How can Bulgaria escape the low value added trap

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Bulgaria is entering the third decade of the 21st century as still the poorest country in the EU, with an increasing gap from the second-to-last Romania. At government level, there doesn’t seem to be any concern about this fact, except for sporadic remarks by Deputy Prime Minister Donchev that Bulgaria has exhausted its current “tolling business” model. However, how can we switch to a new economic model that creates and retains higher added value within the country? Calls for greater cooperation between Bulgarian science and business on various forums have become a clich√© with no tangible results. Even if the academic community were to create some innovation, the shortage of entrepreneurial skills for its commercialization makes business success nearly impossible. The historical reasons for the problem of low added value in our economy date back to the time of communism.

The heavy legacy is mainly expressed in:

  • The liquidation of the national entrepreneurial potential after the WWII and the interruption of decades-long business traditions;
  • The creation of huge industrial complexes with guaranteed markets, whose mission was to produce low-quality products;
  • The transformation of the socialist economic nomenclature into the foundation of the revival of Bulgarian capitalism.

The transition deepened the problem with:

  1. The plundering of Bulgarian enterprises before their privatisation;
  2. Privatization in favor of the communist party, repressive, and economic elite, which gave birth to the first wave of Bulgarian entrepreneurs;
  3. The emigration of a large number of specialists in various fields who preferred fair compensation for their abilities in developed countries.

The result of this historical development is an economy whose competitiveness is based on low labor costs, turning them into a long-standing investment brand for Bulgaria. This model is also supported by the currency board, where our exports cannot rely on the devaluation of the national currency, which is a tool available to many of our competitors. Thus, with the same or higher prices for imported raw materials and energy, our competitiveness for many years relied on the devaluation of labor costs. Only in recent years, the acute shortage of skilled resources has accelerated the growth of wages. As a result, many Bulgarian businesses are faced with the dilemma of either surviving in the informal sector or learning to produce a better product and sell it at a higher price. Below, I will share some observations from our consulting practice and possible solutions for creating higher added value.

Marketing and Sales Strategies

Successful business, in simple terms, requires two core skills: producing a quality product and selling it under the best possible conditions. A distinguishing feature of the first generation of entrepreneurs was that they either replaced these skills with political connections or possessed only the technical skills to create a competitive product. However, few among them had knowledge of marketing and sales to break into or expand their business on international markets. According to a 2015 World Bank study, Bulgaria’s integration into global supply chains increased the value added, but to a lesser extent compared to other countries in the region. “In Bulgaria, about 65% of firms owned by foreigners and only 18% of locally owned firms export at least 1% of their production. The share of locally-owned firms that export more than 1% of their production is higher in Romania (21.1%) and Poland (23.1%) and is almost twice as high in Turkey (35.9%). Exports of foreign-owned firms in Bulgaria account for 60.3% of their total sales value, which is the highest percentage in the sample. This suggests that many foreign firms see Bulgaria as an export platform with lower costs or as an entry point to the EU.” This may be the solution to the case for the new economic model: overcoming the sharp deficit in marketing skills among Bulgarian entrepreneurs and learning to sell on foreign markets, with higher added value.

At the beginning of the century, the widely adopted “lowest price” model was associated with the export of raw materials, materials, and semi-finished products. However, after 2010, the share of products with a higher degree of completion began to increase. For example, in 2018, according to data from the National Statistical Institute (NSI), this type of product (machinery, equipment, vehicles, and various finished products) accounted for nearly 46% of total exports. This progress is most likely due to the redirection of foreign investments after 2009 from sales in the domestic market to greenfield investments for exports.

The major drawback of this model is that it primarily relies on low labor costs. Its sustainability is also attributed to relatively low land and construction costs, as well as the lowest direct taxes in the EU. However, compared to similarly sized countries like Hungary, Slovakia, and the Czech Republic, our export share is much lower and has remained around 2/3 of GDP for over five years.

It is well-known that several types of players extract the highest added value in supply chains. Some have developed brands under which goods and services are produced. Others have access to the end customer. Some have both a brand and access to the end customer. Therefore, the task for Bulgarian entrepreneurs is to implement a business model that brings them closer to these players.

The good news is that there are already Bulgarian companies successfully doing this.

Here are a few examples from our consulting practice in the cosmetics sector.

Model 1: A Bulgarian cosmetics company produces over 400 products from raw materials to packaging for a wholesale distributor in Germany. However, the wholesale distributor owns the brand that needs to be featured on the products. As a result, the Bulgarian company earns only 10% of the final product price in Germany. This model is obviously unsustainable for the Bulgarian company but is widely used throughout our economy. Many manufacturers are content to be part of someone else’s supply chain and rely on order volumes to cover their ongoing expenses. The essence of this model is competitiveness through low production costs.

Model 2: A Bulgarian cosmetics company decides to move away from Model 1 and starts investing in creating its own brand and distribution network in foreign markets, bypassing wholesalers. Additionally, they specialize their products in niches that are not attractive to global giants like Proctor & Gamble. This way, the company first avoids competition and secondly, manages to achieve a higher profit margin. The goal of this model is to establish its own brand and move up the supply chain towards the end customer.

Model 3: A Bulgarian cosmetics company manufactures an original product but fails to establish it in the Russian market. Analysis shows that consumers prefer mainly French products. The company then decides to outsource the packaging of the product to a small rented workshop in France so that they have the right to label it as “Made in France.” The result is a boom in sales with a relatively high profit margin. The goal of this model is to expand the customer base and build loyalty through rebranding the product.

Of course, not all companies produce products for the end consumer (B2C). Those that produce for the next link in the chain before the end customer (B2B) can also increase their added value not only through cost-reducing innovations (process reorganization, new technologies, sales team training, etc.) but also through diversifying their product portfolio, offering additional services, finding larger clients, and reaching clients in other markets. Once again, marketing and sales strategies are key. It is unacceptable for the revenues from a single client to occupy a significant share of the total revenues, making the business dependent on them for sales volume, pricing, and profit margin.

Compared to most European economies, Bulgaria’s economy is relatively small, the purchasing power is weak, and demographic trends are negative. In these conditions, it is challenging for a company to grow without expanding into external markets. The Bulgarian economy needs more national and regional champions in various industries that can create ecosystems around themselves to retain and increase added value in the economy and stimulate overall growth. Bulgaria already has such examples in the pharmaceutical, battery, electrical appliances, insurance, and other sectors. The commonality among all of them is that they are Bulgarian-owned, have an established or recognizable brand, and have a desire for direct access to the end customer.

Where expertise is lacking in how to increase added value, a possible solution is to seek international business partners. Through investment marketing, businesses can attract strategic or financial investors who can support their transformation. The emerging ecosystem of innovative startups in Bulgaria holds significant potential in this regard, as larger businesses can acquire them with ready-made development solutions.

Government Policies

Last but not least, in this transition towards an economy with higher added value, government policies play a critically important role. Some of these policies are widely discussed and directly relate to reducing the costs of doing business in Bulgaria, such as judicial system reform, entering the Schengen and ERM-2, improving credit ratings, and developing modern infrastructure, among others. However, we cannot begin to catch up with our lag without the necessary human capital, which is at the core of innovation and entrepreneurship. Here, the government should initiate labor market reforms that facilitate the attraction of highly skilled professionals from around the world regardless of ethnicity, religion, or nationality because talent is the scarcest resource globally. Deep reforms in every stage of education should also begin immediately to prepare the needed workforce for the digital economy.

In parallel with these reforms, a targeted policy that is not yet discussed is the creation of a new investment brand for Bulgaria. Moving away from the track of cheap labor that the Bulgarian economy is currently on requires a system of interrelated effective measures. These could include hiring globally renowned companies for investment marketing, promoting successful international investor stories in Bulgaria, publishing articles in international media about Bulgaria’s advantages (like the one about technology startups in the Financial Times), and more. However, for the new investment brand to be sustainable, Bulgaria must stop broadcasting negative news to the outside world and implement long-delayed reforms to reduce political, administrative, and corruption risks for investors. As Adam Smith says, nations “are impoverished by the extravagance and folly of their rulers,” and society “can flourish only under a just and perfect freedom” (“The Wealth of Nations”).

In conclusion, possible solutions for increasing added value in the economy:

  1. First, creating unique or better products than competitors with the aim of achieving higher prices and profit margins;
  2. Second, building a proprietary brand around which a base of loyal customers can be developed;
  3. Third, climbing up the value chain by establishing proprietary distribution or acquiring clients with such capabilities;
  4. Fourth, avoiding dependencies on one or a few clients;
  5. Fifth, pursuing acquisitions to consolidate the sector and/or expand into foreign markets to become a market leader or regional champion;
  6. Sixth, acquiring startups with valuable technological solutions or new business models that facilitate digital transformation and provide competitive advantages;
  7. Seventh, government policies to reduce transaction costs in the economy;
  8. Eighth, government policies for labor market reforms and attracting talent from around the world;
  9. Ninth, government policies for radical education reforms that produce human capital for the digital economy;
  10. Tenth, an intensive and focused government policy to create a new investment brand for Bulgaria, making it a magnet for top-tier human, production, and financial capital from around the world.