Case: Alcor Ventures:
Alcor Ventures is planning to become airport developers that will provide development and management services for several government-owned airports in Eastern European. The focus of the case is to answer the following questions:
- Is there a global market opportunity demand for this service?
- What are the strategic issues facing this type of business?
- What alliances would ensure the greatest chance for success?
- What is the most effective method of financing the venture?
- What are your recommendations for the company: go it alone, merge, or be acquired?
This case was prepared by (Team Leader) Aretin Altmann, Cristina Ghets and Jeremiah Stoldt
Columbia EMBA 2002, under the supervision of Professor Jack M. Kaplan as the basis for class discussion. Copyright © 2002 by the Lang Center for Entrepreneurship, Graduate School of Business, Columbia University, 317 Uri’s Hall, 3022 Broadway, New York, NY 10027, Note: For competitive reasons, some financial figures – specifically, financial costs and marketing figures – have been altered or fabricated.
Background:
This proposed venture would provide development and management services for several government-owned airports in Eastern European. The rationale for this corporation is the high demand for modern and technological advanced airports in these countries after the recent destabilizing effects of the fall of communism and the need to compete in a capitalistic world economy. Lack of resources within these countries to make the necessary improvements is curtailing infrastructure development. Therein lies a prime opportunity for privatization. Governments, easier to offload the development and management of their public services, provide a vehicle for enterprising developers to realize substantial returns in a contract with an eager government in countries at the low point of their potential for development.
Market Potential:
The concept of privatization in the airport industry is something that is currently a very hot topic in the United States. In 1996, Congress authorized a two-year privatization pilot program, which allows the Department of Transportation to grant exemptions from certain federal statutory and regulatory requirements for up to five airport privatization projects. To date, Stuart Airport in New York and Brownfield Airport in San Diego have applied to join the pilot program. The U.S. is finding out what countries around the world have known: a government’s sale or long-term lease of an airport, an agreement to a privately owned firm can translate into cost savings as well as a lucrative revenue stream.
While in the United States airport privatization is more of a political scare tactic, in some second-world countries privatization is the only means of realizing necessary upgrades since many of these governments do not have the funding to initiate these upgrades on their own behalf. This need to upgrade the transportation infrastructure, especially for developing countries in the former communist bloc who long to sit at the table with the rest of the European Community, provides a unique opportunity for private investment. We believe that governments in countries like Romania are ripe for an airport privatization effort, which would include a contract to assume operational control of the airport. We believe that at least three airports in Romania, if upgraded to 20th-century standards, could yield a significant return on investment since the potential for expanded volume in these airports is so vast. Romania, as a function of its central location between Europe and the former Soviet republic and gateway to the Near and Far East, provides an excellent location as a hub for international travel for both business and tourism. This Design/Build/Operate/Maintain (DBOM) locks up revenue in design and construction management fees as well as the predictable revenue streams that make up airline paid rates and charges and the myriad services (such as refueling, baggage handling and retail tenants) within any airport.
Competitive Advantages:
In order to do business in the majority of these Eastern European countries, getting one's foot in the door involves contacts with high-level government officials. We feel the largest competitive advantage in our proposed corporation involves the “human capital”:
Network: the owners have the necessary contacts to initiate a conversation with high-ranking officials in the Romanian government that will allow an opportunity to pitch the program to major decision-makers.
Experience: over 50 years combined experience in the fields of design, construction and operation of the most modern and large-scale U.S. airports gives the management team the knowledge to know what is possible and the means of being able to execute a comprehensive development and airport management plan.
First Mover: the privatization effort in Romania and in many Eastern European countries is just starting to gain momentum. By utilizing government contacts, we would be able to move into the airport sector in a way that potential competitors could not.
Product Features and Benefits:
As mentioned, the largest incentive for any developing countries government to privatize any of its public offerings involves the ability to outsource the management and development of its infrastructure and divert its funding to more pressing needs. Our product offering represents a single source, turnkey airport solution for developing economies. Developers are provided with the incentive of growing returns on investment from expanded airport volume, coupled with preferential financing that would be largely secured through international funding vehicles and development agencies. The developing country gets to enjoy the benefits of the increase airport revenue, increased tourism, the infrastructure necessary to support major international business and a symbol of economic development that improves their credentials as a potential European Community member.
Summary of Financials:
The seed funding to successfully secure contracts for at least one of the targeted Romanian airports should less than $1 million. Even though it may be over a year between incorporation and the first contract signing, most of the time will be spent doing background checking and securing political contacts. Activity will begin to increase when it becomes apparent that a presentation to the government decision-makers is forthcoming. Expenses will include legal counsel to establish corporation, and will ramp up as activity increases to include international business consul and participation in contract negotiations. Leased office space in Manhattan with back office operations, necessary marketing research in-country expansion potential, development of construction documents and design drawings and travel expenses incurred during due diligence and meetings with government officials will constitute the other major expenses for the first 2 years. Of these two years, the owners plan on staying employed in their current positions as a way of subsidizing their efforts.
.MARKET ANALYSIS
Romania (Exhibit 1 and 2)
Country Information
Basic data--Romania 2000/2001
- Total area: 238,391 sq km, of which 63% is cultivated (1995)
- Population: 22,450,000 (January 2000)
- Main towns: Population in '000 (July 1st 1999)
Bucharest (capital) 2,011 Cluj-Napoca333
Constanta 340 Galati 328
Iasi 348 Brasov 312
Timisoara 328 Craiova 313
- Climate: Continental with mean temperatures of minus 3 C in the winter and 22-24 C in the summer. Weather in Bucharest (altitude 92 metres): Hottest month, July, 16-30 C (average daily minimum and maximum); coldest month, January, minus 7-1 C; driest month, February, 33 mm average rainfall; wettest month, June, 89 mm average rainfall
- Language: Romanian
- Weights and measures: Metric system
- Currency: Leu = 100 bani; the plural of leu is lei. The average exchange rate in 2000 was Lei21,710:US$1. Exchange rate on March 9th 2001: Lei27,180:US$1
- Time: 2 hours ahead of GMT
- Fiscal year: Calendar year
- Public holidays: January 1st, January 6th, Easter Monday (Orthodox calendar), May 1st, December 1st, December 25th, December 26th
Resources and infrastructure: Natural resources and the environment
Romania is a medium-sized country, with an area of 238,391 sq km (slightly smaller than the UK). Relief is evenly distributed, with mountains, hills and plains each covering about one-third of this. Forests (including some in their primal state) cover more than one-quarter of the area, and the fauna is among the most varied in Europe. Farmland covers 40% of the area and 63% of this are cultivated. Natural conditions favor the cultivation of a range of crops, including cereals, industrial crops, vines and vegetables.
Political background
The leftist Party of Social Democracy in Romania (PSDR), which dominated Romanian
politics in 1990-96 under a number of different names, was returned to power after parliamentary and presidential elections in November 2000. The PSDR won the largest number of seats in the new parliament and elected to form a single-party minority government. The PSDR candidate for the presidency, Ion Iliescu, who was president from 1990 to 1996, won a second-round run-off for the presidency against Corneliu Vadim Tudor, the candidate of the ultra-nationalist Greater Romania Party (GRP). The GRP was also the second largest party in the new parliament after the collapse of support for the center-right parties that had dominated the governing coalition in 1996-2000. The PSDR has ruled out parliamentary co-operation with the GRP and has chosen to govern with the tacit support of the centrist parties.
The remaining parliamentary representatives of the outgoing government, Mr. Roman's Democratic Party, the HDUR and the NLP agreed to form a democratic opposition that would not attempt to overthrow the government.
Labor force
The collapse of the communist economic system has resulted in major changes in the size and composition of the labor force. Up-to-date data are scarce, but total employment fell by over 2m, from 10,945,700 in 1989 to 8,813,000 in 1998. The labor force participation rate (working-age labor force as a proportion of the population of working age) was only 63.6% in 1998, compared with more than 80% in the early 1990s. The largest job losses have been in industry, where the active population fell from 4,169,000 in 1989 to 2,317,000 in 1998. The number of people classified as employees fell from 8,102,000 in 1990 to 4,474,600 in September 2000. Some 38.2% of the population worked in the state and co-operative sectors in 1998. Registered unemployment initially peaked at 1.2m in 1994 (equivalent to 10.9% of the workforce), but has exceeded 1m since 1998 as a result of economic decline in 1997-99 and the closure or part-closure of industries that began in earnest in 1999. Registered unemployment at the end of 2000 was just over 1m, or 10.5% of the labor force (See Reference table 2 for labor force statistics.)
Road and rail
Public investment was concentrated on a number of large-scale prestige projects in the 1970s and 1980s at the expense of infrastructure. As a result, road and rail networks are among the least extensive in Europe. Their state of disrepair constitutes a major obstacle to economic development. In 1998 public roads covered only 73,260 km (30.7 km/100 sq km). Only 113 km were designated as motorways and priority will be attached to improving east-west motorway connections through Bucharest. The rail network, which is the main means of internal transport for passengers and freight, covers 11,385 km (only 34.8% of which is electrified), and the rolling stock is in urgent need of replacement.
Major projects to upgrade the rail and road networks are being implemented with the assistance of the World Bank and the EU. These are largely concentrated on improving pan-European transport corridors. An agreement was reached with Bulgaria in April 2000 for a second bridge between the two countries over the Danube between the Bulgarian port of Vidin and Calafat in Romania, which will form part of the pan-European Transport Corridor IV.
Significant levels of investment will be required in internal communications before they approach the standards of Western Europe. This will put a major strain on Romania's budgetary resources, and will require greater use of private capital and finance by the international financial institutions. Toll roads are being introduced to ease the financial problem, and railway tariffs are scheduled to rise faster than inflation, with the additional revenue to be ploughed back into investment.
Air transport
Air transport has been neglected, although there are three international and 16 domestic airports. Four new domestic airports are planned, and the one at Cluj-Napoca is being upgraded to international standards. Bucharest International Airport at Otopeni is undergoing a major program of upgrading. Proposals to privatize the state airline, Tarom, have suffered from numerous delays. A gradual start has been made in restructuring the company prior to privatization, which has involved downsizing and the continued replacement of ageing Soviet-built aircraft with Boeing 737s and Airbus 310s.
Tourism
Romania has substantial natural resources exploitable for tourism, including the Black Sea coast, Danube delta, and the mountain regions of the Carpathians and Transylvania. The infrastructure for tourism and the quality of hotel facilities are poor, however, partly as a result of delays in privatizing state-owned hotels and facilities. The EU's PHARE program of aid to Eastern Europe will provide assistance in promoting tourism, which is generally regarded as an area with considerable long- term potential. The construction of a new resort called Europa on the Black Sea coast, which will meet the highest European standards, is currently under investigation.
Economy: Economic structure
Main economic indicators 2000
Real GDP growth (%) -2.0(a)
Unemployment rate (year-end; %) 10.5
Consumer price inflation 40.7
General government balance (% of GDP) -4.9(a)
Current-account balance (% of GDP) -4.1(a)
Exchange rate (av; Lei:US$) 21,710
(a) EIU estimate.
Sources: National statistics; IMF.
Privatization
Privatization proceeded slowly after the initial transfer of small enterprises, retail units and small farms, mostly to their operators. Despite an attempt at mass privatization, just 8% of the nominal capital of the 6,600 industrial enterprises listed for privatization was in private hands at the end of 1995. A commitment to speed up the privatization and restructuring of industry was a main plank of the Democratic Convention-led government's economic program. This involved privatizing about 50 enterprises a week (2,200 in all), so that 65% of GDP would be generated by the private sector by the end of 1997. These targets were not achieved: 1,300 companies had been privatized and the private sector accounted for 58% of GDP by the end of 1997, according to the latest data. However, this share has risen since then: 1,015 enterprises were privatized in 1998, and 1,800 companies were said to have been privatized in 1999.
New proposals to accelerate privatization, involving direct sales, boosted privatization at the end of 1998. In December 1998 a 35% share in the state telephone monopoly, Romtelecom, was sold to the to the Greek company OTE and a 51% share in the Romanian Development Bank was sold to Societe Generale of France. In early 1999 a car manufacturer, Automobile Dacia, was sold to Renault, and a 45% stake in the over-the-counter State Savings Bank, Banc Post, was also sold. Although a number of public utilities, principally in transportation, and energy extraction and supply, were turned into public corporations and split up in 1998-99, they remain owned by the state. Little progress was made towards privatization in 2000. Although in its election material the PSDR threatened to investigate every privatization conducted under the previous government, it is unlikely to carry out such a threat in the vast majority of cases.
Competitive Environment
Many Eastern European countries are considering privatization in markets that is beginning to heat up. Several large development firms like Shipol and BAA and construction companies like Philip Holzmann are starting to jockey for the opportunity to bring these countries modern services. The market in Romania, by virtue of the company’s existing contacts within the government, creates a slightly different competitive landscape:
In the above model, leverage exists through the company’s knowledge of the political players combined with major airport development experience. We feel that in Romania, our company possesses a competitive advantage over other firms seeking to develop there. From the initial successes in Romania, the company will move on to other eastern European countries and assess both the need of the country to modernize their airports and the political stability necessary to safeguard the investment in the short and long term. Intense marketing analyses of individual airports would have to be conducted to deduce such factors as current versus potential passenger volume, attractiveness to U.S. and international carriers and long-term tenants, destinations in proximity to the airport and availability of local labor and resources to execute the plan.
Barriers to Entry
The barriers to entry primarily are government uncertainty of privatization and the need to convince the government that they will achieve the necessary benefits to make the enterprise attractive. Couple with this issue is regulations and laws that could thwart development and create an atmosphere not conducive to investments. Risks could just be too high.
As these countries focused on are new democracies the trust in the system has yet to be established. This leads to an instability that has to be overcome to believe in the long-term relationship with the government and not with the individuals in control at a particular time.
To maintain and or develop a barrier to protect the firm from competition, long term exclusive operating and maintenance contract to manage the airports will block other development firms from entry. The ability of our firm to maintain the edge and making the government and regional administrations partners in the developments will further solidify and block other entries into the market.
.MARKETING AND SALES STRATEGY
General Marketing Plan and Vision:
The marketing plan will exist on two levels: the individual country’s privatization climate and factors influencing specific to the client and general brand promotion that will begin in easnest once the first contracts in Romania have been secured. The targeted marketing involves the research and political involvement necessary to secure the contract and will include political lobbying on behalf of the company, both within the government and through contacts in the U.N. General brand recognition efforts will begin with the signing of the first contract and will feature a web presence, placement on several international privatization boards, the Black Sea Economic Cooperation Forum and a presence in several international aviation trade magazines.