Report from Europe: EMS powerhouses Jabil and Flextronics invest in Ukrainian hot spot

Spiraling costs and tightening labor markets in neighboring Central and Eastern Europe are creating a new low-cost manufacturing hot spot in the Uzhgorod area, a province known as Transcarpathia.

By Drew Wilson, Contributing Writer -- Electronic Business, 8/21/2007

At the border post in Uzhgorod, Ukraine, authorities display their names and badge numbers near a complaints hotline, all in English. Vehicles passing through to Slovakia may wait less than 30 minutes.

Such border efficiency is striking in the former Soviet Union, where crossings typically involve long lines and corrupt practices.

The efficiency is also crucial to the growing presence of manufacturers in the Uzhgorod area. They include Jabil Circuit, which this year started production in a new $50 million factory, and Flextronics International, which is building a $29 million plant in the nearby town of Mukachevo.

Eurocar, a Volkswagen and Skoda automaking venture, is set up with suppliers 15 miles south in the city of Chop. A little farther away, Tyco Electronics has pledged a $60 million investment to build components in the neighboring region of Ivano-Frankivsk.

Spiraling costs and tightening labor markets in neighboring Central and Eastern Europe (CEE) are creating a new low-cost manufacturing hot spot on the EU's doorstep in the Uzhgorod area, a province known as Transcarpathia. Located at the very Western edge of Ukraine, Transcarpathia holds an enviable position, sharing borders with Slovakia, Romania, Hungary, and Poland.

"The two largest EMS companies in the world are investing at the same time in the same region," says Philippe Costemale, general director of Jabil's Ukraine operations in Uzhgorod. "It signals a move to this part of Ukraine."

Location, labor costs attracted Jabil

Jabil's plant turns out tape drives for Hewlett-Packard and roughly 100,000 mobile phones per week for a major OEM. Everything is for export to Europe.

Several factors led Jabil to Uzhgorod, Costemale says. Location was important. Uzhgorod is 90 miles from Jabil's operation in Tiszaujvaros, Hungary, which is used for training, supplies, and logistics support. The Uzhgorod operation's on-premises customs clearance enables trucks to move between the two sites in a couple of hours.

Certainly cost was a key factor. Labor costs are only a third of those in Central and Eastern Europe, he says. Additionally, Ukraine does not suffer from the labor shortage that is becoming a serious issue in CEE. Electronics investment poured into CEE in the run-up to European Union entry in 2004, snapping up the labor force. After EU membership, CEE citizens were free to work in some EU countries and many have moved to higher-paying jobs in the U.K. and Ireland. A 2006 wave of manufacturing investment in Poland, the Czech Republic, and Slovakia aggravated the shortage. The crisis is so acute that at least two countries, Poland and Lithuania, have launched government efforts to try to lure workers to return home.

In Ukraine, despite political turmoil over the last 10 years, migration hasn't accelerated. Finding an engineer with 10 years of experience is difficult, but it's not hard to find engineering graduates, Costemale says. Currently Jabil has 2,000 employees and is hiring 150 people per month.

"We think the labor cost and availability are a long-term play," he says.

Flextronics' plant is expected to employ 3,000, although the date production starts is unknown, according to the Transcarpathian Investment Agency in Uzhgorod. Flextronics officials declined to comment on the Ukraine factory.

Rethinking regional manufacturing

Uzhgorod University, which helped develop weapons systems and space technology in Soviet times, is the main source for engineering graduates. In a special fourth-year program, future graduates are already working for Jabil, says Ivan Opachko, head of the electronics faculty at Uzhgorod University.

"Together with technical institutes, we can supply enough graduates for the local electronics manufacturing industry," he says.

Western Ukraine is another way station in the endless search for low-cost labor, says Charlie Barnhart, senior consultant at Technology Forecasters. But doing manufacturing there is a regional solution strictly to serve Europe. EMS companies are increasingly turning to regional sites as security risks and remedies increase and the price of oil drives up shipping costs.

"Eight years ago, everyone abandoned regional manufacturing and ran to China, and now some of that is being rethought," Barnhart says.

But one drawback of Transcarpathia is the lack of a supply base. Both Jabil and Flextronics have large Hungary-based operations to serve as an interim solution.

Building up a local supply base is the second phase of Jabil's investment, which involves part of an additional $50 million. The company is coinvesting with local authorities in a supplier park that's expected to be ready in 2008. No suppliers have given firm commitments yet, but Costemale is optimistic. The campus strategy has worked well in the past for Jabil and Flextronics in other geographies, says Technology Forecasters' Barnhart. "Jabil has connections in the global supply chain to make it happen," he says.

The Uzhgorod plant has grown steadily after a rough period. The company started in 2004 with a 20-person operation in rented space in a special economic zone (SEZ), which allowed tax-free import and export of goods. Later that year, Ukraine's Orange Revolution saw masses of people in the streets for weeks, protesting fraudulent election results. The national sit-in eventually resulted in a change in government. A crackdown on countrywide corruption followed, and SEZ privileges were canceled. Six months later, the government reinstated some privileges only to Jabil and two other companies in the entire country.

Costemale hopes the government will decide to adopt a nationwide SEZ law, a decision expected later this year. Jabil is also trying to convince Ukrainian authorities to give tax relief or subsidies that would total as much as 50% of a company's investment, a practice similar to the EU's. Ukraine's corporate tax rate is 25%, compared to Hungary's 16%.

"Although Uzhgorod authorities are transitioning faster than we expected, we'd like to see Ukraine implement some investment standards like the EU's," he says.

Make no mistake, Ukraine remains a challenging environment. Although the country is pursuing World Trade Organization (WTO) membership and a closer relationship with the EU, it ranks 99th out of 163 countries on Transparency International's 2006 Corruption Index. But perhaps companies have found an oasis in the Uzhgorod area.

"We are not naive, and we decided to do things right from the beginning," Costemale says. "I can tell you it's possible to do clean business in Ukraine. Even my local team sometimes doesn't believe we are doing this."

Moreover, during the weeks of the Orange Revolution, which most of Western Ukraine strongly supported, Jabil's operation was unaffected, with no absentees and no cross-border trucking delays, he adds.

"They have the right mind-set here," Costemale says.