The launch of the euro on 1 January this year counts as one of the key landmarks in the history of European integration following the inception of the European Community in 1958 and the single European market in 1993. Few other events have involved such a large transfer of sovereignty from a national to a European institution.
It was in 1949 that the Council of Europe, the predecessor to the European Commission, was established. So, on the 50th birthday of the start of the European integration process, we marked its coming of age with a new currency. As with all such birthdays, we had an extensive period of trepidation, and we expected all manner of dreadful events to unravel on 1 January. But after years of dire warnings it came as a pleasant surprise that the birth of Europe’s single currency proceeded as smoothly as one could have hoped for. Computer systems did not crash. Accounts did not get erased. Target, the cross-border payment system run by the European Central Bank, managed to channel record sums from one corner of the eurozone to another.
Many people will be wondering what all the fuss was about. After all, the new currency won’t be in people’s hands until at least early 2002 when euro banknotes and coins are introduced.
But this misses the point. Business in Europe is undergoing its most profound restructuring since the introduction of the Single Market and just as a 50th birthday is a key landmark in any person’s life, the introduction of the euro will be seen as the catalyst for restructuring over the coming decade and beyond.
Quite apart from the enormous logistic task of implementing the single currency across 11 states and the costs associated with doing so, the strategic implications for European business will be a significant driver for M&A growth in Europe over the coming years. The figures below show that this growth in M&A volume has already been driven by the prospect of such changes.
On the international finance markets, the euro has arrived with a bang, just as many supporters had predicted. The first weeks of trading suggested that prophecies of a bipolar financial world, in which the dollar and euro would jointly dominate the global markets, no longer sound as absurd as they did only a few months ago.
During the first months of trading the euro outstripped the dollar as the largest currency in international bond markets. No national European currency would have been able to pull off such a stunt. Many foreign central banks, including those of China and Japan, indicated that they would exchange part of their dollar foreign exchange reserves into euros.
EMU has also continued the process of breaking down barriers between national markets within the euro area. The 11 countries joining EMU in the first wave have the second largest combined GDP in the world. If this is extended to the full 15 members, who are all expected to join in the second wave, it will be the largest. For those outside EMU, entering the euro market will be simplified since a single currency balance sheet will support operations across many countries and the size of the market will draw investment away from other areas of the world.
There will also be longer term changes in respect of the impact on:
*industry of transparent euro-denominated prices;
*traditional financing structures due to a deepening corporate bond market; and
*equity markets due to cross border diversification.
The elimination of currency transaction costs and exchange rate risk represents the removal of the most significant remaining barriers to trade between countries in the EU.
These effects will apply to all firms, regardless of whether the Member State in which it is headquartered joins EMU or not. If in, it will be easier for businesses in that country to enter other EU markets due to the elimination of transaction costs and exchange rate risk. If out, barriers to entry to other EU markets will also be lower due to reduced exchange rate risk and lower transaction costs from dealing with only a single currency across a number of participating EMU states. As a result, all firms face the opportunity of expanded markets, and the threat of increased competition, for which they need to prepare.
EMU will ensure greater price transparency across EMU Member States as all goods and services sold in participating countries will be priced in euros. Consumers, and agents acting on behalf of customers, will therefore, for the first time, be able easily to compare the prices of goods.
Just as customers will be able to observe these pricing differences much more clearly, distributors will find it easier to trade on such price disparities, given that they will bear no exchange rate risks in doing so. To the extent that price disparities do not reflect differences in costs or quality, they will be unsustainable and prices will tend to drop towards those which an importer from another Member State could offer for goods and services with comparable attributes.
Some companies, however, are considering moving to more uniform prices across the EU but offering different product/service propositions in different markets to reduce the scope for the sort of price arbitrage mentioned above.
The effect of conversion into euro pricing will also have an impact on the strategic price bands operated by firms. Attractive price focal points at GBP1.99, GBP9.99 etc. will be transformed into rather inconvenient equivalent figures in euros. Possible strategies to respond to these changes will involve price increase or reductions to more attractive price bands and possible product changes to down-rate or up-rate products accordingly.
EMU therefore presents an opportunity (and in some cases a necessity) to review the brand positioning of existing products. It will also open up the opportunities to introduce new products and services. In particular, EMU will make some products/services more interchangeable – for example, financial products such as savings accounts and loans, billing services, and mail order services giving organisations greater opportunities to expand across national borders.
Bond markets will be larger and more liquid, encouraging yet more firms to issue bonds. Credit risk, rather than currency risk will become a key determinant for these markets.
The majority of European companies currently use traditional bank credit as their only form of external debt finance, as the European bond markets are neither deep enough nor liquid enough to provide the necessary funding. The advent of the euro, however, is helping to lead to the creation of a single corporate bond market, characterised by reduced volatility combined with increased liquidity and expertise. This could impact on the debt financing strategies of small- to medium-sized companies, as they will have access to a bond market where no such access existed before.
The removal of currency barriers to cross-border investment will allow greater international diversification of portfolios. Equity trading is likely to become focused in a smaller number of highly liquid exchanges. While those stocks at the larger end of domestic markets will be more liquid, there is likely to be reduced liquidity (if, in some sectors, that is possible) in mid- and small-cap companies.
M&A and IPO activity will increase as investors will be able to diversify their portfolio across a much larger market without taking on currency risk. The speed of portfolio rebalancing will be dependent on investor confidence although it is likely that, for the time being at least, investors will continue to account for differing country risks until the transition to a stable and optimal economic zone is complete.
The single currency will help with the creation of a stable economic zone that will continue to enjoy the benefits of low inflation that are being experienced at present. Those countries joining EMU in the first wave are already benefiting from lower interest rates than those outside EMU (although, clearly, their participation in EMU is not the only reason for this). This will provide a framework around which firms in these countries can plan and invest.
The existence of a large single currency area will lead some businesses to consider relocating operations into the eurozone to avoid currency fluctuations. Operational changes, such as rationalisation of the supply chain, will be effected to take advantage of the single currency.
In summary, most people continue to underestimate the impact that EMU will have on European businesses, irrespective of whether or not their individual Member State took part in the first wave of euro implementation. Strategically, EMU offers very significant opportunities to accelerate and enhance future business strategies and M&A activity will be a core part of European business gameplans for some time to come.
Those of us who have shrugged off the hangover from the party and are getting back to business as usual are in for a bit of a surprise. Europe is starting to realise that perhaps life does start at 50.
Table 2: The Impact of EMU on Strategic Pricing Bands
Existing price points (GBP) New price points Possible pricing strategy
at GBP/euro rate
GBP1.99 euro 2.89 3% price rise to euro 2.99
GBP4.99 euro 7.24 3% price cut to euro 6.99 GBP9.99 euro 14.48 3% price rise to euro 14.99
GBP19.99 euro 28.98 12% price cut to euro 24.99
Note: figures at GBP/euro exchange rate on 1 March 1999. GBP1=euro 1.45
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