economies of sale, and coordination across divisions is often

poor i.e. software not matching up.. However, the drawbacks can be

overcome through strict controlling of resources etc and so this still remains

the most efficient organizational structure for DB in the Ukraine. (Daft,

Kendrick, Vershinina 2010)

36

Figure 11 showing the functional division organizational structure (Bscdesigner 2011)

Oleg Pinchuk is currently acting as the Chief Executive Officer (CEO) in

charge of the DB operation in the Ukraine and all of the functional

37

departments. He should continue to be the top manager for this division due

to his successful implementation of the company into the Ukraine market via

the three distinct stages for achieving behavioral and attitude change:

freezing, changing and refreezing. However, the further investment and

expansion of the business may require the implementation of separate

functional department managers to ensure continued efficiency as there will

greater demands on each department. This may be cost detrimental to begin

with but will be cost beneficial long-term if expansion is successful (Deutsche

Brauerei 2007)

38

Control measures:

A machine control (result oriented) control archetype will be most applicable to

the DB structure as it is decentralized as it has outsourced to the Ukraine and

has clearly defined areas of responsibility and accountability e.g. the Ukraine

division CEO can allocate budget to functional divisions at his discretion but

his total financial budget for the year will come from the DB board. The reward

and incentive structure will most likely be action oriented as it is a family

company so there will not always be a direct link between performance and

rewards as an action oriented structure adheres to family unity and

39

commitment. When evaluating and monitoring performance and in terms of

standardization, an explanatory control archetype will be relevant as it will

refer to emerging standards of the Ukraine and German markets separately.

Being a family business a do your best approach would be undertaken with

no ex ante standards and targets. (Spekle 2001).

To conclude, the Ukrainian beer market provides much opportunity for

investment, but there are risks to consider including increasingly intensive

competition. Its contrasting culture to that of Germany suggests that a

divisional organization structure would be most suitable in order to allow

40

adaptation to each countrys environment easily to ensure efficiency and the

best competitive advantage. The CEO will remain at the head of the Ukraine

subsidiary but now with separate functional managers to aid him. Control

measures should ensure a safe and successful further investment without

losing the unique family values of the company.

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