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Executive Report on Strategies in Italy
ICON Group International, June 2007, Pages: 394
How to Strategically Evaluate Italy
Perhaps the most efficient way of evaluating Italy is to consider key dimensions which themselves are composites of multiple factors. Composite portfolio approaches have long been used by strategic planners. The biggest challenge in this approach is to choose the appropriate factors that are the most relevant to international planning. The two measures of greatest relevance are “latent demand” and “market accessibility”. The figure below summarizes the key dimensions and recommendations of such an approach. Using these two composites, one can prioritize all countries of the world. Countries of high latent demand and high relative accessibility (e.g. easier entry for one firm compared to other firms) are given highest priority. The figure below shows two different scenarios. Accessibility is defined as a firm’s ease of entering or supplying from or to a market (the “supply side”), and latent demand is an indicator of the potential in serving from or to the market (the “demand side”).
Framework for Prioritizing Countries
Demand/Market Potential Driven Firm
Relative Accessibility
Accessibility/Supply Averse Firm
Relative Accessibility
In the top figure, the firm is driven by market potential, whereas the bottom figure represents a firm that is driven by costs or by an aversion to difficult markets. This report treats the reader as coming from a “generic firm” approaching the global market - neither a market-driven nor a cost-driven company. Planners must therefore augment this report with their own company-specific factors that might change the priorities.
Latent Demand and Accessibility in Italy
This report provides an extremely detailed overview of factors driving latent demand and accessibility in Italy. Latent demand is largely driven by economic fundamentals. But, latent demand only represents half of the picture. A country may at first sight appear to be attractive due to a high latent demand, but it is often less attractive when one considers at the macro level how easy it might be to serve that entire potential and/or general business risks.
Chapter 2 deals with macro-accessibility. While accessibility will always vary from one company to another for a given country, the following domains are typically considered when evaluating macro-accessibility in Italy:
Openness to Trade in Italy
Openness to Direct Investment in Italy
Local Marketing and Entry Strategy Alternatives
Local Human Resources
Local Risks
Across these domains, a number of not-so-obvious factors can affect accessibility and risk. These are also covered in Chapter 2, which is presented from the perspective of an American firm, though it is equally applicable to most firms entering Italy. This chapter has been authored by local offices of the U.S. Government. I have included a number of edits to clarify the provided information as it relates to the general strategic framework.
In Chapter 3, I summarize the economic potential for Italy over the next five years for hundreds of industries, categories, and products. The goal of this chapter is to report my findings on the real economic potential, or latent demand, represented by Italy when defined as an area of dominant influence. The data presented are the result of various spatial econometric and time-series forecasting models which, for each category presented, are applied to forecast and allocate latent demand across all countries of the world and major distribution centers or centers of dominant influence within each country. This is accomplished knowing that economic fundamentals (e.g. income) generally vary from one country to another within a given country over time. In this chapter, I report the allocation for each category for Italy as an area of dominant influence in Europe and, potentially, the world.
The report concludes with trade indicators for Italy. Often, the amount of trade flowing into and out of a country is a strong indicator of trading partners, trade openness, and related latent demand. Trade indicators are purely statistical in nature. Although international trade is not a direct measure of latent demand, it does provide an indicator of general market conditions with respect to trade flows and trade openness in Italy.
As a whole, this report presents a strategic assessment of Italy by considering an extremely broad set of factors affecting both latent demand and accessibility, as outlined in the following chapters.
MACRO-ACCESSIBILITY IN ITALY
Fundamental Dynamics
During most of the 1990’s, Italy’s gross domestic product (GDP) growth was the slowest in what is now the Economic and Monetary Union (EMU) zone. The gap was once attributed to the tough budget discipline of the ‘90s, but now, at the end of the EMU accession process, seems to reflect structural impediments in the Italian economy that discourage investment and job creation.
Dynamics in Agriculture
Italy’s agricultural trade is primarily with other EU Member States. Over 73 percent of total imports (mainly represented by raw materials) come from within the EU, while almost two-thirds of Italian exports (chiefly value-added products) stay within the EU.
National and international developments are expected to shape Italy’s agricultural sector in the near future. At the national level, the main drivers are national budget review and the decentralization of the decision making process, with an increasing number of agricultural competences being transferred from the Rome government to regional administrations.
The “decoupling” of CAP farm payments from agricultural production, and the parallel increase of EU budget for rural development, will probably result in a shift in marginal areas from traditional farming activities to other complementary activities (e.g., rural tourism, landscape management, etc.). The completion of the EU farm policy reform will likely result in different land uses (intensive vs. extensive agriculture) and in a new geographic distribution of productions in the country (re-location where more competitive).
The eventual future accession of countries such as Romania, Bulgaria and Turkey to the EU (likely to happen in the next 5-7 years) is creating some concerns to Italian farmers. This event would increase competition in the EU for some products that are key for Italy, especially fruit, vegetables and olive oil. The effects of this second round of enlargement are expected to be much more stronger than those of the May 2004 enlargement.
The EU Commission is in charge of almost all the extra EU agricultural trade issues, including WTO negotiations and bilateral agreements with other countries (or group of countries). Italy for obvious reasons has a special interest in the current negations for the creation of the Mediterranean free trade area (Euromed).
Dynamic Markets
Italian companies are adjusting to a period of slower growth in both the domestic economy and the euro-zone as a whole. Both inflation and unit labor costs have risen faster in Italy than the euro-area average, eroding Italian exporters’ competitiveness and market shares abroad. Italy is heavily dependent on exports to its largest market, Germany, which has also entered a recessionary period. In addition, Italian exporters are also facing increasing competition from lower cost producers in Eastern Europe and Asia in other large export markets in Europe and the United States. To accommodate these conditions, Italian exporters need to streamline operations to reduce production costs, which likely will entail moderate investment in labor-saving equipment and technology. Given the more favorable dollar-euro exchange rate at present, U.S. firms have a slight pricing advantage vis-à-vis their European competitors, but must be aggressive in identifying opportunities for their products and services.
In general, rationalizing business practices and achieving cost-savings create opportunities for U.S. equipment, technology and expertise in computer software and hardware, management consulting. The full liberalization of the Italian telecommunications market, with a belated but enthusiastic interest in the Internet, is creating substantial business opportunities. Privatization and liberalization in the energy sector following EU directives should also spur future demand for equipment and services in this sector. In addition, the Italian public as well as private sector is looking for ways to improve efficiency while reducing costs, through outsourcing, training programs and better application of new information technologies. U.S. firms with products and services that contribute to the further rationalization and increased competitiveness of the Italian economy will find that Italy offers significant opportunities.
Despite the current economic climate in Italy, the fluctuations in the dollar/euro exchange rate, and the often protectionist regulations of the CAP, there are still many opportunities in the near-to-medium term to both maintain and expand the market for a variety of U.S. agricultural products.
Government Intervention Risks
In the post World War II period, the Italian state traditionally played a dominant role in the Italian economy. In the early 1990s, the Italian government controlled about a third of all industrial activity and almost two-thirds of banking operations. In many sectors, the state’s role was eliminated or vastly reduced. In the last ten years, the GOI raised USD135 billion through privatizations, which helped reduce the debt/GDP ratio from 125 to 106 percent of GDP. Despite substantial sales of state assets in the 1990’s, the GOI still holds substantial stakes in more than 20 Italian companies with a total value of more than USD 80 billion. The most important remaining assets to be sold include a significant portion of ENEL, Italy’s main electricity producer, in which the GOI owns 61 percent of the stock. The other large assets are the GOI’s 30.33 percent share in ENI (Italy’s hydrocarbon conglomerate, and the country’s largest company) and its 32.34 percent share of Finmeccanica (the large aerospace and defense holding company). Despite official statements, the GOI seems reluctant to sell any part of firms in sectors considered critical to national security, such as aerospace and defense, and is committed to keeping a controlling share in these key companies.
Since 1993, four major banks (Credito Italiano, Banca Commerciale Italiana, Istituto Mobiliare Italiano and Banca Nazionale del Lavoro (BNL)) and the country’s second largest insurance company, INA, have seen government control transferred to banking foundations, which are non-profit entities with government-approved directors. IRI, once the major government-owned industrial holding company, dismantled itself through sell-offs in the 1990s. Telecom Italia was sold in a stock offering in 1997. There have been five offerings of stakes in oil and gas parastatal ENI. Since 1999 there have been offerings of 39 percent of Enel, the electricity company; 87 percent of Autostrade, which operates highways; 45 percent of Finmeccanica, the defense industries holding company; and 52 percent of the Rome Airport Authority.
The GOI Treasury still holds a 53 percent stake in Alitalia, the national flag airline. If Alitalia survives its severe financial crisis, through a program of layoffs, new management, and bridge loans, the GOI has vague plans to sell at least some of its share in the distant future.
Infrastructure Development
To jump-start the ambitious ten-year effort to improve and expand the transportation network, the Parliament approved the GOI bill that included measures intended to eliminate bureaucratic obstacles to public works and infrastructure investment.
Railroad
The railroad system is operated by the Italian State Railways (Ferrovie dello Stato, abbreviated FS), a government agency. The railroad provides an efficient and economical method of transportation. More than half of the rail system is electrified.
Highway
The highway system is approximately 197,000 miles long, including over 3,000 miles of superhighways, called “autostrade.” The network connects the major industrial centers and offers easy access to Northern Europe. Mainly private companies under government concession operate trucking services.
Air
Alitalia, a state owned company is Italy’s principal airline, providing both international and domestic service. Additional service is provided by Lauda Air, Itavia, Air Europe and Meridiana airlines. Charter service is offered by SAM, an Alitalia subsidiary, and by Air One, while air-taxi service is available from Unijet Italia in Rome and Agena in Milan. Italy has an extensive airport network consisting of 19 international, 17 domestic, and 59 general aviation airports. Federal Express, UPS, DHL, and other rapid delivery services are also available.
Sea
Italy has eight major seaports: Gioia Tauro, Genoa, La Spezia, Livorno, Naples, Palermo, Trieste, and Venice. In addition, there are 35 smaller ports primarily used for coastal shipping.
Industrial Districts
Small and medium sized enterprises, especially in the North, have increased Italy’s output, exports and job creation. The districts take advantage of areas where many small enterprises operate in the same industry and where the steps of production are divided up among the various enterprises. Over time, cooperation among the firms (and often unions of their workers) has paid off in better exchange of information, group purchases, and market development. The districts have been given legal recognition so that communities have the tools to plan joint activities, tap national and regional financing for projects, establish service contracts (for example, with research institutes and universities), and otherwise maximize public and private resources for the success of their industry and local development.
Economic Relationship with the United States
Italy is an important economic and political partner of the United States. Italy’s proximity to areas of tension in the Balkans, the Eastern Mediterranean, and North Africa underscores its strategic significance. A founding member of NATO, Italy has worked with the United States in efforts to promote reconstruction, democratization and stability in Iraq, Afghanistan, and Central and Eastern Europe, implementation of the Dayton accords in Bosnia, and the success of the Middle East Peace Process. Italy played a crucial role in NATO’s action in Kosovo and in managing the refugee crisis, as well as in efforts toward economic and political stabilization in Albania. Italy has played a central role in the growth of the European Union, supporting European economic and political integration and advocating a stronger European security and defense identity within NATO.
The Political System
The Republic of Italy is a parliamentary democracy. Parliament consists of the Chamber of Deputies (630 members) and the Senate (315 members). The Chamber of Deputies is the more influential body. No single political party commands a parliamentary majority and coalition governments are the norm. Much of Parliament’s work takes place in committees.
Executive authority is vested in the Council of Ministers, headed by the President of the Council (Prime Minister) who, as Head of Government, is responsible for its day-to-day functioning. The ministries form the basic structure of the state’s public administration. The Berlusconi government has 22.
The President of the Republic is Head of State and has limited powers. He or she appoints the Prime Minister, subject to parliamentary concurrence. The President can also dissolve Parliament and call for elections if it is clear that no governing majority can be formed. The President is elected for a term of seven years by the Members of the Chamber of Deputies, the Senate and representatives of the 20 regions.
The judicial system includes three separate lower courts whose decisions may be appealed to the Assizes Court of Appeals. Decisions of the Assizes Court of Appeals can be appealed to the highest court, the Court of Cassation (Supreme Court) in Rome. The Constitutional Court rules only on matters concerning the constitutional legitimacy of referenda, legislation and other actions of the central and regional governments.
Although State authority in Italy remains centralized, the country has devolved certain responsibility for transportation, health and welfare issues to regional and local bodies. Regions can also present draft laws to Parliament on issues of particular interest.
Major Political Parties
Center-Right “Freedom House” Governing Coalition:
Forza Italia (FI)
National Alliance (AN)
Northern League (LEGA)
Union of Christian Democrats of the Center (UDC)
Center-Left Opposition:
Democrats of the Left (DS)
Italian People’s Party (PPI)
The Democrats (DEMOCRATICI)
Union of Democrats for Europe (UDEUR)
Italian Renewal (RI)
Italian Communists (PDCI)
The Greens (VERDI)
Italian Democratic Socialists (SDI)
Independents:
Communist Renewal (RC)
Political Risks for Agriculture
In the center-left Government of Giuliano Amato in 2000, the GOI unilaterally banned the import of the four main biotech corn varieties (even though they had been approved for use within the EU for several years) based on arguments that the products should have had a full EU review instead of an abbreviated review based on substantial equivalence. Imports of non-biotech corn and soybean seed for planting were also hindered over concerns of adventitious biotech presence. Minister of Agriculture Alemanno, while not a member of the Green party, has allied himself with the Greens’ position insofar as they oppose the import and use of products derived from agricultural biotechnology.
Marketing Strategies
Distribution Channel Options
American business representatives will find that selling in Italy offers new challenges, but it presents no overwhelming problems. Over 7,500 American companies are actively represented in Italy, with approximately 850 of them having subsidiaries there. U.S. executives may find that some commercial practices differ from those in the United States, but most will be very familiar. The system of retail and wholesale distribution, for instance, centers on small, family-operated stores. Despite this phenomenon, the supermarket type operation has gained importance, and there are a number of substantial department store operations.
Retail Distribution in Italy
The Italian retail distribution system is faced with the new challenges of competition and technology. Reforms introduced starting in 1998 have entailed some degree of liberalization, especially as regards small retail businesses. Nevertheless, compared to other EU countries, Italy’s retail distribution sector is characterized by a large number of small firms and low concentration. In food retailing, for example, the combined market shares of the five largest retailers in Italy is 17.6 percent, the lowest ratio in the EU, and considerably lower than the EU average of around 50 percent. The retail sector has one of the highest outlet densities in the EU, with a very low average number of employees per enterprise, reflecting the general absence of medium and large retail outlets. Thus, productivity in the sector is low, and estimated mark-ups in wholesale and retail distribution in Italy are among the highest for EU countries.
Accounting for this is the fact that retail distribution in Italy traditionally has been subject to more extensive regulation that in other EU countries and is hindered by numerous restrictions. A law introduced in 1998 liberalized the opening, relocation and expansion of mall-sized outlets by abolishing the requirement for small business to obtain commercial licenses in order to start-up. However, implementation of regulatory measures at the regional level, in line with Italy’s devolution of authority to regional governments, has meant that new commercial establishments, rather than being subject to regulation on commercial activities, are now subject to regulations on urban planning. In practice this has meant that authorization for medium and large outlets is required (and rarely granted) in order to integrate them into urban development plans, while the opening of small shops has been liberalized.
Firms operating in the Italian retail distribution sector find that they must invest large amounts of money in new techniques, management, research, media promotion, and equipment. The industry’s average return on investment is approximately 13 percent. In terms of existing points of sale, there is a gradual trend away from the family type stores and street vendors to the distribution chains. Italian distribution systems include small family-owned stores, street vendors, hyper-markets, shopping malls, specialized stores and discount stores.
Horizontal points of sale such as general stores, which had experienced boom conditions in the early 1980s, very gradually have begun to lose ground to specialized stores, franchising chains, and hyper-markets. In order to create a unique business identity, department stores have begun a process of realignment and now tend to attract the more affluent, quality-oriented consumers, as well as compete on price and product selection. Supermarket chains now look toward further expansion, particularly in creating and operating large shopping malls. Where such shopping centers exist, they are proving to be successful.
Agents and Distributors
Italy represents a large and affluent market where language and personal relationships are valued when conducting business transactions. Consequently, some form of local presence is generally required to be successful. Companies wishing to enter the Italian market, as an alternative to establishing a subsidiary, might decide to use an agent or a distributor. The choice depends on the nature of the goods or services to be distributed in Italy. There are important distinctions in Italian law between distribution and agency agreements:
Agency Agreement: Agency contracts are governed by the Italian Civil Code and by a number of other legislative decrees. The term “commercial agent”, as a literal translation from the Italian Civil Code, does not correspond exactly to the concept of agency in common law countries. Under an agency contract the principal (manufacturer or exporter) appoints an agent as principal’s sole agent for the territory concerned, who then permanently acts for and on behalf of the principal in promoting the execution of the agreements. The agent may or may not have a special power of attorney to execute contracts, but, if so, will do so only on behalf of the principal. The contractual relationship is thus between the principal and the buyer, not the agent. The normal pattern of remuneration for an agent is either entirely by commission or partially by commission in addition to a periodic payment.
Distribution Agreement: Under Italian law a distribution agreement is one by which a manufacturer or exporter contracts with a distributor to purchase goods which the distributor then sells on the distributor’s own account, usually to retailers for ultimate resale to the public. The incentive for the distributor is in the price differential between one transaction and the other. There may be variations involving the possibility of returning the non-sold goods or other formulae, but the distributor is always acting as the principal in the contract with the subsequent purchaser. There are no laws or regulations currently in effect in Italy providing for advance notice of termination, termination compensation, or social security payments in connection with these agreements.
Frequently, a distributorship agreement provides for exclusive sales rights. There is nothing in Italian law preventing exclusive arrangements in all or part of Italy. However, if these agreements provide for exclusive sales rights in all or part of the EU, they should be examined carefully, and with the assistance of a competent international lawyer, in light of the antitrust provisions of the EU regulations.
Appointing an Agent or a Distributor
It is important to obtain specific legal advice on appointing an agent or distributor. However, some general guidelines apply and are outlined here. Italy implemented EU directive 86-653 in October 1991. As a result, Italian agency law is now in conformity with EU requirements. All agent agreements should be in writing and state the marketing area and any exclusivity arrangements. Termination of the relationship is the area that most frequently causes problems for American exporters. Generally, the civil code protects the interests of the representative. In the absence of termination provisions in a written agreement, the law provides for a minimum notice of termination of one month during the first year of the agreement, two months during the second year, three months for the third year, four months for the fourth year, five months for the fifth year, and six months for the sixth and additional years. Parties may agree to other terms, provided the notice of termination is not less than the above. An agreement with a definite period terminates on the agreed expiration date. If the parties continue to operate under the agreement after that date, the agreement becomes an agreement of indefinite term, which can be terminated in accordance with the aforementioned notice periods. If the American principal wants to terminate the relationship, notice of termination should be given, even with a definite term contract.
The termination of an agreement without the required notice makes a U.S. principal liable for compensation. The Italian sales agent could seek to claim the amount of the commissions that would have been earned during the termination period or for the amount of actual damages suffered. In exceptional cases, and only for just cause (such as competition or fraud), an agreement may be terminated without notice provided the other party is immediately advised of the reason. In such cases, the courts may be requested to terminate the contract.
At the expiration or termination of an agreement, by whatever means, an agent who has increased the value of the business is entitled, in principle, to an adequate remuneration which cannot exceed the average of the commissions in 1 year. Such claims by agents are subject to an expiration period of 1 year.
Three kinds of distribution agreements are commonly used:
Exclusive distributorships, where the distributor has the sole right to sell specified goods within a defined area
Quasi-exclusive distributorships, where the distributor sells almost all the specified products within a defined area
Informal distributor arrangements, under which the grantor imposes heavy obligations on the distributor and which would cause damage to the distributorship if the grantor terminated the agreement.
In the absence of mutual agreement, or the failure to meet contract obligations, a distribution agreement of indefinite term cannot be terminated by the grantor without reasonable notice or fair compensation. In general, grantors should consider protecting themselves by entering into agreements for definite periods rather than an indefinite period. Also, specific minimum performance clauses should be considered, such as percent of distributor’s sales, minimum annual sales, and number of business contacts to be made, and grantors should propose that U.S. law and courts have jurisdiction.
A continued and close working contact between the American firm and the agent or distributor is very desirable and should be developed early in the relationship. Certain products and equipment require servicing to maintain their useful life. The U.S. exporter should determine if servicing is needed and develop a distribution network to include such servicing by qualified personnel. To build trust, loyalty, and marketing skills, U.S. producers frequently bring their agents or distributors to the United States for training and marketing assistance.
Franchising
The Italian business community has accepted the concept that franchising is the most innovative way to introduce a new business concept. The Italian population has shown itself to be receptive to the fast and efficient formulas provided by franchises. At the same time, the Italian end-user is not always open to franchises for services that are traditionally strong and consolidated in the country. Nevertheless, the Italian market’s receptivity to the franchising concept appears to be steadily growing, particularly in the services sector.
End-User Profile
There are considerable differences in economic characteristics among various geographic regions of the country. Northern Italy, the most developed part of the country, has a larger number of commercial, financial, and industrial enterprises and double the per capita income of the south. Similarly, among the various regions distribution of franchising is disparate, with franchising networks concentrated in northern Italy. However, there are recent indications that franchising is also gaining momentum in southern Italy, where it is perceived as a way to alleviate the effects of chronic unemployment.
Competitive Situation
Italy has an extremely fragmented distribution system. The predominance of small, family-owned stores and the disproportionately large number of point-of-sale outlets contribute to market inefficiency. The present retail system survives mainly due to the complexity and protective nature of existing regulations. However, there is now a noticeable move towards concentration in retail distribution, which creates economies of scale and more efficient management. Thus, franchising seems to be increasingly a system well suited to Italy.
Franchising in Italy was formally established in 1971, with the foundation of the Italian Franchise Association (Assofranchising Italiana). The beginnings were very slow and in 1978 there were only 15 franchisers in the country. Growth has since escalated, and between 1990-1995 there was a surge in growth, with 89 percent more new brands. Local Italian franchisers have now been in operation for a number of years and have achieved both success and profitability and some have acquired name recognition worldwide.
The most developed segment of the franchising sector is services, with over 20,000 franchisees and 297 franchisers, while the personal products sub-sector ranks second, with 8,000 franchisees and 157 franchisers. Another very strong sub-sector is specialty retail stores, with 77 franchisers and 4,000 franchisees.
The Italian business community views American franchising companies with a very open attitude and recognizes their predominance in the sector. However, smaller American franchisers trying to find Italian master licensees may find they face obstacles related to lack of name recognition in Italy and to inexperience with local business practices. The price for the master license is almost always set too high and the assistance to be provided by the franchiser is often not spelled out clearly enough. Commercial Service Italy can assist in this regard by providing introductions to the most qualified, suitable potential business partners for U.S. firms in Italy, either through one-on-one counseling and assistance, or through such events as our U.S. Pavilion at the annual Franchising and Partnership trade show in Milan, usually held during the fall each year (for more information, contact Commercial Service Italy at E-mail: rome.office.box@mail.doc.gov).
Best Sales Prospects
The sectors that appear to have the best potential are in the services area. New activities stemming from the “new economy” are making a breakthrough and concepts linked to Internet, E-commerce, telecommunications and information technology have a proven record of success. Other very promising and more consolidated areas are travel and tourism, education and training, fast delivery services, management and consulting services, and automotive services. Other good prospects are offered in fast food and hotels that have good brand recognition, and in personal items and fashion.
Legal Requirements
After several years of negotiations, Italy has signed a law regulating franchising activities. The Italian franchising law became effective on May 2004. An English version of the Ita
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