Business and the euro crisis: Under the volcano "THERE is nothing sinister about this," says the chief executive of a Portuguese drugs firm. We have to consider: what would happen with inflation, how would we get credit, collect debts and pay our suppliers and workers? For months he and other Portuguese bosses have been rehearsing plans for what to do if the euro zone fractures or breaks apart completely. Many firms also have formal contingency plans for a sudden exit by Portugal by itself. Such planning is not just a matter for companies in threatened economies on the periphery. Even a partial break-up would be catastrophic for companies throughout the euro zone, and pretty dire elsewhere in Europe's single market. Like a hard punch on the jaw, it would cause painful dislocation. New currencies would have to be introduced. Panic would seize the banks on which companies depend for funding. Economic growth would hit a wall. This is not a calamity it is easy to plan for. News of a euro-zone fragmentation, if it comes, will come suddenly, like a declaration of war. Where countries leave, borders will likely be closed to prevent mass smuggling of euro notes and coins from "peripheral" euro-zone countries. Similar barriers are likely to paralyse cross-border electronic payments, and maybe even telecoms traffic. With the financial sector in disarray companies with operations across the euro zone would fend for themselves in each country. Where are their euro debtors and creditors? Which are the "German" euros, which "Greek" or "Italian"? A company treasurer would need this information on his desk in a couple of hours. That would be just the beginning. A company used to operating across Europe, shuttling containers daily, flipping staff from one office to another, would have to rethink its entire portfolio against a background of market chaos, bank runs and supply-chain shocks. Should it split itself into two or more parts between a "core Europe" with a hard currency and a periphery with many weak ones? New treasuries, legal identities, communication and logistics systems and so on cannot be set up overnight. But the quicker a company can do it, and the more prepared it is now, the less its business will be disrupted. The companies thinking the shouldn't-be-thinkable in these ways are unwilling to share their insights. For one thing, good strategies, should there be any such, may be less good if too widely followed. And in a world already drained of confidence, one doesn't have to be superstitious to think that talking about contingency plans makes them more likely to be needed. But plans are being hatched nonetheless. Shell, an Anglo-Dutch oil giant, has three scenarios for the euro zone: what it calls "muddling through," a deepening of monetary union, or a break-up. "It would surprise me if any well-run company were not preparing itself for the worst scenarios, however remote those may be," says Leif Johansson, former chief executive of Volvo, a Swedish manufacturer of commercial vehicles, and chairman of both Ericsson, a Swedish telecoms firm, and the European Roundtable of Industrialists. Services are springing up to help companies prepare; in June FiREapps, an Arizona-based software provider, launched a new program to help companies understand how their foreign-exchange exposure might change in real time in various different reconfigurations of the euro zone. All in it together When not planning for every contingency they can think of, Europe's industrial bosses oscillate between fear, anger and disbelief. The bad news is occasionally interrupted by what feels like a reprieve, such as last week's German Bundestag vote in favour of more powers for the European Financial Stability Facility (EFSF), the main fund for bailing out troubled countries. But for the most part, as with this week's troubles at Dexia, a Franco-Belgian bank, another downgrading of Italy's credit rating, and delays in funding for Greece, the unending flow of woe feeds businesspeople's fear. The fear then stokes the anger and disbelief. Company bosses long to yell "You're fired!" at any number of European politicians. They find it inconceivable that Greece - which with debts representing just 2% of euro-zone GDP is a tiny subsidiary, to their way of thinking - has been allowed to send the system spinning out of control. For now, most companies still reckon a euro-zone break-up is unlikely. But for such a catastrophic event, even a small probability is worrying. What's more, the fear of calamity causes real problems even if that calamity is averted. Many firms are considering whether to relocate investment either towards more financially solid countries inside the EU, or out of Europe entirely. That is why European business will be reshaped by this crisis even if the euro zone isn't. The worries come at a time when Europe's bigger companies are, by some measures, doing very well. Analysts expect France's largest 40 listed companies to increase profits by 15% this year to a level nearly equal to 2008's record high. German industry is still benefiting from a massive surge in engineering orders. The country's engineering association is predicting a 14% jump in production by its members to €199 billion ($266 billion) this year, just exceeding 2008's record high. During the recession of 2008-09, European companies took harsh measures to cut costs and improve efficiency. Despite a strong recovery in most firms' profits, they have been reluctant to shoulder new fixed costs and keen to maintain flexibility, which should help them weather another downturn. More than two-thirds of 150 German firms recently surveyed by Roland Berger, a consultancy, said that the crisis of 2008-09 brought benefits in that it helped make them more competitive. It was all going so well As well as curbing their costs, European firms benefited from shifting their gaze abroad. Their rebound from the 2008-09 recession was mainly driven by a diversion of corporate energy into Asia, Latin America, America and other overseas markets. German exports to China nearly doubled between 2008 and 2011. Volkswagen Group, Europe's biggest carmaker, sold 1.7m cars in western Europe in the first half of 2011, just 2% more than for the same period in 2007. Sales to Asia, by contrast, leapt by 151% to 1.3m. In general Europe's big firms rely on European customers for only half their business (see chart 1). Unfortunately the effect of the euro crisis on the global economy is now becoming a drag on robust growth elsewhere. Leading indicators such as purchasing managers' indices suggest that the euro zone's manufacturing sector is contracting at an accelerating rate. Companies are braced for a slowdown in orders. Lutz Goebel, the boss of Henkelhausen, a mid-sized German engine manufacturer, says his customers are already starting to procrastinate over purchases of new diesel engines. Volvo, says Mr Johansson, expects customers to start hesitating over big purchases. "If they wait one month," he says, "that takes out a twelfth of the market." Firms which sell to governments have an added level of exposure. In one of the most striking responses to the euro crisis, Roche, a Swiss pharmaceutical firm, halted delivery of some of its drugs to state-owned hospitals in Greece this summer, following non-payment of its bills. The company may soon take the same tough approach with Spanish hospitals. Smaller companies are particularly fearful. Many middling French engineering firms, says Jérôme Frantz, president of the Fédération des Industries Mécaniques, are preparing for a slowdown and drawing up plans to fire workers if necessary. Eric Chaney, chief economist at AXA, an insurer, says European firms are cutting production faster than slowing demand would require. The aim, he says, is to lower stocks and raise cash reserves in case of a liquidity crunch. Fears about the future thus quickly become self-fulfilling. Finance is the area where European companies feel most vulnerable. The threat of another credit crunch terrifies them. French companies are already seeing a lending freeze as French banks become more conservative amid fears about their balance-sheets. A recent survey by the French association of corporate treasurers confirmed that financing conditions are worsening; companies are finding it harder to get bank funding, and are paying higher rates. One French carmaker recently asked for outside help to devise a plan to secure liquidity in the event of a euro-zone break-up. Mr Frantz, whose 87-year old firm, Frantz Electrolyse, is a key supplier to Peugeot and Renault, France's two big car manufacturers, says banks have not lent to companies like his since 2008. Small to medium companies have found other sources of credit, including government agencies. When his firm wanted to buy a new machine recently, Mr Frantz says, he got finance from Total, an oil and gas giant, in return for committing exclusively to use a Total chemical product. German firms, too, face worsening conditions. According to Roland Berger's recent survey, a third of companies are seeing a decline in banks' willingness to lend. And Italy's CIR Group, which has interests in car components, media, energy and health care, reckons that the cost of capital for Italian companies has gone up 30% over the past few months. The timing could not be worse. European companies will need to roll over a mountain of debt in the next few years. According to Standard & Poor's, a credit-rating agency, European non-financial firms will be obliged to refinance $1.1 trillion of debt which will mature between 2011 and 2015, reflecting heavy reliance on cheap credit in the middle of the 2000s. That refinancing could be tricky, says the agency, not just because of banks' reluctance to lend but also because credit-gobbling governments could crowd out corporate borrowers. The head of Britain's Association of Corporate Treasurers advises his members to "keep calm and carry on" under the threat of scarcer and more costly finance. Recognising that that is hardest for small and medium-sized firms, the British government is expected to start a programme of buying bonds issued by such firms as part of its measures to pump more money into the economy. Cash problems, credit problems The bigger, cash-rich companies have another problem: where to keep their money while they are waiting for a better investment climate. Many have been pouring deposits into German and French banks. For Siemens, Germany's largest company by market capitalisation, even that may have seemed too risky. Last month, according to the Financial Times, it withdrew €500m from Société Générale, a French bank, and moved it to the European Central Bank in search of a haven. French businesspeople were outraged that Siemens would do such a thing, and, worse, talk about it afterwards. Also in September, Match.com, the American owner of Meetic, a French online dating service, told its subsidiary to dump its French bank and switch to an American one. At the end of the month, LVMH, a luxury-goods group, sent most of its cash hoard to shareholders in Bulgari, an Italian firm, to close its purchase of the company. "Now I don't have to worry about which European bank our money is safest in," says Jean-Jacques Guiony, the group's chief financial officer. Faced with slowing sales and a lack of access to credit, companies may have to cut costs further - hard when they are already uncomfortably lean. Rodolfo de Benedetti, chief executive of the CIR Group, says that to squeeze costs any more, his firm would have to summon up new reserves of creativity and re-engineer its processes. Some of this could in turn require new investment. Companies may take more drastic steps this time than they took in 2008, such as closing down entire divisions rather than trying to trim them incrementally. The best strategy for a European company, it would seem, is to have as little exposure to Europe as possible. Investors and banks are busy drawing up lists of the companies which have the highest proportion of sales to countries outside Europe. Bad luck for France Télécom, for instance, with 92% of its sales in Europe. But good news for a group like LVMH, with just 34% of its revenues earned in Europe thanks to Asian consumers' seemingly endless appetite for its baubles. The first priority for many firms is to reduce their exposure to the most troubled peripheral euro-zone countries. Telefónica, a Spanish communications group, announced in September that it would consolidate its Spanish business with its European and global headquarters in London. This is a natural progression after its 2006 purchase of O2, a mobile-phone operator based in Britain that is now the main focus of the company's European business. But it is also an undeniably convenient moment to be pulling its centre of gravity away from Spain. The acquisition of Hochtief, a big German rival, has provided the Spanish construction group ACS with a similarly timely way to reduce its reliance on Spain's construction sector. The next goal for many European firms is to move even quicker into fast-growing emerging economies. The euro crisis, say business leaders, simply makes such diversification even more urgent than it was before. E.ON, Germany's biggest utility, is selling billions of euros of European assets in order to shift its focus to emerging markets. Klöckner & Company, a Mittelstand firm which trades metals globally, bought a Brazilian trading company in May, and is preparing to open a China office. Despite their interest in markets elsewhere, European businesses remain deeply committed to the EU's single market at home, and desperate that the euro-zone crisis should not threaten it. Mutual recognition of national product rules means that a company anywhere in the EU can sell to 100m households, a market larger than America's. It is thanks to the single market, says Mr Johansson, that Volvo has been able to reach outside Europe to achieve more than 30% of its sales in countries such as India and China; a restructured, competitive European manufacturing base and a strong home market were the crucial foundation. Being able to reach a large market has been a particular benefit for small and medium-sized companies. Executives are grateful that they no longer have to deal with competitive currency devaluations in Europe. The old hedging strategies they had to employ were complex and often did not work. They were also difficult for small to medium-sized businesses to use. Enthusiasm for the single market does not preclude ruthlessness about the euro zone. "You need to know...who's inside the boat, who's outside the boat and fix it," growls Carlos Ghosn, chief executive of carmakers Renault and Nissan. Other bosses have taken a similarly pragmatic line; eliminate uncertainty, they say, even if that means tossing some countries out of the single currency area. If they ruled the world Germany is divided. Big firms tend to favour further support for indebted euro-zone members. Mittelstand firms (medium-sized, owner-managed companies which often dominate global niches) bitterly oppose it. Just before Germany's vote empowering the EFSF four lobby groups for the country's biggest companies wrote urging parliamentarians to vote "yes." But Die Familienunternehmer, a lobby group for family firms, said Germany must refuse. The reason, says Mr Goebel, who is president of Die Familienunternehmer as well as running his own firm, is that family business owners are personally liable for debts, which makes them more prudent. They would rather endure a Greek default than burden Germany with more debt. Many executives in Germany and elsewhere are uncomfortable with the idea of Eurobonds which would entail the most creditworthy countries guaranteeing the debts of the weakest. And in general support for reinforcing Europe's safety nets among European businesspeople seems to be strongest in the countries that might have most to gain from such interventions (see chart 2). But a majority of Europe's businesspeople definitely wants politicians to do more to hold the euro zone together. That they don't think the politicians are delivering on this is what makes them angry. Chief executives, especially in southern Europe, were already cross with their politicians. Now they are livid. This week, Diego Della Valle, chief executive of Tod's, a luxury Italian leatherware brand, blasted Italian politicians in the country's main newspapers, calling them incompetent and ill-prepared to deal with the crisis facing Europe. Sergio Marchionne, chief executive of Fiat, Italy's biggest private company, has in the past threatened to make fewer cars in Italy because of inflexible labour laws. On October 3rd he said Fiat would pull out of Confindustria, Italy's employers' association, and negotiate its own labour deals. The company, he said, "cannot afford to operate in Italy in an environment of uncertainty that is so incongruous with the conditions that exist elsewhere." While Fiat denies plans to move production elsewhere, statements like that keep speculation rife. But while businesspeople are both angry and scared, they are not blind to the fact that there may be opportunities. Even if things work out well, eggs will be broken on a scale that promises some industrial omelette-making. For example, to ensure that it stays in the euro zone and meets its commitments to reduce its debt, Portugal will shortly embark on a radical privatisation programme. TAP, the airline, ANA, the airport management company, and part of RTP, the public TV network, will all be up for sale. Given the constraints of the schedule and the financing environment, the assets should go for reasonable prices. "Buyers will make a killing," splutters one Portuguese executive. At least some of those buyers will be businesses from elsewhere in the euro zone. Pedro Passos Coelho, Portugal's prime minister, has already invited Germany's Lufthansa to snap up TAP. Like Portugal, Spain and Ireland will sell some crown jewels, and the buyers may find rich pickings in the rubble.