Cheap labour no longer an effective strategy

As a result of rapid economic growth, focusing a company’s business strategy on cheap labour is no longer considered effective in Estonia. Rising production costs have led to an increasing need for more effective labour strategies, which will enable companies to remain competitive. This is illustrated by the case of the large textiles company, Kreenholm, which has already seen masssive collective redundancies over the past two years and is again facing a significant reduction of its workforce.

Increase in labour expenditure

Over the past number of years, Estonia has experienced rapid economic growth which has led to significant wage increases both in nominal and real terms. For example, the average wage of EEK 4,907 (€313.6 as at 23 May 2007) in 2000 increased to EEK 8,073 (€516) by 2005. The national minimum wage level has also risen rapidly from EEK 1,400 (€89.5) a month in 2000 to EEK 3,600 (€230.1) a month from 1 January 2007 (EE0701029I). As a result, labour expenses have increased significantly.

End of cheap labour strategy

The Estonian Institute of Economic Research (Eesti Konjuktuuriinstituut, EKI) evaluates the overall situation of Estonian industry to be satisfying. Exceptions in this instance are large companies that have built their business strategy on cheap labour. As labour costs have increased significantly in Estonia in recent years, it has become more difficult for these companies to remain competitive in the global market. The representative of EKI has emphasised that it is essential for the survival of these companies to renew and update their production processes.

According to the macroeconomic analyst, Maris Lauri, companies in the manufacturing industry that have made the principle of cheap labour part of their business strategy will probably go bankrupt. Ms Lauri has declared that the sustainability of the Estonian economy is largely dependent on whether and how these enterprises will be able to reorganise their production processes and manage the increasing wages. In order to remain competitive in foreign markets, she contends, companies can no longer rely on a cheap labour strategy.

Example of Kreenholm

One example of a company that has built its business strategy on cheap labour is Kreenholm, the largest textiles manufacturer in Estonia. The company currently employs about 3,200 workers and its manufacturing plant is owned by the Swedish company Borås Wäfvery. At the particular time, the company decided to set up its manufacturing plant in Estonia, since production costs were much lower than in Sweden.

At the beginning of this year, Kreenholm paid an average monthly salary of about EEK 4,400 (€281.2), which is not significantly higher than the monthly national minimum wage level of EEK 3,600 (€230.1).

In recent months, however, Kreenholm has faced a rapid increase in labour costs. The significant wage increases in Estonia have resulted in higher wage demands by the company’s employees. As a result of a collective agreement, the company’s wages were raised by 15% in January 2007 and a further wage increase of 5% will be due in July 2007.

Moreover, company management announced that in order to cope with the increasing labour costs, negotiations were underway in relation to redundancy plans affecting 800 workers, since, by 2008, the company’s workforce should comprise less than 2,000 employees. This announcement follows some 376 job cuts made in 2005, along with a further 300 job cuts implemented in 2006.

In addition to rising labour costs, Kreenholm is also facing a rapid growth in expenditure relating to public utilities. The price of water, gas and electricity has increased significantly over the recent months and this has contributed to the company’s rising debts. According to the Estonian daily newspaper Eesti Päevaleht, the Kreenholm liability for water services has reached EEK 19 million (€1.2 million). In the dispute over water prices, the company has repeatedly threatened to close down its operations; however, this has not yet happened partly due to the support of the Narva city government, which is concerned about the consequences of mass unemployment.

Thus, it appears that a business plan built on the principle of cheap production costs is no longer a viable strategy for remaining competitive on a national or global scale. One possible solution for the textiles company Kreenholm is to concentrate on value-added production processes, which constitute the company’s new direction and strategy, according to the manager of the plant. Nevertheless, the problems concerning Kreenholm’s current debts and low wages need to be addressed first.

Commentary

Kreenholm is one of the largest textiles companies in the country and a major employer in the northeastern Ida-Virumaa region. Last year, company losses amounted to EEK 72 million (€4.6 million), bearing in mind that the region is characterised by one of the highest unemployment rates in Estonia, along with the largest concentration of non-nationals in the population.

Epp Kallaste and Kirsti Nurmela, PRAXIS Centre for Policy Studies