HUNGARY IS a modest-sized country with a population that has remained steady over the past decade at about 10 million people. Nearly 3 million of them live in Budapest, the capital. Although served by the Danube River, Hungary is landlocked in the middle of Europe.
And yet, despite what some might see as serious handicaps, the country has managed to stake out an important global role in both the chemical and pharmaceutical sectors.
To do so has required leaders in these industries to overcome the legacy of 50 years of a centrally planned communist economy and the collapse of that economy, along with the old socialist regime, in 1989. Sales slumped dramatically when guaranteed markets and trading partners vanished, but since then there has been a gradual rebuilding of a more competitive industry.
"We have gone through a serious restructuring," says Árpád Olvasó, chief executive officer of petrochemical giant TVK and president of Mavesz, the Hungarian chemical industry association. "Fifteen years ago, practically the entire industry was bankrupt. When we came out of the trough, we generated enough cash to invest in assets that are competitive" and can match assets elsewhere in Europe in technology and size, he says. "Privatization has been completed—all the big players are privatized. That's healthy. Government should govern the country, not the companies."
Hungary's chemical sales reflect this new competitiveness. They are expected to come in at $8.3 billion in 2007, up from $7.7 billion in 2006. And the pharmaceutical sector is expected to report sales of $5.7 billion, up from about $5.2 billion in 2006.
Growth will again be strong this year, executives across the industry predict. Exports will continue to be important but so will domestic demand, in particular from sectors such as construction and automotive, which are being buoyed by foreign investment in the country.
In fact, things have picked up enough that employment in the chemical industry has stablilized. During the socialist era, the industry employed about 76,000 people, according to Iván Budai, director general of Mavesz. The number is now 30,000 people, reflecting 15 years of technology improvements and cuts in what had been bloated staffs. For a while, employment fell about 0.5% annually. But in 2006, Budai points out, the industry's employment numbers turned slightly upward.
The picture is not uniformly rosy, of course. There have been casualties along the way, particularly over the past five or six years as Hungary geared up to join the European Union in 2004.
For larger companies, the accession to the EU merely made official what was a de facto way of operating. "We had already developed close links to the European Union and removed barriers to trade, movement of capital, and so on," Olvasá says. "May 1, 2004, when we joined the EU, was only symbolic, especially for petrochemicals—we began open competition right after the collapse" of the socialist system, he adds.
However, he and Budai note that EU regulations controlling the agrochemical industry, in particular, hit small and medium-sized enterprises (SMEs) in Hungary that were unable to cover costs of registering their products. Unlike large Western agrochemical producers that could afford to withdraw some products rather than pay registration costs, many Hungarian SMEs were forced to go out of business.
ACCORDING TO BUDAI, "Before 1990, 20% of Hungary's chemicals production was of agrochemicals. Now there are only two small companies producing pesticides, and everything else is imported." Increased competition with the larger multinational firms took a toll as well, he adds.
And now, the industry is braced for a similar impact on its SMEs from the EU's REACH program, which went into effect in June to ensure the safety of chemicals by requiring them to be registered, evaluated, and officially authorized. "Even the most conservative estimate of the Hungarian chemical industry predicts that 20–30% of SMEs won't be able to finance the requirements for REACH," Budai frets.
Budai sees the business environment as particularly hostile to the country's chemical SMEs. "The overwhelming weight of multinationals and imports are very big challenges for SMEs now," he says.
He ticks off some of the problems confronting small companies. SMEs lack investment capital and have low profit margins. They have difficulty in recruiting a high-quality workforce and suffer most from the costs of regulation. Each year, he adds, several go bankrupt.
SMEs are only part of the chemical industry, however. Petrochemical producers are in robust health, and it is in this part of the Hungarian industry where companies are making their mark as pan-European players.
Hungary's petrochemical industry got its start through the former East bloc's Council for Mutual Economic Assistance, or Comecon. Under Comecon, each country was allocated areas of specialization from which it then supplied all members of the pact. One of Hungary's specialties was petrochemicals, including olefins, polyolefins, polyvinyl chloride, and, subsequently, fertilizers and man-made fibers.
Hungary's chemicals giant is TVK, a division of MOL, formerly a government-owned oil producer that is now publicly traded. TVK operates roughly 20% of the petrochemical capacity in Central Europe. It is the only regional producer of polypropylene and low- and high-density polyethylene.
The other major Hungarian petrochemical player is BorsodChem. Recently acquired by Europe-based private equity firm Permira, BorsodChem is a leading regional producer of polyvinyl chloride and the urethane precursors methylene diphenyl diisocyanate (MDI) and toluene diisocyanate (TDI).
TVK traces its roots to Tiszavid??ki Vegyi Kombinát, a company formed by the government in 1951 to build a new petrochemical complex in the Tisza River basin from scratch. TVK is currently in the midst of a $650 million development project to expand capacity at the site. Ethylene production capacity has been nearly doubled, and polyethylene and polypropylene capacity has increased.
Although Hungary's commodity chemical producers are successful, industry executives acknowledge that future growth will require more investment in R&D-intensive specialty chemicals. Currently, the chemical industry in Hungary spends about 1.5% of sales on R&D. The Hungarian government is trying to raise that spending, Secretary of State for International Economic Relations Ábel Garamhegyi told the European Chemical Industry Council's annual assembly in Budapest last October.
"We have R&D-related incentives—the more R&D, the less tax," he explained. "We want to focus on quality development and best value for money. Hungary is too small to run on quantity—we must focus on quality."
In fact, R&D is underpinning a drive by Hungarian chemical producers to move up the value-added chain.
A case in point is BorsodChem, which plans to be the largest European producer of TDI. It is building a world-scale TDI plant set to open by 2009, and it plans to build a comparably sized MDI plant to double capacity by 2010 or 2011. At the same time, BorsodChem aims to add value to its MDI and TDI through a move downstream into specialized urethane systems—all at a cost of some $750 million.
Increasing global demand for TDI allows BorsodChem to "exploit a unique opportunity to become the number one European producer of TDI," company CEO Kay Gugler said when presenting the strategic plan to shareholders in April 2006. According to the plan, by 2012 BorsodChem will be second only to Bayer among Europe's isocyanates players. The only clouds over the plan are the high energy costs that are handicapping all Hungarian industry and uncertainties following the company's acquisition by Permira.
ON A SMALLER SCALE, St. Louis-based Zoltek—founded by Hungarian expatriate Zsolt Rumy—is moving up the value chain by expanding a facility 30 miles west of Budapest with the aim of making it the world's largest carbon fiber plant.
The Hungarian government has kicked in roughly $14.5 million to Zoltek's Hungarian subsidiary to establish an R&D center and boost capacity for both carbon fiber and its acrylic fiber precursor. By the end of 2009, Zoltek expects its annual carbon fiber production in Hungary to reach 8,000 metric tons, up from a mere 800 tons at the beginning of 2005.
Zoltek got its start in Hungary in 1995 when it acquired the acrylic textile fiber maker Magyar Viscosa from the Hungarian government. Since then, Zoltek has made substantial investments to redirect the acrylic fiber to be a raw material for manufacturing carbon fiber. Today, Zoltek operates four carbon fiber production lines in Hungary.
Foreign investment is also helping to build a new foundation for chemistry in Hungary. Evonik Industries' chemicals unit, formerly known as Degussa, has long been well-placed on the value chain. Currently, the company is investing to underpin its operations in Kaba, where it makes the feed additive l-threonine. Annual production capacity will soon reach 20,000 metric tons.
Degussa had acquired the site, a lysine plant known as Agroferm, from Japan's Kyowa Hakko Kogyo in the spring of 2004. Hubert Wennemer, president of the feed additives business, explains that right from the beginning, "it was our intention to transform the former lysine production into a state-of-the-art l-threonine plant." Sigmar Eisele, president of Agroferm, adds that the conversion is a low-cost alternative to building a new plant.
As for the success of Hungary's pharmaceutical industry, László Buzás, director of the Hungarian Pharmaceutical Manufacturers Association (Magyosz), points to the country's skilled workforce. "We have a very good supply of people: Education has traditionally been good in Hungary in biology, chemistry, and similar sciences," Buzás says. As he sees it, the main problem facing the Hungarian drug industry is lack of capital to commercialize discoveries. That's why a company that has discovered a new compound has to find strategic alliances to develop it and launch it internationally, he says.
EXPORTS HAVE always been crucial to the Hungarian drug industry, Buzás points out. In 1990, according to Magyosz data, 57% of the country's $330 million in drug sales were exports. Exports began to shrink soon after the collapse of Eastern European markets. By 1996, however, the industry had begun regaining export markets. In 1997, exports accounted for 60% of the industry's $990 million in sales, and by 2006 they made up 70% of pharma sales of $5.19 billion.
By the end of the 1940s, all the country's drug companies and labs had been nationalized. Like petrochemicals, pharmaceuticals became a specialty of Hungary under Comecon agreements.
Those controlled market conditions gave the Hungarian industry expertise that it was later able to turn to its advantage. As Buz??s explains, companies were able to invest only limited amounts—typically 2-7% of revenues—in R&D. To develop an original molecule and launch it in developed countries, he says, local manufacturers had to cooperate with cash-rich Western companies, so a willingness to work with other companies became a part of the industry's culture.
Moreover, Hungary's process patent system spurred chemists to develop expertise in working out new production processes for drugs launched in countries by innovators who had patented their own processes."These reproduction developments required high-level knowledge of synthetic chemistry, as researchers had to find independent manufacturing processes," Buzás points out.
Following the collapse of the socialist regimes in the region, however, the Hungarian industry emerged into the highly competitive world of international pharma. The country changed its patent system to reflect EU standards. And privatization has been a key element underpinning modernization, Buzás says. Now, all of the country's top six drug companies either have foreign investors or are majority owned by foreign companies. The rest of the industry is made up of about a dozen small companies. They are dynamically growing, he says, but account for only about 5% of the industry's sales.
Buz??s is convinced that foreign investment encourages pharmaceutical and fine chemicals R&D. At least one foreign investor, Albany Molecular Research Inc. (AMRI), would vouch for that. In 2006, the Albany, N.Y.-based contract chemistry research firm acquired the Budapest-based ComGenex, which was founded in 1992 to specialize in compound-library generation, combinatorial chemistry, and similar services.
ComGenex, now called AMRI Hungary, is being led by Michael A. Guaciaro, an AMRI executive who moved to Budapest in 2006. "Hungary has a good reputation for chemistry-there is a broad-based supply of chemists here," he says. "To gain strategically a site in Europe was important to us to make us more visible to European customers." He adds that the company received no government incentives to support the purchase.
Although Hungary is part of the EU, Philip W. Small, AMRI's director of chemistry, points out that it is a more cost-effective place to do business than the older EU members. "A custom library business has to be economically viable, as you are competing with low-cost countries in Eastern Europe, Russia, and Asia. And contract research organizations in the U.S. and the U.K. had found it increasingly difficult to compete with companies like ComGenex given their low-cost structure," he says.
GUACIARO ADDS that AMRI is expanding R&D at its new labs with Hungarian chemists. "We just hired a senior chemist who had done his postdoc in France and came back," he notes. "Being part of the EU makes it easier for young people to leave and do postdocs. There is no guarantee they will come back, but it seems most do. And the supply of people seems to be good." He notes that AMRI has boosted its Ph.D. density in Hungary from 16% of the staff to close to 30%. All the added Ph.D.s are Hungarian.
That kind of news pleases people at Mavesz. During the past two decades, the chemical industry lost its prestige in Hungary, Budai concedes, but he sees the situation stabilizing. "Colleges and universities report that more young people are interested in chemistry. We must get across the message that this is a stable industry, and important. It's 17% of the manufacturing output of the country. We can offer a stable career for young people."
Such a change could not happen fast enough to suit Olvasó, a chemical engineer. "Hungary is producing fewer and fewer engineers," he worries. "For now, the industry is suffering. New graduates don't want to come to the industry to work, or it is difficult to keep them within the companies. I know five new colleagues—very good engineers—who left TVK to join international companies as salespeople. There is a real threat that the good people will be poached by global competitors."
A stable career, good pay, and an industry respected by society-that's a prescription for securing the future that could apply around the world. After all the obstacles it has overcome in the past 20 years, the Hungarian pharmaceutical and chemical industries may be leading the way in implementing that prescription.