Traditionalists may still be taken aback by references to the 'new' Europe, but the center of gravity of the continent is shifting eastward. In 2004, the European Union afforded membership to ten additional countries (Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia and Slovenia); three more-Bulgaria, Romania and Turkey-are expected to join within the next decade. The 'old' Europe, long synonymous with the France-Germany axis, is in the process of being-if not supplanted-at least considerably expanded. And with this expansion comes a need for shippers to reappraise their European supply chain strategies.

It is not only the number of new countries that is 'tilting' Europe eastward, but also the fact that they represent the fastest growing economies in the region. The growth of the 13 new and future EU countries is much larger than in the old EU countries. Correspondingly, for many international companies, these countries will be their primary target for market growth in near term.

What does this heightened economic interest mean to U.S.-based shippers? Supply chain directors will have to adapt their pan-European supply chains to enable this projected growth. Service levels in these countries will have to improve as buyers and sellers in these markets come to expect performance comparable to their western European counterparts. As a means of serving both these ends, new distribution structures have to be set up in these countries.

Movement is already underway. An increasing number of manufacturing activities are relocating from Western Europe towards Eastern Europe and Asia Pacific. Since most raw material shipments are arriving at ports in Western Europe, the logistics flow of raw materials from Western European ports to Eastern European manufacturing plants is rising strongly. The relocation of manufacturing activities towards Asia Pacific (primarily China) leads to a large increase in finished product container shipments from China towards ports in Western Europe. Financial figures from the leading container shipping companies in the world have shown that sea container transport from Chinese ports towards Western European ports have grown over 10 percent each year. All of these manufacturing relocations lead to a movement in the configuration of European distribution networks for many companies.

The impact on logistics

Many U.S.-based companies might tend to regard Europe as one large geographical market, but in practice Europe is more a collection of a lot of different countries. The logistics service provider industry in Europe is therefore still very fragmented in comparison to North America. Although the last few years have seen strong consolidation trends among the logistics service provider industry, particularly fuelled by large logistics service provider acquisitions made by former country-based postal companies (Deutsche Post World Net (DHL), TNT, La Poste, Royal Mail), there remain a lot of single-country based logistics service providers. In current practice, even the large pan-European logistics service providers are still organized country-by-country and their trans-national coverage in all of the different European countries tends to be not very good.

In real-world practice, most of the companies in Europe are still outsourcing transport and warehousing on a transport lane-by-transport lane and warehouse-by-warehouse basis. It is not uncommon for companies to be using more than 50 different logistics service providers across Europe. Even so, the signal is clear-large logistics service providers are moving to pan-European logistics service providers.

Within Europe there remain a lot of tax differences between the different countries. Since all tax structures across Europe are based on value-added activities (company profits are allocated to the different countries based on the added value of the processes in each of them) and since country tax levels vary considerably, there is a clear link between locating distribution centers in a specific country and the taxes which need to be paid on the processes taking place in those distribution centers.

The implications for European distribution networks

While acknowledging that companies have specific strategies, general trends and implications of EU expansion need to be taken into account when redesigning any pan-European supply chain network:

Worldwide distribution center functions (and global plants) will be increasingly moving to the European Union. The addition of 10 new countries to the EU will grow that market from a GDP of 8.60 to 9.01 trillion U.S. dollars. The size of this market will increasingly demand dedicated manufacturing and distribution.

As important as aggregate growth is, the accelerating rate of growth in the new member states is potentially more important in influencing trade decisions. In the long term, the EU has added high-growth regions which, while still far behind GDP per capita levels in Western Europe, will experience the same kind of development and modernization that Portugal and Ireland are enjoying since their EU accession. The appearance of high-growth markets in the EU can be expected to stimulate foreign direct investment in manufacturing. And with this, we expect that worldwide distribution center functions will increasingly be moving to the European Union.

European distribution center functions will move eastwards from their present concentration in the Netherlands and Belgium towards Germany.

Traditionally, the Benelux region has enjoyed a position as the center of the EU, which attracted a lot of European distribution centres to this region. Since the geographical center of gravity is moving eastwards towards Germany, we expect that Germany will become an increasingly more important location for these European DCs.

There will be growing and consequential bi-directional East-West trade flow within the European Union.

Currently, a significant amount of manufacturing activities have already been moved from Western Europe towards the low-cost regions in Eastern Europe. We expect that this trend will continue over the next few years. This will result in the establishment of a large bi-directional East-West flow within the European Union. As raw materials are imported into the western part of the European Union, manufacturing will take place primarily in the eastern part and consumption will take place primarily in the western part of the European Union.

This large bi-directional East-West flow within the EU region will lead to extra infrastructure investments in road, rail and inland waterway networks.

There will be increasing use of multi-modal transport infrastructures along the borders of Germany.

Germany, Czech Republic, Poland, Slovenia and Hungary have strong rail networks while road networks in the Eastern European countries are less well developed. Transport in Eastern European countries will therefore favor rail transport while transport in Western European countries favors road transport. A rise in multi-modal transport infrastructures is therefore expected on the borders between Eastern and Western Europe, particularly on the borders of Germany (as it has both well developed road and rail transport infrastructures). Currently, however, the well developed rail networks within Germany are primarily from northern Germany to southern Germany and vice-versa. Additional infrastructure investments will be needed to establish an efficient rail network between western and eastern Germany.

Of great significance will be the establishment of rail routes from Asia Pacific through Russia into the eastern part of the European Union. The Russian market will become a close neighbor of the new European Union (although Russia was also a close neighbor to Finland in the northern part of the EU). Countries like Latvia and Finland will be used as a starting point for export to the Russian market, but Russia will also be used as a passage for imported products from Asia Pacific to EU as an alternative to sea transport from Asia Pacific to ports in Western Europe. This alternative import route might even grow in importance because of the continuing economic growth in China, a close neighbor to Russia.

The building of an extensive railroad infrastructure will be part of more generally improved accessibility of the Russian market. It will become easier for European Union countries to do business with Russia. Latvia, in particular, promises to be an excellent location to locate a regional distribution center that both serves (part of) the Northern European market as well as the Russian export market. Due to the closer alignment of Russia to the new EU, we expect that sea container transport from Germany to Latvia and Finland will increase strongly. This will benefit the positions of the Northern German ports of Hamburg and Bremen

In sum, European distribution for the most aggressive companies will become a two-tiered structure. Over the last ten years, many companies have consolidated their distribution operations into one central European Distribution Center (EDC) covering all European Union countries. This was made possible by the fact that most EU countries could be delivered within two to three working days from one central EDC location. The new European Union, however, covers a much larger geographic region, making delivery to all countries within that time frame impossible. We therefore expect that many companies will be moving back to a two-tiered European distribution structure consisting of a central European Distribution Center (EDC) together with regional distribution centers in Northern Europe, UK/Ireland, Southern Europe, Eastern Europe and Italy/Greece.

Sidebar: What This Means to You

• European Distribution Networks moving back from a 1-tiered to a 2-tiered structure

• Large market growth expected in Eastern European countries

• Northern Europe could become an excellent operating base for export to Russia (which is also a fast growing market)

• European logistics service provider industry is continuing to consolidate

• Combining tax optimization with pan-European supply chain network redesign will achieve much higher benefits than stand-alone tax and distribution network optimization

• Multi-modal transport flows will grow in importance in the new Europe

Sidebar: Tax Effective European Supply Chain Management Boosts Results

Distribution Network Design processes with Tax Optimization considerations

Experience has shown that normal supply chain results can be boosted by a factor 3 or 4 by taking both supply chain and tax consequences into account instead of looking at each activity separately.

Typical sub-optimized pan-European distribution networks are 10 to 18 percent more expensive than optimized ones. Flags for sub-optimization include the following:

• It has been more than 4 years since your company has re-evaluated its pan-European supply chain;

• There have been important changes in the location of manufacturing sources or customers;

• Your pan-European supply chain has a decentralized structure;

• Customer service level requirements have changed considerably;

• There has been merger-acquisition-divestiture activity within your company.

Best practices in this area of European Distribution is to resist ad-hoc changes and, instead, base decisions on a pan-European perspective. Nor should initiatives be executed on a 'stand-alone' basis since tax optimization is contingent on the entire supply chain network.

Typical benefits from pan-European Distribution Network Redesign projects
We have learned from our long-standing experience in both European Network Design projects and also Tax Effective Supply Chain Management projects, that benefits typically include the following:

Many international companies still have average effective tax rates of larger than 30 percent within Europe. By applying Tax Effective Supply Chain Management structures, the average effective tax rate in most industries can generally be reduced from 18 to 22 percent. An improvement of effective tax rate from 30 percent to 20 percent will typically increase net profit by more than 15 percent.

The on-going consolidation of the European logistics sector is enabling many international companies to reduce their number of service providers, cutting down their pan-European transportation spend between 5 to 10 percent. The costs associated with 3PL management also are reduced considerably.

Inventory levels can be reduced up to 50 to 90 percent by consolidating the number of warehouses across Europe and by using product postponement strategies (like moving product customization activities from the factories towards the distribution centers).